Until the recession became the top story in the news, most Americans had no clue about the Federal Reserve Bank.
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Is it a private institution or it part of the government?
Does it oversee the nation’s banks or merely serve their interests?
Is it beholden only to the Wall Street power brokers? Or does it perform a larger purpose in protecting the integrity of the dollar and our entire financial system?
The correct answer is … yes.
By definition, the Federal Reserve Bank is a quasi-public and quasi-private banking entity. Better known as The Fed, its origin dates back to the administration of Woodrow Wilson and the Federal Reserve Act of 1913.
Steeped in Anonymity
The Fed’s Board of Governors and Chairman are Presidentially appointed. Each must be confirmed by the U.S. Senate.
It has 12 regional branches in major cities that act as fiscal agents of the U.S. government. Private U.S. member banks subscribe to required amounts of non-transferable stock in The Fed as a condition of participating in its reserve system.
Ben Bernanke is currently the top dog at The Fed. The legendary Alan Greenspan preceded him as the last Fed Chairman.
Even though The Fed has been around for nearly a century, adding stability to the banking system while acting as the de facto controller of the currency, unless and until there is a financial crisis, the central bank operates in relative anonymity.
Since the financial crisis captured headlines, however, The Fed and its Chairman have been more visible than ever. While the President may hold the bully pulpit, make no mistake, the economy has been taking its cues from Chairman Bernanke and The Fed.
In his attempt to yank the economy out of its worst crisis since World War II, Bernanke has been a man possessed. It's as if he werjuggling chainsaws, alligators and golf clubs.
Over the past year, The Fed has pumped more than $1 trillion into the banking system through bond purchases and emergency loans, doubling the assets on its balance sheet. Nobody really knows how The Fed can keep doing what it’s doing; but somehow, it just keeps doing it.
To date, The Fed has expanded credit through increased loans to banks to provide liquidity and rescues of financial companies such as American International Group Inc. It also has begun market backstops such as the Commercial Paper Funding Facility, which holds $109.2 billion in short-term IOUs issued by corporations, and the Term Asset-Backed Securities Loan Facility, which has lent $24.9 billion to investors to buy securities tied to auto, and other consumer and business loans.
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The Fed also has pledged to buy $1.75 trillion in mortgage- backed securities, Treasury notes, and federal housing agency bonds. As of July 9, the Fed had bought $200.7 billion of Treasuries.
While The Fed is not legally subject to an audit of its books, its Chairman is required to appear twice yearly before Congress to report progress on its efforts to keep stable prices and maximize employment.
What Strategy? Mr. Chair
With The Fed having taken a wider role than ever in the economy, Bernanke and his bank are going to be under the lens of the Congressional microscope. During the course of Bernanke’s upcoming testimony, all of the bank’s actions in response to the crisis will be painstakingly dissected and scrutinized.
Bernanke’s preamble to Congress is likely to include the description of an economy still reeling from the credit crisis that began in 2007 and intensified after Lehman Brothers Holdings Inc. filed for bankruptcy in September. He will lament the loss of 6.5 million jobs that has compelled the central bank to keep pumping money into the economy even after cutting the effective benchmark interest rate to zero.
But of particular interest to Congress will be The Fed’s growing portfolio and the broad intervention it has taken in areas that seem to be outside its charter. On top of that, Congress will press Bernanke on details of the course he has plotted to keep both the economy and his bank afloat.
Members of Congress will want to know where it will all end. Can The Fed continue holding the lid on interest rates while it forks out billions without risking the kind of hyper-inflation that paralyzed the economy during last major financial crisis in the late 1970s.
The growing uncertainty about The Fed and its ability to maintain ballast in the economy has been reflected not only the recent persistent decline in stock prices but also the rapidly expanding purchases of Treasuries despite their falling yield.
With all of these issues in the mix, Bernanke will be under more pressure than any of his predecessors to wring clarity out of the chaos. So far, Bernanke has been up to the task.
But there comes a point, where even the best jugglers risk losing a finger.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
