Season Investments


A Three Legged Stool

Posted on February 26, 2019

“I think we’re mysterious to people. I think they’re not sure what we do.” - Jeffrey Lacker, Federal Reserve Bank of Richmond

2019-02-26_stool.jpgWe are in the middle of a revamped Insight series on the US Federal Reserve. This series was originally published in 2013 but was recently refreshed for a presentation we gave to the Kissing Camels Coffee and Donuts club. Our last several posts have covered the history of banking in the United States, starting around the time of the Revolutionary War and leading up to the modern era of central banking. We shift gears this week to an examination of how the US Federal Reserved is structured and the roles of its various branches. We will follow up with two final posts in which we will explain the Fed’s primary monetary policy tools and recap how those tools were deployed during the financial crisis. 

The opening quote from Jeffrey Lacker is actually taken from an interview in a documentary released in 2013 called Money for Nothing. It’s a sad but true reality that the average American is heavily impacted by the Fed’s policies, but really has very little understanding of what the central bank actually does. Before we get into the nuts and bolts of the Fed’s activities, we’ll focus this week on the various components that make up the central banking system here in the US. 

As the image below shows, the Federal Reserve is comprised of three distinct parts, like the three legs of a stool: 1) the Board of Governors, 2) the twelve Regional Fed Banks and 3) the Federal Open Market Committee. 


Leg #1: Board of Governors

The Board of Governors (the “Board”) is a government agency based in Washington DC and is at the top of the food chain in the Federal Reserve System. It is comprised of seven members, all appointed by the President and confirmed by the Senate. Each member serves a 14-year term, and the board is led by a Chairman and Vice-Chairman who both serve 4-year terms. 

The Board is mandated by law to be non-partisan and act completely independently of any other government agency. It is to serve the entire nation, representing its “financial, agricultural, industrial and commercial interests”. In addition to overseeing and managing the entire Federal Reserve institution, the primary policy role of the Board of Governors is to set banking reserve requirements and determine the target discount rate (more on both of these topics next week). 

Leg #2: Regional Fed Banks

Part of the intent of the Federal Reserve Act of 1913 was to spread power out across the nation’s geography rather than having it all focused on the East Coast. Thus, the country was split into 12 distinct regions, each having its own Federal Reserve Bank providing services locally and serving as representation on boards and committees back East. The map below shows these various regions and the cities in which their regional banks are located. You’ll notice that the regions on the left side of the map are much larger geographically than on the right side. This is because the country’s population was still heavily concentrated in the East in 1913. To correct for changing population densities over time, the Regional Banks have opened additional branches in some of the territories (not shown on the map). For instance, the Kansas City Regional Fed Bank also has branches operating in Omaha, Oklahoma City and Denver. 

2013-11-12_Fed_Map.pngThese Regional Banks play multiple roles in the Federal Reserve system. First, they are known as the “bankers’ banks” insomuch as they provide services such as currency distribution, payment processing and most importantly lending directly to commercial banks in their region. They also provide services such as account maintenance, check processing and securities auctions directly to the US Treasury. Finally, these banks are staffed with small armies of economic analysts who are responsible for monitoring economic conditions throughout their region and conducting special research projects for public and government use. You can think of these Regional Banks as the boots on the ground, carrying out the actual day to day operations of the Federal Reserve. 

Leg #3: Federal Open Market Committee

The Federal Open Market Committee (or “FOMC”) is the policy-making branch of the Federal Reserve. The committee is made up of the seven members of the Board of Governors and the twelve presidents of the regional Federal Reserve banks. Although all members participate in discussions, voting members include only the seven members of the Board of Governors, the President of the Federal Reserve Bank of New York and four other regional bank presidents who take turns serving 1-year terms. 

The FOMC meets eight times per year regularly, but special meetings can be called when warranted. Committee meetings start with economic updates from the regional bank presidents followed by deliberations on overall conditions and policy ideas. Once policies are confirmed by vote, the committee then directs the trading desk in New York on how to implement those policies. 

We’ve now seen how the Board of Governors, the twelve Regional Federal Reserve Banks and the FOMC all play a distinct role, like the three legs of a stool, within a Federal Reserve system that employs over 20,000 individuals across the country. In addition to the policy making highlighted in the financial news, the various branches of the Federal Reserve also perform a number of more mundane functions including distributing new currency, processing payments, conducting securities auctions, regulating member banks and drafting federal law governing the banking and consumer credit industries – all of which the general public might not ever see or realize when considering the Fed’s role in our country’s economy. Now that we’ve laid this groundwork, next week we will take a closer look at the three primary policy tools the Fed uses as it goes about attempting to manage the nation’s economy and financial markets.

david_headshot_bw.jpgAuthor David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.

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