5 Myths & 5 Ugly Truths About the Fed

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Myth #4: The Fed is a private enterprise not beholden to the government

uncle sam money 5 Myths & 5 Ugly Truths About the FedIt’s true that the 12 Federal Reserve banks are organized like private corporations, and are designed to operate largely independently of the federal government. It’s also true that big financial firms like Citigroup (NYSE: C) and Bank of America (NYSE: BAC) own stock in the banks and are paid a fixed 6% dividend on their holdings in District Reserve Banks. However, private bankers do not “oversee” the Fed since that stock does not come with voting rights.  It is the seven members of the publicly appointed Board of Governors – of which Ben Bernanke is the chairman – who set national monetary policy and give marching orders to the District Reserve Banks that they oversee. Private banks have no direct role in that process.

But here’s an ugly truth about the Fed’s government ties…

Though the dividend-paying Fed stock doesn’t come with a vote on day-to-day affairs, it does give private member banks a say in the Reserve Bank board of directors. Member banks elect six of the nine members of Reserve Banks’ boards. And it’s almost a given that former Wall Street banking execs wind up running the major reserve banks in the system. Take the current president of the New York branch of the Fed, William Dudley, served almost 20 years at Goldman Sachs (NYSE: GS). The fact is that since it is set up as a public-private venture in an effort to give free enterprise a stake on behalf of national businesses, there are inherent limits on the amount of control the government – and subsequently the American people – can exert.

Myth #5: We are better off without a central bank

money lock 150x150 5 Myths & 5 Ugly Truths About the Fed

It is folly to believe that a major economic power could exist without a central bank to manage monetary policy. Let’s look at some history: For nearly eighty years, the U.S. was without a central bank after the charter for the Second Bank of the United States was allowed to expire after policy missteps and accusations of corruption. Sound familiar? On the plus side, the American economy did not implode and we did not slip into the dark ages as a nation. But the economy was hardly a beacon of stability. The Depression of 1893 was one of the worst in American history, with the unemployment rate exceeding 10% for half a decade. What’s more, a series of financial crises persisted — culminating with the 1907 Bankers’ Panic due to an inelastic U.S. currency and a run on banks that prompted the Federal Reserve’s founding. Whether or not you are willing to admit a central bank would have prevented or mitigated the economic crises in the decades before the Federal Reserve act, clearly the absence of the Fed did not categorically stabilize the American economy.

But here’s an ugly truth about Fed’s role in the economy …

Fed defenders point to these historical events — or to Paul Volker’s deft moves to end U.S. stagflation in the 1970s — as proof the economy isn’t better off without a central bank.But critics have an equally damning list of disasters that occurred under the Federal Reserve’s watch. Many commentators blame former chairman Alan Greenspan for partially inflating the recent housing bubble with persistently low interest rates during his last few years at the Fed. Others criticize Greenspan for not raising rates fast enough during the Dot-Com bubble, or failing to use other tools at his disposal such as raised margin requirements. And while only time will tell whether Ben Bernanke’s massive “quantitative easing” policies will ultimately result in more harm than good, there are very legitimate concerns about the actions. In short, America may not have been free from economic disaster without the Federal Reserve’s stewardship, but the central bank doesn’t exactly have a stellar report card. And if the Fed can’t prove convincingly that it does more good than bad or that it prevents more crises than it overlooks, what the heck is the point?

Jeff Reeves is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks or funds named here. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.

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