By Jonny Lupsha, Wondrium Staff Writer
The U.S. Federal Reserve restricted top officials’ stock trading last week. The restrictions were imposed just weeks after two regional bank presidents resigned amid accusations of insider trading. The Fed has a storied and turbulent history.
On Thursday, the U.S. Federal Reserve imposed new rules and restrictions on its top officials regarding individual stock trading and other investment actions. The action is the result of a recent controversy surrounding two of the 12 regional Federal Reserve bank presidents, who resigned in light of their active stock trading in 2020 being made public. The reports set off a series of accusations of ethics breaches which culminated in Senator Elizabeth Warren (D-MA) calling for an insider trading investigation of the Fed.
However, despite the fact that the Federal Reserve has existed for more than two centuries, many are still unclear on what the Fed does. In his video series International Economic Institutions: Globalism vs. Nationalism, Dr. Ramon DeGennaro, CBA Professor in Banking and Finance at The University of Tennessee, Knoxville, clarified how its first incarnation rose and fell.
An Institution of Mixed Success
“As long as there have been banks, there have been problems with banks—the Federal Reserve System, or the Fed for short, was founded to solve, or at least reduce, the frequency and severity of those problems,” Dr. DeGennaro said. “The Fed is a big, big institution; it includes the Board of Governors, the Federal Open Market Committee, 12 Federal Reserve Banks, more than 20 branches, and several advisory committees.
“In short, the Fed is the central bank of the United States, and being the central bank of a big, big country—like the United States—is a big, big job.”
According to Dr. DeGennaro, the Fed’s job is to ensure stable economic growth, low inflation, and healthy employment, which has had mixed success. In fact, the modern Fed is the United States’ third attempt at a central bank, the first two of which failed. So what does it do?
“The idea is that the Fed would lend freely, at a penalty interest rate, and against good collateral from sound banks with temporary liquidity problems,” Dr. DeGennaro said. “To make sure the Fed recovers the money it lends, it gets collateral to make good on the loans in the event the borrower can’t repay with cash. Sound banks have such collateral.”
Compared to most of Europe, the United States came to central banking quite a bit later. Americans were still wary of centralized power after the Revolutionary War, feeling that centralization led to corruption. However, centralized banking had a persuasive proponent.
The Room Where It Happened
“After the Revolutionary War, Alexander Hamilton became the point person for supporters of a central bank,” Dr. DeGennaro said. “Hamilton argued the new nation needed a national bank to lubricate the flow of credit—no economic law keeps 13 states from issuing 13 different currencies, but that does make transactions across state lines a little more difficult.
“Think of converting Canadian dollars to U.S. dollars without the convenience of high-speed computers.”
Obviously a single national currency would make things far easier. The Fed could issue a single paper currency. Of course, many government officials opposed the idea, chief among them Thomas Jefferson. Jefferson worried that a central bank would concentrate too much power into a small amount of hands, essentially rendering the United States into an oligarchy. However, Hamilton came out on top.
“In 1791, President George Washington signed a bill granting a 20-year charter to the First Bank of the United States, located in Carpenters’ Hall, in what is now Philadelphia’s Historic District,” Dr. DeGennaro said. “The First Bank served as the U.S. government’s fiscal agent. It received revenues, held deposits, and made payments; it also offered services to individuals.”
Unfortunately, international interests and domestic conflicts crippled and ultimately killed off the central bank’s first iteration. After a lukewarm reboot of the Fed, Andrew Jackson successfully ran a political campaign to defund the second bank in 1833. This allowed it to stagnate and die by 1836. The third and current central bank wouldn’t be founded until 1913 under President Woodrow Wilson.