The Federal Reserve is at the center of particularly turbulent economic conditions. The COVID-19 pandemic shutdowns and reopening caused major economic dislocations, which, combined with sanctions on Russian energy following the Russo-Ukrainian War, resulted in historically high inflation, peaking in summer 2022 but remaining elevated. To fight it, the Fed began a high-profile tightening cycle, quickly raising interest rates to combat fast-rising prices. This unfortunately then precipitated a bank panic in the underregulated middle tier of regional banks, fed by the ease of smartphone apps that take the “run” out of a bank run.
The Fed continued raising rates in the face of this recent panic, even as banks were making gigantic withdrawals from its emergency facilities to keep the panic from causing bank failures. This increases the chance of a “hard landing”—a full recession with accompanying high unemployment, potentially during the likely-fraught 2024 election year.
What is the Federal Reserve, and who put it in charge? Is there no other way to fight inflation? Just what the hell is going on here?
Riding the Business Cycle
The Federal Reserve system (or “Fed”) is America’s central bank, an institution that most countries have and which conducts various policies related to financial markets. The Fed’s most prominent job is managing monetary policy—using various financial tools to nudge interest rates up or down. Interest rates of course are the cost of borrowing money, whether on a credit card, home mortgage, or business loan. Big purchases usually involve debt, like getting a mortgage loan, which allows you to live in a house for the decades needed to repay the loan. Large corporate investments (even by cash-rich companies) are usually at least partially financed as well. So by pushing interest rates up, the Fed can effectively hit the brakes on the economy, since more expensive credit translates into fewer homes and cars bought, and fewer corporate investments made, which broadly means less hiring. Likewise, if the Fed cuts rates, the cheaper money means more borrowing for houses and trucks and business investments, stimulating economic growth to help get out of recessions.
Notably, the Fed does not control most interest rates directly, but rather uses tools to influence the “federal funds rate,” the rate at which banks borrow from one another overnight to meet the legally-required reserve level—a set percentage of depositor money that legally must be kept on hand for withdrawals. But changes in this rate influence the cost of funds in the capital markets through which credit cards and mortgage loans are drawn, so these rates (and the ones you pay on your actual credit card balance or mortgage) broadly track the federal funds rate up and down. The Fed has more influence over finance markets than direct control, but the breadth and fundamental nature of its power is quite real.
Generally the Fed is expected to raise interest rates during the upswing of the business cycle in order to keep inflation under control and to prevent market bubbles, and then to lower rates during recessions, to make borrowing and hiring cheaper, which can make the downturn shorter and milder. This can work in hand with the classic New Deal-era Keynesian model focused on the separate tool of fiscal policy, where Congress may cut taxes or raise spending to “stimulate” the economy out of recessions, or run the “austerity” of economy-cooling tax raises and spending cuts during the upswings, to pay down public debt and cool total demand.
The Fed has other important monetary policy tools, including the ability to set the specific level of the required reserves mentioned above, as well as the ability to buy and sell U.S. Treasury bonds, known as “free market operations,” which can pull cash out of the bank system or add to it. By buying and selling bonds (or usually “repo” agreements to purchase them), the Fed can increase or decrease the “monetary base,” or amount of circulating money, known technically as M1 and M2 among economists. These tools are powerful, but changing the required reserve level is considered disruptive to daily banking, and today the Fed’s efforts to influence the federal funds rate via open market ops is the main media event.
The head of the Federal Reserve’s policy-making body, the Board of Governors, is its Chairperson, who is often counted among the most powerful individuals in the world because of the ability of their mere words to move trillions in global markets. The pinnacle of the Chair’s reputation was probably reached in the early 1990s, when then Chair Alan Greenspan was celebrated in a biography titled Maestro by prominent D.C. bootlicking toady Alan Woodward. Fifteen years later, Greenspan’s reputation returned to Earth; by then, financial markets, which had been heavily deregulated in the 1980s and ’90s, had become chronically prone to bubbles and crashes. After the monumental disaster of 2008, Congress hauled the secretive banker, a reader of Ayn Rand in his youth, in front of national cameras and forced him to concede “a flaw” in free market economics.
The Fed itself is a fascinating institution, very much a product of the grudging recognition by early 20th century policymakers of the need to regulate the financial markets in some way, especially after the endlessly repeated succession of giant manic economic bubbles and booms alternating with devastating economic plunges into major recessions and depression. (Notably, the Great Depression of the 1930s was actually the third or fourth market downturn to carry the name, along with the storied crashes and mass bankruptcies of the 1870s and 1890s.)
So there was widespread support among senior bankers for an emergency lender and system-stabilizer after the especially brutal Panic of 1907, a highly free-market episode in which a tycoon’s botched attempt to corner the copper market set in motion an excruciatingly arcane series of financial transactions that triggered a giant stock market collapse and incredibly widespread bank runs and panics. The spreading catastrophe was only halted by the towering finance capitalist J.P. Morgan, whose central economic legacy was “Morganizing” enormous naked monopolies in industries from oil to steel to banking. The 1907 maelstrom only ended when he personally pledged gigantic amounts of his own money to essential banks, and was famously able to cajole other elite financiers into going along by threatening them with collapse. Even the American ruling class had to recognize that a “lender of last resort” should at least be a legally defined institution rather than a single hyperloaded capitalist with a weird face.
The Fed was thus created to provide stability to the banking system, but also to carefully avoid bringing it under anything approaching popular control. Its original mandate was simply to be the “lender of last resort,” a semi-public body that could provide emergency cash to banks on the edge of failure—meaning their depositors were demanding their money back. Because commercial banks only hold a small portion of our deposits as cash, and loan the rest out as mortgages and business loans, the potential exists for depositors wanting to make large withdrawals to exceed the bank’s cash-on-hand, which historically and today have the potential to lead to major panics when people rushed to the bank to try to get their money out, known as a “bank run.” Obviously, with a still-rolling run on various midsize and large banks as I write, this issue hasn’t faded with time.
But at the time of the Bretton Woods economic accords, the U.S. Congress gave the Fed a new, broader mandate: the twin goals of maintaining full employment (meaning medium-low unemployment) and price stability (meaning low inflation). But since then, the Fed has developed a track record that suggests far more devotion to the anti-inflation part of its mission, which caters to inflation-hating Wall Street financial institutions, rather than the full employment leg.
The clearest example of this can be found in the most obvious predecessor to our current moment—the high inflation of the 1970s and the Fed’s extremely aggressive and destructive means of cooling it. At this time, with the New Deal era ending as neoliberal ideologies of small government were taking hold, the economy was stuck in “stagflation”—an especially ugly economic circumstance characterized by both high inflation and weak growth or recession. Notably, at this pre-neoliberal time, organized labor was still a significant force in the national economy and strikes were running at levels unheard-of today. And most importantly, the high inflation rates and relatively high worker pay due to unionization led to a fateful development—corporate profits actually fell in the late ’70s.
The Fed, run at this time by former Chase Bank Vice President Paul Volcker, used the Fed’s policy tools to dramatically raise interest rates from 1979 to 1981, driving the federal funds rate north of 20 percent and aggravating a recession that reached a double-digit unemployment rate for the first time since the Great Depression. This complemented U.S. President Ronald Reagan’s anti-labor policies, most dramatically his firing thousands of striking members of the air traffic controllers’ union, and then his inauguration of a galaxy of policies that undermined unions, from cutting enforcement of organizer protections to encouraging trade deals that allowed offshoring of industry. This major shift in national policy, combined with the Fed’s fairly brutal recession, was enough to break the organizational ability of the working class for generations.
Today’s conditions are their own beast, with hopes of avoiding a recession next year fading as the bank panic will itself definitely reduce lending and thus reinforce the Fed’s still-tightening policy. Corporate profits have wavered in recent earnings reports but still remain well above rates of return from the 1970s, even after adjusting for inflation. Jerome Powell’s Fed doesn’t appear to have internally committed to a major recession as Volcker’s did, but time will tell.
Wall Street Potholes
The willingness of the Federal Reserve to sacrifice the working class to the needs of the business cycle is especially striking compared to how the Fed manages bank runs and failures, which we’ve had far more of since the financial sector was deregulated in the 1990s. While some finance pillars like Citibank had been rescued previously, the 2008 financial meltdown witnessed a whole new scale of government bailouts of the megabanks like Citi and Wells Fargo, which themselves only arose after the industry was deregulated to allow interstate and inter-sector mergers among commercial and investment banks. These giant beasts truly can’t be allowed to just go under when they make bad bets, as they did on housing in this case, because of their enormity—Chase, Bank of America, Wells Fargo, and Citigroup each manage over a trillion dollars in assets, far more than the FDIC can make whole. These truly too-big-to-fail institutions got the infamous $700 billion TARP bailout from Congress, which took two tries to pass and is an outrageous story unto itself.
But not many people are aware of the other bailout, which was the Fed’s then-mostly secret emergency loan program. First the Board authorized hundreds of billions in discreet loans to large and medium-tier banks, foreign central banks, and other important institutions to avoid a crunch in access to dollars, which play a special role as the world reserve currency. But perhaps even more significantly, it embarked on an unheard-of effort to replace the short-term bond market.
Bonds are how institutions like governments or corporations borrow money, and among today’s giant heinous oligopoly corporations, there’s a tendency toward chunky cash flow—small numbers of giant suppliers or distributors, and big expenses like payday, tend to lead to big alternating floods and droughts of cash.
To smooth out the cash flow, even cash-rich companies engage in short-term borrowing of relatively modest amounts for short periods, a little-reported market known in finance as the “commercial paper” market. During the panic created by the Lehman Brothers bankruptcy at the start of the 2008 crisis, banks were quite spooked from lending, and in the resulting “credit crisis” this important market completely dried up. This meant that the great (and quite creditworthy) household name companies of the U.S. and world suddenly could not borrow money, threatening very real bankruptcies across the greater non-financial economy, spreading the Wall Street crisis to Main Street, as in the 1930s.
The Fed gave itself the authority to essentially replace the panicking banks in the commercial paper market, creating new “facilities” for all this lending, and it kept the Fortune 500 in near-term credit so they could avoid skipping payments to suppliers or bondholders, which would have been dangerous developments for huge firms. It also fought like a dog to avoid revealing who needed this credit and how much was loaned, until years later they were finally forced to release the data by a freshman senator named Bernard Sanders. Who ever heard of him!
It turned out that on top of the American and overseas banks getting enormous lines of easy credit, a roster of blue-chip corporations were forced by the credit crisis to rely on Federal Reserve loans until the megabanks got over their fainting spells and felt like doing their jobs again. Household names like McDonald’s, Harley-Davidson, Verizon, and Toyota were on the list of program customers. The Fed is fascinating among semi-government entities for granting itself large new powers during crises and then winding them down again when the emergency is over, ceding the space back to the enormous private sector entities that normally run it. Now that’s a bailout!
And of course the Fed ran a whole new program of emergency loans with the advent of the COVID-19 pandemic and shutdowns, keeping Wall Street financially and emotionally reassured as well as making sure that the giant corporations of the U.S. wouldn’t have a heart attack of frozen cash flow. This time the federal government unleashed an unusually adequate amount of social spending, leading to fiscal and monetary policy actually pulling in the same direction, and having the effect of dramatically decreasing poverty, although also contributing to inflation. And today’s new bailout of regional lenders like Silicon Valley Bank takes its place in the tradition, including a rescue of deposits above the FDIC insurance cap, keeping the banks from insolvency fears by offering face value for bonds that have lost value over the tightening cycle. And above all, the Fed continues its traditional easy-terms, last-resort lending “discount window” for banks, running a gigantic business as our hair-trigger over-financialized economy staggers, hitting an all-time high of $152 billion early in the panic.
Fed to the Teeth
The Fed is unpopular on both the political Left and Right in the U.S.—but for very different reasons.
On the Right, the Fed is seen as an inappropriate government intrusion into free capital markets, which should be mostly free of the Fed’s regulatory powers. But above all, the central bank and its requirement of the “fractional reserve” system of holding just a few percent of depositor money as reserves, mentioned above, has become a convenient scapegoat for the Right and the financial world to blame our regular parade of asset bubbles and crashes on. Most associated with former congressman Ron Paul and his son, present Senator and general useless dickhead Rand Paul, calls to “End the Fed” cast the institution as completely to blame for the bubbles and crashes of today.
And they even have a point, since the Fed’s responsibility to avoid bubbles is usually neglected, with the policymakers often as swept up as the investors in bubble manias, from subprime housing securities to NFTs. And coming from the financial world in general and Wall Street in particular, the Fed’s Board seldom wants to interrupt the real profits made during market bubbles or to spoil the manic mood. Then when the bubble crashes, partly due to the Fed declining to regulate markets or at least lift interest rates (which tends to limit bubbles since they often thrive on cheap credit for buying and flipping assets), the bank tends to overreact and flood the market with cash to help stimulate the economy to limit the recessions that often follow. The effect is indeed to enable market bubbles.
But as usual, the moment the historical record is considered, the right-wing argument collapses like a Jenga tower in the hands of an underage drunk. After all, the Fed was first created as the banker of last resort in 1913 to put an end to one of the worst features of the capitalist golden age of the 19th century. This period of unregulated markets, no income taxes and almost no inheritance taxes, almost no labor unions, and no meaningfully-enforced antitrust law, was known as the Gilded Age. That gloriously pre-Federal Reserve, small-government period was a nonstop nightmare roller coaster of alternating feverish booms and terrifying crashes. Blaming the Fed Board for the horrors of today’s preposterous bubbles and financial crises of Wall Street slimeballs is pretty typical shallow-ass weak-sauce right-wing evasion of the horror show that free financial markets have turned out to be.
Better Red Than Fed
The critique from the Left has the advantage of being in touch with reality. The Fed is run by a revolving door of big-time finance capitalists, is completely insulated from any democratic processes which socialists tend to favor, and takes the low-inflation mandate far more seriously than the part that involves getting jobs for working-class people, who also tend to suffer the most in the recessions wrought to calm the price level.
Putting the “End the Fed” libertarian demand into practice would return us to 1907, when the judgment of J.P. Morgan alone was the only hope to steer banks around gigantic crashes. Socialists may not have a perfect vision of the future of monetary policy making, but there are thoughtful progressive proposals to remove the outright control of the regional banks from the financial services industry, and to put some accountability on the Board’s policy moves. Clearly, keeping the Fed utterly insulated from any democratic influence is offensive to anyone who believes in worker control of the economy.
Managing today’s turbulent economic crosscurrents—beset by stubborn inflation (anathema to Wall Street) and the perennial perception-obsession of market panics—would require a level of technocratic competence seldom seen in today’s ruling class. Time will tell how well Powell’s board carries out its effort to suffocate hot prices while avoiding recession and now larger financial disasters. But we can say this: it will use as much secrecy and technocratic independence of democracy as possible, and will with absolute certainty try to fix the mounting problems of our era on the back of the working stiff.
The Fed is a creature of capitalism and will use its market operations to restore the status quo that sees Americans running online fundraisers for health expenses while billionaires fly private jets overseas for high-end cosmetic surgery. A socialist revolution worth its salt will see the Reserve getting its just deserts.