Annual Report of the Federal Reserve Board, 2002

Annual ^Report Vj 2002 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 Fulfillment, Mail Stop 127, Washington, DC 20551. It is also available on the Board's web site, at 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 2003 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-ninth annual report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 2002. 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 4 Monetary Policy, Financial Markets, and the Economy over 2002 and Early 2003 8 Economic Projections for 2003 11 ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2002 AND EARLY 2003 12 The Household Sector 14 The Business Sector 20 The Government Sector 21 The External Sector 23 The Labor Market 25 Prices 27 U.S. Financial Markets 34 International Developments 41 MONETARY POLICY REPORT OF JULY 2002 41 Monetary Policy and the Economic Outlook 45 Economic and Financial Developments in 2002 Federal Reserve Operations 69 CONSUMER AND COMMUNITY AFFAIRS 69 Supervision for Compliance with Consumer Protection and Community Reinvestment Laws 79 Implementation of Statutes Designed to Inform and Protect Consumers 82 Consumer Complaints 84 Advice from the Consumer Advisory Council 86 Promotion of Community Development in Historically Underserved Markets 93 BANKING SUPERVISION AND REGULATION 94 Scope of Responsibilities for Supervision and Regulation 95 Supervision for Safety and Soundness 105 Supervisory Policy 114 Supervisory Information Technology 115 Staff Development 115 Regulation of the U.S. Banking Structure 121 Enforcement of Other Laws and Regulations 123 Federal Reserve Membership Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

125 FEDERAL RESERVE BANKS 125 Major Initiatives 126 Developments in Federal Reserve Priced Services 131 Developments in Currency and Coin 131 Developments in Fiscal Agency and Government Depository Services 134 Electronic Access 134 Information Technology 134 Examinations of the Federal Reserve Banks 135 Income and Expenses 136 Holdings of Securities and Loans 136 Volume of Operations 136 Federal Reserve Bank Premises 138 Pro Forma Financial Statements for Federal Reserve Priced Services 143 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE AND RESULTS ACT 143 Strategic and Performance Plans and Performance Report 143 Mission 143 Goals and Objectives 144 Interagency Coordination 147 FEDERAL LEGISLATIVE DEVELOPMENTS Records 151 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS 151 Regulation A (Extensions of Credit by Federal Reserve Banks) and Regulation D (Reserve Requirements of Depository Institutions) 151 Regulation C (Home Mortgage Disclosure) 153 Regulation D 154 Regulation H (Membership of State Banking Institutions in the Federal Reserve System) 154 Regulation H and Regulation Y (Bank Holding Companies and Change in Bank Control) 155 Regulation K (International Banking Operations) 155 Regulation W (Transactions between Member Banks and Their Affiliates) 156 Policy Statements and Other Actions 157 Discount Rates in 2002 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

161 MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS 161 Authorization for Domestic Open Market Operations 163 Guidelines for the Conduct of System Open Market Operations in Federal Agency Issues 163 Domestic Policy Directive 163 Authorization for Foreign Currency Operations 165 Foreign Currency Directive 165 Procedural Instructions with Respect to Foreign Currency Operations 166 Meeting Held on January 29-30, 2002 180 Meeting Held on March 19, 2002 189 Meeting Held on May 7, 2002 197 Meeting Held on June 25-26, 2002 205 Meeting Held on August 13, 2002 213 Meeting Held on September 24, 2002 220 Meeting Held on November 6, 2002 229 Meeting Held on December 10, 2002 237 LITIGATION 237 Litigation under the Gramm-Leach-Bliley Act 237 Other Actions Federal Reserve System Organization 241 BOARD OF GOVERNORS 244 FEDERAL OPEN MARKET COMMITTEE 245 ADVISORY COUNCILS TO THE BOARD OF GOVERNORS 245 Federal Advisory Council 246 Consumer Advisory Council 247 Thrift Institutions Advisory Council 248 FEDERAL RESERVE BANKS AND BRANCHES 248 Officers of the Banks and Branches 249 Conference of Chairmen 249 Conference of Presidents 250 Conference of First Vice Presidents 250 Directors of the Banks and Branches 267 HISTORICAL RECORDS: MEMBERS OF THE BOARD OF GOVERNORS, 1913-2002 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 272 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2002 and 2001 276 2. Federal Reserve Open Market Transactions, 2002 280 3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2000-02 281 4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2002 282 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2002 286 6. Income and Expenses of the Federal Reserve Banks, 1914-2002 290 7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks and Branches, December 31, 2002 291 8. Operations in Principal Departments of the Federal Reserve Banks, 1999-2002 292 9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2002 293 10. Reserve Requirements of Depository Institutions, December 31, 2002 294 11. Initial Margin Requirements under Regulations T, U, and X 295 12. Principal Assets and Liabilities and Number of Insured Commercial Banks in the United States, by Class of Bank, June 30, 2002 and 2001 296 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-2002 and Month-End 2002 302 14. Banking Offices and Banks Affiliated with Bank Holding Companies in the United States, December 31, 2001 and 2002 Federal Reserve System Audits 305 AUDITS OF THE FEDERAL RESERVE SYSTEM 307 BOARD OF GOVERNORS FINANCIAL STATEMENTS 317 FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS 328 OFFICE OF INSPECTOR GENERAL ACTIVITIES 329 GENERAL ACCOUNTING OFFICE REVIEWS 331 MAPS OF THE FEDERAL RESERVE SYSTEM 335 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 The economy of the United States has housing remained solid and was supsuffered a series of blows in the past few ported by another installment of tax years, including the fall in equity market reductions, widespread price discountvalues that began in 2000, cutbacks in ing, and low mortgage interest rates. capital spending in 2001, the horrific By midyear, the cutbacks in employterrorist attacks of September 11, the ment came to an end, and private payemergence of disturbing evidence of rolls started to edge higher. corporate malfeasance, and an esca- Although economic performance lation of geopolitical risks. Despite appeared to be gradually improving, the these adversities, the nation's economy tentative nature of this improvement emerged from its downturn in 2001 to warranted the continuation of a highly post moderate economic growth last accommodative stance of monetary polyear. The recovery was supported by icy. Accordingly, the Federal Open Maraccommodative monetary and fiscal ket Committee (FOMC) held the federal policies and undergirded by unusually funds rate at P/4 percent through the rapid productivity growth that boosted first part of the year. In March, however, household incomes and held down busi- the FOMC shifted from an assessment ness costs. The productivity perfor- that the risks over the foreseeable future mance was also associated with a rapid to its goals of maximum sustainable expansion of the economy's potential, growth and price stability were tilted and economic slack increased over the toward economic weakness to an assessyear despite the growth in aggregate ment that the risks were balanced. demand. Around midyear, the economy began After turning up in late 2001, activity to struggle again. Concerns about corbegan to strengthen more noticeably porate governance came to weigh early last year. Sharp inventory cutbacks heavily on investors' confidence, and in 2001 had brought stocks into better geopolitical tensions, especially the alignment with gradually rising final situation in Iraq, elevated uncertainties sales, and firms began to increase pro- about the future economic climate. duction in the first quarter of 2002 to Equity prices fell during the summer, curtail further inventory runoffs. More- liquidity eroded in corporate debt marover, businesses slowed their contrac- kets, and risk spreads widened. Busition of investment spending and began nesses once again became hesitant to to increase outlays for some types of spend and to hire, and both manufaccapital equipment. Household spending turing output and private payrolls began on both personal consumption items and to decline. State and local governments struggled to cope with deteriorating NOTE. The discussion here and in the next fiscal positions, and the economies section ("Economic and Financial Developments of some of our major trading partners in 2002 and Early 2003") consists of the text, remained weak. Although the already tables, and selected charts from the Monetary Polaccommodative stance of monetary policy Report submitted to the Congress on Februicy and strong upward trend of producary 11, 2003, pursuant to section 2B of the Federal Reserve Act. tivity were providing important support Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

89th Annual Report, 2002 to spending, the Committee perceived a Business caution is anticipated to give risk that the near-term weakening could way over the course of the year to become entrenched. In August, the clearer signs of improving sales. Inven- FOMC adjusted its weighting of risks tories are lean relative to sales at toward economic weakness, and in present, and restocking is likely to pro- November, it reduced the targeted vide an additional impetus to production federal funds rate 50 basis points, to in the period ahead. The rapid expansion \lA percent. The policy easing allowed of productivity, the waning effects of the Committee to return to an assess- earlier declines in household wealth, and ment that the risks to its goals were the highly accommodative stance of balanced. With inflation expectations monetary policy should also continue to well contained, this additional monetary boost activity. Although state and local stimulus seemed to offer worthwhile governments face budgetary problems, insurance against the threat of persistent their restraint is likely to offset only a economic weakness and substantial part of the stimulus from past and prodeclines in inflation from already low spective fiscal policy actions at the fedlevels. eral level. In addition, the strengthening On net, the economy remained slug- economies of our major trading partners gish at the end of 2002 and early this along with the improving competitiveyear. The household sector continued ness of U.S. products ought to support to be a solid source of demand. Motor demand for our exports. Taken together, vehicle sales surged at year-end on the these factors are expected to lead to tide of another round of aggressive dis- a faster pace of economic expansion, counting by the manufacturers, other while inflation pressures are anticipated consumer outlays trended higher, and to remain well contained. activity in housing markets remained exceptionally strong. Concerns about Monetary Policy, Financial corporate governance appeared to Markets, and the Economy recede somewhat late last year, in part over 2002 and Early 2003 because no new revelations of major wrongdoing had emerged. However, the As economic growth picked up during ongoing situation in Iraq, civil strife in the early months of 2002, the FOMC Venezuela that has curtailed oil produc- maintained its target for the federal tion, and tensions on the Korean penin- funds rate at 13A percent. A sharply sula have sustained investors' uncer- reduced pace of inventory liquidation tainty about economic prospects and accounted for a significant portion of have pushed prices higher on world oil the step-up in real GDP growth, but markets. Faced with this uncertainty, other indicators also suggested that businesses have been cautious in spend- the economy was gaining momentum. ing and changed payrolls little, on net, Reductions in business outlays on equipover December and January. ment and software had moderated sig- Mindful of the especially high degree nificantly after dropping precipitously of uncertainty attending the economic in 2001, and consumer spending was outlook in the current geopolitical well maintained by sizable gains in real environment, the members of the disposable personal income. Residential FOMC believe the most likely outcome construction activity was spurred by to be that fundamentals will support low home mortgage interest rates. The a strengthening of economic growth. improvement in economic conditions Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook 5 Selected Interest Rates mm Percent ;;; Ten-year Treasury — 6 V Two-yearTreasury Discount rate (primary credit) — 3 ' Intended federal funds rate V>'^ Vv /\ y*\, Discount rate (adjustment credit) 4/1S5/J5 0/27 S/21 9/i7 10/2 ii/6 12/1 i 1/30 5/7 6/26 8/13 9/24 ; 1/6 12/1.0 1/29 200! 2002 2003 NOTE. The data are daily and extend through Federal Reserve changed the main credit program February 5, 2003. The dates on the horizontal axis are offered at the discount window by terminating the those of scheduled FOMC meetings and of any adjustment credit program and beginning the primary intermeeting policy actions. On January 9, 2003, the credit program. sparked a rally in equity markets late in Although the decline in investment the first quarter and pushed up yields spending during the first quarter of on longer-term Treasury instruments 2002 was the smallest in a year, and investment-grade corporate bonds; gloomy business sentiment and large yields on speculative-grade bonds margins of excess capacity in numerdeclined in reaction to brighter eco- ous industries were likely to hamper nomic prospects and the perceived capital expenditures. According to reduction in credit risk. Meanwhile, anecdotal reports, many firms were surging energy prices exerted upward unwilling to expand capacity until they pressure on overall inflation, but still- saw more conclusive evidence of growappreciable slack in resource utilization ing sales and profits. At the same time, and a strong upward trend in private- however, the FOMC noted that, with sector productivity were holding down the federal funds rate unusually low core price inflation. on an inflation-adjusted basis and At both its March and May meetings, considerable fiscal stimulus in train, the FOMC noted that the apparent vigor macroeconomic policies would proof the economy was importantly attrib- vide strong support to further economic utable to a slowdown in the pace of expansion. Against this backdrop, the inventory liquidation and that con- Committee at the March 19 meeting siderable uncertainty surrounded the judged the accommodative stance of outlook for final sales over the next monetary policy to be appropriate and several quarters. The Committee was announced that it considered the risks especially concerned about prospects to achieving its long-run objectives for a rebound in business fixed invest- as being balanced over the foreseeable ment, which it viewed as key to ensur- future, judgments it retained at its meeting sustainable economic expansion. ing in early May. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

89th Annual Report, 2002 The information reviewed at the earlier momentum. Turbulence in finan- June 25-26 FOMC meeting confirmed cial markets appeared to be holding back that the economy was expanding but at the pace of the economic expansion. a slower pace than earlier in the year. Market participants focused their atten- As expected, the degree of impetus tion on the lack of convincing evidence to economic activity from decelerating that the recovery was gaining traction inventory liquidation had moderated. and the possibility that more news of Residential investment and consumer corporate misdeeds would surface in the spending also had slowed appreciably run-up to the Securities and Exchange after surging earlier in the year. The Commission's August 14 deadline for most recent data on orders and ship- the certification of financial statements ments suggested a small upturn in by corporate executives. Although the business spending on equipment and cumulative losses in financial wealth software, but the improvement in capi- since 2000 were restraining expendital spending appeared to be limited, tures by households, very low mortgage unevenly distributed across industries, interest rates were helping to sustain and not yet firmly indicative of sus- robust demand for housing. Moreover, tained advance. Industrial production the financial resources made available continued to increase, and the unem- by a rapid pace of mortgage refinancing ployment rate declined somewhat. activity, in combination with attractive In financial markets, investors and incentives offered by auto manufacturlenders had apparently become more ers, supported other consumer spending. risk averse in reaction to the mixed The Committee continued to judge the tone of economic data releases, grow- prevailing degree of monetary accoming geopolitical tensions, further warn- modation as appropriate to foster a solid ings about terrorist attacks, and addi- expansion that would bring the econtional revelations of dubious corporate omy to fuller resource utilization. At the accounting practices. In concert, these same time, the Committee recognized developments pushed down yields on the considerable risks to that outlook longer-term Treasury securities, while and the potential adverse consequences interest rates on lower-quality corporate for economic prospects from possible bonds rose notably, and equity prices additional deterioration of financial condropped sharply. Although the economy ditions. The members noted, however, continued to expand and the prospects that a further easing of monetary policy, for accelerating aggregate demand if it came to be viewed as appropriate, remained favorable, downbeat business could be accomplished in a timely mansentiment and skittish financial markets ner. In light of these considerations, the rendered the timing and extent of the FOMC opted to retain a target rate of expected strengthening of the expansion PA percent for the federal funds rate, subject to considerable uncertainty. In but it viewed the risks to the economy as these circumstances, the FOMC left the having shifted from balanced to being federal funds rate unchanged to keep tilted toward economic weakness. monetary policy very accommodative When the FOMC met on Septemand once again assessed the risks to the ber 24, data indicated that economic outlook as being balanced. growth had picked up in the third quar- By the time of the August 13 FOMC ter, on average, buoyed in part by a meeting, it had become apparent that surge in motor vehicle production. The economic activity had lost some of its uneventful passing of the mid-August Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook deadline for recertification of corporate major trading partners spelled difficulfinancial statements briefly alleviated ties for U.S. exports, and a rebound in investors' skittishness in debt and equity foreign output seemed more likely to markets. However, the most timely follow than to lead a rebound at home. information suggested that some soften- Moreover, economic slack that was ing in economic activity had occurred larger and more persistent than previlate in the summer. Those economic ously anticipated ran the risk of reducreports, along with a darker outlook for ing core inflation appreciably further corporate profits and escalating fears of from already low levels. Given these a possible war against Iraq, led market considerations, the Committee lowered participants to revise down their expec- its target for the federal funds rate tations for the economy. Equity prices Vi percentage point, to \lA percent. The and yields on both longer-term Treasury relatively aggressive adjustment in the and private securities moved sharply stance of monetary policy was deemed lower in early autumn. In the Commit- to offset the potential for greater ecotee's view, heightened geopolitical ten- nomic weakness, and the Committee sions constituted a significant additional accordingly announced that it judged source of uncertainty clouding the eco- risks to the outlook as balanced with nomic outlook. Still, fundamentals sug- respect to its long-run goals of price gested reasonable prospects for contin- stability and sustainable economic ued expansion. Accordingly, the FOMC growth. left the federal funds rate unchanged at When the FOMC met on Decemthe close of the September meeting but ber 10, overall conditions in financial also reiterated its view that the risks to markets had calmed considerably. Indithe outlook were weighted toward eco- cators of production and spending, hownomic weakness. ever, remained mixed. The manufactur- The information reviewed at the ing sector registered large job losses in November 6 meeting indicated a more the autumn, and industrial production persistent spell of below-par economic continued its slide, which had begun performance than the FOMC had antici- around midyear. A more vigorous pated earlier. With home mortgage rates rebound in business fixed investment at very low levels, residential con- was not evident, and indeed the recent struction activity remained high. But data on orders and shipments and anecconsumer spending had decelerated dotal reports from business contacts noticeably since midsummer under the generally signaled continued softness in combined weight of stagnant employ- capital spending. Very low home mortment and declining household wealth gage interest rates were supporting resiresulting from further decreases in dential construction activity, but conequity prices. Worries about the poten- sumption expenditures were sluggish. tial for war against Iraq, as well as On balance, the Committee's view was persistent concerns about the course of that in the absence of major shocks economic activity and corporate earn- to consumer and business confidence, ings, were apparently engendering a a gradual strengthening of the economic high degree of risk aversion among busi- expansion was likely over the comness executives that was constraining ing quarters, especially given the very capital spending and hiring. Despite a accommodative stance of monetary polweakening in the exchange value of the icy and probable further fiscal stimulus. dollar, sluggish economic growth among The FOMC left the federal funds rate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

8 89th Annual Report, 2002 unchanged and indicated that it contin- 3V2 percent, measured as the change ued to view the risks to the outlook as between the final quarter of 2002 and balanced over the foreseeable future. the final quarter of this year. The full By the time of the FOMC meeting on range of these forecasts is 3 percent to January 28-29, 2003, it had become 33/4 percent. Of course, neither the cenapparent that the economy had grown tral tendency nor the range is intended only slowly in the fourth quarter of last to convey the uncertainties surrounding year, but little evidence of cumulating the individual forecasts of the members. weakness appeared in the most recent The civilian unemployment rate is data, and final demand had held up rea- expected to end the year in the 53A personably well. The escalation of global cent to 6 percent range. tensions weighed heavily on business Apart from the geopolitical and other and investor sentiment. Firms appar- uncertainties, the forces affecting ently were remaining very cautious in demand this year appear, on balance, their hiring and capital spending, and conducive to a strengthening of the equity prices had declined on balance economic expansion. Monetary policy since the December meeting. But yield remains highly accommodative, and spreads on corporate debt—especially federal fiscal policy is and likely will for riskier credits—narrowed further, be stimulative. However, spending by and longer-term Treasury yields many state and local governments will declined slightly. Although the funda- continue to be restrained by considermentals still pointed to favorable pros- able budget difficulties. Activity abroad pects for economic growth beyond the is expected to improve this year, even if near term, geopolitical developments at a less robust pace than in the United were making it especially difficult to States; such growth together with the gauge the underlying strength of the improving competitiveness of U.S. prodeconomy, and uncertainties about the ucts should generate stronger demand economic outlook remained substantial. for our exports. Furthermore, robust Against this background, the Committee gains in productivity, though unlikely to decided to leave the federal funds rate be as large as in 2002, ought to continue unchanged and stated that it continued to promote both household and business to judge the risks to the outlook as spending. Household purchasing power balanced. should be supported as well by a retreat in the price of imported energy products that is suggested by the oil futures mar- Economic Projections for 2003 ket. And the adverse effects on house- An unusual degree of uncertainty hold spending from past declines in attends the economic outlook at present, equity wealth probably will begin to in large measure, but not exclusively, wane. because of potential geopolitical devel- A reduction of businesses' hesitancy opments. But Federal Reserve policy- to expand investment and hiring is makers believe the most probable out- critical to the durability of the expancome for this year to be a pickup in the sion, and such a reduction should occur pace of economic expansion. The cen- gradually if geopolitical risks ease and tral tendency of the real GDP forecasts profitability improves. Inventories are made by the members of the Board relatively lean, and some restocking of Governors and the Federal Reserve ought to help boost production this year, Bank presidents is 3lA percent to albeit to a much smaller extent than did Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook 9 Economic Projections for 2003 Percent Federal Reserve Governors and Reserve Bank presidents Indicator MEMO: 2002 actual Central Range tendency Change, fourth quarter to fourth quarter^ Nominal GDP 4.1 W2SV2 43/4-5 Real GDP 2.8 3-33/4 3!/*-3V£ PCE chain-type price index 1.9 VA-VA VA-V/2 Average level, fourth quarter Civilian unemployment rate 5.9 53/4-6 53/4-6 1. Change from average for fourth quarter of previous year to average for fourth quarter of year indicated. last year's cessation of sharp inventory Federal Reserve policymakers believe liquidations. In addition, the continued that consumer prices will increase less growth of final sales, the tax law provi- this year than in 2002, especially if sion for partial expensing of equipment energy prices partly reverse last year's purchases, replacement demand, and a sharp rise. In addition, resource utilizamore hospitable financial environment tion likely will remain sufficiently slack should induce many firms to increase to exert further downward pressure their capital spending. The growth of on underlying inflation. The central teninvestment likely will be tempered, dency of FOMC members' projections however, by the persistence of excess for increases in the chain-type price capital in some areas, notably the tele- index for personal consumption expencommunications sector, and reductions ditures (PCE) is IV4 percent to IV2 perin business spending on many types of cent this year, lower than the actual new structures may continue this year. increase of about 2 percent in 2002. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

11 Economic and Financial Developments in 2002 and Early 2003 In 2002, the United States economy cial markets and geopolitical develextended the upturn in activity that opments boosted oil prices and added began in late 2001. Real GDP increased to the uncertainty already faced by 23/4 percent over the four quarters of last businesses about the economic outlook. year, according to the advance estimate In the summer, equity prices fell, risk from the Commerce Department. How- spreads widened, and liquidity eroded in ever, the pace of activity was uneven corporate debt markets. Businesses' cauover the course of the year, as concerns tion was reflected in their reluctance to about emerging economic and political substantially boost investment, restock developments at times weighed heav- inventories, or add to payrolls. Respondily on an economy already adjusting to ing to these developments, as well a succession of shocks from previous as some weakening in demand from years. abroad, manufacturers trimmed produc- Economic conditions improved tion during the fall. Employment at prithrough the first part of the year. House- vate businesses declined again, and the hold spending on both personal con- unemployment rate rose to 6 percent in sumption items and housing remained December. However, despite the modest solid, businesses curtailed their inven- pace of last year's overall recovery, tory liquidation and began to increase output per hour in the nonfarm busitheir outlays for some types of capi- ness sector grew 33A percent over the tal equipment, and private employment year—an extraordinary increase even by started to edge higher. But the forward the standards of the past half decade or momentum diminished noticeably later so. in the year when concerns about corpo- Signals on the trajectory of the econrate governance put a damper on finan- omy as we enter 2003 remain mixed. Some of the factors that had noticeably Change in Real GDP restrained the growth of real GDP in the fourth quarter of last year—most espe- Percent, annual rate cially a sharp decline in motor vehicle production—are not on track to be repeated. Moreover, employment leveled off on average in December and lllkJi — 4 January, and readings on industrial production have had a somewhat firmer tone of late. Nevertheless, the few data in hand suggest that the economy has L__ L J.. • J I i_J not yet broken out of the pattern of 1996 1998 2000 2002 subpar performance experienced over NOTE. Here and in subsequent charts, except as noted, the past year. annual changes are measured from Q4 to Q4, and Consumer price inflation moved up a change for a half-year is measured between its final quarter and the final quarter of the preceding period. bit last year, reflecting sharply higher Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

12 89th Annual Report, 2002 Change in PCE Chain-Type Price Index often seen early in an economic recovery; in contrast to the situation in many Percent, annual rate previous cycles, spending on durable goods did not decline sharply during • Total H Excluding food and energy .-, the recession and so had less cause to rebound as the recovery got under way. Apart from outlays on durable goods, spending for most categories of consumer goods and services increased at a moderate rate last year. That moderate rate of aggregate con- 1996 1998 2000 2002 sumption growth was the product of NOTE. The data are for personal consumption various crosscurrents. On the positive expenditures (PCE). side, real disposable personal income rose nearly 6 percent last year, the energy prices. Excluding the prices of fastest increase in many years. Strong food and energy items, the price index productivity growth partially offset for personal consumption expenditures the effects of stagnant employment in increased 13A percent, about lA per- restricting the growth of household centage point less than in 2001; this income, and the phase-in of additional deceleration most likely resulted from tax reductions from the Economic continued slack in labor and product Growth and Tax Relief Reconciliation markets, robust gains in productivity, Act of 2001 boosted household purchasand somewhat lower expectations of ing power appreciably. In addition, high future inflation. levels of mortgage refinancing allowed homeowners to reduce their monthly payments, pay down more costly con- The Household Sector sumer credit, and, in many cases, extract equity that could be used to support Consumer Spending other spending. On the negative side, Consumer spending grew at a moderate household wealth again moved lower pace last year and, on the whole, contin- last year, as continued reductions in ued to be an important source of support equity values outweighed further apprefor overall demand. Personal consump- ciation of house prices. By the end of tion expenditures rose 2lA percent in real terms, near the 23A percent increase in 2001 and down from the more than Change in Real Income and Consumption 4 percent average growth over the preceding several years. Sales of new Percent, annual rate motor vehicles fell only a little from I Disposable personal income the extremely high levels of late 2001; 1 Personal consumption n outlays were especially strong during expenditures jj the summer and late in the year, when — 6 manufacturers were offering aggressive • I I I • • I price and financing incentives. Growth of spending on other durable goods was well maintained last year as well, J J J_ although the gains were smaller than is 1996 1998 2000 2002 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 13 the third quarter, according to the Fed- cent in the first months of the year, fell eral Reserve's flow-of-funds accounts, to around 6 percent by the autumn and the ratio of household net worth to dis- dipped below that level early this year— posable income had reversed nearly all the lowest in thirty-five years. Not surof its run-up since the mid-1990s. prisingly, attitudes toward homebuying, Consumer confidence, which had as measured by the Michigan SRC, declined during most of 2001 and espe- remained quite favorable. cially after the September 11 attacks, Starts of new single-family homes picked up in the first half of last year, were at 1.36 million units last year, according to both the Michigan Survey 7 percent above the already solid pace Research Center (SRC) and Conference for 2001. Sales of both new and existing Board surveys. However, confidence homes were brisk as well. Home prices retreated over the summer along with continued to rise but at a slower rate the drop in equity prices, and by early than in 2001, at least according to some this year, consumer confidence again measures. The repeat-sales price index stood close to the levels of late 2001. for existing homes rose 5Vi percent over These levels of consumer confidence, the four quarters ended in 2002:Q3, a though at the bottom of readings of the slowing from the S3A percent increase past several years, are nevertheless over the comparable year-earlier period. above levels normally associated with The constant-quality price index for new recession. homes rose 4V2 percent last year, but The personal saving rate, which has this increase was close to the average trended notably lower since the early pace over the past few years. At the 1980s, moved above 4 percent by late same time, measures of house prices last year after having averaged 2lA per- that do not control for the mix of homes cent in 2001. The saving rate has been sold rose considerably more last year buffeted during the past two years by than in 2001, a difference indicating that surges in income induced by tax cuts a larger share of transactions were in and by spikes in spending associated relatively expensive homes. with variations in motor vehicle incen- In the multifamily sector, starts avertives. But, on balance, the extent of aged a solid 345,000 units last year, the increase in the saving rate has an amount in line with that of the prebeen roughly consistent with a gradual ceding several years. However, the pace response of consumption to the reduc- of building slowed a little in the fall. tion in the ratio of household wealth to Apartment vacancy rates moved notably disposable income. higher last year and rent and property values declined; these changes suggest that the strong demand for single-family Residential Investment homes may be eroding demand for Real expenditures on residential invest- apartment space. ment increased 6 percent in 2002—the largest gain in several years. Demand Household Finance for housing was influenced by the same factors affecting household spending Households continued to borrow at a more generally, but it was especially rapid pace last year; the 9Vi percent supported by low interest rates on mort- increase in their debt outstanding was gages. Rates on thirty-year fixed-rate the largest since 1989. Low mortgage mortgages, which stood at around 7 per- interest rates helped spur both very Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

14 89th Annual Report, 2002 strong home purchases and refinanc- ment credit, and auto leases—relative to ing of existing loans, which together their incomes below previous peaks. increased home mortgage debt 11V^ per- Against this backdrop, broad measures cent. Refinancing activity was especially of household credit quality deteriorated elevated in the fourth quarter, when very little last year, and signs of finanfixed mortgage interest rates dipped cial stress were confined mainly to the to around 6 percent. Torrid refinancing subprime segment of the market. Delinactivity helps explain last year's slow- quency rates on home mortgages inched down of consumer credit, which is up, while those on auto loans at finance household borrowing not secured by real companies were flat. Delinquency rates estate: A significant number of house- on credit cards bundled into securitized holds reportedly extracted some of the asset pools remained close to those of equity from their homes at the time of recent experience. refinancing and used the proceeds to repay other debt as well as to finance The Business Sector home improvements and other expenditures. According to banks that partici- Overall business fixed investment pated in the Federal Reserve's Senior moved lower last year, although the Loan Officer Opinion Survey on Bank decline was not nearly so precipitous as Lending Practices in October, the fre- in 2001. Outlays for equipment and softquency and size of cash-out refinanc- ware edged up, but spending on strucings were substantially greater than had tures fell sharply. Financing conditions been reported in the January 2002 sur- worsened over the summer, with equity vey. Although automakers' financing prices declining, initial public offerings incentives and attractive cash rebates (IPOs) drying up, credit market spreads stimulated a substantial amount of con- widening, and banks tightening up sumer borrowing, the growth rate of somewhat on credit standards in the consumer credit in 2002, at AlA percent, wake of increased reports of corporate was more than 2Vi percentage points malfeasance. In addition, geopolitical below the pace in 2001. concerns increased firms' already Even though households took on a heightened uncertainty about the ecolarge amount of mortgage debt last year, nomic outlook. These factors contribextraordinarily low mortgage rates kept uted to an apparent deterioration in busithe servicing requirement for that debt ness confidence, and businesses still (measured as a share of homeowners' have not felt any great urgency to boost disposable income) well below its pre- investment appreciably. For similar reavious peak levels. Moreover, reflect- sons, although firms slowed their rate of ing large gains in residential real estate inventory liquidation last year, they have values, equity in homes has continued yet to undertake a sustained restocking. to increase despite sizable debt-financed extractions. The combined influence Fixed Investment of low interest rates and the sizable gain in disposable personal income also After dropping sharply in 2001, real kept the total servicing costs faced by spending on equipment and software households—which in addition to home rose 3 percent last year. Spending on mortgage payments include costs of high-technology equipment, one of the other financial obligations such as rental hardest-hit sectors in 2001, showed payments of tenants, consumer install- signs of uneven improvement. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 15 Change in Real Business Fixed Investment by rental companies weakened sharply along with the drop in air traffic that Percent, annual rate occurred after September 11 but recovered gradually over the course of last • Structures £ Equipment and software ™ year. Purchases of medium and heavy trucks fell off overall, despite the fact i i j i • n that demand for heavy (class 8) trucks — 0 was boosted by spending in advance of the implementation of more-stringent — 20 environmental regulations. Investment in equipment other than high-tech and transportation goods [H High-tech equipment moved modestly higher through most and software — 40 of last year, as real outlays for indus- • Other equipment trial machinery and a wide range of — 20 other equipment gradually strengthened through the summer. Although spending edged lower again in the fourth quarter, investment in non-high-tech, nontransportation equipment increased 3Vz per- 1996 1997 1998 1999 2000 2001 2002 cent for the year as a whole. NOTE-:. High-tech equipment consists of computers Spending on equipment and software and peripheral equipment and communications equipment. was supported last year by low interest rates, which helped hold down the clearest rebound was in computing cost of capital, as did the tax proviequipment, for which spending rose sion enacted in March 2002 that allows 25 percent in real terms; this gain fell partial expensing of new equipment short of the increases posted in the late and software purchased before Sep- 1990s but far more than reversed the tember 11, 2004. Moreover, modest previous year's decline. Software invest- increases in final sales together with ment also turned positive, rising 6 per- replacement demand no doubt spurred cent after declining about 3 percent in many firms to make new capital outlays. 2001. By contrast, real outlays for com- Nevertheless, some sectors, most notamunications equipment were reported bly telecommunications, probably still to be up only slightly in 2002 after had excess holdings of some forms plummeting 30 percent in 2001. of capital. Concerns about corporate Business spending on aircraft fell malfeasance, which had become more sharply last year. Airlines were hit espe- intense over the spring and summer, cially hard by the economic downturn weighed heavily on financial markets and by the reduction in air travel after and raised the cost of capital through the September 11 attacks; although reduced share prices and higher yields expenditures for new aircraft held up on the bonds of lower-rated firms. In through the end of 2001 because of addition, uncertainty about the geopothe very long lags involved in producing litical situation, including the possible planes, shipments of planes slowed consequences for oil prices of an outgreatly thereafter. Meanwhile, business break of war with Iraq, likely made outlays on motor vehicles edged up last many firms reluctant to commit themyear. Demand for autos and light trucks selves to new expenditures. In all, busi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

16 89th Annual Report, 2002 nesses have been, and appear to remain, over production and inventories; with quite cautious about undertaking new prospects for the strength of the recovcapital spending projects. ery having diminished in the second Real business spending for nonresi- half of the year, businesses quickly cut dential structures declined sharply for production, and inventories only edged a second year in 2002. Outlays for up in the fourth quarter, according to the construction of office buildings incomplete and preliminary data. In all, and industrial buildings were especially total inventories were about unchanged weak. Vacancy rates for such buildings last year compared with a liquidation increased throughout the year, and prop- of more than $60 billion in 2001, and erty values and rents moved lower. Con- this turnaround contributed 1 percentstruction of new hotels and motels also age point to the growth of real GDP fell considerably, reflecting the weak- over the year. At year-end, inventory-toness in the travel industry. By contrast, sales ratios in most sectors stood near spending on other commercial build- the low end of their recent ranges. ings, such as those for retail, wholesale, In the motor vehicle industry, last and warehouse space, moved only a year's very strong sales were matched little lower last year. by high levels of production, and the A number of factors likely account stock of inventories, especially for light for investment in structures having been trucks, appeared at times to be higher much weaker than investment in equip- than the industry's desired levels. Nevment. Structures depreciate very slowly, ertheless, the surge in sales late in the so businesses can defer new outlays year helped to pare stocks, and dealers without incurring much additional ended the year with inventories of light deterioration of their capital stock. And vehicles at a comfortable level. unlike investment in equipment, spending on structures is not eligible for par- Corporate Profits and tial expensing. According to some ana- Business Finance lysts, concerns about additional acts of terrorism (and, until late in the year, the The profitability of the U.S. nonfinanlack of insurance to cover such events) cial corporate sector improved from its may also have had a damping effect on lows of 2001 but relative to sector outsome types of construction, particularly put remained at the low end of the large "trophy" projects. range experienced over the past thirty years. Economic profits of nonfinancial corporations—that is, book prof- Inventory Investment its adjusted for inventory valuations The sharp inventory runoffs that charac- and capital consumption allowances— terized the economic downturn, together rebounded in late 2001 and were little with gradually rising final sales, implied changed through the third quarter of last that, by early last year, stocks were year. The sluggish expansion of aggrein much better alignment with sales than gate demand and the lack of pricing had been the case during 2001. Accord- power associated with intense competiingly, businesses lessened the pace of tive pressures were the main factors that inventory liquidation early in the year held down profits in 2002. Also playing and by summer had turned to some a role, especially in the manufacturing modest restocking. However, firms sector, were costs arising from underappeared to have exerted tight control funded defined-benefit pension plans. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 17 Reflecting the pause in economic such as bank loans and commercial growth, earnings reports for the fourth paper. Buoyed by declining yields, gross quarter indicate that profits may have issuance of below-investment-grade dropped some late in the year. bonds for the most part also held up well A dearth of expenditures on fixed during the first half, although this segcapital and moribund merger and acqui- ment of the market was hit hard after sition activity were the chief culprits revelations of corporate malfeasance, as behind the sluggish pace of nonfinan- investors shunned some of the riskiest cial corporate borrowing last year. Also issues; issuance was especially weak in important was the propensity of some the beleaguered telecom and energy secfirms to draw on liquid assets—which tors, which continue to be saddled with began the year at high levels—rather overcapacity and excessive leverage. than to seek external financing. Conse- Despite falling share prices, seasoned quently, debt of the nonfinancial corpo- equity offerings were also well mainrate sector expanded only \Vi percent, tained over the first half of the year, in a rate slower than the already subdued part because of the decision of some pace in 2001. The composition of busi- firms—especially in the telecom and ness borrowing was dominated last energy sectors—to reduce leverage. year, as it was in 2001, by longer-term IPOs, by contrast, were sparse. The sources of funds. Robust demand for evaporation of cash-financed mergers higher-quality corporate debt on the part and acquisitions and desire by firms to of investors, combined with the desire conserve cash kept equity retirements at of firms to lock in low interest rates, their slowest pace since 1994. prompted investment-grade corporations Over the summer, investors grew to issue a large volume of bonds dur- more reluctant to buy corporate bonds ing the first half of 2002. With funding because of concerns about the reliabilneeds limited, investment-grade issu- ity of financial statements, deterioraters continued to use the proceeds to ing credit quality, and historically low strengthen their balance sheets by refi- recovery rates on defaulted speculativenancing higher-coupon bonds and by grade debt. Macroeconomic data sugpaying down short-term obligations gesting that the economic recovery was Major Components of Net Business Spreads of Corporate Bond Yields over Financing the Ten-Year Treasury Yield Billions of dollars Percentage points Commercialpaper — 800 U Bonds High yield H Bank loans Sum of major — 600 components — 400 sJPn — 200 III__ Mi — 0 — 200 2000 2001 2002 2001 2002 2003 NOTE. Seasonally adjusted annual rate for nonfarm NOTE. The data are daily and extend through nonfinancial corporate business. The data for the sum of February 5, 2003. The spreads compare the yields on the major components are quarterly. The data for 2002:Q4 Merrill Lynch AA, BBB, and 175 indexes with the yield are estimated. on the ten-year off-the-run Treasury note. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

18 89th Annual Report, 2002 losing momentum and widespread com- caused a rebound in gross bond issupany warnings about near-term prof- ance, with firms continuing to use bond its pushed yields on speculative-grade proceeds to refinance long-term debt debt sharply higher. Risk spreads on and to pay down short-term debt. Rising investment-grade bonds also widened stock prices and reduced volatility also appreciably in the third quarter, as yields allowed seasoned equity issuance to in that segment of the corporate bond regain some ground in the fourth quarmarket declined less than those on Trea- ter. The improved tone in corporate debt sury securities of comparable matu- markets carried over into early 2003. rity. Investors' aversion to risk was also Gross corporate bond issuance continheightened by mounting tensions with ued at a moderate pace, and despite the Iraq; by early autumn, risk spreads on drop in stock prices in the latter half junk-rated bonds reached their high- of January, seasoned equity issuance has est levels in more than a decade. Gross been reasonably well maintained. IPO bond issuance both by investment- activity and venture capital financing, grade and below-investment-grade firms however, remained depressed. fell off markedly, and the amount of The heavy pace of bond issuance, redemptions was large. By the third sagging capital expenditures, and diminquarter, net issuance of bonds by non- ished merger and acquisition activfinancial corporations had turned nega- ity allowed firms to pay down large tive for the first time since the early amounts of both business loans at banks 1950s. Trading conditions in the corpo- and commercial paper last year. The rate bond market deteriorated during this runoff in business loans that started period, as bid-asked spreads reportedly in early 2001 intensified in the first half widened in all sectors. With share prices of 2002. At the same time, commercial dropping and stock market volatility paper issuers that were perceived as havincreasing, issuance of seasoned equity ing questionable accounting practices nearly stalled in the summer and early encountered significant investor resisautumn. IPOs were virtually nonexistent tance, and most of these issuers disconamid widely publicized investigations tinued their programs. Bond rating ageninto the IPO allocation process at large cies stepped up the pressure on firms to investment banks. substitute longer-term debt for shorter- A smattering of more upbeat news term debt and thereby reduce rollover about the economy in mid-autumn and risk. In addition, banks raised the total the absence of major revelations of cor- cost of issuing commercial paper by porate wrongdoing sparked a rally in tightening underwriting standards and equity prices and rekindled investors' boosting fees and spreads on the associappetite for corporate debt. Over the ated backup lines of credit—especially remainder of the year and during early for lower-rated issuers. In doing so, 2003, risk spreads narrowed consid- respondents to the April Senior Loan erably on investment-grade corporate Officer Opinion Survey on Bank Lendbonds—especially for the lowest rated ing Practices cited heightened concerns of these issues—and even more on about the deterioration of issuers' credit speculative-grade bonds, although they quality and a higher probability of lines remained high by historical standards. being drawn. Many commercial paper In the meantime, liquidity in the corpo- issuers either turned to longer-term rate bond market generally improved. financing or dropped out of the credit A brightening of investor sentiment markets altogether, and the volume Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 19 of nonfinancial commercial paper out- flow in the nonfinancial corporate sector standing shrank about one-fourth during last year. Even so, many firms struggled the first six months of the year after to service their debt, and corporate having dropped one-third in 2001. credit quality deteriorated markedly. The The volatility that gripped equity and trailing average default rate on corpobond markets around midyear, how- rate bonds, looking back over the preever, did not spill over to the commer- ceding twelve months, was already elecial paper market. Quality spreads in the vated and climbing when WorldCom's commercial paper market were largely $26 billion default in July propelled unaffected, in part because many of the the average rate to a record level. The riskiest issuers had already exited the amount of nonfinancial corporate debt market, while others had strengthened downgraded by Moody's Investors Sertheir cash positions and significantly vice last year was more than fourteen reduced rollover risk earlier in the year. times the amount upgraded. At less than Indeed, because of difficulties in the cor- 25 percent, the average recovery rate in porate bond market, some nonfinancial 2002 on all defaulted bonds—as meafirms turned temporarily to the commer- sured by the price of bonds at default— cial paper market to obtain financing, was at the low end of recovery rates and the volume of outstanding paper over the past decade. Delinquency rates rose in July after a lengthy period of on business loans at commercial banks declines. Over the remainder of the year, rose noticeably before stabilizing in the business loans at banks and commer- second half of the year, and charge-off cial paper outstanding contracted rap- rates remained quite high throughout idly, as inventory investment remained 2002. negligible, and firms continued to take After expanding rapidly in 2001, advantage of relatively low longer-term commercial mortgage debt grew much interest rates by issuing bonds. more slowly during the first quarter of A decline in market interest rates and last year, as business spending on nonimproved profitability helped reduce the residential structures fell. Despite the ratio of net interest payments to cash continued contraction in outlays on nonresidential structures, commercial mort- Default Rate on Outstanding Bonds Ratings Changes of Nonfinancial Corporations Upgrades 1992 1994 1996 1998 2000 2002 NOTE. The default rate is monthly and extends 1996 1998 2000 through December 2002. The rate for a given month is the face value of bonds that defaulted in the twelve NOTE. Data are at an annual rate. Debt upgrades months ending in that month divided by the face value (downgrades) are expressed as a percentage of par value of all bonds outstanding at the end of the calendar of all bonds outstanding. quarter immediately preceding the twelve-month period. SOURCE. Moody's Investors Service. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

20 89th Annual Report, 2002 gage debt accelerated over the remain- realizations and to lower tax rates that der of the year, apparently because of were enacted in the 2001 tax bill. refinancing to extract a significant por- Meanwhile, federal outlays increased tion of equity from existing properties. nearly 8 percent in fiscal 2002 and The issuance of commercial-mortgage- 11 percent excluding a decline in net backed securities (CMBS), a key source interest expenses. Spending increased of commercial real estate financing in notably in many categories, including recent years, was well maintained in defense, homeland security, Medicaid, 2002. Even as office vacancy rates rose, and income security (which includes the quality of commercial real estate the temporary extended unemployment credit remained stable last year. Com- compensation program). Federal govmercial banks firmed standards on com- ernment consumption and investment— mercial real estate loans in 2002, on net, the part of spending that is counted in and delinquency rates on commercial GDP—rose more than 7 percent in real real estate loans at banks stayed at his- terms in 2002. (Government spending torically low levels. Delinquency rates on items such as interest payments on CMBS leveled off after increasing and transfers are not counted in GDP appreciably in late 2001, and forward- because they do not constitute a direct looking indicators also do not suggest purchase of final production.) elevated concerns about prospective The turn to deficit in the unified buddefaults: Yield spreads on CMBS over get means that the federal government, swap rates remained in the fairly narrow which had been contributing to national range that has prevailed over the past saving since 1997, began to reduce several years. national saving last year. The reversal more than offset an increase in saving by households and businesses, and gross The Government Sector national saving declined to 15 percent of GDP by the third quarter of last year— Federal Government the lowest national saving rate since the Despite modest economic growth, the 1940s. federal budget position deteriorated After it reentered the credit markets sharply in 2002. After running a unified as a significant borrower of net new budget surplus of $127 billion in fiscal funds in the second half of 2001, the 2001, the federal government posted a Treasury continued to tap markets in deficit of $158 billion in fiscal 2002— volume last year. Federal net borrowing and that deficit would have been was especially brisk over the first half $23 billion larger if not for the shifting of the year. With federal debt rapidly of some corporate tax payments from approaching its statutory borrowing fiscal 2001 to fiscal 2002. After adjust- limit, the Secretary of the Treasury ment for that tax shifting, receipts declared a debt ceiling emergency on declined 9 percent in fiscal 2002: A May 16 and identified about $80 billion $50 billion drop in corporate payments worth of accounting measures that could stemmed largely from tax provisions be used to create financing room within enacted in the 2002 stimulus bill (espe- the existing $5.95 trillion limit. The Seccially the partial-expensing provision on retary's announcement and subsequent investment), and a decline in individual employment of one of these devices—in tax payments of $136 billion was largely which Treasury securities held in govattributable to a drop in capital gains ernment trust funds were temporarily Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 21 ing to the capital markets, many states Federal Government DebtHeld by the Public will be forced to boost revenues and hold the line on spending. Percentof nominal GDP Real expenditures for consumption r and gross investment by state and local governments rose less than 2 percent \ — 45 in 2002—the smallest increase in ten years. The slowdown in spending V^— 35 growth was widespread across expenditure categories and included notably — 25 smaller increases in outlays for con- 1 !! II t! II 1 struction. Employment in the state and 1962 1972 1982 1992 2002 local sector continued to rise in 2002, NOTE. Through 2001, the data lor debt are year-end but at a slower rate than in recent years. figures and the corresponding value for GDP is for Q4 Debt of the state and local governat an annual rate; the final observation is for 2002:Q3. Excludes securities held as investments of federal gov- ment sector expanded last year at the ernment accounts. fastest pace since 1987. Governments used the proceeds to finance capital replaced by Treasury IOUs not subject spending and to refund existing debt to the debt ceiling—had little effect in advance. Net issuance of short-term on Treasury yields, as market partici- municipal bonds was also well mainpants were apparently confident that tained, as California and some other the ceiling would be raised in time to states facing fiscal difficulties turned to avoid default. And indeed, the Congress shorter-term borrowing while fashionapproved legislation raising the statu- ing more permanent solutions to their tory borrowing limit to $6.4 trillion on budget problems. Worsening budget June 27. With its credit needs remaining situations contributed to some deterisubstantial, the Treasury continued to oration in municipal credit quality last borrow heavily over the second half of year. Credit-rating downgrades outpaced 2002. The increase in the Treasury's net upgrades by a significant margin, and borrowing last year caused the ratio of the yield spread of BBB-rated over publicly held debt to nominal GDP to insured AAA-rated municipal bonds rise for the first time since 1993. rose significantly over the second half of 2002. State and Local Governments The External Sector State and local governments have continued to struggle in response to slug- The U.S. current account deficit widgish growth of receipts. In the current ened again in 2002 after a brief respite fiscal year (which ends June 30 for most during the cyclical slowdown in 2001. states), most state governments are Two-thirds of the expansion of the defireported to be facing significant short- cit last year was attributable to a decline falls. Although a variety of strategies in the balance on goods and services, may be available for the purpose of although net investment income also fell technically complying with balanced- sharply as receipts from abroad declined budget requirements, including tapping more than payments to foreign invesnearly $20 billion in combined rainy- tors in the United States. The broad day and general fund balances and turn- exchange value of the dollar peaked Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

22 89th Annual Report, 2002 around February 2002 after appreciating strongest—Canada, Mexico, and several about 13 percent in real terms from developing Asian economies. A gain of January 2000; in early February 2003 it 12 percent in real exports of services was down about 5 percent from the Feb- in 2002 more than reversed the preruary 2002 level. vious year's decline and reflected both a pickup in tourism and an increase in other private services. Export prices Trade and the Current Account turned up in the second quarter after a Both exports and imports rebounded in year of decline and continued to rise at a 2002 as the cyclical downturn of the moderate pace in the second half. previous year was reversed and spend- The very rapid growth of real imports ing on travel recovered from the post- of goods in the first half of last year was September 11 slump. As is often the a reaction to the revival of U.S. activity, case, the amplitude of the recent cycle and they gained about 9 percent over in trade has been greater than that of real the year. The particularly large gains GDP. In 2001, stagnant real GDP in the in imports of consumer goods and auto- United States and abroad was coupled motive products reflected the buoywith declines of IIV2 percent in real ancy of U.S. consumption expenditures. exports and 8 percent in real imports. Imports of most major categories of Last year, moderate growth of both capital goods also increased on balforeign and domestic real GDP was ance over the year. However, as with exceeded by gains of 5 percent and exports, import growth was consider- 9 percent, respectively, in our real ably stronger in the first half of the year exports and imports. The faster growth than in the second. This pattern likely of imports relative to exports over the reflected the deceleration in U.S. GDP, past two years was consistent with the along with the effects of some deprehistorical pattern in which the respon- ciation of the dollar. In addition, there siveness of imports to income is greater may have been some shifting of import in the United States than in the rest of demand from later in the year to the the world. Although the dollar depreci- earlier months as it began to appear ated on balance last year, the lagged more likely that labor contract negoeffects of its prior appreciation over the tiations at West Coast ports would not two previous years contributed to the go smoothly.1 Imports of services more faster growth in imports relative to than reversed their 2001 decline over exports in 2002. the course of the year, and gains were Real exports of goods posted a strong recorded for both travel and other prigain in the second quarter of 2002 after vate services. Prices of non-oil imports six consecutive quarters of decline. turned up in the second quarter after However, as output growth slowed declining over the preceding four quarabroad, exports decelerated in the third quarter and then fell in the fourth 1. The dispute between the Pacific Maritime quarter. On balance, exports of goods Association and the International Longshore and rose about 2 percent over the course Warehouse Union eventually led to an eleven-day of the year, reversing only a small port closure in late September and early October portion of the previous year's decline. that ended when President Bush invoked the Taft- Not surprisingly, the increase in goods Hartley Act. Although the monthly pattern of trade was influenced by the closure, the overall level of exports in 2002 was concentrated in the imports for the year does not appear to have been destinations where GDP growth was much affected. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 23 ters, as a result of the weaker exchange from equities and toward Treasury securate and a turnaround in prices of inter- rities. This shift may have reflected the nationally traded commodities. damping of equity demand caused by The spot price of West Texas interme- slower economic growth and continued diate crude oil climbed above $35 per concern about corporate governance and barrel in early 2003, its highest level accounting. Over the same period, pursince the beginning of 2000. Oil prices chases by private U.S. investors of forhad fallen to around $20 per barrel dur- eign securities declined nearly $100 biling 2001 amid general economic weak- lion. Accordingly, the net balance of ness, but they began rising in Febru- private securities trading recorded a ary and March of last year in response sharp increase in net inflows. to both improving global economic ac- In contrast, net foreign direct investtivity as well as a production-limiting ment inflows fell about $70 billion agreement between OPEC and several between 2001 and 2002. Foreign investmajor non-OPEC producers. Even ment in the United States and investthough production in a number of OPEC ment abroad by U.S. residents both and non-OPEC countries in fact declined, but the decline in flows into exceeded the agreed limits last year, the United States was considerably heightened tensions in the Middle East larger, as merger activity slowed and along with severe political turmoil in corporate profits showed little vigor. Venezuela continued to put upward U.S. direct investment abroad held up pressure on prices. The pressure inten- fairly well in 2002, a result largely sified late in the year as a strike in reflecting retained earnings. Venezuela that began on December 2 virtually shut down that country's oil industry, and Venezuelan oil production The Labor Market was still well below pre-strike levels in early 2003. Concern over a possible war Employment and Unemployment with Iraq, along with a very low level of crude oil inventories in the United Labor markets appeared to stabilize last States, has helped to keep spot prices spring after the sharp deterioration of high. Also in response to the heightened 2001 and early 2002. Employment on tensions, the price of gold shot up about private payrolls, which had declined an 30 percent over the past year. average of 160,000 per month in 2001, leveled off in the spring and moved slightly higher over the summer. But The Financial Account labor demand weakened again as the The increase in the current account defi- economy softened later in the summer, cit in 2002 was about equal on balance and private employment declined about to the stepped-up foreign official pur- 80,000 per month on average in the last chases of U.S. assets, as changes in four months of the year. Private paythe components of private capital flows rolls rebounded nearly 150,000 in Januwere offsetting. Private foreign pur- ary, though the magnitude of both the chases of U.S. securities were about especially sharp decline in December $360 billion at an annual rate through and the rebound in January likely was November, a volume similar to last exaggerated by difficulties in adjusting year's total. However, there was some for the normal seasonal movements in shift in the composition of flows away employment during these months. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

24 89th Annual Report, 2002 The manufacturing sector continued Measures of Labor Utilization to be the weakest segment of the labor market; even during the spring and early summer, when the overall labor market seemed to be improving, factory payrolls contracted on average. Declines in factory employment were more pronounced—at about 50,000 per month—toward the end of the year. Employment at help-supply firms and in wholesale trade—two sectors in which liJxMJ_LLU_LLU.ilillilLL] LJ activity closely tracks that of manufac- 1973 1983 1993 2003 turing proper—rose over the summer NOTE. The data extend through January 2003. The civilian rate is the number of civilian unemployed but also turned down again later in the divided by the civilian labor force. The augmented rate year. And employment in retail trade, adds to the numerator and the denominator of the though quite erratic, leveled off over the civilian rate the number of those who are not in the labor force but want a job. The small break in the augmented summer before declining further in the rate in January 1994 arises from the introduction of a fall. However, employment in services redesigned survey. For the civilian rate, the data are monthly; for the augmented rate, the data are quarterly other than help supply grew reasonably through December 1993 and monthly thereafter. steadily throughout the year and rose nearly 50,000 per month after March; health services and education services fits have expired to be more selective in contributed more than half of those job accepting job offers and provides them gains. The finance and real estate sec- with an incentive not to withdraw from tors also added jobs last year, probably the labor force. In addition, as would be because of the surge in mortgage refi- expected in a still-weak labor market, nancings and high levels of activity in the labor force participation rate moved housing markets. Last year's job losses lower last year. in the private sector were partially offset by an increase in government employ- Productivity and Labor Costs ment that averaged about 20,000 per month; the increase resulted mostly Labor productivity rose impressively in from hiring by states and munici- 2002. Output per hour in the nonfarm palities, but it also reflected hiring in business sector increased an estimated the fall by the Transportation Security Administration. Change in Output Per Hour Overall employment moved lower, on net, and the unemployment rate Percent, annual rate increased a little less than Vz percentage point over the year, to 6 percent, before dropping back to 5.7 percent in Janu- - 6 ary 2003. The unemployment rate probably has been boosted slightly by ll -•••••• III ! the federal temporary extended unemployment compensation program. By extending benefits for an additional _L_... J. 1. . .-L..1. : . three months, the program allows unem- 1992 1994 1996 1998 2000 2002 ployed individuals whose regular bene- NOTE. Nonfarm business sector. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 25 33/4 percent from the fourth quarter component of the ECI both posted of 2001 to the fourth quarter of 2002. smaller increases last year. The decele- Labor productivity typically suffers in ration was less pronounced for the an economic downturn as businesses benefits component, however, which reduce hours worked by proportionally was boosted by further large increases less than the decline in output; con- in employers' health insurance costs. versely, productivity typically rebounds According to the ECI, health insurance early in an expansion as labor is brought costs, which constitute about 6 percent back toward fuller utilization. During of overall compensation, rose 10 percent the most recent downturn, however, last year after having risen about 9 perproductivity held up comparatively well, cent in each of the preceding two years. a performance that makes last year's An alternative measure of compensurge all the more impressive. Indeed, sation costs is compensation per hour productivity rose at an average annual in the nonfarm business sector, which is rate of nearly 3 percent over the past derived from information in the national two years, faster than the average pace income and product accounts. Accordof increase during the late 1990s. ing to this measure, hourly compensa- Very likely, the rapid pace of last tion rose 4V4 percent last year—a little year's productivity growth was due more than the increase in the ECI and up in part to the special circumstances from a much smaller increase in 2001. that developed after the September 11 One important difference between these attacks. Businesses cut labor substan- two measures of compensation is that tially in late 2001 and early 2002 amid the ECI omits stock options, while nonwidespread fear of a sharp decline in farm compensation per hour captures demand; when demand held up better the value of these options upon exercise. than expected, businesses proved able to The very small increase in the latter operate satisfactorily with their existing measure in 2001 likely reflects, in part, workforces. Moreover, the fact that this a drop in option exercises in that year, step-up in productivity was not reversed and the larger increase in 2002 may later in the year suggests that at least a point to a firming, or at least to a smaller portion of it is sustainable. The recent rate of decline, of these exercises. rapid growth in productivity may derive in part from ongoing improvements Prices in the use of the vast amount of capital installed in earlier years, and it may also The chain-type price index for personal stem from organizational innovations consumption expenditures (PCE) rose induced by the weak profit environment. about 2 percent last year, compared with Indicators of hourly compensation an increase of Wi percent in 2001. This sent mixed signals last year. The rise step-up in consumer price inflation in the employment cost index (ECI) for resulted from a jump in energy prices. hourly compensation in private nonfarm Outside of the energy sector, consumer businesses, 3VA percent, was 1 percent- price inflation was pushed lower last age point lower than the increase in year by continued slack in labor and 2001. Compensation increases likely product markets as well as by expectawere damped last year by the soft labor tions of future inflation that appeared to market and expectations of lower con- be lower in 2002 than in most of 2001. sumer price inflation. The wages and The increase in PCE prices excluding salaries component and the benefits food and energy, which was just 13A per- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

26 89th Annual Report, 2002 Alternative Measures of Price Change The PCE price index for food and Percent beverages increased only Wi percent last year; the increase followed a 3 per- Price measure 2001 2002 cent rise in 2001 that reflected supplyrelated price increases for many live- Chain-type stock products including beef, poultry, Gross domestic product 2.0 1.3 Gross domestic purchases 1.3 1.6 and dairy products. But livestock sup- Personal consumption expenditures 1.5 1.9 plies had recovered by early last year, Excluding food and energy ... 1.9 1.7 and a drought-induced selloff of cattle Chained CPI 1.2 1.9 Excluding food and energy ... 1.8 1.6 herds last summer pushed prices still lower. Fixed-weight Consumer price index 1.9 2.3 The prices of goods other than food Excluding food and energy ... 2.7 2.1 and energy items decelerated sharply last year. Prices for apparel, new and NOTE. Changes are based on quarterly averages and are measured to the fourth quarter of the year indicated used motor vehicles, and a wide range from the fourth quarter of the preceding year. of other durable goods all declined cent, was about lA percentage point less noticeably and, on average, at a faster than in 2001. The price index for GDP pace than in 2001. Price increases was less affected by last year's rise in for services were much larger than for energy prices than was the PCE mea- goods and slowed less from the presure; much of the energy price increase vious year. Both tenants' rent and was attributable to higher prices of the imputed rent of owner-occupied imported oil, which are not included housing—categories that account for a in GDP because they are not part sizable share of services—rose signifiof domestic production. On net, GDP cantly less last year than they did in prices rose only \lA percent last year, 2001. But many other services prices a deceleration of 3A percentage point posted increases in 2002 that were about that reflected not just the deceleration the same as in 2001. Information on in core consumer prices but also con- medical prices was mixed. According to siderably smaller increases for prices of the CPI, the price of medical services construction. continued to accelerate, rising 5l/i per- The upturn in consumer energy prices cent last year. But the increase in in 2002 was driven by a jump in crude the PCE measure of medical services oil prices. Gasoline prices increased prices was less than 3 percent, a smaller some 25 percent from December 2001 increase than in 2001. One reason for to December 2002; prices of fuel oil this difference is that the prices of serincreased considerably as well. By con- vices paid for by Medicare and Meditrast, consumer prices of natural gas caid are included in the PCE index but posted only a modest rise after declining not in the CPI (because services prosharply in 2001, and electricity prices vided by Medicare and Medicaid do not moved lower. More recently, the rise represent out-of-pocket costs to conin crude oil prices since mid-December, sumers and so are outside of the CPFs together with cold weather, has scope), and Medicare reimbursement increased the demand for natural gas rates for physicians were reduced last and has led to higher spot gas prices; year. the higher spot prices for both oil and Despite the acceleration in medical gas are likely to be boosting consumer prices in the CPI but not in the PCE energy prices early this year. price index, the CPI excluding food and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 27 energy decelerated notably more than 23/4 percent during 2002, a rate a little did the core PCE price index between lower than the 3 percent inflation expec- 2001 and 2002. The two price measures tations that had prevailed through most differ in a number of respects, but much of 2001. of last year's greater deceleration in the CPI can be traced to the fact that the U.S. Financial Markets CPI suffers from a form of "substitution bias" that is not present in the PCE Developments in financial markets last index. The CPI, being a fixed-weight year were shaped importantly by sharp price index, overstates increases in the declines, on net, in equity prices and cost of living because it does not ade- most long-term interest rates and by quately take into account the fact that periods of heightened market volatility. consumers tend to substitute away from In contrast to 2001, when the Federal goods that are rising in relative price; by Reserve eased the stance of monetary contrast, the PCE price index does a policy eleven times, last year saw one better job of taking this substitution into reduction in the intended federal funds account. Last year, the Bureau of Labor rate—in early November—and interest Statistics began to publish a new index rates on short-term Treasury securities called the chained CPI; like the PCE had moved little until then. Longer-term price index, the chained CPI does a interest rates, by contrast, were more more complete job of taking consumer volatile. Investors' optimism about substitution into account, but it is other- future economic prospects pressured wise identical to the official CPI. In longer-term Treasury bond yields higher 2001, an unusually large gap between early in 2002. But as the year proincreases in the official CPI and the gressed, that optimism faded when chained CPI arose, pointing to very the economy failed to gather much large substitution bias in the official CPI momentum, and longer-term Treasury in that year. This gap narrowed in 2002, yields ended the year appreciably lower. indicating that substitution bias declined Softer-than-expected readings of the between the two years. (Final estimates economic expansion, a marked deterioof the chained CPI are not yet available; ration in corporate credit quality, conthe currently available data for both cerns about corporate governance, and 2001 and 2002 are preliminary and sub- heightened geopolitical tensions made ject to revision.) investors especially wary about risk. Survey measures of expected infla- Lower-rated firms found credit substantion generally ran a little lower in 2002 tially more expensive, as risk spreads on than in 2001. According to the Michigan speculative-grade debt soared for most SRC, median one-year inflation expecta- of the year before narrowing somewhat tions plummeted after the September 11 over the last few months. Even for attacks, but by early 2002, expecta- higher-quality firms, risk spreads widtions returned to the 23A percent range ened temporarily during the tumultuous that had prevailed during the previous conditions that prevailed in financial summer. These expectations gradually markets over the summer. In addition, moved lower over the course of last commercial banks tightened standards year and now stand around 2Vi per- and terms for business borrowers, on cent. Meanwhile, the Michigan SRC's net, in 2002, and risk spreads on busimeasure of five- to ten-year inflation ness loans remained in an elevated range expectations remained steady at about throughout the year. Increased caution Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

28 89th Annual Report, 2002 on the part of investors was particularly as much as Wi percentage points, on acute in the commercial paper market, net, in 2002. Longer-term interest rates where the riskiest issuers discontinued began last year under upward pressure, their programs. as signs that the economy had bottomed Federal borrowing surged last year, out started to nudge rates higher in the while private borrowing was held down final weeks of 2001. Positive economic by the significantly reduced credit needs news pushed interest rates up appreof business borrowers. Declines in ciably further during the first quarter of longer-term interest rates during the 2002. The increase in longer-term interfirst half of the year created incentives est rates was consistent with the sharp for both businesses and households to upward tilt of money market futures lock in lower debt-service obligations rates, which suggested that market parby heavily tapping corporate bond and ticipants expected that the FOMC would home mortgage markets, respectively. almost double the intended level of the While mortgage borrowing remained funds rate by year's end. However, as strong, businesses sharply curtailed their readings on the strength of the economic issuance of longer-term debt during the expansion came in on the soft side, second half of 2002 amid the nervous- investors substantially trimmed their ness then prevailing in the financial expectations for policy tightening, and markets. yields on longer-term Treasury securities turned down in the spring. The slide in longer-term Treasury Interest Rates yields intensified over the summer amid Reflecting an unchanged stance of weaker-than-expected economic data, monetary policy over most of last year, heightened geopolitical tensions, fresh short-term market interest rates moved revelations of corporate malfeasance, little until early November, when the and disappointing news about near-term FOMC lowered the target federal funds corporate profits. In concert, these rate Vi percentage point, and other short- developments prompted investors to term interest rates followed suit. Yields mark down their expectations for ecoon intermediate- and long-term Trea- nomic growth and, consequently, their sury securities, by contrast, declined anticipated path for monetary policy. A widespread retrenchment in risk-taking sent yields on speculative-grade corpo- Interest Rates on Selected Treasury rate bonds sharply higher and kept those Securities on the lower rungs of investment grade from declining, even as longer-term Percrent nominal Treasury yields fell to very low - 7 levels by the end of July. — Ten-year 6 The uneventful passing of the Secu- —fj^/^v 5 rities and Exchange Commission's 1 \VJW* — 4 August 14 deadline for officers of large Two-year 3 companies to certify corporate financial statements somewhat assuaged inves- - Three-month 1 tors' anxieties about corporate gover- :oo2 2003 nance problems. But subsequent news suggesting that the economy was los- NOTE. The data are daily and extend through ing momentum and a flare-up in ten- February 5, 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 29 sions with Iraq further boosted demand ened bid-asked spreads in the corporate for Treasury securities. The FOMC's bond market enough to impair traddecision at the August meeting—to ing. Risk spreads on speculative-grade leave the intended federal funds rate bonds narrowed considerably over the unchanged but to judge the balance year's final quarter and in early 2003, of risks to the outlook as weighted though they remain elevated by histoward economic weakness—pulled the torical standards; risk spreads for the expected path of the funds rate lower, weaker speculative-grade credits remain and longer-term Treasury yields sank to exceptionally wide, as investors eviforty-year lows in early autumn. A high dently anticipate a continued high level degree of investor uncertainty about the of defaults and low recovery rates. future path of monetary policy was evidenced by implied volatilities of short- Equity Markets term interest rates derived from option prices, which soared to record levels in Equity prices were buffeted last year by early autumn. The size of the FOMC's considerable fluctuations in investors' November cut in the target federal funds assessments of the outlook for the rate and the shift to balance in its assess- economy and corporate earnings and ment of risks surprised market partici- by doubts about the quality and transpants, but the policy easing appeared to parency of corporate balance sheets. lead investors to raise the odds that the Net declines in stock prices in 2002 economy would pick up from its slug- exceeded those posted during either of gish pace. Generally positive economic the preceding two years. Worries about news and rising equity prices over the the pervasiveness of questionable corporemainder of the year also bolstered con- rate governance and a deterioration in fidence and prompted market partici- the earnings outlook—especially in the pants to mark up the expected path for technology sector—depressed equity monetary policy and push up longer- prices in early 2002. The positive tenor term Treasury yields. of economic data, however, managed Yields on higher-quality investment- to outweigh those concerns, and stock grade corporate bonds generally tracked prices staged a rally halfway through the those on Treasuries of comparable matu- first quarter, with the gains tilted toward rity last year, although risk spreads on "old economy" firms. But the rebound these instruments widened moderately over the summer and early autumn Major Stock Price Indexes before narrowing over the remainder of the year. Interest rates on below- Januan 2. 2001 = 100 investment-grade corporate debt, by contrast, increased for much of last year, — 125 as spreads over Treasuries ballooned in ^Nasdaq response to mounting concerns about Wilshire5000 — 100 corporate credit quality, historically low - 75 recovery rates on defaulted bonds, and revelations of improper corporate gover- S&P 500 — 50 nance; credit risk spreads widened in all speculative sectors but especially in tele- 2001 2002 2003 com and energy. By the summer, inves- NOTE. The data are daily and extend through tors' retreat from risk-taking had wid- February 5, 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

30 89th Annual Report, 2002 was short lived. Share prices started to Implied S&P 100 Volatility tumble in early spring across all sectors as weaker-than-expected economic data eroded investors' confidence in the strength of the economic expansion. — 50 These developments were reinforced by — 40 first-quarter corporate earnings reports — 30 that, though mostly matching or exceed- — 20 ing investors' expectations, painted a bleak picture of prospective sales and — 10 profits. i 1 i i i 1 i i I 1 i i i I i i i Over the spring and summer, account- 1997 1999 2001 2003 ing scandals, widespread warnings NOTE. The data are daily and extend through February 5, 2003. The series shown is the implied about near-term corporate profitability, volatility of the S&P 100 stock price index as calculated and heightened geopolitical tensions from the prices of options that expire over the next intensified the slide in stock prices. Par- several months. SOURCE. Chicago Board Options Exchange. ticularly large declines in share prices were posted for technology firms, whose prospects for sales and earnings were of economic data. Greater confidence especially gloomy. Equity prices were among investors in the economic outboosted briefly by the uneventful pass- look also helped bring down the implied ing of the August 14 deadline to certify volatility on the S&P 100 significantly financial statements, but they quickly by year-end, although it remains at reversed course on continued concerns an elevated level by historical standards. about the pace of economic growth and Despite the fourth-quarter rebound, corporate earnings and the escalat- broad equity indexes were down, on net, ing possibility of military action against about 20percent in 2002, while the tech- Iraq. By early October, equity indexes heavy Nasdaq lost more than 30 percent. sank to their lowest levels since the The decline in equity prices durspring of 1997, and implied stock price ing the first three quarters of 2002 is volatility on the S&P 100 surged to its estimated to have erased more than highest reading since the stock market $31/2 trillion in household wealth, a loss crash of 1987. The drop in stock prices of nearly 9 percent of total household widened the gap between the expected net worth, although the fourth-quarter year-ahead earnings-price ratio for the rise in stock prices restored about S&P 500 and the real ten-year Treasury $600 billion. Still, the level of houseyield—one simple measure of the equity hold net worth at the end of last year premium—to levels not seen since the was more than 40 percent higher than it mid-1990s. was at the start of the bull market in Share prices turned around in late 1995. Equity prices maintained their October, as the third-quarter corporate upward momentum during the first half earnings reports were not as weak as of January 2003 but then fell sharply investors had originally feared. Equity amid the looming prospects of military prices were also given a boost in early action against Iraq and a still-gloomy November by the larger-than-expected outlook for corporate earnings. Broad monetary policy easing, and the rally stock price indexes have lost almost was sustained over the remainder of the 5 percent this year; however, solid year by the generally encouraging tone fourth-quarter earnings from many Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 31 prominent technology companies helped pickup was driven by large acquisibrighten investors' sentiment regarding tions of securities, especially mortgagethat sector, and the Nasdaq is down backed securities, as well as a surge in about 3 percent this year. home equity and residential real estate lending. By contrast, business lending at com- Debt and Financial Intermediation mercial banks dropped 7 percent last A deceleration of business borrowing year after falling almost 4 percent in slowed growth of the debt of nonfed- 2001; last year's decline kept overall eral sectors about 1 percentage point in loan growth for 2002 to about 5 percent. 2002, to 6x/2 percent. By contrast, the In the October Senior Loan Officer decline in interest rates last year kept Opinion Survey on Bank Lending Pracborrowing by households and state and tices, respondents noted that the decline local governments brisk. At the federal in commercial and industrial (C&I) level, weak tax receipts and an accelera- lending since the beginning of the year tion in spending pushed debt growth to reflected not only the limited funding IVi percent last year after a slight con- needs of creditworthy borrowers that traction in 2001. found bond financing or a runoff of For the year as a whole, corporate liquid assets more attractive, but also a borrowing was quite weak, mainly reduction in the pool of creditworthy because of sagging capital expenditures, borrowers. Over the course of last year, a drying up of merger and acquisition banks reported some additional net activity, and a reliance on liquid assets. tightening of standards and terms on Although businesses tapped bond mar- C&I loans, mainly in response to greater kets in volume over the first half of the uncertainty about the economic outlook year, subsequent concerns about the and rising corporate bond defaults, reliability of financial statements and although the proportions of banks that the quality of corporate governance and reported doing so declined noticeably. deteriorating credit worthiness ruined Direct measures of loan pricing condiinvestors' appetite for corporate debt in tions from the Federal Reserve's quarthe summer and early autumn. House- terly Survey of Terms of Business Lendholds, by contrast, flocked to the mort- ing also indicated that banks were gage markets to take advantage of low cautious lenders last year, as the average mortgage rates throughout the year, and spread of C&I loan rates over market strong motor vehicle sales supported interest rates on instruments of comthe expansion of consumer credit. For parable maturity remained wide, and depository institutions, the net effect of spreads on new higher-risk loans these developments was an accelera- declined only slightly from the lofty levtion of credit to 6V2 percent last year, els that prevailed over the first half of 2 percentage points above the pace the year. Although bank lenders were of 2001. The growth of credit at thrift wary about business borrowers, espeinstitutions moderated, though the slow- cially toward lower-rated credits, they down can be attributed for the most did not significantly constrict the supply part to a large thrift institution's conver- of loans: Most small firms surveyed by sion to a bank charter. The growth of the National Federation of Independent credit at commercial banks accelerated Businesses in 2002 reported that they to 63/4 percent—a significant increase experienced little or no difficulty satisfyfrom the anemic pace in 2001; the ing their borrowing needs. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

32 89th Annual Report, 2002 Loan quality at commercial banks deterioration in corporate credit quality. improved overall last year. Loan delin- However, these negative pressures were quency rates edged down through the offset somewhat by the continued strong third quarter of 2002—the latest growth of insurance premiums, and both period for which Call Report data are sectors of the insurance industry stayed available—in response to better perfor- fairly well capitalized in 2002. mance of residential real estate and consumer loans and a stable delinquency Monetary Aggregates rate on C&I loans. Despite the improvement in consumer loan quality, domestic The broad monetary aggregates decelerbanks imposed somewhat more strin- ated noticeably last year after surging in gent credit conditions when lending 2001. Short-term market interest rates, to households, according to the survey which had declined swiftly during 2001, on bank lending practices. Moderate net were stable over the first half of the proportions of surveyed institutions year; deposit rates, in a typical pattern tightened credit standards and terms for of lagged adjustment, continued to fall. credit card and other consumer loans Consequently, the opportunity cost of throughout last year. The net fraction of holding M2 assets increased, especially banks that tightened standards on resi- for its liquid deposit (checking and savdential mortgage loans rose late in the ings accounts) and retail money fund year to the highest share in the past components, thereby restraining the decade, but nonetheless remained quite demand for such assets. After decelelow. Commercial banks generally reg- rating in the first half of the year, M2 istered strong profit gains last year, rebounded significantly in the second although steep losses on loans to energy half, because of a surge in liquid deposand telecommunications firms signifi- its and retail money market mutual cantly depressed profits at several large funds. The strength in both components bank holding companies. Despite the partly reflected elevated volatility in increased rate of provisioning for loan equity markets against the backdrop of losses, the banking sector's profitability a still-low opportunity cost of holding stayed in the elevated range recorded such deposits. In addition, another wave for the past several years, as a result of the robust fee income from mortgage M2 Growth Rate and credit card lending, effective cost controls, and the relatively inexpen- Percent, annual rate sive funding offered by inflows of core deposits. As of the third quarter of last — 10 year, virtually all assets in the banking 11 sector were at well-capitalized insti- — 6 tutions, and the substitution of securities for loans on banks' balance sheets — 4 helped edge up risk-based capital ratios. The financial condition of insurance companies, by contrast, worsened nota- 1990 1994 1998 2002 bly last year. Both property and casualty NOTE. M2 consists of currency, travelers checks, insurers and life and health insurers demand deposits, other checkable deposits, savings sustained significant investment losses deposits (including money market deposit accounts), small-denomination time deposits, and balances in retail from the decline in equity prices and the money market funds. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 33 of mortgage refinancing boosted M2 since the late 1960s had usually been set growth during this period. (Refinanc- below market interest rates. The subings cause prepayments to accumu- sidy required Federal Reserve Banks to late temporarily in deposit accounts administer credit extensions heavily in before being distributed to investors order to ensure that borrowing instituin mortgage-backed securities.) All tions used credit only in appropriate told, over the four quarters of the year, circumstances—specifically, when they M2 increased 7 percent, a pace that had exhausted other reasonably availexceeded the expansion of nominal able funding sources. That administraincome. As a result, M2 velocity—the tion was necessarily somewhat subjecratio of nominal GDP to M2—declined tive and consequently difficult to apply for the fifth year in a row, roughly in consistently across Reserve Banks. In line with the drop in the opportunity addition, the heavy administration was cost of M2 over this period. one factor that caused depository insti- Reflecting in part the slowing of tutions to become reluctant to use the its M2 component, M3—the broadest window even in appropriate conditions. money aggregate—expanded 6V2 per- Also, depository institutions were concent in 2002, a pace well below the cerned at times about being marked with 123/4 percent advance posted in 2001. a "stigma" if market analysts and coun- Growth in M3 was also held down terparties inferred that the institution by a sharp deceleration of institutional was borrowing from the window and money funds, as their yields dropped to suspected that the borrowing signaled close alignment with short-term market that the institution was having financial interest rates. This effect was only partly difficulties. The resulting reluctance to offset by the pickup in needs to fund use the window reduced its usefulness bank credit, which resulted in an accele- in buffering shocks to the reserve marration in the issuance of managed lia- ket and in serving as a backup source bilities, including large time deposits. of liquidity to depository institutions, M3 velocity continued to decline in and thus undermined its performance as 2002. a monetary policy tool. To address these issues, the Board of Governors specified that primary credit New Discount Window Programs may be made available at an above- On October 31, 2002, following a three- market interest rate to depository instimonth public comment period, the tutions in generally sound financial con- Board of Governors approved changes dition. The above-market interest rate to its Regulation A that established eliminates the implicit subsidy. Also, two new types of loans to depository restricting eligibility for the program institutions—primary and secondary to generally sound institutions should credit—and discontinued the adjustment reduce institutions' concerns that their and extended credit programs. The new borrowing could signal financial programs were implemented on Janu- weakness. ary 9, 2003. The seasonal credit pro- The Federal Reserve set the initial gram was not altered. primary credit rate at 2.25 percent, The primary reason for adopting the 100 basis points above the FOMC's tarnew programs was to eliminate the sub- get federal funds rate as of January 9, sidy to borrowing institutions that was 2003. The target federal funds rate implicit in the basic discount rate, which remained unchanged, and thus the adop- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

34 89th Annual Report, 2002 tion of the new programs did not repre- rapid pace of recovery slowed in develsent a change in the stance of monetary oping Asia and in Canada, while perforpolicy. In the future, the primary credit mance remained lackluster in much of rate will be adjusted from time to time the rest of the world. as appropriate, using the same discre- Monetary policy actions abroad also tionary procedure that was used in the diverged across countries in 2002 as past to set the adjustment credit rate. authorities reacted to differing economic The Federal Reserve also established conditions. In Canada, official interest procedures to reduce the primary credit rates were raised in three steps by July rate to the target federal funds rate in a amid concerns that buoyant domestic national emergency, even if key policy- demand and sharply rising employmakers are unavailable. ment would ignite inflationary pres- Institutions that do not qualify for sures. Monetary authorities in Australia primary credit may obtain secondary and Sweden also increased policy rates credit when the borrowing is consistent in the first half of the year. However, as with a prompt return to market sources economic conditions weakened around of funds or is necessary to resolve severe the world in the second half, official financial difficulties. The interest rate interest rates were held constant in Canon secondary credit is set by for- ada and Australia and were lowered mula 50 basis points above the pri- in Sweden. Monetary policy was held mary credit rate. The rate was set steady throughout 2002 in the United initially at 2.75 percent. Because sec- Kingdom, where growth was moderate ondary credit borrowers are not in and inflation subdued, but official intersound financial condition, extensions of est rates were lowered 25 basis points, secondary credit usually involve some to 3.75 percent, in early February 2003 administration. in response to concerns about the prospects for global and domestic demand. The European Central Bank (ECB) held International Developments rates constant through most of the year, The international economy rebounded as inflation remained above the ECB's in 2002 after a stagnant performance in 2 percent target ceiling, but rates were 2001, but recovery was uneven in both lowered 50 basis points in December as timing and geographical distribution. the euro area's already weak recovery Growth abroad picked up sharply in the appeared to be stalling. Japanese shortfirst half of last year, as a strong rally term interest rates remained near zero, in the high-tech exporting economies in while authorities took some limited furdeveloping Asia was joined by robust ther steps to stimulate demand through growth in Canada and, to a lesser extent, nontraditional channels. Monetary pol- Mexico. Japan also posted respectable icy was tightened in both Mexico and growth in the first half, largely as a Brazil in response to concerns about result of a surge of exports. However, the inflationary effects of past currency performance in the euro area remained depreciation. sluggish, and several South American Yield curves in the major foreign economies experienced difficulties, with industrial countries steepened and full-fledged crises in Argentina and shifted up in the first quarter of 2002 Venezuela and mounting concerns about in response to generally favorable ecoprospects for Brazil. As the U.S. econ- nomic news, but later they flattened out omy decelerated in the second half, the and moved back down as the outlook Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 35 Equity Indexes in Selected mies; equity prices began to decline Foreign Industrial Countries around midyear as global demand softened but posted modest rebounds late in Week ending January 5, 2001 = 100 the year. The foreign exchange value of the dollar continued its mild upward trend — 100 into the early part of 2002, as it appeared that the United States was poised to lead a global economic recovery. However, Euro area the dollar weakened sharply in the late United Kingdom \/w "r spring and early summer amid deepening concerns about U.S. corporate 2001 2002 2003 governance and profitability. Around NOTH. The data are weekly. The last observations are that time market analysts also appeared the average of trading days through February 5, 2003. to become more worried about the growing U.S. current account deficit and deteriorated. Similarly, equity prices in its potential negative influence on the the major foreign industrial economies future value of the dollar. The dollar held up well early in the year but then rebounded somewhat around midyear as declined along with the U.S. stock mar- growth prospects for other major econket and ended the year down sharply omies, particularly in the euro area, from the previous year. The perfor- appeared to dim; the dollar dropped mance of the stock markets in the back again late in the year, as geopolitiemerging-market economies was mixed. cal tensions intensified, and continued Share prices in Brazil and Mexico fell to depreciate in early 2003. In nominal sharply in the second and third quarters terms the dollar has declined about but then showed some improvement 5 percent on balance over the past year, toward the end of the year. In the Asian with depreciations against the currenemerging-market economies, equity cies of the major industrial countries prices rose in the first half of 2002 on and several of the developing Asian a general wave of optimism, especially economies partly offset by appreciation in the high-technology producing econo- against the currencies of several Latin American countries. Equity Indexes in Selected Emerging Markets Industrial Economies The Canadian economy recorded the Week ending January5.2001= 100 strongest performance among the major Developing Asia foreign industrial countries last year A .Mexico j.1 \ 120 k r^s r\ \ A/ despite some slowing in the second half. 100 The strength, which was largely homegrown, reflected robust growth of con- 80 sumption and residential construction A 60 as well as an end to inventory runoffs Argentina . V/ early in the year. The expansion was 2001 2002 Brazil accompanied by very rapid increases in employment and utilization of capacity, NOTE. The data are weekly. The last observations are the average of trading days through Februa2ry0 053, 2003. and the core inflation rate breached the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

36 89th Annual Report, 2002 upper end of the government's 1 percent announced in the fall, but the details to 3 percent target range near the end of of this plan are still not fully specified. the year. The Canadian dollar appreci- In September, the Bank of Japan ated against the U.S. dollar in the first announced a plan to buy shares from half of the year, but it dropped back banks with excessive holdings of equity, somewhat in the second half as the which would help to reduce bank economy slowed; by the end of the year exposure to stock market fluctuations. it was up only slightly on balance. The Because the transactions are to occur at Canadian dollar has moved up some- market prices, there would be no net what more so far this year. financial transfer to the banks. Near the The Japanese economy recorded posi- end of last year the Bank of Japan (BOJ) tive growth during 2002, although it was raised its target range for bank reserves not enough to fully reverse the decline at the BOJ from ¥10-15 trillion to in output that occurred in 2001. Despite ¥15-20 trillion, increased the monthly about 10 percent appreciation of the yen amount of its outright purchases of longagainst the dollar in 2002, Japanese term government bonds, and broadgrowth was driven largely by exports, ened the range of collateral that can be with smaller contributions from both used for market operations. In Decemincreased consumption and a slower ber the monetary base was up about pace of inventory reduction. In contrast, 20 percent from a year earlier, a rise private investment continued to decline, partially reflecting the increased level although not as sharply as in 2001. of bank reserves at the BOJ. However, Labor market conditions remained quite the twelve-month rate of base money depressed, and consumer prices contin- growth was considerably below the ued to fall. Little progress was made on 36 percent pace registered in April. the serious structural problems that have Broad money growth remains subdued. plagued the Japanese economy, includ- Economic performance in the euro ing the massive and growing amount area was quite sluggish last year. of bad loans on the books of Japanese Although exports were up sharply, banks. A new set of official measures growth in consumption was modest, that aims at halving the value of bad and private investment declined. The loans within two and a half years was area's lackluster economic performance pushed the unemployment rate up by U.S. Dollar Exchange Rate against several tenths of a percentage point by Selected Major Currencies the end of the year. Economic weakness was particularly pronounced in some of Week ending January 5, 2001 = 100 the larger countries—Germany, Italy, the Netherlands, and, to a lesser extent, Japanese yen — 110 France. In contrast, growth in Spain and some of the smaller euro-area — 100 countries—Ireland, Portugal, Finland, dollar and Greece—was much more robust. — 90 Headline inflation jumped to a bit above Euro 2Vi percent early in the year, owing to higher food and energy prices and in 2001 2002 2003 small part to the introduction of euro NOTH. The data are weekly. Exchange rates are in notes and coins. Increased slack in the foreign currency units per dollar. Last observations are economy, however, together with the the average of trading days through February 5, 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 37 15 percent appreciation of the euro by approved in September 2002, $6 billion the end of the year, helped to mitigate of which was disbursed by the end of inflation concerns, and the ECB low- the year. However, financial conditions ered its policy interest rate in Decem- improved markedly after Lula won the ber. The euro continued to appreciate in election in late October and appointed early 2003. a cabinet perceived to be supportive of Economic growth in the United King- orthodox fiscal and monetary policies, dom held up better than in the other including greater central bank indepenmajor European countries last year, and dence. By January 2003 the real had sterling strengthened about 10 percent reversed about one-fourth of its previversus the dollar. However, the expan- ous decline against the dollar, and bond sion remained uneven, with the services spreads had fallen sharply. However, sector continuing to grow more rapidly the new administration still faces some than the smaller manufacturing sec- major challenges. In particular, serious tor. Despite tight labor markets, infla- concerns remain over the very large tion remained a bit below the Bank of quantity and relatively short maturity England's target of 2J/2 percent for most of the outstanding government debt. In of the past year. A sharp rise in housing addition, last year's currency depreciaprices has, however, raised some con- tion fueled a rise in inflation that has cern about the possibility of a real estate price bubble. The British government announced its intention to complete a U.S. Dollar Exchange Rates and Bond rigorous assessment of its criteria for Spreads for Selected Emerging Markets joining the European Monetary Union (EMU) by the middle of this year and, if January 5. 2001 = 100 Januarys, 2001= 100 they are met, to hold a referendum on Exchange rates entry. 360 — 180 Brazilian real 280 J Mexican 140 Emerging-Market Economies 200 100 Korean won The Brazilian economy posted a surpris- Argentine peso! 120 60 ingly strong rebound in 2002 despite a 1 [ j ,.,.,,.,1,,,, i major political transition and accompanying turbulence in financial markets. Percentage points Percentagepoints The Brazilian real depreciated sharply Bond spreads between May and October, and sover- 80 ,m. _ 20 eign bond spreads climbed to 2,400 60 Argentina 15 basis points as it became increasingly f\ v likely that Luiz Inacio Lula da Silva 40 J'\kf 10 r (Lula), the Workers' Party candidate, Mexico 20 5 would win the presidential election. Given some of the past stances of the 2001 2002 2003 party, this possibility fueled concerns among foreign investors about a poten- NOTE. The data are weekly averages that are indexed to the week ending January 5, 2001. Exchange rates (top tial erosion of fiscal and monetary dispanel) are in foreign currency units per dollar. Bond cipline. In response to the sharp dete- spreads (bottom panel) are the J.P. Morgan Emerging rioration in financial conditions facing Market Bond Index (EMBI+) spreads over U.S. Treasuries. Last observations are the average of trading Brazil, a $30 billion IMF program was days through February 5, 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

38 89th Annual Report, 2002 prompted several increases in the mone- the dollar, and the bolivar depreciated tary policy interest rate. In January the sharply. Opponents of President Hugo government raised the upper bound of Chavez mounted a short-lived coup in its inflation target range for this year to April and declared a national strike in 8.5 percent from 6.5 percent, although early December. The strike brought the the target for next year was lowered already-weak economy to a standstill, at the same time to 5.5 percent from and output in the key oil industry plum- 6.25 percent. meted. The strike abated in early Febru- Argentine GDP contracted further in ary in all sectors but oil. In response to 2002 after declining 10 percent in 2001. the strike, Chavez increased his control The currency board arrangement that of the state-owned oil company and oil had pegged the peso at a one-to-one rate production began rising in early 2003, with the dollar collapsed early last year; but it was still well below pre-strike the peso lost nearly three-fourths of its levels. With the exchange rate plunging value by late June, and sovereign bond in late January, the government susspreads spiked to more than 7,000 basis pended currency trading for two weeks points. By early 2002, the banking sys- before establishing a fixed exchange rate tem had become effectively insolvent as regime and some restrictions on foreign a result of the plunging peso, the weak currency transactions. economy, and the government's default One of the few bright spots in Latin on debt that the banks held mostly invol- America last year was the Mexican untarily. Confronted with this situation, economy. Boosted by the U.S. recovery, the government forced the conversion growth was moderate for the year as a of the banks' dollar-denominated assets whole despite some late slowing. Howand liabilities to pesos and also man- ever, financial conditions deteriorated dated the rescheduling of a large share somewhat after midyear as market of deposits. As a result of these and participants reevaluated the strength of other measures, confidence in the bank- the North American recovery. Mexican ing system, already shaken, was further stock prices slid about 25 percent impaired. Financial and economic con- between April and September, and sovditions eventually stabilized in the sec- ereign bond spreads widened nearly ond half of the year, but there are no 200 basis points to around 430 basis signs yet of a sustained recovery. The points over the same period. Nevergovernment also defaulted on obliga- theless, the Mexican economy did not tions to multilateral creditors in late appear to be much affected by spillovers 2002 and early 2003. In January, Argen- from the problems elsewhere in Latin tina and the International Monetary America; bond spreads dropped sharply Fund reached agreement on a $6.6 bil- between October and the end of the lion short-term program that will go year to around 300 basis points, a level to meeting Argentina's payments to considerably lower than elsewhere in the IMF at least through the elections the region. The peso depreciated about expected in the spring and also to clear- 12 percent against the dollar over the ing its overdue obligations to the multi- course of last year. The decline fueled lateral development banks. an increase in twelve-month inflation to Venezuela experienced extreme eco- more than 5!/2 percent by year-end. The nomic and political turmoil over the past acceleration put inflation above the govyear. In February 2002 the central bank ernment target rate of AVi percent and abandoned the bolivar's crawling peg to well above the ambitious 3 percent tar- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2002 and Early 2003 39 get set for 2003. In response to increas- The performance of the ASEAN-5 ing inflation, the Bank of Mexico has economies—Indonesia, Malaysia, the tightened monetary policy four times Philippines, Singapore, and Thailand— since September 2002. The peso has also was generally robust in 2002, continued to depreciate in early 2003, although the overall softening in global and bond spreads have moved back up a demand in the second half of the year bit. was evident there as well. The second- The Asian emerging-market econo- half slowing in production was particumies generally performed well in 2002, larly pronounced in Singapore, which is although there were significant dif- heavily dependent on exports of highferences within the region. Outside technology products. Taiwan, another of China, the strongest growth was high-technology producer, also showed recorded in South Korea, which bene- a significant deceleration in output fited in the first half of the year from between the first and second halves of both an upturn in global demand for the year. Both of these economies expehigh-tech products and a surge in rienced some mild deflation in 2002, domestic demand, particularly consump- although prices turned up toward the tion. However, consumer confidence end of the year. deteriorated at the end of the year as ten- Although the Hong Kong economy sions over North Korea intensified; the did not show as much improvement as uneasy situation, as well as the substan- most other emerging Asian economies tial existing consumer debt burden, pose in the first half of last year, it recorded significant risks to growth in consump- very strong growth in the third quarter. tion this year. The Korean won appreci- Nevertheless, prices continued to fall for ated sharply against the dollar between the fourth consecutive year. The main- April and midyear in response to land Chinese economy, which again outimproving economic conditions; it then performed the rest of the region in 2002, dropped back in late summer and early enjoyed surging investment by the govfall as perceptions about the strength of ernment and by foreign investors as well the global recovery were adjusted down- as robust export growth. The Chinese ward. However, the won turned back up economy continued to experience mild against the dollar late last year. deflation last year. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

41 Monetary Policy Report of July 2002 Monetary Policy and the ity to provide growth over the longer Economic Outlook haul. The Federal Reserve had moved The pace of economic activity in the aggressively in 2001 to counter the United States picked up noticeably in weakness that had emerged in aggregate the first half of 2002 as some of the demand; by the end of the year, it had powerful forces that had been restrainlowered the federal funds rate to ing spending for the preceding year and PA percent, the lowest level in forty a half abated. With inventories in many years. With only tentative signs that industries having been brought into activity was picking up, the Federal more comfortable alignment with sales, Open Market Committee (FOMC) firms began boosting production around decided to retain that unusual degree the turn of the year to stem further runof monetary accommodation by leavoffs of their stocks. And while capital ing the federal funds rate unchanged at spending by businesses has yet to show its January meeting. Confirmation of an any real vigor, the steep contraction of improvement in activity was evident by the past year or so appears to have come the time of the March meeting, and the to an end. Household spending, as it has FOMC moved toward an assessment throughout this cyclical episode, continthat the risks to the outlook were balued to trend up in the first half. With anced between its long-run goals of employment stabilizing, the increases price stability and maximum sustainin real wages made possible by gains able economic growth, a view mainin labor productivity and the effects of a tained through its June meeting. The variety of fiscal actions have provided durability and strength of the expansion noticeable support to disposable inwere recognized to depend on the tracomes. At the same time, low interest jectory of final sales. The extent of a rates have buoyed the purchase of duraprospective strengthening of final sales ble goods and the demand for housing. was—and still is—uncertain, however, Growth was not strong enough to foreand with inflation likely to remain constall a rise in the unemployment rate, tained, the Committee has chosen to and slack in product and labor markets, maintain an accommodative stance of along with declining unit costs as propolicy, leaving the federal funds rate at ductivity has soared, has helped to keep its level at the end of last year. core inflation low. The exceptionally The economy expanded especially strong performance of productivity over rapidly early in the year. As had been the past year provides further evidence anticipated, much of the first quarter's of the U.S. economy's expanded capacstrength in production resulted from the efforts of firms to limit a further draw- NOTE. The discussion in this section consists down of inventories after the enormous of the text and tables from the Monetary Policy liquidation in the fourth quarter of 2001. Report submitted to the Congress on July 16, With respect to first-quarter sales, pur- 2002; the charts from this report (as well as earlier chases of light motor vehicles dropped reports) are available on the Board's web site, at www.federalreserve.gov/boarddocs/hh. back from their extraordinary fourth- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

42 89th Annual Report, 2002 quarter level, but other consumer spend- cial market conditions could reinforce ing increased substantially. Housing business caution. starts, too, jumped early in the year— Nevertheless, a number of factors are albeit with the help of weather condi- likely to boost activity as the economy tions favorable for building in many moves into the second half of 2002. parts of the country—and spending on With the inflation-adjusted federal funds national defense moved sharply higher. rate barely positive, monetary policy All told, real GDP is now estimated to should continue to provide substantial have increased at an annual rate in support to the growth of interestexcess of 6 percent in the first quarter. sensitive spending. Low interest rates Economic activity appears to have also have allowed businesses and housemoved up further in recent months but holds to strengthen balance sheets by at a slower pace than earlier in the year. refinancing debt on more favorable Industrial production has continued to terms. Fiscal policy actions in the form post moderate gains, and nonfarm pay- of lower taxes, investment incentives, rolls edged up in the second quarter and higher spending are providing conafter a year of nearly steady declines. siderable stimulus to aggregate demand However, several factors that had con- this year. Foreign economic growth tributed importantly to the outsized gain has strengthened and, together with a of real output in the first quarter appear decline in the foreign exchange value to have made more modest contribu- of the dollar, should bolster U.S. exports. tions to growth in the second quarter. Finally, the exceptional performance of Available data suggest that the swing in productivity has supported household inventory investment was considerably and business incomes while relieving smaller in the second quarter than in the pressures on price inflation, a combinafirst. Consumer spending has advanced tion that augurs well for the future. more slowly of late, and while the construction of new homes has expanded Monetary Policy, Financial further, its contribution to the growth of Markets, and the Economy real output has not matched that of earover the First Half of 2002 lier in the year. Notable crosscurrents remain at work The information reviewed by the FOMC in the outlook for economic activity. at its meeting of January 29 and 30 Although some of the most recent indi- seemed on the whole to indicate that cators have been encouraging, busi- economic activity was bottoming out nesses still appear to be reluctant to add and that a recovery might already be appreciably to workforces or to boost under way. Consumer spending had held capital spending, presumably until they up remarkably well, and the rates of see clearer signs of improving prospects decline in manufacturing production and for sales and profits. These concerns, as business purchases of durable equipwell as ongoing disclosures of corporate ment and software had apparently modaccounting irregularities and lapses in erated toward the end of 2001. In addicorporate governance, have pulled down tion, the expectation that the pace of equity prices appreciably on balance inventory runoff would slow after sevthis year. The accompanying decline eral quarters of substantial and growing in net worth is likely to continue to liquidation constituted another reason restrain household spending in the for anticipating that economic activity period ahead, and less favorable finan- would improve in the period imme- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 43 diately ahead. Nonetheless, looking hold led to noticeable increases in broad beyond the near term, the FOMC faced stock indexes and in long-term interest considerable uncertainty about the rates. But the strength of the recovery strength of final demand. Because remained unclear. The outlook for busihousehold spending had not softened to ness fixed investment—which would the usual extent during the recession, be one key to the strength of economic it appeared likely to have only limited activity once the thrust from inventory room to pick up over coming quarters. restocking came to an end—was espe- Intense competitive pressures were cially uncertain, with anecdotal reports thought to be constraining the growth of indicating that businesses remained profits, which could damp investment hesitant to enter into major long-term and equity prices. At the same time, the commitments. While the FOMC beoutlook for continued subdued inflation lieved that the fiscal and monetary poliremained favorable given the reduced cies already in place would continue to utilization of resources and the fur- stimulate economic activity, it considther pass-through of earlier declines in ered the questions surrounding the outenergy prices. Taken together, these con- look for final demand over the quarters ditions led the FOMC to leave the stance ahead still substantial enough to justify of monetary policy unchanged, keeping the retention of the current accommodaits target for the federal funds rate at tive stance of monetary policy, particul3/4 percent. In light of the tentative larly in light of the relatively high unemnature of the evidence suggesting that ployment rate and the prospect that the upturn in final demand would be the lack of price pressures would persist. sustained, the FOMC decided to retain Given the positive tone of the availits assessment that the more important able economic indicators, the FOMC risk to achieving its long-run objectives announced that it considered the risks to remained economic weakness—the pos- achieving its long-run objectives as now sibility that growth would fall short of being balanced over the foreseeable the rate of increase in the economy's future. potential and that resource utilization By the time of the May 7 FOMC would fall further. meeting, it had become evident that eco- When the FOMC met on March 19, nomic activity had expanded rapidly economic indicators had turned even early in 2002. But the latest statistical more positive, providing encouraging data and anecdotal reports suggested evidence that the economy was recov- that the expansion was moderating conering from last year's recession. Con- siderably in the second quarter and that sumer spending had remained brisk in the extent to which final demand would the early part of the year, the decline in strengthen was still unresolved. Busibusiness expenditures on equipment and ness sentiment remained gloomy as software appeared to have about run its many firms had significantly marked course, and housing starts had turned down their own forecasts of growth in back up. Industrial production, which sales and profits over coming quarters. had been falling for nearly a year and a These revised projections, along with half, increased in January and February the uncertainty surrounding the robustas businesses began to meet more of the ness of the overall economic recovrise in sales from current production and ery, had contributed to sizable declines less from drawing down inventories. in market interest rates and weighed Indications that an expansion had taken heavily on equity prices, which had Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

44 89th Annual Report, 2002 dropped substantially between the that the risks to the economic outlook March and May meetings. The outlook remained balanced. for inflation had remained benign despite some firming in energy prices, as excess capacity in labor and product Economic Projections markets held the pricing power of many for 2002 and 2003 firms in check, and the apparent strong The members of the Board of Governors uptrend in productivity reduced cost and the Federal Reserve Bank presipressures. In these circumstances, the dents, all of whom participate in the FOMC decided to keep the federal funds deliberations of the FOMC, expect the rate at its accommodative level of l3/4 percent and maintained its view that, economy to expand rapidly enough over the next six quarters to erode current against the background of its long-run margins of underutilized capital and goals of price stability and sustainable labor resources. The central tendency of economic growth, the risks to the outthe forecasts for the increase in real look remained balanced. GDP over the four quarters of 2002 is Over the next seven weeks, news on the economy did little to clarify questions regarding the vigor of the ongoing recovery. The information received in Economic Projections for 2002 and 2003 advance of the June 25-26 meeting of Percent the FOMC continued to suggest that economic activity had expanded in the Federal Reserve Governors and second quarter, but both the upward Reserve Bank presidents Indicator impetus from the swing in inventory Central investment and the growth in final Range tendency demand appeared to have diminished. In financial markets, heightened concerns 2002 about accounting irregularities at promi- Change, fourth quarter nent corporations and about the outlook to fourth quarter1 for profits had contributed to a substan- Nominal GDP 41/2-51/2 43/4-5V4 tial decline in equity prices and corre- R PC ea E l G ch D ai P n-type price 3-4 31/2-33/4 spondingly to a further erosion in house- index ll/4-2 lV2-l3/4 hold wealth. But some cushion to the Average level, effects on aggregate demand of the fourth quarter Civilian unemployment decline in share prices had been pro- rate 5V6-6l/4 53/4-6 vided by the fall in the foreign exchange value of the dollar and the drop in long- 2003 term interest rates. Although the FOMC Change, fourth quarter believed that robust underlying growth to fourth quarter1 in productivity, as well as accommoda- Nominal GDP 4i/2_6 5-53/4 Real GDP 3V4-4V4 VA-A tive fiscal and monetary policies, would PCE chain-type price continue to support a pickup in the rate index 1-2V4 l'/2-l3/4 of increase of final demand over com- Average level, ing quarters, the likely degree of the fourth quarter Civilian unemployment strengthening remained uncertain. The rate 5-6 5VAT-51A FOMC decided to keep unchanged 1. Change from average for fourth quarter of previous its monetary policy stance and its view year to average for fourth quarter of year indicated. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 45 3J/2 percent to 33A percent, and the cen- Economic and Financial tral tendency for real GDP growth in Developments in 2002 2003 is 3Vi percent to 4 percent. The central tendency of the projections of The pace of economic activity picked the civilian unemployment rate, which up considerably in the first half of 2002 averaged just under 6 percent in the after being about unchanged, on balsecond quarter of 2002, is that it stays ance, in the second half of 2001. Final close to this figure for the remainder sales advanced modestly as substantial of the year and then moves down to gains in household and government between 5V4 percent and 5V2 percent by spending were partly off-set by weak the end of 2003. business fixed investment and a widen- Support from monetary and fiscal ing gap between imports and exports. policies, as well as other factors, should In addition, inventory liquidation slowed lead to a strengthening in final demand sharply as businesses stepped up proover coming quarters. Business spend- duction to bring it more closely in line ing on equipment and software will with the pace of final sales. The increase likely be boosted by rising sales, in real GDP was particularly rapid early improving profitability, tax incentives, in the year, with the first-quarter gain and by the desire to acquire new capi- elevated by a steep reduction in the tal embodying ongoing technological pace of the inventory run-off, a surge advances. Improving labor market con- in defense spending, and a weatherditions and a robust underlying trend in induced spurt in construction. Real GDP productivity growth should further bol- is currently estimated to have risen at an ster household income and contribute to annual rate of just over 6 percent in the an uptrend in spending. In addition, the first quarter and appears to have posted liquidation of last year's inventory over- a more moderate gain in the second hangs has left businesses in a position to quarter. begin rebuilding stocks as they become Private payroll employment declined more persuaded that the recovery in through April, and at midyear the unemfinal sales will be sustained. ployment rate stood somewhat above Most FOMC participants expect its average in the fourth quarter of 2001. underlying inflation to remain close to Core inflation—which excludes the recent levels through the end of 2003. direct influences of the food and energy Core inflation should be held in check sectors—remained subdued through by productivity gains that hold down May, held down by slack in resource cost increases, a lack of pressure on utilization and continued sizable resources, and well-anchored inflation advances in labor productivity. Overall expectations. Overall inflation, which inflation was boosted by a surge in was depressed last year by a notable energy prices in March and April, but decline in energy prices, is likely to run energy prices have since retreated a bit. slightly higher this year. In particular, Inflation expectations remained in check the central tendency of the projections in the first half of this year. of the increase in the chain-type index As judged by declines in most interest for personal consumption expenditures rates over the first half of the year, finanover the four quarters of both 2002 cial market participants have marked and 2003 is IV2 percent to PA percent, down their expectation of the vigor of compared with last year's pace of the economic expansion. Interest rates, 1 VA percent. along with most equity indexes, rose Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

46 89th Annual Report, 2002 noticeably toward the end of the first posable income have supported a solid quarter in reaction to generally stronger- underlying pace of spending. The than-expected economic data. But Trea- decline in stock prices in the first half of sury yields and equity prices more than 2002 reduced household wealth, and the rolled back those increases on renewed debt-service burden remained high, but questions about the strength of the financial stress among households to rebound in the economy, including date has been limited. growing uncertainty regarding prospective corporate profits and concerns about Consumer Spending escalating geopolitical tensions and about the governance and transparency Real consumer expenditures increased of U.S. corporations. Private demands at an annual rate of 3V4 percent in the on credit markets moderated in the first first quarter. Demand for motor vehicles half of the year, as businesses substan- dropped from an extraordinary fourthtially curbed their net borrowing. For quarter pace, but purchases remained the most part, this reduction reflected supported in part by continued large further declines in business investment, incentive packages. Outlays for other a pickup in operating profits, and a goods and services advanced smartly in return to net equity issuance. But, in the first quarter. In the second quarter, addition, lenders became more cautious the rate of increase in consumer spendand selective, especially for borrowers ing looks to have eased somewhat. of marginal credit quality. Motor vehicle purchases were little Market perceptions that the recov- changed, and most other major categoery in the United States might turn out ries of consumer spending likely posted to be less robust than anticipated also smaller gains than earlier in the year. put downward pressure on the foreign Real disposable personal income exchange value of the dollar as mea- moved sharply higher in the first quarter sured against the currencies of our major and appears to have risen a little further trading partners, especially during the in the second quarter. Wages and salasecond quarter of 2002. Central banks in ries have increased only moderately this some foreign countries, including Can- year. But tax payments have fallen ada, tightened policy as growth firmed. markedly; last year's legislation low- The euro-area economy recovered mod- ered withheld tax payments again this estly during the first half, and some year, and final payments this spring on brighter signs were evident in Japan. In tax obligations for 2001 were substancontrast, the dollar strengthened on bal- tially below last year's level (likely ance against the currencies of our other related at least in part to a decline in important trading partners; in particular, capital gains realized last year). All told, the Mexican peso lost ground, and real disposable income increased at an financial markets reacted to political and annual rate of 8 percent between the economic problems in several South fourth quarter of last year and May. American countries. However, household net worth has likely fallen further because the negative effect of the decline in stock prices The Household Sector has been only partly offset by an appar- Household spending began the year on a ent continued appreciation in the value strong note and continued to rise in the of residential real estate. According to second quarter. Further gains in dis- the flow of funds accounts, by the end Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 47 of the first quarter, the ratio of house- ing homes jumped in early 2002 after hold net worth to disposable income had moving sideways during the preceding reversed close to two-thirds of its run-up three years; sales of new homes have in the second half of the 1990s; this ratio also been running quite high in recent has undoubtedly registered additional months. declines since the end of March. Con- Home prices have continued to move sumer sentiment improved over the first up strongly. For example, over the year several months of the year, with indexes ending in the first quarter, the constantfrom both the Conference Board and quality price index for new homes the Michigan Survey Research Center rose 5lA percent, and the repeat-sales reversing last fall's sharp deterioration. price index for existing homes was up However, both indexes have given up 62/4 percent. Despite these increases, some of those gains more recently. low mortgage rates have kept housing The personal saving rate increased in affordable. Rates on thirty-year conventhe first half of this year, as the decline tional fixed-rate loans averaged less than in wealth over the past two years likely 7 percent in the first half of this year, held down consumer spending relative and rates on adjustable-rate loans conto disposable personal income. In May, tinued the downtrend that began in early the saving rate stood at 3 percent of 2001. The share of median household disposable income, up from an average income required to finance the purchase of Wi percent over 2001. Movements of a median-price house is close to its in the saving rate have been very erratic average for the past ten years and well over the past year, reflecting cyclical below the levels that prevailed in the factors, the timing of tax cuts, and 1970s and 1980s. adjustments in incentives to purchase In the multifamily sector, housing motor vehicles. starts averaged 340,000 units at an annual rate over the first five months of the year, a pace close to the average of Residential Investment the previous five years. However, condi- Real residential investment increased tions in this market have deteriorated at an annual rate of about 15 percent somewhat during the past year. In the in the first quarter, and the level of activ- first quarter, the vacancy rate for apartity appears to have remained robust ments spiked to the highest level since in the second quarter. The first-quarter the late 1980s, and rents and property surge was spurred partly by unseason- values were below year-earlier readings. ably warm and dry winter weather, which apparently encouraged builders Household Finance to move forward some of their planned construction. At the same time, under- As it did last year, household debt lying housing activity has been sup- appears to have expanded at more than ported by the gains in income and confi- an 8 percent annual rate during the first dence noted above, and, importantly, by half of 2002. Although consumer credit low interest rates on mortgages. In the (debt not secured by real estate) has single-family sector, starts averaged an increased, the bulk of the expansion in annual rate of 1.35 million units over household debt has come from a sizable the first five months of the year—up buildup of home mortgage debt. Refi- 6V2 percent from the already buoyant nancing activity has fallen below last pace registered in 2001. Sales of exist- year's record pace, but it has remained Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

48 89th Annual Report, 2002 strong as households have continued to sion are likely still restraining equipextract a portion of the accumulated ment demand, but rising output, improvequity in their homes. ing corporate profits, and continuing The aggregate household debt-service technological advances appear to be burden—the ratio of estimated mini- working in the opposite direction. Many mum scheduled payments on mortgage businesses have worked off their excess and consumer debt to disposable per- stocks, and the substantial inventory sonal income—although still elevated, runoff that began in the first quarter of has moved little this year. The effect of last year seems to be drawing to a close. the fast pace of household borrowing on The combination of higher profits and the debt burden has been offset by lower weak investment spending has led to a interest rates and the brisk growth in drop in borrowing by the nonfinancial disposable income. On balance, indi- business sector thus far this year. cators of credit quality do not suggest much further deterioration in the finan- Fixed Investment cial condition of households. While delinquency rates for subprime borrow- Real business spending on equipment ers have risen further for auto loan pools and software (E&S) was little changed and have stayed high for mortgages, in the first quarter after having dropped mortgage delinquencies for all borrow- sharply last year. In the high-tech cateers have changed little, and delinquen- gory, real expenditures moved up in the cies on credit card accounts at banks first quarter after a double-digit decline have not risen significantly since the in 2001. Outlays for computers posted mid-1990s. The number of personal large gains in inflation-adjusted terms in bankruptcy filings also has essentially both the fourth and first quarters; many moved sideways this year, albeit at a businesses apparently postponed comhistorically high rate. Lenders have puter replacement over much of last year apparently reacted to these indicators but now seem to be taking advantage of household credit quality by tighten- of ongoing technological progress and ing standards for consumer loans, as the associated large declines in prices. reported on the Federal Reserve's Senior In contrast, real expenditures for Loan Officer Opinion Surveys. Stan- communications equipment were little dards for mortgage loans, however, have changed in the first quarter after havchanged little, and, on the whole, credit ing plunged by one-third during 2001. appears to have remained readily avail- Excess capacity in the provision of teleable to the household sector. com services is continuing to weigh heavily on the demand for communications equipment. Business outlays for The Business Sector software edged down in real terms in the Spending in the business sector appears first quarter. to have bottomed out recently, but a Real spending on transportation strong recovery has not yet taken hold. equipment dropped in the first quarter. Real business fixed investment, which Outlays for aircraft shrank dramatically declined sharply last year, fell again in as the reduction in orders after last the first quarter, but seems to have year's terrorist attacks began to show firmed in the second quarter. Excess through to spending. Outlays for motor capacity in some sectors and uncertainty vehicles fell sharply early in the year about the pace of the economic expan- owing to weakness in the market for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 49 heavy trucks and a reported reduction in began in the middle of last year in the fleet sales to rental companies related to wake of the decline in the prices of oil the downturn in air travel. Real E&S and natural gas from their peaks a few spending outside of the high-tech and quarters earlier. Incoming data point to transportation categories moved up in further declines in spending for nonresithe first quarter after sizable declines in dential structures in the second quarter. the three preceding quarters. This pattern probably reflects the deceleration Inventory Investment and subsequent acceleration in business output, which is an important determi- Businesses ran off inventories at an nant of spending in this category. annual rate of nearly $30 billion in the In the second quarter, real E&S first quarter. This drawdown followed a spending likely rose, borne along by much larger liquidation—at an annual increases in sales and a rebound in rate of roughly $120 billion—in the profits. Incoming data on orders and fourth quarter, and the associated shipments suggest that real outlays for step-up in production contributed almost high-tech equipment advanced and that 3Vi percentage points to the first-quarter expenditures for other nontransportation increase in real GDR Book-value data equipment also rose. Spending on air- on inventories outside of the motor vehicraft probably contracted further, but cle sector point to a further slackening orders for heavy trucks surged this of the drawdown more recently. Since spring, as some companies reportedly last fall, inventory-sales ratios have shifted purchases forward in anticipa- more than reversed the run-up that tion of stricter emissions requirements occurred as the economy softened. Curthat are scheduled to take effect in the rently, inventories do not appear to be fall. Because of lags in the ordering and excessive for the economy as a whole, building of new equipment, the provi- although industry reports suggest that sion for partial expensing in the Job overhangs persist in a few areas. In con- Creation and Worker Assistance Act trast to inventories in other sectors, passed by the Congress in early March motor vehicle stocks increased in the will likely bolster investment spending first half of this year, as automakers gradually. boosted production in order to rebuild Real outlays for nonresidential struc- stocks that had been depleted by the tures registered a very large decline in robust pace of sales in late 2001. Motor the first quarter after having slipped vehicle inventories were no longer lean appreciably in 2001. Outlays for office as of the middle of this year. and industrial structures, lodging facilities, and public utilities dropped sub- Corporate Profits and Business stantially. Vacancy rates for offices Finance jumped in the first quarter to their highest level since the mid-1990s; in addi- The economic profits of the U.S. nonfition, rents and property values were nancial corporate sector grew 5 percent noticeably below their levels one year at a quarterly rate in the first quarter of earlier. Vacancy rates have risen dra- this year after a surge of 133/4 percent matically in the industrial sector as well. in the fourth quarter of 2001. The corre- Construction of drilling structures also sponding ratio of profits to sector GDP contracted sharply in the first quarter, has edged up to 8% percent, reversing a thereby continuing the downtrend that portion of the steep decline registered Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

50 89th Annual Report, 2002 over the preceding few years but continued to weigh on issuance this remaining well below its peak in the year. mid-1990s. Early indicators point to fur- Although many businesses have ther profit gains in the second quarter. apparently substituted bond debt for The rise in profits since late 2001, shorter-term financing by choice, othcombined with weak capital expendi- ers, especially investment-grade firms tures and low share repurchase and cash- in the telecommunications sector, have financed merger activities, have helped done so by necessity: They were pushed keep nonfinancial corporations' need for out of the commercial paper market or external funds (the financing gap) below otherwise encouraged by investors and the average of last year. In addition, credit-rating agencies to curb their relicorporations have turned to the equity ance on short-term sources of financing markets to raise a portion of their to limit the associated rollover risk. needed external funds: Corporations Indeed, commercial paper outstanding have sold more new equity than they ran off sharply in February and early have retired this year—the first period March, when several companies that of net equity issuance in nearly a were perceived as having questionable decade. They have used much of these accounting practices were forced to tap funds to repay debt. As a result, the bank lines to pay off maturing commergrowth of nonfinancial business debt cial paper. With lower-quality borrowappears to have slowed considerably in ers leaving the market in the face of the first half of 2002 after rapid gains in elevated risk spreads, commercial paper preceding years. outstanding shrank nearly 30 percent in the first half of the year after a sizable Much of the growth in nonfinancial decline in 2001. business debt this year has been concentrated in the corporate bond market Some firms that exited the commer- (though issuance has not been quite so cial paper market turned, at least temstrong as in 2001), as firms have taken porarily, to banks as an alternative. advantage of historically attractive Nonetheless, on net, commercial and yields. Many corporations have used the industrial loans at banks have declined proceeds of their bond offerings to pay this year, reflecting borrowers' preferdown commercial and industrial (C&I) ence for lengthening the maturity of loans at banks and commercial paper. In their liabilities and the overall reduction recent months, however, net corporate in the demand for external financing, bond issuance has slowed, and the con- noted earlier. To a more limited extent, a traction in short-term funding appears to somewhat less receptive lending envihave moderated. ronment probably also weighed on busi- About one fifth of total bond offer- ness borrowing at banks. In particular, ings over the first half of 2002 have banks continued to tighten terms and been in the speculative-grade market. standards on C&I loans on net over This fraction is about unchanged from the first half of this year, although the last year but still well below the propor- fraction of banks that reported having tions seen in the latter half of the 1990s, done so fell noticeably in the Federal and speculative-grade bond offerings Reserve's Senior Loan Officer Opinion have been concentrated in the higher Survey in April. Banks have also quality end of that market. Troubles in imposed stricter underwriting standards the two largest sectors of the market— and higher fees and spreads on backup telecommunications and energy—have lines of credit for commercial paper over Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 51 most of 2001 and early 2002; banks Nonetheless, investor appetite for cited increased concerns about the credit- CMBS has apparently been strong, as worthiness of issuers and a higher likeli- yield spreads have narrowed this year. hood of lines being drawn down. Delinquency rates on CMBS pools, Indicators of credit quality still point which had been rising during the early to some trouble spots in the nonfinancial part of the year, seem to have stabilized business sector. The ratio of net interest in recent months, and delinquency rates payments to cash flow has trended up on commercial mortgages held by banks since the mid-1990s for the nonfinan- and insurance companies have remained cial corporate sector as a whole, with near their historical lows. increases most pronounced for weaker The low level of risk spreads for speculative-grade firms. The default rate CMBS suggests that concerns about teron outstanding corporate bonds has rorism insurance have not been wideremained quite elevated by historical spread in the market for commercial standards. By contrast, although the mortgages, and responses to the Federal delinquency rate on C&I loans at banks Reserve's Senior Loan Officer Opinion has risen a bit further this year, it has Survey in April indicate that most stayed well below rates observed in the domestic banks required insurance on early 1990s. In part, however, this per- less than 10 percent of the loans being formance may be attributable to more used to finance high-profile or heavyaggressive loan sales and charge-offs traffic properties. Nonetheless, that than in the past. It may be that problems fraction was much higher at a few have risen more for large firms than banks, and some credit-rating agencies for smaller ones, as the increase in C&I have placed certain CMBS issues— loan delinquencies over recent quarters mainly those backed by high-profile was limited to large banks, where loans properties—on watch for possible to larger firms are more likely to be downgrade because of insufficient terheld. Credit rating downgrades contin- rorism insurance. ued to outpace upgrades by a substantial margin, as was the case in the last quarter of 2001. Spreads of corporate bond The Government Sector yields over those on comparable Trea- The federal unified budget moved into suries have remained high by historical deficit in fiscal 2002 after having posted standards and have risen considerably a substantial surplus in fiscal 2001. The across the credit-quality spectrum for deterioration reflects a sharp drop in tax telecom firms. Corporate bond spreads collections (resulting in part from the also widened, though to a much smaller effects of the economic downturn, the extent, for a few highly rated firms in decline in stock prices, and legislated other industries owing to concerns about tax cuts) and unusually large suppletheir accounting practices. mental spending measures. As a conse- After having surged late last year, quence, federal debt held by the public growth in commercial mortgage debt increased in the first half of the year dropped back in the first half of this year after rapid declines during the previous amid a sharp decline in construction several years. The budgets of states and activity. Issuance of commercial mort- localities have also been strained by ecogage backed securities (CMBS), a major nomic events, and many state and local component of commercial mortgage governments have taken steps to relieve finance, has been especially weak. these pressures. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

52 89th Annual Report, 2002 Federal Government ment increased further in the second quarter. Over the first eight months of fiscal year Federal saving, which equals the uni- 2002 (October through May) the unified fied budget surplus adjusted to conform budget recorded a deficit of $147 bil- to the accounting practices followed lion, compared with a surplus of in the national income and product $137 billion over the same period of accounts, has fallen considerably since fiscal year 2001. Nominal receipts were the middle of last year. Net federal sav- 12 percent lower than during the same ing, which accounts for the depreciation period of fiscal 2001, and daily Treasury of government capital, turned negative data since May suggest that receipts in the first quarter of this year. At the have remained subdued. Individual tax same time, the net saving of households, payments are running well below last businesses, and state and local governyear's pace; this weakness reflects gen- ments has moved up from its trough of eral macroeconomic conditions, the leg- last year. On balance, net national savislated changes in tax policy, and the ing as a share of GDP has held roughly decline in stock prices and consequent steady in the past several quarters after reduction in capital gains realizations in having moved down sharply since 1999. 2001. The extent of the weakness was Federal debt held by the public, which not widely anticipated—this spring's had been declining rapidly over the past nonwithheld tax payments, which few years, grew at a 3V4 percent annual largely pertain to last year's liabilities, rate in the first quarter of 2002 and is generated the first substantial negative estimated to have increased consider- April surprise in revenue collections in ably more in the second quarter. The a number of years. Corporate tax pay- ratio of federal government debt held ments have also dropped from last by the public to nominal GDP fell only year's level because of weak profits and slightly in the first quarter following the business tax provisions included in several years of steep declines. In the Job Creation and Worker Assistance response to the changing budget out- Act of 2002. look, the Treasury suspended its buy- Nominal federal outlays during the back operations through mid-August first eight months of fiscal 2002 were and increased the number of auctions 10 percent higher than during the same of new five-year notes and ten-year period last year; excluding a drop in net indexed securities. interest payments owing to the current During the second quarter, the Trealow level of interest rates, outlays were sury took unusual steps to avoid breachup 14 percent. The rate of increase was ing its statutory borrowing limit especially large for expenditures on of $5.95 trillion. In early April, it income security, health, and national and temporarily suspended investments in homeland defense. Real federal expendi- the Government Securities Investment tures for consumption and gross invest- Fund—the so-called G-fund of the Fedment, the part of government spending eral Employees' Retirement System. that is a component of real GDP, rose at Incoming individual nonwithheld tax an annual rate of roughly IIV2 percent receipts later that month allowed the in the first calendar quarter of 2002 as Treasury to reinvest the G-fund assets defense spending surged. The available with an adjustment for interest. Late data suggest that real federal expendi- in May, the Treasury declared a debt tures for consumption and gross invest- ceiling emergency, which allowed it to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 53 disinvest a portion of the Civil Service to borrow heavily in bond markets to Retirement and Disability Fund, in addi- finance capital expenditures and to tion to the G-fund, to keep its debt from refund existing obligations, including breaching the statutory limit. At the time short-term debt issued last year. The of the declaration, the Treasury indi- overall credit quality of the sector has cated that disinvestments from these two remained high despite the fiscal stresses funds, combined with other stopgap associated with the recent economic measures, would be sufficient to keep slowdown, and yield ratios relative to it from breaching the debt ceiling only Treasuries have changed little this year, through late June. The Congress on net. approved legislation raising the statutory borrowing limit to $6.4 trillion on June 27. The External Sector Stronger growth in the United States State and Local Governments contributed to a widening of U.S. external deficits in the first quarter of this Slow growth of revenue resulting from year. The United States has continued the economic downturn has also generto receive large net private financial ated a notable deterioration in the fiscal inflows in 2002, but both inflows and position of many state and local governoutflows have been at lower levels than ments over the past year. In response, in recent years. many states and localities have been trimming spending plans and, in some Trade and the Current Account cases, raising taxes and fees. In addition, many states have been dipping into The U.S. deficit on trade in goods and rainy-day and other reserve funds. services widened about $27 billion in Together, these actions are helping to the first quarter, to nearly $380 billion move operating budgets toward balance. at an annual rate, as a surge in imports Real consumption and investment overwhelmed a slower expansion of spending by state and local governments exports. U.S. net investment income rose at an annual rate of 4V4 percent in decreased $33 billion to a slight deficit the first quarter, but available data sug- position after recording modest surgest that outlays were little changed pluses in all four quarters last year. The in the second quarter. Outlays for con- U.S. deficit on other income and transsumption items seem to have held to fers widened about $9 billion, to nearly only moderate increases in the first half $70 billion at an annual rate. The U.S. of this year, a step-down from last year's current account, which is the sum of the more robust gains. Investment spending above, recorded a deficit in the first rose briskly in the first quarter and quarter of $450 billion at an annual rate, retreated in the second quarter; this 4.3 percent of GDP and nearly $70 bilpattern largely reflects the contour of lion larger than the deficit in the fourth construction expenditures, which were quarter of 2001. boosted early in the year by unseason- Real exports of goods and services ably warm and dry weather. increased 3 percent at an annual rate in Debt growth in the state and local the first quarter, after five quarters of government sector has slowed so far in decline. This improvement resulted from 2002 from last year's very rapid pace. a very large step-up in service receipts, States and localities have continued as payments by foreign travelers moved Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

54 89th Annual Report, 2002 back up to near pre-September 11 levels helped keep the value of oil imports and other private service receipts at a very low level in the first quarter. increased as well. The real value of But oil prices began to rise in February exported goods contracted in the first and March as global economic activity quarter, but at only a 3Vi percent annual picked up and as OPEC reduced its rate. Goods exports had declined much production targets in an agreement more steeply in the previous three quar- with five major non-OPEC producers ters under the effects of slower output (Angola, Mexico, Norway, Oman, and growth abroad, continued appreciation Russia). Oil prices remained firm in the of the dollar, and plunging global second quarter around $26 per barrel demand for high-tech products. The amid turmoil in the Middle East, a onebetter performance in the first quarter of month suspension of oil exports by Iraq, 2002 included a markedly slower rate disruption of supply from Venezuela, of decline of machinery exports and a and increasing global demand. The price small increase in exported aircraft. of gold also has reacted to heightened While exports of computers continued geopolitical tensions and moved up to fall, exports of semiconductors rose more than 13 percent over the first half for the first time in nearly two years. of 2002. Export prices continued to edge down in the first quarter. The Financial Account U.S. real imports of goods and services expanded in the first quarter at an The shift in the pattern of U.S. interna- 8 percent annual rate. As was the case tional financial flows observed in the with exports, a substantial part of the second half of 2001 continued into the increase came from larger service first quarter of this year. Influenced payments related to increased travel by increased economic uncertainty, abroad by U.S. residents. Reflecting the questions about corporate governance rebound in U.S. economic activity, and accounting, and sagging share imports of real goods rose at about a prices, foreign demand for U.S. equities 4 percent pace in the first quarter of remained weak. Foreign net purchases 2002, the first increase in four quarters, of U.S. bonds slowed; although puras a decline in oil imports was more chases of corporate bonds continued than offset by a substantial increase in to be robust, demand for agency and imports of other goods. Growth of non- Treasury bonds slackened. Nonetheless, oil imports was led by increased imports because U.S. net purchases of foreign of computers, autos, and consumer securities also fell off, the contribution goods. The price of imported non-oil of net inflows through private securities goods declined at about a 2lA percent transactions to financing the U.S. curannual rate, in line with its trend in rent account deficit remained at a high 2001; prices fell for a wide range of level. Preliminary and incomplete data capital goods and industrial supplies. for the second quarter of 2002 suggest a Declining demand during the second continuation of this pattern. half of last year put the price of West Slower economic activity, both in the Texas intermediate (WTI) crude oil in United States and abroad, and reduced December 2001 at around $19 per bar- merger activity caused direct investment rel, its lowest level since mid-1999. inflows and outflows to drop sharply Unusually warm winter weather in the late last year. Direct investment inflows, United States—along with low prices— which were strong through the first half Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 55 of 2001, plummeted in the second half. month in the first quarter and declined U.S. direct investment abroad stayed at 8,000 per month in the second quarter. a high level through the third quarter In the second quarter, hiring in conbut then fell sharply. Both inflows and struction fell by the same amount as in outflows remained weak in the first the first quarter. Retail employment quarter of 2002. Available data point to declined somewhat after rising a bit in a pickup of capital inflows from official the first quarter, and the employment sources during the first half of 2002, as gain in services other than help supply the recent weakening of the foreign was slightly smaller than in the first exchange value of the dollar prompted quarter. However, employment losses in some official purchases. several other categories abated in the second quarter. The unemployment rate in the second The Labor Market quarter averaged 5.9 percent, up from a reading of 5.6 percent in both the fourth Labor markets weakened further in the quarter of last year and the first quarter first few months of the year; they now of this year. The higher unemployment appear to have stabilized but have yet to rate in recent months is consistent with show signs of a sustained and substanweak employment gains, and it probably tial pickup. Growth of nominal compenwas boosted a bit by the federal temposation slowed further in the first part rary extended unemployment compensaof the year after having decelerated tion program. Because this program proin 2001. With productivity soaring in vides additional benefits to individuals recent quarters, unit labor costs have who have exhausted their regular state fallen sharply. benefits, it encourages unemployed individuals to be more selective about tak- Employment and Unemployment ing a job offer and likely draws some After having fallen an average of nearly people into the labor force to become 160,000 per month in 2001, private pay- eligible for these benefits. roll employment declined at an average monthly rate of 88,000 in the first quar- Productivity and Labor Costs ter and was about unchanged in the second quarter. Employment losses in the Labor productivity has increased rapidly manufacturing sector have moderated in in recent quarters. After rising at an recent months, and employment in the average annual rate of around 1 percent help supply services industry—which in the first three quarters of last year, provides many of its workers to the output per hour in the nonfarm business manufacturing sector—has increased. sector jumped at an annual rate of These two categories, which were a 5Vi percent in the fourth quarter of last major locus of weakness last year, year and 8V2 percent in the first quarter gained an average of 11,000 jobs per of this year. Productivity likely continmonth over the past three months, com- ued to rise in the second quarter, albeit pared with an average loss of 76,000 at a slower pace. Labor productivity jobs per month in the first quarter of the often rises briskly in the early stages of year and 163,000 jobs per month over economic recoveries, but what makes 2001. the recent surge unusual is that it fol- Apart from manufacturing and help lowed a period of modest increases, supply, private payrolls fell 12,000 per rather than declines. In earlier postwar Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

56 89th Annual Report, 2002 recessions, productivity deteriorated as their value when exercised. The decelefirms retained more workers than may ration in this measure of compensation have been required to meet reduced is much more dramatic than in the ECI production needs. The strength in pro- because the ECI does not include stock ductivity growth around the beginning options. The moderate increase in nomiof this year suggests that employers nal compensation combined with the may have doubted the durability of the spike in productivity growth led unit pickup in sales and, therefore, deferred labor costs to drop at an annual rate in new hiring until they became more con- excess of 5 percent in the first quarter, vinced of the vigor of the expansion. after a decline of 3 percent in the fourth Smoothing through the recent cyclical quarter. fluctuations, productivity advanced at an Information about the behavior of average annual rate of close to 2>Vi per- compensation in more recent months cent between the fourth quarter of 2000 is limited. Readings on average hourly and the first quarter of this year. earnings of production or nonsupervi- Although this pace is unlikely to be sory workers suggest a further decelerasustained, it further bolsters the view tion in wages: The twelve-month change that the underlying trend in productivity in this series was 3lA percent in June, has moved up since the first half of the 3A percentage point below the change 1990s. for the preceding twelve months. The employment cost index (ECI) for private nonfarm businesses increased Prices just under 4 percent during the twelve months ended in March of this year, A jump in energy prices in the spring after rising about AXA percent in the pre- pushed up overall inflation in the first ceding twelve-month period. The recent part of 2002, but core inflation remained small step-down likely reflects the subdued. The chain-type price index lagged effects of the greater slack in for personal consumption expenditures labor markets and lower consumer price (PCE) increased at an annual rate of inflation. The wages and salaries com- 2VA percent over the first five months ponent and the benefits component of of the year, compared with a rise of just the ECI both decelerated by lA percent- over 1 percent for the twelve months of age point relative to the preceding year. 2001. Core PCE prices rose at an annual The slowing in benefits costs occurred rate of just over IV2 percent during the despite a 2Vi percentage point pickup first five months of this year, which was in health insurance cost inflation, to a the pace recorded for 2001. 10^2 percent rate of increase. Energy prices rose sharply in March Nominal compensation per hour in and April but have turned down more the nonfarm business sector—an alter- recently. Gasoline prices spiked in those native measure of compensation based two months, as crude oil costs moved on the national income and product higher and retail gasoline margins accounts—rose 3!/2 percent during the surged. Since April, gasoline prices year ending in the first quarter. This rate have, on balance, reversed a small part represented a sharp slowing from the of this rise. Natural gas prices stayed IVA percent pace recorded four quarters low in early 2002 against a backdrop of earlier, which likely had been boosted very high inventories; however, these significantly by stock options; stock prices have, on average, moved higher options are included in this measure at in more recent months. Electricity prices Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 57 have dropped this year, a move reflect- However, the levels of inflation correing deregulation of residential prices in sponding to these two alternative mea- Texas as well as lower prices for coal sures of consumer prices are markedly and natural gas, which are used as inputs different: Core PCE inflation was about in electricity generation. All told, energy IV2 percent over the twelve months prices increased at an annual rate of ended in May, while core CPI inflation 20 percent over the first five months of was about 2Vi percent. This gap is more the year, reversing a little more than half than Vi percentage point larger than the of last year's decline. average difference between these infla- Consumer food prices increased at tion measures during the 1990s (based an annual rate of IV2 percent between on the current methods used to construct December and May. A poor winter crop the CPI instead of the official published of vegetables pushed up prices early CPI). The larger differential arises from this year, but supplies subsequently several factors. First, the PCE price increased and prices came down. In index (unlike the CPI) includes several addition, consumer prices for meats and components for which market-based poultry, which began to weaken late last prices are not available, such as checkyear, remained subdued this spring. ing services provided by banks without Core inflation was held down over explicit charges; the imputed prices for the first five months of the year by con- these components have increased continued softness in goods prices, includ- siderably less rapidly in the past couple ing a significant decline in motor vehi- of years than previously. Second, the cle prices. Non-energy services prices substantial acceleration in shelter costs continued to move up at a faster pace since the late 1990s has provided a than core goods prices, although the larger boost to the CPI than to the PCE very sizable increases in residential rent price index because housing services and the imputed rent of owner-occupied have a much larger weight in the CPI. housing have eased off in recent months. Third, PCE medical services prices— The rate of increase in core consumer which are largely based on producer prices has been damped by several price indexes rather than information forces. One is the lower level of from the CPI—have increased more resource utilization that has prevailed over the past year. Core price increases were also held down by declines in non- Alternative Measures of Price Change oil import prices and the lagged effects Percent of last year's decline in energy prices on firms' costs. In addition, inflation expec- 2000 2001 tations have stayed in check: The Michi- Price measure to to 2001 2002 gan Survey Research Center index of median expected inflation over the sub- Chain-type sequent year has rebounded from last Gross domestic product 2.3 1.4 Gross domestic purchases 2.2 .7 fall's highly unusual tumble, but its Personal consumption average in recent months of 2% percent expenditures 2.4 .7 Excluding food and energy ... 1.9 1.3 is below the average reading of 3 per- Fixed-weight cent in 2000. Consumer price index 3.4 1.2 Like core PCE inflation, inflation Excluding food and energy ... 2.7 2.5 measured by the core consumer price NOTE. Changes are based on quarterly averages and index (CPI) has remained subdued. are measured from Ql to Ql. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

58 89th Annual Report, 2002 slowly than CPI medical services prices early in 2002, as evidenced by strong over the past couple of years. flows into both equity and bond mutual The chain-type price index for gross funds. Equity fund inflows lessened in domestic purchases—which captures May and turned into outflows in June, prices paid for consumption, investment, however, as concerns about the strength and government purchases—rose at an and accuracy of corporate earnings annual rate of roughly 1 percent in the reports mounted. But the net shift first quarter of 2002, putting the four- toward longer-term assets this year quarter change at 3A percent. This pace appears to have contributed to a signifirepresents a marked slowing relative to cant deceleration in M2, which has also the 2lA percent rise in the year-earlier been slowed by reduced mortgage refiperiod, owing to both a drop in energy nancing activity and a leveling out of the prices (as the decline in the second half opportunity cost of holding M2 assets. of 2001 was only partly offset by the increase this spring) and more rapid Interest Rates declines in the prices of investment goods such as computers. The GDP Uncertain about the robustness of the price index rose at an annual rate of economic recovery, the FOMC opted to 1V4 percent in the first quarter and was retain its accommodative policy stance up almost IV2 percent relative to the over the first half of 2002, leaving first quarter of last year. The GDP price its target for the federal funds rate at index decelerated somewhat less than l3/4 percent. Market participants, too, the index for gross domestic purchases, have apparently been unsure about the in part because declining oil prices strength of the recovery, and shifts in receive a smaller weight in U.S. produc- their views of the economic outlook tion than in U.S. purchases. have played a significant role in movements in market interest rates so far this year. During the first quarter of the year, U.S. Financial Markets news on aggregate spending and output Market interest rates have moved lower, came in well above expectations, and on net, since the end of 2001, as market Treasury coupon yields rose between participants apparently viewed the ongo- 35 and 65 basis points. The second quaring recovery as likely to be less robust ter, however, brought renewed concerns than they had been expecting late last about the economic outlook, comyear. Such a reassessment of the strength pounded by sharp declines in equity of economic activity and associated prices. In recent months, Treasury coubusiness earnings, along with worries pon yields have more than reversed their about the accuracy of published cor- earlier increases and are now 40 to porate financial statements, weighed 50 basis points below their levels at the heavily on major equity indexes, which end of 2001. dropped 12 to 31 percent. The debt Survey measures of long-term inflaof the nonfinancial sectors expanded tion expectations have been quite stable at a moderate pace, but lenders have this year, implying that real rates imposed somewhat firmer financing changed about as much as nominal terms, especially on marginal borrowers. rates. The spread between nominal Households' preferences for safer and inflation-indexed Treasury yields, assets, which had intensified following another gauge of investors' expectations last year's terrorist attacks, diminished about inflation, has moved over a rela- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 59 tively wide range since the end of 2001, banks have moved a bit higher this year, but, on net, it has edged up only slightly. as banks have raised the spread of the Even the small widening of this spread average interest rate on business loans likely overstates a shift in sentiment over the target federal funds rate. The regarding future price pressures in the wider spread reflects higher risk premieconomy. In mid-February, the Trea- ums on C&I loans to lower-quality borsury reassured investors that it would rowers; spreads for higher-quality borcontinue to issue indexed debt, an rowers have changed little on net. announcement that was reinforced in May when the Treasury made public its Equity Markets decision to add one more auction of ten-year indexed notes to its annual After falling in January in reaction schedule of offerings. This reafFirmation to pessimistic assessments of expected of the Treasury's commitment to issue business conditions over the coming indexed securities may have pulled year—especially in the tech sector— indexed yields down by bolstering the stock prices rebounded smartly toward actual and expected liquidity of the the end of the first quarter on strongermarket. than-expected macroeconomic data. Yields on longer-maturity bonds is- Most first-quarter corporate earnings sued by investment-grade corporations releases met or even exceeded market have stayed close to their lows of the participants' expectations, but many past ten years, but speculative-grade firms included sobering guidance on yields remained near the high end of sales and earnings prospects in those their range since the mid-1990s. Spreads announcements. These warnings, comrelative to Treasury yields have widened bined with mounting questions about most recently for both investment- and corporate accounting practices, worries speculative-grade bonds as concerns about threats of domestic terrorism, and about corporate earnings reporting escalating geopolitical tensions, have intensified. Such concerns have also taken a considerable toll on equity prices played a prominent role in the commer- since the end of March. On net, all cial paper market, especially early this major equity indexes are down subyear, when investors, who had become stantially so far this year. Share prices increasingly worried about accounting in the telecom and technology sectors scandals, imposed high premiums on have performed particularly poorly, and, lower-quality borrowers. Subsequently, on July 10, the Nasdaq was 31 percent however, many such borrowers either lower than at the end of 2001. The left the commercial paper market or Wilshire 5000, a broad measure of reduced their reliance on commer- equity prices, fell I8V2 percent over the cial paper financing, and the average same period, returning to a level 40 peryield spread on second-tier commercial cent below its historical peak reached in paper over top-tier paper has narrowed March 2000. considerably. Declining share prices pulled down Interest rates on car loans have the price-earnings ratio for the S&P 500 changed little, on net, this year, and index (calculated using operating profits mortgage rates have moved lower. How- expected over the coming year). Noneever, according to the Federal Reserve's theless, the ratio remained elevated Survey of Terms of Business Lending, relative to its typical values before the interest rates on C&I loans at domestic mid-1990s, suggesting that investors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

60 89th Annual Report, 2002 continued to anticipate rapid long-term The Federal Reserve also addressed growth in corporate profits. possible changes to the structure of its discount window facility. On May 17, 2002, the Federal Reserve Board Monetary Policy Instruments released for public comment a proposed At its March 19 meeting, the FOMC amendment to the Board's Regulation A assessed the priorities, given limited that would substantially revise its resources, it should attach to further discount window lending procedures. studies of the feasibility of outright pur- Regulation A currently authorizes the chases for the System Open Market Federal Reserve Banks to operate Account (SOMA) of mortgage-backed three main discount window programs: securities guaranteed by the Govern- adjustment credit, extended credit, and ment National Mortgage Association seasonal credit. The proposed amend- (GNMA-MBS) and the addition of for- ment would establish two new discount eign sovereign debt securities to the window programs called primary credit list of collateral eligible for U.S. dollar and secondary credit as replacements repurchase agreements by the System. for adjustment and extended credit. The As noted in the February and July 2001 Board also requested comment on the Monetary Policy Reports to the Con- continued need for the seasonal program gress, such alternatives could prove but did not propose any substantive useful if outstanding Treasury debt obli- changes to the program. gations were to become increasingly The proposal envisions that primary scarce relative to the necessary growth credit would be available for very short in the System's portfolio, and the terms, ordinarily overnight, to deposi- FOMC had requested that the staff tory institutions that are in generally explore these options. Noting that many sound financial condition at an interest of the staff engaged in these studies rate that would usually be above shortwere also involved in contingency plan- term market interest rates, including ning, which had been intensified after the federal funds rate; currently, the disthe September 11 attacks, the FOMC count rate is typically below money decided to give the highest priority market interest rates. The requirement to such planning. Federal budgetary that only financially sound institutions developments over the past year meant should have access to primary credit that constraints on Treasury debt sup- should help reduce the stigma currently ply would not become as pressing associated with discount window boran issue as soon as the FOMC had rowings. In addition, because the propreviously thought. Still, given the posed discount rate structure will elimiinherent uncertainty of budget fore- nate the incentive that currently exists casts, the likely significant needs for depository institutions to borrow to for large SOMA operations in com- exploit a positive spread between shorting years, and the lead times required term money market rates and the disto implement new procedures, the count rate, the Federal Reserve will be FOMC decided that the exploratory able to reduce the administrative burden work on the possible addition of out- on borrowing banks. As a result, deposiright purchases of GNMA-MBS should tory institutions should be more likely go forward once it was possible to do so to turn to the discount window when without impeding contingency planning money markets tighten significantly, efforts. enhancing the window's ability to serve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 61 as a marginal source of reserves for the The proportion of total credit supoverall banking system and as a backup plied by depository institutions over source of liquidity for individual deposi- the first half of the year is estimated to tory institutions. Secondary credit would have been near its lowest value since be available, subject to Reserve Bank 1993. Although banks have continued approval and monitoring, for depository to acquire securities at about the same institutions that do not qualify for pri- rapid pace observed in 2001, the shift mary credit. in household and business preferences The proposed amendment is intended toward longer-term sources of credit to improve the functioning of the dis- greatly reduced the demand for bank count window and the money market loans. As noted, banks' loans to busimore generally. Adoption of the pro- nesses ran off considerably, as corporate posal would not entail a change in the borrowers turned to the bond market in stance of monetary policy. It would not volume to take advantage of favorable require a change in the FOMC's target long-term interest rates. Growth of real for the federal funds rate and would not estate loans slowed markedly this year, affect the overall level of market interest partly as outlays for nonresidential rates. The comment period on the pro- structures declined, but growth of conposal ends August 22, 2002. If the sumer loans was fairly well maintained. Board then votes to revise its lending With some measures of credit quality in programs, the changes likely would take the business and household sectors still place several months later. pointing to pockets of potential strain, loan-loss provisions remained high at banks and weighed on profits. Nonethe- Debt and Financial Intermediation less, bank profits in the first quarter Growth of the debt of domestic nonfi- stayed in the elevated range observed nancial sectors other than the federal over the past several years, and virtually government is estimated to have slowed all banks—98 percent by assets— during the first half of 2002, as busi- remained well capitalized. nesses' needs for external funds Among nondepository financial interdeclined further owing to weak capital mediaries, government-sponsored enterspending, continuing inventory liqui- prises (GSEs) curtailed their net lending dation, and rising profits. In addition, (net acquisition of credit market instrugrowth in consumer credit moderated ments) during the first quarter of the following a surge in auto financing late year, but available data suggest that last year. On balance, nonfederal debt insurance companies more than made expanded at a 5Vi percent annual rate in up for the shortfall. The GSEs appeared the first quarter of the year after grow- to continue to restrain their net lending ing IVi percent in 2001. In contrast, the in the second quarter, in part as yields stock of federal debt held by the public, on mortgage-backed securities, which which had contracted slightly in 2001, are a major component of their holdings grew ?>lA percent at an annual rate in the of financial assets, compared less favorfirst quarter and expanded further in the ably to yields on the debt they issue. second quarter, as federal tax revenues Net lending by insurance providers in fell short of expectations and govern- the first quarter was especially strong ment spending increased substantially. among life insurance companies, which The sharp rise in federal debt outstand- experienced a surge in sales late last ing followed a few years of declines. year in the aftermath of the Septem- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

62 89th Annual Report, 2002 ber 11 terrorist attacks. Net lending by large declines registered throughout the GSEs amounted to 14 percent of the 2001. net funds raised by both the financial M3—the broadest monetary and nonfinancial sectors in the credit aggregate—grew 3V2 percent at an markets in the first quarter of 2002, and annual rate through the first six months the figure for insurance companies was of the year after rising 12% percent in 10 percent; depository credit accounted 2001. Most of this deceleration, apart for 13 percent of all net borrowing over from that accounted for by M2, resulted the same period. from the weakness of institutional money market funds, which declined slightly, after having surged about Monetary Aggregates 50 percent last year. Yields on these The broad monetary aggregates deceler- funds tend to lag market yields someated considerably during the first half what, and so the returns on the funds, of this year. M2 rose 4!/2 percent at an like those on many M2 assets, became annual rate after having grown 10V4 per- less attractive as their yields caught up cent in 2001. Several factors contributed with market rates. to the slowing in M2. Mortgage refinancing activity, which results in pre- International Developments payments that temporarily accumulate in deposit accounts before being distrib- Signs that economic activity abroad had uted to investors in mortgage-backed reached a turning point became clearer securities, moderated over the first half during the first half of 2002, but recovof this year. In addition, the opportunity ery has been uneven and somewhat tepid cost of holding M2 assets has leveled on average in the major foreign indusout in recent months, so the increase in trial countries. Improving conditions in this aggregate has been more in line the high-tech sector have given a boost with income. Because the rates of return to some emerging-market economies, provided by many components of M2 especially in Asia, but several Latin move sluggishly, the rapid declines in American economies have been troubled short-term market interest rates last by a variety of adverse domestic develyear temporarily boosted the attractive- opments. Foreign financial markets ness of M2 assets. In recent months, became increasingly skittish during the however, yields on M2 components first half of the year amid worries about have fallen to more typical levels global political and economic developrelative to short-term market interest ments, including concerns about corrates. Lastly, precautionary demand for porate governance and accounting trig- M2, which was high in the aftermath of gered by U.S. events. Oil prices reversed last year's terrorist attacks, seems to a large part of their 2001 decline. have unwound in 2002, with investors During the first half, monetary shifting their portfolios back toward authorities in some foreign countries longer-term assets such as equity and where signs of recovery were most bond mutual funds. With growth in evident and possible future inflation nominal GDP picking up significantly pressures were becoming a concern— this year, M2 velocity—the ratio of Canada, Australia, New Zealand, and nominal GDP to M2—rose about Sweden, among others—began to roll 1V2 percent at an annual rate in the first back a portion of last year's easing, raisquarter of 2002, in sharp contrast to the ing expectations that policy tightening Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 63 might become more widespread. How- the consequences of global geopolitical ever, policy was held steady at the Euro- developments. With U.S. investments pean Central Bank (ECB) and the Bank perceived as becoming less attractive, of England. The Bank of Japan (BOJ) the financing requirements of a large maintained short-term interest rates near and growing U.S. current account deficit zero and kept balances of bank deposits also seemed to emerge as a more promiat the BOJ at elevated levels. Yield nent negative factor. The dollar has lost curves in most foreign industrial coun- more than 9 percent against the major tries became a bit steeper during the first currencies since the end of March and is quarter as long-term rates rose in reac- down, on balance, more than 8 percent tion to news suggesting stronger U.S. so far in 2002. In contrast, the dollar has growth and improving prospects for glo- gained about 2 percent this year, on a bal recovery. Since then, long-term rates weighted-average basis, against the curhave edged lower, on balance, in part as rencies of our other important trading investors shifted out of equity invest- partners. ments. Foreign equities performed The dollar's exchange rate against the well in most countries early in the year, Japanese yen was quite volatile in the but share prices in many countries first half and, on balance, the dollar has have fallen since early in the second fallen more than 10 percent since the quarter—in some cases more steeply beginning of the year. Although Japan's than in the United States. The broad domestic economy continued to struggle stock indexes for the major industrial with deflation and severe structural countries are down since the beginning problems, including mounting bad loans of the year, except in Japan, where stock in the financial sector and growing prices, on balance, are about unchanged. bankruptcies, some indicators (includ- High-tech stocks have been hit espe- ing strong reported first-quarter GDP, a cially hard. firming of industrial production, and a During the first quarter of 2002, the somewhat better reading on business foreign exchange value of the dollar sentiment in the BOJ's second-quarter (measured by a trade-weighted index Tankan survey) suggested that a cycliagainst the currencies of major indus- cal recovery has begun. The yen's trial countries) appeared to react prima- rise occurred despite downgradings of rily to shifting market views about the Japan's government debt by leading relative strength of the U.S. recovery rating services in April and May and and its implications for the timing and several episodes of intervention sales of extent of future monetary tightening. yen in foreign exchange markets by Despite some fluctuations in this period, Japanese authorities in May and June. the dollar stayed fairly close to the more Japanese stock prices, which had fallen than sixteen-year high reached in Janu- to eighteen-year lows in early February, ary. In the second quarter, however, turned up later as economic prospects the dollar trended downward as earlier became less gloomy. At midyear, the market enthusiasm about U.S. recovery TOPIX index was about where it was at dimmed. Concerns about profitability, the start of the calendar year. corporate governance, and disclosure After declining in the final quarter of at U.S. corporations appeared to dampen 2001, euro-area GDP appears to have the attraction of U.S. securities to inves- increased in the first half, though at only tors, as did worries that the United a modest rate. Exports firmed and inven- States was particularly vulnerable to tory de-stocking appeared to be winding Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

64 89th Annual Report, 2002 down, but consumption remained weak. the exchange value of the Swiss franc The pace of activity varied across has been driven up by flows into Swiss countries, with growth in Germany—the assets prompted in part by uncertainties euro area's largest economy—lagging about global political developments. The behind. Despite lackluster area-wide Swiss National Bank eased its official growth, concerns about inflation became rates in May to counteract this presincreasingly prominent. For most of the sure and provide support for the Swiss first half, euro-area headline inflation economy. persisted at or above the ECB's 2 per- Economic recovery appears to be cent target limit, partly on higher energy well under way in Canada. Real GDP and food price inflation; even excluding increased 6 percent at an annual rate in the effects of those two components, the first quarter, and other indicators inflation picked up somewhat during the point to continued strong perforperiod. Inflation concerns also were mance in the second quarter. Canafanned by difficult labor market negotia- dian exports—particularly automotive tions this spring, but the strength of the exports—benefited early in the year euro may blunt inflationary pressures from the firming of U.S. demand, but to some extent. The new euro notes and the expansion has become more widecoins were introduced with no notice- spread, and employment growth has able difficulties at the beginning of the been strong. Although headline conyear, but the euro drifted down against sumer price inflation has remained in the dollar for several weeks thereafter. the bottom half of the Bank of Canada's Since then, however, the euro has target range of 1 percent to 3 percent, reversed direction and moved steadily core inflation has crept up this year. higher. On balance, the dollar has lost In April, the Bank of Canada increased nearly 11 percent against the euro so far its overnight rate 25 basis points, citing in 2002. stronger-than-expected growth in both The United Kingdom seemed to the United States and Canada, and it weather last year's slump better than increased that rate again by the same most industrial countries, as strength amount in June. The Canadian dollar, in consumption counteracted weakness which had been at a historically low in investment and net exports, though level against the U.S. dollar in January, growth did weaken in the last quarter of moved up quite steeply in the second 2001 and into the first quarter of 2002. quarter and has gained about 5 percent Notable increases in industrial produc- for the year so far. tion and continued strength in the ser- The Mexican economy was hit hard vice sector indicate that growth picked by the global slump in 2001 and espeup in the second quarter. Household bor- cially by the weaker performance of the rowing has increased briskly, supported U.S. economy. Mexican exports stabiby rapid increases in housing prices, and lized early this year as U.S. activity unemployment rates remain near record picked up, and other indicators also now lows. At the same time, retail price suggest that the Mexican economy is inflation has remained below the Bank beginning to recover. In February, of England's 2J/2 percent target. Sterling despite the weak level of activity at the has fallen nearly 5 percent against the time, the Bank of Mexico tightened euro since the beginning of the year, monetary policy to keep inflation on while it has gained more than 6 percent track to meet its 4V2 percent target for against the dollar. Elsewhere in Europe, 2002, and the Mexican peso moved up a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2002 65 bit against the dollar during February more volatile. Brazilian markets have and March. In April, with inflation been roiled by political uncertainties apparently under control, the central related to national elections coming bank eased policy, and since then the in the fall. Attention has focused on peso has moved down substantially. vulnerabilities associated with Brazil's Against the dollar, the decline since the large outstanding stock of debt, much beginning of the year has amounted to of which is short-term. Since April, the almost 7 percent. After rising through value of the real against the dollar has April, Mexican share prices also fell fallen nearly 20 percent, and Brazilian sharply, leaving them at midyear about spreads have widened substantially. Sevunchanged from their end-2001 levels. eral other South American countries, Financial and economic conditions including Uruguay and Venezuela, also deteriorated significantly in Argentina have been beset by growing financial this year. The Argentine peso was deval- and economic problems. ued in January and then allowed to float Asian economies that rely importantly in early February; since then, it has lost on exports of computers and semiconmore than 70 percent of its value versus ductors (Korea, Singapore, Malaysia, the dollar. The peso's fall severely and Taiwan) have grown quite vigstrained balance sheets of Argentine orously so far this year, a buoyancy issuers of dollar-based obligations. Vari- reflecting in part the recent turnaround ous stop-gap measures intended to of conditions in the technology sector restrict withdrawals from bank accounts and stronger U.S. growth. The currenand to force conversion of dollar- cies of several countries of this group denominated loans and deposits into have moved up against the dollar. In peso-denominated form put banks and Korea, the expansion has been more depositors under further stress. Mean- broad-based, as domestic demand was while, economic activity has continued fairly resilient during the recent global to plummet, and the government has downturn and has remained firm. China, struggled to gain support for reforms which is less dependent on technology that would address chronic fiscal imbal- exports, has continued to record strong ances. Since late 2001, the government growth as well. Other countries in the has been servicing its obligations only region also have started to recover from to its multilateral creditors, and spreads steep slowdowns or contractions in on Argentina's international debt have 2001, although Hong Kong has continsoared to more than 65 percentage ued to be troubled by the collapse of points. property prices. Most stock markets in In recent months financial markets the region have recorded gains so far elsewhere in the region have become this year. 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

69 Consumer and Community Affairs Among the Federal Reserve's responsi- • Analyzes applications for mergers and bilities in the areas of consumer and acquisitions by state member banks community affairs are and bank holding companies in relation to CRA performance • Supervising banks to ensure their compliance with the regulations • Disseminates information on community development techniques to bank- • Writing and interpreting regulations ers and the public through Commuto implement federal laws intended to nity Affairs Offices at the Reserve protect and inform consumers Banks. • Investigating complaints from the Examination for public about bank compliance with Compliance with the CRA the regulations The Federal Reserve assesses the CRA performance of state member banks dur- • Promoting community development in ing examinations for compliance with historically underserved markets. consumer protection regulations. By statute, banks with assets of less then These responsibilities are carried out $250 million that were rated "satisfacby members of the Board of Governors, tory" for CRA performance in their the Board's Division of Consumer and most recent examination are examined Community Affairs, and the consumer not more than once every forty-eight and community affairs staffs at the Fedmonths, and those that were rated "outeral Reserve Banks. standing" for CRA purposes in their most recent examination are examined Supervision for Compliance not more than once every sixty months. with Consumer Protection and Banks with assets of $250 million Community Reinvestment Laws or more that were rated "satisfactory" or "outstanding" in their most recent Activities Related to the examination are examined not more than Community Reinvestment Act once every twenty-four months. During the 2002 reporting period, the Federal The Community Reinvestment Act Reserve conducted 312 CRA examina- (CRA) requires that the Board and other tions. Of the banks examined, 40 were banking agencies encourage financial rated "outstanding" in meeting commuinstitutions to help meet the credit needs nity credit needs, 270 were rated "satof the local communities in which they isfactory," 1 was rated "needs to do business, consistent with safe and improve," and 1 was rated as being in sound business practices. To carry out "substantial noncompliance."x this mandate, the Federal Reserve • Examines state member banks to 1. The 2002 reporting period was from July 1, assess compliance with the CRA 2001, through June 30, 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

70 89th Annual Report, 2002 Analysis of Applications for Bank, had received a CRA rating in Mergers and Acquisitions in 2001 of "needs to improve" from its Relation to the CRA primary supervisor, the Office of Thrift Supervision. The Board considered During 2002, the Board of Governors information indicating that Tucker Fedconsidered applications for several sigeral Bank's CRA performance had nificant banking mergers: improved since then and noted that Tucker would be merged into RBC Cen- • In June, the Board approved an appli- tura Bank (which had a CRA rating of cation by Royal Bank of Canada "satisfactory") upon consummation of (Montreal, Canada) and RBC Centura the merger of the holding company. Bank, Inc. (Rocky Mount, North In the Citigroup case, many of the Carolina), to acquire Eagle Banepublic commenters' concerns related to shares, Inc., and its subsidiary, the activities of Citigroup's subprime Tucker Federal Bank (both in Tucker, lending subsidiaries. A special examina- Georgia). tion of those activities, by the Federal Reserve Bank of New York, was still • In October, the Board approved an under way at the time. In acting on the application by Citigroup, Inc. (New application, the Board noted that a care- York, New York), to acquire Golden ful review of the record indicated that State Bancorp, Inc. (San Francisco, Citigroup, on balance, had a satisfac- California). tory record of compliance and concluded that the ongoing examination • In December, the Board approved of the subprime subsidiaries did not an application by Cooperatieve Cen- warrant delay or denial. The Board inditrale Raiffeisen-Boerenleenbank B.A. cated that many of the issues raised by (Rabobank Nederland Utrecht, The commenters could be more adequately Netherlands) to acquire VIB Corp. addressed through the special examinaand its subsidiary, Valley Independent tion. The Board noted, moreover, that if Bank (both in El Centro, California). violations or other concerns were identified during the special examination, the Comments were received from the Board has broad authority to enforce public on each of these applications. compliance with fair lending and other Many commenters expressed concern applicable laws through the supervisory that the proposed merger or acquisition process. could lead to decreased lending levels In the third application, the Board in low-income communities, includ- found that the CRA record of the ing mortgage, small-business, and com- depository institution was consistent munity development lending; abusive with approval. lending practices; the provision of costly The Board acted on other bank and and inadequate banking services to bank holding company applications that low-income consumers; and the clo- involved protests by members of the sure of branch offices in low-income public concerning CRA performance; communities. one also involved a bank having a In the case of the Royal Bank of CRA rating lower than "satisfactory." Canada application, the bank subsidiary Another thirty-three applications raised of Eagle Bancshares, Tucker Federal other issues related to CRA, fair lend- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 71 ing, or compliance with consumer credit the Reserve Banks' consumer compliprotection laws and regulations.2 ance supervision program, Division staff visited each Reserve Bank during the year to review documents developed Other Consumer Compliance by Reserve Bank consumer compliance Activities examiners during bank examinations The Division of Consumer and Com- and other supervisory activities. munity Affairs' Compliance Oversight Also during 2002, the Board issued Section supports and oversees the super- guidance for Reserve Bank examiners visory efforts of the Federal Reserve on consumer protection laws and regula- Banks to ensure that consumer protec- tions. For example, the Board clarified tion laws and regulations are fully and the signature provisions of Regulafairly enforced. Section staff provide tion B, which implements the Equal guidance and expertise to the Reserve Credit Opportunity Act, and provided Banks on consumer protection regu- supplemental guidance to assist examinlations, enforcement techniques, exam- ers in writing CRA performance evaluainer training, and emerging issues. They tions for large banks. develop, update, and revise examination policies, procedures, and guidelines Fair Lending and review Reserve Bank supervisory reports and work products. Section staff Under the Equal Credit Opportunity also participate in interagency activities Act, the Board refers any violation that designed to promote uniformity in it has reason to believe constitutes examination principles and standards. a "pattern or practice" of discrimination Examinations are the Federal Re- to the Department of Justice. During serve's primary means of enforcing 2002 the Board made six such referrals. bank compliance with consumer pro- Two involved violations of the prohibitection laws. During the reporting tion against requiring an applicant's period, the Reserve Banks con- spouse to sign a credit obligation (unless ducted 387 consumer compliance the spouse is a co-applicant or the examinations—316 of state member spouse's signature is necessary under banks and 71 of foreign banking organi- state law to permit the creditor to take zations.3 To assess the effectiveness of possession of the property in case of default). Two other referrals involved 2. In addition, nine applications involving other discrimination on the basis of marital CRA issues, fair lending issues, or compliance status by lenders that combined the with consumer credit protection laws and regulaincome of married joint applicants but tions were withdrawn in 2002. Other applications were handled by the Reserve Banks under author- not the income of unmarried joint appliity delegated to them by the Board. cants. One of the two lenders was also 3. The foreign banking organizations examined found to have priced loans on the basis by the Federal Reserve are organizations operating of marital status. A fifth referral resulted under section 25 or 25 (a) of the Federal Reserve Act (Edge Act and agreement corporations) and from a lender's practice of failing to state-chartered commercial lending companies consider child support a source of owned or controlled by foreign banks. These insti- income and imposing a minimum tutions are not subject to the Community Reinvest- income requirement, which had a disment Act and typically engage in relatively few parate impact on the basis of sex. The activities that are covered by consumer protection laws. sixth referral involved a lender that Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

72 89th Annual Report, 2002 engaged in a pattern or practice of two state member banks for violations redlining (discouraging loan applica- of the Board's Regulation H, which tions from consumers living in minority implements the National Flood Insurneighborhoods) in a major city. ance Act: In October 2001, a consent In 2001 the Board supplemented order assessing penalties of $10,500 was interagency procedures for fair lend- issued against Mcllroy Bank and Trust ing examinations with alternative (Fayetteville, Arkansas), and in April procedures for banks having low- 2002, a consent order assessing penaldiscrimination-risk profiles. Typically, ties of $10,000 was issued against Comsuch banks are stable community banks, munity Bank of Granbury (Granbury, commonly specializing in commercial Texas). or agricultural lending, that are located in suburban or rural markets having a Coordination with low percentage of minority residents. Other Federal Banking Agencies The alternative procedures facilitate Member agencies of the Federal Finanthe allocation of resources for morecial Institutions Examination Council intensive analysis of institutions that (FFIEC) develop uniform examination have higher-risk profiles. During 2002, principles, standards, procedures, and roughly 25 percent of all fair lending report formats.4 In 2002, the FFIEC examinations were conducted using the issued examiner guidance under the alternative procedures. Real Estate Settlement Procedures Act regarding settlement service mark-ups Flood Insurance and unearned fees. The FFIEC is in the process of revising examination proce- The National Flood Insurance Reform dures related to the Truth in Lending Act of 1994 substantially amended the Act, the Home Ownership and Equity National Flood Insurance Act of 1968, Protection Act, the Home Ownership which created the National Flood Insur- Counseling Act, and the Homeowners ance Program (NFIP). The amendments Protection Act. sought to increase compliance with In 2001, the Federal Reserve joined federal flood insurance requirements, with the Federal Deposit Insurance increase participation in the NFIP, Corporation (FDIC), the Office of the increase income to the National Flood Comptroller of the Currency (OCC), and Insurance Fund, and decrease the finanthe Office of Thrift Supervision (OTS) cial burden on the federal government, to publish an advance notice of protaxpayers, and victims resulting from posed rulemaking, seeking public comfloods. Under the amendments, the Fedment on a wide range of questions eral Reserve Board and the other federal related to revising the Community Reinfinancial institution supervisory agenvestment Act. In 2002, the agencies cies are required to impose civil money reviewed the comments and weighed penalties when they find a pattern or various possible amendments to the practice of violations of the NFIP. Any such civil money penalties are remitted to the Federal Emergency Management 4. The FFIEC member agencies are the Board Agency for deposit in the National of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office Flood Mitigation Fund. of the Comptroller of the Currency, the Office of During the 2002 reporting period, the Thrift Supervision, and the National Credit Union Board imposed civil money penalties on Administration. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 73 regulations. At year-end 2002, they were thinking, and decisionmaking skills. reaching a final decision about whether Commissioned examiners serve as to issue a proposed rule and, if so, what "examiners in charge" of bank examchanges to propose. They were weigh- inations. ing whether any change with the To help ensure that supervision staff potential for substantial benefits would have the knowledge and skills needed to be justified in light of the burdens of be successful in an evolving financial implementation. industry, the System must continually Also in 2002, the Board, the OCC, identify, develop, coordinate, and review and the FDIC conducted the annual training and development opportunities. update for the host-state loan-to-deposit At least every three years, Board and ratios used to determine compliance Reserve Bank staff review the core conwith section 109 of the Riegle-Neal sumer affairs curriculum, updating sub- Interstate Banking and Branching Effi- ject matter and adding new elements ciency Act of 1994. as appropriate. Each course is updated periodically to take account of major technical changes as well as changes Consumer and CRA Training in instructional delivery techniques. The for Bank Examiners staff also look for opportunities to Ensuring that financial institutions com- deliver courses via alternative channels ply with laws and regulations that pro- such as the Internet or other distancetect consumers and encourage commu- learning technologies. nity reinvestment is an important part of The core consumer affairs curriculum the bank examination and supervision comprises five courses focused on variprocess. As the number and complexity ous consumer laws, regulations, and of consumer financial transactions grow, examining concepts. In 2002, these training for examiners of the state mem- courses were offered in twelve sessions ber banks under the Federal Reserve's to more than 200 consumer compliance supervisory responsibility becomes even examiners: more important. Federal Reserve bank examiners are • Consumer Compliance Examinaemployees of the Federal Reserve tions I. Emphasizes examination pro- Banks, which carry out compliance cedures and the practical application supervision under authority delegated by of banking regulations; focuses on the the Board. Their training, however, is a consumer laws and regulations that shared responsibility of the Board and govern financial institution operathe Reserve Banks. Individuals seeking tional procedures and non-real-estate to become commissioned examiners for lending. The course is geared toward the Federal Reserve must complete a assistant examiners with three to six formal course of training. Assistant months of examination experience. examiners complete three levels of course work, with attention to internal • Consumer Compliance Examinacontrols, information technology, risk tions II. Equips assistant examiners management, risk-focused examination with the fundamental skills needed to techniques, and integrated supervision determine compliance with the basic concepts. In addition to passing two elements of consumer laws and reguproficiency examinations, examiners lations governing real estate transmust exhibit strong analytical, critical- actions; also covers System policies Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

74 89th Annual Report, 2002 on all major aspects of the consumer public certain data about their home purcompliance risk-focused examination chase, home improvement, and refinancprocess. Assistant examiners have six ing loan transactions. Depository instituto twelve months of examination tions generally are covered if (1) they experience when they complete the are located in metropolitan areas, course. (2) they met the asset threshold at the end of the preceding calendar year (for • Fair Lending Examination Tech- 2001, assets of more than $31 million; niques. Provides assistant examiners for 2002, more than $32 million), and with the skills and knowledge needed (3) they originated at least one home to plan and conduct a risk-focused fair purchase loan (or refinancing) in the lending examination. Assistant exam- preceding calendar year. For-profit iners generally have eighteen months mortgage companies are covered if of examination experience when they (1) they are located in metropolitan complete the course. areas, (2) they had assets of more than $10 million (when combined with the • Community Reinvestment Act Exami- assets of any parent company) at the end nation Techniques. Prepares assistant of the preceding calendar year or origiexaminers to write performance eval- nated 100 or more home purchase loans uations for the CRA portion of con- and refinancings in the preceding sumer compliance examinations. Stu- calendar year, and (3) their home purdents must be familiar with the CRA chase loan originations and refinancings regulation and CRA examination accounted for 10 percent or more of procedures. their total loans by dollar volume in the preceding calendar year. • Commercial Lending Essentials for In 2002, a total of 6,659 depository Consumer Affairs. Optional training institutions and affiliated mortgage comopportunity. Familiarizes assistant panies and 972 independent mortgage examiners with basic techniques for companies reported HMDA data for underwriting and pricing commercial calendar year 2001. Lenders submitted loans, including identifying the bank's information about the disposition of loan credit culture and risk profile. applications, the geographic location of the properties related to loan applica- In addition to providing core training, tions and loans, and, in most cases, the the training program emphasizes the race or national origin, income, and sex importance of continuing professional of applicants and borrowers. The FFIEC development. Opportunities for continu- processed the data and produced discloing development might include special sure statements on behalf of the FFIEC projects and assignments, self-study pro- member agencies and the Department grams, rotational assignments, instruct- of Housing and Urban Development ing at System schools, or mentoring. (HUD). The FFIEC prepared individual disclosure statements for each lender that Reporting on Home Mortgage reported data—one statement for each Disclosure Act Data metropolitan area in which the lender The Home Mortgage Disclosure Act had offices and reported loan activity. (HMDA) requires that mortgage lenders In 2002, the FFIEC prepared more than covered by the act collect and make 53,000 disclosure statements, reporting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 75 data for calendar year 2001.5 Each insti- was higher in 2001 than in 2000; the tution made its disclosure statement increase was 2 percent for lower-income public in July, and reports contain- and higher-income applicants and 4 pering aggregate data for all mortgage cent for middle-income applicants. From and home improvement loans in each 1993 through 2001, the number of home of 330 metropolitan areas were made purchase loans to lower-, middle-, and available at central depositories.6 FFIEC upper-income applicants increased member agencies, the reporting institu- 82 percent, 50 percent, and 60 percent tions, HUD, the Department of Justice respectively. (DOJ), and members of the public use In 2001, 32 percent of Hispanic applithese data. The data also assist HUD, cants and 29 percent of black applicants the DOJ, and state and local agencies in for home purchase loans reported responding to allegations of lending dis- under HMDA sought governmentcrimination and in targeting lenders for backed mortgages; the comparable figfurther inquiry. ures were 16 percent for white and for The HMD A data reported for 2001 Native American applicants and 8 percovered 27.6 million loans and applica- cent for Asian applicants. Twenty-seven tions, about 44 percent more than in percent of lower-income applicants for 2000. The greater volume was due pri- home purchase loans, compared with marily to an increase of about 120 per- 9 percent of higher-income applicants, cent in refinancing activity. The number applied for government-backed mortof home purchase loans covered by gages in 2001. HMD A and extended in 2001, com- Overall, the denial rate for convenpared with 2000, increased 8 percent tional home purchase loans (that is, for Hispanics, 4 percent for Asians, and loans that are not government-backed) 1 percent for whites but fell 7 percent was 21 percent in 2001. The rate rose for blacks. The precise change for steadily from 1993 through 1998 but has Native Americans could not be deter- fallen since then. In 2001, denial rates mined because of reporting errors in the for conventional home purchase loans 2000 data. Over the period 1993 through reported under HMDA were 36 percent 2001, the number of home purchase for black applicants, 35 percent for loans extended increased 158 percent Native American applicants, 23 percent for Hispanics, 92 percent for Asians, for Hispanic applicants, 16 percent for 76 percent for blacks, 28 percent for white applicants, and 11 percent for Native Americans, and 26 percent for Asian applicants. Each of these rates whites. was lower than the comparable rate for For each income category, the num- 2000. ber of home purchase loans reported Agency Reports on Compliance with Consumer Protection Laws 5. The FFIEC also compiles information on applications for private mortgage insurance (PMI) and Regulations similar to the information on home mortgage lending collected under HMDA. Lenders typically The Board is required to report annually require PMI for conventional mortgages that on compliance with consumer protecinvolve small down payments. tion laws by entities supervised by the 6. Central depository sites include libraries, various federal agencies. This section universities, and city planning offices. A list of summarizes data collected from the the sites can be found at www.ffiec.gov/hmdacf/ centdep/default2.cfm. twelve Federal Reserve Banks, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

76 89th Annual Report, 2002 FF1EC member agencies, and other fed- reporting period—two by the OTS and eral enforcement agencies.7 one by the OCC. The Federal Trade Commission settled one action and con- Regulation B tinued its litigation against a mortgage (Equal Credit Opportunity) lender for alleged violations of the Equal Credit Opportunity Act (ECOA) and The FFIEC agencies reported that Regulation B. The alleged violations 83 percent of the institutions examined include failing to take written applicaduring the 2002 reporting period were in tions for mortgage loans, failing to procompliance with Regulation B, the same vide rejected applicants with written percentage as for the 2001 reporting notice of adverse action, failing to colperiod. Of the institutions not in full lect required information about the race compliance, 81 percent had five or or national origin and sex of applicants fewer violations. The most frequent viofor mortgage loans; and, when providlations involved failure to take one or ing notice of adverse action, failing to more of the following actions: give the name and address of the federal agency that administers compliance with • Provide a written notice of credit the ECOA. denial or other adverse action contain- The other agencies that enforce the ing a statement of the action taken, ECOA—the Farm Credit Adminthe name and address of the creditor, istration (FCA), the Department of a notice of rights, and the name and Transportation, the Securities and address of the federal agency that Exchange Commission, the Small enforces compliance Business Administration, and the Grain Inspection, Packers and Stockyards • Provide a statement of reasons for Administration of the Department of credit denial or other adverse action Agriculture—reported substantial comthat is specific and indicates the prinpliance among the entities they supercipal reasons for the adverse action vise. The FCA's examination and enforcement activities revealed viola- • Collect information for monitoring tions of the ECOA mostly related to purposes about the race or national creditors' failure to collect information origin and sex of the applicants seekin mortgage applications for monitoring ing credit primarily for the purchase purposes and failure to comply with or refinancing of a principal residence rules regarding adverse action notices. No formal enforcement actions relating • Notify the credit applicant of the to Regulation B were initiated by these action taken within the time frames agencies. specified in the regulation. Three formal enforcement actions Regulation E containing provisions relating to Regu- (Electronic Fund Transfers) lation B were issued during the 2002 The FFIEC agencies reported that approximately 92 percent of the institu- 7. Because the agencies use different methods tions examined during the 2002 reportto compile the data, the information presented ing period were in compliance with here supports only general conclusions. The 2002 Regulation E, compared with 95 perreporting period was from July 1, 2001, through June 30, 2002. cent for the 2001 reporting period. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 11 The most frequent violations involved Regulation Z failure to comply with the following (Truth in Lending) requirements: The FFIEC agencies reported that 77 percent of the institutions examined • Determine whether an error occurred, during the 2002 reporting period were and transmit the results of the invesin compliance with Regulation Z, comtigation to the consumer within ten pared with 79 percent for the 2001 business days reporting period. Of the institutions not in full compliance, 73 percent had five • Credit the customer's account in the or fewer violations, compared with amount of the alleged error within ten 75 percent for the 2001 reporting period. business days of receiving the error The most frequent violations involved notice, if more time is needed to con- failure to take one or more of the followduct the investigation ing actions: • Report the results of the investigation • Accurately disclose the finance to the consumer within three business charge, taking any prepaid finance days after its completion. charges into account The agencies did not issue any formal • Accurately disclose the number, enforcement actions relating to Regula- amounts, and timing of payments tion E during the reporting period. scheduled to repay the obligation Regulation M • Ensure that if the disclosed finance (Consumer Leasing) charge (which affects other disclosures) is understated, the amount dis- The FFIEC agencies reported that more closed is understated by no more than than 99 percent of the institutions exam- $100 ined during the 2002 reporting period were in compliance with Regulation M, • Ensure that disclosures reflect the which is comparable to the level of comterms of the legal obligation between pliance for the 2001 reporting period. the parties The few violations noted involved failure to adhere to specific disclosure • Provide the index value for the perirequirements. The agencies did not issue odic adjustments to variable-rate any formal enforcement actions relating loans. to Regulation M during the reporting period. Three formal enforcement actions containing provisions relating to Regu- Regulation P lation Z were issued during the 2002 (Privacy of reporting period—two by the OTS and Consumer Financial Information) one by the OCC. In addition, 174 insti- July 2001 through June 2002 marked tutions supervised by the Federal the first full year of implementation of Reserve, the FDIC, or the OTS were Regulation P. Examinations found few required, under the Interagency Enforceviolations, and no formal enforcement ment Policy on Regulation Z, to refund actions were issued. a total of approximately $1.2 million Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

78 89th Annual Report, 2002 to consumers for the 2002 reporting tutions examined during the 2002 period. During the reporting period, the reporting period were in compliance, the FTC continued its efforts to curb abu- same proportion as for the 2001 reportsive practices by some subprime mort- ing period. Among the institutions not gage lenders, entering into three set- in full compliance, the most frequently tlements, initiating three legal actions, cited violations involved and pursuing litigation against one creditor for alleged violations of the • Failing to provide a clear, conspicuous Truth and Lending Act (TILA) and the disclosure regarding a cosigner's lia- Home Ownership and Equity Protection bility for a debt Act. The Department of Transportation • Entering into a consumer credit con- (DOT) concluded its investigation of tract containing a nonpossessory secufive cases involving air carriers for posrity interest in household goods, a sible violations of the TILA. All five practice barred by Regulation AA. cases involved the timeliness of processing requests for credit card refunds. Four No formal enforcement actions relatof the cases were closed with warning ing to Regulation AA were issued durletters; in the fifth case, DOT entered ing the reporting period. into a consent order that directed the carrier to cease and desist from further violations of the refund provisions of Regulation CC the TILA and assessed a civil penalty of (Availability of Funds and $25,000. In addition, the DOT contin- Collection of Checks) ued to prosecute a cease-and-desist con- The FFIEC agencies reported that sent order issued in 1993 against a travel 90 percent of institutions examined duragency and a charter operator. The coming the 2002 reporting period were in plaint alleged that the two organizations compliance with Regulation CC, comhad violated Regulation Z by routinely pared with 91 percent for the 2001 failing to send credit statements for reporting period. Among the institutions refund requests to credit card issuers not in full compliance, the most frewithin seven days of receiving fully quently cited violations involved the documented credit refund requests from failure to take one or more of the followcustomers. The case remained pending ing actions: because the principal of the company was serving a prison sentence for an unrelated airline bankruptcy fraud • Make funds from certain checks, both conviction. local and nonlocal, available for withdrawal within the times prescribed by the regulation Regulation AA (Unfair or Deceptive Acts • Provide a written notice explaining or Practices) why an exception to the institution's The three banking regulators with availability policy was invoked responsibility for enforcing Regulation AA's Credit Practices Rule—the • Provide a written notice when the Federal Reserve, the OCC, and the depository bank extended the time for FDIC—reported that 99 percent of insti- making funds available for withdrawal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 79 • Follow special procedures when technology and information-processing invoking the exception for large-dollar capabilities. Prominent among these deposits. developments have been the movement to risk-based pricing of mortgage credit No formal enforcement actions relat- and the growth of new channels for ing to Regulation CC were issued dur- loan applications, funding, and originaing the reporting period. tion. In 2002, the Board took note of these changes in carrying out a review of Regulation C, which implements Regulation DD the Home Mortgage Disclosure Act (Truth in Savings) (HMDA). The FFIEC agencies reported that The express purposes of HMDA are 87 percent of institutions examined dur- to ing the 2002 reporting period were in compliance with Regulation DD, com- • Provide the public and government pared with 88 percent for the 2001 officials with data that will help show reporting period. Among the institutions whether lenders are serving the homenot in full compliance, the most fre- lending needs of the neighborhoods quently cited violations involved and communities in which they are located • Advertisements that were inaccurate or misleading (or both) • Help government officials target public investment to promote private • Use of the phrase "annual percentage investment where it is needed yield" in an advertisement without disclosing additional terms and condi- • Provide data that assist in identifying tions of customer accounts possible discriminatory lending patterns and enforcing antidiscrimination • Failure to provide notice before matu- statutes. rity for automatically renewing time accounts having a term of more than Regulation C requires lenders to one month. report data about each mortgage loan application or origination (including No formal enforcement actions relat- loan amount, type, and purpose), each ing to Regulation DD were issued dur- applicant or borrower (including race ing the reporting period. or ethnicity, sex, and income), and each property (including location and occupancy status). These data are made Implementation of available to the public after identifying Statutes Designed to information is removed to protect con- Inform and Protect Consumers sumers' privacy. In 2002, the Board concluded that significant changes to Regulation C Changes in the Collection of were needed to keep pace with develop- Data on Home Mortgage Loans ments in the mortgage-lending market. The past decade has witnessed impor- One change was to broaden the types of tant developments in mortgage markets, data collected to include data on loan spurred in part by improvements in pricing. This change will aid both in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

80 89th Annual Report, 2002 deterring discrimination and in help- requests that are approved and result in ing data users better understand the loan originations as well as requests that mortgage market, particularly the are denied. Lenders may, but will not be subprime market. Over the years, the required to, report preapproval requests focus of concerns about discrimination that are approved but not accepted by has shifted from lenders' decisions to the applicant. approve or deny applications to lenders' In addition, the Board revised the loan-pricing practices. The widespread categories for identifying the race and adoption of risk-based pricing has national origin of applicants and borfocused attention on the fairness of lend- rowers to conform to categories used by ers' pricing decisions. Obtaining infor- the Bureau of the Census and other fedmation about loan pricing is critical to eral agencies. Following guidance proensuring the continued utility of the vided by the Office of Management and HMDA data. Budget, the Board will permit an appli- Beginning January 1, 2004, lenders cant to select more than one race and will report rate spreads for loans that will distinguish between race and Hisexceed a certain price threshold (for first panic ethnicity; these changes take effect lien loans, prices must be reported if the January 1, 2004. difference between the loan's annual In response to the growing numpercentage rate and the yield on Trea- ber of telephone applications and the sury securities with comparable maturi- increasing proportion of loan applicaties is 3 percentage points or more; for tions for which information on applicant subordinate lien loans, if the difference race, ethnicity, or sex is missing, the is 5 percentage points or more). Lenders Board mandated collection of such data will also report whether a loan meets the on telephone applications; this rule, price-based triggers of the Home Own- which parallels the rule for mail and ership and Equity Protection Act, which Internet applications, took effect Janurequires that borrowers of high-priced ary 1, 2003. loans be given special disclosures and Finally, the Board made several other protections. changes to improve the consistency The Board also revised Regulation C and utility of the HMDA data. These to reflect another major change in the changes include simplifying the definimortgage market—the increasing avail- tions of loan types and distinguishing ability of preapproval programs. Preap- loans for manufactured homes from proval programs offer the possibility of loans for site-built homes. conditional approval of a mortgage loan before a borrower has chosen a prop- Revisions to erty, enabling the borrower to demon- Truth in Lending Regulations strate to potential home sellers that the borrower will likely be able to obtain In April 2002, the Board revised the a loan. Regulation C will require lend- official staff commentary to Regulaers to report preapproval requests that tion Z (Truth in Lending) to clarify how are evaluated under programs in which creditors that place Truth in Lending the lender gives approved applicants Act disclosures in the same document a written commitment letter, good for as the credit contract can satisfy the a set period and for up to a fixed dollar requirement to provide the discloamount. Beginning January 1, 2004, sures before consummation and in a lenders will identify preapproval form the consumer can keep. The revi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 81 sions also provide guidance on disclos- ATM card. In 2002, the number of ATM ing costs for certain credit insurance transactions per month averaged almost policies. 1.2 billion, an increase of nearly 3 per- The Board also took the following cent from 2001. The number of installed regulatory actions during the year: ATMs rose nearly 9 percent, to about 352,000. • Raised from $480 to $488 the total Direct deposit is also widely used. dollar amount of points and fees that About 60 percent of U.S. households triggers additional requirements for have funds deposited directly into their certain mortgage loans under the checking or savings accounts. Use of the Home Ownership and Equity Protec- service is particularly common in the tion Act, effective in January 2003, to public sector: Approximately 72 percent reflect changes in the consumer price of all government payments in fiscal index, as prescribed by the statute. year 2002 were made using electronic funds transfer, including 79 percent of • Maintained at $32 million the exemp- social security payments, 98 percent of tion threshold for depository institu- federal salary and retirement payments, tions required to collect data in 2003 and 39 percent of federal income tax under the Home Mortgage Disclosure refunds. Act, in keeping with the consumer Direct bill payment is a less widely price index for urban wage earners used EFT payment mechanism. About and clerical workers (CPI-W), as pre- 36 percent of U.S. households have payscribed by the statute. ments automatically deducted from their accounts. About one-third of U.S. households Economic Effects of the use debit cards, which consumers use at Electronic Fund Transfer Act merchant terminals to debit their check- As required by the Electronic Fund ing or savings accounts. These point-of- Transfer Act (EFTA), the Board moni- sale (POS) systems account for a fairly tors the effects of the act on institutions' small share of electronic transactions, compliance costs and the benefits of the but their use has continued to grow act to consumers. rapidly. The average number of POS Approximately 85 percent of U.S. transactions per month rose almost households have or use one or more 39 percent, from 304.0 million in 2001 electronic fund transfer (EFT) service— (revised from previously reported data) for example, an ATM card, a debit card, to 421.7 million in 2002, though the or direct deposit. The proportion of number of POS terminals fell, to households using EFT services has 3.5 million. grown over the past ten years at an Electronic check conversion is a annual rate of 2 percent to 3 percent, variation of electronic funds transfer according to data from the Board's whereby a check is used as the source Survey of Consumer Finances (the most of information for a one-time electronic recent data available were from 1998; payment from the consumer's checking data from the 2001 survey are to be account via EFT. During 2002, Board released in 2003). staff helped develop and distribute Automated teller machines remain the consumer information to explain the most widely used EFT service. About process (www.federalreserve.gov/pubs/ two-thirds of U.S. households have an checkcon v/default .htm). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

82 89th Annual Report, 2002 The incremental costs associated with The Board also established an advithe Electronic Fund Transfer Act are sory group to assess the Federal difficult to quantify because no one Reserve's complaints and inquiry knows how industry practices would database—Complaints Analysis Evaluhave evolved in the absence of statutory ation System and Reports (CAESAR). requirements. The benefits of the EFTA The advisory group is organized into are also difficult to measure because two subcommittees: one to develop and they cannot be isolated from consumer implement improvements to data entry protections that would have been pro- and reporting processes, and the other to vided in the absence of regulation. The analyze the adequacy of the complaint available evidence suggests no serious and inquiry code structure. Enhanceconsumer problems with the EFTA (see ments to CAESAR will be implemented the section "Agency Reports on Compli- in the first quarter of 2003. ance with Consumer Protection Laws and Regulations"). Complaints against State Member Banks Consumer Complaints In 2002 the Federal Reserve received The Federal Reserve investigates com- just over 5,700 complaints from conplaints against state member banks and sumers. The majority (63 percent) forwards to the appropriate enforcement related to practices that are not subject agency complaints that involve other to federal regulation (see next seccreditors and businesses. Each Reserve tion, "Unregulated Practices"). About Bank investigates complaints against 48 percent of the complaints received state member banks in its District. were against state member banks (see The Board provides guidance to the tables). Of the complaints against state Reserve Banks on complaint program member banks, 66 percent involved loan policies and procedures through advi- functions: 3 percent alleged discrimsory letters and periodic updates to the ination on a basis prohibited by law Consumer Complaint Manual. In 2002, (race, color, religion, national origin, the Board issued guidance and new sex, marital status, age, the fact that the codes for identifying complaints and applicant's income comes from a public inquiries about electronic check conver- assistance program, or the fact that the sion transactions and the sale of insur- applicant has exercised a right under ance by state member banks. The Board the Consumer Credit Protection Act), also clarified procedures for investigat- and 63 percent concerned other crediting complaints alleging unlawful credit related practices, such as the imposition discrimination. In addition, the Board of annual membership fees, or credit established supplemental procedures to denial on a basis not prohibited by law help the Reserve Banks focus and expe- (for example, credit history or length of dite investigations. residence). Twenty-four percent of the In 2002 the Board initiated a work- complaints against state member banks flow study of the Federal Reserve's involved disputes about interest on complaint-handling process to identify deposits and general deposit account ways to maximize efficiency and effec- practices, and the remaining 10 percent tiveness. The study is expected to be concerned disputes about electronic completed by early spring 2003. fund transfers, trust services, or other Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 83 Consumer Complaints against State Member Banks and Other Institutions Received by the Federal Reserve System, 2002 State member Other Subject banks institutionsx Total Regulation B (Equal Credit Opportunity) 66 36 102 Regulation C (Home Mortgage Disclosure Act) 0 1 1 Regulation E (Electronic Fund Transfers) 64 76 140 Regulation H (Bank Sales of Insurance) 0 0 0 Regulation M (Consumer Leasing) 0 0 0 Regulation P (Privacy of Consumer Financial Information) 12 4 16 Regulation Q (Payment of Interest) 0 0 0 Regulation Z (Truth in Lending) 617 374 991 Regulation BB (Community Reinvestment) 2 1 3 Regulation CC (Expedited Funds Availability) 29 25 54 Regulation DD (Truth in Savings) 72 48 120 Fair Credit Reporting Act 375 201 576 Fair Debt Collection Practices Act 64 17 81 Fair Housing Act 1 5 6 Flood insurance rules 3 10 13 Regulations T, U, and X 0 0 0 Real Estate Settlement Procedures Act 20 14 34 Unregulated practices 1,440 2,128 3,568 Total 2,765 2,940 5,705 1. Complaints against these institutions were referred to the appropriate regulatory agencies. practices. Information on the outcomes Unregulated Practices of the investigations of these complaints is provided in the table. As required by section 18(f) of the Fed- During 2002, the Federal Reserve eral Trade Commission Act, the Board completed the investigation of 86 com- monitors complaints about banking plaints against state member banks that practices that are not subject to existing were pending at year-end 2001 and regulations, focusing on those that confound four violations of regulations. cern possible unfair or deceptive prac- In the vast majority of cases, the bank tices. In 2002 the Board received more had correctly handled the customer's than 1,400 complaints that involved account; notwithstanding, the bank in unregulated practices. The categories many cases chose to reimburse or other- that received the most complaints wise accommodate the consumer. involved checking and credit card Also during the year, the Federal accounts: Consumers alleged that unau- Reserve handled more than 2,000 thorized withdrawals were made from inquiries about consumer credit and their checking accounts (101), disputed banking policies and practices. In amounts withdrawn (155), and comresponding to these inquiries, the Board plained about insufficient-funds charges and Reserve Banks gave specific expla- and procedures (141); they also comnations of laws, regulations, and bank- plained about fees associated with credit ing practices and provided relevant card accounts (149) and about debtprinted materials on consumer issues. collection tactics (109). The remainder Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

84 89th Annual Report, 2002 Consumer Complaints Received by the Federal Reserve System, by Subject of Complaint, 2002 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 19 1 2 1 6 0 Credit cards 20 1 8 1 8 2 Other loans 27 1 0 2 12 0 Other type of complaint Real estate loans 508 18 16 37 211 92 Credit cards 1,007 37 7 7 340 429 Other loans 227 8 10 22 91 29 Deposits 658 24 21 83 272 112 Electronic fund transfers 64 2 3 5 20 15 Trust services 30 1 1 4 11 1 Other 205 7 7 21 84 22 Total 2,765 100 75 183 1,055 702 of the complaints concerned unregu- adverse action notice, which the bank lated practices in other areas: Consum- subsequently corrected. The remaining ers complained about credit denials seven cases are pending. attributed to credit history, failure to remove the lien on property for which Advice from the the mortgage had been paid off, and Consumer Advisory Council poor customer service. The Board's Consumer Advisory Council—whose members are drawn Complaint Referrals to HUD from consumer and community organi- In accordance with a memorandum of zations, the financial services indusunderstanding between HUD and the try, academic institutions, and state federal bank regulatory agencies, in agencies—advises the Board on matters 2002 the Federal Reserve referred to concerning laws administered by the HUD ten complaints alleging state Board and other issues related to conmember bank violations of the Fair sumer financial services. Council meet- Housing Act. In two of the ten cases ings are open to the public. the Federal Reserve's investigations In 2002, the Council met in March, revealed no evidence of illegal discrimi- June, and October. The rules implementnation. In a third case the bank had ing the Community Reinvestment Act made an error regarding the consumer's (CRA) were a major topic at the March Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 85 Consumer Complaints Received—Continued Complaints against state member banks 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 by corrective the courts action 0 0 0 2 0 8 19 38 0 1 0 0 0 0 7 27 0 1 2 1 0 9 10 37 0 75 13 10 11 43 498 1,006 1 79 16 8 1 119 795 1,802 1 42 4 1 4 23 521 748 2 74 27 10 14 43 475 1,133 0 6 0 9 1 5 76 140 0 2 4 0 3 4 21 51 2 14 9 0 2 44 518 723 6 294 75 41 36 298 2,940 5,705 and June meetings. In March, Council text in evaluating a bank's CRA permembers commented on the investment formance and emphasized that bankers test, data collection, and the small-bank should review the performance context test. Some members considered the with regulators at the beginning of existing investment test to be sufficient, examinations. while others preferred that a separate In March, Council members discommunity development test replace the cussed Regulation C, which implements investment test. Regarding data collec- the Home Mortgage Disclosure Act. tion for small-business and small-farm They provided views on issues still lending, some members emphasized under review after the Board's January that gathering quality data is a substan- 2002 revisions to the regulation, includtial burden for small banks and ques- ing the appropriate threshold for collecttioned the overall benefits of collecting ing price data on higher cost loans; a detailed data. Members also commented proposal to require lenders to ask teleon the appropriate size-definition of phone applicants their race, ethnicity, "small bank." In June, Council mem- and sex; and a proposal to report lien bers considered the effectiveness of status for applications and originated the evaluation criteria for community loans. A discussion of Regulation B, development performance in terms of which implements the Equal Credit changing community dynamics. Mem- Opportunity Act, focused on proposed bers also noted the importance of con- changes to the definition of "creditor" Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

86 89th Annual Report, 2002 and the prohibition against data nota- that limiting the use and display of pertion for non-mortgage credit. Members sonal identifiers (such as social security provided both supporting and opposing numbers) and providing additional tools views on removing the prohibition to identity-theft victims to clear their against data notation. credit records would be beneficial. The In June, Council members discussed discussion of access to credit cards the rules implementing the privacy pro- focused on consumers who may not visions of the Gramm-Leach-Bliley have the ability to repay their debt, par- Act. Members commented on the effec- ticularly students. tiveness of the required privacy notices in light of the notices' length and complexity. Other comments concerned the Promotion of Community low rates of response to the notices. Development in Historically Also in June, Council members dis- Underserved Markets cussed financial literacy and noted the challenges of designing and delivering In 2002, the community affairs function financial literacy training in an envi- within the Federal Reserve System ronment of technological advances and expanded its activities to promote ecoexpanding financial products. They nomic growth and financial literacy in emphasized that no single solution or historically underserved markets. The design works for all consumers and that structure and mission of the community a broad approach to training and deliv- affairs program was conceived to help ery systems is necessary to reach those financial institutions meet their responin need of training. sibilities under the Community Rein- At the October meeting, the amend- vestment Act, and Community Affairs ments proposed by the Department of Offices around the System continued Housing and Urban Development to its during the year to hold CRA round- Regulation X, which implements the tables with bankers and community Real Estate Settlement Procedures Act development organizations to increase (RESPA), were a topic of discussion. understanding of CRA-related policy Council members focused on whether issues and investment tools. However, the proposed "guaranteed mortgage community affairs programs have broadpackage agreement" and the proposed ened to respond to the evolving finanrevisions to the good-faith estimate cial and regulatory needs of diverse would benefit financial institutions and groups and communities. Reserve Bank consumers during the mortgage selec- Community Affairs Offices focus on tion process. Members also addressed providing information and investment inconsistencies between the Board's opportunities to low- and moderate- Truth in Lending Act disclosure rules income communities within their Disand HUD's proposed RESPA rules. tricts, while the Board's Community The Council also discussed identity Affairs Office brings a national perspectheft and access to credit cards during tive, engaging in projects that have sigthe October meeting. Regarding identity nificant implications for public policy. theft, members considered the adequacy In 2002, System community affairs of current laws and whether potential programs also addressed financial legislative, regulatory, or industry solu- education, financial services for Native tions would be effective in combating Americans, banking for immigrant comidentify theft. Many members agreed munities, emerging issues and opportu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 87 nities in community development, and ment for Financial Education in a community development finance. national symposium on financial literacy and provided training on consumer credit management for Air Force Com- Promotion of Financial Education mand financial specialists. Consumer education materials on financial privacy, Consumers who are well informed on developed in collaboration with other financial matters are generally able to government agencies, were launched make better decisions for their families, during National Consumer Protection increasing their economic security and Week 2002 (www.federalreserve.gov/ well-being. In turn, secure families are pubs/privacy/default.htm). better able to contribute to vital, thriving Across the Federal Reserve System, communities, further fostering commu- Community Affairs Offices organized nity economic development. As a conse- programs to heighten employee awarequence, financial education has risen on ness of fundamental financial managethe agendas of educators, community ment concepts. At the Board, commugroups, businesses, government agen- nity affairs staff organized lunch-andcies, and policymakers. learn sessions on savings and budgeting The Board supported a wide range of and joined with staff of the Manageactivities promoting financial education ment Division to identify best practices in 2002, including conducting research, in employee financial education. The sponsoring meetings, providing training, Federal Reserve Bank of St. Louis and preparing educational materials. held information sessions focused on Staff in the Board's Division of Con- employee housing and credit resources, sumer and Community Affairs prepared and several Reserve Banks hosted Conarticles for the Journal of Family and sumer Protection Week activities for Consumer Sciences and the Federal their employees. Reserve Bulletin ("Financial Literacy: Reserve Banks in Atlanta, Boston, An Overview of Practice, Research, and Chicago, Cleveland, Philadelphia, and Policy," www.federalreserve.gov/pubs/ San Francisco supported financial edubulletin/2002/11021ead.pdf) summariz- cation initiatives in their Districts. For ing efforts in research, fieldwork, and example, the San Francisco Reserve public policy that further the goal of Bank published a compendium of creating financially literate consumers. financial literacy resources for bank- Research initiated by Board staff ers interested in offering financial eduinvestigated consumers' financial man- cation programs that serve their local agement practices and their engagement markets (www.frbsf.org/community/ in the financial services marketplace, webresources/bankersguide.pdf). The consumers' choices of financial insti- Chicago Reserve Bank coordinated tutions for home-secured loans, con- asset-building workshops in Illinois sumers' efforts at comparison shopping, and southeastern Wisconsin to provide and consumers' complaint actions with information on investment approaches respect to problems with credit cards. for low- and moderate-income persons. During the year, partnerships with And the Boston, Atlanta, and Chicago other agencies and organizations were Reserve Banks hosted workshops in formed to undertake a variety of finan- their communities on the benefits of the cial education initiatives. Board staff federal Earned Income Tax Credit and collaborated with the National Endow- Assets for Independence programs as Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88 89th Annual Report, 2002 Lending in Indian Country Overcoming challenges to development requires leadership, commitment, creativity, and flexibility. . . . [T]he vision of tribal leaders and the involvement of partners have helped to bring the new ideas, as well as the capital and technical assistance, necessary to create viable economies in Indian Country. Mark W. Olson, Member, Board of Governors November 18, 2002 Extension of economic development into sovereign nations, Native American comunderserved communities often rests on munities have the right to self-govern and gaining an understanding of local culture to adjudicate contractual disputes in their and history. With such an understand- own tribal courts. While the exercise of ing, lenders, developers, and local lead- sovereignty preserves the right of tribal ers can bridge the information and credit self-governance, it also creates a complex gaps to facilitate the flow of capital and legal environment that results in uncerother resources that support growth and tainty for lenders and investors, who seek development. consistency in their evaluation of risk and Understanding local culture and history the likely return on investment. At the is especially critical to overcoming the same time, some tribal members are unfachallenges of lending on Indian reserva- miliar with the requirements and expectations and tribal lands, collectively known tions of lenders and other private-sector as Indian Country. In many Native Ameri- investors. These competing forces—the can communities, misunderstanding, mis- business need for certainty and predictabiltrust, and discrimination have histori- ity on one hand and unfamiliarity with cally hindered the development of the lender and investor needs on the other— infrastructures—governmental, physical, can disrupt the flow of information educational, and financial—needed to sup- between Native American communities port market-based economies. Further, and the banking industry, impairing the many tribal communities are underserved operation of an efficient market. by financial institutions, a situation that limits their access to the credit and capital The Role of the Federal Reserve vital to their growth and development. As a result, many tribal communities struggle Staff of the Community Affairs Offices with significant social and economic chal- (CAOs) at the Board of Governors and lenges, as seen in high rates of unemploy- several Federal Reserve Banks have ment, inadequate housing, and low educa- worked with tribal leaders and bankers for tional attainment. nearly a decade to address the factors that Sovereignty is a central issue in eco- hinder lending and discourage financial nomic development in Indian Country. As investments in Indian Country. CAO staff wealth-creation vehicles for low-income faced by Native American populations families. through sponsorship of the Federal Reserve System's first national conference on banking opportunities on Indian Programs in Cooperation reservations and tribal lands (see box with Native Americans "Lending in Indian Country"). System In 2002, the community affairs function staff continued to facilitate meetings and addressed credit and lending barriers workshops and to convene task forces to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 89 have sought to increase communication of the Board and participating Reserve and highlight opportunities for profitable Banks (the Reserve Banks of Chicago, relationships and development in Indian Kansas City, Minneapolis, and San Fran- Country by creating mutually benefi- cisco). The committee helped ensure that cial partnerships. They have fostered the agenda topics were culturally sensitive and exchange of information through work- accurately portrayed the credit needs and shops on sovereign lending, articles in concerns of Native American communities Reserve Bank newsletters, assistance in and at the same time emphasized the critidesigning a financial training curriculum cal role of banks in creating economic for Native American students, and support opportunity in Indian Country. To promote for the development of regulations and pro- the partnerships between lenders and comcedures that govern secured credit trans- munities that are essential to the growth actions. At the national level, CAO staff and stabilization of local economies, the at the Board have served on federal task conference agenda was developed to highforces that helped develop policy to light ways in which creative economic improve funding opportunities in Indian development efforts—financed by leverag- Country. ing funds from government loan and guar- Through ongoing relationships with antee programs with bank credit—can tribal leaders and bankers, the Federal result in safe, sound lending transactions. Reserve has gained valuable insight into The conference, held on November 18the cultural and legal issues and the con- 20, 2002, in Scottsdale, Arizona, drew cerns of all parties. This insight led to more than 400 participants. It provided a recognition by the Federal Reserve and its forum for financiers, tribal leaders, and Native American partners of a need for a economic developers to discuss innovative national dialogue on lending in Indian development opportunities in Indian Coun- Country. try. The conference format employed "talking circles;' a discussion method unique to the Native American culture that Pathway to a National Conference invites tribal members to enter into dia- To promote a national dialogue, the Fed- logue following each plenary session. eral Reserve and its tribal partners began Breakout sessions addressed related issues planning a conference that could serve as integral to development in Indian Couna catalyst, stimulating new partnerships try, including commercial codes, bank forand creative initiatives in Native American mation, regulatory matters, and wealthcommunities across the country. An advi- building strategies. The breakout sessions sory committee made up of tribal leaders, afforded an opportunity to explore more lenders, community development practi- fully the topics addressed in panel discustioners, attorneys, and academics knowl- sions, enabling the building of partnerships edgeable about Indian Country issues was to effect sustainable economic revitalizaformed by the Community Affairs Officers tion in Indian Country, discuss financing of housing and small Banking for businesses on tribal lands and finan- Immigrant Communities cial literacy within tribal communities. Through a national interagency Native Major demographic changes and pop- American task force, Board staff began ulation shifts have been the impetus planning for a policy development for several Federal Reserve initiatives forum on financial literacy in Indian involving immigrant banking markets. Country scheduled for May 2003. Seven Reserve Banks—Atlanta, Boston, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

90 89th Annual Report, 2002 Chicago, Dallas, Kansas City, New • Loss mitigation and foreclosure York, and Richmond—sponsored pro- prevention grams and outreach meetings during 2002 to heighten financial institutions' • Sustaining and revitalizing communiawareness of the credit and financial ties affected by economic downturns. service needs of Hispanic communities. English and Spanish versions of materi- Community Development als on Electronic Transfer Accounts (an account designed by the U.S. Treasury Federal Reserve outreach activities and for recipients of federal benefits), the programs in rural markets continued in matricula consular card for Mexican 2002. Initiatives included conferences nationals seeking banking services, and on community development challenges financial literacy ("Building Wealth: A and opportunities for rural residents Beginner's Guide to Securing Your and business owners, rural policy, and Financial Future") are available on the opportunities for public-private partner- Dallas Reserve Bank's web site (at ships to further economic development www.dallasfed.org/htm/ca/pubs.html). in rural communities. Board staff contin- Through other activities, the Chicago ued to work with the Rural Home Loan Reserve Bank addressed the needs of Partnership, an interagency group comthe Asian-American community, and mitted to increasing affordable housing the Minneapolis Reserve Bank, the in rural communities. needs of Islamic and Hmong immigrant Small-business development is an communities. important component of efforts to rebuild and strengthen communities. Several Reserve Banks held workshops Emerging Issues and Opportunities to provide information on opportunities for business development and part- The Federal Reserve in 2002 conducted nerships with local community developprograms and held conferences on ment organizations. Reserve Banks also emerging issues in community develop- provided technical assistance and informent to encourage research and discus- mation on the mechanics of accessing sion among academics and practitioners. tax credits for small businesses and for Among the topics discussed were commercial development. Board staff participated on a task force sponsored • Community development and smart by the Department of Commerce to growth (affordable housing, brown- explore development and capital formafields redevelopment, transit systems, tion for minority microentrepreneurs. and urban revitalization) The community affairs function continued to expand its presence in the • Microenterprise development in small international arena. Board staff particicities and towns pated with the Organisation for Economic Co-operation and Development • Entry-level employment opportunities (OECD), a body of international groups in technology for low- and moderate- working to build partnerships and idenincome persons tify collaborative approaches to development, and delivered remarks at an • Financial innovation in community OECD conference in England on the use development of private finance for community build- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 91 ing. Board staff also held meetings with ple, Board staff served as the Federal officials from Indonesia, Japan, Yugo- Reserve liaison to the Local Initiatives slavia, New Zealand, and Russia to dis- Support Corporation advisory board's cuss community development policies Center for Home Ownership. Board and strategies. staff also provided support to Governor The preservation of affordable hous- Edward Gramlich in his role as chairing remains a central issue for the Fed- man of the board of directors for the eral Reserve. During 2002, Board staff Neighborhood Reinvestment Corporaserved in various capacities to support tion, a national nonprofit organization the housing activities of the Federal charged by Congress with revitalizing Reserve's external partners. For exam- older, distressed communities. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

93 Banking Supervision and Regulation The U.S. banking system exhibited con- Net interest margins widened modersiderable strength in 2002, producing ately for the year, a result of low interest record earnings while absorbing sig- rates and growth in low-cost core deposnificant deterioration in asset quality, its. Demand for business loans was lackluster revenues from financial- weak, leading to a $70 billion (or 7 permarket activities, and the effects of eco- cent) decline in aggregate commercial nomic weakness more generally. This and industrial loans outstanding. With remarkable performance is attributable supply boosted by historically low mortin part to historically low interest gage rates, banks added significantly rates; it also reflects the benefits of to their holdings of one- to four-family fundamentally strong balance sheets mortgage loans and pass-through securiand prudent capitalization as well as ties. Loans outstanding under home the industry's continuing enhancements equity lines of credit grew nearly 40 perto risk-management processes and cent, the third consecutive year that capabilities. these balances have risen by more than Industry earnings rose 20 percent for 20 percent. Commercial real estate lendthe year, supported by robust growth in ing, especially lending to finance nonlow-cost core deposits, continued profit- farm nonresidential properties, multiability from consumer lending and mort- family housing, and new construction, gage banking operations, and improved also grew rapidly. operating efficiency. Elevated credit The economic environment also costs and reversals in market-sensitive affected the way in which banks funded lines of business offset some of this their operations. During this period improvement. of low interest rates and soft equity Nonperforming assets rose over the prices, many households shifted funds year, particularly at large, complex insti- into interest-bearing bank transaction tutions. The rise was fueled by a series accounts at the same time many banks of high-profile bankruptcies and con- undertook significant initiatives to boltinuing weak economic growth. The ster core deposit growth. By the end of effect on banks of these bankruptcies 2002, money market deposit accounts was somewhat muted, however, as and savings deposits accounted for bondholders rather than banks absorbed nearly 30 percent of the industry's fundmuch of the credit costs associated with ing. Capital remains a key strength of these high-profile borrowers. Credit- the industry, as the total risk-based capiprotection instruments also played a tal ratio remained at about 12.7 percent. role in reducing bank credit losses. Non-interest revenues from the origi- Banks thus appear to have benefited nation of mortgages for sale to others significantly from their ability to dis- were a major positive for the industry, perse risk through credit derivatives, as were service charges on rapidly growthe syndicated loan market, loan sales, ing deposit accounts. Market-sensitive and securitization activities, combined revenues were again weak, consistent with better risk-management and risk- with the overall softness in equity marmeasurement systems. kets. Most banks supported their earn- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

94 89th Annual Report, 2002 ings by taking significant securities Scope of Responsibilities for gains, in some cases associated with Supervision and Regulation adjustments to the institution's interest The Federal Reserve is the federal rate risk profile. supervisor and regulator of all U.S. bank Banks also reported significant gains holding companies (including financial in operating efficiency, attributable in holding companies formed under the part to a change in accounting pracauthority of the Gramm-Leach-Bliley tice that reduced expenditures to amor- Act) and of state-chartered commercial tize goodwill. Special charges offset banks that are members of the Federal some of these gains at a small number Reserve System. In overseeing these of large institutions related to restrucorganizations, the Federal Reserve seeks turing and potential litigation-related primarily to promote their safe and expenses. sound operation and their compliance Work continued toward finalizing with laws and regulations, including the a new international capital standard, Bank Secrecy Act and consumer protecwith approval of the new framework tion and civil rights laws.1 expected in 2003 and implementation The Federal Reserve also has responof the new rules in 2007. This year's sibility for the supervision of all Edge efforts included an unprecedented coor- Act and agreement corporations; the dinated effort among supervisors and international operations of state member bankers in the G-10 countries to banks and U.S. bank holding companies; assemble detailed information on the and the operations of foreign banking risk profiles of individual banks and the companies in the United States. measured risks associated with these The Federal Reserve exercises imporpositions. tant regulatory influence over entry into Bankers and supervisors enter 2003 the U.S. banking system and the strucin a strong position but with a cautious ture of the system through its adminisoutlook. Both the positive and negative tration of the Bank Holding Company influences seen in 2002 appear likely to Act, the Bank Merger Act (with regard subside. By year-end 2002, asset quality to state member banks), the Change in was showing signs of some improve- Bank Control Act (with regard to bank ment at most banks and possible signs holding companies and state member of economic improvement and some banks), and the International Banking recovery in equity markets were emerging. Charge-offs on consumer loans remained generally stable, as available 1. The Board's Division of Consumer and Community Affairs is responsible for coordinating evidence continued to suggest that the Federal Reserve's supervisory activities with household debt burdens were manageregard to the compliance of banking organizations able. Bankers expect credit quality to with consumer protection and civil rights laws. To stabilize and ultimately to improve in carry out this responsibility, the Federal Reserve the coming year, although an uncertain trains a number of its bank examiners in the evaluation of institutions with regard to such complieconomy and geopolitical concerns may ance. The chapter of this volume covering concontinue to affect the activities and out- sumer and community affairs describes these look of both households and businesses. regulatory responsibilities. Compliance with other Despite these uncertainties, the funda- banking statutes and regulations, which is treated in this chapter, is the responsibility of the Board's mental strengths of the industry leave it Division of Banking Supervision and Regulation well positioned to support, and benefit and the Federal Reserve Banks, whose examiners from, an economic recovery. also check for safety and soundness. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 95 Act. The Federal Reserve is also respon- tions. The table provides information on sible for imposing margin requirements the examinations and inspections conon securities transactions. In carrying ducted by the Federal Reserve during out these responsibilities, the Federal the past five years. Reserve coordinates its supervisory activities with other federal banking State Member Banks agencies, state agencies, functional regulators, and the bank regulatory At the end of 2002, 949 state-chartered agencies of other nations. banks (excluding nondepository trust companies and private banks) were members of the Federal Reserve Sys- Supervision for tem. These banks represented approxi- Safety and Soundness mately 12 percent of all insured U.S. To ensure the safety and soundness commercial banks and held approxiof banking organizations, the Federal mately 27 percent of all insured com- Reserve conducts on-site examinations mercial bank assets in the United States. and inspections and off-site surveillance The guidelines for Federal Reserve and monitoring. It also undertakes examinations of state member banks enforcement and other supervisory are fully consistent with section 10 of actions. the Federal Deposit Insurance Act, as amended by section 111 of the Federal Deposit Insurance Corporation Improve- Examinations and Inspections ment Act of 1991 and by the Riegle The Federal Reserve conducts examina- Community Development and Regulations of state member banks, the U.S. tory Improvement Act of 1994. A fullbranches and agencies of foreign banks, scope, on-site examination of these and Edge Act and agreement cor- banks is required at least once a year; porations. In a process distinct from exceptions are certain well-capitalized, examinations, it conducts inspections of well-managed institutions having assets holding companies and their nonbank of less than $250 million, which may be subsidiaries. Pre-examination planning examined once every eighteen months. and on-site review of operations are integral parts of the overall effort to Bank Holding Companies ensure the safety and soundness of financial institutions. Whether it is an At year-end 2002, a total of 5,963 U.S. examination or an inspection, the review bank holding companies were in operaentails (1) an assessment of the quality tion, of which 5,135 were top-tier bank of the processes in place to identify, holding companies. These organizations measure, monitor, and control risks, controlled 6,278 insured commercial (2) an appraisal of the quality of the banks and held approximately 94 perinstitution's assets, (3) an evaluation of cent of all insured commercial bank management, including an assessment assets in the United States. of internal policies, procedures, con- Federal Reserve guidelines call for trols, and operations, (4) an assessment annual inspections of large bank holding of the key financial factors of capital, companies as well as smaller companies earnings, liquidity, and sensitivity to that have significant nonbank assets. market risk, and (5) a review for compli- In judging the financial condition of ance with applicable laws and regula- the subsidiary banks owned by holding Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

96 89th Annual Report, 2002 State Member Banks and Holding Companies, 1998-2002 Entity/Item 2002 2001 2000 1999 1998 State member banks Total number 949 970 991 1,010 994 Total assets (billions of dollars) 1,863 1,823 1,645 1,423 1,312 Number of examinations 814 816 899 858 820 By Federal Reserve System . 550 561 610 551 511 By state banking agency 264 255 289 307 309 Top-tier bank holding companies Large (assets of more than $1 billion) Total number 329 312 309 283 273 Total assets (billions of dollars) 7,483 6,905 6,213 5,625 5,136 Number of inspections 439 413 352 332 290 By Federal Reserve System' 431 409 346 329 281 On site 385 372 309 298 262 Off site 46 37 37 31 19 By state banking agency 4 6 3 9 Small (assets of $1 billion or less) Total number 4,806 4,816 4,800 4,831 4,880 Total assets (billions of dollars) 821 768 716 679 647 Number of inspections 3,726 3,486 3,347 3,064 3,257 By Federal Reserve System 3,625 3,396 3,264 2,973 3,178 On site2 264 730 835 684 723 Off site 3,361 2,666 2,429 2,289 2,455 By state banking agency 101 90 83 91 79 Financial holding companies Domestic 602 567 462 Foreign 30 23 21 NOTE. Data for prior periods have been updated. inspections being performed off site versus on site. 1. For large bank holding companies subject to con- See text section "Bank Holding Companies" for more tinuous, risk-focused supervision, includes multiple tar- information. geted reviews. . . . Not applicable. 2. In 2002, the supervisory program for small bank holding companies was revised, resulting in more companies, Federal Reserve examiners of such companies. If all of a company's consult examination reports prepared subsidiary depository institutions have by the federal and state banking authori- composite and management ratings of ties that have primary responsibility "satisfactory" or better, and if no matefor the supervision of those banks, rial outstanding issues at the holding thereby minimizing duplication of effort company or consolidated level are otherand reducing the burden on banking wise indicated, only a composite rating organizations. and a management rating based on the Small, noncomplex bank holding ratings of the lead subsidiary depository companies—those that have consoli- institution are assigned to the company. dated assets of $1 billion or less—are In 2002, the Federal Reserve conducted subject to a special supervisory pro- 3,361 reviews of such bank holding gram that was implemented in 1997 and companies. If a company's subsidiary modified in 2002.2 The program permits depository institutions have ratings a more flexible approach to supervision lower than "satisfactory" or other significant supervisory issues, a more thorough off-site review of the organization 2. Refer to SR letter 02-01 for a discussion of is conducted using surveillance results the factors considered in determining whether a bank holding company is complex or noncomplex. and other information. If the informa- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 97 tion obtained off site from these sources lion and $15 billion; 85, between is not sufficient to determine the overall $500 million and $1 billion; and 390, financial condition of the holding com- less than $500 million. pany and to assign the composite and management ratings, the holding com- Specialized Examinations pany is subject to increased supervisory review that may include an on-site The Federal Reserve conducts specialreview and off-site monitoring. ized examinations of banking organiza- While the 2002 modifications to the tions in the areas of information technolspecial supervisory program principally ogy, fiduciary activities, transfer agent affect the supervision of small holding activities, and government and municicompanies, they also promote morepal securities dealing and brokering. The effective use of targeted on-site reviews Federal Reserve also conducts specialto fulfill the requirements for, when ized examinations of certain entities, necessary, the full-scope inspection of other than banks, brokers, or dealers, larger holding companies—those with that extend credit subject to the Board's consolidated assets of $1 billion to margin regulations. $5 billion. In general, the modifications With passage of the Gramm-Leachdirect Reserve Banks to use surveillance Bliley Act in 1999, the Federal Reserve results and other information to focus ceased conducting routine annual attention and resources on holding comexaminations of securities underwriting panies that warrant increased scrutiny. and dealing activities through so-called section 20 subsidiaries of bank holding Financial Holding Companies companies. Under the act, the Federal Reserve is generally required to rely on Under the Gramm-Leach-Bliley Act, the supervisory activities of the functhe Federal Reserve has supervisory tional regulator for broker-dealer suboversight authority and responsibility sidiaries unless the Board has cause for bank holding companies, includto believe that a broker-dealer poses ing those that operate as financial holda material risk to an insured depository ing companies. The statute streamlines affiliate. No such examinations for cause the Federal Reserve's supervision of all were conducted during 2002. bank holding companies and sets forth parameters for the relationship between Information Technology Activities the Federal Reserve and other regulators. The statute differentiates between In recognition of the importance of the Federal Reserve's relations with information technology to safe and regulators of depository institutions and sound operations in the financial indusits relations with functional regulators try, the Federal Reserve reviews the (that is, regulators for insurance, securi- information technology activities of ties, and commodities). supervised financial institutions as well As of year-end 2002, 602 domestic as certain independent data centers that bank holding companies and 30 foreign provide information technology services banking organizations had financial to these institutions. Several years ago, holding company status. Of the domes- the information technology reviews of tic institutions, 37 financial holding banking institutions were integrated into companies had consolidated assets of the overall supervisory process, and thus $15 billion or more; 90, between $1 bil- all safety and soundness examinations Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

98 89th Annual Report, 2002 Adoption of Rules Governing Transactions with Affiliates In 2002, the Federal Reserve Board issued but emphasized, in the statutory and regulaa new regulation that addresses transac- tory frameworks it established, the importions between insured depository insti- tance of limitations on affiliate transactions tutions and their affiliates. The new as a means of protecting depository instituregulation—Regulation W (Transactions tions from losses in their transactions with between Member Banks and Their affiliates. Affiliates)—implements sections 23A and 23B of the Federal Reserve Act. It takes Key Provisions of Regulation W effect April 1,2003. Key provisions of Regulation W, and some of the important exemptions from the rule, Background are described below. Sections 23A and 23B of the Federal Reserve Act are designed to protect deposi- Derivatives Transactions and tory institutions from losses in transactions Intraday Credit with their affiliates. They also limit a depository institution's ability to transfer to Derivatives transactions between a deposiits affiliates the subsidy arising from the tory institution and its affiliates are not institution's access to the federal safety subject to the quantitative limitations and net. Section 23A subjects covered trans- collateral requirements of section 23A. actions between depository institutions and They are, however, subject to the market their affiliates (for example, loans from a terms requirement of section 23B. In addidepository institution to or for the benefit tion, depository institutions are required to of an affiliate, and purchases of assets by a adopt policies and procedures under secdepository institution from an affiliate) to tion 23A to manage the credit exposure quantitative limits and collateral require- arising from their derivatives transactions ments. Section 23B requires that deposi- with affiliates. tory institutions conduct most transactions Intraday extensions of credit by deposiwith affiliates on terms and under circum- tory institutions to affiliates also are substances that are substantially the same as ject to the market terms requirement of those granted to nonaffiliates—that is, a section 23B. However, such extensions depository institution may not grant its of credit are exempt from the quantitative affiliate more favorable terms and condi- limits and collateral requirements of sections than it would grant a similarly situ- tion 23A if the depository institution adopts ated nonaffiliate in a comparable transac- policies and procedures to manage its tion. This provision is commonly referred credit exposure to affiliates in such transto as the "market terms requirement." actions and has no reason to believe that Before adoption of Regulation W, the the affiliate receiving intraday credit would statutory provisions of sections 23A and have difficulty repaying the loan. 23B of the Federal Reserve Act had been implemented by means of Board interpreta- Scope of Application— tions and informal staff guidance. Having a Foreign Banking Organizations comprehensive and consistent application of the statutory provisions became espe- To help ensure a competitive playing field cially important with passage in 1999 of for U.S. depository institutions vis-a-vis the Gramm-Leach-Bliley Act (GLBA). foreign banking organizations operating in GLBA not only provided for broader affili- the United States, Regulation W applies to ations among financial services providers transactions between the U.S. branches and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 99 agencies of a foreign bank and the foreign was legally conducting before Regulabank's affiliates engaged in the United tion W was issued. States in securities underwriting and dealing, insurance underwriting, merchant Loan Purchases banking, and insurance company invest- For some years, the Board has allowed a ment. The issue of competitive equity depository institution to purchase a loan arises most strongly in connection with from an affiliate if the institution makes an these activities—activities that a U.S. bank independent evaluation of the borrower's cannot engage in directly or through an creditworthiness before the affiliate extends operating subsidiary. the loan and if the institution commits to purchasing the loan before the affiliate Scope of Application— extends the loan. In 1995, Board staff Financial Subsidiaries expressly limited the availability of this exemption to institutions whose loan pur- Congress amended section 23A in 1982 to chases from any one affiliate represented provide that under the statute, subsidiaries no more than 50 percent of the dollar of a depository institution generally are amount of the loans made by that affiliate. not affiliates of the institution. This provi- This condition was designed to prevent sion was based on the premise that subsidibank holding companies from using the aries of a depository institution generally exemption extensively to fund their nonare consolidated with the depository instibank lending affiliates. tution and are engaged only in activities that the depository institution may conduct Regulation W retains this 50 percent directly. limitation but allows the institution's primary federal regulator, on a case-by-case In 1999, GLBA authorized depository basis, to restrict loan purchases even more institutions to own financial subsidiaries if appropriate to protect the safety and that engage in activities that the parent soundness of the institution. institution may not conduct directly. GLBA At the time Regulation W was adopted, also amended section 23A to define a the Board sought comment on a proposed financial subsidiary of a bank as an affiliate rule that would prevent a depository instiof the bank—and thus subjected transactution from using this exemption if its purtions between the bank and its financhases of loans from an affiliate under the cial subsidiaries to the limitations of exemption exceeded 100 percent of the sections 23A and 23B. Section 23A, as institution's capital stock and surplus. amended by GLBA, defines a financial subsidiary as a subsidiary of any state or Conclusion national bank that is engaged in an activity that is not permissible for national banks A key premise of the Gramm-Leach- (other than a subsidiary that federal law Bliley Act is that sections 23A and 23B of specifically authorizes national banks to the Federal Reserve Act limit the risk to control). A subsidiary of a financial subsid- depository institutions of the broader affiliiary is also a financial subsidiary. ations permitted by GLBA and make exten- Exceptions to the definition of a finan- sive prior-transaction review by the bank cial subsidiary are included in Regula- regulatory agencies unnecessary. In light tion W for (1) insurance agency subsidi- of the greater role of these statutory aries of banks, (2) subsidiaries of state- provisions in risk management, Federal chartered banks that engage in activities Reserve examiners and other supervisory that the parent state bank may engage in staff have been directed to review interdirectly under federal and state law, and company transactions for compliance with (3) subsidiaries of state-chartered banks the statute and Regulation W frequently that engage in activities that the subsidiary and rigorously. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

100 89th Annual Report, 2002 are now expected to include a review the year the Federal Reserve examined of information technology risks and 1 state member limited-purpose trust activities. During 2002, the Federal company acting as a national securities Reserve was the lead agency in two depository. examinations of large, multiregional data processing servicers examined in Government and Municipal Securities cooperation with the other federal bank- Dealers and Brokers ing agencies. The Federal Reserve is responsible for examining state member banks and for- Fiduciary Activities eign banks for compliance with the Gov- The Federal Reserve has supervi- ernment Securities Act of 1986 and with sory responsibility for institutions that Department of the Treasury regulations together hold more than $15 trillion governing dealing and brokering in of assets in various fiduciary capacities. government securities. Thirty-five state During on-site examinations of fidu- member banks and 10 state branches of ciary activities, the institution's compli- foreign banks have notified the Board ance with laws, regulations, and general that they are government securities dealfiduciary principles and potential con- ers or brokers not exempt from Treaflicts of interest are reviewed; its man- sury's regulations. During 2002 the Fedagement and operations, including its eral Reserve conducted 9 examinations asset- and account-management, risk- of broker-dealer activities in governmanagement, and audit and control pro- ment securities at these institutions. cedures, are also evaluated. In 2002, These examinations are generally con- Federal Reserve examiners conducted ducted concurrently with the Federal 194 on-site fiduciary examinations. Reserve's examination of the state member bank or branch. The Federal Reserve is also respon- Transfer Agents and sible for ensuring compliance with the Securities Clearing Agencies Securities Act Amendments of 1975 by As directed by the Securities Exchange state member banks and bank holding Act of 1934, the Federal Reserve con- companies that act as municipal securiducts specialized examinations of those ties dealers, which are examined pursustate member banks and bank holding ant to the Municipal Securities Rulecompanies that are registered with the making Board's rule G-16 at least once Board as transfer agents. Among other each two calendar years. Of the 27 entithings, transfer agents countersign and ties that dealt in municipal securities monitor the issuance of securities, reg- during 2002, 8 were examined during ister the transfer of securities, and the year. exchange or convert securities. On-site examinations focus on the effective- Securities Credit Lenders ness of the institution's operations and its compliance with relevant securities Under the Securities Exchange Act of regulations. During 2002, the Federal 1934, the Federal Reserve Board is Reserve conducted on-site examinations responsible for regulating credit in cerat 30 of the 98 state member banks and tain transactions involving the purchase bank holding companies that were reg- or carrying of securities. In addition to istered as transfer agents. Also during examining banks under its jurisdiction Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 101 for compliance with the Board's margin enforcement). In addition to formal regulations as part of its general exami- enforcement actions, the Reserve nation program, the Federal Reserve Banks in 2002 completed 116 informal maintains a registry of persons other enforcement actions, such as resolutions than banks, brokers, and dealers who with boards of directors and memoranextend credit subject to those regula- dums of understanding. tions. The Federal Reserve may conduct specialized examinations of these lenders if they are not already subject to Risk-Focused Supervision supervision by the Farm Credit Admin- In recent years the Federal Reserve istration, the National Credit Union has created several programs aimed at Administration, or the Office of Thrift enhancing the effectiveness of the super- Supervision. visory process. The main objective of At the end of 2002, 795 lenders other these initiatives has been to sharpen the than banks, brokers, or dealers were regfocus on (1) those business activities istered with the Federal Reserve. Other posing the greatest risk to banking orgafederal regulators supervised 166 of nizations and (2) the organizations' these lenders, and the remaining 629 management processes for identifying, were subject to limited Federal Reserve measuring, monitoring, and controlling supervision. On the basis of regulatory risk. requirements and annual reports, the Federal Reserve exempted 281 lenders Regional Banking Organizations from its on-site inspection program. The securities credit activities of the remain- The risk-focused supervision program ing 348 lenders were subject to either for regional banking organizations biennial or triennial inspection. One applies to institutions having a managehundred twenty-seven inspections were ment structure organized by function or conducted during the year, compared business line, a broad array of products, with 65 in 2001. and operations that span multiple supervisory jurisdictions. For smaller regional banking organizations, the supervi- Enforcement Actions sory program may be implemented with and Civil Money Penalties a point-in-time inspection. For larger In 2002 the Federal Reserve completed institutions, it may take the form of a 18 enforcement cases involving 32 sep- series of targeted reviews. For the largparate actions, such as cease-and-desist est, most complex institutions, the proorders, written agreements, removal and cess is continuous, as described in the prohibition orders, and civil money pen- next section. To minimize burden on the alties. The Board of Governors collected institution, work is performed off site to $60,829 in civil money penalties. All the greatest extent possible. Additionfunds collected were remitted to the ally, to minimize the number of requests Department of the Treasury. for information from the institution, All final enforcement orders issued examiners make use of public and regby the Board and all written agreements ulatory financial reports, market data, executed by the Reserve Banks in information from automated surveil- 2002 are available to the public and lance screening systems (see section are posted on the Board's web site "Surveillance and Risk Assessment"), www.federalreserve.gov/boarddocs/ and internal management reports. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

102 89th Annual Report, 2002 Large, Complex Banking Organizations During the year, the Federal Reserve, the Office of the Comptroller of the The Federal Reserve applies a risk- Currency, and the Securities and focused supervision program to Exchange Commission formed an interlarge, complex banking organizations agency working group to assess (LCBOs).3 The key features of the whether, in light of the post-Septem- LCBO supervision program are (1) idenber 11 risk environment, additional tifying those LCBOs that are judged, on guidance on business resumption is the basis of their shared risk characterneeded. The agencies held a series of istics, to present the highest level of meetings with financial institutions and supervisory risk to the Federal Reserve core clearing and settlement organiza- System, (2) maintaining continual supertions to discuss lessons learned and the vision of these institutions to keep need for improving the resilience of the current the Federal Reserve's assessfinancial system after a wide-scale disment of each organization's condition, ruption. In September 2002, the work- (3) assigning to each LCBO a superviing group published for comment a sory team composed of Reserve Bank Draft Interagency White Paper on Sound staff members who have skills appro- Practices to Strengthen the Resilience of priate for the organization's risk profile the U.S. Financial System.4 The agen- (the team leader is the central point of cies are continuing to work with reprecontact, has responsibility for only one sentatives of the industry to identify LCBO, and is supported by specialists sound practices and plan to issue a final skilled in evaluating the risks of LCBO paper in 2003. business activities and functions), and (4) promoting Systemwide and inter- Community Banks agency information-sharing through an automated system. The risk-focused supervision program Supporting the supervision process for community banks emphasizes the is an automated application and review of activities having the highdatabase—the Banking Organization est level of risk to an institution and National Desktop (BOND)—that was provides a tiered approach to the examideveloped to facilitate real-time, secure nation of these activities. Examination information-sharing and collaboration procedures are tailored to the characross the Federal Reserve System and acteristics of the bank, keeping in with certain other federal and state mind its size, complexity, and risk proregulators. During 2002, BOND was file. The examination procedures entail enhanced to include the capability of both off-site and on-site work, includsearching and accessing supervisory ing planning, completion of a predocuments using web-based technology. examination visit, preparation of a BOND performance and functionality detailed scope-of-examination memowere also improved to promote analysis randum, thorough documentation of across institutions. the work done, and preparation of an examination report tailored to the scope and findings of the examination. 3. For an overview of the Federal Reserve's The framework for risk-focused super- LCBO program, see Lisa M. DeFerrari and David E. Palmer, "Supervision of Large Complex Banking Organizations," Federal Reserve Bulle- 4. Federal Register, vol. 67, no. 172 (Sept. 5, tin, vol. 87 (February 2001), pp. 47-57. 2002), pp. 56835-56842. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 103 vision of community banks was devel- insurance activities collected via the oped jointly with the Federal Deposit report. Insurance Corporation and has been Historically, paper copies of the Bank adopted by the Conference of State Holding Company Performance Reports Bank Supervisors. have been provided to individual bank holding companies and to state banking agencies. Effective with the March Surveillance and Risk Assessment 2002 report, paper distribution was The Federal Reserve uses automated replaced by electronic distribution of screening systems to monitor the finan- non-confidential information via the cial condition and performance of state Board's National Information Center member banks and bank holding compa- web site. The change was made to nies between on-site examinations. The improve the efficiency and timeliness of screening systems analyze supervisory distribution of the reports and to provide data and regulatory financial reports broader access to the reports by public to identify companies that appear to users. be weak or deteriorating. This analysis The Federal Reserve works through helps to direct examination resources to the Federal Financial Institutions institutions that exhibit higher risk pro- Examination Council (FFIEC) Task files. Screening systems also assist in Force on Surveillance Systems to coorthe planning of examinations by identi- dinate surveillance activities with the fying companies that are engaging in other federal banking agencies.5 During new or complex activities. the year, the task force added to the In addition to using automated screen- Uniform Bank Performance Report seving systems, the Federal Reserve pre- eral items on securitization activities pares quarterly Bank Holding Com- substantially similar to the items added pany Performance Reports for use in to the Bank Holding Company Performonitoring and inspecting supervised mance Report. Also during the year, the banking organizations. The reports con- task force adopted a web-based distributain, for individual bank holding com- tion system for the Uniform Bank Perpanies, financial statistics and compari- formance Report. sons with peer companies. They are compiled from data provided by large International Activities bank holding companies in quarterly regulatory reports (FR Y-9C and The Federal Reserve supervises the for- FR Y-9LP). During 2002, information eign branches of and overseas investon securitization and asset sales activ- ments by member banks, Edge Act and ities was added to the report to help agreement corporations, and bank holdexaminers and analysts evaluate the ing companies; and investments by bank potential risks of these activities. holding companies in export trading Among the new information collected companies. It also supervises the activiis detail on the volume and composi- ties that foreign banking organizations tion of securitization activities, the volume and composition of retained credit 5. The member agencies of the FFIEC are the exposures, and delinquencies of and net Board of Governors, the Federal Deposit Insurlosses on securitized assets. Also dur- ance Corporation (FDIC), the National Credit Union Administration (NCUA), the Office of the ing the year the Federal Reserve sub- Comptroller of the Currency (OCC), and the stantially expanded the information on Office of Thrift Supervision (OTS). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

104 89th Annual Report, 2002 conduct through entities in the United U.S. economy with a means of financ- States, including branches, agencies, ing international business, especially representative offices, and subsidiaries. exports. Agreement corporations are similar organizations, state chartered or federally chartered, that enter into an Foreign Operations of agreement with the Board to refrain U.S. Banking Organizations from exercising any power that is The Federal Reserve examines the not permissible for an Edge Act international operations of state member corporation. banks, Edge Act corporations, and bank Under sections 25 and 25A of the holding companies principally at the Federal Reserve Act, Edge Act and U.S. head offices of these organizations, agreement corporations may engage in where the ultimate responsibility for international banking and foreign finantheir foreign offices lies. In 2002 the cial transactions. These corporations, Federal Reserve examined 1 foreign most of which are subsidiaries of membranch of a state member bank and ber banks, may (1) conduct a deposit 4 foreign subsidiaries of Edge Act cor- and loan business in states other than porations and bank holding companies. that of the parent, provided that the busi- The examinations abroad were con- ness is strictly related to international ducted with the cooperation of the transactions, and (2) make foreign supervisory authorities of the countries investments that are broader than those in which they took place; when appro- made by member banks because they priate, the examinations were coordi- may invest in foreign financial organinated with the Office of the Comptroller zations, such as finance companies and of the Currency. Examiners also make leasing companies, as well as in foreign visits to the overseas offices of U.S. banks. banks to obtain financial and operating Edge Act and agreement corporainformation and, in some instances, tions numbered 80 and were operating to evaluate their efforts to implement 12 branches at year-end 2002. These corrective measures or to test their corporations are examined annually. adherence to safe and sound banking practices. U.S. Activities of Foreign Banks At the end of 2002, 61 member banks were operating 855 branches in for- The Federal Reserve has broad authority eign countries and overseas areas of the to supervise and regulate the U.S. activ- United States; 31 national banks were ities of foreign banks that engage in operating 652 of these branches, and banking and related activities in the 30 state member banks were oper- United States through branches, agenating the remaining 203. In addition, cies, representative offices, commercial 16 nonmember banks were operating lending companies, Edge Act corpora- 17 branches in foreign countries and tions, commercial banks, and certain overseas areas of the United States. nonbank companies. Foreign banks continue to be significant participants in the U.S. banking system. Edge Act and Agreement Corporations As of year-end 2002, 193 foreign Edge Act corporations are international banks from 55 countries were operating banking organizations chartered by the 253 state-licensed branches and agen- Board to provide all segments of the cies (of which 10 were insured by the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 105 Federal Deposit Insurance Corporation) these two processes provide critical as well as 52 branches licensed by the information to U.S. supervisors in a Office of the Comptroller of the Cur- logical, uniform, and timely manner. rency (of which 6 had FDIC insurance). The Federal Reserve conducted or par- These foreign banks also directly owned ticipated with state and federal regu- 16 Edge Act and agreement corpora- latory authorities in 307 examinations tions and 3 commercial lending compa- during 2002. nies; in addition, they held an equity interest of at least 25 percent in 86 U.S. Technical Assistance commercial banks. Altogether, the U.S. offices of these In 2002 the Federal Reserve System foreign banks at the end of 2002 con- continued to provide technical assistrolled approximately 18 percent of tance on bank supervisory matters U.S. commercial banking assets. These to foreign central banks and superviforeign banks also operated 92 rep- sory authorities. Technical assistance resentative offices; an additional 57 for- involves visits by System staff members eign banks operated in the United to foreign authorities as well as consul- States solely through a representative tations with foreign supervisors who office. visit the Board or the Reserve Banks. State-licensed and federally licensed Technical assistance in 2002 was conbranches and agencies of foreign banks centrated in Latin America, Asia, and are examined on site at least once every former Soviet bloc countries. eighteen months, either by the Federal During the year, the Federal Reserve Reserve or by a state or other federal offered supervision training courses in regulator; in most cases, on-site exami- Washington, D.C., and in a number of nations are conducted at least once foreign jurisdictions exclusively for forevery twelve months, but the period eign supervisory authorities. System may be extended to eighteen months staff also took part in technical assisif the branch or agency meets certain tance and training missions led by the criteria. International Monetary Fund, the World The Federal Reserve conducts a joint Bank, the Inter-American Developprogram for supervising the U.S. opera- ment Bank, the Asian Development tions of foreign banking organizations Bank, the Basel Committee on Banking in cooperation with the other federal Supervision, and the Financial Stability banking agencies and state banking Institute. agencies. The program has two main parts. One part focuses on the examina- Supervisory Policy tion process for those foreign banking organizations that have multiple U.S. Within the supervisory policy function, operations and is intended to improve the Federal Reserve develops guidance coordination among the various U.S. for examiners and financial institutions supervisory agencies. The other part as well as regulations for financial instiis a review of the financial and opera- tutions under the supervision of the Fedtional profile of each organization to eral Reserve. Staff members also particiassess its general ability to support its pate in international supervisory forums U.S. operations and to determine what and provide support for the work of the risks, if any, the organization poses Federal Financial Institutions Examinathrough its U.S. operations. Together, tion Council. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

106 89th Annual Report, 2002 Capital Adequacy Standards the new capital rule was published in SR letter 02-4 on March 4, 2002. During 2002, the Federal Reserve, together with the other federal banking Claims on Securities Firms agencies, issued two final rules amending the agencies' regulatory capital In April, the federal banking agencies guidelines and issued guidance on a issued final rules amending the risknumber of policy topics. One final rule based capital standards for banks, bank established the regulatory capital treat- holding companies, and savings associament of equity investments in nonfinan- tions by reducing from 100 percent to cial companies held by banking orga- 20 percent the risk weight accorded to nizations. The other final rule reduced certain claims on, and claims guaranteed from 100 percent to 20 percent the risk by, qualifying securities firms having weight applied, under the agencies' high investment-grade ratings in counrisk-based capital guidelines, to certain tries that are members of the Organiclaims on qualifying securities firms. sation for Economic Co-operation and The Federal Reserve, together with the Development. The change brings the other federal banking agencies, also risk weight in line with a 1998 revision issued policy guidance on manage- to the Basel Capital Accord. Qualifying ment of country risk and asset securi- U.S. securities firms are broker-dealers tization and draft guidance on credit registered with the Securities and card lending. The Federal Reserve also Exchange Commission (SEC) that are in clarified that preferred stock covered compliance with the SEC's net capital by certain hedging arrangements is not rule. The Board's final rule also applies includable in regulatory capital. In addi- a 20 percent risk weight to certain coltion, the Federal Reserve issued guid- lateralized claims on qualifying securiance introducing a new statistical loan- ties firms. sampling methodology for community banks. Management of Country Risk In February, the Federal Reserve and Capital for Nonfinancial the other federal banking agencies pub- Equity Investments lished guidance for banking organiza- In January, the Federal Reserve, together tions concerning the elements of an with the OCC and the FDIC, adopted a effective country risk management profinal rule governing the regulatory capi- cess. The interagency guidance builds tal treatment of equity investments in on the findings of a 1998 study by the nonfinancial companies held by banks, Interagency Country Exposure Review bank holding companies, and finan- Committee on the country risk mancial holding companies. The final rule agement practices of U.S. banks, supsubjects covered equity investments to plementing and strengthening previous a capital charge that increases in steps guidance and ensuring that banking as the banking organization's level of organizations' management of risks concentration in equity investments arising from their international activiincreases. Agency monitoring also ties are appropriately and adequately increases as the level of concentra- addressed during the examination protion in equity investments increases. cess. The guidance was contained in A summary of the key provisions of SR letter 02-5, issued March 8, 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 107 Credit Card Lending hensiveness and effectiveness of credit review in examinations of certain com- In July, under the auspices of the Fedmunity banks. In addition, the guidance eral Financial Institutions Examination clarified that loan reviews conducted Council, the federal banking agencies as part of full-scope Federal Reserve issued draft guidance on account manexaminations are expected to comply agement and loss allowance for credit with existing Federal Reserve guidcard lending. The draft guidance ance or with the new loan-sampling describes the agencies' expectations guidance. regarding prudent risk-management practices for credit card activities, particularly with regard to credit-line Securitization Guidance management, over-limit accounts, and workouts. It also addresses income rec- In May 2002, the federal banking ognition and loss-allowance practices in agencies released several policy stateconnection with credit card lending. ments on securitization-related issues. The guidance builds on the agencies' final rules for "Capital Treatment of Hedging of Preferred Stock Issued Recourse, Direct Credit Substitutes, and through Special-Purpose Entities Residual Interests in Asset Securiti- In March, the Federal Reserve issued zations," which were issued in Novemguidance clarifying that preferred stock ber 2001. The agencies also issued a issued through special entities owned by question-and-answer document respondbank holding companies is not includ- ing to some questions that have arisen able in tier 1 capital if it is covered by regarding their rules. certain hedging derivatives contracts. To be included in tier 1 capital, the Federal • One policy statement clarified the Reserve requires that the provisions of risk-based capital treatment of accrued such preferred stock permit a banking interest receivables for banking orgaorganization to defer dividends for up nizations that securitize credit card to five years, a feature that allows bank receivables through trusts and record holding companies to conserve cash in as an on-balance-sheet asset the intertimes of financial and liquidity pressure. est and fee income due on the secu- Some hedging derivatives contracts conritized receivables. Because such travene this policy by requiring a bank amounts of interest and fee income holding company to make contract paygenerally must be paid to the trust for ments on the derivative to its counterpayment to holders of senior positions party during periods of deferral on the in a securitization before any amount preferred stock while providing for the is returned to the banking organizadeferral of payments to the bank holding tion, the banking organization must company by the counterparty. treat the accrued interest receivable as a residual for purposes of riskbased capital. This treatment results Statistical Loan Sampling in the banking organization's being at Community Banks required, under the recourse pro- In October, the Federal Reserve issued visions of the agencies' capital rules, guidance introducing a statistical sam- to hold "dollar-for-dollar" capital pling method to increase the compre- against the receivable amount. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

108 89th Annual Report, 2002 In another policy statement, the agen- Interagency Advisory on cies advised examiners and banking Accounting for Accrued Interest organizations that the use by banking Receivable Related to Credit Card organizations of adverse supervisory Securitizations actions or negative changes in supervisory thresholds as triggers for the In December 2002, the Federal Reserve early amortization or transfer of ser- and the other federal banking agencies vicing in securitizations constitutes an issued guidance regarding the approunsafe and unsound banking practice. priate accounting treatment for finan- Examples of such supervisory trig- cial institutions that record an asset gers include a downgrade in a bank- commonly referred to as accrued intering organization's CAMELS rating, est receivable (AIR) in connection an enforcement action, or a down- with the securitization of credit card grade in a bank's "prompt corrective receivables. Consistent with generally action" capital category. The supervi- accepted accounting principles, the sory concern arises because a banking guidance clarifies that when the terms of organization that triggers such a provi- the securitization legally isolate the sion is likely to already be subject to institution's (seller's) right to the AIR, financial and liquidity pressure. Trig- the seller generally should report the gering an early amortization or trans- AIR as a subordinated retained interest fer of servicing in a securitization can when accounting for the sale of credit create or exacerbate liquidity and card receivables. This means that the earnings problems that may lead to value of the AIR, at the date the receivfurther deterioration in the banking ables are transferred to the trust, must be organization's financial condition. adjusted on the basis of its relative fair (market) value. A third policy statement was intended to aid examiners and banking organizations in identifying instances of Business Continuity "implicit recourse," a term that generally refers to a banking organization's In 2002, in response to the events providing greater credit support to a of September 11, 2001, the Federal securitization than is required contrac- Reserve developed a business-continuity tually. Because banking organiza- risk profile that provides a consistent tions' risk-based capital requirements framework for benchmarking businessgenerally are based on their maximum continuity programs and serves as a tool credit exposure under contract, such in conducting targeted examinations of capital requirements do not capture business-continuity planning. Federal the additional credit risk being under- Reserve examiners plan to pilot test the taken by the organization through its business-continuity risk profile in 2003, implicit recourse actions. This guid- with the goal of identifying areas for ance identifies several types of improvement at individual institutions implicit recourse and supervisory and developing a profile of businessactions that the agencies may take to continuity programs at large, complex address banking organizations' pro- banking organizations supervised by the vision of implicit recourse. Federal Reserve. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 109 International Guidance on following issuance of a first paper in Supervisory Policies October 2001. The purpose of the second paper was to discuss and seek feed- As a member of the Basel Committee on back on some revisions to the secu- Banking Supervision (Basel Commitritization framework discussed in the tee), the Federal Reserve in 2002 partwo consultative papers. In Decemticipated in efforts to revise the interber 2002, a committee working group national capital regime and to develop issued a paper on pillar III—market international supervisory guidance. The discipline—in order to seek feedback on Federal Reserve's goals in these activithe latest proposals on disclosure. ties are to advance sound supervisory policies for internationally active banking institutions and to improve the sta- Risk Management bility of the international banking sys- The Federal Reserve contributed to sevtem. The efforts are described in the eral supervisory policy papers, reports, following sections. and recommendations issued by the Basel Committee during 2002. These documents were generally aimed at Capital Adequacy improving the supervision of banking The Federal Reserve continued to par- organizations' risk-management practicipate in a number of technical work- tices. The paper "Management and ing groups of the Basel Committee in Supervision of Cross-Border Electronic efforts to develop a new capital accord. Banking Activities" (issued in October) These groups worked to develop a was prepared for the purposes of identirevised consultative paper based on fur- fying banks' risk-management responther deliberations of the committee and sibilities with respect to cross-border on comments received by the committee banking and focusing attention on the on its January 2001 consultative paper need for effective home country superand on technical papers subsequently vision of, and continued international issued by the working groups. The com- cooperation regarding, electronic bankmittee and working groups also contin- ing. The paper "Sound Practices for the ued formal and informal communica- Management and Supervision of Operation with the banking industry and other tional Risk" (issued in July) outlines a interested parties, including the launch- set of principles that provide a frameing of a third quantitative impact study, work for the effective management and referred to as QIS 3. QIS 3 was under- supervision of operational risk. The taken with the goal of ensuring the effi- framework is intended for use by banks cacy of the Basel Committee's propos- and supervisory authorities when evaluals and gathering information helpful in ating policies and practices related to assessing whether further modifications the management of operational risk. are necessary before the committee's The report "Supervisory Guidance in planned release of a revised consultative Dealing with Weak Banks" (issued in paper in spring 2003. March) provides practical guidance for In addition, in October 2002, a com- banking supervisors in their work with mittee working group issued a second weak banks. The guidance includes disworking paper on asset securitization, cussions of problem identification, cor- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

110 89th Annual Report, 2002 rective action, resolution techniques, Gramm-Leach-Bliley Act and exit strategies. The Gramm-Leach-Bliley Act (GLBA) repealed those provisions of the Glass- Internal Control, Accounting, Steagall Act and the Bank Holding and Disclosure Company Act that restricted the ability The Federal Reserve participates in of bank holding companies to affiliate the Basel Committee's Task Force on with securities firms and insurance Accounting Issues and the Transparency companies. The provisions of GLBA, Group and represents the Basel Com- together with the Federal Reserve's mittee at international meetings on the implementing regulations, establish conissues addressed by these groups. In ditions that a bank holding company or particular, the Federal Reserve in 2002 a foreign bank must meet to be deemed represented the Basel Committee at a financial holding company and to meetings of the committee of the Inter- engage in expanded activities. national Accounting Standards Board In addition to controlling depository (IASB) that works to improve guidance institutions, a financial holding comon accounting for financial instruments. pany may engage in securities under- In addition, a representative of the Fed- writing and dealing, serve as an insureral Reserve participates in the IASB's ance agent and insurance underwriter, Standards Advisory Council. act as a futures commission merchant, During 2002 the Federal Reserve also and engage in merchant banking. Percontributed to several reports, papers, missible activities also include activities and comment letters on internal control, that the Board and the Secretary of the accounting, and disclosure that were Treasury jointly determine to be finanissued by the Basel Committee, includ- cial in nature or incidental to financial ing a proposed amendment to the activities and activities that the Federal International Accounting Standard on Reserve determines are complementary financial instruments, the International to a financial activity and do not pose a Accounting Standard on disclosures for substantial risk to the safety and soundfinancial statements of financial insti- ness of depository institutions or the tutions, guidance on international loan- financial system generally. During 2002, loss reserving, and a survey of bank the Federal Reserve continued its efforts disclosure practices. to ensure that supervisory policies applied to banking institutions are consistent with the provisions of GLBA. Joint Forum In its role as holding company super- In its work with the Basel Committee, visor, the Federal Reserve in 2002 conthe Federal Reserve also continued its tinued to host cross-sector meetings with participation in the Joint Forum—a representatives of the banking agencies, group made up of representatives of the securities and commodities and futures committee, the International Organiza- authorities, and state insurance comtion of Securities Commissions, and the missions. Cross-sector forums provide International Association of Insurance an opportunity for multiple supervisors Supervisors. The Joint Forum works to (both federal and state) to discuss issues increase mutual understanding of issues of common interest and to enhance comrelated to the supervision of firms oper- munication and cooperation. Topics disating in each of the financial sectors. cussed in 2002 included corporate gov- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 111 ernance, the initiatives of the Securities Thus, transparency can promote effiand Exchange Commission in imple- ciency in financial markets and sound menting the Sarbanes-Oxley Act, and practices by banks. The Federal Reserve other topics of mutual interest across the also seeks to strengthen audit and consectors. trol standards for banks; the quality of management information and financial reporting is dramatically affected by Sarbanes-Oxley Act internal control systems, including inter- In October 2002, the Federal Reserve nal and external audit programs. issued a supervisory letter (SR letter 02- During 2002, the Federal Reserve 20) to give banking organizations Board commented on a proposed information on the provisions of the Financial Accounting Standards Board Sarbanes-Oxley Act that set forth stan- (FASB) standard concerning specialdards for audits, financial reporting and purpose entities. The Board supports disclosure, and corporate governance at FASB's objective to increase transpublic companies. The provisions apply parency, particularly with respect to to public companies, including banks off-balance-sheet risk exposures that and bank holding companies, that have a special-purpose entities can pose to class of securities registered under sec- organizations and market participants. tion 12 of the Securities Exchange Act To further advance objectives related of 1934 or are otherwise required to to transparency, the Federal Reserve file periodic reports under section 5(d) works with other regulators, the of the 1934 act. The Federal Reserve accounting profession, and a wide varistaff is working with the other banking ety of market participants, both domestiagencies to clarify the applicability of cally and internationally. During 2002, Sarbanes-Oxley to banking organiza- the Federal Reserve also worked with tions. The staff is also considering the the Securities and Exchange Commisneed for additional standards to reaffirm sion to coordinate an enforcement action the important duties and responsibili- against an institution for deficiencies in ties of banking organizations' boards of public and regulatory reports and interdirectors and executive officers. nal controls. Additionally, the Federal Reserve provided guidance to financial organizations that faced possible inter- Efforts to Enhance Transparency ruption in audit services as a result of The Federal Reserve has long supported problems at a large accounting firm. sound accounting policies and meaningful public disclosure by banking and financial organizations to improve mar- Bank Holding Company ket discipline and foster stable finan- Regulatory Financial Reports cial markets. Effective market discipline can serve as an important comple- The Federal Reserve requires that U.S. ment to bank supervision and regula- bank holding companies submit perition. The more informative the informa- odic regulatory financial reports. These tion released by financial institutions, reports, the FR Y-9 series and the the better the evaluation of counterparty FR Y-ll and FR 2314 series for nonrisks by market participants can be and bank subsidiaries, provide information the better their adjustments to the avail- essential to the supervision of the orgaability and pricing of funds will be. nizations and the formulation of regula- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

112 89th Annual Report, 2002 tions and supervisory policies. The Fed- essential information for supervising eral Reserve also uses the information and regulating nonbank subsidiaries and in responding to requests from the Con- reduces burden. Under the new framegress and the public for information on work, bank holding companies file a bank holding companies and their non- detailed report (FR Y-ll or FR 2314) bank subsidiaries. for their more-significant nonbank sub- The FR Y-9 series of reports pro- sidiaries quarterly or annually, dependvides standardized financial statements ing on total assets or other reporting for the consolidated bank holding com- criteria. Bank holding companies must pany. The reports are used to detect also file, annually, an abbreviated, fouremerging financial problems, review item report (FR Y-11S or FR 2314S) performance and conduct pre-inspection for their smaller nonbank subsidiaries. analysis, monitor and evaluate risk pro- The smallest nonbank subsidiaries, files and capital adequacy, evaluate nearly three-fifths of all nonbank subsidproposals for bank holding company iaries, are now exempt from all filing mergers and acquisitions, and analyze requirements. the holding company's overall finan- In addition, functionally regulated cial condition. The nonbank subsidi- nonbank subsidiaries generally are no ary series of reports aids the Federal longer required to file individual non- Reserve in determining the condition bank subsidiary reports with the Federal of bank holding companies that are Reserve. In keeping with provisions of engaged in nonbanking activities and in the Gramm-Leach-Bliley Act, the Fedmonitoring the volume, nature, and con- eral Reserve will rely on reports and dition of their nonbanking subsidiaries. information provided to the primary In March 2002, several revisions to regulator. The Federal Reserve will conthe FR Y-9C report were implemented tinue to collect limited information on to make it consistent with revisions to nonbank subsidiaries of bank holding the bank Call Report and to conform to companies on a consolidated basis in changes in generally accepted account- FR Y-9 reports. ing principles. Also, the relevance of the FR Y-9 series of reports was improved Federal Financial Institutions by revising the existing items and add- Examination Council ing new items related to new activities and other developments that may During 2002, the Federal Reserve conexpose institutions to new or different tinued its active participation as a memtypes of risk. In addition, a new report ber of the Federal Financial Institutions (FR Y-9ES) was created to collect Examination Council. Among other information annually from bank holding activities, the FFIEC revised the bank companies that are employee stock own- Call Reports, issued a revised examinaership plans. tion framework for information technol- In December 2002, the nonbank re- ogy service providers, and revised the porting framework for non-functionally- information systems manual. regulated nonbank subsidiaries of U.S. bank holding companies was stream- nonbank subsidiaries, which are entities whose lined.6 The revised framework provides primary regulator is an organization other than the Federal Reserve, namely, the Securities and Exchange Commission, the Commodity Futures 6. Non-functionally-regulated nonbank subsidi- Trading Commission, state insurance commissionaries are distinguished from functionally regulated ers, or state securities departments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 113 Bank Call Reports ing. The revisions would add several items related to bank credit card activi- As the federal supervisor of state memties, break down two existing items to ber banks, the Federal Reserve, acting in provide more detail to address safety concert with the other federal banking and soundness considerations, and add agencies through the FFIEC, requires a supplement to the report that would banks to submit quarterly Reports of enable the agencies to collect a limited Condition and Income (Call Reports). amount of data from certain banks in the Call Reports are the primary source of event of an immediate and critical need data for the supervision and regulation for specific information. The proposed of banks and for the ongoing assessment revisions also include a few processing of the overall soundness of the nation's changes to implement a new Call Report financial structure. Call Report data, business model the agencies plan to which also serve as benchmarks for institute in 2004. the financial information required by many other Federal Reserve regulatory financial reports, are widely used by Information Technology state and local governments, state bank- Also in 2002, the FFIEC issued a ing supervisors, the banking industry, revised framework for the interagency securities analysts, and the academic examination program for information community. technology service providers. Examina- For the 2002 reporting period, the tions of these providers of information FFIEC implemented several revisions to technology and processing services to the Call Report. The principal revisions financial institutions are conducted by included the Federal Reserve or other financial institution supervisory agencies under • Breaking down several existing bal- the Bank Service Company Act. The ance sheet and income statement revised framework is designed to proitems into greater detail to facilitate mote a more risk-based rationale for supervision and to implement two conducting such examinations by identinew accounting standards fying and analyzing material supervisory risks to financial institutions that • Collecting new information on the fair use the services of these companies. It value of credit derivatives, the volume includes risk-focused criteria for deterof merchant credit card sales, and the mining the examination schedule and amount of past-due loans and leases the scope of the exams. The revised held for sale. framework was implemented as a twoyear pilot program that began in January The FFIEC also revised the Report 2002. of Assets and Liabilities of U.S. In addition, in 2002 the FFIEC began Branches and Agencies of Foreign to prepare for the issuance of revisions Banks (FFIEC 002), effective with the to the FFIEC information systems June 2002 report, to maintain consis- manual, last updated in 1996. A project tency with the Call Report. plan for the development of individual In November, the Federal Reserve booklets to replace the current manand the other federal banking agencies ual's chapters was established. Federal proposed a small number of revisions to Reserve and other agency examiners the Call Report for March 2003 report- participated in field testing the booklets Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

114 89th Annual Report, 2002 on technology service providers, infor- SIT Project Management mation security, and business continuity. In 2002, the SIT project management Field testing of booklets on outsourcstaff made significant progress in identiing, audits, electronic banking, wholefying opportunities for enhancing busisale payment systems, retail payment ness value through the use of inforsystems, and Fedline is scheduled for mation technology. In March, the early 2003. Booklets on management, supervision function received approval development and programming, and to implement a Systemwide technology operations are scheduled for developplatform for scheduling examination ment in 2003. resources. The staff provided substantial resources and leadership in developing Supervisory Information a business case and evaluating tech- Technology nology alternatives for the deployment of an enterprise document management The Supervisory Information Technol- system. Staff members also provided ogy (SIT) function within the Board's substantial assistance and resources to Division of Banking Supervision and support modernization of the Shared Regulation facilitates the management National Credit Program. The modernof information technology within the ization is an interagency effort aimed at Federal Reserve's supervision function. reducing examination costs and improv- Its goals are to ensure that ing the timeliness and reliability of data associated with the review of large, • IT initiatives support a broad range of syndicated credit facilities of commersupervisory activities without duplica- cial banks. The staff continued to assess tion or overlap opportunities to improve the delivery of information technology services for • The underlying IT architecture fully supervision in conjunction with efforts supports those initiatives of Board and Reserve Bank internal IT providers. • The supervision function's use of technology leverages the resources National Information Center and expertise available more broadly within the Federal Reserve System The National Information Center (NIC) is the Federal Reserve's comprehensive • Practices that maximize supervision's repository for supervisory, financial, and business value and cost effectiveness banking structure data and documents. are identified, analyzed, and approved NIC includes the National Examination for implementation. Data (NED) system, which provides supervisory personnel and state banking SIT works through assigned staff at authorities with access to NIC data, and the Board of Governors and the Reserve the Central Document and Text Reposi- Banks and through a Systemwide com- tory, which contains documents supportmittee structure that ensures that key ing the supervisory process. staff members throughout the Federal In 2002, the NED system was modi- Reserve System participate in identify- fied in accordance with a policy change ing requirements and setting priorities regarding the supervision program for for IT initiatives. small bank holding companies, to com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 115 plement the web-enabled NED applica- In 2002 the Federal Reserve trained tion, and to add functionality that further 2,748 students in System schools, 492 in supports the supervision of banking schools sponsored by the FFIEC, and institutions. Changes to the production 52 in other schools, for a total of 3,292, application were also made to accom- including 214 representatives of foreign modate changes in the commercial central banks (table). The number of bank Call Report and the bank holding training days in 2002 totaled 16,824. company FR Y-9 reports. A new ver- The System gave scholarship assission of the Central Document and Text tance to the states for training their Repository was implemented to handle examiners in Federal Reserve and a larger volume of documents. FFIEC schools. Through this program, 454 state examiners were trained— 345 in Federal Reserve courses, 92 in Staff Development FFIEC courses, and 17 in other courses. The Federal Reserve System's staff A staff member seeking an examdevelopment program trains staff iner's commission is required to take a members at the Board of Governors, first proficiency examination, as well the Reserve Banks, and state banking as a second proficiency examination in departments who have supervisory and one of three specialty areas: safety and regulatory responsibilities; students soundness, consumer affairs, or informafrom foreign supervisory authorities tion technology (table). At the end of attend training sessions on a space- 2002, the System had 1,234 field examavailable basis. The program's goal is, iners, of which 892 were commissioned in part, to provide greater cross training (table). in the agencies. Training is offered at the basic, intermediate, and advanced Regulation of the levels in the four disciplines of bank U.S. Banking Structure supervision: bank examinations, bank holding company inspections, surveil- The Board of Governors administers the lance and monitoring, and applications Bank Holding Company Act, the Bank analysis. Classes are conducted in Merger Act, the Change in Bank Con- Washington, D.C., and at other locations trol Act, and the International Banking and are sometimes held jointly with Act as they apply to bank holding comother regulators. panies, financial holding companies, The System also participates in train- member banks, and foreign banking ing offered by the FFIEC and by certain organizations. In doing so, the Federal other regulatory agencies. The System's Reserve acts on a variety of proposals involvement includes assisting in the that directly or indirectly affect the development of basic and advanced structure of U.S. banking at the local, training in relation to emerging issues as regional, and national levels; the interwell as in specialized areas such as trust national operations of domestic banking activities, international banking, infor- organizations; and the U.S. banking mation technology, municipal securities operations of foreign banks. dealing, capital markets, payment systems risk, white collar crime, and real Bank Holding Company Act estate lending. In addition, the System co-hosts the World Bank Seminar for Under the Bank Holding Company Act, students from developing countries. a corporation or similar organization Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

116 89th Annual Report, 2002 Training Programs for Banking Supervision and Regulation, 2002 Number of sessions conducted Program Total Regional Schools or seminars conducted by the Federal Reserve Core schools Banking and supervision elements 9 7 Operations and analysis 7 5 Bank management 4 1 Report writing 16 16 Management skills 10 10 Conducting meetings with management 18 18 Other schools Loan analysis 3 Examination management 6 Real estate lending seminar 2 1 Specialized lending seminar 1 0 Senior forum for current banking and regulatory issues 2 2 Banking applications 1 0 Principles of fiduciary supervision 3 1 Commercial lending essentials for consumer affairs 3 3 Consumer compliance examinations I 2 0 Consumer compliance examinations II 2 2 CRA examination techniques 2 2 Fair lending examination techniques 3 2 Foreign banking organizations 3 3 Information systems continuing education 2 0 Capital markets seminars 13 10 Technology risk integration 13 13 Leadership dynamics 7 6 Seminar for senior supervisors of foreign central banksl 1 1 Other agencies conducting courses2 Federal Financial Institutions Examination Council 34 The Options Institute 2 1. Conducted jointly with the World Bank. 2. Open to Federal Reserve employees. must obtain the Federal Reserve's considers the financial and managerial approval before forming a bank hold- resources of the applicant, the future ing company through the acquisition prospects of both the applicant and the of one or more banks in the United firm to be acquired, the convenience and States. Once formed, a bank holding needs of the community to be served, company must receive Federal Reserve the potential public benefits, the comapproval before acquiring or estab- petitive effects of the proposal, and the lishing additional banks. The act also applicant's ability to make available to identifies other activities permissible the Board information deemed necesfor bank holding companies; depend- sary to ensure compliance with applicaing on the circumstances, these activi- ble law. In the case of a foreign banking ties may or may not require Federal organization seeking to acquire control Reserve approval in advance of their of a U.S. bank, the Federal Reserve also commencement. considers whether the foreign bank is When reviewing a bank holding com- subject to comprehensive supervision or pany application or notice that requires regulation on a consolidated basis by its prior approval, the Federal Reserve home country supervisor. Data on deci- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 111 Resultsof Proficiency Examinations, 2002 Second proficiency exam First Result proficiency exam Safety and Consumer Information soundness affairs technology Passed . 133 82 29 3 Failed 17 15 0 2 Total ... 150 97 29 5 sions regarding domestic and interna- ies firms and insurance companies and tional applications in 2002 are shown in may engage in certain merchant bankthe accompanying table. ing activities. Bank holding companies Bank holding companies generally seeking financial holding company stamay engage in only those activities that tus must file a written declaration with the Board has previously determined to the Federal Reserve System; most declabe closely related to banking under sec- rations are acted upon by one of the tion 4(c)(8) of the act. Since 1996, the Reserve Banks under delegated authoract has provided an expedited prior- ity. In 2002, 82 domestic financial holdnotice procedure for certain permissible ing company declarations and 7 foreign nonbank activities and for acquisitions bank declarations were approved. of small banks and nonbank entities. Financial holding companies do not Since that time the act also has permit- have to obtain the Board's prior ted well-run bank holding companies approval to engage in or acquire a comthat satisfy certain criteria to commence pany engaged in certain new financial certain other nonbank activities on a de activities that are permissible under the novo basis without first obtaining Fed- Gramm-Leach-Bliley Act. Instead, the eral Reserve approval. financial holding company must notify Since 2000, the Bank Holding Com- the Board within thirty days after company Act has permitted the creation mencing the new activity or acquiring of a special type of bank holding com- a company engaged in the new activity. pany called a financial holding com- A financial holding company may also pany. Financial holding companies are engage in certain other activities that allowed to engage in a broader range of have been determined to be financial in nonbank activities than are traditional nature or incidental to a financial activbank holding companies. Among other ity or that are determined to be complethings, they may affiliate with securit- mentary to a financial activity. Trends in Reserve Bank Supervision Levels, 1998-2002 Type of staff 2002 2001 2000 1999 1998 Field examination staff 1,234 1,242 1,172 1,216 1,250 Commissioned field staff 892 861 786 893 933 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

118 89th Annual Report, 2002 Decisions by the Federal Reserve on Domestic and International Applications, 2002 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 e n ct 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 .... 6 0 0 0 0 0 144 58 208 Merger of bank holding company 2 0 0 0 0 2 28 12 44 Acquisition or retention of bank 7 1 0 0 0 2 85 41 136 Acquisition of nonbank 0 0 3 0 0 8 0 101 112 Merger of bank 7 0 0 0 0 1 78 0 86 Change in control 0 0 1 0 0 0 0 160 161 Establishment of a branch, agency, or representative office by a foreign bank 2 0 0 19 0 0 0 0 21 Other 58 0 0 54 0 88 464 453 1,117 Total 82 1 4 73 0 101 799 825 1,885 Bank Merger Act When the FDIC, the OCC, or the OTS has jurisdiction over a merger, the The Bank Merger Act requires that Federal Reserve is asked to comment on all proposals involving the merger of the competitive factors. By using staninsured depository institutions be acted dard terminology in assessing competion by the appropriate federal banking tive factors in merger proposals, the four agency. If the institution surviving the agencies have sought to ensure consismerger is a state member bank, the Fedtency in administering the Bank Merger eral Reserve has primary jurisdiction. Act. The Federal Reserve submitted Before acting on a merger proposal, the 515 reports on competitive factors to the Federal Reserve considers the finanother agencies in 2002. cial and managerial resources of the applicant, the future prospects of the Change in Bank Control Act existing and combined institutions, the convenience and needs of the commu- The Change in Bank Control Act nity to be served, and the competitive requires persons seeking control of a effects of the proposed merger. It also U.S. bank or bank holding company to considers the views of certain other obtain approval from the appropriate agencies regarding the competitive fac- federal banking agency before complettors involved in the transaction. During ing the transaction. The Federal Reserve 2002, the Federal Reserve approved is responsible for reviewing changes in 86 merger applications. the control of state member banks and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 119 bank holding companies. In its review, operations; the managerial resources the Federal Reserve considers the finan- of the foreign bank; whether the home cial position, competence, experience, country supervisor shares information and integrity of the acquiring person; regarding the operations of the foreign the effect of the proposed change on the bank with other supervisory authorities; financial condition of the bank or bank whether the foreign bank has provided holding company being acquired; the adequate assurances that information effect of the proposed change on compe- concerning its operations and activities tition in any relevant market; the com- will be made available to the Board, if pleteness of information submitted by deemed necessary to determine and the acquiring person; and whether the enforce compliance with applicable law; proposed change would have an adverse whether the foreign bank has adopted effect on the federal deposit insurance and implemented procedures to combat funds. As part of the process, the Fed- money laundering and whether the home eral Reserve may contact other regula- country of the foreign bank is developtory or law enforcement agencies for ing a legal regime to address money information about acquiring persons. laundering or is participating in multilat- The appropriate federal banking agen- eral efforts to combat money laundercies are required to publish notice of ing; and the record of the foreign bank each proposed change in control and to with respect to compliance with U.S. invite public comment, particularly from law. persons located in the markets served by In 2002, the Federal Reserve the institution to be acquired. approved 21 applications by foreign In 2002, the Federal Reserve banks to establish branches, agencies, approved 161 changes in control of and representative offices in the United state member banks and bank holding States. companies. Overseas Investments by International Banking Act U.S. Banking Organizations The International Banking Act, as U.S. banking organizations may engage amended by the Foreign Bank Supervi- in a broad range of activities overseas. sion Enhancement Act of 1991, requires Many of the activities are conducted foreign banks to obtain Federal Reserve indirectly through Edge Act and agreeapproval before establishing branches, ment corporation subsidiaries. Although agencies, commercial lending company most foreign investments are made subsidiaries, or representative offices in under general consent procedures that the United States. involve only after-the-fact notification In reviewing proposals, the Federal to the Board, large and other significant Reserve generally considers whether investments require the prior approval the foreign bank is subject to compre- of the Board. Excluding proposals relathensive supervision or regulation on a ing to large domestic mergers, the Board consolidated basis by its home country in 2002 approved 23 proposals for supervisor. It also considers whether the significant overseas investments by home country supervisor has consented U.S. banking organizations. The Federal to the establishment of the U.S. office; Reserve also approved 1 application to the financial condition and resources of acquire an Edge Act corporation, 1 the foreign bank and its existing U.S. application to extend the corporate exist- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

120 89th Annual Report, 2002 ence of an existing Edge Act corpora- the Federal Reserve reviewed 10 stock tion, and 1 application to establish or repurchase proposals by bank holding acquire a new agreement corporation. companies; all were approved by a Reserve Bank under delegated authority. Applications by Member Banks State member banks must obtain Federal Public Notice of Reserve approval to establish domestic Federal Reserve Decisions branches, and all member banks (includ- Most decisions by the Federal Reserve ing national banks) must obtain Federal that involve a bank holding company, Reserve approval to establish foreign a bank merger, a change in control, or branches. When reviewing proposals to the establishment of a new U.S. banking establish domestic branches, the Federal presence by a foreign bank are effected Reserve considers the scope and nature by an order or an announcement. Orders of the banking activities to be constate the decision, the essential facts ducted. When reviewing proposals for of the application or notice, and the foreign branches, the Federal Reserve basis for the decision; announcements considers, among other things, the constate only the decision. All orders and dition of the bank and the bank's experiannouncements are made public immeence in international banking. In 2002, diately; they are subsequently reported the Federal Reserve acted on new and in the Board's weekly H.2 statistical merger-related branch proposals for release and in the monthly Federal 836 domestic branches and granted prior Reserve Bulletin. The H.2 release also approval for the establishment of 5 new contains announcements of applications foreign branches. and notices received by the Federal State member banks must also obtain Reserve but not yet acted on. For each Federal Reserve approval to establish pending application and notice, the financial subsidiaries. These subsidiaries related H.2A contains the deadline may engage in activities that are finanfor comments. In 2002, the Board's cial in nature or incidental to finanweb site (www.federalreserve.gov) concial activities, including securities- and tinued to provide information on orders insurance agency-related activities. In and announcements. 2002, 3 applications for financial subsidiaries were approved. Timely Processing of Stock Repurchases by Applications Bank Holding Companies The Federal Reserve sets internal target A bank holding company may repur- time frames for the processing of applichase its own shares from its share- cations. The setting of targets promotes holders. When the company borrows efficiency at the Board and the Reserve money to buy the shares, the trans- Banks and reduces the burden on appliaction increases the company's debt cants. Generally, the length of the target and decreases its equity. The Federal period ranges from 12 days to 60 days, Reserve may object to stock repurchases depending on the type of application or by holding companies that fail to meet notice filed. In 2002, 93 percent of decicertain standards, including the Board's sions were made within the target time capital adequacy guidelines. In 2002, period. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 121 Enforcement of Several regulatory agencies enforce Other Laws and Regulations the Board's securities credit regulations. The SEC, the National Association of The Federal Reserve's enforcement Securities Dealers, and the national responsibilities also extend to financial securities exchanges examine brokers disclosures by state member banks; and dealers for compliance with Regsecurities credit; and efforts, under the ulation T. With respect to compliance Bank Secrecy Act, to counter money with Regulation U, the federal banking laundering. agencies examine banks under their respective jurisdictions; the Farm Credit Financial Disclosures by Administration, the National Credit State Member Banks Union Administration, and the Office of Thrift Supervision examine lenders State member banks that issue securities under their respective jurisdictions; and registered under the Securities Exchange the Federal Reserve examines other Act of 1934 must disclose certain infor- Regulation U lenders. mation of interest to investors, including annual and quarterly financial reports Since 1990 the Board has published and proxy statements. By statute, the a nonexclusive list of foreign stocks Board's financial disclosure rules must that are eligible for margin treatment be substantially similar to those of the at broker-dealers on the same basis as Securities and Exchange Commission. domestic margin securities. In 2002 the At the end of 2002, 17 state member foreign list was revised in March and banks were registered with the Board September. under the Securities Exchange Act. Anti-Money Laundering Securities Credit The Department of the Treasury's reg- Under the Securities Exchange Act, the ulation (31 CFR 103) implementing Board is responsible for regulating the Currency and Foreign Transactions credit in certain transactions involving Reporting Act (commonly referred to as the purchase or carrying of securities. the Bank Secrecy Act, or BSA) requires The Board's Regulation T limits the banks and other types of financial instiamount of credit that may be provided tutions to file certain reports and mainby securities brokers and dealers when tain certain records. These documents the credit is used to trade debt and record information on persons involved equity securities. The Board's Regula- in large currency transactions and on tion U limits the amount of credit that suspicious activity related to possible may be provided by lenders other than violations of federal law, including brokers and dealers when the credit is money laundering, terrorism, and other used to purchase or carry publicly held financial crimes. The act is a primary equity securities if the loan is secured tool in the fight against money launderby those or other publicly held equity ing; its requirements inhibit money securities. The Board's Regulation X laundering by creating a paper trail of applies these credit limitations, or mar- financial transactions that helps law gin requirements, to certain borrowers enforcement and regulators identify and and to certain credit extensions, such as trace the proceeds of illegal activity. credit obtained from foreign lenders by In addition to the specific require- U.S. citizens. ments of the Bank Secrecy Act, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

122 89th Annual Report, 2002 Board's Regulation H (12 CFR 208.63) In 2002, the Federal Reserve continrequires each banking organization ued to provide expertise and guidance supervised by the Federal Reserve to to the BSA Advisory Group, a commitdevelop a written program for BSA tee established by the Congress at the compliance that is formally approved Department of the Treasury that seeks to by the institution's board of directors. reduce unnecessary burdens created by The compliance program must (1) estab- the BSA and to increase the utility of lish a system of internal controls to data gathered under the act to aid reguensure compliance with the act, (2) pro- lators and law enforcement. The Fedvide for independent compliance test- eral Reserve also assisted the Treasury ing, (3) identify individuals responsible Department in providing feedback to for coordinating and monitoring day-to- financial institutions on the reporting of day compliance, and (4) provide train- suspicious activity. ing for personnel as appropriate. To Since the terrorist attacks of Septemmonitor compliance, each Reserve Bank ber 11, 2001, and continuing through designates senior, experienced examin- 2002, the Federal Reserve has played an ers as BSA and anti-money-laundering important role in many joint activities contacts. During examinations of state with bank supervisory and law enforcemember banks and U.S. branches and ment authorities and the banking comagencies of foreign banks, examin- munity, both domestically and abroad, ers review the institution's compliance to combat money laundering and terrorwith the BSA and determine whether ist financing. The Federal Reserve Bank adequate procedures and controls to of New York created a dedicated e-mail guard against money laundering are in system for financial institutions to place. report matches on the law enforcement The Board has a Special Investiga- list of "suspected terrorists" and, at the tions Section in the Division of Banking request of law enforcement and pursu- Supervision and Regulation that con- ant to subpoenas, searched the records ducts financial investigations, provides of Fedwire for information related to the expertise to the U.S. law enforce- terrorist acts. In addition, multi-agency ment community for investigation and teams led by various U.S. government training initiatives, and offers training agencies were deployed to foreign counto various foreign central banks and tries to analyze bank and other financial government agencies; section staff also records. On several of these occasions, speak at banking conferences to pro- senior Reserve Bank examiners traveled mote best practices in the industry with and worked with the teams. In the wake respect to anti-money-laundering initia- of the terrorist attacks, the FBI formed tives. Internationally, section staff have a multi-agency law enforcement task provided anti-money-laundering train- force to trace the transactions and assets ing and technical assistance to countries of terrorists; staff of the Special Invesin Asia, eastern Europe, South and tigations Section participate in the task Central America, and the Caribbean. force. Staff members have also participated To address the mandates of the USA extensively in numerous multilateral PATRIOT Act, the Federal Reserve anti-money-laundering initiatives such issued a number of supervisory letters to as the Financial Action Task Force all domestic and foreign banking orgaand the Basel Committee on Banking nizations under its supervision on such Supervision. topics as private and correspondent Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 123 Extensions of Credit by State Member Banks to their Executive Officers, 2001 and 2002 Range of interest Period Number Amount (dollars) rates charged (percent) 2001 October 1-December 31 727 64,965,000 1.0-20.0 2002 January 1-March 31 620 65,557,000 2.0-19.8 April 1-June 30 632 69,260,000 3.0-19.8 July 1-September 30 740 78,073,000 2.0-19.8 October 1-December 31 644 72,668,000 2.0-19.8 SOURCE. Call Reports. banking as well as new information- Extensions of Credit to sharing protocols. The letters described Executive Officers the act's requirements in these areas and Under section 22(g) of the Federal the new rules that have been or will be Reserve Act, a state member bank must issued. include in its quarterly Call Report At the request of Treasury Departinformation on all extensions of credit ment staff, and consistent with statutory by the bank to its executive officers requirements for consultation, the Fedsince the date of the preceding report. eral Reserve continues to actively assist The accompanying table summarizes in the development of many other new this information for 2002. rules related to the PATRIOT Act. The Federal Reserve's Patriot Act Working Group, which is composed of senior, Federal Reserve Membership experienced Bank Secrecy Act/antimoney-laundering examiners from At the end of 2002, 2,977 banks were throughout the System, met several members of the Federal Reserve System times during 2002. The group worked and were operating 50,095 branches. on interim examination procedures rela- These banks accounted for 38 percent tive to the act's provisions and are con- of all commercial banks in the United tinuing to develop a new training cur- States and for 74 percent of all commerriculum for examiners. cial banking offices. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

125 Federal Reserve Banks The Federal Reserve Banks and their positioned to meet public demand for Branches carry out a number of System cash in the event of an emergency. operations, including operating a nation- During the year, the Reserve Banks wide payments system, distributing the and the Board also reviewed and nation's currency and coin, and serving enhanced their mechanisms for crisis as fiscal agent and depository to the communications between the Board, United States. Federal Reserve offices, other government agencies, financial industry participants, System employees, the media, Major Initiatives and the general public. During 2002, the Federal Reserve Sys- The events of September 11, 2001, tem took a number of significant steps illustrated the interdependence among to enhance further its resilience in participants in the financial system and case of emergency. It worked to ensure the way that business concentration, market liquidity, continuity of Federal both market-based and geographic, can Reserve operations, and effective Fed- intensify disruptions. The New York eral Reserve communications. In addi- Reserve Bank contributed to two white tion, it supported two efforts to increase papers on these matters that the Board, the resilience of the private sector's together with other regulatory agencies, financial system infrastructure. published for comment during the year. While the Reserve Banks have his- One paper discussed sound practices to torically worked to ensure the continuity increase the resilience of critical U.S. of their operations, they undertook sev- financial markets in the face of a eral projects in 2002 to reassess the regional disaster. The other paper conadequacy of their business-continuity sidered potential structural changes in plans and to make them more robust. the way settlement services for govern- The Banks strengthened their ability to ment securities are provided and preprovide liquidity by enhancing backup sented a framework for discussing issues for open market operations and the dis- that need to be further explored. In count window. As a result, the Federal response to public comments on the lat- Reserve is better positioned to provide ter paper, the Board in November crenecessary market liquidity, helping to ated a private-sector working group to ensure that payment systems and finan- explore ways the clearing banks for govcial markets can continue to function ernment securities could substitute for smoothly during a financial crisis. each other should the services of either In addition, the Reserve Banks eval- be interrupted or terminated. The workuated their Fedwire contingency plans, ing group was asked to submit a report their business-continuity planning pro- to the Board before the end of 2003. cess, staff concentration and leadership The Reserve Banks also worked to succession, telecommunications and net- improve the efficiency of their operawork contingency, and the physical tions through a strategy of standardisecurity of their facilities and personnel. zation and consolidation of a variety Moreover, the Reserve Banks are better of information systems, operations, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

126 89th Annual Report, 2002 programs. For example, the Reserve years, the Federal Reserve Banks have Banks are standardizing and consolidat- recovered 98.8 percent of their priced ing a number of financial management services costs, including the PSAF applications for budgeting, cost account- (table). ing, and accounts payable. In addition, Overall, fees charged in 2002 for efforts are under way to move separate priced services increased approximately human resources information and pay- 1.3 percent from 2001.2 Revenue from roll systems in each of the twelve Dis- priced services amounted to $916.3 miltricts into common systems located in lion, other income related to priced sera single District. The Reserve Banks vices was $2.1 million, and costs related have also initiated efforts to consoli- to priced services totaled $891.7 mildate their electronic access customer- lion, resulting in net income of support function as well as human $26.6 million and a recovery rate of resources operations into fewer sites. 93.3 percent of costs, including the Finally, the Reserve Banks are imple- PSAF.3 menting a standard health insurance program and have adopted a standard Commercial Check prescription drug plan. The expected Collection Service benefits of these consolidations and standardized programs include lower In 2002, operating expenses and administrative and operating costs and imputed costs for the Reserve Banks' improved functionality. check collection service totaled $751.2 million, while revenue amounted to $759.2 million and other income was Developments in $1.7 million, resulting in net income of Federal Reserve Priced Services $9.7 million. In 2001, by comparison, operating expenses and imputed costs The Monetary Control Act of 1980 totaled $754.4 million, while revenue requires that the Federal Reserve set amounted to $764.7 million and other fees for providing "priced services" to income was $28.5 million, resulting depository institutions that, over the in net income of $38.9 million. The long run, recover all the direct and indi- decline in check service revenue in 2002 rect costs of providing the services as well as the imputed costs, such as services; in the pro forma statements at the end of the income taxes that would have been this chapter, Board expenses are included in operpaid and the return on equity that would ating expenses and Board assets are part of longhave been earned had the services been term assets. provided by a private firm. The imputed 2. Based on a chained Fisher Ideal price index not adjusted for quality changes. costs and imputed profit are collectively 3. Financial data reported throughout this referred to as the private-sector adjustchapter—revenue, other income, cost, net revement factor (PSAF).1 Over the past ten nue, and income before taxes—can be linked to the pro forma statements at the end of this chapter. Other income is revenue from investment of clear- 1. In addition to income taxes and the return on ing balances net of earnings credits, an amount equity, the PSAF is made up of three imputed termed net income on clearing balances. Total cost costs: interest on debt, sales taxes, and assess- is the sum of operating expenses, imputed costs ments for deposit insurance by the Federal Deposit (interest on debt, interest on float, sales taxes, and Insurance Corporation. Also allocated to priced the Federal Deposit Insurance Corporation assessservices are assets and personnel costs of the ment), imputed income taxes, and the targeted Board of Governors that are related to priced return on equity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 127 Priced Services Cost Recovery, 1993-2002 Millions of dollars except as noted Operating Revenue from Targeted return Total Cost recovery Year services' im ex p p u e t n e s d e s c a o n st d s2 on equity costs (percent)3 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 57.2 832.9 104.2 2000 922.8 818.2 98.4 916.6 100.7 2001 960.4 901.9 109.2 1,011.1 95.0 2002 918.3 891.7 92.5 984.3 93.3 1993-2002 8,450.5 7,963.0 591.4 8,554.4 98.8 NOTE. In this and other tables in this chapter, compo- 2. For the ten-year period, includes operating expenses nents may not sum to totals or yield percentages shown of $7,114.7 million, imputed costs of $489.7 million, and because of rounding. Amount in bold is a restatement due imputed income taxes of $265.1 million. Also includes to errors in previously reported data. the effect of one-time accounting changes net of taxes of 1. For the ten-year period, includes revenue from ser- $74.1 million for 1993 and $19.4 million for 1995. vices of $8,183.0 million and other income and expense 3. Revenue from services divided by total costs. (net) of $267.5 million. was largely the result of declining vol- lower-than-expected returns on pension ume and customers' moving to lower- credits. margin products. The Reserve Banks To address the apparent continuing handled 16.6 billion checks in 2002, decline in check volumes, the Reserve a decrease of 1.9 percent from 2001 Banks are developing a business and (table). The decline in Reserve Bank operational strategy that will position check volume appears to be consistent the service to achieve its financial and with nationwide trends away from the payment system objectives over the long use of checks and toward greater use of term. In 2002, the Banks contracted electronic payment methods.4 Although with a consultant to analyze their checkthe Reserve Banks took steps to reduce processing infrastructure. The analysis check operating costs in 2002, the defined criteria for balancing efficient reductions were largely offset by provision of service in a decliningvolume environment with the need to provide an adequate level of service 4. The Federal Reserve System's recent retail nationwide. The Banks have used these payments research suggests that the number of checks written in the United States has been criteria to develop potential options as declining since the mid-1990s. See Geoffrey R. to the number, location, and operational Gerdes and Jack K. Walton II, "The Use of capabilities of its check-processing Checks and Other Noncash Payment Instrusites. Subsequently, the Reserve Banks ments in the United States," Federal Reserve announced that they are reducing their Bulletin, vol. 88 (August 2002), pp. 360-74. (The article is available on the Board's web site at check service operating costs through a www.federalreserve.gov/pubs/bulletin/default.htm.) combination of measures: streamlining During the late 1990s, the volume of checks pro- their check-management structures, cessed by the Reserve Banks rose, albeit slowly, reducing staff, decreasing the number of suggesting that the proportion of interbank checks cleared through the Reserve Banks increased. check-processing locations, and increas- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

128 89th Annual Report, 2002 Activity in Federal Reserve Priced Services, 2002, 2001, and 2000 Thousands of items Percent change Service 2002 2001 2000 2001 to 2002 2000 to 2001 Commercial check 16,586,804 16,905,016 16,993,800 -1.9 -.5 Funds transfer 117,133 115,308 111,175 1.6 3.7 Securities transfer 8,480 6,708 5,666 26.4 18.4 Commercial ACH 4,986,152 4,448,361 3,812,191 12.1 16.7 Noncash 333 412 519 -19.2 -20.7 Cash transportation 9 18 19 -52.5 -7.0 NOTE. Activity in commercial checks is the total num- on which fees were assessed; and in cash transportation, ber of commercial checks collected, including processed the number of registered mail shipments and FRBand fine-sort items; in funds transfers and securities trans- arranged armored carrier stops. fers, the number of transactions originated on line and off Amount in bold is restatement of previously reported line; in commercial ACH, the total number of commercial data. items processed; in noncash services, the number of items ing processing capacity in other loca- Commercial Automated tions. The Reserve Banks will continue Clearinghouse Services to provide check services nationwide. Reserve Bank operating expenses and The volume of checks for which the imputed costs for commercial automated Federal Reserve office that serves the clearinghouse (ACH) services totaled depositing bank is not the office that $62.5 million in 2002. Revenue from serves the paying bank increased ACH operations and other income 4.4 percent, from 3.6 billion in 2001 to totaled $71.8 million, resulting in net 3.7 billion in 2002. Of all the checks income of $9.3 million. The Reserve presented by the Reserve Banks to pay- Banks processed 5.0 billion commercial ing banks, 22.0 percent (approximately ACH transactions (worth $13.1 trillion), 3.6 billion checks) were presented elecan increase of 12.1 percent from 2001. tronically, compared with 21.7 percent Consolidation of customer support in 2001. The Reserve Banks captured activities to two Reserve Bank offices images of 8.1 percent of the checks they was completed during 2002. These two collected, the same percentage as in Banks now share responsibility for 2001. supporting all ACH operations, includ- The Reserve Banks continued in 2002 ing ensuring the timely and accurate a check modernization project begun processing of payments, maintaining the in 2000 to install uniform software and integrity of the ACH application, monihardware for check processing, check toring file processing, and responding to imaging, and check adjustments in all customers' questions. Before consolida- Reserve Bank offices and to give tion, these responsibilities were handled depository institutions web-based access by each of the twelve Reserve Banks. to check services. The Reserve Banks expect to recover the cost of the project over the long run because the mod- Fedwire Funds and ernization effort will increase operat- National Settlement Services ing efficiency and make it possible to offer additional services to depository Reserve Bank operating expenses and institutions. imputed costs for the Fedwire Funds Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 129 and National Settlement Services Fees Paid by Depository Institutions for totaled $53.5 million in 2002. Revenue Selected Federal Reserve Priced Services, 2001 and 2002 from these operations totaled $58.6 million, and other income amounted to Dollars $0.1 million, resulting in net income of Item 2001 2002 $5.2 million. FEDWIRE FUNDS TRANSFERS, BY VOLUME TIER1 Fedwire Funds Service Tier (number of transfers per month)2 The Reserve Banks' Fedwire Funds 1 (1 to 2,500) .33 .31 2 (2,501 to 80,000) .24 .22 Service allows depository institutions 3 (80,001 and more) .16 .15 to draw on their reserve or clearing bal- Off-line surcharge 15.00 15.00 ances at the Reserve Banks and transfer NATIONAL SETTLEMENT funds to other institutions that maintain SERVICES accounts at the Reserve Banks. In 2002, Entries, each .95 .80 Files, each 12.00 14.00 the number of Fedwire funds transfers Minimum per month 60-100 60-100 originated by depository institutions FEDWIRE SECURITIES increased 1.6 percent from 2001, to TRANSFERS approximately 117.1 million. The Account maintenance Reserve Banks reduced the transfer fees Per issue .45 .41 Per account 15.00 15.00 for each of the volume-based tiers Transfers, each2 .70 .66 (table). The off-line funds transfer sur- Off-line surcharge 25.00 25.00 charge remained unchanged.5 NONCASH COLLECTION The final phase of consolidation of Bonds, each 40.00 40.00 the operations of the Fedwire Funds Deposit envelopes Service was completed in May. Also (per envelope of coupons)3 1-5 4.75 4.75 during 2002, the Reserve Banks 6-50 2.50 2.50 improved the resilience of the service Cash letters by increasing the readiness of a third (flat fee, by number of envelopes of coupons)3 data processing center. In the event of 1-5 7.50 7.50 an outage at the primary or second- 6-50 15.00 15.00 ary site or at both sites, resources at Return items, each 20.00 20.00 the third site are available to support 1. Rates apply only to their specified volume tiers. same-day recovery of Fedwire appli- 2. Originated and received. cations. This enhancement adds to the 3. Deposits and cash letters may contain no more than already robust contingency capabilities 50 envelopes of coupons. provided by the primary and secondary sites. The three sites are distant from service would open at 9:00 p.m. eastern each other. time (ET), three and one-half hours In December, the Board requested earlier than the current opening time comment on a proposal to expand the of 12:30 a.m. ET. The earlier opening operating hours for the on-line Fedwire time is intended to facilitate the func- Funds Service. Under the proposal, the tioning and continued development of the payments system and to increase efficiency and reduce risk in making 5. Depository institutions that do not have an payments and settlements. The proposal electronic connection to the Fedwire funds transdoes not affect the Fedwire Securities fer system can originate transfers via "off-line" telephone instructions. Service. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

130 89th Annual Report, 2002 National Settlement Service securities to the Fedwire system was completed in March; the securities are Private clearing arrangements that now transferred and settled on the Fedexchange and settle transactions may wire Securities Service. The final phase use the Reserve Banks' National Settleof consolidation of the operations of the ment Service to settle their transactions. Fedwire Securities Service, an effort to The Reserve Banks provide settlement reduce costs, was completed in May. services to approximately seventy local Operational support for processing joint and national private arrangements, pricustody collateral was also consolidated marily check clearinghouse associations in May. but also other types of arrangements. Also during 2002, the Reserve Banks In 2002, the Reserve Banks processed increased the readiness of a third data more than 415,000 settlement entries processing center for the Fedwire Secufor these arrangements. rities Service to serve as a backup in the event of an outage at the primary Fedwire Securities Service or secondary site or both. Processing resources at the third site are available The Fedwire Securities Service allows to support same-day recovery of the participants to electronically transfer Fedwire applications. This enhancesecurities issued by the U.S. Treasury, ment to the third site adds to the federal government agencies, and other already robust contingency capabilities entities to other participants in the provided by the primary and secondary United States.6 Reserve Bank operating sites. The three sites are distant from expenses and imputed costs for provideach other. ing this service totaled $21.5 million in 2002. Revenue and other income totaled $23.8 million, resulting in net income of Noncash Collection Service $2.3 million. Approximately 8.5 million The Reserve Banks provide a service transfers were processed by the service to collect and process municipal bearer during the year, an increase of 26.4 perbonds and coupons issued by state and cent from 2001. The basic per-transfer local governments (referred to as "nonfee for transfers originated and received cash" items). The service, which is cenby participants and the monthly account tralized at one Federal Reserve office, maintenance fees were lowered, while processed 333,000 noncash transacthe off-line securities transaction surtions in 2002. Operating expenses and charge remained unchanged. imputed costs for noncash operations Conversion of Government National totaled $1.5 million in 2002, and reve- Mortgage Association (Ginnie Mae) nue totaled $1.7 million, resulting in net income of $0.2 million. 6. The expenses, revenues, and volumes reported here are for transfers of securities issued by federal government agencies, government- Special Cash Services sponsored enterprises, and international institutions. When the Reserve Banks provide transfer, The Reserve Banks charge fees for account maintenance, and settlement services for providing special cash-related services, U.S. Treasury securities, they are acting as fiscal such as packaging currency in a agents of the United States. The Treasury Departnonstandard way. These services— ment assesses fees on depository institutions for collectively referred to as "special cash some of these services. For details, see the section "Fiscal Agency Services" later in this chapter. services"—account for a very small Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 131 proportion (less than 1 percent) of the tions continued for the introduction of a total cost of cash services provided to new currency design, which includes depository institutions by the Reserve new and enhanced security features. Banks. Operating expenses and imputed costs for special cash services totaled $1.4 million in 2002. Revenue and other Developments in income also totaled $1.4 million, result- Fiscal Agency and ing in no net income. Government Depository Services The total cost of providing fiscal agency Float and depository services to the Treasury and other government agencies in 2002 Federal Reserve float decreased in 2002 amounted to $308.5 million, compared to a daily average of -$318.6 million, with $285.4 million in 2001 (table). The from a daily average of $604.6 million majority of these costs were incurred on in 2001.7 The Federal Reserve includes behalf of the Treasury. Treasury-related the cost of or income from float associcosts were $269.4 million in 2002, comated with priced services as part of the pared with $246.5 million in 2001, an fees for those services. increase of 9.3 percent. The cost of providing services to other government Developments in agencies was $39.1 million, compared Currency and Coin with $38.9 million in 2001. In 2002, as in 2001, the Treasury and other The Reserve Banks received 34.7 bilgovernment agencies reimbursed the lion notes from circulation in 2002, a Reserve Banks for costs to provide these 3.1 percent increase from 2001, and services. made payments of 35.4 billion notes to circulation in 2002, a 2.9 percent increase from 2001. The Banks received Fiscal Agency Services 43.4 billion coins from circulation in 2002, a 9.3 percent increase from 2001, As fiscal agents, the Reserve Banks proand made payments of 58.6 billion coins vide to the Treasury services related to to circulation in 2002, a 3.0 percent the federal debt. For example, they increase from 2001. issue, transfer, reissue, exchange, and The Reserve Banks enhanced their redeem marketable Treasury securities national business-continuity framework and savings bonds; they also process for the cash services function during the secondary market transfers initiated by year. This effort included the refinement depository institutions. Additionally, the of operating procedures, expansion of Reserve Banks support Treasury and the crisis partner network for the Banks, other government agencies in their and continuation of cash contingency efforts to modernize government paytesting. ment and accounting systems. Also during the year, the Federal Reserve worked closely with the Bureau Marketable Treasury Securities of Engraving and Printing as prepara- Reserve Bank operating expenses for activities related to marketable Treasury 7. Float results from differences in the timing securities (Fedwire Securities Service, of exchanges of debits and credits (settlements) between entities in financial transactions. TreasuryDirect, marketable issues, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

132 89th Annual Report, 2002 Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2002, 2001, and 2000 Thousands of dollars Agency and service 2002 2001 2000 DEPARTMENT OF THE TREASURY Bureau of the Public Debt Savings bonds 68,888.3 69,569.8 70,786.7 TreasuryDirect and Treasury coupons 33,953.6 36,610.1 42,372.4 Commercial book entry 8,830.1 9,998.1 13,924.6 Marketable Treasury issues 14,597.6 11,366.8 14,224.3 Computer applications and infrastructure development and support 2,349.6 222.4 Other services 2,385.8 1,255.7 96.8 Total 131,005.0 129,022.9 141,404.7 Financial Management Service Treasury tax and loan and Treasury general account 30,111.0 31,106.0 38,649.0 Government check processing 30,284.4 30,310.2 31,866.9 Automated clearinghouse 6,280.0 9,665.2 10,799.1 Government agency deposits 2,082.2 2,272.9 2,218.8 Fedwire funds transfers 201.4 199.2 182.9 Computer applications and infrastructure development and support 46,782.6 27,281.3 21,209.6 Other services 8,173.1 3,490.2 5,805.8 Total 123,914.7 104,324.9 110,732.2 Other Treasury Total 14,471.2 13,149.8 10,362.8 Total, Treasury 269,390.9 246,497.5 262,499.7 OTHER FEDERAL AGENCIES Department of Agriculture Food coupons 10,240.8 13,197.2 16,463.7 U.S. Postal Service Postal money orders 12,381.6 11,255.0 9,213.5 Miscellaneous agencies Other services 16,494.1 14,434.0 13,747.1 Total, other agencies 39,116.5 38,886.2 39,424.3 Total reimbursable expenses 308,507.4 285,383.7 301,924.0 NOTE. Amounts in bold are restatements due to reclas- . . . Not applicable sification of previously reported data. Treasury coupons) totaled $57.4 mil- provides custody services only.8 Almost lion, a 1.0 percent decrease from 2001. 98 percent of the total par value of Trea- The Reserve Banks processed 167,000 sury securities outstanding at year-end tenders for Treasury securities (exclud- 2002 was held by the Fedwire Securities ing tenders processed by the Treasury, Service. The Reserve Banks in 2002 which were previously included in this originated 8.3 million transfers of Treafigure), compared with 181,000 in 2001, sury securities, a 6.2 percent increase and handled 2.5 million reinvestment from 2001. requests, compared with 2.8 million in TreasuryDirect customers may sell 2001. their securities for a fee through Sell- The Reserve Banks operate two book- Direct, a program operated by one of the entry securities systems for Treasury Reserve Banks. The Bank sold nearly securities: the Fedwire Securities Service, which provides custody and trans- 8. TreasuryDirect was designed for individuals fer services, and TreasuryDirect, which who plan to hold their securities until maturity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 133 14,000 securities worth $589.8 million interest rate being determined by aucin 2002, compared with nearly 15,000 tion. This pilot program added approxisecurities worth $699.9 million in 2001. mately $3.0 million to the Treasury's It collected more than $464,000 in fees investment income. on behalf of the Treasury, a decrease of 9.1 percent from the almost $510,000 in Payments Processed for the Treasury fees collected in 2001. Reserve Bank operating expenses related to government payments Savings Bonds amounted to $38.8 million in 2002. The Reserve Bank operating expenses for Banks processed 883.2 million ACH savings bond activities totaled transactions for the Treasury, a decrease $68.9 million in 2002, a decrease of of 1.9 percent from 2001, and nearly 1.0 percent from 2001. The Banks 140,000 Fedwire funds transfers, a printed and mailed 37.2 million savings decrease of 10.2 percent from 2001. bonds on behalf of the Treasury's Bu- They also processed 289.3 million paper reau of the Public Debt, a 1.5 percent government checks, a decrease of decrease from 2001. They issued nearly 16.3 percent from 2001. In addition, the 4.7 million new Series I (inflation- Banks issued 368,000 fiscal agency indexed) savings bonds and 27.9 million checks, a decrease of 15.5 percent from new Series EE savings bonds. In addi- 2001. tion, the Banks processed approximately During the year, the Reserve Banks 618,000 redemption, reissue, and assisted Treasury's efforts to facilitate exchange transactions, a 9.7 percent electronic payments to the federal govincrease from 2001. Reserve Bank staff ernment. The Banks operate Pay.gov, a responded to 1.6 million service calls Treasury program that allows members from owners of savings bonds, approxi- of the public to pay the government mately the same number as in 2001. over the Internet. The Banks also operate the Treasury's Paper Check Conversion program, whereby checks written Depository Services to government agencies are converted at the point of sale into ACH transactions. The Reserve Banks maintain the Treasury's funds account, accept deposits of In 2002, the first full year of operation federal taxes and fees, pay checks drawn for both programs, the Reserve Banks on the Treasury's account, and make originated nearly 215,000 ACH transacelectronic payments on behalf of the tions through the programs, a significant Treasury. increase from the 10,000 originated in 2001. Federal Tax Payments Services Provided to Other Entities Reserve Bank operating expenses related to federal tax payments in The Reserve Banks provide fiscal 2002 totaled $30.1 million. The Federal agency and depository services to other Reserve enhanced the Treasury tax and domestic and international agencies loan program at midyear by pilot testing when they are required to do so by the the Term Investment Option, whereby Secretary of the Treasury or when they the Treasury can place investments with are required or permitted to do so by depository institutions for a set term, the federal statute. One such service is the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

134 89th Annual Report, 2002 provision of food coupon services for each other and to depository institutions the Department of Agriculture. Reserve is substantially complete. The technol- Bank operating expenses for food cou- ogy has improved the speed, reliability, pon services in 2002 totaled $10.2 mil- and performance of the depository instilion, 22.4 percent lower than in 2001. tutions' electronic connections during The Banks redeemed 500.5 million food contingencies as well as the capacity coupons, a decrease of 14.7 percent and flexibility to support new electronic from 2001. services using web-based technologies. As fiscal agents of the United States, Also, several major cost-reduction the Reserve Banks also process all initiatives to centralize or standardize postal money orders deposited by banks information technology utilities and for collection. In 2002, they processed resources common to the Reserve Banks 216.5 million postal money orders, a have begun. Projects are under way to decrease of 5.6 percent from 2001. standardize certain local area network components as well as desktop hardware and software to facilitate interoper- Electronic Access ability, improve network efficiency, and The Federal Reserve continued in 2002 increase productivity. Certain Reserve to improve electronic access for deposi- Banks are supporting common informatory institutions and to offer web-based tion technology functions such as deskapplications for imaging checks, order- top standardization and management, ing cash, and processing savings bonds. remote access, and incident response. Specifically, the Reserve Banks made These initiatives are expected to contribthe strategic decision to deliver services ute to a System effort to reduce informausing web-based technologies in the tion technology costs over the long term. next two years and to discontinue development of the FedLine for Windows NT Examinations of the operating system. This strategic direc- Federal Reserve Banks tion will allow the Banks to provide more-flexible access to the full array of Section 21 of the Federal Reserve Act financial information and transaction requires the Board of Governors to order services, including high-risk Fedwire an examination of each Federal Reserve and ACH, and to improve the quality of Bank at least once a year. The Board financial services. engages a public accounting firm to per- To complement the move to web- form an annual audit of the combined based electronic access, the Reserve financial statements of the Reserve Banks plan to consolidate the customer Banks (see the section "Federal Reserve support function for electronic access at Banks Combined Financial Statements"). each Reserve Bank to two sites during The public accounting firm also audits 2003 and 2004. The consolidation is the annual financial statements of each expected to improve the efficiency and of the twelve Banks. The Reserve Banks consistency of customer support. use the framework established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) Information Technology in assessing their internal controls over Implementation of frame relay technol- financial reporting, including the safeogy on the telecommunications network guarding of assets. Within this frameconnecting the Reserve Bank offices to work, each Reserve Bank provides an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 135 assertion letter to its board of directors Reserve's Federal Open Market Comannually confirming adherence to the mittee (FOMC), the division also exam- COSO standards, and a public account- ines the accounts and holdings of the ing firm certifies management's asser- System Open Market Account at the tion and issues an attestation report to Federal Reserve Bank of New York and the Bank's board of directors and to the the foreign currency operations con- Board of Governors. ducted by that Bank. In addition, a pub- The firm engaged for the audits of the lic accounting firm certifies the schedindividual and combined financial state- ule of participated asset and liability ments of the Reserve Banks for 2002 accounts and the related schedule of parwas PricewaterhouseCoopers LLP ticipated income accounts at year-end. (PwC). Fees for these services totaled Division personnel follow up on the $1.0 million. To ensure auditor indepen- results of these audits. The FOMC dence, the Board requires that PwC be receives the external audit reports and independent in all matters relating to the the report on the division's follow-up. audit. Specifically, PwC may not perform services for the Reserve Bank or Income and Expenses others that would place it in a position of auditing its own work, mak- The accompanying table summarizes ing management decisions on behalf the income, expenses, and distributions of the Reserve Banks, or in any other of net earnings of the Federal Reserve way impairing its audit independence. Banks for 2001 and 2002. In 2002 the Reserve Banks engaged Income in 2002 was $26,760 million, PwC for advisory services totaling compared with $31,871 million in 2001. $176,600 for project management advi- Expenses totaled $2,862 million ($2,071 sory services related to the System's million in operating expenses, $156 milcheck modernization project. The Board lion in earnings credits granted to believes that these advisory services do depository institutions, $205 million in not directly affect the preparation of assessments for expenditures by the the financial statements audited by PwC Board of Governors, and $430 miland are not incompatible with the ser- lion for the cost of new currency). vices provided by PwC as an indepen- Revenue from priced services was dent auditor. $916.3 million. The Board's annual examination of The profit and loss account showed a the Reserve Banks in 2002 included a net profit of $2,149 million. The profit wide range of off-site and on-site over- was due primarily to unrealized gains on sight activities conducted by the Divi- assets denominated in foreign currension of Reserve Bank Operations and cies revalued to reflect current market Payment Systems. Division staff moni- exchange rates. Statutory dividends paid tors the activities of each Reserve Bank to member banks totaled $484 million, on an ongoing basis and conducts $56 million more than in 2001; the on-site reviews according to the divi- increase reflects an increase in the capision's risk-assessment methodology. tal and surplus of member banks and a The 2002 examination also included consequent increase in the paid-in capiassessing the efficiency and effective- tal stock of the Reserve Banks. ness of the internal audit function. Payments to the U.S. Treasury in the Each year, to assess compliance with form of interest on Federal Reserve the policies established by the Federal notes totaled $24,496 million in 2002, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

136 89th Annual Report, 2002 Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2002 and 2001 Millions of dollars Item 2002 2001 Current income 26,760 31,871 Current expenses 2,227 2,085 Operating expenses1 2,071 1,834 Earnings credits granted 156 250 Current net income 24,533 29,786 Net additions to (deductions from, - ) current net income 2,149 -1,117 Assessments by the Board of Governors 635 634 For expenditures of Board 205 295 For cost of currency 430 339 Net income before payments to Treasury 26,048 28,035 Dividends paid 484 428 Transferred to surplus 1,068 518 Payments to Treasury2 24,496 27,089 1. Includes a net periodic credit for pension costs of 2. Interest on Federal Reserve notes. $157 million in 2002 and $331 million in 2001. down from $27,089 million in 2001; the The average rate of interest earned payments equal net income after the on the Reserve Banks' holdings of govdeduction of dividends paid and of the ernment securities declined to 4.11 peramount necessary to bring the surplus of cent, from 5.46 percent in 2001, and the Reserve Banks to the level of capital the average rate of interest earned on paid in. loans declined to 1.94 percent, from In the "Statistical Tables" section of 3.18 percent. this volume, table 5 details the income and expenses of each Reserve Bank for Volume of Operations 2002, and table 6 shows a condensed statement for each Bank for the years Table 8 in the "Statistical Tables" sec- 1914 through 2002. A detailed account tion shows the volume of operations in of the assessments and expenditures of the principal departments of the Federal the Board of Governors appears in the Reserve Banks for the years 1999 section "Board of Governors Financial through 2002. Statements." Holdings of Securities and Loans Federal Reserve Bank Premises The Reserve Banks' average daily hold- In 2002, design work continued for the ings of securities and loans during 2002 Dallas Reserve Bank's new Houston amounted to $621,834 million, Branch building and the Chicago Bank's an increase of $62,511 million from Detroit Branch building. Also, the Board 2001 (table). Holdings of U.S. govern- approved the purchase of property for ment securities increased $62,795 mil- the new Detroit Branch building and a lion, and holdings of loans decreased new building program for the Kansas $284 million. City Bank. The St. Louis Reserve Bank Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 137 Securities and Loans of the Federal Reserve Banks, 2000-2002 Millions of dollars except as noted U.S. Item and year Total government Loans2 securitiesx Average daily holdings3 2000 528,139 527,774 365 2001 559,323 558,926 397 2002 621,834 621,721 113 Earnings4 2000 32,760 32,737 23 2001 30,536 30,523 13 2002 25,527 25,525 2 Average interest rate (percent) 2000 6.20 6.20 6.27 2001 5.46 5.46 3.18 2002 4.11 4.11 1.94 1. Includes federal agency obligations. 4. Earnings have not been netted with the inter- 2. Does not include indebtedness assumed by the Fed- est expense on securities sold under agreements to eral Deposit Insurance Corporation. repurchase. 3. Based on holdings at opening of business. continued to analyze its long-term plan- for the main chiller plant in the headning options for its headquarters facility. quarters building was completed, and The multiyear renovation program at the annex building in New York City the New York Reserve Bank's head- was sold. quarters building continued, including At all facilities, security enhancement the cleaning and repair of the exterior programs were undertaken as a result of stonework. The improvement program the events of September 11, 2001. > Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

138 89th Annual Report, 2002 Pro Forma Financial Statements for Federal Reserve Priced Services Pro Forma Balance Sheet for Priced Services, December 31, 2002 and 2001 Millions of dollars Item 2002 2001 Short-term assets (Note 1) Imputed reserve requirements on clearing balances 1,047.8 860.8 Investment in marketable securities ... 9,051.3 7,747.3 Receivables 78.7 76.5 Materials and supplies 3.4 3.1 Prepaid expenses 34.8 30.5 Items in process of collection 6,958.6 1,772.1 Total short-term assets 17,174.7 10,490.3 Long-term assets (Note 2) Premises . 475.0 473.0 Furniture and equipment 179.2 176.1 Leases and leasehold improvements .. 91.2 88.1 Prepaid pension costs 809.2 760.8 Total long-term assets 1,554.6 1,498.0 Total assets 18,729.3 11,988.3 Short-term liabilities Clearing balances and balances arising from early credit of uncollected items 10,550.2 8,524.5 Deferred-availability items 6,886.4 1,855.7 Short-term debt .0 20.8 Short-term payables 83.9 89.2 Total short-term liabilities 17,520.5 10,490.3 Long-term liabilities Long-term debt .0 519.7 Postretirement/postemployment benefits obligation 272.3 257.8 Total long-term liabilities 272.3 777.4 Total liabilities 17,792.8 11,267.7 Equity 936.4 720.6 Total liabilities and equity (Note 3) ... 18,729.3 11,988.3 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

Federal Reserve Banks 139 Pro Forma Income Statement for Federal Reserve Priced Services, 2002 and 2001 Millions of dollars Item 2002 2001 Revenue from services provided to depository institutions (Note 4) ... 916.3 926.5 Operating expenses (Note 5) 876.0 814.9 Income from operations 40.2 111.7 Imputed costs (Note 6) Interest on float -6.8 15.5 Interest on debt .0 32.0 Sales taxes 11.4 12.6 FDIC insurance .0 4.6 .0 60.1 Income from operations after imputed costs 35.6 51.6 Other income and expenses (Note 7) Investment income 148.9 273.3 Earnings credits -146.8 2.1 -239.4 33.9 Income before income taxes 37.7 85.4 Imputed income taxes (Note 8) 11.0 26.9 Net income 26.6 58.5 MEMO: Targeted return on equity (Note 9) 92.5 109.2 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. Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2002 Millions of dollars Com- Commercial Fedwire Fedwire Noncash Cash Item Total mercial check funds securities services services ACH collection Revenue from services (Note 4) 916.3 759.2 58.6 23.7 71.7 1.7 1.4 Operating expenses (Note 5) 876.0 744.3 50.7 20.3 58.0 L4 L4 Income from operations 40.2 14.9 7.9 3.5 13.7 .2 -.0 Imputed costs (Note 6) 4.6 2.9 .7 .3 .7 .0 _Q Income from operations after imputed costs 35.6 12.0 7.3 3.1 13.0 -.0 Other income and expenses, net (Note 7) 2.1 1.7 .1 .0 .2 .0 .0 Income before income taxes .. 37.7 13.7 7.4 3.2 13.2 .2 -.0 Imputed income taxes (Note 8) 11.0 4.0 2.2 .9 3.9 .1 -.0 Net income ... 26.6 9.7 5.2 2.3 9.3 .2 -.0 MEMO: Targeted return on equity (Note 9) 92.5 78.2 5.5 2.2 6.5 .1 .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

140 89th Annual Report, 2002 FEDERAL RESERVE BANKS NOTES TO PRO FORMA FINANCIAL STATEMENTS FOR PRICED SERVICES (1) SHORT-TERM ASSETS ment factor (PSAF). The PSAF consists of the taxes that would have been paid and the return on capital that would The imputed reserve requirement on clearing balances have been provided had priced services been furnished by held at Reserve Banks by depository institutions reflects a a private-sector firm. Other short-term liabilities include treatment comparable to that of compensating balances clearing balances maintained at Reserve Banks and held at correspondent banks by respondent institutions. deposit balances arising from float. Other long-term lia- The reserve requirement imposed on respondent balances bilities consist of accrued postemployment and postretiremust be held as vault cash or as non-earning balances ment benefits costs and obligations on capital leases. maintained at a Reserve Bank; thus, a portion of priced services clearing balances held with the Federal Reserve is shown as required reserves on the asset side of the (4) REVENUE balance sheet. Another portion of the clearing balances Revenue represents charges to depository institutions for is used to finance short-term and long-term assets. The priced services and is realized from each institution remainder of clearing balances is assumed to be invested through one of two methods: direct charges to an instituin three-month Treasury bills, shown as investment in tion's account or charges against its accumulated earnmarketable securities. ings credits. Receivables are (1) amounts due the Reserve Banks for priced services and (2) the share of suspense-account and difference-account balances related to priced services. (5) OPERATING EXPENSES Materials and supplies are the inventory value of short- Operating expenses consist of the direct, indirect, and term assets. other general administrative expenses of the Reserve Prepaid expenses include salary advances and travel Banks for priced services plus the expenses for staff advances for priced-service personnel. members of the Board of Governors working directly on Items in process of collection is gross Federal Reserve the development of priced services. The expenses for cash items in process of collection (CIPC) stated on a Board staff members were $5.1 million in 2002 and basis comparable to that of a commercial bank. It reflects $4.9 million in 2001. The credit to expenses under adjustments for intra-System items that would otherwise SFAS 87 (see note 2) is reflected in operating expenses. be double-counted on a consolidated Federal Reserve The income statement by service reflects revenue, balance sheet; adjustments for items associated with non- operating expenses, and imputed costs. Certain corporate priced items, such as those collected for government overhead costs not closely related to any particular priced agencies; and adjustments for items associated with service are allocated to priced services in total based on providing fixed availability or credit before items are an expense-ratio method, but are allocated among priced received and processed. Among the costs to be recovered services based on management decision. Corporate overunder the Monetary Control Act is the cost of float, or net head was allocated among the priced services during CIPC during the period (the difference between gross 2002 and 2001 as follows (in millions): CIPC and deferred-availability items, which is the portion of gross CIPC that involves a financing cost), valued at 2002 2001 the federal funds rate. Check 40.3 43.5 (2) LONG-TERM ASSETS ACH 4.1 4.4 Fedwire funds 3.3 3.5 Consists of long-term assets used solely in priced ser- Fedwire securities 1.9 1.9 vices, the priced-services portion of long-term assets Noncash services .1 .1 shared with nonpriced services, and an estimate of the Special cash services .1 .0 assets of the Board of Governors used in the development Total 49.7 53.4 of priced services. Effective Jan. 1, 1987, the Reserve Banks implemented the Financial Accounting Standards Board's Statement of Financial Accounting Standards (6) IMPUTED COSTS No. 87, Employers' Accounting for Pensions (SFAS 87). Imputed costs consist of interest on float, interest on debt, Accordingly, the Reserve Banks recognized credits to sales taxes, and the FDIC assessment. Interest on float is expenses of $48.4 million in 2002 and $101.0 million in derived from the value of float to be recovered, either 2001 and corresponding increases in this asset account. explicitly or through per-item fees, during the period. Float costs include costs for checks, book-entry securities, noncash collection, ACH, and funds transfers. (3) LIABILITIES AND EQUITY Interest is imputed on the debt assumed necessary to Under the matched-book capital structure for assets, finance priced-service assets. There was no debt in 2002 short-term assets are financed with clearing balances in because clearing balances fund short-term and long-term 2002 and short-term payables and short-term debt in debt. The sales taxes and FDIC assessment that the Federal Reserve would have paid had it been a private-sector 2001. Long-term assets are financed with clearing balfirm are among the components of the PSAF (see note 3). ances in 2002, and in 2001 with long-term debt and Float cost or income is based on the actual float equity in a proportion equal to the ratio of long-term debt incurred for each priced service. Other imputed costs are to equity for the fifty largest bank holding companies, allocated among priced services according to the ratio of which are used in the model for the private-sector adjust- operating expenses less shipping expenses for each ser- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 141 vice to the total expenses for all services less the total reserve or clearing balances or by billing institutions shipping expenses for all services. directly. Float recovered through direct charges and per- The following list shows the daily average recovery of item fees is valued at the federal funds rate; credit float actual float by the Reserve Banks for 2002 in millions of recovered through per-item fees has been subtracted from dollars: the cost base subject to recovery in 2002. Total float -9.3 (7) OTHER INCOME AND EXPENSES Unrecovered float 68.6 Consists of investment income on clearing balances and Float subject to recovery -77.9 the cost of earnings credits. Investment income on clear- Sources of recovery of float ing balances represents the average coupon-equivalent Income on clearing balances -8.2 yield on three-month Treasury bills applied to the total As-of adjustments -309.3 clearing balance maintained, adjusted for the effect of Direct charges 430.8 reserve requirements on clearing balances. Expenses for Per-item fees -809.8 earnings credits granted to depository institutions on their clearing balances are derived by applying the average federal funds rate to the required portion of the clearing Unrecovered float includes float generated by services balances, adjusted for the net effect of reserve requireto government agencies and by other central bank serments on clearing balances. vices. Float recovered through income on clearing balances is the result of the increase in investable clearing balances; the increase is produced by a deduction for float (8) INCOME TAXES for cash items in process of collection, which reduces Imputed income taxes are calculated at the effective tax imputed reserve requirements. The income on clearing rate derived from the PSAF model (see note 3). balances reduces the float to be recovered through other means. As-of adjustments and direct charges refer to float that is created by interterritory check transportation and (9) RETURN ON EQUITY the observance of non-standard holidays by some deposi- The after-tax rate of return on equity that the Federal tory institutions. Such float may be recovered from the Reserve would have earned had it been a private business depository institutions through adjustments to institution firm, as derived from the PSAF model (see note 3). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

143 The Board of Governors and the Government Performance and Results Act Under the Government Performance and and discusses validation of data and veri- Results Act of 1993 (GPRA), federal fication of results. The performance agencies are required to prepare, in con- report indicates that the Board generally sultation with the Congress and outside met its goals for 2000-01. A scheduling stakeholders, a strategic plan covering a problem with state bank regulatory multiyear period and to submit annual agencies was cited as a reason for not performance plans and performance meeting all of the goals. Accordingly, reports. Though not covered by the act, the Board is implementing a new schedthe Board of Governors is volunta- uling system that will help resolve rily complying with many of the act's the problem. mandates. The strategic plan, performance plan, and performance report are available on the Board's public web site Strategic and Performance Plans (www.federalreserve.gov/boarddocs and Performance Report /rptcongress). The Board's mission The Board's current strategic plan in statement and a summary of the goals the GPRA format, released in Decem- and objectives set forth in the strategic ber 2001, covers the period 2001-05. and performance plans are given below. The document articulates the Board's mission, sets forth major goals for the period, outlines strategies for achieving Mission those goals, and discusses the environ- The mission of the Board is to foster the ment and other factors that could affect stability, integrity, and efficiency of the their achievement. The strategic plan nation's monetary, financial, and payalso addresses issues that cross agency ment systems so as to promote optimal jurisdictional lines, identifies key quanmacroeconomic performance. titative measures of performance, and discusses performance evaluation. The 2002-03 performance plan and Goals and Objectives the 2000-01 performance report were posted on the Board's public web site The Federal Reserve has three primary in November 2002 for access by the goals with interrelated and mutually Congress, the public, and the General reinforcing elements: Accounting Office. The performance plan sets forth specific targets for some of the performance measures identi- Goal fied in the strategic plan (except those associated with the monetary policy To conduct monetary policy that profunction). The performance plan also motes the achievement of maximum describes the operational processes and sustainable long-term growth and the resources needed to meet those targets price stability that fosters that goal. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

144 89th Annual Report, 2002 Objectives • Promote equal access to banking services • Stay abreast of recent developments • Administer and ensure compliance and prospects in the U.S. economy with consumer protection statutes and financial markets and in those relating to consumer financial transabroad, so that monetary policy deciactions (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 in out congressional intent, striking the 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 research activities Goal • 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 • Promote understanding of Federal • Develop sound, effective policies Reserve policy among other govern- and regulations that foster payment ment policy officials and the general system integrity, efficiency, and public. accessibility • Produce high-quality assessments of Federal Reserve Bank operations, Goal projects, and initiatives that help Federal Reserve management foster and To promote a safe, sound, competitive, strengthen sound internal control and accessible banking system and systems and efficient and effective stable financial markets. performance • Conduct research and analysis that Objectives contributes to policy development and increases the Board's and others' • Provide comprehensive and effective understanding of payment system supervision of U.S. banks, bank and dynamics and risk. financial holding companies, foreign banking organizations with U.S. operations, and related entities Interagency Coordination • Promote overall financial stability, manage and contain systemic risk, and Interagency coordination helps focus ensure that emerging financial crises efforts to eliminate redundancy and are identified early and successfully lower costs. As mandated by the Govresolved ernment Performance and Results Act • Improve efficiency and effectiveness and in conformance with past practice, and reduce burden on supervised the Board has worked closely with other institutions federal agencies to consider plans and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

The Board of Governors and the Government Performance and Results Act 145 strategies for programs, such as bank officers of the five agencies has been supervision, that transcend the jurisdic- created to address and report on issues tion of each agency. Coordination with related to those general goals and objecthe Department of the Treasury and tives that cross agency functions, proother agencies is evident throughout grams, and activities. This working both the strategic and performance group has been meeting since June plans. Much of the Board's formal effort 1997. These and similar planning efforts to plan jointly has been made through can eliminate redundancy and signifithe Federal Financial Institutions cantly lower the government's costs for Examination Council (FFIEC), a group data processing and other activities, as made up of the five federal agencies that well as lower depository institutions' regulate depository institutions.1 In costs for complying with federal regulaaddition, a coordinating committee of tions, while enhancing public access to representatives of the chief financial the data. • 1. The FFIEC consists of the Board of Gover- forms for the federal examination of financial nors of the Federal Reserve System, the Federal institutions and to make recommendations to pro- Deposit Insurance Corporation, the National mote uniformity in the supervision of financial Credit Union Administration, the Office of the institutions. The FFIEC also provides uniform Comptroller of the Currency, and the Office of examiner training and has taken a lead in develop- Thrift Supervision. It was established in 1979 pur- ing standardized software needed for major data suant to title X of the Financial Institutions Regu- collection programs to support the requirements of latory and Interest Rate Control Act of 1978. The the Home Mortgage Disclosure Act and the Com- FFIEC is a formal interagency body empowered to munity Reinvestment Act. prescribe uniform principles, standards, and report Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

147 Federal Legislative Developments On November 26, 2002, President Bush five-member vote if fewer than five signed the Terrorism Risk Insurance Act members are in office at the time of the of 2002 into law. Section 301 of that action (that is, if more than two seats on act amended section 11 of the Federal the Board are vacant). Second, it allows Reserve Act (12 U.S.C. 248) to enhance those members of the Board that are the Board's ability to respond to emer- available to approve a loan to a nondegency situations. Before the amend- pository institution under section 13(3) ment, the Federal Reserve Act allowed of the Federal Reserve Act if these the Board to take five types of actions available members unanimously deteronly upon the affirmative vote of at mine that (1) unusual and exigent cirleast five Board members. Among the cumstances exist and the borrower is actions requiring supermajority approval unable to secure adequate credit accomwas Board authorization of a Federal modations from other sources; (2) action Reserve Bank to extend credit to a on the loan is necessary to prevent, nondepository institution in unusual correct, or mitigate serious harm to the and exigent circumstances under sec- economy or the stability of the U.S. tion 13(3) of the Federal Reserve Act. financial system; (3) all available tele- See 12 U.S.C. §343; see also 12 U.S.C. phonic, telegraphic, and other means §§248(b), 347a, and 461(b)(3) and have been used to attempt to contact the other members of the Board; and These five-member voting require- (4) action on the loan request is necesments could have impaired the Board's sary before the other Board members ability to act in an emergency. The Ter- can be contacted. At least two Board rorism Risk Insurance Act amended members must be available and particithese requirements in two respects. First, pate in the emergency loan approval, it allows fewer than five Board mem- and any loan made by a Reserve Bank bers, by unanimous vote, to approve any under this emergency procedure must be action that would otherwise require a payable upon demand. • 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

151 Record of Policy Actions of the Board of Governors Regulation A rate. A secondary credit program, Extensions of Credit with an interest rate initially 50 basis by Federal Reserve Banks points above the primary credit rate, is available in appropriate circumstances Regulation D to depository institutions that do not Reserve Requirements qualify for primary credit. of Depository Institutions The revisions are intended to improve the functioning of the discount window October 31, 2002—Amendments and do not indicate a change in the stance of monetary policy. The seasonal The Board amended Regulations A and credit program, used mainly by small D to implement new discount window banks that have pronounced seasonal programs, effective January 9, 2003. funding needs, remains essentially unchanged. Votes for this action: Messrs. Greenspan, Ferguson, and Gramlich, Ms. Bies, and Messrs. Olson, Bernanke, and Kohn. Regulation C The revisions to Regulation A replace Home Mortgage Disclosure the adjustment and extended credit programs with new primary and secondary January 23, 2002—Amendments credit programs, reorganize and stream- The Board approved amendments to line the rule, and would facilitate a Regulation C, which implements the reduction of the primary credit rate in Home Mortgage Disclosure Act, to the event of a financial emergency. The expand the amount of data and num- Board also amended Regulation D to ber of lenders subject to the reporting conform the calculation of penalties for requirements of the act, effective Janureserve deficiencies, which are based on ary 1, 2003. the discount rate, to the new discount rate framework. Votes for this action: Messrs. Ferguson, Under the new primary credit pro- Meyer, and Gramlich, Ms. Bies, and gram, the Federal Reserve Banks offer Mr. Olson. very short term credit, at an interest rate above the targeted federal funds rate, as The Home Mortgage Disclosure Act a backup source of liquidity to deposi- requires covered lenders to collect, tory institutions that are in generally report, and publicly disclose certain data sound financial condition. The Reserve on home purchase and home improve- Banks establish the primary credit rate ment loans (both loans they originate at least every two weeks, subject to and those they purchase) and applicareview and determination by the Board, tions that do not result in originations. through the same procedure that had These data include the race, ethnicity, been used to set the adjustment credit sex, and income of the applicants and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

152 89th Annual Report, 2002 borrowers and the location of the prop- ment to require reporters under the act erty. The amendments require, among to use 2000 census data, effective Januother things, that lenders report loan- ary 1, 2003. pricing data showing the spread between the annual percentage rate charged for Votes for this action: Messrs. Greenspan, originated loans and the rate on U.S. Ferguson, and Gramlich, Ms. Bies, and Mr. Olson. Treasury securities having comparable maturity periods, if the spread equals The Board extended for one year the or exceeds certain thresholds set by effective date of amendments approved the Board. Lenders are also required to on January 23, 2002, as discussed identify loans subject to the Home Ownabove, to give institutions sufficient time ership and Equity Protection Act and to implement the new reporting requirereport denials of applications for credit ments. The extension allows institutions received through certain preapproval to fully implement the new rules withprograms. In addition, the amendments out jeopardizing the quality and usefulexpand the regulation's coverage of ness of the data and without incurring nondepository lenders by adding a substantial additional implementation dollar-volume test of $25 million in costs that could be avoided by a delay total home purchase loan originations in the effective date. The Board also (including refinancings of home puradopted an interim amendment to chase loans) for the preceding year. improve the accuracy and usefulness The Board published for comment a of the data submitted under the act by proposal that reporting thresholds for requiring reporters to use 2000 census first-lien loans be set at 3 percentage data, effective January 1, 2003. points above the U.S. Treasury rate and 5 percentage points above that rate for subordinate-lien loans. The Board also June 3, 2002—Amendments requested public comment on requiring The Board approved amendments to lenders to collect, for applications and implement the following proposals originated loans, data on whether the made in connection with the January application or loan is secured by a first 2002 amendments to Regulation C: or subordinate lien on a dwelling or is establish reporting thresholds for loanunsecured (the lien status) and requiring pricing data and require reporting of lenders to request, for loan applications lien-status data, effective January 1, made by telephone, the race, ethnicity, 2004, and require lenders to request and sex of the applicant. additional information in telephone applications, effective January 1, 2003. May 2, 2002—Delay of Effective Date and Interim Amendment Votes for this action: Messrs. Greenspan, Ferguson, and Gramlich, Ms. Bies, and The Board extended the effective date Mr. Olson. for most of the amendments to Regulation C, which expand the amount of data As discussed above, the Board and number of lenders subject to the approved amendments to the data colreporting requirements of the Home lection requirements of Regulation C on Mortgage Disclosure Act, from Janu- January 23, 2002. It also published for ary 1, 2003, to January 1, 2004. The comment proposals that would estab- Board also adopted an interim amend- lish thresholds for reporting loan-pricing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 153 data based on a rate spread (between the 2001, to June 30, 2002, warranted an annual percentage rate on a loan and the increase in the low reserve tranche yield on comparable U.S. Treasury secu- from $41.3 million to $42.1 million, rities) of 3 percentage points for first- and the Board amended Regulation D lien loans and 5 percentage points for accordingly. subordinate-lien loans; require lenders The Garn-St Germain Depository to report the lien status of applications Institutions Act of 1982 establishes a and originated loans; and require lend- zero percent reserve requirement on the ers to request the race, ethnicity, and first $2 million of an institution's reservsex of telephone applicants. The Board able liabilities. The act also provides for approved these proposals with the effec- annual adjustments to that exemption tive dates indicated. amount based on percentage increases in reservable liabilities at all depository institutions over the one-year period Regulation D ending on the most recent June 30. Reserve Requirements of The growth in total reservable liabili- Depository Institutions ties from June 30, 2001, to June 30, 2002, warranted an increase in the October 1, 2002—Amendments reservable liabilities exemption level from $5.7 million to $6 million, and The Board amended Regulation D to the Board amended Regulation D increase the amount of net transacaccordingly. tion accounts at depository institutions For institutions that report weekly, the to which a lower reserve requirement amendments adjusting the low reserve applies (low reserve tranche) and the tranche and the reservable liabilities amount of reservable liabilities exempt exemption level are effective for the from reserve requirements (reservable fourteen-day reserve computation period liabilities exemption level) for 2003, beginning Tuesday, November 26, 2002, effective for the reserve computation and for the corresponding fourteen-day period beginning November 26, 2002, reserve maintenance period beginning for institutions reporting weekly. Thursday, December 26, 2002. For institutions that report quarterly, the amend- Votes for this action: Messrs. Greenspan, Ferguson, and Gramlich, Ms. Bies, and ments are effective for the seven-day Messrs. Olson, Bernanke, and Kohn. reserve computation period beginning Tuesday, December 17, 2002, and for Under the Monetary Control Act of the corresponding seven-day reserve 1980, depository institutions, Edge and maintenance period beginning Thursagreement corporations, and U.S. agen- day, January 16, 2003. cies and branches of foreign banks are Nonexempt depository institutions subject to reserve requirements set by that have total reservable liabilities the Board. The act directs the Board to greater than the amount exempted from adjust annually the amount of the low reserve requirements ($6 million in reserve tranche on the basis of percent- 2003) report either weekly or quarterly age changes in net transaction accounts depending on the amount of their total at all depository institutions over the deposits. To ease the reporting burden one-year period ending on the most on small institutions, the Board requires recent June 30. The growth in total nonexempt depository institutions with net transaction accounts from June 30, total deposits below a specified level Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

154 89th Annual Report, 2002 (nonexempt deposit cutoff level) to Regulation H implements the provireport their deposits and reservable lia- sion of the Riegle-Neal Interstate Bankbilities quarterly or less frequently, ing and Branching Efficiency Act of while larger institutions must report 1994 that prohibits a bank from estabweekly.1 To reflect the growth of total lishing or acquiring a branch outside deposits at all depository institutions its home state primarily for the purpose from June 30, 2001, to June 30, 2002, of deposit production. That act also the Board increased the nonexempt provides guidelines for determining deposit cutoff level from $106.9 million whether the bank is reasonably helping to $112.3 million, to be implemented in to meet the credit needs of the commu- September 2003. nities served by the branch. Congress Exempt institutions (those with total enacted the prohibition to ensure that reservable liabilities equal to or less the authorization for interstate branches than the reservable liabilities exemption would not result in banks' taking deposlevel of $6 million in 2003) with at least its from a community without reason- $6 million in total deposits may report ably helping to meet the credit needs of annually, and exempt institutions with that community. less than $6 million in total deposits are The Gramm-Leach-Bliley Act of not required to file deposit reports. 1999 expands the prohibition against deposit-production offices to include any branch of a bank controlled by an Regulation H out-of-state bank holding company. The Membership of State Banking Board, the Federal Deposit Insurance Institutions in the Federal Reserve Corporation, and the Office of the System Comptroller of the Currency jointly May 30, 2002—Amendments amended their regulations on June 5, 2002, to conform to the expanded The Board amended Regulation H to prohibition. include any branch of a bank controlled by an out-of-state bank holding com- Regulation H pany under the prohibition against using Membership of State Banking interstate branches primarily for deposit Institutions in the Federal Reserve production, effective October 1, 2002. System Votes for this action: Messrs. Greenspan, Regulation Y Ferguson, and Gramlich, Ms. Bies, and Bank Holding Companies and Mr. Olson. Change in Bank Control January 28, 2002—Amendments 1. All U.S. branches and agencies of foreign banks and Edge and agreement corporations are The Board reduced, for state member required to submit the Report of Transaction banks and bank holding companies, the Accounts, Other Deposits, and Vault Cash risk weighting in capital standards for (FR 2900) weekly regardless of size. In addition, certain claims on securities firms, effecdepository institutions that obtain funds from nontive July 1, 2002. US, sources or that have foreign branches or international banking facilities continue to be required to file the Report of Certain Eurocurrency Trans- Votes for this action: Messrs. Greenspan, actions (FR 2950/FR 2951) at the same frequency Ferguson, Meyer, and Gramlich, Ms. Bies, as they file the FR 2900 report. and Mr. Olson. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 155 The Board, the Federal Deposit Insur- required for particular international ance Corporation, the Office of the assets. The amendments conform these Comptroller of the Currency, and the provisions to those of the other fed- Office of Thrift Supervision jointly eral banking agencies by eliminating amended their risk-based capital stan- requirements for a particular accounting dards for supervised banking and sav- method for fees on international loans ings institutions on March 27, 2002, to and requiring instead that institutions reduce the risk weight applied to certain follow generally accepted accounting claims on, and claims guaranteed by, principles (GAAP) for such fees. qualifying securities firms incorporated in the United States and in other coun- Regulation W tries that are members of the Organ- Transactions between Member isation for Economic Co-operation Banks and Their Affiliates and Development (OECD). The Federal Deposit Insurance Corporation and the October 31, 2002—New Office of Thrift Supervision also con- Regulation formed their capital standards to those of the other agencies by permitting a The Board approved new Regulation W, zero percent risk weight for certain which comprehensively implements secclaims on qualifying securities firms that tions 23A and 23B of the Federal are collateralized by (1) cash on deposit Reserve Act, effective April 1, 2003. in the lending institution or (2) securities issued or guaranteed by the U.S. Votes for this action: Messrs. Greenspan, Ferguson, and Gramlich, Ms. Bies, and government or its agencies or OECD Messrs. Olson, Bernanke, and Kohn. central governments. Sections 23A and 23B of the Federal Reserve Act restrict loans by a member Regulation K bank to its affiliates, asset purchases International Banking Operations by a member bank from its affiliates, and certain other transactions between a December 30, 2002—Amendments member bank and its affiliates. The pur- The Board amended provisions of Regu- pose of the statute is to limit a member lation K on international lending super- bank's risk of loss in transactions with vision to conform to technical changes affiliates and to limit a member bank's adopted by the other federal banking ability to transfer to its affiliates the agencies, effective February 10, 2003. benefits arising from its access to the federal safety net. Regulation W unifies Votes for this action: Messrs. Greenspan, in one document previous interpre- Ferguson, and Gramlich, Ms. Bies, and tations of sections 23A and 23B as Messrs. Olson, Bernanke, and Kohn. well as new interpretations of the statute, including interpretations that Subpart D of Regulation K, which address derivative transactions, intraimplements the International Lending day extensions of credit, and financial Supervision Act of 1983, governs inter- subsidiaries. national lending by state member banks, The Board also approved a preamble bank holding companies, and Edge and to Regulation W that provides a detailed agreement corporations engaged in explanation of the rule. In addition, the banking and specifies when reserves are Board published for comment a pro- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

156 89th Annual Report, 2002 posed rule that would limit the current ated third party if such purchases are exemption from section 23 A for certain made under the same conditions and loan purchases from an affiliate. restrictions applicable to national banks. A state member bank must receive the prior approval of the Board's Director of the Division of Banking Supervision Policy Statements and and Regulation to engage in equity Other Actions hedging activities and must conduct its equity derivative and equity hedging February 11, 2002—Statement on activities in accordance with applicable Equity Hedging Activities by State law. Member Banks The Board issued a statement indicating April 5, 2002—System Regulations that it would not apply section 9 of the for Federal Reserve Law Federal Reserve Act to prohibit a state Enforcement Officers member bank from acquiring equity securities to hedge its bank-permissible The Board approved regulations govequity derivative transactions if such erning the exercise of law enforcement transactions are conducted in accor- authority by designated Federal Reserve dance with the same restrictions applica- System personnel, effective June 7, ble to national banks, effective Febru- 2002. ary 21, 2002. Votes for this action: Messrs. Greenspan, Votes for this action: Messrs. Greenspan, Ferguson, and Gramlich, Ms. Bies, and Ferguson, and Gramlich, Ms. Bies, and Mr. Olson. Mr. Olson. The USA PATRIOT Act of 2001 Section 9 of the Federal Reserve Act amended section 11 of the Federal provides that state member banks are Reserve Act to provide federal law subject to the same limitations and con- enforcement authority for protection ditions on the purchase, sale, underwrit- personnel at the Federal Reserve Banks, ing, and holding of investment securities and for special agents in the Protective and stock that apply to national banks. Services Unit and security officers at the The Office of the Comptroller of the Board. The implementing regulations, Currency has determined that national which were subsequently approved by banks may acquire equity securities to the Attorney General of the United hedge their exposure to customer-driven States in accordance with the act, authoequity derivative transactions lawfully rize designated on-duty personnel to entered into by the bank. Such transac- carry firearms when protecting System tions may include equity swaps, equity- personnel, property, or operations; make index swaps, equity-index deposits, and arrests for violations of federal law; and equity-linked loans. Accordingly, the obtain law enforcement information. statement provides that the Board would The regulations also contain specific not apply section 9 of the act to prohibit training requirements and rules governa state member bank from purchasing ing the use of law enforcement authorequity securities to hedge risks aris- ity. The Board delegated authority to ing from equity derivative transactions each Reserve Bank to designate law entered into by the bank with an unaffili- enforcement personnel. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 157 April 18, 2002—Joint Agency (2) reject all payments with settlement- Statement on Parallel-Owned day finality that would cause an insti- Banking Organizations tution to exceed its daylight overdraft capacity level. The Board approved an interagency statement on the potential risks posed by Votes for this action: Messrs. Greenspan, parallel-owned banking organizations Ferguson, and Gramlich, Ms. Bies, and and the supervisory approach to address Messrs. Olson, Bernanke, and Kohn. those risks, effective April 23, 2002. These proposed changes were among Votes for this action: Messrs. Greenspan, several modifications to its payments Ferguson, and Gramlich, Ms. Bies, and system risk policy that the Board had Mr. Olson. published for comment in June 2001 after a broad review of the policy. An The Board, the Federal Deposit Insurinstitution's net debit cap refers to the ance Corporation, the Office of the maximum dollar amount of uncollateral- Comptroller of the Currency, and the ized daylight overdrafts that it may incur Office of Thrift Supervision jointly in its Federal Reserve account. A dayissued a statement on parallel-owned light overdraft occurs when a depository banking organizations on April 23, institution's Federal Reserve account 2002. A parallel-owned banking organiis in a negative position at any time zation is created when a U.S. depository during the business day. institution and a foreign bank are both Although the Board chose not to controlled directly or indirectly by one implement the two proposals in the foreperson or a group of persons rather than seeable future, it will continue to anaby a bank or thrift holding company lyze the benefits and potential drawsubject to supervision by a federal regubacks of a third proposed modification: lator. Accordingly, each of the organia two-tiered pricing system for dayzation's banks is supervised by only the light overdrafts in which institutions regulatory authority for the home counthat pledge collateral to the Federal try of the bank. The interagency state- Reserve Banks would pay a lower fee ment contains guidance on identifying on their collateralized daylight overparallel-owned banking organizations, drafts than on their uncollateralized dayreviews the risks associated with them, light overdrafts. and discusses actions that the agencies may take to minimize those risks. It also describes the agencies' approach to Discount Rates in 2002 applications and notices filed by U.S. depository institutions in parallel-owned During 2002, the Board of Governors banking organizations. approved one change in the basic discount rate charged by the Federal Reserve Banks. On November 6, the August 13, 2002—Policy Statement basic rate was reduced by Vi percentage on Payments System Risk point to a level of % percent. The rates The Board decided not to adopt two for seasonal and extended credit, which proposed changes to its payments sys- were recalculated biweekly in accortem risk policy that would (1) lower dance with market-related formulas, self-assessed net debit caps and elim- exceeded the basic rate by different inate two-week average caps and amounts during the year. On October 31, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

158 89th Annual Report, 2002 the Board approved new discount recovery over the coming year. There window programs, effective January 9, were no further decisions on the basic 2003. discount rate in 2002. Structure of Discount Rates Basic Discount Rate The basic discount rate was the rate The Board's decisions on the basic disnormally charged on loans to depository count rate were made against the backinstitutions for short-term adjustment ground of the policy actions of the Fedcredit, and it continued to be set on eral Open Market Committee (FOMC) the basis of general monetary policy and related economic and financial considerations. The Federal Reserve developments. These developments are Banks provided two other types of disreviewed more fully in other parts of count window credit: (1) seasonal credit, this Report, including the minutes of the whose purpose was to assist smaller FOMC meetings held in 2002. institutions in managing liquidity needs that arose from regular seasonal swings Reduction in the Basic Rate in in loans and deposits, and (2) extended November 2002 credit, which was available in appropri- Before November 6, the Board re- ate circumstances to depository instituviewed, but took no action on, requests tions that experienced somewhat longerby a number of Federal Reserve Banks term liquidity needs. The rates on both to raise or lower the basic discount rate. types of credit were calculated every The Board's decision on November 6 two weeks in accordance with formulas was consistent with its practice in recent based on market interest rates. Under years generally to adjust the basic rate those formulas, the rates charged for when the FOMC makes changes to its seasonal credit in 2002 were somewhat target for the federal funds rate. Under- higher than the basic discount rate, and lying the decisions on both rates in 2002 the rate on extended credit was 50 basis was the persistence of a high degree of points higher than that for seasonal uncertainty about the outlook for contin- credit. During 2002, the rate for seaued economic recovery in the context sonal credit ranged from a high of of an uneven pace of expansion and, 1.85 percent to a low of 1.30 percent, particularly over the summer and fall, a and the rate for extended credit ranged predominance of downside risks to the from a high of 2.35 percent to a low of economy. By early November, generally 1.80 percent. At the end of 2002, the disappointing information on the per- structure of discount rates was as folformance of the economy seemed to lows: a basic rate of 0.75 percent for presage a longer-lasting spell of subpar short-term adjustment credit and rates of economic growth than had been antici- 1.30 percent for seasonal credit and pated earlier. Although the stance of 1.80 percent for extended credit. monetary policy was already accommodative, the FOMC and the Board on Board Votes November 6 approved relatively sizable reductions of Vi percentage point in the Under the Federal Reserve Act, the target rate for the federal funds rate and boards of directors of the Federal the basic discount rate to enhance the Reserve Banks are required to establish prospects of a strengthening economic rates on loans to depository institutions Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 159 at least every fourteen days and must ment of the lending Federal Reserve submit the rates to the Board of Gover- Bank, are in generally sound financial nors for review and determination. Dur- condition. Primary credit will be ing 2002, the Reserve Banks submitted, extended at a rate above the federal on the same schedule, requests to renew funds rate to be established at least every the formulas based on short-term market two weeks, subject to the Board's interest rates for calculating the rates review and determination. By applying on seasonal and extended credit. Votes an above-market rate and restricting on the reestablishment of the formulas eligibility to generally sound institufor these flexible rates are not shown in tions, the primary credit program is this summary. All votes taken by the expected to substantially reduce the Board of Governors during 2002 were need for the Federal Reserve to review unanimous. the funding situations of borrowers and monitor their use of borrowed funds. Vote on the Basic Discount Rate Secondary credit will be available in appropriate circumstances to depository November 6, 2002. Effective this date, institutions that do not qualify for prithe Board approved actions taken by the mary credit. When the new programs directors of the Federal Reserve Banks were approved, the Board expected that of New York, Dallas, and San Francisco Reserve Banks would initially establish to reduce the basic discount rate by a primary credit rate at a level 100 basis Vi percentage point to 3A percent. The points above the federal funds target same decrease was approved for the rate and a secondary credit rate at a level remaining Federal Reserve Banks, effec- 50 basis points above the primary rate.2 tive November 7, 2002. The seasonal credit program was not affected by these changes. The rate on Votes for this action: Messrs. Greenspan, seasonal credit will continue to be set by Ferguson, and Gramlich, Ms. Bies, and a formula based on market interest rates. Messrs. Olson, Bernanke, and Kohn. New Discount Window Programs Votes for this action: Messrs. Greenspan, Ferguson, and Gramlich, Ms. Bies, and On October 31, 2002, the Board Messrs. Olson, Bernanke, and Kohn. • amended its Regulation A to establish two new forms of discount window credit, primary and secondary credit, to 2. On January 7, 2003, the Board of Governors replace adjustment and extended credit, approved requests by the twelve Reserve Banks to effective January 9, 2003. Primary credit establish primary credit rates of 2lA percent and secondary credit rates of 23A percent, which were will be made available for very short 100 basis points and 150 basis points respectively terms as a backup source of liquidity to above the FOMC's target rate for the federal funds depository institutions that, in the judg- rate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

161 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 2002. 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, 2002 themselves as to the reasons for their votes; in such cases, the range of their 1. The Federal Open Market Committee authorizes and directs the Federal Reserve views is noted in the minutes. When Bank of New York, to the extent necesmembers dissent from a decision, they sary to carry out the most recent domestic are identified in the minutes and a sum- policy 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

162 89th Annual Report, 2002 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 65 business 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 65 business days or less on terms by competitive bidding, after applying reacomparable to those available on such transsonable limitations on the volume of agreeactions in the market; and (b) for New York ments with individual dealers; provided that Bank account, when appropriate, to underin the event Government securities or agency take with dealers, subject to the conditions 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 Systo 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 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 65 business 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 163 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 continue to be weighted mainly most recent meeting and the Committee's toward conditions that may generate ecolong-run objectives for price stability and nomic weakness in the foreseeable future. sustainable economic growth, and shall be based on economic, financial, and monetary developments during the intermeeting period. Consistent with Committee prac- Authorization for Foreign tice, the Chairman, if feasible, will consult Currency Operations with the Committee before making any adjustment. In Effect January 1, 2002 Guidelines for the Conduct of 1. The Federal Open Market Committee System Open Market Operations authorizes and directs the Federal Reserve 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 In Effect January 1, 2002 and express authorizations by the Committee pursuant thereto, and in conformity with 1. System open market operations in Fedsuch procedural instructions as the Commiteral agency issues are an integral part of total tee may issue from time to time: 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 2. System open market operations in Fedthe open market at home and abroad, includeral agency issues are not designed to suping transactions with the U.S. Treasury, with port individual sectors of the market or the U.S. Exchange Stabilization Fund estabto channel funds into issues of particular lished by Section 10 of the Gold Reserve agencies. Act of 1934, with foreign monetary authorities, with the Bank for International Settlements, and with other international financial Domestic Policy Directive institutions: In Effect January 1, 20021 Canadian dollars Mexican pesos Danish kroner Norwegian kroner Euro Swedish kronor The Federal Open Market Committee seeks Pounds sterling Swiss francs monetary and financial conditions that will Japanese yen 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 reducing the federal funds rate to an average of around PA 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 sentence below for inclusion in the press in paragraph 2 below, provided that drawings by either party to any such arrangement statement to be released shortly after the shall be fully liquidated within 12 months December 11, 2001, 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 11, 2001. cifically authorizes a delay. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

164 89th Annual Report, 2002 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. 2. The Federal Open Market Commit- 5. Foreign currency holdings shall be intee directs the Federal Reserve Bank of vested to ensure that adequate liquidity is New York to maintain reciprocal currency maintained to meet anticipated needs and so arrangements ("swap" arrangements) for the that each currency portfolio shall generally System Open Market Account for periods up have an average duration of no more than to a maximum of 12 months with the follow- 18 months (calculated as Macaulay duraing foreign banks, which are among those tion). When appropriate in connection with designated by the Board of Governors of the arrangements to provide investment facilities Federal Reserve System under Section 214.5 for foreign currency holdings, U.S. Governof Regulation N, Relations with Foreign ment securities may be purchased from for- Banks and Bankers, and with the approval of eign central banks under agreements for the Committee to renew such arrangements repurchase of such securities within 30 calon maturity: endar days. 6. All operations undertaken pursuant to Amount the preceding paragraphs shall be reported of arrangement Foreign bank (millions of promptly to the Foreign Currency Subdollars 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 3. All transactions in foreign currencies the Subcommittee shall be called at the undertaken under paragraph l.A. above request of any member, or at the request of shall, unless otherwise expressly authorized the Manager, System Open Market Account by the Committee, be at prevailing market ("Manager"), for the purposes of reviewing rates. For the purpose of providing an invest- recent or contemplated operations and of ment return on System holdings of foreign consulting with the Manager on other matcurrencies, or for the purpose of adjusting ters relating to his responsibilities. At the interest rates paid or received in connection request of any member of the Subcommittee, 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. nonmarket 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 165 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 System and the Treasury; C. For such other purposes as may be 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 paragraph 3 G(l) of the Board of Governors' Operations Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks In Effect January 1, 2002 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, 2002 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

166 89th Annual Report, 2002 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. Ms. Bies Mr. Ferguson C. Any operation that might generate a Mr. Gramlich substantial volume of trading in a particular Mr. Jordan currency by the System, even though the Mr. McTeer change in the System's net position in that Mr. Olson currency might be less than the limits speci- Mr. Santomero fied in l.B. Mr. Stern D. Any swap drawing proposed by a Messrs. Broaddus, Guynn, Moskow, foreign bank not exceeding the larger of and Parry, 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- Mr. Hoenig, Ms. Minehan, and mittee (or with the Subcommittee, if the Mr. Poole, Presidents of the Subcommittee believes that consultation Federal Reserve Banks of with the full Committee is not feasible in the Kansas City, Boston, and St. Louis time available, or with the Chairman, if the respectively Chairman believes that consultation with the Subcommittee is not feasible in the time Mr. Kohn, Secretary and Economist Mr. Bernard, Deputy Secretary available): Mr. Gillum, Assistant Secretary Ms. Smith, Assistant Secretary A. Any operation that would result in a Mr. Mattingly, General Counsel change in the System's overall open position Mr. Baxter,2 Deputy General Counsel in foreign currencies exceeding $1.5 billion Ms. Johnson, Economist since the most recent regular meeting of the Mr. Reinhart, Economist Committee. Mr. Stockton, Economist B. Any swap drawing proposed by Mr. Connors, Ms. Cumming, a foreign bank exceeding the larger of Messrs. Howard, Lindsey, (i) $200 million or (ii) 15 percent of the Ms. Mester, Messrs. Oliner, size of the swap arrangement. Rolnick, Rosenblum, Sniderman, and Wilcox, Associate Economists 3. The Manager shall also consult with the Subcommittee or the Chairman about pro- Mr. Kos, Manager, System Open posed swap drawings by the System and Market Account about any operations that are not of a routine character. Mr. Winn, Assistant to the Board, Office of Board Members, Board of Governors Meeting Held on Mr. Skidmore, Special Assistant to the January 29-30, 2002 Board, Office of Board Members, Board of Governors A meeting of the Federal Open Market Committee was held in the offices of the Messrs. Ettin and Madigan, Deputy Directors, Divisions of Research Board of Governors of the Federal and Statistics and Monetary Reserve System in Washington, D.C., Affairs respectively, Board of on Tuesday, January 29, 2002, at Governors 2:30 p.m. and continued on Wednesday, January 30, 2002, at 9:00 a.m. 2. Attended Tuesday session only. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes ofFOMC Meetings, January 167 Mr. Simpson, Senior Adviser, Division Messrs. Beebe, Eisenbeis, Fuhrer, of Research and Statistics, Goodfriend, Hakkio, Hunter, Board of Governors Ms. Krieger, and Mr. Rasche, Senior Vice Presidents, Federal Messrs. Slifman and Struckmeyer, Reserve Banks of San Francisco, Associate Directors, Division of Atlanta, Boston, Richmond, Research and Statistics, Board of Kansas City, Chicago, New York, Governors and St. Louis respectively Messrs. Kamin3 and Whitesell, In the agenda for this meeting, it was Deputy Associate Directors, reported that advices of the election of Divisions of International Finance the following members and alternate and Monetary Affairs respectively, members of the Federal Open Market Board of Governors Committee for the period commencing Messrs. Gagnon3 and ReifSchneider,3 January 1, 2002, and ending Decem- Assistant Directors, Divisions of ber 31, 2002, had been received and that International Finance and these individuals had executed their Research and Statistics oaths of office. respectively, Board of Governors The elected members and alternate Mr. Small,3 Section Chief, Division of members were as follows: Monetary Affairs, Board of Governors William J. McDonough, President of the Federal Reserve Bank of New York, Mr. Morton,4 Senior Economist, with Jamie B. Stewart, Jr., First Vice Division of International Finance, President of the Federal Reserve Bank Board of Governors of New York, as alternate. Messrs. Lebow4 and Williams,3 Senior Anthony M. Santomero, President of the Economists, Division of Research Federal Reserve Bank of Philadelphia, and Statistics, Board of Governors with J. Alfred Broaddus, Jr., President of the Federal Reserve Bank of Rich- Messrs. Ahearn3 and Wright,3 mond, as alternate. Economists, Division of International Finance, Board of Jerry L. Jordan, President of the Federal Governors Reserve Bank of Cleveland, with Michael H. Moskow, President of the Mr. Zakrajsek,4 Economist, Division Federal Reserve Bank of Chicago, as of Monetary Affairs, Board of alternate. Governors Robert D. McTeer, Jr., President of the Fed- Ms. Low, Open Market Secretariat eral Reserve Bank of Dallas, with Jack Assistant, Office of Board Guynn, President of the Federal Members, Board of Governors Reserve Bank of Atlanta, as alternate. Mr. Lyon, First Vice President, Federal Gary H. Stern, President of the Federal Reserve Bank of Minneapolis Reserve Bank of Minneapolis, with Robert T. Parry, President of the Federal Reserve Bank of San Francisco, as 3. Attended portion of meeting relating to the alternate. discussion of monetary policy near the zero bound on nominal interest rates. By unanimous vote, the following 4. Attended portion of meeting relating to the above discussion and to the Committee's review officers of the Federal Open Market of the economic outlook. Committee were elected to serve until Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

168 89th Annual Report, 2002 the election of their successors at the as Manager was satisfactory to the board first regularly scheduled meeting of the of directors of the Federal Reserve Bank of New York. Committee after December 31, 2002, with the understanding that in the event By unanimous vote, the Authorizaof the discontinuance of their official tion for Domestic Open Market Operaconnection with the Board of Governors tions was reaffirmed in the form shown or with a Federal Reserve Bank, they below. would cease to have any official connection with the Federal Open Market Committee: Authorization for Domestic Open Market Operations Alan Greenspan Chairman (Reaffirmed January 29, 2002) William J. McDonough Vice Chairman 1. The Federal Open Market Committee Donald L. Kohn Secretary and authorizes and directs the Federal Reserve Economist Bank of New York, to the extent neces- Normand R.V. Bernard Deputy Secretary sary to carry out the most recent domestic Gary P. Gillum Assistant policy directive adopted at a meeting of the Secretary Committee: Michelle A. Smith Assistant (a) To buy or sell U.S. Government Secretary securities, including securities of the Federal J. Virgil Mattingly, Jr. General Counsel Financing Bank, and securities that are direct Thomas C. Baxter, Jr. Deputy General obligations of, or fully guaranteed as to prin- Counsel cipal and interest by, any agency of the Karen H. Johnson Economist United States in the open market, from or to Vincent R. Reinhart Economist securities dealers and foreign and interna- David J. Stockton Economist tional accounts maintained at the Federal Reserve Bank of New York, on a cash, regu- Thomas A. Connors, Christine Cumming, lar, or deferred delivery basis, for the System David H. Howard, David E. Lindsey, Open Market Account at market prices, and, Loretta J. Mester, Stephen D. Oliner, for such Account, to exchange maturing U.S. Arthur J. Rolnick, Harvey Rosenblum, Government and Federal agency securities Mark S. Sniderman, and David W. with the Treasury or the individual agencies Wilcox, Associate Economists or to allow them to mature without replacement; provided that the aggregate amount of By unanimous vote, the Federal U.S. Government and Federal agency securi- Reserve Bank of New York was selected ties held in such Account (including forward commitments) at the close of business on the to execute transactions for the System day of a meeting of the Committee at which Open Market Account until the adjournaction is taken with respect to a domestic ment of the first regularly scheduled policy directive shall not be increased or meeting of the Committee after Decem- decreased by more than $12.0 billion during ber 31, 2002. the period commencing with the opening of business on the day following such meeting By unanimous vote, Dino Kos was and ending with the close of business on the selected to serve at the pleasure of the day of the next such meeting. Committee as Manager, System Open (b) To buy U.S. Government securities Market Account, on the understanding and obligations that are direct obligations of, that his selection was subject to being or fully guaranteed as to principal and intersatisfactory to the Federal Reserve Bank est by, any agency of the United States, from dealers for the account of the Federal of New York. Reserve Bank of New York under agreements for repurchase of such securities or Secretary's note: Advice subsequently obligations in 65 business days or less, at was received that the selection of Mr. Kos rates that, unless otherwise expressly autho- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 169 rized by the Committee, shall be determined Bank account, when appropriate, to underby competitive bidding, after applying rea- take with dealers, subject to the conditions sonable limitations on the volume of agree- imposed on purchases and sales of securities ments with individual dealers; provided that in paragraph l(b), repurchase agreements in in the event Government securities or agency U.S. Government and agency securities, and issues covered by any such agreement are to arrange corresponding sale and repurchase not repurchased by the dealer pursuant to the agreements between its own account and agreement or a renewal thereof, they shall be foreign and international accounts mainsold in the market or transferred to the Sys- tained at the Bank. Transactions undertaken tem Open Market Account. with such accounts under the provisions of (c) To sell U.S. Government securities this paragraph may provide for a service fee and obligations that are direct obligations of, when appropriate. or fully guaranteed as to principal and inter- 4. In the execution of the Committee's est by, any agency of the United States to decision regarding policy during any interdealers for System Open Market Account meeting period, the Committee authorizes under agreements for the resale by dealers of and directs the Federal Reserve Bank of New such securities or obligations in 65 business York, upon the instruction of the Chairman days or less, at rates that, unless otherwise of the Committee, to adjust somewhat in expressly authorized by the Committee, shall exceptional circumstances the degree of be determined by competitive bidding, after pressure on reserve positions and hence the applying reasonable limitations on the vol- intended federal funds rate. Any such adjustume of agreements with individual dealers. ment shall be made in the context of the 2. In order to ensure the effective conduct Committee's discussion and decision at its of open market operations, the Federal Open most recent meeting and the Committee's Market Committee authorizes the Federal long-run objectives for price stability and Reserve Bank of New York to lend on an sustainable economic growth, and shall be overnight basis U.S. Government securities based on economic, financial, and moneheld in the System Open Market Account to tary developments during the intermeeting dealers at rates that shall be determined by period. Consistent with Committee praccompetitive bidding but that in no event shall tice, the Chairman, if feasible, will consult be less than 1.0 percent per annum of the with the Committee before making any market value of the securities lent. The Fed- adjustment. eral Reserve Bank of New York shall apply reasonable limitations on the total amount of By unanimous vote, the Committee a specific issue that may be auctioned, and on the amount of securities that each dealer approved until the Committee's first may borrow. The Federal Reserve Bank regularly scheduled meeting in 2003 a of New York may reject bids which could further extension of the temporary susfacilitate a dealer's ability to control a single pension of paragraphs 3 to 6 of the issue as determined solely by the Federal Guidelines for the Conduct of System Reserve Bank of New York. Open Market Operations in Federal 3. In order to ensure the effective conduct of open market operations, while assisting in Agency Issues. For the year ahead, the the provision of short-term investments for Guidelines therefore continued to read foreign and international accounts main- as shown below: tained at the Federal Reserve Bank of New York, the Federal Open Market Committee authorizes and directs the Federal Reserve Bank of New York (a) for System Open Guidelines for the Conduct of Market Account, to sell U.S. Government System Open Market Operations securities to such foreign and international accounts on the bases set forth in para- in Federal Agency Issues graph l(a) under agreements providing for (Reaffirmed January 29, 2002) the resale by such accounts of those securities in 65 business days or less on terms 1. System open market operations in Fedcomparable to those available on such trans- eral agency issues are an integral part of total actions in the market; and (b) for New York System open market operations designed to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

170 89th Annual Report, 2002 influence bank reserves, money market con- because of exceptional circumstances, speditions, and monetary aggregates. cifically authorizes a delay. 2. System open market operations in D. To maintain an overall open posi- Federal agency issues are not designed to tion in all foreign currencies not exceeding support individual sectors of the market or $25.0 billion. For this purpose, the overall to channel funds into issues of particular open position in all foreign currencies is agencies. defined as the sum (disregarding signs) of net positions in individual currencies. The By unanimous vote, the Authoriza- net position in a single foreign currency is defined as holdings of balances in that curtion for Foreign Currency Operations rency, plus outstanding contracts for future was reaffirmed in the form shown receipt, minus outstanding contracts for below. future delivery of that currency, i.e., as the sum of these elements with due regard to sign. Authorization for Foreign 2. The Federal Open Market Commit- Currency Operations tee directs the Federal Reserve Bank of (Reaffirmed January 29, 2002) New York to maintain reciprocal currency arrangements ("swap" arrangements) for the 1. The Federal Open Market Committee System Open Market Account for periods up authorizes and directs the Federal Reserve to a maximum of 12 months with the follow- Bank of New York, for System Open Market ing foreign banks, which are among those Account, to the extent necessary to carry out designated by the Board of Governors of the the Committee's foreign currency directive Federal Reserve System under Section 214.5 and express authorizations by the Committee of Regulation N, Relations with Foreign pursuant thereto, and in conformity with Banks and Bankers, and with the approval of such procedural instructions as the Commit- the Committee to renew such arrangements tee may issue from time to time: on maturity: A. To purchase and sell the following foreign currencies in the form of cable transfers through spot or forward transactions on Amount of the open market at home and abroad, includ- Foreign bank arrangement ing transactions with the U.S. Treasury, with (millions of dollars equivalent) the U.S. Exchange Stabilization Fund established by Section 10 of the Gold Reserve Act Bank of Canada 2,000 of 1934, with foreign monetary authori- Bank of Mexico 3,000 ties, with the Bank for International Settlements, and with other international financial institutions: Any changes in the terms of existing swap arrangements, and the proposed terms of any Canadian dollars Mexican pesos new arrangements that may be authorized, Danish kroner Norwegian kroner shall be referred for review and approval to Euro Swedish kronor the Committee. Pounds sterling Swiss francs Japanese yen 3. All transactions in foreign currencies undertaken under paragraph LA. above B. To hold balances of, and to have shall, unless otherwise expressly authorized outstanding forward contracts to receive or by the Committee, be at prevailing market to deliver, the foreign currencies listed in rates. For the purpose of providing an investparagraph A above. ment return on System holdings of foreign C. To draw foreign currencies and to currencies, or for the purpose of adjusting permit foreign banks to draw dollars under interest rates paid or received in connection the reciprocal currency arrangements listed with swap drawings, transactions with forin paragraph 2 below, provided that draw- eign central banks may be undertaken at ings by either party to any such arrangement nonmarket exchange rates. shall be fully liquidated within 12 months 4. It shall be the normal practice to after any amount outstanding at that time arrange with foreign central banks for the was first drawn, unless the Committee, coordination of foreign currency transac- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 111 tions. In making operating arrangements foreign currency operations between the Syswith foreign central banks on System hold- tem and the Treasury; ings of foreign currencies, the Federal B. To keep the Secretary of the Trea- Reserve Bank of New York shall not commit sury fully advised concerning System foritself to maintain any specific balance unless eign currency operations and to consult with authorized by the Federal Open Market the Secretary on policy matters relating to Committee. Any agreements or understand- foreign currency operations; ings concerning the administration of the C. From time to time, to transmit accounts maintained by the Federal Reserve appropriate reports and information to the Bank of New York with the foreign banks National Advisory Council on International designated by the Board of Governors under Monetary and Financial Policies. Section 214.5 of Regulation N shall be 8. Staff officers of the Committee are referred for review and approval to the authorized to transmit pertinent informa- Committee. tion on System foreign currency operations 5. Foreign currency holdings shall be to appropriate officials of the Treasury invested to ensure that adequate liquidity is Department. maintained to meet anticipated needs and so 9. All Federal Reserve Banks shall parthat each currency portfolio shall generally ticipate in the foreign currency operations have an average duration of no more than for System Account in accordance with para- 18 months (calculated as Macaulay dura- graph 3 G(l) of the Board of Governors' tion). When appropriate in connection with Statement of Procedure with Respect to Forarrangements to provide investment facilities eign Relationships of Federal Reserve Banks for foreign currency holdings, U.S. Govern- dated January 1, 1944. ment securities may be purchased from foreign central banks under agreements for By unanimous vote, the Foreign Currepurchase of such securities within 30 calrency Directive was reaffirmed in the endar days. form shown below. 6. All operations undertaken pursuant to the preceding paragraphs shall be reported promptly to the Foreign Currency Subcommittee and the Committee. The Foreign Cur- Foreign Currency Directive rency Subcommittee consists of the Chair- (Reaffirmed January 29, 2002) man and Vice Chairman of the Committee, the Vice Chairman of the Board of Gover- 1. System operations in foreign currennors, and such other member of the Board cies shall generally be directed at countering as the Chairman may designate (or in the disorderly market conditions, provided that absence of members of the Board serving on market exchange rates for the U.S. dollar the Subcommittee, other Board members reflect actions and behavior consistent with designated by the Chairman as alternates, the IMF Article IV, Section 1. and in the absence of the Vice Chairman 2. To achieve this end the System shall: of the Committee, his alternate). Meetings A. Undertake spot and forward purof the Subcommittee shall be called at the chases and sales of foreign exchange. request of any member, or at the request of B. Maintain reciprocal currency the Manager, System Open Market Account ("swap") arrangements with selected for- ("Manager"), for the purposes of reviewing eign central banks. recent or contemplated operations and of C. Cooperate in other respects with consulting with the Manager on other mat- central banks of other countries and with ters relating to his responsibilities. At the international monetary institutions. request of any member of the Subcommittee, 3. Transactions may also be undertaken: questions arising from such reviews and con- A. To adjust System balances in light sultations shall be referred for determination of probable future needs for currencies. to the Federal Open Market Committee. B. To provide means for meeting Sys- 7. The Chairman is authorized: tem and Treasury commitments in particular A. With the approval of the Commit- currencies and to facilitate operations of the tee, to enter into any needed agreement or Exchange Stabilization Fund. understanding with the Secretary of the Trea- C. For such other purposes as may be sury about the division of responsibility for expressly authorized by the Committee. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

172 89th Annual Report, 2002 4. System foreign currency operations C. Any operation that might generate a shall be conducted: substantial volume of trading in a particular A. In close and continuous consulta- currency by the System, even though the tion and cooperation with the United States change in the System's net position in that Treasury; currency might be less than the limits speci- B. In cooperation, as appropriate, with fied in l.B. foreign monetary authorities; and D. Any swap drawing proposed by a C. In a manner consistent with the obli- foreign bank not exceeding the larger of gations of the United States in the Interna- (i) $200 million or (ii) 15 percent of the size tional Monetary Fund regarding exchange of the swap arrangement. arrangements under the IMF Article IV. 2. The Manager shall clear with the Committee (or with the Subcommittee, if the Subcommittee believes that consultation By unanimous vote, the Procedural with the full Committee is not feasible in the Instructions with Respect to Foreign time available, or with the Chairman, if the Currency Operations, in the form shown Chairman believes that consultation with the below, were reaffirmed. Subcommittee is not feasible in the time available): A. Any operation that would result in a change in the System's overall open position Procedural Instructions with in foreign currencies exceeding $1.5 billion since the most recent regular meeting of the Respect to Foreign Committee. Currency Operations B. Any swap drawing proposed by a (Reaffirmed January 29, 2002) foreign bank exceeding the larger of (i) $200 million or (ii) 15 percent of the size of the In conducting operations pursuant to the swap arrangement. authorization and direction of the Federal 3. The Manager shall also consult with Open Market Committee as set forth in the the Subcommittee or the Chairman about Authorization for Foreign Currency Opera- proposed swap drawings by the System and tions and the Foreign Currency Directive, about any operations that are not of a routine the Federal Reserve Bank of New York, character. through the Manager, System Open Market Account ("Manager"), shall be guided by On January 17, 2002, copies of the the following procedural understandings continuing rules, regulations, and other with respect to consultations and clearances with the Committee, the Foreign Currency instructions of the Committee had been Subcommittee, and the Chairman of the distributed with the advice that, in Committee. All operations undertaken pur- accordance with procedures approved suant to such clearances shall be reported by the Committee, they were being promptly to the Committee. called to the Committee's attention 1. The Manager shall clear with the Subcommittee (or with the Chairman, if the before the January 29-30 organization Chairman believes that consultation with the meeting to give members an opportunity Subcommittee is not feasible in the time to raise any questions they might have available): concerning them. Members were asked A. Any operation that would result in a to indicate if they wished to have any change in the System's overall open position of the instruments in question placed in foreign currencies exceeding $300 million on any day or $600 million since the most on the agenda for consideration at this recent regular meeting of the Committee. meeting, and no requests for consider- B. Any operation that would result in a ation were received. Accordingly, all of change on any day in the System's net posithese instruments remained in effect in tion in a single foreign currency exceedtheir existing form. ing $150 million, or $300 million when the operation is associated with repayment of By unanimous vote, the minutes of swap drawings. the meeting of the Federal Open Market Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 173 Committee held on December 11, 2001, The information reviewed at this were approved. meeting indicated that economic activ- The Manager of the System Open ity probably steadied in the fourth Market Account reported on recent quarter after a sizable drop in the developments in foreign exchange summer. Final demand appeared to markets. There were no open mar- have increased appreciably, reflecting ket operations in foreign currencies strength in consumer spending and a for the System's account in the period smaller decline in business purchases of since the previous meeting of the durable equipment and software. How- Committee. ever, businesses met a good part of the The Manager also reported on devel- pickup in final demand through a large opments in domestic financial markets runoff of inventories, and as a conseand on System open market transactions quence manufacturing activity and payin government securities and federal roll employment continued to weaken agency obligations during the period late in the year, though at a slower pace. December 11, 2002, to January 29, Falling energy prices and widespread 2002. By unanimous vote, the Commit- discounting of goods held down contee ratified these transactions. sumer price inflation. At this meeting, members discussed The labor market deteriorated somestaff background analyses of the impli- what further in December, and the cations for the conduct of policy if the unemployment rate continued to climb, economy were to deteriorate substan- to 5.8 percent. Private nonfarm payrolls tially in a period when nominal short- fell considerably, with manufacturing term interest rates were already at very again experiencing the largest job low levels. Under such conditions, while losses, but the decrease was less than in unconventional policy measures might previous months and aggregate hours be available, their efficacy was uncer- worked by private production workers tain, and it might be impossible to leveled out after six months of decline. ease monetary policy sufficiently Recent data on initial claims for unemthrough the usual interest rate process to ployment insurance pointed to a further achieve System objectives. The mem- moderation in employment losses in bers agreed that the potential for such an January. economic and policy scenario seemed Industrial production edged down in highly remote, but it could not be dis- December after having fallen sharply missed altogether. If in the future such in previous months. A number of circumstances appeared to be in the pro- industries experienced further reduccess of materializing, a case could be tions in output, with weakness most made at that point for taking preemptive pronounced in consumer nondurables easing actions to help guard against and business equipment. In contrast, the potential development of economic motor vehicle assemblies rose to weakness and price declines that could a still higher rate, presumably in be associated with the so-called "zero response to the robust sales of the bound" policy constraint. preceding two months, and the pro- The Committee then turned to a dis- duction of semiconductors and comcussion of the economic and financial puters continued to strengthen. The outlook and the implementation of rate of utilization of total manufacturmonetary policy over the intermeeting ing capacity declined a little further period ahead. in December, and the average rate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

174 89th Annual Report, 2002 for the fourth quarter was at its lowest favorable weather over much of the quarterly level since 1983. country. Spending on industrial struc- Growth of consumer spending tures plunged, reflecting low capacity strengthened considerably late in the utilization in manufacturing and rising year after a slow advance in the third vacancy rates. Office building activity quarter. A surge in purchases of motor also fell as increasing amounts of availvehicles in response to attractive financ- able space and uncertainties regarding ing incentives was a key factor in rents and property values weighed on the pickup, but expenditures on goods the office market. other than motor vehicles evidently also Nonfarm inventory liquidation apparaccelerated slightly. By contrast, spend- ently was very rapid in the fourth quaring on services expanded at a reduced ter, but inventory-sales ratios remained pace, owing at least in part to relatively elevated in an environment of weak low demand for residential heating sales. The book value of manufacturing services. and trade inventories plunged in Octo- Despite unseasonably warm and dry ber and November (latest data), but autumn weather, residential construction progress in getting inventory overhangs slowed somewhat in the fourth quarter. under control was limited. In manu- For the year as a whole, though, home- facturing, the sector's stock-shipments building and home sales remained rela- ratio persisted at a high level despite tively brisk as very low mortgage rates continuing sizable rundowns in inventended to offset the effects of a weaken- tories since the spring. Wholesalers ing job market and sluggish growth apparently stepped up their runoffs of in personal income. An apparent conse- excess stocks in recent months, yet the quence of reduced income growth and aggregate inventory-sales ratio for the of lower equity prices was a change in sector had fallen only slightly since midthe mix of single-family homebuilding, year. Retailers made greater progress with less emphasis on construction of in reducing inventories, and despite high-priced homes. relatively sluggish sales the sector's Business expenditures on durable inventory-sales ratio dropped considerequipment and software contracted ably and appeared to be at a fairly comless rapidly in the fourth quarter, and fortable level. monthly data indicated that such spend- The U.S. trade deficit in goods and ing might be bottoming out late in the services narrowed slightly on balance year despite further decreases in busi- in October and November (latest data) ness output and continuing weakness in from the third-quarter level (adjusted to corporate cash flows. Business pur- exclude large, one-time payments by chases of motor vehicles accounted for foreign insurers related to the events some of the improvement, and expendi- of September 11) as the value of imports tures for computers and related equip- for the two-month period fell by more ment apparently recorded a small gain. than the value of exports. The available Elsewhere, though, acquisitions of com- information suggested further slight munications equipment were still on a slippage of economic activity in the downward trend, and business spending foreign industrial countries in the in sectors other than high technology fourth quarter. The Japanese economy and transportation remained weak. Non- remained very weak, economic activity residential construction declined sharply in the euro area and Canada seemed further in the fourth quarter despite to have contracted, and growth in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes ofFOMC Meetings, January 175 United Kingdom apparently slowed. to about l3/4 percent. The members also There were some indications, however, agreed that the balance of risks remained of a brighter economic outlook ahead in weighted toward conditions that could the euro area, Canada, and the United generate economic weakness in the Kingdom that would result in part from foreseeable future. The members noted monetary easing actions that their that there were preliminary signs of respective central banks had taken. Eco- some abatement of the contractionary nomic conditions in the major emerging- forces acting on the economy, but they market countries were mixed. There believed that a subpar economic perforwere increasing signs of a recovery in mance was likely to persist for a time. developing Asia, especially in some of They also recognized that the stance of the countries that had been hurt by the policy was already quite accommodaglobal high-tech slump, but conditions tive and that much of the effect of recent in Latin America remained relatively monetary easing actions was yet to be weak, with the Argentine economy hav- felt. In the circumstances, they saw a ing deteriorated further. modest further reduction of the federal Consumer price inflation was quite funds rate as providing some added low at year-end. With energy prices insurance against a more extended condeclining, both the consumer price traction of the economy at little risk of a index (CPI) and the personal consump- pickup in inflation. tion expenditure (PCE) chain-type price Federal funds traded at rates close to index edged down on balance in the Committee's target level of 13A per- November and December. Moreover, cent during the intermeeting period. The excluding the effects of volatile oil Committee's action had been widely prices, core consumer price inflation anticipated, but the financial markets was held down late in the year by wide- evidently interpreted the announcement spread discounting of goods. Consumer as indicating that the FOMC's assessprice inflation as measured by the core ment of the economic outlook was PCE index declined somewhat on a weaker than had been assumed. Corpoyear-over-year basis, while core CPI rate announcements of downward reviinflation increased slightly in 2001. At sions to forecasts of future revenues the producer level, core prices for fin- and capital spending also contributed to ished goods changed little in November some marking down by market particiand December, and the index for core pants of prospects for economic activity. producer inflation slowed noticeably last Yields on Treasury coupon securities year. With regard to labor costs, growth declined slightly over the intermeeting of average hourly earnings of produc- period, risk spreads on corporate debt tion or nonsupervisory workers picked securities changed little, and major up in November and December, but the indexes of equity prices edged lower on average wage increase for the year was balance. moderate and slightly less than that for In foreign exchange markets, the 2000. trade-weighted value of the dollar in At its meeting on December 11, 2001, terms of the major foreign currencies the Committee adopted a directive that increased somewhat on balance over called for implementing conditions the intermeeting period and reached in reserve markets consistent with a its highest level since the mid-1980s. decrease of 25 basis points in the Weakness of the Japanese yen was an intended level of the federal funds rate, important factor in that rise, as market Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

176 89th Annual Report, 2002 participants focused on continuing ery would be associated with a marked problems in the Japanese economy and slowing in the contraction of business on comments by Japanese officials that capital investment and the added conseemed to signal a willingness to accept sumer purchasing power arising from a weaker value for the yen. The dollar recent declines in oil prices. Economic also appreciated slightly against the expansion was projected to strengthen euro, perhaps reflecting a market view appreciably by the second half of 2002 that the U.S. economy was likely to lead and subsequently, as the climate for the rebound from the global slowdown. business fixed investment continued to In addition, the exchange value of the improve and as a strengthening of fordollar increased slightly in terms of an eign economies led to somewhat greater index of the currencies of other impor- demand for U.S. exports. The unemploytant trading partners, in part because of ment rate would begin to edge down. the depreciation of the Argentine peso. Subpar expansion over the next few Growth of M2 slowed slightly in quarters was expected to foster an appre- December from November's robust pace ciable further easing of pressures on and moderated considerably further in resources and some moderation in core the early weeks of January. The brisk consumer price inflation. expansion of liquid deposits over recent In the Committee's discussion of curmonths had been associated with the rent and prospective economic condieffects of mortgage refinancing activity tions, members commented that the and the substantial decline in the oppor- recent information was more positive tunity costs of such deposits that was than they had anticipated and seemed related to previous easing actions. The on the whole to indicate that economic currency component of M2 also had activity was bottoming out and a recovbeen strong in the latter part of 2001, ery might already be under way. Imporlargely the result of a pickup in demand tant impetus to economic activity in the for U.S. currency abroad. The debt of period immediately ahead likely would the domestic nonfinancial sectors was be provided by a turnaround in invenestimated to have expanded at a slightly tory investment following several quarslower rate in December, reflecting ters of increasingly large liquidation that some moderation in business debt had culminated in the outsized decline financing, a slightly slower pace of in inventories reported for the fourth household borrowing, and little net bor- quarter. Looking beyond the near term, rowing by the federal government. members expressed considerable uncer- The staff forecast prepared for this tainty about the prospective strength of meeting suggested that economic activ- final demand. The stimulus from fisity likely would start to turn up early cal and monetary actions taken in 2001, in 2002 as inventory liquidation tapered the impetus to growth from the induceoff, and would gather strength only ment to new investment provided by gradually. The monetary ease and fiscal improving technology, and the persiststimulus already in place would provide ing uptrend in household spending impetus for the recovery, though the would support the economic recovery. wealth effects of earlier reductions in However, household spending had been equity prices, sluggish growth abroad, relatively robust during the cyclical and the dollar's strength would tend to downturn and likely had only limited offset some of that support for a time. room for a pickup over coming quarters, The gradual strengthening of the recov- and intense competitive pressures could Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 111 well constrain profits, investment, and thrust to the expansion over the nearer equity prices. As a result, the members term. The inventory correction that had were concerned that the acceleration in occurred over the past year was of a final demand could be modest, at least magnitude that would inevitably result for a time. Against this background, the in a reduced rate of liquidation and an prospects for continued low inflation eventual restocking unless, contrary to remained favorable, given the currently current expectations, consumer spendreduced utilization of resources and ing were to weaken markedly. The indeed the prospect for some added accompanying fillip to production and slack should economic growth remain incomes would have positive feedback below potential in coming quarters, as effects over time on household expenmany members anticipated. Moreover, ditures and business investment. The the further passthrough of earlier extent and timing of the turnaround in declines in energy prices would con- inventory investment for the economy tinue to ease pressures on prices and as a whole were subject to a considercosts more generally throughout the able degree of uncertainty, but members economy. noted that some firms already appeared In preparing for the semi-annual to have adjusted their inventories to monetary policy report to the Congress, what they viewed as acceptable levels, the Board members and Reserve Bank and there were indications that some presidents provided their individual pro- manufacturing firms were making jections for the growth of GDP, civilian efforts to rebuild inventories in the conunemployment, and consumer price text of improving orders. More generinflation for the year 2002. They pro- ally, however, business firms appeared jected that the economy would begin to to have remained very cautious in setrecover this year from the generally mild ting their inventory investment plans. downturn experienced in 2001, but the The evidence of unexpected strength pace of expansion would pick up only in overall final demand indicated by the gradually and the unemployment rate just-released GDP report was supported would climb somewhat further. The cen- by anecdotal commentary from around tral tendency of their forecasts of growth the nation. Regional economic reports in real GDP for 2002 was 2Vi to 3 per- were somewhat mixed in that declining cent, measured as the change between activity still characterized conditions in the fourth quarter of 2001 and the fourth some areas, but the pace of the declines quarter of 2002, while their forecasts of appeared to have moderated in those the civilian unemployment rate in the areas and improved conditions were fourth quarter of the year were centered noted in other parts of the country. on 6 to 6x/4 percent. The forecasts Business sentiment, while still quite of consumer price inflation this year, as depressed in some areas, was described measured by the PCE chain-type price in many reports as having shifted toward index, were narrowly clustered around cautious optimism. lx/2 percent. Concerning prospective develop- With regard to the prospective course ments in final demand in major sectors of the projected recovery, members gen- of the economy, several members undererally anticipated that a positive swing scored what they viewed as the key role in inventory investment abetted by of household expenditures. Such spendfurther growth in consumer spending ing had held up remarkably well in the would provide an important upward face of major adverse developments, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

178 89th Annual Report, 2002 including sharp declines in stock mar- cate that additional impetus, if any, from ket wealth and rising unemployment, housing construction would be limited that were exacerbated by the events over the next several quarters. of September 11. But with households The outlook for business capital remaining confident about the future and expenditures was improving, but anecequity prices having rebounded from dotal reports suggested that business their post-attack declines, sustained executives were still notably cautious growth in household expenditures was in formulating their spending plans, seen as a likely prospect. Such spend- and indications of accelerating capital ing also would be supported in part investment were still quite limited. In by some strengthening or less weakness the high-tech sector, positive signs were in other important sectors of the econ- noted in the demand for computers and omy. Some members nonetheless cited peripherals, but the outlook for commua number of potential negatives relating nications equipment was still very negato the prospects for consumer spend- tive. Business spending for other equiping, including the possibility of adverse ment was also expected to remain soft. effects on consumer confidence of fur- On balance, the capital investment secther anticipated increases in unemploy- tor seemed likely to retard the overall ment and the risk that generally dis- advance in economic activity during the appointing business profits or more quarters immediately ahead as many widespread downward restatements of firms continued to pare excess capacity reported profits might generate sizable and businesses awaited clearer indicadeclines in stock market prices and con- tions of rising demand and profits. sumer wealth. Moreover, the unusually Beyond the nearer term, however, the large sales of motor vehicles and to a favorable outlook for productivity degree other durable goods during the growth and related profit opportunities closing months of 2001 might have bor- pointed to a revival of robust capital rowed to some extent from sales in com- spending. Indeed, past experience suging months. On balance, the positive gested that once a rebound in capital and negative factors bearing on the out- spending took hold it easily could look for consumer spending suggested exceed current forecasts of moderate that moderate growth was a reasonable acceleration. expectation. Fiscal policy would continue to pro- Residential construction expendi- vide substantial stimulus to the econtures, like household spending for con- omy this year in light of the ongoing sumer goods and services, had held effects of the tax reduction measures up well despite the cyclical downturn enacted in 2001 and the sharp increase in employment and sizable net losses in federal government spending in in stock market wealth. Low mortgage train. This outlook did not incorporate interest rates and, in recent months, the possible enactment of further tax favorable weather conditions had pro- cut legislation, whose prospects now vided vital support to this sector of the seemed to be remote. A partial offset economy. Recent housing activity, to federal government stimulus was including record sales in some areas, the likelihood of considerably reduced suggested persisting underlying strength spending growth at the state and local in residential construction. Even so, the government levels, where numerous large additions to the supply of new government entities were experienchomes in earlier years tended to indi- ing severe budget strains associated Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 179 with recession-related weakness in tax policy had been eased substantially over revenues. the past year, and, with the real federal The external sector of the economy funds rate at an unusually low level, was seen as a source of some poten- policy seemed well positioned to suptial downside for the domestic econ- port an economic recovery as the forces omy in the period just ahead. Gener- restraining demand abated. In fact, a ally weak foreign economies and the growing number of indicators pointed to recent strength of the dollar in foreign a reduction in the pressures holding back exchange markets were expected to con- the economy and to an emerging busitinue to restrain U.S. exports. Economic ness recovery. In these circumstances, a recoveries in many foreign nations pause seemed desirable to monitor the seemed likely over the course of this still-incomplete effects of the Commityear, but the strength of those recoveries tee's easing over the past year—a sigwas subject to considerable uncertainty, nificant part of which had been impleand the risk that serious difficulties in mented in recent months—and the some important economies might spread contours of the turnaround in economic could not be overlooked. Recovery activity. abroad, notably in some key U.S. trad- All the members indicated that they ing partners, would be tied to an could support the issuance of a public important extent to the course of U.S. statement indicating that the risks economic activity and would not be remained tilted toward economic weakproviding much impetus to U.S. exports ness. Although the economy was probover coming quarters. At this point signs ably strengthening, a variety of factors of an upturn in foreign trade were not could well keep the pace of expansion entirely lacking, notably in some high- below the rate of growth of potential tech goods, but those indications were for a while, even at the current policy still very limited. stance. Moreover, inflation was running Inflation was likely to remain quite at a fairly low rate and quite possibly subdued. Indeed, core inflation could would edge down a little further over well edge lower. The indirect effects of coming quarters. In these circumstances, the declines that had occurred in energy the risk to achieving the Committee's prices would continue to hold down objective for fostering sustainable ecoother input prices and be passed on more nomic growth seemed to be greater than fully to final purchasers. More gener- to its objective of maintaining reasonally, the low rate of resource utiliza- able price stability. In the view of a few tion anticipated over the year ahead, ris- members, an argument could be made ing productivity, and highly competitive for moving to a balanced-risks statemarket pricing could be expected to ment, given that they could envisage moderate price pressures. Against that developments that could strengthen the background, members continued to view economy beyond their current forecasts. the greater risks to the economy as those However, they agreed that a shift to relating to concerns about economic balanced risks in conjunction with an activity rather than prices. unchanged policy stance could at this In the Committee's discussion of pol- point be misread in financial markets as icy for the intermeeting period ahead, all an indication of a much more optimistic the members agreed that recent develop- view of the economic outlook than the ments argued for keeping the stance of members currently entertained. Such an policy unchanged at this time. Monetary interpretation might foster unwarranted Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

180 89th Annual Report, 2002 and counterproductive adjustments in ing of each year, the members discussed financial markets. In any event, emerg- their policies regarding the extent of the ing economic conditions in line with information that is released to the pubthe members' current forecasts would lic about its discussions and decisions provide ample opportunity to shift to along with the timing of the release of a balanced-risks statement at a future such information. They noted that the meeting when it might be more clearly changes in disclosure policy and pracappropriate. tices implemented in recent years, At the conclusion of this discussion, including the announcement of policy the Committee voted to authorize and actions and brief explanations of the direct the Federal Reserve Bank of New basis for those actions, have served both York, until it was instructed otherwise, the Federal Reserve and the public well. to execute transactions in the System They also believed that it would be Account in accordance with the follow- appropriate to explore whether there ing domestic policy directive: might be scope for some further evolution in the Committee's policies in the The Federal Open Market Committee direction of greater transparency, though seeks monetary and financial conditions that additional study and analysis would will foster price stability and promote susbe needed. They agreed to discuss the tainable growth in output. To further its longissues further at a future meeting. run objectives, the Committee in the immediate future seeks conditions in reserve It also was agreed that the next meetmarkets consistent with maintaining the fed- ing of the Committee would be held on eral funds rate at an average of around Tuesday, March 19, 2002. PA percent. The meeting adjourned at 12:30 p.m. on January 30, 2002. The votes encompassed approval of the sentence below for inclusion in the Donald L. Kohn press statement to be released shortly Secretary after the meeting. Against the background of its long-run Meeting Held on goals of price stability and sustainable eco- March 19, 2002 nomic growth and of the information currently available, the Committee believes that A meeting of the Federal Open Market the risks continue to be weighted mainly Committee was held in the offices of toward conditions that may generate ecothe Board of Governors of the Federal nomic weakness in the foreseeable future. Reserve System in Washington, D.C., on Tuesday, March 19, 2002, at Votes for this action: Messrs. Greenspan, McDonough, Ms. Bies, Messrs. Ferguson, 9:00 a.m. Gramlich, Jordan, McTeer, Olson, Santomero, and Stern. Vote against this Presentaction: None. Absent and not voting: Mr. Greenspan, Chairman Mr. Meyer. Mr. McDonough, Vice Chairman Ms. Bies Mr. Ferguson Disclosure Policy Mr. Gramlich Mr. Jordan Mr. McTeer In accordance with the Committee's Mr. Olson routine practice of reviewing its rules Mr. Santomero and regulations at its first regular meet- Mr. Stern Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 181 Messrs. Broaddus, Guynn, Moskow, Ms. Low, Open Market Secretariat and Parry, Alternate Members Assistant, Office of Board of the Federal Open Market Members, Board of Governors Committee Ms. Pianalto and Mr. Stewart, First Mr. Hoenig, Ms. Minehan, and Vice Presidents, Federal Reserve Mr. Poole, Presidents of the Banks of Cleveland and New York Federal Reserve Banks of respectively Kansas City, Boston, and St. Louis respectively Messrs. Beebe, Eisenbeis, Fuhrer, Goodfriend, Hakkio, Hunter, and Mr. Kohn, Secretary and Economist Rasche, Senior Vice Presidents, Mr. Bernard, Deputy Secretary Federal Reserve Banks of Mr. Gillum, Assistant Secretary San Francisco, Atlanta, Boston, Ms. Smith, Assistant Secretary Richmond, Kansas City, Chicago, Mr. Mattingly, General Counsel and St. Louis respectively Ms. Johnson, Economist Mr. Reinhart, Economist Ms. Hargraves, Vice President, Federal Mr. Stockton, Economist Reserve Bank of New York Mr. Connors, Ms. Cumming, By unanimous vote, the minutes of Messrs. Howard and Lindsey, Ms. Mester, Messrs. Oliner, the meeting of the Federal Open Market Rolnick, Rosenblum, Sniderman, Committee held on January 29-30, and Wilcox, Associate Economists 2002, were approved. By notation vote completed on Mr. Kos, Manager, System Open March 19, 2002, the members of the Market Account Federal Open Market Committee voted unanimously to accept the Report of Mr. Winn, Assistant to the Board, Examination of the System Open Mar- Office of Board Members, Board of Governors ket Account conducted as of the close of business on November 14, 2001, by the Messrs. Ettin and Madigan, Deputy Division of Reserve Bank Operations Directors, Divisions of Research and Payment Systems of the Board of and Statistics and Monetary Governors. Affairs respectively, Board The Manager of the System Open of Governors Market Account reported on recent developments in foreign exchange mar- Mr. Whitesell, Deputy Associate Director, Division of Monetary kets. There were no open market opera- Affairs, Board of Governors tions in foreign currencies for the System's account in the period since the Mr. Simpson, Senior Adviser, Division previous meeting. of Research and Statistics, The Manager also reported on devel- Board of Governors opments in domestic financial markets and on System open market transactions Mr. English, Assistant Director, in government securities and securities Division of Monetary Affairs, issued or fully guaranteed by federal Board of Governors agencies during the period January 30, 2002, through March 18, 2002. By Mr. Skidmore, Special Assistant to the Board, Office of Board unanimous vote, the Committee ratified Members, Board of Governors these transactions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

182 89th Annual Report, 2002 At this meeting the staff requested nation of outright purchases of GNMA- Committee guidance on the priorities, MBS. Although these securities have a given limited staff resources, it should number of shortcomings as an outright attach to further studies of the feasibil- investment vehicle from the System's ity of outright purchases for the Sys- perspective, the market for GNMAtem Open Market Account (SOMA) of MBS was well developed and the secumortgage-backed securities guaranteed rities were guaranteed by the full faith by the Government National Mort- and credit of the U.S. government. gage Association (GNMA-MBS) and The Committee then turned to a disthe addition of foreign sovereign debt cussion of the economic and financial securities to the list of collateral eligi- outlook and the conduct of monetary ble for U.S. dollar repurchase agree- policy over the intermeeting period ments by the System. Such alternatives ahead. could prove useful if outstanding Trea- The information reviewed at this sury debt obligations were to become meeting indicated that economic activincreasingly scarce relative to the nec- ity had turned up in the final quarter essary growth in the System's portfolio, of last year and strengthened further and the Committee had previously since then. Consumer spending on requested initial staff exploration of goods other than motor vehicles was these options. Noting that many of the brisk in the early part of this year, staff engaged in these studies were also business purchases of equipment and involved in contingency planning, which software appeared to be beginning to had been intensified after the Sep- recover from their marked decline of tember 11 attacks, the consensus of last year, and housing starts turned back the members was to give the highest up. Amid signs that most firms had priority to such planning. All the mem- worked down their inventories to more bers preferred continued reliance to the comfortable levels, industrial producextent feasible on direct Treasury debt tion increased slightly after having for outright System transactions, and declined for nearly a year and a half, they were persuaded that budget devel- and payroll employment appeared to be opments over the last year meant that bottoming out. Inflation remained low constraints on Treasury debt supplies despite some firming of energy prices. would not become as pressing an issue Private nonfarm payroll employment as soon as they had previously thought. moved up in February, retracing part Still, given the inherent uncertainty of of January's drop. Layoffs in manufacbudget forecasts, the likely significant turing slowed further, the construction needs for large SOMA operations in industry added back some workers in coming years and the lead times needed February, and the retail trade and serto implement new procedures, the Com- vices sectors continued to hire in both mittee decided that the study of alter- months. The unemployment rate edged native market instruments should go down again in February to 5.5 percent, forward once it was possible to do so and initial claims for unemployment without impeding the contingency plan- insurance continued to drop. ning effort. With regard to the two pro- Industrial production increased someposed alternatives for broadening the what in January and February after a System's options for open market operasteep decline from its June 2000 peak. tions, the members instructed the staff to Manufacturing output rose in both give a higher priority to further examimonths, and the factory operating rate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 183 moved up slightly from its low level at down in January after a December year-end. The pickup in manufacturing bounce. Shipments in most other sectors this year was spread across several recorded increases and were particularly major industries, including chemicals, robust for machinery, engines, and turcomputers and semiconductors, paper, bines. Business demand for motor vehiand tobacco. In addition, output of com- cles remained mixed, with fleet sales munications equipment steadied after of light vehicles higher and purchases having plunged for more than a year. In of medium and heavy trucks somewhat contrast, production of motor vehicles weaker. Nonresidential construction and parts changed little over January remained in a slump, with spending on and February after a surge late in 2001. new office buildings and industrial Consumer spending remained strong structures down sharply in an environin the early part of the year, despite a ment of elevated vacancy rates. sizable drop in purchases of light vehi- The pace of liquidation of manufaccles in January that was followed by a turing and trade inventories, excluding rebound in February as manufacturers motor vehicles, slowed in January after switched from attractive financing terms a very rapid rundown in the fourth quarto cash rebates. Outlays for retail items ter, and with sales higher the aggregate other than motor vehicles expanded fur- inventory-sales ratio declined to its lowther in February after the large increases est level since midyear 2000. Manufacrecorded in the two prior months. Out- turers' stocks were drawn down sharply lays for services continued to rise further in January, and the sector's moderately in January (latest data). stock-to-shipments ratio fell apprecia- Consumer purchases were supported by bly. At the wholesale level, the rate a sizable gain in disposable personal of inventory runoff slowed somewhat, income in January, and readings on con- but the sector's inventory-sales ratio sumer sentiment were close to their his- declined further. The level of inventorical averages. tories at the retail level increased some- Residential construction had been what despite a rise in sales, and the very strong in the past several months, sector's aggregate inventory-sales ratio with new starts reaching their highest was at an historically low level. level in almost two years. The strength The U.S. trade deficit in goods and in homebuilding was associated in part services widened somewhat in January. with unusually warm and dry weather, The value of exports changed little but but very low mortgage rates also contin- the value of imports rose appreciably, to ued to play an important role. about the November level. The available Business spending on durable equip- information indicated that economic ment and software appeared to be turn- activity in the foreign industrial couning upward after a marked moderation tries showed little net change in the in the fourth quarter of the steep decline fourth quarter. The Canadian economy recorded in the two previous quarters. rebounded from a weak third quarter, Shipments and orders of nondefense but economic expansion in the United capital goods were unexpectedly strong Kingdom nearly came to a halt in the in January. There were signs of recovery fourth quarter, economic activity in the in the high-tech sector, with shipments euro area slipped a little, and the Japaof computers and peripherals increasing nese economy recorded a steep drop. for a fifth straight month, but shipments There were indications, however, of a of communications equipment turned gradually improving economic outlook Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

184 89th Annual Report, 2002 in several of these economies in the first inflation-adjusted federal funds rate was quarter as a consequence of previous at an unusually low level. As a result, monetary policy easing actions that their policy was positioned to support an ecorespective central banks had taken and nomic recovery as forces restraining from the effects of an improved eco- aggregate demand abated. Nonetheless, nomic performance in the United States. the members agreed that there were fac- Among the major emerging-market tors that might keep the pace of expancountries, the exports of a number of sion below the rate of growth of poten- Asian economies were benefiting from tial for a while, and thus the balance the nascent recovery in high-tech of risks continued to be tilted toward industries around the world. In Latin economic weakness in the foreseeable America, although Argentina remained future. in a steep downward trend, the Mexican The federal funds rate remained close and Brazilian economies seemed to be to the Committee's target level of recovering from weakness in the fourth 1% percent during the intermeeting quarter. period. However, short-term market Consumer price inflation picked up a rates increased slightly over the interbit in January as energy prices posted meeting interval, and yields on longertheir first increase since September. term Treasury instruments and high- However, on a year-over-year basis, grade corporate bonds rose by more. core price inflation as measured by the The rise in rates was sparked initially consumer price index leveled out at a by market participants' reading of the moderate rate, while core PCE (per- Committee's press statement as sugsonal consumption expenditure) price gesting greater-than-expected optimism inflation declined appreciably. Labor about the economy going forward. That costs also appeared to have decelerated assessment was subsequently strengthrecently. The employment cost index for ened by data on spending and output hourly compensation in private industry released during the intermeeting interval rose moderately in the fourth quarter of that came in well above market expectalast year and for the year as a whole. tions. Speculative-grade bond yields fell Both the salary and benefits components somewhat in reaction to the improved recorded slightly smaller increases last economic outlook and the perceived year. Average hourly earnings of pro- reduction of credit risk. Most major duction and nonsupervisory workers indexes of equity prices moved up advanced only slightly in January and sharply on the bullish economic reports. February of this year, and the average In foreign exchange markets, the wage increase during the twelve months trade-weighted value of the dollar in through February was slightly lower terms of the major foreign currencies than that for the twelve-month period eased slightly on balance over the interending in February 2001. meeting period. The dollar fell more At its meeting on January 29-30, against the yen than the euro despite 2002, the Committee adopted a directive negative economic news from Japan and that called for implementing conditions the disappointing reaction to the Japain reserve markets consistent with keep- nese government's announcement of an ing the intended level of the federal "anti-deflation" package. The exchange funds rate at 13A percent. The members value of the dollar changed little in noted that policy had been eased sub- terms of an index of the currencies of stantially over the past year and that the other important trading partners, in part Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes ofFOMC Meetings, March 185 because of the further depreciation of anticipated earlier despite higher prothe Argentine peso. jected growth in structural productivity. Expansion of M2 rebounded some- Even so, overall activity would remain what in February from January's lack- below estimates of the economy's luster rate, but growth in the early part potential output for some time, and the of the year was down sharply from the persistence of underutilized resources robust pace of late last year. The slow- was expected to keep downward presdown apparently was related to the ebb- sure on core price inflation. ing effect of earlier declines in oppor- In the Committee's discussion of curtunity costs of holding M2 assets and rent and prospective economic developto the shift of large amounts of money ments, members commented that the from retail money market funds into decidedly positive information received bond and equity mutual funds as con- over the intermeeting period provided cerns about volatility in financial mar- strong evidence that an economic recovkets eased. Reduced demand for mort- ery was now under way, though its progage refinancing also seemed to have spective strength remained subject to contributed to the deceleration of M2. substantial uncertainty. In this regard it The debt of the domestic nonfmancial was noted that the economy was undersectors was estimated to have increased going significant structural changes and at a relatively slow rate in January, those changes were adding to the usual reflecting weak demand for business difficulty of projecting the trajectory of debt financing and little net borrowing economic activity after a turning point. by the federal government. Unexpected strength in household The staff forecast prepared for this expenditures, much reduced weakness meeting suggested that economic activ- in business capital spending, and subity was expanding briskly in the early stantial slowing in inventory liquidamonths of the year after having turned tion had produced an earlier upturn in up and increased modestly in the fourth economic activity than many had anticiquarter. Elevated household spending pated. A further strengthening of invenand a shift from inventory liquidation to tory investment would probably genaccumulation would provide significant erate appreciable further growth in impetus for the recovery in the context business activity over the quarters just of the substantial monetary ease and fis- ahead. Once the ongoing inventory corcal stimulus already in place. Moreover, rection was completed, however, it was the recently enacted federal incentive not clear to what extent final demand for new business equipment invest- in key sectors of the economy, notably ment along with the outlook for contin- business capital investment, would ued robust gains in productivity were provide support for further economic expected to help boost business capi- growth. While the members agreed that tal spending. At the same time, still- the stimulative fiscal and monetary polidepressed equity prices, limited growth cies currently in place would undergird abroad, and the dollar's strength would further economic expansion, most contend to hold down the pace of recovery. tinued to anticipate a relatively subdued On balance, recent developments sug- rate of expansion that would only gradugested that the course of final sales now ally erode current margins of underhad a more positive contour over the utilized productive resources. The memforecast horizon and that resource utili- bers viewed the outlook for core price zation would rise somewhat more than inflation as still quite benign, largely Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

186 89th Annual Report, 2002 reflecting the ample availability of labor a boost to industrial production. Lookand other producer resources to accom- ing ahead, inventory investment likely modate rising economic activity and the would turn toward accumulation as favorable prospects for further robust business firms facing brisk demand and growth in productivity. depleted stocks stepped up their new Anecdotal commentary from around orders, providing a source of significant the country was somewhat less positive strength in fostering economic recovery on the whole than the recent macroeco- over the near term. nomic data for the nation. Business con- A major uncertainty in the economic ditions were reported to be improving in outlook was the extent to which growth most areas and industries, but the pickup in final demand by households and busiwas uneven, with continued weakness ness firms would provide ongoing supstill characterizing numerous industries. port for the expansion as the impetus Many business contacts, although some- from inventory investment dissipated. what less pessimistic about the eco- The prospects for consumer spending nomic outlook, still did not appear to be remained favorable against the backanticipating a strong upturn this year. drop of a solid uptrend in disposable Gradual recovery was reported in the incomes associated to an important depressed tourism and travel industries. extent with an improving employment The manufacturing sector, where much picture, robust underlying growth in of the economy's weakness had been labor productivity, and the further concentrated, was displaying increased phase-in of personal income tax cuts signs of stabilizing, with activity actu- enacted in 2001. Consumer confidence ally picking up in a number of industries had improved considerably in recent and some firms anticipating increases months and consumer expenditures had in their payrolls over the next sev- displayed surprising strength. Members eral months after experiencing large nonetheless cited some negatives in the declines. However, employers in manu- outlook for consumer spending includfacturing and other sectors of the econ- ing the possibilities that a negative stock omy generally remained cautious in market wealth effect stemming from their hiring policies and in their plans large earlier declines and the somewhat for capital spending. elevated rate of unemployment would In their discussion of developments in weigh on consumer confidence. Imporkey expenditure sectors of the economy, tantly, because consumer spending for members commented that inventory automobiles and other consumer durainvestment was likely to remain a piv- bles had been well maintained through otal factor in the nearer-term perfor- the extended period of economic weakmance of the economy. Firms had ness, further gains in such expenditures moved rapidly to correct earlier inven- were likely to be limited over coming tory imbalances. Data indicating a very quarters in contrast to the typical surge large drawdown of inventories in the in past economic recoveries. Moreover, fourth quarter and further, albeit much energy price increases, especially if they diminished, liquidation in January along were to become more pronounced, with anecdotal commentary suggested would tend to hold back household that inventories were now close to spending. On balance, members saw desired levels in many industries, nota- moderate further growth in consumer bly in the retail sector, and the swing spending as a reasonable prospect for toward smaller drawdowns was giving coming quarters. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 187 After a lull during the fall of 2001, vacancy rates in commercial structures housing activity had displayed renewed in many parts of the nation. Members vigor in recent months, in part as a con- nonetheless cited some positives in this sequence of widely favorable weather outlook that included the favorable conditions. Indeed, single-family con- effects on incentives to purchase capital struction was described as a particularly equipment stemming from the outlook bright sector in a number of local econ- for relatively rapid growth in productivomies. Looking ahead, the favorable ity and the recent passage of legislation factors affecting consumer spending providing a temporary tax incentive for more generally along with relatively low investments in equipment and software. mortgage interest rates were expected to On balance, a substantial pickup in oversustain a high level of housing expendi- all capital spending seemed likely to be tures this year. In keeping with the out- delayed in the absence of surprising look for consumer durables, however, a strength in final demand, but a wide long period of active housing construc- range of possible outcomes could not tion suggested that significant additional be ruled out for this key sector of the strength in housing was unlikely in com- economy. ing quarters. Several members referred to the cur- The members generally viewed busi- rently high degree of fiscal policy stimness fixed investment spending as the ulus, which had been augmented by key to the strength of economic activity recent legislation. Much of the added once the thrust from inventory restock- stimulus from the investment incentive ing had run its course. The outlook for component of that legislation was not business capital expenditures would be likely to be felt for some period and governed to an important extent by busi- might occur at a time when the economy ness expectations regarding sales and would already be expanding at a solid profits. After the steep declines in busi- pace. Federal spending was increasing ness investment over the past year, anec- rapidly and its growth could taper off dotal reports from around the country more slowly than current budget estiprovided scattered indications of an mates implied. An at least partially offupturn but no evidence at this point of setting factor was the prospect that state any broad-based improvement. Accord- and local government expenditures ing to such reports and despite the would increase at a reduced pace this strength of recent economic statistics, year amid widespread budget pressures which had boosted the economic fore- that had emerged as tax receipts weakcasts of many observers, business confi- ened along with the economy. However, dence remained at a low level, evidently some reports indicated that spending on reflecting a weak outlook for profits local infrastructure projects was conin the business community in the con- tinuing at a solid pace in some parts of text of strong competitive pressures. the nation. Negative factors bearing on the out- Members saw a number of downlook for investment in capital equip- side risks from potential developments ment included the persistence of large abroad. In particular, concern was margins of excess capacity in many expressed about heightened tensions in industries. The outlook for commercial the Middle East and their possible and other nonresidential construction impact on oil markets and the cost of seemed even less promising, at least for energy. For a variety of reasons, oil the next several quarters, given high prices already had risen appreciably Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

188 89th Annual Report, 2002 since the start of the year. With regard to Looking ahead, however, the stance the outlook for foreign trade, members of policy would need to be adjusted at reported some indications of an improv- some point to provide less stimulus as ing volume of trade with some Asian the members gained more confidence nations. However, the nation's net that the recovery was becoming better export position could deteriorate further entrenched and the risks had shifted when much of the impetus to world toward rising inflationary pressures. The economic growth was coming from the need to adjust monetary policy during U.S. economy. the early stages of a recovery presented The members expected price pres- a special challenge with regard to its sures to remain relatively contained over timing and extent in that raising rates the next several quarters in the context prematurely or too precipitately could of what they anticipated would be only weaken or abort the recovery, while a gradual reduction of the excess capac- waiting too long could risk a pickup in ity in labor and product markets as inflationary pressures later. Members the recovery progressed. Moreover, the concluded that the Committee would be prospects of relatively robust growth in a better position to assess the approin productivity in a highly flexible and priate timing of a policy change at the competitive economy likely would mod- May meeting when it would have more erate the extent of any potential buildup information to gauge the economy's in inflationary pressures in the future. performance in two critical areas, Members nonetheless mentioned some namely developments relating to invenpotential negatives in this outlook, nota- tory investment and the implications bly the possibility of rising wage pres- of trends in sales and profits for capital sures as labor markets became more investment. A reference to the Comfully employed and upward price pres- mittee's currently accommodative polsures stemming from increasing steel, icy stance in the press announcement energy, and insurance costs. to be issued shortly after this meeting In the Committee's discussion of pol- would alert the public to the need to icy for the intermeeting period ahead, firm policy at some point in the future. all the members supported a proposal All the members indicated that they to maintain an unchanged policy stance, could accept a proposal to move the with the target for the federal funds rate balance of risks statement from potenstaying at VA percent. While the econ- tial weakness to a neutral position. It omy currently appeared to be expanding was clear that significant downside risks at a fairly vigorous pace, the advance remained in the economy even apart importantly reflected a temporary swing from any major unanticipated shocks in inventory investment and consid- to business and consumer confidence, erable uncertainty surrounded the out- but in light of the strength of the recent look for final demand over the quarters economic information nearly all the ahead. Against this background, the members agreed that a balanced risks members judged the currently accom- statement now best represented their modative stance of monetary policy to consensus regarding the economic outbe appropriate for now, especially in look over the foreseeable future. Memlight of the relatively high unemploy- bers noted that a neutral statement did ment rate, low capacity utilization rates not preclude a tightening policy move in numerous industries, and quiescent should the latter seem warranted by rapinflation pressures. idly evolving economic conditions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 189 At the conclusion of this discussion, as part of the minutes after the next the Committee voted to authorize and meeting. direct the Federal Reserve Bank of New It was agreed that the next meeting of York, until it was instructed otherwise, the Committee would be held on Tuesto execute transactions in the System day, May 7, 2002. Account in accordance with the follow- The meeting adjourned at 1:30 p.m. ing domestic policy directive: Donald L. Kohn The Federal Open Market Committee Secretary seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the imme- Meeting Held on diate future seeks conditions in reserve May 7, 2002 markets consistent with maintaining the federal funds rate at an average of around PA percent. A meeting of the Federal Open Market Committee was held in the offices of The vote encompassed approval of the Board of Governors of the Federal the sentence below for inclusion in the Reserve System in Washington, D.C., press statement to be released shortly on Tuesday, May 7, 2002, at 9:00 a.m. after the meeting: Present: Against the background of its long-run Mr. Greenspan, Chairman goals of price stability and sustainable eco- Mr. McDonough, Vice Chairman nomic growth and of the information cur- Ms. Bies rently available, the Committee believes that Mr. Ferguson the risks are balanced with respect to pros- Mr. Gramlich pects for both goals in the foreseeable future. Mr. Jordan Mr. McTeer Votes for this action: Messrs. Greenspan, Mr. Olson McDonough, Ms. Bies, Messrs. Ferguson, Mr. Santomero Gramlich, Jordan, McTeer, Olson, San- Mr. Stern tomero, and Stern. Votes against this action: None. Messrs. Broaddus, Guynn, Moskow, and Parry, Alternate Members of the Federal Open Market Disclosure Policy Committee By unanimous vote, the Committee Mr. Hoenig, Ms. Minehan, and approved a proposal to include the vote Mr. Poole, Presidents of the Federal Reserve Banks of on monetary policy in the press state- Kansas City, Boston, and ment released after every meeting, St. Louis respectively beginning with this meeting. In addition to identifying the voters, the press Mr. Kohn, Secretary and Economist release would indicate the policy pref- Mr. Bernard, Deputy Secretary erences of dissenters, if any. Such Mr. Gillum, Assistant Secretary information could prove useful to mar- Ms. Smith, Assistant Secretary Mr. Mattingly, General Counsel ket participants, who on occasion had Mr. Baxter, Deputy General Counsel employed indirect and frequently mis- Ms. Johnson, Economist leading information to gauge the Com- Mr. Reinhart, Economist mittee's vote before it was released Mr. Stockton, Economist Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

190 89th Annual Report, 2002 Mr. Connors, Ms. dimming, By unanimous vote, the minutes of Messrs. Howard and Lindsey, the meeting of the Federal Open Market Ms. Mester, Messrs. Oliner, Committee held on March 19, 2002, Rolnick, Rosenblum, and Wilcox, were approved. Associate Economists The Manager of the System Open Mr. Kos, Manager, System Open Market Account reported on recent Market Account developments in foreign exchange markets. TTiere were no open market opera- Messrs. Ettin and Madigan, Deputy tions in foreign currencies for the Sys- Directors, Divisions of Research tem's account in the period since the and Statistics and Monetary previous meeting. Affairs respectively, Board of Governors The Manager also reported on developments in domestic financial markets Messrs. Slifman and Struckmeyer, and on System open market transactions Associate Directors, Division in government securities and securities of Research and Statistics, issued or fully guaranteed by federal Board of Governors agencies during the period March 19, Mr. Whitesell, Deputy Associate 2002, through May 6, 2002. By unani- Director, Division of Monetary mous vote, the Committee ratified these Affairs, Board of Governors transactions. By unanimous vote, the Committee Mr. Clouse, Assistant Director, approved the extension for one year Division of Monetary Affairs, Board of Governors beginning in December 2002 of the System's reciprocal currency ("swap") Mr. Simpson, Senior Adviser, Division arrangements with the Bank of Canada of Research and Statistics, and the Bank of Mexico. The arrange- Board of Governors ment with the Bank of Canada is in the amount of $2 billion equivalent and that Mr. Skidmore, Special Assistant to the Board, Office of Board with the Bank of Mexico in the amount Members, Board of Governors of $3 billion equivalent. Both arrangements are associated with the Federal Ms. Low, Open Market Secretariat Reserve's participation in the North Assistant, Office of Board American Framework Agreement. The Members, Board of Governors early vote to renew the System's partici- Mr. Barron, First Vice President, pation in the swap arrangements matur- Federal Reserve Bank of Atlanta ing in December relates to the provision that each party must provide six months Messrs. Eisenbeis, Fuhrer, Goodfriend, prior notice of an intention to terminate Hakkio, Hunter, Judd, and its participation. Ms. Perelmuter, Senior Vice The Committee then turned to a dis- Presidents, Federal Reserve Banks of Atlanta, Boston, cussion of the economic and financial Richmond, Kansas City, Chicago, outlook and the conduct of monetary San Francisco, and New York policy over the intermeeting period respectively ahead. The information reviewed at this Messrs. Altig and Coughlin, Vice meeting indicated that economic activ- Presidents, Federal Reserve Banks of Cleveland and St. Louis ity expanded rapidly early in the year. respectively Consumer spending increased moder- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 191 ately after large gains around the turn than half of its fourth-quarter plunge. of the year, business outlays on dura- The gain was widespread across market ble equipment and software apparently groups and industries. High-tech equipsteadied after a long decline, and single- ment, notably computers and semiconfamily housing activity persisted at a ductors, and motor vehicles and parts relatively high level. Industrial pro- led the upturn with very large increases, duction picked up in response to the while the telecommunications and airadvance in final demand and a slow- craft industries weakened sharply furdown in the runoff of excess inventory ther. Capacity utilization in manufacturstocks. The demand for labor began to ing continued to rise in March from its firm in April. Available information low level at year-end, but at the end of suggested that labor productivity had the first quarter it was still substantially risen substantially in the first quarter. below its long-run average. Although the recent surge in energy Consumer spending was well mainprices boosted headline consumer infla- tained in the first quarter, supported tion in the first quarter, core measures of by sizable gains in disposable income. inflation had trended lower over the past Demand for light motor vehicles year. remained robust, though somewhat Private nonfarm payroll employment below the fourth-quarter pace, in an turned up in April after having posted environment of continued aggressive small declines in February and March manufacturer pricing and low financing and steep reductions earlier. Job gains in rates. Expenditures on a wide range of April were spread across a wide range other consumer goods and services of industries. The services sector regis- expanded briskly. tered a sizable increase, with much of Residential housing activity surged that rise occurring in the temporary-help in the first three months of the year, industry that provides many of its work- evidently spurred by unusually mild ers to the manufacturing sector. In addi- winter weather and low mortgage rates. tion, layoffs continued to slow in the Starts of single-family homes reached manufacturing sector, and some indus- a twenty-three-year high in February tries recorded their first solid advances before moderating somewhat in March, in employment in more than a year. but multifamily starts were only slightly By contrast, the construction industry above the relatively slow pace in 2001. posted another large job decline as hir- New home sales moderated a bit in the ing again fell short of the usual seasonal first quarter from the very strong pace of rise. Despite the pickup in private pay- the fourth quarter, while quarterly sales rolls, the unemployment rate rose to of existing homes rose on the strength of 6.0 percent in April, perhaps reflecting a record high in February. to an important extent the incentives Business outlays for durable equipcreated by the new federal program of ment and software had changed little extended unemployment benefits for thus far this year following the steep some jobless workers to continue, or decline recorded in 2001. Spending on resume, looking for work. computer equipment continued to rise Industrial production increased for a rapidly in the first quarter, and outlays third straight month in March after the for communications equipment generlengthy decline from its June 2000 peak. ally stabilized after a large and lengthy In the manufacturing sector, output in decline. By contrast, business purchases the first quarter retraced a little more of both motor vehicles and aircraft Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

192 89th Annual Report, 2002 slowed sharply. In the nonresidential early months of the year. The Canadian construction sector, investment slumped economy appeared to have expanded in office buildings, industrial structures, robustly in the first quarter, and ecolodging facilities, and in drilling and nomic activity in Europe evidently had mining. Moreover, available informa- turned upward. By contrast, available tion indicated that this sector would indicators suggested that the Japanese remain depressed: Vacancy rates for economy was still contracting, though at office and industrial buildings continued a less rapid rate. to rise, with deterioration in the office Although higher energy prices continsector especially pronounced in areas ued to push up headline consumer price dominated by high-tech firms, and prop- inflation in March, inflation had moved erty values and rents for retail space and downward over the past twelve months. warehouses weakened. Both the overall consumer price index The pace of liquidation of manufac- (CPI) and the personal consumption turing and trade inventories slowed expenditure (PCE) chain-linked index sharply in January and February after a decelerated significantly over the past notably large contraction in the fourth year. Moreover, excluding their volatile quarter, and the aggregate inventory- food and energy components, both measales ratio declined a bit further. Stocks sures of inflation also fell over the past of manufacturers continued to fall year. At the producer level, prices for through March (latest data). Whole- finished goods echoed the pattern of salers also continued to reduce their consumer prices: Both total and core inventories during January and February finished goods inflation decelerated on a (latest data), and the sector's inventory- year-over-year basis. Labor cost growth, sales ratio dropped further. At the retail as measured by hourly compensation in level, stocks jumped in January and Feb- private industry, also appeared to have ruary, but almost all of the increase slowed a bit over the latest twelveoccurred at automotive dealers. The month period. inventory-sales ratio for retail trade At its meeting on March 19, 2002, edged up over the two months but was the Committee adopted a directive that still at a relatively low level. called for maintaining conditions in The U.S. trade deficit in goods and reserve markets consistent with keeping services widened in January and Feb- the intended level of the federal funds ruary, reflecting a considerably larger rate at VA percent. With the economy expansion in the value of imports than expanding at a significant pace, the in that of exports. The rise in imports Committee now saw the risks to achievrelated in part to the royalties and ing its long-term goals as balanced. license fees paid to the International Members noted that the impetus for Olympics Committee for the rights to the economic advance was to a large broadcast the Winter Olympic Games. extent a temporary swing in inventory With regard to economic activity investment rather than a clear and subabroad, the available information indi- stantial upswing in final demand. As cated that, on balance, foreign economic a result, the outlook for the economy output had rebounded in the first quar- remained somewhat uncertain, and the ter. The economies of the technology- current accommodative stance of policy sensitive Asian countries had already continued to be viewed as appropriturned up in the fourth quarter and ate. The members contemplated, howseemed to have grown rapidly in the ever, that the stance of monetary policy Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 193 would have to become less accommo- market funds to stock and bond mutual dative once clearer evidence emerged funds. Reduced demand for mortgage that a healthy expansion was firmly refinancing and lower nonwithheld fedestablished. eral payments also contributed impor- The federal funds rate remained close tantly to the weakness in the broad to the Committee's target level of monetary aggregates. PA percent during the intermeeting The staff forecast prepared for this period. However, doubts about the meeting suggested that the expansion in strength of the recovery owing to the economic activity was slowing substantone of the Committee's press statement tially in the current quarter but would along with mixed incoming data on final pick up in the second half of the year demand, announcements of weaker- and continue at a moderate pace next than-expected corporate earnings, and year. An emerging shift by businesses heightening tensions in the Middle East from inventory liquidation to some prompted declines in yields on short- replenishment of stocks would help to intermediate-term Treasury securi- boost activity over the next several ties. Yields on investment-grade bonds quarters, but the ongoing recovery tended to edge higher, however, in the would depend increasingly on growth in wake of concerns about the transpar- spending by households and businesses. ency of the accounting statements of Such spending would be fostered by some firms. Most major indexes of the monetary ease and fiscal stimulus equity prices moved down sharply in already in place and abetted by vigorous response to the outlook for a weaker anticipated growth in structural proeconomic recovery and the adverse ductivity, which would support houseimplications for corporate profits of hold incomes and business investment economic and other developments. incentives. With a relatively robust In foreign exchange markets, the contour for the course of final sales over trade-weighted value of the dollar in the forecast horizon, the pressure on terms of the major foreign currencies resources would rise somewhat despite eased somewhat over the intermeeting the anticipated higher growth of strucperiod. Much of the dollar's decline tural productivity. Nonetheless, activity occurred late in the period in response to would remain below the economy's the mixed character of U.S. economic potential for a period ahead and the perdata and relatively small declines in sistence of underutilized resources was benchmark longer-term yields abroad. expected to contribute to damped core The dollar rose slightly on average in consumer price inflation. terms of an index of the currencies of In the Committee's discussion of curother important trading partners, in part rent and prospective economic develbecause of the further depreciation of opments, members commented that the Argentine peso. recently available statistical data and M2 and M3 contracted in March and anecdotal reports suggested that the April. The declines evidently reflected expansion in business activity was conin part the rising opportunity costs of tinuing. However, it had slowed considholding M2 assets as yields on the erably from its pace earlier in the year components of M2 declined in lagged when it had received substantial impetus response to the earlier easing of mone- from a marked slowing in the runoff of tary policy and fostered transfers out of inventories. How much final demand M2 funds, especially from retail money would strengthen going forward was Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

194 89th Annual Report, 2002 still uncertain. A pause in the expansion entrenched economic expansion. Howwas not an unusual development during ever, the pickup likely would be limited the early stages of a cyclical recovery, inasmuch as household spending had and the members generally viewed a remained elevated through the period of pickup in growth as a reasonable expec- economic weakness. Members comtation. The currently stimulative stance mented that such an outlook was subof both fiscal and monetary policy ject to uncertainties in both directions. would tend to undergird final demand, On the upside, faster-than-anticipated especially in the context of an econ- growth could well materialize in an omy that had exhibited a marked degree environment of monetary and fiscal polof resilience and strength in underly- icy ease and of gradually firming labor ing productivity growth that would markets and rising productivity that bolster household incomes and provide would be boosting income growth. On incentives for business capital spend- the other hand, employment growth had ing. Members noted, however, that an been very sluggish to date, with employalready high level of consumer spending ers remaining quite cautious in their hirpointed to more limited than usual scope ing practices, and continued softness for further growth in such spending, and in labor markets could damp consumer gloomy business sentiment in the face confidence. The run-up in energy prices of disappointing sales and profits raised also was a negative for household pura question about the extent to which chasing power. business investment would help to lift Household expenditures on new final demand over coming quarters. homes were likewise at an elevated Given growth in economic activity level, although members reported weakbroadly in line with current expecta- ness in some price segments and geotions, inflation was likely to remain graphic areas of the housing market. In benign for some time in the context of general, however, housing displayed an apparently strong uptrend in struc- ongoing strength in response to low tural labor productivity, excess capacity mortgage rates, with rising prices in in many labor and product markets, and many areas, and the downside risks to a related absence of pricing power in this sector of the economy appeared generally very competitive markets. to be limited. At the same time, mem- In their review of developments and bers anticipated that growth, if any, prospects in key expenditure sectors of in homebuilding activity would be subthe economy, members commented that dued over the next several quarters after household spending had continued to an extended period of strong expansion. be well maintained. In the consumer The members generally viewed busiarea, recent anecdotal reports provided ness fixed investment as the key sector a somewhat mixed, but on the whole that would determine the strength of the positive, picture of consumer spending expansion. Such investment had conacross the nation. Sales of motor vehi- tracted further in the first quarter, but cles had moderated after a surge during the decline was the smallest in a year. the closing months of 2001, but they Looking ahead, the members anticipated remained relatively high and other con- a sluggish and delayed upturn in capisumer outlays had continued to increase. tal expenditures in the next few quar- Looking ahead, some growth in overall ters against the backdrop of persistently consumer spending appeared likely in gloomy business sentiment and large association with the now more firmly margins of excess capacity in numerous Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 195 industries. Many business contacts com- closer alignment with sales, members mented on their unwillingness to expand anticipated much less impetus to overall capacity until they saw persuasive evi- economic activity from inventories over dence of growing sales and profits. coming quarters. Accordingly, much of their current Recent and immediately prospective investment spending was focused on legislation had increased the fiscal cost-saving equipment and software in stimulus in the federal budget, and an effort to bolster profits in a stable members commented that the current price environment that made it diffi- dynamics of the budget process could cult to pass on rising costs. The recent result in larger increases in government passage of temporary legislation that spending than foreseen in recent budget permitted a partial acceleration of tax estimates. In this regard some expressed expensing was expected to provide some concern about the longer-term impliimpetus to capital investments, but the cations of what they saw as a decline legislation appeared to have had little in fiscal discipline. At the state and effect thus far. With regard to the out- local government levels, however, detelook for nonresidential construction, riorating fiscal positions in 2001 had members saw little prospect of any impelled many states and localities to material increase in such construction curb spending and raise various taxes over the next several quarters, given and fees. widespread anecdotal and statistical Although foreign economic activity reports of high vacancy rates and excess appeared to be picking up to some capacity. extent and the dollar had edged lower, The markedly reduced pace of inven- net exports were expected to remain a tory liquidation in the first quarter of the negative factor in the growth of the year accounted for much of the step-up domestic economy. Members cited in GDP growth in that quarter and pro- anecdotal reports that tended to support vided a strong indication that the period statistical evidence of strengthening of inventory liquidation under way for economies in Europe and a number of more than a year probably was coming developing Asian nations. Nonetheto an end. Indeed, anecdotal reports sug- less, given a recovery in U.S. domestic gested that efforts to rebuild inventories demand approximating their current were now being undertaken in a number forecasts, growth in imports likely of industries, such as steel and motor would exceed that of exports by a wide vehicles, and one regional survey indi- margin over the forecast horizon. cated that businesses planned to accu- The outlook for inflation remained mulate inventories over the next six favorable. Nearly all measures of total months. However, businesses remained and core prices had decelerated over quite cautious about the outlook for the past year, and in the context of foresales, and many firms might also be in casts implying a continued sizable gap the process of adapting to much reduced between actual and potential output, levels of inventories in relation to sales the risk that inflationary pressures would rather than restoring earlier inventory- intensify significantly over coming sales ratios. A shift to inventory stock- quarters appeared to be quite limited; ing in the near term, possibly in the indeed, inflation might edge a bit lower current quarter, was seen as a reasonable in the early stages of the expansion. The expectation, but with numerous firms deceleration in labor costs over the having already moved production into past several quarters, evidence of a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

196 89th Annual Report, 2002 surprisingly strong uptrend in structural ing developments and tighten policy as labor productivity, low and stable infla- needed later. tion expectations, and the widespread All the members favored the retention absence of pricing power in highly of a neutral balance of risks statement to competitive markets were signs that be released shortly after this meeting. upside inflation risks in the period ahead Against the longer-term inflation risks were relatively small. The members inherent in the current stance of policy, recognized nonetheless that there were the members weighed the possibility upward pressures on costs in a num- that the expansion could be relatively ber of areas. These included signifi- subdued for a time, damping prices cant increases in energy costs in further and failing to reduce margins of recent months, evidence of an upturn in underutilized resources. In any event, a some industrial prices, sharp increases neutral statement regarding the risks to in many insurance costs, continuing the economy in the foreseeable future upward pressures on medical costs, and would not preclude a preemptive tightmodest recent declines in the foreign ening adjustment in the stance of policy exchange value of the dollar. With the stance should new evidence bearing on stance of monetary policy currently the strength of the expansion and the quite accommodative, the members outlook for inflation warrant such a polsaw the need for careful monitoring of icy move. the potential for rising inflation pres- At the conclusion of the discussion, sures as the economic recovery gained the Committee voted to authorize and momentum. direct the Federal Reserve Bank of New In the Committee's discussion of pol- York, until it was instructed otherwise, icy for the intermeeting period ahead, to execute transactions in the System all the members agreed on the desirabil- Account in accordance with the followity of maintaining an unchanged policy ing domestic policy directive. stance, with the target federal funds rate staying at 13A percent. The economic The Federal Open Market Committee recovery was clearly continuing, but seeks monetary and financial conditions that its rate of advance had moderated con- will foster price stability and promote sussiderably and the economy's future tainable growth in output. To further its longrun objectives, the Committee in the immecourse was subject to a marked degree diate future seeks conditions in reserve of uncertainty. While the longer-term markets consistent with maintaining the outlook for a strengthening economy federal funds rate at an average of around remained favorable, a firming of policy P/4 percent. at this time would be premature and would incur an undue risk to a healthy The vote encompassed approval of expansion. The members recognized the sentence below for inclusion in the that monetary policy exerted its effects press statement to be released shortly with a considerable lag and that the after the meeting: current stance of policy probably was inconsistent with the Committee's inflation objective over time. However, cur- Against the background of its long-run goals of price stability and sustainable ecorent inflation pressures were subdued nomic growth and of the information curand were expected to remain so for a rently available, the Committee believes that considerable period, thereby providing the risks are balanced with respect to prosadequate opportunity to evaluate ongo- pects for both goals in the foreseeable future. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 197 Votes for this action: Messrs. Greenspan, Mr. Reinhart, Economist McDonough, Ms. Bies, Messrs. Ferguson, Mr. Stockton, Economist Gramlich, Jordan, McTeer, Olson, Santomero, and Stern. Votes against this Mr. Connors, Ms. Cumming, action: None. Messrs. Howard and Lindsey, Ms. Mester, Messrs. Oliner, It was agreed that the next meeting Rolnick, Rosenblum, Sniderman, of the Committee would be held on and Wilcox, Associate Economists Tuesday-Wednesday, June 25-26,2002. Mr. Kos, Manager, System Open The meeting adjourned at 12:15 p.m. Market Account Donald L. Kohn Messrs. Ettin and Madigan, Deputy Secretary Directors, Divisions of Research and Statistics and Monetary Affairs respectively, Board Meeting Held on of Governors June 25-26, 2002 Messrs. Slifman and Struckmeyer, A meeting of the Federal Open Market Associate Directors, Division Committee was held in the offices of of Research and Statistics, Board of Governors the Board of Governors of the Federal Reserve System in Washington, D.C., Messrs. Freeman5 and Whitesell, on Tuesday, June 25, 2002, at 2:30 p.m. Deputy Associate Directors, and continued on Wednesday, June 26, Divisions of International Finance 2002, at 9:00 a.m. and Monetary Affairs respectively, Board of Governors Present: Mr. Greenspan, Chairman Mr. English, Assistant Director, Mr. McDonough, Vice Chairman Division of Monetary Affairs, Ms. Bies Board of Governors Mr. Ferguson Mr. Gramlich Messrs. ReifSchneider6 and Wascher,6 Mr. Jordan Assistant Directors, Division Mr. McTeer of Research and Statistics, Mr. Olson Board of Governors Mr. Santomero Mr. Stern Mr. Simpson, Senior Adviser, Division of Research and Statistics, Messrs. Broaddus, Moskow, and Parry, Board of Governors Alternate Members of the Federal Open Market Committee Mr. Bray ton,6 Ms. Dynan,5 Messrs. Lebow6 and Roberts,6 Mr. Hoenig, Ms. Minehan, and Senior Economists, Division Mr. Poole, Presidents of the of Research and Statistics, Federal Reserve Banks of Board of Governors Kansas City, Boston, and St. Louis respectively Mr. Bomfim,5 Senior Economist, Division of Monetary Affairs, Mr. Kohn, Secretary and Economist Board of Governors Mr. Bernard, Deputy Secretary Mr. Gillum, Assistant Secretary 5. Attended portion of meeting relating to the Ms. Smith, Assistant Secretary discussion of economic developments. Mr. Mattingly, General Counsel 6. Attended portion of meeting relating to a Ms. Johnson, Economist special agenda discussion of inflation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

198 89th Annual Report, 2002 Mr. Skidmore, Special Assistant to The Committee then turned to a disthe Board, Office of Board cussion of the economic and financial Members, Board of Governors outlook and the conduct of monetary policy over the intermeeting period Ms. Low, Open Market Secretariat ahead. Assistant, Office of Board The information reviewed at this Members, Board of Governors meeting indicated that economic activity continued to expand in recent Mr. Barron, First Vice President, months, though at a slower pace than Federal Reserve Bank of Atlanta earlier in the year. Consumer purchases, residential housing outlays, and govern- Messrs. Eisenbeis, Fuhrer, Goodfriend, ment spending recorded smaller gains, Hakkio, Hunter, Judd, but business investment in durable Ms. Krieger, and Mr. Rasche, equipment and software appeared to be Senior Vice Presidents, Federal Reserve Banks of Atlanta, Boston, leveling out after a long decline. Indus- Richmond, Kansas City, Chicago, trial production continued to pick up. San Francisco, New York, and Employment had risen a little, but not St. Louis respectively enough to lower the unemployment rate, and labor productivity seemed to By unanimous vote, the minutes of be trending sharply upward. The surge the meeting of the Federal Open Market in energy prices this year had boosted Committee held on May 7, 2002, were headline inflation, but core measures of approved. inflation had trended lower. The Manager of the System Open Private nonfarm payroll employment Market Account reported on recent edged up in April and May after a slowdevelopments in foreign exchange mar- down in the first quarter in the pace of kets. There were no open market oper- layoffs and job separations. Hiring was ations in foreign currencies for the relatively brisk in the services sector in System's account in the period since the the April-May period, with most of the previous meeting. advances occurring in the temporary- The Manager also reported on recent help industry. Manufacturing payrolls developments in domestic financial recorded small declines in both months, markets and on System open market while the number of jobs in construction transactions in government securities steadied in May after a large drop in and securities issued or fully guaranteed April. The civilian unemployment rate by federal agencies during the period moved down somewhat, to 5.8 percent May 7, 2002, through June 24, 2002. By in May, but the average rate for the unanimous vote, the Committee ratified April-May period remained above the these transactions. level in the two previous quarters. The Committee voted unanimously to Industrial production rose for a fifth update its longstanding authorization straight month in May. In manufacturfor the Federal Reserve Bank of New ing, output increases in April and May York to enter into agreements that would continued to be spread widely across enable another Federal Reserve Bank to market groups and industries. The highconduct System open market operations tech sector, notably computers and semion a temporary basis in an emergency conductors, and the motor vehicles and after designation by the Committee or parts sector remained strong, while the the Chairman. telecommunications and aircraft indus- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 199 tries weakened further. Capacity utiliza- tion of retail space, warehouses, and tion in manufacturing in May was a institutional structures picked up. little above its depressed level at year- Liquidation of manufacturing and end, but substantially below its long-run trade inventories continued in April average. at about the pace of the first quarter, Growth of consumer spending slowed and the aggregate inventory-sales ratio appreciably in April and May from the declined further. In manufacturing, the brisk pace of the first quarter. Retail rate of liquidation slowed substantially, sales slumped in May after a sizable and the aggregate stock-shipments ratio rise in April, largely reflecting weaker for the sector was at a very low level. spending at apparel stores and general Wholesalers ran down their inventories merchandise outlets and an apparent in April at a somewhat faster rate than in pause in purchases of light motor vehi- the first quarter; the sector's inventorycles after an April surge. Real outlays sales ratio fell sharply further to a relaon services in April (latest data) were tively low level. Retailers boosted their unchanged. stocks slightly in April, with all of the Residential housing activity remained increase occurring at automotive dealelevated during April and May. Hous- ers. The sector's aggregate inventorying starts jumped in May after a small sales ratio edged up in April but decline in April. The strength in starts remained relatively low. over the two months evidently reflected The U.S. trade deficit in goods and the persistence of very positive home- services widened somewhat in April buying attitudes arising at least in part from both the March and the firstfrom low mortgage rates. In May, sales quarter levels, as the value of imports of new single-family homes established increased significantly more than that of a new record high, and sales of existing exports. The rise in imports from March single-family homes were only slightly to April reflected higher prices for below the peak reached in the first imported oil along with greater demand quarter. for a wide range of goods. The monthly The decline in business outlays for step-up in exports was also broadly durable equipment and software had spread across categories of goods. With moderated further in the first quarter, regard to economic activity abroad, the and the available information suggested available information indicated that, on that spending on equipment and soft- balance, foreign economic output had ware was turning upward in the second rebounded in the first half of the year, quarter. Shipments of nondefense capi- though the pace of recovery was uneven tal goods other than aircraft rose in April across regions and countries. Australia, and May; shipments of computers and Canada, and emerging Asia had experiperipherals remained strong, shipments enced strong growth; the euro area also of communications equipment were still was expanding, but at a slower rate; and weak, and shipments of other durable Japan appeared to have experienced a goods continued to advance. In the limited upturn in its economy. In South nonresidential construction sector, out- America, Brazil's economy was expandlays for office and industrial structures, ing but its financial markets had come lodging facilities, and public utilities under considerable stress, and elsewhere declined substantially. In addition, on the continent economic activity was expenditures for drilling and mining generally weak, particularly in Argencontinued to drop. By contrast, construc- tina and Venezuela. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

200 89th Annual Report, 2002 Both the consumer price index and dropped somewhat over the intermeetthe personal consumption expenditure ing period. The dollar's decline against chain-linked index indicated that con- the major foreign currencies occurred as sumer price inflation was moderate questions about the strength of U.S. ecoduring the April-May period. Moreover, nomic recovery and corporate earnings both measures showed that core price and the related lowering of expectations inflation during the first five months for near-term monetary tightening led to of the year had been a bit lower than in concerns that net foreign capital inflows 2001. At the producer level, prices for might not be consistent with a stable core finished goods changed little over exchange value for the dollar in the con- April and May and decelerated on a text of growing U.S. net international year-over-year basis. Labor costs, as indebtedness. By contrast, the dollar measured by the average hourly earn- rose slightly on average in terms of an ings of production or nonsupervisory index of the currencies of other imporworkers, also decelerated. tant trading partners, notably the curren- At its meeting on May 7, 2002, the cies of several Latin American countries Committee adopted a directive that that were experiencing political and ecocalled for maintaining conditions in nomic problems. reserve markets consistent with keeping Growth of the broad monetary aggrethe intended level of the federal funds gates picked up in May owing to the rate at 13A percent, and it also retained a unwinding of distortions from final tax neutral balance of risks statement. The payments and, apparently, to falling Committee's press statement, with its equity prices. The heightened volatility language indicating that the Commit- of equity markets may have enhanced tee remained uncertain about the extent the attractiveness of safe and liquid M2 and timing of the strengthening of final assets, including liquid deposits and demand, was viewed by market par- retail money market funds. ticipants as expressing less confidence The staff forecast prepared for this in the strength of the recovery than had meeting suggested that the expansion of been expected, and yields on Treasury economic activity would pick up in the securities declined slightly in response. last half of the year from the sluggish Subsequently, investors became more pace of the second quarter and reach risk averse in reaction to a mixture of a relatively brisk pace next year. The economic data releases, growing geo- considerable monetary ease and fiscal political tensions, further warnings stimulus already in place and the conabout terrorism, and additional revela- tinuing sizable gains in productivity tions regarding questionable corporate would provide significant impetus for accounting practices. Yields on Trea- spending, though weakness in equity sury securities dropped somewhat on net prices would tend to offset some of that over the period, rates on lower-quality support. With business capital stocks bonds rose, and equity prices fell moving closer to desired levels, investsharply further. The federal funds rate ment spending would be boosted by a remained close to the Committee's tar- gradually improving outlook for sales get level of P/4 percent during the inter- and profits, low financing costs, and the meeting period. temporary federal tax incentive for In foreign exchange markets, the investment in new equipment and softtrade-weighted value of the dollar in ware. A more robust contour for final terms of the major foreign currencies sales over the forecast horizon would Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 201 lead to somewhat greater pressure on and spending and encourage a pickup resource margins, despite the expected in business investment. The strength strong growth of structural productiv- in productivity also would help to ity, though the level of activity would hold down cost and price pressures remain below the economy's poten- and, given an economic expansion and tial for some time. The persistence of resource utilization in line with the underutilized resources was expected to members' forecasts, would reinforce the foster some moderation in core price prospect that core price inflation would inflation. remain low. In the Committee's discussion of cur- In preparation for the midyear monerent and prospective economic condi- tary policy report to Congress, the memtions, members commented that there bers of the Board of Governors and the had been little change since the May presidents of the Federal Reserve Banks meeting in the factors bearing on what submitted individual projections of the they viewed as a favorable outlook for growth of GDP, the rate of unemploya pickup in the expansion. Although ment, and the rate of inflation for the financial markets, and perhaps busi- years 2002 and 2003. The forecasts of ness and household confidence, had the rate of expansion in real GDP had been shaken by revelations of account- central tendencies of V/i to 33/4 percent ing irregularities, the economy had for 2002, implying growth in the second continued to expand and the prospects half of the year at a rate close to that for accelerating aggregate demand currently estimated for the first half, and remained positive. Some members 3V2 to 4 percent for 2003. These rates of observed, however, that they had growth were expected to keep the civilexpected to see firmer indications of a ian rate of unemployment in a central strengthening recovery by the time of tendency of 53/4 to 6 percent in the this meeting. The degree of impetus fourth quarter of 2002 before it fell to from decelerating inventory liquidation 5V4 to 5!/2 percent by the fourth quarter and growth in final demand had moder- of 2003. Forecasts of the rate of inflaated during the spring, and anecdotal tion, as measured by the chain-type and other evidence indicated that the price index for personal consumption performance of various industries and expenditures, pointed to little change firms had remained uneven. Looking from recent inflation levels and were ahead, the timing and strength of an centered on a range of VA to \3A perupturn in the expansion remained sub- cent for both this year and 2003. ject to considerable uncertainty, but With imbalances in inventories apparin the absence of major further adverse ently largely worked off and the conshocks to confidence the members tribution of inventory investment to the anticipated that economic activity would expansion likely diminishing in coming accelerate over coming months to a quarters, final demand would play its pace in the vicinity of, and perhaps usual primary role in determining the somewhat above, the rate of growth strength of the expansion. In that regard, of the economy's potential. In support consumer spending was seen as likely to of this view, members cited the accom- provide some continuing, though modmodative stance of both fiscal and erate, impetus to the growth of the econmonetary policy and the continuation omy. A favorable factor in this outlook of impressive growth in productivity cited by members was the ability and that should buttress household incomes willingness of households to extract siz- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

202 89th Annual Report, 2002 able financing resources for consumer likely to provide much added stimulus and other expenditures by drawing on to the expansion. the appreciated equity in their homes A pickup in business spending was in one form or another. The ample avail- viewed as a key to sustained solid ability of credit to most consumers growth, and questions about the timwas another positive factor. Although ing and strength of such a pickup was consumer confidence as measured by a major source of uncertainty about national surveys recently had declined the pace of the expansion in coming somewhat from relatively elevated lev- quarters. The preconditions for a els, reports of strength in motor vehicle robust advance in investment spending sales and in other retail sales in several appeared to be largely in place, includparts of the nation in recent weeks sug- ing the evident progress over the past gested that consumer spending was con- several quarters in adjusting capital tinuing to be well maintained. The mem- stocks to desired levels, the temporary bers recognized that a typical recovery- tax incentive, and the need for competiperiod surge in consumer spending was tive reasons to take advantage of the unlikely inasmuch as expenditures had availability of increasingly productive registered solid growth through the eco- equipment. In fact, recent orders and nomic downturn, implying an absence shipments data suggested an upturn in of significant pent-up demands. More- spending for new equipment, but the over, forecasts of even moderate growth improvement was still quite limited, in spending were subject to downside unevenly distributed across industries, risks emanating, for example, from pos- and not yet firmly indicative of a sussible further shocks to confidence and tained advance. While the members household wealth should weakness in expected further gains in spending on stock prices persist, and from political equipment, they continued to report turmoil overseas and threats of terrorism widespread pessimism among their busiat home. ness contacts, though exceptions had Homebuilding, though down after an begun to emerge, and the persistence of unsustainable surge earlier in the year, a high degree of caution that was leadhad been well maintained in recent ing business executives to defer numermonths. Recent statistics supported by ous investment projects until they saw widespread anecdotal reports pointed to more conclusive evidence of stronger persisting strength in housing activity, sales and profits. though there were indications of soft- The outlook for nonresidential conness in high-priced homes in at least struction activity remained bleak amid some parts of the country. Looking for- indications of a widespread overhang of ward, members expected a high level available space and attendant declines in of home construction to continue. A rents and property values. Indeed, the key factor in this outlook was the ready drop in such construction did not appear availability of mortgage financing to to have run its course for the nation as a most borrowers at very attractive rates. whole. Even so, the ongoing adjustment Members also referred to growing of nonresidential capacity to demand population pressures, abetted by sizable had been substantial in recent quarters immigration, on increasingly scarce and likely would give way to a modest buildable land in numerous areas. On recovery during the year ahead. balance, however, given its already For the economy as a whole, the liquirobust level, housing was not seen as dation of business inventories appeared Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 203 to be near completion in the current important trading partners. Indeed, quarter, and some rebuilding in associa- members provided anecdotal reports of tion with forecasts of moderate expan- better export markets for a number of sion in sales seemed a likely prospect U.S. products. At the same time, howfor coming quarters. The restocking was ever, severe problems being experienced expected to proceed gradually, given the by a number of large countries in South probable persistence of a relatively high America raised the specter of a deependegree of uncertainty and caution in the ing financial crisis within that region business community. Such an outlook and the possibility of more widespread implied that inventory investment would contagion. supply positive but limited impetus to Given their anticipation of strong prothe expansion over the forecast horizon. ductivity growth and continuing slack The federal tax cuts and large in labor and other markets, members increases in federal spending legislated expected inflation to remain low over over the past year were expected to the next several quarters. An underlying provide support for aggregate demand factor in the good inflation performance over the projection period. Some mem- of recent years and its extension into bers expressed concern, however, about the future was the continuing absence of what they perceived to be the erosion of pricing power throughout the economy, long-term fiscal discipline and increas- evidently related in part to increased ing prospects that federal deficits would price competition in markets around persist even after the economy recov- the world stemming from globalization. ered, with adverse effects on the domes- Members cited examples of rising prices tic savings available for investment. for a few products, notably steel, and the Concurrently, however, at the state and possibility that energy prices might raise local government level where budget costs. They also referred to the potential flexibility was more limited, sizable for upward pressure on prices associated budgetary shortfalls likely would hold with the recent depreciation of the doldown expenditures and induce some tax lar. Nonetheless, with rising productivincreases, with restraining effects over a ity and moderate wage gains likely conperiod of time. tinuing to help hold down unit labor With regard to the outlook for the costs, the outlook for subdued inflation external sector of the economy, the siz- remained promising, especially for the able decline in the foreign exchange nearer term. value of the dollar since the start of the The discussion of the inflation outyear had given rise to market forecasts look was held against the backdrop of of appreciable further depreciation. The an earlier consideration at this meetfactors that governed the exchange value ing of the factors behind the decline in of the dollar were complex, and histori- inflation in the 1990s and the value of cally forecasts of trends in exchange structural models for forecasting inflarates had not been reliable. To the extent tion. Most Committee members, while that the depreciation of the dollar was acknowledging the deficiencies of strucnot reversed or that it continued, it tural models, viewed them as useful in would of course tend to boost net their efforts to understand how the inflaexports. Exports would in any event be tion process was changing and also as likely to strengthen somewhat as a con- input to inflation forecasts. The memsequence of the evidently improving bers saw greater productivity growth, economies of a number of the nation's changing labor markets, and increased Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

204 89th Annual Report, 2002 competition in product markets as hav- still somewhat mixed. Still, in current ing played a part along with mone- circumstances, there was little risk of tary policy in lowering inflation. They triggering an increase in inflation by agreed that more research—across coun- waiting for a better reading on the tries as well as across time—was needed course of the economy. Some members before they could become more con- were concerned that markets might not fident about the value and stability of fully appreciate the inevitability of evensuch models. tual policy tightening. However, others In the Committee's discussion of pol- pointed out that market participants icy for the intermeeting period ahead, seemed to have little doubt about the all the members agreed that recent Committee's determination to keep developments argued for maintaining an inflation low and in that context markets unchanged policy stance, with the target were likely to anticipate Committee for the federal funds rate remaining at action once incoming information sugl3/4 percent. The members saw favor- gested it was becoming appropriate. able prospects for a significant accelera- The members said that they could see tion in the expansion from the reduced risks on both sides of their forecasts, pace in the current quarter, but consider- which indicated that growth would pick able uncertainty still surrounded the tim- up and inflation would remain low over ing and strength of the pickup. In the coming quarters at the current stance current situation, retention of the cur- of policy. Accordingly, they agreed to rently accommodative policy stance was retain an assessment of balanced risks to desirable to counter the lingering effects their long-term objectives in the Comof financial and other shocks to the mittee's post-meeting press release. economy that were continuing to exert Such a statement would not be an a depressing impact on output and impediment to adjusting policy should a resource use. Inflation was still edging significant and unanticipated change in down, inflation expectations appeared to economic conditions materialize in the be low and stable, and going forward near term. the members' forecasts for growth and At the conclusion of the discussion, productivity implied that unit costs and the Committee voted to authorize and prices would remain subdued for some direct the Federal Reserve Bank of New time. York, until it was instructed otherwise, A number of members noted that the to execute transactions in the System current policy stance was too accommo- Account in accordance with the followdative to be consistent over time with ing domestic policy directive. the Committee's objectives of price stability and maximum sustainable eco- The Federal Open Market Committee nomic growth. Economic performance seeks monetary and financial conditions that will foster price stability and promote susin line with their current forecasts would tainable growth in output. To further its longat some point require an adjustment run objectives, the Committee in the immeto policy toward a less accommodative diate future seeks conditions in reserve stance once more definitive indications markets consistent with maintaining the fedof sustained strengthening started to eral funds rate at an average of around emerge. And given the lags in monetary PA percent. policy such an adjustment would probably need to be made at a time when The vote encompassed approval of the incoming economic information was the sentence below for inclusion in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 205 press statement to be released shortly Mr. Hoenig, Ms. Minehan, and after the meeting: Mr. Poole, Presidents of the Federal Reserve Banks of Kansas City, Boston, and Against the background of its long-run St. Louis respectively goals of price stability and sustainable economic growth and of the information cur- Mr. Reinhart, Secretary and Economist rently available, the Committee believes that Mr. Bernard, Deputy Secretary the risks are balanced with respect to pros- Mr. Gillum, Assistant Secretary pects for both goals in the foreseeable future. Ms. Smith, Assistant Secretary Mr. Mattingly, General Counsel Votes for this action: Messrs. Greenspan, Ms. Johnson, Economist McDonough, Ms. Bies, Messrs. Ferguson, Mr. Stockton, Economist Gramlich, Jordan, McTeer, Olson, Santomero, and Stern. Votes against this Mr. Connors, Ms. Cumming, action: None. Messrs. Howard and Lindsey, Ms. Mester, Messrs. Oliner, It was agreed that the next meeting of Rolnick, and Wilcox, Associate the Committee would be held on Tues- Economists day, August 13, 2002. Mr. Kos, Manager, System Open The meeting adjourned on June 26, Market Account 2002, at 11:40 a.m. Mr. Winn, Assistant to the Board, Vincent R. Reinhart Office of Board Members, Secretary Board of Governors Messrs. Ettin and Madigan, Deputy Meeting Held on Directors, Divisions of Research August 13, 2002 and Statistics and Monetary Affairs respectively, Board A meeting of the Federal Open Market of Governors Committee was held in the offices of the Board of Governors of the Federal Messrs. Slifman and Struckmeyer, Reserve System in Washington, D.C., Associate Directors, Divisions of Research and Statistics, on Tuesday, August 13, 2002, at Board of Governors 9:00 a.m. Mr. Whitesell, Deputy Associate Present: Director, Division of Monetary Mr. Greenspan, Chairman Affairs, Board of Governors Mr. McDonough, Vice Chairman Mr. Bernanke Mr. Clouse, Assistant Director, Ms. Bies Division of Monetary Affairs, Mr. Ferguson Board of Governors Mr. Gramlich Mr. Jordan Mr. Simpson, Senior Adviser, Division Mr. Kohn of Research and Statistics, Mr. McTeer Board of Governors Mr. Olson Mr. Santomero Mr. Skidmore, Special Assistant Mr. Stern to the Board, Office of Board Members, Board of Governors Messrs. Broaddus, Guynn, Moskow, and Parry, Alternate Members Ms. Low, Open Market Secretariat of the Federal Open Market Assistant, Office of Board Committee Members, Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

206 89th Annual Report, 2002 Messrs. Connolly and Stewart, The information reviewed at this First Vice Presidents, Federal meeting indicated that economic activ- Reserve Banks of Boston and ity expanded only slightly in the second New York quarter. Businesses added a bit to their inventory positions after an extended Messrs. Goodfriend, Hakkio, Hunter, period of sizable declines, but final sales and Rasche, Senior Vice Presidents, Federal Reserve changed little: business capital spend- Banks of Richmond, Kansas City, ing weakened somewhat further while Chicago, and St. Louis growth in consumer spending, residenrespectively tial housing expenditures, and government outlays slowed. The scant infor- Messrs. Bryan, Cox, and Cunningham, mation available for the third quarter, Ms. Hargraves, principally July's very strong motor Messrs. Rudebusch and Tootell, vehicle sales, suggested that domestic Vice Presidents, Federal Reserve Banks of Cleveland, Dallas, demand was still recovering but rela- Atlanta, New York, San Francisco, tively sluggishly. Industrial production and Boston respectively had continued to advance since the first quarter, but the demand for labor ser- By unanimous vote, the minutes of vices had increased only slightly and the the meeting of the Federal Open Market unemployment rate had risen. Impor- Committee held on June 25-26, 2002, tantly, labor productivity continued on were approved. a strong upward trend. Overall price By unanimous vote, Vincent R. Rein- inflation had fallen sharply over the past hart was elected as Secretary and Econ- year, largely reflecting developments in omist of the Committee for the period the food and energy sectors, and core until the first regularly scheduled meet- inflation had eased a little. ing in 2003. Private nonfarm payroll employment The Manager of the System Open inched up in July after a mild increase in Market Account reported on recent June, though aggregate hours worked by developments in foreign exchange mar- production or nonsupervisory workers kets. There were no open market opera- declined steeply. The help-supply portions in foreign currencies for the Sys- tion of the services sector and the contem's account in the period since the struction industry recorded substantial previous meeting. net job losses over the June-July period, The Manager also reported on devel- but manufacturing registered its smallopments in domestic financial markets est payroll decline in two years in July, and on System open market transactions and hiring was relatively brisk in serin government securities and securi- vices other than help-supply. The civilties issued or fully guaranteed by fed- ian unemployment rate edged up in eral agencies during the period June 26, June, to 5.9 percent, and was unchanged 2002, through August 12, 2002. By in July. unanimous vote, the Committee ratified Industrial production jumped in June, these transactions. and gains in output were widespread The Committee then turned to a dis- across market groups and industries. cussion of the economic and finan- However, the limited available inforcial outlook and the conduct of mone- mation indicated that output leveled out tary policy over the intermeeting period in July after six consecutive months of ahead. increases. Capacity utilization in manu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 207 facturing moved a little higher in June the nonresidential construction sector, but remained substantially below its outlays for office, industrial, and other long-run average. structures, lodging facilities, and public Retail sales were relatively brisk in utilities declined substantially further. June and July despite plunging equity By contrast, construction of institutional prices and an apparently marked ero- structures was up again in the second sion in consumer confidence. House- quarter. holds spent heavily on motor vehicles in Nonfarm inventory investment turned response to incentives offered by auto slightly positive in the second quarter manufacturers, and their expenditures on after several quarters of heavy liquidaother retail categories were generally tion. Success in pruning inventories had well maintained. resulted in inventory-sales ratios that Residential housing activity remained generally were at very low levels across strong in the second quarter, buoyed by the manufacturing, wholesale, and retail a very favorable mortgage financing sectors. There appeared to be only a few environment. The pace of homebuilding industries with still sizable inventory in the quarter continued well above that overhangs. seen during the past few years even The U.S. trade deficit in goods and though single-family housing starts in services widened further in May and for June did not reach the elevated May the April-May period. The expansion of level. Sales of new single-family homes the deficit over the two months reflected in June remained at a record high, but a sharp rise in the value of imports that sales of existing homes declined notice- exceeded a sizable gain in the value ably. In the multifamily sector, June of exports. The step-up in imports starts were in the lower end of their was spread widely across almost all range over recent quarters. Market con- the major trade categories, with notable ditions in the condominium and coop- increases in motor vehicles, consumer erative apartment portion of the housing goods, and machinery. The advance in sector appeared to be favorable, but exports was primarily in automotive rising vacancy rates and weaker rents parts, industrial supplies, and capital apparently hindered the rental apartment equipment. With regard to economic segment. activity abroad, the available informa- Business investment in equipment tion, which is released in many cases and structures declined further in the only with a considerable lag, indicated second quarter as the continuing down- that foreign economic output generally draft in nonresidential construction more continued to rebound during the first than offset a pickup in business spend- half of the year, though the pace of ing for durable equipment and soft- recovery was uneven across regions and ware. Despite gradually improving countries. Growth was strong in Canfundamentals—rising output and prof- ada, the United Kingdom, and emerging its, new tax incentives, and a low cost of Asia, but expansion in the euro area capital—firms remained cautious about and Japan remained sluggish, owing to stepping up their investments in equip- continued weakness in final domestic ment and software, and recent data on demand. In South America, economic orders and shipments of nondefense and financial conditions had deteriocapital goods coupled with anecdotal rated significantly during the intermeetreports suggested further lackluster ing period, especially in Brazil and Urugains in spending in coming months. In guay, and economic activity remained Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

208 89th Annual Report, 2002 particularly weak in Argentina and trading, as investors sought a safe haven Venezuela. for their funds and trimmed their expec- Consumer price inflation trended tations about the path for the intended down over the past year. Much of the federal funds rate in coming quarters. drop reflected developments in the However, doubts about corporate balfood and energy sectors, but core infla- ance sheets and the prospects for earntion also eased a little. In May and June, ings growth led to steep increases in both the consumer price and the chain- corporate debt yields, particularly for weighted personal consumption indexes lower-quality issues. exhibited little change in total and core In foreign exchange markets, the prices. Moreover, at the producer level, trade-weighted value of the dollar inflation in core finished goods was at a changed little on balance in terms of low rate in the May-June period and the the major foreign currencies over the past twelve months. With regard to labor intermeeting period, though early in costs, the employment cost index for the period the dollar declined sharply hourly compensation of private industry against those currencies amid further workers increased at a somewhat faster disclosures of U.S. corporate accounting rate during the three months ended in irregularities and concerns about the June, reflecting a surge in benefit costs. strength of the U.S. recovery. Against From a somewhat longer perspective, the background of a similar combination however, growth of compensation costs of disappointing concerns, European over the twelve months ended in June stock prices dropped more than those in was the same as in the previous twelve- the United States, while Japanese equity month period. prices declined less as incoming data At its meeting on June 25-26, 2002, seemed to point to a mild pickup of the Committee adopted a directive that economic activity in Japan. Across all called for maintaining conditions in the major industrial economies, invesreserve markets consistent with keeping tors tended to shift funds toward less the intended level of the federal funds risky instruments and to lower their rate at 13A percent, and it also retained a expectations for policy rates. The dollar neutral balance of risks statement. There also was little changed on balance was little market reaction to the Com- against the index of currencies of other mittee's rate decision or its statement. important trading partners, even though Instead, market participants focused several South American countries were their attention on further revelations experiencing difficult financial and of corporate malfeasance, fears that political problems. more earnings restatements would Borrowing by domestic nonfinanbe announced in the run-up to the cial businesses had been weak recently, August 14 deadline for certifying cor- likely reflecting deteriorating conditions porate financial statements, and con- in credit markets and reduced requirecerns that second-half corporate earn- ments for funds to finance capital spendings might prove disappointing. In this ing projects. Growth of M2 surged in environment, equity prices plunged July in association with large inflows to before recovering somewhat later in the liquid deposits and retail money market intermeeting period; on net, the major funds. broad equity indexes were down sub- The staff forecast prepared for this stantially. Yields on Treasury securities meeting suggested that, in light of also fell markedly on balance in volatile weaker-than-expected incoming eco- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 209 nomic data, the expansion of economic included the stimulative stances of fisactivity would pick up gradually over cal and monetary policy, the apparent the next year and a half from the very completion in most industries of efforts sluggish pace of the second quarter. The to bring inventories and capital facilities considerable monetary ease and fiscal into desired alignment with expected stimulus already in place and the con- sales, and the support to consumer tinuing sizable gains in structural pro- incomes and business incentives productivity would provide significant vided by the continued rise in structural impetus for spending, though the per- productivity. Further gains in productivsisting volatility and weakness in equity ity and the prospect for relatively conprices would tend to offset some of that tained demand pressures on resources, support. Inventory overhangs appeared which were likely to be somewhat more to have been largely eliminated and limited for a time than members had business capital stocks to have moved anticipated earlier, would contribute to closer to desired levels. As a conse- keeping price inflation subdued. quence, a gradually improving outlook A number of members commented on for sales and profits, low financing financial developments that appeared to costs, and the temporary federal tax be holding back the pace of the expanincentive for investment in new equip- sion. While prices in equity markets had ment and software were expected to turned up from their recent lows, the boost business investment spending. cumulative losses in financial wealth However, a less robust pickup in final incurred since early 2000 clearly were sales was now expected over the fore- having an adverse impact on expendicast period, which would put somewhat tures by households and the higher cost less pressure on resource margins than of equity capital was inhibiting busihad been anticipated previously, and the ness investment. The declines in equity level of activity would remain below prices had been accompanied by a the economy's potential for a somewhat heightened degree of risk aversion that longer time. The persistence of underuti- had led to widened credit spreads in lized resources was expected to foster financial markets and the curtailment some moderation in core price inflation. of credit availability to potential borrow- In the Committee's discussion of cur- ers whose repayment prospects were rent and prospective economic devel- viewed as questionable. To an extent opments, members commented that that was difficult to determine, the curmuch of the incoming information on rent skittishness in debt and equity mareconomic activity had been disappoint- kets reflected lender and investor reacing, and many indicated that they had tions to the ongoing revelations of marked down their growth forecasts for corporate governance failures. Those the months ahead. Even so, with recent reactions, which were proving to be weakness concentrated in volatile high- more severe and probably would be frequency data that might well prove to longer-lasting than many had anticibe transitory and with business and con- pated, appeared to be contributing to sumer confidence unlikely to deteriorate more cautious business spending and further in the absence of a major shock hiring, at least temporarily. It was to the economy, members continued to unclear when the associated uncertainplace favorable odds on an underlying ties would diminish and confidence outlook of strengthening expansion. would begin to rebuild, though the Factors cited for this positive outlook outlook might come into better focus Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

210 89th Annual Report, 2002 after the mid-August SEC deadline for sustaining homebuilding activity at a the certification of financial statements relatively elevated level. Housing marby corporate executives. On the posi- kets continued to exhibit strength across tive side, home mortgage financing much of the country, with few indicaremained widely available at low inter- tions of any moderation except for sales est rates and was providing important of high-priced homes. It was noted that, support to household spending. More in the absence of an unanticipated downgenerally, interest costs had declined for turn in general economic activity, underborrowers with acceptable credit rat- lying pressures for housing as the popings, and the overall condition of the ulation expanded coupled with the banking system remained sound with scarcity of viable homebuilding sites in bank credit widely available. Moreover, urban areas likely would preclude any for many households, the negative substantial decline in housing activity or wealth effects stemming from losses on housing prices in the foreseeable future. equities were offset, at least to some The weakness in business fixed extent, by continuing increases in home investment was still a depressant on equity values. These ongoing factors overall economic activity, though the suggested to some members that the decline in business outlays had abated effects of the financial restraints on eco- since the latter part of 2001; indeed, nomic activity might be fairly limited at spending for equipment and software this point. had edged up in the second quarter. With In their review of demand prospects excess stocks of capital inventories in key sectors of the economy, members seemingly worked down to more acceptnoted that household spending was con- able levels in many industries and with tinuing to play a key role in sustaining expansion in final sales expected to the expansion. Retail sales, buttressed become more firmly established, an by strength in motor vehicles, had been acceleration in spending for equipment well maintained in recent months and software was likely in store. As they despite survey evidence of declining had at earlier meetings, however, memconsumer confidence. The extraction of bers observed that business sentiment funds from increases in home equity remained extraordinarily cautious on the evidently remained an important source whole and that business firms in most of financing for household expenditures, industries continued to direct their especially including outlays for home investment spending primarily toward modernization. Looking ahead, the enhancing the productivity of their anticipated pickup in employment and operations rather than also increasing related gains in incomes, undergirded capacity. Exceptions cited by members by continued robust growth in structural included the enlargement of production productivity, was seen as supporting fur- facilities by some firms in industries ther expansion in consumer spending. that were currently enjoying vigorous Some members commented, however, demand, such as producers of motor that the declines in equity wealth and vehicles. How soon the gloom surroundthe possible persistence of turmoil in ing the outlook for a pickup in sales and equity markets might continue to profits and the associated concerns in restrain the pickup in consumer expen- financial markets would dissipate was ditures in the months ahead. subject to substantial uncertainty, but In the housing sector, low mortgage increasing needs for capital as the interest rates remained a key factor in economy continued to expand, further Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 211 growth in investment opportunities in growth in their expenditures. Anecdotal conjunction with the uptrend in struc- reports suggested, however, that sizable tural productivity, and the temporary tax spending on a variety of construction incentive provision for equipment and projects was continuing, financed in software likely would support a sus- part through bond issues. On balance, tained recovery in investment expendi- the government sector was expected to tures over coming quarters that would remain a positive factor in the economic provide essential impetus for lifting eco- recovery. nomic growth. The depreciation of the dollar and The prospects for an upturn in non- overall strengthening in foreign ecoresidential construction appeared to nomic activity were projected to foster many to be more bleak. Reports from moderate added growth in U.S. exports around the nation pointed to high, and over the next several quarters. However, in many areas still rising, vacancy rates recent developments, including indifor commercial and industrial space, and cations of weaker-than-projected ecohotel construction continued to be held nomic recovery in Europe, growing down by the problems afflicting the questions about the outlook for several travel industry. Against this backdrop, important economies in South America, overall nonresidential building activity and the continued sluggish performance seemed likely to decline further over the of the Japanese economy, threatened next several quarters. to limit the improvement in exports, at Business inventories edged up in the least over the nearer term. Providing a second quarter after declining persis- partial counterweight were anecdotal tently since early 2001. Indeed, the reports indicating sizable growth in U.S. strengthening was sufficient to account exports to a number of Asian countries. for the small advance in GDP in the The outlook for inflation remained latest quarter. With inventories now very favorable in the context of continuapparently close to desired levels in ing slack in labor markets and robust many sectors of the economy and report- growth in structural productivity. Under edly below such levels for some retail- these conditions, increases in trend unit ers, the expected strengthening in final labor costs were likely to remain subsales would probably foster some inven- dued over the next several quarters tory accumulation over coming quarters, despite likely further escalation in thereby adding impetus to the projected the cost of worker healthcare benegrowth of the economy. fits. Indeed, the risks of any significant Government spending also was run-up in inflation appeared to have expected to provide ongoing stimulus to receded, and more time than anticipated the expansion, especially given the pros- earlier was likely to elapse before the pects for further spending initiatives expansion reached a pace that would in forthcoming federal legislation. In begin to reduce margins of underutilized addition, already enacted income tax labor and other producer resources. cuts and the tax expensing provision for Even so, examples of rising cost and certain investment outlays would help price pressures were not entirely absent. to support both consumer and busi- In addition to healthcare insurance costs, ness expenditures. Concurrently, though, these pressures included insurance state and local governments facing large costs more generally, steel prices, some shortfalls in revenues in a sluggish econ- materials costs, and, in association with omy were holding down the overall the dollar's depreciation, some upward Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

212 89th Annual Report, 2002 pressures on import prices. On balance Committee was contemplating easing and barring a major supply shock to the in the near term. All the members economy, members saw little reason agreed, however, on the desirability for concern about the prospect of an of communicating in some form— increase in inflation in the foreseeable whether in the text of the post-meeting future. press release or through a shift in the In the Committee's discussion of pol- risks statement or both—their view icy for the intermeeting period ahead, that the expansion recently had been all the members were in favor of an less robust than expected and that unchanged policy stance consistent with for the foreseeable future the risks retaining a target rate of PA percent of a more extended period of subpar for the federal funds rate. Although growth had increased while those of some economic and financial indicators inflation had declined. Several also had deteriorated since the June meeting commented that while the shift under and the members generally had scaled consideration might raise expectations down their economic forecasts, they of some easing in coming months, those continued to see favorable prospects expectations and related market adjustfor a strengthening economy over time. ments would be shaped principally by To be sure, a further significant weak- the tenor of the incoming economic ening in economic prospects—for information. example, that might be associated with At the conclusion of the discussion, additional deterioration in financial the Committee voted to authorize and markets—might well call for a policy direct the Federal Reserve Bank of New response, but for now the members York, until it was instructed otherwise, viewed the current degree of monetary to execute transactions in the System accommodation as appropriately cali- Account in accordance with the followbrated to provide the stimulus needed ing domestic policy directive. to foster a solid expansion that would bring the economy to fuller resource The Federal Open Market Committee utilization. seeks monetary and financial conditions that All the members indicated that they will foster price stability and promote sustainable growth in output. To further its longcould accept, and most said they prerun objectives, the Committee in the immeferred, a proposal to shift the Com- diate future seeks conditions in reserve mittee's assessment of the risks to the markets consistent with maintaining the economy from the currently neutral federal funds rate at an average of around statement to one that was tilted toward VA percent. weakness in the foreseeable future. A few expressed a preference to retain the The vote encompassed approval of current balanced risks statement for the the sentence below for inclusion in the press release to be issued shortly after press statement to be released shortly this meeting. In support of this view, after the meeting: they underscored the considerable uncertainty surrounding the outlook for Against the background of its long-run financial and economic conditions and goals of price stability and sustainable ecothe prospect that many observers in nomic growth and of the information currently available, the Committee believes that financial markets could misread a shift the risks are weighted mainly toward condiin the Committee's assessment of the tions that may generate economic weakness risks to the outlook as a signal that the in the foreseeable future. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes ofFOMC Meetings, September 213 Votes for this action: Messrs. Greenspan, Mr. Baxter, Deputy General Counsel McDonough, Bernanke, Ms. Bies, Ms. Johnson, Economist Messrs. Ferguson, Gramlich, Jordan, Mr. Stockton, Economist Kohn, McTeer, Olson, Santomero, and Stern. Votes against this action: None. Messrs. Connors, Howard, and Lindsey, Ms. Mester, It was agreed that the next meeting of Messrs. Oliner, Rolnick, the Committee would be held on Tues- Rosenblum, Sniderman, and Wilcox, Associate Economists day, September 24, 2002. The meeting adjourned at 12:40 p.m. Mr. Kos, Manager, System Open Market Account Vincent R. Reinhart Secretary Messrs. Ettin and Madigan, Deputy Directors, Divisions of Research and Statistics and Monetary Meeting Held on Affairs respectively, Board September 24, 2002 of Governors A meeting of the Federal Open Market Messrs. Slifman and Struckmeyer, Committee was held in the offices of Associate Directors, Division the Board of Governors of the Federal of Research and Statistics, Board of Governors Reserve System in Washington, D.C., on Tuesday, September 24, 2002, at Mr. Whitesell, Deputy Associate 9:00 a.m. Director, Division of Monetary Affairs, Board of Governors Present: Mr. Greenspan, Chairman Mr. Clouse, Assistant Director, Mr. McDonough, Vice Chairman Division of Monetary Affairs, Mr. Bernanke Board of Governors Ms. Bies Mr. Ferguson Mr. Simpson, Senior Adviser, Division Mr. Gramlich of Research and Statistics, Mr. Jordan Board of Governors Mr. Kohn Mr. McTeer Mr. Skidmore, Special Assistant to the Mr. Olson Board, Office of Board Members, Mr. Santomero Board of Governors Mr. Stern Messrs. Broaddus, Guynn, Moskow, Ms. Low, Open Market Secretariat and Parry, Alternate Members Assistant, Division of Monetary of the Federal Open Market Affairs, Board of Governors Committee Mr. Moore, First Vice President, Mr. Hoenig, Ms. Minehan, and Federal Reserve Bank of Mr. Poole, Presidents of the San Francisco Federal Reserve Banks of Kansas City, Boston, and Messrs. Eisenbeis, Fuhrer, Hakkio, St. Louis respectively Judd, Lacker, and Steindel, Senior Vice Presidents, Federal Reserve Mr. Reinhart, Secretary and Economist Banks of Atlanta, Boston, Mr. Bernard, Deputy Secretary Kansas City, San Francisco, Mr. Gillum, Assistant Secretary Richmond, and New York Mr. Mattingly, General Counsel respectively Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

214 89th Annual Report, 2002 Messrs. Coughlin, Elsasser, and Aggregate labor market conditions Sullivan, Vice Presidents, Federal had been mixed in recent months. While Reserve Banks of St. Louis, nonfarm payroll employment registered New York, and Chicago further small gains in July and August, respectively the aggregate hours worked by produc- By unanimous vote, the minutes of tion or nonsupervisory workers declined the meeting of the Federal Open Market on balance over the two-month period. Committee held on August 13, 2002, The manufacturing and retail trade secwere approved. tors registered sharp job losses in The Manager of the System Open August, but those were more than offset Market Account reported on recent by hiring in the services and construcdevelopments in foreign exchange mar- tion sectors. A hefty increase in governkets. There were no open market opera- ment jobs at the federal, state, and local tions in foreign currencies for the Sys- levels also boosted payroll employment. tem's account in the period since the The civilian unemployment rate fell to previous meeting. 5.7 percent in August despite advances The Manager also reported on devel- in claims for unemployment insurance. opments in domestic financial markets Industrial production declined in and on System open market transactions August, largely offsetting July's rise. in government securities and securi- Excluding motor vehicles, manufacturties issued or fully guaranteed by federal ing output was unchanged in both July agencies during the period August 13, and August after sizable advances in the 2002, through September 23, 2002. By first half of the year. Production in the unanimous vote, the Committee ratified high-tech sector jumped in August, these transactions. the manufacture of aircraft and parts fell The Committee then turned to a dis- further, and output in the remainder of cussion of the economic and financial the industrial sector was mixed. Capacoutlook and the conduct of monetary ity utilization in manufacturing changed policy over the intermeeting period little in August and was substantially ahead. below its long-run average. The information reviewed at this Retail sales remained relatively brisk meeting indicated that the economy in August despite further decreases in continued to expand in the third quarter, stock prices and consumer confidence. though the tenor of incoming reports Households boosted their already high was mixed. Data on household and busi- level of spending on motor vehicles in ness spending had been solid for the response to zero percent financing and most part, and residential construction larger cash incentives offered by auto remained high. Motor vehicle produc- manufacturers, and household purchases tion provided a sizable boost to eco- of goods other than motor vehicles connomic activity, but other factory out- tinued to advance at a moderate pace. put changed little on net. Employment According to the latest available data, continued to expand unevenly, while outlays for services rose moderately in labor productivity remained on a strong July. upward trend. Overall price inflation Residential housing activity slowed a had fallen over the past year, reflecting little in July and August from the robust favorable developments in the food and pace of the second quarter as further energy sectors and a decline in core declines in mortgage rates apparently inflation. helped to support housing activity in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 215 an environment of sluggish employment The smaller deficit in July reflected conand diminishing household wealth. tinued strong expansion of the value of Starts of single-family units fell in exports coupled with a decrease in the August to their lowest rate since last value of imports. The step-up in goods November, while starts in the multi- exports occurred mostly in motor vehifamily sector in the July-August period cles and aircraft, while the gain in were at their average rate for the first exports of services was spread across half of the year. Sales of new single- travel and other private services. The family homes posted a record high in decline in imports was concentrated in July, and the inventory of unsold new consumer and capital goods, royalties, homes remained low. Sales of existing and license fees. The very limited availsingle-family homes in July partially able information on economic activity retraced a large drop in June. abroad in the third quarter suggested Based on the limited information continued sluggish expansion in the euro available, business investment in equip- area and Japan, moderate growth in the ment and software seemed to be advanc- United Kingdom, further brisk recoving at a solid pace in the third quarter. ery in Canada, and ongoing recovery This reflected an acceleration in spend- in emerging Asia. Conditions in South ing that was associated importantly with America remained fragile: Economic notably stronger motor vehicle sales activity was still very weak in Argentina and a halt to the contraction in aircraft and Venezuela, and the Brazilian econexpenditures. Outside the transportation omy had been adversely affected by the sector, outlays on equipment continued turbulence in financial markets, though to expand at a moderate pace; in addi- those markets had stabilized recently. tion, the level of orders in July (latest By contrast, Mexico experienced brisk data) moved above shipments for the growth in the second quarter. first time since early last year, and Despite a slight pickup in consumer the backlog of unfilled orders edged price inflation in August, the increase up. Nonresidential construction activ- in consumer prices (measured by either ity remained on a steep downtrend in the consumer price index or the chain- July, with further reductions of spending indexed personal consumption expendiin all major categories except office ture index) for the year ending in August buildings. was considerably smaller than that The book value of manufacturing and for the previous twelve-month period. trade inventories excluding motor vehi- Much of the drop in inflation reflected cles registered a second straight monthly developments in the food and energy gain in July after many months of heavy sectors, but core inflation also declined liquidation. Despite die rise in stocks, noticeably. Producer prices for core fingains in sales and shipments drove ished goods likewise signaled a drop in inventory-sales ratios to even lower lev- inflation over the last year. With regard els across the manufacturing, wholesale, to labor costs, average hourly earnings and retail sectors. Survey and anecdotal of production or nonsupervisory workinformation suggested that few indus- ers decelerated sharply over the twelve tries were burdened with sizable inven- months ended in August, reflecting the tory overhangs. effects of both the rise in unemployment The U.S. trade deficit in goods and and the drop in consumer price inflation. services narrowed appreciably in July At its meeting on August 13, 2002, after two quarters of large increases. the Committee retained a directive that Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

216 89th Annual Report, 2002 called for maintaining conditions in in mortgage refinancing activity, and reserve markets consistent with keeping the safe haven provided from volatile the intended level of the federal funds equity prices. Borrowing by domestic rate at 13A percent, but it shifted from a nonfinancial businesses remained weak, statement of a neutral balance of risks likely reflecting reduced requirements to one that was tilted toward economic for funds to finance capital spending weakness in the foreseeable future. projects and perhaps the improved tone Market participants read the tilt and the in the corporate bond market and a modwording of the announcement as indicat- est increase in the issuance of corporate ing that economic activity in the coming debt. months likely would be weaker than had The staff forecast prepared for this been expected, and some short-term meeting suggested that, in light of interest rates eased slightly while broad weaker-than-expected incoming ecoindexes of equity prices moved lower. nomic data, the expansion of economic The following day's deadline for the activity would pick up more gradually recertification of corporate financial but would still reach a relatively brisk statements passed uneventfully and pace late next year. The considerable equity markets rallied. Subsequently, monetary ease and fiscal stimulus however, a weaker tone to incoming already in place, continuing gains in data on production and employment, a structural productivity, and improving gloomier outlook for business profits, business confidence would provide and heightening tensions over Iraq significant impetus for spending. Invenseemed to lead investors to revise down tory overhangs appeared to have been their outlook for the economy. Over the largely eliminated, and business capital intermeeting period, intermediate- and stocks appeared to have moved closer longer-term Treasury security yields and to desired levels. As a consequence, a broad equity indexes fell considerably gradually improving outlook for sales on balance. and profits, low financing costs, and In foreign exchange markets, the the temporary federal tax incentive for trade-weighted value of the dollar in investment in new equipment and softterms of the major foreign currencies ware were expected to boost business appreciated slightly on balance over the investment spending. However, a less intermeeting period as projections for robust pickup in final sales was now growth of foreign industrial countries, expected over the forecast period, which particularly Germany and Japan, were would put somewhat less pressure marked down more than those for the on resource margins than had been United States. The dollar moved within anticipated previously, and the level of narrow ranges against most major cur- activity would remain below that of rencies but rose somewhat against the the economy's potential for a longer yen and the currencies of other impor- time. The persistence of underutilized tant trading partners. resources was expected to foster some M2 growth remained elevated in moderation in core price inflation. August, though somewhat below July's In the Committee's discussion of currapid pace. Much of the strength of the rent and prospective economic condiaggregate's liquid components likely tions, members commented that ecowas associated with the continuing nomic growth appeared to have picked historically low opportunity costs of up in the third quarter but that the most holding such deposits, the recent surge recent information had been mixed, rais- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes ofFOMC Meetings, September 217 ing questions about whether the pace gains. Increasing home equity values of the expansion going forward would probably were also providing some be strong enough to erode margins counterweight to the impact on conof underutilized labor and capital sumer spending of the negative wealth resources. For now, a high degree of effects associated with the declines in business caution in the context of stock market prices since the spring substantial uncertainties, exacerbated of 2000. Other positive factors cited recently by apparently increased con- as helping to undergird the persisting cerns about the geopolitical outlook, strength in consumer spending included continued to restrain business invest- reductions in federal income tax rates; ment and hiring. Even so, the economy the availability of financing for conappeared to be well positioned for solid sumer durable goods at relatively attracgains over time in light of the prog- tive interest rates, including zero interress that had been made in bringing est rates for selected motor vehicles; and inventories and capital stocks into bet- the cumulative effects of productivity ter alignment with sales, the stimulus gains on current and expected real conprovided by accommodative fiscal and sumer incomes. Looking ahead, sales of monetary policies, and the implications motor vehicles likely would moderate to of the strong uptrend in productivity for some extent over coming months from profitable investment opportunities and their currently unsustainable levels, and growth in consumer incomes. With the some members referred to indications growth of economic activity nonetheless of slower growth in retail sales in late expected to remain below the econo- summer and somewhat downbeat foremy's potential for some time, pressures casts for coming months reported by a on labor and other resources would number of retailer contacts. Moreover, be limited and in turn wage and price the absence of significant growth in increases likely would continue to edge employment, should it persist, could lower. at some point have significant adverse In their review of developments in repercussions on consumer spending. and prospects for key sectors of the On balance, consumer spending was economy, members commented that seen as likely to remain a positive but household spending had continued to be possibly a more limited source of supwell maintained. Buttressed by excep- port for the expansion over the next tional strength in sales of motor vehi- several quarters. cles, consumer spending had displayed In the context of sustained growth solid growth during the summer months. in incomes, low mortgage interest rates, While survey indicators of consumer by facilitating the extraction of homeconfidence had declined this year, the owners' equity, had played a key role high levels of consumer spending on in inducing a high level of spending homes, motor vehicles, and other big- on residential structures and home ticket items were, in the view of at least improvement expenditures. Tending to some members, perhaps a better gauge confirm currently available data on of consumer confidence. The value of housing activity, members cited persisthomes had continued to rise in most ing anecdotal reports of robust home areas, and unusually low interest rates sales and residential construction in were inducing people to refinance mort- many regions, though indications of gages and in the process to extract and softening were noted in some areas spend some of the embedded equity and market segments, particularly in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

218 89th Annual Report, 2002 high-price sector of the housing market. deferring major investment initiatives Some members questioned whether gen- until they saw clear evidence of an erally rising housing prices and elevated increased need for capital to meet growlevels of refinancings would persist. ing demand. However, given the anticipated continu- Business firms appeared to be in the ation of accommodative conditions in process of moving from inventory liquimortgage markets and forecasts of ris- dation to accumulation, and the availing incomes, the overall outlook for able evidence suggested that inventory housing remained favorable. positions were getting tighter. Accord- Business fixed investment remained ingly, prospective growth in final a significant question mark in the out- demand would have to be met through look for economic expansion. Recent increased production. And as demand readings on business spending for rose over the next several quarters, equipment and software pointed to businesses were expected to accumugradual improvement, but nonresiden- late inventories to maintain desired tial construction activity continued to be inventory-sales ratios, adding in the severely depressed in many areas. It was process some limited impetus to the unclear whether the recent strength in growth of GDP. orders and shipments signaled a signifi- The growth of economic activity in cant acceleration in capital outlays, and most major foreign countries appeared in this regard the new information that to be falling below expectations earlier would become available in the next few in the year, with adverse implications weeks might provide important evidence for U.S. exports. Among those nations, on the outlook for capital spending and only Canada had experienced a robust thus for the performance of the econ- economic recovery thus far this year. omy more generally. At least for now, Current forecasts continued to anticipate however, anecdotal reports suggested strengthening activity abroad, but as in that a high degree of caution continued the case of the U.S. economy substantial to characterize business investment uncertainties surrounded the timing and decisions in the face of an elevated level pace of the improvement. of uncertainty. Much of the current In the context of limited demand presspending for equipment and software sures on labor and other resources, curreportedly represented replacement rent forecasts continued to point to quite demand largely associated with the short low and perhaps declining inflation over useful lives of various types of equip- the next several quarters, although there ment, and there appeared to be little appeared to be significant crosscurspending that would entail capital deep- rents in the outlook for prices. Rapid ening. At the same time, several positive increases in healthcare and other insurfactors in the outlook for capital spend- ance costs and the lagged passthrough ing could be cited including the greater of large increases in oil prices would productivity of new capital equipment, tend to maintain upward pressure on the temporary accelerated expensing tax prices. Tending to oppose those forces, incentives, generally strong business though, were the effects on resource cash positions, and the relatively rapid use of an extended period of economic depreciation of existing capital equip- activity below the economy's potential ment. For the present, however, business as well as the effects of robust produccontacts widely reported that because tivity gains on costs, apparently declinof prevailing uncertainties they were ing inflation expectations, and the per- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 219 sistent absence of pricing power in already strong evidence of a persisting highly competitive markets. Indeed, the unsatisfactory, and perhaps weakening, members did not rule out the emergence economic performance. While the curof appreciably lower inflation. In this rent stance of policy was already accomregard, some observed that a significant modative, they felt that greater stimulus decline in inflation from current levels was now called for to foster an acceptcould imply an unwelcome tighten- able pace of economic expansion. ing of monetary policy in real terms. All the members agreed that the risks In addition, further sizable disinflation to the economy remained tilted toward that resulted in a nominal inflation rate weakness and that such an assessment near zero could create problems for needed to be incorporated in the statethe implementation of monetary policy ment to be released shortly after today's through conventional means in the event meeting. The members also accepted a of an adverse shock to the economy that proposal to add a reference in the statecalled for negative real policy interest ment regarding what they viewed as rates. recently heightened geopolitical risks In the Committee's discussion of pol- that appeared to constitute a major icy for the intermeeting period ahead, all source of the uncertainty currently prebut two of the members endorsed a pro- vailing in the economy. The addition posal to maintain an unchanged policy was not intended to signal that any parstance. In the view of all the members, ticular policy response would be forthcurrent forecasts clearly were subject to coming in the event of a crisis. Rather, the risk that economic growth would not consistent with its usual practice, the be sufficient to reduce excess capacity Committee would assess the impliin labor and capital markets. However, cations of any such development for the members who favored a steady pol- the domestic economy before deciding icy course noted that the recent data on on an action. Indeed, if the geopolitical household and business spending had uncertainties were to ease significantly been a bit stronger than expected and along with what already were apparthat a number of factors pointed to solid ently diminishing concerns about corgrowth over time. In these circum- porate governance issues, the resulting stances, they believed that in the context improvement in business and consumer of prevailing uncertainties more evi- sentiment could generate a more robust dence of subpar expansion was desir- economic expansion. able before policy was eased further. It At the conclusion of the discussion, was noted in this regard that the infor- the Committee voted to authorize and mation that would become available direct the Federal Reserve Bank of New over the next several weeks should pro- York, until it was instructed otherwise, vide an improved basis for assessing to execute transactions in the System the recent anecdotal reports from around Account in accordance with the followthe nation that pointed to a possibly ing domestic policy directive. slowing expansion. Several members indicated that if compelling evidence The Federal Open Market Committee of a weak economy were to material- seeks monetary and financial conditions that will foster price stability and promote susize they would be prepared to ease tainable growth in output. To further its longpromptly. Two members preferred an run objectives, the Committee in the immeimmediate easing action because they diate future seeks conditions in reserve were persuaded by what they viewed as markets consistent with maintaining the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

220 89th Annual Report, 2002 federal funds rate at an average of around Votes for this action: Messrs. Greenspan, 13A percent. Bernanke, Ms. Bies, Messrs. Ferguson, Gramlich, Jordan, Kohn, McTeer, Olson, Santomero, and Stern. Votes The vote encompassed approval of against this action: None. Abstention: the sentence below for inclusion in the Mr. McDonough. press statement to be released shortly after the meeting: Vincent R. Reinhart Secretary Against the background of its long-run goals of price stability and sustainable economic growth and of the information cur- Meeting Held on rently available, the Committee believes that November 6, 2002 the risks continue to be weighted mainly toward conditions that may generate eco- A meeting of the Federal Open Market nomic weakness in the foreseeable future. Committee was held in the offices of the Board of Governors of the Federal Votes for this action: Messrs. Greenspan, Reserve System in Washington, D.C., McDonough, Bernanke, Ms. Bies, Messrs. Ferguson, Jordan, Kohn, Olson, San- on Wednesday, November 6, 2002, at tomero, and Stern. Votes against this 9:00 a.m. action: Messrs. Gramlich and McTeer. Present: Mr. Greenspan, Chairman Messrs. Gramlich and McTeer dis- Mr. McDonough, Vice Chairman sented because they preferred to ease Mr. Bernanke monetary policy at this meeting. The Ms. Bies economic expansion, which resumed Mr. Ferguson Mr. Gramlich almost a year ago, had recently lost Mr. Jordan momentum, and job growth had been Mr. Kohn minimal over the past year. With infla- Mr. McTeer tion already low and likely to decline Mr. Olson further in the face of economic slack Mr. Santomero Mr. Stern and rapid productivity growth, the potential cost of additional stimulus Messrs. Broaddus, Guynn, Moskow, seemed low compared with the risk of and Parry, Alternate Members further weakness. of the Federal Open Market It was agreed that the next meeting Committee of the Committee would be held on Wednesday, November 6, 2002. Mr. Hoenig, Ms. Minehan, and Mr. Poole, Presidents of the The meeting adjourned at 1:30 p.m. Federal Reserve Banks of Kansas City, Boston, and St. Louis respectively Notation Vote Mr. Reinhart, Secretary and Economist By notation vote completed on Sep- Mr. Bernard, Deputy Secretary tember 30, 2002, the Committee autho- Mr. Gillum, Assistant Secretary Ms. Smith, Assistant Secretary rized Vice Chairman McDonough to Mr. Mattingly, General Counsel accept the "Decoration of Merit" honor Mr. Baxter, Deputy General Counsel to be awarded by the government of Ms. Johnson, Economist Argentina. Mr. Stockton, Economist Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 221 Messrs. Howard, Lindsey, Ms. Mester, Mr. Lang, Executive Vice President, Messrs. Oliner, Rosenblum, Federal Reserve Bank of Sniderman, and Wilcox, Associate Philadelphia Economists Messrs. Eisenbeis, Fuhrer, Goodfriend, Mr. Kos, Manager, System Open Hakkio, Hunter, Judd, Market Account Ms. Perelmuter, and Mr. Rasche, Senior Vice Presidents, Federal Messrs. Ettin and Madigan, Deputy Reserve Banks of Atlanta, Boston, Directors, Divisions of Research Richmond, Kansas City, Chicago, and Statistics and Monetary San Francisco, New York, and Affairs respectively, Board of St. Louis respectively Governors Mr. Peach, Vice President, Federal Messrs. Slifman and Struckmeyer, Reserve Bank of New York Associate Directors, Division of Research and Statistics, Board of Governors Mr. Weber, Senior Research Officer, Federal Reserve Bank of Messrs. Kamin and Whitesell, Deputy Minneapolis Associate Directors, Divisions of International Finance and By unanimous vote, the minutes of Monetary Affairs respectively, the meeting of the Federal Open Market Board of Governors Committee held on September 24, 2002, were approved. Mr. Clouse, Assistant Director, Division of Monetary Affairs, The Manager of the System Open Board of Governors Market Account reported on recent developments in foreign exchange mar- Mr. Simpson, Senior Adviser, Division kets. There were no open market operaof Research and Statistics, Board tions in foreign currencies for the Sysof Governors tem's account in the period since the Mr. Nelson,7 Senior Economist, previous meeting. Division of Monetary Affairs, The Manager also reported on devel- Board of Governors opments in domestic financial markets and on System open market transactions Mr. Skidmore, Special Assistant to the in government securities and securities Board, Office of Board Members, issued or fully guaranteed by federal Board of Governors agencies during the period Septem- Mr. Forte,7 Senior Technical Editor, ber 24, 2002, through November 5, Division of Research and 2002. By unanimous vote, the Commit- Statistics, Board of Governors tee ratified these transactions. The Committee then turned to a dis- Ms. Low, Open Market Secretariat cussion of the economic and financial Assistant, Division of Monetary Affairs, Board of Governors outlook and the conduct of monetary policy over the intermeeting period Mr. Varvel, First Vice President, ahead. Federal Reserve Bank of The information reviewed at this Richmond meeting suggested that economic growth had slowed from the moderate 7. Attended portion of meeting relating to the pace of the third quarter. Residential discussion of alternatives to holding Treasury securities in the System Open Market Account. construction activity remained high, but Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

222 89th Annual Report, 2002 consumer spending had softened and turing edged lower in September and business investment was still sluggish. was substantially below its long-run Industrial production had slipped in average. recent months and private payroll In the context of limited gains in peremployment had changed little, while sonal income and declining consumer labor productivity remained on a strong confidence, retail sales weakened in upward trend. Overall price inflation September after two months of robust had fallen over the past year, reflecting increases. The earlier gains were fueled both favorable developments in the food mainly by very large manufacturer disand energy sectors and a continuing counts on 2002 models of motor vehidecline in core inflation. cles. Incentives on 2003 models were Aggregate labor market conditions smaller in September, and consumer weakened further in October. Private response was tepid. Retail sales of nonnonfarm payroll employment declined auto goods also decreased in September in September and October after four pre- after having registered only modest vious months of modest gains in hiring. growth in July and August. Outlays for The number of jobs in manufacturing services edged up in September. and related industries continued to fall, Residential housing activity, supwith losses widely spread. The construc- ported by mortgage rates near historical tion, transportation, and utilities indus- lows, remained very strong in Septemtries also registered further job losses. ber despite an environment of sluggish By contrast, the services sector contin- employment and declining household ued to expand despite job reductions in wealth. Starts of single-family units the help-supply industry, and the strong reached a twenty-three year high in Sephousing market and mortgage refinanc- tember, and starts in the multifamily ing activity led to brisk hiring in the sector were a little above their average finance, insurance, and real estate indus- since January of this year. Sales of new tries. Total hours worked by private pro- homes edged up to a record level in duction workers moved down in Octo- September, and sales of existing homes ber, and initial claims for unemployment continued to be brisk, though a little insurance were at a relatively elevated below the exceptional pace of the first rate. The civilian unemployment rate half of the year. The strength of housing rose to 5.7 percent in October. demand was also reflected in further Industrial production decreased rapid gains in home prices. slightly further in September, and avail- Business fixed investment edged up able weekly information pointed to in the third quarter, as a pickup in expenanother reduction in output in October. ditures for equipment and software Softness in the manufacturing sector nearly offset a further sharp decline in was widespread. In the high-tech sector, spending on nonresidential structures. output continued to rise, but much less The return to positive growth of spendrapidly than earlier in the year. Motor ing for equipment and software was led vehicle assemblies ebbed a little from by robust business outlays for computthe robust third-quarter pace. Elsewhere ers and peripheral equipment and for in manufacturing, production weakened motor vehicles. By contrast, investment in many categories, including commer- in telecommunications equipment and cial aircraft, non-auto consumer goods, aircraft remained on a steep downward and various types of business equip- trend. Nonresidential construction activment. Capacity utilization in manufac- ity also continued to decline rapidly, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 223 with considerable further reductions in sumer surveys, slower price increases all major categories. over the past year apparently led con- The book value of manufacturing and sumers to lower their expectations trade inventories excluding motor vehi- of near-term inflation. At the producer cles registered consecutive gains in July level, prices for core finished goods and August after months of heavy liqui- likewise decelerated over the twelve dation. Despite the recent accumulation, months ended in September. With inventory-sales ratios in most industries regard to labor costs, growth in average were at, or near, historic lows. hourly earnings of production or nonsu- The U.S. trade deficit in goods and pervisory workers declined significantly services widened in August, and the over the twelve months ended in Sepaverage deficit for July and August tember, evidently reflecting the effects was virtually unchanged from that for of both the rise in unemployment and the second quarter. The value of both the drop in consumer price inflation. imports and exports changed little in At its meeting on September 24, the July-August period. The available 2002, the Committee adopted a directive information on economic activity abroad that called for maintaining conditions in in the third quarter suggested mixed reserve markets consistent with keeping results. Canada apparently grew briskly, the federal funds rate around 13A perand the United Kingdom recorded cent, and it also retained a balance of further moderate economic expansion. risks statement that was tilted toward In the euro area and Japan, growth economic weakness in the foreseeable appeared to be weakening. The pace of future. Market participants had anticirecovery in most of emerging Asia also pated the unchanged policy stance and appeared to have slowed, though China risk assessment, but the inclusion in evidently remained on a path of robust the policy announcement of a reference expansion. In South America, economic to heightened geopolitical risks led to conditions generally remained fragile. downward revisions to expectations for Economic activity was still very weak the future path of the federal funds rate. in Argentina and Venezuela, and the The subsequent release of better-than- Brazilian economy continued to be expected news on profits for several adversely affected by uncertainties con- major corporations buoyed equity prices cerning the economic policies of the and lifted market interest rates and preincoming government. Mexico has been dicted policy rates. Later in the interlargely unaffected by the financial and meeting period, weaker-than-anticipated political problems of major South economic data along with press reports American countries, but it nonetheless suggesting that the FOMC was inclined experienced slower economic growth in to ease by year-end led again to downthe third quarter. ward revisions of the expected path of Consumer price inflation continued to the federal funds rate target. Over the trend downward in September. The rise intermeeting period as a whole, broad in consumer prices for the year ending equity indexes registered sizable gains in September was considerably smaller and intermediate- and longer-term bond than that for the previous twelve- yields increased somewhat. month period. While much of that drop The dollar traded in a narrow range reflected developments in the food in foreign exchange markets during and energy sectors, core inflation also the intermeeting period. It depreciated declined noticeably. Judged by con- slightly in terms of an index of major Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

224 89th Annual Report, 2002 foreign currencies and was little less pressure on resource margins than changed on balance against the curren- had been anticipated previously, and cies of other important trading partners. the level of activity would remain below M2 grew more moderately on aver- the economy's potential for a longer age in September and October, with time. The persistence of underutilized aggregate spending apparently soften- resources was expected to foster a slight ing, the effects of past monetary easing moderation in core price inflation. actions wearing off, and significantly In the Committee's discussion of weaker foreign demand for currency current and prospective economic conemerging. By contrast, the high level of ditions, members commented that the mortgage refinancing activity provided recent data on the performance of the a continuing boost to deposit growth. economy had been disappointing and The staff forecast prepared for this had tended to confirm widespread anecmeeting suggested that, in light of fur- dotal indications that economic growth ther weaker-than-expected incoming had slowed to a pace well below that economic data, the expansion of eco- experienced earlier in the year. Even nomic activity would be relatively so, the members acknowledged that muted for some time. Moreover, current the economy had displayed remarkable and prospective sluggish economic resiliency over the past year despite growth among major trading partners being subjected to severe adverse would damp U.S. exports, and busi- shocks. While the latter clearly had nesses and households were likely to taken their toll on confidence, notably in hold their spending down while faced the business sector, consumer spending with the possibility of a military conflict had held up relatively well. Business as well as persisting concerns about investment expenditures continued to be the near-term course of economic activ- constrained by a high degree of uncerity and corporate earnings. Nonethe- tainty and related caution. Looking less, those restraining influences were beyond the near term, the members expected to abate over time and eco- anticipated that as the prevailing uncernomic activity strengthen gradually. The tainties began to diminish, the econoconsiderable monetary ease and fiscal my's resiliency abetted by broadly stimulus already in place, continuing accommodative monetary and fiscal gains in structural productivity, and polices and the continuation of a strong anticipated improvement in business uptrend in productivity would underpin confidence would provide significant a gradual economic recovery. Indeed, impetus for spending. Inventory over- some members commented that an even hangs already had been largely elimi- more robust recovery could not be ruled nated, and business capital stocks had out in the absence of further major moved closer to desired levels. As a shocks to confidence. With pressures on consequence, a slowly improving out- labor and other resources expected to be look for sales and profits, low financing limited over coming quarters, inflation costs, and the temporary federal tax was likely to remain subdued and perincentive for investment in new equip- haps even to edge a little lower. ment and software were expected to In their review of developments and boost business investment spending. prospects in key expenditure sectors Even so, a less robust pickup in final of the economy, members noted that sales was now expected over the fore- consumer spending appeared to have cast period, which would put somewhat decelerated since midsummer, while an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 225 anticipated and hopefully compensating few signs of a significant pickup in the strengthening in business investment nearer term. Apart from notably adverse had not yet materialized. Factors cited business sentiment and disappointing by the members that appeared to help growth in sales and profits, factors that account for the recent softness in were curbing capital expenditures cited consumer demand included substantial by members included persisting capital decreases in equity wealth, declining overhangs stemming from what were consumer confidence in the context of now seen as excessive earlier buildups geopolitical and other uncertainties, the in equipment and software and substanwaning effects of earlier income tax tial idle capacity in many industrial and cuts, and the failure of the most recent commercial structures. Some divergence round of motor vehicle sales incentives of opinion was expressed regarding to maintain the extraordinary level of the overall extent of capital overhangs, sales seen during the summer. Looking though it was clearly evident in some ahead, some members referred to sub- industries and in high vacancy rates in dued expectations among their retailer nonresidential buildings in many areas contacts regarding the upcoming holi- of the country. Looking to the future, the day season, with sales prospects likely timing and strength of a decisive upturn to be held back at least marginally in capital expenditures, a key factor in by the lingering effects of the recent the outlook for some improvement in West Coast dock strike on the avail- the performance of the overall economy, ability of merchandise. There also was would depend critically on the dissipasome question as to whether funds tion of prevailing uncertainties, includextracted from rising home equity ing those associated with geopolitical values would continue to provide as risks, and increasing prospects for profimportant a source of financing for its. In the latter regard, it was suggested purchases of consumer durables as they that in the context of rising productivity, had for some time unless mortgage profits could prove to be stronger than interest rates declined from their already many now expected, with favorable low levels. Members also mentioned a implications for cash flows and in turn number of favorable factors bearing on investment activity. the longer-term outlook for consumer Cautious business attitudes and exspending. These included the prospect pectations of sluggish sales over coming of strengthening consumer confidence months were inducing business firms if geopolitical uncertainties began to to continue to hold down what were dissipate, the gradual diminution of the already generally lean inventories. negative wealth effects from earlier Nonetheless, some members commented stock market declines, and importantly that inventory accumulation was likely the outlook for continued robust growth to provide some limited impetus to the in structural labor productivity and its economy over the next several quarters favorable effects over time on wages to the extent that an acceleration in ecoand salaries. nomic activity occurred and businesses High and persisting uncertainty and sought to maintain an acceptable balconcomitant aversion to risk among ance between their inventories and sales. business executives apparently contin- Indeed, with inventories at unusually ued to hold down business investment low levels in many industries, efforts spending. While such expenditures to rebuild such inventories appeared remained at a high level, members saw inevitable. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

226 89th Annual Report, 2002 Housing activity had remained at a efforts to control very large deficits generally elevated level in recent likely would lead to tax and spending months and in the context of low mort- legislation that would offset at least part gage interest rates likely would continue of the remaining stimulus inherent in the to provide important support to the federal budget. economy over the forecast period. Most Members commented that little if any regional reports indicated persisting stimulus could be expected from the strength in the housing sector, though export sector of the economy in light there was evidence of modestly flagging of current and prospective shortfalls in activity in some areas. In this regard, the economic performance of important it was noted that the declining trend U.S. trading partners. Indeed, recent in mortgage interest rates probably forecasts incorporated downward reviwould not continue once forecasts of sions to the growth of overall foreign a strengthening economic expansion economic activity. began to materialize. Indeed, the rise in With the economy evidently on a bond yields since the September meet- lower-than-anticipated growth path and ing associated with the improvement with slack in labor and product markets in the stock market had induced a small at elevated levels, members anticipated increase in mortgage rates from their that inflation would remain quite subvery low levels. At some point the dued over the year ahead even in the extraordinary levels of cash-outs from context of some anticipated acceleration mortgage refinancings and home sales in economic activity. Indeed, the proswould undoubtedly moderate, with pect of some persisting slack in resource adverse implications for spending on use over coming quarters pointed to home improvements and consumer further disinflation. In this regard, some durables more generally. Still, house- members referred to the possibility, hold spending probably would continue which they viewed as remote, of a to be supported by the increases in period of deflation in the event of a income and wealth associated with strongly negative demand shock. strengthening economic expansion and In the Committee's discussion of polrising productivity. icy for the intermeeting period ahead, Members commented that fiscal pol- all the members favored a proposal to icy remained accommodative, but an reduce the target for the intended federal analysis cited at this meeting suggested funds rate by 50 basis points to \lA perthat the stimulus embodied in current cent. While the current stance of monelegislation had diminished considerably tary policy was still accommodative and since earlier in the year. Reference also was providing important support to ecowas made to the partial expensing pro- nomic activity, the members were convision of the tax legislation enacted in cerned that the generally disappointing March of this year, which was seen as data since the previous meeting, reina positive but not in itself a compelling forcing the general thrust of the anecfactor in inducing expenditures on busi- dotal evidence in recent months, pointed ness equipment and software. Some to a longer-lasting spell of subpar ecomembers observed that further federal nomic performance than they had anticitax cuts, should they be enacted, would pated earlier. In the circumstances, a likely take effect too late to foster much relatively aggressive easing action could added spending over the year ahead. At help to ensure that the current soft spot the state and local government levels, in the economy would prove to be tern- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 227 porary and enhance the odds of a robust voiced reservations about the need for rebound in economic activity next year. such a shift. The economy probably A further reason cited by some members would continue to underperform in the for a sizable easing move related to their period immediately ahead, but in the perceptions of a diminishing stimulus absence of unpredictable adverse shocks from earlier policy easing actions and this sluggish performance was more indications that overall financial condi- likely to be balanced by subsequent ecotions, including bank lending terms, had nomic strength in light of the policy become more restrictive this year even action. A 50 basis point move would though the nominal federal funds rate tend to have a more pronounced effect target had not been changed since late than usual in financial markets, at least 2001. The members agreed that mone- initially, because it would be largely tary policy could do little to improve unexpected and would come after an the performance of the economy in the extended hiatus in implementing policy near term, but some emphasized that a changes. In the view of many members, 50 basis point easing likely would feed retaining the assessment that the risks through to some degree to market inter- were tilted toward weakness would raise est rates, with favorable implications for the odds of an overreaction in financial spending next year. markets, which might well misread the Members commented that the poten- Committee's decision as a sign that the tial costs of a policy easing action that members were more concerned about later proved not to have been needed the potential for greater economic weakwere quite limited in that there was little ness than was in fact the case and that risk that such a move would foster infla- therefore the Committee currently saw a tionary pressures under likely economic likely need for further easing later. Some conditions over the next several quar- members saw a lesser risk of such a ters. Moreover, the policy easing could development, partly because of widereadily be unwound without signifi- spread market expectations that even cant effects on financial markets if the with a sizable reduction in the intended reversal appeared to be warranted by federal funds rate the Committee would growing pressures on resources in a not change its assessment of unbalanced strengthening economy. In contrast, a risks to the economy in present cirfailure to take an action that was needed cumstances. Although they had at least because of a faltering economic per- a marginal preference for retaining formance would increase the odds of a the current tilt toward weakness, these cumulatively weakening economy and members were willing to accept a balpossibly even attendant deflation. An anced statement in light of the uncertaineffort to offset such a development, ties that surrounded prospective market should it appear to be materializing, reactions. While the possible market would present difficult policy imple- response was not a primary factor determentation problems. mining the desirability of a policy All the members indicated that, in action, the Committee needed to take it light of the contemplated 50 basis point into account in gauging the potential easing action, they could support a shift effects of particular policy moves. in the Committee's assessment of the At the conclusion of the discussion, risks to the economy from tilted toward the Committee voted to authorize and economic weakness to balanced for direct the Federal Reserve Bank of New the foreseeable future, although some York, until it was instructed otherwise, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

228 89th Annual Report, 2002 to execute transactions in the System ments made it clear that earlier concerns Account in accordance with the follow- about a contracting supply of securities ing domestic policy directive: in the U.S. government securities market would not likely impose constraints on The Federal Open Market Committee the System's open market operations in seeks monetary and financial conditions that the near term. will foster price stability and promote sus- Even so, the members expressed a tainable growth in output. To further its longconsensus in favor of continuing to run objectives, the Committee in the immestudy alternatives to Treasury obligadiate future seeks conditions in reserve markets consistent with reducing the fed- tions for potential future use. Pursueral funds rate to an average of around ant to the Committee's instructions \lA percent. in March, the staff had activated its study of the possible employment of The vote encompassed approval of mortgage-backed securities guaranteed the sentence below for inclusion in the by the Government National Mortgage press statement to be released shortly Association (Ginnie Maes) in outright after the meeting: System open market operations. Such obligations were already being utilized Against the background of its long-run for temporary additions to the System's goals of price stability and sustainable eco- portfolio through repurchase agreenomic growth and of the information curments. During their discussion at this rently available, the Committee believes that meeting, the members recognized that the risks are balanced with respect to prospects for both goals in the foreseeable future. outright purchases of Ginnie Maes for permanent additions to the System's Votes for this action: Messrs. Green- portfolio would present a number of span, McDonough, Bernanke, Ms. Bies, difficulties and would require extensive Messrs. Ferguson, Gramlich, Jordan, preparations for their effective integra- Kohn, McTeer, Olson, Santomero, and tion, if deemed desirable at a later date, Stern. Votes against this action: None. into the conduct of outright System open market operations. Still, in view of their possible advantages in helping to meet Use of Alternative Assets SOMA portfolio objectives at some in Open Market Operations point in the future, the Committee At this meeting the Committee provided instructed the staff to continue to focus further guidance to the staff on priorities available resources on the possible use for the continuing study of alternatives of Ginnie Maes for such operations. The to Treasury securities in the conduct of Committee also decided to discontinue System open market operations. At its further consideration of the possible use meeting in March of this year, the Com- of foreign sovereign debt obligations mittee had reaffirmed its preference for as collateral for repurchase agreements the use of Treasury securities to imple- in light of the problems that were ment the System's monetary policy, envisaged in the employment of such contingent upon the continued availabil- securities. ity of a sufficient outstanding volume At this meeting the Committee also of such obligations to accommodate reviewed work that had been done on the System's very large operations. As the potential use of an auction credit was already apparent at the time of the facility (ACF) that could serve as a March meeting, fiscal policy develop- partial substitute for Treasury or other Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes ofFOMC Meetings, December 229 securities. In addition, the Committee Present: reviewed a study that considered Mr. Greenspan, Chairman Mr. McDonough, Vice Chairman whether an ACF might be adapted for Mr. Bernanke use in a contingency (CACF) as a full Ms. Bies substitute for open market operations. Mr. Ferguson Many of the members commended the Mr. Gramlich staff for its careful assessment of the Mr. Jordan potential for such operations. The mem- Mr. Kohn Mr. McTeer bers concluded, however, that signifi- Mr. Olson cant resources should not be assigned Mr. Santomero at this time to the further study of these Mr. Stern alternatives to open market operations given the prospects for an enlarged Messrs. Broaddus, Guynn, Moskow, supply of Treasury obligations, the and Parry, Alternate Members of the Federal Open Market decision to focus on Ginnie Maes, and Committee the introduction of a new discount window program, the System's primary Mr. Hoenig, Ms. Minehan, and credit facility, scheduled for imple- Mr. Poole, Presidents of the mentation in early 2003. In addition, the Federal Reserve Banks of CACF had been made unnecessary by Kansas City, Boston, and the implementation of contingency plans St. Louis respectively and backup facilities since September Mr. Reinhart, Secretary and Economist 2001. The members concurred with the Mr. Bernard, Deputy Secretary staff's recommendation that the staff Mr. Gillum, Assistant Secretary studies prepared for the Committee in Ms. Smith, Assistant Secretary January 2001, when it discussed in Mr. Mattingly, General Counsel detail various alternatives to holding Ms. Johnson, Economist Mr. Stockton, Economist U.S. government securities, should be released to the public after light editing Mr. Connors, Ms. dimming, was completed. Messrs. Howard and Lindsey, It was agreed that the next meeting of Ms. Mester, Messrs. Oliner, Rolnick, Rosenblum, Sniderman, the Committee would be held on Tuesand Wilcox, Associate Economists day, December 10, 2002. The meeting adjourned at 1:55 p.m. Mr. Kos, Manager, System Open Market Account Vincent R. Reinhart Secretary Messrs. Ettin and Madigan, Deputy Directors, Divisions of Research and Statistics and Monetary Affairs respectively, Board of Meeting Held on Governors December 10 2002 9 Messrs. Slifman and Struckmeyer, A meeting of the Federal Open Market Associate Directors, Division Committee was held in the offices of of Research and Statistics, Board of Governors the Board of Governors of the Federal Reserve System in Washington, D.C., Mr. Whitesell, Deputy Associate on Tuesday, December 10, 2002, at Director, Division of Monetary 9:00 a.m. Affairs, Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

230 89th Annual Report, 2002 Mr. Clouse, Assistant Director, The Committee then turned to a dis- Division of Monetary Affairs, cussion of the economic and financial Board of Governors outlook and the conduct of monetary policy over the intermeeting period Mr. Simpson, Senior Adviser, Division ahead. of Research and Statistics, Board The information reviewed at this of Governors meeting suggested that economic growth had been sluggish on balance Mr. Skidmore, Special Assistant to the Board, Office of Board Members, since midsummer. Housing demand Board of Governors remained strong, but business fixed investment was still in the doldrums Ms. Low, Open Market Secretariat and consumer spending had flagged in Assistant, Division of Monetary late summer before apparently picking Affairs, Board of Governors up somewhat in the autumn. Payroll employment had changed little since Ms. Holcomb, First Vice President, midyear, and industrial production still Federal Reserve Bank of Dallas seemed to be on a downward trend. Most price indexes continued to indicate Messrs. Eisenbeis, Fuhrer, Goodfriend, that inflation had declined over the past Green, Hakkio, and Rasche, year. Senior Vice Presidents, Federal Reserve Banks of Atlanta, Boston, Private nonfarm payroll employment Richmond, Chicago, Kansas City, remained stagnant in the third quarter and St. Louis respectively and edged down in October and November. Job losses in manufacturing were Messrs. Elsasser and Furlong, Vice again large in the two months, and Presidents, Federal Reserve Banks employment declined in construction of New York and San Francisco respectively and in the wholesale and retail trade industries. By contrast, services (except By unanimous vote, the minutes of help-supply) and the finance, insurance, the meeting of the Federal Open Market and real estate grouping recorded fur- Committee held on November 6, 2002, ther solid gains. The unemployment rate were approved. rose to 6 percent in November, a level The Manager of the System Open more consonant with other recent labor Market Account reported on recent market indicators. Labor productivity in developments in foreign exchange mar- the nonfarm business sector continued kets. There were no open market opera- to climb briskly, with the advance over tions in foreign currencies for the Sys- the last four quarters being the largest tem's account in the period since the since 1973. previous meeting. Industrial production dropped sharply The Manager also reported on devel- further in October, with roughly half opments in domestic financial markets of the decline related to a slowdown in and on System open market transactions motor vehicle assemblies and the manuin government securities and securities facture of related parts. The rest of the issued or fully guaranteed by federal manufacturing sector also was weak on agencies during the period November 6, balance, with output down in almost all 2002, through December 9, 2002. By market groups. The high-tech sector was unanimous vote, the Committee ratified an exception, although the rise in outthese transactions. put of computers and semiconductors in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 231 October was smaller than earlier in the with anecdotal reports from businesses, year and the production of communi- signaled renewed weakness. Shipments cations equipment continued to fall. of nondefense capital goods rebounded Consistent with the poor performance in October, led by a rise in computing of industrial production, capacity utiliza- equipment. In contrast, shipments of tion in manufacturing fell again in Octo- communications equipment plunged. ber and remained substantially below its Construction in the nonresidential sector long-run average. slowed sharply further in the third quar- Against the backdrop of smaller gains ter, but a few signs, including a rise in in disposable personal income and activity in October, suggested some low readings on consumer confidence, moderation in the rate of decline. growth of consumer spending had been The aggregate book value of manuquite sluggish in the last several months. facturing inventories changed little in Much of the weakness reflected a falloff October: declines in stocks of many in spending on new motor vehicles in types of durable goods were offset by September and October, largely because modest stockbuilding of nondurables, of reduced manufacturer discounts. and the ratio of stocks to shipments Apart from motor vehicles, personal remained very low. Anecdotal informaconsumption expenditures picked up in tion suggested that disruptions of West October following two months of soft- Coast dock operations stemming from a ness. Increases in outlays for services in labor dispute had been quite small. September and October remained mod- The U.S. trade deficit in goods and est and about equal to the average rate services changed little in September and of rise earlier in the year. the third quarter. The available informa- Housing starts dropped moderately in tion on economic activity abroad in the October, which was an unusually wet third quarter indicated that economic month across much of the country. How- expansion remained moderate in the ever, residential housing activity had United Kingdom and sluggish in the been very strong on balance this year euro area. Economic growth subsided despite an environment of sluggish somewhat from elevated second-quarter employment and declining household rates in Canada, Japan, and emerging wealth. Mortgage rates near historical Asia. Economic conditions in South lows had provided important support for America were generally still fragile. single-family housing demand, and sales Core consumer price inflation, as of new and existing homes had remained measured by the consumer price index buoyant. In the multifamily sector, starts (CPI) and the chain-weighted personal plunged in October to the slowest pace consumption expenditure (PCE) index, in almost six years. While some of the continued to trend lower in October. decline likely was attributable to inclem- Inflation, in terms of both indexes, was ent weather, apartment vacancy rates down over the last twelve months when had risen significantly over the past compared with the previous twelveyear, perhaps partly in response to the month period. At the producer level, single-family housing boom. core price inflation for finished goods Business spending on equipment and over the twelve months ended in Octosoftware increased moderately in the ber was at a very low rate. With regard third quarter, but the recent monthly to labor costs, average hourly earnings pattern of data on shipments and orders of production or nonsupervisory workfor nondefense capital goods, along ers increased moderately in November, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

232 89th Annual Report, 2002 and the growth in those earnings over M2 growth slowed a little in Novemthe last twelve months fell considerably, ber from October's elevated pace. The evidently reflecting the slack in labor further advance again was concentrated markets. in liquid deposits. The low level of At its meeting on November 6, 2002, opportunity costs and heavy mortgage the Committee adopted a directive that financing continued to support the called for lowering the target for the demand for liquid assets. intended federal funds rate by 50 basis The staff forecast prepared for this points, to \lA percent. The Committee meeting suggested that the expansion of also agreed that, in light of the decision economic activity would be relatively to ease, it would be appropriate to indi- muted over the near term. Faced with cate in the press release that the risks heightened geopolitical tensions as well were balanced for the foreseeable future. as persisting concerns about the near- Market participants had expected a term course of economic activity and 25 basis point cut and retention of a corporate earnings, businesses and statement of risks toward weakness. households were likely to hold down The unexpectedly large reduction in the their spending, and the outlook for confederal funds rate target led to an initial tinued sluggish economic growth among decline in Treasury coupon yields. That most major trading partners would damp drop was reversed when market partici- U.S. exports. However, those restraining pants apparently focused on the shift to influences were expected to abate over balanced risks and concluded that the time, and the considerable monetary odds of pronounced economic weakness ease and fiscal stimulus already in place, had fallen. The subsequent release of continuing strong gains in structural probetter-than-expected economic data and ductivity, and anticipated improvement earnings news provided reassurance to in business confidence would provide investors, though more mixed economic significant impetus to spending. Invenreports became available late in the tory overhangs had been largely elimiintermeeting period. Over the period as nated and business capital stocks had a whole, major equity indexes registered moved closer to desired levels. As a mixed changes, and yields on longer- consequence, a slowly improving outterm Treasury bonds increased some- look for sales and profits, low financwhat. In private debt markets, rates ing costs, and the temporary federal tax on investment-grade debt issues eased incentive for investment in new equipa little, and those on speculative-grade ment and software were expected to bonds fell considerably more. provide a gradual boost to business The dollar appreciated slightly in investment spending. The persistence of terms of an index of major foreign cur- underutilized resources was expected to rencies, principally against the yen, and foster a slight moderation in core price changed little against the currencies of inflation. other important trading partners. The In the Committee's discussion of curdollar edged lower against most major rent and prospective economic condicurrencies in the aftermath of the policy tions, members noted that the recent easing on November 6, but those losses information had continued on the whole were subsequently retraced after the to suggest quite sluggish economic release of U.S. economic data that were growth. Uncertainties about the outlook seen as suggesting relatively better eco- remained substantial, and downside nomic conditions in the United States. risks stemming from potential shocks, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 233 notably those associated with a high well above the lows of early October. level of geopolitical risks, could not be Some of this improvement in financial dismissed. Nonetheless, the behavior of markets seemed to be related to apparfinancial markets in recent weeks sug- ently lessening concerns about new gested that investor concerns about an revelations of corporate governance actual downturn in the economy had issues as a result of the passage of time diminished, as data on economic devel- without further significant incidents. opments took on a more mixed tone In addition, many business firms had after having been somewhat nega- continued to enhance their prospects tive for some time. The improvement for rising profits through productivity in financial markets reinforced the improvements and debt restructurings members' expectations that a gradual that were strengthening their balance strengthening of the economic expan- sheets and liquidity. Concurrently, indision was likely over coming quarters, cators of credit quality in the household with the growth in economic activity sector appeared to have remained essengaining momentum over time in the tially stable. Reference also was made to absence of major adverse shocks to busi- the continued robust growth in reserve ness and consumer confidence. Their and money measures. assessment took account of the currently The better tone in financial markets very accommodative stance of monetary might also have been signaling a modest policy, likely further fiscal policy stim- reduction in uncertainty and risk averulus, and the positive effects on busi- sion among business executives from ness and consumer spending of a strong the extraordinarily elevated levels that uptrend in labor productivity. With had been constraining investment spendregard to the outlook for inflation, the ing. Lingering excess capacity in a gap between actual and potential output number of industries undoubtedly was was anticipated to diminish only slowly continuing to inhibit new investment unless aggregate demand expanded outlays as well. The members agreed much more rapidly than the members that a pickup in capital spending currently foresaw. Given the persistence remained the essential factor in the outof limited pressures on resources, cost look for substantial strengthening of and price increases were expected to economic activity. On the positive side, remain subdued and possibly to edge spending for business equipment had lower. turned up since early this year, and with The improvement of overall condi- efforts to reduce excess capacity seemtions in financial markets had provided ingly well under way or completed in an additional positive element to the many industries, further firming in such economic outlook. The improvement capital expenditures was anticipated began before the November meeting and as the year 2003 progressed. However, had been given added impetus by the nonresidential building was expected to Committee's sizable easing at that meet- continue to lag, especially given high ing. The general calming of financial vacancy rates in industrial and office markets was reflected in some decline structures in many major markets. in risk spreads from very high levels The household sector of the economy and sizable new issuance in private bond had continued to provide major support markets; in equity markets, issuance to the recovery in economic activity. had edged up and stock prices, though The increase in consumer spending evirecently declining somewhat, were still dently had moderated in the current Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

234 89th Annual Report, 2002 quarter, largely as a result of a decline in tional stimulus on the federal level sales of motor vehicles from an extraor- would be an offset to measures that were dinary pace during the summer. How- being taken by numerous state and local ever, the latest information on retail governments to address severe budget sales, including anecdotal reports, deficits. At the same time, a number of pointed to some improvement in recent members expressed the hope that new weeks, and key measures of consumer fiscal legislation would not endanger the confidence had turned up from their prospects for federal budget discipline recent lows. While some uncertainty over the longer run, given the desirabilsurrounded the prospects for consumer ity of supporting national saving and spending, members cited continued siz- capital accumulation. able increases in income, more stable With regard to the external sector, wealth-to-income ratios, and the ongo- members commented that the growth ing stimulus of equity extractions from of the nation's important trading parthousing as favorable factors in the out- ners had remained sluggish, and there look for consumer expenditures. seemed to be little basis for anticipat- Housing activity had continued to dis- ing any appreciable impetus to the U.S. play solid overall strength, though mem- economy from significant strengthening bers mentioned weakness in multifamily in demand for U.S. exports. Indeed, construction and the high-end sector economic growth abroad was widely of the single-family market. Historically viewed as dependent to a significant low mortgage interest rates along with extent on the performance of the U.S. rising incomes evidently were continu- economy. Conditions in some major ing to sustain the robust demand for Latin American countries were espehousing. In addition, large extractions of cially problematic, and adverse develequity from appreciated housing values opments there could have negative continued to foster not only added con- repercussions on international financial sumer spending but also improvement markets and trade. in the financial condition of many Members believed that the economy households through debt consolidation probably would continue to operate with and repayments and reduced interest significant margins of slack in both charges. However, there were anecdotal labor and product markets. Moreover, in indications of decreasing refinancing an environment characterized by highly activity in the housing sector. competitive markets and the absence The outcome of the recent Congres- of pricing power, business firms would sional elections had fostered expecta- persist in their efforts to hold down or tions that fiscal policy might be more reduce costs, with favorable implicaexpansive than previously anticipated, tions for productivity. In these circumalthough the size, timing, and composi- stances, inflation pressures could be tion of federal budget initiatives were expected to remain subdued and some subject to substantial uncertainty. Mem- further disinflation might well occur. bers commented that added fiscal stimu- In this regard, members commented lus might prove to be a useful comple- that appreciable disinflation seemed ment to an accommodative monetary unlikely, but if that were to occur it policy in the period immediately ahead could present difficult problems for when economic activity was likely to monetary policy. One member noted, remain below the economy's potential. however, that declining inflation or even In this regard, some observed that addi- some deflation in the context of rapid Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 235 growth in productivity could turn out to At the conclusion of the discussion, be relatively benign. the Committee voted to authorize and In the Committee's discussion of pol- direct the Federal Reserve Bank of New icy for the intermeeting period ahead, York, until it was instructed otherwise, all the members endorsed a proposal to to execute transactions in the System retain the current stance of policy. The Account in accordance with the followmembers agreed that, given what was ing domestic policy directive: now a quite accommodative policy following the relatively aggressive easing The Federal Open Market Committee move in November, monetary policy seeks monetary and financial conditions that will foster price stability and promote suswas well positioned to support a tainable growth in output. To further its strengthening economic expansion in long-run objectives, the Committee in the line with their expectations for coming immediate future seeks conditions in reserve quarters. Although it was uncertain how markets consistent with maintaining the fedlong the current period of below-par eral funds rate at an average of around 1 VA percent. growth would persist, the economic outlook remained subject to upside as well The vote encompassed approval of as downside risks. Indeed, all the memthe sentence below for inclusion in the bers also supported the retention of the press statement to be released shortly current balanced-risks statement in the after the meeting: post-meeting press release, with some commenting that recent developments Against the background of its long-run had established a firmer basis for such goals of price stability and sustainable ecoa risk assessment than at the Novem- nomic growth and of the information curber meeting when it was adopted. The rently available, the Committee believes that November easing had contributed to the risks are balanced with respect to prossome improvement in financial markets pects for both goals in the foreseeable future. that, in conjunction with prospects for Votes for this action: Messrs. Greenfurther stimulus from fiscal policy, span, McDonough, Bernanke, Ms. Bies, should bolster the anticipated accelera- Messrs. Ferguson, Gramlich, Jordan, tion of economic activity. At the same Kohn, McTeer, Olson, Santomero, and time, the members saw little risk of Stern. Votes against this action: None. any significant increase in inflationary It was agreed that the next meeting pressures over the foreseeable future. of the Committee would be held on Against this background, the members Tuesday-Wednesday, January 28-29, concluded that there was no need to 2003. change the stance of monetary policy; The meeting adjourned at 12:05 p.m. they would continue to assess emerging economic and financial developments, retaining the flexibility to adjust Vincent R. Reinhart monetary policy as emerging conditions Secretary might warrant. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

237 Litigation During 2002, the Board of Governors to certain Board employees under the was a party in three lawsuits or appeals Board's retirement plan. filed that year and was a party in seven Caesar v. United States, No. 02-0612 other cases pending from previous (EGS) (D. District of Columbia, years, for a total of ten cases; in 2001, removed on April 1, 2002, from the the Board had been a party in a total Superior Court of the District of Columof twenty cases. None of the lawsuits or bia), is an action seeking damages for appeals filed in 2002 raised questions personal injury. under the Bank Holding Company Act. Community Bank & Trust v. United As of December 31, 2002, six cases States, No. 01-571C (Court of Federal were pending. Claims, filed October 3, 2001), is an action challenging on constitutional grounds the failure to pay interest on Litigation under the reserve accounts held at Federal Reserve Gramm-Leach-Bliley Act Banks. Trans Union LLC v. Federal Trade Laredo National Bancshares, Inc. v. Commission, et al, No. 01-5202 (D.C. Whalen v. Board of Governors, No. 01- Circuit, filed June 4, 2001), was an CV-134 (S. D. Texas, removed on Sepappeal of a district court order uphold- tember 5, 2001, from Webb County, ing challenged provisions of the inter- Texas, district court), was a third-party agency rule Privacy of Consumer Finan- petition seeking indemnification or concial Information (145 F. Supp. 2d 6, tribution from the Board in connection April 30, 2001). On July 16, 2002, the with a claim asserted against defendant court of appeals affirmed the district Whalen that alleged tortious interfercourt's decision upholding the regula- ence with a contract. On September 27, tion (295 F.3d 42). 2002, the district court dismissed all claims against the individual third-party defendants, granted the United States' Other Actions motion to substitute the United States Sedgwick v. United States, No. 02-5378 for the third-party defendants, and dis- (D.C. Circuit, filed November 26, missed all claims against the Board and 2002), is an appeal of the dismissal of the United States. appellant's claim for a declaratory judg- Radfar v. United States, No. ment under the Federal Tort Claims Act l:01CV1292 (D. District of Columbia, and the Constitution regarding the bank- filed June 11,2001), was an action under ing agencies' alleged failure to inter- the Federal Tort Claims Act for injury vene on his behalf in civil litigation on Board premises. On October 3, 2002, involving a regulated institution. the action was dismissed on the stipula- Albrecht v. Board of Governors, tion of the parties. No. 02-5235 (D.C. Circuit, filed Octo- Artis v. Greenspan, No. 01-0400 (D. ber 18, 2002), is an appeal of a district District of Columbia, filed February 22, court order dismissing a challenge to 2001), is an employment discrimination the pension funding method applicable action. An identical action, No. 99-2073 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

238 89th Annual Report, 2002 (EGS) (D. District of Columbia, filed shares. On March 26, 2002, the district August 3, 1999), was consolidated with court granted the defendants' motion to this action on August 15, 2001. dismiss the action. Howe v. Bank for International Settle- In Fraternal Order of Police v. Board ments, No. 00CV12485 (RCL) (D. Mas- of Governors, No. 98-3116 (D. District sachusetts, filed December 7, 2000), of Columbia, filed December 22, 1998), was an action seeking damages in con- plaintiffs seek a declaratory judgment nection with gold market activities and regarding the Board's labor policy govthe repurchase by the Bank for Interna- erning Federal Reserve Banks. • tional Settlements of its privately owned Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

Federal Reserve System Organization 241 Board of Governors December 31,2002 Members LEGAL DIVISION—Continued Term expires January 31, Katherine H. Wheatley, Assistant General Alan Greenspan, of New York, Counsel Chairman1 2006 Cary K. Williams, Assistant General Roger W. Ferguson, Jr., of Counsel Massachusetts, Vice Chairman1 2014 Edward M. Gramlich, of Virginia .. 2008 OFFICE OF THE SECRETARY Mark W. Olson, of Maryland 2010 Jennifer J. Johnson, Secretary Susan S. Bies, of Tennessee 2012 Robert deV. Frierson, Deputy Secretary Ben S. Bernanke, of New Jersey ... .2004 Margaret M. Shanks, Assistant Secretary Donald L. Kohn, of Virginia 2016 Officers DIVISION OF INTERNATIONAL FINANCE OFFICE OF BOARD MEMBERS Karen H. Johnson, Director Donald J. Winn, Assistant to the Board David H. Howard, Deputy Director and Director Thomas A. Connors, Associate Director Lynn S. Fox, Assistant to the Board Dale W. Henderson, Associate Director Michelle A. Smith, Assistant to the Board Richard T. Freeman, Deputy Associate Winthrop P. Hambley, Deputy Director Congressional Liaison William L. Helkie, Senior Adviser John Lopez, Special Assistant Steven B. Kamin, Deputy Associate to the Board Director Rosanna Pianalto-Cameron, Special Jon W. Faust, Assistant Director Assistant to the Board David Skidmore, Special Assistant Joseph E. Gagnon, Assistant Director to the Board Michael P. Leahy, Assistant Director D. Nathan Sheets, Assistant Director LEGAL DIVISION Ralph W. Tryon, Assistant Director J. Virgil Mattingly, Jr., General Counsel Scott G. Alvarez, Associate General DIVISION OF MONETARY AFFAIRS Counsel Vincent R. Reinhart, Director Richard M. Ashton, Associate David E. Lindsey, Deputy Director General Counsel Brian F. Madigan, Deputy Director Kathleen M. O'Day, Associate General William C. Whitesell, Deputy Associate Counsel Director Stephanie Martin, Assistant General James A. Clouse, Assistant Director Counsel William B. English, Assistant Director Ann Misback, Assistant General Counsel Richard D. Porter, Senior Adviser Stephen L. Siciliano, Assistant General Normand R.V. Bernard, Special Assistant Counsel to the Board 1. The designations as Chairman and Vice Chairman expire on June 20, 2004, and October 5, 2003, respectively, unless the service of these members of the Board shall have terminated sooner. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

242 89th Annual Report, 2002 Board of Governors—Continued DIVISION OF RESEARCH James A. Embersit, Assistant Director AND STATISTICS Charles H. Holm, Assistant Director David J. Stockton, Director William G. Spaniel, Assistant Director David M. Wright, Assistant Director Edward C. Ettin, Deputy Director William C. Schneider, Jr., Project Director, David W. Wilcox, Deputy Director National Information Center Myron L. Kwast, Associate Director Stephen D. Oliner, Associate Director Patrick M. Parkinson, Associate Director DIVISION OF CONSUMER Lawrence Slifman, Associate Director AND COMMUNITY AFFAIRS Charles S. Struckmeyer, Associate Director Dolores S. Smith, Director Joyce K. Zickler, Deputy Glenn E. Loney, Deputy Director Associate Director Sandra F. Braunstein, Senior Associate J. Nellie Liang, Assistant Director Director Stuart Wayne Passmore, Assistant Director Maureen P. English, Associate Director David L. Reifschneider, Assistant Director Adrienne D. Hurt, Associate Director Janice Shack-Marquez, Assistant Director Irene Shawn McNulty, Associate Director William L. Wascher III, Assistant Director Alice Patricia White, Assistant Director DIVISION OF FEDERAL RESERVE Glenn B. Canner, Senior Adviser BANK OPERATIONS AND PAYMENT David S. Jones, Senior Adviser SYSTEMS Thomas D. Simpson, Senior Adviser Louise L. Roseman, Director Paul W. Bettge, Associate Director DIVISION OF BANKING SUPERVISION Jeffrey C. Marquardt, Associate Director AND REGULATION Kenneth D. Buckley, Assistant Director Richard Spillenkothen, Director Joseph H. Hayes, Jr., Assistant Director Stephen C. Schemering, Deputy Director Edgar A. Martindale III, Assistant Director Herbert A. Biern, Senior Associate Marsha W. Reidhill, Assistant Director Director Jeff J. Stehm, Assistant Director Roger T. Cole, Senior Associate Director Jack K. Walton II, Assistant Director William A. Ryback, Senior Associate Director OFFICE OF STAFF DIRECTOR Gerald A. Edwards, Jr., Associate Director FOR MANAGEMENT Stephen M. Hoffman, Jr., Associate Stephen R. Malphrus, Staff Director for Director Management James V. Houpt, Associate Director Sheila Clark, Equal Employment Jack P. Jennings, Associate Director Opportunity Programs Director Michael G. Martinson, Associate Director Molly S. Wassom, Associate Director MANAGEMENT DIVISION Howard A. Amer, Deputy Associate William R. Jones, Director Director Stephen J. Clark, Associate Director Norah M. Barger, Deputy Associate Darrell R. Pauley, Associate Director Director David L. Williams, Associate Director Betsy Cross-Jacowski, Deputy Associate Christine M. Fields, Assistant Director Director Billy J. Sauls, Assistant Director Deborah P. Bailey, Assistant Director Donald A. Spicer, Assistant Director Barbara J. Bouchard, Assistant Director DigitizedA fonrg FeRlaA DSEesRm ond, Assistant Director http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 243 Board of Governors—Continued DIVISION OF OFFICE OF INSPECTOR GENERAL INFORMATION TECHNOLOGY Barry R. Snyder, Inspector General Marianne M. Emerson, Deputy Director Donald L. Robinson, Deputy Inspector Maureen T. Hannan, Associate Director General Tillena G. Clark, Assistant Director Geary L. Cunningham, Assistant Director Wayne A. Edmondson, Assistant Director Po Kyung Kim, Assistant Director Susan F. Marycz, Assistant Director Sharon L. Mowry, Assistant Director Raymond Romero, Assistant Director Robert F. Taylor, Assistant Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

244 89th Annual Report, 2002 Federal Open Market Committee December 31,2002 Members JAMIE B. STEWART, JR., First Vice President, Federal Reserve Bank of ALAN GREENSPAN, Chairman, Board of New York Governors WILLIAM J. MCDONOUGH, Vice Officers Chairman, President, Federal Reserve VINCENT R. REINHART, Secretary and Bank of New York Economist BEN S. BERNANKE, Board of Governors NORMAND R.V. BERNARD, Deputy SUSAN SCHMIDT BIES, Board of Secretary Governors GARY P. GILLUM, Assistant Secretary ROGER W. FERGUSON, JR., Board of MICHELLE A. SMITH, Assistant Secretary Governors J. VIRGIL MATTINGLY, JR., General Counsel THOMAS C. BAXTER, JR., Deputy General EDWARD M. GRAMLICH, Board of Counsel Governors KAREN H. JOHNSON, Economist JERRY L. JORDAN, President, Federal DAVID J. STOCKTON, Economist Reserve Bank of Cleveland THOMAS A. CONNORS, Associate Economist DONALD L. KOHN, Board of Governors CHRISTINE M. CUMMING, Associate ROBERT D. MCTEER, JR., President, Economist Federal Reserve Bank of Dallas DAVID H. HOWARD, Associate Economist MARK W. OLSON, Board of Governors DAVID E. LINDSEY, Associate Economist LORETTA J. MESTER, Associate Economist ANTHONY M. SANTOMERO, President, Federal Reserve Bank of Philadelphia STEPHEN D. OLINER, Associate Economist GARY H. STERN, President, Federal ARTHUR J. ROLNICK, Associate Economist Reserve Bank of Minneapolis HARVEY ROSENBLUM, Associate Economist Alternate Members MARK S. SNIDERMAN, Associate Economist DAVID W. WILCOX, Associate Economist J. ALFRED BROADDUS, JR., President, DINO Kos, Manager, System Open Market Federal Reserve Bank of Richmond Account JACK GUYNN, President, Federal Reserve Bank of Atlanta During 2002 the Federal Open Market Committee held eight regularly scheduled meet- MICHAEL H. MOSKOW, President, ings (see "Minutes of Federal Open Market Federal Reserve Bank of Chicago Committee Meetings" in this volume.) ROBERT T. PARRY, President, Federal Reserve Bank of San Francisco Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 245 Federal Advisory Council December 31,2002 Members District 10—CAMDEN R. FINE, President and Chief Executive Officer, Midwest District 1—DAVID A. SPINA, Chairman and Independent Bank, Jefferson City, Chief Executive Officer, State Street Missouri Corporation, Boston, Massachusetts District 11—RICHARD W. EVANS, JR., Chair- District 2—DAVID A. COULTER, Vice Chair- man and Chief Executive Officer, Frost man, J.P. Morgan Chase & Co., New National Bank, San Antonio, Texas York, New York District 12—MICHAEL E. O'NEILL, Chair- District 3—RUFUS A. FULTON, JR., Chair- man, Chief Executive Officer, and man and Chief Executive Officer, Ful- President, Bank of Hawaii, Honolulu, ton Financial Corporation, Lancaster, Hawaii Pennsylvania District 4—DAVID A. DABERKO, Chairman and Chief Executive Officer, National City Officers Corporation, Cleveland, Ohio DAVID A. DABERKO, President District 5—L.M. BAKER, JR., Chairman L.M. BAKER, JR., Vice President and Chief Executive Officer, Wachovia JAMES E. ANNABLE, Co-Secretary Corporation, Winston-Salem, North Carolina WILLIAM J. KORSVIK, Co-Secretary District 6—L. PHILLIP HUMANN, Chairman, The Federal Advisory Council, which is President, and Chief Executive Officer, composed of one representative of the bank- SunTrust Banks, Inc., Atlanta, Georgia ing industry from each of the twelve Federal District 7—ALAN G. MCNALLY, Chairman Reserve Districts, is required by the Federal and Chief Executive Officer, Harris Reserve Act to meet in Washington at least Bankcorp, Inc., Chicago, Illinois four times each year and is authorized by the District 8—DAVID W. KEMPER, Chairman, act to consult with, and advise, the Board President, and Chief Executive Officer, of Governors on all matters within the juris- Commerce Bancshares, Inc., St. Louis, diction of the Board. The council met on Missouri January 31-February 1, May 2-3, September 5-6, and December 5-6, 2002. The District 9—R. SCOTT JONES, Vice Chairman, Associated Bank Minnesota, Red Board met with the council on February 1, Wing, Minnesota May 3, September 6, and December 6, 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

246 89th Annual Report, 2002 Consumer Advisory Council December 31,2002 Members JEREMY NOWAK, Chief Executive Officer, The Reinvestment Fund, Philadelphia, ANTHONY ABBATE, President and Chief Pennsylvania Executive Officer, Interchange Bank, ELIZABETH RENUART, Staff Attorney, Saddle Brook, New Jersey National Consumer Law Center, Boston, JANIE BARRERA, President and Chief Execu- Massachusetts tive Officer, ACCION Texas, San DEBRA S. REYES, President, Neighborhood Antonio, Texas Lending Partners, Inc., Tampa, Florida KENNETH P. BORDELON, Chief Executive BENSON ROBERTS, Vice President for Policy, Officer, E Federal Credit Union, Baton Local Initiatives Support Corporation, Rouge, Louisiana Washington, District of Columbia TERESA A. BRYCE, General Counsel, AGNES BUNDY SCANLAN, Managing Direc- Nexstar Financial Corporation, St. Louis, tor and Chief Compliance Officer, Missouri FleetBoston Financial, Boston, MANUEL CASANOVA, JR., Executive Vice Massachusetts President, International Bank of Com- RUSSELL SCHRADER, Senior Vice President merce, Brownsville, Texas and Assistant General Counsel, Visa CONSTANCE CHAMBERLIN, President and U.S.A., San Francisco, California Chief Executive Officer, Housing FRANK TORRES III, Legislative Counsel, Opportunities Made Equal, Richmond, Consumers Union, Washington, District Virginia of Columbia ROBERT M. CHEADLE, Legislative Counsel, HUBERT VAN TOL, Co-Director, Fairness in The Chickasaw Tribal Legislature, Ada, Rural Lending, Sparta, Wisconsin Oklahoma ROBIN COFFEY, Vice President, Harris Trust and Savings Bank, Chicago, Illinois Officers LESTER WM. FIRSTENBERGER, Attorney at DOROTHY BROADMAN, Chair Law, Pittsfield, New Hampshire Director of Corporate Citizenship THOMAS FITZGIBBON, Senior Vice President, Capital One Financial Corporation MB Financial Bank, Chicago, Illinois Falls Church, Virginia LARRY HAWKINS, President and Chief RONALD REITER, Vice Chair Executive Officer, Unity National Bank, Supervising Deputy Attorney General Houston, Texas California Department of Justice EARL JAROLIMEK, Vice President/Corporate San Francisco, California Compliance Officer, Community First Bankshares, Fargo, North Dakota The Consumer Advisory Council was established pursuant to the 1976 amendments to J. PATRICK LIDDY, Director of Compliance, Fifth Third Bancorp, Cincinnati, Ohio the Equal Credit Opportunity Act to advise the Board of Governors on consumer finan- RUHI MAKER, Senior Attorney, Law Office cial services. It is composed of academics, of Rochester, Rochester, New York state and local government officials, repre- OSCAR MARQUIS, Attorney, Hunton and Wil- sentatives of the financial industry, and repliams, Park Ridge, Illinois resentatives of consumer and community PATRICIA MCCOY, Professor of Law, interests. The council met with members of Massachusetts Institute of Technology, the Board on March 14, June 27, and Octo- Cambridge, Massachusetts ber 24, 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 247 Thrift Institutions Advisory Council December 31,2002 Members EVERETT STILES, President and Chief Executive Officer, Macon Bank, Franklin, JOHN B. DICUS, President, Capitol Federal North Carolina Savings Bank, Topeka, Kansas DAVID L. VIGREN, President and Chief RONALD S. ELIASON, President and Chief Executive Officer, Utah Community Fed- Executive Officer, ESL Federal Credit eral Credit Union, Provo, Utah Union, Rochester, New York KAREN L. MCCORMICK, President and Chief MARK H. WRIGHT, President and Chief Executive Officer, First Federal Savings Executive Officer, USAA Federal Savings and Loan Association, Port Angeles, Bank, San Antonio, Texas Washington JAMES F. MCKENNA, President and Chief Officers Executive Officer, North Shore Bank, MARK H. WRIGHT, President FSB, Brookfield, Wisconsin KAREN L. MCCORMICK, Vice President CHARLES C. PEARSON, JR., Co-Chairman and Chief Executive Officer, Waypoint The Thrift Institutions Advisory Council, Bank, Harrisburg, Pennsylvania which is composed of representatives from KEVIN E. PIETRINI, President and Chief credit unions, savings and loan associations, Executive Officer, Queen City Federal and savings banks, consults with, and ad- Savings Bank, Virginia, Minnesota vises, the Board of Governors on issues per- HERBERT M. SANDLER, Chairman and Chief taining to the thrift industry and on various Executive Officer, World Savings Bank, other matters within the Board's jurisdiction. FSB, Oakland, California The members of the council met with the Board on March 1, July 12, and Decem- WILLIAM J. SMALL, Chairman and Chief ber 13, 2002. Executive Officer, First Federal Bank, Defiance, Ohio Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

248 89th Annual Report, 2002 Federal Reserve Banks and Branches December 31,2002 Officers Chairman1 President Vice President BANK or Branch Deputy Chairman First Vice President in charge of Branch BOSTON2 William 0. Taylor Cathy E. Minehan James J. Norton Paul M. Connolly NEW YORK2 Peter G. Peterson William J. McDonough Gerald M. Levin Jamie B. Stewart, Jr. Buffalo Patrick P. Lee 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 V. Larkin Martin Lee C. Jones Jacksonville Marsha G. Rydberg Christopher L. Oakley Miami Rosa Sugranes James T. Curry III Nashville Beth Dortch Franklin MelvynK. Purcell3 New Orleans R. Glenn Pumpelly Robert J.Musso3 CHICAGO2 Robert J. Darnall Michael H. Moskow W. James Farrell Gordon R.G. Werkema Detroit Timothy D. Leuliette Glenn Hansen3 ST. LOUIS Charles W. Mueller William Poole Walter L. W. LeGrande Rives Metcalfe, Jr. Little Rock A. Rogers Yarnell II Robert A. Hopkins Louisville J. Stephen Barger Thomas A. Boone Memphis Russell Gwatney Martha Perine Beard MINNEAPOLIS Ronald N. Zwieg Gary H. Stern Linda Hall Whitman James M. Lyon Helena Thomas 0. Markle Samuel H. Gane Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 249 Federal Reserve Banks and Branches—Continued Chairman1 President Vice President BANK or Branch Deputy Chairman First Vice President in charge of Branch KANSAS CITY Terrence P. Dunn Thomas M. Hoenig Richard H. Bard Richard K. Rasdall Denver Robert M. Murphy Mary Ann F. Hunter3 Oklahoma City Patricia B. Fennell Dwayne E. Boggs Omaha Bob L. Gottsch Steven D. Evans DALLAS H.B. Zachry, Jr. Robert D. McTeer, Jr. Patricia M. Helen E. Holcomb Patterson El Paso Gail S. Darling Sammie C. Clay Houston Edward O. Gaylord Robert Smith IIP San Antonio Ron R. Harris James L. Stull3 SAN FRANCISCO Nelson C. Rising Robert T. Parry George M. Scalise John F. Moore Los Angeles William D. Jones MarkL. Mullinix4 Portland Nancy Wilgenbusch Richardson B. Hornsby Salt Lake City H. Roger Boyer Andrea P. Wolcott Seattle Boyd E. Givan David K. Webb3 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 Conference of Chairmen Conference of Presidents The chairmen of the Federal Reserve Banks The presidents of the Federal Reserve Banks are organized into the Conference of Chair- are organized into the Conference of Presimen, which meets to consider matters of dents, which meets periodically to consider common interest and to consult with, and matters of common interest and to consult advise, the Board of Governors. Such meet- with, and advise, the Board of Governors. ings, attended also by the deputy chairmen, J. Alfred Broaddus, Jr., President of the were held in Washington on May 29 and 30, Federal Reserve Bank of Richmond, served and on December 4 and 5, 2002. as chair of the conference in 2002, and The members of the Executive Com- Michael H. Moskow, President of the Fedmittee of the Conference of Chairmen dur- eral Reserve Bank of Chicago, served as its ing 2002 were Peter G. Peterson, chair; vice chair. Betty M. Fahed, of the Federal Charisse R. Lillie, vice chair; and Robert J. Reserve Bank of Richmond, served as its Darnall, member. secretary, and Valerie J. Van Meter, of the On December 5, 2002, the conference Federal Reserve Bank of Chicago, served as elected its Executive Committee for 2003; its assistant secretary. it named Robert J. Darnall as chair, Wes- On October 29, 2002, the conference ley S. Williams, Jr., as vice chair, and Ron- elected Michael H. Moskow as its chair for ald N. Zweig as the third member. 2003-04, and elected Cathy E. Minehan, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

250 89th Annual Report, 2002 President of the Federal Reserve Bank Class A directors represent the stockholdof Boston, as its vice chair. ing member banks in each Federal Reserve District. Class B and Class C directors represent the public and are chosen with due, but not exclusive, consideration to the interests Conference of First of agriculture, commerce, industry, services, Vice Presidents labor, and consumers; they may not be offi- The Conference of First Vice Presidents of cers, directors, or employees of any bank or the Federal Reserve Banks was organized in bank holding company. In addition, Class C 1969 to meet periodically for the consider- directors may not be stockholders of any ation of operations and other matters. bank or bank holding company. Paul M. Connolly, First Vice President of For the election of Class A and Class B the Federal Reserve Bank of Boston, served directors, the Board of Governors classifies as chair of the conference in 2002, and the member banks of each Federal Reserve Walter A. Varvel, First Vice President of the District into three groups. Each group, which Federal Reserve Bank of Richmond, served comprises banks with similar capitalization, as its vice chair. David K. Park, of the Fed- elects one Class A director and one Class B eral Reserve Bank of Boston, served as its director. Annually, the Board of Governors secretary, and Janice E. Clatterbuck, of the designates one of the Class C directors as Federal Reserve Bank of Richmond, served chair of the board and Federal Reserve Agent as its assistant secretary. of each District Bank, and it designates another Class C director as deputy chair. Federal Reserve Branches have either five or seven directors, a majority of whom are Directors appointed by the parent Federal Reserve The following list of directors of Federal Bank; the others are appointed by the Board Reserve Banks and Branches shows for each of Governors. One of the directors appointed director the class of directorship, the direc- by the Board is designated annually as chair tor's principal organizational affiliation, and of the board of that Branch in a manner the date the director's term expires. Each prescribed by the parent Federal Reserve Federal Reserve Bank has a nine-member Bank. board: three Class A and three Class B direc- For the name of the chair and deputy chair tors, who are elected by the stockholding of the board of directors of each Reserve member banks, and three Class C directors, Bank and of the chair of each Branch, see who are appointed by the Board of Gover- the preceding table, "Officers of Federal nors of the Federal Reserve System. Reserve Banks and Branches." Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 251 Directors BANK or Branch Term expires Titlp Director Dec. 31 DISTRICT 1—BOSTON Class A David S. Outhouse President and Chief Executive Officer, 2002 First and Ocean National Bank, Newburyport, Massachusetts Richard C. White Chairman, President, and Chief Executive Officer, 2003 Community National Bank, Derby, Vermont Lawrence K. Fish Chairman, President, and Chief Executive Officer, 2004 Citizens Financial Group, Inc., Providence, Rhode Island Class B Orit Gadiesh Chairman, Bain & Company, Inc., 2002 Boston, Massachusetts Sherwin Greenblatt Past President, Bose Corporation, 2003 Framingham, Massachusetts Blenda J. Wilson President and Chief Executive Officer, 2004 Nellie Mae Education Foundation, Quincy, Massachusetts Class C William O. Taylor Chairman Emeritus, The Boston Globe, 2002 Boston, Massachusetts James J. Norton Vice President, AFL-CIO, Washington, D.C. 2003 Samuel 0. Thier, M.D President and Chief Executive Officer, 2004 Partners HealthCare System, Inc., Boston, Massachusetts DISTRICT 2—NEW YORK Class A 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, Citigroup Inc., 2003 New York, New York Jill M. Considine Chairman and Chief Executive Officer, 2004 The Depository Trust Company, New York, New York Class B Ann M. Fudge Former Executive Vice President, Kraft Foods, Inc., and 2002 Former President, Coffee and Cereals Division, Tarrytown, New York Jerry I. Speyer President and Chief Executive Officer, 2003 Tishman Speyer Properties, New York, New York Ronay Menschel Chairman, Phipps Houses, New York, New York 2004 Class C Albert J. Simone President, Rochester Institute of Technology, 2002 Rochester, New York Gerald M. Levin Retired Chief Executive Officer, 2003 AOL Time Warner Inc., New York, New York Peter G. Peterson Chairman, The Blackstone Group, New York, New York 2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

252 89th Annual Report, 2002 Directors—Continued BANK or Branch Term expires Titif Director 1111C Dec. 31 Buffalo Branch Appointed by the Federal Reserve Bank 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 Emerson L. Brumback Executive Vice President, M&T Bank Corp., 2004 Buffalo, New York Appointed by the Board of Governors PatrickP.Lee Chairman and Chief Executive Officer, IMC, Inc., 2002 Buffalo, New York Katherine E. Keough President, St. John Fisher College, Rochester, New York 2003 Marguerite D. Hambleton .. President and Chief Executive Officer, 2004 AAA Western and Central New York, Williamsville, New York DISTRICT 3— PHILADELPHIA Class A Frank Kaminski, Jr. Retired Chairman, Atlantic Central Bankers Bank, 2002 Camp Hill, Pennsylvania Robert J. Vanderslice President and Chief Operating Officer, 2003 Pennsville National Bank, Pennsville, New Jersey Walter E. Daller, Jr. Chairman, President, and Chief Executive Officer, 2004 Harleysville National Corporation, Harleysville, Pennsylvania Class B 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 P. Coleman Townsend, Jr. .. Chairman and Chief Executive Officer, 2004 Townsends, Inc., Wilmington, Delaware Class C Ronald J. Naples Chairman and Chief Executive Officer, 2002 Quaker Chemical Corporation, Conshohocken, Pennsylvania Glenn A. Schaeffer President Emeritus, 2003 Pennsylvania Building and Construction Trades Council, Harrisburg, Pennsylvania Charisse R. Lillie Chair, Litigation Department, 2004 Ballard Spahr Andrews & Ingersoll, Philadelphia, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 253 BANK or Branch Term expires Title Director Dec. 31 DISTRICT 4—CLEVELAND Class A 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 John R. Cochran Chairman and Chief Executive Officer, 2004 FirstMerit Corporation, Akron, Ohio Class B 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 Wayne R. Embry Former President and Chief Operating Officer, 2004 Cleveland Cavaliers, Cleveland, Ohio Class C 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 David H. Hoag Former Chairman, The LTV Corporation, 2004 Cleveland, Ohio Cincinnati Branch Appointed by the Federal Reserve Bank V. Daniel Radford Executive Secretary-Treasurer, Cincinnati AFL-CIO 2002 Labor Council, Cincinnati, Ohio Mary Ellen Slone Chief Executive Officer and Chairman, 2002 Meridian Communications, Lexington, Kentucky Bick Weissenrieder Chairman of the Board and Chief Executive Officer, 2003 Hocking Valley Bank, Athens, Ohio James H. Booth President, Czar Coal Corporation, Lovely, Kentucky 2004 Appointed by the Board of Governors George C. Juilfs Chairman and Chief Executive Officer, 2002 SENCORP, Newport, Kentucky Charles Whitehead President, Ashland Inc. Foundation, 2003 Covington, Kentucky Herbert R. Brown Senior Vice President, Western and Southern Life 2004 Insurance Company, Cincinnati, Ohio Pittsburgh Branch Appointed by the Federal Reserve Bank Georgia Berner President, Berner International Corp., 2002 New Castle, Pennsylvania Peter N. Stephans Chairman and Chief Executive Officer, 2002 Trigon Incorporated, McMurray, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

254 89th Annual Report, 2002 Directors—Continued BANK or Branch Term expires Titif Director 1 lllc Dec. 31 Kristine N. Molnar President and Chief Executive Officer, 2003 WesBanco Bank, Inc., Wheeling, West Virginia Michael J. Hagan President and Chief Executive Officer, 2004 Iron and Glass Bank, Pittsburgh, Pennsylvania Appointed by the Board of Governors Charles E. Bunch President and Chief Operating Officer, 2002 PPG Industries, Inc., Pittsburgh, Pennsylvania James I. Mitnick Senior Vice President, Turner Construction Company, 2003 Pittsburgh, Pennsylvania Robert 0. Agbede President and Chief Executive Officer, 2004 Advanced Technology Systems, Inc., Pittsburgh, Pennsylvania DISTRICT 5—RICHMOND Class A 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 and Chief Executive Officer, 2003 St. Michaels Bank, St. Michaels, Maryland Eddie Canterbury President and Chief Executive Officer, 2004 Logan Bank & Trust Company, Logan, West Virginia Class B W. Henry Harmon President and Chief Executive Officer, 2002 Triana Energy, LLC, Charleston, West Virginia, and Union Drilling, Inc., Bridgeville, Pennsylvania James E. Haden President and Chief Executive Officer, 2003 Martha Jefferson Hospital, Charlottesville, Virginia Joe Edens Chairman, Edens & Avant, Columbia, South Carolina 2004 Class C Jeremiah J. Sheehan Retired Chairman, Reynolds Metals Company, 2002 Richmond, Virginia Wesley S. Williams, Jr. Partner, Covington & Burling, Washington, D.C. 2003 Irwin Zazulia Retired President and Chief Executive Officer, 2004 Hecht's, Arlington, Virginia Baltimore Branch Appointed by the Federal Reserve Bank Dyan Brasington President, Technology Council of Maryland, 2002 Rockville, Maryland 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 Donald P. Hutchinson President and Chief Executive Officer, 2004 SunTrust Bank, Maryland, Baltimore, Maryland Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 255 BANK or Branch Term expires Titlf Director 1 lllc Dec. 31 Appointed by the Board of Governors George L. Russell, Jr. Law Offices of Peter G. Angelos, Baltimore, Maryland 2002 William C. Handorf Professor of Finance, School of Business and Public 2003 Management, The George Washington University, Washington, D.C. Owen E. Herrnstadt Director, International Department, 2004 International Association of Machinists and Aerospace Workers, AFL-CIO, Upper Marlboro, Maryland Charlotte Branch Appointed by the Federal Reserve Bank Lucy J. Reuben Provost and Vice Chancellor for Academic Affairs, 2002 North Carolina Central University, Durham, North Carolina Elleveen T. Poston President, Quality Transport, Inc., 2003 Lake City, South Carolina Cecil W. Sewell, Jr Chairman Emeritus, RBC Centura Banks, Inc., 2003 Rocky Mount, North Carolina William H. Nock President and Chief Executive Officer, 2004 Sumter National Bank, Sumter, South Carolina Appointed by the Board of Governors 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 James F. Goodmon President and Chief Executive Officer, 2004 Capitol Broadcasting Company, Inc., Raleigh, North Carolina DISTRICT 6—ATLANTA Class A Richard G. Hickson Chairman 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 James F. Beall Chairman, President, and Chief Executive Officer, 2004 Farmers & Merchants Bank, Centre, Alabama Class B Egbert L. J. Perry Chairman and Chief Executive Officer, 2002 The Integral Group, LLC, Atlanta, Georgia John Dane III President and Chief Executive Officer, 2003 Trinity Yachts LLC, New Orleans, Louisiana Suzanne E. Boas President, Consumer Credit Counseling Service of 2004 Greater Atlanta, Inc., Atlanta, Georgia Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

256 89th Annual Report, 2002 Directors—Continued BANK or Branch Term expires Title Director Dec. 31 Class C 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 David M. Ratcliffe President and Chief Executive Officer, 2004 Georgia Power Company, Atlanta, Georgia Birmingham Branch Appointed by the Federal Reserve Bank W.Charles Mayer III Senior Executive Vice President, Alabama Banking 2002 Group Head, Commercial Banking Group Head, AmSouth Bank, Birmingham, Alabama Hundley Batts, Sr. Owner and Managing General Agent, 2003 Hundley Batts & Associates, HuntsviUe, Alabama James Austin Vickery International Representative, Laborers' International 2003 Union of Norm America, Gadsden, Alabama John B. Barnett III Chairman, The Monroe County Bank, 2004 Monroeville, Alabama Appointed by the Board of Governors V. Larkin Martin Managing Partner, Martin Farm, Couitland, Alabama 2002 W. Miller Welborn President, Welborn and Associates, Inc., 2003 Lookout Mountain, Tennessee Catherine Sloss Crenshaw .. President, Sloss Real Estate Group, Inc., 2004 Birmingham, Alabama Jacksonville Branch Appointed by the Federal Reserve Bank Jerry M. Smith Chairman and President, First National Bank of 2002 Alachua, Alachua, Florida Robert L. Fisher President and Chief Executive Officer, 2003 MacDill Federal Credit Union, Tampa, Florida Michael W. Poole Principal, Poole Carbone Eckbert, Inc., 2003 Winter Park, Florida Harvey R. Heller President, Heller Brothers Packing Corp., 2004 Winter Garden, Florida Appointed by the Board of Governors Marsha G. Rydberg Partner, The Rydberg Law Firm, Tampa, Florida 2002 William E. Flaherty Retired Chairman, Blue Cross and Blue Shield of 2003 Florida, Inc., Jacksonville, Florida Julie K. Hilton Vice President and Co-Owner, 2004 Paradise Found Resorts & Hotels, Panama City Beach, Florida Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 257 BANK or Branch Term expires Titlp Director l Hie Dec. 31 Miami Branch Appointed by the Federal Reserve Bank 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 Rudy E. Schupp Consultant, Florida Operations, Wachovia, N.A., 2004 North Palm Beach, Florida Appointed by the Board of Governors Mark T. Sodders President, Lakeview Farms, Inc., Pahokee, Florida 2002 Brian E. Keeley President and Chief Executive Officer, 2003 Baptist Health South Florida, Coral Gables, Florida Rosa Sugranes Chairman, Iberia Tiles Corp., Miami, Florida 2004 Nashville Branch Appointed by the Federal Reserve Bank Michael B. Swain President and Chief Executive Officer, 2002 First National Bank of Oneida, Oneida, Tennessee Emil Hassan Senior Vice President, North American Manufacturing, 2003 Purchasing, Quality and Logistics, Nissan North America, Inc., Smyrna, Tennessee James W. Spradley, Jr. President, Standard Candy Company, Inc., 2003 Nashville, Tennessee Sam O. Franklin III Chairman, SunTrust Bank, Nashville, 2004 Nashville, Tennessee Appointed by the Board of Governors 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 F. Rodney Lawler Co-Founder and Chief Executive Officer, 2004 Lawler-Wood, LLC, Knoxville, Tennessee New Orleans Branch Appointed by the Federal Reserve Bank C. R. Cloutier President and Chief Executive Officer, 2002 MidSouth Bank, Lafayette, Louisiana Ten 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 David E. Johnson Chairman and Chief Executive Officer, 2004 The First Bancshares, Inc., and the First National Bank of South Mississippi, Hattiesburg, Mississippi Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

258 89th Annual Report, 2002 Directors—Continued BANK or Branch Term expires Title Director Dec. 31 Appointed by the Board of Governors R. Glenn Pumpelly President and Chief Executive Officer, 2002 Pumpelly Oil Inc., Sulphur, Louisiana Ben Tom Roberts Senior Executive Vice President/Owner, 2003 Roberts Brothers, Inc., Realtors, Mobile, Alabama Dave Dennis President, Specialty Contractors & Assoc, Inc., 2004 Gulfport, Mississippi DISTRICT 7—CHICAGO Class A 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 Alan R. Tubbs President, Maquoketa State Bank and 2004 Ohnward Bancshares Inc., Maquoketa, Iowa Class B 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 James H. Keyes Chairman and Chief Executive Officer, 2004 Johnson Controls, Inc., Milwaukee, Wisconsin Class C Robert J. Darnall Retired Chairman and Chief Executive Officer, 2002 Inland Steel Industries, Inc., Chicago, Illinois W. James Farrell Chairman and Chief Executive Officer, 2003 Illinois Tool Works Inc., Glenview, Illinois MilesD. White Chairman and Chief Executive Officer, 2004 Abbott Laboratories, Abbott Park, Illinois Detroit Branch Appointed by the Federal Reserve Bank IrmaB. Elder President, Elder Ford, Troy, Michigan 2002 MarkT. Gaffney President, Michigan AFL-CIO, Lansing, Michigan 2002 David J. Wagner Chairman, Fifth Third Bank, Grand Rapids, Michigan 2003 Robert E. Churchill Chairman and Chief Executive Officer, 2004 Citizens National Bank, Cheboygan, Michigan Appointed by the Board of Governors Edsel B. Ford II Board Director, Ford Motor Company, 2002 Dearborn, Michigan Timothy D. Leuliette President and Chief Executive Officer, 2003 Metaldyne, Plymouth, Michigan IrvinD.Reid President, Wayne State University, Detroit, Michigan 2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 259 BANK or Branch Term expires Titip Director 1 lllc Dec. 31 DISTRICT 8—ST. LOUIS Class A 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 Lewis F. Mallory, Jr Chairman and Chief Executive Officer, 2004 National Bank of Commerce, Starkville, Mississippi Class B 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 Bert Greenwalt Partner, Greenwalt Company, Hazen, Arkansas 2004 Class C Gayle P. W. Jackson Managing Director, FondElec Clean Energy Group, Inc., 2002 St. Louis, Missouri Walter L. Metcalfe, Jr. Chairman, Bryan Cave LLP, St. Louis, Missouri 2003 Charles W. Mueller Chairman and Chief Executive Officer, 2004 Ameren Corporation, St. Louis, Missouri Little Rock Branch Appointed by the Federal Reserve Bank David R. Estes President and Chief Executive Officer, First State Bank, 2002 Lonoke, Arkansas Everett Tucker III Chairman, Moses Tucker Real Estate, Inc., 2002 Little Rock, Arkansas Raymond E. Skelton Regional President, U.S. Bank, N.A., 2003 Little Rock, Arkansas Lawrence A. Davis, Jr. Chancellor, University of Arkansas at Pine Bluff, 2004 Pine Bluff, Arkansas Appointed by the Board of Governors A. Rogers Yarnell II President, Yarnell Ice Cream Co., Inc., Searcy, Arkansas 2002 Vacancy 2003 Vick M. Crawley Plant Manager, Baxter Healthcare Corporation, 2004 Mountain Home, Arkansas Louisville Branch Appointed by the Federal Reserve Bank Thomas W. Smith President, Thomas W. Smith & Associates, Inc., 2002 Danville, Kentucky Marjorie Z. Soyugenc Executive Director and Chief Executive Officer, 2002 Welborn Foundation, Evansville, Indiana Frank J. Nichols Chairman, President, and Chief Executive Officer, 2003 Community Financial Services, Inc., Benton, Kentucky Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

260 89th Annual Report, 2002 Directors—Continued BANK or Branch Term expires Tiflp Director Dec. 31 David H. Brooks Chairman and Chief Executive Officer, 2004 Stock Yards Bank & Trust Company, Louisville, Kentucky Appointed by the Board of Governors J. Stephen Barger Executive Secretary-Treasurer, 2002 Kentucky State District Council of Carpenters, Frankfort, Kentucky Norman E. Pfau, Jr. President and Chief Executive Officer, 2003 Geo. Pfau's Sons Company, Inc., Jeffersonville, Indiana Cornelius A. Martin President and Chief Executive Officer, 2004 Martin Management Group, Bowling Green, Kentucky Memphis Branch Appointed by the Federal Reserve Bank James A. England Chairman, President, and Chief Executive Officer, 2002 Decatur County Bank, Decaturville, Tennessee TomA. Wright Chairman, President, and Chief Executive Officer, 2002 Enterprise National Bank, Memphis, Tennessee E. C. Neelly III Management Consultant, First American National Bank, 2003 Iuka, Mississippi Walter L. Morris, Jr. President, H&M Lumber Co., Inc., 2004 West Helena, Arkansas Appointed by the Board of Governors Mike P. Sturdivant, Jr. Partner, Due West, Glendora, Mississippi 2002 Russell Gwatney President, Gwatney Companies, Memphis, Tennessee 2003 Gregory M. Duckett Senior Vice President and Corporate Counsel, 2004 Baptist Memorial Health Care Corporation, Memphis, Tennessee DISTRICT 9— MINNEAPOLIS Class A Roger N. Berglund Chairman and President, Dakota Western Bank, 2002 Bowman, North Dakota Dan M. Fisher Chief Information Officer, Community First Bankshares, 2003 Inc., Fargo, North Dakota Kay Clevidence President, Farmers State Bank, Victor, Montana 2004 Class B 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 Jay F. Hoeschler President, Hoeschler Corporation, La Crosse, Wisconsin 2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 261 BANK or Branch Term expires Titif Director 11 lie Dec. 31 Class C Linda Hall Whitman Chief Executive Officer, QuickMedx, Inc., 2002 Minneapolis, Minnesota Ronald N. Zwieg President, United Food & Commercial Workers, 2003 Local 653, Plymouth, Minnesota Frank L. Sims Corporate Vice President, Transportation Cargill, Inc., 2004 Wayzata, Minnesota Helena Branch Appointed by the Federal Reserve Bank 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 Richard E. Hart President, Senior Lender, and Director, 2003 Mountain West Bank, Kalispell, Montana Appointed by the Board of Governors William P. Underriner President, Underriner Motors, Billings, Montana 2002 Tom Markle President and Chief Executive Officer, 2003 Markle's Inc., Glasgow, Montana DISTRICT 10— KANSAS CITY Class A Dennis E. Barrett Vice Chairman, FirstBank Holding Company 2002 of Colorado, Lakewood, Colorado Bruce A. Schriefer President, Bankers' Bank of Kansas, Wichita, Kansas 2003 Jeffrey L. Gerhart President and Chief Executive Officer, 2004 First National Bank, Newman Grove, Nebraska Class B 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 Frank Moore President, Spearhead Ranch Company, 2004 Douglas, Wyoming Class C Rhonda Holman Vice President, Kauffman Center for Entrepreneurial 2002 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 Richard H. Bard Founder and Manager, IdeaSpring, LLC, 2004 Denver, Colorado Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

262 89th Annual Report, 2002 Directors—Continued BANK or Branch Term expires Title Director Dec. 31 Denver Branch Appointed by the Federal Reserve Bank Virginia K. Berkeley President, Colorado Business Bank N. A., 2002 Denver, Colorado John W.Hay III President, Rock Springs National Bank, 2003 Rock Springs, Wyoming Kathryn A. Paul President, Delta Dental Plan of Colorado, 2003 Denver, Colorado Thomas Williams President and Chief Executive Officer, 2004 Williams Group LLC, Golden, Colorado Appointed by the Board of Governors Kathleen Avila Managing Member, Avila Retail Development & 2002 Management, Albuquerque, New Mexico Robert M. Murphy President, Sandia Properties Ltd., Co., 2003 Albuquerque, New Mexico James A. King Chief Executive Officer, BT, Inc., Riverton, Wyoming 2004 Oklahoma City Branch Appointed by the Federal Reserve Bank Robert A. Funk Chairman and Chief Executive Officer, 2002 Express Personnel Services International, Oklahoma City, Oklahoma Russell W. Teubner Founder and Director, Esker, Inc., StiUwater, Oklahoma 2003 Robert R. Gilbert III President and Chief Operating Officer, 2004 The F&M Bank & Trust Company, Tulsa, Oklahoma W. Carlisle Mabrey III President and Chief Executive Officer, 2004 Citizens Bank & Trust Co., Okmulgee, Oklahoma Appointed by the Board of Governors J. Clifford Hudson Chairman and Chief Executive Officer, Sonic Corp., 2002 Oklahoma City, Oklahoma Patricia B. Fennell Executive Director, Latino Community Development 2003 Agency, Oklahoma City, Oklahoma Vacancy 2004 Omaha Branch Appointed by the Federal Reserve Bank 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 CynthiaHardinMilligan ... Dean, College of Business Administration, 2004 University of Nebraska-Lincoln, Lincoln, Nebraska Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 263 BANK or Branch Term expires Director Dec. 31 Appointed by the Board of Governors 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 Timothy Sandos Former Vice President and State Executive Officer- 2004 Nebraska, Qwest Communications, Omaha, Nebraska DISTRICT 11—DALLAS Class A 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 David S. Barnard Chairman, National Bank, Gatesville, Texas 2004 Class B Malcolm Gillis President, Rice University, Houston, Texas 2002 Judy Ley Allen Partner, Allen Investments, Houston, Texas 2003 Julie Spicer England Vice President, Texas Instruments, Dallas, Texas 2004 Class C Patricia M. Patterson President, Patterson Investments, Inc., Dallas, Texas 2002 H. B. Zachry, Jr. Chairman and Chief Executive Officer, 2003 H. B. Zachry Company, San Antonio, Texas Ray L. Hunt Chairman, President, and Chief Executive Officer, 2004 Hunt Consolidated, Inc., Dallas, Texas El Paso Branch Appointed by the Federal Reserve Bank Melissa W. O'Rourke President, Charlotte's Inc., El Paso, Texas 2002 James D. Renfrow President and Chief Executive Officer, 2002 The Carlsbad National Bank, Carlsbad, New Mexico Ron C. Helm Owner, Helm Cattle Company, Van Horn, Texas 2003 F. James Volk President and Chief Executive Officer, 2004 State National Bank, El Paso, Texas Appointed by the Board of Governors James Haines Director and Vice Chairman, El Paso Electric Company, 2002 El Paso, Texas Gail Darling President, Gail Darling Inc., El Paso, Texas 2003 Cecilia 0. Levine President, MFI International Mfg., LLC, 2004 USA/Mexico Strategic Alliance, El Paso, Texas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

264 89th Annual Report, 2002 Directors—Continued BANK or Branch Term expires Title Director Dec. 31 Houston Branch Appointed by the Federal Reserve Bank RayB.Nesbitt President (Retired), Exxon Chemical Company, 2002 Houston, Texas PriscillaD.Slade President, Texas Southern University, Houston, Texas 2002 Alan R. Buckwalter III Chairman and Chief Executive Officer, 2003 Chase J.P. Morgan Bank, South Region, Houston, Texas Richard W. Weekley Chairman, Weekley Development Company, 2004 Houston, Texas Appointed by the Board of Governors Lupe Fraga President and Chief Executive Officer, 2002 Tejas Office Products, Inc., Houston, Texas Vacancy 2003 Edward 0. Gaylord Chairman, Jacintoport Terminal Company, 2004 Houston, Texas San Antonio Branch Appointed by the Federal Reserve Bank Mary Rose Cardenas 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 R. Tom Roddy Chairman Clear Lake National Bank, 2004 San Antonio, Texas Appointed by the Board of Governors Patty Puig Mueller Vice President-Finance, Mueller Energetics Corp., 2002 Corpus Christi, Texas Marvin L. Ragsdale President, Iron Workers District Council of the State 2003 of Texas, Georgetown, Texas Ron R. Harris President and Chief Executive Officer, 2004 Pervasive Software, Inc., Austin, Texas DISTRICT 12— SAN FRANCISCO Class A E. Lynn Caswell Chairman and Managing Director, Zurich American 2002 Trust Co., AG, Laguna Niguel, California Richard C. Hartnack Vice Chairman, Union Bank of California, 2003 Los Angeles, California Richard W. Decker, Jr. Chairman and Co-Founder, Belvedere Capital Partners, 2004 LLC, San Francisco, California Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 265 BANK or Branch Term expires Titip Director 11L1C Dec. 31 Class B Robert S. Attiyeh Senior Vice President, Chief Financial Officer (Retired), 2002 and Consultant, Amgen, Inc., Thousand Oaks, California Barbara L. Wilson Idaho and Regional Vice President (Retired), 2003 Qwest Corporation, Boise, Idaho JackMcNally Business Manager (Retired), IBEW Local Union 1245, 2004 and Principal, JKM Consulting, Sacramento, California Class C 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 Sheila D. Harris Director, Arizona Department of Housing, 2004 Phoenix, Arizona Los Angeles Branch Appointed by the Federal Reserve Bank John H. Gleason Regional President, California and Texas, 2002 Del Webb Group, Phoenix, Arizona Linda Griego Managing Partner, Engine Co. No. 28, 2003 Los Angeles, California D. Linn Wiley President and Chief Executive Officer, 2003 Citizens Business Bank, Ontario, California Russell Goldsmith Chairman and Chief Executive Officer, 2004 City National Bank, Beverly Hills, California Appointed by the Board of Governors Lori R. Gay President, Los Angeles Neighborhood Housing 2002 Services, Inc., Los Angeles, California Lonnie Kane President, Karen Kane, Inc., Los Angeles, California 2003 William D. Jones Chairman, President, and Chief Executive Officer, 2004 CityLink Investment Corporation, San Diego, California Portland Branch Appointed by the Federal Reserve Bank L. Martin Brantley President and General Manager (Retired), 2002 Oregon's 12-KPTV, Portland, Oregon Vacancy 2002 Peter 0. Kohler President, Oregon Health & Science University, 2003 Portland, Oregon George J. Passadore Chairman-Oregon, Wells Fargo Bank, Portland, Oregon 2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

266 89th Annual Report, 2002 Directors—Continued BANK or Branch Term expires Director 11UC Dec. 31 Appointed by the Board of Governors Nancy Wilgenbusch President, Marylhurst University, Marylhurst, Oregon 2002 Patrick Borunda Principal, The Navigator Group, Vancouver, Washington 2003 Karla S. Chambers Vice President, Stahlbush Island Farms, Inc., 2004 Corvallis, Oregon Salt Lake City Branch Appointed by the Federal Reserve Bank Maria Garciaz Executive Director, Salt Lake Neighborhood Housing 2002 Services, Inc., Salt Lake City, Utah J. Pat McMurray President and Chief Executive Officer, 2002 Idaho Region, Wells Fargo, Boise, Idaho Peggy A. Stock President Emeritus, Westminster College, 2003 Salt Lake City, Utah Curtis H. Harris Chairman, President, and Chief Executive Officer, 2004 Barnes Banking Company, Kaysville, Utah Appointed by the Board of Governors H. Roger Boyer Chairman, The Boyer Company, Salt Lake City, Utah 2002 William C. Glynn President, Intermountain Industries, Inc., Boise, Idaho 2003 Gary L. Crocker Chairman, ARUP Laboratories, Salt Lake City, Utah 2004 Seattle Branch Appointed by the Federal Reserve Bank James C. Hawkanson Chairman (Retired), The Commerce Bank of 2002 Washington, N.A., Seattle, Washington Mary E. Pugh President, Pugh Capital Management, Inc., 2002 Seattle, Washington Betsy Lawer Vice Chair and Chief Operating Officer, 2003 First National Bank Alaska, Anchorage, Alaska Peter H. van Oppen Chairman and Chief Executive Officer, 2004 Advanced Digital Information Corp., Redmond, Washington Appointed by the Board of Governors Boyd E. Givan Senior Vice President and Chief Financial Officer 2002 (Retired), The Boeing Company, Seattle, Washington David W. Wyckoff Chairman and Chief Executive Officer, 2003 Wyckoff Farms, Inc., Grandview, Washington Mic R. Dinsmore Chief Executive Officer, Port of Seattle, 2004 Seattle, Washington Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2002 267 Members of the Board of Governors, 1913-2002 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. JJ. 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

268 89th Annual Report, 2002 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 Term expired Jan. 31, 2002. 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 Ben S. Bernanke Atlanta Aug. 5, 2002 Donald L. Kohn Kansas City Aug. 5, 2002 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2002 269 Appointed Members—Continued Name Term Chairmen3 Charles S. Hamlin Aug. 10, 1914-Aug. 9, 1916 W.RG. 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- NOTE. Under the original Federal Reserve Act, the office on Aug. 23, 1935, continue to serve until Feb. 1, Federal Reserve Board was composed of five appointed 1936, or until their successors were appointed and had members, the Secretary of the Treasury (ex-officio chair- qualified; and that thereafter the terms of members be man of the Board), and the Comptroller of the Currency. fourteen years and that the designation of Chairman and The original term of office was ten years; the five original Vice Chairman of the Board be for four years. appointed members had terms of two, four, six, eight, and 1. Date following "Resigned" and "Retired" denotes ten years. In 1922 the number of appointed members was final day of service. increased to six, and in 1933 the term of office was raised 2. Successor took office on this date. to twelve years. The Banking Act of 1935 changed the 3. Before Aug. 23, 1935, Chairmen and Vice Chairname to the Board of Governors of the Federal Reserve men were designated Governor and Vice Governor. System and provided that the Board be composed of 4. Served as Chairman Pro Tempore from February 3, seven appointed members; that the Secretary of the Trea- 1948, to April 15, 1948. sury and the Comptroller of the Currency continue to 5. Served as Chairman Pro Tempore from March 3, serve until Feb. 1, 1936; that the appointed members in 1996, to June 20, 1996. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

270 89th Annual Report, 2002 Ex-Officio Members Name Term 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 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

272 89th Annual Report, 2002 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2002 and 2001 Millions of dollars Total Boston Item 2002 2001 2002 2001 ASSETS Gold certificate account 11,039 11,045 533 546 Special drawing rights certificate account 2,200 2,200 115 115 Coin 988 1,047 45 54 Loans To depository institutions 40 34 0 2 Other 0 0 0 0 Securities purchased under agreements to resell (triparty) 39,500 50,250 Federal agency obligations Bought outright 10 10 1 1 Held under repurchase agreements 0 0 0 0 U.S. Treasury securities Bought outright' 629,406 551,675 36,062 33,146 Held under repurchase agreements 0 0 0 0 Total loans and securities 668,956 601,969 36,062 33,149 Items in process of collection 11,498 3,829 1,002 317 Bank premises 1,542 1,512 91 91 Other assets Denominated in foreign currencies 2 16,913 14,559 964 757 Other3 20,112 20,819 973 1,076 Interdistrict settlement account 0 0 -6,558 -2,362 Total assets 733,249 656,980 33,227 33,743 LIABILITIES Federal Reserve notes outstanding (issued to Bank) . 759,256 751,540 32,969 35,614 Less: Notes held by Federal Reserve Bank 104,983 139,783 4,065 3,808 Federal Reserve notes, net 654,273 611,757 28,905 31,806 Securities sold under agreements to repurchase 21,091 1,208 Deposits Depository institutions 22,541 17,478 1,212 626 U.S. Treasury, general account 4,420 6,645 0 0 Foreign, official accounts 136 61 2 2 Other4 1,156 828 61 40 Total deposits 28,254 25,012 1,274 668 Deferred credit items 10,666 3,131 832 283 Other liabilities and accrued dividends5 2,205 2,395 135 149 Total liabilities 716,488 642,295 32^55 32,906 CAPITAL ACCOUNTS Capital paid in 8,380 7,373 436 418 Surplus 8,380 7,312 436 418 Other capital accounts 0 0 0 0 Total liabilities and capital accounts 733,249 656,980 33,227 33,743 FEDERAL RESERVE NOTE STATEMENT Federal Reserve notes outstanding 759,256 751,540 Less: Held by Bank not subject to collateralization 101,559 138,0006 Collateralized Federal Reserve notes 657,696 613,539 Collateral for Federal Reserve notes Gold certificate account 11,039 11,045 Special drawing rights certificate account 2,200 2,200 Other eligible assets 0 0 U.S. Treasury and federal agency securities 644,458 600,2946 Total collateral 657,696 613,539* For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 273 1.—Continued NewYork Philadelphia Cleveland Richmond 2002 2001 2002 2001 2002 2001 2002 2001 4,364 4,451 430 454 522 538 819 741 874 874 83 83 104 104 147 147 33 63 61 44 43 61 144 165 0 0 0 0 0 0 0 1 0 0 0 0 0 0 0 0 39,500 50,250 4 4 0 0 1 1 1 1 0 0 0 0 0 0 0 0 247,647 225,984 24,202 22,659 34,727 32,298 49,089 32,957 0 0 0 0 0 0 0 0 287,151 276,239 24,203 22,660 34,728 32,298 49,090 32,958 992 473 494 526 764 218 917 174 185 177 50 49 153 152 129 132 3,465 3,099 510 481 1,531 996 4,048 3,544 9,292 9,787 743 810 989 1,087 1,515 1,231 24,567 -29,004 -5,391 -2,239 -5,818 -2,008 -3,052 13,211 330,923 266,158 21,182 22,868 33,015 33,448 53,757 52,304 329,740 293,294 25,517 28,335 32,587 34,936 54,372 55,438 24,922 41,528 6,893 6,562 4,417 4,316 9,023 10,230 304,818 251,766 18,624 21,773 28,170 30,620 45,349 45,208 8,299 811 1,164 1,645 7,571 3,092 577 413 1,393 1,103 1,381 3,191 4,420 6,645 0 0 0 0 0 0 112 37 1 1 3 2 7 7 330 447 49 29 72 30 191 70 12,433 10,221 626 443 1,467 1,135 1,579 3,269 1,069 381 556 100 685 224 808 109 686 782 99 110 125 139 229 205 327,305 263,150 20,717 22,425 31,610 32,118 49,610 48,790 1,809 1,504 233 221 702 665 2,073 1,757 1,809 1,504 233 221 702 665 2,073 1,757 0 0 0 0 0 0 0 0 330,923 266,158 21,182 22,868 33,015 33,448 53,757 52,304 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

274 89th Annual Report, 2002 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2002 and 2001— Continued Millions of dollars Atlanta Chicago Item 2002 2001 2002 2001 ASSETS Gold certificate account 926 871 1,080 1,028 Special drawing rights certificate account 166 166 212 212 Coin 103 113 126 117 Loans To depository institutions 7 6 15 Other 0 0 0 0 Securities purchased under agreements to resell (triparty) 0 Federal agency obligations Bought outright 1 1 1 1 Held under repurchase agreements 0 0 0 0 US. Treasury securities Bought outright1 44,816 37,935 74,069 62,482 Held under repurchase agreements 0 0 0 0 Total loans and securities 44,825 37,943 74,076 62,497 Items in process of collection 748 149 1,169 526 Bank premises 279 281 116 105 Other assets Denominated in foreign currencies2 1,231 1,046 1,827 1,333 Other3 1,258 1,278 1,980 2,005 Interdistrict settlement account -1,692 7,088 -14,583 6,071 Total assets 47,844 48,934 66,004 73,895 LIABILITIES Federal Reserve notes outstanding (issued to Banks) 59,126 65,085 63,905 74,543 Less: Notes held by Federal Reserve Banks 16,757 18,763 7,397 6,424 Federal Reserve notes, net 42,368 46,323 56,508 68,119 Securities sold under repurchase agreements 1,502 2,482 Deposits Depository institutions 1,735 1,169 3,943 3,498 U.S. Treasury, general account 0 0 0 0 Foreign, official accounts 2 2 3 3 Other4 133 37 123 44 Total deposits 1,870 1,208 4,069 3,544 Deferred credit items 972 138 997 386 Other liabilities and accrued dividends5 182 196 232 258 Total liabilities 46,894 47,864 64,289 72,308 CAPITAL ACCOUNTS Capital paid in 475 535 858 793 Surplus 475 535 858 793 Other capital accounts 0 0 0 0 Total liabilities and capital accounts 47,844 48,934 66,004 73,895 NOTE. Components may not sum to totals because of back under matched sale-purchase transactions, which rounding were discontinued in December 2002. 1. Includes securities loaned—fully guaranteed by U.S. 2. Valued daily at market exchange rates. Treasury securities pledged with Federal Reserve Banks— 3. The System total includes depository institution overand excludes securities sold and scheduled to be bought drafts of $3 million for 2002 and $22 million for 2001. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 275 1.—Continued St. Louis Minneapolis Kansas City Dallas San Francisco 2002 2001 2002 2001 2002 2001 2002 2001 2002 2001 346 343 179 143 309 317 485 477 1,046 1,136 71 71 30 30 66 66 98 98 234 234 59 58 35 31 66 69 163 128 111 144 11 3 7 3 2 3 0 0 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 0 0 0 0 0 0 0 0 0 0 22,380 19,884 9,839 1,721 18,605 17,028 13,969 10,001 54,001 55,580 0 0 0 0 0 0 0 0 0 0 22,392 19,888 9,846 1,725 18,608 17,031 13,969 10,001 54,006 55,581 695 215 612 526 870 236 624 202 2,608 267 44 43 127 123 50 49 142 137 176 171 343 291 343 563 440 378 378 398 1,833 1,673 624 655 295 122 526 575 434 385 1,484 1,807 -3,554 721 4,063 12,065 -2,244 -358 14,306 4,041 -43 -7,226 21,021 22,286 15,530 15,329 18,691 18^63 30,599 15,866 61,456 53,788 22,002 24,022 15,088 16,070 19,979 21,077 36,839 33,441 67,131 69,686 3,088 2,586 1,785 2,015 3,854 4,117 8,424 19,062 14,359 20,372 18,914 21,435 13,304 14,055 16,125 16,960 28,416 14,378 52,772 49,314 750 330 623 468 1,810 480 344 430 460 822 758 727 695 2,273 2,129 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 3 3 34 22 2 0 33 24 24 31 105 54 514 366 433 462 855 783 752 727 2,381 2,187 346 79 713 457 598 135 505 349 2,584 490 99 107 72 57 88 103 85 83 173 206 20,623 21,988 14,851 15,031 18,289 17,981 30,226 15,538 59,719 52,196 199 149 340 180 201 191 186 164 868 796 199 149 340 118 201 191 186 164 868 796 0 0 0 0 0 0 0 0 0 0 21,021 22,286 15,530 15,329 18,691 18,363 30,599 15,866 61,456 53,788 4. Includes international organization deposits of 6. Amounts are restatements due to changes in previ- $100 million for 2002 and $127 million for 2001. These ously reported data. deposits are held solely by the Federal Reserve Bank of . . . Not applicable. New York. 5. Includes exchange-translation account reflecting the monthly revaluation at market exchange rates of foreign exchange commitments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

276 89th Annual Report, 2002 2. Federal Reserve Open Market Transactions, 2002 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 2,772 1,042 3,013 1,047 Gross sales 0 0 0 0 Exchanges 55,521 54,619 48,483 45,376 New bills 55,521 54,619 48,483 45,376 Redemptions 0 0 0 0 Others within 1 year Gross purchases 0 2,894 1,455 2,709 Gross sales 0 0 0 0 Maturity shift 5,850 7,537 0 14,515 Exchanges -5,766 -8,432 0 -15,522 Redemptions 0 0 0 0 0 to 5 years Gross purchases 2,872 1,101 2,181 1,142 Gross sales 0 0 0 0 Maturity shift -5,850 -6,283 0 -14,515 Exchanges 5,766 7,679 0 15,522 5 to 10 years Gross purchases 0 334 637 1,670 Gross sales 0 0 0 0 Maturity shift 0 -501 0 0 Exchanges 0 753 0 0 More than 10 years Gross purchases 582 1,054 291 210 Gross sales 0 0 0 0 Maturity shift 0 -753 0 0 Exchanges 0 0 0 0 All maturities Gross purchases 6,226 6,425 7,577 6,777 Gross sales 0 0 0 0 Redemptions 0 0 0 0 Net change in U.S. Treasury securities 6,226 6,425 7,577 6,777 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 277 2.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 3,524 3,656 4,838 529 750 0 250 0 21,421 0 0 0 0 0 0 0 0 0 70,978 53,015 45,828 63,083 53,314 62,947 51,394 53,374 657,931 70,978 53,015 45,828 63,083 53,314 62,947 51,394 53,374 657,931 0 0 0 0 0 0 0 0 0 2,826 0 1,104 445 1,286 0 0 0 12,720 0 0 0 0 0 0 0 0 0 6,714 0 11,052 8,987 11,174 6,143 3,688 0 0 -9,031 0 -14,183 -5,040 -15,189 -5,435 -1,419 0 0 0 0 0 0 0 0 0 0 0 1,439 0 1,755 1,921 0 0 0 339 12,748 0 0 0 0 0 0 0 0 0 -1,620 0 -11,052 -629 -11,174 -6,143 -2,380 0 0 8,639 0 13,283 3,396 15,189 5,435 1,308 0 0 259 542 577 690 51 0 0 314 5,074 0 0 0 0 0 0 0 0 0 -5,094 0 0 -6,714 0 0 722 0 0 391 0 900 1,645 0 0 111 0 0 0 0 63 80 0 0 0 0 2,280 0 0 0 0 0 0 0 0 0 0 0 0 -1,645 0 0 -2,030 0 0 0 0 0 0 0 0 0 0 0 8,048 4,198 8,336 3,665 2,087 0 250 653 54,242 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 8,048 4,198 8,336 3,665 2,087 0 250 653 54,242 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

278 89th Annual Report, 2002 2. Federal Reserve Open Market Transactions, 2002—Continued Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. FEDERAL AGENCY OBLIGATIONS Outright transactions Gross purchases Gross sales Redemptions Net change in agency obligations TEMPORARY TRANSACTIONS Repurchase agreementsx Gross purchases 118,550 101,749 70,850 102,200 Gross sales 131,300 104,750 75,849 100,200 Matched sale-purchase agreements Gross purchases 407,791 367,906 393,273 436,936 Gross sales 404,296 368,060 393,151 437,881 Reverse repurchase agreements2 Gross purchases 0 0 0 0 Gross sales 0 0 0 0 Net change in temporary transactions -9,255 -3,155 ^,877 1,056 Total net change in System Open Market Account. -3,030 3,270 2,700 7,833 NOTE. Sales, redemptions, and negative figures reduce 1. Cash value of agreements, which are collateralized holdings of the System Open Market Account; all other by U.S. government and federal agency securities. figures increase such holdings. Components may not sum 2. Cash value of agreements, which are collateralized to totals because of rounding. by U.S. Treasury securities. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 279 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 0 106,426 98,850 68,750 84,000 93,500 72,000 113,501 112,750 1,143,126 109,926 94,850 81,250 80,500 94,750 77,250 101,501 101,750 1,153,876 466,807 447,555 513,400 495,729 449,250 429,029 378,381 195,565 4,981,624 469,046 448,330 511,902 497,031 449,986 425,399 377,535 175,820 4,958,437 0 0 0 0 0 0 0 231,272 231,272 0 0 0 0 0 0 0 252,363 252,363 -5,738 3,225 -11,002 2,198 -1,986 -1,620 12,847 9,654 -8,654 2,310 7,423 -2,666 5,863 101 -1,620 13,096 10^07 45,588 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

280 89th Annual Report, 2002 3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2000-02 Millions of dollars December 31 Change Description 2001 to 2000 to 2002 2001 2000 2002 2001 U.S. TREASURY SECURITIES Held outright1 629,406 574363 532,815 54,543 42,048 By remaining maturity Bills 1-90 days 153,311 136,695 130,710 16,616 5,985 91 days to 1 year 73,372 68,567 69,143 4,805 -576 Notes and bonds 1 year or less 96,827 83,785 73,812 13,042 9,973 More than 1 year through 5 years 172,758 153,158 132,792 19,600 20,366 More than 5 years through 10 years 53,300 53,338 55,461 -38 -2,123 More than 10 years 79,840 79,320 70,896 520 8,424 By type Bills 226,682 205,262 199,854 21,420 5,408 Notes 297,893 265,941 240,177 31,952 25,764 Bonds 104,832 103,660 92,784 1,172 10,876 FEDERAL AGENCY SECURITIES Held outright1 10 10 130 -120 By remaining maturity 1 year or less 10 0 0 10 0 More than 1 year through 5 years 0 10 130 -10 -120 More than 5 years through 10 years 0 0 0 0 0 More than 10 years 0 0 0 0 0 By issuer Federal Home Loan Banks 0 0 0 0 Federal National Mortgage Association 10 10 130 -120 TEMPORARY TRANSACTIONS Repurchase agreements2 39,500 50,250 43,375 -10,750 6,875 Matched sale-purchase agreements Foreign official and international accounts 23,188 21,112 -23,188 2,076 Dealers 0 0 0 0 Reverse repurchase agreements3 Foreign official and international accounts 21,091 21,091 Dealers 0 0 NOTE. Components may not sum to totals because of 2. Cash value of agreements, which are coUateralized rounding. by U.S. government and federal agency securities. 1. Excludes the effects of temporary transactions— 3. Cash value of agreements, which are collateralized repurchase agreements and matched sale-purchase agree- by U.S. Treasury securities. ments (MSPs). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 281 4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2002 President Other officers Employees Total Federal Reserve Bank (including Number Branches) Salary Num- Salaries Salaries Num- Salaries (dollars)1 ber (dollars)1 Full- Part- (dollars)1 ber (dollars)1 time time Boston 247,500 74 10,151,114 1,111 152 63,320,113 1,338 73,718,727 New York 313,300 260 42,919,160 2,896 65 183,014,637 3,222 226,247,097 Philadelphia 224,300 57 7,533,500 1,120 50 51,228,840 1,228 58,986,640 Cleveland 244,500 55 7,015,525 1,317 43 57,433,719 1,416 64,693,744 Richmond 242,400 90 11,104,700 1,894 93 88,778,343 2,078 100,125,443 Atlanta 267,900 92 12,117,100 1,981 33 84,533,525 2,107 96,918,525 Chicago 272,700 95 12,630,586 1,943 72 104,536,952 2,111 117,440,238 St. Louis 228,7002 75 8,874,497 1,172 76 51,492,774 1,324 60,595,971 Minneapolis 254,100 42 5,587,900 1,163 120 54,199,997 1,326 60,041,997 Kansas City 248,600 71 8,993,500 1,544 58 71,205,673 1,674 80,447,773 Dallas 240,200 55 6,767,400 1,340 67 60,871,423 1,463 67,879,023 San Francisco ... 327,800 76 11,444,250 2,125 44 121,423,179 2,246 133,195,229 Federal Reserve Information Technology . 0 29 3,981,500 694 9 49,766,522 732 53,748,022 Office of Employee Benefits .... 0 6 1,117,250 26 0 1,870,401 32 2,987,651 Total 3,112,000 1,077 150,237,982 20,326 882 1,043,676,098 22,297 1,197,026,080 1. Annualized salary liability based on salaries in effect as $218,000 in table 4 of the 2001 Annual Report. The on December 31, 2002. correct annualized salary was $218,600. 2. The annualized salary for the President of the Federal Reserve Bank of St. Louis was reported incorrectly Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

282 89th Annual Report, 2002 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2002 Thousands of dollars Item Total Boston New York Philadelphia Cleveland CURRENT INCOME Loans 2,197 33 47 213 U.S. Treasury and federal agency securities 25,524,901 1,458,648 10,397,780 984,126 1,409,402 Foreign currencies 271,904 15,409 55,833 8,247 24,242 Priced services 916,252 53,983 100,154 45,672 66,456 Other 44,860 1,190 27,125 1,552 Total 26,760,113 1,529,263 10,580,938 1,038,932 1,501,865 CURRENT EXPENSES Salaries and other personnel expenses 1,342,260 79,730 252,819 65,558 68,413 Retirement and other benefits 363,660 38,401 123,407 23,909 25,904 Net periodic pension costs1 . -155,062 170 -156,844 120 167 Fees 67,352 4,244 5,621 1,250 3,789 Travel 57,719 2,555 6,515 2,012 3,696 Software expenses 110,683 4,391 11,735 2,645 10,361 Postage and other shipping costs 85,830 1,841 4,747 1,537 2,129 Communications 14,143 2,233 1,952 361 718 Materials and supplies 52,155 3,000 8,986 3,475 3,085 Building expenses Taxes on real estate 29,310 4,739 4,391 1,556 -451 Property depreciation 78,985 4,698 13,638 3,223 6,325 Utilities 30,892 2,628 5,495 2,523 2,058 Rent 37,033 802 13,441 320 394 Other 31,984 945 5,869 1,433 2,790 Equipment Purchases 26,284 2,108 3,384 1,305 1,407 Rentals 35,723 1,252 1,834 748 307 Depreciation 107,661 5,098 15,564 5,279 5,113 Repairs and maintenance 93,156 6,151 9,554 5,203 5,976 Earnings-credit costs 155,939 10,518 50,293 8,416 12,214 Other 67,230 4,138 12,231 3,099 3,698 Recoveries -77,915 -12,948 -8,927 -2,692 -2,614 Expenses capitalized2 -18,950 -758 -4,795 -735 -1,163 Total 2,536,073 165,934 380,911 130,546 154,315 Reimbursements -308,995 -25,357 -69,250 -20,049 -25,606 Net expenses 2,227,078 140,578 311,661 110,498 128,709 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 283 5.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 111 579 303 532 202 69 90 1,833,772 1,772,097 2,926,105 896,686 306,580 751,643 529,587 2,258,474 65,150 19,780 29,094 5,515 5,825 7,070 6,158 29,581 80,322 125,385 107,553 52,560 53,126 70,427 62,663 97,952 2,212 1,767 3,876 963 321 601 555 3,819 1,981,467 1,919,140 3,067,208 956,026 366,384 829,944 599,031 2,389,915 171,467 124,472 125,025 65,440 63,947 90,381 76,707 158,300 -139,475 44,305 45,324 39,423 35,902 38,514 33,243 54,803 245 164 142 142 130 158 135 211 25,485 6,844 6,564 794 6,289 1,588 1,663 3,220 7,700 6,779 6,027 2,966 3,969 4,183 3,300 8,018 43,704 5,061 11,643 4,181 2,747 3,284 3,950 6,979 3,713 47,709 4,458 2,845 3,021 4,329 2,483 7,016 1,526 1,186 1,806 907 721 727 919 1,087 6,163 5,805 4,962 3,410 1,786 3,202 3,544 4,736 1,918 3,892 2,833 383 3,790 603 2,502 3,153 7,095 10,074 6,597 4,288 4,161 4,014 5,967 8,905 2,898 2,726 2,347 1,612 1,677 1,321 2,190 3,419 14,353 890 2,743 1,028 142 1,471 1,272 178 3,740 3,138 5,271 999 1,464 764 2,662 2,909 3,725 2,618 2,732 1,548 1,546 1,617 1,633 2,662 27,637 858 896 196 764 235 238 759 29,373 10,193 7,669 4,575 3,915 6,007 4,366 10,509 18,819 11,976 9,473 3,911 3,540 3,362 5,190 10,000 20,328 6,806 19,946 3,392 3,575 5,469 3,689 11,294 9,536 6,477 7,340 3,293 3,076 4,254 4,051 6,038 -26,858 -3,598 -5,521 -1,735 -807 -1,534 -6,203 ^,478 -3,156 -1,256 -701 -665 -549 -1,528 -531 -3,113 229,936 297,117 267,575 142,934 144,808 172,421 152,970 296,605 -36,300 -13,223 -11,282 -38,277 -22,468 -15,959 -11,610 -19,617 193,637 283,894 256,293 104,657 122,340 156,462 141,361 276,988 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

284 89th Annual Report, 2002 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2002—Continued Thousands of dollars Item Total Boston New York Philadelphia Cleveland PROFIT AND LOSS Current net income 24,533,035 1,388,686 10,269,277 928,434 1,373,156 Additions to and deductions from (-) current net income3 Profits on sales of U.S. Treasury and federal agency securities 76,527 4,512 30,852 3,063 4,377 Profits on foreign exchange transactions 2,082,516 119,799 424,785 62,129 193,518 Other additions 3,484 4 3,235 1 3 Total additions 2,162,527 124,315 458,872 65,194 197,899 Losses on sales of U.S. Treasury and federal agency securities 0 0 0 0 0 Losses on foreign exchange transactions 0 0 0 0 0 Interest expense on reverse repurchase agreements -13,068 -749 -5,144 -503 -721 Other deductions -118 0 -82 -2 -2 Total deductions -749 -5,225 -504 -724 Net addition to or deduction from (-) -13,186 current net income 123,566 453,647 64,689 197,175 Cost of unreimbursed Treasury 2,149,341 services Assessments by Board 13 Board expenditures4 205,111 11,443 42,920 6,098 18,179 Cost of currency 429,568 22,487 177,353 15,310 21,611 Net income before payment to U.S. Treasury 26,047,684 1,478,321 10,502,637 971,716 1,530,542 Dividends paid 483,596 25,830 103,843 13,810 41,266 Payments to U.S. Treasury (interest on Federal Reserve notes) 24,495,490 1,434,682 10,093,923 946,441 1,451,626 Transferred to/from surplus 1,068,598 17,809 304,871 11,465 37,650 Surplus, January 1 7,311,522 418,391 1,504,031 221,361 664,687 Surplus, December 31 8,380,120 436,200 1,808,902 232,826 702,337 NOTE. Components may not sum to totals because of 2. Includes expenses for labor and materials capitalrounding. ized and depreciated or amortized as charges to activities 1. Reflects the effect of Financial Accounting Stan- in the periods benefited. dards Board Statement of Financial Accounting Stan- 3. 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 stale Reserve Bank checks that are written off. reduction in expenses of $157,159 thousand. The Benefit 4. For additional details, see the chapter "Board of Equalization Retirement Plan and the Supplemental Governors Financial Statements." Employees Retirement Plan are recorded by each Federal Reserve Bank. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 285 5.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 1,787,830 1,635,246 2,810,915 851,369 244,044 673,481 457,671 2,112,927 5,134 5,332 8,804 2,744 624 2,322 1,513 7,250 497,533 151,846 228,679 42,341 38,067 54,179 45,396 224,243 5 69 10 0 21 8 21 106 502,671 157,247 237,493 45,085 38,713 56,509 46,930 231,599 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -1,020 -926 -1,538 -465 -204 -386 -290 -1,122 -8 -13 -1 -1 -1 -2 -4 -1 -1,028 -938 -1,540 ^66 -205 -388 -294 -1,123 501,643 156,308 235,953 44,619 38,507 56,121 46,636 230,477 0 0 0 0 0 0 0 0 49,899 14,135 21,687 4,401 4,786 5,221 4,488 21,854 31,701 32,022 48,058 15,044 9,848 11,929 9,828 34,378 2,207,873 1,745,398 2,977,124 876,542 267,918 712,452 489,990 2,287,171 120,193 27,873 49,156 11,179 18,777 11,785 10,372 49,511 1,771,878 1,776,865 2,863,517 815,379 27,580 690,973 457,352 2,165,275 315,802 -59,340 64,451 49,984 221,561 9,694 22,267 72,386 1,757,409 534,584 793,150 149,052 118,076 190,959 164,015 795,807 2,073,211 475,244 857,601 199,035 339,637 200,652 186,282 868,193 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

286 89th Annual Report, 2002 6. Income and Expenses of the Federal Reserve Banks, 1914-2002 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 -4,442 723 1923 50,709 29,062 -8,233 703 1924 38,340 27,768 -6,191 663 1925 41,801 26,819 -4,823 709 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 -4,862 782 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 287 6.—Continued Payments to U.S. Treasury Dividends T Jl r l a u n ll s a f l p C r l r I p C d U T 1 r I a d n l l ^ o f l P C T i T lC PH U paid Statutory Interest on to surplus to surplus transfers 2 Federal Reserve (section 13b) (section 7) notes 217 1,743 6,804 1,134 '. '. '. ' iJ34 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

288 89th Annual Report, 2002 6. Income and Expenses of the Federal Reserve Banks, 1914-2002—Continued 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 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 ^9,616 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 2002 26,760,113 2,227,078 2,149,328 205,111 429,568 Total, 1914-2002 594,417,190 42,492,506 4,378,548 3,568,694 6,851,034 Aggregate for each Bank, 1914-2002 Boston 32,275,936 2,857,036 160,569 145,739 394,515 New York 202,526,500 6,360,7694 1,460,696 882,397 2,331,851 Philadelphia 22,370,492 2,329,674 105,590 153,563 265,160 Cleveland 37,468,955 2,702,150 236,225 249,593 412,717 Richmond 46,000,087 3,766,672 144,329 394,978 567,281 Atlanta 30,459,421 4,335,205 358,501 284,947 412,472 Chicago 74,551,863 5,448,459 572,925 428,964 810,225 St. Louis 20,723,931 2,188,134 74,585 92,904 253,781 Minneapolis 9,732,977 2,068,590 74,234 107,309 107,030 Kansas City 22,223,280 2,774,287 125,301 127,656 252,836 Dallas 27,466,412 2,780,416 402,746 201,661 298,097 San Francisco 68,617,336 4,881,114 662,846 498,980 745,068 Total 594,417,190 42,492,506 4,378,548 3,568,694 6,851,034 NOTE. Components may not sum to totals because of 2. Represents transfers made as a franchise tax from rounding. 1917 through 1932; transfers made under section 13b of ... Not applicable. the Federal Reserve Act from 1935 through 1947; and 1. For 1987 and subsequent years, includes the cost of transfers made under section 7 of the Federal Reserve Act services provided to the Treasury by Federal Reserve for 1996 and 1997. Banks for which reimbursement was not received. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 289 6.—Continued Payments to U.S. Treasury Transferred 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 5,5l'7,*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 27,089,222 517,580 483,596 0 24,495,490 1,068,598 5,986,552 44,113,958 483,309,206 -4 12,473,792 3 258,431 2,579,504 25,577,909 135 623,235 1,488,080 17,307,161 172,945,225 -433 2,672,148 264,879 1,312,118 17,775,458 291 374,939 433,911 2,827,043 30,091,201 -10 988,575 715,222 3,083,928 34,535,320 -72 3,081,086 452,324 2,713,230 21,850,351 5 769,388 703,616 4,593,811 61,904,183 12 1,235,517 156,577 1,833,837 15,971,723 -27 301,585 189,630 416,227 6,432,657 65 485,704 207,085 1,249,703 17,419,748 -9 317,276 311,869 1,510,802 22,440,242 55 326,015 804,928 4,686,594 56,365,188 -17 1,298,326 5,986,552 44,113,958 483309,206 -4 12,473,7923 3. The $12,473,792 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 $8,380,120 thousand on Decemfor contributions to capital of the Federal Deposit Insur- ber 31, 2002. ance Corporation (1934), $4 thousand net upon elimina- 4. This amount is reduced $2,653,914 thousand, which tion of section 13b surplus (1958), and $106,000 thou- is related to the System Retirement Plan. See note 1, sand (1996), $107,000 thousand (1997), and table 5. Digitized$ f3o,7r5 F2,R00A0S tEhoRus and (2000) transferred to the Treasury http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

290 89th Annual Report, 2002 7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks and Branches, December 31, 2002 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 22,074 102,508 17,448 142,030 91,350 NEW YORK 19,853 198,609 49,615 268,077 180,477 5,113 3,662 9,663 4,829 Buffalo 2,561 67,471 10,783 80,814 49,590 PHILADELPHIA . 3,112 118,732 23,275 145,118 118,565 CLEVELAND 2,247 19,190 9,652 31,089 14,244 Cincinnati 1,658 14,092 11,753 27,503 19,743 Pittsburgh RICHMOND 10,051 68,019 35,797 113,868 79,932 Baltimore 6,482 27,271 4,929 38,682 23,536 Charlotte 3,130 28,233 4,891 36,254 25,749 ATLANTA 22,770 148,994 15,571 187,335 181,488 Birmingham 7,110 45,481 3,239 55,830 53,262 Jacksonville 1,730 18,489 3,011 23,231 16,118 48 Miami 3,746 15,013 3,876 22,635 14,132 Nashville 629 3,673 3,197 7,498 3,743 New Orleans 3,776 8,489 4,320 16,584 10,617 CHICAGO 4,994 132,171 17,734 154,900 102,980 Detroit 4,565 8,945 3,814 17,325 12,743 ST. LOUIS 700 30,497 9,021 40,218 22,337 Little Rock 1,148 7,278 2,982 11,408 8,834 Louisville 800 4,761 2,068 7,629 4,309 Memphis 1,136 7,783 4,151 13,069 8,895 MINNEAPOLIS .. 14,581 103,282 13,494 131,358 116,293 Helena 2,621 9,640 937 13,198 10,447 KANSAS CITY .. 2,416 20,848 9,404 32,668 15,102 Denver 3,188 8,798 5,068 17,054 9,917 Oklahoma City ... 646 11,328 3,493 15,467 8,904 Omaha 6,535 12,080 2,359 20,974 16,388 DALLAS 29,049 107,984 20,375 157,408 124,835 El Paso 262 3,476 1,018 4,756 2,503 Houston 0 7,145 0 7,145 7,145 26,667 San Antonio 482 7,584 2,825 10,892 7,192 SAN FRANCISCO 15,600 89,732 19,536 124,868 80,569 Los Angeles 4,981 67,489 11,429 83,899 60,048 Portland 2,884 12,199 3,251 18,334 13,886 Salt Lake City .... 495 9,546 2,113 12,154 8,867 Seattle 380 13,220 4,699 18,298 12,867 Total 209,278 1,565,166 344,790 2,119,234 1,542,435 26,716 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. . . . Not applicable. 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 291 8. Operations in Principal Departments of the Federal Reserve Banks, 1999-2002 Operation 2002 2001 2000 1999 Millions of pieces (except as noted) Currency processed 34,208 33,740 31,505 29,032 Currency destroyed 8,363 7,850 8,179 7,257 Coin received' 4,621 6,321 5,138 6,719 Checks handled U.S. government checks 289 346 262 288 Postal money orders 216 229 230 226 Other 16,587 16,905 16,994 17,075 Government securities transfers 17 15 14 13 Transfer of funds 115 112 108 103 Automated clearinghouse transactions Commercial 4,986 4,448 3,812 3,344 Government 883 900 838 809 Food stamps redeemed 500 587 686 1,158 Millions of dollars Currency processed 565,302 540,746 542,567 444,234 Currency destroyed 92,511 86,298 112,164 82,951 Coin received1 602 767 666 778 Checks handled U.S. government checks 307,627 333,849 282,791 306,077 Postal money orders 30,161 30,461 30,036 29,118 Other 15,033,298 14,853,072 13,849,084 13,788,037 Government securities transfers 228,907,121 212^43,034 188,133,178 179,486,282 Transfer of funds 405,761,750 423,606,365 379,756,389 343,381,658 Automated clearinghouse transactions Commercial 13,135,350 12,707,247 11,619,954 10,862,424 Government 2,711,384 2,528,562 2,404,491 2,233,279 Food stamps redeemed 2,543 2,989 3,414 6,221 NOTE. Amounts in bold are restatements due to errors 1. Does not include coin activity at Federal Reserve in previously reported data. off-site coin terminals. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

292 89th Annual Report, 2002 9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2002 Extended credit3 Adjustment Seasonal Reserve Bank credit1 credit2 First thirty After thirty days of days of borrowing borrowing All Federal Reserve Banks 0.75 1.30 0.75 1.80 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. applied. Effective January 9, 2003, the adjustment credit Extended-credit loans outstanding more than thirty program will be discontinued. days will be charged a flexible rate somewhat above rates 2. Seasonal credit is available to help smaller deposi- on market sources of funds; the rate will always be at tory institutions meet regular seasonal needs for funds least 50 basis points above the discount rate applicable to that cannot be met through special industry lenders and adjustment credit. The flexible rate is reestablished on the that arise from a combination of expected patterns of first business day of each two-week reserve maintenance movement in their deposits and loans. The discount rate period. At the discretion of the Federal Reserve Bank, the on seasonal credit takes into account rates on market flexible rate may be charged on extended-credit loans that sources of funds and ordinarily is reestablished on the are outstanding less than thirty days. Effective January 9, first business day of each two-week reserve maintenance 2003, the extended credit program will be discontinued. period; however, it is never lower than the discount rate applicable to adjustment credit. Until January 9,2003, see section 201.3(b) of Regulation A. Effective January 9, 2003, see section 201.4(c) of Regulation A. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 293 10. Reserve Requirements of Depository Institutions, December 31, 2002 Requirements Type of deposit Percentage of deposits Effective date Net transaction accounts' $0 million-$6 million2 0 12-26-02 More than $6 million-$42.1 million3 3 12-26-02 More than $42.1 million4 10 12-26-02 Nonpersonal time deposits5 0 12-27-90 Eurocurrency liabilities6 0 12-27-90 NOTE. Required reserves must be held in the form of tions that report quarterly, the exemption was raised from deposits with Federal Reserve Banks or vault cash. Non- $5.7 million to $6.0 million. member institutions may maintain reserve balances with a 3. The Monetary Control Act of 1980 requires that the Federal Reserve Bank indirectly, on a pass-through basis, amount of transaction accounts against which the 3 perwith certain approved institutions. For previous reserve cent reserve requirement applies be modified annually by requirements, see earlier editions of the Annual Report or 80 percent of the percentage change in transaction the Federal Reserve Bulletin. Under the Monetary Con- accounts held by all depository institutions, determined as trol Act of 1980, depository institutions include commer- of June 30 each year. Effective with the reserve maintecial banks, savings banks, savings and loan associations, nance period beginning December 26, 2002, for deposicredit unions, agencies and branches of foreign banks, tory institutions that report weekly, and with the reserve and Edge Act corporations. maintenance period beginning January 16, 2003, for insti- 1. Transaction accounts include all deposits against tutions that report quarterly, the amount was increased which the account holder is permitted to make withdraw- from $41.3 million to $42.1 million. als by negotiable or transferable instruments, payment 4. 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 5. 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. Under the Garn-St Germain Depository Institutions period that began December 27, 1990. For institutions Act of 1982, the Board adjusts the amount of reservable that report quarterly, the reserve requirement on nonperliabilities subject to a zero percent reserve requirement sonal time deposits with an original maturity of less than each year for the succeeding calendar year by 80 percent 1.5 years was reduced from 3 percent to zero on Janof the percentage increase in the total reservable liabilities uary 17, 1991. of all depository institutions, measured on an annual basis The reserve requirement on nonpersonal time deposits as of June 30. No corresponding adjustment is made in with an original maturity of 1.5 years or more has been the event of a decrease. The exemption applies only to zero since October 6, 1983. accounts that would be subject to a 3 percent reserve 6. The reserve requirement on eurocurrency liabilities requirement. Effective with the reserve maintenance was reduced from 3 percent to zero in the same manner period beginning December 26, 2002, for depository and on the same dates as the reserve requirement on institutions that report weekly, and with the reserve main- nonpersonal time deposits with an original maturity of tenance period beginning January 16, 2003, for institu- less than 1.5 years (see note 5). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

294 89th Annual Report, 2002 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 Con b v o e 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 295 12. Principal Assets and Liabilities and Number of Insured Commercial Banks in the United States, by Class of Bank, June 30, 2002 and 2001 Millions of dollars, except as noted Member banks Nonmember Item Total banks Total National State 2002 ASSETS Loans and investments 4,798,152 3,755,257 2,673,168 1,082,089 1,042,895 Loans, gross 3,594,011 2,852,608 2,056,938 795,670 741,402 Net 3,591,278 2,850,558 2,055,165 795,393 740,720 Investments 1,204,142 902,649 616,231 286,418 301,493 U.S. Treasury and federal agency securities 248,538 153,103 78,284 74,819 95,435 Other 955,604 749,546 537,946 211,600 206,058 Cash assets, total 263,009 215,087 154,757 60,330 47,922 LIABILITIES Deposits, total 3,754,435 2,862,152 2,024,281 837,871 892,282 Interbank 54,619 44,810 31,320 13,490 9,809 Other transaction 605,321 450,257 325,710 124,547 155,064 Other nontransaction 3,094,494 2,367,085 1,667,251 699,834 727,409 Equity capital 605,538 486,215 345,079 141,135 119,323 Number of banks 7,944 3,049 2,101 948 4,895 2001 ASSETS Loans and investments 4,561,478 3,527,620 2,508,999 1,018,621 1,033,858 Loans, gross 3,523,938 2,775,703 2,022,579 753,124 748,235 Net 3,521,844 2,774,486 2,021,670 752,816 747,358 Investments 1,037,540 751,917 486,420 265,497 285,623 U.S. Treasury and federal agency securities 233,187 148,577 79,672 68,905 84,610 Other 804,353 603,340 406,748 196,592 201,013 Cash assets, total 257,196 210,439 151,083 59,356 46,757 LIABILITIES Deposits, total 3,529,783 2,645,449 1,887,121 758,327 884,334 Interbank 55,952 47,276 33,538 13,738 8,676 Other transaction 607,288 457,860 332,383 125,477 149,428 Other nontransaction 2,866,543 2,140,313 1,521,200 619,113 726,230 Equity capital 546,344 432,167 302,733 129,434 114,178 Number of banks 8,152 3,146 2,172 974 5,006 NOTE. Data are the domestic assets and liabilities basis only). Components may not sum to totals because of (except for those components reported on a consolidated rounding. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

296 89th Annual Report, 2002 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-2002 and Month-End 2002 Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Spe- U.S. Treasury and cial Treafederal agency securities draw- sury Period ing curu H n e d l e d r Loans Float3 ot A he ll 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 g r a h t t i t e f s - s r t o e a n u n c t d - y - Total o B u o tr u ig g h h t t 1 r c e h p a u s r e - assets5 co ac u - nt ing7 agreement2 1918.. 239 239 0 1,766 199 294 2,498 2,873 1,795 1919.. 300 300 0 2,215 201 575 3,292 2,707 1,707 1920.. 287 287 0 2,687 119 262 3,355 2,639 1,709 1921.. 234 234 0 1,144 40 146 1,563 3,373 1,842 1922.. 436 436 0 618 78 273 1,405 3,642 1,958 1923.. 134 80 54 723 27 355 1,238 3,957 2,009 1924.. 540 536 4 320 52 390 1,302 4,212 2,025 1925.. 375 367 643 63 378 1,459 4,112 1,977 1926.. 315 312 3 637 45 384 1,381 4,205 1,991 1927.. 617 560 57 582 63 393 1,655 4,092 2,006 1928.. 228 197 31 1,056 24 500 1,809 3,854 2,012 1929.. 511 23 632 34 405 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 2,274 21,995 3,087 1941.. 2,254 2,254 0 3 94 10 2,361 22,737 3,247 1942.. 6,189 6,189 0 6 471 14 6,679 22,726 3,648 1943.. 11,543 11,543 0 5 681 10 12,239 21,938 4,094 1944.. 18,846 18,846 0 815 4 19,745 20,619 4,131 1945.. 24,252 24,252 0 249 578 2 15,091 20,065 4,339 1946.. 23,350 23,350 0 163 580 1 24,093 20,529 4,562 1947.. 22,559 22,559 0 85 535 1 23,181 22,754 4,562 1948.. 23,333 23,333 0 223 541 1 24,097 24,244 4,589 1949.. 18,885 18,885 0 78 534 2 19,499 24,427 4,598 1950.. 20,778 20,725 53 67 1,368 3 22,216 22,706 4,636 1951.. 23,801 23,605 196 19 1,184 5 25,009 22,695 4,709 1952.. 24,697 24,034 663 156 967 4 25,825 23,187 4,812 1953.. 25,916 25,318 598 28 935 2 26,880 22,030 4,894 1954.. 24,932 24,888 44 143 1 25,885 21,713 4,985 1955.. 24,785 24,391 394 108 1,585 29 26,507 21,690 5,008 1956.. 24,915 24,610 305 50 1,665 70 26,699 21,949 5,066 1957.. 24,238 23,719 519 55 1,424 66 25,784 22,781 5,146 1958.. 26,347 26,252 95 64 1,296 49 27,755 20,534 5,234 1959.. 26,648 26,607 41 458 1,590 75 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 297 13.—Continued Factors absorbing reserve funds Deposits, other Member bank than reserves, with Federal Reserve Banks reserves10 Cur- Re- Other Reverse Trea- Other Federal rency repur- sury Federal quired Reserve in chase cash Reserve ciear- liacir- agree- hold- ac- ing bilities With Curc t u io la n - ments8 ings9 T su re r a y - F ei o g r n - Other counts 5 a b n a c l e - s ca a p n it d al5 R Fe e d se e r r v a e l re a n n c d y qu R ir e ed - 12 ce E s x s1 - 2 Banks coin" 4,951 0 288 51 96 25 118 0 0 1,636 0 1,585 51 5,091 0 385 51 73 28 208 0 0 1,890 0 1,822 68 5,325 0 218 57 5 18 298 0 0 1,781 0 0 0 4,403 0 214 96 12 15 285 0 0 1,753 0 1,654 99 4,530 0 225 11 3 26 276 0 0 1,934 0 0 0 4,757 0 213 38 4 19 275 0 0 1,898 0 1,884 14 4,760 0 211 51 19 20 258 0 0 2,220 0 2,161 59 4,817 0 203 16 8 21 272 0 0 2,212 0 2,256 -44 4,808 0 201 17 46 19 293 0 0 2,194 0 2.250 -56 4,716 0 208 18 5 21 301 0 0 2,487 0 2,424 63 4,686 0 202 23 6 21 348 0 0 2,389 0 2,430 -41 4,578 0 216 29 6 24 393 0 0 2,355 0 2,428 -73 4,603 0 211 19 6 22 375 0 0 2,471 0 2,375 96 5,360 0 222 54 79 31 354 0 0 1,961 0 1,994 -33 5,388 0 272 8 19 24 355 0 0 2,509 0 1,933 576 5,519 0 284 3 4 128 360 0 0 2,729 0 1,870 859 5,536 0 3,029 121 20 169 241 0 0 4,096 0 2,282 1,814 5,882 0 2,566 544 29 226 253 0 0 5,587 0 2,743 2,844 6,543 0 2,376 244 99 160 261 0 0 6,606 0 4,622 1,984 6,550 0 3,619 142 172 235 263 0 0 7,027 0 5,815 1,212 6,856 0 2,706 923 199 242 260 0 0 8,724 0 5,519 3,205 7,598 0 2,409 634 397 256 251 0 0 11,653 0 6,444 5,209 8,732 0 2,213 368 1,133 599 284 0 0 4,026 0 7,411 6,615 11,160 0 2,215 867 774 586 291 0 0 12,450 0 9,365 3,085 15,410 0 2,193 799 793 485 256 0 0 13,117 0 11,129 1,988 20,499 0 2,303 579 1,360 356 339 0 0 12,886 0 11,650 1,236 25,307 0 2,375 440 1,204 394 402 0 0 14,373 0 12,748 1,625 28,515 0 2,287 977 862 446 495 0 0 15,915 0 14,457 1,458 28,952 0 2,272 393 508 314 607 0 0 16,139 0 15,577 562 28,868 0 1,336 870 392 569 563 0 0 17,899 0 16,400 1,499 28,224 0 1,325 1,123 642 547 590 0 0 20,479 0 19,277 1,202 27,600 0 1,312 821 767 750 106 0 0 16,568 0 15,550 1,018 27,741 0 1,293 668 895 565 714 0 0 17,681 0 16,509 1,172 29,206 0 1,270 247 526 363 746 0 0 20,056 0 19,667 389 30,433 0 1,270 389 550 455 777 0 0 19,950 0 20,520 -570 30,781 0 761 346 423 493 839 0 0 20,160 0 19,397 763 30,509 0 796 563 490 441 907 0 0 18,876 0 18,618 258 31,158 0 767 394 402 554 925 0 0 19,005 0 18,903 102 31,790 0 775 441 322 426 901 0 0 19,059 0 19,089 -30 31,834 0 761 481 356 246 998 0 0 19,034 0 19,091 -57 32,193 0 683 358 272 391 1,122 0 0 18,504 0 18,574 -70 32,591 0 391 504 345 694 841 0 0 18,174 310 18,619 -135 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

298 89th Annual Report, 2002 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-2002 and Month-End 2002—Continued Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Spe- U.S. Treasury and cial Treafederal agency securities draw- sury Period ing curu H n e d l e d r Loans Float* 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 e i c g r a h t t i t e f s - s r t o e a u n n t c d - y - Total o B u o tr u ig g h h t t 1 r c e h p a u s r e - co ac u - nt agreement2 27,384 26,984 400 33 1,847 74 0 29,338 17,767 5,398 28,881 30,478 159 130 2,300 51 0 31,362 16,889 5,585 30,820 28,722 342 38 2,903 110 0 33,871 15,978 5,567 33,593 33,582 11 63 2,600 162 0 36,418 15,513 5,578 37,044 36,506 538 186 2,606 94 0 39,930 15,388 5,405 40,768 40,478 290 137 2,248 187 0 43,340 13,733 5,575 44,316 43,655 661 173 2,495 193 0 47,177 13,159 6,317 49,150 48,980 170 141 2,576 164 0 52,031 11,982 6,784 52,937 52,937 0 186 3,443 58 0 56,624 10,367 6,795 57,154 7,1545 0 183 3,440 64 2,743 64,584 10,367 6,852 62,142 62,142 0 335 4,261 57 1,123 67,918 10,732 400 7,147 70,804 69,481 1,323 39 4,343 261 1,068 76,515 10,132 400 7,710 71,230 71,119 111 1,981 3,974 106 1,260 78,551 10,410 400 8,313 80,495 80,395 100 1,258 3,099 68 1,152 86,072 11,567 400 8,716 85,714 84,760 954 299 2,001 999 3,195 92,208 11,652 400 9,253 94,124 92,789 1,335 211 3,688 1,126 3,312 102,461 11,599 500 10,218 104,093 100,062 4,031 25 2,601 991 3,182 110,892 11,598 1,200 10,810 111,274 108,922 2,352 265 3,810 954 2,442 118,745 11,718 1,250 11,331 118,591 117,374 1,217 1,174 6,432 587 4,543 131,327 11,671 1,300 11,831 126,167 124,507 1,660 1,454 6,767 704 5,613 140,705 11,172 1,800 13,083 130,592 128,038 2,554 1,809 4,467 776 8,739 146,383 11,160 2,518 13,427 140,348 136,863 3,485 1,601 1,762 195 9,230 153,136 11,151 3,318 13,687 148,837 144,544 4,293 717 2,735 1,480 9,890 63,659 11,148 4,618 13,786 160,795 159,203 1,592 918 1,605 418 8,728 172,464 11,121 4,618 15,732 169,627 167,612 2,015 3,577 833 0 12,347 186,384 11,096 4,618 16,418 191,248 186,025 5,223 3,060 0 15,302 210,598 11,090 4,718 17,075 221,459 205,454 16,005 1,565 1,261 0 17,475 241,760 11,084 5,018 17,567 231,420 226,459 4,961 3,815 811 0 15,837 251,883 11,078 5,018 18,177 247,489 240,628 6,861 2,170 1,286 0 18,803 269,748 11,060 5,018 18,799 235,417 233,300 2,117 481 1,093 0 39,631 276,622 11,059 8,518 19,628 259,785 241,431 18,354 190 2,566 0 39,880 302,421 11,058 10,018 20,402r 288,429 272,531 15,898 218 1,026 0 34,524 324,197 11,059 10,018 21,014r 308,517 300,423 8,094 675 3,350 0 30,278 342,820 11,056 8,018 21,447r 349,866 336,654 13,212 94 963 0 33,394 384,317 11,053 8,018 22,095 < 378,746 368,156 10,590 223 740 0 33,441 413,150 11,051 8,018 22,994r 394,693 380,831 13,862 135 231 0 33,483 428,543 11,050 10,168 24,003r 414,715 393,132 21,583 85 5,297 0 32,222 452,319 11,048 9,718 24,966r 455,260 431,420 23,840 2,035 561 0 32,044 489,901 11,047 9,200 25,543 ' 482,854 452,478 30,376 17 1,009 0 37,692 521,573 11,046 9,200 26,270 618,784 478,144 140,640 233 407 0 34,799 654,223 11,048 6,200 28,013 555,208 511,833 43,375 110 795 0 36,8% 593,009 11,046 2,200 31,219 601,935 551,685 50,250 34 698 0 36,885 639,552 11,045 2,200 33,195 668,916 629,416 39,500 40 832 0 38,574 708,363 11,039 2,200 34,497 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 299 13.—Continued Factors absorbing reserve funds Deposits, other Member bank than reserves, with Federal Reserve Banks reserves10 Cur- Re- Other Reverse Trea- Other Federal rency repur- sury Federal quired Reserve in chase cash Reserve rciipeaarr- liacir- agree- hold- ac- ing bilities With Curc t u io la n - ments8 ings9 T su re r a y - F ei o g r n - Other counts 5 a b n a c l e - s ca a p n it d al5 R Fe e d se e r r v a e l re a n n c d y qu R ir e ed - 12ces E s x 12 - '13 Banks coin11 32,869 0 377 485 217 533 941 0 0 17,081 2,544 18,988 637 33,918 0 422 465 279 320 1,044 0 0 17,387 2,544 18,988 96 35,338 0 380 597 247 393 1,007 0 0 17,454 3,262 20,071 645 37,692 0 361 880 171 291 1,065 0 0 17,049 4,099 20,677 471 39,619 0 612 820 229 321 1,036 0 0 18,086 4,151 21,663 574 42,056 0 760 668 150 355 211 0 0 18,447 4,163 22,848 -238 44,663 0 1,176 416 174 588 -147 0 0 19,779 4,310 24,321 -232 47,226 0 1,344 1,123 135 563 -773 0 0 21,092 4,631 25,905 -182 50,961 0 695 703 216 747 -1,353 0 0 21,818 4,921 27,439 -700 53,950 0 596 1,312 134 807 0 0 1,919 22,085 5,187 28,173 -901 57,903 0 431 1,156 148 1,233 0 0 1,986 24,150 5,423 30,033 -460 61,068 0 460 2,020 294 999 0 0 2,131 27,788 5,743 32,496 1,035 66,516 0 345 1,855 325 840 0 0 2,143 25,647 6,216 32,044 9813 72,497 0 317 2,542 251 1,41914 0 0 2,669 27,060 6,781 35,268 -1,360 79,743 0 185 2,113 418 1,27514 0 0 2,935 25,843 7,370 37,011 -3,798 86,547 0 483 7,285 353 1,090 0 0 2,968 26,052 8,036 35,197 -1,10315 93,717 0 460 10,393 352 1,357 0 0 3,063 25,158 8,628 35,461 -1,535 103,811 0 392 7,114 379 1,187 0 0 3,292 26,870 9,421 37,615 -1,265 114,645 0 240 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 0 441 3,062 411 617 0 0 4,671 27,456 13,654 40,558 675 144,774 0 443 4,301 505 781 0 117 5,261 25,111 15,576 42,145 -1,442 154,908 0 429 5,033 328 1,033 0 436 4,990 26,053 16,666 41,391 1,328 171,935 0 479 3,661 191 851 0 1,013 5,392 20,413 17,821 39,179 -945 183,796 0 513 5,316 253 867 0 1,126 5,952 20,693 197,488 0 550 9,351 480 1,041 0 1,490 5,940 27,141 211,995 0 447 7,588 287 917 0 1,812 6,088 46,295 230,205 0 454 5,313 244 1,027 0 1,687 7,129 40,097 247,649 0 395 8,656 347 548 0 1,605 7,683 37,742 260,456 0 450 6,217 589 1,298 0 1,618 8,486 36,713 286,963r 0 561 8,960 369 242 0 1,962 8,147 36,696 307,756' 0 636 17,697 968 1,706 0 3,949 8,113 25,464 334/701' 0 508 7,492 206 372 0 5,898 7,984 26,181 n.a. n.a. n.a. 365,271r 0 377 14,809 386 397 0 6,332 9,292 28,619 403,843' 0 335 7,161 250 876 0 4,197 11,959 26,592 424,244' 0 270 5,979 386 932 0 5,167 12,342 24,444 450,648' 0 249 7,742 167 892 0 6,601 13,829 17,923 482,327' 0 225 5,444 457 900 0 6,665' 15,500 24,173' 517,484 0 85 6,086 167 1,605 0 6,784 16,354 19,522 628,359 0 109 28,402 71 1,261 0 7,482' 17,256 16,545' 593,694' 0 450 5,149 216 1,382 0 6,332 17,962 12,713 643,301' 0 425 6,645 61 820 0 8,534 17,083 8,944 687,418 21,091 367 4,420 136 1,152 0 10,533 18,977 12,004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

300 89th Annual Report, 2002 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-2002 and Month-End 2002—Continued Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Spe- U.S. Treasury and cial Treafederal agency securities draw- sury Period ing curu 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 e i c g r a h t t i t e f s - s r t o e a u n n t c d - y - Total Bought repur- assets5 ac- ing' outright1 chase count agreement2 2002 Jan 598,886 561,386 37,500 19 4,272 0 37,744 640,921 11,045 2,200 33,471 Feb 602,143 567,644 34,499 68 -912 0 35,404 636,702 11,044 2,200 33,549 Mar. .... 604,866 575,366 29,500 20 -339 0 37,571 642,117 11,044 2,200 33,630 612,818 581,318 31,500 72 -81 0 38,605 651,415 11,044 2,200 33,710 May'.'.'.'.'. 615,199 587,199 28,000 124 -618 0 36,674 651,379 11,044 2,200 33,871 June 622,693 590,693 32,000 184 -79 0 39,188 661,986 11,044 2,200 33,995 July .... 619,965 600,465 19,500 186 -815 0 39,712 659,047 11,038 2,200 33,995 Aug 625,836 602,836 23,000 330 31 0 37,887 664,083 11,038 2,200 34,247 Sept 625,951 604,201 21,750 177 -332 0 38,246 664,043 11,038 2,200 34,315 Oct 624,375 607,875 16,500 80 -690 0 39,171 662,937 11,038 2,200 34,385 Nov 637,495 608,995 28,500 59 -216 0 37,031 674,368 11,038 2,200 34,441 Dec 668,916 629,416 39,500 40 832 0 38,574 708,363 11,039 2,200 34,497 NOTE. For a description of figures and discussion of dends, less the sum of bank premises and other assets, their significance, see Banking and Monetary Statistics, and is reported as "Other Federal Reserve accounts"; 1941-1970 (Board of Governors of the Federal Reserve thereafter, "Other Federal Reserve assets" and "Other System, 1976), pp. 507-23. Federal Reserve liabilities and capital" are shown Components may not sum to totals because of separately. rounding. 6. Before January 30, 1934, includes gold held in . . . Not applicable. Federal Reserve Banks and in circulation. r. Revised. 7. Includes currency and coin (other than gold) issued n.a. Not available. directly by the Treasury. The largest components are 1. In 1969 and thereafter, includes securities loaned— fractional and dollar coins. For details see "Currency and fully guaranteed by U.S. government securities pledged Coin in Circulation," Treasury Bulletin. with Federal Reserve Banks—and excludes securities 8. Collateralized by U.S. Treasury securities. sold and scheduled to be bought back under matched 9. Coin and paper currency held by the Treasury, as sale-purchase transactions. On September 29, 1971, and well as any gold in excess of the gold certificates issued thereafter, includes federal agency issues bought outright. to the Reserve Bank. 2. On December 1, 1966, and thereafter, includes 10. In November 1979 and thereafter, includes federal agency obligations held under repurchase reserves of member banks, Edge Act corporations, and agreements. U.S. agencies and branches of foreign banks. On Novem- 3. In 1960 and thereafter, figures reflect a minor ber 13, 1980, and thereafter, includes reserves of all change in concept; see Federal Reserve Bulletin, vol. 47 depository institutions. (February 1961), p. 164. In 1984 and thereafter, data on "Currency and coin" 4. Principally acceptances and, until August 21, 1959, and "Required" and "Excess" reserves changed from industrial loans, the authority for which expired on that daily to biweekly basis. date. 11. Between December 1, 1959, and November 23, 5. For the period before April 16, 1969, includes the 1960, part was allowed as reserves; thereafter, all was total of Federal Reserve capital paid in, surplus, other allowed. capital accounts, and other liabilities and accrued divi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 301 13.—Continued Factors absorbing reserve funds Deposits, other Member bank than reserves, with Federal Reserve Banks Other Cur- Re- Reverse Trea- Other Federal rency repur- sury Federal quired Reserve chase cash Reserve liacir- agree- hold- ac- ing bilities With Curcula- ments 8 ings9 Trea- For- Other counts5 bal- and Federal rency Re- Extion sury eign ances capital5 Reserve and quired12cess12-13 Banks coin" 631,141 0 415 13,688 162 286 0 8,650 17,385 15,909 638,325 0 414 5,752 89 254 0 8,872 17,792 11,997 641,873 0 412 5,692 256 181 0 9,631 18,163 12,784 645,495 0 393 5,387 111 287 0 9,869 19,202 17,626 653,796 0 416 5,883 128 207 0 9,810 19,504 8,751 657,900 0 395 8,116 % 212 0 9,903 20,186 12,421 661,144 0 377 6,242 164 236 0 9,960 18,940 9,219 664,116 0 361 4,874 86 194 0 9,922 19,526 12,489 660,082 0 380 7,879 150 221 0 9,938 19,719 13,226 663,370 0 397 5,878 89 233 0 10,057 19,720 10,816 673,822 0 377 4,928 78 253 0 10,281 19,616 12,692 687,418 21,091 367 4,420 136 1,152 0 10,533 18,977 12,004 12. Estimated through 1958. Before 1929, data were owned banking institutions held with member banks and available only on call dates (in 1920 and 1922 the call redeposited in full with Federal Reserve Banks in connecdate was December 29). Since September 12, 1968, the tion with voluntary participation by nonmember instituamount has been based on close-of-business figures for tions in the Federal Reserve System program of credit the reserve period two weeks before the report date. restraint. 13. For the week ending November 15, 1972, and As of December 12, 1974, the amount of voluntary thereafter, includes $450 million of reserve deficiencies nonmember bank and foreign-agency and branch deposits on which Federal Reserve Banks are allowed to waive at Federal Reserve Banks that are associated with marpenalties for a transition period in connection with bank ginal reserves are no longer reported. However, two adaptation to Regulation J as amended, effective Novem- amounts are reported: (1) deposits voluntarily held as ber 9,1972. Allowable deficiencies are as follows (begin- reserves by agencies and branches of foreign banks operning with first statement week of quarter, in millions): ating in the United States and (2) eurodollar liabilities. 1973—Ql, $279; Q2, $172; Q3, $112; Q4, $84; 15. Adjusted to include waivers of penalties for re- 1974—Ql, $67; Q2, $58. The transition period ended serve deficiencies, in accordance with change in Board with the second quarter of 1974. policy, effective November 19, 1975. 14. For the period before July 1973, includes certain deposits of domestic nonmember banks and foreign- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

302 89th Annual Report, 2002 14. Banking Offices and Banks Affiliated with Bank Holding Companies (BHCs) in the United States, December 31, 2001 and 2002 Commercial banks' Statechartered Type of office Total Member savings Total Nonmember banks Total National State All banking offices BANKS Number, Dec. 31,2001 .. 8,454 8,033 3,056 2,089 967 4,977 421 Changes during 2002 New banks 83 81 33 29 4 48 2 Banks converted into branches -261 -253 -121 -70 -51 -132 -8 Ceased banking operation2 -47 -36 -19 -10 -9 -17 -11 Other3 0 2 28 -8 36 -26 -2 Net change -225 -206 -79 -59 -20 -127 -19 Number, Dec. 31,2002 .. 8,229 7327 2,977 2,030 947 4,850 402 BRANCHES AND ADDITIONAL OFFICES Number, Dec. 31, 2001 .. 69,876 66,405 49,091 34,727 14364 17314 3,471 Changes during 2002 New branches 1,989 1,879 1,300 909 391 579 110 Branches converted from banks 261 259 148 91 57 111 2 Discontinued2 -1,222 -1,137 -878 -542 -336 -259 -85 Other3 0 70 434 577 -143 -364 -70 Net change 1,028 1,071 1,004 1,035 -31 67 -43 Number, Dec. 31, 2002 .. 70,904 67,476 50,095 35,762 14,333 17,381 3,428 Banks affiliated with BHCs BANKS Number, Dec. 31, 2001 .. 6,526 6,408 2,583 1,752 831 3,825 118 Changes during 2002 BHC-affiliated new banks 165 157 49 30 19 108 8 Banks converted into branches -226 -220 -109 -61 -48 -111 -6 Ceased banking operation2 -42 -33 -18 -10 -8 -15 -9 Other3 0 1 24 -2 26 -23 -1 Net change -103 -95 -54 -43 -11 -41 -8 Number, Dec. 31,2002 .. 6,423 6313 2,529 1,709 820 3,784 110 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

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

305 Audits of the Federal Reserve System The Board of Governors, the Federal by an independent outside auditor. In Reserve Banks, and the Federal Reserve addition, the Reserve Banks are subject System as a whole are all subject to to annual examination by the Board. several levels of audit and review. The As discussed in the chapter "Federal Board's financial statements, and its Reserve Banks," the Board examination compliance with laws and regulations includes a wide range of ongoing overaffecting those statements, are audited sight activities conducted on and off annually by an outside auditor retained site by staff of the Board's Division of by the Board's Office of Inspector Gen- Reserve Bank Operations and Payment eral. The Office of Inspector General Systems. also audits and investigates the Board's Federal Reserve operations are also programs and operations, as well as subject to review by the General those Board functions delegated to the Accounting Office. • Reserve Banks. The financial statements of the Reserve Banks are also audited annually Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

307 Board of Governors Financial Statements The financial statements of the Board for 2002 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 sheets of the Board of Governors of the Federal Reserve System (the Board) as of December 31, 2002 and 2001, and the related statements of revenues and expenses and changes in cumulative results of operations and cash flows for the years 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 audits. We conducted our audits 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 audits provide 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, 2002 and 2001, and its results of operations and its cash flows for the years 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 28, 2003 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 28, 2003 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

308 89th Annual Report, 2002 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BALANCE SHEETS As of December 31, 2002 2001 ASSETS CURRENT ASSETS Cash $ 8,635,164 $ 40,788,564 Accounts receivable 871,626 1,325,065 Prepaid expenses and other assets 801,031 866,407 Total current assets 10,307,821 42,980,036 PROPERTY AND EQUIPMENT, NET (Note 5) 143,971,006 138,895,601 Total assets $154,278,827 $181,875,637 LIABILITIES AND CUMULATIVE RESULTS OF OPERATIONS CURRENT LIABILITIES Accounts payable and accrued liabilities $ 11,450,099 $ 16,125,797 Accrued payroll and related taxes 8,102,710 7,307,754 Accrued annual leave 11,873,527 10,732,356 Capital lease payable (current portion) 50,546 247,242 Unearned revenues and other liabilities 442,066 391,572 Total current liabilities 31,918,948 34,804,721 LONG-TERM LIABILITIES Capital lease payable (non-current portion) 32,153 80,276 Accumulated retirement benefit obligation (Note 2) 614,108 651,628 Accumulated postretirement benefit obligation (Note 3) 4,917,787 4,555,487 Accumulated postemployment benefit obligation (Note 4) 4,299,252 3,591,571 Total long-term liabilities 9,863,300 8,878,962 Total liabilities 41,782,248 43,683,683 CUMULATIVE RESULTS OF OPERATIONS Working capital (21,560,581) 8,422,557 Unfunded long-term liabilities (9,831,147) (8,798,686) Net investment in property and equipment 143,888,307 138,568,083 Total cumulative results of operations 112,496,579 138,191,954 Total liabilities and cumulative results of operations $154,278,827 $181,875,637 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 309 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, 2002 2001 BOARD OPERATING REVENUES Assessments levied on Federal Reserve Banks for Board operating expenses and capital expenditures $205,110,800 $295,055,600 Other revenues (Note 6) 9,039,417 8,747,799 Total operating revenues 214,150,217 303,803,399 BOARD OPERATING EXPENSES Salaries 146,022,212 132,647,612 Retirement and insurance contributions 25,560,734 22,277,244 Contractual services and professional fees 18,073,228 19,339,948 Depreciation and net losses on disposals 12,426,581 10,394,156 Utilities 7,218,999 5,880,777 Software 6,822,066 5,415,856 Postage and supplies 5,961,699 8,252,490 Travel 5,925,674 5,037,577 Repairs and maintenance 4,666,439 4,201,386 Printing and binding 2,026,370 2,095,676 Equipment and facilities rental 318,132 3,830,557 Other expenses (Note 6) 4,823,458 4,157,305 Total operating expenses 239,845,592 223,530,584 RESULTS OF OPERATIONS (25,695,375) 80,272,815 ISSUANCE AND REDEMPTION OF FEDERAL RESERVE NOTES Assessments levied on Federal Reserve Banks for currency costs 429,568,393 338,537,426 Expenses for currency printing, issuance, retirement, and shipping 429,568,393 338,537,426 CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES 0 0 TOTAL RESULTS OF OPERATIONS (25,695,375) 80,272,815 CUMULATIVE RESULTS OF OPERATIONS, Beginning of year 138,191,954 57,919,139 CUMULATIVE RESULTS OF OPERATIONS, End of year $112,496,579 $138,191,954 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

310 89th Annual Report, 2002 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF CASH FLOWS For the years ended December 31, 2002 2001 CASH FLOWS FROM OPERATING ACTIVITIES RESULTS OF OPERATIONS $(25,695,375) $80,272,815 Adjustments to reconcile results of operations to net cash provided by (used in) operating activities: Depreciation and net losses on disposals 12,426,581 10,394,156 (Increase) decrease in assets: Accounts receivable, prepaid expenses, and other assets 518,815 (24,805) Increase (decrease) in liabilities: Accounts payable and accrued liabilities (4,675,698) 5,423,057 Accrued payroll and related taxes 794,956 1,266,793 Accrued annual leave 1,141,171 2,239,628 Unearned revenues and other liabilities 50,494 (1,652,588) Accumulated retirement benefit obligation (37,520) (43,154) Accumulated postretirement benefit obligation 362,300 489,783 Accumulated postemployment benefit obligation 707,681 482,115 Net cash provided by (used in) operating activities (14,406,595) 98,847,800 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposals 5,200 119,013 Capital expenditures (17,507,186) (80,886,996) Net cash provided by (used in) investing activities (17,501,986) (80,767,983) CASH FLOWS FROM FINANCING ACTIVITIES Capital lease payable (244,819) (133,505) Net cash provided by (used in) financing activities (244,819) (133,505) NET INCREASE (DECREASE) IN CASH (32,153,400) 17,946,312 CASH BALANCE, Beginning of year 40,788,564 22,842,252 CASH BALANCE, End of year $ 8,635,164 $40,788,564 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 311 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM NOTES TO FINANCIAL STATEMENTS FOR THE expenses during the reporting period. Actual results could YEARS ENDED DECEMBER 31, 2002 AND 2001 differ from those estimates. Reclassifications—Certain 2001 amounts have been reclassified to conform with the 2002 presentation. (1) SIGNIFICANT ACCOUNTING POLICIES Organization—The Federal Reserve System was estab- (2) RETIREMENT BENEFITS lished by Congress in 1913 and consists of the Board of Governors (Board), the Federal Open Market Committee, Substantially all of the Board's employees participate the twelve regional Federal Reserve Banks, the Federal in the Retirement Plan for Employees of the Federal Advisory Council, and the private commercial banks that Reserve System (System Plan). The System Plan is a are members of the System. The Board, unlike the multi-employer plan which covers employees of the Fed- Reserve Banks, was established as a federal government eral Reserve Banks, the Board, and the Plan Administraagency and is supported by Washington staff numbering tive Office. about 1,700, as it carries out its responsibilities in con- Employees of the Board who entered on duty prior to junction with other components of the Federal Reserve 1984 are covered by a contributory defined benefits pro- System. gram under the System Plan. Employees of the Board who entered on duty after 1983 are covered by a non- The Board is required by the Federal Reserve Act to contributory defined benefits program under the System report its operations to the Speaker of the House of Plan. Contributions to the System Plan are actuarially Representatives. The Act also requires the Board each determined and funded by participating employers at year to order a financial audit of each Federal Reserve amounts prescribed by the System Plan's administrator. Bank and to publish each week a statement of the finan- Based on actuarial calculations, it was determined that cial condition of each such Reserve Bank and a consoliemployer funding contributions were not required for the dated statement for all of the Reserve Banks. Accordyears 2002 and 2001, and the Board was not assessed ingly, the Board believes that the best financial disclosure a contribution for these years. Excess Plan assets are consistent with law is achieved by issuing separate finanexpected to continue to fund future years' contributions. cial statements for the Board and for the Reserve Banks. Because the plan is part of a multi-employer plan, infor- Therefore, the accompanying financial statements include mation as to vested and nonvested benefits, as well as only the operations and activities of the Board. A complan assets, as it relates solely to the Board, is not readily bined financial statement for the Federal Reserve Banks available. are included in the Board's annual report to the Speaker of the House of Representatives. A relatively small number of Board employees partici- Basis of Accounting—The financial statements have pate in the Civil Service Retirement System (CSRS) or been prepared on the accrual basis of accounting. the Federal Employees' Retirement System (FERS). The Board matches employee contributions to these plans. Revenues—Assessments for operating expenses and These defined benefit plans are administered by the additions to property are based on expected cash needs. Office of Personnel Management. The Board's contribu- Amounts over or under assessed due to differences tions to these plans totaled $327,000 and $308,000 in between actual and expected cash needs flow into 2002 and 2001, respectively. The Board has no liability "Cumulative Results of Operations" during the year. for future payments to retirees under these programs, and Issuance and Redemption of Federal Reserve Notes— it is not accountable for the assets of the plans. The Board incurs expenses and assesses the Federal Employees of the Board may also participate in the Reserve Banks for currency printing, issuance, retire- Federal Reserve System's Thrift Plan. Under the Thrift ment, and shipping of Federal Reserve Notes. These Plan, members may contribute up to a fixed percentage assessments and expenses are separately reported in the of their salary. Board contributions are based upon a statements of revenues and expenses because they are not fixed percentage of each member's basic contribution Board operating transactions. and were $7,185,000 and $5,540,000 in 2002 and 2001, Property and Equipment—The Board's property, buildrespectively. ings and equipment are stated at cost less accumulated Effective January 1, 1996, Board employees covered depreciation. Depreciation is calculated on a straight-line under the System Plan are also covered under a Benefits basis over the estimated useful lives of the assets, which Equalization Plan (BEP). Benefits paid under the BEP are range from 3 to 10 years for furniture and equipment and limited to those benefits that cannot be paid from the from 10 to 50 years for building equipment and struc- System Plan due to limitations imposed by Sectures. Upon the sale or other disposition of a depreciable tions 401(a)(17), 415(b) and 415(e) of the Internal Reveasset, the cost and related accumulated depreciation are nue Code of 1986. Pension costs attributed to the BEP removed from the accounts and any gain or loss is reduce the pension costs of the System Plan. Activity for recognized. the BEP for 2002 and 2001 is summarized in the follow- Estimates—The preparation of financial statements in ing table: conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

312 89th Annual Report, 2002 (3) POSTRETIREMENT BENEFITS 2002 2001 The Board provides certain life insurance programs for Change in benefit its active employees and retirees. Activity for 2002 and obligation 2001 is summarized in the following table: Projected benefit obligation at 2002 2001 beginning of year .. $ 2,125 1,804 Service cost 3,363 450 Change in benefit Interest cost 561 112 obligation Plan participants' Benefit obligation at contributions 0 0 beginning of year .. $5,868,425 $ 4,255,290 Plan amendments 2,852 0 Service cost 158,179 133,550 Actuarial(gain)/loss .... 3,965 (241) Interest cost 386,215 345,753 Benefits paid 0 0 Plan participants' contributions 0 0 Projected benefit Plan amendments 0 95,993 obligation at Actuarial (gain)/loss .... (63,554) 1,037,839 endofyear $ 12,866 2,125 Benefitspaid (214,870) 0 Benefit obligation Change in plan assets atendofyear $ 6,134,395 $ 5,868,425 Fair value of plan assets at beginning Change in plan assets of year $ Fair value of plan Actual return on plan assets at beginning assets of year $ 0 Employer contributions . Actual return on Plan participants' plan assets 0 0 contributions Employer contributions 213,958 0 Benefits paid Plan participants' Fair value of plan assets contributions .... 0 0 at end of year $_ Benefits paid (213,958) 0 Fair value of plan assets at end Reconciliation of funded of year $ 0 $ 0 status at end of year Funded status $ (12,866) $ (2,125) Unrecognized net Reconciliation of actuarial (gain)/ funded status loss (297,773) (329,169) at end of year Unrecognized prior Funded status $(6,134,395) $(5,868,425) service cost (1,050,946) (1,170,405) Unrecognized net Unrecognized net actuarial transition (asset)/ (gain)/loss 1,126,688 1,216,945 obligation 747,477 850,071 Unrecognized prior Postretirement service cost 89,920 95,993 benefit liability .... $ (614,108) Unrecognized net transition obligation 0 0 Weighted-average Prepaid/(accrued) assumptions as of postretirement December 31 benefit liability $(4,917,787) $(4,555,487) Discount rate 6.75% 7.00% Expected asset return N/A N/A Components of net Salary scale 4.25% 4.50% periodic cost Corridor 10.00% 10.00% for year Service cost $$ 158,179 $ 133,550 Components of net Interest cost 386,215 345,756 periodic benefit cost Amortization of prior Service cost $ 3,363 $ 450 service cost 6,073 0 Interest cost 561 112 Amortization of Expected return (gains)/losses .. 26,706 10,477 on plan assets ... 0 0 Total net periodic Amortization of cost $ 577,173 $ 489,783 prior service cost (116,607) (116,848) Recognized actuarial (gain)/loss (27,431) (29,462) Amortization of net transition (asset)/ obligation 102,594 102,594 Net periodic benefit cost $ (37,520) $ (43,154) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 313 The liability and costs for the postretirement benefit (5) PROPERTY AND EQUIPMENT plan were determined using discount rates of 6.75 percent The following is a summary of the components of the and 7.00 percent as of December 31, 2002 and 2001, Board's property, buildings and equipment, at cost, net respectively. Unrecognized losses of $1,126,688 and of accumulated depreciation. $1,216,945 as of December 31, 2002 and 2001, respectively, result from changes in the discount rate used to As of December 31, measure the liabilities. Under Statement of Financial 2002 2001 Accounting Standards No. 106, Employers' Accounting Land and for Postretirement Benefits Other Than Pensions, the improvements ... $ 18,640,314 $ 18,640,314 Board may have to record some of these unrecognized Buildings 113,309,775 104,403,830 losses in operations in future years. The assumed salary Furniture and trend rate for measuring the increase in postretirement equipment 37,044,828 54,301,936 benefits related to life insurance was an average of Software 9,830,112 9,215,280 4.25 percent. Construction in The above accumulated postretirement benefit obliga- process 9,467,020 6,901,864 tion is related to the Board sponsored life insurance 188,292,049 193,463,224 programs. The Board has no liability for future payments Less accumulated to employees who continue coverage under the federally depreciation (44,321,043) (54,567,623) sponsored life and health programs upon retiring. Contri- Property and butions for active employees participating in federally equipment, net... $143,971,006 $138,895,601 sponsored health programs totaled $6,205,000 and $5,364,000 in 2002 and 2001, respectively. Furniture and equipment includes $864,000 for capitalized leases as of December 31, 2002 and 2001, respec- (4) POSTEMPLOYMENT BENEFIT PLAN tively. Accumulated depreciation includes $654,000 and $510,000 for capitalized leases as of December 31, 2002 The Board provides disability and survivor income and 2001, respectively. The Board paid interest related to benefits to eligible employees after employment but bethese capital leases in the amount of $15,731 and $32,201 fore retirement. Effective January 1, 1994, the Board for 2002 and 2001, respectively. adopted Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment The Board began the Eccles Building Infrastructure Benefits, which requires that employers providing Enhancement Project in July 1999. This $12.5 million postemployment benefits to their employees accrue the project, scheduled for nineteen phases over three and a cost of such benefits. Prior to January 1994, postemploy- half years, includes asbestos removal, lighting and plumbment benefit expenses were recognized on a pay-as- ing improvements, cabling and other enhancements. Mulyou-go basis. tiple phases will be in process at the same time. In 2001, the Board purchased land and building located 2002 2001 at 1709 New York Avenue, N.W., Washington, DC. This purchase increased land and improvements by Change in benefit obligation $17,339,000 and buildings by $48,727,000 for 2001. Benefit obligation In 2002, fully depreciated furniture and equipment at beginning totaling $22,350,000 was retired. of year $3,591,571 $3,109,456 (6) OTHER REVENUES AND OTHER EXPENSES Service cost 891,192 755,135 Interest cost 166,520 115,142 The following are summaries of the components of Plan participants' Other Revenues and Other Expenses. contributions 0 0 Plan amendments 0 0 As of December 31, Actuarial (gain)/loss ... (76,282) (129,585) 2002 2001 Benefits paid (273,749) (258,577) Other revenues Benefit obligation at Data processing end of year $4,299,252 $3,591,571 revenue $4,830,600 $4,427,360 Rent 1,996,893 664,537 Weighted-average Subscription assumptions as of revenue 810,032 869,595 December 31 Reimbursable Discount rate 6.75% 7.00% services to Expected asset return .. N/A N/A other agencies ... 788,095 568,753 Salary scale 4.25% 4.50% Board sponsored Corridor 10.00% 10.00% conferences 115,965 240,967 National Information Center 30,334 25,591 Miscellaneous 467,498 1,950,996 Total Other Revenues $9,039,417 $8,747,799 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

314 89th Annual Report, 2002 Other expenses (9) FEDERAL RESERVE BANKS Tuition, registration, The Board performs certain transactions for the and membership Reserve Banks in conjunction with its responsibilities for fees $1,642,013 $1,472,539 the Federal Reserve System, and the Federal Reserve Subsidies and Banks provide certain administrative functions for the contributions ... 900,049 851,225 Board. Activity related to the Board and Reserve Banks Public transportation for 2002 and 2001 is summarized in the following table: subsidy 745,973 484,618 Meals and 2002 2001 representation .. 378,387 438,748 Contingency Board paid to the operations 264,232 180,871 Reserve Banks: Security Assessments for investigations ... 229,387 108,981 employee benefits .. $ 2,014,839 $ 1,859,752 Miscellaneous 663,417 620,323 Data processing and communication .... 2,154,087 2,469,052 Total Other Contingency site 264,232 180,871 Expenses $4,823,458 $4,157,305 Total Board paid to the Reserve Banks $ 4,433,158 $ 4,509,675 (7) COMMITMENTS The Board has entered into several operating leases to Reserve Banks paid secure office, training and warehouse space for periods to the Board: ranging from one to ten years. Minimum future commit- Assessments for ments under those leases having an initial or remaining currency costs $429,568,393 $338,537,426 Assessments for noncancelable lease term in excess of one year at Decemoperating expenses ber 31, 2002, are as follows: of the Board 205,110,800 295,055,600 Data processing 1,281,759 1,499,559 2003. $151,038 Total Reserve Banks 2004. 157,079 paid to the 2005. 163,363 Board $635,960,952 $635,092,585 2006. 71,991 $543,471 Rental expenses under the operating leases were $156,000 and $171,000 in 2002 and 2001, respectively. (8) FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL The Board is one of the five member agencies of the Federal Financial Institutions Examination Council (the "Council"), and currently performs certain management functions for the Council. Activity related to the Board and Council for 2002 and 2001 is summarized in the following table: 2002 2001 Board paid to the Council: Assessments for operating expenses of the Council $ 300,000 $ 293,000 Total Board paid to the Council $ 300,000 $ 293,000 Council paid to the Board: Data processing related services 3,350,412 2,788,243 Administrative services 69,593 66,117 Total Council paid to the Board $3,420,005 $2,854,360 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 315 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 years ended December 31, 2002 and 2001, and have issued our report thereon dated March 28, 2003. 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 2002 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. 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 the U.S. Congress, and is not intended to be and should not be used by anyone other than these specified parties. LCP March 28, 2003 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

316 89th Annual Report, 2002 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 years ended December 31, 2002 and 2001, and have issued our report thereon dated March 28, 2003. We conducted our audits 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 2002 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 the U.S. Congress, and is not intended to be and should not be used by anyone other than these specified parties. March 28, 2003 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

317 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, 2002 and 2001. Q 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, 2002 and 2001, and the related combined statements of income and changes in capital for the years then ended, which have been prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of The Federal Reserve System. 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 the 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 generally accepted accounting principles generally accepted in the United States of America. In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of the Reserve Banks as of December 31, 2002 and 2001, and the combined results of their operations for the years then ended, in comformity with the basis of accounting described in Note 3. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

318 89th Annual Report, 2002 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CONDITION December 31, 2002 and 2001 (in millions) ASSETS 2002 2001 Gold certificates $ 11,039 $ 11,045 Special drawing rights certificates 2,200 2,200 Coin 988 1,047 Items in process of collection 10,291 3,188 Loans to depository institutions 40 34 Securities purchased under agreements to resell (tri-party) 39,500 50,250 U.S. government and federal agency securities, net 639,125 561,701 Investments denominated in foreign currencies 16,913 14,559 Accrued interest receivable 5,470 5,729 Bank premises and equipment, net 2,044 2,021 Other assets 3,367 3,175 Total assets $730,977 $654,949 LIABILITIES AND CAPITAL LIABILITIES Federal Reserve notes outstanding, net $654,273 $611,757 Securities sold under agreements to repurchase 21,091 . . . Deposits Depository institutions 22,541 17,478 U.S. Treasury, general account 4,420 6,645 Other deposits 444 287 Deferred credit items 9,459 2,490 Interest on Federal Reserve notes due U.S. Treasury 838 498 Accrued benefit costs 915 882 Other liabilities 236 227 Total liabilities 714,217 640,264 CAPITAL Capital paid-in 8,380 7,373 Surplus 8,380 7,312 Total capital 16,760 14,685 Total liabilities and capital $730,977 $654,949 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 319 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF INCOME for the years ended December 31, 2002 and 2001 (in millions) 2002 2001 Interest income Interest on U.S. government and federal agency securities $25,525 $30,523 Interest on investments denominated in foreign currencies 272 331 Interest on loans to depository institutions 2 13 Total interest income 25,799 30,867 Interest expense: Interest expense on securities sold under agreements to repurchase 13 . . . Net interest income 25,786 30,867 Other operating income Income from services 916 926 Reimbursable services to government agencies 309 286 Foreign currency gains (losses), net 2,083 (1,435) Government securities gains, net 77 316 Other income 80 108 Total other operating income 3,465 201 Operating expenses Salaries and other benefits 1,532 1,285 Occupancy expense 208 204 Equipment expense 263 268 Assessments by Board of Governors 635 634 Other expenses 565 642 Total operating expenses 3,203 3,033 Net income prior to distribution $26,048 $28,035 Distribution of net income Dividends paid to member banks $ 484 $ 428 Transferred to surplus 1,068 518 Payments to U.S. Treasury as interest on Federal Reserve notes 24,496 27,089 Total distribution $26,048 $28,035 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

320 89th Annual Report, 2002 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CHANGES IN CAPITAL for the years ended December 31, 2002 and 2001 (in millions) Capital Total paid-in Surplus capital Balance at January 1, 2001 (139 million shares) $6,997 $6,794 $13,791 Net income transferred to surplus 518 518 Net change in capital stock issued (8 million shares) 376 376 Balance at December 31, 2001 (147 million shares) $7,373 $7,312 $14,685 Net income transferred to surplus 1,068 1,068 Net change in capital stock issued (20 million shares) 1,007 1,007 Balance at December 31, 2002 (167 million shares) $8,380 $8,380 $16,760 The accompanying notes are an integral part of these combined financial statements. NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS (1) STRUCTURE Act, supervision and control of each Reserve Bank is exercised by a Board of Directors. The Federal Reserve The twelve Federal Reserve Banks (Reserve Banks) are Act specifies the composition of the Board of Directors part of the Federal Reserve System (System) created by for each of the Reserve Banks. Each board is composed Congress under the Federal Reserve Act of 1913 (Federal of nine members serving three-year terms: three directors, Reserve Act) which established the central bank of the including those designated as Chairman and Deputy United States. The Reserve Banks are chartered by the Chairman, are appointed by the Board of Governors, and federal government and possess a unique set of govern- six directors are elected by member banks. Of the six mental, corporate, and central bank characteristics. Other elected by member banks, three represent the public and major elements of the System are the Board of Governors three represent member banks. Member banks are divided of the Federal Reserve System (Board of Governors), the into three classes according to size. Member banks in Federal Open Market Committee (FOMC) and the Fed- each class elect one director representing member banks eral Advisory Council. The FOMC is composed of mem- and one representing the public. In any election of direcbers of the Board of Governors, the president of the tors, each member bank receives one vote, regardless of Federal Reserve Bank of New York (FRBNY) and, on a the number of shares of Reserve Bank stock it holds. rotating basis, four other Reserve Bank presidents. Banks that are members of the System include all national banks and any state chartered bank that applies and is approved (2) OPERATIONS AND SERVICES for membership in the System. The System performs a variety of services and operations. Although the Reserve Banks are chartered as indepen- Functions include: formulating and conducting monetary dent organizations overseen by the Board of Governors, policy; participating actively in the payments mechanism, the Reserve Banks work jointly to carry out their statuincluding large-dollar transfers of funds, automated cleartory responsibilities. The majority of the assets, liabilities, inghouse (ACH) operations and check processing; distriband income of the Reserve Banks is derived from central uting coin and currency; performing fiscal agency funcbank activities and responsibilities with regard to monetions for the U.S. Treasury and certain federal agencies; tary policy and currency. For this reason, the accompanyserving as the federal government's bank; providing ing combined set of financial statements for the twelve short-term loans to depository institutions; serving the independent Reserve Banks is prepared with adjustments consumer and the community by providing educational to eliminate interdistrict accounts and transactions. materials and information regarding consumer laws; supervising bank holding companies, state member banks Board of Directors and U.S. offices of foreign banking organizations; and administering other regulations of the Board of Gover- The Reserve Banks serve twelve Federal Reserve Dis- nors. The Board of Governors' operating costs are funded tricts nationwide. In accordance with the Federal Reserve 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 321 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED The FOMC establishes policy regarding open market 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, the sale of securities under agreements to repurchase, and the lending of U.S. government securities. FRBNY is also autho- (A) Gold Certificates rized by the FOMC to hold balances of and to execute The Secretary of the Treasury is authorized to issue gold spot and forward foreign exchange (F/X) and securities certificates to the Reserve Banks to monetize gold held contracts in nine foreign currencies, maintain reciprocal by the U.S. Treasury. Payment for the gold certificates by currency arrangements (F/X swaps) with various central the Reserve Banks is made by crediting equivalent banks, and "warehouse" foreign currencies for the U.S. amounts in dollars into the account established for the Treasury and Exchange Stabilization Fund (ESF) through U.S. Treasury. These gold certificates held by the Reserve the Reserve Banks. 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. Treasury's account is charged and the Reserve Banks' gold Accounting principles for entities with the unique powers certificate account is lowered. The value of gold for and responsibilities of the nation's central bank have not purposes of backing the gold certificates is set by law at been formulated by the Financial Accounting Standards $42% a fine troy ounce. Board. The Board of Governors has developed specialized 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 US. 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 Rows. 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 loans were ever 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, disclosure of contingent assets and liabilities at the option to impose a surcharge above the basic rate in the date of the combined financial statements, and the certain circumstances. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

322 89th Annual Report, 2002 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED (D) US. Government and Federal Agency Securities and tains renewable, short-term F/X swap arrangements with Investments Denominated in Foreign Currencies two authorized foreign central banks. The parties agree to exchange their currencies up to a pre-arranged maximum The FOMC has designated the FRBNY to execute open amount and for an agreed upon period of time (up to market transactions on its behalf and to hold the resulting twelve months), at an agreed upon interest rate. These securities in the portfolio known as the System Open arrangements give the FOMC temporary access to foreign Market Account (SOMA). In addition to authorizing and currencies that it may need for intervention operations to directing operations in the domestic securities market, support the dollar and give the partner foreign central the FOMC authorizes and directs the FRBNY to execute bank temporary access to dollars it may need to support operations in foreign markets for major currencies in its own currency. Drawings under the F/X swap arrangeorder to counter disorderly conditions in exchange mar- ments can be initiated by either the FRBNY or the partner kets or to meet other needs specified by the FOMC in foreign central bank, and must be agreed to by the carrying out the System's central bank responsibilities. drawee. The F/X swaps are structured so that the party Such authorizations are reviewed and approved annually initiating the transaction (the drawer) bears the exchange by the FOMC. rate risk upon maturity. The Bank will generally invest In December 2002, matched sale-purchase (MSP) the foreign currency received under an F/X swap in transactions were replaced with securities sold under interest-bearing instruments. agreements to repurchase. MSP transactions, accounted Warehousing is an arrangement under which the for as separate sale and purchase transactions, are trans- FOMC agrees to exchange, at the request of the Treasury, actions in which the FRBNY sells a security and buys it U.S. dollars for foreign currencies held by the Treasury back at the rate specified at the commencement of the or ESF over a limited period of time. The purpose of the transaction. Securities sold under agreements to repur- warehousing facility is to supplement the U.S. dollar chase are treated as secured borrowing transactions with resources of the Treasury and ESF for financing purthe associated interest expense recognized over the life of chases of foreign currencies and related international the transaction. operations. In addition to the aforementioned matched sale- In connection with its foreign currency activities, the purchase transactions and sales of securities under agree- FRBNY, on behalf of the Reserve Banks, may enter into ments to repurchase, the FRBNY engages in tri-party contracts which contain varying degrees of off-balance purchases of securities under agreements to resell (tri- sheet market risk, because they represent contractual comparty agreements). Tri-party agreements are conducted mitments involving future settlement, and counter-party with two custodial banks that manage the clearing and credit risk. The FRBNY controls credit risk by obtaining settlement of collateral. Acceptable collateral under tri- credit approvals, establishing transaction limits, and perparty repurchase agreements primarily includes U.S. Gov- forming daily monitoring procedures. ernment and agency securities, pass-through mortgage While the application of current market prices to the securities of GNMA, FHLMC, and FNMA, STRIP secu- securities currently held in the SOMA portfolio and rities of the U.S. Government and "stripped" securities investments denominated in foreign currencies may result of other government agencies. The tri-party agreements in values substantially above or below their carrying are accounted for as financing transactions with the values, these unrealized changes in value would have no associated interest income accrued over the life of the direct effect on the quantity of reserves available to the agreements. banking system or on the prospects for future Reserve The FRBNY has sole authorization by the FOMC to Bank earnings or capital. Both the domestic and foreign lend U.S. government securities held in the SOMA to U.S. components of the SOMA portfolio from time to time government securities dealers and to banks participating involve transactions that can result in gains or losses in U.S. government securities clearing arrangements on when holdings are sold prior to maturity. Decisions behalf of the System, in order to facilitate the effective regarding the securities and foreign currencies transacfunctioning of the domestic securities market. These tions, including their purchase and sale, are motivated securities-lending transactions are fully collateralized by by monetary policy objectives rather than profit. Accordother U.S. government securities. FOMC policy requires ingly, market values, earnings, and any gains or losses FRBNY to take possession of collateral in excess of the resulting from the sale of such currencies and securities market values of the securities loaned. The market values are incidental to the open market operations and do not of the collateral and the securities loaned are monitored motivate its activities or policy decisions. by FRBNY on a daily basis, with additional collateral U.S. government and federal agency securities and obtained as necessary. The securities loaned continue to investments denominated in foreign currencies comprisbe accounted for in the SOMA. ing the SOMA are recorded at cost, on a settlement-date F/X contracts are contractual agreements between two basis, and adjusted for amortization of premiums or accreparties to exchange specified currencies, at a specified tion of discounts on a straight-line basis. Interest income price, on a specified date. Spot foreign contracts normally is accrued on a straight-line basis and is reported as settle two days after the trade date, whereas the settlement "Interest on U.S. government and federal agency securidate on forward contracts is negotiated between the con- ties" or "Interest on investments denominated in foreign tracting parties, but will extend beyond two days from the currencies," as appropriate. Income earned on securities trade date. The FRBNY generally enters into spot con- lending transactions is reported as a component of "Other tracts, with any forward contracts generally limited to the income." Gains and losses resulting from sales of securisecond leg of a swap/warehousing transaction. 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 323 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED and federal agency securities are reported as "Gov- a first and paramount lien on all the assets of the Reserve ernment securities gains, net." Foreign-currency- Banks. Finally, as obligations of the United States, Feddenominated assets are revalued daily at current market eral Reserve notes are backed by the full faith and credit exchange rates in order to report these assets in U.S. of the United States government. dollars. Realized and unrealized gains and losses on The "Federal Reserve notes outstanding, net" account investments denominated in foreign currencies are represents Federal Reserve notes outstanding reduced by reported as "Foreign currency gains (losses), net." For- the Reserve Banks' currency holdings of $104,983 mileign currencies held through F/X swaps, when initiated lion and $139,783 million at December 31, 2002 and by the counterparty, and warehousing arrangements are 2001, respectively. revalued daily, with the unrealized gain or loss reported At December 31, 2002, all gold certificates, all special as a component of "Other assets" or "Other liabilities," drawing rights certificates, and $644,458 million of as appropriate. domestic securities and securities purchased under agreements to resell were pledged as collateral. At December 31, 2002, no loans or investments denominated in (E) Bank Premises, Equipment, and Software foreign currencies were pledged as collateral. Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a (G) Capital Paid-in straight-line basis over estimated useful lives of assets ranging from 2 to 50 years. New assets, major alterations, The Federal Reserve Act requires that each member bank renovations and improvements are capitalized at cost as subscribe to the capital stock of the Reserve Bank in an additions to the asset accounts. Maintenance, repairs and amount equal to 6 percent of the capital and surplus of the minor replacements are charged to operations in the year member bank. As a member bank's capital and surplus incurred. Costs incurred for software, either developed changes, its holdings of the Reserve Bank's stock must be internally or acquired for internal use, during the appli- adjusted. Member banks are those state-chartered banks cation stage are capitalized based on the cost of direct that apply and are approved for membership in the Sysservices and materials associated with designing, coding, tem and all national banks. Currently, only one-half of the installing, or testing software. subscription is paid-in and the remainder is subject to call. These shares are nonvoting with a par value of $100. They may not be transferred or hypothecated. By law, (F) Federal Reserve Notes each member bank is entitled to receive an annual dividend of 6 percent on the paid-in capital stock. This Federal Reserve notes are the circulating currency of the cumulative dividend is paid semiannually. A member United States. These notes are issued through the various bank is liable for Reserve Bank liabilities up to twice the Federal Reserve agents (the Chairman of the Board of par value of stock subscribed by it. Directors of each Reserve Bank) to the Reserve Banks upon deposit with such agents of certain classes of collateral security, typically U.S. government securities. These (H) Surplus notes are identified as issued to a specific Reserve Bank. The Federal Reserve Act provides that the collateral The Board of Governors requires Reserve Banks to mainsecurity tendered by the Reserve Bank to the Federal tain a surplus equal to the amount of capital paid-in as of Reserve agent must be equal to the sum of the notes December 31. This amount is intended to provide addiapplied for by such Reserve Bank. In accordance with the tional capital and reduce the possibility that the Reserve Federal Reserve Act, gold certificates, special drawing Banks would be required to call on member banks for rights certificates, U.S. government and federal agency additional capital. Pursuant to Section 16 of the Federal securities, securities purchased under agreements to Reserve Act, Reserve Banks are required by the Board of resell, loans to depository institutions, and investments Governors to transfer to the U.S. Treasury excess earndenominated in foreign currencies are pledged as collat- ings, after providing for the costs of operations, payment eral for Federal Reserve notes. The collateral value is of dividends, and reservation of an amount necessary to equal to the book value of the collateral tendered, with the equate surplus with capital paid-in. Surplus was not exception of securities whose collateral value is equal to equated to capital at December 31, 2001 at one Reserve the par value of the securities tendered and securities Bank where the amount of additional surplus required purchased under agreements to resell, which are valued at exceeded the Bank's net income. the contract amount. The par value of securities pledged In the event of losses, or a substantial increase in for securities sold under agreements to repurchase is capital, a Reserve Bank will suspend its payments to the similarly deducted. The Board of Governors may, at any U.S. Treasury until such losses or increases in capital are time, call upon a Reserve Bank for additional security recovered through subsequent earnings. Weekly payto adequately collateralize the Federal Reserve notes. To ments to the U.S. Treasury may vary significantly. satisfy the obligation to provide sufficient collateral for outstanding Federal Reserve notes, the Reserve Banks (I) Income and Costs Related to Treasury Services have entered into an agreement that provides that certain assets of the Reserve Banks are jointly pledged as collat- Reserve Banks are required by the Federal Reserve Act eral for the Federal Reserve notes of all Reserve Banks. to serve as fiscal agents and depositories of the United In the event that this collateral is insufficient, the Federal States. By statute, the Department of the Treasury is Reserve Act provides that Federal Reserve notes become permitted, but not required, to pay for these services. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

324 89th Annual Report, 2002 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED (J) Taxes Securities purchased under agreements to resell at December 31, 2002 and 2001 were $39,500 million and The Reserve Banks are exempt from federal, state, and $50,250 million, respectively, and consisted entirely of local taxes, except for taxes on real property, which are agreements through third party custodial arrangements. reported as a component of "Occupancy expense." As mentioned in footnote 3, in December 2002, the FRBNY replaced MSP transactions with securities sold (4) U.S. GOVERNMENT AND FEDERAL AGENCY under agreements to repurchase. At December 31, 2002, SECURITIES securities sold under agreements to repurchase with a contract amount of $21,091 million and a par value of Securities bought outright are held in the SOMA at the $21,098 million were outstanding. At December 31,2001, FRBNY. MSP transactions involving U.S. government securities with a par value of $23,188 million were outstanding. Total securities held in the SOMA at December 31, Securities sold under agreements to repurchase and MSP 2002 and 2001, that were bought outright, were as fol- transactions are generally overnight arrangements. lows (in millions): At December 31, 2002 and 2001, U.S. government securities with par values of $1,841 million and 2002 2001 $7,345 million, respectively, were loaned from the SOMA. Par value Federal agency $ 10 $ 10 U.S. government (5) INVESTMENTS DENOMINATED IN Bills 226,682 182,074 FOREIGN CURRENCIES Notes 297,893 265,941 Bonds 104,832 103,660 The FRBNY, on behalf of the Reserve Banks, holds Total par value 629,417 551,685 foreign currency deposits with foreign central banks and the Bank for International Settlements, and invests in Unamortized premiums 10,762 11,302 foreign government debt instruments. Foreign govern- Unaccreted discounts (1,054) (1,286) ment debt instruments held include both securities bought Total $639,125 $561,701 outright and securities held under agreements to resell. These investments are guaranteed as to principal and interest by the foreign governments. The maturity distribution of U.S. government and fed- Total investments denominated in foreign currencies, eral agency securities bought outright and securities pur- valued at current exchange rates at December 31, were as chased under agreements to resell, which were held in follows (in millions): the SOMA at December 31, 2002, was as follows (in millions): 2002 2001 U.S. Federal European Union Euro government agency Foreign currency deposits $ 5,580 $ 4,593 Maturities of securities obligations Government debt instruments securities held (Par) (Par) Total including agreements to resell 3,298 2,695 Within 15 days ... $ 27,444 $. . . $ 27,444 16 days to 90 days. 154,225 154,225 Japanese Yen 91 days to 1 year .. 141,840 10 141,850 Foreign currency deposits 1,789 1,891 Over 1 year to Government debt instruments 5 years . 172,758 172,758 including agreements Over 5 years to toresell 6,164 5,315 10years .... . 53,300 53,300 Over 10 years.... . 79,840 79,840 Accrued interest 82 65 Total.... $629,407 $10 $629,417 Total $16,913 $14,559 Repurchase Maturities of agreements securities held (Contract amount) Within 15 days $25,500 16 days to 90 days 14,000 91 days to 1 year Over 1 year to 5 years Over 5 years to 10 years • • • Over 10 years _1_L_L_ Total $39,500 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 325 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, 2002, was as follows (in millions): At December 31,2002, the Reserve Banks were obligated under noncancelable leases for premises and equipment Maturities of Investments Denominated with terms ranging from 1 to approximately 21 years. in Foreign Currencies These leases provide for increased rentals based upon increases in real estate taxes, operating costs, or selected Within 1 year $15,611 price indices. Over 1 year to 5 years 904 Rental expense under operating leases for certain oper- Over 5 years to 10 years 398 ating facilities, warehouses, and data processing and Total $16,913 office equipment (including taxes, insurance and maintenance when included in rent), net of sublease rentals, was At December 31, 2002 and 2001, there were no open $70 million and $69 million for the years ended Decemforeign exchange contracts or outstanding F/X swaps. ber 31, 2002 and 2001, respectively. Certain of the At December 31,2002 and 2001, the warehousing facil- Reserve Banks' leases have options to renew. ity was $5,000 million, with a zero balance outstanding. Future minimum rental payments under noncancelable (6) BANK PREMISES AND EQUIPMENT operating leases, net of sublease rentals, with terms of one year or more, at December 31, 2002, were (in A summary of bank premises and equipment at Decemmillions): ber 31 is as follows (in millions): Operating Capital 2002 2001 Bank premises and equipment 2 20 0 0 0 3 4 $ 1 1 1 0 . .2 0 $ 6 6 . .3 2 Land $ 209 $ 201 2005 8.8 .4 Buildings 1,514 1,478 2006 7.4 .4 Building machinery and 2007 6.6 equipment 345 329 Thereafter . $130.8 Construction in progress 51 32 Furniture and equipment 1,362 1,365 $174.8 $13.3 3,481 3,405 Amount representing interest ... (1.1) Accumulated depreciation (1,437) (1,384) $12.2 Bank premises and At December 31,2002, the Reserve Banks had contracequipment, net $2,044 $2,021 tual commitments through the year 2007 totaling Depreciation expense was $187 million and $186 mil- $119.7 million for the maintenance of currency machines lion for the years ended December 31, 2002 and 2001, and check-processing-related services, $118.7 million of respectively. which has not been recognized. Two Reserve Banks contract for these services on behalf of the System. Bank premises and equipment at December 31 include Three Reserve Banks have additional contractural comthe following amounts for leases that have been capital- mitments through the year 2007 for software mainteized (in millions): nance, architectural services, and check transportation services. At December 31, 2002, these contractual com- 2002 2001 mitments totaled $160.8 million, $143.7 million of which has not been recognized. Bank premises and equipment $15 $21 The Reserve Banks are involved in certain legal actions Accumulated depreciation _(12) (14) and claims arising in the ordinary course of business. Capitalized leases, net $J[ $J7 Although it is difficult to predict the ultimate outcome of these actions, in management's opinion, based on discus- Certain of the Reserve Banks lease unused space to sions with counsel, the aforementioned litigation and outside tenants. Those leases have terms ranging from 1 claims will be resolved without material adverse effect to 13 years. Rental income from such leases totaled on the financial position or results of operations of the $21 million and $20 million for the years ended Decem- Reserve Banks. ber 31, 2002 and 2001, respectively. Future minimum lease payments under noncancelable agreements in existence at December 31, 2002, were (in millions): (8) RETIREMENT AND THRIFT PLANS 2003 $17 Retirement Plans 2004 15 2005 12 The Reserve Banks currently offer two defined benefit 2006 9 retirement plans to their employees, based on length of 2007 6 service and level of compensation. Substantially all of Thereafter 21 the Reserve Banks', Board of Governors', and the Plan Total $80 Administrative Office's employees participate in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

326 89th Annual Report, 2002 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Retirement Plan for Employees of the Federal Reserve The weighted-average assumptions used in developing System (System Plan) and the Benefit Equalization the pension benefit obligation for the System Plan are as Retirement Plans offered by each individual Reserve follows: Bank (BEP) and certain Bank officers participate in a Supplemental Employee Retirement Plan (SERP). 2002 2001 The System Plan is a multi-employer plan with contri- Discount rate 6.75% 7.00% butions fully funded by participating employers. Certain Expected long-term rate of Board employees not covered by the Social Security Act return on plan assets 9.00% 9.00% also contribute to the plan. No separate accounting is Rate of compensation increase 4.25% 4.50% maintained of assets contributed by the participating 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. 2002 2001 Following is a reconciliation of the beginning and Service cost—benefits earned ending balances of the System Plan benefit obligation (in during the period $ 104 $ 85 millions): Interest cost on projected benefit obligation 226 207 2002 2001 Amortization of initial net transition obligation (45) Estimated actuarial present value Amortization of prior service of projected benefit cost 27 16 obligation at January 1 $3,091 $2,810 Recognized net (gain) (44) Service cost—benefits earned Expected return on plan assets (514) (550) during the period 104 85 Net periodic pension benefit (credit). $(157) $(331) Interest cost on projected benefit obligation 226 207 Actuarial loss 126 125 Net periodic pension benefit (credit) is reported as a Contributions by plan participants .. 3 3 component of "Salaries and other benefits." Benefits paid (170) (139) Plan amendments 143 _j_^_ The Reserve Banks' projected benefit obligation and net pension costs for the BEP at December 31, 2002 and Estimated actuarial present value 2001, and for the SERP at December 31, 2002, and for of projected benefit obligation at December 31 .... $3,523 $3,091 the years then ended, are not material. Thrift Plan Following is a reconciliation of the beginning and ending balances 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 Federal Reserve System (Thrift Plan). The Reserve 2002 2001 Banks' Thrift Plan contributions totaled $63 million and Estimated fair value of plan $50 million for the years ended December 31, 2002 and assets at January 1 $5,795 $6,176 2001, respectively, and are reported as a component of Actual return on plan assets (631) (245) "Salaries and other benefits." Contributions by plan participants .. 3 3 Benefits paid (170) (139) (9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Estimated fair value of plan AND POSTEMPLOYMENT BENEFITS assets at December 31 $4,997 $5,795 Postretirement Benefits Other Than Pensions Funded status $1,474 $2,703 Unrecognized prior service cost .... 223 107 In addition to the Reserve Banks' retirement plans, Unrecognized net actuarial employees who have met certain age and length of serloss/(gain) 1,042 (228) vice requirements are eligible for both medical benefits Prepaid pension benefit costs 2,739 2,582 and life insurance coverage during retirement. The Reserve Banks fund benefits payable under the Prepaid pension benefit costs are reported as a component medical and life insurance plans as due and, accordingly, of "Other assets." have no plan assets. Net postretirement benefit costs are actuarially determined using a January 1 measurement date. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 327 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Following is a reconciliation of beginning and ending One percentage One percentage balances of the benefit obligation (in millions): point increase point decrease 2002 2001 Effect on aggregate of service and Accumulated postretirement benefit interest cost obligation at January 1 $674 $644 components of Service cost—benefits earned during net periodic theperiod 17 16 postretirement Interest cost of accumulated ^ benefit costs $ 9 $ (8) benefit obligation 47 47 Effect on accumulated Actuarial loss 49 54 postretirement Contributions by plan participants 4 4 benefit obligation ... 94 (81) Benefits paid (37) (31) Plan amendments, curtailments, The following is a summary of the components of net and special termination benefits ... (12) (60) periodic postretirement benefit costs for the years ended Accumulated postretirement benefit December 31 (in millions): obligation at December 31 $742 $674 = = 2002 2001 Following is a reconciliation of the beginning and ending balances of the plan assets, the unfunded postretirement Servic k e cost-benefits earned during benefit obligation and the accrued postretirement benefit me ^nod $17 $16 costs (in millions): Interest cost of accumulated benefit obligation 47 47 2002 2001 Amortization of prior service cost (14) (9) Recognized net actuarial loss/(gain) 2 (1) Fair value of plan assets at January 1 ... $ $ Net periodic postretirement benefit costs .. $52 $53 Contributions by the employer 33 27 v F = = Contributions by plan participants 4 4 Benefits paid (37) (31) Net periodic postretirement benefit costs are reported as a Fair value of plan assets at component of "Salaries and other benefits." December31 $• • . $. • . Postemployment Benefits Unfunded postretirement benefit obligation $742 $674 The Reserve Banks offer benefits to former or inactive Unrecognized prior service cost 141 146 employees. Postemployment benefit costs are actuarially Unrecognized net actuarial gain/(loss) .. J93) J48) determined md include me cost of medical md dental Accrued postretirement benefit costs ... $790 $772 insurance, survivor income, disability benefits, and those workers' compensation expenses self-insured by indi- Accrued postretirement benefit costs are reported as a vidual Reserve Banks. Costs were projected using the component of "Accrued benefit costs." same diSCOunt rate and health care trend rates as were At December 31, 2002 and 2001, the weighted-average used for projecting postretirement costs. The accrued discount rate assumptions used in developing the post- postemployment benefit costs recognized by the Reserve retirement benefit obligation were 6.75 percent and Banks at December 31, 2002 and 2001, were $121 mil- 7.00 percent, respectively. lion and $110 million, respectively. This cost is included For measurement purposes, a 9.00 percent annual rate as a component of "Accrued benefit costs." Net periodic of increase in the cost of covered health care benefits was postemployment benefit costs included in 2002 and 2001 assumed for 2003. Ultimately, the health care cost trend operating expenses were $26 million and $21 million, rate is expected to decrease gradually to 5.00 percent by respectively. 2008, and remain at that level thereafter. Assumed health care cost trend rates have a significant (10) SUBSE<*>ENT EVENT effect on the amounts reported for health care plans. A T T ~n~~ , „ , ., , _ one percentage point change in assumed health care cost to h 'H 2003' *e Sy.stem d£lded t0 reslIuctu" lts trendI rates would have the following effects for the year ch<^ coIlectl?n. "^fons- ™" restructuring plans ended December 31.2002 (in millions): mfde •*»*»»'« «"» check management structure, reducing staff, decreasing the number of check-processing locations and increasing processing capacity in other locations. The restructuring, which is expected to begin in 2003 and conclude by the end of 2004, will result in the Reserve Banks discontinuing check operations in thirteen offices, increasing check processing capacity in nine offices, and consolidating check adjustment functions in twelve offices. At this time, the Reserve Banks have not developed detailed estimates of the cost of the restucturing plan in the aggregate or for the individual Reserve Banks affected. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

328 Office of Inspector General Activities The Board's Office of Inspector General and abuse in Board and Board-delegated (OIG) functions in accordance with the programs and operations as well as in Inspector General Act of 1978, as activities administered or financed by amended. In addition to retaining an the Board. The OIG keeps the Congress independent auditor each year to audit and the Chairman of the Board of the Board's financial statements, the Governors fully informed about serious OIG plans and conducts audits and abuses and deficiencies and about the investigations of the Board's programs status of any corrective actions. and operations and its delegated func- During 2002, the OIG completed tions at the Federal Reserve Banks. The eleven audits, reviews, and other assess- OIG also reviews existing and proposed ments (table) and conducted a number legislation and regulations for economy of follow-up reviews to evaluate action and efficiency. It recommends policies, taken on earlier recommendations. The and it supervises and conducts activities OIG also closed twenty-seven investigathat promote economy and efficiency tions and performed numerous legislaand that prevent and detect waste, fraud, tive and regulatory reviews. Completed OIG Audits, Reviews, and Assessments, 2002 Report title Report number Month issued Audit of Board's Government Travel Card Program AOOll January Audit of the FFIEC's Financial Statements (Years Ended 2000 and 2001) .. A0115 February Bond Life Cycle Assessment R0103 February Audit of the Board's Financial Statements (Years Ended 2000 and 2001)... A0115BD March Audit of the Board's Use of and Controls over Purchase Cards A0109 May Review of the Eccles Building Project—Phase 3 R0202 May Board's Recruiting Process Assessment R0203 May Review of Integrating Support Services into the Management Division R0204 June Business Process Review of the Board's Publications Program—Phase 3 ... R0201 June Audit of the Board's Information Security Program A0205 September Report on the Failure of the Oakwood Deposit Bank Company A0202 October Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

329 General Accounting Office Reviews Under the Federal Banking Agency on selected aspects of Federal Reserve Audit Act (Public Law 95-320), most of operations (table). Seven projects conthe operations of the Federal Reserve cerning the Federal Reserve were in System are under the purview of the various stages of completion at year- General Accounting Office (GAO). In end (table). The reports are available 2002, the GAO completed four reports directly from the GAO. Completed GAO Reports Relating to the Federal Reserve System, 2002 Report title Report number Date issued Payment Systems: Central Bank Roles Vary, but Goals Are the Same GAO-02-303 2-25-02 Federal Reserve Banks: Areas for Improvement in Computer Controls GAO-02-832R 7-30-02 Federal Reserve System: The Surplus Account GAO-02-939 9-18-02 Federal Reserve System: Update on GAO's 1996 Recommendations GAO-02-774 9-25-02 Active GAO Projects Relating to the Federal Reserve System, Year-End 2002 Subject of project Date initiated Supervisory and regulatory policies regarding cyber-threats 5-24-02 Business continuity planning and security issues for Fedwire 5-30-02 Risk assessment, security, and controls for the pay.gov system 7-30-02 Federal Reserve's relationship with U.S. Mint and BEP 7-30-02 Prevention and identification of illegal tying 9-24-02 Role investment banks play in design and marketing various types of financial transactions 10-25-02 Progress with implementing information technology enterprise architectures 10-29-02 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

332 89th Annual Report, 2002 The Federal Reserve System 1 BOSTON INNEAPOLiS | 7 _ o •NEW YORK CHICAGO CLEVELAND PHILADELPHIA I SAM FRANCISCO 4 ° lCAN$ASfclTY| JBT RICHMOND ST. LOUIS 8 5 11 6 • DALLAS ATLANTA HAWAII fi LEGEND Both pages Facing page • Federal Reserve Bank city • Federal Reserve Branch city Q 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 2002. 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 333 1-A 2-B 3-C 4-D 5-E ME Pittsburgh Balti PA Buffalo •Charlotte BOSTON NEW YORK PHILADELPHIA CLEVELAND RICHMOND 7-G 8-H ATLANTA CHICAGO ST. LOUIS MINNEAPOLIS 12-L •Los Angeles 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

337 Index Accrued interest receivable, guidance, Banking organizations, U.S.—Continued 108 Overseas investments, 119 Agreement corporations, 103, 104, 153, Parallel-owned, 157 155 Risk-focused supervision of, 101-103 Applications, processing of, 120 Banks, U.S. Assets and liabilities Number, 295, 302 Banks, insured commercial, by class, Operating efficiency, 94 295 Basel Committee on Banking Supervision, Board of Governors, 308 109 Federal Reserve Banks, 272-75 Board of Governors (See also Federal Nonperforming assets, 93 Reserve System) ATMs (See Automated teller machines) Audit of, 307-16 Auditors' reports, 307, 315, 316, 317 Consumer Advisory Council, 84, 246 Automated clearinghouse services, Federal Federal Advisory Council, 245 Reserve Banks, 128, 291 FFIEC activities, 107, 112-14 Automated screening systems, 103 Financial statements, 307-16 Automated teller machines, use of, 81 Government Performance and Results Availability of Funds and Collection of Act, 143-45 Checks (See Regulations: CC) Inspector General, Office of, audits and reviews, 328 Balance sheets Law enforcement authority, 156 Board of Governors, 308-14 Members and officers, lists, 241-43, Federal Reserve Banks, combined, 267-70 317-27 Policy actions, 151-59 Federal Reserve priced services, 138-41 Public notice of decisions, 120 Bank holding companies Thrift Institutions Advisory Council, 247 Capital standards, 106, 154 Borrowers of Securities Credit (See Financial reports, 111 Regulations: X) Inspections and examinations of, 95-97, Business loans, demand for, 93 100, 103, 104" Business spending, investment, and International lending, 155 finance, 14-20, 48-51 Stock repurchases by, 120 Business-continuity plans, Federal Reserve Bank Holding Companies and Change in Banks, 125 Bank Control (See Regulations: Y) Business-continuity risk profile, 108 Bank Holding Company Act, 115 Bank Holding Company Performance CAESAR (See Complaint Analysis Reports, 103 Evaluation System and Reports) Bank Merger Act, 118 Call Reports, 113 Bank Secrecy Act, 121 Capital Banking industry, structuring, 115-20 Accounts, Federal Reserve Banks, Banking organizations, U.S. 272-75, 318 Capital standards, 106, 109 Changes in, Federal Reserve Banks, 320 Examinations and inspections of, 95-101 Flows, 23, 54 Financial reporting, transparency, 111 Standards, 94, 106, 109, 154 Foreign operations, 104 Car loans, interest rates, 59 Internal controls, 111 Cash flows, Board of Governors, 310 Operating efficiency, 94 Cash services, Federal Reserve Banks, 130 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

338 89th Annual Report, 2002 Chain-type price index, 58 Current account (See Trade, Foreign) Change in Bank Control Act, 118 Check collection and processing, Federal Debit card and direct deposit use, 81 Reserve Banks, 126-28, 291 Debt and financial intermediation, 31, 61 Citigroup, Inc., merger application, 70 Depository institutions Civil money penalties, 101 Discount window credit, 151 Commercial Lending Essentials for Electronic access, 134 Consumer Affairs, examiner training, Interest rates on loans from Reserve 74 Banks, 292 Commercial, banks, number of, 295, 302 Mortgage lending, 74 Community affairs, 69-91 Reserve requirements, 153, 293 Community banks, risk-focused supervision Reserves held, 296-301 of, 102 Services to, by Federal Reserve Banks, Community development 126-31 Indian Country, 88 Depository services to U.S. Treasury, by Small businesses, 90 Federal Reserve Banks, 133 Underserved markets, 86 Deposits Community Reinvestment Act Federal Reserve Banks, 272-75, 297, Compliance examinations, 69-71 299, 301 Mergers and acquisitions, applications Insured commercial banks, 295 for, 70 Direct bill payment, 81 Review of, 72 Direct deposit, 81 Community Reinvestment Act Examination Directors, Federal Reserve Banks and Techniques, examiner training, 74 Branches, list, 250-66 Complaint Analysis Evaluation System and Disclosure statements and requirements, 74, Reports, 82 121 Compliance examinations, 71-75, 75-79 Discount rate (See also Interest rates), Consumer 157-59 Affairs, 69-91 Discount window credit, 33, 60, 151, 159 Complaints, 82-84 Leasing (See Regulations: M) Earnings, banking industry, 93 Privacy protection, 86 Economic projections, 8, 44 Protection laws, compliance with, 75-79 Economies, foreign, 34-39, 62-65 Spending, 12, 46 Economy, U.S. Consumer Advisory Council, 84-86, 246 Business sector, 14-20, 48-51 Consumer Compliance Examinations I Debt, 31, 61 and II, examiner training, 73 Equity markets, 29-31, 59 Coooperatieve Centrale Raiffeisen- Financial account, 23, 54 Boerenleenbank, B.A., merger Financial markets, 27-34, 58-62 application, 70 Government sector, 20, 51-53 Corporate profits, 16-20, 49-51 Household sector, 12-14, 46-48 Country risk, management of, 106 Interest rates, 28, 58 Courses, consumer compliance examiners, Labor market, 23-25, 55 73 Monetary aggregates, 32, 62 Credit by Banks for the Purpose of Monetary policy, 3-9, 41-45 Purchasing or Carrying Margin Stocks Prices, 25-27, 56-58 (See Regulations: U) Trade and current account, 22, 53 Credit card lending, guidance, 107 Edge Act corporations, 103, 104, 153, 155 Credit, primary and secondary, 159 Electronic access to Federal Reserve Currency and coin, operations and services, 134 developments in, 131, 291, 296, 298, Electronic Fund Transfer Act, economic 300, 318 effects of, 81 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 339 Electronic Fund Transfers (See FOMC—Continued Regulations: E) Disclosure policy, 180, 189 Emerging-market economies (See Guidelines and procedural instructions, Economies, Foreign) 163, 165, 169, 172 Employment, 23, 55 Meetings, minutes of, 166, 180, 189, Employment cost index, 25, 56 197, 205, 213, 220, 229 Enforcement actions, Federal Reserve Members and officers, list, 244 System, 101 Notation votes, 220 Equal Credit Opportunity (See Regulations: Federal Reserve Act, 98, 155 B) Federal Reserve Banks Equity markets, 29, 59, 156 Assessments by Board of Governors, Examinations and inspections 284, 286-89 Bank holding companies, 95-97 Audits of, 134, 305, 317-27 Compliance with consumer protection Branches laws, 69-79 Directors, list, 250-66 Fair lending, 71 Officers, list, 248 Federal Reserve Banks, 134 Premises, 136 Financial holding companies, 97 Vice presidents in charge, list, 248 International banking activities, 103-105 Business-continuity plans, 125 Specialized Checks handled, 291 Fiduciary activities, 100 Condition statements, 272-75, 318 Government and municipal securities Conferences of chairmen, presidents, and dealers and brokers, 100 first vice presidents, 249 Information technology activities, 97, Consumer and community affairs, 69-91 100 Currency and coin, operations and Securities clearing agencies, 100 developments in, 131, 291, 318 Securities credit lenders, 100 Deposits, 272-75 Transfer agents, 100 Directors, list, 250-66 State member banks, 71, 95, 104 Discount rate, 157-59, 292 Supervisory policy, 105-14 Discount window programs, revisions, U.S. banking organizations, foreign 151 operations, 104 Examinations of, 134 Extensions of Credit by Federal Reserve Financial statements, combined, 317-27 Banks (See Regulations: A) Float, credit outstanding, 131, 296, 298, 300 Fair Lending Examination Techniques, Holdings of loans and securities, 136, examiner training, 74 137, 272-75, 296-301 Fair lending examinations, 71 Income and expenses, 132, 135, 138-41, Federal Advisory Council, 245 282-85, 286-89, 319 Federal agency securities and obligations Information technology, 134 Depository institution holdings, 295 Initiatives, 125 Federal Reserve Banks, 272-75, 280, Law enforcement authority, 156 282-85, 296, 298, 300 Officers and employees, number and Federal Reserve open market operations, salaries, 281 225, 278 Officers, list, 248 Federal Financial Institutions Examination Operations, volume, 291 Council, activities, 103, 112-14 Payments to the U.S. Treasury, 287, 289 Federal funds rate, 4, 6, 7, 43, 44 Premises, 136, 272-75, 290, 318 Federal Open Market Committee Priced services, 126-31, 282 Authorizations, 161, 163, 168, 170 Salaries of officers and employees, 281 Directives, 171, 180, 189, 196, 204, 212, Securities and loans, holdings of, 136, 219, 228, 235 137, 272-75, 296-301 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

340 89th Annual Report, 2002 Federal Reserve Banks—Continued Fiscal agency services, Federal Reserve Services Banks, 131 Automated clearinghouse, 128, 291 Float, Federal Reserve, 131, 296, 298, 300 Cash, 130 Rood insurance, compliance with Check collection, 126-28 Regulation H, 72 Depository, 131, 133 Food coupon services, Federal Reserve Fedwire Funds, 128, 291 Banks, 134, 291 Fedwire Securities, 130 Foreign Fiscal agency, 131 Banking organizations Float associated with, 131 Regulation W, 98 Food coupon, 291 U.S. activities, examination of, 104 National Settlement, 128, 130 U.S. agencies and branches of, reserve Noncash collection, 130 requirements, 153 Special cash, 130 Currency income, Federal Reserve Federal Reserve notes, interest on, 287, Banks, 282 289 Currency operations Federal Reserve System (See also Board of Authorization for the conduct of, 163, Governors) 170 Applications and proposals, 120 Procedural instructions for, 165, 172 Decisions, public notice of, 120 Economic developments, 34-39, 62-65 Enforcement actions and civil money Trade, 22, 53 penalties, 101 Funds transfers, Federal Reserve Banks, Examinations and inspections, 95-101 291 Examiner training, 73, 115 Intraday credit, 98 G-fund, 52 Maps, 332 Garn-St Germain Depository Institutions Membership, 123 Act of 1982, 153 Supervision and regulation General Accounting Office, 329 responsibilities, 93-123 Gold certificate account of Reserve Banks Technical assistance and training, 105 and gold stock, 272-75, 296, 298, Federal sector, 20, 52 300, 318 Federal tax payments, 133 Fedwire, 129, 130 Government Performance and Results Act FFIEC (See Federal Financial Institutions of 1993, 143-45 Examination Council) Government Securities Investment Fund Fiduciary activities, supervision of, 100 (G-fund), 52 Finance, business and household, 13, 16, Government, federal 47,49 Depository services to, 133 Financial Fiscal agency services to, 131-33 Education for consumers, 87 Receipts, spending, and debt, 20, 51-53 Holding companies, 97 Securities dealers and brokers, Institutions, credit extensions to, 60 examination of, 100 Markets, 4-9, 27-34, 42-44, 58-62 Government, state and local, 21, 53 Reports, bank holding companies, 111 Gramm-Leach-Bliley Act of 1999, 86, 98, Statements 110, 154, 237 Board of Governors, 307-16 Disclosures of, 121 Home Mortgage Disclosure (See Federal Reserve Banks, combined, Regulations: C) 317-27 Home Mortgage Disclosure Act Federal Reserve priced services, Data collection, changes in procedures, 138-41 79,85 Subsidiaries and Regulation W, 99 Data on loan transactions, 74 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 341 Home Ownership and Equity Protection Investments—Continued Act, examination procedures, 72 Federal Reserve Banks, 272-75 Home Ownership Counseling Act, Inventory, 16, 49 examination procedures, 72 Overseas, by U.S. banking organizations, Homeowners Protection Act, examination 119 procedures, 72 Residential, 13, 47 Host-state loan-to-deposit ratios, updated, 73 Joint Forum, 110 Household sector, 12-14, 46-48 Justice, Department of, Board referrals to, Housing and Urban Development, 71 Department of, complaint referrals, 84 Labor market, 23-25, 55 Identity theft, 86 Labor productivity, 24, 55 Immigrant communities, banking for, 89 Large, complex banking organizations, Income and expenses supervision of, 102 Board of Governors, 309 Law enforcement authority, Federal Federal Reserve Banks, 132-34, 135, Reserve Board and Banks, 156 282-85, 286-89, 319 Legislation, federal, 147 Federal Reserve priced services, 126-31, Litigation involving the Board of 138-41, 282 Governors Inflation, 25-27, 56-58 Albrecht, 237 Information technology Artis, 237 Federal Reserve examination of, 97, 100 Caesar, 237 Interagency examination program, 113 Community Bank Trust, 237 Services to depository institutions, 134 Fraternal Order of Police, 238 Supervisory Information Technology Howe, 238 (SIT), 114 Laredo National Bancshares, Inc., 237 Inspector General, Office of, audits and Radfar, 237 reviews, 328 Sedgwick, 237 Insured commercial banks, assets and Trans Union LLC, 237 liabilities, 295 Loans Interest rates (See also Discount rate and Federal Reserve Banks Federal funds rate), 28, 58, 93, 292 Holdings of and earnings on, 136, International 137, 272-75, 296, 298, 300 Banking activities, 155 Interest rates for depository Banking activities, supervision of, institutions, 292 103-105 Economic developments, 34-39, 62-65 Insured commercial banks, 295 International Accounting Standards Board, Purchases and Regulation W, 99 110 State member bank executive officers, International Banking Act, applications 123 under, 119 International Banking Operations (Reg. K), Maps, Federal Reserve System, 332 155 Margin stocks and requirements, 121, 294 International Lending Supervision Act of Margin stocks, interest, 93 1983, 155 Member banks (See also State member Interstate bank branches, 154 banks) Intraday credit, 98 Applications by, 120 Investments Assets and liabilities, 295 Business, 14-16, 48, 49 Number of, 295, 302 Equity, regulatory capital treatment of, Reserves, 297, 299, 301 106 Transactions with affiliates, 155 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

342 89th Annual Report, 2002 Members and officers, Board of Governors, Prices 241^3, 267-70 Consumer, 25-27, 56, 58 Membership of State Banking Institutions Energy, 25, 56 in the Federal Reserve System (See Equity, 29-31, 59 Regulations: H) Gasoline, 26, 56 Mergers and acquisitions under CRA, 70 Privacy of Consumer Financial Information Monetary aggregates (Ml, M2, M3), 32, 62 (See Regulations: P) Monetary Control Act of 1980, 153 Privacy, consumer rights, 86 Monetary policy, 3-9, 41-45 Profit and loss, Federal Reserve Banks, 284 Monetary policy reports to the Congress Profits, corporate, 16-20, 49-51 February 2003, 3-9, 11-39 July 2002, 41-65 Real Estate Settlement Procedures Act Money laundering, 121 (RESPA), examiner review and Municipal securities dealers and brokers, guidance, 72, 86 examination of, 100 Regional banking organizations, supervision of, 101 National Flood Insurance Act of 1968, 72 Regulations National Information Center (NIC), 114 A, Extensions of Credit by Federal Native Americans, community Reserve Banks, 60, 151, 159 development, 88 B, Equal Credit Opportunity, 76 Noncash collection services, Federal C, Home Mortgage Disclosure, 79, 85, Reserve Banks, 130 151, 152 Nonmember banks, 295, 302 D, Reserve Requirements of Depository Notes, Federal Reserve Institutions, 151, 153 Interest, 287, 289 E, Electronic Fund Transfers, 76, 81 Operations, 131, 291, 318 H, Membership of State Banking Institutions in the Federal Reserve Oil prices, 23, 54 System, 154 Open market operations K, International Banking Operations, 155 Alternative assets, use, 228 M, Consumer Leasing, 77 Authorization for conduct of, 161, 163, P, Privacy of Consumer Financial 168 Information, 77 Guidelines for the Conduct of System Open Market Operations in Federal T, Credit by Brokers and Dealers, 294 Agency Issues, 163 U, Credit by Banks for the Purpose of Volume of transactions, 276-79 Purchasing or Carrying Margin Overseas investments, U.S. banking Stocks, 294 organizations, 119 W, Transactions between Member Banks and Their Affiliates, 98, 155 Parallel-owned banking organizations, X, Borrowers of Securities Credit, 294 157 Y, Bank Holding Companies and Change Payments system, risk, 157 in Bank Control, 154 Point-of-sale transactions, 81 Z, Truth in Lending, 77, 80 Policy statements and actions, 105-110, AA, Unfair or Deceptive Acts or 151-59 Practices, 78 Postal money order services, Federal CC, Availability of Funds and Collection Reserve Banks, 134 of Checks, 78 Preferred stock, hedging of, guidance, 107 DD, Truth in Savings, 79 Premises, Federal Reserve Banks, 136, Reports of Condition and Income, 113 272-75, 290, 318 Reserve requirements, 293 Priced services, Federal Reserve Banks, Reserve Requirements of Depository 126-41, 282 Institutions (See Regulations: D) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 343 Reserves of depository institutions, Special drawing rights certificate account, 296-301 272-75, 296, 298, 300, 318 Revenue and income State and local government sector, 21, 53 Board of Governors, 309 State banks, number, 302 Federal Reserve Banks, 135, 282-85, State member banks (See also Member 286-89, 319 banks) Federal Reserve priced services, 125-41, Capital standards, 154 282 Claims on securities firms, 154 Non-interest, 93 Community Reinvestment Act, Riegle-Neal Interstate Banking and compliance with, 69 Branching Efficiency Act of 1994, 154 Complaints against, 82, 83, 84 Risk-based capital standards, final rule Credit to executive officers, 123 amending, 106 Examinations of, 69, 71-74, 95, 100, 103 Risk-focused supervision program, 101 Financial disclosure by, 121 Risk management, supervisory policy, 109 Foreign operations of, 104 Royal Bank of Canada, merger application, International activities of, 103-105, 155 70 Number, 295, 302 Rules Securities clearing agencies, 100 Regulatory capital treatment of equity Transfer agents, 100 investments, 106 State-chartered banks, number, 302 Risk-based capital standards, 106 Statistical loan sampling, guidance on, 107 Stock repurchases, bank holding Salaries, Federal Reserve Bank officers companies, 120 and employees, 281 Supervision and regulation responsibilities, Sarbanes-Oxley Act, 111 Federal Reserve System, 94-123 Savings bonds, 133 Supervisory Guidance in Dealing with Securities (See also Treasury securities) Weak Banks, report, 109 Clearing agencies, examination of, 100 Supervisory Information Technology (SIT), Credit for purchasing or carrying, 121, 114 294 Supervisory policies, guidance, 105-114 Credit lenders, examination of, 100 System Open Market Account (SOMA), Dealers and brokers, supervision of, 100 holdings and operations, 163, 169 Firms, claims on, 106, 154 Government and municipal, 100 Technical assistance by, Federal Reserve Holdings by Federal Reserve Banks, System, 105 136, 137, 280, 318 Terrorism Risk Insurance Act of 2002, 147 Marketable, 131 Thrift Institutions Advisory Council, 247 State member banks, 154 Trade, foreign, 22, 53 Securities Act Amendments of 1975, Training, Federal Reserve examiners, 73, compliance with, 100 115 Securitization, guidance on, 107 Training, foreign supervisory authorities, Settlement services, Federal Reserve 105 Banks, 130 Transactions between Member Banks and Small businesses, community development, Their Affiliates (See Regulations: W) 90 Transfer agents, supervision of, 100 SOMA (See System Open Market Account) Transparency in financial reporting, 111 Sound Practices for the Management and Treasury securities Supervision of Operational Risk, Depository institution holdings, by class policy paper, 109 of bank, 295 Special cash services, Federal Reserve Federal Reserve Banks, holdings, Banks, 130 272-75, 280, 282-85, 296, 298, 300 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

344 89th Annual Report, 2002 Treasury securities—Continued Truth in Savings (See Regulations: DD) Open market transactions, 276-79 Repurchase agreements, 272-75, 278, Unemployment, 23, 55 980 OQfx 9Q8 ^00 T n on !; * **u ,o i Unfair or Deceptive Acts or Practices (See Treasury, U.S. Department of the (See also Regulations- AA^ Treasury securities), 287, 289 Regulations. AA) Currency outstanding, 296, 298, 300 USA PATRIOT Act, 122, 156 Truth in Lending (See Regulations: Z) Truth in Lending Act, examination West Texas intermediate, prices, 23, 54 procedures, 72 FRB1/1-600O-0403 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis