The Federal Reserve and Financial Regulation: The First Hundred Years
This paper surveys the role of the Federal Reserve within the financial regulatory system, with particular attention to the interaction of the Fed's role as both a supervisor and a lender-of-last-resort (LOLR). The institutional design of the Federal Reserve System was aimed at preventing banking panics, primarily due to the permanent presence of the discount window. This new system was successful at preventing a panic in the early 1920s, after which the Fed began to discourage the use of the discount window and intentionally create "stigma" for window borrowing - policies that contributed to the panics of the Great Depression. The legislation of the New Deal era centralized Fed power in the Board of Governors, and over the next 75 years the Fed expanded its role as a supervisor of the largest banks. Nevertheless, prior to the recent crisis the Fed had large gaps in its authority as a supervisor and as LOLR, with the latter role weakened further by stigma. The Fed was unable to prevent the recent crisis, during which its LOLR function expanded significantly. As the Fed begins its second century, there are still great challenges to fulfilling its original intention of panic prevention.
Thanks to Doug Diamond, Anil Kashyap, Christina Romer, and David Romer for helpful comments, and to Ellis Tallman for sharing Figure 1, which appears in Tallman (2010). Neither author has anything currently relevant to disclose. Gorton worked with AIG Financial Products during 1996-2008. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.