The Federal Reserve: the cornerstone of the
American economy. For just over a century the Fed has overseen
the financial system of the US, but its track record has been far from perfect.
Worse yet, it has such a unique and convoluted structure that it’s very difficult for people
to really understand it, which is why unsurprisingly the Fed has been subject to various conspiracy
theories, from being owned by the Rothschilds to being operated by lizard people.
Today, we’re going back to the dawn of American finance to see how the Fed was created, how
it works and who really owns it. This video is brought to you by Skillshare,
where you can find a ton of different classes including my own series of videos on how the
stock market works. You can watch them for free by registering
with the link in the description. America during the late 19th century was a
nation in turmoil and not just in the literal sense.
The Civil War was no doubt devastating, but even during the peace that followed America
was plagued by frequent and deep economic depressions.
The underlying cause was simple: America just lacked a proper financial system and more
importantly, it didn’t have a central bank to save the day when things turned bad.
Now, keep in mind, central banking wasn’t a new concept.
The Dutch were the first to come up with a central bank in 1609 and it was instrumental
in transforming the Netherlands from a swampy backwater into a global economic empire.
Following the example of the Dutch, the English created the Bank of England in 1694, which
of course became the backbone of the British Empire.
But it’s exactly this association with the British that made the Founding Fathers reluctant
to use the same model in the United States. There were two attempts at establishing a
central bank even despite public opposition: Alexander Hamilton himself led the first movement
in 1791. But in both cases the systems lasted under
20 years and did little to stabilize the situation. And by all accounts the situation was very
very bad. Back then even a single local bank failing
could result in nationwide panics. People knew that no one could save their bank
if it went bust, so as soon as rumors of insolvency started spreading, everyone frantically started
withdrawing whatever they had, bankrupting otherwise healthy and solvent banks simply
out of fear. Such bank runs happened with frightening regularity
and the depressions that followed were long and painful.
Of course, American bankers realized very well just how bad their industry was doing.
Paul Warburg, one of the great American bankers of his day, said in 1907 that the American
banking system then was at about the same point as 15th century Italy or Babylon in
2,000 BC. Just a few months after Warburg made that
statement, the country suffered the Panic of 1907 and it was particularly severe.
To start things off, in 1906 a devastating earthquake destroyed 80% of San Francisco.
With reconstruction efforts underway, capital was very tight and because all the money back
then was in paper form it was much more difficult to reallocate it across the country.
One banker tried to abuse that by manipulating the stock price of the United Copper company
back on Wall Street. He hoped to see his shares rise exponentially
in value, but instead they crashed, dragging down the entire stock market with them.
That banker was involved in 10 different banks across the East Coast and one after another
these banks failed as people assumed they were insolvent and withdrew all their money.
Pretty soon even banks that had nothing to do with that guy were going under, and so
the fearful bankers of America turned to the only man with the power to save them: J. P.
Morgan. Back then, John Morgan was the king of Wall
Street, and even today the bank he created is the largest one in America.
He wasn’t the wealthiest man at the time, that title belonged to John Rockefeller, but
Morgan was certainly the man everyone turned to when things got bad.
In October 1907 Morgan summoned the great bankers of the day to his office at 23 Wall
Street. With the collective capital of America’s
big banks, Morgan arranged for the rescue of the healthy banks that were nevertheless
near bankruptcy due to irrational fears. Virtually the same thing would happen a century
later in 2008 when the government bailed out the banks, but this time it was happening
entirely thanks to private individuals like John Morgan.
Once the panic was contained, it became clear to everyone that a central bank was necessary
and Congress immediately passed legislation to create one.
However, that was pretty much the only thing everyone agreed on: the actual details of
how it would work sparked long and fierce debates that halted any progress.
The agricultural South, for example, was afraid that a powerful central bank would give Washington
and Wall Street too much power over them. The bankers meanwhile wanted to make sure
that the central bank would not be manipulated by political interests: they wanted it to
be as independent as possible from Washington. The sheer number of competing parties made
creating a central bank extremely difficult and negotiations would in fact take over 5
years to finalize. What’s interesting though, is that these
negotiations weren’t happening on Capitol Hill.
Instead, they were held 600 miles south of Washington on Jekyll Island in Georgia.
That resort was home to an exclusive club of over a hundred of the wealthiest men at
the time, including John Morgan. Of course, only a select few would help draft
the actual plan for the central bank and it wouldn’t be until 1913 that legislation
would actually come to pass. The newly created Federal Reserve was truly
a miracle of compromise. To accommodate all the various interests of
the diverse United States, the Fed became a central bank unlike any other in the world.
To begin with, it wasn’t even a single bank, instead it was a network of twelve regional
banks each governed by local bankers and businessmen. Some of these banks were in obvious places,
like New York and Chicago, but many of the other locations came down to politics.
The Senator from Missouri, for example, was a key vote needed to pass legislation, which
why today Missouri is the only state to have two federal reserve banks within its borders.
To appease Washington, these twelve regional banks would have a single governing body,
comprised of seven people appointed by the president and confirmed by the Senate.
To limit the president’s power, he can only appoint one governor every two years with
a 14-year term. But the really unique part of the Fed’s
structure, and you can thank John Morgan for that, is the fact that each regional bank
is actually structured as a private corporation that has its own stock.
Here’s how it works: every nationally-chartered bank in America is required by law to keep
6% of its capital in its regional reserve bank.
In exchange, that private bank receives an equivalent amount of shares in the regional
reserve bank. These shares, however, are quite different
from the shares of public companies. Their price is fixed at $100 per share and
they cannot be sold or traded. They carry voting rights to about two-thirds
of the Board of Directors for that regional reserve bank, but as we know the real power
is in the Board of Governors appointed by the President.
What these shares do have, however, is a fixed 6% dividend per year.
It’s worth noting that this dividend doesn’t entitle the banks to any the Fed’s profits.
Instead, everything the Fed earns above that 6% payout goes directly into the Treasury.
And keep in mind, the Fed is very profitable: in 2017 it sent $80 billion to the Treasury,
while only paying out $14 billion to the regular banks that hold its stock.
So who are the shareholders of the Federal Reserve?
Well, basically every big bank in America. The full list is 150 pages long, but pretty
much every name you know appears on it. But here’s the beautiful thing: most of
America’s big banks are public corporations. In other words, if you want to benefit and
make money off of the unique structure of the Federal Reserve you can do that by purchasing
stock in American banks. Since ownership in the Fed depends on capital,
the bigger the bank, the bigger its ownership stake.
Therefore, it would be wisest to start from the top of the list.
And speaking of the stock market, in case you somehow missed it last month I released
a 20-minute animated series of videos on how the stock market works on Skillshare.
I cover topics like how dividends get paid out or how ETFs work and if you want to watch
the full class you can register for a 2-month free trial of Skillshare using the link in
the description. Once you’ve registered, search for “investing
101” or follow the link I’ve left in the comments below.
If you don’t know, Skillshare is the best online learning platform out there.
It has thousands of different classes on a wide variety of topics, including business
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I’ll let you know when that course goes live, but until then make sure you’ve checked
out Skillshare and my one course on it. Anyway, thanks for watching.
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