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United States: Debunking the Conspiracy Theory
Ted Wieseman (New York)
Over the past couple of weeks, we have received several inquiries regarding Federal Reserve activity in the equity futures market. A number of investors believe that the Fed has been intervening in this market, and we believe it’s time to put this speculation to rest. In our view, the claim is ideologically inconsistent, and in practical terms, it is impossible to hide this type of activity on the Fed’s balance sheet (which is released in full detail every week). Most important, to put it bluntly, the Fed does not have the legal authority to intervene in the S&P futures market.
The Federal Reserve Act specifically identifies the types of securities the central bank is allowed to buy and sell. These include Treasuries, agencies, short-duration munis, bankers’ acceptances, and gold (the US was under a gold standard when the Fed was established in 1913). After a long and contentious debate over its legality, the Fed in 1962 also "reinterpreted" Section 14 of the Federal Reserve Act as giving it the legal authority to buy and sell foreign currencies (see Robert L. Hetzel’s paper "Sterilized Foreign Exchange Intervention: The Fed Debate in the 1960s" in the spring 1996 issue of the Richmond Fed’s Economic Quarterly for background on the debate and legal arguments advanced by Fed and Treasury lawyers justifying currency intervention). Subsequently, in 1980, the Congress gave the Fed legal authority to invest the proceeds of foreign exchange operations in short-term foreign government bonds.
However, the Fed clearly has no legal authority to buy equities or corporate bonds, and no reasonable interpretation of the Federal Reserve Act would give them that right. Indeed, when the Fed began to consider changes to System Open Market Account (SOMA) procedures a couple of years ago in response to concerns about a shrinking supply of Treasuries, it acknowledged that a change in the law would be required to go beyond the securities listed above. In the interim, it investigated expanding its outright purchases to include GNMA MBS, and their repo operations, to include munis and foreign government bonds, because these securities were "assets that could be purchased under existing legal authority but were not currently authorized by the Committee" (see the January 2001 FOMC minutes). Moreover, in his February 2001 Humphrey-Hawkins testimony explaining the Fed's investigation of these possibilities, Fed Chairman Greenspan acknowledged that any further steps would require that the FOMC "request the Congress for a broadening of its statutory authority for acquiring assets via open market operations." Clearly, the Fed is a long way from having the legal authority to operate in equity markets. The conspiracy theorists are going to have to look elsewhere for an explanation of the recent market gyrations.
The relevant section of the Federal Reserve Act is as follows:
"Section 14. Any Federal reserve bank may, under rules and regulations prescribed by the Federal Reserve Board, purchase and sell in the open market, at home or abroad, either from or to domestic or foreign banks, firms, corporations, or individuals, cable transfers and bankers' acceptances and bills of exchange of the kinds and maturities by this Act made eligible for rediscount, with or without the endorsement of a member bank.
Every Federal reserve bank shall have power: (a) To deal in gold coin and bullion at home or abroad, to make loans thereon, exchange Federal reserve notes for gold, gold coin, or gold certificates, and to contract for loans of gold coin or bullion, giving therefor, when necessary, acceptable security, including the hypothecation of United States bonds or other securities which Federal reserve banks are authorized to hold; (b) to buy and sell, at home or abroad, bonds and notes of the United States, and bills, notes, revenue bonds, and warrants with a maturity date of purchase of not exceeding six months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any State, county, district, political subdivision, or municipality in the continental United States, including irrigation, drainage, and reclamation districts, such purchases to be made in accordance with rules and regulations prescribed by the Federal Reserve Board; (c) to purchase from member banks and to sell, with or without its endorsement, bills of exchange arising out of commercial transactions, as hereinbefore defined; (d) to establish from time to time, subject to review and determination of the Federal Reserve Board, rates of discount to be charged by the Federal reserve bank for each class of paper, which shall be fixed with a view of accommodating commerce and business; (e) to establish accounts with other Federal reserve banks for exchange purposes and, with the consent of the Federal Reserve Board, to open and maintain banking accounts in foreign countries, appoint correspondents, and establish agencies in such countries wheresoever it may deem best for the purpose of purchasing, selling, and collecting bills of exchange, and to buy and sell with or without its endorsement, through such correspondents or agencies, bills of exchange arising out of actual commercial transactions which have not more than ninety days to run and which bear the signature of two or more responsible parties."
Section 14b was amended in the Monetary Control Act of 1980 to expressly grant the Fed the authority to invest in "short-term foreign government securities," though the Fed’s questionable legal basis for acquiring foreign currency in the first place has never been remedied by Congressional legislation.
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