Who Owns the Fed?

by Bill Woolsey

Bill Woolsey teaches economics at The Citadel in Charleston, S.C.

The Federal Reserve System prints $100 bills at a cost of 6¢. So who pockets the $99.94 profit? ---------------------------------------

It was in the late eighties. I was a new faculty member at The Citadel, teaching Money and Banking. A memo was in my box. There was a phone number and a note that someone had questions about the Federal Reserve. Being dutiful (and not tenured), I returned the call. A man answered. I said that I was from The Citadel and understood that he had some questions about the Fed.

An interrogation then began. "Isn't it true," he demanded, "that the Federal Reserve pays the Treasury three cents for each dollar bill printed?" I replied that this was pretty much true. He continued, "Isn't it true that the Federal Reserve lends this money to ordinary banks and charges 3% interest?" I noted that while the discount rate was currently at 3%, it has sometimes been higher or lower. I added that the Fed doesn't really lend out currency directly and that these Federal reserve advances aren't very important.

He interrupted, "Is it true or not?"

I said, "Pretty much so."

His next question was a bit different. He asked, "Isn't it true that the Federal Reserve is privately owned?"

I agreed that it was, "kind of."

The rest came out in a bit of a rush. "So, isn't it true that, for every dollar printed, the Federal Reserve covers the three cent cost of printing the currency with the interest and so makes a one dollar profit for the owners. And that's how the international bankers get their money to rule the world."

I said that no, that wasn't true, but I had no quick and easy explanation. And my conspiracy theorist wasn't interested in anything other than a confirmation of the first three premises. His logical deduction of a one dollar profit and his alleged bankers' conspiracy weren't things he needed to have confirmed. The government prints money and spends it. The result is price inflation, which is often blamed on the greed of businessmen.

I had never heard anything like it. Now, don't get me wrong. I have been a libertarian since I was a teenager in the mid-'70s. The notion that the Federal Reserve, as an engine of inflation, was nefarious seemed natural. It was just this particular approach to the evils of the Fed that was new to me.

Soon after, a former student visited and asked me about Pat Robertson's discussion of the Federal Reserve in his book "The New World Order."1 As my student relayed the story, the Fed pays three cents for each dollar, lends it out at 3% interest and so on. Another student reported on a story about a Washington call girl. She claimed that all the politicians had credit cards. Where did they get the money? The Fed pays three cents per dollar bill and so on.

A year later, at a local Libertarian Party meeting, a newcomer was distributing issues of The Spotlight, a publication of the anti-Semitic Liberty Lobby. Among the articles about the dual loyalists in the State department was one about the Fed. It pays three cents per dollar bill, lends it out at 3% interest, and so on. This time, however, it was the international Jewish bankers making all the profit. A Google search on the Federal Reserve and ownership will generate several hundred thousand hits, many of which allege that the private owners of the Fed are making huge profits from the issue of currency.

There are quite a few links to sites that specifically debunk the conspiracy theory. Some links are to Federal Reserve sites that describe the system's ownership structure. The conventional wisdom among libertarian economists is that central banking is the modern means by which governments continue their traditional policy of debasement using inflation as a means of public finance.

The government prints money and spends it. The result is price inflation, which is often blamed on the greed of businessmen who actually set the prices. Could economists be wrong? So I did some research. The conspiracy theorists have a point regarding the ownership of the Federal Reserve. The Federal Reserve system is made up of twelve Federal Reserve banks. According to the Atlanta Federal Reserve bank, "They were to be quasi-private bankers' banks, owned by the member banks, which would buy all the stock of the Reserve Banks and receive dividends for it."2 It is impossible for the shareholders of Federal Reserve banks to earn capital gains or suffer capital losses on their stock. Any Principles of Economics or Money and Banking text describes the situation, usually in similarly ambiguous terms.

Baumol and Blinder state, "Technically, each Federal Reserve bank is a corporation; its stockholders are its member banks."3 Mishkin explains, "Each of the Federal Reserve banks is a quasi-public (part private, part government) institution owned by the private commercial banks in the district that are members of the Federal Reserve system."4

The courts have taken notice of the Fed's peculiar status. In the 1982 case, Lewis v. United States (see "The Lewis Decision"), the Ninth Circuit Federal Court of Appeals opined, "Federal reserve banks are not federal instrumentalities for purposes of a Federal Torts Claims Act, but are independent, privately owned and locally controlled corporations." On the other hand, the opinion notes, "The Reserve Banks have properly been held to be federal instrumentalities for some purposes."5 Apparently, there is something unusual about the status of these Federal Reserve banks. Some libertarian economists describe claims about the "private" nature of the Fed with an attitude of "if only." In the context of a proposal to privatize the Federal Reserve banks,

Richard Timberlake explains that "The member commercial banks already 'own' the twelve Fed banks," but adds that, "they have no property rights."6 Murray Rothbard notes that "[c]entral banks are often nominally owned by private individuals or, as in the United States, jointly by private banks, but they are always directed by government-appointed officials, and serve as arms of the government."7

According to the Federal Reserve Act, a Federal Reserve bank is a special type of corporation chartered by the Federal government.8 Shortly after the act was passed, the United States was divided into twelve districts and a Federal Reserve bank was organized in each district.9 National banks (private commercial banks chartered by the Federal government) were forced to join the Federal Reserve system. State chartered banks could join if they chose, though most did not.10 Any newly chartered national bank must still join the system and existing or new state chartered banks can still choose to join. One requirement of membership was for a bank to purchase stock in its district Federal Reserve bank. The amount purchased was fixed by the Act. Each member bank must purchase stock equal to 3% of its capital.11 While the Fed no longer pays off Federal Reserve notes with anything, it continues to account for them as liabilities.

Take a bank's total assets vault cash, loans, investments, building, and equipment. Then subtract its liabilities checking accounts, savings accounts, bonds. The difference is the bank's capital, which, in banking lingo, is another term for net worth. Multiply by 3% and that is the dollar value of the Federal Reserve stock a bank must hold. The par value of the Federal Reserve stock was fixed by the Act at $100 per share.12 As a bank's net worth changes and deviates from the 3% requirement, its Federal Reserve bank issues it new shares or buys back excess shares always at the $100 par value. If any bank joins the system, its district Federal Reserve bank issues new shares. If any member bank fails, its district Federal Reserve bank pays off the shares. The Federal Reserve Act contained a provision for selling shares to the general public or even to the U.S. Treasury if necessary to meet a minimum capitalization for each district bank. These provisions weren't needed, and so all shares are held by member banks.13

All member banks are U.S. chartered banks, chartered by the federal government as national banks, or by one of the states. However, the stockholders of the various banks can be U.S. citizens or foreigners. So, private investors, including foreigners, own the member banks which in turn seem to own Federal Reserve banks.

That is the element of truth in the conspiracy theory. The member banks' "ownership" of the Fed is consistently described as "quasi," technical, or nominal. The key reason is that owning stock in a Federal Reserve bank does not provide the usual benefits of stock ownership. In 2003, the total dividends to the member banks were $518 million. That amounts to .02% of government spending. One of the key benefits of the corporate form of business relative to partnerships is that the owners can sell part or all of their interest in a business by selling some or all of their shares. But Federal Reserve banks aren't like ordinary corporations.

Aside from the transactions with their Federal Reserve banks to maintain the 3% ratio to capital, the member banks cannot buy additional shares or sell off their shares. They cannot pledge the shares as collateral for loans.14 Most investors purchase stock to earn capital gains, in the hope that it will increase in value. There is no market for Federal Reserve stock its price remains at the par value of $100. It is impossible for the shareholders of Federal Reserve banks to earn capital gains or suffer capital losses on their stock. Of course, stockholders in ordinary corporations can also hope for dividends. As the owners of the business, all profits belong to them. In most corporations, the board of directors decides if and when to pay dividends on common stock.

But the Federal Reserve banks are different. The Federal Reserve Act fixes dividends at 6% per year.15 That is $6 per year per $100 share. Any additional earnings go to the U.S. Treasury. If an ordinary corporation is liquidated, any remaining assets belong to the stockholders. But that isn't the situation with the Federal Reserve banks. If the Federal Reserve is liquidated, the member banks get back their $100 per share and pending dividends and anything left over goes to the U.S. Treasury.16 Stockholders generally vote for their corporation's board of directors, and that is true of the stockholders of the Federal Reserve banks. But there are some very unusual voting rules. Usually, stockholders vote their shares, so that the largest stockholders get the most votes. Each member bank, however, gets just one vote regardless of the number of shares it owns in its Federal Reserve bank.17

Each Federal Reserve bank has nine board members. They are divided into three groups. There are three Class A directors, three Class B directors, and three Class C directors.18 The politicians control the Fed in the same sense that they control the judiciary. The Class A directors can be involved in the banking industry and usually are. The member banks are divided into three groups ? large, medium, and small banks. While this is measured by their stockholdings, stock holding is proportional to net worth, which is closely associated with total bank size. The large banks elect one Class A director, the medium-sized banks elect another, and the small banks elect the third.19 Class B directors are elected in much the same way, except that none of them can be bank employees or stockholders. Each member bank gets one vote and the large, medium, and small banks elect one director each. Class C directors cannot be involved in the banking industry either, but they aren't chosen by the stockholders. They are instead appointed by the Board of Governors in Washington D.C.20 To sum up, the stockholders of each Federal Reserve Bank elect two-thirds of its board of directors. They don't vote by shares, but rather each bank gets one vote. Bank size does influence voting, however, with large, medium, and small banks getting two directors each one banker and one nonbanker.

For most corporations, the board of directors selected by the stockholders is free to choose top management. While the board of directors of each Federal Reserve bank chooses its president, that decision is subject to approval by the Board of Governors in Washington, D.C.21 There are seven members of the Board of Governors and they are appointed by the president of the United States with the advice and consent of the U.S. Senate. They are appointed for 14-year terms. The chairman is appointed by the president with approval by the Senate for a four-year term.22 The current chairman is Alan Greenspan. The Board of Governors is clearly a federal government agency. Its members have substantial independence from the president and Congress because of their long terms ? less than federal judges, but more than those serving on most federal regulatory commissions. The Board of Governors dominates the twelve Federal Reserve banks. Not only does it appoint one-third of their boards of directors, it has an effective veto power over the selection of the twelve Federal Reserve bank presidents. The Federal Reserve Act authorized the board of directors of each Federal Reserve bank to set its own discount rate in consultation with the Board of Governors. This was the interest rate at which Federal Reserve banks made loans (called advances) to member banks.23 While some of those supporting the Federal Reserve Act thought that there would be different discount rates across the United States depending on local conditions, the consultation process with the board of governors resulted in the twelve boards of directors setting a uniform discount rate.24 During the Great Depression, the Banking Act of 1933 changed consultation to a requirement that Federal Reserve banks obtain Board of Governors approval for their discount rates.25 There continued to be a single discount rate for the Federal Reserve system, though it was routinely approved by each Federal Reserve Bank's board of directors.

There are any number of ways in which regulations associated with the Federal Reserve system impose unjustified costs on banks. In 2003, the Fed changed its lending policy. Today, any financially sound bank (member or not) can obtain loans from its district Federal Reserve bank at the primary credit rate. It is set at 1% above the Federal Funds rate.26 Since the Federal Funds rate is the interest rate at which banks borrow from and lend to other banks for overnight loans, there is little motivation to borrow from the Fed. Financially troubled banks can obtain loans at the secondary credit rate. That rate is set at .5% above the Federal Funds rate and entails added supervision.27

Given this new policy, the "power" of the board of directors of a Federal Reserve bank to set the discount rate has become a dead letter. While the Federal Reserve Act implies that lending at the discount rate would be the key element of monetary policy, that approach was long ago superseded by open market operations. Open market operations are the purchase or sale of government bonds by the Federal Reserve. The Federal Reserve Open Market Committee directs open market operations. It is made up of the seven members of the Board of Governors and five Federal Reserve Bank presidents. The president of the New York Federal Reserve always serves and the other four slots rotate among the other eleven Federal Reserve bank presidents.28 The committee sets a target for the Federal Funds rate.29 The open market trading desk at the New York Federal Reserve buys or sells government bonds. Generally, they purchase them at either a faster or slower rate so that surpluses or shortages of funds in the market cause private traders to agree to interest rates on overnight loans close to the target. When the Federal Reserve Open Market Committee sets its target for the Federal Funds rate, it is also determining the primary and secondary credit rates for loans by the Federal Reserve banks.

Today, monetary policy is controlled entirely by the Open Market Committee. The politicians appoint the Board of Governors, which makes up seven of the twelve members of the committee. That same Board of Governors appoints one-third of the boards of directors, which select the Federal Reserve bank Presidents that make up the remaining five-twelfths of the committee. And the Board of Governors has an effective veto over the selection of Federal Reserve bank presidents.

Because of the 14-year terms for the members of the Board of Governors, today's monetary policy mostly depends on the appointments made by politicians in the past. Short of rewriting the Federal Reserve Act, appointments by today's politicians will only gradually effect future monetary policy. That is why the Federal Reserve System is described as an independent agency within the federal government. For the Fed, final authority is in the hands of the politicians. Many of the conspiracy theories claim that the private owners of the Fed are making large profits from the issue of currency Federal Reserve notes. The twelve Federal Reserve banks are responsible for issuing Federal Reserve notes, but they don't print currency themselves. They pay the Bureau of Printing and Engraving, a division of the U.S. Treasury, for the service. Estimates for the amount the Fed pays for printing each note vary from 2 cents to 6 cents. In 2003, about 8 billion notes were printed. The Fed purchased currency with a face value of $143 billion30 and then paid the U.S. Treasury $508 million.31 That amounts to about 6 cents per note and .3 cents per dollar printed. It is like having copies made at Kinko's, and even more like the cost of printing checks. The printing cost doesn't have much to do with the amount the checks will be worth when they are written and spent. While paying less than one cent per dollar issued sounds profitable, the Federal Reserve Banks do not treat this as profit. The Fed accounts for Federal Reserve notes as a liability, a debt of a Federal Reserve bank.32

When the Fed was formed, the United States was on a gold standard and the Fed was obligated to pay off Federal Reserve notes on demand with lawful U.S. money, mostly gold coins and gold certificates. While the Fed no longer pays off Federal Reserve notes with anything, it continues to account for them as liabilities. After the Fed has currency printed and before it is issued, it is just paper, like a blank check. When the currency is issued to banks or ends up in the hands of other firms or households, it becomes a liability for the Fed. When the currency is deposited by a bank back into the Fed, it is again meaningless paper, like a cancelled check. Unlike a used check, however, the Fed can issue out currency again.

While the Fed accounts for Federal Reserve notes as liabilities, the U.S. government guarantees them as well. If a Federal Reserve bank were to fail, then the U.S. government would pay off the outstanding currency. To protect the U.S. government from losses, it requires that Federal Reserve banks set aside U.S. government bonds or gold certificates as collateral.33 When the United States left the gold standard, there was no longer any possibility of the Fed defaulting on Federal Reserve notes, so the secondary U.S. government guarantee became meaningless. Still, the Federal Reserve banks pledge collateral for Federal Reserve notes.

The Federal Reserve doesn't directly lend currency to banks. When a bank gets an "advance" from the Fed, the Fed just makes an entry into its computer and credits the bank's deposit account. So rather than paying less than one cent per dollar for the money they lend to banks, the Fed actually pays nothing. Of course, banks can withdraw currency from their deposit accounts at the Federal Reserve banks whenever they want. And they do so regularly, to cover currency withdrawals by their depositors and to stock ATM machines. The Federal Reserve banks have currency printed up as needed to cover withdrawals by the banks. And while the total stock of currency is usually expanding, a substantial portion of the Fed's printing cost is for new currency to replace worn currency that has been withdrawn from circulation and shredded.

In 2003, the Fed increased the stock of Federal Reserve notes by $42 billion and replaced $101 billion of worn currency.34 The conspiracy theorists' claim that private owners of the Fed are making bundles of money is false. Suppose the Fed lent money to a bank, charging 2.25% annual interest (the primary credit rate in August 2004).35 The bank might withdraw the funds and the Fed would be obligated to issue it currency which would cost .3 cents per dollar (or 6 cents per note). When the bank repaid the loan (probably the next day), the Fed would earn a tiny fraction of a cent per dollar. The returned Federal Reserve note, however, wouldn't be revenue. And the Fed could issue it out (perhaps by lending) again and again until it wears out.

Total outstanding loans by the Fed to the banks was $245 million in July 2004.36 At 2.25% interest, that would earn the Fed an income of about $5.5 million per year. The total amount of Federal Reserve notes is approximately $700 billion,37 and it is apparent that Fed lending to banks does not play a significant role in the creation of currency. Conspiracy theorists, like Thomas Schauf38 and Eustace Mullins,39 complain that the private owners of the Federal Reserve are profiting from the national debt. Since the Federal Reserve creates money out of thin air through open market operations purchasing government bonds, they are at least looking in the right direction. As of July 2004, the Fed held government bonds worth $693 billion. 40 Contrary to the claims by some conspiracy theorists that the entire national debt is associated with the issue of currency, the Fed's holdings are about 9% of the $7.5 trillion gross national debt.41 After subtracting securities held by various federal government trust funds, the Fed's holdings are about 15% of the remaining $4.5 trillion net national debt.42 When Fed bond holdings are added to the small amount of its lending to banks, the $11 billion gold reserve, $40 billion in holdings of foreign exchange, along with repurchase agreements, Federal Reserve bank promises, and the like, the Fed's assets cover its liabilities, Federal Reserve notes issued, the $25 billion that banks have deposited at the Fed, the government's $4 billion deposited in the Fed, and various other small items.43 Since government bonds make up the bulk of the Fed's assets, the interest from those bonds provides most of its revenue. In 2003, the Federal Reserve's total income was $24 billion, of which $22 billion came from holdings of government securities.44 While that is a substantial amount of money, the total interest expense for the U.S. government was $153 billion45 and total government spending was $2.157 trillion.46 The Federal Reserve's earnings on bonds were a bit over 14% of the government's interest expense and 1% of total government spending.

Some conspiracy theorists have claimed that personal income tax funds are earmarked to pay interest to the Fed, and if no such interest was paid, there would be no need for the income tax. Fed interest earnings amount to a bit over 2% of the $987 billion in personal income collections in 2003.47 Total interest payments by the government are about 15% of income tax revenues. The chief problem with the theory that the private owners are making huge profits from the Fed is that the Fed transfers large amounts of money back to the U.S. Treasury each year. In 2003, the amount transferred was $22 billion.48 Since that is exactly how much interest the Fed earned from U.S. securities, the net cost of the Federal Reserve to the U.S. taxpayers was zero. Zero? The conventional view among economists is that the Fed makes money for the government. How? One way to look at it is that if the Fed didn't own these government bonds, then someone else would. Those investors would not transfer their earnings back to the Treasury. By having the Federal Reserve own a portion of the national debt, the U.S. government saved $22 billion in interest expense in 2003.

Conspiracy theorists like Schauf have proposed that the government replace Federal Reserve notes with "greenbacks", U.S. Treasury notes that bear no interest.49 They claim that this would free the government from paying interest on part (or even all) of the national debt. If the government replaced Federal Reserve notes with that sort of currency and retired interest-bearing debt, then the government would not have paid the Federal Reserve $22 billion in interest. But neither would the Fed have transferred the $22 billion back to the Treasury.

An exact match doesn't occur every year. In 2002, the Fed earned $25 billion on government bonds and transferred back only $24 billion.50 Still, that didn't create an additional $1 billion "profit" for the member banks that "own" the Federal Reserve. The member banks make six cents on each dollar they are forced to have invested in the Federal Reserve system. In 2003, the total dividends to the member banks were $518 million.51 That amounts to .02% of U.S. government spending. It amounts to about .5% of the $100 billion in total commercial bank earnings.52 The rough equivalence between the interest the Fed earns from the government and the amount it transfers to the U.S. Treasury causes most economists to see these financing issues as a shell game. Since nearly all the interest paid on debt sold to the Fed is transferred back to the U.S. Treasury, there isn't really any interest paid. The government uses the Fed to partly finance its deficit by creating money and spending it. The end result is no different than if the U.S. Treasury just printed up "greenbacks" and spent them. The process is just a bit more "efficient" than the ancient practice of melting down silver coins and mixing in lead.

Most economists would argue that the Fed created $36 billion for the government in 2003.53 That is the change in the monetary base (currency and reserves) less the expenses of operating the Federal Reserve system. Do shady international bankers control the Federal Reserve? Perhaps, but not because they "own" the Federal Reserve system. The politicians have control, in the same sense that they control the federal judiciary. Government appointees make up the majority of the Open Market Committee and those same appointees have an effective veto in selecting the Federal Reserve presidents who make up the remainder of the body. Further, they appoint one-third of each Federal Reserve bank's board of directors, which in turn choose those presidents. However, if one begins with an understanding that the Fed is fundamentally a political operation, then it is unusual in that bankers have an extra avenue of influence. Like everyone else, they can vote, lobby, and make campaign contributions and so influence the politicians. Unlike everyone else, they can own shares of stock in member banks that "own" the Federal Reserve banks and so influence directors, Federal Reserve bank presidents, and the Open Market Committee.

Do shady international bankers make large profits from the Federal Reserve? It depends on what is meant by "large." Since there is little or no risk in stock whose value remains at par, and the interest rate earned by the Fed on its government securities portfolio is closer to 3% than the 6% dividend, perhaps a substantial cut in payments to the member banks is in order. If the dividend rate were reduced to reflect the current return on the Fed's portfolio, the taxpayers could save as much as $250 million a year in financing the national debt. However, this potential gain depends on the low levels of interest rates for the last few years. Since 1960, the rate on Treasury bills has been greater than 6% almost 40% of the time. It was consistently above 6% from the fall of 1977 to the summer of 1986. When the T-bill rate peaked at 15% in March of 1980, the Fed was earning substantially more on its security portfolio than the dividend rate it was paying the member banks.54 Further, from a libertarian perspective, there are any number of ways in which regulations associated with the Federal Reserve system impose unjustified costs on banks. Reserve requirements force banks to tie up more funds than they believe necessary in vault cash and Federal Reserve deposits. The banks earn less interest and the Fed and the U.S. Treasury collect roughly what the banks lose. More importantly, by taking away the right of banks to issue redeemable, dollar-denominated banknotes, the Fed's compulsory monopoly on currency issue reduces bank earnings by tens of billions of dollars.

How a competitive banking system would distribute those funds between bank stockholders and customers is difficult to predict, but there is a cost to having the government finance its budget deficits by issuing currency. Who owns the Fed? The owners of a business typically have ultimate authority over operations and serve as residual claimant. Stockholders elect directors, who appoint top management. Stockholders receive the profits, excess revenues after all other claims on funds are paid. For the Fed, final authority is in the hands of the politicians. They appoint the Board of Governors, who dominate the Federal Reserve banks. Further, any earnings of the Federal Reserve banks beyond expenses, including the 6% dividend to the member banks, goes to the U.S. Treasury. Since the U.S. government has final authority and serves as residual claimant, the most reasonable view is that the Federal Reserve system is government-owned.

The conspiracy theorists' claim that private owners of the Fed are making bundles of money is false. The conventional view among economists (including libertarian ones) that the Fed is a government operation that partially finances fiscal deficits by money creation is fundamentally correct. The live question among libertarians is how to get the government out of the banking system? Perhaps by truly privatizing the Fed's operations in a way that prevents inflation and macroeconomic instability.

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Footnotes