How Do Federal Reserve Banks Get Funded?

September 11, 2019 · 4 minute read

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How Do Federal Reserve Banks Get Funded?

The Federal Reserve is frequently featured in headlines. You may have read about the bank’s chairman announcing whether it would be adjusting interest rates up or down, or about the stock market immediately reacting to its actions. Or perhaps you’ve seen stories about how the bank tries to stimulate the economy and how well it maintains its independence.

But how much do you really know about the Federal Reserve system? Who owns the Federal Reserve bank, and how do central banks create money? These questions might seem abstract, but understanding how the system functions is key to getting a clear picture of how the U.S. economy works.

In short, the Federal Reserve—affectionately known as “the Fed”—is the country’s central bank. Its goals are much loftier than that of traditional banks: to make sure the U.S. economy works smoothly and serves the public interest.

Specifically, the bank tries to keep the financial system and individual institutions stable, protect consumers, and make sure the transactions system is secure and efficient.

Perhaps most importantly, the bank also manages short-term interest rates, which in turn affects the availability of credit and eventually things like consumer spending, investment, employment, and inflation.

The bank’s goals with these actions is to promote maximum employment, keep prices stable (the bank aims for an inflation rate of 2%), and keep long-term interest rates moderate.

Who Owns the Federal Reserve Bank?

Even though parts of the Federal Reserve are structured like a private bank, it’s not really owned by anyone. Congress created the Federal Reserve in 1913, and it remains an independent government agency. However, the board that oversees it—which is appointed by the president and confirmed by the Senate—still reports to Congress today.

Its leaders are required to testify in Congress and submit a lengthy report on its plans twice a year. The Federal Reserve actually consists of 12 Reserve Banks spread across different regions of the U.S. Although each one has a board of directors and is incorporated, it’s not actually a private entity and the banks aren’t in business to make a profit.

How Does the Federal Reserve Make Money?

The Federal Reserve does not “make” money exactly, in that it doesn’t print money—that’s the Treasury Department’s job. But it does serve as a bank for other banks and government agencies, allowing them to open accounts to hold their reserves, take out loans, issue government securities, and take other actions.

When it comes to other banks, the Fed is there to lend to them in case they have problems getting funding, either because of unexpected fluctuations in their loans and deposits or due to extreme events, such as the 9/11 terrorist attacks or the 2008 financial crisis.

The Fed lends at a higher rate than the market in order to ensure that it’s used as a last resort. The Federal Reserve does not lend money or provide bank accounts for individuals, like SoFi and other banks do. (Beware of scams that claim you can open an account with the Federal Reserve using your Social Security number).

While the Federal Reserve does not actually print money, it does put in orders with the U.S. Treasury for “Federal Reserve notes” based on the demand it expects both domestically and internationally.

Federal Reserve notes are actually just another name for U.S. paper currency and no different from the dollars in normal circulation. For fiscal year 2020, the Federal Reserve’s board ordered 5.2 billion notes, which are valued at $146.4 billion. Most of these notes go to replacing bills that are no longer in usable shape.

How is the Federal Reserve Funded?

So where does the Fed get its funding? Unlike other government agencies, it doesn’t get funded by Congress as part of the normal budget process. Instead, it makes money mainly through interest on government securities that it bought on the open market.

These primarily include U.S. Treasury securities, mortgage-backed securities, and government-sponsored enterprise (GSE) securities.

How much money does the federal reserve have? As of mid-August 2019, the Fed had nearly $3.8 trillion in assets on its balance sheet. Those have grown significantly compared to 12 years ago, when the Fed had just around $870 billion in assets.

The reason for this has to do with the Fed’s response to the Great Recession and the economy’s slow comeback afterward. But remember how the Federal Reserve isn’t in it for the profits?

Once it pays its own overhead, the rest of its earnings go right into the country’s coffers in the U.S. Treasury. In 2018, the Fed transferred $65.3 billion of its earnings to the Treasury, down by more than $17 billion from the previous year.

How the Fed Affects Interest Rates

In its attempts to steer the ship of the U.S. economy on a solid course, one of the main things the Fed does is influence interest rates. The Fed can either raise or lower the federal funds rate , which is the rate at which financial institutions that hold deposits can borrow and lend funds they keep at Federal Reserve banks from each other.

The Federal Open Market Committee , which is made up of some members of the Fed’s Board of Governors and others, meets eight times a year to determine what they want the federal fund rates to be.

These decisions then influence other longer-term interest rates, such as those on savings accounts, mortgages, and loans.

The Fed often cuts interest rates to energize the economy by making it less expensive for businesses and consumers to borrow money. It raises rates when inflation seems too high and the economy is doing better.

As of 2019, interest rates are pretty low by historical standards. As of August 2019, the target federal funds rate was 2.00-2.25% . That’s higher than the rate of 0-0.25% in December 2008, following the Great Recession.

But it’s pretty far below 5.25%, where it was in June 2006, and way lower than its peak of 20% in 1978 and 1980, when the Fed was reacting to runaway inflation.

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