CHAPTER 1 – INTRODUCTION

1.1 AIM

The aim is to understand the concept for Federal Reserve Act, 1913 which will help to understand role of Federal Reserve Bank in various regulations as well as handling of various financial crises in US economy. This study also focuses on the financial crisis of 1907 due to which a systematic Act i.e. Federal Reserve Act, 1913 was formed.

Federal Reserves Act, 1913

1.2 STATEMENT OF PROBLEM

Federal Reserve Act, 1913 which is known as one of the most important Act in the history of U.S through which the Federal Reserve Banks was established had a very crucial role with respect to currency and also for having proper price stability in the economy. To have a proper central bank which will manage and monitor all the other banks for the proper functioning, Federal Reserve looks after all the banks. The financial crisis faced in United States several times where Federal Reserve had to bring out various plans and programs to handle the situation and bring back the crisis to its normal situation. There were issues which lead to financial crisis and therefore to know whether Federal Reserve were missing on some major things which lead to such crisis.

1.3 ABSTRACT

United States of America the most powerful country in terms of Economy, technology, laws, etc. Various laws, regulations necessary for the welfare is made for the well-being of the country. The finance sector is much more advanced and strict laws are prepared for preventions from any types of downfall, crisis or any loss in the economy. Banking sector which is one of the very important part in any country for proper cash flows, maintaining proper deposits of depositors and any such other directions necessary for regulating a proper flow of money in the market. In India, Reserve Bank of India is the central bank handling, monitoring every banks in the country likewise in USA the Federal Reserve Bank govern all the important sectors of US economy. Printing of currency, adjustment of interest rate and various other important steps are been taken by this bank. It is one of the most important institutions in the world.

Financial Crisis is a deep depression of wealth, faced by many countries which bring a huge loss in the economy. The reason Federal Banks was established for systematic flow to handle and monitoring all the flow of currency in the economy, was the financial crisis of 1907 which brought huge loss and disturbance in the economy. The Federal Reserve Act, 1913 was then made for proper regulations and management of currency and price stability in the market. The financial crisis of 1907 due to which the Act was formed and also “THE GREAT RECESSION” of 2008 where how does it bailout other banks and institutions will be studied. The research will thereby conclude by certain suggestions as per required.

1.4 RESEARCH QUESTION/ HYPOTHESIS

Whether the role of Federal Reserve Banks who faced various crises controlled in an appropriate manner?

1.5 RESEARCH METHODOLOGY

This research is a doctrinal study relating to Federal Reserve Act, 1913. This paper will be based on various readings, observations, from different authors, journal as well as research articles. The Library-based research method will be followed for deriving the answer for the Hypothesis. The search will be conducted on the basis of primary sources such as statutes and secondary sources such as books, online articles available freely as well as on legal databases. The paper is based on pure theoretical research.

1.6 REVIEW OF LITERATURE

The Author explains the concept about structure of Federal Reserve system which is created by the Federal Reserve Act, 1913. The Author also provides with the various periods in Federal Reserve history. In each period various economic, monetary issues which was faced and how Federal Reserve made various regulations for stabilizing the price stability in the economy. The Author further discussed about Federal Reserve’s role played in various ideas during such crisis and also decision making. The Author also shed light on the financial crisis of 2007-2008.

CHAPTER 2 – FEDERAL RESERVE BANKS – ROLE AND HOW IT WAS FORMED

2.1  Introduction

The Federal Reserve which is mostly referred as “The Fed” is known as the central bank of the utmost financial authority of the world’s largest economy i.e. The United States of America. It is one of the most influential financial institutional in the whole world. The Federal Reserve handles monetary policy and without any intervention. It also implements other functions such as regulating bank actions, also maintains financial stability in the economy. The headquarters of the Federal Reserve is Washington D.C. There are total twelve Federal Reserve Districts which was created by the Federal Reserve Act. 1913 which are in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kanas City, Dallas, San Francisco.

2.2 Role of Federal Reserve

a. Directing monetary policyThe Congress has laid down three main objectives which is attempted by the Federal Reserve through its monetary policy which are maximum no. of employment, stability in prices and low long term interest rates. By controlling the credit in the economy it monitors inflation, investments, etc.

b. Promotes financial stability– The Fed safeguards the price stability and monitors internal and external factors which effects the economy.

c. Development in payment and settlement safety– It ensures for a secure system for payment gateways and for the welfare of the citizens of US.

d. Encouraging consumer protection– The Federal Reserve works efficiently for rights of all consumers which are essential component of monetary services sector.

e. Regulating financial institutions– To control the economy and manage it with various majors it also manages the functioning of financial institutions.

2.3 The Reason behind Forming of Federal Reserve Bank

In the year 1907 there was a huge financial crisis which took place in the period of mid-October. Falling of New York Stock Exchange from almost 50% there was a time of economic recession where this panic occurred. These panic spread throughout the whole nation when many banks and businesses were bankrupt. Withdrawal of liquidity in many New York banks and deteriorating depositors confidence was the causes. The trust companies faced a lot of issues for following less directive than state banks and national banks. After some days the New York City’s third largest trust company in that time known as Knickerbocker Trust Company had a big downfall. The reason was the gamble which was undone due to investing millions of dollars in copper into the market for stopping the takeover into some other organization. The President was planning to drive up the cost of copper by cornering the market. During that time the then president was Charles T. Barney. He did not get any financial assistance from the bank. The board of Knickerbocker Trust told Barney to resign after he admitted his involvement.

After the collapse, the regional banks withdraw all the reserves from the banks situated in New York and also various individuals did the same withdrawing all deposits from such banks. The trust companies continued to worsen and during that time without being a central bank, the leading financers like J.P Morgan stepped and made provisions for liquidity which played a very important role in managing the crisis and also by his huge network tried to organize funds for rescuing major financial institutions. The government provided around $30 million and even financer John D. Rockefeller managed to help the economy.

Due to this panic it rises to the development of the Federal Reserve System and it ultimately led to draft the framework of monetary policy and regulations in banking sector. The then President Woodrow Wilson signed the legislation and it came to be known as the Federal Reserve Act, 1913. Then 1907 financial crisis is also known as 1907 Bankers Panic or Knickerbocker Crisis or Panic of 1907.

CHAPTER 3 – MAIN CRISIS FACED BY FEDERAL RESERVE

3.1 INTRODUCTION

Financial Crisis is any situation where one or more important financial assets which are stocks, real estate sector, or oil which suddenly and unexpectedly incur loss of a substantial amount of their value. The financial crisis severe fluctuating of liquidity in financial markets led to collapse of U.S market. Because of financial crisis it affects the international financial system and also failure in many investment as well as commercial banks, insurance companies, etc. lead to the Great Recession (2007-09) which was the worst downturn since the Great Depression (1929-39).  The U.S government had a long history with respect to bailouts. The first ever situation occurred during the panic of 1792 where Treasury Secretary Alexander Hamilton made purchases to prevent securities market. Bailouts are basically providing resources or money by businesses or government to a failing banks, company, etc which prevents from bankruptcy and bringing back to normal. The most recent is the Covid-19 Pandemic where on March 27, 2020 the President Donald Trump signed the Coronavirus Aid, Relief and Economic Security (CARES) Act, which provided more than $2 trillion in assistance also with a great downfall in economic activity the financial market was affected. The Fed even provided liquidity by expanding its balance sheet.

3.2 THE STOCK MARKET CRASH OF 1929

Dow Jones industrial had risen to about 400% in last five years in the stock market. The Stock market crash of 1929 also known as the Wall Street crash of 1929 which occurred in the month of October where the share prices of New York Stock Exchange collapsed. The causes of the crash is mainly because of the heavy fall of Dow Jones industries and various other industries, the reason was over production done in many industries caused more supply of steel, iron, etc. When it was known that demand had become very low and not enough buyer is left so the manufacturers dumped all their stock in loss and it reflected the stock market as it started decreasing.  Agriculture sector was also affected. On October 24th the market fall by 11% and many US banks decided to purchase many stocks for stabilizing the price and it could only close down with just 6 points. On 28th October the market fell more by 13% and 12% on Tuesday. In These two days, market lost approximately $30 million.  Various sectors were having a fall such as General Electric, United States Steel, etc.  During the period Federal Reserve had tighten the credit by increasing the discount rate from 5% to 6%.  The then President Hoover and treasury Secretary Andrew W. Mellon after various predictions and bringing back the economy back to normal. The Dow Industry reached 300 mark in the year 1930 again. Because of this crash and globally commercial bank failure, two Congress members introduced the Act known as the Glass-Steagall Act which will separate investments and commercial banking functioning. One of the main reason of the crash was the huge commercial bank involvement in investment of stock market by taking high risk of depositors money

3.3 THE STOCK MARKET CRASH OF 1987

The global crisis in the year of 1987 which is also known as Black Monday brought a deep effect in the stock exchanges in the United States. The well-known the Dow Jones Industry had a great fall of about 22.6% in a single day largest fall in the history and not even on the financial crisis of 1929. During the first half of the year 1987 the stock market as well as the Dow Jones gained around 44%. The Federal Reserve in the year 1985 made agreement in 5 nations i.e. France, Germany, the United Kingdom and Japan to depreciate the U.S dollar currency market to control trade deficit. The government revealed a larger trade deficit and the value of dollar was falling down. Many markets incurred daily a huge amount of losses. Many investors moved towards liquidating funds. During the crisis the stocks, future market used various methods other than the regulations for settling their trades which lead to negative trading account and forced liquidations. During that time the regulators were in need of trade clearing protocols for bringing uniformity in the market. They brought the rule of circuit breakers which allows to halt trading for some time in cases where there is a huge price fall. It also takes place to curb panic selling. These apply to large markets such as S&P 500 (Standard & Poor’s 500 index). The Federal Reserve taking the responsibility as a Central Bank declared that for supporting the economic and financial system they will bailout to many failed banks and also encouraged to lend loans for preserving the system as a whole. After this the stock market recovered and Dow Jones Industrial Average gained back to around 288 points.

3.4 FINANCIAL CRISIS OF 2007-2009

The first instance of the financial crisis is on 9th August 2007, PNB Paribas declared about suspending redemptions on three funds because they were unable to value the debt obligations by these funds and liquidity was reducing for subprime mortgage assets (Subprime borrowers are individuals who represent a higher risk to the lenders. They take loans and have to pay higher interest rate. These borrowers basically take loans and deals on home prices like refinancing, mortgaging and sell their home in profit and pay off their mortgages). Due to this interbank markets lending seized up. Federal Reserve provided liquidity and to support by various programs improved the working in financial markets. Even by this, the crisis extended in US with respect to house construction, their prices as well as credit. The house prices was higher in the year 2007 as per Federal Housing Agency House and reason for a huge fall was likely because of increasing mortgage defaults and subsequently the holders of such securities. In the year 2008 Lehman Brothers, one of the best and biggest financial institutions were bankrupt. Billions were wiped off in a single day. Also the country’s two big home lenders i.e. Fannie Mae and Freddie was seized by the government. Due to the low lending standard and also the prices lead to issues reduction of liquidity in the market. After this the banks and subprime lenders again sold the mortgages to free up money and bring liquidity. When defaults started arising many buyers were left with no money and crisis began. Federal Reserve bail out huge amount of money to various banks, institutions which were bankrupt and also many individuals who were affected by this recession. The biggest banks who supported to this crisis were JP Morgan, Goldman Sachs, Morgan Stanley who were such developed banks who repaid the bailout money to the government and also brought liquidity in the market and the recession came to an end in the year 2009.

CHAPTER 4 – CONCLUSION

Federal Reserve Bank has always played a very important role in every financial crisis and for the regulation of the United States. The Federal Reserve Act, 1913 was important for having a central banks holding and managing all the banks and for proper regulation over all these banks. Federal Reserve had played an immense role also with respect to the financial crisis which was needed by bringing liquidity and also bailout many institutions, banks, etc. Though various leading financers such a J.P Morgan always supported to the public by various manners and also the government. The Role of Federal Reserves should have been more strict and properly monitored and if these would be done then financial Crisis could be avoided. With respect to the financial crisis of   2007 if the Federal Reserve could stop the improper flow of mortgages and also by putting more improved mortgage lending standards which needs to be strictly followed could make a huge difference. There were excessive borrowing, risky investments which were taken by banks, also there were no proper risk management of banks, etc if this all should be properly monitored as well as specific limit would be given so crisis would not had happened. Federal Banks were not prepared for any of the crisis and which brought panic in financial market. The Federal Reserve did appropriate way to handle the market by lending to the weak banks and also by bringing a change in the rates when needed for bringing the economy to its normal position. Therefore to conclude, the Federal Reserve Act, 1913 brought changes in the economy and by way of Federal Reserves the banks were properly monitored and the major decisions could be taken by Federal Reserves being the central bank.

REFERENCE

A. PRIMARY SOURCES

  • The Federal Reserve Act, 1913

B. SECONDARY SOURCES

ARTICLES

a. Edward J. Schoen, “The 2007-2009 Financial Crisis: An Erosion of Ethics: A Case Study” , CrossMark, 146:805-830, (2017).

https://link.springer.com/content/pdf/10.1007/s10551-016-3052-7.pdf

b. Chad Emerson, “The Illegal Actions of the Federal Reserves: An Analysis of How the Nation’s Central Bank has acted Outside the Law in Responding to the Current Financial Crisis”, William & Mary Business Law Review, Volume 1, Issue 1, (2010).

c. Michael D. Bordo, John S. Landon, “The Global Financial Crisis of 2007-08:is it unprecedented?”, National Bureau of Economic Research, NBER Working Paper No. 16589, JEL No. E30, G01, N20, (December 2010).

https://www.nber.org/system/files/working_papers/w16589/w16589.pdf

d. Michael D. Bordo, Edward S. Prescott, ”Federal Reserve Structure, Economics Ideas and Monetary and Financial Policy”, National Bureau of Economic Research, NBER Working Paper No. 26098, JEL NO. B0, E58, G28, H1, (July 2019).

WEBSITES

a. https://www.federalreservehistory.org/essays/stock-market-crash-of-1987

b. https://www.federalreservehistory.org/essays/great-recession-and-its-aftermath

c. https://www.federalreserve.gov/

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Qualification: LL.B / Advocate
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Location: Mumbai, Maharashtra, India
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A qualified law professional with specialization in important Laws governing corporate sector i.e. Insolvency and Bankruptcy Code, 2016, Foreign Exchange Management Act, 1999, Fintech laws, Anti-Corruption and Bribery Laws, Comparative Global Financial Regulations and others. View Full Profile

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