Wall Street - The Federal Reserve banking system
Wall Street: The Federal Reserve banking system
A while ago I read a very nice book on the US and Wall Street called “Why Wall Street matters” of William D. Cohan from 2017. This inspired me to write 2 short blogs/ articles on Wall Street. The book is the source for these 2 blogs.
I will also be in New York/ Wall Street again from 17-20 December 2019! :-) When you work in finance let me know when you want to meet!
My first article on Wall Street was a broad introduction, and can be found here:
And in this second and last short article I will talk about the “Federal Reserve banking system”.
The Federal Reserve banking system: An introduction
The Federal Reserve is the centralized national bank of the US. It is created more than a century ago by powerful bankers on a remote location.
Because of the constant turmoil of boom and bust cycles in the late 19th century, and early 20th century, there was a belief in the US that a more tightly, structured and centralized financial system was needed.
Back then Mr. J.P. Morgan saved the financial system already a couple of times, but he would not live forever.
And also the nation’s financial system grew alongside the economy. So people got skeptic on whether one man could save the system over and over again.
In November 1910 the Rhode Island senator Aldrich invited a select group of politicians and bankers to the exclusive Jekyll Island Club off the coast of Georgia.
During the next two weeks the bankers and the senator set up a system of 12 regional “Federal Reserve Banks” with a central governing board.
And this board is composed of not politicians but bankers, or men and woman appointed by bankers.
(William D. Cohan, 2017)
Goals of the Federal Reserve banking system
The plan was to institutionalize what Mr. J.P. Morgan had done in both the financial crises in 1893 and 1907.
The new central bank would become the nation’s lender of last resort. And it would also strive to keep the financial system from overheating in the first place.
The politicians of the time augured against the banker’s ideas made on Jekyll Island. Congress simply feared putting Wall Street in control of something as crucial as the central bank.
Much of that fear derived from the concentration of financial power that was already in the hands of a small group of Wall Street bankers.
(William D. Cohan, 2017)
Development of the Federal Reserve system
The Federal Reserve Act of 1913 created a system of 12 regional Federal Reserve banks. These are owned by the commercial banks in the various districts.
And they have the ability to regulate the money supply, to tame inflation, and to serve as the nation’s lender of last resort during a financial crisis.
The act also provided for a governing board based in Washington; the Federal Reserve Board. The members were to be appointed by the president of the US. And the chairman of the Federal Reserve Board is one of the most powerful individuals in Washington.
(William D. Cohan, 2017)
Lender of last resort
The Federal Reserve system was created, in part, to be a lender of last resort.
But of course, it would not be normal for a bank to get “aid” from a reserve banks.
The danger is that when a bank has financial concerns and goes to the central bank to get help in the first place, the financial concerns/ problems could be a self-fulfilling prophecy. This because of the public opinion.
That very fear is what caused Hank Paulson; the Treasury secretary, to insist that all the big banks take TARP money (“Troubled Asset Relief Program”) during the 2008 financial crisis, whether they said they needed it or not.
More than 100 years after the founding of the system it is much debated whether the Federal Reserve system is a source of good or evil.
For now let’s stick to the basis, and that implies that the Federal Reserve is designed to act in the interest of banks, bankers, and the overall financial system.
And they do this by focusing on keeping inflation low and employment robust.
Of course this needs to be done to coincide with the interests of the American people.
(William D. Cohan, 2017)
Sources used for this blog
Book: “Why Wall Street matters” of William D. Cohan from 2017.
Just a very nice book for people interested in Wall Street, its function and history, and its future! 😊
Earlier blogs on Business Valuation: The “cost of capital”
Article 1: Valuation & Betas (CAPM)
Article 2: Valuation & Equity Market Risk Premium (CAPM)
Article 3: Is the Capital Asset Pricing Model dead ? (CAPM)
Article 4: Valuation & the cost of debt (WACC)
Article 5: Valuation & Capital Structure (WACC)
Article 6: International WACC & Country Risk – Part 1
Article 7: International WACC – Part 2
Article 8: Present Values, Real Options, the Dot.com Bubble
Article 9: Valuation: Different DCF & WACC techniques
Earlier blogs on “Business valuation to Enterprise Value”
From June until August I have written the following blogs on valuation:
1) Leveraged Buyout (LBO) Analysis:
2) M&A Analysis – Accretion/ Dilution:
3) Discounted Cash Flow Valuation:
4) Valuation Multiples 1 – Comparable Companies Analysis:
5) Excel Shortcuts & Business Valuation:
6) Valuation Multiples 2 – Precedent Transaction Analysis:
Joris@kerstencf.nl / +31 6 8364 0527 / www.kerstencf.nl/training
