The Federal Reserve System is nuts. Here’s how we could remake it.

August 9, 2013

The Federal Reserve System makes no sense. Oh, sure, you can understand why in a country as large as the United States you might want the central bank to be a bit, er, decentralized. That's why most of the Fed's work — regulating banks, clearing checks, making cash available to the banking system — is actually carried out by a dozen Federal Reserve banks across the nation. Here's the map of where they are and the zones they cover:

Source: Federal Reserve Board
(Federal Reserve Board)

But the cities those banks are actually based in seems a little, er, idiosyncratic. Richmond, no banking capital, gets a reserve bank, but Charlotte, home of Bank of America, doesn't. Plenty of states are divided in half, which just seems unnecessary; why should one Louisiana bank be regulated by the Atlanta Fed while one in the next county over is regulated out of Dallas? One state, Missouri, has two reserve banks (St. Louis and Kansas City), while highly populous Florida doesn't have one at all. The San Francisco Fed, which covers the entire U.S. west of Colorado, served 19 percent of the population as of 2000, while the Minneapolis Fed served 3 percent. Here is the full breakdown of the relative populations of the 12 reserve districts:

Source: Federal Reserve Bank of San Francisco
(Federal Reserve Bank of San Francisco)

There are two reasons for the idiosyncrasies: Time and politics. The locations of reserve banks and the district lines were set a century ago, when the Federal Reserve Act was first enacted, and haven't been changed since, even as the population has shifted from the Northeast and Midwest toward the South and West. As this chart shows, the lines may have not perfectly divided the nation by population back then, but came a lot closer:

Source: Federal Reserve Bank of San Francisco
(Federal Reserve Bank of San Francisco)

But politics was the other factor. The Federal Reserve Act passed by the skin of its teeth (this has never been a country terribly comfortable with centralized financial authority). So to get it through Congress, certain compromises were needed. Richmond wasn't a particularly major financial capital even in 1913. But Carter Glass, the an architect of the bill in the House, was a Virginian, so Richmond would be home to a Fed bank. James A. Reed of Missouri was a crucial Senate vote, hence the two reserve banks in that state.

But what if we were to design the Fed system today, without regard to the vagaries of partisan politics? There is no active effort to redraw the Fed district system to make it more rational. But what if there were? Yesterday, some Fed watchers on Twitter had a bit of fun doing just that. (Fed watchers' definition of fun is different from that of most people.)

The qualities of a perfect map would be this: Each district would have about the same population. Each city that is a major banking hub would have a reserve bank. And no state would be divided in two.

Is it possible? Yeah. Josh Zumbrun at Bloomberg took a quite good try at it yesterday afternoon.  Here's roughly what a more rational Fed district map might look like. The big changes? New Federal Reserve banks in Charlotte, Miami, Memphis, Phoenix and Seattle, and shutting down Richmond, Atlanta, Minneapolis, St. Louis and Cleveland. We can call it the Zumbrun Plan.

ZumbrunPlan

I have some minor quibbles with it. Atlanta is a big enough financial center that it could be good to let it keep its bank instead of adding Memphis, and shifting Georgia into that district, for example. But overall, pretty good!

It even does okay — or at least better than the status quo — in having relatively even division of the United States by population:


Now, just as in 1913, any changes to the Fed system would have to go through Congress, and politics would inevitably affect how things shake out. Looking through the relevant Congressional leadership, House Financial Services Committee Chairman Jeb Hensarling should be okay with this, as Texas keeps its Federal Reserve district. House leadership might be a little more crotchety; one imagines that Speaker John Boehner (R-Ohio) would not like the closure of the Cleveland Fed, nor would Majority Leader Eric Cantor (R-Va.) care for the elimination of the Richmond Fed. In the Senate, Banking Committee Chairman Tim Johnson may want there to be a reserve bank in his state of South Dakota, but surely would know it's not very plausible given there are no major financial centers there.

And Senate Majority Leader Harry Reid (D-Nev.) is a wily operator who surely would have the brilliant idea of locating the new Federal Reserve bank for the Southwest not in Phoenix, as proposed here, but in Las Vegas. I like to imagine that the president of the Las Vegas Fed would show up at every FOMC meeting a little bleary-eyed and hungover, and offer to deploy part of the Fed balance sheet toward the craps table, where he totally has the hot hand. You want unconventional monetary policy? He'll show you some unconventional monetary policy.

On second thought, maybe the Fed system map is okay the way it is.

Correction: This post originally gave the wrong name for the Missouri senator who ensured that Missouri have two Federal Reserve banks, and an incorrect title for Virginia Congressman Carter Glass. Both have been fixed.

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Brad Plumer · August 9, 2013