Annual Report of the Federal Reserve Board, 2001

Annual 'Report x £> 2001 •?*Mm?y Board of Governors of the Federal Reserve System Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

This publication is available from the Board of Governors of the Federal Reserve System, Publications Services, Mail Stop 127, Washington, DC 20551. It is also available at the Board's World Wide Web site, at http://www.federalreserve.gov/ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Letter of Transmittal BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Washington, D.C., April 2002 THE SPEAKER OF THE HOUSE OF REPRESENTATIVES Pursuant to the requirements of section 10 of the Federal Reserve Act, I am pleased to submit the eighty-eighth annual report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 2001. Sincerely, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Contents Monetary Policy and Economic Developments 3 MONETARY POLICY AND THE ECONOMIC OUTLOOK 7 Monetary Policy, Financial Markets, and the Economy over 2001 and Early 2002 9 Economic Projections for 2002 11 ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2001 AND EARLY 2002 12 The Household Sector 14 The Business Sector 20 The Government Sector 22 The External Sector 25 The Labor Market 27 Prices 29 U.S. Financial Markets 35 International Developments 41 MONETARY POLICY REPORTS TO THE CONGRESS 41 Report of February 13, 2001 71 Report of July 18, 2001 99 DOMESTIC OPEN MARKET OPERATIONS DURING 2001 99 Implementation of Monetary Policy in 2001 101 Banks' Demand for Fed Balances 103 Autonomous Factors Affecting the Supply of Fed Balances 105 Domestic Financial Assets on the Federal Reserve Balance Sheet and Open Market Operations 111 The Federal Funds Rate and Discount Window Credit 113 The Conduct of Monetary Operations after September 11 Federal Reserve Operations 121 CONSUMER AND COMMUNITY AFFAIRS 121 Curbing Abusive Lending 122 Fostering Research 122 Preparing for the Community Reinvestment Act Review 123 Expanding Access to Consumer Information 126 Regulatory Matters Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

CONSUMER AND COMMUNITY AFFAIRS—Continued 126 CRA Bank Examinations and Activities 128 Community Affairs 129 Consumer Advisory Council 131 HMDA Data and Mortgage Lending Patterns 132 Economic Effects of the Electronic Fund Transfer Act 133 Compliance Activities 134 Agency Reports on Compliance with Consumer Protection Laws and Regulations 137 Consumer Complaints 141 BANKING SUPERVISION AND REGULATION 142 Scope of Responsibilities for Supervision and Regulation 143 Supervision for Safety and Soundness 151 Supervisory Policy 162 Supervisory Information Technology 163 Staff Training 165 Regulation of the U.S. Banking Structure 169 Enforcement of Other Laws and Regulations 172 Federal Reserve Membership 173 FEDERAL RESERVE BANKS 173 Major Initiatives 173 Developments in Federal Reserve Priced Services 179 Developments in Currency and Coin 180 Developments in Fiscal Agency and Government Depository Services 182 Information Technology 182 Examinations of Federal Reserve Banks 183 Income and Expenses 184 Holdings of Securities and Loans 184 Volume of Operations 184 Federal Reserve Bank Premises 186 Pro Forma Financial Statements for Federal Reserve Priced Services 191 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE AND RESULTS ACT 191 Strategic and Performance Plans 191 Mission 191 Goals and Obj ectives 192 Interagency Coordination Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

195 FEDERAL LEGISLATIVE DEVELOPMENTS 195 USA PATRIOT Act 196 Proposed Check Truncation Act Records 199 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS 199 Regulation B (Equal Credit Opportunity), Regulation E (Electronic Fund Transfers), Regulation M (Consumer Leasing), Regulation Z (Truth in Lending), and Regulation DD (Truth in Savings) 199 Regulation D (Reserve Requirements of Depository Institutions) 200 Regulation E 201 Regulation H (Membership of State Banking Institutions in the Federal Reserve System) 202 Regulation H and Regulation Y (Bank Holding Companies and Change in Bank Control) 203 Regulation K (International Banking Operations) and Rules Regarding Delegation of Authority 204 Regulation Y 205 Regulation Z 205 Miscellanous Interpretations 206 Rules Regarding Equal Opportunity 207 Policy Statements and Other Actions 208 Discount Rates in 2001 215 MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS 215 Authorization for Domestic Open Market Operations 217 Guidelines for the Conduct of System Open Market Operations in Federal Agency Issues 217 Domestic Policy Directive 217 Authorization for Foreign Currency Operations 219 Foreign Currency Directive 219 Procedural Instructions with Respect to Foreign Currency Operations Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS—Continued 220 Meeting Held on January 30-31, 2001 236 Meeting Held on March 20, 2001 246 Meeting Held on May 15, 2001 255 Meeting Held on June 26-27, 2001 264 Meeting Held on August 21, 2001 273 Meeting Held on October 2, 2001 282 Meeting Held on November 6, 2001 290 Meeting Held on December 11, 2001 301 LITIGATION 301 Judicial Review of Board Orders under the Bank Holding Company Act 301 Litigation under the Financial Institutions Supervisory Act 301 Litigation under the Gramm-Leach-Bliley Act 301 Other Actions Federal Reserve System Organization 305 BOARD OF GOVERNORS 307 FEDERAL OPEN MARKET COMMITTEE 308 ADVISORY COUNCILS TO THE BOARD OF GOVERNORS 308 Federal Advisory Council 309 Consumer Advisory Council 310 Thrift Institutions Advisory Council 311 FEDERAL RESERVE BANKS 311 Officers of Federal Reserve Banks and Branches 313 Conference of Chairmen 313 Conference of Presidents 313 Conference of First Vice Presidents 313 Directors of the Banks and Branches 334 HISTORICAL RECORDS: MEMBERSHIP OF THE BOARD OF GOVERNORS, 1913-2001 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 338 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2001 and 2000 342 2. Federal Reserve Open Market Transactions, 2001 346 3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 1999-2001 347 4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2001 348 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2001 352 6. Income and Expenses of the Federal Reserve Banks, 1914-2001 356 7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks and Branches, December 31, 2001 357 8. Operations in Principal Departments of the Federal Reserve Banks, 1998-2001 358 9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2001 359 10. Reserve Requirements of Depository Institutions, December 31, 2001 360 11. Initial Margin Requirements under Regulations T, U, and X 361 12. Principal Assets and Liabilities and Number of Insured Commercial Banks in the United States, by Class of Bank, June 30, 2001 and 2000 362 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-2001 and Month-End 2001 368 14. Banking Offices and Banks Affiliated with Bank Holding Companies in the United States, December 31, 2000 and 2001 Financial Statements 371 BOARD OF GOVERNORS FINANCIAL STATEMENTS 381 FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS 393 MAPS OF THE FEDERAL RESERVE SYSTEM 397 INDEX Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and Economic Developments Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook Last year was a difficult one for the in that rate to 3 percentage points by economy of the United States. The August. slowdown in the growth of economic The devastating events of Septemactivity that had become apparent in late ber 11 further set back an already fragile 2000 intensified in the first half of the economy. Heightened uncertainty and year. Businesses slashed investment badly shaken confidence caused a widespending—making especially deep spread pullback from economic activity cuts in outlays for high-technology and from risk-taking in financial marequipment—in response to weakening kets, where equity prices fell sharply for final demand, an oversupply of some several weeks and credit risk spreads types of capital, and declining profits. widened appreciably. The most pressing As actual and prospective sales deterio- concern of the Federal Reserve in the rated, many firms in the factory sector first few days following the attacks was struggled with uncomfortably high lev- to help shore up the infrastructure of els of inventories, and the accompany- financial markets and to provide masing declines in manufacturing output sive quantities of liquidity to limit potensteepened. At the same time, foreign tial disruptions to the functioning of economies also slowed, further reducing those markets. The economic fallout of the demand for U.S. production. The the events of September 11 led the Fedaggressive actions by the Federal eral Open Market Committee (FOMC) Reserve to ease the stance of monetary to cut the target federal funds rate after a policy in the first half of the year pro- conference call early the following week vided support to consumer spending and and again at each meeting through the the housing sector. Nevertheless, the end of the year (see box "Monetary weakening in activity became more Policy after the Terrorist Attacks"). widespread through the summer, job Displaying the same swift response to losses mounted further, and the unem- economic developments that appears ployment rate moved higher. With few to have characterized much business indications that economic conditions behavior in the current cyclical episode, were about to improve, with underlying firms moved quickly to reduce payrolls inflation moderate and edging lower, and cut production after mid-September. and with inflation expectations well Although these adjustments occurred contained, the Federal Reserve contin- across a broad swath of the economy, ued its efforts to counter the ongoing manufacturing and industries related to weakness by cutting the federal funds travel, hospitality, and entertainment rate, bringing the cumulative reduction bore the brunt of the downturn. Measures of consumer confidence fell sharply in the first few weeks after the NOTE. The discussions here and in the next attacks, but the deterioration was not section ("Economic and Financial Developments especially large by cyclical standards, in 2001 and Early 2002") consist of the text, and improvement in some of these tables, and selected charts from Monetary Policy indexes was evident in October. Simi- Report to the Congress (Board of Governors, February 2002). larly, equity prices started to rebound in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88th Annual Report, 2001 Monetary Policy after the Terrorist Attacks The terrorist attacks on September 11 Depository institutions took up the offer, destroyed a portion of the infrastructure of and borrowing surged to a record U.S. financial markets, disrupted communi- $45 Vi billion by Wednesday. Discount cation networks, and forced some market loans outstanding dropped off sharply on participants to retreat to contingency sites Thursday and returned to very low levels in varying states of readiness. These devel- by Friday. Separately, overnight overdrafts opments, along with the tragic loss of life on Tuesday and Wednesday rose to several among the employees of a few major finan- billion dollars, as a handful of depository cial firms, greatly complicated trading, and other institutions with accounts at the clearing, and settlement of many different Federal Reserve were forced into overdraft classes of financial instruments. Direct dis- on their reserve accounts. Overnight overlocations elevated uncertainties about pay- drafts returned to negligible levels by the ment flows, making it difficult for the end of the week. reserve market to channel funds where they Like their U.S. counterparts, foreign were needed most. Depositories that held financial institutions operating in the more reserve balances than they preferred United States faced elevated dollar liquidhad considerable difficulty unloading the ity needs. In some cases, however, these excess in the market; by contrast, deposi- institutions encountered difficulties positories awaiting funds had to scramble to tioning the collateral at their U.S. branches cover overdraft positions. As a result, the to secure Federal Reserve discount window effective demand for reserves ballooned. credit. To be in a position to help meet The Federal Reserve accommodated the those needs, three foreign central banks increase in the demand for reserves through established new or expanded arrangements a variety of means, the relative importance with the Federal Reserve to receive dollars of which shifted through the week. On in exchange for their respective currencies. Tuesday morning, shortly after the attacks, These swap lines, which lasted for the Federal Reserve issued a press release thirty days, consisted of $50 billion for the reassuring financial markets that the Fed- European Central Bank, $30 billion for the eral Reserve System was functioning nor- Bank of England, and an increase of $8 bilmally and stating that "the discount win- lion (from $2 billion to $10 billion) for dow is available to meet liquidity needs." the Bank of Canada. The European Central late September, and risk spreads began ately following September 11. Several to narrow somewhat by early Novem- factors were at work in support of ber, when it became apparent that the household spending during this period. economic effects of the attacks were Low and declining interest rates proproving less severe than many had vided a lift to outlays for durable goods feared. and to activity in housing markets. Consumer spending remained sur- Nowhere was the boost from low interprisingly solid over the final three est rates more apparent than in the sales months of the year in the face of of new motor vehicles, which soared in enormous economic uncertainty, wide- response to the financing incentives spread job losses, and further deteriora- offered by manufacturers. Low morttion of household balance sheets from gage interest rates not only sustained the sharp drop in equity prices immedi- high levels of new home construction Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook Bank drew on its line that week to channel level. As anticipated by the FOMC, federal the funds to institutions with a need for funds traded somewhat below their new dollars. target level for the rest of the week. By the By Thursday and Friday, the disruption end of the month, bid-asked spreads and in air traffic caused the Federal Reserve to trading volumes in the interbank and other extend record levels of credit to depository markets receded to more normal levels, institutions in the form of check float. Float and federal funds consistently began to increased dramatically because the Federal trade around the intended rate. Reserve continued to credit the accounts of The Federal Reserve took several steps banks for deposited checks even though the to facilitate market functioning in Septemgrounding of airplanes meant that checks ber in addition to accommodating the normally shipped by air could not be pre- heightened demand for reserves. The hours sented to the checkwriters' banks on the of funds and securities transfer systems usual schedule. Float declined to normal operated by the Federal Reserve were levels the following week once air traffic extended significantly for a week after the was permitted to recommence. Lastly, over attacks. The Federal Reserve Bank of New the course of the week that included Sep- York liberalized the terms under which it tember 11, as the market for reserves began would lend the securities in the System to function more normally, the Federal portfolio, and the amount of securities lent Reserve resumed the use of open market rose to record levels in the second half operations to provide the bulk of reserves. of September. For the ten days following The open market Desk accommodated the attacks, the Federal Reserve reduced all propositions down to the target federal or eliminated the penalty charged on overfunds rate, operating exclusively through night overdrafts, largely because those overnight transactions for several days. The overdrafts were almost entirely the result injection of reserves through open market of extraordinary developments beyond the operations peaked at $81 billion on Friday. control of the account holders. In addition, The combined infusion of liquidity from the Federal Reserve helped restore commuthe various sources pushed the level of nication between market participants and reserve balances at Federal Reserve Banks in some cases processed bilateral loans of to more than $100 billion on Wednesday, reserves between account holders in lieu September 12, about ten times the normal of market intermediation. but also allowed households to refi- of demand, the surprising strength in nance mortgages and extract equity from household spending late in the year homes to pay down other debts or to resulted in a dramatic liquidation of increase spending. Fiscal policy pro- inventories. In the end, real gross vided additional support to consumer domestic product posted a much better spending. The cuts in taxes enacted last performance than had been anticipated year, including the rebates paid out over in the immediate aftermath of the the summer, cushioned the loss of attacks. income from the deterioration in labor More recently, there have been markets. And the purchasing power of encouraging signs that economic activhousehold income was further enhanced ity is beginning to firm. Job losses by the sharp drop in energy prices dur- diminished considerably in December ing the autumn. With businesses having and January, and initial claims for unempositioned themselves to absorb a falloff ployment insurance and the level of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88th Annual Report, 2001 insured unemployment have reversed provide some stimulus to activity this their earlier sharp increases. Although year. Perhaps the most significant potenmotor vehicle purchases have declined tial support to the economy could come appreciably from their blistering fourth- from farther gains in private-sector proquarter pace, early readings suggest that ductivity. Despite the pronounced slowconsumer spending overall has remained down in real GDP growth last year, outvery strong early this year. In the put per hour in the nonfarm business business sector, new orders for capital sector increased impressively. Continequipment have provided some tentative ued robust gains in productivity, stemindications that the deep retrenchment ming from likely advances in technolin investment spending could be abat- ogy, should provide a considerable boost ing. Meanwhile, purchasing managers to household and business incomes and in the manufacturing sector report that spending and contribute to a sustained, orders have strengthened and that they noninflationary recovery. view the level of their customers' inven- Still, the economy faces considerable tories as being in better balance. Indeed, risk of subpar economic performance the increasingly rapid pace of inventory in the period ahead. Because outlays for runoff over the course of the last year durable goods and for new homes have has left the level of production well been relatively well maintained in this below that of sales, suggesting scope for cycle, the scope for strong upward impea recovery in output given the current tus from household spending seems sales pace. Against this backdrop, the more limited than has often been the FOMC left its target for the federal case in past recoveries. Moreover, the funds rate unchanged in January. How- net decline in household net worth relaever, reflecting a concern that growth tive to income over the past two years is could be weaker than the economy's likely to continue to restrain the growth potential for a time, the FOMC retained of spending in coming quarters. To be its assessment that the risks were sure, the contraction in business capital tilted unacceptably toward economic spending appears to be waning. But weakness. spending on some types of equipment, The extent and persistence of any most notably communications equiprecovery in production will, of course, ment, continues to decline, and there are depend critically on the trajectory of few signs yet of a broad-based upturn in final demand in the period ahead. Sev- capital outlays. Activity abroad remains eral factors are providing impetus to subdued, and a rebound of foreign outsuch a recovery in the coming year. put is likely to follow, not lead, a With the real federal funds rate hovering rebound in the United States. Furtheraround zero, monetary policy should be more, lenders and equity investors positioned to support growth in spend- remain quite cautious. Banks have coning. Money and credit expanded fairly tinued to tighten terms and standards rapidly through the end of the year, and on loans, and risk spreads have many households and businesses have increased a little this year. Stock prices strengthened their finances by locking have retreated from recent highs as earnin relatively low-cost long-term credit. ings continue to fall amid concerns The second installment of personal about the transparency of corporate income tax cuts and scheduled increases financial reports and uncertainty about in government spending on homeland the pace at which profitability will security and national defense also will improve. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook Monetary Policy, Financial 2Vi percentage points—in 5 half-point Markets, and the Economy steps—by the middle of May. Moreover, over 2001 and Early 2002 the FOMC indicated throughout this period that it judged the balance of risks As economic weakness spread and to the outlook as weighted toward ecointensified over the first half of 2001, nomic weakness. The Board of Goverthe FOMC aggressively lowered its tar- nors of the Federal Reserve System get for the federal funds rate. Because approved reductions in the discount rate firms reacted unusually swiftly to indi- that matched the Committee's cuts in cators that inventories were uncom- the target federal funds rate. As a result, fortably high and capital was becoming the discount rate declined from 6 perunderutilized, the drop in production cent to 3^2 percent over the period. and business capital spending was espe- At its June and August meetings, cially steep. Moreover, sharp downward the FOMC noted information suggestrevisions in corporate profit expecta- ing continued softening in the economy tions caused equity prices to plunge, and a lack of convincing evidence that which, along with a decline in consumer the end of the slide in activity was in confidence, pointed to vulnerability in sight. Although consumer spending on household spending. Meanwhile, a sig- both housing and nonhousing items— nificant deceleration in energy prices, buoyed by the tax cuts and rebates, low after a surge early in the year, began to mortgage interest rates, declining energy hold down overall inflation; the restrain- prices, and realized capital gains from ing effect of energy prices, combined home sales—remained fairly resilient, with the moderation of resource utiliza- economic conditions in manufacturing tion, also promised to reduce core infla- deteriorated further. Firms continued to tion. Responding to the rapid deteriora- reduce payrolls, work off excess invention in economic conditions, the FOMC tories, and cut back capital equipment cut its target for the federal funds rate expenditures amid sluggish growth in Selected Interest Rates 2/2 3/21 5/16 6/28 8/22 10/3 11/15 12/19 1/3 1/31 3/20 4/18 5/15 6/27 8/219/17 10/2 11/6 12/1! 1/30 2000 2001 2002 NOTE. The data are daily and extend through February 25, 2002. The dates on the horizontal axis are those of scheduled FOMC meetings and of any intermeeting policy actions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

8 88th Annual Report, 2001 business sales, significantly lower cor- to flock from private to Treasury and porate profits, and greater uncertainty federal agency debt, boosted risk about future sales and earnings. With spreads sharply, especially on lowerenergy prices in retreat, price inflation rated corporate debt. Increased demand remained subdued. In reaching its policy for safe and liquid assets contributed to decisions at its June and August meet- selling pressure in the stock market. At ings, the FOMC took into account the its October 2 meeting, the FOMC had substantial monetary policy stimulus little hard information available on ecoalready implemented since the start of nomic developments since the attacks. the year—but not yet fully absorbed by However, evidence gleaned from surthe economy—and the oncoming effects veys, anecdotes, and market contacts of stimulative fiscal policy measures indicated that the events of Septemrecently enacted by the Congress. Con- ber 11 had considerable adverse repersequently, the Committee opted for cussions on an already weak economy: smaller interest rate cuts of lA percent- Survey indicators of consumer confiage point at both the June and August dence had fallen, and consumer spendmeetings, which brought the target fed- ing had apparently declined. At the same eral funds rate down to 3x/2 percent; as time, anecdotal information pointed to earlier in the year, the FOMC continued additional deep cutbacks in capital to indicate that it judged the balance of spending by many firms after an risks to the outlook as weighted toward already-significant contraction in busieconomic weakness. After both meet- ness fixed investment over the summer ings, the Board of Governors of the months. Federal Reserve System also approved When the FOMC met on November similar reductions in the discount rate, 6, scattered early data tended to confirm which moved down to 3 percent. the information that the decline in pro- After the terrorist attacks on Septem- duction, employment, and final demand ber 11, the available Committee mem- had steepened after the terrorist attacks. bers held a telephone conference on Although an economic turnaround September 13, during which they agreed beginning in the first half of 2002 was that the financial markets were too dis- a reasonable expectation according to rupted to allow for an immediate alter- the Committee, concrete evidence that ation in the stance of monetary policy. the economy was stabilizing had yet However, the members were in agree- to emerge. Meanwhile, the marked ment that the attacks' potential effects decrease in energy prices since the on asset prices and on the performance spring had induced a decline in overall of the economy, and the resulting uncer- price inflation, and inflation expectainty, would likely warrant some policy tations had fallen. Accordingly, the easing in the very near future. Accord- FOMC voted to lower its target for the ingly, the FOMC, at a telephone confer- federal funds rate Vi percentage point ence on September 17, voted to reduce at both its October and November meetits target for the federal funds rate ings and reiterated its view that the risks l/i percentage point, to 3 percent, and to the outlook were weighted toward stated that it continued to judge the risks economic weakness. The sizable adjustto the outlook to be weighted toward ments in the stance of monetary policy economic weakness. in part reflected concerns that insuffi- Over subsequent weeks, heightened cient policy stimulus posed an unacceptaversion to risk, which caused investors ably high risk of a more extended cycli- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook cal retrenchment that could prove rate that matched the FOMC's cuts in progressively more difficult to counter, the target federal funds rate, bringing given that the federal funds rate—at the discount rate to 1 lA percent, its low- 2 percent—was already at such a low est level since 1948. level. Subsequent news on economic activ- By the time of the December FOMC ity bolstered the view that the economy meeting, the most recent data were sug- was beginning to stabilize. The informagesting that the rate of economic decline tion reviewed at the January 29-30, might be moderating. After plunging 2002, FOMC meeting indicated that earlier in the year, orders and shipments consumer spending had held up remarkof nondefense capital goods had turned ably well, investment orders had firmed up early in the fourth quarter, and the further, and the rate of decline in manumost recent survey evidence for manu- facturing production had lessened facturing also suggested that some toward the end of 2001. With weakness expansion in that sector's activity might in business activity abating, and monebe in the offing. In the household sec- tary policy already having been eased tor, personal consumption expenditures substantially, the FOMC left the federal appeared to have been quite well main- funds rate unchanged at the close of its tained, an outcome that reflected the meeting, but it continued to see the risks continuation of zero-rate financing to the outlook as weighted mainly packages offered by the automakers, toward economic weakness. widespread price discounting, and low interest rates. In an environment of very Economic Projections for 2002 low mortgage interest rates, household demand for housing remained at a rela- Federal Reserve policymakers are tively high level, and financial resources expecting the economy to begin to freed up by a rapid pace of mortgage recover this year from the mild downrefinancing activity also supported con- turn experienced in 2001, but the pace sumer spending. of expansion is not projected to be suffi- Nonetheless, the evidence of emerg- cient to cut into the margin of underutiing stabilization in the economy was lized resources. The central tendency of quite tentative and limited, and the the real GDP growth forecasts made by Committee saw subpar economic perfor- the members of the Board of Governors mance as likely to persist over the near and the Federal Reserve Bank presiterm. Moreover, in the probable absence dents is 2Vi percent to 3 percent, meaof significant inflationary pressures for sured as the change between the final some time, a modest easing action could quarter of 2001 and the final quarter of be reversed in a timely manner if it this year. The pace of expansion is likely turned out not to be needed. In view of to increase only gradually over the these considerations, the FOMC low- course of the year, and the unemployered its target for the federal funds rate ment rate is expected to move higher for VA percentage point, to VA percent, on a time. The FOMC members project the December 11, 2001, and stated that it civilian unemployment rate to stand at continued to judge the risks to the out- about 6 percent to 6x/4 percent at the end look to be weighted mainly toward eco- of 2002. nomic weakness. As had been the case A diminution of the rate of inventory throughout the year, the Board of Gover- liquidation is likely to be an important nors approved reductions in the discount factor helping to buoy production this Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

10 88th Annual Report, 2001 Economic Projections for 2002 Percent Federal Reserve Governors and Reserve Bank presidents Indicator MEMO: 2001 actual Central Range tendency Change, fourth quarter to fourth quarter1 Nominal GDP 1.9 3'/2-5i/2 4-41/2 Real GDP .1 2-31/2 2'/2-3 PCE chain-type price index 1.3 1-2 About IV2 Average level, fourth quarter Civilian unemployment rate 5.6 53/4-6i/2 6-61/4 1. Change from average for fourth quarter of previous year to average for fourth quarter of year indicated. year. In 2001, businesses cut inventories through this period of economic weaksharply so as to avoid carrying exces- ness suggests a lack of pent-up consive stocks relative to the weaker pace sumer demand going forward. In addiof sales, and although this process of tion, consumers likely will not benefit liquidation probably is not yet complete from declining energy prices to the in many industries, the overall pace of extent they did last year, and the net reduction is likely to slow. Then, as decline in equity values since mid-2000 final demand strengthens, liquidation will probably continue to weigh on conshould give way to some restocking later sumption spending in the period ahead. in the year. Federal Reserve policymakers believe As noted above, the forces affecting that consumer prices will increase demand this year are mixed. On the slightly more rapidly in 2002 than in positive side are the stimulative effects 2001, as last year's sharp decline in of both fiscal policy and the earlier energy prices is unlikely to be repeated. monetary policy actions. A gradual turn- The central tendency of the FOMC around in employment and a strengthen- members' projections for increases in ing of the economies of our major trad- the chain-type price index for personal ing partners should provide some lift consumption expenditures (PCE) is to final demand, and spending by both about W2 percent; last year's actual households and businesses ought to increase was about \lA percent. Neverbe supported by robust productivity theless, diminished levels of resource growth. On the other hand, the problems utilization, the indirect effects of previfacing the high-tech sector have not yet ous declines in energy prices on firms' completely receded, and indications are costs, and continued competitive presthat spending on other types of capital sures all ought to restrain the pace of equipment remains lackluster. The sur- price increases outside of the energy prising strength of household spending sector this year. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

11 Economic and Financial Developments in 2001 and Early 2002 In 2001, the economy turned in its maintained, buoyed by lower interest weakest performance in a decade. Real rates and cuts in federal taxes. Firms GDP increased at an annual rate of trimmed payrolls through most of the 3A percent in the first half of the year year, and the unemployment rate moved and, according to the advance estimate up nearly 2 percentage points to around from the Commerce Department, 5% percent by year-end. Job losses were declined at a Vi percent annual rate in especially large following the terrorist the second half. Although the effects of attacks of September 11, which had the weakening economy were broadly extremely adverse effects on certain secfelt, the factory sector was especially tors of the economy—most notably, airhard hit. Faced with slumping demand line transportation and hospitality indusboth here and abroad, manufacturers tries. Nevertheless, by early this year cut production aggressively to limit some signs appeared that the economy excessive buildups of inventories. More- was beginning to mend. over, businesses sharply reduced their Inflation declined last year, pulled investment spending, with particularly down by a sharp drop in energy prices. dramatic cuts in outlays for high- Excluding food and energy items, contechnology equipment. By contrast, sumer price inflation leveled off and, by household spending was reasonably well some measures, moved lower last year. Weakening economic activity, the indirect effects of declining energy prices on Change in Real GDP Percent, annual rate Change in PCE Chain-Type Price Index — 4 • Total | Excluding food and energy 1995 1997 1999 2001 NOTE. Here and in subsequent charts, except as noted, annual changes are measured from Q4 to Q4, 1995 1997 1999 2001 and change for a half-year is measured between its final quarter and the final quarter of the preceding NOTE. The data are for personal consumption period. expenditures (PCE). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

12 88th Annual Report, 2001 firms' costs, and continued strong com- wealth position of many households; petitive pressures helped keep a lid on in the aggregate, however, household core consumer price inflation. wealth deteriorated further as equity prices moved lower, on net. The decline in wealth since mid-2000 likely exerted a notable restraining influence on house- The Household Sector hold spending last year. Both monetary and fiscal policy sup- Consumer Spending ported consumer spending over the past Growth in consumer spending slowed year. Low interest rates helped enable last year but remained sufficiently solid motor vehicle finance companies to to provide an important source of offer favorable financing on new vehisupport to overall final demand. Per- cles. In addition, low mortgage rates led sonal consumption expenditures (PCE) to a spate of mortgage refinancing that increased 3 percent in real terms in 2001 lasted most of the year, lowering payafter having advanced 4lA percent in ments and freeing cash to be used by 2000 and around 5 percent in both 1998 households for other spending needs. and 1999. The deceleration in consumer Indeed, many households apparently spending was widespread among dura- used these refinancings as an opportuble goods, nondurable goods, and ser- nity to extract equity from their homes, vices. However, motor vehicle expen- a move that further accommodated conditures remained strong through most sumer spending. Furthermore, the first of the year and surged in the fall as wave of tax reductions from the Ecoconsumers responded enthusiastically to nomic Growth and Tax Relief Reconciliautomakers' aggressive expansion of ation Act of 2001—including the $300 financing incentives. After Septem- and $600 rebate checks mailed last ber 11, spending declined in certain summer—likely helped to boost spendtravel- and tourism-related categories, ing in the latter part of the year. The including air transportation, hotels and continued phase-in of the tax reductions motels, and recreation services such as enacted last year should provide further amusement parks; spending in these categories has recovered only partially Change in Real Income and Consumption since then. Last year's downshift in consumption Percent, annual rate growth reflected the weakening labor market and associated deceleration of Q] Disposable personal income | Personal consumption income as well as the erosion in house- — expenditures — 8 hold wealth since the middle of 2000. With employment declining over much of last year, real personal income rose only about \3A percent after a gain of 4Vi percent in 2000. The slowing of ___ 4 income growth was even sharper in nominal terms, but price declines for gasoline and other energy items in the I— 2 latter half of the year substantially cushioned the blow to real incomes. A continued rise in house prices supported the 1995 1997 1999 2001 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 13 stimulus to income and consumption down sharply to very low levels in the this year. fourth quarter and into early 2002. The personal saving rate, which had According to the Michigan SRC survey, declined through 1999, leveled off in declining mortgage rates have helped 2000 and in the first half of 2001. The elevate consumers' assessments of saving rate moved erratically in the sec- homebuying conditions substantially ond half of the year but rose on average. since mid-2000. It shot up in the summer as households In the single-family sector, 1.27 milreceived their tax rebates; it then lion new homes were started last year, declined later in the year as households 3x/2 percent more than in 2000, when spent some of the rebates and as pur- activity had been held down by higher chases of new motor vehicles soared in mortgage rates. The pace of starts response to the incentives. moved up further in January 2002, in Consumer sentiment, as measured by part because of unusually favorable both the University of Michigan Survey weather. Furthermore, sizable backlogs Research Center (SRC) and the Con- of building permits early this year ference Board, had been running at suggest that construction activity will extremely high levels through most of remain solid. Sales of new homes were 2000 but fell considerably near the elevated throughout 2001—indeed, for beginning of last year as concerns about the year, they were the highest on the economy intensified. By the spring, record—and sales of existing homes measures of sentiment leveled off near remained strong as well. Meanwhile, the their historical averages and well above increase in home prices moderated last levels normally associated with reces- year. The constant-quality price index of sions. Sentiment dropped in September. new homes, which attempts to control The SRC measure recovered gradually for the mix of homes sold, rose only thereafter, while the Conference Board 1Vi percent last year, down from a 6 perindex fell further before turning up later cent gain in 2000. in the year; by early 2002, both senti- In the multifamily sector, starts averment measures again stood near their aged 328,000 units last year, a rate close historical averages. to the solid pace of the past several years. Conditions are still relatively favorable for the construction of multi- Residential Investment family units. In particular, vacancy rates As with consumer spending, real expen- have remained low, although rents and ditures on housing were well maintained property values increased at a slower last year, buoyed by favorable mortgage rate last year than in 2000. interest rates. Interest rates on thirtyyear fixed-rate mortgages, which had Household Finance been as high as SV2 percent in the spring of 2000, hovered around the low level Households continued to borrow at a of 7 percent in the first half of 2001. brisk pace last year, increasing their debt They moved down further to 61/2 per- outstanding an estimated 83/4 percent, a cent by late October, before backing up rate about 1 percentage point faster than to 7 percent again by December as pros- the average growth over the previous pects for the economy improved. As two years. The cumulative declines in monetary policy eased, contract rates mortgage interest rates encouraged on adjustable-rate mortgages moved households to take on large amounts of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

14 88th Annual Report, 2001 mortgage debt, both by fostering home- credit in that segment of the market buying and by making it attractive to moved sharply higher. refinance existing mortgages and extract some of the accumulated equity; indeed, The Business Sector the Mortgage Bankers Association (MBA) refinancing index in October Much of the weakness in activity last reached the highest level since its incep- year was concentrated in the business tion in January 1980. The frenzied pace sector. In late 2000, manufacturers had of refinancing activity tailed off some begun to cut back production in an effort later in the fourth quarter, when fixed to reduce an undesired build-up of mortgage interest rates backed up. All inventories, and sharp inventory liquidatold, mortgage debt grew an estimated tion continued throughout last year. 9 percent last year. Strength in durable Moreover, the boom in capital outlays goods outlays supported growth in con- that had helped drive the expansion sumer credit (debt not secured by real through the late 1990s gave way to a estate) in the first quarter of 2001, but as softening of spending in late 2000 and consumption spending decelerated over to sharp declines last year. Spending the next two quarters, the expansion of dropped for most types of capital equipconsumer credit slowed sharply. How- ment and structures; cutbacks were ever, consumer credit growth surged in especially severe for high-tech equipthe fourth quarter, in large part because ment, some types of which may have of the jump in motor vehicle sales. For been over-bought. A sharp reduction in the year as a whole, the rate of expan- corporate profits and cash flow contribsion of consumer credit, at 6lA percent, uted to last year's downturn in capital was well below the 1014 percent rate spending, as did general uncertainty posted in 2000. about the economic outlook. Despite the Hefty household borrowing out- reduction in interest rates, which helped stripped the growth of disposable per- restrain businesses' interest expenses, sonal income in 2001. As a result, financing conditions worsened somedespite lower interest rates, the house- what, on balance, given weaker equity hold debt-service burden—an estimate values, higher borrowing costs for risky of minimum scheduled payments on firms, and some tightening of banks' mortgage and consumer debt as a share lending standards. of disposable income—finished the year near the peak recorded at the end of Fixed Investment 1986. Measures of household credit quality deteriorated noticeably last year. Real spending on equipment and soft- According to the MBA, delinquency ware (E&S) declined 8V2 percent in rates on home mortgages continued to 2001 after an increase of the same trend higher from their historic lows of amount in 2000 and double-digit rates the late 1990s, and auto loan delinquen- of increase for several preceding years. cies at finance companies edged up, Spending on high-tech equipment, although they too remained at a rela- which has accounted for about 40 pertively subdued level. The economic cent of E&S spending in recent years, slowdown and the rise in unemployment dropped especially sharply last year. significantly eroded the quality of loans Outlays for computers and peripheral to subprime borrowers, and delinquency equipment, which had risen more than rates for both mortgages and consumer 30 percent in each of the preceding Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 15 seven years, fell 9 percent in 2001. ditions and the absence of new appli- Spending on communications equip- cations requiring the most up-to-date ment swung even more severely, mov- machines. But in addition, the magniing from increases of more than 20 per- tude by which these categories of expencent on average from 1998 to 2000 to a diture had increased in preceding years, decline of more than 30 percent last together with the abruptness of their year. Business spending on software downturn, suggests that firms may have held up comparatively well, falling only been too optimistic about the immediate 2Vi percent in 2001 after having risen profitability of some types of high-tech around 12 percent in 1999 and 2000. capital; as these expectations were A number of factors may have revised, businesses viewed their previous investment as more than sufficient weighed on outlays for high-tech equipto meet anticipated demand. This possiment, including businesses' decisions to bility is especially likely in the case of lengthen the replacement cycle for com- communications equipment, for which puters in light of weak economic con- expectations about prospects for growth Change in Real Business Fixed Investment in demand appear to have been disappointed. Some of the cutbacks may have Percent, annual rate reflected a general pulling back in an environment of greater uncertainty. The Structures sharp rise and subsequent decline of Equipment and software — 20 equity values in the high-tech sector nih mirrors the pattern of rising and slowing — 10 investment and provides some support for the notion that earnings expectations may have been overly upbeat in the past. Under the influence of ongoing weakness in the market for heavy trucks, — 20 business spending on motor vehicles declined through most of the year. But spending stabilized in the fourth quarter, Percent, annual rate as the generous incentives on motor High-tech equipment vehicles may have helped boost spend- — 50 and software ing by small businesses as well as con- Other equipment — 40 sumers. Domestic orders for new aircraft declined last year, especially after n — 30 the terrorist attacks last fall, but these [j j! ____ 20 lower orders had not yet affected spending by year-end because of the very — 10 long lags involved in producing planes. - i • Apart from spending on transportation 0 and high-tech equipment, real outlays declined IVi percent last year after hav- 1 1 ing increased 6 percent in 2000, with the 1995 1997 1999 2001 turnaround driven by a sharp swing in spending on many types of industrial NOTE. High-tech equipment includes computers and peripheral equipment and communications equipment. machinery and on office furniture. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

16 88th Annual Report, 2001 Late last year, conditions in some seg- of fiber-optic networks. Investment in ments of the high-tech sector showed the energy sector was a pocket of signs of bottoming. Developments in the strength last year. Construction of drillsemiconductor industry have improved, ing structures surged in 2000 and much with production increasing during the of 2001, as the industry responded to fall. Some of the improvement is appar- elevated prices of oil and natural gas. ently coming from increased demand However, with oil and natural gas prices for computers. In the advance estimate reversing their earlier increases, drilling from the Commerce Department for the activity turned down in the latter part of fourth quarter, real spending on comput- the year. ers and peripheral equipment was reported to have surged at an annual rate Inventory Investment of 40 percent. However, spending on communications equipment, for which By late 2000, manufacturers were evidence of a capital overhang has been already cutting production to slow the most pronounced, continued to decline pace of inventory accumulation as sharply in the fourth quarter, and orders inventories moved up relative to sales. for communications equipment have Production cuts intensified in early yet to display any convincing signs of 2001, and producers and distributers turning around. As for other types of liquidated inventories at increasing rates capital equipment, spending continued throughout the year. The runoff of to decline in the fourth quarter, but inventories was a major factor holding a moderate rebound in new orders down GDP growth last year. Indeed, the for many types of capital goods arithmetic subtraction from real GDP from their autumn lows hinted that a growth attributable to the decline in nonbroader firming of demand may be farm inventory investment was Wi perunder way. centage points over the four quarters Real business spending for nonresi- of 2001. However, because sales also dential structures also declined sharply were weakening, inventory-sales ratios in 2001. Construction of office buildings remained high in much of the manufacdropped last year after having increased turing sector, and in some portions of notably for several years; industrial the wholesale sector as well, throughout building remained fairly steady through the year. the first half of last year but plummeted The motor vehicle sector accounted in the second half. Vacancy rates for for about one-quarter of last year's overthese two types of properties rose con- all inventory drawdown. Late in 2000 siderably, and by year-end the indus- and early last year, automakers cut protrial vacancy rate had reached its high- duction in an attempt to clear out excess est level since mid-1993. Meanwhile, stocks held by dealers. By the spring, spending on non-office commercial vehicle assemblies had stabilized, and buildings (a category that includes retail, the automakers instead dealt with heavy wholesale, and some warehouse space) stocks by further sweetening incentives decreased moderately last year. Invest- to boost sales. By the end of the year, ment in public utilities moved down inventories of cars and light trucks stood as well, a decline reflecting, in part, a at a relatively lean 2lA million units, cutback in spending for communi- nearly 1 million units fewer than were cations projects such as the installation held a year earlier. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 17 Corporate Profits and Business Business borrowing slowed markedly Finance last year because firms slashed investment in fixed capital and inventories The profitability of the U.S. nonfinaneven more than the drop in profits and cial corporate sector suffered a severe other internally generated funds. Busiblow in 2001. The profit slump had ness debt expanded at a 6lA percent begun in the fourth quarter of the previannual rate in 2001, well below the ous year, when the economic profits of double-digit rates of the two previous nonfinancial corporations—that is, book years, and its composition shifted decidprofits from current production with edly toward longer-term sources of inventory and capital consumption funds. Early in the year, favorable condiadjustments compiled by the Commerce tions in the corporate bond market, com- Department—plummeted almost 45 perbined with firms' desire to lock in low cent at an annual rate. The first three interest rates, prompted investmentquarters of 2001 brought little respite, grade firms to issue a high volume of and economic profits spiraled downbonds. They used the proceeds to ward at an average annual rate of 25 perstrengthen their balance sheets by repaycent. The ratio of the profits of nonfiing short-term debt obligations, refinancial corporations to the sector's gross nancing other longer-term debt, and nominal output fell to IVi percent last building up liquid assets. Junk bond year, a level not seen since the early issuance was also strong early in 2001, 1980s. Earnings reports for the fourth as speculative-grade yields fell in quarter indicate that nonfinancial corporesponse to monetary policy easings, rate profits continued to fall late in the although investors shunned the riskiest year. issues amid increasing economic uncertainty and rising defaults among below- Before-Tax Profits of Nonfinancial investment-grade borrowers. Corporations as a Percent of Sector GDP The heavy pace of bond issuance, along with a reduced need to finance capital investments, enabled firms to decrease their business loans at banks and their commercial paper outstanding. The move out of commercial paper — 12 also reflected elevated credit spreads between high- and low-tier issuers resulting from the defaults of California 10 utilities and several debt downgrades among prominent firms early in the year. Announcements of new equity share repurchase programs thinned considerably in the first half of the year, as firms sought to conserve their cash buffers I I _L in response to plummeting profits. A 1981 1986 1991 1996 2001 significant slowdown in cash-financed NOTE. The data are quarterly and extend through merger activity further damped equity 2001 :Q3. Profits are from domestic operations of retirements, although these retirements nonfinancial corporations, with inventory valuation and capital consumption adjustments. still outpaced gross equity issuance, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

18 88th Annual Report, 2001 which was restrained by falling share recovered, because of ongoing concerns prices. Over the summer, issuance of about credit quality and ratings downinvestment-grade bonds dropped off grades among some high-profile issuers appreciably. Moreover, market senti- in the fall. ment toward speculative-grade issues By early October, the investmentcooled, as further erosion in that sector's grade corporate bond market had largely credit quality took its toll. Business recovered from the disruptions associloans and outstanding commercial paper ated with the terrorist attacks, and bond continued to contract, and with share issuance in that segment of the market prices in the doldrums, nonfinancial picked up considerably. Firms capitalfirms raised only a small amount of ized on relatively low longer-term funds in public equity markets in the interest rates to pay down short-term third quarter. obligations, to refinance existing higher- The terrorist attacks on September 11 coupon debt, and to boost their holdings constricted corporate financing flows for of liquid assets. With high-yield bond a time. The stock market closed for that risk spreads receding moderately, issuweek, and trading in corporate bonds ance in the speculative-grade segment came to a virtual halt. After the shut- of the corporate bond market stirred down of the stock market, the Securities somewhat from its moribund state, and Exchange Commission, in an effort although investors remained highly to ensure adequate liquidity, temporarily selective. Public equity issuance, after lifted some restrictions on firms' repur- stalling in September, also regained chases of their own shares. According some ground in the fourth quarter, to reports from dealers, this change spurred by a rebound in stock prices. As triggered a spate of repurchases in the was the case for most of the year, initial first few days after the stock markets reopened on September 17. When full-scale trading in corporate bonds Spreads of Corporate Bond Yields over the resumed on September 17, credit Ten-Year Swap Rate spreads on corporate bonds widened sharply: Risk spreads on speculativegrade private debt soared to levels not seen since late 1991, and spreads on investment-grade corporate bonds also moved higher, although by a considerably smaller amount. Against this backdrop, junk bond issuance nearly dried up for the rest of the month. Commercial paper rates—even for top-tier issuers— jumped immediately after the attacks, as risk of payment delays increased. In response to elevated rates, some issuers tapped their backup lines at commercial banks, and business loans spiked in the 2000 2001 2002 weeks after the attacks. Risk spreads for low-tier borrowers in the commercial NOTE. The data are daily and extend through February 21, 2002. The spreads compare the yields on the paper market remained elevated, even Merrill Lynch AA, BBB, and 175 indexes with the after market operations had largely ten-year swap rate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 19 public offerings and venture capital recent years, and most firms did not financing remained at depressed levels. experience significant difficulties servic- Commercial paper issuance recovered ing their debt. However, many firms somewhat early in the fourth quarter as were downgraded, and evidence of firms repaid bank loans made in the financial distress mounted over the immediate aftermath of the terrorist course of the year. The twelve-month attacks and as credit spreads for lower- trailing average of the default rate on rated issuers started to narrow. How- corporate bonds nearly tripled last year ever, the collapse of the Enron Corpora- and by December ran almost Vi percenttion combined with typical year-end age point higher than its peak in 1991. pressures to widen quality spreads in Delinquency rates on business loans at early December. All told, the volume of banks also rose, although not nearly as domestic nonfinancial commercial paper dramatically. The amount of nonfinanoutstanding shrank by one-third over the cial debt downgraded by Moody's year as a whole. Business loans at banks Investors Service last year was more fell further in the fourth quarter; for the than five times the amount upgraded; year, business loans contracted AlA per- downgrades were especially pronounced cent, their first annual decline since in the fourth quarter, when ratings agen- 1993. cies lowered debt ratings of firms in the The slowing of sales and the drop in telecommunication, energy, and auto profits caused corporate credit quality sectors. to deteriorate noticeably last year. In Commercial mortgage debt, suppart because of the decline in market ported by still-strong construction interest rates, the ratio of net interest spending, expanded at a brisk 10 percent payments to cash flow in the nonfinan- pace over the first half of 2001. The cial corporate sector moved only mod- growth of commercial mortgage debt estly above the relatively low levels of edged down only Vi percentage point in the second half, despite a sharp slowdown in business spending on nonresidential structures. As a result, Default Rate on Outstanding Bonds the issuance of commercial-mortgagebacked securities (CMBS) maintained a robust pace throughout the year. Available data indicate some deterioration in the quality of commercial real estate credit. Delinquency rates on commercial real estate loans at banks rose steadily in 2001 and have started to edge out of their recent record-low range. In addition, CMBS delinquency rates increased, especially toward the end of the year, amid the rise in office vacancy rates. Despite the erosion in credit quality in commercial real estate and heavy issuance of CMBS, yield spreads on 1991 1993 1995 1997 1999 2001 investment-grade CMBS over swap rates were about unchanged over the NOTE. The data are monthly; the series shown is a twelve-month moving average. year, suggesting that investors view Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

20 88th Annual Report, 2001 credit problems in this sector as being decline in net interest payments, outlays contained. Commercial banks, however, increased nearly 6 percent, a second stiffened their lending posture in year of increases larger than had preresponse to eroding prospects for the vailed for some time. Outlays have commercial real estate sector; signifi- increased across all major categories of cant net fractions of loan officers expenditure, including defense, Medisurveyed over the course of the year care and Medicaid, and social security. reported that their institutions had As for the part of federal spending that firmed standards on commercial real is counted in GDP, real federal outlays estate loans. for consumption and gross investment increased somewhat more rapidly than in recent years through the first three The Government Sector quarters of 2001 as defense expenditures picked up. Spending rose faster Federal Government still in the fourth quarter because of Deteriorating economic conditions and increases for homeland security and the new fiscal initiatives have led to smaller additional costs associated with the war federal budget surpluses than had been in Afghanistan. anticipated earlier. The fiscal 2001 sur- The existence of surpluses through plus on a unified basis was $127 billion, fiscal 2001 meant that the federal govor about VA percent of GDP—well ernment continued to contribute to the below both the record $236 billion sur- pool of national saving. Nevertheless, plus recorded in fiscal 2000 and the gross saving by households, businesses, $281 billion surplus that the Congres- and governments has been trending sional Budget Office had anticipated down over the past few years from the for fiscal 2001 at this time last year. recent high of around 19 percent of GDP Receipts, which had increased at least in 1998. 6 percent in each of the preceding seven The Treasury used federal budget fiscal years, declined around 2 percent surpluses over the first half of the year in fiscal 2001; the rise in individual tax to pay down its outstanding marketable receipts slowed dramatically and cor- debt. In the third quarter, however, the porate receipts plunged 27 percent. The cut in personal income taxes and a lower receipts reflected both the weak- weakening in receipts as the economy ening economy—specifically, slow contracted led the Treasury to reenter growth of personal income, the drop in the credit markets as a significant borcorporate profits, and a pattern of rower of new funds. The Treasury's declines in equity values that led to budget position swung back into surplus lower net capital gains realizations— late in the year owing to somewhat and changes associated with the Eco- stronger-than-expected tax receipts, nomic Growth and Tax Relief Reconcili- which helped push fourth-quarter net ation Act of 2001. Some provisions of borrowing below its third-quarter level. the act went into effect immediately, Despite the increase in the Treasury's including the rebate checks that were net borrowing over the second half of mailed last summer. In addition, the act the year, publicly held debt remained at shifted some corporate tax payments only about one-third of nominal GDP into fiscal 2002. last year, its lowest level since the mid- Meanwhile, outlays were up 4 per- 1980s and well below the 1993 peak of cent in fiscal 2001; abstracting from a almost 50 percent. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 21 Federal Government Debt debt buybacks scheduled for late Sep- Held by the Public tember to conserve cash, it later announced that buyback operations Percent of nominal GDP would begin again in October. With its credit needs still limited, the Treasury announced on October 31 that it was suspending issuance of nominal — 45 and inflation-indexed thirty-year securities. Subsequently, the thirty-year Treasury bond yield fell sharply, bid-asked 35 spreads on outstanding bonds widened, and liquidity in the bond sector deteriorated. Although bid-asked spreads nar- — 25 rowed over the balance of the year, market participants reported that liquidity in the bond sector remained below its 1 1 1 i 1 I i i1 1i1 11 Ml II1 Ml level before the Treasury's announce- 1961 1971 1981 1991 2001 ment. The announcement on October 31 NOTE. The data are as of the end of the fiscal year. also indicated that after the January Excludes debt held in federal government accounts 2002 buyback operations, the Treasury and by the Federal Reserve System. would determine the amount and timing of buybacks on a quarter-by-quarter The terrorist attacks on September 11 basis, thereby fueling speculation that and the associated disruptions to finan- future buybacks might be scaled back in cial markets had some spillover effects light of the changed budget outlook. on Treasury financing. On the day of the attacks, the Treasury cancelled its scheduled bill auction; over the next State and Local Governments several days, it drew down nearly all of its compensating balances with com- Real expenditures for consumption and mercial banks—about $12V2 billion in gross investment by states and localities total—to meet its obligations. On Thurs- rose 5 percent last year after an increase day of that week, the settlement of secu- of 2Vi percent in 2000. Much of the rities sold the day before the attacks acceleration reflected a burst of spendeased the Treasury's immediate cash ing on construction of schools and other squeeze, and the incoming stream of infrastructure needs. In addition, outlays estimated quarterly personal income tax at the end of last year were boosted payments provided additional funds. by the cleanup from the September 11 Infrastructure problems involving the attacks in New York. As for employtrading and clearing of Treasury securi- ment, state and local governments added ties were largely resolved over the fol- jobs in 2001 at a more rapid pace than lowing week, and when the Treasury they did over the previous year and resumed its regular bill issuance on thereby helped to offset job losses in the September 17, exceptionally strong private sector. demand for bills pushed stop-out rates— The fiscal condition of state and local that is, the highest yield accepted during governments has been strained by the the auction—to their lowest level since deterioration in economic performance. 1961. Although the Treasury cancelled State governments are considering a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

22 88th Annual Report, 2001 variety of actions to achieve budget The External Sector balance in the current fiscal year. Most states are intending to cut planned Trade and the Current Account expenditures, and many are considering The U.S. current account deficit nardrawing down rainy-day funds, which rowed significantly during 2001, with governments had built up in earlier both imports and exports of goods and years. According to the National Conservices falling sharply in response to a ference of State Legislators, these rainyglobal weakening of economic activity. day funds stood at the relatively high The deficit in goods and services narlevel of $23 billion at the end of fiscal rowed to $333 billion at an annual rate 2001 (June 30). Moreover, some states in the fourth quarter of 2001 from that had planned to fund capital expendi- $401 billion at the end of the previous tures with current receipts appear to be year. In addition, the deficit was temposhifting to debt financing. Finally, a few rarily reduced further in the third quarter states are considering actions such as because service import payments were postponing tax cuts that were enacted lowered by a large one-time estimated earlier. insurance payment from foreign insur- Debt of the state and local governers (reported on an accrual basis) ment sector expanded rapidly last year related to the events of September II.1 after slow growth in 2000. Gross issu- Excluding the estimated insurance ance of long-term municipal bonds figure, the current account deficit was accelerated over the first half of 2001 as $434 billion at an annual rate over state and local governments took advanthe first three quarters of the year, tage of lower yields to refund outstand- or AlA percent of GDP, compared with ing debt. Spurred by falling interest rates $445 billion and AV2 percent for the and declining tax revenues, these govyear 2000. Net investment income ernments continued to issue long-term payments were about the same during bonds to finance new capital projects at the first three quarters of 2001 as in a rapid clip over the second half of the the corresponding period a year earyear. Despite a deterioration in tax lier; higher net payments on our growreceipts, credit quality in the municipal ing net portfolio liability position were market remained high in 2001. Late in offset by higher net direct investment the year, however, signs of weakness receipts. had emerged, as the pace of net credit- U.S. real exports were hit by slower ratings upgrades slowed noticeably. growth abroad, continued appreciation Especially significant problems continue of the dollar, and plunging global to plague California and New York, both of which saw their debt ratings lowered in November. In California, the problems were attributed to declining tax 1. The "insurance payment" component of revenues and difficulties related to the imported services is calculated as the value of premiums paid to foreign companies less the state's electricity crisis earlier in the amount of losses recovered from foreign compayear, while New York's slip in credit nies. In the third quarter, the estimated size of quality resulted not only from deteriorat- losses recovered far exceeded the amount paid for ing tax receipts but also from fears of insurance premiums, resulting in a negative recorded insurance payment. According to NIPA higher-than-expected costs related to accounting, the entire amount of a recovery is clean up and rebuilding after the terrorrecorded in the quarter in which the incident ist attacks. occurred. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 23 demand for high-tech products. Real during the year.2 Imported goods fell exports of goods and services fell 6 percent last year, with much of the 11 percent over the four quarters of decrease in capital goods (computers, 2001, with double-digit declines begin- semiconductors, and other machinery). ning in the second quarter. Service In contrast, real imports of automotive receipts decreased 7 percent; all of the products, consumer goods, oil, and other decline came after the events of Sep- industrial supplies were little changed, tember 11. Receipts from travel and and imports of foods rose. The pattern passenger fares, which plunged fol- of import growth appears to have shifted lowing the terrorist attacks, were about toward the end of the year. Imports of one-fourth lower in the fourth quarter real non-oil goods declined at about a than in the second quarter. Receipts 10 percent annual rate during the first from foreigners for other services three quarters of the year but fell less changed little over the year. Exports rapidly in the fourth quarter. The price declined in almost all major goods of imported non-oil goods, after rising categories, with the largest drops by in the first quarter, declined at an annual far in high-tech capital goods and rate of about 6 percent from the second other machinery. Two exceptions were quarter through the fourth quarter, led exports of automotive products, which by decreases in the price of imported rose during the second and third quar- industrial supplies. ters (largely parts to Canada and Mexico The value of imported oil fell more destined ultimately for use in U.S. than one-third over the four quarters of markets, and vehicles to Canada), and 2001, a drop resulting almost entirely agricultural goods. About 45 percent from a sharp decline in oil prices. The of U.S. exports of goods were capital spot price of West Texas intermediate equipment; 20 percent were industrial (WTI) crude decreased about $10 per supplies; and 5 percent to 10 percent barrel during the year, with much of the each were agricultural, automotive, condecline occurring after September 11. sumer, and other goods. The value of During the first eight months of 2001, exported goods declined at double-digit the spot price of WTI averaged $28 per rates for almost all major market destibarrel as weakened demand for oil nations. Even exports to Canada and and increased non-OPEC supply were Mexico declined sharply, despite suplargely offset by OPEC production port from two-way trade with the United restraint. In the wake of the terrorist States in such sectors as automotive attacks, oil prices dropped sharply in products. response to a decline in jet fuel con- As growth of the U.S. economy sumption, weaker economic activity, slowed noticeably, real imports of goods and reassurance from Saudi Arabia that and services turned down and declined supply would be forthcoming. Oil prices 8 percent for 2001 as a whole. Service continued to drift lower during the payments dropped 15 percent last year. The plunge in outlays for travel and passenger fares after September 11 held 2. According to NIPA accounting, the value of down total real service payments, bring- the one-time insurance payments by foreign insuring their level in the fourth quarter ers is not reflected in NIPA real imports of 15 percent below that in the second services. The deflator for service imports was adjusted down for the third quarter to offset the quarter. Spending on services other than lower value of service imports; the deflator travel and passenger fares changed little returned to its usual value in the fourth quarter. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

24 88th Annual Report, 2001 fourth quarter, reflecting OPEC's appar- eigners, who had sold a significant ent unwillingness to continue to sacri- quantity of Treasury securities during fice market share in order to defend 2000, roughly halted their sales in the higher oil prices. In late December, how- first half of 2001. The increased capiever, OPEC worked out an arrangement tal inflows arising from larger foreign in which it agreed to reduce its produc- purchases of U.S. securities in the tion targets an additional 1.5 million first half was only partly offset by an barrels per day, contingent on the increase in the pace at which U.S. resipledges from several non-OPEC produc- dents acquired foreign securities, espeers (Angola, Mexico, Norway, Oman, cially equities. and Russia) to reduce oil exports a total The pattern of private securities transof 462,500 barrels per day. Given the actions changed significantly in the third uncertainty over the extent to which quarter: Foreign purchases of U.S. equithese reductions will actually be imple- ties slowed markedly, and U.S. investors mented and the comfortable level of oil shifted from net purchases of foreign inventories, the spot price of WTI securities to net sales. However, the remained near $20 per barrel in early reduced flows in the third quarter 2002. seem to have reflected short-lived reactions to events in the quarter. Preliminary data for the fourth quarter show a significant bounceback in foreign pur- Financial Account chases of U.S. securities and a return to The slowing of U.S. and foreign eco- purchases of foreign securities by U.S. nomic growth over the course of last residents. year had noticeable effects on the com- The changing economic climate also position of U.S. capital flows, especially affected direct investment capital flows. when the slowing became more pro- During 2000, foreign direct investnounced in the second half. On bal- ment in the United States averaged ance, net private capital flowed in at more than $70 billion per quarter. a pace only slightly below the record These flows slowed to less than set in 2000, including unprecedented $60 billion per quarter in the first net inflows through private securities half and then dropped to only $26 biltransactions. lion in the third quarter (the last avail- During the first half of 2001, sagging able data). The drop resulted in part stock prices and signs of slower growth from a decline in the outlook for corbrought a shift in the types of U.S. secu- porate profits and a significant reducrities demanded by private foreigners tion in general merger and acquisition but did not reduce the overall demand activity. By contrast, U.S. direct investfor them. Indeed, during the first half, ment abroad picked up over the course foreign private purchases of U.S. securi- of 2001. The third quarter outflow of ties averaged $137 billion per quarter, a $52 billion—a record—reflected both a rate well above the record $109 billion large merger and robust retained earnpace set in 2000. A slowing of foreign ings by the foreign affiliates of U.S. purchases of U.S. equities, relative to firms. Capital inflows from official 2000, was more than offset by a pickup sources were relatively modest in 2001, in foreign purchases of corporate and totaling only $15 billion, compared with agency bonds. In addition, private for- $36 billion in 2000. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 25 The Labor Market Early last year, employment in manufacturing, which had been trend- Employment and Unemployment ing down for several years, began to decline more rapidly. Job losses were Last year's weakening in economic widespread within the manufacturing activity took its toll on the labor market. sector but were most pronounced in Payroll employment edged up early last durable-goods industries, such as those year and then dropped nearly Wi milproducing electrical and industrial lion by January 2002. Declines were machinery and metals. Employment at particularly large in manufacturing, help supply firms and in wholesale which has shed one in twelve jobs since trade—industries that are directly mid-2000. Job cuts accelerated in the related to manufacturing—also began to months following the terrorist attacks of decline. Outside of manufacturing and September 11, with declines occurring its related industries, private payrolls in a wide variety of industries. The continued to increase robustly in the first unemployment rate moved up from quarter of last year, but hiring then 4 percent in late 2000 to 5.8 percent by slowed, although it remained positive, December 2001. In January 2002, the on net, in the second and third quarters. unemployment rate edged down to Construction payrolls increased into 5.6 percent. the spring but flattened out thereafter. Employment at retail trade establishments also continued to increase moder- Measures of Labor Utilization ately through the spring but began to decline in the late summer. In services industries other than help supply firms—a broad group that accounted for — 15 nearly half of the private payroll Augmented increases over the preceding several unemployment years—job gains slowed but remained positive in the second and third quarters of last year. In all, private payroll employment declined about 115,000 per month in the second and third quarters, and the unemployment rate moved up Civilian steadily to 4V2 percent by the spring and unemployment to nearly 5 percent by August. 1 1 1 I I The labor market was especially hard 1972 1982 1992 2002 hit by the terrorist attacks. Although labor demand was weak prior to the NOTE. The data extend through January 2002. The augmented umemployment rate is the number of attacks, the situation turned far worse unemployed plus those who are not in the labor force following the events of September 11, and want a job, divided by the civilian labor force and private payrolls plunged more than plus those who are not in the labor force and want a 400,000 per month on average in Octojob. In January 1994, a redesigned survey was introduced; data for the augmented rate from that point ber and November. Employment fell on are not directly comparable with those of earlier substantially not only in manufacturing periods. For the augmented rate, the data are quarterly and in industries directly affected by through December 1993 and monthly thereafter; for the civilian labor force rate, the data are monthly. the attacks, such as air transportation, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

26 88th Annual Report, 2001 hotels, and restaurants, but also in a magnitude of that deceleration. The wide variety of other industries such as slowing likely reflected the influence of construction and much of the retail the soft labor market, energy-driven sector. declines in price inflation toward the Employment continued to decline in latter part of the year, and subdued infla- December and January but much less tion expectations. Compensation probthan in the preceding two months. ably was also held down by a reduction Manufacturing and its related industries in variable pay, such as bonuses that are lost jobs at a slower pace, and employ- tied to company performance and stockment leveled off in other private indus- option activity. tries. The unemployment rate moved up According to the employment cost to 5.8 percent in December but then index, hourly compensation costs ticked down to 5.6 percent in January. increased 4V4 percent during 2001, The recent reversal of the October and down from a AVi percent increase in November spikes in new claims for 2000; both the wages and salaries and unemployment insurance and in the benefits components recorded slightly level of insured unemployment also smaller increases. The deceleration in point to some improvement in labor the index for wages and salaries was market conditions early this year. concentrated among sales workers, whose wages often include a substantial commission component and so are espe- Productivity and Labor Costs cially sensitive to cyclical develop- Given economic conditions, growth of ments. Although the increase in employlabor productivity was impressive in ers' cost of benefits slowed overall, 2001. Productivity growth typically the cost of providing health insurance drops when the economy softens, partly increased more than 9 percent last year; because businesses tend not to shed the rise continued this component's workers in proportion to reduced accelerating contribution to labor costs demand. Last year, however, output per over the past few years after a period hour in the nonfarm business sector increased a relatively solid 1 Vi percent, Change in Output per Hour according to the advance estimate, after having risen 2Vi percent in 2000—a Percent, annual rate mild deceleration by past cyclical standards. Indeed, productivity is estimated — 4 to have increased at an annual rate of more than 2 percent in the second half of the year, an impressive performance — 3 during a period when real GDP was, on net, contracting. The buoyancy of pro- - 2 ductivity during 2001 provides further support to the view that the underlying —- 1 trend of productivity growth has stepped up notably in recent years. Hourly labor compensation costs increased more slowly last year than in LL J L _U 1991 1993 1995 1997 1999 2001 2000, although different compensation measures paint different pictures of the NOTE. Nonfarm business sector. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 27 of restrained cost increases in the mid- The chain-type price index for personal 1990s. consumption expenditures (PCE) An alternative measure of hourly increased 1.3 percent last year after havcompensation is the BLS's measure of ing increased 2.6 percent in 2000; the compensation per hour in the non- turnaround in consumer energy prices farm business sector, which is derived accounted for almost all of that decelerafrom compensation information in tion. Increases in PCE prices excluding the national accounts; this measure food and energy items also slowed a increased 4 percent last year, a very little last year after having moved up in large drop from the 13A percent increase 2000. The chain-type price index for registered in 2000. One reason that gross domestic purchases—the broadest these two compensation measures may price measure for domestically purdiverge is that only nonfarm compensa- chased goods and services—decelerated tion per hour captures the cost of stock considerably last year. The small options. Although the two compensa- increase in this index reflected both the tion measures differ in numerous other drop in energy prices and a resumption respects as well, the much sharper decel- of rapid declines for prices of investeration in nonfarm compensation per ment goods, especially computers, folhour may indicate that stock option lowing a period of unusual firmness in exercises leveled off or declined in 2001 2000. The price index for GDP—the in response to the fall in equity values. broadest price measure for domestically However, because nonfarm compensa- produced goods and services—posted a tion per hour can be revised substan- smaller deceleration of about V2 percenttially, one must be cautious in interpret- age point between 2000 and 2001 ing the most recent quarterly figures because lower oil prices have a smaller from this series. weight in U.S. production than in US. Unit labor costs, the ratio of hourly purchases. compensation to output per hour in the Consumer energy prices continued to nonfarm business sector, increased about move higher through the early months 2 percent last year. Although down from of 2001 before turning down sharply in a huge 5 percent increase in 2000 that the second half of the year. Despite the reflected that year's surge in nonfarm fact that crude oil prices were declining compensation per hour, the figure for 2001 is still a little higher than the mod- Alternative Measures of Price Change erate increases seen over the preceding several years. Last year's increase in Percent unit labor costs was held up by the Price measure 2000 2001 smaller productivity increases that accompanied weak economic activity; Chain-type accordingly, subsequent increases in unit Gross domestic product 2.4 1.8 Gross domestic purchases 2.5 1.1 labor costs would be held down if out- Personal consumption put per hour begins to increase more expenditures 2.6 1.3 Excluding food and energy ... 1.9 1.6 rapidly as the economy strengthens. Fixed-weight Consumer price index 3.4 1.9 Prices Excluding food and energy ... 2.5 2.7 Inflation declined in 2001 largely NOTE. Changes are based on quarterly averages and are measured to the fourth quarter of the year indicated because of a steep drop in energy prices. from the fourth quarter of the preceding year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

28 88th Annual Report, 2001 over the first half of the year, retail large increases in livestock prices— gasoline prices increased at an annual especially beef. But these prices softrate of 8 percent during that period. The ened later in the year under the influsizable increase in margins on gasoline ence of higher supplies, lower domestic reflected both refinery disruptions and demand, and foreign outbreaks of mad low inventory levels going into the sum- cow disease, which apparently damped mer driving season. But gasoline prices demand for beef no matter where fell sharply thereafter as refineries came produced. back on line, imports of gasoline picked Excluding food and energy items, up, and crude oil prices moved consider- PCE prices rose 1.6 percent last year, a ably lower over the latter half of the small deceleration from its 1.9 percent year. In all, gasoline prices were down increase over 2000. That deceleration 19 percent over the year as a whole. was concentrated in prices of goods, Heating oil prices reflected crude oil with prices especially soft for motor developments more directly and vehicles and apparel. By contrast, prices declined sharply through most of the of many services continued to accelerate year. Meanwhile, spot prices of natural last year. In particular, shelter costs— gas peaked in January 2001 at the which include residential rent, the extraordinarily high level of nearly $10 imputed rent of owner-occupied housper million BTUs, and prices at the con- ing, and hotel and motel prices— sumer level continued to surge in the increased 4!/4 percent last year after havfirst few months of the year. These ing risen 3Vi percent in 2000. increases reflected the pressure from Standing somewhat in contrast to the ongoing strength in demand coupled small deceleration in core PCE prices, with unusually cold weather early last the core consumer price index (CPI) winter that left stocks at very low levels. increased 23A percent last year, about But the situation improved as expanded the same rate as in 2000. Although comsupply allowed stocks to be replenished: ponents of the CPI are key inputs of the Spot prices reversed those earlier PCE price index, the two price measures increases, and prices of consumer natu- differ in a variety of ways. One imporral gas declined substantially through tant difference is that the PCE measure the rest of the year. is broader in scope; it includes expendi- In contrast, electricity prices rose tures made by nonprofit institutions and through most of last year. The increases consumption of items such as checking reflected the effects of the earlier rises in services that banks provide without the prices of natural gas and coal on fuel explicit charge. Prices for the PCE catecosts of utilities as well as problems gories that are outside the scope of the with electricity generation in California. CPI decelerated notably in 2001 and California was able to avoid serious accounted for much of the differential power disruptions last summer because movements of inflation measured by the high electricity prices, weak economic two price indexes. Another difference is activity, and moderate weather all that the CPI places a larger weight on helped keep demand in check. housing than does the PCE price index, Consumer food prices increased more and last year's acceleration of housing rapidly last year, rising about 3 percent prices therefore boosted the CPI relative after having risen only 21/2 percent in to the PCE measure. 2000. Early in the year, strong demand, The leveling off or decline in core both domestic and foreign, led to consumer price inflation reflects a vari- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 29 ety of factors, including the weakening increased likelihood of federal budget of economic activity and the accompa- deficits and, except in the immediate nying slackening of resource utilization; aftermath of the terrorist attacks, by the decline in energy prices that reduced investors' optimism about future ecofirms' costs; and continuing intense nomic prospects. Despite this opticompetitive pressures in product mar- mism, the slowdown in final demand, a kets. These factors also likely helped slump in corporate earnings, and a to reduce inflation expectations late last marked deterioration in credit quality year, and this reduction itself may be of businesses in a number of sectors contributing to lower inflation. Accord- made investors more wary about risk. ing to the Michigan SRC, median one- Although interest rates on higher-rated year inflation expectations, which had investment- grade corporate bonds genheld near 3 percent through 2000 and erally moved in line with those on into last summer, moved down to comparably dated government securi- 23/4 percent in the third quarter and ties, lower-rated firms found credit to plummeted to 1 percent or lower in be considerably more expensive, as October and November. Falling energy risk spreads on speculative-grade debt prices and widespread reports of dis- soared for most of the year before narcounting following the September 11 rowing somewhat over the last few attacks likely played a role in causing months. Interest rates on commercial this sharp break in expectations. Part of paper and business loans fell last year this drop was reversed in December, and by about as much as the federal funds since then, inflation expectations have rate, but risk spreads generally remained remained around 2 percent—a rate still in the elevated range. In addition, comwell below the levels that had prevailed mercial banks tightened standards and earlier. Meanwhile, the Michigan SRC's terms for business borrowers throughout measure of longer-term inflation expec- the year. Equity prices were exceptiontations, which had also remained close ally volatile and fell further, on balance, to 3 percent through 2000 and the first in 2001. half of 2001, ticked down to 23A percent Increased caution on the part of lendin October and stood at that level early ers did not appear to materially damp this year. aggregate credit flows. Private borrowing was robust last year, especially when compared with the marked slowing in U.S. Financial Markets nominal spending. Relatively low longterm interest rates encouraged both busi- As a consequence of the Federal nesses and households to concentrate Reserve's aggressive easing of the borrowing in longer-term instruments, stance of monetary policy in 2001, inter- thereby locking in lower debt-service est rates on short- and intermediate-term obligations. The proceeds of long-term Treasury securities fell substantially borrowing were also used to strengthen over the course of the year. Longer-term balance sheets by building stocks of liq- Treasury bond yields, however, ended uid assets. A shift toward safer and more the year about unchanged, on balance. liquid asset holdings showed through in These rates had already fallen appre- rapid growth of M2, which was spurred ciably in late 2000 in anticipation of further by reduced short-term market monetary policy easing. They may also interest rates and elevated stock market have been held up last year by an volatility. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

30 88th Annual Report, 2001 Interest Rates and longer-term interest rates turned down again. Short-term market interest rates moved The terrorist attacks of September 11 down with the FOMC's cumulative cut dramatically redrew the picture of the in the target federal funds rate of nation's near-term economic prospects. 43/4 percentage points, and yields on Market participants lowered markedly intermediate-term Treasury securities their expected trajectory for the path of declined almost 2 percentage points. the federal funds rate in the immediate Longer-term interest rates had already aftermath of the attacks, and revisions to fallen in the latter part of 2000, when policy expectations, combined with coninvestors began to anticipate significant siderable flight-to-safety demands, cut policy easing in response to weakening short- and intermediate-term Treasury economic growth. As the FOMC aggresyields substantially over subsequent sively eased the stance of monetary poldays. The FOMC, confronted with eviicy during the winter and spring, invesdence of additional weakness in final tors' expectations of a prompt revival in demand and prices, eased policy further economic activity took hold and were over the balance of the year, and shortmanifested in a sharp upward tilt of term market interest rates continued to money market futures rates and an decline. In early November, however, appreciable rise in longer-term interest intermediate- and long-term interest rates over the second quarter. Howrates turned up, as it became apparent ever, signs of the anticipated economic that the economic fallout from the turnaround failed to materialize as attacks would be more limited than the summer progressed. Indeed, the some had originally feared, and as miliweakening in economic activity was tary success in Afghanistan bolstered becoming more widespread, which investors' confidence and moderated prompted expectations of further monesafe-haven demands. By the end of the tary policy easing over the near term, year, yields on intermediate-term Treasury securities had reversed about half of their post-September 11 decline, Rates on Selected Treasury Securities while yields on longer-term Treasury securities had risen enough to top their pre-attack levels. In early 2002, however, yields on intermediate- and longerterm Treasuries edged down again, as market participants trimmed their expectations for the strength of the economic rebound, and the Congress failed to move forward with additional fiscal stimulus. Yields on higher quality investmentgrade corporate bonds generally fol- Three-month \V_~ ^ lowed those on comparably dated Treasury securities last year, although risk spreads widened moderately before 2000 2001 2002 narrowing over the last few months. In contrast, interest rates on speculative- NOTE. The data are daily and extend through February 21, 2002. grade corporate debt increased steadily Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 31 in 2001, as risk spreads ballooned came to a halt at the end of the first in response to mounting signs of finan- quarter, with the Wilshire 5000—a very cial distress among weaker firms. Even broad index of stock prices—down with a considerable narrowing over about 13 percent, while the tech-heavy the final two months of the year, risk Nasdaq ended the first quarter at its spreads on below-investment-grade lowest level since 1998 and more than bonds remained quite wide. Spreads for 60 percent below its record high reached high-yield bonds edged down further in in March of 2000. 2002 after rising sharply in early Janu- Companies, especially in the technolary, when several important technology ogy sector, reported weak profits for the and telecommunications companies first quarter, but their announcements revised down their earnings forecasts or generally surpassed analysts' sharply released corrections to past earnings lowered expectations. With the 1 perstatements. Interest rates on commercial centage point reduction in the federal and industrial (C&I) loans at banks fell funds rate over March and April, inveslast year by about as much as the federal tors became more confident that an funds rate. According to the Federal improvement in economic conditions Reserve's quarterly Survey of Terms of was in train, and equity prices rallied; Business Lending, the spread over the the rebound was particularly strong for target federal funds rate of the average technology companies—the Nasdaq interest rate on C&I loans varied some- rose almost 40 percent between April what over the year, falling for a while and the end of May. The forward then rising sharply between August and momentum in equity markets was November; nonetheless, it has generally checked in June, however, in part remained in the elevated range that has because analysts slashed their estimates persisted since late 1998. The same sur- for near-term corporate earnings growth. vey also indicated that over the course Although the stock market initially of last year commercial banks, like other proved resilient in the face of the bleak lenders, have become especially cautious about lending to marginal credits, Major Stock Price Indexes as indicated by the average spread on riskier C&I loans not made under a pre- January 3, 2000 = 100 vious commitment, which soared in 2001. Equity Markets The exceptional volatility of equity prices in 2001 likely reflected the dra- 75 matic fluctuations in investors' assessment of the outlook for the economy and corporate earnings. Share prices 50 tumbled early last year, as pessimism Nasdaq and uncertainty about the direction of the economy were intensified by a spate 1 . , i , • , 1 of negative earnings announcements and 2000 2001 2002 profit warnings in February and March. NOTE. The data are daily and extend through Feb- The pronounced sell-off of equities ruary 21, 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

32 88th Annual Report, 2001 profit news, suggesting that weak earn- 10 percent, while the Nasdaq fell 20 perings had been largely anticipated by cent. The widespread decline in equity investors, the steady barrage of dismal prices through the first three quarters of economic news—particularly in the 2001 is estimated to have wiped out technology and telecommunications nearly $3!/2 trillion in household wealth, sectors—started to exert downward translating into 8V4 percent of total pressure on share prices by early household net worth. Of this total, how- August. The slide in stock prices intensi- ever, about $1V4 trillion was restored by fied in early September, with technology the stock market rally in the fourth quarstocks taking an exceptional drubbing. ter. Moreover, the level of household net By September 10, the Wilshire 5000 worth at the end of last year was still was down almost 10 percent from the almost 50 percent higher than it was at end of July, while the Nasdaq had lost the end of 1995, when stepped-up promore than 16 percent. ductivity gains had begun to induce The attacks on September 11, a Tues- investors to boost significantly their day, caused stock markets to shut down expectations of long-term earnings and to remain closed for the rest of that growth. In January and early February week. Trading resumed in an orderly of 2002, investors reacted to generally fashion on Monday, September 17, but disappointing news about expected earnthe day ended with the market as a ings, especially in the telecommunicawhole down about 5 percent—with air- tions sector, and to concerns about corline and hotel stocks pounded most— porate accounting practices by erasing and trading volume on the New York some of the fourth-quarter gain in equity Stock Exchange hitting a record high. prices. Despite this decline, the price- Major stock price indexes, which sagged earnings ratio for the S&P 500 index further in subsequent days and weeks, (calculated using operating earnings were weighed down by investors' more expected over the next year) remained pessimistic evaluation of the near-term close to its level at the beginning of economic outlook and by sizable down- 2001. The relatively elevated ratio ward revisions to analysts' earnings reflected lower market interest rates as projections for the rest of 2001. By the well as investor anticipation of a return third week of the month, broad stock to robust earnings growth. price indexes had fallen a total of 12 percent from their levels on Septem- Debt and Depository Intermediation ber 10. In late September, stock prices staged The growth of the debt of nonfederal a comeback that lasted through the sectors was strong over the first half of fourth quarter, as incoming information the year, as the decline in longer-term suggested that the economy had proven interest rates during the final months of remarkably resilient and economic pros- 2000 prompted some opportunistic tappects were improving. On the percep- ping of bond markets by businesses and tion that the worst for the technology helped keep the expansion of household sector would soon pass, share prices of credit brisk. However, the combination firms in technology industries jumped of a stepdown in the growth of consharply, lifting the Nasdaq more than sumer durables purchases, a further drop 35 percent from its September nadir. On in capital expenditures, and a substantial balance, last year's gyrations in stock inventory liquidation over the second prices left the Wilshire 5000 down about half of the year resulted in a signifi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 33 cantly slower pace of private borrowing. October, however, the disruptions to On balance, growth of nonfederal debt business financing patterns and payment retreated about 1 percentage point in systems that bloated bank balance sheets 2001, to IVi percent. Federal debt con- had largely dissipated, and loans continued to contract early last year; it then tracted sharply. turned up as the budget fell into a deficit Commercial banks reported a marked reflecting the implementation of the tax deterioration in loan performance last cut, the effect of the weaker economy year. Delinquency and charge-off rates on tax receipts, and emergency spending on C&I loans trended up appreciably, in the wake of the terrorist attacks. As although they remained well below rates a result, the federal government paid recorded during the 1990-91 recession. down only 11A percent of its debt, on Delinquency rates on credit card net, over 2001, compared with 63A per- accounts increased for the second year cent in the previous year. With nominal in a row, reaching 5 percent for the first GDP decelerating sharply, the ratio of time since early 1992. Banks responded nonfinancial debt to GDP moved up to the deteriorating business and housenotably in 2001, more than reversing its hold balance sheets by tightening credit decrease in the previous year. standards and terms for both types of The economic slowdown and the loan, according to the Federal Reserve's decline in market interest rates last year Senior Loan Officer Opinion Survey on left a noticeable imprint on the composi- Bank Lending Practices. Banks indition of financial flows, with borrowing cated that they had tightened business by businesses and households migrating lending policies in response to greater toward longer-term bond and mortgage uncertainty about the economic outlook markets. As a consequence, credit at and their reduced tolerance for risk. depository institutions expanded slug- Similarly, the net fractions of banks gishly over the year. Growth of loans at reporting that they had tightened stancommercial banks dropped off sharply, dards for both credit card and other confrom 12 percent in 2000 to 2VA per- sumer loans rose markedly over the first cent in 2001. The slowdown in total half of last year. As household financial bank credit—after adjustments for conditions continued to slip, the net promark-to-market accounting rules—was portion of banks that tightened stanless severe, because banks acquired dards on consumer loans remained at an securities, largely mortgage-backed elevated level in the second half of the securities, at a brisk pace throughout the year. year. A healthy banking sector served as In response to rising levels of delinan important safety valve for several quent and charged-off loans, commerweeks after September 11, as businesses cial banks significantly boosted the rate tapped backup lines of credit to over- of provisioning for loan losses last year, come problems associated with the which, along with reduced income from repayment of maturing commercial capital market activities, cut into the paper and issuance of new paper. More- banking sector's profits. Nonetheless, over, with payment flows temporarily through the third quarter of 2001— interrupted by the terrorist attacks, a the latest period for which Call Report substantial volume of overdrafts was data are available—measures of induscreated, causing a spike in the "other" try profitability remained near the loan category that includes loans to elevated range recorded for the past sevdepository institutions. By the end of eral years, and banks continued to hold Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

34 88th Annual Report, 2001 substantial capital to absorb losses. assets, especially for its liquid deposits Indeed, virtually all assets were at well- (the sum of checking and savings capitalized banks at the end of the third accounts) and retail money funds comquarter, and the substitution of securities ponents. Moreover, negative returns and for loans on banks' balance sheets also elevated volatility in equity markets helped edge up risk-based capital ratios. likely raised household demand for M2 In the fourth quarter, a number of large assets through the fall. An unprecbanks saw their profits decline further edented level of mortgage refinancing because of their exposure to Enron and, activity (which results in prepayments to a lesser extent, Argentina. On the that temporarily accumulate in deposit positive side, wider net interest margins accounts before being distributed to helped support profits throughout 2001. investors in mortgage-backed securities), as well as increased foreign demand for U.S. currency, also bolstered The Monetary Aggregates the growth of M2 over the course of the The broad monetary aggregates grew year. very rapidly in 2001. Over the four quar- Involuntary accumulation of liquid ters of the year, M2 increased 1014 per- deposits resulting from payment system cent, a rate significantly above the pace disruptions after the terrorist attacks, of the past several years. Because the combined with elevated safe-haven rates of return provided by many com- demands, caused M2 to surge tempoponents of M2 move sluggishly, the rarily in the weeks following Septemswift decline in short-term market inter- ber 11. At the same time, plunging est rates last year significantly lowered equity prices led to a sharp step-up the opportunity cost of holding M2 in the growth of retail money market mutual funds. After a substantial unwinding of distortions to money flows M2 Growth Rate in October, M2 growth over the balance of the year was spurred by further Percent declines in its opportunity cost resulting from additional monetary policy easings and by heightened volatility in equity markets. The hefty advance in M2 last 8 year outpaced the anemic expansion of nominal income, and M2 velocity—the — 6 ratio of nominal GDP to M2—posted a record decline. M3—the broadest monetary aggregate—grew 13 percent over 2001. In addition to the surge in its M2 component, huge inflows into institutional money funds boosted M3 growth. Inves- 1991 1993 1995 1997 1999 2001 tors' appetite for these instruments was enormous last year because their returns NOTE. M2 consists of currency, travelers checks, demand deposits, other checkable deposits, savings were unusually attractive as they lagged deposits (including money market deposit accounts), the steep decline in market interest rates. small-denomination time deposits, and balances in The slow-down in the growth of bank retail money market funds. Annual growth rates are computed from fourth-quarter averages. credit over the summer, which resulted Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 35 in a contraction in managed liabilities, expect economic recovery, thereby supdamped the rise in M3 somewhat. The porting long-term interest rates. Followvelocity of M3 dropped for the seventh ing the terrorist attacks in September, year in the row, to a record low. interest rates declined around the globe as expected economic activity weakened and demand shifted away from International Developments equities and toward the relative safety of Economic activity in foreign economies bonds. However, toward year-end, as the weakened substantially in 2001. Early in period of crisis passed, long-term interthe year, activity abroad was depressed est rates rebounded strongly. by high oil prices, the global slump in Overall stock indexes in foreign the high-tech sector, and spillover from industrial economies declined for the the U.S. economic slowdown. The Sep- second consecutive year as activity faltember terrorist attacks further height- tered and actual and projected corporate ened economic uncertainty. On average, earnings fell sharply. Technologyforeign economic activity was about flat oriented stock indexes again fell more over the year. The weakest performer than the overall indexes. Among emergamong industrial economies was Japan, ing market economies, the performance where output declined. The euro area of stocks was mixed; stock indexes in eked out a slight increase in its real several Asian emerging market econo- GDP. Activity in most emerging market mies rebounded strongly late in the year, economies in both Asia and Latin a move possibly reflecting market par- America declined. Asian developing ticipants' hopes for a revival in global economies were particularly hard hit by demand for the high technology prodthe falloff in demand for their high-tech ucts that feature prominently in these exports. In Latin America, the output countries' exports. Argentine financial decline in Mexico largely reflected markets came under increasing pressure sharply reduced export demand from the United States; Argentina's financial crisis precipitated a further sharp drop Foreign Equity Indexes in output in that country. An easing of January1999= 100 average foreign inflation reflected the weakness of activity as well as a net decline in global oil prices over the — A Latin America 200 / 1 A course of the year. — 1 175 In response to the pronounced weakness in economic activity, monetary hxJ 150 authorities in the major industrial counin tries eased policy throughout the year. — 125 Nevertheless, interest rates on long-term 4government securities showed little net 100 change from the beginning to the end of Developing Asia v""^^__ the year in most major industrial coun- V— 75 Japan tries. Weak economic conditions tended i I i 1 i i f ! i i i to put downward pressure on long-term 1999 2000 2001 2002 rates, but moves toward more stimulative macroeconomic policies appeared NOTE. The data are monthly. The last observations are the average of trading days through February 21, to encourage market participants to 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

36 88th Annual Report, 2001 throughout the year because of growing ing U.S. economic performance in the fears of a debt default and the end of the near term. The dollar's average foreign peso's peg to the dollar. Near year-end, exchange value against the currencies of Argentine authorities in fact suspended other major industrial countries recorded debt payments to the private sector and, a net increase of 8 percent over 2001 as early in 2002, ended the one-to-one peg a whole. The dollar also strengthened, to the dollar. There was limited negative but by a lesser amount, against the curspillover to other emerging financial rencies of our most important developmarkets from the sharp deterioration in ing country trading partners. So far this Argentina's economic and financial con- year, the dollar's average value has risen dition, in contrast to the situation that further on balance. prevailed during other emerging market financial crises of recent years. Industrial Economies The dollar's average foreign exchange value remained strong through The dollar showed particular strength most of 2001. The dollar continued to against the Japanese yen last year, rise despite mounting evidence of weak- appreciating nearly 15 percent. The ening U.S. economic activity and the weakness of the yen reflected serious significant easing of monetary policy ongoing structural problems and the by the FOMC. Market participants may relapse of the Japanese economy back have felt that the falloff in economic into recession. Early in the year, in growth in foreign economies and expec- response to signs of renewed weakening tations that the United States offered of the economy, the Bank of Japan stronger prospects for economic growth announced that it was easing policy by in the future outweighed disappoint- shifting its operating target from the overnight rate—already not far above zero—to balances held by financial Nominal U.S. Dollar Exchange Rate Indexes institutions at the Bank of Japan. Policy was eased further and more liquidity January 1999= 100 was injected into the banking system when the balances target was raised Major currencies — 115 three times later in the year. The yen received a temporary boost when Junichiro Koizumi, widely seen as more — 110 likely to introduce economic reforms, became prime minister in April. The yen — 105 again strengthened in the immediate wake of the September terrorist attacks, prompting the Bank of Japan to make Broad -— 100 substantial intervention sales of yen. However, later in the year, amid signs of a renewed deterioration of economic 1999 2000 2001 2002 conditions, the yen again started to weaken significantly. NOTE. The data are monthly. Indexes are tradeweighted averages of the exchange value of the dollar For the year as a whole, Japanese real against major currencies and against the currencies of GDP is estimated to have declined more a broader group of important U.S. trading partners. than 1 percent, a reversal of the rebound Last observations are the average of trading days through February 21, 2002. recorded the previous year. Private Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 37 investment declined and private con- pants appeared to revise downward their sumption moved lower, as households expectation of an early U.S. recovery. curtailed spending in the face of rising Then, later in the year, with more signs unemployment and falling real income. of a further weakening of activity in The winding-down of the large-scale Europe, the euro again declined. On balpublic works programs of recent years ance, the dollar appreciated more than more than offset the effect on growth 5 percent relative to the euro over the from the additional spending contained course of the year. Real GDP in the euro in several supplemental budgets. Last area is estimated to have increased at year marked the third consecutive year less than a 1 percent rate in 2001, a of deflation, with the prices of both con- sharp slowing from the nearly 3 percent sumer goods and real estate continuing growth rate of the previous year. Fixed to move lower. investment and inventory investment The dollar's movements against the both are estimated to have made negaeuro in 2001 appear to have been mainly tive contributions to the growth of real influenced by market perceptions of the GDP, whereas consumption growth strength of economic activity in the remained near the rate of the previous United States relative to that in the euro year. The slowing of growth in the euro area. In the early part of the year, the area was not uniform across countries, euro weakened as evidence mounted with weakness being more pronounced that the economic slowdown that was in Germany and less so in France. already apparent in the United States as The European Central Bank (ECB) the year began was also taking hold in held off easing monetary policy in the Europe. During the summer, the euro early months of the year, restrained by rose against the dollar as market partici- the euro's weakness, growth of M3 that remained in excess of the ECB's reference value, and a euro-area inflation rate U.S. Dollar Exchange Rate against the Euro above its 2 percent target ceiling. In and the Japanese Yen May, evidence of slowing activity prompted the ECB to reduce its key January 1999= 100 policy rate 25 basis points. Three additional reductions followed later in the year, as activity weakened further and the inflation rate receded toward its target ceiling. The total reduction in the ECB's key policy rate over the course of the year was 150 basis points. The — 110 beginning of 2002 saw the introduction of euro notes and coins, a process that — 100 proceeded smoothly. Japanese yen The dollar appreciated 6 percent — 90 against the Canadian dollar in 2001 as the Canadian economy slowed abruptly. i i i 1 Real GDP in Canada is estimated to 1999 2000 2001 2002 have been about flat last year after NOTE. The data are monthly. Exchange rates are in growing more than 3 percent in 2000. A foreign currency units per dollar. Last observations key factor in this slowing was the sharp are the average of trading days through February 21, 2002. drop-off in Canadian exports to the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

38 88th Annual Report, 2001 United States. An inventory correction in the year; financial asset prices fell also depressed output. Earlier in the sharply, and funds moved out of the year, consumption was buoyed by con- banking system as the government tinued employment growth, tax cuts, and moved to restructure its debt and the a housing boom. However, later in the one-to-one peg to the dollar looked year, growth of consumption faltered as increasingly precarious. In early Decememployment prospects worsened and ber, the government imposed capital asset prices weakened. The Bank of controls, including limits on bank Canada has moved aggressively to account withdrawals. These restrictions counter the slowing of economic activ- led to widespread protests, which trigity by lowering its key policy interest gered the resignation of President de la rate nine times in 2001 and once in Rua and an interval of political turmoil. January 2002 for a cumulative total of After the resignation of President de la 375 basis points.3 When the Bank of Rua, the government announced it Canada initiated easing moves early in would suspend debt payments to the pri- 2001, inflation was slightly above the vate sector. The government of the new Bank's target range of 1 percent to president, Eduardo Duhalde, suspended 3 percent; but by the end of the year, Argentina's currency board arrangement slack activity and falling energy prices and established a temporary dual had pushed the inflation rate down to exchange rate system. In early February, near the bottom of the range. the dual exchange rate system was abandoned, and the peso's floating rate moved to about 2 pesos per dollar amid Emerging Market Economies continuing economic uncertainty. For 2001 as a whole, Argentine real GDP is Argentina was a main focus of attention estimated to have fallen at well over a among emerging market economies in 5 percent rate, and prices declined 2001. In the first part of the year, further. worse-than-expected data on the fiscal To date, the negative spillover from situation and concerns that the governevents in Argentina to other emerging ment would be unable to implement financial markets has been limited, posannounced fiscal measures heightened sibly because market participants had doubts about whether Argentina would been well aware of Argentina's probbe able to avoid a default on its debt. lems for some time and viewed them as Argentine financial markets received largely confined to that country. Brazil only temporary support from a largewas probably most heavily affected by scale debt exchange completed in June events in Argentina, and the bond spread and an enhancement of IMF support on Brazilian debt showed a net increase approved in September. With financial of about 110 basis points over the course market confidence eroding, conditions of last year while the spread on Argentook a dramatic turn for the worse late tina debt exploded upward. Other important factors weighing on Brazilian economic activity last year likely were 3. Among these reductions was one on Septem- weak growth in the United States— ber 17, when the Bank of Canada (along with the Brazil's most important export market— ECB) announced a reduction of its policy rate by and the emergence of an energy short- 50 basis points, following the 50 basis point reducage as drought limited hydroelectric tion in the federal funds rate announced by the FOMC earlier in the day. output. For the year as a whole, Brazil- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2001 and Early 2002 39 ian real GDP is estimated to have risen had fueled rapid export growth in the at less than a 1 percent rate after grow- region in recent years. ing at a 4 percent rate the previous two The economies of Taiwan, Singapore, years. The Brazilian currency registered and Malaysia are highly dependent on a net depreciation against the dollar of exports of semiconductors and other about 16 percent over the course of last high-tech products, and as global year, while stock prices declined more demand for these goods was cut back than 10 percent. The Brazilian central sharply, real GDP in these countries bank tightened policy last year in an declined by an estimated 5 percent on effort to hold down the inflationary average last year. Indonesia and Thaiimpact of currency depreciation. land, both relatively less dependent on Real GDP in Mexico declined about high-tech exports and experiencing 1 percent in 2001, a sharp reversal from some reduction in political tension over the 5 percent growth rates recorded in the course of the year, managed to the previous two years. The falloff in record small positive real GDP growth activity was mainly a reflection of the rates last year, albeit well below rates of negative effects on direct trade and con- the previous year. fidence in Mexico arising from the slow- Korean real GDP is estimated to have down of the U.S. economy. In light of increased about 2 percent in 2001. the marked weakening of activity, While in an absolute sense Korea is an declining inflation, and a strong peso, important exporter of high-tech prodthe Bank of Mexico started to loosen the ucts such as semiconductors, it has a stance of monetary policy in May, and relatively more diversified economy short-term interest rates continued to than most of its Asian neighbors, and decline over the rest of the year. In thus the magnitude of its slowdown last February 2002, the Bank of Mexico year was somewhat muted. Government moved to tighten monetary conditions, moves toward monetary and fiscal polciting concerns that an increase in icy stimulus over the course of the year administered prices would raise infla- helped support domestic demand in tion. Mexican financial markets fared Korea. quite well last year, with the peso appre- In China, recorded growth of real ciating 5 percent against the dollar and GDP remained robust last year. China's stock prices rising nearly 15 percent. lesser dependency on exports in general, The effect on Mexican financial markets and high-tech exports in particular, from Argentina's difficulties appeared cushioned it from last year's global to have been quite limited, as indicated slowdown, and the government stepped by the net decline of the Mexican debt up the pace of fiscal stimulus to offset spread by 80 basis points over the weakening private demand. Hong Kong, course of the year. with exports not heavily concentrated Economic growth in the Asian emerg- in high-tech goods and an economy ing market economies turned negative closely integrated with a rapidly growlast year. On average, real GDP in ing Chinese economy, is nevertheless developing Asia is estimated to have estimated to have experienced a decline declined about 1 percent in 2001, com- in real GDP last year. The peg of Hong pared with average growth of 6 percent Kong's currency to a strengthening U.S. in the previous year. A key factor in this dollar put pressure on its competitive slowing was the sharp falloff in global position, and domestic price deflation demand for the high-tech products that continued. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

40 88th Annual Report, 2001 Conditions in financial markets in for the region as a whole, exchange rates emerging Asia were, for the most part, against the dollar generally moved not particularly volatile last year. Debt lower, and stock indexes declined somespreads were little changed on average what on average. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

41 Monetary Policy Reports to the Congress Report submitted to the Congress on their highs earlier in the year, slumped February 13, 2001, pursuant to sec- sharply starting in September, slicing tion 2B of the Federal Reserve Act away a portion of household net worth and discouraging the initial offering of new shares by firms. Many businesses encountered tightening credit Report of February 13, 2001 conditions, including a widening of risk spreads on corporate debt issuance and bank loans. Foreign economic activity Monetary Policy and the decelerated noticeably in the latter part Economic Outlook of the year, contributing to a weakening When the Federal Reserve submitted its of the demand for U.S. exports, which previous Monetary Policy Report to the also was being restrained by an earlier Congress, in July of 2000, tentative appreciation in the exchange value of signs of a moderation in the growth the U.S. dollar. of economic activity were emerging The dimensions of the economic following several quarters of extraor- slowdown were obscured for a time by dinarily rapid expansion. After having the usual lags in the receipt of economic increased the interest rate on federal data, but the situation began to come funds through the spring to bring the into sharper focus late in the year as growth of aggregate demand and poten- the deceleration steepened. Spending on tial supply into better alignment and business capital, which had been risthus contain inflationary pressures, the ing rapidly for several years, elevating Federal Reserve had stopped tightening stocks of these assets, flattened abruptly as evidence of an easing of economic in the fourth quarter. Consumers growth began to appear. clamped down on their outlays for motor Indications that the expansion had vehicles and other durables, the stocks moderated from its earlier rapid pace of which also had climbed to high gradually accumulated during the sum- levels. As the demand for goods softmer and into the autumn. For a time, this ened, manufacturers adjusted producdownshifting of growth seemed likely to tion quickly to counter a buildup leave the economy expanding at a pace in inventories. Rising concern about roughly in line with that of its potential. slower growth and worker layoffs con- Over the last few months of the year, tributed to a sharp deterioration of conhowever, elements of economic restraint sumer confidence. In response to the emerged from several directions to slow accumulating weakness, the Federal growth even more. Energy prices, rather Open Market Committee (FOMC) lowthan turning down as had been antici- ered the intended interest rate on federal pated, kept climbing, raising costs funds Vi percentage point on January 3 throughout the economy, squeezing of this year. Another rate reduction of business profits, and eroding the income that same size was implemented at the available for discretionary expendi- close of the most recent meeting of the tures. Equity prices, after coming off FOMC at the end of last month. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

42 88th Annual Report, 2001 As weak economic data induced ment of low and stable underlying inflainvestors to revise down their expecta- tion suggest that the longer-run outlook tions of future short-term interest rates for the economy is still quite favorable, in recent months and as the Federal even though downside risks may remain Reserve eased policy, financial market prominent in the period immediately conditions became more accommoda- ahead. tive. Since the November FOMC meeting, yields on many long-term corporate bonds have dropped on the order of a Monetary Policy, Financial full percentage point, with the largest Markets, and the Economy declines taking place on riskier bonds as over the Second Half of 2000 the yield spreads on those securities narand Early 2001 rowed considerably from their elevated levels. In response, borrowing in long- As described in the preceding Monetary term credit markets has strengthened Policy Report to the Congress, the very appreciably so far in 2001. The less rapid pace of economic growth over restrictive conditions in financial mar- the first half of 2000 was threatening kets should help lay the groundwork for to place additional strains on the econoa rebound in economic growth. my's resources, which already appeared That rebound should also be encour- to be stretched thin. Private long-term aged by underlying strengths of the interest rates had risen considerably in economy that still appear to be present response to the strong economy, and, in despite the sluggishness encountered of an effort to slow the growth of aggregate late. The most notable of these strengths demand and thereby prevent a buildup is the remarkable step-up in structural of inflationary pressures, the Federal productivity growth since the mid- Reserve had tightened its policy settings 1990s, which seems to be closely related substantially through its meeting in to the spread of new technologies. Even May 2000. Over subsequent weeks, preas the economy slowed in 2000, evi- liminary signs began to emerge suggestdence of ongoing efficiency gains were ing that growth in aggregate demand apparent in the form of another year of might be slowing, and at its June meetrapid advance in output per worker hour ing the FOMC left the federal funds rate in the nonfarm business sector. With unchanged. households and businesses still in the Further evidence accumulated over process of putting recent innovations the summer to indicate that demand in place and with technological break- growth was moderating. The rise in throughs still occurring, an end to profit- mortgage interest rates over the preable investment opportunities in the vious year seemed to be damping activtechnology area does not yet seem to ity in the housing sector. Moreover, be in sight. Should investors continue the growth of consumer spending had to seek out emerging opportunities, the slowed from the exceptional pace of earongoing transformation and expansion lier in the year; the impetus to spending of the capital stock will be maintained, from outsized equity price gains in 1999 thereby laying the groundwork for fur- and early 2000 appeared to be partly ther gains in productivity and ongoing wearing off, and rising energy prices advances in real income and spending. were continuing to erode the purchasing The impressive performance of produc- power of households. By contrast, busitivity and the accompanying environ- ness fixed investment still was increas- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

42 88th Annual Report, 2001 As weak economic data induced ment of low and stable underlying inflainvestors to revise down their expecta- tion suggest that the longer-run outlook tions of future short-term interest rates for the economy is still quite favorable, in recent months and as the Federal even though downside risks may remain Reserve eased policy, financial market prominent in the period immediately conditions became more accommoda- ahead. tive. Since the November FOMC meeting, yields on many long-term corporate bonds have dropped on the order of a Monetary Policy, Financial full percentage point, with the largest Markets, and the Economy declines taking place on riskier bonds as over the Second Half of 2000 the yield spreads on those securities narand Early 2001 rowed considerably from their elevated levels. In response, borrowing in long- As described in the preceding Monetary term credit markets has strengthened Policy Report to the Congress, the very appreciably so far in 2001. The less rapid pace of economic growth over restrictive conditions in financial mar- the first half of 2000 was threatening kets should help lay the groundwork for to place additional strains on the econoa rebound in economic growth. my's resources, which already appeared That rebound should also be encour- to be stretched thin. Private long-term aged by underlying strengths of the interest rates had risen considerably in economy that still appear to be present response to the strong economy, and, in despite the sluggishness encountered of an effort to slow the growth of aggregate late. The most notable of these strengths demand and thereby prevent a buildup is the remarkable step-up in structural of inflationary pressures, the Federal productivity growth since the mid- Reserve had tightened its policy settings 1990s, which seems to be closely related substantially through its meeting in to the spread of new technologies. Even May 2000. Over subsequent weeks, preas the economy slowed in 2000, evi- liminary signs began to emerge suggestdence of ongoing efficiency gains were ing that growth in aggregate demand apparent in the form of another year of might be slowing, and at its June meetrapid advance in output per worker hour ing the FOMC left the federal funds rate in the nonfarm business sector. With unchanged. households and businesses still in the Further evidence accumulated over process of putting recent innovations the summer to indicate that demand in place and with technological break- growth was moderating. The rise in throughs still occurring, an end to profit- mortgage interest rates over the preable investment opportunities in the vious year seemed to be damping activtechnology area does not yet seem to ity in the housing sector. Moreover, be in sight. Should investors continue the growth of consumer spending had to seek out emerging opportunities, the slowed from the exceptional pace of earongoing transformation and expansion lier in the year; the impetus to spending of the capital stock will be maintained, from outsized equity price gains in 1999 thereby laying the groundwork for fur- and early 2000 appeared to be partly ther gains in productivity and ongoing wearing off, and rising energy prices advances in real income and spending. were continuing to erode the purchasing The impressive performance of produc- power of households. By contrast, busitivity and the accompanying environ- ness fixed investment still was increas- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 43 ing very rapidly, and strong growth of meeting. While recognizing that the foreign economies was fostering greater risks in the outlook were shifting, the demand for U.S. exports. Weighing this FOMC believed that the tautness of evidence and recognizing that the effects labor markets and the rise in energy of previous tightenings had not yet been prices meant that the balance of those fully felt, the FOMC decided at its risks still was weighted toward heightmeeting in August to hold the federal ened inflation pressures, and this assessfunds rate unchanged. The Committee ment was noted in the balance-of-risks remained concerned that demand could statement. continue to grow faster than potential By the time of the November FOMC supply at a time when the labor market meeting, conditions in the financial marwas already taut, and it saw the balance kets were becoming less accommodaof risks still tilted toward heightened tive in some ways, even as the Federal inflation pressures. Reserve held the federal funds rate The FOMC faced fairly similar cir- steady. Equity prices had declined cumstances at its October meeting. By considerably over the previous several then, it had become more apparent months, resulting in an erosion of that the growth in demand had fallen household wealth that seemed likely to to a pace around that of potential sup- restrain consumer spending going forply. Although consumer spending had ward. Those price declines, along with picked up again for a time, it did not the elevated volatility of equity prices, regain the vigor it had displayed earlier also hampered the ability of firms to in the year, and capital spending, while raise funds in equity markets and were still growing briskly, had decelerated likely discouraging business investment. from its first-half pace. With increases Some firms faced more restrictive conin demand moderating, private employ- ditions in credit markets as well, as risk ment gains slowed from the rates seen spreads in the corporate bond market earlier in the year. However, labor mar- widened significantly for firms with kets remained exceptionally tight, and lower credit ratings and as banks tightthe hourly compensation of workers had ened the standards and terms on their accelerated to a point at which unit labor business loans. Meanwhile, incoming costs were edging up despite strong data indicated that the pace of economic gains in productivity. In addition, siz- activity had softened a bit further. Still, able increases in energy prices were the growth of aggregate demand apparpushing broad inflation measures above ently had moved only modestly below the levels of recent years. Although core that of potential supply. Moreover, while inflation measures were at most only crude oil prices appeared to be topping creeping up, the Committee felt that out, additional inflationary pressures there was some risk that the increase in were arising in the energy sector in the energy prices, which was lasting longer form of surging prices for natural gas, than had seemed likely earlier in the and there had been no easing of the year, would start to leave an imprint on tightness in the labor market. In assessbusiness costs and longer-run inflation ing the evidence, the members of the expectations, posing the risk that core Committee felt that the risks to the outinflation rates could rise more substan- look were coming into closer balance tially. Weighing these considerations, but had not yet shifted decisively. At the the FOMC decided to hold the federal close of the meeting, the FOMC left the funds rate unchanged at its October funds rate unchanged once again, and it Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

44 88th Annual Report, 2001 stated that the balance of risks continued that an intermeeting policy action was to point toward increased inflation. called for. However, in the statement released after Additional evidence that economic the meeting, the FOMC noted the possi- activity was slowing significantly bility of subpar growth in the economy emerged not long after the December in the period ahead. meeting. New data indicated a marked Toward the end of the year, the mod- weakening in business investment, and eration of economic growth gave way, retail sales over the holiday season fairly abruptly, to more sluggish con- were appreciably lower than businesses ditions. By the time of the December had expected. To contain the resulting FOMC meeting, manufacturing activity buildup in inventories, activity in the had softened considerably, especially in manufacturing sector continued to drop. motor vehicles and related industries, In addition, forecasts of near-term corand a number of industries had accu- porate profits were being marked down mulated excessive stocks of inventories. further, resulting in additional declines Across a broader set of firms, forecasts in equity prices and in business confifor corporate sales and profits in the dence. Market interest rates continued to fourth quarter and in 2001 were being fall, as investors became more pessimisslashed, contributing to a continued tic about the economic outlook. Based decline in equity prices and a further on these developments, the Committee widening of risk spreads on lower-rated held a telephone conference call on corporate bonds. In this environment, January 3, 2001, and decided to cut growth in business fixed investment the intended federal funds rate Vi perappeared to be slowing appreciably. centage point. Equity prices surged on Consumer spending showed signs of the announcement, and the Treasury decelerating further, as falling stock yield curve steepened considerably, prices eroded household wealth and con- apparently because market participants sumer confidence weakened. Moreover, became more confident that a prolonged growth in foreign economies seemed to downturn in economic growth would be slowing, on balance, and U.S. export likely be forestalled. Following the polperformance began to deteriorate. Mar- icy easing, the Board of Governors ket interest rates had declined sharply in approved a decrease in the discount rate response to these developments. Against of a total of Vi percentage point. this backdrop, the FOMC at its Decem- The Committee's action improved ber meeting decided that the risks to the financial conditions to a degree. Over outlook had swung considerably and the next few weeks, equity prices rose, now were weighted toward economic on net. Investors seemed to become less weakness, although it decided to wait wary of credit risk, and yield spreads for additional evidence on the extent narrowed across most corporate bonds and persistence of the slowdown before even as the issuance of these securities moving to an easier policy stance. Rec- picked up sharply. But in some other ognizing that the current position of respects, investors remained cautious, as the economy was difficult to discern evidenced by widening spreads in combecause of lags in the data and that mercial paper markets. Incoming data prospects for the near term were particu- pointed to further weakness in the manularly uncertain, the Committee agreed at facturing sector and a sharp decline in the meeting that it would be especially consumer confidence. Moreover, slower attentive over coming weeks to signs U.S. growth appeared to be spilling over Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 45 to several important trading partners. In ployment rate in the fourth quarter of late January, the FOMC cut the intended this year will be about 4!/2 percent, still federal funds rate V2 percentage point quite low by historical standards. while the Board of Governors approved The rate of economic expansion over a decrease in the discount rate of an the near term will depend importantly equal amount. Because of the significant on the speed at which inventory overerosion of consumer and business con- hangs that developed over the latter fidence and the need for additional part of 2000 are worked off. Gains in adjustments to production to work off information technology have no doubt elevated inventory levels, the FOMC enabled businesses to respond more indicated that the risks to the outlook quickly to a softening of sales, which continued to be weighted toward eco- has steepened the recent production cuts nomic weakness. but should also damp the buildup in inventories and facilitate a turnaround. The motor vehicle industry made some Economic Projections for 2001 progress toward reducing excess stocks Although the economy appears likely to in January owing to a combination of be sluggish over the near term, the mem- stronger sales and a further sharp cutbers of the Board of Governors and the back in assemblies. In other parts of Reserve Bank presidents expect stronger manufacturing, the sizable reductions conditions to emerge as the year in production late last year suggest that progresses. For 2001 overall, the central producers in general were moving tendency of their forecasts of real GDP quickly to get output into better aligngrowth is 2 percent to IVi percent, mea- ment with sales. Nevertheless, stocks at sured as the change from the fourth year-end were above desired levels in a quarter of 2000 to the fourth quarter of number of industries. 2001. With growth falling short of its Once inventory imbalances are potential rate, especially in the first half worked off, production should become of this year, unemployment is expected more closely linked to the prospects for to move up a little further. Most of the sales. Household and business expendigovernors and Reserve Bank presidents tures have decelerated markedly in are forecasting that the average unem- recent months, and uncertainties about Economic Projections for 2001 Percent Federal Reserve governors and Reserve Bank presidents Memo: Indicator 2000 actual Central Range tendency Change, fourth quarter to fourth quarter1 N Re o a m l i G na D l P G 2 DP 5 3 . . 9 5 3-y 2 4 -2 -5 -Y '/4 4 4 2- - 2 5 '/2 PCE chain-type price index 2.4 PA-2V2 VA-2V4 Average level, fourth quarter Civilian unemployment rate 4.0 4'/2-5 About 4Vi 1. Change from average for fourth quarter of 2000 to 2. Chain-weighted. average for fourth quarter of 2001. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

46 88th Annual Report, 2001 how events might unfold are consider- some degree and would leave more able. But, responding in part to the eas- discretionary income in the hands of ing of monetary policy, financial mar- households. kets are shifting away from restraint, How quickly investment spending and this shift should create a more starts to pick up again will depend not favorable underpinning to the expected only on the cost of finance but also on pickup in the economy as the year the prospective rates of return to capital. progresses. The sharp drop in mortgage This past year, expectations regarding interest rates since May of last year the prospects of some high-tech compaappears to have stemmed the decline nies clearly declined, and capital spendin housing activity; it also has enabled ing seems unlikely to soon regain the many households to refinance existing exceptional strength that was evident mortgages at lower rates, an action that in the latter part of the 1990s and for should free up cash for added spending. a portion of last year. From all indica- Conditions of business finance also have tions, however, technological advance eased to some degree. Interest rates on still is going forward at a rapid pace, investment-grade corporate bonds have and investment will likely pick up again recently fallen to their lowest levels in if, as expected, the expansion of the about IV2 years. Moreover, the premi- economy gets back on more solid footums required of bond issuers that are ing. Private analysts are still anticipating perceived to be at greater risk have high rates of growth in corporate earndropped back in recent weeks from the ings over the long-run, suggesting that elevated levels of late 2000. As credit the current sluggishness of the economy conditions have eased, firms have issued has not undermined perceptions of large amounts of corporate bonds so far favorable long-run fundamentals. in 2001. However, considerable caution The degree to which increases in is evident in the commercial paper mar- exports might help to support Ithe U.S. ket and among banks, whose loan offi- economy through a stretch of sluggishcers have reported a further tightening ness has become subject to greater of lending conditions since last fall. In uncertainty recently because foreign equity markets, prices have recently economies also seem to have decelerdropped in response to negative reports ated toward the end of last year. Howon corporate earnings, reversing the ever, the expansion of imports has gains that took place in January. slowed sharply, responding in part to the The restraint on domestic demand softening of domestic demand growth. from high energy prices is expected to In effect, some of the slowdown in ease in coming quarters. Natural gas demand in this country is being shifted prices have dropped back somewhat in to foreign suppliers, implying that the recent weeks as the weather has turned adjustments required of domestic promilder, and crude oil prices also are ducers are not as great as they otherwise down from their peaks. Although these would have been. prices could run up again in conjunction In adjusting labor input to the slowing with either a renewed surge in demand of the economy, businesses are facing or disruptions in supply, participants in conflicting pressures. Speedy adjustfutures markets are anticipating that ment of production and ongoing gains prices will be trending gradually lower in efficiency argue for cutbacks in labor over time. A fall in energy prices would input, but companies are also reluctant relieve cost pressures on businesses to to lay off workers that have been diffi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 47 cult to attract and retain in the tight 1999, it showed only a slight step-up in labor market conditions of the past few the rate of increase after excluding the years. In the aggregate, the balance that prices of food and energy. Unit labor has been struck in recent months has costs picked up moderately, adding to led, on net, to slower growth of employ- the cost pressures from energy, but the ment, cutbacks in the length of the aver- ability of businesses to raise prices was age workweek, and, in January of this restrained by the slowing of the econyear, a small increase in the unemploy- omy and the persistence of competitive ment rate. pricing conditions. Inflation is not expected to be a pressing concern over the coming year. Most The Household Sector of the governors and Reserve Bank presidents are forecasting that the rise Personal consumption expenditures in the chain-type price index for per- increased AV2 percent in real terms in sonal consumption expenditures will be 2000 after having advanced 5 percent in smaller than the price rise in 2000. The 1998 and 5Vi percent in 1999. A large central tendency of the range of fore- portion of last year's gain came in the casts is l3/4 percent to 2lA percent. Infla- first quarter, when consumption moved tion should be restrained this coming ahead at an unusually rapid pace. The year by an expected downturn in energy increase in consumer spending over the prices. In addition, the reduced pressure remainder of the year was moderate, on resources that is associated with the averaging about 3J/2 percent at an annual slowing of the economy should help rate. Consumer outlays for motor vehidamp increases in labor costs and prices. cles and parts surged to a record high early in 2000 but reversed that gain over the remainder of the year; sales of Economic and Financial vehicles tailed off especially sharply as Developments in 2000 the year drew to a close. Real consumer and Early 2001 purchases of gasoline fell during the The combination of exceptionally strong year in response to the steep run-up in growth in the first half of 2000 and gasoline prices. Most other broad catesubdued growth in the second half gories of goods and services posted sizresulted in a rise in real GDP of about able gains over the year as a whole, but 3!/2 percent for the year overall. Domes- results late in the year were mixed: Real tic demand started out the year with outlays for goods other than motor incredible vigor but decelerated there- vehicles eked out only a small gain in after and was sluggish by year-end. the fourth quarter, while real outlays for Exports surged for three quarters and consumer services rose very rapidly, not then faltered. In the labor market, only because of higher outlays for home growth of employment slowed over the heating fuels during a spell of colderyear but was sufficient to keep the than-usual weather but also because of unemployment rate around the lowest continued strength in real outlays for sustained level in more than thirty years. other types of services. Core inflation remained low in 2000 Changes in income and wealth proin the face of sharp increases in energy vided less support to consumption in prices. Although the chain-type price 2000 than in other recent years. Real index for personal consumption expen- disposable personal income rose about ditures (PCE) moved up faster than in 2!/4 percent last year after a gain of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

48 88th Annual Report, 2001 slightly more than 3 percent in 1999. two months ended in January. The Disposable income did not rise quite as marked shift in attitudes toward yearmuch in nominal terms as it had in 1999, end probably was brought on by a comand rising prices eroded a larger portion bination of developments, including the of the nominal gain. Meanwhile, the net weakness in the stock market over the worth of households turned down in latter part of the year and more frequent 2000 after having climbed rapidly for reports of layoffs. several years, as the effect of a decline Real outlays for residential investin the stock market was only partially ment declined about 2lA percent, on net, offset by a sizable increase in the value over the course of 2000, as construction of residential real estate. With the peak of new housing dropped back from the in stock prices not coming until the year elevated level of the previous year. was well under way, and with valuations Investment in housing was influenced having previously been on a sharp by a sizable swing in mortgage interest upward course for an extended period, rates as well as by slower growth of stock market wealth may well have employment and income and the downcontinued to exert a strong positive turn in the stock market. After having effect on consumer spending for several moved up appreciably in 1999, mortmonths after share values had topped gage rates continued to advance through out. As time passed, however, the impe- the first few months of 2000. By midtus to consumption from this source May, the average commitment rate on most likely diminished. The personal conventional fixed-rate mortgages was saving rate, which had dropped sharply above 8V2 percent, up roughly Wi perduring the stock market surge of pre- centage points from the level of a year vious years, fell further in 2000, but the earlier. New construction held up even rate of decline slowed, on average, after as rates were rising in 1999 and early the first quarter. 2000, but it softened in the spring of last Even with real income growth slow- year. Starts and permits for singleing and the stock market turning down, family houses declined from the first consumers maintained a high degree quarter to the third quarter. of optimism through most of 2000 But even as homebuilding activity regarding the state of the economy and was turning down, conditions in mortthe economic outlook. Indexes of senti- gage markets were moving back in a ment from both the University of Michi- direction more favorable to housing. gan Survey Research Center and the From the peak in May, mortgage interest Conference Board rose to new peaks rates fell substantially over the remainin the first quarter of the year, and the der of the year and into the early part of indexes remained close to those levels 2001, reversing the earlier increases. for several more months. Survey read- Sales of new homes firmed as rates ings on personal finances, general busi- turned down, and prices of new houses ness conditions, and the state of the continued to trend up faster than the labor market remained generally favor- general rate of inflation. Inventories of able through most of the year. As of unsold new homes held fairly steady late autumn, only mild softness could over the year and were up only moderbe detected. Toward year-end, however, ately from the lows of 1997 and 1998. confidence in the economy dropped With demand well-maintained and sharply. Both of the indexes of confi- inventories under control, activity stabidence showed huge declines over the lized. Starts and permits for single- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 49 family houses in the fourth quarter of and terms on consumer loans, particu- 2000 were up from the average for the larly non-credit-card loans, over the third quarter. past several months, perhaps because Households continued to borrow at a of some uneasiness about how the finanbrisk pace last year, with household debt cial position of households will hold up expanding an estimated &3A percent, as the pace of economic activity slows. well above the growth rate of disposable personal income. Consumer credit The Business Sector increased rapidly early in the year, boosted by strong outlays on durable Real business fixed investment rose goods; but as consumer spending cooled 10 percent in 2000 according to the later in the year, the expansion of con- advance estimate from the Commerce sumer credit slowed. For the year as a Department. Investment spending shot whole, consumer credit is estimated to ahead at an annual rate of 21 percent in have advanced more than iVi percent, the first quarter of the year; its strength up from the 7 percent pace of 1999. in that period came, in part, from high- Households also took on large amounts tech purchases that had been delayed of mortgage debt, which grew an esti- from 1999 by companies that did not mated 9 percent last year, reflecting the want their operating systems to be in a solid pace of home sales. state of change at the onset of the new With the rapid expansion of house- millennium. Expansion of investment hold debt in recent years, the household was slower but still relatively brisk in debt service burden has increased to lev- the second and third quarters, at annual els not seen since the late 1980s. Even rates of about 15 percent and 8 perso, with unemployment low and house- cent respectively. In the fourth quarter, hold net worth high, the credit quality of however, capital spending downshifted the household sector appears to have abruptly in response to the slowing deteriorated little last year. Personal economy, tightening financial condibankruptcy filings held relatively steady tions, and rising concern about the prosand remain well below their peak from pects for profits; the current estimate several years ago. Delinquency rates on shows real investment outlays having home mortgages, credit cards, and auto fallen at an annual rate of 1 Vi percent in loans have edged up in recent quarters that period. but are at most only slightly above their Fixed investment in equipment and levels of the fourth quarter of 1999. software was up 9Vi percent in 2000, Lenders did not appear to be signifi- with the bulk of the gain coming in the cantly concerned about the credit qual- first half of the year. Spending slowed to ity of the household sector for most of a rate of growth of about 5lA percent in last year, although some lenders have the third quarter and then declined in the become more cautious of late. Accord- fourth quarter. Business investment in ing to surveys of banks conducted by motor vehicles fell roughly 15 percent, the Federal Reserve, few commercial on net, during 2000, with the largest banks tightened lending conditions on portion of the drop coming in the fourth consumer installment loans and mort- quarter; the declines in real outlays on gage loans to households over the first larger types of trucks were particularly three quarters of 2000. However, the sizable. Investment in industrial equipmost recent survey indicates that a ment, tracking the changing conditions number of banks tightened standards in manufacturing, also fell in the fourth Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

50 88th Annual Report, 2001 quarter but was up appreciably for the mer suggested that some firms might be year overall. Investment in high-tech encountering a bit of backup in stocks equipment decelerated over the year but but that the problems were not severe was still expanding in the fourth quarter: overall. In the latter part of the year, Real outlays for telecommunications however, inventory-sales ratios turned equipment posted exceptionally large up, indicating that more serious overgains in the first half of the year, flat- hangs were developing. Responding to tened out temporarily in the third quar- the slowing of demand and the increases ter, and expanded again in the fourth. in stocks, manufacturers reduced output Spending on computers and peripherals in each of the last three months of the increased, in real terms, at an average year by successively larger amounts. rate of about 45 percent over the first Businesses also began to clamp down three quarters of the year but slowed on the flow of imports. Despite those abruptly to a 6 percent rate of expansion adjustments, stocks in a number of in the year's final quarter, the smallest domestic industries were likely well quarterly advance in several years. above desired levels as the year drew to Investment in nonresidential struc- a close. tures rose substantially in 2000, about The Commerce Department's com- 12x/2 percent in all, after having declined pilation of business profits currently 1% percent in 1999. Investment in fac- extends only through the third quarter tory buildings, which had fallen more of 2000, but these data show an evolvthan 20 percent in 1999 in an apparent ing pattern much like that of other ecoreaction to the economic disruptions nomic data. After having risen at an abroad and the associated softness in annual rate of more than 16 percent in demand for U.S. exports, more than the first half of the year, U.S. corporarecouped that decline over the course of tions' economic profits—that is, book 2000. Real outlays for office construc- profits with inventory and capital contion, which had edged down in 1999 sumption adjustments—slowed to less after several years of strong advance, than a 3 percent rate of growth in the got back on track in 2000, posting a gain third quarter. Profits from operations of about 13V2 percent. Real investment outside the United States continued to in commercial buildings other than increase rapidly in the third quarter. offices was little changed after moderate However, economic profits from domesgains in the two previous years. Spend- tic operations edged down in that period, ing on structures used in drilling for as solid gains for financial corporations energy strengthened in response to the were more than offset by a 4 percent rate surge in energy prices. of decline in the profits of nonfinancial Business inventory investment was corporations. Profits of nonfinancial subdued early in the year when final corporations as a share of their gross sales were surging; aggregate inventory- nominal output rose about Vi percentsales ratios, which have trended lower in age point in the first half of 2000 but recent years as companies became more reversed part of that gain in the third efficient at managing stocks, edged quarter. Earnings reports for the fourth down further. As sales moderated in quarter indicate that corporate profits subsequent months, production growth fell sharply in that period. did not decelerate quite as quickly, and Business debt expanded strongly over inventories began to rise more rapidly. the first half of 2000, propelled by Incoming information through the sum- robust capital spending as well as by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 51 share repurchases and cash-financed As concerns about risk mounted, merger activity. The high level of capital lenders became more cautious about expenditures outstripped internally gen- extending credit to some borrowers. An erated funds by a considerable margin increasingly large proportion of banks despite continued impressive profits. reported firming terms and standards To meet their borrowing needs, firms on business loans over the course of the tapped commercial paper, bank loans, year. In the corporate bond market, yield and corporate bonds in volume in the spreads on high-yield and lower-rated first quarter. The rapid pace of borrow- investment-grade bonds, measured relaing continued in the second quarter, tive to the ten-year swap rate, began although borrowers relied more heavily climbing sharply in September and by on bank loans and commercial paper to year-end were at levels well above those meet their financing needs in response seen in the fall of 1998. Lower-rated to a rise in longer-term interest rates. commercial paper issuers also had to Business borrowing slowed apprecia- pay unusually large premiums late in bly in the second half of the year. As the year, particularly on paper spanning economic growth moderated and profits the year-end. As financial conditions weakened, capital spending decelerated became more stringent, issuance of sharply. In addition, firms held down high-yield debt was cut back sharply in their borrowing needs by curbing their the fourth quarter, although investmentbuildup of liquid assets, which had been grade bond issuance remained strong. accumulating quite rapidly in previous Bank lending to businesses was also quarters. Borrowing may have been light at that time, and net issuance of deterred by a tightening of financial con- commercial paper came to a standstill. ditions for firms with lower credit rat- In total, the debt of nonfinancial busiings, as investors and lenders apparently nesses expanded at an estimated 5Vz perbecame more concerned about credit cent rate in the fourth quarter, less than risk. Those concerns likely were exacer- half the pace of the first half of the year. bated by indications that credit quality The slowdown in borrowing in the latter had deteriorated at some businesses. The part of the year damped the growth of default rate on high-yield bonds contin- nonfinancial business debt over 2000, ued to climb last year, reaching its high- although it still expanded an estimated est level since 1991. Some broader mea- 83/4 percent. sures of credit quality also slipped. The In early 2001, borrowing appears to amount of nonfinancial debt down- have picked up from its sluggish fourthgraded by Moody's Investor Services quarter pace. Following the easing of in 2000 was more than twice as large monetary policy in early January, yield as the amount upgraded, and the delin- spreads on corporate bonds reversed a quency rate on business loans at com- considerable portion of their rise over mercial banks continued to rise over the the latter part of 2000, with spreads on year. But while some firms were clearly high-yield bonds narrowing more than a having financial difficulties, many other percentage point. As yields declined, firms remained soundly positioned to corporate bond issuance picked up, and service their debt. Indeed, the ratio of even some below-investment grade net interest payments to cash flow for all issues were brought to the market. In nonfinancial firms moved only mod- contrast, investors in the commercial estly above the relatively low levels of paper market apparently became more recent years. concerned about credit risk, partly in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

52 88th Annual Report, 2001 response to the defaults of two Cali- mildly positive over the past couple of fornia utilities on some bonds and com- years. The consumption and investment mercial paper in mid-January related expenditures of state and local governto the difficulties in the electricity mar- ments rose about 2x/2 percent in 2000 ket in that state. After those defaults, after an unusually large increase of spreads between top-tier and second-tier 4x/4 percent in 1999. The slowdown in commercial paper widened further, and spending was mainly a reflection of a investors became more discriminating downshift in government investment in even within the top rating tier. Some structures, which can be volatile from businesses facing resistance in the com- year to year and had posted a large gain mercial paper market reportedly met in 1999. their financing needs by tapping backup Total federal spending, as reported in credit lines at banks. the unified budget, rose 5 percent in Growth in commercial mortgage fiscal year 2000, the largest increase debt slowed last year to an estimated in several years. A portion of the rise rate of 9lA percent, and issuance of stemmed from shifts in the timing of commercial-mortgage-backed securities some outlays in a way that tended to in 2000 fell back from its 1999 pace. boost the tally for fiscal 2000. But even Spreads on lower-rated commercial- allowing for those shifts, the rise in mortgage-backed securities over swap spending would have exceeded the rates widened by a small amount late in increases of other recent years. Outlays the year, and banks on net reported tight- accelerated for most major functions, ening their standards on commercial real including defense, health, social secuestate credit over the year. Nevertheless, rity, and income security. Of these, fundamentals in the commercial real spending on health—about threeestate market remain solid, and delin- fourths of which consists of outlays quency rates on commercial mortgages for Medicaid—recorded the biggest stayed around their historic lows. increase. Medicaid grants to the states were affected last fiscal year by increased funding for the child health The Government Sector insurance initiative that was passed in Real consumption and investment ex- 1997 and by a rise in the portion of penditures of federal, state, and local Medicaid expenses picked up by the fedgovernments, the part of government eral government. Spending on agriculspending that is included in GDP, rose ture rose very sharply for a third year only 1 lA percent in the aggregate during but not as rapidly as in fiscal 1999. The 2000. The increase was small partly ongoing paydown of debt by the federal because the consumption and invest- government led to a decline of nearly ment expenditures of the federal gov- 3 percent in net interest payments in ernment had closed out 1999 with a fiscal 2000 after a somewhat larger drop large increase in advance of the century in these payments in fiscal 1999. date change. Federal purchases in the Federal receipts increased 103/4 perfourth quarter of 2000 were about 1 per- cent in fiscal year 2000, the largest cent below the elevated level at year- advance in more than a decade. The end 1999. Abstracting from the bumps increase in receipts from taxes on the in the spending data, the underlying income of individuals amounted to more trend in real federal consumption and than 14 percent. In most recent years, investment outlays appears to have been these receipts have grown much faster Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 53 than nominal personal income as mea- its debt last year at an even faster pace sured in the national income and prod- than in recent years. As of the end of uct accounts. One important factor in fiscal 2000, the stock of marketable the difference is that rising levels of Treasury debt outstanding had fallen income and a changing distribution have about $500 billion from its peak in 1997. shifted more taxpayers into higher tax The existing fiscal situation and the brackets; another is an increase in reve- anticipation that budget surpluses would nues from taxes on capital gains and continue led the Treasury to implement other items that are not included in per- a number of debt management changes sonal income. Receipts from the taxa- during 2000, many designed to preserve tion of corporate profits also moved up the liquidity of its securities. In particusharply in fiscal 2000, rebounding from lar, the Treasury sought to maintain a small decline the previous fiscal year. large and regular offerings of new secu- With federal receipts rising much faster rities at some key maturities, because than spending, the surplus in the unified such attributes are thought to imporbudget rose to $236 billion in fiscal tantly contribute to market liquidity. 2000, nearly double that of fiscal 1999. In part to make room for continued The on-budget surplus, which excludes sizable auctions of new securities, the surpluses accumulating in the social Treasury initiated a debt buyback prosecurity trust fund, rose from essentially gram through which it can purchase zero in fiscal 1999 to $86 billion in debt that it previously issued. In total, fiscal 2000. Excluding net interest pay- the Treasury conducted twenty buyback ments, a charge resulting from past defi- operations in 2000, repurchasing a total cits, the surplus in fiscal 2000 was about of $30 billion par value of securities $460 billion. with maturities ranging from twelve to twenty-seven years. Those operations Federal saving, which is basically were generally well received and caused the federal budget surplus adjusted to little disruption to the market. Going conform to the accounting practices folforward, the Treasury intends to conduct lowed in the national income and prodtwo buyback operations per month and uct accounts, amounted to about 3Vi perexpects to repurchase about $9 billion cent of nominal GDP over the first three par value of outstanding securities in quarters of 2000. This figure has been each of the first two quarters of 2001. rising roughly 1 percentage point a year over the past several years. Mainly Despite conducting buybacks on that because of that rise in federal saving, scale, the Treasury had to cut back conthe national saving rate has been run- siderably its issuance of new securities. ning at a higher level in recent years To still achieve large sizes of individual than was observed through most of the issues at some maturities, the Treasury 1980s and the first half of the 1990s, implemented a schedule of regular even as the personal saving rate has reopenings—in which it auctions addiplunged. The rise in federal saving has tional amounts of a previously issued kept interest rates lower than they other- security instead of issuing a new one— wise would have been and has contrib- for its five-, ten-, and thirty-year instruuted, in turn, to the rapid growth of ments. Under that schedule, every other capital investment and the faster growth auction of each of those securities is a of the economy's productive potential. smaller reopening of the previously auc- The burgeoning federal budget sur- tioned security. At other maturities, the plus allowed the Treasury to pay down Treasury reduced the sizes of its two- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

54 88th Annual Report, 2001 year notes and inflation-indexed securi- pal market improved considerably last ties and eliminated the April auction year, with credit upgrades outnumbering of the thirty-year inflation-indexed downgrades by a substantial margin. bond. In addition, the Treasury recently The only notable exception was in the announced that it would stop issuing not-for-profit health care sector, where one-year bills following the February downgrades predominated. auction, after having cut back the frequency of new offerings of that security last year. The External Sector These reductions in the issuance of Trade and Current Account Treasury securities have caused the Federal Reserve to modify some of The current account deficit reached its procedures for obtaining securities at $452 billion (annual rate) in the third Treasury auctions, as described in detail quarter of 2000, or 4.5 percent of GDP, below. In addition, the Treasury made compared with $331 billion and 3.6 perchanges in the rules for auction par- cent for 1999. Most of the expansion ticipation by foreign and international in the current account deficit occurred monetary authority (FIMA) accounts, in the balance of trade in goods and which primarily include foreign central services. The deficit on trade in goods banks and governmental monetary enti- and services widened to $383 billion ties. The new rules, which went into (annual rate) in the third quarter from effect on February 1, 2001, impose lim- $347 billion in the first half of the year. its on the size of non-competitive bids Data for trade in October and Novemfrom individual FIMA accounts and on ber suggest that the deficit may have the total amount of such bids that will increased further in the fourth quarter. be awarded at each auction. These lim- Net payments on investments were a bit its will leave a larger pool of securities less during the first three quarters of available for competitive bidding at the 2000 than in the second half of 1999 auctions, helping to maintain the liquid- owing to a sizable increase in income ity and efficiency of the market. More- receipts from direct investment abroad. over, FIMA purchases will be subtracted U.S. exports of goods and services from the total amount of securities rose an estimated 7 percent in real terms offered, rather than being added on as during 2000. Exports surged during the they were in some previous instances, first three quarters, supported by a making the amount of funds raised at pickup in economic activity abroad that the auction more predictable. began in 1999. By market destination, State and local government debt U.S. exports were strongest to Mexico increased little in 2000. Gross issuance and countries in Asia. About 45 percent of long-term municipal bonds was well of U.S. goods exports were capital below the robust pace of the past two equipment, 20 percent were industrial years. Refunding offerings were held supplies, and roughly 10 percent each down by higher interest rates through were agricultural, automotive, conmuch of the year, and the need to raise sumer, and other goods. Based on data new capital was diminished by strong for October and November, real exports tax revenues. Net issuance was also are estimated to have declined in the damped by an increase in the retire- fourth quarter, reflecting in part a slowment of bonds from previous refunding ing of economic growth abroad. This activity. Credit quality in the munici- decrease was particularly evident in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 55 exports of capital goods, automotive Financial Account products, consumer goods, and agricultural products. The counterpart to the increased U.S. The quantity of imported goods and current account deficit in 2000 was services expanded rapidly during the an increase in net capital inflows. As first three quarters of 2000, reflecting in 1999, U.S. capital flows in 2000 the continuing strength of U.S. domestic reflected the relatively strong cyclical demand and the effects of past dollar position of the U.S. economy for most of appreciation on price competitiveness. the year and the global wave of corpo- Increases were widespread among trade rate mergers. Foreign private purchases categories. Based on data for October of U.S. securities were exceptionally and November, real imports of goods robust—well in excess of the record set and services are estimated to have risen in 1999. The composition of U.S. securionly slightly in the fourth quarter. Mod- ties purchased by foreigners continued erate increases in imported consumer the shift away from Treasuries as the and capital goods were partly offset by U.S. budget surplus, and the attendant declines in other categories of imports, decline in the supply of Treasuries, lowparticularly industrial supplies and auto- ered their yield relative to other debt. motive products, for which domestic Last year private foreigners sold, on net, demand had softened. The price of about $50 billion in Treasury securities, non-oil imports is estimated to have compared with net sales of $20 billion increased by less than 1 percent during in 1999. Although sizable, these sales 2000. were slightly less than what would have The price of imported oil rose nearly occurred had foreigners reduced their $7 per barrel over the four quarters of holdings in proportion to the reduction 2000. During the year, oil prices gener- in Treasuries outstanding. The increased ally remained high and volatile, with the sale of Treasuries was fully offset by spot price of West Texas intermediate larger foreign purchases of U.S. securi- (WTI) crude fluctuating between a low ties issued by government-sponsored of $24 per barrel in April and a high agencies. Net purchases of agency secuabove $37 per barrel in September. rities topped $110 billion, compared Strong demand—driven by robust world with the previous record of $72 billion economic growth—kept upward pres- set in 1999. In contrast to the shrinksure on oil prices even as world supply ing supply of Treasury securities, U.S. increased considerably. Over the course government-sponsored agencies accelof 2000, OPEC raised its official pro- erated the pace of their debt issuance. duction targets by 3.7 million barrels per Private foreign purchases of U.S. corpoday, reversing the production cuts made rate debt grew to $180 billion, while net in the previous two years. Oil produc- purchases of U.S. equities ballooned to tion from non-OPEC sources rebounded $170 billion compared with $108 billion as well. During the last several weeks of in 1999. 2000, oil prices fell sharply as market The pace of foreign direct investment participants became convinced that the inflows in the first three quarters of 2000 U.S. economy was slowing. In early also accelerated from the record pace 2001, however, oil prices moved back of 1999. As in the previous two years, up when OPEC announced a planned direct investment inflows were driven production cut of 1.5 million barrels per by foreign acquisition of U.S. firms, day. reflecting the global strength in merger Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

56 88th Annual Report, 2001 and acquisition activity. Of the roughly confidence until late summer. Over the $200 billion in direct investment remainder of the year monthly increases inflows in the first three quarters, about in private employment stepped down $100 billion was directly attributable to further. Job growth came almost to a merger activity. Many of these mergers stop in December, when severe weather were financed, at least in part, by an added to the restraint from a slowexchange of equity, in which shares in ing economy. In January of this year, the U.S. firm were swapped for equity employment picked up, but the return of in the acquiring firm. Although U.S. milder weather apparently accounted for residents generally appear to have sold a a sizable portion of the gain. portion of the equity acquired through Employment rose moderately in the these swaps, the swaps likely contrib- private service-producing sector of the uted significantly to the $97 billion capi- economy in 2000, about 2 percent overtal outflow attributed to U.S. acquisition all after an increase of about 3 percent of foreign securities. U.S. direct invest- in 1999. In the fourth quarter, however, ment abroad was also boosted by merger hiring in the services-producing secactivity and totaled $117 billion in the tor was relatively slow, in large part first three quarters of 2000, a slightly because of a sizable decline in the numfaster pace than that of 1999. ber of jobs in personnel supply—a Capital inflows from foreign official category that includes temporary help sources totaled $38 billion in 2000—a agencies. Employment in construction slight increase from 1999. Nearly all increased about 2Vi percent in 2000 of the official inflows were attributable after several years of gains that were to reinvested interest earnings. Modest considerably larger. The number of jobs official sales of dollar assets associated in manufacturing was down for a third with foreign exchange intervention were year, owing to reductions in factory offset by larger inflows from some non- employment in the second half of the OPEC oil exporting countries, which year, when manufacturers were adjustbenefited from the elevated price of oil. ing to the slowing of demand. Those adjustments in manufacturing may also have involved some cutbacks in the The Labor Market employment of temporary hires, which Nonfarm payroll employment increased would help to account for the sharp job about \xh percent in 2000, measured on losses in personnel supply. The average a December-to-December basis. The job length of the workweek in manufacturcount had risen slightly more than 2 per- ing was scaled back as well over the cent in 1999 and roughly 2Vi percent a second half of the year. year over the 1996-98 period. Over the The slowing of the economy did not first few months of 2000, the expansion lead to any meaningful easing in the of jobs proceeded at a faster pace than in tightness of the labor market in 2000. 1999, boosted both by the federal gov- The household survey's measure of the ernment's hiring for the decennial Cen- number of persons employed rose 1 persus and by a somewhat faster rate of job cent, about in line with the expansion of creation in the private sector. Indications labor supply. On net, the unemployment of a moderation in private hiring started rate changed little; its fourth-quarter to emerge toward mid-year, but because average of 4.0 percent was down just of volatility of the incoming data a slow- a tenth of a percentage point from the down could not be identified with some average unemployment rate in the fourth Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 57 quarter of 1999. The flatness of the rate picks up some forms of employee comthrough the latter half of 2000, when the pensation that the ECI omits but that economy was slowing, may have partly also is more subject to eventual revision reflected a desire of companies to hold than the ECI, showed hourly compensaon to labor resources that had been diffi- tion advancing 53A percent this past cult to attract and retain in the tight year, up from a 1999 increase of about labor market of recent years. January of 4Vz percent. Tightness of the labor marthis year brought a small increase in the ket was likely one factor underlying rate, to 4.2 percent. the acceleration of hourly compensation Productivity continued to rise rapidly in 2000, with employers relying both in 2000. Output per hour in the nonfarm on larger wage increases and more business sector was up about 3Vi per- attractive benefit packages to attract cent over the year as a whole. Sizable and retain workers. Compensation gains gains in efficiency continued to be evi- may also have been influenced to some dent even as the economy was slowing degree by the pickup of consumer price in the second half of the year. Except for inflation since 1998. Rapid increases in 1999, when output per hour rose about the cost of health insurance contributed 33A percent, the past year's increase was importantly to a sharp step-up in benefit the largest since 1992, a year in which costs. the economy was in cyclical recovery Unit labor costs, the ratio of hourly from the 1990-91 recession. Cutting compensation to output per hour, through the year-to-year variations in increased about 2lA percent in the nonmeasured productivity, the underlying farm business sector in 2000 after havtrend still appears to have traced out a ing risen slightly more than Vi percent pattern of strong acceleration since the in 1999. Roughly three-fourths of the middle part of the 1990s. Support for acceleration was attributable to the a step-up in the trend has come from faster rate of increase in compensation increases in the amount of capital per per hour noted above. The remainder worker—especially high-tech capital— stemmed from the small deceleration and from organizational efficiencies that of measured productivity. The labor cost have resulted in output rising faster rise for the latest year was toward the than the combined inputs of labor and high end of the range of the small to capital. moderate increases that have prevailed Alternative measures of the hourly over the past decade. compensation of workers, while differing in their coverage and methods of Prices construction, were consistent in showing some acceleration this past year. The Led by the surge in energy prices, the employment cost index for private aggregate price indexes showed some industry (ECI), which attempts to mea- acceleration in 2000. The chain-type sure changes in the labor costs of non- price index for real GDP, the broadest farm businesses in a way that is free measure of goods and services produced from the effects of employment shifts domestically, rose 2lA percent in 2000, among occupations and industries, rose roughly 3A percentage point more than nearly 4Vi percent during 2000 after in 1999. The price index for gross having increased about 3Vi percent in domestic purchases, the broadest mea- 1999. Compensation per hour in the sure of prices for goods and services nonfarm business sector, a measure that purchased by domestic buyers, posted a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

58 88th Annual Report, 2001 rise of almost 2V2 percent in 2000 after demand for heating that resulted from having increased slightly less than 2 per- unusually cold weather in November cent the previous year. Prices paid by and December. Electricity costs jumped consumers, as measured by the chain- for some users, and prices nationally type price index for personal consump- rose faster than in other recent years, tion expenditures, picked up as well, about 2x/4 percent at the consumer level. about as much as the gross purchases Businesses had to cope with rising index. The consumer price index (CPI) costs of energy in production, transcontinued to move up at a faster pace portation, and temperature control. In than the PCE index this past year, and it some industries that depend particuexhibited slightly more acceleration—an larly heavily on energy inputs, the rise increase of nearly 3Vi percent in 2000 in costs had a large effect on product was % percentage point larger than the prices. Producer prices of goods such 1999 rise. Price indexes for fixed invest- as industrial chemicals posted increases ment and government purchases also that were well above the average rates accelerated this past year. of inflation last year, and rising prices The prices of energy products pur- for natural gas sparked especially steep chased directly by consumers increased price advances for nitrogen fertilizers about 15 percent in 2000, a few per- used in farming. Prices of some services centage points more than in 1999. In also exhibited apparent energy impacts: response to the rise in world oil prices, Producers paid sharply higher prices for consumer prices of motor fuels rose transportation services via air and water, nearly 20 percent in 2000, bringing the and consumer airfares moved up rapidly cumulative price hike for those products for a second year, although not nearly over the past two years to roughly as much as in 1999. Late in 2000 and 45 percent. Prices also rose rapidly for early this year, high prices for energy home heating oil. Natural gas prices inputs prompted shutdowns in producincreased 30 percent, as demand for that tion at some companies, including those fuel outpaced the growth of supply, pull- producing fertilizers and aluminum. ing stocks down to low levels. Prices of Despite the spillover of energy effects natural gas this winter have been excep- into other markets, inflation outside the tionally high because of the added energy sector remained moderate overall. The ongoing rise in labor productivity helped to contain the step-up in labor Alternative Measures of Price Change costs, and the slow rate of rise in the Percent prices of non-oil imports meant that domestic businesses had to remain cau- Price measure 1999 2000 tious about raising their prices because of the potential loss of market share. Chain-type Gross domestic product 1.6 2.3 Rapid expansion of capacity in manu- Gross domestic purchases 1.9 2.4 facturing prevented bottlenecks from Personal consumption expenditures 2.0 2.4 developing in the goods-producing Excluding food and energy ... 1.5 1.7 sector of the economy when domestic Fixed-weight demand was surging early in the year; Consumer price index 2.6 3.4 Excluding food and energy ... 2.1 2.6 later on, an easing of capacity utilization was accompanied by a softening of NOTE. Changes are based on quarterly averages and prices in a number of industries. Inflaare measured to the fourth quarter of the year indicated tion expectations, which at times in the from the fourth quarter of the preceding year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 59 past have added to the momentum of years, several of which had brought rising inflation, remained fairly quies- small declines in investment prices. cent in 2000. Although the price index for investment Against this backdrop, core inflation in residential structures slowed a little, remained low in 2000. Producer prices to about a 3Vi percent rise, the index for of intermediate materials excluding food nonresidential structures sped up from a and energy, after having accelerated 23/4 percent increase in 1999 to one of through the first few months of 2000, AVi percent in 2000. Moreover, the price slowed thereafter, and their four-quarter index for equipment and software ticked rise of PA percent was only a bit larger up slightly, after having declined 2 perthan the increase during 1999. Prices cent or more in each of the four preof crude materials excluding food and ceding years. To a large extent, that energy fell moderately this past year turnabout was a reflection of a smaller after having risen about 10 percent a rate of price decline for computers; they year earlier. At the consumer level, the had dropped at an average rate of more CPI excluding food and energy moved than 20 percent through the second up 2l/i percent in 2000, an acceleration half of the 1990s but fell at roughly half of slightly less than Vi percentage point that rate in 2000. Excluding computers, from 1999 when put on a basis that equipment prices increased slightly in maintains consistency of measurement. 2000 after having declined a touch in The rise in the chain-type price index 1999. for personal consumption expenditures excluding food and energy was PA per- U.S. Financial Markets cent, just a bit above the increases recorded in each of the two previous Financial markets in 2000 were influyears. enced by the changing outlook for the Consumer food prices rose 2Vi per- U.S. economy and monetary policy and cent in 2000 after an increase of about by shifts in investors' perceptions of and 2 percent in 1999. In large part, the attitudes toward risk. Private longermoderate step-up in these prices prob- term interest rates generally firmed in ably reflected cost and price consid- the early part of the year as growth erations similar to those at work else- remained unsustainably strong and as where in the economy. Also, farm market participants anticipated a further commodity prices moved up, on net, tightening of monetary policy by the during 2000, after three years of sharp Federal Reserve. Later in the year, as it declines, and this turnabout likely became apparent that the pace of ecoshowed through to the retail level to nomic growth was slowing, market parsome extent. Meat prices, which are ticipants began to incorporate expectalinked more closely to farm prices than tions of significant policy easing into is the case with many other foods, asset prices, and most longer-term interrecorded increases that were apprecia- est rates fell sharply over the last several bly larger than the increases for food months of 2000 and into 2001. Over the prices overall. course of the year, investors became The chain-type price index for private more concerned about credit risk and fixed investment rose about PA per- demanded larger yield spreads to hold cent in 2000, but that small increase lower-rated corporate bonds, especially amounted to a fairly sharp acceleration once the growth of the economy slowed from the pace of the preceding few in the second half. Banks, apparently Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

60 88th Annual Report, 2001 having similar concerns, reported wid- eurodollar futures, which can be used as ening credit spreads on business loans a rough gauge of policy expectations, and tightening standards for lending were indicating that market participants to businesses. Weakening economic expected additional policy tightening growth and tighter financial conditions going forward. in some sectors led to a slowing in the Signs of a slowdown in the growth pace of debt growth over the course of of aggregate demand began to appear the year. in the incoming data soon after the Stock markets had another volatile May FOMC meeting and continued to year in 2000. After touching record gradually accumulate over subsequent highs in March, stock prices turned months. In response, market participants lower, declining considerably over the became increasingly convinced that last four months of the year. Valuations the FOMC would not have to tighten in some sectors fell precipitously from its policy stance further, which was high levels, and near-term earnings fore- reflected in a flattening of the term casts were revised down sharply late in structure of rates on federal funds and the year. On balance, the broadest stock eurodollar futures. Interest rates on most indexes fell more than 10 percent last corporate bonds declined gradually on year, and the tech-heavy Nasdaq was the shifting outlook for the economy, down nearly 40 percent. and by the end of August had fallen more than Vi percentage point from their peaks in May. Interest Rates Most market interest rates continued The economy continued to expand at an to edge lower into the fall, as the growth exceptionally strong and unsustainable of the economy seemed to moderate pace in the early part of 2000, prompt- further. Over the last couple months of ing the Federal Reserve to tighten its 2000 and into early 2001, as it became policy stance in several steps ending at apparent that economic growth was its May meeting. Private interest rates slowing more abruptly, market particiand shorter-term Treasury yields rose pants sharply revised down their expecconsiderably over that period, reaching tations for future short-term interest a peak just after the May FOMC meet- rates. Treasury yields plummeted over ing. Investors apparently became more that period, particularly at shorter matuconcerned about credit risk as well; rities: The two-year Treasury yield spreads between rates on lower-rated dropped more than a full percentage corporate bonds and swaps widened in point from mid-November to early Januthe spring, adding to the upward pres- ary, moving below the thirty-year yield sure on private interest rates. Long-term for the first time since early 2000. Treasury yields, in contrast, remained Yields on inflation-indexed securities below their levels from earlier in the also fell considerably, but by less than year, as market participants became their nominal counterparts, suggesting increasingly convinced that the supply that the weakening of economic growth of those securities would shrink consid- lowered expectations of both real intererably in coming years and incorporated est rates and inflation. a "scarcity premium" into their prices. Although market participants had By mid-May, with the rapid expansion come to expect considerable policy easof economic activity showing few signs ing over the first part of this year, the of letting up, rates on federal funds and timing and magnitude of the intermeet- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 61 ing cut in the federal funds rate in early Overall, yields on most investment- January was a surprise. In response, grade corporate bonds have reached investors built into asset prices anticipa- their lowest levels since the first half of tions of a more rapid policy easing over 1999, while rates on most high-yield the near-term. Indeed, the further sub- bonds have fallen about 2 percentage stantial reduction in the federal funds points from their peaks and have rate implemented at the FOMC meeting reached levels similar to those of midlater that month was largely expected 2000. and elicited little response in financial Although investors at times in recent markets. Even with a full percentage months appeared more concerned about point reduction in the federal funds rate credit risk than they were in the fall of in place, futures rates have recently 1998, the recent financial environment, pointed to expectations of additional by most accounts, did not resemble policy easing over coming months. the market turbulence and disruption of Investors appear to be uncertain about that time. The Treasury and investmentthis outlook, however, judging from the grade corporate bond markets remained recent rise in the implied volatilities of relatively liquid, and the investmentinterest rates derived from option prices. grade market easily absorbed the high On balance since the beginning of 2000, volume of bond issuance over 2000. the progressive easing in the economic Investors continued to show a heightoutlook, in combination with the effects ened preference for larger, more liquid of actual and prospective reductions in corporate issues, but they did not exhibit the supply of Treasury securities, has the extreme desire for liquidity that was resulted in a sizable downward shift in apparent in the fall of 1998. For examthe Treasury yield curve. ple, the liquidity premium for the on- The prospect of a weakening in eco- the-run ten-year Treasury note this year nomic growth, along with sizable remained well below the level of that declines in equity prices and downward fall. revisions to profit forecasts, apparently Nonetheless, the Treasury market has caused investors to reassess credit risks become somewhat less liquid than it was in the latter part of last year. Spreads several years ago. Moreover, in 2000, between rates on high-yield corporate particular segments of the Treasury marbonds and swaps soared beginning in ket occasionally experienced bouts of September, pushing the yields on those unusually low liquidity that appeared bonds substantially higher. Concerns related to actual or potential reductions about credit risk also spilled over into in the supply of individual securities. the investment-grade sector, where yield Given the possibility that liquidity could spreads widened considerably for lower- deteriorate further as the Treasury rated securities. For most investment- continues to pay down its debt, market grade issuers, though, the effects of the participants reportedly increased their revised policy outlook more than offset reliance on alternative instruments— any widening in risk spreads, resulting including interest rate swaps and in a decline in private interest rates in debt securities issued by governmentthe fourth quarter. Since the first policy sponsored housing agencies and other easing in early January, yield spreads on corporations—for some of the hedging corporate bonds have narrowed consid- and pricing functions historically proerably, including a particularly large vided by Treasury securities. Fannie drop in the spread on high-yield bonds. Mae and Freddie Mac continued to issue Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

62 88th Annual Report, 2001 large amounts of debt under their ognizing this possibility, last year the Benchmark and Reference debt pro- FOMC initiated a study to consider grams, which are designed to mimic alternative approaches to managing the characteristics of Treasury securities— Federal Reserve's portfolio, including such as large issue sizes and a regular expanding the use of the discount calendar of issuance—that are believed window and broadening the types of to contribute to their liquidity. By the assets acquired in the open market. As it end of 2000, the two firms together had continues to study various alternatives, more than $300 billion of notes and the FOMC will take into considerabonds and more than $200 billion of tion the effect that such approaches bills outstanding under those programs. might have on the liquidity and safety of Trading volume and dealer positions its portfolio and the potential for distortin agency securities have risen consid- ing the allocation of credit to private erably since 1998, and the market for entities. repurchase agreements in those securi- Meanwhile, some measures have ties has reportedly become more active. been taken to prevent the System's hold- Also, several exchanges listed options ings of individual Treasury securities and futures on agency debt securities. from reaching possibly disruptive levels Open interest on some of those futures and to help curtail any further lengthencontracts has picked up significantly, ing of the average maturity of the Sysalthough it remains small compared to tem's holdings. On July 5, 2000, the that on futures contracts on Treasury Federal Reserve Bank of New York securities. announced guidelines limiting the Sys- The shrinking supply of Treasury tem's holdings of individual Treasury securities and the possibility of a con- securities to specified percentages of sequent decline in market liquidity also their outstanding amounts, depending pose challenges for the Federal Reserve. on the remaining maturity of the issue. For many years, Treasury securities Those limits range from 35 percent for have provided the Federal Reserve with Treasury bills to 15 percent for longeran effective asset for System portfolio term bonds. As a result, the System holdings and the conduct of monetary has redeemed some of its holdings of policy. The remarkable liquidity of Treasury securities on occasions when Treasury securities has allowed the Sys- the amount of maturing holdings has tem to conduct sizable policy operations exceeded the amount that could be quickly and with little disruption to mar- rolled over into newly issued Treasury kets, while the safety of Treasury securi- securities under these limits. Redempties has allowed the System to avoid tions of Treasury holdings in 2000 credit risk in its portfolio. However, exceeded $28 billion, with more than if Treasury debt continues to be paid $24 billion of the redemptions in down, at some point the amount out- Treasury bills. In addition, the Federal standing will be insufficient to meet Reserve accommodated a portion of the Federal Reserve's portfolio needs. the demand for reserves last year by Well before that time, the proportion increasing its use of longer-term repurof Treasury securities held by the Sys- chase agreements rather than by purtem could reach levels that would sig- chasing Treasury securities outright. nificantly disrupt the Treasury market The System maintained an average of and make monetary policy operations more than $15 billion of longer-term increasingly difficult or costly. Rec- repurchase agreements over 2000, typi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 63 cally with maturities of twenty-eight composite plunged 39 percent, leaving it days. at year-end more than 50 percent below its record high and erasing nearly all of its gains since the beginning of 1999. Equity Prices The broad decline in equity prices last After having moved higher in the first year is estimated to have lopped more quarter of 2000, equity prices reversed than $P/4 trillion from household course and finished the year with con- wealth, or more than 4 percent of the siderable declines. Early in the year, total net worth of households. Neverthethe rapid pace of economic activity less, the level of household net worth is lifted corporate profits, and stock ana- still quite high—about 50 percent above lysts became even more optimistic about its level at the end of 1995. Investors future earnings growth. In response, continued to accumulate considerable most major equity indexes reached amounts of equity mutual funds over record highs in March, with the Wil- 2000, although they may have become shire 5000 rising 63A percent above its increasingly discouraged by losses on 1999 year-end level and the Nasdaq their equity holdings toward the end soaring 24 percent, continuing its rapid of the year, when flows into equity run-up from the second half of 1999. funds slumped. At that time, money Equity prices fell from these highs dur- market mutual funds expanded sharply, ing the spring, with a particularly steep as investors apparently sought a refuge drop in the Nasdaq, as investors grew for financial assets amid the heightmore concerned about the lofty valua- ened volatility and significant drops tions of some sectors and the prospect of in equity prices. So far in 2001, major higher interest rates. equity indexes are little changed, on Broader equity indexes recovered balance, as the boost from lower intermuch of those losses through August, est rates has been countered by consupported by the decline in market inter- tinued disappointments over corporate est rates and the continued strength of earnings. earnings growth in the second quarter. Some of the most dramatic plunges in But from early September through the share prices in 2000 took place among end of the year, stock prices fell con- technology, telecommunications, and siderably in response to the downshift in Internet shares. While these declines economic growth, a reassessment of the partly stemmed from downward reviprospects for some high-tech industries, sions to near-term earnings estimates, and disappointments in corporate earn- which were particularly severe in some ings. In December and January, equity cases, they were also driven by a reasanalysts significantly reduced their fore- sessment of the elevated valuations of casts for year-ahead earnings for the many companies in these sectors. The S&P 500. However, analysts apparently price-earnings ratio (calculated using view the slowdown in earnings as short- operating earnings expected over the lived, as long-run earnings forecasts did next year) for the technology componot fall much and remain at very high nent of the S&P 500 index fell substanlevels, particularly for the technology tially from its peak in early 2000, sector. although it remains well above the ratio On balance, the Wilshire 5000 index for the S&P 500 index as a whole. For fell 12 percent over 2000—its first the entire S&P 500 index, share prices annual decline since 1994. The Nasdaq fell a bit more in percentage terms than Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

64 88th Annual Report, 2001 the downward revisions to year-ahead and has remained subdued so far in earnings forecasts, leaving the price- 2001. earnings ratio modestly below its historical high. Debt and the Monetary Aggregates The volatility of equity price movements during 2000 was at the high end Debt and Depository Intermediation of the elevated levels observed in recent years. In the technology sector, the Aggregate debt of domestic nonfinanmagnitudes of daily share price changes cial sectors increased an estimated were at times remarkable. There were 5!/4 percent over 2000, a considerable twenty-seven days during 2000 in which slowdown from the gains of almost the Nasdaq composite index moved up 7 percent posted in 1998 and 1999. The or down by at least 5 percent; by com- expansion of nonfederal debt moderated parison, such outsized movements were to SVi percent in 2000 from 9l/z percent observed on a total of only seven days in 1999; the slowing owed primarily to a from 1990 to 1999. weakening of consumer and business Despite the volatility of share price borrowing in the second half of the year, movements and the large declines on as the growth of durables consumption balance over 2000, equity market con- and capital expenditures fell off and ditions were fairly orderly, with few financial conditions tightened for some reports of difficulties meeting margin firms. Some of the slowdown in total requirements or of large losses creating nonfinancial debt was also attributable problems that might pose broader sys- to the federal government, which paid temic concerns. The fall in share prices down 63/4 percent of its debt last year, reined in some of the margin debt of compared with 2x/2 percent in 1999. In equity investors. After having run up 1998 and 1999, domestic nonfinancial sharply through March, the amount of debt increased faster than nominal GDP, outstanding margin debt fell by about despite the reduction in federal debt over 30 percent over the remainder of the those years. The ratio of nonfinancial year. At year-end, the ratio of margin debt to GDP edged down in 2000, debt to total equity market capitaliza- however, as the federal debt paydown tion was slightly below its level a year accelerated and nonfederal borrowing earlier. slowed. The considerable drop in valuations Depository institutions continued to in some sectors and the elevated volatil- play an important role in meeting the ity of equity price movements caused demand for credit by businesses and the pace of initial public offerings to households. Credit extended by slow markedly over the year, despite a commercial banks, after adjustment large number of companies waiting to for mark-to-market accounting rules, go public. The slowdown was particu- increased 10 percent over 2000, well larly pronounced for technology com- above the pace for total nonfinancial panies, which had been issuing new debt. Bank credit expanded at a particushares at a frantic pace early in the larly brisk rate through late summer, year. In total, the dollar amount of initial when banks, given their ample capital public offerings by domestic nonfinan- base and solid profits, were willing to cial companies tapered off in the fourth meet strong loan demand by households quarter to its lowest level in two years and businesses. Over the remainder of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 65 the year, the growth of bank credit vious years. With delinquency rates for declined appreciably, as banks became consumer and real estate loans having more cautious lenders and as several changed little, on net, last year, banks banks shed large amounts of govern- did not tighten credit conditions signifiment securities. cantly for loans to households over the Banks reported a deterioration of the first three quarters of 2000. More quality of their business loan portfolios recently, however, an increasing portion last year. Delinquency and charge-off of banks increased standards and terms rates on C&I loans, while low by his- for consumer loans other than credit torical standards, rose steadily, partly cards, and some of the banks surveyed reflecting some repayment difficulties anticipated a further tightening of condiin banks' syndicated loan portfolios. tions on consumer loans during 2001. Several large banks have stated that the uptrend in delinquencies is expected to The Monetary Aggregates continue in 2001. Higher levels of provisioning for loan losses and some nar- The monetary aggregates grew rather rowing of net interest margins contrib- briskly last year. The expansion of the uted to a fallback of bank profits from broadest monetary aggregate, M3, was the record levels of 1999. In addition, particularly strong over the first three capitalization measures slipped a bit last quarters of 2000, as the robust growth year. Nevertheless, by historical stan- in depository credit was partly funded dards banks remained quite profitable through issuance of the managed liabilioverall and appeared to have ample ties included in this aggregate, such as capital. In the aggregate, total capital large time deposits. M3 growth eased (the sum of tier 1 and tier 2 capital) somewhat in the fourth quarter because remained above 12 percent of risk- the slowing of bank credit led deposiweighted assets over the first three quar- tory institutions to reduce their reliters of last year, more than two per- ance on managed liabilities. Institutional centage points above the minimum money funds increased rapidly throughlevel required to be considered well- out 2000, despite the tightening of polcapitalized. icy early in the year, in part owing In response to greater uncertainty to continued growth in their provision about the economic outlook and a of cash management services for busireduced tolerance for risk, increasing nesses. For the year as a whole, M3 proportions of banks reported tightening expanded 9VA percent, well above the standards and terms on business loans VA percent pace in 1999. This advance during 2000 and into 2001, with the again outpaced that of nominal income, share recently reaching the highest level and M3 velocity—the ratio of nominal since 1990. The tightening became income to M3—declined for the sixth widespread for loans to large and year in a row. middle-market firms. A considerable M2 increased 6XA percent in 2000, portion of banks reported firming stan- about unchanged from its pace in 1999. dards and terms on loans to small busi- Some slowing in M2 growth would have nesses as well, consistent with surveys been expected based on the rise in shortof small businesses indicating that a term interest rates over the early part of larger share of those firms had difficulty the year, which pushed up the "opportuobtaining credit in 2000 than in pre- nity cost" of holding M2, given that the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

66 88th Annual Report, 2001 Growth of Money and Debt M2 slightly exceeded that of nominal Percent income, and M2 velocity edged down. The behavior of the components of Domestic M2 was influenced importantly by internon- Period Ml M2 M3 financial est rate spreads. The depressing effect of debt higher short-term market interest rates was most apparent in the liquid deposit Annual1 1990 4.2 4.2 1.9 6.7 components, including checkable depos- 1991 7.9 3.1 1.2 4.5 its and savings accounts, whose rates 1992 14.4 1.8 .6 4.5 1993 10.6 1.3 1.0 4.9 respond very sluggishly to movements 1994 2.5 .6 1.7 4.8 in market rates. Small time deposits and 1995 -1.5 3.8 6.1 5.4 retail money market mutual funds, 1996 -4.5 4.5 6.8 5.3 1997 -1.2 5.6 8.9 5.4 whose rates do not lag market rates as 1998 2.2 8.4 10.9 6.9 much, expanded considerably faster than 1999 1.8 6.2 7.7 6.8 liquid deposits. Currency growth was 2000 -1.5 6.3 9.2 5.3 held down early in the year by a runoff Quarterly of the stockpile accumulated in advance (annual rate) 2 of the century date change. In addition, 2000:Ql 2.0 5.8 10.6 5.6 Q2 -1.8 6.4 9.0 6.2 it was surprisingly sluggish over the bal- Q3 -3.7 5.8 8.9 4.7 Q4 -2.7 6.6 7.1 4.1 ance of the year given the rapid pace of income growth, with weakness appar- NOTE. Ml consists of currency, travelers checks, ently in both domestic and foreign demand deposits, and other checkable deposits. M2 condemands. sists of Ml plus savings deposits (including money market deposit accounts), small-denomination time deposits, and balances in retail money market funds. M3 consists of M2 plus large-denomination time deposits, balances in International Developments institutional money market funds, RP liabilities (overnight and term), and eurodollars (overnight and term). In 2000, overall economic activity in Debt consists of the outstanding credit market debt of the U.S. government, state and local governments, house- foreign economies continued its strong holds and nonprofit organizations, nonfinancial busi- performance of the previous year. Hownesses, and farms. ever, in both industrial and developing 1. From average for fourth quarter of preceding year to average for fourth quarter of year indicated. countries, growth was strongest early, 2. From average for preceding quarter to average for and clear signs of a general slowing quarter indicated. emerged later in the year. Among industrial countries, growth in Japan last year moved up to an estimated 2 percent, and interest rates on many components of growth in the euro area slowed slightly M2 do not increase by the same amount to 3 percent. Emerging market econoor as quickly as market rates. However, mies in both Asia and Latin America with the level of long-term rates close to grew about 6 percent on average in that of short-term rates, investors had 2000. For Asian developing economies, much less incentive to shift funds out of this represented a slowing from the M2 assets and into assets with longer torrid pace of the previous year, while maturities, which helped support M2 growth in Latin America, especially growth. M2 was also boosted at times Mexico, picked up from 1999. Average by households' increased preference for foreign inflation edged up slightly to safe and liquid assets during periods of 3 percent, mainly reflecting higher oil heightened volatility in equity markets. prices. Over the first part of the year, On balance over the year, the growth of monetary authorities moved to tighten Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 67 conditions in many industrial countries, year when evidence emerged that the in reaction to continued strong growth pace of U.S. activity was slowing much in economic activity that was starting to more sharply than had been expected. impinge on capacity constraints, as well Despite this decline, the dollar's average as some upward pressures on prices. foreign exchange value against the cur- Interest rates on long-term government rencies of other major foreign industrial securities declined on balance in most countries recorded a net increase of over industrial countries, especially toward 7 percent for the year as a whole. The year-end when evidence of a slowdown dollar also strengthened nearly as much in global economic growth started to on balance against the currencies of the emerge. most important developing country trad- Conditions in foreign financial mar- ing partners of the United States. So far kets were somewhat more unsettled than this year, the dollar's average value has in the previous year. Overall stock remained fairly stable. indexes in the foreign industrial countries generally declined, most notably Industrial Economies in Japan. As in the United States, technology-oriented stock indexes were The dollar showed particular strength extremely volatile during the year. After last year against the euro, the common reaching peaks in the first quarter, they currency of much of Europe. During the started down while experiencing great first three quarters of the year, the euro swings toward mid-year, then fell continued to weaken, and by late Octosharply in the final quarter, resulting in ber had fallen to a low of just above net declines for the year of one-third or 82 cents, nearly one-third below its more. Stock prices in emerging market value when it was introduced in January economies were generally quite weak, 1999. The euro's decline against the dolespecially in developing Asia, where lar through most of last year appeared to growth in recent years has depended be due mainly to the vigorous growth of heavily on exports of high-tech goods. real GDP and productivity in the United Although there was no major default or States contrasted with steady but less devaluation among emerging market impressive improvements in Europe. In economies, average risk spreads on addition, investors may have perceived developing country debt still moved that Europe was slower to adopt "new higher on balance over the course of the economy" technologies, making it a year, as the threat of potential crises in relatively less attractive investment cliseveral countries, most notably Argen- mate. In September, a concerted intertina and Turkey, heightened investor vention operation by the monetary concerns. authorities of the G-7 countries, includ- The dollar's average foreign ex- ing the United States, was undertaken at change value increased over most of the request of European authorities to the year, supported by continued robust provide support for the euro. The Eurogrowth of U.S. activity, rising interest pean Central Bank also made intervenrates on dollar assets, and market per- tion purchases of euros on several occaceptions that longer-term prospects for sions acting on its own. Late in the year, U.S. growth and rates of return were the euro abruptly changed course and more favorable than in other industrial started to move up strongly, reversing countries. Part of the rise in the dollar's over half of its decline of earlier in the average value was reversed late in the year. This recovery of the euro against Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

68 88th Annual Report, 2001 the dollar appeared to reflect mainly a had maintained for nearly a year and a market perception that, while growth half, and its target for the overnight rate was slowing in both Europe and the was raised to 25 basis points. Later in United States, the slowdown was much the year, evidence emerged suggesting sharper for the United States. For the that the nascent recovery in economic year as a whole, the dollar appreciated, activity was losing steam, and in on net, about 7 percent against the response the yen started to depreciate euro. sharply against the dollar. The European Central Bank raised its For the year as a whole, Japanese real policy interest rate target six times by a GDP is estimated to have increased total of 175 basis points over the first about 2 percent, a substantial improveten months of the year. These increases ment from the very small increase of the reflected concerns that the euro's previous year and the decline recorded depreciation, tightening capacity con- in 1998. Growth, which was concenstraints and higher oil prices would put trated in the first part of the year, was upward pressure on inflation. While led by private nonresidential investcore inflation—inflation excluding food ment. In contrast, residential investment and energy—remained well below the slackened as the effect of tax incentives 2 percent inflation target ceiling, higher waned. Consumption rebounded early in oil prices pushed the headline rate above the year from a sharp decline at the end the ceiling for most of the year. Real of 1999 but then stagnated, depressed in GDP in the euro area is estimated to part by record-high unemployment and have increased about 3 percent for 2000 concerns that ongoing corporate restrucas a whole, only slightly below the rate turing could lead to further job losses. of the previous year, although activity Public investment, which gave a major slowed toward the end of the year. boost to the economy in 1999, remained Growth was supported by continued strong through the first half of last year strong increases in investment spending. but then fell off sharply, and for the year Net exports made only a modest contri- as a whole the fiscal stance is estimated bution to growth, as rapid increases in to have been somewhat contractionary. exports were nearly matched by robust Inflation was negative for the second imports. Overall activity was sufficiently consecutive year, with the prices of both strong to lead to a further decline in the consumer goods and real estate continuaverage euro-area unemployment rate to ing to move lower. below 9 percent, a nearly 1 percentage The dollar appreciated 4 percent relapoint reduction for the year. tive to the Canadian dollar last year. The dollar rose about 12 percent Among the factors that apparently against the Japanese yen over the course contributed to the Canadian currency's of 2000, roughly reversing the decline weakness were declines in the prices of of the previous year. Early in the year, commodities that Canada exports, such the yen experienced periods of upward as metals and lumber, and a perception pressure on evidence of a revival of by market participants of unfavorable activity in Japan. On several of these differentials in rates of return and ecooccasions, the Bank of Japan made nomic growth prospects in Canada relasubstantial intervention sales of yen. By tive to the United States. For the year as August, signs of recovery were strong a whole, real GDP growth in Canada enough to convince the Bank of Japan to is estimated to have been only slightly end the zero interest rate policy that it below the strong 5 percent rate of 1999, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, February 69 although, as in most industrial countries, time of a general heightening of finanthere were signs that the pace of growth cial market volatility and rising interest was tailing off toward the end of the rates in industrial countries, as well as year. Domestic demand continued to be increased political uncertainty in several robust, led by surging business invest- developing countries. After narrowing ment and solid personal consumption at mid-year, risk spreads on emerging increases. In the first part of the year, the market economy debt again widened sustained rapid growth of the economy later in the year, reflecting a general led Canadian monetary authorities to movement on financial markets away become increasingly concerned with a from riskier assets, as well as concerns buildup of inflationary pressures, and that Argentina and Turkey might be facthe Bank of Canada matched all of the ing financial crises that could spread to Federal Reserve's interest rate increases other emerging market economies. Risk in 2000, raising its policy rate by a total spreads generally narrowed in the early of 100 basis points. By the end of the part of 2001. year, the core inflation rate had risen to Among Latin American countries, near the middle of the Bank of Canada's Mexico's performance was noteworthy. 1 percent to 3 percent target range, Real GDP rose an estimated 7 percent, while higher oil prices pushed the an acceleration from the already strong overall rate above the top of the range. result of the previous year. Growth was So far this year, the Bank of Canada boosted by booming exports, especially has only partially followed the Federal to the United States, favorable world Reserve in lowering interest rates, and oil prices, and a rebound in domestic the Canadian dollar has remained little demand. In order to keep inflation on a changed. downward path in the face of surging domestic demand, the Bank of Mexico tightened monetary conditions six times Emerging Market Economies last year, pushing up short-term interest In emerging market economies, the rates, and by the end of the year the rate average growth rate of economic activ- of consumer price inflation had moved ity in 2000 remained near the very below the 10 percent inflation target. strong 6 percent rate of the previous The run-up to the July presidential elecyear. However, there was a notable and tion generated some sporadic financial widespread slowing near the end of the market pressures, but these subsided year, and results in a few individual in reaction to the smooth transition to countries were much less favorable. the new administration. Over the course Growth in developing Asian economies of the year, the risk spread on Mexislowed on average from the torrid pace can debt declined on balance, probably of the previous year, while average reflecting a favorable assessment by growth in Latin America picked up market participants of macroeconomic somewhat. No major developing coun- developments and government policies, try experienced default or devaluation in reinforced by rating upgrades of Mexi- 2000, but nonetheless, financial markets can debt. During 2000, the peso depredid undergo several periods of height- ciated slightly against the dollar, but by ened unrest during the year. In the less than the excess of Mexican over spring, exchange rates and equity prices U.S. inflation. weakened and risk spreads widened in Argentina encountered considerable many emerging market economies at a financial distress last year. Low tax Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

70 88th Annual Report, 2001 revenues due to continued weak activity developing economies following their along with elevated political uncertainty financial crises. In addition, a sharp fall greatly heightened market concerns in Korean equity prices over the course about the ability of the country to fund of the year, as well as continued diffiits debt. Starting in October, domestic culties with the process of financial and interest rates and debt risk spreads corporate sector restructuring, tended soared amid market speculation that to depress consumer and business confithe government might lose access to dence. These developments contributed credit markets and be forced to abandon to the downward pressure on the won the exchange rate peg to the dollar. seen near the end of the year. Elsewhere Financial markets began to recover after in Asia, market concerns over heightan announcement in mid-November ened political instability were a major that an IMF-led international finan- factor behind financial pressures last cial support package was to be put year in Indonesia, Thailand, and the in place. Further improvement came Philippines. In China, output continued in the wake of an official announcement to expand rapidly in 2000, driven by a in December of a $40 billion support combination of surging exports early in package. The fall in U.S. short-term the year, sustained fiscal stimulus, and interest rates in January eased pressure some recovery in private consumption. on Argentina's dollar-linked economy In contrast, growth in both Hong Kong as well. and Taiwan slowed, especially in the Late in the year, Brazilian financial latter part of the year. In Taiwan, the markets received some negative spill- exchange rate and stock prices both over from the financial unrest in Argen- came under downward pressure as a tina, but conditions did not approach result of the slowdown in global electhose prevailing during Brazil's finan- tronics demand and apparent market cial crisis of early 1999. For 2000 as a concerns over revelations of possible whole, the Brazilian economy showed weaknesses in the banking and corposeveral favorable economic trends. Real rate sectors. GDP growth increased to an estimated Turkey's financial markets came 4 percent after being less than 1 percent under severe strain in late November as the previous two years, inflation contin- international investors withdrew capital ued to move lower, and short-term inter- amid market worries about the health of est rates declined. Turkey's banks, the viability of the gov- Growth in Asian developing coun- ernment's reform program and its crawltries in 2000 slowed from the previous ing peg exchange rate regime, and the year, when they had still been experienc- widening current account deficit. The ing an exceptionally rapid bounceback resulting liquidity shortage caused shortfrom the 1997-1998 financial crises term interest rates to spike up and led to experienced by several countries in the a substantial decline in foreign exchange region. In Korea, real GDP growth last reserves held by the central bank. Maryear is estimated to have been less than kets stabilized somewhat after it was half of the blistering 14 percent rate announced in December that Turkey had of 1999. Korean exports, especially been able to reach loan agreements with of high-tech products, started to fade the IMF, major international banks, and toward the end of 2000. Rapid export the World Bank in an effort to provide growth had been a prominent feature of liquidity and restore confidence in the the recovery of Korea and other Asian banking system. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 71 Report submitted to the Congress on confidence, raised the possibility of July 18, 2001, pursuant to section 2B of becoming increasingly self-reinforcing the Federal Reserve Act were households and businesses to postpone spending while reassessing their situations. In addition, other financial Report of July 18, 2001 developments, including a higher foreign exchange value of the dollar, lower Monetary Policy and the equity prices, and tighter lending terms Economic Outlook and standards at banks, were tending When the Federal Reserve submitted to restrain aggregate demand and thus its report on monetary policy in mid- were offsetting some of the influence February, the Federal Open Market of the lower federal funds rate. Finally, Committee (FOMC) had already re- despite some worrisome readings early duced its target for the federal funds rate in the year, price increases remained twice to counter emerging weakness in fairly well contained, and prospects the economy. As the year has unfolded, for inflation have become less of a conthe weakness has become more persis- cern as rates of resource utilization have tent and widespread than had seemed declined and energy prices have shown likely last autumn. The shakeout in the signs of turning down. high-technology sector has been espe- The information available at midyear cially severe, and with overall sales and for the recent performance of both the profits continuing to disappoint, busi- U.S. economy and some of our key tradnesses are curtailing purchases of other ing partners remains somewhat downtypes of capital equipment as well. The beat, on balance. Moreover, with invenslump in demand for capital goods has tories still excessive in some sectors, also worked against businesses' efforts orders for capital goods very soft, and to correct the inventory imbalances that the effects of lower stock prices and emerged in the second half of last year the weaker job market weighing on and has contributed to sizable declines consumers, the economy may expand in manufacturing output this year. At only slowly, if at all, for a while longer. the same time, foreign economies have Nonetheless, a number of factors are slowed, limiting the demand for U.S. in place that should set the stage for exports. stronger growth later this year and in To foster financial conditions that will 2002. In particular, interest rates have support strengthening economic growth, declined since last fall; the lower rates the FOMC has lowered its target for the have helped businesses and housefederal funds rate four times since Feb- holds strengthen their financial posiruary, bringing the cumulative decline tions and should show through to aggrethis year to 23/4 percentage points. A gate demand in coming quarters. The number of factors spurred this unusually recently enacted tax cuts and the apparsteep reduction in the federal funds rate. ent cresting of energy prices should also In particular, the slowdown in growth bolster aggregate demand fairly soon. In was rapid and substantial and carried addition, as firms at some point become considerable risks that the sluggish per- more satisfied with their inventory holdformance of the economy in the first ings, the cessation of liquidation will half of this year would persist. Among boost production and, in turn, provide other things, the abruptness of the slow- a lift to employment and incomes; a ing, by jarring consumer and business subsequent shift to inventory accumula- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

72 88th Annual Report, 2001 tion in association with the projected that slowing was only beginning to strengthening in demand should pro- come into focus. At that meeting, the vide additional impetus to production. FOMC concluded that the risks to the Moreover, with no apparent sign of economy in the foreseeable future had abatement in the rapid pace of tech- shifted to being weighted mainly toward nological innovation, the outlook for conditions that may generate economic productivity growth over the longer weakness and that economic and finanrun remains favorable. The efficiency cial developments could warrant further gains made possible by these innova- close review of the stance of policy well tions should spur demand for the capi- before the next scheduled meeting. Subtal equipment that embodies the new sequent data indicated that holiday retail technologies once the overall economic sales had come in below expectations situation starts to improve and should and that conditions in the manufacturing support consumption by leading to solid sector had deteriorated. Corporate profit increases in real incomes over time. forecasts had also been marked down, Even though an appreciable recovery and it seemed possible that the resulting in the growth of economic activity by decline in equity values, along with the early next year seems the most likely expense of higher energy costs, could outcome, there is as yet no hard evi- damp future business investment and dence that this improvement is in train, household spending. In response, the and the situation remains very uncer- FOMC held a telephone conference on tain. In these circumstances, the FOMC January 3, 2001, and decided to reduce continues to believe that the risks are the target federal funds rate Vi percentweighted toward conditions that may age point, to 6 percent, and indicated generate economic weakness in the that the risks to the outlook remained foreseeable future. At the same time, weighted toward economic weakness. the FOMC recognizes the importance The timing and size of the cut in the of sustaining the environment of low target rate seemed to ease somewhat the inflation and well-anchored inflation concerns of financial market participants expectations that enabled the Federal about the longer-term outlook for the Reserve to react rapidly and forcefully economy. Equity prices generally rose to the slowing in real GDP growth over in January, risk spreads on lower-rated the past several quarters. When, as the corporate bonds narrowed significantly, FOMC expects, activity begins to firm, and the yield curve steepened. However, the Committee will continue to ensure incoming data over the month revealed that financial conditions remain consis- that the slowing in consumer and busitent with holding inflation in check, a ness spending late last year had been key requirement for maximum sustain- sizable. Furthermore, a sharp erosion able growth. in survey measures of consumer confidence, a backup of inventories, and a steep decline in capacity utilization Monetary Policy, Financial posed the risk that spending could Markets, and the Economy remain depressed for some time. In light over the First Half of 2001 of these developments, the FOMC at its By the time of the FOMC meeting on scheduled meeting on January 30 and 31 December 19, 2000, it had become evi- cut its target for the federal funds rate dent that economic growth had down- another lh percentage point, to 5x/2 pershifted considerably, but the extent of cent, and stated that it continued to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 73 judge the risks to be weighted mainly rise in mid-April as financial market toward economic weakness. investors became more confident that a The information reviewed by the cumulative downward spiral in activity FOMC at its meeting on March 20 sug- could be avoided, reports continued to gested that economic activity continued suggest flagging economic performance to expand, but slowly. Although con- and risks of extended weakness ahead. sumer spending seemed to be rising In particular, spending by consumers moderately and housing had remained had leveled out and their confidence had relatively firm, stock prices had declined fallen further. The FOMC discussed substantially in February and early economic developments in conference March, and reduced equity wealth and calls on April 11 and April 18, deciding lower consumer confidence had the on the latter occasion to reduce its target potential to damp household spending for the federal funds rate another Vi pergoing forward. Moreover, manufac- centage point, to 4x/2 percent. The Comturing output had contracted further, mittee again indicated that it judged as businesses continued to work down the balance of risks to the outlook as their excess inventories and cut back on weighted toward economic weakness. capital equipment expenditures. In addi- When the FOMC met on May 15, tion, economic softness abroad raised economic conditions remained quite the likelihood of a weakening in U.S. sluggish, especially in manufacturing, exports. Core inflation had picked up a where production and employment had bit in January, but some of the increase declined further. Although members reflected the pass-through of a rise in were concerned that some indicators of energy prices that was unlikely to con- core inflation had moved up in the early tinue, and the FOMC judged that the months of the year and that part of the slowdown in the growth of aggregate recent backup in longer-term interest demand would ease inflationary pres- rates may have owed to increased inflasures on labor and other resources. tion expectations, most saw underly- Accordingly, the FOMC on March 20 ing price increases as likely to remain lowered its target for the federal funds damped as continued subpar growth rate another Vi percentage point, to relieved pressures on resources. In light 5 percent. The members also continued of the prospect of continued weakness to see the risks to the outlook as remain- in the economy and the significant risks ing weighted mainly toward economic to the economic expansion, the FOMC weakness. Furthermore, the FOMC reduced its target for the federal funds recognized that in a rapidly evolving rate an additional Vi percentage point, to economic situation, it would need to 4 percent. With the softening in aggrebe alert to the possibility that a con- gate demand still of unknown persisference call would be desirable dur- tence and dimension, the FOMC coning the relatively long interval before tinued to view the risks to the outlook the next scheduled meeting to discuss as weighted toward economic weakness. the possible need for a further policy Still, the FOMC recognized that it had adjustment. eased policy substantially this year and Capital markets continued to soften that, in the absence of further sizable in late March and early April, in part adverse shocks to the economy, at future because corporate profits and economic meetings it might need to consider activity remained quite weak. Although adopting a more cautious approach to equity prices and bond yields began to further policy actions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

74 88th Annual Report, 2001 Subsequent news on economic activ- tendency of the forecasts for real GDP ity and corporate profits failed to point growth in 2002 is 3 percent to 3J/4 perto a rebound. In June, interest rates on cent. The civilian unemployment rate, longer-term Treasuries and on higher- which averaged 4Vi percent in the secquality private securities declined, some ond quarter of 2001, is expected to move risk spreads widened, and stock prices up to the area of 43/4 percent to 5 percent fell as financial market participants by the end of this year. In 2002, with the trimmed their expectations for eco- economy projected to expand at closer nomic activity and profits. When the to its trend rate, the unemployment rate FOMC met on June 26 and 27, con- is expected to hold steady or perhaps to ditions in manufacturing appeared to edge higher. With pressures in labor and have worsened still more. It also seemed product markets abating and with energy likely that slower growth abroad would prices no longer soaring, inflation is restrain demand for exports and that expected to be well contained over the weakening labor markets would hold next year and a half. down growth in consumer spending. In Despite the projected increase in real light of these developments, but also GDP growth, the uncertainty about the taking into account the cumulative near-term outlook remains considerable. 250 basis points of easing already undertaken and the other forces likely to be Economic Projections for 2001 and 2002 stimulating spending in the future, the FOMC lowered its target for the fed- Percent eral funds rate VA percentage point, to 33/4 percent, and continued to view the Board of a n G d overnors risks to the outlook as weighted toward Reserve Bank presidents Indicator economic weakness. Central Range The Board of Governors of the Fed- tendency eral Reserve System approved cuts in 2001 the discount rate in the first half of the year that matched the FOMC's cuts in Change, fourth quarter the target federal funds rate. As a result, to fourth quarter1 Nominal GDP 314-5 3Vfe-41/4 the discount rate declined from 6 per- Real GDP2 1-2 1 i/4-2 cent to 3VA percent over the period. PCE prices 2-23/4 2-2V2 Average level, fourth quarter Economic Projections Civilian unemployment for 2001 and 2002 rate 43/4-5 43/4-5 2002 The members of the Board of Governors and the Federal Reserve Bank presi- Change, fourth quarter dents, all of whom participate in the to fourth quarter^ deliberations of the FOMC, expect eco- N Re o a m l i G na D l P G 2 DP 43 3 /4 - _ 3 6 1 /2 5 3 _ - 5 3 i/ V 2 4 nomic growth to remain slow in the near PCE prices 11/2-3 i3/4-2y2 term, though most anticipate that it will Average level, pick up later this year at least a little. fourth quarter Civilian unemployment The central tendency of the forecasts rate 43/4-51/2 43/4-51/4 for the increase in real GDP over the four quarters of 2001 spans a range of 1. Change from average for fourth quarter of previous year to average for fourth quarter of year indicated. WA percent to 2 percent, and the central 2. Chain-weighted. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 75 This uncertainty arises not only from the lative macroeconomic policies in some difficulty of assessing when businesses countries. will feel that conditions are sufficiently The chain-type price index for perfavorable to warrant a pickup in capi- sonal consumption expenditures rose tal spending but also from the difficulty 2lA percent over the four quarters of of gauging where businesses stand in 2000, and most FOMC participants the inventory cycle. Nonetheless, all the expect inflation to remain around that FOMC participants foresee a return to rate through next year; indeed, the censolid growth by 2002. By then, the tral tendency of their forecasts for the inventory correction should have run its increase in this price measure is 2 percourse, and the monetary policy actions cent to 2V2 percent in 2001 and PA pertaken this year, as well as the recently cent to 2Vi percent in 2002. One favorenacted tax reductions, should be pro- able factor in the inflation outlook is the viding appreciable support to final behavior of energy prices. Those prices demand. have declined recently after having In part because of lower interest rates, increased rapidly in the past couple of many firms have been able to shore up years, and prospects are good that they their balance sheets. And although some could stabilize or even fall further lower-rated firms, especially in tele- in coming quarters. In addition to their communications and other sectors with direct effects, lower energy prices gloomy near-term prospects, may con- should tend to limit increases in other tinue to find it difficult to obtain financ- prices by reducing input costs for a wide ing, businesses generally are fairly well range of energy-intensive goods and serpositioned to step up their capital spend- vices and by helping damp inflation ing once the outlook for sales and prof- expectations. More broadly, the comits improves. By all accounts, techno- petitive conditions that have restricted logical innovation is still proceeding businesses' ability to raise prices in rapidly, and these advances should even- recent years are likely to persist. And tually revive high-tech investment, espe- although labor costs could come under cially with the price of computing power upward pressure as wages tend to catch continuing to drop sharply. up to previous increases in productiv- In addition, consumer spending is ity, the slackening in resource utilizaexpected to get a boost from the tax tion this year is expected to contribute cuts and from falling energy prices, to reduced inflation pressures going which should help offset the effects of forward. the weaker job market and the decline over the past year in stock market Economic and Financial wealth. Housing activity, which has Developments in 2001 been buoyed in recent quarters by low mortgage interest rates, is likely to Economic growth remained very slow remain firm into 2002. Significant in the first half of 2001 after having concerns remain about the foreign eco- downshifted in the second half of 2000. nomic outlook and the prospects for U.S. Real gross domestic product rose at an exports. Nevertheless, economic activity annual rate of just VA percent in the abroad is expected to benefit from a first quarter, about the same as in the strengthening of the U.S. economy, a fourth quarter, and appears to have stabilization of the global high-tech posted at best a meager gain in the sector, an easing of oil prices, and stimu- second quarter. Businesses have been Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

76 88th Annual Report, 2001 working to correct the inventory imbal- stantial expansion of incentives and rose ances that emerged in the second half to just a tad below the record pace of of last year, which has led to sizable 2000 as a whole. In addition, outlays declines in manufacturing output, and for non-auto goods posted a solid gain, capital spending has weakened apprecia- and spending on services rose modestly bly. In contrast, household spending— despite a weather-related drop in outlays especially for motor vehicles and for energy services. In the second quarhouses—has held up well. Employment ter, however, the rise in consumer spendincreased only modestly over the first ing seems to have lessened as sales of three months of the year and turned light motor vehicles dropped a bit, on down in the spring; the unemployment average, and purchases of other goods rate in June stood at 4Vi percent, Vi per- apparently did not grow as fast in real centage point higher than in the fourth terms as they had in the first quarter. quarter of last year. The rise in real consumption so far The inflation news early this year was this year has been considerably smaller not very favorable, as energy prices than the outsized gains in the second continued to soar and as measures of half of the 1990s and into 2000. But the core inflation—which exclude food and increase in spending still outstripped energy—registered some pickup. More the growth in real disposable personal recently, however, energy prices have income (DPI), which has been restrained moved lower, and the monthly readings this year by further big increases in conon core inflation have returned to more sumer energy prices and by the detemoderate rates. Moreover, apart from rioration in the job market; between the energy, prices at earlier stages of pro- fourth quarter of 2000 and May, real cessing have been quiescent this year. DPI increased just about 2 percent at an annual rate, well below the average pace of the preceding few years. In addition, The Household Sector the net worth of households fell again in the first quarter, to a level 8 percent Growth in household spending has below the high reached in the first quarslowed noticeably from the rapid pace ter of 2000. On net, the ratio of houseof the past few years. Still, it was fairly hold net worth to DPI has returned to well maintained in the first half of 2001 about the level reached in 1997, signifidespite the weaker tenor of income, cantly below the recent peak but still wealth, and consumer confidence, and high by historical standards. In addition, the personal saving rate declined a bit consumer sentiment indexes, which had further. A greater number of households risen to extraordinary levels in the late encountered problems servicing debt, 1990s and remained there through last but widespread difficulties or restricfall, fell sharply around the turn of the tions on the availability of credit did not year. However, these indexes have not emerge. deteriorated further, on net, since the winter and are still at reasonably favor- Consumer Spending able levels when compared with the Real consumer spending grew at an readings for the pre-1997 period. annual rate of 3Vi percent in the first Rising household wealth almost cerquarter. Some of the increase reflected tainly was a key factor behind the surge a rebound in purchases of light motor in consumer spending between the midvehicles, which were boosted by a sub- 1990s and last year, and thus helps to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 11 explain the sharp fall in the personal able, mainly because of perceptions that saving rate over that period. The saving mortgage rates are low. rate has continued to fall this year— Likely because of the sustained from -0.7 percent in the fourth quarter strength of housing demand, home of 2000 to -1.1 percent in May—even prices have continued to rise faster than though the boost to spending growth overall inflation, although the various from the earlier run-up in stock prices measures that attempt to control for has likely run its course and the effects shifts in the regional composition of of lower wealth should be starting to sales and in the characteristics of houses feed through to spending. The apparent sold provide differing signals on the decline in the saving rate may simply magnitude of the price increases. Notareflect noisiness in the data or a slower bly, over the year ending in the first response of spending to wealth than quarter, the constant-quality price index average historical experience might sug- for new homes rose 4 percent, while gest. In addition, consumers probably the repeat-sales price index for existing base their spending decisions on income homes was up nearly 9 percent. Despite prospects over a longer time span than the higher prices, the share of income just a few quarters. Thus, to the extent required to finance a home purchase— that consumers do not expect the current one measure of affordability—has fallen sluggishness in real income growth to in recent quarters as mortgage rates have persist, the tendency to maintain spend- dropped back after last year's bulge, and ing for a time by dipping into savings or that share currently is about as low as it by borrowing may have offset the effect has been at any time in the past decade. of the decline in wealth on the saving Rates on thirty-year conventional fixedrate. rate loans now stand around 11A percent, and ARM rates are at their lowest levels in a couple of years. Residential Investment In the multifamily sector, housing Housing activity remained buoyant in starts averaged 343,000 units at an the first half of this year as lower mort- annual rate over the first five months of gage interest rates appear to have offset the year, matching the robust pace that the restraint from smaller gains in has been evident since 1997. Moreover, employment and income and from lower conditions in the market for multifamily levels of wealth. In the single-family housing continue to be conducive to sector, starts averaged an annual rate new construction. The vacancy rate for of 1.28 million units over the first five multifamily rental units in the first quarmonths of the year—4 percent greater ter held near its low year-earlier level, than the hefty pace for 2000 as a whole. and rents and property values continued Sales of new and existing homes to rise rapidly. strengthened noticeably around the turn of the year and were near record levels Household Finance in March; they fell back in April but reversed some of that drop in May. The growth of household debt is esti- Inventories of new homes for sale are mated to have slowed somewhat in the exceptionally low; builders' backlogs first half of this year to a still fairly hefty are sizable; and, according to the Michi- IV2 percent annual rate—about a pergan survey, consumers' assessments of centage point below its average pace homebuying conditions remain favor- over the previous two years. Households Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

78 88th Annual Report, 2001 have increased both their home mort- loans they are willing to make, substangage debt and their consumer credit tial increases from the November sur- (debt not secured by real estate) substan- vey. Of those that had tightened, most tially this year, although in both cases cited actual or anticipated increases in the growth has moderated a bit recently. delinquency rates as a reason. The relatively low mortgage interest rates have boosted mortgage borrowing both by stimulating home purchases The Business Sector and by making it attractive to refinance The boom in capital spending that has existing mortgages and extract some of helped fuel the economic expansion the buildup in home equity. The rapid came to a halt late last year. After havgrowth in consumer credit has been coning risen at double-digit rates over the centrated in credit card debt, perhaps preceding five years, real business fixed reflecting households' efforts to sustain investment flattened out in the fourth their consumption in the face of weaker quarter of 2000 and rose only a little in income growth. the first quarter of 2001. Demand for The household debt service burden— capital equipment has slackened apprethe ratio of minimum scheduled payciably, reflecting the sluggish economy, ments on mortgage and consumer debt sharply lower corporate profits and cash to disposable personal income—rose flow, earlier overinvestment in some to more than 14 percent at the end of sectors, and tight financing conditions the first quarter, a twenty-year high, and facing some firms. In addition, invenavailable data suggest a similar reading tory investment fell substantially in the for the second quarter. In part because first quarter as businesses moved to of the elevated debt burden, some meaaddress the overhangs that began to sures of household loan performance develop late last year. With investment have deteriorated a bit in recent quarspending weakening, businesses have ters. The delinquency rate on home cut back on new borrowing. Following mortgage loans has edged up but the drop in longer-term interest rates remains low, while the delinquency rate in the last few months of 2000, credit on credit card loans has risen noticeably demands have been concentrated in and is in the middle part of its range longer-term markets, though cautious over the past decade. Personal bankruptinvestors have required high spreads cies jumped to record levels in the from marginal borrowers. spring, but some of the spurt was probably the result of a rush to file before Fixed Investment Congress passed bankruptcy reform legislation. Real spending on equipment and soft- Lenders have tightened up somewhat ware (E&S) began to soften in the secin response to the deterioration of house- ond half of last year, and it posted small hold financial conditions. In the May declines in both the fourth quarter of Senior Loan Officer Opinion Survey on 2000 and the first quarter of 2001. Much Bank Lending Practices, about a fifth of of the weakness in the first quarter was the banks indicated that they had tight- in spending on high-tech equipment and ened the standards for approving appli- software; such spending, which now cations for consumer loans over the pre- accounts for about half of E&S outceding three months, and about a fourth lays when measured in nominal terms, said that they had tightened the terms on declined at an annual rate of about Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 79 12 percent in real terms—the first real surprisingly, one bright spot is the quarterly drop since the 1990 recession. energy sector, where expenditures for An especially sharp decrease in outlays drilling and mining have been on a for communications equipment reflected steep uptrend since early 1999 (mainly the excess capacity that had emerged as because of increased exploration for a result of the earlier surge in spending, natural gas) and the construction of the subsequent re-evaluation of profit- facilities for electric power generation ability, and the accompanying financing remains very strong. difficulties faced by some firms. In addition, real spending on computers and Inventory Investment peripheral equipment, which rose more than 40 percent per year in the second A sharp reduction in the pace of invenhalf of the 1990s, showed little growth, tory investment was a major damping on net, between the third quarter of 2000 influence on real GDP growth in the and the first quarter of 2001. The level- first quarter of 2001. The swing in real ing in real computer spending report- nonfarm inventory investment from an edly reflects some stretching out of busi- accumulation of $51 billion at an annual nesses' replacement cycles for personal rate in the fourth quarter of 2000 to a computers as well as a reduced demand liquidation of $25 billion in the first for servers. Outside the high-tech area, quarter of 2001 subtracted 3 percentage spending rose in the first quarter as pur- points from the growth in real GDP in chases of motor vehicles reversed some the first quarter. Nearly half of the negaof the decline recorded over the second tive contribution to GDP growth came half of 2000 and as outlays for industrial from the motor vehicle sector, where a equipment picked up after having been sizable cut in assemblies (added to the flat in the fourth quarter. reduction already in place in the fourth Real E&S spending likely dropped quarter) brought the overall days' supfurther in the second quarter. In addition ply down to comfortable levels by the to the ongoing contraction in outlays end of the first quarter. A rise in truck on high-tech equipment, the incoming assemblies early in the second quarter data for orders and shipments point to a led to some backup of inventories in decline in investment in non-high-tech that segment of the market, but truck equipment, largely reflecting the weak- stocks were back in an acceptable range ness in the manufacturing sector this by June; automobile assemblies were up year. only a little in the second quarter, and Outlays on nonresidential construc- stocks remained lean. tion posted another sizable advance in Firms outside the motor vehicles early 2001 after having expanded nearly industry also moved aggressively to 13 percent in real terms in 2000, but address inventory imbalances in the first the incoming monthly construction data half of the year, and this showed through imply a sharp retrenchment in the sec- to manufacturing output, which, excludond quarter. The downturn in spending ing motor vehicles, fell at an annual rate comes on the heels of an increase in of IVi percent over this period. These vacancy rates for office and industrial production adjustments—along with a space in many cities. Moreover, while sharp reduction in the flow of imports— financing generally remains available contributed to a small decline in real for projects with viable tenants, lenders non-auto stocks in the first quarter, and are now showing greater caution. Not book-value data for the manufactur- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

80 88th Annual Report, 2001 ing and trade sector point to a further The decline in C&I loans and comdecrease, on net, in April and May. As mercial paper owes, in part, to less of May, stocks generally seemed in line hospitable conditions in shorter-term with sales at retail trade establishments, funding markets. The commercial paper but there were still some notable over- market was rattled in mid-January by hangs in wholesale trade and especially the defaults of two large California utiliin manufacturing, where inventory- ties. Commercial paper is issued only by shipments ratios for producers of com- highly rated corporations, and default is puters and electronic products, primary extremely rare. The defaults, along with and fabricated metals, and chemicals some downgrades, led investors in comremained very high. mercial paper to pull back and reevaluate the riskiness of issuers. For a while, issuance by all but top-rated names Business Finance became very difficult and quality The economic profits of U.S. corpora- spreads widened significantly, pushing tions fell at a 19 percent annual rate in some issuers into the shortest maturities the first quarter after a similar decline and inducing others to exit the market in the fourth quarter of 2000. As a result, entirely. As a consequence, the amount the ratio of profits to GDP declined of commercial paper outstanding plum- 1 percentage point over the two quar- meted. In the second quarter, risk ters, to 8.5 percent; the ratio of the prof- spreads returned to more typical levels its of nonfinancial corporations to sector and the runoff moderated. By the end output fell 2 percentage points over of June, the amount of nonfinancial the interval, to 10 percent. Investment commercial paper outstanding was spending has declined by more than nearly 30 percent below its level at the profits, however, reducing somewhat the end of 2000, with many firms still not still-elevated need of nonfinancial cor- having returned to the market. porations for external funds to finance Even though banks' C&I loans were capital expenditures. Corporations have boosted in January and February by borhusbanded their increasingly scarce rowers substituting away from the cominternal funds by cutting back on cash- mercial paper market, loans declined, on financed mergers and equity repur- net, over the first half of the year, in part chases. While equity retirements have because borrowers paid down their bank therefore fallen, so has gross equity issu- loans with proceeds from bond issues. ance, though by less. Inflows of venture Many banks reported on the Federal equity capital, in particular, have been Reserve's Bank Lending Practices surreduced substantially. Businesses have veys this year that they had tightened met their financing needs by borrowing standards and terms—including the preheavily in the bond market while paying miums charged on riskier loans, the cost down both commercial and industrial of credit lines, and loan covenants— (C&I) loans at banks and commercial on C&I loans. Loan officers cited a paper. In total, after having increased worsened economic outlook, industry- 9V2 percent last year, the debt of non- specific problems, and a reduced tolerfinancial businesses rose at a 5 percent ance for risk as the reasons for having annual rate in the first quarter of this tightened. Despite these adjustments to year and is estimated to have risen at banks' lending stance, credit appears to about the same pace in the second remain amply available for sound borquarter. rowers, and recent surveys of small Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 81 businesses indicate that they have not other measures of credit performance found credit significantly more difficult have shown a more moderate worsento obtain. ing. The ratio of the liabilities of failed Meanwhile, the issuance of corporate businesses to those of all nonfinancial bonds this year has proceeded at about businesses and the delinquency rate on double the pace of the preceding two C&I loans at banks have risen noticeyears. With the yields on high-grade ably from their lows in 1998, but both bonds back down to their levels in the remain well below levels posted in the first half of 1999 and with futures early 1990s. quotes suggesting interest rates will be Commercial mortgage debt increased rising next year, corporations apparently at about an S3A percent annual rate in judged it to be a relatively opportune the first half of this year, and the issutime to issue. Although investors remain ance of commercial-mortgage-backed somewhat selective, they have been securities (CMBS) maintained its robust willing to absorb the large volume of pace of the past several years. While issuance as they have become more con- spreads of the yields on investment- and fident that the economy would recover speculative-grade CMBS over swap and a prolonged disruption to earnings rates have changed little this year, sigwould be avoided. The heavy pace of nificant fractions of banks reported issuance has been supported, in part, by on the Bank Lending Practices survey inflows into bond mutual funds, which that they have tightened terms and may have come at the expense of equity standards on commercial real estate funds. loans. Although the delinquency rates The flows are forthcoming at rela- on CMBS and commercial real estate tively high risk spreads, however. loans at banks edged up in the first Spreads of most grades of corporate debt quarter, they remained near record lows. relative to rates on swaps have fallen Nevertheless, those commercial banks a little this year, but spreads remain that reported taking a more cautious unusually high for lower investment- approach toward commercial real estate grade and speculative-grade credits. The lending stated that they are doing so, in elevated spreads reflect the deteriora- part, because of a less favorable ecotion in business credit quality that has nomic outlook in general and a worsenoccurred as the economy has slowed. ing of the outlook for commercial real While declines in interest rates have estate. held aggregate interest expense at a relatively low percentage of cash flow, The Government Sector many individual firms are feeling the pinch of decreases in earnings. Over the The fiscal 2001 surplus in the federal twelve months ending in May, 11 per- unified budget is likely to be smaller cent of speculative-grade bonds, by dol- than the surplus in fiscal 2000 because lar volume, have defaulted—the highest of the slower growth in the economy percentage since 1991 and a substan- and the recently enacted tax legislation. tial jump from 1998, when less than Nonetheless, the unified surplus will 2 percent defaulted. This deterioration remain large, and the paydown of the reflects not only the unusually large federal debt is continuing at a rapid defaults by the California utilities, but clip. As a consequence, the Treasury has also stress in the telecommunications taken a number of steps to preserve sector and elsewhere. However, some liquidity in a shrinking market. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

82 88th Annual Report, 2001 weaker economy is also reducing reve- technology-driven boom in domestic nues at the state and local level, but investment in recent years. these governments remain in reasonably Federal receipts in the first eight good fiscal shape overall and are taking months of the current fiscal year were advantage of historically low interest just AXA percent higher than during the rates to refund existing debt and to issue first eight months of fiscal 2000—a new debt. much smaller gain than those posted, on average, over the preceding several years. Much of the slowing was in cor- Federal Government porate receipts, which dropped below The fiscal 2001 surplus in the federal year-earlier levels, reflecting the recent government's unified budget is likely to deterioration in profits. In addition, indicome in below the fiscal 2000 surplus of vidual income tax payments rose less $236 billion. Over the first eight months rapidly than over the preceding few of the fiscal year—October to May—the years, mainly because of slower growth unified budget recorded a surplus of in withheld tax payments. This spring's $137 billion, $16 billion higher than nonwithheld payments of individual during the comparable period last year. taxes, which are largely payments on the But over the balance of the fiscal year, previous year's liability, were relatively receipts will continue to be restrained strong. Indeed, although there was no by this year's slow pace of economic appreciable "April surprise" this year— growth and the associated decline in that is, these payments were about in corporate profits. Receipts will also be line with expectations—liabilities again reduced significantly over the next few appear to have risen faster than the months by the payout of tax rebates and NIPA tax base in 2000. One factor that the shift of some corporate payments has lifted liabilities relative to income into fiscal 2002, provisions included in in recent years is that rising levels of the Economic Growth and Tax Relief income and a changing distribution have Reconciliation Act of 2001. shifted more taxpayers into higher tax Federal saving, which is basically brackets. Higher capital gains realizathe unified budget surplus adjusted to tions also have helped raise liabilities conform to the accounting practices fol- relative to the NIPA tax base over this lowed in the national income and prod- period. (Capital gains are not included uct accounts (NIPA), has risen dramati- in the NIPA income measure, which, by cally since hitting a low of —3V2 percent design, includes only income from curof GDP in 1992 and stood at 33/ percent rent production.) 4 of GDP in the first quarter—a swing of The faster growth in outlays that more than 7 percentage points. Reflect- emerged in fiscal 2000 has extended ing the high level of federal saving, into fiscal 2001. Smoothing through national saving, which comprises saving some timing anomalies at the start of the by households, businesses, and govern- fiscal year, nominal spending during the ments, has been running at a higher rate first eight months of fiscal 2001 was since the late 1990s than it did over more than 4 percent higher than during most of the preceding decade, even as the same period last year; excluding the the personal saving rate has plummeted. sizable drop in net interest outlays that The deeper pool of national saving, has accompanied the paydown of the along with large inflows of foreign federal debt, the increase in spending capital, has provided resources for the so far this year was nearly 6 percent. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 83 Spending in the past couple of years following the market turmoil in the fall has been boosted by sizable increases of 1998. in discretionary appropriations as well The Treasury has taken a number of as by faster growth in outlays for the steps to limit the deterioration in the major health programs. The especially liquidity of its securities. In recent years, rapid increase in Medicaid outlays it has concentrated its issuance into reflects the higher cost and utilization fewer securities, so that the auction sizes of medical care (including prescription of the remaining securities are larger. drugs), growing enrollments, and a rise Last year, in order to enable issuance of in the share of expenses picked up a larger volume of new securities, the by the federal government. Outlays for Treasury began buying back less-liquid Medicare have been lifted, in part, by older securities, and it also made every the higher reimbursements to providers second auction of its 5- and 10-year that were enacted last year. notes and 30-year bond a reopening of Real federal expenditures for con- the previously issued security. In Februsumption and gross investment, the part ary, the Treasury put limits on the nonof government spending that is included competitive bids that foreign central in GDP, rose at a 5 percent annual rate banks and governmental monetary entiin the first quarter. Over the past couple ties may make, so as to leave a larger of years, real nondefense purchases have and more predictable pool of securities remained on the moderate uptrend that available for competitive bidding, helphas been evident since the mid-1990s, ing to maintain the liquidity and effiwhile real defense purchases have ciency of the market. In May, the Treastarted to rise slowly after having bot- sury announced that it would begin tomed out in the late 1990s. issuing Treasury bills with a four-week The Treasury has used the substantial maturity to provide it with greater flexfederal budget surpluses to pay down ibility and cost efficiency in managits debt further. At the end of June, the ing its cash balances, which, in part outstanding Treasury debt held by the because new securities are now issued public had fallen nearly $600 billion, or less frequently, have become more vola- 15 percent, from its peak in 1997. Rela- tile. Finally, also in May, the Treasury tive to nominal GDP, publicly held debt announced it would in the next few has dropped from nearly 50 percent in months seek public comment on a plan the mid-1990s to below 33 percent in to ease the "35 percent rule," which the first quarter, the lowest it has been limits the bidding at auctions by those since 1984. holding claims on large amounts of an Declines in outstanding federal debt issue. With reopenings increasingly and the associated reductions in the sizes being used to maintain liquidity in indiand frequency of auctions of new issues vidual issues, this rule was constraining have diminished the liquidity of the many potential bidders. As discussed Treasury market over the past few years. below, the reduced issuance of Trea- Bid-asked spreads are somewhat wider, sury securities has also led the Federal quote sizes are smaller, and the differ- Reserve to modify its procedures for ence between yields on seasoned versus acquiring such securities and to study most-recently issued securities has possible future steps for its portfolio. increased. In part, however, these devel- In early 2000, as investors focused opments may also reflect a more cau- on the possibility that Treasury securitious attitude among securities dealers ties were going to become increasingly Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

84 88th Annual Report, 2001 scarce, they became willing to pay a managed to adopt balanced budgets for premium for longer-dated securities, fiscal 2002 with only minor adjustments pushing down their yields. However, to taxes and spending. these premiums appear to have largely Real consumption and investment unwound later in the year as market spending by state and local governments participants made adjustments to the rose at nearly a 5 percent annual rate new environment. These adjustments in the first quarter and apparently posted include the substitution of alternative a sizable increase in the second quarter instruments for hedging and pricing, as well. Much of the strength this year such as interest rate swaps, prominent has been in construction spending, high-grade corporate bonds, and securi- which has rebounded sharply after a ties issued by government-sponsored reported decline in 2000 that was hard enterprises (GSEs). To benefit from to reconcile with the sector's ongoing adjustments by market participants, in infrastructure needs and the good finan- 1998, Fannie Mae and Freddie Mac ini- cial condition of most governments. tiated programs to issue securities that Hiring also remained fairly brisk during share some characteristics with Trea- the first half of the year; on average, sury securities, such as regular issuance employment rose 30,000 per month, calendars and large issue sizes; in the about the same as the average monthly first half of this year they issued $88 bil- increase over the preceding three lion of coupon securities and $502 bil- years. lion of bills under these programs. The Although interest rates on munici- GSEs have also this year begun buy- pal debt have edged up this year, they ing back older securities to boost the remain low by historical standards. size of their new issues. Nevertheless, State and local governments have taken the market for Treasury securities advantage of the low interest rates to remains considerably more liquid than refund existing debt and to raise new markets for GSE and other fixed-income capital. Credit quality has remained securities. quite high in the municipal sector even as tax receipts have softened, with credit upgrades outpacing downgrades State and Local Governments in the first half of this year. Most State and local governments saw an notable among the downgrades was that enormous improvement in their budget of California's general obligation bonds. positions between the mid-1990s and Standard and Poor's lowered Califorlast year as revenues soared and spend- nia's debt two notches from AA to A+, ing generally was held in check; accord- citing the financial pressures from the ingly, these governments were able both electricity crisis and the likely adverse to lower taxes and to make substan- effects of the crisis on the state's tial allocations to reserve funds. More economy. recently, however, revenue growth has slowed in many states, and reports of The External Sector fiscal strains have increased. Nonetheless, the sector remains in relatively The deficits in U.S. external balances good fiscal shape overall, and most gov- narrowed sharply in the first quarter of ernments facing revenue shortfalls have this year, largely because of a smaller Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 85 deficit in trade in goods and services. quarter, slightly higher than the rate of Most of the financial flows into the increase recorded in 2000. United States continued to come from U.S. real exports were hit by slower private foreign sources. growth abroad, the strength of the dollar, and plunging global demand for high-tech products. Real exports of Trade and Current Account goods and services, which had grown After widening continuously during the strongly in the first three quarters of past four years, the deficits in U.S. exter- 2000, fell 6V2 percent at an annual rate nal balances narrowed in the first quar- in the fourth quarter of last year and ter of 2001. The current account deficit declined another 1 percent in the first in the first quarter was $438 billion at an quarter of this year. The largest declines annual rate, or 4.3 percent of GDP, com- in both quarters were in high-tech capipared with $465 billion in the fourth tal goods and automotive products (priquarter of 2000. Most of the reduction marily in intrafirm trade with Canada). of the current account deficit can be By market destination, the largest traced to changes in U.S. trade in goods increases in U.S. goods exports during and services; the trade deficit narrowed the first three quarters of 2000 had been from an annual rate of $401 billion in to Mexico and countries in Asia; the the fourth quarter of 2000 to $380 bil- recent declines were mainly in exports lion in the first quarter of this year. The to Asia and Latin America. In contrast, trade deficit in April continued at about goods exports to Western Europe the same pace. Net investment income increased steadily throughout the entire payments were a bit less in the first period. About 45 percent of U.S. goods quarter than the average for last year exports in the first quarter of 2001 were primarily because of a sizable decrease capital equipment; 20 percent were in earnings by U.S. affiliates of foreign industrial supplies; and 5 to 10 percent firms. each were agricultural, automotive, consumer, and other goods. As US. economic growth slowed in the second half of last year and early After increasing through much of this year, real imports of goods and 2000, the spot price of West Texas interservices, which had grown very rapidly mediate (WTI) crude oil reached a peak in the first three quarters of 2000, above $37 per barrel in September, the expanded more slowly in the fourth highest level since the Gulf War. As quarter and then contracted 5 percent world economic growth slowed in the at an annual rate in the first quarter. latter part of 2000, oil price declines The largest declines were in high-tech reversed much of the year's price gain. products (computers, semiconductors, In response, OPEC reduced its official and telecommunications equipment) production targets in January of this year and automotive products. In contrast, and again in March. As a result, oil imports of petroleum and petroleum prices have remained relatively high in products increased moderately. A tem- 2001 despite weaker global economic porary surge in the price of imported growth and a substantial increase in natural gas pushed the increase of the U.S. oil inventories. Oil prices have also average price of non-oil imports above been elevated by the volatility of Iraqi an annual rate of 1 percent in the first oil exports arising from tense relations Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

86 88* Annual Report, 2001 between Iraq and the United Nations. ing, and the unemployment rate rose. During the first six months of this year, Increases in hourly compensation have the spot price of WTI has fluctuated, continued to trend up in recent quarters, with only brief exceptions, between $27 while measured labor productivity has and $30 per barrel. been depressed by the slower growth of output. Financial Account In the first quarter of 2001, as was the Employment and Unemployment case in 2000 as a whole, nearly all of the After having risen an average of net financial flows into the United States 149,000 per month in 2000, private paycame from private foreign sources. Forroll employment increased an average eign official inflows were less than of only 63,000 per month in the first $5 billion and were composed primarquarter of 2001, and it declined an averily of the reinvestment of accumulated age of 117,000 per month in the second interest earnings. Reported foreign quarter. The unemployment rate moved exchange intervention purchases of dolup over the first half of the year and in lars were modest. June stood at 4Vi percent, V2 percentage Inflows arising from private foreign point higher than in the fourth quarter of purchases of U.S. securities accelerated last year. further in the first quarter and are on a Much of the weakness in employment pace to exceed last year's record. All of in the first half of the year was in the the pickup is attributable to larger net manufacturing sector, where job losses foreign purchases of U.S. bonds, as foraveraged 78,000 per month in the first eign purchases of both corporate and quarter and 116,000 per month in the agency bonds accelerated and private second quarter. Since last July, manufacforeign sales of Treasuries paused. Forturing employment has fallen nearly eign purchases of U.S. equities are only 800,000. Factory job losses were wideslightly below their 2000 pace despite spread in the first half of the year, with the apparent decline in expected returns some of the biggest cutbacks at industo holding US. equities. tries struggling with sizable inventory The pace at which U.S. residents overhangs, including metals and indusacquired foreign securities changed little trial and electronic equipment. The between the second half of last year and weakness in manufacturing also cut into the first quarter of this year. As in previemployment at help-supply firms and at ous years, most of the foreign securities wholesale trade establishments. acquired were equities. Apart from manufacturing and the Net financial inflows associated with closely related help-supply and wholedirect investment slowed a good bit in sale trade industries, employment the first quarter, as there were signifigrowth held up fairly well in the first cantly fewer large foreign takeovers of quarter but began to slip noticeably in U.S. firms and US. direct investment the second quarter. Some of the slowing abroad remained robust. in the second quarter reflected a drop in construction employment after a strong first quarter that likely absorbed a por- The Labor Market tion of the hiring that normally takes Labor demand weakened in the first place in the spring; on average, conhalf of 2001, especially in manufactur- struction employment rose a fairly brisk Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 87 15,000 per month over the first half, through the annual revision process— about the same as in 2000. Hiring in the shows a steady uptrend over the past services industry (other than help-supply couple of years; it rose 6 percent over firms) also slowed markedly in the sec- the year ending in the first quarter after ond quarter. Employment in retail trade having risen AVi percent over the preremained on a moderate uptrend over ceding year. the first half of the year, and employ- According to the ECI, wages and ment in finance, insurance, and real salaries rose at an annual rate of about estate increased modestly after having AV2 percent in the first quarter. Excludbeen unchanged, on net, last year. ing sales workers, wages rose 5 percent (annual rate) in the first quarter and 4V4 percent over the year ending in Labor Costs and Productivity March; this compares with an increase Through the first quarter, compensation of 3% percent over the year ending in growth remained quite strong—indeed, March 2000. Separate data on average trending higher by some measures. hourly earnings of production or non- These gains likely reflected the influ- supervisory workers also show a disence of earlier tight labor markets, cernible acceleration of wages: The higher consumer price inflation— twelve-month change in this series was largely due to soaring energy prices— AXA percent in June, V2 percentage point and the greater real wage gains made above the reading for the preceding possible by faster structural productivity twelve months. growth. The upward pressures on labor Benefit costs as measured in the ECI costs could abate in coming quarters if have risen faster than wages over the pressures in labor markets ease and past year, with the increase over the energy prices fall back. twelve months ending in March totaling Hourly compensation, as measured by 5 percent. Much of the pressure on benethe employment cost index (ECI) for fits is coming from health insurance, private nonfarm businesses, moved up where employer payments have accelerin the first quarter to a level about ated steadily since bottoming out in the AlA percent above its level of a year mid-1990s and are now going up about earlier; this compares with increases of 8 percent per year. The surge in spendabout 4Vi percent over the preceding ing on prescription drugs accounts for year and 3 percent over the year before some of the rise in health insurance that. The slight deceleration in the most costs, but demand for other types of recent twelve-month change in the ECI medical care is increasing rapidly as is accounted for by a slowdown in the well. Moreover, although there has growth of compensation for sales work- been some revamping of drug coverage ers relative to the elevated rates that had to counter the pressures of soaring prevailed in early 2000; these workers' demand, many employers have been pay includes a substantial commission reluctant to adjust other features of the component and thus is especially sensi- health benefits package in view of the tive to cyclical developments. Compen- need to retain workers in a labor market sation per hour in the nonfarm business that has been very tight in recent years. sector—a measure that picks up some Measured labor productivity in the forms of compensation that the ECI nonfarm business sector has been omits but that sometimes has been bounced around in recent quarters by revised substantially once the data go erratic swings in hours worked by self- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88 88th Annual Report, 2001 employed individuals, but on balance, it May but eased in June and early July. In has barely risen since the third quarter addition, core PCE price inflation has of last year after having increased about dropped back after the first-quarter 3 percent per year, on average, over the spurt, and the twelve-month change in preceding three years. This deceleration this series, which is a useful indicator of coincides with a marked slowing in out- the underlying inflation trend, stood at put growth and seems broadly in line \xh percent in May, about the same as with the experience of past business the change over the preceding twelve cycles; these readings remain consistent months. The core consumer price index with a noticeable acceleration in struc- (CPI) continued to move up at a faster tural productivity having occurred in the pace than the core PCE measure over second half of the 1990s. Reflecting the the past year, rising 2Vi percent over the movements in hourly compensation and twelve months ending in May, also the in actual productivity, unit labor costs in same rate as over the preceding year. the nonfarm business sector jumped in PCE energy prices rose at an annual the first quarter and have risen 3Vi per- rate of about 11 percent in the first quarcent over the past year. ter and, given the big increases in April Looking ahead, prospects for favor- and May, apparently posted another able productivity performance will sizable advance in the second quarter. hinge on a continuation of the rapid Unlike the surges in energy prices in technological advances of recent years 1999 and 2000, the increases in the first and on the willingness of businesses to half of 2001 were not driven by develexpand and update their capital stocks opments in crude oil markets. Indeed, to take advantage of the new efficiency- natural gas prices were the major factor enhancing capital that is becoming boosting overall energy prices early this available at declining cost in many year as tight inventories and concerns cases. To be sure, the current weakness about potential stock-outs pushed spot in business investment will likely damp prices to extremely high levels; natuthe growth of the capital stock relative ral gas prices have since receded as to the pace of the past couple of years. additional supplies have come on line But once the cyclical weakness in the and inventories have been rebuilt. In economy dissipates, continued advances the spring, gasoline prices soared in in technology should provide impetus to response to strong demand, refinery renewed capital spending and a return to disruptions, and concerns about lean solid increases in productivity. inventories; with refineries back on line, imports up, and inventories restored, gasoline prices have since fallen notice- Prices ably below their mid-May peaks. Elec- Inflation moved higher in early 2001 but tricity prices also rose substantially has moderated some in recent months. in the first half of the year, reflecting After having risen 2VA percent in 2000, higher natural gas prices as well as the the chain price index for personal con- problems in California. Capacity probsumption expenditures (PCE) increased lems in California and the hydropower about 3V4 percent in the first quarter of shortages in the Northwest persist, 2001 as energy prices soared and as core though California's electricity consumpconsumer prices—which exclude food tion has declined recently and wholeand energy—picked up. Energy prices sale prices have dropped. In contrast, continued to rise rapidly in April and capacity in the rest of the country Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 89 has expanded appreciably over the past firms facing foreign competition to year and, on the whole, appears ade- raise prices for fear of losing market quate to meet the normal seasonal rise in share. In addition, apart from energy, demand. price pressures at earlier stages of Core PCE prices rose at a 2J/2 percent processing have been minimal. Indeed, annual rate in the first quarter—a hefty excluding food and energy, the producer increase by the standards of recent price index (PPI) for intermediate mateyears. But the data are volatile, and the rials has been flat over the past year, and first-quarter increase, no doubt, exagger- the PPI for crude materials has fallen ates any pickup. Based on monthly data 11 percent. Moreover, inflation expecfor April and May, core PCE inflation tations, on balance, seem to have appears to have slowed considerably in remained quiescent: According to the the second quarter; the slowing was con- Michigan survey, the median expectacentrated in the goods categories and tion for inflation over the upcoming year seems consistent with reports that retail- generally has been running about 3 perers have been cutting prices to spur sales cent this year, similar to the readings in in an environment of soft demand. 2000. Core consumer price inflation— In contrast to the step-up in consumer whether measured by the PCE index or prices, prices for private investment by the CPI—in recent quarters almost goods in the NIPA were up only a little certainly has been boosted by the effects in the first quarter after having risen of higher energy prices on the costs of about 2 percent last year. In large part, producing other goods and services. this pattern was driven by movements in Additional pressure has come from the the price index for computers, which fell step-up in labor costs. That said, firms at an annual rate of nearly 30 percent in appear to have absorbed much of these the first quarter as demand for high-tech cost increases in lower profit margins. equipment plunged. This drop in com- Meanwhile, non-oil import prices have puter prices was considerably greater remained subdued, thus continuing to than the average decrease of roughly restrain input costs for many domestic 20 percent per year in the second half industries and to limit the ability of of the 1990s and the unusually small Alternative Measures of Price Change Percent, Ql to Ql 1998 1999 2000 Price measure to to to 1999 2000 2001 Chain-type Gross domestic product 1.5 1.8 2.3 Gross domestic purchases 1.2 2.3 2.2 Personal consumption expenditures 1.5 2.5 2.2 Excluding food and energy 1.8 1.6 1.7 Fixed-weight Consumer price index 1.7 3.3 3.4 Excluding food and energy 2.2 2.2 2.7 NOTE. A fixed-weight index uses quantity weights to change each year. The consumer price indexes are for from a base year to aggregate prices from each distinct all urban consumers. Changes are based on quarterly item category. A chain-type index is the geometric aver- averages. age of two fixed-weight indexes and allows the weights Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

90 88th Annual Report, 2001 11 percent decrease in 2000. Monthly first half of this year as near-term cor- PPI data suggest that computer prices porate earnings were revised down subwere down again in the second quarter, stantially. Rates on longer-term Treathough much less than in the first sury issues rose a little, but those on quarter. corporate bonds were about unchanged, All told, the GDP chain-type price with the narrowing spread reflecting index rose at an annual rate of 3Vi per- greater investor confidence in the outcent in the first quarter and has risen look. But risk spreads remained wide 2VA percent over the past four quarters, by historical standards for businesses an acceleration of Vi percentage point whose debt was rated as marginally from the comparable year-earlier period. investment grade or below; many of The price index for gross domestic these firms had been especially hard purchases—which is defined as the hit by the slowdown and the near-term prices paid for consumption, investment, oversupply of high-tech equipment and and government purchases—also accel- services, and defaults by these firms erated in the first quarter—to an increase became more frequent. Nevertheless, for of about 23/4 percent; the increase in this most borrowers the environment for measure over the past year was 2lA per- long-term financing was seen to be quite cent, about the same as over the preced- favorable, and firms and households ing year. Excluding food and energy, the tended to tap long-term sources of credit latest four-quarter changes in both GDP in size to bolster their financial condiand gross domestic purchases prices tions and lock in more favorable costs. were roughly the same as over the preceding year. Interest Rates In response to the abrupt deceleration U.S. Financial Markets in economic growth and prospects for Longer-term interest rates and equity continued weakness in the economy, the prices have shown remarkably small net FOMC lowered the target federal funds changes this year, given the consider- rate 23A percentage points in six steps able shifts in economic prospects and in the first half of this year, an unusually major changes in monetary policy. To steep decline relative to many past eassome extent, the expectations of the eco- ing cycles. Through March, the policy nomic and policy developments in 2001 easings combined with declining equity had already become embedded in finan- prices and accumulating evidence that cial asset prices as last year came to a the slowdown in economic growth was close; from the end of August through more pronounced than had been iniyear-end, the broadest equity price tially thought led to declines in yields indexes fell 15 percent and investment- on intermediate- and longer-term Treagrade bond yields declined 40 to sury securities. Over the second quar- 70 basis points. In addition, however, ter, despite the continued decrease in equity prices and long-term interest rates short-term rates and further indications were influenced importantly by growing of a weakening economy, yields on optimism in financial markets over the intermediate-term Treasury securities second quarter of 2001 that the econ- were about unchanged, while those on omy and profits would rebound strongly longer-term securities rose appreciably. toward the end of 2001 and in 2002. On On net, yields on intermediate-term net, equity prices fell 6 percent in the Treasury securities fell about 3A per- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 91 centage point in the first half of this vated. Spreads of corporate bond yields year, while those on longer-term Trea- relative to swap rates narrowed a bit, sury securities rose about lA percentage although they still remain high. Amidst point. signs of deteriorating credit quality and The increase in longer-term Treasury a worsening outlook for corporate earnyields in the second quarter appears to ings, risk spreads on speculative-grade have been the result of a number of bonds had risen by about 2 percentage factors. The main influence seems to points late last year, reaching levels not have been increased investor confidence seen since 1991. Much of this widening that the economy would soon pick up. was reversed early in the year, as inves- That confidence likely arose in part from tors became more confident that corpothe aggressive easing of monetary pol- rate balance sheets would not deterioicy and also in part from the improving rate substantially, but speculative-grade prospects for, and passage of, a sizable bond spreads widened again recently in tax cut. The tax cut and the growing response to negative news about secondsupport for certain spending initiatives quarter earnings and declines in share implied stronger aggregate demand and prices, leaving these spreads at the end less federal saving than previously of the second quarter only slightly anticipated. The prospect that the fed- below where they began the year. Noneeral debt might be paid down less rap- theless, investors, while somewhat idly may also have reduced slightly selective, appear to remain receptive the scarcity premiums investors were to new issues with speculative-grade willing to pay for Treasury securities. ratings. Finally, a portion of the rise may have Interest rates on commercial paper been the result of increased inflation and C&I loans have fallen this year by expectations. Inflation compensation as about as much as the federal funds rate, measured by the difference between although some risk spreads widened. nominal Treasury rates and the rates The average yield spread on second-tier on inflation-indexed Treasury securities commercial paper over top-tier paper rose about lA percentage point in the widened to about 100 basis points in second quarter. Despite this increase, late January, about four times its typithere is little evidence that inflation is cal level, following defaults by a few expected to go up from its current level. prominent issuers. As the year pro- At the end of last year, inflation com- gressed, investors became less conpensation had declined to levels suggest- cerned about the remaining commering investors expected inflation to fall, cial paper borrowers, and this spread and the rise in inflation compensation in has returned to a more normal level. the second quarter largely reversed those According to preliminary data from the declines. Moreover, survey measures of Federal Reserve's quarterly Survey of longer-term inflation expectations have Terms of Business Lending, the spread changed little since the middle of last over the target federal funds rate of year. the average interest rate on commercial Yields on longer-maturity corporate bank C&I loans edged up between bonds were about unchanged, on net, November and May and remains in the over the first half of this year. Yields on elevated range it shifted to in late 1998. investment-grade bonds are near their Judging from the widening since 1998 lows for the past ten years, but those of the average spread between rates on on speculative-grade bonds are ele- riskier and less-risky loans, banks have Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

92 88th Annual Report, 2001 become especially cautious about lend- time. This measure of the earningsing to marginal credits. price ratio remains near the levels reached in 1999, suggesting that investors still anticipate robust long-term Equity Markets earnings growth, likely reflecting expec- After rising in January in response to the tations for continued strong gains in initial easing of monetary policy, stock productivity. prices declined in February and March Despite the substantial variation in in reaction to profit warnings and weak share prices over the first half of this economic data, with the Wilshire 5000, year, trading has been orderly, and the broadest major stock price index, financial institutions appear to have ending the first quarter down 13 percent. encountered no difficulties that could Stock prices retraced some of those pose broader systemic concerns. Market losses in the second quarter, rising 7 per- volatility and a less ebullient outlook cent, as first-quarter earnings releases have led investors to buy a much smaller came in a little above sharply reduced share of stock on margin. At the end of expectations and as investors became May, margin debt was 1.15 percent of more confident that economic growth total market capitalization, equal to its and corporate profits would soon pick level at the beginning of 1999 and well up. On net, the Wilshire 5000 ended the below its high of 1.63 percent in March half down 6 percent, the DJIA declined of last year. 3 percent, and the tech-heavy Nasdaq fell 13 percent. Earnings per share of the Federal Reserve Open Market S&P 500 in the first quarter decreased Operations 10 percent from a year earlier. A disproportionate share of the decline in S&P As noted earlier, the Federal Reserve earnings—more than half—was attribut- has responded to the diminished size of able to a plunge in the technology sec- the auctions of Treasury securities by tor, where first-quarter earnings were modifying its procedures for acquiring down nearly 50 percent from their peak such securities. To help maintain supply in the third quarter of last year. in private hands adequate for liquid mar- The decline in stock prices has left kets, since July of last year the System the Wilshire 5000 down by about has limited its holdings of individual 20 percent, and the Nasdaq down by securities to specified percentages, rangabout 60 percent, from their peaks in ing from 15 percent to 35 percent, of March 2000. Both of these indexes are outstanding amounts. To stay within near their levels at the end of 1998, these limits, the System has at times not having erased the sharp run-up in rolled over all of its holdings of maturprices in 1999 and early 2000. But both ing securities, generally investing the indexes remain more than two and one- difference by purchasing other Treasury half times their levels at the end of securities on the open market. The Fed- 1994, when the bull market shifted into eral Reserve also has increased its holda higher gear. The ratio of expected one- ings of longer-term repurchase agreeyear-ahead earnings to equity prices ments (RPs), including RPs backed by began to fall in 1995 when, as produc- agency securities and mortgage-backed tivity growth picked up, investors began securities, as a substitute for outright to build in expectations that increases purchases of Treasury securities. In the in earnings would remain rapid for some first half of the year, longer-term RPs, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 93 typically with maturities of twenty-eight in the growth of nonfederal and federal days, averaged $13 billion. debt this year have mostly offset each As reported in the previous Monetary other. The growth of nonfederal debt Policy Report, the FOMC also initiated moderated from SV2 percent in 2000 to a a study to evaluate assets to hold on its still-robust 11A percent pace in the first balance sheet as alternatives to Treasury half of this year. Households' borrowing securities. That study identified several slowed some but was still substantial, options for further consideration. In the buoyed by continued sizable home and near term, the Federal Reserve is con- durable goods purchases. Similarly, sidering purchasing and holding Ginnie business borrowing moderated even as Mae mortgage-backed securities, which bond issuance surged, as a good portion are explicitly backed by the full faith of the funds raised was used to pay and credit of the U.S. government, down commercial paper and bank loans. and engaging in repurchase operations Tending to boost debt growth was a against foreign sovereign debt. For pos- slowing in the decline in federal debt to sible implementation later, the Federal a 6lA percent rate in the first half of this Reserve is studying whether to auction year from 63A percent last year, largely longer-term discount window credit, and because of a decline in tax receipts on it will over time take a closer look at corporate profits. a broader array of assets for repurchase The share of credit to nonfinancial and for holding outright, transactions sectors held at banks and other deposithat would require additional legal tory institutions edged down in the first authority. half of the year. Bank credit, which accounts for about three-fourths of depository credit, increased at a 31/2 per- Debt and the Monetary Aggregates cent annual rate in the first half of the year, well off the 9Vi percent growth The growth of domestic nonfinancial registered in 2000. Banks' loans to busidebt in the first half of 2001 is estimated nesses and households decelerated even to have remained moderate, slowing more, in part because borrowers preslightly from the pace in 2000 as a ferred to lock in the lower rates availreduction in the rate of increase in nonable from longer-term sources of funds federal debt more than offset the effects such as bond and mortgage markets and of smaller net repayments of federal perhaps also in part because banks debt. In contrast, the monetary aggrefirmed up their lending stance in reacgates have grown rapidly so far this tion to concerns about loan perforyear, in large part because the sharp mance. Loan delinquency and chargedecline in short-term market interest off rates have trended up in recent rates has reduced the opportunity cost of quarters, and higher loan-loss provisions holding the deposits and other assets have weighed on profits. Nevertheless, included in the aggregates. through the first quarter, bank profits remained in the high range recorded for Debt and Depository Intermediation the past several years, and virtually all The debt of the domestic nonfinancial banks—98 percent by assets—were well sectors is estimated to have expanded at capitalized. With banks' financial condia 43A percent annual rate over the first tion still quite sound, they remain well half of 2001, a touch below the 5lA per- positioned to meet future increases in cent growth recorded in 2000. Changes the demand for credit. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

94 88th Annual Report, 2001 The Monetary Aggregates kept headline inflation rates somewhat elevated, but even though core rates of The monetary aggregates have expanded inflation have edged up in countries rapidly so far this year, although growth where economic slack has diminished, rates have moderated somewhat inflationary pressures appear to be well recently. M2 rose \0xA percent at an under control. annual rate in the first half of this year Monetary authorities in most cases after having grown 6lA percent in 2000. reacted to signs of slowdown by lower- The interest rates on many of the coming official rates, but by less than in the ponents of M2 do not adjust quickly or United States. Partly in response to these fully to changes in market interest rates. actions, yield curves have steepened As a consequence, the steep declines in noticeably so far in 2001. Although short-term market rates this year have long-term interest rates moved down left investments in M2 assets relatively during the first quarter, they more than more attractive, contributing importantly reversed those declines in most cases to the acceleration in the aggregate. M2 as markets reacted to a combination of has also probably been buoyed by the the anticipation of stronger real growth volatility in the stock market this year, and the risk of increased inflationary and perhaps by lower expected returns pressure. Foreign equity markets— on equity investments, leading investors especially for high-tech stocks—were to seek the safety and liquidity of M2 buffeted early this year by many of assets. the same factors that affected U.S. M3, the broadest monetary aggreshare prices: negative earnings reports, gate, rose at a 13VA percent annual rate weaker economic activity, buildups of through June, following 9lA percent inventories of high-tech goods, and growth in 2000. All of the increase in uncertainties regarding the timing and M3, apart from that accounted for by extent of policy responses. In recent M2, resulted from a ballooning of instimonths, the major foreign equity tutional money market funds, which indexes moved up along with U.S. stock expanded by nearly a third. Yields on prices, but they have edged off lately these funds lag market yields somewhat, and in most cases are down, on balance, and so the returns to the funds, like for the year so far. those on many M2 assets, became rela- Slower U.S. growth, monetary easing tively attractive as interest rates on by the Federal Reserve, fluctuations short-term market instruments declined. in U.S. stock prices, and the large U.S. external deficit have not undermined dollar strength. After the December International Developments 2000 FOMC meeting, the dollar lost So far this year, average foreign growth ground against the major currencies; but has weakened further and is well below shortly after the FOMC's surprise rate its pace of a year ago. Activity abroad cut on January 3, the dollar reversed all was restrained by the continued high of that decline as market participants level of oil prices, the global slump evidently reassessed the prospects for of the high-technology sector, and recovery in the United States versus that spillover effects from the U.S. eco- in our major trading partners. The dollar nomic slowdown, but in some countries as measured by a trade-weighted index domestic demand softened as well in against the currencies of major indusreaction to local factors. High oil prices trial countries gained in value steadily Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 95 in the first three months of 2001, reach- inflation moves up to zero or above. ing a fifteen-year high in late March. After the yen had moved near the end of Continued flows of foreign funds into March to its weakest level relative to the U.S. assets appeared to be contribut- dollar in more than four years, Japanese ing importantly to the dollar's increase. financial markets were buoyed by the Market reaction to indications that the surprise election in May of Junichiro U.S. economy might be headed toward Koizumi to party leadership and thereby a more prolonged slowdown undercut to prime minister. The yen firmed the dollar's strength somewhat in early slightly for several weeks thereafter, but April, and the dollar eased further after continued weak economic fundamentals the unexpected April 18 rate cut by the and increased market focus on the FOMC. However, the dollar has more daunting challenges facing the new govthan made up that loss in recent months ernment helped push the yen back down as signs of weakness abroad have and beyond its previous low level. emerged more clearly. On balance, the At the start of 2001, economic activdollar is up about 7 percent against the ity in the euro area had slowed noticemajor currencies so far this year; against ably from the more rapid rates seen a broader index that includes currencies early last year but still was fairly robust. of other important trading partners, the Average GDP growth of near 2 perdollar has appreciated 5 percent. cent was only slightly below estimated The dollar has gained about 9 percent rates of potential growth, although some against the yen, on balance, as the Japa- key countries (notably Germany) were nese economy has remained troubled showing signs of faltering further. by structural problems, stagnant growth, Although high prices for oil and food and continuing deflation. Industrial pro- had raised headline inflation, the rate of duction has been falling, and real GDP change of core prices was below the declined slightly in the first quarter, with 2 percent ceiling for overall inflation set both private consumption and invest- by the European Central Bank (ECB). ment contracting. Japanese exports also The euro also was showing some signs have sagged because of slower demand of strength, having moved well off the from many key trading partners. Early low it had reached in October. However, in the year, under increasing pressure to negative spillovers from the global respond to signs that their economy was slowdown started to become more eviweakening further, the Bank of Japan dent in weaker export performance in (BOJ) slightly reduced the uncollateral- the first quarter, and leading indicators ized overnight call rate, its key policy such as business confidence slumped. interest rate. By March, the low level Nevertheless, the ECB held policy of equity prices, which had been declin- steady through April, as further weakening since early 2000, was provoking ing of the euro against the dollar (folrenewed concerns about the solvency of lowing a trend seen since the FOMC's Japanese banks. In mid-March, the BOJ rate cut in early January), growth of M3 announced that it was shifting from aim- in excess of the ECB's reference rate, ing at a particular overnight rate to tar- and signs of an edging up of euro-area geting balances that private financial core inflation were seen as militating institutions hold at the Bank, effectively against an easing of policy. returning the overnight rate to zero; In early May, the ECB surprised marthe BOJ also announced that it would kets with a 25 basis point reduction of continue this easy monetary stance until its minimum bid rate and parallel reduc- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

96 88th Annual Report, 2001 tions of its marginal lending and deposit dian dollar has regained much of the rates. In explaining the step, the ECB ground it had lost earlier and is down noted that monetary developments no about 2 percent on balance since the longer posed a threat to price stability beginning of the year. and projected that moderation of GDP Global financial markets were rattled growth would damp upward price pres- in February by serious problems in the sure. The euro has continued to fall Turkish banking sector. Turkish interest since then and, on balance, has declined rates soared and, after market pressures 9 percent against the dollar since the led authorities to allow the Turkish lira beginning of the year. Faced with a simi- to float, it experienced a sharp deprecialar slowdown in the U.K. economy that tion of more than 30 percent. An IMF was exacerbated by the outbreak of foot- program announced in mid-May that and-mouth disease, the Bank of England will bring $8 billion in support this year also cut its official call rate three times and require a number of banking and (by a total of 75 basis points) during the other reforms helped steady the situafirst half of the year. The Labor Party's tion temporarily, but market sentiment victory in parliamentary elections in started to deteriorate again in early July. early June seemed to raise market In Argentina, the weak economy and expectations of an early U.K. euro refer- the government's large and growing endum and put additional downward debt burden stoked market fears that pressure on sterling, but that was partly the government would default on its offset by signs of stronger inflationary debt and alter its one-for-one peg of the pressure. On balance, the pound has lost peso to the dollar. In April, spreads about 6 percent against the dollar this on Argentina's internationally traded year, while it has strengthened against bonds moved up sharply, and interest the euro. rates spiked. In June, the government The exchange value of the Canadian completed a nearly $30 billion debt dollar has swung over a wide range in exchange with its major domestic and 2001. In the first quarter, the Canadian international creditors aimed at alleviatdollar fell about 5 percent against the ing the government's cash flow squeeze, U.S. dollar as the Canadian economy improving its debt amortization profile, showed signs of continuing a decelera- and giving it time to enact fiscal reforms tion of growth that had started in late and revive the economy. Argentine 2000. Exports—especially autos, auto financial conditions improved somewhat equipment, and electronic equipment— following agreement on the debt swap. suffered from weaker U.S. demand. However, this improvement proved tem- Softer global prices for non-oil com- porary, and an apparent intensification modities also appeared to put downward of market concerns about the possibility pressure on the Canadian currency. With of a debt default triggered a sharp fall in inflation well within its target range, the Argentine financial asset prices at mid- Bank of Canada cut its policy rate sev- July. This financial turbulence in Argeneral times by a total of 125 basis points. tina negatively affected financial mar- So far this year, industries outside of kets in several other emerging market manufacturing and primary resources economies. The turmoil in Argentina appear to have been much less affected took a particular toll on Brazil, where an by external shocks, and domestic energy crisis added to other problems demand has maintained a fairly healthy that have kept growth very slow since pace. Since the end of March, the Cana- late last year. Intervention purchases of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Reports, July 97 the real by the Brazilian central bank Singapore, and Hong Kong, for examand a 300 basis point increase in its ple, fell from a 15 percent annual rate in main policy interest rate helped take late 2000 to close to zero in mid-2001. some pressure off the currency, but the The turnaround of the high-tech comporeal has declined about 24 percent so far nent of industrial production in those this year. countries was even more abrupt—from The weak performance of the Mexi- more than a 30 percent rate of increase can economy at the end of last year to a slight decline by midyear. In the caused largely by a fall in exports to Philippines and Indonesia, economic the United States (notably including a difficulties were compounded by serious sharp drop in exports of automotive political tensions. Currencies in many products) and tight monetary policy car- of these countries moved down versus ried over into early 2001. With inflation the dollar, and stock prices declined. declining, the Bank of Mexico loosened In Korea, the sharp slump in activity monetary policy in May for the first that began late last year continued into time in three years. Problems with 2001, as weakness in the external sector Mexican growth did not spill over to spread to domestic consumption and financial markets, however. The peso investment. The Bank of Korea lowered has remained strong and is up about its target interest rate a total of 50 basis 3 percent so far this year, and stock points over the first half of the year in prices have risen. response to the weakening in activity. Average growth in emerging Asia The Chinese economy, which is less slowed significantly in the first half; dependent on technology exports than GDP grew more slowly or even declined many other countries in the region, conin economies that were more exposed to tinued to expand at a brisk pace in the the effects of the global drop in demand first half of this year, as somewhat softer for high-tech products. Average growth export demand was offset by increased of industrial production in Malaysia, government spending. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

99 Domestic Open Market Operations during 2001 Implementation of in the following section. The conduct of Monetary Policy in 2001 open market operations in the aftermath of the terrorist attacks on the World The directives pertinent to the imple- Trade Center and Pentagon on Septemmentation of domestic open market ber 11 is reviewed in the final section. operations issued by the Federal Open Market Committee (FOMC) instruct the Trading Desk at the Federal Reserve Overview of Operating Procedures Bank of New York (FRBNY) to foster to Control the Federal Funds Rate conditions in the market for reserves The FOMC lowered the federal funds consistent with maintaining the federal rate target on eleven different occasions funds rate at an average around a speciduring 2001, reducing it by a cumulafied rate. This indicated rate is comtive 43/4 percentage points to end the monly referred to as the federal funds year at a level of 13A percent (table). rate target. The Desk arranges open mar- Three of these rate changes were made ket operations to target the funds rate, between regularly scheduled FOMC while at the same time achieving cermeetings. Associated with each FOMC tain other objectives that may affect the policy move, the Board of Governors structure of the Federal Reserve balance approved an equal-sized reduction in the sheet. basic discount rate, which preserved a This report reviews the conduct of 50 basis point spread of the target funds open market operations in 2001. It rate over the discount rate. begins with a description of the operat- To target the federal funds rate, the ing procedures that are used to control Desk uses open market operations to the funds rate and a summary of the key new developments in the policy imple- Changes in the Federal Funds Rate mentation framework. The demand for Specified in FOMC Directives balances at the Federal Reserve and the Percent behavior of autonomous factors outside the control of the Desk that affect the Target federal Associated Date of change funds rate discount rate supply of these balances are described in the following sections. Next, the dif- May 16, 2000 6'/2 6 ferent domestic financial assets held by the Federal Reserve, and the various January 3, 2001' ... 6 53/4 (5'/2onJan.4) types of open market operations used to January 31 5«/2 5 March 20 5 41/2 adjust them, are reviewed. The behavior April 181 4'/2 4 of the federal funds rate in 2001 and use May 15 4 31/2 of the discount window are discussed June 27 3-y4 3'/4 A Se u p g t u e s m t b 2 e 1 r 17] 3 3 '/2 3 2'/2 NOTE. This chapter is adapted from the annual October 2 21/2 2 November 6 2 1 !/2 r A e c p c o o r u t n o t f t t h o e t M he a n F a e g d e e r r o a f l t O he p e S n y st M em ar k O e p t en C o M m a m rk i e tt December 11 iy4 11/4 tee. The original report is available at http:// 1. Policy change came between regularly scheduled www.ny.frb.org/pihome/Omo/omo2001 .pdf. meetings. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

100 88th Annual Report, 2001 align the supply of balances held by their holdings of balances over the days depository institutions at the Federal within a maintenance period to meet Reserve—or Fed balances—with banks' their requirements gives them considerdemand for holding balances at the tar- able leeway in managing their accounts get rate. Each morning, the Desk consid- from day to day. This flexibility limits ers whether open market operations are the volatility in rates that can develop needed based on estimates of the supply when the Desk mis-estimates either the of and demand for balances, taking supply of or demand for balances. Noneaccount of possible forecast errors and theless, the funds rate will firm if the minimal levels of aggregate Fed bal- level of balances falls so low that some ances that in practice are needed to banks have difficulty finding sufficient facilitate settlement of wholesale finan- funds to cover late-day deficits in their cial payments by banks. When the funds Fed accounts; the rate will soften if rate is already near its target, the Desk balances are so high that some banks aims to supply a level of balances in line risk ending a period holding undesired with its best estimate of demand. And excess balances. when the funds rate deviates from the target, the Desk may adjust the level of Fed balances it aims to supply accord- New Developments in 2001 ingly, to nudge the rate in the appro- There were no changes made to the priate direction. Operations designed FOMC's Authorization for Domestic to alter the supply of Fed balances that Open Market Operations in 2001 same day, most commonly of a short- (appendix A). At its January meeting, term temporary nature, are typically the FOMC once again extended tempoarranged around 9:30 a.m. eastern time rarily, through its first regularly schedeach morning, shortly after a complete uled meeting in 2002, its authorization set of estimates is available. Open marfor an expanded pool of eligible collatket operations that are designed prieral for the Desk's repurchase agreemarily to meet other objectives that ments (RPs). The principal effect was influence the size or composition of to continue the inclusion of pass-through the Fed's balance sheet can generally be mortgage securities of the Government arranged at other times of the day, but National Mortgage Association, Freddie their use must be coordinated with those Mac, and Fannie Mae, and of stripped operations geared toward achieving a securities of government agencies. To particular level of Fed balances on each implement this decision, the FOMC day. voted to extend temporarily its suspen- The average level of balances banks sion of several provisions of its "Guidedemand over two-week reserve mainte- lines for the Conduct of System Open nance periods is in large measure deter- Market Operations in Federal Agency mined by certain requirements to hold Issues," which impose restrictions on balances, with only a small level of transactions in federal agency securities additional, or excess, balances typically (appendix B). Late in 2001, the Desk demanded. Levels of requirements and began to accept permanently the direct period-average demands for excess are debt obligations of the Student Loan relatively insensitive to changes in the Marketing Association as collateral on target level of the federal funds rate or its repurchase transactions. only respond with some lag. The ability The Desk continued to operate under of depository institutions to average the guidelines first articulated in July Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 101 2000 that limit the permanent holdings and, under lagged reserve accounting of single Treasury securities in the rules in effect since August 1998, System Open Market Account (SOMA) reserve balance requirements are deterto a given share of the total outstand- mined prior to the start of each mainteing amount.1 These guidelines were nance period, which facilitates estimaprompted by the prospect of paydowns tion of the demand for Fed balances. of marketable debt associated with But not all as-of adjustments are known projected budget surpluses. Meanwhile, when a period starts. Most problemati- Federal Reserve staff continued work cally, when large as-of adjustments are begun in 2000 on various studies of applied or reported to the Desk on the alternative assets the Federal Reserve settlement day, it affords the Desk little might hold in its portfolio. or no opportunity to adjust its estimates of demand and its operations. Decreases in short-term interest rates Banks' Demand for Fed Balances contributed to an increase in the under- The Desk aims to satisfy banks' demand lying level of requirements, particularly for holding Fed balances. Total demand over the second half of the year (chart). may be viewed as the sum of two com- Falling interest rates spurred growth ponents: the portion needed to meet all in reservable deposits over the year.3 requirements, and the portion held in As a consequence, aggregate reserve excess of requirements. requirements rose above the level of banks' applied vault cash, lifting the level of reserve balance requirements Total Balance Requirements in a sustained fashion for the first time A bank's total balance requirement mea- since the wholesale adoption of sweep sures the level of balances it must hold programs in 1995. The reduction in at the Federal Reserve on average over interest rates also contributed to a rise a two-week maintenance period to meet in clearing balance requirements, which various regulatory obligations. Total registered their first significant increase balance requirements may be decom- in several years. With the Fed using posed into two basic parts: reserve bal- lower interest rates linked to the target ance requirements (the level of reserve funds rate to compute earning credits requirements not met with applied vault on clearing balance requirements, banks cash) and clearing balance requirements. that wish to have the maximum useful In addition, various as-of accounting adjustments may be applied that affect the actual level of Fed balances a bank bank's total balance requirements, and hence its demand for Fed balances. In published data on must hold to meet all these requirereserves, these three variables are treated as ments.2 Clearing balance requirements sources of reserve supply. 3. At the same time, there was little further growth in new sweep account programs, which in 1. A detailed description of these guidelines the past had been a major source of decline in and their motivation can be found on the web reserve requirements. The estimated amount of site of the Federal Reserve Bank of New York demand deposits swept by commercial banks at http://www.ny.frb.org/pihome/news/announce/ through the introduction of new sweep programs 2000/an000705.html. They were also discussed in during 2001 was about $40 billion, somewhat more detail in the Domestic Open Market Opera- down from recent years and well below the peak tions report for 2000. level. A reduction in interest rates also reduces the 2. Clearing balance requirements, applied vault incentive banks have to expand sweeps to reduce cash, and as-of adjustments affect the level of a the level of their requirements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

102 88th Annual Report, 2001 Total Balance Requirements Excess Demands and and Components Actual Excess Levels Period-average and daily levels of Fed balances are measured relative to the period-average level of requirements, to obtain measures of excess balances. Demands for excess balances display fairly stable and predictable patterns that are insensitive to the level of requirements, and the Desk must estimate these excess demand patterns as part of estimating total demand for Fed balances.4 1998 1999 2000 2001 The reasons for the severe distortions NOTE. Maintenance period averages through Janu- to excess levels in the aftermath of the ary 9, 2002. September 11 attacks are described in 1. Reserve requirements minus applied vault cash, and the final section of this report. less all as-of adjustments. Over the last two months of the year, period-average levels of excess balances level of clearing balance requirements, became more elevated, most notably at that is, the level that generates just smaller banking institutions where posienough income credits to pay for all tive excess levels historically are concovered Fed services, had room to centrated (chart). To some degree, typiincrease these requirements. Over the twelve months ending in December, the underlying level of total balance requirements rose about $5 billion, with 4. In this section, actual levels of excess balances on average over time are used as an approxisomewhat more than half coming from mation of excess demand, even though a number the higher reserve balance requirements. of factors can cause actual excess levels to deviate This aggregate increase is not large from demand on any day or for any period. when measured against the size of the Fed's balance sheet, but it is significant as a portion of total requirements. Excess Balances Total balance requirements increased dramatically, but temporarily, in the two Billions of dollars maintenance periods ended October 17 and October 31, as a byproduct of dis- — 1 — 3.0 ruptions following the September 11 — 1 — 2.5 attacks. Reservable deposits soared at It All institutions — 2.0 a handful of key money center banks A A/ pF 15 that were not able to transfer out funds Y v /— 1.0 on behalf of their customers, and under i Large banks » lagged reserve accounting rules, these institutions faced much higher reserve requirements in October. These banks 1999 2000 2001 were able to restore their operational capabilities within days, and the higher NOTE. Maintenance period averages through Janulevels of reserve requirements were ary 9, 2002. Period ended September 19, 2001, not shown (total transitory. excess, $38 billion). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 103 Median Levels of Excess Balances, adopt a lower target rate at its meetings by Day in a Maintenance Period during the year, most of which happened Millions of dollars to fall on the second Tuesday of a maintenance period, which pushed demands Day of period 1998-2000 2001 for balances toward the end of these periods. Weekl Thursday 725 775 Friday -400 -1,000 Monday 975 200 Autonomous Factors Affecting Tuesday 675 0 Wednesday 725 0 the Supply of Fed Balances Week 2 Autonomous factors are the assets and Thursday 675 -475 Friday -175 -625 liabilities on the Federal Reserve bal- Monday 3,450 2,550 ance sheet that are outside the direct Tuesday 2,925 4,250 Wednesday 6,075 8,150 control of the Trading Desk.6 They exclude the domestic financial assets controlled through open market operacal seasonal factors, the size of which tions, discount window loans, and the can vary from year to year, may account deposit balances held by depository for this late-year increase. But anec- institutions at the Fed. Federal Reserve dotal evidence also suggests that the low note liabilities represent the largest absolute level to which interest rates single autonomous factor on the Fed's have dropped, thereby lowering the op- balance sheet by far, and for this reason portunity cost of holding excess bal- the net value (assets minus liabilities) of ances, may have contributed to the all autonomous factors has a large negaincrease. No evidence suggests that tive value; the net value of all other excess demand at larger banks has been factors is close to zero. Net movements increasing. in autonomous factors affect the supply The daily intraperiod distribution of of Fed balances, and thereby create a excess balances in 2001 continued to need for open market operations to reflect banks' strong preference for con- change the levels of the various domescentrating their accumulation of Fed bal- tic financial assets on the Fed's balance ances late in a maintenance period, after sheet to offset the effects of these facthe second weekend (table).5 The degree tors.7 The behavior of key factors in the of skew was more pronounced over this aftermath of the September 11 attacks past year, with banks typically holding is discussed in the final section of this somewhat lower levels of excess on report. most days ahead of the second weekend and larger excess balances on the settlement day. This greater concentration of excess accumulated on the final day was 6. Autonomous factors are defined to include encouraged by strongly held market liabilities arising from matched sale-purchase agreements arranged with foreign official instiexpectations that the FOMC would tutions as part of the foreign RP pool. The foreign RP pool is not reported directly on the Fed's balance sheet, but it is a factor that affects the 5. Median values are shown in table 2 because supply of Fed balances. they are less influenced than average values by the 7. In fact, the Desk retains a small degree of extreme and unrepresentative deviations from nor- discretionary influence over the levels of some mal levels of daily excess that arise from time to autonomous factors, which may be used to shape time. the need for open market operations on some days. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

104 88th Annual Report, 2001 Federal Reserve Notes Changes in Other Autonomous Factors Federal Reserve notes expanded by nearly $50 billion over the year and By comparison, the change in the net were once again the largest source of value of all other autonomous factors exogenous change on the Fed's balance was small over the year. Some huge sheet (chart).8 Federal Reserve notes temporary changes in the foreign RP outstanding increased at an 8 percent pool, Federal Reserve float, and foreign pace over the twelve-month period end- exchange holdings followed the Septeming in December, somewhat faster than ber 11 attacks, but most quickly returned their 63A percent average annual rate of to their pre-attack values. The greatest expansion over the preceding five-year exception was the level of the foreign interval. Lower interest rates likely RP pool, which remained elevated spurred demand for Federal Reserve throughout the fourth quarter of the year. notes in 2001 by reducing the economic Primarily as a consequence of these cost of holding non-interest-bearing higher pool levels, the net value of notes. Foreign demand also contributed autonomous factors other than Federal to faster growth late in the year, com- Reserve notes fell a bit, by roughly pounding the seasonal increase in $2 billion, over 2001. Federal Reserve notes that occurred ahead of the holidays. Unsettled economic conditions in Argentina seemed Volatility and Predictability of to stimulate demand throughout much Key Autonomous Factors of the second half of the year. Excluding the roughly two-week period following the September 11 attacks, the 8. The unusual decline in Federal Reserve notes average of the daily absolute changes over the twelve months ended in December 2000 in the net value of autonomous factors was a byproduct of the temporary bulge in Federal was down from the previous year, and Reserve notes outstanding around the century date same-day predictability showed a slight change. improvement (table). Reduced volatility in currency in circulation, which is used Net Value of All Autonomous Factors and as a proxy for Federal Reserve notes Value of Federal Reserve Notes in putting together daily forecasts of autonomous factors, mostly reflected the Billions of dollars impact of the huge swings in this factor around the century date change, which -450 elevated volatility in each of the two All autonomous factors -475 previous years.9 Although the foreign Federal -500 RP pool was somewhat more volatile Reserve notes — -525 y -550 -575 i -600 9. Currency in circulation consists mostly of 1 \ Federal Reserve notes, but it also includes about 1 $30 billion of coins, which are liabilities of the 1998 1999 2000 2001 Treasury. In absolute terms, changes in currency NOTE. Net value equals assets minus liabilities. Main- in circulation almost entirely reflected movements tenance period averages through January 9, 2002. in Federal Reserve notes. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 105 Daily Changes and Forecast Misses in Key Autonomous Factors: Average and Maximum of Absolute Values Millions of dollars 2001 2001, 1999 2000 excluding Sept. 11-28 Item Sept. 11-28 Average Maximum Average Maximum Average Maximum Average Maximum Daily change Currency in circulation 918 5,379 970 8,087 851 2,696 919 2,537 Treasury balance 911 7,446 1,460 23,434 823 7,413 2,297 5,671 Foreign RP pool 588 6,050 485 4,015 586 3,273 3,699 7,812 Float 712 6,217 887 9,677 894 4,923 6,888 32,099 Net value 1,709 17,653 2,058 23,896 1,828 7,918 7,028 30,770 Daily forecast miss Currency in circulation 233 1,361 238 1,648 210 1,043 502 1,135 Treasury balance 599 3,284 615 6,866 534 2,975 608 1,821 Foreign RP pool 224 1,817 129 976 81 1,127 2,070 4,966 Float 394 4,274 392 2,742 447 2,084 2,312 10,398 Net value 811 5,443 787 7,218 762 3,503 2,568 12,723 NOTE. Forecast misses are based on New York staff estimates. Currency in circulation is used as a proxy for Federal Reserve notes. during 2001, forecasting errors were cash balances. This helped moderate down. volatility in the Treasury's Fed balance The Treasury's Fed balance was by reducing the number of days on much less volatile during 2001 than it which the Fed balance jumped because was during 2000, and somewhat more of insufficient TT&L capacity, and it predictable. Over the past few years, the also may have improved indirectly the ability of the staff to forecast the Trea- ability to forecast the Treasury's Fed sury's Fed balance on a same-day basis balance.10 has benefited from improved methods for collecting tax payment information Domestic Financial Assets on the early each morning from around the Federal Reserve Balance Sheet financial system. In 2001, predictability and Open Market Operations was also enhanced by a new cash management technique adopted by the The total value of all domestic financial Treasury, called dynamic investing, that assets (less any matched sale-purchase enabled it to move some portion of unexpected flows arriving in its Fed 10. In 2001, the Treasury's general cash balaccount into its Treasury tax and loan ance exceeded TT&L capacity, including Special (TT&L) accounts at commercial banks Direct Investment capacity, by more than the noron a same-day basis. Throughout the mal level of balances placed at the Fed (usually $5 billion) on only two days, compared with six year, TT&L capacity remained high days in 2000. The number of such occasions was relative to the level of Treasury's total seven in 1999 and sixteen in 1998. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

106 88th Annual Report, 2001 agreements arranged in the market) roughly corresponded to the increase in held by the Federal Reserve mirrors Federal Reserve note liabilities.14 the net level of autonomous factors The distribution of SOMA holdings and of Fed balances.11 More substan- by remaining maturity and across inditively, the behavior of various autono- vidual issues is intended to achieve varimous factors and of sources of demand ous objectives associated with having for Fed balances will influence the a liquid portfolio without distorting the choice of open market operations used yield curve or impairing the liquidity to adjust the Fed's domestic financial of the market for individual Treasury portfolio.12 securities. In pursuit of these objectives, the Desk continued to adhere to the per-issue guideline limits on SOMA Permanent Holdings in the holdings of individual Treasury issues, System Open Market Account articulated in July 2000. It also continand Outright Open Market Activity ued to limit SOMA purchases of newly The domestic SOMA includes all the issued Treasury securities, as it has no domestic securities held on an outright particular portfolio need for some of the basis. By and large, changes in the level liquidity characteristics that can add to of the SOMA have been used to accom- the value of these issues in the market. modate net changes in autonomous factors and in demands for Fed balances Auction Participation that are expected to endure. For this and Redemptions reason, these holdings are often characterized as being "permanent," although Typically, any needed expansion of the their net value cam be reduced whenever SOMA is achieved by making outright needed. The par value of the SOMA purchases of Treasury securities in the stood at $575 billion at year-end, con- secondary market, which are then sussisting almost entirely of Treasury secu- tained by replacing maturing holdings rities, about $42 billion higher than with newly issued debt at Treasury aucone year earlier.13 The expansion in tions. At Treasury auctions of coupons the SOMA in 2001, as in many years, and bills in 2001, the FRBNY continued to place add-on bids for the SOMA equal to the lesser of (1) its maturing 11. In this report, the securities sold under temholdings on the issue date of a new porary matched sale-purchase agreements (MSPs) as part of the foreign RP pool or in the market are security or (2) the amount that would considered financial assets held by the Fed, bring SOMA holdings as a percentage although they are not officially recorded as such of the issue to the percentage guideline on the Fed's balance sheet. See footnote 6 for the limits.15 There were no issues maturing treatment of the foreign RP pool as an autonomous factor liability. In keeping with this treatment, in this report MSPs arranged in the market are considered a financial liability arranged at the discre- 14. By comparison, the slight increase in net tion of the Desk. balance sheet liabilities from movements in other 12. Discount window activity is discussed in autonomous factors and the rise in total balance the section "The Federal Funds Rate and Discount requirements added only modestly to any need for Window Credit." a "permanent" increase in the value of financial 13. The increase reflects almost entirely new assets in the Fed's portfolio. purchases in excess of redemptions but also 15. Foreign add-ons, which are not known at includes a $529 million increase in the inflation the time the Desk determines its level of participacompensation component of inflation-indexed tion at auctions, were assumed to be zero in this securities, bringing its level to $961 million. calculation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 107 on dates when newly auctioned Trea- budget situation and Treasury issuance sury Inflation Indexed Securities (TIIS) patterns. Also during the year, $120 milsettled. In cases where maturing hold- lion of holdings of Federal agency secuings were to be rolled into more than rities were called, which left a mere one new issue of different maturities, $10 million of agency holdings in the the Desk allocated the maturing amount SOMA at year-end. in such a way as to leave the same gap, measured in percentage points, between Secondary Market Purchases and the per-issue cap and the actual per- Operational Techniques centage holding of each new issue. A With redemptions again so large over slightly different approach was taken for the year as a whole and growth in Fedthe weekly bill auctions after the introeral Reserve notes strong, the necessary duction of the new twenty-eight-day expansion of the SOMA required a bill because of the potential volatility in record value of outright purchases of amounts of twenty-eight-day bills auc- Treasury securities by the Trading Desk, tioned from week to week. The Desk amounting to $68.5 billion (table). There determined the amount of maturing bills were no sales of securities. to be rolled over and its allocation on About $15 billion of bills were purthe basis of the smallest twenty-eightchased, and bill holdings increased by a day bill auction size experienced to date, significant amount for the first time in rather than the actual auction size. several years. Altogether, the Desk pur- Remaining within the per-issue perchased $8 billion of bills in the market centage caps while the Treasury continin four operations. Another $7 billion ued to cut back on auction sizes through were purchased directly from foreign the first half of the year forced another central banks, in small daily increments $27 billion of redemptions of maturon days when sell orders from these ing Treasury holdings in 2001, roughly accounts were available and consistent equal to the previous year's total; this with SOMA portfolio guidelines.16 includes about $1.5 billion of maturing holdings that were redeemed because of the cancellation of a twenty-eight-day 16. The Desk sets a $250 million limit on total bill auction on September 11. Redempdaily purchases, from foreign accounts, subject tions tapered off over the year, largely as to review if reserve needs or orders warrant an a consequence of the changed federal exception. Purchases and Redemptions of Treasury Bills and Coupons Billions of dollars Item 1997 1998 1999 2000 2001 Treasury bills Purchased outright 5.5 0 0 6.2 8.4 Purchased from internal foreign accounts 3.6 3.6 0 2.5 7.1 Redemptions 0 -2.0 0 -23.8 -10.1 Treasury coupons Purchased outright 35.0 26.4 45.4 35.7 53.2 Redemptions -2.0 -.6 -1.4 -4.1 -16.8 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

108 88th Annual Report, 2001 The Desk also purchased $53 billion $228 billion of marketable Treasury of coupon securities in the market, securities remained purchasable under arranging a record sixty-four coupon the Desk's guidelines for percentage operations.17 These operations contin- holdings—compared with $260 billion ued to be segmented into separate at the end of the previous year. The tranches across different portions of the gross remaining purchasable amount yield curve to facilitate rapid execution. was $183 billion if account is taken Given the frequent need for secondary of the practices of avoiding purchases market purchases, the Desk sought to of recently issued debt, purchases that distribute its purchases evenly over time would contribute to sizable redemptions, as much as possible and did not attempt and purchases of issues that mature to concentrate operations in periods within four weeks. when Federal Reserve note growth was fastest. Temporary Holdings and The selection of specific issues in Open Market Operations each operation was based on the relative attractiveness of propositions and Long-Term Repurchase Agreements portfolio considerations. In addition to remaining within the per-issue-guideline Over the past two years, long-term RPs, limits and avoiding on-the-run issues, defined as operations with an original the Desk avoided purchases that would maturity of more than fifteen days, be expected to cause a sizable redemp- have been a standard asset in the Fed's tion on any day in the foreseeable future, domestic financial portfolio.18 Tempoand it bought no issues in the secondary rarily increasing the total size of outmarket that had less than four weeks standing long-term RPs has proved to be remaining to maturity. an effective way of addressing significant increases in the net value of autono- General Characteristics of mous factor liabilities or increases in Domestic Permanent SOMA Holdings demands for Fed balances that are at Year-End expected to last for a number of weeks or months, but not permanently. Long- The average maturity of the entire term RPs can also be adjusted readily SOMA portfolio of Treasury securities to accommodate an extended mismatch was 53.5 months at year-end, up slightly between changes in the permanent from 52.9 months one year earlier. SOMA and in levels of autonomous fac- The share of all outstanding marketable tors and total balance requirements. Treasury securities held in the SOMA During the year, the Desk adhered to was 19 percent, about a percentage point the practice of arranging an RP with a higher than a year earlier. The SOMA held 25 percent of all bills (compared with 31 percent a year ago), and 17 per- 18. The choice of any maturity to distinguish cent of all coupons including TIIS (com- long-term from short-term RPs is somewhat arbipared with 14 percent a year earlier). trary. Fifteen days had been the maximum allow- At the end of the year, approximately able maturity under the FOMC's Authorization for many years until 1998, and it approximates the length of a reserve maintenance period. Fifteen days is designated to be the longest "short-term" 17. This total includes five TIIS operations, maturity because, as noted in this section, the RPs totaling $3.3 billion. On one day, two separate the Desk used that carried a fifteen-day maturity coupon operations were arranged. had a clear short-term operational focus. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 109 twenty-eight-day maturity on the Mon- Temporary Operations Outstanding day or Thursday (or both) of each week.19 These operations are typically Billions of dollars arranged early in the morning, before final daily reserve estimates are available, as their use is not geared toward addressing daily volatility in autonomous factors and excess demands. In other respects, these RPs are operationally just like those for short-term maturities. Dealer participation in these long-term RPs has consistently been 1999 2000 2001 very strong, measured by the size of propositions. NOTE. Maintenance period averages through January 9, 2002. The sizes of the twenty-eight-day RPs arranged over the year ranged from $2 billion to $5 billion. Over most of the day volatility in autonomous factors and first half of 2001, their total outstanding in demands for Fed balances. These value stood at $12 billion, which was operations are also used to fill tempoalso the lowest outstanding total for rarily the gaps left by more-enduring the year (chart). In the third quarter, the changes in autonomous factors and Fed Desk built up their underlying level balance demands that are not immedimodestly, but in the immediate after- ately met by changes in the permanent math of the September 11 attacks the SOMA or long-term RPs outstanding. Desk allowed two long-term RPs to Daily volatility in short-term tempomature without replacement, to simplify rary operations outstanding (RPs less its market involvement at the time. As MSPs), measured by the average of reserve deficiencies deepened late in the absolute daily changes in short-term year, at first when requirements bulged agreements outstanding, has been in October and then as Federal Reserve around $31/2 billion in each of the past notes began to grow from seasonal two years. Daily levels of net shortfactors, long-term RPs were gradually term operations outstanding ranged increased, peaking at a level of $31 bil- from -$4 billion to +$81 billion; excludlion in the year-end maintenance period. ing the days immediately following the September 11 attacks, the peak Short-term RPs and MSPs was +$31 billion. On a period-average basis, short-term operations outstanding Short-term temporary operations, RPs ranged from $4 billion to $38 billion; and matched sale-purchases (MSPs), are excluding the two exceptionally high the primary tool used to address day-toperiod-average levels that covered late September, the period-average peak was $14 billion. For the year as a whole, 19. This practice was first begun in March 2000. In January 2002, the Desk began to arrange short-term temporary operations outthese twenty-eight-day RPs just once per week, on standing averaged $10 billion. The avereach Thursday, adjusting the size of each opera- age was closer to $8 billion excluding tion to achieve the same desired total outstanding the September 19 maintenance period, amount. This weekly schedule will continue to provide the desired flexibility to the portfolio at which was somewhat above the $5 bileven lower operational cost. lion average outstanding level in 2000. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

110 88th Annual Report, 2001 Number of Temporary Operations, by Maturity and Type Item 1998 1999 2000 2001 One business day 144 147 142 133 Term RPs up to fifteen days 62 83 46 85 Term RPs over fifteen days 3 14 61 88 One-business-day MSPs 21 13 16 10 Term MSPs 10 3 0 Volatility in autonomous factors and dates, by the time the Desk was prein demand for Fed balances requires the pared to arrange its short-term opera- Desk to be prepared to arrange these tions, dealers had already met a greateroperations each day, and often an over- than-normal share of their total overlapping structure of short-term opera- night borrowing needs, in response to tions is constructed. By far the most heightened demand from their institucommon operation was an overnight RP tional customers. These cash investors (which includes all RPs that cover just had greater amounts to invest on an one business day), of which 133 were overnight basis with the dealers because arranged in 2001 (table). As usual, the the borrowers with whom they normally Fed's portfolio continued to be struc- placed cash on a term basis were issuing tured in such a way as to keep reliance less term debt on days of expected rate on MSPs relatively low.20 cuts. In general, propositions were suffi- Also in 2001, the Desk arranged two cient to cover the intended size of the short-term RPs, an overnight operation short-term operations the Desk wished and a term agreement of up to fifteen to arrange. However, ahead of days on days, on seven different maintenance which propositions were expected to period settlement dates, usually out of run low, the Desk sometimes layered- concern that propositions on the overin term agreements of short duration night RP alone might not be adequate to to ensure this outcome. For example, address all of the remaining period need. dealer participation on overnight RPs Given banks' usual preference for holdwas relatively low on quarter-end dates, ing higher excess levels on settlement when high excess needs usually required dates, which was even more pronounced a large amount of short-term RPs to be in 2001, the Desk sometimes faced a outstanding. Propositions on RPs on larger remaining "add need" on these FOMC meeting dates in 2001 also days than it was comfortable addressing tended to be low, as a byproduct of with a single, overnight operation. The expected imminent rate cuts. On these term agreements arranged on these occasions were used to help meet needs in the following maintenance period. 20. One reason the Desk avoids heavy reliance on MSPs is that propositions on these operations in general are low compared with RPs, reflecting Collateral Distribution dealers' net borrowing needs. Also, given the structure of the Fed's balance sheet, routine reli- The Desk solicited propositions across ance on MSPs would require expanding the Fed's the entire pool of eligible collateral on holdings of financial assets above the level that is all RPs arranged in 2001. But with the needed to meet its net autonomous factor liabilities and demands for Fed balances. exception of nine RPs arranged on the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 111 Average Annual RPs Outstanding, by Collateral Tranche Billions of dollars 2000 2001 Item Short-term RPs Long-term RPs Short-term RPs Long-term RPs Treasury 2.3 7.1 4.1 8.0 Agency 1.3 3.7 2.2 4.1 Mortgage-backed 1.5 5.3 3.4 4.5 Total 5.1 16.1 9.7 16.6 days immediately following the Septem- the next. In 2001, tranches in which ber 11 attacks, all RPs were arranged as mortgage-backed securities were elithree separate simultaneous operations gible tended to account for a somewhat differentiated by type of collateral eli- smaller share of total outstanding RPs. gible. In the first of these, only Treasury Their share on short-term RPs in 2001 debt was accepted; in the second, direct was about the same as in the previous federal agency obligations (in addition year, but only because of the large, to Treasury debt) were eligible; and in single-tranche RPs arranged in the afterthe third, mortgage-backed agency debt math of September 11 (table).21 was eligible (in addition to the other two categories of debt). For the purposes of The Federal Funds Rate and this report, these separate operations are Discount Window Credit counted as different tranches of a single RR In order to simplify the structure of The Federal Funds Rate its operations, for several days after September 11 the Desk arranged only RPs Daily volatility in the federal funds rate with a single tranche, under which deal- and deviations of effective rates from ers had the option to deliver Treasury, target in 2001 were slightly higher than agency, or mortgage-backed collateral. in the preceding year, but still to the low All RPs arranged in 2001 settled under side of recent norms (table). Deviations the triparty agreements established with of morning funds rates from target, often two clearing banks in 1999. Under a measure of market expectations for these agreements, dealers have flexibil- likely rate behavior later in the day, conity to choose, and to change from day to tinued to show the kinds of recurring day, the specific securities they deliver patterns associated with certain calenwithin each tranche. dar events seen in previous years. The The distribution of accepted propo- deviations of the morning rate from tarsitions across collateral categories on get on high-payment-flow days and on multi-tranche RPs was determined by Fridays were a touch smaller than in the relative attractiveness of rates in past years. However, morning premiums each tranche benchmarked against current market financing rates for that class of collateral. Distributions of collateral 21. These tranches reflect options that dealers by tranche on outstanding RPs tend have for delivering different categories of collateral on outstanding RPs where, for example, a to be reasonably stable, but they can dealer has the option to deliver Treasury debt on be very volatile from one operation to agency RPs but not vice versa. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

112 88th Annual Report, 2001 Federal Funds Rate Behaviors: Medians and Averages of Daily Values Basis points Item 1998 1999 2000 2001 Deviations of effective rate from target Median -1 0 Average -1 -1 Absolute deviations of effective rate from target Median 8 7 Average 13 11 Intraday standard deviations Median 12 Medians of morning rates less target rate on High-payment-flow days (excluding quarter-ends) 25 19 19 16 Fridays -6 -6 -6 -3 Maintenance period settlement days 13 0 0 6 on maintenance period settlement days, credit is seasonal borrowing, which which had been common in the past behaviorally is more akin to an autonobut which had largely disappeared over mous factor in terms of its implications the preceding couple of years, were for open market operations.22 Adjustagain evident in 2001, averaging around ment credit is typically quite small, but 6 basis points. The higher levels of the existence of the adjustment credit excess reserves that had to be accumu- facility is an important part of the monelated on the final day to meet require- tary policy implementation framework. ments in 2001 may have contributed It acts as a stabilizer, moderating the to funding anxieties of bank reserve upward movements in the federal funds managers. rate in the event a shortage of Fed balances leaves a bank overdrawn on its Fed account at the end of any day or Discount Window Credit deficient in meeting its requirements on Discount window credit makes up a a maintenance period settlement day. relatively small portion of the total domestic financial assets held by the 22. There were no instances of extended credit Federal Reserve (table). Much of this borrowing at the discount window. Discount Window Borrowing Activity 2001 Item 1998 1999 2000 2001 excluding Sept. 11-13 Average daily amount outstanding (millions of dollars) Seasonal credit 96 127 258 73 73 Adjustment credit 66 95 108 319 77 Number of days on which total adjustment borrowing by large banks More than $100 million-$500 million 23 17 12 10 10 More than $500 million 10 13 14 11 8 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 113 The critical role of the adjustment credit night basis. Communications disruptions facility during times of severe stress in prevented many borrowers from having financing markets is highlighted by the normal access to their investor base for discussion in the following section of its the first few days after September 11, use immediately following the Septem- even among those not directly affected ber 11 attacks. For meeting more-routine by the attacks, and the impaired ability reserve shortfalls and payments difficul- of a major clearing bank to process ties, even levels of adjustment borrow- funds and securities transfers for itself ing that are small relative to the total and on behalf of its customers created supply of Fed balances can help allevi- additional uncertainties. Banks and dealate the degree of upward rate pressure ers, uncertain about their general cash that can develop in the market. position or the availability of financing, Large banks as a group borrowed an tended to refrain from making cash outamount in excess of $500 million on lays until later than normal in the day. eleven different days in 2001, including In the federal funds market, several of three occasions coming in the imme- the major brokers ceased operations for diate aftermath of the September 11 a time, and many large banks resorted attacks. This total is in line with the to arranging trades directly with one number of occasions banks borrowed another. Although not fully back to norat least that much in the preceding mal levels of operating efficiency, the three years. Large banks borrowed a payments and communications infrasomewhat smaller but still significant structure most critical to the functioning amount, in excess of $100 million, on of the financing market had recovered another ten occasions in 2001, but this considerably by Monday, September 17, number was somewhat below the fre- and participation levels were much quency in most other recent years. improved. Behavior of Autonomous Factors The Conduct of Monetary Operations after September 11 Levels of several of the autonomous factors on the Fed's balance sheet were This section presents an overview of the dramatically affected by some of the context and conduct of open market responses to the World Trade Center operations in the aftermath of the terand Pentagon attacks. Over the threerorist attacks on the World Trade Cenday interval September 12 through ter and Pentagon on Tuesday, Septem- September 14 (Wednesday through Friber 11. day), net autonomous factor movements increased the supply of Fed balances General Financing Market dramatically, and then net factor move- Conditions ments began to drain large quantities. Immediately following the attacks, The level of float in the banking system, many financial markets effectively normally around $1 billion, peaked at ceased operations. But with Fedwire $47 billion on that Thursday as a result and other wholesale payments networks of the temporary curtailment of air trafremaining open, securities dealers and fic nationwide. Another $20 billion of banks faced a continuing need to obtain Fed balances was created that day when funding for large pre-existing positions the European Central Bank drew on a that they typically finance on an over- temporary foreign currency swap line Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

114 88th Annual Report, 2001 that had just been established. Mean- demands for financing far surpassed any while, investments in the foreign RP need to arrange operations simply to pool jumped between $15 billion and provide an aggregate level of Fed bal- $20 billion above recent norms, reduc- ances that would help banks meet their ing the supply of Fed balances. The requirements or their desired end-of-day factors that were adding to the supply holdings of balances at the Fed. To more of Fed balances returned to something effectively serve as a source of financlike normal levels by Monday, Septem- ing of last resort and to help encourage ber 17, but persistent high levels of the dealers to continue to intermediate on pool began to leave large underlying behalf of some of their own customers, deficiencies. the Desk operated relatively late in the day, after dealers had a good opportunity to assess their full financing needs Federal Reserve Monetary and to secure all available financing in Operations, and the Level and the market. Distribution of Fed Balances The size of the overnight RPs, On the morning of September 11, the which typically may be around $3 bil- Federal Reserve issued a public release lion, peaked on Thursday and Friday at stating, "The Federal Reserve System $70 billion and $81 billion, respectively, is open and operating. The discount the same days that autonomous factors window is available to meet liquidity also added the most to the supply of Fed needs," to encourage banks to view the balances. Before discount window bordiscount window as a source of liquid- rowing, Fed balances on both those days ity. September 11 fell in the middle of topped $110 billion, and, in general, Fed the maintenance period ended Septem- balances before borrowing were extraorber 19; for the remainder of that period, dinarily elevated from Wednesday the Desk arranged only overnight RPs through Monday (chart). But even with for same-day settlement because of the such high levels of Fed balances, severe high degree of volatility in the needed dislocations that interfered with their level of RPs outstanding from one day distribution in the first few days after to the next. From Wednesday through the following Monday, the sizes of open market operations were aimed at satisfying all Total Federal ReserveBalances around September 11 the financing that dealers wished to arrange with the Desk, in order to miti- Billions ofdiliars gate to the extent possible the disrupt a i r o r n a s n g t e o m n e o n r t m s.2 a 3 l O tr n a d t i h n e g s e a n fo d u r s e d tt a l y e s m , e a n l t l _ r \y1 N ba o l n an b c o e rr s o we — d 100 propositions with rates at or above the — 80 prevailing target were accepted, which was the vast majority. Dealers' total Borrowed / 60 balances : 40 V —- _w^V // I 20 23. The RP on September 12 was arranged from the FRBNY's Main Building. Subsequent operations were arranged out of the contingency 9/5 9/11 9/179/19 10/3 site at the Bank's East Rutherford Operations NOTE. Vertical dashed lines separate reserve mainte- Center. nance periods. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 115 the attacks caused many banks to bor- In part to simplify the nature of our row at the discount window to cover direct market involvement under exioverdraft positions. As a result, levels of gent circumstances, from September 11 adjustment borrowing soared to record through the remainder of the maintelevels on Tuesday and Wednesday. nance period under way, the Desk did By the final days of the maintenance not replace any of its maturing longperiod, after financing markets began to term RPs, and it arranged no outright function more normally, the Desk aimed operations. On the settlement day, its operations at maintaining a more the Desk arranged three term RPs that traditional balance between the supply settled on a forward basis on the first of and demand for Fed balances, consis- day of the following maintenance tent with the federal funds rate trading period, totaling $23 billion, in order to around the target level, lowered to 3 per- reduce the level of intervention that cent on September 17. With cumula- would be needed in financing martive excess positions so high and with kets in upcoming days. Other changes financing rates generally quite low, were also made to simplify operations. reflecting the weight of these excess Instead of differentiating between collatpositions, the Desk was aiming to leave eral types, each RP was arranged as a relatively low levels of Fed balances single tranche where dealers had the in place each day. The size of the RPs option to deliver any of the three categoneeded to provide even these relatively ries of collateral. Because some dealers low levels of balances remained large lacked connectivity at their contingency for a time, reflecting the impact of sites, the Desk operated in a semiautonomous factors that were now manual mode, inputting propositions for reducing the supply of Fed balances many dealers (although the automated below normal levels. As dealers increas- trade processing system continued to ingly were able to communicate with operate uninterrupted). Because of the and obtain financing from their usual time required to establish voice commucustomers, the Desk had to move up nications with dealers lacking electronic its operating time to ensure a suffi- connections and the time needed to cient level of participation for the receive bids by phone, the time between large RPs that were still needed, and when an operation was first announced it had to accept the vast majority of and when it was closed was lengthened, propositions—even those offered at and the Desk often pre-announced its rates well below the new 3 percent tar- time frame for operating. get level—in order to arrange RPs of sufficient size. Financing Rate Behavior Even with the low levels of excess provided late in the maintenance period, From Tuesday, September 11, through the average level of excess balances most of Thursday, September 13, marfor the period ended September 19 was ket participants in both the government $38 billion. This excess was highly con- securities RP markets and in the federal centrated at a small number of institu- funds market simply priced their trades tions that accumulated high balances as at the target funds rate, a response to the a result of an inability to make payments attacks that likely helped maintain some or to sell funds in the first days after the order in these markets. The high levels attacks, and it did not reflect any desire of excess balances provided through the to hold huge excess balances. Desk's RPs first began to weigh heavily Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

116 88th Annual Report, 2001 Federal Funds Rates around September 11 zation in effect at the end of 2001 is reprinted below. Percentage points Target rate Authorization for Domestic Open Market Operations 1. The Federal Open Market Committee Effective \ authorizes and directs the Federal Reserve — rate V Bank of New York, to the extent necessary to carry out the most recent domestic \i policy directive adopted at a meeting of the Committee: •: 9/5 9/11 9/17 9/19 10/3 (a) To buy or sell U.S. Government securities, including securities of the Federal NOTE. Vertical dashed lines separate reserve mainte- Financing Bank, and securities that are direct nance periods. obligations of, or fully guaranteed as to principal and interest by, any agency of the United States in the open market, from or on the funds rate during late trading on to securities dealers and foreign and inter- Thursday and again on Friday, although national accounts maintained at the Federal through Monday, September 17, morn- Reserve Bank of New York, on a cash, regular, or deferred delivery basis, for the System ing rates generally reverted back to Open Market Account at market prices, and, the target (chart). Thereafter, extremely for such Account, to exchange maturing U.S. low rates prevailed in the funds and RP Government and Federal agency securities markets for several days, falling even with the Treasury or the individual agencies below 1 percent. These low rates in or to allow them to mature without replacement; provided that the aggregate amount of large measure reflected misperceptions U.S. Government and Federal agency securithat the Desk was continuing to provide ties held in such Account (including forward high levels of balances, a view rein- commitments) at the close of business on the forced by the continuing large sizes day of a meeting of the Committee at which of the RPs and widespread reports that action is taken with respect to a domestic were crediting the Desk with providing policy directive shall not be increased or decreased by more than $12.0 billion during abundant liquidity to the market. Sevthe period commencing with the opening of eral episodes of rates being pushed business on the day following such meeting higher in late-day trading, induced by and ending with the close of business on the the relatively low levels of Fed balances day of the next such meeting; the Desk was leaving in place, were (b) To buy U.S. Government securities, needed to nullify these perceptions and obligations that are direct obligations of, or to bring the funds rate back up closer to fully guaranteed as to principal and interest the target. by, any agency of the United States, from dealers for the account of the Federal Reserve Bank of New York under agreements for repurchase of such securities or Appendix A: obligations in 65 business days or less, at Authorization for Domestic rates that, unless otherwise expressly autho- Open Market Operations rized by the Committee, shall be determined by competitive bidding, after applying rea- Open market operations were conducted sonable limitations on the volume of agreeunder the Authorization for Domestic ments with individual dealers; provided that Open Market Operations. The Authori- in the event Government securities or agency Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Domestic Open Market Operations during 2001 111 issues covered by any such agreement are imposed on purchases and sales of securities not repurchased by the dealer pursuant to the in paragraph l(b), repurchase agreements in agreement or a renewal thereof, they shall be U.S. Government and agency securities, and sold in the market or transferred to the Sys- to arrange corresponding sale and repurchase tem Open Market Account. agreements between its own account and foreign and international accounts main- (c) To sell U.S. Government securities tained at the Bank. Transactions undertaken that are direct obligations of, or fully guarwith such accounts under the provisions of anteed as to principal and interest by, any this paragraph may provide for a service fee agency of the United States to dealers for when appropriate. System Open Market Account under agreements for the resale by dealers of such secu- 4. In the execution of the Committee's rities or obligations in 65 business days or decision regarding policy during any interless, at rates that, unless otherwise expressly meeting period, the Committee authorizes authorized by the Committee, shall be deter- and directs the Federal Reserve Bank of mined by competitive bidding, after apply- New York, upon the instruction of the Chairing reasonable limitations on the volume of man of the Committee, to adjust somewhat agreements with individuals dealers. in exceptional circumstances the degree of pressure on reserve positions and hence the 2. In order to ensure the effective conduct intended federal funds rate. Any such adjustof open market operations, the Federal Open ment shall be made in the context of the Market Committee authorizes the Federal Committee's discussion and decision at its Reserve Bank of New York to lend on an most recent meeting and the Committee's overnight basis U.S. Government securities long-run objectives for price stability and held in the System Open Market Account to sustainable economic growth, and shall be dealers at rates that shall be determined by based on economic, financial, and monecompetitive bidding but that in no event shall tary developments during the intermeeting be less than 1.0 percent per annum of the period. Consistent with Committee pracmarket value of the securities lent. The Fedtice, the Chairman, if feasible, will consult eral Reserve Bank of New York shall apply with the Committee before making any reasonable limitations on the total amount of adjustment. a specific issue that may be auctioned and on the amount of securities that each dealer may Appendix B: borrow. The Federal Reserve Bank of New York may reject bids which could facilitate Guidelines for the Conduct of a dealer's ability to control a single issue System Open Market Operations as determined solely by the Federal Reserve in Federal Agency Issues Bank of New York. The FOMC has established specific 3. In order to ensure the effective conduct guidelines for operations in agency of open market operations, while assisting securities to ensure that Federal Reserve in the provision of short-term investments for foreign and international accounts main- operations do not have undue market tained at the Federal Reserve Bank of New effects and do not serve to support York, the Federal Open Market Committee individual issuers. Provisions 3-6 of authorizes and directs the Federal Reserve the guidelines were first temporarily Bank of New York (a) for System Open suspended in August 1999, in order to Market Account, to sell U.S. Government securities to such foreign and international expand the types of agency securities accounts on the bases set forth in para- the Desk could accept in its operations graph l(a) under agreements providing for around the century date change. This the resale by such accounts of those securi- suspension was extended in March ties in 65 business days or less on terms 2000, in light of anticipated paydowns comparable to those available on such transof federal debt, and it was reaffirmed in actions in the market; and (b) for New York Bank account, when appropriate, to under- January 2001 until the FOMC's first take with dealers, subject to the conditions meeting in 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

118 88th Annual Report, 2001 Guidelines for the Conduct of 4. Purchases will be limited to fully tax- System Open Market Operations able issues not eligible for purchase by the Federal Financing Bank, for which there is in Federal Agency Issues an active secondary market. Purchases will 1. System open market operations in Fed- also be limited to issues outstanding in eral agency issues are an integral part of total amounts of $300 million or over in cases System open market operations designed to where the obligations have maturity of five influence bank reserves, money market con- years or less at the time of issuance, and to ditions, and monetary aggregates. issues outstanding in amounts of $200 million or over in cases where the securities 2. System open market operations in Fed- have a maturity of more than five years at eral agency issues are not designed to sup- the time of issuance. port individual sectors of the market or 5. System holdings of any one issue at to channel funds into issues of particular any one time will not exceed 30 percent of agencies. the amount of the issue outstanding. Aggregate holdings of the issues of any one agency 3. System holdings of agency issues shall will not exceed 15 percent of the amount of be modest relative to holdings of U.S. Govoutstanding issues of that agency. ernment securities, and the amount and timing of System transactions in agency issues 6. All outright purchases, sales, and holdshall be determined with due regard for the ings of agency issues will be for the System desirability of avoiding undue market effects. Open Market Account. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Operations Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

121 Consumer and Community Affairs In 2001, the Division of Consumer limitations on, and additional disclosure and Community Affairs of the Federal requirements in connection with, home Reserve Board was active in several equity loans that have interest rates important areas: above a certain level or fees above a certain amount. It also authorizes the • Curbing abusive lending practices Board to expand HOEPA s coverage to more loans and to prohibit certain acts • Fostering research in community de- and practices in mortgage lending. The velopment and consumer economics Board had published proposed revisions to Regulation Z in December 2000. • Preparing for a review of the regula- The final revisions broaden the scope tions that implement the Community of loans subject to HOEPA s protections Reinvestment Act by adjusting the price triggers that determine coverage under the act. The rate- • Expanding access to consumer infor- based trigger was lowered two permation. centage points for first-lien loans (from 10 to 8 percentage points) but was kept In addition, the division continued at 10 percentage points for subordinateits work in drafting regulations that lien loans. The fee-based trigger was govern providers of consumer finan- revised to count as fees any amounts cial services; reviewing applications for paid at closing for optional credit insurmergers and acquisitions; monitoring ance and similar debt-protection prodfair lending activities and compliance ucts obtained in connection with the with the Community Reinvestment Act; mortgage. supporting community development The revisions also restrict certain activities throughout the System; ana- acts and practices in home-secured lyzing data gathered under the Home transactions. For example, creditors may Mortgage Disclosure Act; monitoring not refinance their HOEPA loans within compliance with consumer protection one year of extension if the refinancregulations; and addressing consumer ing is not in the borrower's interest. complaints. To strengthen the existing prohibition against extending credit on the basis of homeowner equity without regard to Curbing Abusive Lending ability to repay, creditors must verify In December, the Board of Governors and document the homeowner's repayrevised the provisions of Regulation Z ment ability. The disclosures that must (Truth in Lending) that implement the be given three days before closing to Home Ownership and Equity Protection borrowers obtaining HOEPA-covered Act (HOEPA). Enacted in 1994 in loans must state the total amount borresponse to evidence of abusive lending rowed and must indicate whether that practices in the home-equity-lending amount includes payment for optional markets, the act imposes substantive credit insurance or similar products. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

122 88th Annual Report, 2001 Fostering Research • "Making Small Cities and Towns Work" (Philadelphia and Richmond The Federal Reserve continues to foster Reserve Banks) research in community development and consumer economics. In April, the • "New Roads and e-Roads: Market System's Community Affairs Offices Innovations in Community Developheld a second biennial research conferment" (Dallas Reserve Bank). ence, "Changing Financial Markets and Community Development." The con- On the consumer economics side, ference featured the work of economists members of the Board's Consumer Poliand other scholars on the delivery cies staff conducted research on a wide of financial services to lower-income range of subjects. Studies on households populations and small businesses; prewith high-cost home-secured loans and sentations were made on the Commuconsumers' choice of financial instinity Reinvestment Act, predatory lendtutions for home-secured loans were ing, credit scoring, wealth creation, conducted in support of the division's and alternative financial services. The efforts to address concerns about abuimportance of financial literacy and sive lending practices. Studies on lowconsumer education was discussed by income and underserved consumers, Board Chairman Alan Greenspan in including research on reasons consumhis keynote address. The proceedings ers do not have checking accounts and of the conference, including speeches, on changes in account ownership over papers, and discussant statements, are time, supported Federal Reserve initiaavailable on the web site of the tives regarding financial access for the Federal Reserve Bank of Chicago, at unbanked. Other research focused on http://www.chicagofed.org/cedric/2001/ electronic banking, consumers' comsessionone.cfm. Members of the Board's plaints about credit card problems, con- Community Affairs staff, in partnership sumers' satisfaction with the Federal with research colleagues at the Board Reserve's complaint process, and finanand the Reserve Banks, are now plancial literacy. The division staff received ning for the 2003 research conference, an award from the Association for which will focus on "Sustainable Com- Financial Planning and Counseling Edumunity Development: What Works, cation for research on the ability of low- What Doesn't, and Why." income households to save. Also during the year, the Reserve Banks sponsored programs focused on emerging issues in community develop- Preparing for the Community ment to encourage research and facili- Reinvestment Act Review tate discussion among academics and The current regulations implementpractitioners. Topics included ing the Community Reinvestment Act (CRA) were adopted in 1995 by the • "Smart Growth and Community supervisory agencies that have CRA Development: Working Together responsibilities—the Federal Reserve, Smartly" (Philadelphia, Richmond, the Federal Deposit Insurance Corpoand Atlanta Reserve Banks) ration (FDIC), the Office of the Comp- • "Smart Codes: A Local Perspective troller of the Currency (OCC), and the on Planning and Growth" (St. Louis Office of Thrift Supervision (OTS). The Reserve Bank) regulations reflect the agencies' efforts Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 123 to (1) emphasize an institution's actual publishing an advance notice of properformance in addressing its CRA posed rulemaking. responsibilities rather than the process, By the end of 2001, the agencies (2) promote consistency in evaluations, had received approximately 400 comand (3) eliminate unnecessary burden on ments in response to the notice. These institutions. To this end, CRA examina- comments will be taken into account in tions focus on the quantitative aspects the agencies' analysis for determining of an institution's performance, such as whether regulatory changes are needed the number and dollar amount of loans to increase the CRA regulations' and investments made; they also include effectiveness. a review of qualitative aspects, such as whether the bank is innovative in meet- Expanding Access to ing the credit needs of the community. Consumer Information The regulations require large institutions to collect, report, and disclose data The Board substantially expanded the on small-business, small-farm, and com- Spanish-language offerings of its conmunity development loans and, for insti- sumer education program in 2001: tutions already reporting Home Mort- Spanish-language versions of material gage Disclosure Act data, data on home on three subjects—mortgages, vehicle mortgage lending outside metropolitan leasing, and consumer complaints— areas.1 Large retail institutions are were launched on the Board's public evaluated on their record of providing web site, and Spanish-language versions loans, investments, and services to their of two consumer brochures—Looking communities. Small institutions, in con- for the Best Mortgage and How to File trast, are evaluated under a streamlined a Consumer Complaint—were released. approach that focuses on their lending; The materials can be found at http:// some small institutions elect to have www.federalreserve.gov/consumers.htm. their investment and service activities In 2001, the Board also completed a reviewed as well in order to be consid- major revision of its consumer brochure ered for an "outstanding" CRA rating. on credit cards, Shop—The Credit Card The regulations also include a commu- You Pick Can Save You Money, incornity development test for limited- porating information on new disclosure purpose and wholesale banks and an requirements under Regulation Z and option for any bank to be examined information from the re-instituted Surunder a strategic plan. vey of Credit Card Plans conducted by When they adopted the regulations, the Board. A design review of all the the supervisory agencies committed to Board's consumer education publicaconducting a full review in 2002 to tions is under way to ensure that the determine whether their stated goals are materials are meeting consumers' needs. being achieved. The agencies began In addition to enhancing its own conthe review process in July 2001 by sumer education program, the Board also worked with other agencies on resources to help consumers make deci- 1. A large institution is an institution that as of sions on financial privacy (see box) and December 31 of the previous two calendar years avoid abusive lending practices. either had total assets of $250 million or more or In recognition of the importance was affiliated with a holding company that had of financial education in increasing total banking and thrift assets of $1 billion or more. economic opportunity, the Community Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

124 88th Annual Report, 2001 Financial Information and Consumers' Rights to Privacy Gramm-Leach-Bliley also contains very important and far-reaching privacy provisions. . . . Our objective is to devise disclosure requirements and consumer "opt-out" procedures that protect consumer privacy without overwhelmingly burdening financial institutions or consumers. Laurence H. Meyer, Member, Board of Governors July 1, 2001, marked the deadline for mation is shared with a third party. In addifinancial companies—banks, brokers, and tion to this initial notice, customers, as insurance companies, among others—to long as they remain customers, must be provide privacy notices to their existing given an annual notice describing the comcustomers. Companies were required to tell pany's privacy policies and practices. their customers Consumers must be given an opportunity to tell the company not to share the • What kinds of personal information the information—that is, they must be allowed company collects (for example, income, to "opt out." Opting out must be reasonassets, and account balances) ably convenient—accomplished by checking a box on an application, returning a • How the company uses the information, preaddressed reply form, or calling a tolland whether it intends to make the infor- free telephone number, for example. And mation available to nonaffiliated third consumers must be allowed a "reasonparties (such as mortgage brokers, direct able" length of time to respond (generally marketers, or nonprofit organizations) thirty days). The opt-out right does not apply to all • What customers can do to limit some of types of personal information. For examthat information sharing ple, it does not apply to a consumer's telephone number if that number is published • How the company safeguards personal in a telephone directory. The right also nonpublic information against fraudulent does not apply in certain situations—for access. example, consumers may not stop their banks from sharing information needed to Consumers must now be given a privacy process their credit card or check transacnotice at the time they enter into a cus- tions, to comply with a court order, or to tomer relationship with the company— prevent fraud. A financial company may for instance, when they open a checking also disclose personal financial informaaccount. And consumers, whether or not tion to comply with federal, state, or local they have actually become "customers" requirements—such as a local law requir- (for example, consumers who have simply ing mortgage documents to be recorded filled out an application), must be given a in public records—without providing connotice before their personal financial infor- sumers an opt-out right. Affairs Offices at the Board and the preparation for home ownership and Reserve Banks offer resources and pro- on the effective use of credit. The Dallas grams to promote personal financial Reserve Bank launched an interactive literacy skills. In 2001, the Community web-based version of Building Wealth: Affairs staff at the Board organized A Beginner's Guide to Securing Your workshops for Board employees on Financial Future, a program to help Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 125 Origins of the New Rights Compliance with the to Financial Privacy Privacy Provisions Financial companies share information Financial companies supervised by the about customers for a variety of reasons. In FFIEC agencies are subject to examination some instances, they may do so simply in to ensure that they are complying with the the course of providing basic services to provisions of the Gramm-Leach-Bliley their customers—when they process credit Act. Examination procedures were develcard payments or arrange for the printing oped by the FFIEC, and examinations of personalized checks, for example. They began in July 2001 as part of regular may also use the information in offer- consumer compliance examinations. As ing additional services or introducing new of the end of 2001, few violations had banking products. Some consumers want been found. Of those that were found, to take advantage of these opportunities many concerned not giving notices on time and are willing to have their personal or giving notices that did not contain all of financial information shared with third the necessary information. parties. Others prefer to limit the promo- To help financial institutions in their tional materials they receive and do not efforts, the Board, working with the other want marketers and others to have such agencies, has issued a set of frequently information. asked questions for financial institutions Concern about consumer privacy led (available at http://www.federalreserve.gov/ to passage of federal legislation govern- boarddocs/press/general/2001 /200112122/ ing the protection and disclosure of non- attachment.pdf). public personal information by financial The eight federal agencies hosted a daycompanies as part of the Gramm-Leaeh- long workshop, "Get Noticed: Effective Bliley Act. Regulations implementing the Financial Privacy Notices/' in December act's privacy provisions were issued in 2001 to discuss how financial institutions June 2000 and became effective the follow- can provide consumers with more effective ing November. Eight federal agencies have notice of their privacy policies and pracresponsibilities for enforcing the privacy tices. Information on the workshop is availprovisions: the Board of Governors of the able at http://www.ftc.gov/bcp/workshops/ Federal Reserve System, the Office of the glb/index.html. Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office Consumer Education of Thrift Supervision, and the National Credit Union Administration (which col- The Board and the other agencies have lectively make up the Federal Finan- prepared information for consumers cial Institutions Examination Council, or explaining their financial privacy rights FFIEC); the Securities and Exchange under Gramm-Leach-Bliley. The infor- Commission; the Federal Trade Commis- mation is available at http://www. sion; and the Commodity Futures Trading federalreserve.gov/pubs/privacy. Commission. consumers develop a plan for building continues to support the Consumer Fedpersonal wealth that includes setting eration of America's "Cleveland Saves" financial goals, budgeting, saving and program to help low- and moderateinvesting, and managing debt (http:// income families create personal savings www.dallasfed.org / htm / wealth / index, plans. The New York and San Francisco html). The Cleveland Reserve Bank Reserve Banks, in cooperation with a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

126 88th Annual Report, 2001 national nonprofit organization dedi- In addition to these rulemaking activicated to the economic self-sufficiency of ties, the Board took the following reguinner-city residents, are developing pro- latory and interpretive actions during the grams focused on enhancing economic year: as well as computer literacy. • Raised from $465 to $480 the total dollar amount of points and fees that Regulatory Matters trigger additional requirements for In March 2001, the Board revised Regu- certain mortgage loans under HOEPA, lation E to implement amendments to to reflect changes in the consumer the Electronic Fund Transfer Act con- price index (CPI), effective in January cerning ATM fees. Under the amend- 2002 ments, ATM operators that impose a fee on consumers for providing electronic • Increased from $31 million to fund transfer (EFT) services must post a $32 million the exemption threshold notice to that effect in a prominent loca- for depository institutions required to tion on or at the ATM where the transfer collect data in the year 2002 under the is initiated. Before a consumer com- Home Mortgage Disclosure Act, to mits to completing the transaction, the reflect changes in the consumer price operator must disclose that a fee will index for urban wage earners and be imposed and the amount of the fee. clerical workers (CPI-W), as pre- When a consumer contracts with a scribed by the statute financial institution for an EFT service, such as obtaining an ATM or debit card, • Revised the official staff commentary the institution's initial disclosures must for Regulation E to provide guidance include notice that a fee may be charged on transactions that involve electronic for transfers initiated at an ATM oper- check conversion, whereby a conated by another entity. sumer authorizes a merchant's use Also in March, the Board published of a check to capture encoded inforinterim rules establishing standards for mation that is then used to initiate the electronic delivery of federally man- an electronic debit from the condated disclosures under five consumer sumer's account. The commentary protection regulations: Regulation B revisions also provide guidance on (Equal Credit Opportunity), Regula- computer-initiated bill payments, the tion E (Electronic Fund Transfers), authorization of recurring debits from Regulation M (Consumer Leasing), a consumer's account, and telephone- Regulation Z (Truth in Lending), and initiated transfers. Regulation DD (Truth in Savings). In keeping with the Electronic Signatures CRA Bank Examinations in Global and National Commerce Act and Activities (the "E-Sign Act"), which was enacted in June 2000, financial institutions, The Community Reinvestment Act creditors, and others may, under the requires the Board and other banking Board's interim rules, deliver disclo- agencies to encourage financial instisures electronically if they obtain the tutions to help meet the credit needs of consumer's consent. The interim rules the local communities in which they do are not final; they serve as guidance business, consistent with safe and sound until final rules are adopted. business practices. To carry out this Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 111 mandate, the Federal Reserve has a ments), the implementing regulation three-faceted program that includes for the CRA Sunshine provisions of the Gramm-Leach-Bliley Act. The act • Examining institutions to assess comrequires insured depository institutions pliance with the CRA and nongovernmental entities or persons who are parties to CRA-related • Analyzing applications for mergers agreements to make certain of those and acquisitions from state member agreements public and to file annual banks and bank holding companies in reports about their activities under the relation to CRA performance agreements. • Disseminating information on community development techniques to Analysis of Applications in bankers and the public through Com- Relation to CRA Performance munity Affairs Offices at the Reserve Banks. Actions on bank and bank holding company applications during 2001 included the following: Examinations for Compliance with the CRA • In February, the Board approved an The Federal Reserve assesses the CRA application by FleetBoston Corp. performance of state member banks dur- (Boston, Mass.) to acquire Summit ing regularly scheduled examinations Bancorp (Princeton, N.J.). for compliance with consumer protection regulations. By law, small banks • Also in February, the Board approved (banks with assets of less then $250 mil- an application by MetLife, Inc. (New lion) that are rated "satisfactory" for York, N. Y.), to become a bank holding CRA performance are examined not company by acquiring Grand Bank, more than once every forty-eight N.A. (Kingston, N.J.). This was the months, and those that are rated "out- first application by an insurance standing" for CRA purposes are exam- company to become simultaneously a ined not more than once every sixty bank holding company and a financial months. During the 2001 reporting holding company under the Grammperiod, the Federal Reserve conducted Leach-Bliley Act. 183 CRA examinations.2 Of the banks examined, 29 were rated "outstanding" • In April, the Board approved an in meeting community credit needs, 151 application by Countrywide Credit were rated "satisfactory," 1 was rated Industries, Inc. (Calabasas, Calif.), to "needs to improve," and 2 were rated as acquire Treasury Bank, Ltd. (Washbeing in "substantial noncompliance." ington, D.C.). This was the first appli- Also during 2001, the Federal cation by a nonbanking financial com- Reserve worked with the other agencies pany engaged primarily in mortgage that have CRA responsibilities (the banking activities to become simulta- FDIC, OCC, and OTS) and issued the neously a bank holding company and Board's Regulation G (Disclosure and a financial holding company under the Reporting of CRA-Related Agree- Gramm-Leach-Bliley Act. In July, the Board approved an appli- 2. The 2001 reporting period was from July 1, 2000, through June 30, 2001. cation by Citigroup, Inc. (New York, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

128 88th Annual Report, 2001 N.Y.), to acquire European American ratings (that is, "needs to improve" Bank (Uniondale, N.Y.). or "substantial noncompliance") and another thirty-nine applications involv- • Also in July, the Board approved an ing other issues related to the CRA, fair application by Citigroup, Inc. (New lending, or compliance with consumer York, N.Y.), to acquire Grupo Finan- credit protection laws.3 ciero Banamex Accival, S.A. de C.V. and Banco Nacional de Mexico, S.A. Dissemination of Community (both in Mexico City, Mexico). Development Information • In August, the Board approved an The Community Affairs Offices at the application by First Union Corp. Reserve Banks continue to hold regular (Charlotte, N.C.) to acquire Wachovia roundtable discussions with financial Corp. (Winston-Salem, N.C). Sun- institutions in their Districts on issues Trust Banks, Inc. (Atlanta, Ga.), sub- related to the Community Reinvestment mitted a competing bid for Wachovia, Act and community development. Durwhich it withdrew after Wachovia ing 2001, some of the Banks sponsored shareholders voted against SunTrust's training for lenders and community proposal. groups on the disclosure and reporting requirements for CRA-related agree- Comments from the public on each ments. (Also see the next section, of these applications in relation to CRA "Community Affairs.") performance raised allegations primarily about predatory lending, insuffi- Community Affairs cient lending to lower-income areas, or inadequate banking services in lower- The System's Community Affairs proincome areas. In each case, the Board gram supports the economic growth found that the CRA records of the objectives of the Federal Reserve by depository institutions were consistent providing information and technical with approval. In the case of the acqui- assistance to facilitate efficient markets sition of European American Bank, the in historically underserved communi- Board ordered an on-site examination of ties. The year 2001 marked twenty years Citigroup's subprime-lending affiliates. since the program's inception. The Board also stipulated that Citigroup Community Affairs Offices throughmust report quarterly for two years out the System continued outreach on the status of litigation involving activities and programs in rural markets. subprime lending and on their compli- The Federal Reserve Banks of Atlanta, ance with court orders or court-approved Cleveland, Richmond, Kansas City, settlements. and Minneapolis sponsored conferences During the year, the Board acted on to foster workforce development and fourteen other bank and bank holding encourage integration of communitycompany applications that involved protests by members of the public concerning the performance of insured deposi- 3. In addition, one application involving a CRA tory institutions in relation to the CRA. protest, another application involving an adverse CRA rating, and nine applications involving other The Federal Reserve also reviewed CRA issues, fair lending issues, or compliance three applications involving institutions with consumer credit protection regulations were having less than "satisfactory" CRA withdrawn in 2001. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 129 based research, policies, and practices The preservation of affordable houswith community development activities. ing remains a central concern of the The Board's staff continued to work Community Affairs program. During with the Rural Home Loan Partnership, 2001, Board staff served in various an interagency group committed to capacities to support housing activities increasing affordable housing in rural conducted by external partners. They communities. served as liaison to the advisory board The San Francisco, Minneapolis, and for the Local Initiatives Support Cor- Chicago Reserve Banks convened meet- poration's Center for Home Ownership ings and workshops for bankers, devel- and assisted with planning an annual opers, and tribal representatives to pro- summit on housing issues. They also vide information on the legal and policy provided support to Board member aspects of financing housing and small Edward Gramlich, who chairs the board businesses on Native American tribal of directors of the Neighborhood Reinlands. The Board's Community Affairs vestment Corporation—a national nonstaff continued to participate in a task profit organization charged by the Conforce with representatives of other fed- gress with revitalizing older, distressed eral agencies, nonprofit organizations, communities. financial institutions, and other entities Also during the year, the Board's to promote financial literacy programs Community Affairs Office engaged in for members of Native American interagency efforts to raise awareness of communities. issues having national scope. For exam- Recognizing the importance of sup- ple, staff members worked with other port services to workforce development, agencies to publish Crossing the Bridge the Community Affairs Offices partici- to Self-Employment: A Federal Micropated in programs to improve access to enterprise Resource Guide. child care. The Seattle Branch of the Through the programs described San Francisco Reserve Bank facilitated above, the Federal Reserve System development of a micro-loan fund for during 2001 sponsored more than 300 child-care providers unable to secure conferences and workshops, conducted conventional lending, and the New York approximately 1,500 outreach meetings, and Philadelphia Reserve Banks spon- facilitated research, and distributed more sored a conference on investment and than 250,000 community economic lending models for child-care facilities. development publications. The Community Affairs program has expanded its reach to diverse communities and populations through Consumer Advisory Council effective use of information technology and communication tools. The The Consumer Advisory Council, Boston Reserve Bank cosponsors whose members represent consumer and a web site to support faith-based community organizations, the financial community developers (http://www. services industry, academic institutions, faithandcommunityatwork.com), and and state agencies, advises the Board of the Dallas Reserve Bank publishes Governors on matters concerning laws e-Perspectives, an electronic version that the Board administers and other of its community affairs newsletter issues related to consumer financial ser- (http://www.dallasfed.org / htm / pubs / vices. Council meetings are open to the perspectonline.html). public. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

130 88th Annual Report, 2001 In 2001, the Council met in March, to Regulation C to improve the quality, June, and October. The rules implement- clarity, and utility of data collected ing the Community Reinvestment Act, under the Home Mortgage Disclosure scheduled for review by banking and Act. At both meetings, members focused thrift institution regulators in 2002, were on the proposed requirements regarding a major topic at all three meetings. the reporting of the annual percentage In March and June, Council members rate (APR) on home mortgage loans and commented on the definition of "assess- discussed the burdens and benefits of ment area," the investment test, and having lenders report pricing and other the service test. They agreed that the data. Some members asserted that the assessment area definition needs to rec- reliability and validity of APR data for ognize that technological change has pricing analysis was questionable, but affected how and where financial insti- others believed that the reporting of the tutions conduct business. Regarding the data would facilitate public debate and investment and service tests, members enable pricing concerns to be more concluded that investments are impor- readily addressed. tant but challenging and difficult to Also discussed during 2001 were the make and that the service test provides interim final rules governing the elecopportunities for lenders to find inno- tronic delivery of disclosures required vative ways to serve communities and under Regulations B (Equal Credit build banking relationships. In October, Opportunity), E (Electronic Fund Transmembers offered views on the defini- fers), M (Consumer Leasing), Z (Truth tion of small-business and community- in Lending), and DD (Truth in Savings). development lending and on whether In June and October, Council members loan originations should receive more discussed the requirement that an e-mail credit than loan purchases under the message be sent to the consumer when a lending test. disclosure is placed on a company's web The proposed amendments to Regu- site and supported flexibility in the rules lation Z, designed to broaden the scope for delivery of these alerts. They also of mortgage loans subject to the Home discussed the challenges of re-delivering Ownership and Equity Protection Act, returned e-mail messages and provided were a key topic at the March and June differing views on the requirement that meetings. In March, Council members an institution maintain disclosures on a discussed expanding the dollar test web site for ninety days. applied to the points and fees trigger In October, the Council began to idento include amounts paid at loan closing tify issues for an upcoming review by for single-premium credit life insur- the Board of Regulation Z. Members ance. The June discussion focused on a discussed the differences in disclosure proposal that creditors be prohibited requirements for open- and closed-end from refinancing a zero-interest or low- lending and noted that greater flexiinterest loan into a higher-rate loan dur- bility exists for open-end disclosures. ing the first five years of the loan unless Future discussions will focus on the the refinancing is in the borrower's types of disclosures that are imporinterest; members considered the diffi- tant for credit card products and on culty of defining "borrower's interest" streamlining the disclosures for closedand of identifying low-cost loans. end mortgage loans to facilitate con- In March and June, the Council dis- sumer comparisons of loan costs among cussed the Board's proposed changes lenders. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 131 HMDA Data and The FFIEC prepared individual dis- Mortgage Lending Patterns closure statements for each lender that reported data—one statement for each The Home Mortgage Disclosure Act metropolitan area in which the lender requires that mortgage lenders covered had offices and reported loan activity. In by the act collect and make public cer- 2001, the FFIEC prepared 52,776 distain data about their home purchase, closure statements, reporting data for home improvement, and refinancing calendar year 2000. Each institution loan transactions. Depository institu- made its disclosure statement public in tions generally are covered if they were July, and reports containing aggregate located in metropolitan areas, met the data for all lenders in a given metroasset threshold at the end of the preced- politan area were made available at cening year, and originated at least one tral depositories in the nation's approxihome purchase loan (or refinancing) in mately 330 metropolitan areas. These the preceding year. For 2000, the asset data are used by the FFIEC member threshold was $30 million; for 2001, it agencies, the reporting institutions, the was $31 million. Mortgage companies public, the Department of Justice, and are covered if (1) they were located in or HUD. The data also assist HUD, the made loans in metropolitan areas, Department of Justice, and state and (2) had assets of more than $10 million local agencies in responding to allega- (when combined with the assets of any tions of lending discrimination and in parent company) at the end of the pre- targeting lenders for further inquiry.5 ceding year or originated 100 or more The data reported for 2000 covered home purchase loans and refinancings 19.2 million loans and applications, in the preceding year, and (3) their about 16 percent fewer than in 1999. home purchase loans (and refinancings) The decline was due primarily to a accounted for 10 percent or more of decline of about 30 percent in refinanctheir total loans by dollar volume. ing activity. The number of home pur- In 2001, a total of 6,704 depository chase loans extended in 2000 compared institutions and affiliated mortgage comwith 1999 increased 8 percent for Asians panies and 1,009 independent mortgage and 7 percent for Hispanics but fell companies reported HMDA data for 1 percent for blacks, 5 percent for calendar year 2000. Lenders submitted Native Americans, and 6 percent for information about the geographic locawhites. Between 1993 and 2000, the tion of the properties related to loans number of home purchase loans and loan applications, the disposition of extended increased 138 percent for Hisloan applications, and, in most cases, the panics, 109 percent for Native Amerirace or national origin, income, and sex of applicants and borrowers. The Federal Financial Institutions Examination Federal Deposit Insurance Corporation, the Office Council (FFIEC) processed the data of the Comptroller of the Currency, the Office of and produced disclosure statements on Thrift Supervision, and the National Credit Union Administration. behalf of the Department of Housing 5. On behalf of the nation's seven active priand Urban Development (HUD) and the vate mortgage insurance (PMI) companies, the FFIEC member agencies.4 FFIEC also compiles information on applications for PMI similar to the information on home mortgage lending collected under HMDA. Lenders 4. The FFIEC member agencies are the Board typically require PMI for conventional mortgages of Governors of the Federal Reserve System, the that involve small down payments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

132 88th Annual Report, 2001 cans, 89 percent for blacks, 84 percent costs as well as the benefits of the act for Asians, and 25 percent for whites. for consumers. For most income categories, the num- The proportion of U.S. households ber of home purchase loans extended using EFT services has grown over the was lower in 2000 than in 1999; the past decade at an annual rate of 3 pernumber made to lower-income appli- cent, according to data from the Survey cants fell 4 percent, but the number of Consumer Finances (the most recent made to upper-income applicants rose data available from these triennial sur- 3 percent. From 1993 through 2000, veys were gathered in 1998; data from the number of home purchase loans to the 2001 survey are not yet available). lower-income and upper-income appli- Approximately 85 percent of households cants increased 79 percent and 56 per- use one or more EFT services—for cent respectively. example, they use an ATM or debit card, In 2000, 31 percent of Hispanic appli- direct deposit, or direct payment. cants and 27 percent of black appli- Automated teller machines remain the cants for home purchase loans sought most widely used EFT service. About government-backed mortgages; the two-thirds of U.S. households have an comparable figure for white and Native ATM card. In 2001, the average number American applicants was 14 percent, of ATM transactions a month exceeded and for Asian applicants 9 percent. 1.1 billion, a slight increase over the Twenty-five percent of lower-income preceding year. The number of installed applicants for home purchase loans, ATMs rose about 19 percent, to about compared with 9 percent of upper- 324,000. income applicants, applied for Direct deposit is also widely used. government-backed mortgages. About 60 percent of U.S. households Overall, the denial rate for conven- have funds deposited directly into their tional (that is, non-government-backed) transaction accounts (checking or savhome purchase loans was 27 percent in ings). Use of the service is particularly 2000. The rate rose steadily from 1993 common in the public sector, accounting through 1998 but has now fallen slightly for 78 percent of social security pay- (about 1 percentage point) for the sec- ments, 98 percent of federal salary and ond consecutive year. Denial rates for retirement payments, and 33 percent of conventional home purchase loans in federal income tax refunds during fiscal 2000 were 45 percent for black appli- year 2001. cants, 42 percent for Native American A less widely used EFT payment applicants, 31 percent for Hispanic mechanism is direct bill-paying. About applicants, 22 percent for white appli- 36 percent of U.S. households have paycants, and 12 percent for Asian appli- ments automatically deducted from their cants. Except for Asian applicants, each transaction accounts. of these rates was lower than the compa- About one-third of U.S. households rable rate for 1999. have debit cards, which are used at merchant terminals to debit their transaction accounts. Point-of-sale (POS) systems Economic Effects of the account for a fairly small share of elec- Electronic Fund Transfer Act tronic transactions, but their use contin- As required by the Electronic Fund ued to grow rapidly in 2001. From 2000 Transfer Act (EFTA), the Board moni- to 2001, the average number of POS tors the effects of the act on institutions' transactions a month rose about 34 per- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 133 cent, from about 258.9 million to about visory resources are targeting higher- 348.0 million, and the number of POS risk areas, a consumer compliance riskterminals rose about 30 percent, to about focused supervision program was fully 3.6 million. implemented in 2001. The program The incremental costs associated emphasizes evaluating the appropriatewith the EFTA are difficult to quantify ness of an institution's risk-management because no one knows how industry practices and tailors supervisory activipractices would have evolved in the ties to fit the institution's risk profile. absence of statutory requirements. The The program also incorporates various benefits of the act to consumers are also monitoring procedures that are designed difficult to measure, because the protec- to identify high-risk institutions and to tions afforded by the act cannot be iso- facilitate a more continuous supervisory lated from protections that would have process. been provided in the absence of regulation. The available evidence suggests Fair Lending that there have been no serious consumer problems in relation to the act Pursuant to a 1991 amendment to the (see the section "Agency Reports on Equal Credit Opportunity Act, the Board Compliance with Consumer Protection refers to the Department of Justice any Laws and Regulations"). violation of the act that it has reason to believe constitutes a "pattern or prac- Compliance Activities tice" of discrimination. During 2001 the Board referred one case involving dis- The Federal Reserve conducts com- parate treatment in the underwriting of pliance examinations to carry out its automobile loans. responsibility for ensuring that state In May the Board supplemented the member banks and certain foreign bankinteragency procedures for fair lending ing organizations comply with fedexaminations by adopting alternative eral laws and regulations concerning procedures for banks having lowfair lending and consumer protections. discrimination-risk profiles. Typically, The Board provides consumer complisuch banks are stable community banks, ance training for the System's specommonly specializing in commercial cialized examiners and participates in or agricultural lending, that are located compliance-related activities of the Fedin suburban or rural markets having eral Financial Institutions Examination a low percentage of minority residents. Council. The alternative procedures are expected to reduce the resources devoted to these Compliance Examinations banks and to facilitate the allocation of resources for more intensive analysis of During the 2001 reporting period higher-risk institutions. (July 1, 2000, through June 30, 2001), the Federal Reserve conducted 343 consumer compliance examinations— under section 25 or 25 (a) of the Federal Reserve 261 examinations of state member banks Act (Edge Act and agreement corporations) and state-chartered commercial lending companies and 82 examinations of foreign banking owned or controlled by foreign banks. These instiorganizations.6 To ensure that supertutions are not subject to the Community Reinvestment Act and typically engage in relatively few 6. The foreign banking organizations examined activities that are covered by consumer protection by the Federal Reserve are organizations operating laws. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

134 88th Annual Report, 2001 Examiner Training agencies, and other federal supervisory agencies.7 Reserve Bank examiners receive training in consumer protection laws, fair lending laws, and the Community Regulation B Reinvestment Act as well as in com- (Equal Credit Opportunity) plaint analysis and investigation. During The FFIEC agencies reported that the 2001 reporting period, 221 examin- 83 percent of the institutions examined ers were trained in thirteen sessions during the 2001 reporting period were of varying lengths. Offerings included in compliance with Regulation B, combasic and advanced compliance courses pared with 81 percent for the 2000 and courses on fair lending, the Commu- reporting period. Of the institutions not nity Reinvestment Act, and commercial in full compliance, 20 percent had five lending. The consumer compliance cur- or fewer violations. The most frequent riculum is continually monitored and violations involved the failure to take updated to reflect regulatory and mar- one or more of the following actions: ketplace changes. • Provide a written notice of credit denial or other adverse action contain- Participation in FFIEC Activities ing a statement of the action taken, the name and address of the creditor, Through cooperation among its member a notice of rights, and the name and agencies, the FFIEC develops uniform examination principles, standards, pro- address of the federal agency that cedures, and report formats. In 2001, the enforces compliance FFIEC issued a revised report format • Provide a statement of reasons for and standardized tables for use in CRA credit denial or other adverse action performance evaluations; host-state that is specific and indicates the prinloan-to-deposit ratios for determining cipal reasons for the adverse action compliance with section 109 of the Riegle-Neal Interstate Banking and • Collect information for monitoring Branching Efficiency Act of 1994; and purposes about the race or national documents providing answers to freorigin, sex, marital status, and age of quently asked questions about Reguthe applicants seeking credit primarily lation P (Consumer Privacy) and the for the purchase or refinancing of a CRA. principal residence • Notify the credit applicant of the Agency Reports on Compliance action taken within the time frames with Consumer Protection Laws specified in the regulation. and Regulations Four formal enforcement actions con- The Board is required to report annually taining provisions relating to Regulaon compliance with consumer protection laws and regulations by entities supervised by the various federal agen- 7. Because the agencies use different methods to compile the data, the information presented cies. Summarized in this section are here supports only general conclusions. The 2001 data collected from the twelve Federal reporting period was from July 1, 2000, through Reserve Banks, the FFIEC member June 30, 2001. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 135 tion B were issued during the 2001 failure to comply with the following reporting period—three by the FDIC requirements: and one by the OCC. The Federal Trade Commission (FTC) filed one action and • Investigate an alleged error promptly continued other litigation against two after receiving a notice of error mortgage lenders for alleged violations of the Equal Credit Opportunity Act • Determine whether an error actually (ECOA). The alleged violations include, occurred, and transmit the results of among other things, failing to take writ- the investigation and determination to ten applications for mortgage loans, the consumer within ten business days failing to provide rejected applicants with written notice of adverse action, • Credit the customer's account in the and failing to collect required infor- amount of the alleged error within ten mation about the race or national ori- business days of receiving the error gin, sex, marital status, and age of notice if more time is needed to conapplicants. duct the investigation The other agencies that enforce the ECOA—the Farm Credit Administra- • Provide initial disclosures at the time tion (FCA), the Department of Trans- a consumer contracts for an electronic portation (DOT), the Securities and fund transfer service or before the first Exchange Commission (SEC), the Small electronic fund transfer involving the Business Administration (SBA), and the consumer's account is made. Grain Inspection, Packers and Stockyards Administration of the Department In 2001, the FDIC issued three formal of Agriculture—reported substantial enforcement actions containing provicompliance among the entities they sions relating to Regulation E. The FTC supervise. The FCA's examination and continued its efforts to educate conenforcement activities revealed viola- sumers and businesses in this area and tions of the ECOA mostly attributable to released a new brochure, Electronic creditors' failure to collect information Check Conversion, that gives consumers for monitoring purposes and failure to information about this new form of eleccomply with rules regarding adverse tronic banking. action notices. No formal enforcement actions containing provisions relating to Regulation B were initiated by these Regulation M (Consumer Leasing) agencies. The FFIEC agencies reported that more than 99 percent of the institutions exam- Regulation E ined during the 2001 reporting period were in full compliance with Regula- (Electronic Fund Transfers) tion M. This level of compliance is The FFIEC agencies reported that comparable to the level during the 2000 approximately 95 percent of the institu- reporting period. The few violations tions examined during the 2001 report- noted involved failure to adhere to speing period were in compliance with cific disclosure requirements. The agen- Regulation E, compared with 94 per- cies did not issue any formal enforcecent for the 2000 reporting period. The ment actions containing provisions most frequent violations involved the relating to Regulation M. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

136 88th Annual Report, 2001 Regulation Z (Truth in Lending) In 2001, the FTC continued its efforts to curb abusive practices by some The FFIEC agencies reported that subprime mortgage lenders, initiating 79 percent of the institutions examined one new action and pursuing two ongoduring the 2001 reporting period were ing litigations against mortgage lenders in compliance with Regulation Z, com- for alleged violations of the Truth and pared with 77 percent for the 2000 Lending Act (TILA) and the Home reporting period. Of the institutions Ownership and Equity Protection Act. not in full compliance, 75 percent had In addition, the FTC obtained settlefive or fewer violations, compared with ments in two cases that alleged vio- 64 percent in 2000. The most frequent lations of the TILA and Regulaviolations involved the failure to take tion Z—one involving vacation travel one or more of the following actions: packages and the other, Internet-access products and services. • Accurately disclose the finance The DOT is currently investigating charge, payment schedule, annual per- cases involving four different air carricentage rate, security interest in collat- ers regarding possible violations of the eral, or amount financed TILA. All four cases involve the timeliness of processing requests for credit • Disclose the annual percentage rate card refunds. In 2001, the DOT continon a periodic statement using the term ued to prosecute a cease-and-desist con- "annual percentage rate" sent order issued in 1993 against a travel agency and a charter operator. The com- • Provide disclosures within three busi- plaint alleged that the two organizations ness days of application as required had violated Regulation Z by routinely for applications for residential mort- failing to send credit statements for gages covered by the Real Estate refund requests to credit card issuers Settlement Procedures Act within seven days of receiving fully documented credit refund requests from • Ensure that disclosures reflect the customers. terms of the legal obligation between the parties Regulation AA (Unfair or Deceptive Acts • Provide the index value for adjustor Practices) ments to variable-rate loans. The three banking regulators with Four formal enforcement actions con- responsibility for enforcing Regulataining provisions relating to Regula- tion AA's Credit Practices Rule—the tion Z were issued during the 2001 Federal Reserve, the OCC, and the reporting period—three by the FDIC FDIC—reported that 99 percent of instiand one by the OCC. In addition, tutions examined during the 2001 report- 218 institutions supervised by the Fed- ing period were in compliance. Of the eral Reserve, the FDIC, or the OTS were institutions not in full compliance, the required, under the Interagency Enforce- most frequently cited violations involved ment Policy on Regulation Z, to refund a total of approximately $891,000 to • Failing to provide a clear, conspicuous consumers in 2001 because of improper disclosure regarding a cosigner's liadisclosures. bility for a debt Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 137 • Entering into a consumer credit con- • Failure to provide all applicable infortract containing a nonpossessory secu- mation on account disclosures. rity interest in household goods. No formal enforcement actions con- No formal enforcement actions con- taining provisions relating to Regulataining provisions relating to Regula- tion DD were issued during the 2001 tion A A were issued during the 2001 reporting period. reporting period. Consumer Complaints Regulation DD (Truth in Savings) The Federal Reserve investigates com- The FFIEC agencies reported that plaints against state member banks and 88 percent of institutions examined durforwards to the appropriate enforceing the 2001 reporting period were in ment agency complaints it receives that compliance with Regulation DD. Of involve other creditors and businesses. the institutions not in full compliance, During 2001, the Federal Reserve the most frequently cited violations fully implemented an automated sysinvolved tem for generating letters designed to • Advertisements that were inaccurate help Reserve Banks expedite responses or misleading (or both) to consumer complaints. The lettergeneration system is a component of the • Use of the phrase "annual percentage Complaints Analysis Evaluation System yield" in an advertisement without and Reports (CAESAR) database, which disclosing additional terms and condi- is used to track complaints and inquirtions of customer accounts ies. The CAESAR system produces Consumer Complaints against State Member Banks and Other Institutions Received by the Federal Reserve System, 2001 State member Other Subject banks institutionsl Total Regulation B (Equal Credit Opportunity) 59 27 86 Regulation E (Electronic Fund Transfers) 41 55 96 Regulation H (Bank Sales of Insurance) 0 0 0 Regulation M (Consumer Leasing) 0 1 1 Regulation P (Privacy of Consumer Financial Information). 14 19 33 Regulation Q (Payment of Interest) 0 0 0 Regulation Z (Truth in Lending) 300 560 860 Regulation BB (Community Reinvestment) ... 3 2 5 Regulation CC (Expedited Funds Availability) 22 28 50 Regulation DD (Truth in Savings) 38 55 93 Fair Credit Reporting Act 178 270 448 Fair Debt Collection Practices Act 13 21 Fair Housing Act 5 13 Rood insurance rules 2 5 7 Regulations T, U, and X 0 0 0 Real Estate Settlement Procedures Act . 7 11 18 Unregulated practices 1,359 1,412 2,771 Total 2,039 2,463 4,502 1. Complaints against these institutions were referred to the appropriate regulatory agencies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

138 88th Annual Report, 2001 Consumer Complaints Received by the Federal Reserve System, by Subject of Complaint, 2001 Complaints against state member banks Total Not investigated Investigated Bank legally correct Subject of complaint Unable to obtain Explanation Goodwill Number Percent in s f u o f r f m ici a e t n io t n p o ro f v l i a d w ed b N u o rs e re m im en - t re m im en b t u r o s r efrom to consumer or other other consumer accommo- accommodation dation Loans Discrimination alleged Real estate loans 15 1 0 3 4 1 Credit cards 19 1 0 1 13 2 Other loans 25 1 1 8 5 0 Other type of complaint Real estate loans 22 1 1 7 10 0 Credit cards 797 39 7 25 213 460 Other loans 254 13 2 75 94 28 Deposits 608 30 5 99 257 112 Electronic fund transfers 41 2 0 5 17 7 Trust services .... ... 25 1 2 8 11 0 Other 233 11 12 75 79 18 Total 2,039 100 30 306 703 628 acknowledgment letters based on infor- Complaints against mation maintained in the database but State Member Banks also allows Reserve Banks to tailor letters to particular circumstances. In 2001 the Federal Reserve received Besides conducting training for a total of 4,502 complaints—3,875 by Reserve Bank staff in complaint analy- mail, 545 by telephone, 10 in person, sis and investigation during the year, and 72 electronically via the Internet. Board staff also held sessions on the Complaint volume was reduced in the CAESAR query facility, which allows fourth quarter because of problems in the System to track individual com- the national mail system, including mail plaints as well as to aggregate data for facilities in the Washington metropolipurposes of trend analysis. tan area. Also continuing in 2001 was the About 45 percent of the complaints System's residency program for Reserve were against state member banks (see Bank staff who come to the Board tables). Of the complaints against state for several weeks at a time to work with member banks, 56 percent involved complaint staff on projects and to gain credit transactions: 3 percent alleged familiarity with complaint operations in discrimination on a basis prohibited Washington. by law (race, color, religion, national Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 139 Consumer Complaints Received—Continued Complaints against state member 1)anks Investigated Referred to Total Factual or Possible other complaints contractual bank Pending, agencies Customer Bank dispute— violation— Matter in December 31 error error resolvable bank took litigation only corrective by courts action 0 0 0 1 0 6 13 28 0 0 0 0 0 3 8 27 0 0 1 1 1 8 6 31 0 1 0 1 2 0 18 40 1 59 6 0 1 25 807 1,604 1 30 9 1 7 7 401 655 1 80 19 0 12 23 509 1,117 0 6 1 2 2 1 55 96 0 0 3 0 1 0 14 39 1 21 10 1 3 13 632 865 4 197 49 7 29 86 2,463 4,502 origin, sex, marital status, age, the fact or other practices. Information on the that the applicant's income comes from outcomes of the investigations of these a public assistance program, or the fact complaints is provided in the table. that the applicant has exercised any right During 2001, the System completed under the Consumer Credit Protection investigations of 181 complaints against Act), and 53 percent concerned other state member banks that were pending credit-related practices, such as the im- at year-end 2000 and found three vioposition of annual membership fees on lations of regulations. In the vast majorcredit card accounts, the amount of ity of cases, the banks had correctly interest banks charge on credit card handled customers' accounts; notwithaccounts, or credit denial on a basis not standing, banks chose to reimburse or prohibited by law (for example, credit otherwise accommodate consumers in history or length of residence). Thirty more than half of these cases. percent of the complaints against state The Federal Reserve received more member banks involved disputes about than 1,800 inquiries about consumer interest on deposits and general deposit credit and banking policies and pracaccount practices, and the remaining tices during the year. In responding 14 percent concerned disputes about to these inquiries, the Board and the electronic fund transfers, trust services, Reserve Banks gave specific explana- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

140 88th Annual Report, 2001 tions of laws, regulations, and banking credit cards (113), and customer service practices and provided relevant printed problems (101). The remainder of the materials on consumer issues. complaints concerned a wide range of To assess satisfaction with the Sys- unregulated practices in other areas, tem's handling of complaints, the Board including such matters as check-cashing sends complainants follow-up question- problems experienced by non-account naires. Because of mail disruptions dur- holders, consumer dissatisfaction with ing the fourth quarter of 2001, analysis reduced availability of branch tellers, of data for the entire year was impos- and the marketing practice of banks' sible. However, data for the first three sending what appear to be "live" checks quarters show that consumers were sat- in the mail. isfied or very satisfied with the System's handling of their complaints. Complaint Referrals to HUD In 2001 the Federal Reserve, in accor- Unregulated Practices dance with a memorandum of under- As required by section 18(f) of the Fed- standing between the Department of eral Trade Commission Act, the Board Housing and Urban Development and continues to monitor complaints about the federal bank regulatory agencies, banking practices that are not subject referred nine complaints to HUD that to existing regulations and to focus on alleged state member bank violations of those complaints that concern possible the Fair Housing Act. Of the six invesunfair or deceptive practices. In 2001 tigations completed by the Federal the Board received a wide range of com- Reserve, five revealed no evidence of plaints about unregulated practices. The unlawful discrimination. The parties in category that received the most com- the sixth complaint were seeking resoplaints involved credit cards: Consum- lution through the courts; the Federal ers complained about penalty charges Reserve does not intervene in consumer (125), interest rates and terms (118), cases that are in litigation. • other miscellaneous problems involving Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

141 Banking Supervision and Regulation The U.S. banking system maintained charge-off rates, both of which reached its overall financial strength in 2001 the highest levels since 1992. Commerdespite having weathered some of the cial net charge-off rates surged, reflectmost challenging operating conditions ing the adverse effect on corporate in a decade. An already slowing econ- earnings of a retrenchment in business omy slid into recession, dampening con- investment, particularly investment in sumer confidence and equity markets equipment and software. With unemgenerally. Conditions became even ployment rates and personal bankruptworse in the aftermath of the Septem- cies rising, consumer net charge-off ber 11 terrorist attacks in New York rates rose moderately. Compared with and Washington, D.C. The effects of the the previous year, the banking industry's attacks and the bursting of the high-tech nonperforming assets grew 28 percent, bubble, together with the largest chap- to $44.9 billion, or 1.1 percent of loans ter 11 bankruptcy ever (filed by domes- and foreclosed assets, still well below tic energy-trading company Enron) and the peak that prevailed during the last events in Argentina, exacerbated a dete- recession. Through this period, banks rioration in credit conditions. maintained adequate loss reserves and Nevertheless, banking industry net improved their capital ratios. income rose 6 percent during the year. The generally benign effect of rela- Asset growth continued, and the return tively stressful events on the financial on assets remained at a historically high condition of U.S. banks in 2001 may level. Net interest margins narrowed reflect, at least in part, the progress that slightly, particularly at community banks and their regulators have made banks, in response to very low market in identifying and responding promptly interest rates and reluctance by banks to emerging weakness. Many banking to fully reflect lower rates in their organizations, particularly large orgacore deposit pricing. Monetary easing nizations, have developed and are induced a record volume of mortgage implementing more sophisticated riskloan originations and refinancings, measurement and risk-management syswhich contributed to strong growth in tems that help them evaluate and price fee income. However, depressed finan- credit risk better and identify changing cial markets constrained larger banks' levels of risk as they occur. ability to generate revenue from non- Through the Basel Committee on traditional banking activities, particu- Banking Supervision, the Federal larly investment banking, asset man- Reserve and other bank supervisors agement, private equity investments, worldwide are building on banks' interand trading. Even with reduced market- nal risk-measurement systems in revissensitive revenues, total non-interest ing regulatory capital requirements for income improved somewhat, buttressed internationally active banks. In January by securities gains (versus losses a year 2001, the Basel Committee issued for earlier). public comment a proposal to base capi- Credit costs mounted as banks raised tal requirements on an institution's interprovisioning rates in excess of net nal credit-risk ratings and other factors, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

142 88th Annual Report, 2001 such as its estimates of expected loss. remains strong in its ability to deal with This development effort continues. adversities and to continue supporting The terrorist attacks of September 11 domestic and worldwide economic temporarily disrupted many interbank growth. and securities settlement activities and strained the activities of key institu- Scope of Responsibilities for tions in these markets before commu- Supervision and Regulation nications and operating systems were fully restored. Throughout the period, The Federal Reserve is the federal Federal Reserve System supervisory supervisor and regulator of all U.S. bank staff facilitated communications within holding companies (including financial the banking and regulatory systems and holding companies formed under the worked to minimize the disruptive authority of the Gramm-Leach-Bliley effects. The experience highlighted the Act) and of state-chartered commercial need to review and strengthen contin- banks that are members of the Federal gency plans within the financial system Reserve System. In overseeing these and its oversight process. That work is organizations, the Federal Reserve seeks also actively under way. primarily to promote their safe and sound operation and their compliance November 2001 marked the secwith laws and regulations, including the ond anniversary of enactment of Bank Secrecy Act and consumer protecthe Gramm-Leach-Bliley Act, which tion and civil rights laws.1 allows bank holding companies to become "financial holding compa- The Federal Reserve also has responnies" (FHCs) and to conduct a broad sibility for the supervision of all Edge range of banking, securities, and Act and agreement corporations; the insurance-underwriting activities. As the international operations of state member "umbrella supervisor" of all FHCs, the banks and U.S. bank holding companies; Federal Reserve relies as much as pos- and the operations of foreign banking sible on the supervisory efforts of an companies in the United States. institution's primary bank supervisor The Federal Reserve exercises imporand nonbank functional regulator(s) to tant regulatory influence over entry into ensure that any nonbank activities do the U.S. banking system and the strucnot present unacceptable risks to affili- ture of the system through its adminisated banks. By year-end, 567 domestic tration of the Bank Holding Company bank holding companies and 23 foreign banking organizations had received 1. The Board's Division of Consumer and Community Affairs is responsible for coordinating FHC status, suggesting potentially widethe Federal Reserve's supervisory activities with spread interest in the expanded powers regard to the compliance of banking organizations provided by the legislation. To date, with consumer protection and civil rights laws. To however, many FHCs are such in name carry out this responsibility, the Federal Reserve only, conducting little or no expanded trains a number of its bank examiners in the evaluation of institutions with regard to such compliactivity permissible under the law (see ance. The chapter of this volume covering conbox, "Organizational Evolution: Results sumer and community affairs describes these of the Gramm-Leach-Bliley Act"). regulatory responsibilities. Compliance with other Uncertainty is a key factor in any banking statutes and regulations, which is treated in this chapter, is the responsibility of the Board's commercial activity, and 2001 presented Division of Banking Supervision and Regulation significant challenges to many banks. and the Federal Reserve Banks, whose examiners Nevertheless, the U.S. banking system also check for safety and soundness. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 143 Act, the Bank Merger Act (with regard trols, and operations, (4) an assessment to state member banks), the Change in of the key financial factors of capital, Bank Control Act (with regard to bank earnings, liquidity, and sensitivity to holding companies and state member market risk, and (5) a review for banks), and the International Banking compliance with applicable laws and Act. The Federal Reserve is also respon- regulations. sible for imposing margin requirements on securities transactions. In carrying State Member Banks out these responsibilities, the Federal At the end of 2001, 970 state-chartered Reserve coordinates its supervisory banks (excluding nondepository trust activities with other federal banking companies and private banks) were agencies, state agencies, functional regmembers of the Federal Reserve Sysulators, and the bank regulatory agentem. These banks represented approxicies of other nations. mately 12.1 percent of all insured U.S. commercial banks and held approxi- Supervision for mately 25.9 percent of all insured com- Safety and Soundness mercial bank assets in the United States. The guidelines for Federal Reserve To ensure the safety and soundness examinations of state member banks of banking organizations, the Federal are fully consistent with section 10 of Reserve conducts on-site examinations the Federal Deposit Insurance Act, as and inspections and off-site surveilamended by section 111 of the Federal lance and monitoring. It also undertakes Deposit Insurance Corporation Improveenforcement and other supervisory ment Act of 1991 and by the Riegle actions. Community Development and Regulatory Improvement Act of 1994. A Examinations and Inspections full-scope, on-site examination of these banks is required at least once a year; The Federal Reserve conducts examinaexceptions are certain well-capitalized, tions of state member banks, branches well-managed institutions having assets and agencies of foreign banks, and Edge of less than $250 million, which may be Act and agreement corporations. In a examined once every eighteen months. process distinct from examinations, it During 2001 the Federal Reserve conducts inspections of holding compa- Banks conducted 534 examinations of nies and their nonbank subsidiaries. Prestate member banks (some of them examination planning and on-site review jointly with state agencies), and state of operations are integral parts of the banking departments conducted 264 overall effort to ensure the safety and independent examinations of state memsoundness of financial institutions. ber banks. Whether it is an examination or an inspection, the review entails (1) an Bank Holding Companies assessment of the quality of the processes in place to identify, measure, At year-end 2001, a total of 6,318 U.S. monitor, and control risks, (2) an bank holding companies were in operaappraisal of the quality of the insti- tion. These organizations controlled tution's assets, (3) an evaluation of 6,420 insured commercial banks and management, including an assessment held approximately 94.2 percent of all of internal policies, procedures, con- insured commercial bank assets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

144 88th Annual Report, 2001 Organizational Evolution: Results of the Gramm-Leach-Bliley Act With passage of the Gramm-Leach-Bliley reported $6.1 trillion in total assets, or Act (GLBA) in 1999, the Congress about 80 percent of U.S. bank holding comremoved long-standing legal impediments pany assets. Many large FHCs have used to the combining of banking, insurance, the authority granted by the GLBA to and securities activities within a single conduct securities underwriting and merfinancial institution. Since then, more than chant banking activities; several have also 550 domestic bank holding companies engaged in insurance underwriting. About have elected to become financial holding one-fifth of domestic financial holding companies (FHCs). In addition, a few U.S. companies have established insurance securities firms and one large insurance agencies under GLBA authority; insurance company have elected financial holding brokerage is the only financial activity that company status. Data collected by the many smaller FHCs are conducting under Federal Reserve (summarized in the table) the act. document the increase in the number of Twenty-three foreign banking organidomestic financial holding companies since zations had also received FHC status as of the act's implementation. They also show a December 31, 2001. Sixteen of these comsubstantial increase in U.S. financial hold- panies were conducting financial activiing company assets associated with GLBA ties under GLBA authority as of year-end activities. 2001, primarily as broker-dealers (thir- Many of the largest bank holding teen) and merchant banks (nine). Five of companies are FHCs; most domestic the sixteen had insurance underwriting sub- FHCs, however, are relatively small. As sidiaries, and two were operating insurance of December 31, 2001, domestic FHCs agencies. Federal Reserve guidelines call for Small, non-complex bank holding annual inspections of large bank holding companies—those that have less than companies as well as smaller companies $1 billion in consolidated assets, do that have significant nonbank assets. not have debt outstanding to the public, In judging the financial condition of and do not engage in significant nonthe subsidiary banks owned by holding bank activities—are subject to a special companies, Federal Reserve examiners supervisory program that became effecconsult examination reports prepared by tive in 1997.2 The program permits a the federal and state banking authorities more flexible approach to supervision of that have primary responsibility for the those entities in a risk-focused environsupervision of these banks, thereby ment. Each such holding company is minimizing duplication of effort and subject to off-site review once durreducing the burden on banking organi- ing the examination cycle for the comzations. In 2001, Federal Reserve examiners conducted 1,212 bank holding company inspections, of which 1,118 2. Certain modifications to this supervisory program will be adopted at the beginning of 2002. were on site and 94 were off site, and These modifications will extend the program to all state examiners conducted 79 indepenbank holding companies that have less than $1 bildent inspections. lion in consolidated assets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 145 Domestic FHCs and their activities under GLBA authority 2000 2001 Item June 30 Dec. 31 June 30 Dec. 31 Number of FHCs Large 74 91 112 114 Small 250 371 416 453 Using GLBA authority Large 36 44 58 58 Small 28 47 60 77 GLBA activities, by number of FHCs and related assets or investments (billions of dollars) Securities underwriting activities Number 31 35 41 39 Assets 529 519 619 668 Merchant banking activities | Number j 16 16 21 25 Carrying value of investments j 5 8 9 8 j Insurance underwriting activities | Number 7 15 21 Assets 114 116 327 342 Insurance agency activities Number Large 13 19 30 33 Small 25 43 58 68 NOTE. Large financial holding companies (FHCs) or more; small FHCs, those with assets of less than are defined here as those with assets of $1 billion $1 billion. pany's lead bank. In 2001 the Federal tions in the areas of information technol- Reserve conducted 2,594 reviews of ogy, fiduciary activities, transfer agent these companies. activities, and government and municipal securities dealing and brokering. The Financial Holding Companies Federal Reserve also conducts special- As of year-end 2001, 567 domestic bank ized examinations of certain entities, holding companies and 23 foreign bank- other than banks, brokers, or dealers, ing organizations had received finan- who extend credit subject to the Board's cial holding company status. Of the margin regulations. domestic institutions, 34 had consoli- With passage of the Gramm-Leachdated assets of $15 billion or more, Bliley Act in 1999, the Federal Reserve 80 between $1 billion and $15 billion, ceased conducting routine annual 54 between $500 million and $1 billion, examinations of securities underwriting and 399 less than $500 million. and dealing activities through so-called section 20 subsidiaries of bank holding companies. Under the act, the Federal Specialized Examinations Reserve is generally required to rely on The Federal Reserve conducts special- the supervisory activities of the "funcized examinations of banking organiza- tional regulator" for broker-dealer sub- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

146 88th Annual Report, 2001 sidiaries unless the Board has cause to fiduciary principles and potential conbelieve that a broker-dealer poses a flicts of interest are reviewed; its manmaterial risk to an insured depository agement and operations, including its affiliate. No such examinations for cause asset- and account-management, riskwere conducted during 2001. management, and audit and control The Federal Reserve has developed a procedures, are also evaluated. In 2001, series of case studies to educate System Federal Reserve examiners conducted personnel responsible for supervising 177 on-site trust examinations. nonbank activities about communications with, and reliance on the supervisory activities of, functional regulators Transfer Agents and (that is, regulators for securities, com- Securities Clearing Agencies modities, and insurance activities). As directed by the Securities Exchange Act of 1934, the Federal Reserve conducts specialized examinations of those Information Technology state member banks and bank holding In recognition of the importance of companies that are registered with the information technology to safe and Board as transfer agents. Among other sound operations in the financial indus- things, transfer agents countersign and try, the Federal Reserve reviews the monitor the issuance of securities, reginformation technology activities of the ister the transfer of securities, and banking institutions it examines as well exchange or convert securities. On-site as certain independent data centers that examinations focus on the effectiveprovide information technology services ness of the institution's operations and to these institutions. In 2000, the infor- its compliance with relevant securities mation technology reviews of banking regulations. During 2001, the Federal institutions were integrated into the Reserve conducted on-site examinations overall process of supervision, and thus at 33 of the 108 state member banks and all safety and soundness examinations bank holding companies that were regare now expected to include a review istered as transfer agents. Also during of information technology risks and the year the Federal Reserve examined activities. During the year, the Federal one state member limited-purpose trust Reserve was the lead agency in one company acting as a national securities examination of a large, multiregional depository. data processing servicer examined in cooperation with the other federal banking agencies. Government and Municipal Securities Dealers and Brokers The Federal Reserve is responsible for Fiduciary Activities examining state member banks and for- The Federal Reserve has supervisory eign banks for compliance with the Govresponsibility for institutions that ernment Securities Act of 1986 and with together hold more than $15 trillion of Department of the Treasury regulations assets in various fiduciary capacities. governing dealing and brokering in During on-site examinations of fidu- government securities. Thirty-nine state ciary activities, the institution's compli- member banks and 9 state branches ance with laws, regulations, and general of foreign banks have notified the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 147 Board that they are government securi- ing 346 lenders were subject to either a ties dealers or brokers not exempt biennial or triennial inspection. Sixtyfrom Treasury's regulations. During five inspections were conducted during 2001 the Federal Reserve conducted the year, compared with 147 in 2000. 11 examinations of broker-dealer activities in government securities at these institutions. Enforcement Actions The Federal Reserve is also respon- and Civil Money Penalties sible for ensuring compliance with the In 2001 the Federal Reserve initiated 21 Securities Act Amendments of 1975 by enforcement cases involving 30 separate state member banks and bank holding actions, such as cease-and-desist orders, companies that act as municipal securiwritten agreements, removal and prohities dealers. Of the 31 entities that dealt bition orders, and civil money penalties. in municipal securities during 2001, The Board of Governors collected 10 were examined during the year. $66.4 million in civil money penalties, which included a substantial collection Securities Credit Lenders from the BCCI case, a long-standing litigation matter. All funds collected Under the Securities Exchange Act of were remitted to the U.S. Department of 1934, the Federal Reserve Board is the Treasury. responsible for regulating credit in cer- All final enforcement orders issued tain transactions involving the purchase by the Board and all written agreeor carrying of securities. In addition to ments executed by the Reserve Banks examining banks under its jurisdiction in 2001 are available to the public and for compliance with the Board's margin can be accessed from the Board's public regulations as part of its general examiweb site (http://www.federalreserve.gov/ nation program, the Federal Reserve boarddocs/enforcement). maintains a registry of persons other In addition to formal enforcement than banks, brokers, and dealers who actions, the Reserve Banks in 2001 extend credit subject to those regulacompleted 111 informal enforcement tions. The Federal Reserve may conduct actions, such as resolutions with boards specialized examinations of these lendof directors and memorandums of ers if they are not already subject to understanding. supervision by the Farm Credit Administration, the National Credit Union Administration, or the Office of Thrift Risk-Focused Supervision Supervision. At the end of 2001, 802 lenders other In recent years the Federal Reserve has than banks, brokers, or dealers were created several programs aimed at registered with the Federal Reserve. enhancing the effectiveness of the super- Other federal regulators supervised 183 visory process. The main objective of of these lenders, and the remaining 619 these initiatives has been to sharpen the were subject to limited Federal Reserve focus on (1) those business activities supervision. On the basis of regulatory posing the greatest risk to banking orgarequirements and annual reports, the nizations and (2) the organizations' Federal Reserve exempted 273 lenders management processes for identifying, from its on-site inspection program. The measuring, monitoring, and controlling securities credit activities of the remain- their risks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

148 88th Annual Report, 2001 Regional Banking Organizations tion's condition, (3) assigning to each LCBO a supervisory team composed of The risk-focused supervision program Reserve Bank staff members who have for regional banking organizations skills appropriate for the organization's applies to institutions having a funcrisk profile (the team leader is the centional management structure, a broad tral point of contact, has responsibility array of products, and operations that for only one LCBO, and is supported by span multiple supervisory jurisdictions. specialists skilled in evaluating the risks For smaller regional banking organiof LCBO business activities and funczations, the supervisory program may tions), and (4) promoting Systemwide be implemented with a point-in-time and interagency information-sharing inspection; for larger institutions, the through an automated system. program may take the form of a series of Supporting the supervision process targeted reviews. For the largest, most is an automated application and complex institutions, the process is condatabase—the Banking Organization tinuous, as described in the next section. National Desktop (BOND)—which is To minimize burden on the institution, being developed to facilitate real-time, work is performed off site to the greatest secure information-sharing and collaboextent possible. Additionally, to reduce ration across the Federal Reserve Systhe number of information requests to tem and with certain other federal and the institution, examiners make use of state regulators. The final stage of public and regulatory financial reports, phase I of BOND development was market data, information from the autoimplemented during 2001, and work mated surveillance screening systems was begun on phase II, which will add (see later section "Surveillance and functionality that promotes analysis Monitoring Programs"), and internal across institutions. management reports. The events of September 11, 2001, directly and adversely affected the func- Large, Complex Banking Organizations tioning of U.S. payment and clearing The Federal Reserve applies a risk- systems, requiring an extraordinary focused supervision program to large, cooperative and coordinated effort complex banking organizations among bank supervisory agencies both (LCBOs).3 The key features of the domestically and internationally. In LCBO supervision program are (1) iden- addition to providing supervisory guidtifying those LCBOs that, based on their ance for regulated institutions during the shared risk characteristics, present the crisis, LCBO supervisory staffs across highest level of supervisory risk to the the Federal Reserve System facilitated Federal Reserve System, (2) maintain- the sharing of information among finaning continual supervision of these cial regulatory agencies worldwide; in institutions to keep current the Federal many instances, examiners were sent on Reserve's assessment of each organiza- site to lend assistance to and assess the status of key institutions. 3. For an overview of the Federal Reserve's Community Banks LCBO program, see the article by Lisa M. DeFerrari and David E. Palmer, "Supervision of The risk-focused supervision program Large Complex Banking Organizations," in the for community banks emphasizes that Federal Reserve Bulletin, vol. 87 (February 2001), pp. 47-57. certain elements are critical to the sue- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 149 cess of the risk-focused process. These pany cash flow, intercompany transelements include adequate planning actions, parent company leverage, and time, completion of a pre-examination consolidated capital ratios. Also during visit, preparation of a detailed scope- the year the Federal Reserve revised the of-examination memorandum, thorough Bank Holding Company Performance documentation of the work done, and Report to incorporate new information preparation of an examination report on sources of nonbank income and on tailored to the scope of the examination. insurance activities. The framework for risk-focused super- The Federal Reserve works with the vision of community banks was devel- other federal banking agencies to oped jointly with the Federal Deposit enhance and coordinate surveillance Insurance Corporation and has been activities through the Task Force on Suradopted by the Conference of State veillance Systems of the Federal Finan- Bank Supervisors. cial Institutions Examination Council (FFIEC).4 Surveillance and Monitoring Programs International Activities The Federal Reserve uses automated The Federal Reserve supervises the screening systems to monitor the finan- foreign branches of member banks; cial condition and performance of state overseas investments by member banks, member banks and bank holding compa- Edge Act and agreement corporations, nies between on-site examinations. The and bank holding companies; and screening systems analyze supervisory investments by bank holding companies data and regulatory financial reports to in export trading companies. It also identify companies that appear to be supervises the activities that foreign weak or deteriorating. This analysis banking organizations conduct through helps to direct examination resources to entities in the United States, includinstitutions exhibiting higher risk pro- ing branches, agencies, representative files. Screening systems also assist in offices, and subsidiaries. the planning of examinations by identifying companies that are engaging Foreign-Office Operations of in new or complex activities. Also used U.S. Banking Organizations in the monitoring process are quar- The Federal Reserve examines the interterly Bank Holding Company Perfornational operations of state member mance Reports prepared by the Federal banks, Edge Act corporations, and bank Reserve. holding companies principally at the During 2001, the Federal Reserve U.S. head offices of these organizations, refined its surveillance program for where the ultimate responsibility for small bank holding companies to their foreign offices lies. In 2001 the respond to changes in supervisory procedures for these institutions. The revised screening systems focus on 4. The member agencies of the FFIEC are the identifying potential problems at parent Board of Governors of the Federal Reserve Syscompanies and nonbank subsidiaries tem, the Federal Deposit Insurance Corporation that could adversely affect affiliated (FDIC), the National Credit Union Administration (NCUA), the Office of the Comptroller of the insured depository institutions. In par- Currency (OCC), and the Office of Thrift Superticular, the screens address parent com- vision (OTS). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

150 88th Annual Report, 2001 Federal Reserve examined 3 foreign international banking and foreign finanbranches of state member banks and cial transactions. These corporations, 7 foreign subsidiaries of Edge Act cor- which in most cases are subsidiaries porations and bank holding companies. of member banks, may (1) conduct a The examinations abroad were con- deposit and loan business in states other ducted with the cooperation of the than that of the parent, provided that supervisory authorities of the countries the business is strictly related to interin which they took place; when appro- national transactions, and (2) make forpriate, the examinations were coordi- eign investments that are broader than nated with the Office of the Comptroller those of member banks because they of the Currency. Examiners also make may invest in foreign financial organizavisits to the overseas offices of U.S. tions, such as finance companies and banks to obtain financial and operating leasing companies, as well as in foreign information and, in some instances, banks. to evaluate their efforts to implement Edge Act and agreement corporations corrective measures or to test their numbered 75 and were operating 17 adherence to safe and sound banking branches at year-end 2001. These corpopractices. rations are examined annually. Foreign Branches of Member Banks U.S. Activities of Foreign Banks At the end of 2001, 64 member banks The Federal Reserve has broad authority were operating 937 branches in foreign to supervise and regulate the U.S. activicountries and overseas areas of the ties of foreign banks that engage in United States; 34 national banks were banking and related activities in the operating 725 of these branches, and 30 United States through branches, agenstate member banks were operating the cies, representative offices, commercial remaining 212. In addition, 18 nonmem- lending companies, Edge Act corporaber banks were operating 22 branches in tions, commercial banks, and certain foreign countries and overseas areas of nonbank companies. Foreign banks conthe United States. tinue to be significant participants in the U.S. banking system. As of year-end 2001, 208 foreign Edge Act and Agreement Corporations banks from 56 countries were operating Edge Act corporations are international 287 state-licensed branches and agenbanking organizations chartered by the cies (of which 13 were insured by the Board to provide all segments of the Federal Deposit Insurance Corporation) U.S. economy with a means of financ- as well as 51 branches licensed by the ing international business, especially Office of the Comptroller of the Curexports. Agreement corporations are rency (of which 6 had FDIC insurance). similar organizations, state chartered or These foreign banks also directly owned federally chartered, that enter into an 15 Edge Act corporations and 3 comagreement with the Board to refrain mercial lending companies; in addition, from exercising any power that is not they held an equity interest of at least permissible for an Edge Act corporation. 25 percent in 90 U.S. commercial banks. Under sections 25 and 25(A) of the Further, 23 foreign banks and certain of Federal Reserve Act, Edge Act and their affiliates were granted financial agreement corporations may engage in holding company status. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 151 Altogether, these U.S. offices of for- program was refined further in light of eign banks at the end of 2001 controlled experience in using it over the past five approximately 19.0 percent of U.S. com- years. mercial banking assets. These foreign banks also operated 181 representative Technical Assistance offices; an additional 97 foreign banks In 2001 the Federal Reserve System operated in the United States solely continued to provide technical assisthrough a representative office. tance on bank supervisory matters State-licensed and federally licensed to foreign central banks and superbranches and agencies of foreign banks visory authorities. Technical assistance are examined on site at least once every involves visits by System staff members eighteen months, either by the Federal to foreign authorities as well as consul- Reserve or by a state or other federal tations with foreign supervisors who regulator; in most cases, on-site examivisit the Board or the Reserve Banks. nations are conducted at least once every Technical assistance in 2001 was contwelve months, but the period may be centrated in Latin America, the Far East, extended to eighteen months if the and former Soviet bloc countries. branch or agency meets certain criteria. During the year, the Federal Reserve The Federal Reserve conducted or paroffered supervision training courses in ticipated with state and federal regula- Washington, D.C., and in a number of tory authorities in 289 examinations durforeign jurisdictions exclusively for ing 2001. foreign supervisory authorities. System staff also took part in technical assis- Joint Program for tance and training missions led by the Supervising the U.S. Operations of International Monetary Fund, the World Foreign Banking Organizations Bank, the Inter-American Development Bank, the Asian Development The Federal Reserve, in cooperation Bank, the Basel Committee on Banking with the other federal banking agencies Supervision, and the Financial Stability and with state banking agencies, con- Institute. ducts a joint program for supervising the U.S. operations of foreign banking orga- Supervisory Policy nizations. The program has two main parts. One part focuses on the examina- Within the supervisory policy function, tion process for those foreign banking the Federal Reserve develops guidance organizations that have multiple U.S. for examiners and financial institutions operations and is intended to improve as well as regulations for financial insticoordination among the various U.S. tutions under the supervision of the Fedsupervisory agencies. The other part is a eral Reserve. Staff members also particireview of the financial and operational pate in international supervisory forums profile of each organization to assess its and provide support for the work of the general ability to support its U.S. opera- Federal Financial Institutions Examinations and to determine what risks, if tion Council. any, the organization poses through its U.S. operations. Together, these two pro- Capital Adequacy Standards cesses provide critical information to U.S. supervisors in a logical, uniform, During 2001 the Federal Reserve, and timely manner. During 2001 the together with the other federal bank- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

152 88th Annual Report, 2001 ing agencies, issued a final rule 25 percent are to be deducted from tier 1 that amended the capital standards for capital, which will have the effect of recourse, direct credit substitutes, and reducing the leverage ratio as well as the residual interests in asset securitizations. risk-based capital ratios. The portion of The agencies also continued discussions the rule dealing with interest-only strips on a possible notice of proposed rule- receivables will go into effect at the end making to simplify the risk-based capi- of 2002. tal framework. The Federal Reserve revised its policy of generally applying Simplified Capital Framework for its capital adequacy guidelines to top- Non-Complex Institutions tier U.S. bank holding companies owned by foreign banks qualifying as financial In November 2000, the federal banking holding companies under the Gramm- agencies published an advance notice of Leach-Bliley Act. Finally, the agencies proposed rulemaking and solicited comcontinued to work on developing final ments on proposals for creating a simrules governing securities borrowing pler capital framework for non-complex transactions and claims on securities domestic financial institutions. Most firms. comments did not support significant substantive changes to the existing framework. After considering the com- Recourse, Direct Credit Substitutes, ments, the agency staffs in 2001 decided and Residual Interests in not to proceed with a simplified capital Asset Securitizations approach. Instead, they are continuing On November 29, 2001, the Federal discussions on possible ways to mod- Reserve, together with the other federal ify the regulatory capital rules more banking agencies, issued a final rule to broadly. amend their respective risk-based and leverage capital standards for the treat- Supervisory Policy on the Application ment of recourse obligations, direct of Capital Requirements to Bank credit substitutes, and residual interests Holding Companies Owned by Foreign that expose banks, bank holding compa- Banking Organizations nies, and thrift institutions to credit risk. The final rule combined two earlier pro- In January 2001, the Federal Reserve posals on these matters that had over- revised its policy of subjecting all toplapped in some respects. It makes use of tier U.S. bank holding companies to external credit ratings to match the risk- the U.S. minimum regulatory capital based capital assessment more closely requirements. A limited exception was to an institution's relative risk of loss in made for top-tier U.S. bank holding asset securitizations. The rule requires companies owned by foreign banks that institutions hold risk-based capital qualifying as financial holding comin an amount equal to the amount of panies under the Gramm-Leach-Bliley residual interests that arise in securitiza- Act. For a foreign bank to qualify as a tions (or other transfers of assets) and financial holding company, the Board that are retained on the balance sheet. In must have determined that it is well addition, credit-enhancing interest-only capitalized and well managed under strips receivables, either purchased standards comparable to those applied or retained, are limited to 25 percent to U.S. banks owned by bank holding of tier 1 capital. Amounts exceeding companies qualifying as financial hold- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 153 ing companies. A top-tier U.S. bank intended to align the capital requireholding company owned by such a for- ments for these transactions more approeign bank will continue to be required priately with the risk involved and to to report its capital under the U.S. capi- level the playing field for banking tal adequacy guidelines for bank hold- organizations vis-a-vis their domestic ing companies but will not be required and foreign competitors. Among the to meet the regulatory minimums. Mini- public comments submitted by the due mum levels of capital for these organi- date of January 19, 2001, support for the zations will instead be determined on a interim rule was unanimous. The interim supervisory basis. In making this revi- rule remains in effect. sion, the Federal Reserve determined that relying on the capital strength of Claims on Securities Firms the consolidated foreign bank, as well In December 2000, the federal bankas requiring subsidiary banks to meet ing agencies proposed to reduce from appropriate capital and management 100 percent to 20 percent the risk weight standards, is consistent with the Fedaccorded to claims on, and claims eral Reserve's supervisory assessment guaranteed by, qualifying securities process for domestic bank holding firms in countries that are memcompanies. bers of the Organisation for Economic Co-operation and Development. The Capital for Nonfinancial change would bring the risk weight in Equity Investments line with a 1998 revision to the Basel In February 2001, the Federal Reserve, Capital Accord. Qualifying U.S. securitogether with the OCC and the FDIC, ties firms would be broker-dealers regissued a proposal concerning the regula- istered with the Securities and Exchange tory capital treatment of equity invest- Commission (SEC) that are in comments in nonfinancial companies held pliance with the SEC's net capital rule by banks, bank holding companies, and and meet certain other requirements. financial holding companies. The pro- Work continued during 2001, and the posal represented a modification of a agencies expect to issue a final rule in proposal that had been issued in March the first quarter of 2002. 2000. Under the revised proposal, a capital charge would be imposed that Fiduciary Activities would increase in steps as the banking In February 2001, the Federal Reserve organization's level of concentration in issued guidance concerning the inteequity investments increased. Agency gration of trust and transfer agency monitoring also would increase as the examinations into safety and soundness level of concentration in equity investexaminations. Fiduciary activities and ments increased. related services generally include traditional trust services—such as personal Securities Borrowing Transactions trust, corporate trust, and transfer agent In December 2000, the Federal Reserve, services—and employee benefit account together with the FDIC and the OCC, products and services, as well as cusissued an interim rule to revise the capi- todial and securities lending services tal treatment of cash collateral that is and clearing-and-settlement, assetposted in connection with securities management, and investment-advisory borrowing transactions. The change was activities. The intent of the guidance is Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

154 88th Annual Report, 2001 to improve integration of the super- the depository institution and may rapvisory assessment of banking organi- idly shift funds to another institution or zations' fiduciary activities into the investment in search of a higher return. overall safety and soundness super- The advisory states that banking organivision process and to focus supervisory zations should employ appropriate sysresources on areas of greatest risk. tems to identify and control this risk. Such systems include appropriate fundsmanagement policies, adequate due dili- Securities Activities of gence in assessing deposit brokers and State Member Banks financial risks, reasonable control and On May 14, 2001, the Federal Reserve limit structures, adequate information issued guidance to examiners and systems, and contingency funding plans. other supervisory personnel regarding changes to the permissible securities International Guidance on activities of state member banks under Supervisory Policies the Gramm-Leach-Bliley Act. The act authorized well-capitalized state mem- As a member of the Basel Committee on ber banks to underwrite, deal in, and Banking Supervision (Basel Commitinvest in municipal revenue bonds with- tee), the Federal Reserve in 2001 parout limitation as to the level of these ticipated in efforts to revise the interactivities that may be conducted relative national capital regime and to develop to the bank's capital. Until that time, international supervisory guidance. The state member banks could, without capi- Federal Reserve's goals in these activital limitation, underwrite, deal in, or ties are to advance sound supervisory invest in only general obligation munici- policies for internationally active bankpal bonds backed by the full faith and ing institutions and to improve the credit of an issuer having general pow- stability of the international banking ers of taxation. system. The efforts are described in the following sections. Joint Agency Advisory on Capital Adequacy Rate-Sensitive Deposits The Federal Reserve continued to par- In May 2001, the Federal Reserve, ticipate in a number of technical worktogether with the other federal banking ing groups of the Basel Committee in agencies, issued an interagency advisory efforts to develop a new capital accord. outlining the risk-management proce- These groups, in grappling with a numdures that banking organizations should ber of difficult issues, released several follow in assessing and controlling the consultative papers during 2001: risks associated with significant reliance on brokered and rate-sensitive deposits. • In January, the Basel Committee The advisory states that deposits raised issued for public consultation a series through intermediary sources, such as of papers setting forth proposals for a deposit brokers, the Internet, and other new capital accord. This consultative automated service providers, may be package laid the groundwork for forless stable than traditional deposits, mal and informal discussions with the primarily because depositors making banking industry and other interested deposits through intermediary sources parties on a revised international capimay not have other relationships with tal framework. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 155 • In continuing its work on a new capi- of sound practices for the management tal accord, and in response to public of operational risk. comments on the January consultative package, the Basel Committee issued Joint Forum for further consultation a number of technical working papers, includ- In its work with the Basel Committee, ing "Internal Ratings-Based (IRB) the Federal Reserve also continued its Treatment of Expected Losses and participation in the Joint Forum, a group Future Margin Income" (July); "Risk- made up of representatives of the com- Sensitive Approaches for Equity mittee, the International Organization Exposures in the Banking Book for of Securities Commissions, and the IRB Banks" (August); "Pillar 3— International Association of Insurance Market Discipline" (September); Supervisors. The Joint Forum works to "Regulatory Treatment of Operational increase mutual understanding of issues Risk" (September); "Internal Ratings- related to the supervision of firms oper- Based Approach to Specialized Lend- ating in each of the financial sectors. In ing Exposures" (October); and this regard, the Federal Reserve contrib- "Treatment of Asset Securitizations" uted to two Joint Forum papers issued (October). in November 2001: "Risk Management Practices and Regulatory Capital," which compares current industry prac- Risk Management tices in all three sectors, and "Core The Federal Reserve contributed to a Principles: Cross-Sectoral Comparison," number of supervisory policy papers, which identifies similarities and differreports, and recommendations issued ences among the core principles of the by the Basel Committee during 2001. three sectors. These documents were generally aimed at improving the supervision of banks' Internal Control, Accounting, risk-management practices. The paper and Disclosure "Review of Issues Relating to Highly Leveraged Institutions" (issued in Feb- The Federal Reserve participates in ruary) set forth sound risk-management the Basel Committee's Task Force on practices when dealing with highly Accounting Issues and its Transparency leveraged institutions. "Risk Manage- Group and represents the Basel Comment Principles for Electronic Banking" mittee at international meetings on the (issued in May) was intended to help issues addressed by these groups. In parbanking institutions expand their exist- ticular, during 2001 the Federal Reserve ing risk-management policies and prac- represented the Basel Committee at tices to cover their electronic-banking meetings of the committee of the Interactivities. The paper "Customer Due national Accounting Standards Board Diligence for Banks" (issued in Octo- (IASB) that works to improve accountber) provides guidance on effective ing guidance concerning financial incontrols and procedures for getting to struments. In addition, a representative know customers. The consultative paper of the Federal Reserve was appointed a "Sound Practices for the Management member of the IASB's Standards Adviand Supervision of Operational Risk" sory Council. (issued in December) solicited banking During 2001 the Federal Reserve also industry comments on a proposed range contributed to a letter and several papers Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

156 88th Annual Report, 2001 on internal control, accounting, and dis- mittee (IAPC). Staff also represented closure issued by the Basel Committee, the Basel Committee's Task Force on including the following: Accounting Issues at meetings with representatives of the IAPC and the Inter- • "Comment Letter on Fair Value national Forum on Accountancy Devel- Accounting"—In this letter (issued in opment to encourage the adoption of September) the IASB solicited views enhanced international auditing stanon the benefits and costs associated dards and practices. with a fair value accounting model for In December the Board sent a comfinancial instruments. The Basel Com- ment letter to the IASB on an intermittee recommended that the IASB national proposal to adopt fair value explore additional disclosure of fair accounting. The comment letter attached value information and improve stan- a staff research report that explored a dards for loan loss allowances and number of issues arising from the prodisclosures about credit risk in lieu posal's suggestion that banks and other of introducing a comprehensive fair companies use their internal creditvalue accounting model at this time. grading systems to estimate fair values when certain criteria are met. • "The Relationship Between Banking Supervisors and Banks' External Gramm-Leach-Bliley Act Auditors"—This joint paper by the Basel Committee and the International The Gramm-Leach-Bliley Act (GLBA) Auditing Practices Committee (to be repealed those provisions of the Glassissued in January 2002) provides Steagall Act and the Bank Holding guidance on ways to strengthen the Company Act that restricted the ability relationship between bank auditors of bank holding companies to affiliate and supervisors and incorporates the with securities firms and insurance com- Basel Committee's core principles for panies. The provisions of GLBA, and effective banking supervision. the Federal Reserve's final rule, which was adopted in January 2001, establish • "Internal Audit in Banks and the conditions that a bank holding company Supervisor's Relationship with or a foreign bank must meet to be Auditors"—This paper (issued in deemed a financial holding company August) sets forth objectives and prin- and to engage in expanded activities. ciples for an effective bank internal- In addition to controlling depository audit function, the role of internal institutions, financial holding compaaudit, and the banking supervisors' nies may engage in securities underwritviews on ways to strengthen the rela- ing and dealing, serve as an insurance tionship between banking supervisors agent and insurance underwriter, act as and internal and external auditors. a futures commission merchant, and engage in merchant banking. Permis- Staff members also supported the sible activities also include activities Basel Committee's Task Force on that the Board and the Secretary of the Accounting Issues in the development Treasury jointly determine to be finanof comment letters on major propos- cial in nature or incidental to financial als of the International Federation of activities and activities that the Federal Accountants (IFAC) and of IFAC's Reserve determines are complementary International Auditing Practices Com- to a financial activity and do not pose a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 157 substantial risk to the safety and sound- missions. Cross-sector forums provide ness of depository institutions or the an opportunity for multiple supervisors financial system generally. (both federal and state) to discuss issues On January 2, 2001, the Federal of common interest and to enhance Reserve and the Department of the Trea- communication and cooperation. At the sury issued an interim rule defining the October meeting, the group focused on following as permissible activities: lend- the impact and implications of the Seping, exchanging, transferring, investing tember 11 terrorist attacks on each of for others, or safeguarding financial the sectors. Three cross-sector meetings assets other than money or securities; are scheduled for 2002. providing any device or other instrumentality for transferring money or Merchant Banking Activities other financial assets; and arranging, On January 31, 2001, the Board and effecting, or facilitating financial transthe Secretary of the Treasury jointly actions for the account of third parties. adopted a final rule governing merchant In addition, in February 2001 the Fedbanking investments made by financial eral Reserve and the Department of the holding companies.5 The rule imple- Treasury extended the comment period ments provisions of GLBA that permit for a December 2000 proposal that financial holding companies to make would include real estate brokerage and investments as part of a bona fide secureal estate management as permissible rities underwriting or merchant or activities under GLBA. investment banking activity. The Board Under GLBA, the Federal Reserve and the Secretary incorporated a numhas supervisory oversight authority and ber of amendments to the final rule to responsibility for bank holding comaddress issues raised by public companies, including those that operate as menters, to reduce potential regulatory financial holding companies. The statute burdens, and to clarify the application streamlines the Federal Reserve's superof the rule. These changes included vision for all bank holding companies expanding the definition of "securiand sets forth parameters for the relaties affiliate" to include a department tionship between the Federal Reserve or division of a bank registered as a and other regulators. The statute differmunicipal securities dealer; modifying entiates between the Federal Reserve's the provisions defining prohibited rourelations with regulators of depository tine management and operation of portinstitutions and its relations with funcfolio companies; adopting a sunset protional regulators (that is, regulators for vision for the investment thresholds insurance, securities, and commodities). under the interim rule and eliminating During 2001, the Federal Reserve conthe dollar-based threshold for the review tinued its efforts to ensure that superof a financial holding company's mervisory policies applied to banking instichant banking activities; streamlining tutions are consistent with the provisions the rule's reporting and recordkeeping of GLBA. requirements; broadening the definition In its role as the holding company supervisor, the Federal Reserve in 2001 hosted two cross-sector meetings with 5. "Merchant banking" investments may be made in any type of ownership interest and in any representatives of the banking agencies, type of nonfinancial entity (portfolio company) securities and commodities and futures and may represent any amount of the equity of a authorities, and state insurance com- portfolio company. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

158 88th Annual Report, 2001 of "private equity" funds and clarifying things, the FFIEC issued substantial the rule's application to such funds; and revisions to the Call Report; a statement adopting several safe harbors to the regarding a major revision of article 9 of presumptions in the rule governing the the Uniform Commercial Code; a policy definition of "affiliate" for purposes of statement on methodologies and docusections 23A and 23B of the Federal mentation in connection with allow- Reserve Act. The final rule became ances for loan and lease losses; and effective February 15, 2001. guidance on risk-management issues. Information-Security Standards Bank Call Reports Under section 501(b) of GLBA, the fed- As the federal supervisor of state memeral banking agencies are required to ber banks, the Federal Reserve, acting issue standards for information security. in concert with the other federal banking In February 2001, after soliciting pubagencies through the FFIEC, requires lic comment on a June 2000 proposal, banks to submit quarterly Reports of the agencies published "Interagency Condition and Income (the Call Report). Guidelines Establishing Standards for This report is the primary source of data Safeguarding Customer Information." used in the supervision and regulation of The guidelines require banks and holdbanks and in the ongoing assessment ing companies to establish a written of the overall soundness of the nation's information-security program and to financial structure. Call Report data, control the risk of unauthorized access which also serve as benchmarks for the or other threats to the security and confifinancial information required in many dentiality of customer information. other Federal Reserve regulatory financial reports, are widely used by state and Financial Subsidiary Provisions local governments, state banking super- On August 16, 2001, the Board adopted visors, the banking industry, securities a final rule implementing the financial analysts, and the academic community. subsidiary provisions of GLBA for state For the 2001 reporting period, the member banks. The act authorizes state FFIEC implemented substantial revimember banks that comply with the sions to the Call Report to streamline requirements of the rule to control, or the reporting requirements and to add hold an interest in, a financial subsidi- new items that focus on areas of increasary, which may conduct certain finan- ing supervisory concern. The principal cial activities that the parent bank may revisions included not conduct directly. The final rule is substantially similar to the interim rule • Combining the three separate report adopted by the Board in March 2000. forms for banks of various sizes that have only domestic offices (FFIEC 032, 033, and 034) into a Federal Financial Institutions single form (designated FFIEC 041), Examination Council while retaining the separate form for banks having foreign offices During 2001, the Federal Reserve con- (FFIEC 031) tinued its active participation as a member of the Federal Financial Institutions • Eliminating a number of data items Examination Council. Among other that were no longer warranted Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 159 • Introducing a revised regulatory capi- contains a number of new or revised tal schedule that takes a step-by-step rules for secured transactions that affect "building block" approach to comput- financial institutions' procedures, sysing the key elements of the capital tems, documentation, and the enforceratios for all banks ability of security interests. In the statement, the FFIEC advised financial • Collecting new information on asset institutions and their legal counsel to sales and certain nontraditional bank consider carefully the changes in state activities. In addition, collection of law brought about by revised article 9 in the Annual Report of Trust Assets order to ensure the attachment and per- (FFIEC 001) and the Annual Report fection of their existing and future secuof International Fiduciary Activities rity interests. (FFIEC 006) was discontinued and a streamlined fiduciary-activities sched- Risk-Management Controls in the ule was added to the Call Report. Use of Electronic Financial Services Also, the Report of Assets and Liabili- In August 2001, the Federal Reserve ties of U.S. Branches and Agencies issued a new policy, developed by the of Foreign Banks (FFIEC 002) was FFIEC member agencies, addressing revised, effective with the June 2001 authentication in an electronic banking report, to maintain consistency with environment. In recognition of the the Call Report. importance of effective authentication measures in reducing the risk of fraud In October, the Federal Reserve and and strengthening information-security the other federal banking agencies proprograms, the guidance describes riskposed a few revisions to the Call Report management issues that banks should to facilitate effective supervision. The consider as they design and update their revisions would, effective with the on-line customer-authentication sys- March 2002 report, add a few items tems. The main portion of the guidto conform with changes in generally ance gives background information accepted accounting principles, speand describes sound risk-management cifically, the reporting requirements of measures. Processes for verifying the Statement of Financial Accounting Stanidentity of prospective customers and dard No. 141, Business Combinations, authenticating existing customers who and No. 142, Goodwill and Other Intanuse on-line systems, such as Internet gible Assets. The revisions would also banking services, are discussed, and add several items to address new safety details are provided concerning various and soundness considerations. authentication technologies and issues to consider when implementing these Revisions to Article 9 of the processes. Uniform Commercial Code On February 28, 2001, the FFIEC issued Efforts to Enhance Transparency a statement regarding a major revision and Bank Regulatory Financial of article 9 of the Uniform Commercial Reports Code and its effect on financial institutions. Article 9 governs transactions The Federal Reserve has long supported involving the granting of credit secured sound accounting policies and meaningby personal property. Revised article 9 ful public disclosure by banking and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

160 88th Annual Report, 2001 financial organizations to improve mar- be systematic, consistently applied, and ket discipline and foster stable financial auditable; validated periodically; and markets. Effective market discipline modified as needed to incorporate new can be an important complement to events or findings. The guidance also bank supervision and regulation. As provides examples of appropriate docufinancial institutions make more infor- mentation and illustrations showing how mation available, market participants the guidance should be implemented. are able to make better evaluations of counterparty risk and better adjustments Interagency Guidance on to the availability and pricing of funds. Loans Held for Sale Thus, transparency can promote efficiency in financial markets and sound In March the Federal Reserve, the other practices by banks. The Federal Reserve federal banking agencies, and the also seeks to strengthen audit and con- National Credit Union Administration trol standards for banks; the quality of issued guidance regarding the approprimanagement information and financial ate treatment of loans that an institution reporting is dramatically affected by in- intends to sell. Consistent with GAAP, ternal control systems, including inter- the guidance requires an institution to nal and external audit programs. record a charge-off against the ALLL To advance these objectives, the Fed- when it decides to sell loans whose fair eral Reserve works with other regula- value has declined for any reason other tors, the accounting profession, and a than a change in the general market wide variety of market participants, both level of interest or foreign exchange domestically and internationally. rates. Interagency Guidance on the Private-Sector Working Group on Allowance for Loan and Lease Losses Public Disclosure In July 2001, the Federal Reserve, the The Private-Sector Working Group on Securities and Exchange Commission, Public Disclosure, a group composed of and the other federal banking agencies senior executives from major domestic issued joint guidance regarding docu- and foreign banking organizations and mentation of the allowance for loan and securities firms, was established by the lease losses. The Federal Reserve and Federal Reserve to recommend ways the other federal banking agencies to enhance public financial statement issued the guidance as an FFIEC policy disclosures. The SEC and OCC also statement, and the SEC issued parallel participated in the effort. In January, guidance as Staff Accounting Bulletin the working group released a report 102. The guidance clarifies the agen- recommending enhanced and morecies' expectations in regard to documen- frequent public disclosure of financial tation supporting the methodology used information by banking and securito calculate allowances for loan and ties firms. Subsequently, the Federal lease losses (ALLL). It requires that Reserve, SEC, and OCC issued supera financial institution's ALLL meth- visory guidance encouraging banking odology be consistent with generally organizations and securities firms to accepted accounting principles (GAAP) follow these recommendations. Privateand all outstanding supervisory guid- sector efforts, such as those of the ance. Further, the methodology should working group, and official regulatory Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 161 initiatives can help foster consensus and Improvement Act of 1994, which directs advance thinking on what constitutes the banking agencies to review the inforsound or best practice regarding public mation that institutions report in the Call disclosure. Report and the bank holding company reports and eliminate requirements that are not warranted for safety and sound- Bank Holding Company ness or other public policy purposes. Regulatory Financial Reports As part of the streamlining process, The Federal Reserve requires that U.S. the Federal Reserve made changes to bank holding companies submit peri- other FR Y-9 and FR Y-ll series odic regulatory financial reports. These reports to introduce more uniformity to reports, the FR Y-9 and FR Y-ll certain aspects of regulatory reporting. series, provide information essential The changes not only increased unito the supervision of the organizations formity within the holding company and to the formulation of regulations reports but also brought several reportand supervisory policies. The Federal ing items into closer alignment with the Reserve also uses the information in Call Report and the Thrift Financial responding to requests from the Con- Report. Other modifications to the holdgress and the public for information on ing company reports were made so that bank holding companies and their non- their form and content would more bank subsidiaries. closely resemble the manner in which The FR Y-9 series of reports pro- information is presented in financial vides standardized financial statements statements that banking organizations for the consolidated bank holding prepare in accordance with generally company. The reports are used to detect accepted accounting principles for other emerging financial problems, review financial reporting purposes. performance and conduct pre-inspection Besides streamlining the FR Y-9C analysis, monitor and evaluate risk reporting requirements by eliminating profiles and capital adequacy, evaluate information no longer of significant proposals for bank holding company value, the Federal Reserve also mergers and acquisitions, and analyze improved the relevance of the FR Y-9C the holding company's overall financial by identifying new types of information condition. that are expected to be critical to the The FR Y-ll series of reports aids Federal Reserve's future supervisory the Federal Reserve in determining the data needs. The improvements focus on condition of bank holding companies new activities and other recent develthat are engaged in nonbanking activi- opments that may expose institutions to ties and in monitoring the volume, new or different types of risk. nature, and condition of their nonbank- In light of the Gramm-Leach-Bliley ing subsidiaries. Act and the increased involvement In March 2001, the Federal Reserve of banking organizations in merchant implemented numerous revisions to the banking and equity investment in nonfi- FR Y-9C report that streamlined the nancial companies, the Federal Reserve reporting requirements. The streamlin- implemented the new Consolidated ing was part of the Federal Reserve's Bank Holding Company Report of effort to achieve the objectives set forth Equity Investments in Nonfinancial in section 307(c) of the Riegle Com- Companies (FR Y-12), effective Sepmunity Development and Regulatory tember 30, 2001. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

162 88th Annual Report, 2001 Supervisory Information tify, implement, and deploy a common Technology document-management technology for the supervision function on a System- The Supervisory Information Technolwide basis. In 2001, as part of its ogy (SIT) function within the Board's project-management training for Board Division of Banking Supervision and and Reserve Bank staff, it also revised Regulation facilitates management of and updated the project managers' handinformation technology within the Fedbook, which draws on the best practices eral Reserve's supervision function. Its in private industry and government. goals are to ensure that • IT initiatives support a broad range of Enhancements to the supervisory activities without duplica- National Information Center tion or overlap The National Information Center (NIC) is the Federal Reserve's comprehensive • The underlying IT architecture fully repository for supervisory, financial, and supports those initiatives banking-structure data and documents. NIC includes the National Examination • The supervision function's use of Data (NED) system, software that protechnology takes advantage of the vides supervisory personnel and state systems and expertise available more banking authorities with access to NIC broadly within the Federal Reserve data, and the Central Document and System. Text Repository (CDTR), which contains documents supporting the super- SIT works through assigned staff at visory process. the Board of Governors and the Reserve In 2001 much work was accom- Banks and through a committee strucplished to make the NED system availture that ensures that key staff members able over the web and to add functionalthroughout the Federal Reserve System ity to further support the supervision of participate in identifying requirements banking institutions. Implementation of and setting priorities for IT initiatives. this new version of NED is planned for SIT also houses the management of the the second quarter of 2002. National Information Center, a compre- In September, new structure report hensive repository for vital supervision forms were put into use to capture information. changes in the organizational structure of bank holding companies (FR Y-10) and foreign banking organizations SIT Activities (FR Y-10F). Also, extensive revisions In 2001 SIT revised and updated the were made to NIC to support the collecoperating plan for the ongoing approval tion of data and the quality of reports. In and reassessment of IT projects, which addition, an Internet-based reporting was prepared in 2000. It is developing a mechanism was implemented to allow capital planning and information tech- bank holding companies to submit nology investment guide to ensure that reports electronically. During the year, IT investments in proposed projects and progress was made on enhancements products support the function's strategic to the CDTR so that it will be able to goals. SIT is undertaking an enterprise handle more documents, accept docudocument management project to iden- ments from other agencies, and permit Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 163 web-based access. Implementation is disciplines of bank supervision: bank planned for June 2002. examinations, bank holding company inspections, surveillance and monitoring, and applications analysis. Classes Staff Training are conducted in Washington, D.C., The System Staff Development Program as well as at other locations and are trains staff members at the Board of sometimes held jointly with other Governors, the Reserve Banks, and state regulators. banking departments who have supervi- The Federal Reserve System also sory and regulatory responsibilities; stu- participates in training offered by the dents from foreign supervisory authori- FFIEC and by certain other regulatory ties attend training sessions on a space- agencies. The System's involvement available basis. The program's goal is, includes developing and implementing in part, to provide greater cross-training. basic and advanced training in relation Training is offered at the basic, interme- to various emerging issues as well as in diate, and advanced levels in the four specialized areas such as trust activities, Training Programs for Banking Supervision and Regulation, 2001 Number of sessions conducted Program Total Regional Schools or seminars conducted by the Federal Reserve Core schools Banking and supervision elements 10 Operations and analysis 6 5 Bank management 4 1 Report writing 20 20 Management skills 9 9 Conducting meetings with management 16 16 Other schools Loan analysis Examination management Real estate lending seminar Specialized lending seminar Senior forum for current banking and regulatory issues Banking applications Principles of fiduciary supervision Commercial lending essentials for consumer affairs Consumer compliance examinations I Consumer compliance examinations II CRA examination techniques Fair lending examination techniques Foreign banking organizations Information systems continuing education Capital markets seminars 11 Technology risk integration 24 24 Leadership dynamics 4 4 Seminar for senior supervisors of foreign central banks' Other agencies conducting courses 2 Federal Financial Institutions Examination Council 37 The Options Institute 1 1. Conducted jointly with the World Bank. . . Not applicable. 2. Open to Federal Reserve employees. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

164 88th Annual Report, 2001 Student Examination Results, First Track, 2001 Specialty Core Result proficiency Safety and Consumer Trust Information soundness affairs technology Passed 35 25 8 3 1 Failed 19 4 9 1 3 Total 54 29 17 4 4 NOTE. These examinations are for examiners hired before February 28, 1998. international banking, information tech- A staff member seeking an examinnology, municipal securities dealing, er's commission follows one of two capital markets, payment systems risk, training tracks. One track, for staff memwhite collar crime, and real estate lend- bers hired before February 28, 1998, ing. In addition, the System co-hosts the involves a "core proficiency examina- World Bank Seminar for students from tion" as well as a specialty examination developing countries. in an area of the student's choice— In 2001 the Federal Reserve trained safety and soundness, consumer affairs, 2,832 students in System schools, 645 in trust, or information technology. Stuschools sponsored by the FFIEC, and 15 dents on this track had to complete the in other schools, for a total of 3,492, commissioning requirements by Decemincluding 234 representatives of foreign ber 31, 2001. In 2001, 35 examiners central banks (see accompanying table). passed the core proficiency examination The number of training days in 2001 (see table). totaled 18,483. The other track, for staff members The System gave scholarship assis- hired after February 27, 1998, involves tance to the states for training their a "first proficiency examination" as examiners in Federal Reserve and well as a "second proficiency examina- FFIEC schools. Through this program, tion" in one of the four specialty areas. 445 state examiners were trained— The table below reflects 2001 pass rates 277 in Federal Reserve courses, 166 for the second track. At the end of 2001, in FFIEC programs, and 2 in other the System had 1,242 field examiners, courses. of which 861 were commissioned. Student Examination Results, Second Track, 2001 Second proficiency First Result proficiency Safety and Consumer Trust Information soundness affairs technology Passed 199 49 17 5 3 Failed 3 11 4 0 0 Total 202 60 21 5 3 NOTE. These examinations are for examiners hired after February 27, 1998. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 165 Regulation of the of one or more banks in the United U.S. Banking Structure States. Once formed, a bank holding company must receive Federal Reserve The Board of Governors administers the approval before acquiring or estab- Bank Holding Company Act, the Bank lishing additional banks. The act also Merger Act, the Change in Bank Conidentifies other activities permissible trol Act, and the International Banking for bank holding companies; depend- Act, each in relation to bank holding ing on the circumstances, these activicompanies, financial holding compaties may or may not require Federal nies, member banks, and foreign bank- Reserve approval in advance of their ing organizations, as appropriate. In commencement. doing so, the Federal Reserve acts on a Bank holding companies generally variety of proposals that directly or indimay engage in only those activities that rectly affect the structure of U.S. bankthe Board has previously determined to ing at the local, regional, and national be closely related to banking under seclevels; the international operations of tion 4(c)(8) of the act. Since 1996, the domestic banking organizations; and act has provided an expedited priorthe U.S. banking operations of foreign notice procedure for certain permissible banks. nonbank activities and for acquisitions In November 2001, revisions to of small banks and nonbank entities. Regulation K—which governs the for- Since that time the act has also permiteign operations of U.S. banking orga- ted well-run bank holding companies nizations and the U.S. operations of that satisfy certain criteria to commence foreign banking organizations—were certain other nonbank activities on a implemented. In general, the revisions de novo basis without first obtaining streamlined foreign branching proce- Federal Reserve approval. dures for U.S. banking organizations, When reviewing a bank holding comauthorized expanded activities at forpany application or notice to engage in eign branches of U.S. banks, and implean activity that requires prior approval, mented recent statutory changes. the Federal Reserve considers the Changes were also made to the profinancial and managerial resources of visions governing permissible foreign the applicant, the future prospects of activities of U.S. banking organizaboth the applicant and the firm being tions, including securities activities, and acquired, the convenience and needs of investments made under general consent the community to be served, the potenprocedures. In addition, the revisions tial public benefits, the competitive streamlined the application procedures effects of the proposal, and the appliapplicable to foreign banks seeking to cant's ability to make available to the expand their operations in the United Board information deemed necessary States. to ensure compliance with applicable law. In the case of a foreign banking organization seeking to acquire control Bank Holding Company Act of a U.S. bank, the Federal Reserve Under the Bank Holding Company Act, also considers whether the foreign a corporation or similar organization bank is subject to comprehensive supermust obtain the Federal Reserve's vision or regulation on a consoliapproval before forming a bank hold- dated basis by its home country ing company through the acquisition supervisor. Data on decisions regard- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

166 88th Annual Report, 2001 Decisions by the Federal Reserve on Domestic and International Applications, 2001 Action under authority delegated by the Board of Governors Direct action Proposal Board o b f y G th o e vernors Div D is i i r o ec n t o o r f o B f a t n h k e ing O of f f t i h ce e Federal Total Supervision and Secretary Reserve Banks Regulation Approved Denied Permitted Approved Denied Approved Approved Permitted Formation of bank holding company 28 0 0 0 0 3 170 59 260 Merger of bank holding company 8 0 0 0 0 6 40 22 76 Acquisition or retention of bank 19 0 0 0 0 6 86 39 150 Acquisition of nonbank 0 0 62 0 0 7 0 124 193 Merger of bank 10 0 0 0 0 9 106 0 125 Change in control Establishment of a 0 0 0 0 0 3 0 111 114 branch, agency, or representative office by a foreign bank 12 0 4 3 0 0 9 0 28 Other 360 0 29 56 0 69 1,081 155 1,750 Total 437 0 95 59 0 103 1,492 510 2,696 ing domestic and international applica- company declarations and 3 foreign tions in 2001 are shown in the accompa- bank declarations were approved. nying table. Financial holding companies do not Since 2000, the Bank Holding Com- have to obtain the Board's prior pany Act has permitted the creation of approval to engage in or acquire a coma special type of bank holding com- pany engaged in new financial activities pany called a financial holding com- under GLBA. Instead, the financial pany. Financial holding companies are holding company must notify the Board allowed to engage in a broader range of within thirty days after commencing a nonbank activities than are traditional new activity or acquiring a company bank holding companies: Among other engaged in a new activity. A financial things, they may affiliate with securi- holding company also may engage in ties firms and insurance companies and certain other activities that have been engage in certain merchant banking determined to be financial in nature or activities. Bank holding companies incidental to a financial activity or that seeking financial holding company sta- are determined to be complementary to tus must file a written declaration with a financial activity. the Federal Reserve System; most declarations are acted on by one of the Bank Merger Act Reserve Banks under authority delegated by the Board of Governors. In The Bank Merger Act requires that all 2001, 135 domestic financial holding proposals involving the merger of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 167 insured depository institutions be acted tition in any relevant market; the comon by the appropriate federal banking pleteness of information submitted by agency. If the institution surviving the the acquiring person; and whether the merger is a state member bank, the Fed- proposed change would have an adverse eral Reserve has primary jurisdiction. effect on the federal deposit insur- Before acting on a merger proposal, the ance funds. As part of the process, the Federal Reserve considers the financial Federal Reserve may contact other and managerial resources of the appli- regulatory or law enforcement agencies cant, the future prospects of the existing for information about each acquiring and combined institutions, the conve- person. nience and needs of the community to The appropriate federal banking agenbe served, and the competitive effects cies are required to publish notice of of the proposed merger. It also con- each proposed change in control and to siders the views of certain other agen- invite public comment, particularly from cies regarding the competitive factors persons located in the markets served by involved in the transaction. During the institution being acquired. 2001 the Federal Reserve approved In 2001 the Federal Reserve approved 125 merger applications. 114 proposed changes in control of When the FDIC, the OCC, or the state member banks and bank holding OTS has jurisdiction over a merger, the companies. Federal Reserve is asked to comment on the competitive factors; by using stan- International Banking Act dard terminology in assessing competitive factors in merger cases, the four The International Banking Act, as agencies have sought to ensure consis- amended by the Foreign Bank Supervitency in administering the act. The Fed- sion Enhancement Act of 1991, requires eral Reserve submitted 653 reports on foreign banks to obtain Federal Reserve competitive factors to the other agencies approval before establishing branches, in 2001. agencies, commercial lending company subsidiaries, or representative offices in the United States. Change in Bank Control Act In reviewing proposals, the Federal The Change in Bank Control Act Reserve generally considers whether requires persons seeking control of a the foreign bank is subject to compre- U.S. bank or bank holding company to hensive supervision or regulation on a obtain approval from the appropriate consolidated basis by its home country federal banking agency before complet- supervisor. It also considers whether the ing the transaction. The Federal Reserve home country supervisor has consented is responsible for reviewing changes in to the establishment of the U.S. office; the control of state member banks and the financial condition and resources bank holding companies. In its review, of the foreign bank and its existing U.S. the Federal Reserve considers the finan- operations; the managerial resources cial position, competence, experience, of the foreign bank; whether the home and integrity of the acquiring person; country supervisor shares information the effect of the proposed change on the regarding the operations of the foreign financial condition of the bank or bank bank with other supervisory authorities; holding company being acquired; the whether the foreign bank has provided effect of the proposed change on compe- adequate assurances that information Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

168 88th Annual Report, 2001 concerning its operations and activities domestic branches, and all member will be made available to the Board, banks (including national banks) must if deemed necessary to determine and obtain Federal Reserve approval to enforce compliance with applicable law; establish foreign branches. When whether the foreign bank has adopted reviewing proposals to establish domesand implemented procedures to combat tic branches, the Federal Reserve conmoney laundering and whether the home siders the scope and character of the country of the foreign bank is develop- proposed banking activities to be coning a legal regime to address money ducted. When reviewing proposals for laundering or is participating in multilat- foreign branches, the Federal Reserve eral efforts to combat money launder- considers, among other things, the coning; and the record of the foreign bank dition of the bank and the bank's experiwith respect to compliance with U.S. law. ence in international banking. Once a In 2001 the Federal Reserve approved member bank has received authority to 28 applications by foreign banks to open a branch in a particular foreign establish branches, agencies, and repre- country, that bank may open additional sentative offices in the United States. branches in that country without prior approval from the Federal Reserve. Excluding proposals related to recent Overseas Investments by large domestic mergers, the Federal U.S. Banking Organizations Reserve in 2001 acted on proposals U.S. banking organizations may engage involving 1,399 new or merger-related in a broad range of activities overseas. domestic branches and granted prior Many of the activities are conducted approval for the establishment of 13 forindirectly through Edge Act and agree- eign branches. ment corporation subsidiaries. Although State member banks also must obtain most foreign investments are made Federal Reserve approval to establish under general consent procedures that financial subsidiaries. These subsidiaries involve only an after-the-fact notifica- may engage in activities that are finantion to the Board, large and other signi- cial in nature or incidental to financial ficant investments require the prior activities, including certain securitiesapproval of the Board. Excluding pro- and insurance-related activities that the posals relating to recent large domestic parent bank may not conduct directly. In mergers, the Federal Reserve in 2001 2001, 6 applications for financial subapproved 26 proposals for significant sidiaries were approved. overseas investments by U.S. banking organizations. The Federal Reserve also Stock Repurchases by approved 1 application to acquire an Bank Holding Companies Edge Act corporation, 3 to extend the corporate existence of an established A bank holding company may repur- Edge Act corporation, and 12 to estab- chase its own shares from its sharelish or acquire a new agreement holders. When the company borrows corporation. money to buy the shares, the transaction increases the company's debt and decreases its equity. The Federal Applications by Member Banks Reserve may object to stock repurchases State member banks must obtain Fed- by holding companies that fail to meet eral Reserve approval to establish certain standards, including the Board's Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 169 capital adequacy guidelines. In 2001 Delegation of Applications the Federal Reserve reviewed 20 stock Historically, the Board of Governors has repurchase proposals by bank holding delegated certain regulatory functions, companies; all were approved by a including the authority to approve, but Reserve Bank under delegated authority. not to deny, certain types of applications, to the Reserve Banks, to the Public Notice of Director of the Board's Division of Federal Reserve Decisions Banking Supervision and Regulation, and to the Secretary of the Board. In Most decisions by the Federal Reserve 2001, 80 percent of the applications prothat involve a bank holding company, a cessed were handled under delegated bank merger, a change in control, or the authority. establishment of a new U.S. banking presence by a foreign bank are effected by an order or an announcement. Orders Enforcement of state the decision, the essential facts Other Laws and Regulations of the application or notice, and the The Board's enforcement responsibilibasis for the decision; announcements ties also extend to financial disclosures state only the decision. All orders and by state member banks; securities credit; announcements are made public immeand efforts, under the Bank Secrecy Act, diately; they are subsequently reported to counter money laundering. in the Board's weekly H.2 statistical release and in the monthly Federal Reserve Bulletin. The H.2 release also Financial Disclosures by includes announcements of applications State Member Banks and notices received by the Federal State member banks that issue securities Reserve but not yet acted on. For each registered under the Securities Exchange pending application and notice, the Act of 1934 must disclose certain inforrelated H.2A states the deadline for mation of interest to investors, including comments. The Board's public web site annual and quarterly financial reports (http://www.federalreserve.gov) continand proxy statements. By statute, the ues to provide information relevant to Board's financial disclosure rules must the applications process. be substantially similar to those of the Securities and Exchange Commission. At the end of 2001, twenty-three state Timely Processing of Applications member banks were registered with the The Federal Reserve sets internal target Board under the Securities Exchange time frames for the processing of appli- Act. cations. The setting of targets promotes efficiency at the Board and the Reserve Securities Credit Banks and reduces the burden on applicants. Generally, the length of the target Under the Securities Exchange Act, the period ranges from twelve to sixty days, Board is responsible for regulating depending on the type of application credit in certain transactions involving or notice filed. In 2001, 92 percent of the purchase or carrying of securities. applications were processed within the The Board's Regulation T limits the established time period. amount of credit that may be provided Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

170 88th Annual Report, 2001 by securities brokers and dealers when tain records. These documents record the credit is used to trade debt and information on persons involved in large equity securities. The Board's Regula- currency transactions and on suspicious tion U limits the amount of credit that activity related to possible violations of may be provided by lenders other than federal law, including money laundering brokers and dealers when the credit is and other financial crimes. The act is a used to purchase or carry publicly held primary tool in the fight against money equity securities if the loan is secured by laundering; its requirements inhibit those or other publicly held equity secu- money laundering by creating a paper rities. The Board's Regulation X applies trail of financial transactions that helps these credit limitations, or margin law enforcement and regulators identify requirements, to certain borrowers and and trace the proceeds of illegal activity. to certain credit extensions, such as In addition to the specific requirecredit obtained from foreign lenders by ments of the Bank Secrecy Act (BSA), U.S. citizens. the Board's Regulation H (12 CFR Several regulatory agencies enforce 208.63) requires each banking organizathe Board's securities credit regulations. tion supervised by the Federal Reserve The SEC, the National Association of to develop a written program for BSA Securities Dealers, and the national compliance that is formally approved securities exchanges examine brokers by the institution's board of directors. and dealers for compliance with Regula- The compliance program must (1) estabtion T. The federal banking agencies lish a system of internal controls to examine banks under their respective ensure compliance with the act, (2) projurisdictions for compliance with Regu- vide for independent compliance testlation U; the Farm Credit Administra- ing, (3) identify individuals responsible tion, the National Credit Union Admin- for coordinating and monitoring day-toistration, and the Office of Thrift day compliance, and (4) provide train- Supervision examine lenders under their ing for personnel as appropriate. To respective jurisdictions for compliance monitor compliance, each Reserve Bank with Regulation U, and the Federal has designated a senior, experienced Reserve examines other Regulation U examiner as the Bank Secrecy Act and lenders. anti-money-laundering contact. During Since 1990 the Board has published a examinations of state member banks and list of foreign stocks that are eligible for U.S. branches and agencies of formargin treatment at broker-dealers on eign banks, specially trained examiners the same basis as domestic margin secu- review the institution's compliance with rities. In 2001 the foreign list was the act. revised in March and September. The Board has a special investigations section in the Division of Banking Supervision and Regulation that con- Anti-Money Laundering ducts financial investigations, provides The Department of the Treasury's regu- expertise to the U.S. law enforcement lation (31 CFR 103) implementing the community for investigation and train- Currency and Foreign Transactions ing initiatives, and offers training to Reporting Act (commonly referred to as various foreign central banks and govthe Bank Secrecy Act) requires banks ernment agencies; section staff speak at and other types of financial institutions banking conferences to promote best to file certain reports and maintain cer- practices in the industry. Internationally, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 171 the section has provided anti-money- sory letter in November to all domestic laundering training and technical assis- and foreign banking organizations under tance to countries in Asia; in Eastern its supervision. The letter described the Europe, including the newly indepen- act's provisions, highlighted those prodent states; in South and Central visions needing immediate attention by America; and in the Caribbean. Staff financial institutions and supervisory members have also participated in staff, and described the new rules that numerous multilateral anti-money- would be issued under the act. laundering initiatives such as the Finan- At the request of Treasury staff and cial Action Task Force and the Basel consistent with statutory requirements Committee on Banking Supervision. for consultation, the Federal Reserve has In 2001, the Federal Reserve contin- been actively assisting in the developued to provide expertise and guidance to ment of these new rules. Of the twenty the Bank Secrecy Act Advisory Group, working groups established by the Treaa committee established by the Con- sury Department to carry out the differgress at the Department of the Treasury ent regulatory projects required by the to seek measures to reduce unneces- act, Federal Reserve staff are involved sary burdens created by the act and to in fifteen. The Federal Reserve also increase the utility of data gathered established a PATRIOT Act Workunder the act to aid regulators and law ing Group composed of senior, experienforcement. The Federal Reserve also enced Bank Secrecy Act/anti-moneyassisted the Treasury Department in pro- laundering examiners from throughout viding feedback to financial institutions the System. This group, which is on the reporting of suspicious activity. charged with overseeing the System's Since the terrorist attacks of Septem- implementation of the new law, worked ber 11, the Federal Reserve has played on drafting new examination procedures an important role in many joint activi- and developing a new training curricuties with bank supervisory and law lum for examiners who conduct Bank enforcement authorities and the bank- Secrecy Act and anti-money-laundering ing community, both domestically and examinations. abroad, to combat money laundering and terrorist financing. In addressing the Loans to Executive Officers mandates of the anti-money-laundering provisions of the USA PATRIOT Act, Under section 22(g) of the Federal the Federal Reserve issued a supervi- Reserve Act, a state member bank must Loans by State Member Banks tctheir Executive Officers, 2000 and 2001 Range of interest Period Number Amount (dollars) rates charged (percent) 2000 October 1-December 31 702 59,232,000 5.5-20.8 2001 January 1-March 31 633 65,663,000 2.0-21.0 April 1-June 30 710 51,109,000 3.9-18.0 July 1-September 30 665 56,830,000 4.6-19.5 SOURCE. Call Reports. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

172 88th Annual Report, 2001 include in its quarterly Call Report and were operating 49,102 branches. information on all extensions of credit These banks accounted for 38 percent of by the bank to its executive officers all commercial banks in the United since the date of the preceding report. States and for 74 percent of all commer- The accompanying table summarizes cial banking offices. • this information for 2001. Federal Reserve Membership At the end of 2001, 3,058 banks were members of the Federal Reserve System Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

173 Federal Reserve Banks The Federal Reserve Banks devoted cost effective while continuing to proconsiderable attention in 2001 to vide high-quality, reliable services. improving security, operational effi- Another cost-reduction project begun ciency, and service quality. This chapter during the year was a concentrated multidescribes those efforts as well as other year effort to reduce employee benefit activities affecting the Reserve Banks. costs by consolidating health and welfare plans and their administration, by outsourcing, and by implementing cost- Major Initiatives effective benefit-plan design strategies. Since the terrorist attacks on Septem- The savings from these efforts are ber 11, the Federal Reserve has reevalu- expected to fully offset enhancements ated its contingency and business conti- of employee benefits that are intended nuity plans and operations and is taking to make employment at the Federal steps to enhance them. All information Reserve more attractive and thus technology infrastructures—both within improve the institution's ability to comand outside the Federal Reserve's pete for and retain the skilled profescontrol—that support critical operations sionals, technical staff, and key execuare being reexamined to ensure that they tives needed to carry out the Federal have appropriate security, redundancy, Reserve's mission. and diversity. Experience gained from preparing for the century date change and Developments in in the aftermath of the attacks is being Federal Reserve Priced Services applied to strengthen further the Federal Reserve's national incident-response pro- The Monetary Control Act of 1980 cedures and communications. requires that the Federal Reserve set fees In 2001, the Federal Reserve Banks for providing "priced services" to made an ambitious commitment to depository institutions that, over the reduce System costs in certain areas sig- long run, recover all the direct and indinificantly over the next three years. To rect costs of providing the services as achieve this objective, they initiated sev- well as the imputed costs, such as the eral cost-reduction projects in the infor- taxes that would have been paid and the mation technology, accounting, and return on equity that would have been human resources functions. earned had the services been provided Among the cost-reduction projects are by a private firm. The imputed costs and several to centralize or standardize com- imputed profit are collectively referred mon information technology utilities to as the private-sector adjustment facand resources. The Reserve Banks are tor (PSAF).1 Over the past ten years, the also collaborating on several projects to eliminate duplication of efforts in appli- 1. Along with income taxes and the return on cation development and to identify com- equity, the PSAF is made up of three additional mercially available alternatives to soft- imputed costs: interest on debt, sales taxes, and assessments for deposit insurance from the Fedware planned for development. These eral Deposit Insurance Corporation. Also allocated efforts will enable the Banks to be more to priced services are assets and personnel costs of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

174 88th Annual Report, 2001 September 11 and the Payments System We are blessed with a financial system that is creative, that is flexible, that is innovative. Banks—including the central bank—were there when they were needed and did what was required with dispatch. We should be proud of the banking system's role in minimizing the economic fallout of that tragic day. Alan Greenspan, Chairman, Board of Governors For several days after the terrorist attacks Reserve accounts averaged ten times their on September 11, 2001, communications usual level, with more than 70 percent of and connectivity problems disrupted por- those balances held by just six institutions, tions of the nation's payments system compared with the 20 percent this group infrastructure, requiring many banks, secu- normally holds. Disruptions in large payrities dealers, and settlement utilities in ment flows also resulted from problems lower Manhattan to relocate their opera- in the clearance and settlement of U.S. govtions to contingency sites. Although most ernment securities transactions and the backup procedures worked as planned, redemption of maturing commercial paper telecommunications problems impaired transactions. some firms' ability to communicate with Although electronic funds transfer syscounterparties and employees and to trans- tems, such as Fedwire, CHIPS, the automit payment and settlement instructions. mated clearinghouse (ACH), and credit and Transportation problems in the Manhattan debit card networks, were not directly area also made it difficult to move employ- affected by the attacks, some participants ees to contingency sites. experienced connectivity problems, result- Disruptions to the payments system due ing in a decline in payments activity. The to telecommunications and transportation value of aggregate daily payments over problems resulted in payment delays and CHIPS, for example, was lower than liquidity dislocations among financial mar- normal through September 14 but recovket participants for several days. As one ered the following week, while the value indication of liquidity dislocations, from of government securities transfers over September 12 to 14, the balances that the Fedwire securities transfer system depository institutions held in their Federal remained low through the week of Septem- Federal Reserve Banks have recovered priced services was $926.5 million, 99.8 percent of their priced services other income related to priced services costs, including the PSAF (table). was $33.9 million, and costs related to Overall, fees charged in 2001 for priced services were $901.9 million, priced services increased approximately resulting in net revenue of $58.5 million 5.2 percent from 2000.2 Revenue from and a recovery rate of 95.0 percent of costs, including the PSAF.3 the Board of Governors that are related to priced services; in the pro forma statements at the end of 3. Financial data reported throughout this the chapter, Board expenses are included in operat- chapter—revenue, other income, cost, net reveing expenses, and Board assets are part of long- nue, and income before taxes—can be linked to term assets. the pro forma statements at the end of the chapter. 2. Based on a chained Fisher Ideal price index Other income is revenue from investment of clearnot adjusted for quality changes. ing balances, net of earnings credits, an amount Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 175 ber 17. Although the value of Fedwire The Federal Reserve also worked closely funds transfers initially declined on Sep- with the financial industry to restore contember 11, the value of transfers increased nectivity and the normal flow of payments. materially starting on September 12 and The Board used its authority under the remained high throughout the month. Telecommunications Service Priority pro- The Federal Reserve responded to these gram to expedite emergency provision disruptions in a variety of ways. On the of telecommunications circuits for the morning of September 11, the Federal Reserve Banks and several key payment Reserve announced, "The Federal Reserve providers and market utilities in the New System is open and operating. The dis- York City area. In addition, the Federal count window is available to meet liquidity Reserve extended the operating hours of needs." Depository institutions affected by the Fedwire funds and securities transfer the disruptions to the payments system bor- systems to give financial institutions and rowed heavily from the window for several their customers more time to process each days. In addition, the Federal Reserve pro- day's intended payments. The Federal vided a large volume of reserves through Reserve also executed a significant number open market operations. Daylight and over- of off-line Fedwire funds payment orders night overdrafts also increased dramati- on behalf of institutions that were experically, reflecting the difficulties that account encing connectivity problems. Finally, the holders experienced in managing their Fed- Reserve Banks continued to credit the eral Reserve accounts as a result of pay- value of all check deposits to depositing ments system disruptions. In view of these institutions' accounts, even if the Reserve difficulties, the Reserve Banks waived day- Banks could not present the checks to light overdraft fees and overnight overdraft (and debit the accounts of) paying banks penalty fees from September 11 through 21 because airplanes were grounded. As a for all account holders. To support the result of the decision to credit these deposdirect provision of U.S. dollar liquidity to its, daily check float, which normally is foreign-based entities, the Federal Reserve less than $1 billion, peaked at $47.4 billion arranged currency swaps with the Bank of on September 13, providing an additional Canada, the Bank of England, and the significant source of liquidity to the bank- European Central Bank. ing system. Check Collection operations totaled $764.7 million, and other income amounted to $28.5 mil- Federal Reserve Bank operating exlion. Net income from check services penses and imputed costs for commerwas $38.9 million, a $44.4 million, or cial check services in 2001 totaled 53.3 percent, decrease compared with $754.4 million, compared with $680.1 2000 net income. million in 2000. Revenue from check The Reserve Banks handled 16.9 billion checks in 2001, a decrease of termed net income on clearing balances. Total cost 0.5 percent from 2000 (see table). The is the sum of operating expenses, imputed costs volume of checks deposited that (interest on debt, interest on float, sales taxes, and required processing by the Reserve the Federal Deposit Insurance Corporation assess- Banks increased 0.8 percent, a slightly ment), imputed income taxes, and the targeted slower rate than the 1.1 percent increase return on equity. Net revenue is revenue plus net income on clearing balances minus total cost. in 2000. The volume of fine-sort checks, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

176 88th Annual Report, 2001 Priced Services Cost Recovery, 1992-2001 Millions of dollars except asnoted Operating Revenue from Targeted return Total Cost recovery Year services' im ex p p u e t n e s d e s c o a s n t d s2 on equity costs (percent)3 1992 760.8 710.7 24.9 735.6 103.4 1993 774.5 820.4 17.5 837.9 92.4 1994 767.2 760.2 21.0 781.2 98,2 1995 765.2 752.7 31.5 784.2 97.6 1996 815.9 746.4 42.9 789.3 103.4 1997 818.8 752.8 54.3 807.1 101.5 1998 839.8 743.2 66.8 809.9 103.7 1999 867.6 775.7 57.2 833.0 104.2 2000 922.8 818.2 98.4 916.6 100.7 2001 960.4 901.9 109.2 1,011.1 95.0 1992-2001 8,293.0 7,782.2 523.7 8,305.9 99.8 NOTE. In this and the following tables, components 2. Includes operating expenses of $6,861.3 million, may not sum to totals or yield percentages shown because imputed costs of $552.4 million, and imputed income of rounding. Amounts in bold are restatements due to taxes of $275.0 million for the ten-year period. Also, errors in previously reported data. the effect of one-time accounting changes net of taxes of 1. Includes revenue from services of $8,025.2 million $74.1 million and $19.4 million is included for 1993 and and other income and expense (net) of $267.8 million for 1995 respectively. the ten-year period. 3. Revenue from services divided by total costs. which are presorted by the depositing expedite check returns; lessons learned banks according to paying bank, during the project are being incorpodeclined 10.4 percent, compared with a rated into new proposals to exploit tech- 10.7 percent decrease in 2000. nology and reduce transportation costs The Reserve Banks continued to in check clearing. encourage the use of electronic check During 2001, the Federal Reserve products to make the collection system Banks continued a five-year check modmore efficient. In 2001, the percentage ernization project to install uniform of all checks presented electronically by software and hardware for check prothe Reserve Banks to paying banks was cessing, check imaging, and check 21.7 percent (approximately 3.7 billion adjustments in forty-five Reserve Bank checks), compared with 20.4 percent offices and to give depository instituin 2000. The Reserve Banks captured tions web-based access to check serimages of 8.1 percent of the checks they vices. The project costs are expected to collected, compared with 7.2 percent in be recovered over the long run because 2000. the modernization effort will increase To assess the potential benefits, in operating efficiency and make it posterms of error corrections and opera- sible to offer additional services to tional processes, of keeping image depository institutions. copies of all checks processed, the New York Reserve Bank's Utica office con- Automated Clearinghouse tinued a pilot project to capture images of the checks processed on all its high- Reserve Bank operating expenses and speed check sorters. The Minneapolis imputed costs for commercial automated Bank's Helena Branch concluded its clearinghouse (ACH) services totaled pilot project to use check images to $67.7 million in 2001. Revenue from Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 111 Activity in Federal Reserve Priced Services, 2001, 2000, and 1999 Thousands of items Percent change Service 2001 2000 1999 2000 to 2001 1999 to 2000 Commercial checks 16,905,016 16,993,800 17,075,008 -.5 -.5 Funds transfers 115,308 111,175 105,408 3.7 5.5 Securities transfers 6,708 5,666 5,147 18.4 10.1 Commercial ACH 4,448,361 3,812,191 3,343,615 16.7 14.0 Noncash services 412 519 613 -20.7 -15.3 Cash transportation 18 19 18 -5.3 5.6 NOTE. Activity in commercial checks is the total num- items processed; in noncash services, the number of items ber of commercial checks collected, including processed on which fees are assessed; and in cash transportation, and fine-sort items; in funds transfers and securities trans- the number of registered mail shipments and FRBfers, the number of transactions originated on line and off arranged armored carrier stops. line; in commercial ACH, the total number of commercial ACH operations and other income Reserve Bank offices the support for totaled $79.4 million, resulting in net ACH operations once provided by each income of $11.9 million. The Reserve of the twelve Federal Reserve Banks. Banks processed 4.4 billion commercial Support activities being consolidated ACH transactions (worth $12.7 trillion), include ensuring the timely and accurate an increase of 16.7 percent from 2000. processing of payments, maintaining the In 2000, the Board approved a new integrity of the ACH application, moniapproach to pricing ACH transactions toring file processing, and responding that the Reserve Banks deliver through to customers' questions. The consolidaand receive from private-sector ACH tion, which is expected to reduce ACH operators (PSOs). Among other things, costs while maintaining service quality, the Board authorized the Reserve Banks is scheduled to be complete by the end to initiate discussions with the PSOs to of the first quarter of 2002. negotiate the structure and level of fees that the Reserve Banks charge the PSOs for processing inter-operator transac- Fedwire Funds Transfer and tions as well as the fees that the Reserve Net Settlement Banks pay the PSOs. Negotiations continued into 2001, and a new inter- Reserve Bank operating expenses and operator fee structure became effective imputed costs for Fedwire funds transon October 1. On that same date, the fer and net settlement services totaled Reserve Banks also implemented a new $56.7 million in 2001. Revenue from pricing method for their depository insti- these operations totaled $61.8 miltution ACH customers. Monthly fixed lion, and other income amounted to fees were increased, and per-item fees $2.0 million, resulting in net income of were decreased. The new method better $7.1 million. corresponds to the Reserve Banks' ACH cost structure, which is characterized by Funds Transfer high fixed and low variable costs. In August, the Reserve Banks began The Fedwire funds transfer system the process of consolidating at two allows depository institutions to draw Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

178 88th Annual Report, 2001 Fees Paid by Depository Institutions for transfer surcharge also remained Selected Federal Reserve Priced Services, unchanged.4 2000 and 2001 In September, the Reserve Banks Dollars began the final phase of consolidating the operations of the Fedwire funds Item 2000 2001 transfer service.5 The consolidation is FEDWIRE FUNDS TRANSFERS, expected to reduce operating costs upon BY VOLUME TIER1 its completion in August 2002. Tier (number of transfers per month)2 1 (1 to 2,500) .33 .33 Net Settlement 2 (2,501 to 80,000) .24 .24 3 (80,001 and more) .17 .16 Private clearing arrangements that Off-line surcharge 15.00 15.00 exchange and settle transactions may NET SETTLEMENT, use the Reserve Banks' net settlement BY TYPE OF SERVICE Net settlement sheet service to settle their transactions. The Entries, each .95 .95 Reserve Banks provide settlement ser- Files, each 12.00 12.00 Minimum per month 60-175 60-100 vices to approximately 70 local and national private arrangements, including FEDWIRE SECURITIES local check clearinghouse associations, Account maintenance Per issue .45 .45 automated clearinghouse networks, and Per account 15.00 15.00 credit card processors. In 2001, the Transfers, each2 .70 .70 Reserve Banks processed more than Off-line surcharge 18.00 25.00 417,000 settlement entries for these NONCASH COLLECTION arrangements, and fees remained at their Bonds, each 40.00 40.00 2000 levels. Deposit envelopes (per envelope of coupons)3 1-5 4.75 4.75 6-50 2.50 2.50 Fedwire Securities Service Cash letters (flat fee, by number of The Fedwire securities service allows envelopes of coupons)3 depository institutions to transfer securi- 1-5 7.50 7.50 6-50 15.00 15.00 ties issued by the U.S. Treasury, federal government agencies, and other entities Return items, each 15.00 20.00 electronically to other institutions in the NOTE. Rates for 2000 are as of April 3. United States. Reserve Bank operating 1. Rates apply only to their specified volume tiers. expenses and imputed costs for provid- 2. Originated and received. 3. Deposits and cash letters may contain no more than ing this service totaled $19.5 million 50 envelopes of coupons. in 2001. Revenue totaled $19.0 million, and other income amounted to $0.7 million, resulting in net income of on their reserve or clearing balances at $0.2 million. Approximately 6,708 milthe Reserve Banks and transfer funds lion transfers were processed on the to other institutions. The number of Fedwire funds transfers originated by depository institutions increased 4. Depository institutions that do not have an 3.7 percent in 2001, to 115,308 mil- electronic connection to the Fedwire funds translion. In August, the Reserve Banks fer system can originate transfers via "off-line" reduced the transfer fee for the highest- telephone instructions. 5. The first phase of this and the Fedwire secuvolume tier while keeping other fees rities service consolidation was completed in unchanged (table). The off-line funds March 1999. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 179 system during the year, an increase of item fee was increased from $15 to $20, 18.4 percent from 2000.6 The basic per- and the other collection fees remained transfer fee for transfers originated and the same. received by depository institutions and the monthly account maintenance fees Special Cash Services were unchanged in 2001, while the offline securities transaction surcharge was The Reserve Banks charge fees for increased from $18.00 to $25.00. providing special cash-related services, In September, the Reserve Banks such as currency packaged in a nonbegan the final phase of consolidation standard way. These services— of the Fedwire securities service in an collectively referred to as "special cash effort to reduce costs. The consolidation services"—account for a very small is expected to be complete in August proportion (less than 1 percent) of the 2002. total cost of cash services provided by The Government National Mortgage the Reserve Banks to depository institu- Association (Ginnie Mae) announced tions. Operating expenses and imputed plans in 2001 to have its securities clear costs for special cash services totaled and settle on the Fedwire securities $2.1 million in 2001. Revenue and other transfer system. The conversion is income totaled $2.3 million, resulting in expected to be complete by March 2002. net income of $0.2 million. Noncash Services Float The Federal Reserve provides a service Federal Reserve float decreased in 2001 to collect and process municipal bearer to a daily average of $604.6 million, bonds and coupons issued by state and from a daily average of $774.2 million local governments (referred to as "non- in 2000. The Federal Reserve recovers cash" items). The service, which has the cost of float associated with priced been centralized at one Federal Reserve services as part of the fees for those office, processed 412,000 noncash trans- services. actions in 2001. Operating expenses and imputed costs Developments in for noncash services totaled $1.6 million Currency and Coin in 2001. Revenue from noncash operations totaled $2.0 million, resulting in Currency volume in the Federal Reserve net income of $0.4 million. The return- System continued to be high in 2001. Reserve Banks received 33.5 billion notes from circulation in 2001, a slight 6. The expenses, revenues, and volumes reported here are for transfers of securities issued increase from the 33.3 billion notes by federal government agencies, government- received in 2000, the Y2K flowback sponsored enterprises, and international institu- year (when depository institutions tions such as the World Bank. The Fedwire securireturned the extra vault cash they had ties service also provides account maintenance, held in anticipation of the century date transfer, and settlement services for U.S. Treasury securities. When the Reserve Banks provide these change). Reserve Banks also made payservices, they act as fiscal agents of the United ments of 34.3 billion notes to circulation States. The Treasury Department assesses fees on in 2001, a 7 percent increase from 2000. depository institutions for some of these services. The Federal Reserve Bank of San For details, see the section "Fiscal Agency Services" later in this chapter. Francisco officially opened the Phoenix Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

180 88th Annual Report, 2001 cash-processing center on September 4. and depository expenses, a decrease of The center will operate as a satellite $16.6 million from 2000. office of the Los Angeles Branch. Fiscal Agency Services Developments in Fiscal Agency and As fiscal agents, Reserve Banks provide Government Depository Services to the Treasury services related to the federal debt. For example, they issue, The total cost of providing fiscal agency transfer, reissue, exchange, and redeem and depository services to the Treasury marketable Treasury securities and savin 2001 amounted to $246.5 million, ings bonds; they also process secondary compared with $262.5 million in 2000 market transfers initiated by depository (table). The cost of providing services institutions. to other government agencies was $38.9 million, compared with $39.4 mil- Marketable Treasury Securities lion in 2000. In 2001, the Reserve Banks requested reimbursement by the Trea- Reserve Bank operating expenses for sury and other government agencies activities related to marketable Treasury of $285.4 million for fiscal agency securities in 2001 (Treasury Direct, Expenses of Federal Reserve Banks for Fiscal Agency and Depository Services, 2001, 2000, and 1999 Thousands of dollars Agency and service 2001 2000 1999 DEPARTMENT OF THE TREASURY Bureau of the Public Debt Savings bonds 69,569.8 70,786.7 70,285.8 Treasury Direct 37,326.6 41,259.3 40,446.2 Commercial book entry 9,998.1 13,924.6 15,744.2 Marketable Treasury issues 11,366.8 14,224.3 13,715.1 Definitive securities and Treasury coupons 610.9 1,069.3 4,886.7 Other services 150.7 132.5 100.4 Total 129,022.9 141,404.7 145,178.4 Financial Management Service Treasury tax and loan and Treasury general account 31,106.0 38,649.0 34,971.0 Government check processing 30,310.2 31,866.9 33,365.4 Automated clearinghouse 9,665.2 10,799.1 11,263.4 Government agency check deposits 2,272.9 2,218.8 2,422.7 Fedwire funds transfers 199.2 182.9 187.7 Other services 30,771.5 27,015.4 20,423.5 Total 104,324.9 110,732.2 102,633.7 Other Treasury Total 13,149.8 10,362.8 7,786.8 Total, Treasury 246,497.5 262,499.7 255,598.9 OTHER FEDERAL AGENCIES Department of Agriculture Food coupons 13,197.2 16,463.7 18,643.9 U.S. Postal Service Postal money orders 11,255.0 9,213.5 6,623.3 Miscellaneous agencies Other services 14,434.0 13,747.1 13,983.0 Total, other agencies 38,886.2 39,424.3 39,250.2 Total reimbursable expenses 28533.7 301,924.0 294,849.1 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 181 Fedwire book-entry system, marketable printed and mailed 37.8 million savings issues, definitive securities, and Trea- bonds on behalf of the Treasury's sury coupons) totaled $59.3 million, Bureau of the Public Debt, a 3.3 percent a 15.9 percent decrease from 2000. increase from 2000. They also processed The Reserve Banks processed nearly nearly 5.5 million original-issue trans- 258,000 tenders for Treasury securities, actions for the Series I (inflationcompared with 220,000 in 2000, and indexed) savings bond and 26.2 milhandled 2.8 million reinvestment lion original-issue transactions for the requests, compared with 2.0 million in Series EE savings bond. In addition, the 2000. Banks processed approximately 563,000 The Reserve Banks operate two book- redemption, reissue, and exchange transentry securities systems for Treasury actions, a 1.0 percent decrease from securities: the Fedwire system, which 2000. Reserve Bank staff responded to provides custody and transfer, and Trea- 1.6 million service calls from owners of sury Direct, which provides custody ser- savings bonds, a 4.4 percent increase vices only.7 Almost all book-entry Trea- from 2000. sury securities, 97.5 percent of the total par value outstanding at year-end Depository Services 2001, were maintained on Fedwire; the remainder were maintained on Treasury The Reserve Banks maintain the Trea- Direct. The Reserve Banks in 2001 sury's funds account, accept deposits of originated 7.8 million Fedwire transfers federal taxes and fees, pay checks drawn of Treasury securities, a 1.9 percent on the Treasury's account, and make increase from 2000. electronic payments on behalf of the On behalf of Treasury Direct custom- Treasury. ers, the Reserve Bank designated to handle sales sold nearly 15,000 securi- Federal Tax Payments ties worth $699.9 million, compared Reserve Bank operating expenses with more than 16,000 securities worth related to federal tax payments in 2001 $581.2 million in 2000, collecting totaled $31.1 million. The Federal almost $510,000 in fees on behalf of the Reserve enhanced the Treasury tax and Treasury, a decrease of 8.4 percent from loan program at midyear 2001 by the almost $557,000 in fees collected in enabling the Treasury to invest funds 2000. with eligible depository institutions throughout the afternoon rather than just Savings Bonds in the morning, adding approximately Reserve Bank operating expenses $3.0 million to Treasury's investment for savings bond activities totaled income. It also worked with the Trea- $69.6 million in 2001, a decrease of sury to develop a pilot program whereby 1.7 percent from 2000. The Banks the Treasury could place investments with depository institutions for a set term, the interest rate being determined 7. The Fedwire book-entry securities mecha- by auction. nism is also used for safekeeping and transfer of securities issued by federal government agencies, government-sponsored enterprises, or interna- Payments Processed for the Treasury tional institutions. For details, see the section Reserve Bank operating expenses "Fedwire Securities Service" earlier in this chapter. related to government payments in 2001 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

182 88th Annual Report, 2001 amounted to $42.4 million. The Banks Information Technology processed 900.4 million ACH trans- The Federal Reserve continued in 2001 actions for the Treasury, an increase of to provide highly reliable and secure 7.4 percent from 2000. They also proelectronic services and expanded its cessed 345.8 million paper government electronic access options to depository checks, an increase of 32.0 percent from institutions. Significant progress was 2000. In addition, the Banks issued made on the System's project to implenearly 435,000 paper fiscal agency ment frame relay technology on Fednet, checks, a decrease of 17.4 percent from the telecommunications network that 2000. supports both external electronic con- During the year, a Reserve Bank nections between the Federal Reserve assisted Treasury's efforts to facilitate and depository institutions and internal electronic payments to the federal govcommunications among Reserve Banks. ernment. The Bank began sending ACH The improvements will improve the debits and making related accounting speed, reliability, and performance of entries for Treasury's Pay.gov web site the depository institutions' electronic and began converting checks received connections during contingencies and by the Treasury at the point of sale at will also increase the capacity and flexfour overseas military bases. ibility to support new electronic services using web-based technologies. The Reserve Banks continued to improve Services Provided to Other Entities electronic access options for depository institutions and to offer web-based The Reserve Banks provide fiscal applications for check imaging, cash agency and depository services to other ordering, and savings bonds processing. domestic and international agencies The Banks plan to offer other new webwhen they are required to do so by the based services over the next several Secretary of the Treasury or when they years. are required or permitted to do so by federal statute. One such service is the provision of food coupon services for Examinations of the Department of Agriculture. Reserve Federal Reserve Banks Bank operating expenses for food coupon services in 2001 totaled $13.2 mil- Section 21 of the Federal Reserve Act lion, 19.8 percent lower than in 2000. requires the Board of Governors to order The Banks redeemed 587 million food an examination of each Federal Reserve coupons, a decrease of 14.5 percent Bank at least once a year. The Board from 2000. The Federal Reserve System engages a public accounting firm to peris consolidating food coupon processing form an annual audit of the combined and expects 2001 consolidations to save financial statements of the Reserve more than $500,000 per year. Banks (see the section "Federal Reserve As fiscal agents of the United States, Bank Combined Financial Statements"). the Reserve Banks also process all The public accounting firm also audits postal money orders deposited by banks the annual financial statements of each for collection. In 2001, they processed of the twelve Banks. The Reserve Banks 229.4 million postal money orders, use the framework established by the approximately the same number as in Committee of Sponsoring Organizations 2000. of the Treadway Commission (COSO) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 183 in assessing their internal controls over tion at each Reserve Bank includes an financial reporting, including the safe- assessment of the effectiveness of the guarding of assets. Within this frame- Bank's internal audit function. work, each Reserve Bank provides an Each year, to assess compliance with assertion letter to its board of directors the policies established by the Federal annually confirming adherence to the Reserve's Federal Open Market Com- COSO standards, and a public account- mittee (FOMC), the division also examing firm certifies management's asser- ines the accounts and holdings of the tion and issues an attestation report to System Open Market Account at the the Bank's board of directors and to the Federal Reserve Bank of New York and Board of Governors. the foreign currency operations con- The firm engaged for the audits of ducted by that Bank. In addition, a pubthe individual and combined financial lic accounting firm certifies the schedstatements of the Reserve Banks for ule of participated asset and liability 2001 was PricewaterhouseCoopers LLP accounts and the related schedule of (PwC). Fees for these services totaled participated income accounts at year- $1.3 million. In order to ensure auditor end. Division personnel follow up on independence, the Board requires that the results of these audits. The FOMC PwC be independent in all matters relat- receives the external audit reports and ing to the audit. Specifically, PwC may the report on the division's follow-up. not perform services for the Reserve Bank or others that would place it in a Income and Expenses position of auditing its own work, making management decisions on behalf The accompanying table summarizes the of the Reserve Banks, or in any other income, expenses, and distributions of way impairing its audit independence. net earnings of the Federal Reserve In 2001 the Reserve Banks engaged Banks for 2000 and 2001. PwC for advisory services totaling Income in 2001 was $31,871 million, $0.9 million, $0.7 million of which was compared with $33,964 million in 2000. for project management advisory ser- Total expenses were $2,718 million vices related to the System's check mod- ($1,834 million in operating expenses, ernization project. The Board believes $250 million in earnings credits granted that these advisory services do not to depository institutions, and $295 mildirectly affect the preparation of the lion in assessments for expenditures financial statements audited by PwC and by the Board of Governors). The cost are not incompatible with the services of new currency was $339 million. provided by PwC as an independent Revenue from priced services was auditor. $926.5 million. In 2001, the examinations by the The profit and loss account showed a Board's Division of Reserve Bank net loss of $1,117 million. The loss was Operations and Payment Systems of the due primarily to unrealized losses on Reserve Banks, using a format consis- assets denominated in foreign currentent with the integrated COSO frame- cies revalued to reflect current market work, assessed the efficiency and effec- exchange rates. Statutory dividends paid tiveness of operations, the reliability to member banks totaled $428 million, of financial reporting, compliance with $18 million more than in 2000; the rise applicable laws and regulations, and the reflects an increase in the capital and safeguarding of assets. The annual atten- surplus of member banks and a conse- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

184 88th Annual Report, 2001 Income, Expenses, and Distribution of Net Earnings of Federal Reserve Banks, 2001 and 2000 Millions of dollars Item 2001 2000 Current income 31,871 33,964 Current expenses 2,085 1,972 Operating expenses' 1,834 1,586 Earnings credits granted 250 385 Current net income 29,786 31,992 Net additions to (deductions from, - ) current net income -1,117 -1,492 Cost of unreimbursed services to Treasury 0 8 Assessments by the Board of Governors 634 624 For expenditures of Board 295 188 For cost of currency 339 436 Net income before payments to Treasury 28,035 29,868 Dividends paid 428 410 Transferred to surplus 518 4,115 Payments to Treasury2 27,089 25,344 1. Includes a net periodic credit for pension costs of 2. Interest on Federal Reserve notes. $331 million in 2001 and $393 million in 2000. quent increase in the paid-in capital (see table). Holdings of U.S. governstock of the Reserve Banks. ment securities increased $31,152 mil- Payments to the Treasury in the form lion, and holdings of loans increased of interest on Federal Reserve notes $32 million. totaled $27,089 million in 2001, up from The average rate of interest earned $25,344 million in 2000; the payments on the Reserve Banks' holdings of govequal net income after the deduction of ernment securities declined to 5.46 perdividends paid and of the amount neces- cent, from 6.20 percent in 2000, and sary to bring the surplus of the Reserve the average rate of interest earned on Banks to the level of capital paid in. loans declined to 3.18 percent, from In the "Statistical Tables" section of 6.27 percent. this volume, table 5 details the income and expenses of each Federal Reserve Volume of Operations Bank for 2001, and table 6 shows a condensed statement for each Bank for Table 8 in the "Statistical Tables" secthe years 1914 through 2001. A detailed tion shows the volume of operations in account of the assessments and expendi- the principal departments of the Federal tures of the Board of Governors appears Reserve Banks for the years 1996 in the section "Board of Governors through 2001. Financial Statements." Federal Reserve Bank Premises Holdings of Securities and Loans In 2001, construction of the Atlanta The Reserve Banks' average daily hold- Reserve Bank's new headquarters buildings of securities and loans during ing and the San Francisco Bank's new 2001 amounted to $559,323 million, an cash-processing center in Phoenix was increase of $31,184 million from 2000 completed. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 185 Securities and Loans of Federal Reserve Banks, 1999-2001 Millions of dollars except as noted U.S. Item and year Total government Loans 2 securities' Average daily holdings71 1999 495,606 495,384 221 2000 528,139 527,774 365 2001 .. 559,323 558,926 397 Earnings 1999 28,227 28,216 11 2000 32,760 32,737 23 2001 30,536 30,523 13 Average interest rate (percent) 1999 5.70 5.70 5.02 2000 6.20 6.20 6.27 2001 . . 5.46 5.46 3.18 1. Includes federal agency obligations. 3. Based on holdings at opening of business. 2. Does not include indebtedness assumed by the Federal Deposit Insurance Corporation. The Board approved a new building and planning options for its Seattle program for the Chicago Bank's Detroit and Portland Branches. The lease on Branch. The Bank relocated its check- the Cleveland Bank's regional checkprocessing function from its head- processing center in Columbus, Ohio, quarters building to leased space near was renewed. Midway Airport in Chicago and sold The multiyear renovation program its Westgate warehouse in suburban and the cleaning and repair of the exte- Chicago. rior stonework continued at the New Design work for the Dallas Bank's York Bank's headquarters building. new Houston Branch building contin- An improvement program for the main ued. The Kansas City Bank continued to chiller plant in the headquarters building analyze the long-term planning options continued. Also, the improvements to for its headquarters facility, and the the New York Bank's leased office facil- St. Louis Bank initiated a similar analy- ity in New York City were completed. sis of its headquarters facility. At all facilities, security enhancement The San Francisco Bank began a programs were undertaken as a result of study of the long-term business needs the events of September 11. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

186 88th Annual Report, 2001 Pro Forma Financial Statements for Federal Reserve Priced Services Pro Forma Balance Sheet for Priced Services, December 31, 2001 and 2000 Millions of dollars Item 2001 2000 Short-term assets (Note 1) Imputed reserve requirements on clearing balances 860.8 667.0 Investment in marketable securities ... 7,747.3 6,002.6 Receivables 76.5 74.9 Materials and supplies 3.1 3.2 Prepaid expenses 30.5 35.2 Items in process of collection 1,772.1 4,094.6 Total short-term assets 10,490.3 10,877.4 Long-term assets (Note 2) Premises 473.0 471.9 Furniture and equipment 176.1 171.2 Leases and leasehold improvements .. 88.1 65.3 Prepaid pension costs 760.8 659.9 Total long-term assets 1,498.0 1,368.3 Total assets ... .... 11,988.3 12,245.7 Short-term liabilities Clearing balances and balances arising from early credit of uncollected items 8,524.5 6,886.1 Deferred-availability items 1,855.7 3,878.1 Short-term debt 20.8 113.2 Short-term payables 89.2 .0 Total short-term liabilities 10,490.3 10,877.4 Long-term liabilities Long-term debt 519.7 443.0 Postretirement/postemployment benefits obligation 257.8 243.9 Total long-term liabilities 777.4 686.9 Total liabilities 11,267.7 11,564.3 Equity 720.6 681.4 Total liabilities and equity (Note 3) ... 11,988.3 12,245.7 NOTE. Components may not sum to totals because of The accompanying notes are an integral part of these rounding. Amounts in bold are restatements due to errors pro forma priced services financial statements. in previously reported data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 187 Pro Forma Income Statement for Federal Reserve Priced Services, 2001 and 2000 Millions of dollars Item 2001 2000 Revenue from services provided to depository institutions (Note 4) 926.5 881.5 Operating expenses (Note 5) 814.9 716.5 Income from operations 111.7 165.1 Imputed costs (Note 6) Interest on float 15.5 12.8 Interest on debt 32.0 31.5 Sales taxes 12.6 9.3 FDIC insurance .0 60.1 .0 53.6 Income from operations after imputed costs 51.6 111.4 Other income and expenses (Note 7) Investment income 273.3 411.8 Earnings credits -239.4 33.9 -370.5 41.3 Income before income taxes 85.4 152.7 Imputed income taxes (Note 8) 26.9 48.1 Net income ... . . 58.5 104.6 MEMO: Targeted return on equity (Note 9) ... 109.2 98.4 NOTE. Components may not sum to totals because of The accompanying notes are an integral part of these rounding. Amounts in bold are restatements due to errors pro forma priced services financial statements, in previously reported data. Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2001 Millions of dollars Com- Funds Commercial transfer Fedwire Noncash Cash Total check and net securities ACH services services collection settlement Revenue from services (Note 4) 926.5 764.7 61.8 19.0 76.9 2.0 2.2 Operating expenses (Note 5) 814.9 684.3 50.3 18.4 58.5 1.3 2.0 Income from operations 111.7 80.4 11.4 .6 18.4 .7 .2 Imputed costs (Note 6) 60.1 52.2 3.1 L0 _3.8 _A J) Income from operations after imputed costs 51.6 28.2 8.4 -.4 14.6 .6 2 Other income and expenses, net (Note 7) 33.9 28.5 2.0 .7 2.5 .0 .1 [ncome before income taxes .. 85.4 56.7 10.4 .3 17.2 .6 .2 Imputed income taxes (Note 8) 26.9 17.9 3.3 .1 5.4 .2 .1 Net income 58.5 38.9 7.1 .2 11.8 .4 .2 MEMO: Targeted return on equity (Note 9) 109.2 90.2 7.4 2.3 8.9 .2 .1 NOTE. Components may not sum to totals because of The accompanying notes are an integral part of these rounding. pro forma priced services financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

188 88th Annual Report, 2001 Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2000 Millions of dollars Com- Funds Commercial transfer Fedwire Noncash Cash Item Total mercial check and net securities services services ACH collection settlement Revenue from services (Note 4) 881.5 728.6 61.9 17.8 68.8 2.3 2.1 Operating expenses 716.5 595.5 49.5 14.0 53.6 L7 2J (Note 5) 165.1 133.1 12.4 3.8 15.2 .6 .0 Income from operations 53.6 46.3 3.1 .8 3.3 .1 .0 Imputed costs (Note 6) Income from operations 111.4 86.8 9.3 3.0 11.9 after imputed costs Other income and expenses, net (Note 7) 41.3 34.7 2.7 .8 2.9 _A_ Income before income taxes .. 152.7 121.5 12.0 3.8 14.8 .6 .1 Imputed income taxes (Note 8) 48.1 38.3 3.8 1.2 4.7 _2 Net income 104.6 83.2 8.2 2.6 10.1 A .i MEMO: Targeted return on equity (Note 9) 98.4 80.8 7.5 1.9 8.0 .2 .i NOTE. Components may not sum to totals because of The accompanying notes are an integral part of these rounding. Amounts in bold are restatements due to errors pro forma priced services financial statements, in previously reported data. FEDERAL RESERVE BANKS NOTES TO PRO FORMA FINANCIAL STATEMENTS FOR PRICED SERVICES (1) SHORT-TERM ASSETS be double-counted on a consolidated Federal Reserve balance sheet; adjustments for items associated with non- The imputed reserve requirement on clearing balances priced items, such as those collected for government held at Reserve Banks by depository institutions reflects a agencies; and adjustments for items associated with treatment comparable to that of compensating balances providing fixed availability or credit before items are held at correspondent banks by respondent institutions. received and processed. Among the costs to be recovered The reserve requirement imposed on respondent balances under the Monetary Control Act is the cost of float, or net must be held as vault cash or as non-earning balances CIPC during the period (the difference between gross maintained at a Reserve Bank; thus, a portion of priced CIPC and deferred-availability items, which is the portion services clearing balances held with the Federal Reserve of gross CIPC that involves a financing cost), valued at is shown as required reserves on the asset side of the the federal funds rate. balance sheet. The remainder of clearing balances is assumed to be invested in three-month Treasury bills, shown as investment in marketable securities. (2) LONG-TERM ASSETS Receivables are (1) amounts due the Reserve Banks for Consists of long-term assets used solely in priced serpriced services and (2) the share of suspense-account and vices, the priced-services portion of long-term assets difference-account balances related to priced services. shared with nonpriced services, and an estimate of the Materials and supplies are the inventory value of short- assets of the Board of Governors used in the development term assets. of priced services. Effective Jan. 1, 1987, the Reserve Prepaid expenses include salary advances and travel Banks implemented the Financial Accounting Standards advances for priced-service personnel. Board's Statement of Financial Accounting Standards Items in process of collection is gross Federal Reserve No. 87, Employers' Accounting for Pensions (SFAS 87). cash items in process of collection (CIPC) stated on a Accordingly, the Reserve Banks recognized credits to basis comparable to that of a commercial bank. It reflects expenses of $101.0 million in 2001 and $115.5 million in adjustments for intra-System items that would otherwise 2000 and corresponding increases in this asset account. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 189 (3) LIABILITIES AND EQUITY Interest is imputed on the debt assumed necessary to finance priced-service assets. The sales taxes and FDIC Under the matched-book capital structure for assets, assessment that the Federal Reserve would have paid had short-term assets are financed with short-term payables it been a private-sector firm are among the components of and short-term debt in 2001 and only short-term debt in the PSAF (see note 3). 2000. Long-term assets are financed with long-term debt Float costs are based on the actual float incurred for and equity in a proportion equal to the ratio of long-term each priced service. Other imputed costs are allocated among priced services according to the ratio of operating debt to equity for the fifty largest bank holding compaexpenses less shipping expenses for each service to the nies, which are used in the model for the private-sector total expenses for all services less the total shipping adjustment factor (PSAF). The PSAF consists of the taxes expenses for all services. that would have been paid and the return on capital that The following list shows the daily average recovery of would have been provided had priced services been fur- actual float by the Reserve Banks for 2001 in millions of nished by a private-sector firm. Other short-term liabili- dollars: ties include clearing balances maintained at Reserve Banks and deposit balances arising from float. Other Total float 1,056.3 long-term liabilities consist of accrued postemployment Unrecovered float 112.3 and postretirement benefits costs and obligations on capi- Float subject to recovery 944.0 tal leases. Sources of recovery of float Income on clearing balances 94.4 As-of adjustments 451.7 (4) REVENUE Direct charges 505.3 Revenue represents charges to depository institutions for Per-item fees (107.4) priced services and is realized from each institution Unrecovered float includes float generated by services through one of two methods: direct charges to an institu- to government agencies and by other central bank sertion's account or charges against its accumulated earn- vices. Float recovered through income on clearing balings credits. ances is the result of the increase in investable clearing balances; the increase is produced by a deduction for float for cash items in process of collection, which reduces (5) OPERATING EXPENSES imputed reserve requirements. The income on clearing Operating expenses consist of the direct, indirect, and balances reduces the float to be recovered through other other general administrative expenses of the Reserve means. As-of adjustments and direct charges refer to float that is created by interterritory check transportation and Banks for priced services plus the expenses for staff the observance of non-standard holidays by some deposimembers of the Board of Governors working directly on tory institutions. Such float may be recovered from the the development of priced services. The expenses for depository institutions through adjustments to institution Board staff members were $4.9 million in 2001 and reserve or clearing balances or by billing institutions $4.2 million in 2000. The credit to expenses under directly. Float recovered through direct charges and per- SFAS 87 (see note 2) is reflected in operating expenses. item fees is valued at the federal funds rate; credit float recovered through per-item fees has been subtracted from The income statement by service reflects revenue, opthe cost base subject to recovery in 2001. The 2001 float erating expenses, and imputed costs. Certain corporate levels were unusually high because of the effect of Sepoverhead costs not closely related to any particular priced tember 11 events. service are allocated to priced services in total based on an expense-ratio method, but are allocated among priced services based on management decision. Corporate over- (7) OTHER INCOME AND EXPENSES head was allocated among the priced services during Consists of investment income on clearing balances and 2001 and 2000 as follows (in millions): the cost of earnings credits. Investment income on clearing balances represents the average coupon-equivalent yield on three-month Treasury bills applied to the total 2001 2000 clearing balance maintained, adjusted for the effect of reserve requirements on clearing balances. Expenses for Check 43.5 40.3 earnings credits granted to depository institutions on their ACH 4.4 3.7 clearing balances are derived by applying the average Funds transfer 3.5 4.3 federal funds rate to the required portion of the clearing Book entry 1.9 1.1 balances, adjusted for the net effect of reserve require- Noncash services .1 .1 ments on clearing balances. Special cash services .0 .1 Total 53.4 49.6 (8) INCOME TAXES Imputed income taxes are calculated at the effective tax rate derived from the PSAF model (see note 3). (6) IMPUTED COSTS Imputed costs consist of interest on float, interest on debt, (9) RETURN ON EQUITY sales taxes, and the FDIC assessment. Interest on float is derived from the value of float to be recovered, either The after-tax rate of return on equity that the Federal explicitly or through per-item fees, during the period. Reserve would have earned had it been a private business Float costs include costs for checks, book-entry securi- firm, as derived from the PSAF model (see note 3). ties, noncash collection, ACH, and funds transfers. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

191 The Board of Governors and the Government Performance and Results Act Under the Government Performance and of the performance measures identified Results Act of 1993 (GPRA), federal in the strategic plan (except those assoagencies are required, in consultation ciated with the monetary policy funcwith the Congress and outside stake- tion). It also describes the operational holders, to prepare a strategic plan cov- processes and resources needed to meet ering a multiyear period and to submit those targets and discusses validation annual performance plans and perfor- and verification of results. mance reports. Although it is not cov- The strategic and performance plans ered by the act, the Board of Governors are available on the Board's public has chosen to voluntarily comply with web site (http://www.federalreserve.gov/ the act. boarddocs/rptcongress). The Board's mission statement and a summary of the goals and objectives set forth in Strategic and Performance Plans the strategic and performance plans are The Board's most recent strategic plan given below. in the GPRA format, released in December 2001, covers the period 2001-05. Mission Like the earlier plan, which covered 1997-2002, the most recent document The mission of the Board is to foster the states the Board's mission, articulates stability, integrity, and efficiency of the major goals for the period, outlines strat- nation's monetary, financial, and payegies for achieving those goals, and dis- ment systems so as to promote optimal cusses the environment and other fac- macroeconomic performance. tors that could affect their achievement. It also addresses issues that cut across agency jurisdictional lines, identifies Goals and Objectives key quantitative measures of perfor- The Federal Reserve has three primary mance, and discusses the evaluation of goals with interrelated and mutually performance. reinforcing elements: The Board's most recent performance plan covers its 1998-99 budget.1 The plan sets forth specific targets for some Goal To conduct monetary policy that pro- 1. The Board's budget covers two calendar years (making it slightly incongruent with the motes the achievement of maximum act's requirement that a performance plan be sub- sustainable long-term growth; price stamitted for each fiscal year). Neither a performance bility fosters that goal. plan for 2000-01 nor a performance report for 1998-99 was prepared, as staff attention was diverted to matters associated with the century Objectives date change and the Gramm-Leach-Bliley Act. A performance plan for 2002-03 will be issued in • Stay abreast of recent developments the second quarter of 2002. and prospects in the U.S. economy Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

192 88th Annual Report, 2001 and financial markets and in those relating to consumer financial transabroad, so that monetary policy deci- actions (Truth in Lending, Truth in sions will be well informed Savings, Consumer Leasing, and • Enhance our knowledge of the struc- Electronic Funds Transfer) to carry tural and behavioral relationships out congressional intent, striking the in the macroeconomic and financial proper balance between protection of markets and improve the quality of consumers and burden to the industry. the data used to gauge economic performance, through developmental Goal research activities • Implement monetary policy effec- To provide high-quality professional tively in rapidly changing economic oversight of Reserve Bank operations circumstances and in an evolving and to foster the integrity, efficiency, financial market structure and accessibility of U.S. payment and • Contribute to the development of U.S. settlement systems. international policies and procedures, in cooperation with the Department of Objectives the Treasury and other agencies • Develop sound, effective policies and • Promote understanding of Federal regulations that foster payment system Reserve policy among other governintegrity, efficiency, and accessibility ment policy officials and the general • Produce high-quality assessments of public. Federal Reserve Bank operations, projects, and initiatives that assist Goal Federal Reserve management in fostering and strengthening sound inter- To promote a safe, sound, competitive, nal control systems and efficient and and accessible banking system and effective performance stable financial markets. • Conduct research and analysis that contributes to policy development Objectives and/or increases the Board's and others' understanding of payment system • Provide comprehensive and effective dynamics and risk. supervision of U.S. banks, bank and financial holding companies, U.S. operations of foreign banking organi- Interagency Coordination zations, and related entities • Promote overall financial stability, Interagency coordination helps focus manage and contain systemic risk, and efforts to eliminate redundancy and ensure that emerging financial crises lower costs. As required by the Governare identified early and successfully ment Performance and Results Act and resolved in conformance with past practice, the • Improve efficiency and effectiveness Board has worked closely with other and reduce burden on supervised federal agencies to consider plans and institutions strategies for programs, such as bank • Promote equal access to banking supervision, that cross jurisdictional services lines. In particular, coordination with the • Administer and ensure compliance Department of the Treasury and other with consumer protection statutes agencies is evident throughout both the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

The Board of Governors and the Government Performance and Results Act 193 strategic and performance plans. Much the five agencies has been created to of the Board's formal effort to plan address and report on strategic planning jointly has been made through the Fed- issues of mutual concern. This working eral Financial Institutions Examination group has been meeting since June Council (FFIEC), a group made up of 1997. These and similar planning efforts the five federal agencies that regulate can significantly lower the governdepository institutions.2 In addition, a ment's costs for data processing and coordinating committee of representa- other activities as well as depository tives of the chief financial officers of institutions' costs for complying with federal regulations. • 2. The FFIEC consists of the Board of Governors of the Federal Reserve System, the Federal forms for the federal examination of financial Deposit Insurance Corporation, the National institutions and to make recommendations to pro- Credit Union Administration, the Office of the mote uniformity in the supervision of financial Comptroller of the Currency, and the Office of institutions. The FFIEC also provides uniform Thrift Supervision. It was established in 1979 pur- examiner training and has taken a lead in developsuant to title X of the Financial Institutions Regu- ing standardized software needed for major data latory and Interest Rate Control Act of 1978. The collection programs to support the requirements of FFIEC is a formal interagency body empowered to the Home Mortgage Disclosure Act and the Comprescribe uniform principles, standards, and report munity Reinvestment Act. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

195 Federal Legislative Developments One federal law was enacted during tions. The following discussion summa- 2001 that significantly affects the Fed- rizes title III and describes the portions eral Reserve System and the institutions that bear significantly on the Federal it supervises. In addition, legislation was Reserve System and the institutions it proposed by the Board of Governors supervises. that would, if enacted, facilitate check Title III requires a broad range of truncation and enhance the efficiency financial institutions in the United States of the nation's payments system as a to establish anti-money-laundering prowhole. grams, including policies, procedures, controls, and audit functions.1 Covered financial institutions must establish con- USA PATRIOT Act trols that are reasonably designed to The Uniting and Strengthening Amer- detect instances of money laundering ica by Providing Appropriate Tools through certain correspondent or priv- Required to Intercept and Obstruct Ter- ate banking accounts. In addition, these rorism Act of 2001 (USA PATRIOT institutions generally may not establish Act), Public Law 107-56, enacted on or administer correspondent accounts October 26, 2001, adds to and amends in the United States for, or on behalf of, existing laws, including laws pertaining a foreign shell bank. to financial institutions, to enhance Title III also directs the Secretary of domestic security following the Septem- the Treasury (Secretary), in consultation ber 11, 2001, attacks. Title III of the act with the Board of Governors and the amends various federal banking laws Securities and Exchange Commission and other laws related to financial insti- (SEC), to issue regulations that genertutions or products, principally the Bank ally would require securities brokers and Secrecy Act but also the Bank Holding dealers to submit suspicious activity Company Act of 1956, the Fair Credit reports regarding suspected money- Reporting Act, and the Right to Finan- laundering transactions. The Secretary cial Privacy Act. In addition, the USA and the federal financial regulators must PATRIOT Act amends the Federal also issue joint regulations for financial Reserve Act to authorize certain System institutions regarding the verification personnel to act as law enforcement offi- of customer identification upon account cers and carry firearms to protect and opening. safeguard System premises and staff. Under title III, the Secretary, in Title III of the act directs certain consultation with certain other governgovernment agencies, principally the ment officials, including the Chairman Department of the Treasury in consulta- of the Board of Governors, may impose tion with the Board of Governors of the Federal Reserve System, to take steps to investigate and curtail money launder- 1. Financial institutions supervised by the ing and other activities that might be Board and other federal financial regulators are subject to existing regulations that direct the undertaken to finance terrorist actions institutions to implement anti-money-laundering or disrupt legitimate banking opera- programs. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

196 88th Annual Report, 2001 special measures to address money- conducting certain actions at domestic laundering problems associated with financial institutions. specific foreign jurisdictions, foreign financial institutions, and transactions Proposed Check Truncation Act involving such jurisdictions or institutions. Title III also amends the Bank In December, the Board proposed that Holding Company Act and the Bank Congress adopt legislation to facilitate Merger Act to reflect the Board's prac- check truncation.2 The proposed legislatice of considering the effectiveness of tion, titled the Check Truncation Act, is an institution's anti-money-laundering designed to foster payment system innoactivities when evaluating certain appli- vation and enhance payment system effications under these acts. ciency by reducing some of the legal Title III directs the Secretary, in con- impediments to check truncation that sultation with certain agencies and par- exist under current law. If enacted, the ties, including the Chairman, to evaluate proposed legislation would enable banks certain provisions of the USA PATRIOT to expand the use of electronics in the Act and to report to the Congress on the collection and return of checks, reducfindings. The report must include rec- ing the industry's reliance on transporommendations for any additional legis- tation to move checks across the nation. lative action. Moreover, the Secretary, Details are available on the Board's web the SEC, and the Board must submit site at http://www.federalreserve.gov/ joint recommendations to the Congress paymentsys.htm. • on regulations that would apply certain provisions of the Bank Secrecy Act to registered and unregistered investment 2. Check truncation refers to any of a number of arrangements in which the original paper checks companies and on whether personal are removed from the collection or return process holding companies should be required before reaching either paying or depositary banks, to disclose their beneficial owners when respectively, or reaching their customers. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Records Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

199 Record of Policy Actions of the Board of Governors Regulation B sumer financial services transactions. Equal Credit Opportunity Under the Electronic Signatures in Global and National Commerce Act Regulation E (E-Sign Act), electronic documents and Electronic Fund Transfers signatures have the same validity as paper documents and handwritten signa- Regulation M tures. In this light, the Board approved Consumer Leasing interim amendments to Regulations B, E, M, Z, and DD to accommodate elec- Regulation Z tronic disclosures if the consumer has Truth in Lending affirmatively consented in accordance Regulation DD with the E-Sign Act. The amendments also provide guidance on complying Truth in Savings with the regulations' timing and deliv- March 19, 2001—Interim Rules ery requirements when electronic disclosures are used, to ensure that consumers The Board approved interim rules to have an adequate opportunity to access provide uniform standards for the elecand retain the information. In addition, tronic delivery of disclosures required the Board requested public comment on under Regulations B, E, M, Z, and DD, the interim rules. effective March 30, 2001, with mandatory compliance by a date to be designated in the final rules.1 Regulation D Reserve Requirements of Votes for this action: Messrs. Greenspan, Depository Institutions Ferguson, Kelley, Meyer, and Gramlich. October 9, 2001—Amendments Several federal statutes and the implementing regulations administered by the The Board amended Regulation D to Board require that written disclosures be decrease the amount of net transaction provided in connection with certain con- accounts at depository institutions to which a lower reserve requirement applies (low reserve tranche) and to increase the amount of reservable liabili- NOTE. In voting records throughout this chapties exempt from reserve requirements ter, Board members, except Chairman Greenspan and Vice Chairman Ferguson, are listed in order of (reserve exemption level) for 2002, seniority. effective for the reserve computation 1. The interim rules originally required manda- period beginning November 27, 2001, tory compliance by October 1, 2001. Because it is for institutions reporting weekly. considering adjustments to the rules to provide additional flexibility, on August 1, 2001, the Board lifted the mandatory compliance date for the Votes for this action: Messrs. Greenspan, interim rules. Ferguson, Kelley, Meyer, and Gramlich. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

200 88th Annual Report, 2001 Under the Monetary Control Act of must report weekly.2 To reflect increases 1980, depository institutions, Edge cor- in the rate of growth of total deposits at porations, agreement corporations, and all depository institutions, the Board U.S. agencies and branches of foreign increased the deposit cutoff levels used banks are subject to reserve require- in determining the frequency and detail ments set by the Board. The act directs of reporting from $101 million to the Board to adjust annually the amount $106.9 million for nonexempt deposiof the low reserve tranche to reflect tory institutions, beginning in Septemchanges in net transaction accounts at ber 2002. depository institutions. Recent declines Exempt institutions (those with total in net transaction accounts warranted a reservable liabilities not exceeding the decrease in the low reserve tranche reserve exemption level of $5.7 milfrom $42.8 million to $41.3 million, lion) that have at least $5.7 million in and the Board amended Regulation D total deposits may report annually, and accordingly. exempt institutions that have less than The Garn-St Germain Depository $5.7 million in total deposits are not Institutions Act of 1982 establishes a required to file deposit reports. zero percent reserve requirement on the first $2 million of an institution's reserv- Regulation E able liabilities. The act also provides for Electronic Fund Transfers annual adjustments to that exemption amount based on increases in reservable February 27, 2001—Amendments liabilities at depository institutions. Recent growth in reservable liabilities The Board amended Regulation E to warranted an increase in the amount require disclosure of certain fees assoexempted from reserve requirements ciated with automated teller machine from $5.5 million to $5.7 million, (ATM) transactions, effective March 9, and the Board amended Regulation D 2001, with mandatory compliance by accordingly. October 1, 2001. For institutions reporting weekly, the Votes for this action: Messrs. Greenspan, amendments are effective with the Ferguson, Meyer, and Gramlich. Absent reserve computation period beginning and not voting: Mr. Kelley. November 27, 2001, and the corresponding reserve maintenance period The Electronic Fund Transfer Act, beginning December 27, 2001. For insti- which is implemented by Regulation E, tutions reporting quarterly, the amendwas amended by the Gramm-Leachments are effective with the reserve computation period beginning December 18, 2001, and the corresponding 2. All U.S. branches and agencies of foreign reserve maintenance period beginning banks and Edge and agreement corporations are required to submit the Report of Transaction January 17, 2002. Accounts, Other Deposits, and Vault Cash To reduce the reporting burden on (FR 2900) weekly regardless of size. In addition, small institutions, depository institutions depository institutions that obtain funds from nonhaving total deposits below specified U.S. sources or that have foreign branches or international banking facilities continue to be required levels are required to report their deposto file the Report of Certain Eurocurrency Transits and reservable liabilities quarterly or actions (FR 2950/FR 2951) at the same frequency less frequently, while larger institutions as they file the FR 2900 report. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board Policy Actions 201 Bliley Act to add certain requirements is among the 100 largest insured banks for ATM transactions. The amendments may control or hold an interest in a to Regulation E implement these provi- financial subsidiary if the bank has at sions by requiring ATM operators that least one issue of outstanding eligible impose a fee to post a notice to that debt that is rated in one of the three effect on or at the ATM and to disclose highest rating categories by a nationally the amount of the fee either on the recognized statistical rating organizascreen or on a paper notice before the tion. Banks among the second 50 largest customer is committed to completing insured banks may also qualify under an the transaction. Financial institutions are alternative standard that the Board and also required to include in their initial the Secretary of the Treasury determine disclosures to a customer contracting for by regulation to be comparable and conelectronic fund transfer services a notice sistent with the debt-rating requirement. that a fee may be imposed by an ATM The final rule, which for state memoperator not holding the customer's ber banks is incorporated in Regulaaccount or by any national, regional, tion H, provides that a bank qualifies or local network used to complete the under the alternative standard if it has a transaction. current long-term issuer credit rating from a nationally recognized statistical rating organization that is within the Regulation H organization's three highest investment- Membership of grade rating categories. A long-term State Banking Institutions credit rating is defined as a written in the Federal Reserve System opinion that assesses the bank's overall capacity and willingness to pay in a January 17, 2001—Amendments timely manner its unsecured, dollar- The Board approved a final rule that denominated financial obligations that provides an alternative to the debt-rating mature in not less than one year. requirement for certain large state member banks that propose to own a financial subsidiary, effective March 5, 2001. March 7, 2001—Delay of Effective Date Votes for this action: Messrs. Greenspan, Ferguson, Kelley, and Gramlich. Absent The Board extended, from April 1 to and not voting: Mr. Meyer. October 1, 2001, the effective date for a new rule that provides consumer protec- The Board and the Department of tions in connection with insurance sales the Treasury jointly approved a final by state member banks. rule that establishes an alternative to the debt-rating requirement that certain Votes for this action: Messrs. Greenspan, large banks may meet when they seek Ferguson, Kelley, Meyer, and Gramlich. to acquire a financial subsidiary and thereby engage in expanded financial The Board, jointly with the Federal activities. The final rule is substantially Deposit Insurance Corporation, the similar to the interim rule adopted in Office of the Comptroller of the Cur- March 2000. rency, and the Office of Thrift Super- Under the Gramm-Leach-Bliley Act, vision, approved a six-month extension a national or state member bank that of the effective date of a new inter- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

202 88th Annual Report, 2001 agency final rule on the sale of insur- qualifying criteria for a state member ance by depository institutions that had bank to own a financial subsidiary; and been published on December 4, 2000. describes the procedures and restrictions The new joint rule implements the con- that would apply if a state member bank sumer protection provisions of the or an affiliate ceased to meet these cri- Gramm-Leach-Bliley Act applicable to teria. It also provides guidance on how the retail sale, solicitation, advertising, the act's capital deduction and CRA or offer of an insurance product or annu- requirements apply to a state member ity by a depository institution or by a bank having a financial subsidiary. person engaged in such activities at an office of or on behalf of a depository institution. The agencies provided the Regulation H extension to give institutions sufficient Membership of time to ensure implementation of the State Banking Institutions new protections. in the Federal Reserve System Regulation Y August 8, 2001—Amendments Bank Holding Companies and Change in Bank Control The Board approved a final rule amending Regulation H to permit qualify- October 15, 2001—Amendments ing state member banks to engage in expanded financial activities through The Board approved amendments to financial subsidiaries, effective Septem- Regulations H and Y to revise the regber 17, 2001. ulatory capital treatment of securitization transactions by state member banks Votes for this action: Messrs. Greenspan, and bank holding companies, including Ferguson, Kelley, Meyer, and Gramlich. financial holding companies, effective January 1, 2002. The Board approved a final rule implementing the provisions of the Votes for this action: Messrs. Greenspan, Gramm-Leach-Bliley Act that autho- Ferguson, Kelley, Meyer, and Gramlich. rize qualifying state member banks to control or hold an interest in a financial The Board, jointly with the Federal subsidiary, which may engage in certain Deposit Insurance Corporation, the activities that are financial in nature, Office of the Comptroller of the Curor incidental thereto, but that the parent rency, and the Office of Thrift Superbank may not conduct directly. The vision, amended the regulatory capital final rule is substantially similar to the standards to address the treatment of interim rule approved by the Board in recourse obligations, residual interests, March 2000 and to the rule adopted by and direct credit substitutes related to the Office of the Comptroller of the securitization transactions that expose Currency for financial subsidiaries of banking and thrift institutions to credit national banks. risk. The amended standards better The final rule provides a streamlined reflect the institutions' relative exposure prior-notice procedure for acquiring an to credit risks and provide a more coninterest in a financial subsidiary; incor- sistent regulatory capital treatment for porates the capital, managerial, Commu- certain transactions that involve siminity Reinvestment Act (CRA), and other lar risk. They also increase consistency Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board Policy Actions 203 among the supervisory agencies in the tion 4(c)(6) or 4(c)(7) of the Bank Holdarea of regulatory capital requirements. ing Company Act, the portfolio invest- For transactions entered into before the ment authority under Regulation K effective date, institutions may either (International Banking Operations), the adopt any portion of the final rule that authority to make investments in small would reduce their capital requirements business investment companies (SBICs) or defer adoption until December 31, under the Small Business Investment 2002, if complying with the rule would Act, and the authority to make investincrease their capital requirements. ments under section 24 of the Federal Deposit Insurance Act (other than section 24(f)). The rule exempts from December 10, 2001—Amendments the new capital charges any individual The Board amended the capital guide- investment made by a bank or bank lines in Regulations H and Y to estab- holding company before March 13, lish minimum capital requirements for 2000. In addition, the new charges do equity investments in nonfinancial com- not apply to investments made in or panies by state member banks and bank through SBICs to the extent that such holding companies, including financial investments, in the aggregate, represent holding companies, effective April 1, 15 percent or less of the banking organi- 2002. zation's tier 1 capital. Votes for this action: Messrs. Greenspan, Ferguson, Meyer, and Gramlich, Ms. Bies, Regulation K and Mr. Olson. Absent and not voting: International Banking Operations Mr. Kelley. Rules Regarding The Board, jointly with the Federal Delegation of Authority Deposit Insurance Corporation and the Office of the Comptroller of the Cur- October 10, 2001—Amendments rency, adopted special minimum capital requirements for equity investments The Board approved amendments to Regulation K to eliminate unnecessary in nonfinancial companies by banks regulatory burden, increase transparand bank holding companies, including ency, and streamline the approval profinancial holding companies. The final cess for U.S. banking organizations rule imposes a series of marginal capital seeking to expand their operations charges on covered equity investments abroad and for foreign banks seeking to that increase with the level of the bankexpand their U.S. operations, effective ing organization's overall exposure to November 26, 2001. nonfinancial equity investments relative to its tier 1 capital. The new capital Votes for this action: Messrs. Greenspan, requirements apply symmetrically to Ferguson, Meyer, and Gramlich. Absent equity investments made by banks and and not voting: Mr. Kelley. bank holding companies in nonfinancial companies. The new charges apply to Consistent with the Riegle Comequity investments held under the mer- munity Development and Regulatory chant banking authority of the Gramm- Improvement Act, the Federal Reserve Leach-Bliley Act, the authority to Act, and the International Banking Act, acquire up to 5 percent of the voting the Board approved amendments in conshares of any company under sec- nection with its review of Regulation K. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

204 88th Annual Report, 2001 The amended provisions regulate the holding companies, effective Februforeign investments and activities of ary 15, 2001, replacing the Board's all member banks, Edge and agreement interim rule on this subject, which had corporations, and bank holding compa- become effective on March 17, 2000. nies (subpart A); U.S. activities of for- Votes for this action: Messrs. Greenspan, eign banking organizations (subpart B); Ferguson, Kelley, Meyer, and Gramlich. and export trading companies (subpart C). The Board also requested pub- The Board and the Department of the lic comment on proposed amendments Treasury jointly approved a final rule to provisions on international lending incorporated in Regulation Y to implesupervision (subpart D). ment the merchant banking provisions The amendments provide streamlined of the Gramm-Leach-Bliley Act. Like foreign branching procedures for U.S. the interim rule it replaces, the final rule banking organizations, authorize ex- defines the scope of permissible merpanded activities by foreign branches chant banking activities and implements of U.S. banks, and implement recent the limitations in the act on the potenstatutory amendments that permit mem- tial mixing of banking and commerce. ber banks to invest up to 20 percent of The rule contains provisions designed their capital and surplus in Edge corpo- to protect the safety and soundness of rations. Regulation K's provisions gov- depository institutions. It also contains erning permissible foreign activities streamlined recordkeeping and reporting of U.S. banking organizations, including provisions to assist in monitoring comsecurities activities, and investments by pliance with, and to prevent evasions U.S. banking organizations under the of, the Bank Holding Company and general consent procedures also were Gramm-Leach-Bliley Acts. amended. Other revisions streamline The final rule differs from the interim the applications procedures for foreign rule in several key respects. It modifies banks seeking to expand operations in the interim rule's provisions defining the U.S., modify provisions concerning prohibited routine management and the qualification of foreign banking or- operation of portfolio companies and ganizations for exemption from the non- provides three situations in which finanbanking prohibitions in section 4 of the cial holding companies will not be pre- Bank Holding Company Act, and imple- sumed to control portfolio companies ment provisions of the Riegle-Neal for purposes of applying sections 23A Interstate Banking and Branching Effi- and 23B of the Federal Reserve Act. ciency Act that affect foreign banks. In addition, the final rule broadens the The Board also delegated authority to definition of "private equity funds," Board staff and the Reserve Banks to clarifies the rule's application to such approve certain transactions. funds, and expands the types of financial holding companies that may engage in merchant banking activities. The Regulation Y final rule also adopts a sunset provision Bank Holding Companies and for the aggregate investment thresholds Change in Bank Control included in the interim rule and eliminates immediately the dollar-based January 10, 2001—Amendments investment threshold for the review of a The Board approved a final rule on the financial holding company's merchant merchant banking activities of financial banking activities. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board Policy Actions 205 Regulation Z regard to their ability to repay the loan Truth in Lending and revise the consumer disclosures that must be provided before a loan December 12, 2001—Amendments closing. The Board amended Regulation Z to expand the applicability of the Home Ownership and Equity Protection Act, Miscellaneous Interpretations effective December 20, 2001, with mandatory compliance by October 1, Applicability of Sections 23A and 2002. 23B of the Federal Reserve Act to Derivative Transactions with Votes for this action: Messrs. Greenspan, Affiliates and Intraday Ferguson, Meyer, and Gramlich, Ms. Bies, Extensions of Credit to Affiliates and Mr. Olson. Absent and not voting: Mr. Kelley. May 2, 2001- -Interim Amendments The Home Ownership and Equity Protection Act amended the Truth in The Board adopted interim rules on the Lending Act to address potentially abuapplicability of sections 23 A and 23B of sive practices in connection with closedthe Federal Reserve Act to derivative end home-equity loans that are not transactions and intraday extensions home-purchase loans. It imposes subof credit involving insured depository stantive limitations, such as restrictions institutions and their affiliates, effective on short-term balloon notes and prepay- January 1, 2002. ment penalties, and additional disclosure requirements on these types of Votes for this action: Messrs. Greenspan, loans if annual percentage rates or fees Ferguson, Kelley, Meyer, and Gramlich. exceed specified threshold amounts. The Board is authorized to expand the act's The interim amendments implement applicability and to prohibit certain provisions of the Gramm-Leach-Bliley practices. Act that require the Board to adopt rules The Board approved amendments that under section 23A to address credit make more home-equity loan transac- exposure arising out of derivative transtions subject to the act by lowering the actions between insured depository rate-based threshold for first-lien loans institutions and their affiliates and intraand by including certain charges for day extensions of credit by insured optional credit insurance and credit- depository institutions to their affiliprotection plans in the calculation of ates. The interim rules require insured the fee-based threshold. The amend- depository institutions to adopt policies ments also restrict certain acts and prac- and procedures reasonably designed tices, such as refinancing a covered loan to monitor, manage, and control credit within one year unless the refinancing exposures in derivative transactions with is in the borrower's interest and wrong- their affiliates and in intraday extenfully documenting a covered loan as an sions of credit to their affiliates. In addiopen-end credit transaction to evade tion, they clarify that these transactions the act. In addition, the amendments are subject to section 23B. The Board strengthen the act's prohibition on loans also requested public comment on the based on homeowners' equity without interim rules. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

206 88th Annual Report, 2001 Applicability of Section 23 A of manner consistent with safe and sound the Federal Reserve Act to the banking practices. Purchase of Securities from The Board also adopted an interpreta- Certain Affiliates tion and provided exemptions applicable to certain loans made by insured Applicability of Section 23A of depository institutions to customers who the Federal Reserve Act to Loans use the loan proceeds to purchase a and Extensions of Credit Made security or other asset through an affiliby a Member Bank ate of the depository institution. The to a Third Party interpretation confirms that section 23A does not apply to such loan and pur- May 2, 2001—Amendments chase transactions as long as the affiliate is acting exclusively as a broker in the The Board adopted rules regarding the transaction and the affiliate retains no applicability of section 23A of the portion of the loan proceeds. The Board Federal Reserve Act to certain transalso exempted from section 23A any actions involving securities affiliates of portion of the loan that an affiliate insured depository institutions, effective retains as a market-rate brokerage com- June 11, 2001. mission or agency fee. In addition, the Board provided exemptions for trans- Votes for this action: Messrs. Greenspan, Ferguson, Kelley, Meyer, and Gramlich. actions in which loan proceeds are used by a customer to purchase a third party's Section 23A restricts the ability of a security through a broker-dealer affilimember bank to fund its affiliates ate of the institution that makes the through investments, loans, asset acqui- loan if the affiliate is acting as a riskless sitions, or certain other transactions, principal in the securities transaction. including transactions that involve a Finally, the Board provided an exempmember bank and a nonaffiliated party tion for extensions of credit used by to the extent that the proceeds from the customers to purchase securities from a transaction are used for the benefit of broker-dealer affiliate of the institution or are transferred to an affiliate of the extending the credit under a preexisting bank. The amendments provide that credit line not entered into in contemplacertain transactions involving securi- tion of the securities purchase. ties affiliates of insured depository institutions are not covered under sec- Rules Regarding tion 23A. Equal Opportunity The Board adopted an interpretation that expands the types of asset pur- January 2, 2001—Interim chases eligible for exemption under the Amendments provision in section 23A that exempts The Board approved interim amendthe purchase from an affiliate of an asset ments to its Rules Regarding Equal that has a readily identifiable and pub- Opportunity, effective January 25, 2001. licly available market quotation. The interpretation increases the ability of Votes for this action: Messrs. Greenspan, insured depository institutions to pur- Ferguson, Kelley, Meyer, and Gramlich. chase securities from their registered broker-dealer affiliates while ensuring The Board's Rules Regarding Equal that the transactions are conducted in a Opportunity require a workplace that is Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board Policy Actions 207 free of discrimination based on race, ticipant") designates another depository color, religion, sex, national origin, institution or other service provider to age, physical or mental disability, or initiate, receive, or otherwise process retaliation and provide a procedure for Fedwire funds transfers or book-entry processing discrimination complaints. securities transfers that are posted to the The rules, which were adopted under participant's account at the Federal the Federal Reserve Act, are substan- Reserve. The Federal Reserve's experitially similar to the Equal Employ- ence with the Fedwire third-party access ment Opportunity Commission's regu- policy indicates that, properly managed, lations for federal sector employment. such arrangements pose little additional In November 1999, the Commission risk to the Federal Reserve. Supervisory amended its regulations, and the Board's guidance on outsourcing, issued by the interim amendments implement the Board and the other federal banking changes that are applicable to Board regulators in 2000, addresses domesemployment. In addition, the interim tic and foreign arrangements and sets amendments revise provisions in the forth basic supervisory expectations rules that prohibit discrimination on for outsourcing of Fedwire and other the basis of disability and address the information- and transaction-processing employment of noncitizens, which are activities conducted by banking organinot covered by the Commission's regu- zations. Fedwire outsourcing arrangelations. The Board also requested public ments will continue to be reviewed as comment on the interim amendments. appropriate during the normal supervisory process. In this light, the Board concluded that the administrative bur- Policy Statements and den on participants of complying with a Other Actions separate third-party access policy warranted its rescission. April 4, 2001—Policy Statement on Payments System Risk May 29, 2001—Policy Statement The Board rescinded the third-party on Payments System Risk access policy for Fedwire transactions in connection with its review of the Fed- The Board rescinded its interaffiliate eral Reserve's Policy Statement on Pay- transfer policy, effective January 1, ments System Risk, effective April 9, 2002. 2001. Votes for this action: Messrs. Greenspan, Votes for this action: Messrs. Greenspan, Ferguson, Kelley, Meyer, and Gramlich. Ferguson, Kelley, Meyer, and Gramlich. In 1987, the Board modified its Pol- In 1987, the Board, as part of its icy Statement on Payments System Risk policy to reduce payments system to include a policy on interaffiliate transrisk, approved a set of conditions fers that addressed potential risks arisunder which Fedwire third-party access ing from credit decisions among affiliarrangements could be established. The ates that are not at arm's length. The Board allowed institutions meeting Board has rescinded the interaffilithe conditions to establish third-party ate transfer policy because the risks access arrangements under which a addressed by the policy are approprisending or receiving institution ("par- ately addressed through the existing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

208 88th Annual Report, 2001 supervisory process and the Reserve The Board adopted, with minor modi- Banks' credit-risk-management controls. fications, the interim policy statement on depository institutions' use of Fed- May 29, 2001—Policy Statement eral Reserve intraday credit, or daylight overdrafts, that was approved on on Payments System Risk May 29, 2001, and is discussed above. The Board approved an interim policy In addition, the Board approved modistatement that gives depository insti- fications to the criteria for determining tutions access to intraday credit from foreign banking organizations' U.S. the Federal Reserve Banks above their capital equivalency measure for purself-assessed net debit caps, effective poses of calculating their net debit caps, May 30, 2001. effective February 21, 2002. The Board also approved modifications to the post- Votes for this action: Messrs. Greenspan, ing time for electronic check present- Ferguson, Kelley, Meyer, and Gramlich. ments to a depository institution's Federal Reserve account for purposes Controlling depository institutions' of measuring daylight overdrafts; the use of intraday Federal Reserve credit, modifications, made in order to remove commonly known as daylight overa potential impediment to the use of drafts, is an integral part of the Board's electronic check presentment, became Policy Statement on Payments System effective April 1, 2002. Finally, the Risk. The interim policy statement pro- Board decided to retain the $50 million motes risk-reduction efforts while minilimit on the value of book-entry securimizing disruptions to the payments systies transfers. tem. It allows depository institutions having self-assessed net debit caps, which are maximum limits on their day- Discount Rates in 2001 light overdrafts, to pledge collateral for During 2001, the Board of Governors additional daylight overdraft capacity approved twelve reductions, totaling above their net debit caps, subject to 43/4 percentage points, in the basic Reserve Bank approval. The interim discount rate charged by the Federal policy statement reflects the Board's Reserve Banks. These actions lowered ongoing efforts to ensure that the paythe basic rate from 6 percent at the start ments system functions effectively and of the year to 11A percent in Decemefficiently. The Board also requested ber. There were no rate increases durpublic comment on the interim policy ing 2001. The rates for seasonal and statement. extended credit, which are recalculated biweekly in keeping with market-related December 7, 2001—Policy formulas, exceeded the basic rate by Statement on Payments varying amounts during the year. System Risk The Board approved revisions to its Basic Discount Rate Policy Statement on Payments System The Board's decisions on the basic dis- Risk, effective December 10, 2001, count rate were made against the backexcept as noted below. ground of the policy actions of the Fed- Votes for this action: Messrs. Greenspan, eral Open Market Committee (FOMC) Ferguson, Kelley, Meyer, and Gramlich. and related economic and financial Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board Policy Actions 209 developments. These developments are of continuing indications of a softening reviewed more fully in other parts of economy characterized by further weakthis Report, including the minutes of the ness in capital spending, inventory FOMC meetings held in 2001. liquidation, and deteriorating export markets. However, household spending was being well maintained, and Federal Reductions in the Basic Rate Reserve officials took account of the during 2001 considerable easing of monetary policy From January 3 to December 11, 2001, undertaken in recent months, whose the Board approved twelve reductions in effect had not yet been fully felt, and of the basic rate in conjunction with simi- Congressional approval of tax cuts that lar decreases in the target for the federal would help to support the economy in funds rate set at meetings of the FOMC. coming quarters. Even so, the risks were As the year began, information relating seen as still tilted toward further econotably to sales and production sug- nomic weakness that called for some gested that the expansion had begun added easing in monetary policy. to weaken considerably in late 2000. Despite cumulative reductions of Against that background and given indi- 3 percentage points in the basic discations that inflation pressures remained count rate and the federal funds rate contained, the FOMC lowered the target by August, the economy appeared to federal funds rate by 50 basis points and remain vulnerable to further deteriorathe Board decided that an equal reduc- tion, with more-widespread indications tion in the basic discount rate was also of weakness and mounting job losses. appropriate. Over the months that fol- Against this background, the terrorist lowed, evidence of a marked slowdown attacks on September 11 posed a severe in the growth of economic activity inten- threat to financial markets and the econsified. Businesses substantially reduced omy. The uncertainty created by the their investment spending in response to attacks depressed equity prices, raised weakening demand for their goods and risk premiums, and further restrained services, an oversupply of some types economic activity. In these circumof capital, and declining profits. Many stances, the Federal Reserve acted business firms also sought to reduce promptly to provide massive amounts of what they viewed as excessive inven- liquidity on a temporary basis to facilitories, fostering a decline in manufac- tate the functioning of financial markets turing output and an upturn in unem- and took several actions to reduce its ployment. Concurrently, business and policy rates further. Three reductions consumer confidence eroded, although of 50 basis points were made in the household spending continued to grow, basic discount rate and the federal funds albeit at a somewhat reduced pace. rate from mid-September through early Against this background, the Board November. By the first part of Decemand the FOMC eased monetary policy ber, there were signs that the weakness aggressively in a series of coordinated in aggregate demand might be abating, 50 basis point rate reductions over the though those indications were still quite first five months of the year. limited and tentative. Over the closing In late June and again in August, months of the year, efforts to liquidate lesser reductions of 25 basis points in inventories and reduce capital spending the basic discount rate and the federal continued to induce production cutfunds rate were made in the context backs. However, after displaying some Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

210 88th Annual Report, 2001 weakness immediately after the events under sustained liquidity pressure and in September, household spending sub- are not able to obtain funds from other sequently appeared to have returned to sources. The rate for extended credit is a moderate growth trend. Low interest 50 basis points higher than the rate for rates and widespread price discount- seasonal credit and is at least 50 basis ing, among other factors, were helping points above the basic rate. In approprito hold up expenditures on household ate circumstances, the basic rate may be durables and residential construction applied to extended-credit loans for up despite a high degree of consumer cau- to thirty days, but any further borrowtion. Moreover, stock prices reversed ings would be charged the flexible, their post-attack losses and an upturn market-related rate. in new orders for capital goods sug- Exceptionally large adjustment-credit gested that business confidence might loans that arise from computer breakbe returning. In this situation, while the downs or other operating problems not risks to the economy were still viewed clearly beyond the reasonable control as tilted toward weakness, the Board of the borrowing institution are assessed and the FOMC agreed that further the highest rate applicable to any credit reductions in their policy rates should be extended to depository institutions. No limited to 25 basis points. At year-end, loans of this type were made during the key policy rates were at their lowest 2001. nominal levels in four decades. At the end of 2001, the structure of discount rates was as follows: a basic rate of 1.25 percent for short-term Structure of Discount Rates adjustment credit and rates of 1.80 per- The basic discount rate is the rate nor- cent for seasonal credit and 2.30 permally charged on loans to depository cent for extended credit. During 2001, institutions for short-term adjustment the rate for seasonal credit ranged from credit, while flexible, market-related a high of 6.45 percent to a low of rates generally apply to seasonal and 1.80 percent; that for extended credit extended credit. The flexible rates are ranged from a high of 6.95 percent to a calculated every two weeks in accor- low of 2.30 percent. dance with formulas that are approved by the Board. Board Votes The objective of the seasonal credit program is to help smaller institutions Under the Federal Reserve Act, the meet liquidity needs arising from a clear boards of directors of the Federal pattern of intra-yearly movements in Reserve Banks must establish rates on their deposits and loans. Funds may be loans to depository institutions at least provided for longer periods than those every fourteen days and must submit permitted under adjustment credit. Since such rates to the Board of Governors for its introduction in early 1992, the flex- review and determination. The Reserve ible rate charged on seasonal credit Banks are also required to submit on the has been closely aligned with short- same schedule requests to renew the forterm market rates; it is never less than mulas based on short-term market interthe basic rate applicable to adjustment est rates for calculating the rates on credit. seasonal and extended credit. Votes on The purpose of extended credit is the reestablishment of the formulas to assist depository institutions that are for these flexible rates are not shown in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board Policy Actions 211 this summary. All votes taken by the directors of the Federal Reserve Banks Board of Governors during 2001 were of New York, Philadelphia, Cleveland, unanimous. Atlanta, Chicago, Minneapolis, Dallas, and San Francisco to reduce the basic Votes on the Basic Discount Rate3 discount rate by Vi percentage point, to 5 percent. The same decrease was January 3, 2001. Effective this date, the approved for the Federal Reserve Bank Board approved actions taken by the of St. Louis, effective February 1, 2001. directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, Kan- Votes for this action: Messrs. Greenspan, sas City, Dallas, and San Francisco to Ferguson, Kelley, Meyer, and Gramlich. reduce the basic discount rate by lA per- Votes against this action: None. centage point, to 53/4 percent. The same decrease was approved for the Federal The Board subsequently approved the Reserve Bank of St. Louis, effective same reduction for the Federal Reserve January 4, 2001. The Board also indi- Banks of Boston and Richmond, effeccated that it stood ready to approve Fedtive January 31, 2001, and the Federal eral Reserve Bank requests to lower the Reserve Bank of Kansas City, effective basic rate further, to 5V2 percent. February 1, 2001. Votes for this action: Messrs. Greenspan, Ferguson, Kelley, Meyer, and Gramlich. March 20, 2001. Effective this date, Votes against this action: None. the Board approved actions taken by the directors of the Federal Reserve Banks January 4, 2001. Effective this date, of Boston, New York, Philadelphia, the Board approved actions taken by the Cleveland, Richmond, Atlanta, Chicago, directors of the Federal Reserve Banks Minneapolis, Kansas City, Dallas, and of Boston, New York, Philadelphia, San Francisco to reduce the basic dis- Cleveland, Richmond, Atlanta, Chicago, count rate by xh percentage point, to Minneapolis, Kansas City, Dallas, and 4V2 percent. The same reduction was San Francisco to lower the basic dis- approved for the Federal Reserve Bank count rate by VA or Vi percentage point, of St. Louis, effective March 21, 2001. to 5x/2 percent. The Board also approved an action taken by the directors of the Votes for this action: Messrs. Greenspan, Federal Reserve Bank of St. Louis to Ferguson, Kelley, Meyer, and Gramlich. reduce the basic rate by lA percentage Votes against this action: None. point, to 5Vi percent, effective January 5, 2001. April 18, 2001. Effective this date, the Board approved actions taken by the Votes for this action: Messrs. Greenspan, directors of the Federal Reserve Banks Ferguson, Kelley, Meyer, and Gramlich. of Boston, New York, Philadelphia, Votes against this action: None. Cleveland, Atlanta, Minneapolis, Kansas City, Dallas, and San Francisco to January 31, 2001. Effective this date, reduce the basic discount rate by Vi perthe Board approved actions taken by the centage point, to 4 percent. 3. There were two vacancies on the Board of Votes for this action: Messrs. Greenspan, Governors from the start of the year until Decem- Ferguson, Kelley, Meyer, and Gramlich. ber?, 2001. Votes against this action: None. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

212 88th Annual Report, 2001 The Board subsequently approved the Bank of St. Louis, effective June 29, same actions taken by the directors of 2001. the Federal Reserve Banks of Richmond and Chicago, effective April 19, 2001, August 21, 2001. Effective this date, and by the directors of the Federal the Board approved actions taken by Reserve Bank of St. Louis, effective the directors of the Federal Reserve April 20, 2001. Banks of Boston, New York, Philadelphia, Richmond, Chicago, Kansas City, May 15, 2001. Effective this date, the Dallas, and San Francisco to reduce the Board approved actions taken by the basic discount rate by lA percentage directors of the Federal Reserve Banks point, to 3 percent. of New York, Richmond, Chicago, and San Francisco to reduce the basic dis- Votes for this action: Messrs. Greenspan, Ferguson, Kelley, Meyer, and Gramlich. count rate by Vi percentage point, to Votes against this action: None. 3Vi percent. An identical decrease was approved for the Federal Reserve Bank The Board subsequently approved the of St. Louis, effective May 16, 2001. same actions taken by the directors of the Federal Reserve Bank of Minneapo- Votes for this action: Messrs. Greenspan, Ferguson, Kelley, Meyer, and Gramlich. lis, effective August 22, 2001, and by Votes against this action: None. the directors of the Federal Reserve Banks of Cleveland, Atlanta, and The Board subsequently approved the St. Louis, effective August 23, 2001. same actions taken by the directors of the Federal Reserve Banks of Boston, September 17, 2001. Effective this Atlanta, Kansas City, and Dallas, effec- date, the Board approved actions taken tive May 16, 2001, and by the directors by the directors of the Federal Reserve of the Federal Reserve Banks of Phila- Banks of Boston, New York, Philadelphia, Cleveland, and Minneapolis, delphia, Cleveland, Richmond, Atlanta, effective May 17, 2001. Chicago, Minneapolis, Kansas City, Dallas, and San Francisco to reduce June 27, 2001. Effective this date, the the basic discount rate by Vi percent- Board approved actions taken by the age point, to IVi percent. An identical directors of the Federal Reserve Banks decrease was approved for the Federal of Boston, New York, Philadelphia, Reserve Bank of St. Louis, effective Atlanta, Chicago, Dallas, and San Fran- September 18, 2001. cisco to reduce the basic discount rate by lA percentage point, to ?>lA percent. Votes for this action: Messrs. Greenspan, Ferguson, Kelley, Meyer, and Gramlich. Votes against this action: None. Votes for this action: Messrs. Greenspan, Ferguson, Kelley, Meyer, and Gramlich. Votes against this action: None. October 2, 2001. Effective this date, the Board approved actions taken by the The Board subsequently approved directors of the Federal Reserve Banks identical actions taken by the directors of Boston, New York, Cleveland, Richof the Federal Reserve Banks of Cleve- mond, Atlanta, Chicago, Kansas City, land, Richmond, Minneapolis, and Kan- Dallas, and San Francisco to reduce the sas City, effective June 28, 2001, and by basic discount rate by Vi percentage the directors of the Federal Reserve point, to 2 percent. A similar decrease Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board Policy Actions 213 was approved for the Federal Reserve apolis, effective November 7, 2001, and Bank of St. Louis, effective October 3, by the directors of the Federal Reserve 2001. Banks of Boston, Cleveland, Atlanta, Kansas City, and Dallas, effective Votes for this action: Messrs. Greenspan, November 8, 2001. Ferguson, Kelley, Meyer, and Gramlich. Votes against this action: None. December 11, 2001. Effective this The Board subsequently approved the date, the Board approved actions taken same actions taken by the directors of by the directors of the Federal Reserve the Federal Reserve Banks of Minne- Banks of Boston, New York, Philaapolis and Philadelphia, effective Octo- delphia, Chicago, and San Francisco to ber 3 and 4, 2001, respectively. reduce the basic discount rate by lA percentage point, to \lA percent. An identi- November 6, 2001. Effective this date, cal decrease was approved for the Fedthe Board approved actions taken by the eral Reserve Bank of St. Louis, effective directors of the Federal Reserve Banks December 12, 2001. of New York, Richmond, and San Francisco to reduce the basic discount rate Votes for this action: Messrs. Greenspan, by Vi percentage point, to IVz percent. Ferguson, Meyer, Gramlich, Ms. Bies, and Mr. Olson. Votes against this action: None. Absent and not voting: Mr. Kelley. Votes for this action: Messrs. Greenspan, Ferguson, Kelley, Meyer, and Gramlich. Votes against this action: None. The Board subsequently approved the same actions taken by the directors of The Board subsequently approved the Federal Reserve Banks of Cleveidentical actions taken by the directors land, Richmond, Atlanta, Minneapoof the Federal Reserve Banks of Phila- lis, Kansas City, and Dallas, effective delphia, Chicago, St. Louis, and Minne- December 13, 2001. . Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

215 Minutes of Federal Open Market Committee Meetings The policy actions of the Federal Open execute transactions for the System Market Committee, contained in the Open Market Account. In the area of minutes of its meetings, are presented in domestic open market operations, the the ANNUAL REPORT of the Board of Federal Reserve Bank of New York Governors pursuant to the requirements operates under three sets of instructions of section 10 of the Federal Reserve from the Federal Open Market Com- Act. That section provides that the mittee: an Authorization for Domestic Board shall keep a complete record of Open Market Operations, Guidelines for the actions taken by the Board and by the Conduct of System Open Market the Federal Open Market Committee on Operations in Federal Agency Issues, all questions of policy relating to open and a Domestic Policy Directive. (A market operations, that it shall record new Domestic Policy Directive is therein the votes taken in connection adopted at each regularly scheduled with the determination of open market meeting.) In the foreign currency area, policies and the reasons underlying each the Committee operates under an policy action, and that it shall include in Authorization for Foreign Currency its annual report to the Congress a full Operations, a Foreign Currency Direcaccount of such actions. tive, and Procedural Instructions with The minutes of the meetings contain Respect to Foreign Currency Operathe votes on the policy decisions made tions. These policy instruments are at those meetings as well as a resume of shown below in the form in which they the information and discussions that led were in effect at the beginning of 2001. to the decisions. The summary descrip- Changes in the instruments during the tions of economic and financial condi- year are reported in the minutes for the tions are based on the information that individual meetings. was available to the Committee at the time of the meetings rather than on data Authorization for Domestic as they may have been revised later. Open Market Operations Members of the Committee voting for a particular action may differ among In Effect January 1, 2001 themselves as to the reasons for their votes; in such cases, the range of their 1. The Federal Open Market Committee views is noted in the minutes. When authorizes and directs the Federal Reserve members dissent from a decision, they Bank of New York, to the extent necessary to carry out the most recent domestic are identified in the minutes and a sumpolicy directive adopted at a meeting of the mary of the reasons for their dissent is Committee: provided. (a) To buy or sell U.S. Government Policy directives of the Federal Open securities, including securities of the Federal Market Committee are issued to the Financing Bank, and securities that are direct Federal Reserve Bank of New York as obligations of, or fully guaranteed as to the Bank selected by the Committee to principal and interest by, any agency of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

216 88th Annual Report, 2001 United States in the open market, from or to 2. In order to ensure the effective conduct securities dealers and foreign and inter- of open market operations, the Federal Open national accounts maintained at the Federal Market Committee authorizes the Federal Reserve Bank of New York, on a cash, regu- Reserve Bank of New York to lend on an lar, or deferred delivery basis, for the Sys- overnight basis U.S. Government securities tem Open Market Account at market prices, held in the System Open Market Account to and, for such Account, to exchange maturing dealers at rates that shall be determined by U.S. Government and Federal agency securi- competitive bidding but that in no event shall ties with the Treasury or the individual be less than 1.0 percent per annum of the agencies or to allow them to mature without market value of the securities lent. The Fedreplacement; provided that the aggregate eral Reserve Bank of New York shall apply amount of U.S. Government and Federal reasonable limitations on the total amount of agency securities held in such Account a specific issue that may be auctioned, and (including forward commitments) at the on the amount of securities that each dealer close of business on the day of a meeting of may borrow. The Federal Reserve Bank the Committee at which action is taken with of New York may reject bids which could respect to a domestic policy directive shall facilitate a dealer's ability to control a single not be increased or decreased by more than issue as determined solely by the Federal $12.0 billion during the period commencing Reserve Bank of New York. with the opening of business on the day following such meeting and ending with the 3. In order to ensure the effective conduct of close of business on the day of the next such open market operations, while assisting in meeting; the provision of short-term investments for foreign and international accounts main- (b) To buy U.S. Government securities tained at the Federal Reserve Bank of New and obligations that are direct obligations of, York, the Federal Open Market Committee or fully guaranteed as to principal and interauthorizes and directs the Federal Reserve est by, any agency of the United States, from Bank of New York (a) for System Open dealers for the account of the Federal Market Account, to sell U.S. Government Reserve Bank of New York under agreesecurities to such foreign and international ments for repurchase of such securities or accounts on the bases set forth in paraobligations in 90 calendar days or less, at graph l(a) under agreements providing for rates that, unless otherwise expressly authothe resale by such accounts of those securirized by the Committee, shall be determined ties within 90 calendar days on terms compaby competitive bidding, after applying rearable to those available on such transactions sonable limitations on the volume of agreein the market; and (b) for New York Bank ments with individual dealers; provided that account, when appropriate, to undertake with in the event Government securities or agency dealers, subject to the conditions imposed on issues covered by any such agreement are purchases and sales of securities in paranot repurchased by the dealer pursuant to the graph l(b), repurchase agreements in U.S. agreement or a renewal thereof, they shall be Government and agency securities, and to sold in the market or transferred to the Sysarrange corresponding sale and repurchase tem Open Market Account. agreements between its own account and foreign and international accounts main- (c) To sell U.S. Government securities tained at the Bank. Transactions undertaken and securities that are direct obligations of, with such accounts under the provisions of or fully guaranteed as to principal and interthis paragraph may provide for a service fee est by, any agency of the United States to when appropriate. dealers for System Open Market Account under agreements for the resale by dealers of such securities or obligations in 90 calendar 4. In the execution of the Committee's decidays or less, at rates that, unless otherwise sion regarding policy during any intermeetexpressly authorized by the Committee, shall ing period, the Committee authorizes and be determined by competitive bidding, after directs the Federal Reserve Bank of applying reasonable limitations on the vol- New York, upon the instruction of the Chairume of agreements with individual dealers. man of the Committee, to adjust somewhat Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings 217 in exceptional circumstances the degree of Against the background of its long-run pressure on reserve positions and hence the goals of price stability and sustainable ecointended federal funds rate. Any such adjust- nomic growth and of the information curment shall be made in the context of the rently available, the Committee believes that Committee's discussion and decision at its the risks are weighted mainly toward condimost recent meeting and the Committee's tions that may generate economic weakness long-run objectives for price stability and in the foreseeable future. sustainable economic growth, and shall be based on economic, financial, and monetary developments during the intermeeting Authorization for Foreign period. Consistent with Committee prac- Currency Operations tice, the Chairman, if feasible, will consult with the Committee before making any adjustment. In Effect January 1, 2001 1. The Federal Open Market Committee Guidelines for the Conduct of authorizes and directs the Federal Reserve System Open Market Operations Bank of New York, for System Open Market in Federal Agency Issues Account, to the extent necessary to carry out the Committee's foreign currency directive and express authorizations by the Commit- In Effect January 1, 2001 tee pursuant thereto, and in conformity with such procedural instructions as the Commit- 1. System open market operations in Fedtee may issue from time to time: eral agency issues are an integral part of total System open market operations designed to influence bank reserves, money market con- A. To purchase and sell the following ditions, and monetary aggregates. foreign currencies in the form of cable transfers through spot or forward transactions on the open market at home and abroad, includ- 2. System open market operations in Feding transactions with the U.S. Treasury, with eral agency issues are not designed to supthe U.S. Exchange Stabilization Fund estabport individual sectors of the market or lished by Section 10 of the Gold Reserve to channel funds into issues of particular Act of 1934, with foreign monetary authoriagencies. ties, with the Bank for International Settlements, and with other international financial Domestic Policy Directive institutions: Canadian dollars Mexican pesos In Effect January 1, 20011 Danish kroner Norwegian kroner Euro Swedish kronor Pounds sterling Swiss francs The Federal Open Market Committee seeks Japanese yen monetary and financial conditions that will foster price stability and promote sustainable B. To hold balances of, and to have growth in output. To further its long-run outstanding forward contracts to receive or objectives, the Committee in the immediate to deliver, the foreign currencies listed in future seeks conditions in reserve markets paragraph A above. consistent with maintaining the federal funds rate at an average of around 6V2 percent. C. To draw foreign currencies and to permit foreign banks to draw dollars under The Committee also approved the the reciprocal currency arrangements listed in paragraph 2 below, provided that drawsentence below for inclusion in the press ings by either party to any such arrangement statement to be released shortly after the shall be fully liquidated within 12 months December 19, 2000, meeting: after any amount outstanding at that time was first drawn, unless the Committee, 1. Adopted by the Committee at its meeting on because of exceptional circumstances, spe- December 19, 2000. cifically authorizes a delay. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

218 88th Annual Report, 2001 D. To maintain an overall open posi- ing operating arrangements with foreign tion in all foreign currencies not exceeding central banks on System holdings of foreign $25.0 billion. For this purpose, the overall currencies, the Federal Reserve Bank of open position in all foreign currencies is New York shall not commit itself to maintain defined as the sum (disregarding signs) of any specific balance, unless authorized by net positions in individual currencies. The the Federal Open Market Committee. Any net position in a single foreign currency is agreements or understandings concerning the defined as holdings of balances in that cur- administration of the accounts maintained by rency, plus outstanding contracts for future the Federal Reserve Bank of New York with receipt, minus outstanding contracts for the foreign banks designated by the Board future delivery of that currency, i.e., as the of Governors under Section 214.5 of Regusum of these elements with due regard to lation N shall be referred for review and sign. approval to the Committee. 5. Foreign currency holdings shall be in- 2. The Federal Open Market Commitvested to ensure that adequate liquidity is tee directs the Federal Reserve Bank of maintained to meet anticipated needs and so New York to maintain reciprocal currency that each currency portfolio shall generally arrangements ("swap" arrangements) for the have an average duration of no more than System Open Market Account for periods up 18 months (calculated as Macaulay durato a maximum of 12 months with the followtion). When appropriate in connection with ing foreign banks, which are among those arrangements to provide investment facilities designated by the Board of Governors of the for foreign currency holdings, U.S. Govern- Federal Reserve System under Section 214.5 ment securities may be purchased from forof Regulation N, Relations with Foreign eign central banks under agreements for Banks and Bankers, and with the approval of repurchase of such securities within 30 calthe Committee to renew such arrangements endar days. on maturity: 6. All operations undertaken pursuant to Amount the preceding paragraphs shall be reported of arrangement promptly to the Foreign Currency Sub- Foreign bank (millions of dollars equivalent) committee and the Committee. The Foreign Currency Subcommittee consists of the Bank of Canada ... 2,000 Chairman and Vice Chairman of the Com- Bank of Mexico ... 3,000 mittee, the Vice Chairman of the Board of Governors, and such other member of the Any changes in the terms of existing swap Board as the Chairman may designate (or in arrangements, and the proposed terms of any the absence of members of the Board serving new arrangements that may be authorized, on the Subcommittee, other Board members shall be referred for review and approval to designated by the Chairman as alternates, the Committee. and in the absence of the Vice Chairman of the Committee, his alternate). Meetings of the Subcommittee shall be called at the 3. All transactions in foreign currencies request of any member, or at the request of undertaken under paragraph l.A. above the Manager, System Open Market Account shall, unless otherwise expressly authorized ("Manager"), for the purposes of reviewing by the Committee, be at prevailing market recent or contemplated operations and of rates. For the purpose of providing an investconsulting with the Manager on other matment return on System holdings of foreign ters relating to his responsibilities. At the currencies, or for the purpose of adjusting request of any member of the Subcommittee, interest rates paid or received in connection questions arising from such reviews and conwith swap drawings, transactions with forsultations shall be referred for determination eign central banks may be undertaken at to the Federal Open Market Committee. non-market exchange rates. 7. The Chairman is authorized: 4. It shall be the normal practice to arrange with foreign central banks for the coordina- A. With the approval of the Committion of foreign currency transactions. In mak- tee, to enter into any needed agreement or Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings 219 understanding with the Secretary of the Trea- currencies, and to facilitate operations of the sury about the division of responsibility for Exchange Stabilization Fund. foreign currency operations between the Sys- C. For such other purposes as may be tem and the Treasury; expressly authorized by the Committee. B. To keep the Secretary of the Trea- 4. System foreign currency operations shall sury fully advised concerning System forbe conducted: eign currency operations, and to consult with the Secretary on policy matters relating to A. In close and continuous consultaforeign currency operations; tion and cooperation with the United States Treasury; C. From time to time, to transmit appropriate reports and information to the B. In cooperation, as appropriate, with National Advisory Council on International foreign monetary authorities; and Monetary and Financial Policies. C. In a manner consistent with the obli- 8. Staff officers of the Committee are autho- gations of the United States in the Internarized to transmit pertinent information on tional Monetary Fund regarding exchange System foreign currency operations to appro- arrangements under the IMF Article IV. priate officials of the Treasury Department. 9. All Federal Reserve Banks shall partici- Procedural Instructions with pate in the foreign currency operations for Respect to Foreign Currency System Account in accordance with para- Operations graph 3 G(l) of the Board of Governors' Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks In Effect January 1, 2001 dated January 1, 1944. In conducting operations pursuant to the authorization and direction of the Federal Foreign Currency Directive Open Market Committee as set forth in the Authorization for Foreign Currency Opera- In Effect January 1, 2001 tions and the Foreign Currency Directive, the Federal Reserve Bank of New York, 1. System operations in foreign currencies through the Manager, System Open Market shall generally be directed at countering dis- Account ("Manager"), shall be guided by orderly market conditions, provided that the following procedural understandings market exchange rates for the U.S. dollar with respect to consultations and clearances reflect actions and behavior consistent with with the Committee, the Foreign Currency the IMF Article IV, Section 1. Subcommittee, and the Chairman of the Committee. All operations undertaken pur- 2. To achieve this end the System shall: suant to such clearances shall be reported A. Undertake spot and forward pur- promptly to the Committee. chases and sales of foreign exchange. 1. The Manager shall clear with the Sub- B. Maintain reciprocal currency committee (or with the Chairman, if the ("swap") arrangements with selected for- Chairman believes that consultation with the eign central banks. Subcommittee is not feasible in the time C. Cooperate in other respects with available): central banks of other countries and with international monetary institutions. A. Any operation that would result in a change in the System's overall open position 3. Transactions may also be undertaken: in foreign currencies exceeding $300 million on any day or $600 million since the most A. To adjust System balances in light recent regular meeting of the Committee. of probable future needs for currencies. B. To provide means for meeting Sys- B. Any operation that would result in a tem and Treasury commitments in particular change on any day in the System's net posi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

220 88th Annual Report, 2001 tion in a single foreign currency exceeding Present: $150 million, or $300 million when the Mr. Greenspan, Chairman operation is associated with repayment of Mr. McDonough, Vice Chairman swap drawings. Mr. Ferguson Mr. Gramlich C. Any operation that might generate a Mr. Hoenig substantial volume of trading in a particular Mr. Kelley currency by the System, even though the Mr. Meyer change in the System's net position in that Ms. Minehan currency might be less than the limits speci- Mr. Moskow fied in I.B. Mr. Poole D. Any swap drawing proposed by a Messrs. Jordan, McTeer, Santomero, foreign bank not exceeding the larger of and Stern, Alternate Members (i) $200 million or (ii) 15 percent of the size of the Federal Open Market of the swap arrangement. Committee 2. The Manager shall clear with the Com- Messrs. Broaddus, Guynn, and mittee (or with the Subcommittee, if the Parry, Presidents of the Subcommittee believes that consultation Federal Reserve Banks of with the full Committee is not feasible in the Richmond, Atlanta, and time available, or with the Chairman, if the San Francisco respectively Chairman believes that consultation with the Subcommittee is not feasible in the time Mr. Kohn, Secretary and Economist available): Mr. Bernard, Deputy Secretary Ms. Fox, Assistant Secretary A. Any operation that would result in a Mr. Gillum, Assistant Secretary change in the System's overall open position Mr. Mattingly, General Counsel in foreign currencies exceeding $1.5 billion Mr. Baxter, Deputy General Counsel since the most recent regular meeting of the Ms. Johnson, Economist Committee. Mr. Stockton, Economist B. Any swap drawing proposed by Ms. Cumming, Messrs. Fuhrer, Hakkio, a foreign bank exceeding the larger of Howard, Hunter, Lindsey, Rasche, (i) $200 million or (ii) 15 percent of the Reinhart, and Slifman, Associate size of the swap arrangement. Economists 3. The Manager shall also consult with the Mr. Fisher, Manager, System Open Subcommittee or the Chairman about pro- Market Account posed swap drawings by the System and about any operations that are not of a routine Mr. Winn,2 Assistant to the Board, character. Office of Board Members, Board of Governors Meeting Held on Ms. Johnson,3 Secretary of the Board, January 30-31, 2001 Office of the Secretary, Board of Governors A meeting of the Federal Open Market Committee was held in the offices of Mr. Simpson, Senior Adviser, Division the Board of Governors of the Federal of Research and Statistics, Board of Governors Reserve System in Washington, D.C., beginning on Tuesday, January 30, 2001, at 9:00 a.m. and continuing on 2. Attended Tuesday session only. Wednesday, January 31, 2001, at 3. Attended portion of meeting relating to a 9:00 a.m. staff study of the Federal Reserve asset portfolio. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 221 Mr. Madigan, Associate Director, January 1, 2001, and ending Decem- Division of Monetary Affairs, ber 31, 2001, had been received and Board of Governors that these individuals had executed their oaths of office. Messrs. Oliner, Struckmeyer, and Whitesell, Assistant Directors, The elected members and alternate Divisions of Research and members were as follows: Statistics, Research and Statistics, and Monetary Affairs respectively, William J. McDonough, President of the Board of Governors Federal Reserve Bank of New York, with Jamie B. Stewart, Jr., First Vice Messrs. Morton,2 Rosine,2 and Sack,2 President of the Federal Reserve Bank Senior Economists, Divisions of of New York, as alternate International Finance, Research and Statistics, and Monetary Cathy E. Minehan, President of the Fed- Affairs respectively, Board of eral Reserve Bank of Boston, with Governors Anthony M. Santomero, President of the Federal Reserve Bank of Philadel- Mr. Reifschneider,4 Section Chief, phia, as alternate Division of Research and Statistics, Board of Governors Michael H. Moskow, President of the Federal Reserve Bank of Chicago, with Ms. Garrett,4 Economist, Division of Jerry L. Jordan, President of the Federal Monetary Affairs, Board of Reserve Bank of Cleveland, as alternate Governors William Poole, President of the Federal Ms. Low, Open Market Secretariat Reserve Bank of St. Louis, with Rob- Assistant, Division of Monetary ert D. McTeer, Jr., President of the Affairs, Board of Governors Federal Reserve Bank of Dallas, as alternate Mr. Lang, Executive Vice President, Federal Reserve Bank of Thomas M. Hoenig, President of the Federal Philadelphia Reserve Bank of Kansas City, with Gary H. Stern, President of the Fed- Messrs. Beebe, Eisenbeis, Goodfriend, eral Reserve Bank of Minneapolis, as Kos, Ms. Krieger, Messrs. alternate Rosenblum, and Sniderman, Senior Vice Presidents, Federal Reserve Banks of San Francisco, By unanimous vote, the following Atlanta, Richmond, New York, officers of the Federal Open Market New York, Dallas, and Cleveland Committee were elected to serve until respectively the election of their successors at the first regularly scheduled meeting of Mr. Weber, Vice President, Federal Reserve Bank of Minneapolis the Committee after December 31, 2001, with the understanding that in the event In the agenda for this meeting, it was of the discontinuance of their official reported that advices of the election of connection with the Board of Governors the following members and alternate or with a Federal Reserve Bank, they members of the Federal Open Market would cease to have any official con- Committee for the period commencing nection with the Federal Open Market Committee: Alan Greenspan Chairman 4. Attended Wednesday session only. William J. McDonough Vice Chairman Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

222 88th Annual Report, 2001 Donald L. Kohn Secretary and a broad study of alternative approaches Economist to the management of the System asset Normand R.V. Bernard Deputy Secretary portfolio in the current and prospective Lynn S. Fox and environment of large budget surpluses Gary P. Gillum Assistant Secretaries and rapid associated declines in the J. Virgil Mattingly, Jr. General Counsel amount of Treasury debt outstanding. Thomas C. Baxter, Jr. Deputy General Such paydowns were having favorable Counsel effects on the macroeconomy and would Karen H. Johnson and not impair the Committee's ability to David J. Stockton Economists pursue its overall economic objectives. But the FOMC's historical reliance on Christine M. Cumming, Jeffrey C. Fuhrer, Craig S. Hakkio, William C. Hunter, purchases and sales of Treasury securi- David H. Howard, David E. Lindsey, ties to implement monetary policy Robert H. Rasche, Vincent R. Reinhart, would be difficult to maintain if steep and Lawrence Slifman, Associate paydowns of debt were, as seemed Economists likely, to continue. To prepare for such a contingency, the Committee needed to By unanimous vote, Peter R. Fisher identify and explore alternative instruwas selected to serve at the pleasure ments for the conduct of monetary of the Committee as Manager, System policy. Open Market Account, on the under- In their discussion at this meeting, standing that his selection was subject to the members agreed that continuing being satisfactory to the Federal Reserve paydowns of Treasury debt outstand- Bank of New York. ing could create complications for the implementation of monetary policy well Secretary's note: Advice subsequently was before the full repayment of marketable received that the selection of Mr. Fisher as federal debt. In particular, the Treasury Manager was satisfactory to the board of market could be expected to become directors of the Federal Reserve Bank of less liquid over time, making it more New York. difficult for the Federal Reserve to accommodate the trend growth of cur- By unanimous vote, the minutes rency through outright purchases of of the meetings of the Federal Open Treasuries without unduly affecting Market Committee held on Decem- market prices. Reduced activity in the ber 19, 2000, and January 3, 2001, were Treasury repurchase agreement (RP) approved. market could complicate the use of such The next item on the agenda encom- obligations to respond to seasonal and passed issues relating in part to the dis- unexpected variations in the aggregate count window and other matters that are supply of reserves. within the legal purview of the Board of In reviewing the possibilities, the Governors. Accordingly, a Board meet- members noted that relative to investing was formally convened and this item ments in Treasury securities, all of the was considered in a joint Board-Federal options could entail significant draw- Open Market Committee session. The backs, including increases in credit risk, Board members voted unanimously at reductions in liquidity, and potentially the outset to close the Board meeting. distorting effects on relative prices in At its meeting in March 2000, the financial markets. In light of these Committee asked the staff to undertake potential issues, the Committee agreed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 223 that it should proceed cautiously and mittee decided to undertake any such maintain the current emphasis on Trea- operations. sury securities in the SOMA portfolio, From a somewhat longer-term perespecially the portion of the portfolio spective, Committee members identiheld outright, for as long as practicable. fied several alternative issues for fur- In that regard, some members suggested ther study. One involved the appropriate that the Committee look carefully at degree of reliance on outright purchases whether it could loosen the limits it cur- of a broader array of assets relative rently imposes on holdings of individual to greater use of temporary short-term Treasury issues without causing undue transactions undertaken through intermarket distortions. Some felt it would mediaries. A number of members saw be desirable to consider buying and advantages to the greater reliance on holding Ginnie Mae mortgage-backed the latter—RPs with security dealers securities, which are guaranteed by the and discount window loans to deposifull faith and credit of the United States. tory institutions—especially when they A few members suggested that consider- involved a wide range of underlying ation might be given to the possibility of assets. It was noted that such instrucontinuing to rely on Treasury securi- ments would afford the Federal Reserve ties, even as the publicly held debt is considerable protection against credit paid down, by acquiring such securities risks, could be structured to provide subthrough special arrangements with the stantial liquidity to respond to unantici- Treasury. pated changes in the supply or demand In the near term, the members agreed for reserves, and, relative to outright that it would be useful to extend for at purchases of the underlying collateral, least another year the temporary author- could help to mitigate potential disity, in effect since late August 1999, of tortions to asset pricing and credit allothe Manager to supplement repurchase cation. Many members indicated that agreements in Treasuries and direct a potentially attractive approach to agency debt with repurchase transac- expanding the role of the discount wintions in mortgage-backed securities dow might involve auctioning such guaranteed by a federal agency or a credit to financially sound depository government-sponsored enterprise. They institutions. Some members expressed also asked the staff to investigate the reservations about this option, noting possibility of authorizing the Desk to that such a program would have to be engage in RP operations using assets carefully structured in order to avoid that could be purchased under exist- situations in which some institutions ing legal authority but were not cur- might become heavily dependent on rently authorized by the Committee— such credit or engage in excessive risk specifically, certain debt obligations of taking. But extremely heavy reliance U.S. state and local governments and of on temporary transactions could itself foreign governments. Making a wider influence credit flows, suggesting that range of assets available for RP opera- approaches to staying longer with Treations would reduce the potential for dis- sury securities or adding new assets not tortions to the pricing of instruments currently allowed by law to the permacollateralizing RPs, but would entail nent portfolio would also need to be resolving a number of issues. The Con- studied. gress and market participants would The use of private securities for need to be consulted before the Com- temporary transactions or permanent Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

224 88th Annual Report, 2001 portfolio holdings had a number of risk- to securities dealers and foreign and intermanagement and accounting implica- national accounts maintained at the Federal Reserve Bank of New York, on a cash, regutions that would need to be examined lar, or deferred delivery basis, for the System carefully. Another aspect that required Open Market Account at market prices, and, further examination was the approach for such Account, to exchange maturing U.S. to diversification of the System port- Government and Federal agency securities folio in order to minimize any effects with the Treasury or the individual agencies on credit conditions. In this context, or to allow them to mature without replacement; provided that the aggregate amount of the members compared the merits of an U.S. Government and Federal agency securiincremental approach in which classes ties held in such Account (including forward of private securities were gradually commitments) at the close of business on the added to the RP pool or the permanent day of a meeting of the Committee at which portfolio, with the safest and most liquid action is taken with respect to a domestic being used first, to an alternative policy directive shall not be increased or decreased by more than $12.0 billion during approach in which very broad diversithe period commencing with the opening of fication was sought quickly through business on the day following such meeting investment in diverse pools of assets. and ending with the close of business on the In view of the importance of these day of the next such meeting; issues and their complexity, the Com- (b) To buy U.S. Government securities and obligations that are direct obligations of, mittee determined to explore various or fully guaranteed as to principal and intermeans to seek the input of the public est by, any agency of the United States, from and the Congress to develop and refine dealers for the account of the Federal alternatives and to investigate all the Reserve Bank of New York under agreeassociated policy issues. ments for repurchase of such securities or obligations in 65 business days or less, at rates that, unless otherwise expressly autho- By unanimous vote, the Commitrized by the Committee, shall be determined tee approved amendments to paraby competitive bidding, after applying reagraphs l(b), l(c), and 3 of the Authori- sonable limitations on the volume of agreezation for Domestic Open Market ments with individual dealers; provided that Operations to permit temporary opera- in the event Government securities or agency tions with a maturity limit of 65 busi- issues covered by any such agreement are ness days. not repurchased by the dealer pursuant to the agreement or a renewal thereof, they shall be sold in the market or transferred to the System Open Market Account; Authorization for Domestic (c) To sell U.S. Government securities Open Market Operations and obligations that are direct obligations of, (Amended January 30, 2001) or fully guaranteed as to principal and interest by, any agency of the United States to 1. The Federal Open Market Committee dealers for System Open Market Account authorizes and directs the Federal Reserve under agreements for the resale by dealers of Bank of New York, to the extent neces- such securities or obligations in 65 business sary to carry out the most recent domestic days or less, at rates that, unless otherwise policy directive adopted at a meeting of the expressly authorized by the Committee, shall Committee: be determined by competitive bidding, after (a) To buy or sell U.S. Government applying reasonable limitations on the volsecurities, including securities of the Federal ume of agreements with individual dealers. Financing Bank, and securities that are direct 2. In order to ensure the effective conduct obligations of, or fully guaranteed as to of open market operations, the Federal Open principal and interest by, any agency of the Market Committee authorizes the Federal United States in the open market, from or Reserve Bank of New York to lend on an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 225 overnight basis U.S. Government securities long-run objectives for price stability and held in the System Open Market Account to sustainable economic growth, and shall be dealers at rates that shall be determined by based on economic, financial, and monecompetitive bidding but that in no event shall tary developments during the intermeeting be less than 1.0 percent per annum of the period. Consistent with Committee pracmarket value of the securities lent. The Fed- tice, the Chairman, if feasible, will consult eral Reserve Bank of New York shall apply with the Committee before making any reasonable limitations on the total amount of adjustment. a specific issue that may be auctioned, and on the amount of securities that each dealer By unanimous vote, the Committee may borrow. The Federal Reserve Bank approved until the Committee's first of New York may reject bids which could scheduled meeting in 2002 an extension facilitate a dealer's ability to control a single of the temporary suspension of paraissue as determined solely by the Federal Reserve Bank of New York. graphs 3 to 6 of the Guidelines for the Conduct of System Operations in Fed- 3. In order to ensure the effective conduct of open market operations, while assisting eral Agency Issues. For the year ahead, in the provision of short-term investments the Guidelines therefore continued to for foreign and international accounts main- read as follows: tained at the Federal Reserve Bank of New York, the Federal Open Market Committee authorizes and directs the Federal Reserve Guidelines for the Conduct of Bank of New York (a) for System Open System Open Market Operations Market Account, to sell U.S. Government in Federal Agency Issues securities to such foreign and international accounts on the bases set forth in para- (Reaffirmed January 30, 2001) graph l(a) under agreements providing for 1. System open market operations in Fedthe resale by such accounts of those securieral agency issues are an integral part of total ties in 65 business days or less on terms System open market operations designed to comparable to those available on such transinfluence bank reserves, money market conactions in the market; and (b) for New York ditions, and monetary aggregates. Bank account, when appropriate, to under- 2. System open market operations in take with dealers, subject to the conditions Federal agency issues are not designed to imposed on purchases and sales of securities support individual sectors of the market or in paragraph l(b), repurchase agreements in to channel funds into issues of particular U.S. Government and agency securities, and agencies. to arrange corresponding sale and repurchase agreements between its own account and By unanimous vote, the Foreign Curforeign and international accounts mainrency Authorization was reaffirmed in tained at the Bank. Transactions undertaken with such accounts under the provisions of the form shown below. this paragraph may provide for a service fee when appropriate. Authorization for Foreign 4. In the execution of the Committee's Currency Operations decision regarding policy during any inter- (Reaffirmed January 30, 2001) meeting period, the Committee authorizes and directs the Federal Reserve Bank of New 1. The Federal Open Market Committee York, upon the instruction of the Chairman authorizes and directs the Federal Reserve of the Committee, to adjust somewhat in Bank of New York, for System Open Market exceptional circumstances the degree of Account, to the extent necessary to carry out pressure on reserve positions and hence the the Committee's foreign currency directive intended federal funds rate. Any such adjust- and express authorizations by the Commitment shall be made in the context of the tee pursuant thereto, and in conformity with Committee's discussion and decision at its such procedural instructions as the Commitmost recent meeting and the Committee's tee may issue from time to time: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

226 88th Annual Report, 2001 A. To purchase and sell the following foreign currencies in the form of cable trans- Amount of fers through spot or forward transactions on Foreign bank arrangement (millions of the open market at home and abroad, includdollars equivalent) ing transactions with the U.S. Treasury, with the U.S. Exchange Stabilization Fund estab- Bank of Canada 2,000 lished by Section 10 of the Gold Reserve Bank of Mexico 3,000 Act of 1934, with foreign monetary authorities, with the Bank for International Settlements, and with other international financial Any changes in the terms of existing swap institutions: arrangements, and the proposed terms of any new arrangements that may be authorized, Canadian dollars Mexican pesos shall be referred for review and approval to Danish kroner Norwegian kroner the Committee. Euro Swedish kronor 3. All transactions in foreign currencies Pounds sterling Swiss francs Japanese yen undertaken under paragraph l.A. above shall, unless otherwise expressly authorized B. To hold balances of, and to have by the Committee, be at prevailing market outstanding forward contracts to receive or rates. For the purpose of providing an investto deliver, the foreign currencies listed in ment return on System holdings of foreign paragraph A above. currencies, or for the purpose of adjusting C. To draw foreign currencies and to interest rates paid or received in connection permit foreign banks to draw dollars under with swap drawings, transactions with forthe reciprocal currency arrangements listed eign central banks may be undertaken at in paragraph 2 below, provided that draw- non-market exchange rates. ings by either party to any such arrangement 4. It shall be the normal practice to shall be fully liquidated within 12 months arrange with foreign central banks for the after any amount outstanding at that time coordination of foreign currency transacwas first drawn, unless the Committee, tions. In making operating arrangements because of exceptional circumstances, spe- with foreign central banks on System holdcifically authorizes a delay. ings of foreign currencies, the Federal D. To maintain an overall open posi- Reserve Bank of New York shall not commit tion in all foreign currencies not exceeding itself to maintain any specific balance unless $25.0 billion. For this purpose, the overall authorized by the Federal Open Market open position in all foreign currencies is Committee. Any agreements or understanddefined as the sum (disregarding signs) of ings concerning the administration of the net positions in individual currencies. The accounts maintained by the Federal Reserve net position in a single foreign currency is Bank of New York with the foreign banks defined as holdings of balances in that cur- designated by the Board of Governors under rency, plus outstanding contracts for future Section 214.5 of Regulation N shall be receipt, minus outstanding contracts for referred for review and approval to the future delivery of that currency, i.e., as the Committee. sum of these elements with due regard to 5. Foreign currency holdings shall be sign. invested to ensure that adequate liquidity is 2. The Federal Open Market Commit- maintained to meet anticipated needs and so tee directs the Federal Reserve Bank of that each currency portfolio shall generally New York to maintain reciprocal currency have an average duration of no more than arrangements ("swap" arrangements) for the 18 months (calculated as Macaulay dura- System Open Market Account for periods up tion). When appropriate in connection with to a maximum of 12 months with the follow- arrangements to provide investment facilities ing foreign banks, which are among those for foreign currency holdings, U.S. Governdesignated by the Board of Governors of the ment securities may be purchased from for- Federal Reserve System under Section 214.5 eign central banks under agreements for of Regulation N, Relations with Foreign repurchase of such securities within 30 cal- Banks and Bankers, and with the approval of endar days. the Committee to renew such arrangements 6. All operations undertaken pursuant to on maturity: the preceding paragraphs shall be reported Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 227 promptly to the Foreign Currency Subcom- Foreign Currency Directive mittee and the Committee. The Foreign Cur- (Reaffirmed January 30, 2001) rency Subcommittee consists of the Chairman and Vice Chairman of the Committee, 1. System operations in foreign currenthe Vice Chairman of the Board of Gover- cies shall generally be directed at countering nors, and such other member of the Board disorderly market conditions, provided that as the Chairman may designate (or in the market exchange rates for the U.S. dollar absence of members of the Board serving on reflect actions and behavior consistent with the Subcommittee, other Board members the IMF Article IV, Section 1. designated by the Chairman as alternates, 2. To achieve this end the System shall: and in the absence of the Vice Chairman A. Undertake spot and forward purof the Committee, his alternate). Meetings chases and sales of foreign exchange. of the Subcommittee shall be called at the B. Maintain reciprocal currency request of any member, or at the request of ("swap") arrangements with selected forthe Manager, System Open Market Account eign central banks. ("Manager"), for the purposes of reviewing C. Cooperate in other respects with recent or contemplated operations and of central banks of other countries and with consulting with the Manager on other matinternational monetary institutions. ters relating to his responsibilities. At the 3. Transactions may also be undertaken: request of any member of the Subcommittee, A. To adjust System balances in light questions arising from such reviews and conof probable future needs for currencies. sultations shall be referred for determination B. To provide means for meeting Systo the Federal Open Market Committee. tem and Treasury commitments in particular 7. The Chairman is authorized: currencies, and to facilitate operations of the A. With the approval of the Commit- Exchange Stabilization Fund. tee, to enter into any needed agreement or C. For such other purposes as may be Understanding with the Secretary of the Trea- expressly authorized by the Committee. sury about the division of responsibility for 4. System foreign currency operations foreign currency operations between the Sys- shall be conducted: tem and the Treasury; A. In close and continuous consulta- B. To keep the Secretary of the Trea- tion and cooperation with the United States sury fully advised concerning System for- Treasury; eign currency operations, and to consult with B. In cooperation, as appropriate, with the Secretary on policy matters relating to foreign monetary authorities; and foreign currency operations; C. In a manner consistent with the obli- C. From time to time, to transmit gations of the United States in the Internaappropriate reports and information to the tional Monetary Fund regarding exchange National Advisory Council on International arrangements under the IMF Article IV. Monetary and Financial Policies. 8. Star! officers of the Committee are By unanimous vote, the Procedural authorized to transmit pertinent informa- Instructions with Respect to Foreign tion on System foreign currency operations to appropriate officials of the Treasury Currency Operations were reaffirmed in Department. the form shown below. 9. All federal Reserve Banks shall participate in the foreign currency operations for System Account in accordance with para- Procedural Instructions with graph 3 G(l) of the Board of Governors' Respect to Foreign Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks Currency Operations dated January 1, 1944. (Reaffirmed January 30, 2001) In conducting operations pursuant to the authorization and direction of the Federal By unanimous vote, the Foreign Cur- Open Market Committee as set forth in the rency directive was reaffirmed in the Authorization for Foreign Currency Operaform shown below. tions and the Foreign Currency Directive, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

228 88th Annual Report, 2001 the Federal Reserve Bank of New York, proposed swap drawings by the System and through the Manager, System Open Market about any operations that are not of a routine Account ("Manager"), shall be guided by character. the following procedural understandings with respect to consultations and clearances with the Committee, the Foreign Currency On January 22, 2001, the continuing Subcommittee, and the Chairman of the rules, regulations, and other instructions Committee. All operations undertaken pur- of the Committee had been distributed suant to such clearances shall be reported with the advice that, in accordance with promptly to the Committee. procedures approved by the Committee, 1. The Manager shall clear with the Subthey were being called to the Commitcommittee (or with the Chairman, if the tee's attention before the January 30-31 Chairman believes that consultation with the Subcommittee is not feasible in the time organization meeting to give members available): an opportunity to raise any questions A. Any operation that would result in a they might have concerning them. Memchange in the System's overall open position bers were asked to indicate if they in foreign currencies exceeding $300 million wished to have any of the instruments in on any day or $600 million since the most question placed on the agenda for conrecent regular meeting of the Committee. sideration at this meeting. The Guide- B. Any operation that would result in a change on any day in the System's net posi- lines for the Conduct of System Operation in a single foreign currency exceed- tions in Federal Agency Issues were ing $150 million, or $300 million when the placed on the agenda and an extenoperation is associated with repayment of sion of their temporary amendment was swap drawings. approved as noted above. C. Any operation that might generate a The Manager of the System Open substantial volume of trading in a particular currency by the System, even though the Market Account reported on recent change in the System's net position in that developments in foreign exchange marcurrency might be less than the limits speci- kets. There were no open market operafied in l.B. tions in foreign currencies for the Sys- D. Any swap drawing proposed by a tem's account in the period since the foreign bank not exceeding the larger of previous meeting. (i) $200 million or (ii) 15 percent of the size The Manager also reported on develof the swap arrangement. 2. The Manager shall clear with the Com- opments in domestic financial markets mittee (or with the Subcommittee, if the and on System open market transactions Subcommittee believes that consultation in government securities and federal with the full Committee is not feasible in the agency obligations during the period time available, or with the Chairman, if the December 20, 2000, through January 30, Chairman believes that consultation with the 2001. By unanimous vote, the Commit- Subcommittee is not feasible in the time tee ratified these transactions. available): A. Any operation that would result in a The Committee then turned to a change in the System's overall open position discussion of the economic and finanin foreign currencies exceeding $1.5 billion cial outlook and the implementation of since the most recent regular meeting of the monetary policy over the intermeeting Committee. period ahead. A summary of the eco- B. Any swap drawing proposed by a nomic and financial information availforeign bank exceeding the larger of (i) $200 able at the time of the meeting and of million or (ii) 15 percent of the size of the the Committee's discussion is provided swap arrangement. 3. The Manager shall also consult with below, followed by the domestic policy the Subcommittee or the Chairman about directive that was approved by the Com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 229 mittee and issued to the Federal Reserve year-end all major market groups had Bank of New York. registered steep declines in production. The information reviewed at this Weaker factory activity in December meeting indicated that the expansion resulted in a sizable drop in the rate of of economic activity had slowed appre- capacity utilization in manufacturing ciably over the fourth quarter. Consumer to a level further below its long-run and business spending decelerated fur- average. ther, with outlays for consumer durables Against a background of slowing and business equipment particularly growth of disposable personal income weak. Housing construction remained and abrupt declines in consumer sentirelatively firm, though significantly ment, consumer spending decelerated below its brisk pace of earlier in the substantially in the fourth quarter. Puryear. The slower growth of final spend- chases of motor vehicles slumped and ing resulted in inventory overhangs in outlays for other goods increased only a number of industries, most notably a little. However, spending on services those related to the motor vehicle sector. picked up somewhat in November (lat- Manufacturing production declined est data), reflecting at least in part higher sharply as a result, and overall employ- expenditures for heating services owing ment gains moderated further. Price to unseasonably cold weather. inflation was still relatively subdued. The decline in mortgage rates since Labor demand softened further in the middle of last year had provided December, with private nonfarm pay- some support to residential building roll employment continuing to increase activity. Total housing starts increased slowly and the average workweek to slightly further in December, with decline. Nonetheless, the labor market single-family starts recording a brisk remained very tight and the unemploy- rise that might have been, in part, a ment rate held at 4 percent, its average response to the lower mortgage rates. for the year. Reduced labor demand in By contrast, multifamily starts slowed, manufacturing accounted for much of more than reversing November's runthe slowdown in nonfarm payroll gains up. Sales of new homes jumped in in the fourth quarter, with factory pay- December to a very high level, but sales rolls falling sharply further in Decem- of existing homes dropped considerably. ber, but in addition sizable cuts in net Business fixed investment contracted new hires were recorded in the help- slightly in the fourth quarter, reflecting a supply and construction industries. sizable decline in business spending on The contraction in industrial produc- equipment and software that was offset tion that began in October, largely in in part by a large increase in nonresidenthe motor vehicle sector, deepened and tial construction. Data on nominal shipbroadened in November and December. ments of nondefense capital goods in For the fourth quarter as a whole, the the fourth quarter indicated a drop in drop in production was concentrated office and computing equipment, only in manufacturing; mining activity fell a small gain in communications equipby less while utilities output surged late ment, and a decline, on net, in non-highin the year in response to unseason- tech equipment. By contrast, investment ably cold weather. Most of the initial in nonresidential structures increased weakness in manufacturing output was briskly further in October and Novemrelated directly or indirectly to the slow- ber (latest data). While spending for new ing in the motor vehicle sector, but by office buildings was rising less rapidly, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

230 88th Annual Report, 2001 outlays for other commercial structures nomic growth in Canada and the United picked up, and investment in industrial Kingdom seemed to have slowed somestructures remained robust. what in the fourth quarter. In addition, Business inventories on a book- the latest data for the major developing value basis mounted further in October countries pointed to reduced expansion and November. Despite production in many of those countries. cutbacks, stockbuilding in manufactur- By most measures, price inflation had ing remained rapid and sizable inven- remained moderate in recent months. tory overhangs had emerged in some Judging by the consumer price index industries, particularly those related to (CPI), total and core consumer prices the motor vehicle sector. As a result, rose mildly over November and Decemthe aggregate stock-sales ratio for the ber, but both accelerated somewhat on a manufacturing sector continued its year-over-year basis. In terms of the perupward drift that began early last year. sonal consumption expenditure (PCE) Sizable inventory buildups and associ- chain-type price index, however, core ated overhangs also were apparent in consumer price inflation was modest portions of the retail sector, and the in both November (latest data) and the aggregate inventory-sales ratio for the twelve months ended in November, and sector remained at the upper end of its there was essentially no change year range over the past year. At the whole- over year. At the producer level, core sale level, inventory accumulation was prices edged up over the Novembermoderate in October and November, but December period, and the rise in core the sector's inventory-sales ratio contin- prices over the year was minimal as ued to be at the top of its range for the well. With regard to labor costs, the last twelve months. employment cost index of hourly com- The U.S. trade deficit in goods and pensation for private industry workers services fell slightly in October and (ECI) decelerated noticeably in the November after having posted a new fourth quarter, with both the wage and record high in September. Nevertheless, benefit components recording smaller the average deficit for October and gains. However, growth of ECI compen- November was larger than the rate for sation picked up somewhat in 2000 from the third quarter. The value of exports 1999, probably owing in large part to declined in both months, and the aver- the upward trend in productivity growth. age value for the two-month period was Productivity improvements also showed below the third-quarter level; the weak- through to the average hourly earnings ness in exports was spread across a of production or nonsupervisory worknumber of trade categories. The value ers, which exhibited a roughly similar of imports for the first two months of acceleration. the fourth quarter was slightly above the At its meeting on December 19, 2000, third-quarter average. Economic growth the Committee adopted a directive that in foreign industrial countries mod- continued to call for maintaining condierated in the second half of last year. tions in reserve markets consistent with The pace of economic expansion in the an unchanged federal funds rate of about euro area softened somewhat further in 6V2 percent. At the same time, however, the fourth quarter, as consumer spending the members concluded that the balance remained weak. In Japan, available indi- of risks had shifted sufficiently that they cators suggested that economic activity had become weighted toward conditions had stagnated in the fourth quarter. Eco- that could generate economic weakness Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 231 in the foreseeable future. Indeed, very changed little on balance over the interrecent information had seemed to signal meeting interval in terms of an index of sudden further weakness, but it was major foreign currencies. The dollar lost largely anecdotal and most of the aggre- ground against the euro as market pargate data on spending and employment ticipants took note of the deterioration suggested continued economic expan- of near-term prospects for economic sion, albeit at a relatively slow rate. As growth in the United States relative to a result, most members believed that it those for Europe. However, that decline would be prudent to await further con- was roughly counterbalanced by a rise firmation of a noticeably weaker expan- in the dollar against the yen, reflectsion before implementing any monetary ing continuing economic stagnation in easing, particularly given the current Japan. The dollar posted a small gain high level of resource utilization and against an index of the currencies of the record over the last several years other important trading partners, largely of strong rebounds from brief lulls in reflecting expectations that some growth. If, however, incoming data were emerging economies might be adversely to reinforce the recent anecdotal indica- affected by slower growth in the United tions, the Committee would be prepared States. to respond promptly. The broad monetary aggregates accel- Open market operations during the erated sharply in December and apparintermeeting period were initially ently strengthened further in January. directed toward maintaining the federal The pickup in M2 growth evidently funds rate at the Committee's targeted reflected a flight from heightened equity level of 6V2 percent. However, informa- market volatility late last year to the tion that became available in the weeks safety and liquidity of M2 assets along after the December meeting tended to with a recent narrowing of the opporconfirm the earlier indications of weak- tunity costs of holding funds in M2 ness in spending, and at a telephone accounts. M3 grew even faster than M2, conference on January 3, 2001, the boosted in part by stepped-up issuance Committee approved a V2 percentage of large time deposits to fund a pickup point reduction in the federal funds rate, in bank credit. The expansion of domesto 6 percent, and also agreed that the tic nonfinancial debt increased in risks remained weighted toward eco- November and December (latest data), nomic weakness. The federal funds rate reflecting greater business borrowing, remained close to the Committee's tar- perhaps to finance growing inventories gets over the intermeeting period, and and smaller contractions in the amount interest rates on short-term Treasury of federal debt outstanding. securities and high-quality private debt The staff forecast prepared for this obligations declined over the period meeting suggested that, after a pause almost as much as the funds rate. The associated in part with an inventory cor- Committee's action seemed to help ease rection, the economic expansion would some concerns about the longer-term regain strength over the next two years outlook, and risk spreads on lower-grade and gradually move to a rate near the bonds fell substantially while broad staff's current estimate of the growth of indexes of U.S. stock market prices rose the economy's potential output. The on balance over the intermeeting period. period of subpar activity was expected In foreign exchange markets, the to foster an appreciable slackening of trade-weighted value of the dollar resource utilization and some modera- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

232 88th Annual Report, 2001 tion in core price inflation. The forecast economic expansion would be largely anticipated that the expansion of domes- limited to a relatively short inventory tic final demand would be held back to correction or would involve a more some extent by the decline in household extensive cyclical adjustment. net worth associated with the downturn In general, members saw favorable that had occurred in equity prices, the prospects for an appreciable recovery remaining effects of prior monetary in overall business activity as the year restraint, and the continuation of some- progressed. Members referred to indiwhat stringent credit terms and condi- cations that both residential and nontions on some types of loans by finan- residential construction activity had cial institutions. As a result, growth of remained relatively robust and to fragspending on consumer durables was mentary data and anecdotal reports expected to be appreciably below that of suggesting that consumer spending had the first half of last year and housing steadied or possibly turned up early this demand to be about unchanged from its year. Several commented that the sound recent level. Business fixed investment, condition of the banking system was notably outlays for equipment and soft- another supportive factor. Some also ware, was projected to resume relatively observed that, counter to the experience robust growth after a comparatively generally associated with the onset of brief period of adjustment of capital earlier recessions, monetary growth had stocks to more desirable levels; growth been well maintained in recent months, abroad was seen as supporting the and a few noted that long-term interest expansion of U.S. exports; and fiscal rates currently were appreciably below policy was assumed to become more their peaks of the past year. The prosexpansionary. pect that fiscal policy might begin to In the Committee's discussion of cur- move in an expansionary direction later rent and prospective economic develop- in the year was cited as another factor in ments, members commented that while the outlook for stronger economic activa slowdown in the expansion over the ity. A decline in energy prices, should second half of 2000 was not unexpected it materialize as anticipated in futures in light of the previously unsustainable markets, would have a positive effect on rate of increase in output, the speed and both business and consumer spending extent of the slowdown were much more by lowering business costs and raising pronounced than they had anticipated. disposable consumer incomes adjusted Consumer spending and business capital for energy costs. Perhaps the most critiinvestment had decelerated markedly, cal element in this outlook was the perpartly in association with a sharp decline sistence of elevated growth in structural in consumer and business confidence. labor productivity, which seemed likely This weakening, which was especially to play a vital role in supporting growth evident in durable goods producing in incomes and aggregate demand while industries, had led to large cutbacks in also helping to limit inflation pressures. manufacturing output as numerous busi- At the same time, members also ness firms attempted to pare what they saw considerable downside risks to now viewed as excessive inventories. the economic expansion. Energy prices The eventual degree and duration of remained elevated and were continuing the softening in economic conditions to depress business and household purwere difficult to predict. In particular, chasing power; the overhang of excess it was unclear whether the pause in the capital stocks in some sectors could turn Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 233 out to be sizable, depressing investment from the projected reductions in energy spending for some time; consumer prices. confidence could worsen appreciably The marked deceleration in final sales more in the face of weaker expansion experienced late last year was concenof incomes and higher job layoffs; and trated in consumer spending for motor investor concerns about earnings could vehicles and other durable goods and increase further, sparking lower equity in business expenditures for equipment prices and tighter standards and terms and software. In the household sector, on credit. rapidly declining consumer confidence, Except for prices of energy and medi- apparently associated in important meacal services, the currently available sure with increasing worker layoffs and information indicated relatively subdued growing concerns about future job prosrates of inflation, and recent surveys pects, had contributed to generally dispointed to little change in inflation appointing retail sales during the holiexpectations. Looking ahead, members day season. There was some evidence anticipated that somewhat reduced pres- that sales had stabilized and possibly sures in labor and product markets risen slightly in January, though a part would foster some softening in con- of the improvement could reflect steep sumer price inflation over coming price discounts for the purpose of reducquarters, a development that would be ing inventories. Other negative factors abetted should prices of oil and natural cited by the members included the gas ease during the year in line with adverse wealth effects of the decrease in current market expectations. stock market valuations, relatively high In preparation for a semi-annual consumer debt service burdens, and posreport to Congress, the members of the sible retrenchment by consumers after Board of Governors and the presidents an extended period of large increases of the Federal Reserve Banks provided in purchases and related buildups of individual projections of the growth in consumer durables. Nonetheless, in the nominal and real GDP, the rate of unem- absence of possible developments leadployment, and the rate of inflation ing to further deterioration in consumer for the year 2001. The forecasts were sentiment, the members saw reasonable concentrated in ranges of 4 to 5 per- prospects for strengthening consumer cent for the growth in nominal GDP spending this year even assuming some and 2 to 2lA percent for the expansion in decline in such expenditures relative to real GDP, implying some strengthening income. An important factor in this outof economic activity as the year pro- look was the expectation of some reducgressed. With growth in business activ- tion in energy prices, which would boost ity falling short of the expansion in the disposable incomes available for noneconomy's potential, the rate of unem- energy expenditures and likely provide ployment was expected to rise some- a fillip to consumer sentiment in the what to an average of about AVi per- process. Moreover, with the relatively cent by the fourth quarter of the year. high rate of growth in structural produc- Forecasts of the rate of inflation, as tivity showing little or no signs of wanmeasured by the chain-type price index ing, the longer-run prospects for housefor personal consumption expenditures, hold incomes remained positive. On were centered in a range of VA to balance, the various factors weighing on 2lA percent, reflecting declines from the the outlook for consumer spending later inflation rate last year largely stemming this year seemed favorable, though sub- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

234 88th Annual Report, 2001 stantial downside risks clearly would fairly high level was seen as a reasonpersist for some interim period of uncer- able expectation. tain duration. The outlook for inventory investment The depressing effects of lagging final was more uncertain. The drop in final sales on business investment spending, sales during late 2000 evidently was notably for equipment and software, much faster than generally expected, were reinforced by deterioration in the and inventories rose considerably over financial balance sheets of some busi- the fourth quarter as a whole despite ness firms, tighter supply conditions sharp downward adjustments in manuin segments of the credit markets, and facturing output. In keeping with just-ina buildup in excess capacity that had time inventory policies, which had been eroded profitability. In this regard, mem- furthered in recent years by advances in bers referred to earlier unsustainable technology that allowed faster and more rates of investment by many high-tech complete readings on sales and adjustfirms that were now obliged to retrench ments in orders, efforts to reduce invendespite still high rates of growth in the tories were continuing in recent weeks demand for their products and services. and net inventory liquidation was antici- With regard to the nonresidential con- pated in the current quarter. Looking struction sector, members provided further ahead, a number of members anecdotal reports of continued high commented that they expected a period levels of activity in several parts of the of inventory correction that would be country and little evidence of the sub- relatively sharp but short by historical stantial overbuilding that had character- standards. Improvements in inventory ized the construction industry in earlier management and related indications that periods of developing economic weak- inventory overhangs were small comness. On balance, while the business pared to earlier historical experience investment outlook seemed vulnerable were factors in this assessment. At the to somewhat greater than projected same time, members recognized that the weakness in the short run, the members inventory correction had just begun and were persuaded that, against the back- its duration would depend importantly ground of large continuing gains in on the ongoing strength of final sales. In structural productivity and cost savings this regard, developments bearing on from further investment in equipment business and consumer confidence and and software, business firms were likely willingness to spend would play a cruto accelerate their spending for new cial, though at this point uncertain, role. capital after a period of adjustment. Members expressed some divergence Concerning the outlook for housing of views regarding the outlook for foractivity, recent statistical and anecdotal eign economic activity and the implicareports indicated that housing sales and tions for the domestic economy. Some construction were being well maintained emphasized that most of the nation's and indeed were a bright spot in several important trading partners had growing regions. Reduced mortgage interest rates economies that were likely to provide appeared to be largely offsetting the support for expanding U.S. exports. marked decline in consumer confidence. Other members were concerned about Accordingly, and contrary to the experi- indications of growing weakness in a ence in earlier periods of softening eco- number of foreign economies that might nomic activity, the stabilization of hous- increasingly inhibit U.S. exports and add ing activity at a pace near its current to competitive pressures on U.S. produc- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 235 ers in domestic markets. The large cur- represent a relatively aggressive policy rent account deficit was seen as a factor adjustment in a short period of time, but pointing to potential depreciation of the the members agreed on its desirability dollar over time, with adverse repercus- in light of the rapid weakening in the sions on domestic inflation albeit favor- economic expansion in recent months able effects on exports. and associated deterioration in business In their comments about the outlook and consumer confidence. The extent for inflation, members noted that current and duration of the current economic indicators continued on the whole to correction remained uncertain, but the point to subdued price increases, with stimulus provided by the Committee's lagging demand and strong competitive policy easing actions would help guard pressures in many markets severely against cumulative weakness in ecolimiting the ability of business firms to nomic activity and would support the raise their prices. Labor markets were positive factors that seemed likely to described as still tight across the nation, promote recovery later in the year. Sevbut reports of layoffs in specific indus- eral members observed that the evolving tries were increasing and numerous nature of the domestic economy, includbusiness contacts indicated that open- ing the ongoing improvements in invenings were now much easier to fill in tory management and the increase in many job markets. There were some managerial flexibility to alter the level related indications that wage pressures and mix of capital equipment, associmight be easing. Against the back- ated in part with the greater availability ground of a sluggish economy in the of information, appeared to have fosnear term and forecasts of only mod- tered relatively prompt adjustments by erate economic growth, the members businesses to changing economic condianticipated that inflation would remain tions. As a consequence, monetary polcontained over the forecast horizon. A icy reactions to shifts in economic trends key factor in this assessment continued needed in this view to be undertaken to be their outlook for rapid further gains more aggressively and completed sooner in structural productivity that would than in the past. In current circumhelp to hold down increases in unit labor stances, members saw little inflation risk costs. Other factors included the pros- in such a "front-loaded" easing policy, pect of some decline in energy prices given the reduced pressures on resources and the persistence of generally benign stemming from the sluggish perforinflation expectations. On balance, with mance of the economy and relatively pressures in labor and product markets subdued expectations of inflation. ebbing, the outlook for inflation was a All the members agreed that the source of diminished though persisting balance of risks sentence in the press concern. statement to be released shortly after In the Committee's discussion of this meeting should continue to indicate policy for the intermeeting period ahead, that the risks would remain tilted toward all the members endorsed a proposal economic weakness even after today's calling for a further easing in reserve easing action. The members saw subconditions consistent with a 50 basis stantial underlying strength and resilpoint decrease in the federal funds rate ience in the economy and they remained to a level of 5lA percent. Such a policy optimistic about its prospects beyond move in conjunction with the 50 basis the near term in light of the monetary point reduction in early January would policy stimulus that was being imple- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

236 88th Annual Report, 2001 mented and the persistence of rapid ket Committee voted unanimously to advances in productivity. In this regard, select Dino Kos as Manager for Domessome members commented that the tic and Foreign Operations of the Sysupside risks could not be totally dis- tem Open Market Account to serve missed. But with the adjustments to in that capacity until the first regularly the stock of capital, consumer durable scheduled meeting after December 31, goods, and inventories to more sustain- 2001, subject to the understanding that able levels likely only partly completed in the event of the discontinuance of his and with investors in financial markets official connection with the Federal remaining skittish, the risks that growth Reserve Bank of New York he would would persist below that of the econo- cease to have any official connection my' s productivity-enhanced potential with the Federal Open Market Commitcontinued to dominate the outlook. tee. It also was understood that this At the conclusion of this discussion, selection needed to be satisfactory to the Committee voted to authorize and the Federal Reserve Bank of New York. direct the Federal Reserve Bank of New Advice subsequently was received that York, until it was instructed otherwise, the selection of Mr. Kos as Manager to execute transactions in the System was satisfactory to the board of directors Account in accordance with the follow- of that Bank. ing domestic policy directive: It was agreed that the next meeting of the Committee would be held on Tues- The Federal Open Market Committee day, March 20, 2001. seeks monetary and financial conditions that The meeting adjourned at 10:50 a.m. will foster price stability and promote suson January 31,2001. tainable growth in output. To further its longrun objectives, the Committee in the immediate future seeks conditions in reserve Donald L. Kohn markets consistent with reducing the fed- Secretary eral funds rate to an average of around 5 ^percent. Meeting Held on The vote encompassed approval of March 20, 2001 the sentence below for inclusion in the press statement to be released shortly A meeting of the Federal Open Market after the meeting: Committee was held in the offices of the Board of Governors of the Federal Against the background of its long-run Reserve System in Washington, D.C., goals of price stability and sustainable economic growth and of the information cur- beginning at 9:00 a.m. on Tuesday, rently available, the Committee believes that March 20, 2001. the risks are weighted mainly toward conditions that may generate economic weakness Present: in the foreseeable future. Mr. Greenspan, Chairman Mr. McDonough, Vice Chairman Votes for this action: Messrs. Greenspan, Mr. Ferguson McDonough, Ferguson, Gramlich, Hoe- Mr. Gramlich nig, Kelley, Meyer, Ms. Minehan, Messrs. Mr. Hoenig Moskow and Poole. Votes against this Mr. Kelley action: None. Mr. Meyer Ms. Minehan By notation vote completed on Mr. Moskow March 15, 2001, the Federal Open Mar- Mr. Poole Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 237 Messrs. Jordan, McTeer, Santomero, Messrs. Eisenbeis and Goodfriend, Stern, and Stewart, Alternate Mses. Krieger and Mester, and Members of the Federal Open Mr. Rolnick, Senior Vice Market Committee Presidents, Federal Reserve Banks of Atlanta, Richmond, New York, Messrs. Broaddus, Guynn, and Parry, Philadelphia, and Minneapolis Presidents of the Federal Reserve respectively Banks of Richmond, Atlanta, and San Francisco respectively Ms. Orrenius, Economist, Federal Reserve Bank of Dallas Mr. Kohn, Secretary and Economist Mr. Bernard, Deputy Secretary Mr. Trehan, Research Advisor, Federal Mr. Gillum, Assistant Secretary Reserve Bank of San Francisco Ms. Fox, Assistant Secretary Mr. Baxter, Deputy General Counsel Mr. Haubrich, Consultant, Federal Ms. Johnson, Economist Reserve Bank of Cleveland Mr. Stockton, Economist By unanimous vote, the minutes of Ms. Cumming, Messrs. Fuhrer, Hakkio, the meeting of the Federal Open Market Howard, Hunter, Lindsey, Rasche, Reinhart, Slifman, and Wilcox, Committee held on January 30-31, Associate Economists 2001, were approved. By unanimous vote, David Wilcox Mr. Kos, Manager, System Open was elected to serve as an Associate Market Account Economist for the period until the first regularly scheduled meeting of the Ms. Smith and Mr. Winn, Assistants Committee after December 31, 2001. to the Board, Office of Board Members, Board of Governors The Manager of the System Open Market Account reported on develop- Mr. Ettin, Deputy Director, Division ments in foreign exchange markets. of Research and Statistics, There had been no operations in foreign Board of Governors currencies for the System's account since the previous meeting. Mr. Simpson, Senior Adviser, Division The Manager also reported on of Research and Statistics, Board of Governors developments in domestic financial markets and on System open market Messrs. Madigan, Oliner, and transactions in U.S. government securi- Struckmeyer, Associate Directors, ties and federal agency obligations Divisions of Monetary Affairs, during the period January 31, 2001, Research and Statistics, and through March 19, 2001. By unanimous Research and Statistics, Board of Governors vote, the Committee ratified these transactions. Mr. Whitesell, Assistant Director, The Committee then turned to a Division of Monetary Affairs, discussion of the economic and finan- Board of Governors cial outlook and the implementation of monetary policy over the intermeeting Ms. Low, Open Market Secretariat period ahead. A summary of the eco- Assistant, Division of Monetary nomic and financial information avail- Affairs, Board of Governors able at the time of the meeting and of Mr. Barron, First Vice President, the Committee's discussion is provided Federal Reserve Bank of Atlanta below, followed by the domestic policy Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

238 88th Annual Report, 2001 directive that was approved by the Com- further in the motor vehicle sector, and mittee and issued to the Federal Reserve production continued to decelerate in Bank of New York. high-tech industries. The rate of capac- The information reviewed at this ity utilization in manufacturing dropped meeting suggested that economic noticeably in January and February to a activity continued to expand very slowly level further below its long-run average. in the first quarter. Growth of final Against a background of slowing spending apparently picked up slightly, income gains and a sizable pullback in with consumer expenditures record- consumer sentiment since last autumn, ing another moderate gain, business consumer spending evidently grew only purchases of equipment and software moderately on balance in January and increasing sluggishly after a fourth- February. Purchases of motor vehicles quarter decline, and homebuilding picked up in response to increased remaining relatively firm. However, marketing incentives put in place by inventory overhangs were still apparent Chrysler and General Motors, and retail in some industries, and manufacturing sales of items other than motor vehicles production was cut sharply further. climbed moderately. Spending on ser- Overall employment gains were rela- vices was held down in January (latest tively well maintained, and labor data) by reduced expenditures for heatmarkets were still tight though show- ing services as winter temperatures ing signs of softening. Price inflation returned to more seasonal levels followhad picked up a little but, abstracting ing unusually cold weather late last year; from energy, had remained relatively excluding heating, however, spending subdued. on other services rose slowly. After a sluggish fourth quarter, pri- The decline in mortgage rates that vate nonfarm payroll employment rose began around the middle of last year at a slightly higher rate on average continued to provide support to resiin January and February, though still dential building activity. Total housing considerably below the pace of the first starts rose somewhat further in January three quarters of 2000. Manufacturing and February, reflecting net increases and related industries, notably help- in both single-family and, especially, supply and wholesale trade, experienced multifamily units. Sales of new homes further large declines in payrolls in dropped sharply in January (latest data), the January-February period. However, after having surged in December, but hiring elsewhere held up relatively remained quite robust by historical well, especially in construction, which standards. Sales of existing homes recorded a surge in employment in Janu- rebounded in January after having fallen ary. While the labor market remained considerably in December and were up tight on balance, the unemployment rate slightly on balance over the two months. increased to 4.2 percent in February, and The limited available information other indicators such as initial claims for suggested that business fixed investment unemployment insurance suggested that was firming early this year after a pressures in labor markets had begun to decline in the fourth quarter of last year. abate. Nominal shipments of nondefense capi- The contraction in industrial produc- tal goods other than aircraft and parts tion that began in October accelerated changed little on balance in December and broadened in the first two months and January, while prices of high-tech of the year. In manufacturing, output fell equipment continued to fall. Moreover, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 239 orders for nondefense capital goods rate on average in the fourth quarter. turned up briskly in January after a Expansion in the euro area picked sharp fourth-quarter drop. Nonresiden- up, while growth in Canada and the tial construction activity continued its United Kingdom slowed significantly. robust rise early in the year. Strength in The Japanese economy rebounded in building activity was widespread across the fourth quarter but was little changed the sector, most notably in new office on balance over the second half of the construction. year, and recent indicators suggested a Business inventories on a book-value sharply weaker performance in the early basis increased in January at about part of this year. In addition, growth in the rapid fourth-quarter pace; inven- the major developing countries slowed tory positions appeared to be especially markedly in the fourth quarter, with the large for construction materials, metals, slowdown in most of those countries electrical equipment, paper, chemicals, reflecting weaker demand for their and textiles. In the manufacturing sec- exports. tor, overall stocks jumped in January Price inflation had picked up a bit while shipments fell, and the aggregate recently. The consumer price index inventory-shipments ratio rose to its (CPI) jumped in January (latest data), highest level in two years. In the whole- reflecting a surge in energy prices; sale trade sector, aggregate stocks moreover, the index increased considfell again in January and the sector's erably more during the twelve months inventory-sales ratio edged down to the ending in January than it did during the middle of its very narrow range for the previous twelve months. The core compast year. Retail stocks continued to ponent of the CPI also accelerated in climb in January, but sales rose by more; January and on a year-over-year basis, the sector's inventory-sales ratio also but by lesser amounts than did the total edged lower, but it remained near the index. The increase in the core personal top of its range for the past twelve consumption expenditure (PCE) chainmonths. type price index in January matched that The U.S. trade deficit in goods and of the core CPI; on a year-over-year services changed little in December but basis, however, the pickup in core PCE posted a new record high for the fourth inflation was a little smaller than that for quarter. The value of exports dropped the core CPI. At the producer level, core substantially in that quarter, with notable finished goods retraced in February only declines occurring in agricultural prod- part of the sizable step-up in prices ucts, aircraft, automotive products, com- recorded in January, and core producer puters and semiconductors, consumer price inflation was up somewhat on a goods, and telecommunications equip- year-over-year basis. With regard to ment. The value of imports remained labor costs, recent data also pointed to at the high level recorded in the third some acceleration. Compensation per quarter. Lower imports of automotive hour in the nonfarm business sector products, chemicals, computers and advanced appreciably more rapidly in semiconductors, and steel were offset the fourth quarter of 2000 and for the by higher imports of consumer goods year as a whole. That trend also showed and telecommunications equipment and through to the average hourly earnings smaller increases in other categories of of production or nonsupervisory worktrade. Economic growth in the foreign ers through February, which exhibited a industrial countries was at a moderate roughly similar acceleration. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

240 88th Annual Report, 2001 At its meeting on January 30-31, somewhat over the intermeeting interval 2001, the Committee adopted a directive in terms of many of the major foreign that called for maintaining conditions currencies. The dollar strengthened most in reserve markets consistent with a against the currencies of countries that decrease of 50 basis points in the were seen to have the greatest potential intended level of the federal funds rate, for economic weakening, notably Japan. to about 5V2 percent. This move, in con- The dollar also posted a small gain junction with the easing on January 3, against an index of the currencies of was intended to help guard against other important trading partners. cumulative weakness in economic activ- The broad monetary aggregates conity and to provide some support to a tinued to grow rapidly in February, rebound in growth later in the year. In though at slightly lower rates than in the existing circumstances, the members January. The strength in M2 was conagreed that the balance of risks remained centrated in its liquid components, weighted toward conditions that could apparently in response to the further nargenerate economic weakness in the rowing of opportunity costs, the yield foreseeable future. Though rapid advantage of money funds relative to advances in underlying productivity longer-term investments, and the appeal were expected to continue, the adjust- of a safe haven from volatile equity ments to stocks of capital, consumer markets. M3 grew somewhat less rapgoods, and inventories to more sus- idly than M2; a pullback in the issuance tainable levels were only partly com- of bank-managed liabilities, particularly pleted, and financial markets remained large time deposits, was associated with unsettled. slower expansion of bank credit. Growth Open market operations were directed of domestic nonfinancial debt decelerthroughout the intermeeting period ated noticeably in January (latest data), toward maintaining the federal funds reflecting reduced expansion of debt in rate at the Committee's reduced target the nonfederal sectors coupled with a level of 5x/2 percent, and the funds rate larger contraction in the amount of fedstayed close to that target. However, eral debt outstanding. incoming economic data, a steady flow The staff forecast prepared for this of disappointing corporate earnings meeting suggested that, after a period reports, related sharp declines in stock of slow growth associated in part with prices, and a notable drop in consumer an inventory correction, the economic confidence led market participants to expansion would gradually regain conclude that more monetary easing strength over the next two years and would be required. Yields on Treasury move toward a rate near the staff's cursecurities, both short- and long-term, rent estimate of the growth of the economoved appreciably lower. However, my's potential output. The period of rates on high-yield private debt obliga- subpar expansion was expected to foster tions fell only a little, and banks further an appreciable easing of pressures on tightened standards and terms on busi- resources and some moderation in core ness loans, given the weakening outlook price inflation. The forecast anticipated for profits. Broad indexes of U.S. stock that the expansion of domestic final market prices moved sharply lower, with demand would be held back to an extent the tech-heavy Nasdaq experiencing an by the decline in household net worth especially large drop. Nonetheless, the associated with the downturn that had trade-weighted value of the dollar rose occurred in equity prices, the lingering Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 241 effects of last year's relatively high growth, stable low inflation, generally interest rates, and the continuation of sound financial institutions, lower interrelatively stringent terms and conditions est rates, and relatively robust expansion on some types of loans by financial in many measures of money. However, institutions. As a result, growth of the members saw clear downside risks spending on consumer durables was in the outlook for consumer and investexpected to be appreciably below the ment spending in the context of the rapid pace in the first half of last year, marked decline that had occurred in and housing demand would increase equity prices and consumer confidence, only a little from its recent level. Busi- and in expected business profitability, ness fixed investment, notably outlays and they were concerned that weaker for equipment and software, was pro- exports might also hold down the expanjected to resume relatively robust sion of economic activity. With regard growth after a period of adjustment of to the outlook for inflation, some recent capital stocks to more desirable levels; measures of increases in core prices had growth abroad was seen as supporting fluctuated on the high side of earlier the expansion of U.S. exports; and fiscal expectations, but apart from energy policy was assumed to become more prices and medical costs, inflation was expansionary. still relatively quiescent. With the In the Committee's discussion of cur- growth in output likely to remain below rent and prospective economic develop- the expansion of the economy's potenments, members commented that the tial for a while, members anticipated recent statistical and anecdotal informa- that inflation would remain subdued. tion had been mixed, but they viewed Mirroring the statistics for the nation evolving business conditions as consis- as a whole, business conditions in differtent on the whole with a continued soft- ent parts of the country displayed mixed ness in economic activity. Members industry patterns, but members reported noted that consumer spending had that overall business activity currently strengthened early in the year and hous- appeared to be growing at a sluggish ing activity had remained at a relatively pace in most regions, and business conhigh level. These positive developments tacts were exhibiting a heightened sense needed to be weighed against an appre- of caution, or even concern, in some ciable weakening in business investment industries. In their review of developspending and the near-term restraining ments in key sectors of the economy, effects of a drawdown in inventories. members indicated that they saw favor- Looking ahead, while sales and pro- able prospects for continued moderduction data suggested that excess ate growth in consumer expenditures, inventories were being worked off, the though considerable uncertainty suradjustment did not appear to have rounded this outlook. Downside risks been completed. Beyond the inventory cited by the members included the correction, the members continued to substantial declines that had already anticipate an acceleration of the expan- occurred in measures of consumer consion over time, though likely on a more fidence and equity wealth, and the posdelayed basis and at a more gradual sibility that consumer sentiment might pace than they had forecast earlier. They be undermined even further by continnoted a number of favorable underly- ued volatility and additional declines ing factors that would tend to support in the stock market and by rising cona rebound, including solid productivity cerns about job losses amid persistent Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

242 88th Annual Report, 2001 announcements of layoffs. Members was being postponed, if not canceled. also referred to the retarding effects on The capital stock had grown at an unsusconsumer expenditures of elevated lev- tainable pace for a time, so some downels of household debt and high energy shifting in investment was inevitable. costs. Against this background, consum- Moreover, those earlier very substaners might well endeavor to boost their tial investment outlays seemed to have savings, and even a fairly small increase created excess capacity in a number of in what currently was a quite low saving industries, and how large an adjustment rate would have large damping effects in spending for business equipment on aggregate demand that could weaken, might now be under way was still if not abort, the expansion. To date, unclear, especially with regard to highhowever, overall consumer spending tech industries. At the same time, the had remained relatively strong and information available for the first seemingly at odds with measures of quarter indicated considerable strength consumer confidence and reduced in nonresidential construction activity, equity wealth. How this divergence including large outlays on public-sector might eventually be resolved was a sig- infrastructure projects in some areas. nificant source of uncertainty and down- On balance, business spending for plant side risk. On balance, while there were and equipment was likely to pick up reasons to be concerned about the out- only gradually this year. Over the longer look for consumer spending, members term, however, a return to more robust believed that recent spending trends business investment seemed likely, and the outlook for further growth in and indeed business earnings forecasts employment and incomes pointed to beyond the nearer term had not declined continued expansion in this key sector very much, reflecting continuing expecof the economy, though likely at a rela- tations of substantial profit opportunitively sluggish pace. ties related to persisting strong gains in Another major source of downside productivity. risk to the expansion was business fixed Housing activity was generally holdinvestment. Spending for equipment and ing up well across the country, as the software declined in the fourth quarter, effects of appreciably reduced mortgage and the available statistical and anec- interest rates apparently compensated dotal reports pointed to weakness during for the negative effects of declining the first half of this year, largely reflect- financial wealth on the demand for ing developments in high-tech indus- housing. While housing construction tries. Substantial downward adjustments was generally described as elevated, to expected near-term business earnings some members referred to overbuilding had persisted, suggesting that firms saw or weakness in some local housing marinvestment as much less profitable than kets. It was noted that homebuilders they had before and that cash flows were generally optimistic about the would be constrained. Many businesses prospects for the year ahead, given their also were inhibited in their investment current backlogs and expectations of activities by less accommodative finan- further growth in employment and cial conditions associated with weaker incomes. equity markets and tighter credit terms The ongoing adjustments in business and conditions imposed by banking inventories had played a significant institutions. As a consequence, a sub- role in curbing the growth of economic stantial volume of planned investment activity in recent months, but such Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 243 adjustments seemed likely gradually to reflecting the combination of diminished become a more neutral factor over the growth in overall demand and strong balance of this year. In the motor vehi- competitive pressures in most markets. cle industry, inventory liquidation had With regard to the outlook for wages been especially pronounced and the and prices, members commented that process now seemed largely completed. the prospects for an extended period of However, the inventory-correction pro- growth in demand at a pace below the cess in high-tech industries apparently economy's potential should ease preswas not as far along. In the absence sures on labor and other resources and of renewed weakness in overall final help to contain inflation. demand, which could not be ruled out In the Committee's discussion of polgiven current consumer and business icy for the intermeeting period ahead, confidence, production would need to most of the members preferred and all pick up at some point to accommodate could support a further easing of reserve ongoing final demand. Some members conditions consistent with a 50 basis observed that the adjustment in inven- point reduction in the federal funds rate, tories might require more time than to 5 percent. The members agreed that they had anticipated earlier. In any a strengthening in the economic expanevent, completion of the process clearly sion over coming quarters was a reasonwould foster an upturn in manufacturing able expectation, but absent further easactivity. ing in monetary policy that pickup was Members commented on the down- unlikely to bring growth to an acceptside risks to U.S. exports and the U.S. able pace in the foreseeable future. Busiexpansion from what appeared to be ness investment would be held back softening economic conditions in a num- by lower earnings expectations and a ber of important foreign economies. In capital overhang of unknown dimensome countries, the risks were exacer- sions; consumption was subject to bated by the apparent inability or unwill- downside risks from previous decreases ingness of government officials to in equity wealth and declining confiaddress underlying structural problems dence; and the strong dollar and weaker in their economies and financial sys- foreign growth would constrain exports. tems. Members noted anecdotal reports Inflation was likely to be damped by of weakening business conditions in a ebbing pressures on labor and product number of Asian and South American markets. While many of the members nations. The potential impact on exports generally believed that additional policy of less vigor in the global economy easing might well prove to be necessary would be augmented, of course, by at some time, the easing favored by most the strength of the dollar in foreign members incorporated what they viewed exchange markets. as an adequate degree of stimulus under Although labor markets in general current economic conditions and repreremained tight throughout the nation, sented an appropriately calibrated step anecdotal reports of less scarce labor given the uncertainties in the economic resources were becoming more fre- outlook. It was noted in this regard that quent in some areas or occupations. in combination with the two easing Some price increases had been noted; actions earlier this year, the Committee however, apart from the energy and would have implemented in a relatively health care sectors, price inflation had short period a considerable amount remained relatively subdued, evidently of monetary easing whose economic Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

244 88th Annual Report, 2001 effects would be felt over time. How- the possible need for a further policy ever, some commented that the amount adjustment. of financial stimulus was much smaller At the conclusion of this discussion, than might otherwise be expected from the Committee voted to authorize and policy easing of this cumulative amount direct the Federal Reserve Bank of New because it had been accompanied by York, until it was instructed otherwise, further declines in stock market prices, to execute transactions in the System more stringent financing terms for many Account in accordance with the followbusiness borrowers, and a stronger dol- ing domestic policy directive: lar, all of which would be holding down domestic spending and production. The Federal Open Market Committee Indeed, financial markets had come to seeks monetary and financial conditions that place some odds on a larger move of will foster price stability and promote sustainable growth in output. To further its long- 75 basis points in recent days, imporrun objectives, the Committee in the immetantly reflecting the possibility of a diate future seeks conditions in reserve presumed policy response to the siz- markets consistent with reducing the federal able declines in equity prices that had funds rate to an average of around 5 percent. occurred as earnings prospects proved disappointing. Most members agreed, The vote encompassed approval of however, that in the context of their the sentence below for inclusion in the focus on the economy, smaller, pos- press statement to be released shortly sibly more frequent, policy adjustments after the meeting: were appropriate to afford them the opportunity to recalibrate policy in Against the background of its long-run rapidly changing and highly uncertain goals of price stability and sustainable ecocircumstances. nomic growth and of the information currently available, the Committee believes that A few members expressed a prefer- the risks are weighted mainly toward condience for a 75 basis point reduction in the tions that may generate economic weakness federal funds rate. In their view, a more in the foreseeable future. forceful action was justified by current Votes for this action: Messrs. Greenspan, and prospective economic conditions. McDonough, Ferguson, Gramlich, Hoe- The members agreed that even with a nig, Kelley, Meyer, Ms. Minehan, Messrs. further 50 basis point reduction in the Moskow and Poole. Votes against this federal funds rate, the risks to the econ- action: None. omy would remain decidedly to the downside. This conclusion would be The Chairman called for a recess after reflected in the press statement to be this vote and convened a meeting of the released after today's meeting. The Board of Governors to consider reducstatement also would emphasize the tions of one-half percentage point in the need for close monitoring of rapidly discount rate that had been proposed by evolving economic conditions. The all the Federal Reserve Banks. After the members anticipated that in the rela- recess, the Chairman informed the Comtively long interval before the next reg- mittee that the pending reductions had ularly scheduled meeting on May 15, been approved. 2001, economic developments might It was agreed that the next meeting suggest the desirability of a Committee of the Committee would be held on conference call to assess business con- Tuesday, May 15, 2001. The meeting ditions across the nation and to consider adjourned at 1:15 p.m. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 245 Telephone Conferences the Committee's May meeting, an easing move was called for at this time. On April 11, 2001, the Committee Although a few preferred to wait until reviewed economic and financial devel- the next scheduled meeting, all the opments since its last meeting and dis- members supported or could accept a cussed the possible need for some fur- proposal for an easing of reserve conther easing of monetary policy. The data ditions consistent with a reduction of and anecdotal information were mixed: 50 basis points in the federal funds rate They did not indicate that the economy to a level of 4Vi percent. The Committee had been weakening further, but they voted to authorize and direct the Federal raised questions about the potential Reserve Bank of New York, until it was strength of a rebound in growth over instructed otherwise, to execute transaccoming quarters. In particular, height- tions in the System Account in accorened business concerns about future dance with the following domestic polsales and further downward revisions to icy directive: expected earnings threatened to restrain capital spending for some time. In the The Federal Open Market Committee circumstances, the members could see seeks monetary and financial conditions that the need for a further easing of policy will foster price stability and promote susat some point, though some had a strong tainable growth in output. To further its longpreference for taking such actions at run objectives, the Committee in the immediate future seeks conditions in reserve regularly scheduled meetings. They all markets consistent with reducing the fedagreed that an easing on this date would eral funds rate to an average of around not be advisable, inasmuch as the atten- 4V2 percent. dant surprise to most outside observers risked unpredictable reactions in finan- The vote encompassed approval of cial markets that had been especially the sentence below for inclusion in the volatile in recent days, and additional press statement to be released shortly important data would become available after the meeting: over the near term. A week later, on April 18, 2001, the Against the background of its long-run Committee held a telephone conference goals of price stability and sustainable ecomeeting for the purpose of considering nomic growth and of the information cura policy easing action. The members rently available, the Committee believes that the risks are weighted mainly toward condinoted that the statistical and anecdotal tions that may generate economic weakness information received since the last conin the foreseeable future. ference call had supported their view that an easing of policy would be appro- Votes for this action: Messrs. Greenspan, priate. In addition to the continuing McDonough, Ferguson, Gramlich, Hoeconcerns about business plans for capi- nig, Kelley, Meyer, Ms. Minehan, Messrs. tal investment, consumer spending had Moskow and Poole. Votes against this leveled out and confidence had fallen action: None. further. In these circumstances, lower interest rates were likely to be necessary Chairman Greenspan indicated that to foster more satisfactory economic shortly after this meeting the Board expansion. With financial markets more of Governors would consider pending settled, and with nearly a month until requests of eight Federal Reserve Banks Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

246 88th Annual Report, 2001 to reduce the discount rate by 50 basis Mr. Ettin, Deputy Director, Division points. of Research and Statistics, Board of Governors Donald L. Kohn Mr. Simpson, Senior Adviser, Division Secretary of Research and Statistics, Board of Governors Messrs. Connors,5 Madigan, Oliner, Meeting Held on and Struckmeyer, Associate May 15, 2001 Directors, Divisions of International Finance, Monetary A meeting of the Federal Open Market Affairs, Research and Statistics, and Research and Statistics, Committee was held in the offices of Board of Governors the Board of Governors of the Federal Reserve System in Washington, D.C., Mr. Whitesell, Assistant Director, on Tuesday, May 15, 2001, starting at Division of Monetary Affairs, 9:00 a.m. Board of Governors Present: Mr. Skidmore, Special Assistant to the Mr. Greenspan, Chairman Board, Office of Board Members, Mr. McDonough, Vice Chairman Board of Governors Mr. Ferguson Mr. Gramlich Mr. Kumasaka, Assistant Economist, Mr. Hoenig Division of Monetary Affairs, Mr. Kelley Board of Governors Mr. Meyer Ms. Minehan Ms. Low, Open Market Secretariat Mr. Moskow Assistant, Division of Monetary Mr. Poole Affairs, Board of Governors Messrs. Jordan, McTeer, Santomero, Mr. Connolly, First Vice President, and Stern, Alternate Members Federal Reserve Bank of Boston of the Federal Open Market Committee Messrs. Beebe, Eisenbeis, and Goodfriend, Mses. Mester and Messrs. Broaddus, Guynn, and Parry, Perlmutter, Messrs. Rosenblum Presidents of the Federal Reserve and Sniderman, Senior Vice Banks of Richmond, Atlanta, and Presidents, Federal Reserve Banks San Francisco respectively of San Francisco, Atlanta, Richmond, Philadelphia, Mr. Kohn, Secretary and Economist New York, Dallas, and Cleveland Mr. Gillum, Assistant Secretary respectively Ms. Fox, Assistant Secretary Mr. Mattingly, General Counsel Mr. Sullivan, Vice President, Federal Ms. Johnson, Economist Reserve Bank of Chicago Mr. Stockton, Economist Mr. Weber, Senior Research Officer, Ms. Cumming, Messrs. Fuhrer, Hakkio, Federal Reserve Bank of Howard, Lindsey, Rasche, Minneapolis Reinhart, Slifman, and Wilcox, Associate Economists Mr. Kos, Manager, System Open 5. Attended portion of meeting relating to staff Market Account briefings. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 247 By unanimous vote, the minutes of mittee and issued to the Federal Reserve the meeting of the Federal Open Market Bank of New York. Committee held on March 20, 2001, The information reviewed at this were approved. meeting suggested that the economic The Manager of the System Open expansion remained very sluggish. Market Account reported on recent Household spending, especially for developments in foreign exchange mar- housing and motor vehicles, had held kets. There were no open market opera- up relatively well, but business investtions in foreign currencies for the Sys- ment was quite weak and appeared to tem's account in the period since the be decreasing further. Persistent invenprevious meeting. tory overhangs in a number of sectors The Manager also reported on devel- had led to additional substantial cuts in opments in domestic financial markets manufacturing production. Reflecting and on System open market transactions in part the downtrend in manufacturin government securities and federal ing output, labor demand had weakened agency obligations during the period considerably and unemployment had March 20, 2001, through May 14, 2001. risen. Price inflation had picked up a By unanimous vote, the Committee rati- little but, abstracting from energy, had fied these transactions. remained relatively subdued. By unanimous vote, the Committee Private nonfarm payroll employment approved the extension for one year fell sharply in April after a small drop beginning in December 2001 of the in March. Manufacturing, construction, System's reciprocal currency ("swap") and the service sector recorded large arrangements with the Bank of Canada payroll declines in April, and gains elseand the Bank of Mexico. The arrange- where were small. The unemployment ment with the Bank of Canada is in the rate increased further, to 4.5 percent in amount of $2 billion equivalent and that April, and initial claims for unemploywith the Bank of Mexico in the amount ment insurance averaged over the four of $3 billion equivalent. Both arrange- weeks ended April 28 were at their highments are associated with the Federal est level since 1993. Reserve's participation in the North Industrial production declined appre- American Framework Agreement. The ciably further in April. Manufacturing early vote to renew the System's partici- output registered a seventh consecutive pation in the swap arrangements matur- monthly drop, while a robust boost to ing in December relates to the provision mining activity associated with strong that each party must provide six months gains in crude oil and gas production prior notice of an intention to terminate was offset by a decrease in utilities its participation. output in a period of unusually warm The Committee then turned to a dis- weather. In manufacturing, the produccussion of the economic and financial tion of motor vehicles and parts was outlook and the implementation of unchanged in April after having surged monetary policy over the intermeeting in February and March, but the output period ahead. A summary of the eco- of high-tech equipment continued to nomic and financial information avail- trend steeply downward, and there was able at the time of the meeting and of widespread weakness in the manuthe Committee's discussion is provided facture of other industrial products. below, followed by the domestic policy Reflecting the production cutbacks, the directive that was approved by the Com- rate of utilization of manufacturing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

248 88th Annual Report, 2001 capacity fell even further below its long- expenditures for oil and gas exploration run average. surged in the first quarter, and nonresi- Consumer spending had held up dential building activity continued at a relatively well thus far this year despite rapid pace, with sizable gains recorded the deceleration in personal incomes, for most major categories of buildings. reduced household net worth, and dete- Business inventories on a book-value rioration in consumer sentiment since basis fell steeply further in March, last autumn. After a solid first-quarter with roughly half of the decline reflectgain, nominal retail sales rose briskly in ing a runoff of motor vehicle stocks April, reflecting strong outlays at gen- at the wholesale and retail levels. eral merchandise and apparel stores, Despite the sharp liquidation of invenbuilding and material outlets, and auto- tories in the manufacturing sector in motive dealers. Growth of spending on February and March, the aggregate services slowed in the first quarter (lat- inventory-shipments ratio for that secest data), partly because of a weather- tor edged higher in March to a level related drop in consumption of energy well above that of a year ago. In the services. wholesale trade sector, aggregate stocks Low mortgage rates continued to dropped somewhat on balance in the provide support to residential building first quarter and the sector's stock-sales activity. The first-quarter average for ratio edged lower; nonetheless, the sectotal housing starts was the strongest tor's ratio in March also was above its quarterly reading in a year despite a level of a year earlier. Retail inventories March decline in starts that might have ran off in February and March after a been exaggerated by unusual weather small January rise, and the sector's patterns. In addition, sales of new and inventory-sales ratio decreased someexisting homes remained brisk through what on balance to around the middle of March. New home sales reached a new its range for the past twelve months. high in March, and sales of existing The U.S. trade deficit in goods and homes were only a little below their services narrowed considerably in Febrecord high in June 1999. ruary, reflecting a further rise in the Against the background of a sluggish value of exports and a sharp drop in the economy and deteriorating earnings, value of imports. The average deficit business capital spending on equipment for the first two months of the year was and software declined somewhat further smaller than that for the fourth quarter. in the first quarter. Increased purchases Nonetheless, exports for the Januaryof cars and trucks were among the few February period were below the fourthareas of strength in business equip- quarter average, with notable declines ment expenditures; elsewhere, outlays occurring in automotive products, for high-tech equipment decreased on a industrial supplies, and semiconductors. quarterly basis for the first time since The slowdown in imports in Januarythe 1990 recession, and spending for February was broadly spread across equipment such as industrial machinery trade categories, with the largest changed little. Moreover, recent data decreases occurring in automotive prodon orders for nondefense capital goods ucts, high-tech goods, and oil. Recent suggested that some further slippage information indicated that economic in future spending for equipment was activity in the foreign industrial counlikely. By contrast, nonresidential con- tries had decelerated since the fourth struction continued to expand briskly; quarter. Expansion in the euro area, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 249 United Kingdom, and Canada appeared of 50 basis points in the intended level to have slowed significantly, while the of the federal funds rate, to about 5 per- Japanese economy seemed to have fal- cent. This action, in conjunction with a tered after a brief rebound late last year. further easing of Vi percentage point on In addition, economic growth in the April 18, was intended to help promote major developing countries had soft- a more satisfactory economic expansion ened markedly, with the slowdown going forward. Under then-current conin most of those countries reflecting ditions, the members agreed that the balweaker external demand. ance of risks remained weighted toward Overall inflation had been held down conditions that could generate economic thus far this year by a deceleration in weakness in the foreseeable future. energy prices, but by some measures Federal funds traded at rates near the core price inflation had picked up a bit. Committee's target levels over the inter- The total consumer price index (CPI) meeting period. Other short-term interincreased moderately in February and est rates generally fell somewhat less March (latest data), and the increase in than the reduction in the federal funds that index during the past twelve months rate because the markets had anticipated was smaller than that during the pre- the easing in policy, though only in part. vious twelve-month period, reflecting In contrast to the declines in short-term reduced increases in energy prices. By rates, longer-term yields rose on balance contrast, core CPI inflation picked up as investors apparently became more slightly in the February-March period confident of a pickup in output growth, and on a year-over-year basis. However, supported in part by improved prospects inflation as measured by the core per- for substantial federal tax reductions. sonal consumption expenditure (PCE) The more optimistic assessment of the chain-type price index, though also run- economic outlook and the unexpected ning a little higher in February-March, intermeeting easing action apparently recorded a small decline on a year-over- contributed to a narrowing of risk premiyear basis. At the producer level, core ums on lower-grade private debt oblifinished goods inflation was subdued in gations and to a rise in equity prices. March and April but moved up some- Better-than-expected first-quarter earnwhat on a year-over-year basis. With ings also boosted stock prices, and broad regard to labor costs, growth in the indexes of U.S. stock market prices employment cost index (ECI) for hourly moved substantially higher. compensation picked up noticeably in In foreign exchange markets, the the first quarter of this year; however, trade-weighted value of the dollar in the gain in compensation for the four terms of many of the major foreign curquarters ended in March was a little rencies changed little on balance over below the large increase for the four- the intermeeting interval. A number of quarter period ended in March 2000. By major foreign central banks cut their contrast, average hourly earnings of pro- policy rates during the period, but by duction or nonsupervisory workers rose less than the two easing steps in the more briskly in April and on a year- United States. The dollar's appreciation over-year basis. against the euro was offset by its decline At its meeting on March 20, 2001, the in terms of the yen and the Canadian Committee adopted a directive that dollar. The dollar also was essentially called for maintaining conditions in re- unchanged in terms of an index of the serve markets consistent with a decrease currencies of other important trading Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

250 88th Annual Report, 2001 partners. The value of the Mexican peso on some types of loans by financial rose appreciably against the dollar as institutions, and the appreciation of the monetary authorities maintained their dollar. Partly as a result of the decline in tight policy stance and as spreads on household wealth, growth of consumer Mexican debt narrowed. In contrast, spending was expected to remain relaconcerns about potential spillovers from tively low for some time, and housing Argentina's worsening financial diffi- demand would increase only a little culties depressed the value of the Brazil- from its recent level. However, business ian real relative to the dollar. fixed investment, notably outlays for The broad monetary aggregates con- equipment and software, would resume tinued to grow rapidly in March and relatively good growth after a period April. In addition to the effects of lower of adjustment of capital stocks to more market interest rates, extensive mort- desirable levels; a projected recovery gage financing activity and a flight in the growth of foreign economies to safety from volatile equity markets was seen as providing increased support likely added to M2's strong upward for U.S. exports; and fiscal policy was trend. The expansion of M3 was bol- assumed to become more expansionary. stered by robust growth of institution- In the Committee's discussion of curonly money funds and by greater issu- rent and prospective economic develance of managed liabilities included opments, members commented that the in this aggregate to help finance faster slowdown in the expansion to a now growth of bank credit and a shift in bank quite sluggish pace was likely to be funding from foreign to U.S. sources. more prolonged than they had antici- The debt of domestic nonfinancial sec- pated earlier and indeed, with the econtors had grown at a moderate pace on omy displaying some signs of fragility balance through April. and inventories still appearing excessive The staff forecast prepared for this in some sectors, it was not entirely clear meeting suggested that, after a period that the slowing in the growth of the of slow growth associated in part with economy had bottomed out. Despite the an inventory correction, the economic crosscurrents and uncertainties that were expansion would gradually regain involved, members saw an upturn in the strength over the next two years and economic expansion by later in the year move back toward a rate near the staff's as the most likely outlook. This view current estimate of the growth of the was premised in large measure on the economy's potential output. The period lagged effects of the Committee's relaof subpar expansion was expected to tively aggressive easing actions this foster an easing of pressures on year, including any further easing that resources and some moderation in core might be adopted at this meeting, growprice inflation. Despite the substantial ing prospects of some fiscal policy easing in the stance of monetary policy, stimulus later in the year, and more the forecast anticipated that the expan- generally the favorable effects of still sion of domestic final demand would be substantial productivity gains on profit held back to an extent by some of the opportunities and income growth and developments in financial markets—in hence on business and household particular, the decline in household net demands for goods and services. As worth associated with the earlier down- business profits stabilized and final turn in equity prices, the continuation of demand firmed, inventory liquidation relatively stringent terms and conditions would come to an end, adding to the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 251 upward momentum of economic activ- backs, heavy consumer debt loads, and ity. The members were uncertain as to previous overspending by many conthe degree and timing of the strengthen- sumers. A recent survey had indicated ing in final demand, and although a rela- that consumer sentiment had firmed a tively prompt and strong rebound could little, but the survey results had yet to not be ruled out, many saw a variety be confirmed by additional surveys and of factors that pointed to the possibility the level of consumer confidence was that the upturn could be weaker or more still well below earlier highs. As in the delayed than the central tendencies of past, consumer spending attitudes likely their expectations. With regard to the would depend importantly on trends outlook for inflation, a number of mem- in employment and income, and further bers expressed concern about a tendency increases in unemployment in the period for some measures of inflation to edge just ahead along with the negative higher this year, but many members wealth effects of earlier stock market expected that the easing of pressures in price declines and the persistence of labor and product markets that already high energy costs were likely to conhad occurred, and that was likely to strain the growth in consumer expendicontinue in the months ahead, would tures over coming quarters. damp inflation going forward. Household expenditures on home In their review of developments construction had been maintained at a across the nation, members referred to relatively robust level in recent months, quite sluggish economic conditions in evidently reflecting the cushioning many parts of the country. Weakness effects of very attractive mortgage interremained especially pronounced in est rates. Housing activity was described manufacturing, but as reflected in the as a source of strength in many regions. employment data for April and in wide- Housing prices had tended to edge spread anecdotal reports, softening had higher across the nation, though there spread to other sectors of the economy were signs that the price appreciation as well. At the same time, pockets of had eased in some parts of the country, strength could be found in a number of notably on the West Coast. While the industries, notably in energy and con- prevailing negative influences on housestruction, and overall business activity hold spending might spill over a bit continued to display considerable vigor more to housing activity during the year in a number of regions. Members noted ahead, there were few current developthat business confidence had deterio- ments in housing markets that might be rated, but some also observed that the read as signaling any marked weakening pessimism tended to be limited to the in this sector of the economy. nearer term and was accompanied by A softening in business demand for favorable expectations regarding the capital equipment had accounted for outlook later in the year and in 2002. much of the slowdown in the growth of With regard to the outlook for key final demand in late 2000 and early sectors of the economy, a number of 2001. The latest available data on new members commented that consumer orders pointed to further, and possibly spending had held up reasonably well larger, declines in business spending on in recent months despite a variety of equipment and software over the months adverse developments including the ahead. Members cited anecdotal and negative wealth effects of stock market survey reports that indicated many busideclines, widely publicized job cut- ness firms were canceling, cutting back, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

252 88th Annual Report, 2001 or stretching out planned capital expen- much later in the year and could take ditures. It was difficult to see any signs even longer for high-tech firms. This of a significant near-term turnaround in evaluation assumed continued sluggish business spending for equipment and growth in final demand during the software, and the timing and strength period immediately ahead. Stronger of a subsequent rebound would depend growth, which could not be ruled out, importantly on the outlook for sales and would of course bring inventory-sales profits. With regard to profit expec- ratios to desired levels more quickly. tations, the most recent data showed Members also expressed concern continued markdowns, but the pace of about the potential implications for U.S. downward revisions was diminishing. It expansion from developments abroad. was too early to conclude that the out- To some extent, economic difficulties in look for profits might be approaching a foreign nations had occurred in concert degree of stability or be near the point with softening activity in the United of turning up, and in any event it was States, and notable weakness in world clear that business sentiment currently high-tech markets along with the downwas quite gloomy. Looking to the future, ward adjustment in equity prices glohowever, members anticipated that con- bally represented a downside risk factor tinuing gains in efficiency engendered worldwide. The anticipated recovery in by new technologies would provide sub- this country would help to strengthen stantial profit opportunities and likely many foreign economies and in turn strengthen investment spending during improve prospects for U.S. exports. the course of the year ahead. In the Members noted, however, that in some meantime, nonresidential construction nations persisting structural problems and energy-related investments were a presented threats to national economic source of some support to investment prosperity and international trade. On spending, but they provided only a very balance, while the external risks to the partial offset to widespread weakness in U.S. economy clearly were to the downother business spending. side, at least over the nearer term, the Ongoing efforts to reduce excess prospective rebound in U.S. economic inventories were continuing to curb activity and stimulative macroeconomic output in manufacturing industries and policies abroad were expected to conto restrain growth in overall economic tribute to strengthening growth worldactivity. A number of members com- wide and to improving prospects for mented that anecdotal and other evi- exports during the year ahead. dence suggested that considerable The nation's fiscal outlook was seen progress already had been made in scal- as supportive of aggregate demand. ing down unwanted inventories, notably While the exact structure of tax cuts was of motor vehicles, but substantial further still being negotiated, passage of new progress probably would be needed in fiscal measures seemed imminent and high-tech industries where sales were likely would help bolster consumption still falling. How long inventory cut- spending beginning later in the year. backs would continue to exert a signifi- Whatever its precise timing, the expancant drag on the economic expansion sionary fiscal package would undoubtremained a key uncertainty in the eco- edly join at some point in coming quarnomic outlook. In the view of many ters with the lagged effects of the members, the adjustment process might System's policy easing actions to foster not be substantially completed until strengthening economic expansion. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 253 A number of members commented were some risks of rising inflation. An that the persisting updrift in some key unexpectedly strong rebound in ecomeasures of core inflation had become nomic growth could begin to put added increasingly worrisome. In this regard, upward pressure on prices at a time they noted that some of the recent when labor markets were still tight increases in bond yields could represent by historical standards and accelerating a rise in long-term inflation expecta- productivity no longer held down tions. Such a rise would not be entirely increases in unit labor costs. Given the unexpected in the context of improving lags in the effectiveness of monetary sentiment about the strength of the policy, such pressure might materialize expansion, the potentially adverse impli- before the effects of countervailing cations for costs of the cyclical weak- actions by the Committee had a chance ness in productivity, and the possibility to take hold. that high energy prices and their In the Committee's discussion of polpassthrough effects might persist longer icy for the forthcoming intermeeting than had been anticipated earlier. To period, all but one of the members india considerable extent, however, any cated that they could support a proposal uptick in inflation expectations likely calling for further easing of reserve represented a reversal of anticipated conditions consistent with a 50 basis declines in inflation earlier this year point reduction in the federal funds when economic prospects had seemed rate to a level of 4 percent. One memweaker and survey data did not confirm ber expressed a strong preference for a any increase in long-term inflation 25 basis point reduction and two others expectations. Moreover, not all mea- indicated that they could have accepted sures of core inflation had accelerated; that more limited easing move. Despite in particular, core PCE price inflation their somewhat differing preferences, all had been quite stable on a twelve-month the members agreed that further easing basis for some time. was desirable in light of what they Looking ahead, most members did viewed as the continuing weakness in not foresee a significant rise in inflation the economy, the absence of evidence as a likely prospect. They cited the that growth had stabilized or was about prevalence of highly competitive condi- to rebound, and still decidedly downside tions in most markets, which continued risks to the economic expansion. Some to make it very difficult for business members noted that, although policy had firms to raise prices despite pressures to been eased substantially, it might still do so in a period of rising labor, energy, be considered to be only marginally and other costs. Widespread evidence of accommodative in relation to the forces some lessening of pressures in most that were damping aggregate demand. labor markets across the nation had not Accordingly, the action contemplated yet resulted in lower wage inflation, but for today was needed to provide adethe members expected that recent and quate stimulus to an economy whose anticipated ebbing of pressures on labor outlook for significant strengthening and other resources and associated slack remained tenuous in a climate of frain product markets in a period of con- gile business and consumer confidence. tinuing subpar economic growth, along Members noted that the lagged effects with projected declines in energy prices, of the monetary policy easing implewould hold down inflation over the mented earlier this year were still very forecast horizon. Nonetheless, there hard to discern, though they should be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

254 88th Annual Report, 2001 felt increasingly over the year ahead. In cantly adverse shocks, and some memthis regard the risks of rising inflation bers noted that the end of the easing could not be dismissed, and while those process might be near. Even so, with the risks appeared to be quite limited for the economy perhaps still in the midst of a nearer term, excessive monetary stimu- process of weakening growth in aggrelus had to be avoided to avert rising gate demand of unknown persistence inflation expectations and added infla- and dimension, the members generally tion pressures over time. Members who agreed that, given prevailing uncertainpreferred or could support a 25 basis ties, it would be premature for the Compoint easing action gave particular mittee to shift its balance of risks stateemphasis to the desirability at this point ment at this time. of taking and signaling a more cautious At the conclusion of this discussion, approach to policy, relative to the the Committee voted to authorize and 50 basis point federal funds rate reduc- direct the Federal Reserve Bank of New tions the Committee had been imple- York, until it was instructed otherwise, menting, given the lagged effects of the to execute transactions in the System substantial reduction in the federal funds Account in accordance with the followrate to date, the accompanying buildup ing domestic policy directive: in liquidity, and the related risk that a further aggressive easing action would The Federal Open Market Committee increase the odds of an overly accom- seeks monetary and financial conditions that modative policy stance and rising infla- will foster price stability and promote sustainable growth in output. To further its longtion pressures in the future. run objectives, the Committee in the imme- All the members accepted a proposal diate future seeks conditions in reserve to include in the press statement to be markets consistent with reducing the federal released after this meeting a sentence funds rate to an average of around 4 percent. indicating that the Committee continued to regard the risks to the economic out- The vote encompassed approval of look as being tilted toward weakness the sentence below for inclusion in the even after today's easing action. Fore- press statement to be released shortly casts of growth in business earnings and after the meeting: spending continued to be revised down, and until that process ended, weakness Against the background of its long-run goals of price stability and sustainable ecoin demand seemed to be the main threat nomic growth and of the information curto satisfactory economic performance. rently available, the Committee believes that At the same time the members antici- the risks continue to be weighted mainly pated that a neutral balance of risks toward conditions that may generate ecostatement could be appropriate before nomic weakness in the foreseeable future. long, probably well before substantial evidence had emerged that economic Votes for this action: Messrs. Greenspan, McDonough, Ferguson, Gramlich, Kelley, growth had strengthened appreciably, Meyer, Ms. Minehan, Messrs. Moskow once the Committee could see that poland Poole. Vote against this action: icy had eased enough to promote a Mr. Hoenig. future return to maximum sustainable economic growth. Indeed, it was not Mr. Hoenig dissented because he preclear how much more the federal funds ferred a less aggressive easing action rate might have to be reduced after involving a reduction of 25 basis points today in the absence of further signifi- in the federal funds rate. While the risks Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 255 of weaker economic growth still tended Mr. Kelley to dominate those of rising inflation and Mr. Meyer Ms. Minehan called for some further easing, the Com- Mr. Moskow mittee had added significant liquidity to Mr. Poole the economy this year through its cumulatively large easing actions. The lagged Messrs. Jordan, McTeer, Santomero, effects of those actions should be felt and Stern, Alternate Members increasingly over time. Moreover, fol- of the Federal Open Market lowing the rapid and aggressive policy Committee actions already taken, a more cautious policy move at this point would in his Messrs. Broaddus, Guynn, and Parry, Presidents of the Federal Reserve view appropriately limit the risks of pro- Banks of Richmond, Atlanta, and ducing an overly accommodative policy San Francisco respectively stance and rising inflation over time. The Chairman called for a recess after Mr. Kohn, Secretary and Economist this vote and convened a meeting of the Mr. Bernard, Deputy Secretary Board of Governors to consider one-half Mr. Gillum, Assistant Secretary percentage point reductions in the dis- Ms. Fox, Assistant Secretary count rate that had been proposed by a Mr. Mattingly, General Counsel Mr. Baxter, Deputy General Counsel number of Federal Reserve Banks. After Ms. Johnson, Economist the recess, the Chairman informed the Mr. Stockton, Economist Committee that the pending reductions had been approved. Messrs. Fuhrer, Hakkio, Howard, It was agreed that the next meeting of Hunter, Lindsey, Rasche, Reinhart, the Committee would be held on Slifman, and Wilcox, Associate Tuesday-Wednesday, June 26-27, 2001. Economists The meeting adjourned at 1:15 p.m. Mr. Kos, Manager, System Open Market Account Donald L. Kohn Secretary Ms. Smith and Mr. Winn, Assistants to the Board, Office of Board Members, Board of Governors Meeting Held on June 26-27, 2001 Mr. Ettin, Deputy Director, Division of Research and Statistics, A meeting of the Federal Open Market Board of Governors Committee was held in the offices of the Board of Governors of the Federal Mr. Simpson, Senior Adviser, Division Reserve System in Washington, D.C., of Research and Statistics, beginning on Tuesday, June 26, 2001, at Board of Governors 2:00 p.m. and continuing on Wednesday, June 27, 2001, at 9:00 a.m. Mr. Madigan, Associate Director, Division of Monetary Affairs, Board of Governors Present: Mr. Greenspan, Chairman Mr. McDonough, Vice Chairman Messrs. Oliner and Struckmeyer, Mr. Ferguson Associate Directors, Division Mr. Gramlich of Research and Statistics, Mr. Hoenig Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

256 88th Annual Report, 2001 Messrs. Freeman6 and Whitesell, The Manager of the System Open Assistant Directors, Divisions Market Account reported on recent deof International Finance and velopments relating to foreign exchange Monetary Affairs, Board of markets. There were no open market Governors operations in foreign currencies for the Ms. Kusko6 and Mr. Sichel,7 Senior System's account in the period since the Economists, Division of Research previous meeting. and Statistics, Board of Governors The Manager also reported on developments in domestic financial markets Mr. Nelson,6 Senior Economist, and and on System open market transactions Ms. Garrett, Economist, Division in government securities and federal of Monetary Affairs, Board of Governors agency obligations during the period May 15, 2001, through June 26, 2001. Mr. Fleischman,7 Economist, Division By unanimous vote, the Committee ratiof Research and Statistics, fied these transactions. Board of Governors The Committee then turned to a discussion of the economic and financial Ms. Low, Open Market Secretariat Assistant, Division of Monetary outlook and the implementation of Affairs, Board of Governors monetary policy over the intermeeting period ahead. A summary of the eco- Ms. Pianalto, First Vice President, nomic and financial information avail- Federal Reserve Bank of able at the time of the meeting and of Cleveland the Committee's discussion is provided Messrs. Beebe, Eisenbeis, and below, followed by the domestic policy Goodfriend, Mses. Krieger and directive that was approved by the Com- Mester, Messrs. Rolnick, mittee and issued to the Federal Reserve Rosenblum, and Steindel, Senior Bank of New York. Vice Presidents, Federal Reserve The information reviewed at this Banks of San Francisco, Atlanta, Richmond, New York, meeting suggested that economic activ- Philadelphia, Minneapolis, ity continued to grow little, if at all, Dallas, and New York in the second quarter. Employment fell respectively somewhat over the first two months of the quarter, industrial output dropped Mr. Altig, Vice President, Federal sharply, and the limited available infor- Reserve Bank of Cleveland mation suggested that both probably Mr. Fernald,8 Economist, Federal continued to decline in June. Expansion Reserve Bank of Chicago in consumer spending appeared to have slowed and business purchases of equip- By unanimous vote, the minutes of ment and software had fallen apprethe meeting of the Federal Open Market ciably, though homebuilding had been Committee held on May 15, 2001, were well maintained. Energy prices had been approved. relatively flat recently, at a high level, and core price inflation had moderated a little. 6. Attended portion of meeting relating to staff Private nonfarm payroll employment presentations. fell slightly further in May after a sharp 7. Attended portion of meeting relating to prodrop in April and lackluster growth in ductivity developments. 8. Attended Tuesday's session only. the first quarter. Manufacturing recorded Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 257 additional widespread job losses in May, the high first-quarter level, as stronger and there were signs that weakness in single-family starts offset a slower pace employment was spreading to related of multifamily starts. Sales of new and sectors, notably wholesale trade and existing homes slipped in April (latest help-supply services. By contrast, con- data) after both reached near-record levstruction employment rebounded in els in March. May, retracing part of its large April Business spending on equipment and loss, and hiring in finance, insurance, software declined further early in the and real estate remained brisk. The second quarter in response to sluggish unemployment rate edged lower in May, sales, an erosion of earnings and corto 4.4 percent, but initial unemployment porate cash flows, and an uncertain insurance claims and other data sug- outlook for future sales and earnings. gested persisting softening in the labor Shipments of nondefense capital goods market in that month. slumped in April, and the weakness The rapid contraction in industrial in incoming orders suggested that shipproduction continued unabated in May, ments would fall further in coming with manufacturing output registering months. Fleet sales of cars and trucks, an eighth consecutive monthly drop. which had been among the few areas Moreover, output from electric utility of strength in business equipment plants fell, and mining activity slowed expenditures in the first quarter, also further in May following a strong first- slowed. By contrast, nonresidential conquarter gain. Within manufacturing, struction remained robust, though the decreases in output were widely spread level of activity slipped a little in April across sectors, and the production of and slightly higher vacancy rates and high-tech equipment continued to plum- smaller increases in rents suggested that met. The motor vehicle industry was the profitability of new nonresidential one of the few sectors to record a rise investment might be lessening. Strength in production. The further contraction in was particularly evident in outlays for production in May brought the rate of industrial structures, partly reflecting utilization of manufacturing capacity to construction of electric power plants and its lowest level since 1983. facilities for cogeneration of power by Growth of consumer spending industrial companies, and in continuing seemed to have slowed in the second strong oil and gas exploration activity. quarter, reflecting the deceleration in Business inventories on a book-value personal income, the rise in unemploy- basis edged higher in April after a sizment, and the earlier decline in house- able runoff in the first quarter. Excludhold net worth. Nominal retail sales ing motor vehicles, manufacturing were up only slightly in May after a stocks were little changed in April, but brisk rise in April, and the average rate shipments were down sharply and the of increase over the two months was aggregate inventory-shipments ratio for somewhat slower than that of the first the sector remained on a steep upward quarter. trend, with many industries facing siz- Low mortgage rates continued to able inventory overhangs. In the wholeprovide support to residential building sale sector, inventories rose in step with activity in April and May despite a sales; the sector's inventory-sales ratio weakening labor market and sluggish was unchanged in April and remained at growth in personal income. Total hous- the top of its range for the past twelve ing starts in April-May remained at months. Retail inventories continued Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

258 88th Annual Report, 2001 to decline in April, and the sector's were indications that upward pressures inventory-sales ratio decreased further on energy prices had abated somewhat. and was near the middle of its range for In particular, the return of some domesthe past twelve months. tic refineries to operation after main- The U.S. trade deficit in goods and tenance or breakdowns and a surge in services continued to shrink in April. imports had replenished gasoline stocks, The value of exports fell, with most and as a result wholesale and retail gasoof the drop occurring in capital goods, line prices had retreated recently. With notably computers and semiconductors. regard to labor costs, average hourly The value of imports also decreased but earnings of production or nonsuperviby slightly more than exports, reflect- sory workers continued to rise in April ing sizable declines in capital and con- and May at the relatively brisk rate that sumer goods that were partly offset by had prevailed over the past year. increases in oil and automotive prod- At its meeting on May 15, 2001, the ucts. Recent information indicated that Committee adopted a directive that economic growth in the euro area and called for maintaining conditions in rethe United Kingdom in the first quarter serve markets consistent with a decrease was at about the reduced pace seen in of 50 basis points in the intended level the fourth quarter, and growth likely of the federal funds rate, to about 4 perstayed relatively slow more recently. cent. The members generally agreed that Expansion in Canada appeared to have this action was necessary in light of the weakened recently after a slight pickup continuing weakness of the economic in the first quarter. In Japan, the contrac- expansion and the lack of evidence that tion in economic activity that began output growth had stabilized or was early in the year appeared to have con- about to rebound, coupled with a clitinued into the second quarter. Most mate of fragile business and consumer of the developing countries, with the confidence. In addition, the members notable exception of China, also were believed that the balance of risks experiencing an economic slowdown remained weighted toward conditions that was related at least in part to weaker that could generate economic weakness external demand. in the foreseeable future. Core price inflation had moderated a Federal funds traded at rates near the little recently after a pickup earlier in Committee's target level over the interthe year. The core consumer price index meeting period. Other short-term market (CPI) rose relatively slowly in April and rates declined somewhat following the May, and the increase in that index dur- Committee's announcement of the easing the past twelve months was about ing action and subsequently moved the same as that during the previous down noticeably further in response twelve-month period. The core personal to weaker-than-expected news on ecoconsumption expenditure (PCE) chain- nomic activity and corporate earnings. type price index presented a similar pic- Yields on long-term Treasury and ture, with inflation in April and May a investment-grade corporate securities little lower than earlier in the year and fell appreciably during the intermeeting no change in inflation on a year-over- interval, but rates on speculative-grade year basis. Core producer price inflation bonds rose sharply in response to the for finished goods also was subdued in adverse earnings news. The pessimistic the April-May period but edged higher earnings reports also weighed on equity on a year-over-year basis. There also prices, which edged lower on balance. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 259 In foreign exchange markets, the some moderation in core price inflation. trade-weighted value of the dollar in Despite the substantial monetary easing terms of many of the major foreign that had been implemented already and currencies increased slightly over the the fiscal stimulus, including federal intermeeting interval, as the dollar's tax rebates, that was in train, the foreappreciation against the euro and other cast anticipated that sluggish hiring and European currencies more than offset the decline in household wealth would the U.S. dollar's further decline against restrain the growth of both consumer the Canadian dollar. European curren- spending and housing demand. Busicies weakened in response to disap- ness fixed investment, notably outlays pointing data on economic activity, with for equipment and software, would be inflation concerns seen as constraining weaker for a while but would return to countervailing monetary easing actions. relatively robust growth after a period of The dollar also was up slightly on net adjustment of capital stocks to more in terms of an index of the currencies desirable levels. The gradual strengthenof other important trading partners. The ing of investment, together with a proreal was adversely affected by Brazil's jected improvement in foreign econointernal problems and spillovers from mies that was seen as providing some Argentina's financial difficulties, while support for U.S. exports, would foster the Mexican peso benefited from contin- the pickup in growth of demand and ued foreign interest in Mexican invest- output. ments and from high oil prices. In the Committee's discussion of cur- The broad monetary aggregates con- rent and prospective economic develtinued to grow rapidly in the second opments, members noted that by some quarter, reflecting the effects of lower measures overall economic activity opportunity costs of holding liquid remained at a reasonably high level. deposits and money market mutual However, recent data indicated that funds, a buildup in deposits associated growth of spending and output was quite with extensive mortgage financing sluggish and below the pace many memactivity, and a flight to liquidity and bers had anticipated at the time of the safety from volatile equity markets. The previous meeting. Weakness in business debt of domestic nonfinancial sectors spending for equipment and software, expanded at a moderate pace on balance efforts to reduce excess inventories, and through May. the ongoing adaptation to lower equity The staff forecast prepared for this prices in the United States and around meeting suggested that after a period the world were likely to hold back of very slow growth associated in large economic activity in the short run. part with an inventory correction, a siz- Nonetheless, the members continued to able decline in capital spending, and a anticipate a strengthening as the year related sharp contraction in manufac- progressed and during 2002, fostered to turing output, the economic expansion a large extent by the lagged effects on would gradually regain strength over the spending of the substantial easing in forecast horizon and move back to a rate monetary policy since early this year, around the staff's current estimate of the the stimulus from recently enacted tax growth of the economy's potential out- cuts, and the positive effects on houseput. The period of subpar expansion hold and business purchasing power of was expected to foster an appreciable some recent reductions in energy prices. easing of pressures on resources and In addition, the abatement and eventual Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

260 88th Annual Report, 2001 turnaround of the downward adjust- index for personal consumption expenments to capital spending and inven- ditures, were centered on a range of 2 to tories would add impetus to economic 21/2 percent for this year and 13A to growth going forward. It was noted, 2Vi percent in 2002. however, that the unique characteris- Continuing softness in the expansion tics of the current cyclical experience, of economic activity was mirrored in including the heavy concentration of anecdotal reports of business conditions weakness in business expenditures and in much of the nation. Typical regional manufacturing output, increased the reports referred to slowing increases uncertainty that surrounded any fore- in economic activity from an already cast. Most of the members believed that reduced pace or to the persistence of the risks to the expansion, notably for sluggish business activity and generally the nearer term, remained to the down- downbeat business sentiment. Manufacside of current forecasts. Potential turing continued to display particular sources of shortfalls included the effects weakness. However, actions to reduce of possible further increases in unem- excess inventories or to address probployment on consumer and business lems relating to overcapacity in some confidence; the risks of disappointing sectors of the economy, including telebusiness earnings that could damp communications and other high-tech investment and, through lower equity industries, were under way and were prices, consumption; and the growing likely to exert a decreasing drag on ecoindications of weakness in foreign nomic activity over coming quarters as economies that could limit demand for corrective adjustments were completed. exports. In an environment of dimin- Financial conditions, while generally ished pressures in product and labor supportive of greater spending, premarkets and of lower energy costs, sented a mixed picture in some respects. members commented that price pres- Short- and intermediate-term interest sures were likely to remain contained, at rates had fallen substantially this year, least over the near to intermediate term. and long-term yields had moved down In preparation for the midyear mone- late last year. But equity prices were tary policy report to Congress, the mem- only holding their own after a substanbers of the Board of Governors and the tial decline earlier and the dollar had presidents of the Federal Reserve Banks appreciated. Though lenders were cauprovided individual projections of the tious about marginally creditworthy growth of GDP, the rate of unemploy- firms, most businesses were finding ment, and the rate of inflation for the ample credit available at attractive years 2001 and 2002. The forecasts of terms. the rate of expansion in real GDP had In their comments about developcentral tendencies of 1 lA to 2 percent for ments in key sectors of the economy, 2001, suggesting at least a little accele- members noted that overall business ration in the second half of the year, and activity had been supported, at least to 3 to 2>lA percent for 2002. The civilian this point, by the relative strength of rates of unemployment associated with household demand. Growth in consumer these forecasts had central tendencies of spending for goods and services, while 43/4 to 5 percent in the fourth quarter of moderating appreciably since earlier in 2001 and 43A to 5V4 percent in the fourth the year, had nonetheless held up unexquarter of 2002. Forecasts of the rate of pectedly well given the adverse wealth inflation, as measured by the chain price effects associated with the declines in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 261 stock market prices, relatively high lev- many business firms indicated that they els of consumer indebtedness, and job were delaying at least some equipment losses in a growing number of indus- and software outlays until evidence of tries. Members referred in particular to an upturn in their sales and earnings the persisting strength in demand for began to accumulate. Caution was light motor vehicles, which evidently especially pronounced among high-tech was boosted by continuing sales incen- firms, many of which had experienced tives and attractive financing terms. major cutbacks in the demand for their Looking ahead, the outlook for con- products and services. An analysis presumer spending was subject to a number pared for this meeting suggested that of downside risks that included the in the aggregate the apparent overhang possibility of rising unemployment and of excess capital might not be large, further weakness in the stock market, but the dimensions and duration of the which could damp consumer confidence adjustment in spending on capital goods as well as income and wealth. However, were a major source of uncertainty in some further growth in consumer spend- the outlook, and there was some risk of ing remained the most likely prospect substantially greater weakness in investfor the balance of the year in light of the ment spending than was forecast for impetus provided by monetary and fis- coming months. Beyond the nearer term, cal policy and the apparent stabilization however, the prospects for an upturn in in consumer sentiment in recent months investment outlays seemed favorable in after its earlier decline. the context of profit opportunities asso- Housing activity remained at a high ciated with expectations of continued level as attractive mortgage interest rates elevated rates of technological progress evidently continued to counterbalance and rapid declines in the prices of new the negative effects on consumer atti- equipment. In this regard the members tudes of somewhat weaker labor mar- reviewed several staff reports that generkets and reduced stock market wealth. ally concluded that the growth of pro- While housing activity in a number of ductivity in the years ahead was highly areas continued to be described as fairly likely to remain appreciably stronger robust, members noted that residential than it had been from the mid-1970s sales and construction had slipped in to the mid-1990s, though how much some parts of the nation. Even so, given stronger was an open question. With existing backlogs and the continued regard to the outlook for nonresidential availability of attractive mortgage rates, construction activity, members referred nationwide housing construction was to signs of developing weakness in some expected to remain near its currently commercial real estate markets, but elevated level. there were few reports of overbuilding The near-term outlook for business and the construction of commercial fixed investment seemed less promising. facilities was being well maintained in The weakness in spending for new other parts of the country. On balance, equipment and software had played a further modest growth in nonresidenkey role in the softening of the overall tial construction, though well below the expansion of economic activity in recent average pace in recent quarters, was quarters, and a material pickup in such seen as a likely prospect. expenditures did not appear likely until Business efforts to bring their inventhe latter part of this year or early next tories into better alignment with sales year. Indeed, anecdotal reports from were a key factor in the deceleration Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

262 88th Annual Report, 2001 of overall economic activity in recent increases on a broad range of costs and quarters and in forecasts that the upturn prices appeared to have begun to subin economic activity would be relatively side as a result. Inflation expectations limited over the balance of the year. that currently appeared by various mea- Net inventory liquidation appeared to sures and survey results to be essentially have diminished in the current quarter flat or even to have declined a bit were from its pace earlier in the year, but reinforcing the factors holding down inventory-sales ratios had risen further price increases. Some negatives in the in recent months, especially for high- inflation outlook also were noted, such tech equipment. Accordingly, liquida- as some increase in labor compensation tion was not likely to abate substantially including rapid advances in health care further for some time. costs, and a consequent squeeze on With regard to the foreign sector of profit margins that was exacerbated by a the economy, members commented that cyclical decline in productivity gains. economic activity had softened more Labor pressures on business costs might than anticipated in many nations that persist for a time in lagged response to were important trading partners, with earlier advances in headline consumer clearly negative implications for U.S. price inflation and labor productivity, exports. Major Latin American coun- but their effects would tend to diminish tries were experiencing particularly or to be offset over time if, in line with severe economic difficulties, but growth the members' forecasts, pressures on was slowing or economic activity labor resources continued to ease. Some declining in many industrial countries members expressed concern about the as well. At the same time, a number of longer-run prospects for wages and important U.S. industries were subject to prices if the stimulative stance of moneincreased domestic competition from tary policy was maintained too long and foreign imports. While growth abroad allowed demand pressures to outrun the could be expected to rebound next year, economy's potential. responding in part to faster expansion in In the Committee's discussion of polthe US. economy, the nearer-term out- icy for the intermeeting period ahead, look for U.S. and indeed world trade all but one of the members supported was less favorable. both some further easing of reserve con- In their review of the outlook for in- ditions consistent with a 25 basis point flation, members generally anticipated reduction in the target federal funds that increases in consumer prices would rate and the retention of the Commitremain relatively subdued over the next tee's public statement that the risks were several quarters. Factors underlying that weighted toward excessively soft ecoassessment included the emergence of nomic performance. The information less taut conditions in labor markets, received since the May meeting sugrelatively low capacity utilization rates gested a somewhat weaker economic in manufacturing, and the persistence performance than most had anticipated, of highly competitive conditions in most and the members were persuaded that product markets that made it very diffi- in the absence of firm evidence that the cult for business firms to preserve or deceleration in the economic expansion increase their profit margins by raising had run its course a further easing action prices. Moreover, energy prices recently was needed at this point to help stabilize had declined appreciably, and the ear- the economy. With greater slack in labor lier inflationary effects of energy price and product markets, and with inflation Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 263 expectations contained, an added easing move. The member who opposed addiran very little risk of exacerbating price tional policy easing expressed strong pressures, provided the Committee was reservations about such a statement prepared to firm the stance of policy because in his view it likely would be promptly if and when demand pressures interpreted as an intention to ease policy threatened to intensify. One member further, which was contrary to his own was persuaded that policy had already assessment that a more neutral outlook become so expansionary that further regarding the future course of policy easing ran an unacceptable risk of exac- was desirable. In the view of most erbating inflation over time. members, however, the weakness of the A smaller easing move than those the recent information relating to the perfor- Committee had been making earlier this mance of the economy was consistent year was deemed desirable by the mem- with unbalanced risks at least insofar as bers in light of the substantial easing it pertained to the outlook for the rest that already had been implemented since of this year, and their primary policy the start of this year. By a number of concern at this point remained the measures—including the level of real strength of economic activity rather than federal funds rates, the robust growth potentially worsening inflation over the of the monetary aggregates, and the longer term. ready availability of finance to most At the conclusion of this discussion, borrowers—policy had become stimula- the Committee voted to authorize and tive. Such a policy stance was appropri- direct the Federal Reserve Bank of New ate for a time to counter the various York, until it was instructed otherwise, forces holding back economic expan- to execute transactions in the System sion. But much of the lagged effects of Account in accordance with the followthe Committee's earlier easing actions ing domestic policy directive: had not yet been felt in the economy, and they would be supplemented in The Federal Open Market Committee coming quarters by the implementation seeks monetary and financial conditions that of the recently legislated tax cut stimu- will foster price stability and promote suslus. In these circumstances, a smaller tainable growth in output. To further its longmove than those undertaken earlier this run objectives, the Committee in the immediate future seeks conditions in reserve year would have the advantage of reducmarkets consistent with reducing the feding the odds on adding to inflation preseral funds rate to an average of around sures later and of underlining the Com- VA percent. mittee's assessment of its policy stance. In the view of a number of members, the The vote encompassed approval of Committee might well be near the end the sentence below for inclusion in the of its easing cycle. At the same time, press statement to be released shortly several emphasized that they did not after the meeting: want to rule out further easing later if warranted by the tenor of incoming economic information. Against the background of its long-run All except one of the members goals of price stability and sustainable economic growth and of the information curaccepted a proposal to retain the Comrently available, the Committee believes mittee's press statement that the risks that the risks continue to be weighted mainly would continue to be weighted toward toward conditions that may generate ecoeconomic weakness after today's easing nomic weakness in the foreseeable future. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

264 88th Annual Report, 2001 Votes for this action: Messrs. Greenspan, Notation Vote McDonough, Ferguson, Gramlich, Hoenig, Kelley, Meyer, Ms. Minehan, and By notation vote completed on August Mr. Moskow. Vote against this action: 16, 2001, the Committee members voted Mr. Poole. unanimously to elect Vincent R. Reinhart to the position of economist for the period until the first regularly scheduled Mr. Poole dissented because he meeting in 2002, with the understanding believed that FOMC actions this year that in the event of the discontinuance had already established a highly stimu- of his official connection with the Board lative monetary policy stance. The M2 of Governors he would cease to have and MZM measures of money had risen any official connection with the Federal at annual rates in excess of 10 percent Open Market Committee. and 20 percent respectively over the past six months, and the real federal funds Donald L. Kohn rate was very likely below its equilib- Secretary rium level. Other more qualitative information on financial conditions pointed Meeting Held on in the same direction. Economic fore- August 21, 2001 casts were that the economy's growth would resume later this year and the fact A meeting of the Federal Open Market that long-term interest rates had not Committee was held in the offices of declined since December also indicated the Board of Governors of the Federal that the market anticipated a revival of Reserve System in Washington, D.C., faster economic growth before long. on Tuesday, August 21, 2001, at Given the lags in monetary processes, 9:00 a.m. he believed that adding further mone- Present: tary policy stimulus raised an undue Mr. Greenspan, Chairman risk of fostering higher inflation in the Mr. McDonough, Vice Chairman future. Moreover, against this back- Mr. Ferguson ground, he was especially concerned Mr. Gramlich Mr. Hoenig that a statement that the Committee Mr. Kelley continued to view the balance of risks Mr. Meyer as weighted toward weakness would be Ms. Minehan read in the market as a sign that the Mr. Moskow Mr. Poole Committee was likely to ease further in the near term. He thought future Messrs. Jordan, McTeer, Santomero, developments were equally likely to and Stern, Alternate Members warrant an action in either direction, and of the Federal Open Market he did not think the Committee should Committee take a step that probably would cause Messrs. Broaddus, Guynn, and Parry, expectations of further easing to become Presidents of the Federal Reserve embedded in market interest rates. Banks of Richmond, Atlanta, and It was agreed that the next meeting of San Francisco respectively the Committee would be held on Tues- Mr. Kohn, Secretary and Economist day, August 21, 2001. Mr. Bernard, Deputy Secretary The meeting adjourned at 12:25 p.m. Mr. Gillum, Assistant Secretary Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 265 Mr. Mattingly, General Counsel Messrs. Eisenbeis and Lacker, Mr. Baxter, Deputy General Counsel Ms. Mester, Messrs. Rosenblum Ms. Johnson, Economist and Sniderman, Senior Vice Mr. Reinhart, Economist Presidents, Federal Reserve Mr. Stockton, Economist Banks of Atlanta, Richmond, Philadelphia, Dallas, and Ms. Cumming, Messrs. Hakkio, Cleveland respectively Howard, Hunter, Lindsey, Rasche, Slifman, and Wilcox, Associate Ms. Hargraves and Mr. Judd, Vice Economists Presidents, Federal Reserve Banks of New York and San Francisco Mr. Kos, Manager, System Open respectively Market Account Mr. Webber, Senior Research Officer, Ms. Smith, Assistant to the Board, Federal Reserve Bank of Office of Board Members, Minneapolis Board of Governors Mr. Ettin, Deputy Director, Division By unanimous vote, the minutes of of Research and Statistics, the meeting of the Federal Open Market Board of Governors Committee held on June 26-27, 2001, were approved. Mr. Madigan, Deputy Director, The Manager of the System Open Division of Monetary Affairs, Board of Governors Market Account reported on recent developments relating to foreign exchange Mr. Simpson, Senior Adviser, Division markets. There were no open market of Research and Statistics, operations in foreign currencies for the Board of Governors System's account in the period since the previous meeting. Messrs. Oliner and Struckmeyer, Associate Directors, Division The Manager also reported on develof Research and Statistics, opments in domestic financial markets Board of Governors and on System open market transactions in U.S. government securities and secu- Mr. Helkie, Assistant Director, rities issued or fully guaranteed by fed- Division of International Finance, Board of Governors eral agencies during the period June 27, 2001, through August 20, 2001. By Mr. Whitesell, Assistant Director, unanimous vote, the Committee ratified Division of Monetary Affairs, these transactions. Board of Governors The Committee then turned to a dis- Mr. Skidmore, Special Assistant to the cussion of the economic and financial Board, Office of Board Members, outlook and the implementation of Board of Governors monetary policy over the intermeeting period ahead. A summary of the eco- Mr. Kumasaka, Assistant Economist, Division of Monetary Affairs, nomic and financial information avail- Board of Governors able at the time of the meeting and of the Committee's discussion is provided Ms. Low, Open Market Secretariat below. Assistant, Office of Board The information reviewed at this Members, Board of Governors meeting suggested that economic activ- Ms. Browne, Executive Vice President, ity exhibited little, if any, upward move- Federal Reserve Bank of Boston ment in midsummer. Increases in house- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

266 88th Annual Report, 2001 hold expenditures on consumer items at moderately favorable levels in recent and housing appeared to have been months. Supported by low mortgage relatively well maintained, but busi- rates, residential building activity had ness capital expenditures had weakened held up well this year. In July, singlesubstantially since early in the year. family starts increased slightly from a Efforts to reduce inventories were con- strong pace in the first and second quartinuing, and manufacturing activity had ters, though permits fell marginally. decreased further. Employment had Sales of new homes rose in June (latest declined over recent months. With data), and sales of existing homes edged energy prices having turned down, over- down but remained only slightly below all consumer price inflation had eased their historical peak. slightly in recent months, while core Business spending on equipment and measures of consumer prices showed software declined substantially in the mixed changes on a twelve-month basis. second quarter after falling somewhat in Measures of labor costs had decelerated the preceding two quarters. The weakon balance. ness stemmed from sluggish growth in Private nonfarm payroll employment, business sales, significantly reduced corafter declining appreciably during the porate cash flows, and continued uncersecond quarter, fell further in July, led tainty about prospects for future sales by additional job losses in manufac- and earnings. Shipments of nondefense turing and help-supply services. Labor capital goods declined in June after a demand remained weak in other sectors, modest increase in May, but for the secwith employment in most industries flat ond quarter as a whole they contracted to down. The unemployment rate edged at more than twice the first-quarter pace. up to 4.5 percent in June and remained Moreover, orders data for June were at that level in July. Although initial extraordinarily weak, led by a steep claims for unemployment insurance had decline in communications equipment. declined in recent weeks, on balance Those data, as well as numerous anecdata suggested persisting softening in dotal reports, suggested further weakthe labor market. ness in spending for equipment and Industrial production edged lower in software going forward. Nonresidential July after larger drops in each of the construction, which had held up well in previous three months. Motor vehicle the first quarter, was down substantially assemblies rose markedly, but produc- in the second quarter, as spending for tion of high-tech equipment continued office, industrial, and lodging facilito plummet, registering its largest one- ties contracted sharply. Vacancy rates, month decline in more than a decade. particularly in high-tech centers, had Outside those two industries, manufac- increased significantly in recent months, turing production either moved side- as demand for office space and data ways or fell slightly. The rate of utili- centers plunged. In contrast, expendization of manufacturing capacity was tures for drilling and mining equipment little changed in July and remained well soared further in the second quarter. below its long-run average. Business inventory liquidation was Growth in consumer spending slowed sizable in the second quarter, at a pace somewhat in the second quarter, but estimated to be a bit more rapid than in except for automotive dealers, retailers the first quarter. Manufacturing stocks, reported sizable gains in July. Consumer particularly of computers and electronic confidence appeared to have stabilized products, were reduced substantially; Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 267 however, shipments of those products data indicated that the core personal also plunged and the inventory-sales consumption expenditure (PCE) chain ratio in the computer and electronics index had decelerated on a year-oversector rose further from an already high year basis. At the producer level, prices level. Elsewhere in manufacturing, the fell in July, leaving the twelve-month ratio of stocks to sales held steady, with change in the producer price index for stocks remaining high in a number of finished goods somewhat below the manufacturing industries despite aggres- twelve-month change of a year earlier. sive production cutbacks. Inventories With regard to labor costs, the employrose in the wholesale sector and, given ment cost index (ECI) increased at a sluggish sales of late, the ratio of inven- somewhat slower pace in the twelve tories to sales moved sharply higher in months ended in June than over the prethe second quarter. Stocks in the auto- ceding twelve months. mobile sector declined over the quarter At its meeting on June 26-27, 2001, and moved lower in July. Retail inven- the Committee adopted a directive that tories, excluding motor vehicles, fell called for maintaining conditions in remoderately and the sector's inventory- serve markets consistent with a decrease sales ratio edged lower. of 25 basis points in the intended level The U.S. trade deficit in goods and of the federal funds rate, to about services narrowed over the May-June 33A percent. This action was deemed period and was about $20 billion smaller appropriate in light of incoming inforat an annual rate in the second quarter mation indicating somewhat weaker than in the first. The value of imports economic performance than most memdropped sharply in the second quarter. bers had anticipated and the absence of The value of exports also decreased firm evidence that the deceleration in significantly, with most of the decline in the economic expansion had run its capital goods, primarily computers and course or that output growth was about semiconductors. Recent information on to rebound. With greater slack in labor foreign industrial economies suggested and product markets and with inflation that growth weakened further in the sec- expectations contained, the members ond quarter. The Japanese economy con- agreed that the balance of risks contintracted in the quarter, and growth in the ued to be weighted toward conditions euro area appeared to have weakened that could generate economic weakness substantially. Among the developing in the foreseeable future. countries, economic and financial condi- Federal funds traded at rates near the tions had deteriorated further in Argen- Committee's reduced target level over tina. In most other developing countries, the intermeeting period, and other shortthe pace of economic growth continued term rates also fell. Market participants to decline. became less optimistic regarding the Consumer price inflation had eased in economic outlook over the intermeeting recent months, as energy prices turned period, inducing widespread declines down and increases in core consumer in longer-term Treasury yields over the prices subsided after a pickup early in period that were most pronounced at the year. The core consumer price index the shorter end of the coupon maturity (CPI) rose in July at about the same spectrum. Except for the obligations of pace as in the second quarter, but the the most troubled sectors, declines in twelve-month change in that index had investment-grade corporate bond yields increased slightly. However, revised were about in line with those on Trea- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

268 88th Annual Report, 2001 sury issues of comparable maturity, train, the forecast anticipated that the leaving most risk spreads little changed expansion of domestic final demand on balance. A spate of weak second- would continue to be held back by the quarter earnings reports and sizable effects on household net worth of recent reductions in analysts' earnings projec- and possible future declines in stock tions for the remainder of the year took market prices and by damped consumer a toll on equity markets, however, and and business sentiment in a weaker job broad stock market indexes moved market. With long-term trends in innodown appreciably over the intermeeting vation holding up reasonably well, interval. business fixed investment, notably out- The trade-weighted value of the dol- lays for equipment and software, likely lar, after an extended period of strength, would return to relatively robust growth fell against most major foreign curren- after a period of adjustment of capital cies, with much of the decline occurring stocks to more desirable levels, and a in the days just before this meeting. The projected pickup in foreign economies decline was particularly marked against was seen as providing some support for the yen, the euro, and the Swiss franc. In U.S. exports. contrast, the dollar was little changed In the Committee's discussion of against the currencies of some major current and prospective economic develtrading partners, including Canada and opments, many of the members com- Mexico. mented that the anticipated strength- Growth in the broad monetary aggre- ening in economic expansion had not gates remained strong in July but was yet occurred and, indeed, that the econbelow the average pace over the first omy and near-term economic prospects half of the year. Despite some recent appeared to have deteriorated marginslowing, deposit growth was held up by ally further in the period since the previa flight to liquidity and safety in light ous meeting. Several members referred of the poor performance and substan- to a number of recently available ecotial volatility in equity markets. Foreign nomic indicators that in their view sugdemands for U.S. currency also boosted gested the possibility that the string of money growth in July. disappointing readings on the economy The staff forecast prepared for this might be about to end, but those indicameeting suggested that, after a period tors were insufficiently robust and too of very slow growth associated in large recent to provide conclusive evidence part with very weak business fixed of emerging stabilization, much less investment and to some extent with that some overall strengthening might an inventory correction, the economic be under way. Among other things, the expansion would gradually regain economy was still adjusting to downstrength over the forecast horizon and ward revisions to expected earnings and move back to a rate around the staff's to perceptions of greater risk and associcurrent estimate of the growth of the ated declines in wealth. In sum, the timeconomy's potential output. The period ing of the pickup in the growth of the of subpar expansion was expected to economy had again been pushed back. foster an appreciable easing of pressures Even so, the prospects for an upswing on resources and some moderation in over coming quarters remained favorcore price inflation. Although substan- able against the backdrop of the lagged tial monetary easing had already been effects of substantial monetary policy implemented and fiscal stimulus was in easing already implemented this year, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 269 the recent passage and initial imple- ing energy prices, and widespread dismentation of stimulative fiscal policy counting of retail prices were cited as measures, the progress businesses had positive factors in support of consumer already achieved toward completing spending on a wide range of goods and inventory adjustments, and the under- services. In addition, increasingly perlying support for business investments suasive evidence indicated that realfrom continued technological innova- ized capital gains from the sale of homes tions. Nonetheless, the members recog- were a source of fairly significant nized that the recovery in business fixed amounts of consumer purchasing power investment, the major source of weak- in the economy. Looking ahead, memness in the economy, was likely to fol- bers expressed some concern about how low a more extended period of adjust- long the household sector would conment than had been anticipated in their tinue to prop up the economy in the earlier forecasts. With regard to the absence of an upturn in business expenoutlook for inflation, members reported ditures. While accommodative financial on widespread indications of some conditions and reduced income tax rates slackening in what were still generally should continue to undergird consumer tight labor markets and also noted that spending and the data on retail sales capacity utilization rates had declined for July displayed relatively impressubstantially in many industries. The sive gains, negative wealth effects from reduced pressures on resources along falling stock market prices, declining with expectations of some further payrolls, and sluggish income gains— declines in energy prices were seen by should they persist—might well depress many members as likely to foster a mod- consumer expenditures over coming est deceleration in many measures of months. In this regard, some recent wages and prices. anecdotal reports pointed to weaker Statistical evidence of an ongoing, retail sales, importantly including motor though gradual, worsening in overall vehicles. There also were some recent business conditions was supported by indications of declining consumer confianecdotal reports from around the dence, and many retailers had become nation. Weakness continued to be con- less optimistic about the outlook for centrated in manufacturing, notably in sales over the balance of the year. the high-tech sector and in high-tech Homebuilding generally had reservice industries. Indications that the mained robust in recent months, as softening was spreading more generally relatively low mortgage interest rates were still fairly limited as suggested by continued to offset weakness in employemployment data and anecdotal reports. ment and incomes and the negative At the same time, members cited some effects of declining stock market wealth. still quite tentative signs that declines Most regions continued to report strong in manufacturing had slowed or that housing markets, albeit with evidence of activity had steadied in some depressed some weakening in sales of high-priced industries. homes in a number of areas. For now, In their review of developments in however, there were few signs that overkey sectors of the economy, members all housing activity might be softening, again emphasized the ongoing strength though members noted that potentially in household spending and its vital role bearish factors relating to the outlook in moderating the weakness in overall for consumer spending might at some economic activity. Tax rebates, declin- point also affect housing. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

270 88th Annual Report, 2001 With household spending already factor in the current performance elevated relative to income and its rate of the economy. While considerable of increase unlikely to strengthen mate- progress reportedly had been made by rially, if at all, under foreseeable near- numerous business firms in reducing term economic conditions, the antici- their inventories to bring them into betpated upturn in overall economic ter alignment with sales, a rebound to expansion would depend critically on inventory accumulation did not appear business investment spending and in imminent for the economy as a whole. turn on improved prospects for busi- Unexpected weakness in final demands ness profits and cash flows. Business would, of course, lead to additional capital expenditures appeared to be efforts to pare inventories, which would slowing sharply further after posting tend to damp and delay the rebound. large declines earlier in the year in Even so, leaner inventories had favorconjunction with the marking down of able implications for production going the expected growth of demand for and forward. profitability of capital equipment, weak Fiscal policy developments were a sales, the emergence of substantial supportive factor in the economy. The excess capacity in many industries, tax rebates currently being distributed notably in high-tech facilities, and the undoubtedly were having a limited resulting decline in earnings. Market but positive effect on consumers, which forecasts of business profits were pro- likely would continue over coming gressively being reduced, and as a con- months. The impetus could not be measequence members saw little likelihood sured precisely, but it was reflected in of a marked turnaround in business capi- available anecdotal reports. Moreover, tal investment over the months ahead the reductions in income tax rates would despite some elements of strength such have an ongoing effect in boosting as sizable construction projects involv- disposable household incomes. On the ing public utilities, energy, and, in some negative side, financial difficulties in a areas, public works. Indeed, history number of states were being met in part strongly suggested that capital spend- through higher taxes that implied at least ing might well fall below sustainable some offset to the federal tax relief. levels for a time as business firms over Many of the members expressed conadjusted on the downside to previously cern about what appeared to be cumuexcessive or misdirected buildups of lating weakness in numerous foreign capital resources. While the near-term economies that would feed back to the outlook for business investment was not U.S. economy through reduced demand promising and considerable uncertainty for U.S. exports and potentially through surrounded the timing of the eventual perceptions of greater risks in financial upturn, members remained optimistic markets. A number of major industrial about the longer-term prospects for capi- economies were growing more slowly tal expenditures. In the context of a still than had been expected earlier in the favorable outlook for continued elevated summer. Moreover, severe economic rates of technological progress, business and financial problems in a few developfirms reportedly had not yet exploited ing nations could spill over to their tradmany potentially profitable investment ing partners and other similarly situated opportunities. countries that could in turn have adverse The persistence of substantial inven- repercussions more generally on the tory liquidation was another negative world economy. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 271 The members generally viewed a policy stimulus already in train seemed modest decline in inflation as a rea- adequate to promote and support an sonable prospect, at least for a while. eventual appreciable rise in the growth Reports from around the nation indi- of business activity to a pace near that cated that labor market conditions had of the economy's potential, but the eased, though they remained generally strength and timing of the pickup tight and workers available to fill a remained uncertain and further weakvariety of skilled job openings contin- ness was a distinct threat in the nearer ued to be in short supply. On balance, term. In particular, possible faltering in however, upward pressures on labor household expenditures at a time when compensation appeared to be easing business firms were still adjusting to somewhat despite large increases in the inventory imbalances and to capital costs of medical care. Competitive pres- overinvestments would exacerbate the sures continued to make it very difficult slowdown in the economy and delay its for business firms to raise their prices, anticipated recovery. Growing concerns and there were no signs that widespread about foreign economies added to the discounting might be coming to an end. current unease about potential near-term An apparent downtrend in the costs of developments. energy was another favorable factor in Against the considerable forces of the outlook for inflation. Some members restraint on aggregate demand, the fedexpressed a degree of concern, however, eral funds rate had been lowered subabout the longer-term outlook for infla- stantially and the monetary aggregates tion. Pressures on resources would rise were growing rapidly, but some memas the anticipated upturn and possible bers noted that in a number of respects above-trend growth brought the econ- financial conditions did not indicate as omy closer to full capacity utilization. much oncoming stimulus. Since the start An important uncertainty in this regard of the year, long-term interest rates genwas the outlook for productivity, whose erally had not extended earlier declines, growth might have moderated from the prices in equity markets had fallen unusually high growth rates of 1999 and substantially further, and the dollar had 2000, with possibly adverse implica- appreciated in foreign exchange martions for labor costs at very low levels of kets. Accordingly, the inflation risks of unemployment. some further monetary stimulus seemed In the Committee's discussion of pol- limited and were outweighed by the icy for the intermeeting period ahead, all need to lean against actual and potenthe members endorsed a proposal call- tial shortfalls in demand and business ing for a slight further easing in reserve activity. conditions consistent with a 25 basis The members recognized that in light point reduction in the federal funds rate of the lags in the effects of policy, the to a level of Zxh percent. No member easing process probably would have to expressed a preference for leaving pol- be terminated before available measures icy unchanged or easing by more than of economic activity provided clear 25 basis points. The economy had con- evidence of a substantial strengthening tinued to be weak—indeed, weaker than trend. In the view of some members, many had expected—and data and anec- this point might come relatively soon. dotal reports from around the country Beyond the nearer term members also had yet to point to persuasive signs of envisaged the desirability of moving a turnaround. The monetary and fiscal preemptively to offset some of the extra Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

272 88th Annual Report, 2001 monetary stimulus now in the economy It was agreed that the next meeting of in advance of inflation pressures begin- the Committee would be held on Tuesning to build. The members were fully day, October 2, 2001. prepared to act on a timely basis, but The meeting adjourned at 12:40 p.m. several emphasized the recognition lags that would be involved in stopping and subsequently beginning to reverse the Reciprocal Currency Arrangements policy easing. Given their views about the risks to Following the terrorist attacks on Septhe economy, notably over the nearer tember 11, 2001, the Committee estabterm, all the members supported the lished or enlarged reciprocal currency retention of the sentence in the press (swap) arrangements with the European statement indicating that the risks con- Central Bank, the Bank of Canada, and tinued to be weighted toward further the Bank of England. The purpose of weakness in the foreseeable future. these arrangements was to facilitate the At the conclusion of this discussion, functioning of U.S. financial markets by the Committee voted to authorize and providing as necessary through the fordirect the Federal Reserve Bank of New eign central banks the liquidity in dol- York, until it was instructed otherwise, lars needed by European, Canadian, and to execute transactions in the System British banks whose U.S. operations had Account in accordance with the follow- been disrupted by the disturbances in ing domestic policy directive: the United States. These central bank arrangements would mature in thirty The Federal Open Market Committee days unless extended by the Committee. seeks monetary and financial conditions that Except for an initial drawing of up to will foster price stability and promote sus- $12 billion by the European Central tainable growth in output. To further its longrun objectives, the Committee in the imme- Bank on September 12, individual drawdiate future seeks conditions in reserve ings were subject to approval by the markets consistent with reducing the fed- Foreign Currency Subcommittee of the eral funds rate to an average of around Federal Open Market Committee. Under 3V2 percent. the agreements, dollars would be made available in the form of deposits at the The vote encompassed approval of Federal Reserve Bank of New York the sentence below for inclusion in the in exchange for deposits in the counterpress statement to be released shortly party central banks of an equivaafter the meeting: lent amount of their currencies. The individual actions and votes were as Against the background of its long-run follows: goals of price stability and sustainable economic growth and of the information currently available, the Committee believes that On September 12, 2001, available memthe risks continue to be weighted mainly bers of the Committee voted unanimously to toward conditions that may generate eco- establish a $50 billion swap line with the nomic weakness in the foreseeable future. European Central Bank with a maturity of thirty days unless renewed. Votes for this action: Messrs. Greenspan, McDonough, Ferguson, Gramlich, Hoe- Votes for this action: Messrs. Greenspan, nig, Kelley, Meyer, Ms. Minehan, Messrs. Ferguson, Gramlich, Hoenig, Ms. Mine- Moskow and Poole. Votes against this han, Messrs. Moskow, Poole, and Stewart. action: None. Absent and not voting: Messrs. Kelley and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 273 Meyer. Mr. Stewart voted as alternate for be needed to counter unusual strains and Mr. McDonough. help assure the effective functioning of the banking system and restore more On September 13, 2001, available members of the Committee voted unanimously to normal conditions in financial markets. increase the System's swap line with the Subsequently, on September 17, Bank of Canada from $2 billion to $10 bil- 2001, the Committee members voted lion, with the added facility to mature in unanimously to ease reserve conditions thirty days unless renewed. appreciably further, consistent with a Votes for this action: Messrs. Greenspan, reduction in the federal funds rate of McDonough, Ferguson, Gramlich, Hoe- 50 basis points to a level of 3 percent. nig, Kelley, Ms. Minehan, Messrs. This policy action was associated with Moskow and Poole. Absent and not votthe approval by the Board of Governors ing: Mr. Meyer. of a reduction of equal size in the dis- On September 14, 2001, available mem- count rate to a level of 2!/2 percent. bers of the Committee voted unanimously to These actions were taken against the establish a $30 billion swap line with the backdrop of heightened concerns and Bank of England, with a maturity of thirty uncertainty created by the recent terrordays unless renewed. ist attacks and their potentially adverse Votes for this action: Messrs. Greenspan, effects on asset prices and the perfor- McDonough, Ferguson, Hoenig, Kelley, mance of the economy. In conjunction Ms. Minehan, Messrs. Moskow and Poole. with these policy moves, the Federal Absent and not voting: Messrs. Gramlich Reserve would continue to supply, as and Meyer. needed, an atypically large volume of liquidity to the financial system. As a Intermeeting Policy Action consequence, the Committee recognized that the federal funds rate might fall On September 13, 2001, the Committee below its target on occasion until more met by telephone conference to assess normal conditions were restored in the economic and financial developments functioning of the financial system. The stemming from the terrorist attacks on Committee's vote encompassed the September 11 and the possible need for retention of a statement in its press a monetary policy response. Banking release indicating that the balance of and other financial market conditions, risks remained weighted toward weaknotably in New York City but also ness for the foreseeable future. around the nation, were discussed in some detail as well as the outlook for Votes for this action: Messrs. Greenspan, reopening the stock exchanges. While McDonough, Ferguson, Gramlich, Hoethe ongoing reactions to the recent trag- nig, Kelley, Meyer, Ms. Minehan, Messrs. edy were undoubtedly a negative factor Moskow and Poole. Votes against this in the economic outlook, the members action: None. agreed that financial markets were still too disrupted and the economic outlook Donald L. Kohn too uncertain to provide an adequate Secretary basis for a policy move at this time. However, the members contemplated Meeting Held on the need for some policy easing in the October 2, 2001 very near future. In the interim, the System would continue to stand ready A meeting of the Federal Open Market to provide whatever liquidity might Committee was held in the offices of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

274 88th Annual Report, 2001 the Board of Governors of the Federal Mr. Connors, Associate Director, Reserve System in Washington, D.C., Division of International Finance, Board of Governors on Tuesday, October 2, 2001, at 9:00 a.m. Messrs. Oliner and Struckmeyer, Associate Directors, Division Present: of Research and Statistics, Mr. Greenspan, Chairman Board of Governors Mr. McDonough, Vice Chairman Mr. Ferguson Mr. Whitesell, Assistant Director, Mr. Gramlich Division of Monetary Affairs, Mr. Hoenig Board of Governors Mr. Kelley Mr. Meyer Mr. Kumasaka, Assistant Economist, Ms. Minehan Division of Monetary Affairs, Mr. Moskow Board of Governors Mr. Poole Ms. Low, Open Market Secretariat Messrs. Jordan, McTeer, Santomero, Assistant, Office of Board and Stern, Alternate Members Members, Board of Governors of the Federal Open Market Messrs. Eisenbeis and Goodfriend, Committee Ms. Mester, Messrs. Rolnick, Rosenblum, and Sniderman, Messrs. Broaddus, Guynn, and Parry, Senior Vice Presidents, Federal Presidents of the Federal Reserve Reserve Banks of Atlanta, Banks of Richmond, Atlanta, and Richmond, Philadelphia, San Francisco respectively Minneapolis, Dallas, and Cleveland respectively Mr. Kohn, Secretary and Economist Mr. Bernard, Deputy Secretary Messrs. Evans, Hilton, and Judd, Vice Ms. Fox, Assistant Secretary Presidents, Federal Reserve Banks Mr. Mattingly, General Counsel of Chicago, New York, and Ms. Johnson, Economist San Francisco respectively Mr. Reinhart, Economist Mr. Stockton, Economist By unanimous vote, the minutes of Ms. Cumming, Messrs. Fuhrer, Hakkio, the meeting of the Federal Open Market Howard, Lindsey, Rasche, Committee held on August 21, 2001, Slifman, and Wilcox, Associate and the conference calls held on Sep- Economists tember 13 and 17, 2001, were approved. The Manager of the System Open Mr. Kos, Manager, System Open Market Account Market Account reported on recent developments in foreign exchange mar- Ms. Smith, Assistant to the Board, kets. There were no open market opera- Office of Board Members, tions in foreign currencies for the Sys- Board of Governors tem's account in the period since the previous meeting. The Manager also Messrs. Ettin and Madigan, Deputy Directors, Divisions of Research reported on developments in domestic and Statistics and Monetary financial markets and on System open Affairs respectively, Board market transactions in government secuof Governors rities and securities issued or fully guaranteed by federal agencies during the Mr. Simpson, Senior Adviser, Division of Research and Statistics, period August 21, 2001, through Octo- Board of Governors ber 1, 2001. By unanimous vote, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 275 Committee ratified these transactions. Industrial production fell substan- The Committee expressed its apprecia- tially further in August after posting tion of the outstanding manner in which monthly losses starting in October of the Federal Reserve Bank of New York last year. Motor vehicle assemblies were had carried out its open market opera- down sharply, reversing a large advance tions and other responsibilities under in July, and production of high-tech very difficult circumstances after the ter- equipment continued to register large rorist attacks on September 11, 2001. declines. Outside of those two indus- The Committee then turned to a tries, production of business equipdiscussion of the economic and finan- ment, business supplies, consumer cial outlook and the implementation of nondurables, and materials also moved monetary policy over the intermeeting appreciably lower. The rate of capacity period ahead. A summary of the eco- utilization in manufacturing continued nomic and financial information avail- to fall, reaching its lowest level since able at the time of the meeting and of mid-1983. the Committee's discussion is provided Growth in consumer spending picked below. up somewhat in July and August from The information reviewed at this a reduced pace in the second quarter meeting suggested that the attacks of despite a small drop in sales of new September 11 might well have induced motor vehicles. However, anecdotal a mild downturn in economic activity reports from around the nation pointed after several months of little movement to a downturn in September, largely in the level of economic activity. While reflecting marked weakness after the few nonfinancial economic data were terrorist attacks. Indicators of consumer available on developments since the confidence fell further in September. attacks, anecdotal and survey reports Despite low mortgage interest rates, suggested that heightened uncertainty residential building activity softened and sharply reduced confidence had somewhat in August and some indicacurtailed consumer spending and had tors of housing demand, including mortintensified the downward trajectory in gage applications for home purchases, business capital expenditures. Consumer had downshifted a bit further in recent price inflation had remained relatively weeks. However, builder backlogs subdued over the summer months. appeared to be large enough to sustain Data for August portrayed some con- homebuilding activity at a fairly eletinued softening in overall labor mar- vated level for several months. Sales of ket conditions. Private nonfarm payroll new homes edged up in August but were employment fell appreciably further, little changed on balance since April. with the decline more than accounted Business capital spending contracted for by additional job losses in manufac- substantially further over the summer turing. Labor demand remained sluggish months, and anecdotal information after in most other sectors, though some September 11 pointed to even deeper pickup was reported in services. The cutbacks by many firms. The added unemployment rate rose to 4.9 percent weakness evidently stemmed from in August, its highest level in four years. increased concerns about future sales A sharp increase in initial claims for and earnings, which also was reflected unemployment insurance in recent in the sharp declines in stock market weeks was suggestive of additional dete- prices after the equity markets reopened rioration in labor markets. on September 17. Available indicators Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

276 88th Annual Report, 2001 suggested that expenditures for equip- ery, industrial supplies, and automotive ment and software had remained on a products. The reduction in imports was sharp downward trajectory into late led by declines in oil, semiconductors, summer, though the overall decline in other machinery, automotive products, such spending was moderated by sizable and consumer goods. Data for foreign outlays for aircraft in July and August. industrial economies confirmed earlier New orders for nondefense capital indications of little or no growth in those goods edged up in August but were still economies in the second quarter, and well below their average for the second more recent information for the period quarter. Nonresidential construction prior to the terrorist attacks pointed to activity appeared to be falling apprecia- further weakness, including evidence of bly further after a sharp downturn in the declining activity in Japan. Available second quarter. information on conditions in major Business inventory liquidation re- developing countries also suggested mained substantial in July, extending slowing or negative growth in recent the sizable declines since the start months, in part as a consequence of of the year. Large drawdowns were weakness in their exports to the United recorded in manufacturing and, exclud- States and, notably for some Asian ing motor vehicles, in both wholesale economies, the poor performance of the and retail trade. The limited data avail- global high-tech industry. able for August indicated some reduc- Consumer price inflation remained tion in dealer stocks of motor vehicles relatively limited in July and August, and sizable further liquidation of dura- with core personal consumption expenble goods by firms in the manufactur- diture (PCE) price inflation on an appreing sector. Nonetheless, the aggregate ciably lower track than core consumer inventory-sales ratio for producers of price index (CPI) inflation. For the durable goods edged up in August, led twelve months ending in August, core by a further rise in the ratio for comput- PCE prices rose a bit less, and core CPI ers and electronic products. In the days prices a bit more, than over the previous following the terrorist attacks, anecdotal twelve-month period. Consumer energy reports indicated that disruptions in prices fell sharply in July and August, transportation facilities, including the but a sizable rebound was anticipated in temporary suspension of air cargo ser- September as prices of petroleum prodvice and lengthy trucking delays at ucts moved higher after midsummer the nation's borders, caused some back- in response to refinery disruptions and ups in inventories at some firms and tightening supplies. In electricity marshortages at others, but these problems kets, upward price pressures dissipated generally seemed to ease within a few over the summer, while the sharp run-up days. of natural gas prices continued to The U.S. trade deficit in goods and unwind as inventories rose further in the services was about unchanged in July context of persisting high levels of profrom its June level, but both exports and duction and sluggish demand. At the imports dropped sharply as weakness in producer level, core prices declined in worldwide economic activity continued August, notably at the early stages of to affect the nation's foreign trade. The processing. With regard to labor costs, reduced value of exports in July was the rise in average hourly earnings of spread among most trade categories but production or nonsupervisory workers was especially pronounced in machin- diminished somewhat over July and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 277 August, but the year-over-year advance indexes fell appreciably. For a few days was still appreciably above that for the after September 11, with federal funds previous twelve-month period. In addi- brokerage disrupted, banks generally tion, large increases in health insurance agreed to trade reserves at the 3Vi percosts were continuing to add to overall cent federal funds target rate then preemployment costs. vailing. As more normal functioning At its meeting on August 21, 2001, resumed in the federal funds market, the the Committee adopted a directive that rate fell well below the Committee's called for implementing conditions in formal targets, including the reduced reserve markets consistent with a reduc- rate set on September 17. By the latter tion of 25 basis points in the intended part of September and early October, level of the federal funds rate to a level however, the effective rate was fluctuatof about 3!/2 percent. The Committee ing around the new target level. After took this action in light of the absence the terrorist attacks, rates on short- and of firm evidence that the deceleration in intermediate-term Treasury securities the economic expansion had run its fell appreciably further, as did yields course or that a recovery in output was on highly rated obligations such as fedimminent. With increasing slack in labor eral agency debt. However, the yield and product markets and with inflation declines did not extend to long-term expectations contained, the members Treasury bonds, which changed little agreed that the balance of risks con- as investors apparently reacted to the tinued to be weighted toward conditions deteriorating outlook for the federal that could generate economic weak- budget surplus and prospectively larger ness in the foreseeable future. Subse- Treasury bond supplies. Yields on quently, on September 17, the Commit- investment-grade corporate bonds also tee reduced its target for the federal were little changed, but rates on highfunds rate by a further Vi percentage yield bonds, evidently reflecting point. This action was taken against increased investor aversion to holding the backdrop of heightened concerns risky securities, rose sharply in very thin and uncertainty created by the recent markets. In the stock market, broad terrorist attacks and their potentially equity price measures fell considerably adverse effects on asset prices and the further in volatile trading after the marperformance of the economy. In con- kets reopened on September 17, but part junction with this easing move, the Fed- of those losses had been recovered by eral Reserve indicated that it would con- the time of this meeting. tinue to supply unusually large volumes The trade-weighted value of the dollar of liquidity, and the Committee recog- against the other major foreign currennized that the federal funds rate might cies was about unchanged on average fall below its new target until the normal over the period since the August functioning of financial markets was meeting, as modest dollar appreciarestored. tion early in the period was reversed In the period before the terrorist after September 11. The dollar ended attacks, federal funds traded at rates near the period somewhat lower against the the reduced target level established at yen and the euro but registered an the August meeting. Most market inter- advance against the Canadian dollar. est rates edged lower over that period in The dollar rose over the period against response to generally downbeat news on the currencies of other important trading the economy, and broad stock market partners. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

278 88th Annual Report, 2001 Growth of M2 remained relatively the first half of 2002, especially against robust in July and August, though below the backdrop of a very accommodative the average pace in the first half of the monetary policy and an increasingly year, while the expansion of M3 weak- stimulative fiscal policy. The recovery ened markedly over the two months. would gather momentum during 2002 More recently, a record surge in M2 to a pace late in the year near the staff's components in the week ending Septem- current estimate of the growth in the ber 17, which was largely reversed in economy's potential. With long-term the following week, resulted in very trends in innovations and business rapid growth in both aggregates on a opportunities expected to remain favormonthly average basis in September. In able, business fixed investment after the immediate aftermath of the terrorist the completion of ongoing adjustments attacks, disruptions to the infrastructure likely would return to robust rates of of financial markets, including commu- growth, with favorable implications for nications and transportation facilities, employment, labor productivity, and led to massive dislocations in the distri- consumer spending. The current and bution of deposits and reserves. At the prospective slack in resource use over same time, greatly heightened demand coming quarters, augmented by the for safe and liquid assets encouraged pass-through effects of lower oil prices, shifts from equity markets into deposit would result in some modest deceleraassets. These financial disturbances tion in core PCE and CPI inflation. called for and were accommodated by In the Committee's discussion of currecord infusions of Federal Reserve rent and prospective economic developcredit through open market operations, ments, the members focused on the the discount window, and other sources. shock to consumer and business confi- In addition, the Federal Reserve eased dence occasioned by the events of Sepits rules for lending securities to deal- tember 11 and the adverse repercussions ers and took a number of other steps to on an already weak economy. The econfacilitate the operation of financial mar- omy appeared to have been growing kets. To a considerable extent, more nor- very little, if at all, prior to the terrorist mal functioning was restored to those attacks, and the dislocations arising markets by the latter part of September, from the latter seemed to have induced and the unusual demand for reserves a downturn in overall economic activabated. ity against the backdrop of heightened In the presentation of its forecast to anxiety and uncertainty about economic the Committee, the staff indicated that prospects and a sharp drop, at least its downward revised outlook was sub- initially, in stock prices after the equity ject to a very wide range of uncertainty markets reopened on September 17. regarding the ongoing effects of the Looking ahead, the members generally tragic events of September 11. A mild saw a relatively mild and short contracdownturn in overall economic activity tion followed by a gradual recovery next probably was now under way and busi- year as a plausible forecast but one that ness conditions would continue to be was subject to an unusually wide range depressed for some uncertain period by of uncertainty, notably in the direction the sharp further deterioration in busi- of a potentially much weaker outcome ness and consumer confidence triggered in the nearer term. In the short period by the terrorist attacks. However, a since the attacks, anecdotal reports progradual recovery was anticipated during vided indications of a rebound from the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 279 sharp cutback in spending that charac- sures on labor and other resources and terized the immediate aftermath of those declining energy prices. tragic events, but on balance business The Committee's review of recent activity seemed to be in the process of and prospective developments in key moving lower. It was especially difficult sectors of the economy underscored the to assess the outlook for consumer senti- uncertainty that surrounded the overall ment and spending in the period immedi- economic outlook. The major question ately ahead, which likely would depend at this point was the extent to which to an important extent on the progress of the recent tragedies would continue to the war against terrorism and reactions weigh on consumer spending and busito any further terrorist activities. One ness investment. In the consumer sector, risk bearing on that outlook was the spending had with some exceptions held possibility that prices in equity markets up well through late summer, but conmight continue to decline and perhaps fidence had begun to deteriorate even even overadjust to lower earnings ex- before September 11. A factor that pectations. The confluence of world- seemed to be exerting an increasingly wide economic weakness added to cur- depressing effect on consumer attitudes rent uncertainties and concerns. In these was the persisting stream of worker circumstances a substantial further drop layoffs and rising unemployment. The in consumer and business confidence adverse wealth effects stemming from and spending could not be ruled out. the cumulative declines in stock market The members nonetheless saw favor- prices were a further negative, though able prospects for an upturn in business one that had been cushioned by continactivity next year, though the recovery ued increases in the value of real estate. clearly would be more delayed than they Retail sales along with expenditures had anticipated before September 11. associated with travel-related services Major reasons for optimism about the had fallen dramatically in the immediate outlook were the substantial easing in aftermath of the terrorist attacks. Very monetary policy, whose lagged effects recent anecdotal reports suggested some would be felt increasingly in the year improvement in consumer spending, ahead, and the fiscal stimulus mea- though not a total recovery, with mixed sures that already had been enacted and indications ranging from a rebound to might well be supplemented over com- levels near pre-attack norms to still ing months. Other supportive elements relatively depressed activity. Looking included a likely rebound in business ahead, many retailer contacts anticipated high-tech investment after its sharp sluggish sales over coming months. retrenchment and a gradual turnaround There were no historical precedents for in inventory investment as stocks judging the likely effects on consumer became better aligned with expected confidence and spending of the unique sales. A sound banking system and low recent events, though it seemed likely inflation were seen as sources of under- that prospects for added job losses and lying strength in the economy that the decline in equity wealth already would contribute to the eventual pickup experienced would hold down consumer in economic activity. Even with a expenditures over the months ahead. rebound in activity next year, however, Even so, the members did not rule out a consumer price inflation appeared likely stronger-than-anticipated pickup later, to remain subdued or perhaps trend a bit depending in part on the size of addilower in association with reduced pres- tional fiscal policy actions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

280 88th Annual Report, 2001 Housing demand had remained at a equipment and other production facilirelatively elevated level across much ties. More generally, the increase in of the nation, though signs of some soft- uncertainty and the decline in business ening were apparent prior to Septem- confidence and corporate profits along ber 11, especially in the high-priced with the currently high levels of excess segment of the housing market. The capacity in many industries pointed to near-term outlook suggested some fur- the persistence of poor prospects for ther waning in housing demand in asso- capital spending over the short to interciation with the prospective weakness mediate term, with declines in outlays in employment and income. Some for high-tech products expected to members noted in this regard that they remain especially pronounced. Looking sensed growing caution among home- further ahead, however, a robust upturn builders. However, the outlook for hous- in business capital spending was still a ing activity over the intermediate to probable outcome. Businesses likely longer term remained fairly promising would respond to profit opportunities against the backdrop of relatively low stemming not only from rising demand mortgage interest rates and a prospec- resulting in part from fiscal and monetive recovery in overall economic activ- tary stimulus but also from ongoing ity that would foster rising employment technological improvements and the and incomes. need for new capital equipment as the The events of September 11 produced process of retrenchment from earlier a marked increase in uncertainty and overinvestments was completed. anxiety among contacts in the business With a few short-lived exceptions, sector. Spending for equipment and soft- production on the whole had not been ware and for commercial structures had directly disrupted by the effects of the been declining sharply through the terrorist attacks. Consequently, some summer, with only a few tentative signs unintended accumulation of inventories that the pace of decline might be about probably had occurred as a result of to ebb. According to contacts, intensi- sizable and unanticipated declines in the fied concerns about prospects for sales demand for many products. Even so, the and profits were depressing investment pronounced downtrend in overall invenfurther by fostering an increasingly tory spending appeared to be continuwidespread wait-and-see attitude about ing, and with many business firms undertaking new investment expendi- evidently still trying to liquidate what tures. While nationwide statistics on they viewed as excessive stocks, the expenditures in the period since the inventory adjustment process was likely terrorist attacks were not yet available, to persist for some time. Nonetheless, anecdotal reports pointed to especially as progress was made in reducing large cutbacks in planned spending unwanted stocks, the rate of inventory for commercial aircraft and rental cars liquidation would diminish and an evenstemming from the sudden and sharp tual turn toward accumulation would deterioration of activity in the travel and emerge, with positive implications for tourist industries. Reports from banking economic activity. Indeed, this buildup contacts also indicated a substantial drop could be larger than previously anticiin demand for business loans that was pated if businesses now felt the need attributed in part to the diminished will- to hold larger stocks against the continingness of small businesses in particular gency of supply-chain slowdowns and to undertake new investments in capital disruptions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 281 The members saw the international tend to support business and household sector as contributing to weakness in the confidence, which a number of memdomestic economy, especially over the bers saw as especially important in nearer term. Downshifts in the U.S. the current circumstances. Even after a economy were reinforcing more slug- 50 basis point reduction, the federal gish performance in many foreign funds rate would not reflect an unusueconomies, which in association with ally accommodative policy stance in continued firmness in the dollar was that, in real terms, it would still be posiin turn depressing the outlook for U.S. tive by many measures and above its exports to those countries. In this regard, typical level in most earlier periods several members cited anecdotal evi- of economic weakness. Moreover, the dence of flagging foreign markets for a decline in stock market prices and the variety of U.S. products. On the positive widening of risk spreads had damped side, weakness in world demand for oil the stimulative financial effects of the was fostering a significant downtrend in Committee's earlier easing actions. The energy prices, albeit with adverse effects relatively low level of inflation and on energy producers in this country and well-contained inflationary expectations abroad. allowed the Committee flexibility to Members viewed the outlook for focus on countering the downside risks inflation as favorable. Expectations of to the economy without incurring a siggreater and longer-lasting slack in labor nificant threat of fostering expectations and product markets than anticipated of higher inflation. Monetary policy is earlier had led to downward revisions a flexible instrument and, with inflation to forecasts of wage and price inflation. expectations likely to remain relatively This outlook was abetted by substantial benign, policy could be reversed in a declines in oil and other commodity timely manner later should stimulaprices. On the negative side, increases in tive policy measures and the inherent spending on insurance and security and resiliency of the economy begin to foscontinued upward pressure on costs in ter an unsustainable pace of economic the healthcare industry likely would expansion. impinge on business margins, limiting In keeping with their views about the the downward adjustment of inflation. risks to the economy, all the members In the discussion of policy for the supported the retention of the sentence intermeeting period ahead, all the mem- in the press statement indicating that the bers endorsed a proposal calling for risks continued to be weighted toward some further easing of reserve condi- further weakness in the foreseeable tions consistent with a 50 basis point future. reduction in the federal funds rate to At the conclusion of this discussion, a level of 2lA percent. While monetary the Committee voted to authorize and policy had already been eased substan- direct the Federal Reserve Bank of New tially this year, the increased evidence of York, until it was instructed otherwise, a faltering economy and the decidedly to execute transactions in the System downside risks in the outlook called for Account in accordance with the followa further move at this meeting. Easing ing domestic policy directive: would help limit the extent of the downturn and later provide impetus to the The Federal Open Market Committee eventual upturn in economic activity. seeks monetary and financial conditions that Further vigorous easing action would will foster price stability and promote sus- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

282 88th Annual Report, 2001 tainable growth in output. To further its long- Ms. Minehan run objectives, the Committee in the imme- Mr. Moskow diate future seeks conditions in reserve Mr. Poole markets consistent with reducing the federal funds rate to an average of around Messrs. Jordan, McTeer, Santomero, 22/2 percent. and Stern, Alternate Members of the Federal Open Market The vote encompassed approval of Committee the sentence below for inclusion in the press statement to be released shortly Messrs. Broaddus, Guynn, and Parry, Presidents of the Federal Reserve after the meeting. Banks of Richmond, Atlanta, and San Francisco respectively Against the background of its long-run goals of price stability and sustainable eco- Mr. Kohn, Secretary and Economist nomic growth and of the information cur- Mr. Bernard, Deputy Secretary rently available, the Committee believes that Mr. Gillum, Assistant Secretary the risks continue to be weighted mainly Ms. Smith, Assistant Secretary toward conditions that may generate eco- Mr. Mattingly, General Counsel nomic weakness in the foreseeable future. Ms. Johnson, Economist Mr. Reinhart, Economist Votes for this action: Messrs. Greenspan, Mr. Stockton, Economist McDonough, Ferguson, Gramlich, Hoenig, Kelley, Meyer, Ms. Minehan, Messrs. Ms. Cumming, Messrs. Fuhrer, Hakkio, Moskow and Poole. Votes against this Howard, Hunter, Lindsey, action: None. Slifman, and Wilcox, Associate Economists It was agreed that the next meeting of the Committee would be held on Tues- Mr. Kos, Manager, System Open day, November 6, 2001. Market Account The meeting adjourned at 12:30 p.m. Mr. Winn, Assistant to the Board, Donald L. Kohn Office of Board Members, Board of Governors Secretary Messrs. Ettin and Madigan, Deputy Meeting Held on Directors, Divisions of Research and Statistics and Monetary November 6, 2001 Affairs respectively, Board of Governors A meeting of the Federal Open Market Committee was held in the offices of Mr. Simpson, Senior Adviser, Division the Board of Governors of the Federal of Research and Statistics, Reserve System in Washington, D.C., Board of Governors on Tuesday, November 6, 2001, at 9:00 a.m. Messrs. Oliner and Struckmeyer, Associate Directors, Division Present: of Research and Statistics, Mr. Greenspan, Chairman Board of Governors Mr. McDonough, Vice Chairman Mr. Ferguson Messrs. Kamin and Whitesell, Mr. Gramlich Assistant Directors, Divisions Mr. Hoenig of International Finance and Mr. Kelley Monetary Affairs respectively, Mr. Meyer Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 283 Mr. Skidmore, Special Assistant to the By notation vote circulated before Board, Office of Board Members, this meeting, the Committee members Board of Governors unanimously approved the selection of Michelle A. Smith to serve as an assis- Ms. Low, Open Market Secretariat tant secretary of the Committee for the Assistant, Office of Board Members, Board of Governors period until the first regularly scheduled meeting in 2002. Mr. Stewart, First Vice President, The Committee then turned to a Federal Reserve Bank of discussion of the economic and finan- New York cial outlook and the implementation of monetary policy over the intermeeting Messrs. Cox and Goodfriend, Mses. Mester and Perlmutter, period ahead. A summary of the eco- Messrs. Rolnick and Sniderman, nomic and financial information avail- Senior Vice Presidents, Federal able at the time of the meeting and of Reserve Banks of Dallas, the Committee's discussion is provided Richmond, Philadelphia, below. New York, Minneapolis, and Cleveland respectively The information reviewed at this meeting indicated that economic activ- Mr. Thornton, Vice President, Federal ity, already weak in late summer, had Reserve Bank of St. Louis softened further after the terrorist attacks. Overall consumer spending fal- Mr. Robertson, Assistant Vice tered, though purchases of motor vehi- President, Federal Reserve cles reached a near-record level, and the Bank of Atlanta downward trajectory in business capital Mr. Rudebusch, Senior Research expenditures steepened. With sales con- Advisor, Federal Reserve Bank tracting and inventory imbalances still of San Francisco substantial, the manufacturing sector continued its sharp slide, and aggregate By unanimous vote, the minutes of employment plunged. Energy prices the meeting of the Federal Open Market were moderating somewhat in response Committee held on October 2, 2001, to lower worldwide demand, and core were approved. price inflation remained subdued. The Manager of the System Open Conditions in the labor market dete- Market Account reported on recent riorated sharply further in October, with developments in foreign exchange mar- private nonfarm payroll employment kets. There were no open market opera- suffering its worst monthly decline since tions in foreign currencies for the Sys- 1975. The largest drop was in manutem's account in the period since the facturing, but nearly every major sector previous meeting. experienced sizable job losses. Among The Manager also reported on devel- other job market indicators, the average opments in domestic financial markets workweek edged down, initial claims and on System open market transactions for unemployment insurance remained in government securities and securities very high, and the unemployment rate issued or fully guaranteed by federal jumped to 5.4 percent, an increase of agencies during the period October 2, one-half percentage point. 2001, through November 5, 2001. By Industrial production recorded unanimous vote, the Committee ratified another large decrease in September these transactions. (latest data), and the weakness was Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

284 88th Annual Report, 2001 spread across most market groups and Nonresidential construction activity also industries. Motor vehicle assemblies declined in the spring and summer. registered a further sharp contraction, Total business inventories on a bookand output of high-technology goods value basis decreased in July and August plunged still lower. The additional (latest data for wholesalers and retaildecline in production in September ers) at a rate close to that of the second brought the rate of utilization of overall quarter. At the manufacturing level, manufacturing capacity to its lowest stocks continued to run off at a brisk reading since May 1983. pace through September; however, ship- Personal consumption expenditures ments weakened by more in the third fell sharply in September; purchases of quarter, and the aggregate inventorygoods plummeted and consumption of shipments ratio for the sector reached services, particularly transportation and its highest level in more than five years. recreation services, declined as well. In Wholesalers also experienced a sizable October, sales of light vehicles surged decline in inventories over July and to near-record levels in response to spe- August that resulted in a slight reduction cial financing packages offered by many in their aggregate inventory-sales ratio, automakers, but available information but that ratio was still in the upper end suggested that non-auto spending was of its range for the past two years. Retail weak. inventories climbed somewhat in July Residential building activity edged and August, but the sector's inventorydown during the August-September sales ratio was little changed in August period, and signs of some further soft- and was in the lower end of its range for ness had emerged in recent weeks. the past year. Nonetheless, in an environment of very The U.S. trade deficit in goods and low mortgage rates, residential construc- services contracted slightly in August tion had been sustained at a compara- after having changed little in July, and tively high level despite a weakening the deficit for July and August comlabor market and sluggish growth in per- bined was considerably smaller than sonal income. Sales of new and existing that for the second quarter. The value of homes slipped in September but were exports fell in the July-August period, not far below the near-record levels of with most of the drop occurring in capilast March. tal goods, consumer goods, and indus- Business capital spending on equip- trial supplies. The value of imports was ment and software fell sharply further down appreciably more than that of in the third quarter. Moreover, the exports, with decreases occurring in available information on orders and almost all major trade categories; autoshipments of nondefense capital goods motive products, food, and aircraft were suggested another steep drop in such the only exceptions. Recent information spending in the latter part of this year in indicated that foreign economic activity the current environment of eroding cor- had changed little in the third quarter, porate earnings and cash flows and a and some forward indicators and anecvery uncertain outlook for future sales dotal information pointed to reduced and earnings. The weakness in demand activity later in the year. Economic for durable equipment was spread across activity in the euro area and the United almost all categories of equipment but Kingdom appeared to be reviving in the was particularly prominent for high-tech summer months, but renewed softening goods, aircraft, automobiles, and trucks. stemming from a downturn in business Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 285 and consumer confidence seemed to believed that the increased evidence of have emerged in September and Octo- a faltering economy and the decidedly ber. Japan remained the weakest of the downside risks to the outlook called major foreign industrial economies; the for a further move. The additional rate sharp contraction in economic activity reduction would help limit the extent that began early in the year continued of the downturn and later would contribin the third quarter, and the unemploy- ute to an upturn. Moreover, the recent ment rate reached a record high in Sep- declines in equity prices and widening tember. Most major emerging-market of risk spreads tended to offset some of economies, with the notable exception the stimulative effects of earlier easings, of China, also were continuing to expe- and the relatively low level of inflation rience an economic slowdown that was and inflationary expectations provided related at least in part to weakness in the room to counter downside forces withindustrialized world. out incurring significant risks of higher Core consumer price inflation re- inflation. The members also believed mained at a relatively subdued pace in that the balance of risks remained August and September; and with energy weighted toward conditions that could prices having moderated over the past generate economic weakness in the foreyear, total consumer price inflation had seeable future. moved down, on a year-over-year basis, Federal funds traded at rates near the to the slower pace of its core com- Committee's target level over the interponent. Both the core consumer price meeting period. Most interest rates (CPI) index and the personal consump- declined significantly during the period tion expenditure (PCE) chain-type index even though the reduction in the target exhibited this general pattern. Core pro- level for the federal funds rate had ducer price inflation for finished goods been anticipated by market participants. also held at a low rate in the August- They apparently saw the Committee's September period and on a year-over- announcement and the subsequent year basis. With regard to labor costs, release of weaker-than-expected data as total hourly compensation of private portending further policy easing. With industry workers decelerated further in yields on private debt securities down the third quarter, despite a surge in bene- sharply and investors perhaps becoming fit costs, and also slowed noticeably on more confident about long-term busia year-over-year basis. Average hourly ness prospects, major indexes of equity earnings of production or nonsupervi- prices moved higher over the intermeetsory workers continued to rise in August ing period. and September at the relatively mod- In foreign exchange markets, the erate rate that had prevailed in earlier trade-weighted value of the dollar in months. terms of the major foreign currencies At its meeting on October 2, 2001, had increased slightly on balance since the Committee adopted a directive that the October meeting. Incoming data for called for maintaining conditions in re- the foreign industrial economies were serve markets consistent with a decrease weaker than expected, and market interof 50 basis points in the intended level est rates abroad declined in response to of the federal funds rate, to about reductions in policy interest rates in 2l/i percent. The members recognized Canada and the United Kingdom and to that monetary policy already had been market expectations that the European eased substantially this year, but they Central Bank would lower its policy Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

286 88th Annual Report, 2001 rates by year-end. The dollar moved estimate of the growth of the economy's down slightly on balance in terms of an potential output. The period of subpar index of the currencies of other impor- expansion was expected to foster an tant trading partners. The Brazilian real appreciable easing of pressures on was adversely affected by spillovers resources and some moderation in core from Argentina's financial difficulties, price inflation. while the Mexican peso rebounded from In the Committee's discussion of curits decline against the dollar in the wake rent and prospective economic condiof the September terrorist attacks. tions, members commented that wide- M2 changed little in October after a spread anecdotal reports supported surge in September that was related in statistical indications that the economy important measure to a temporary bulge was contracting, and they saw no sigin transaction deposits stemming largely nificant evidence that overall business from delayed settlements of security conditions were in the process of stabitrades in the aftermath of the terrorist lizing prior to recovering. While the attacks. On balance, M2 grew rapidly members continued to see a fairly brief over the September-October period, re- and limited decrease in economic activflecting the sharp drop in market interest ity as the most likely outcome, they also rates and perhaps the deposit of federal agreed that the risks to such a foretax rebates. M3 also increased rapidly cast were strongly tilted to the downover September and October, largely in side. Business investment expenditures conjunction with the expansion of M2. clearly seemed likely to continue to The debt of domestic nonfinancial sec- decline over coming months. On the tors grew at a moderate pace on balance other hand, consumer spending had held through August. up reasonably well thus far, but further The staff forecast prepared for this job losses could undermine consumer meeting emphasized the continuing confidence and spending. Looking furwide range of uncertainty surrounding ther ahead, the longer-term prospects the outlook in the wake of the Septem- for productivity and growth in the U.S. ber attacks. The mild downturn in eco- economy remained bright and an upturn nomic activity in the third quarter was during 2002 was a likely prospect. Such seen as likely to deepen over the remain- a recovery would be fostered by the der of the year and to continue for a time lagged stimulus from both fiscal and next year. However, the cumulative eas- monetary policies interacting with ing that had occurred in the stance of progress by business firms toward commonetary policy, coupled with the fiscal pleting their adjustments to overhangs stimulus already in place and prospec- in capital resources and excess inventive additional measures, would provide tories. However, the strength and timing support for economic activity. More- of the eventual recovery remained subover, the ongoing liquidation of inven- ject to question especially in light of the tories would eventually abate and give marked degree of uncertainty that sura sizable boost to production, while an rounded the prospects for further fiscal expected pickup in foreign economies policy legislation, developments in the would provide some support for U.S. war against terrorism, and weakness exports. As a result, economic expan- in foreign economies. In the context of sion was projected to resume and gradu- diminished pressures on labor and other ally gain strength through 2003, reach- resources, the members expected undering a rate around the staff's current lying consumer price inflation to remain Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 287 benign and possibly to drift lower over caution among households and by the coming quarters, abetted by the indirect decline in stock market wealth over the effects of generally weaker energy last year or so. Consumer confidence prices. was vulnerable to renewed terrorism and In their review of developments to further weakness in labor markets. in key sectors of the economy, mem- Housing activity, though still at a bers noted that surveys and anecdotal relatively elevated level, had displayed commentary pointed to a considerable signs of some slippage in recent months. decline in consumer confidence, though There were anecdotal reports of excess in the view of some members the inventories of unsold homes in some decline seemed less than might have areas, and members again cited indicabeen expected given prevailing circum- tions of particular softness in the highstances. Retail sales, led by a surge in price segment of the housing market. motor vehicles, had improved consider- Weakness in employment and more genably following a downturn in the weeks erally the rise in uncertainty were havafter September 11. Even so, retail sales ing a depressing effect on homebuilding were still generally below their levels activity, which likely would persist over prior to the terrorist attacks, and overall coming months. Nonetheless, low mortspending on consumer services had de- gage interest rates continued to provide celerated considerably, notably reflect- important support to homebuilding, and ing continuing weakness in expendi- in the absence of a much weaker econtures on airline travel and related travel omy than was currently anticipated or activities. The extraordinary increase in of a further sizable shock to consumer sales of light motor vehicles in October confidence, there appeared to be little clearly was propelled by exceptionally basis in ongoing trends and housing attractive financing incentives, but such finance conditions to expect substaninducements were temporary and many tial additional erosion in residential of the resulting sales undoubtedly bor- construction. rowed from the future. Still, the jump Business fixed investment currently in motor vehicle sales was a sign that seemed to be declining at an even faster underlying consumer confidence and rate than earlier in the year, and the willingness to spend had held up reason- sharp decrease in new orders of capital ably well in this period. Looking ahead, goods in September pointed to marked reports from retailer contacts were additional weakness over the months somewhat mixed; many anticipated rela- ahead. According to widespread anectively depressed holiday sales and where dotal reports, business confidence possible were making efforts to limit appeared to have worsened considerably buildups of holiday merchandise, while further since late summer in the context other retailers were confident that sales of a generally deteriorating outlook for would be reasonably well maintained, sales and earnings. In these circumalbeit generally somewhat below levels stances, business firms were likely to or growth rates experienced in previous persist in their efforts to reduce what holiday seasons. Beyond the months they viewed as excess capacity, notably immediately ahead, members antici- in high-tech and travel-related induspated that, in addition to a drop in motor tries. Some exceptions related to the vehicle sales to more sustainable levels, expansion of healthcare and securityconsumer spending was likely to be held enhancing facilities. However, the back by the persistence of widespread longer-term attractiveness of efficiency- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

288 88th Annual Report, 2001 inducing capital investment would at but prospects appeared to have diminsome point promote a robust upturn in ished for prompt passage of fiscal policy such expenditures. The timing remained initiatives that could significantly boost uncertain, but a number of members saw economic activity in the next several a reasonable prospect that the decline in quarters. expenditures for capital equipment and Business firms were continuing to software would abate early next year cut back production in efforts to adjust and that such spending probably would output to faltering demand and to pare turn up during the second half of the excess inventories. Even so, with year as businesses succeeded in better demand generally tending to be weaker aligning actual and desired capital than expected, inventory-sales ratios stocks. With regard to nonresidential had remained on the high side for many construction, widespread increases in firms and strong efforts to reduce invenvacancy rates around the country sug- tories were persisting, including efforts gested that the turnaround in overall by many retailers in light of their expecactivity might be more delayed despite tations that holiday sales would prove some near-term stimulus from recon- disappointing. The pace of inventory struction activity in New York City. In liquidation was thought likely to modergeneral and given prevailing wait-and- ate in coming quarters and subsequently see business attitudes, members believed turn to accumulation as inventories that the risks over the forecast horizon came into better balance with sales, remained in the direction of a shortfall with increasingly positive implications in capital expenditures from what were for overall production and economic already weak expectations. activity. A key uncertainty in the outlook for Weakness in foreign economies was investment spending was the outcome continuing to foster declines in U.S. of the ongoing Congressional debate exports in what appeared to be an relating to tax incentives for investment increasingly synchronous and mutually in equipment and software. Both the reinforcing pattern of economic activity passage and the specific contents of such among the world's nations. With recent legislation remained in question. More- indications that on the whole foreign over, several members stressed the economic activity was deteriorating difficulty of assessing the effectiveness somewhat further and by more than of temporary fiscal policy measures previously anticipated, members viewed directed at boosting investment expen- the risks for activity in foreign nations ditures. Though undoubtedly helpful in and their related demand for U.S. goods fostering greater capital spending while and services as tilted decidedly to the the tax incentives remained in place, downside. members expressed reservations about The considerable slack in labor the extent of the favorable effects in the markets, evidenced by both statistical nearer term when marked disincentives and widespread anecdotal reports, was existed for many firms to make capital expected to exert appreciable downward expenditures in the context of excess pressure on wage increases over the capacity, weak markets, and poor profit forecast period. Concurrently, however, opportunities. More generally, forecasts the favorable impact of wage disinflaof a reasonably vigorous rebound in the tion on business costs would be offset economy over 2002 depended in part in part by increasing costs of healthcare on expectations of added fiscal stimulus, insurance, slower gains in structural Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 289 productivity associated with reduced uncertainty about the course of the business capital investment, and by economy and the appropriate stance of the necessity to divert some resources policy. These members noted that polto enhance security. The passthrough icy was already accommodative. Indeed, effects of the substantial decline in policy had been eased substantially furenergy prices over the past year were a ther in September and October, and the favorable factor in the outlook for core effects of those actions and any added inflation. On balance, core consumer easing at this meeting would be felt price inflation was projected to remain mostly during the year ahead when fissubdued and quite possibly edge lower. cal stimulus and the inherent resilience In the Committee's discussion of pol- of the economy should already be boosticy for the intermeeting period ahead, all ing growth substantially. Some also the members indicated that they could were concerned that the more sizable support a proposal calling for further action in combination with an announceeasing in reserve conditions consistent ment of the Committee's continuing with a 50 basis point reduction in the concern about further economic weakfederal funds rate to a level of 2 percent. ness would lead markets to build in The heightened degree of uncertainty inappropriate expectations of even more and risk aversion following the terrorist monetary stimulus. attacks seemed to be having a pro- Most members, however, favored a nounced effect on business and house- 50 basis point reduction in the Commithold spending. The continued contrac- tee's target federal funds rate. These tion in the economy and marking down members stressed the absence of eviof most forecasts of inflation and dence that the economy was beginning resource utilization going forward to stabilize and some commented that strongly suggested the desirability of indications of economic weakness had further easing in the stance of policy. in fact intensified. Moreover, it was Although policy had been eased sub- likely in the view of these members that stantially in 2001, the forces restraining core inflation, which was already moddemand had been considerable, and a est, would decelerate further. In these variety of factors had limited the circumstances insufficient monetary polpassthrough of lower short-term interest icy stimulus would risk a more extended rates into long-term rates, equity prices, contraction of the economy and possibly bank lending rates, and the foreign even downward pressures on prices that exchange value of the dollar. In circum- could be difficult to counter with the stances in which inflation was already current federal funds rate already quite reasonably low and pressures on low. Should the economy display unanresources and prices were likely to abate ticipated strength in the near term, the further in coming months, the risks were emerging need for a tightening action quite small that additional monetary would be a highly welcome developstimulus aimed at bolstering the econ- ment that could be readily accommoomy would foster a pickup in inflation. dated in a timely manner to forestall any A number of members noted that the potential pickup in inflation. choice between 25 and 50 basis points All the members indicated that with of easing was a close call. Three favored the risks to the economy clearly tilted a smaller move on balance, although toward further weakness, they could they could accept the larger decrease in vote in favor of retaining a statement to the current environment of substantial that effect in the press statement to be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

290 88th Annual Report, 2001 released shortly after today's meeting. The meeting adjourned at 1:20 p.m. Several stressed that such a statement did not constitute a commitment by the Donald L. Kohn Committee to ease policy further at the Secretary next meeting. While the members agreed that significant further weakness in the economy might indeed warrant additional easing, a decision in that Meeting Held on regard would depend entirely on the December 11, 2001 nature of future economic and financial A meeting of the Federal Open Market developments. Committee was held in the offices of At the conclusion of this discussion, the Board of Governors of the Federal the Committee voted to authorize and Reserve System in Washington, D.C., direct the Federal Reserve Bank of New on Tuesday, December 11, 2001, at York, until it was instructed otherwise, 9:00 a.m. to execute transactions in the System Account in accordance with the follow- Presenting domestic policy directive: Mr. Greenspan, Chairman Mr. McDonough, Vice Chairman The Federal Open Market Committee Ms. Bies seeks monetary and financial conditions that Mr. Ferguson will foster price stability and promote sus- Mr. Gramlich tainable growth in output. To further its long- Mr. Hoenig run objectives, the Committee in the imme- Mr. Meyer diate future seeks conditions in reserve Ms. Minehan markets consistent with reducing the federal Mr. Moskow funds rate to an average of around 2 percent. Mr. Olson Mr. Poole The vote encompassed approval of Messrs. Jordan, McTeer, Santomero, the sentence below for inclusion in the and Stern, Alternate Members press statement to be released shortly of the Federal Open Market after the meeting. Committee Messrs. Broaddus, Guynn, and Parry, Against the background of its long-run Presidents of the Federal Reserve goals of price stability and sustainable eco- Banks of Richmond, Atlanta, and nomic growth and of the information cur- San Francisco respectively rently available, the Committee believes that the risks continue to be weighted mainly Mr. Kohn, Secretary and Economist toward conditions that may generate eco- Mr. Bernard, Deputy Secretary nomic weakness in the foreseeable future. Mr. Gillum, Assistant Secretary Ms. Smith, Assistant Secretary Votes for this action: Messrs. Greenspan, Mr. Mattingly, General Counsel McDonough, Ferguson, Gramlich, Hoe- Mr. Baxter, Deputy General Counsel nig, Kelley, Meyer, Ms. Minehan, Messrs. Ms. Johnson, Economist Moskow and Poole. Votes against this Mr. Reinhart, Economist action: None. Mr. Stockton, Economist Ms. Cumming, Messrs. Fuhrer, Hakkio, It was agreed that the next meeting of Howard, Lindsey, Rasche, the Committee would be held on Tues- Slifman, and Wilcox, Associate day, December 11, 2001. Economists Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 291 Mr. Kos, Manager, System Open Mr. Weber, Senior Research Officer, Market Account Federal Reserve Bank of Minneapolis Mr. Winn, Assistant to the Board, Office of Board Members, Prior to this meeting, Ms. Susan Schmidt Board of Governors Bies and Mr. Mark W. Olson had executed their oaths of office as members of the Board Messrs. Ettin and Madigan, Deputy of Governors and the Federal Open Market Directors, Divisions of Research Committee. and Statistics and Monetary Affairs respectively, Board By unanimous vote, the minutes of of Governors the meeting of the Federal Open Market Committee held on November 6, 2001, Mr. Simpson, Senior Adviser, Division were approved. of Research and Statistics, The Manager of the System Open Board of Governors Market Account reported on recent Mr. Connors, Associate Director, developments in foreign exchange mar- Division of International Finance, kets. There were no open market opera- Board of Governors tions in foreign currencies for the System's account in the period since the Messrs. Oliner and Struckmeyer, previous meeting. Associate Directors, Division The Manager also reported on develof Research and Statistics, opments in domestic financial markets Board of Governors and on System open market transactions Mr. Whitesell, Assistant Director, in government securities and securities Division of Monetary Affairs, issued or fully guaranteed by federal Board of Governors agencies during the period November 6, 2001, through December 10, 2001. By Mr. Skidmore, Special Assistant to the unanimous vote, the Committee ratified Board, Office of Board Members, these transactions. Board of Governors The Committee then turned to a discussion of the economic and financial Ms. Low, Open Market Secretariat Assistant, Office of Board outlook and the conduct of monetary Members, Board of Governors policy over the intermeeting period ahead. A summary of the economic and Mr. Rasdall, First Vice President, financial information available at the Federal Reserve Bank of time of the meeting and of the Commit- Kansas City tee's discussion is provided below. The information reviewed at this Messrs. Eisenbeis and Goodfriend, meeting indicated that economic activ- Mses. Krieger and Mester, and ity had continued to decline into the Mr. Rosenblum, Senior Vice Presidents, Federal Reserve Banks fourth quarter, although some very of Atlanta, Richmond, New York, recent data suggested that the rate Philadelphia, and Dallas of decline might be moderating. Labor respectively market conditions had worsened further, especially in manufacturing and related Messrs. Bryan, Judd, and Krane, Vice industries, and industrial production Presidents, Federal Reserve Banks had fallen in October and probably also of Cleveland, San Francisco, and Chicago respectively in November. However, purchases of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

292 88th Annual Report, 2001 motor vehicles were very strong in both ber decline, and were slightly above months, and other household and busi- the third-quarter average. Purchases of ness spending seemed to have recovered motor vehicles surged in response to somewhat from the sharp September aggressive zero-rate financing packages decline. Energy prices were moderating offered by automakers, while spending noticeably in response to lower world- on other goods made a partial recovery wide demand, and core price inflation from the September drop. Outlays on remained subdued. consumer services strengthened in Octo- The labor market deteriorated sub- ber, but they remained below their thirdstantially in October and November. quarter average. Nonfarm payroll employment fell sig- Residential building activity softened nificantly in both months, with the larg- somewhat further in October, but in an est job losses occurring in manufac- environment of very low mortgage rates, turing, help supply services, and retail homebuilding remained at a relatively trade. Steep cuts in employment also high level despite the weak labor market occurred in industries directly affected and sluggish growth in personal income. by the September attacks, notably trans- Demand for single-family housing had portation, lodging, and tourism. Among held up relatively well. Sales of new the few industries that had not been single-family homes changed little in adversely affected were health services, October and had been relatively steady which continued to add workers, and since May, while sales of existing homes finance, insurance, and real estate, partially retraced the sharp drop-off that which maintained stable employment on occurred in September. balance. The heavy job losses boosted Recent information suggested that the unemployment rate to 5.7 percent in the downward trend in business spend- November. ing on durable equipment and software Industrial production fell sharply fur- might be moderating somewhat. After ther in October, and the cuts continued plunging during the spring and summer, to be spread widely across groups and orders and shipments of nondefense industries, reflecting weak demand for capital goods turned up in October. Of business equipment, efforts by firms to particular note, both orders and shippare inventories, and foreign competi- ments of office and computing equiption. Motor vehicle assemblies slowed ment increased in October after having for a third straight month from the rela- declined sharply for most of the year. tively high levels attained in the spring For durable equipment in general, shipand early summer, and the output of ments had exceeded new orders since high-technology goods remained on a the first of the year, and as a result the steep downward trajectory, though a few backlog of unfilled orders was now positive signs had begun to emerge in below its level of a year ago. Nonresithe semiconductor and computer indus- dential construction also had been weak tries. The rate of utilization of total during the spring and summer, reflectmanufacturing capacity contracted fur- ing an upward trend in vacancy rates ther in October and was at a level sub- and uncertainties regarding rents and stantially below the trough reached in property values. Although spending on the 1990-91 recession. industrial structures dropped further in Personal consumption expenditures October, outlays for ^office buildings and are estimated to have rebounded in other commercial structures picked up October, following the large Septem- noticeably. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 293 The book value of business inven- attacks. Additional monetary easing tories fell steeply in the third quarter. actions by the European Central Bank, The bulk of the reduction occurred in the Bank of England, and the Bank the manufacturing sector, but the sharp of Canada contributed to that brighter drop in stocks was matched by a con- outlook. Japan remained the weakest of traction in shipments and the aggre- the major foreign industrial economies, gate stock-shipments ratio for the sector and the available information suggested remained at a very high level. In Octo- further contraction in economic activity ber, an additional sizable decline in and worsened labor market conditions manufacturing stocks resulted in a this quarter. Economic conditions in decrease in the sector's aggregate stock- the major emerging-market countries shipments ratio, though it remained remained weak, but there were signs elevated. Wholesalers also experienced that the worst might be over in some a sizable drop in inventories in the third of the Asian economies most affected quarter that produced a slight reduction by the global downdraft in the highin their aggregate inventory-sales ratio, tech sector. Economic growth in China but the latter was still in the upper por- seemed to have slowed a little. In Latin tion of its range for the past two years. America, Argentina remained mired in Retail inventories and the sector's recession, and the global slowdown coninventory-sales ratio both edged up in tinued to depress the economies of other the third quarter. Nonetheless, the sec- nations in that region. tor's ratio remained in the lower end of Core consumer price inflation reits range for the past year. mained at a relatively subdued pace in The U.S. trade deficit in goods and September and October, and a renewed services narrowed significantly in Sep- decline in energy prices in October contember and the third quarter, though tributed to a sizable drop in total conmost of those declines reflected esti- sumer price inflation during the twelve mated payments by foreign insurers months ended in October when comrelated to the events of September 11. pared with the previous twelve-month Abstracting from those payments, the period. The core personal consumption trade deficit fell only a little in the third expenditure (PCE) chain-type price quarter as the value of exports fell by index also indicated that consumer inflaless than the value of imports. The soft- tion was significantly lower during the ness in exports was widespread, with year ended in October, while the core steep declines occurring in consumer consumer price index (CPI), with its goods, capital goods, and industrial sup- narrower range of spending categories, plies. Reductions in imports also were had changed little over the past year. widespread, and as with exports, capital Core producer prices for finished goods goods and industrial supplies were down edged up on balance during September sharply. The limited available informa- and October, but inflation as measured tion suggested a further weakening of by this index moderated slightly on a economic activity in the foreign indus- year-over-year basis. With regard to trial countries in the current quarter, but labor costs, growth of average hourly there were some indications of a pos- earnings of production or nonsupersible brightening of the economic out- visory workers slowed in September look in the period ahead despite a sharp and October from the relatively moderdecline in business confidence in the ate rate that had prevailed in earlier aftermath of the September terrorist months. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

294 88th Annual Report, 2001 At its meeting on November 6, 2001, In foreign exchange markets, the the Committee adopted a directive that trade-weighted value of the dollar in called for implementing conditions terms of the major foreign currencies in reserve markets consistent with a increased slightly on balance over the decrease of 50 basis points in the intermeeting period; the release of intended level of the federal funds better-than-expected U.S. economic data rate, to about 2 percent. The members lifted the dollar early in the intermeeting referred to the heightened degree of period, but subsequent data releases led uncertainty and risk aversion following to some erosion of that gain. Abroad, the terrorist attacks that was having a central bank policy rates were lowered significant effect on business and house- in the euro area, England, and Canada in hold spending, and they noted that the response to indications of flagging ecosubstantial easing of monetary policy nomic activity. In Japan, disappointing that had been put in place this year had economic news and comments by Japanot shown through fully to long-term nese officials about possible interveninterest rates, equity prices, bank lend- tion to weaken the yen contributed to a ing rates, and the foreign exchange decline in that currency. Meanwhile, the value of the dollar. In these circum- dollar was about unchanged on balance stances, with price inflation relatively in terms of an index of the currencies low and pressures on prices and of other important trading partners. The resources likely to ebb further, the mem- Mexican peso changed little on balance, bers concluded that further monetary the Brazilian real firmed despite the stimulus would provide some added deepening problems of Argentina, and insurance against a more extended con- the Korean won rose against the backtraction of the economy at little risk ground of incoming data that suggested of a pickup in inflation. The members the persistence of resilient domestic also believed that the balance of risks demand. remained weighted toward conditions M2 growth in November was robust that could generate economic weakness though well below the average pace of in the foreseeable future. the two previous months. Liquid depos- Federal funds traded at rates close to its continued to increase rapidly, reflectthe Committee's target level of 2 per- ing the sharp drop in market interest cent during the intermeeting period. rates this year, but inflows to retail Against the background of better-than- money funds slowed as the economic expected incoming economic data and outlook improved and the equity marof favorable news on military operations kets rallied. M3 expansion remained at a in Afghanistan, short-term interest rates very high rate in November, bolstered declined a little over the intermeeting by the growth of M2 and heavy bank interval while intermediate- and long- acquisitions of nondeposit liabilities. term Treasury rates rose substantially. The debt of domestic nonfinancial sec- With market concerns about the eco- tors grew at a moderate pace on balance nomic outlook diminishing, yields on through October. investment-grade corporate debt securi- The staff forecast prepared for this ties increased considerably less than meeting suggested that economic activthose on comparable-maturity Treasur- ity would extend its decline for a time ies, rates on speculative-grade bonds fell in 2002 but then would begin to turn sharply, and major indexes of equity upward. The recovery would be supprices moved significantly higher. ported in part by the cumulative easing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 295 that had occurred in the stance of mone- economic weakness. Among those risks, tary policy, along with the fiscal stimu- members cited the apparently reduced lus already in place and some assumed prospects for additional fiscal stimulus additional measures not yet enacted. legislation, the vulnerability of current The turnaround in the economy and the stock market valuations should forecasts gradual strengthening of the recovery of a robust rebound in earnings fail to would also be fostered by the comple- materialize, the possibility of further tion of downward adjustments to inven- terrorist incidents, and especially the tories, a marked slowing in the contrac- potentially adverse effect on consumer tion of business capital investments, and confidence and spending of additional the added purchasing power arising deterioration in labor market conditions. from the recent declines in oil prices. Nonetheless, with the critical consumer Economic expansion was projected to sector holding up relatively well thus strengthen appreciably by the second far, members continued to anticipate an half of 2002 as the climate for business upturn in the economy during the year fixed investment improved and a ahead in light of the progress already strengthening of foreign economies led made by business firms in reducing to somewhat greater demand for U.S. excess inventories and unwinding capiexports. Subpar expansion in the next tal overhangs, and the beneficial effects few quarters was expected to foster an of the decline of energy prices. The appreciable further easing of pressures lagged effects of the substantial easing on resources and some moderation in in monetary policy this year and the core price inflation. fiscal stimulus measures already enacted In the Committee's discussion of cur- into law were expected to buttress rent and prospective economic develop- demand and economic recovery over the ments, members commented that the next year. The outlook for inflation was economy clearly was continuing to con- viewed as favorable, given the slack in tract, led by further inventory liquida- labor and product markets, subdued tion and ongoing reductions in capital inflationary expectations, and the prosspending. The decline in inventories was pect that aggregate demand would likely to abate before long, boosting pro- remain well below the economy's duction, but the course of a recovery potential output over the next several would depend on the behavior of final quarters. demand. The recent statistical and anec- In the consumer sector, a major downdotal information was more mixed than side concern was the possibility that had been the case earlier and pointed on substantial further deterioration in labor balance toward some moderation in the market conditions, which was widely decline of overall final demand; for the anticipated, could have a significant first time in a long while the incoming inhibiting effect on consumer confidata did not call for a downward revi- dence, incomes, and spending. Other sion to current forecasts. The members potentially adverse economic factors agreed, however, that the evidence of cited by members included rising conemerging stabilization in the economy sumer debt burdens, the risk of a downremained quite tentative and the timing turn in the stock market, and the recent and strength of the eventual recovery rise in mortgage interest rates. That continued to be surrounded by a high increase, among other things, would degree of uncertainty, with the risks to impinge on the extraction of capital the economy still clearly tilted toward gains from the turnover or refinancing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

296 88th Annual Report, 2001 of existing homes, which had provided rent levels over the quarters immediimportant support for consumer spend- ately ahead. ing. However, consumer expenditures Business capital spending appeared to appeared to have been relatively well be continuing to decline at a rapid pace sustained thus far, evidently in part the as business firms persisted in their result of widespread price discounting efforts to bring production capacity into and low interest rates, including zero better alignment with forecasts for the rates on many motor vehicle loans, that growth of sales. With the near-term outwere helping to overcome a currently look for sales and profits remaining high degree of caution and price con- relatively depressed, the prospects for a sciousness among consumers. More- significant pickup in spending for equipover, recent survey evidence suggested ment and software did not seem favorthat consumer confidence might be sta- able for the period immediately ahead. bilizing after earlier declines. The sig- Businesses were reported to be very caunificant decreases that had occurred in tious, with many business executives the prices of fuel oil and gasoline were a awaiting concrete indications of improvpositive factor that would continue to ing markets before proceeding with bolster household spending for a while. planned investment expenditures. Even Looking ahead, it was unclear how the so, members referred to some tentative various factors affecting consumers indications, such as an uptick in orders would interact, though apart from a for durable goods and expectations of likely downward adjustment in sales improving sales of some high-tech prodof motor vehicles to a more sustain- ucts, that might be signaling a turnable level following their recent surge, around in overall capital spending over members generally anticipated that solid coming quarters. Further progress in gains in consumer spending would adjusting capacity and strengthening underpin the economic recovery. profit expectations would at some point Like consumer spending, new home lead to an upturn in spending for new construction and sales had displayed equipment and software, but business considerable resilience in recent months, contacts indicated that the timing for apparently in large part as a result of individual firms would vary considerrelatively attractive mortgage interest ably, with delays extending in some rates and perhaps to some extent as cases into 2003. New construction of a consequence of favorable weather nonresidential structures had declined conditions in many parts of the coun- sharply over the past several quarters, try. Though overall housing activity and with vacancy rates still rising in remained at a high level, members many key markets a further sizable reported softening activity in a few decline was anticipated over the year areas of the nation, notably in apart- ahead. Some members reported that ment units in some major cities. Sales of higher insurance costs since the Septemhigh-end houses also continued to be ber 11 terrorist attacks were exerting an relatively depressed. With regard to the inhibiting effect on some nonresidential outlook, the recent rise in mortgage construction activity in their regions. interest rates could be expected to have The liquidation of business invena retarding effect on housing activity. tories appeared to have accelerated in Even so, in the absence of seriously the current quarter, fostered to an imporadverse shocks to confidence, housing tant extent by very large declines in activity seemed likely to hold near cur- stocks of motor vehicles. Inventories Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 297 now seemed to be approaching levels foreign economic activity would depend where firms would start to reduce their more on recovery in the United States. rate of liquidation early next year and Expectations that output would perhaps turn to inventory accumulation remain below the economy's potential as the year ahead progressed, giving a for some time led many members to boost to production and incomes. Anec- believe that underlying inflation might dotal reports provided some support well edge lower from its currently modfor such an outlook, including wide- est levels. Reinforcing this outlook was spread indications that retail inventories recent evidence of somewhat faster were already at quite lean levels, even than anticipated productivity growth, the outside the motor vehicle sector. At prospect that world economic condithe same time, recent survey results tions would hold down energy prices, pointed to less discomfort with current and a sharp drop in near-term inflation inventory levels though some further expectations of households as reported inventory correction was anticipated in in recent surveys. Moreover, labor commanufacturing. pensation appeared to be on a decele- Further fiscal stimulus remained rating trend despite rapid increases in under active debate in the Congress, the cost of healthcare and other worker but with the rapid approach of the date benefits. In these circumstances and for adjourning the current session, it given the persistence of highly comwas now questionable whether the leg- petitive conditions in domestic and islation would be enacted this year. international markets, the ability of most Although an expansionary fiscal policy businesses to raise prices was likely was already in place as a result of earlier to remain quite limited or even nonlegislation and more stimulus might be existent. While a number of members legislated next year, especially if the referred to the possibility of further economy continued to deteriorate, mem- disinflation, some also noted that the bers saw an additional boost to near- risks of a deflationary spiral seemed term economic activity from new fis- very limited, given the economy's selfcal initiatives as increasingly unlikely. correcting resilience and the ongoing Some members also commented on effects of stimulative fiscal and monemounting state and local government tary policies. deficits, largely the result of diminishing In the Committee's discussion of income and sales tax receipts, and the policy for the intermeeting period ahead, adverse implications for governmental all but one member indicated their supbudgets and spending in various parts of port of a proposal to ease reserve conthe country. ditions slightly further, consistent with Reflecting unusually synchronous a 25 basis point reduction in the federal global economic developments, foreign funds rate to a level of \3A percent. nations also were experiencing sluggish While there were signs that the weakeconomic activity and in many instances ness in aggregate demand might be abatactual recessions. The weakness was ing, those signs were still quite limited reflected in declining U.S. exports. and tentative. For now, contractionary Members saw little prospect that foreign forces continued to depress overall economies would strengthen sufficiently economic activity, and subpar economic on their own to provide significant inde- performance seemed likely to persist, at pendent impetus to U.S. exports, at least least for a time. Moreover, a number of over the near term. Instead, an upturn in members saw substantial risks that eco- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

298 88th Annual Report, 2001 nomic activity could even fall short desirability of signaling that view to the of a projection of stabilization in the public. near term and moderate recovery later Given their views about the risks to next year. In these circumstances, the the economy, the members supported consequences of inactivity at this the retention of the sentence in the press meeting could turn out to be con- statement to be released shortly after siderable, and several members viewed this meeting indicating that the risks an easing action as a measure of insur- continued to be weighted mainly toward ance against the potential for greater or conditions that could foster economic more prolonged economic weakness weakness in the foreseeable future. Such than they currently anticipated. If a a statement was not intended to conmodest easing action taken today turned vey the impression that the Committee out to be unneeded, the Committee necessarily contemplated further easing would have ample opportunity to actions. Members felt that the reduced reverse its action without incurring any size of today's action along with a referreal risk of allowing inflationary pres- ence in the statement to the emergence sures to gather momentum, given the of signs that weakness in the economy projected degree of slack in resource use could be moderating would tend to mitiand the current absence of significant gate such an interpretation. inflationary pressures. The risk that a At the conclusion of this discussion, policy reversal, should it prove to be the Committee voted to authorize and needed in the near term, would foster direct the Federal Reserve Bank of significant market unsettlement seemed New York, until it was instructed otherlimited in light of widespread expecta- wise, to execute transactions in the Systions of some further easing at this meet- tem Account in accordance with the foling to be followed by a policy turn- lowing domestic policy directive: around next year. At the same time, members empha- The Federal Open Market Committee sized that the stance of policy was seeks monetary and financial conditions already quite accommodative, that much that will foster price stability and promote of the effects of recent easings had yet sustainable growth in output. To further its to be felt, and that tentative signs sug- long-run objectives, the Committee in the immediate future seeks conditions in reserve gested the economy and the economic markets consistent with reducing the fedoutlook were beginning to stabilize. In eral funds rate to an average of around these circumstances several saw a deci- PA percent. sion to ease as a close call, but they favored it on balance given their weight- The vote encompassed approval of ing of the possible consequences should the sentence below for inclusion in the restraining forces in the economy persist press statement to be released shortly to a greater extent than they currently after the meeting: expected. In the view of one member, policy was already sufficiently stimulative and the outlook improved enough to Against the background of its long-run warrant a pause to assess further devel- goals of price stability and sustainable ecoopments. In any event, members com- nomic growth and of the information currently available, the Committee believes that mented that the Committee's easing the risks continue to be weighted mainly cycle was likely to be approaching its toward conditions that may generate ecocompletion, and several suggested the nomic weakness in the foreseeable future. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 299 Votes for this action: Messrs. Greenspan, give the current policy more time to and McDonough, Ms. Bies, Messrs. Fer- work through the economy. It was also guson, Gramlich, Meyer, Ms. Minehan, his position that reducing the federal Messrs. Moskow, Olson, and Poole. Votes funds rate at this meeting could increase against this action: Mr. Hoenig. Absent and not voting: Mr. Kelley. interest rate volatility by creating an expectation of a faster or a more aggressive reversal of policy. Mr. Hoenig dissented because he It was agreed that the next meeting preferred to leave the federal funds rate of the Committee would be held on unchanged. He judged that a 2 percent Tuesday-Wednesday, January 29-30, federal funds rate was already quite 2002. stimulative and that a more stimulative The meeting adjourned at 1:20 p.m. policy was not needed. Following the rapid and aggressive policy actions Donald L. Kohn already taken, it would be prudent to Secretary Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

301 Litigation During 2001 the Board of Governors ing the court of appeals's determination was a party in seven lawsuits or appeals requiring a 10 percent surcharge and filed that year and was a party in thir- prejudgment interest on the penalty teen other cases pending from previous imposed. On January 29, 2001, the court years, for a total of twenty cases; in approved a settlement and terminated 2000, the Board had been a party in a the action. total of twenty-seven cases. None of the lawsuits or appeals filed in 2001 raised Litigation under the questions under the Bank Holding Com- Gramm-Leach-Bliley Act pany Act. As of December 31, 2001, eight cases were pending. Trans Union LLC v. Federal Trade Commission, et al, No. 01-5202 (D.C. Circuit, filed June 4, 2001), is an appeal Judicial Review of Board Orders of a district court order upholding chalunder the Bank Holding lenged provisions of an interagency Company Act rule regarding Privacy of Consumer Dime Bancorp, Inc. v. Board of Gover- Financial Information (145 F. Supp. nors, No. 00-4249 (2nd Circuit, filed 2d 6, April 30, 2001). The action was December 11, 2000), was a petition for consolidated with Individual Reference review of a Board order dated Sep- Services Group, Inc., v. Board of Govtember 27, 2000, approving the applica- ernors, No. 01-5175 (D.C. Circuit, filed tions of North Fork Bancorporation, May 25, 2001), Reed Elsevier, Inc. v. Inc., Melville, New York, to acquire Board of Governors, No. 00-1289 (D.C. control of Dime Bancorp, Inc., and to Circuit, filed June 30, 2000), and related thereby acquire its wholly owned sub- petitions for review filed against other sidiary, The Dime Savings Bank of New federal agencies challenging the same York, FSB, both of New York, New rules. On August 1, 2001, all appeals York (86 Federal Reserve Bulletin 767). and petitions other than Trans Union The petition was dismissed on the par- LLC were dismissed on the motion of ties' stipulation on July 23, 2001. the appellants and petitioners. Litigation under the Financial Other Actions Institutions Supervisory Act Community Bank & Trust v. United Board of Governors v. Pharaon, No. States, No. 01-571C (Court of Fed- 91-CIV-6250 (S.D. New York, filed eral Claims, filed October 3, 2001), September 17, 1991), was an action is an action challenging on constitubrought to recover assets of an indi- tional grounds the failure to pay interest vidual subject to a civil money penalty on reserve accounts held at Federal imposed by the Board. The case was Reserve Banks. remanded from the U.S. Court of Emran v. Greenspan, No. Appeals for the Second Circuit for deter- l:01CV1992 (D. District of Columbia, mination of the penalty amount follow- filed September 20, 2001), was an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

302 88th Annual Report, 2001 employment discrimination claim. On 2000), was an appeal of the district December 21, 2001, the case was dis- court's dismissal of an action under the missed by stipulation of the parties. Federal Tort Claims Act alleging viola- Laredo National Bancshares, Inc. v. tion of bank supervision requirements. Whalen v. Board of Governors, No. 01- On May 31, 2001, the court of appeals CV-134 (S.D. Texas, removed on Sep- affirmed the district court judgment. tember 5, 2001, from Webb County, A petition for certiorari (No. 01-5654, Texas, district court), is a third-party filed August 6, 2001) was denied by the petition seeking indemnification or con- U.S. Supreme Court on October 1, 2001. tribution from the Board in connection Bettersworth v. Board of Governors, with a claim asserted against defendant No. 00-50262 (5th Circuit, filed Whalen alleging tortious interference April 14, 2000), was an appeal of the with a contract. district court's dismissal of appellant's Radfar v. United States, No. Privacy Act claims. On April 12, 2001, l:01CV1292 (D. District of Columbia, the court denied the petition for review. filed June 11, 2001), is an action under A petition for certiorari (No. 01-444, the Federal Tort Claims Act for injury filed September 10, 2001) was denied on Board premises. by the U.S. Supreme Court on Novem- Howe v. Bank for International Settle- ber 13, 2001. ments, No. 00CV12485 RCL (D. Massa- Albrecht v. Board of Governors, chusetts, filed December 7, 2000), is No. 00-CV-317 (CKK) (D. District of an action seeking damages in connec- Columbia, filed February 18, 2000), tion with gold market activities and the is an action challenging the method of repurchase by the Bank for Interna- funding of the retirement plan for certional Settlements of its privately owned tain Board employees. shares. Artis v. Greenspan, No. l:99CV02073 Barnes v. Reno, No. l:00CV02900 (EGS) (D. District of Columbia, filed (D. District of Columbia, filed Decem- August 3, 1999), is an employment disber 4, 2000), was a civil rights action. crimination action. An identical action, On June 13, 2001, the district court dis- No. l:00CV0400 (filed February 22, missed the action. 2001), was consolidated with this action. Guerrero v. United States, No. 99- Nelson v. Greenspan, No. 6771 (E.D. California, service effected 1-.99CV00215 (EGS) (D. District of November 21, 2000), was a suit brought Columbia, filed January 28, 1999), was by a prisoner. On October 30, 2001, the an employment discrimination comdistrict court dismissed the action. plaint. On August 15, 2001, the court El Bey v. United States, No. 00-5293 granted the Board's motion for sum- (D.C. Circuit, filed August 31, 2000), mary judgment and dismissed the case. was an appeal of a district court order In Fraternal Order of Police v. Board dismissing a pro se action against the of Governors, No. 98-3116 (D. District Federal Reserve and other defendants of Columbia, filed December 22, 1998), as lacking an arguable basis in law. On plaintiff seeks a declaratory judgment January 11, 2001, the court dismissed regarding the Board's labor policy govthe appeal. erning Federal Reserve Banks. • Sedgwick v. Board of Governors, No. 00-16525 (9th Circuit, filed August 16, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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Federal Reserve System Organization 305 Board of Governors December 31,2001 Term expires January 31, ALAN GREENSPAN, of New York, Chairman1 2006 ROGER W. FERGUSON, JR., of Massachusetts, Vice Chairman1 2014 LAURENCE H. MEYER, of Missouri 2002 EDWARD W. KELLEY, JR., of Texas2 2004 EDWARD M. GRAMLICH, of Virginia 2008 MARK W. OLSON, of Maryland 2010 SUSAN S. BIES, of Tennessee 2012 Officers OFFICE OF BOARD MEMBERS LEGAL DIVISION—Continued Lynn S. Fox, Assistant to the Board Cary K. Williams, Assistant General Michelle A. Smith, Assistant to the Board Counsel Donald J. Winn, Assistant to the Board Donald L. Kohn, Adviser to the Board OFFICE OF THE SECRETARY Jennifer J. Johnson, Secretary Winthrop P. Hambley, Deputy Robert deV. Frierson, Deputy Secretary Congressional Liaison Margaret M. Shanks, Assistant Secretary Normand R.V. Bernard, Special Assistant to the Board John Lopez, Special Assistant DIVISION OF INTERNATIONAL FINANCE to the Board Karen H. Johnson, Director Bob Stahly Moore, Special Assistant David H. Howard, Deputy Director to the Board Thomas A. Connors, Associate Director Rosanna Pianalto-Cameron, Special Dale W. Henderson, Associate Director Assistant to the Board Richard T. Freeman, Deputy Associate David Skidmore, Special Assistant Director to the Board William L. Helkie, Deputy Associate Director LEGAL DIVISION Steven B. Kamin, Deputy Associate J. Virgil Mattingly, Jr., General Counsel Director Scott G. Alvarez, Associate General Jon W. Faust, Assistant Director Counsel Joseph E. Gagnon, Assistant Director Richard M. Ashton, Associate Michael P. Leahy, Assistant Director General Counsel D. Nathan Sheets, Assistant Director Kathleen M. O'Day, Associate General Ralph W. Tryon, Assistant Director Counsel Stephanie Martin, Assistant General DIVISION OF MONETARY AFFAIRS Counsel Vincent R. Reinhart, Director Ann Misback, Assistant General Counsel David E. Lindsey, Deputy Director Stephen L. Siciliano, Assistant General Brian F. Madigan, Deputy Director Counsel William C. Whitesell, Deputy Associate Katherine H. Wheatley, Assistant General Director Counsel James A. Clouse, Assistant Director 1. The designations as Chairman and Vice Chairman expire on June 20, 2004, and October 5, 2003, respec- William B. English, Assistant Director tively, unless the service of these members of the Board Richard D. Porter, Senior Adviser shall have terminated sooner. Digitized fo2r. FRResAigSneEdR D ecember 31, 2001. http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

306 88th Annual Report, 2001 Board of Governors—Continued DIVISION OF RESEARCH Barbara J. Bouchard, Assistant Director AND STATISTICS Angela Desmond, Assistant Director David J. Stockton, Director James A. Embersit, Assistant Director Edward C. Ettin, Deputy Director Charles H. Holm, Assistant Director David W. Wilcox, Deputy Director Heidi Willmann Richards, Assistant Myron L. Kwast, Associate Director Director Stephen D. Oliner, Associate Director William G. Spaniel, Assistant Director Patrick M. Parkinson, Associate Director David M. Wright, Assistant Director Lawrence Slifman, Associate Director William C. Schneider, Jr., Project Director, Charles S. Struckmeyer, Associate Director National Information Center Joyce K. Zickler, Deputy Associate Director DIVISION OF CONSUMER J. Nellie Liang, Assistant Director AND COMMUNITY AFFAIRS Stuart Wayne Passmore, Assistant Director Dolores S. Smith, Director David L. Reifschneider, Assistant Director Glenn E. Loney, Deputy Director Janice Shack-Marquez, Assistant Director Sandra F. Braunstein, Assistant Director William L. Wascher III, Assistant Director Maureen P. English, Assistant Director Alice Patricia White, Assistant Director Adrienne D. Hurt, Assistant Director Glenn B. Canner, Senior Adviser Irene Shawn McNulty, Assistant Director David S. Jones, Senior Adviser Thomas D. Simpson, Senior Adviser DIVISION OF FEDERAL RESERVE BANK OPERATIONS AND PAYMENT SYSTEMS Louise L. Roseman, Director DIVISION OF BANKING SUPERVISION Paul W. Bettge, Associate Director AND REGULATION Jeffrey C. Marquardt, Associate Director Richard Spillenkothen, Director Kenneth D. Buckley, Assistant Director Stephen C. Schemering, Deputy Director Joseph H. Hayes, Jr., Assistant Director Herbert A. Biern, Senior Associate Edgar A. Martindale III, Assistant Director Director Marsha W. Reidhill, Assistant Director Roger T. Cole, Senior Associate Director Jeff J. Stehm, Assistant Director William A. Ryback, Senior Associate Jack K. Walton II, Assistant Director Director Gerald A. Edwards, Jr., Associate Director OFFICE OF STAFF DIRECTOR Stephen M. Hoffman, Jr., Associate FOR MANAGEMENT Director Stephen R. Malphrus, Staff Director for James V. Houpt, Associate Director Management Jack P. Jennings, Associate Director Sheila Clark, Equal Employment Michael G. Martinson, Associate Director Opportunity Programs Director Molly S. Wassom, Associate Director Howard A. Amer, Deputy Associate MANAGEMENT DIVISION Director William R. Jones, Director Norah M. Barger, Deputy Associate Stephen J. Clark, Associate Director Director Darrell R. Pauley, Associate Director Betsy Cross-Jacowski, Deputy Associate David L. Williams, Associate Director Director Christine M. Fields, Assistant Director Deborah P. Bailey, Assistant Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 307 Board of Governors—Continued DIVISION OF INFORMATION Susan F. Marycz, Assistant Director TECHNOLOGY Sharon L. Mowry, Assistant Director Richard C. Stevens, Director Robert F. Taylor, Assistant Director Marianne M. Emerson, Deputy Director Maureen T. Hannan, Associate Director OFFICE OF THE INSPECTOR GENERAL Tillena G. Clark, Assistant Director Barry R. Snyder, Inspector General Geary L. Cunningham, Assistant Director Donald L. Robinson, Deputy Inspector Wayne A. Edmondson, Assistant Director General Po Kyung Kim, Assistant Director Federal Open Market Committee December 31, 2001 Members ALAN GREENSPAN, Chairman, Board of Governors WILLIAM J. McDoNOUGH, Vice Chairman, President, Federal Reserve Bank of New York SUSAN SCHMIDT BIES, Board of Governors ROGER W. FERGUSON, JR., Board of Governors EDWARD M. GRAMLICH, Board of Governors THOMAS M. HOENIG, President, Federal Reserve Bank of Kansas City EDWARD W. KELLEY, JR., Board of Governors LAURENCE H. MEYER, Board of Governors CATHY E. MlNEHAN, President, Federal Reserve Bank of Boston MICHAEL H. MOSKOW, President, Federal Reserve Bank of Chicago MARK W. OLSON, Board of Governors WILLIAM POOLE, President, Federal Reserve Bank of St. Louis Alternate Members JERRY L. JORDAN, President, Federal Reserve Bank of Cleveland ROBERT D. MCTEER, JR., President, Federal Reserve Bank of Dallas ANTHONY M. SANTOMERO, President, Federal Reserve Bank of Philadelphia GARY H. STERN, President, Federal Reserve Bank of Minneapolis JAMIE B. STEWART, JR., First Vice President, Federal Reserve Bank of New York Officers DONALD L. KOHN, J. VIRGIL MATTINGLY, JR., Secretary and Economist General Counsel NORMAND R.V BERNARD, THOMAS C. BAXTER, JR., Deputy Secretary Deputy General Counsel GARY P. GILLUM, KAREN H. JOHNSON, Assistant Secretary Economist MICHELLE A. SMITH, VINCENT R. REINHART, Assistant Secretary Economist Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

308 88th Annual Report, 2001 Federal Open Market Committee—Continued DAVID J. STOCKTON, WILLIAM C. HUNTER, Economist Associate Economist CHRISTINE M. CUMMING, DAVID E. LINDSEY, Associate Economist Associate Economist JEFFREY C. FUHRER, ROBERT H. RASCHE, Associate Economist Associate Economist CRAIG S. HAKKIO, LAWRENCE SLIFMAN, Associate Economist Associate Economist DAVID H. HOWARD, DAVID W. WILCOX, Associate Economist Associate Economist DINO Kos, Manager, System Open Market Account During 2001 the Federal Open Market Com- ings (see "Minutes of Federal Open Market mittee held eight regularly scheduled meet- Committee Meetings" in this volume.) Federal Advisory Council December 31,2001 Members District 1—LAWRENCE K. FISH, Chairman, President, and Chief Executive Officer, Citizens Financial Group, Inc., Providence, Rhode Island District 2—DOUGLAS A. WARNER III, Chairman, J.P. Morgan Chase & Co., Incorporated, New York, New York District 3—RONALD L. HANKEY, Chairman and Chief Executive Officer, Adams County National Bank, Gettysburg, Pennsylvania District 4—DAVID A. DABERKO, Chairman and Chief Executive Officer, National City Corporation, Cleveland, Ohio District 5—L.M. BAKER, JR., Chairman and Chief Executive Officer, Wachovia Corporation, Winston Salem, North Carolina District 6—L. PHILLIP HUMANN, Chairman, President, and Chief Executive Officer, SunTrust Banks, Inc., Atlanta, Georgia District 7—ALAN G. MCNALLY, Chairman and Chief Executive Officer, Harris Bancorp, Inc., Chicago, Illinois District 8—KATIE S. WINCHESTER, President and Chief Executive Officer, First Citizens National Bank, Dyersburg, Tennessee District 9—R. SCOTT JONES, President and Chief Executive Officer, Signal Financial Corporation, Mendota Heights, Minnesota District 10—CAMDEN R. FINE, President and Chief Executive Officer, Midwest Independent Bank, Jefiferson City, Missouri District 11—RICHARD W. EVANS, JR., Chairman and Chief Executive Officer, Frost National Bank, San Antonio, Texas District 12—STEVEN L. SCHEID, Vice Chairman and President, Charles Schwab Corporation, San Francisco, California Officers DOUGLAS A. WARNER III, President LAWRENCE K. FISH, Vice President JAMES E. ANNABLE, Co-Secretary Digitized for FRASER WILLIAM J. KORSVIK, Co-Secretary http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 309 Federal Advisory Council—Continued The Federal Advisory Council met on Feb- industry from each of the twelve Federal ruary 1-2, May 3-4, September 6-7, and Reserve Districts, is required by the Federal December 13-14, 2001. The Board of Gov- Reserve Act to meet in Washington at least ernors met with the council on Febru- four times each year and is authorized by the ary 2, May 4, September 7, and Decem- act to consult with, and advise, the Board ber 14, 2001. The council, which is com- on all matters within the jurisdiction of the posed of one representative of the banking Board. Consumer Advisory Council December 31, 2001 Members ANTHONY ABB ATE, President and Chief Executive Officer, Interchange Bank, Saddle Brook, New Jersey TERESA A. BRYCE, General Counsel, Nexstar Financial Corporation, St. Louis, Missouri MALCOLM BUSH, President, Woodstock Institute, Chicago, Illinois MANUEL CASANOVA, JR., Executive Vice President, International Bank of Commerce, Brownsville, Texas CONSTANCE CHAMBERLIN, President and Chief Executive Officer, Housing Opportunities Made Equal, Richmond, Virginia ROBERT M. CHEADLE, Legislative Counsel, The Chickasaw Tribal Legislature, Ada, Oklahoma MARY ELLEN DOMEIER, President, State Bank and Trust Company of New Ulm, New Ulm, Minnesota LESTER WM. FIRSTENBERGER, Attorney, Pittsfield, New Hampshire JOHN C. GAMBOA, Executive Director, The Greenlining Institute, San Francisco, California EARL JAROLIMEK, Vice President and Corporate Compliance Officer, Community First Bankshares, Fargo, North Dakota WILLIE JONES, Senior Vice President, The Community Builders, Inc., Boston, Massachusetts ANNE S. LI, Former Executive Director, New Jersey Community Loan Fund, Trenton, New Jersey J. PATRICK LIDDY, Director of Compliance, Fifth Third Bancorp, Cincinnati, Ohio OSCAR MARQUIS, Attorney, Hunton and Williams, Park Ridge, Illinois JEREMY NOWAK, Chief Executive Officer, The Reinvestment Fund, Philadelphia, Pennsylvania MARTA RAMOS, Vice President and Community Reinvestment Act Officer, Banco Popular de Puerto Rico, San Juan, Puerto Rico RONALD REITER, Supervising Deputy Attorney General, California Department of Justice, San Francisco, California ELIZABETH RENUART, Staff Attorney, National Consumer Law Center, Boston, Massachusetts RUSSELL W. SCHRADER, Senior Vice President and Assistant General Counsel, Visa U.S.A., San Francisco, California FRANK TORRES III, Legislative Counsel, Consumers Union, Washington, District of Columbia Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

310 88th Annual Report, 2001 Consumer Advisory Council—Continued GARY S. WASHINGTON, Senior Vice President, ABN AMRO, Chicago, Illinois ROBERT L. WYNN II, Financial Education Officer, Wisconsin Department of Financial Institutions, Madison, Wisconsin Officers LAUREN ANDERSON, Chair DOROTHY BROADMAN, Vice Chair Executive Director, Director of Corporate Citizenship, Neighborhood Housing Services Capital One Financial Corporation, of New Orleans, Inc., Falls Church, Virginia New Orleans, Louisiana The Consumer Advisory Council met with tatives of consumer and community intermembers of the Board of Governors on ests. It was established pursuant to the 1976 March 22, June 28, and October 25, 2001. amendments to the Equal Credit Opportunity The council is composed of academics, state Act to advise the Board on consumer finanand local government officials, representa- cial services. tives of the financial industry, and represen- Thrift Institutions Advisory Council December 31,2001 Members TOM R. DORETY, President and Chief Executive Officer, Suncoast Schools Federal Credit Union, Tampa, Florida RONALD S. ELIASON, President and Chief Executive Officer, Utah Community Federal Credit Union, Provo, Utah D.R. GRIMES, Vice Chairman and Chief Executive Officer, NetBank, Alpharetta, Georgia THOMAS S. JOHNSON, Chairman and Chief Executive Officer, GreenPoint Bank, New York, New York CORNELIUS D. MAHONEY, Chairman, President, and Chief Executive Officer, Woronco Savings Bank, Westfield, Massachusetts KAREN L. MCCORMICK, President and Chief Executive Officer, First Federal Savings and Loan Association, Port Angeles, Washington JAMES F. MCKENNA, President and Chief Executive Officer, North Shore Bank, FSB, Brookfield, Wisconsin CHARLES C. PEARSON, JR., Co-Chairman and Chief Executive Officer, Waypoint Bank, Harrisburg, Pennsylvania HERBERT M. SANDLER, Chairman and Chief Executive Officer, World Savings Bank, FSB, Oakland, California EVERETT STILES, President and Chief Executive Officer, Macon Bank, Franklin, North Carolina Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 311 Thrift Institutions Advisory Council—Continued MARK H. WRIGHT, President and Chief Executive Officer, USAA Federal Savings Bank, San Antonio, Texas CLARENCE ZUGELTER, President, Chief Executive Officer, and Chairman, First Federal Bank, FSB, Kansas City, Missouri Officers THOMAS S. JOHNSON, President MARK H. WRIGHT, Vice President The members of the Thrift Institutions unions, savings and loan associations, and Advisory Council met with the Board of savings banks, consults with, and advises, Governors on February 23, July 13, and the Board on issues pertaining to the thrift November 9, 2001. The council, which is industry and on various other matters within composed of representatives from credit the Board's jurisdiction. Officers of Federal Reserve Banks and Branches December 31, 2001 Chairman1 President Vice President BANK or Branch Deputy Chairman First Vice President in charge of Branch BOSTON2 William C. Brainard Cathy E. Minehan William O. Taylor Paul M. Connolly NEW YORK2 Peter G. Peterson William J. McDonough Gerald M. Levin Jamie B. Stewart, Jr. Buffalo Bal Dixit Barbara L. Walter3 PHILADELPHIA Charisse R. Lillie Anthony M. Santomero Glenn A. Schaeffer William H. Stone, Jr. CLEVELAND2 David H. Hoag Jerry L. Jordan Robert W. Mahoney Sandra Pianalto Cincinnati George C. Juilfs Barbara B. Henshaw Pittsburgh Charles E. Bunch Robert B. Schaub RICHMOND2 Jeremiah J. Sheehan J. Alfred Broaddus, Jr. Wesley S. Walter A. Varvel Williams, Jr. Baltimore George L. Russell, Jr. William J. Tignanelli3 Charlotte James F. Goodmon Dan M. Bechter3 ATLANTA John F. Wieland Jack Guynn James M. McKee3 Paula Lovell Patrick K. Barron Birmingham Catherine Sloss Andre T. Anderson Crenshaw Jacksonville Julie K. Hilton Robert J. Slack3 Miami Mark T. Sodders James T. Curry III Nashville Whitney Johns Martin Melvyn K. Purcell3 New Orleans Ben Tom Roberts Robert J. Musso3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

312 88th Annual Report, 2001 Officers of Federal Reserve Banks and Branches- Continued Chairmanl President Vice President BANK or Branch Deputy Chairman First Vice President in charge of Branch CHICAGO2 Arthur C. Martinez Michael H. Moskow Robert J. Darnall Gordon R.G. Werkema Detroit Timothy D. Leuliette David R. Allardice3 ST. LOUIS Charles W. Mueller William Poole Walter L. W. LeGrande Rives Metcalfe, Jr. Little Rock Vick M. Crawley Robert A. Hopkins Louisville Roger Reynolds Thomas A. Boone Memphis Gregory M. Duckett Martha Perine Beard MINNEAPOLIS James J. Howard Gary H. Stern Ronald N. Zwieg James M. Lyon Helena Thomas 0. Markle Samuel H. Gane KANSAS CITY Terrence P. Dunn Thomas M. Hoenig Jo Marie Dancik Richard K. Rasdall Denver Kathryn A. Paul Maryann F. Hunter3 Oklahoma City Patricia B. Fennell Dwayne E. Boggs Omaha Gladys Styles Johnston Steven D. Evans DALLAS H.B. Zachry, Jr. Robert D. McTeer, Jr. Patricia M. Helen E. Holcomb Patterson El Paso Beauregard Brite White Sammie C. Clay Houston Edward O. Gaylord Robert Smith III3 San Antonio Patty P. Mueller James L. Stull3 SAN FRANCISCO Nelson C. Rising Robert T. Parry George M. Scalise John F. Moore Los Angeles William D. Jones Mark L. Mullinix4 Portland Nancy Wilgenbusch Raymond H. Laurence3 Salt Lake City H. Roger Boyer Andrea P. Wolcott Seattle Richard R. Sonstelie David K. Webb 3 NOTE. A current list of these officers appears each York; East Rutherford, New Jersey; Columbus, Ohio; month in the Federal Reserve Bulletin. Charleston, West Virginia; Columbia, South Carolina; 1. The Chairman of a Federal Reserve Bank serves, by Indianapolis, Indiana; Milwaukee, Wisconsin; Des statute, as Federal Reserve Agent. Moines, Iowa; and Peoria, Illinois. 2. Additional offices of these Banks are located at 3. Senior Vice President Windsor Locks, Connecticut; Utica at Oriskany, New 4. Executive Vice President Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 313 Conference of Chairmen Kansas City, served as its secretary, and David K. Park, of the Federal Reserve Bank The chairmen of the Federal Reserve Banks of Boston, served as its assistant secretary. are organized into the Conference of Chair- On October 16, 2001, the conference men, which meets to consider matters of elected Paul M. Connolly as its chair for common interest and to consult with, and 2002-2003, and Walter A. Varvel, First Vice advise, the Board of Governors. Such meet- President of the Federal Reserve Bank of ings, attended also by the deputy chairmen, Richmond, as its vice chair. were held in Washington on May 30 and 31, and on November 28 and 29, 2001. The members of the Executive Committee of the Conference of Chairmen during Directors 2001 were John F. Wieland, chair; Peter G. Peterson, vice chair; and Charisse R. Lillie, The following list of directors of Federal member. Reserve Banks and Branches shows for each On November 29, 2001, the Conference director the class of directorship, the direcelected its Executive Committee for 2002; tor's principal organizational affiliation, and it named Peter G. Peterson as chair, the date the director's term expires. Each Charisse R. Lillie as vice chair, and Robert J. Federal Reserve Bank has a nine-member Darnall as the third member. board: three Class A and three Class B directors, who are elected by the stockholding member banks, and three Class C directors, Conference of Presidents who are appointed by the Board of Gover- The presidents of the Federal Reserve Banks nors of the Federal Reserve System. are organized into the Conference of Presi- Class A directors represent the stockholddents, which meets periodically to consider ing member banks in each Federal Reserve matters of common interest and to consult District. Class B and Class C directors reprewith, and advise, the Board of Governors. sent the public and are chosen with due, but J. Alfred Broaddus, Jr., President of the not exclusive, consideration to the interests Federal Reserve Bank of Richmond, served of agriculture, commerce, industry, services, as chair of the conference in 2001, and labor, and consumers; they may not be offi- Michael H. Moskow, President of the Fed- cers, directors, or employees of any bank or eral Reserve Bank of Chicago, served as its bank holding company. In addition, Class C vice chair. Betty M. Fahed, of the Federal directors rriay not be stockholders of any Reserve Bank of Richmond, served as its bank or bank holding company. secretary, and Valerie J. Van Meter, of the For the election of Class A and Class B Federal Reserve Bank of Chicago, served as directors, the Board of Governors classifies its assistant secretary. the member banks of each Federal Reserve District into three groups. Each group, which Conference of First comprises banks with similar capitalization, Vice Presidents elects one Class A director and one Class B director. Annually, the Board of Governors The Conference of First Vice Presidents of designates one of the Class C directors as the Federal Reserve Banks was organized in chair of the board and Federal Reserve Agent 1969 to meet periodically for the consider- of each District Bank, and it designates ation of operations and other matters. another Class C director as deputy chair. Richard K. Rasdall, Jr., First Vice Presi- Federal Reserve Branches have either five dent of the Federal Reserve Bank of Kan- or seven directors, a majority of whom are sas City, served as chair of the conference appointed by the parent Federal Reserve in 2001, and Paul M. Connolly, First Vice Bank; the others are appointed by the Board President of the Federal Reserve Bank of of Governors. One of the directors appointed Boston, served as its vice chair. Leesa M. by the Board is designated annually as chair Guy ton, of the Federal Reserve Bank of of the board of that Branch in a manner Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

314 88th Annual Report, 2001 prescribed by the parent Federal Reserve Bank and of the chair of each Branch, see Bank. the preceding table, "Officers of Federal For the name of the chair and deputy chair Reserve Banks and Branches." of the board of directors of each Reserve Directors of Federal Reserve Banks and Branches Term expires Dec. 31 DISTRICT l—BOSTON Class A Terrence Murray Chairman and Chief Executive Officer, 2001 FleetBoston Financial Corporation, Boston, Massachusetts David S. Outhouse President and Chief Executive Officer, 2002 First & Ocean National Bank, Newburyport, Massachusetts Richard C. White Chairman, President, and Chief Executive Officer, 2003 Community National Bank, Derby, Vermont Class B Robert R. Glauber President and Chief Executive Officer, 2001 National Association of Securities Dealers, Inc., Washington, D.C. Orit Gadiesh Chairman, Bain & Company, Inc., 2002 Boston, Massachusetts Sherwin Greenblatt President and Chief Operating Officer, 2003 Bose Corporation, Framingham, Massachusetts Class C William C. Brainard Professor of Economics, Yale University, 2001 New Haven, Connecticut William O. Taylor Chairman Emeritus, The Boston Globe, 2002 Boston, Massachusetts James J. Norton Vice President, AFL-CIO, Washington, D.C. 2003 DISTRICT 2—NEW YORK Class A T. Joseph Semrod Vice Chairman, FleetBoston Financial, 2001 Princeton, New Jersey George W Hamlin IV President and Chief Executive Officer, 2002 The Canandaigua National Bank and Trust Company, Canandaigua, New York Sanford I. Weill Chairman and Chief Executive Officer, 2003 Citigroup Inc., New York, New York Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 315 Term expires Dec. 31 DISTRICT 2, NEW YORK—Continued Class B Ronay Menschel Chairman, Phipps Houses, New York, New York 2001 Ann M. Fudge Retired Executive Vice President, Kraft Foods, 2002 Inc., and Retired President, Coffee & Cereals Division, Tarrytown, New York, Westport, Connecticut Jerry I. Speyer President and Chief Executive Officer, 2003 Tishman Speyer Properties, New York, New York Class C Peter G. Peterson Chairman, The Blackstone Group, 2001 New York, New York Albert J. Simone President, Rochester Institute of Technology, 2002 Rochester, New York Gerald M. Levin Chief Executive Officer, AOL Time Warner, Inc., 2003 New York, New York BUFFALO BRANCH Appointed by the Federal Reserve Bank Kathleen R. Whelehan Executive Vice President, Consumer Finance 2001 Division, HSBC, Buffalo, New York Geraldine C. Ochocinska ....Director, Region 9, UAW, Buffalo, New York 2002 Peter G. Humphrey President and Chief Executive Officer, 2003 Financial Institutions, Inc., Warsaw, New York Maureen Torrey Marshall ...Co-Owner, Torrey Farms, Inc., Elba, New York 2003 Appointed by the Board of Governors Bal Dixit President and Chief Executive Officer, 2001 Newtex Industries, Inc., Victor, New York Patrick P. Lee Chairman and Chief Executive Officer, 2002 International Motion Control, Inc., Buffalo, New York John E. Friedlander President and Chief Executive Officer, 2003 Kaleida Health, Buffalo, New York DISTRICT 3—PHILADELPHIA Class A Rufus A. Fulton, Jr Chairman and Chief Executive Officer, 2001 Fulton Financial Corporation, Lancaster, Pennsylvania Frank Kaminski, Jr. Chairman, Atlantic Central Bankers Bank, 2002 Camp Hill, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

316 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 3, Class A—Continued Robert J. Vanderslice President and Chief Operating Officer, 2003 Pennsville National Bank, Pennsville, New Jersey Class B Howard E. Cosgrove Chairman and Chief Executive Officer, 2001 Conectiv, Wilmington, Delaware Robert E. Chappell Chairman and Chief Executive Officer, 2002 Penn Mutual Life Insurance Co., Horsham, Pennsylvania Doris M. Damm President and Chief Executive Officer, 2003 Accu Staffing Services, Cherry Hill, New Jersey Class C Charisse R. Lillie Partner, Ballard Spahr Andrews & Ingersoll, 2001 Philadelphia, Pennsylvania Ronald J. Naples Chairman and Chief Executive Officer, 2002 Quaker Chemical Corporation, Conshohocken, Pennsylvania Glenn A. Schaeffer President, Pennsylvania Building and 2003 Construction Trades Council, Harrisburg, Pennsylvania DISTRICT A—CLEVELAND Class A John R. Cochran Chairman and Chief Executive Officer, 2001 FirstMerit Corporation, Akron, Ohio Tiney M. McComb Chairman and President, Heartland BancCorp, 2002 Gahanna, Ohio Stephen P. Wilson President and Chief Executive Officer, 2003 Lebanon Citizens National Bank, Lebanon, Ohio Class B Wayne R. Embry Retired President and Chief Operating Officer, 2001 Cleveland Cavaliers, Cleveland, Ohio David L. Nichols President and Chief Operating Officer, 2002 Rich's/Lazarus/Goldsmith's, Atlanta, Georgia Cheryl L. Krueger-Horn President and Chief Executive Officer, 2003 Cheryl&Co., Westerville, Ohio Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 317 Term expires Dec. 31 DISTRICT 4, CLEVELAND—Continued Class C David H. Hoag Former Chairman, The LTV Corporation, 2001 Cleveland, Ohio Phillip R. Cox President and Chief Executive Officer, 2002 Cox Financial Corporation, Cincinnati, Ohio Robert W. Mahoney Retired Chairman and Chief Executive Officer, 2003 Diebold Incorporated, Canton, Ohio CINCINNATI BRANCH Appointed by the Federal Reserve Bank Jean R. Hale Vice Chairman, President, and 2001 Chief Executive Officer, Community Trust Bancorp, Inc., Pikeville, Kentucky Mary Ellen Slone Chief Executive Officer and Chairman, 2002 Meridian Communications, Lexington, Kentucky V. Daniel Radford Executive Secretary-Treasurer, 2002 Cincinnati AFL-CIO Labor Council, Cincinnati, Ohio Bick Weissenrieder Chairman, President, and Chief Executive Officer, 2003 Hocking Valley Bank, Athens, Ohio Appointed by the Board of Governors Thomas Revely III President and Chief Executive Officer, 2001 CBS Technologies, LLC, Cincinnati, Ohio George C. Juilfs Chairman and Chief Executive Officer, 2002 SENCORP, Newport, Kentucky Charles Whitehead President, Ashland Inc. Foundation, 2003 Covington, Kentucky PITTSBURGH BRANCH Appointed by the Federal Reserve Bank Edward V. Randall, Jr. Management Advisor and Consultant, 2001 Babst, Calland, Clements, & Zomnir, PC, Pittsburgh, Pennsylvania Georgia Berner President, Berner International Corp., 2002 New Castle, Pennsylvania Peter N. Stephans Chairman and Chief Executive Officer, 2002 Trigon Incorporated, McMurray, Pennsylvania Kristine N. Molnar President, Upper Ohio Valley Region, 2003 WesBanco Bank, Inc., Wheeling, West Virginia Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

318 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 4, PITTSBURGH BRANCH—Continued Appointed by the Board of Governors Gretchen R. Haggerty Vice President, Accounting and Finance, 2001 U.S. Steel Group, Pittsburgh, Pennsylvania Charles E. Bunch Executive Vice President, PPG Industries, Inc., 2002 Pittsburgh, Pennsylvania James I. Mitnick Senior Vice President, Turner Construction 2003 Company, Pittsburgh, Pennsylvania DISTRICT 5—RICHMOND Class A James M. Culberson, Jr. Chairman Emeritus, First National Bank and 2001 Trust Company, Asheboro, North Carolina Fred L. Green III Chairman, President and Chief Executive Officer, 2002 The National Bank of South Carolina, Columbia, South Carolina William W. Duncan, Jr. President/Chief Executive Officer, 2003 St. Michaels Bank, St. Michaels, Maryland Class B Craig A. Ruppert President, Ruppert Nurseries Inc., 2001 Laytonsville, Maryland W. Henry Harmon President and Chief Executive Officer, 2002 Triana Energy, LLC, Charleston, West Virginia, Union Drilling, Inc., Bridgeville, Pennsylvania James E. Haden President/Chief Executive Officer, 2003 Martha Jefferson Hospital, Charlottesville, Virginia Class C Irwin Zazulia Retired President and Chief Executive Officer, 2001 Hecht's, Arlington, Virginia Jeremiah J. Sheehan Retired Chairman, Reynolds Metals Company, 2002 Richmond, Virginia Wesley S. Williams, Jr Partner, Covington & Burling, Washington, D.C. 2003 BALTIMORE BRANCH Appointed by the Federal Reserve Bank Jeremiah E. Casey Director and Former Chairman, 2001 Allfirst Financial, Inc., Baltimore, Maryland Dyan Brasington President, Technology Council of Maryland, 2002 Rockville, Maryland Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 319 Term expires Dec. 31 DISTRICT 5, BALTIMORE BRANCH Appointed by the Federal Reserve Bank—Continued William L. Jews President and Chief Executive Officer, 2003 CareFirst BlueCross BlueShield, Owings Mills, Maryland Kenneth C. Lundeen President, C. J. Langenfelder & Son, Inc., 2003 Baltimore, Maryland Appointed by the Board of Governors Owen E. Herrnstadt Director, International Department, International 2001 Association of Machinists and Aerospace Workers, AFL-CIO, Upper Marlboro, Maryland George L. Russell, Jr. Law Offices of Peter G. Angelos, 2002 Baltimore, Maryland William C. Handorf Professor of Finance, School of Business and 2003 Public Management, The George Washington University, Washington, D.C. CHARLOTTE BRANCH Appointed by the Federal Reserve Bank William H. Nock President and Chief Executive Officer, 2001 Sumter National Bank, Sumter, South Carolina Lucy J. Reuben Dean, School of Business, South Carolina 2002 State University, Orangeburg, South Carolina Elleveen T. Poston President, Quality Transport, Inc., 2003 Lake City, South Carolina Cecil W Sewell, Jr. Chairman and Chief Executive Officer Emeritus, 2003 RBC Centura Banks, Inc., Raleigh, North Carolina Appointed by the Board of Governors James F. Goodmon President and Chief Executive Officer, 2001 Capitol Broadcasting Company, Inc., Raleigh, North Carolina Michael A. Almond President and Chief Executive Officer, 2002 Charlotte Regional Partnership, Charlotte, North Carolina Jim Lowry President, High Point Chevrolet Jeep, 2003 High Point, North Carolina DISTRICT 6—ATLANTA Class A Waymon L. Hickman Chairman and Chief Executive Officer, 2001 First Farmers and Merchants National Bank, Columbia, Tennessee Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

320 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 6, Class A—Continued Richard G Hickson President and Chief Executive Officer, 2002 Trustmark Corporation, Jackson, Mississippi William G. Smith, Jr. President and Chief Executive Officer, 2003 Capital City Bank Group, Inc., Tallahassee, Florida Class B Suzanne E. Boas President, Consumer Credit Counseling 2001 Service, Inc., Atlanta, Georgia Juanita P. Baranco Executive Vice President, Baranco 2002 Automotive Group, Morrow, Georgia John Dane III President and Chief Executive Officer, 2003 Trinity Yachts, Inc., New Orleans, Louisiana Class C Maria Camila Leiva Executive Vice President, MFZ Management 2001 Corporation, Coral Gables, Florida John F. Wieland Chief Executive Officer and Chairman, 2002 John Wieland Homes and Neighborhoods, Inc., Atlanta, Georgia Paula Lovell President, Lovell Communications, Inc., 2003 Nashville, Tennessee BIRMINGHAM BRANCH Appointed by the Federal Reserve Bank Robert M. Barrett Chairman, President, and Chief Executive Officer, 2001 First Community Bank of Central Alabama, Wetumpka, Alabama W. Charles Mayer III Senior Executive Vice President, 2002 Alabama Banking Group Head, and Commercial Banking Group Head, AmSouth Bank, Birmingham, Alabama James A. Vickery International Representative, Laborers' 2003 International Union of North America, Gadsden, Alabama Hundley Batts, Sr Owner and Managing General Agent, 2003 Hundley Batts & Associates, Huntsville, Alabama Appointed by the Board of Governors Catherine Sloss Crenshaw ...President, Sloss Real Estate Group, Inc., 2001 Birmingham, Alabama V. Larkin Martin Managing Partner, Martin Farm, 2002 Courtland, Alabama W. Miller Welborn Chairman, Welborn & Associates, Inc., 2003 Tuscaloosa, Tennessee Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 321 Term expires Dec. 31 DISTRICT 6, ATLANTA—Continued JACKSONVILLE BRANCH Appointed by the Federal Reserve Bank Harvey R. Heller President, Heller Brothers Packing Corp., 2001 Winter Garden, Florida Jerry M. Smith Chairman and President, First National Bank 2002 of Alachua, Alachua, Florida Robert L. Fisher President and Chief Executive Officer, 2003 MacDill Federal Credit Union, Tampa, Florida Michael W. Poole Poole Carbone Eckbert, Winter Park, Florida 2003 Appointed by the Board of Governors Julie K. Hilton Vice President and Co-Owner, Hilton Inc., 2001 Panama City Beach, Florida Marsha G. Rydberg Partner, The Rydberg Law Firm, Tampa, Florida 2002 William E. Flaherty Former Chairman, Blue Cross and Blue Shield 2003 of Florida, Inc., Jacksonville, Florida MIAMI BRANCH Appointed by the Federal Reserve Bank Rudy E. Schupp Chairman, Florida Banking, Wachovia, N.A., 2001 West Palm Beach, Florida D. Keith Cobb Managing Director, Cobb Consulting Group, 2002 Ft. Lauderdale, Florida James W. Moore Managing Partner, Riverside Capital, LLC, 2002 Fort Myers, Florida Miriam Lopez President and Chief Executive Officer, 2003 TransAtlantic Bank, Miami, Florida Appointed by the Board of Governors Rosa Sugranes Chairman, Iberia Tiles Corp., Miami, Florida 2001 Mark T. Sodders President, Lakeview Farms, Inc., 2002 Pahokee, Florida Brian E. Keeley President and Chief Executive Officer, 2003 Baptist Health Systems of South Florida, Coral Gables, Florida Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

322 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 6, NASHVILLE BRANCH Appointed by the Federal Reserve Bank Dale W. Polley Past President, First American Corporation, 2001 Nashville, Tennessee L.A. Walker, Jr. Chairman, BB&T McMinn/Monroe Counties, 2002 Tennessee, Athens, Tennessee James W. Spradley, Jr. President, Standard Candy Company, Inc., 2003 Nashville, Tennessee Emil Hassan Senior Vice President, North America 2003 Manufacturing, Purchasing, Quality and Logistics, Nissan North America, Inc., Smyrna, Tennessee Appointed by the Board of Governors Frances F. Marcum General Partner, Marcum Capital, L.L.C., 2001 Tullahoma, Tennessee Beth Dortch Franklin President and Chief Executive Officer, 2002 Star Transportation, Inc., Nashville, Tennessee Whitney Johns Martin Chairman and Chief Executive Officer, 2003 Capital Across America, Nashville, Tennessee NEW ORLEANS BRANCH Appointed by the Federal Reserve Bank David E. Johnson Chairman and Chief Executive Officer, 2001 The First Bancshares, Inc., and The First National Bank of South Mississippi, Hattiesburg, Mississippi C.R. Cloutier President and Chief Executive Officer, 2002 MidSouth Bank, Lafayette, Louisiana Teri G. Fontenot President and Chief Executive Officer, 2003 Woman's Hospital, Baton Rouge, Louisiana David Guidry President and Chief Executive Officer, 2003 Guico Machine Works, Inc., Harvey, Louisiana Appointed by the Board of Governors Dave Dennis President, Specialty Contractors & Assoc, Inc., 2001 Gulfport, Mississippi R. Glenn Pumpelly President and Chief Executive Officer, 2002 Pumpelly Oil Inc., Sulphur, Louisiana Ben Tom Roberts Senior Executive Vice President, 2003 Roberts Brothers, Inc., Realtors, Mobile, Alabama Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 323 Term expires Dec. 31 DISTRICT 7—CHICAGO Class A Alan R. Tubbs President, Maquoketa State Bank and Ohnward 2001 Bancshares Inc., Maquoketa, Iowa William A. Osborn Chairman and Chief Executive Officer, 2002 Northern Trust Corporation and The Northern Trust Company, Chicago, Illinois Robert R. Yohanan Managing Director and Chief Executive Officer, 2003 First Bank & Trust, Evanston, Illinois Class B James H. Keyes Chairman and Chief Executive Officer, 2001 Johnson Controls, Inc., Milwaukee, Wisconsin Connie E. Evans President and Chief Executive Officer, 2002 WSEP Ventures, Chicago, Illinois Jack B. Evans President, The Hall-Perrine Foundation, 2003 Cedar Rapids, Iowa Class C Arthur C. Martinez Retired Chairman and Chief Executive Officer, 2001 Sears, Roebuck and Co., Chicago, Illinois Robert J. Darnall Chairman, Prime Advantage Chicago, 2002 Chicago, Illinois W. James Farrell Chairman and Chief Executive Officer, 2003 Illinois Tool Works Inc., Glenview, Illinois DETROIT BRANCH Appointed by the Federal Reserve Bank Richard M. Bell Retired President and Chief Executive Officer, 2001 The First National Bank of Three Rivers, Three Rivers, Michigan Mark T. Gaffney President, Michigan State AFL-CIO, 2002 Lansing, Michigan Irma B. Elder President, Elder Ford, Troy, Michigan 2002 David J. Wagner Chairman, Fifth Third Bank, 2003 Grand Rapids, Michigan Appointed by the Board of Governors Stephen R. Polk Chairman and Chief Executive Officer, 2001 R. L. Polk & Co., Southfield, Michigan Edsel B. Ford II Board Director, Ford Motor Company, 2002 Dearborn, Michigan Timothy D. Leuliette President and Chief Executive Officer, 2003 Metaldyne, Plymouth, Michigan Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

324 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 8—ST. LOUIS Class A Thomas H. Jacobsen Chairman Emeritus, Firstar Corporation 2001 (now U.S. Bancorp), St. Louis, Missouri Lunsford W. Bridges President and Chief Executive Officer, 2002 Metropolitan National Bank, Little Rock, Arkansas Bradley W. Small President and Chief Executive Officer, 2003 The Farmers and Merchants National Bank, Nashville, Illinois Class B Bert Greenwalt Partner, Greenwalt Company, Hazen, Arkansas 2001 Joseph E. Gliessner, Jr. Executive Director, New Directions Housing Corp., 2002 Louisville, Kentucky Robert L. Johnson Chairman and Chief Executive Officer, 2003 Johnson Bryce, Inc., Memphis, Tennessee Class C Charles W. Mueller Chairman and Chief Executive Officer, 2001 Ameren Corporation, St. Louis, Missouri Gayle P.W. Jackson Managing Director, Fond Elec Group, Inc., 2002 St. Louis, Missouri Walter L. Metcalfe, Jr. Chairman, Bryan Cave LLP, St. Louis, Missouri 2003 LITTLE ROCK BRANCH Appointed by the Federal Reserve Bank Lawrence A. Davis, Jr. Chancellor, University of Arkansas at Pine Bluff, 2001 Pine Bluff, Arkansas Everett Tucker III Chairman, Moses Tucker Real Estate, Inc., 2002 Little Rock, Arkansas David R. Estes President and Chief Executive Officer, 2002 First State Bank, Lonoke, Arkansas Raymond E. Skelton Regional President, U.S. Bank, 2003 Little Rock, Arkansas Appointed by the Board of Governors Vick M. Crawley Plant Manager, Baxter Healthcare Corporation, 2001 Mountain Home, Arkansas A. Rogers Yarnell II President, Yarnell Ice Cream Co., Inc., 2002 Searcy, Arkansas Cynthia J. Brinkley President, Arkansas Southwestern Bell 2003 Telephone Company, Little Rock, Arkansas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 325 Term expires Dec. 31 DISTRICT 8, LOUISVILLE BRANCH Appointed by the Federal Reserve Bank Orson Oliver President, Mid-America Bank of Louisville, 2001 Louisville, Kentucky Marjorie Z. Soyugenc Executive Director and Chief Executive Officer, 2002 Welborn Foundation, Evansville, Indiana Thomas W. Smith President and Chief Executive Officer, 2002 Ephraim McDowell Health, Danville, Kentucky Frank J. Nichols Chairman, President, and Chief Executive Officer, 2003 Community Financial Services, Inc., Benton, Kentucky Appointed by the Board of Governors Roger Reynolds President and Chief Executive Officer, 2001 Interlink Logistics LLC, Louisville, Kentucky J. Stephen Barger Executive Secretary-Treasurer, Kentucky State 2002 District Council of Carpenters, AFL-CIO, Frankfort, Kentucky Norman E. Pfau, Jr. President and Chief Executive Officer, 2003 Geo. Pfau's Sons Company, Inc., Jeffersonville, Indiana MEMPHIS BRANCH Appointed by the Federal Reserve Bank Walter L. Morris, Jr. President, H&M Lumber Co., Inc., 2001 West Helena, Arkansas James A. England Chairman, President, and Chief Executive Officer, 2002 Decatur County Bank, Decaturville, Tennessee John C. Kelley, Jr. President, Business Financial Services, 2002 First Tennessee Bank, Memphis, Tennessee E.C. Neelly III Management Consultant, First American 2003 National Bank, Iuka, Mississippi Appointed by the Board of Governors Gregory M. Duckett Senior Vice President and Corporate Counsel, 2001 Baptist Memorial Health Care Corporation, Memphis, Tennessee Mike P. Sturdivant, Jr. Partner, Due West, Glendora, Mississippi 2002 Russell Gwatney President, Gwatney Companies, 2003 Memphis, Tennessee Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

326 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 9—MINNEAPOLIS Class A W.W. LaJoie Chief Executive Officer and Chairman, 2001 Central Savings Bank, Sault Ste. Marie, Michigan Roger N. Berglund Chairman and President, Dakota Western Bank, 2002 Bowman, North Dakota Dan M. Fisher Chief Information Officer, 2003 Community First Bankshares, Inc., Fargo, North Dakota Class B Jay F. Hoeschler President and Owner, Hoeschler Corporation, 2001 La Crosse, Wisconsin Rob L. Wheeler Vice President, Wheeler Mfg. Co., Inc., 2002 Lemmon, South Dakota D. Greg Heineman Chairman, Williams Insurance Agency, 2003 Sioux Falls, South Dakota Class C James J. Howard Chairman Emeritus, Xcel Energy, Inc., 2001 Minneapolis, Minnesota Linda Hall Whitman Former President, Ceridian, 2002 Minneapolis, Minnesota Ronald N. Zwieg President, United Food & Commercial Workers, 2003 Local 653, Plymouth, Minnesota HELENA BRANCH Appointed by the Federal Reserve Bank Richard E. Hart President, Senior Lender, and Director, 2001 Mountain West Bank, Kalispell, Montana Emil W. Erhardt Chairman and President, Citizens State Bank, 2002 Hamilton, Montana Marilyn F. Wessel Dean and Director, Museum of the Rockies, 2002 Bozeman, Montana Appointed by the Board of Governors Thomas O. Markle President and Chief Executive Officer, 2001 Markle's Inc., Glasgow, Montana William P. Underriner President, Selover Buick Inc., 2002 Billings, Montana Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 327 Term expires Dec. 31 DISTRICT 10—KANSAS CITY Class A Jeffrey L. Gerhart President and Chief Executive Officer, 2001 First National Bank, Newman Grove, Nebraska Dennis E. Barrett Vice Chairman, FirstBank Holding 2002 Company of Colorado, Lakewood, Colorado Bruce A. Schriefer President, Bankers' Bank of Kansas, 2003 Wichita, Kansas Class B Frank A. Potenziani M&T Trust, Albuquerque, New Mexico 2001 Paula Marshall-Chapman ....Chief Executive Officer, The Bama Companies, Inc., 2002 Tulsa, Oklahoma Hans C. Helmerich President and Chief Executive Officer, 2003 Helmerich & Payne, Inc., Tulsa, Oklahoma Class C Jo Marie Dancik Regional Managing Partner, Ernst & Young LLP, 2001 Minneapolis, Minnesota Rhonda Holman Vice President, Kauffman Center for 2002 Entrepreneurial Leadership at the Ewing Marion Kauffman Foundation, Kansas City, Missouri Terrence P. Dunn President and Chief Executive Officer, 2003 J. E. Dunn Construction Company, Kansas City, Missouri DENVER BRANCH Appointed by the Federal Reserve Bank Albeit C. Yates President, Colorado State University, 2001 Ft. Collins, Colorado Virginia K. Berkeley President, Colorado Business Bank N.A., 2002 Denver, Colorado Robert M. Murphy President, Sandia Properties Ltd., Co., 2003 Albuquerque, New Mexico John W. Hay III President, Rock Springs National Bank, 2003 Rock Springs, Wyoming Appointed by the Board of Governors James A. King Chief Executive Officer, BT, Inc., 2001 Riverton, Wyoming Kathleen Avila Partner and Chief Executive Officer, 2002 Avila Retail, Albuquerque, New Mexico Kathryn A. Paul President, Delta Dental Plan of Colorado, 2003 Denver, Colorado Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

328 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 10, OKLAHOMA CITY BRANCH Appointed by the Federal Reserve Bank Betty Bryant Shaull President-Elect and Director, 2001 Bank of Cushing and Trust Company, Cushing, Oklahoma W. Carlisle Mabrey III President and Chief Executive Officer, 2001 Citizens Bank & Trust Co., Okmulgee, Oklahoma Robert A. Funk Chairman and Chief Executive Officer, 2002 Express Personnel Services International, Oklahoma City, Oklahoma Russell W. Teubner Founder and Director, Esker, Inc., 2003 Stillwater, Oklahoma Appointed by the Board of Governors Vacancy 2001 J. Clifford Hudson Chairman and Chief Executive Officer, 2002 Sonic Corp., Oklahoma City, Oklahoma Patricia B. Fennell Executive Director, Latino Community 2003 Development Agency, Oklahoma City, Oklahoma OMAHA BRANCH Appointed by the Federal Reserve Bank Vacancy 2001 Judith A. Owen President and Chief Executive Officer, 2002 Wells Fargo Bank Nebraska, N.A., Omaha, Nebraska Frank L. Hayes President, Hayes & Associates, L.L.C., CPAs, 2003 Omaha, Nebraska H.H. Kosman Chairman, President, and Chief Executive Officer, 2003 Platte Valley National Bank, Scottsbluff, Nebraska Appointed by the Board of Governors Gladys Styles Johnston Chancellor, University of Nebraska at Kearney, 2001 Kearney, Nebraska Bob L. Gottsch Vice President, Gottsch Feeding Corporation, 2002 Hastings, Nebraska A.F. Raimondo Chairman and Chief Executive Officer, 2003 Behlen Mfg. Co., Columbus, Nebraska Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 329 Term expires Dec. 31 DISTRICT 11—DALLAS Class A Dudley K. Montgomery Director, The Security State Bank of Pecos, 2001 Pecos, Texas Kenneth T. Murphy Chairman, President, and Chief Executive Officer, 2002 First Financial Bankshares, Inc., Abilene, Texas Matthew T. Doyle Vice Chairman and Chief Executive Officer, 2003 Texas First Bank, Texas City, Texas Class B Julie Spicer England Vice President, Texas Instruments, Dallas, Texas 2001 Malcolm Gillis President, Rice University, Houston, Texas 2002 Judy Ley Allen Owner, Allen Investments, Houston, Texas 2003 Class C Ray L. Hunt Chairman and Chief Executive Officer, 2001 Hunt Consolidated, Inc., Dallas, Texas Patricia M. Patterson President, Patterson Investments, Inc., 2002 Dallas, Texas H.B. Zachry, Jr. Chairman and Chief Executive Officer, 2003 H. B. Zachry Company, San Antonio, Texas EL PASO BRANCH Appointed by the Federal Reserve Bank Lester L. Parker President and Chief Executive Officer, 2001 United Bank of El Paso del Norte, El Paso, Texas James D. Renfrow President and Chief Executive Officer, 2002 The Carlsbad National Bank, Carlsbad, New Mexico Melissa W. O'Rourke President, Charlotte's Inc., El Paso, Texas 2002 Ron C. Helm Owner, Helm Cattle Company, El Paso, Texas 2003 Appointed by the Board of Governors Beauregard Brite White Rancher, J. E. White, Jr. & Sons, Marfa, Texas 2001 James Haines Chief Executive Officer and President, 2002 El Paso Electric Company, El Paso, Texas Gail S. Darling President, Gail Darling Inc., El Paso, Texas 2003 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

330 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 11, HOUSTON BRANCH Appointed by the Federal Reserve Bank Richard W. Weekley Chairman, Weekley Development Company, 2001 Houston, Texas Priscilla D. Slade President, Texas Southern University, 2002 Houston, Texas Ray B. Nesbitt President (Retired), Exxon Chemical Company, 2002 Houston, Texas Alan R. Buckwalter III Chairman and Chief Executive Officer, 2003 J.P. Morgan Chase Bank, Texas Region, Houston, Texas Appointed by the Board of Governors Edward O. Gaylord Chairman, Jacintoport Terminal Company, 2001 Houston, Texas Lupe Fraga President and Chief Executive Officer, 2002 Tejas Office Products, Inc., Houston, Texas Jeffrey K. Skilling President and Chief Executive Officer, 2003 Veld Interests, Inc., Houston, Texas SAN ANTONIO BRANCH Appointed by the Federal Reserve Bank R. Tom Roddy Chairman, Clear Lake National Bank, 2001 San Antonio, Texas Mary Rose Cardenas Executive Vice President, Cardenas Motors, Inc., 2002 Brownsville, Texas Daniel B. Hastings, Jr. President and Owner, Daniel B. Hastings, Inc., 2002 Laredo, Texas Arthur R. Emerson Chairman and Chief Executive Officer, 2003 Groves Rojas Emerson, San Antonio, Texas Appointed by the Board of Governors Ron R. Harris President and Chief Executive Officer, 2001 Pervasive Software Inc., Austin, Texas Patty P. Mueller Vice President, Mueller Energetics Corp., 2002 Corpus Christi, Texas Marvin L. Ragsdale President, Iron Workers District Council of 2003 the State of Texas, Austin, Texas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 331 Term expires Dec. 31 DISTRICT 12—SAN FRANCISCO Class A Warren K.K. Luke Chairman, President, and Chief Executive Officer, 2001 Hawaii National Bank, Honolulu, Hawaii E. Lynn Caswell Chairman and Managing Director, 2002 Zurich American Trust Co., AG, Laguna Niguel, California Richard C. Hartnack Vice Chairman, Union Bank of California, 2003 Los Angeles, California Class B Jack McNally Business Manager, IBEW, Local Union 1245, 2001 and Principal, JKM Consulting, Sacramento, California Robert S. Attiyeh Senior Vice President, Chief Financial Officer 2002 (Retired), and Consultant, Amgen, Inc., Thousand Oaks, California Barbara L. Wilson Idaho and Regional Vice President (Retired) 2003 and Consultant, Qwest Corporation, Boise, Idaho Class C Sheila D. Harris Director, Governor's Office of Housing 2001 Development, Phoenix, Arizona George M. Scalise President, Semiconductor Industry Association, 2002 San Jose, California Nelson C. Rising Chairman and Chief Executive Officer, 2003 Catellus Development Corporation, San Francisco, California Los ANGELES BRANCH Appointed by the Federal Reserve Bank Russell Goldsmith Chairman and Chief Executive Officer, 2001 City National Bank, Beverly Hills, California John H. Gleason Regional President, California and Texas, 2002 Del Webb Corporation, Phoenix, Arizona D. Linn Wiley President and Chief Executive Officer, 2003 Citizens Business Bank, Ontario, California Linda Griego Managing Partner, Engine Co. No. 28, 2003 Los Angeles, California Appointed by the Board of Governors William D. Jones Chairman, President, and Chief Executive Officer, 2001 CityLink Investment Corporation, San Diego, California Lori R. Gay President, Los Angeles Neighborhood Housing 2002 Service, Inc., Los Angeles, California Lonnie Kane President, Karen Kane, Inc., 2003 Los Angeles, California Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

332 88th Annual Report, 2001 Term expires Dec. 31 DISTRICT 12, PORTLAND BRANCH Appointed by the Federal Reserve Bank George J. Passadore President, Oregon Wells Fargo Bank, 2001 Portland, Oregon Phyllis A. Bell President, Oregon Coast Aquarium, 2002 Newport, Oregon Martin Brantley President and General Manager (Retired), 2002 Oregon's 12-KPTV, Portland, Oregon Guy L. Williams President and Chief Executive Officer, 2003 Security Bank, Coos Bay, Oregon Appointed by the Board of Governors Karla S. Chambers Vice President and Co-Owner, 2001 Stahlbush Island Farms, Inc., Corvallis, Oregon Nancy Wilgenbusch President, Marylhurst University, 2002 Marylhurst, Oregon Patrick Borunda Principal, The Navigator Group, 2003 Yacolt, Washington SALT LAKE CITY BRANCH Appointed by the Federal Reserve Bank Curtis H. Harris Chairman, President, and Chief Executive Officer, 2001 Barnes Banking Company, Kaysville, Utah J. Pat McMurray President and Chief Executive Officer, 2002 Idaho Region, Wells Fargo Bank, Boise, Idaho Maria Garciaz Executive Director, Salt Lake Neighborhood 2002 Housing Services, Inc., Salt Lake City, Utah Peggy A. Stock President, Westminster College, 2003 Salt Lake City, Utah Appointed by the Board of Governors Gary L. Crocker Chairman, ARUP Laboratories, 2001 Salt Lake City, Utah H. Roger Boyer Chairman, The Boyer Company, Salt Lake City, Utah 2002 William C. Glynn President, Intermountain Industries, Inc., 2003 Boise, Idaho Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 333 Term expires Dec. 31 DISTRICT 12, SEATTLE BRANCH Appointed by the Federal Reserve Bank Peter H. van Oppen Chairman and Chief Executive Officer, 2001 Advanced Digital Information Corp., Redmond, Washington Mary E. Pugh President, Pugh Capital Management, Inc., 2002 Seattle, Washington James C. Hawkanson Chairman (Retired), The Commerce Bank of 2002 Washington, N.A., Seattle, Washington Betsy Lawer Vice Chair and Chief Operating Officer, 2003 First National Bank of Alaska, Anchorage, Alaska Appointed by the Board of Governors Helen M. Rockey Chief Executive Officer and President (Retired), 2001 Just for Feet, Inc., Seattle, Washington Boyd E. Givan Senior Vice President and Chief Financial 2002 Officer (Retired), The Boeing Company, Seattle, Washington Richard R. Sonstelie Chairman (Retired), Puget Sound Energy, Inc., 2003 Bellevue, Washington Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

334 88th Annual Report, 2001 Membership of the Board of Governors, 1913-2001 Appointed Members Name Federal Reserve Date initially took Other dates1 District oath of office Charles S. Hamlin Boston Aug. 10, 1914 Reappointed in 1916 and 1926. Served until Feb. 3, 1936.2 Paul M. Warburg New York Aug. 10, 1914 Term expired Aug. 9,1918. Frederic A. Delano Chicago Aug. 10, 1914 Resigned July 21, 1918. W.P.G. Harding Atlanta Aug. 10, 1914 Term expired Aug. 9,1922. Adolph C. Miller San Francisco Aug. 10, 1914 Reappointed in 1924. Reappointed in 1934 from the Richmond District. Served until Feb. 3, 1936.2 Albert Strauss New York Oct. 26,1918 Resigned Mar. 15, 1920. Henry A. Moehlenpah Chicago Nov. 10, 1919 Term expired Aug. 9, 1920. Edmund Platt New York June 8,1920 Reappointed in 1928. Resigned Sept. 14, 1930. David C.Wills Cleveland Sept. 29,1920 Term expired Mar. 4, 1921. John R. Mitchell Minneapolis May 12, 1921 Resigned May 12,1923. Milo D. Campbell Chicago Mar. 14, 1923 Died Mar. 22, 1923. Daniel R. Crissinger Cleveland May 1, 1923 Resigned Sept. 15, 1927. George R. James St. Louis May 14, 1923 Reappointed in 1931. Served until Feb. 3, 1936.3 Edward H. Cunningham Chicago May 14, 1923 Died Nov. 28, 1930. Roy A. Young Minneapolis Oct. 4, 1927 Resigned Aug. 31, 1930. Eugene Meyer New York Sept. 16,1930 Resigned May 10, 1933. Wayland W. Magee Kansas City May 18, 1931 Term expired Jan. 24, 1933. Eugene R. Black Atlanta May 19, 1933 Resigned Aug. 15, 1934. M.S. Szymczak Chicago June 14, 1933 Reappointed in 1936 and 1948. Resigned May 31, 1961. J.J. Thomas Kansas City June 14, 1933 Served until Feb. 10, 1936.2 Marriner S. Eccles San Francisco Nov. 15, 1934 Reappointed in 1936, 1940, and 1944. Resigned July 14, 1951. Joseph A. Broderick New York Feb. 3, 1936 Resigned Sept. 30, 1937. John K. McKee Cleveland Feb. 3, 1936 Served until Apr. 4, 1946.2 Ronald Ransom Atlanta Feb. 3,1936 Reappointed in 1942. Died Dec. 2, 1947. Ralph W. Morrison Dallas Feb. 10, 1936 Resigned July 9, 1936. Chester C. Davis Richmond June 25, 1936 Reappointed in 1940. Resigned Apr. 15, 1941. Ernest G. Draper New York Mar. 30, 1938 Served until Sept. 1,1950.2 Rudolph M. Evans Richmond Mar. 14,1942 Served until Aug. 13, 1954.2 James K. Vardaman, Jr. St. Louis Apr. 4, 1946 Resigned Nov. 30, 1958. Lawrence Clayton Boston Feb. 14,1947 Died Dec. 4, 1949. Thomas B. McCabe Philadelphia Apr. 15, 1948 Resigned Mar. 31, 1951. Edward L. Norton Atlanta Sept. 1, 1950 Resigned Jan. 31, 1952. Oliver S. Powell Minneapolis Sept. 1, 1950 Resigned June 30, 1952. Wm. McC. Martin, Jr. New York April 2, 1951 Reappointed in 1956. Term expired Jan. 31, 1970. A.L. Mills, Jr. San Francisco Feb. 18,1952 Reappointed in 1958. Resigned Feb. 28, 1965. J.L. Robertson Kansas City Feb. 18, 1952 Reappointed in 1964. Resigned Apr. 30, 1973. C. Canby Balderston Philadelphia Aug. 12, 1954 Served through Feb. 28, 1966. Paul E. Miller Minneapolis Aug. 13, 1954 Died Oct. 21, 1954. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Membership of the Board of Governors, 1913-2000 335 Appointed Members—Continued Name Federal Reserve Date initially took Other dates1 District oath of office Chas. N. Shepardson Dallas Mar. 17, 1955 Retired Apr. 30, 1967. G.H. King, Jr. Atlanta Mar. 25, 1959 Reappointed in 1960. Resigned Sept. 18, 1963. George W. Mitchell Chicago Aug. 31, 1961 Reappointed in 1962. Served until Feb. 13, 1976.2 J. Dewey Daane Richmond Nov. 29, 1963 Served until Mar. 8, 1974.2 Sherman J. Maisel San Francisco Apr. 30, 1965 Served through May 31, 1972. Andrew F. Brimmer Philadelphia Mar. 9, 1966 Resigned Aug. 31, 1974. William W. Sherrill Dallas May 1, 1967 Reappointed in 1968. Resigned Nov. 15, 1971. Arthur F. Burns New York Jan. 31, 1970 Term began Feb. 1, 1970. Resigned Mar. 31, 1978. John E. Sheehan St. Louis Jan. 4, 1972 Resigned June 1, 1975. Jeffrey M. Bucher San Francisco June 5, 1972 Resigned Jan. 2, 1976. Robert C. Holland Kansas City June 11, 1973 Resigned May 15, 1976. Henry C. Wallich Boston Mar. 8, 1974 Resigned Dec. 15, 1986. Philip E. Coldwell Dallas Oct. 29, 1974 Served through Feb. 29, 1980. Philip C. Jackson, Jr. Atlanta July 14, 1975 Resigned Nov. 17, 1978. J. Charles Partee Richmond Jan. 5, 1976 Served until Feb. 7, 1986.2 Stephen S. Gardner Philadelphia Feb. 13, 1976 Died Nov. 19, 1978. David M. Lilly Minneapolis June 1, 1976 Resigned Feb. 24, 1978. G. William Miller San Francisco Mar. 8, 1978 Resigned Aug. 6, 1979. Nancy H. Teeters Chicago Sept. 18, 1978 Served through June 27, 1984. Emmett J. Rice New York June 20, 1979 Resigned Dec. 31, 1986. Frederick H. Schultz Atlanta July 27, 1979 Served through Feb. 11, 1982. Paul A. Volcker Philadelphia Aug. 6, 1979 Resigned August 11, 1987. Lyle E. Gramley Kansas City May 28, 1980 Resigned Sept. 1, 1985. Preston Martin San Francisco Mar. 31, 1982 Resigned April 30, 1986. Martha R. Seger Chicago July 2, 1984 Resigned March 11, 1991. Wayne D. Angell Kansas City Feb. 7, 1986 Served through Feb. 9, 1994. Manuel H. Johnson Richmond Feb. 7, 1986 Resigned August 3, 1990. H. Robert Heller San Francisco Aug. 19, 1986 Resigned July 31, 1989. Edward W.Kelley, Jr. Dallas May 26, 1987 Resigned Dec. 31,2001. Alan Greenspan New York Aug. 11, 1987 Reappointed in 1992. John P. LaWare Boston Aug. 15, 1988 Resigned April 30, 1995. David W. Mullins, Jr. St. Louis May 21, 1990 Resigned Feb. 14, 1994. Lawrence B. Lindsey Richmond Nov. 26, 1991 Resigned Feb. 5, 1997. Susan M. Phillips Chicago Dec. 2, 1991 Served through June 30, 1998. Alan S. Blinder Philadelphia June 27, 1994 Term expired Jan. 31, 1996. Janet L. Yellen San Francisco Aug. 12, 1994 Resigned Feb. 17, 1997. Laurence H. Meyer St. Louis June 24, 1996 Alice M. Rivlin Philadelphia June 25, 1996 Resigned July 16, 1999. Roger W. Ferguson, Jr. Boston Nov. 5, 1997 Reappointed in 2001. Edward M. Gramlich Richmond Nov. 5, 1997 Susan S. Bies Chicago Dec. 7, 2001 Mark W. Olson Minneapolis Dec. 7, 2001 NOTE. Under the original Federal Reserve Act, the to twelve years. The Banking Act of 1935 changed the Federal Reserve Board was composed of five appointed name to the Board of Governors of the Federal Reserve members, the Secretary of the Treasury (ex-officio chair- System and provided that the Board be composed of man of the Board), and the Comptroller of the Currency. seven appointed members; that the Secretary of the Trea- The original term of office was ten years; the five original sury and the Comptroller of the Currency continue to appointed members had terms of two, four, six, eight, and serve until Feb. 1, 1936; that the appointed members in ten years. In 1922 the number of appointed members was office on Aug. 23, 1935, continue to serve until Feb. 1, increased to six, and in 1933 the term of office was raised 1936, or until their successors were appointed and had Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

336 88th Annual Report, 2001 CHAIRMEN3 Charles S. Hamlin Aug. 10, 1914-Aug. 9, 1916 W.P.G. Harding Aug. 10, 1916-Aug. 9, 1922 Daniel R. Crissinger May 1,1923-Sept. 15,1927 Roy A. Young Oct. 4, 1927-Aug.31,1930 Eugene Meyer Sept. 16,1930-May 10, 1933 Eugene R. Black May 19,1933-Aug. 15, 1934 Marriner S. Eccles Nov. 15, 1934-Jan. 31, 19484 Thomas B. McCabe Apr. 15, 1948-Mar. 31, 1951 Wm. McC. Martin, Jr. Apr. 2,1951-Jan.31, 1970 Arthur F. Burns Feb. 1,1970-Jan. 31, 1978 G.William Miller Mar. 8, 1978-Aug. 6, 1979 Paul A. Volcker Aug. 6,1979-Aug. 11, 1987 Alan Greenspan Aug. 11, 1987-5 VICE CHAIRMEN3 Frederic A. Delano Aug. 10,1914-Aug. 9,1916 Paul M. Warburg Aug. 10,1916-Aug. 9, 1918 Albert Strauss Oct. 26, 1918-Mar. 15, 1920 Edmund Platt July 23,1920-Sept. 14,1930 J.J. Thomas Aug. 21,1934-Feb. 10,1936 Ronald Ransom Aug. 6, 1936-Dec. 2,1947 C. Canby Balderston Mar. 11, 1955-Feb. 28, 1966 J.L. Robertson Mar. 1,1966-Apr. 30,1973 George W. Mitchell May 1,1973-Feb. 13, 1976 Stephen S. Gardner Feb. 13, 1976-Nov. 19, 1978 Frederick H. Schultz July 27,1979-Feb. 11,1982 Preston Martin Mar. 31, 1982-Apr. 30, 1986 Manuel H. Johnson Aug. 4, 1986-Aug. 3, 1990 David W. Mullins, Jr. July 24, 1991-Feb. 14, 1994 Alan S. Blinder June 27, 1994-Jan. 31, 1996 Alice M. Rivlin June 25, 1996-July 16, 1999 Roger W. Ferguson, Jr. Oct. 5, 1999- Ex-Officio Members SECRETARIES OF THE TREASURY W.G. McAdoo Dec. 23, 1913-Dec. 15, 1918 Carter Glass Dec. 16,1918-Feb. 1, 1920 David F. Houston Feb. 2,1920-Mar. 3,1921 Andrew W. Mellon Mar. 4, 1921-Feb. 12, 1932 Ogden L. Mills Feb. 12, 1932-Mar. 4, 1933 William H. Woodin Mar. 4,1933-Dec. 31,1933 Henry Morgenthau, Jr. Jan. 1, 1934-Feb. 1,1936 COMPTROLLERS OF THE CURRENCY John Skelton Williams Feb. 2,1914-Mar. 2,1921 Daniel R. Crissinger Mar. 17,1921-Apr. 30,1923 Henry M. Dawes May 1, 1923-Dec. 17, 1924 Joseph W. Mclntosh Dec. 20, 1924-Nov. 20, 1928 J.W. Pole Nov. 21, 1928-Sept. 20, 1932 J.F.T. O'Connor May 11,1933-Feb. 1, 1936 qualified; and that thereafter the terms of members be 3. Before Aug. 23, 1935, Chairmen and Vice Chairfourteen years and that the designation of Chairman and men were designated Governor and Vice Governor. Vice Chairman of the Board be for four years. 4. Served as Chairman Pro Tempore from February 3, 1. Date following "Resigned" and "Retired" denotes 1948, to April 15,1948. final day of service. 5. Served as Chairman Pro Tempore from March 3, 2. Successor took office on this date. 1996, to June 20,1996. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

338 88th Annual Report, 2001 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2001 and 2000 Millions of dollars Total Boston Item 2001 2000 2001 2000 ASSETS Gold certificate account 11,045 11,046 546 535 Special drawing rights certificate account 2,200 2,200 115 115 Coin 1,047 949 54 46 Loans To depository institutions 34 110 Other 0 0 Securities purchased under agreements to resell (triparty) 50,250 43,375 Federal agency obligations Bought outright 10 130 1 7 Held under repurchase agreements 0 0 0 0 US. Treasury securities Bought outright1 551,675 511,703 33,146 29,376 Held under repurchase agreements 0 0 0 0 Total loans and securities 601,969 555,318 33,149 29,385 Items in process of collection 3,829 8,019 317 473 Bank premises 1,512 1,460 91 93 Other assets Denominated in foreign currencies 2 14,559 15,670 757 703 Other3 20,819 19,769 1,076 955 Interdistrict settlement account 0 0 -2,362 2,782 Total assets 656,980 614,431 33,743 35,088 LIABILITIES Federal Reserve notes 611,757 563,450 31,806 31,891 Deposits Depository institutions 17,478 19,045 626 1,645 U.S. Treasury, general account 6,645 5,149 0 0 Foreign, official accounts 61 216 2 1 Other4 828 1,390 40 63 Total deposits 25,012 25,800 668 1,709 Deferred credit items 3,131 7,225 283 521 2,395 4,165 149 249 Other liabilities and accrued dividends5 42,295 600,640 32,906 34,371 Total liabilities CAPITAL ACCOUNTS 7,373 6,997 418 358 Capital paid in 7,312 6,794 418 358 Surplus 0 0 0 0 Other capital accounts 656,980 614,431 33,743 35,088 Total liabilities and capital accounts FEDERAL RESERVE NOTE STATEMENT 751,540 751,714 35,614 36,707 Federal Reserve notes outstanding (issued to Bank) 139,783 188,264 3,808 4,816 Less: Held by Bank 611,757 563,450 31,806 31,891 Federal Reserve notes, net Collateral for Federal Reserve notes Gold certificate account 11,045 11,046 Special drawing rights certificate account 2,200 2,200 Other eligible assets 0 0 U.S. Treasury and federal agency securities 598,512 550,205 DigitizedT footra lF cRolAlaSteEraRl 611,757 563,450 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 339 1.—Continued New York Philadelphia Cleveland Richmond 2001 2000 2001 2000 2001 2000 2001 2000 4,451 4,428 454 414 538 520 741 750 874 874 83 83 104 104 147 147 63 74 44 52 61 67 165 117 0 0 0 2 0 0 1 5 0 0 0 0 0 0 0 0 50,250 43,375 4 50 0 5 1 7 1 8 0 0 0 0 0 0 0 0 225,984 197,518 22,659 21,313 32,298 28,635 32,957 30,038 0 0 0 0 0 0 0 0 276,239 240,944 22,660 21,320 32,298 28,643 32,958 30,051 473 893 526 384 218 282 174 658 177 166 49 51 152 154 132 128 3,099 3,230 481 486 996 1,083 3,544 4,121 9,787 8,577 810 769 1,087 964 1,231 1,689 -29,004 -3,255 -2,239 1,353 -2,008 2,260 13,211 2,402 266,158 255,930 22,868 24,911 33,448 34,078 52^4 40,063 251,766 240,061 21,773 23,114 30,620 31,183 45,208 34,048 3,092 4,570 413 702 1,103 1,249 3,191 1,641 6,645 5,149 0 0 0 0 0 0 37 192 1 1 2 2 7 8 447 646 29 46 30 112 70 42 10,221 10,556 443 749 1,135 1,363 3,269 1,691 381 943 100 404 224 349 109 683 782 1,435 110 188 139 239 205 283 263,150 252,995 22,425 24,456 32,118 33,134 48,790 36,706 1,504 1,468 221 228 665 472 1,757 1,679 1,504 1,468 221 228 665 472 1,757 1,679 0 0 0 0 0 0 0 0 266,158 255,930 22,868 24,911 33,448 34,078 52304 40,063 293,294 300,366 28,335 31,820 34,936 36,272 55,438 50,845 41,528 60,305 6,562 8,706 4,316 5,089 10,230 16,797 251,766 240,061 21,773 23,114 30,620 31,183 45,208 34,048 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

340 88th Annual Report, 2001 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2001 and 2000—Continued Millions of dollars Atlanta Chicago Item 2001 2000 2001 2000 ASSETS Gold certificate account 871 802 1,028 1,064 Special drawing rights certificate account 166 166 212 212 Coin 113 83 117 114 Loans To depository institutions 15 25 Other 0 0 Securities purchased under agreements to resell (triparty) Federal agency obligations Bought outright 1 9 1 16 Held under repurchase agreements 0 0 0 0 US. Treasury securities Bought outright1 37,935 34,060 62,482 61,207 Held under repurchase agreements 0 0 0 0 Total loans and securities 37,943 34,075 62,497 61,248 Items in process of collection 149 514 526 1,119 Bank premises 281 251 105 104 Other assets Denominated in foreign currencies2 1,046 1,122 1,333 1,409 Other3 1,278 1,147 2,005 1,953 Interdistrict settlement account 7,088 4,499 6,071 -770 Total assets 48,934 42,658 73,895 66,453 LIABILITIES Federal Reserve notes 46,323 39,286 68,119 61,206 Deposits Depository institutions 1,169 1,097 3,498 2,796 U.S. Treasury, general account 0 0 0 0 Foreign, official accounts 2 2 3 3 Other4 37 86 44 134 Total deposits 1,208 1,185 3,544 2,933 Deferred credit items 138 877 386 575 196 320 258 476 Other liabilities and accrued dividends5 7,864 41,668 7238 65,190 Total liabilities CAPITAL ACCOUNTS 535 495 793 632 Capital paid in 535 495 793 632 Surplus 0 0 0 0 Other capital accounts Total liabilities and capital accounts 48,934 42,658 73^95 66,453 FEDERAL RESERVE NOTE STATEMENT Federal Reserve notes outstanding (issued to Bank) 65,085 60,948 74,543 70,685 Less: Held by Bank 18,763 21,662 6,424 9,479 Federal Reserve notes, net 46323 39086 68,119 61,206 NOTE. Components may not sum to totals because of and excludes securities sold and scheduled to be bought rounding back under matched sale-purchase transactions. 1. Includes securities loaned—fully guaranteed by U.S. Treasury securities pledged with Federal Reserve Banks— Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 341 1.—Continued St. Louis Minneapolis Kansas City Dallas San Francisco 2001 2000 2001 2000 2001 2000 2001 2000 2001 2000 343 359 143 158 317 340 477 514 1,136 1,162 71 71 30 30 66 66 98 98 234 234 58 51 31 33 69 67 128 91 144 155 3 8 3 5 3 31 0 5 0 23 0 0 0 0 0 0 0 0 0 0 0 5 0 1 0 4 0 4 1 14 0 0 0 0 0 0 0 0 0 0 19,884 19,438 1,721 2,154 17,028 17,052 10,001 15,140 55,580 55,770 0 0 0 0 0 0 0 0 0 0 19,888 19,451 1,725 2,159 17,031 17,087 10,001 15,148 55,581 55,807 215 539 526 516 236 579 202 334 267 1,727 43 34 123 126 49 49 137 138 171 166 291 385 563 572 378 436 398 513 1,673 1,609 655 643 122 140 575 571 385 544 1,807 1,816 721 -740 12,065 -642 -358 -818 4,041 -5,829 -7,226 -1,241 22,286 20,793 15329 3,093 18363 18377 15,866 11,552 53,788 61,435 21,435 19,410 14,055 1,587 16,960 16,646 14,378 9,754 49,314 55,263 344 596 460 456 758 722 695 939 2,129 2,632 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 3 3 22 39 0 1 24 53 31 32 54 137 366 636 462 458 783 776 727 972 2,187 2,771 79 296 457 451 135 433 349 298 490 1,394 107 175 57 63 103 164 83 151 206 422 21,988 20,517 15,031 2,560 17,981 18,020 15,538 11,175 52,196 59,850 149 138 180 368 191 179 164 188 796 792 149 138 118 165 191 179 164 188 796 792 0 0 0 0 0 0 0 0 0 0 22,286 20,793 15,329 3,093 18363 18^77 15,866 11,552 53,788 61,435 24,022 23,180 16,070 9,581 21,077 21,578 33,441 32,467 69,686 77,265 2,586 3,770 2,015 7,994 4,117 4,932 19,062 22,713 20,372 22,001 21,435 19,410 14,055 1,587 16,960 16,646 14378 9,754 49314 55,263 2. Valued monthly at market exchange rates. deposits are held solely by the Federal Reserve Bank of 3. The System total includes depository institution New York. overdrafts of $22 million for 2001 and $8 million for 5. Includes exchange-translation account reflecting the 2000. monthly revaluation at market exchange rates of foreign 4. Includes international organization deposits of exchange commitments. Digitize$1d2 7fo mr iFllRionA SfoEr R20 01 and $133 million for 2000 These http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

342 88th Annual Report, 2001 2. Federal Reserve Open Market Transactions, 2001 Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. U.S. TREASURY SECURITIES Outright transactions (excluding matched transactions) Treasury bills Gross purchases 520 2,683 579 308 Gross sales 0 0 0 0 Exchanges 40,769 42,767 46,712 38,317 New bills 40,769 42,767 46,712 38,317 Redemptions 228 638 211 3,537 Others within 1 year Gross purchases 0 1,605 67 3,027 Gross sales 0 0 0 0 Maturity shift 10,296 5,609 0 12,204 Exchanges -6,667 -6,799 0 -7,000 Redemptions 2,422 1,529 0 4,368 0 to 5 years Gross purchases 925 2,983 1,883 4,480 Gross sales 0 0 0 0 Maturity shift -10,296 -2,784 0 -12,204 Exchanges 6,667 4,945 0 7000 5 to 10 years Gross purchases 1,283 0 0 1,390 Gross sales 0 0 0 0 Maturity shift 0 -1,855 0 0 Exchanges 0 971 0 0 More than 10 years Gross purchases 296 495 1,000 913 Gross sales 0 0 0 0 Maturity shift 0 -971 0 0 Exchanges 0 883 0 0 All maturities Gross purchases 3,024 7,766 3,529 10,118 Gross sales 0 0 0 0 Redemptions 2,650 2,166 211 7,905 Matched transactions Gross purchases 356,250 320,060 396,029 381,667 Gross sales 352,336 322,056 395,151 381,895 Repurchase agreements Gross purchases 0 0 0 0 Gross sales 0 0 0 0 Net change in U.S. Treasury securities 4,289 3,604 4,196 1,984 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 343 2.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 624 2,165 718 2,899 348 772 3,075 812 15,503 0 0 0 0 0 0 0 0 0 47,112 40,363 42,001 55,231 42,268 50,274 59,292 43,771 548,879 47,112 40,363 42,001 55,231 42,268 50,274 59,292 43,771 548,879 3,939 0 0 0 1,543 0 0 0 10,095 2,174 1,410 235 1,385 0 1,411 1,408 2,942 15,663 0 0 0 0 0 0 0 0 0 8,117 0 7,088 9,379 0 6,535 5,873 0 0 -8,965 0 -7,667 -6,873 0 -11,809 -9,559 0 0 2,287 0 4,668 1,055 0 473 0 0 16,802 2,685 1,428 4,193 810 851 22 1,920 634 22,814 0 0 0 0 0 0 0 0 0 -1,913 0 1,838 -9,379 0 -2,164 -3,073 0 0 6,508 0 7,667 5,290 0 11,809 7,967 0 0 657 0 756 935 0 422 459 101 6,003 0 0 0 0 0 0 0 0 0 -5,130 0 -8,926 1,043 0 -4,372 -1,824 0 0 2,457 0 0 1,043 0 0 1,592 0 0 1,241 1,419 815 720 0 1,184 0 448 8,531 0 0 0 0 0 0 0 0 0 -1,074 0 0 -1,043 0 0 -975 0 0 0 0 0 540 0 0 0 0 0 7,380 6,422 6,716 6,749 1,199 3,811 6,862 4,937 68,513 0 0 0 0 0 0 0 0 0 6,226 0 4,668 1,055 1,543 473 0 0 26,897 398,039 367,462 392,721 406,143 508,129 431,887 377,247 387,033 4,724,743 397,600 366,411 394,381 405,627 515,429 425,110 378,129 390,617 4,722,667 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1,592 7,472 388 6,211 -7,645 10,114 5,980 1,354 39,540 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

344 88th Annual Report, 2001 2. Federal Reserve Open Market Transactions, 2001—Continued Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. FEDERAL AGENCY OBLIGATIONS Outright transactions Gross purchases 0 0 0 Gross sales 0 0 0 Redemptions 0 120 0 Repurchase agreements Gross purchases 0 0 0 Gross sales 0 0 0 Net change in agency obligations -120 TRIPARTY ARRANGEMENTS Repurchase agreements1 Gross purchases 104,930 67,655 86,472 85,166 Gross sales 129,385 62,910 88,142 82,154 Net change in triparty arrangements -24,455 4,745 -1,670 3,012 Total net change in System Open Market Account. -20,166 8,229 2,526 4,9% NOTE. Sales, redemptions, and negative figures reduce 1. Cash value of agreements through third-party custoholdings of the System Open Market Account; all other dial banks. These agreements are collateralized by U.S. figures increase such holdings. Components may not sum government and federal agency securities. to totals because of rounding. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 345 2.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 120 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -120 120,135 65,005 106,355 103,255 406,930 110,885 121,530 117,650 1,495,968 114,832 72,065 103,255 99,850 388,805 113,715 130,080 103,900 1,489,093 5,303 -7,060 3,100 3,405 18,125 -2,830 -8,550 13,750 6,875 6,895 412 3,488 9,616 10,480 7,284 -2,570 15,104 46,295 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

346 88th Annual Report, 2001 3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 1999-2001 Millions of dollars December 31 Change Description 2000 to 1999 to 2001 2000 1999 2001 2000 U.S. TREASURY SECURITIES Held outright1 574,863 532,815 517,145 42,048 15,670 By remaining maturity Bills 1-90 days 136,695 130,710 124,294 5,985 6,416 91 days to 1 year 68,567 69,143 91,405 -576 -22,262 Notes and bonds 1 year or less 83,785 73,812 59,899 9,973 13,913 More than 1 year through 5 years 153,158 132,792 124,169 20,366 8,623 More than 5 years through 10 years ... 53,338 55,461 51,107 -2,123 4,354 More than 10 years 79,320 70,896 66,270 8,424 4,626 By type Bills 205,262 199,854 215,699 5,408 -15,845 Notes 265,941 240,177 218,467 25,764 21,710 Bonds 103,660 92,784 82,978 10,876 9,806 Repurchase agreements 0 0 0 0 0 MSPs, foreign accounts 23,188 21,112 39,182 2,076 -18,070 MSPs, in the market 0 0 0 0 0 FEDERAL AGENCY SECURITIES Held outright1 10 130 181 -120 -51 By remaining maturity 1 year or less 0 0 51 0 -51 More than 1 year through 5 years 10 130 10 -120 120 More than 5 years through 10 years 0 0 120 0 -120 More than 10 years 0 0 0 0 0 By issuer Federal Farm Credit Banks 0 0 0 0 0 Federal Home Loan Banks 0 0 6 0 -6 Federal Land Banks 0 0 0 0 0 Federal National Mortgage Association .. 10 130 175 -120 -45 Repurchase agreements TRIPARTY ARRANGEMENTS Repurchase agreements2 50,250 43,375 0 6,875 43,375 NOTE. Components may not sum to totals because of 2. Cash value of agreements through third-party custorounding. dial banks. These arrangements are coUateralized by U.S. 1. Excludes the effects of temporary transactions— government and federal agency securities. repurchase agreements and matched sale-purchase agreements (MSPs). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 347 4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2001 President Other officers Employees Total Federal Reserve Bank (including Number Branches) Salary Num- Salaries Salaries Num- Salaries (dollars) ber (dollars) Full- Part- (dollars) ber (dollars) time time Boston 235,000 71 9,324,712 1,139 160 61,040,485 1,371 70,600,197 New York 297,500 264 43,353,198 3,010 76 179,465,224 3,351 223,115,922 Philadelphia 214,400 56 7,156,100 1,165 59 50,104,158 1,281 57,474,658 Cleveland 233,700 54 6,553,386 1,277 45 53,572,491 1,377 60,359,577 Richmond 232,400 91 10,710,700 1,965 129 88,446,879 2,186 99,389,979 Atlanta 253,200 91 11,153,550 2,324 64 100,365,842 2,480 111,772,592 Chicago 260,700 94 12,007,065 1,981 74 101,077,671 2,150 113,345,436 St. Louis 218,000 73 8,225,332 1,185 77 49,329,373 1,336 57,772,705 Minneapolis 243,400 43 5,271,300 1,164 132 51,068,713 1,340 56,583,413 Kansas City 235,600 70 8,275,700 1,621 67 70,398,868 1,759 78,910,168 Dallas 231,000 61 7,262,600 1,406 79 60,798,997 1,547 68,292,597 San Francisco ... 315,200 78 11,186,650 2,346 76 125,695,480 2,501 137,197,330 Federal Reserve Information Technology . 0 31 4,112,900 684 14 46,662,374 729 50,775,274 Office of Employee Benefits .... 0 7 1,233,800 23 0 1,643,578 30 2,877,378 Total 2,970,100 1,084 145,826,993 21,290 1,052 1,039,670,133 23,438 1,188,467,226 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

348 88th Annual Report, 2001 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2001 Thousands of dollars Item Total Boston New York Philadelphia Cleveland CURRENT INCOME Loans 12,618 762 3,610 34 1,025 US. Treasury and federal agency securities 30,523,365 1,752,159 12,867,992 1,218,963 1,707,517 Foreign currencies 330,525 16,629 74,749 10,659 22,243 Priced services 926,545 57,122 98,056 47,017 64,601 Other 77,668 3,303 40,588 2,169 3,395 Total 31,870,721 1,829,975 13,084,994 1,278,842 1,798,781 CURRENT EXPENSES Salaries and other personnel expenses 1,269,156 74,413 240,012 63,303 62,853 Retirement and other benefits 347,132 19,344 75,381 15,417 17,662 Net periodic pension costs' . -330,683 -10 -330,726 2 -1 Fees 59,716 3,129 6,396 1,195 2,595 Travel 55,287 2,420 6,165 1,993 3,543 Software expenses 95,636 3,506 10,434 2,715 8,275 Postage and other shipping costs 86,930 1,627 5,270 1,600 2,083 Communications 15,597 2,876 2,789 376 696 Materials and supplies 54,955 3,443 9,292 4,085 3,033 Building expenses Taxes on real estate 32,005 4,812 4,264 1,621 2,031 Property depreciation 72,705 4,845 13,612 3,149 5,983 Utilities 32,066 3,091 6,486 2,571 2,066 Rent 35,651 747 11,293 275 350 Other 31,146 863 6,169 1,631 2,817 Equipment Purchases : 29,515 1,816 4,888 1,596 1,037 Rentals 34,284 128 1,776 383 267 Depreciation 113,395 5,737 19,010 5,597 5,685 Repairs and maintenance 90,745 5,497 9,950 5,054 5,302 Earnings-credit costs 250,423 15,531 51,512 10,566 24,593 Other 69,801 4,715 12,275 2,573 4,393 Shared costs, net2 0 13,231 46,175 8,232 7,052 Recoveries -71,509 -12,311 -9,009 -2,629 -2,789 Expenses capitalized3 -3,355 -38 0 -92 0 Total 2,370,597 159,413 203,413 131,212 159,527 Reimbursements -285,888 -23,286 -63,190 -19,967 -23,103 Net expenses 2,084,708 136,127 140,222 111,245 136,424 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 349 5.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 1,350 558 2,139 542 970 537 96 996 1,756,437 2,012,875 3,403,094 1,082,307 101,786 933,808 636,494 3,049,934 79,718 23,313 29,676 6,656 12,459 8,485 9,056 36,881 78,089 134,309 109,787 53,680 51,526 72,120 64,323 95,914 3,733 4,604 7,309 2,094 400 1,755 1,159 7,158 1,919,328 2,175,660 3,552,006 1,145,279 167,141 1,016,704 711,128 3,190,883 159,762 119,561 123,743 61,406 59,834 84,638 75,304 144,327 42,958 34,829 32,772 19,166 17,276 18,852 20,608 32,867 1 41 -4 8 4 4 -2 0 16,763 5,436 5,085 1,230 9,935 2,155 1,720 4,079 7,005 5,354 5,786 3,126 3,857 4,285 3,538 8,213 40,391 5,201 5,480 3,465 2,807 2,499 3,230 7,634 3,695 46,699 5,552 2,744 3,130 5,311 2,624 6,597 1,356 1,343 1,780 1,017 494 876 973 1,021 6,180 5,901 5,307 3,330 1,778 3,461 3,768 5,375 1,738 2,611 4,064 448 4,613 578 2,342 2,884 6,457 6,864 5,875 3,712 4,136 3,807 5,578 8,687 2,813 2,449 2,685 1,700 1,751 1,462 1,936 3,057 12,428 4,560 1,904 1,050 118 1,384 1,370 173 3,150 2,390 5,789 895 1,281 839 2,767 2,556 4,275 2,999 2,167 1,505 1,443 2,289 1,593 3,904 28,298 746 875 214 592 171 148 685 24,923 11,507 8,900 4,885 4,900 6,528 4,855 10,869 18,652 12,334 9,512 3,454 3,395 3,407 4,838 9,350 42,292 13,815 34,433 7,628 10,740 11,884 9,000 18,428 9,171 5,631 8,809 3,691 3,439 4,674 4,264 6,165 -165,505 9,928 9,493 9,924 19,109 16,629 8,520 17,214 -21,735 -3,799 -5,750 -1,516 -1,071 -1,186 -5,276 -4,437 -393 -676 -148 -38 0 -1,938 -32 0 244,676 295,722 274,106 133,043 153,561 172,609 153,667 289,648 -33,982 -13,202 -10,908 -26,432 -23,163 -16,616 -11,701 -20,338 210,694 282,520 263,198 106,611 130,398 155,993 141,966 269,310 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

350 88th Annual Report, 2001 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2001—Continued Thousands of dollars Item Total Boston New York Philadelphia Cleveland PROFIT AND LOSS Current net income 29,786,013 1,693,847 12,944,772 1,167,597 1,662,357 Additions to and deductions from (-) current net income4 Profits on sales of U.S. Treasury and federal agency securities 316,308 18,826 127,996 13,030 18,346 Profits on foreign exchange transactions 0 0 0 0 0 Other additions 1,651 9 63 12 30 Total additions 317,958 18,836 128,059 13,042 18,376 Losses on sales of U.S. Treasury and federal agency securities 0 0 0 0 Losses on foreign exchange transactions -1,435,178 -73,124 -304,063 -47,007 -98,360 Other deductions -131 0 -3 -1 Total deductions -1,435,309 -73,124 -304,103 -47,010 -98,361 Net addition to or deduction from (-) current net income -1,117,350 -54,288 -176,044 -33,968 -79,985 Cost of unreimbursed Treasury services 85 8 77 Assessments by Board Board expenditures5 295,056 15,811 62,898 9,721 19,707 Cost of currency 338,537 19,261 144,690 13,787 18,805 Net income before payment to U.S. Treasury 28,034,984 1,604,487 12,561,133 1,110,044 1,543,860 Dividends paid 428,183 24,553 87,974 13,491 30,519 Payments to U.S. Treasury (interest on Federal Reserve notes) 27,089,222 1,519,990 12,436,785 1,103,093 1,320,598 Transferred to/from surplus 517,580 59,944 36,374 -6,539 192,744 Surplus, January 1 6,793,942 358,447 1,467,657 227,900 471,943 Surplus, December 31 7,311,522 418,391 1,504,031 221,361 664,687 NOTE. Components may not sum to totals because of 3. Includes expenses for labor and materials temporounding. rarily capitalized and charged to activities when products 1. Reflects the effect of Financial Accounting Stan- are consumed. dards Board Statement of Financial Accounting Stan- 4. Includes reimbursement from the U.S. Treasury for dards No. 87, Employers' Accounting for Pensions (SFAS uncut sheets of Federal Reserve notes, gains and losses on 87). The System Retirement Plan for employees is the sale of Reserve Bank buildings, counterfeit currency recorded on behalf of the System on the books of the that is not charged back to the depositing institution, and Federal Reserve Bank of New York, resulting in a reduc- stale Reserve Bank checks that are written off. tion in expenses of $330,891 thousand. The Retirement 5. For additional details, see the chapter "Board of Benefits Equalization Plan is recorded by each Federal Governors Financial Statements." Reserve Bank. 2. Includes distribution of costs for projects performed by one Reserve Bank for the benefit of one or more other Reserve Banks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 351 5.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 1,708,634 1,893,140 3,288,808 1,038,668 36,743 860,711 569,162 2,921,573 18,827 21,604 36,248 11,530 1,059 9,927 6,497 32,416 0 0 0 0 0 0 0 0 11 31 1,471 4 1 3 5 12 18,838 21,635 37,718 11,534 1,061 9,930 6,503 32,428 -353,442 -103,039 -131,092 -29,667 -55,079 -37,610 -40,325 -162,372 -5 -4 -2 -1 -1 -66 -5 -1 -353,447 -103,043 -131,094 -29,668 -55,080 -37,676 -40,330 -162,373 -334,609 -81,408 -93,375 -18,134 -54,019 -27,746 -33,827 -129,945 0 0 0 0 0 0 0 0 71,102 21,475 27,780 5,989 10,878 7,784 7,795 34,118 20,441 23,297 36,831 11,677 958 10,026 5,781 32,985 1,282,482 1,766,960 3,130,822 1,002,869 -29,112 815,155 521,760 2,724,525 102,398 30,950 42,977 8,785 17,727 11,136 9,595 48,078 1,101,384 1,696,757 2,926,212 983,036 0 791,890 536,468 2,673,007 78,700 39,252 161,632 11,047 ^6,839 12,129 -24,303 3,440 1,678,709 495,332 631,518 138,004 164,915 178,830 188,318 792,368 1,757,409 534,584 793,150 149,052 118,076 190,959 164,015 795,807 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

352 88th Annual Report, 2001 6. Income and Expenses of the Federal Reserve Banks, 1914-2001 Thousands of dollars Assessments by Net additions Board of Governors Federal Reserve Bank Current Net or and period income expenses deductions (-)1 Board Costs expenditures of currency All Banks 1914-15 . 2,173 2,018 6 302 1916 5,218 2,082 -193 192 1917 16,128 4,922 -1,387 238 1918 67,584 10,577 -3,909 383 1919 102,381 18,745 ^,673 595 1920 181,297 27,549 -3,744 710 1921 122,866 33,722 -6,315 741 1922 50,499 28,837 -AM2 723 1923 50,709 29,062 -8,233 703 1924 38,340 27,768 -6,191 663 1925 41,801 26,819 ^,823 709 1926 47,600 24,914 -3,638 722 1,714 1927 43,024 24,894 -2,457 779 1,845 1928 64,053 25,401 -5,026 698 806 1929 70,955 25,810 782 3,099 1930 36,424 25,358 -93 810 2,176 1931 29,701 24,843 311 719 1,479 1932 50,019 24,457 -1,413 729 1,106 1933 49,487 25,918 -12,307 800 2,505 1934 48,903 26,844 -4,430 1,372 1,026 1935 42,752 28,695 -1,737 1,406 1,477 1936 37,901 26,016 486 1,680 2,178 1937 41,233 25,295 -1,631 1,748 1,757 1938 36,261 25,557 2,232 1,725 1,630 1939 38,501 25,669 2,390 1,621 1,356 1940 43,538 25,951 11,488 1,704 1,511 1941 41,380 28,536 721 1,840 2,588 1942 52,663 32,051 -1,568 1,746 4,826 1943 69,306 35,794 23,768 2,416 5,336 1944 104,392 39,659 3,222 2,296 7,220 1945 142,210 41,666 -830 2,341 4,710 1946 150,385 50,493 -626 2,260 4,482 1947 158,656 58,191 1,973 2,640 4,562 1948 304,161 64,280 -34,318 3,244 5,186 1949 316,537 67,931 -12,122 3,243 6,304 1950 275,839 69,822 36,294 3,434 7,316 1951 394,656 83,793 -2,128 4,095 7,581 1952 456,060 92,051 1,584 4,122 8,521 1953 513,037 98,493 -1,059 4,100 10,922 1954 438,486 99,068 -134 4,175 6,490 1955 412,488 101,159 -265 4,194 4,707 1956 595,649 110,240 -23 5,340 5,603 1957 763,348 117,932 -7,141 7,508 6,374 1958 742,068 125,831 124 5,917 5,973 1959 886,226 131,848 98,247 6,471 6,384 1960 1,103,385 139,894 13,875 6,534 7,455 1961 941,648 148,254 3,482 6,265 6,756 1962 1,048,508 161,451 -56 6,655 8,030 1963 1,151,120 169,638 615 7,573 10,063 1964 1,343,747 171,511 726 8,655 17,230 1965 1,559,484 172,111 1,022 8,576 23,603 1966 1,908,500 178,212 996 9,022 20,167 1967 2,190,404 190,561 2,094 10,770 18,790 1968 2,764,446 207,678 8,520 14,198 20,474 1969 3,373,361 237,828 -558 15,020 22,126 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 353 6.—Continued Payments to U.S. Treasury Dividends paid t S ra ta n t s u f t e o r r s y 2 Fed In er te a r l e R st e o se n rve (s t e o c t s io u n rp l 1 u 3 s b) ( t s o e c s t u io rp n l u 7 s ) notes 217 1,743 6,804 1,134 ' 1,134 5,541 48,334 5,012 2,704 70,652 5.654 60,725 82,916 6,120 59,974 15,993 6,307 10,851 -660 6,553 3,613 2,546 6,682 114 -3,078 6,916 59 2,474 7,329 818 8,464 7,755 250 5,044 8,458 2,585 21,079 9,584 4,283 22,536 10,269 17 -2,298 10,030 -7,058 9,282 2,011 11,021 8,874 -917 8,782 -^60 6,510 8,505 298 28 607 7,830 227 103 353 7,941 177 67 2,616 8,019 120 -419 1,862 8,110 25 -426 4,534 8,215 82 -54 17,617 8,430 141 -4 571 8,669 198 50 3,554 8,911 245 135 40,327 9,500 327 201 48,410 10,183 248 262 81,970 10,962 67 28 81,467 11,523 36 75,284 87 8,366 11,920 166,690 18,523 12,329 193,146 21,462 13,083 196,629 21,849 13,865 254,874 28,321 14,682 291,935 46,334 15,558 342,568 40,337 16,442 276,289 35,888 17,712 251,741 32,710 18,905 401,556 53,983 20,081 542,708 61,604 21,197 524,059 59,215 22,722 910,650 -93,601 23,948 896,816 42,613 25,570 687,393 70,892 27,412 799,366 45,538 28,912 879,685 55,864 30,782 1,582,119 -465,823 32,352 1,296,810 27,054 33,696 1,649,455 18,944 35,027 1,907,498 29,851 36,959 2,463,629 30,027 39,237 3,019,161 39,432 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

354 88th Annual Report, 2001 6. Income and Expenses of the Federal Reserve Banks, 1914-2001—Continued Thousands of dollars Assessments by Net additions Board of Governors Federal Reserve Bank Current Net or and period income expenses deductions (-) Board Costs expenditures of currency 1970 3,877,218 276,572 11,442 21,228 23,574 1971 3,723,370 319,608 94,266 32,634 24,943 1972 3,792,335 347,917 -49,616 35,234 31,455 1973 5,016,769 416,879 -80,653 44,412 33,826 1974 6,280,091 476,235 -78,487 41,117 30,190 1975 6,257,937 514,359 -202,370 33,577 37,130 1976 6,623,220 558,129 7,311 41,828 48,819 1977 6,891,317 568,851 -177,033 47,366 55,008 1978 8,455,309 592,558 -633,123 53,322 60,059 1979 10,310,148 625,168 -151,148 50,530 68,391 1980 12,802,319 718,033 -115,386 62,231 73,124 1981 15,508,350 814,190 -372,879 63,163 82,924 1982 16,517,385 926,034 -68,833 61,813 98,441 1983 16,068,362 1,023,678 -400,366 71,551 152,135 1984 18,068,821 1,102,444 -412,943 82,116 162,606 1985 18,131,983 1,127,744 1,301,624 77,378 173,739 1986 17,464,528 1,156,868 1,975,893 97,338 180,780 1987 17,633,012 1,146,911 1,796,594 81,870 170,675 1988 19,526,431 1,205,960 -516,910 84,411 164,245 1989 22,249,276 1,332,161 1,254,613 89,580 175,044 1990 23,476,604 1,349,726 2,099,328 103,752 193,007 1991 22,553,002 1,429,322 405,729 109,631 261,316 1992 20,235,028 1,474,531 -987,788 128,955 295,401 1993 18,914,251 1,657,800 -230,268 140,466 355,947 1994 20,910,742 1,795,328 2,363,862 146,866 368,187 1995 25,395,148 1,818,416 857,788 161,348 370,203 1996 25,164,303 1,947,861 -1,676,716 162,642 402,517 1997 26,917,213 1,976,453 -2,611,570 174,407 364,454 1998 28,149,477 1,833,436 1,906,037 178,009 408,544 1999 29,346,836 1,852,162 -533,557 213,790 484,959 2000 33,963,992 1,971,688 -1,500,027 188,067 435,838 2001 31,870,721 2,084,708 -1,117,435 295,056 338,537 Total, 1914-2001 567,657,077 40,265,428 2,229,219 3,363,583 6,421,466 Aggregate for each Bank, 1914-2001 Boston 30,746,673 2,716,458 37,003 134,297 372,028 New York 191,945,563 6,049,1084 1,007,062 839,477 2,154,497 Philadelphia 21,331,560 2,219,176 40,901 147,465 249,850 Cleveland 35,967,090 2,573,441 39,050 231,415 391,107 Richmond 44,018,620 3,573,035 -357,314 345,080 535,580 Atlanta 28,540,281 4,051,311 202,193 270,812 380,450 Chicago 71,484,655 5,192,166 336,971 407,278 762,168 St. Louis 19,767,905 2,083,477 29,966 88,503 238,737 Minneapolis 9,366,593 1,946,250 35,727 102,523 97,182 Kansas City 21,393,336 2,617,824 69,180 122,435 240,907 Dallas 26,867,381 2,639,056 356,111 197,173 288,269 San Francisco 66,227,420 4,604,125 432,369 477,126 710,691 Total 567,657,077 40,265,428 2,229,219 3^63,583 6,421,466 NOTE. Components may not sum to totals because of 2. Represents transfers made as a franchise tax from rounding. 1917 to 1932; transfers made under section 13b of the ... Not applicable. Federal Reserve Act from 1935 to 1947; and transfers 1. For 1987 and subsequent years, includes the cost of made under section 7 of the Federal Reserve Act for 1996 services provided to the Treasury by Federal Reserve and 1997. Banks for which reimbursement was not received. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 355 6.—Continued Payments to U.S. Treasury Dividends Interest on to surplus to surplus Statutory Federal Reserve (section 13b) (section 7) transfers2 notes 41,137 3,493,571 32,580 43,488 3,356,560 40,403 46,184 3,231,268 50,661 49,140 4,340,680 51,178 52,580 5,549,999 51,483 54,610 5,382,064 33,828 57,351 5,870,463 53,940 60,182 5,937,148 45,728 63,280 7,005,779 47,268 67,194 9,278,576 69,141 70,355 11,706,370 56,821 74,574 14,023,723 76,897 79,352 15,204,591 78,320 85,152 14,228,816 106,663 92,620 16,054,095 161,996 103,029 17,796,464 155,253 109,588 17,803,895 91,954 117,499 17,738,880 173,771 125,616 17,364,319 64,971 129,885 21,646,417 130,802 140,758 23,608,398 180,292 152,553 20,777,552 228,356 171,763 16,774,477 402,114 195,422 15,986,765 347,583 212,090 20,470,011 282,122 230,527 23,389,367 283,075 255,884 5,517/716 14,565,624 635,343 299,652 20,658,972 0 831,705 343,014 17,785,942 8,774,994 731,575 373,579 0 25,409,736 479,053 409,614 0 25,343,892 4,114,865 428,183 0 27,089,222 517,580 5,502,956 44,113,958 458,813,715 -4 11,405,195 3 232,601 2,579,504 24,143,227 135 605,425 1,384,237 17,307,161 162,851,302 -433 2,367,277 251,069 1,312,118 16,829,018 291 363,475 392,645 2,827,043 28,639,575 -10 950,925 595,029 3,083,928 32,763,442 -72 2,765,284 424,450 2,713,230 20,073,486 5 828,728 654,461 4,593,811 59,040,666 12 1,171,065 145,398 1,833,837 15,156,343 -27 251,601 170,853 416,227 6,405,077 65 264,143 195,299 1,249,703 16,728,775 -9 307,583 301,497 1,510,802 21,982,890 55 303,748 755,417 4,686,594 54,199,914 -17 1,225,940 5,502,956 44,113,958 458,813,715 -4 11,405,1953 3. The $11,405,195 thousand transferred to surplus as statutorily required; and was increased by transfer of was reduced by direct charges of $500 thousand for $11,131 thousand from reserves for contingencies (1955), charge-off on Bank premises (1927), $139,300 thousand leaving a balance of $7,311,522 thousand on Decemfor contributions to capital of the Federal Deposit Insur- ber 31, 2001. ance Corporation (1934), $4 thousand net upon elimina- 4. This amount is reduced $2,496,755 thousand, which tion of section 13b surplus (1958), and $106,000 thou- is related to the System Retirement Plan. See note 1, sand (1996), $107,000 thousand (1997), and table 5. $3,752,000 thousand (2000) transferred to the Treasury Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

356 88th Annual Report, 2001 7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks and Branches, December 31, 2001 Thousands of dollars Acquisition costs Federal Reserve Net Other Bank or Buildings Building ma- book real Branch Land (including chinery and Total2 value estate3 vaults)1 equipment BOSTON 22,074 100,144 15,591 137,809 91,244 NEW YORK 20,330 187,668 49,519 275,517 172,044 888 5,277 3,233 9,397 4,967 Buffalo 2,533 66,210 9,620 78,363 49,415 PHILADELPHIA . 3,112 118,858 24,637 146,606 121,668 CLEVELAND .... 2,247 18,717 8,693 29,657 13,337 Cincinnati 1,658 13,007 9,612 24,277 16,794 Pittsburgh RICHMOND 10,051 68,244 34,401 112,697 82,261 Baltimore 6,480 27,101 4,929 38,511 24,125 Charlotte 3,130 27,594 4,750 35,474 25,763 ATLANTA 22,116 145,789 15,571 183,475 181,549 Birmingham 7,098 44,406 3,239 54,743 53,308 Jacksonville 1,730 18,489 2,976 23,195 16,631 48 Miami 3,746 15,021 3,790 22,557 14,544 Nashville 629 3,672 3,042 7,342 3,791 New Orleans 3,709 8,614 4,206 16,530 11,039 CHICAGO 4,994 126,709 13,443 145,146 97,442 Detroit 798 7,303 3,814 11,914 7,967 ST. LOUIS 700 27,381 8,670 36,752 21,095 Little Rock 1,148 7,687 2,033 10,869 8,721 Louisville 800 4,697 2,053 7,549 4,741 Memphis 1,136 7,743 3,716 12,594 8,828 MINNEAPOLIS .. 11,377 100,472 13,381 125,230 113,029 Helena 2,042 9,551 944 12,537 10,049 KANSAS CITY .. 2,048 19,826 8,408 30,282 14,104 Denver 3,188 8,040 4,534 15,762 9,128 Oklahoma City ... 646 11,243 3,493 15,382 9,559 Omaha 6,535 12,823 1,337 20,695 16,047 DALLAS 29,049 106,245 20,359 155,653 126,730 El Paso 262 2,911 1,018 4,191 2,238 Houston 0 2,129 0 2,129 2,129 26,495 San Antonio 482 6,308 2,722 9,513 6,198 SAN FRANCISCO 15,600 79,472 19,536 114,608 73,708 Los Angeles 5,005 66,611 11,232 82,848 61,133 Portland 2,884 12,190 3,065 18,139 14,357 Salt Lake City .... 495 9,425 2,832 12,751 9,205 Seattle 325 12,724 4,706 17,755 12,951 Total 201,045 1,510,298 329,105 2,040,448 1,511,836 26,543 NOTE. Components may not sum to totals because of 3. Covers acquisitions for banking-house purposes and rounding. Bank premises formerly occupied and being held pending 1. Includes expenditures for construction at some sale. offices, pending allocation to appropriate accounts. 2. Excludes charge-offs of $17,699 thousand before 1952. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 357 8. Operations in Principal Departments of the Federal Reserve Banks, 1998-2001 Operation 2001 2000 1999 1998 Millions of pieces (except as noted) Loans (thousands)' 4 Currency processed 33,740 31,505 23,092 26,341 Currency destroyed 7,850 8,179 7,257 7,251 Coin received2 6,321 5,138 6,719 8,454 Checks handled U.S. government checks 346 262 288 321 Postal money orders 229 230 226 213 Other 13,314 16,994 17,075 16,573 Government securities transfers 15 14 13 14 Transfer of funds 112 108 103 98 Automated clearinghouse transactions Commercial 4,448 3,812 3,344 2,966 Government 900 838 809 753 Food stamps redeemed 587 686 1,158 1,843 Millions of dollars Loans' 20,431 Currency processed 540,746 542,567 444,234 409,166 Currency destroyed 86,298 112,164 82,951 94,858 Coin received2 767 666 778 1,001 Checks handled U.S. government checks 333,849 282,791 306,077 343,670 Postal money orders 30,461 30,036 29,118 28,469 Other 11,697,711 13,849,084 13,788,037 13,076,097 Government securities transfers 212,332,604 188,133,178 179,486,282 197,781,609 Transfer of funds 423,606,365 379,756,389 343,381,658 328,748,912 Automated clearinghouse transactions Commercial 12,707,247 11,619,954 10,862,424 10,338,376 Government 2,528,562 2,404,491 2,233,279 1,988,335 Food stamps redeemed 2,989 3,414 6,221 9,278 1. Collection of data discontinued effective 1999. 2. For 1999 and 2000, does not include coin activity at Federal Reserve off-site coin terminals. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

358 88th Annual Report, 2001 9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2001 Extended credit3 Adjustment Seasonal Reserve Bank credit1 credit2 First thirty After thirty days of days of borrowing borrowing All Federal Reserve Banks 1.25 1.80 1.25 2.30 1. Adjustment credit is available on a short-term basis 3. Extended credit is available to depository institutions to help depository institutions meet temporary needs for if similar assistance is not reasonably available from other funds that cannot be met through reasonable alternative sources, when exceptional circumstances or practices sources. Adjustment credit is usually provided at the involve only a particular institution, or when an instibasic discount rate, but under certain circumstances a tution is experiencing difficulties adjusting to changing special rate or rates above the basic discount rate may be market conditions over a longer period of time. See applied. See section 201.3(a) of Regulation A. section 201.3(c) of Regulation A. 2. Seasonal credit is available to help smaller deposi- Extended-credit loans outstanding more than thirty tory institutions meet regular seasonal needs for funds days will be charged a flexible rate somewhat above rates that cannot be met through special industry lenders and on market sources of funds; the rate will always be at that arise from a combination of expected patterns of least 50 basis points above the discount rate applicable to movement in their deposits and loans. The discount rate adjustment credit. The flexible rate is reestablished on the on seasonal credit takes into account rates on market first business day of each two-week reserve maintenance sources of funds and ordinarily is reestablished on the period. At the discretion of the Federal Reserve Bank, the first business day of each two-week reserve maintenance flexible rate may be charged on extended-credit loans that period; however, it is never lower than the discount rate are outstanding less than thirty days. applicable to adjustment credit. See section 201.3(b) of Regulation A. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 359 10. Reserve Requirements of Depository Institutions, December 31, 2001 Requirements Type of deposit Percentage of deposits Effective date Net transaction accounts' $0 million-$41.3 million2 3 12-27-01 More than $41.3 million3 10 12-27-01 Nonpersonal time deposits4 0 12-27-90 Eurocurrency liabilities5 0 12-27-90 NOTE. Required reserves must be held in the form of liabilities subject to a zero percent reserve requirement deposits with Federal Reserve Banks or vault cash. Non- each year for the succeeding calendar year by 80 percent member institutions may maintain reserve balances with a of the percentage increase in the total reservable liabilities Federal Reserve Bank indirectly, on a pass-through basis, of all depository institutions, measured on an annual basis with certain approved institutions. For previous reserve as of June 30. No corresponding adjustment is made in requirements, see earlier editions of the Annual Report or the event of a decrease. The exemption applies only to the Federal Reserve Bulletin. Under the Monetary Con- accounts that would be subject to a 3 percent reserve trol Act of 1980, depository institutions include commer- requirement. Effective with the reserve maintenance cial banks, savings banks, savings and loan associations, period beginning December 27, 2001, for depository credit unions, agencies and branches of foreign banks, institutions that report weekly, and with the reserve mainand Edge Act corporations. tenance period beginning January 17, 2002, for institu- 1. Transaction accounts include all deposits against tions that report quarterly, the exemption was raised from which the account holder is permitted to make withdraw- $5.5 million to $5.7 million. als by negotiable or transferable instruments, payment 3. The reserve requirement was reduced from 12 perorders of withdrawal, or telephone or preauthorized trans- cent to 10 percent on April 2, 1992, for institutions that fers for the purpose of making payments to third persons report weekly, and on April 16, 1992, for institutions that or others. However, accounts subject to the rules that report quarterly. permit no more than six preauthorized, automatic, or 4. For institutions that report weekly, the reserve reother transfers per month (of which no more than three quirement on nonpersonal time deposits with an original may be by check, draft, debit card, or similar order maturity of less than 1.5 years was reduced from 3 perpayable directly to third parties) are savings deposits, not cent to 1.5 percent for the maintenance period that began transaction accounts. December 13, 1990, and to zero for the maintenance 2. The Monetary Control Act of 1980 requires that the period that began December 27, 1990. For institutions amount of transaction accounts against which the 3 per- that report quarterly, the reserve requirement on nonpercent reserve requirement applies be modified annually by sonal time deposits with an original maturity of less than 80 percent of the percentage change in transaction 1.5 years was reduced from 3 percent to zero on Janaccounts held by all depository institutions, determined as uary 17, 1991. of June 30 each year. Effective with the reserve mainte- The reserve requirement on nonpersonal time deposits nance period beginning December 27, 2001, for deposi- with an original maturity of 1.5 years or more has been tory institutions that report weekly, and with the reserve zero since October 6,1983. maintenance period beginning January 17, 2002, for insti- 5. The reserve requirement on eurocurrency liabilities tutions that report quarterly, the amount was decreased was reduced from 3 percent to zero in the same manner from $42.8 million to $41.3 million. and on the same dates as the reserve requirement on Under the Garn-St Germain Depository Institutions nonpersonal time deposits with an original maturity of Act of 1982, the Board adjusts the amount of reservable less than 1.5 years (see note 4). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

360 88th Annual Report, 2001 11. Initial Margin Requirements under Regulations T, U, and X Percent of market value Effective date M st a o r c g k i s n Co b n o ve n r d t s ible Sh T o o rt n s l a y l 1 es, 1934, Oct. 1 25-45 1936, Feb. 1 25-55 Apr. 1 55 1937, Nov. 1 40 50 1945, Feb. 5 50 50 July 5 75 75 1946, Jan. 21 100 100 1947, Feb. 21 75 75 1949, Mar. 3 50 50 1951, Jan. 17 75 75 1953, Feb. 20 50 50 1955, Jan. 4 . 60 60 Apr. 23 70 70 1958, Jan. 16 50 50 Aug. 5 70 70 Oct. 16 90 90 1960, July 28 70 70 1962, July 10 50 50 1963, Nov. 6 70 70 1968, Mar. 11 70 50 70 June 8 80 60 80 1970, May 6 65 50 65 1971, Dec. 6 55 50 55 1972, Nov. 24 65 50 65 1974, Jan. 3 . 50 50 50 NOTE. These regulations, adopted by the Board of adopted effective October 15, 1934; Regulation U, effec- Governors pursuant to the Securities Exchange Act of tive May 1, 1936; and Regulation X, effective Novem- 1934, limit the amount of credit to purchase and carry ber 1,1971. The former Regulation G, which was adopted "margin securities" (as defined in the regulations) when effective March 11, 1968, was merged with Regulation U, such value is collateralized by securities. Margin require- effective April 1,1998. ments on securities are the difference between the market 1. From October 1, 1934, to October 31, 1937, the value (100 percent) and the maximum loan value of requirement was the margin "customarily required" by collateral as prescribed by the Board. Regulation T was the brokers and dealers. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 361 12. Principal Assets and Liabilities and Number of Insured Commercial Banks in the United States, by Class of Bank, June 30, 2001 and 2000 Millions of dollars, except as noted Member banks Nonmember Item Total banks Total National State 2001 ASSETS Loans and investments 4,561,484 3,527,619 2,508,988 1,018,632 1,033,864 Loans, gross 3,523,990 2,775,751 2,022,571 753,180 748,239 Net 3,521,897 2,774,534 2,021,662 752,873 747,362 Investments 1,037,494 751,869 486,417 265,452 285,625 U.S. Treasury and federal agency securities 233,182 148,577 79,672 68,905 84,604 Other 804,312 603,291 406,745 196,546 201,021 Cash assets, total 257,069 210,319 151,085 59,234 46,751 LIABILITIES Deposits, total 3,529,843 2,645,508 1,887,181 758,327 884,334 Interbank 8,327 7,829 4,168 3,661 498 Other transaction 640,057 488,456 355,567 132,889 151,601 Other nontransaction 2,881,458 2,149,223 1,527,446 621,778 732,235 Equity capital 546,649 432,466 302,735 129,731 114,183 Number of banks 8,152 3,146 2,172 974 5,006 2000r ASSETS Loans and investments 4,401,363 3,471,955 2,495,087 976,868 929,408 Loans, gross 3,372,546 2,683,625 1,979,485 704,140 688,921 Net 3,370,051 2,682,145 1,978,425 703,720 687,906 Investments 1,028,818 788,330 515,602 272,728 240,488 U.S. Treasury and federal agency securities 315,139 213,706 127,525 86,181 101,433 Other 713,679 574,624 388,077 86,547 139,055 Cash assets, total 244,304 201,237 151,593 49,644 43,067 LIABILITIES Deposits, total 3,259,838 2,485,484 1,788,442 697,041 774,354 Interbank 53,948 44,923 32,540 12,382 9,026 Other transaction 623,032 470,638 340,530 130,108 152,393 Other nontransaction 2,582,858 1,969,922 1,415,371 554,551 612,936 Equity capital 493,861 395,963 279,305 116,658 97,898 Number of banks 8,449 3,292 2,297 995 5,157 NOTE. Components may not sum to totals because of rounding, r. Data have been revised. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

362 88th Annual Report, 2001 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-2001 and Month-End 2001 Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Spe- U.S. Treasury and cial Treafederal agency securities draw- sury Period u H n e d l e d r Loans Float3 ot A h l e l r4 R F O e e d s th e e r e r v a r e l Total s G to o c l k d 6 c r i i e c i g n r a h t g t i t e f s - s r t e c o a u n u n r c t d - - y - Total Bought repur- assets5 ac- ing7 outright1 chase count agreement2 1918 239 239 0 1,766 199 294 0 2,498 2,873 1,795 1919 300 300 0 2,215 201 575 0 3,292 2,707 1,707 1920 287 287 0 2,687 119 262 0 3,355 2,639 1,709 1921 234 234 0 1,144 40 146 0 1,563 3,373 1,842 1922 436 436 0 618 78 273 0 1,405 3,642 1,958 1923 134 80 54 723 27 355 0 1,238 3,957 2,009 1924 540 536 4 320 52 390 0 1,302 4,212 2,025 1925 375 367 8 643 63 378 0 1,459 4,112 1,977 1926 315 312 3 637 45 384 0 1,381 4,205 1,991 1927 617 560 57 582 63 393 0 1,655 4,092 2,006 1928 228 197 31 1,056 24 500 0 1,809 3,854 2,012 1929 511 488 23 632 34 405 0 1,583 3,997 2,022 1930 739 686 43 251 21 372 0 1,373 4,306 2,027 1931 817 775 42 638 20 378 0 1,853 4,173 2,035 1932 1,855 1,851 4 235 14 41 0 2,145 4,226 2,204 1933 2,437 2,435 2 98 15 137 0 2,688 4,036 2,303 1934 2,430 2,430 0 7 5 21 0 2,463 8,238 2,511 1935 2,431 2,430 1 5 12 38 0 2,486 10,125 2,476 1936 2,430 2,430 0 3 39 28 0 2,500 11,258 2,532 1937 2,564 2,564 0 10 19 19 0 2,612 12,760 2,637 1938 2,564 2,564 0 4 17 16 0 2,601 14,512 2,798 1939 2,484 2,484 0 7 91 11 0 2,593 17,644 2,963 1940 2,184 2,184 0 3 80 8 0 2,274 21,995 3,087 1941 2,254 2,254 0 3 94 10 0 2,361 22,737 3,247 1942 6,189 6,189 0 6 471 14 0 6,679 22,726 3,648 1943 11,543 11,543 0 5 681 10 0 12,239 21,938 4,094 1944 18,846 18,846 0 80 815 4 0 19,745 20,619 4,131 1945 24,252 24,252 0 249 578 2 0 15,091 20,065 4,339 1946 23,350 23,350 0 163 580 1 0 24,093 20,529 4,562 1947 22,559 22,559 0 85 535 1 0 23,181 22,754 4,562 1948 23,333 23,333 0 223 541 1 0 24,097 24,244 4,589 1949 18,885 18,885 0 78 534 2 0 19,499 24,427 4,598 1950 20,778 20,725 53 67 1,368 3 0 22,216 22,706 4,636 1951 23,801 23,605 196 19 1,184 5 0 25,009 22,695 4,709 1952 24,697 24,034 663 156 967 4 0 25,825 23,187 4,812 1953 25,916 25,318 598 28 935 2 0 26,880 22,030 4,894 1954 24,932 24,888 44 143 808 1 0 25,885 21,713 4,985 1955 24,785 24,391 394 108 1,585 29 0 26,507 21,690 5,008 1956 24,915 24,610 305 50 1,665 70 0 26,699 21,949 5,066 1957 24,238 23,719 519 55 1,424 66 0 25,784 22,781 5,146 1958 26,347 26,252 95 64 1,296 49 0 27,755 20,534 5,234 1959 26,648 26,607 41 458 1,590 75 0 28,771 19,456 5,311 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 363 13.—Continued Factors absorbing reserve funds Deposits, other Member bank than reserves, with Federa[ ReserveBanks reserves 9 Other Cur- Trea- Other Re- Federal rency sury Federal quired Reserve in cash Reserve clear- liacir- hold- ac- ing bilities With Curcula- ings8 Trea- For- Other counts 5 bal- and Federal rency Re- Extion sury eign ances capital5 Reserve and quired11 cess ]' Banks coin10 4,951 288 51 96 25 118 0 0 1,636 0 1,585 51 5,091 385 51 73 28 208 0 0 1,890 0 1,822 68 5,325 218 57 5 18 298 0 0 1,781 0 0 0 4,403 214 96 12 15 285 0 0 1,753 0 1,654 99 4,530 225 11 3 26 276 0 0 1,934 0 0 0 4,757 213 38 4 19 275 0 0 1,898 0 1,884 14 4,760 211 51 19 20 258 0 0 2,220 0 2,161 59 4,817 203 16 8 21 272 0 0 2,212 0 2,256 -44 4,808 201 17 46 19 293 0 0 2,194 0 2.250 -56 4,716 208 18 5 21 301 0 0 2,487 0 2,424 63 4,686 202 23 6 21 348 0 0 2,389 0 2,430 ^1 4,578 216 29 6 24 393 0 0 2,355 0 2,428 -73 4,603 211 19 6 22 375 0 0 2,471 0 2,375 96 5,360 222 54 79 31 354 0 0 1,961 0 1,994 -33 5,388 272 8 19 24 355 0 0 2,509 0 1,933 576 5,519 284 3 4 128 360 0 0 2,729 0 1,870 859 5,536 3,029 121 20 169 241 0 0 4,096 0 2,282 1,814 5,882 2,566 544 29 226 253 0 0 5,587 0 2,743 2,844 6,543 2,376 244 99 160 261 0 0 6,606 0 4,622 1,984 6,550 3,619 142 172 235 263 0 0 7,027 0 5,815 1,212 6,856 2,706 923 199 242 260 0 0 8,724 0 5,519 3,205 7,598 2,409 634 397 256 251 0 0 11,653 0 6,444 5,209 8,732 2,213 368 1,133 599 284 0 0 4,026 0 7,411 6,615 11,160 2,215 867 774 586 291 0 0 12,450 0 9,365 3,085 15,410 2,193 799 793 485 256 0 0 13,117 0 11,129 1,988 20,499 2,303 579 1,360 356 339 0 0 12,886 0 11,650 1,236 25,307 2,375 440 1,204 394 402 0 0 14,373 0 12,748 1,625 28,515 2,287 977 862 446 495 0 0 15,915 0 14,457 1,458 28,952 2,272 393 508 314 607 0 0 16,139 0 15,577 562 28,868 1,336 870 392 569 563 0 0 17,899 0 16,400 1,499 28,224 1,325 1,123 642 547 590 0 0 20,479 0 19,277 1,202 27,600 1,312 821 767 750 106 0 0 16,568 0 15,550 1,018 27,741 1,293 668 895 565 714 0 0 17,681 0 16,509 1,172 29,206 1,270 247 526 363 746 0 0 20,056 0 19,667 389 30,433 1,270 389 550 455 in 0 0 19,950 0 20,520 -570 30,781 761 346 423 493 839 0 0 20,160 0 19,397 763 30,509 796 563 490 441 907 0 0 18,876 0 18,618 258 31,158 767 394 402 554 925 0 0 19,005 0 18,903 102 31,790 775 441 322 426 901 0 0 19,059 0 19,089 -30 31,834 761 481 356 246 998 0 0 19,034 0 19,091 -57 32,193 683 358 272 391 1,122 0 0 18,504 0 18,574 -70 32,591 391 504 345 694 841 0 0 18,174 310 18,619 -135 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

364 88th Annual Report, 2001 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-2001 and Month-End 2001—Continued Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Spe- U.S. Treasuryand cial Trea- Period federal agency securities draw- sury u H n e d l e d r Loans Float3 ot A h l e l r4 R F e O e s t d e e h r r e a v r l e Total s G t o o l c d k6 c r i e i i c r g n a t h i t g t f e s - s r o t c e a u u n n t r c d - - y - Total Bought repur- assets5 ac- ing7 outright1 chase count agreement2 1960 27,384 26,984 400 33 1,847 74 0 29,338 17,767 5,398 1961 28,881 30,478 159 130 2,300 51 0 31,362 16,889 5,585 1962 30,820 28,722 342 38 2,903 110 0 33,871 15,978 5,567 1963 33,593 33,582 11 63 2,600 162 0 36,418 15,513 5,578 1964 37,044 36,506 538 186 2,606 94 0 39,930 15,388 5,405 1965 40,768 40,478 290 137 2,248 187 0 43,340 13,733 5,575 1966 44,316 43,655 661 173 2,495 193 0 47,177 13,159 6,317 1967 49,150 48,980 170 141 2,576 164 0 52,031 11,982 6,784 1968 52,937 52,937 0 186 3,443 58 0 56,624 10,367 6,795 1969 57,154 7,1545 0 183 3,440 64 2,743 64,584 10,367 6,852 1970 62,142 62,142 0 335 4,261 57 1,123 67,918 10,732 400 7,147 1971 70,804 69,481 1,323 39 4,343 261 1,068 76,515 10,132 400 7,710 1972 71,230 71,119 111 1,981 3,974 106 1,260 78,551 10,410 400 8,313 1973 80,495 80,395 100 1,258 3,099 68 1,152 86,072 11,567 400 8,716 1974 85,714 84,760 954 299 2,001 999 3,195 92,208 11,652 400 9,253 1975 94,124 92,789 1,335 211 3,688 1,126 3,312 102,461 11,599 500 10,218 1976 104,093 100,062 4,031 25 2,601 991 3,182 110,892 11,598 1,200 10,810 1977 111,274 108,922 2,352 265 3,810 954 2,442 118,745 11,718 1,250 11,331 1978 118,591 117,374 1,217 1,174 6,432 587 4,543 131,327 11,671 1,300 11,831 1979 126,167 124,507 1,660 1,454 6,767 704 5,613 140,705 11,172 1,800 13,083 1980 130,592 128,038 2,554 1,809 4,467 776 8,739 146,383 11,160 2,518 13,427 1981 140,348 136,863 3,485 1,601 1,762 195 9,230 153,136 11,151 3,318 13,687 1982 148,837 144,544 4,293 717 2,735 1,480 9,890 63,659 11,148 4,618 13,786 1983 160,795 159,203 1,592 918 1,605 418 8,728 172,464 11,121 4,618 15,732 1984 169,627 167,612 2,015 3,577 833 0 12,347 186,384 11,096 4,618 16,418 1985 191,248 186,025 5,223 3,060 988 0 15,302 210,598 11,090 4,718 17,075 1986 221,459 205,454 16,005 1,565 1,261 0 17,475 241,760 11,084 5,018 17,567 1987 231,420 226,459 4,961 3,815 811 0 15,837 251,883 11,078 5,018 18,177 1988 247,489 240,628 6,861 2,170 1,286 0 18,803 269,748 11,060 5,018 18,799 1989 235,417 233,300 2,117 481 1,093 0 39,631 276,622 11,059 8,518 19,628 1990 259,785 241,431 18,354 190 2,566 0 39,880 302,421 11,058 10,018 20,402r 1991 288,429 272,531 15,898 218 1,026 0 34,524 324,197 11,059 10,018 21,014' 1992 308,517 300,423 8,094 675 3,350 0 30,278 342,820 11,056 8,018 21,447r 1993 349,866 336,654 13,212 94 963 0 33,394 384,317 11,053 8,018 22,095r 1994 378,746 368,156 10,590 223 740 0 33,441 413,150 11,051 8,018 22,994r 1995 394,693 380,831 13,862 135 231 0 33,483 428,543 11,050 10,168 24,003r 1996 414,715 393,132 21,583 85 5,297 0 32,222 452,319 11,048 9,718 24,966r 1997 455,260 431,420 23,840 2,035 561 0 32,044 489,901 11,047 9,200 25,543r 1998 482,854 452,478 30,376 17 1,009 0 37,692 521,573 11,046 9,200 26,270 1999 618,784 478,144 140,640 233 407 0 34,799 654,223 11,048 6,200 28,013 2000 555,208 511,833 43,375 110 795 0 36,896 593,009 11,046 2,200 31,219 2001 601,935 551,685 50,250 34 698 0 36,885 639,552 11,045 2,200 33,195 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 365 13.—Continued Factors absorbing reserve funds Deposits, other Member bank than reserves, with reserves 9 Federal Reserve Banks Other Cur- Trea- Other Re- Federal rency sury Federal quired Reserve in cash Reserve clear- liacir- hold- ac- ing bilities With Curcula- ings8 Trea- For- Other counts 5 bal- and Federal rency Re- Extion sury eign ances capital5 Reserve and quired11 cess11-12 Banks coin10 32,869 377 485 217 533 941 0 0 17,081 2,544 18,988 637 33,918 422 465 279 320 1,044 0 0 17,387 2,544 18,988 96 35,338 380 597 247 393 1,007 0 0 17,454 3,262 20,071 645 37,692 361 880 171 291 1,065 0 0 17,049 4,099 20,677 471 39,619 612 820 229 321 1,036 0 0 18,086 4,151 21,663 574 42,056 760 668 150 355 211 0 0 18,447 4,163 22,848 -238 44,663 1,176 416 174 588 -147 0 0 19,779 4,310 24,321 -232 47,226 1,344 1,123 135 563 -773 0 0 21,092 4,631 25,905 -182 50,961 695 703 216 747 -1,353 0 0 21,818 4,921 27,439 -700 53,950 596 1,312 134 807 0 0 1,919 22,085 5,187 28,173 -901 57,903 431 1,156 148 ,233 0 0 1,986 24,150 5,423 30,033 -460 61,068 460 2,020 294 999 0 0 2,131 27,788 5,743 32,496 1,035 66,516 345 1,855 325 840 0 0 2,143 25,647 6,216 32,044 9812 72,497 317 2,542 251 1,41913 0 0 2,669 27,060 6,781 35,268 -1,360 79,743 185 2,113 418 l,27513 0 0 2,935 25,843 7,370 37,011 -3,798 86,547 483 7,285 353 1,090 0 0 2,968 26,052 8,036 35,197 -1,103 u 93,717 460 10,393 352 1,357 0 0 3,063 25,158 8,628 35,461 -1,535 103,811 392 7,114 379 1,187 0 0 3,292 26,870 9,421 37,615 -1,265 114,645 240 4,196 368 1,256 0 0 4,275 31,152 10,538 42,694 -893 125,600 494 4,075 429 1,412 0 0 4,957 29,792 11,429 44,217 -2,835 136,829 441 3,062 411 617 0 0 4,671 27,456 13,654 40,558 675 144,774 443 4,301 505 781 0 117 5,261 25,111 15,576 42,145 -1,442 154,908 429 5,033 328 ,033 0 436 4,990 26,053 16,666 41,391 1,328 171,935 479 3,661 191 851 0 1,013 5,392 20,413 17,821 39,179 -945 183,796 513 5,316 253 867 0 1,126 5,952 20,693 197,488 550 9,351 480 1,041 0 1,490 5,940 27,141 211,995 447 7,588 287 917 0 1,812 6,088 46,295 230,205 454 5,313 244 1,027 0 1,687 7,129 40,097 247,649 395 8,656 347 548 0 1,605 7,683 37,742 260,456 450 6,217 589 1,298 0 1,618 8,486 36,713 286,963r 561 8,960 369 242 0 1,962 8,147 36,696 307,756r 636 17,697 968 ,706 0 3,949 8,113 25,464 334,701r 508 7,492 206 372 0 5,898 7,984 26,181 n.a. n.a. n.a. 365,271/ 377 14,809 386 397 0 6,332 9,292 28,619 403,843r 335 7,161 250 876 0 4,197 11,959 26,592 424,244r 270 5,979 386 932 0 5,167 12,342 24,444 450,648r 249 7,742 167 892 0 6,601 13,829 17,923 482,327r 225 5,444 457 900 0 6,665r 15,500 24,173r 517,484 85 6,086 167 ,605 0 6,784 16,354 19,522 628,359 109 28,402 71 1,261 0 7,482r 17,256 16,545r 593,271 450 5,149 216 ,382 0 6,332 17,962 12,713 643,479 425 6,645 61 820 0 8,534 17,083 8,944 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

366 88th Annual Report, 2001 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-2001 and Month-End 2001—Continued Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Spe- US. Treasury and cial Treafederal agency securities draw- sury Period u H n e d l e d r Loans Float3 ot A he ll r4 R F O e e s d th e e r e r v a r e l Total s G to o c l k d 6 c r i i e c i g n r a h t g t i t e f s - s r t c e o a u n u n r c t d - - y - Total Bought repur- assets5 ac- ing7 outright1 chase count agreement2 2001 Jan. ... 535,068 516,148 0 35 2,217 0 36,634 573,954 11,046 2,200 31,888 Feb. ... 543,293 519,628 0 18 1,105 0 34,395 578,811 11,046 2,200 32,087 Mar. ... 545,867 523,872 0 22 380 0 35,789 582,058 11,046 2,200 32,271 Apr. ... 550,929 525,922 0 80 -27 0 36,866 587,847 11,046 2,200 32,417 May ... 557,882 527,572 0 154 -240 0 34,704 592,499 11,046 2,200 32,562 June ... 558,370 535,120 0 150 -128 0 36,604 594,995 11,044 2,200 32,670 July ... 561,938 535,588 0 201 1,019 0 37,421 600,580 11,044 2,200 32,726 Aug. ... 571,572 541,817 0 123 655 0 36,077 608,427 11,044 2,200 32,957 Sept. ... 582,026 534,146 0 88 -295 0 37,821 619,640 11,045 2,200 33,013 Oct. ... 589,347 544,297 0 55 -157 0 38,236 627,482 11,045 2,200 33,069 Nov. ... 586,824 550,324 0 38 1,478 0 35,825 624,166 11,045 2,200 33,139 Dec. ... 601,935 551,685 0 34 698 0 36,885 639,552 11,045 2,200 33,195 NOTE. For a description of figures and discussion of capital accounts, and other liabilities and accrued divitheir significance, see Banking and Monetary Statistics, dends, less the sum of bank premises and other assets, 1941-1970 (Board of Governors of the Federal Reserve and is reported as "Other Federal Reserve accounts"; System, 1976), pp. 507-23. thereafter, "Other Federal Reserve assets" and "Other Components may not sum to totals because of Federal Reserve liabilities and capital" are shown rounding. separately. . . . Not applicable. 6. Before January 30, 1934, includes gold held in r. Revised. Federal Reserve Banks and in circulation. n.a. Not available. 7. Includes currency and coin (other than gold) issued 1. Beginning in 1969, includes securities loaned— directly by the Treasury. The largest components are fully guaranteed by U.S. government securities pledged fractional and dollar coins. For details see "Currency and with Federal Reserve Banks—and excludes securities Coin in Circulation," Treasury Bulletin. sold and scheduled to be bought back under matched 8. Coin and paper currency held by the Treasury, as sale-purchase transactions. Beginning September 29, well as any gold in excess of the gold certificates issued 1971, includes federal agency issues bought outright. to the Reserve Bank. 2. Beginning December 1, 1966, includes federal 9. Beginning in November 1979, includes reserves agency obligations held under repurchase agreements. of member banks, Edge Act corporations, and U.S. agen- 3. Beginning in 1960, figures reflect a minor change in cies and branches of foreign banks. Beginning on concept; see Federal Reserve Bulletin, vol. 47 (February November 13, 1980, includes reserves of all depository 1961), p. 164. institutions. 4. Principally acceptances and, until August 21, 1959, Beginning in 1984, data on "Currency and coin" and industrial loans, authority for which expired on that date. "Required" and "Excess" reserves changed from daily 5. For the period before April 16, 1969, includes the to biweekly basis. total of Federal Reserve capital paid in, surplus, other Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 367 13.—Continued Factors absorbing reserve funds Deposits, other Member bank than reserves, with Federal Reserve Banks Other Cur- Trea- Other Re- Federal rency sury Federal quired Reserve in cash Reserve clear- liacir- hold- ac- ing bilities With Curcula- ings8 Trea- For- Other counts 9 bal- and Federal rency Re- Extion sury eign ances capital5 Reserve and quired11 cess11'12 Banks coin10 579,782 477 5,256 199 306 0 6,092 17,648 9,328 585,129 505 4,956 196 377 0 6,106 17,842 9,033 585,853 478 5,657 70 248 0 6,318 17,441 11,510 588,191 516 7,894 102 403 0 6,449 18,232 11,723 595,911 510 4,396 85 321 0 6,778 17,845 12,460 596,674 444 7,188 102 271 0 6,841 17,583 11,806 604,179 418 5,592 84 330 0 7,072 18,219 10,655 613,266 416 5,533 80 276 0 7,233 18,139 9,685 612,069 422 9,796 609 191 0 7,650 17,875 17,287 616,853 435 5,112 75 271 0 7,427 17,773 25,851 624,672 434 6,219 528 236 0 8,241 18,101 12,118 643,479 425 6,645 61 820 0 8,534 17,083 8,944 10. Between December 1, 1959, and November 23, 13. For the period before July 1973, includes certain 1960, part was allowed as reserves; thereafter, all was deposits of domestic nonmember banks and foreignallowed. owned banking institutions held with member banks and 11. Estimated through 1958. Before 1929, data were redeposited in full with Federal Reserve Banks in connecavailable only on call dates (in 1920 and 1922 the call tion with voluntary participation by nonmember institudate was December 29). Beginning on September 12, tions in the Federal Reserve System program of credit 1968, the amount is based on close-of-business figures restraint. for the reserve period two weeks before the report date. As of December 12, 1974, the amount of voluntary 12. Beginning with week ending November 15, 1972, nonmember bank and foreign-agency and branch deposits includes $450 million of reserve deficiencies on which at Federal Reserve Banks that are associated with mar- Federal Reserve Banks are allowed to waive penalties for ginal reserves are no longer reported. However, two a transition period in connection with bank adaptation to amounts are reported: (1) deposits voluntarily held as Regulation J as amended, effective November 9, 1972. reserves by agencies and branches of foreign banks oper- Allowable deficiencies are as follows (beginning with ating in the United States and (2) eurodollar liabilities. first statement week of quarter, in millions): 1973—Ql, 14. Adjusted to include waivers of penalties for re- $279; Q2, $172; Q3, $112; Q4, $84; 1974—Ql, $67; Q2, serve deficiencies, in accordance with change in Board $58. The transition period ended with the second quarter policy, effective November 19, 1975. of 1974. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

368 88th Annual Report, 2001 14. Banking Offices and Banks Affiliated with Bank Holding Companies (BHCs) in the United States, December 31, 2000 and 2001 Commercial banksl Statechartered Type of office Total Member savings Total Nonmember banks Total National State All banking offices BANKS Number, Dec. 31, 2000 .. 8,697 8,261 3,164 2,175 989 5,097 436 Changes during 2001 New banks 139 132 49 34 15 83 7 Banks converted into branches -330 -321 -165 -86 -79 -156 -9 Ceased banking operation2 -45 -34 -15 -13 -2 -19 -11 Other3 0 1 25 -20 45 -24 -1 Net change -236 -222 -106 -85 -21 -116 -14 Number, Dec. 31,2001 .. 8,461 8,039 3,058 2,090 968 4,981 422 BRANCHES AND ADDITIONAL OFFICES Number, Dec. 31, 2000 .. 68,929 65,793 48,033 34,611 13,422 17,760 3,136 Changes during 2001 New branches 1,700 1,510 1,099 672 427 411 190 Branches converted from banks 330 323 194 110 84 129 7 Discontinued2 -1,230 -1,072 -948 -636 -312 -124 -158 Other3 0 29 724 -10 734 -695 -29 Net change 800 790 1,069 136 933 -279 10 Number, Dec. 31, 2001 .. 69,729 66,583 49,102 34,747 14,355 17,481 3,146 Banks affiliated with BHCs BANKS Number, Dec. 31, 2000 .. 6,650 6,529 2,654 1,803 851 3,875 121 Changes during 2001 BHC-affiliated new banks 206 197 76 57 19 121 9 Banks converted into branches -295 -291 -156 -79 -77 -135 -4 Ceased banking operation2 -40 -31 -12 -12 0 -19 -9 Other3 0 1 19 -19 38 -18 -1 Net change -129 -124 -73 -53 -20 -51 -5 Number, Dec. 31,2001 .. 6,521 6,405 2,581 1,750 831 3,824 116 1. For purposes of this table, banks are entities that defined as an insured bank in section 3(h) of the FDIC are defined as banks in the Bank Holding Company Act Act. Covers entities in the United States and its territories as amended and implemented in Federal Reserve Regula- and possessions (affiliated insular areas). tion Y. Generally, a bank is any institution that accepts 2. Institutions that no longer meet the Regulation Y demand deposits and is engaged in the business of definition of bank. making commercial loans or any institution that is 3. Interclass changes and sales of branches. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Financial Statements Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

371 Board of Governors Financial Statements The financial statements of the Board for 2001 were audited by KPMG LLP, independent auditors. 2001 M Street, N.W. Washington, D.C. 20036 INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENTS To the Board of Governors of the Federal Reserve System We have audited the accompanying balance sheet of the Board of Governors of the Federal Reserve System (the Board) as of December 31, 2001 and the related statements of revenues and expenses and changes in cumulative results of operations and cash flows for the year then ended. These financial statements are the responsibility of the Board's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements as of and for the year ended December 31, 2000 were audited by other auditors who issued an unqualified opinion thereon dated February 21, 2001. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Board at December 31, 2001, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In accordance with Government Auditing Standards, we have also issued our reports dated March 22, 2002 on our consideration of the Board's internal control over financial reporting and its compliance with laws and regulations. Those reports are an integral part of an audit conducted in accordance with Government Auditing Standards, and should be read in conjunction with this report in considering the results of our audit. March 22, 2002 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

372 88th Annual Report, 2001 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BALANCE SHEETS As of December 31, 2001 2000 ASSETS CURRENT ASSETS Cash $ 40,788,564 $22,842,252 Accounts receivable 1,325,065 1,057,901 Prepaid expenses and other assets 866,407 1,108,766 Total current assets 42,980,036 25,008,919 PROPERTY AND EQUIPMENT, NET (Note 5) 138,895,601 68,521,774 Total assets $181,875,637 $93,530,693 LIABILITIES AND CUMULATIVE RESULTS OF OPERATIONS CURRENT LIABILITIES Accounts payable and accrued liabilities $ 16,125,797 $10,702,740 Accrued payroll and related taxes 7,307,754 6,040,961 Accrued annual leave 10,732,356 8,492,728 Capital lease payable (current portion) 247,242 180,340 Unearned revenues and other liabilities 391,572 2,044,160 Total current liabilities 34,804,721 27,460,929 LONG-TERM LIABILITIES Capital lease payable (non-current portion) 80,276 280,683 Accumulated retirement benefit obligation (Note 2) 651,628 694,782 Accumulated postretirement benefit obligation (Note 3) 4,555,487 4,065,704 Accumulated postemployment benefit obligation (Note 4) 3,591,571 3,109,456 Total long-term liabilities 8,878,962 8,150,625 Total liabilities 43,683,683 35,611,554 CUMULATIVE RESULTS OF OPERATIONS Working capital 8,175,315 (2,452,010) Unfunded long-term liabilities (8,798,686) (7,869,942) Net investment in property and equipment 138,815,325 68,241,091 Total cumulative results of operations 138,191,954 57,919,139 Total liabilities and cumulative results of operations $181,875,637 $93,530,693 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 373 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF REVENUES AND EXPENSES AND CHANGES IN CUMULATIVE RESULTS OF OPERATIONS For the years ended December 31, 2001 2000 BOARD OPERATING REVENUES Assessments levied on Federal Reserve Banks for Board operating expenses and capital expenditures $295,055,600 $ 188,067,200 Other revenues (Note 6) 8,747,799 10,099,585 Total operating revenues 303,803,399 198,166,785 BOARD OPERATING EXPENSES Salaries 132,647,612 118,632,019 Retirement and insurance contributions 22,277,244 19,945,692 Contractual services and professional fees 19,339,948 14,503,464 Depreciation and net losses on disposals 10,394,156 8,855,763 Postage and supplies 8,252,490 5,839,569 Utilities 5,880,777 6,249,503 Software 5,415,856 4,192,658 Travel 5,037,577 5,769,788 Repairs and maintenance 4,201,386 3,375,478 Equipment and facilities rental 3,830,557 5,075,502 Printing and binding 2,095,676 2,047,590 Other expenses (Note 6) 4,157,305 5,085,135 Total operating expenses 223,530,584 199,572,161 RESULTS OF OPERATIONS 80,272,815 (1,405,376) ISSUANCE AND REDEMPTION OF FEDERAL RESERVE NOTES Assessments levied on Federal Reserve Banks for currency costs 338,537,426 435,837,762 Expenses for currency printing, issuance, retirement, and shipping 338,537,426 435,837,762 CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES 0 0 TOTAL RESULTS OF OPERATIONS 80,272,815 (1,405,376) CUMULATIVE RESULTS OF OPERATIONS, Beginning of year 57,919,139 59,324,515 TRANSFERS TO THE U.S. TREASURY Transfers from surplus Federal Reserve Bank earnings (Note 1) 0 3,752,000,000 Transfers to the U.S. Treasury (Note 1) 0 (3,752,000,000) CUMULATIVE RESULTS OF OPERATIONS, End of year $138,191,954 $ 57,919,139 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

374 88th Annual Report, 2001 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF CASH FLOWS For the years ended December 31, 2001 2000 CASH FLOWS FROM OPERATING ACTIVITIES RESULTS OF OPERATIONS $80,272,815 $(1,405,376) Adjustments to reconcile change in results of operations to net cash provided by (used in) operating activities: Depreciation and net losses on disposals 10,394,156 8,855,763 (Increase) decrease in assets: Accounts receivable, prepaid expenses, and other assets (24,805) (499,519) Increase (decrease) in liabilities: Accounts payable and accrued liabilities 5,423,057 (1,657,349) Accrued payroll and related taxes 1,266,793 (1,049,793) Accrued annual leave 2,239,628 429,073 Unearned revenues and other liabilities (1,652,588) (303,143) Accumulated retirement benefit obligation (43,154) (52,935) Accumulated postretirement benefit obligation 489,783 450,876 Accumulated postemployment benefit obligation 482,115 528,377 Net cash provided by (used in) operating activities 98,847,800 5,295,974 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposals 119,013 44,400 Capital expenditures (80,886,996) (13,609,871) Net cash provided by (used in) investing activities (80,767,983) (13,565,471) CASH FLOWS FROM FINANCING ACTIVITIES Capital lease payable (133,505) (77,499) Capital lease obligations incurred 0 116,340 Net cash provided by (used in) financing activities (133,505) 38,841 NET INCREASE (DECREASE) IN CASH 17,946,312 (8,230,656) CASH BALANCE, Beginning of year 22,842,252 31,072,908 CASH BALANCE, End of year $40,788,564 $22,842,252 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 375 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM NOTES TO FINANCIAL STATEMENTS FOR THE Employees of the Board who entered on duty prior to YEARS ENDED DECEMBER 31, 2001 AND 2000 1984 are covered by a contributory defined benefits program under the System Plan. Employees of the Board who entered on duty after 1983 are covered by a non- (1) SIGNIFICANT ACCOUNTING POLICIES contributory defined benefits program under the System Organization—The Federal Reserve System was Plan. Contributions to the System Plan are actuarially founded by Congress in 1913 and consists of the Board of determined and funded by participating employers at Governors (Board) and twelve regional Reserve Banks. amounts prescribed by the System Plan's administrator. The Board was established as a federal government Based on actuarial calculations, it was determined that agency and is supported by Washington staff numbering employer funding contributions were not required for the about 1,700, as it carries out its responsibilities in con- years 2001 and 2000, and the Board was not assessed junction with other components of the Federal Reserve a contribution for these years. Excess Plan assets are System. The accompanying financial statements include expected to continue to fund future years' contributions. only the operations and activities for the Board. Because the plan is part of a multi-employer plan, infor- Basis of Accounting—The financial statements have mation as to vested and nonvested benefits, as well as been prepared on the accrual basis of accounting. plan assets, as it relates solely to the Board, is not readily Revenues—Assessments for operating expenses and available. additions to property are based on expected cash needs. A relatively small number of Board employees partici- Amounts over or under assessed due to differences pate in the Civil Service Retirement System (CSRS) or between actual and expected cash needs flow into the Federal Employees' Retirement System (FERS). The "Cumulative Results of Operations" during the year. Board matches employee contributions to these plans. Issuance and Redemption of Federal Reserve Notes— These defined benefit plans are administered by the The Board incurs expenses and assesses the Federal Office of Personnel Management. The Board's contribu- Reserve Banks for the costs of printing, issuing, shipping, tions to these plans totaled $308,000 and $266,000 in and retiring Federal Reserve Notes. These assessments 2001 and 2000, respectively. The Board has no liability and expenses are separately reported in the statements of for future payments to retirees under these programs, and revenues and expenses because they are not Board operat- it is not accountable for the assets of the plans. ing transactions. Employees of the Board may also participate in the Property and Equipment—The Board's property, build- Federal Reserve System's Thrift Plan. Under the Thrift ings and equipment are stated at cost less accumulated Plan, members may contribute up to a fixed percentage depreciation. Depreciation is calculated on a straight-line of their salary. Board contributions are based upon a basis over the estimated useful lives of the assets, which fixed percentage of each member's basic contribution range from 3 to 10 years for furniture and equipment and and were $5,540,000 and $5,133,000 in 2001 and 2000, from 10 to 50 years for building equipment and struc- respectively. tures. Upon the sale or other disposition of a depreciable Effective January 1, 1996, Board employees covered asset, the cost and related accumulated depreciation are under the System Plan are also covered under a Benefits removed from the accounts and any gain or loss is Equalization Plan (BEP). Benefits paid under the BEP are recognized. limited to those benefits that cannot be paid from the Federal Reserve Bank Surplus Earnings—The Federal System Plan due to limitations imposed by Sec- Reserve Act, as amended, required that $3,752,000,000 tions 401(a)(17), 415(b) and 415(e) of the Internal Reveof surplus Federal Reserve Bank earnings be transferred nue Code of 1986. Section 401 (a) of the Code was from the Banks to the Board and then to the U.S. Treasury amended to increase the contribution limitation base for in 2000. highly paid employees to $170,000 from $160,000 effec- Estimates—The preparation of financial statements in tive in 2000. This increase resulted in a reduction in the conformity with accounting principles generally accepted benefit obligation of the BEP for 2000. Pension costs in the United States of America requires management to attributed to the BEP reduce the pension costs of the make estimates and assumptions that affect the reported System Plan. Activity for the BEP for 2001 and 2000 is amounts of assets and liabilities and the disclosure of summarized in the following table: contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and 2001 2000 expenses during the reporting period. Actual results could differ from those estimates. Change in benefit obligation Reclassifications—Certain 2000 amounts have been Benefit obligation at reclassified to conform with the 2001 presentation. beginning of year $1,804 $631,264 Service cost 450 544 Interest cost 112 99 (2) RETIREMENT BENEFITS Plan participants' Substantially all of the Board's employees participate contributions 0 0 in the Retirement Plan for Employees of the Federal Plan amendments 0 (552,770) Actuarial (gain)/loss (241) (69,229) Reserve System (System Plan). The System Plan is a Benefits paid 0 (8,104) multi-employer plan which covers employees of the Federal Reserve Banks, the Board, and the Plan Administra- Benefit obligation at tive Office. end of year $2,125 $ 1,804 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

376 88th Annual Report, 2001 (3) POSTRETIREMENT BENEFITS 2001 2000 The Board provides certain life insurance programs for Change in plan assets its active employees and retirees. Activity for 2001 and Fair value of plan assets 2000 is summarized in the following table: at beginning of year $ 2001 2000 Actual return on plan assets 0 0 Change in benefit Employer contributions . 0 8,104 obligation Plan participants' Benefit obligation at contributions 0 0 beginning of year .. $ 4,255,290 $4,096,411 Benefits paid 0 (8,104) Service cost 133,550 126,076 Fair value of plan assets Interest cost 345,753 312,298 at end of year $ 0 $ 0 Plan participants' contributions 0 0 Reconciliation of funded Plan amendments 95,993 0 status at end of year Actuarial (gain)/loss 1,037,839 (278,501) Funded status $ (2,125) $ (1,804) Benefits paid 0 (994) Unrecognized net Benefit obligation actuarial (gain)/ at end of year $ 5,868,425 $ 4,255,290 loss (329,169) (358,390) Unrecognized prior Change in plan assets service cost (1,170,405) (1,287,253) Fair value of plan Unrecognized net assets at beginning transition (asset)/ of year $ 0 $ 0 obligation 850,071 952,665 Actual return on Prepaid/(accrued) plan assets 0 0 Employer contributions . 0 994 postretirement benefit cost $ (651,628) $ (694/782) Plan participants' contributions 0 0 Benefits paid 0 (994) Weighted-average Fair value of plan assumptions as of assets at end December 31 of year $ 0 $ 0 Discount rate 7.00% 7.50% Expected asset return ... N/A N/A Salary scale 4.50% 5.00% Reconciliation of Corridor 10.00% 10.00% funded status at end of year Components of net Funded status $(5,868,425) $(4,255,290) periodic expense Unrecognized net f S o e r rv y i e c a e r cost $ 450 $ 544 a (g c a tu in a ) r / i l a o l ss 1,216,945 189,586 Interest cost 112 99 Unrecognized prior Expected return service cost 95,993 0 on plan assets 0 0 Unrecognized net Amortization of transition prior service cost .. (116,848) (116,848) obligation 0 Recognized net Prepaid/(accrued) actuarial gain (29,462) (31,220) postretirement Amortization of benefit cost $(4,555,487) $(4,065,704) net (asset)/ obligation 102,594 102,594 Components of net Net periodic benefit periodic expense expense $ (43,154) $ (44,831) for year Service cost $ 133,550 $ 126,076 Interest cost 345,753 312,298 Amortization of prior service cost 0 0 Amortization of (gains)Aosses 10,477 $ 13,497 Total net periodic expense $ 489,780 $ 451,871 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 377 The liability and costs for the postretirement benefit (5) PROPERTY AND EQUIPMENT plan were determined using discount rates of 7.00 percent The following is a summary of the components of the and 7.50 percent as of December 31, 2001 and Decem- Board's property, buildings and equipment, at cost, net ber 31, 2000 respectively. Unrecognized losses of of accumulated depreciation. $1,216,945 and $189,586 as of December 31, 2001 and 2000, respectively, result from changes in the discount As of December 31, rate used to measure the liabilities. Under Statement of 2001 2000 Financial Accounting Standards No. 106, Employers' Land and Accounting for Postretirement Benefits Other Than Pen- improvements . $ 18,640,314 $ 1,301,314 sions, the Board may have to record some of these Buildings 104,403,830 45,233,537 unrecognized losses in operations in future years. The Furniture and assumed salary trend rate for measuring the increase in equipment 54,301,936 49,090,528 postretirement benefits related to life insurance was an Software 9,215,280 7,883,210 average of 5 percent. Construction in The above accumulated postretirement benefit obliga- process 6,901,864 9,725,857 tion is related to the Board sponsored life insurance 193,463,224 113,234,446 programs. The Board has no liability for future payments Less accumulated to employees who continue coverage under the federally depreciation ... (54,567,623) (44,712,672) sponsored programs upon retiring. Contributions for Property and active employees participating in federally sponsored pro- equipment, net . $138,895,601 $ 68,521,774 grams totaled $5,364,000 and $4,792,000 in 2001 and 2000, respectively. Furniture and equipment includes $864,000 for capitalized leases as of December 31, 2001 and 2000. Accumu- (4) POSTEMPLOYMENT BENEFIT PLAN lated depreciation includes $510,000 and $366,000 for capitalized leases as of December 31, 2001 and 2000, The Board provides certain postemployment benefits respectively. The Board paid interest in the amount of to eligible employees after employment but before $32,201 and $70,830 for 2001 and 2000, respectively. retirement. Effective January 1, 1994, the Board adopted Statement of Financial Accounting Standards No. 112, The Board began the Eccles Building Infrastructure Employers' Accounting for Postemployment Benefits, Enhancement Project in July 1999. This $12.5 million which requires that employers providing postemployment project, scheduled for nineteen phases over three and a benefits to their employees accrue the cost of such bene- half years, includes asbestos removal, lighting and plumbfits. Prior to January 1994, postemployment benefit ing improvements, cabling and other enhancements. Mulexpenses were recognized on a pay-as-you-go basis. tiple phases will be in process at the same time. In 2001, the Board purchased land and building located As of December 31, at 1709 New York Avenue, N.W., Washington, DC. 2001 2000 This purchase increased land and improvements by $17,339,000 and buildings by $48,727,000 for 2001. Change in benefit obligation Benefit obligation (6) OTHER REVENUES AND OTHER EXPENSES at beginning The following are summaries of the components of of year $3,109,456 $2,581,079 Other Revenues and Other Expenses. Service cost 755,135 721,293 Interest cost 115,142 159,808 As of December 31, Plan participants' 2001 2000 contributions 0 0 Other revenues Plan amendments 0 0 Data processing Actuarial (gain)/loss .. (129,585) (29,733) revenue $4,427,360 $ 4,817,207 Benefits paid (258,577) (322,991) Subscription Benefit obligation revenue 869,595 1,079,822 at end of year $3,591,571 $3,109,456 Reimbursable services to other agencies ... 568,753 607,716 National Information Center 25,591 2,606,998 Miscellaneous 2,856,500 987,842 Total Other Revenues $8,747,799 $10,099,585 Other expenses Tuition, registration, and membership fees $1,472,539 $ 1,429,231 Subsidies and contributions .... 851,225 837,071 Miscellaneous 1,833,541 2,818,833 Total Other Expenses $4,157,305 $ 5,085,135 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

378 88th Annual Report, 2001 (7) COMMITMENTS (8) FEDERAL FINANCIAL INSTITUTIONS The Board has entered into several operating leases to EXAMINATION COUNCIL secure office, training and warehouse space for periods The Board is one of the five member agencies of the ranging from one to ten years. Minimum future commit- Federal Financial Institutions Examination Council (the ments under those leases having an initial or remaining "Council"). During 2001 and 2000, the Board paid noncancelable lease term in excess of one year at Decem- $293,000 and $256,000 respectively, in assessments for ber 31, 2001, are as follows: operating expenses of the Council. These amounts are included in other expenses for 2001 and 2000. • 2002 $162,840 2003 151,038 2004 157,079 2005 163,363 2006 71,991 After 2006 0 $706,311 Rental expenses under the operating leases were $171,000 and $155,000 in 2001 and 2000, respectively. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 379 2001 M Street, N.W. Washington, D.C. 20036 INDEPENDENT AUDITORS' REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING To the Board of Governors of the Federal Reserve System We have audited the financial statements of the Board of Governors of the Federal Reserve System (the Board) as of and for the year ended December 31, 2001, and have issued our report thereon dated March 22, 2002. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. In planning and performing our audit, we considered the Board's internal control over financial reporting by obtaining an understanding of the Board's internal control, determining whether these internal controls had been placed in operation, assessing control risk, and performing tests of controls in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements. The objective of our audit was not to provide assurance on internal control. Consequently, we do not provide an opinion on internal control. Our consideration of the internal control over financial reporting would not necessarily disclose all matters in internal control over financial reporting that might be material weaknesses under standards established by the American Institute of Certified Public Accountants. Material weaknesses are conditions in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements, in amounts that would be material in relation to the financial statements being audited, may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. Because of inherent limitations in internal control, misstatements due to error or fraud may occur and not be detected. However, we noted no matters involving internal control and its operation that we consider to be material weaknesses as defined above. This report is intended solely for the information and use of the Board and management, the U.S. Office of Management and Budget, and Congress, and is not intended to be and should not be used by anyone other than these specified parties. March 22, 2002 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

380 88th Annual Report, 2001 2001 M Street, N.W. Washington, D.C. 20036 INDEPENDENT AUDITORS' REPORT ON COMPLIANCE WITH LAWS AND REGULATIONS To the Board of Governors of the Federal Reserve System We have audited the financial statements of the Board of Governors of the Federal Reserve System (the Board) as of and for the year ended December 31, 2001, and have issued our report thereon dated March 22, 2002. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. The management of the Board is responsible for complying with laws and regulations applicable to the Board. As part of obtaining reasonable assurance about whether the Board's financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws and regulations, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with laws and regulations was not an objective of our audit and, accordingly, we do not express such an opinion. The results of our tests of compliance with the laws and regulations described in the preceding paragraph disclosed no instances of noncompliance that are required to be reported under Government Auditing Standards. This report is intended solely for the information and use of the Board and management, the U.S. Office of Management and Budget, and Congress, and is not intended to be and should not be used by anyone other than these specified parties. LL7> March 22, 2002 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

381 Federal Reserve Banks Combined Financial Statements The combined financial statements of the Federal Reserve Banks were audited by PricewaterhouseCoopers LLP, independent accountants, for the years ended December 31, 2001 and 2000. REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Governors of The Federal Reserve System and the Board of Directors of each of The Federal Reserve Banks: We have audited the accompanying combined statements of condition of The Federal Reserve Banks (the "Reserve Banks") as of December 31, 2001 and 2000, and the related combined statements of income and changes in capital for the years then ended. These financial statements are the responsibility of the Reserve Banks' management. Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 3, the combined financial statements were prepared in conformity with accounting principles, policies, and practices established by the Board of Governors of The Federal Reserve System. These principles, policies, and practices, which were designed to meet the specialized accounting and reporting needs of The Federal Reserve System, are set forth in the Financial Accounting Manual for Federal Reserve Banks and constitute a comprehensive basis of accounting other than accounting principles generally accepted in the United States of America. In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of the Reserve Banks as of December 31, 2001 and 2000, and results of their operations for the years then ended, on the basis of accounting described in Note 3. Washington, D.C. . r March 4,2002 ( ^^cc^CfcjU^^^ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

382 88th Annual Report, 2001 THE FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CONDITION December 31, 2001 and 2000 (in millions) ASSETS 2001 2000 Gold certificates $ 11,045 $ 11,045 Special drawing rights certificates 2,200 2,200 Coin 1,047 949 Items in process of collection 3,188 7,152 Loans to depository institutions 34 110 Securities purchased under agreements to resell (tri-party) 50,250 43,375 U.S. government and federal agency securities, net 561,701 518,501 Investments denominated in foreign currencies 14,559 15,670 Accrued interest receivable 5,729 6,111 Bank premises and equipment, net 2,021 1,949 Other assets 3,175 2,815 Total assets $654,949 $609,877 LIABILITIES AND CAPITAL LIABILITIES Federal Reserve notes outstanding, net $611,757 $563,450 Deposits Depository institutions 17,478 19,046 U.S. Treasury, general account 6,645 5,149 Other deposits 287 426 Deferred credit items 2,490 6,357 Interest on Federal Reserve notes due U.S. Treasury 498 560 Accrued benefit costs 882 848 Other liabilities 227 250 Total liabilities 640,264 596,086 CAPITAL Capital paid-in 7,373 6,997 Surplus 7,312 6,794 Total capital 14,685 13,791 Total liabilities and capital $654,949 $609,877 The accompanying notes are an integral part of these combined financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 383 THE FEDERAL RESERVE BANKS COMBINED STATEMENTS OF INCOME for the years ended December 31, 2001 and 2000 (in millions) 2001 2000 Interest income Interest on U.S. government and federal agency securities $30,523 $32,737 Interest on investments denominated in foreign currencies 331 269 Interest on loans to depository institutions 13 23 Total interest income 30,867 33,029 Other operating income (loss) Income from services 926 882 Reimbursable services to government agencies 286 302 Foreign currency losses, net (1,435) (1,410) Government securities gains (losses), net 316 (82) Other income 108 82 Total other operating income (loss) 201 (226) Operating expenses Salaries and other benefits 1,616 1,507 Occupancy expense 204 196 Equipment expense 268 243 Assessments by Board of Governors 634 624 Other expenses 311 357 Cost of unreimbursed Treasury services • • 8 Total operating expenses 3,033 2,935 Net income prior to distribution $28,035 $29,868 Distribution of net income Dividends paid to member banks $ 428 $ 410 Transferred to surplus 518 4,115 Payments to U.S. Treasury as interest on Federal Reserve notes 27,089 25,343 Total distribution $28,035 $29,868 The accompanying notes are an integral part of these combined financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

384 88th Annual Report, 2001 THE FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CHANGES IN CAPITAL for the years ended December 31, 2001 and 2000 (in millions) Capital Total paid-in Surplus capital Balance at January 1, 2000 (128 million shares) $6,431 $6,431 $12,862 Net income transferred to surplus 4,115 4,115 Surplus transfer to the US. Treasury (3,752) (3,752) Net change in capital stock issued (11 million shares) 566 566 Balance at December 31, 2000 (139 million shares) $6,997 $6,794 $13,791 Net income transferred to surplus 518 518 Net change in capital stock issued (8 million snares) 376 376 Balance at December 31, 2001 (147 million shares) $7,373 $7,312 $14,685 The accompanying notes are an integral part of these combined financial statements. NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS (1) ORGANIZATION AND BASIS OF PRESENTATION Board of Directors The twelve Federal Reserve Banks (Reserve Banks) are The Federal Reserve Act specifies the composition of the part of the Federal Reserve System (System) created by Board of Directors for each of the Reserve Banks. Each Congress under the Federal Reserve Act of 1913 (Federal board is composed of nine members serving three-year Reserve Act) which established the central bank of the terms: three directors, including those designated as United States. The Reserve Banks are chartered by the Chairman and Deputy Chairman, are appointed by the federal government and possess a unique set of govern- Board of Governors, and six directors are elected by mental, corporate, and central bank characteristics. Other member banks. Of the six elected by member banks, three major elements of the System are the Board of Governors represent the public and three represent member banks. of the Federal Reserve System (Board of Governors), the Member banks are divided into three classes according Federal Open Market Committee (FOMC) and the Fed- to size. Member banks in each class elect one director eral Advisory Council. The FOMC is composed of mem- representing member banks and one representing the pubbers of the Board of Governors, the president of the lic. In any election of directors, each member bank Federal Reserve Bank of New York (FRBNY) and, on a receives one vote, regardless of the number of shares of rotating basis, four other Reserve Bank presidents. Reserve Bank stock it holds. Although the Reserve Banks are chartered as independent organizations overseen by the Board of Governors, the Reserve Banks work jointly to carry out their statu- (2) OPERATIONS AND SERVICES tory responsibilities. The majority of the assets, liabilities, and income of the Reserve Banks is derived from central The System performs a variety of services and operations. bank activities and responsibilities with regard to mone- Functions include: formulating and conducting monetary tary policy and currency. For this reason, the accompany- policy; participating actively in the payments mechanism, ing combined set of financial statements for the twelve including large-dollar transfers of funds, automated clearindependent Reserve Banks is prepared with adjustments inghouse (ACH) operations and check processing; distribto eliminate interdistrict accounts and transactions. uting coin and currency; performing fiscal agency functions for the U.S. Treasury and certain federal agencies; Structure serving as the federal government's bank; providing short-term loans to depository institutions; serving the The Reserve Banks serve twelve Federal Reserve Dis- consumer and the community by providing educational tricts nationwide. In accordance with the Federal Reserve materials and information regarding consumer laws; Act, supervision and control of each Reserve Bank is supervising bank holding companies, state member banks exercised by a Board of Directors. Banks that are mem- and U.S. offices of foreign banking organizations; and bers of the System include all national banks and any administering other regulations of the Board of Goverstate chartered bank that applies and is approved for nors. The Board of Governors' operating costs are funded membership in the System. through assessments on the Reserve Banks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 385 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED The FOMC establishes policy regarding open market the reported amounts of income and expenses during the operations, oversees these operations, and issues authori- reporting period. Actual results could differ from those zations and directives to the FRBNY for its execution of estimates. Certain amounts relating to the prior year have transactions. Authorized transaction types include direct been reclassified to conform to the current-year presentapurchase and sale of U.S. government and federal agency tion. Unique accounts and significant accounting policies securities, matched sale-purchase transactions, the pur- are explained below. chase of securities under agreements to resell, and the lending of U.S. government securities. FRBNY is also authorized by the FOMC to hold balances of and to (A) Gold Certificates execute spot and forward foreign exchange (F/X) and securities contracts in nine foreign currencies, maintain The Secretary of the Treasury is authorized to issue gold reciprocal currency arrangements (F/X swaps) with vari- certificates to the Reserve Banks to monetize gold held ous central banks, and "warehouse" foreign currencies by the U.S. Treasury. Payment for the gold certificates by for the U.S. Treasury and Exchange Stabilization Fund the Reserve Banks is made by crediting equivalent (ESF) through the Reserve Banks. amounts in dollars into the account established for the U.S. Treasury. These gold certificates held by the Reserve Banks are required to be backed by the gold of the U.S. Treasury. The U.S. Treasury may reacquire the gold certificates at any time and the Reserve Banks must deliver (3) SIGNIFICANT ACCOUNTING POLICIES them to the U.S. Treasury. At such time, the U.S. Trea- Accounting principles for entities with the unique powers sury's account is charged and the Reserve Banks' gold and responsibilities of the nation's central bank have not certificate account is lowered. The value of gold for been formulated by the Financial Accounting Standards purposes of backing the gold certificates is set by law at Board. The Board of Governors has developed special- $422/9 a fine troy ounce. ized accounting principles and practices that it believes are appropriate for the significantly different nature and (B) Special Drawing Rights Certificates function of a central bank as compared to the private sector. These accounting principles and practices are Special drawing rights (SDRs) are issued by the Internadocumented in the Financial Accounting Manual for Fedtional Monetary Fund (Fund) to its members in proporeral Reserve Banks {Financial Accounting Manual), tion to each member's quota in the Fund at the time of which is issued by the Board of Governors. All Reserve issuance. SDRs serve as a supplement to international Banks are required to adopt and apply accounting policies monetary reserves and may be transferred from one naand practices that are consistent with the Financial tional monetary authority to another. Under the law pro- Accounting Manual. viding for United States participation in the SDR system, These combined financial statements have been pre- the Secretary of the U.S. Treasury is authorized to issue pared in accordance with the Financial Accounting SDR certificates, somewhat like gold certificates, to the Manual. Differences exist between the accounting prin- Reserve Banks. At such time, equivalent amounts in ciples and practices of the System and generally accepted dollars are credited to the account established for the U.S. accounting principles in the United States of America Treasury, and the Reserve Banks' SDR certificate account (GAAP). The primary differences are the presentation is increased. The Reserve Banks are required to purchase of all security holdings at amortized cost, rather than at SDRs, at the direction of the U.S. Treasury, for the the fair value presentation requirements of GAAP, and the purpose of financing SDR certificate acquisitions or for accounting for matched sale-purchase transactions as financing exchange stabilization operations. separate sales and purchases, rather than secured borrowings with pledged collateral, as is generally required by GAAP. In addition, the Board of Governors and the (C) Loans to Depository Institutions Reserve Banks have elected not to present a Statement of Cash Flows. The Statement of Cash Flows has not been The Depository Institutions Deregulation and Monetary included as the liquidity and cash position of the Reserve Control Act of 1980 provides that all depository insti- Banks are not of primary concern to users of these tutions that maintain reservable transaction accounts or combined financial statements. Other information regard- nonpersonal time deposits, as defined in Regulation D ing the Reserve Banks' activities is provided in, or may issued by the Board of Governors, have borrowing privibe derived from, the Statements of Condition, Income, leges at the discretion of the Reserve Banks. Borrowers and Changes in Capital. Therefore, a Statement of Cash execute certain lending agreements and deposit suffi- Flows would not provide any additional useful informa- cient collateral before credit is extended. Loans are evalution. There are no other significant differences between ated for collectibility, and currently all are considered the policies outlined in the Financial Accounting Manual collectible and fully collateralized. If any loans were and GAAP. deemed to be uncollectible, an appropriate reserve would The preparation of the combined financial statements be established. Interest is accrued using the applicable in conformity with the Financial Accounting Manual discount rate established at least every fourteen days by requires management to make certain estimates and the Board of Directors of the Reserve Banks, subject to assumptions that affect the reported amounts of assets and review by the Board of Governors. Reserve Banks retain liabilities and disclosure of contingent assets and liabili- the option to impose a surcharge above the basic rate in ties at the date of the combined financial statements and certain circumstances. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

386 88th Annual Report, 2001 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED (D) US. Government and Federal Agency Securities and currencies that it may need for intervention operations to Investments Denominated in Foreign Currencies support the dollar and give the partner foreign central bank temporary access to dollars it may need to support The FOMC has designated the FRBNY to execute open its own currency. Drawings under the F/X swap arrangemarket transactions on its behalf and to hold the resulting ments can be initiated by either the FRBNY or the partner securities in the portfolio known as the System Open foreign central bank, and must be agreed to by the Market Account (SOMA). In addition to authorizing and drawee. The F/X swaps are structured so that the party directing operations in the domestic securities market, initiating the transaction (the drawer) bears the exchange the FOMC authorizes and directs the FRBNY to execute rate risk upon maturity. The Bank will generally invest operations in foreign markets for major currencies in the foreign currency received under an F/X swap in order to counter disorderly conditions in exchange mar- interest-bearing instruments. kets or to meet other needs specified by the FOMC in Warehousing is an arrangement under which the carrying out the System's central bank responsibilities. FOMC agrees to exchange, at the request of the Treasury, Such authorizations are reviewed and approved annually U.S. dollars for foreign currencies held by the Treasury by the FOMC. or ESF over a limited period of time. The purpose of the Matched sale-purchase transactions are accounted for warehousing facility is to supplement the U.S. dollar as separate sale and purchase transactions. Matched resources of the Treasury and ESF for financing pursale-purchase transactions are transactions in which the chases of foreign currencies and related international FRBNY sells a security and buys it back at the rate speci- operations. fied at the commencement of the transaction. In connection with its foreign currency activities, the In addition to the aforementioned matched sale- FRBNY, on behalf of the Reserve Banks, may enter into purchase transactions, the FRBNY engages in tri-party contracts which contain varying degrees of off-balanceagreements. Tri-party agreements are conducted with two sheet market risk, because they represent contractual comcustodial banks that manage the clearing and settlement mitments involving future settlement, and counter-party of collateral. Acceptable collateral under tri-party repur- credit risk. The FRBNY controls credit risk by obtaining chase agreements primarily includes U.S. Government credit approvals, establishing transaction limits, and perand agency securities, pass-through mortgage securities forming daily monitoring procedures. of GNMA, FHLMC, and FNMA, STRIP securities of While the application of current market prices to the the U.S. Government and "stripped" securities of other securities currently held in the SOMA portfolio and government agencies. The tri-party repurchase transac- investments denominated in foreign currencies may result tions are accounted for as financing transactions with the in values substantially above or below their carrying associated interest income accrued over the life of the values, these unrealized changes in value would have no agreement. direct effect on the quantity of reserves available to the The FRBNY has sole authorization by the FOMC to banking system or on the prospects for future Reserve lend U.S. government securities held in the SOMA to U.S. Bank earnings or capital. Both the domestic and foreign government securities dealers and to banks participating components of the SOMA portfolio from time to time in U.S. government securities clearing arrangements on involve transactions that can result in gains or losses behalf of the System, in order to facilitate the effective when holdings are sold prior to maturity. However, decifunctioning of the domestic securities market. These sions regarding the securities and foreign currencies transsecurities-lending transactions are fully collateralized by actions, including their purchase and sale, are motivated other U.S. government securities. FOMC policy requires by monetary policy objectives rather than profit. Accord- FRBNY to take possession of collateral in excess of the ingly, earnings and any gains or losses resulting from the market values of the securities loaned. The market values sale of such currencies and securities are incidental to the of the collateral and the securities loaned are monitored open market operations and do not motivate its activities by FRBNY on a daily basis, with additional collateral or policy decisions. obtained as necessary. The securities loaned continue to U.S. government and federal agency securities and be accounted for in the SOMA. investments denominated in foreign currencies compris- Foreign exchange contracts are contractual agreements ing the SOMA are recorded at cost, on a settlement-date between two parties to exchange specified currencies, at a basis, and adjusted for amortization of premiums or accrespecified price, on a specified date. Spot foreign contracts tion of discounts on a straight-line basis. Interest income normally settle two days after the trade date, whereas the is accrued on a straight-line basis and is reported as settlement date on forward contracts is negotiated "Interest on U.S. government and federal agency securibetween the contracting parties, but will extend beyond ties" or "Interest on investments denominated in foreign two days from the trade date. The FRBNY generally currencies," as appropriate. Income earned on securities enters into spot contracts, with any forward contracts lending transactions is reported as a component of "Other generally limited to the second leg of a swap/warehousing income." Gains and losses resulting from sales of securitransaction. ties are determined by specific issues based on average The FRBNY, on behalf of the Reserve Banks, main- cost. Gains and losses on the sales of U.S. government tains renewable, short-term F/X swap arrangements with and federal agency securities are reported as "Governtwo authorized foreign central banks. The parties agree to ment securities gains (losses), net." Foreign-currencyexchange their currencies up to a pre-arranged maximum denominated assets are revalued daily at current market amount and for an agreed upon period of time (up to exchange rates in order to report these assets in U.S. twelve months), at an agreed upon interest rate. These dollars. Realized and unrealized gains and losses on arrangements give the FOMC temporary access to foreign investments denominated in foreign currencies are Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 387 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED reported as "Foreign currency gains (losses), net." For- held in the vaults of the Reserve Banks of $139,783 mileign currencies held through F/X swaps, when initiated lion and $188,264 million at December 31, 2001 and by the counterparty, and warehousing arrangements are 2000, respectively. revalued daily, with the unrealized gain or loss reported At December 31, 2001 and 2000, all gold certificates, as a component of "Other assets" or "Other liabilities," all special drawing rights certificates, and domestic as appropriate. securities with par values of $598,512 million and Statement of Financial Accounting Standards No. 133, $550,205 million respectively, were pledged as collateral. as amended and interpreted, became effective on Janu- At December 31, 2001 and 2000, no loans or investary 1, 2001. For the periods presented, the Reserve Banks ments denominated in foreign currencies were pledged as had no derivative instruments required to be accounted collateral. for under the standard. (G) Capital Paid-in (E) Bank Premises and Equipment The Federal Reserve Act requires that each member bank subscribe to the capital stock of the Reserve Bank in an Bank premises and equipment are stated at cost less amount equal to 6 percent of the capital and surplus of the accumulated depreciation. Depreciation is calculated on a member bank. As a member bank's capital and surplus straight-line basis over estimated useful lives of assets changes, its holdings of the Reserve Bank's stock must be ranging from 2 to 50 years. New assets, major alterations, adjusted. Member banks are those state-chartered banks renovations and improvements are capitalized at cost as that apply and are approved for membership in the System additions to the asset accounts. Maintenance, repairs and and all national banks. Currently, only one-half of the minor replacements are charged to operations in the year subscription is paid-in and the remainder is subject to call. incurred. Internally developed software is capitalized These shares are nonvoting with a par value of $100. They based on the cost of direct materials and services and may not be transferred or hypothecated. By law, each those indirect costs associated with developing, implemember bank is entitled to receive an annual dividend of menting, and testing software. 6 percent on the paid-in capital stock. This cumulative dividend is paid semiannually. A member bank is liable (F) Federal Reserve Notes for Reserve Bank liabilities up to twice the par value of stock subscribed by it. Federal Reserve notes are the circulating currency of the United States. These notes are issued through the various (H) Surplus Federal Reserve agents to the Reserve Banks upon deposit with such agents of certain classes of collateral The Board of Governors requires Reserve Banks to mainsecurity, typically U.S. government securities. These notes tain a surplus equal to the amount of capital paid-in as of are identified as issued to a specific Reserve Bank. The December 31. This amount is intended to provide addi- Federal Reserve Act provides that the collateral security tional capital and reduce the possibility that the Reserve tendered by the Reserve Bank to the Federal Reserve Banks would be required to call on member banks for agent must be equal to the sum of the notes applied for by additional capital. Reserve Banks are required by the such Reserve Bank. In accordance with the Federal Board of Governors to transfer to the U.S. Treasury excess Reserve Act, gold certificates, special drawing rights earnings, after providing for the costs of operations, paycertificates, U.S. government and federal agency securi- ment of dividends, and reservation of an amount necessary ties, tri-party agreements, loans allowed under Section 13, to equate surplus with capital paid-in. and investments denominated in foreign currencies are The Consolidated Appropriations Act of 2000 (Public pledged as collateral for net Federal Reserve notes out- Law 106-113, Section 302) directed the Reserve Banks to standing. The collateral value is equal to the book value transfer to the U.S. Treasury additional surplus funds of of the collateral tendered, with the exception of securities, $3,752 million during the Federal Government's 2000 whose collateral value is equal to the par value of the fiscal year. Reserve Banks were not permitted to replenish securities tendered. Tri-party agreements, however, are surplus for these amounts during fiscal year 2000, which valued at the contract amount. The Board of Governors ended September 30, 2000; however, the surplus was may, at any time, call upon a Reserve Bank for additional replenished by December 31, 2000, for eleven of the security to adequately collateralize the Federal Reserve twelve Reserve Banks. Surplus was not equated to capital notes. To satisfy the obligation to provide sufficient col- at December 31, 2001 and 2000, at one Reserve Bank lateral for outstanding Federal Reserve notes, the Reserve where the amount of additional surplus required exceeded Banks have entered into an agreement that provides that the Bank's net income. certain assets of the Reserve Banks are jointly pledged as In the event of losses, or a substantial increase in collateral for the Federal Reserve notes of all Reserve capital, a Reserve Bank will suspend its payments to the Banks. In the event that this collateral is insufficient, the U.S. Treasury until such losses or increases in capital are Federal Reserve Act provides that Federal Reserve notes recovered through subsequent earnings. Weekly payments become a first and paramount lien on all the assets of the to the U.S. Treasury may vary significantly. Reserve Banks. Finally, as obligations of the United States, Federal Reserve notes are backed by the full faith (I) Income and Costs Related to Treasury Services and credit of the United States government. The "Federal Reserve notes outstanding, net" account Reserve Banks are required by the Federal Reserve Act represents Federal Reserve notes reduced by currency to serve as fiscal agents and depositories of the United Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

388 88th Annual Report, 2001 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED States. By statute, the Department of the Treasury is Repurchase permitted, but not required, to pay for these services. The Maturities of agreement costs of providing fiscal agency and depository services securities held triparty to the Treasury Department that have been billed but will (Contract amount) not be paid are reported as the "Cost of unreimbursed Within 15 days $35,250 Treasury services." 16 days to 90 days 15,000 91 days to 1 year • • (J) Taxes Over 1 year to 5 years • • • Over 5 years to 10 years • • • The Reserve Banks are exempt from federal, state, and Over 10 years • • • local taxes, except for taxes on real property, which are Total $50,250 reported as a component of "Occupancy expense." (4) U.S. GOVERNMENT AND FEDERAL AGENCY Total securities held under agreements to resell at SECURITIES December 31, 2001 were $50,250 million that consisted entirely of agreements through third party custodial Securities bought outright are held in the SOMA at the arrangements and are reported as Securities purchased FRBNY. under agreements to resell (tri-party). In January 2001, the FOMC reduced the maximum permissible maturity Total securities held in the SOMA at December 31, for securities purchased under agreements to resell from 2001 and 2000, that were bought outright, were as fol- 90 days to 65 days. lows (in millions): At December 31, 2001 and 2000, matched salepurchase transactions involving U.S. government 2001 2000 securities with par values of $23,188 million and $21,112 million, respectively, were outstanding. Matched Par value sale-purchase transactions are generally overnight Federal agency $ 10 $ 130 arrangements. U.S. government Bills 182,074 178,741 At December 31, 2001 and 2000, U.S. government Notes 265,941 240,178 securities with par values of $7,345 million and Bonds 103,660 92,784 $2,086 million, respectively, were loaned. Total par value 551,685 511,833 (5) INVESTMENTS DENOMINATED IN Unamortized premiums 11,302 9,735 FOREIGN CURRENCIES Unaccreted discounts (1,286) (3,067) Total $561,701 $518,501 The FRBNY, on behalf of the Reserve Banks, holds foreign currency deposits with foreign central banks and the Bank for International Settlements, and invests in foreign government debt instruments. Foreign govern- The maturity distribution of U.S. government and fed- ment debt instruments held include both securities bought eral agency securities bought outright and securities pur- outright and securities held under agreements to resell. chased under agreements to resell, which were held in These investments are guaranteed as to principal and the SOMA at December 31, 2001, were as follows (in interest by the foreign governments. millions): Total investments denominated in foreign currencies, Par value valued at current exchange rates at December 31, were as follows (in millions): U.S. Federal Maturities of government agency 2001 2000 securities held securities obligations Total Within 15 days ... $ 10,685 $. . . $ 10,685 European Union euros Foreign currency deposits $ 4,593 $ 4,633 16 days to 90 days. 124,547 124,547 Government debt instruments 91 days to 1 year .. 130,627 130,627 including agreements Over 1 year to toresell 2,695 2,716 5 years . 153,158 10 153,168 Over 5 years to Japanese yen 10 years . 53,338 53,338 Foreign currency deposits 1,891 2,752 Over 10 years . 79,320 79,320 Government debt instruments Total . $551,675 $10 $551,685 including agreements toresell 5,315 5,497 Accrued interest 65 72 Total $14,559 $15,670 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 389 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED The maturity distribution of investments denominated (7) COMMITMENTS AND CONTINGENCIES in foreign currencies at December 31, 2001, were as follows (in millions): At December 31, 2001, the Reserve Banks were obligated under noncancelable leases for premises and equipment Maturities of Investments Denominated with terms ranging from 1 to approximately 22 years. in Foreign Currencies These leases provide for increased rentals based upon increases in real estate taxes, operating costs or selected Within 1 year $13,714 price indices. Over 1 year to 5 years 403 Over 5 years to 10 years 442 Rental expense under operating leases for certain oper- Over 10 years • • • ating facilities, warehouses, and data processing and office equipment (including taxes, insurance and mainte- Total $14,559 nance when included in rent), net of sublease rentals, was $69 million and $64 million for the years ended Decem- At December 31, 2001 and 2000, there were no open ber 31, 2001 and 2000, respectively. Certain of the foreign exchange contracts or outstanding F/X swaps. Reserve Banks' leases have options to renew. At December 31, 2001 and 2000, the warehousing facility was $5,000 million, with no balance outstanding. Future minimum rental payments under noncancelable operating leases, net of sublease rentals, with terms of (6) BANK PREMISES AND EQUIPMENT one year or more, at December 31, 2001, were (in mil- A summary of bank premises and equipment at Decem- lions): ber 31 is as follows (in millions): Operating 2001 2000 2002 $ 15 Bank premises and equipment 2003 11 Land $ 201 $ 192 2004 11 Buildings 1,478 1,285 2005 9 Building machinery and 2006 8 equipment 329 296 Thereafter $145 Construction in progress 32 163 Total $199 Furniture and equipment 1,365 1,290 3,405 3,226 At December 31, 2001, the Reserve Banks had contractual commitments through the year 2007 totaling Accumulated depreciation (1,384) (1,277) $100.5 million for the maintenance of currency machines Bank premises and and check-processing-related services, none of which has equipment, net $2,021 $1,949 been recognized. Four Reserve Banks contract for these services on behalf of the System. Depreciation expense was $186 million and $182 mil- The Reserve Banks are involved in certain legal actions lion for the years ended December 31, 2001 and 2000, and claims arising in the ordinary course of business. respectively. Although it is difficult to predict the ultimate outcome of these actions, in management's opinion, based on discus- Bank premises and equipment at December 31 include sions with counsel, the aforementioned litigation and the following amounts for leases that have been capitalclaims will be resolved without material adverse effect ized (in millions): on the financial position or results of operations of the 2001 2000 Reserve Banks. Bank premises and equipment $21 $34 Accumulated depreciation (H) (22) (8) RETIREMENT AND THRIFT PLANS Capitalized leases, net $_^7 $12 Retirement Plans Certain of the Reserve Banks lease unused space to The Reserve Banks currently offer two defined benefit outside tenants. Those leases have terms ranging from 1 retirement plans to their employees, based on length of to 14 years. Rental income from such leases totaled service and level of compensation. Substantially all of $20 million and $18 million for the years ended Decemthe Reserve Banks', Board of Governors', and the Plan ber 31, 2001 and 2000, respectively. Future minimum Administrative Office's employees participate in the lease payments under noncancelable agreements in exist- Retirement Plan for Employees of the Federal Reserve ence at December 31, 2001, were (in millions): System (System Plan) and the Benefit Equalization 2002 $17 Retirement Plans offered by each individual Reserve 2003 14 Bank (BEP). 2004 . 11 The System Plan is a multi-employer plan with contri- 2005 . 10 butions fully funded by participating employers. Certain 2006 . 7 Board employees not covered by the Social Security Act Thereafter _16 also contribute to the plan. No separate accounting is Total $75 maintained of assets contributed by the participating Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

390 88th Annual Report, 2001 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED employers. FRBNY acts as a sponsor of this Plan. The The components of net periodic pension benefit credit prepaid pension cost includes amounts related to employ- for the System Plan as of December 31 are shown below ees participating in the plans from the 12 Reserve Banks, (in millions): the Board of Governors, and the Plan Administrative Office. 2001 2000 Following is a reconciliation of the beginning and ending balances of the System Plan benefit obligation (in Service cost—benefits earned millions): during the period $ 85 $ 80 Interest cost on projected benefit obligation 207 190 2001 2000 Amortization of initial net transition obligation (45) (45) Estimated actuarial present value Amortization of prior service of projected benefit cost 16 16 obligation at January 1 $2,810 $2,576 Recognized net (gain) (44) (85) Service cost—benefits earned Expected return on plan assets (550) (549) during the period 85 80 Interest cost on projected Net periodic pension benefit (credit). $(331) $(393) benefit obligation 207 191 Actuarial loss 125 90 Net periodic pension benefit (credit) is reported as a Contributions by plan participants .. 3 3 component of "Other expense." Benefits paid (139) (132) Plan amendments . . . 2 The Reserve Banks' projected benefit obligation and Estimated actuarial present value net pension costs for the BEP at December 31, 2001 and of projected benefit 2000, and for the years then ended, are not material. obligation at December 31 .... $3,091 $2,810 Thrift Plan Following is a reconciliation showing the beginning and ending balance of the System Plan assets, the funded Employees of the Reserve Banks may also participate in status, and the prepaid pension benefit costs (in millions): the defined contribution Thrift Plan for Employees of the 2001 2000 Federal Reserve System (Thrift Plan). The Reserve Banks' Thrift Plan contributions totaled $50 million and Estimated fair value of plan $47 million for the years ended December 31, 2001 and assets at January 1 $6,176 $6,156 2000, respectively, and are reported as a component of Actual return on plan assets (245) 149 "Salaries and other benefits." Contributions by plan participants .. 3 3 Benefits paid (139) (132) Estimated fair value of plan (9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS assets at December 31 $5,795 $6,176 AND POSTEMPLOYMENT BENEFITS Funded status $2,703 $3,366 Postretirement Benefits Other Than Pensions Unrecognized initial net transition (obligation) • • • (45) Unrecognized prior service cost 107 122 In addition to the Reserve Banks' retirement plans, Unrecognized net actuarial (gain) .. (228) (1,192) employees who have met certain age and length of service requirements are eligible for both medical benefits Prepaid pension benefit cost 2,582 2,251 and life insurance coverage during retirement. Prepaid pension benefit costs are reported as a component The Reserve Banks fund benefits payable under the of "Other assets." medical and life insurance plans as due and, accordingly, have no plan assets. Net postretirement benefit costs are The weighted-average assumptions used in developing actuarially determined using a January 1 measurement the pension benefit obligation for the System Plan are as date. follows: 2001 2000 Discount rate 7.00% 7.50% Expected long-term rate of return on plan assets 9.00% 9.00% Rate of compensation increase 4.50% 5.00% Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 391 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Following is a reconciliation of beginning and ending 1 Percentage 1 Percentage balances of the benefit obligation (in millions): Point Increase Point Decrease 2001 2000 Effect on aggregate of service and Accumulated postretirement benefit interest cost obligation at January 1 $644 $600 components of Service cost—benefits earned during net periodic the period 16 16 postretirement Interest cost of accumulated benefit costs $ 12 $ (9) benefit obligation 47 44 Effect on accumulated Actuarial loss 54 14 postretirement Contributions by plan participants 4 3 benefit obligation ... 86 (76) Benefits paid (31) (28) Plan amendments (60) (5) The following is a summary of the components of net . i . . • i. r-. periodic postretirement benefit costs for the years ended Accumulated postretirement benefit tl , O1 .. obligation at December 31 $674 $644 December 31 (in millions): 2001 2000 Following is a reconciliation of the beginning and ending =^-i t^± , b alan r c - e o L f i - t he • p lan a J s U se ts, the u J n funded • postreti L re me s n r t S „ ervi . c e cost4— b , enef _ it s earned , d , u r . ing benefit obligation and the accrued postretirement benefit , . , ° *., *.<costs (in millions): Interest^oTof accumulated benefit 2001 2000 obligation 47 44 Amortization of prior service cost (9) (9) Fair value of plan assets at January 1 ...$... $ ... Recognized net actuarial loss Jl) Jl) Contributions by the employer 27 25 Net dodic postretirement benefit costs .. $53 $49 Contributions by plan participants 4 3 r r = = Benefits paid (31) (28) r, . , £ , Net periodic postretirement benefit costs are reported as a Dtember31 $... $... component of "Salaries and other benefits." Unfunded postretirement benefit Postemployment Benefits obligation $674 $644 Unrecognized prior service cost 146 95 The Reserve Banks offer benefits to former or inactive Unrecognized net actuarial gain/(loss) .. (48) 7 employees. Postemployment benefit costs are actuarially Accrued postretirement benefit costs ... $772 $746 determined and include the cost of medical and dental ~~:=~ insurance, survivor income, disability benefits, and those Accrued postretirement benefit costs are reported as a workers' compensation expenses self-insured by indicomponent of "Accrued benefit costs." vidual Reserve Banks. Costs were projected using the At December 31, 2001 and 2000, the weighted-average same discount rate and health care trend rates as were discount rate assumption used in developing the postre- used for projecting postretirement costs. The accrued tirement benefit obligation were 7.00 percent and postemployment benefit costs recognized by the Reserve 7.50 percent, respectively. Banks at December 31, 2001 and 2000, were $110 mil- For measurement purposes, a 10.00 percent annual rate lion and $102 million, respectively. This cost is included of increase in the cost of covered health care benefits was as a component of "Accrued benefit costs." Net periodic assumed for 2002. Ultimately, the health care cost trend postemployment benefit costs included in 2001 and 2000 rate is expected to decrease gradually to 5.00 percent by operating expenses were $21 million. 2008, and remain at that level thereafter. Assumed health care cost trend rates have a significant ^ SUBSEQUENT EVENT effect on the amounts reported for health care plans. A one percentage point change in assumed health care cost Sub nt10 December 31, 2001 Federal Reserve Systrend rates would have the following effects for the year tem management determined that it would not proceed ended December 31, 2001 (in millions): with m ongoing technology project Accordingly, an asset impairment of $7 million will be recognized in 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Maps of the Federal Reserve System Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

394 88th Annual Report, 2001 The Federal Reserve System 9 1 * MINNEAPOLIS • 2 BOSTON n 7 12 — Q BNEWYORK X+mt CHICAGO • CLEV • E LAND 3 P m HILADELPHIA • SAN FRANCISCO 10 A • KANSAS CITY • g ^ m > ST. LOUIS 8 RIC5HMOND 6 • 11 • ATLANTA DALLAS It ^W^ ALASKA 4^; HAWAII LEGEND Both pages Facing page • Federal Reserve Bank city • Federal Reserve Branch city D Board of Governors of the Federal — Branch boundary Reserve System, Washington, D.C. NOTE The Federal Reserve officially identifies Bank serves the Commonwealth of Districts by number and by Reserve Puerto Rico and the U.S. Virgin Islands; Bank city (shown on both pages) and by the San Francisco Bank serves Ameriletter (shown on the facing page). can Samoa, Guam, and the Common- In the 12th District, the Seattle wealth of the Northern Mariana Islands. Branch serves Alaska, and the San Fran- The maps show the boundaries within cisco Bank serves Hawaii. the System as of year-end 2001. The System serves commonwealths and territories as follows: The New York Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Maps of the Federal Reserve System 395 1-A 2-B 3-C 4-D 5-E Pittsburgh Bal \ Buffalo Mi •Cincinnati • Charlotte BOSTON NEW YORK PHILADELPHIA CLEVELAND RICHMOND 6-F 7-G 8-H •Nashville Binningham Detroit • Louisville •Memphis Little Rock ATLANTA CHICAGO ST. LOUIS i •Helena MINNEAPOLIS 10-J 12-L Omaha • Denver Oklahoma City KANSAS CITY 11-K Salt Lake City 7 " X^--VH •Los Angeles San Antonio DALLAS SAN FRANCISCO Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

399 Index Abusive practices, home equity lending, Banking organizations, U.S.—Continued 121 Regulatory financial reporting, Agreement corporations, examination of, transparency, 159 150 Risk-focused supervision of, 147-49 Applications, processing of, 169 Structure, regulation of, 142 As-of accounting adjustments, 101 Basel Committee on Banking Supervision Assessment area, definition, 130 Capital requirements, 141, 154 Assets and liabilities Reports, 155 Banks, insured commercial, by class, Task Force on Accounting Issues, 155 361 Bies, Governor Susan Schmidt, oath of Board of Governors, 372 office executed, 291 Federal Reserve Banks, 338-41, 382 Board of Governors {See also Federal ATM {See Automated teller machines) Reserve System) Auditors' reports, 371, 379, 380, 381 Consumer Advisory Council, 129, 309 Automated clearinghouse services, 176 Federal Advisory Council, 308 Automated teller machines, disclosure of Financial statements, 371-80 fees and use, 126, 132, 200 Government Performance and Results Act, 191-93 Members and officers, lists, 305-07, Balance sheets 334-36 Board of Governors, 372 Mission, 191 Federal Reserve Banks, combined, 382 Policy actions, 199-213 Federal Reserve priced services, 186 Strategic and performance plans, 191 Federal Reserve System, autonomous Thrift Institutions Advisory Council, 310 factors, 103-05 BOND {See Banking Organization National Bank holding companies Desktop) Applications, 127 Building Wealth: A Beginner's Guide to Inspections of, 143-45 Securing Your Financial Future, Owned by foreign banking organizations, program, 124 capital requirements, 152 Business spending, investment, and Regulatory financial reports, 161 finance, 14-20, 49-52, 78-81 Stock repurchases by, 168 Bank Holding Companies and Change in CAESAR {See Complaint Analysis Bank Control {See Regulations: Y) Evaluation System and Reports) Bank Holding Company Act, 165 Call Reports, 158 Bank Merger Act, 166 Capital Bank Secrecy Act, 170 Accounts, Federal Reserve Banks, Banking Organization National Desktop 338-41 (BOND), 148 Changes in, Federal Reserve Banks, 384 Banking organizations, U.S. Rows, 24, 55, 86 Capital adequacy, 151, 154 Standards, 151-53, 154 Examinations and inspections of, 143 Cash flows, Board of Governors, 374 Foreign-office operations, 149 Cash services, Federal Reserve Banks, 179 Internal control, accounting, and Change in Bank Control Act, 167 disclosure, 155 Changing Financial Markets and Overseas investments, 168 Community Development, conference, Recourse obligations, 152, 202 122 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

400 88th Annual Report, 2001 Check collection and processing, Federal Direct bill-paying, 132 Reserve Banks, 175 Direct deposit, 132 Check Truncation Act, proposed, 196 Directors, Federal Reserve Banks and Child care, programs to improve access, Branches, list, 313-33 129 Disclosure Civil money penalties, 147 ATM fees, 200 Clearing balance requirements, 101 Financial statements, 160 Commercial banks, number of, 361, 368 Open- and closed-end lending, 130 Community affairs, 128 Disclosures on web sites, 130 Community banks, risk-focused supervision Discount rate (See also Federal funds rate of, 148 and Interest rates), 208-13 Community development, research, 122 Discount window credit, 112 Community Reinvestment Act Dollar test, 130 Bank holding company applications, 127 Compliance examinations, 127 e-Perspectives, electronic newsletter, 129 Review, 122 E-Sign Act, 126, 199 Complaint Analysis Evaluation System and Economic projections, 9, 45-47, 74 Reports, 137 Economies Compliance examinations, 127 Foreign, 35-40, 66-70, 94-97 Consumer Economy, U.S. Complaints, 137-40 Business sector, 14-20, 49-52, 78-81 Leasing (See Regulations: M) Debt, nonfinancial sectors, 32-34, 64, 93 Privacy protection, 124 Equity markets, 31, 63, 92 Regulations, compliance with, 134-37 Financial account, 24, 55, 86 Spending, 4, 12, 41, 47, 76 Financial markets, 29-35, 59-64, 90-93 Consumer Advisory Council, 129, 309 Government sector, 20-22, 52-54, 81-84 Consumer and community affairs, 121-40 Household sector, 12-14, 47-49, 76-78 Crossing the Bridge to Self-Employment: A Interest rates, 7, 30, 60, 90-92 Federal Micro-enterprise Resource Labor market, 25-27, 56, 86-88 Guide, 129 Monetary aggregates, 34, 65, 94 Currency and coin, 179 Monetary policy, 3-9, 41-45, 71-74 Current account (See Trade, Foreign) Prices, 27-29, 57-59, 88-90 Trade and current account, 22-24, 54, 85 Debit cards, 132 Edge Act corporations, examination of, 150 Debt and depository intermediation, 32-34, Electronic banking, reduction of fraud risk, 64,93 159 Depository institutions Electronic check conversion, 126 Credit extension, 33, 64 Electronic Fund Transfer Act (See also Disclosures, 130, 160, 200 Regulations: E), 132 Mortgage lending, 131 Electronic fund transfer services, 132 Reserves, 362-67 Electronic Signatures in Global and Services provided to by Federal Reserve National Commerce Act (E-Sign Act), Banks, 173-79 126, 199 Depository services, U.S. Treasury, 180, Emerging market economies (See 181 Economies, Foreign) Deposits Employment, 25, 56, 86 Federal Reserve Banks, 338-41 Enforcement actions, Federal Reserve Insured commercial banks, 361 System, 147 Rate-sensitive, 154 Equal Credit Opportunity (See Regulations: Derivative transactions, 205 B) Desk (See Trading Desk) Equity markets, 31, 63, 92 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 401 Examinations and inspections Federal Reserve Banks Bank holding companies, 143-45 Assessments by Board of Governors, Compliance with consumer protection 352-55 laws, 133 Audits of, 182, 381-91 Fair lending, 133 Branches Federal Reserve Banks, 182 Directors, list, 313-33 Fiduciary activities, 146, 153 Officers, list, 311 Financial holding companies, 145 Premises, 184, 356 Foreign banking companies, 142 Vice presidents in charge, list, 311 International banking activities, 149-51 Community affairs, 121-40 Specialized Condition statements, 338-41, 382 Fiduciary activities, 146 Conferences of chairmen, presidents, and Government and municipal securities first vice presidents, 313 dealers and brokers, 146 Deposits, 338-41 Information technology activities, 146 Directors, list, 313-33 Securities clearing agencies, 146 Discount rate, 208-13, 358 Transfer agents, 146 Examinations of, 182 State member banks, 143 Financial statements, combined, 381-91 Supervisory policy, 151-61 Income and expenses, 183, 348-51, 352, U.S. banking organizations, 354, 383 foreign-office operations, 149 Officers and employees, number and salaries, 347 Fair lending examinations, 133 Officers, list, 311 Faith and communities at work, web site, Operations, volume, 357 129 Payments to the U.S. Treasury, 353, 355 Federal Advisory Council, 308 Premises, 184, 338-41, 356, 382 Federal agency securities Priced services, 173-79, 186-89, 348-51 Federal Reserve Banks, 338-41, 346, Salaries of officers and employees, 347 362, 364, 366 Securities and loans, holdings of, 184, Federal Reserve open market operations, 338-41, 346, 348-51, 362-67 225, 342-45 Services Federal Financial Institutions Examination Automated clearinghouse, 176 Council, activities, 134, 158, 159 Check collection, 175 Federal funds rate, 7, 9, 42-45, 72-74, 99, Depository, 180, 181 111 Fedwire funds transfer, 177 Federal Open Market Committee Fedwire securities, 178 Authorizations, 100, 116, 215, 217, 224 Fiscal agency, 180 Bies, Governor Susan Schmidt, oath Float associated with, 179 executed, 291 Food coupon, 182 Directives, guidelines, and procedural Net settlement, 179 instructions, 100, 117, 217, 219, Noncash, 179 225, 227, 236, 244, 245, 254, 263, Postal money order, 182 272, 281, 290, 298 Special cash, 179 Meetings, minutes of, 220, 236, 246, Tax payments, 181 255, 264, 273, 282, 290 Federal Reserve notes, 104, 338-41, 353, Telephone conferences, 8, 72, 245, 355 273 Federal Reserve System {See also Board of Members and officers, list, 307 Governors) Notation votes, 264, 283 Applications and proposals, 168 Olson, Governor Mark W., oath of office Balance sheet, autonomous factors, executed, 291 103-05 Federal Reserve Act, 205, 206 Decisions, public notice of, 169 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

402 88th Annual Report, 2001 Federal Reserve System—Continued Government Enforcement actions and civil money Depository services, Federal Reserve penalties, 147 Banks, 180, 181 Examinations and inspections, 143-47 Fiscal agency services, Federal Reserve Intraday credit, 205, 208 Banks, 180 Maps, 394, 395 Receipts, spending, and debt, 20-22, Membership, 172 52-54, 81-84 Staff training, 163 Securities dealers and brokers, Supervision and regulation examination of, 146 responsibilities, 141-72 State and local, 21, 52, 54, 84 Technical assistance, 151 Government Performance and Results Act Federal sector, 20, 52-54, 81-84 of 1993, 191-93 Federal tax payments, 181 Gramm-Leach-Bliley Act, 124, 142, 144, Fednet, 182 156-58 Guidelines for the Conduct of System Fedwire, 177, 178, 181 Open Market Operations in Federal FFTEC (See Federal Financial Institutions Agency Issues, 100, 117 Examination Council) Fiduciary activities, supervision of, 146, Home equity lending, abusive practices, 153 121 Finance Home Mortgage Disclosure Act, data on Business, 17-20, 50-52, 80 loan applications and transactions, 131 Household, 13, 49, 77 Home Ownership and Equity Protection Financial Act, 121, 205 Holding companies, 142, 144, 145, 156, Household sector, 12-14, 47-49, 76-78 157, 204 Housing and Urban Development, Markets, 7-9, 29-35, 42-45, 59-64, Department of, complaint referrals, 72-74, 90-93 140 Statements How to File a Consumer Complaint, Board of Governors, 371-80 Spanish-language brochure, 123 Disclosures of, 160, 169 Federal Reserve Banks, combined, Income and expenses 381-91 Board of Governors, 373 Federal Reserve priced services, Federal Reserve Banks, 183, 348-51, 186-89 352-55, 383 Fiscal agency services, Federal Reserve Federal Reserve priced services, 173-79, Banks, 180 186-89, 348-51 Float, Federal Reserve, 179 Information security, 158 Food coupon services, 182 Information technology Foreign Federal Reserve examination of, 146 Banking organizations, U.S. activities, Services to depository institutions, 182 examination of, 133, 150, 151 Supervisory Information Technology Currencies, 348-51 (SIT), 162 Economic developments, 35-40, 66-70, Insurance sales, consumer protection, 201 94-97 Insured commercial banks, assets and Operations, U.S. banking organizations, liabilities, 361 149 Interest rates (See also Discount rate and Trade, 22-24, 54, 85 Federal funds rate), 7, 30, 60, 90-92, 358 Gold certificate account of Reserve International Banks and gold stock, 338-41, 362, Banking activities, supervision of, 364, 366 149-51, 203 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 403 International—Continued Loans—Continued Economic developments, 35-40, 66-70, Insured commercial banks, 361 94-97 Loss reserves, 160 International Banking Act, applications State member bank executive officers, under, 167 171 Intraday credit, 205, 208 Looking for the Best Mortgage, Investment test, 130 Spanish-language brochure, 123 Investment Business, 14-16, 49, 78-80 Making Small Cities and Towns Work, Commercial banks, 361 program, 122 Federal Reserve Banks, 338-41 Maps, Federal Reserve System, 394, 395 Overseas, by U.S. banking organizations, Margin requirements, 169, 360 168 Margin stocks, 170, 360 Residential, 13, 48, 77 Matched sale-purchase transactions, 109 Member banks (See also State member Joint Forum, papers, 155 banks) Applications by, 168 Labor market, 25-27, 56, 86-88 Assets and liabilities, 361 Large, complex banking organizations Foreign branches, supervision of, 150 (LCBOs), supervision of, 148 Loans and extensions of credit, 206 Legislation, federal, 195 Number of, 361, 368 Lending practices, 121 Members and officers, Board of Governors, Litigation involving the Board of 305-07, 334-36 Governors Membership of State Banking Institutions Albrecht, 302 in the Federal Reserve System (See Artis, 302 Regulations: H) Bank for International Settlements, 302 Merchant banking activities, GLBA, 157, Barnes, 302 204 Bettersworth, 302 Monetary aggregates (Ml, M2, M3), 34, Community Bank & Trust, 301 65,94 Dime Bancorp, Inc., 301 Monetary policy, 3-9, 41-45, 71-74 El Bey, 302 Monetary policy reports to the Congress Emran, 301 February 2001, 41-70 Federal Trade Commission, 301 February 2002, 3-40 Fraternal Order of Police, 302 July 2001, 71-97 Guerrero, 302 Money laundering, 170 Howe, 302 Mortgage lending statistics, 131 Laredo National Bancshares, Inc., 302 Municipal securities dealers, examination Nelson, 302 of, 146 Pharaon, 301 Radfar, 302 National Information Center (NIC), 162 Reno, 302 Native American tribal land, housing and Sedgwick, 302 businesses on, 129 Trans Union LLC, 301 New Roads and e-Roads: Market Loans Innovations in Community Federal Reserve Banks Development, program, 122 Holdings of and income from, 184, Non-complex financial institutions, 152 338-41, 357, 362, 364, 366 Noncash services, Federal Reserve Banks, Interest rates for depository 179 institutions, 358 Nonmember banks, 361, 368 Home equity lending, abusive practices, Notes, Federal Reserve, 104, 338-41, 353, 121 355 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

404 88th Annual Report, 2001 Olson, Governor Mark W., oath of office Regulations—Continued executed, 291 K, International Banking Operations, 203 Open market operations, 92, 99-118 M, Consumer Leasing, 126, 135, 199 Opt-out right, 124 P, Privacy of Consumer Financial Overseas investments, U.S. banking Information, 124 organizations, 168 T, Credit by Brokers and Dealers, 169, 360 Payments system U, Credit by Banks for the Purpose of Effects of terrorist attacks on, 174 Purchasing or Carrying Margin Risk, 207, 208 Stocks, 170, 360 Point-of-sale transactions, 132 X, Borrowers of Securities Credit, 170, Policy statements and other actions, Board 360 of Governors, 207 Y, Bank Holding Companies and Change Postal money order services, 182 in Bank Control, 202, 204 Premises, Federal Reserve Banks, 184, Z, Truth in Lending, 121, 126, 130, 136, 338-41, 356, 382 199, 205 Priced services, Federal Reserve Banks, AA, Unfair or Deceptive Acts or 173-79, 186-89, 348 Practices, 136 Prices DD, Truth in Savings, 126, 137, 199 Consumer, 27-29, 57-59, 88-90 Reports of condition and income, 158 Equity, 31, 63, 92 Repurchase agreements, 108, 109 Privacy of Consumer Financial Information Reserve balance requirements, 101-03 (See Regulations: P) Reserve Requirements of Depository Privacy, consumer rights, 124 Institutions (See Regulations: D) Profit and loss, Federal Reserve Banks, 350 Reserves of depository institutions, 362-67 Publications Residual interests, final rule, 152 Crossing the Bridge to Self-Employment: Revenue and income A Federal Micro-enterprise Board of Governors, 373 Resource Guide, 129 Federal Reserve Banks, 183, 348-51, e-Perspectives, electronic newsletter, 129 352, 354, 383 How to File a Consumer Complaint, Federal Reserve priced services, 173-79, Spanish-language brochure, 123 183, 186-89, 348 Looking for the Best Mortgage, Risk-focused supervision program, 147-49 Spanish-language brochure, 123 Risk-management supervisory policy, 155 Shop—The Credit Card You Pick Can Rules Regarding Delegation of Authority, Save You Money, brochure, 123 203 Rules Regarding Equal Opportunity, 206 Reciprocal currency arrangements, 272 Recourse obligations, final rule, 152 Salaries, Federal Reserve Bank officers Regional banking organizations, and employees, 347 supervision of, 148 Savings bonds, 181 Regulations Securities (See also Treasury securities) B, Equal Credit Opportunity, 126, 134, Borrowing transactions, 153 199 Clearing agencies, examination of, 146 C, Home Mortgage Disclosure, 130 Credit for purchasing or carrying, 169, D, Reserve Requirements of Depository 360 Institutions, 199, 359 Credit lenders, examination of, 147 E, Electronic Fund Transfers, 126, 135, Dealers and brokers, supervision of, 146 199, 200 Firms, claims on, 153 H, Membership of State Banking Holdings by Federal Reserve Banks, Institutions in the Federal Reserve 184, 346 System, 201, 202 Purchases from certain affiliates, 206 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 405 Securities_Continued Supervisory Information Technology (SIT), State member banks, 154 162 Service test, 130 System Open Market Account (SOMA), Settlement services, 178 holdings and operations, 92, 99-118, Shop—The Credit Card You Pick Can Save 217, 225 You Money, brochure, 123 Smart Codes: A Local Perspective on Technical assistance, Federal Reserve Planning and Growth, program, 122 System, 151 Smart Growth and Community Terrorist attacks, effects of, 3, 4, 8, 12, 18, Development: Working Together 21, 25, 30, 32, 35, 113-16, 142, 148, Smartly, program, 122 173 SOMA (See System Open Market Account) Thrift Institutions Advisory Council, 310 Special cash services, 179 Trade, foreign, 22-24, 54, 85 Special drawing rights certificate account, Trading Desk, 99, 100 338-41, 362, 364, 366 Training, examiner, 134, 163 State and local government sector, 21, 52, Transfer agents, supervision of, 146 54,84 Treasury securities State member banks (See also Member Depository institution holdings, by class banks) of bank, 361 Applications by, 168 Federal Reserve Banks Community Reinvestment Act, Holdings, 338-41, 346, 348-51 compliance, 127 Marketable, 180 Complaints against, 137, 138 Open market transactions, 342-45 Examination of, 133, 143 Repurchase agreements, 338-41, Financial disclosure by, 169 342-45, 346, 362, 364, 366 Financial subsidiaries, 201, 202 Treasury, U.S. Department of the, 180-82, Foreign branches, 150 353, 355 Insurance sales, 201 Truth in Lending (See Regulations: Z) Loans to executive officers, 171 Truth in Savings (See Regulations: DD) Number, 361, 368 Securities activities, 154 Securities dealers and brokers, 146 Unemployment, 25, 56, 86 Securitization transactions, regulatory Uniform Commercial Code, revisions, 159 USA PATRIOT Act, 171, 195 treatment of, 202 Transfer agents, 146 Stock repurchases, bank holding Web sites companies, 168 Building Wealth: A Beginners Guide to Student Loan Marketing Association, debt Securing Your Financial Future, obligations, 100 124 Supervision and regulation responsibilities, Disclosures on, 130 Federal Reserve System, 141-72 West Texas intermediate, prices, 23, 55, 85 FRB1/1-7000-0402 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis