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The Rundown
Deep Dive: A Brief History of the Federal Reserve (And the Threat It Faces Today)
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Welcome back to the Rundown for another weekend deep dive. Today we are talking about the Federal Reserve. The Fed plays a crucial role in the U.S. economy. Their job is to keep inflation low and employment high. But now the Fed is facing a crisis that could have wide ranging impacts. So in today's episode, we'll break down what the Federal Reserve actually is, why it was created, how it shaped some of the biggest moments in American history. The and why the current beef between President Trump and Fed Chair Jerome Powell might be the biggest threat to the Fed's independence in decades. We got a great one for you today. Let's dive in. To understand why the Federal Reserve is so important, you have to first look at how things were like before they existed. You know, the American banking system before the Fed was a total mess. See, throughout the 1800s, a financial crisis was like a seasonal event. Every few years, people would lose confidence in their banks. Then everyone rush to the bank to withdraw their money. At the same time, the bank would then collapse because remember, banks don't keep all their deposits in cash in the vaults. So these bank runs would destroy livelihoods and take down the economy. And this was happening regionally every few years. The breaking point was the panic of 1907. This bank run was so bad that multiple banks in New York collapsed and the stock market fell 50% in three weeks. I mean, imagine that happening today. Like we freak out when the markets dropped 5% in three weeks. Imagine 50. So things got so bad in 1907 that J.P. morgan, yes, the actual guy who made the bank, had to step in himself. He gathered the city's top bankers into his private library. He locked the doors and he refused to let them leave until they agreed to pull their money together and bail out the banking system. After that, Congress finally stepped in. I think they realized that maybe it wasn't a great idea to rely on a handful of rich bankers to bail out the economy every time things went south. So in 1913, Congress passed the Federal Reserve act, which created the Federal Reserve. The goal was to create a safer, more stable banking system. Now, here's what makes the Federal Reserve unique. It's not a government agency, but it's also not a private bank. Like a weird hybrid situation. Think of them like a quasi government institution. You know, Congress created the Federal Reserve. They oversee the Federal Reserve, but the Fed operates independently. They don't take orders from the President or Congress when it comes to setting monetary policy. And that independence is key. But we'll come back to that because that is at the Heart of the beef between President Trump and the Fed today. Now, the Fed's powers have evolved a lot since 1913, but for the last five decades it's operated under what's called the dual mandate. This was written into law in the 1970s and it gives the Fed two main jobs. Number one is to keep prices stable, basically keeping inflation in check. And number two is maximum employment, keeping unemployment low and the job market strong. Now, the main way the Fed does this is by controlling interest rates. By raising or lowering rates, the Fed can essentially speed up or slow down the entire economy. Lowering rates makes borrowing money cheaper, which encourages spending and investment, while higher rates do the opposite. They make borrowing more expensive, which slows things down. It's an incredibly powerful tool. And the Fed's decisions have a massive impact on the economy. And sometimes they get their decisions wrong. So let's go through some of the big moments for the Fed over the last 100 plus years. The federal Reserve likes to operate in the background, but during the biggest moments in American history, like wars, depressions and pandemics, the Fed becomes the main character and their track record is mixed. Let's first start with the biggest L in the Fed's history, the Great Depression. See, back in the 1920s when the Fed was first formed, they seemed to have things figured out. They were adjusting interest rates, buying and selling government securities, and the economy was humming along. You might remember hearing about the Roaring Twenties from history class. Well, that all came crashing down in 1929. The stock market crashed and so did the economy. GDP fell by 30%, unemployment hit 25, and the economy entered the Great Depression. Now, many economists and historians today blame the Fed for not stepping up and being more aggressive. See, instead of flooding the system with cash to keep banks alive, they let banks fail by the thousands, which destroyed confidence in the entire financial system. And it's that lack of action by the Fed that probably made the Great Depression worse than it had to be. You know, I actually talked to financial journalist Andrew Ross Sorkin about the fed's role in 1929. In my recent interview with him, Andrew wrote a very detailed and great book about the crash in 1929. The first part of the book is about the failure of the Fed.
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One of the reasons the Fed didn't do more than it did in 1929. And they were talking about what to do in advance of the crash, meaning in terms of trying to tamp down speculation. They were worried about the politics in the moment. They were worried that if they actually raised interest rates too high to stamp out speculation that they would get slaughtered politically. And back then, the Fed was so new, it was considered still an experiment to some degree. It had just been born in 1913. They thought Congress could shut down the whole thing.
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So go check out that interview. If you missed it, it was a great conversation. Now, this massive failure by the bank led to Congress passing new laws regarding the Fed, including shifting powers away from the regional reserve banks and centralizing it in Washington with a board of governors. Now, the Fed did learn from their mistake, and their next big test came during World War II. During the 1940s, the Fed kept interest rates artificially low to help the US Government finance the war efforts to build tanks and planes. Now, after the war ended, the US treasury wanted to keep interest rates low to reduce the US Government's borrowing costs. But the Fed actually pushed back. They argued that keeping rates too low for too long would cause inflation to spiral out of control. And this led to a major turning point in 1951 called the Accord. It freed the Fed to use monetary policy independently without being forced to support the U.S. treasury. See, before this, the Fed was basically taking orders from the Treasury Department. But the accord finally separated them, establishing the Fed's independence. That allowed the Fed to set interest rates based on economic data and not what the Treasury Department wanted or what the President wanted. And it's this accord that is considered the birth of the modern Fed independence. Now, the next major shakeup for the Fed came in the 1970s. This was a time of great inflation, and the Fed's independence was tested. See, during the 1970s, the Fed kept interest rates low to boost employment. But keeping interest rates too low can cause inflation. And that's exactly what happened happened. Inflation climbed to double digits in the 1970s. But here's the thing. A part of the reason the Fed kept rates low was because of political pressure. At the time, President Richard Nixon leaned heavily on Fed chair Arthur Burns to keep rates low. Heading into the 1972 election, Arthur Burns gave in and inflation just got out of control. And that's the exact nightmare scenario an independent Fed is supposed to prevent. So this disaster of the 1970s led to major reforms of the Fed. In 1977, Congress passed the Federal Reserve Reform Act. This was huge because it formally gave the Fed its dual mandate, which we talked about before, which is maximum employment and price stability. This law also required the Fed to report regularly to Congress on how it was meeting those goals. On top of that, it made structural changes. For the first time, the Fed chair and Vice chair had to be confirmed by the Senate, and their terms were limited to four years. So this created more accountability at the Fed while still preserving the independence. So then in 1979, Paul Volcker became the Fed chair. And Volcker did what needed to be done. He jacked up interest rates to nearly 20% to break the back of inflation. Now, look, this move was very unpopular. It led to economic pain, massive job losses, and a recession, but it worked. By the mid-1980s, inflation was under control. And that is a great example of why an independent Fed is so important, because they have to make difficult choices that a lot of times might not be politically popular. So after Paul Volcker tanked inflation in the 1980s, the US entered what economists called the Great Moderation, which was 20 years of low and stable inflation. And during this period, the Fed also became way more transparent. For most of its history, the Federal Reserve was notoriously secretive. But that started to change in the 1990s. In 1994, the Fed started issuing public statements after every meeting explaining their decisions. Then in 2007, the Fed began releasing quarterly economic projections so everyone can see where Fed officials thought the economy was headed. And then in 2011, was the big one. The Fed chair started holding regular press conferences at their meetings to explain the Fed's thinking. Now, these press conferences are now followed very closely. The markets are following every word the Fed chair says. Now, this transparency from the Fed was actually strategic, because the more clearly the Fed communicates, the more effective their policy becomes. If businesses and investors understand where rates are headed, they can plan accordingly. And that stability actually helps the economy. So by the 2000s, the Fed had evolved into a much more professional, transparent, and accountable institution than it was in the 1970s. The next big test for the Fed came in 2008, during the Great Financial Crisis. That financial crisis is still fresh in my mind. The housing market had collapsed, Major financial institutions were on the verge of failure, and the entire global financial system was teetering on the edge. And the Fed responded aggressively. They slashed interest rates to basically zero. They launched massive bond buying programs known as qualitative easing, or qe, to inject liquidity into the system. And they created emergency lending programs to prevent a total collapse. And I remember seeing then Fed chair Ben Bernanke on TV all the time. Now, today, most people agree that those aggressive measures by the Fed prevented an even worse outcome in 08. And the most recent test the Fed faced was during COVID 19. The Fed actually acted even faster than they did in 08. They bought massive amounts of bonds and they set up emergency lending facilities almost overnight. These aggressive moves by the Fed likely prevented a global economic collapse, but it also led to 9% inflation. And while inflation has come down significantly, it's still higher than the Fed's 2% target. Which brings me to today and the unprecedented beef between President Trump and Fed Chair Jerome Powell. President Trump has been pushing for lower interest rates since he returned to the Oval Office. See, lowering rates generally juice the economy and the stock market. It makes borrowing cheaper for businesses and home buyers. So that would be good politically for President Trump. And to be fair, the Fed has been cutting interest rates. They cut rates three times in the second half of 2025, bringing the Fed funds rate down to a range of 3.5 to 3.75%. But Trump wants these rates to be even lower. The problem, though, is that inflation is still elevated. It's running at 2.7%, which is above the Fed's 2% target. And Fed Chair Jerome Powell has signaled that the Fed is going to be cautious about cutting rates even further until they're confident that inflation is under control. Add in the fact that while the labor market is cooling, the unemployment rate right now is near historic lows. So the Fed is in no hurry to keep cutting rates. And that's why President Trump is not a fan of Fed Chair Jerome Powell right now. What's funny is that Trump was the one who nominated Jerome Powell to be Fed chair during his first term back in 2018. But since being reelected, President Trump has relentlessly attacked Powell for his refusal to lower interest rates. Trump has called Powell a lot of names. He's called him clueless. He's called him enemy of the people. He even called him a jerk. But things really escalated this past week when Jerome Powell dropped a video on Sunday night announcing that the Department of Justice had opened a criminal investigation into the Federal Reserve and into Jerome Powell. This investigation is supposedly about the cost overruns on the Fed's headquarter renovations. But Jerome Powell made it clear that this criminal investigation was politically motivated because the Fed refused to drop interest rates to the level that the President wanted. I mean, I watched the video on Sunday night. It was shocking because it was the first time where Jerome Powell responded to the relentless attacks by Trump. Now, I should point out that presidents in the past have pressured the Fed before. Lyndon B. Johnson did it. Richard Nixon also did it. They wanted lower rates to help their poll numbers. But a threat of a criminal investigation against a sitting Fed chair is uncharted territory. Now, there's been Pretty strong backlash to this investigation. Jerome Powell has received bipartisan support from politicians and former Fed officials and even Wall street veterans. In fact, Republican Senator Thom Tillis of North Carolina, who sits on the Banking Committee, says he's going to block any nominee to replace Jerome Powell until this investigation is resolved. There's also Jamie Dimon, CEO of JPMorgan Chase. He weighed in this week saying that anything that undermines the Fed's independence is probably not a great idea. So we'll see if this bipartis backlash is enough for the DOJ to back down. What I don't understand though is like the timing of all this because remember, Jerome Powell's term as Fed Chair ends in May and Trump is going to replace him with someone who probably shares Trump's views on interest rates. Right now the leading candidates are Kevin Warsh, a former Fed governor, and Kevin Hassett, Trump's economic advisor. So Trump will get his chance to change the head of the Fed in just a few months. But despite that, the DOJ is still going after the Fed and Jerome Powell and threatening the Fed's independence. And honestly, this move could end up back backfiring for Trump. So what's my take here? Well, the Federal Reserve and its independence plays a key role in how our economic system works today. And Trump's plan to break that independence to lower rates could end up backfiring. The more that Trump is seen as trying to control the Fed, the less credible the Fed becomes. And if investors start to doubt the Fed's independence, they're going to demand higher interest rates to compensate for that risk. Now look, I got to say, the Fed isn't perfect, okay? They've made mistakes in the past, including recently in 2021 when the dot that inflation was transitory and they turned out to be wrong. But having a politicized Federal Reserve that makes decisions based on election cycles instead of economic conditions could lead to a terrible economic situation. So personally I'm glad that Jerome Powell finally responded to Trump's threats. But remember, Jerome Powell is only going to be the Fed Chair for a few more months. Trump's hand picked Fed chair is going to take over in May. If the market sees the new Fed chair taking orders from the President, that's going to shake the market's confidence that the Fed is independ. Is that going to be enough to spook the markets? I guess we'll have to see. Well, all right guys, that's it for today's weekend deep dive. Let us know in the comments on Spotify and YouTube on your thoughts about the Fed and its independence. I'm sure we're going to have to revisit this topic in a few months once we see who Trump nominates as the next Fed Chair and how the markets react to it. By the way, if you're new here, just an FYI, we post 10 minute episodes every morning throughout the week explaining everything happening in the markets. And with earnings season about to kick into gear and the drama with the Fed right now, it's a great, great time to get subscribed and tune in every day if you aren't already. Thank you guys again for listening, watching and commenting. Shout out to Mike and Connor for all the work behind the scenes and we'll see you guys back here tomorrow.