Federal Reserve Bank or System?
Last week will go down in history as one of the most tumultuous weeks in financial history. History was made and precedents were set and no where will the effects last longer than in the Federal Reserve System. The Federal Reserve System was set up in 1913 in order to create a method for which the government could have a hand in controlling money supply.
The Federal Reserve achieves its goals through its member banks which require all chartered banks to contribute capital to the Federal Reserve as well as co-operate with reserve requirements, the amount a depository institution must deposit to the Fed as a percentage of assets. The money contributed to this pool is used to backstop the financial commitments of all member banks and, more generally, the financial markets as whole. At the time that the Federal Reserve System was created, much of the world’s liquidty flowed through commercial banks and, as a result, monetary policy changes enacted by various Fed means would typically flow through the rest of the markets.
Unfortunately, with the Gramm-Leach-Bliley Act in 1999 and the resulting intertwining of investment banks, insurance companies, and traditional depository commercial banks, our financial system has become that much more complex and has fored the Fed to act in ever expanding ways. As we’ve seen over the last few months, the Fed has now begun using its funds to backstop prime brokers and buy out insurance companies. But, how is it doing so? With the contributed capital of the nations banks. Money that anyone with a savings account is contributing. It’s being put to risk, not to provide liquidity to the system of commercial banks in the US, but to create a market for risky assets and prop up financial institutions that ought never to have been able to wreak so much havoc on the average citizen.
The question going forward now becomes, where do we go from here? Is it really right that the commercial depository institutions of this nation are lending their money to hold up the whole system? Will we see an expansion of the Fed system to include prime brokers and insurance companies and maybe even hedge fund in the future? And, if so, will this come with increasing government oversight in our supposed free markets? What we do know is that the system as it was created cannot continue as it was.
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