The Federal Reserve is consolidating check-processing operations into a few sites. This is good management, but begs the broader question of whether we really need 12 separate Federal Reserve districts.
Check volumes are dropping precipitously as more and more people use online banking. At one time, the Fed processed checks at some 50 district banks, branches and regional processing centers. The Fed already had closed some facilities before announcing a sweeping consolidation plan in late June. By 2011, most such work will occur at just four sites.
The Minneapolis Federal Reserve Bank will phase out its check department completely, losing more than 200 positions.
This restructuring is a welcome example of a government institution adapting to changing conditions by its own initiative. So, why not similarly consolidate the entire Fed system? A structure that was appropriate in 1913 may not be what we need a century later.
(By way of disclosure, I worked as a regional economist for the Federal Reserve Bank of Minneapolis. My duties included drafting the Minneapolis Fed’s section of the report on regional economic conditions prepared before each meeting of the Fed’s key policy committee.)
The Fed structure of 12 independent district banks spread from Boston to Atlanta to San Francisco is unique among central banks. It stems from political compromises needed to pass the Federal Reserve Act in 1913. Banking interests did not want a government agency headquartered in Washington, D.C. But farmers and main-street businesses did not want a private central bank with monopoly powers located on Wall Street.
The compromise was to create the 12 regional banks. These nominally were privately owned. Each was to have a board of directors drawn from the bankers and other business people in the specific geographic area the bank served. Power was dispersed, not concentrated either in New York or Washington.
The decentralized system supposedly would be more responsive to local conditions, making money more or less available as needed. It also had practical advantages. Checks could be cleared regionally. Bank examiners would have expertise in a specific geographic area. Most importantly, commercial bankers across the country would have easy access to their district’s Reserve Bank whenever they needed to borrow funds.
To further that end, more than 30 branch banks were established. These served as consolation prizes for cities like Baltimore, Detroit and Denver that did not get one of the 12 district-headquarters banks. But they also make it even more possible for most bankers in the nation to reach a reserve bank in one day’s travel or less.
With slow and expensive communications, the dispersed system of nearly 50 banks and branches made sense. And it meshed with the idea of decentralized monetary policies that varied by region.
The failure of the Fed to limit the Great Depression showed flaws in that plan. The Federal Reserve Act was amended to establish the current Board of Governors. District banks still had a major role in setting monetary policy, but it was one policy for the nation as a whole. The Federal Open Market Committee that set key policies met in Washington.
This change also meant that buying and selling bonds would be the key tool to change the money supply and thus interest rates, not making more or fewer direct loans to private banks as envisioned in 1913.
With monetary decisions moved to Washington and diminishing direct lending to banks, administrative functions like issuing currency, clearing checks and examining banks came to dominate regional bank operations.
Technology has changed much of that. On the surface, the reasons for a decentralized system that prevailed in 1913 have largely disappeared. So if check clearing can be consolidated into four sites, why not everything else?
The answer is that the decentralized system of 12 highly autonomous banks produces better monetary policy than we would have if it were left strictly to a Washington-based staff. Twelve district presidents reporting to 12 boards of directors and supported by 12 research staffs produce better information. It is a classic example of the role of checks and balances so valued by the writers of our Constitution.
Better monetary policy benefits the economy in ways that far outweigh the marginal expense of the existing system. As someone who played a minor administrative role in the process, this seems emphatically true and vitally important. But it is hard to explain to the average citizen and hard to defend against perennial Fed critics in Congress. Efficient restructuring of an administrative function may lead to unfortunate change in a vital one – determining the appropriate money supply and interest rates for the nation.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.