The Federal Reserve:
Predators in the Guise of Technocrats
by Stoney Bird
This is the eleventh in a continuing series of articles that began with the January 2014 issue. The series is an attempt to address some of the impediments to democracy in American society. Earlier articles covered the Lewis Powell memorandum, the Constitution, the electoral system, and the job system — all of which have contributed to our system of unrepresentative and plutocratic government. Stoney Bird is a retired corporate lawyer working on understanding how the system really works. It doesn’t work the way we were told in the fifth grade. Indeed much of it that is crucial we never hear of despite long years of “education” and any number of hours tuned in to the corporate media.
“The Board … shall maintain long run growth of the monetary and credit aggregates … so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
— Section 225a of the Federal Reserve Act1
“[A] central bank, captured by the financial sector, is going to make decisions that represent the beliefs and interests of the financial sector. …[A] central bank’s decisions are essentially political; they should not be delegated to technocrats and they certainly can’t be left to those who disproportionately represent one of the vested interests.”
— Joseph Stiglitz, Nobel Prize Winner in Economics2
The “Progressive” Era
It is commonly thought that in the first two decades of the twentieth century there was a great surge of public outcry against the power of the wealthy and that the government responded. There was indeed a great deal of new legislation, but the effect of it was not what people thought — then or even later. Revisionist historian Gabriel Kolko has shown that the new regulatory regimes were only adopted if acceptable to the industries being regulated.3,4 Indeed it was those very industries who were often the strongest advocates for the system of regulation.
The Federal Reserve, formed in 1913, is a prime example. In November 1910, six representatives of the Rockefeller, Morgan and Kuhn, Loeb banking interests boarded a private rail car in Hoboken, NJ, and proceeded to a private club on Jekyll Island, GA, of which J.P. Morgan was a member. They attempted to maintain complete secrecy as to their identities and the fact that they were meeting. An alert journalist discovered their meeting, but he was told they were “duck hunting.”
What was really happening was this — the bankers were discussing Paul Warburg’s draft bill to establish a central bank. The ins and outs of the campaign to adopt the bill matter less than the fact that the bankers got what they wanted. Newly-elected President Woodrow Wilson signed the bill into law in 1913. In August 1913, A. Barton Hepburn of the Chase National Bank told the American Bankers Association at its annual meeting: “The measure recognizes and adopts the principles of a central bank. Indeed … it will make all incorporated banks together joint owners of a central dominating power.”5
The bankers — particularly the big Wall Street banks — had lobbied for and gotten a cartel.
What They Set Up
The Fed is a curious amalgam of public and private features, but in the end the Fed operates in a practical sense outside the control of our elected representatives.6 The President does appoint the members of the Board with the advice and consent of the Senate. But there it ends, and even there presidents are careful to make sure their nominees are acceptable to the financial community, who in a practical sense exercise a veto.7
That’s about it for public control. The members of the Board serve for 14-year staggered terms, so their terms of office outlast those of the President and most members of Congress and the Senate. The Fed devises its own budget, independent of Congress. It controls its own revenue (mostly interest on Government securities that the Fed issues), also independent of Congress. It is free to make its decisions about the money system, that key factor in public and private well-being, again independent of any elected authority.8
Elected officials have theoretical control, but as a practical matter they don’t exercise it. Section 10 of the Federal Reserve Act states that the President can remove any member of the Board “for cause.” I have found no instance where this has ever been done. In any event, “cause” most likely doesn’t relate to disagreements about Fed policy. The Fed also is required to report to Congress twice a year, and Congress has the right to audit the Fed.
More fundamentally, Congress could simply amend the Federal Reserve Act — or repeal it, disbanding the central bank entirely. In fact, over the years, there have been numerous bills in Congress to do these things, but they have never garnered the votes to be passed.9 When it comes to it, according to Greider, the members of Congress are happy to have someone else attend to all those difficult technical questions, not to speak of taking the heat when there is pain to be born as a result of the Fed’s decisions. 10
Many important decisions are made by the Fed’s Federal Open Market Committee (FOMC).11 The FOMC is the body that decides how interest rates are going to go.12 In setting interest rates, the Fed has power to do well by people in general or to benefit people who are already rich. These are intrinsically political decisions. The Fed’s abstractions do not acknowledge this.
The Volker Fed
To pick just one example, under Paul Volker’s chair-manship in the early 1980s, the Fed raised the prime rate as high as 21 percent and kept interest rates high through the decade, causing what many reckon to have been an economic catastrophe: 13
• 66,000 mostly small firms were forced to seek bankruptcy protection. An additional 24,900 were straight out “business failures,” in the expression used by Dun & Bradstreet, meaning that they permanently closed their doors, and creditors had to write off loans worth $15.6 billion.
• Economic output dropped by $570 billion, according to the Urban Institute. 59 percent of the loss was absorbed by workers, 12 million of whom were unemployed at the peak in December 1982. Of those, only 4.4 million had unemployment benefits.
• The lower folks were in the economic pyramid, the more likely they were to suffer. People lost their jobs, their houses, their families, their health, and sometimes even their lives. There was a spike in suicides. For the rich, the recession meant perhaps less growth of their wealth and income but no significant loss in material circumstances.
• One of the consequences of the high interest rates was a reallocation of income and wealth from the poor and middle class to the rich. The rich were the holders of the financial assets like bonds on which the interest was being paid, and out of which the high-interest loans were being made. Interest income in 1982 was $366 billion, roughly equal to the $374 billion in explicit income distribution programs like Social Security, veterans’ benefits and welfare. $148 billion of this was extra income to the holders of financial assets, i.e., the wealthy. It was income they would not have had if interest rates had not risen. The Fed’s rhetoric at the time was all about beating inflation, but its weapon of choice (high interest) also produced this vast transfer of wealth.
• The wreckage and the reallocation of income to the rich also happened internationally. This was the era of the “Washington Consensus” and the IMF imposed “structural adjustment” measures on Third World countries. With the new high interest rates, many countries could no longer keep up interest payments and were forced to increase their debt levels to pay the interest on the previous debt. At the IMF, the “sacred debt contract” took precedence over all other obligations, and many countries were forced to sacrifice much of their education and health care systems, not to speak of investments in infrastructure.
The public discussion of all this used the oblique abstractions that the Federal Reserve favored — “sound money” and taking the “pain” now to prevent worse in the future. The real human cost didn’t factor, or was ignored. The transfer of billions in wealth and income barely touched public consciousness at all.
In other words, an unelected and essentially unaccountable and bank-controlled agency made decisions that affected the lives of everyone in the United States, which prides itself — in public — on being a democratic republic.
The public had then and has now little understanding of how the Fed works and the effect of its actions. What’s even more striking, the public more or less passively took the pain. The contrast with the knowledge and engagement of the dirt-farmer Populists 130 years ago is extreme.14, 15
Since 1988, when Alan Greenspan was appointed to the chairmanship of the Fed, the story has stayed largely unchanged.16 The means have varied from time to time, but the end result has always been the same: more and more wealth to the wealthy, less and less wealth to the poor and middle class and a greater and greater sense of ill-being for all.
The transfers were hard to distinguish from taxes paid to the rich in their effect, although since the mechanisms for their occurrence took place behind closed doors (and you didn’t have to fill out a tax return, with the banking cartel as payee), what was happening was obscured from ordinary people. That the corporate media essentially parroted the Fed’s policy line didn’t help.
During the Greenspan-Bernanke years, the Fed became a decisive advocate for not regulating derivatives. These were “creative” new securities that took conventional mortgages from local savings and loans, packaged them all together with others that were highly risky, and claimed that overall risk was negligible. Apart from anything else the local bank was relieved of the risk in making loans, so it jumped in where it never would have in the past. And the commissions! You should have seen the commissions! To cap it all, Bernanke succeeded in having these gambling contracts guaranteed by the Federal Deposit Insurance Corporation.
Greenspan also lobbied for repeal of the Glass-Steagall Act, the 1930s Depression-era legislation which required insurance companies, commercial banks and investment banks to each have separate ownership. Repeal allowed the gambling mentality of the investment banks to infect the stolid (and relatively secure) business of commercial loans and insurance, and the Fed has now allowed the banks to trade in commodities on their own account. These include metals, mines and oil17
It also allowed abusive credit card fee practices. It failed to temper the housing bubble by not requiring, as it could have, larger down payments and stricter lending standards or disciplining banks for predatory lending practices. It allowed the banks and other financial institutions to merge willy-nilly, creating numerous internal conflicts of interest (for example, between the investment banking arm, trying to sell a new issue of securities for a client, and the commercial lending unit, which knew that the client was in bad straits), and both explicitly and implicitly aiding in the formation of the “too-big-to-fail” idea.
The Fed could have clamped down on outsize executive bonuses during the crash and before. It could have required those bonuses be tied to the long-term results of investments. It did neither. It refused to disclose information about its various rescue programs or — in its supervisory role — what it was discovering about the condition of the banks that it was examining. This failure to disclose greatly harmed bank investors and the public.
It currently maintains the basic interest rate it charges the big banks at barely above zero, which is just another subsidy, since the banks can lend it out at 4 percent, if not a great deal more. With government debt now in the trillions, this part of the subsidy alone is in the tens of billions.
All of these subsidies could have been balanced by adequate taxes, both on the banks themselves and on their super-wealthy employees and owners. In late 2009, the Obama administration discussed the possibility of a “financial crisis responsibility fee” levied on the 50 or so largest banks18 meant to cover any losses in the bail-out program. The big banks stood against it, and the proposal was withdrawn. A tax on bank executives or their bonuses never even reached that level of consideration. To my knowledge the Fed stood silent.
Taking on the Predators
As this article has shown — and as many others have said — the Federal Reserve Board is a renegade agency. Like Congress and many other agencies, it acts in the interests of the few (that it is ostensibly there to rein in) and against the interests of the many. It’s possible that while most of what it does is not against the law, it is in fact operating contrary to the public interest. Not only has it made life a far more anxious proposition for lower income and the middle class folks, but its policies that siphoned off wealth and income to the few has stifled the overall growth in the economy. We won’t go into what the money spree mentality has done to the natural world on which our lives depend.
As citizens of a democratic republic, Americans are responsible for their own government and have the right to exercise that responsibility. Few aspects of our lives are more central to the well-being of the republic and its citizens than the management of the money system. We not only have the responsibility to manage it — we have the power. Our job is to organize it. And we’re all responsible for that, too.
So what are some specific measures that might right the ship in which we are all sailing? I name these fully understanding the political barriers standing in their way. Still, without some aims, how are we going to know even which direction to go in? If I had the space, the list would reach up and down this page, and probably a few others. In the meantime, here are a few.
- Learn about the operations of the Fed. Greider’s book is an excellent place to start, though long. And you can’t do this by paying attention to any of the corporate media (TV, radio, newspapers, magazines), except to some extent on the financial and business pages.
- Put the Fed under active control of elected officials, as the central banks of nearly all other countries are.
- Remove special favors under the Federal Reserve System that advantage the biggest banks.
- Adopt the Tobin tax on financial transactions.
- Readopt the Glass-Steagall Act (which prohibited commercial banks, investment banks, and insurance companies from having interests in one another).
- Readopt the ban on usury.
- Close offshore tax havens for banks, corporations and the wealthy.
- Reinstitute a progressive income tax system, paying particular attention to capital gains.
- Cap executive salaries and bonuses either straight out or by taxation.
- 1Break up the biggest banks.
- 1Get rid of the student debt regime.
- 1Encourage labor organizing and reform efforts.
- Give tax credits for political contributions and charitable contributions below a certain amount.
- 1Require a living wage for all workers and a basic income for all adults so that people in general will have time and energy to put into the work of being a citizen in a democratic republic.
Well, I’ve barely scratched the surface, but that’s enough for now. The point is that we have a lot of work to do, and we all have to get together to get it done.
Participants in the Jekyll Island Retreat
The creators of the proposal on which the Federal Reserve Act is based.
• Nelson Aldrich — Senator from Rhode Island, Father-in-law of John D. Rockefeller, Jr.
• Arthur Shelton — Aldrich’s private secretary
• Henry Davison, J. P. Morgan partner
• Frank Vanderlip, Vice-President of National City Bank in New York, a Rockefeller bank
• A. Piatt Andrew — Professor of Economics at Harvard, Co-Chair of the National Monetary Commission, and Secretary of the Treasury under President William Howard Taft
• Paul Warburg — partner in Kuhn, Loeb and Co., investment bankers
From the Opening Paragraphs of “Secrets of the Temple”
The obscured role of the Federal Reserve in governing the U.S.A:
“In the American system, citizens were taught that the transfer of political power accompanied elections, formal events when citizens made orderly choices about who shall govern….
“The American system depended on deeper transactions than elections. It provided another mechanism of government, beyond the reach of the popular vote, one that managed the continuing conflicts of democratic capitalism….
“Citizens were taught that [the Fed’s] activities were mechanical and nonpolitical, unaffected by the self-interested pressures of competing economic groups, and its pervasive influence over American life was largely ignored by the continuing political debate.…
“The Federal Reserve was the crucial anomaly at the very core of representative democracy, an uncomfortable contradiction with the civic mythology of self-government…. The governors of the Federal Reserve decided the largest questions of the political economy, including who shall prosper and who shall fail, yet their role remained opaque and mysterious. The Federal Reserve was shielded from scrutiny partly by its own official secrecy, but also by the curious ignorance of the American public.”
— William Greider, “Secrets of the Temple,” pp. 11-12
- Greider, William, “Secrets of the Temple: How the Federal Reserve Runs the Country,” Simon & Schuster, 1987
- Kolko, Gabriel, “The Triumph of Conservatism: A Re-interpretation of American History,” 1900-1916, New York, NY: The Free Press, 1963.
- Kolko, Gabriel, “Railroads and Regulation, 1877–1916.” Princeton, NJ: Princeton University Press. 1965.
- Morgenson, Gretchen, “The Week That Shook the Fed,” The New York Times, 22 November, 2014, http://www.nytimes.com/2014/11/23/business/the-week-that-shook-the-fed.html?ref=topics&_r=0
- Rothbard, Murray, “The Origins of the Federal Reserve,” Quarterly Journal of Austrian Economics, Volume 2, No. 3 (Fall 1999), http://mises.org/library/origins-federal-reserve- viewed Feb 25, 2015.
- Stiglitz, Joseph, “The Price of Inequality: How Today’s Divided Society Endangers Our Future,” W. W. Norton & Co., 2013.
- 12 U.S. Code § 225a
- Stiglitz, p. 317, 318.
- A major actual advance was the Constitutional amendment allowing the income tax.
- For the account that follows, I am indebted to Murray Rothbard’s monograph referred to in the bibliography.
- Quoted in Kolko, p. 235.
- The status of the Fed is so ambiguous that in the 40s, the Assessor of Washington, DC, actually attempted to auction off the Fed’s headquarters, saying that it was private property and they were delinquent in paying property taxes. This loggerhead was finally released when all twelve of the regional Federal Reserve Presidents signed quitclaim deeds to the Government. This story appears in William Greider’s massive and definitive study of the operations of the Fed, at p. 49.
- One example of this control over Federal Reserve Board nominees is Peter Diamond, a Nobel Prize winning economist, whose nomination to the Board was defeated in 2011 because he believed the Fed’s policies should focus more on unemployment. Stiglitz, p. 407.
- Other than the United States, only Germany has a central bank that is unaccountable to elected authority. Greider, p. 51.
- Congressman Wright Patman of Texas, who served for many years as chair of the House Banking Committee, was one of those who introduced reform legislation year after year. After Patman’s death in the 70s, others took up the cudgel. None of these passed except for a 1978 bill that allowed Congress to audit the Fed’s books. Greider, p. 51.
- I recall that Greider made these points, but cannot now find the exact citation.
- This body is composed of the seven members of the Board, together with five of the regional Federal Reserve Bank Presidents. One of the five is always the President of the New York Fed. The other four positions rotate every year among the remaining eleven regional Federal Reserve Banks.
- These mechanics are described in numerous places, including Greider’s Chapter 2, “In the Temple,” an excellent Wikipedia article (http://en.wikipedia.org/wiki/Federal_Reserve_System#Tools) and the Federal Reserve’s own website (http://www.federalreserve.gov/default.htm.)
- The statistics that follow can be found in Greider’s chapter entitled “The Slaughter of the Innocents”, beginning on p. 450.
- See my article entitled “An Election System for Whatcom County: Results Not Predetermined by the Redistricters,” in the February 2015 issue of Whatcom Watch, http://www.whatcomwatch.org/php/WW_open.php?id=1816. The web edition is somewhat revised from the print edition of the article, and includes a table that the print edition did not include.
- In another article, we’ll look into the role of the corporate media in preserving the people’s ignorance in this sphere, as well as in many others.
- For the following paragraphs, I am relying to a great extent on the Stiglitz book referred to in the bibliography, particularly his Chapter Nine, entitled “A Macroeconomic Policy By and For the 1 Percent.” Joseph Stiglitz is a former Senior Vice President and Chief Economist of the World Bank and is a former member and Chairman of the President Clinton’s Council of Economic Advisers. He won the Nobel Prize in Economics in 2001 for his work on “screening”, by which some participants in a market have greater access to information than others, distorting the operation of the “free” market.
- See the Morgenson article.
- Calmes, Jackie, Taxing Banks for the Bailout, The New York Times, January 14, 2010, http://www.nytimes.com/2010/01/15/us/15tax.html?pagewanted=all viewed March 11, 2015.