The United States prides itself as being a world economic leader as a free market-based nation. And, for the most part, this is assertion is true: the economy of the U.S. is based upon the ideal of an unfettered, free market system. However, there are in place a number of regulatory mechanisms that help keep the free market in the U.S. from careening out of control during times of unusual instability. One of these regulatory mechanisms is the Federal Reserve System, a.k.a. "the Fed."
Why The U.S. Is Not A Pure Free Market System
Capitalism, in its purest form, is based upon the idea of individual actors (people, non-profits or corporations) who are always trying to make decisions that will ultimately maximize their ability to accumulate wealth. In theory, it is very much a sink-or-swim ideology: each actor competes with the others given the skills and resources at their disposal, but each is ultimately on their own in terms of any type of governmental help.
In reality, however, there is no economy in the world that operates purely on this ideal; and, the U.S. is no exception. Over the years since it was founded as a nation - and especially during the 20th century - the U.S. Congress has enacted a series of measures to help regulate the economy, protect corporations and protect consumers. Some examples of such governmental controls that have been established over the years include:
* the Securities and Exchange Commission (SEC), which regulates how companies buy and sell stocks
* the Social Security Administration, a government-run program to help individuals maintain a certain income after retirement
* the Food and Drug Administration, which regulates the sale of pharmaceuticals and food products from a consumer safety perspective
One of the most significant innovations in terms of these government control measures was enacted in 1913 with the Federal Reserve Act. The goal was to create a safer, better-controlled banking system that protects the rights of banking customers. One of the most important roles of the Fed is to regulate banks and lending institutions.
The Role Of The Fed In Regulating Banks And Lenders
The Fed regulates banks and lending institutions in a number of ways. Here is how the Federal Reserve regulates banks:
1. Extends loans to member banks based upon the "discount rate." This discount rate trickles down to the rest of the economy, having an important influence on determining lending interest rates for everything from bank-to-bank loans (paid at the federal funds rate) to commercial lending to consumer auto loans and mortgages.
2. Defines some of the conditions under which banks can extend loans.
3. Mandates that any bank that calls itself a "national bank" must maintain minimum levels of funds in one of the 12 Federal Reserve banks, the amount which is determined as a percentage of total savings and checking account deposits. These are broken down into two categories: required reserves (usually 10 percent of total customer deposits) and excess reserves (any amount beyond the required reserves amount).
4. Requires regular and ongoing examinations of national banks and their affiliates by the Fed.
5. Regulates overall monetary supply through the sale of U.S. Treasure securities. By selling securities, banks pay for them by drawing on their own reserves. This serves to reduce the monetary supply in the open market. By buying them back, it increases the supply.
6. Establishes a nationwide check clearing system in order to ensure that checks written can be cashed properly and without delay, thereby improving confidence in the financial system.
7. Consumer credit-related legislation, such as the Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009.
Through powers and responsibilities like these, the Fed can take actions vis-a-vis banks that influence the stability of the national economy, the cost of money (by influencing the interest rate), and the degree and nature of banking consumer's rights.
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