Spread the Fed, Part I


Robert Hockett is the Edward Cornell Professor of Law at Cornell Law School.


Robert Hockett is the Edward Cornell Professor of Law at Cornell Law School.

From Federal Disintegration through Community QE to Central Bank Decentralization

Central banking and finance in the US have a curiously ‘dialectical’ history – a history mirroring, in interesting ways, that of our federal union itself. Both histories reflect ambivalence about, and hence oscillation both toward and away from, collective agency and its political manifestation in centralized governance. Tracing these parallel trajectories can shed helpful light upon certain features of American monetary history, finance-regulatory tendencies, and of course public finance. But it also affords us a more immediate benefit in this time of global pandemic and associated financial and economic distress: it provides clues as to where we are now, where we are going, and how to optimize where we’re going where finance, economic recovery, and resumed economic development are concerned.

More specifically, tracing the political and monetary histories just noted affords means of better understanding the full significance of several potentially ‘game-changing’ new lending facilities opened by the Federal Reserve this past spring: the Fed’s new Main Street Lending (MSL) facilities and its new Municipal Liquidity Facility (MLF), or what I have been calling, in a series of Columns, OpEds, and advisory memoranda, ‘Community QE’ and ‘Small Business QE.’ And understanding this fuller significance, in turn, illuminates pathways both to improving, vastly, these facilities’ operations, and to generalizing from them to a far better Fed – what I call a ‘re-distrubuted,’ or better ‘spread,’ Fed.

Here then is how my two posts will proceed. In the present post I’ll trace the paired histories with which I just opened this discussion – those of our ambivalence about centralized governance on the one hand, and central banking and currency-issuance on the other hand. Then in tomorrow’s follow-up post I’ll interpret Community QE against the backdrop of those histories, and explain how these histories help make sense of the ‘Spread the Fed’ proposal I put out earlier this year that will make liquidity creation more broadly available.

On, then, to history …

As is well known to constitutional historians in particular, our republic has long been of two minds where centralizing governance among distinct political units with actual or vicarious histories of mutual independence is concerned. Our first experiment with a written national constitution, the Articles of Confederation, was notoriously stingy in its grant of authority, powers, and functionality to the central government. Indeed it was so sparing in this respect that it quickly came a cropper as the separate states succumbed to a multitude of collective action problems that they had no means of collective agency to address.

The full Constitution that replaced the Articles at the end of the 1780s accordingly looked much more promising on paper than had its predecessor. It afforded the nation qua nation both with the authority and with the institutional means to exercise collective agency, both via legislation and via what Hamilton famously called an ‘energetic executive.’ But the Constitution’s ratification was not easy, and facts on the ground where citizen attitudes were concerned did not synch very well with the new document’s content until many controversies, and at least one civil war, later. Indeed even today the historic ambivalence remains, and once again threatens our national unity as political parties become largely regional in character and states once again speak of secession – first jokingly, then something resembling more seriously.

While the broad outlines of our fluctuating federalist/antifederalist dialectic are reasonably well known among lawyers and readers of history, the ways in which our money and public finance have traveled that trajectory are unsurprisingly less so. But mirror that constitutional pathway they do, from the ‘now you see it, now you don’t’ flickering of early central banking and currency issuance on the part of the First and Second Banks of the US in the late 18th and early 19th centuries, through the banking and currency reforms of the mid-1860s which brought us the ‘Greenback’ and our system of ‘national banks,’ on down to the long evolution of the Federal Reserve System, the Treasury with which it routinely partners, and banking thereunder from 1913 to the present.

I trace those parallel lines in detail, and explain why their mutual mirroring and overlapping are no accident, in a lengthy and detailed forthcoming work. I would like here to attend to one particular feature of the Fed System that is in effect now being ‘re-upped’ as the global Covid pandemic lays bare how successful Steve Bannon and likeminded Trump cronies have been at least temporarily ‘deconstructing [our] administrative state.’

The success of the Bannonite national deconstruction – or perhaps better put, demolition – project is now necessitating a counterpart deconsolidation of the Federal Reserve System itself, simply in order to keep people alive and essential services operating, through Community QE. But this particular instance of deconsolidation is likely to be only the first among many. For small businesses, community banks, and even state public banks are likely themselves to require much more locally responsive Fed solicitude in the months and years ahead – a development which has already begun in the Fed’s ‘Main Street Lending’ facilities, and which will in time make the Fed look again much as it looked over one hundred years ago.

In short, as Trump & Co. strip the federal government down into something resembling its late 19th century Gilded Age form, the Fed is now having to work back toward something resembling its earliest 20th century form. And while the degeneracy that’s now necessitating this devolution is more than a little regrettable, the upshot might not be all bad. We can make a silk purse of this proverbial sow’s ear, as it were. We can make, that’s to say, a far more community-, small business-, and people-oriented central bank.

Let us begin, then, with that early 20th century form the Fed took – let’s start, in other words, in 1913…

Owing to the US’s longstanding ambivalence about banking and central banking, the Federal Reserve System (‘System,’ or ‘FRS’) as first designed and then instituted embodied a delicate compromise. On the one hand, the Federal Reserve Board (‘Board,’ or ‘FRB’) at the apex of the System would operate nationwide as a liquidity risk-pooling authority and national money-modulator, which at a minimum any ‘central’ bank worth the name must do. On the other hand, the Federal Reserve ‘System’ would indeed be federated, and would manifest public-private hybridity. This, it was conjectured, would remove the two principal holdups that had traditionally stood in the way of successfully instituting a new central bank after President Andrew Jackson’s allowing its predecessor to ‘sunset’: fears of (a) financial and hence productive dominance by northeastern money centers, especially New York, Boston, and Philadelphia; and (b) a putatively oversized, ‘socialist’ public sector.

The principal means by which the Fed System addressed and allayed these concerns was through what I call the ‘distributed’ system of regional Federal Reserve Banks, in the plural, that would serve as the full System’s primary interface with private sector commercial and manufacturing activity nationwide. The Regional Feds, as I’ll call them, were assigned specific territorial jurisdictions, in a manner roughly tracking the Circuit system of federal appellate courts with which all students of American law become quickly familiar.

The idea that prompted this structure was that the national economy circa 1913 roughly divided into distinct, not-yet-fully-integrated regions in which particular industries and particular cultures of credit and attendant financial practices held particular importance. In New York and Boston, for example, finance and manufacturing were predominant, as were large investment banks that often organized groups of small firms into more sprawling conglomerates. In the Midwest it was agriculture and small-scale ‘ag-‘ and community banking that prevailed. In the Southwest both ranching and petroleum were growth sectors with idiosyncratic modes of financing, while in the Southeast it was cash crops, coal, and personal lending or local banking that prevailed.

The thought, then, seems to have been that if each intelligibly distinct region of the country had access to its own Fed discount and lending facilities, along with a means by which to communicate face-to-face with the nationwide Fed ‘System,’ the danger of central banking too wedded to any one region, sector, or set of financial practices would be attenuated. A collateral thought might have been that by distributing Fed operations regionally, we would also put into place an institutional mechanism that could facilitate inter-regional convergence on certain would-be universal best practices.

As it happened, the regionalist answer to the set of concerns just elaborated also afforded means by which to address the other set of concerns – the set rooted in fears of ‘government overreach.’ Key here was the regional Feds’ ownership and associated governance structures. In essence, the regional Fed Banks would be owned – in a novel and rather thin sense of ‘owning’ – by their private sector Member Banks, even while overseen from the Fed Board in Washington. In addition, each Fed Bank would be overseen by a 9-member board, three of whose members would be chosen by the Fed Board in DC, three others of whom would be selected by local Member Banks, and the remaining three of whom would be chosen by non-financial local businesses and labor organizations.

This would, it was apparently thought, render the Fed System something more like a public-private partnership than a ‘command and control’ style federal regulator. And it would further enshrine those forms of regional and sectoral pluralism that anti-centralizers had been keen to preserve through the nation’s history then to date.

The upshot of this FRA settlement was that in its earliest decades the Fed as a ‘System’ was nontrivially diffuse and distributed in a way mirroring the still-incomplete integration of national governance and the national economy themselves, with regional economic and cultural differences playing discernible roles in determining Fed policy across regions. As time passed and the nation’s economy and political cultures grew more integrated and less heterogeneous, however, the Fed itself grew more practically unitary in tandem.

The Federal Open Market Committee (FOMC), for example, which gave pride of place to the Fed Board and New York’s Regional Fed while rotating the remainder of its seats across other Regional Feds, was established just over two decades after enactment of the Federal Reserve Act itself by the New Deal era Banking Act of 1935, as a means of tightening federal monetary control and thereby preventing a repeat of the financially volatile 1920s that had culminated in 1929’s crash. Variations across regions in the practice of monetizing commercial paper and engaging in other lending forms also narrowed, some of these having been implicated in both the real estate finance abuses and capital market excesses that generated the bubble that 1929 burst. And in time even non-Member Banks came to fall under a universally applicable Fed-administered liquidity-regulatory regime nationwide.

In part all these post-1929 changes simply reflected a less and less variegated, even though still at least somewhat heterogeneous, national economy. And in part they reflected the growing necessity of unified ‘systemic’ money modulation and financial regulation as accelerating trans-regional financial integration amplified both the potential for and the consequences of nationwide financial contagion.

similar dynamic some eighty years later brought the Dodd-Frank response to that other ‘Great’ financial calamity, the Great Recession of the early 2010s. Here the financial integration that necessitated greater regulatory and money-modulatory integration was at least as much a response to functional integration in financial services (think ‘shadow banking’) as it was to national integration of one highly systemically important subsector of that sector – mortgage finance.

In the end, then, especially after the financial dramas of the Great Depression and Great Recession eras, the Fed Board and Federal Reserve Bank of New York had by 2010 or so fully emerged both as ‘first among equals’ where national monetary and financial policy were concerned, and even as ‘central bank to the world,’ more or less, where crisis management in an ever more integrated global financial system was concerned. More integrated economy, more integrated governance – and hence ever more centralized central banking.

And then there came Trump…

The political emergence of a bottomlessly petulant man effectively personifying fears and resentments is best understood, I think, as a clue both to what remained undone after the Great Recession and to what is in store for our states, cities, and central bank soon if we do not reverse the trajectory that produced him. What produced him, for its part, stemmed from what remained undone after the crash of 2008. And what remained undone after the crash of 2008 was any counterpart to the transformative New Deal that had prevented terminal political and economic disintegration after the crash of 1929.

Though it seems to have been widely forgotten by now, the post-crash 1930s raised the specter not only of fascist and communist revolution, but also of federal disintegration. Californians sought to bar ‘Okie’ migration to their state after the Dust Bowl calamity. Southerners resisted northern pressure to stop disenfranchising non-white citizens in an era where who governed determined who ate and who didn’t. Regions of the country where finance, manufacturing, or agriculture predominated argued bitterly over trade and monetary policy in a shrinking global economy. Regions of the country with largely German-, Irish-, English-, or Italian-descended populations squabbled over whom if anyone to support in a gathering European cold war. And so on.

One way to think of the New Deal is accordingly not only as the bare minimum that was necessary to preserve both ‘capitalism’ and some semblance of political democracy nationwide, but also as the minimum that was necessary to preserve our federal political union itself.

While the 21st century Fed after 2008, unlike the 20th century Fed after 1929, did remarkable work to preserve our monetary and financial systems during the Great Recession, nothing on the scale of the New Deal developed to reform the underlying ‘real’ economy that had brought 1929 and 2008 on in the first place ever crystalized. In consequence, incomes and wealth accumulation below the top of the national distributions continued to lag even as shareholder-held businesses grew ever more adept at relying on ‘gig’ labor that didn’t enjoy labor protections, living wages, health insurance or retirement insurance. The ‘precariat’ that grew to become an ever-larger part of our population accordingly seethed, and found succor in political visions that could both explain their plights and offer means of redress.

As in the post-1929 era, so here the movements that grew out of this cauldron took left and right forms, with the first vesting its hopes in avowed ‘Democratic Socialist’ (in fact, more New Dealer) Bernie Sanders and the second opting instead for the Mussolini-reminiscent Donald Trump. Like in Europe during the 1930s, so here in the 2010s the more fascistic element, trading on cultural symbols of the cherished national past, won the day – but with a wrinkle: In contrast to the European fascism of the 1930s, which consolidated national at the expense of regional and local power, the American fascism of the 2010s worked in the opposite direction, exploiting class and ethnic divisions in ways that divided the nation regionally and in so doing undermined those regions’ last vestige of nationwide collective agency – our federal government. This form of fascism’s architects, perhaps best personified by the aforementioned Mr. Bannon if not Trump himself, professed devolution, not revolution as their aim.

The Bannonites’ professed aim was to ‘deconstruct’ the Progressive and New Deal eras’ administrative state, and leave ever more federal functions to, if anything, sub-federal units of government. It is easy to formulate both cultural and political-economic explanations for this inverted form of fascism in the US. Culturally speaking, fascism’s nostalgia for a nation’s past in America looked back, not to ‘the glory that was Rome’ or ‘Prussia’ – two consolidated polities – as did Italian and German fascism, but to the ‘greatness’ that was far-flung, not-yet-integrated 19th century America.

State and local government also tended often to be more ethnically and culturally homogeneous than the federal government could be – a great attraction to ethno-fascists in a multiethnic polity like the US, even when less pronounced in less ethnically heterogeneous ‘national’ polities elsewhere in the world. Where political economy is concerned, meanwhile, the wealthy interests that funded Bannon, Trump, and their circle seem to have preferred state and local over federal governance because smaller state and local governments were more consistently capturable than was the federal government.

The upshot with which we’ve been living ever since is now plain to see. Federal agencies have been hollowed out as the Trump administration foments shrinkage by attrition both by routinely firing officials and by not filling consequent or even prior vacancies. And, when it appoints people at all, it appoints personal cronies devoid of competence or experience in agencies’ mandate fields. This development has of course not gone unremarked over the past several years, but its consequences have proved quite dramatic during the Covid pandemic. For federal powers, agencies, and modes of national action that have been commonly employed in the past to address not only national calamities, but even regional or local calamities when too ‘big’ to be only locally managed, have effectively gone AWOL. Very little is or yet has been done federally – a fact about which Mr, Trump actually crows – and the bulk of pandemic response has accordingly fallen to states and their subdivisions.

It is against this backdrop that the new Fed facilities that I mentioned above and discuss in the next post take on what I believe to be their principal significance. For in effect, they signal Fed recognition that de facto federal agencies, even when de jure sub-federal, must be federally funded. And on that note we shall resume in the next post.

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