Fed should NOT be expanded to be a “kitchen-sink” agency --- undermines its effectiveness

(Lev Menand, Associate Professor of Law, Columbia Law School, “The Logic and Limits of the Federal Reserve Act,” 40 Yale J. on Reg. 197, pg lexis//um-ef)

The Fed, I argue here, is the capstone of the American Monetary Settlement. Congress built it to administer the investor-owned banking system and to stabilize it both economically and politically. Drawing on the text, structure, and legislative history of the Federal Reserve Act (FRA), as amended, I argue that today's Fed was designed to address three problems with monetary outsourcing that contemporary scholars and commentators tend to overlook, underplay, or misunderstand: monetary contraction, an uneven playing field in the banking system, and a lack of public accountability and control. I then use this understanding of the statutory scheme to answer questions left unsettled in the existing literature. First, I show that the Fed is not a kitchen-sink agency: its core statutory tools all relate to its monetary mission, as does the justification for its [*204] substantial independence from executive oversight and judicial review. Second, I explain why the Fed's expanding activities since 2008 are largely the product of a shift in the underlying structure of the banking system: the rise of financial firms that issue alternative forms of money without bank charters. Third, I consider three downsides of the gap between the Fed's enlarged footprint and the logic animating its enabling act.

The Article proceeds in five parts. Part I provides what I believe to be the critical historical and legal context. It reconstructs the U.S. monetary framework and explains the central role played by investor-owned banks. The money these banks issue is known as deposits. People use deposits to pay their credit card bills, receive their salary, and make their rent. And although banks back deposits with a promise to pay a type of money issued directly by the government ("cash"), most people prefer deposits to cash. While roughly $ 2 trillion in cash is in circulation,37 there are around $ 18 trillion in deposits.38 This monetary expansion is possible because banks do not need cash to issue deposits, which they create with a keystroke.

To check the power of banks, legislators limited them in three ways: (1) separating them from "commerce," that is, from nonmonetary business activity; (2) restricting their ability to merge and branch, diffusing them geographically; and (3) subjecting them to intensive oversight by special government officials known as supervisors. These core features of banking law separation, diffusion, and supervision were designed to sustain outsourcing. Legislators believed that delegating the power to create money to organizations owned by private investors was worth the effort; the alternative, they thought, was government corruption, economic stagnation, and the expropriation of private property by legislative majorities.

Part II reexamines the Fed's enabling act in light of this understanding of money and banking. It argues that the Fed was not established as a "central bank" on the model of its European predecessors, which were investor owned and operated institutions engaged in a general banking business with the public. Nor was the Fed established to issue the entire money supply itself. It is a government monetary authority a super supervisor built to administer a decentralized system in which the power to expand and contract the money supply rests in the hands of thousands of investor-owned banks. Today's Fed is designed to perform three primary functions with respect to this system (addressing the three problems with monetary outsourcing mentioned above): (1) stimulate banks to create enough money to keep the country's economic resources fully employed; [*205] (2) level the playing field among banks, large and small; and (3) serve as a site of public accountability for and control over the investor-owned banking system. Although Congress charged the Fed with other tasks at various points in its history, these are the core responsibilities reflected in current law and which Congress has repeatedly reinforced.

A series of conclusions follow in Parts III, IV, and V. Part III elucidates the Fed's place within the federal government. First, it explains why the Fed's organizational structure is coherent (which is not to say optimal). Its instruments, often treated as unrelated by both practitioners and scholars, serve a unified purpose: lending, purchasing, rate setting, rule writing, supervising, and facilitating payments are all ways that Congress empowered the Fed to regulate the supply and distribution of bank deposits. Interest rate targeting (commonly known as "monetary policy") and traditional bank regulation (including both rule writing and supervision) are different sides of the same coin: both stimulate and restrain bank balance sheets. The Fed's intensive involvement in bank operations reflects the fact that in a system that relies on banks to issue most of the money supply, ensuring an adequate quantity of money requires monitoring its quality (i.e., the solvency of banks). Meanwhile, the Fed's "lender of last resort" role, often treated as another distinct function, is also a mechanism of monetary control: Congress authorized the Fed to lend to banks to stabilize the size of their balance sheets and to lend beyond banks in unusual circumstances when the banking system has broken down.

Part III also ties the logic underpinning the Federal Reserve Act to the Fed's unique institutional design. The Fed's twelve regionally controlled FRBs most of whose directors are appointed by investor-owned banks reflect the role of private investors in, as well as the diffuse nature of, the American banking system. The Fed's relative insulation from executive oversight and judicial review, meanwhile, reflects distinctive separation-of-powers concerns that date back to the Founding (and England's Glorious Revolution before that). Many of the legislators who championed our banking system, including the Fed, understood money issuance to be a type of fiscal power, an alternative to taxing or borrowing that could be used to facilitate government spending. Accordingly, they designed the Fed and the banking system to be accountable primarily to Congress rather than to the President or the Federal courts.

Part IV uses Part II's account of the Federal Reserve Act to make sense of the Fed's recent lending, borrowing, and purchasing programs. It argues that the Fed is increasingly using its statutory powers in unexpected ways to maintain order in a monetary system that has spun out of control.39 The root problem is [*206] shadow banking: firms without banking charters (like broker-dealers, hedge funds, money market funds, and foreign financial institutions), which operate outside the confines of U.S. banking law. These firms create dollar-denominated deposit substitutes that also function as money. While these alternative forms of money are used primarily by businesses and institutional investors (not ordinary people), over the past thirty years they have come to represent an increasingly large share of the total money supply at times more than half.40 The Fed has responded by attempting to carry out its apex mission, monetary expansion consistent with full long-term capacity utilization, in a world that has evolved beyond the imagination of the legislators who crafted its enabling act. The Fed's post-2008 lending programs, ballooning balance sheet, and efforts to aid ordinary households and businesses are products of this shift in the composition of the money supply and the economic instability to which it gave rise.

The result a Fed unbound, so to speak has prompted a further crisis, one of ultimate aims and limits. Part V contributes to the debate over the Fed's proper remit by drawing on the logic of its enabling act and its place in the U.S. monetary system. The Fed was carefully constructed to carry out a complex and charged task. When the Fed deviates from the statutory scheme to accommodate the existence of monetary instruments issued by shadow banks, it threatens key legislative goals and jeopardizes the long-term political and economic durability of monetary outsourcing. The Fed's growing footprint also raises questions about its ability to carry out its activities effectively and equitably and to do so without undermining the vitality of the democratic process. Legislators, I conclude, should modernize the Federal Reserve Act and amend Title 12 of the U.S. Code to restore the structural integrity of the banking laws and improve the fit between the Fed's tools and its responsibilities.

I. The U.S. Legal Framework for Money and Banking

The Federal Reserve is a government organization that issues paper notes used for hand-to-hand transactions. Corporations owned by private investors, meanwhile, issue deposit account balances, which are an even more common means of payment and store of value. One approach to understanding the Fed the dominant one in recent decades is to separate these domains and examine them piecemeal. This approach treats the Fed as a public monetary institution and banks as private financial intermediaries profit-oriented firms that borrow government-issued money from savers and lend it out to borrowers.41 On this view, banking is like any other commercial business and the state regulates it to address specific market failures.

[*207] A growing group of scholars has challenged this view of banking, noting that banks, unlike other financial intermediaries or commercial businesses, do not need government-issued money to lend; bank deposits function as a distinct form of money. But these scholars have primarily disputed the "intermediation paradigm" on conceptual grounds.42 This Part deepens the critique by recovering the historical and legal foundations of banks as monetary institutions. It argues that American banks do not merely function as monetary institutions; they were designed to function as monetary institutions. Chartered banks in the U.S. are part of an outsourcing scheme for monetary expansion, and U.S. banking law is animated by concerns about delegating public power to profit-motivated investors. Recovering these political economy dimensions of U.S. banking law, the core of which I call the American Monetary Settlement, is critical to understanding the purposes and functions of the Federal Reserve, an organization that Congress created to superintend and strengthen a monetary system comprised primarily of investor-owned banks.

A. English and Early American Antecedents

As with other foundational elements of the American state, the U.S. monetary system has its roots in England. There, beginning in the 1690s, Parliament, the Crown, and London business elites worked out an unprecedented economic arrangement, which included three key features.43 The first was delegation: Parliament and the Crown repudiated their traditional role in managing the money supply. Instead, they fixed the exchange rate between government-issued money, known as pounds, and gold and silver metal, and they pledged to neither alter the exchange rate nor issue money without gold or silver backing.44 To expand the supply of money, Parliament chartered the Bank of England, an investor-owned corporation. Parliament authorized the Bank of England to issue two new forms of money: paper notes and deposit account balances.45 The Bank collateralized these notes and deposits with promises to [*208] pay gold and silver coins denominated in pounds, but the Bank did not hold sufficient coins to make good on these promises. The notes and deposits were not bailments; they were an additional form of money that the Bank intended to keep convertible with government-issued money at par. And people for the most part treated the Bank's notes and deposits as equivalent to gold and silver coins (rather than as investments in the Bank). The Bank was not an ordinary commercial enterprise; it was a public instrumentality.46

It is worth dwelling briefly on the result of this arrangement. Whereas the government's ability to issue more money was constrained by the supply of gold and silver, the Bank could issue as many notes as the populace was willing to use without redeeming them for government-issued coins. It did this primarily by using them to make loans. The Bank, therefore, was in control of "monetary policy": unlike the government, it could adjust the supply of money, through lending, to spur economic expansion or contraction.

The second feature in England's innovative system was separation. To limit the Bank's power and prevent it from monopolizing ordinary trade, Parliament prohibited the Bank from engaging in commercial activities.47 The Bank could deal in gold and silver, lend, and issue notes, but it could not compete with its nonfinancial customers. Private investors mostly merchants were recruited to operate the Bank. But they were not allowed to use the Bank to interfere in "private" business activities.

A third characteristic of the English model was monopoly privilege: to bolster the Bank's financial position and prevent competing entities from augmenting the money supply, Parliament pledged not to charter any other "banks of issue." It also prohibited corporations and private partnerships (consisting of six or more people) from circulating paper notes.48 The result was a franchise system. Much private currency was snuffed out. A government-run mint ministerially supplied a base of metal-backed coins. And a governmentchartered, investor-owned bank expanded the supply of money in a discretionary manner by issuing paper notes and deposits.

A century later, with each of these features firmly established in Britain, Congress set up a similar arrangement in the United States.49 Congress [*209] established a new monetary unit of account, the U.S. dollar, and fixed the price of dollars in terms of gold and silver.50 It further pledged not to issue dollars without gold or silver backing.51 To expand the supply of dollars, Congress chartered the Bank of the United States (BUS), a federal corporation owned primarily by private investors. Congress prohibited the BUS from engaging in ordinary business and promised that federal legislators would not charter any other banks.52 Although Congress did not take steps to prevent states from setting up parallel quasi-governmental institutions, these state banks were subject to significant informal regulation by the BUS.53

But this English-inspired monetary system did not take to American soil. The central problems were political. First, the owners and managers of the BUS resembled a financial oligarchy. As one writer put it in 1819, "the congress of the United States, by the charter of the [BUS], has lost the power to control its concerns in their most essential particulars."54 By allowing the Bank to expand the money supply, Congress lodged "vast power . . . in the hands of less than fifty individuals, who may make the whole monied capital of the United States bow to them, or suffer incalculable derangements and loses."55 To the Bank's critics, this was "an aristocracy worthy [of] the resistance . . . an aristocracy paramount to the law of the United States, and only to be subordinated by the reserved rights of the individual states, and the force of public opinion."56

The second problem was that the new bankers were mostly Federalists. Partisan entrenchment, even more than the bank's oligarchic character, proved fatal. While Secretary of the Treasury Alexander Hamilton and others anticipated sustained opposition to banking from Thomas Jefferson and his allies, they did not foresee the emergence of the two-party system and the subsequent movement by Jefferson's party to charter "Republican" banks to compete with the BUS and its state cousins. As Jefferson's party took control of state governments and the number of state banks grew, so did resentment of the BUS and its de facto control over these local competitors. When the Bank's charter expired in 1811, Congress declined to renew it. Policymakers chartered a second BUS in 1816 (this time attempting partisan balance). But during the five years without a federal bank, [*210] the states had multiplied their own banks (to fill the void), expanding a constituency (state bankers) who lobbied to eliminate the new federal instrumentality. In 1832, the state bankers prevailed, and President Jackson vetoed a bill to renew the federal Bank's charter.57

B. The American Monetary Settlement

Over the next forty years, amidst intense social and political struggle, a new monetary configuration emerged, what I call the American Monetary Settlement. The American Monetary Settlement still undergirds our money and banking laws today (although, as we will see, its policy aims have been seriously undermined by subsequent regulatory and financial developments). It has four key features: delegation, separation, diffusion, and supervision. This Section unpacks each of these features and their distinctive political economy. In so doing, it lays the groundwork for understanding why Congress ultimately created the Fed to strengthen the American Monetary Settlement, and in particular to enhance supervision and preserve delegation.58

1. Delegation

Delegation is at the heart of the American monetary system. Specially chartered, investor-owned banks, rather than government agencies, issue most of the money in the United States.59 Today's legal framework dates to the Civil War, when Congress passed the National Bank Act (NBA).60 The NBA established a system of "national banks," which legislators imagined would be like a third Bank of the United States split into hundreds of parts.61 The biggest [*211] issuers today include organizations like Chase, Wells Fargo, and Bank of America. These banks are federal corporations chartered administratively by the Office of the Comptroller of the Currency (OCC), a quasi-independent bureau in the Treasury Department.62 In 1933, Congress added a series of further federal banks for special purposes. The most important of these are called savings and loan associations or "thrifts" and are designed to promote homeownership.63 Although at several points, federal legislators aimed to wholly displace statechartered banks, they never succeeded. Congress still permits states to charter banks, which the federal government strictly regulates through a variety of federal laws.64

State- and federally chartered banks (and thrifts) are designed to expand the money supply.65 Each issues its own money in the form of deposit account balances recorded on its books.66 Deposit account balances function as an alternative to government-issued cash they can be used to make payments by check or wire. But they are not truly equivalent to cash, as banks do not hold cash to back them. And even though banks promise to pay their depositors cash on demand, these promises are not meant to be kept, at least not at scale. Banks generally hold very little cash and can create new deposits at a keystroke. Most transactions settle on bank books without any government cash ever changing hands.67

Today, the reasons why Congress delegated the power to issue money to banks are submerged. Drawing on models in financial economics, scholars tend to assume either that the government issues the whole money supply and that banks are mere intermediaries,68 or that the system of investor-owned money issuers is the product of private ordering, with the government intervening [*212] largely to prevent instability.69 Either way, scholars overlook the various rationales that underpin delegation.

The first step to understanding the Fed, therefore, is to denaturalize delegation. The U.S. banking system was not the organic byproduct of market forces. It was actively constructed by the government. Delegation was a policy choice. And it implicates not only matters of efficiency and stability, but also broader issues of political economy. Delegation, for example, limits the role of the government in credit allocation and the power of political majorities to redistribute resources. It also entrenches elites, who tend to control banks and hence access to money and credit. When many of our banking laws were written, these dimensions of banking law were at the forefront of the public discussion.

It is worth examining briefly the leading arguments advanced in favor of outsourcing: (1) preventing inflation, (2) protecting property rights, (3) strengthening the government, and (4) averting public corruption.70

Preventing inflation was perhaps the most significant motivation. Congress delegated ownership of banks and thrifts to managers selected by private shareholders because policymakers believed that "hybrid money" was the best money.71 Only by recruiting investors motivated by profit, the thinking went, could the state expand the money supply beyond gold and silver without undermining confidence in the currency.72 One problem was that if the government issued paper and deposit money directly, legislators could use it to pay for current consumption.73 Another problem was that the mere prospect of government overissue might lead people to dump dollars for foreign currency or other stores of value, depreciating the dollar and destabilizing the economy. Banks, according to their proponents, could create new money only in exchange [*213] for investment assets like loans (they lend new deposits into circulation). And investor-owned banks would be incentivized to make new loans only when they expected to be paid back.74 As a result, they would issue the amount of money needed for economic flourishing and no more.75

Closely related to the concern about excessive monetary expansion and maintaining confidence in the value of money over time was a desire to protect private property rights. An interest in property rights was among the primary motivations for the original English arrangement in the early eighteenth century.76 Property rights also prompted Adam Smith to criticize experiments with government-issued paper currencies in colonial America.77 And protecting property rights led members of the First Congress to charter the BUS. Many Founders saw monetary outsourcing as a critical aspect of English liberty that they wished to retain freedom from a state that could extract private wealth without levying taxes.78 The present-day insulation of the monetary system from democratic politics, on this view, is not a bug; it is a feature perhaps the most desirable feature of an investor-owned banking system. It limits the ability of redistribute resources from creditors to debtors.

A third factor that drove the government to establish investor- rather than government-owned banks is harder to appreciate today: the state's need to cultivate powerful stakeholders. Delegation took root and developed in the Anglo-American legal system during moments of state formation: in the 1690s, following the Glorious Revolution; in the 1780s and 90s, following the American Revolution; and in the 1860s, amidst the Civil War. During each of these moments, the state sought assistance from wealthy citizens. By offering these citizens a say in economic governance, as well as a steady stream of rents,79 the state gave them a reason to support it.

[*214] A fourth argument in favor of delegation was also related to state building: preventing government corruption. When the federal government established the national banking system during the Civil War, policymakers worried that it would be impossible for the Treasury during normal times to provide money "in sufficient amounts for the wants of the people" merely by spending it to pay the government's bills.80 Rather, the government would have to, on occasion, lend money into circulation, which would "convert the treasury into a government bank, with all its hazards and mischiefs."81 "No Government," one leading congressman worried, "can perform the functions of a bank by loaning money without becoming corrupt and progressively arbitrary and despotic."82

2. Separation

Much of the rest of American banking law was designed to make delegation politically palatable and institutionally durable. This is especially true of separation. Separation dates to the 1690s, when Parliament chartered the Bank of England. The very first U.S. bank charters included separation provisions83 prohibiting banks, which were considered quasi-governmental enterprises, from entering the "private" sphere of ordinary commerce.

Today, separation is codified in the NBA, among other places.84 The NBA authorizes banks to exercise only "such incidental powers as shall be necessary to carry on the business of banking," which the law defines as issuing notes and deposits, making loans, discounting bills, and dealing in precious metals and foreign currency.85 Congress designed the NBA to bar banks from using their power to create money to compete with nonmonetary businesses, including financial firms like securities dealers and wealth managers.86

During the 1930s, Congress blocked banks from skirting these restrictions by affiliating with businesses that shared ownership and management personnel.87 It also barred everyone else from engaging in banking (i.e. issuing [*215] deposits) without government authorization.88 In 1956, to close further loopholes, Congress passed the Bank Holding Company Act (BHCA), which it strengthened in 1966 and 1970 to prevent evasion.89 Although regulators and courts weakened these statutory barriers, especially from the 1980s on,90 legislators have only once significantly liberalized separations: in 1999, Congress authorized "Financial Holding Companies," affiliations of banks, securities dealers, and insurers under a single corporate umbrella.91

Although the "separation of banking and commerce" has attracted increasing attention since the 2008 financial crisis, this attention focuses on a stability rationale, a relatively recent reason for limiting the activities of banks and their affiliates.92 This rationale also tends to take the distributional politics out of monetary system design.93 Until the Great Depression, the animating legislative purpose behind separation was to prevent unfair trade practices and the undue concentration of private power.94

The concern that, wielding their monetary privileges, bankers would infringe on commercial liberty is coeval with the decision to delegate monetary powers to investor-owned banks. Parliament wrote into the law its reason for barring the Bank of England from the "buying or selling of any Goods Wares or Merchandizes": it did not want the Bank to "oppress[]" the merchants it was designed to assist.95 This purpose is unsurprising. The Whigs who forged the English monetary framework (and championed the Bank of England) were trying to protect commercial freedom from what they considered an extractive and [*216] arbitrary government; they certainly did not want to escape oppression by the Crown only to find themselves oppressed by the Bank.96

Following America's first "bank war" in 1787, Pennsylvania copied Parliament's language almost verbatim into the charter of the country's first bank, the Bank of North America.97 Similar concerns motivated separations provisions in the 1790s, 1810s, 1830s, as well as at each critical moment when current law was enacted: 1863, 1933, 1956, and 1966.98 As Congressman William Bourke Cockran put it in 1895, bank money "is not issued for the benefit of the banks, but principally for the benefit of the depositors. Banks can not absorb all the profits of industry. They are the servants, not the masters of commerce."99

Relatedly, Congress restricted bank activities to preserve political liberty by checking the power and influence of the people who run banks. Again, the concern goes all the way back to the creation of the Bank of England. As one London merchant wrote in 1707:

It's impossible to foresee all the Mischiefs that may happen by a Confederacy of such as are Directors both of [the East] India Company and Bank of England; for what cann't Two so Powerful Bodies by their United Force bring about? What cann't they Promote or Obstruct in Parliament, wherein they Interest themselves? . . . Especially having the Nation's Purse at their Girdle . . . we can never again hope to retrieve the Fatal Oversight, since those that have got the Power will never part with it . . . .100

This same concern the possibility that private power could corrupt representative government features in U.S. legislative debates from the 1790s to the 1980s.101 And it is reflected in current law, which authorizes the [*217] government to block acquisitions of bank shares not only when officials conclude that it "is necessary to prevent . . . decreased or unfair competition [or] conflicts of interest" but also if they determine that it is needed to prevent the "undue concentration of resources."102

Stability is by comparison a rather recent rationale for separating banking and commerce. It arises for the first time in the 1930s, in response to evidence that banks affiliating with securities dealers can reduce the integrity of the money supply.103 It appears again in the legislative history of the BHCA.104 And it features heavily in contemporary debates about reversing the fusion of banking and various financial businesses in the 1980s and 1990s.105 For example, in 2010, Congress rolled back banks' authority to deal in swaps (a type of financial derivative).106 Proponents of these measures did not justify them as necessary to prevent banks from monopolizing these markets, even though banks were, in fact, monopolizing them. Instead, they argued that separations were required to protect taxpayers from losses that banks might incur through these activities.107

3. Diffusion

Separation alone proved insufficient to sustain delegation in the United States.108 Following a tumultuous period of experimentation that culminated in the Civil War, Congress adopted a new approach to money that New York pioneered in the 1830s and that over a dozen states later implemented [*218] successfully: diffusion.109 Congress enabled anyone to apply for a charter to open a national bank110 and created a special government bureau, the OCC, to process applications.111 The idea was to eliminate the special privileges associated with legislative chartering, as well as to disperse the power to expand the money supply across many different people and geographic regions. To that end, Congress sought also to prevent conglomeration.112 For most of U.S. history, this meant no branching banks were limited to one location.113 While Congress reversed many of the federal restrictions in the 1990s,114 leading to the emergence of large, complex banking organizations,115 the U.S. banking system remains highly diffuse compared to other countries.116

Today, scholars take the core principles of diffusion for granted. But multiplying banks and reducing their size was a major policy shift in the early republic. Indeed, many at the time viewed it as irresponsible,117 as they believed that diffusion would lead to excessive competition, which would weaken banks, increase the chances of bank failure, and undermine stability. Policymakers have generally cited four reasons for running these risks: (1) democratizing money creation; (2) preventing corruption; (3) checking private power; and (4) promoting accountability.118

Democratizing money creation was New York's original impetus for adopting administrative chartering in 1838. A political movement, which catapulted Andrew Jackson to the White House and nearly splintered the [*219] Democratic Party, held that money creation should not be a privilege reserved for a select few, but freely available to all. "It is but justice and good policy," President Jackson explained in his message vetoing the recharter of the second BUS, "to let each in his turn enjoy an opportunity to profit by our bounty."119 According to Jackson, the government should pursue "equal protection, and, as Heaven does its rains, shower its favor alike on the high and the low, the rich and the poor."120 If Congress insisted on delegating its control over monetary expansion to private actors, it had to do so on principles of open access.121 The alternative, Jackson and others argued, offended the Constitution.122

These advocates were also concerned with preventing corruption, as the history of legislative chartering in the country was rife with scandal.123 Officials hoped that diffusion would eliminate bribes and other foul play and that administrative chartering would free the legislature from both the appearance of picking winners as well as the unsavory dealing involved in passing private bills, two significant problems in antebellum politics.124

Additionally, diffusion was designed to split apart the power to issue money to such an extent that no single bank enjoyed too much stature and importance. As President Franklin D. Roosevelt explained when he called on Congress to prevent banks from conglomerating through holding company structures, "the liberty of a democracy is not safe if the people tolerate the growth of private power to a point where it becomes stronger than their democratic state itself."125 Moreover, in a system dominated by one bank, like the BUS, balance sheet expansion faces few exterior constraints when the bank makes new loans, it knows that any cash it pays out to borrowers will find its way back to the bank after the borrowers spend it. In a system with many banks, by contrast, banks check each other, disciplining overissue. A diffuse system also offers people a choice over which bank's money they hold, which incentivizes banks to be responsive to deposit holders, reduces oligopoly abuses, and opens new avenues to access bank credit.

Finally, diffusion was meant to increase accountability. In a system where banks are small and numerous, bankers are local.126 The BUS, which loomed as a bugbear in American money matters well into the twentieth century, was a distant and alien power to most Americans. The National Bank Act created a [*220] system in which bankers tended to live in the communities they served,127 enhancing their legitimacy and increasing the likelihood that their communities would prevent them from abusing their franchise. To quote President Roosevelt again: private "power [over banking resources] becomes particularly dangerous when it is exercised from a distance."128

4. Supervision

Diffusion necessitated a further innovation: a new form of technocratic administration to manage a dispersed monetary system. With the government no longer handpicking its franchisees, and with so many franchisees spread about the country, legislators commissioned officials to coordinate banks to ensure that they worked together and in the public interest. Known as "supervision," the mode of governance that emerged is distinct from modern rulemaking and adjudication (as well as the common agency practice of issuing general statements of policy and other guidance). It is "extensive and informal."129 It proceeds through iterative, ongoing, firm-specific engagement. It tends not to involve any final agency action at all. Through ongoing examination, dialogue, and confidential letters, supervisors share their concerns with banks, and banks adjust their activities.130 This practice of comment and response is rooted in (and takes place in the shadow of) "capacious [statutory] approval powers, monitoring rights, and remedial authorities."131 These authorities permit agencies to discipline banks not only when bankers break bright-line legal rules, but whenever, "in the opinion of [the agencies]," bankers are engaging in, have engaged in, or are about to engage in "unsafe or unsound practice[s]."132 ("Although there is in fact an iron hand within the velvet glove of the banking authorities, the glove is seldom removed."133)

New York and Massachusetts laid the groundwork for supervision in the 1830s and '40s when they first began to diffuse the banking franchise. During the Civil War, Congress imported some state supervisory practices as part of the National Bank Act. Congress later enhanced supervision in the 1930s and reinforced it at least once each decade beginning in the 1960s.134 In the late 1990s [*221] and early 2000s, as the financial sector conglomerated, supervisors disarmed, and supervision as a distinct mode of governance fell out of the legal imagination.135 But following the 2008 crisis, officials revived supervisory oversight and its statutory purposes have received renewed attention.136 These purposes include (1) protecting the public interest in, among other things, monetary stability, (2) promoting confidence in the money supply, and (3) checking the power of bankers.

As in any franchisor-franchisee relationship, the government-banker relationship is fraught with conflicts of interest.137 To protect the public, policymakers decided that banks ought to be "supervise[d] [by the government] to see to it that they conform to certain high standards."138 To this end, three federal banking agencies alongside state regulators write and fill gaps in regulatory rules, promote sound bank money, and manage the government's financial exposure to bank balance sheets. Using stress testing, examinations, and continuous dialogue, supervisors ensure that banks hew to their public purposes and do not take advantage of their special privileges to extract rents.

Supervisors also promote confidence in banks. Since each bank issues its own money, each bank is vulnerable to runs by depositors and other short-term creditors who lose confidence in its operations. Supervisors offer an official stamp of approval.139 One role that supervisory stress tests have played in recent years, for example, is signaling to market participants that bank money is just as good as cash, and that the government stands behind it.

Finally, as with separation and diffusion, supervision mitigates concerns about overmighty bankers. Supervisors limit banker discretion and uncover abuses. When faced with instability or scandal in the banking system, Congress has invariably responded by both blaming supervisors140 and enhancing their power.141 It was during one particularly turbulent period that Congress decided [*222] to expand government control over banking through the creation of a new and more powerful supervisor: the Federal Reserve.

II. The Forgotten Logic of the Federal Reserve Act

When Congress created the Federal Reserve in 1913, the key features of U.S. banking law were over fifty years old. Thousands of investor-owned banks legally separated from commercial enterprises, largely controlled by local executives, and subject to close oversight by special state and federal officials issued most of the money in the United States. Yet monetary outsourcing remained politically and economically unstable. With each bank operating for profit, no bank had an incentive to look out for the system as a whole. When moments of economic uncertainty emerged, bank counterparties lost confidence in the value of bank assets, which produced monetary contractions and severe economic depressions. During these periods, Americans were exposed to the private power of prominent bankers and bankers' associations located in big cities like New York and Chicago.142 With each passing year, these actors became stronger, leaving southern and western regions starved for money and credit, especially during downturns.143 Limited in their regulatory tools, supervisors were unable to mount an effective response. Meanwhile, grassroots movements and Democratic Party leaders agitated for government control of the money supply, unwilling to accept the role investor-owned banks played in economic and public life.144

This Part shows how Congress designed the Federal Reserve to respond to these challenges: periodic deflations, an uneven playing field among banks, and insufficient public accountability and control. It contends that separation, diffusion, and supervision as they existed at the turn of the century were not sufficient to sustain delegation in the United States. Congress established the Federal Reserve Board in 1913 as a "super supervisor" to administer the banking [*223] system. Not satisfied with the initial results, Congress later amended the law on several occasions to better address these same problems.

Drawing on legislative debates, committee reports, statutory text, public speeches, private correspondence, and newspaper accounts, I argue that current law the product primarily of bills passed in 1913, 1933, 1935, 1977, 1978, 1980, and 2010 reflects three overarching legislative purposes: (1) to promote full capacity utilization in the economy by stimulating bank monetary expansion over time; (2) to ensure a nationwide, level playing field in the investor-owned banking system; and (3) to enhance public accountability and control over monetary conditions.145 Read in pari materia with the other statutes governing money and banking, the Federal Reserve Act is both a technical fix for a malfunctioning monetary system and a rebalancing of the American political economy toward public control over macroeconomic and financial conditions.

In recovering the Fed's core statutory purposes, this Part also addresses a series of what I believe to be misconceptions and omissions in the economic and legal literatures. First, it argues that the common view that the Fed is meant to trade off maximum employment and price stability as two independent goals146 is ahistorical and legally ungrounded. The legislators who wrote and revised the Federal Reserve Act were primarily concerned with ensuring monetary expansion sufficient to achieve full capacity utilization in the economy over the long term. For them, overissue of money by banks was troubling insofar as it led to economic instability, subsequent monetary collapse, and job loss. But combatting price level appreciation in the short or medium term caused by factors like supply shocks was not understood to be a primary objective of Fed policy. Second, I draw attention to insufficiently appreciated infrastructural aspects of the Federal Reserve Act. The Fed is not just a macroeconomic steward. It is also an institutional framework for counteracting the regional concentration [*224] of money and credit, as well as certain types of abuses within the banking system. To this end, the Fed is designed to facilitate interbank payments clearing checks, processing wires, and operating an automated checking electronic transfer network. Finally, I emphasize the Fed's novelty. With the Fed postdating institutions like the Bank of England, Bank of France, and Reichsbank by decades and in some cases centuries, many scholars treat the United States as a copycat.147 By contrast, I see the Fed as the first of its kind: a public monetary authority that administers bank monetary expansion to advance public purposes.148 When the Fed was established, its counterparts like the Bank of England were investor-owned banks, nationalized only decades later. When it comes to what today is considered "central banking" that is, the discretionary management of monetary conditions by public officials America led the world, not the other way around.149

A. Maintaining Bank Balance Sheet Expansion

A kitchen-sink approach to the Fed one that treats bank regulation, lending, and interest rate policy as various, unrelated responsibilities obscures the Fed's primary purpose throughout its history: counteracting the banking system's tendency toward monetary contraction. This pathology was the impetus [*225] for the original Federal Reserve Act. It also triggered the two most significant amendments to the law the Banking Act of 1935150 and the Federal Reserve Reform Act of 1977 (FRRA).151 The latter statute articulated an explicit mandate for the Fed: "maintain[ing] long run growth of the monetary and credit aggregates commensurate with the economy's long run potential . . . so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."152 This mandate is misunderstood today as a "dual mandate" to manage two competing goals: maximum employment and price stability. But the law in fact charges the Fed with a single goal: promoting full capacity utilization in the economy by ensuring adequate monetary expansion over time. It comes from a New Deal-era law, the Employment Act of 1946, and is a refinement on the Fed's initial stabilization remit.

1. The Initial Stabilization Remit

If one adopts a model of banks as private intermediaries (that merely pass along money created by the government) then monetary policy will appear to be a function only of the federal funds rate, which is an overnight interest rate that banks charge each other for cash and which varies based on the size of the Fed's balance sheet. But this is not how many of the legislators who designed the banking system thought about banks. As discussed in Part I, U.S. legislators established banks to create money as well as to lend it. And when they outsourced this power to expand the money supply to investor-owned banks, they hoped to avoid politically motivated overissue.153 What many experts eventually came to recognize is that the investor-owned banking system was also prone to periods of chronic underissue sometimes as a result of exogenous economic shocks, other times as a reaction to destabilizing periods of overissue (i.e., inflationary bubbles) induced by banks' drive for profit.154 These monetary contractions were extremely disruptive. They led otherwise viable businesses to fail and threw [*226] millions of people out of work.155 Preventing such contractions was one of the main reasons legislators supported the FRA in 1913.156

The Fed's expansionary function is clear in the legislative history. As the Senate Banking Committee put it: "The chief purpose[] of the banking and currency bill [i.e., the FRA] is to give stability to the commerce and industry of the United States, prevent financial panics or financial stringencies; . . . [and to] put an end to . . . the use of [bank] reserves for gambling purposes on the stock exchange."157 Or in the words of the House Banking Committee: "A general tendency toward stringency evidently exists," as the current banking system "fails to afford any safeguard against panics . . . or any means of alleviating them."158 According to the Committee, "the public has been put to great inconvenience and loss upon such occasions."159 The burden of these stringencies, they recognized, is not shared equally: it falls primarily on the poor and on debtors people who owe a nominal amount of monetary units on a loan or other obligation.

The law's key supporters, including Secretary of State William Jennings Bryan,160 President Wilson,161 Chair of the Senate Banking Committee Robert Owen,162 and Chair of the House Banking Committee Carter Glass,163 all sought to correct the contractionary tendency of the system of investor-owned banks. To Senator Owen who considered the FRA "the most important measure that [*227] has been presented to the country since the Civil War" the act was "intended to correct the chief defects in our system," the "principal" one being "no adequate protection against panics."164

The initial statute reflected the Fed's stabilization mandate in three ways. First, it authorized the Fed to issue a new currency of "Federal reserve notes" to provide "elasticity" to the monetary system, directly checking the deflationary tendencies of the investor-owned banking system.165 Second, it empowered the Fed to lend to banks (allowing officials to combat monetary contraction by alleviating pressure on banks to shrink their balance sheets).166 Third, it structured the Fed to check speculative banking practices that policymakers thought drove overissue and ultimately triggered panics.167

2. The Depression-Era Reforms

Monetary contractions continued after the Fed's founding, due to a combination of faulty institutional design, misguided policy decisions, and widespread deposit money creation by state-chartered banks and trusts operating outside of the Fed's ambit.168 In the 1930s, when the system collapsed, Congress revisited the FRA to provide the Fed with additional tools to combat contractions. In 1932, Congress empowered the Fed to expand the money supply even when banks are unable or unwilling to lend.169 In 1934, Congress gave the Fed the power to limit leverage in securities markets, aiming to reduce speculative overissue of money, which might result in asset price bubbles and ultimately trigger contractions.170 In 1935, Congress diminished the influence of investor-owned banks within the Fed itself,171 as policymakers argued that public officials [*228] would manage monetary conditions more effectively.172 For the first time, Congress also wrote explicit instructions into the law, charging the Fed with exercising its power to purchase financial assets "with a view to accommodating commerce and business and with regard to their bearing upon the general credit situation of the country."173

Another important change that resulted from the Great Depression came a decade later when Congress enacted a landmark law: the Employment Act of 1946. The Employment Act put a much finer point on the Banking Act's charge to expand the money supply to accommodate commerce and business. It required every part of the federal government, including the Fed, "to use all practicable means consistent with its need and obligations and other essential considerations of national policy . . . to promote maximum employment, production, and purchasing power."174 The Employment Act, inspired by Keynesian economic theory, represented a remarkable, explicit commitment on the part of the state to foster broad-based economic growth.

The Federal Reserve embraced the Employment Act, and played a significant role in its development.175 In a remarkable document from 1937, the Board expressly rejected arguments that the Federal Open Market Committee (FOMC) should target "price stability."176 The "broader objective of maximum sustainable utilization of the nation's resources cannot be achieved by attempting to maintain a fixed level of prices," the Board explained, and "therefore, price [*229] stability should not be the sole or principal objective of monetary policy."177 The proper goal "economic stability" entails "as full employment of labor and of the productive capacity of the country as can be continuously sustained."178 According to the Board, "[t]here are situations in which changes in the price level would work toward maintenance of stability; declining prices resulting from technological improvements, for example, may contribute to stability by increasing consumption." But there are also "situations when the restoration and maintenance of relatively full employment may be possible only with an advance in prices."179 Inflation, in other words, might be an acceptable cost, indeed a desirable one, if it resulted in greater sustainable employment. It was only price appreciation that led to economic instability and subsequent contractions, reducing employment, that policymakers sought to avoid.

3. The 1970s Amendments

Remarkably, Congress reaffirmed the Fed's role in facilitating monetary expansion and maximum employment in 1977 during a period of economic stagnation characterized by record high inflation. The text of the current mandate, codified as section 2A of the Federal Reserve Act, derives from an episode in 1975. That year, despite persistent depreciation of the dollar, Congress took the unprecedented step of directing the Fed to increase the money supply. Prominent legislators believed that the Fed's policy was too tight and had therefore increased unemployment and exacerbated the worst economic crisis since the Great Depression.180 In March, rebuffing pressure from the Fed and the administration,181 Congress approved House Concurrent Resolution 133, which instructed the Fed to "pursue policies in the first half of 1975 so as to encourage lower long term interest rates and expansion in monetary and credit aggregates appropriate to facilitating prompt economic recovery."182 The resolution further stated that the Fed should "maintain long run growth of monetary and credit [*230] aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates."183

There was nothing new in 1975 about this mandate. Policymakers saw it as redundant with the Employment Act so far as its goals were concerned.184 When Congress subsequently incorporated it into the FRRA in 1977, the key figures similarly understood the text to be merely "reaffirming the objectives of the Employment Act."185 Although the Fed's Chairman, Arthur Burns, told Congress that the Fed did not need any further instruction "we believe that our Nation is benefiting from a monetary policy that . . . is faithful to the objectives of the Employment Act"186 legislators disagreed.187 Senator William Proxmire said that while the provision was "mother and apple pie and the Fourth of July [and] also the law of the land, clearly implicit in the 1946 Employment Act," it is "essential that the Congress reassert this principle because in [the Fed's] more than 60-year history, the erratic fluctuations in the money supply . . . ha[ve] deepened recessions or depressions and aggravated inflations."188 Proxmire thus invoked the widely held view about the Fed's expansionist purpose when explaining the FRRA. The Fed's job was not to combat inflation per se it was to ensure that banks create enough money to keep the nation's productive resources fully utilized over the long term, which meant pursuing maximum employment.

[*231] To be sure, "price stability" was one of the outcomes that Congress thought an economy operating at full potential entailed, along with "moderate long term interest rates," the oft-ignored third prong of section 2A. But legislators did not expect the Fed to trade off price stability for employment,189 taking steps to reduce employment to put downward pressure on prices.190 Instead, they charged the Fed with ensuring that a lack of money (or an excess of it) was not standing in the way of these outcomes (themselves products of an economy operating at its full potential) over the long run.191 That is the Fed's sole mandate.192

At the time the law was enacted, the mandate's long run focus, monetary nature, and emphasis on employment was recognized even by those at the Fed who opposed the legislation like Arthur Burns. After stepping down from the Board, Burns, in a well-known speech, explained why he had not taken more aggressive steps to stabilize prices during the 1970s a period when rising inflation was, in his view, largely a product of nonmonetary factors.193 Burns expressly cited section 2A. Elaborating, he said: if the Fed had "sought to create a monetary environment that fell seriously short of accommodating the upward [*232] pressures on prices that were being released or reinforced by governmental action, severe difficulties could be quickly produced in the economy." "Not only that," he continued, "the Federal Reserve would be frustrating the will of the Congress, to which it was responsible . . . ."194 It was the legislature's intent that Fed officials prevent recessions resulting from monetary tightening, not induce them.

B. Leveling the Playing Field Among Banks

Although the Fed's explicit statutory mandate is monetary expansion sufficient to ensure full capacity utilization in the economy,195 legislators also cared deeply about how the Fed went about achieving this goal. Congress structured the Fed to manage the money supply in a way that strengthens local and regional banks and limits abuses by large institutions in major cities. Legislators, in other words, were not merely concerned with how much money the banking system created, but also where it was being created and who benefited from its creation. In particular, they were worried that a handful of banks might wield excessive power over the rest of the banking system through their control of interbank payment utilities known as clearinghouses. As with the Fed's expansionary purpose, the Fed's level-playing-field function dates to the Progressive Era and the problems created by delegation that prompted the Fed's founding. In 1980 and 2010, Congress made further changes designed to reinforce this function in response to changes in the structure of financial activity and in the relationship between the Fed and the banking system.

1. A Public Clearinghouse for Member Banks

Banking is a system: a single bank cannot operate for long if other banks do not accept its notes and deposits as money.196 Prior to the Fed's founding, the government played only a minor role in coordinating this system (although policymakers increasingly recognized its importance). Most of the work was done by the banks themselves. Smaller banks in less populated parts of the country developed relationships with larger banks in "money centers" like New York and Chicago. These money center banks cleared payments between banks in the periphery, allowing customers to write checks drawn on their accounts and use them to pay for goods and services. Money center banks also lent cash to smaller banks to help them manage short-term spikes in customer [*233] withdrawals.197 As the money center banks grew increasingly powerful, they were able to influence the availability of credit in distant cities and towns.198

Money center banks also played a prominent role in the private clearinghouse associations that bankers built to settle interbank payments of checks. Clearinghouses policed their members by examining them. These practices led smaller banks to allege abuse by the larger firms that dominated the management of the clearinghouses.199 Clearinghouses also issued a form of emergency currency known as loan certificates. These certificates were secured by the assets of the clearinghouse members and served as a source of elasticity when banks were forced by uncertainty or withdrawals to shrink their balance sheets.200 In a crisis, access to certificates from the clearinghouse could determine whether a bank lived or died. For example, the Panic of 1907 began in earnest when the Bank of Commerce, a money center bank dominated by J.P. Morgan, stopped clearing payments for a depository institution called the Knickerbocker Trust Company. The panic subsided when Morgan and his associates, after letting several otherwise solvent firms fail,201 authorized the New York clearinghouse to issue loan certificates to assist depository institutions facing runs.202

Public concern with the power of Morgan and other large firms grew in the aftermath of the Panic. The outrage reached a fever pitch in 1912 during the Pujo Hearings, which according to the Senate Banking Committee, revealed "a vast concentration of power in the hands of a few men over the credit system of the United States."203 In pressing Congress to pass the FRA, President Wilson asked: "What will it profit us to be quit of one kind of monopoly [Standard Oil and the like] if we are to remain in the grip of another and more effective kind?"204 To [*234] Wilson, the creation of the Fed was a question of commercial freedom. As Wilson's advisor Louis D. Brandeis explained, banks must function as "public service corporations," not purely private enterprises, and a few large banks must not be allowed to overly influence the operation of all the others.205

The Fed provided a public-oriented infrastructure to stitch together the banking system on nondiscriminatory terms. This infrastructure was intended to address the problem of private power by supplementing and largely displacing the investor-dominated clearinghouse associations and money center banks as pivot points in the payments system.206 In the original vision, the Fed was to ultimately attain universal membership which would also make the then highly fragmented system more efficient for all participants.207

First, banks were authorized to borrow from regional Federal Reserve Banks and these FRBs would be required to lend without favor.208 Unlike private clearing associations, FRBs were "always prepared to furnish [banks] with accommodation at a reasonable rate of interest."209

Second, the FRA was drafted to strengthen smaller banks by freeing them from the grip of money center institutions and tying their ability to expand their balance sheets, and hence the money supply, to the size of their regional FRBs. According to the Senate Banking Committee, this was one of the chief purposes of the FRA: to "make available effective commercial credit for individuals engaged in manufacturing, in commerce, in finance, and in business to the extent of their just deserts."210 Legislators thought the new system would make much of the existing regime obsolete, dramatically weakening the power of large banks (especially those implicated in the Pujo Hearings).211

[*235] Third, the FRBs offered banks a way to clear payments and borrow to cover liquidity needs without paying premiums. (Initially, the FRBs cleared checks and processed wires. Today they also operate an automated checking system and are developing a real time funds transfer service for retail transactions.212) No longer could large money center banks and the clearinghouses they controlled exert as much power over smaller banks outside the big cities. Policymakers hoped that the result would be reduced rent extraction, redounding to the benefit of households and businesses.213

2. Equal Treatment for Nonmember Banks

As the number of banks outside of the Federal Reserve System grew (known as nonmember banks), Congress revisited the FRA to ensure that the communities these banks served typically people in rural, less developed parts of the country were also able to access the money and payment system on equal terms. In 1980, Congress passed the Monetary Control Act, requiring the Fed to offer its services not just to its member banks but to all depository institutions regardless of their membership status.214 It further required that the Fed price its services at cost, to charge the same price to all depository institutions, and to publish its prices publicly.215 And perhaps most importantly, it changed how the Fed's reserve requirements were calculated, alleviating burdens on smaller institutions.216

3. Treatment of Nonbanks

Congress reinforced the FRA's neutrality mandate again in 2010 in the wake of the 2008 financial crisis. As we will examine further in Part IV, during the crisis, the Fed intervened at several points to support individual financial firms facing classic bank runs saving some, while allowing others to fail. Title XI of the Dodd-Frank Act of 2010 amended the Fed's nonbanking lending power, requiring that it only extend credit through facilities with "broad-based [*236] eligibility."217 This meant the Fed could not lend in ways "structured to remove assets from the balance sheet of a single and specific company,"218 as it had in 2008 to aid the merger of the independent broker-dealer Bear Stearns with the financial conglomerate J.P. Morgan Chase.219 Nor could the Fed "assist[] a single and specific company [to] avoid bankruptcy, resolution . . . , or any other Federal or State insolvency proceeding,"220 as the Fed had done for the insurance conglomerate AIG. Title XI thus reduces the likelihood that the Fed's crisis fighting programs replicate the problems with the old clearinghouse system: favored treatment for large institutions headquartered in New York, less support for smaller banks (which over time would likely result in further conglomeration), and reduced access to credit for the customers smaller banks serve.

C. Offering Public Accountability for the Banking System

A third problem with monetary outsourcing, related to the two just described, is inculcating public accountability. Although this problem was at its most severe in the decades preceding the Fed's founding, Congress initially gave the Fed relatively limited powers to check banks. After problems with public control reappeared in subsequent years, Congress amended the Federal Reserve Act, most notably in 1935, 1978, and 2010, to ensure that the Fed served as an adequate site of public accountability for the monetary system.

1. The Fed's Board as a Public Monetary Authority

The Federal Reserve Act was a compromise between the political and business establishment and a movement of Greenbackers, populists, and progressive democrats who fought for fifty years to reverse delegation and replace the national banking system with government-issued currency.221 This movement objected to the fact that the most important decisions about monetary conditions were made behind closed doors in bank boardrooms and clearinghouses decisions, moreover, that often seemed to benefit private interests more than advance the public welfare.222 By 1913, the Democratic Party was no longer willing to accept a system in which "the lifeblood of commerce" was in the hands of for-profit enterprise. As one legislator explained, money is [*237] "the yardstick by which all products of labor are measured. The control of this standard of value should be in the hands of the Government. . . . Any power that can control the volume of money, increasing it or decreasing it arbitrarily to serve selfish interests, has the power of life and death over American business and industry."223

Congress's response to this problem was to create the Federal Reserve Board, a public monetary authority designed to administer the system of investor-owned banks.224 The Board is the keystone of the Federal Reserve Act. It not only serves as a site of accountability for the banking system but actively influences and limits the power of shareholder-appointed executives who issue most of the money in the country. As President Wilson explained, "the control of the system of banking . . . must be public, not private, must be vested in the Government itself, so that the banks may be the instruments, not the masters, of business and of individual enterprise and initiative."225 Or as one member put it during debate over the bill,

[T]he great power of banking and currency, probably the mightiest tool of the people, an instrument designed to carry on the business of trade and commerce, is secured to the Government by this section . . . . I can not understand how men at all familiar with the principles of government can hesitate in deciding to place [the power] with the Government and not with the banks, because the power over the expansion and contraction of currency and credit is so great and so absolutely controls all business that as a power it must be abused if it is permitted to be exploited by selfish men or still more selfish corporations. And when abused under the form of law this power becomes tyranny and oppression.226

In 1913, no other major country had a monetary system led by government officials. All had "central banks" on the model of the Bank of England investor-owned, quasi-monopolies running a general banking business. The clients of these national champions included other banks, nonbank financial firms, businesses, and even individuals. To the policymakers who wrote the [*238] FRA, the Fed was decidedly not a "central bank": "The Federal reserve board, technically speaking, has no banking function. It is strictly a board of control, properly constituted of high Government officials, doing justice to the banks, but fairly and courageously representing the interests of the people."227 Money creation, to these statesmen, was not an obscure, technocratic challenge; it was a political matter, managed in response to the social movements that propelled and challenged the monetary system from the founding up until that point. Money creation was an act of governance.228

In 1935, following the Board's failure to prevent a severe monetary contraction, Congress strengthened the Board's control over the System and created a single policy committee to manage open market operations. It also reduced the influence of investor-appointed bank managers on Fed decisions and on the course of U.S. monetary conditions.229 In centralizing power, legislators made the Fed function more like a public version of its foreign counterparts. President Roosevelt hoped that these reforms which he paired with repairs to aspects of the American Monetary Settlement that had deteriorated in the 1920s such as separations and supervision230 would satisfy critics of monetary outsourcing and quell renewed calls to institute a fully government-issued money supply.231

2. The Full Employment and Balanced Growth Act of 1978

The New Deal reforms worked for many decades. However, in the 1970s, a new problem major supply shocks caused unemployment to reach exceptionally high levels with price indices also rising. In response, Congress amended the FRA to dial up avenues for political influence and reduce the Fed's insulation from legislative jawboning and public scrutiny. As previously mentioned, in 1975, Congress reminded the Fed of the primacy of full capacity utilization over the long term, directing the Board to stimulate banks to expand the money supply. Congress also required the Fed to file periodic reports with House and Senate committees, including the agency's planned targets for monetary aggregates for the coming year (a requirement that legislators left in place until 2000).232 The push for transparency culminated in the Full [*239] Employment and Balance Growth Act of 1978, also known as Humphrey-Hawkins, which mandates to this day that the Fed's Chair testify before Congress semiannually.233 The FRA also requires that the Fed's decision-making bodies file numerous reports to Congress.234 Although agency reporting requirements are common, and agency officials often testify to Congress, legally required hearings are rare. These hearings and reports not only allow Congress to influence Fed decision making but legitimate monetary outsourcing by subjecting the Fed's oversight of the banking system to public participation and regular legislative interrogation.235

3. The Dodd-Frank Act of 2010

Congress reaffirmed the Fed's role as a site of public accountability in 2010. Most notably, the Dodd-Frank Act requires the Fed to file detailed reports on its lending activities;236 creates a Fed official responsible for bank oversight;237 and requires that official to testify regularly before Congress.238 In the years since the Act's passage, in response to political pressure, the Fed has increasingly opened up its own decision-making processes and released more information to the public. The result is a system that as the House Banking Committee put it in 1913 "retains to the Government power over the exercise of the broader banking functions, while it leaves to individuals and privately owned institutions the actual direction of routine."239

III. The Federal Reserve and Administrative Law

Part II explained what federal legislators built the Fed to do stimulate the expansion of monetary aggregates, promote a level playing field among investor-owned banks, and provide a site of public accountability for the bank-based monetary system. This Part explains how Congress designed the Fed to accomplish these goals. In so doing, this Part sheds light on aspects of the Fed's [*240] design that often puzzle administrative law scholars, including the Fed's mix of seemingly unrelated responsibilities,240 its significant policy independence (including its power to make major economic decisions with little to no oversight ex ante from the President or risk of ex post judicial review241 ), and its close ties to investor-owned banks.

Section III.A starts with the Fed's toolkit, cataloguing and explicating the ways that Congress empowered the Fed to administer the banking system. Section III.B turns to the Fed's bespoke institutional structure, explaining how it too reflects the Fed's overarching purposes and role within the banking system. My goal throughout is descriptive: not to justify the Federal Reserve Act, but to make sense of it within our legal and constitutional tradition.

A. The Instruments of Monetary Administration

Scholars who draw a sharp line between the Fed and the rest of the banking system treat the Fed as a kitchen sink agency that performs a wide range of functions brought together by little more than historical happenstance and political expediency. This Section suggests a more unified understanding. It argues that each of the Fed's core authorities to (1) operate the interbank payments system; (2) modulate the price of reserves (by buying and selling financial assets, lending to banks, and paying interest to banks); (3) promulgate rules, supervise individual banks (and bank holding companies), and enforce prudential requirements; and (4) lend in unusual and exigent circumstances to nonbank financial firms are designed to address the problems with monetary outsourcing described in Parts I and II. Each empowers the Fed to regulate the quantity and quality of deposit money issued by banks.

1. Regulating by Clearing and Settling Interbank Payments

Much of the Fed's regulatory toolkit masquerades as a suite of banking services. One of the most important of these is clearing and settling interbank payments. Formally and operationally, the Fed is a bank for banks.242 Over five thousand banks maintain accounts at one of the twelve FRBs.243 These accounts [*241] are called "reserve accounts" or "master accounts," and the balances in them are called "reserves" or "settlement balances." Banks can withdraw cash or coin from these accounts (and that is how all cash and essentially all coin enter general circulation), but most of the time, banks use reserves as a special type of money to make payments to each other. Banks do this using a service called Fedwire. Fedwire allows banks to clear and settle in real time by instructing the Fed to adjust the balances in their respective accounts.244 The Fed also helps banks calculate the amounts they owe to each other (and net these amounts) by operating a nationwide check-clearing system and an electronic service known as FedACH, which processes payments drawn on banks by depositors of other banks.245

The Fed provides these payment services not as a subsidy for banks and their investors, but to regulate bank money issuance. The goals should be familiar I touched on them in Part II. First, the Fed uses its pivot position to promote monetary expansion, in particular by encouraging households, businesses, and banks to treat bank deposits as fungible with each other and with cash (in good times and bad).246 The Fed does this in several ways. Most directly, it clears and settles interbank payments without regard for profit, replacing an investor-run interbank clearing and settlement infrastructure that was prone to abuse. For example, while the Fed is still subject to improper influence, it is less likely to cut banks off to gain a competitive advantage or to avoid short-term losses.247 It is also more likely to provide intraday credit during turbulent periods, reducing the prospects of failed payments. And because clearing and settling interbank payments through the Fed is far more centralized, it is more efficient, reducing the number of uncollected checks outstanding at any time and addressing what H. Parker Willis, one of the Fed's key architects, called "a continual menace to the safety and liquidity of the banking system."248

[*242] Fed payment services also promote monetary stability indirectly by providing Fed officials with valuable information about the operation and the liquidity of the banking system, which they can use to inform their efforts to regulate the size and composition of bank balance sheets using their other tools (see infra).249 To quote Willis again, central bank clearing "is not only a means of economizing cash and capital, but is also a means of testing at any time the degree of liquidity which the community is maintaining, a matter which is essential for the central bank to know from day to day."250

Second, by facilitating interbank payments the Fed, in theory and at least to a certain extent in practice, levels the playing field among banks. No matter the size, location, or business model of a bank and no matter the race or religion of its owners or managers banks have a statutory right to clear their payments at the Fed.251 Because the Federal Reserve Banks are largely under public control, investor-appointed bank executives are limited in their ability to interfere with this critical economic infrastructure to create frictions or compete unfairly.252 Before the Fed's creation, rural banks and smaller banks incurred substantial costs to plug into the interbank payments system. By operating a nationwide infrastructure with nondiscriminatory pricing based on overall cost, the Fed strengthens peripheral banks and their customers. As one expert explained, the Fed's establishment quickly "cut in half the time required to collect checks" and "greatly reduced the 'interest charge' which some banks make for the use of funds represented by uncollected checks."253

2. Regulating by Modulating the Price of Reserves

The Fed's prominent "monetary policy" tools leverage its position as payments pivot and are also regulatory: they are means to stimulate (or impede) bank balance sheet expansion. Today, there are three: (a) buying and selling financial assets through "open market operations," (b) lending to banks through the "discount window," and (c) administering "interest on reserves." The first two were the Fed's traditional levers; they rely on the fact that banks settle payments between each other using reserves issued by the Fed, and the Fed has [*243] the power to create reserves "out of thin air" by writing up or down a bank's account balance on its books. As, with few exceptions,254 only banks use reserves, when the Fed adds reserves to a bank's master account, it is giving the bank permission in the form of a ledger entry (or "settlement balance") to expand its balance sheet, that is, to make new loans by adding deposits to the accounts of its customers.255

Creating settlement balances has this regulatory effect for two reasons. First, and most straightforwardly, Congress gave the Fed the power to require banks to hold a certain level of settlement balances.256 Banks cannot create new deposits (by making new loans) if they do not have enough reserves to meet these requirements. Second, and more importantly, banks need reserves, independent of these requirements, to settle their debts to each other resulting from the checks their customers write payable to customers of other banks.257 If a bank extends more loans, all else equal, it will need more reserves. The ability and willingness of banks to expand the supply of deposits by originating new loans is a function of the cost of borrowing reserves overnight.

(a) Regulating by Buying and Selling Financial Assets. One way that the Fed can adjust the cost of borrowing reserves is by buying short-term Treasury securities, using reserves it creates with a keystroke, or by selling securities that it previously purchased, writing down the account of the buyer.258 These "open market operations" affect the rate at which banks lend reserves to each other, a rate known as the federal funds rate. To raise the federal funds rate, the Fed reduces the size of its balance sheet (by selling Treasury securities) until the price that banks are paying to lend each other reserves overnight increases to the desired level. In other words, it reduces the supply of reserves. To lower the federal funds rate, the Fed does the opposite. It goes without saying the Fed could also adjust the federal funds rate by changing the volume of reserves that each bank is required to maintain, thereby changing the demand for reserves, but to [*244] do so would might require the Fed to engage in notice-and-comment rulemaking259 (whereas open market operations bypass that process).260

(b) Regulating by Lending to Banks. The Fed can also affect the level of reserves through lending. If a bank is unable to borrow reserves in the federal funds market, perhaps because other banks have doubts about its financial condition, the bank can turn to the Fed at any time and borrow at the "discount window."261 Although the Fed relied on the discount window to conduct monetary policy in its early years, today the Fed uses the discount rate only as a backstop.262 When Fed policymakers "raise rates," they raise their target for the federal funds rate and simultaneously set the price they quote banks for discount window loans to an even higher level, so that in the normal course when a bank originates new loans and expands its balance sheet it acquires any extra reserves it needs by borrowing from other banks rather than by borrowing from the Fed.263

In an emergency, of course, when depositors demand cash and the interbank lending market becomes stressed or frozen, the Fed acts as the "lender of last resort," preventing panic-induced declines in the money stock by lending reserves to banks so they can meet depositor withdrawals.264 The point of this lending is not to invest in banks to lend to banks in the way that ordinary people or banks themselves lend. Rather, it is to regulate the amount of money in the economy by ensuring that deposits trade at par with cash.265

(c) Regulating by Paying Interest on Reserves (IOR). Starting in 2008, Congress amended the Federal Reserve Act to give the Fed an additional tool to [*245] regulate bank balance sheet expansion: interest on reserves.266 When the Fed sought the authority to pay interest on reserves (and Congress authorized it), policymakers did not intend to use these interest payments as an alternative to open market operations. Nonetheless, due to a dramatic increase in excess reserves in the 2010s, the Fed decided to shift toward a "floor system" in which it adjusts the IOR rate, rather than the quantity of reserves, to keep the federal funds rate within its target range. Under the floor system, the Fed creates a bottom in the federal funds market: No bank will lend excess reserves to another bank for less than the amount the Fed is already paying in interest. Interest on reserves thereby influences banks looking to expand their balance sheets even when most banks have excess reserves and do not need to borrow them (either from other banks or from the Fed directly).267 The Fed at present no longer uses traditional open market operations (or adjustments to reserve requirements) to modulate the price of reserves.268

3. Regulating by Promulgating Rules and Supervising

Congress also empowered the Fed to regulate the money supply by tightening (or loosening) more conventional restrictions on the size and composition of bank balance sheets. One way the Fed can do this is through ordinary regulatory rules governing bank equity capital, liquidity, and activities. Another way is via examination and safety-and-soundness supervision (an iterative, institution-specific practice of comment and response that rarely involves any final agency action). Two caveats apply. First, the Fed generally writes rules and supervises banks to reduce their likelihood of encountering financial distress, not to modulate money creation directly, even though these [*246] rules necessarily affect the sorts of assets banks can originate or purchase by requiring banks to maintain certain balance sheet ratios or limiting their ability to do business with certain counterparties.269 Second, the Fed has only partial control of these tools. It shares rule-writing and supervisory powers over banks with state banking commissioners and two other federal agencies, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (a feature of our monetary architecture that has repeatedly contributed to dysfunction and breakdowns).

In practice, the Fed uses its regulatory rules to set a baseline on top of which its supervisory officials engage in firm-specific oversight. Through ongoing dialogue with banks, supervisors share their view on the safety and soundness of specific bank investments, activities, practices, and balance sheet configurations.270 The Fed also conducts supervisory stress tests of the largest banks, the results of which it uses to determine whether bank balance sheets are too large or too risky. These powers limit the ability of banks to issue more deposits.

Although rule-writing and supervision transparently regulate the banking system (as compared with clearing interbank payments or modulating the price of reserve balances), they are also difficult to challenge in court. Ongoing supervision generally does not result in final agency action,271 and safety-and-soundness adjudication that does result in final action is subject to a highly deferential standard of review272 and is backed up by the Fed's near plenary powers to deny banks access to the discount window, the interbank payment system,273 and intraday liquidity, and to withhold approvals for mergers, capital payouts, and even the purchase of office buildings.274 The Fed's regulatory rules, meanwhile, are rarely challenged given the dependence of banks on the Fed's goodwill and because bank-specific safety-and-soundness requirements often exceed what is required of a bank under the regulatory rules (limiting the potential upside of challenging these rules in court).

[*247] Fed officials today do not generally use rules and supervision interchangeably with their power to modulate the price of reserves.275 This division in practice has led many scholars to treat the two categories as conceptually distinct.276 But this approach, I believe, is mistaken for two reasons.277 First, to accomplish its statutory mandate, the Fed must regulate not merely the quantity of bank money but also its quality deposits backed by bad assets are unstable and may disappear in the face of economic uncertainty and asset price shocks. History and theory suggest that insolvent monetary institutions are the biggest threat to the Fed's mission.278 In crises like the one experienced in 2008, the Fed can relax the constraints on bank balance sheet expansion all it wants (pumping more reserves into the system, suspending capital requirements, etc.) but if banks have more liabilities than assets, they will be forced to shrink their deposits and hence the money supply.

Second, by regulating the quality of bank money, the Fed necessarily influences the quantity of money the banking system will create. If the Fed demands high equity levels, banks cannot originate as many loans and accordingly as many new deposits (at least not without going into the capital markets and raising more equity). In this way adding reserves and reducing equity requirements are substitutes.279 When the Fed adds reserves in its open market operations, it lowers the hurdle rate for banks to originate new loans and add new deposits to the money supply. When the Fed lowers capital requirements, either by promulgating new capital rules or by adjusting stress tests and relaxing supervisory constraints, it produces the same monetary effect: lower [*248] capital requirements free up balance sheet capacity for additional bank lending and deposit creation.280

Although the Fed exercises a good deal of control over lending volumes through rule writing and supervision, as well as through conventional reserve-based policy implementation, there are important limits to the Fed's powers. The Fed cannot directly control balance sheets, for example by setting the interest rates banks pay their depositors or formally directing the volume of loans that banks originate.281 The Fed possessed the former power between 1933 and 1980, when Congress changed the law.282 China's monetary authority, the People's Bank of China, regularly uses the latter method to control monetary conditions.283 The Fed also has little power over individual lending decisions. Private ordering and decentralized control over monetary expansion are longstanding features of the U.S. monetary system.

4. Regulating by Lending to Nonbank Financial Firms

The Fed has one tool for administering the banking system that works around banks rather than through them. In 1932, Congress added section 13(3) to the Federal Reserve Act, authorizing the Fed to lend to any individual, partnership, or corporation.284 (Prior to 1932, the Fed was authorized to lend and [*249] offer banking services only to its membership.285 ) Standing alone, such an authorization would permit the Fed to act as an ordinary bank rather than as a monetary authority: extending credit as banks do, and interacting directly with businesses, nonprofits, and governments rather than regulating the supply of bank money by interacting exclusively with banks.

But section 13(3) includes a variety of restrictions that prevent the Fed from conducting a general banking business with the public. First, unlike the Fed's other tools, the law requires the approval of the Treasury Secretary and five members of the Fed's Board to identify "unusual and exigent circumstances." Second, before lending, the Fed's FRBs must further obtain evidence that borrowers are unable to access adequate credit accommodations from banks (the "credit availability proviso").286 Third, the Board must establish policies and procedures to ensure that (1) security is sufficient to protect taxpayers from losses, (2) borrowers are solvent, (3) loans are not designed to remove assets from the balance sheet of any single company, and (4) lending is for the purpose of providing liquidity to the financial system (the "financial system liquidity clause").287

Two of the above restrictions the credit availability proviso and the financial system liquidity clause underline the power's monetary purpose. The credit availability proviso prevents the FRBs from lending to households, nonprofits, municipalities, and businesses, as banks do, unless they can first obtain evidence that the banking system has ceased to function properly. The proviso was part of a compromise in 1932 between legislators who sought to empower a new government agency, the Reconstruction Finance Corporation, to serve as a general-purpose public lender, and President Hoover, who was opposed to public banking.288 By adding 13(3) to the Federal Reserve Act, policymakers expected the Fed to replace lost credit in communities where banks had failed or were in such weak condition that they could not continue to lend to their existing customers.289

[*250] The other major restriction, the financial system liquidity clause, dates to 2010. This clause scales back the circumstances in which FRBs can bypass the banking system. By limiting the FRBs to lending for the purpose of providing liquidity to the financial system, this requirement rules out most (if not all) lending to households and businesses, even where the Fed is able to obtain evidence that borrowers are unable to access adequate credit accommodations from banks. What it permits is support for nonbank financial institutions (like Lehman Brothers and Bear Stearns) when their funding from banks dries up (as it did in 2008). Just as the Fed provides discount window lending to banks when they cannot borrow from other banks in the federal funds market, it can extend that privilege to nonbank financial firms in special circumstances.290 The stringent conditions that are placed on this tool, however, demonstrate that it is the exception that proves the rule: the Fed was built to act through banks.

B. The Institutions of Monetary Administration

In addition to illuminating the common denominator among the Fed's myriad instruments, contextualizing the Fed within the U.S. statutory framework for money and banking clarifies the Fed's unusual structure and relationship to the rest of the government. First, it sheds light on the Fed's insulation from the President and the courts. Money issue is a type of fiscal power that the framers thought should be trusted to the legislature and that policymakers have long treated differently from other regulatory tasks. Second, it helps us to appreciate why legislators devolved some decision-making power over monetary expansion to Federal Reserve Bank officials who are in part selected by investor-owned banks. This decentralization and outsourcing within the Fed preserves elements of the diffusion and delegation that policymakers embedded in the underlying banking system. (The structure of both the Board and the FRBs actually enhanced the power of government officials to influence monetary policy when compared to the monetary architecture that predominated prior to 1913.)

1. The Independent Board of Governors

The Fed's Board of Governors is subject to little executive or judicial oversight. When viewed as a kitchen-sink agency, with a range of unrelated operational and regulatory responsibilities, this "independence" presents a bit of a puzzle. Why wouldn't Congress give the President a greater role in superintending at least some of the Fed's activities, such as its enforcement and operational functions?291 And why wouldn't legislators want the courts to do more to police the Fed's exercise of its substantial regulatory powers? The body's positioning relative to the President and the courts becomes easier to understand and to justify when we recognize that it is a monetary [*251] authority that uses a range of orthodox and unorthodox tools to manage the bank-issued money supply. Its freedom of action is a feature of its design, not an unintended bug.

First, Congress has intentionally circumscribed the President's role,292 in part to ensure that Fed officials are accountable primarily to Congress. Although the Fed is engaged in what appears to be quintessential "executive"293 activity (buying and selling financial assets, lending money, enforcing statutory rules, clearing payments, offering financial services to banks and other entities), Board governors are term tenured and can be removed by the President only "for cause."294 Other key officials such as the FRB presidents and directors295 are neither appointed by the President nor removable by the President, even for cause.296 Although the Fed's Board is susceptible to certain forms of presidential administration, such as jawboning,297 its Board is unusually shielded from Presidential influence. Unlike with other independent agencies, like the Securities and Exchange Commission, Congress drafted the FRA so that even [*252] the Fed's Chair, despite exercising significant administrative control over the agency, cannot be replaced by the President at will.298

Second, the Fed is rarely subject to meaningful judicial review. While adding or subtracting reserves is equivalent to promulgating new balance sheet rules, the courts treat this activity as nonjusticiable.299 Federal courts have also recognized the informal nature of the Fed's supervisory process300 and have repeatedly deferred to Fed determinations in cases in which they've been challenged in court.301

This lack of procedural safeguards for banks is not an oversight. The policymakers who built the system saw banks as public utilities performing a sovereign function.302 The Federal Reserve Act intentionally concentrates control over the banking system in the hands of the Board, which legislators thought would enhance private liberty by constraining bank managers and [*253] shareholders and preventing abuses. (Banks, after all, expand the money supply without facing any procedural constraints of the sort imposed on federal agencies by the Administrative Procedure Act.)

To temper this insulation from executive and judicial control, the Federal Reserve Act subjects Fed officials to enhanced legislative oversight.303 Congress supervises the Fed throughout the year304 and it is sometimes said that the Fed is a "creature" of Congress and "not an agency of the Executive."305 Although this understanding is out of sync with contemporary judicial understandings,306 it is consonant with a longstanding "monetary separation of powers." Rather than wielding "executive power," the Fed is best conceptualized as sharing in the legislature's exclusive fiscal authority.307 As Alexander Hamilton put it, money is "the vital principle of the body politic . . . that which sustains its life and motion, and enables it to perform its most essential functions."308 The power to issue money sits alongside the power to tax, spend, and borrow, as it is a means for harnessing resources and directing economic activity: the government can issue more money as an alternative to raising revenue by coercing contributions.309 Money is also the medium in which the government collects tax revenues, measures tax obligations, and denominates expenditures. As Charles Pinckney observed during the debates on the Constitution, the "exclusive right of coining Money," including "regulating its alloy, and determining in what species of money the common Treasury shall be supplied," is "essential to assuring the Federal Funds."310 In Britain, monetary policy was long used by the [*254] Crown as a way to finance expenditures and repay debts.311 Executive abuse of this royal prerogative fueled the Glorious Revolution in 1688. The Framers understood this and sought to deprive the President of a means of bypassing the legislature. On their view, the approval of Congress was necessary to legitimate resource gathering by the government.312 As Hamilton explained in Federalist No. 69 on the "real characters of the proposed executive," whereas in Britain the King "can coin money," in the United States, the President "can prescribe no rules concerning the . . . currency of the nation."313 The Constitution reflects Hamilton's safeguard by enumerating the power to coin money and regulate its value in Article I,314 and doctrine affirms this division of power.315

For many years, this was also the explicit view of most policymakers.316 For example, Congress expressly drew on the Coinage Clause when it amended [*255] the FRA in the 1970s to clarify the Fed's relationship to the legislature and President. House Concurrent Resolution 133, the seed of the Fed's statutory mandate, characterized the Fed as the agent of Congress and instructed it on how to exercise its statutory authority.317 Even Fed officials who clashed repeatedly with Congress acknowledged the institution's subservience to the legislature:

The CHAIRMAN [Proxmire]. You do acknowledge, do you not, only Congress has the constitutional authority to regulate the money supply, and the Federal Reserve is an agent of the Congress independent of the executive branch?

Dr. BURNS. I have no quarrel with that. I know the Constitution and I am a law-abiding citizen.318

Traditionally, then, the division of monetary powers between Congress and the Board, between the elected legislature and a technocratic agency, was a question to be settled by legislators. The current statutory design, as we have seen, is weighted heavily toward technocracy when it comes to expansion and contraction. When it comes to other aspects of monetary policy like credit allocation (who benefits from the creation of new money) existing law shares control between legislators, technocrats, and investor-owned banks. The Fed's independence from executive and judicial oversight is not just a matter of insulating monetary policy from executive abuse or judicial second guessing, but also a matter of protecting legislative primacy within the government in monetary affairs. It can only be understood in light of the Fed's monetary functions and place within the monetary system.

[*256] 2. The Private and Regional Federal Reserve Banks

Scholars today tend to treat the Fed's regional Reserve Banks as vestigial or even unconstitutional.319 The FRA's twelve nongovernmental federal corporations operate many of the Fed's most important monetary tools. Although their autonomy has declined over the past century,320 the FRBs still open and maintain accounts for banks,321 clear and settle Fedwire transactions,322 determine whether to make discount window loans, assess the sufficiency of bank collateral, and extend emergency loans to nonbanks.323 The FRBs also play a major role, alongside the Board, in determining the scope of open market operations and what federal funds rate to target. Relying on authority delegated by the Board, the FRBs even supervise member banks and bank holding companies.324

This devolution of federal regulatory power is not simply an anachronism or oversight. It reflects a sort of monetary federalism: the fact that the United States employs a diffuse network of investor-owned banks to expand the money supply. Even at the Founding, when the economy was dominated by the Bank of the United States, the First Congress permitted the states to charter banks of their own. And although Congress largely federalized the state banking system between 1863 and 1935, it also embraced diffusion so that many decisions about money and credit could be made by private bankers at a local level. The FRBs preserve this structure by retaining a role for investor-owned banks and regionally selected officials. FRB leaders are not appointed by national officials like the President.325 They have regional backgrounds and are likely more accountable to regional interests than other federal leaders.326

[*257] IV. Understanding the Fed Unbound

Contextualizing the Federal Reserve Act and grounding it in a theory of U.S. money and banking, helps to situate the Fed within the modern administrative state allowing us to appreciate how and why it regulates with little judicial scrutiny (through commercial transactions and nonfinal actions), the justifications for its insulation from executive oversight, and why it operates using nominally private federal corporations spread across the country. Understanding the logic of the Federal Reserve Act also explains the Fed's expanding footprint over the past fourteen years. This Part argues that the Fed's transformation, especially since 2008, is a function of the rise of money creation outside of the chartered banking system, that is, shadow banking. Section IV.A briefly recounts the emergence of shadow banking (and the Fed's role in that emergence). Section IV.B explains why shadow banking ultimately led the Fed to expand its balance sheet and pursue ad hoc lending and purchasing programs.

A. The Rise of Shadow Banking

The Federal Reserve Act presumes an economy that relies primarily on monetary instruments issued by chartered banks. The Fed lacks the statutory authority to oversee or backstop nonbank money issuers, except during unusual or exigent circumstances,327 and federal law restricts entry into the business of receiving deposits to organizations regulated as banks by either the states or federal government.328 Even the Monetary Control Act of 1980, which permits depository institutions outside of the Fed's member system to access the Fed's balance sheet, does not contemplate Fed services for entities without a state or federal bank charter.329

But beginning in the 1950s, the basic structure of U.S. banking law began to fray. Broker-dealers started operating like banks without bank charters. Although these dealers were legally prohibited from maintaining deposits, they created an alternative money instrument that was formally structured as a pair of financial transactions called repurchase agreements (repos). Repos were economically equivalent in key respects to deposits that could be withdrawn daily. The Fed, deviating from the logic underlying its enabling act, supported dealer repos. In the 1950s, it developed an ersatz discount window program, [*258] drawing on the repo structure to lend directly to nonbank government securities dealers.330 This program allowed eligible dealers to function as de facto banks and to bypass banks for their short-term funding needs.331

In 1962, a new front opened, as the Fed lent its backing to another type of shadow bank, foreign firms issuing dollar-denominated deposits without bank charters from the U.S. government.332 Like U.S. broker-dealers, on the asset side these institutions held U.S. bank deposits as reserves and borrowed them as needed to cover withdrawals from their dollar deposit accounts (known as "Eurodollars"). But without access to the Fed's discount window, such foreign shadow banks (the largest of which, at first, were in London and Paris333 ) were vulnerable to being cut off by U.S. banks in a downturn or following a change in risk appetite. Seeking to stabilize this emerging supply of dollar deposits overseas, the Fed entered into agreements with foreign central banks to swap dollar reserves at the FRBs for foreign currency.334 In effect, the Fed expanded its discount window program once again: bringing foreign central banks and their banking systems into the ambit of the Federal Reserve System. In 1974, when a run materialized in the Eurodollar market the first run in the dollar system since 1933 the Fed formalized its commitment to managing Eurodollar rates, joining [*259] a communique issued by the Bank for International Settlements, a clearing association of central banks based in Basel, Switzerland.335

In the 1970s, the shadow banking system grew even further when the SEC, with subsequent approval from the Justice Department,336 authorized mutual fund managers to issue shares in portfolios of short-term debt instruments and offer daily redemption at par with cash.337 The resulting "money market funds" grew from less than $ 4 billion in 1975 to over $ 200 billion in 1982, as the gap between the yield on these deposit substitutes and the yield on deposit account balances soared.338 Money funds could outcompete banks on interest expense because banks were subject to regulatory restrictions on the amount they could pay their depositors. When the interest income earned by the assets owned by money funds was low, the difference in rates was minor. But when the Fed hiked overnight interest rates in the late 1970s, the difference grew to be substantial. A similar dynamic also facilitated the growth of foreign banks issuing Eurodollars.

Banks, unsurprisingly, responded to these competitive pressures by looking for higher returns and lobbying for regulatory relief. In 1991, Congress facilitated further growth of shadow banking by amending the Federal Reserve Act to permit the Fed to accept the securities that broker-dealers carry on their books as collateral for emergency loans under section 13(3).339 Further liberalization accelerated the shift away from deposit banking and toward deposit-alternative shadow banking. By 2007, deposit substitutes, such as repos, money market fund shares, and Eurodollars, accounted for more than the total of bank deposits in circulation.340 It was against this backdrop that the system ran aground in 2008,341 spurring a dramatic transformation in the Fed's role in the financial system.

[*260] B. The Fed's Response

Since 2008, the Fed has shifted from an agency focused primarily on administering the banking system (using its statutory tools as they were designed to be used) to an agency increasingly stretching its statutory tools to address shadow banking and the consequences of the monetary instability that shadow banking has engendered. The result has been a slew of ad hoc lending and purchasing initiatives that have seen the Fed's balance sheet grow tenfold342 and turn from a largely passive function of cash demand in the economy to an active tool of policy.

This Section analyzes the turn and explains how it relates back to monetary problems created by shadow banking. First, it examines the changes that are a direct product of shadow banking: the Fed's ongoing and growing programs to backstop and manage shadow bank money by opening up both the left-hand and right-hand sides of its balance sheet to shadow banks. Second, it turns to two indirect consequences of shadow banking: the Fed's massive asset purchase programs known as quantitative easing (QE) and its recent emergency lending to ordinary businesses and state and local governments. The former initiative was geared toward assisting shadow banks and addressing economic stagnation triggered by shadow banking. The latter was a political byproduct of the scale and scope of shadow bank support: to legitimate the central bank's shadow-bank backstops, legislators and Fed officials sought to expand the circle of beneficiaries of Fed balance sheet expansion.

1. Backstopping Shadow Banks

The clearest and most salient examples of how the Fed has changed since 2008 are its large-scale financial sector lending programs. Each of these programs is a byproduct of the rise of shadow banking, designed to stabilize a different type of deposit alternative. They are essentially ersatz discount windows for various classes of shadow banks and various types of deposit alternatives (specifically, repos, Eurodollars, commercial paper, and money market mutual fund shares). Although the beneficiaries of this lending operate largely outside of the banking laws and are not subject to the Fed's ex ante monetary tools, they are deeply interconnected with the chartered banking system and their deposit alternatives are a critical component of the economy's money supply. As a result, barring an act of Congress, there is no way for the Fed to achieve monetary expansion consistent with its section 2A mandate without backstopping the money shadow banks issue. Were the Fed to permit the shadow banking system to collapse, a second Great Depression, or worse, would result.

[*261] As it turned out, the Fed's support to this system was incomplete in 2008. Lehman Brothers failed on September 15. The result was a rapid contraction in money and credit and the sharpest decline in economic activity in eighty years.343 In the decade that followed, the Fed institutionalized the backstops it created during the global financial crisis.344 First, in the fall of 2019, it lent hundreds of billions of dollars to align the repo rate with the effective federal funds rate.345 Second, in March 2020, when the pandemic prompted a rapid repricing of risk assets, the Fed rolled out support facilities for money market mutual funds, commercial paper issuers, and broker-dealers, dialed up repo market lending (with nearly $ 500 billion outstanding to dealer firms at one point), and entered into swaps with over a dozen foreign central banks (lending nearly $ 500 billion at the peak).346 Third, in 2021, the Fed announced that it would convert its emergency repo operations program into a standing repo facility, offering the primary dealers the same sort of ongoing recognition that the Federal Reserve Act bestows on banks.347 The Fed has also left its FIMA repo facility and five of its swap lines in place converting foreign central banks into a sort of limited-purpose network of regional reserve banks empowered to support organizations issuing dollar deposit substitutes in overseas jurisdictions.348 In effect, the Fed has extended its statutory framework to accommodate the monetary liabilities of shadow banks across the business cycle.

2. Borrowing From Shadow Banks

The Fed has also opened up the liability side of its balance sheet to accommodate shadow banks. In 2014, it launched the overnight reverse repurchase agreement facility (ON RRP) to help control monetary expansion.349 Through the ON RRP, the Fed borrows cash from select shadow banks [*262] (predominantly money market mutual funds) by selling securities off its balance sheet.350 Then the Fed buys its securities back for a higher price the next day (or at some pre-set date), paying the shadow bank interest and therefore controlling the rate at which the shadow bank will be willing to lend to other borrowers. These artificial transactions provide shadow banks with a way to hold central bank money just like banks. The ON RRP rate that the Fed pays to shadow banks serves as an analog to the statutory IOR rate that the Fed pays to banks. The Fed typically raises and lowers both in tandem so that it can administer both the banking and shadow banking system.351

As with the ersatz discount windows that the Fed has set up for shadow banks, the ON RRP is out of step with the design of the Federal Reserve Act. By allowing shadow banks to park large balances in nondefaultable form at the Fed, the facility empowers shadow banks to effectively deposit money with the Fed even though the FRA does not include these firms among the list of entities authorized to hold Fed deposits.352 It also partly replicates the economics of a master account, paying shadow banks a rate close to IOR, even though the Federal Reserve Act authorizes the Fed to pay that rate only to depository institutions.353 Moreover, ON RRP involves the same statutory stretch as the Fed's direct repo program for broker-dealers: neither the purchase nor the sale in ON RRP transactions are at a market price as required by section 14.354

As with the Fed's ersatz discount windows for domestic and foreign shadow banks, these new ersatz reserve balances355 are evidence that the Fed has yielded to the reality that shadow banks, rather than chartered banks, are the source of elasticity in the contemporary monetary system.356 If the Fed wants to regulate [*263] the amount of money in circulation the collective balance sheet of money issuers it has to influence their behavior. These firms are too big, and their balance sheets too complex, to regulate indirectly through banks.357 The result is a situation in which the Fed now decides who can access these workarounds, extending privileges to actors that Congress never chose to grant ongoing access to the Fed's balance sheet indeed, even to actors that legislators intended to exclude from such access.

3. Buying Financial Assets

Another area in which the Fed has moved beyond the Federal Reserve Act's logic buying financial assets for reasons unrelated to adjusting the supply of reserves in the banking system is a second order consequence of shadow banking. The Fed launched its first "quantitative easing" initiative (QE1) in December 2008. Its goal was to lower the cost of mortgage servicing and raise the value of mortgage-backed securities. QE1 was thus a product of shadow banking and the crisis it unleashed: Fed officials recognized the critical importance of correcting the damage inflicted by monetary contraction and buttressing shadow bank and bank balance sheets to improve their capital position and their ability to resume monetary expansion.358

In 2010, the Fed launched a second round of QE. This time officials aimed to respond to inadequate fiscal policy by turning the Fed's monetary tools to new ends. Over the next few years, the Fed purchased a substantial portfolio of U.S. Treasury securities and agency MBS.359 These purchases were not designed to [*264] stimulate bank monetary expansion, at least not as a first-order matter; they were designed to influence behavior in credit markets and bolster aggregate demand.

They did this in three ways. First, they lowered long-term interest rates, creating a wealth effect for asset owners. With lower long-term rates, existing cash flows were worth more, raising asset prices. The resulting appreciation enriched households with financial investments, enabling them to spend more. It also increased the value of assets on business balance sheets, making it easier for businesses to borrow to finance new investments and pay off existing debt. Second, by lowering long-term interest rates, QE reduced the interest burden of debtors. Interest due on floating rate loans fell, and debtors with fixed-rate loans could refinance to lock in lower interest rates. The result was that fewer people defaulted on loans and more people had money to spend on goods and services.360 Third, by removing large amounts of "safe assets" from the capital markets (like government debt and agency MBS), QE stimulated savers to invest in higher-risk businesses. QE may also have driven financial institutions (including banks) to change the composition of their balance sheets: making credit more cheaply available to nongovernment borrowers.361

The Fed's MBS purchases gave homeowners a special boost, further decreasing the cost of borrowing money to buy a home (beyond the decrease generated by the Fed's Treasury purchases) and further increasing home prices.362 Up to a point, this resulted in fewer mortgage defaults, fewer bank losses on mortgages, and homeowners with more money to spend on goods and services.363

In March 2020, in response to a pandemic-induced panic on Wall Street, the Fed launched a new round of asset purchases, "distinct in both their [*265] purpose . . . and their scale and speed, which have been unparalleled."364 The goal was to support market functioning by absorbing pressure from shadow banks and other financial firms rushing to sell their securities to raise cash. The pace was unprecedented, with more than $ 100 billion in assets being purchased on some days. As a result, the Fed added $ 1.7 trillion of Treasury securities and $ 800 billion of agency MBS to its balance sheet.365 After market functioning had improved, the Fed continued the program to sustain market functioning and bolster economic activity by further reducing long-term interest rates. In total, this round of purchases added $ 80 billion of Treasury securities and $ 40 billion in MBS to the Fed's balance sheet each month. The Fed slowed this program in November 2021 and halted it in March 2022.366

While the Fed has the statutory authority to conduct large scale asset purchases, legislators did not expect for the Fed to use section 14(b) in this manner. As Senator Carter Glass explained in 1935:

The sole purpose of the open-market [authority] . . . was to enable [the FRBs] to use any surplus funds they might have on hand in order to cover overhead charges, and to enable them to do as the Bank of England has always done, to enforce their rediscount rate. And that was all. It was never intended that they should go into speculative transactions and buy all sorts of securities and all that sort of thing.367

QE, whether meant to suppress long-term interest rates, transfer wealth from the public to homeowners, or subsidize overleveraged financial firms by reducing their transaction costs, is not designed to directly stimulate the expansion of bank balance sheets. It is not monetary policy as traditionally practiced: it does not work through the banking system, nor is it geared primarily toward increasing the supply of deposits. In many ways, it resembles fiscal policy: government investment designed to stimulate the economy. This investment is non-neutral, especially the MBS component, which assists individuals and institutions that own MBS or underlying assets.368

Although there were many factors that led the Fed to pursue several rounds of QE, at least three important factors relate to the rise of shadow banking. First, QE1 in 2009 and the first stage of QE Infinity in 2020 were specifically directed [*266] at ensuring market functioning in the shadow banking system following a run on deposit alternatives. Second, QE2 and QE3 in the 2010s and the second stage of QE Infinity in 2020 and 2021 were efforts to correct damage inflicted by shadow banking; the Fed's conventional policy rate has been near zero due, at least in part, to a monetary contraction which slowed economic growth. Third, QE in all its incarnations relied on the Fed's balance sheet in ways that were politically possible, even imperative, as a result of the reorientation of the Fed that attended the rise of shadow banking and the crisis of 2008. Prior to the run on Bear Stearns, the Fed had largely used its balance sheet in technical ways to administer bank balance sheets: the Fed didn't aim to create money directly; it attempted to stimulate bank money creation. But once the Fed revealed that it could create money and bypass the banking system using its balance sheet, for example, to rescue AIG and lend to foreign central banks the idea that the Fed could use its money creation tools for nonregulatory purposes went from "off-the-wall" to "on-the-wall."369

4. Lending to Municipalities and Ordinary Enterprises

A fourth way in which the Fed has evolved beyond its enabling act is also connected, albeit indirectly, to the rise of shadow banking. In 2020, the Fed offered emergency credit to nonfinancial businesses, municipalities, and nonprofits. This assistance was expressly authorized by Congress. The CARES Act directed the Treasury Secretary to invest in Fed facilities that lend to businesses, municipalities, and nonprofits even though such lending does not otherwise square with the law.370 The result was a suite of programs including five Main Street Lending Programs, the Municipal Liquidity Facility, and two Corporate Credit Facilities. The Fed's Main Street Lending Programs targeted businesses with up to $ 5 billion in annual revenues and 15,000 employees and nonprofits with endowments less than $ 3 billion.371 The Fed lent $ 16.5 billion to 1,796 enterprises, mostly in the fourth quarter of 2020. The Fed's Municipal Liquidity Facility purchased bespoke bonds from New York's Metropolitan Transit Authority and the State of Illinois.372 Its corporate credit facilities purchased $ 13.5 billion, split between high-yield and investment-grade bond ETFs and individual bonds issued by investment-grade blue-chip American corporates.373

These programs were in part a political byproduct of the Fed's ongoing and massive lending to the financial sector. It is highly unlikely that Congress would [*267] have authorized the Fed, as opposed to other government entities, to do this sort of lending in 2020 if shadow banking had not thrust the Fed into the role of lending trillions of dollars to the financial sector during recessions. It is also unlikely that the Fed would have embraced the role if it were not for the need to legitimate and sustain political support for its ongoing Wall Street lending.374 Although the relatively small scale of these programs suggests Fed officials were reluctant to wade into private credit markets, their existence also reflects the determination of Fed officials to dispel notions that its emergency support was reserved for Wall Street.

V. The Costs of Exceeding the Limits

The Fed's new initiatives since 2008 have had clear benefits. But unpacking the FRA helps to illuminate the costs and downsides of relying on the Fed to stabilize an unstable monetary system and tackle a host of nonmonetary problems. This Part emphasizes three. Section V.A examines the ways in which the Fed's response to shadow banking has undermined important legislative objectives embedded in the Federal Reserve Act and U.S. banking law more generally. Section V.B considers how the Fed unbound is less effective. It is poorly designed to tackle problems outside the chartered banking system, and new programs undermine its ability to carry out its core statutory functions. Section V.C explores how central bank maximalism an approach to central banking that calls on central bankers to do whatever they can to address economic problems impedes democracy when it is not undergirded by structures developed by legislators.

A. Undermining the Law's Implemental Purposes

The Fed's expansion beyond the logic of its enabling act, even where it has been in accord with the act's ultimate ends (e.g., promoting monetary expansion), has undermined the choices that legislators made about the best means to carry out those ends, that is, the law's "implemental purposes."375 Most significantly, the Fed's efforts to prevent shadow bank failures have facilitated the further expansion of shadow banking. By backstopping shadow banks, the Fed offers implicit and explicit recognition of the alternative forms of money that they issue. But when shadow bankers draw on this recognition to expand the money supply, they are not constrained by statutory restrictions regarding the sorts of assets they monetize or any of the other rules governing monetary expansion.

Accordingly, Fed-backed shadow banking undermines the core pillars of the American Monetary Settlement:

[*268] Separation: Because shadow banks are not subject to the same activities restrictions that apply to banks, they often engage in financial and nonfinancial activities that are off limit to banks. Since the Fed now implicitly or explicitly backs most shadow bank money, shadow banks mix state-recognized money issue with private "commerce," allowing firms engaged in shadow banking to gain a competitive edge on traditional business organizations by undercutting their cost of funds.376 The result is a financial system in which financial activity and monetary activity are increasingly tied together as firms that engage in financial activities but not monetary activities cannot survive. For example, it is difficult today to operate a broker-dealer on a partnership model. Instead, broker-dealers rely heavily on repo financing and are often part of larger financial conglomerates.

Diffusion: The Fed's support for shadow banks also undermines diffusion. On the surface, the rise of shadow banks appears to further diffuse monetary powers among even more separate management teams. (Shadow banks do not even have to apply for a charter before they can start issuing alternative forms of money.) But the dynamic effect of shadow banking is actually toward consolidation. Diffusion in banking was never the product of market forces. Rather, it was the result of specific policy choices and legal restrictions, which shadow banks are not subject to. By underpricing banks issuing deposit substitutes without complying with costly banking regulations shadow banking contributed to decisions by legislators and bank regulators to adopt more accommodative policies toward bank mergers beginning in the late 1970s.377 The result is an increasingly concentrated banking sector.

Supervision: The rise of money augmentation outside of the bank regulatory perimeter undermines bank supervision. Shadow banks are not supervised. The Fed cannot restrict or control shadow bank balance sheets or activities to the same extent as banks.378 When shadow banks expand the supply of monetary instruments in the economy they also do so without public direction. For example, the asset portfolios of shadow banks are not covered by laws like the Community Reinvestment Act or other statutes that steer the benefits of monetary elasticity (by, for example, requiring banks to extend credit in the same places they maintain deposit balances).

Shadow banking also undermines the core goals that animate the Federal Reserve Act:

Monetary Expansion: Shadow bank money is unstable. It does not benefit from the ex ante regulations that constrain excessive risk taking within the [*269] banking system and address various market failures. Nor do shadow banks have deposit insurance or access to explicit government backstopping. An economy with a large shadow banking sector is likely to experience intermittent panics, which will threaten monetary contraction and acute recession.

Level Playing Field: Backstopping shadow banks and paying interest to a select group of financial firms through ON RRP undermines the fair access principle underlying section 4(8) of the FRA.379 For example, the Fed backstops some shadow banks, such as the primary dealers, even though there is no statutory application process for this de facto monetary franchise.380 This dynamic runs counter to the goals of Congress in 1913 to end the sort of special treatment and unpredictable backstopping that sparked public outrage following the Panic of 1907, when bank-run clearinghouses saved firms with the right connections and let others sink. Such ad hoc treatment returned in 2008 and 2020, with the Fed lending to support certain nonbank firms (such as Bear Stearns) while declining to assist others (such as Lehman Brothers).381

Public Accountability and Control: The Fed is able to provide the public with less insight into the activities of shadow banks, the assets they monetize, and even their owners. Most troublingly, Fed officials have limited visibility into the sources of vulnerability that gave rise to panic in March 2020, lacking data about the scale and scope of the repo market and the Eurodollar market. Accordingly, the Fed's effort to manage the shadow banking system over time has also reduced the Fed's ability to serve as a site of public accountability and control for the monetary system.382

The downstream consequences of the Fed's effort to accommodate shadow banking, such as the Fed's quantitative easing and real economy lending programs, also undercut the FRA's implemental goals and in some cases conflict with its high-level purposes. These programs expand the Fed from a monetary authority that supervises a system of publicly chartered, investor-owned banks to a government credit authority that also invests directly in households, businesses, and government securities and seeks to allocate credit either through its own balance sheet or through its power to influence the composition of bank balance sheets.383 For example, the choice to purchase MBS regardless of the rationale enriches homeowners by raising the value of real estate and reducing the costs of home loans. It is a form of general economic policy that benefits [*270] certain parties and disadvantages others. Congress did not design the Fed to play this sort of role it is not reflected in the statutory framework, toolkit, or institutional structure.

B. Reducing Effectiveness

There is a practical cost to relying on the Fed to tackle tasks for which it was not designed: reduced effectiveness. Agencies pursuing multiple, unrelated tasks true kitchen-sink agencies or "kludges" cannot be expected to execute their tasks especially well. In an efficient agency, legal instruments and institutions are tailored to suit the agency's underlying mission. The agency's relationship to the political branches, statutory interconnections with other agencies, susceptibility to judicial review, and level of engagement with civil society are calibrated so that it can excel at a particular function in a particular political economy. For example, the optimal structure of an agency built to provide critical economic infrastructure, such as the U.S. Postal Service, is not the same as the optimal structure of an agency designed to check corporate power, such as the Federal Trade Commission, or prevent air pollution, such as the Environmental Protection Agency. It would not be a good idea, all else equal, for the Consumer Financial Protection Bureau to deliver the mail or regulate carbon emissions.

Kludging is particularly problematic for a monetary authority like the Fed given its bespoke design. As we've seen, the Fed is unusually intertwined with investor-owned business organizations, subject to minimal oversight by the executive, insulated from judicial review, and able to act with little ex ante engagement from civil society. Although the normative merits of the Fed's structure are open to debate, each of these features can be explained by reference to mission-specific challenges involved in monetary provisioning and the Fed's role as the administrator of a system of specially chartered, investor-owned business organizations. Among other things, the Fed must interact with profit-oriented banks on a daily basis, provide them with critical financial services, and rely on them to achieve its primary objectives because Congress based the U.S. monetary system on outsourcing. For these reasons, Congress also granted banks an ongoing role in the Fed's governance. Similarly, the legislators who designed the Fed sought to depoliticize decisions about the rate of expansion of the money supply and separate those decisions from ordinary government activity, so they limited the ability of the President to appoint and remove its leaders and exempted the Fed from the annual budgetary process. Congress similarly shielded the Fed from judicial review and public scrutiny, permitting it to carry out its mission without generally resorting to notice-and-comment rulemaking or other reviewable final actions.

Fed operations beyond the limits of its enabling act produce sub-optimal policy along two dimensions. First, when the Fed takes on activities outside the banking system, it is less likely to perform them well. Second, when the Fed [*271] takes on activities outside the banking system, it is less likely to perform its core function administering the banking system well.