Clarifying the relationship between federal reserve banks and the Board of Governors: United States v Wells Fargo …

United States v Wells Fargo (Docket No. 18-1746) was a case argued in the United States Court of Appeals in the Second Circuit. While the case centered on whether funds borrowed by Wells Fargo from the Federal Reserve Bank of New York should be treated as a claim under the Fraudulent Claims Act, what stood out for me was the philosophy behind the role of federal reserve banks. The governance of money in the United States is a hybrid public-private partnership with the private banks, in my opinion, carrying the load.

The role of federal reserve banks

In describing the role of the federal reserve banks, the court makes it clear that the twelve federal reserve banks are not a part of the government. They are private banks chartered by the Congress via passage of the Federal Reserve Act of 1913. They are in effect private corporations and not a part of any government agency.

Although they are private corporations, they are not operated for profit. Rather, as instrumentalities of national policy, they play a role in managing the nation’s money supply. They are authorized to lend money to commercial institutions via their discount window and other lending facilities. They are, as I like to put it, resellers of the government’s currency.

Federal reserve banks, according to the court, “serve the interest of, but stand apart from, the sovereign.”

Where do the Board of Governors fit

While not a part of a government agency, they are subject to the oversight of the Board of Governors of the Federal Reserve System, an independent government agency described, by the court, as being within the executive branch.

The court’s view that the Board of Governors was located inside the Executive branch took me for a loop. The standard “School House Rock” view of the Executive is that branch of government that ensures the laws of the land are carried out.

One could make the argument that the Board of Governors have been designated by Congress as the agency responsible for executing the Federal Reserve Act and the Act’s primary policy of money supply management. The court could have been a bit clearer since putting the Board of Governors in the Executive branch implies direct control of the Federal Reserve System by the constitutional head of the government, the President of the United States. For now, subject to some additional statutory checks, we will view the Board of Governors as part of the executive to illustrate the connection between it, the federal reserve banks, and national banking policy.

Tethering the Board of Governors and federal reserve banks

The Federal reserve banks are tethered to national monetary policy via the regulatory and supervisory oversight of the Board of Governors. The Board of Governors’ dual mandate of maximum employment and stable prices is met by controlling the money supply via a number of monetary policy tools.

Three of the Board of Governor’s primary monetary policy tools: the discount window and rate, interest on bank reserves, and reserve requirements, are carried out by federal reserve banks.

For example, federal reserve banks operationalize monetary policy tools in a couple ways. The federal reserve banks lend funds to commercial banks through its discount window at a discount rate set by the Board of Governors. This lending typically occurs when a commercial bank cannot meet its reserve requirements or is unable to borrow reserves from other commercial banks.

The federal reserve banks pay an interest rate, set by the Board of Governors, on commercial bank reserves held by federal reserve banks. If the Board of Governors wished to reduce money supply in the financial system, increasing the interest rate on bank reserves could provide commercial banks an incentive to lend fewer dollars by keeping otherwise loanable funds in their vaults.

And where a commercial bank’s vault cash is insufficient to meet reserve requirements, the requirement may be met by maintaining a balance in an account with a federal reserve bank.

Conclusion

Congress has seen it fit since the early days of the Republic to leave the governance of money in private hands. The court noted that this governance has been carried out by a “subtle and conscious balance of public and private elements.”

Evidence that this balance is being met mostly by private players is evidenced by the heavy operational lift carried out by private federal reserve banks and commercial banks. Throw in the trade of foreign currencies in the interbank market where exchange rates are set by trading desks and you see the balance tilt toward the private portion of the hybrid relationship.

Makes me wonder if a broader niche could be created for digital money in private hands.

Alton Drew

4 October 2022

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Disclaimer: This blog post should not be construed as legal advice or an agreement to provide legal or political analysis.  To set up a consultation, contact us at altondrew@altondrew.com.