The Clinton Herald, Clinton, Iowa

National News

December 24, 2013

5 ways Fed's influence has expanded over 100 years

WASHINGTON, D.C. — The press called it an early Christmas present for President Woodrow Wilson: On Dec. 23, 1913, Congress passed legislation creating the Federal Reserve. Hours later, Wilson signed the Federal Reserve Act into law.

No one at the White House ceremony that day could foresee what the Fed has become: A titanic institution with power over people and economies worldwide. Its actions shape loan rates and job growth. They affect trade, stock prices, bank rules, financial systems. Economic decisions are made with the Fed in mind. Retirement savings hinge on its policies.

"If Woodrow Wilson and the other architects of the Federal Reserve could have known how powerful it would become, they would have been shocked," said Sung Won Sohn, an economics professor at California State University Channel Islands. "There is no part of the global economy today which is not affected by actions of the Federal Reserve."

Supporters of the 1913 bill were responding to a spate of banking panics. Depositor runs were causing bank failures. Recessions often followed. An especially severe panic struck in 1907. Without a central bank, financier J.P. Morgan had to intervene to save the financial system.

Five years ago, when the financial meltdown struck, the Fed expanded its reach. Its response to the worst such crisis since the 1930s was to ease credit, print money and boost confidence.

"If you are a central banker with the power to print money and the willingness to use that power, it gets the attention of financial markets," said David Jones, author of a forthcoming history of the Fed. "The Fed has grown into this colossus which is basically a fourth branch of government."

Here are five ways the Fed has expanded its influence over the past century:

DISCOUNT WINDOW

When the Fed was created, the "discount window" was its main tool. When commercial banks in the Fed system fell short of money, they could borrow from one of 12 regional Fed banks. This became a vital Fed role: Lender of last resort.

The discount window gained vast significance during the financial crisis. Hundreds of banks, including some of the biggest, borrowed from it. The Fed supplied trillions in loans — to U.S. banks and foreign banks with U.S. subsidiaries.

That effort, along with a rescue fund approved by Congress, helped save the financial system. But the 2010 Dodd-Frank financial overhaul law restricted the Fed's ability to give emergency aid to non-banks like insurance giant American International Group, which got billions. The Fed would now need the Treasury secretary's approval. And the support couldn't be directed to a single company.

SHORT-TERM RATE

This is the Fed's main lever to influence the economy. It was discovered almost by accident about a decade after the Fed's creation. The Fed found it could influence short-term rates by buying and selling Treasurys that banks hold as reserves. The Fed was slow to exploit this power during the Depression, when it could have delivered a desperately needed economic jolt.

The Fed uses short-term rates to meet its dual mandate: Maximizing employment and stabilizing prices.

To lower rates, it creates money and uses it to buy bonds from banks. The banks can use the reserves to make loans. To raise rates, the Fed does the reverse: It sells Treasurys to banks and takes money out of circulation. Rates rise.

The Fed last week strengthened its commitment to low short-term rates. It said it would likely keep its benchmark rate at a record low near zero "well past" the time unemployment falls below 6.5 percent from the current 7 percent.

BOND PURCHASES

Since the Fed can't lower its short-term rate below zero, it's taken other steps to spur growth. Starting in 2009, it's been buying Treasurys and mortgage bonds in a program never tried before on such a scale.

The idea is to lower long-term loan rates to stimulate borrowing and spending. The Fed's bond buying has swollen its investment portfolio to a record $4 trillion. The purchases have helped keep long-term rates low. But they've incited critics who fear the Fed is inflating bubbles in assets from stocks to farmland.

Last week, the Fed said it will slow its monthly purchases from $85 billion a month to $75 billion.

GREATER OPENNESS

The Fed has tried to assure investors that short-term rates will stay low even after unemployment falls further. This assurance is part of its effort to be more publicly transparent. The Fed had long guarded its operations closely. Until the 1990s, it didn't even announce when it changed short-term rates.

Starting with Bernanke's predecessor, Alan Greenspan, the Fed became more open. It began releasing statements after each meeting to explain what it had done and why.

Bernanke went much further. He updated economic forecasts more frequently. He became the first chairman to hold quarterly news conferences. He sat for TV interviews and held town-hall meetings. Some critics felt the Fed limited its flexibility by speaking too explicitly about its plans.

POLITICAL INDEPENDENCE

Congress has sought to insulate the Fed from political meddling to preserve its independence. Yet the Fed has become a target for critics because of the unorthodox steps it's taken over the past five years. Some Republicans think it isn't accountable enough.

House Financial Services Committee Chairman Jeb Hensarling, R-Texas, plans to review whether changes should be made to the Fed's operations — especially, Hensarling argues, because "the Fed has either implicitly or explicitly assumed so many mandates and has, historically, been subject to little or no congressional oversight."

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