Dodd-Frank's expansion of Fed power: a historical perspective.

• Author: Michel, Norbert

It has become somewhat fashionable to refer to the vast expansion of the Federal Reserve's power under the 2010 Dodd-Frank Act. This Act certainly expanded the Fed's authority and its reach into markets, but the vastness of these changes should be kept in perspective. The Fed now has a full 100-year history to judge, and to a large extent its past exemplifies what we see with virtually all government bureaucracies: incessant mission creep. Glossing over this fact contributes to the general misunderstanding of what the Fed is and how it functions.

From the very beginning, this institution has grown in terms of its scope and general authority over both banking and the broader economy. Many of the changes have taken place through legislation, but others have come about by virtue of assertive Board members. The line between these two methods has become somewhat blurred now that the Board of Governors has a Congressional Liaison Office to actively lobby Congress for what the Board wants, but the distinction was much clearer at the Fed's founding. This article highlights two of the major changes in the Fed's early years to provide context for several of the major Dodd-Frank-mandated expansions in the Federal Reserve's power.

The Decentralized Central Bank

The Federal Reserve Act of 1913 created a sleepy little institution by today's standard. The Fed's original purpose was to provide an "elastic currency" to stem seasonal fluctuations in reserve requirements and provide liquidity to member banks. These problems ebbed and flowed mainly with the agricultural seasons. Of course, the Fed was supposed to carry out its functions within the framework of the gold standard. Initially, the Federal Reserve System was designed primarily around the 12 District Reserve Banks, with a relatively weak federal oversight.

The Reserve System was created largely by nationalizing private clearing-houses and turning them into the Reserve Banks, which held gold reserves and operated fairly autonomously. The original Reserve Banks could be thought of as super-commercial banks that provided clearing functions to the system's member banks and served as their members' lender of last resort.

The original Federal Reserve Board was rather weak and served as a sort of liaison between the District Reserve Banks and Congress. The Board had agents situated in the Reserve Banks essentially to make sure the district managers were not breaking the law. It sounds paradoxical, but we really did have a decentralized central bank.

The lack of a strong central authority was by design. Some members of Congress, as well as members of the financial industry, were scared to death of a federally controlled central bank. For instance, Frank Vanderlip, president of National City Bank of New York, advised Rep. Carter Glass (D-Va.) and Sen. Robert Owen (D-Okla.) against creating a federal board in Washington. Before legislation was completed, Vanderlip predicted that a Washington-based Board would "very rapidly lose the power to direct wisely," because it would be "subject to all the vicissitudes of political pressure and party trading" (Livingston 1986: 219).

After the law was passed, some in the congressional majority staunchly denied they had created a central bank, likening the institution instead to the (supposedly benign) Interstate Commerce Commission (Timberlake 1993: chap. 15). Some members genuinely believed they had created a system of autonomous, regional Reserve Banks with a benevolent federal regulator.

Others in Congress, though, understood exactly what they had created. Sen. Gilbert Hitchcock (D-Neb.), for example, argued that "the central bank does not consist of a vault. The central bank does not consist of a mass of money.... The central bank consists of central control, and that is provided in this bill. The control is centralized [in the Federal Reserve Board], and when you get your control centralized you have a central bank (Timberlake 1993: 231-32).

Hitchcock recognized that the essence of a central bank existed in the Federal Reserve Act, but others did more to point out the long-term dangers and philosophical contradictions of the 1913 Act. Rep. Charles Lindbergh Sr. (R-Minn.), for instance, noted: "This Act establishes the most gigantic trust on earth, such as the Sherman Antitrust Act would dissolve if Congress did not by this Act expressly create what by that Act it prohibited" (Timberlake 1993: 233). Taking a broader view, Rep. Frank Mondell (R-Wyo.) presciently warned:

The Federal Reserve Board under this bill is an organization of vastly wider power, authority, and control over currency [and] banks ... than the reserve associations contemplated by the National Monetary Commission.... [I]t is of a character which in practical operation would tend to increase and centralize. ... In your frantic efforts to escape the bogey man of a central bank ... you have come perilously near...