Have you ever had one, one of those moments where
you're just standing in the middle of a grocery
store aisle staring at a carton of eggs or a
gallon of milk and you suddenly realize the price
has jumped yet again? Oh, yeah. It's a very common
feeling these days. Right. Or maybe you're scrolling
through housing listings on your phone. looking
at the current mortgage rates and trying to figure
out why buying a starter home suddenly feels,
well, like a financial impossibility compared
to just a few years ago. Yeah, you watch the
job market tighten up, you see the yield on your
high -yield savings account bounce around. Exactly.
And it all feels like this chaotic, entirely
unpredictable weather system. I mean, it feels
like you're just at the mercy of the economic
elements. But then, if you look a little closer
at the data, you start tracing the wires back
to the source. And you realize something profound.
It is not the weather. It's not totally random.
No, it's not. There is actually a single massive
entity pulling the levers behind the scenes.
It's the ultimate... man behind the curtain scenario,
right? It really is. I mean, when you see those
mortgage rates spike or when you notice that
companies are suddenly doing mass layoffs or
conversely going on massive hiring sprees, you're
feeling the direct. calculated effects of a highly
engineered, deeply complex system. Wow. Yeah.
We're talking about an institution that has the
power to single -handedly influence the economic
trajectory of the entire United States and, by
extension, the entire global economy. OK. Let's
unpack this. Right. Because that is exactly our
mission for this deep dive. Right. We are taking
a comprehensive look at the Federal Reserve,
the central bank of the United States. Also known
just as the Fed. Exactly. Yeah. We're going to
explore. the Fed manages the stability of the
banking sector and actively, deliberately steers
national economic growth. And we have some great
source material for this. We do. Our foundational
guide for this journey is a massive, incredibly
detailed Wikipedia article on the Federal Reserve.
It's an exhaustive repository detailing its,
well... It's tumultuous history, its labyrinthine
structure, and the incredibly complex monetary
tools it uses to do its job. Setting the tone
right away is crucial here, I think, because
the Fed is not just some giant passive vault
of money sitting in Washington, D .C. Right.
It's not like a Scrooge McDuck money bin where
the government just, you know, hoards gold. No,
not at all. It is an active dynamic mechanism
and it's designed to balance on a terrifying
razor's edge. A tightrope act, basically. Exactly.
On one side of this tightrope, you have the threat
of runaway inflation, which destroys the purchasing
power of your money, making your savings completely
worthless. Right. And then on the other side,
you have the threat of a complete economic freeze,
a deflationary spiral and a devastating depression.
So the Federal Reserve exists right in that middle
space, constantly tweaking the dials to keep
the whole machine from just shaking itself apart.
That's precisely it. But, you know, to understand
how the Fed controls the modern economy, we first
have to understand why it even exists in the
first place. We have to go back in time. Yeah,
back to a time before its creation in 1913. We're
talking about an era in the United States that
was, for all intents and purposes, the financial
Wild West. Calling it the Wild West is is barely
an exaggeration. The history of central banking
in the US was not a straight line of progress
at all. It was a series of failed experiments.
The founding The fathers were actually deeply
divided on this. Right. Alexander Hamilton and
Thomas Jefferson. Exactly. Hamilton championed
the first Bank of the United States in 1791 to
handle the new nation's war debt, but Jefferson
and his allies despised it. They feared a massive
concentration of financial power. So they let
the charter expire. Right. Then they tried a
second Bank of the United States in 1816, but
President Andrew Jackson famously went to war
against it. Oh, yeah. He vetoed its renewal,
didn't he? He did, yeah. he believed it favored
wealthy elites over common citizens. And what
followed was this chaotic period known as the
free banking era, where basically any institution
could issue its own paper money. That sounds
like a nightmare. It was. And then there was
a fractured system of national banks instituted
during the Civil War in 1863. And without a central
steering wheel, without a unified system to manage
the flow of money, things were remarkably unstable.
Very unstable. The 19th and early 20th centuries
were punctuated by these massive, devastating
financial panics. I mean, we're talking about
the panic of 1873, the panic of 1893, and the
really big one that changed everything, the panic
of 1907. Right. These were not just dips in the
stock market. These were society -altering events.
Thousands of businesses collapsed, unemployment
skyrocketed, and people's life savings simply
vanished overnight. Just poof. Gone. But to understand
why these panics kept happening with such brutal
regularity, we have to look at the core vulnerability
of the banking system itself. Yeah, we have to
talk about fractional reserve banking. Let's
break that down, because I think a lot of people
still operate under a misconception about how
their local bank actually works. Oh, for sure.
Banks do not just take your paycheck, put the
cash in a little metal lockbox with your name
on it, and guard it until you come back. Far
from it. When you deposit money, The bank takes
the vast majority of those funds and immediately
invest them. Usually by lending it out, right?
Exactly. They lend your money out to other people,
to a family, buying a 30 -year mortgage, or a
local entrepreneur taking out a five -year loan
to build a restaurant. Right. The bank is legally
required to keep only a small fraction of its
total deposits in liquid cash, basically, in
reserve. That's the fractional part of fractional
reserve banking. And under normal everyday circumstances,
this system works perfectly right. Because statistically,
not every single depositor you're going to walk
into the bank and demand their money back on
the exact same Tuesday. Right, exactly. I always
think of it like the coat check at a massive
Broadway theater. Oh, that's a good analogy.
Yeah, you go to see a play in the dead of winter,
you hand the attendant your heavy winter coat,
and they give you a little numbered ticket. Now,
the actual coat check room is surprisingly small.
They pack those coats in tight. But the system
functions beautifully. Because people leave the
theater at slightly different times, or they
dawdle in the lobby, or they grab a drink, the
attendants have time to fetch the coats as people
casually trickle out. But imagine someone yells
fire in the middle of the second act. Every single
patron in that 2 ,000 seat theater panics, rushes
to the lobby, and demands their coat. at the
exact same second. Complete chaos. Total chaos.
The attendants are completely overwhelmed. The
room is too small to navigate. The system instantly,
catastrophically breaks down. And in the financial
world, that is a bank run. That analogy perfectly
captures the sheer panic and the mechanical failure
of it all. A bank run happens when too many customers,
driven by fear or rumors that the bank is going
under, demand to withdraw their savings all at
once. And the bank just doesn't have the cash.
Right. It simply does not have the cash on hand.
It's not that the bank's assets are gone. It's
that the money is tied up in a 30 -year mortgage
on a house across town. You can't just chop a
roof off a house and hand it over the teller
counter. Exactly. They can't instantly convert
that house back into cash. And in the late 1800s
and early 1900s, when one bank failed this way...
the fear became a contagion. Contagion is the
perfect word. I mean, if you see the bank across
the street locking its doors with a mob of angry
depositors outside, you don't wait to see if
your bank is healthy. No, you run. You run to
your bank and pull your money out immediately.
And that causes your perfectly healthy bank to
collapse. And furthermore, banks during this
era would stop clearing checks from each other
out of suspicion, which froze the entire payment
system. Wow. Yeah, in the panic of 1907, the
situation escalated so rapidly following the
collapse of a massive institution called the
Knickerbocker Trust Company that the federal
government was completely powerless to stop it.
The government couldn't do anything. Nothing.
The crisis was only halted because J .P. Morgan,
the actual man, the private banker, locked the
city's most prominent financiers in his private
library and personally strong -armed them into
committing tens of millions of dollars of their
own money. Just to bail out the failing institutions.
Exactly. To provide the liquidity needed to stop
the panic. It is wild to think about. I mean,
the entire financial survival of the United States
relied on one incredibly wealthy guy locking
a door and twisting arms. It was a very precarious
situation. That was the ultimate wake up call
for the nation, right? The government and the
public realized that a modern industrialized
economy cannot rely on the goodwill and personal
wealth of a single individual to save it from
ruin. No, absolutely not. The country suffered
from what's called an inelastic currency, meaning
the money supply couldn't quickly expand to meet
emergency demand. And there was a fatal lack
of centralized liquidity. They needed a permanent
structural solution. Which brings us to 1913.
Yes, the 1913 solution. The origins of this are
quite famous, actually, often cited in financial
lore. In 1910, Senator Nelson Aldrich, alongside
representatives from the nation's top financial
and industrial groups, literally boarded a train
under assumed names. assumed names? Yeah. Like
spies. Oh, basically, yeah. They traveled in
secret to a private resort on Jekyll Island off
the coast of Georgia. They spent days secluded
there, drafting a comprehensive plan for a centralized
banking system. The famous Jekyll Island meeting.
Right. That Aldrich plan, after significant political
wrangling and modifications, eventually evolved
into the Federal Reserve Act of 1913, which was
signed into law by President Woodrow Wilson.
What's fascinating here is how targeted that
original design was. I mean, they weren't trying
to manage the global economy or set the price
of goods. Not at all. The original mandate was
a direct mechanical response to the specific
vulnerability of bank runs. They wanted a lender
of last resort. Yeah, a giant reservoir of cash
that a struggling bank could borrow from in an
emergency so they wouldn't have to lock their
doors when the depositors panicked. And they
also wanted an elastic currency, right? A money
supply that could physically expand and contract
as the seasonal agricultural economy required.
It was essentially designed as emergency plumbing
for the financial sector. Plumbing. I like that.
Yeah, but over the subsequent decades, particularly
in the crucible of the Great Depression in the
1930s and later the 2008 financial crisis, that
narrow mandate evolved dramatically. It really
did. Today, the Federal Reserve's responsibilities
have expanded to managing the entire macro economy
of the United States. Looking at our deep dive
materials, the core purposes of the modern FED
are vastly broader than the 1913 vision. Yes,
they still act as that crucial lender of last
resort to address banking panics. They still
maintain an elastic currency, but now they're
tasked with managing systemic risk in the global
financial markets. They regulate and supervise
private banks to make sure they aren't taking
reckless gambles with depositor money. Right,
and they protect consumer credit rights. And
they serve as the central nervous system for
national payments. What does that mean, practically?
Well, when you deposit a check, the Fed is often
the intermediary clearing that transaction between
your bank and the payer's bank. They process
trillions millions of dollars in electronic transfers.
They even handle the physical logistics, accepting,
verifying, and distributing the paper currency
and coins printed by the U .S. Treasury and pulling
old damaged bills out of circulation. OK, so
we've established that by 1913, the founders
of this system knew a central bank was absolutely
necessary to stop these devastating panics. But
as we discussed with Hamilton and Jackson. Americans
historically harbored a deep, almost genetic
distrust of a centralized financial power. Oh,
absolutely. A very deep distrust. You had agrarian
progressives out West and in the South who were
terrified that a central bank would just be a
tool for Wall Street elites to control credit
and crush farmers. Right. And on the flip side...
The Wall Street bankers were terrified that a
central bank run by political appointees in Washington
would lead to the government micromanaging their
businesses and using the money supply to buy
votes. Everyone was scared of everyone else.
Exactly. So how did they construct a system that
wouldn't be completely captured by either of
these bitter factions? They engineered a brilliant,
highly unusual compromise. The Federal Reserve
is not a standard government agency, nor is it
a private corporation. It has a hybrid structure.
A hybrid, okay. Yeah, in constitutional and administrative
terms, it is often described as being independent
within the government, not independent of government.
It is simultaneously public and private, centralized
and decentralized. Okay, let's pull apart the
anatomy of this hybrid, because it's built on
three main pillars that balance each other out.
Pillar number one is the centralized public face,
the Board of Governors. The Board of Governors
is based in Washington, D .C., and it represents
the federal government's oversight of the system.
It consists of seven members who are appointed
directly by the president of the United States
and then must be confirmed by the Senate. Much
like a Supreme Court justice or a cabinet secretary.
Exactly. But unlike a cabinet secretary who serves
at the pleasure of the president and usually
leaves when a new administration takes over.
Yeah. These governors are heavily insulated from
the daily churn of partisan politics. Very insulated.
They serve staggered 14 year terms. Yeah, 14
years. It's a long time. It is. One term expires
every two years. So theoretically, no single
president serving a four year or even an eight
year term can just sweep in, fire everyone and
pack the board with loyalists to force them to
enact economically reckless but politically popular
policies right before an election. And the current
chair leading this board, based on the data in
our sources, is Jerome Powell. That's right.
And that 14 -year insulation is a cornerstone
of modern economic theory. Economists across
the political spectrum generally agree that monetary
policy should be insulated from short -term electoral
politics. Why is that so crucial? Because if
a president or Congress had direct daily control
over the money supply, there would be an overwhelming
temptation to artificially lower interest rates
and flood the economy with cash six months before
an election. To make things look great right
before people vote. Exactly. It would create
a temporary euphoric economic boom, ensuring
the reelection. But it would inevitably lead
to massive punishing inflation a year later.
The long -terms are designed to allow the governors
to make unpopular, painful decisions without
fear of immediate political termination. Okay,
that covers the folks in Washington. But if you're
trying to manage the economy of a continent -spanning
nation, sitting in a D .C. office isn't going
to give you the full picture. No, you need sensors
on the ground. Right. And that brings us to pillar
number two, the 12 regional Federal Reserve banks.
This is where the decentralized private aspect
comes into play. The architects of the Fed divided
the United States into 12 distinct districts,
placing a regional reserve bank in key cities.
Like where? Well, you have the Federal Reserve
Bank of Boston, New York, Philadelphia, Cleveland,
Richmond, Atlanta, Chicago, St. Louis, Minneapolis,
Kansas City, Dallas, and San Francisco. That's
a lot on the East Coast. Yeah, it's worth noting
that this map was drawn based on the population
and economic distribution back in 1913, which
is why the eastern half of the country is heavily
represented while the massive San Francisco district
covers everything from California up to Alaska
and Hawaii. Wow. Okay, so these regional banks
are the boots on the ground. They gather economic
data from their specific districts. They supervise
the local commercial banks, and they interact
directly with the private financial sector. Right.
And here is the part of the Fed structure that
often sparks conspiracy theories until you look
closely at the actual mechanics. Private commercial
banks actually own stock in these regional Federal
Reserve banks. Yeah, that is a factual statement
that requires immediate, precise clarification
because it is easily misunderstood. Definitely.
Unpack that for us. So member banks, which are
the private commercial institutions where you
might have your checking account, are required
by law to hold stock in their regional Fed branch.
Specifically, they must subscribe to stock equal
to 3 % of their combined capital and surplus.
However, this is absolutely not like owning stock
in a publicly traded tech company like Apple
or Microsoft. Right. You can't log on to a brokerage
app and buy shares of the Federal Reserve. Exactly.
A member bank cannot sell this stock, they cannot
trade it on Wall Street, and they cannot pledge
it as collateral for a loan. Furthermore, Owning
this stock does not grant these private banks
control over the Federal Reserve System, right?
No, not at all. It does not give them the power
to dictate national monetary policy. What it
does do is fulfill a structural membership requirement,
and in return, the member banks receive a statutorily
fixed dividend. Like a payout? Yeah. For member
banks with $10 billion or less in assets, they
receive a 6 % annual dividend on that stock.
For larger banks, the dividend is the lesser
of 6 % or the current 10 -year treasury option
rate. So it's just a mandated feature of the
hybrid public -private partnership? Exactly.
It's designed to ensure the private banking sector
has a vested capitalized interest in the stability
of the regional reserve banks without granting
them sovereign control. OK, so we have the seven
presidentially appointed governors in D .C. and
we have the 12 regional reserve banks anchored
in the private sector across the country. But...
having a pulse on the economy and a board of
directors isn't enough. Someone has to actually
make the medical decisions for the economy. The
actual policy. Right. How do these two halves
come together to actually vote on policy? That
is pillar number three, the FOMC or the Federal
Open Market Committee. The FOMC is the absolute
steering wheel of the United States economy.
This is the committee that meets every six weeks
to evaluate economic conditions and actually
set national monetary policy, primarily by determining
interest rates. And how many people are on this
committee? The committee consists of exactly
12 voting members. And the math here perfectly
illustrates the compromise we were talking about
earlier. All seven members of the Board of Governors
get a permanent vote. So the public, Washington
appointed side, always holds the majority. The
remaining five voting seats go to the presidents
of the regional reserve banks. But wait, since
there are 12 regional presidents, how do they
determine who gets to vote? It's a rotation.
One seat is permanently assigned to the president
of the Federal Reserve Bank of New York. Why
New York? Well, this is a practical necessity
because the New York branch is uniquely situated
on Wall Street. They are the ones who execute
the actual market operations and trades on behalf
of the entire system. That makes sense. Yeah.
And the other four voting seats rotate annually
among the remaining 11 regional bank presidents.
So at any given FOMC meeting, you have a blend
of politically insulated Washington appointees
and regionally focused banking leaders making
the decisions collaboratively. On paper, This
structure is an elegant masterpiece of checks
and balances. But our deep dive material brings
up a very recent, highly contentious, real world
stress test of this exact structure. Oh, yes.
Specifically regarding that concept of insulation
from political pressure we just talked about.
We're looking at events stretching into 2025
and 2026 during the second Trump presidency.
Yeah. The documentation provides a profound case
study of the tension between the executive branch
of the government and the mandated independence
of the Federal Reserve. We need to examine the
facts exactly as they're laid out in the legal
and historical record, maintaining complete analytical
impartiality, of course. Absolutely. Here's the
situation. President Trump attempted to remove
Governor Lisa Cook from the Board of Governors
before her 14 year term was completed. Right.
Now, the Federal Reserve Act states that a president
can only remove a governor for cause. It's not
like firing a cabinet secretary over a policy
disagreement. For cause historically implies
a rigorous legal standard. Usually involving
severe ethical breaches, malfeasance, or criminal
behavior. It means you cannot fire a governor
just because they refuse to lower interest rates
when you ask them to. Right. And according to
the source material, the president formally cited
alleged misconduct as the justification or the
cause for her removal. And Governor Cook immediately
and categorically disputed these allegations.
Her position was that the dismissal was entirely
unlawful, that it was fundamentally politically
motivated to alter the balance of the board,
and she subsequently filed a federal lawsuit
to contest the removal. And the fascinating mechanical
reality is that as of the 2026 data in our sources.
While this massive constitutional litigation
slowly plays out in the federal courts, Lisa
Cook is legally still considered an active sitting
governor. Yeah, the Federal Reserve itself even
issued an official statement affirming her status
as a governor pending a final judicial ruling.
Which is pretty incredible. The implications
of this are staggering for administrative law.
I mean, the core question before the courts is
who gets to define for cause and how broad is
that definition? Right. If the judiciary rules
in favor of the president, essentially allowing
the executive branch wide latitude to determine
what constitutes cause, then those 14 -year term
limits are functionally gutted. Exactly. And
the Fed's independence is drastically reduced
because future presidents could simply allege
misconduct to clear the board. But conversely,
if the courts side with the governor and apply
a strict, narrow definition of cause, that 14
-year insulation is fortified, cementing the
Fed's operational autonomy against the executive
branch. It's a massive stress test. And to add
another layer of operational complexity, the
source also details the situation regarding Governor
Stephen Marin. Oh, right. The holdover situation.
Yes. His official 14 year term on the board expired
on January 31st, 2026. However, he didn't just
pack up his desk and leave. Why not? Because
the statute governing the Fed includes a provision
stating that a governor can continue to serve
after their term expires until a successor is
officially appointed by the president and confirmed
by the Senate. So he is remaining in his seat
indefinitely. Both of these scenarios, a governor
actively fighting removal in federal court to
protect her term and a governor lingering indefinitely
past his term waiting for the political appointment
process to function. They demonstrate that the
structure of the Federal Reserve isn't merely
theoretical. Not at all. It is a living institution
operating within a highly charged, relentless
political reality. The delicate balance between
democratic accountability and independent monetary
policy is constantly being tested and redefined.
So we've established who is sitting in the driver's
seat, and we understand the intense political
gravity they have to resist. But how exactly
do they steer this multi -trillion dollar machine?
When the FOMC meets, what exactly are they trying
to achieve? They're executing what Congress explicitly
mandated them to do. In the amended Federal Reserve
Act, Congress gave the Fed what is universally
known as the dual mandate. The dual mandate.
Right. They are tasked with two primary objectives
for national monetary policy, maximizing employment
and stabilizing prices. Now at first glance,
that sounds fantastic. It sounds like a political
campaign promise. I mean, everyone wants to have
a well -paying job and nobody wants their grocery
bill to double every six months. Sure. But if
you think about how economics actually works,
those two goals frequently pull in completely
opposite directions. They're often in direct
conflict. Precisely the problem. Let's trace
the logic. When employment is maximized, When
the economy is running incredibly hot, businesses
are expanding, everyone who wants a job has one,
and companies are raising wages to attract scarce
talent. everyday people have significantly more
disposable income. They go out and buy cars.
They renovate their homes. They take vacations.
Exactly. That massive surge in consumer demand
allows businesses to raise their prices because
people are willing and able to pay. And that
rapid price increase is inflation. Right. Conversely,
if the Fed wants to cool down inflation and stabilize
prices, the primary method is to make borrowing
money more expensive. This slows down business
expansion, which leads to higher freezes or layoffs,
which increases unemployment. Managing the dual
mandate is a constant agonizing tightrope walk.
I want to zoom in on the second half of that
mandate, stabilizing prices, because the language
is a little deceptive. When the Federal Reserve
says stable, they absolutely do not mean zero
inflation, do they? No, they don't. They don't
want the price of a gallon of milk to stay at
$3 .50 for the next 50 years. That is correct.
The Fed interprets the mandate of stable prices
as an ongoing inflation rate of exactly 2 % per
year on average over the long term. 2%. Right.
They track this primarily using a specific metric
called the Personal Consumption Expenditures
Price Index, or the PCE, which measures the changing
prices of goods and services consumed by households.
But I think a lot of listeners might struggle
with this concept. I mean, if inflation destroys
the purchasing power of my dollar, why is the
goal 2 %? Why wouldn't zero inflation, where
prices never go up, be the absolute ideal scenario
for the American consumer? It is deeply counterintuitive,
I know. But, most mainstream macroeconomic theory
favors a low, steady rate of inflation for a
few vital mechanical reasons. First and foremost,
a 2 % target acts as a crucial buffer. If your
goal is strictly 0 % inflation, any slight unexpected
economic downturn could easily tip the economy
into negative inflation, which is called deflation.
And on a micro level, deflation sounds amazing.
If I want to buy a new refrigerator and prices
are dropping, that's great for me. But macroeconomically,
deflation is a nightmare. Right. A total nightmare.
Because if you know the refrigerator is going
to be 10 % cheaper next month, you don't buy
it today. You wait. Everyone waits. Exactly.
When consumers expect prices to fall, they postpone
purchasing. The appliance store's revenue plummets.
They stop ordering inventory from the factory.
The factory's profits crash, so they lay off
workers. And those unemployed workers stop spending
entirely. Right, which causes even more businesses
to lose revenue. It creates a devastating, self
-reinforcing death spiral. Deflation can also
lead to what economists call a liquidity trap,
where interest rates hit zero, but people still
won't borrow or spend, rendering the Fed's primary
tools completely ineffective. So a 2 % inflation
target keeps us safely away from that black hole.
You hear advisors to the Fed, like Diane C. Swank,
who is quoted in our source materials, compare
inflation to a medical condition. She says, and
I quote, from the Fed's perspective, you have
to remember, inflation is kind of like cancer.
If you don't deal with it now with something
that may be painful, you could have something
that metastasized and becomes much more chronic
later on. It is a grim but accurate metaphor.
The medicine for high inflation is economic pain.
You have to actively slow the economy down, which
means people lose jobs and businesses fail. The
tightrope walk again. Exactly. The Fed believes
that enduring a little bit of pain early on is
vastly preferable to letting hyperinflation take
root, which would require catastrophic economic
chemotherapy down the line. So what does this
all mean? We know the target is 2%. But how does
the Fed actually hit that target? They don't
have a dial in Washington that directly controls
the price of eggs No, they don't they have to
influence the behavior of hundreds of millions
of people and millions of businesses They do
this indirectly primarily by targeting something
called the federal funds rate or the FFR Okay,
we need to trace the mechanical domino effect
here step by step Yeah, what exactly is the federal
funds rate to understand the FFR? We have to
go back to the concept of reserves Remember that
private banks are required or financially incentivized
to keep reserves parked at their local Federal
Reserve Bank. Right. At the end of every single
business day, the banking system has to balance
its books, like closing out a cash register at
a massive restaurant. Makes sense. Some banks
will have taken in lots of deposits and have
excess reserves sitting idle. Other banks might
have issued a ton of loans that day and find
themselves slightly short of their internal targets
or legal requirements. So to balance everything
out, the banks with excess cash lend it to the
banks that are short. And these are incredibly
short term loans, right? literally overnight.
They lend the millions at five favor zero p .m.
and get it back the next morning. Correct. The
interest rate that these private commercial banks
charge each other for these unsecured overnight
loans is the federal funds rate. But here's the
critical distinction that often gets lost in
the news. The Federal Reserve does not explicitly
dictate or mandate this exact rate. It's an open
market rate. Right, it is determined by banks
negotiating with other banks. What the Fed does
is set a target range for the FFR. They announced
to the world, we want the overnight lending rate
to hover between 4 .5 % and 4 .75%. And this
is where the first domino falls. If the Federal
Reserve takes action to push that FFR target
higher, It suddenly becomes more expensive for
a private bank to borrow the money it needs to
cover its daily operations. And banks are businesses.
They do not just absorb that increased cost of
doing business. They immediately pass it on to
the consumer. If it costs a major bank more to
borrow money overnight, they are going to raise
the prime rate, the baseline interest rate they
charge their best, most credit -worthy corporate
customers. And when the prime rate goes up...
Everything else goes up. Mortgage rates climb.
Credit card interest rates spike. The APR on
a new car loan gets more expensive. And this
is how the Fed steers the macro economy. When
borrowing becomes expensive across the board,
the behavior of consumers and corporations changes.
Exactly. If a 30 -year mortgage leaps from 3
% to 7%, millions of families can no longer afford
the monthly payment, so they don't buy the house.
The housing market cools. Right. And if a corporation's
cost to borrow capital doubles, they cancel plans
to build a new factory or hire a thousand new
workers. Because borrowing is expensive, spending
slows down, demand across the entire economy
cools off. And when demand cools, when fewer
dollars are chasing the same amount of goods,
businesses can no longer aggressively raise prices.
Consequently, the rate of inflation goes down.
It is an incredibly powerful, indirect skewering
mechanism. You change the cost of overnight money
for banks, and six months later, it alters the
trajectory of a family buying a minivan. But
it brings up a huge mechanical question. If the
Fed doesn't just push a magic button to legally
set the FFR, because again, it's determined by
the free market of banks lending to each other,
what specific tangible tools does the Fed use
to manipulate that free market so that the banks
naturally arrive at the Fed's target range? This
brings us into the Federal Reserve's toolkit.
And according to the historical data in our source
material, to understand how they do it today,
we have to understand a massive paradigm shift
that fundamentally altered the plumbing of the
financial system. We have to discuss the transition
from a limited reserves regime to an ample reserves
regime. Let's start with the old school method.
How things worked before the 2008 financial crisis.
This was the era of the limited reserves regime.
Back then, the Fed's primary tool was something
called open market operations, or FOMO. Walk
me through the mechanics of a transaction. The
Fed decides they want to lower interest rates
to stimulate a sluggish economy. What physical
actions do they take? In a limited reserves environment,
the total amount of cash sitting in the reserve
accounts of all the banks is relatively small.
It is a scarce resource. So the Fed controls
the federal funds rate by manipulating the supply
of that scarce resource. They do this by actively
buying or selling U .S. Treasury securities government
bonds on the open market. OK. So the Fed wants
to lower rates. They go to the open market specifically
dealing with a select group of major financial
institutions called primary dealers. And they
say we want to buy billions of dollars worth
of U .S. treasuries from you. How do they pay
for them? Do they send a truck full of physical
cash? No, it is entirely electronic. When the
Fed buys those treasury bonds from a primary
dealer, they pay for them simply by electronically
crediting the reserve account that the dealer's
bank holds at the Federal Reserve. Wait, they
just make it up? They literally type the numbers
into a computer. creating the money out of thin
air and deposit it into the bank's account. So
they instantly inject a massive amount of new
cash directly into the banking system. Yes. And
because reserves were previously limited, this
sudden influx of cash changes the math. Now,
the banking system has an abundance of reserves.
Supply and demand. Exactly. According to the
basic laws of supply and demand, when the supply
of something increases, its price goes down.
In this case, the price of reserves is the interest
rate banks charge each other to borrow them.
Because every bank suddenly has plenty of cash,
they have to lower the interest rate they charge
to entice anyone to borrow from them. And the
federal funds rate drops. Precisely. Conversely,
if the Fed wanted to raise rates, they would
sell treasuries, pull cash out of the bank's
accounts as payment, making reserves scarce again,
which drives the overnight borrowing rate up.
I think of it like a municipal plumbing system.
The Fed has a master valve. They open the valve
to flood the pipes with cash to lower the pressure,
or they drain cash out of the pipes to increase
the pressure and make money tight. That's a great
way to visualize it. But that was the elegant
old school way. Post 2008. the entire nature
of the plumbing fundamentally changed. It was
a tectonic shift. During and after the 2008 financial
crisis, the Fed injected trillions of dollars
into the banking system to prevent a total collapse,
which we will discuss in depth shortly. The consequence
of that rescue was that the banks became absolutely
flooded with cash permanently. Reserves were
no longer scarce, they were ample. So the old
tool basically broke. If I have a massive reservoir
that is overflowing with water and you come along
and dump one bucket of water into it or take
one bucket out, it doesn't change the water pressure
at all. Exactly. If BAMPs already have trillions
more in cash than they know what to do with,
the Fed buying or selling a few billion dollars
in Treasury bonds through open market operations
isn't going to move the needle on supply and
demand. The old method couldn't steer the FFR
anymore. So what did they do? They needed a new
school tool to operate in an ample reserves regime
and the primary modern tool became a mechanism
called interest on reserve balances or IORB.
This mechanism is conceptually fascinating. Because
reserves are now ample, the Fed decided to start
directly paying banks an interest rate just to
keep their money safely parked at the Federal
Reserve. Right. It is an administered rate. It's
not negotiated on an open market. It is set explicitly
by the Federal Reserve Board of Governors. If
the Fed wants to raise the federal funds rate
today, they simply raise the IORB rate. The easiest
way to conceptualize the IORB is to think of
it like a minimum wage for bank money. Oh, that's
a good comparison. Let's say the Fed wants the
overnight lending rate to be around 3 .6%. So
they set the IORB at 3 .65%. If you're the manager
of a major commercial bank, the Federal Reserve
is offering you a 100 % risk -free, federally
guaranteed return of 3 .65 % just to leave your
excess cash sitting completely idle in your Reserve
account. Right. Are you ever under any circumstances
going to take that cash and lend it to another
private bank in the overnight market for a measly
3 .5 %? Absolutely not. It would be a violation
of fiduciary duty. No rational financial institution
would take on the counterparty risk, however,
slight of lending to another private bank for
a lower return than they can get absolutely risk
free from the sovereign central bank. So by simply
raising the IORB, The Fed instantly drags the
entire federal funds rate up with it. It sets
an impenetrable floor under the market. Exactly.
The banks will never lend to each other for less
than they can get from the Fed. It is an incredibly
clever, direct way to steer a flooded market
without having to drain the floodwaters first.
It's the primary steering mechanism of the modern
era. But it's not the only tool they use to manage
this corridor, right? While the IORB sets the
floor, they also have a backup mechanism called
the discount window. Right. Let's look at the
discount window. If IORB is the floor, the discount
window acts as the ceiling. How does it work?
The discount window is a standing lending facility.
The Federal Reserve will lend money directly
to depository institutions. The interest rate
they charge for these loans is the discount rate,
formerly known as the primary credit rate. And
how is that rate set? The Fed generally sets
this discount rate at a premium, typically about
100 basis points or one full percentage point,
above their target federal funds rate. OK, so
if the Fed's target for the overnight market
is 3 .5%, they might set the discount rate at
4 .5%. Exactly. The intentional premium is designed
to encourage banks to borrow from each other
in the open market first. It is cheaper to borrow
from your neighbor than from the central bank.
That makes sense. But if there is a sudden localized
shock, or a specific bank desperately needs cash
at the end of the day, and no other private bank
is willing to lend to them, they can always go
to the Fed as a last resort. Which puts a natural
ceiling on rates. Right. Because no bank in their
right mind would agree to borrow from another
private bank at an extortionate rate of 5 % if
they know they can just walk over to the discount
window and borrow from the Fed at 4 .5%. So the
IRB pushes the rate up from the bottom, the discount
window pushes it down from the top, and the FFR
stays happily bouncing around in that narrow
channel. Precisely. Now, speaking of the tools
banks use, there's a detail hidden in this section
of the source material that completely upends
a concept taught in basic economics classes.
Oh. What's that? Well, we spent the beginning
of this deep dive talking about fractional reserve
banking and how the defining feature of a bank
is that they are legally required to hold a specific
percentage of their deposits in liquid reserve,
the required reserve ratio. Yes, the required
reserve ratio. Historically, adjusting that ratio
was a blunt instrument used by the Fed to control
the money supply. If they raise the requirement
from 10 percent to 15 percent, banks instantly
had less money to lend out, tightening the economy.
Historically being the operative word, because
the text notes that in March 2020, as part of
the chaotic response to the onset of the COVID
-19 pandemic, the Federal Reserve dropped that
required reserve ratio to zero, literally zero
percent. Yes, they did. As we speak today. Commercial
banks in the United States are legally required
to hold zero percent of their customers' deposits
in reserve. It sounds incredibly alarming, almost
reckless when you first hear it. Sounds like
they removed the fundamental safety net of the
banking system. It really does. But you have
to view this change strictly within the context
of the ample reserves regime we just discussed.
Because the Fed was already flooding the entire
financial system with massive amounts of liquidity
and actively paying high interest, the IORB to
banks to keep excess cash parked at the Fed,
the actual mandate became obsolete. Banks were
naturally voluntarily holding vastly more reserves
than the old legal requirements dictated just
to earn that risk -free interest. So the Fed
simply zeroed out the legal requirement to free
up administrative overhead. Though the statutory
framework absolutely still exists to reinstate
it at any time if conditions change. It is a
perfect example of how fundamentally the actual
mechanics of central banking have mutated over
the last two decades. These tools we've explored,
the IORB setting the floor, the discount window
setting the ceiling, the open market operations
humming in the background to ensure the reservoir
stays full, they are highly effective for everyday
steering. They keep the economic car on the road.
Exactly. But what happens when the road falls
away completely? What happens when a black swan
event hits and the entire financial system faces
catastrophic systemic collapse? That is the moment
when the Federal Reserve steps away from tweaking
interest rates and deploys its ultimate original
superpower, acting as the lender of last resort.
When the normal everyday transmission mechanisms
of monetary policy freeze and completely break
down, the central bank has to aggressively intervene
to prevent the absolute destruction of the global
economy. And our source provides a harrowing
step by step look at exactly what this looks
like in practice, specifically zooming in on
the dark days of the 2008 financial crisis. This
was a nightmare scenario for policymakers. It
originated with a subprime mortgage crisis and
the spectacular bursting of the U .S. housing
bubble. Suddenly, massive Wall Street financial
institutions woke up and realized that the trillions
of dollars of mortgage -backed securities they
were holding on their balance sheets were essentially
toxic waste. We should briefly clarify the mechanics
of a mortgage -backed security or MBS to understand
the panic. Yeah, let's do that. In the years
leading up to 2008, a local bank would issue
a mortgage to a family. Instead of keeping that
loan, the bank would sell it to Wall Street.
Wall Street firms would take thousands of these
individual mortgages from all over the country,
bundle them together into a massive pool, and
sell slices of that pool to global investors
as a single bond in MBS. The logic was that while
one family might default on their home, it was
statistically impossible for thousands of families
across different states to all default at the
exact same time. Right. So the rating agencies
stamped these bonds as AAA, perfectly safe risk
-free investments, pension funds, international
banks, and insurance companies bought them by
the truckload. But there was a fatal flaw. What
was it? Wall Street had run out of good mortgages
to bundle, so they started bundling subprime
mortgages loans given to people with terrible
credit, no verified income, and adjustable interest
rates. When the housing market stopped going
up and those adjustable rates suddenly reset
higher, millions of people defaulted simultaneously.
The statistically impossible happened. And the
fear generated by those defaults was highly contagious.
Because these toxic MBS bonds were interwoven
into the balance sheets of almost every major
financial institution on earth, no one knew who
was solvent and who was secretly bankrupt. Exactly.
Banks looked at each other and thought, I don't
know if you're holding billions in worthless
mortgages, so I'm not going to lend you money.
The interbank lending market, the very mechanism
that determines the federal funds rate we just
discussed, completely and totally froze out of
sheer terror. But wait, this brings up an obvious
question. Earlier, we established that this exact
scenario is what the discount window is designed
for. If private banks are too terrified to lend
to each other overnight, they're supposed to
just walk over to the Federal Reserve and borrow
from the discount window to stay afloat. Right.
In textbook theory, yes. But in the brutal reality
of 2008, the discount window was utterly failing.
The source material explains this failure was
driven by a powerful psychological phenomenon
known as the stigma of bank failure. The optics
of desperation. Yes. If you were the CEO of a
massive, prestigious Wall Street investment bank,
and the market finds out you had to go to the
Fed's discount window to beg for emergency cash
just to keep your lights on. It sends a flare
up to the entire world that you are financially
radioactive. Your clients will panic, pull all
their money out of your bank the next morning,
and your stock will plummet to zero. Exactly.
So out of pride and self -preservation, banks
absolutely refuse to use the Fed's emergency
tools. And because the banks refuse to borrow,
the liquidity crisis reached a breaking point.
The text highlights a very specific staggering
intervention that illustrates the sheer scale
of the panic. On September 16, 2008, the Federal
Reserve Board of Governors authorized an $85
billion emergency loan to the American International
Group, commonly known as AIG. Now AIG is an international
insurance giant. They are not a traditional depository
bank. Right. Why on earth did the central bank
step in to bail out an insurance company? Because
AIG had essentially written insurance policies
called credit default swaps on billions of dollars
of those toxic mortgage -backed securities for
institutions all over the world, they had promised
to pay out if the mortgages defaulted. When the
housing market collapsed, AIG was suddenly on
the hook for tens of billions of dollars they
did not have. If AIG was allowed to declare bankruptcy,
they would default on all those insurance payouts.
The international banks relying on that insurance
would instantly become insolvent. So it was a
domino effect. The Fed realized that AIG's collapse
would trigger a domino effect that would bring
down the entire global financial system like
a house of cards. So the Fed, in emergency coordination
with the U .S. Treasury, stepped in with $85
billion to stave off that specific bankruptcy.
But throwing $85 billion at AIG wasn't enough
to unfreeze the wider system. Because the traditional
discount window was crippled by stigma and banks
still wouldn't lend to each other, the Fed realized
they had to invent entirely unconventional weapons.
They had to bypass the frozen interbank market
and pump cash directly into the veins of the
economy. This brings us to a massive controversial
tool, quantitative easing or QE. Under standard
limited reserve open market operations, the Fed
traditionally only bought short -term, incredibly
safe U .S. Treasury bills to slightly adjust
the money supply. Under the emergency protocol
of quantitative easing, the Fed drastically expanded
the scope and scale of its purchases. Crossing
a historic Rubicon, the Fed announced it would
start buying the toxic mortgage -backed securities
directly from the struggling financial institutions.
The numbers in the source are staggering. Over
the course of the crisis, the Fed bought $1 .25
trillion in mortgage -backed securities. Let
that number sink in. That was roughly one -fifth
of all U .S. government -backed mortgages in
existence at the time. The central bank was literally
acting as a giant vacuum cleaner sucking up the
toxic assets that no private investor would touch
just to forcefully inject cash into a crashing
housing market and artificially stabilize prices.
It was unprecedented. Now I have to pause and
push back on this because reading through this
section of the history is where a huge portion
of the American public gets incredibly frustrated
and frankly angry with the Federal Reserve. Sure.
If the central bank can just step in with an
infinite blank check buy up trillions in toxic
debt and bail out massive institutions that made
terrible, greedy, reckless bets on subprime mortgages.
Aren't they just printing money to reward bad
behavior? Doesn't this create a massive systemic...
moral hazard. It's a very fair question. I mean
if I am a Wall Street CEO and I know the Fed
will unconditionally save me if my massive gamble
fails, why wouldn't I take insane risks to maximize
my bonuses? Where is the accountability? If we
connect this to the bigger picture, you have
perfectly articulated the central agonizing dilemma
of a central bank operating in a crisis. The
economists at the Fed are acutely aware of the
concept of moral hazard. They know that bailing
out reckless actors encourages future recklessness,
but in September In 2008, they were not sitting
in a seminar room debating theoretical economic
models. They were looking over the edge of a
genuine abyss. Their argument is that they had
to make a horrific choice. Let the bad actors
fail and suffer the righteous consequences, but
allow the entire global payment system to collapse
with them, taking the innocent public down too.
Or save the system, keep the lights on and hold
their noses while the bad actors essentially
got bailed out. That is the grim reality of the
situation. If the global payment system actually
collapses, the consequences are apocalyptic for
the average citizen. ATMs stop dispensing cash.
Corporate payrolls don't clear the banks, so
millions of workers don't get paid on Friday.
Grocery stores cannot secure short term credit
to buy food inventory, leading to empty shelves
within days. The real physical economy halts.
Right. So the Fed leadership decided that ensuring
the immediate physical survival of the economic
system vastly outweighed the long term philosophical
risk of moral hazard. And to get that money flowing
quickly to the specific sectors that were suffocating
without triggering the toxic stigma of the discount
window, they created a massive alphabet soup
of temporary, highly targeted emergency lending
facilities. The alphabet soup. The source document
lists so many of these acronyms, it makes your
head spin. They basically set up these specialized,
sometimes anonymous mechanisms to inject cash
precisely where the arteries were blocked. Let's
look at two notable examples from the text, the
TALF and the CPFF. Okay, the TALF stands for
the term asset -backed securities loan facility.
The goal here was to save the consumer credit
market. The Fed provided loans to investors specifically
to encourage them to buy newly issued asset -backed
securities tied to everyday things, auto loans,
student loans, and credit card receivables. So
the Fed was trying to unfreeze the consumer lending
pipelines so that normal people could still get
a loan to buy a car to get to work or take out
a student loan to go to college. Exactly. And
then there was the CPFF, the Commercial Paper
Fund. This one is mechanically fascinating because
it represents a massive expansion of a central
bank's traditional role. Through the CPFF, the
Federal Reserve essentially bypassed the banking
system entirely and became a direct lender to
non -financial corporations. To understand why
this was necessary, you have to understand commercial
paper. Large corporations, let's say an automaker
like Ford or a massive retailer like Target,
do not keep billions of dollars in cash just
sitting idly in a checking account to pay their
weekly bills. They invest their cash. Right.
So when they need $50 million in liquid cash
on a Wednesday to make their massive employee
payroll on Friday, they issue short -term debt
called commercial paper. They borrow the $50
million from money market funds for a few days,
pay their workers, and then repay the debt on
Monday when their weekend retail receipts clear
the bank. It's the circulatory system of corporate
America. But in the autumn of 2008, fear was
so high that investors completely stopped buying
commercial paper. The market froze. Without that
short -term cash, major corporations were days
away from bouncing payroll checks, which would
have triggered immediate mass layoffs across
the country. So the Fed stepped in, created the
CPFF, and said, fine, if the open market won't
buy your commercial paper, the Federal Reserve
will buy it directly. They lent out a staggering
$738 billion through this specific program to
keep corporate America's lights on. And the really
crucial point the source notes is that the CPFF
wasn't just a one -time anomaly confined to the
history books of 2008. When the COVID -19 pandemic
triggered massive, unprecedented market disruptions
and lockdowns in March 2020, the commercial paper
market threatened to freeze again. The Fed didn't
hesitate. They immediately dusted off the 2008
playbook and reintroduced the CPFF to stabilize
the flow of credit to households and businesses.
These radical crisis tools are no longer anomalies.
They are becoming a permanent part of the standard
operating playbook. which represents a profound
historic shift in the nature of monetary policy.
But executing this modern playbook, buying trillions
in mortgage bonds, bailing out insurance giants,
funding corporate payrolls, and paying high interest
to banks on their massive ample reserves requires
financial resources on a scale that is genuinely
difficult for the human mind to comprehend. Exactly.
You can't just write these checks out of thin
air without it showing up somewhere. Where does
the Federal Reserve keep track of all this? And
what happens when the bill inevitably comes due?
This requires us to open up the books and look
at the Federal Reserve's balance sheet. Right.
The Federal Reserve is required to publish its
balance sheet every single week. It is a public
accounting detailing all of the central bank's
assets. what it owns, and its liabilities, what
it owes. And over the last 15 years, the sheer
size of this balance sheet has grown to staggering
proportions. According to the source data, the
Fed's total assets peaked at over $7 .7 trillion
in 2021. As of August 2024, it was sitting at
roughly $7 .139 trillion, trillion with a T.
To put a number that large into perspective,
$7 trillion is roughly equivalent to one -third
of the entire annual gross domestic product of
the United States. And if you look at the composition
of those assets, it tells the entire financial
story of the last decade and a half. Where's
that money? The vast majority of that $7 trillion
is held in U .S. Treasury securities and mortgage
-backed securities, the exact assets they purchased
by the truckload during multiple rounds of quantitative
easing to artificially stabilize the markets
in 2008 and 2020. Now a logical question arises.
How does the Fed afford to buy $7 trillion worth
of assets? Do they get a massive appropriation
of taxpayer money from Congress every year? No,
they do not. The Federal Reserve is an entirely
self -funded institution. They do not receive
a budget from Congress. Then how? Over 90 % of
their revenue is generated organically from the
interest they earn on that massive multi -trillion
dollar portfolio of treasury and mortgage -backed
securities they hold. They also generate a small
amount of income from the fees they charge depository
institutions for the financial services they
provide like clearing checks and transferring
funds So if I am understanding the mechanics
correctly, they have the unique power to digitally
create money They use that newly created money
to buy interest bearing government bonds, and
then they collect the interest payments on the
bonds they bought with the money they created.
It is an incredibly lucrative setup if you can
get the charter for it. It is a totally unique
sovereign position. And historically, because
of this dynamic, the Federal Reserve has been
incredibly profitable. The law dictates a very
specific waterfall for those profits. First,
the Fed pays for all of its own operating expenses,
staff salaries, maintaining the banks, printing
the physical currency. Second, they pay out that
legally mandated 6 % dividend to the private
member banks we discussed earlier. Finally, by
law, they must remit all the massive remaining
excess profits directly back to the U .S. Treasury.
And these remittances used to be a massive boon
for the federal government. The source notes
that in 2015, during a period of relative stability,
the Fed earned a net income of $100 .2 billion.
After expenses, they transferred a staggering
$97 .7 billion directly into the Treasury's coffers.
That is almost $100 billion of revenue that essentially
reduced the national deficit just handed over
by the central bank. That highly profitable dynamic
was a reliable status quo for a very long time.
But the deep dive material reveals a massive,
surprising plot twist that occurred in the accounting
books in 2023, a complete reversal of fortune.
Right. To understand why they started losing
money, we have to look at how they fought the
recent inflation spike. Remember how the Fed
fights inflation in an ample reserves regime?
They raise the IORB, the interest rate they paid
to commercial banks to park their cash. In 2022
and 2023, to combat the severe post -COVID inflation,
the Fed had to raise those interest rates aggressively
and dramatically. At the exact same time, they
initiated a process called quantitative tightening
or QT. Quantitative tightening is the mechanical
reverse of quantitative easing. Instead of buying
bonds to put money into the economy, the Fed
starts shrinking its balance sheet to pull money
out of the economy. They do this by letting those
trillions in bonds mature without replacing them,
or by actively selling the bonds back onto the
open market. But here is the catch. Because the
Fed had aggressively raised interest rates, the
older bonds they were holding, which were issued
years earlier at much lower interest rates, became
significantly less valuable. Let's make sure
that concept is totally clear, because the inverse
relationship between bond prices and bond yields
trips up a lot of people. Imagine the Fed bought
a 10 -year Treasury bond back in 2020 that pays
a 2 % yield. It pays $20 a year. But now it's
2023. The Fed has raised rates to fight inflation,
so brand new treasury bonds being issued by the
government are paying a 5 % yield, or $50 a year.
Right. If the Fed wants to sell its old 2 % bond
on the open market to shrink its balance sheet,
no investor is going to pay full price for a
bond that only yields $20 when they could just
buy a new one yielding $50. To convince an investor
to buy the old bond, the Fed has to sell it at
a steep discount, taking a loss on the principal.
Exactly. So you had two massive financial forces
colliding on the Fed's balance sheet in 2023.
First, their expenses skyrocketed because they
were suddenly paying out billions in high interest
IORB payments to commercial banks. Second, the
value of their multi -trillion dollar portfolio
dropped and they were taking losses on the bonds
they were selling off. The result. In 2023, the
Federal Reserve reported a record net negative
income of $114 .3 billion. They operated at a
staggering $100 billion loss. It's wild to think
about. Now, if a private corporation like Amazon
or General Motors loses $114 billion in a single
year, they're instantly insolvent. They go bankrupt,
their stock goes to zero, and they liquidate.
But the Federal Reserve does not go bankrupt.
They survive using a very specific, almost magical
accounting quirk. The central bank employs an
accounting mechanism called a deferred asset.
When the Federal Reserve takes a net operating
loss, it does not declare insolvency. Instead,
it simply creates a new liability line item on
its balance sheet called a deferred asset. In
the 2023 case, this massive loss was booked as
an interest on Federal Reserve notes due to U
.S. Treasury liability, totaling $133 So in plain
English, they just take a pen and write down
$133 billion IOU to themselves on the ledger.
Essentially, yes. What this deferred asset means
in practical terms is that the Federal Reserve
will not remit a single dollar of profit to the
U .S. Treasury until they generate enough future
net income to completely pay down the $133 billion
deferred asset. Wow. Based on the source's projections,
the Fed will likely not resume its regular remittances
to the Treasury until roughly 2027 or Now, having
a massive deferred asset does not legally or
mechanically stop the Fed from conducting monetary
policy. They can still set interest rates and
buy bonds, but it serves as a glaring mathematical
testament to the sheer terrifying scale of the
financial forces they are attempting to manipulate.
unchecked financial power, the ability to unilaterally
create trillions of dollars, buy up massive sectors
of the bond market, bail out failing global corporations,
set a floor on global interest rates, and casually
absorb about $133 billion operating loss with
an accounting trick, inevitably draws intense
passionate criticism. Yeah, truly. And our source
material covers these critics extensively. We're
going to impartially report on these diverse
viewpoints because to truly understand what the
Fed is, you have to understand the strongest
arguments against its very existence. This raises
an important question then. The criticism of
the Federal Reserve is not monolithic. It comes
from multiple, often opposing economic and political
perspectives. Let's start by examining the monetarist
critique, which is most famously represented
by the late Nobel laureate economist Milton Friedman.
Friedman's core argument was that the Fed doesn't
just awkwardly try to solve economic crises.
Its clumsy interventions are often the primary
cause of them. The source explicitly highlights
his famous controversial analysis of the Great
Depression. Right. Friedman, along with Anna
Schwartz, painstakingly argued that the crash
of 1929 did not have to become a decade -long
depression. He believed the Fed caused the severity
of the Depression because they inappropriately
and stubbornly refused to lend money to small,
struggling banks during the bank runs of the
early 1930s. Instead of acting as the expansive
lender of last resort they were designed to be,
they actually tightened the money supply, allowing
a third of the nation's banks to fail. and starving
the economy of liquidity when it needed it most.
And modern monetarists apply a very similar analytical
lens to more recent events. The source points
out that many contemporary economists squarely
blame the Federal Reserve's prolonged zero interest
rate policies and their massive sustained quantitative
easing campaigns during the COVID -19 pandemic
for directly causing the massive painful inflation
spike that followed in 2022. The monetarist argument
is straightforward. The Fed kept the emergency
money spigot wide open for far too long, flooding
the system with too much cheap cash. That excess
liquidity chased a constrained supply of goods,
inevitably inflating massive asset bubbles in
real estate and the stock market, and drastically
driving up consumer prices. Then moving to a
different flank, there is the Austrian economics
perspective, which is championed heavily in modern
political discourse by libertarian figures like
former Congressman Ron Paul. This critique is
much more fundamental and radical. They don't
just want the Fed to tweak its mathematical formulas
or change its target rates. They advocate for
the total abolition of the central bank. The
Austrian critique centers primarily on the dangers
of fiat currency. To understand this, we have
to look back to 1971, when the Nixon administration
officially closed the gold window, completely
severing the US dollar's tie to physical gold.
Since then, the dollar has been a pure fiat currency,
meaning its value is backed by nothing physical,
only the full faith and credit of the US government.
Ron Paul and the Austrian School argue that allowing
a centralized, unelected committee to arbitrarily
manipulate the supply and price of a fiat currency
is inherently destructive. They argue it inevitably
causes long -term, insidious inflation that robs
savers of their wealth, and it artificially engineers
devastating boom -and -bust economic cycles by
distorting natural market interest rates. The
text specifically mentions Ron Paul's influential
book, and the Fed. In it, he argues that the
central bank not only undermines true economic
stability, but it serves as a mechanism that
unfairly enriches a politically connected banking
elite at the direct expense of the general public.
There is a powerful populist argument embedded
here regarding the wealth gap. Think about the
mechanics of quantitative easing. When the Fed
prints trillions of dollars and buys assets,
that new money enters the economy through massive
financial institutions. It instantly inflates
the prices of assets like stocks and real estate.
So if you are wealthy and own a massive stock
portfolio and multiple homes, your net worth
skyrockets. But if you are a working class citizen
who rents an apartment and lives off an hourly
wage, you don't see those massive asset gains.
You just see the resulting inflation eating away
at your purchasing power at the grocery store.
Critics argue the Fed's policies mathematically
exacerbate wealth inequality. This profound concentration
of power, combined with the opaque nature of
their interventions, raises an incredibly important
question regarding transparency and democratic
accountability. This is another major vector
of criticism detailed in the source. Right. Now,
the Federal Reserve is technically audited by
the Government Accountability Office, the GAO.
But the source explicitly and importantly clarifies
that these GAO audits are heavily restricted
by law. They're essentially limited to administrative
functions. Right. explicitly do not cover the
Fed's actual market -moving monetary policy actions.
The GAO is not allowed to audit discount window
lending records or the specifics of open market
operations or communications with foreign central
banks. The Fed's institutional defense is that
they desperately need that veil of secrecy to
maintain their operational independence and to
prevent market panic. If the public knew exactly
which banks were borrowing emergency funds in
real time, it would trigger those fatal bank
runs we discussed earlier. But critics argue
that an institution wielding trillions of dollars
in public, sovereign power simply cannot be allowed
to operate in the shadows of a democratic society.
The source provides a wild, high -stakes example
of this exact tension, the Bloomberg FOIA lawsuit.
It is a landmark case for financial transparency.
During the darkest days of the 2008 crisis, the
Fed loaned out trillions of dollars through that
alphabet soup of emergency facilities we discussed,
the TALF, CPFF, and others. But they absolutely
refused to disclose which specific banks and
corporations were receiving this taxpayer -backed
lifeline, or what highly questionable collateral
those banks were pledging in return for the cash.
Bloomberg News filed a Freedom of Information
Act lawsuit to force the central bank to open
its books and reveal the details of the bailouts.
And the Fed fought this transparency demand tooth
and nail. They litigated it for years, fighting
it all the way to the United States Supreme Court,
utilizing the exact argument you just mentioned,
that revealing the names of the borrowing banks
would stigmatize them and cause a renewed run
on the financial system. Bloomberg ultimately
won the case in 2011, forcing the Fed to release
thousands of pages of detailed transaction data.
But for the critics, the mere fact that it required
a multi -year, multi -million dollar Supreme
Court battle just for the American public to
find out exactly where trillions of dollars of
emergency funding went is a massive, glaring
indictment of the institution's systemic lack
of accountability. It perfectly encapsulates
the enduring paradox of the Federal Reserve.
We demand that they possess the absolute power
and secrecy necessary to act decisively in a
crisis to save the economy, but we deeply resent
the unaccountable, undemocratic nature of that
exact same power. Okay, we have covered an immense,
staggering amount of ground in this deep dive.
We started by standing in the grocery store wondering
why the price of milk was fluctuating, and we
ended up analyzing Supreme Court battles over
multi -trillion dollar secret balance sheets.
Let's try to synthesize and summarize the massive
high wire balancing act that the Federal Reserve
performs for you every single day. It has been
a remarkable improvised evolution over the last
century. It started in 1913 with a secret meeting
on Jekyll Island to design a purely mechanical,
limited solution to stop localized banking panics.
A simple lender of last resort. Today, operating
through a complex, hybridized structure of presidentially
appointed public governors in D .C. and private
regional banks across the country, it actively
manages the very lifeblood of the global economy.
They execute this through their congressional
dual mandate, striving to maximize employment
so people have jobs, while simultaneously fighting
the economic cancer of inflation by targeting
a steady 2 % rate. And they achieve this not
by simply decreeing prices, but by subtly and
powerfully manipulating the deep plumbing of
the financial system. We saw how they shifted
paradigms, moving from a world where they bought
and sold treasury bonds to tweak limited reserves
to our modern cash -flooded reality where they
simply set an impenetrable floor on all interest
rates by adjusting the IORB. And perhaps most
significantly, we examine what happens when that
system threatens to tear itself apart entirely,
as it did in 2008 and again in 2020. In those
moments, the Fed abandons its traditional boundaries.
They buy toxic mortgage assets. They lend hundreds
of billions directly to non -financial corporations
to make payroll, they expand their balance sheet
to over $7 trillion, absorbing the catastrophic
risk of the private sector to keep the global
payment system functioning, even if it results
in logging $100 billion deferred asset liability
on their own books. Which is a lot to process.
Here's where it gets really interesting and what
I want to leave you as we wrap up. Because all
of this historical context and mechanical explanation
leaves us with a profound, almost philosophical
question about the future of our economic system.
Over the last 15 years, we have watched the Fed's
balance sheet balloon to incomprehensible sizes.
We have seen their radical break -the -glass
emergency crisis tools like buying corporate
debt, directly funding commercial paper, and
essentially bailing out entire sectors of the
economy increasingly become part of the standard
operating procedure at the very first sign of
a market disruption. The historical line separating
rare emergency intervention and permanent active
market management has become incredibly, perhaps
permanently blurred. Exactly. So I want to leave
you with this final provocative thought to ponder
as you look at your next bank statement or grocery
receipt. As the Federal Reserve continually expands
its reach, essentially setting a permanent floor
on global investments to prevent any major institutional
collapse, have we fundamentally altered the definition
of what a central bank actually is? If the ultimate
lender of last resort is now actively buying
up corporate debt and aggressively intervening
to ensure the stock market doesn't fall too far
and hurt retirement accounts, is there any truly
free market left out there? Or are we all, from
the high -frequency Wall Street trader moving
billions down to you deciding whether you can
afford a carton of eggs, just quietly trading
inside the margins of the Federal Reserve spreadsheet?
It is arguably the defining economic question
of our era. Because as long as the mandate to
protect the economy remains, the tools they invent
to fulfill it will continue to evolve in unprecedented
ways. And we will be right here to unpack those
tools when they do. Thank you so much for joining
us on this deep dive into the machine that runs
the world. Stay curious, keep an eye on those
interest rates, and we will see you next time.