Annual Report of the Federal Reserve Board, 2003

€/fnnual ^Report \O 2003 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 2004 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 ninetieth annual report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 2003. 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 2003 and Early 2004 7 Economic Projections for 2004 9 ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2003 AND EARLY 2004 10 The Household Sector 12 The Business Sector 16 The Government Sector 18 The External Sector 20 The Labor Market 22 Prices 24 U.S. Financial Markets 28 International Developments 33 MONETARY POLICY REPORT OF JULY 2003 33 Monetary Policy and the Economic Outlook 37 Economic and Financial Developments in 2003 Federal Reserve Operations 61 CONSUMER AND COMMUNITY AFFAIRS 61 Supervision for Compliance with Consumer Protection and Community Reinvestment Laws 71 Implementation of Statutes Designed to Inform and Protect Consumers 73 Consumer Complaints 76 Advice from the Consumer Advisory Council 78 Promotion of Community Economic Development in Historically Underserved Markets 82 Outreach Activities 83 BANKING SUPERVISION AND REGULATION 84 Scope of Responsibilities for Supervision and Regulation 85 Supervision for Safety and Soundness 94 Supervisory Policy 104 Supervisory Information Technology 105 Staff Development 106 Regulation of the U.S. Banking Structure 111 Enforcement of Other Laws and Regulations 113 Federal Reserve Membership Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

115 FEDERAL RESERVE BANKS 115 Major Initiatives 116 Developments in Federal Reserve Priced Services 120 Developments in Currency and Coin 121 Developments in Fiscal Agency and Government Depository Services 124 Electronic Access 124 Information Technology 124 Examinations of the Federal Reserve Banks 125 Income and Expenses 126 Holdings of Securities and Loans 127 Volume of Operations 127 Federal Reserve Bank Branches 127 Federal Reserve Bank Premises 129 Pro Forma Financial Statements for Federal Reserve Priced Services 133 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE AND RESULTS ACT 133 Strategic Plan, Performance Budget, and Performance Report 133 Mission 133 Goals and Objectives 135 Interagency Coordination 137 FEDERAL LEGISLATIVE DEVELOPMENTS 137 Check 21 Act 137 FACT Act Records 143 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS 143 Regulation B (Equal Credit Opportunity) 143 Regulation D (Reserve Requirements of Depository Institutions) 143 Regulation H (Membership of State Banking Institutions in the Federal Reserve System) 144 Regulation H and Regulation K (International Banking Operations) 144 Regulation H and Regulation Y (Bank Holding Companies and Change in Bank Control) 144 Regulation K 145 Regulation V (Fair Credit Reporting) 145 Regulation Y 145 Rules of Organization 146 Rules of Practice for Hearings 146 Rules Regarding Equal Opportunity 146 Policy Statements and Other Actions 147 Discount Rates in 2003 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

151 MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS 151 Authorization for Domestic Open Market Operations 153 Guidelines for the Conduct of System Open Market Operations in Federal Agency Issues 153 Domestic Policy Directive 153 Authorization for Foreign Currency Operations 155 Foreign Currency Directive 155 Procedural Instructions with Respect to Foreign Currency Operations 156 Meeting Held on January 28-29, 2003 170 Meeting Held on March 18, 2003 177 Meeting Held on May 6, 2003 184 Meeting Held on June 24-25, 2003 194 Meeting Held on August 12, 2003 201 Meeting Held on September 16, 2003 209 Meeting Held on October 28, 2003 216 Meeting Held on December 9, 2003 225 LITIGATION 225 Litigation under the Financial Institutions Supervisory Act 225 Other Actions Federal Reserve System Organization 229 BOARD OF GOVERNORS 232 FEDERAL OPEN MARKET COMMITTEE 233 ADVISORY COUNCILS TO THE BOARD OF GOVERNORS 233 Federal Advisory Council 234 Consumer Advisory Council 235 Thrift Institutions Advisory Council 236 FEDERAL RESERVE BANKS AND BRANCHES 236 Officers of the Banks and Branches 237 Conference of Chairmen 237 Conference of Presidents 238 Conference of First Vice Presidents 238 Directors of the Banks and Branches 255 HISTORICAL RECORDS: MEMBERS OF THE BOARD OF GOVERNORS, 1913-2003 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 260 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2003 and 2002 264 2. Federal Reserve Open Market Transactions, 2003 268 3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2001-03 269 4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2003 270 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2003 274 6. Income and Expenses of the Federal Reserve Banks, 1914-2003 278 7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks and Branches, December 31, 2003 279 8. Operations in Principal Departments of the Federal Reserve Banks, 2000-2003 280 9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2003 281 10. Reserve Requirements of Depository Institutions, December 31, 2003 282 11. Initial Margin Requirements under Regulations T, U, and X 283 12. Principal Assets and Liabilities of Insured Commercial Banks in the United States, by Class of Bank, June 30, 2003 and 2002 284 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items A. Year-End 1984-2003 and Month-End 2003 B. Year-End 1918-1983 292 14. Banking Offices and Banks Affiliated with Bank Holding Companies in the United States, December 31, 2002 and 2003 Federal Reserve System Audits 295 AUDITS OF THE FEDERAL RESERVE SYSTEM 297 BOARD OF GOVERNORS FINANCIAL STATEMENTS 307 FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS 320 OFFICE OF INSPECTOR GENERAL ACTIVITIES 321 GENERAL ACCOUNTING OFFICE REVIEWS 323 MAPS OF THE FEDERAL RESERVE SYSTEM 327 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 economic expansion in the United eventually lead to a pickup in the pace States gathered strength during 2003 of the expansion, the timing and extent while price inflation remained quite low. of the improvement were uncertain. At the beginning of the year, uncertain- During the spring, the rally that occurred ties about the economic outlook and in equity markets when the war-related about the prospects of war in Iraq appar- uncertainties lifted suggested that marently weighed on spending decisions ket participants viewed the economic and extended the period of subpar eco- outlook as generally positive. By then, nomic performance that had begun more the restraints imparted by the earlier than two years earlier. However, with sharp decline in equity prices, the the support of stimulative monetary and retrenchment in capital spending, and fiscal policies, the nation's economy lapses in corporate governance were weathered that period of heightened receding. As the price of crude oil uncertainty to post a marked accelera- dropped back and consumer confidence tion in economic activity over the sec- rebounded last spring, household spendond half of 2003. Still, slack in resource ing seemed to be rising once again at utilization remained substantial, unit a moderate rate. Businesses, however, labor costs continued to decline as remained cautious; although the deterioproductivity surged, and core inflation ration in the labor market showed signs moved lower. The performance of the of abating, private payroll employment economy last year further bolstered the was still declining, and capital spending case that the faster rate of increase in continued to be weak. In addition, ecoproductivity, which began to emerge in nomic activity abroad gave few signs of the late 1990s, would persist. The com- bouncing back, even though long-term bination of that favorable productivity interest rates in major foreign econotrend and stimulative macroeconomic mies had declined sharply. At its June policies is likely to sustain robust eco- meeting, the FOMC provided additional nomic expansion and low inflation in policy accommodation, given that, as 2004. yet, it had seen no clear evidence of an At the time of our last Monetary Pol- acceleration of U.S. economic activity icy Report to the Congress, in July, near- and faced the possibility that inflation term prospects for U.S. economic activ- might fall further from an already low ity remained unclear. Although the level. Federal Open Market Committee During the next several months, evi- (FOMC) believed that policy stimulus dence was accumulating that the econand rapid gains in productivity would omy was strengthening. The improvement was initially most apparent in NOTE. The discussion here and in the next financial markets, where prospects for section ("Economic and Financial Developments stronger economic activity and corpoin 2003 and Early 2004") consists of the text, rate earnings gave a further lift to equity tables, and selected charts from the Monetary Polprices. Interest rates rose as well, but icy Report submitted to the Congress on Februfinancial conditions appeared to remain, ary 11, 2004, pursuant to section 2B of the Federal Reserve Act. on net, stimulative to spending, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

90th Annual Report, 2003 additional impetus from the midyear look despite these generally favorable changes in federal taxes was in train. fundamentals. In particular, questions Over the remainder of the year, in the remain as to how willing businesses will absence of new shocks to economic be to spend and hire and how durable activity and with gathering confidence will be the pickup in economic growth in the durability of the economic expan- among our trading partners. At its sion, the stimulus from monetary and meeting on January 27-28, 2004, the fiscal policies showed through more Committee perceived that upside and readily in an improvement in domestic downside risks to the attainment of susdemand. Consumer spending and resi- tainable growth for the next few quardential construction, which had provided ters are roughly equal. solid support for the expansion over Prospects for sustained high rates of the preceding two years, rose more rap- increase in productivity are quite favoridly, and business investment revived. able. Businesses are likely to retain their Spurred by the global recovery in the focus on controlling costs and boosthigh-tech sector and by a pickup in eco- ing efficiency by making organizational nomic activity abroad, U.S. exports also improvements and exploiting investposted solid increases in the second half ments in new equipment. With the ongoof the year. Businesses began to add to ing gains in productivity, the existing their payrolls, but only at a modest pace margins of slack in resource utilizathat implied additional sizable gains in tion should recede gradually, and any productivity. upward pressure on prices should The fundamental factors underlying remain well contained. The FOMC indithe strengthening of economic activity cated at its January meeting that, with during the second half of 2003 should inflation low and resource use still slack, continue to promote brisk expansion in it can be patient in removing its policy 2004. Monetary policy remains accom- accommodation. modative. Financial conditions for businesses are quite favorable: Profits have been rising rapidly, and corporate bor- Monetary Policy, Financial rowing costs are at low levels. In the Markets, and the Economy household sector, last year's rise in over 2003 and Early 2004 the value of equities and real estate exceeded the further accumulation of During the opening months of 2003, the debt by enough to raise the ratio of softness in economic conditions was household net worth to disposable exacerbated by the substantial uncerincome after three consecutive years of tainty surrounding the onset of war in decline. In addition, federal spending Iraq. Private nonfarm businesses began and tax policies are slated to remain again to cut payrolls substantially, constimulative during the current fiscal sumer spending slowed, and business year, while the restraint from the state investment was muted. Although the and local sector should diminish. Lastly, jump in energy prices pushed up overall the lower foreign exchange value of the inflation, slack in resource utilization dollar and a sustained economic expan- and the rapid rise in labor productivity sion among our trading partners are pushed core inflation down. In financial likely to boost the demand for U.S. pro- markets, the heightened sense of caution duction. Considerable uncertainty, of among investors generated safe-haven course, still attends the economic out- demands for Treasury and other fixed- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook 5 Selected InterestRates Percent — Ten-year Treasury 1/30 3/19 5/7 6/26 8/13 9/24 ! 1/6 12/10 1/29 3/18 5/6 6/25 8/12 9/16 10/28 12/9 1/28 2002 2003 2004 NOTE. The data are daily and extend through February 4, 2004. The dates on the horizontal axis are those of scheduled FOMC meetings. income securities, and equity prices to suggest only tepid growth. Uncerdeclined. tainty in financial markets had declined, At its meeting on March 18, the and rising consumer confidence and a FOMC maintained its 1 lA percent target wave of mortgage refinancing appeared for the federal funds rate to provide to be supporting consumer spending. support for a stronger economic expan- However, persistent excess capacity sion that appeared likely to materialize. evident in labor and product markets The Committee noted that the prevailing pointed to possible further disinflation. high degree of geopolitical uncertainty The lifting of some of the uncertainty complicated any assessment of pros- clouding the economic outlook allowed pects for the economy, and members the Committee to make the determinarefrained from making a determination tion that the risks to economic growth about the balance of risks with regard were balanced but that the probability of to its goals of maximum employment an unwelcome substantial fall in inflaand stable prices. At the same time, the tion exceeded that of a pickup in infla- Committee agreed to step up its surveil- tion. The FOMC judged that, taken lance of the economy, which took the together, the balance of risks was form of a series of conference calls in weighted toward weakness. The Comlate March and early April to consult mittee left the federal funds rate target about developments. When military at VA percent, but the Committee's action in Iraq became a certainty, finan- announcement prompted a rally in the cial markets began to rally, with risk Treasury market, and coupon yields fell spreads on corporate debt securities nar- substantially as market participants rowing and broad equity indexes reg- marked down their expectations for the istering notable gains. Economic news, path of the federal funds rate. however, remained mixed. By the time of the June 24-25 FOMC Indicators of the economy at the time meeting, risk spreads had narrowed furof the May 6 FOMC meeting continued ther and equity prices had extended their Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

90th Annual Report, 2003 rise, but the prospects for sustained eco- strengthened, and the housing market nomic expansion still seemed tentative. remained robust. By the time of the Although Committee members referred August 12 FOMC meeting, members to signs of improvement in some sec- generally perceived a firming in the tors of the economy, they saw no con- economy, most encouragingly in busicrete evidence of an appreciable overall ness investment spending, and believed strengthening in the economic expan- that, even after the rise in longer-term sion and viewed the excess capacity in rates, financial conditions were still supthe economy as likely to keep inflation portive of vigorous economic growth. in check. The Committee lowered the Given the continued slack in resource target for the federal funds rate V* per-use across the economy, however, memcentage point, to 1 percent, to add fur- bers saw little risk of inducing higher ther support to the economic expansion inflation by leaving the federal funds and as a form of insurance against a rate at its accommodative level. On the further substantial drop in inflation, basis of the economic outlook, and to however unlikely. The members saw reassure market participants that policy no serious obstacles to further conven- would not reverse course soon, Committional policy ease down to the zero tee members decided to include in the lower bound on nominal interest rates announcement a reference to their judgshould that prove to be necessary. The ment that under the anticipated circum- Committee also discussed alternative stances, policy accommodation could be means of providing monetary stimulus maintained for a "considerable period." should the target federal funds rate be Through the September 16 and Octoreduced to a point at which they would ber 28 FOMC meetings, the brightening have little or no latitude for additional prospects for future growth put upward easing through this traditional channel. pressure on equity prices and longer- Longer-term interest rates backed up term interest rates. The Committee's following the meeting, as investors had retention of the phrase "considerable apparently placed substantial odds on a period" in the announcements followpolicy move larger than 25 basis points ing each of these meetings apparently and may have been disappointed that provided an anchor for near-term interthe announcement failed to mention any est rates. The Committee's discussion potential "unconventional" monetary at these two meetings focused on the policy options. Ten-year Treasury yields increased evidence of a broadly based rose sharply during the following weeks acceleration in economic activity and in reaction to interpretations of the on the continued weakness in labor Chairman's congressional testimony, markets. Rising industrial production, the release of Committee members' eco- increased personal consumption and nomic projections, and positive incom- business investment spending, higher ing news about the economy and corpo- profits, receptive financial markets, and rate profits. A substantial unwinding of a lower foreign exchange value of the hedging positions related to mortgage dollar all suggested that sustained and investments may well have amplified robust economic growth was in train. the upswing in market yields. Over the The Committee's decision to leave the intermeeting period, labor markets con- stance of monetary policy unchanged tinued to be soft, but industrial pro- over this period reflected, in part, a conduction, personal consumption expen- tinuing confidence that gains in producditures, and business outlays all tivity would support economic growth Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook and suppress inflationary pressures. In reassurance from reports of plans for fact, the Committee generally viewed its stronger capital spending and the widegoal of price stability as essentially hav- spread distribution of increased activity ing been achieved. across regions. Accommodative finan- By the time of the December 9 cial market conditions, including higher FOMC meeting, the economic expan- equity prices, narrower risk spreads on sion appeared likely to continue at a rate bonds, and eased standards on business sufficient to begin to reduce slack in loans, also seemed supportive of ecolabor and product markets. Equity mar- nomic expansion. However, some risks kets continued to rally, and risk spreads, remained in light of continued lackluster particularly on the debt of speculative- hiring evidenced by the surprisingly grade firms, narrowed further. The labor weak December payroll employment market was finally showing some signs report. With the likelihood for rapid of improvement, and spending by productivity growth seemingly more households remained strong even as the assured, Committee members generally impetus from earlier mortgage refinanc- agreed that inflation pressures showed ings and tax cuts began to wane. The no sign of increasing and that a bit more acceleration in capital spending and evi- disinflation was possible. Under these dence that some firms were beginning circumstances, the Committee conto accumulate inventories seemed to cluded that current conditions allowed signal that business confidence was on monetary policy to remain patient. As to the mend. However, twelve-month core the degree of policy accommodation, the consumer price inflation was noticeably Committee left its target for the federal lower than in the previous year. Even funds rate unchanged. The Committee's though the unemployment rate was characterization that policy could be expected to move down gradually, con- patient instead of its use of the phrase tinued slack in labor and product mar- "considerable period" in its announcekets over the near term was viewed as ment prompted a rise in Treasury yields sufficient to keep any nascent inflation across the yield curve and a fall in subdued. Uncertainty about the pace at equity prices. which slack would be worked down, however, made longer-run prospects for Economic Projections for 2004 inflationary pressures difficult to gauge. Given the better outlook for sustained Federal Reserve policymakers expect economic growth, the possibility of per- that the economic expansion will connicious deflation associated with a pro- tinue at a brisk pace in 2004. The central nounced softening in real activity was tendency of the forecasts of the change seen as even more remote than it had in real gross domestic product made by been earlier in the year. The Committee the members of the Board of Governors indicated that keeping policy accommo- and the Federal Reserve Bank presidative for a considerable period was dents is AVi percent to 5 percent, meacontingent on its expectation that infla- sured from the final quarter of 2003 to tion would remain low and that resource the final quarter of 2004. The full range use would remain slack. of these forecasts is somewhat wider— At its meeting on January 27-28, from 4 percent to 5Vi percent. The 2004, the Committee viewed a self- FOMC participants anticipate that the sustaining economic expansion as even projected increase in real economic more likely. Members drew particular activity will be associated with a further Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

8 90th Annual Report, 2003 Economic Projections for 2004 Percent Federal Reserve Governors and Reserve Bank presidents Indicator MEMO: 2003 actual Central Range tendency Change, fourth quarter to fourth quarter1 Nominal GDP 5.9 5x/i-6V2 5V2-6lA Real GDP 4.3 4-51/2 41/2-5 PCE chain-type price index 1.4 1-11/2 1-1 VA Average level, fourth quarter Civilian unemployment rate 5.9 5V4-5Vi 5V<x-5Vi 1. Change from average for fourth quarter of previous year to average for fourth quarter of year indicated. gradual decline in the unemployment that inflation will remain quite low this rate. They expect that the unemploy- year. The central tendency of their forement rate, which has averaged 53/4 per- casts for the change in the chain-type cent in recent months, will be between price index for personal consumption 5!/4 percent and 51/2 percent in the fourth expenditures (PCE) is 1 percent to quarter of the year. With rapid increases VA percent; this measure of inflation in productivity likely to be sustained was 1.4 percent over the four quarters of and inflation expectations stable, Fed- 2003. eral Reserve policymakers anticipate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 The pace of economic expansion seemed to recede. Real GDP increased strengthened considerably in the second at an annual rate of 6 percent, on averhalf of 2003 after almost two years age, in the third and fourth quarters of of uneven and, on balance, sluggish last year. In contrast, between late 2001 growth. In early 2003, accommodative and mid-2003, real GDP had risen at an monetary policy and stimulative fiscal annual rate of only 2Vi percent. policies were in place, but economic During the period of recession and activity still seemed to be weighed subpar economic expansion, considerdown by a number of factors that had able slack developed in labor and prodrestrained the recovery earlier: Geopo- uct markets. The firming of economic litical tensions were again heightened, activity in the second half of last year this time by the impending war in Iraq, produced modest increases in rates of businesses remained unusually cautious resource utilization. Sustained efforts by about the strength of the expansion, and businesses to control costs led to further economic activity abroad was still weak. rapid gains in productivity. As a result, In June the continued lackluster eco- unit labor costs declined, and core nomic growth and a further downshift in rates of inflation continued to slow in inflation from an already low level 2003; excluding food and energy, the prompted a further reduction in the fed- PCE chain-type price index increased eral funds rate. In addition, the tax cuts just 0.9 percent last year. Measures of that became effective at midyear pro- overall inflation, which were boosted vided a significant boost to disposable by movements in food and energy income. In the succeeding months, the prices, were higher than those for core macroeconomic stimulus began to show inflation. through clearly in sales and produc- Domestic financial market conditions tion, and some of the business caution appeared to become increasingly sup- Change in Real GDP Change in PCE Chain-Type Price Index Percent, annual rale • Total 51 Excluding food and energy — 4 — 2 1997 1999 2001 2003 1997 1999 2001 2003 NOTH. Here and in subsequent charts, except as noted, change for a given period is measured to its final quarter NOTE. The data are for personal consumption expenfrom the final quarter of the preceding period. ditures (PCE). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

10 90th Annual Report, 2003 portive of economic growth last year. eligible for child tax credits provided The economic expansion lowered inves- a substantial boost to after-tax income. tors' perception of, and perhaps aver- In 2003, real disposable personal sion to, risk, and continued disinflation income increased VA percent, after havwas interpreted as a sign that monetary ing risen VA percent in 2002. Low interpolicy would remain on hold, even as est rates provided additional impetus the economy picked up steam. Although to household spending by reducing yields on Treasury coupon securities borrowing costs for new purchases of rose modestly on balance over the year, houses and durable goods; they also risk spreads on corporate debt narrowed indirectly stimulated spending by facilito the point that yields on corporate tating an enormous amount of mortgage issues declined. The low-interest-rate refinancing. environment spurred considerable cor- The personal saving rate has fluctuporate bond issuance and generated a ated within a fairly narrow range around massive wave of mortgage refinancing 2 percent over the past three years. activity by households. Equity markets Although households continued to see began to rally when the uncertainty over the value of their homes appreciate over the timing of military intervention in this period, they also were adjusting to Iraq was resolved. The climb in stock the substantial drop in equity wealth that prices continued for the rest of the year, occurred after the peak in the stock mardriven by improving corporate earnings ket in 2000. By itself, a fall in the ratio reports and growing optimism about the of household wealth to income of the prospects for the economy. At the same magnitude that households experienced time, with economic conditions abroad between 2000 and 2002 might have trigimproving and with concerns about the gered a noticeable increase in the perfinancing burden of the U.S. current sonal saving rate. However, in this case, account deficit gaining increased atten- the tendency for households to save tion in financial markets, the dollar fell more as their wealth declines appears to appreciably on a trade-weighted basis. have been tempered in part by their willingness to take advantage of the attractive pricing and financing environment The Household Sector for consumer goods. Real consumer expenditures for dura- Consumer Spending ble goods surged more than 11 percent Early in 2003, consumer spending was in 2003. Sales of new motor vehicles still rising at about the same moderate pace as in 2001 and 2002. In the late Change in Real Income and Consumption spring and in the summer, however, households stepped up their spending Percent, annual rate sharply. As a result, in the second half • Disposable personal income of last year, real personal consumption — M Personal consumption — 8 expenditures rose at an annual rate of expenditures 43/4 percent after having increased at a — 6 rate of just under 3 percent in the first llllni — 4 half. Although wage and salary earnings — 2 rose slowly during most of the year, the midyear reductions in tax rates and U the advance of rebates to households 1997 1999 2001 2003 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 11 remained brisk as many consumers rates in more than forty years, which, responded to the low financing rates and according to the Michigan SRC's survarious incentive deals that manufactur- vey of consumer sentiment, buoyed coners offered throughout the year. Falling sumer attitudes toward homebuying prices also made electronic equipment throughout the year. The average rate on attractive to consumers, and spending thirty-year fixed-rate mortgages dropped on home furnishings likely received a sharply during the first half of 2003 and boost from the strength of home sales. reached a low of 5^4 percent in June. Altogether, real outlays for furniture and Although the thirty-year rate subsehousehold equipment jumped Yblh per- quently firmed somewhat, it remained cent in 2003. below 6 percent, on average, in the sec- In contrast, real consumer expendi- ond half of last year. tures on nondurable goods and on ser- Construction of new single-family vices continued to rise at a moderate homes accelerated during 2003, and for pace, on balance, last year. Outlays for the year as a whole, starts averaged food and apparel increased a bit faster 1.5 million units, an increase of 10 perthan in 2002, and the steady uptrend cent compared with the level in 2002. in spending for medical services was Sales of both new and existing singlewell maintained. However, consumers family homes also picked up sharply responded to the higher cost of energy further last year. The brisk demand by cutting back their real spending on for homes was accompanied by rapid gasoline, fuel oil, and natural gas and increases in the average price paid for electricity services. them. The average price paid for new Consumer confidence was shaken homes rose 10 percent over the four temporarily early in 2003 by concerns quarters of 2003, and the average price about the consequences of a war in of existing homes was up 73/4 percent Iraq, but it snapped back in the spring. over the same period. However, house Toward year-end, sentiment appeared to price inflation was lower after adjusting brighten more as households saw their for shifts in the composition of transcurrent financial conditions improve and actions toward more expensive homes. gained confidence that business condi- The constant-quality price index for tions would be better during the year new homes, which eliminates the influahead. Those positive views became ence of changes in their amenities and more widely held in January, and the their geographic distribution, increased index of consumer sentiment prepared 43/4 percent over the four quarters of by the Michigan Survey Research Cen- 2003—down from an increase of 6 perter (SRC) reached its highest level in cent during 2002. The year-over-year three years. increase in Freddie Mac's index of the prices paid in repeat sales of existing homes stood at 5x/i percent as of the Residential Investment third quarter of 2003, compared with a rise of 7]/4 percent as of the third quarter Housing activity was robust for a secof 2002. ond consecutive year in 2003. After having risen 7 percent in 2002, real expen- Starts in the multifamily sector totaled ditures on residential construction 350,000 units in 2003, a pace little jumped more than 10 percent in 2003. changed from that of the past several These gains were fueled importantly by years. Vacancy rates for these units rose the lowest levels of mortgage interest and rents fell during the year, but falling Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

12 90th Annual Report, 2003 mortgage rates apparently helped to Mortgage Rates maintain building activity. Household Finance Household debt increased IO3A percent last year, in large part because of the surge in mortgage borrowing induced by record-low mortgage interest rates. Refinancing activity was torrid in the first half of the year, as mortgage rates declined. Some of the equity that house- 2000 2001 2002 2003 2004 holds extracted from their homes dur- NOTE. The data, which are monthly and extend ing refinancings was apparently used through January 2004, are contract rates on thirty-year mortgages. to fund home improvements and to pay SOURCE. Federal Home Loan Mortgage Corporation. down higher-interest consumer debt. When mortgage rates rebounded in the second half of the year, mortgage bor- Although the companies directly implirowing slowed from the extremely rapid cated in wrongdoing experienced heavy clip of the first half, but it remained outflows from their funds, most of these brisk through year-end. Consumer credit withdrawals apparently were transferred increased at a pace of 5lA percent in to other mutual funds with little effect 2003, a little faster than a year earlier, as on the industry as a whole. A considerrevolving credit picked up somewhat able rise in real estate wealth further from the slow rise recorded in 2002. augmented household assets. Although Despite the pickup in household bor- prices of existing homes climbed more rowing, low interest rates kept the slowly than they had in the previous household debt-service and financial- year, the rate of increase remained sizobligation ratios—which gauge pre- able. Overall, the advance in the value committed expenditures relative to dis- of household assets outstripped the posable income—at roughly the levels accumulation of household debt by posted in 2002. Most measures of delin- enough to boost the ratio of net worth to quencies on consumer loans and home disposable income over the year. mortgages changed little on net last year, and household bankruptcies held The Business Sector roughly steady near their elevated level in 2002. Fixed Investment Even with the rapid expansion in debt, net worth of the household sec- Business spending on equipment and tor increased as the value of household software was still sluggish at the beginassets rose noticeably. Stock prices were ning of 2003. However, it accelerated boosted by the rise in corporate earn- noticeably over the course of the year as ings and the ebbing of uncertainty profits and cash flow rebounded and about future economic growth. House- as businesses gained confidence in the holds directed substantial flows into strength of the economic expansion and stock mutual funds in the third and in the prospective payoffs from new fourth quarters despite highly publicized investment. At the same time, business scandals in the mutual fund industry. financing conditions were very favor- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 13 Change in Real Business Fixed Investment communications equipment, which had continued to contract in 2002 after hav- Percent, annual rate ing plummeted a year earlier, turned up markedly. Structures Equipment and software — 20 In contrast, the recovery in spending J J J n — 10 on non-high-tech equipment was, on balance, more muted, in part because — 0 outlays for transportation equipment — 10 continued to fall. The prolonged slump — 20 in business purchases of new aircraft continued in 2003 as domestic air carriers grappled with overcapacity and high • High-tech equipment fixed costs. By the fourth quarter, real and software — 60 outlays for aircraft had dropped to their 9 Other equipment excluding transportation — 40 lowest level in ten years. In the market for heavy (class 8) trucks, sales were — 20 quite slow in early 2003 when busi- L i b . _ rm L_ o nesses were concerned about the perfor- LI mance of models with engines that met new emission standards. But as poten- 1997 1999 2001 2003 tial buyers overcame those concerns, Noni. High-tech equipment consists of computers sales recovered. By the fourth quarter of and peripheral equipment, software, and communications equipment. 2003, sales of medium and heavy trucks had moved noticeably above the slow able: Interest rates remained low, equity pace of 2001 and 2002. Apart from values rallied, and the enhanced partial- outlays for transportation equipment, expensing tax provision gave a spe- investment in other types of non-highcial incentive for the purchase of new tech equipment was, on balance, little equipment and software. After having changed during the first half of the year. changed little in the first quarter of the Demand was strong for medical equipyear, real outlays for equipment and ment, instruments, and mining and oilsoftware increased at an annual rate of field machinery, but sales of industrial 11% percent over the remaining three equipment and farm and construction quarters of the year. machinery were sluggish. In the second Outlays for high-technology items— half of the year, however, the firming computers and peripherals, software, in business spending for non-high-tech and communications equipment—which items became more broadly based. had risen a moderate 4V2 percent in The steep downturn in nonresidential 2002, posted a significantly more robust construction that began in 2001 moderincrease of more than 20 percent in ated noticeably in 2003, although mar- 2003. That gain contributed importantly ket conditions generally remained weak. to the pickup in overall business outlays After having contracted at an average for equipment and software and pushed annual rate of 13^2 percent during 2001 the level of real high-tech outlays above and 2002, real expenditures for nonresithe previous peak at the end of 2000. dential construction slipped just 11A per- The increase in spending last year on cent, on balance, during 2003. Spending computing equipment marked the sharp- on office buildings and manufacturing est gain since 1998, and investment in structures, which had dropped sharply Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

14 90th Annual Report, 2003 over the preceding two years, fell again Corporate Profits and in 2003. The high office vacancy rates Business Finance in many areas and low rates of factory Higher profits allowed many firms to utilization implied little need for new finance capital spending with internal construction in these sectors even as funds, and business debt rose only economic activity firmed. Investment in slightly faster than the depressed rate communications infrastructure, where a in 2002. Moreover, a paucity of cashglut of long-haul fiber-optic cable had financed merger and acquisition activity developed earlier, also continued to further limited the need to issue debt. shrink. In contrast, outlays for retail Gross equity issuance was extremely facilities, such as department stores and weak in the first half of the year but shopping malls, turned up last year, and perked up in the latter half in response the retrenchment in construction of new to the rally in equity prices. Neverthehotels and motels ended. In addition, less, for the year as a whole, firms extininvestment in drilling and mining strucguished more equity than they issued. tures, which is strongly influenced by The pace of gross corporate bond the price levels for crude oil and natural issuance was moderate at the start of the gas, increased noticeably in 2003. year but shot up in late spring as firms took advantage of low bond yields to Inventory Investment pay down short-term debt, to refund existing long-term debt, and to raise During 2002, businesses appeared to cash in anticipation of future spending. have addressed most of the inventory Bond issuance by investment-grade imbalances that had developed a year firms slowed after midyear as firms earlier. But the moderate pace of accumulated a substantial cushion of final demand during the first half of liquid assets and as interest rates on 2003 apparently restrained firms from higher-quality debt backed up. Howembarking on a new round of inventory ever, issuance by speculative-grade accumulation. Even though final sales firms continued apace, with the yields picked up in the second half of the year, on their debt continuing to decline drathe restraint seemed to recede only gradually. Over the first three quarters of 2003, nonfarm businesses trimmed Before-Tax Profits of Nonfinancial their inventories at an average annual Corporations as a Percent of Sector GDP rate of %23A billion in constant-dollar terms, and the preliminary estimate for the final quarter of the year indicated only modest restocking. As a result, — 14 most firms appear to have ended the year with their inventories quite lean relative to sales, even after tak- : ing into account the downward trend in inventory-sales ratios that has accom- — 6 panied the ongoing shift to improved J_L ill U 11 I inventory management. Motor vehicle 1978 1983 1993 1998 2003 dealers were an exception; their days' NOTE. The data are quarterly and extend through supply of new vehicles moved higher on 2003 :Q3. Profits are from domestic operations of nonfinancial corporations, with inventory valuation and average for a second year in a row. capital consumption adjustments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 15 Major Components of Net Business the increase in loan demand toward the Financing end of the year. The apparent divergence between survey responses and data on Billions of dollars actual loan volumes may suggest that L] Commercial paper _____ g™ demand for lines of credit has increased H Bonds but that these lines have not yet been — • Bank loans Sum of major "~600 drawn. In other short-term financing components —- 400 developments, nonfinancial firms that issued commercial paper in 2003 found a very receptive market, in large part because of the scarcity of outstanding issues. Many of the riskiest borrow- 2001 2002 2003 ers had exited the market in 2002, and NOTE. Seasonally adjusted annual rate for non- remaining issuers improved their attracfinancial corporate business. The data for the sum of tiveness to investors by continuing to major components are quarterly. The data for 2003:Q4 are estimated. restructure their balance sheets. Gross equity issuance rose over the course of 2003 as the economic outlook matically presumably because of inves- strengthened and stock prices moved tors' increased optimism about the eco- higher. The market for initial public nomic outlook and greater willingness offerings continued to languish in the to take on risk. The sum of bank loans first half of the year but showed signs of and commercial paper outstanding, life by the end of the summer. The volwhich represent the major components ume of seasoned offerings also picked of short-term business debt, contracted up in the second half of the year. On the throughout the year. In large part, this other side of the ledger, merger and decline reflected ongoing substitution acquisition activity again extinguished toward bond financing, but it also was shares in 2003, although only at a subdriven by the softness of fixed invest- dued pace. In addition, firms continued ment early in the year and the liquida- to retire a considerable volume of equity tion of inventories over much of the through share repurchases. For the year year. as a whole, net equity issuance was Respondents to the Senior Loan Offi- negative. cer Opinion Survey on Bank Lending Corporate credit quality improved, Practices noted that terms and standards on balance, over the year. Notably, the on business loans were tightened during default rate on corporate bonds declined the first half of the year but that both sharply, delinquency rates on commerhad been eased considerably by year- cial and industrial (C&I) loans at comend. They also reported that demand for mercial banks turned down, and the pace business loans was quite weak for much of bond-rating downgrades slowed of the year. However, despite the fact considerably. Low interest rates and the that outstanding levels of business loans resulting restructuring of debt obligacontinued to decline, survey responses tions toward longer terms also imporin the last quarter of the year indicated tantly contributed to improved business that demand for loans had begun to sta- credit quality. Bank loan officers noted bilize. Many banks cited customers' that the aggressive tightening of lending increased investment and inventory standards in earlier years was an imporspending as factors helping to generate tant factor accounting for the lower Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

16 90th Annual Report, 2003 delinquency and charge-off rates in between fiscal years. In addition, perrecent quarters. sonal income tax collections dropped Commercial mortgage debt increased sharply because of the slow rise in noticeably during most of 2003 despite nominal wages and salaries, diminished persistently high vacancy rates, falling capital gains realizations in 2002, and rents, and sluggish growth in construc- the tax cuts enacted under the Jobs tion expenditures. Low interest rates and Growth Tax Relief Reconciliation on this type of collateralized debt may Act of 2003. The act advanced refund have induced some corporate borrowers checks to households eligible for the to tap the market to pay down more- 2003 increment to the child tax credit costly unsecured debt. Delinquency and resulted in lower withholding schedrates on commercial mortgages gener- ules for individual taxpayers. The act ally remained low throughout 2003, and also expanded the partial-expensing risk spreads were relatively narrow. incentive for businesses, but because Loan performance has held up well corporate profits accelerated sharply last because of low carrying costs for prop- year, corporate tax receipts rose appreerty owners and because the outstanding ciably after adjusting for the shifts in the loans generally had been structured to timing of payments. include a sizable equity contribution, At the same time, federal outlays which makes default less attractive to other than for interest expense rose rapborrowers. idly for the second consecutive year in fiscal 2003; these outlays increased about 9 percent after having risen The Government Sector 11 percent in fiscal 2002. Spurred by operations in Iraq, defense spending Federal Government soared again, and outlays for homeland The federal budget deficit continued to security rose further. Spending for widen in fiscal year 2003 as a result of income support, such as unemployment the slow increase in nominal incomes, insurance, food stamps, and child credoutlays associated with the war in Iraq, its under the earned income tax credit and legislative actions that reduced taxes program, also posted a sizable increase. and boosted spending. The deficit in The ongoing rise in the cost and utilithe unified budget totaled $375 billion, zation of medical services continued up substantially from the deficit of Federal Receipts and Expenditures $158 billion recorded in fiscal 2002. The Congressional Budget Office is projecting that the unified federal deficit Percent of nominal GDP will increase further in fiscal 2004, to 24 more than $475 billion. Expenditures Federal receipts have fallen in each of — Receipts — 22 <V the past three years; the drop of nearly Expenditures^^ *-v ex. net interest ^) 4 percent in fiscal 2003 brought the ratio — 18 of receipts to GDP to I6V2 percent, — — 16 2 percentage points below the average for the past thirty years. About half of i I 1 1 1 i i 1 1 1 ! 1 1 i 1 ! i ! i 1 1l.ll 1985 1988 1991 1994 1997 2000 2003 the decrease in receipts last year was a consequence of legislation that shifted NOTE. The budget data are from the unified budget and are for fiscal years (October through September); due dates for corporate payments GDP is for the year ending in Q3. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 17 to push up spending for Medicare and Federal Government DebtHeld Medicaid. Overall, real federal con- by the Public sumption and investment (the measure of federal spending that is included in Percentof nomirii\\ GDP real GDP) increased 6 percent over the __ four quarters of 2003, after having risen - 55 r\ 10 percent a year earlier. - 45 J The federal government had contrib- \ uted increasingly to national saving in - 35 the late 1990s and 2000 as budget defi- - 25. cits gave way to accumulating surpluses. However, with the swing back to large illlill IMJiili Lj deficits in recent years, the federal 1963 1973 1983 1993 2003 government has again become a drain NOTE. Through 2002. the data for debt are year-end figures, and the corresponding value for GDP is for Q4 on national saving. Using the accountat an annual rate; the final observation is for 2003:Q3. ing practices followed in the national Excludes securities held as investments of federal govincome and product accounts (NIPA), ernment accounts. gross federal saving as a percent of GDP dropped sharply in late 2001 and has the case in 2002, the Treasury was trended down since then; the drop con- forced to resort temporarily to accounttributed to a decline in overall gross ing devices in the spring of 2003 when national saving as a percent of GDP the statutory debt ceiling became a confrom 18 percent in calendar year 2000 to straint, but debt markets were not dis- 13 percent, on average, in the first three rupted noticeably. In May, the Congress quarters of 2003. Federal saving net raised the debt ceiling from $6.4 trilof estimated depreciation fell from its lion to $7.4 trillion. With large deficits recent peak of 2V2 percent of GDP in expected to persist, the Treasury made a 2000 to negative 4 percent of GDP, on number of adjustments to its regular boraverage, in the first three quarters of rowing program, including reintroduc- 2003. As a result, despite a noticeable ing the three-year note, increasing to pickup in saving from domestic nonfed- monthly the frequency of five-year note eral sources, overall net national saving, auctions, reopening the ten-year note in which is an important determinant of the month following each new quarterly private capital formation, fell to less offering, and adding another auction than 1 Vi percent of GDP, on average, in of ten-year inflation-indexed debt. As the first three quarters of 2003, com- a result of these changes, the average pared with a recent high of 61/2 percent maturity of outstanding Treasury debt, of GDP in 1998. which had reached its lowest level in decades, began to rise in the latter half of 2003. Federal Borrowing The Treasury ramped up borrowing in State and Local Governments 2003 in response to the sharply widening federal budget deficit, and federal State and local governments faced debt held by the public as a percent another difficult year in 2003. Tax of nominal GDP increased for a second receipts on income and sales continued year in a row after having trended down to be restrained by the subdued perforover the previous decade. As had been mance of the economy. Despite further Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

18 90th Annual Report, 2003 efforts to rein in spending, the sector's low longer-term rates to fund capital aggregate net saving, as measured in the expenditures and to advance refund NIPA, reached a low of negative $40 bil- existing higher-cost debt. Because of lion (at an annual rate), or negative the financial stresses facing these gov- 0.4 percent of GDP, in the first quarter ernments, the credit ratings of several of the year. Most of these jurisdictions states, most notably California, were are subject to balanced-budget require- lowered last year. Although bond downments and other rules that require them grades outnumbered upgrades for the to respond to fiscal imbalances. Thus, in sector as a whole, the imbalance addition to reducing operating expenses, between the two was smaller than it was governments drew on reserves, issued in 2002. bonds, sold assets, and made various one-time adjustments in the timing of The External Sector payments to balance their books. In recent years, many have also increased Over the first three quarters of 2003, the taxes and fees, thereby reversing the U.S. current account deficit widened trend toward lower taxes that prevailed relative to the comparable period in during the late 1990s. 2002, a move largely reflecting develop- Recent indications are that the fiscal ments in the deficit on trade in goods stress in this sector is beginning to ease. and services. Net investment income The improvement reflects a noticeable rose over the same period, as receipts upturn in tax collections in recent quar- from abroad increased and payments to ters while restraint on operating expen- foreign investors in the United States ditures largely remains in place. On a declined. NIPA basis, real spending on compensation and on goods and services pur- International Trade chased by state and local governments was little changed in the second half of The trade deficit widened considerably 2003, as it was over the preceding year. in the first half of 2003 but narrowed However, investment in infrastructure, slightly in the third quarter, as the value most of which is funded in the capital of exports rebounded in response to markets, accelerated in the second half strengthening foreign economic activof 2003. As of the third quarter of 2003, ity and the depreciation of the dollar. state and local net saving had moved back into positive territory. U.S. Trade and Current Account Balances State and Local Government Billion s of dollars, annual rate Borrowing Gross issuance of debt by state and local __ 200 governments was quite robust last year. Weak tax receipts from a sluggish econ- Current accoi 400 omy, significant demands for infrastructure spending, and low interest rates all — 600 contributed to the heavy pace of borrow- 1 .In. 1 1 M 1 1 1 1 1i 1i ! I ! i 1 i !I 1 ! I i II 1 1 1 1 ing. Borrowing was strongest in the sec- 1997 1999 2001 2003 ond quarter of the year, as governments NOTE. The data are quarterly and extend ithrough took advantage of the extraordinarily 2003:Q3. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 19 Available trade data through November epidemic and the war in Iraq came suggest that the trade deficit narrowed and went; for the year as a whole, further in the fourth quarter, as an addi- real imports of services were about tional strong increase in exports out- unchanged from the previous year. Real weighed an increase in imports. imports of goods expanded about 4 per- Real exports of goods and services cent in response to the strengthening increased about 6 percent in 2003. of U.S. demand, but the pattern was Exports of services rose about 5 percent. choppy, with large gains in the second They were held down early in the year and fourth quarters partially offset by by a drop in receipts from foreign travel- declines in the first and third. Despite a ers, owing to the effects of the SARS surge in the second quarter, the volume (severe acute respiratory syndrome) epi- of oil imports increased modestly, on demic and the war in Iraq; services balance, over the course of the year. exports rebounded strongly later in the Real non-oil imports were up about year as those concerns receded. Exports AVi percent, with the largest increases of goods rose about 63A percent over the in capital goods and consumer goods. course of the year—considerably faster Imports of computers posted solid gains, than in 2002. Exports increased in all whereas imports of semiconductors major end-use categories of trade, with were flat. particularly strong gains in capital goods Despite a substantial decline in the and consumer goods. Reflecting the glo- value of the dollar, the prices of bal recovery in the high-tech sector, imported non-oil goods rose only modexports of computers and semiconduc- erately in 2003. By category, the prices tors picked up markedly in 2003, par- of consumer goods were unchanged last ticularly in the second half. By geo- year, and prices of capital goods excludgraphic area, exports of goods increased ing aircraft, computers, and semiconto Western Europe, Canada, and, par- ductors increased only a little more than ticularly, to developing countries in East 1 percent. Price increases were larger Asia—a region where economic activity for industrial supplies. The price of expanded at a rapid pace last year. Prices imported natural gas spiked in March of exported goods rose in 2003, with and rose again late in the year; these prices of agricultural exports recording fluctuations were large enough to show particularly large increases. In response through to the overall price index for to poor crops and strong demand, prices imported goods. At year-end, prices of for cotton and soybeans increased industrial metals rose sharply, with the sharply. For beef, disruptions in supply spot price of copper reaching the highest led to notably higher prices through level in six and one-half years. The much of 2003. Beef prices, however, fell strength in metals and other commodity back in late December after a case of prices has been attributed, at least in mad cow disease was discovered in the part, to depreciation of the dollar and state of Washington and most countries strong global demand, particularly from imposed bans on beef imports from the China. United States. In 2003, the spot price of West Texas Real imports of goods and services intermediate (WTI) crude oil averaged rose about 3Vi percent in 2003. Imports more than $31 per barrel—the highest of services fell in the first half of the annual average since the early 1980s. year but bounced back in the second The spot price of oil began to rise at the half, as concerns about the SARS end of 2002 when ethnic unrest in Nige- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

20 90th Annual Report, 2003 ria and a nationwide strike in Venezuela official purchases of U.S. assets surged sharply limited oil supplies from those to record levels in 2003, with the accutwo countries. In the first quarter of mulation of dollar reserves particularly 2003, geopolitical uncertainty in the high in China and Japan. period leading up to the war in Iraq also Compared with the pace in 2002, added upward pressure on oil prices. On foreign direct investment in the March 12, the spot price of WTI closed United States increased, as merger activat $37.83 per barrel, the highest level ity picked up and corporate profits since the Gulf War in 1990. When the improved. U.S. direct investment abroad main Iraqi oil fields had been secured held relatively steady at a high level and it became apparent that the risks that was largely the result of continued to oil supplies had subsided, the spot retained earnings. On net, foreign direct price of WTI fell sharply to a low of investment outflows fell about $50 bil- $25.23 per barrel on April 29. However, lion through the first three quarters of oil prices began rising again when, 2003. because of difficult security conditions, the recovery of oil exports from Iraq The Labor Market was slower than expected. Prices also were boosted in September by the sur- Employment and Unemployment prise reduction in OPEC's production target. In the fourth quarter of 2003 and With economic activity still sluggish early 2004, strengthening economic during the first half of 2003, the labor activity, falling oil inventories, and the market continued to weaken. Over the continued depreciation of the dollar con- first eight months of the year, private tributed to a further run-up in oil prices. nonfarm payroll employment fell, on average, more than 35,000 per month, extending the prolonged period of cut- The Financial Account backs that began in early 2001. The The financing counterpart to the current civilian unemployment rate, which had account deficit experienced a sizable hovered around 53/4 percent for much of shift in 2003, as net private inflows fell 2002, moved up to 6lA percent by June. while foreign official inflows increased. However, by late in the summer, the Private foreign purchases of U.S. securi- labor market began to recover slowly. ties were at an annual rate of about Declines in private payrolls gave way to $350 billion through November, about $50 billion lower than in the previous year. Private foreign purchases of U.S. Net Change in Payroll Employment equities continued to recede, and, although the level of bond purchases Thousands of jobs, monthly average was little changed in the aggregate, Private nonfarm foreign purchases shifted somewhat — 400 away from agency bonds and toward corporate bonds. Over the same period, jillllll Jan."" 200 purchases by private U.S. investors of r 0 foreign securities increased nearly $80 billion. Accordingly, net inflows 200 through private securities transactions decreased markedly. In contrast, foreign 1992 1994 1996 1998 2000 2002 2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 21 moderate increases in employment; over stabilized in many industries that prothe five months ending in January, pri- duce durable goods, such as metals, furvate nonfarm establishments added, on niture, and wood products, as well as average, about 85,000 jobs per month. in a number of related industries that By January, the unemployment rate store and transport goods. In several moved back down to 5.6 percent. other areas, employment remained During the late summer and early fall, weak. Manufacturers of nondurables, prospects for business sales and pro- such as chemicals, paper, apparel, and duction brightened, and firms began to textiles, continued to cut jobs. Employlay off fewer workers. Initial claims for ment in retail trade remained, on net, unemployment insurance dropped back, little changed. and the monthly Current Population Survey (CPS) of households reported a Productivity and Labor Costs decline in the number of workers who had lost their last job. However, for Business efforts to increase efficiency many unemployed workers, jobs contin- and control costs led to another impresued to be difficult to find, and the num- sive gain in labor productivity last year. ber of unemployed who had been out of Output per hour in the nonfarm business work for twenty-seven weeks or more sector surged 5lA percent in 2003 after remained persistently high. The labor having risen a robust 4 percent in 2002 force participation rate, which tends to and 23/4 percent in 2001. What is parbe sensitive to workers' perceptions of ticularly remarkable about this period is the strength of labor demand, drifted that productivity did not decelerate siglower. Although the CPS indicated nificantly when output declined in 2001, a somewhat greater improvement in and it posted persistently strong gains employment than the payroll report— while the recovery in aggregate demand even after adjusting for conceptual dif- was sluggish. Typically, the outsized ferences between the two measures— increases in productivity that have the increase in household employment occurred during cyclical recoveries have lagged the rise in the working-age popu- followed a period of declines or very lation, and the ratio of employment to weak increases in productivity during population fell further during 2003. the recession and have been associated The modest upturn in private payroll with rebounds in economic activity that employment that began in September was marked by a step-up in hiring at businesses supplying professional, busi- Change in Output per Hour ness, and education services, and medical services continued to add jobs. Employment in both the construction industry and the real estate industry rose further, although the number of jobs in related financial services dropped back — 4 Ljiiiiill a bit as mortgage refinancing activity slackened. At the same time, although manufacturers were still laying off workers, the monthly declines in factory 1 1 1! i 1 i , employment became smaller and less 1993 1995 1997 1999 2001 2003 widespread than earlier. Employment NOTE. Nonfarm business sector. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

22 90th Annual Report, 2003 were stronger than has been the case, benefits. The ECI for wages and salaries until recently, in this expansion. rose 3 percent—up slightly from the On balance, since the business cycle pace in 2002 but still well below the peak in early 2001, output per hour has rates of increase in the preceding six risen at an average annual rate of 4 per- years. Wage gains last year likely were cent—noticeably above the average restrained by persistent slack in the increase of 2Vi percent that prevailed demand for labor as well as by the presbetween 1996 and 2000. In the earlier sure on employers to control overall period, an expansion of the capital stock labor costs in the face of the rapidly was an important element in boosting rising cost of benefits. Employer costs the efficiency of workers and their firms; for benefits, which had risen 4% percent that impetus to productivity has weak- in 2002, climbed another 6V2 percent in ened in the recent period as a result of 2003. The cost of health insurance as the steep cutbacks in business invest- measured by the ECI has been moving ment in 2001 and 2002. Instead, the up at close to a double-digit rate for recent gains appear to be grounded in three consecutive years. In addition, organizational changes and innovations in late 2002 and early 2003, employers in the use of existing resources—which needed to substantially boost their conare referred to as multifactor productiv- tributions to defined-benefit retirement ity. The persistence of a rapid rise in plans to cover the declines in the market multifactor productivity in recent years, value of plan assets. along with signs of a pickup in capital spending, suggests that part of the Prices step-up in the rate of increase of labor productivity may be sustained for some Headline consumer price inflation in time. 2003 was maintained by an accelera- In 2003, the employment cost index tion in food prices and another sizable (ECI) for private nonfarm businesses, increase in energy prices, but core rates which is based on a survey conducted of inflation fell for a second year. quarterly by the Bureau of Labor Statis- Although the strong upturn in economic tics, rose 4 percent—about 3A percent- activity in the second half of last year age point more than the increase in began to reduce unemployment and to 2002. Compensation per hour in the boost industrial utilization rates, connonfarm business sector, which is based siderable slack in labor and product on data constructed for the NIPA, is markets continued to restrain inflation estimated to have increased 3!/4 percent throughout the year. A further moderain 2003, up from Wi percent in 2002. In tion in the costs of production also recent years, the NIPA-derived series helped to check inflation: As a result of has shown much wider fluctuations in another rapid rise in productivity, busihourly compensation than the ECI, in nesses saw their unit labor costs decline part because it includes the value of in 2003 for a second consecutive year. stock option exercises, which are In contrast, prices for imported goods excluded from the ECI. The value of excluding petroleum, computers, and options exercised shot up in 2000 and semiconductors increased at about the then dropped over the next two years. same rate as prices more generally; Most of the acceleration in hourly between 1996 and 2002, these import compensation in 2003 was the result of prices fell relative to overall prices for larger increases in the costs of employee personal consumption expenditures Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 23 (PCE). The chain-type price index for Europe, contributed importantly to the PCE excluding food and energy rose heightened demand for U.S. farm prodjust under 1 percent in 2003, about ucts. Thus, despite a bumper crop of 3/4 percentage point less than in 2002. A corn and some other grains in the United broader measure of inflation, the chain- States, world stocks were tight and type price index for GDP, increased prices remained high. In addition, the l!/2 percent in 2003, the same slow pace U.S. soybean crop was crimped by lateas in 2002. Both measures of inflation season heat and dryness, which further were roughly a percentage point lower tightened world supplies. Concerns than in 2001. about the cases of mad cow disease that Consumer energy prices fluctuated were identified in herds in Japan and widely over the four quarters of 2003, Canada supported strong domestic and and the PCE index for energy was up export demand for U.S. beef for most of IVA percent over the period. In the first last year while supplies edged down. quarter of the year, the combination of But, at year-end, when a case of mad a further rise in the cost of crude oil, cow disease was discovered in a domesincreased wholesale margins for gaso- tic herd, export demand for U.S. beef line, and unusually tight supplies of plunged and drove the price of live natural gas pushed up consumer energy cattle down sharply. A portion of the prices sharply. Although the prices of drop in cattle prices likely will show petroleum-based products turned down through to consumer prices for beef when the price of crude oil fell back in early this year. March, a number of supply disruptions The decline in core inflation in 2003 in late summer resulted in another tem- was broadly based. Prices of core conporary run-up in the retail price of gaso- sumer goods fell somewhat faster than line. In the spring, the price of natural a year earlier; the declines were led by gas began to ease as supplies improved, larger cuts in prices of apparel, motor but it remained high relative to the level vehicles, electronic equipment, and a in recent years. Electricity prices also variety of other durable goods. At the moved up during 2003, in part because same time, prices of non-energy serof the higher input costs of natural gas. vices rose less rapidly. The deceleration In January 2004, a cold wave in the in core consumer prices measured by Northeast, together with the rise in the the CPI is somewhat greater than that price of crude oil since early December, measured by the PCE index. In each once again led to spikes in the prices of index, the costs of housing services to gasoline and natural gas. tenants and owners rose less in 2003 The PCE price index for food and than in 2002, but because these costs beverages increased 23A percent in 2003 receive a larger weight in the CPI, their after having risen just VA percent a year slowing contributed a greater amount to earlier. Much of the acceleration can be the CPFs deceleration. In addition, the traced to strong demand for farm prod- different measurement of the prices of ucts, but prices paid by consumers for medical services in the two series confood away from home—which depend tributed to the smaller deceleration in much more heavily on the cost of labor non-energy services in the PCE. The than on prices of food products—were medical services component of the CPI, up 3 percent in 2003, also somewhat which measures out-of-pocket expenses more than overall consumer price infla- paid by consumers, increased 4 percent tion. Poor harvests abroad, especially in in 2003, down from 5!/2 percent a year Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

24 90th Annual Report, 2003 Alternative Measures of Price Change with the sharp increase in energy prices Percent and dipped briefly to an unusually low level at midyear as actual inflation eased Price measure 2001 2002 2003 in response to lower energy prices. However, year-ahead inflation expecta- Chain-type tions settled back to just over 2Vi per- Gross domestic product 2.4 1.4 1.5 Gross domestic purchases 1.6 1.7 1.6 cent at the end of the year, about the Personal consumption expenditures 1.6 1.8 1.4 same as at the end of 2002. Excluding food and energy ... 2.1 1.6 .9 The PPI for crude materials exclud- Chained CPI 1.5 1.8 1.4 Excluding food and energy ... 2.1 1.6 .6 ing food and energy products, which had dropped 10 percent in 2001, rose Fixed-weight Consumer price index 1.8 2.2 1.9 H3/4 percent in 2002 and another Excluding food and energy ... 2.7 2.1 1.2 17V2 percent in 2003. The upswing was driven by the pickup in demand asso- NOTE. Changes are based on quarterly averages and are measured to the fourth quarter of the year indicated ciated with the acceleration in both from the fourth quarter of the preceding year. domestic and worldwide industrial activity and by the pass-through of earlier. Alternatively, the PCE for medi- higher energy costs. Such wide cyclical cal services is a broader measure that swings in commodity prices have only a uses producer price indexes (PPI) to small effect on movements in the prices capture the costs of services provided by of intermediate and finished goods. At hospitals and doctors; it continued to later stages of production and distribuincrease more slowly than the CPI for tion, commodity costs represent only a medical services last year, VA percent, small share of overall costs, and some but it was up slightly from its increase portion of the change in commodity of 2!/2 percent in 2002. prices tends to be absorbed in firms' Survey measures of expected infla- profit margins. Thus, the recent pickup tion were little changed, on balance, in in prices at the intermediate stage of 2003. According to the Federal Reserve processing has been more muted; after Bank of Philadelphia's survey of profes- having fallen almost l!/2 percent in sional forecasters, expectations for CPI 2001, the PPI for core intermediate inflation ten years ahead remained at materials rose VA percent in 2002 and 2!/2 percent last year. As measured by 2 percent in 2003. the Michigan Survey Research Center survey of households, median five- to U.S. Financial Markets ten-year inflation expectations, which averaged 3 percent in 2001, were steady On balance, financial market condiat 23A percent in 2003 for a second tions became increasingly supportive of consecutive year. Inflation compensa- growth over 2003 as investors became tion as measured by the spread between more assured that the economy was on the yield on nominal Treasury securities solid footing. Equity prices marched and their indexed counterparts varied up after the first quarter of the year in over a wide range in 2003, settling at response to the initiation and swift conjust under 2Vi percent at year-end. clusion of major combat operations in Shorter-term inflation expectations also Iraq, positive earnings reports, and—in posted some wide swings during 2003; the second half of the year—a stronger year-ahead expectations in the Michigan pace of economic growth. Risk spreads SRC survey spiked early in the year on corporate debt declined, with the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 25 spreads on the debt of both investment- Interest Rates on Selected Treasury Securities grade firms and speculative-grade firms ending 2003 at their lowest levels since 1998. Thus, although Treasury coupon yields ended the year 30-40 basis points higher, yields on many corporate bonds ended the year lower. Commercial banks appeared somewhat slower than bond investors to lend at more favorable terms; nevertheless, by late in the year, banks had eased both standards and terms on C&I loans. 2001 2002 2003 2004 Demand for short-term debt, however, remained very weak, and business NOTH. The data are daily and extend through February 4, 2004. loans and outstanding commercial paper continued to run off. In response to a widening budget deficit and a rapid ued to hold down Treasury yields. The expansion of federal debt, the Treasury FOMC's statement following its May increased the frequency of its debt auc- meeting that an "unwelcome fall in tions. Declines in mortgage interest rates inflation" remained a risk reinforced the over the first half of the year led to an notion that monetary policy would stay extraordinary increase in mortgage debt, accommodative, and, indeed, judging as originations for home purchase and from market quotes on federal funds for refinancings both climbed to record futures, market participants anticipated levels. further easing. Mortgage rates followed Treasury yields lower, precipitating a huge surge of mortgage refinancing. To Interest Rates offset the decline in the duration of their Interest rates fell for most of the first portfolios stemming from the jump in half of 2003, primarily in response to prepayments, mortgage investors reportcontinuing weak economic data and an edly bought large quantities of longerassociated marking down of expecta- dated Treasuries, amplifying the fall in tions for the federal funds rate. Global yields. Interest rates on corporate bonds uncertainty ran high, particularly sur- also declined in the first half of the year, rounding the timing of military interven- prompting many firms to issue longtion in Iraq, which elevated safe-haven term debt to pay down other, more demands and depressed yields on Trea- expensive forms of debt and build up sury securities. Moreover, the weak cash assets. Growing confidence that March employment report and other dis- the frequency and severity of corporate appointing news about economic activ- accounting scandals were waning likely ity seemed to cause a substantial shift in contributed to the narrowing in risk views about monetary policy. Data from spreads. By the end of spring, default the federal funds futures market sug- rates on corporate bonds had begun to gested a significant probability of a fur- decline, and corporate credit quality ther easing of policy and did not imply appeared to stabilize. any tightening before early 2004. Even By the time of the June FOMC meetas geopolitical tensions eased, weaker- ing, federal funds futures data implied than-expected economic data contin- that market participants had generally Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

26 90th Annual Report, 2003 come to expect an aggressive reduction larly those on speculative-grade issues, in the target federal funds rate, so the continued to fall over the second half of Committee's decision to lower the tar- the year. Treasury yields fell early in get rate by only 25 basis points came as 2004, largely in response to the weakera surprise to some. In addition, some than-expected December labor market investors were reportedly disappointed report. After the release of the Committhat the statement following this meet- tee's statement following its January ing included no mention of "unconven- meeting, Treasury yields backed up tional" monetary policy actions that a bit as futures market prices implied would be aimed at lowering longer- an expectation of an earlier onset of term yields more directly than through tightening than had been previously changes in the federal funds rate tar- anticipated. get alone. As a result, market interest rates backed up, with the move prob- Equity Markets ably amplified by the unwinding of mortgage-related hedging activity. The Broad equity price indexes ended the Chairman's monetary policy testimony year 25 percent to 30 percent higher. in July, and the FOMC's statements at Early in the year, stock prices were bufsubsequent meetings that noted that feted by mixed news about the pace of policy could remain accommodative for economic expansion and by heightened "a considerable period," apparently pro- geopolitical tensions. Rising oil prices vided an anchor for the front end of the boosted the shares of energy companies yield curve. At the same time, increas- very early in the year while, by and ingly positive economic reports bol- large, stocks in other sectors were stumstered confidence in the markets, and bling. By spring, however, positive news longer-dated Treasury securities ended on corporate earnings—often exceeding the year about 40 basis points above expectations—and easing of geopolititheir year-earlier levels. But, with the cal tensions associated with the initiaexpansion evidently gaining traction and tion of military action in Iraq boosted investors becoming more willing to take equity prices significantly. Subseon risk, corporate risk spreads, particu- quently, the swift end to major combat operations in Iraq caused implied vola- Spreads of Corporate Bond Yields over tility on the S&P 500 index to fall subthe Ten-Year Treasury Yield stantially. Over the rest of the year, increasingly positive earnings results Percentage points contributed to a sustained rally in stock prices, and implied volatility in 10 equity markets fell further. Corporate High-yield — 8 scandals—albeit on a smaller scale than 6 in previous years—continued to emerge 4 in 2003, but these revelations appeared 2 to leave little lasting imprint on broad + 0 measures of stock prices. For the year ,!,,>,,1 as a whole, the Russell 2000 index of 2001 2002 2003 2004 small-cap stocks and the technology- NOTE. The data are daily and extend through laden Nasdaq composite index, which February 4, 2004. The spreads compare the yields on the rose 45 percent and 50 percent, respec- Merrill Lynch AA, BBB, and 175 high-yield indexes tively, noticeably outpaced broader with the yield on the ten-year off-the-run Treasury note. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 27 Major Stock Price Indexes especially for riskier borrowers— narrowing, corporate treasurers shifted January 2, 2002 = 100 their debt issuance toward bond financing and away from shorter-term debt. Household borrowing also shifted in response to lower longer-term rates. Mortgage rates followed Treasury rates lower in the spring, and mortgage originations for both home purchases and refinancings surged. Refinancing activity appears to have held down growth of 2002 2003 2004 consumer credit as households extracted NOTE. The data are daily and extend through Feb- equity from their homes and used the ruary 4, 2004. proceeds, in part, to pay down highercost consumer debt. Nevertheless, conindexes. To date in 2004, equity markets sumer credit posted a moderate advance have continued to rally. in 2003, buoyed by heavy spending on With the sustained rise in stock autos and other durables. A substantial prices, the ratio of expected year-ahead widening of the federal deficit forced earnings to stock prices for firms in the the Treasury to increase its borrowing S&P 500 edged down over 2003. The significantly. To facilitate the pickup in gap between this ratio and the real ten- borrowing, the Treasury altered its aucyear Treasury yield—a crude measure tion cycle to increase the frequency of of the equity risk premium—narrowed a certain issues and reintroduced the bit over the course of the year, though it three-year note. remains in the upper part of the range Depository credit rose 6 percent in observed over the past two decades. 2003 and was driven by mortgage lending and the acquisition of mortgagebacked securities by both banks and Debt and Financial Intermediation thrift institutions. Consumer lending Aggregate debt of the domestic non- also was substantial, as lower interest financial sectors is estimated to have rates and auto incentives spurred spendincreased about 8!A percent in 2003, just ing on durable goods. In contrast, busiover a percentage point faster than in ness loans fell 714 percent over 2003, a 2002. Federal debt accelerated sharply, drop similar to the runoff in 2002. Surrising 11 percent, owing to the larger vey evidence suggests that the decline in budget deficit. Household debt rose business lending at banks was primarily almost as rapidly, and the increase in the result of decreased demand for these state and local government debt also loans, with respondent banks often citwas substantial. In contrast, business ing weak investment and inventory borrowing remained subdued last year. spending. Moreover, the contraction was In the business sector, investment concentrated at large banks, whose cusspending, particularly in the beginning tomers tend to be larger corporations of the year, was mainly financed with that have access to bond markets, and internal funds, limiting, though not the proceeds of bond issuance were eliminating, businesses' need to increase apparently used, in part, to pay down debt. With long-term rates falling bank loans. The January 2004 Senior through midyear and credit spreads— Loan Officer Opinion Survey reported a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

28 90th Annual Report, 2003 pickup in business loan demand arising higher returns led households to shift mainly from increased spending on plant funds from M2 assets to equities, a view and equipment and on inventories. Sup- reinforced by the strong flows into ply conditions apparently played a sec- equity mutual funds. ondary role in the weakness in business loans in 2003. Banks tightened stan- International Developments dards and terms on business loans somewhat in the first half of the year, but by Economic growth abroad rebounded in year-end they had begun to ease terms the second half of last year as factors and standards considerably, in part that weighed on the global economy in because of reduced concern about the the first half—including the SARS epieconomic outlook. demic and uncertainty surrounding the war in Iraq—dissipated. Foreign growth also was boosted by the strong rebound The M2 Monetary Aggregate in the U.S. economy, the revival of the M2 increased 5lA percent in 2003, a global high-tech sector, and, in many pace somewhat slower than in 2002 and countries, ample policy stimulus. a bit below the rate of expansion of Strong second-half growth in China nominal income. The deceleration in M2 stimulated activity in other emerging largely reflected a considerable contrac- Asian economies and Japan by raising tion in the final quarter of the year after the demand for their exports. Growth in three quarters of rapid growth. The Japan also was spurred by a recovery in robust growth in money around mid- private spending there on capital goods. year was concentrated in liquid deposits Economic activity in Europe picked up and likely resulted in large part from in the second half, as export growth the wave of mortgage refinancings, resumed. Economic growth in Latin which tend to boost M2 as the proceeds America has been less robust; the Mexiare temporarily placed in non-interest- can economic upturn has lagged that of bearing accounts pending disbursement the United States, and Brazil's economy to the holders of mortgage-backed secu- has only recently begun to recover from rities. Moreover, around the middle of the effects of its 2002 financial crisis. the year, the equity that was extracted Monetary authorities abroad generfrom home values during refinancings ally eased their policies during the first probably provided an additional boost half of 2003 as economic activity stagto deposits for a time, as households nated. In the second half, market particitemporarily parked these funds in M2 pants began to build in expectations of accounts before paying down other debt eventual monetary tightening abroad, or spending them. In the fourth quarter, and official interest rates were raised M2 contracted at an annual rate of 2 per- by year-end in the United Kingdom and cent, the largest quarterly decline since Australia. Canadian monetary policy consistent data collection began in 1959. followed a different pattern; the Bank of As mortgage rates backed up and the Canada raised official interest rates in pace of refinancing slowed, the funds the spring as inflation moved well above that had been swelling deposits flowed its 1 percent to 3 percent target range out, depressing M2. The sustained rally but cut rates later in the year and again in equity markets after the first quarter early this year as slack emerged and of the year may also have slowed M2 inflation moderated. Similarly, lower growth, as expectations of continued inflation in Mexico and Brazil allowed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 29 authorities to ease monetary policy dur- U.S. Dollar Exchange Rate against ing 2003. The Bank of Japan maintained Selected Major Currencies official interest rates near zero and continued to increase the monetary base. Week ending January5, 2001 = 100 In foreign financial markets, equity /\\ Japanese yen prices fell, on average, until mid-March ___ 110 but since then have risen in reaction __ 100 to indications of stronger-than-expected pound Vvu \ I 1 _ \v V/\ global economic activity. Emerging- 90 market equity indexes outpaced those ~~~ d C o a l n la a r d ian Eu \_ ro /w A J \ \ * VA \/ ~~ 80 in the industrial countries in 2003, with markets in Latin America posting par- i i i i i 1 i i 1 i i i i i 1 , , 1 i . 1 . i 1 i > i i i ! i i 1 f . 1 t . : 2001 2002 2003 2004 ticularly strong gains. Around midyear, long-term interest rates declined to NOTK. The data are weekly and are in foreign currency units per dollar. Last observations are the multiyear lows in many countries as average of trading days through February 4, 2004. economic growth slowed and inflationary pressures diminished, but those rates moved higher in the second half against the Mexican peso. On balance, as growth prospects improved. Bond the dollar depreciated 9 percent during spreads came down substantially during 2003 on a trade-weighted basis against the year, both for industrial-country cor- the currencies of a broad group of U.S. porate debt and for emerging-market trading partners. sovereign debt; spreads of the J.R Morgan Emerging Market Bond Index Industrial Economies (EMBI+) over U.S. Treasury securities fell to their lowest levels since before The euro-area economy contracted in the Russian crisis of 1998. Gross capital the first half of 2003, weighed down flows to emerging markets, however, in part by geopolitical uncertainty and remained well below their 1997 peak. higher oil prices. In the second half, The foreign exchange value of the economic activity in the euro area began dollar continued to decline last year as to grow as the global pickup in activity concerns over the financing of the large spurred a recovery of euro-area exports and growing U.S. current account deficit despite the continued appreciation of the took on greater prominence. The dollar euro. The monetary policy of the Eurodeclined 18 percent against the Cana- pean Central Bank (ECB) was supportdian dollar, 17 percent against the euro, ive of growth, with the policy interest and 10 percent against the British pound rate lowered to 2 percent by midyear. and the Japanese yen. In contrast, the Consumer price inflation slowed to value of the dollar was little changed, around 2 percent, the upper limit of on net, against the currencies of our the ECB's definition of price stability. other important trading partners, in part Despite increased economic slack, inflabecause officials of China and of some tion moved down only a little, partly other emerging Asian economies man- because the summer drought boosted aged their exchange rates so as to main- food prices. For the second straight tain stability in terms of the dollar. year, the governments of Germany and Among Latin American currencies, the France each recorded budget deficits dollar declined against the Brazilian and in excess of the 3 percent deficit-to- Argentine currencies but appreciated GDP limit specified by the Stability Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

30 90th Annual Report, 2003 and Growth Pact. However, in light of Japanese real GDP recorded signifieconomic conditions, European Union cant growth in 2003 for the second finance ministers chose not to impose straight year. Private investment spendsanctions. ing made the largest contribution to After a sluggish first quarter, the U.K. the expansion. Consumer spending economy expanded at a solid pace for remained sluggish as labor market conthe remainder of 2003, supported by ditions continued to be soft. However, robust consumption spending and con- nominal wages stabilized following a siderable government expenditure. The sharp drop in 2002, and leading indi- Bank of England cut rates in the first cators of employment moved higher. half of the year but reversed some of Despite an appreciation of the yen late that easing later in the year and early in the year, Japanese exports posted this year as the economy picked up a strong increase in 2003 primarily and housing prices continued to rise at because of gains in exports to China and a rapid, albeit slower, pace. In June, other emerging Asian economies. With the British government announced its consumer prices continuing to decline, assessment that conditions still were the Bank of Japan (BOJ) maintained not right for the United Kingdom to its policy interest rate near zero and adopt the euro. In December, the Brit- eased monetary policy several times ish government changed the inflation during 2003 by increasing the target measure to be targeted by the Bank of range for the outstanding balance of England from the retail prices index reserve accounts held by private finanexcluding mortgage interest (RPIX) to cial institutions at the BOJ. The BOJ the consumer prices index. U.K. infla- also took other initiatives last year to tion currently is well below the objec- support the Japanese economy, including launching a program to purchase tive of 2 percent on the new target securities backed by the assets of smallindex. and medium-sized enterprises. Japanese The Canadian economy contracted in banks continued to be weighed down by the second quarter owing to the impact large amounts of bad debt, but some of the SARS outbreak in Toronto on progress was made in resolving probtravel and tourism, but it rebounded in lems of insufficient bank capital and the latter half of the year. Canadian ecoin reducing bad-debt levels from their nomic growth continued to be led by previous-year highs. strong domestic demand; consumption remained robust and investment spending accelerated, offsetting the negative effect of Canadian dollar appreciation Emerging-Market Economies on both exports and import-competing industries. Canadian consumer price Growth in the Asian developing econoinflation swung widely last year, rising mies rebounded sharply in the second to AV2 percent on a twelve-month basis half of 2003 after having contracted in in February before falling to W2 per- the first half. The outbreak of SARS cent in November and ending the year in China and its spread to other Asian at 2 percent. The swing partly reflected economies was the primary factor movements in energy prices, but depressing growth in the first half, and changes in auto insurance premiums and the subsequent recovery of retail sales cigarette taxes also played an important and tourism after the epidemic was conrole. tained was an important factor in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2003 and Early 2004 31 U.S. Dollar Exchange Rates and Bond markets in Beijing and Shanghai, may Spreads for Selected Emerging Markets be overheating. Korean economic growth turned January 5, 2001 = 100 January 5. 200 = 100 negative in the first half, as the high level of household debt, labor unrest, Exchange rates 440 ^0 - Brazilian and concerns over North Korea's 360 — Arg6 en p t e in s e o [ r * J ~ *r~ V k A T\ "~ —" 180 nuclear development depressed private- 280 ^ U f \A^T%^-^V —_ 140 sector spending. A sharp rise in exports /T VNL/ Mexican peso spurred a revival of growth in the 200 100 f Korean won second half even as domestic demand 120 60 remained subdued. i i t .( ! . i 1 . .1 i . ! ii t i i [ i , 1 ii i ii 1 i i 1 , i i i i h i I i i The Mexican economy remained Percentage points Percentage points sluggish through much of the year but recently has shown some signs of Bond spreads u A. 80 — Hi Brazil — 20 improvement. After lagging the rise in U.S. production, Mexican industrial 60 — Argentina A ^ny \ A^ — 15 production posted strong gains in Octo- — J^kff \ - 40 10 ber and November, although it remains well below the peak it reached in 2000. 20 / Mexico ^Sv 5 Exports rose late last year to almost the peak they had reached in 2000. Con- 2001 2002 2003 2004 sumer price inflation came down over NOTE. The exchange rate data are weekly averages the course of 2003 to 4 percent, the indexed to the week ending January 5, 2001. Last upper bound of the 2 percent to 4 perobservations are the average of trading days through cent target range. The Bank of Mexico February 4, 2004. Exchange rates (top panel) are in foreign currency units per dollar. Bond spreads (bottom has left policy unchanged since tightenpanel) are the spreads of the J.P. Morgan Emerging ing five times between September 2002 Market Bond Index (EMBI+) over U.S. Treasury securities. and March 2003, but market interest rates have fallen owing to weakness in economic activity. sharp rebound. The pattern of Asian The Brazilian economy contracted in growth also reflected the sharp recovery the first half of 2003 partly as a result of of the global high-tech sector in the the 2002 financial crisis and the consecond half after a prolonged period of sequent monetary policy tightening. It weakness. Exports continued to be the then expanded moderately in the second main engine of growth for the region. half, boosted by strong export growth However, domestic demand contributed and a recovery in investment spending. importantly to growth in China, where Brazilian financial indicators improved state-sector investment increased at a significantly in 2003, in part because the rapid clip and a boom in construction Brazilian government began to run a activity continued. Supply problems substantial primary budget surplus and caused food prices and overall con- to reform the public-sector pension syssumer prices in China to rise on a tem. The Brazilian stock market soared twelve-month basis last year, following nearly 100 percent last year, and Braa period of price deflation during the zil's EMBI+ bond spread narrowed by previous year. In addition, concerns nearly two-thirds. As the Brazilian curemerged that some sectors of the Chi- rency stabilized and began to appreciate, nese economy, particularly the property Brazil's inflation outlook improved, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

32 90th Annual Report, 2003 allowing the central bank to reverse and many of Argentina's structural fully its earlier rate hikes and to reduce problems have not been addressed. With the overnight interest rate to a multi- the government still in default to its year low, although real interest rates bondholders, the country's sovereign remained high. debt continued to carry a very low credit The Argentine economy rebounded rating, and its EMBI+ spread remained in 2003 from the sharp contraction that extremely high. Even so, the Argentine occurred in the wake of its financial peso appreciated on balance in 2003, crisis in 2001-02. Still, economic activ- and the Merval stock index nearly ity remains far below pre-crisis levels, doubled over the course of the year. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

33 Monetary Policy Report of July 2003 Monetary Policy and the rising energy costs. These concerns also Economic Outlook caused consumer confidence to sag and added to a general disinclination of The subpar performance of the U.S. firms to spend, hire, and accumulate economy extended into the first half of inventories. Caution was apparent in 2003. Although accommodative macrofinancial markets as well, and investors economic policies and continued robust bid down the prices of equities in favor productivity growth helped to sustain of less-risky securities. aggregate demand, businesses remained The swift prosecution of the war in cautious about spending and hiring. All Iraq resolved some of these exceptional told, real gross domestic product continuncertainties but by no means all of ued to rise in the first half of the year them. Nonetheless, oil prices receded, but less quickly than the economy's proand the improvement in the economic ductive capacity was increasing, and climate was sufficient to cause stock margins of slack in labor and product prices to rally, risk spreads on corporate markets thereby widened further. As a securities to narrow, and consumer conresult, underlying inflation remained fidence to rebound. At the same time, low—and, indeed, seems to have moved the incoming economic data—much of down another notch. In financial marwhich reflected decisions made before kets, longer-term interest rates fell, on the war—remained mixed, and inflation net, over the first half of the year as the trended lower. At the conclusion of its decline in inflation and the subdued per- May meeting, the Federal Open Market formance of the economy led market Committee (FOMC) indicated that, participants to conclude that short-term whereas the risks to the outlook for ecointerest rates would be lower than prenomic growth were balanced, the risk of viously anticipated. These lower interest rates helped to sustain a rally in equity an unwelcome substantial fall in inflaprices that had begun in mid-March. tion from its already low level, though minor, exceeded that of a pickup in During the first quarter of the year, inflation. In the weeks that followed, the economy's prospects were clouded market participants pushed down the by the uncertainties surrounding the expected future path of the federal funds onset, duration, and potential conserate, which contributed to the fall in quences of war in Iraq. War-related conlonger-term interest rates and a further cerns provided a sizable boost to crude rise in equity prices. oil prices; as a result, households faced At the time of the June FOMC meethigher bills for gasoline and heating oil, ing, the available evidence did not yet and many firms were burdened with compellingly demonstrate that a material step-up in economic growth was NOTE. The discussion in this section consists under way, though some indicators did of the text and tables from the Monetary Policy point to a firming in spending and a Report submitted to the Congress on July 15, stabilization in the labor and product 2003; the charts from this report (as well as earlier markets. The Committee concluded that reports) are available on the Board's web site, at www.federalreserve.gov/boarddocs/hh. a slightly more expansive monetary pol- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

34 90th Annual Report, 2003 icy would be warranted to add further which encouraged firms to issue bonds support to the economic expansion. The to reduce their financing costs and Committee's assessment and ranking of restructure their balance sheets. Meanthe risks to the outlook for economic while, moderate gains in household growth and inflation were the same as in income and historically low mortgage May. rates underpinned still-considerable The Federal Reserve expects eco- demand for housing. Retail sales, parnomic activity to strengthen later this ticularly those of motor vehicles, also year and in 2004, in part because of the were strong at the end of 2002 despite accommodative stance of monetary pol- some drop-off in consumer confidence. icy and the broad-based improvement in Core inflation seemed to be on a declinfinancial conditions. In addition, fiscal ing trend, although the foreign exchange policy is likely to be stimulative as the value of the dollar had depreciated, and provisions of the Jobs and Growth Tax top-line inflation was being boosted by Relief Reconciliation Act of 2003 go a sizable run-up in energy prices. The into effect and as defense spending con- substantial slack in resource utilization, tinues to ramp up. Severe budgetary as well as the solid gains in labor propressures are causing state and local ductivity, led members to the view governments to cut spending and to that consumer price inflation—by then increase taxes and fees, but these actions already very low—was unlikely to should offset only a portion of the impe- increase meaningfully. Against that tus from the federal sector. Moreover, backdrop, the Committee members conthe continued favorable performance of tinued to believe that economic funproductivity growth should lift house- damentals were in place to support a hold and business incomes and thereby pickup in the growth of economic activencourage capital spending. Given the ity during the year ahead. Accordingly, ongoing gains in productivity and the the FOMC decided at the January meetexisting margin of resource slack, aggre- ing to leave interest rates unchanged and gate demand could grow at a solid pace assessed the risks as balanced with for some time before generating upward respect to its dual goals of sustainable pressure on inflation. economic growth and price stability. In subsequent weeks, economic performance proved disappointing. The Monetary Policy, Financial increasing likelihood of war in Iraq was Markets, and the Economy accompanied by a steep rise in crude over the First Half of 2003 oil prices and considerable volatility During the weeks before the January in financial markets. For much of that meeting of the FOMC, geopolitical period, investors sought the relative developments and the uneven tone of safety of fixed-income instruments; that economic data releases created substan- preference induced declines in yields on tial uncertainty. Businesses had contin- Treasury securities and high-quality corued to reduce their payrolls and post- porate bonds and a drop in stock prices. pone capital expenditures. However, the Consumer outlays also softened after absence of fresh revelations of lapses January, although low mortgage rates in corporate governance or accounting and rising incomes were still providing problems and some increased appetite support for household spending. Busifor risk on the part of investors helped nesses continued to trim workforces and push down yields on corporate debt, cut capital spending. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 35 When the Committee met on In light of the financial and policy March 18, full-scale military conflict in stimulus already in place, the FOMC Iraq seemed imminent. In an environ- left the federal funds rate unchanged ment of considerable uncertainty, the at its May meeting. To provide more FOMC had to weigh whether economic specific guidance about its views, the sluggishness was largely related to FOMC included in its announcement worries about the war, and hence would separate assessments of the risks to lift once the outcome was decided, or the outlook for economic growth and was indicative of deep-seated restraints inflation as well as the overall balon economic activity. The Committee, ance between the two. The Committee which reasoned that it could not make viewed the upside and downside risks to such a distinction in the presence of so economic growth as balanced, but it permuch uncertainty, left the funds rate ceived a higher probability of an unwelunchanged and declined to character- come substantial fall in inflation than ize the balance of risks with respect to of a pickup in inflation from its current its dual goals. However, the Commit- low level. The Committee considered tee noted that, given the circumstances, that the overall balance of risks to its heightened surveillance would be par- dual objectives was weighted toward ticularly informative, and it held a series weakness. That said, members conof conference calls during late March cluded that there was only a remote and April to discuss the latest economic possibility that resource utilization developments. would remain so low that the disinfla- Some of the uncertainty was resolved tion process would cumulate to produce by the quick end to major military a declining overall price level for an action in Iraq. Equity prices and con- extended period. sumer confidence rose while oil prices Financial market participants reacted and risk spreads on corporate debt strongly to this characterization of risks, fell. Fiscal policy seemed set to become believing that the Committee's focus on even more stimulative given the pros- leaning against appreciable disinflation pect of increased spending on defense implied that monetary policy would be and homeland security as well as more accommodative and remain so for the likely enactment of additional tax longer than previously thought. Invescuts. Part of the federal stimulus, tors pushed down the expected path of however, was thought likely to be the federal funds rate in the weeks foloffset by the efforts of state and local lowing the meeting. Intermediate- and governments to close their budget long-term interest rates fell significantly gaps. and spurred another round of long-term Economic reports were generally bond issuance. The resulting decline in disappointing. Industrial production real interest rates helped sustain the rally declined in March, and capacity utili- in equity prices. zation fell to a twenty-year low. The Between the May and June meetings, employment reports for March and April a few tentative signs suggested that indicated that private nonfarm payrolls the pace of economic activity might had continued to fall. Although order be firming. Industrial production and backlogs for nondefense capital goods retail sales edged up in May, available had risen recently, businesses generally data indicated that employment had remained reluctant to invest in new stopped declining, residential investcapacity. ment remained strong, and survey mea- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

36 90th Annual Report, 2003 sures of consumer sentiment and busi- Economic Projections for 2003 and 2004 ness conditions were well above the Percent levels of earlier in the year. Financial conditions had improved markedly, but Federal Reserve Governors and businesses reportedly remained some- Reserve Bank presidents Indicator what averse to new investment projects, in part because of significant unused Range Central tendency capacity. They also seemed reluctant to expand their workforces until they 2003 viewed a sustained pickup in aggregate demand as more certain. Change, fourth quarter to fourth quarter1 With inflation already low and infla- Nominal GDP 3i/2-43/4 33/4^i/2 tion expectations subdued, the Commit- Real GDP 21/4-3 21/2-23/4 PCE chain-type price tee judged that it would be prudent to index add further support for economic expan- Average level, 1-13/4 11/4-11/2 sion, and it lowered the target for the fourth quarter Civilian unemployment federal funds rate 25 basis points, to rate 1 percent. The FOMC continued to view the risks to economic growth as bal- 6-61/4 2004 6-61/4 anced and again noted that the minor probability of substantial further dis- Change, fourth quarter to fourth quarter1 inflation exceeded the probability of a Nominal GDP 43/4-6i/2 51/4-61/4 pickup in inflation from its current low Real GDP 31/2-51/4 33/4-43/4 PCE chain-type price level. But because of the considerable index a a m nd o u t n h t e o e f c o e n c o o m no y m 's ic a b s i l l a it c y k t p o r e e v x a p il a i n n d g f A o v u e r r th a g q e u l a e r v t e e l r , 3/4_2 l_ll/2 Civilian unemployment without putting upward pressure on rate prices, the Committee indicated that the small chance of an unwelcome substan- 1. Change from average for f5o1u/2rt-h61 /q4u arter o5f1 /p2r-e6vious year to average for fourth quarter of year indicated. tial decline in the inflation rate was likely to remain its predominant concern for the foreseeable future. cent, which, given the modest increase in real GDP in the first quarter, implies a noticeable pickup in growth as the year progresses. The central tendency for Economic Projections projections of real GDP growth in 2004 for 2003 and 2004 spans a range of 33A percent to 43/4 per- The members of the Board of Governors cent. The civilian unemployment rate is and the Federal Reserve Bank presi- expected to be between 6 percent and dents, all of whom participate in the 6!/4 percent in the fourth quarter of 2003 deliberations of the FOMC, expect eco- and to decline to between 5^2 percent nomic activity to accelerate in the sec- and 6 percent by the fourth quarter of ond half of this year and to gather addi- 2004. tional momentum in 2004. The central Inflation is anticipated to be quite low tendency of the FOMC participants' over the next year and a half. The chainforecasts for the increase in real GDP type price index for personal consumpover the four quarters of 2003 spans a tion expenditures (PCE) rose 1% pernarrow range of 2!/2 percent to 23A per- cent over the four quarters of 2002, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 37 most FOMC participants expect infla- longer-term yields declined, in some tion to run somewhat lower this year cases to their lowest levels on record. and then to hold fairly steady in 2004. Equity prices, which through mid- The central tendency of projections for March had fallen in response to weaker- PCE inflation is VA percent to 1 Vi per- than-expected economic news and riscent in 2003 and 1 percent to \xh per- ing geopolitical tensions, began a broad cent in 2004. rally as it became clear that the war in Iraq would begin imminently. The apparent increase in investors' appetite Economic and Financial for risk also helped push down risk Developments in 2003 spreads on corporate bonds and trig- Economic activity in the United States gered inflows to equity and high-yield remained sluggish in the first half of bond mutual funds. Since the beginning 2003. Businesses continued to be reluc- of the year, the foreign exchange value tant to undertake new projects given the of the dollar has depreciated nearly unusual degree of uncertainty in the eco- 5 percent against the broad group of nomic environment, and the softness in currencies of our major trading partners. activity abroad crimped the demand for Households and businesses have U.S. exports. However, consumer spend- taken advantage of the decline in ing grew moderately, housing activity intermediate-term and long-term interretained considerable vigor, and defense est rates from their already low levels, spending picked up. Real GDP rose at mostly by refinancing debt at ever more an annual rate of just 1 Vi percent in the favorable rates. Partly as a result, housefirst quarter and appears to have posted hold credit quality was little changed another modest gain in the second quar- over the first half of the year, and houseter. With output growth remaining tepid hold debt continued to expand at a rapid and labor productivity rising at a fairly pace as mortgage interest rates fell robust pace, firms continued to trim pay- to their lowest levels in more than rolls in the first half of 2003, though job three decades. Business balance sheets losses in the private sector were a little strengthened noticeably, and many measmaller than they had been, on average, sures of corporate credit performance in 2002. showed some improvement. Still, net For much of the first half of the year, borrowing by businesses continued to headline inflation news was shaped be damped by the softness in investment by movements in energy prices, which spending. soared during the winter, retreated during the spring, and more recently firmed. Core inflation—which excludes The Household Sector the direct effects of food and energy Consumer Spending prices—was held to a low level by slack in resource utilization and continued siz- Consumer spending continued to inable advances in labor productivity. crease in the first half of 2003, though As a result of slow economic growth not as quickly as in the past few years. and the prospect that inflation would In total, real personal consumption remain very subdued, the federal funds expenditures (PCE) rose at an annual rate was maintained at the accommoda- rate of 2 percent in the first quarter and tive level of 1 VA percent for much of the likely posted another moderate advance first half of the year. Intermediate- and in the second quarter. Purchases of new Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

38 90th Annual Report, 2003 light motor vehicles were sustained past few years. Reflecting these influby the automakers' use of increasingly ences, the personal saving rate averaged aggressive price and financing incen- 3x/2 percent over the first five months of tives. Spending on goods other than the year—about the same as the annual motor vehicles rose briskly in the first average for 2002 but more than 1 perquarter, though that was largely because centage point above that for 2001. of the high level of spending around the Consumer confidence, which has turn of the year; the data through May exhibited some sharp swings in recent suggest a further increase for this cate- years, remained volatile in the first half gory in the second quarter. In contrast, of 2003. After having declined markoutlays on services rose only slowly edly over the second half of 2002, surover the first five months of the year vey readings from both the Michigan as weakness lingered in a number of Survey Research Center and the Concategories, including air travel and ference Board took another tumble early recreation. this year on concerns about the potential The rise in real consumption expendi- consequences of a war in Iraq. With the tures so far in 2003 has about matched combat in Iraq largely over and the the growth in real disposable personal stock market recovering, confidence income (DPI), which has been restrained rose appreciably, on net, in the spring. by the poor job market and by the surge in consumer energy prices early in the Residential Investment year. Real DPI rose about 2lA percent at an annual rate between the fourth Housing activity remained robust in the quarter of 2002 and May after having first half of this year, as very low mortincreased at a considerably faster pace gage interest rates apparently offset in 2002; the larger increase in real DPI much of the downward pressure from in 2002 in part reflected the effects of the soft labor market. In the singlethe tax cuts enacted in 2001. family sector, starts averaged an annual Among other key influences on con- rate of 1.39 million units over the first sumption, household wealth grew about five months of the year—2 percent in line with nominal DPI in the fourth greater than the rapid pace for 2002 as quarter of 2002 and the first quarter of a whole. In addition, sales of new and 2003 after having fallen sharply over the existing homes moved to exceptionally preceding two years. While the rebound high levels. According to the Michiin the stock market in the second quarter gan survey, consumers' assessments of should help the wealth-to-income ratio homebuying conditions currently are recoup some of the ground it lost earlier, very favorable, mainly because of the households likely have not yet com- low mortgage rates. pleted the adjustment of their spending The available indicators provide difto the earlier drop in wealth. Mean- fering signals on the magnitude of recent while, the high level of mortgage refi- increases in home prices, but, in general, nancing in recent quarters has bolstered they point to smaller gains than those consumer spending by allowing home- recorded a year or two ago. Notably, owners to reduce their monthly pay- over the year ending in the first quarter, ments, pay down more costly consumer the constant-quality price index for new debt, and in many cases cash out some homes rose just 2Vi percent, one of the of the equity that has accumulated dur- lowest readings of the past few years. ing the upswing in house prices over the Meanwhile, the four-quarter increase in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 39 the repeat-sales price index for existing quarters of 2003 in response to the homes, which topped out at %xh per- declines in mortgage rates. According cent in 2001, was 6!/2 percent in the to Freddie Mac, more than 40 percent first quarter. Still, the share of income of the refinancings in the first quarter required to finance the purchase of a were "cash-out" refinancings, and the new home, adjusted for variations over amount of equity extracted likely set a time in structural characteristics, has record in the first half of this year. The continued to move down as mortgage combination of rising home prices and rates have dropped, and it is now very low interest rates also energized home low by historical standards. equity lending during the first half of Activity in the multifamily sector 2003. appears to have slipped somewhat this A major use of the proceeds from year, perhaps in part because the strong both cash-out refinancing and home demand for single-family homes may equity loans reportedly has been to pay be cutting into the demand for apart- down credit card and other higher-cost ments. Multifamily starts totaled consumer debt. Indeed, in line with 325,000 units at an annual rate over the those reports, consumer debt advanced first five months of the year, a pace at a relatively subdued AV2 percent 6 percent below that for 2002 as a annual rate in the first quarter. The whole. In addition, vacancy rates for growth of revolving debt was about multifamily rental properties rose fur- 5 percent at an annual rate, and nonrether in the first quarter, and apartment volving debt expanded at a 3Vi percent rents continued to fall. annual rate. The growth of consumer debt picked up in the spring; the acceleration in part reflected somewhat Household Finance higher motor vehicle sales that boosted Household real estate debt grew rapidly the nonrevolving component, which in in the first half of the year with the turn offset a deceleration in revolving support of the brisk pace of home sales, credit. Meanwhile, the average interest rising home prices, and falling mort- rates charged on credit cards and on new gage interest rates. Indeed, according to car loans at auto finance companies this Freddie Mac, the average rate on thirty- year have remained near the low end of year conventional home mortgages fell their recent ranges. sharply until June, though it has edged In total, household debt grew at a back up in recent weeks and now stands 10 percent annual rate in the first quarat about 5Vi percent. Applications for ter, a pace about unchanged from last mortgages to purchase homes rose well year's. Despite the marked rise of this above the already elevated level of last debt over the past several quarters, the year. Sales of existing homes, in par- aggregate debt-service burden of houseticular, add significantly to the level of holds ticked down in both the fourth mortgage debt because the purchaser's quarter of 2002 and the first quarter of mortgage is typically much larger than this year—periods during which borthe seller's had been. The pace of rowing rates fell and the average matumortgage refinancing—which adds to rity of household debt rose. Although borrowing because households often households continued to borrow at a increase the size of their mortgages rapid pace in the second quarter, the when they refinance—set consecutive declines in mortgage interest rates and quarterly records in the first and second an elevated level of refinancing imply Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

40 90th Annual Report, 2003 that the debt-service burden was likely tainty about the economic outlook little changed. and heightened risk aversion in the The credit quality of household debt wake of last year's corporate goverremained fairly stable in the first quar- nance and accounting problems. Excess ter. The delinquency rates both on resi- capacity—in addition to being a dential mortgages and on credit card factor weighing on nonresidential loans edged down in the first quarter, construction—also is limiting demand though persistently high delinquencies for some types of equipment, most notaamong subprime borrowers remain a bly in the telecommunications area. But problem area. Delinquency rates on auto other key determinants of equipment loans at captive finance companies have spending are reasonably favorable. The edged up in recent months from their aggressive actions taken by firms over very low levels of the past few years. the past few years to boost productivity However, lenders probably anticipated and trim costs have provided a lift to some increase as the plethora of new corporate profits and cash flow. In addivehicle loans issued in late 2001 and tion, low interest rates and a rising stock early 2002 seasoned. The fact that a market are helping hold down firms' large number of households declared cost of capital, as is the partialbankruptcy in the first half of the year expensing investment tax incentive. In suggests that some households continue addition, technological advances conto experience considerable distress. tinue to depress the relative price of In a continuation of the trend during computers at a time when stretched-out the second half of 2002, households replacement cycles have apparently widinvested heavily in bond mutual funds— ened the gap between the latest technoland relatively safe bond funds at that— ogy and that embodied in many of the during the first quarter of 2003 and dis- machines currently in use. invested from equity funds. However, Real spending on E&S fell at an starting in March, households showed a annual rate of nearly 5 percent in the growing willingness to purchase shares first quarter. The outlays were restrained of riskier funds. As corporate credit by a sharp decline in spending on transquality improved and risk-free interest portation equipment, especially motor rates fell to record lows, a significantly vehicles; excluding that category, spendlarger portion of the investment in bond ing posted a small gain. Real outlays on mutual funds flowed into corporate bond high-tech equipment and software rose funds—including high-yield funds—at at an annual rate of about 11 percent in the expense of government bond funds. the first quarter, a bit faster than they Inflows to equity mutual funds report- had in 2002. Real purchases of computedly resumed in mid-March and contin- ers and peripheral equipment remained ued through June. on the moderate uptrend that has been evident since such spending bottomed out in 2001, and outlays on communica- The Business Sector tions equipment picked up after an extended period of weakness. Mean- Fixed Investment while, investment outside the transporta- Investment in equipment and software tion and high-tech areas dropped back a (E&S) continues to languish. Firms bit. reportedly remain reluctant to under- Real E&S spending appears to have take new projects because of the uncer- turned up in the second quarter, in part Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 41 because of a step-up in the pace of real investment in the first quarter was a computer investment. However, incom- meager $5 billion at an annual rate and ing data suggest that outlays on com- occurred entirely in the motor vehicle munications equipment did not repeat industry, where sagging sales and ambitheir first-quarter spurt. The data on tious production early in the year creshipments of capital goods point to mod- ated a noticeable bulge in dealer stocks, erate increases in spending outside of especially of light trucks. In the second high-tech and transportation in the quarter, the automakers reduced assemsecond quarter; moreover, backlogs of blies and expanded incentives to bolster unfilled orders for equipment in this sales, but these steps were sufficient broad category have risen some this year only to reduce stocks a little, and invenafter having declined over the preceding tories remained high relative to sales two years. through June. Apart from the motor Nonresidential construction remained vehicle industry, firms reduced stocks, weak in the first half of 2003. Although on net, over the first five months of real construction outlays were off only a 2003, and, with only a few exceptions, little in the first quarter, they had fallen inventories appear reasonably well nearly 16 percent in 2002, and partial aligned with sales. data for the second quarter point to continued softness. The downturn in spend- Corporate Profits ing has been especially pronounced in and Business Finance the office sector, where vacancy rates have surged and rents have plunged. Before-tax profits of nonfarm, nonfinan- Spending on industrial facilities also has cial corporations grew at a 6V2 percent fallen dramatically over the past couple annual rate in the first quarter of 2003, of years; it has continued to contract and they constituted 8V2 percent of the in recent quarters and is unlikely to sector's first-quarter GDP, the highest improve much in the absence of a sig- proportion since the third quarter of nificant rise in factory operating rates. 2000. Focusing on the companies that Construction expenditures on other make up the S&P 500, earnings per commercial buildings (such as those for share for the first quarter were up about retail, wholesale, and warehouse space), 7 percent at a quarterly rate from the which had declined less than did outlays fourth quarter of 2002 and were 11 perfor other major categories of nonresi- cent higher than four quarters earlier. dential construction over the past couple Although oil companies accounted for of years, moved up in the first quarter of the majority of the four-quarter increase, 2003, but they too have shown some earnings from the financial, utility, and renewed softness lately. One bright spot consumer durable sectors were also is the drilling and mining sector, in strong and exceeded the market's conwhich outlays have risen sharply this servative expectations by larger-thanyear in response to higher natural gas usual margins. The recent depreciation prices. of the dollar substantially boosted revenues of U.S. multinational corporations, but the hedging of currency risk likely Inventory Investment limited the extent to which sales gains Most businesses have continued to keep showed through to profits. a tight rein on inventories after the mas- Net equity retirements in the first sive liquidation in 2001. Real inventory quarter of 2003 were probably a shade Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

42 90th Annual Report, 2003 larger than in the fourth quarter of 2002, Senior Loan Officer Opinion Survey on as the decline in gross new issuance Bank Lending Practices. more than offset lower gross retire- The runoff in C&I loans appears ments. Equity retirements from cash- related more to a decrease in demand financed mergers were a bit below their than to a tightening of supply condipace in the past two years, and share tions, and bank credit appears to remain repurchases appear to be running some- available for qualified business borrowwhat slower as well. Volatile and declin- ers. The net fraction of banks in the ing equity prices in the first quarter Senior Loan Officer Opinion Survey that brought initial public offerings (IPOs) to reported having tightened lending stana standstill during the first four months dards and terms on C&I loans during the of this year. One small IPO was under- first part of the year decreased marktaken in May, and another one came to edly, and the Survey of Small Business market in June. With regard to seasoned by the National Federation of Indepenequity offerings, a war-related lull in dent Business showed that the net per- March and April held the average centage of small businesses believing monthly pace of issuance this year well credit had become more difficult to below last year's level. Most of these obtain hovered near the middle of its offerings have been from energy firms recent range. Moreover, in the April and utilities that have used the proceeds Senior Loan Officer Opinion Survey, a primarily to reduce leverage and number of banks reported that they had increase liquidity. eased lending terms in response to The net debt growth of nonfinancial increased competition for C&I loans corporate business was just 3 percent at from nonbank lenders. Indeed, data from an annual rate in the first quarter, as Loan Pricing Corporation indicate that rising profits and lower outlays for fixed nonbank financial institutions purchased and working capital held down corpo- a record amount of new syndicated loans rations' need for external funds. None- during the first quarter of this year; the theless, low interest rates continued to buyers were reportedly attracted in part attract firms to the bond market during by improving liquidity in the secondary the first half of 2003, and issuance ran loan market. well ahead of its rate of the second half The decline in both short- and longof 2002. Moreover, a large fraction of term interest rates, combined with slow the issues were from below-investment- increases in total business debt, congrade firms, which likely were respond- tributed to a further reduction in the net ing to the even sharper fall in their interest burden of nonfinancial corporaborrowing rates than investment-grade tions during the first quarter. Moreover, firms enjoyed. A substantial portion of by issuing bonds and paying down the proceeds of recent bond issues have short-term debt, businesses have subbeen slated to pay down commercial stantially lengthened the overall matupaper and commercial and industrial rity of their debt, thus reducing their (C&I) loans, and each of those com- near-term repayment obligations. These ponents contracted markedly during the developments, together with higher first half of the year. Another factor profitability, have helped most measures contributing to the weakening in of corporate credit performance to demand for C&I loans this year was the improve this year. The number of ratabsence of merger and acquisition activ- ings downgrades continued to exceed ity, according to the Federal Reserve's upgrades but by a notably smaller mar- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 43 gin than last year. The six-month trail- to refinance at lower interest rates; they ing bond default rate declined consider- also mentioned that the many borrowably in the first half of the year. The ers with substantial equity positions in four-quarter moving average of recov- the mortgaged properties have an extra ery rates on defaulted bonds improved incentive to remain current. Banks also a bit in the first quarter, although it pointed to their having tightened lendremained at the low end of its range of ing standards and terms, including the past several years. The delinquency maximum loan-to-value ratios, well in rate on C&I loans at commercial banks advance of the current downturn. also moved down some in the first quar- In line with the assessment that, to ter, albeit to a level well above that of date, credit quality in the sector remains the late 1990s. good, spreads on CMBS over Treasuries have remained in the lower half of the ranges observed over the past few years. Commercial Real Estate Market reports indicate that CMBS issu- The growth of debt backed by commer- ers generally have had access to terrorcial real estate remained robust this year ism insurance for the underlying properdespite some deterioration in that sec- ties, and the cost of that insurance has tor's underlying fundamentals. In the come down significantly. In addition, first quarter of 2003, the expansion of newly formed pools that include highdebt was driven by lending at commer- profile properties reportedly have been cial banks and was spread about equally diversified to further protect investors across broadly defined types of commer- from losses due to acts of terrorism. cial real estate loans. Although the issuance of commercial-mortgage-backed securities (CMBS) slowed somewhat in The Government Sector the first quarter from the rapid pace of Federal Government the second half of last year, issuance appears to have rebounded strongly in The federal budget deficit has widened the second quarter. significantly as a consequence of the Despite continued increases in va- persistent softness in receipts and legiscancy rates and declines in the rents lative actions affecting both spending charged for various types of commercial and taxes. Over the first eight months properties, the credit quality of commer- of the current fiscal year—October to cial mortgages has yet to show appre- May—the deficit in the unified budget ciable signs of deterioration. At com- was $292 billion, nearly $150 billion mercial banks, delinquency rates on larger than that recorded during the commercial mortgages edged up only comparable period last year. Moreover, slightly in the first quarter of 2003 from recent policy actions are projected to their historically low levels of recent boost the deficit significantly over the years. Delinquency rates on CMBS, remainder of the fiscal year. In particuwhich were stable in 2002 at about the lar, receipts will be reduced appreciably midpoint of their recent range, have also by several provisions of the Jobs and risen just a bit this year. Respondents Growth Tax Relief Reconciliation Act to the April 2003 Senior Loan Officer of 2003, including advance refund Opinion Survey attributed the resiliency checks for the 2003 increment to the of the credit quality of commercial real child tax credit, downward adjustments estate loans in part to borrowers' ability to withholding schedules for individual Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

44 90th Annual Report, 2003 taxpayers, and the sweetening of the sensitive to capital income, dropped partial-expensing investment incentive sharply. This spring's net final payfor businesses. In addition, outlays will ments, which are largely payments on be boosted by the supplemental appro- the previous year's liabilities, were priations for defense and foreign aid and exceptionally soft for a second year in by additional grants to the states. If the a row; in combination with the inforlatest projection from the Congressional mation on withheld and estimated Budget Office is realized, the unified payments, they imply that individual liadeficit will increase from $158 billion in bilities continued to shrink as a percentfiscal 2002 to more than $400 billion in age of the NIPA tax base in 2002. The fiscal 2003. substantial drop in the ratio of liabilities The deterioration in the unified bud- to NIPA income over the past couple get has been mirrored in a sharp down- of years reflects in part a reversal of swing in federal saving—essentially, the the capital gains bonanza of the late unified surplus or deficit adjusted to 1990s and the tax reductions enacted in conform to the accounting practices fol- 2001. (Capital gains are not included in lowed in the national income and prod- the NIPA income measure, which, by uct accounts (NIPA). Indeed, net federal design, includes only income from cursaving, which accounts for the depre- rent production.) In addition, the change ciation of government capital, fell from in the distribution of income in the late a high of a positive 2 percent of GDP 1990s, which concentrated more income in 2000 to a negative 2x/2 percent of in the upper tax brackets, may have been GDP in the first quarter of 2003. With reversed some during the past couple of little change, on balance, in nonfederal years. domestic saving over this period, the Federal spending during the first eight downswing in federal saving showed months of fiscal year 2003 was 6V2 perthrough into net national saving, which cent higher than during the same period was equal to less than 1 percent of GDP last year; excluding the drop in net interin the first quarter, compared with the est outlays, spending was more than recent high of 6V2 percent of GDP in IV2 percent higher. Spurred by the war 1998. If not reversed over the longer in Iraq, defense spending has moved up haul, such low levels of national saving another 15 percent thus far this year; could eventually impinge on the forma- outlays for homeland security have tion of private capital that contributed to risen briskly as well. Expenditures the improved productivity performance for income security programs, which of the past half-decade. include the temporary extended unem- Federal receipts in the first eight ployment compensation program, also months of the current fiscal year were have risen at a fairly rapid rate. Though nearly 3 percent lower than during the growth in spending on Medicare and comparable period of fiscal 2002 after Medicaid, taken together, has slowed a adjusting for some shifts in the timing of bit this year, the rising cost and utilipayments during the fall of 2001. Indi- zation of medical care continue to put vidual receipts were especially weak: upward pressure on these programs. Although withheld taxes, which tend to Expenditures for consumption and move in line with wages and salaries, gross investment, the part of federal held up fairly well (after adjusting for spending that is included in GDP, rose changes in tax law) during this period, just slightly in real terms in the first nonwithheld payments, which are more quarter as a sizable increase in non- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 45 defense purchases was nearly offset by able budgetary surpluses in the late a surprising decline in defense spending. 1990s and now face large deficits. After The dip in defense spending followed having enacted a series of tax reductions several quarters of large increases; with in the second half of the 1990s, they the supplemental appropriation in place, subsequently saw their receipts eroded defense spending in the second quar- by weak incomes and the falling stock ter appears to have resumed its rapid market. At the same time, these entigrowth. ties boosted their outlays considerably, Federal debt held by the public in large part because of rising health advanced at a 2V4 percent annual rate care costs and increased demands for in the first quarter and remained at just security-related spending. The fiscal below 35 percent of nominal GDP. Dur- difficulties have been especially acute at ing the first half of the year, the Trea- the state level. And although local govsury announced several changes in its ernments generally have fared somedebt management, including the reintro- what better, many are now facing reducduction of three-year notes and regular tions in assistance from cash-strapped reopenings of certain five-year and ten- states. According to the NIPA, the state year notes, to position itself better to and local sector's aggregate current defiaddress the widening federal deficit. cit rose to about $50 billion in 2002—or These steps have the consequences of Vi percent of GDP, the largest annual lengthening the average maturity of its deficit relative to GDP on record—and outstanding debt and trimming the size that gap exceeded $65 billion at an of some of its auctions. The Treasury annual rate in the first quarter of 2003. also noted that it would be increasing Almost all states and most localities the frequency and size of its auctions of are subject to balanced budget and other inflation-indexed securities. statutory rules that force them to address Beginning in February 2003, the fiscal imbalances. These rules typically Treasury needed to take steps to avoid apply to operating budgets, and governexceeding the level of the statutory debt ments have taken a variety of actions to ceiling and employed several account- meet their budgetary requirements for ing devices to which market participants fiscal 2003 and to pass acceptable budhave become accustomed. It also tempo- gets for fiscal 2004, which started on rarily suspended the issuance of the type July 1 in most states and many localof Treasury debt instrument in which ities. Strategies have included drawthe proceeds of advance refundings by ing upon accumulated reserves, issuing state and local governments are allowed bonds, and, in some cases, using oneto be invested. No adverse reaction in time measures such as moving payments financial markets was apparent during into the next fiscal year and selling this period, however, and a bill increas- assets. Increases in taxes and fees also ing the debt ceiling $984 billion, to have become more widespread. Still, $7,384 trillion, was enacted on May 23. spending restraint has remained an important component of the adjustment. Governments—especially at the state State and Local Governments level—have held the line on hiring and On the whole, the budget situation at have limited their outlays for a variety state and local governments remains of other goods and services. In the grim. Like the federal government, NIPA, real expenditures for consumpstates and localities were running siz- tion and gross investment in the state Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

46 90th Annual Report, 2003 and local sector rose only Vi percent imports rose more than that of exports. over the year ending in the first quar- U.S. net investment income registered a ter, compared with increases averaging $16 billion surplus in the first quarter, more than 3V2 percent per year over little changed from the previous quarter the preceding five years. Available data but significantly larger than the outcome point to continued softness in such for last year as a whole. The increase spending in the second quarter. over last year is attributable primarily The pace of gross issuance of munici- to lower net interest and dividend paypal bonds remained robust in the first ments. Net unilateral transfers and other half of the year; it was fueled in part by income were a negative $74 billion, the needs of state and local governments down from a negative $67 billion in the to finance capital spending, which is not fourth quarter. subject to balanced budget requirements. Real exports of goods and services Long-term debt issuance was heavily fell 1XA percent at an annual rate in the used for new education and transpor- first quarter; this decline, like that in the tation projects. Declining yields on previous quarter, reflected in part slow municipal debt and high short-term bor- economic growth of our major trading rowing demands also provided impor- partners. Within this total, exports of tant impetus to debt issuance. Despite goods increased nearly 2 percent after continued fiscal pressures on many state declining sharply in the fourth quarter and local governments, the credit qual- of last year. Moderate increases in most ity of municipal bonds has shown some trade categories were partly offset by a signs of stabilizing. Although the spread decrease in exports of capital goods of BBB-rated over AAA-rated munici- (particularly aircraft and computers). pal bond yields has widened somewhat, Meanwhile, real exports of services the number of municipal bond upgrades declined about 8 percent in the first by S&P has slightly exceeded the num- quarter, mainly because of a drop in ber of downgrades so far this year. The receipts from foreign travelers. Prices of yields on municipal bonds declined exported goods and services, which rose more slowly than the yields on Trea- nearly 4 percent at an annual rate in the sury securities of comparable maturity first quarter, were boosted by rising over much of the first half of the year; prices of services and industrial supthese moves lowered the yield differen- plies (mainly goods with a high energy tial from the tax-advantaged status of component). Prices of exported capital municipal securities. goods, automotive products, and consumer goods showed little change in the first quarter. The External Sector U.S. real imports of goods and services declined 6lA percent at an annual Trade and the Current Account rate in the first quarter following four In the first quarter of 2003, the U.S. quarters of increases. Imports of oil, current account deficit amounted to other industrial supplies, aircraft, and $544 billion at an annual rate, or about services (primarily U.S. travel abroad) 5 percent of GDP, a somewhat higher all dropped sharply. Imports of autopercentage than in any quarter of last motive products decreased for the secyear. The deficit on trade in goods and ond consecutive quarter, but imports of services widened $22 billion in the first machinery and consumer goods rose. quarter, to $486 billion, as the value of The price of imported goods jumped Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 47 12 percent at an annual rate in the first in response to downward pressures on quarter, mainly resulting from spikes in the foreign exchange value of the dollar. the prices of natural gas and oil. The U.S. residents, who had sold foreign price of imported goods excluding fuels securities on net last year, recorded sizrose about 2 percent in the first quarter, able net purchases in the first quarter of the fourth consecutive quarter of small this year: Relatively large purchases of increases, in part because of the depre- foreign equities outweighed further sales ciation of the dollar since early 2002. of bonds. Slight declines in prices of imported Direct investment into the United capital goods, automotive products, and States, after being restrained in 2002 consumer goods were offset by small by a slowdown of global mergers and increases in other categories. acquisitions, picked up in the first quar- The spot price of West Texas inter- ter of 2003, as merger activity resumed. mediate crude oil rose to a twelve-year U.S. direct investment abroad was high of nearly $38 per barrel in mid- steady in 2002 and the first quarter of March as the United States moved closer 2003. to war in Iraq and as a nationwide strike slowed Venezuelan oil production to a trickle. With the commencement of The Labor Market military action in Iraq and the relatively rapid conclusion of the war, prices fell Employment and Unemployment to less than $26 per barrel by late April. Downward pressure on prices was also The demand for labor has weakened furexerted by increased production from ther this year, though the pace of job some OPEC countries, particularly losses appears to have slowed some- Saudi Arabia, Kuwait, and Venezuela, what. After having fallen an average of where oil production recovered substan- 55,000 per month in 2002, private paytially relative to the first quarter. In early roll employment declined 35,000 per June, oil prices moved back above $30 month, on average, in the first quarter of per barrel after it became apparent that 2003 and 21,000 per month in the sec- Iraqi exports of oil would return more ond quarter. The civilian unemployment slowly than market participants had pre- rate, which had been fluctuating around viously expected. 53/4 percent since late 2001, was little changed in the first quarter but moved up in the spring. In June, it stood at The Financial Account 6.4 percent. The U.S. current account deficit con- The manufacturing sector has contintinued to be financed in large part by ued to shed jobs this year. On average, private flows into U.S. bonds and by factory payrolls fell 55,000 per month foreign official inflows. Private for- over the first half of 2003—essentially eign purchases of U.S. securities, which as fast as over 2002 as a whole. Employslowed in the latter part of 2002, stepped ment declines were widespread, but down a bit more in the first quarter of the metals, machinery, and computers 2003, owing in part to weaker demand and electronics industries continued to for U.S. equities. In contrast, inflows be especially hard hit. The weakness in into the United States from official manufacturing also cut into employment sources, which surged in 2002, picked at help-supply firms and at wholesale up further in the first half of 2003 partly trade establishments, although help- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

48 90th Annual Report, 2003 supply jobs increased noticeably in May demand. According to the currently puband June. lished data, output per hour worked in Apart from manufacturing and related the nonfarm business sector rose at an industries, private employment in- annual rate of 2 percent in the first quarcreased slightly, on net, in the first half ter and 2T/2 percent over the four quarafter having been about unchanged in ters ending in the first quarter. Though 2002. Employment in the financial the recent gains are down from the very activities sector rose briskly, in part rapid increases in late 2001 and 2002, because of the boom in mortgage refi- they are similar to those achieved in nancings. Construction employment, the second half of the 1990s. However, which had been essentially unchanged, whereas the earlier productivity gains on net, since 1999, remained soft in the were driven importantly by an expanfirst quarter but posted a sizable gain sion of the capital stock, the recent gains in the second quarter. Employment in appear to have come mainly from the information sector, which includes efficiency-enhancing changes in organitelecommunications, publishing, and zational structures and better use of the Internet-related services, continued to capital already in place. decrease, though a shade less rapidly The employment cost index (ECI) for than over the preceding two years. private nonfarm businesses increased Demand for workers in retail trade, lei- about 33A percent over the twelve sure and hospitality, and transportation months ending in March—only a shade and utilities remained lackluster. less than over the preceding year but The unemployment rate was little more than Vi percentage point below the changed in the first quarter, but it subse- increases of a few years earlier. The quently turned up. In June, it stood at deceleration in hourly compensation 6.4 percent, lA percentage point higher over the past few years has been concenthan the average in the fourth quarter of trated in wages, for which gains slowed 2002 and about 2l/i percentage points from about 4 percent per year in 2000 above the lows reached in 2000. The and 2001 to 3 percent over the year rise in the unemployment rate over the ending this March. The slowing in wage spring was chiefly driven by the ongo- growth primarily reflects the effects of ing softness in labor demand. Most the soft labor market and lower rates of recently, it also coincided with an uptick price inflation; in addition, employers in labor force participation. That uptick may be exerting more restraint on wages notwithstanding, the participation rate to offset some of the upward pressure on has trended down over the past couple total compensation from rising benefit of years, a slide mainly reflecting costs. The increase in benefits was espedeclines for adult men and younger cially sharp in the first quarter of 2003; persons. in that period, employers stepped up their contributions to defined-benefit retirement plans in response to declines Productivity and Labor Costs in the market value of plan assets, and Labor productivity has continued to post health insurance costs continued to solid gains in recent quarters as busi- increase rapidly. In total, benefit costs nesses have remained reluctant to rose 6 percent over the year ending in expand their payrolls and instead have March. focused on cutting costs in an envi- The growth in compensation per hour ronment of sluggish—and uncertain— in the nonfarm business sector—an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 49 alternative measure of hourly compen- sure had been considerably higher sation based on the NIPA—has swung earlier in the year, when energy prices widely in recent years. Fluctuations in were rising, and it is difficult to know the value of stock option exercises, whether the decline of late was driven which are excluded from the ECI, likely chiefly by the retreat in energy prices have contributed importantly to these during the spring. Non-oil import prices swings. In any event, the increase in this posted a sizable increase in the first measure over the year ending in the first quarter after having been little changed quarter was 3lA percent and roughly in in 2002, but the first-quarter rise was line with the rise indicated by the ECI. due largely to a spike in the price of imported natural gas, which should not have much effect on core consumer Prices price inflation. Given the decline in the Headline inflation numbers have been dollar from its peak in early 2002, nonheavily influenced by movements in oil import prices will probably trend up energy prices, but underlying inflation modestly in coming quarters. has remained subdued and according to PCE energy prices rose sharply in the some measures has even moved some- first quarter but turned down in the what lower. Reflecting the surge in spring, a pattern largely mirroring the energy prices, the chain-type price index swings in crude oil prices. Gasoline for personal consumption expenditures prices, which had already been elevated (PCE) increased at an annual rate of in late 2002 by weather-related supply 23A percent in the first quarter, about disruptions, increased further early this 1 percentage point faster than the year as crude oil costs rose and wholeincrease over 2002 as a whole; this sale margins remained large; by June 1, index moved down in April and May as gasoline prices had reversed that energy prices retreated. PCE prices increase, and they have changed little, excluding food and energy—the so- on net, since that time. Natural gas called core PCE price index—were prices also soared in early 2003 as nearly unchanged during the spring, and tight inventories were depleted further the twelve-month change in this series by unusually cold weather; since the stood at VA percent in May, compared unwinding of February's dramatic spike, with a reading of \3A percent over the prices have held in a narrow range. preceding twelve months. Inventories of natural gas have increased In the main, the quiescence of under- significantly of late, but they are still lying inflation reflects continued slack low enough to raise concerns about the in labor and product markets and the possibility of future price spikes in the robust productivity gains of recent event of a heat wave later this summer years. In addition, inflation expectations or an unusually cold winter. Reflecting have remained in check—and, indeed, the higher natural gas input costs, PCE may have subsided a bit further. For electricity prices rose substantially over example, according to the Michigan the first five months of 2003 after hav- Survey Research Center, the median ing fallen some in 2002. expectation for inflation over the com- Increases in core consumer prices of ing year was running about 2 percent in both goods and services have slowed May and June, compared with 2Vi per- over the past year, with the deceleration cent to 3 percent over much of the pre- most pronounced for goods. Prices for ceding few years. Readings on this mea- core PCE goods fell 2lA percent over Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

50 90th Annual Report, 2003 the year ending in May after having Alternative Measures of Price Change decreased 1 percent over the preceding Percent twelve months. Meanwhile, the rise in prices for non-energy services totaled 2001 2002 Price measure to to 23/4 percent over the year ending in May, 2002 2003 a little less than over the preceding period. Among the major types of ser- Chain-type Gross domestic product 1.4 1.6 vices, the price of owner-occupied hous- Gross domestic purchases .8 2.3 ing was up only IVi percent after having Personal consumption expenditures .9 2.2 risen AVA percent over the preceding Excluding food and energy ... 1.5 1.5 period. But prices for some other types Chained CPI .9 2.5 Excluding food and energy ... 1.9 1.4 of services accelerated. Most notably, Fixed-weight the prices of financial services provided Consumer price index 1.3 2.9 by banks without explicit charge turned Excluding food and energy ... 2.5 1.8 up after having decreased over the pre- NOTE. Changes are based on quarterly averages and ceding two years; because these prices are measured from Ql to Ql. cannot be derived from market transactions and thus must be imputed, they are difficult to measure and tend to be vola- in this category in 2001 and 2002 tended tile from year to year. to lift the CPI relative to the PCE Increases in the core consumer price index. index (CPI) also have been very small Broader price measures likewise point recently, and the twelve-month change to low inflation over the year ending in in this measure slowed from 2lA percent the first quarter. In particular, the chainin May 2002 to IV2 percent in May type price index for GDP rose only 2003—a somewhat greater deceleration IV2 percent over that period, about than in core PCE prices. The greater the same as during the comparable deceleration in the CPI is primarily period four quarters earlier. Meanwhile, accounted for by its narrower scope and the price index for gross domestic different weighting structure than the purchases—which is defined as the PCE measure. In particular, it excludes prices paid for consumption, investment, the imputed prices of financial services and government purchases—increased rendered without explicit charge as well 2lA percent, up from 3A percent during as several other categories for which the preceding period. The upswing market prices are not available; these mainly reflects the effect of higher non-market-based prices have acceler- energy prices and roughly matches the ated notably recently. In fact, when the acceleration in total PCE prices; the nonmarket categories are stripped from price indexes for construction and govthe core PCE index, the remaining com- ernment purchases also recorded someponents show a deceleration close to what larger increases than they had over that in the core CPI. Another consider- the preceding period. ation is that housing costs have a much larger weight in the CPI than in the PCE U.S. Financial Markets index, partly because of the CPFs narrower coverage. Thus, the smaller price On balance, major stock indexes have increases for housing services of late climbed noticeably this year, governhave a bigger damping effect on core ment and corporate interest rates have CPI inflation, just as the hefty increases declined, and risk spreads, which had Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 51 dropped significantly late last year, have grade bonds rose a bit, on balance, fallen further. between mid-January and mid-March, a move that left their risk spreads higher as well. Before the War in Iraq The year began on an optimistic note in After the War in Iraq financial markets, in part owing to the release of a surprisingly strong report Once it became clear that military action from the Institute for Supply Manage- in Iraq was imminent, a robust rally ment and the announcement of a larger- erupted in both the equity and bond than-expected package of proposed tax markets, as some of the uncertainties cuts, which included elimination of the apparently dissipated and investors personal federal income tax on many began to show a greater appetite for corporate dividend payments. In addi- riskier assets. Equity indexes jumped tion, yields and risk spreads on corpo- about 8 percent in the two weeks rate bonds had dropped significantly bracketing the President's ultimatum to in the fourth quarter of 2002, partly in Saddam Hussein, and prices climbed an reaction to the absence of new reve- additional 3 percent through the end of lations of accounting irregularities and April, partly on the release of generally to the improved outlook for corporate better-than-expected earnings reports for credit quality. Money market futures the first quarter. Gains in share prices rates apparently embedded an expec- were fairly widespread and included tation that the FOMC would begin technology, defense, petroleum, and increasing the federal funds rate as early especially financial companies. as mid-summer 2003. The easing of tensions also put That short burst of optimism was upward pressure on Treasury yields, quickly damped by subsequent eco- but additional disappointing economic nomic reports that were decidedly less data offset the diminished safe-haven rosy, a jump in oil prices in response to demands and left those rates down, on the looming prospect of war in Iraq, and balance, during the period covering the increased tensions with North Korea. war in Iraq and its immediate aftermath. Measures of uncertainty, such as implied Yields on corporate bonds also declined, volatility, moved up in several markets. in part because of strengthened cor- Major equity indexes slid and by mid- porate balance sheets, the reduction in March were off about 4 percent to 9 per- uncertainty, and perhaps because invescent from the beginning of the year. tors began to search for higher returns. Investors also came to believe that the Moreover, according to one widely used onset of FOMC tightening would occur measure, spreads on speculative-grade later than they had earlier believed, a bonds tumbled about 150 basis points, shift in perception that was reflected in to about 520 basis points, from midlower yields on Treasury bonds. Yields March until mid-May, and then flucon investment-grade corporate bonds tuated somewhat before ending June fell about in line with those on Treasur- near that level. The rally in belowies, and investors appeared to be substi- investment-grade bonds was particularly tuting high-quality bonds for equities evident in sectors that had previously as part of a broader flight to fixed- experienced some of the greatest widenincome securities over this period. By ing of spreads—telecom, energy tradcontrast, yields on below-investment- ing, and utilities; the interest in these Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

52 90th Annual Report, 2003 sectors further indicated investors' in- suries over the same period, but yields creased appetite for risk. on speculative-grade bonds edged up A stubbornly sluggish economy and only slightly, and risk spreads narrapid growth of productivity muted both rowed further. Forward-looking ecoinflation and inflation expectations, nomic indicators were generally posiinducing the FOMC to begin pointing to tive, and stock price indexes—the a further substantial decline in inflation Nasdaq, in particular—continued to as a concern at its May meeting. Market trend higher. participants took this to imply that short- On net, the constant-maturity yield on term rates would be held along a lower the two-year Treasury note has fallen path for longer than they had previously 24 basis points this year, to 1.37 perexpected. This shift in expectations trig- cent as of July 9, while the yield on gered a further decline in intermediate- the ten-year Treasury bond has fallen and long-term yields. With long-term 10 basis points, to 3.73 percent. Over inflation expectations apparently only the same period, the Wilshire 5000 is up little changed, the decline in yields 15 Vi percent, and the Nasdaq has surged translated into a sizable decline in real more than 30 percent. As a result of the interest rates. decline in real interest rates, the spread That drop in real interest rates was between the twelve-month forward among several factors providing a boost earnings-price ratio for the S&P 500 to equity prices in May and June. and the real ten-year yield remains wide Implied volatility of the S&P 100 index, despite the run-up in stock prices. which had been elevated earlier in the year, fell substantially with the conclu- Shorter-Term Debt Markets sion of major hostilities in Iraq; it is now near the bottom of its range of the past The average interest rate on commercial several years. Moreover, downward and industrial loan originations—a subrevisions to analysts' earnings expecta- stantial majority of which have adjusttions for the year ahead have been the able interest rates—has fallen to its lowsmallest since early 2000. The tax pack- est level since the start of the Federal age passed in late May, which included Reserve's Survey of Terms of Business a cut in taxes on capital gains and divi- Lending in 1977. The survey also indidends, may have provided some addi- cates that risk spreads on these loans tional impetus to equity prices. receded a bit over the first half of 2003 The FOMC decided on June 25 to after having trended up for most of the reduce the target federal funds rate past several years. Prices in the second- 25 basis points, to 1 percent, but some ary loan market have risen this year, observers had been anticipating a cut of reportedly in part because some of the 50 basis points. In addition, markets large inflows to high-yield mutual funds appeared to read the Committee's were used to purchase distressed loans assessment of economic prospects as and because of the expectation that more upbeat than expected. Partly as a many outstanding loans would continue result, yields on longer-dated Treasury to be prepaid with the proceeds of bond securities reversed a portion of their pre- refinancing. vious decline in the weeks following the Interest rates on commercial paper meeting. Yields on high-quality corpo- also dropped to very low levels in the rate bonds rose about in line with Trea- first half of 2003. Risk spreads in this Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 53 market were relatively stable and near some time now in the Senior Loan Offithe bottom of the range observed over cer Opinion Survey. On a seasonally the past several years, in part because adjusted basis, the ratio of loan-loss proof businesses' efforts to strengthen visions to assets declined in the final their balance sheets and improve their quarter of last year, and it was about liquidity. unchanged from that still-elevated level in the first quarter of 2003. In addition to the buffer against future losses Debt and Financial Intermediation provided by their high profitability The debt of all domestic nonfinancial and substantial provisions, virtually all sectors—government, businesses, and banks—98 percent by assets—remain households—grew at a 6V2 percent well capitalized. annual rate in the first quarter, down Among nondepository financial instifrom 8 percent in the fourth quarter of tutions, issuers of asset-backed securi- 2002 but still well in excess of the ties provided about 13 percent of the growth of nominal GDP. The proportion total credit extended to domestic nonof the new credit supplied by depository financial sectors in the first quarter. The institutions rose significantly in the sec- share of net lending supplied by mutual ond half of last year and remained at funds increased notably to almost about 25 percent in the first half of this 10 percent in the first quarter, and with year. In large part, the jump reflects the the continuation of strong flows to bond sector's support of the booming mort- mutual funds, they likely were large gage market—through both direct lend- suppliers in the second quarter as well. ing and the acquisition of mortgage- Meanwhile, available data suggest that backed securities—which has more than insurance companies likely accounted offset weak business lending. At com- for about 7 percent of total credit mercial banks, revenues from mortgage- extended during the first half of the year, related activities reportedly helped sus- a proportion near the top of the range tain profits in the first quarter at the seen since the mid-1990s. elevated levels of the past several years Government-sponsored enterprises despite some erosion in net interest (GSEs) provided 11 percent of the net margins. lending (net acquisition of credit market The delinquency rate on all loans and instruments) in the first quarter, an leases at banks edged down further dur- amount roughly in line with their level ing the first quarter, to its lowest level in the second half of 2002. The durain two years. Increases in the delin- tion gaps in the portfolios of the housquency rates on commercial real estate ing GSEs were maintained near their loans and non-credit-card consumer targets. In early June, Freddie Mac loans were offset by declines in those on replaced its top three executives amid residential real estate loans, credit card questions about its accounting practices. loans, and business loans. For business The spreads on longer-term Freddie Mac and credit card loans, however, the debt widened a bit, and its stock price delinquency rates at banks remain ele- declined sharply; the prices of Fannie vated, and the recent improvement Mae securities also declined but to a likely reflects, in part, the effect of lesser extent. On net, there appears to be the tightening of lending standards little, if any, spillover into broader finanand terms that has been reported for cial markets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

54 90th Annual Report, 2003 Monetary Aggregates output in the euro area and Japan little changed from the previous quarter. Geo- Through the first half of 2003, the political uncertainties, higher oil prices, growth rate of M2 was buoyed by slow growth in the United States, perseveral factors and remained elevated. sistent weakness in global high-tech The rising level of mortgage refinancsectors, and continued negative wealth ing causes money growth to accelerate effects from past declines in equity because the associated prepayments on prices all weighed on foreign growth. mortgage-backed securities that are Foreign economic expansion appeared temporarily held in escrow accounts to remain weak in the second quarter increase liquid deposits. Demand for M2 despite the reduction in uncertainty was also supported by the decline in associated with Iraq. Indicators suggest short-term market interest rates, which that manufacturing activity abroad has further reduced the opportunity cost of not picked up; instead, industrial proholding money. Precautionary demand duction declined in April and May, on for safe and liquid M2 assets also likely average, relative to the first quarter in buttressed the growth of M2 in the Japan, Germany, and France. Concerns run-up to the war in Iraq. over the spread of the SARS virus In contrast, mutual fund flows related appear to have hurt growth in the second to the bond market rally and the postquarter in several Asian developing war pickup in the stock market may economies and in Canada. have siphoned funds from M2. Retail Central banks in several major formoney market mutual funds and small eign industrial countries moved to ease time deposits both experienced net outmonetary policy during the first half flows during the first half of the year. of this year. The European Central Bank While some of that money continued to and the central banks of the United feed the extraordinary growth of liquid Kingdom, Sweden, Switzerland, Nordeposits, it is likely that a portion was way, and New Zealand all cut official redirected to long-term mutual funds. interest rates. The pace of monetary eas- After having weakened significantly ing in Europe picked up toward midin 2002, growth of M3 slowed further year, when inflation pressures dissipated in the first half of 2003. Much of this amid growing slack, currency appreciayear's slowdown can be attributed to tion vis-a-vis the dollar, and the decline rapid runoffs of institutional money marin oil prices after the conflict in Iraq. ket mutual funds. The runoffs were, in In contrast, the Bank of Canada raised turn, partially the result of an unwinding interest rates twice in the spring, in a of the strength late last year and the fact continued effort to contain inflation. The that interest rates paid by those funds Bank of Canada left rates unchanged in declined faster than the interest rates June, however, in response to a sharp paid by the underlying assets this year. appreciation of the Canadian dollar and The drop in institutional money funds a drop in Canadian inflation in April, has been offset by growth in eurodollar some slackening of demand in labor deposits and repurchase agreements. markets in May, and concerns about the pace of activity in the United States. The Bank of Japan (BOJ) maintained International Developments short-term interest rates at near-zero lev- Economic activity abroad was sluggish els, further expanded its target for curin the first quarter of 2003, with real rent account balances held by financial Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 55 institutions at the BOJ, and took some cerns appeared to abate. After the resoadditional measures to add stimulus to lution in April of major hostilities, the the economy. dollar fell further, and market commen- In the first quarter, foreign financial tary focused more on the financing markets were influenced by heightened needs posed by the large and growing anxieties ahead of the war in Iraq, but U.S. current account deficit. those concerns appeared to diminish as the war proceeded. Foreign equity prices Industrial Economies declined in the first quarter, but they have since recovered. Broad stock The euro-area economy stagnated in the indexes for the major industrial coun- first quarter of 2003. Consumer spendtries are up on balance since the begin- ing continued to expand at a modest ning of the year but, with the exception rate and inventory investment grew, but of Japan, they have gained less than in business fixed investment fell sharply the United States. Long-term interest and exports declined. The German econrates in most foreign industrial coun- omy contracted in the first quarter and tries fell during the first half of the year continued to underperform the euro-area because prospects for inflation dimin- average, in part owing to a fiscal tightished, growth sputtered, and market par- ening undertaken to bring the budget ticipants began to expect that policy deficit into line with limits set out in the interest rates would remain low for an euro area's Stability and Growth Pact. extended period. Asset prices in emerg- The rise in the exchange value of the ing markets, particularly in Latin euro over the past year has begun to America, picked up during the first half hurt euro-area manufacturers; exports of this year; equity prices rose signifi- have leveled off while imports have concantly, and risk spreads on emerging- tinued to rise. Recent indicators have market bonds narrowed. Bonds issued shown little rebound in the pace of euroby a number of emerging-market econo- area activity following the conclusion of mies included collective action clauses the Iraq war, and business and consumer (CACs) that are designed to facilitate sentiment have remained sour. Core a debt restructuring in the event of inflation has slowed from its 2002 peak, default; this development had little and headline inflation, which was temnoticeable effect on spreads. porarily boosted by oil prices, recently The dollar's foreign exchange value has fallen to the 2 percent upper limit of continued to decrease in the first half of the ECB's definition of price stability. 2003. Since the end of 2002, the dollar Economic growth in the United has depreciated on a trade-weighted Kingdom slowed to a crawl in the first basis nearly 5 percent against the curren- quarter, but recent indicators—such as cies of a broad group of U.S. trading consumer confidence and industrial partners. The dollar has declined 13 per- production—suggest that the pace has cent against the Canadian dollar and been somewhat stronger during the past more than 7 percent on net against the few months. Growth of consumption has euro but has fallen less than 1 percent slowed but continues to be held up by a versus the Japanese yen. During the first strong labor market and by past gains in quarter, the dollar appeared to react to housing prices, although lately these concerns about the war in Iraq, falling prices have decelerated. when news indicated a heightened risk The Japanese economy barely grew of hostilities and strengthening as con- in the first quarter after expanding Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

56 90th Annual Report, 2003 almost 2Vi percent in 2002. Business couple of months. The Hong Kong investment continued to grow in the economy also contracted, following first quarter, and private consumption strong growth in the second half of last increased despite stagnating incomes; year. The SARS outbreak held down however, residential and public invest- both personal consumption and tourism ment both fell sharply, and exports in the first quarter, and even more negadeclined because of the weak global tive effects are likely to be seen in the economy. The severity of consumer second-quarter data. Although the Chiprice deflation lessened somewhat, nese economy has also been adversely partly because of the spike in energy affected by SARS, it has been sustained prices. Japanese banks continued to be by strong export growth and investment. weighed down by bad loans. Chinese inflation has moved back into Canada's economy maintained a positive territory on a twelve-month moderate pace of expansion in the first basis, largely owing to higher prices for quarter, but recent indicators suggest energy and food. that growth of real GDP slowed in the The Mexican economy contracted in second quarter. First-quarter growth was the first quarter, and exports and busisupported by continued strength in ness confidence have declined in recent domestic demand, as Canada's strong months. Consumer price inflation has labor and housing markets kept propel- come down recently, a decline helped in ling the economy. However, exports part by the net appreciation of the Mexideclined in the first quarter, largely can peso since early March. Measures of because of a drop in exports of indus- inflation expectations suggest that martrial supplies and forestry products ket participants expect the central bank to the United States. More recently, to come close to achieving its inflation employment declined slightly in April target this year. and May, and the unemployment rate Brazilian economic growth stagnated moved up. The outbreak of the SARS in the first quarter largely as a result of virus in Toronto hurt Canadian travel the tightening of macroeconomic poliand tourism, and weak U.S. demand cies in response to the financial crisis slowed the Canadian manufacturing sec- that erupted in mid-2002. The growth tor. In June, employment rebounded, but slowdown largely reflected a continued the gain was almost all in part-time weakening in domestic demand, but work, and manufacturing employment exports also deteriorated. Monthly inflacontinued to fall. tion has come down since early this year, and Brazil's central bank recently lowered slightly its benchmark interest Emerging-Market Economies rate. The Lula administration's efforts Economic growth in the Asian develop- to implement social security and tax ing countries slowed in the first quarter, reforms have bolstered investor confibrought down by weakness in business dence. Financial conditions in Brazil investment and consumer spending. In have improved markedly: Equity prices South Korea, growth of real GDP turned have risen more than 20 percent so far negative in the first quarter after a rapid this year, the real has gained more than expansion in 2002. Tensions with North 20 percent against the U.S. dollar, and Korea contributed to a decline in con- credit spreads on Brazilian government sumer and business sentiment, but these debt have narrowed more than 600 basis indicators have stabilized in the past points. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2003 57 The Argentine economy has started to not been addressed. The Argentine peso turn around from the sharp contraction appreciated more than 20 percent that occurred in the wake of the devalu- against the dollar during the first half of ation and default in late 2001, but the the year. In July, Argentina implemented level of economic activity remains far controls on short-term capital inflows in below pre-crisis levels, and many of an effort to stabilize the appreciating Argentina's structural problems have currency. • 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

61 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 • writing and interpreting regulations to implement federal laws that protect • disseminates information on commuand inform consumers nity development techniques to bankers and the public through Community Affairs Offices at the Reserve • supervising banks to ensure their com- Banks pliance with the regulations Examinations for • investigating complaints from the Compliance with the CRA public about bank compliance with regulations The Federal Reserve assesses and rates the CRA performance of state member • promoting community development in banks in the course of examinations carhistorically underserved markets ried out at a frequency set by statute.1 During the 2003 reporting period, the These responsibilities are carried out by Federal Reserve conducted 313 CRA the members of the Board of Governors, examinations. Of the banks examined, the Board's Division of Consumer and 42 were rated "outstanding" in meeting Community Affairs, and the consumer community credit needs, 270 were rated and community affairs staff at the Fed- "satisfactory," none were rated "needs eral Reserve Banks. to improve," and 1 was rated as being in "substantial noncompliance."2 Supervision for Compliance Analysis of Applications for with Consumer Protection and Mergers and Acquisitions in Community Reinvestment Laws Relation to the CRA Activities Related to the Under the Bank Holding Company Act Community Reinvestment Act and the Bank Merger Act, the Board The Community Reinvestment Act 1. By statute, banks with assets of less than (CRA) requires that the Board and other $250 million that were rated "satisfactory" for banking agencies encourage financial CRA performance in their most recent examinainstitutions to help meet the credit needs tion are examined not more than once every fortyeight months, and those that were rated "outstandof the local communities in which they ing" are examined not more than once every sixty do business, consistent with safe and months. Banks with assets of $250 million or sound business practices. To carry out more that were rated "satisfactory" or "outstandthis mandate, the Federal Reserve ing" in their most recent examination are examined not more than once every twenty-four months. • examines state member banks to 2. The 2003 reporting period was July 1, 2002, assess their compliance with the CRA through June 30, 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

62 90th Annual Report, 2003 considers applications for which CRA Corporation (Grand Junction, Coloprotests are raised or significant issues rado) were approved in October. exist regarding CRA or consumer compliance. Other cases are decided Comments from the public were by the Reserve Banks under delegated received on each of these applications. authority. Most of the commenters expressed con- During 2003, the Board of Governors cerns that lending to lower-income comconsidered applications for several sig- munities and populations was insuffinificant banking mergers: cient and that the institutions had failed to address the convenience and needs • An application by Royal Bank of of affected communities. Commenters Canada (Toronto, Canada) and RBC also raised issues relating to potentially Banks, Inc. (Rocky Mount, North abusive lending practices involving Carolina), to acquire Admiralty subprime and payday lenders; the poten- Bancorp, Inc. (Palm Beach Gardens, tially adverse effects of branch closings; Florida), was approved in January. failure of minority-owned and -operated institutions to adequately serve other • An application by M&T Bank Corpo- minority populations; and alleged fraud. ration (Buffalo, New York) to acquire In addition to considering these appli- Allfirst Financial, Inc. (Baltimore, cations for significant banking mergers, Maryland), was approved in March. the Board acted on twelve other bank and bank holding company applications • An application by SouthTrust Cor- that involved protests by members of poration (Birmingham, Alabama) to the public concerning the performance acquire Founders Bancshares, Inc. of insured depository institutions under (Dallas, Texas), was approved in the CRA. The Board also reviewed two March. applications that involved institutions having CRA ratings lower than satis- • Two applications by The Royal Bank factory and another thirty applications of Scotland Group, pic (Edinburgh, involving other issues related to the Scotland), and Citizens Financial CRA, fair lending, or compliance with Group, Inc. (Providence, Rhode consumer credit protection laws.3 Island), to acquire Port Financial Corp. (Brighton, Massachusetts) Other Consumer Compliance and Thistle Group Holdings, Co. Activities (Philadelphia, Pennsylvania), were approved in June and December The Division of Consumer and Commurespectively. nity Affairs supports and oversees the supervisory efforts of the Federal • An application by Cathay Bancorp, Reserve Banks to ensure that consumer Inc., to acquire GBC Bancorp (both protection laws and regulations are fully in Los Angeles, California) was and fairly enforced. Division staff proapproved in September. vide guidance and expertise to the • Applications by Wells Fargo & Com- 3. In addition, two applications involving pany (San Francisco, California) to adverse CRA ratings and three involving other acquire Pacific Northwest Bancorp CRA or compliance issues were withdrawn in (Seattle, Washington) and Two Rivers 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 63 Reserve Banks on consumer protection iner guidance for reviewing mortgageregulations, examination and enforce- servicing disclosures and a checklist to ment techniques, examiner training, and assist examiners in reviewing financial emerging issues. They develop and institutions' web sites for compliance update examination policies, proce- with consumer protection laws. dures, and guidelines and review Reserve Bank supervisory reports and Fair Lending work products. They also participate in interagency activities that promote uni- The Board has a responsibility to ensure formity in examination principles and that the banks under its jurisdiction comstandards. ply with the federal fair lending laws— Examinations are the Federal the Equal Credit Opportunity Act Reserve's primary means of enforc- (ECOA) and the Fair Housing Act. The ing bank compliance with consumer ECOA prohibits creditors from discrimiprotection laws. During the 2003 nating against an applicant, in any reporting period, the Reserve Banks aspect of a credit transaction, on the conducted 402 consumer compliance basis of race, color, religion, national examinations—368 of state member origin, sex, marital status, or age. banks and 34 of foreign banking In addition, creditors may not discrimiorganizations.4 nate against an applicant because the The Board periodically issues guid- applicant receives income from a public ance for Reserve Bank examiners on assistance program or has exercised, consumer protection laws and regula- in good faith, any right under the Contions. In addition to updating examina- sumer Credit Protection Act. Congress tion procedures for a number of regula- assigned responsibility for administrations in concert with the other federal tive enforcement of the ECOA to the financial institution regulatory agencies, Board for banks under its jurisdiction, to the Board in 2003 revised the Federal other regulators for creditors that they Reserve's procedures for reviewing regulate, and to the Federal Trade Comcompliance with the Children's Online mission for all other creditors. Privacy Protection Act. Further, the The Fair Housing Act covers credit Board updated its risk-focused supervi- for the purchase, construction, improvesion program to facilitate the sharing of ment, maintenance, or repair of a dwellinformation about risks in the consumer ing. It makes it unlawful for a creditor to compliance area with examiners in other deny any form of financial assistance, or specialty areas (for example, safety and to discriminate in fixing the amount, soundness, trust, and information tech- interest rate, or any other terms or connology). The Board also issued exam- ditions of any financial assistance, on the basis of race, color, religion, national origin, handicap, familial status, or sex. 4. The foreign banking organizations examined The ECOA also obligates the Board by the Federal Reserve are organizations operating and other agencies with enforcement under section 25 or 25(a) of the Federal Reserve Act (Edge Act and agreement corporations) and responsibilities under the act to refer state-chartered commercial lending companies any pattern or practice of ECOA violaowned or controlled by foreign banks. These insti- tions to the Department of Justice. When tutions are not subject to the Community Reinvesta violation of the ECOA also violates ment Act and typically engage in relatively few the Fair Housing Act, the matter may be activities that are covered by consumer protection laws. referred to the Department of Urban Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

64 90th Annual Report, 2003 Development. To promote consistency ards. Under the Federal Reserve's Reguin the way fair lending issues are ana- lation H, which implements the act, state lyzed throughout the System, Division member banks in general are prohibited of Consumer and Community Affairs from making, extending, increasing, or staff coordinate the investigation of renewing any such loan unless the buildpotential fair lending violations with ing or mobile home and any personal Reserve Bank staff and develop recom- property securing the loan are covmendations for the division director ered by flood insurance for the term of regarding whether referral is necessary the loan. The act requires the Federal or appropriate. Reserve to impose civil money penalties During 2003, division staff received when it finds a pattern or practice of and reviewed seven reports from violations. The money is turned over Reserve Banks regarding possibly refer- to the Federal Emergency Management able violations. Four of the reports Agency for deposit into the National involved possible discrimination in Flood Mitigation Fund. underwriting standards on the basis of During 2003, the Board imposed civil age or gender; the other three involved money penalties on eleven state member apparent discriminatory loan-pricing banks for violations of the flood insurpractices. In three of the underwriting ance rules. The penalties, which were standards cases, the staff concluded that assessed via consent orders, ranged from referral was not warranted; the other $1,750 to $34,100. four cases remained under consideration at year-end. Coordination with Since 1994, the Federal Reserve has Other Federal Banking Agencies used a two-stage statistical regression program to help assess fair lending The member agencies of the Federal compliance by high-volume mortgage Financial Institutions Examination lenders. The program uses reported Council (FFIEC) develop uniform HMDA data for a stage one analysis examination principles, standards, proto identify banks having significant cedures, and report formats.5 In 2003, disparities between minority and non- the FFIEC issued revised examination minority applicants' loan denial rates; it procedures for determining compliance then targets these banks for a stage two with Regulation Z (Truth in Lending); analysis that considers extensive addi- Regulation M (Consumer Leasing); the tional information taken from a sample Real Estate Settlement Procedures Act; of a bank's loan files. The program pro- the homeownership counseling providuces statistically reliable results even sions of the Housing and Urban Develin cases in which the number of denied opment Act; and Regulation C, which applicants in a protected class is rela- implements the Home Mortgage Distively small. closure Act (HMDA). Additionally, the FFIEC issued an updated edition of its Flood Insurance The National Flood Insurance Act 5. The FFIEC member agencies are the Board imposes certain requirements for loans of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office secured by buildings or mobile homes of the Comptroller of the Currency, the Office of located in, or to be located in, areas Thrift Supervision, and the National Credit Union determined to have special flood haz- Administration. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 65 booklet "A Guide to HMD A Reporting: number and complexity of consumer Getting It Right!" which is designed to financial transactions grow, training for assist financial institutions in accurately examiners of the state member banks reporting HMDA data. under the Federal Reserve's supervisory The FFIEC member agencies main- responsibility becomes even more tain a database of local community con- important. The consumer affairs curricutacts that can help the agencies' exam- lum comprises courses on various conination staffs develop community sumer protection laws, regulations, and profiles, identify opportunities for finan- examination concepts. In 2003, these cial institutions to meet local credit courses were offered in ten sessions to needs, and help provide a context more than 200 Federal Reserve confor evaluating institutions' CRA per- sumer compliance examiners. formance. The FFIEC significantly Board and Reserve Bank staff reguupgraded the community contacts data- larly review the core curriculum for base in 2003 to facilitate the sharing of examiner training, updating subject matinformation among the agencies and to ter and adding new elements as approstreamline the process by which the data priate. During 2003, the staff revised are accessed and maintained. two core courses to incorporate changes Ten federal agencies—the FFIEC in policy and laws. The courses member agencies, the Federal Trade reviewed were Commission, the Department of Housing and Urban Development, the • Introduction to Consumer Compliance Department of Justice, the Federal Examinations. Emphasizes examina- Housing Finance Board, and the tion procedures and the practical Office of Federal Housing Enterprise application of banking regulations, Oversight—collaborated in 2003 to and focuses on the consumer laws that develop a consumer education brochure govern financial institutions' non-realtitled "Putting Your Home on the Loan estate lending and operational proce- Line Is Risky Business." The brochure dures. Geared toward assistant examcautions consumers to carefully con- iners with three to six months of sider the terms of equity-based loans examination experience. before using their home equity to address financial problems. • Consumer Compliance Examinations During the year the Board, the OCC, II. Equips assistant examiners with the and the FDIC also updated the host-state skills needed to determine compliance loan-to-deposit ratios used to determine with the basic elements of consumer compliance with section 109 of the laws governing real estate transac- Riegle-Neal Interstate Banking and tions; also covers System policies Branching Efficiency Act of 1994. on all major aspects of the consumer compliance risk-focused examination process. For assistant examiners with Training for Bank Examiners six to twelve months of examination experience. Ensuring that financial institutions comply with laws that protect consumers Also in 2003, a new course that will and encourage community reinvestment be added to the core curriculum, CA is an important part of the bank exami- Risk-Focused Examination Techniques, nation and supervisory process. As the was pilot-tested. The course is designed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

66 90th Annual Report, 2003 to enhance examiners' analytical, deci- (when combined with the assets of any sionmaking, and leadership skills. parent company) at the end of the pre- In addition to providing core training, ceding calendar year or it originated 100 the examiner curriculum emphasizes the or more home purchase loans or refiimportance of continuing professional nancings in the preceding calendar year, development. Opportunities for continu- and (3) its home purchase loan originaing development include special projects tions and refinancings accounted for and assignments, self-study programs, 10 percent or more of its total loans by rotational assignments, instructing at dollar volume in the preceding calendar System schools, and mentoring. year. The training staff also look for oppor- In 2003, a total of 6,767 depository tunities to deliver courses via alterna- institutions and affiliated mortgage comtive channels such as the Internet or panies and 1,004 independent mortgage other distance-learning technologies. companies reported HMDA data for For example, a live videoconference calendar year 2002. Lenders submitted curriculum, which included a session information about the disposition of loan discussing recent revisions to the applications, the geographic location of HMD A data reporting requirements, the properties related to loans and loan was implemented during the year. In applications, and, in most cases, the race addition, the staff assisted in developing or national origin, income, and sex of online materials for the consumer affairs applicants and borrowers. The FFIEC portion of the Banking and Supervision processed the data and produced disclo- Elements course, a foundation course sure statements on behalf of the FFIEC for assistant examiners from all exami- member agencies and the Department nation specialty areas. of Housing and Urban Development (HUD). The FFIEC prepared individual dis- Reporting on Home Mortgage closure statements for each lender that Disclosure Act Data reported data—one statement for each metropolitan area in which the lender The Home Mortgage Disclosure Act had offices and reported loan activity for (HMDA) requires that mortgage lenders 2002. In 2003, the FFIEC prepared more collect and make public certain data than 57,000 disclosure statements.6 In about their home purchase, home July, each institution made its disclosure improvement, and refinancing loan statement public, and reports containing transactions. A depository institution aggregate data for all mortgage and generally is covered by the act if (1) it home improvement loans in each of the is located in a metropolitan area, (2) it 337 metropolitan areas in the United met the asset threshold at the end of States were made available at central the preceding calendar year (for 2001, depositories.7 These data are used by assets of more than $31 million; for 2002 and 2003, more than $32 million), 6. The FFIEC also compiles information on and (3) it originated at least one home applications for private mortgage insurance (PMI) purchase loan (or refinancing) in the similar to the information on home mortgage lendpreceding calendar year. A for-profit ing collected under HMDA. Lenders typically mortgage company is covered if (1) it require PMI for conventional mortgages that involve small down payments. has offices in a metropolitan area, (2) it 7. Central depository sites include libraries, had assets of more than $10 million universities, and city planning offices. A list of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 67 FFIEC agencies, the reporting institu- cants. Twenty-five percent of lowertions, HUD, the Department of Justice income applicants for home purchase (DOJ), and members of the public. They loans, compared with 7 percent of also assist HUD, the DOJ, and state and upper-income applicants, applied for local agencies in responding to allega- government-backed mortgages. tions of lending discrimination and in Overall, the denial rate for conventargeting lenders for further inquiry. tional home purchase loans (that is, The HMDA data reported for 2002 loans that are not government-backed) covered 31 million loans and loan appli- was 14 percent in 2002. The rate rose cations, about 13 percent more than in steadily from 1993 through 1998 but has 2001. The greater volume was due pri- fallen since then. In 2002, denial rates marily to an increase of about 22 per- for conventional home purchase loans cent in refinancing activity. The num- reported under HMDA were 26 percent ber of covered home purchase loans for black applicants, 23 percent for extended in 2002, compared with 2001, Native American applicants, 18 percent increased 11 percent for Hispanics, for Hispanic applicants, 12 percent for 18 percent for Asians, 2 percent for white applicants, and 10 percent for blacks, 23 percent for Native Ameri- Asian applicants. Each of these rates cans, and 3 percent for whites. Over the was lower than the comparable rate for period 1993 through 2002, the number 2001. of loans extended for home purchase increased 186 percent for Hispanics, Agency Reports on Compliance 126 percent for Asians, 80 percent for with Consumer Protection Laws blacks, 57 percent for Native Americans, and 30 percent for whites. The Board reports annually on compli- For each income category, the num- ance with consumer protection laws by ber of home purchase loans reported entities supervised by federal agencies. was higher in 2002 than in 2001; the This section summarizes data collected increase was 4.5 percent for lower- from the twelve Federal Reserve Banks, income applicants, 3.2 percent for the FFIEC member agencies, and other middle-income applicants, and 4.1 per- federal enforcement agencies.8 cent for upper-income applicants. From 1993 through 2002, the number of home Regulation B purchase loans to lower-, middle-, and (Equal Credit Opportunity) upper-income applicants increased The FFIEC agencies reported that 91 percent, 54 percent, and 66 percent 84 percent of the institutions examined respectively. during the 2003 reporting period were In 2002, 27 percent of Hispanic appliin compliance with Regulation B, comcants and 28 percent of black applicants pared with 83 percent for the 2002 for home purchase loans reported under reporting period. The most frequent vio- HMDA sought government-backed lations involved failure to take one or mortgages; the comparable figures more of the following actions: were 14 percent for white applicants, 19 percent for Native American applicants, and 6 percent for Asian appli- 8. Because the agencies use different methods to compile the data, the information presented here supports only general conclusions. The 2003 sites can be found at www.ffiec.gov/hmdacf/ reporting period was July 1, 2002, through centdep/default2.cfm. June 30, 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

68 90th Annual Report, 2003 • collect information for monitoring The FCA's examination and enforcepurposes about the race or national ment activities revealed that most Reguorigin and sex of applicants seeking lation B violations involved creditors' credit primarily for the purchase or failure to provide timely or complete refinancing of a principal residence notifications of denial or failure to identify the FCA as the federal agency that • note on the application form when administers compliance. These agencies an applicant chooses not to provide did not initiate any formal enforcement monitoring information regarding race actions relating to Regulation B during or national origin and sex 2003, although the FCA indicated that its supervisory process requires correc- • provide a written notice of credit tive actions for violations noted. denial or other adverse action containing a statement of the action taken, the name and address of the creditor, Regulation E a notice of rights, and the name and (Electronic Fund Transfers) address of the federal agency that enforces compliance The FFIEC agencies reported that approximately 94 percent of the institu- • notify the credit applicant of the tions examined during the 2003 reportaction taken within the time frames ing period were in compliance with specified in the regulation Regulation E, compared with 92 percent for the 2002 reporting period. The most • provide a statement of reasons for frequent violations involved failure to credit denial or other adverse action comply with one or more of the followthat is specific and indicates the prin- ing requirements: cipal reasons for the adverse action • determine whether an error occurred, Three formal enforcement actions and transmit the results of the invescontaining provisions relating to Regu- tigation to the consumer within ten lation B were issued during the 2003 business days reporting period—two by the OCC and one by the OTS. During 2003, the Fed- • provide initial disclosures at the time eral Trade Commission continued liti- a consumer contracts for an electronic gation against a mortgage lender for fund transfer service that contain alleged violations of the ECOA and required information, including limi- Regulation B as well as enforcement tations on the types of transfers perefforts against other organizations. mitted and error resolution procedures The other agencies that enforce the ECOA—the Farm Credit Administra- • credit the customer's account in the tion (FCA), the Department of Trans- amount of the alleged error within ten portation, the Securities and Exchange business days of receiving the error Commission, the Small Business notice, if more time is needed to con- Administration, and the Grain Inspec- duct the investigation tion, Packers and Stockyards Administration of the Department of Agri- • when a determination is made that no culture—reported substantial compli- error has occurred, provide a written ance among the entities they supervise. explanation and note the consumer's Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 69 right to request documentation sup- • provide a clear and conspicuous initial porting the institution's findings privacy notice to customers that accurately reflects the institution's privacy In 2003, the Federal Trade Commis- policies and practices, not later than sion filed and settled one case in federal when the customer relationship is district court involving violations of the established Electronic Fund Transfer Act (EFTA). The defendants had conditioned the • disclose the institution's informationextension of credit to consumers on sharing practices in initial, annual, and agreement to compulsory electronic revised privacy notices funds transfers from consumer accounts, in violation of the EFTA. The settlement • provide a clear and conspicuous requires the defendant to cancel and annual privacy notice to customers cease collections on approximately $24 million in final court judgments The OCC issued one formal enforceagainst consumers, bars misrepresenta- ment action containing provisions relattions about the terms of any contract, ing to the privacy regulations during the and requires the defendants to give con- 2003 reporting period. sumers the option to switch their method of payment. Regulation Z (Truth in Lending) Regulation M The FFIEC agencies reported that (Consumer Leasing) 78 percent of the institutions examined during the 2003 reporting period were The FFIEC agencies reported that more in compliance with Regulation Z, comthan 99 percent of the institutions exampared with 77 percent for the 2002 ined during the 2003 reporting period reporting period. The most frequent viowere in compliance with Regulation M, lations involved failure to take one or which is comparable to the level of commore of the following actions: pliance for the 2002 reporting period. The few violations noted involved • accurately disclose the finance charge, failure to adhere to specific disclousing that term, and provide a brief sure requirements. The agencies did not definition of "finance charge" issue any formal enforcement actions relating to Regulation M during the • accurately disclose the amount period. financed, appropriately subtracting any prepaid finance charges Regulation P • ensure that disclosures reflect that the (Privacy of Consumer creditor has or will acquire a security Financial Information) interest in the property identified The FFIEC agencies reported that 97 percent of the institutions examined • on certain residential mortgage transduring the 2003 reporting period were in actions, provide a good faith estimate compliance with Regulation P. The most of the required disclosures before frequent violations involved failure to consummation, or not later than three comply with one or more of the follow- business days after receipt of the loan ing requirements: application Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

70 90th Annual Report, 2003 Four formal enforcement actions Regulation CC containing provisions relating to Regu- (Availability of Funds and lation Z were issued during the 2003 Collection of Checks) reporting period—three by the OCC and The FFIEC agencies reported that one by the OTS. In addition, 147 institu- 90 percent of institutions examined durtions supervised by the Federal Reserve, ing the 2003 reporting period were in the FDIC, or the OTS were required, compliance with Regulation CC, the under the Interagency Enforcement Polsame proportion as for the 2002 reporticy on Regulation Z, to refund a total of ing period. Among the institutions not approximately $1.3 million to consumin full compliance, the most frequently ers. The FTC continued its enforcement cited violations involved the failure activities to halt certain illegal practices to take one or more of the following of subprime lenders. The agency entered actions: into two settlements, issued one new complaint (currently in litigation), and • make available on the next business pursued two ongoing lawsuits for day the lesser of $100 or the aggregate alleged violations of the Truth in Lendamount of checks deposited that are ing Act and the Federal Trade Commisnot subject to next-day availability sion Act. • follow special procedures when invoking the exception for large-dollar Regulation AA deposits (Unfair or Deceptive Acts or Practices) • make funds from certain checks, both The three banking regulators with local and nonlocal, available for withresponsibility for enforcing Regula- drawal within the times prescribed by tion AA's Credit Practices Rule—the the regulation Federal Reserve, the OCC, and the FDIC—along with the NCUA reported • when placing an exception hold on an that 99 percent of institutions examined account other than a new account, produring the 2003 reporting period were in vide the customer with a notice concompliance, the same proportion as for taining certain information within prethe 2002 reporting period. The few vio- scribed time periods lations involved one or both of the following actions: The OTS issued one formal enforcement action containing provisions relating to Regulation CC during the 2003 • failing to provide a clear and conreporting period. spicuous disclosure regarding a cosigner's liability for a debt Regulation DD • entering into a consumer credit con- (Truth in Savings) tract containing a nonpossessory security interest in household goods The FFIEC agencies reported that 89 percent of institutions examined dur- No formal enforcement actions relat- ing the 2003 reporting period were in ing to Regulation AA were issued dur- compliance with Regulation DD, coming the reporting period. pared with 87 percent for the 2002 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 71 reporting period. Among the institutions or noting, an applicant's sex, race, color, not in full compliance, the most fre- religion, and national origin. The quently cited violations involved premise for this prohibition is that if creditors are not allowed to inquire • failing to provide account disclo- about or note applicants' personal charsures containing certain required acteristics, they are less likely to coninformation sider that information unlawfully in credit transactions. • using the phrase "annual percentage The Board's proposal to remove this yield" in an advertisement without prohibition in connection with nondisclosing additional terms and condi- mortgage credit elicited strong comtions of customer accounts ments from those favoring removal and those opposed. In the final rule, the • providing advertisements that were Board generally retained the prohibition inaccurate or misleading (or both). restricting creditor access to information about applicants' personal characteris- No formal enforcement actions relat- tics. It did, however, create an exception ing to Regulation DD were issued dur- that allows a creditor to collect informaing the reporting period. tion on applicant characteristics for the limited purpose of conducting a selftest. Implementation of A self-test is a program, practice, or Statutes Designed to study designed and used by a creditor Inform and Protect Consumers specifically to determine its compliance with the ECOA. Under the ECOA, Changes to Regulation B because the results of the self-test are privileged, they may not be obtained In February 2003, following a comprein an examination or investigation of hensive review of the regulation and the creditor, or in any proceeding staff commentary, the Board published a or lawsuit alleging a violation of the final rule amending Regulation B, which ECOA or Regulation B. Certain other implements the Equal Credit Opportuinformation—such as whether a creditor nity Act (ECOA). Two significant reviconducted a self-test and the methodolsions were made, one relating to the ogy or the scope of the test—is not general prohibition against a creditor's privileged. The purpose of the self-test noting an applicant's personal characterprivilege, which was added to the ECOA istics and the other to prescreened credit by Congress in 1996, was to encourage solicitations. The final rule took effect institutions to undertake candid and in April 2003, and compliance becomes complete self-tests for possible fair lendmandatory on April 15, 2004. ing violations and to act decisively to correct any discovered problems. The Data Collection in Connection with privilege applies only if the creditor Nonmortgage Credit takes appropriate corrective action when Because the ECOA makes it unlawful the creditor determines that it is more for creditors to consider any prohibited likely than not that a violation occurred. basis of discrimination in extending Under the exception adopted by the credit, Regulation B has generally pro- Board, creditors will be able to develop hibited creditors from inquiring about, compliance programs that use appli- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

72 90th Annual Report, 2003 cant data in a controlled and targeted practices systematically on the basis manner. The constraints imposed by of information that creditors currently the self-test provision help ensure that maintain. For example, under the Fair personal information such as race and Credit Reporting Act, creditors that ethnicity is not used to discriminate use information in consumer reports to on a prohibited basis, but that it select recipients for offers of credit are is collected and used to monitor com- required to retain records pertaining pliance with the ECOA and to serve to the selection criteria for three years as a basis for appropriate corrective after the date the offer is made to the action. consumer. Prescreened Credit Solicitations Other Regulatory Actions There has long been a concern that prescreened solicitations could provide the The Board also took the following regumeans for creditors to circumvent or latory actions during 2003: evade the ECOA and defeat its purposes by excluding prospective applicants on • In March the Board revised the offia prohibited basis. The issue arises in cial staff commentary to Regulation Z part because the ECOA generally pro- (Truth in Lending) to give guidance tects credit applicants—persons who on certain fees associated with credit have, at a minimum, requested credit— cards; the replacement of an existing from discrimination. In the case of pre- credit card with one or more cards; screened solicitations, the creditor iden- the disclosure of private mortgage tifies prospective customers and solicits insurance premiums; and the selecan application from those who meet its tion of the appropriate Treasury yield criteria. for determining whether a mortgage With advances in technology that loan is covered by the Home Ownerfacilitate the building of databases, the ship and Equity Protection Act of use of prescreened solicitations has 1994. become more common and more sophisticated. Prescreened solicitations can be • In August the Board raised from $488 used to target those consumers who are to $499 the total dollar amount of most likely to use a particular credit points and fees that triggers additional product or those segments of the popula- requirements for certain mortgage tion most likely to respond to the offer loans under the Home Ownership and of credit. Conversely, prescreened Equity Protection Act, effective in solicitations can be used to exclude January 2004, to reflect changes in the some consumers from receiving offers consumer price index, as prescribed of credit. by the statute. Under the final rule, creditors are required to retain information about the • In December the Board raised to criteria used to select potential custom- $33 million the threshold for deposiers, the text of any solicitation mailing, tory institutions required to collect and any complaints received about the data in 2004 under the Home solicitation. This requirement will allow Mortgage Disclosure Act, to reflect the Board and other enforcement agen- changes in the consumer price index, cies to monitor creditors' solicitation as prescribed by the statute. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 73 Economic Effects of the The incremental costs associated Electronic Fund Transfer Act with the EFTA are difficult to quantify because no one knows how industry As required by the Electronic Fund practices would have evolved in the Transfer Act (EFTA), the Board moni- absence of statutory requirements. The tors the effects of the act on the costs of benefits of the EFTA are also difficult to compliance to financial institutions and measure, as they cannot be isolated from the benefits of the act to consumers. consumer protections that would have According to data from the most been provided in the absence of regurecent Survey of Consumer Finances lation. The available evidence suggests (conducted in 2001), approximately no serious consumer problems with the 88 percent of U.S. families in that year EFTA (see 'Agency Reports on Complihad or used one or more EFT services— ance with Consumer Protection Laws" for example, an ATM card, a debit card, earlier in this chapter). direct deposit, or direct payment—up from approximately 85 percent in 1998. Consumer Complaints Automated teller machines (ATMs) remained the most widely used EFT ser- The Federal Reserve investigates comvice; approximately 70 percent of U.S. plaints against state member banks and families had an ATM card. In 2003, the forwards to the appropriate enforcement number of ATM transactions per month agency complaints that involve other averaged approximately 902 million, creditors and businesses. Each Reserve and the number of installed ATMs Bank investigates complaints against rose nearly 5.4 percent from 2002, to state member banks in its District. 371,000. The Board provides guidance to the Direct deposit is also widely used. Reserve Banks on complaint program About 67 percent of U.S. families have policies and procedures through advifunds deposited directly into their sory letters and periodic updates to the checking or savings account. Use of the Consumer Complaint Manual. In 2003, service is particularly common in the the Board issued guidance on releaspublic sector; during fiscal year 2003, ing information in response to Privacy approximately 74 percent of all govern- Act and Freedom of Information Act ment payments were made using EFT, requests. The Board also revised its polincluding 80 percent of social security icy and special procedures for Reserve payments, 98 percent of federal salary Bank investigations of complaints allegand retirement payments, and 41 percent ing credit discrimination and streamof federal income tax refunds. lined the review process. About 47 percent of U.S. families use Complaints and inquiries received by debit cards, which consumers can use at the Federal Reserve System are entered merchant terminals to pay for purchases. into its online database, Complaint Approximately 15.6 billion debit card Analysis Evaluation System and Reports transactions took place in 2002, an (CAESAR). The CAESAR Users Adviincrease of approximately 25 percent sory Group released a new version of from the previous year's volume. Direct the CAESAR data entry system in payment is a less widely used EFT pay- 2003. Enhancements included features ment mechanism; about 40 percent of that allow Board and Reserve Bank U.S. families have payments automati- staff to identify emerging consumer cally deducted from their accounts. concerns; to document dollar amounts Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

74 90th Annual Report, 2003 Consumer Complaints against State Member Banks, by Subject of Complaint, 2003 Total Not investigated Unable Subject of complaint to obtain Explanation sufficient of law Number Percent information provided from to consumer consumer Loans Discrimination alleged Real estate loans 16 1 0 0 Credit cards 11 1 0 1 Other loans 11 1 1 1 Other type of complaint Real estate loans 521 19 9 44 Credit cards 971 36 1 66 Other loans 207 8 3 19 Deposits 637 24 14 102 Electronic fund transfers . 38 1 1 1 Trust services 24 1 0 5 Other 208 8 7 35 Total 2,644 100 36 274 returned to consumers as a result of improvements that will help consumer complaint investigations; and to more complaints and consumer compliance quickly update and retrieve data in the staff carry out their supervisory and risk- CAESAR database. The advisory group management responsibilities. also completed an analysis of the Fed- In September the Board held a confereral Reserve System's code structure ence for Reserve Bank officers and manand its statistical reports for consumer agers in charge of the complaint procomplaints. As a result of that analysis, gram. The conference covered policy new codes and enhanced reports were and program changes recently impleimplemented. mented by the Board; issues related The advisory group is currently devel- to investigation of complaints alleging oping requirements for a web-based credit discrimination; Reserve Bank CAESAR database application that complaint programs in general; and the will streamline the complaint process Board's proposal to create a national to better serve the System's business complaint web site. It also included preneeds and to facilitate the sharing of sentations on complaint trends and demcomplaint information with consumer onstrations by Board and Reserve Bank compliance supervisory staff. The staff of automation tools currently used web-based system will enable the in an integrated compliance risk envi- Federal Reserve to eliminate duplica- ronment as well as a demonstration by tive automation tools at the Reserve the Office of the Comptroller of the Banks and disseminate information to Currency of its automated complaints and from other System applications— and inquiry database. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 75 Consumer Complaints—Continued Investigated Bank legally correct Factual or Possible Pending, Goodwill contractual bank December 31 No reim- Customer Bank dispute— violation— Matter in reimbursebursement error error resolvable bank took litigation ment or or other only by corrective other accommo- the courts action accommodation dation 6 0 3 0 1 6 2 2 1 0 0 5 2 2 0 0 0 5 213 107 87 14 11 29 275 431 90 7 2 89 75 46 29 7 4 15 241 131 70 25 4 9 41 11 9 6 1 7 0 2 12 0 1 0 0 3 3 51 19 16 8 2 4 65 888 747 303 62 31 36 260 Complaints against or credit denial on a basis not prohibited State Member Banks by law (for example, credit history or length of residence). Twenty-four per- In 2003 the Federal Reserve received cent of the complaints involved disputes almost 5,500 complaints from consum- about interest on deposits and general ers by mail, by telephone, and electroni- deposit account practices, and the cally via the Internet. About 48 percent remaining 10 percent concerned disof the complaints (2,644) were against putes about electronic fund transfers, state member banks (see tables); the trust services, or other practices. Inforremainder were referred to other agen- mation on the outcome of investigations cies. Of the complaints against state of these complaints is provided in the member banks, 66 percent involved loan table. functions: 3 percent alleged discrimina- During 2003, the Federal Reserve tion on a basis prohibited by law (race, System completed investigations of 286 color, religion, national origin, sex, complaints against state member banks marital status, age, the fact that the that were pending at year-end 2002, applicant's income comes from a public finding ten violations. In most cases, assistance program, or the fact that the the bank had handled the customer's applicant has exercised a right under the account correctly but nevertheless chose Consumer Credit Protection Act), and to reimburse or otherwise accommodate 63 percent concerned other credit- the customer. related practices, such as the interest The Federal Reserve also handled rate charged on credit card accounts almost 1,700 inquiries about consumer Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

76 90th Annual Report, 2003 Consumer Complaints against State disputed amounts withdrawn (115); they Member Banks, by Classification, 2003 complained about fees associated with credit card accounts (114), interest rates Classification Number and terms (109), and escrow account problems (96). The remainder of the Regulation B (Equal Credit Opportunity) ... 38 complaints concerned a wide range of Regulation C (Home Mortgage Disclosure Act) 0 unregulated practices in other areas, Regulation E (Electronic Fund Transfers) ... 38 including credit card fraud, the amount Regulation H (Bank Sales of Insurance) 0 Regulation M (Consumer Leasing) 0 charged for late payments, and credit Regulation P (Privacy of Consumer denials attributed to credit history. Financial Information) 13 Regulation Q (Payment of Interest) 0 Regulation Z (Truth in Lending) 318 Complaint Referrals to HUD Regulation BB (Community Reinvestment) 1 Regulation CC (Expedited Funds Availability) 19 In accordance with a memorandum Regulation DD (Truth in Savings) 35 of understanding between HUD and Fair Credit Reporting Act 150 the federal bank regulatory agencies, Fair Debt Collection Practices Act 9 in 2003 the Federal Reserve referred Fair Housing Act 1 Flood insurance rules 27 eleven complaints to HUD that alleged Regulations T, U, and X 0 state member bank violations of the Fair Real Estate Settlement Procedures Act 19 Unregulated practices 1,976 Housing Act. In six of the eleven cases the Federal Reserve's investigations Total 2,644 revealed no evidence of illegal discrimination. In one case, the bank had made credit and banking policies and prac- an error in handling the customer's tices during 2003. In responding to these construction-permanent loan payments, inquiries, the Board and Reserve Banks which it had subsequently corrected. gave specific explanations of laws, regu- The remaining four cases were pending lations, and banking practices and pro- at year-end. vided relevant print materials on consumer issues. Advice from the Consumer Advisory Council Unregulated Practices The Board's Consumer Advisory As required by section 18(f) of the Fed- Council—whose members represent eral Trade Commission Act, the Board consumer and community organizations, monitors complaints about banking the financial services industry, academic practices that are not subject to existing institutions, and state agencies—advises regulations, focusing on those that con- the Board of Governors on matters concern practices that are possibly unfair or cerning laws and regulations that the deceptive. In 2003 the Board received Board administers and on other issues almost 2,000 complaints against state related to consumer financial services. member banks that involved unreg- Council meetings are open to the public. ulated practices. The categories that (For a list of members of the Council, received the most complaints involved see the section "Federal Reserve Syschecking accounts, credit card accounts, tem Organization.") and real estate loans. Consumers com- In 2003, the Council met in March, plained about insufficient-funds charges June, and October. In March, Council and procedures (136 complaints) and members discussed bounced-check pro- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 11 tection services and how those services members emphasized the significant should be treated under Regulation Z role the Federal Reserve and other fed- (Truth in Lending). The discussion eral agencies can play in preventing focused on whether the fees that banks predatory practices. charge to cover overdrafts on custom- In June, Council members also disers' accounts are finance charges. Coun- cussed the 1996 amendments to the Fair cil members who believed that the fees Credit Reporting Act, which preempted are finance charges argued that Regula- the states from enacting laws or regution Z applies to bounced-check protec- lations pertaining to the availability of tion and that, consequently, fee disclo- information for underwriting purposes, sures are required. The disclosures, they procedures for dispute resolution, and said, would make consumers aware of the marketing of credit information. the high cost of these services. Other Some members asserted that because the members asserted that because financial credit reporting system is a national sysinstitutions make no promise to pay tem, uniform national standards are necoverdrafts and have no written agree- essary to maintain its viability. Other ment with the customer to pay over- members believed that states have an drafts, overdraft fees are not finance important role in protecting the public charges and hence are not covered by and are in the best position to respond Regulation Z. to local concerns about credit informa- Other discussion of Regulation Z in tion. Despite differing views, members March focused on credit card disclo- agreed on the critical importance of sures and on the type of cost informa- accurate reporting, given the devastating tion that is most useful to consumers. effect that errors in credit information Members discussed, but did not reach can have, particularly on the lives of consensus on, whether disclosing the low-income individuals. dollar amount of fees on periodic state- Also in June, Council members disments or disclosing the annual percent- cussed the lengthy and complex privacy age rate, which reflects both the interest notices that financial institutions use and other fees charged, is the better way to comply with the privacy portions to inform consumers about the cost of of the Gramm-Leach-Bliley Act. After credit. reviewing a proposed "short-form" Predatory lending was a topic at the notice, members strongly supported the March and June meetings. The March concept of short-form privacy notices discussion focused on the effectiveness but urged the federal financial instiof state and local laws in reducing tution regulators to obtain customer predatory lending practices. While many comment on the notices before moving Council members favored reliance on forward. state and local laws, others noted those At the October meeting, members dislaws' lack of uniformity and believed cussed the effect on nonprofit organizathat federal regulators are in the best tions of a decline in operating income position to establish and enforce effec- and funding sources. Council members tive laws to combat abusive practices. cited possible reasons for the dimin- In June, Council members discussed ished capacity of nonprofit organizaefforts to counter the tactics of abusive tions to serve the needs of their commulenders and to provide assistance to nities and suggested ways in which consumers who experience the conse- nonprofits could mitigate the effects of quences of predatory lending. Several cutbacks by major funding sources. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

78 90th Annual Report, 2003 The Council also discussed payroll cific topics addressed by the System's cards and convenience checks issued in community affairs programs in 2003 connection with credit card accounts. included personal financial education, Members considered whether the Truth evaluating the effectiveness of various in Lending Act's consumer protections community economic development for credit cards should extend to conve- strategies, identifying sources of fundnience checks and whether Regulation Z ing and investment for community disclosures are adequate. With respect development, the challenges to creating to payroll cards, which employers use sustainable community economic develto make salary and other compensation opment organizations, and creating polipayments to employees, the discussion cies that support the development of focused on whether requirements of the minority-owned small businesses. Electronic Fund Transfer Act and Regu- While the Federal Reserve has sponlation E should or should not apply. sored activities related to financial literacy for many years, the System increased its visibility in this area in 2003 by sponsoring a national aware- Promotion of Community ness campaign on personal financial Economic Development in education. Various programs were Historically Underserved undertaken by the Board and the Markets Reserve Banks to support national, During 2003, the community affairs regional, and local financial education function within the Federal Reserve Sys- efforts. (See related box "Spotlight on tem engaged in a variety of initiatives Financial Education.") to promote community economic devel- To promote effective community ecoopment that benefit low- and moderate- nomic development strategies, the comincome communities and populations. munity affairs function undertook sev- Activities included conducting research, eral significant initiatives. The System's preparing publications, sponsoring con- third biennial community affairs ferences and seminars, and providing research conference in April focused on advisory services, all of which facilitate evaluating the efficacy of various comthe delivery of pertinent information to munity development efforts. Titled both general and targeted audiences. Seeds of Growth—Sustainable Commu- As a decentralized function, the com- nity Development: What Works, What munity affairs programs at the Board Doesn't, and Why, the conference and each of the twelve Reserve Banks attracted nearly 350 attendees and prodesign activities that are responsive to vided a forum for discussion of the the communities in the regions they strengths and weaknesses of programs, serve. Reserve Bank Community Affairs projects, partnerships, and policies Offices focus on providing information related to development in lower-income and promoting awareness of investment neighborhoods. The conference papers opportunities to financial institutions, and other community development government agencies, and organizations research studies are posted on the Systhat serve low- and moderate-income tem's research repository web site, the communities and populations, while Community and Economic Developthe Board's Community Affairs Office ment Research Information Center engages in activities that have national (CEDRIC) (www.chicagofed.org/cedric/ implications for public policy. Spe- cedric_index.cfm). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 79 The Board's Community Affairs ing to community development invest- Office, in partnership with the Chicago, ments. San Francisco's Center for Kansas City, Philadelphia, and St. Louis Community Development Investments, Reserve Banks, undertook an initia- drawing on the expertise of an advisory tive designed to foster learning and board of community economic develophighlight models of community eco- ment professionals, offers an in-depth nomic development. The web-based discussion of various investment vehidatabase Lessons Learned: Community cles used to finance community develand Economic Development Case opment. As a centralized resource for Studies (www.chicagofed.org/cedric/ information, contacts, and training lesle_index.cfm) provides detailed case opportunities, the center seeks to expand studies that identify a community devel- access to information on the funding opment issue, present one community's tools that can support economic growth solution, describe the results, and offer in low- and moderate-income commu- "lessons learned" to community devel- nities (www.sf.frb.org/cdinvestments/ opers addressing similar concerns in index.html). their communities. Residing on the Similarly, the Board's community CEDRIC web site, the database is an affairs program developed a web site efficient means for exchanging informa- that gives guidance on the types of tion among community development investments certain banking institutions professionals, giving them the benefit of may engage in to support community the experiences of their counterparts economic development and public welthroughout the country. fare benefits (www.federalreserve.gov/ Another web-based resource, the Fis- communityaffairs/cdi/default.htm). In cal Impact Tool, was launched in 2003 addition, several Reserve Banks partto support community and economic nered with a nonprofit organization, development activity in mid-size com- Wall Street Without Walls, to help munities. This analytic tool enables increase awareness of the capital marcommunity economic developers to kets' role in funding community ecoconduct a cost-benefit analysis of a nomic development. In 2003, the Bosproposed development project by esti- ton, Richmond, and Atlanta Reserve mating its effect on local sales and Banks cosponsored seminars that gave property tax revenues and on costs an overview of the benefits of and chalto local government. The tool, which lenges associated with accessing the is available through the Board's web capital markets to fund development site (www.federalreserve.gov/forms/ in lower-income neighborhoods and fiscalimpactrequest.cfm), can aid deci- populations. sionmakers in determining the economic Given the important role of public value of a proposed activity for their policy in effecting change in undercommunity. served communities, the community The community affairs area has been affairs function engaged in activities a source of information on creative to examine challenges relating to the financing of community economic community development field. The development for many years, and in Board's Community Affairs Office 2003, efforts in this area expanded. The addressed the sustainability of commu- Community Affairs Offices at both the nity economic development organiza- San Francisco Reserve Bank and the tions in a policy forum cohosted with Board developed new resources relat- the Aspen Institute, a national research Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

80 90th Annual Report, 2003 Spotlight on Financial Education No. matter who you are, making informed decisions about what to do with your money will help build a more stable financial future for you and your family. Alan Greenspan, Chairman, Board of Governors May 2003 The growing complexity of the financial video were used to broaden consumers' services marketplace—in terms of both the access to information on personal financial products offered and the number and education and to help establish the Fedvariety of providers—has in recent years eral Reserve System as a central source of focused the attention of government agen- information. A toll-free number was estabcies and consumer and community groups lished to respond to inquiries generated on the importance of financial education. by the announcement, and a brochure In addition, ongoing interest in protect- describing strategies for taking charge of ing consumers from abusive and deceptive one"s finances was sent to interested calllending practices has underscored the ers. For consumers who like to obtain their role of education as a line of defense information electronically, a robust central against entanglement in unsuitable finan- Federal Reserve web site was launched, cial arrangements that can have detrimen- linking to specially prepared educational tal, even devastating, effects. tools and resource information on the Consistent with its interest in economic web sites of the twelve Reserve Banks growth, consumer protection, and commu- (www.federalreserveeducation.org/fined/ nity development, the Federal Reserve Sys- index, cfm). tem has long been an active supporter of The campaign attracted the attention of educational programs that provide practical other central banks that are also seeking information on how the economy and the ways to help consumers better manage banking industry function. More recently, their finances. During the year. Board this interest has extended to personal finan- staff met with officials of the central banks cial education as a way of helping con- of Canada, England, Finland, and Malaysia sumers develop the skills that can lead to to discuss the Federal Reserve's various financial success for themselves and their roles in supporting personal financial families. To underscore this message, the education. Community Affairs and Public Information The System undertook numerous Offices of the Federal Reserve System in projects during the year to reinforce the 2003 collaborated to raise awareness oi' the campaign's objectives. For example, the importance of personal financial manage- Board and several Reserve Banks partment and to highlight some of the resources nered with a national nonprofit financial available to consumers. education organization, Operation HOPE, The collaboration resulted in the nation- to emphasize the importance of underwide campaign 'There's a Lot to Learn standing and managing finances to students about Money." This multifaceted cam- in inner-city public schools. In one partnerpaign was launched in May 2003 with a ship activity, Chairman Greenspan and the public service announcement featuring president of the Richmond Reserve Bank Chairman Greenspan, who has spoken recounted for middle school students in often of the importance of education in Washington, D.C., the ways in which developing sound financial decisionmak- financial education, as well as their interest ing skills. Electronic and print media and in finances, has affected their lives. Simi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 81 larily, the presidents of the Boston, Cleve- In addition to providing practical inforland, Chicago, St. Louis, Kansas City, and mation, the Federal Reserve System is Dallas Banks spoke with students in those contributing to policy development, public cities. information, and research on financial edu- The Community Affairs Offices at sev- cation. Staff have conducted research on eral Reserve Banks used their research savings patterns among low-income housecapacity, publications, and work with local holds and on households without checkorganizations to raise awareness of regional ing accounts and have shared the results efforts that support financial education. with researchers and practitioners in those The Cleveland Reserve Bank surveyed areas. organizations offering personal financial As an extension of long-standing efforts education programs in the Fourth District to support community economic developto increase understanding of the breadth ment in Native American communities, the of providers of such programs. The survey Community Affairs Offices at the Board led to the convening of regional round- and the Minneapolis, Kansas City, and tables at which financial educators in San Francisco Reserve Banks in May 2003 Cleveland, Pittsburgh, and Cincinnati dis- cosponsored a policy forum on financial cussed opportunities for partnerships to education for residents of Indian Country. leverage resources and increase efficiency Together with a coalition of tribal leaders, in delivering financial education. The bankers, and Native American nonprofit Atlanta and Kansas City Banks sponsored development and policy organizations, the initiatives to help establish regional net- Federal Reserve is working to facilitate works. The Boston Bank collaborated with partnerships that can provide financial edua group serving a low-income Hispanic cation and improve access to financial sercommunity in Springfield, Massachusetts, vices on reservations. Task forces have to develop a curriculum that meets the been established to work on specific initiainformation needs of residents of the tives, including developing a national trainneighborhood. The New York, Philadel- ing strategy, designing research to evaluate phia, Atlanta, St. Louis, Minneapolis, the effectiveness of programs, and formu- Dallas, and San Francisco Banks hosted lating a national outreach initiative to protrain-the-trainer sessions—some focused mote financial literacy in Indian Country. on youth, Hispanic, faith-based, and Native To contribute to the limited body of American populations—to help increase research, the Board is collaborating with the effectiveness of organizations that the Department of Defense on a longitudiprovide financial education in their nal study of the efficacy of the personal communities. financial education the department pro- Research having indicated that the work- vides to military personnel. The study will place is an effective venue for financial assess financial behaviors and changes in education, the Community Affairs Offices financial status over time to determine at the Board and the Boston, Atlanta, whether and how financial education con- St. Louis, and Dallas Banks in 2003 con- tributes to positive outcomes. ducted seminars for employees on personal In recognition of the role that financial financial management strategies and con- education plays in the successful functionsumer protection issues. The Board hosted ing of households and of the broader econsessions on budgeting and saving, reading omy, the Federal Reserve will continue to and correcting credit reports, using the seek opportunities to highlight its interest Board's benefit programs to meet savings and to pursue initiatives that will contribgoals, and understanding the implications ute to better informed and more knowlof identity theft. edgeable consumers of financial services. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

82 90th Annual Report, 2003 and leadership development organiza- Outreach Activities tion. Featuring preliminary findings of research on these topics conducted by The Board engages in outreach activithe institute, the event explored some ties throughout the year to provide inforof the challenges that confront the com- mation to the public about the Board's munity economic development field responsibilities, to facilitate understandrelating to organizational infrastructure ing of changes in banking regulations and capitalization. Forum participants— and their impact on banks and consumleaders of prominent national com- ers, to promote community development munity development organizations— and consumer education, and to foster described, from their particular per- discussion of public policy issues. Board spectives, the fundamental issues that staff periodically meet with financial define the mission and future of their institutions, community groups, and organizations. The Cleveland Reserve other members of the public in formal Bank sponsored a conference on the evo- and informal settings. The Board sponlution of community economic devel- sors and participates in meetings, conopment as policy has shifted from ferences, and seminars for the general program-driven to market-based strate- public and for targeted audiences. This gies for addressing redevelopment chal- year, the Board participated in the Conlenges in lower-income neighborhoods. gressional Black Caucus Foundation's The Board's community affairs pro- 2003 annual legislative conference, gram also participated in an interagency which provides a national forum for expolicy initiative involving minority amining strategies and viable solutions small business development in 2003. As to public policy issues facing African part of the initiative, the agencies issued Americans. Board staff distributed cona joint policy paper that examines ways sumer education materials provided by in which their policies and regulations the Federal Reserve System and used can be more effective in supporting the opportunity to inform conference access to capital and technical assis- attendees about the Federal Reserve and tance by minority business owners. its multifaceted responsibilities. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

83 Banking Supervision and Regulation Insured commercial banks in 2003 expe- uting to deposit growth, also limited the rienced record earnings and built benefit of lower rates for overall fundstronger balance sheets while adapting ing costs. to significant changes in the business Commercial lending and marketclimate. Net income reached $100 bil- sensitive revenues were weak throughlion, up 14 percent from the preceding out the year, reflecting cautious year. Historically low interest rates, improvement in economic activity and along with the resilience of the U.S. equity markets. The latter showed some household sector, continued to support recovery late in the year. Growth in strong mortgage origination revenues commercial real estate loans remained and healthy growth of mortgage-related rapid in 2003, exceeding 9 percent assets early in the year. Lower interest for the seventh consecutive year and rates created the opportunity for banks reaching 11.1 percent of the industry's to sell their higher-yielding investment assets. securities at a premium, realizing gains Non-interest expense grew only modthat further supported earnings in the erately. At the same time, banks were first half of the year. Although the able to realize benefits from cost-cutting steeper yield curve began to dampen measures. Salary and benefits expense mortgage origination activity in the lat- per employee grew 6.4 percent for the ter half of the year, continuing recovery year. in the U.S. economy sparked equity mar- Core deposits, especially money kets and bolstered fees related to finanmarket and savings accounts, expericial market activities. Moreover, asset enced remarkable growth. These deposquality improved steadily during the its offer banks greater funding stability year, allowing banks to set aside less of and attractive interest rate risk charactertheir income for future credit losses. istics in addition to growth in deposit Net interest margins—the pretax rate fees. As a strategic objective, banks of profitability on earning assets— actively competed to attract these deposcontracted significantly during the year, its, offering attractive rates and investfor several reasons. New mortgage- ing in branches and other delivery sysrelated assets carried historically low tems. Depositors for their part appeared yields, the same reason refinancing was content to hold assets in the form of attractive to mortgage borrowers. Nor- these highly liquid insured deposits mal repricing of interest-sensitive assets, while interest rates remained low and, coupled with rate-motivated accelera- during the first half of the year, while tion of prepayments, reduced asset equity prices remained weak. Money yields. By liquidating higher-yielding market and savings balances funded investment securities in order to record 30.6 percent of bank assets at year-end, gains in current income, banks effec- up from 28.9 percent a year earlier. This tively traded future margin income for funding provided support to the acquisicurrent-period revenues. Finally, pre- tion of residential mortgage and home mium pricing on money market and sav- equity loans and, in the first half of the ings deposit accounts, although contrib- year, mortgage-backed securities. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

84 90th Annual Report, 2003 A steeper yield curve in midyear loans remained somewhat elevated at eroded a significant portion of unreal- year-end 2003, with nonperforming ized gains on banks' investment securi- assets representing 0.94 percent of loans ties and also slowed the pace of mort- and related assets. Nonetheless, the peak gage refinancing. Responding to these levels reached in this credit cycle did market changes, banks strategically not approach the extremes of the early reduced their holdings of long-term 1990s. securities during the latter half of the The number of insured commercial year, although not by enough to offset banks fell by 121 institutions, to 7,761, the acquisitions earlier in the year. The principally because of acquisitions and effect was most pronounced in mortgage consolidation of related bank charters pass-through securities, which declined by multibank organizations. Two banks, about 6.5 percent during the second half with combined assets of $1.4 billion, of 2003. Banks also issued new long- failed in 2003. term fixed-rate debt, prepaid higher-cost Significant acquisitions of banking pre-existing term debt, and acquired institutions and major business lines interest rate derivatives to hedge against were an important development in 2003. possible future increases in market inter- Bank of America and FleetBoston est rates. announced their proposed merger late in Capitalization remained a key source 2003, and J.P. Morgan Chase and Bank of strength for the industry. Banks added One announced their proposed merger $42.5 billion in equity (net) during the just after year-end. Each of these instituyear. Aggregate regulatory capital ratios tions would have assets in the vicinity remained well above minimums, while of $ 1 trillion. Assuming that these transnearly 99 percent of insured commercial actions are consummated, the three banks were well capitalized at year-end largest bank holding companies in the 2003. Dividend payout increased only United States would together account slightly for the year—77.4 percent of for $3.2 trillion in assets, or 37 percent earnings, versus 76.4 percent in 2002— of the assets of all reporting bank holddespite the introduction of more- ing companies. favorable federal tax treatment of dividend income. Nonperforming assets and net charge- Scope of Responsibilities for offs declined steadily through the year, Supervision and Regulation each having earlier reached a peak level in September 2002. Although this The Federal Reserve is the federal decline was influenced by positive supervisor and regulator of all U.S. bank macroeconomic developments, it was holding companies (including financial also supported by secondary markets for holding companies formed under the troubled loans that remained deep and authority of the Gramm-Leach-Bliley liquid through the year. At the same Act) and of state-chartered commercial time, banks strengthened their credit risk banks that are members of the Federal management and measurement capabili- Reserve System. In overseeing these ties and were able to call on a wider organizations, the Federal Reserve seeks range of credit risk mitigation instru- primarily to promote their safe and ments and techniques to manage the sound operation and their compliance extent of their risk-taking. Problem with laws and regulations, including the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 85 Bank Secrecy Act and consumer protec- Examinations and Inspections tion and civil rights laws.1 The Federal Reserve conducts examina- The Federal Reserve also has respontions of state member banks, the U.S. sibility for the supervision of all Edge branches and agencies of foreign banks, Act and agreement corporations; the and Edge Act and agreement corpointernational operations of state member rations. In a process distinct from banks and U.S. bank holding companies; examinations, it conducts inspections of and the operations of foreign banking holding companies and their nonbank companies in the United States. subsidiaries. Pre-examination planning The Federal Reserve exercises imporand on-site review of operations are tant regulatory influence over entry into integral parts of the overall effort to the U.S. banking system and the strucensure the safety and soundness of ture of the system through its adminisfinancial institutions. Whether it is an tration of the Bank Holding Company examination or an inspection, the review Act, the Bank Merger Act (with regard entails (1) an assessment of the quality to state member banks), the Change in of the processes in place to identify, Bank Control Act (with regard to bank measure, monitor, and control risks, holding companies and state member (2) an appraisal of the quality of the banks), and the International Banking institution's assets, (3) an evaluation of Act. The Federal Reserve is also responmanagement, including an assessment sible for imposing margin requirements of internal policies, procedures, conon securities transactions. In carrying trols, and operations, (4) an assessment out these responsibilities, the Federal of the key financial factors of capital, Reserve coordinates its supervisory earnings, liquidity, and sensitivity to activities with other federal banking market risk, and (5) a review for compliagencies, state agencies, functional ance with applicable laws and regularegulators, and the bank regulatory tions. The table provides information on agencies of other nations. the examinations and inspections conducted by the Federal Reserve during Supervision for the past five years. Safety and Soundness State Member Banks To ensure the safety and soundness of banking organizations, the Federal At the end of 2003, 935 state-chartered Reserve conducts on-site examinations banks (excluding nondepository trust and inspections and off-site surveillance companies and private banks) were and monitoring. It also undertakes members of the Federal Reserve Sysenforcement and other supervisory tem. These banks represented approxiactions. mately 12 percent of all insured U.S. 1. The Board's Division of Consumer and ance. The chapter of this volume covering con- Community Affairs is responsible for coordinating sumer and community affairs describes these reguthe Federal Reserve's supervisory activities with latory responsibilities. Compliance with other regard to the compliance of banking organizations banking statutes and regulations, which is treated with consumer protection and civil rights laws. To in this chapter, is the responsibility of the Board's carry out this responsibility, the Federal Reserve Division of Banking Supervision and Regulation trains a number of its bank examiners in the evalu- and the Federal Reserve Banks, whose examiners ation of institutions with regard to such compli- also check for safety and soundness. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

86 90th Annual Report, 2003 State Member Banks and Holding Companies, 1999-2003 Entity/Item 2003 2002 2001 2000 1999 State member banks Total number 935 949 970 991 1,010 Total assets (billions of dollars) 1,912 1,863 1,823 1,645 1,423 Number of examinations 822 814 816 899 858 Byy Federal Reserve Syystem . 581 550 561 610 551 B bki 241 264 255 289 307 By state banking agency Top-tier bank holding companies Large (assets of more than $1 billion) Total number 365 329 312 309 283 Total assets (billions of dollars) 8,295 7,483 6,905 6,213 5,625 Number of inspections 454 439 413 352 332 By Federal Reserve System1 446 431 409 346 329 On site 399 385 372 309 298 Off site 47 46 37 37 31 By state banking agency 4 6 3 Small (assets of $1 billion or less) Total number 4,787 4,806 4,816 4,800 4,831 Total assets (billions of dollars) 847 821 768 716 679 Number of inspections 3,453 3,726 3,486 3,347 3,064 By Federal Reserve System 3,324 3,625 3,396 3,264 2,973 On site2 183 264 730 835 684 Off site 3,141 3,361 2,666 2,429 2,289 By state banking agency 129 101 90 83 91 Financial holding companies Domestic 612 602 567 462 Foreign 32 30 23 21 1. For large bank holding companies subject to con- inspections being performed off site versus on site. tinuous, risk-focused supervision, includes multiple tar- See text section "Bank Holding Companies" for more geted reviews. information. 2. In 2002, the supervisory program for small bank . . . Not applicable. holding companies was revised, resulting in more commercial banks and held approxi- Bank Holding Companies mately 26 percent of all insured commercial bank assets in the United States. At year-end 2003, a total of 6,038 U.S. The guidelines for Federal Reserve bank holding companies were in operaexaminations of state member banks tion, of which 5,152 were top-tier bank are fully consistent with section 10 of holding companies. These organizations the Federal Deposit Insurance Act, as controlled 6,298 insured commercial amended by section 111 of the Federal banks and held approximately 96 per- Deposit Insurance Corporation Improve- cent of all insured commercial bank ment Act of 1991 and by the Riegle assets in the United States. Community Development and Regula- Federal Reserve guidelines call for tory Improvement Act of 1994. A full- annual inspections of large bank holdscope, on-site examination of these ing companies as well as smaller combanks is required at least once a year; panies that have significant nonbank exceptions are certain well-capitalized, assets. In judging the financial condiwell-managed institutions having assets tion of the subsidiary banks owned of less than $250 million, which may be by holding companies, Federal Reserve examined once every eighteen months. examiners consult examination reports Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 87 prepared by the federal and state Financial Holding Companies banking authorities that have primary Under the Gramm-Leach-Bliley Act, responsibility for the supervision of the Federal Reserve has supervisory those banks, thereby minimizing duplioversight authority and responsibility cation of effort and reducing the burden for bank holding companies, including on banking organizations. those that operate as financial holding Small, noncomplex bank holding companies. The statute streamlines the companies—those that have consoli- Federal Reserve's supervision of all dated assets of $1 billion or less—are bank holding companies and sets forth subject to a special supervisory program parameters for the relationship between that was implemented in 1997 and modified in 2002.2 The program permits the Federal Reserve and other regulators. The statute also differentiates a more flexible approach to supervision between the Federal Reserve's relations of such companies. If all of a company's with regulators of depository institusubsidiary depository institutions have tions and its relations with functional composite and management ratings of regulators (that is, regulators for insur- "satisfactory" or better, and if no mateance, securities, and commodities). rial outstanding issues at the holding As of year-end 2003, 612 domestic company or consolidated level are otherbank holding companies and 32 foreign wise indicated, only a composite rating banking organizations had financial and a management rating based on the ratings of the lead subsidiary deposi- holding company status. Of the domestory institution are assigned to the tic financial holding companies, 45 company. In 2003, the Federal Reserve had consolidated assets of $15 billion conducted 3,324 reviews of such bank or more; 98, between $1 billion and holding companies. If a company's sub- $15 billion; 93, between $500 million sidiary depository institutions have and $1 billion; and 376, less than ratings lower than "satisfactory" or $500 million. have other significant supervisory issues, a more thorough off-site review of the organization is conducted using Specialized Examinations surveillance results and other infor- The Federal Reserve conducts specialmation. If the information obtained offized examinations of banking organizasite from these sources is not sufficient tions in the areas of information technolto determine the overall financial condiogy, fiduciary activities, transfer agent tion of the holding company and to asactivities, and government and municisign the composite and management ratpal securities dealing and brokering. The ings, the holding company is subject to Federal Reserve also conducts specialincreased supervisory review that may ized examinations of certain entities, include an on-site review and off-site other than banks, brokers, or dealers, monitoring. that extend credit subject to the Board's margin regulations. 2. Refer to SR Letter 02-01 for a discussion of the factors considered in determining whether Information Technology Activities a bank holding company is complex or non- In recognition of the importance of complex (www. federalreserve. go v/boarddoc s/ SRLETTERS/2002/sr0201 .htm). information technology to safe and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88 90th Annual Report, 2003 sound operations in the financial indus- monitor the issuance of securities, regtry, the Federal Reserve reviews the ister the transfer of securities, and information technology activities of exchange or convert securities. On-site supervised financial institutions as well examinations focus on the effectiveas certain independent data centers that ness of the institution's operations and provide information technology services its compliance with relevant securities to these institutions. Several years ago, regulations. During 2003 the Federal the information technology reviews of Reserve conducted on-site examinations banking institutions were integrated into at 27 of the 92 state member banks and the overall supervisory process, and thus bank holding companies that were regall safety and soundness examinations istered as transfer agents. Also during are now expected to include a review of the year the Federal Reserve examined information technology risks and activi- 1 state member limited-purpose trust ties. During 2003 the Federal Reserve company acting as a national securities was the lead agency in two examina- depository. tions of large, multiregional data processing servicers examined in coopera- Government and Municipal Securities tion with the other federal banking Dealers and Brokers 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 supervisory ernment Securities Act of 1986 and with responsibility for institutions that Department of the Treasury regulations together hold more than $14 trillion of governing dealing and brokering in govassets in various fiduciary capacities. ernment securities. Thirty-three state During on-site examinations of fidu- member banks and 9 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 2003 the Fedagement and operations, including its eral Reserve conducted 10 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 2003 Fed- These examinations are generally coneral Reserve examiners conducted 164 ducted concurrently with the Federal 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 24 entithings, transfer agents countersign and ties that dealt in municipal securities Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 89 during 2003, 8 were examined during removal and prohibition orders, and the year. civil money penalties. In 2003 the Board of Governors Securities Credit Lenders assessed $103.1 million in civil money penalties. All civil money penalties Under the Securities Exchange Act of assessed by the Board are remitted, 1934, the Federal Reserve Board is as directed by statute, either to the responsible for regulating credit in cer- U.S. Department of the Treasury or tain transactions involving the purchase to the Federal Emergency Management or carrying of securities. In addition to Agency. examining banks under its jurisdiction All final enforcement orders issued for compliance with the Board's margin by the Board and all written agreeregulations as part of its general examiments executed by the Reserve Banks nation program, the Federal Reserve are available to the public and are maintains a registry of persons other posted on the Board's web site than banks, brokers, and dealers who (www.federalreserve.gov/boarddocs/ extend credit subject to those regulaenforcement). In addition to formal tions. The Federal Reserve may conduct enforcement actions, the Reserve Banks specialized examinations of these lendin 2003 completed 141 informal ers if they are not already subject to enforcement actions, such as board of supervision by the Farm Credit Admindirectors resolutions and memoranda of istration, the National Credit Union understanding. These informal actions Administration, or the Office of Thrift are not available to the public. Supervision. At the end of 2003, 700 lenders other than banks, brokers, or dealers were reg- Risk-Focused Supervision istered with the Federal Reserve. Other federal regulators supervised 215 of In recent years the Federal Reserve has these lenders, and the remaining 485 created several programs aimed at were subject to limited Federal Reserve enhancing the effectiveness of the supersupervision. On the basis of regulatory visory process. The main objective of requirements and annual reports, the these programs has been to sharpen the Federal Reserve exempted 269 lenders focus on (1) those business activities from its on-site inspection program. The posing the greatest risk to banking orgasecurities credit activities of the remain- nizations and (2) the organizations' ing 216 lenders were subject to either management processes for identifying, biennial or triennial inspection. Eighty- measuring, monitoring, and controlling nine inspections were conducted dur- risks. ing the year, compared with 127 in 2002. Regional Banking Organizations The risk-focused supervision program for regional banking organizations Enforcement Actions applies to institutions having a manageand Civil Money Penalties ment structure organized by function or In 2003 the Federal Reserve completed business line, a broad array of products, 44 enforcement cases involving 62 sepa- and operations that span multiple superrate actions. The actions included cease- visory jurisdictions. For smaller regional and-desist orders, written agreements, banking organizations, the supervisory Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

90 90th Annual Report, 2003 program may be implemented with a agency information-sharing through an point-in-time inspection. For larger automated system. institutions, it may take the form of a In support of the supervision of series of targeted reviews. For the larg- domestic banking organizations and est, most complex institutions, the pro- foreign banking organizations (FBOs) cess is continuous, as described in the with a U.S. banking presence, there is next section. To minimize burden on the an automated application—the Bankinstitution, work is performed off site to ing Organization National Desktop the greatest extent possible. Addition- (BOND)—which was developed to ally, to minimize the number of requests facilitate real-time, secure electronic for information from the institution, information-sharing and collaboration examiners make use of public and reg- among federal and certain state banking ulatory financial reports, market data, regulators. During 2003, BOND was information from automated surveil- comprehensively updated to provide lance screening systems (see section information on regional and community "Surveillance and Off-Site Monitor- banking organizations; to allow for ing"), and internal management reports. seamless integration with other Federal Reserve national information systems, Large, Complex Banking Organizations such as the National Examination Database (NED), Central Document and The Federal Reserve applies a risk- Text Repository (CDTR), Performance focused supervision program to Report Information and Surveillance large, complex banking organizations Monitoring (PRISM), and the National (LCBOs).3 The key features of the Information Center (NIC); and to enable LCBO supervision program are (1) identhe addition of supervisory documents tifying those LCBOs that are judged, on to the CDTR and FBO rating data to the basis of their shared risk character- NED. Other revisions facilitate analyistics, to present the highest level of sis across business activities and help supervisory risk to the Federal Reserve document the sharing of confiden- System, (2) maintaining continual supertial supervisory information on FBOs vision of these institutions to keep and domestic banking organizations current the Federal Reserve's assesshaving a global presence with foreign ment of each organization's condition, regulators. (3) assigning to each LCBO a super- In April 2003, the Federal Reserve, visory team composed of Reserve Bank the Office of the Comptroller of the staff members who have skills appro- Currency (OCC), and the Securities and priate for the organization's risk profile Exchange Commission (SEC) published (the team leader is the central point of "Interagency Paper on Sound Practices contact, has responsibility for only one to Strengthen the Resilience of the U.S. LCBO, and is supported by specialists Financial System." An interagency skilled in evaluating the risks of LCBO working group had been formed in 2002 business activities and functions), and to assess whether, in light of the post- (4) promoting Systemwide and inter- September 11 risk environment, additional guidance on business resumption 3. For an overview of the Federal Reserve's was needed. The agencies held a series LCBO program, see Lisa M. DeFerrari and of meetings with financial institutions David E. Palmer, "Supervision of Large Complex and core clearing and settlement organi- Banking Organizations," Federal Reserve Bulletin, vol. 87 (February 2001), pp. 47-57. zations to discuss lessons learned and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 91 the need to improve the resilience of the screening systems analyze supervisory financial system after a wide-scale dis- data and regulatory financial reports to ruption. In September 2002, the work- identify companies that appear to be ing group published for comment a draft weak or deteriorating. This analysis interagency white paper on strengthen- helps to direct examination resources to ing resilience. The final paper incorpo- institutions that exhibit higher risk prorated comments received on that draft files. Screening systems also assist in and additional discussions with indus- the planning of examinations by identry representatives. In 2003, the Federal tifying companies that are engaging in Reserve began to develop a process for new or complex activities. The Federal assessing the implementation by finan- Reserve also monitors various market cial institutions of the sound practices indices, including equity prices, debt presented in the paper. spreads and ratings, and measures of expected default frequency to gauge Community Banks market perceptions of the risks in banking organizations. The risk-focused supervision program In addition to using automated screenfor community banks emphasizes the ing systems, the Federal Reserve prereview of activities having the highest pares quarterly Bank Holding Company level of risk to an institution and pro- Performance Reports (BHCPRs) for use vides a tiered approach to the examinain monitoring and inspecting supervised tion of these activities. Examination probanking organizations. The reports concedures are tailored to the characteristics tain, for individual bank holding comof the bank, keeping in mind its size, panies, financial statistics and comcomplexity, and risk profile. The examiparisons with peer companies. They are nation procedures entail both off-site compiled from data provided by large and on-site work, including planning, bank holding companies in quarterly completion of a pre-examination visit, regulatory reports (FR Y-9C and preparation of a detailed scope-of- FR Y-9LP). BHCPRs are made availexamination memorandum, thorough able to the public on the Board's documentation of the work done, and National Information Center web site preparation of an examination report (www.ffiec.gov/nic/). tailored to the scope and findings of the During 2003, a web version of the examination. The framework for risk- Performance Report Information and focused supervision of community Surveillance Monitoring application banks was developed jointly with the was implemented. PRISM is a querying Federal Deposit Insurance Corporation tool for Federal Reserve analysts that (FDIC) and has been adopted by the accesses and displays financial, surveil- Conference of State Bank Supervisors. lance, and examination data. In the analytical module, users can customize the presentation of financial data for banks, Surveillance and bank holding companies, and other Off-Site Monitoring financial institutions that are drawn from The Federal Reserve uses automated data in several types of reports—Call screening systems to monitor the finan- Report, Uniform Bank Performance cial condition and performance of state Report, FR Y-9, and Bank Holding member banks and bank holding compa- Company Performance Report, among nies between on-site examinations. The others. In the surveillance module, users Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

92 90th Annual Report, 2003 can generate reports summarizing the and, in some instances, to evaluate their results of System surveillance screens efforts to implement corrective measures for banks and bank holding companies. or to test their adherence to safe and Users can also use PRISM to generate sound banking practices. customized surveillance screens, and all At the end of 2003, 56 member banks PRISM reports can be transferred to were operating 818 branches in for- Excel spreadsheets. eign countries and overseas areas of the The Federal Reserve works through United States; 32 national banks were the Federal Financial Institutions operating 622 of these branches, and Examination Council (FFIEC) Task 24 state member banks were operat- Force on Surveillance Systems to coor- ing the remaining 196. In addition, dinate surveillance activities with the 17 nonmember banks were operating other federal banking agencies. 19 branches in foreign countries and overseas areas of the United States. International Activities Edge Act and Agreement Corporations The Federal Reserve supervises the for- Edge Act corporations are international eign branches of and overseas investbanking organizations chartered by the ments by member banks, Edge Act and Board to provide all segments of the agreement corporations, and bank hold- U.S. economy with a means of financing companies and the investments ing international business, especially by bank holding companies in export exports. Agreement corporations are trading companies. It also supervises similar organizations, state chartered or the activities that foreign banking federally chartered, that enter into an organizations conduct through entities agreement with the Board to refrain in the United States, including branches, from exercising any power that is not agencies, representative offices, and subsidiaries. permissible for an Edge Act corporation. Under sections 25 and 25A of the Federal Reserve Act, Edge Act and Foreign Operations of agreement corporations may engage in U.S. Banking Organizations international banking and foreign finan- The Federal Reserve examines the inter- cial transactions. These corporations, national operations of state member most of which are subsidiaries of membanks, Edge Act corporations, and bank ber banks, may (1) conduct a deposit holding companies principally at the and loan business in states other than U.S. head offices of these organizations, that of the parent, provided that the busiwhere the ultimate responsibility for ness is strictly related to international their foreign offices lies. The examina- transactions, and (2) make foreign tions abroad are conducted with the investments that are broader than those cooperation of the supervisory authori- made by member banks, as they may ties of the countries in which they take invest in foreign financial organizations, place; when appropriate, the examina- such as finance companies and leasing tions are coordinated with the Office companies, as well as in foreign banks. of the Comptroller of the Currency. Edge Act and agreement corporations Examiners also make visits to the over- numbered 78 and were operating 11 seas offices of U.S. banks to obtain branches at year-end 2003. These corpofinancial and operating information rations are examined annually. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 93 U.S. Activities of Foreign Banks in cooperation with the other federal banking agencies and state banking The Federal Reserve has broad authority agencies. The program has two main to supervise and regulate the U.S. activ- parts. One part addresses the examinaities of foreign banks that engage in tion process for those foreign banking banking and related activities in the organizations that have multiple U.S. United States through branches, agen- operations and is intended to ensure cies, representative offices, commercial coordination among the various U.S. lending companies, Edge Act corpora- supervisory agencies. The other part is a tions, commercial banks, and certain review of the financial and operational nonbank companies. Foreign banks con- profile of each organization to assess its tinue to be significant participants in the general ability to support its U.S. opera- U.S. banking system. tions and to determine what risks, if any, As of year-end 2003, 190 foreign the organization poses through its U.S. banks from 54 countries were operating operations. Together, these two pro- 240 state-licensed branches and agen- cesses provide critical information to cies (of which 8 were insured by the U.S. supervisors in a logical, uniform, Federal Deposit Insurance Corporation) and timely manner. The Federal Reserve as well as 51 branches licensed by the conducted or participated with state and Office of the Comptroller of the Cur- federal regulatory authorities in 269 rency (of which 6 had FDIC insurance). examinations during 2003. These foreign banks also directly owned 16 Edge Act and agreement corporations and 3 commercial lending compa- Technical Assistance nies; in addition, they held an equity interest of at least 25 percent in 85 U.S. In 2003 the Federal Reserve System commercial banks. continued to provide technical assis- Altogether, the US. offices of these tance on bank supervisory matters to foreign banks at the end of 2003 con- foreign central banks and supervitrolled approximately 18 percent of U.S. sory authorities. Technical assistance commercial banking assets. These for- involves visits by System staff members eign banks also operated 73 representa- to foreign authorities as well as consultive offices; an additional 60 foreign tations with foreign supervisors who banks operated in the United States visit the Board or the Reserve Banks. solely through a representative office. Technical assistance in 2003 was con- State-licensed and federally licensed centrated in Latin America, Asia, and branches and agencies of foreign banks former Soviet bloc countries. are examined on site at least once every During the year, the Federal Reserve eighteen months, either by the Federal offered supervision training courses in Reserve or by a state or other federal Washington, D.C., and in a number of regulator; in most cases, on-site exami- foreign jurisdictions exclusively for fornations are conducted at least once every eign supervisory authorities. System twelve months, but the period may be staff also took part in technical assisextended to eighteen months if the tance and training missions led by the branch or agency meets certain criteria. International Monetary Fund, the World The Federal Reserve conducts a joint Bank, the Inter-American Development program for supervising the U.S. opera- Bank, the Asian Development Bank, tions of foreign banking organizations the Basel Committee on Banking Super- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

94 90th Annual Report, 2003 vision, and the Financial Stability organizations as a result of Financial Institute. Accounting Standards Board Financial Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). The Supervisory Policy comment period ended on Novem- The Federal Reserve's supervisory pol- ber 17, 2003. The interim capital treaticy function is responsible for develop- ment allows sponsoring banking organiing guidance for examiners and finan- zations to remove the consolidated cial institutions as well as regulations ABCP program assets from their riskfor financial institutions under the super- weighted asset bases for purposes of vision of the Federal Reserve. Staff calculating their risk-based capital members participate in international ratios. Sponsoring banking organizasupervisory forums and provide support tions must continue to hold risk-based for the work of the Federal Financial capital against all other risk exposures Institutions Examination Council. arising in connection with ABCP programs, including direct credit substitutes, recourse obligations, residual Capital Adequacy Standards interests, long-term liquidity facilities, and loans, in accordance with existing During 2003 the Federal Reserve, risk-based capital standards. In addition, together with the Office of the Company minority interests in ABCP protroller of the Currency, the Federal grams that are consolidated as a result of Deposit Insurance Corporation, and the FIN 46 are to be excluded from spon- Office of Thrift Supervision, issued an soring banking organizations' minority interim rule amending the agencies' interest component of tier 1 capital and, regulatory capital guidelines, an advance hence, from total risk-based capital. notice of proposed rulemaking on regu- The interim capital treatment is in latory capital standards for internationeffect only for the regulatory reportally active banking organizations, and ing periods ending September 30 and guidance on credit card lending; revised December 31, 2003, and March 31, the appraisal guidelines; and issued an 2004. In addition, the interim capital advisory on mortgage banking activitreatment does not alter the accounting ties. The Federal Reserve also clarified rules for balance sheet consolidation, the reporting and capital treatment of nor does it affect the denominator of the trust preferred stocks. tier 1 leverage capital ratio calculation, which continues to be based primarily Asset-Backed Commercial Paper on on-balance-sheet assets as reported Programs and Early Amortization under generally accepted accounting Provisions principles (GAAP). Thus, as a result of In October the Federal Reserve and the FIN 46, banking organizations must other federal banking agencies adopted include all assets of consolidated ABCP an interim rule with a request for com- programs in on-balance-sheet assets for ments that amended the agencies' risk- purposes of calculating the tier 1 leverbased capital standards by providing an age capital ratio. The interim risk-based interim capital treatment for assets in capital treatment will expire on April 1, asset-backed commercial paper (ABCP) 2004. programs that are consolidated onto the Concurrent with the issuance of the balance sheets of sponsoring banking interim rule, the agencies also published Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 95 a notice of proposed rulemaking that forth the agencies' current views on a would amend their risk-based capital proposed framework for implementing standards by removing the April 1, revisions to the Basel Capital Accord 2004, sunset provision in order to permit in the United States. In particular, the sponsoring banking organizations to ANPR described significant elements continue to exclude from their risk- of the advanced internal ratings-based weighted asset base those assets in approach for credit risk and the ABCP programs that are consolidated advanced measurement approaches for onto sponsoring banking organizations' operational risk (together, the advanced balance sheets as a result of FIN 46. The approaches). The ANPR specified cricomment period ended on Novem- teria for determining which banking ber 17, 2003. The removal of the sunset organizations would be required to use provision is contingent upon the agen- the advanced approaches and the cricies' implementing proposed risk-based teria, supervisory standards, and discapital requirements for liquidity facili- closure requirements the banking orgaties having an original maturity of one nizations would be required to meet. year or less that organizations provide to Other organizations meeting the cri- ABCP programs, regardless of whether teria would be permitted to use the organization sponsors the program the advanced approaches. Under the or must consolidate the program under advanced approaches, banking organi- GAAP. This treatment recognizes that zations would use internal estimates of such facilities expose banking organiza- certain risk components as key inputs tions to credit risk and is consistent with in determining their regulatory capithe industry's practice of internally allo- tal requirements. The ANPR included cating economic capital against this risk a number of questions intended to associated with such facilities. A sepa- highlight for the industry certain areas rate capital charge on liquidity facilities for which comment was particularly provided to an ABCP program would requested. not be required of banking organizations Concurrent with the issuance of the that are required to (or of other banks ANPR, the federal banking agencies that choose to) consolidate the program issued for public comment draft supervifor purposes of risk-based capital. In sory guidance on internal ratings-based addition, the agencies proposed a risk- systems for corporate credits and based capital charge for certain types advanced measurement approaches for of securitizations of revolving retail operational risk. The guidance described credit facilities (for example, credit card supervisory expectations for institureceivables) that incorporate early- tions that are considering developing amortization provisions. advanced measurement systems. The guidance on corporate credit set forth essential components and characteristics Proposed Advance Rulemaking of the of an internal ratings-based system, Risk-Based Capital Standards for including expectations vis-a-vis assign- Certain Internationally Active ment of internal ratings, quantification, Banking Organizations data maintenance, and control and over- In August the Federal Reserve, along sight mechanisms. The draft supervisory with the OCC, FDIC, and OTS, issued guidance on operational risk measurefor public comment an advance notice ment approaches outlined critical expecof proposed rulemaking (ANPR) setting tations vis-a-vis corporate governance, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

96 90th Annual Report, 2003 the elements of operational risk manage- activities, particularly with respect ment, and the primary components of an to credit-line management, over-limit advanced measurement approach. accounts, and workouts. It also The comment period for the ANPR addresses income recognition and lossand the draft supervisory guidance allowance practices in connection with ended on November 3, 2003. The Fed- credit card lending. eral Reserve received more than 100 comments on the two issuances. Work is Regulation W continuing on both the framework and In SR Letter 03-2, which was issued in the guidance. January, the Federal Reserve summarized the significant issues resolved with Guidance on the Reporting the adoption of Regulation W. Regulaand Capital Treatment tion W, which implements sections 23A of Trust Preferred Stocks and 23B of the Federal Reserve Act, includes seventy years' worth of inter- In July the Board issued SR Letter 03pretative guidance furnished by the 13, which instructed bank holding com- Federal Reserve concerning statutory panies to continue to follow the existing requirements. The nine significant issues guidelines for the reporting and capital resolved by the issuance of Regulatreatment of trust preferred stocks when tion W are (1) the conditions for derivapreparing bank holding company regutives transactions, (2) the conditions for latory reports even though these treatintraday credit transactions, (3) the defiments may not concur with the most nition of financial subsidiaries as affilicurrent treatment of trust preferred ates of banks, (4) the exemption for stocks set forth in FIN 46. Under existgeneral-purpose credit card transactions, ing procedures, bank holding companies (5) the application of sections 23A and report trust preferred stocks as minority 23B to certain activities of U.S. branches interest in the equity accounts of a conand agencies of foreign banks, (6) the solidated subsidiary and include trust conditions for the exemption of a bank's preferred stocks in tier 1 capital. The purchase of loans from its affiliates, interpretation of FIN 46 would have (7) the exemption of certain bank loans resulted in bank holding companies' to a third party secured by securities reflecting subordinated debt issued to issued by a mutual fund affiliate of the the trusts on their consolidated balbank, (8) an exemption that would perance sheets under generally accepted mit a banking organization to engage accounting principles instead of the more expeditiously in certain internal preferred stocks issued by the trusts to reorganization transactions, and (9) new third-party investors. valuation rules. Credit Card Lending Appraisal Guidelines In January the Federal Reserve, along with the OCC, the FDIC, and the In October the Federal Reserve and the OTS, jointly issued Account Manage- other federal banking agencies issued ment and Loss Allowance Guidance. a joint statement on the independence The guidance describes the agencies' of the collateral valuation process expectations regarding prudent risk- (SR Letter 03-18). The purpose of the management practices for credit card statement is to serve as a reminder to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 97 regulated institutions that there needs to Business Continuity be an effective, independent real estate appraisal and evaluation program for all In April the Federal Reserve, along their lending functions, including all with the Office of the Comptroller of real-estate-related financial transactions the Currency and the Securities and originated or purchased by a regulated Exchange Commission, published an institution for its own portfolio or as interagency paper titled "Sound Pracassets held for sale. The statement tices to Strengthen the Resilience of the should be read in conjunction with U.S. Financial System." The paper ideneach agency's appraisal and with real- tifies four sound practices for organiestate-lending regulations and the 1994 zations that provide core clearing and Interagency Appraisal and Evaluation settlement services and firms that play Guidelines. significant roles in critical financial markets. The sound practices focus on the back-up capacity necessary for recovery Mortgage Banking Activities and resumption of clearing and settle- The Federal Reserve, along with the ment of material open transactions and OCC, the FDIC, and the OTS, issued an are designed to minimize the immediate interagency advisory on mortgage bank- systemic effects of a wide-scale disruping activities in February. The purpose tion of critical financial markets. They of the guidance (SR Letter 03-4) was build on long-standing principles of to address the weaknesses in risk man- business continuity planning and reflect agement, valuation, and modeling of actions identified by industry members hedging practices related to mortgage- in meetings and in comments on a draft servicing assets (MSAs) noted in recent of the paper that was published during examinations. These weaknesses include 2002. the use of unsupported or inappropri- The sound practices include the idenate valuation assumptions; inadequate tification of all clearing and settlement stratification, amortization, and impair- activities that support critical financial ment practices; and weak oversight and markets and the determination of approcontrols. Additional examiner scrutiny priate recovery and resumption objecis warranted when such weaknesses tives (that is, within the business day on are encountered. Banking organiza- which the disruption occurs). They protions were reminded of the expectation vide that covered organizations should that they fully comply with generally maintain sufficient geographically disaccepted accounting principles and with persed resources to meet recovery and accounting guidance regarding servicing resumption objectives. They also proassets that was issued previously. The vide that recovery and resumption banking agencies expect institutions to arrangements should be in routine use or perform mortgage-banking operations in subject to sufficient testing to ensure a safe and sound manner. Management that they are effective. should ensure that detailed policies and Core clearing organizations are procedures are in place to monitor and expected to implement the sound praccontrol mortgage-banking activities, tices by the end of 2004, and firms that including loan production, pipeline and play significant roles in critical markets warehouse administration, secondary are expected to implement the sound market transactions, servicing opera- practices during 2006, although the tions, and management of MSAs. implementation period may have to be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

98 90th Annual Report, 2003 extended in some cases. Implementation discussed sound practices in using priplans should incorporate interim mile- mary credit program borrowings in stones against which progress can be liquidity contingency planning. measured. Financial firms not deemed to be a core clearing and settlement Commodities Derivatives Authority organization or a firm that plays a significant role in critical markets are In June the Federal Reserve approved a encouraged to review and consider modification to Regulation Y that allows implementing the sound practices. bank holding companies engaged in permissible derivatives activities to transfer title to commodities underlying deriv- Anti-Tying Restrictions atives contracts on an instantaneous, In August the Federal Reserve requested pass-through basis. Prior to this modifipublic comment on an interpretation of cation, a bank holding company could the anti-tying restrictions in section 106 take and make delivery only on physiof the Bank Holding Company Act cally settled derivatives involving com- Amendments of 1970 and related super- modities that a state member bank is visory guidance. Section 106 generally permitted to own, such as investmentprohibits a bank from conditioning the grade corporate debt securities, U.S. availability or price of one product on government and municipal securities, the customer's obtaining another prod- foreign exchange, and certain precious uct from the bank or an affiliate. The metals. For all other types of physically Board's proposed interpretation of sec- settled derivatives, the bank holding tion 106 provides banking organizations company was required to make reasonand their customers a comprehensive able efforts to avoid delivery, and the guide to the special anti-tying restric- contract was required to have assigntions applicable to banks under sec- ment, termination, or offset provisions. tion 106. The related supervisory guidance describes the types of policies and procedures that should help banks International Guidance on ensure and monitor their compliance Supervisory Policies with section 106. As a member of the Basel Committee on Banking Supervision, the Federal Discount Window Guidance Reserve in 2003 participated in efforts to revise the international capital regime In July the Federal Reserve and the and to develop international supervisory other federal banking, thrift, and credit guidance. The Federal Reserve's goals union regulatory agencies issued guidin these activities are to advance sound ance on the appropriate use of the Fedsupervisory policies for internationeral Reserve's primary credit discount ally active banking institutions and to window program in depository instiimprove the stability of the internatutions' liquidity risk management and tional banking system. The efforts are contingency planning. The guidance described in the following sections. provided background on the Federal Reserve's discount window programs Capital Adequacy and reiterated well-established supervisory policies on sound contingency The Federal Reserve continued to parplanning in relation to liquidity. It also ticipate in a number of technical work- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 99 ing groups of the Basel Committee in reports, and recommendations issued efforts to develop a new capital accord. by the Basel Committee during 2003. In April the Basel Committee published These documents were generally aimed a revised consultative paper based on at improving the supervision of bankfurther deliberations of the committee ing organizations' risk-management and on comments received by the com- practices. mittee on its January 2001 consultative paper and on technical papers subse- • "Principles and Management and quently issued by the working groups. Supervision of Interest Rate Risk," The Basel Committee received more (issued in September) revised an earthan 200 comments on the consultative lier version of the paper on the basis paper. of comments received from institu- Also during 2003, the Federal tions, industry associations, supervi- Reserve and other U.S. bank regulatory sory authorities, and others. agencies participated in the third international Quantitative Impact Study con- • "Management and Supervision of ducted by the Basel Committee to evalu- Cross-B order Electronic Banking ate the possible effects of the proposed Activities" (issued in July) and "Risk revised capital standards. The study, Management for Electronic Banking" which involved 22 large U.S. banking (issued in July) were prepared for the organizations and more than 350 banks purposes of identifying banks' riskworldwide, has helped guide the com- management responsibilities with mittee in developing capital require- respect to cross-border banking and ments for banks' individual portfolios focusing attention on the need for and sub-portfolios. During the second effective home country supervision of, half of the year the technical working and continued international cooperagroups analyzed the comments and data tion regarding, electronic banking. gathered through the study and developed additional modifications to the • "Management and Supervision of capital proposals. U.S. authorities plan Operational Risk" (issued in Februto conduct a fourth study during 2004 ary) outlines a set of principles that before issuing new capital regulations provide a framework for the effecfor public comment. tive management and supervision of In addition, the Basel Committee operational risk, for use by banks and decided to base the revised framework supervisory authorities when evaluaton unexpected losses rather than com- ing operational-risk-management polibined unexpected and expected losses, cies and practices. which had served as the basis for earlier proposals. The committee solicited additional public comment through International Accounting December 31, 2003, on this fundaand Disclosure mental change to the proposed capital framework. The Federal Reserve participates in the Basel Committee's Task Force on Accounting Issues and its Transparency Risk Management Group and represents the Basel Commit- The Federal Reserve contributed to tee at international meetings on the several supervisory policy papers, issues addressed by these groups. In Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

100 90th Annual Report, 2003 particular, a Federal Reserve official in IOSCO to Combat Money Laundering 2003 represented the Basel Committee and the Financing of Terrorism" (June), at meetings of a committee of the Inter- "Trends in Risk Integration and Aggrenational Accounting Standards Board gation" (August), and "Operational (IASB) that works to improve guidance Risk Transfer across Financial Sectors" on accounting for financial instruments. (August). In addition, a representative of the Federal Reserve is a member of the IASB's Securities Underwriting Authority Standards Advisory Council. During 2003, the Federal Reserve and In February the Federal Reserve issued the Basel Committee provided com- an interpretation concerning securities ments on the IASB's amendments to underwriting by banking organizations statements 32 and 39. The amendments that are subject to the Bank Holding addressed key issues related to financial Company Act. The interpretation clariinstruments, including loan-loss allow- fies that a banking organization that ances, fair-value accounting, and hedge wishes to engage in underwriting securiaccounting. The Federal Reserve and the ties that are to be distributed in the Basel Committee also worked with the United States must either be a financial International Federation of Accountants holding company or have authority to to promote stronger international audit engage in underwriting activity under standards and greater participation by section 4(c)(8) of the Bank Holding public interest groups in the audit- Company Act. standard-setting process. The Transparency Group is developing guidance on Sarbanes-Oxley Act improving disclosure, for the purpose of enhancing market discipline. The The Federal Reserve is actively involved group's current focus is on developing in evaluating the effect of the Sarbanesand finalizing "Pillar 3" proposals that Oxley Act on financial institutions. In would improve disclosures in support May, in conjunction with the OCC and of the revised international capital the OTS, the Federal Reserve issued accord. SR Letter 03-8, Statement on Application of Recent Corporate Governance Initiatives to Non-Public Banking Orga- Joint Forum nizations. The interagency statement In its work with the Basel Committee responded to questions that the agen- (BCBS), the Federal Reserve also con- cies had received as to whether the tinued its participation in the Joint agencies expected small, non-public Forum—a group made up of representa- banking organizations to comply with tives of the committee, the International the Sarbanes-Oxley Act and the recent Organization of Securities Commissions corporate governance proposals of (IOSCO), and the International Associa- the New York Stock Exchange and tion of Insurance Supervisors (IAIS). Nasdaq. The Joint Forum works to increase In issuing this interagency statement, mutual understanding of issues related the banking agencies reiterated their to the supervision of firms operating in long-standing endorsement, through each of the financial sectors. The Joint regulation and guidance, of sound cor- Forum issued three papers during 2003: porate governance and auditing policies "Initiatives by the BCBS, IAIS, and and practices for all banking organi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 101 zations under their supervision. They for banks; the quality of management stated that their regulatory approach, as information and financial reporting is well as the approach adopted by Con- dramatically affected by internal control gress in the Sarbanes-Oxley Act, has systems and internal and external audit sought to balance the goal of strong programs. corporate governance with the recogni- As part of ongoing efforts to address tion that smaller, non-public banking bank supervisory issues and enhance organizations typically have fewer supervision through guidance that resources and less-complex operations encourages sound practices, the Fedthan public organizations. eral Reserve, together with the other The Federal Reserve also provided banking agencies, in March amended comments to the Securities and the guidance on internal audit and out- Exchange Commission and the Public sourcing. SR Letter 03-5 conformed Company Accounting Oversight Board supervisory guidance to the indepenon their efforts to promote enhanced dence rules for external auditors promstandards for management and external ulgated under the Sarbanes-Oxley Act. auditors to follow when considering In addition, the policy strengthened internal control matters. In addition, and refined guidance intended to the Federal Reserve is working with enhance corporate governance at reguthe FDIC and other banking agen- lated institutions. cies to consider what changes should The Federal Reserve worked closely be made to the regulations imple- with the other banking agencies in menting the Federal Deposit Insur- reviewing the American Institute of ance Corporation Improvement Act Certified Public Accountants' exposure to promote strong internal controls draft of a proposed statement of posiand consistency with Sarbanes-Oxley tion, "Allowance for Credit Losses," requirements. which was issued for public comment in June. A joint comment letter was submitted in October. Efforts to Enhance Transparency In August the Federal Reserve, along The Federal Reserve has long supported with the other federal bank and thrift sound accounting policies and meaning- regulatory agencies, issued final rules ful public disclosure by banking and governing their authority to take discifinancial organizations to improve mar- plinary actions against independent pubket discipline and foster stable financial lic accountants and accounting firms markets. Effective market discipline that perform the audit and attestation can serve as an important complement services required by section 36 of the to bank supervision and regulation. Federal Deposit Insurance Act. The final The more informative the data released rules, which took effect on Octoby financial institutions, the better the ber 1, 2003, establish procedures under evaluation of counterparty risks by mar- which the agencies can, for good cause, ket participants can be and the better remove, suspend, or bar an accounttheir adjustments to the availability and ant or firm from performing audit pricing of funds will be. Thus, transpar- and attestation services for insured ency can promote efficiency in financial depository institutions with assets of markets and sound practices by banks. $500 million or more. The rules per- The Federal Reserve also seeks to mit immediate suspensions in limited strengthen audit and control standards circumstances. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

102 90th Annual Report, 2003 Bank Holding Company FR Y-9 series of reports was improved Regulatory Financial Reports by revising existing items and adding new items related to companies acquired The Federal Reserve requires that U.S. by bank holding companies that are bank holding companies submit peri- involved in significant acquisitions. odic regulatory financial reports. These In addition, mandatory electronic reports provide information essential submission of several reports— to the supervision of the organizations FR Y-9C, FR Y-9LP, FR Y-9SP, and and the formulation of regulations FR Y-9ES—was implemented, resultand supervisory policies. The Federal ing in more-efficient data collection and Reserve also uses the information in dissemination. responding to requests from Congress In June the FR Y-8 was revised to and the public for information on bank collect additional information to be holding companies and their nonbank used in monitoring compliance with subsidiaries. section 23A and to assist in monitoring The FR Y-9 series of reports pro- derivatives transactions and establishing vides standardized financial statements policy for regulating such transactions. for the consolidated bank holding com- The report was also revised to reflect pany. The reports are used to detect interpretations and definitions in Reguemerging financial problems, review lation W, the rule that comprehensively performance and conduct pre-inspection implements sections 23 A and 23B of the analysis, monitor and evaluate risk pro- Federal Reserve Act. files and capital adequacy, evaluate proposals for bank holding company Federal Financial Institutions mergers and acquisitions, and analyze Examination Council the holding company's overall financial condition. The nonbank subsidiary The Federal Reserve continued its parseries of reports, FR Y-ll and FR 2314, ticipation on the Federal Financial Instiaid the Federal Reserve in determining tutions Examination Council over 2003. the condition of bank holding compa- The FFIEC serves as a coordinating nies that are engaged in nonbanking body for the federal banking agencies activities and in monitoring the volume, and the National Credit Union Adminisnature, and condition of their nonbank- tration. State supervisory authorities also ing subsidiaries. The FR Y-8 report participate in some FFIEC initiatives. collects information on transactions During 2003, the FFIEC focused on between an insured depository institu- coordinating the agencies' efforts to tion and its affiliate that are subject identify and eliminate outdated, unnecto section 23A of the Federal Reserve essary, or unduly burdensome regu- Act. It enhances the Federal Reserve's lations. This initiative is pursuant to ability to monitor bank exposures to the Economic Growth and Regulatory affiliates and to ensure compliance with Paperwork Reduction Act of 1996. The section 23 A of the Federal Reserve Act. FFIEC also initiated a project to mod- In March 2003, several revisions to ernize and streamline the way in which the FR Y-9C report were implemented the banking agencies collect, process, to make it consistent with revisions to and distribute quarterly bank financial the bank Call Report and to conform to reports. In addition, the FFIEC continchanges in generally accepted account- ued its efforts related to examiner training principles. Also, the relevance of the ing and education, consumer compli- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 103 ance issues, bank surveillance processes, the Report of Assets and Liabilities of and information sharing. A few initia- U.S. Branches and Agencies of Fortives are highlighted below. eign Banks (FFIEC 002) to include additional information on derivatives contracts. Bank Call Reports As the federal supervisor of state mem- Information Technology ber banks, the Federal Reserve, acting in concert with the other federal banking In 2003 the FFIEC completed the first agencies through the FFIEC, requires year of a two-year pilot test of its banks to submit quarterly Reports of revised framework for the interagency Condition and Income (Call Reports). examination program for information Call Reports are the primary source of technology service providers. Examinadata for the supervision and regulation tions of providers of information techof banks and for the ongoing assessment nology and processing services to finanof the overall soundness of the nation's cial institutions are conducted by the banking system. Call Report data, which Federal Reserve or other financial also serve as benchmarks for the finan- institution supervisory agencies under cial information required by many other the Bank Service Company Act. The Federal Reserve regulatory financial revised framework promotes a riskreports, are widely used by state and based rationale for conducting such local governments, state banking super- examinations by identifying and analyzvisors, the banking industry, securities ing material supervisory risks to finananalysts, and the academic community. cial institutions that use the services The Call Report modernization of these companies. It includes riskproject is intended to improve the time- focused criteria for determining the liness and quality of supervisory data examination schedule and the scope of and to enhance market discipline the examinations. through more timely access by the During the year, the FFIEC also public. Proposed enhancements to the issued revisions to the FFIEC informadata collection and disclosure process tion systems examination manual, last include requiring electronic submission updated in 1996. Booklets on six topics of Call Reports to a central data reposi- (which will replace the current chaptory, accelerating the filing deadline for ters in the manual) were issued: inforreports, and requiring data validation mation security; business continuity checks to be performed by respondents planning; information technology audit; as a condition of the accepted filing e-banking; FedLine; and supervision of the reports. The central repository is of technology service providers. Also in expected to be ready for testing in late 2003, the Federal Reserve and the other 2004. agencies began developing the final six Call Report changes implemented in booklets planned to update the manual: 2003 include the reporting of insurance- retail payments; outsourcing; operarelated income, credit enhancements for tions; wholesale payments; managesecuritizations, accrued fees and finance ment; and development and acquisition. charges on credit cards, and the fair Agency examiners field-tested all but value of derivatives at small banks hav- the wholesale payments booklet in 2003, ing derivatives contracts. Also, a pro- and all six remaining booklets are schedposal was issued in November to revise uled for publication in 2004. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

104 90th Annual Report, 2003 Supervisory Information Reserve System staff, made significant Technology progress in identifying opportunities for enhancing business value through the Under the direction of the division's use of information technology. The chief technology officer, the supervisory supervision function completed impleinformation technology (SIT) function mentation of a Systemwide technology within the Board's Division of Banking platform for scheduling examination Supervision and Regulation facilitates resources. Staff members continue to the management of information technolprovide substantial assistance and ogy within the Federal Reserve's superresources to support modernization of vision function. Its goals are to ensure the Shared National Credit program. that The modernization is an interagency effort aimed at reducing examination • IT initiatives support a broad range of costs and improving the timeliness and supervisory activities without duplicareliability of data associated with the tion or overlap review of large, syndicated credit facilities of commercial banks. In conjunc- • the underlying IT architecture fully tion with efforts of Board and Reserve supports those initiatives Bank internal IT providers, the staff has also supported supervision and regu- • adequate resources are devoted to lation projects to assess opportunities interagency working groups on superin the areas of electronic applications, visory initiatives (for example, Call administrative systems, and learning Report modernization for the FFIEC management systems to improve the central data repository) delivery of information technology ser- • the supervision function's use of tech- vices for supervision. nology leverages the resources and expertise available more broadly National Information Center within the Federal Reserve System The National Information Center is • practices that maximize supervision's the Federal Reserve's comprehensive business value, cost effectiveness, and repository for supervisory, financial, and quality are identified, analyzed, and banking structure data and documents. approved for implementation NIC includes the National Examination Data system, which provides super- SIT works through assigned staff at the visory personnel and state banking Board of Governors and the Reserve authorities with access to NIC data, and Banks and through a Systemwide com- the Central Document and Text Reposimittee structure that ensures that key tory (CDTR), which contains documents staff members throughout the Federal supporting the supervisory process. Reserve System participate in identify- In 2003, a secure, web-enabled vering requirements and setting priorities sion of the NED application was put for IT initiatives. into operation. The application was updated to reflect changes in OCC and FDIC examination processes and SIT Project Management changes in the commercial bank Call In 2003, the SIT project management Report and the bank holding company staff, in partnership with other Federal FR Y-9 reports. The secure web ver- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 105 sion of NED is expected to be made bers at the Board of Governors, the available to state banking departments Reserve Banks, and state banking in early 2004. Also in 2003, the CDTR departments who have supervisory and was modified to include examina- regulatory responsibilities and students tion reports from other agencies and from foreign supervisory authorities. expanded to include reports of regional Training is offered at the basic, intermeand community examinations filed by diate, and advanced levels in several the Reserve Banks. Significant resources disciplines within bank supervision: continue to be devoted in support of Call safety and soundness, information tech- Report modernization for the FFIEC nology, international banking, and concentral data repository initiative, with sumer affairs. Classes are conducted in expected implementation in the fourth Washington, D.C., as well as at Reserve quarter of 2004. Banks and other locations. The Federal Reserve System also participates in training offered by the Staff Development FFIEC and by certain other regulatory The Federal Reserve System's staff agencies. The System's involvement development program trains staff mem- includes developing and implementing Training Programs for Banking Supervision and Regulation, 2003 Number of sessions conducted Program Total Regional Schools or seminars conducted by the Federal Reserve Core schools Banking and supervision elements 5 4 Operations and analysis 4 3 Bank management 4 2 Report writing 16 16 Management skills 10 9 Conducting meetings with management 13 13 Other schools Loan analysis 4 3 Examination management 5 5 Real estate lending seminar 3 3 Senior forum for current banking and regulatory issues 1 1 Banking applications 1 0 Principles of fiduciary supervision 2 1 Commercial lending essentials for consumer affairs .. 2 2 Introduction to consumer compliance examinations .. 2 0 Consumer compliance examinations II 2 2 CRA examination techniques 2 2 Fair lending examination techniques 2 2 Foreign banking organizations 2 2 Information systems continuing education 3 2 Capital markets seminars 8 6 Technology risk integration 8 8 Leadership dynamics 6 5 Seminar for senior supervisors of foreign central banks 1 1 Other agencies conducting courses 2 Federal Financial Institutions Examination Council 44 1 The Options Institute 1 1 1. Conducted jointly with the World Bank. 2. Open to Federal Reserve employees. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

106 90th Annual Report, 2003 Trends in Reserve Bank SupervisionLevels, 1999-2003 Type of staff 2003 2002 2001 2000 1999 Field examination staff 1,239 1,234 1,242 1,172 1,216 Commissioned field staff 936 892 861 786 893 basic and advanced training in relation was 79 percent. At the end of 2003, the to various emerging issues as well as System had 1,239 field examiners, of in specialized areas such as interna- which 936 were commissioned (table). tional banking, information technology, municipal securities dealing, capital markets, payment systems risk, white Regulation of the collar crime, and real estate lending. In U.S. Banking Structure addition, the System co-hosts the World The Board of Governors administers the Bank Seminar for students from devel- Bank Holding Company Act, the Bank oping countries. Merger Act, the Change in Bank Con- In 2003, the Federal Reserve trained trol Act, and the International Banking 1,952 students in System schools, 384 Act in relation to bank holding compain schools sponsored by the FFIEC, and nies, financial holding companies, mem- 19 in other schools, plus 283 representaber banks, and foreign banking organitives of foreign central banks, for a total zations. In doing so, the Federal Reserve of 2,638. (See accompanying table.) The acts on a variety of proposals that number of training days in 2003 totaled directly or indirectly affect the structure 13,768. of U.S. banking at the local, regional, The System gave scholarship assisand national levels; the international tance to the states for training their operations of domestic banking organiexaminers in Federal Reserve and zations; and the U.S. banking operations FFIEC schools. Through this program, of foreign banks. 309 state examiners were trained—209 in Federal Reserve courses, 95 in FFIEC programs, and 5 in other courses. Bank Holding Company Act A staff member seeking an examiner's commission is required to take a Under the Bank Holding Company Act, first proficiency examination and also a a corporation or similar organization second proficiency examination in one must obtain the Federal Reserve's of the following three specialty areas: approval before forming a bank holding safety and soundness, consumer affairs, company through the acquisition of one or information technology. In 2003, 121 or more banks in the United States. examiners passed the first proficiency Once formed, a bank holding comexamination. In the second proficiency pany must receive Federal Reserve examination, 55 examiners passed the approval before acquiring or estabsafety and soundness examination, 41 lishing additional banks. The act also passed the consumer affairs examina- identifies other activities permissible tion, and 1 passed the information tech- for bank holding companies; dependnology examination. The overall pass ing on the circumstances, these activirate for these proficiency examinations ties may or may not require Federal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 107 Decisions by the Federal Reserve on Domestic and International Applications, 2003 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 ir io ec n t o o r f o B f a t n h k e ing O of f f t i h ce e Federal Total Supervision and Secretary Reserve Banks Regulation Approved Denied Permitted Approved Denied Approved Approved Permitted Formation of bank holding company 14 0 0 0 0 152 53 222 Merger of bank holding company 6 0 0 0 0 4 25 12 47 Acquisition or retention of bank 27 0 0 0 0 2 95 33 157 Acquisition of nonbank 0 0 25 0 0 14 0 70 109 Merger of bank 6 0 0 0 0 7 59 0 72 Change in control 0 0 0 0 0 1 0 119 120 Establishment of a branch, agency, or representative office by a foreign bank .... 3 0 0 13 0 0 0 0 16 Other 287 0 0 53 0 131 1,106 348 1,925 Total 343 0 25 66 0 162 1,437 635 2,668 Reserve approval in advance of their petitive effects of the proposal, and the commencement. applicant's ability to make available to In 2003, the Board allowed bank the Board information deemed necesholding companies engaged in permis- sary to ensure compliance with applicasible derivatives activities to transfer ble law. In the case of a foreign banking title to commodities underlying deriva- organization seeking to acquire control tives contracts on an instantaneous, of a U.S. bank, the Federal Reserve also pass-through basis. In addition, the considers whether the foreign bank is Board expanded the degree to which subject to comprehensive supervision or bank holding companies may process, regulation on a consolidated basis by its store, and transmit nonfinancial data as home country supervisor. Data on decithey process, store, and transmit finan- sions regarding domestic and internacial data. tional applications in 2003 are shown in When reviewing a bank holding com- the accompanying table. pany application or notice that requires Bank holding companies generally prior approval, the Federal Reserve may engage in only those activities that considers the financial and managerial the Board has previously determined to resources of the applicant, the future be closely related to banking under secprospects of both the applicant and the tion 4(c)(8) of the act. Since 1996, the firm to be acquired, the convenience and act has provided an expedited priorneeds of the community to be served, notice procedure for certain permissible the potential public benefits, the com- nonbank activities and for acquisitions Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

108 90th Annual Report, 2003 of small banks and nonbank entities. Bank Merger Act Since that time the act has also permit- The Bank Merger Act requires that ted well-run bank holding companies all proposals involving the merger of that satisfy certain criteria to commence insured depository institutions be acted certain other nonbank activities on a on by the appropriate federal banking de novo basis without first obtaining agency. If the institution surviving the Federal Reserve approval. merger is a state member bank, the Fed- Since 2000, the Bank Holding Comeral Reserve has primary jurisdiction. pany Act has permitted the creation of Before acting on a merger proposal, the a special type of bank holding com- Federal Reserve considers the financial pany called a financial holding comand managerial resources of the applipany. Financial holding companies are cant, the future prospects of the existing allowed to engage in a broader range of and combined institutions, the convenonbank activities than are traditional nience and needs of the community to bank holding companies. Among other be served, and the competitive effects things, they may affiliate with securiof the proposed merger. It also considties firms and insurance companies and ers the views of certain other agenengage in certain merchant banking cies regarding the competitive factors activities. Bank holding companies involved in the transaction. During seeking financial holding company sta- 2003, the Federal Reserve approved tus must file a written declaration with seventy-two merger applications. the Federal Reserve System; most declarations are acted upon by one of the When the FDIC, the OCC, or the OTS has jurisdiction over a merger, the Reserve Banks under delegated author- Federal Reserve is asked to comment on ity. In 2003, forty-one domestic finanthe competitive factors related to the cial holding company declarations and proposal. By using standard terminoltwo foreign bank declarations were ogy in assessing competitive factors approved. in merger proposals, the four agencies Financial holding companies do not have sought to ensure consistency in have to obtain the Board's prior administering the Bank Merger Act. The approval to engage in or acquire a com- Federal Reserve submitted 506 reports pany engaged in financial activities that on competitive factors to the other agenare permissible under the Grammcies in 2003. Leach-Bliley Act. Instead, the financial holding company must notify the Board within thirty days after commencing the Change in Bank Control Act new activity or acquiring the company. A financial holding company may also The Change in Bank Control Act engage in certain other activities that requires persons seeking control of a have been determined to be financial in U.S. bank or bank holding company to nature or incidental to a financial activ- obtain approval from the appropriate ity or that are determined to be comple- federal banking agency before completmentary to a financial activity. In 2003, ing the transaction. The Federal Reserve the Board determined that certain lim- is responsible for reviewing changes in ited physical commodity trading activi- the control of state member banks and ties are complementary to the financial bank holding companies. In its review, activity of engaging regularly as princi- the Federal Reserve considers the finanpal in commodity derivatives activities. cial position, competence, experience, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 109 and integrity of the acquiring person; country supervisor shares information the effect of the proposed change on the regarding the operations of the foreign financial condition of the bank or bank bank with other supervisory authorities; holding company being acquired; the whether the foreign bank has provided effect of the proposed change on compe- adequate assurances that information tition in any relevant market; the com- concerning its operations and activities pleteness of information submitted by will be made available to the Board, the acquiring person; and whether the if deemed necessary to determine and proposed change would have an adverse enforce compliance with applicable law; effect on the federal deposit insur- whether the foreign bank has adopted ance funds. As part of the process, and implemented procedures to combat the Federal Reserve may contact other money laundering and whether the home regulatory or law enforcement agen- country of the foreign bank is develcies for information about acquiring oping a legal regime to address money 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 2003, the Federal Reserve the institution to be acquired. approved sixteen applications by for- In 2003, the Federal Reserve eign banks to establish branches, agenapproved 120 changes in control of cies, and representative offices in the state member banks and bank holding United 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 the investments require the prior approval foreign bank is subject to comprehen- of the Board. Excluding proposals sive supervision or regulation on a con- related to large domestic mergers, the solidated basis by its home country Board in 2003 approved sixteen propossupervisor. It also considers whether the als for significant overseas investments home country supervisor has consented by U.S. banking organizations. The Fedto the establishment of the U.S. office; eral Reserve also approved eleven applithe financial condition and resources of cations to make additional investments the foreign bank and its existing U.S. through an Edge Act corporation, one operations; the managerial resources of application to extend the corporate existthe foreign bank; whether the home ence of an existing Edge Act corpora- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

110 90th Annual Report, 2003 tion, and no applications to establish or the Federal Reserve reviewed eleven acquire a new agreement corporation. stock repurchase proposals by bank holding companies; all were approved by a Reserve Bank under delegated Applications by Member Banks authority. State member banks must obtain Federal Reserve approval to establish Public Notice of domestic branches, and all member Federal Reserve Decisions banks (including national banks) must obtain Federal Reserve approval to Most decisions by the Federal Reserve establish foreign branches. When that involve a bank holding company, reviewing proposals to establish domes- a bank merger, a change in control, or tic branches, the Federal Reserve the establishment of a new U.S. banking considers the scope and nature of the presence by a foreign bank are made banking activities to be conducted. known to the public by an order or an When reviewing proposals for foreign announcement. Orders state the decibranches, the Federal Reserve consid- sion, the essential facts of the appliers, among other things, the condition of cation or notice, and the basis for the the bank and the bank's experience in decision; announcements state only the international banking. In 2003, the Fed- decision. All orders and announcements eral Reserve acted on new and merger- are made public immediately; they are related branch proposals for 1,646 subsequently reported in the Board's domestic branches and granted prior weekly H.2 statistical release and in approval for the establishment of 4 new the Federal Reserve Bulletin. The H.2 foreign branches. release also contains announcements of State member banks must also obtain applications and notices received by the Federal Reserve approval to establish Federal Reserve upon which action has financial subsidiaries. These subsidiaries not yet been taken. For each pending may engage in activities that are finan- application and notice, the related H.2A cial in nature or incidental to finan- contains the deadline for comments. cial activities, including securities- and In 2003, the Board's public web site insurance-agency-related activities. In (www.federalreserve.gov) continued to provide information on orders and 2003, no applications for financial subannouncements. The web site was also sidiaries were approved. expanded to include an online guide for U.S. and foreign banking organizations Stock Repurchases by submitting applications or notices to the Bank Holding Companies Federal Reserve. A bank holding company may repurchase its own shares from its share- Timely Processing of Applications holders. When the company borrows money to buy the shares, the trans- The Federal Reserve sets internal target action increases the company's debt time frames for the processing of appliand decreases its equity. The Federal cations. The setting of internal targets Reserve may object to stock repurchases promotes efficiency at the Board and the by holding companies that fail to meet Reserve Banks and reduces the burden certain standards, including the Board's on applicants. Generally, the length of capital adequacy guidelines. In 2003, the target period ranges from twelve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 111 days to sixty days, depending on the rities. The Board's Regulation X applies type of application or notice filed. In these credit limitations, or margin 2003, 83 percent of decisions were made requirements, to certain borrowers and within the target time period. to certain credit extensions, such as credit obtained from foreign lenders by U.S. citizens. Enforcement of Several regulatory agencies enforce Other Laws and Regulations the Board's securities credit regulations. The Federal Reserve's enforcement The SEC, the National Association of responsibilities also extend to financial Securities Dealers, and the national disclosures by state member banks; securities exchanges examine brokers securities credit; and efforts, under the and dealers for compliance with Regula- Bank Secrecy Act, to counter money tion T. With respect to compliance with laundering. Regulation U, the federal banking 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 State member banks that issue securities of Thrift Supervision examine lenders registered under the Securities Exchange under their respective jurisdictions; and Act of 1934 must disclose certain infor- the Federal Reserve examines other mation of interest to investors, including Regulation U lenders. annual and quarterly financial reports Since 1990 the Board has published a and proxy statements. By statute, the nonexclusive list of foreign stocks that Board's financial disclosure rules must are eligible for margin treatment at be substantially similar to those of the broker-dealers on the same basis as Securities and Exchange Commission. domestic margin securities. In 2003 the At the end of 2003, fifteen 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 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 an important equity securities if the loan is secured by tool in the fight against money launderthose or other publicly held equity secu- ing; its requirements inhibit money laun- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

112 90th Annual Report, 2003 dering by creating a paper trail of ment Network and the Office of Foreign financial transactions that helps law Assets Control. enforcement and regulators identify and Staff of both sections also speak at trace the proceeds of illegal activity. banking conferences to promote best In addition to the specific require- practices in the industry with respect to ments of the Bank Secrecy Act, the anti-money-laundering initiatives. Inter- Board's Regulation H (12 CFR 208.63) nationally, section staff have provided requires each banking organization anti-money-laundering training and supervised by the Federal Reserve to technical assistance to countries in eastdevelop a written program for BSA ern and southern Africa, Asia, South compliance that is formally approved by and Central America, and the Caribthe institution's board of directors. The bean. Staff members have also particicompliance program must (1) establish pated in numerous multilateral antia system of internal controls to ensure money-laundering initiatives such as the compliance with the act, (2) provide Financial Action Task Force. for independent compliance testing, In 2003, the Federal Reserve contin- (3) identify individuals responsible for ued to provide expertise and guidance to coordinating and monitoring day-to-day the BSA Advisory Group, a committee compliance, and (4) provide training for established by Congress at the Treasury personnel as appropriate. To monitor Department that seeks to reduce unneccompliance, each Reserve Bank desig- essary burdens created by the BSA and nates senior, experienced examiners as to increase the utility of data gathered BSA and anti-money-laundering con- under the act to aid regulators and law tacts. During examinations of state enforcement. The Federal Reserve also member banks and U.S. branches and assisted the Treasury Department in agencies of foreign banks, examiners providing feedback to financial instireview the institution's compliance tutions on the reporting of suspicious with the BSA and determine whether activity. adequate procedures and controls to Since the terrorist attacks of Septemguard against money laundering are in ber 11, 2001, and continuing through place. 2003, the Federal Reserve has played an The Board has a Special Investiga- important role in many joint activities tions Section in the Division of Banking with bank supervisory and law enforce- Supervision and Regulation that con- ment authorities and the banking comducts financial investigations, provides munity, both domestically and abroad, expertise to the U.S. law enforcement to combat money laundering and terrorcommunity for investigation and train- ist financing. In the wake of the terrorist ing initiatives, and offers training to attacks, the FBI formed a multi-agency various foreign central banks and gov- law enforcement task force to trace the ernment agencies. In 2003, the division transactions and assets of terrorists; staff created an Anti-Money Laundering Pol- of the Special Investigations Section icy and Compliance Section, which is continue to participate in the task force. responsible for BSA and USA Patriot To address the mandates of the USA Act matters and works closely with vari- Patriot Act, the Federal Reserve issued a ous units at the Treasury Department, number of supervisory letters to domesincluding the Financial Crimes Enforce- tic and foreign banking organizations Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 113 Extensions of Credit by State Member Banks to their Executive Officers, 2002 and 2003 Range of interest Period Number Amount (dollars) rates charged (percent) 2002 October 1-December 31 650 74,514,000 0.0-19.8 2003 January 1-March 31 618 82.776,000 0.0-20.0 April 1-June 30 751 80,895,000 0.0-21.0 July 1-September 30 649 74,584,000 0.0-18.0 October 1-December 3 i 590 66,901,000 0.0-18.0 SOURCE. Call Reports. under its supervision on such topics as Extensions of Credit to private and correspondent banking and Executive Officers the new information-sharing protocols. Under section 22(g) of the Federal The letters described the act's require- Reserve Act, a state member bank must ments in these areas and the new rules include in its quarterly Call Report that have been or will be issued. information on all extensions of credit At the request of Treasury Departby the bank to its executive officers ment staff, and consistent with statutory since the date of the preceding report. requirements for consultation, the Fed- The accompanying table summarizes eral Reserve continues to actively assist this information for 2003. in the development of many other new rules related to the USA Patriot Act. The Federal Reserve's Patriot Act Working Federal Reserve Membership Group, which is composed of senior, experienced Bank Secrecy Act/anti- At the end of 2003, 2,890 banks were money-laundering examiners from members of the Federal Reserve System throughout the System, continues to and were operating 50,425 branches. work on examination procedures rela- These banks accounted for 37 percent of tive to the act's provisions and to all commercial banks in the United develop a new training curriculum for States and for 70 percent of all commerexaminers. cial banking offices. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

115 Federal Reserve Banks The Federal Reserve Banks contribute five to thirty-two and the number of to the setting of national monetary pol- check-adjustment locations from fortyicy and are involved in the supervision three to twelve. and regulation of banks and other finan- Spurred in part by aggressive multicial entities. They also operate a nation- year cost-containment targets, the wide payments system, distribute the Reserve Banks also undertook a number nation's currency and coin, and serve as of initiatives during the year to increase fiscal agent and depository to the United efficiency in the support services and States. customer support areas. In information technology, savings were realized through such initiatives as centralization of e-mail server administration and Major Initiatives management, standardization of desk- During 2003, the Federal Reserve Banks top PC configurations, and standardicontinued efforts to improve the effi- zation of server management. In human ciency of their operations through strate- resources, the Reserve Banks expect to gies aimed at standardizing and con- have centralized most of their payroll solidating operations, information sys- and benefits functions by year-end 2004, tems, and programs. Major milestones and in accounting, the Banks have sucassociated with two key initiatives cessfully adhered to a multiyear plan in the check-processing operation were to hold costs to 1997 spending levels. reached: the end of the check mod- In addition, the Banks have undertaken ernization project and the launch of a initiatives to reduce customer support check restructuring effort to reduce costs. In early 2004, the Banks will the number of Federal Reserve check- complete an effort to consolidate processing locations. electronic-access customer support at The check modernization effort two sites. reengineered check-processing hardware The events of September 11, 2001, and software to provide the Reserve illustrated the interdependence among Banks with common processing, imag- participants in the financial system and ing, and adjustment systems and to the way that market-based and geoenable the Banks to offer services via graphic concentration can intensify disthe Internet. ruptions. The New York Reserve Bank Check restructuring, which was contributed to two efforts to address announced early in 2003, will better these matters, which the Board, together align the Federal Reserve check- with other regulatory agencies, has been processing infrastructure with the pursuing since September 11. One effort decline in the use of checks, provide involved the development of sound greater flexibility in managing check practices to strengthen the resilience of operations, and improve resource allo- critical U.S. financial markets in the face cation. The Reserve Banks expect to of a regional disaster. A final paper on reduce, by year-end 2004, the number of sound practices was published jointly by check-processing locations from forty- the Board, the Office of the Comptroller Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

116 90th Annual Report, 2003 of the Currency, and the Securities and years, the Federal Reserve Banks have Exchange Commission in April 2003. recovered 97.8 percent of their priced The other effort concerned strength- services costs, including the PSAF ening the resilience of clearing and (table). settlement in the government securities Overall, the price index for priced market. A private-sector working group services decreased 0.9 percent from created by the Board in 2002 to explore 2002. Revenue from priced services ways in which resilience might be amounted to $886.9 million, other strengthened submitted its report in income related to priced services was December 2003 (and the Board pub- -$5.2 million, and costs related to priced lished the report in early January 2004). services totaled $931.3 million, result- The report contains recommendations ing in net income of -$49.6 million and for mitigating risks to the financial sys- a recovery rate of 85.1 percent of costs, tem resulting from the interruption or including the PSAF.2 termination of the services of a clearing bank for government securities due to operational or non-operational prob- Commercial Check lems. The Board endorsed the recom- Collection Service mendations. In 2003, operating expenses and imputed costs for the Reserve Banks' Developments in commercial check collection service Federal Reserve Priced Services totaled $803.2 million, while revenue amounted to $742.2 million and other The Monetary Control Act of 1980 income was -$4.3 million, resulting in requires that the Federal Reserve set net income of -$65.3 million. In 2002, fees for providing "priced services" to by comparison, operating expenses and depository institutions that, over the imputed costs totaled $751.2 million, long run, recover all the direct and indiwhile revenue amounted to $759.2 milrect costs of providing the services as lion and other income was $1.7 million, well as the imputed costs, such as the resulting in net income of $9.7 million. income taxes that would have been paid The decline in check service revenue and the return on equity that would have in 2003 was largely the result of declinbeen earned had the services been proing volume and customers' moving to vided by a private firm. The imputed lower-margin products. The Reserve costs and imputed profit are collectively Banks handled 15.8 billion checks, a referred to as the private-sector adjustdecrease of 4.7 percent from the ment factor (PSAF).1 Over the past ten 2. Financial data reported throughout this 1. In addition to income taxes and the return on chapter—revenue, other income, cost, net reveequity, the PSAF is made up of three imputed nue, and income before taxes—can be linked to costs: interest on debt, sales taxes, and assess- the pro forma statements at the end of this chapter. ments for deposit insurance by the Federal Deposit Other income is revenue from investment of clear- Insurance Corporation. Also allocated to priced ing balances net of earnings credits, an amount services are assets and personnel costs of the termed net income on clearing balances. Total cost Board of Governors that are related to priced is the sum of operating expenses, imputed costs services; in the pro forma statements at the end of (interest on debt, interest on float, sales taxes, and this chapter, Board expenses are included in oper- the Federal Deposit Insurance Corporation assessating expenses and Board assets are part of long- ment), imputed income taxes, and the targeted term assets. return on equity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 111 Priced Services Cost Recovery, 1994-2003 Millions of dollars except as noted Operating Revenue from Targeted return Total Cost recovery Year servicesl im ex p p u e t n e s d e s c o an st d s2 on equity costs (percent)3 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 2003 881.7 931.3 104.7 1,036.1 85.1 1994-2003 8,557.7 8,074.0 678.5 8,752.6 97.8 NOTE. Here and elsewhere in this chapter, components 2. For the ten-year period, includes operating expenses may not sum to totals or yield percentages shown because of $7,382.6 million, imputed costs of $440.3 million, and of rounding. imputed income taxes of $231.6 million. Also includes 1. For the ten-year period, includes revenue from ser- the effect of one-time accounting changes net of taxes of vices of $8,312.7 million and other income and expense $74.1 million for 1993 and $19.4 million for 1995. (net) of $245.1 million. 3. Revenue from services divided by total costs. 16.6 billion checks handled in 2002 operational strategy that will position (table). The decline in Reserve Bank the service to achieve its financial and check volume appears to be consistent payment system objectives over the long with nationwide trends away from the term. The strategy will reduce operating use of checks and toward greater use costs through a combination of meaof electronic payment methods.3 Over- sures: streamlining management strucall, the price index for check services tures, reducing staff, decreasing the increased 3.2 percent from 2002. number of check-processing locations, In response to the apparent contin- and increasing processing capacity at uing decline in check volumes, the some locations. The Banks will continue Reserve Banks took further steps in to provide check services nationwide, 2003 to reduce check service operating but by the end of 2004, the number of costs by implementing a business and sites at which checks are processed will be reduced to thirty-two, down from forty-five. Additionally, the number of 3. The Federal Reserve System's recent retail locations at which check adjustments payments research suggests that the number of checks written in the United States has been are made will be reduced from fortydeclining since the mid-1990s. See Geoffrey R. three to twelve. Of the thirteen offices Gerdes and Jack K. Walton II, "The Use of that will no longer process checks, the Checks and Other Noncash Payment Instruments five regional sites dedicated solely to in the United States," Federal Resen>e Bulletin, vol. 88 (August 2002), pp. 360-74. (The article processing checks will close. These is available on the Board's web site at changes are expected to reduce annual www.federalreserve.gov/pubs/bulletin/default.htm.) operating costs for the check service by During the late 1990s, the volume of checks proabout $60 million in 2005. cessed by the Reserve Banks rose, albeit slowly, suggesting that the proportion of interbank checks The volume of checks for which the cleared through the Reserve Banks increased. Federal Reserve office that serves the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

118 90th Annual Report, 2003 Activity in Federal Reserve Priced Services, 2003, 2002, and 2001 Thousands of items Percent change Service 2003 2002 2001 2002 to 2003 2001 to 2002 Commercial check 15,805,894 16,586,804 16,905,016 -4.7 -1.9 Funds transfer 125,936 117,133 115,308 7.5 1.6 Securities transfer 10,071 8,480 6,708 18.8 26.4 Commercial ACH 5,588,381 4,986,152 4,448,361 12.1 12.1 Noncash 280 333 412 -15.8 -19.2 NOTE. Activity in commercial check is the total num- line; in commercial ACH, the total number of commercial ber of commercial checks collected, including processed items processed; and in noncash, the number of items on and fine-sort items; in funds transfer and securities trans- which fees were assessed. fer, the number of transactions originated on line and off depositing bank is not the office that resulting in net income of $7.7 milserves the paying bank was slightly less lion. The Reserve Banks processed than the 3.7 billion in 2002. Of all 5.6 billion commercial ACH transacthe checks presented by the Reserve tions (worth $14.0 trillion), an increase Banks to paying banks, 22.7 percent of 12.1 percent from 2002. Overall, the (approximately 3.6 billion checks) were price index for ACH services decreased presented electronically, compared with 13.1 percent from 2002. 22.0 percent in 2002. The Banks cap- During 2003, the Reserve Banks tured images of 9.3 percent of the increased the number of countries to checks they collected, an increase from which they provide international ACH 8.1 percent in 2002. funds transfers from the United States In 2003, the Reserve Banks com- by initiating limited production services pleted a multiyear check modernization to Switzerland and the United Kingdom. project that standardized their software The Banks also prepared to offer limited and hardware for check processing, production services to Austria, Gercheck imaging, and check adjustments. many, the Netherlands, and Mexico in They also made available to deposi- 2004. tory institutions web-based access to check services. These investments are Fedwire Funds and expected to increase operating efficiency National Settlement Services and to enhance the Reserve Banks' ability to offer additional services to deposi- Reserve Bank operating expenses and tory institutions. imputed costs for the Fedwire Funds and National Settlement Services totaled $47.1 million in 2003. Revenue from Commercial Automated these operations totaled $51.4 million, Clearinghouse Services and other income amounted to Reserve Bank operating expenses and -$0.3 million, resulting in net income of imputed costs for commercial automated $4.0 million. During 2003, the Reserve clearinghouse (ACH) services totaled Banks improved the resilience of the $60.6 million in 2003. Revenue from services by establishing a third level of ACH operations totaled $68.7 million backup personnel to support Fedwire and other income totaled -$0.4 million, applications. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 119 Fedwire Funds Service government-sponsored enterprises, and certain international organizations to The Fedwire Funds Service allows par- other participants in the United States.4 ticipants to draw on their reserve or Reserve Bank operating expenses and clearing balances at the Reserve Banks imputed costs for providing this service and transfer funds to other institutions totaled $18.4 million in 2003. Revenue that maintain accounts at the Banks. In from the service totaled $21.9 million, 2003, the number of Fedwire funds and other income totaled -$0.1 million, transfers originated by depository instiresulting in net income of $3.4 million. tutions increased 7.5 percent from 2002, Approximately 10.1 million transfers of to approximately 125.9 million. Treasury and other securities were pro- In May, the Board announced that it cessed by the service during the year, an will expand the operating hours for the increase of 18.8 percent from 2002. Fedonline Fedwire Funds Service. The serwire Securities Service transfer fees for vice will open three and one-half hours both Treasury and non-Treasury securiearlier—at 9:00 p.m. eastern time the ties were reduced in 2003, while the previous calendar day rather than the service incorporated new fees associcurrent opening time of 12:30 a.m. eastated with automated claim adjustment ern time. Full implementation of the processing and a joint custody originaexpanded operating hours will occur in tion surcharge (table). May 2004. The impetus for the expansion of operating hours was industry requests to achieve greater overlap of Noncash Collection Service U.S. wholesale payments system operat- The Reserve Banks provide a service to ing hours with those of Asia-Pacific collect and process municipal bearer markets. bonds and coupons issued by state and local governments (referred to as "non- National Settlement Service cash" items). The service, which is cen- Private clearing arrangements that tralized at one Federal Reserve office, exchange and settle transactions may processed 280,000 noncash transactions use the Reserve Banks' National Settle- in 2003. In 2003, the Reserve Banks ment Service to settle their transactions. simplified the pricing structure for the This service is provided to approxi- Noncash Collection Service by charging mately seventy local and national pri- a single price regardless of deposit size. vate arrangements, primarily check The Banks now charge a single fee per clearinghouse associations but also cash letter of $13.00 and a single fee per other types of arrangements. In 2003, coupon envelope of $4.50. The Banks the Reserve Banks processed more also increased the return-item fee to than 422,000 settlement entries for these arrangements. 4. The expenses, revenues, and volumes reported here are for transfers of securities issued by federal government agencies, governmentsponsored enterprises, and international institu- Fedwire Securities Service tions. When the Reserve Banks provide transfer, account maintenance, and settlement services for The Fedwire Securities Service allows U.S. Treasury securities, they are acting as fiscal agents of the United States. The Treasury Departparticipants to electronically transfer ment assesses fees on depository institutions for securities issued by the U.S. Trea- some of these services. For details, see the section sury, federal government agencies, "Fiscal Agency Services" later in this chapter. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

120 90th Annual Report, 2003 Fees Paid by Depository Institutions for net income of -$104,172. Two Reserve Selected Federal Reserve Priced Services, Banks provided special cash services 2002 and 2003 during 2003 but had discontinued these Dollars services by year-end. The Banks will not provide special cash services in Item 2002 2003 2004. FEDWIRE FUNDS TRANSFERS, BY VOLUME TIER1 Float Tier (number of transfers per month 2) 1 (1 to 2,500) .31 .30 The Federal Reserve had daily average 2 (2,501 to 80,000) .22 .20 credit float of $43.0 million in 2003 and 3 (80,001 and more) .15 .10 Off-line surcharge 15.00 15.00 $318.6 million in 2002.5 The Federal Reserve includes the cost of or income NATIONAL SETTLEMENT SERVICES from float associated with priced ser- Entries, each .80 .80 vices as part of the fees for those Files, each 14.00 14.00 Minimum per month 60-100 60-100 services. FEDWIRE SECURITIES TRANSFERS Developments in Account maintenance Currency and Coin Per issue .41 .40 Per account 15.00 15.00 The Federal Reserve Banks received Transfers, each2 . .66 .40 35.7 billion notes from circulation in Off-line surcharge 25.00 25.00 2003, a 2.9 percent increase from 2002, and made payments of 36.6 billion notes 1. Rates apply only to their specified volume tiers. 2. Originated and received. to circulation during the year, a 3.2 percent increase from 2002. They received 48.1 billion coins from circulation in $35.00 and the bond-collection fee to 2003, a 10.8 percent increase from 2002, $55. Operating expenses and imputed and made payments of 61.5 billion coins costs for noncash operations totaled to circulation, a 5.3 percent increase $1.7 million in 2003, and revenue from 2002.6 totaled $2.3 million, resulting in net In October the Reserve Banks began income of $0.6 million. issuing to depository institutions the Department of the Treasury's rede- Special Cash Services signed $20 note, which features new and enhanced security features, including The Reserve Banks charge fees for prosubtle background colors. In connection viding special cash-related services, with the release of the new currency, the such as packaging currency in a Federal Reserve and the Bureau of nonstandard way. These services— Engraving and Printing conducted a glocollectively referred to as "special cash bal campaign to raise public awareness services"—account for a very small of the new note's design and security proportion (less than 1 percent) of the features. total cost of cash services provided to depository institutions by the Banks. Operating expenses and imputed costs 5. Credit float occurs when the Reserve Banks for special cash services totaled receive settlement for items prior to providing credit to the depositing institution. $504,284 in 2003. Revenue and other 6. Percentages reflect restatements of previincome totaled $400,112, resulting in ously reported data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 121 Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2003, 2002, and 2001 Thousands of dollars Agency and service 2003 2002 2001 DEPARTMENT OF THE TREASURY Bureau of the Public Debt Savings bonds 66,403.7 68,888.3 69,569.8 TreasuryDirect and Treasury coupons 33,013.5 33,953.6 36,610.1 Commercial book entry 4,836.3 8,830.1 9,998.1 Marketable Treasury issues 16,802.6 14,597.6 11,366.8 Computer applications and infrastructure development and support 7,836.7 2,349.6 222.4 Other services 1,460.7 2,385.8 1,255.7 Total 130,353.4 131,005.0 129,022.9 Financial Management Service Treasury tax and loan and Treasury general account .. 27,083.2 30,111.0 31,106.0 Government check processing ^5 624.7 30,284.4 30,310.2 Automated clearinghouse 6,253.9 6,280.0 9,665.2 Government agency deposits 2,217.6 2,082.2 2,272.9 Fedwire funds transfers 187.3 201.4 199.2 Computer applications and infrastructure development and support 75,511.9 46,782.6 27,281.3 Other services 10,602.8 8,173.1 3,490.2 Total 147,481.5 123,914.7 104,324.9 Other Treasury Total ' 13,913.5 14,471.2 13,149.8 Total, Treasury 291,748.5 269,390.9 246,497.5 OTHER ENTITIES Department of Agriculture Food coupons 7,791.4 10,240.8 13,197.2 U.S. Postal Service Postal money orders .... 10,959.5 12,381.6 11,255.0 All other entities Other services 16,508.2 16,494.1 14,434.0 Total, other entities 35,259.2 39,116.5 38,886.2 Total reimbursable expenses 327,007.7 308,507.4 285,383.7 Also during the year the Federal Developments in Reserve Board requested public com- Fiscal Agency and ment on its proposed currency recircula- Government Depository Services tion policy, which is designed to reduce depository institutions' overuse of Fed- The total cost of providing fiscal agency eral Reserve cash-processing services. and depository services to the Treasury The proposed policy, which would affect and other entities in 2003 amounted to approximately one hundred institutions $327.0 million, compared with $308.5 that have large cash businesses, includes million in 2002 (table). The majority of two key elements: (1) a custodial inven- these costs were incurred on behalf tory program that provides an incentive of the Treasury. Treasury-related costs to depository institutions to hold cur- were $291.7 million in 2003, comrency in their vaults and (2) a fee to pared with $269.4 million in 2002, an institutions that deposit and order cur- increase of 8.3 percent. The cost of prorency within the same week. viding services to other entities was Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

122 90th Annual Report, 2003 $35.3 million, compared with $39.1 mil- sury securities, a 12.7 percent increase lion in 2002. In 2003, as in 2002, the from 2002. Treasury and other entities reimbursed TreasuryDirect customers may sell the Reserve Banks for the costs of pro- their securities for a fee through Sell viding these services. Direct, a program operated by one of the Reserve Banks. That Bank sold more Fiscal Agency Services than 14,000 securities worth $671.6 million in 2003, compared with nearly As fiscal agents, the Reserve Banks 14,000 securities worth $589.8 million provide to the Treasury services related in 2002. It collected more than $491,000 to the federal debt. For example, they in fees on behalf of the Treasury, an issue, transfer, reissue, exchange, and increase of 6 percent from the almost redeem marketable Treasury securities $464,000 in fees collected in 2002. and savings bonds; they also process secondary market transfers initiated by Savings Bonds depository institutions. Additionally, the Reserve Banks support Treasury and Reserve Bank operating expenses other government agencies in their for savings bond activities totaled efforts to modernize government pay- $66.4 million in 2003, a decrease of ment systems. 3.6 percent from 2002. The Banks printed and mailed 40.1 million savings Marketable Treasury Securities bonds on behalf of the Treasury's Bureau of the Public Debt, a 7.6 percent Reserve Bank operating expenses for increase from 2002. They issued more activities related to marketable Treasury than 7.0 million Series I (inflationsecurities (Fedwire Securities Service, indexed) savings bonds and 28.6 mil- TreasuryDirect, marketable issues, and lion Series EE savings bonds. Reissued Treasury coupons) totaled $54.7 milor exchanged bonds accounted for lion, a 4.8 percent decrease from 2002. the remaining bonds printed. The The Reserve Banks processed nearly Banks processed approximately 569,000 140,000 tenders for Treasury securiredemption, reissue, and exchange transties, compared with 167,000 in 2002, actions, a 7.9 percent decrease from and handled 2.2 million reinvestment 2002. Reserve Bank staff responded to requests, compared with 2.5 million in 1.7 million service calls from owners of 2002. savings bonds, a 4.9 percent increase The Reserve Banks operate two bookfrom 2002. Starting in 2004, the Reserve entry securities systems for Treasury Banks will reduce the number of Fedsecurities: the Fedwire Securities Sereral Reserve sites that provide savings vice, which provides custody and transbond and retail marketable Treasury fer services, and TreasuryDirect, which securities services. The consolidation provides custody services only.7 Almost will be managed to minimize the effect 98 percent of the total par value of Treaon investors as these services move sury securities outstanding at year-end toward all-electronic processing. 2003 was held by the Fedwire Securities Service. The Reserve Banks in 2003 originated 9.4 million transfers of Trea- Depository Services The Reserve Banks maintain the Trea- 7. TreasuryDirect was designed for individuals who plan to hold their securities until maturity. sury's funds account, accept deposits of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 123 federal taxes and fees, pay checks drawn ate the Treasury's Paper Check Converon the Treasury's account, and make sion program, whereby checks written electronic payments on behalf of the to government agencies are converted at Treasury. the point of sale into ACH transactions. In 2003, the Reserve Banks originated Federal Tax Payments nearly 1.2 million ACH transactions through the two programs, a significant Reserve Bank operating expenses increase from the nearly 215,000 origirelated to federal tax payments in 2003 nated in 2002, which was the first full totaled $27.1 million. These operayear for both programs. tions include the Treasury Tax and Loan The Banks operate Treasury's Autoprogram, which allows the Treasury to mated Standard Application for Payinvest balances with qualifying deposiment (ASAP), which processed $384.2 tory institutions. The Federal Reserve billion in Fedwire funds transfers and enhanced the program in 2003 by mak- ACH payments in 2003, compared with ing the Term Investment Option a per- $360.0 billion in 2002. In December, the manent feature. The Term Investment Reserve Banks implemented ASAP.gov, Option allows the Treasury to place which allows grant recipients to request investments with depository institutions payments on the Internet. The Reserve for a set term, the interest rate being Banks also operate Treasury's Intradetermined by auction. The program governmental Payments and Collecadded approximately $2.8 million to the tion application (IPAC), which transfers Treasury's investment income in 2003. funds and descriptive data between federal agencies. In 2003, IPAC processed Payments Processed for the Treasury nearly one million transactions, with a Reserve Bank operating expenses re- total value of nearly $41.9 trillion, comlated to government payments amounted pared with nearly $37.4 trillion in 2002. to $34.3 million in 2003. The Banks processed 914.0 million ACH trans- Services Provided to Other Entities actions for the Treasury, an increase of 3.5 percent from 2002, and 667,000 The Reserve Banks provide fiscal Fedwire funds transfers, an increase of agency and depository services to other 55.1 percent from 2002.8 They also domestic and international entities when processed 266.9 million paper govern- required to do so by the Secretary of the ment checks, a decrease of 7.7 percent Treasury or when required or permitted from 2002. In addition, the Banks issued to do so by federal statute. One such 311,000 fiscal agency checks, a decrease service is the provision of food coupon of 15.5 percent from 2002. services for the Department of Agri- The Reserve Banks also assist Trea- culture. In 2003, operating expenses sury with its continued efforts to facili- for food coupon services declined to tate electronic payments. The Banks $7.8 million, 24.0 percent lower than in operate Pay.gov, a Treasury program 2002. The Banks redeemed 286.6 milthat allows members of the public to lion food coupons, a decrease of make payments to the federal govern- 42.7 percent from 2002. ment over the Internet. They also oper- As fiscal agents of the United States, the Reserve Banks also process all postal money orders deposited by banks 8. The latter percentage reflects restatement of previously reported data. for collection. In 2003, they processed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

124 90th Annual Report, 2003 198.3 million postal money orders, a security/emergency preparedness prodecrease of 8.4 percent from 2002. grams offered by the National Communications System. In partnership with Electronic Access the Securities and Exchange Commission and the Commodity Futures Trad- The Federal Reserve continues to ing Commission, the Federal Reserve improve the ability of depository instituextended sponsorship to clearing and tions to access an array of web-based settlement utilities, key financial instituapplications for check imaging, cash tions, and key market participants. ordering, savings bond processing, and The Reserve Banks initiated efforts accounting information. With improveto improve the resilience of the Fedwire ments in the technology enabling the telecommunications network and are security of web applications, the working with telecommunications ven- Reserve Banks plan to continue to dors and other government agencies to expand the delivery of web-based seridentify policies that would improve vices to include funds transfer services the resilience of the telecommunications through Fedwire and ACH and to cominfrastructure for critical financial serplete the migration of all remaining services functions. vices provided through FedLine DOS to FedLine for the Web. To complement the move to web- Examinations of the based electronic access, the Reserve Federal Reserve Banks Banks are completing consolidation of Section 21 of the Federal Reserve Act the electronic-access customer support requires the Board of Governors to order function to two offices. The consolian examination of each Federal Reserve dation will improve the efficiency and Bank at least once a year. The Board consistency of customer support while engages a public accounting firm to perensuring the continued delivery of form an annual audit of the combined high-quality electronic-access support financial statements of the Reserve services. Banks (see the section "Federal Reserve Banks Combined Financial State- Information Technology ments"). The public accounting firm In 2003, the Federal Reserve Banks also audits the annual financial statecontinued several major cost-reduction ments of each of the twelve Banks. The initiatives to centralize or standardize Reserve Banks use the framework estabcommon information technology utili- lished by the Committee of Sponsoring ties and resources. Projects are under Organizations of the Treadway Comway to standardize certain local area mission (COSO) in assessing their internetwork components, telephone pri- nal controls over financial reporting, vate branch exchange systems, remote including the safeguarding of assets. access, and desktop hardware and soft- Within this framework, management of ware. In addition to reducing costs each Reserve Bank provides an asserover the long term, these initiatives tion letter to its board of directors annuare expected to facilitate interoperabil- ally confirming adherence to COSO ity, improve network efficiency, and standards, and a public accounting firm increase productivity. certifies management's assertion and During the year, the Federal Reserve issues an attestation report to the Bank's board of directors and to the Board of also expanded its criteria for participa- Governors. tion in the telecommunications national Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 125 Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2003 and 2002 Millions of dollars Item 2003 2002 Current income 23,793 26,760 Current expenses 2,463 2,227 Operating expensesl .... 2,342 2,071 Earnings credits granted 121 156 Current net income 21,330 24,533 Net additions to (deductions from, - ) current net income 2,481 2,149 Assessments by the Board of Governors 805 635 For expenditures of Board 297 205 For cost of currency 508 430 Net income before payments to Treasury 23,006 26,048 Dividends paid 518 484 Transferred to surplus 467 1,068 Payments to Treasury2 22,022 24,496 1. Includes net periodic pension costs of $60 million in 2. Interest on Federal Reserve notes. 2003 and a credit for net periodic pension costs of $157 million in 2002. The firm engaged for the audits of on-site reviews based on the division's the individual and combined financial risk-assessment methodology. The 2003 statements of the Reserve Banks for examinations also included assessing the 2003 was PricewaterhouseCoopers LLP efficiency and effectiveness of the inter- (PwC). Fees for these services totaled nal audit function. $1.4 million. To ensure auditor indepen- Each year, to assess compliance with dence, the Board requires that PwC be the policies established by the Federal independent in all matters relating to the Reserve's Federal Open Market Comaudit. Specifically, PwC may not per- mittee (FOMC), the division also examform services for the Reserve Banks or ines the accounts and holdings of the others that would place it in a position System Open Market Account at the of auditing its own work, making man- Federal Reserve Bank of New York and agement decisions on behalf of the the foreign currency operations con- Reserve Banks, or in any other way ducted by that Bank. In addition, a impairing its audit independence. In public accounting firm certifies the 2003 the Reserve Banks did not engage schedule of participated asset and lia- PwC for non-audit services other than a bility accounts and the related schedmiscellaneous purchase of educational ule of participated income accounts at and research materials at a rate available year-end. Division personnel follow to the general public. up on the results of these audits. The The Board's annual examination of FOMC receives the external audit the Reserve Banks in 2003 included a reports and the report on the division's wide range of off-site and on-site over- follow-up. sight activities conducted by the Division of Reserve Bank Operations and Income and Expenses Payment Systems. Division personnel monitor the activities of each Reserve The accompanying table summarizes the Digitized B fo a r n F k R o A n S E a R n ongoing basis and conduct income, expenses, and distributions of http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

126 90th Annual Report, 2003 Securities and Loans of the Federal Reserve Banks, 2001-2003 Millions of dollars except as noted U.S. Item and year Total government Loans 2 securitiesl Average daily holdings3 2001 559,323 558,926 397 2002 621,834 621,721 113 2003 683,438 683,294 144 Earnings4 2001 . 30,536 30,523 13 2002 25,527 25,525 2 2003 22,598 22,597 1 Average interest rate (percent) 2001 5.46 5.46 3.18 2002 4.11 4.11 1.94 2003 3.31 3.31 1.00 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. net earnings of the Federal Reserve down from $24,496 million in 2002; Banks for 2002 and 2003. the payments equal net income after the Income in 2003 was $23,793 million, deduction of dividends paid and of the compared with $26,760 million in 2002. amount necessary to bring the surplus of Expenses totaled $3,268 million ($2,342 the Reserve Banks to the level of capital million in operating expenses, $121 mil- paid in. lion in earnings credits granted to In the "Statistical Tables" section of depository institutions, $297 million in this volume, table 5 details the income assessments for expenditures by the and expenses of each Reserve Bank for Board of Governors, and $508 million 2003 and table 6 shows a condensed for the cost of new currency). Revenue statement for each Bank for the years from priced services was $887 million. 1914 through 2003. A detailed account The profit and loss account showed a of the assessments and expenditures of net profit of $2,481 million. The profit the Board of Governors appears in the was due primarily to unrealized gains on section "Board of Governors Financial assets denominated in foreign curren- Statements." cies revalued to reflect current market exchange rates. Statutory dividends paid Holdings of Securities and Loans to member banks totaled $518 million, $34 million more than in 2002; the The Federal Reserve Banks' average increase reflects an increase in the capi- daily holdings of securities and loans tal and surplus of member banks and a during 2003 amounted to $683,438 milconsequent increase in the paid-in capi- lion, an increase of $61,604 million tal stock of the Reserve Banks. from 2002 (table). Holdings of U.S. gov- Payments to the U.S. Treasury in the ernment securities increased $61,573 form of interest on Federal Reserve million, and holdings of loans increased notes totaled $22,022 million in 2003, $31 million. The average rate of interest Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 127 earned on the Reserve Banks' holdings have been the only operation remaining of government securities declined to at the two Branches. Management at the 3.31 percent, from 4.11 percent in 2002, St. Louis Reserve Bank concluded that and the average rate of interest earned the most cost-effective solution would on loans declined to 1.00 percent, from be to consolidate currency processing at 1.94 percent. two other Reserve Bank offices and outsource the paying and receiving functions to a cash depot (to be carried out Volume of Operations by either an armored carrier or a finan- Table 8 in the "Statistical Tables" sec- cial institution). tion shows the volume of operations in With this consolidation and outsourcthe principal departments of the Federal ing arrangement, the Louisville and Reserve Banks for the years 2000 Little Rock Branches will operate on a through 2003. public and community affairs model and will be responsible for such activities as director recruitment, economic informa- Federal Reserve Bank Branches tion gathering, community outreach, and In 2003, the Board voted to approve economic and financial education. Each a proposal by the St. Louis Federal Branch will maintain its economic Reserve Bank to change substantively policy input through meetings of the the nature of the Louisville and Little Branch board of directors, will arrange Rock Branches to a community out- strategic opportunities for public appearreach focus with no operations. Both ances by senior Federal Reserve offi- Branches will maintain their presence in cials, and will maintain contacts with leased office space to accommodate the local politicians and business leaders. boards of directors and the community outreach programs, thereby eliminating Federal Reserve Bank Premises the need for the existing Branch buildings. The Reserve Bank's board of In 2003, the final designs for the Dallas directors and the Financial Services Pol- Federal Reserve Bank's new Houston icy Committee reviewed and endorsed Branch and the Chicago Bank's Detroit the proposal. In the past, Reserve Branch buildings were approved, and Bank Branch responsibilities typically construction of both new buildings included a larger array of operations began. Also, the Board approved the than is the case today. For example, purchase of property for the new Kansas most Branches in the 1980s performed City Bank building, the Bank retained ACH, off-line Fedwire, and fiscal ser- design and construction consultants for vices and processed food coupons in the project, and the project's design was addition to cash and checks. Reserve initiated. Banks have since consolidated many of The Board also approved the purtheir operations, and operations at most chase of a parking garage and a ware- Branches are limited to cash and check house for the St. Louis Reserve Bank to processing. be used for staff parking and for remote Check operations at the Louisville screening of deliveries, as well as the and Little Rock Branches will be elimi- Bank's long-term plan to construct an nated as part of the ongoing check addition to its current headquarters facilrestructuring initiative. With the elimi- ity. In addition, the Board approved the nation of check operations, cash would Richmond Reserve Bank's purchase of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

128 90th Annual Report, 2003 an office building as a relocation site for receiving facility and projects at several critical System staff. Internal renovation Banks to prepare facilities for the conof the building was essentially com- solidation of certain retail payments pleted in 2003. activities. Also during the year the Board The multiyear renovation program approved a building program for the continued at the New York Bank's head- San Francisco Bank's Seattle Branch quarters building, and the cleaning and that includes a new building for the repair of the exterior stonework was Branch's cash operation and Branch completed. administration and the lease or purchase Security enhancement programs were of a building for the Branch's retail pay- undertaken in 2003 at several facilities ments operation. The Bank continued as a result of the events of Septemto interview potential design consultants ber 11, 2001. The programs included a and evaluate possible sites for the project to improve external perimeter project. security for the Boston Bank that In addition, the Board approved involved restoration of Bank property the purchase of property behind the necessitated by construction of the Dallas Bank for construction of a re- recently completed Central Artery/ mote vehicle-screening and shipping/ Tunnel, an underground roadway. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 129 Pro Forma Financial Statements for Federal Reserve Priced Services Pro Forma Balance Sheet for Priced Services, December 31, 2003 and 2002 Millions of dollars Item 2003 2002 Short-term assets (Note 1) Imputed reserve requirements on clearing balances 1,296.4 1,047.8 Investment in marketable securities ... 11,332.5 9,051.3 Receivables 77.1 78.7 Materials and supplies 2.3 3.4 Prepaid expenses 35.6 34.8 Items in process of collection 5,271.9 6,958.6 Total short-term assets 18,015.8 17,174.7 Long-term assets (Note 2) Premises 494.6 475.0 Furniture and equipment 179.4 179.2 Leases and leasehold improvements .. 103.2 91.2 Prepaid pension costs 787.9 809.2 Total long-term assets 1,565.1 1,554.6 Total assets 19,580.9 18,729.3 Short-term liabilities Clearing balances and balances arising from early credit of uncollected items 11,788.1 10,550.2 Deferred-availability items 6,448.3 6,886.4 Short-term debt .0 .0 Short-term pavables 78.1 83.9 Total short-term liabilities 18,314.4 17,520.5 Long-term liabilities Long-term debt .0 .0 Postretirement/postemployment benefits obligation 287.5 272.3 Total long-term liabilities 287.5 272.3 Total liabilities 18,601.9 17,792.8 Equity 979.0 936.4 Total liabilities and equity (Note 3) ... 19,580.9 18,729.3 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

130 90th Annual Report, 2003 Pro Forma Income Statement for Federal Reserve Priced Services, 2003 and 2002 Millions of dollars Item 2003 2002 Revenue from services provided to depository institutions (Note 4) 886.9 916.3 Operating expenses (Note 5) 941.6 876.0 Income from operations -54.7 40.2 Imputed costs (Note 6) Interest on float -.7 -6.8 Interest on debt .0 .0 Sales taxes 12.1 11.4 FDIC insurance .0 11.4 .0 4.6 Income from operations after imputed costs -66.1 35.6 Other income and expenses (Note 7) Investment income 108.0 148.9 Earnings credits -113.2 -5.2 -146.8 2.1 Income before income taxes -71.3 37.7 Imputed income taxes (Note 8) -21.7 11.0 Net income -49.6 26.6 MEMO: Targeted return on equity (Note 9) ... 104.7 92.5 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, 2003 Millions of dollars Com- Commercial Fedwire Fedwire Noncash Cash Item Total check funds securities mercial services services ACH collection Revenue from services (Note 4) 886.9 742.2 51.4 21.9 68.7 2.3 Operating expenses 941.6 822.0 44.8 16.6 56.4 L4 -A (Note 5) -54.7 -79.8 6.7 5.3 12.3 .9 -.1 Income from operations 11.4 9.7 .6 .3 .8 .0 .0 Imputed costs (Note 6) Income from operations -66.1 -89.5 6.0 5.1 11.5 -.1 after imputed costs Other income and expenses, net (Note 7) -5.2 -4.3 -.3 -.1 -.4 Income before income taxes .. -71.3 -93.8 5.7 4.9 11.1 -.1 Imputed income taxes (Note 8) -21/7 -28.5 1.7 1.5 3.4 Net income . -49.6 -65.3 4.0 3.4 7.7 -.1 MEMO: Targeted return on equity (Note 9) 104.7 89.4 5.4 2.2 7.5 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 131 FEDERAL RESERVE BANKS NOTES TO PRO FORMA FINANCIAL STATEMENTS FOR PRICED SERVICES (1) SHORT-TERM ASSETS nished by a private-sector firm. Other short-term liabilities include clearing balances maintained at Reserve The imputed reserve requirement on clearing balances Banks and deposit balances arising from float. Other held at Reserve Banks by depository institutions reflects a long-term liabilities consist of accrued postemployment treatment comparable to that of compensating balances and postretirement benefits costs and obligations on capiheld at correspondent banks by respondent institutions. tal leases. The reserve requirement imposed on respondent balances must be held as vault cash or as non-earning balances maintained at a Reserve Bank; thus, a portion of priced (4) REVENUE services clearing balances held with the Federal Reserve Revenue represents charges to depository institutions for is shown as required reserves on the asset side of the priced services and is realized from each institution balance sheet. Another portion of the clearing balances through one of two methods: direct charges to an instituis used to finance short-term and long-term assets. The tion's account or charges against its accumulated earnremainder of clearing balances is assumed to be invested ings credits. in three-month Treasury bills, shown as investment in marketable securities. Receivables are (1) amounts due the Reserve Banks for (5) OPERATING EXPENSES priced services and (2) the share of suspense-account and Operating expenses consist of the direct, indirect, and difference-account balances related to priced services. other general administrative expenses of the Reserve Materials and supplies are the inventory value of short- Banks for priced services plus the expenses for staff term assets. members of the Board of Governors working directly on Prepaid expenses include salary advances and travel the development of priced services. The expenses for advances for priced-service personnel. Board staff members were $6.4 million in 2003 and Items in process of collection is gross Federal Reserve $5.1 million in 2002. The credit to expenses under cash items in process of collection (CIPC) stated on a SFAS 87 (see note 2) is reflected in operating expenses. basis comparable to that of a commercial bank. It reflects The income statement by service reflects revenue, adjustments for intra-System items that would otherwise operating expenses, and imputed costs. Certain corporate be double-counted on a consolidated Federal Reserve overhead costs not closely related to any particular priced balance sheet; adjustments for items associated with non- service are allocated to priced services in total based on priced items, such as those collected for government an expense-ratio method, but are allocated among priced agencies; and adjustments for items associated with services based on management decision. Corporate overproviding fixed availability or credit before items are head was allocated among the priced services during received and processed. Among the costs to be recovered 2003 and 2002 as follows (in millions): under the Monetary Control Act is the cost of float, or net CIPC during the period (the difference between gross 2003 2002 CIPC and deferred-availability items, which is the portion of gross CIPC that involves a financing cost), valued at Check 38.9 40.3 the federal funds rate. ACH 3.3 4.1 Fedwire funds 2.1 3.3 Fedwire securities 1.1 1.9 (2) LONG-TERM ASSETS Noncash services .1 .1 Consists of long-term assets used solely in priced ser- Special cash services .0 .1 vices, the priced-services portion of long-term assets Total 53.4 49.7 shared with nonpriced services, and an estimate of the assets of the Board of Governors used in the development of priced services. Effective Jan. 1, 1987, the Reserve (6) IMPUTED COSTS Banks implemented the Financial Accounting Standards Imputed costs consist of interest on float, interest on debt, Board's Statement of Financial Accounting Standards sales taxes, and the FDIC assessment. Interest on float is No. 87, Employers' Accounting for Pensions (SFAS 87). derived from the value of float to be recovered, either Accordingly, the Reserve Banks recognized expenses explicitly or through per-item fees, during the period. of $21.3 million in 2003 and credits to expenses of Float costs include costs for checks, book-entry securi- $48.4 million in 2002 and corresponding decrease or ties, noncash collection, ACH, and funds transfers. increase in this asset account. Interest is imputed on the debt assumed necessary to finance priced-service assets. There was no debt in 2003 (3) LIABILITIES AND EQUITY because clearing balances fund short-term and long-term Under the matched-book capital structure for assets, debt. The sales taxes and FDIC assessment that the Fedshort-term assets are financed with clearing balances in eral Reserve would have paid had it been a private-sector 2002 and short-term payables and short-term debt in firm are among the components of the PSAF (see note 3). 2001. Long-term assets are financed with clearing bal- Float cost or income is based on the actual float ances in 2003 and 2002. The PSAF consists of the taxes incurred for each priced service. Other imputed costs are that would have been paid and the return on capital that allocated among priced services according to the ratio of would have been provided had priced services been fur- operating expenses less shipping expenses for each ser- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

132 90th Annual Report, 2003 vice to the total expenses for all services less the total directly. Float recovered through direct charges and pershipping expenses for all services. item fees is valued at the federal funds rate; credit float The following list shows the daily average recovery of recovered through per-item fees has been subtracted from actual float by the Reserve Banks for 2003 in millions of the cost base subject to recovery in 2003. dollars: (7) OTHER INCOME AND EXPENSES Total float 285.2 Consists of investment income on clearing balances and Unrecovered float 6.9 the cost of earnings credits. Investment income on clear- Float subject to recovery 278.3 ing balances represents the average coupon-equivalent Sources of recovery of float yield on three-month Treasury bills applied to the total Income on clearing balances 27.9 clearing balance maintained, adjusted for the effect of As-of adjustments -328.3 reserve requirements on clearing balances. Expenses for Direct charges 624.8 Per-item fees -702.7 earnings credits granted to depository institutions on their clearing balances are derived by applying the average Unrecovered float includes float generated by services federal funds rate to the required portion of the clearing to government agencies and by other central bank ser- balances, adjusted for the net effect of reserve requirevices. Float recovered through income on clearing bal- ments on clearing balances. ances 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). reserve or clearing balances or by billing institutions Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

133 The Board of Governors and the Government Performance and Results Act Under the Government Performance and report for 2002-03 should be completed Results Act of 1993 (GPRA), federal in April 2004. agencies are required to prepare, in con- When completed, the strategic plan, sultation with the Congress and outside performance budget, and performance stakeholders, a strategic plan covering a report will be available on the Board's multiyear period and to submit annual public web site (www.federalreserve.gov/ performance budgets and performance boarddocs/rptcongress). The Board's misreports. Though not covered by the act, sion statement and a summary of the the Board of Governors is volunta- goals and objectives set forth in the strarily complying with many of the act's tegic plan and performance budget are mandates. given below. Strategic Plan, Performance Mission Budget, and Performance Report The mission of the Board is to foster the stability, integrity, and efficiency of the The Board's latest strategic plan in the nation's monetary, financial, and pay- GPRA format, to be released in early ment systems so as to promote optimal 2004, covers the period 2004-08. The document articulates the Board's mis- macroeconomic performance. sion, sets forth major goals for the period, outlines strategies for achieving Goals and Objectives those goals, and discusses the environ- The Federal Reserve has five primary ment and other factors that could affect goals with interrelated and mutually their achievement. It also addresses reinforcing elements: issues that cross agency jurisdictional lines, identifies key quantitative measures of performance, and discusses Goal performance evaluation. To conduct monetary policy that pro- The 2004-05 performance budget and motes the achievement of maximum the 2002-03 performance report will be sustainable long-term growth and the posted on the Board's public web site in price stability that fosters that goal. early 2004 for access by the Congress, the public, and the General Accounting Objectives Office. The performance budget sets forth specific targets for some of the • Stay abreast of recent developments performance measures identified in the and prospects in the U.S. economy strategic plan. The performance budget and financial markets and in those also describes the operational processes abroad, so that monetary policy deciand resources needed to meet those tar- sions will be well informed. gets and discusses data validation and • Enhance our knowledge of the strucverification of results. The performance tural and behavioral relationships in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

134 90th Annual Report, 2003 the macroeconomic and financial mar- applicable laws, rules, regulations, kets, and improve the quality of the policies, and guidelines through a data used to gauge economic per- comprehensive and effective superviformance, through developmental sion program. research activities. • Implement monetary policy effectively in rapidly changing economic Goal circumstances and in an evolving financial market structure. To enforce the consumer financial ser- • Contribute to the development of U.S. vices laws fully and fairly, protect and international policies and procedures, promote the rights of consumers under in cooperation with the Department of these laws, and encourage banks to meet the Treasury and other agencies. the credit needs of consumers, including • Promote understanding of Federal those in low- and moderate-income Reserve policy among other govern- neighborhoods. ment policy officials and the general public. Objectives • Maintain a strong consumer compli- Goal ance supervision and complaint investigation program that protects con- To promote a safe, sound, competitive, sumers and reflects the rapidly and accessible banking system and changing financial services industry. stable financial markets. • Implement statutes designed to inform and protect consumers that reflect Objectives congressional intent while achieving the proper balance between consumer • Promote overall financial stability, protection and industry costs. manage and contain systemic risk, and • Promote equal access to banking ensure that emerging financial probservices. lems are identified early and success- • Promote community development in fully resolved before they become historically underserved areas. crises. • Provide a safe, sound, competitive, and accessible banking system Goal through comprehensive and effective supervision of U.S. banks, bank and To foster the integrity, efficiency, and financial holding companies, foreign accessibility of U.S. payment and settlebanking organizations, and related ment systems. entities. • Enhance efficiency and effectiveness, Objectives while remaining sensitive to the burden on supervised institutions, by • Develop sound, effective policies addressing the supervision function's and regulations that foster payment procedures, technology, resource allo- system integrity, efficiency, and cation, and staffing issues. accessibility. • Promote adherence by domestic and • Conduct research and analysis that foreign banking organizations super- contributes to policy development and vised by the Federal Reserve with increases the Board's and others' Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

The Board of Governors and the Government Performance and Results Act 135 understanding of payment system tions Examination Council (FFIEC), a dynamics and risk. group made up of the five federal agencies that regulate depository institutions.1 In addition, a coordinating com- Goal mittee has been created to address and To provide high-quality professional report on issues related to those general oversight of Reserve Banks. goals and objectives that cross agency functions, programs, and activities. This Objective working group has been meeting since June 1997. These and similar planning • Produce high-quality assessments of efforts can eliminate redundancy and Federal Reserve Bank operations, significantly lower the government's projects, and initiatives in order to costs for data processing and other help Federal Reserve management activities, as well as lower depository foster and strengthen sound internal institution costs for complying with fedcontrol systems and efficient and eral regulations, while enhancing public effective performance. access to the data. Interagency Coordination Interagency coordination helps focus 1. The FFIEC consists of the Board of Goverefforts to eliminate redundancy and nors of the Federal Reserve System, the Federal lower costs. As mandated by the Gov- Deposit Insurance Corporation, the National ernment Performance and Results Act Credit Union Administration, the Office of the Comptroller of the Currency, and the Office of and in conformance with past practice, Thrift Supervision. It was established in 1979 purthe Board has worked closely with other suant to title X of the Financial Institutions Regufederal agencies to consider plans and latory and Interest Rate Control Act of 1978. The strategies for programs, such as bank FFIEC is a formal interagency body empowered to supervision, that transcend the jurisdic- prescribe uniform principles, standards, and report forms for the federal examination of financial tion of each agency. Coordination with institutions and to make recommendations to prothe Department of the Treasury and mote uniformity in the supervision of financial other agencies is evident throughout institutions. The FFIEC also provides uniform both the strategic plan and the perfor- examiner training and has taken a lead in developing standardized software needed for major data mance budget. Much of the Board's forcollection programs to support the requirements of mal effort to plan jointly has been made the Home Mortgage Disclosure Act and the Comthrough the Federal Financial Institu- munity Reinvestment Act. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

137 Federal Legislative Developments Check 21 Act ing both banks and customers, in the event of losses arising from the use On October 28, 2003, President Bush of substitute checks. The Check 21 Act signed the Check Clearing for the 21st also includes expedited recredit proce- Century Act (the Check 21 Act) into dures to help consumers who receive law. The Check 21 Act, which becomes substitute checks resolve problems effective on October 28, 2004, will related to those checks. Furthermore, the facilitate check truncation and the act requires banks to provide a conexchange of checks in electronic forsumer awareness disclosure regarding mat.1 The act authorizes the creation substitute checks and substitute-check and use of a new negotiable instrument rights to consumers who receive those called a "substitute check." A substitute checks. check is a paper reproduction of an Within nine months of its enactment, original check that contains an image of the Check 21 Act also requires the the front and back of the original check, Board to publish model language to is MICR-encoded, and is otherwise able assist banks in complying with the act's to be processed in the same way as the consumer notice requirement. Further, original check. The act provides that a the Check 21 Act empowers the Board properly prepared substitute check is the to prescribe such regulations as it deems legal equivalent of the original check for necessary to implement, prevent evasion all purposes. The act does not require of, or facilitate compliance with the probanks to create substitute checks or visions of the Check 21 Act. to accept delivery of electronic check images; instead, the act simply requires banks to accept properly prepared sub- FACT Act stitute checks. By empowering banks On December 4, 2003, President Bush to create machine-readable substitute signed the Fair and Accurate Credit checks that are legally equivalent to Transactions Act of 2003 (the FACT original checks, the Check 21 Act Act) into law. The act amends the enables banks to truncate original paper Fair Credit Reporting Act (FCRA) to checks early in the collection process, (1) enhance the ability of consumers to process them electronically, and, where combat identity theft and (2) increase necessary, create substitute checks for the accuracy of consumer reports. The delivery to banks that do not accept FACT Act also imposes obligations on checks electronically. institutions that sell or share certain The Check 21 Act includes new warconsumer information and restricts the ranties and an indemnity that protect use and disclosure of sensitive medirecipients of substitute checks, includcal information. In addition, the FACT Act includes other provisions that are 1. Check truncation refers to any of a number designed to limit the use of certain inforof arrangements in which the original paper checks mation received from affiliates for marare removed from the collection or return process keting purposes. Lastly, the FACT Act before reaching either paying or depositary banks, respectively, or reaching their customers. establishes uniform national standards Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

138 90th Annual Report, 2003 in key areas of regulation regarding con- to certain conditions, must place a sumer report information to further pro- fraud alert in the consumer's file and mote the efficient operation of national provide the alert along with any credit credit markets. To allow a reasonable score generated from that file. Activetime to implement the newly enacted duty military personnel also may requirements, the act sets delayed effec- request that a consumer reporting tive dates for some provisions and, for agency place an "active-duty alert" in other provisions, requires the Board and their files. the Federal Trade Commission (FTC) to set effective dates through joint reg- • A consumer reporting agency, upon a ulations. Certain provisions of the act request from a consumer and subject require implementing regulations. The to certain conditions, must block the dates for compliance with those regula- reporting of any information which tions will be established by the federal the consumer identifies as resulting banking agencies, the National Credit from an incident of identity theft that Union Administration (NCUA), the has been reported to the appropriate Securities and Exchange Commission law enforcement authority. The con- (SEC), and the FTC, as appropriate. sumer reporting agency also must promptly notify the furnisher of the The Board is charged with performinformation identified by the coning various responsibilities under the sumer that the information may be a FACT Act. Certain sections of the act result of identity theft. require the Board to prescribe regulations or guidelines that implement the • A consumer reporting agency must newly enacted requirements with respect notify a user of a consumer report to entities subject to the Board's jurisabout a discrepancy in a consumer's diction. To develop many of these rules, address if the user requests the report the Board must consult and coordinate using an address for the consumer that with the other federal banking agencies, substantially differs from the address the NCUA, the SEC, and the FTC. The in the file the consumer reporting act also requires the Board to undertake agency maintains. The federal bankseveral studies on issues regarding the ing agencies, the NCUA, and the FTC uses of information about consumers are directed to prescribe guidance that and the delivery of financial products describes reasonable policies and proand services to consumers, particularly cedures that, in general, a user of a products involving credit or insurance. consumer report must employ to reconcile a discrepancy in a consumer's address. Identity Theft Prevention The FACT Act includes several provi- • Businesses accepting credit cards or sions that are designed to prevent iden- debit cards must print no more than tity theft and assist a consumer who has the last five digits of the card number been a victim of identity theft restore or the expiration date of the card on the accuracy of his or her credit history. any electronically printed receipt pro- For example, the FACT Act requires the vided to the cardholder at the point of following: sale. • A consumer reporting agency, upon a The act charges the federal banking request from a consumer and subject agencies, the NCUA, and the FTC with Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Legislative Developments 139 establishing "red flag guidelines" for requires a financial institution that use by financial institutions to identify regularly furnishes information to possible instances of identity theft and a nationwide consumer reporting to protect account holders, customers, agency regarding credit extended to a and institutions from the risks associ- customer to provide a notice, in writated with identity theft. The act also ing, to the customer if the institution requires the FTC, in consultation with has furnished or will furnish negative the federal banking agencies, to pre- information about him or her to a conpare a model summary of the rights of sumer reporting agency; consumers with respect to identity theft prevention, and mandates that the con- requires a person that furnishes inforsumer reporting agencies provide the mation about a consumer to a consummary when a consumer expresses sumer reporting agency to maintain a belief that he or she is the victim of reasonable policies and procedures to identity theft. ensure the accuracy and integrity of the furnished consumer information, in accordance with regulatory guide- Accuracy of Consumer Credit lines prescribed by the federal bank- Reports ing agencies, the NCUA, and the FTC, as appropriate; and The FACT Act includes several provisions that are designed to enhance a requires a person that furnishes inforconsumer's access to information in his mation about a consumer to a conor her consumer report and to improve sumer reporting agency, upon request the accuracy of that information. For by the consumer, to reinvestigate a example, the FACT Act dispute concerning the accuracy of information contained in a consumer • allows a consumer to request that report under certain circumstances, as any nationwide consumer reporting prescribed by the federal banking agency or nationwide specialty con- agencies, the NCUA, and the FTC. sumer reporting agency provide the consumer with one free consumer credit report during any twelve-month Limits on the Use and Sharing of period, if certain conditions are Medical Information satisfied; The FACT Act adds to the existing pro- • allows a consumer to obtain his or her visions of the FCRA that govern the credit score, as well as certain infor- sharing and use of medical information. mation relating to the credit score, Among other things, the FACT Act from any consumer reporting agency; • prohibits a consumer reporting agency • requires any person who makes or from providing a third party with a arranges consumer loans and uses a consumer report containing medical credit score in connection with a con- information about a consumer unless sumer's application for a loan to make the information is relevant to the conthe credit score, as well as certain sumer's employment or a credit transinformation about the score, available action involving the consumer and the to the consumer; consumer specifically consents, in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

140 90th Annual Report, 2003 writing, to the release of such infor- augment the financial literacy and edumation; and cation programs, grants, and materials of the federal government, including • generally prohibits a creditor from developing financial education curricula obtaining or using medical informa- for all Americans. tion about a consumer in connection with any determination of the con- Relation to State Laws sumer's eligibility for credit. The FACT Act makes permanent the preemption provisions of the FCRA that Promotion of Financial Literacy were scheduled to terminate, or "sunand Education set," on December 31, 2003, including The FACT Act establishes the Financial the provision that generally preempts Literacy and Education Commission, to any state law requirement regarding the be composed of a representative from exchange of information about a coneach of the federal banking agencies. sumer among affiliated persons. Sec- The commission is charged with devel- tion 711 of the FACT Act also specifies oping a national strategy for improving that several of the act's new protections the financial literacy and education of preempt state laws "with respect to the persons in the United States. The com- conduct required by" those provisions mission also is authorized to take appro- of the act. • priate actions to streamline, improve, or 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

143 Record of Policy Actions of the Board of Governors Regulation B Regulation D Equal Credit Opportunity Reserve Requirements of [Docket No. R-1008] Depository Institutions [Docket No. R-1163] On February 19, 2003, the Board approved amendments that, among other On October 1, 2003, the Board approved things, retain the general prohibition amendments to reflect the annual indexagainst inquiring about or noting appli- ing of the low reserve tranche and of cant characteristics (such as race, the reserve requirement exemption for national origin, religion, age, or sex) in use in reserve requirement calculations nonmortgage credit transactions and in 2004. The amendments increase the create an exception when such data are 3 percent low reserve tranche for net collected as part of a creditor's self-test transaction accounts to $45.4 million to determine compliance with the Equal (from $42.1 million in 2003) and Credit Opportunity Act. The amend- increase the reserve requirement exempments also require creditors to retain tion to $6.6 million (from $6 million in certain records related to prescreened 2003). credit solicitations for twenty-five Votes for this action: Chairman Greenmonths. The amendments are effective span, Vice Chairman Ferguson, and Gov- April 15, 2003, with mandatory compliernors Gramlich, Bies, Olson, Bernanke, ance by April 15,2004. and Kohn. Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- Regulation H ernors Gramlich, Olson, Bernanke, and Membership of State Banking Kohn. Absent and not voting: Governor Institutions in the Federal Reserve Bies. System [Docket No. R-1129] On January 23, 2003, the Board approved amendments to administer and enforce several reporting, disclosure, NOTE. Full texts of the policy actions are available from the electronic reading room on the and corporate-governance provisions of Board's Freedom of Information Act web page the Sarbanes-Oxley Act of 2002, which (www.federalreserve.gov/generalinfo/foia/) by are applicable to state member banks using the "Policy Statements and Staff Manuals" that have securities registered under the link or on request from the Board's Freedom of Information Office (Tel: 202-452-3684; TDD: Securities Exchange Act of 1934 (regis- 202-263-4869; Fax: 202-872-7565). Internet tered banks). The amendments generally access to the Board's public web site is also avail- require registered banks to comply with able during regular business hours at the Freethe rules, regulations, and forms adopted dom of Information Office, Martin Building, by the Securities and Exchange Com- Room M-P-500, 20th and C Streets NW, Washington, DC 20551. mission to implement the provisions of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

144 90th Annual Report, 2003 the Sarbanes-Oxley Act specified in Kohn. Absent and not voting: Governor section 12(i) of the Securities Exchange Gramlich. Act of 1934, unless those requirements are modified by the Board. The amend- Regulation H ments are effective April 1, 2003. Membership of State Banking Institutions in the Federal Reserve Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- System ernors Gramlich, Bies, Olson, Bernanke, and Kohn. Regulation Y Bank Holding Companies and Change in Bank Control Regulation H [Docket No. R-1156] Membership of State Banking Institutions in the Federal Reserve On September 12, 2003, the Board, acting with the federal bank and thrift regu- System latory agencies, approved interim interagency amendments (with a request for Regulation K comment) that provide an interim capi- International Banking Operations tal treatment for assets in asset-backed [Docket No. R-1127] commercial paper programs that are consolidated on the balance sheets of On April 21, 2003, the Board, acting sponsoring banks, bank holding compawith the Department of the Treasury and nies, and thrifts as a result of a recently the federal financial institutions reguissued Financial Accounting Standards latory agencies, approved interagency Board Interpretation (FASB No. 46). amendments to implement section 326 The interim capital treatment is in effect of the USA Patriot Act of 2001 cononly for the regulatory reporting periods cerning customer identification proending September 30 and December 31, grams. The amendments require that 2003, and March 31, 2004. banks, savings associations, credit unions, private banks, and trust compa- Votes for this action: Chairman Greennies (1) implement reasonable procespan, Vice Chairman Ferguson, and Govdures to verify the identity of any per- ernors Gramlich, Bies, Olson, Bernanke, son who seeks to open an account, to and Kohn. the extent reasonable and practicable; (2) maintain records of the information used to verify the person's identity; Regulation K and (3) determine whether the person International Banking Operations appears on any lists of known or sus- [Docket No. R-1143] pected terrorists or terrorist organiza- On February 7, 2003, the Board issued tions provided to the financial instituan interpretation of Regulation K to tion by any government agency. The clarify that a foreign bank planning to amendments are effective June 9, 2003, engage in underwriting securities to be with mandatory compliance by Octodistributed in the United States must ber 1, 2003. either be a financial holding company or have the authority to engage in under- Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and writing activity under section 4(c)(8) of Governors Bies, Olson, Bernanke, and the Bank Holding Company Act. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 145 interpretation is effective February 19, The amendments are effective August 4, 2003. 2003. Votes for this action: Chairman Green- Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, ernors Gramlich, Bies, Olson, Bernanke, and Kohn. and Kohn. On November 26, 2003, the Board Regulation V approved amendments to expand the Fair Credit Reporting ability of all bank holding companies, [Docket No. R-1172] including financial holding companies, to process, store, and transmit nonfinan- On December 16, 2003, the Board, actcial data in connection with their finaning with the Federal Trade Commission, cial data processing, storage, and transapproved new interim interagency rules mission activities by raising the revenue (with a request for comment) that establimit on nonfinancial data processing lish December 31, 2003, as the effecactivities from 30 percent to 49 percent tive date for provisions of the Fair and of the company's total annual revenues Accurate Credit Transactions Act of derived from data processing, data stor- 2003 that determine the relationship age, and data transmission activities. between the Fair Credit Reporting Act The Board also announced that it would and state laws and provisions that authoconsider, case by case in accordance rize rulemakings or other implementing with applicable procedures, proposals by actions by various agencies. financial holding companies to engage in, or acquire a company engaged in, Votes for this action: Chairman Greenother nonfinancial data processing, span, Vice Chairman Ferguson, and Govinformation portal, and technologyernors Gramlich, Bies, Olson, Bernanke, and Kohn. related activities that the financial holding company believes are complementary to financial activities. The Regulation Y amendments are effective January 8, Bank Holding Companies and 2004. Change in Bank Control [Docket Nos. R-1146 and R-1092] Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- On June 27, 2003, the Board approved ernors Gramlich, Bies, Olson, and Bernanke. Absent and not voting: Governor amendments that permit bank holding Kohn. companies to enter into (1) commodity derivative contracts that are settled by the bank holding company receiving and Rules of Organization transferring title to the underlying com- [Docket No. R-1149] modity instantaneously, by operation of contract, and without taking physi- On April 29, 2003, the Board amended cal possession of the commodity and its definition of a quorum to provide that (2) certain commodity derivative con- a majority of the members in office contracts that do not require cash settlement stitutes a quorum of the Board, except or specifically provide for assignment, that four members constitute a quorum termination, or offset before delivery. if there are five members in office. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

146 90th Annual Report, 2003 revised definition enhances the Board's opportunity in the federal government ability to function in a national emer- generally. The amendments also incorgency, but does not alter the number of porate changes to provisions of the Board members required to constitute a commission's parallel regulation that quorum during normal operations when address the Rehabilitation Act; the comthe Board has five or more members. mission adopted these changes after the The amendment is effective April 29, Board's interim rule. The amendments 2003. are effective April 15, 2003. Votes for this action: Chairman Green- Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, ernors Gramlich, Bies, Olson, Bernanke, and Kohn. and Kohn. Rules of Practice for Hearings Policy Statements and Subpart J—Removal, Suspension, Other Actions and Debarment of Accountants from Performing Audit Services Interagency Paper on Sound [Docket No. R-1139] Practices to Strengthen the Resilience of the U.S. Financial On August 6, 2003, the Board, acting System with the federal bank and thrift regu- [Docket No. R-1128] latory agencies, approved interagency amendments that establish procedures On April 7, 2003, the Board, acting for removing, suspending, or debarring with the Office of the Comptroller of accountants, for good cause, from per- the Currency and the Securities and forming the audit services required Exchange Commission, approved an under section 36 of the Federal Deposit interagency paper that, among other Insurance Act for insured depository things, identifies (1) new business contiinstitutions with total assets of $500 mil- nuity objectives that have special imporlion or more. The amendments are effec- tance for all financial firms and tive October 1,2003. (2) sound practices to ensure the resilience of the U.S. financial system, with Votes for this action: Chairman Green- a focus on minimizing the immediate span, Vice Chairman Ferguson, and systemic effects of a wide-scale disrup- Governors Bies, Olson, Bernanke, and tion on critical financial markets. Kohn. Absent and not voting: Governor Gramlich. Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, Rules Regarding Equal and Kohn. Opportunity [Docket No. R-1096] Expansion of the Operating Hours On April 9, 2003, the Board approved for the Online Fedwire Funds amendments, adopted in January 2001 Service as interim amendments, to incorporate [Docket No. R-1138] changes that the Equal Employment Opportunity Commission made to its On May 20, 2003, the Board approved parallel regulation on equal employment an expansion of the operating hours for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors \A1 the online Fed wire Funds Service from counts and advances, primary and seceighteen to twenty-one and one-half ondary credit, that would replace adjusthours each business day. The new open- ment and extended credit, effective ing time, 9:00 p.m. eastern time for on- January 9, 2003. On January 6, 2003, line funds transfers with a business date the Board voted to approve for all the of the following calendar day, is three Reserve Banks an initial primary credit and one-half hours earlier than the cur- rate of 2lA percent and a formula for rent 12:30 a.m. opening time. The clos- calculating a secondary credit rate that ing time remains 6:30 p.m. eastern time. yielded an initial rate of 23A percent. The new hours are effective in the sec- In 2003, the rates for primary and ond quarter of 2004. secondary credit consistently exceeded the federal funds rate target, which is set Votes for this action: Chairman Green- by the Federal Open Market Committee span, Vice Chairman Ferguson, and Gov- (FOMC), by 100 and 150 basis points ernors Gramlich, Bies, Olson, Bernanke, respectively. On June 25, a reduction of and Kohn. lA percentage point in the federal funds rate target was accompanied by a simi- Imputed Investment Income lar reduction in both discount rates to on Clearing Balances levels of 2 percent and 21//2 percent. The [Docket No. R-1152] seasonal credit program was not affected On October 22, 2003, the Board modi- by the Regulation A amendments. The fied the method for imputing priced- rate for such credit in 2003 continued to services income from clearing-balance be set on the basis of a market-related investments that is used each year when formula and was equal or close to the the Reserve Banks set fees for Federal FOMC's target federal funds rate Reserve priced services and measure throughout the year. priced-services' cost recovery. The new method, which expresses the imputed investment return as a constant annual Primary Credit Rate spread over the rate for three-month The Board reached its decisions on the Treasury bills, is based on an optimized primary credit rate in conjunction with underlying hypothetical investment the FOMC's decisions on the target fedportfolio that reflects the broader range eral funds rate and related economic and of investments available to banks and financial developments. These developbank holding companies. Selection of ments are referenced below and are the portfolio investments is subject to a reviewed more fully in other parts of risk-management framework. The new this report, including the compilation of method is effective in January 2004. minutes of FOMC meetings held in 2003. Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, Reduction in the Primary Credit Rate and Kohn. in June 2003 Against the background of a sluggish Discount Rates in 2003 economic expansion but already stimu- On October 31, 2002, the Board lative monetary and fiscal policies, the amended its Regulation A to establish Board took no action before June 25 two new forms of Reserve Bank dis- on requests by various Federal Reserve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

148 90th Annual Report, 2003 Banks to lower their primary credit rate circumstances to depository institutions by lA or l/i percentage point. The num- that do not qualify for primary credit; it ber of such requests increased from two is set on the basis of a formula that in in mid-March to eight by the latter part 2003 produced a rate that was l/i perof June amid persisting indications that centage point higher than the primary an anticipated strengthening in the credit rate. Seasonal credit, another type expansion of economic activity was of discount window credit, is availbeing held back by a high degree of able under limited conditions to assist business caution in investment and hir- smaller depository institutions in maning decisions. On June 25 the Board aging liquidity needs that arise from approved a XA percentage point reduc- regular swings in their loans and depostion, to a level of 2 percent, in the pri- its. Rates on seasonal credit are calcumary credit rate of the Federal Reserve lated every two weeks in accordance Banks in conjunction with the FOMC's with a formula based on market interest decision to reduce its target for the fed- rates. Under that formula, the rates eral funds rate by the same amount. The charged for seasonal credit in 2003 were Board and the FOMC concluded that close to the FOMC's target rate for the a slightly more expansive monetary federal funds rate and ranged from policy would add support for an econ- 1.05 percent to 1.25 percent. Discount omy that was expected to improve over rates were as follows at year-end: pritime in the context of robust underly- mary credit at 2 percent, secondary ing growth in productivity, markedly credit at 2.50 percent, and seasonal improved financial conditions, and signs credit at 1.05 percent. that labor and product markets were stabilizing. In July and August, the Board took no Board Votes action on biweekly requests by one Fed- Under the Federal Reserve Act, the eral Reserve Bank to lower its primary boards of directors of the Federal credit rate by an additional lA percent- Reserve Banks are required to estabage point. In light of increasing indicalish rates on discounts and advances to tions of a pronounced acceleration in depository institutions at least every economic activity, no further requests fourteen days and must submit the for changes in their credit rates were rates to the Board of Governors for submitted by any of the Federal Reserve review and determination. Votes on the Banks over the remainder of the year. biweekly establishment of the prime credit rate without change and on the Structure of Discount Rates renewal of the formulas for calculating the rates on secondary and seasonal Under the new discount rate program credit are not shown in this summary. that went into effect on January 9, 2003, All votes on discount rates taken by primary credit is made available for very the Board of Governors in 2003 were short terms as a backup source of liquidunanimous. ity to depository institutions that, in the judgment of the lending Federal Reserve Votes on Changes in the Primary Bank, are in generally sound financial Credit Rate condition. Primary credit is extended at a rate above the federal funds rate. Sec- January 6, 2003. Effective January 9, ondary credit is available in appropriate 2003, the Board approved the establish- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 149 merit by the twelve Federal Reserve directors of the Federal Reserve Banks Banks of a primary credit rate of of Boston, New York, Kansas City, and 2lA percent and approved a formula for San Francisco to reduce their primary calculating a secondary credit rate that credit rate from 2VA percent to 2 percent. yielded a rate of 23A percent. The same decrease was approved for the remaining Federal Reserve Banks, effec- Votes for this action: Chairman Green- tive June 26, 2003. span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, Votes for this action: Chairman Greenand Kohn. span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, June 25, 2003. Effective this date, the and Kohn. • Board approved actions taken by the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

151 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 Gov- Federal Reserve Bank of New York ernors pursuant to the requirements of operates under three sets of instructions section 10 of the Federal Reserve Act. from the Federal Open Market Com- That section provides that the Board mittee: an Authorization for Domestic shall keep a complete record of the Open Market Operations, Guidelines for actions taken by the Board and by the the Conduct of System Open Market Federal Open Market Committee on all Operations in Federal Agency Issues, questions of policy relating to open mar- and a Domestic Policy Directive. (A ket 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 2003. 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, 2003 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

152 90th Annual Report, 2003 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 System overnight basis U.S. Government securities Open Market Account at market prices, and, held in the System Open Market Account to for such Account, to exchange maturing U.S. dealers at rates that shall be determined by Government and Federal agency securities competitive bidding but that in no event shall with the Treasury or the individual agencies be less than 1.0 percent per annum of the or to allow them to mature without replace- market value of the securities lent. The ment; provided that the aggregate amount of Federal Reserve Bank of New York shall U.S. Government and Federal agency securi- apply reasonable limitations on the total ties held in such Account (including forward amount of a specific issue that may be commitments) at the close of business on the auctioned, and on the amount of securities day of a meeting of the Committee at which that each dealer may borrow. The Federal action is taken with respect to a domestic Reserve Bank of New York may reject bids policy directive shall not be increased or which could facilitate a dealer's ability to decreased by more than $12.0 billion during control a single issue as determined solely the period commencing with the opening of by the Federal Reserve Bank of New York. business on the day following such meeting and ending with the close of business on the 3. In order to ensure the effective conduct of day of the next such meeting; open market operations, while assisting in the provision of short-term investments for (b) To buy U.S. Government securities foreign and international accounts mainand obligations that are direct obligations of, tained at the Federal Reserve Bank of New or fully guaranteed as to principal and inter- York, the Federal Open Market Committee est by, any agency of the United States, from authorizes and directs the Federal Reserve dealers for the account of the Federal Bank of New York (a) for System Open Reserve Bank of New York under agree- Market Account, to sell U.S. Government ments for repurchase of such securities or securities to such foreign and international obligations in 65 business days or less, at accounts on the bases set forth in pararates that, unless otherwise expressly autho- graph l(a) under agreements providing for rized by the Committee, shall be determined the resale by such accounts of those securiby competitive bidding, after applying rea- ties within 65 business days or less on terms sonable limitations on the volume of agree- comparable to those available on such transments with individual dealers; provided that actions in the market; and (b) for New York in the event Government securities or agency Bank account, when appropriate, to underissues covered by any such agreement are take with dealers, subject to the conditions not repurchased by the dealer pursuant to the imposed on purchases and sales of securities agreement or a renewal thereof, they shall be in paragraph l(b), repurchase agreements in sold in the market or transferred to the Sys- U.S. Government and agency securities, and tem Open Market Account; to arrange corresponding sale and repurchase 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 obligations 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 153 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 Committee's discussion and decision at its that the risks are balanced with respect to most recent meeting and the Committee's prospects for both goals in the foreseeable long-run objectives for price stability and 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, 2003 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, 2003 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, 2003l 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 maintaining the federal funds rate at an average of around 1 VA 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 10, 2002, 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 10, 2002. cifically authorizes a delay. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

154 90th Annual Report, 2003 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 LA. 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, with swap drawings, transactions with for- questions arising from such reviews and coneign central banks may be undertaken at sultations shall be referred for determination nonmarket exchange rates. to the Federal Open Market Committee. 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 155 understanding with the Secretary of the Trea- currencies and to facilitate operations of the sury about the division of responsibility for Exchange Stabilization Fund. foreign currency operations between the Sys- C. For such other purposes as may be tem and the Treasury; expressly authorized by the Committee. B. To keep the Secretary of the Trea- 4. System foreign currency operations shall sury fully advised concerning System forbe conducted: eign currency operations, and to consult with the Secretary on policy matters relating to A. In close and continuous consultaforeign currency operations; tion and cooperation with the United States Treasury; C. From time to time, to transmit appropriate reports and information to the B. In cooperation, as appropriate, with National Advisory Council on International foreign monetary authorities; and Monetary and Financial Policies. C. In a manner consistent with the obli- 8. Staff officers of the Committee are autho- gations of the United States in the Internarized to transmit pertinent information on tional Monetary Fund regarding exchange System foreign currency operations to appro- arrangements under the IMF Article IV. priate officials of the Treasury Department. 9. All Federal Reserve Banks shall partici- Procedural Instructions with pate in the foreign currency operations for Respect to Foreign Currency System Account in accordance with para- Operations graph 3 G(l) of the Board of Governors' Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks In Effect January 1, 2003 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, 2003 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

156 90th Annual Report, 2003 tion in a single foreign currency exceeding Present: $150 million, or $300 million when the Mr. Greenspan, Chairman operation is associated with repayment of Mr. McDonough, Vice Chairman swap drawings. Mr. Bernanke Ms. Bies C. Any operation that might generate a Mr. Broaddus substantial volume of trading in a particular Mr. Ferguson currency by the System, even though the Mr. Gramlich change in the System's net position in that Mr. Guynn currency might be less than the limits speci- Mr. Kohn fied in l.B. Mr. Moskow Mr. Olson D. Any swap drawing proposed by a Mr. Parry foreign bank not exceeding the larger of (i) $200 million or (ii) 15 percent of the size Mr. Hoenig, Mses. Minehan and of the swap arrangement. Pianalto, Messrs. Poole and Stewart, Alternate Members of the 2. The Manager shall clear with the Com- Federal Open Market Committee mittee (or with the Subcommittee, if the Subcommittee believes that consultation Messrs. McTeer, Santomero, and Stern, with the full Committee is not feasible in the Presidents of the Federal Reserve time available, or with the Chairman, if the Banks of Dallas, Philadelphia and Chairman believes that consultation with Minneapolis respectively the Subcommittee is not feasible in the time available): Mr. Reinhart, Secretary and Economist A. Any operation that would result in a Mr. Bernard, Deputy Secretary change in the System's overall open position Mr. Gillum, Assistant Secretary in foreign currencies exceeding $1.5 billion Ms. Smith, Assistant Secretary since the most recent regular meeting of the Mr. Mattingly, General Counsel Committee. Ms. Johnson, Economist Mr. Stockton, Economist B. Any swap drawing proposed by a foreign bank exceeding the larger of Mr. Connors, Ms. Cumming, (i) $200 million or (ii) 15 percent of the Messrs. Eisenbeis, Goodfriend, size of the swap arrangement. Howard, Hunter, Judd, Lindsey, Struckmeyer, and Wilcox, 3. The Manager shall also consult with the Associate Economists Subcommittee or the Chairman about proposed swap drawings by the System and Mr. Kos, Manager, System Open about any operations that are not of a routine Market Account character. Messrs. Ettin and Madigan, Deputy Directors, Divisions of Research Meeting Held on and Statistics and Monetary Affairs, respectively, Board of January 28-29, 2003 Governors A meeting of the Federal Open Market Messrs. Slifman and Oliner, Associate Committee was held in the offices of the Directors, Division of Research Board of Governors of the Federal and Statistics, Board of Governors Reserve System in Washington, D.C., on Tuesday, January 28, 2003, at Mr. Whitesell, Deputy Associate 2:30 p.m. and continued on Wednesday, Director, Division of Monetary January 29, 2003, at 9:00 a.m. Affairs, Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 157 Messrs. Clouse and ReifSchneider,2 Messrs. Altig and Croushore, Assistant Directors, Divisions of Ms. Hargraves, Messrs. Miller Monetary Affairs and Research and Rudebusch, Vice Presidents, and Statistics, respectively, Board Federal Reserve Banks of of Governors Cleveland, Philadelphia, New York, Minneapolis, and Mr. Simpson, Senior Adviser, Division San Francisco respectively of Research and Statistics, Board of Governors In the agenda for this meeting, it was reported that advices of the election of Mr. Skidmore, Special Assistant to the the following members and alternate Board, Office of Board Members, Board of Governors members of the Federal Open Market Committee for the period commencing Mr. Fallon,3 Senior Counsel, Legal January 1, 2003, and ending Decem- Division, Board of Governors ber 31, 2003, had been received and that Ms. Haltmaier,4 Section Chief, these individuals had executed their Division of International Finance, oaths of office. Board of Governors The elected members and alternate members were as follows: Messrs. Lebow,4 Sack,2 and Tetlow,2 Senior Economists, Divisions of William J. McDonough, President of the Research and Statistics, Monetary Federal Reserve Bank of New York, Affairs, and Research and with Jamie B. Stewart, Jr., First Vice Statistics, respectively, Board President of the Federal Reserve Bank of Governors of New York, as alternate. Mr. Zakrajsek,4 Economist, Division J. Alfred Broaddus, Jr., President of the Fedof Monetary Affairs, Board of eral Reserve Bank of Richmond, with Governors Cathy E. Minehan, President of the Federal Reserve Bank of Boston, as Ms. Low, Open Market Secretariat alternate. Assistant, Division of Monetary Affairs, Board of Governors Jack Guynn, President of the Federal Reserve Bank of Atlanta, with William Mr. Lyon, First Vice President, Federal Poole, President of the Federal Reserve Reserve Bank of Minneapolis Bank of St. Louis, as alternate Messrs. Fuhrer and Hakkio, Michael H. Moskow, President of the Fed- Ms. Mester, Messrs. Rasche and eral Reserve Bank of Chicago, with Rosenblum, Senior Vice Sandra Pianalto,5 President of the Fed- Presidents, Federal Reserve eral Reserve Bank of Cleveland, as Banks of Boston, Kansas City, alternate. Philadelphia, St. Louis, and Dallas respectively Robert T. Parry, President of the Federal Reserve Bank of San Francisco, with Thomas M. Hoenig, President of the Federal Reserve Bank of Kansas City, as alternate 2. Attended portion of meeting relating to dis- By unanimous vote, the following cussion of gradualism in policy making. officers of the Federal Open Market 3. Attended portion of meeting relating to Committee were elected to serve until FOMC rule changes. 4. Attended portion of meeting relating to the FOMC's review of the economic outlook. 5. Election effective February 1, 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

158 90th Annual Report, 2003 the election of their successors at the By unanimous vote, the Committee first regularly scheduled meeting of the approved an amendment to paragraph 2 Committee after December 31, 2003, of the Authorization for Domestic Open with the understanding that in the event Market Operations to give the Federal of the discontinuance of their official Reserve Bank of New York discretion connection with the Board of Governors to set the minimum lending fee for the or with a Federal Reserve Bank, they System Open Market Account securities would cease to have any official con- lending program below the existing nection with the Federal Open Market 1.0 percent per annum rate. The Autho- Committee: rization as amended read as follows: Alan Greenspan Chairman William J. McDonough Vice Chairman Authorization for Domestic Vincent R. Reinhart Secretary and Open Market Operations Economist (Amended January 28, 2003) Normand R.V. Bernard Deputy Secretary Gary P. Gillum Assistant 1. The Federal Open Market Committee Secretary authorizes and directs the Federal Reserve Michelle A. Smith Assistant Bank of New York, to the extent neces- Secretary sary to carry out the most recent domestic J. Virgil Mattingly, Jr. General Counsel policy directive adopted at a meeting of the Thomas C. Baxter, Jr. Deputy General Committee: Counsel (a) To buy or sell U.S. Government Karen H. Johnson Economist securities, including securities of the Federal David J. Stockton Economist Financing Bank, and securities that are direct obligations of, or fully guaranteed as to prin- Thomas A. Connors, Christine Cumming, cipal and interest by, any agency of the Robert A. Eisenbeis, Marvin S. United States in the open market, from or to Goodfriend, David H. Howard, securities dealers and foreign and interna- William C. Hunter, John P. Judd, tional accounts maintained at the Federal David E. Lindsey, Charles S. Reserve Bank of New York, on a cash, regu- Struckmeyer, and David W. Wilcox, lar, or deferred delivery basis, for the System Associate Economists Open Market Account at market prices, and, for such Account, to exchange maturing U.S. By unanimous vote, the Federal Government and Federal agency securities Reserve Bank of New York was selected with the Treasury or the individual agencies to execute transactions for the System or to allow them to mature without replace- Open Market Account until the adjourn- ment; provided that the aggregate amount of U.S. Government and Federal agency securiment of the first regularly scheduled ties held in such Account (including forward meeting of the Committee after Decemcommitments) at the close of business on the ber 31, 2003. day of a meeting of the Committee at which By unanimous vote, Dino Kos was action is taken with respect to a domestic selected to serve at the pleasure of the policy directive shall not be increased or decreased by more than $12.0 billion during Committee as Manager, System Open the period commencing with the opening of Market Account, on the understanding business on the day following such a meetthat his selection was subject to being ing and ending with the close of business on satisfactory to the Federal Reserve Bank the day of the next such meeting; of New York.6 (b) To buy U.S. Government securities, obligations that are direct obligations of, 6. Secretary's note: Advice subsequently was or fully guaranteed as to principal and interreceived that the selection of Mr. Kos as Manager est by, any agency of the United States, from was satisfactory to the board of directors of the dealers for the account of the Federal New York Reserve Bank. Reserve Bank of New York under agree- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 159 ments for repurchase of such securities or ties in 65 business days or less on terms obligations in 65 business days or less, at comparable to those available on such transrates that, unless otherwise expressly autho- actions in the market; and (b) for New York 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 tary developments during the intermeeting to dealers at rates that shall be determined period. Consistent with Committee pracby competitive bidding. The Federal Reserve tice, the Chairman, if feasible, will consult Bank of New York shall set a minimum with the Committee before making any lending fee consistent with the objectives of adjustment. the program and apply reasonable limitations on the total amount of a specific issue that With Mr. Broaddus dissenting, the may be auctioned and on the amount of Authorization for Foreign Currency securities that each dealer may borrow. The Operations and the Foreign Currency Federal Reserve Bank of New York may Directive were reaffirmed as shown reject bids which could facilitate a dealer's ability to control a single issue as deter- below. mined solely by the Federal Reserve Bank of New York. Authorization for Foreign 3. In order to ensure the effective conduct of open market operations, while assisting in Currency Operations the provision of short-term investments for (Reaffirmed January 28, 2003) foreign and international accounts maintained at the Federal Reserve Bank of New 1. The Federal Open Market Committee York, the Federal Open Market Committee authorizes and directs the Federal Reserve authorizes and directs the Federal Reserve Bank of New York, for System Open Market Bank of New York (a) for System Open Account, to the extent necessary to carry out Market Account, to sell U.S. Government the Committee's foreign currency directive securities to such foreign and international and express authorizations by the Committee accounts on the bases set forth in para- pursuant thereto, and in conformity with graph l(a) under agreements providing for such procedural instructions as the Committhe resale by such accounts of those securi- tee may issue from time to time: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

160 90th Annual Report, 2003 A. To purchase and sell the following foreign currencies in the form of cable trans- Amount of arrangement fers through spot or forward transactions on Foreign bank (millions of the open market at home and abroad, includ- dollars equivalent) ing transactions with the U.S. Treasury, with the U.S. Exchange Stabilization Fund estab- Bank of Canada 2,000 lished by Section 10 of the Gold Reserve Act Bank of Mexico 3,000 of 1934, with foreign monetary authorities, with the Bank for International Settle- Any changes in the terms of existing swap ments, and with other international financial arrangements, and the proposed terms of any institutions: new arrangements that may be authorized, shall be referred for review and approval to Canadian dollars Mexican pesos the Committee. Danish kroner Norwegian kroner 3. All transactions in foreign currencies Euro Swedish kronor undertaken under paragraph LA. above Pounds sterling Swiss francs Japanese yen shall, unless otherwise expressly authorized by the Committee, be at prevailing market B. To hold balances of, and to have rates. For the purpose of providing an investoutstanding forward contracts to receive or ment return on System holdings of foreign to deliver, the foreign currencies listed in currencies, or for the purpose of adjusting paragraph A above. interest rates paid or received in connection C. To draw foreign currencies and to with swap drawings, transactions with forpermit foreign banks to draw dollars under eign central banks may be undertaken at the reciprocal currency arrangements listed nonmarket exchange rates. in paragraph 2 below, provided that draw- 4. It shall be the normal practice to ings by either party to any such arrangement arrange with foreign central banks for the shall be fully liquidated within 12 months coordination of foreign currency transacafter any amount outstanding at that time tions. In making operating arrangements was first drawn, unless the Committee, with foreign central banks on System holdbecause of exceptional circumstances, spe- ings of foreign currencies, the Federal cifically authorizes a delay. Reserve Bank of New York shall not commit D. To maintain an overall open posi- itself to maintain any specific balance, unless tion in all foreign currencies not exceeding authorized by the Federal Open Market $25.0 billion. For this purpose, the overall Committee. Any agreements or understandopen position in all foreign currencies is ings concerning the administration of the defined as the sum (disregarding signs) of accounts maintained by the Federal Reserve net positions in individual currencies. The Bank of New York with the foreign banks net position in a single foreign currency is designated by the Board of Governors under defined as holdings of balances in that cur- Section 214.5 of Regulation N shall be rency, plus outstanding contracts for future referred for review and approval to the receipt, minus outstanding contracts for Committee. future delivery of that currency, i.e., as the 5. Foreign currency holdings shall be sum of these elements with due regard to invested to ensure that adequate liquidity is sign. maintained to meet anticipated needs and so 2. The Federal Open Market Commit- that each currency portfolio shall generally tee directs the Federal Reserve Bank of have an average duration of no more than New York to maintain reciprocal currency 18 months (calculated as Macaulay duraarrangements ("swap" arrangements) for the tion). When appropriate in connection with System Open Market Account for periods up arrangements to provide investment facilities to a maximum of 12 months with the follow- for foreign currency holdings, U.S. Governing foreign banks, which are among those ment securities may be purchased from fordesignated by the Board of Governors of the eign central banks under agreements for Federal Reserve System under Section 214.5 repurchase of such securities within 30 calof Regulation N, Relations with Foreign endar days. Banks and Bankers, and with the approval of 6. All operations undertaken pursuant to the Committee to renew such arrangements the preceding paragraphs shall be reported on maturity: promptly to the Foreign Currency Subcom- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 161 mittee and the Committee. The Foreign Cur- disorderly market conditions, provided that rency Subcommittee consists of the Chair- market exchange rates for the U.S. dollar man and Vice Chairman of the Committee, reflect actions and behavior consistent with the Vice Chairman of the Board of Gover- IMF Article IV, Section 1. nors, and such other member of the Board 2. To achieve this end the System shall: as the Chairman may designate (or in the A. Undertake spot and forward purabsence of members of the Board serving on chases and sales of foreign exchange. the Subcommittee, other Board members B. Maintain reciprocal currency designated by the Chairman as alternates, ("swap") arrangements with selected forand in the absence of the Vice Chairman eign central banks. of the Committee, his alternate). Meetings C. Cooperate in other respects with of the Subcommittee shall be called at the central banks of other countries and with request of any member, or at the request of international monetary institutions. the Manager, System Open Market Account 3. Transactions may also be undertaken: ("Manager"), for the purposes of reviewing A. To adjust System balances in light recent or contemplated operations and of of probable future needs for currencies. consulting with the Manager on other mat- B. To provide means for meeting Systers relating to his responsibilities. At the tem and Treasury commitments in particular request of any member of the Subcommittee, currencies and to facilitate operations of the questions arising from such reviews and con- Exchange Stabilization Fund. sultations shall be referred for determination C. For such other purposes as may be to the Federal Open Market Committee. expressly authorized by the Committee. 7. The Chairman is authorized: 4. System foreign currency operations A. With the approval of the Commit- shall be conducted: tee, to enter into any needed agreement or A. In close and continuous consultaunderstanding with the Secretary of the Trea- tion and cooperation with the United States sury about the division of responsibility for Treasury; foreign currency operations between the Sys- B. In cooperation, as appropriate, with tem and the Treasury; foreign monetary authorities; and B. To keep the Secretary of the Trea- C. In a manner consistent with the sury fully advised concerning System for- obligations of the United States in the eign currency operations, and to consult with International Monetary Fund regarding the Secretary on policy matters relating to exchange arrangements under the IMF foreign currency operations; Article IV. C. From time to time, to transmit appropriate reports and information to the Mr. Broaddus dissented in the votes National Advisory Council on International Monetary and Financial Policies. on the Authorization for Foreign Cur- 8. Staff officers of the Committee are rency Operations and the Foreign Curauthorized to transmit pertinent informa- rency Directive because they provide tion on System foreign currency operations the foundation for foreign exchange to appropriate officials of the Treasury market intervention. For the same rea- Department. sons he had given in the past when he 9. All Federal Reserve Banks shall participate in the foreign currency operations had dissented on these policy instrufor System Account in accordance with para- ments, he continued to believe that the graph 3G(1) of the Board of Governors' Federal Reserve's participation in for- Statement of Procedure with Respect to Foreign exchange market intervention comeign Relationships of Federal Reserve Banks promises its ability to conduct monetary dated January 1, 1944. policy effectively. Foreign Currency Directive By unanimous vote, the Procedural (Reaffirmed January 28, 2003) Instructions with Respect to Foreign 1. System operations in foreign curren- Currency Operations were reaffirmed in cies shall generally be directed at countering the form shown below. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

162 90th Annual Report, 2003 Procedural Instructions with in foreign currencies exceeding $1.5 billion Respect to Foreign since the most recent regular meeting of the Committee. Currency Operations B. Any swap drawing proposed by a (Reaffirmed January 28, 2003) 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 the following procedural understandings By unanimous vote, the Committee with respect to consultations and clearances approved the repeal of paragraphs 3 with the Committee, the Foreign Currency through 6 of the Guidelines for the Con- Subcommittee, and the Chairman of the Committee. All operations undertaken pur- duct of System Open Market Operations suant to such clearances shall be reported in Federal Agency Issues. The Commitpromptly to the Committee. tee initially suspended these paragraphs 1. The Manager shall clear with the Sub- in August 1999 and subsequently committee (or with the Chairman, if the extended the suspension annually for the Chairman believes that consultation with the years through 2002. Paragraphs 1 and 2, Subcommittee is not feasible in the time available): which provide general guidance for the A. Any operation that would result in a conduct of System open market operachange in the System's overall open position tions in federal agency obligations, were in foreign currencies exceeding $300 million retained in their existing form. on any day or $600 million since the most recent regular meeting of the Committee. B. Any operation that would result in a change on any day in the System's net posi- Guidelines for the Conduct of tion in a single foreign currency exceed- System Open Market Operations ing $150 million, or $300 million when the in Federal Agency Issues operation is associated with repayment of (Amended January 28, 2003) swap drawings. C. Any operation that might generate a 1. System open market operations in Fedsubstantial volume of trading in a particular eral agency issues are an integral part of total currency by the System, even though the System open market operations designed to change in the System's net position in that influence bank reserves, money market concurrency might be less than the limits speciditions, and monetary aggregates. fied in l.B. 2. System open market operations in D. Any swap drawing proposed by a Federal agency issues are not designed to foreign bank not exceeding the larger of support individual sectors of the market or (i) $200 million or (ii) 15 percent of the size to channel funds into issues of particular of the swap arrangement. agencies. 2. The Manager shall clear with the Committee (or with the Subcommittee, if the Subcommittee believes that consultation By unanimous vote, the Committee with the full Committee is not feasible in the amended its Program for Security of time available, or with the Chairman, if the FOMC Information on January 28, Chairman believes that consultation with the 2003, to update references to the classi- Subcommittee is not feasible in the time available): fication of confidential documents and A. Any operation that would result in a to clarify some of its instructions for change in the System's overall open position safeguarding confidential information. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 163 By unanimous vote, the Committee achieving the Committee's macroamended the Temporary Authority to economic objectives. The staff pre- Operate the System Account to autho- sentations examined whether policy rize the Chairman to appoint an interim adjustments historically had been implemanager of the System Open Market mented gradually or whether, instead, Account in emergency circumstances. the observed tendency for the federal The amended Temporary Authority read funds rate to move slowly through time as follows: reflected the behavior of the underlying variables to which policy was responding. Members expressed a range of Temporary Authority to Operate views regarding the evidence and its the System Account implications for policy, including poten- (Amended January 28, 2003) tial situations that might call for rela- The Chairman of the Committee is tively aggressive policy actions. authorized to appoint a Federal Reserve The Committee then turned to a dis- Bank as agent to operate the System cussion of the economic and financial Account temporarily in case the Federal outlook and the implementation of Reserve Bank of New York is unable to monetary policy over the intermeeting function. In the event the Chairman period ahead. exercises such authority, the Chairman The information reviewed at this also is authorized to appoint a Federal meeting suggested that economic Reserve official to act temporarily as growth was very slow in the fourth quar- Manager of the System Account. ter. Housing demand and consumer By unanimous vote, the minutes of spending firmed toward the end of the the meeting of the Federal Open Market year, but capital spending remained Committee held on December 10, 2002, quite weak in an environment of subwere approved. stantial business uncertainty and pessi- The Manager of the System Open mism. A sharp drop in motor vehicle Market Account reported on recent output held down overall industrial prodevelopments in foreign exchange mar- duction, and the labor market deteriokets. There were no open market opera- rated further. Core consumer price inflations in foreign currencies for the Sys- tion continued to decline through the tem's account in the period since the end of the year. previous meeting. Private nonfarm payroll employment The Manager also reported on devel- fell again in December and was at its opments in domestic financial markets lowest level since September 1999. Job and on System open market transactions losses in manufacturing continued to be in government securities and securities sizable, and employment in retail trade issued or fully guaranteed by federal plunged, although part of that decline agencies during the period Decem- might have been attributable to lowerber 10, 2002, through January 28, 2003. than-usual hiring of temporary sales By unanimous vote, the Committee rati- help for the holiday season. By contrast, fied these transactions. hiring in the services industry picked up, At this meeting the Committee dis- and employment in the finance, insurcussed staff presentations on whether ance, and real estate group continued to policy adjustments incorporating grad- expand. The unemployment rate held at ual movements in the federal funds rate 6 percent in December, a level consiswere desirable in terms of optimally tent with other labor market indicators. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

164 90th Annual Report, 2003 Industrial production slowed a little Business spending on equipment and further in December, reflecting another software appeared to have little or no sharp drop in motor vehicle assemblies forward momentum in the fourth quarter and a decline in electricity generation. and to have been weaker than might Excluding motor vehicles and parts, have been suggested by the recent patmanufacturing output increased slightly tern of business output, corporate cash following small declines in October flow, and the user cost of capital. Both and November. Production of high-tech shipments of and orders for nondefense goods continued to rise in December, capital goods turned down in the fourth and output in industries other than high- quarter, with aircraft and communicatech and transportation increased for tions equipment registering the steepthe first time since August. Despite the est declines in shipments. In the nonuptick in production in some areas of residential sector, construction activity manufacturing, capacity utilization in slowed only a little further in October manufacturing fell again in December and November following a sharp drop and was substantially below its long-run in the third quarter. However, current average. weakness in rents and property values Retail sales increased appreciably in suggested continued deterioration in November and December even though activity. disposable personal income posted rela- The book value of manufacturing and tively modest gains and readings on con- trade inventories excluding motor vehisumer confidence were generally low. cles dropped sharply in October and Purchases of new motor vehicles were changed little in November. Manufacbrisk and were accompanied by moder- turers trimmed stocks in both months, ate further increases in other categories though durable goods manufacturers of retail sales. increased their inventories sharply in Residential housing activity remained December. Wholesalers cut their invenstrong through the end of the year, tories substantially in October and held despite continued sluggish employment them steady in November. Retail invenand additional declines in household tories changed little over the two-month wealth. With mortgage rates remain- period. Aggregate inventory-sales ratios ing near historical lows, single-family in all three categories remained at very housing starts increased further in low levels. November and December, and the The U.S. trade deficit in goods backlog of unused permits along with and services widened significantly in other information suggested that November, with the value of imports starts likely would remain strong in rising more than that of exports. Comcoming months. New home sales bining October and November, imports reached yet another record high in increased from the third-quarter average December, and existing home sales while exports declined somewhat. Availneared their record level established able information on economic activity in January 2002. In the multifamily abroad in the fourth quarter suggested sector, starts rebounded in Novem- slower growth on average in the major ber and December from a sharp drop foreign economies. Economic expanin October. Nonetheless, multifamily sion in Japan appeared to have slowed homebuilding was at a relatively low markedly, and growth in the euro area level at year-end, reflecting falling rents remained sluggish. By contrast, the and high vacancy rates. Canadian economy continued to expand Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 165 briskly while activity in the United disappointing tone, pessimistic expec- Kingdom seemed to be growing more tations for fourth-quarter corporate profmoderately. In the emerging market its, and the Administration's announceeconomies, conditions in South America ment of an economic stimulus package were generally still fragile, the pace of larger than had been anticipated. economic recovery in Mexico appeared Against that backdrop, longer-term to have slowed, and growth had soft- Treasury yields declined somewhat ened in much of emerging Asia. Eco- while, in private debt markets, a sense nomic growth in China remained strong. of reduced concern about governance Core consumer price inflation, as issues and perhaps some increased appemeasured by the consumer price index tite for risk-taking led to a substantial (CPI) and the chain-weighted personal decline in yields across the credit specconsumption expenditure (PCE) index, trum that further narrowed risk spreads. continued to edge lower through the end Major stock price indexes moved widely of the year. However, the sizable run-up during the intermeeting period, but most in energy prices last year boosted over- finished the period a little lower. all consumer price inflation somewhat The dollar depreciated substantially on a year-over-year basis. At the pro- in terms of an index of major foreign ducer level, core prices for finished currencies, with particularly large goods declined in November and declines against the euro, the yen, and December, but for the year as a whole the Swiss franc. Market worries about the jump in energy prices pushed overall growing tensions over Iraq and North producer prices for finished goods up Korea appeared to be a key factor, but slightly. With regard to labor costs, aver- concerns about the downbeat tone of age hourly earnings of production or recent U.S. economic data and the nonsupervisory workers increased mod- potential vulnerability of the dollar to a erately in December, but the change in general pullback of international capital those earnings over the year was consid- further damped market sentiment. The erably smaller than in 2001, evidently drop of the dollar occurred despite conreflecting the slack in labor markets. tinued signs of weak growth in the euro At its meeting on December 10, 2002, area and Japan and sizable reductions in the Committee adopted a directive that the yields of their long-term government called for maintaining conditions in securities. reserve markets consistent with keeping Growth of M2 fell considerably in the federal funds rate around VA per- December. Much of the deceleration cent and retained an assessment that the was concentrated in the liquid comporisks to its longer-term objectives were nents of the aggregate, likely reflecting balanced. The Committee noted that in part an adjustment in the volume of monetary policy was quite accommo- mortgage refinancings and the associdative and well positioned to support ated prepayments on mortgage-backed a strengthening economic expansion in securities. line with the members' expectations for The staff forecast prepared for this coming quarters. The Committee's deci- meeting suggested that the expansion of sion was widely anticipated and elicited economic activity would be muted in little reaction. Financial markets were the very near term. Faced with intensisensitive, however, to shifting percep- fied geopolitical tensions as well as contions of global risks, economic releases tinuing pessimism about the near-term that generally were seen as having a course of economic activity, labor mar- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

166 90th Annual Report, 2003 ket conditions, and corporate earnings, consumer and business spending. Even businesses and consumers were likely to so, the response of the economy was hold down their spending. In addition, hard to anticipate because of the difficontinued sluggish economic growth culty of disentangling the effects of among most major trading partners current geopolitical tensions from the would tend to damp U.S. exports. How- underlying momentum of the economy. ever, those restraining influences were Moreover, even a short and successful expected to abate over time. The consid- military campaign could give rise to a erable monetary ease already in place, variety of disruptions that might limit at the prospect of significantly more fiscal least for a time an improvement in busistimulus, the continuing strong gains in ness and consumer confidence. structural productivity, and the antici- The members nonetheless saw a numpated improvement in business confi- ber of favorable factors that could be dence would provide significant impe- expected to foster a relatively robust tus to spending. Inventory overhangs economic expansion over time. These had been largely eliminated, and busi- included a stimulative monetary policy ness capital stocks had moved closer along with generally accommodative to desired levels. As a consequence, a financial conditions, the prospect of slowly improving outlook for sales and additional fiscal stimulus, an increasing profits, low financing costs, and the tem- need for expenditures by business firms porary federal tax incentive for invest- to replace depreciated equipment and to ment in new equipment and software maintain acceptable inventory levels, were expected to gradually boost busi- and continued vigorous growth in proness investment spending. The persis- ductivity that would support profits and tence of underutilized resources would incomes. With regard to the outlook for tend to foster some moderation in core inflation, prospective growth of spendprice inflation. ing in line with the members' forecasts In the Committee's discussion of cur- likely would continue to be associated rent and prospective economic develop- with only muted pressures on labor and ments, members emphasized that their other resources over the year ahead, and forecasts were subject to substantial given current trends in productivity, uncertainties, dominated at this point by members anticipated that consumer the geopolitical situation, but they con- price inflation would remain subdued; tinued to view a pickup in economic indeed, modest further disinflation growth as a reasonable expectation for might occur over the year ahead. the year ahead. Household spending had In preparing for the semiannual been well maintained over the course of monetary policy report to Congress, the recent months, but a high degree of cau- Board members and Reserve Bank tion had induced business firms to con- presidents provided individual projectinue to hold down their spending and tions of the growth of GDP, civilian hiring. It was suggested that the uncer- unemployment, and consumer price tainties relating to geopolitical tensions inflation for the year 2003. The memand possible war in Iraq, important fac- bers agreed that because of the unusual tors contributing to business caution, uncertainties that clouded their current might be at least partly resolved in the forecasts, the latter should be viewed near term, helping to roll back some of as having extremely wide confidence the recent increase in oil prices and bands. Their forecasts envisaged a likely having favorable implications for strengthening economic recovery but Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 167 not one that was likely to induce a mate- the strength and timing of the prospecrial, if any, decline in the unemployment tive improvement remained subject to rate over the year ahead. Their forecasts a high degree of uncertainty. Indeed, a of growth in real GDP for 2003 had a number of members commented that it central tendency of 3VA to 3Vi percent was possible that some* easing of geopoand a full range of 3 to 33A percent, litical tensions would not lead to a major measured as the change between the near-term upturn in business confidence fourth quarter of 2002 and the fourth and business expenditures. Such an outquarter of 2003. Their projections of the come would be especially likely if oil civilian unemployment rate in the fourth supplies were disrupted, a threat that quarter of the year were all in a range of could not be ruled out, with adverse 53/4 to 6 percent. Their forecasts of con- consequences for oil prices and business sumer price inflation for the year, as costs. Moreover, the current excess measured by the PCE chain-type price capacity would permit many firms to index, were centered in a range of 1 ]A to meet likely demands for some period of V/i percent, with a full range of VA to time without a significant increase in PA percent. capital investments. In the Committee's discussion of The evident uncertainty and pessidevelopments in key sectors of the mism in the business community were economy, members continued to place also reflected in tight inventory control emphasis on the critical role of business policies. Despite continuing gains in spending and hiring decisions in deter- final sales, inventories were estimated to mining the strength of the expansion. have changed little in the fourth quarter An elevated level of business caution and currently were at levels that were clearly was holding back investment widely viewed as unusually low in relaspending, and there were few signs of a tion to sales. In these circumstances, an pickup in the near term. Given an even- easing at some point of current uncertual reduction in prevailing uncertain- tainties and strengthening confidence ties, however, a number of members should induce inventory rebuilding, with noted that the outlook for business positive implications, at least for a time, spending was favorable, and they did for the expansion of economic activity. not rule out a sharp snapback in busi- The household sector had continued ness expenditures as the year pro- to provide vital support to overall gressed. Factors cited in support of this demand in recent months despite a deteview included the wide availability and riorating trend in consumer confidence. low cost of capital, the increasing need While numerous contacts reported genfor replacing worn and outdated capi- erally disappointing holiday sales in tal equipment with the passage of time, an environment of atypically large and a decline in overall stocks of capital widespread discounting, a surge in in relation to the economy's growing motor vehicle sales in December fospotential, and the anticipated continua- tered by aggressive sales incentives and tion of what appeared to be an upward some pickup in retail sales late in the trend in sales, cash flows, and profits. holiday season helped to sustain moder- Some members also referred to the posiate overall growth in consumer spendtive effects on some business decisions ing through the year-end. Looking of the temporary federal tax incentives ahead, a number of factors seemed for expenditures on business equipment likely to undergird consumer spending, and software. The members agreed that including the positive effects on perma- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

168 90th Annual Report, 2003 nent incomes of robust ongoing growth that, given the competing legislative in productivity, the possibly accelerated proposals currently under consideration, phase-in of tax reductions stemming the eventual components and size of from earlier legislation, the prospects that legislation were very uncertain at for additional reductions in federal taxes this point, though they were likely to affecting household incomes, and more be importantly influenced by the pergenerally the continued favorable effects formance of the economy and espeof low interest rates and widely avail- cially labor market conditions over able financing on consumer purchases coming months. A number of members of motor vehicles and other durables. At expressed the hope that the legislation the same time, some members expressed would not encompass provisions that concern about the potential for adverse would lead to permanently large federal effects on consumer incomes and confi- deficits with negative consequences for dence should stagnant conditions persist the economy over the longer term. in labor markets and equity markets As they had at previous meetings, weaken further. Reference also was members also commented on the severe made to the possibility suggested by fiscal problems being experienced by some analysts that the value of housing numerous state and local governments. wealth might be leveling off. In that It was noted that state revenue shortfalls event mortgage refinancings might mod- were being aggravated by federally erate once mortgage rates stabilized, mandated costs related to homeland reducing the impetus to consumer security that were not, at least currently, spending from this source. being reimbursed by the federal govern- Statistical indicators of housing activ- ment. Another problem related to cerity and anecdotal reports from numerous tain tax proposals under consideration in parts of the country pointed to persisting the Congress, notably the exclusion of strength in homebuilding, with no signs dividends from income, that could have of a slowdown in most areas. Mem- adverse consequences for the revenues bers generally anticipated that activity of numerous state and local governin this sector of the economy would be ments that linked their taxable incomes well maintained in the context of low to those reported on federal returns. mortgage rates and further growth in More generally, while state and local incomes, but a few expressed reserva- efforts to redress budget imbalances tions about forecasts of a further pickup were likely to offset only a small part of this year. the probable stimulus in forthcoming The members anticipated the enact- federal legislation, some members comment of new legislation that would add mented that those efforts might well to the fiscal stimulus that was already involve more fiscal restraint than was incorporated in earlier legislation. While currently foreseen by some analysts. greater fiscal stimulus appeared to be Largely reflecting their expectations desirable to counter near-term weakness of ongoing, albeit diminishing, slack in in the economy, the new legislation labor and product markets, the members probably could not be enacted in time to anticipated that consumer price inflation begin to exert an expansionary impact probably would edge down over the next on the economy before the latter part of several quarters from an already low this year when the anticipated strength- level. Members also referred to a numening of the economy might already be ber of crosscurrents bearing on the outwell under way. Members also observed look for prices that included the adverse Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 169 effects of recent declines in the dollar opments over the intermeeting period, and higher oil prices but also the oppos- and their current forecasts in the context ing effects of a strong uptrend in produc- of tensions abroad argued for retaining a tivity and highly competitive markets balanced risks assessment to be included in holding down prices and costs. With in the statement that would be made regard to labor costs, members cited public shortly after this meeting. anecdotal evidence of persisting weak- At the conclusion of this discussion, ness in numerous regional labor markets the Committee voted to authorize and and, given the current reluctance of direct the Federal Reserve Bank of New employers to add to their workforces, York, until it was instructed otherwise, the prospect that job gains and labor to execute transactions in the System compensation would tend to lag the Account in accordance with the followanticipated strengthening in economic ing domestic policy directive: activity, as they often had in the past. In the Committee's discussion of The Federal Open Market Committee policy for the intermeeting period, all seeks monetary and financial conditions that will foster price stability and promote susthe members supported a proposal to tainable growth in output. To further its longmaintain an unchanged policy stance. run objectives, the Committee in the imme- While the economy had continued to diate future seeks conditions in reserve grow slowly, monetary policy and over- markets consistent with maintaining the all financial conditions had remained federal funds rate at an average of around 1 VA percent. accommodative and the prospects for an appreciable strengthening of the eco- The votes encompassed approval of nomic expansion over time were favorthe sentence below for inclusion in the able. As some of the prevailing uncerpress statement to be released shortly tainties currently impairing spending after the meeting. began to lift, possibly in the near term with regard to military developments in Against the background of its long-run the Middle East, the Committee should goals of price stability and sustainable ecobe in a much better position to assess the nomic growth and of the information curunderlying strength of the economy and rently available, the Committee believes that the appropriate policy response. At this the risks are balanced with respect to prospects for both goals in the foreseeable point, the Committee could not rule out future. a range of plausible economic outcomes, including the possibility of a persisting Votes for this action: Messrs. Greenspan, subpar economic performance or a much McDonough, and Bernanke, Ms. Bies, stronger than forecast acceleration of the Messrs. Broaddus, Ferguson, Gramlich, expansion. Indeed, the Committee could Guynn, Kohn, Moskow, Olson, and Parry. envision circumstances when it might Vote against this action: None. find it desirable to adjust its policy stance substantially and promptly in one It also was agreed that the next meetdirection or the other in the months ing of the Committee would be held on ahead. The members concluded that a Tuesday, March 18, 2003. wait-and-see policy stance was desir- The meeting adjourned at 12:55 p.m. able pending an improved basis for on January 29, 2003. judging the ongoing performance of the economy. They also agreed that the Vincent R. Reinhart accommodative stance of policy, devel- Secretary Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

170 90th Annual Report, 2003 Meeting Held on Messrs. Slifman and Oliner, Associate March 18, 2003 Directors, Division of Research and Statistics, Board of Governors A meeting of the Federal Open Market Mr. Whitesell, Deputy Associate Committee was held in the offices of Director, Division of Monetary the Board of Governors of the Federal Affairs, Board of Governors Reserve System in Washington, D.C., on Tuesday, March 18, 2003, at Mr. Clouse, Assistant Director, 9:00 a.m. Division of Monetary Affairs, Board of Governors Present: Mr. Greenspan, Chairman Mr. Skidmore, Special Assistant to the Mr. McDonough, Vice Chairman Board, Office of Board Members, Mr. Bernanke Board of Governors Ms. Bies Mr. Broaddus Ms. Low, Open Market Secretariat Mr. Ferguson Assistant, Division of Monetary Mr. Gramlich Affairs, Board of Governors Mr. Guynn Mr. Kohn Mr. Connolly, First Vice President, Mr. Moskow Federal Reserve Bank of Boston Mr. Olson Mr. Parry Messrs. Fuhrer and Hakkio, Mses. Mester and Perelmuter, Mr. Hoenig, Mses. Minehan and Messrs. Rasche, Rosenblum, Pianalto, and Mr. Poole, Alternate and Sniderman, Senior Vice Members of the Federal Open Presidents, Federal Reserve Market Committee Banks of Boston, Kansas City, Philadelphia, New York, St. Louis, Messrs. McTeer, Santomero, and Stern, Dallas, and Cleveland respectively Presidents of the Federal Reserve Banks of Dallas, Philadelphia, and Mr. Rudebusch, Vice President, Minneapolis respectively Federal Reserve Bank of San Francisco Mr. Reinhart, Secretary and Economist Mr. Bernard, Deputy Secretary Mr. Gillum, Assistant Secretary Mr. Weber, Senior Research Officer, Ms. Smith, Assistant Secretary Federal Reserve Bank of Mr. Mattingly, General Counsel Minneapolis Mr. Baxter, Deputy General Counsel Ms. Johnson, Economist By unanimous vote, the minutes of Mr. Stockton, Economist the meeting of the Federal Open Market Committee held on January 28-29, Mr. Connors, Ms. Cumming, 2003, were approved. Messrs. Eisenbeis, Goodfriend, Howard, Hunter, Lindsey, The Manager of the System Open Struckmeyer, and Wilcox, Market Account reported on recent Associate Economists developments in foreign exchange markets. There were no open market opera- Mr. Kos, Manager, System Open tions in foreign currencies for the Sys- Market Account tem's account in the period since the previous meeting. Mr. Madigan, Deputy Director, Division of Monetary Affairs, The Manager also reported on devel- Board of Governors opments in domestic financial markets Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 111 and on System open market transactions The unemployment rate inched up to in government securities and securities 5.8 percent in February, and the most issued or fully guaranteed by federal recent readings on initial claims for agencies during the period January 29, unemployment insurance suggested that 2003, through March 17, 2003. By labor market conditions remained soft in unanimous vote, the Committee ratified March. these transactions. Industrial production edged up in The Committee then turned to a dis- February after a sharp rise in January. cussion of the economic and financial Electricity generation increased substanoutlook and the conduct of monetary tially in response to unseasonably cold policy over the intermeeting period. weather in much of the East, and mining The information reviewed at this production picked up. Manufacturing meeting suggested that growth of eco- was pulled down in February by a slump nomic activity remained subpar in the in motor vehicle assemblies, but the opening months of the year. While the output of high-tech goods registered underlying demand for residential hous- another sizable gain, reflecting continuing continued to be robust and gov- ing growth in the production of semiernment outlays evidently were rising, conductors and computers, and output the expansion of consumer spending of goods other than motor vehicles and seemed to have slowed, and outlays for high-tech goods was unchanged. With capital spending were still very sluggish manufacturing production lower, capacin an environment of business uncer- ity utilization in manufacturing slipped tainty and pessimism. Declining motor somewhat in February to a rate substanvehicle output held down overall indus- tially below its long-run average. trial production, and the labor market Retail sales were lower on balance in weakened further. Consumer price infla- January and February, partly reflecting a tion as measured by the core CPI decel- decline in motor vehicle sales in both erated over the past year, but steep months and snowstorms that kept many increases in energy prices boosted over- consumers at home in February. In addiall price inflation. tion, rising energy prices eroded part of Private nonfarm payroll employment the sluggish gains in consumer incomes, had fallen sharply on balance in recent and both consumer sentiment and net months, though the quite large February worth deteriorated noticeably. decline may have been exaggerated by With mortgage rates remaining near bad weather, military reserve call-ups, historical lows, strength in residential and seasonal adjustment difficulties. housing demand carried through the February job losses in manufacturing early part of this year. However, bad were at about the same pace as seen weather in February disrupted singleover the past year. However, layoffs in family construction activity and singleconstruction surged, likely reflecting the family starts fell sharply from January's unusually adverse winter weather condi- very high level. Sales of both new and tions over much of the country. There existing homes slipped noticeably in were widespread declines in employ- January but remained at elevated levels. ment in the service sector, particularly in In the multifamily sector, where vacancy industries that had experienced steady rates are high and rents have fallen, growth last year. Job losses in the trans- starts dropped considerably to about the portation industry seemed to have been average pace recorded over the past associated in part with higher fuel costs. three years. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

172 90th Annual Report, 2003 Business investment on equipment gories. Available information on ecoand software increased briskly in the nomic activity abroad indicated that fourth quarter of last year as outlays for most of the major foreign economies aircraft climbed sharply and other major experienced sluggish growth late in categories recorded gains. In January, 2002 that seemed likely to persist in the a rise in shipments of nontransportation first quarter. Economic expansion in the capital equipment suggested that the euro area weakened further in the fourth demand for such goods on the part of quarter and Canadian output decelerated businesses was beginning to respond to sharply, but growth in Japan was relacontinued increases in output and fur- tively well sustained at a modest pace. ther declines in the cost of capital. In the In the emerging-market economies, conhigh-tech sector, shipments of comput- ditions in South America generally ing equipment surged in January, and remained fragile, the pace of economic shipments of communications equip- recovery in Mexico appeared to have ment registered sizable gains. Outside slowed somewhat, and growth was the high-tech sector, however, shipments generally restrained in much of emergedged down. Data on orders for durable ing Asia. Economic growth in China equipment placed in December and remained strong. January suggested that shipments could Most measures of core consumer strengthen in the coming months. In the prices and labor costs decelerated in the nonresidential sector, construction activ- twelve-month period ended in January. ity slowed further in the fourth quarter, However, the recent jump in gasoline with most categories recording sizable and heating oil prices, reflecting a sharp declines in expenditures. Many indica- run-up in crude oil prices and unusually tors of market conditions in the nonresi- cold weather in the Midwest and East, dential sector continued to weaken, with significantly boosted overall consumer vacancy rates rising and rents generally price inflation in the twelve months falling, but an upturn in property values ended in January. At the producer level, suggested that a turnaround in rents core price inflation for finished goods might be near. eased in the twelve-month interval end- The book value of manufacturing and ing in February. With regard to labor trade inventories excluding motor vehi- costs, hourly compensation for private cles edged down in January following industry workers decelerated noticeably buildups of stocks in the third and fourth in 2002, with growth of both the salary quarters of last year. The aggregate and benefits components slowing on a inventory-sales ratio for this sector had year-over-year basis. Growth in average trended down from the high levels hourly earnings of production or nonrecorded in mid-2001 and reached a new supervisory workers also slowed in the low in January, with few imbalances twelve months ending in February. The evident across industries. deceleration in both labor measures The U.S. trade deficit in goods and likely reflected in part the slack in labor services narrowed substantially in Jan- markets. uary as the value of exports partially At its meeting on January 28-29, reversed a large December decline and 2003, the Committee agreed on a directhe value of imports fell from elevated tive that called for maintaining condi- November and December levels. The tions in reserve markets consistent with rise in exports and the drop in imports keeping the federal funds rate around were broadly spread across goods cate- 1 lA percent and retained a balanced risks Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 173 assessment. The Committee noted that nomic weakness in major euro-area the economy continued to grow slowly, countries. The dollar was also little but monetary policy and financial changed against an index of the curconditions were quite accommodative rencies of other important U.S. trading and the prospects for an appreciable partners. strengthening of the economic expan- M2 grew rapidly in February, owing sion over time remained favorable. The mainly to robust inflows to liquid depos- Committee concluded that a wait-and- its. Earlier filings for tax refunds and see policy stance was desirable pend- hefty mortgage prepayments associated ing an improved basis for judging the with refinancing activity likely were facongoing performance of the economy. tors in the strength of M2. In addition, The Committee's decision was widely investors might have seen liquid deposanticipated and elicited little reaction its as a safe haven at a time of considerin financial markets. However, with the able volatility in equity markets. likelihood of war perceived to have The staff forecast prepared for this increased, investor wariness appar- meeting continued to suggest that ecoently intensified downward pressure nomic expansion would be muted for a on equity prices and interest rates over time. Faced with the likely onset of war the intermeeting period. Treasury bond in the very near term and the large yields declined somewhat, perhaps uncertainties relating to its aftermath, reflecting both expectations of lower businesses and consumers were likely to policy rates and greater investor hold down their spending. In addition, demands for safety. Rates in private debt continued sluggish economic growth markets fell by somewhat more than among most major U.S. trading partners comparable-maturity Treasury yields. was expected to damp U.S. exports. Declines in major equity indexes were Nonetheless, those restraining influamplified by lackluster earnings reports ences were expected to abate over time. and disappointing data on auto sales, The considerable monetary ease already labor market conditions, and consumer in place and the likely prospect of sigconfidence. nificantly more fiscal stimulus would The dollar changed little on balance combine with expected continuing over the intermeeting period in terms of strong gains in structural productivity an index of major foreign currencies, and improving business and consumer though the dollar fluctuated widely in confidence to provide significant impethe latter part of the period in reflection tus to spending. Inventory overhangs of market concerns about geopoliti- had been largely eliminated and busical uncertainties. The dollar depreciated ness capital stocks had moved closer against the Canadian dollar, which was to desired levels. As a consequence, a supported by a small monetary tighten- slowly improving outlook for sales and ing action by the Bank of Canada to trim profits, low financing costs, and the teminflationary pressures. By contrast, the porary federal tax incentive for investdollar appreciated slightly against the ment in new equipment and software British pound, partly in response to were expected to gradually boost busian unexpected easing by the Bank of ness investment spending. The persis- England to counter downward pressures tence of underutilized resources was on economic activity. The European expected to maintain some downward Central Bank also cut its key policy pressure on core price inflation over the rates in response to further signs of eco- forecast period. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

174 90th Annual Report, 2003 In the Committee's discussion of cur- dence and heightened caution on houserent and prospective economic devel- hold and business spending but noted opments, members commented that an that it was difficult to attribute the relaunusually high degree of uncertainty had tive contributions of geopolitical risk made it very difficult to assess the fac- and worries about the economy to the tors underlying the performance of the emergence of weaker spending. In any economy. Widespread indications of a event, consumer expenditures appeared strengthening economy near the end of to have been held back recently by last year through the first part of this the impact of higher energy costs, weak year had given way to a disappointing labor markets, and severe winter economic performance more recently. weather in the eastern part of the United It seemed clear that an outbreak of war States. Sales of motor vehicles had with Iraq was imminent and that this declined substantially since the start prospect was having a damping effect of the year despite the introduction on the economy. Uncertainty about of enhanced sales incentives. Nonthe effects of the war had contributed automotive retail sales, after a pickup to higher energy prices, lower equity at the end of 2002 that had extended prices, declines in measures of house- through the first several weeks of this hold confidence, and a tendency for year, had weakened more recently. households and especially businesses Whether the recent experience augured to postpone making commitments. But further softening in consumer spending it was also possible that a part of the was uncertain, but some members recent weakness might reflect under- commented that this weak performance lying economic conditions. In the cir- was not reassuring with regard to forecumstances, some clarification of the casts of substantial strengthening of Iraqi situation, which might occur in the the expansion later this year. Many relatively near future, should improve observed, however, that a favorable outthe Committee's ability to assess ongo- come to the hostilities in the Middle ing developments, though uncertainties East and lower oil prices in line with would remain. Beyond the near term, quotations in futures markets should members acknowledged that relatively generate a positive response in equity subdued growth for a time could not be markets, boost consumer sentiment, and ruled out, but many commented that the foster a rebound in consumer spending conditions were in place for a strength- as the year progressed. ening expansion. In this regard they Housing activity had held up well on referred to the positive effects on busi- the whole, despite a negative report on ness profits and consumer incomes of housing starts for February, and indeed persisting gains in productivity, stimu- was displaying continued strength in lative monetary and fiscal policies, and many parts of the nation. In numerous accommodative financial and bank lend- areas, however, sales of high-end homes ing markets. The likelihood of contin- had continued to lag and there were ued low or even declining inflation was reports of a softening in the middlehigh, especially given expectations of market single-family sector in some persisting slack in resource utilization. areas. Members also cited indications of In the course of the Committee's overbuilding in some parts of the counreview of developments in key sectors try, notably of multifamily housing. On of the economy, members underscored balance, generally robust homebuilding the retarding effects of reduced confi- activity was expected to persist against Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 175 the backdrop of low mortgage interest a positive outcome in the war against rates and rising household incomes. Iraq should have a favorable effect on With regard to the outlook for bus- business capital spending, especially if iness capital expenditures, members it were accompanied by a rally in the commented that a variety of factors stock market. likely would induce business firms to Many firms were trying to keep their continue to hold back on new invest- inventories at especially low levels ment initiatives, at least over the near in light of their concerns that projected term. Indeed, there was as yet no persua- sales might not materialize. Members sive evidence that business fixed invest- cited the resulting lean inventories as a ment would provide the needed support positive element in the outlook for ecofor the strengthening in overall eco- nomic activity, given likely efforts by nomic activity. Geopolitical uncertain- business firms to maintain inventories in ties, notably those relating to devel- broad aligment with anticipated growth opments in Iraq, frequently were cited over time in final sales. by business contacts as a major reason Federal government spending continfor caution, but other factors inhibiting ued to rise rapidly, led by large increases capital expenditures evidently included in defense and homeland security expenexcess capacity and limited prospects ditures, and members noted that the for profits because of increased energy, resulting impetus to growth might be insurance, pension, and other costs and augmented by passage of a fiscal stimua concomitant inability to raise selling lus package in line with that proposed prices. At the same time, there was only by the Administration. Considerable limited evidence thus far that the partial- uncertainty surrounded the eventual size expensing tax incentive, scheduled to of such a package or even whether it expire in September 2004, was having would be enacted this year. A partial a measurable effect on outlays for new offset to the federal fiscal stimulus equipment and software. The outlook stemmed from efforts to address deepenfor commercial construction activity ing budget crises in a number of states was especially downbeat because of and their adverse implications for many high vacancy rates in industrial and local economies. office structures in many areas, and a Against the background of persistent general upturn in such construction was strength in productivity growth and conviewed as unlikely to occur for an tinued low levels of capital and labor extended period of time. While resolu- utilization, inflation would likely remain tion of some of the uncertainties relating subdued going forward. Indeed, memto Iraq seemed likely in the relatively bers saw further disinflation in core near term, many business contacts prices as a distinct possibility over the reported that they would continue to next several quarters. At the same time, hold down their capital investments the outlook for oil prices and energy until demand for their goods and ser- prices more generally was uncertain vices and related profit opportunities and, despite market expectations, oil displayed clear signs of significant prices might remain relatively high in improvement. Some members nonethe- the event of adverse developments in less referred to indications of increasing Iraq and in some other major oil producexpenditures for various categories of ing countries that were experiencing high-tech equipment and software, and serious economic and political probthey noted that impetus to demand from lems. However, high oil prices, should Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

176 90th Annual Report, 2003 they persist, were likely to have more of tainties surrounding the geopolitical an effect in damping demand than in situation made it impossible to assign raising inflation, given well-entrenched reasonable probabilities to plausible expectations of low inflation. alternative economic outcomes and that In the Committee's discussion of pol- any effort to do so would provide a icy for the intermeeting period ahead, misleading impression of the Committhe members unanimously supported a tee's confidence and knowledge about proposal to maintain an unchanged pol- the economic outlook. In light of these icy stance. While the economic expan- considerable uncertainties, the members sion had displayed signs of faltering in agreed that heightened surveillance of recent weeks, the reasons for and hence evolving economic trends would be the duration of any period of weakness especially useful in the weeks ahead. At could not be reliably ascertained. In that the conclusion of the discussion, the regard, members commented that as key Committee voted to authorize and direct geopolitical uncertainties diminished or the Federal Reserve Bank of New York, were resolved, the Committee would be until it was instructed otherwise, to in a much better position to assess eco- execute transactions in the System nomic trends and a desirable course for Account in accordance with the followmonetary policy. Monetary policy was ing domestic policy directive: positioned to accommodate a strengthening economic performance that The Federal Open Market Committee seemed likely to materialize once key seeks monetary and financial conditions that will foster price stability and promote susuncertainties and related concerns began tainable growth in output. To further its longto decrease, perhaps in the relatively run objectives, the Committee in the immenear future, and business and consumer diate future seeks conditions in reserve sentiment started to improve. To be sure, markets consistent with maintaining the fedthe timing and speed of a pickup in eral funds rate at an average of around 1 lA percent. economic activity were not clear, and some members saw continued growth Votes for this action: Messrs. Greenspan, below potential as the primary risk for McDonough, Bernanke, Ms. Bies, Messrs. the near term. The members concluded Broaddus, Ferguson, Gramlich, Guynn, that the prudent course in current cir- Kohn, Moskow, Olson, and Parry. Votes cumstances was to maintain a steady against this action: None. policy stance, a high degree of vigilance, and a readiness to respond It was agreed that the next meeting of promptly as needed to the emergence the Committee would be held on Tuesof clearer evidence relating to the per- day, May 6, 2003. formance of the economy. In the latter The meeting adjourned at 12:50 p.m. regard, some members cautioned that the Committee might well need to adjust Following the outbreak of war in Iraq, its policy in circumstances that contin- the members of the Committee parued to be characterized by a substantial ticipated in a series of conference calls degree of uncertainty. held on March 25, April 1, April 8, and The Committee decided to omit its April 16 in order to keep abreast of usual statement regarding the balance of the latest information and to exchange risks from the press release to be made views regarding the possible implicapublic shortly after the meeting. Most tions of current developments for the members believed that the major uncer- economic outlook and monetary policy. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 111 No policy decisions were made in this Mr. Kos, Manager, System Open period. Market Account Messrs. Ettin and Madigan, Deputy Vincent R. Reinhart Directors, Divisions of Research Secretary and Statistics and Monetary Affairs respectively, Board of Governors Meeting Held on May 6, 2003 Messrs. Slifman and Oliner, Associate Directors, Division of Research A meeting of the Federal Open Market and Statistics, Board of Governors Committee was held in the offices of the Board of Governors of the Federal Mr. Whitesell, Deputy Associate Reserve System in Washington, D.C., Director, Division of Monetary on Tuesday, May 6, 2003, at 9:00 a.m. Affairs, Board of Governors Present: Mr. Clouse, Assistant Director, Mr. Greenspan, Chairman Division of Monetary Affairs, Mr. McDonough, Vice Chairman Board of Governors Mr. Bernanke Ms. Bies Mr. Skidmore, Special Assistant to Mr. Broaddus the Board, Office of Board Mr. Ferguson Members, Board of Governors Mr. Gramlich Mr. Guynn Mr. Luecke, Senior Financial Analyst, Mr. Kohn Division of Monetary Affairs, Mr. Moskow Board of Governors Mr. Olson Mr. Parry Ms. Low, Open Market Secretariat Assistant, Division of Monetary Mr. Hoenig, Mses. Minehan and Affairs, Board of Governors Pianalto, Messrs. Poole and Stewart, Alternate Members Messrs. Fuhrer and Hakkio, of the Federal Open Market Mses. Mester and Perelmuter, Committee Messrs. Rasche, Rosenblum, Rolnick, and Sniderman, Senior Messrs. McTeer, Santomero, and Stern, Vice Presidents, Federal Reserve Presidents of the Federal Reserve Banks of Boston, Kansas City, Banks of Dallas, Philadelphia, and Philadelphia, New York, St. Louis, Minneapolis respectively Dallas, Minneapolis, and Cleveland respectively Mr. Reinhart, Secretary and Economist Mr. Bernard, Deputy Secretary By unanimous vote, the minutes of Mr. Gillum, Assistant Secretary the meeting of the Federal Open Market Ms. Smith, Assistant Secretary Committee held on March 18, 2003, Mr. Mattingly, General Counsel Mr. Baxter, Deputy General Counsel were approved. Ms. Johnson, Economist The Manager of the System Open Mr. Stockton, Economist Market Account reported on recent developments in foreign exchange mar- Mr. Connors, Ms. Cumming, kets. There were no open market opera- Messrs. Eisenbeis, Goodfriend, tions in foreign currencies for the Sys- Howard, Hunter, Judd, Lindsey, Struckmeyer, and Wilcox, tem's account in the period since the Associate Economists previous meeting. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

178 90th Annual Report, 2003 The Manager also reported on devel- had moved lower, but overall consumer opments in domestic financial markets prices had been pushed up recently by and on System open market transactions sharp rises in energy prices. in government securities and securities Private nonfarm payroll employment issued or fully guaranteed by federal continued to fall in April. Manufacturagencies during the period March 18, ing employment registered widespread 2003, through May 5, 2003. By unani- losses, and the retail trade, transportamous vote, the Committee ratified these tion, and utilities industries extended transactions. their declines of prior months. The With Mr. Broaddus dissenting, the unemployment rate rose to 6 percent Committee voted to extend for one year in April, with increases spread widely beginning in mid-December 2003 the across most demographic groups. Initial reciprocal currency ("swap") arrange- claims for unemployment insurance ments with the Bank of Canada and the remained at an elevated level, suggest- Bank of Mexico. The arrangement with ing further labor market weakness in the Bank of Canada is in the amount of May. $2 billion equivalent and that with the Industrial production fell in March, Bank of Mexico in the amount of $3 bil- and weekly physical product data and lion equivalent. Both arrangements are other indicators pointed to another drop associated with the Federal Reserve's in April. Lower output at utilities participation in the North American accounted for some of the decline in Framework Agreement. The vote to overall production in March but manurenew the System's participation in the facturing output, especially motor vehiswap arrangements maturing in Decem- cle assemblies, fell again. Total indusber was taken at this meeting because trial capacity utilization declined in of the provision that each party must March, with capacity utilization in provide six months prior notice of an manufacturing reaching a twenty-year intention to terminate its participation. low. Mr. Broaddus dissented because he Real personal consumer expenditures believed that the swap lines exist prima- rose in March and for the first quarter rily to facilitate foreign exchange mar- as a whole. Spending on durable goods ket intervention, and he was opposed to increased in March but was down a bit such intervention for the reasons he had for the full quarter. By contrast, spendexpressed at the January meeting. ing on services and nondurable goods The Committee then turned to a dis- fell in March but was up on balance in cussion of the economic and financial the first quarter. Disposable income was outlook and the conduct of monetary unchanged in March. Measures of conpolicy over the intermeeting period. sumer confidence rebounded sharply in The information reviewed at this April after sizable declines in February meeting suggested that economic activ- and March. ity continued to grow at a subpar pace Residential housing activity remained in recent months. Consumer spending solid, though some signs of potential advanced slightly in the first quarter moderation emerged. Supported by conand housing activity remained at a high tinued low mortgage rates, first-quarter level, but business investment slowed. housing starts in the single-family sector Industrial production was sluggish, and stayed at the high level of the fourth additional slack accumulated in the quarter. Multifamily starts also changed labor market. Core consumer inflation little in the first three months of the year Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 179 and vacancy rates in the sector remained that of the fourth quarter. The narrowhigh. Sales of existing homes were off a ing in February was accounted for by a bit in March, but sales for the first quar- small decline in imports and a marginal ter as a whole edged up from the fourth- rise in exports. Recent indicators sugquarter rate. New home sales, however, gested continued sluggish economic were down from their fourth-quarter growth in most foreign industrial pace. nations. The Japanese economy was Real outlays on equipment and soft- about flat in the early months of the ware declined in the first quarter after year, activity in the euro area remained rising moderately over the three preced- subdued, and first-quarter growth in the ing quarters. A sharp drop in purchases United Kingdom was lackluster. Canaof transportation equipment more than dian domestic demand remained relaaccounted for the first-quarter decline. tively robust but appeared to be slowing. The weakness in the transportation cate- Economic conditions in other countries gory reflected sluggish expenditures for were mixed. In Latin America, Mexican aircraft, medium and heavy trucks, and data releases pointed toward increases light vehicles. By contrast, the high-tech in economic activity, and the Argencategory recorded strong growth owing tine economy continued to show signs to a surge in spending for computer and of recovery. In contrast, Venezuela peripheral equipment and an upturn in remained in crisis, and economic activpurchases of communications equip- ity in Brazil appeared to have moderated ment. Although investment fundamen- despite improved financial market contals, such as corporate cash flows and ditions. In developing Asia, indicators reduced costs of capital, remained favor- suggested that economic growth had able, reports from businesses were slowed in much of the region. China, downbeat. The extended decline in real however, registered robust growth in the investment spending on nonresidential first quarter. structures moderated further in the first Core consumer price inflation moved quarter, with the smallest decline since down further in the first quarter from the first quarter of 2001. its already low level. A sharp run-up in Real nonfarm inventories exclud- energy prices, however, pushed up overing motor vehicles appeared to have all consumer prices in the first quarter declined a little in the first quarter after and in the year ended in March (meaaccumulating in recent quarters. The sured by both the consumer price index buildup of manufacturing and trade and the chain-type personal consumpinventories, however, continued in Jan- tion expenditure index). Producer prices uary and February at an average pace also were boosted significantly by the similar to that of the second half of jump in energy prices in recent months. 2002. Relative to sales, non-auto inven- Core producer prices were up appreciatory stocks in most sectors were low by bly in the first quarter but at a slower recent standards. According to industry pace than overall producer prices. With reports, inventories in the motor vehicle regard to labor costs, the employment industry apparently had risen above cost index for hourly compensation of desired levels. private industry workers rose at a faster The U.S. trade deficit in goods and rate during the three months ended in services narrowed slightly in February March, reflecting increases in wages and and brought the average deficit for Janu- salaries and in benefit costs. The expanary and February to an annual rate near sion of compensation costs over the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

180 90th Annual Report, 2003 twelve months ended in March was had fallen, but longer-term Treasury virtually the same as in the previous yields had changed little since the March twelve-month period. meeting. Risk spreads on corporate When the Committee met on debt securities narrowed across the March 18, 2003, the nation appeared to credit quality spectrum. Broad equity be on the brink of war. At the end of that indexes registered notable gains related meeting, the Committee adopted a direc- to better-than-expected corporate earntive that called for maintaining condi- ings reports. tions in reserve markets consistent with In foreign exchange markets, the keeping the federal funds rate around trade-weighted value of the dollar in \lA percent. The Committee agreed to terms of the major foreign currencies indicate in its announcement that in light declined over the intermeeting period. of the unusually large uncertainties The dollar depreciated somewhat more clouding the geopolitical situation in the against the euro and the Canadian dollar short run and their apparent effects on and only slightly against the Japanese economic decisionmaking, it could not yen. The dollar also declined against an at that time usefully characterize the cur- index of currencies of other important rent balance of risks with respect to the trading partners. Equity markets in prospects for its long-run goals of price the major industrial economies, except stability and sustainable economic Japan, had risen significantly since the growth. The Committee also agreed that March FOMC meeting. heightened surveillance would be par- Growth in M2 slowed over March ticularly informative. It was noted that and April, but most of the deceleration while the recent economic data were appeared to be attributable to temporary mixed, the hesitancy of the economic tax-related flows of funds. A movement expansion appeared to owe significantly toward earlier electronic filing apparto oil price premiums and other aspects ently weakened M2 in March by shiftof geopolitical uncertainties. The Com- ing refund distributions into February. mittee believed that as those uncertain- Reduced M2 growth in April reflected, ties lifted, the accommodative stance in part, slower-than-average buildups of monetary policy, coupled with the of deposits associated with final tax payongoing growth in productivity, would ments by individuals. Substantial net provide vital support toward fostering inflows to equity mutual funds occurred improving economic performance over during the same period. time. The staff forecast prepared for this The decision to leave policy on hold meeting continued to suggest that ecohad been largely anticipated by market nomic expansion would be sluggish participants, but the inclusion in the in the near term. Faced with persisting policy announcement of a reference to weakness in product and labor markets, "heightened surveillance" led initially businesses and consumers were likely to downward revisions to expectations to hold down their spending. In addifor the future path of the federal funds tion, continued slow economic growth rate. The abatement of war-related risks in most of the nation's major trading was reflected in sizable declines in partners would tend to restrain U.S. forward-looking measures of uncer- exports, though those restraints were tainty in short- and long-term interest expected to abate over time. The cumrates, exchange rates, and oil and equity ulative effects of an accommodative prices. Nearer-term Treasury yields monetary policy, likely further reduction Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 181 in taxes, and robust gains in structural ductivity that provided enhanced investproductivity would provide significant ment opportunities and ongoing supimpetus to spending. Inventory over- port for household incomes. Continued hangs had been substantially reduced, progress in lifting various constraints on and business capital stocks had moved economic growth, including the unwindcloser to desired levels. As a conse- ing of excessive or misdirected capital quence, a slowly improving outlook for expenditures undertaken in earlier years sales and profits, low financing costs, and the steps taken to address corporate and the temporary federal tax incentive governance and credit problems were for investment in new equipment and also working to strengthen the expansoftware were expected to gradually sion. Against that backdrop, it was noteboost business investment spending. worthy that many private-sector fore- Given the ongoing slack in resource casters predicted a pronounced upturn in utilization, downward restraint on core economic growth in the third quarter. price inflation was expected to persist Despite underlying factors that seemed over the forecast period. increasingly conducive to an accelerat- In the Committee's discussion, mem- ing expansion, members noted that the bers commented that the recent informa- timing and vigor of a pickup in ecotion bearing on the economic outlook nomic activity remained uncertain, espewas mixed. The latest reports on eco- cially in the context of a persistently nomic activity generally were disap- high degree of caution in the business pointing, notably those relating to community with regard to investment employment and production, but mem- and hiring decisions. With the removal bers noted that most of these reports of key uncertainties associated with the covered developments occurring before Iraqi war, the information that would the end of hostilities in Iraq. The suc- become available in the weeks ahead cessful prosecution of the war had was expected to provide a clearer basis served to reduce geopolitical uncertain- for assessing future trends in business ties and in turn had helped to foster a spending and, more generally, the undermarked strengthening of domestic finan- lying strength of the economy. Members cial markets, a sizable decline in oil anticipated that inflation would remain prices, and an apparent upturn in con- at a low level for an extended period and sumer confidence. In this improved indeed that the probability of further environment, members anticipated that disinflation was higher than that of a near-term sluggishness in economic pickup in inflation, given the current growth would give way to more vigor- high levels of excess capacity in labor ous expansion as the year progressed. In and product markets, which seemed support of this expectation, it was noted likely to diminish only gradually. that if the substantial gains in financial Business fixed investment remained markets experienced recently persisted, a key factor in the prospects for overall experience indicated that a stronger eco- economic activity, and persisting weaknomic performance generally would ness in such spending in association follow. Favorable factors in the outlook with gloomy sentiment and a high mentioned by members included an degree of risk aversion among business accommodative monetary policy, pro- decisionmakers did not bode well for spective legislation that would increase the capital investment outlook, at least an already stimulative fiscal policy, and for the near term. Anecdotal reports by evidence of a persisting uptrend in pro- business contacts tended to emphasize Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

182 90th Annual Report, 2003 widespread excess capacity as a rea- albeit not as much as some industry son for holding down business capital contacts had hoped, and members spending, including high vacancy rates referred to tentative signs of a pickup in in office and other business structures. retail sales. On balance, however, the In this atmosphere, most business deci- members did not see any firm indicasionmakers evidently preferred to rely tions of significant acceleration in conon the increasingly efficient or fuller sumer spending. More positively, they utilization of existing producer facilities cited recent survey and anecdotal evirather than expanding the latter to meet dence of improving consumer configrowth in demand. Indeed, according to dence and referred to the gains in the business contacts, investment expendi- stock market as a source of potential tures generally were limited to replace- impetus going forward. In the housing ment and to some extent to upgrading of markets, activity currently was someexisting facilities rather than for expan- what uneven across the nation but had sion. In some cases, businesses report- remained at a high overall level. While edly were acquiring used capital equip- favorable financing would help to susment and unoccupied building space at tain the housing sector, members anticigreatly reduced costs, thereby holding pated that any further impetus to growth down the current production of new from that sector was likely to be limited. capital but also relieving selling firms of The members expected economic some excess capacity. activity to be supported by substantial Members nonetheless saw a number fiscal stimulus in coming quarters, with of favorable elements in the outlook for that already built into existing federal business investment expenditures. These legislation likely to be augmented by included a decline in the cost of busi- further initiatives under active considerness capital, a recent rise in orders and ation in the Congress. However, budgets backlogs of nondefense capital goods, of numerous state and local governpersisting gains in productivity that ments remained under severe pressure, undoubtedly pointed to growing profit and efforts to contain spending and raise opportunities, progress in strengthening taxes by those governments would offbusiness balance sheets, and reduced set some of the federal stimulus this capital overhangs. With regard to busi- year and next. It was not clear at this ness attitudes, members reported very point how some state and local governrecent but also widespread indications ments would resolve their current budfrom their contacts that business con- getary crises and what the effects would fidence might be in the process of be on many local economies. improving, though the upturn in confi- A weakening dollar and sluggish ecodence was not likely to show through to nomic conditions abroad were key facinvestment outlays for some time. tors impinging on the prospective con- In the household sector, an appre- tribution of the foreign sector to U.S. ciable decline in sales of motor vehicles economic activity. While foreign and slower growth in other consumer demand for U.S. products and services spending in the first quarter appeared to would be supported by the dollar's reflect concerns relating to the Iraqi war depreciation, relatively weak foreign and adverse weather conditions in some economic activity would tend to hold parts of the country. More recently, down such demand. On balance, the attractive sales incentives had boosted nation's trade deficit was likely to consumer purchases of motor vehicles, remain at an elevated level, with moder- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 183 ate gains in exports more than offset by ing action was not desirable at this time. larger increases in imports if forecasts They noted that not enough time had of relatively robust U.S. growth in fact elapsed since the end of the Iraqi war to materialized. sort out the underlying forces at work Even assuming a pickup in the expan- in the economy. In particular, the lifting sion of economic activity in line with of key uncertainties relating to the war current forecasts for this year and next, would provide an improved opportunity excess capacity in labor and product to assess whether the favorable factors markets would remain elevated and in the outlook would in fact lead to the might well foster further disinflation anticipated strengthening in economic over coming quarters. The decline in activity and, at the same time, diminish inflation might be limited to some extent the risk of appreciable further disinflaby the depreciated value of the dollar tion. Some members cautioned that perin foreign exchange markets and by the sisting uncertainty regarding economic anticipated effects of further large trends should not provide a basis for increases in worker benefit costs. Given prolonged inaction in light of the risks the pressure of a considerable amount of of further disinflation and subpar ecounused resources, any adverse develop- nomic growth. In the absence of conments that held down economic expan- vincing indications of an appreciable sion would increase the probability pickup in economic growth, an easing of further disinflation. Members com- move might be desirable in the near mented that substantial additional disin- term, perhaps at the June meeting. flation would be unwelcome because of With regard to the press announcethe likely negative effects on economic ment to be released shortly after this activity and the functioning of finan- meeting, the members supported new cial institutions and markets, and the language that provided separate assessincreased difficulty of conducting an ments of the risks to the goal for accepteffective monetary policy, at least poten- able economic growth and the risks to tially in the event the economy was sub- the goal of price stability. They recogjected to adverse shocks. Members also nized that the usual summary statement agreed that there was only a remote did not allow for the circumstances in possibility that the process of disinfla- which the Committee saw some probtion would cumulate to the point of a ability, albeit minor, of a significant decline for an extended period in the further decline in inflation to an unwelgeneral price level. come level. After discussion, the mem- In the Committee's discussion of pol- bers generally agreed on separate senicy for the intermeeting period ahead, tences indicating that the risks to its goal all the members indicated that they of sustainable economic growth were could support a proposal to maintain an about balanced but that the probability unchanged policy stance. The members of some disinflation from an already acknowledged that a case could be made low level exceeded that of a pickup in for easing policy immediately in light inflation. The members also accepted a of the generally disappointing reports on summary statement stating that, taken the recent performance of the economy, together, the balance of risks to the the ongoing disinflation trend in a period Committee's dual goals was tilted of already low inflation, and forecasts of toward the downside over the foreseepersisting excess capacity. Nonetheless, able future. There was some concern they concluded that, on balance, an eas- that including such a summary sentence Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

184 90th Annual Report, 2003 in the press release might be mistakenly "Order of the Aztec Eagle" honor to be interpreted as an indication of Commit- awarded by the government of Mexico. tee concern about the outlook for economic activity rather than a judgment Votes for this action: Messrs. Greenspan, about the relative odds on further infla- Bernanke, Ms. Bies, Messrs. Broaddus, Ferguson, Gramlich, Guynn, Kohn, tion. Two members saw merit in adopt- Moskow, Olson, and Parry. Votes ing a balanced risks assessment at this against this action: None. Abstention: meeting despite the evident shortcom- Mr. McDonough. ings in present circumstances of the form of such statements in use in recent Vincent R. Reinhart years. Secretary At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New Meeting Held on York, until it was instructed otherwise, June 24-25, 2003 to execute transactions in the System A meeting of the Federal Open Market Account in accordance with the follow- Committee was held in the offices of ing domestic policy directive. Consisthe Board of Governors of the Federal tent with the decision made at the March Reserve System in Washington, D.C., meeting, the vote did not formally starting on Tuesday, June 24, 2003, at encompass the wording of the press 2:30 p.m. and continuing on Wednesstatement to be released shortly after day, June 25, 2003, at 9:00 a.m. this meeting. Present: The Federal Open Market Committee Mr. Greenspan, Chairman seeks monetary and financial conditions that Mr. Bernanke will foster price stability and promote sus- Ms. Bies tainable growth in output. To further its long- Mr. Broaddus run objectives, the Committee in the imme- Mr. Ferguson diate future seeks conditions in reserve Mr. Gramlich markets consistent with maintaining the fed- Mr. Guynn eral funds rate at an average of around Mr. Kohn 1 lA percent. Mr. Moskow Mr. Olson Votes for this action: Messrs. Greenspan, Mr. Parry McDonough, Bernanke, Ms. Bies, Messrs. Broaddus, Ferguson, Gramlich, Guynn, Mr. Hoenig, Mses. Minehan and Kohn, Moskow, Olson, and Parry. Votes Pianalto, Messrs. Poole and against this action: None. Stewart, Alternate Members of the Federal Open Market It was agreed that the next meeting Committee of the Committee would be held on Tuesday-Wednesday, June 24-25, 2003. Messrs. McTeer, Santomero, and Stern, Presidents of the Federal Reserve The meeting adjourned at 1:25 p.m. Banks of Dallas, Philadelphia, and Minneapolis respectively Notation Vote Mr. Reinhart, Secretary and Economist Mr. Bernard, Deputy Secretary By notation vote completed on May 20, Mr. Gillum, Assistant Secretary 2003, the Committee authorized Vice Ms. Smith, Assistant Secretary Chairman McDonough to accept the Mr. Mattingly, General Counsel Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 185 Ms. Johnson, Economist Mr. Skidmore, Special Assistant to the Mr. Stockton, Economist Board, Office of Board Members, Board of Governors Mr. Connors, Ms. Cumming, Messrs. Eisenbeis, Goodfriend, Mr. Luecke, Senior Financial Analyst, Howard, Judd, Lindsey, Division of Monetary Affairs, Struckmeyer, and Wilcox, Board of Governors Associate Economists Ms. Low, Open Market Secretariat Mr. Kos, Manager, System Open Assistant, Division of Monetary Market Account Affairs, Board of Governors Messrs. Ettin and Madigan, Deputy Mr. Barron, First Vice President, Directors, Divisions of Research Federal Reserve Bank of Atlanta and Statistics and Monetary Affairs respectively, Board of Messrs. Fuhrer and Hakkio, Governors Ms. Mester, Messrs. Rasche, Rolnick, Rosenblum, and Messrs. Slifman and Oliner, Associate Sniderman, Senior Vice Directors, Division of Research Presidents, Federal Reserve and Statistics, Board of Governors Banks of Boston, Kansas City, Philadelphia, St. Louis, Messrs. Clouse and Whitesell, Deputy Minneapolis, Dallas, and Associate Directors, Division of Cleveland respectively Monetary Affairs, Board of Governors Messrs. Evans, Hilton, and Kuttner,8 Vice Presidents, Federal Reserve Mr. Reifschneider,7 Assistant Director, Banks of Chicago, New York, and Division of Research and New York respectively Statistics, Board of Governors By unanimous vote, the minutes of Mr. Orphanides,8 Adviser, Division the meeting of the Federal Open Market of Monetary Affairs, Board of Governors Committee held on May 6, 2003, were approved. Mr. Elmendorf,7 Section Chief, The Manager of the System Open Division of Research and Market Account reported on recent Statistics, Board of Governors developments in foreign exchange mar- Ms. Kusko,7 Senior Economist, kets. There were no open market opera- Division of Research and tions in foreign currencies for the Sys- Statistics, Board of Governors tem's account in the period since the previous meeting. Messrs. Bassett7 and Wood,7 The Manager also reported on devel- Economists, Divisions of opments in domestic financial markets Monetary Affairs and International and on System open market transactions Finance respectively, Board of Governors in government securities and securities issued or fully guaranteed by federal agencies during the period May 6, 2003, through June 24, 2003. By unanimous 7. Attended portion of meeting relating to the vote, the Committee ratified these discussion of economic developments. transactions. 8. Attended portion of meeting relating to the discussion of the conduct of monetary policy in a The Committee discussed at length period of very low interest rates. alternative means of providing mone- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

186 90th Annual Report, 2003 tary stimulus should the target federal on circumstances. For now, however, funds rate be reduced to a point where they believed that arriving at an underthere was little or no latitude for addi- standing of the various options that tional easing through this conventional might be employed prepared them to policy instrument. The members agreed respond more flexibly and effectively to that current economic conditions and the unanticipated developments. While conprevailing stances of monetary and fis- siderable uncertainty surrounded each cal policy made the need to use unusual individual policy option, the members monetary policy tools a quite remote agreed that the effectiveness of these possibility. Even so, they believed it was alternative tools, along with the useful to discuss that possibility because 125 basis points of conventional easing of the implications for financial markets still available, would allow monetary and institutions and for the conduct of policy to combat economic weakness monetary policy of reducing short-term and forestall any unexpected tendency interest rates to very low levels. An for a pernicious deflation to develop. environment involving such interest The information reviewed at this rates could have adverse repercussions meeting suggested that the economy on the functioning of some sectors of continued to expand at a subpar pace the money market, but the members in recent months. Consumer spending agreed that the potential extent of such increased moderately, housing activity disruptions would not be sufficient held at a high level, and government to prevent the Committee from taking outlays grew substantially. Business advantage of the full scope of conven- investment, however, was still soft. tional easing of the federal funds rate, Industrial production and employment should that become necessary. Beyond appeared to have stabilized after an that, a variety of nonconventional mea- extended period of weakness. Consumer sures for further easing was available. price inflation remained at a very low In this regard, the members discussed level. the advantages and disadvantages of Private nonfarm payrolls changed various approaches that, possibly little on balance in April and May after employed in some combination, would declines earlier in the year. Although alter the size and composition of the employment in manufacturing contin- System's balance sheet. They also con- ued to fall in May, hiring in temporary sidered aspects of the Committee's com- help services, which supplies many of munications as a means of underscoring its workers to manufacturing, picked up to the public its willingness to follow noticeably. Construction and financial a sufficiently accommodative path of services continued to add jobs. Unemmonetary policy for as long as necessary ployment edged up further in May, to to foster improved economic perfor- 6.1 percent, and the number of both mance. The members did not see the short-term job losers and longer-term need at this time to reach a consensus on unemployed increased as well. Initial the desirability of any specific nontradi- claims for unemployment insurance tional approach to the implementation remained high. of monetary policy, particularly given Industrial production increased the low probability of its near-term use. slightly in May after sizable declines As experience had shown, at times of in the preceding two months. The economic and financial market stress the manufacturing sector recorded broadspecific policy tools used would depend based improvement, though automobile Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 187 assemblies and the output of communi- The book value of manufacturing cations equipment continued to slide. inventories rose moderately further in The effects of strength in the mining the first quarter and in April. Relative to sector on the industrial production index shipments and sales, inventories of were more than offset by a reduction in manufacturers, wholesalers, and retailutility output. Overall capacity utiliza- ers have remained at quite low levels tion remained very low, with manufac- thus far this year. turing utilization near a twenty-year The U.S. trade deficit in goods and low. services edged up in April from the Real consumer outlays, excluding first-quarter rate. Real GDP growth in cars and trucks, were flat in April but the major foreign industrial countries turned up in May. Spending on motor remained weak in the first quarter as vehicles rose over the two months from external demand sagged amid heightthe first-quarter pace. At the same time, ened geopolitical uncertainties. Real the fundamentals underlying household GDP growth continued to slow in the spending became more favorable: Real first quarter in Japan and the United disposable income posted solid gains, Kingdom, and economic activity in the and both the stock market and consumer euro area was flat. By contrast, ecoconfidence recovered from earlier in the nomic activity accelerated in Canada in year. the first quarter. Activity in the housing market was Sharp declines in energy prices pulled reasonably well maintained in April and down overall consumer prices in April May. Despite unusually wet weather in and May, but core consumer prices many areas, starts of single-family and edged up. On a year-over-year basis, multifamily units in the two months however, core consumer price inflation were just a little below their strong first- eased noticeably. Core producer price quarter levels. Building permits for new inflation also declined over the year endsingle-family and multifamily homes ing in May. With regard to labor costs, were up from a depressed March level. average hourly earnings of production Sales of both existing and new homes in or nonsupervisory workers were flat in April and May were above the high April and increased moderately in May. levels recorded in recent quarters. The twelve-month change was some- Orders and shipments of nondefense what above that for the year earlier. capital goods were lackluster in April At its May 6, 2003, meeting the Fedand May. This sluggish performance fol- eral Open Market Committee adopted a lowed a first-quarter decline in real out- directive that called for maintaining conlays on equipment and software that had ditions in reserve markets consistent more than reversed the fourth-quarter with keeping the federal funds rate at gains. Excluding purchases of trans- around 1XA percent. The Committee disportation equipment, however, outlays cussed a post-meeting release to the grew a bit over the first quarter. Real press stating that over the next few quarinvestment in nonresidential structures ters the upside and downside risks to the dropped further in that quarter, though attainment of sustainable growth were the rate of decline slowed. Outlays for roughly equal, but that, in contrast, over office buildings and industrial structures the same period the probability of an were down sharply, and falling rents and unwelcome substantial fall in inflation, rising vacancy rates in April suggested though minor, exceeded that of a pickup further weakness in the second quarter. in inflation from its already low level. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

188 90th Annual Report, 2003 The Committee also agreed to a state- est rates fell in all major industrial ment that, taken together, the balance of economies, while equity prices rose risks to achieving its goals was weighted substantially. toward weakness over the foreseeable Growth of M2 surged in May. At future. The Committee noted that, while least part of the acceleration was due to the geopolitical tensions that had special factors related to strong mortinhibited economic expansion in earlier gage refinancing activity and to the flow months appeared to have diminished, of funds associated with tax payments. the timing and extent of an improving The staff forecast prepared for this economic performance could not be meeting once again suggested that the reliably ascertained. In the current cir- economic expansion would strengthen cumstances, the members concluded substantially as the year progressed. the prudent course was to maintain a Accommodative financial conditions, steady policy stance, a high degree of recent additional fiscal stimulus, and vigilance, and a readiness to respond robust gains in structural productivity promptly as needed to the emergence of would provide significant impetus to clearer evidence relating to the perfor- spending over the months ahead. Invenmance of the economy. tory overhangs had been substantially The Committee's decision at the May reduced, and business capital stocks meeting relating to the federal funds rate likely had moved closer to desired levwas not a surprise to most market par- els. As a consequence, improving sales ticipants. However, splitting the balance and profits, low financing costs, and of risks statement into separate assess- the temporary federal tax incentive for ments about growth and inflation, in investment in new equipment and softaddition to noting a concern about a ware were expected gradually to boost further possible decline of inflation from business investment spending. Given the an already low level, led market partici- ongoing slack in resource utilization, pants to mark down their expectations downward pressure on core price inflafor the federal funds rate. Consistent tion was expected over the forecast with those expectations, Treasury cou- period. pon yields declined 35 to 60 basis In the Committee's discussion of curpoints. Yields on corporate bonds also rent and prospective economic developfell about in line with rates on Trea- ments, members referred to signs of suries even though capital markets improvement in some sectors of the absorbed a surge in bond issuance by economy, but they saw no conclusive highly rated firms. Equity prices, evidence of an appreciable overall buoyed by the decline in bond yields as strengthening in the sluggish economic well as the improved outlook for eco- expansion. On the positive side, they nomic growth, registered sizable gains pointed to reports of some pickup in over the intermeeting period. retail sales, indications that labor and The dollar continued to depreciate in product markets might be stabilizing, terms of an index of major foreign cur- continued robust activity in housing rencies amid growing concerns about markets, and ongoing impetus from the financing burden of the large and the federal government sector. Concurgrowing U.S. current account deficit and rently, however, weakness persisted questions by market participants about in business capital expenditures, which the commitment of U.S authorities to a members continued to view as the crit- "strong dollar" policy. Long-term inter- ical factor inhibiting the economic Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 189 expansion. Looking ahead, they empha- icy over the projection period and had sized that favorable underlying condi- the opportunity to update them until tions were in place to support a sub- July 3. The forecasts of the rate of stantial acceleration of the expansion, expansion in real GDP had central tenthough the timing and dimensions of a dencies of 2!/2 to 23/4 percent for 2003, significantly improved economic perfor- implying that economic growth would mance remained uncertain. Positive fac- accelerate noticeably in the second half tors bearing on the outlook mentioned of the year, and 33/4 to 43/4 percent for by members included the accommoda- 2004. These rates of growth were assotive stance of monetary policy and sup- ciated with central tendencies for the portive financial conditions more gen- civilian rate of unemployment of 6 to erally, the persistence of rapid growth 6!/4 percent in the fourth quarter of 2003 in labor productivity, sizable declines in and 5!/2 to 6 percent in the fourth quarenergy prices from elevated levels ear- ter of 2004. Forecasts of inflation, as lier in the year, and indications of ris- measured by the chain-type price index ing consumer confidence and of less for personal consumption expenditures, negative business sentiment. Members pointed to the persistence of quite low also gave considerable emphasis to the inflation rates centered on ranges of anticipated effects of recent legislation 1 lA to 1 Vi percent for this year and 1 to that in short order would add substan- F/2 percent in 2004. tially to the degree of fiscal stimulus. Despite some differences with regard In their review of the outlook for to the timing and strength of the anticiinflation, members commented that cur- pated upturn in the expansion, the memrently elevated levels of unused labor bers agreed that accommodative moneand other resources were likely to per- tary and fiscal policies along with much sist for an extended period, even if eco- improved financial conditions were nomic growth turned out to be robust. likely to foster a better economic perfor- And until it was substantially reduced, mance over time. Growing market perthe output gap would undoubtedly pre- ceptions that monetary policy would clude any significant acceleration in remain stimulative for a longer period inflation and could well cause inflation than previously anticipated appeared to to edge down from its already low level. have contributed to significant declines At the same time, a substantial further in interest rates across maturities and decline in inflation was viewed as hav- risk classes, and to rising prices in ing a low probability, though disinfla- equity markets. The gains in equity tion would remain a matter of concern prices and a narrowing of risk spreads until a sustained pickup in overall eco- also appeared to reflect more upbeat nomic activity was firmly established. assessments of underlying business con- In preparation for the midyear mone- ditions and, partly in concert with tary policy report to Congress, the mem- reduced geopolitical risks since the end bers of the Board of Governors and the of major military activity in Iraq, growpresidents of the Federal Reserve Banks ing convictions that the downside vulsubmitted individual projections of the nerability of the domestic economy had growth of GDP, the rate of unemploy- diminished. Both business firms and ment, and the rate of inflation for the households had continued to take advanyears 2003 and 2004. The members tage of generally improving financial based these forecasts on their individual conditions to strengthen their balance views as to the appropriate path of pol- sheets through debt restructuring activ- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

190 90th Annual Report, 2003 ities, thereby helping to buttress the power. And while the low cost and economy's financial underpinnings and ample availability of financing for most foster sustained expansion. business firms along with the recently The ongoing stimulative effects of raised partial tax expensing provision earlier tax cuts and large increases in for certain investment outlays were defense spending had recently been positive factors, reports from business enhanced by added fiscal stimulus that executives indicated that a key factor would provide households with more inhibiting decisions to invest at this spendable income in the months imme- point was the unfavorable outlook for diately ahead than had been anticipated sales growth in the context of substanearlier. The expected result would be a tial margins of excess capacity. Memrelatively prompt and sizable boost to bers also noted that the attention of consumer expenditures and, over time, many boards of directors and other to business spending. Some members senior corporate officials remained expressed reservations, however, about focused on corporate governance and the extent of the near-term effects of tax accounting issues rather than potential rate reductions on overall consumer capital projects, and that concerns about spending, given the likelihood that some vulnerabilities relating to such issues portion of the funds transferred to had damped appetites for taking risks. households would be used to reduce per- In this environment, investment outlays sonal debts or to add to various savings tended to be limited to the replacement vehicles. Members also noted that mea- and upgrading of existing facilities sures taken by many state and local gov- rather than expansion. A number of ernments to raise taxes and trim spend- members nonetheless cited faint signs ing in order to resolve fiscal crises of more positive investment prospects, would offset an uncertain—though in though not of currently increasing the view of most a small—part of the investment expenditures, gleaned from federal sector stimulus over the period anecdotal commentary and responses to ahead. On balance, given the combined recent capital spending surveys. The lateffects of lower tax rates and the out- est readings on orders and shipments of look for continued high levels of durable goods were also seen as a favordefense spending, the federal sector able, though not a conclusive, sign of generally was seen as an important higher investment spending. In general, source of stimulus to the economy, both the members anticipated that current in the near term and over the forecast restraints on business investment spendhorizon. ing would lift slowly as the expan- With regard to the outlook for key sion gathered momentum and business expenditure sectors of the economy, caution in investing and hiring diminmembers again commented that the ished further in response to increasing prospects for robust and sustained demand. expansion would depend importantly Outside the motor vehicle industry, on business fixed investment, a sector business inventories appeared to be at where significant recovery had thus far generally low levels, with many retailers failed to materialize. A high degree of and others reported to be following caucaution continued to dominate business tious inventory policies in anticipation decisionmaking in the context of weak of sluggish sales over coming months. markets for the output of numerous As a consequence, some inventory firms and the related absence of pricing accumulation appeared likely if final Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 191 demand accelerated in line with the mies. The strong performance of the members' current forecasts. housing industry continued to be attrib- Consumer spending, though elevated, uted in large measure to the lowest had grown at a reduced pace in recent mortgage interest rates in several quarters and the members generally saw decades. On a more negative note, some acceleration as a likely but not multifamily construction was reported inevitable prospect. An important factor to be weak in a number of areas, eviin this outlook was the anticipated dently reflecting low occupancy rates effects of sizable additions to disposable and rents. incomes stemming from the recent tax Although current growth in demand legislation. Other favorable factors ref- from abroad was being held down by erenced by the members included indi- the relatively sluggish economies of cations of growing consumer confi- major U.S. trading partners, the weaker dence, the effects of rising stock market dollar was expected to foster somewhat wealth on consumer balance sheets, con- faster expansion in U.S. exports. Howtinued opportunities for many consum- ever, downward revisions to foreign ers to extract equity from the appreci- growth forecasts for the balance of this ated value of their homes and to reduce year implied continuing restraint on the interest service burdens by refinancing expansion in foreign demand for U.S. mortgages, and more fundamentally a goods and services. Members nonethecontinuing uptrend in disposable per- less cited some anecdotal evidence of sonal incomes associated in part with a pickup in foreign orders from U.S. robust gains in labor productivity. Some manufacturers. At the same time, many members nonetheless raised a note of U.S. business contacts continued to caution regarding the potential strength express concern about the strength of of consumer spending. They commented foreign competition for their products in in particular that the lack of significant domestic markets. job growth resulting from persisting With the economy thought likely to business reluctance to hire new workers continue to operate below its potential could undermine consumer confidence for an extended period and productivity and spending at some point, though they growth expected to remain robust, the noted that there was little evidence of members believed that the current lowthis as yet. Some members also referred inflation environment would persist over to the drain on disposable incomes stemthe next several quarters and indeed that ming from rising local taxes and fees some further disinflation could be in intended to address the severe budget store. In this regard, there was concern problems of many state and local govthat inflation could be approaching a ernments. On balance, while they level that would begin to complicate the acknowledged the risks of a weaker outimplementation of monetary policy if come, the members generally expected economic weakness unexpectedly perthe consumer sector to play a key role sisted or the economy was subjected to in their forecasts of a significantly another negative demand shock. Howstrengthening expansion. ever, in the view of at least some mem- The members continued to report a bers, recent developments had reduced high level of housing demand in numer- the unwelcome prospect of substantial ous parts of the country, with housing additional disinflation. Those developconstruction described as a notably ments included a recent uptick in core robust sector in many regional econo- measures of consumer prices, a drop in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

192 90th Annual Report, 2003 the dollar on foreign exchange markets, federal funds rate would about offset and still elevated energy prices—all the apparent increase in the real fedagainst the backdrop of longer-term eral funds rate stemming from a recent inflation expectations that were firmly decline in inflation. In this regard, furanchored. More importantly, however, ther disinflation seemed likely to be a the outlook for a strengthening expan- more significant concern than rising sion, which might well materialize in inflation for a considerable period of the near future, should limit any further time. disinflationary trend. Most of the members expressed a In the Committee's discussion of pol- preference for limiting the reduction to icy for the intermeeting period ahead, all [A percentage point. Some commented but one of the members indicated that that a good case could be made for a they could support a proposal to reduce Vi percentage point easing, though all the target federal funds rate VA percent- but one of these members could support age point to a level of 1 percent. While the smaller decrease. Views cited in a significant step-up in the pace of the favor of the lA percentage point easing expansion appeared to be a likely pros- included the emergence of firmer signs pect, such an outcome was still a fore- of a possible upturn in economic activcast whose eventual realization, includ- ity, the near-term prospect of substantial ing both its timing and extent, remained added fiscal stimulus, and an already uncertain. In the circumstances and very accommodative stance of monetary given currently large margins of unem- policy. No member expressed the opinployed labor and other resources, the ion that a smaller move should be members agreed that an easing move favored because of concerns about diswas desirable to provide additional locations resulting from a very low level insurance that a stronger economy of the overnight interest rate. However, would in fact materialize. Some mem- some members commented that a larger bers noted that at the May meeting reduction might be misread as an indicathey had contemplated the need for an tion of more concern among policymakeasing action at this meeting unless ers about the economic outlook than was compelling evidence developed in the in fact the case. Moreover, a 50 basis interim that the hoped-for acceleration point reduction that was associated with in economic activity was clearly under the communication of a Committee view way. The incoming information since that the risks to achieving its objectives the May meeting, while mildly encour- for economic activity were balanced aging, did not provide compelling evi- might be mistakenly interpreted in the dence to warrant forestalling an easing view of some members as a signal that action. the Committee had come to the end of Members saw virtually no prospect its policy easing moves—a judgment that the proposed easing, though it they were not prepared to make at this would reinforce an already accommoda- time. The case for a larger 50 basis point tive monetary policy, would incur any reduction in the target federal funds rate significant risk of contributing to ris- focused on the desirability of a relaing inflationary pressures, even if the tively forceful policy move that would strengthening of the economy proved to be more likely to promote a strengthenbe somewhat greater than they had ing economic expansion and at the same incorporated in their forecasts. Indeed, time provide greater assurance of counthe proposed reduction in the nominal tering any significant disinflation. One Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 193 member, who interpreted recent eco- The Federal Open Market Committee nomic developments as providing fairly seeks monetary and financial conditions that will foster price stability and promote suspersuasive indications that an upturn in tainable growth in output. To further its longthe expansion was already under way, run objectives, the Committee in the immesaw merit in keeping policy unchanged diate future seeks conditions in reserve but did not oppose a lA percentage point markets consistent with reducing the federal easing. funds rate to an average of around 1 percent. Concerning the press statement to The vote encompassed the following be released to the public shortly after statement whose substance would be today's meeting, the members agreed included in the press release to be made that it should include a reference to signs available shortly after the meeting: of firming economic activity and should highlight the key factors underlying the The risks to the Committee's outlook for members' outlook for a more robust sustainable economic growth over the next economic performance over time. None- several quarters are balanced; the risks to its theless, inflation could edge lower and outlook for inflation over the next several the Committee needed to be cognizant quarters are weighted toward the downside; and, taken together, the balance of risks to its of the risk of substantial further disinobjectives is weighted toward the downside flation, which could have potentially in the foreseeable future. adverse effects. With regard to the Committee's assessment of the risks to be Votes for this action: Messrs. Greenspan, incorporated in the press release, the Bernanke, Ms. Bies, Messrs. Broaddus, Ferguson, Gramlich, Guynn, Kohn, members generally agreed that the risks Moskow, Olson, and Stewart. (Mr. Stewto the goal of sustainable economic ait voted as an alternate member.) Votes growth were about balanced for the against this action: Mr. Parry. next few quarters and that the probability of appreciable further disinflation Mr. Parry dissented because he prefrom an already low level of inflation ferred a 50 basis point reduction in the exceeded the probability of a rise in federal funds rate target as insurance inflation. The members also endorsed against continued sluggishness in ecoa general statement stating that, taken nomic activity and further declines in together, the balance of risks to the inflation measures to undesirably low Committee's dual goals was tilted rates. While he believed that a signifitoward the downside for the foresee- cant increase in the pace of activity over able future. During the discussion, sev- the next several quarters was likely, he eral members also stressed the impor- had not yet seen convincing evidence tance of communicating clearly the that this process was under way. Morereasons for the Committee's deci- over, the current slack in labor and sions, thereby helping to assure the suc- product markets was likely to persist cess of the Committee's policymaking for some time even with a significant efforts. pickup in real GDP growth, and this At the conclusion of the discussion, prospect threatened to reduce inflation the Committee voted to authorize and further. Finally, recent declines in infladirect the Federal Reserve Bank of New tion expectations had raised the real fed- York, until it was instructed otherwise, eral funds rate. In order to offset that to execute transactions in the System increase and provide additional stimu- Account in accordance with the follow- lus, he saw a 50 basis point reduction in ing domestic policy directive: the rate as desirable. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

194 90th Annual Report, 2003 It was agreed that the next meeting of Mr. Kos, Manager, System Open the Committee would be held on Tues- Market Account day, August 12, 2003. Mr. Ettin, Deputy Director, Divisions The meeting adjourned at 1:25 p.m. of Research and Statistics, Board of Governors Vincent R. Reinhart Secretary Messrs. Slifman and Oliner, Associate Directors, Division of Research and Statistics, Board of Governors Meeting Held on August 12, 2003 Mr. Whitesell, Deputy Associate A meeting of the Federal Open Market Director, Division of Monetary Affairs, Board of Governors Committee was held in the offices of the Board of Governors of the Federal Mr. Clouse, Assistant Director, Reserve System in Washington, D.C., Division of Monetary Affairs, on Tuesday, August 12, 2003, at Board of Governors 9:00 a.m. Mr. Skidmore, Special Assistant Present: to the Board, Office of Board Mr. Greenspan, Chairman Members, Board of Governors Mr. Bernanke Ms. Bies Mr. Luecke, Senior Financial Analyst, Mr. Broaddus Division of Monetary Affairs, Mr. Ferguson Board of Governors Mr. Gramlich Mr. Guynn Ms. Low, Open Market Secretariat Mr. Kohn Assistant, Division of Monetary Mr. Moskow Affairs, Board of Governors Mr. Olson Mr. Parry Mr. Moore, First Vice President, Federal Reserve Bank of Mr. Hoenig, Mses. Minehan and Cleveland Pianalto, Messrs. Poole and Stewart, Alternate Members Mr. Hakkio, Ms. Mester, of the Federal Open Market Messrs. Rasche and Sniderman, Committee Senior Vice Presidents, Federal Messrs. McTeer, Santomero, and Stern, Reserve Banks of Kansas City, Presidents of the Federal Reserve Philadelphia, St. Louis, and Cleveland respectively Banks of Dallas, Philadelphia, and Minneapolis respectively Ms. Hargraves and Mr. Tootell, Vice Mr. Reinhart, Secretary and Economist Presidents, Federal Reserve Banks Mr. Bernard, Deputy Secretary of New York and Boston Mr. Gillum, Assistant Secretary respectively Ms. Smith, Assistant Secretary Mr. Baxter, Deputy General Counsel Mr. Weber, Senior Research Officer, Ms. Johnson, Economist Federal Reserve Bank of Mr. Stockton, Economist Minneapolis Mr. Connors, Ms. Cumming, By unanimous vote, the minutes of Messrs. Eisenbeis, Evans, the meeting of the Federal Open Market Goodfriend, Howard, Judd, Madigan, Struckmeyer, and Committee held on June 24-25, 2003, Wilcox, Associate Economists were approved. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 195 By unanimous vote, Charles L. Evans Private nonfarm payroll employment and Brian F. Madigan were elected as fell in both June and July. Notable losses Associate Economists of the Committee occurred in manufacturing over the two to serve until the election of their suc- months, continuing the trend of previcessors at the first regularly scheduled ous months. Wholesale and retail trade, meeting of the Committee after Decem- transportation and utilities, as well as ber 31, 2003, with the understanding information sectors also reduced their that in the event of the discontinuance of workforces further, while the constructheir official connection with the Board tion, financial activities, and temporary of Governors or with a Federal Reserve help sectors continued to add jobs. The Bank, they would cease to have any average workweek edged down, on official connection with the Federal net, over June and July. After rising to Open Market Committee. 6.4 percent in June, the unemployment The Manager of the System Open rate fell to 6.2 percent in July. Market Account reported on recent Industrial production edged up again developments in foreign exchange mar- in June, with gains in manufacturing kets. There were no open market opera- offset to some extent by significant tions in foreign currencies for the Sys- weather-related declines in utility protem's account in the period since the duction. Available data for July indiprevious meeting. cated advances in motor vehicle assem- The Manager also reported on devel- blies and in iron and steel output, and opments in domestic financial markets also a surge in energy production that and on System open market transactions was due to abnormally warm weather. in government securities and securities Overall industry capacity utilization issued or fully guaranteed by federal was about unchanged in June as higher agencies during the period May 6, 2003, usage in manufacturing and mining was through June 24, 2003. By unani- balanced by a sharp decrease at utilities. mous vote, the Committee ratified these Real personal consumption expenditransactions. tures grew in June and in the second The information reviewed at this quarter as a whole, largely reflecting a meeting suggested that economic brisk rise in purchases of motor vehicles activity was mixed in late spring and other durable goods. Consumption and early summer. The labor market of other goods rose more moderately. remained weak, and industrial produc- Declines in spending on energy in June tion improved only slightly. Consumer held down growth in services expendispending, however, advanced further, tures. Real disposable income posted a with brisk growth in expenditures on modest gain in the second quarter, and autos and other durables and more mod- likely was lifted further in July by est expansion in other categories. Home- reduced tax withholding and by refund building continued at a robust rate, checks that were mailed out. Consumer business spending improved somewhat, confidence readings were mixed in June and federal government expenditures and July but remained well above their remained elevated, but these gains were lows earlier in the year. partially offset by fiscal restraint at Boosted by declining mortgage rates, the state and local government levels. housing construction and sales were Despite a recent uptick in consumer robust through June. Single-family prices, year-over-year consumer infla- housing starts rose in June to one of the tion remained at a very low level. highest levels in the past twenty-five Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

196 90th Annual Report, 2003 years, and new permit issuance was the weakness was temporary. GDP also strong. Multifamily housing starts growth in the United Kingdom showed stayed at about the average level of the a moderate rebound in the second previous year and a half. New home quarter. sales surged in June, but existing home Overall consumer prices rose a bit in sales edged down. June, led by increases in the volatile Business outlays on equipment and food and energy categories. Core consoftware jumped in the second quarter sumer prices, however, were unchanged following a lackluster performance for the month. Over the twelve-month over the preceding half year. Spending period ending in June, the increase in on computers and software accelerated core consumer prices as measured by sharply, and purchases of communica- both the consumer price index and the tions equipment increased considerably. chain-type personal consumption expen- The transportation category, by contrast, diture index was notably lower than the contracted as business spending on rise of the previous year. Higher energy motor vehicles stagnated and investment costs pushed up the producer price index in aircraft decreased. Data on orders and in June, but core producer prices ticked shipments for nondefense capital goods down for the month, leaving them in June pointed to growth in nearly slightly below their levels twelve all categories. Expenditures on nonresi- months prior. With regard to labor costs, dential structures turned up in the sec- July average hourly earnings of producond quarter as increases in spending on tion or nonsupervisory workers on priinstitutional and other structures more vate nonfarm payrolls advanced at about than offset declines in expenditures for the same rate as in June. The employoffice and industrial buildings. Office ment cost index for hourly compensabuilding vacancy rates changed little tion of private industry workers rose in the second quarter, while vacancies less in the second quarter than in the in industrial buildings rose to record first quarter. The twelve-month increase levels. was somewhat lower than that for the Nonfarm inventories shrank in the previous year. second quarter, with notable declines At its meeting on June 24-25, the in manufacturing and wholesale stocks. Committee adopted a directive that Inventories relative to shipments and called for lowering the target for the sales were at low levels by historical intended federal funds rate 25 basis standards. points, to 1 percent. In reaching this The U.S. international trade deficit decision, the Committee members genedged up in May as imports of goods erally perceived the upside and downand services increased slightly more side risks to the attainment of sustainthan exports. Recent data generally indi- able growth for the next few quarters as cated that growth in foreign industrial roughly equal; however, they viewed the countries was weak in the second quar- probability, though minor, of a substanter. The economies of Japan and the tial and unwelcome fall in inflation as euro area appeared to have remained exceeding that of a pickup in inflation stagnant. Canadian economic growth from its already low level. On balance, was held back by both the SARS the Committee believed that the conoutbreak and the discovery of mad cern about appreciable disinflation was cow disease, although a rebound in likely to predominate for the foreseeable employment in June suggested that future. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 197 Longer-term interest rates began to money, the effects of mortgage refinancback up after the announcement of the ing activity, and the reduction in per- Committee's decision, as market partici- sonal income tax withholdings. pants had placed substantial odds on a The staff forecast prepared for this larger policy move and, perhaps, even meeting continued to suggest that the the release of details on potential uncon- economic expansion would strengthen ventional policy actions. Ten-year Trea- substantially as the year progressed. sury yields rose dramatically over the Accommodative financial conditions, following weeks. The increase appeared recent additional fiscal stimulus, and to be based on a number of factors, robust gains in structural productivity including investors' interpretation of the would provide significant impetus to Chairman's congressional testimony, the business and consumer spending over release of Committee members' rela- the months ahead. Concurrently, housetively bullish economic projections, and hold expenditures, buoyed by recent tax incoming news regarding the economy cuts, were expected to be well mainand corporate earnings that was seen as tained. Inventory levels had been subsignaling a more likely upturn in eco- stantially reduced, and business capital nomic growth. In these circumstances, stocks apparently had continued to move substantial further disinflation probably closer to acceptable levels. As a consewould not materialize, and the need for quence, improving sales and profits, low further reductions in the federal funds financing costs, and the temporary fedrate or unconventional policy measures eral tax incentive for investment in new would thus be obviated. Yields on equipment and software were expected high-grade corporate bonds moved up to boost business investment spending roughly in line with those on Trea- gradually. Given the substantial ongosury securities, leaving spreads about ing slack in resource utilization, some unchanged. Rates on low-grade corpo- downward pressure on core price inflarate bonds rose much less, and spreads tion was considered a risk in the staff over Treasuries on such obligations nar- forecast. rowed significantly. Despite the sharp In their review of current and prostep-up in Treasury yields, broad equity spective economic developments, memindexes advanced over the intermeeting bers commented that they were encourperiod, supported by positive earning aged by the recent data on economic reports, strong profit forecasts, and activity and the tone of related anecdotal increased confidence regarding eco- commentary. In their view these develnomic prospects. opments, in the context of stimulative The exchange value of the dollar, as fiscal and monetary policies, receptive measured by the major foreign curren- financial conditions, and apparently cies index, rose over the intermeeting improving business and consumer confiperiod as long-term interest rate differ- dence, had brightened the prospects for entials moved sharply in favor of dollar- substantial further strengthening of the denominated assets. Yields on longer- economy. The members acknowledged dated government debt of major foreign that the magnitude of the improvement economies also increased as did many remained subject to considerable uncerforeign equity indexes. tainty, notably with regard to the pros- M2 continued to grow briskly in June pects for business expenditures, and and July, reflecting in large part the they cited both upside and downside near-zero opportunity cost of holding risks to forecasts of a more vigorous Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

198 90th Annual Report, 2003 expansion. Concerning the prospects for and, with nonresidential construction inflation, members expressed the view activity displaying pronounced weakthat even if growth somewhat above the ness, total business fixed investment had economy's potential were to materialize until recently been on a declining trend. over the next several quarters, which Members were encouraged, however, many regarded as a likely scenario, by evidence in recent months that an substantial excess margins of labor and upswing in spending for capital equipother resources would remain and would ment and software might be under way, continue to hold down overall inflation. including more purchases by firms of Indeed, a number of members saw merit non-high-tech equipment as well as an in the staff forecast that some further ongoing rise in purchases of computing disinflation was a likely prospect in such equipment and related peripherals. circumstances. Members also reported some signs of Members commented that current renewed venture capital activity. Sevfinancial conditions remained a positive eral noted that nonresidential building factor in the outlook for the economy appeared to have stabilized in various even after the recent rise in long-term parts of the country after a long period interest rates. To be sure, the increase of decline, and there were reports that would have some restraining effect. new construction projects had been initi- Indeed, mortgage refinancing activity ated in some areas. It was clear, noneappeared to have declined substantially theless, that business sentiment toward according to some reports, prospectively capital expenditures remained exceplessening the support for some consumer tionally cautious. Looking ahead, much and other spending fostered by the would depend on further growth in extraction of equity from housing. Even demand for business products and serso, a number of factors suggested that vices and associated evidence of risthe risks from higher interest rates might ing profits, building on indications of not be large. These included the pos- strengthening in both in recent months. sibility that the higher rates in part For now, survey and anecdotal reports reflected growing optimism about the on business capital spending intentions economic outlook that would engender were somewhat more encouraging than a faster pace of business spending, more earlier but were still generally mixed, than offsetting the effects of the higher with only a small number of firms planrates on consumer spending. Moreover, ning robust capital spending programs. long-term interest rates were still rela- Indeed, in light of the persistence of tively low, risk spreads had narrowed in substantial margins of underutilized recent months, and stock prices had held capital, many business contacts indifirm recently, perhaps in part as a result cated that they intended to meet growof several upside surprises in second- ing demand by adding staff before quarter profit reports. increasing output capacity. Several members reiterated that busi- The weakness in business inventories ness spending was the critical factor that that had damped the expansion thus far would govern to a substantial degree the this year appeared to be continuing in timing and extent of the acceleration in the current quarter according to numeroverall economic activity. Since the year ous business contacts. However, cau- 2000, business capital expenditures had tious inventory policies generally had been mostly limited to replacement reduced stocks to very low levels in demand for equipment and software relation to growing sales, and members Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 199 saw inventory accumulation, starting ing while rates were still low in relation perhaps late this year, as a plausible to historical norms. The potential extent expectation. Indeed, in the view of some of retardation in housing activity stemmembers, a normal cyclical swing in the ming from higher mortgage rates was accumulation of inventories that would uncertain, but demand for housing was bring the latter into a more usual align- expected to be relatively well mainment with growing sales could begin tained, assuming the realization of forerelatively soon and might well be casts of accelerating economic activity markedly more pronounced than many and associated growth in personal now anticipated. The potential for such incomes. a development constituted a sizable In their comments about the outlook upside risk to current economic fore- for the foreign sector of the economy, casts for the quarters ahead. members referred to recent signs of Consumer spending, buttressed by some strengthening in the economies of sales of motor vehicles and other con- the nation's important trading partners. sumer durables, had accelerated in the However, domestic demand in most of second quarter from an already elevated those economies remained relatively level and appeared more recently to weak, and developments abroad were be increasing considerably further. The likely to provide little impetus to available data pointing to improvement demand for U.S. exports in the near in early summer were limited but were term. At this point, business contacts supported by anecdotal information tended to emphasize the persistence of from around the country. Positive fac- strong foreign competition that was contors mentioned with regard to the out- straining their sales in both foreign and look for the consumer sector included domestic markets. the recent tax cuts, the improved perfor- In their review of the outlook for mance of the stock market, the ample prices, members generally anticipated availability of household credit, and that key inflation measures would more generally the effects of rapidly ris- remain near their currently low levels ing productivity in sustaining growth for an extended period. Their assessin household incomes. A potential neg- ment focused on the likely persistence ative cited by some members was the of substantial margins of unemployed possibility that a weak job market, labor and other resources even if, in line should it persist, would at some point with their expectations, business activity adversely affect overall consumer senti- strengthened substantially over coming ment and willingness to spend. quarters. Indeed, a number of members Residential housing sales and con- expressed the view that some further struction had remained at elevated lev- disinflation was probable over the year els, evidently stimulated to an important ahead. To be sure, inflation would extent by earlier declines in mortgage remain subject to a number of crosscurrates to unusually low levels. Although rents. Upward pressures on prices would the appreciable upturn in those rates continue to be exerted by increasing since midyear appeared to have slowed medical insurance and pension costs mortgage refinancing activity, at least and, for many manufacturing firms, the in some areas, housing demand had rising cost of materials. At the same remained buoyant perhaps in part time, the persistence of very strong because many homebuyers were competitive pressures, including those attempting to lock in mortgage financ- arising from foreign competitors, was Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

200 90th Annual Report, 2003 preventing most business firms from capacity and very competitive markets passing on higher costs by raising continued to characterize economic prices, and this lack of pricing power conditions. did not appear to be diminishing. Con- The members agreed that, although currently, however, many firms were economic activity had shown signs able to maintain or even to increase their of firming, the risks to the outlook profit margins through a variety of remained about the same as they had cost-cutting and productivity-enhancing indicated in the previous statement measures. issued after the June meeting. In particu- In the Committee's discussion of pol- lar, the risks to the goal of sustainable icy for the intermeeting period ahead, all economic growth were about balanced the members endorsed a proposal to for the next few quarters and the probmaintain an unchanged policy stance ability of an unwelcome fall in inflation, involving reserve conditions consistent though minor, exceeded that of a rise with a target federal funds rate of 1 per- in inflation from its currently low level. cent. Members noted that the current On balance, the risk of undesirably low stance of monetary policy remained inflation was likely to be the Comquite accommodative and, given the mittee's predominant concern for the tenor of the latest information on the foreseeable future. The Committee also performance of the economy in the con- decided to include a reference in the text of generally favorable financial announcement to its judgment that conditions, they believed that policy under anticipated circumstances policy was appropriately positioned to foster accommodation could be maintained for further strengthening of the economic a considerable period. expansion. While the Committee could Several members commented that the not commit itself to a particular policy nature of the Committee's communicacourse over time, many of the mem- tions had evolved substantially over bers referred to the likelihood that the recent meetings and that it might be Committee would want to keep policy useful to schedule a separate session to accommodative for a longer period than review current practices. They agreed to had been the practice in past periods of do so prior to the next scheduled meetaccelerating economic activity. Reasons ing on September 16. for such an approach to policy stemmed At the conclusion of the discussion, from the need to encourage progress the Committee voted to authorize and toward closing the economy's currently direct the Federal Reserve Bank of New wide output gap and, with inflation York, until it was instructed otherwise, already near the low end of what some to execute transactions in the System members regarded as an acceptable Account in accordance with the followrange, to resist significant further disin- ing domestic policy directive: flation. In the view of these members, appreciable added disinflation would The Federal Open Market Committee potentially blunt the effectiveness of seeks monetary and financial conditions that further policy easing in the event of will foster price stability and promote susstrong adverse shocks to the economy. tainable growth in output. To further its longrun objectives, the Committee in the imme- At the same time, maintaining an diate future seeks conditions in reserve accommodative policy stance was seen markets consistent with maintaining the as involving little risk of inducing rising federal funds rate at an average of around inflation so long as high levels of excess 1 percent. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 201 Votes for this action: Messrs. Greenspan, munication of its assessment of the eco- Bernanke, Ms. Bies, Messrs. Broaddus, nomic situation. Ferguson, Gramlich, Guynn, Kohn, Moskow, Olson, Parry, and Stewart. Vincent R. Reinhart (Mr. Stewart voted as an alternate member.) Votes against this action: None. Secretary The vote encompassed the substance of the following statements Meeting Held on concerning risks that would be con- September 16, 2003 veyed in the Committee's press release to be made available shortly after the A meeting of the Federal Open Market meeting: Committee was held in the offices of the Board of Governors of the Federal The risks to the Committee's outlook for Reserve System in Washington, D.C., sustainable economic growth over the next on Tuesday, September 16, 2003, at several quarters are balanced; the risks to its outlook for inflation over the next several 9:00 a.m. quarters are weighted toward the downside; and, taken together, the balance of risks to its Present: objectives is weighted toward the downside Mr. Greenspan, Chairman in the foreseeable future. Mr. Bernanke Ms. Bies It was agreed that the next regu- Mr. Broaddus Mr. Ferguson lar meeting of the Committee would Mr. Gramlich be held on Tuesday, September 16, Mr. Guynn 2003. Mr. Kohn The meeting adjourned at 1:15 p.m. Mr. Moskow Mr. Olson Mr. Parry On September 15, 2003, the Committee met to review its practices regarding Mr. Hoenig, Mses. Minehan and the communication of its policy deci- Pianalto, Messrs. Poole and sions and its assessment of the risks Stewart, Alternate Members to its objectives of fostering sustainable of the Federal Open Market Committee economic growth and price stability. After a detailed discussion of the issues, Messrs. McTeer, Santomero, and Stern, the Committee elected not to make sub- Presidents of the Federal Reserve stantial changes in its current approach Banks of Dallas, Philadelphia, and to the policy announcement at this Minneapolis respectively time. Although a variety of views was expressed, most members felt that cur- Mr. Reinhart, Secretary and Economist Mr. Bernard, Deputy Secretary rent practices were generally appropri- Ms. Smith, Assistant Secretary ate in providing information to the Mr. Mattingly, General Counsel public about the rationale for the Com- Ms. Johnson, Economist mittee's decisions and its views about Mr. Stockton, Economist the risks to future economic performance. Nonetheless, members recog- Mr. Connors, Ms. Cumming, Messrs. Eisenbeis, Evans, nized that going forward they might, Goodfriend, Howard, Judd, from time to time, consider changes that Madigan, Struckmeyer, and might improve the Committee's com- Wilcox, Associate Economists Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

202 90th Annual Report, 2003 Mr. Kos, Manager, System Open kets. There were no open market opera- Market Account tions in foreign currencies for the System's account in the period since the Mr. Hambley, Assistant to the Board, previous meeting. Congressional Liaison Office, The Manager also reported on devel- Board of Governors opments in domestic financial markets Messrs. Slifman and Oliner, Associate and on System open market transactions Directors, Division of Research in government securities and securities and Statistics, Board of Governors issued or fully guaranteed by federal agencies during the period August 12, Messrs. Clouse, Kamin, and Whitesell, 2003, through September 15, 2003. By Deputy Associate Directors, unanimous vote, the Committee ratified Divisions of Monetary Affairs, International Finance, and these transactions. Monetary Affairs respectively, The information reviewed at this Board of Governors meeting suggested that economic activity had been picking up in recent Mr. English, Assistant Director, months, although the data were not uni- Division of Monetary Affairs, formly positive. Domestic final demand Board of Governors had strengthened appreciably, with solid Mr. Skidmore, Special Assistant to the gains in both household and business Board, Office of Board Members, spending. While industrial production Board of Governors was growing, job losses continued. Inventories were again drawn down. Mr. Luecke, Senior Financial Analyst, Consumer prices had edged up in recent Division of Monetary Affairs, months, but year-over-year consumer Board of Governors inflation remained at a very low level. Ms. Low, Open Market Secretariat Private nonfarm payroll employment Assistant, Division of Monetary fell again in August, with a decline simi- Affairs, Board of Governors lar to those in June and July. Employment continued to fall in the manu- Messrs. Fuhrer and Hakkio, facturing, wholesale and retail trade, Mses. Mester and Perelmuter, transportation and utilities, and informa- Messrs. Rolnick, Rosenblum, and Sniderman, Senior Vice tion categories. Employment in the ser- Presidents, Federal Reserve vice industry was about unchanged as Banks of Boston, Kansas City, job losses in professional and business Philadelphia, New York, services largely offset expansion in non- Minneapolis, Dallas, and business services. Growth in construc- Cleveland respectively tion employment continued. Aggregate hours of private production workers Mr. Bullard, Vice President, Federal Reserve Bank of St. Louis edged down in August, reflecting the employment declines, while the average By unanimous vote, the minutes of workweek was unchanged. The unemthe meeting of the Federal Open Market ployment rate fell to 6.1 percent in Committee held on August 12, 2003, August. were approved. Industrial production posted a solid The Manager of the System Open increase in July after no change in June. Market Account reported on recent Data available for August suggested developments in foreign exchange mar- increased output at utilities, reflecting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 203 abnormally hot weather, but little net Inventories contracted in the second change in manufacturing. Overall capac- quarter, and partial data for July sugity utilization rose in July, led by the gested that the runoff continued into the increase in utility production. third quarter. The book value of manu- Retail sales rose a bit further in facturing inventories declined for the August after surging in July. Real per- month, led by stocks of durable goods. sonal consumption spending advanced However, inventories of wholesale briskly through July (latest data) as all goods edged up. Inventory shipment major categories of outlays recorded ratios for the manufacturing sector at increases. Real disposable income rose book value moved down considerably in substantially in July largely because of July, and book value inventory-sales the reduction in tax withholdings and ratios for wholesalers remained at very the delivery of advance refund checks low levels by historical standards. relating to higher childcare deductions. The U.S. international trade deficit The further delivery of such checks in edged down in June as exports of goods August was expected to have a positive and services increased and imports were effect on spending in that month as well. unchanged. For the major foreign indus- Although the index of consumer senti- trial countries, economic data for the ment ticked down in August and early second quarter were mixed. While real September, it remained well above its GDP grew strongly in Japan and growth March low. picked up in the United Kingdom, real Housing construction and sales GDP edged down in Canada and the remained very strong in July. Single- euro area. family housing starts rose a bit fur- Core consumer prices rose slightly ther from the record level in June, less in August than in July. Both conwhile multifamily housing starts were sumer food and energy prices rose unchanged. Sales of existing homes somewhat faster than the core compowere up sharply in July, and new home nents, leaving the overall consumer sales remained robust but were off inflation rate in August slightly higher slightly from their rapid June advance. than in July. Over the twelve-month Data on orders and shipments of non- period ending in August, overall condefense capital goods in July suggested sumer prices were up a bit from the that the upward trend in real business previous year, while core consumer outlays for equipment and software prices decelerated. After significant had carried into the third quarter. Total declines during the second quarter, shipments of nondefense capital goods overall producer prices edged up in rose moderately in July, with contin- July and rose a bit further in August. ued notable strength in computers and Core producer prices, however, were peripheral equipment. Shipments of little changed for the two months and communications equipment were off posted only a slight increase over the only slightly in July after a surge in twelve-month period. With regard to June. Orders for nondefense capital labor costs, average hourly earnings goods overall were little changed in of production or nonsupervisory work- July. A drop in nonresidential construc- ers on private nonfarm payrolls tion expenditures in July reversed the ticked up in August. The twelve-month gains made in the second quarter, with change in average hourly earnings was declines in all categories except non- about the same as that in the previous office commercial structures. year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

204 90th Annual Report, 2003 At its meeting on August 12, 2003, equity markets of major industrial counthe Federal Open Market Committee tries. Benchmark government bond adopted a directive that called for main- yields rose in most foreign industrial taining conditions in reserve markets economies. consistent with keeping the federal M2 grew briskly again in August, funds rate at around 1 percent. In reach- boosted by the effects of mortgage ing this decision, the Committee mem- refinancing activity, a temporary bulge bers generally perceived the upside and in liquid deposits caused by payment downside risks to the attainment of sus- delays related to power outages, and tax tainable growth for the next few quar- rebate disbursements. ters to be roughly equal; however, they The staff forecast prepared for this viewed the probability, though minor, meeting continued to suggest a substanof an unwelcome fall in inflation as tially stronger economic expansion than exceeding that of a rise in inflation from had occurred earlier in the year. Accomits already low level. The Committee modative financial conditions, recent judged that, on balance, the risk of infla- additional fiscal stimulus, and robust tion becoming undesirably low would gains in structural productivity would remain the predominant concern for provide significant impetus to business the foreseeable future. In those circum- and consumer spending over the months stances, the Committee believed that ahead. Concurrently, household expenpolicy accommodation could be main- ditures, buoyed by recent tax cuts, were tained for a considerable period. expected to be well maintained. Inven- The Committee's decision to leave tory levels had been substantially its target for the federal funds rate and reduced, and the size of business capital assessment of risks unchanged at the stocks apparently had continued to move August meeting was widely anticipated. closer to acceptable levels. As a conse- On net over the intermeeting period, quence, improving sales and profits, low market expectations for the federal financing costs, and the temporary fedfunds rate changed little. However, eral tax incentive for investment in new intermediate- and longer-term interest equipment and software were expected rates were volatile over the period, with to boost business investment spending yields on Treasury coupons declining over time. Given the substantial ongoing slightly on balance. Yields on most slack in resource utilization, some slight investment-grade securities moved in downward pressure on core consumer line with those on Treasury obligations, price inflation was anticipated in the but a more optimistic economic outlook staff forecast. among investors contributed to a sub- In the Committee's discussion of curstantial decline in speculative-grade rent and prospective economic developyields. Broad stock price indexes ments, the members focused both on the rose notably, boosted by improved eco- increased evidence of a pickup in the nomic growth prospects and the associ- pace of the expansion and on the persistated upwardly revised expectations for ing weakness in labor markets. The earnings. advance in economic activity in recent On balance, the nominal value of the months reflected continued strength in dollar changed little on a broad trade- household spending, reinforced by an weighted basis over the intermeeting increasing contribution from business period. Optimism about global recov- investment expenditures. The members ery reportedly prompted gains in the viewed these and related developments Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 205 as supporting forecasts of robust growth expansion. Comments by many conin economic activity over coming quar- tacts in the banking sector were already ters, consistent with the stimulative quite upbeat with regard to the outmonetary and fiscal policies, accommo- look for business spending and optidative conditions in financial markets, mism in financial markets clearly had and the positive implications of strong been improving for several months. productivity growth for both incomes In general, financial markets were and investment outlays. Members none- viewed as well positioned to support theless cited a number of factors that more vigorous expansion in economic had the potential to retard the expansion, activity. including the persistence of notably In their comments about prospective cautious business sentiment, the poten- developments in the major components tial that weak employment conditions, of aggregate demand, members anticishould they persist, would at some point pated that the household sector would depress consumer spending, and the remain the mainstay of the expansion prospect that sluggish economic activity and that it would be significantly reinabroad would curb the growth in U.S. forced going forward by an acceleration exports. On balance, the members saw in business expenditures and, at least favorable prospects for strong economic over the next several quarters, by subgrowth over the forecast horizon, though stantial further increases in federal govthey also expected that the gap between ernment spending. Some softening in actual output and potential output would motor vehicle sales from the exceptional close only slowly and that growth in pace in recent months seemed likely, but employment would remain limited. overall consumer spending probably Against this background and taking would be sustained at a high level by into account the outlook for continued further anticipated gains in disposable strength in productivity, members anticiincomes bolstered by the stimulus from pated that inflation would remain subrecent federal tax cuts. A potential negadued and perhaps even edge lower tive in this outlook was the possibility despite the expected strength in ecothat weakness in employment, if it connomic activity. tinued, would at some point exert a more In their comments about develop- pronounced negative effect on consumer ments in various parts of the country, sentiment. members cited increased examples of an In the housing area, residential sales upturn in confidence among their bus- and construction stayed at elevated leviness contacts. This improvement was els during the summer months, with at not universal, notably within manu- least some portion of the strength reportfacturing sectors of the economy, and edly stemming from efforts by many overall business attitudes toward hiring homebuyers to move ahead of further and investment decisions continued to increases in mortgage interest rates. The be described as exceptionally cautious. run-up in mortgage rates since the latter Members anticipated, however, that part of June was expected to curb houssuch business attitudes would give way ing demand to a limited extent in comto optimism at some point, possibly ing months, but the outlook for housing quite suddenly, as uncertainties relat- activity remained favorable, given an ing to the outlook for final demand were overall economic performance in line replaced by concerns about missing with current forecasts of a robust expanprofit opportunities in a strengthening sion, related growth in incomes, and still Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

206 90th Annual Report, 2003 relatively attractive mortgage interest economic activity in coming quarters, rates. though the degree and timing of the Business fixed investment remained impetus from a prospective buildup in a critical factor and also a major source inventories were subject to considerof uncertainty in the outlook for overall able uncertainty. Pointing to anticipated economic activity, with the strength of strength in inventory accumulation was such investment having a key bearing the substantial drawdown in stocks that on the pace of the overall expansion. In had occurred as final sales picked up this regard, the second-quarter increase this year, a marked resulting drop in in expenditures for equipment and soft- inventory-sales ratios, and expectations ware was an encouraging sign and the of accelerating final demand. At the available evidence pointed to a larger same time, however, the persistence of advance in the third quarter. Looking business uncertainty and related caution beyond the near term, members men- were, with some exceptions, continuing tioned a number of developments that to inhibit inventory investment. Moresupported an optimistic outlook for cap- over, the trend toward improved comital expenditures. These included an munication and delivery systems was appreciable acceleration in final sales encouraging business firms to hold since the first quarter, sizable increases inventories at increasingly low levels in business profits and cash flow this in relation to expected sales. Accordyear, the ready availability of business ing to anecdotal reports, even service financing on attractive terms, and the firms were now increasingly adopting temporarily accelerated expensing pro- advanced management techniques to vision in the tax code. On the constrain- hold down their inventories of items ing side were the persistence of high used in the process of providing their levels of excess capacity and significant services. Against this background, it business uncertainty and caution regard- seemed unlikely that businesses would ing the extent and durability of the seek to rebuild their inventories suffiacceleration in final sales. To date, busi- ciently to restore earlier inventory-sales nesses had displayed only limited signs ratios. Even so, further increases in sales of undertaking any investments other would eventually lead to improved busithan for replacement and cost-cutting ness confidence and induce efforts to purposes. Even so, the recent firming of accumulate inventories, though probably orders and shipments along with some- to a lesser extent than had occurred in what more upbeat anecdotal reports earlier cyclical recoveries. and surveys of business spending plans Fiscal policy was likely to remain a pointed to a relatively brisk further key source of stimulus to the expanadvance in business spending for equip- sion. Federal spending was expected to ment and software, at least over the near increase substantially further, albeit at a term. Nonresidential construction activ- diminishing pace over the next year and ity remained at a generally depressed beyond, and reduced taxes should buoy level but appeared to have bottomed out, both consumer and business expendiwith signs of an upturn in new or tures. It was not clear at this point to planned construction in some areas. what extent the partial expensing provi- Increasing business inventory expen- sion was boosting business investment ditures to accommodate strengthening in equipment and software, but the high final sales were seen as a likely posi- level of consumer spending clearly was tive factor in the expansion of overall playing a role in fostering such invest- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 207 ment. Members commented that the bers expected little change over the year current degree of fiscal stimulus was at ahead and even beyond. Several saw a its highest level since the World War II significant risk of some further disinflaperiod, and some expressed concern in tion over that period even assuming ecothis regard that little legislative consid- nomic growth at a pace that somewhat eration was being given to reapplying exceeded the economy's long-run potenfiscal restraint as changing economic tial. In this regard, members referred to conditions would warrant over time. their expectations that the gap between The fiscal condition of many state and actual and potential output was likely local governments remained severely to narrow only slowly and possibly not stressed, and ongoing efforts by these close completely over their forecast governments to curb spending and horizon. They also noted that the subincrease tax and other revenues pro- stantial margins of excess capacity in vided a partial offset to the federal sec- question likely would continue to chartor stimulus. Some members reported, acterize the international as well as the however, that tax receipts recently had domestic economy for a considerable improved noticeably in a number of period. Tending to counter the resulting states. disinflationary effects were signs that In their comments about the outlook the expansion in globalization might be for the foreign sector of the economy, slowing. In particular, difficulties in members referred to indications of some reaching global trade agreements along overall improvement in foreign eco- with a rise in protectionism could tend nomic activity, which augured well for to inhibit the increasingly strong compethe growth in exports. They also noted tition in worldwide markets that had that the prospective performance of been a key factor in holding down inflaforeign economies would depend to a tion. The members also cited other facsignificant extent on the strength of the tors that would tend to maintain some U.S. economy. With the latter displaying upward pressure on prices, notably the relative vigor, the value of domestic relatively rapid rise in costs of labor imports was likely to continue to exceed benefits, especially medical and pension that of exports by a substantial margin, benefits. Increases in the prices of some thereby tending to perpetuate the large raw materials were also noted. In gencurrent account deficits that had worri- eral, the members concluded that the some implications for the future. Mem- economy would need to grow at a pace bers also expressed concern about indi- above potential for a time before they cations of growing protectionism, which could be confident that the risks of furcharacteristically tended to increase in ther unwelcome disinflation had materiperiods of substantial underutilization ally diminished. of labor and other resources, and the In the Committee's discussion of poladverse effects of that development on icy for the intermeeting period ahead, competition and inflation. all the members endorsed a proposal The members agreed that inflation to maintain an unchanged policy stance was likely to remain subdued for an involving reserve conditions consistent extended period, given current forecasts with a target rate of 1 percent for the of economic activity and labor produc- federal funds rate. The members agreed tivity trends. Specific views regarding that despite the increasing evidence of the most probable course of inflation some acceleration in the expansion of differed to some degree, but many mem- economic activity, an accommodative Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

208 90th Annual Report, 2003 policy stance remained appropriate in and the need for an appropriate policy the context of the currently large and response to changing economic condipersisting margins of unemployed labor tions, the members generally agreed and other resources and very low infla- that the Committee should not usually tion. Several commented that the recent commit itself to a particular policy strengthening of the economy had stance over some pre-established, served to alleviate but had not elimi- extended time frame. The course of nated their concerns about the possi- policy would be determined by the bility of further disinflation. While both evaluation of the outlook, not the pasdownside and upside risks continued sage of time. The unusual configuration to cloud the outlook for economic activ- of already low interest rates and reservaity and thus for monetary policy, the tions about the strength of the expansion economy's sizable output gap strongly had justified the inclusion of the phrase suggested that inflation would remain "for a considerable period" in the statemuted over coming quarters even ment issued in August. While changing assuming relatively robust economic circumstances would call for removal growth in line with current forecasts. of that reference at some point, doing Accordingly, the economy might well so at this meeting might suggest the expand at a brisk pace for an extended members' views on the economy had period before inflationary pressures changed markedly. Accordingly, the began to emerge and call for an adjust- Committee decided to release a statement to monetary policy. ment after this meeting that was virtually identical to that used after the In their discussion of the press state- August meeting apart from some minor ment to be issued shortly after this meetupdating to reflect ongoing economic ing, the members indicated that the developments. Committee's risk assessments relating to economic activity and inflation to At the conclusion of the discussion, be referenced in that statement should the Committee voted to authorize and remain the same as those in use since direct the Federal Reserve Bank of New the May meeting. In particular, the risks York, until it was instructed otherwise, to the goal of sustainable economic to execute transactions in the System growth were about balanced for the next Account in accordance with the followfew quarters and the probability of an ing domestic policy directive: unwelcome fall in inflation, though minor, exceeded that of a rise in infla- The Federal Open Market Committee tion from its currently low level. On seeks monetary and financial conditions that will foster price stability and promote susbalance, the risk of undesirably low tainable growth in output. To further its longinflation was likely to be the Commitrun objectives, the Committee in the immetee's predominant concern for the fore- diate future seeks conditions in reserve seeable future. markets consistent with maintaining the The members also reviewed the fur- federal funds rate at an average of around ther use of the reference concerning the 1 percent. maintenance of an accommodative policy stance "for a considerable period" Votes for this action: Messrs. Greenspan, Bernanke, Ms. Bies, Messrs. Broaddus, that was included in the press state- Ferguson, Gramlich, Guynn, Kohn, ment issued for the August meeting. Moskow, Olson, Parry, and Stewart. Given the uncertainties that characteris- (Mr. Stewart voted as an alternate memtically surround the economic outlook ber.) Votes against this action: None. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 209 The vote encompassed the substance Messrs. McTeer, Santomero, and Stern, of the following statements concerning Presidents of the Federal Reserve Banks of Dallas, Philadelphia, and risks that would be conveyed in the Minneapolis respectively Committee's press release to be made available shortly after the meeting: Mr. Reinhart, Secretary and Economist Mr. Bernard, Deputy Secretary The risks to the Committee's outlook for Ms. Smith, Assistant Secretary sustainable economic growth over the next Mr. Mattingly, General Counsel several quarters are balanced; the risks to its Ms. Johnson, Economist outlook for inflation over the next several Mr. Stockton, Economist quarters are weighted toward the downside; and, taken together, the balance of risks to its Mr. Connors, Ms. Cumming, objectives is weighted toward the downside Messrs. Goodfriend, Howard, in the foreseeable future. Madigan, Struckmeyer, and Wilcox, Associate Economists It was agreed that the next meeting of the Committee would be held on Tues- Mr. Kos, Manager, System Open day, October 28, 2003. Market Account The meeting adjourned at 1:05 p.m. Mr. Ettin, Deputy Director, Division of Research and Statistics, Vincent R. Reinhart Board of Governors Secretary Messrs. Slifman and Oliner, Associate Directors, Division of Research and Statistics, Board of Governors Meeting Held on October 28, 2003 Messrs. Clouse, Kamin, and Whitesell, Deputy Associate Directors, A meeting of the Federal Open Market Divisions of Monetary Affairs, Committee was held in the offices of International Finance, and the Board of Governors of the Federal Monetary Affairs respectively, Reserve System in Washington, D.C., Board of Governors on Tuesday, October 28, 2003, at Mr. English, Assistant Director, 9:00 a.m. Division of Monetary Affairs, Board of Governors Present: Mr. Greenspan, Chairman Mr. Hambley, Assistant to the Board Mr. Bernanke and Director for Congressional Ms. Bies Liaison, Office of Board Mr. Broaddus Members, Board of Governors Mr. Ferguson Mr. Gramlich Mr. Guynn Mr. Skidmore, Special Assistant to the Mr. Kohn Board, Office of Board Members, Mr. Moskow Board of Governors Mr. Olson Mr. Parry Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Mr. Hoenig, Mses. Minehan and Board of Governors Pianalto, Messrs. Poole and Stewart, Alternate Members Ms. Low, Open Market Secretariat of the Federal Open Market Assistant, Division of Monetary Committee Affairs, Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

210 90th Annual Report, 2003 Messrs. Fuhrer and Hakkio, tember was notably lower than during Ms. Mester, Messrs. Rasche, the preceding year. Rolnick, Rosenblum, and Labor markets appeared to be stabiliz- Sniderman, Senior Vice Presidents, Federal Reserve ing as private nonfarm payrolls grew in Banks of Boston, Kansas City, September for the first time since Janu- Philadelphia, St. Louis, ary, and employment losses in July and Minneapolis, Dallas, and August turned out to be smaller than Cleveland respectively data initially had indicated. The largest employment gain in September was in Mr. Dwyer, Ms. Hargraves, the business services sector, which Messrs. Krane and Rudebusch, includes temporary help supply firms. Vice Presidents, Federal Reserve Banks of Atlanta, New York, Employment also increased in most Chicago, and San Francisco other major industries in September, respectively with the exceptions of manufacturing and wholesale trade. Even in these sec- By unanimous vote, the minutes of tors, the pace of job loss was somewhat the meeting of the Federal Open Market slower than the declines of previous Committee held on September 16, 2003, months. Aggregate hours of private were approved. production workers and the average The Manager of the System Open workweek were both unchanged in Sep- Market Account reported on recent tember. The unemployment rate in Sepdevelopments in foreign exchange mar- tember remained at 6.1 percent. kets. There were no open market opera- Conditions in the industrial sector had tions in foreign currencies for the Sys- improved somewhat in the previous tem's account in the period since the months. Industrial output displayed solid previous meeting. growth in the third quarter after declin- The Manager also reported on devel- ing earlier in the year. A downturn opments in domestic financial mar- in motor vehicle assemblies depressed kets and on System open market overall manufacturing somewhat in transactions in government securities August, but a step-up in auto production and securities issued or fully guaran- boosted it significantly in September. teed by federal agencies during the The strength in manufacturing in Sepperiod September 16, 2003, through tember was somewhat offset, however, October 27, 2003. By unanimous by a decrease in energy production as vote, the Committee ratified these temperatures returned to more normal transactions. ranges after being unusually high in July The pace of the economic expansion and August. In line with these patterns appeared to have picked up substan- in output, capacity utilization in manutially. Consumer spending and the facturing, which had been at historically demand for housing were quite strong in low levels, decreased slightly in August, the third quarter and business outlays then firmed in September. for capital evidently accelerated. At the Real personal consumption expendisame time, labor markets seemed to be tures surged in July and August, but leveling out, and industrial production available data suggested that consumer had firmed in recent months. While core spending had fallen back in September, consumer prices had risen faster in largely reflecting a swing in consumer recent months than earlier in the year, purchases of motor vehicles. Even apart the twelve-month increase through Sep- from motor vehicles, outlays rose at a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 211 solid pace in August, and they seemed declines in stocks in August after accuto have declined only slightly in Sep- mulations in July. Generally small tember. Spending was supported in changes in shipments and sales in the recent months by the sizable boost July-August period kept book-value to disposable personal income from tax inventory-sales ratios about flat at very cuts as well as by levels of wealth and low levels. confidence that were considerably above The U.S. international trade deficit their values earlier in the year. declined in August to its lowest level Housing construction and sales since February as imports fell more than remained very strong in August and exports. Available data for the third September despite some rise in mort- quarter generally suggested moderate gage rates from the very low levels growth in the major foreign industrial reached in the early summer. The rapid countries. Evidence pointed to a likely pace of new single-family home con- resumption of real GDP growth in the struction eased slightly in August but third quarter in Canada and the euro advanced again in September. Multifam- area and continued expansion in Japan ily home construction remained around and the United Kingdom. its pace of the past several years. Sales Core consumer prices rose slightly in of existing homes reached a record high August and September, but headline in August and then climbed further in consumer inflation was up a bit more, September. New home sales rose in largely reflecting a run-up in gasoline August and September at a rate just a bit prices. Energy prices also boosted overbelow the record set in June. all consumer inflation over the past Real outlays for equipment and soft- twelve months, while core consumer ware in the third quarter appeared to inflation moved lower over the same have advanced at a faster rate than in period. At the producer level, core prices the second quarter. Shipments of non- were about unchanged during August defense capital goods excluding aircraft and September, but rising energy and moved up in September, more than food prices led to somewhat larger reversing a decline in August. Orders increases in the prices of total finished for these goods rose moderately in Sep- goods. With regard to labor costs, avertember after being flat in August. Nomi- age hourly earnings of production or nal outlays for construction of privately nonsupervisory workers on private nonowned buildings were about unchanged, farm payrolls edged down in September. on net, during the twelve months end- The increase in earnings during the preing in August. Continued strength in vious twelve months was a bit below the construction of private institutional that during the previous year. structures such as schools, churches, and At its meeting on September 16, hospitals was about offset by weak- 2003, the Federal Open Market Comness in other areas of nonresidential mittee adopted a directive that called for construction. maintaining conditions in reserve mar- Manufacturing and trade inventories kets consistent with keeping the federal excluding motor vehicles fell further funds rate at around 1 percent. In reachin August after edging down in July. ing this decision, the Committee mem- Manufacturers ran off stocks at a fairly bers generally perceived the upside and rapid pace in both months, while whole- downside risks to the attainment of sussalers and retailers excluding motor tainable growth for the next few quarvehicle and parts dealers recorded small ters to be roughly equal; however, they Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

212 90th Annual Report, 2003 viewed the probability, though minor, M2 contracted moderately in Septemof an unwelcome fall in inflation as ber after growing rapidly in July and exceeding that of a rise in inflation from August. The reversal appears to have its already low level. The Committee stemmed mainly from a contraction in judged that, on balance, the risk of infla- deposits resulting from reduced morttion becoming undesirably low would gage refinancing activity. In addition, remain the predominant concern for the temporary effects of a major power the foreseeable future. In those circum- blackout in August had boosted M2 stances, the Committee believed that growth in that month, and the subsepolicy accommodation could be main- quent runoff of those deposits likely tained for a considerable period. depressed M2 in September. The Committee's decision to leave The staff forecast prepared for this its target for the federal funds rate and meeting continued to point to a subassessment of risks unchanged at the stantial strengthening in the economic September meeting was widely antici- expansion during the second half of the pated. Although there was relatively year. Accommodative financial condilittle shift in market expectations for the tions, recent additional fiscal stimulus, federal funds rate following the policy and robust gains in structural producdecision, longer-dated federal funds tivity were evidently providing signififutures rates rose significantly in the cant impetus to business and consumer weeks before the October meeting in spending. Inventory levels had been the context of better-than-expected eco- substantially reduced, and the size of nomic data, positive announcements business capital stocks apparently had of corporate earnings, and a pronounced continued to move closer to acceptable weakening of the dollar. Short- and levels. As a consequence, improving intermediate-term Treasury yields also sales and profits, low financing costs, increased somewhat over the intermeet- and the temporary federal tax incentive ing period, but yields on longer-term for investment in new equipment and Treasuries were about unchanged. While software were projected to boost busirates on investment-grade securities ness investment spending over time. moved about in line with those on Trea- Given the substantial ongoing slack in suries, yields and spreads on lower-tier resource utilization, the staff forecast obligations registered further significant anticipated some slight downward presand broad-based declines. Major equity sure on core consumer price inflation. indexes rose roughly 2 percent over the In the Committee's discussion of curintermeeting period. rent and prospective economic develop- The exchange value of the dollar, as ments, members referred to widespread measured by the major currencies index, indications of a marked strengthening in fell significantly over the intermeet- the growth of economic activity. While ing period. Negative market sentiment views regarding the probable vigor of toward the dollar, apparently reinforced the expansion differed to some extent, by market participants' interpretation the members generally anticipated of the G-7 communique from Dubai on growth at a pace near or somewhat September 20, was not overcome by above the economy's potential over the several better-than-expected U.S. eco- forecast horizon, assuming no major nomic reports, though there were some shocks to the economy. Factors cited as short-lived gains related to the data likely to encourage robust and sustained releases during the period. economic growth included substantial Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 213 fiscal and monetary policy stimulus, cant inflationary pressures were not seen accommodative financial conditions, as likely. indications of strengthening foreign Members commented that the economies, much improved business strengthening in final sales had fostered earnings and cash flows, and the favor- some firming in industrial production able implications of strongly rising pro- and had led purchasing managers to ductivity for business investment and report an improvement in current and worker earnings. Members nonetheless anticipated business conditions. Moresaw some factors that could restrain the over, labor demand had begun to show degree of vigor in household and busi- signs of stabilizing after an extended ness spending and present downside period of weakness. Anecdotal reports risks to their forecasts. Among the nega- of plans to increase hiring and of actual tives mentioned were the still-cautious increases had multiplied. However, the business attitudes that continued to extent to which recently positive labor inhibit hiring and investment decisions, market developments might be harthe potentially adverse effect on house- bingers of substantial further employhold confidence if appreciable further ment gains was unclear at this point, gains in employment should fail to given evidently continuing business materialize, and the waning impetus efforts to respond to growing demand by over time of the tax reductions that improving productivity rather than hirhad taken effect this year. On balance, ing new workers. Members nonetheless while the factors pointing to a vigorous expressed optimism regarding the prosexpansion seemed to predominate, pects for substantial employment gains members acknowledged that the econ- once business firms were persuaded that omy was emerging from an atypical a major uptrend in final sales was firmly period that limited the guidance that his- established. torical experience provided for evaluat- In their comments about the outlook ing the economic outlook. Developfor demand in key sectors of the econments in the next few months, notably omy, members continued to view busiincluding the strength of holiday sales, ness capital spending as a critical factor should provide an improved basis for in the prospects for the performance of judging the underlying momentum of the overall economy. Business expendithe expansion. tures for new equipment and software In contrast to the usual experience clearly had turned up since earlier in the in economic recoveries during recent year, but anecdotal reports from around decades, the expansion appeared to be the nation continued to suggest that gathering momentum at a time when much of this spending was for replacekey measures of inflation suggested that ment and upgrading purposes rather than price stability had essentially been expansion. Such reports also indicated achieved. Looking ahead, members gen- that business contacts, while more confierally anticipated that an economic per- dent, remained very cautious, with most formance in line with their expectations firms hesitant to expand their facilities would not entirely eliminate currently or hire permanent workers until they large margins of unemployed labor and saw firmer indications that the recent other resources until perhaps the latter upturn in business activity would be part of 2005 or even later. Accordingly sustained. Some firms reportedly were and given the presumed persistence of directing capital investments to foreign strong worldwide competition, signifi- markets rather than domestically, appar- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

214 90th Annual Report, 2003 ently largely to take advantage of lower the recent improvement in labor market labor costs abroad. Members none- conditions was sustained, there could be theless expressed the view that in the adverse repercussions on consumer atticontext of further anticipated increases tudes and spending. in profits and sales, business confi- Propelled by still low mortgage interdence would continue to improve and est rates, housing demand had remained induce greater investment and work- at a very high level in recent months. force expansions. On the negative side, Indeed, record sales were being reported there were few indications of a possi- in some regions. There were, however, ble upturn in commercial construction indications of concern about the longeractivity. term outlook for housing on the part of The recent strength in final sales was some real estate contacts. associated with sizable inventory liqui- Fiscal policy was expected to be dation by business firms, and recent somewhat less expansionary next year, surveys and anecdotal commentary sug- though still an important contributor to gested that inventories were at unusu- economic growth. Members again menally low levels in relation to sales, tioned concerns on the part of business notably in manufacturing. In the circum- contacts regarding the adverse economic stances, a continuation of robust final implications of very large deficits for demand could be expected to foster the economy over the longer term. efforts to rebuild inventories, with In their comments about the exterpotentially substantial short-run stimu- nal sector of the economy, members lus to the economy. However, the timing referred to indications of strengthening and extent of such restocking were sub- economic activity abroad that in conject to uncertainty, and for now avail- junction with a weaker dollar was fosterable reports indicated that business firms ing some improvement in exports. At were continuing to follow a highly cau- the same time, imports continued to tious approach to inventory investment. expand rapidly, reflecting not only As had been true for an extended growth in U.S. domestic demand but period, household spending had contin- also the increased availability of foreign ued to be the mainstay of what until products at attractive prices stemming recent months had been a sluggish from the rapid expansion of output economic recovery. Personal consump- capacity in a number of foreign countion expenditures had posted quarterly tries. In this regard, many business increases throughout the recent period contacts continued to note pressures on of limited economic growth. During their domestic operations from foreign the summer months, consumer spend- competition. ing evidently was boosted by a surge of In their review of the outlook for disposable income generated by the fed- inflation, members emphasized that the eral tax cuts, but how long that income prospects for persisting slack in labor effect would stimulate increases in con- and other resources in combination with sumer spending remained uncertain. On substantial further increases in producthe encouraging side, according to a tivity were likely to hold inflation to number of reports retailers were opti- very low levels over the next year or mistic about the outlook for sales during two. Indeed, many saw modest further the holiday period and about the econ- disinflation as likely, at least over the omy more generally. However, some year ahead, though they also agreed members expressed concern that unless that the probability of substantial and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 215 worrisome disinflation had become tially consistent with price stability sugincreasingly remote in light of the gested that the Committee could wait recent strengthening in economic activ- for more definitive signs that economic ity. Members also cited the weakness in expansion would otherwise generate the dollar as a factor that would tend to inflationary pressures before making a reduce the degree of any domestic disin- significant adjustment to its current polflation. Some members emphasized that icy stance. the outlook for inflation was clouded In their discussion of the press stateby a high degree of uncertainty about ment to be issued shortly after this meetthe underlying trend in productivity. The ing, the members indicated that the growth in productivity could remain Committee's risk assessments relating higher than had earlier been anticipated, to economic activity and inflation to be damping employment, labor costs, and referenced in that statement should price pressures. On balance, the mem- remain the same as those in use since bers did not view changes in inflation in the May meeting. Some members, while either direction as likely to generate sig- expressing support for this view, also nificant policy concerns over the fore- commented that the time for some cast horizon. changes in the current risk assessments In the Committee's discussion of pol- might be approaching if the economy icy for the intermeeting period ahead, all continued to strengthen in line with the members agreed that an unchanged recent experience. At this meeting, the target of 1 percent remained appropriate members agreed that the risks to the for the federal funds rate. The current goal of sustainable economic growth degree of policy ease evidently was con- were roughly balanced for the next few tributing to an upturn in the expansion quarters and the probability of an unwelof economic activity. The strengthening come fall in inflation, though minor, economy had reduced concerns of sig- exceeded that of a rise in inflation from nificant further disinflation, but those its currently low level. On balance, the concerns had not been eliminated. The risk of undesirably low inflation was pickup in demand had yet to materially likely to remain the Committee's prenarrow currently wide margins of idle dominant concern for the foreseeable labor and other resources, and these future. At the conclusion of this dismargins along with the uncertainties that cussion, the Committee agreed to the still surrounded current forecasts of release of a press statement after this robust economic growth suggested that meeting that was virtually identical to an accommodative monetary policy the one used after the September meetmight remain desirable for a consider- ing apart from some updating to reflect able period of time. Members referred to ongoing economic developments. the contrast between their current policy The Committee voted to authorize expectations and the typical experience and direct the Federal Reserve Bank of during earlier cyclical upturns when it New York, until it was instructed otherwas felt that policy adjustments needed wise, to execute transactions in the Systo be made quite promptly to gain tem Account in accordance with the folgreater assurance that inflation would lowing domestic policy directive: not rise from what were already relatively elevated levels. In present circum- The Federal Open Market Committee stances, the degree of slack in resources seeks monetary and financial conditions that and a rate of inflation that was essen- will foster price stability and promote sus- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

216 90th Annual Report, 2003 tainable growth in output. To further its long- It was agreed that the next meeting of run objectives, the Committee in the imme- the Committee would be held on Tuesdiate future seeks conditions in reserve day, December 9, 2003. markets consistent with maintaining the The meeting adjourned at 2:00 p.m. federal funds rate at an average of around 1 percent. Vincent R. Reinhart Votes for this action: Messrs. Greenspan, Secretary Bernanke, Ms. Bies, Messrs. Broaddus, Ferguson, Gramlich, Guynn, Kohn, Moskow, Olson, Parry, and Stewart. (Mr. Stewart voted as an alternate member.) Votes against this action: None. Meeting Held on December 9, 2003 The vote encompassed the substance of the following statements concerning A meeting of the Federal Open Market risks that would be conveyed in the Committee was held in the offices of Committee's press release to be made the Board of Governors of the Federal available shortly after the meeting: Reserve System in Washington, D.C., on Tuesday, December 9, 2003, at 9:00 a.m. The risks to the Committee's outlook for sustainable economic growth over the next several quarters are balanced; the risks to its Present: outlook for inflation over the next several Mr. Greenspan, Chairman quarters are weighted toward the downside; Mr. Geithner, Vice Chairman and, taken together, the balance of risks to its Mr. Bernanke objectives is weighted toward the downside Ms. Bies in the foreseeable future. Mr. Broaddus Mr. Ferguson Mr. Gramlich At this meeting the members con- Mr. Guynn tinued their earlier discussion of how Mr. Kohn best to communicate the Committee's Mr. Moskow Mr. Olson general assessment of the outlook for Mr. Parry economic activity and inflation. The members recognized that changing cir- Mr. Hoenig, Mses. Minehan and cumstances required adaptations in the Pianalto, Messrs. Poole and Committee's communications with the Stewart, Alternate Members ultimate objective of fostering the best of the Federal Open Market possible public understanding of mone- Committee tary policy decisions. A number of alternative approaches and specific sugges- Messrs. McTeer and Santomero, tions were discussed, and in the absence Presidents of the Federal Reserve of a consensus at this meeting the mem- Banks of Dallas and Philadelphia bers agreed that further study under respectively the guidance of a working group comprised of Committee members was Mr. Reinhart, Secretary and Economist Mr. Bernard, Deputy Secretary desirable. The working group would Ms. Smith, Assistant Secretary develop a limited number of specific Mr. Mattingly, General Counsel proposals for consideration at a later Ms. Johnson, Economist meeting. Mr. Stockton, Economist Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 217 Mr. Connors, Ms. Cumming, Messrs. Fuhrer and Hakkio, Messrs. Eisenbeis, Goodfriend, Ms. Mester, Messrs. Rasche Howard, Madigan, Struckmeyer, and Rosenblum, Senior Vice and Wilcox, Associate Economists Presidents, Federal Reserve Banks of Boston, Kansas City, Mr. Kos, Manager, System Open Philadelphia, St. Louis, and Market Account Dallas respectively Mr. Ettin, Deputy Director, Division Messrs. Bryan, Elsasser, Sullivan, of Research and Statistics, and Weber, Vice Presidents, Board of Governors Federal Reserve Banks of Cleveland, New York, Chicago, Messrs. Slifman and Oliner, Associate and Minneapolis respectively Directors, Division of Research and Statistics, Board of Governors Mr. Trehan, Economist, Federal Reserve Bank of San Francisco Messrs. Clouse, Kamin, and Whitesell, Deputy Associate Directors, By unanimous vote, the minutes of Divisions of Monetary Affairs, International Finance, and the meeting of the Federal Open Market Monetary Affairs, respectively, Committee held on October 28, 2003, Board of Governors were approved. Advice had been received that Mr. English, Assistant Director, Mr. Timothy F. Geithner had been Division of Monetary Affairs, elected by the directors of the Federal Board of Governors Reserve Bank of New York as a member Mr. Hambley, Assistant to the Board of the Federal Open Market Committee and Director for Congressional for the period commencing Novem- Liaison, Office of Board ber 14, 2003, and ending December 31, Members, Board of Governors 2003, and that he had executed his oath of office. Mr. Skidmore, Special Assistant to the Board, Office of Board By unanimous vote, Timothy F. Members, Board of Governors Geithner was elected to serve as Vice Chairman until the first regularly sched- Mr. Nelson, Senior Economist, uled meeting of the Committee after Division of Monetary Affairs, December 31, 2003, with the under- Board of Governors standing that in the event of the discon- Mr. Luecke, Senior Financial Analyst, tinuance of his official connection with Division of Monetary Affairs, a Federal Reserve Bank or the Board of Board of Governors Governors, he would cease to have any official connection to the Committee. Mr. Kumasaka, Financial Analyst, The Manager of the System Open Division of Monetary Affairs, Board of Governors Market Account reported on recent developments in foreign exchange mar- Ms. Low, Open Market Secretariat kets. There were no open market opera- Assistant, Division of Monetary tions in foreign currencies for the Sys- Affairs, Board of Governors tem's account in the period since the previous meeting. Messrs. Lyon and Werkema, First Vice The Manager also reported on devel- Presidents, Federal Reserve Banks of Minneapolis and Chicago opments in domestic financial markets respectively and on System open market transactions Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

218 90th Annual Report, 2003 in government securities and securities pace since the middle of 2000, and proissued or fully guaranteed by federal duction gains continued at a rapid pace agencies during the period October 28, in October. Outside the manufacturing 2003, through December 8, 2003. By sector, unseasonably warm weather conunanimous vote, the Committee ratified tributed to an increase in output at utilithese transactions. ties in October, while mining produc- Real GDP appeared to be advancing tion declined a bit, largely reflecting a at a solid rate in the fourth quarter, albeit decrease in the production of crude oil. well below its extraordinary pace in Capacity utilization edged up in October the third quarter. Consumer spending but remained well below its longer-term appeared to be on a flatter trajectory, but average. spending for equipment and software Consumer spending slipped a little on and residential construction continued balance in September and October after to surge. Meanwhile, the labor mar- soaring in July and August. Much of the ket had finally shown signs of some recent decline was the result of a pullimprovement in recent months, and back in purchases of motor vehicles; activity in the industrial sector was con- elsewhere, expenditures were about tinuing to rise. Consumer price inflation unchanged in September and rose modremained quiescent: The twelve-month estly in October. Spending was supchange in core consumer prices was ported by the upturn in employment, notably lower than the increase during continued impetus from the recently the preceding year. enacted tax cuts, improved confidence, Private nonfarm payrolls rose moder- and a level of wealth that was considerately in November, although by less than ably above that of earlier in the year. the substantial gains in September and Housing activity surged in October. October. The increases in November Single-family housing starts reached a were fairly widespread, with notable record high, while multifamily starts advances in temporary help services, moved down but remained in line with nonbusiness services, and construction. the average pace during the previous Although employment continued to two years. Sales of existing singlefall in manufacturing, the losses had family homes in October were only a bit tapered off since the first half of the below the record level set in Septemyear. The average workweek and aggre- ber. The pace of new home sales also gate hours worked by nonfarm employ- remained brisk in October, albeit down ees increased significantly, and the aver- somewhat from September. age level of nonfarm employee hours in The data on orders for, and shipments October and November was noticeably of, nondefense capital goods through above the average in the third quarter. October suggested continued momen- The unemployment rate fell to 5.9 per- tum in spending on equipment and softcent in November, down from a recent ware, which grew in the third quarter at peak of 6.4 percent at midyear. the fastest pace since 1998. Robust gains Industrial production grew solidly in in spending were posted in the third the third quarter, and the momentum quarter in all the major categories continued in October apart from the pro- except aircraft. The gains were associduction of motor vehicles and parts, ated with recent increases in business which fell back from an elevated third- output and corporate cash flow and with quarter level. High-tech output acceler- a decline this year in the user cost of ated in the third quarter to the fastest capital. Shipments of high-tech equip- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 219 ment climbed further in October, while it was up from even lower levels in shipments in other nondefense sectors the first part of the year, when it was excluding aircraft edged down. New depressed by transitory factors. Over orders of nondefense equipment exclud- the twelve months ending in Octoing aircraft in October continued the ber, core consumer prices rose only upward trend in place since the begin- slightly and noticeably less than in the ning of the year and were consistent previous twelve-month period. Total with ongoing gains in equipment spend- twelve-month consumer inflation was ing. Outlays for the construction of unchanged over the period owing to private-sector nonresidential buildings accelerations in food and energy prices. fell a bit in October, but the extended Producer prices for both core and total contraction in spending on nonresiden- finished goods posted unusually large tial construction appeared to be ending. increases in October, reflecting in part a Nominal spending on office space edged sizable advance in the prices of motor up in September and October, while vehicles. Twelve-month core producer outlays for the construction of other price inflation, however, was on balance commercial buildings moved lower. unchanged over the year ending Octo- Expenditures on institutional buildings ber, although the twelve-month change changed little in recent months. in overall producer prices stood well Real nonfarm inventories fell moder- above its year-earlier level owing to a ately in the third quarter after declining jump in food and energy price inflasubstantially in the second. Manufactur- tion. With regard to labor costs, the ers liquidated stocks by a larger amount average hourly earnings of production in the third quarter than in the previous or nonsupervisory workers on private quarter but added slightly to their inven- nonfarm payrolls rose slightly in the tories in October. Wholesalers and twelve months ending in November; the retailers (excluding those selling motor increase was a bit below that in the vehicles and parts) built up inventories previous twelve months. By contrast, in the third quarter, and, for wholesalers, the increase in the employment cost the stockbuilding continued in October index for hourly compensation in pri- (data on retail inventories in October vate industry for the twelve months endwere unavailable). Still, inventory-sales ing in September was a bit higher than a ratios in all three categories declined a year earlier, reflecting a pickup in benebit further in the third quarter from fit costs. already very low levels. At its meeting of October 28, 2003, The international trade deficit the Federal Open Market Committee increased in September as imports of adopted a directive that called for maingoods and services rose more than taining conditions in reserve markets exports. Recent data suggested that a consistent with keeping the federal recovery had taken hold in the major funds rate at around 1 percent. In reachforeign industrial countries. Growth in ing this decision, the Committee memreal GDP picked up in the third quarter bers generally perceived the upside and in the euro area, the United Kingdom, downside risks to the attainment of susand Canada, and indicators in Japan tainable growth for the next few quarwere consistent with continued eco- ters to be roughly equal; however, they nomic expansion. viewed the probability, though minor, Core consumer price inflation of an unwelcome fall in inflation as remained subdued in October, although exceeding that of a rise in inflation Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

220 90th Annual Report, 2003 from its already low level. The Commit- net, over the remainder of the intermeettee judged that, on balance, the risk ing period, reflecting concerns about an of inflation becoming undesirably low escalation of trade frictions prompted remained the predominant concern for by the U.S. imposition of import quotas the foreseeable future. In those circum- on Chinese textiles, the ability of the stances, the Committee believed that United States to continue to finance its policy accommodation could be main- current account deficit, and risks stemtained for a considerable period. ming from developments in Afghani- The Committee's decision at the stan, Iraq, and Turkey. October meeting to leave its target for M2 contracted significantly in the federal funds rate unchanged had November for the third consecutive been widely anticipated, and rates on month. A sizable part of the declines in near-dated federal funds futures were these three months appeared to be due to virtually unchanged. However, the Com- the falloff in mortgage refinancing activmittee's retention of both an unchanged ity and the resulting reductions in assorisk assessment and its indication that ciated deposit balances. In addition, rispolicy could remain accommodative for ing equity markets may have made M2 a considerable period, which market accounts relatively less attractive. participants apparently had seen as The staff forecast prepared for this less certain outcomes, precipitated a meeting indicated that the economic brief rally in Treasury markets. Over expansion was likely to be sufficiently the intermeeting period as a whole, robust to reduce economic slack subintermediate- and longer-term Treasury stantially in coming quarters. Accomyields were basically unchanged. modative financial conditions, fiscal Upward movements in response to data stimulus, and substantial gains in strucreleases showing an economy building tural productivity would continue to promomentum were offset by the mar- vide significant impetus to business and ket response to several statements by consumer spending over the months policymakers reiterating that policy ahead. In addition, businesses appeared could remain accommodative and to the to be shedding some of the caution that November employment report, which had characterized their behavior for the included a smaller gain in private non- previous three years. As a consequence, farm payrolls than market participants with sales, profits, and stock prices had expected. Yields on investment- higher, the liquidation of inventories grade corporate securities were also appeared to be ending, and the strengthessentially unchanged, while yields on ening of capital investment and pickup speculative-grade securities declined, in hiring already evident in the data continuing the narrowing of their risk were projected to continue. Even though spreads. Major equity indexes were up the unemployment rate was projected to moderately over the intermeeting period. decline over coming quarters, some The exchange value of the dollar, as slight downward pressure on core conmeasured by the major currencies index, sumer price inflation was anticipated declined somewhat, on net, over the in the forecast, given ongoing slack in intermeeting period. The dollar had resource utilization. appreciated in late October and early In the Committee's discussion of cur- November following several stronger- rent and prospective economic developthan-expected U.S. economic data ments, members referred to widespread releases. But the dollar depreciated, on indications that the pickup in the eco- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 221 nomic expansion was broadening and ment outlays and employment going becoming more entrenched. The mem- forward. Even in manufacturing, which bers noted that spending by households had lagged the recovery in the rest had remained strong even as the effects of the economy until recently, output of tax cuts and mortgage refinancing was rising in many subsectors and began to wane. And with business confi- employment displayed signs of stadence on the mend, investment outlays bilizing. Some members reported an had increased rapidly and employment easing of downward pressures on prices had revived. While assessments by indi- in selected industries, but anecdotal vidual members of the likely pace of the reports suggested that competition, expansion going forward differed some- including especially competition from what, they generally expected growth to foreign producers, continued to conrun at a rate that would trim slack in strain pricing. labor and goods markets over the fore- In their comments about the outlook cast period, assuming no major shocks for demand in key sectors of the econto the economy. Factors supporting this omy, members indicated greater confiview included stimulative monetary and dence that the sizable gains in business fiscal policies, accommodative condi- spending in recent quarters would contions in financial markets, building busi- tinue. It now appeared that the increase ness confidence, a rebound in profits, in outlays for equipment and software and the effects on the external sector of in the third quarter was even larger than the weaker dollar and pickup in growth had been thought, and data on orders abroad. While downside risks to the out- and shipments, as well as anecdotal look had diminished, some members reports, pointed to further increases. remained concerned that spending could These gains owed to rising business conslow somewhat next year as the effects fidence, substantial gains in profits and of fiscal stimulus and mortgage refi- cash flow, and accommodative financial nancing faded. Rapid productivity markets. In addition, businesses were growth also could limit employment expected to step up investment outlays gains and so weigh on consumer confi- next year in advance of the expiration of dence. With relatively strong economic temporary tax incentives. Some memgrowth nonetheless seemingly more bers noted that the commercial real assured, members regarded the risks to estate sector, which had been very weak inflation as more nearly balanced than with high vacancy rates and falling earlier in the year. rents, was showing signs of bottoming, In their comments about recent devel- as the strengthening economy boosted opments around the nation, members demand for office and retail space. reported improving economic conditions An easing of business caution was in virtually all regions, with strength in also suggested by growing indications household spending increasingly aug- that business firms were shifting from mented by gains in business out- inventory liquidation to restocking. With lays. Consumer spending remained firm, the level of inventories still quite low and residential construction continued relative to sales and sales expected to at a high level. Committee members' strengthen further, a number of membusiness contacts generally expressed bers noted that inventory investment increasing confidence that the expan- could be expected to contribute to sion would be sustained, and they growth in aggregate demand in coming anticipated further increases in invest- quarters. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

222 90th Annual Report, 2003 Household spending had remained foster a pickup in exports. While some solid even as the effects of tax refunds of the improvement abroad was proband mortgage refinancing, which had ably the result of faster growth in the boosted spending substantially in the United States, domestic demand in sevsummer, waned. While consumption eral major trading partners appeared to spending had slowed earlier in the fall, be strengthening. Nonetheless, the value retail contacts suggested some strength- of U.S. imports was likely to continue to ening more recently and reported that exceed that of exports by a wide margin, holiday sales appeared to be running and the resulting large current account somewhat above last year's pace. Look- deficits and their potential correction ing forward, members anticipated that added to uncertainty about the longerconsumer spending would be supported term prospects for the U.S. economy. by further gains in employment as well In their review of the outlook for as by substantial tax refunds in the first prices, members generally anticipated half of next year. And with the expan- that persisting, though decreasing, marsion picking up momentum, the risk of gins of slack in labor and goods markets a slowdown in such spending clearly and further gains in productivity would seemed to have diminished. Some mem- keep inflation low, with a number of bers pointed, however, to signs of members seeing a small further decline increased financial stress that could limit in inflation as a distinct possibility. Even the ability of many households to hold if growth proved fairly robust, downspending at recent levels, especially if ward pressure on prices could come incomes did not rise at a robust pace in from a narrowing of profit margins, line with current forecasts. In the hous- which were currently quite high, or from ing sector, activity remained elevated further surprising strength in productivdespite some increase in mortgage rates ity, which would reduce labor costs. In since early summer. addition, some members noted that the Members anticipated that growth in current unemployment rate likely underfederal government spending, which had stated the slack in labor markets, since been boosted in recent quarters by a the labor market participation rate had buildup in defense outlays, would slow fallen significantly of late, and changes going forward, while budget pressures in payment and hiring practices had would continue to limit increases in state perhaps reduced the level of unemployand local spending. Although fiscal pol- ment that could be sustained without icy more generally would probably con- upward pressure on wages. However, tinue to strengthen aggregate demand with growth now seen as more assured, next year, this effect was expected to downward risks to inflation were viewed diminish somewhat even though very as considerably reduced relative to earlarge deficits were likely to persist. lier in the year, and the risk of a perni- Over a longer horizon, some members cious deflation in which declining prices expressed concern about the possible reinforced weakness in demand—a risk adverse effects of such deficits on finan- that the members had always viewed as cial markets and the economy. small—was now regarded by most as In their remarks about the external virtually nil. Indeed, the weaker dollar, sector of the economy, members noted higher commodity prices, and outsized that an improvement in the economic increases in benefit costs were seen as outlook in many foreign economies, as suggesting some countervailing upward well as the lower dollar, was likely to pressure on costs and prices even though Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 223 changes in exchange rates and commod- tinue and over time promote fuller utiliity prices generally had not had a large zation of resources. For the near term, effect on retail prices in the past. Mem- however, members saw substantial bers also expressed concern about the benefit in maintaining an unchanged potential for an increase in inflation policy stance and considerable risk in expectations given highly stimulative taking preemptive action that could macroeconomic policies and economic prove to be unneeded against potential growth that seemed to be gathering inflation, with associated costs to ecomomentum. Some noted that the rise nomic performance. in recent months in inflation compen- In their discussion of the announcesation, as measured by the difference ment to be issued shortly after this meetbetween the yields on nominal and ing, the members agreed that in addition indexed Treasury securities, could to updating to reflect recent economic potentially point in this direction. None- developments, some rewording was theless, on balance, most members cur- needed to reflect their evolving assessrently considered the upside risks to ment of the risks to the economy. In inflation to be a bit less pressing than light of the recent acceleration in ecothose on the downside for the next few nomic activity and their expectations of quarters. relatively robust growth ahead, the In the Committee's discussion of pol- members believed that the clearest way icy for the intermeeting period ahead, all to convey their changed assessment was the members favored an unchanged pol- to note that the risks of substantial disinicy that continued to incorporate a target flation had diminished appreciably. of 1 percent for the federal funds rate. While a number of members saw some The data and anecdotal evidence becom- slight further disinflation as the most ing available since the last meeting had plausible outcome, no one expected a made the members more confident that material change in inflation. All could robust growth in economic activity agree that the risks of further disinflawould persist. Nonetheless, they felt that tion were substantially reduced and the currently accommodative policy close to balance for overall inflation. stance remained appropriate in a period In the circumstances, most members characterized by very low inflation, endorsed a proposal to delete as no wide margins of unused labor and other longer necessary the previous summary resources, and still considerable uncer- statement relating to the risks to growth tainty about the speed with which those and inflation taken together. margins would be worked down. In Views differed with regard to the refthese circumstances, inflationary pres- erence in recent statements to maintainsures appeared likely to remain sub- ing an accommodative monetary policy dued well into the future. To be sure, the "for a considerable period." A num- Committee needed to remain attentive ber of members argued that its deletion to any indications of rising inflation would serve to enhance the Commitpressures and to be prepared to adjust its tee's flexibility to adjust monetary polpolicy stance if emerging economic con- icy at a later date when that was deemed ditions warranted such a move. At some appropriate on the basis of evolving point, a move in the direction of a less economic circumstances. A majority, accommodative and more neutral policy however, preferred to retain the phrase, posture might well be necessary should at least for now. They noted that the the apparently vigorous expansion con- changes in their assessment of risk Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

224 90th Annual Report, 2003 would convey the evolving views of the come fall in inflation has diminished in Committee and they believed the "con- recent months and now appears almost equal to that of a rise in inflation. siderable period" reference still accurately conveyed the Committee's policy Votes for this action: Messrs. Greenspan, intentions. Given the decision to retain Geithner, Bernanke, Ms. Bies, Messrs. the reference in question, all the mem- Broaddus, Ferguson, Gramlich, Guynn, bers saw merit in associating it more Kohn, Moskow, Olson, and Parry. Vote clearly with economic conditions, spe- against this action: None. cifically the persistence of quite low At this meeting Mr. Ferguson reinflation and slack in resource use, as ported on the progress of the working opposed to having it appear to be linked group that was charged at the Octoonly to the passage of time. ber 28 meeting with developing some At the conclusion of the discussion, specific proposals regarding how best to the Committee voted to authorize and communicate the Committee's assessdirect the Federal Reserve Bank of New ment of the outlook for economic activ- York, until it was instructed otherwise, ity and inflation. The working group had to execute transactions in the System solicited and received comments from Account in accordance with the followthe members of the Board of Govering domestic policy directive. nors and from the presidents of the Federal Reserve Banks regarding potential "The Federal Open Market Committee seeks monetary and financial conditions that approaches for improving communicawill foster price stability and promote sus- tions with the public and enhancing tainable growth in output. To further its long- thereby the latter's understanding of run objectives, the Committee in the immemonetary policy decisions. It was agreed diate future seeks conditions in reserve that the working group, with the assismarkets consistent with maintaining the federal funds rate at an average of around tance of staff at the Board of Governors 1 percent." and the Federal Reserve Banks, would prepare more detailed proposals together The vote encompassed the following with supporting staff documentation for statements concerning the risks to the consideration at a later meeting of the Committee's outlook for economic Committee. growth and inflation. These statements It was agreed that the next meeting would be included in the press release of the Committee would be held on to be made available shortly after the Tuesday-Wednesday, January 27-28, meeting. 2004. The meeting adjourned at 2:00 p.m. The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are Vincent R. Reinhart roughly equal. The probability of an unwel- Secretary Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

225 Litigation During 2003, the Board of Governors Apjfel v. Board of Governors, No. 03was a party in six lawsuits or appeals 343 (S.D. Texas, filed May 20, 2003), is filed that year and was a party in six a case brought under the Freedom of other cases pending from previous Information Act. years, for a total of twelve cases; in Carter v. Greenspan, No. 03-1026 2002, the Board had been a party in a (D. District of Columbia, filed May 9, total of ten cases. None of the lawsuits 2003), is an employment discrimination or appeals filed in 2003 raised questions action. under the Bank Holding Company Act. Sedgwick v. United States, No. 02- As of December 31, 2003, nine cases 5378 (D.C. Circuit, filed November 26, were pending. 2002), was an appeal of the dismissal of appellant's claim for a declaratory judgment under the Federal Tort Claims Act Litigation under the Financial and the Constitution regarding the bank- Institutions Supervisory Act ing agencies' alleged failure to inter- Ulrich v. Board of Governors, No. 03- vene on his behalf in civil litigation 73854 (9th Circuit, filed October 24, involving a regulated institution. On 2003), and Diehl McCarthy v. Board of March 20, 2003, the court of appeals Governors, No. 03-73997 (9th Circuit, summarily affirmed the district court's filed October 28, 2003), are petitions for dismissal. review of orders of prohibition issued Albrecht v. Board of Governors, by the Board on October 15, 2003. On No. 02-5235 (D.C. Circuit, filed Octo- December 12, 2003, the court consoli- ber 18, 2002), is an appeal of a district dated these cases with related petitions court order dismissing a challenge to for review of orders issued by the Office the pension funding method applicable of the Comptroller of the Currency to certain Board employees under the imposing civil money penalties and res- Board's retirement plan. titution against the petitioners. Caesar v. United States, No. 02-0612 (EGS) (D. District of Columbia, removed April 1, 2002, from the Supe- Other Actions rior Court of the District of Columbia), Lai go v. Board of Governors, No. 03- was an action seeking damages for per- CV-03576-MJP (W.D. Washington, filed sonal injury. On March 30, 2003, the November 19, 2003), is a claim regard- court granted the government's motion ing redemption of U.S. savings bonds. to dismiss the action. In Tavera v. Von Nothaus, et ai, Community Bank & Trust v. United No. 03-763 (D. Oregon, filed June 5, States, No. 01-571C (Court of Federal 2003), the plaintiff claimed that his civil Claims, filed October 3, 2001), is an rights were violated when he was pros- action challenging on constitutional ecuted for passing "Liberty dollar grounds the failure to pay interest on coins" as lawful money. On Decem- reserve accounts held at Federal Reserve ber 10, 2003, the court granted the Banks. Board's motion to dismiss the action. Artis v. Greenspan, No. 01-0400 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

226 90th Annual Report, 2003 (D. District of Columbia, filed Febru- Fraternal Order of Police v. Board of ary 22, 2001), is an employment dis- Governors, No. 98-3116 (D. District of crimination action. An identical action, Columbia, filed December 22, 1998), is No. 99-2073 (EGS) (D. District of an action seeking a declaratory judg- Columbia, filed August 3, 1999), was ment regarding the Board's labor policy consolidated with this action on governing Federal Reserve Banks. • August 15, 2001. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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Federal Reserve System Organization 229 Board of Governors December 31, 2003 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 ... .2018 Margaret M. Shanks, Assistant Secretary Donald L. Kohn, of Virginia 2016 Officers DIVISION OF INTERNATIONAL FINANCE OFFICE OF BOARD MEMBERS Karen H. Johnson, Director Michelle A. Smith, Director David H. Howard, Deputy Director Winthrop P. Hambley, Assistant to the Thomas A. Connors, Associate Director Board and Director for Congressional Dale W. Henderson, Senior Adviser Liaison Richard T. Freeman, Deputy Associate Rosanna Pianalto-Cameron, Special Director Assistant to the Board Steven B. Kamin, Deputy Associate David W. Skidmore, Special Assistant Director to the Board William L. Helkie, Senior Adviser Laricke D. Blanchard, Special Assistant to Jon W. Faust, Assistant Director the Board for Congressional Liaison Joseph E. Gagnon, Assistant Director LEGAL DIVISION Willene A. Johnson, Adviser J. Virgil Mattingly, Jr., General Counsel Michael P. Leahy, Assistant Director Scott G. Alvarez, Associate General D. Nathan Sheets, Assistant Director Counsel Ralph W. Tryon, Assistant Director Richard M. Ashton, Associate General Counsel DIVISION OF MONETARY AFFAIRS Stephanie Martin, Associate General Vincent R. Reinhart, Director Counsel Brian F. Madigan, Deputy Director Kathleen M. O'Day, Associate General James A. Clouse, Deputy Associate Counsel Director Ann Misback, Assistant General Counsel William C. Whitesell, Deputy Associate Stephen L. Siciliano, Assistant General Director Counsel Cheryl L. Edwards, Assistant Director William B. English, Assistant Director Richard D. Porter, Senior Adviser Athanasios Orphanides, Adviser 1. The designations as Chairman and Vice Chairman expire on June 20, 2004, and Octo- Normand R.V. Bernard, Special Assistant ber 28, 2007, respectively, unless the service of to the Board these members of the Board shall have terminated sooner. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

230 90th Annual Report, 2003 Board of Governors—Continued Angela Desmond, Deputy Associate DIVISION OF RESEARCH AND STATISTICS Director David J. Stockton, Director James A. Embersit, Deputy Associate Edward C. Ettin, Deputy Director Director David W. Wilcox, Deputy Director Charles H. Holm, Deputy Associate Myron L. Kwast, Associate Director Director Stephen D. Oliner, Associate Director William G. Spaniel, Deputy Associate Patrick M. Parkinson, Associate Director Director Lawrence Slifman, Associate Director William C. Schneider, Jr., Project Director, Charles S. Struckmeyer, Associate Director National Information Center Joyce K. Zickler, Deputy Jon D. Greenlee, Assistant Director Associate Director Walt H. Miles, Assistant Director J. Nellie Liang, Assistant Director William F. Treacy, Assistant Director S. Wayne Passmore, Assistant Director DIVISION OF CONSUMER David L. ReifSchneider, Assistant Director AND COMMUNITY AFFAIRS Janice Shack-Marquez, Assistant Director Dolores S. Smith, Director William L. Wascher III, Assistant Director Glenn E. Loney, Deputy Director Mary M. West, Assistant Director Sandra F. Braunstein, Senior Associate Alice Patricia White, Assistant Director Director Glenn B. Canner, Senior Adviser Adrienne D. Hurt, Associate Director David S. Jones, Senior Adviser Irene Shawn McNulty, Associate Director Thomas D. Simpson, Senior Adviser James A. Michaels, Assistant Director Tonda E. Price, Assistant Director DIVISION OF BANKING SUPERVISION AND REGULATION DIVISION OF RESERVE BANK Richard Spillenkothen, Director OPERATIONS AND PAYMENT Stephen M. Hoffman, Jr., Deputy Director SYSTEMS Herbert A. Biern, Senior Associate Louise L. Roseman, Director Director Paul W. Bettge, Associate Director Roger T. Cole, Senior Associate Director Jeffrey C. Marquardt, Associate Director Michael G. Martinson, Senior Adviser Kenneth D. Buckley, Assistant Director Stephen C. Schemering, Senior Adviser Joseph H. Hayes, Jr., Assistant Director Deborah P. Bailey, Associate Director Lisa Hoskins, Assistant Director Norah M. Barger, Associate Director Dorothy LaChapelle, Assistant Director Mary Cross-Jacowski, Associate Director Edgar A. Martindale III, Assistant Director Gerald A. Edwards, Jr., Associate Director Marsha W. Reidhill, Assistant Director James V. Houpt, Associate Director Jeff J. Stehm, Assistant Director Jack P. Jennings, Associate Director Jack K. Walton II, Assistant Director Molly S. Wassom, Associate Director David M. Wright, Associate Director OFFICE OF STAFF DIRECTOR Peter J. Purcell, Associate Director and FOR MANAGEMENT Chief Technology Officer Stephen R. Malphrus, Staff Director for Howard A. Amer, Deputy Associate Management Director Sheila Clark, Equal Employment Barbara J. Bouchard, Deputy Associate Opportunity Programs Director Director Lynn S. Fox, Senior Adviser Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 231 Board of Governors—Continued MANAGEMENT DIVISION OFFICE OF INSPECTOR GENERAL H. Fay Peters, Director Barry R. Snyder, Inspector General Stephen J. Clark, Associate Director Donald L. Robinson, Deputy Inspector Darrell R. Pauley, Associate Director General Christine M. Fields, Assistant Director Billy J. Sauls, Assistant Director Donald A. Spicer, Assistant Director DIVISION OF INFORMATION TECHNOLOGY Marianne M. Emerson, Director Maureen T. Hannan, Deputy Director 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

232 90th Annual Report, 2003 Federal Open Market Committee December 31, 2003 Members JAMIE B. STEWART, JR., First Vice President, Federal Reserve Bank of ALAN GREENSPAN, Chairman, Board of New York Governors TIMOTHY F. GEITHNER, Vice Chairman, Officers President, Federal Reserve Bank of VINCENT R. REINHART, Secretary and New York Economist BEN S. BERNANKE, Board of Governors NORMAND R.V. BERNARD, Deputy SUSAN SCHMIDT BIES, Board of Secretary Governors MICHELLE A. SMITH, Assistant Secretary J. ALFRED BROADDUS, JR., President, J. VIRGIL MATTINGLY, JR., General Counsel Federal Reserve Bank of Richmond THOMAS C. BAXTER, JR., Deputy General ROGER W. FERGUSON, JR., Board of Counsel Governors KAREN H. JOHNSON, Economist EDWARD M. GRAMLICH, Board of DAVID J. STOCKTON, Economist Governors THOMAS A. CONNORS, Associate Economist JACK GUYNN, President, Federal Reserve CHRISTINE M. CUMMING, Associate Economist Bank of Atlanta ROBERT A. EISENBEIS, Associate Economist DONALD L. KOHN, Board of Governors CHARLES L. EVANS, Associate Economist MICHAEL H. MOSKOW, President, MARVIN S. GOODFRIEND, Associate Federal Reserve Bank of Chicago Economist MARK W. OLSON, Board of Governors DAVID H. HOWARD, Associate Economist ROBERT T. PARRY, President, Federal JOHN P. JUDD, Associate Economist Reserve Bank of San Francisco BRIAN F. MADIGAN, Associate Economist Alternate Members CHARLES S. STRUCKMEYER, Associate Economist THOMAS M. HOENIG, President, Federal DAVID W. WILCOX, Associate Economist Reserve Bank of Kansas City DINO Kos, Manager, System Open Market CATHY E. MINEHAN, President, Federal Account Reserve Bank of Boston During 2003 the Federal Open Market Com- SANDRA PIANALTO, President, Federal mittee held eight regularly scheduled meet- Reserve Bank of Cleveland ings (see "Minutes of Federal Open Market WILLIAM POOLE, President, Federal Committee Meetings" in this volume). Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 233 Federal Advisory Council December 31, 2003 Members District 10—BYRON G. THOMPSON, Chairman, Country Club Bank, N.A., Kansas District 1—DAVID A. SPINA, Chairman and City, Missouri Chief Executive Officer, State Street Corporation, Boston, Massachusetts District 11—GAYLE M. EARLS, President and Chief Executive Officer, TIB—The District 2—DAVID A. COULTER, Vice Chair- Independent BankersBank, Dallas, Texas man, J.P. Morgan Chase & Co., New York, New York District 12—MICHAEL E. O'NEILL, Chairman, Chief Executive Officer, and District 3—RUFUS A. FULTON, JR., Chair- President, Bank of Hawaii, Honolulu, man and Chief Executive Officer, Ful- Hawaii ton Financial Corporation, Lancaster, Pennsylvania Officers District 4—MARTIN G. MCGUINN, Chairman and Chief Executive Officer, Mellon L. PHILLIP HUMANN, President Financial Corp., Pittsburgh, Pennsylvania ALAN G. MCNALLY, Vice President District 5—FRED L. GREEN III, Chairman, JAMES E. ANNABLE, Co-Secretary President, and Chief Executive Officer, National Bank of South Carolina, WILLIAM J. KORSVIK, Co-Secretary Columbia, South Carolina The Federal Advisory Council, which is District 6—L. PHILLIP HUMANN, Chairman, composed of one representative of the bank- President, and Chief Executive Officer, ing industry from each of the twelve Federal SunTrust Banks, Inc., Atlanta, Georgia Reserve Districts, is required by the Federal District 7—ALAN G. MCNALLY, Chairman Reserve Act to meet in Washington at least and Chief Executive Officer, Harris four times each year and is authorized by the Bankcorp, Inc., Chicago, Illinois act to consult with, and advise, the Board District 8—DAVID W. KEMPER, Chairman, of Governors on all matters within the juris- President, and Chief Executive Officer, diction of the Board. The council met on Commerce Bancshares, Inc., St. Louis, February 6-7, May 1-2, September 4-5, and Missouri December 4-5, 2003. The Board met with District 9—JERRY A. GRUNDHOFER, Presi- the council on February 7, May 2, Septemdent and Chief Executive Officer, U.S. ber 5, and December 5, 2003. Bancorp, Minneapolis, Minnesota Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

234 90th Annual Report, 2003 Consumer Advisory Council December 31, 2003 Members PATRICIA MCCOY, Professor of Law, University of Connecticut School of Law, ANTHONY ABBATE, President and Chief Hartford, Connecticut Executive Officer, Interchange Bank, ELSIE MEEKS, Executive Director, First Saddle Brook, New Jersey Nations Oweesta Corporation, Kyle, JANIE BARRERA, President and Chief Execu- South Dakota tive Officer, ACCION Texas, San MARK PINSKY, President and Chief Execu- Antonio, Texas tive Officer, National Community Capital KENNETH P. BORDELON, Chief Executive Association, Philadelphia, Pennsylvania Officer, E Federal Credit Union, Baton ELIZABETH RENUART, Staff Attorney, Rouge, Louisiana National Consumer Law Center, Boston, SUSAN BREDEHOFT, Senior Vice President, Massachusetts Commerce Bank, N.A., Cherry Hill, New DEBRA S. REYES, President, Neighborhood Jersey Lending Partners, Inc., Tampa, Florida MANUEL CASANOVA, JR., Executive Vice BENSON ROBERTS, Vice President for Policy, President, International Bank of Com- Local Initiatives Support Corporation, merce, Brownsville, Texas Washington, District of Columbia CONSTANCE CHAMBERLIN, President and BENJAMIN ROBINSON III, Senior Vice Chief Executive Officer, Housing President, Strategy Management Execu- Opportunities Made Equal, Richmond, tive, Bank of America, Charlotte, North Virginia Carolina ROBIN COFFEY, Senior Vice President, Har- DIANE THOMPSON, Supervising Attorney, ris Trust and Savings Bank, Chicago, Land of Lincoln Legal Assistance Illinois Foundation, Inc., East St. Louis, Illinois DAN DIXON, Group Senior Vice President, HUBERT VAN TOL, Co-Director, Fairness in World Savings Bank, FSB, Washington, Rural Lending, Sparta, Wisconsin District of Columbia CLINT WALKER, General Counsel/Chief THOMAS FITZGIBBON, Senior Vice President, Administrative Officer, Juniper Bank, MB Financial Bank, Chicago, Illinois Wilmington, Delaware JAMES GARNER, Senior Vice President and General Counsel, North America Consumer Finance for Citigroup, Officers Baltimore, Maryland RONALD REITER, Chair CHARLES GATSON, Vice President and Chief Supervising Deputy Attorney General Operating Officer, Swope Community California Department of Justice Builders, Kansas City, Missouri San Francisco, California LARRY HAWKINS, President and Chief Executive Officer, Unity National Bank, AGNES BUNDY SCANLAN, Vice Chair Managing Director and Chief Houston, Texas Compliance Officer EARL JAROLIMEK, Vice President/Corporate FleetBoston Financial Compliance Officer, Community First Boston, Massachusetts Bankshares, Fargo, North Dakota W. JAMES KING, President and Chief Execu- The Consumer Advisory Council was estabtive Officer, Community Redevelopment lished pursuant to the 1976 amendments to Group, Cincinnati, Ohio the Equal Credit Opportunity Act to advise the Board of Governors on consumer finan- J. PATRICK LIDDY, Director of Compliance, Fifth Third Bancorp, Cincinnati, Ohio cial services. It is composed of academics, state and local government officials, repre- RUHI MAKER, Senior Attorney, Law Office sentatives of the financial industry, and repof Rochester, Rochester, New York resentatives of consumer and community OSCAR MARQUIS, Attorney, Hunton and Wil- interests. The council met with members of liams, Park Ridge, Illinois the Board on March 13, June 26, and Octo- Digitized for FRASER ber 23, 2003. http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 235 Thrift Institutions Advisory Council December 31, 2003 Members GEORGE W. NISE, President and Chief Executive Officer, Beneficial Savings MICHAEL J. BROWN, SR., President and Bank, Philadelphia, Pennsylvania Chief Executive Officer, Harbor Federal KEVIN E. PIETRINI, President and Chief Savings Bank, Fort Pierce, Florida Executive Officer, Queen City Federal JOHN B. DICUS, President, Capitol Federal Savings Bank, Virginia, Minnesota Savings Bank, Topeka, Kansas WILLIAM J. SMALL, Chairman and Chief RICHARD J. DRISCOLL, President, First Sav- Executive Officer, First Federal Bank, ings Bank, FSB, Arlington, Texas Defiance, Ohio CURTIS L. HAGE, Chairman and Chief Executive Officer, Home Federal Bank, Officers Sioux Falls, South Dakota OLAN O. JONES, JR., President and Chief KAREN L. MCCORMICK, President Executive Officer, Eastman Credit Union, WILLIAM J. SMALL, Vice President Kingsport, Tennessee The Thrift Institutions Advisory Council, KIRK KORDELESKI, President and Chief which is composed of representatives from Executive Officer, Bethpage Federal credit unions, savings and loan associations, Credit Union, Bethpage, New York and savings banks, consults with, and ad- D. TAD LOWREY, Chairman, President, and vises, the Board of Governors on issues per- Chief Executive Officer, Jackson Federal taining to the thrift industry and on various Bank, Brea, California other matters within the Board's jurisdiction. The members of the council met with the KAREN L. MCCORMICK, President and Chief Board on February 28, July 11, and Decem- Executive Officer, First Federal Savings ber 12, 2003. and Loan Association, Port Angeles, Washington Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

236 90th Annual Report, 2003 Federal Reserve Banks and Branches December 31,2003 Officers Chairman1 President Vice President BANK or Branch Deputy Chairman First Vice President in charge of Branch BOSTON2 James J. Norton Cathy E. Minehan Samuel 0. Thier Paul M. Connolly NEW YORK2 Peter G. Peterson Timothy F. Geithner John E. Sexton Jamie B. Stewart, Jr. Buffalo Marguerite D. Barbara L. Walter3 Hambleton PHILADELPHIA Glenn A. Schaeffer Anthony M. Santomero Ronald J. Naples William H. Stone, Jr. CLEVELAND2 Robert W. Mahoney Sandra Pianalto Charles E. Bunch Robert Christy Moore Cincinnati Dennis C. Cuneo Barbara B. Henshaw Pittsburgh Roy W. Haley Robert B. Schaub RICHMOND2 Wesley S. Williams, Jr. J. Alfred Broaddus, Jr. Thomas J. Walter A. Varvel Mackell, Jr. Baltimore Owen E. Herrnstadt William J. Tignanelli3 Charlotte Michael A. Almond Jeffreys. Kane3 ATLANTA Paula Lovell Jack Guynn James M. McKee3 David M. Ratcliffe Patrick K. Barron Birmingham W. Miller Welborn Lee C. Jones Jacksonville William E. Flaherty Christopher L. Oakley Miami Brian E. Keeley James T. Curry III Nashville Whitney Johns Martin MelvynK. Purcell3 New Orleans Dave Dennis 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 Vick M. Crawley Robert A. Hopkins Louisville Norman E. Pfau, Jr. Thomas A. Boone Memphis Gregory M. Duckett Martha Perine Beard MINNEAPOLIS Ronald N. Zwieg Gary H. Stern Linda Hall Whitman James M. Lyon Helena ... .... Thomas O. Markle Samuel H. Gane Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 237 Officers—Continued Chairman1 President Vice President BANK or Branch Deputy Chairman First Vice President in charge of Branch KANSAS CITY .... Richard H. Bard Thomas M. Hoenig Robert A. Funk Richard K. Rasdall Denver Robert M. Murphy Pamela L. Weinstein Oklahoma City Patricia B. Fennell Dwayne E. Boggs Omaha A. F. Raimondo Steven D. Evans DALLAS Ray L. Hunt Robert D. McTeer, Jr. Patricia M. Helen E. Holcomb Patterson El Paso Gail S. Darling Robert W. Gilmer4 Houston Lupe Fraga Robert Smith IIP San Antonio Ron R. Harris James L.Stull3 SAN FRANCISCO. George M. Scalise Robert T. Parry Sheila D. Harris John F. Moore Los Angeles William D. Jones MarkL. Mullinix5 Portland Karla S. Chambers Richardson B. Hornsby Salt Lake City H. Roger Boyer Andrea P. Wolcott Seattle Mic R. Dinsmore Mark Gould NOTE. A current list of these officers appears each Charleston, West Virginia; Columbia, South Carolina; quarter in the Federal Reserve Bulletin. Indianapolis, Indiana; Milwaukee, Wisconsin; Des 1. The Chairman of a Federal Reserve Bank serves, by Moines, Iowa; and Peoria, Illinois. statute, as Federal Reserve agent. 3. Senior Vice President 2. Additional offices of these Banks are located at 4. Acting Vice President Windsor Locks, Connecticut; Utica at Oriskany, New 5. Executive Vice President York; East Rutherford, New Jersey; Columbus, Ohio; Conference of Chairmen Conference of Presidents The chairmen of the Federal Reserve Banks The presidents of the Federal Reserve are organized into the Conference of Chair- Banks are organized into the Conference men, which meets to consider matters of of Presidents, which meets periodically to common interest and to consult with and consider matters of common interest and advise the Board of Governors. The deputy to consult with and advise the Board of chairmen of the Federal Reserve Banks also Governors. attend these meetings. Conference meetings Michael H. Moskow, President of the were held in Washington on May 28 and 29, Federal Reserve Bank of Chicago, served and on December 3 and 4, 2003. as chair of the conference in 2003, and The members of the executive com- Cathy E. Minehan, President of the Federal mittee of the Conference of Chairmen dur- Reserve Bank of Boston, served as its vice ing 2003 were Robert J. Darnall, chair; chair. Valerie J. Van Meter, of the Federal Wesley S. Williams, Jr., vice chair; and Reserve Bank of Chicago, served as its sec- Ronald N. Zwieg, member. retary, and Michael P. Malone, of the Federal On December 4, 2003, the conference Reserve Bank of Boston, served as its assiselected its executive committee for 2004, tant secretary. naming Wesley S. Williams, Jr., as chair; George M. Scalise as vice chair; and Walter L. Metcalfe, Jr., as the third member. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

238 90th Annual Report, 2003 Conference of First not exclusive, consideration to the interests Vice Presidents of agriculture, commerce, industry, services, 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 member banks of each Federal as chair of the conference in 2003, and Reserve District are classified into three Walter A. Varvel, First Vice President of the groups. Each group, which comprises banks Federal Reserve Bank of Richmond, served with similar capitalization, elects one as its vice chair. David K. Park, of the Fed- Class A director and one Class B director. eral Reserve Bank of Boston, served as its Annually, the Board of Governors designates secretary, and Janice E. Clatterbuck, of the one of the Class C directors as chair of the Federal Reserve Bank of Richmond, served board of each District Bank, and it desigas its assistant secretary. nates another Class C director as deputy On September 29, 2003, the conference chair. elected Walter A. Varvel as its chair for Federal Reserve Branches have either five 2004-05, and Helen E. Holcomb, First Vice or seven directors, a majority of whom are President of the Federal Reserve Bank of appointed by the parent Federal Reserve Dallas, as its vice chair. Bank; the others are appointed by the Board of Governors. One of the directors appointed by the Board is designated annually as chair Directors of the board of that Branch in a manner Each Federal Reserve Bank has a nine- prescribed by the parent Federal Reserve member board: three Class A and three Bank. For the name of the chair and deputy Class B directors, who are elected by the chair of the board of directors of each stockholding member banks, and three Reserve Bank and of the chair of each Class C directors, who are appointed by the Branch, see the preceding table, "Officers Board of Governors of the Federal Reserve of Federal Reserve Banks and Branches." System. A list of the directors of Federal Reserve Class A directors represent the stockhold- Banks and Branches follows. For each direcing member banks in each Federal Reserve tor, the class of directorship, the director's District. Class B and Class C directors repre- principal organizational affiliation, and the sent the public and are chosen with due, but date the director's term expires is shown. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 239 Directors BANK or BRANCH, Category Title Term expires Name Dec. 31 DISTRICT 1—BOSTON RESERVE BANK Class A Richard C. White Chairman, President, and Chief Executive Officer, 2003 Community National Bank, Derby, Vermont Chairman, President, and Chief Executive Officer, 2004 Lawrence K. Fish Citizens Financial Group, Inc., Providence, Rhode Island President and Chief Executive Officer, 2005 David S. Outhouse First and Ocean National Bank, Newburyport, Massachusetts Class B Sherwin Greenblatt Past President, Bose Corporation, Bolton, Massachusetts 2003 Robert K. Kraft Chairman and Chief Executive Officer, 2004 The Kraft Group, Foxborough, Massachusetts Orit Gadiesh Chairman, Bain & Company, Inc., 2005 Boston, Massachusetts Class C James J. Norton Vice President, AFL-CIO, Washington, D.C. 2003 Samuel 0. Thier Professor of Medicine and Professor of Health Care 2004 Policy—Harvard Medical School, Massachusetts General Hospital, Boston, Massachusetts Blenda J. Wilson President and Chief Executive Officer, Nellie Mae 2005 Education Foundation, Quincy, Massachusetts DISTRICT 2—NEW YORK RESERVE BANK Class A Sanford I. Weill Chairman, Citigroup Inc., New York, New York 2003 Jill M. Considine Chairman and Chief Executive Officer, The Depository 2004 Trust Company, New York, New York Charles V. Wait President, Chief Executive Officer, and Chairman, 2005 The Adirondack Trust Company, Saratoga Springs, New York Class B Jerry I. Speyer President and Chief Executive Officer, Tishman 2003 Speyer Properties, New York, New York Ronay Menschel Chairman, Phipps Houses, New York, New York 2004 Marta Tienda Professor of Sociology and Public Affairs, Princeton 2005 University, Princeton, New Jersey Class C John E. Sexton President, New York University, New York, New York 2003 Peter G. Peterson Chairman, The Blackstone Group, New York, New York 2004 Loretta E. Lynch Partner, Hogan & Hartson LLP, New York, New York 2005 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

240 90th Annual Report, 2003 Directors—Continued BANK or BRANCH, Category Title Term expires Name Dec. 31 BUFFALO BRANCH Appointed by the Federal Reserve Bank Peter G. Humphrey Chairman, 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 President and Chief Operating Officer, Manufacturers 2004 and Traders Trust Company, Buffalo, New York Geraldine C. Ochocinska ... Regional Director, Region 9, UAW, Buffalo, New York 2005 Appointed by the Board of Governors {Catherine E. Keough President, St. John Fisher College, Rochester, New York 2003 Marguerite D. Hambleton .. President and Chief Executive Officer, AAA Western 2004 and Central New York, Buffalo, New York Brian J. Lipke Chairman and Chief Executive Officer, Gibraltar, 2005 Buffalo, New York DISTRICT 3—PHILADELPHIA RESERVE BANK Class A Robert J. Vanderslice President and Chief Operating Officer, Pennsville 2003 National Bank, Pennsville, New Jersey Walter E. Daller, Jr Chairman, President, and Chief Executive Officer, 2004 Harleysville National Corporation, Harleysville, Pennsylvania Kenneth R. Shoemaker President and Chief Executive Officer, Orrstown Bank, 2005 Shippensburg, Pennsylvania Class B Garry L. Maddox Chief Executive Officer, A. Pomerantz & Company, 2003 Philadelphia, Pennsylvania P. Coleman Townsend, Jr. .. Chairman and Chief Executive Officer, Townsends, Inc., 2004 Wilmington, Delaware Robert E. Chappell Chairman and Chief Executive Officer, Penn Mutual 2005 Life Insurance Co., Horsham, Pennsylvania Class C Glenn A. Schaeffer President Emeritus, Pennsylvania Building and 2003 Construction Trades Council, Harrisburg, Pennsylvania Doris M. Damm President and Chief Executive Officer, ACCU Staffing 2004 Services, Cherry Hill, New Jersey Ronald J. Naples Chairman and Chief Executive Officer, Quaker 2005 Chemical Corporation, Conshohocken, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 241 BANK or BRANCH, Category Title Term expires Name Dec. 31 DISTRICT 4—CLEVELAND RESERVE BANK Class A 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 Bick Weissenrieder Chairman of the Board and Chief Executive Officer, 2005 Hocking Valley Bank, Athens, Ohio Class B Cheryl L. Krueger , President and Chief Executive Officer, Cheryl&Co., 2003 Westerville, Ohio Wayne R. Embry Former President and Chief Operating Officer, 2004 Cleveland Cavaliers, Cleveland, Ohio Tanny Crane President and Chief Executive Officer, 2005 Crane Plastics Company, LP, Columbus, Ohio Class C Robert W. Mahoney Retired Chairman and Chief Executive Officer, 2003 Diebold, Incorporated, Uniontown, Ohio Charles E. Bunch President and Chief Operating Officer, 2004 PPG Industries, Inc., Pittsburgh, Pennsylvania Phillip R. Cox President and Chief Executive Officer, 2005 Cox Financial Corporation, Cincinnati, Ohio CINCINNATI BRANCH Appointed by the Federal Reserve Bank Charlotte W. Martin President and Chief Executive Officer, 2003 Great Lakes Bankers Bank, Gahanna, Ohio James H. Booth President, Czar Coal Corporation, Lovely, Kentucky 2004 Glenn D. Leveridge President, Bank One, NA, Lexington, Kentucky 2005 V. Daniel Radford Executive Secretary-Treasurer, Cincinnati AFL-CIO 2005 Labor Council, Cincinnati, Ohio Appointed by the Board of Governors Charles Whitehead Retired President, Ashland Inc. Foundation, 2003 Covington, Kentucky Herbert R. Brown Senior Vice President, The Western and Southern Life 2004 Insurance Company, Cincinnati, Ohio Dennis C. Cuneo Senior Vice President, Toyota Motor Manufacturing 2005 North America Inc., Erlanger, Kentucky PITTSBURGH BRANCH Appointed by the Federal Reserve Bank 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

242 90th Annual Report, 2003 Directors—Continued BANK or BRANCH, Category Title Term expires Name Dec. 31 Ronnie L. Bryant President and Chief Operating Officer, 2005 Pittsburgh Regional Alliance, Pittsburgh, Pennsylvania Georgiana N. Riley President and Chief Executive Officer, 2005 TIGG Corporation, Bridgeville, Pennsylvania Appointed by the Board of Governors James I. Mitnick Senior Vice President, Turner Construction Company, 2003 Pittsburgh, Pennsylvania President and Chief Executive Officer, 2004 Robert O. Agbede Advanced Technology Systems, Inc., Pittsburgh, Pennsylvania Chairman and Chief Executive Officer, WESCO 2005 Roy W. Haley International, Inc., Pittsburgh, Pennsylvania DISTRICT 5—RICHMOND RESERVE BANK Class A William W. Duncan, Jr. President and Chief Executive Officer, 2003 St. Michaels Bank, St. Michaels, Maryland Eddie Canterbury President/CEO, Logan Bank & Trust Company, 2004 Logan, West Virginia Barry J. Fitzpatrick Chairman, Chief Executive Officer, and President, 2005 Branch Banking & Trust Co. of Virginia, Falls Church, Virginia Class B James E. Haden President and Chief Executive Officer, 2003 Martha Jefferson Hospital, Charlottesville, Virginia Joe Edens Chairman, Edens & Avant, Columbia, South Carolina 2004 W Henry Harmon President and Chief Executive Officer, Columbia 2005 Natural Resources, LLC, Charleston, West Virginia Class C Wesley S. Williams, Jr. Partner, Covington & Burling, Washington, D.C. 2003 Theresa M. Stone Chief Financial Officer, Jefferson-Pilot Corporation, 2004 and President, Jefferson-Pilot Communications Company, Greensboro, North Carolina Thomas J. Mackell, Jr. President and Chief Operating Officer, 2005 The Kamber Group, Washington, D.C. BALTIMORE BRANCH Appointed by the Federal Reserve Bank 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 243 BANK or BRANCH, Category Term expires Titif Name i me Dec. 31 Dyan Brasington President, Technology Council of Maryland, 2005 Rockville, Maryland Appointed by the Board of Governors William C. Handorf Professor of Finance, School of Business and Public 2003 Management, George Washington University, Washington, D.C. Owen E. Herrnstadt Director, International Department, International 2004 Association of Machinists and Aerospace Workers, AFL-CIO, Upper Marlboro, Maryland Cynthia Collins Allner Principal, Miles & Stockbridge, PC, 2005 Baltimore, Maryland CHARLOTTE BRANCH Appointed by the Federal Reserve Bank 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 Lucy J. Reuben Provost and Vice Chancellor for Academic Affairs, 2005 North Carolina Central University, Durham, North Carolina Appointed by the Board of Governors Jim Lowry Dealer Operator, Crown Automotive, 2003 High Point, North Carolina James F. Goodmon President and Chief Executive Officer, 2004 Capitol Broadcasting Company, Inc., Raleigh, North Carolina Michael A. Almond President and Chief Executive Officer, 2005 Charlotte Regional Partnership, Charlotte, North Carolina DISTRICT 6—ATLANTA RESERVE BANK Class A 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 Richard G. Hickson Chairman and Chief Executive Officer, 2005 Trustmark Corporation, Jackson, Mississippi Class B John Dane III President and Chief Executive Officer, 2003 Trinity Yachts LLC, New Orleans, Louisiana Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

244 90th Annual Report, 2003 Directors—Continued BANK or BRANCH, Category Titip Term expires Name Dec. 31 Suzanne E. Boas President, Consumer Credit Counseling Service of 2004 Greater Atlanta, Inc., Atlanta, Georgia Egbert L. J. Perry Chairman and Chief Executive Officer, 2005 The Integral Group, LLC, Atlanta, Georgia Class C PaulaLovell President, Lovell Communications, Inc., 2003 Nashville, Tennessee David M. Ratcliffe President and Chief Executive Officer, 2004 Georgia Power Company, Atlanta, Georgia V. Larkin Martin Managing Partner, Martin Farm, Courtland, Alabama 2005 BIRMINGHAM BRANCH Appointed by the Federal Reserve Bank Hundley Batts, Sr. Owner and Managing General Agent, 2003 Hundley Batts & Associates, Huntsville, Alabama James A. Vickery International Representative, Laborers' International 2003 Union of North America, Rainbow City, Alabama John B. Barnett III Chairman, The Monroe County Bank, 2004 Monroeville, Alabama John H. Holcomb III Chairman and Chief Executive Officer, 2005 Alabama National Bancorporation, Birmingham, Alabama Appointed by the Board of Governors W. Miller Welborn President, Welborn and Associates, Inc., 2003 Lookout Mountain, Tennessee Catherine Sloss Crenshaw .. President, Sloss Real Estate Group, Inc., 2004 Birmingham, Alabama James H. Sanford Chairman of the Board, HOME Place Farms, Inc., 2005 Prattville, Alabama JACKSONVILLE BRANCH Appointed by the Federal Reserve Bank 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 Jerry M. Smith Chairman and President, First National Bank of 2005 Alachua, Alachua, Florida Appointed by the Board of Governors William E. Flaherty Retired Chairman, Blue Cross and Blue Shield of 2003 Florida, Inc., Jacksonville, Florida Julie K. Hilton Vice President and Co-Owner, Paradise Found 2004 Resorts & Hotels, Panama City Beach, Florida Fassil Gabremariam President and Founder, U.S.-Africa Free Enterprise 2005 Education Foundation, Tampa, Florida Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 245 BANK or BRANCH, Category Title Term expires Name Dec. 31 MIAMI BRANCH Appointed by the Federal Reserve Bank Miriam Lopez President and Chief Executive Officer, 2003 TransAtlantic Bank, Miami, Florida Rudy E. Schupp President and Chief Executive Officer, 2004 First United Bank, North Palm Beach, Florida Francis V. Gudorf President and Executive Director, Jubilee Community 2005 Development Corporation, Miami, Florida Joseph C. Schwartzel President, Meridian Broadcasting, Inc., 2005 Fort Myers, Florida Appointed by the Board of Governors 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 Edwin A. Jones, Jr President, Angus Investments, Inc., Belle Glade, Florida 2005 NASHVILLE BRANCH Appointed by the Federal Reserve Bank James W. Spradley, Jr President, Standard Candy Company, Inc., 2003 Nashville, Tennessee Vacancy 2003 Sam 0. Franklin III Chairman, SunTrust Bank, Nashville, 2004 Nashville, Tennessee Michael B. Swain President and Chief Executive Officer, 2005 First National Bank, Oneida, Tennessee Appointed by the Board of Governors 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 Beth Dortch Franklin President and Chief Executive Officer, 2005 Star Transportation, Inc., Nashville, Tennessee NEW ORLEANS BRANCH Appointed by the Federal Reserve Bank Teri G. Fontenot President and Chief Executive Officer, 2003 Woman's Hospital, Baton Rouge, Louisiana David Guidry President and Chief Executive Officer, 2003 Guico Machine Works, Inc., Harvey, Louisiana David E. Johnson Chairman and Chief Executive Officer, 2004 The First Bancshares, Inc., and the First National Bank of South Mississippi, Hattiesburg, Mississippi C. R. Cloutier President and Chief Executive Officer, 2005 MidSouth Bank, Lafayette, Louisiana Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

246 90th Annual Report, 2003 Directors—Continued BANK or BRANCH, Category Term expires Name 1111C Dec. 31 Appointed by the Board of Governors Ben Tom Roberts Senior Executive Vice President, 2003 Roberts Brothers, Inc., Realtors, Mobile, Alabama Dave Dennis President, Specialty Contractors & Assoc, Inc., 2004 Gulfport, Mississippi Earl L. Shipp Vice President and Site Director, 2005 The Dow Chemical Company, Louisiana Operations, Plaquemine, Louisiana DISTRICT 7—CHICAGO RESERVE BANK Class A 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 William A. Osborn Chairman and Chief Executive Officer, 2005 Northern Trust Corporation and The Northern Trust Company, Chicago, Illinois Class B JackB. Evans President, The Hall-Perrine Foundation, 2003 Cedar Rapids, Iowa James H. Keyes Chairman of the Board and Chief Executive Officer, 2004 Johnson Controls, Inc., Milwaukee, Wisconsin Connie E. Evans President and Chief Executive Officer, 2005 WSEP Ventures, Chicago, Illinois Class C W. James Farrell Chairman and Chief Executive Officer, 2003 Illinois Tool Works Inc., Glenview, Illinois Miles D. White Chairman and Chief Executive Officer, 2004 Abbott Laboratories, Abbott Park, Illinois Robert J. Darnall Retired Chairman and Chief Executive Officer, 2005 Inland Steel Industries, Inc., Chicago, Illinois DETROIT BRANCH Appointed by the Federal Reserve Bank David J. Wagner Retired Chairman, Fifth Third Bank, 2003 Grand Rapids, Michigan Robert E. Churchill Chairman and Chief Executive Officer, 2004 Citizens National Bank, Cheboygan, Michigan Mark T. Gaffney President, Michigan AFL-CIO, Lansing, Michigan 2005 Tommi A. White Chief Operating Officer, Compuware Corporation, 2005 Detroit, Michigan Appointed by the Board of Governors Timothy D. Leuliette President and Chief Executive Officer, Metaldyne, 2003 Plymouth, Michigan Irvin D. Reid President, Wayne State University, Detroit, Michigan 2004 Edsel B. Ford II Director, Ford Motor Company, Dearborn, Michigan 2005 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 247 BANK or BRANCH, Category Titip Term expires Name 1 lllC Dec. 31 DISTRICT 8—ST. LOUIS RESERVE BANK Class A Bradley W. Small President and Chief Executive Officer, The Farmers and 2003 Merchants National Bank, Nashville, Illinois Lewis F. Mallory, Jr Chairman and Chief Executive Officer, 2004 National Bank of Commerce, Starkville, Mississippi Lunsford W. Bridges President and Chief Executive Officer, 2005 Metropolitan National Bank, Little Rock, Arkansas Class B Robert L. Johnson Chairman and Chief Executive Officer, 2003 Johnson Bryce, Inc., Memphis, Tennessee Bert Greenwalt Partner, Greenwalt Company, Hazen, Arkansas 2004 J. Stephen Barger Executive Secretary-Treasurer, Kentucky State District 2005 Council of Carpenters, Frankfort, Kentucky Class C 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 Gayle P. W. Jackson Managing Director, FondElec Clean Energy Group, Inc., 2005 St. Louis, Missouri LITTLE ROCK BRANCH Appointed by the Federal Reserve Bank Raymond E. Skelton Regional President, U.S. Bank, 2003 North Little Rock, Arkansas Lawrence A. Davis, Jr Chancellor, University of Arkansas at Pine Bluff, 2004 Pine Bluff, Arkansas Everett Tucker III Chairman, Moses Tucker Real Estate, Inc., 2005 Little Rock, Arkansas David R. Estes President and Chief Executive Officer, First State Bank, 2005 Lonoke, Arkansas Appointed by the Board of Governors Scott T. Ford President and Chief Executive Officer, 2003 ALLTEL Corporation, Little Rock, Arkansas Vick M. Crawley Retired Plant Manager, Baxter Healthcare Corporation, 2004 Mountain Home, Arkansas A. Rogers Yarnell II President, Yarnell Ice Cream Co., Inc., Searcy, Arkansas 2005 LOUISVILLE BRANCH Appointed by the Federal Reserve Bank 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

248 90th Annual Report, 2003 Directors—Continued BANK or BRANCH, Category Term expires Title Name Dec. 31 David H. Brooks Chairman and Chief Executive Officer, 2004 Stock Yards Bank & Trust Company, Louisville, Kentucky Thomas W. Smith President, Thomas W. Smith & Associates, Inc., 2005 Danville, Kentucky Marjorie Soyugenc Executive Director and Chief Executive Officer, 2005 Welborn Foundation, Evansville, Indiana Appointed by the Board of Governors Norman E. Pfau, Jr President and Chief Executive Officer, Geo. Pfau's Sons 2003 Company, Inc., Jeffersonville, Indiana Cornelius A. Martin President and Chief Executive Officer, Martin 2004 Management Group, Bowling Green, Kentucky Maria Gerwing Hampton ... President, The Housing Partnership, Inc., 2005 Louisville, Kentucky MEMPHIS BRANCH Appointed by the Federal Reserve Bank 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 James A. England Chairman, President, and Chief Executive Officer, 2005 Decatur County Bank, Decaturville, Tennessee Tom A. Wright Chairman and Chief Executive Officer, 2005 Enterprise National Bank, Memphis, Tennessee Appointed by the Board of Governors 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 Meredith Baird Allen Vice President, Marketing, Staple Cotton Cooperative 2005 Association, Greenwood, Mississippi DISTRICT 9—MINNEAPOLIS RESERVE BANK Class A Dan M. Fisher Chief Information Officer, Community First Bankshares, 2003 Inc., Fargo, North Dakota Kay Clevidence President, Farmers State Bank, Victor, Montana 2004 Robert Dickson Chief Executive Officer, The First National Bank 2005 of Fairfax, Fairfax, Minnesota Class B 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 249 BANK or BRANCH, Category Term expires Titip Name i me Dec. 31 Randy Peterson General Manager, Precision Edge Surgical Products 2005 LLC, Sault Ste. Marie, Michigan Class C Ronald N. Zwieg President, United Food & Commercial Workers, 2003 Local 653, Plymouth, Minnesota Frank L. Sims Corporate Vice President, Transportation, 2004 Cargill, Inc./Lake Office, Wayzata, Minnesota Linda Hall Whitman .. Chief Executive Officer, MinuteClinic, 2005 Minneapolis, Minnesota HELENA BRANCH Appointed by the Federal Reserve Bank Richard E. Hart President, Senior Lender, and Director, 2003 Mountain West Bank, Kalispell, Montana Joy N. Ott Regional President and Chief Executive Officer, 2004 Wells Fargo Bank Montana, N.A., Billings, Montana Marilyn F. Wessel Former Dean and Director, Museum of the Rockies, 2004 Bozeman, Montana Appointed by the Board of Governors Tom Markle President and Chief Executive Officer, Markle's Inc., 2003 Glasgow, Montana Dean Folkvord President and Chief Executive Officer, 2004 Wheat Montana Farms and Bakery, Three Forks, Montana DISTRICT 10—KANSAS CITY RESERVE BANK Class A Bruce A. Schriefer President, Bankers' Bank of Kansas, N.A., 2003 Wichita, Kansas Jeffrey L. Gerhart President and Chief Executive Officer, 2004 First National Bank of Newman Grove, Newman Grove, Nebraska Rick L. Smalley Chief Executive Officer, Dickinson Financial 2005 Corporation, Kansas City, Missouri Class B Hans C. Helmerich President and Chief Executive Officer, 2003 Helmerich & Payne, Inc., Tulsa, Oklahoma Frank Moore President, Spearhead Ranch Company, 2004 Douglas, Wyoming Dan L. Dillingham Chief Executive Officer, Dillingham Insurance, 2005 Enid, Oklahoma Class C Robert A. Funk Chairman of the Board and Chief Executive Officer, 2003 Express Personnel Services International, Oklahoma City, Oklahoma Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

250 90th Annual Report, 2003 Directors—Continued BANK or BRANCH, Category Term expires Tit1<a Name line Dec. 31 Richard H. Bard Chairman and Chief Executive Officer, 2004 International Surface Preparation Corporation, Golden, Colorado Rhonda Holman Interim Director, Entrepreneurial Growth Resource 2005 Center, University of Missouri-Kansas City, Kansas City, Missouri DENVER BRANCH Appointed by the Federal Reserve Bank 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 Virginia K. Berkeley President, Colorado Business Bank N.A., 2005 Denver, Colorado Appointed by the Board of Governors Robert M. Murphy President, Sandia Properties Ltd., Co., 2003 Albuquerque, New Mexico James A. King Chief Executive Officer, BT, Inc., Riverton, Wyoming 2004 Kathleen Avila Managing Member, Avila Retail Development & 2005 Management, Albuquerque, New Mexico OKLAHOMA CITY BRANCH Appointed by the Federal Reserve Bank Richard K. Ratcliffe Chairman, Ratcliffe's Inc., Weatherford, 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 Tyree 0. Minner Plant Manager, General Motors, 2005 Oklahoma City, Oklahoma Appointed by the Board of Governors Patricia B. Fennell Executive Director, Latino Community Development 2003 Agency, Oklahoma City, Oklahoma Vacancy 2004 Clifford Hudson Chairman and Chief Executive Officer, Sonic Corp., 2005 Oklahoma City, Oklahoma OMAHA BRANCH Appointed by the Federal Reserve Bank Frank L. Hayes President, Hayes & Associates, LLC, CPAs, 2003 Omaha, Nebraska H. H. Kosman Chairman, President, and Chief Executive Officer, 2003 Platte Valley National Bank, Scottsbluff, Nebraska Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 251 BANK or BRANCH, Category Titlf Term expires Name 1111C Dec. 31 Cynthia Hardin Milligan ... Dean, College of Business Administration, University of Nebraska-Lincoln, 2004 Lincoln, Nebraska Judith A. Owen President and Chief Executive Officer, 2005 Wells Fargo Bank Nebraska, N.A., Omaha, Nebraska Appointed by the Board of Governors A. F. Raimondo Chairman and Chief Executive Officer, 2003 Behlen Mfg. Co., Columbus, Nebraska Vacancy 2004 James A. Timmerman Chief Financial Officer and Secretary/Treasurer, 2005 Timmerman & Sons Feeding Co., Springfield, Nebraska DISTRICT 11—DALLAS RESERVE BANK Class A Matthew T. Doyle Vice Chairman and Chief Executive Officer, 2003 Texas First Bank, Texas City, Texas David S. Barnard Chairman and Chief Executive Officer, 2004 National Bank, Gatesville, Texas Richard W. Evans, Jr. Chairman and Chief Executive Officer, 2005 Cullen/Frost Bankers, Inc., San Antonio, Texas Class B Judy Ley Allen Owner, Allen Investments, Houston, Texas 2003 Julie Spicer England Vice President, Texas Instruments, Dallas, Texas 2004 Malcolm Gillis President, Rice University, Houston, Texas 2005 Class C Vacancy 2003 Ray L. Hunt Chairman, President, and Chief Executive Officer, 2004 Hunt Consolidated, Inc., Dallas, Texas Patricia M. Patterson President, Patterson Investments, Inc., Dallas, Texas 2005 EL PASO BRANCH Appointed by the Federal Reserve Bank Gerald J. Rubin President and Chief Executive Officer, 2003 Helen of Troy Limited, El Paso, Texas F. James Volk Regional President, State National Bank, El Paso, Texas 2004 Pete Cook Chief Executive Officer, First National Bank 2005 of Alamogordo, Alamogordo, New Mexico Fred Loya Chairman, Fred Loya Insurance, El Paso, Texas 2005 Appointed by the Board of Governors Gail Darling President, Gail Darling Staffing, El Paso, Texas 2003 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

252 90th Annual Report, 2003 Directors—Continued BANK or BRANCH, Category Titip Term expires Name i me Dec. 31 Cecilia 0. Levine President, MFI International Mfg., LLC, El Paso, Texas 2004 Ron C. Helm Owner, Helm Cattle and Land Company, 2005 Van Horn, Texas HOUSTON BRANCH Appointed by the Federal Reserve Bank Alan R. Buckwalter III Retired Chairman and Chief Executive Officer, 2003 Chase Bank of Texas, Houston, Texas Richard W. Weekley Chairman, Weekley Development Company, 2004 Houston, Texas Priscilla D. Slade President, Texas Southern University, Houston, Texas 2005 S. Reed Morian Chairman and President, DX Service Company, Inc., 2005 Houston, Texas Appointed by the Board of Governors Anthony R. Chase Chairman and Chief Executive Officer, 2003 ChaseCom, LP, Houston, Texas James T. Hackett President and Chief Executive Officer, 2004 Anadarko Petroleum Corporation, Houston, Texas Lupe Fraga President and Chief Executive Officer, 2005 Tejas Office Products, Inc., Houston, Texas SAN ANTONIO BRANCH Appointed by the Federal Reserve Bank Arthur R. Emerson Chairman and Chief Executive Officer, 2003 Groves Rojas Emerson, San Antonio, Texas R. Tom Roddy Chairman, Lone Star Capital Bank, N.A., 2004 San Antonio, Texas Matt F. Gorges Chairman and Chief Executive Officer, 2005 Valley International Cold Storage, Harlingen, Texas Daniel B. Hastings, Jr. President and Owner, Daniel B. Hastings, Inc., 2005 Laredo, Texas Appointed by the Board of Governors Marvin L. Ragsdale President, Iron Workers District Council of the State 2003 of Texas, Georgetown, Texas Ron R. Harris General Partner, Southwest Capital Partners, 2004 Austin, Texas Elizabeth Chu Richter Chairman and Chief Executive Officer, 2005 Richter Architects, Corpus Christi, Texas DISTRICT 12—SAN FRANCISCO RESERVE BANK Class A Richard C. Hartnack Vice Chairman, Union Bank of California, N.A., 2003 Los Angeles, California Richard W. Decker, Jr Chairman and Co-Founder, Belvedere Capital 2004 Partners LLC, San Francisco, California Candace H. Wiest President, Inland Empire National Bank, 2005 Riverside, California Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 253 BANK or BRANCH, Category Title Term expires Name Dec. 31 Class B Barbara L. Wilson Consultant and Regional Vice President (Retired), 2003 Qwest Corporation, Boise, Idaho Jack McNally Principal, JKM Consulting, Sacramento, California 2004 David K. Y. Tang Partner, Preston Gates & Ellis LLP, Seattle, Washington 2005 Class C Jay T. Harris Wallis Annenberg Chair in Journalism and 2003 Communication, Annenberg School for Communication, University of Southern California, Los Angeles, California Sheila D. Harris Director, Arizona Department of Housing, 2004 Phoenix, Arizona George M. Scalise President, Semiconductor Industry Association, 2005 San Jose, California Los ANGELES BRANCH Appointed by the Federal Reserve Bank 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 Peter M. Thomas Managing Partner, Thomas & Mack Co., 2005 Las Vegas, Nevada Appointed by the Board of Governors 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 Diane Donoghue Executive Director, Esperanza Community Housing 2005 Corporation, Los Angeles, California PORTLAND BRANCH Appointed by the Federal Reserve Bank Vacancy 2003 George J. Passadore Chairman, Oregon Wells Fargo Bank, Portland, Oregon 2004 Judi Johansen President and Chief Executive Officer, PacifiCorp, 2005 Portland, Oregon William D. Thorndike, Jr. .. President, Medford Fabrication, Medford, Oregon 2005 Appointed by the Board of Governors Patrick Borunda Principal, The Navigator Group, Vancouver, Washington 2003 Karla S. Chambers Vice President and Co-Owner, Stahlbush Island Farms, 2004 Inc., Corvallis, Oregon Peter 0. Kohler President, Oregon Health & Science University, 2005 Portland, Oregon Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

254 90th Annual Report, 2003 Directors—Continued BANK or BRANCH, Category Term expires Titip Name Dec. 31 SALT LAKE CITY BRANCH Appointed by the Federal Reserve Bank Vacancy 2003 Curtis H. Harris Chairman, President, and Chief Executive Officer, 2004 Barnes Banking Company, Kaysville, Utah A. Scott Anderson President and Chief Executive Officer, 2005 Zions First National Bank, Salt Lake City, Utah Deborah Bayle Nielsen President and Chief Executive Officer, 2005 United Way of Salt Lake, Salt Lake City, Utah Appointed by the Board of Governors William C. Glynn President, Intermountain Industries, Inc., Boise, Idaho 2003 Gary L. Crocker President, Crocker Ventures, Inc., 2004 Salt Lake City, Utah H. Roger Boyer Chairman, The Boyer Company, Salt Lake City, Utah 2005 SEATTLE BRANCH Appointed by the Federal Reserve Bank Betsy Lawer Vice Chair and Chief Operating Officer, 2003 First National Bank Alaska, Anchorage, Alaska Peter H. van Oppen Chairman and Chief Executive Officer, Advanced 2004 Digital Information Corp., Redmond, Washington Mary E. Pugh President, Pugh Capital Management, Inc., 2005 Seattle, Washington Kenneth M. Kirkpatrick President, Washington Commercial Banking, 2005 U.S. Bank, Seattle, Washington Appointed by the Board of Governors David W. Wyckoff Chairman and Chief Executive Officer, 2003 Wyckoff Farms, Inc., Grand view, Washington Mic R. Dinsmore Chief Executive Officer, Port of Seattle, 2004 Seattle, Washington James R. Gill President, Pacific Northwest Title Holding Co., 2005 Seattle, Washington Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2003 255 Members of the Board of Governors, 1913—2003 Appointed Members Federal Reserve Date initially took Name District oath of office Other dates' Charles S. Hamlin Boston Aug. 10, 1914 Reappointed in 1916 and 1926. Served until Feb. 3, 1936.2 Paul M. Warburg New York Aug. 10, 1914 Term expired Aug. 9, 1918. Frederic A. Delano Chicago Aug. 10, 1914 Resigned July 21, 1918. W.P.G. Harding Atlanta Aug. 10, 1914 Term expired Aug. 9, 1922. Adolph C. Miller San Francisco Aug. 10, 1914 Reappointed in 1924. Reappointed in 1934 from the Richmond District. Served until Feb. 3, 1936.2 Albert Strauss New York Oct. 26, 1918 Resigned Mar. 15, 1920. Henry A. Moehlenpah Chicago Nov. 10, 1919 Term expired Aug. 9, 1920. Edmund Platt New York June 8, 1920 Reappointed in 1928. Resigned Sept. 14, 1930. David C. Wills Cleveland Sept. 29, 1920 Term expired Mar. 4, 1921. John R. Mitchell Minneapolis May 12, 1921 Resigned May 12, 1923. Milo D. Campbell Chicago Mar. 14, 1923 Died Mar. 22, 1923. Daniel R. Crissinger Cleveland May 1, 1923 Resigned Sept. 15, 1927. George R. James St. Louis May 14, 1923 Reappointed in 1931. Served until Feb. 3, 1936.3 Edward H. Cunningham Chicago May 14, 1923 Died Nov. 28, 1930. Roy A. Young Minneapolis Oct. 4, 1927 Resigned Aug. 31, 1930. Eugene Meyer New York Sept. 16, 1930 Resigned May 10, 1933. Wayland W. Magee Kansas City May 18, 1931 Term expired Jan. 24, 1933. Eugene R. Black Atlanta May 19, 1933 Resigned Aug. 15, 1934. M.S. Szymczak Chicago June 14, 1933 Reappointed in 1936 and 1948. Resigned May 31, 1961. J.J. Thomas Kansas City June 14, 1933 Served until Feb. 10, 1936.2 Marriner S. Eccies 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

256 90th Annual Report, 2003 Appointed Members—Continued Name Federal Reserve Date initially took Other datesx 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 Reappointed in 2003. 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, 1913-2003 257 Appointed Members—Continued Name Term Chairmen 3 Charles S. Hamlin Aug. 10, 1914-Aug. 9, 1916 W.P.G. Harding Aug. 10, 1916-Aug. 9, 1922 Daniel R. Crissinger May 1, 1923-Sept. 15, 1927 Roy A. Young Oct. 4, 1927-Aug. 31, 1930 Eugene Meyer Sept. 16, 1930-May 10, 1933 Eugene R. Black May 19, 1933-Aug. 15, 1934 Marriner S. Eccles Nov. 15, 1934-Jan. 31, 19484 Thomas B. McCabe Apr. 15, 1948-Mar. 31, 1951 Wm. McC. Martin, Jr. Apr. 2, 1951-Jan. 31, 1970 Arthur F. Burns Feb. 1, 1970-Jan. 31, 1978 G. William Miller Mar. 8, 1978-Aug. 6, 1979 Paul A. Volcker Aug. 6, 1979-Aug. 11, 1987 Alan Greenspan Aug. 11, 1987-5 Vice Chairmen2" 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 JJ. 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

258 90th Annual Report, 2003 Ex-Offido 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.2O, 1932 J.F.T. O'Connor Mayll, 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

260 90th Annual Report, 2003 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2003 and 2002 Millions of dollars Total Boston Item 2003 2002 2003 2002 ASSETS Gold certificate account 11,039 11,039 495 533 Special drawing rights certificate account 2,200 2,200 115 115 Coin 722 23 45 Loans To depository institutions 62 40 0 0 Other 0 0 0 0 Securities purchased under agreements to resell (triparty) 43,750 39,500 Federal agency obligations Bought outright 0 10 0 1 Held under repurchase agreements 0 0 0 0 U.S. Treasury securities Bought outrightl 666,665 629,406 32,230 36,062 Held under repurchase agreements 0 0 0 0 Total loans and securities 710,477 668,956 32,230 36,062 Items in process of collection 9,236 11,498 531 1,002 Bank premises 1,630 1,542 93 91 Other assets Denominated in foreign currencies2 19,868 16,913 1,034 964 Other3 18,722 20,112 762 973 Interdistrict settlement account 0 0 3,079 -6,558 Total assets 773,894 733,249 38,363 33,227 LIABILITIES Federal Reserve notes outstanding (issued to Bank) . 799,933 759,256 38,627 32,969 Less: Notes held by Federal Reserve Bank 110,176 104,983 4,750 4,065 Federal Reserve notes, net 689,757 654,273 33,877 28,905 Securities sold under agreements to repurchase 25,652 21,091 1,240 1,208 Deposits Depository institutions 23,058 22,541 1,633 1,212 U.S. Treasury, general account 5,723 4,420 0 0 Foreign, official accounts 162 136 2 2 Other4 730 1,156 19 61 Total deposits 29,673 28,254 1,653 1,274 Deferred credit items 9,026 10,666 576 832 Other liabilities and accrued dividends5 2,092 2,205 119 135 Total liabilities 756,200 716,488 37,466 32,355 CAPITAL ACCOUNTS Capital paid in 8,847 8,380 448 436 Surplus 8,847 8,380 448 436 Other capital accounts 0 0 0 0 Total liabilities and capital accounts 773,894 733,249 38,363 33,227 FEDERAL RESERVE NOTE STATEMENT Federal Reserve notes outstanding 799,933 759,256 Less: Held by Bank not subject to collateralization 110,176 101,559 Collateralized Federal Reserve notes 689,757 657,696 Collateral for Federal Reserve notes Gold certificate account 11,039 11,039 Special drawing rights certificate account 2,200 2,200 Other eligible assets 0 0 U.S. Treasury and federal agency securities 676,518 644,458 Total collateral 689,757 657,696 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 261 1.—Continued NewYork Philadelphia Cleveland Richmond 2003 2002 2003 2002 2003 2002 2003 2002 4,706 4,364 380 430 477 522 808 819 874 874 83 83 104 104 147 147 30 33 37 61 33 43 83 144 15 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 43,750 39,500 0 4 0 0 0 1 0 1 0 0 0 0 0 0 0 0 285,221 247,647 20,843 24,202 31,238 34,727 51,269 49,089 0 0 0 0 0 0 0 0 328,986 287,151 20,843 24,203 31,238 34,728 51,269 49,090 803 992 493 494 595 764 714 917 189 185 53 50 151 153 146 129 4,289 3,465 552 510 1,665 1.531 4,915 4,048 9,264 9,292 588 743 793 989 1,384 1,515 -19,034 24,567 905 -5,391 -2,103 -5,818 2,793 -3,052 330,106 330,923 23,934 21,182 32,954 33,015 62,258 53,757 325,387 329,740 29,636 25,517 33,115 32,587 59,949 54,372 23,793 24,922 8,288 6,893 4,740 4,417 9,855 9,023 301,594 304,818 21,347 18,624 28,375 28,170 50,094 45,349 10,975 8,299 802 811 1,202 1,164 1,973 1,645 5,607 7,571 719 577 1,259 1,393 5,087 1,381 5,723 4,420 0 0 0 0 0 0 139 112 1 1 3 3 7 7 324 330 10 49 26 72 108 191 11,792 12,433 730 626 1,288 1,467 5,203 1,579 1,025 1,069 451 556 521 685 628 808 658 686 87 99 113 125 213 229 326,045 327,305 23,417 20,717 31,500 31,610 58,110 49,610 2,031 1,809 259 233 727 702 2,074 2,073 2,031 1,809 259 233 727 702 2,074 2,073 0 0 0 0 0 0 0 0 330,106 330,923 23,934 21,182 32,954 33,015 62,258 53,757 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

262 90th Annual Report, 2003 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2003 and 2002—Continued Millions of dollars Atlanta Chicago Item 2003 2002 2003 2002 ASSETS Gold certificate account 863 926 982 1,080 Special drawing rights certificate account 166 166 212 212 Coin 82 103 90 126 Loans To depository institutions 5 17 Other 0 0 Securities purchased under agreements to resell (triparty) Federal agency obligations Bought outright 0 1 0 1 Held under repurchase agreements 0 0 0 0 U.S. Treasury securities Bought outright1 45,037 44,816 67,367 74,069 Held under repurchase agreements 0 0 0 0 Total loans and securities 45,043 44,825 67,384 74,076 Items in process of collection 723 748 942 1,169 Bank premises 278 279 125 116 Other assets Denominated in foreign currencies 2 1,127 1,231 2,033 1,827 Other3 1,108 1,258 1,571 1,980 Interdistrict settlement account 4,274 -1,692 -6,831 -14,583 Total assets 53,664 47,844 66,509 66,004 LIABILITIES Federal Reserve notes outstanding (issued to Banks) 66,711 59,126 66,835 63,905 Less: Notes held by Federal Reserve Banks 18,415 16,757 8,141 7,397 Federal Reserve notes, net 48,296 42,368 58,694 56,508 Securities sold under repurchase agreements 1,733 1,502 2,592 2,482 Deposits Depository institutions 1,608 1,735 2,349 3,943 U.S. Treasury, general account 0 0 0 0 Foreign, official accounts 2 2 3 3 Other4 22 133 29 123 Total deposits 1,632 1,870 2,382 4,069 Deferred credit items 855 972 781 997 Other liabilities and accrued dividends5 170 182 211 232 Total liabilities 52,686 46,894 64,660 64,289 CAPITAL ACCOUNTS Capital paid in 489 475 924 858 Surplus 489 475 924 858 Other capital accounts 0 0 0 0 Total liabilities and capital accounts 53,664 47,844 66,509 66,004 NOTE. Components may not sum to totals because of tions, which were accounted for as separate sale and purrounding. chase transactions until they were discontinued in Decem- 1. Includes securities loaned—fully guaranteed by U.S. ber 2002. Treasury securities pledged with Federal Reserve Banks— 2. Valued daily at market exchange rates. and excludes (1) for 2003, securities purchased under 3. The System total includes depository institution overagreements to resell and (2) matched sale-purchase transac- drafts of $3 million for 2003 and 2002. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 263 1.—Continued St. Louis Minneapolis Kansas City Dallas San Francisco 2003 2002 2003 2002 2003 2002 2003 2002 2003 2002 331 346 224 179 303 309 507 485 963 1,046 71 71 30 30 66 66 98 98 234 234 53 59 23 35 42 66 141 163 84 111 0 11 2 7 2 2 0 0 20 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 0 0 0 0 0 0 0 0 0 0 20,974 22,380 14,881 9,839 17,916 18,605 26,126 13,969 53,563 54,001 0 0 0 0 0 0 0 0 0 0 20,974 22,392 14,883 9,846 17,919 18,608 26,126 13,969 53,583 54,006 341 695 426 612 596 870 383 624 2,689 2,608 49 44 125 127 56 50 187 142 179 176 472 343 805 343 476 440 442 378 2,058 1,833 516 624 368 295 439 526 641 434 1,287 1,484 -1,330 -3,554 -166 4,063 25 -2,244 6,997 14,306 11,391 -43 21,477 21,021 16,720 15,530 19,921 18,691 35,522 30,599 72,467 61,456 23,244 22,002 15,491 15,088 21,599 19,979 39,785 36,839 79,553 67,131 3,961 3,088 1,335 1,785 4,083 3,854 7,129 8,424 15,685 14,359 19,283 18,914 14,155 13,304 17,516 16,125 32,657 28,416 63,868 52,772 807 750 573 330 689 623 1,005 468 2,061 1,810 509 480 564 430 813 822 953 727 1,957 2,273 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 3 3 14 34 12 2 48 33 88 24 30 105 524 514 577 433 861 855 1,041 752 1,990 2,381 308 346 650 713 450 598 487 505 2,296 2,584 98 99 74 72 81 88 110 85 157 173 21,020 20,623 16,029 14,851 19,596 18,289 35,301 30,226 70,371 59,719 228 199 346 340 162 201 111 186 1,048 868 228 199 346 340 162 201 111 186 1,048 868 0 0 0 0 0 0 0 0 0 0 21,477 21,021 16,720 15,530 19,921 18,691 35,522 30,599 72,467 61,456 4. Includes international organization deposits of 5. Includes exchange-translation account reflecting the $139 million for 2003 and $100 million for 2002. These monthly revaluation at market exchange rates of foreign deposits are held solely by the Federal Reserve Bank of exchange commitments. New York. . . . Not applicable. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

264 90th Annual Report, 2003 2. Federal Reserve Open Market Transactions, 2003 Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. U.S. TREASURY SECURITIES1 Outright transactions 2 Treasury bills Gross purchases 0 4,161 1,863 3,543 Gross sales 0 0 0 0 Exchanges 71,075 53,860 47,424 51,834 For new bills 71,075 53,860 47,424 51,834 Redemptions 0 0 0 0 Others within 1 year Gross purchases 0 478 1,318 1,422 Gross sales 0 0 0 0 Maturity shifts 6,216 3,214 8,334 8,333 Exchanges -6,834 -13,313 -8,211 -7,293 Redemptions 0 0 0 0 1 to 5 years Gross purchases 0 2,127 710 733 Gross sales 0 0 0 0 Maturity shifts -6,216 2,160 -8,334 -8,333 Exchanges 6,834 11,817 8,211 7,293 5 to 10 years Gross purchases 0 769 522 0 Gross sales 0 0 0 0 Maturity shifts 0 -3,877 0 0 Exchanges 0 1,497 0 0 More than 10 years Gross purchases 0 0 50 0 Gross sales 0 0 0 0 Maturity shifts 0 -1,497 0 0 Exchanges 0 0 0 0 All maturities Gross purchases 0 7,534 4,463 5,699 Gross sales 0 0 0 0 Redemptions 0 0 0 0 Net change in U.S. Treasury securities ... 7,534 4,463 5,699 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 265 2.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 1,684 1,032 808 981 780 880 925 1,494 18,150 0 0 0 0 0 0 0 0 0 76,354 60,706 68,544 56,098 60,835 75,566 56,871 59,719 738,886 76,354 60,706 68,544 56,098 60,835 75,566 56,871 59,719 738,886 0 0 0 0 0 0 0 0 0 786 0 0 0 0 0 2,561 0 6,565 0 0 0 0 0 0 0 0 0 0 14,759 6,662 0 20,174 5,435 0 23,307 96,433 0 -13,699 -4,996 0 -21,901 -6,368 0 -20,538 -103,153 0 0 0 0 0 0 0 0 0 1,057 0 0 0 0 1,447 1,503 237 7,814 0 0 0 0 0 0 0 0 0 0 -9,044 -6,662 0 -16,820 -5,435 0 -17,681 -76,364 0 13,447 4,996 0 19,386 6,368 0 18,905 97,256 234 0 0 0 1,232 280 787 283 4,107 0 0 0 0 0 0 0 0 0 0 -5,463 0 0 2,202 0 0 -3,993 -11,131 0 252 0 0 2,515 0 0 1,634 5,897 0 0 0 0 150 0 0 20 220 0 0 0 0 0 0 0 0 0 0 -252 0 0 -5,556 0 0 -1,634 -8,938 0 0 0 0 0 0 0 0 0 3,761 1,032 808 981 2,162 2,608 5,775 2,034 36,856 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 3,761 1,032 808 981 2,162 2,608 5,775 2,034 36,856 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

266 90th Annual Report, 2003 2. Federal Reserve Open Market Transactions, 2003—Continued Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. FEDERAL AGENCY OBLIGATIONS Outright transactions 2 Gross purchases 0 0 0 0 Gross sales '. 0 0 0 0 Redemptions 0 0 0 0 Net change in federal agency obligations TEMPORARY TRANSACTIONS Repurchase agreements3 Gross purchases 135,749 121,896 95,001 112,251 150,499 119,746 90,151 106,500 Gross sales Reverse repurchase agreements 4 Gross purchases 392,530 343,748 388,069 451,149 Gross sales 389,810 343,395 389,469 452,545 Net change in temporary transactions -12,029 2,502 3,450 4,354 Total net change in System Open Market Account -12,029 10,037 7,914 10,053 NOTE. Sales, redemptions, and negative figures reduce 2. Excludes the effect of temporary transactions— holdings of the System Open Market Account; all other repurchase agreements, matched sale-purchase agreefigures increase such holdings. Components may not sum ments (MSPs), and reverse repurchase agreements to totals because of rounding. (RRPs). 1. Transactions exclude changes in compensation for 3. Cash value of agreements, which are collateralized the effects of inflation on the principal of inflation- by U.S. government and federal agency securities. indexed securities. Transactions include the rollover of 4. Cash value of agreements, which are collateralized inflation compensation into new securities. by U.S. Treasury securities. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 267 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 10 10 -10 -10 124,741 90,500 145,750 156,250 122,500 157,750 122,500 138,000 1,522,888 132,002 88,990 148,500 150,250 120,000 169,250 115,500 127,250 1,518,638 441,555 456,652 445,346 410,913 421,973 427,913 336,765 425,519 4,942,131 443,025 456,447 443,093 411,276 426,766 422,259 336,216 432,390 4,946,691 -8,731 1,715 -497 5,637 -2,293 -5,846 7,549 3,879 -310 -4,971 2,746 311 6,617 -131 -3,238 13,324 5,903 36,536 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

268 90th Annual Report, 2003 3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2001-03 Millions of dollars December 31 Change Description 2002 to 2001 to 2003 2002 2001 2003 2002 U.S. TREASURY SECURITIES Held outright1 666,665 629,406 574,863 37,259 54,543 By remaining maturity Bills 1-90 days 168,381 153,311 136,695 15,070 16,616 91 days to 1 year 76,452 73,372 68,567 3,080 4,805 Notes and bonds 1 year or less 113,301 96,827 83,785 16,474 13,042 More than 1 year through 5 years .. 180,074 172,758 153,158 7,316 19,600 More than 5 years through 10 years 51,312 53,300 53,338 -1,988 -38 More than 10 years 77,146 79,840 79,320 -2,694 520 By type Bills ... 244,833 226,682 205,262 18,151 21,420 Notes .. 323,361 297,893 265,941 25,468 31,952 Bonds .. 98,471 104,832 103,660 -6,361 1,172 FEDERAL AGENCY SECURITIES Held outright1 10 10 -10 By remaining maturity 1 year or less 10 0 -10 10 More than 1 year through 5 years .. 0 10 0 -10 More than 5 years through 10 years 0 0 0 0 More than 10 years 0 0 0 0 By issuer Federal National Mortgage Association .. 10 10 -10 TEMPORARY TRANSACTIONS Repurchase agreements2 43,750 39,500 50,250 4,250 -10,750 Matched sale-purchase agreements 0 0 23,188 0 -23,188 Foreign official and international accounts 0 0 23,188 0 -23,188 Dealers 0 0 0 0 0 Reverse repurchase agreements3 25,652 21,091 0 4,561 21,091 Foreign official and international accounts 25,652 21,091 0 4,561 21,091 Dealers 0 0 0 0 0 NOTE. Components may not sum to totals because of 2. Cash value of agreements, which are collateralized rounding. by U.S. government and federal agency securities. 1. Excludes the effect of temporary transactions— 3. Cash value of agreements, which are collateralized repurchase agreements, matched sale-purchase agree- by U.S. Treasury securities. ments (MSPs), and reverse repurchase agreements (RRPs). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 269 4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2003 President Other officers Employees Ibtal Federal Reserve Bank (including Number Branches) Salary Num- Salaries Salaries Num- (dollars)1 ber (dollars)' Full- Part- (dollars)1 ber (dollars)1 time time Boston 258,600 71 10,091,861 1,026 129 61,176,769 1,227 71,527,230 New York 310,000 267 45,727,195 2,714 61 181,826,851 3,043 227,864,046 Philadelphia 235,300 54 7,381,810 1,098 59 52,245,179 1,212 59,862,289 Cleveland . 231,500 61 7,901,500 1,238 42 58,039,087 1,280 66,172,087 Richmond 252,300 79 10,416,400 1,856 83 92,365,569 2,019 103,034,269 Atlanta 281,000 81 11,534,100 2,157 82 103,107,723 2,321 114,922,823 Chicago 283,800 88 12,296,140 1,762 63 98,502,151 1,914 111,082,091 St. Louis .. 238,000 78 9,948,997 1,109 66 51,471,604 1,254 61,658,601 Minneapolis 264,500 44 6,050,900 1,158 127 55,691,970 1,330 62,007,370 Kansas City 258,800 74 9,829,700 1,468 63 70,873,309 1,606 80,961,809 Dallas 249,800 54 6,959,900 1,298 45 61,072,195 1,398 68,281,895 San Francisco ... 341,900 72 11,073,470 1,979 39 116,739,742 2,091 128,155,112 Federal Reserve Information Technology . 32 4,440,800 691 5 51,426,622 728 55,867,422 Office of Employee Benefits 6 1,214,900 30 0 2,254,713 36 3,469,613 Total 3,205,500 1,061 154,867,673 19,584 864 1,056,793,484 21,459 1,214,866,657 1. Annualized salary liability based on salaries in effect . . . Not applicable. on December 31, 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

270 90th Annual Report, 2003 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2003 Thousands of dollars Item Total Boston New York Philadelphia Cleveland CURRENT INCOME Loans 1,442 63 83 12 173 U.S. Treasury and federal agency securities 22,596,569 1,134,099 9,620,170 742,129 1,096,974 Foreign currencies 259,557 13,641 55,735 7,274 21,932 Priced services 886,916 39,017 128,288 39,671 55,917 Other 48,241 891 30,708 549 1,807 Total 23,792,725 1,187,711 9,834,984 789,635 1,176,803 CURRENT EXPENSES Salaries and other personnel expenses 1,365,734 81,515 253,327 66,397 71,444 Retirement and other benefits 404,558 21,269 76,574 18,890 22,924 Net periodic pension costsl . 60,252 165 58,443 126 140 Fees 79,215 3,579 6,326 879 4,816 Travel 55,234 2,434 5,738 1,820 3,963 Software expenses 114,502 4,255 10,965 4,069 13,106 Postage and other shipping costs 83,369 1,712 4,040 1,561 2,296 Communications 13,019 1,712 2,130 384 564 Materials and supplies 47,006 2,585 8,678 3,557 3,008 Building expenses Taxes on real estate 28,899 4,412 4,645 1,558 1,926 Property depreciation 87,270 4,655 14,523 3,402 7,776 Utilities 31,428 2,783 6,198 2,535 2,058 Rent 37,790 783 13,536 329 393 Other 32,404 771 6,358 1,356 2,543 Equipment Purchases 32,810 1,968 4,408 1,206 1,918 Rentals 34,385 1,763 3,041 708 280 Depreciation 105,224 4,777 13,441 5,732 4,449 Repairs and maintenance 90,554 5,944 9,108 5,543 6,236 Earnings-credit costs 120,791 8,463 39,262 7,007 8,608 Other 65,575 28,922 52,959 9,754 11,697 Recoveries -78,873 -10,376 -9,493 -2,780 -2,787 Expenses capitalized3 -20,743 -517 -6,916 -918 -1,017 Total 2,790,404 173,575 577,288 133,112 166,339 Reimbursements -327,746 -24,913 -68,006 -20,411 -32,427 Net expenses 2,462,658 148,662 509,282 112,702 133,912 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 211 5.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 5 82 414 123 256 96 12 124 1,722,125 1,529,573 2,357,531 727,266 456,220 616,167 768,265 1,826,050 64,000 15,146 26,713 6,073 9,983 6,270 5,773 27,017 71,976 165,371 107,795 44,509 45,083 57,848 50,786 80,655 2,575 1,777 3,116 896 363 448 697 4,412 1,860,681 1,711,950 2,495,569 778,867 511,906 680,828 825,532 1,938,259 180,364 129,968 130,058 71,542 68,553 91,349 75,178 146,039 56,031 37,085 39,052 23,206 20,225 21,299 26,983 41,021 226 169 155 148 140 167 143 232 37,756 6,209 6,564 1,577 4,967 1,867 2,341 2,336 7,475 6,807 6,134 3,004 3,396 4,578 3,179 6,706 47,272 6,201 5,112 3,600 2,624 4,979 4,840 7,481 3,933 48,279 4,070 2,473 2,793 3,434 2,294 6,484 1,536 1,092 1,541 869 834 687 690 982 5,676 5,456 4,352 2,505 1,871 2,710 3,060 3,548 2,168 2,936 4,378 420 -32 707 2,514 3,267 7,203 10,238 8,199 8,788 4,483 4,179 5,284 8,541 3,226 2,818 1,726 1,732 1,566 1,425 1,931 3,430 14,059 882 3,207 1,089 194 1,714 1,438 166 3,472 3,059 4,551 903 1,599 747 4,851 2,196 9,512 2,194 2,498 1,563 1,407 1,874 2,179 2,083 24,179 939 651 169 812 296 904 641 32,887 8,861 6,676 6,460 2,979 5,251 3,938 9,773 17,269 11,471 9,478 3,685 2,968 3,640 5,432 9,780 15,101 5,091 16,607 2,197 2,552 3,902 2,631 9,371 -203,8422 16,392 21,042 43,081 18,909 23,617 24,288 18,756 -30,168 -3,280 -5,186 -1,587 -824 -1,747 -5,582 -5,064 -4,944 -603 -851 -869 -1,727 -677 -561 -1,144 230,392 302,266 270,012 176,554 140,287 175,997 167,955 276,626 -35,186 -18,170 -6,064 -60,347 -20,945 -13,875 -11,133 -16,271 195,206 284,097 263,948 116,207 119,343 162,122 156,823 260,355 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

272 90th Annual Report, 2003 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2003—Continued Thousands of dollars Item Total Boston New York Philadelphia Cleveland PROFIT AND LOSS Current net income 21,330,067 1,039,049 9,325,701 676,934 1,042,891 Additions to and deductions from (—) current net income4 Profits on sales of U.S. Treasury and federal agency securities Profits on foreign exchange transactions 2,695,211 140,894 580,431 75,171 226,708 Other additions 185 4 64 5 0 Total additions 2,695,397 140,898 580,494 75,176 226,708 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 -214,148 -10,900 -89,519 -7,134 -10,543 Other deductions -46 0 -13 -3 0 Total deductions -214,194 -10,900 -89,532 -7,137 -10,543 Net addition to or deduction from (-) current net income 2,481,202 129,998 490,962 68,039 216,165 Cost of unreimbursed Treasury services 76 0 7 69 0 Assessments by Board Board expenditures5 297,020 15,429 64,448 8,365 24,643 Cost of currency 508,144 31,132 124,116 27,212 27,253 Net income before payment to U.S. Treasury 23,006,300 1,122,486 9,628,093 709,327 1,207,159 Dividends paid 517,705 26,647 115,274 15,008 42,326 Payments to U.S. Treasury (interest on Federal Reserve notes) 22,021,528 1,083,616 9,291,164 668,584 1,139,927 Transferred to/from surplus 466,796 12,222 221,655 25,734 24,907 Surplus, January 1 8,380,120 436,200 1,808,902 232,826 702,337 Surplus, December 31 8,846,916 448,422 2,030,557 258,560 727,244 NOTE. Components may not sum to totals because of Bank of Richmond for support services provided to the rounding. System. 1. Reflects the effect of Financial Accounting Stan- 3. Includes expenses for labor and materials capitaldards Board Statement of Financial Accounting Stan- ized and depreciated or amortized as charges to activities dards No. 87, Employers' Accounting for Pensions (SFAS in the periods benefited. 87). The System Retirement Plan for employees is 4. Includes reimbursement from the U.S. Treasury for recorded on behalf of the System on the books of the uncut sheets of Federal Reserve notes, gains and losses on Federal Reserve Bank of New York, resulting in an the sale of Reserve Bank buildings, counterfeit currency increase in expenses of $57,960 thousand. The expenses that is not charged back to the depositing institution, and related to the Benefit Equalization Retirement Plan and stale Reserve Bank checks that are written off. the Supplemental Employees Retirement Plan are 5. For additional details, see the chapter "Board of recorded by each Federal Reserve Bank. Governors Financial Statements." 2. Includes Reserve Bank reimbursements of $216 million in 2003 and $187 million in 2002 to the Reserve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 273 5.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 1,665,475 1,427,853 2,231,621 662,660 392,563 518,706 668,709 1,677,904 665,801 154,818 276,517 63,591 106,756 64,786 59,925 279,813 20 5 25 15 35 3 1 8 665,821 154,823 276,542 63,607 106,791 64,790 59,926 279,821 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -16,535 -14,690 -22,656 -6,988 -4,371 -5,919 -7,354 -17,539 -4 -8 -2 -2 -1 -5 -6 -3 -16,539 -14,698 -22,658 -6,989 -4,372 -5,924 -7,360 -17,542 649,282 140,125 253,884 56,617 102,419 58,866 52,567 262,279 0 0 0 0 0 0 0 0 72,893 16,724 30,651 7,266 12,013 6,964 6,513 31,111 37,111 62,212 44,358 16,903 10,496 17,547 42,015 67,788 2,204,753 1,489,042 2,410,496 695,108 472,473 553,061 672,747 1,841,284 124,627 28,679 53,674 13,191 20,727 11,626 10,682 55,243 2,079,449 1,446,554 2,290,195 652,695 445,852 579,706 737,777 1,606,008 677 13,809 66,626 29,222 5,894 -38,271 -75,712 180,032 2,073,211 475,244 857,601 199,035 339,637 200,652 186,282 868,193 2,073,888 489,053 924,227 228,257 345,531 162,382 110,570 1,048,225 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

274 90th Annual Report, 2003 6. Income and Expenses of the Federal Reserve Banks, 1914-2003 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 275 6.—Continued Payments to U.S. Treasury Transferred Transferred Dividends paid t S ra ta n t s u f t e o r r s y 2 Fed In e t r e a r l e R st e o se n rve (s t e o c t s io u n rp l 1 u 3 s b) ( t s o e c s t u io rp n l u 7 s ) notes 217 1,743 6,804 1,134 1,134 5,541 48,334 5,012 2,704 70,652 5.654 60,725 82,916 6,120 59,974 15,993 6,307 10,851 -660 6,553 3,613 2,546 6,682 114 -3,078 6,916 59 2,474 7,329 818 8,464 7,755 250 5,044 8,458 2,585 21,079 9,584 4,283 22,536 10,269 17 -2,298 10,030 -7,058 9,282 2,011 11,021 8,874 -917 8,782 -60 6,510 8,505 298 28 607 7,830 227 103 353 7,941 177 67 2,616 8,019 120 -419 1,862 8,110 25 -426 4,534 8,215 82 -54 17,617 8,430 141 -4 571 8,669 198 50 3,554 8,911 245 135 40,327 9,500 327 201 48,410 10,183 248 262 81,970 10,962 67 28 81,467 11,523 36 75,284 87 8,366 11,920 166,690 18,523 12,329 193,146 21,462 13,083 196,629 21,849 13,865 254,874 28,321 14,682 291,935 46,334 15,558 342,568 40,337 16,442 276,289 35,888 17,712 251,741 32,710 18,905 401,556 53,983 20,081 542,708 61,604 21,197 524,059 59,215 22,722 910,650 -93,601 23,948 896,816 42,613 25,570 687,393 70,892 27,412 799,366 45,538 28,912 879,685 55,864 30,782 1,582,119 -465,823 32,352 1,296,810 27,054 33,696 1,649,455 18,944 35,027 1,907,498 29,851 36,959 2,463,629 30,027 39,237 3,019,161 39,432 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

276 90th Annual Report, 2003 6. Income and Expenses of the Federal Reserve Banks, 1914-2003—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 -49,616 35,234 31,455 1973 5,016,769 416,879 -80,653 44,412 33,826 1974 6,280,091 476,235 -78,487 41,117 30,190 1975 6,257,937 514,359 -202,370 33,577 37,130 1976 6,623,220 558,129 7,311 41,828 48,819 1977 6,891,317 568,851 -177,033 47,366 55,008 1978 8,455,309 592,558 -633,123 53,322 60,059 1979 10,310,148 625,168 -151,148 50,530 68,391 1980 12,802,319 718,033 -115,386 62,231 73,124 1981 15,508,350 814,190 -372,879 63,163 82,924 1982 16,517,385 926,034 -68,833 61,813 98,441 1983 16,068,362 1,023,678 -400,366 71,551 152,135 1984 18,068,821 1,102,444 -412,943 82,116 162,606 1985 18,131,983 ,127,744 1,301,624 77,378 173,739 1986 17,464,528 ,156,868 1,975,893 97,338 180,780 1987 17,633,012 ,146,911 1,796,594 81,870 170,675 1988 19,526,431 ,205,960 -516,910 84,411 164,245 1989 22,249,276 ,332,161 1,254,613 89,580 175,044 1990 23,476,604 ,349,726 2,099,328 103,752 193,007 1991 22,553,002 ,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 ,657,800 -230,268 140,466 355,947 1994 20,910,742 ,795,328 2,363,862 146,866 368,187 1995 25,395,148 ,818,416 857,788 161,348 370,203 1996 25,164,303 ,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 2003 23,792,725 2,462,658 2,481,127 297,020 508,144 Total, 1914-2003 618,209,915 44,955,164 6,859,674 3,865,714 7,359,178 Aggregate for each Bank, 1914-2003 Boston 33,463,647 3,005,698 290,567 161,168 425,648 New York 212,361,484 6,870,0524 1,951,651 946,845 2,455,966 Philadelphia 23,160,127 2,442,375 173,560 161,928 292,371 Cleveland 38,645,758 2,836,062 452,390 274,236 439,971 Richmond 47,860,768 3,961,878 793,611 467,872 604,392 Atlanta 32,171,370 4,619,301 498,627 301,672 474,684 Chicago 77,047,432 5,712,407 826,808 459,616 854,584 St. Louis 21,502,797 2,304,341 131,202 100,170 270,684 Minneapolis 10,244,883 2,187,933 176,653 119,322 117,526 Kansas City 22,904,109 2,936,408 184,167 134,620 270,383 Dallas 28,291,944 2,937,239 455,313 208,175 340,113 San Francisco 70,555,595 5,141,469 925,125 530,091 812,856 Total 618,209,915 44,955,164 6,859,674 3,865,714 7,359,178 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 277 6.—Continued Payments to U.S. Treasury Dividends paid Interest on to surplus to surplus Statutory Federal Reserve (section 13b) (section 7) transfers 2 notes 41,137 3,493,571 32,580 43,488 3,356,560 40,403 46,184 3,231,268 50,661 49,140 4,340,680 51,178 52,580 5,549,999 51,483 54,610 5,382,064 33,828 57,351 5,870,463 53,940 60,182 5,937,148 45,728 63,280 7,005,779 47,268 67,194 9,278,576 69,141 70,355 11,706,370 56,821 74,574 14,023,723 76,897 79,352 15,204,591 78,320 85,152 14,228,816 106,663 92,620 16,054,095 161,996 103,029 17,796,464 155,253 109,588 17,803,895 91,954 117,499 17,738,880 173,771 125,616 17,364,319 64,971 129,885 21,646,417 130,802 140,758 23,608,398 180,292 152,553 20,777,552 228,356 171,763 16,774,477 402,114 195,422 15,986,765 347,583 212,090 20,470,011 282,122 230,527 23,389,367 283,075 255,884 5,517,716 14,565,624 635,343 299,652 20,658,972 0 831,705 343,014 17,785,942 8,774,994 731,575 373,579 25,409,736 479,053 409,614 25,343,892 4,114,865 428,183 27,089,222 517,580 483,596 24,495,490 1,068,598 517,705 22,021,528 466,796 6,504,257 44,113,958 505,330,734 -4 12,940,589 3 285,078 2,579,504 26,661,526 135 635,457 1,603,354 17,307,161 182,236,389 -433 2,893,803 279,888 1,312,118 18,444,043 291 400,674 476,237 2,827,043 31,231,128 -10 1,013,482 839,849 3,083,928 36,614,769 -72 3,081,763 481,003 2,713,230 23,296,905 5 783,197 757,290 4,593,811 64,194,378 12 1,302,143 169,768 1,833,837 16,624,418 -27 330,807 210,357 416,227 6,878,509 65 491,598 218,711 1,249,703 17,999,454 -9 279,006 322,551 1,510,802 23,178,019 55 250,303 860,171 4,686,594 57,971,197 -17 1,478,358 6,504,257 44,113,958 505,330,734 -4 12,940,589 3 3. The $12,940,589 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 $8,846,916 thousand on Decemfor contributions to capital of the Federal Deposit Insur- ber 31, 2003. ance Corporation (1934), $4 thousand net upon elimina- 4. This amount is reduced $2,711,874 thousand, which tion of section 13b surplus (1958), and $106,000 thou- is related to the System Retirement Plan. See note 1, Digitizeds faondr FR(1A9S96E),R $107,000 thousand (1997), and table 5. $3,752,000 thousand (2000) transferred to the Treasury http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

278 90th Annual Report, 2003 7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks and Branches, December 31, 2003 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)l equipment BOSTON 22,074 107,438 17,949 147,460 92,879 NEW YORK 20,103 201,382 60,179 281,664 185,179 Buffalo 4,307 3,662 8,857 3,914 PHILADELPHIA 2,561 72,770 11,085 86,416 52,531 CLEVELAND 3,112 119,058 23,630 145,799 115,831 Cincinnati 2,247 22,170 10,329 34,745 17,176 Pittsburgh 1,658 13,209 11,788 26,655 18,113 RICHMOND 12,979 83,005 37,504 133,488 95,973 Baltimore 6,482 27,868 4,929 39,280 23,518 Charlotte 3,130 27,653 6,635 37,417 26,054 ATLANTA 22,742 146,278 15,786 184,806 175,023 Birmingham 7,194 45,828 4,145 57,168 53,399 Jacksonville 1,730 20,054 3,241 25,025 17,336 48 Miami 3,746 15,842 4,159 23,747 14,698 Nashville 687 5,887 3,399 9,973 5,939 New Orleans 3,952 9,165 4,903 18,020 11,530 CHICAGO 4,994 139,047 18,491 162,533 105,739 Detroit 4,655 16,234 3,646 24,535 19,489 ST. LOUIS 4,086 37,568 9,003 50,657 30,320 Little Rock 1,148 4,557 2,124 7,830 4,932 Louisville 800 4,654 2,068 7,522 3,729 Memphis 1,136 9,086 4,151 14,372 9,763 MINNEAPOLIS 15,666 103,783 13,521 132,970 114,776 Helena 2,739 9,733 935 13,408 10,360 KANSAS CITY 7,586 22,218 8,121 37,925 21,281 Denver 3,511 8,556 4,832 16,899 9,483 Oklahoma City 977 11,932 3,488 16,397 9,286 Omaha 7,165 11,540 2,437 21,142 16,173 DALLAS 29,049 109,542 20,402 158,992 123,271 El Paso 262 3,585 1,259 5,107 2,538 Houston 19,908 33,872 0 53,781 53,781 7,188 San Antonio 826 7,414 3,103 11,343 7,217 SAN FRANCISCO .... 15,600 93,612 21,735 130,946 83,544 Los Angeles 4,981 70,177 11,429 86,586 60,573 Portland 2,884 12,184 3,251 18,318 13,200 Salt Lake City 495 9,754 2,451 12,699 8,917 Seattle 380 13,346 4,699 18,425 12,361 Total 244,132 1,654,309 364,468 2,262,909 1,629,823 7,236 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 279 8. Operations in Principal Departments of the Federal Reserve Banks, 2000-2003 Operation 2003 2002 2001 2000 Millions of pieces (except as noted) Currency processed 34,832 34,208 33,740 31,505 Currency destroyed 7,375 8,363 7,850 8,179 Coin receivedl 48,138 43,445 39,735 33,738 Checks handled U.S. government checks 267 289 346 262 Postal money orders 198 216 229 230 Other 15,806 16,587 16,905 16,994 Government securities transfers 20 17 15 14 Transfer of funds 123 115 112 108 Automated clearinghouse transactions Commercial 5,588 4,986 4,448 3,812 Government 914 883 900 838 Food stamps redeemed 287 500 587 686 Millions of dollars Currency processed 584,915 565,302 540,746 542,567 Currency destroyed 101,338 92,511 86,298 112,164 Coin receivedl 4,879 4,579 4,296 3,902 Checks handled U.S. government checks 308,055 307,627 333,849 282,791 Postal money orders 29,197 30,161 30,461 30,036 Other 15,431,625 15,033,298 14,853,072 13,849,084 Government securities transfers 267,644,194 228,907,121 212,343,034 188,133,178 Transfer of funds 436,706,269 405,761,750 423,606,365 379,756,389 Automated clearinghouse transactions Commercial 13,951,600 13,135,350 12,707,247 11,619,954 Government 2,810,283 2,711,384 2,528,562 2,404,491 Food stamps redeemed 1,510 2,543 2,989 3,414 1. Amounts in bold are restatements due to the inclusion of coin activity at Federal Reserve off-site coin terminals. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

280 90th Annual Report, 2003 9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2003 Reserve Bank Primary credit1 Secondary credit2 Seasonal credit3 All Federal Reserve Banks 2.00 2.50 1.05 1. Primary credit is available for very short terms as funds that arise from a clear pattern of intra-yearly movea backup source of liquidity to depository institutions that ments in their deposits and loans and that cannot be met are in generally sound financial condition in the judgment through special industry lenders. The discount rate on of the lending Federal Reserve Bank. seasonal credit takes into account rates charged by market 2. Secondary credit is available in appropriate circum- sources of funds and ordinarily is reestablished on the stances to depository institutions that do not qualify for first business day of each two-week reserve maintenance primary credit. period. 3. Seasonal credit is available to help relatively small depository institutions meet regular seasonal needs for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 281 10. Reserve Requirements of Depository Institutions, December 31, 2003 Requirements Type of deposit Percentage of deposits Effective date Net transaction accounts1 $0 million-$6.6 million 2 0 12-25-03 More than $6.6 million-$45.4 million3 3 12-25-03 More than $45.4 million4 10 12-25-03 Nonpersonal time deposits 5 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- $6.0 million to $6.6 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 ail 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 25, 2003, 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 15, 2004, 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 $42.1 million to $45.4 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 25, 2003, 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 15, 2004, for institu- less than 1.5 years (see note 5). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

282 90th Annual Report, 2003 11. Initial Margin Requirements under Regulations T, U, and X Percent of market value Short sales, Effective date T only1 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. 1 . 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 1, 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 283 12. Principal Assets and Liabilities of Insured Commercial Banks in the United States, by Class of Bank, June 30, 2003 and 2002 Millions of dollars, except as noted Member banks Nonmember Item Total banks Total National State 2003 ASSETS Loans and investments 5,375,585 4,237,950 3,008,884 1,229,066 1,137,635 Loans, gross 3,959,459 3,142,026 2,265,242 876,784 817,433 Net 3,957,137 3,140,316 2,263,814 876,502 816,821 Investments 1,416,126 1,095,925 743,642 352,282 320,202 U.S. Treasury and federal agency securities 289,306 186,268 101,919 84,349 103,038 Other 1,126,820 909,657 641,723 267,934 217,163 Cash assets, total 302,232 248,016 178,772 69,244 54,217 LIABILITIES Deposits, total 4,207,923 3,241,704 2,293,678 948,026 966,219 Interbank 68,208 56,529 40,813 15,716 11,679 Other transaction 684,982 505,422 361,669 143,753 179,560 Other nontransaction 3,454,733 2,679,753 1,891,195 788,557 774,980 Equity capital 671,071 539,467 383,717 155,751 131,603 Number of banks 7,816 2,999 2,048 951 4,817 2002 ASSETS Loans and investments 4,841,229 3,798,070 2,717,307 1,080,763 1,043,159 Loans, gross 3,637,050 2,895,399 2,101,054 794,345 741,651 Net 3,634,318 2,893,348 2,099,281 794,067 740,970 Investments 1,204,179 902,671 616,253 286,418 301,508 U.S. Treasury and federal agency securities 248,547 153,104 78,286 74,819 95,443 Other 955,632 749,567 537,968 211,600 206,065 Cash assets, total 264,277 216,341 155,993 60,348 47,935 LIABILITIES Deposits, total 3,756,145 2,863,790 2,025,569 838,220 892,356 Interbank 55,221 45,409 31,554 13,855 9,812 Other transaction 605,442 450,366 325,944 124,422 155,076 Other nontransaction 3,095,482 2,368,014 1,668,071 699,943 727,468 Equity capital 616,280 469,910 355,889 141,021 119,370 Number of banks 7,949 3,052 2,104 948 4,897 NOTE. Data are domestic assets and liabilities (except only). Components may not sum to totals because of for those components reported on a consolidated basis rounding. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

284 90th Annual Report, 2003 13A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2003 and Month-End 2003 Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Special Period drawing Treasury S o e u c h t u r e i r l g i d t h ie t1 s a R g e r p e u em rc e h n as ts e 2 Loans Float R F O e e d s th e e r e r v a r e l Total s G to o c ld k ce a r r c i t c g if o h i u c ts a n t t e s c t u a r n o r d u e i t n n - c g y 3 assets 1984 167,612 2,015 3,577 833 12,347 186,384 11,096 4,618 16,418 1985 186,025 5,223 3,060 988 15,302 210,598 11,090 4,718 17,075 1986 205,454 16,005 1,565 1,261 17,475 241,760 11,084 5,018 17,567 1987 226,459 4,961 3,815 811 15,837 251,883 11,078 5,018 18,177 1988 240,628 6,861 2,170 1,286 18,803 269,748 11,060 5,018 18,799 1989 233,300 2,117 481 1,093 39,631 276,622 11,059 8,518 19,628 1990 241,431 18,354 190 2,566 39,880 302,421 11,058 10,018 20,402r 1991 272,531 15,898 218 1,026 34,524 324,197 11,059 10,018 21,014r 1992 300,423 8,094 675 3,350 30,278 342,820 11,056 8,018 21,447r 1993 336,654 13,212 94 963 33,394 384,317 11,053 8,018 22,095r 1994 368,156 10,590 223 740 33,441 413,150 11,051 8,018 22,994' 1995 380,831 13,862 135 231 33,483 428,543 11,050 10,168 24,003r 1996 393,132 21,583 85 5,297 32,222 452,319 11,048 9,718 24,966r 1997 431,420 23,840 2,035 561 32,044 489,901 11,047 9,200 25,543r 1998 452,478 30,376 17 1,009 37,692 521,573 11,046 9,200 26,270 1999 478,144 140,640 233 407 34,799 654,223 11,048 6,200 28,013 2000 511,833 43,375 110 795 36,896 593,009 11,046 2,200 31,643r 2001 551,685 50,250 34 698 36,885 639,552 11,045 2,200 33,017r 2002 629,416 39,500 40 832 38,574 708,363 11,043r 2,200 34,597r 2003 666,665 43,750 62 211 40,214 750,901 11,043 2,200 35,475 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 285 13 A.—Continued Factors absorbing reserve funds Deposits with Federal Reserve Banks, Other Reserve Currency Reverse Treasury other than reserve balances Required R F e e s d e e r ra v l e ba w l i a t n h ces in repurchase cash clearing liabilities Federal circulation agreements4 holdings5 balances and Reserve Treasury Foreign Other capital Banks6 183,796 513 5,316 253 867 1,126 5,952 20,693 197,488 0 550 9,351 480 1,041 1,490 5,940 27,141 211,995 0 447 7,588 287 917 1,812 6,088 46,295 230,205 0 454 5,313 244 1,027 1,687 7,129 40,097 247,649 0 395 8,656 347 548 1,605 7,683 37,742 260,456 0 450 6,217 589 1,298 1,618 8,486 36,713 286,963r 0 561 8,960 369 242 l,960r 8,147 36,698r 307,756r 0 636 17,697 968 1,706 3,946r 8,113 25,467r 334,701r 0 508 7,492 206 372 5,897r 7,984 26,182r 365,271r 0 377 14,809 386 397 6,332 9,292 28,619 403,843r 0 335 7,161 250 876 4,196r 11,959 26,593r 424,244r 0 270 5,979 386 932 5,167 12,342 24,444 450,648r 0 249 7,742 167 892 6,601 13,829 17,923 482,327r 0 225 5,444 457 900 6,679r 15,500 24,159r 517,484 0 85 6,086 167 1,605 6,781r 16,354 19,525r 628,359 0 109 28,402 71 1,261 7,482r 17,256 16,545r 593,694r 0 450 5,149 216 1,382 6,332 17,962 12,713 643,301r 0 425 6,645 61 820 8,525r 17,083 8,953r 687,518r 21,091 367 4,420 136 1,152 10,533 18,977 12,008r 724,194 25,652 321 5,723 162 717 11,830 19,793 11,228 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

286 90th Annual Report, 2003 13A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2003 and Month-End 2003—Continued Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Period Special Treasury Other Gold drawing currency Securities Repurchase Federal stock rights outou h tr e i l g d ht1 agreements2 Loans Float Reserve Total ce a r c t c if o i u ca n t t e standing 3 assets 2003 Jan 629,416 24,750 7 3,148 39,765 697,086 11,043 2,200 34,597 Feb 636,921 26,900 5 102 37,299 701,227 11,043 2,200 34,710 Mar 641,474 31,750 30 -233 38,747 711,767 11,043 2,200 34,798 Apr. 647,281 37,501 35 31 39,989 724,837 11,043 2,200 34,890 May 651,127 30,240 80 -478 38,268 719,238 11,044 2,200 34,976 June 652,128 31,750 768 -266 38,775 723,154 11,044 2,200 35,065 July .... 652,913 29,000 145 -123 39,589 721,523 11,043 2,200 35,145 Aug 653,909 35,000 158 -158 37,319 726,228 11,043 2,200 35,237 Sept 656,126 37,500 174 -266 39,233 732,767 11,043 2,200 35,293 Oct 658,791 26,000 239 139 40,452 725,621 11,043 2,200 35,363 Nov 664,615 33,000 28 872 38,601 737,117 11,043 2,200 35,419 Dec 666,665 43,750 62 211 40,214 750,901 11,043 2,200 35,475 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 287 13 A.—Continued Factors absorbing reserve funds Deposits with Federal Reserve Banks, Other Reserve Currency Reverse Treasury other than reserve balances Required Federal balances Reserve with in repurchase cash clearing circulation agreements4 holdings5 balances liabilities Federal and Reserve Treasury Foreign Other capital Banks6 674,736 18,370 361 5,509 102 223 10,355 19,478 15,792 681,634 18,018 343 4,268 224 193 10,336 19,739 14,425 685,791 19,418 373 6,746 254 211 10,978 20,230 15,809 688,760 20,814 340 10,583 313 231 10,829 20,049 21,051 692,355 22,285 375 6,505 79 217 10,832 19,973 14,837 693,315 22,080 365 6,939 898 249 10,838 19,898 16,882 694,073 19,827 364 6,356 318 258 10,898 19,674 18,143 700,139 20,190 335 4,589 81 225 10,912 20,251 17,986 698,144 24,983 341 7,224 82 224 11,225 21,164 17,916 702,383 19,329 390 6,110 155 274 11,420 20,026 14,140 712,984 18,781 324 5,912 81 281 11,851 20,590 14,976 724,194 25,652 321 5,723 162 717 11,830 19,793 11,228 NOTE. Components may not sum to totals because of fractional and dollar coins. For details see "Currency and rounding. Coin in Circulation," Treasury Bulletin. 1. Includes U.S. Treasury and federal agency securi- 4. Cash value of agreements, which are collateralized ties. U.S. Treasury securities contain securities lent to by U.S. Treasury securities. dealers and are fully collateralized by other U.S. Treasury 5. Coin and paper currency held by the Treasury, as securities. Federal agency securities are included at face well as any gold in excess of the gold certificates issued value. to the Reserve Bank. 2. Cash value of agreements, which are collateralized 6. Excludes required clearing balances and adjustby U.S. Treasury and federal agency securities. ments to compensate for float. 3. Includes currency and coin (other than gold) issued r. Revised. directly by the Treasury. The largest components are Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

288 90th Annual Report, 2003 13B. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-1983 Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Special Period drawing Treasury S o e u c h t u r e i r l g i d t h ie t1 s m R a c g e h e p r n a e u t s e s e r - 2 - Loans Float3 ot A h l e l r4 R F a O e e ss d s th e e e r e t r v s a r 5 e l Total s G to o c l k d 6 ce a r r c i t c g if o h i u c ts a n t t e s c t u an r o r d u e i t n n - c g y 7 1918.. 239 0 1,766 199 294 2,498 2,873 1,795 1919.. 300 0 2,215 201 575 3,292 2,707 1,707 1920.. 287 0 2,687 119 262 3,355 2,639 1,709 1921.. 234 0 1,144 40 146 1,563 3,373 1,842 1922.. 436 0 618 78 273 1,405 3,642 1,958 1923.. 80 54 723 27 355 1,238 3,957 2,009 1924.. 536 4 320 52 390 1,302 4,212 2,025 1925.. 367 643 63 378 1,459 4,112 1,977 1926.. 312 3 637 45 384 1,381 4,205 1,991 1927.. 560 57 582 63 393 1,655 4,092 2,006 1928.. 197 31 1,056 24 500 1,809 3,854 2,012 1929.. 23 632 34 405 1,583 3,997 2,022 1930.. 686 43 251 21 372 1,373 4,306 2,027 1931.. 775 42 638 20 378 1,853 4,173 2,035 1932.. 1,851 4 235 14 41 2,145 4,226 2,204 1933.. 2,435 2 15 137 2,688 4,036 2,303 1934.. 2,430 0 5 21 2,463 8,238 2,511 1935.. 2,430 1 5 12 38 2,486 10,125 2,476 1936.. 2,430 0 3 39 28 2,500 11,258 2,532 1937.. 2,564 0 10 19 19 2,612 12,760 2,637 1938.. 2,564 0 4 17 16 2,601 14,512 2.798 1939.. 2,484 0 7 91 11 2,593 17,644 2,963 1940.. 2,184 0 3 2,274 21,995 3,087 1941.. 2,254 0 3 94 10 2,361 22,737 3,247 1942.. 6,189 0 6 471 14 6,679 22,726 3,648 1943.. 11,543 0 5 681 10 12,239 21,938 4,094 1944.. 18,846 0 80 815 4 19,745 20,619 4,131 1945.. 24,252 0 249 578 2 15,091 20,065 4,339 1946.. 23,350 0 163 580 1 24,093 20,529 4,562 1947.. 22,559 0 85 535 1 23,181 22,754 4,562 1948.. 23,333 0 223 541 1 24,097 24,244 4,589 1949.. 18,885 0 78 534 2 19,499 24,427 4,598 1950.. 20,725 53 67 1,368 3 22,216 22,706 4,636 1951.. 23,605 196 19 1,184 5 25,009 22,695 4,709 1952.. 24,034 663 156 967 4 25,825 23,187 4,812 1953.. 25,318 598 28 935 2 26,880 22,030 4,894 1954.. 24,888 44 143 1 25,885 21,713 4,985 1955.. 24,391 394 108 1,585 29 26,507 21,690 5,008 1956.. 24,610 305 50 1,665 70 26,699 21,949 5,066 1957.. 23,719 519 55 1,424 66 25,784 22,781 5,146 1958.. 26,252 95 64 1,296 49 27,755 20,534 5,234 1959.. 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 289 13B.—Continued Factors absorbing reserve funds Deposits with Member bank Federal Reserve Banks, Other reserves9 Cur- other than reserve balances Other Federal rency Treasury Required Federal Reserve in cash clearing cir ti c o u n la- holdings8 Treasury Foreign Other a R cc e o s u er n v t e s5 balances l c ia a b a p i n i l t i d a ti l e 5 s R F W e e s d e i e t r r h v a e l Cur a r n e d ncy qu R ir e e - d11 Ex- Banks 4,951 288 51 96 25 118 0 0 1,636 0 1,585 51 5,091 385 51 73 28 208 0 0 1,890 0 1,822 68 5,325 218 57 5 18 298 0 0 1,781 0 0 0 4,403 214 96 12 15 285 0 0 1,753 0 1,654 99 4,530 225 11 3 26 276 0 0 1,934 0 0 0 4,757 213 38 4 19 275 0 0 1,898 0 1,884 14 4,760 211 51 19 20 258 0 0 2,220 0 2,161 59 4,817 203 16 8 21 272 0 0 2,212 0 2,256 -44 4,808 201 17 46 19 293 0 0 2,194 0 2.250 -56 4,716 208 18 5 21 301 0 0 2,487 0 2,424 63 4,686 202 23 6 21 348 0 0 2,389 0 2,430 -41 4,578 216 29 6 24 393 0 0 2,355 0 2,428 -73 4,603 211 19 6 22 375 0 0 2,471 0 2,375 96 5,360 222 54 79 31 354 0 0 1,961 0 1,994 -33 5,388 272 8 19 24 355 0 0 2,509 0 1,933 576 5,519 284 3 4 128 360 0 0 2,729 0 1,870 859 5,536 3,029 121 20 169 241 0 0 4,096 0 2,282 1,814 5,882 2,566 544 29 226 253 0 0 5,587 0 2,743 2,844 6,543 2,376 244 99 160 261 0 0 6,606 0 4,622 1,984 6,550 3,619 142 172 235 263 0 0 7,027 0 5,815 1,212 6,856 2,706 923 199 242 260 0 0 8,724 0 5,519 3,205 7,598 2,409 634 397 256 251 0 0 11,653 0 6,444 5,209 8,732 2,213 368 1,133 599 284 0 0 4,026 0 7,411 6,615 11,160 2,215 867 774 586 291 0 0 12,450 0 9,365 3,085 15,410 2,193 799 793 485 256 0 0 13,117 0 11,129 1,988 20,499 2,303 579 1,360 356 339 0 0 12.886 0 11,650 1,236 25,307 2,375 440 1,204 394 402 0 0 14,373 0 12,748 1,625 28,515 2,287 977 862 446 495 0 0 15,915 0 14,457 1,458 28,952 2,272 393 508 314 607 0 0 16,139 0 15,577 562 28,868 1,336 870 392 569 563 0 0 17,899 0 16,400 1,499 28,224 1,325 1,123 642 547 590 0 0 20,479 0 19,277 1,202 27,600 1,312 821 767 750 106 0 0 16,568 0 15,550 1,018 27,741 1,293 668 895 565 714 0 0 17,681 0 16,509 1,172 29,206 1,270 247 526 363 746 0 0 20,056 0 19,667 389 30,433 1,270 389 550 455 111 0 0 19,950 0 20,520 -570 30,781 761 346 423 493 839 0 0 20,160 0 19,397 763 30,509 796 563 490 441 907 0 0 18,876 0 18,618 258 31,158 767 394 402 554 925 0 0 19,005 0 18,903 102 31,790 775 441 322 426 901 0 0 19,059 0 19,089 -30 31,834 761 481 356 246 998 0 0 19,034 0 19,091 -57 32,193 683 358 272 391 1,122 0 0 18,504 0 18,574 -70 32,591 391 504 345 694 841 0 0 18,174 310 18,619 -135 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

290 90th Annual Report, 2003 13B. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-1983—Continued Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Special Period drawing Treasury S o e u c h t u r e i r l g i d t h ie t1 s m R a c g e e h p r n a e u t s e s e r - 2 - Loans Float3 ot A he ll r4 R F a O e e ss d s th e e e r e t r v s a r 5 e l Total s G to o c l k d 6 ce a r r c i t c g if o h i u c ts n at t e s c t u an r o r d u e i t n n - c g y 7 1960 26,984 400 33 1,847 74 0 29,338 17,767 5,398 1961 30,478 159 130 2,300 51 0 31,362 16,889 5,585 1962 28,722 342 38 2,903 110 0 33,871 15,978 5,567 1963 33,582 11 63 2,600 162 0 36,418 15,513 5,578 1964 36,506 538 186 2,606 94 0 39,930 15,388 5,405 1965 40,478 290 137 2,248 187 0 43,34a 13,733 5,575 1966 43,655 661 173 2,495 193 0 47,177 13,159 6,317 1967 48,980 170 141 2,576 164 0 52,031 11,982 6,784 1968 52,937 0 186 3,443 58 0 56,624 10,367 6,795 1969 57,154 0 183 3,440 64 2,743 64,584 10,367 6,852 1970 62,142 0 335 4,261 57 1,123 67,918 10,732 400 7,147 1971 69,481 1,323 39 4,343 261 1,068 76,515 10,132 400 7,710 1972 71,119 111 1,981 3,974 106 1,260 78,551 10,410 400 8,313 1973 80,395 100 1,258 3,099 68 1,152 86,072 11,567 400 8,716 1974 84,760 954 299 2,001 999 3,195 92,208 11,652 400 9,253 1975 92,789 1,335 211 3,688 1,126 3,312 102,461 11,599 500 10,218 1976 100,062 4,031 25 2,601 991 3,182 110,892 11,598 1,200 10,810 1977 108,922 2,352 265 3,810 954 2,442 118,745 11,718 1,250 11,331 1978 117,374 1,217 1,174 6,432 587 4,543 131,327 11,671 1,300 11,831 1979 124,507 1,660 1,454 6,767 704 5,613 140,705 11,172 1,800 13,083 1980 128,038 2,554 1,809 4,467 776 8,739 146,383 11,160 2,518 13,427 1981 136,863 3,485 1,601 1,762 195 9,230 153,136 11,151 3,318 13,687 1982 144,544 4,293 717 2,735 1,480 9,890 63,659 11,148 4,618 13,786 1983 159,203 1,592 918 1,605 418 8,728 172,464 11,121 4,618 15,732 NOTE. For a description of figures and discussion of 4. Principally acceptances and, until August 21, 1959, their significance, see Banking and Monetary Statistics, industrial loans, the authority for which expired on that 1941-1970 (Board of Governors of the Federal Reserve date. System, 1976), pp. 507-23. 5. For the period before April 16, 1969, includes the Components may not sum to totals because of total of Federal Reserve capital paid in, surplus, other rounding. capital accounts, and other liabilities and accrued divi- 1. In 1969 and thereafter, includes securities loaned— dends, less the sum of bank premises and other assets, fully guaranteed by U.S. government securities pledged and is reported as "Other Federal Reserve accounts"; with Federal Reserve Banks—and excludes securities thereafter, "Other Federal Reserve assets" and "Other sold and scheduled to be bought back under matched Federal Reserve liabilities and capital" are shown sale-purchase transactions. On September 29, 1971, and separately. thereafter, includes federal agency issues bought outright. 6. Before January 30, 1934, includes gold held in 2. On December 1, 1966, and thereafter, includes Federal Reserve Banks and in circulation. federal agency obligations held under repurchase 7. Includes currency and coin (other than gold) issued agreements. directly by the Treasury. The largest components are 3. In 1960 and thereafter, figures reflect a minor fractional and dollar coins. For details see "Currency and change in concept; see Federal Reserve Bulletin, vol. 47 Coin in Circulation," Treasury Bulletin. (February 1961), p. 164. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 291 13B.—Continued Factors absorbing reserve funds Deposits with Member bank Cur- Federal Reserve Banks, Other reserves9 other than reserve balances rency Other Federal Treasury Required in cash Federal clearing Reserve c c u i l r a - - holdings8 a R cc e o s u er n v t e s5 balances liab a i n li d ties F W ed i e t r h al Currency Re- Extion Treasury Foreign Other capital5 Reserve co an in d 10 quired '' cess11-12 Banks 32,869 377 485 217 533 941 0 0 17,081 2,544 18,988 637 33,918 422 465 279 320 1,044 0 0 17,387 2,544 18,988 96 35,338 380 597 247 393 1,007 0 0 17,454 3,262 20,071 645 37,692 361 880 171 291 1,065 0 0 17,049 4,099 20,677 471 39,619 612 820 229 321 1,036 0 0 18,086 4,151 21,663 574 42,056 760 668 150 355 211 0 0 18,447 4,163 22,848 -238 44,663 1,176 416 174 588 -147 0 0 19,779 4,310 24,321 -232 47,226 1,344 1,123 135 563 -773 0 0 21,092 4.631 25,905 -182 50,961 695 703 216 747 -1,353 0 0 21,818 4,921 27,439 -700 53,950 596 1,312 134 807 0 0 1,919 22,085 5,187 28,173 -901 57,903 431 1,156 148 1,233 0 0 1,986 24,150 5,423 30,033 -460 61,068 460 2,020 294 999 0 0 2,131 27,788 5,743 32,496 1,035 66,516 345 1,855 325 840 0 0 2,143 25,647 6,216 32,044 9812 72,497 317 2,542 251 1,419 I3 0 0 2,669 27,060 6,781 35,268 -1,360 79,743 185 2,113 418 1,275 l3 0 0 2,935 25,843 7,370 37,011 -3,798 86,547 483 7,285 353 1,090 0 0 2,968 26,052 8,036 35,197 -1,103 14 93,717 460 10,393 352 1,357 0 0 3,063 25,158 8,628 35,461 -1,535 103,811 392 7,114 379 1,187 0 0 3,292 26,870 9,421 37,615 -1,265 114,645 240 4,196 368 1.256 0 0 4,275 31,152 10,538 42,694 -893 125,600 494 4,075 429 1,412 0 0 4,957 29,792 11,429 44,217 -2,835 136,829 441 3,062 411 617 0 0 4,671 27,456 13,654 40,558 675 144,774 443 4,301 505 781 0 117 5,261 25,111 15,576 42,145 -1,442 154,908 429 5,033 328 1,033 0 436 4,990 26,053 16,666 41,391 1,328 171,935 479 3,661 191 851 0 1,013 5,392 20,413 17,821 39,179 -945 8. Coin and paper currency held by the Treasury, as 1973—Ql, $279; Q2, $172; Q3, $112; Q4, $84; well as any gold in excess of the gold certificates issued 1974—Ql, $67; Q2, $58. The transition period ended to the Reserve Bank. with the second quarter of 1974. 9. In November 1979 and thereafter, includes reserves 13. For the period before July 1973, includes certain of member banks, Edge Act corporations, and U.S. agen- deposits of domestic nonmember banks and foreigncies and branches of foreign banks. On November 13, owned banking institutions held with member banks and 1980, and thereafter, includes reserves of all depository redeposited in full with Federal Reserve Banks in coninstitutions. nection with voluntary participation by nonmember insti- 10. Between December 1, 1959, and November 23, tutions in the Federal Reserve System program of credit 1960, part was allowed as reserves; thereafter, all was restraint. allowed. As of December 12, 1974, the amount of voluntary 11. Estimated through 1958. Before 1929, data were nonmember bank and foreign-agency and branch deposits available only on call dates (in 1920 and 1922 the call at Federal Reserve Banks that are associated with date was December 29). Since September 12, 1968, the marginal reserves is no longer reported. However, two amount has been based on close-of-business figures for amounts are reported: (1) deposits voluntarily held as the reserve period two weeks before the report date. reserves by agencies and branches of foreign banks oper- 12. For the week ending November 15, 1972, and ating in the United States and (2) Eurodollar liabilities. thereafter, includes $450 million of reserve deficiencies 14. Adjusted to include waivers of penalties for reserve on which Federal Reserve Banks are allowed to waive deficiencies, in accordance with change in Board policy, penalties for a transition period in connection with bank effective November 19, 1975. adaptation to Regulation J as amended, effective Novem- . . . Not applicable. ber 9, 1972. Allowable deficiencies are as follows (beginning with first statement week of quarter, in millions) : Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

292 90th Annual Report, 2003 14. Banking Offices and Banks Affiliated with Bank Holding Companies (BHCs) in the United States, December 31, 2002 and 2003 Commercial banks1 Statechartered Type of office Total Member savings Total Nonmember banks Total National State Allbanking offices BANKS Number, Dec. 31, 2002 .. 8,240 7,838 2,979 2,033 946 4,859 402 Changes during 2003 New banks 120 116 23 14 9 93 4 Banks converted into branches -219 -210 -99 -57 -42 -111 -9 Ceased banking operation2 -25 -20 -10 -7 -3 -10 -5 Other3 -2 -1 -3 -22 19 2 -1 Net change -126 -115 -89 -72 -17 -26 -11 Number, Dec. 31, 2003 .. 8,114 7,723 2,890 1,961 929 4,833 391 BRANCHES AND ADDITIONAL OFFICES Number, Dec. 31, 2002 .. 71,283 67,834 50,228 35,877 14,351 17,606 3,449 Changes during 2003 New branches 1,572 1,465 1,018 585 433 447 107 Branches converted from banks 219 212 111 71 40 101 7 Discontinued 2 -677 -649 -532 -370 -162 -117 -28 Other3 -9 41 -400 162 -562 441 -50 Net change 1,105 1,069 197 448 -251 872 36 Number, Dec. 31, 2003 .. 72,388 68,903 50,425 36,325 14,100 18,478 3,485 Banks affiliated with BHCs BANKS Number, Dec. 31, 2002 .. 6,428 6,318 2,529 1,709 820 3,789 110 Changes during 2003 BHC-affiliated new banks 174 162 51 34 17 111 12 Banks converted into branches -178 -174 -87 -50 -37 -87 -4 Ceased banking operation2 -26 -25 -11 -8 -3 -14 -1 Other3 -1 0 -1 -18 17 1 -1 Net change -31 -37 -48 -42 -6 11 6 Number, Dec. 31,2003 .. 6,397 6,281 2,481 1,667 814 3,800 116 1. For purposes of this table, banks are entities that defined as an insured bank in section 3(h) of the FDIC are defined as banks in the Bank Holding Company Act, Act. Covers entities in the United States and its territories as amended, which is implemented by Federal Reserve and possessions (affiliated insular areas). Regulation Y. Generally, a bank is any institution that 2. Institutions that no longer meet the Regulation Y accepts demand deposits and is engaged in the business definition of bank. of 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

295 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

297 Board of Governors Financial Statements The financial statements of the Board for 2003 and 2002 were audited by KPMG LLP, independent auditors. flilS KPMG LLP 2001 M Street NW Washington, DC 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, 2003 and 2002, 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 the standards applicable to financial audits contained in the Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audits 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, 2003 and 2002, and the results of its 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 April 2, 2004, on our consideration of the Board's internal control over financial reporting and its compliance with certain provisions of 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. April 2,2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

298 90th Annual Report, 2003 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BALANCE SHEETS As of December 31, 2003 2002 ASSETS CURRENT ASSETS Cash $ 56,179,654 $ 8,635,164 Accounts receivable 1,251,117 871,626 Prepaid expenses and other assets 2,614,354 801,031 Total current assets 60,045,125 10,307,821 NONCURRENT ASSETS Property and equipment, net (Note 2) 149,595,059 143,971,006 Collections (Note 1) Total noncurrent assets 149,595,059 143,971,006 Total assets $209,640,184 $154,278,827 LIABILITIES AND CUMULATIVE RESULTS OF OPERATIONS CURRENT LIABILITIES Accounts payable and accrued liabilities $ 15,347,390 $ 11,450,099 Accrued payroll and related taxes 5,056,647 8,102,710 Accrued annual leave 13,428,993 11,873,527 Capital lease payable (current portion) 206,590 50,546 Unearned revenues and other liabilities 390,698 442,066 Total current liabilities 34,430,318 31,918,948 LONG-TERM LIABILITIES Capital lease payable (non-current portion) 763,699 32,153 Accumulated retirement benefit obligation (Note 3) 595,601 614,108 Accumulated postretirement benefit obligation (Note 4) 5,322,053 4,917,787 Accumulated postemployment benefit obligation (Note 5) 4,949,892 4,299,252 Total long-term liabilities 11,631,245 9,863,300 Total liabilities 46,061,563 41,782,248 CUMULATIVE RESULTS OF OPERATIONS Working capital 25,821,397 (21,560,581) Unfunded long-term liabilities (10,867,546) (9,831,147) Net investment in property and equipment 148,624,770 143,888,307 Total cumulative results of operations 163,578,621 112,496,579 Total liabilities and cumulative results of operations $209,640,184 $154,278,827 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 299 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, 2003 2002 BOARD OPERATING REVENUES Assessments levied on Federal Reserve Banks for Board operating expenses and capital expenditures $297,020,200 $205,110,800 Other revenues (Note 6) 8,835,440 9,039,417 Total operating revenues 305,855,640 214,150,217 BOARD OPERATING EXPENSES Salaries 156,547,392 146,022,212 Retirement and insurance contributions 28,263,776 25,560,734 Contractual services and professional fees 17,501,035 18,073,228 Depreciation and net losses on disposals 12,194,612 12,426,581 Postage and supplies 8,175,120 5,961,699 Utilities 7,664,716 7,218,999 Travel 5,981,254 5,925,674 Software 5,910,128 6,822,066 Repairs and maintenance 4,029,441 4,666,439 Printing and binding 1,864,006 2,026,370 Other expenses (Note 6) 6,642,118 5,141,590 Total operating expenses 254,773,598 239,845,592 RESULTS OF OPERATIONS 51,082,042 (25,695,375) ISSUANCE AND REDEMPTION OF FEDERAL RESERVE NOTES Assessments levied on Federal Reserve Banks for currency costs 508,144,248 429,568,393 Expenses for currency printing, issuance, retirement, and shipping 508,144,248 429,568,393 CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES 0 0 TOTAL RESULTS OF OPERATIONS 51,082,042 (25,695,375) CUMULATIVE RESULTS OF OPERATIONS, Beginning of year 112,496,579 138,191,954 CUMULATIVE RESULTS OF OPERATIONS, End of year $163,578,621 $112,496,579 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

300 90th Annual Report, 2003 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF CASH FLOWS For the years ended December 31, 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES RESULTS OF OPERATIONS $51,082,042 $(25,695,375) Adjustments to reconcile results of operations to net cash provided by (used in) operating activities: Depreciation and net losses on disposals 12,194,612 12,426,581 (Increase) decrease in assets: Accounts receivable, prepaid expenses, and other assets (2,192,814) 518,815 Increase (decrease) in liabilities: Accounts payable and accrued liabilities 3,897,291 (4,675,698) Accrued payroll and related taxes (3,046,063) 794,956 Accrued annual leave 1,555,466 1,141,171 Unearned revenues and other liabilities (51,368) 50,494 Accumulated retirement benefit obligation (18,507) (37,520) Accumulated postretirement benefit obligation 404,266 362,300 Accumulated postemployment benefit obligation 650,640 707,681 Net cash provided by (used in) operating activities 64,475,565 (14,406,595) CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposals 15,790 5,200 Capital expenditures (16,809,964) (17,507,186) Net cash provided by (used in) investing activities (16,794,174) (17,501,986) CASH FLOWS FROM FINANCING ACTIVITIES Capital lease payments (136,901) (244,819) Net cash provided by (used in) financing activities (136,901) (244,819) NET INCREASE (DECREASE) IN CASH 47,544,490 (32,153,400) CASH BALANCE, Beginning of year 8,635,164 40,788,564 CASH BALANCE, End of year $56,179,654 $ 8,635,164 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Capital lease obligations incurred $ 1,024,491 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 301 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM NOTES TO FINANCIAL STATEMENTS purchased and donated collection items are not recorded. AS OF AND FOR THE YEARS ENDED The value of the Board's collections has not been DECEMBER 31, 2003 AND 2002 determined. Estimates—The preparation of financial statements in conformity with accounting principles generally accepted (1) SIGNIFICANT ACCOUNTING POLICIES in the United States of America requires management to Organization—The Federal Reserve System was estab- make estimates and assumptions that affect the reported lished by Congress in 1913 and consists of the Board of amounts of assets and liabilities and the disclosure of Governors (Board), the Federal Open Market Committee, contingent assets and liabilities at the date of the financial the twelve regional Federal Reserve Banks, the Federal statements and the reported amounts of revenues and Advisory Council, and the private commercial banks that expenses during the reporting period. Actual results could are members of the System. The Board, unlike the differ from those estimates. Reserve Banks, was established as a federal government Reclassifications—Certain 2002 amounts have been agency and is supported by Washington staff numbering reclassified to conform with the 2003 presentation. approximately 1,800, as it carries out its responsibilities in conjunction with other components of the Federal (2) PROPERTY AND EQUIPMENT Reserve System. The following is a summary of the components of the The Board is required by the Federal Reserve Act to Board's property and equipment, at cost, net of accumureport its operations to the Speaker of the House of lated depreciation. Representatives. The Act also requires the Board, each year, to order a financial audit of each Federal Reserve As of December 31, Bank and to publish each week a statement of the finan- 2003 2002 cial condition of each such Reserve Bank and a consoli- Land and dated statement for all of the Reserve Banks. Accord- improvements ... $ 18,640,314 $ 18,640,314 ingly, the Board believes that the best financial disclosure Buildings 129,161,957 113,309,775 consistent with law is achieved by issuing separate finan- Furniture and cial statements for the Board and for the Reserve Banks. equipment 43,890,215 37,044,828 Therefore, the accompanying financial statements include Software 11,425,411 9,830,112 only the operations and activities of the Board. Combined Construction in financial statements for the Federal Reserve Banks are process 0 9,467,020 included in the Board's annual report to the Speaker of 203,117,897 188,292,049 the House of Representatives. Less accumulated Basis of Accounting—The financial statements have depreciation (53,522,838) (44,321,043) been prepared on the accrual basis of accounting. Property and Revenues—Assessments for operating expenses and equipment, net ... $149,595,059 $143,971,006 additions to property are based on expected cash needs. Amounts over or under assessed due to differences Furniture and equipment includes $1,156,000 and between actual and expected cash needs flow in to or out $864,000 for capitalized leases as of December 31, of "Cumulative Results of Operations" during the year. 2003 and 2002, respectively. Accumulated depreciation Issuance and Redemption of Federal Reserve Notes— includes $195,000 and $654,000 for capitalized leases as The Board incurs expenses and assesses the Federal of December 31, 2003 and 2002, respectively. The Board Reserve Banks for currency printing, issuance, retire- paid interest related to these capital leases in the amount ment, and shipping of Federal Reserve Notes. These of $76,007 and $15,731 for 2003 and 2002, respectively. assessments and expenses are separately reported in the The Board began the Eccles Building Infrastructure statements of revenues and expenses because they are not Enhancement Project in July 1999. This $12.5 million Board operating transactions. project, scheduled for nineteen phases over three and Property and Equipment—The Board's property, build- a half years, included asbestos removal, lighting and ings and equipment are stated at cost less accumulated plumbing improvements, cabling and other enhancedepreciation. Depreciation is calculated on a straight-line ments. This project was completed in 2003. basis over the estimated useful lives of the assets, which During 2002, fully depreciated furniture and equiprange from 3 to 10 years for furniture and equipment and ment totaling $22,350,000 was retired. from 10 to 50 years for building equipment and structures. Upon the sale or other disposition of a depreciable (3) RETIREMENT BENEFITS asset, the cost and related accumulated depreciation are Substantially all of the Board's employees participate removed from the accounts and any gain or loss is in the Retirement Plan for Employees of the Federal recognized. Reserve System (System Plan). The System Plan is a Collections—The Board has collections of works of multi-employer plan which covers employees of the Fedart, historical treasures, and similar assets. These collec- eral Reserve Banks, the Board, and the Plan Administrations are maintained and held for public exhibition in tive Office. furtherance of public service. Proceeds from any sales of Employees of the Board who became employed prior collections are used to acquire other items for collections. to 1984 are covered by a contributory defined benefits As permitted by FAS 116, the cost of collections pur- program under the System Plan. Employees of the Board chased by the Board is charged to expense in the year who became employed after 1983 are covered by a non- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

302 90th Annual Report, 2003 contributory defined benefits program under the System Change in plan assets Plan. Contributions to the System Plan are actuarially Fair value of plan assets determined and funded by participating employers at at beginning amounts prescribed by the System Plan's administrator. of year $ 0 $ 0 Actual return on plan Based on actuarial calculations, it was determined that assets 0 0 employer funding contributions were not required for the Employer contributions . 0 0 years 2003 and 2002, and the Board was not assessed Plan participants' a contribution for these years. Excess Plan assets are contributions 0 0 expected to continue to fund future years' contributions. Benefits paid 0 0 Because the plan is part of a multi-employer plan, infor- Fair value of plan assets mation as to vested and nonvested benefits, as well as at end of year $ 0 $ 0 plan assets, as it relates solely to the Board, is not readily available. Reconciliation of funded status at end of year A relatively small number of Board employees partici- Funded status .' $ (74,956) $ (12,866) pate in the Civil Service Retirement System (CSRS) or Unrecognized net the Federal Employees' Retirement System (FERS). The actuarial (gain)/ Board matches employee contributions to these plans. loss (231,189) (297,773) These defined benefit plans are administered by the Unrecognized prior Office of Personnel Management. The Board's contribu- service cost (289,456) (303,469) tions to these plans totaled $312,000 and $327,000 in Retirement benefit liability .... $ (595,601) $ (614,108) 2003 and 2002, respectively. The Board has no liability for future payments to retirees under these programs, and it is not accountable for the assets of the plans. Weighted-average assumptions used to Employees of the Board may also participate in the determine net periodic Federal Reserve System's Thrift Plan. Under the Thrift benefit cost for years Plan, members may contribute up to a fixed percentage ended December 31 of their salary. Board contributions are based upon a Discount rate 6.75% 7.00% fixed percentage of each member's basic contribution Expected asset return ... N/A N/A and were $7,692,000 and $7,185,000 in 2003 and 2002, Salary scale 4.25% 4.50% Corridor 10.00% 10.00% respectively. Effective January 1, 1996, Board employees covered Components of net under the System Plan are also covered under a Benefits periodic benefit cost Equalization Plan (BEP). Benefits paid under the BEP are Service cost $ 13,689 $ 3,363 limited to those benefits that cannot be paid from the Interest cost 3,412 561 System Plan due to limitations imposed by Sec- Expected return tions 401(a)(17), 415(b) and 415(e) of the Internal Reve- on plan assets 0 0 nue Code of 1986. Pension costs attributed to the BEP Amortization of reduce the pension costs of the System Plan. Activity for prior service cost .. (14,013) (14,013) Recognized actuarial the BEP for 2003 and 2002 is summarized in the follow- (gain)/loss $ (21,595) $ (27,431) ing table: Net periodic benefit cost $ (18,507) $ (37,520) 2003 2002 Change in benefit obligation (4) POSTRETIREMENT BENEFITS Projected benefit The Board provides certain life insurance programs for obligation at its active employees and retirees. Activity for 2003 and beginning of year 12,866 2,125 2002 is summarized in the following table: Service cost 13,689 3,363 Interest cost 3,412 561 2003 2002 Plan participants' contributions 0 0 Change in benefit Plan amendments 0 2,852 obligation Actuarial (gain)/loss .. 44,989 3,965 Benefit obligation at Benefits paid 0 0 beginning of year $ 6,134,395 $ 5,868,425 Service cost 170,636 158,179 Projected benefit Interest cost 414,319 386,215 obligation at Plan participants' end of year .. .... $ 74,956 $ 12,866 contributions 0 0 Plan amendments 0 0 Actuarial (gain)/loss .. 673,998 (63,554) Benefits paid (227,202) (214,870) Benefit obligation at end of year $ 7,166,146 $ 6,134,395 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 303 (5) POSTEMPLOYMENT BENEFIT PLAN Change in plan assets Fair value of plan The Board provides disability and survivor income assets at beginning benefits to eligible employees after employment but of year $ 0 $ 0 before retirement. Effective January 1, 1994, the Board Actual return on adopted Statement of Financial Accounting Standards plan assets 0 0 No. 112, Employers' Accounting for Postemployment Employer contributions . 227,202 213,958 Benefits, which requires that employers providing Plan participants' contributions 0 0 postemployment benefits to their employees accrue the Benefits paid (227,202) (213,958) cost of such benefits. Prior to January 1994, postemploy- Fair value of plan ment benefit expenses were recognized on a pay-asassets at end you-go basis. of year $ 0 $ 0 2003 2002 Reconciliation of Change in funded status benefit obligation at end of year Benefit obligation Funded status $(7,166,146) $(6,134,395) at beginning Unrecognized net of year $4,299,252 $3,591,571 actuarial (gain)/loss 1,760,246 1,126,688 Service cost 955,926 891,192 Unrecognized prior Interest cost 157,545 166,520 service cost 83,847 89,920 Plan participants' Prepaid/(accrued) contributions ... 0 0 postretirement Plan amendments .... 0 0 benefit liability .... $(5,322,053) $(4,917,787) Actuarial (gain)/loss . (156,797) (76,282) Benefits paid (306,034) (273,749) Components of net periodic cost Benefit obligation at for year end of year $4,949,892 $4,299,252 Service cost $ 170,636 $ 158,179 Interest cost 414,319 386,215 Weighted-average Amortization of prior assumptions as of service cost 6,073 6,073 December 31 Amortization of Discount rate 6.25% 6.75% (gains)/losses 40,440 26,706 Expected asset return N/A N/A Total net periodic cost $ 631,468 $ 577,173 Salary scale 4.00% 4.25% Corridor 10.00% 10.00% The liability and costs for the postretirement benefit plan were determined using discount rates of 6.25 percent (6) OTHER REVENUES AND OTHER EXPENSES and 6.75 percent as of December 31, 2003 and 2002, The following are summaries of the components of respectively. Unrecognized losses of $1,760,246 and Other Revenues and Other Expenses. $1,126,688 as of December 31, 2003 and 2002, respectively, result from changes in the discount rate used to As of December 31, measure the liabilities. Under Statement of Financial 2003 2002 Accounting Standards No. 106, Employers' Accounting Other revenues for Postretirement Benefits Other Than Pensions, the Data processing Board may have to record some of these unrecognized revenue $4,639,084 $4,830,600 losses in operations in future years. The assumed salary Rent 2,029,514 1,996,893 trend rate for measuring the increase in postretirement Subscription benefits related to life insurance was an average of revenue 799,356 810,032 4.00 percent. Reimbursable The above accumulated postretirement benefit obliga- services to tion is related to the Board sponsored life insurance other agencies ... 588,894 788,095 programs. The Board has no liability for future payments Board sponsored to employees who continue coverage under the federally conferences 275,110 115,965 sponsored life and health programs upon retiring. Contri- National Information butions for active employees participating in federally Center 24,422 30,334 sponsored health programs totaled $7,188,000 and Miscellaneous 479,060 467,498 $6,205,000 in 2003 and 2002, respectively. Total Other Revenues $8,835,440 $9,039,417 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

304 90th Annual Report, 2003 Other expenses 2003 2002 Tuition, registration, and membership Board paid to the fees $1,615,074 $1,642,013 Public transportation Council: Assessments for subsidy 732,124 745,973 operating expenses Contingency of the Council 105,920 $ 300,000 operations 704,699 264,232 Central Data Subsidies and Repository 630,000 0 contributions 627,854 900,049 Uniform Bank Meals and Performance Report . 201,666 0 representation ... 534,618 378,387 Total Board Former employee paid to the related Council 937,586 $ 300,000 payments 507,082 158,066 Security Council paid to the investigations 473,659 229,387 Board: Equipment and Data processing facilities rental ... 439,751 318,132 related services 3,485,701 3,350,412 Administrative Administrative law judges 307,173 147,830 services 72,250 69,593 Miscellaneous 700,084 357,521 Total Council paid to the Total Other Board $3,557,951 $3,420,005 Expenses $6,642,118 $5,141,590 (9) FEDERAL RESERVE BANKS (7) COMMITMENTS The Board performs certain functions for the Reserve The Board has entered into several operating leases to Banks in conjunction with its responsibilities for the secure office, training and warehouse space for remaining Federal Reserve System, and the Federal Reserve Banks periods ranging from one to four years. In addition, the provide certain administrative functions for the Board. Board has entered into an agreement with the Federal Activity related to the Board and Reserve Banks for 2003 Deposit Insurance Corporation and the Office of the and 2002 is summarized in the following table: Comptroller of the Currency, through the Federal Financial Institutions Examination Council (the "Council") to 2003 2002 fund a portion of enhancements for a central data reposi- Board paid to the tory project through 2013. Reserve Banks: Mimimum annual payments under the operating leases Assessments for having an initial or remaining noncancelable lease term in employee benefits .. $ 2,137,781 $ 2,014,839 excess of one year at December 31, 2003, are as follows: Data processing and communication 1,963,247 2,154,087 2004 $157,079 Contingency site 704,699 264,232 2005 163,363 Total Board paid 2006 71,991 to the Reserve Banks $ 4,805,727 $ 4,433,158 After 2006 0 $392,433 Reserve Banks paid to the Board: Assessments for Rental expenses under the operating leases were currency costs $508,144,248 $429,568,393 $156,000 in 2003 and 2002. Assessments for operating expenses (8) FEDERAL FINANCIAL INSTITUTIONS of the Board 297,020,200 205,110,800 EXAMINATION COUNCIL Data processing 1,484,015 1,281,759 The Board is one of the five member agencies of Total Reserve Banks paid to the the Council, and currently performs certain management Board $806,648,463 $635,960,952 functions for the Council. The five agencies which are represented on the Council are the Board, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, and Office of Thrift Supervision. The Board's financial statements do not include financial data for the Council. Activity related to the Board and Council for 2003 and 2002 is summarized in the following table: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 305 fllBH KPMG LLP 2001 M Street NW Washington, DC 20036 Independent Auditors' Report on Internal Control over Financial Reporting To the Board of Governors of the Federal Reserve System: We have audited the balance sheets of the Board of Governors of the Federal Reserve System (the Board) as of December 31, 2003 and 2002, and the related statements of revenues and expenses and changes in cumulative results of operations, and cash flows for the years then ended, and have issued our report thereon dated April 2, 2004. 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. In planning and performing our fiscal year 2003 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 the Board's internal control over financial reporting. Consequently, we do not provide an opinion thereon. Our consideration of the internal control over financial reporting would not necessarily disclose all matters in the internal control over financial reporting that might be material weaknesses under standards issued 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. However, we noted no matters involving the 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 members of the Board and its management, the Office of Inspector General, the U.S. Office of Management and Budget, and Congress, and is not intended to be and should not be used by anyone other than these specified parties. April 2,2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

306 90th Annual Report, 2003 KPMG LLP 2001 M Street NW Washington, DC 20036 Independent Auditors' Report on Compliance with Laws and Regulations To the Board of Governors of the Federal Reserve System: We have audited the balance sheets of the Board of Governors of the Federal Reserve System (the Board) as of December 31, 2003 and 2002, and the related statements of revenues and expenses and changes in cumulative results of operations, and cash flows for the years then ended, and have issued our report thereon dated April 2, 2004. 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 2003 financial statements are free of material misstatement, we performed tests of the Board's 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 members of the Board and its management, the Office of Inspector General, the U.S. Office of Management and Budget, and Congress, and is not intended to be and should not be used by anyone other than these specified parties. $ ir LDP April 2,2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

307 Federal Reserve Banks Combined Financial Statements The combined financial statements of the Federal Reserve Banks were audited by PricewaterhouseCoopers LLP, independent auditors, for the years ended December 31, 2003 and 2002. PRICB/VATERHOUS^OOPERS REPORT OF INDEPENDENT AUDITORS 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, 2003 and 2002, 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, 2003 and 2002, 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

308 90th Annual Report, 2003 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CONDITION December 31, 2003 and 2002 (in millions) ASSETS 2003 2002 Gold certificates $ 11,039 $ 11,039 Special drawing rights certificates 2,200 2,200 Coin 722 988 Items in process of collection 7,793 10,291 Loans to depository institutions 62 40 Securities purchased under agreements to resell (tri-party) 43,750 39,500 U.S. government and federal agency securities, net 675,569 639,125 Investments denominated in foreign currencies 19,868 16,913 Accrued interest receivable 5,064 5,470 Bank premises and equipment, net 2,117 2,044 Other assets 3,303 3,367 Total assets $771,487 $730,977 LIABILITIES AND CAPITAL LIABILITIES Federal Reserve notes outstanding, net $689,757 $654,273 Securities sold under agreements to repurchase 25,652 21,091 Deposits Depository institutions 23,058 22,541 U.S. Treasury, general account 5,723 4,420 Other deposits 394 444 Deferred credit items 7,582 9,459 Interest on Federal Reserve notes due U.S. Treasury 428 838 Accrued benefit costs 956 915 Other liabilities 243 236 Total liabilities 753,793 714,217 CAPITAL Capital paid-in 8,847 8,380 Surplus 8,847 8,380 Total capital 17,694 16,760 Total liabilities and capital $771,487 $730,977 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 309 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF INCOME for the years ended December 31, 2003 and 2002 (in millions) 2003 2002 Interest income Interest on U.S. government and federal agency securities $22,597 $25,525 Interest on investments denominated in foreign currencies 260 272 Interest on loans to depository institutions 1 2 Total interest income 22,858 25,799 Interest expense Interest expense on securities sold under agreements to repurchase 215 13 Net interest income 22,643 25,786 Other operating income Income from services 887 916 Reimbursable services to government agencies 328 309 Foreign currency gains, net 2,695 2,083 Government securities gains, net 77 Other income 79 80 Total other operating income 3,989 3,465 Operating expenses Salaries and other benefits 1,817 1,377 Occupancy expense 213 208 Equipment expense 257 263 Assessments by Board of Governors 805 635 Other expenses 534 720 Total operating expenses 3,626 3,203 Net income prior to distribution $23,006 $26,048 Distribution of net income Dividends paid to member banks $ 518 $ 484 Transferred to surplus 467 1,068 Payments to U.S. Treasury as interest on Federal Reserve notes 22,021 24,496 Total distribution $23,006 $26,048 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

310 90th Annual Report, 2003 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CHANGES IN CAPITAL for the years ended December 31, 2003 and 2002 (in millions) Capital Total paid-in Surplus capital Balance at January 1, 2002 (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 Net income transferred to surplus 467 467 Net change in capital stock issued (9 million shares) 467 467 Balance at December 31, 2003 (176 million shares) $8,847 $8,847 $17,694 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 independent Reserve Banks is prepared with adjustments short-term loans to depository institutions; serving the to eliminate interdistrict accounts and transactions. consumer and the community by providing educational 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 311 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED In performing fiscal agency functions for the U.S. information. There are no other significant differences Treasury, seven Reserve Banks provide U.S. securities between the policies outlined in the Financial Accounting direct purchase and savings bond processing services. Manual and GAAP. In December 2003, the U.S. Treasury announced plans The preparation of the combined financial statements to consolidate the provision of these services at FRB in conformity with the Financial Accounting Manual Cleveland and Minneapolis. An implementation plan is requires management to make certain estimates and expected to be announced in March 2004. At this time, assumptions that affect the reported amounts of assets and the Banks have not developed a detailed estimate of the liabilities, disclosure of contingent assets and liabilities at financial effect of the consolidation. the date of the combined financial statements, and the 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 lend- (A) Gold Certificates ing of U.S. government securities. FRBNY is also authorized 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 (B) Special Drawing Rights Certificates are appropriate for the significantly different nature and function of a central bank as compared with the private Special drawing rights (SDRs) are issued by the Internasector. These accounting principles and practices are tional Monetary Fund (Fund) to its members in propordocumented in the Financial Accounting Manual for Fed- tion to each member's quota in the Fund at the time of eral Reserve Banks {Financial Accounting Manual), issuance. SDRs serve as a supplement to international which is issued by the Board of Governors. All Reserve monetary reserves and may be transferred from one Banks are required to adopt and apply accounting policies national monetary authority to another. Under the law and practices that are consistent with the Financial providing for United States participation in the SDR Accounting Manual. system, the Secretary of the U.S. Treasury is authorized to These combined financial statements have been pre- issue SDR certificates, somewhat like gold certificates, to pared in accordance with the Financial Accounting the Reserve Banks. At such time, equivalent amounts in Manual. Differences exist between the accounting prin- dollars are credited to the account established for the U.S. ciples and practices of the System and generally accepted Treasury, and the Reserve Banks' SDR certificate account accounting principles in the United States of America is increased. The Reserve Banks are required to purchase (GAAP). The primary differences are the presentation SDR certificates, at the direction of the U.S. Treasury, for of all security holdings at amortized cost, rather than at the purpose of financing SDR acquisitions or for financthe fair value presentation requirements of GAAP, and ing exchange stabilization operations. There were no SDR the accounting for matched sale-purchase transactions as transactions in 2003 or 2002. separate sales and purchases, rather than secured borrowings with pledged collateral, as is generally required (C) Loans to Depository Institutions by GAAP. In addition, the Board of Governors and the Reserve Banks have elected not to present a Statement of The Depository Institutions Deregulation and Monetary Cash Flows. The Statement of Cash Flows has not been Control Act of 1980 provides that all depository instiincluded, because the liquidity and cash position of the tutions that maintain reservable transaction accounts or Reserve Banks are not of primary concern to users of nonpersonal time deposits, as defined in Regulation D these combined financial statements. Other information issued by the Board of Governors, have borrowing priviregarding the Reserve Banks' activities is provided in, or leges at the discretion of the Reserve Banks. Borrowers may be derived from, the Statements of Condition, execute certain lending agreements and deposit suffi- Income, and Changes in Capital. A Statement of Cash cient collateral before credit is extended. Loans are evalu- Flows, therefore, would not provide any additional useful ated for collectibility, and currently all are considered Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

312 90th Annual Report, 2003 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED collectible and fully collateralized. If loans were ever price, on a specified date. Spot foreign contracts normally deemed to be uncollectible, an appropriate reserve would settle two days after the trade date, whereas the settlement be established. Interest is accrued using the applicable date on forward contracts is negotiated between the condiscount rate established at least every fourteen days by tracting parties, but will extend beyond two days from the the Board of Directors of the Reserve Banks, subject to trade date. The FRBNY generally enters into spot conreview by the Board of Governors. tracts, with any forward contracts generally limited to the second leg of a swap/warehousing transaction. (D) U.S. Government and Federal Agency Securities and The FRBNY, on behalf of the Reserve Banks, main- Investments Denominated in Foreign Currencies tains renewable, short-term F/X swap arrangements with two authorized foreign central banks. The parties agree to The FOMC has designated the FRBNY to execute open exchange their currencies up to a pre-arranged maximum market transactions on its behalf and to hold the resulting amount and for an agreed-upon period of time (up to securities in the portfolio known as the System Open twelve months), at an agreed-upon interest rate. These Market Account (SOMA). In addition to authorizing and arrangements give the FOMC temporary access to foreign directing operations in the domestic securities market, currencies that it may need for intervention operations to the FOMC authorizes and directs the FRBNY to execute support the dollar and give the partner foreign central operations in foreign markets for major currencies in bank temporary access to dollars it may need to support order to counter disorderly conditions in exchange mar- its own currency. Drawings under the F/X swap arrangekets or to meet other needs specified by the FOMC in ments can be initiated by either the FRBNY or the partner carrying out the System's central bank responsibilities. foreign central bank and must be agreed to by the drawee. Such authorizations are reviewed and approved annually The F/X swaps are structured so that the party initiating by the FOMC. the transaction (the drawer) bears the exchange rate risk In December 2002, matched sale-purchase (MSP) upon maturity. The Bank will generally invest the foreign transactions were replaced with securities sold under currency received under an F/X swap in interest-bearing agreements to repurchase. MSP transactions, accounted instruments. for as separate sale and purchase transactions, are trans- Warehousing is an arrangement under which the actions in which the FRBNY sells a security and buys it FOMC agrees to exchange, at the request of the Treasury, back at the rate specified at the commencement of the U.S. dollars for foreign currencies held by the Treasury transaction. Securities sold under agreements to repur- or ESF over a limited period of time. The purpose of the chase are treated as secured borrowing transactions with warehousing facility is to supplement the U.S. dollar the associated interest expense recognized over the life of resources of the Treasury and ESF for financing purthe transaction. chases of foreign currencies and related international In addition to the aforementioned matched sale- operations. purchase transactions and sales of securities under agree- In connection with its foreign currency activities, the ments to repurchase, the FRBNY may engage in tri-party FRBNY, on behalf of the Reserve Banks, may enter into purchases of securities under agreements to resell (tri- contracts which contain varying degrees of off-balanceparty agreements). Tri-party agreements are conducted sheet market risk, because they represent contractual comwith two custodial banks that manage the clearing and mitments involving future settlement, and counter-party settlement of collateral. Acceptable collateral under tri- credit risk. The FRBNY controls credit risk by obtaining party agreements primarily includes U.S. government and credit approvals, establishing transaction limits, and peragency securities, pass-through mortgage securities of forming daily monitoring procedures. Government National Mortgage Association, Federal While the application of current market prices to the Home Loan Mortgage Corporation, and Federal National securities currently held in the SOMA portfolio and Mortgage Association, STRIP securities of the U.S. gov- investments denominated in foreign currencies may result ernment and "stripped" securities of other government in values substantially above or below their carrying agencies. The tri-party agreements are accounted for as values, these unrealized changes in value would have no financing transactions with the associated interest income direct effect on the quantity of reserves available to the accrued over the life of 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 are incidental to the open market operations and do not market values of the securities loaned. The market values motivate its activities or policy decisions. of the collateral and the securities loaned are monitored 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 313 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED is accrued on a straight-line basis and is reported as Reserve Act was amended to expand the assets eligible to "Interest on U.S. government and federal agency securi- be pledged as collateral security to include all Federal ties" or "Interest on investments denominated in foreign Reserve Bank assets. Prior to the amendment, only gold currencies," as appropriate. Income earned on securities certificates, special drawing rights certificates, U.S. govlending transactions is reported as a component of "Other ernment and federal agency securities, securities purincome." Gains and losses resulting from sales of securi- chased under agreements to resell, loans to depository ties are determined by specific issues based on average institutions, and investments denominated in foreign curcost. Gains and losses on the sales of U.S. govern- rencies could be pledged as collateral. The collateral ment and federal agency securities are reported as value is equal to the book value of the collateral tendered, "Government securities gains, net." Foreign-currency- with the exception of securities whose collateral value denominated assets are revalued daily at current market is equal to the par value of the securities tendered and exchange rates in order to report these assets in U.S. securities purchased under agreements to resell, which dollars. Realized and unrealized gains and losses on are valued at the contract amount. The par value of investments denominated in foreign currencies are securities pledged for securities sold under agreements to reported as "Foreign currency gains (losses), net." For- repurchase is similarly deducted. The Board of Governors eign currencies held through F/X swaps, when initiated may, at any time, call upon a Reserve Bank for additional by the counteiparty, and warehousing arrangements are security to adequately collateralize the Federal Reserve revalued daily with the unrealized gain or loss reported as notes. To satisfy the obligation to provide sufficient cola component of "Other assets" or "Other liabilities." as lateral for outstanding Federal Reserve notes, the Reserve appropriate. Banks have entered into an agreement that provides that In 2003, additional interest income of $61 million, certain assets of the Reserve Banks are jointly pledged as representing one day's interest on the SOMA portfolio, collateral for the Federal Reserve notes of all Reserve was accrued to reflect a change in interest accrual meth- Banks. In the event that this collateral is insufficient, the ods. Interest accruals and the amortization of premiums Federal Reserve Act provides that Federal Reserve notes and discounts are now recognized beginning the day that become a first and paramount lien on all the assets of the a security is purchased and ending the day before the Reserve Banks. Finally, as obligations of the United security matures or is sold. Previously, accruals and amor- States, Federal Reserve notes are backed by the full faith tization began the day after the security was purchased and credit of the United States government. and ended on the day that the security matured or was The "Federal Reserve notes outstanding, net" account sold. The effect of this change was not material; there- represents Federal Reserve notes outstanding reduced by fore, it was included in the 2003 interest income. the Reserve Banks' currency holdings of $110,176 million and $104,983 million at December 31, 2003 and 2002, respectively. (E) Bank Premises, Equipment, and Software At December 31, 2003 all Federal Reserve notes outstanding were fully collateralized. All gold certificates, Bank premises and equipment are stated at cost less all special drawing rights certificates, and $676,518 milaccumulated depreciation. Depreciation is calculated on a lion of domestic securities and securities purchased under straight-line basis over estimated useful lives of assets agreements to resell were pledged as collateral. At ranging from two to fifty years. Major alterations, renova- December 31, 2003, no loans or investments denominated tions and improvements are capitalized at cost as additions to the asset accounts. Maintenance, repairs and in foreign currencies were pledged as collateral. minor replacements are charged to operations in the year (G) Capital Paid-in incurred. Costs incurred for software, either developed internally or acquired for internal use, during the appli- The Federal Reserve Act requires that each member bank cation stage are capitalized based on the cost of direct subscribe to the capital stock of the Reserve Bank in an services and materials associated with designing, coding, amount equal to 6 percent of the capital and surplus of the installing, or testing software. Capitalized software costs member bank. As a member bank's capital and surplus are amortized on a straight-line basis over the estimated useful lives of the software applications, which range changes, its holdings of the Reserve Bank's stock must be from two to five years. adjusted. Member banks are those state-chartered banks that apply and are approved for membership in the System and all national banks. Currently, only one-half of the (F) Federal Reserve Notes subscription is paid-in and the remainder is subject to call. These shares are nonvoting with a par value of $100. Federal Reserve notes are the circulating currency of the They may not be transferred or hypothecated. By law, United States. These notes are issued through the various each member bank is entitled to receive an annual divi- Federal Reserve agents (the Chairman of the Board of dend of 6 percent on the paid-in capital stock. This Directors of each Reserve Bank) to the Reserve Banks cumulative dividend is paid semiannually. A member upon deposit with such agents of certain classes of collat- bank is liable for Reserve Bank liabilities up to twice the eral security, typically U.S. government securities. These par value of stock subscribed by it. notes are identified as issued to a specific Reserve Bank. The Federal Reserve Act provides that the collateral (H) Surplus security tendered by the Reserve Bank to the Federal Reserve agent must be equal to the sum of the notes The Board of Governors requires Reserve Banks to mainapplied for by such Reserve Bank. In 2003, the Federal tain a surplus equal to the amount of capital paid-in as of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

314 90th Annual Report, 2003 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED December 31. This amount is intended to provide addi- with enhanced postretirement benefits provided by the tional capital and reduce the possibility that the Reserve Reserve Banks are discussed in footnote 9. Banks would be required to call on member banks for additional capital. Pursuant to Section 16 of the Federal (4) U.S. GOVERNMENT AND FEDERAL AGENCY Reserve Act, Reserve Banks are required by the Board of SECURITIES Governors to transfer to the U.S. Treasury as interest on Federal Reserve notes excess earnings, after providing for Securities bought outright are held in the SOMA at the the costs of operations, payment of dividends, and reser- FRBNY. vation of an amount necessary to equate surplus with capital paid-in. Total securities held in the SOMA at December 31 that In the event of losses, or a substantial increase in were bought outright, were as follows (in millions): capital, a Reserve Bank will suspend its payments to the U.S. Treasury until such losses or increases in capital are 2003 2002 recovered through subsequent earnings. Weekly payments to the U.S. Treasury may vary significantly. ^^ aggncy $ $ 1Q U.S. government (I) Income and Costs Related to Treasury Services Bills 244 833 226 682 Notes'.'.'.'.'.'.'.''.'.'.'.'.'.'.'.'.'.'..' 323^361 297^893 Reserve Banks are required by the Federal Reserve Act Bonds 98,471 104,832 to serve as fiscal agents and depositories of the United Total par value 666,665 629,417 States. By statute, the Department of the Treasury is permitted, but not required, to pay for these services. Unamortized premiums 9,797 10,762 Unaccreted discounts (893) (1,054) (J) Taxes Total $675,569 $639,125 The Reserve Banks are exempt from federal, state, and local taxes, except for taxes on real property. Real prop- As noted in footnote 3, the FRBNY replaced MSP ery taxes were $33 million and $32 million for the years transactions with securities sold under agreements to ended December 31, 2003 and 2002, respectively, and are repurchase in December 2002. At December 31, 2003 and reported as a component of "Occupancy expense." 2002, securities sold under agreements to repurchase with a contract amount of $25,652 million and $21,091 mil- (K) Recent Accounting Developments lion, respectively, were outstanding. At December 31, 2003 and 2002, securities sold under agreements to repur- In May 2003, the Financial Accounting Standards Board chase with a par value of $25,658 million and $21,098 issued SFAS No. 150, "Accounting for Certain Financial million, respectively, were outstanding. Instruments with Characteristics of both Liabilities and The maturity distribution of U.S. government and fed- Equity." SFAS No. 150, which will become applicable for eral agency securities bought outright, securities purthe Reserve Banks in 2004, establishes standards for how chased under agreements to resell, and securities sold an issuer classifies and measures certain financial instru- under agreements to repurchase, which were held in ments with characteristics of both liabilities and equity the SOMA at December 31, 2003, was as follows (in and imposes certain additional disclosure requirements. millions): When adopted, there may be situations in which a Reserve Bank has not yet processed a member bank's Securities Securities application to redeem its Reserve Bank stock. In those purchased sold situations, this standard requires that the portion of the under under agree- agreecapital paid-in that is mandatorily redeemable be reclassi- U.S. ments to ments to fied as debt. government resell repurchase Maturities of securities (Contract (Contract (L) 2003 Restructuring Charges securities held (Par) amount) amount) In 2003, the System restructured several operations, pri- Within 15 days ... $ 47,733 $43,750 $25,652 marily in the check and currency services. The restructur- 91 days to 1 year 164^071 ing included streamlining the management and support Over 1 year to structures, reducing staff, decreasing the number of pro- 5 years .. 187,056 cessing locations, and increasing processing capacity in Over 5 years to the remaining locations. 10 years ..... 51,312 Footnote 10 describes the restructuring and provides Over 10 years ..... 77,146 information about Reserve Bank costs and liabilities asso- Total .... $666,665 $43,750 $25,652 ciated with employee separations and contract terminations. The costs associated with the write-down of certain Reserve Bank assets are discussed in footnote 6. Costs At December 31, 2003 and 2002, U.S. government and liabilities associated with enhanced pension benefits securities with par values of $4,426 million and for all Reserve Banks are recorded on the books of the $1,841 million, respectively, were loaned from the FRBNY as discussed in footnote 8 and those associated SOMA. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 315 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED (5) INVESTMENTS DENOMINATED IN Bank premises and equipment at December 31 include FOREIGN CURRENCIES the following amounts for leases that have been capitalized (in millions): The FRBNY, on behalf of the Reserve Banks, holds foreign currency deposits with foreign central banks and 2003 2002 the Bank for International Settlements, and invests in Bank premises and equipment $36 $15 foreign government debt instruments. Foreign govern- Accumulated depreciation (27) 02) ment debt instruments held include both securities bought outright and securities held under agreements to resell. Capitalized leases, net $_9 $_3 These investments are guaranteed as to principal and interest by the foreign governments. Certain of the Reserve Banks lease unused space to Total investments denominated in foreign currencies, outside tenants. Those leases have terms ranging from 1 valued at current exchange rates at December 31, were as to 13 years. Rental income from such leases totaled follows (in millions): $20 million and $21 million for the years ended Decem- 2003 2002 ber 31, 2003 and 2002, respectively. Future minimum lease payments under noncancelable agreements in exist- European Union Euro ence at December 31, 2003, were (in millions): Foreign currency deposits $ 6,870 $ 5,580 Government debt instruments including agreements 2004 . $18 2005 16 to resell 4,090 3,298 2006 13 2007 9 Japanese Yen Foreign currency deposits 1,475 1,789 2008 8 Thereafter 34 Government debt instruments including agreements Total .. $98 to resell 7,341 6,164 Accrued interest 92 82 The Reserve Banks have capitalized software assets, net of amortization, of $158 million and $141 million at Total $19,868 $16,913 December 31, 2003 and 2002, respectively. Amortization The maturity distribution of investments denominated expense was $54 million and $45 million for the years in foreign currencies at December 31, 2003, was as ended December 31, 2003 and 2002, respectively. follows (in millions): Several Reserve Banks have impaired assets as a result of the System's restructuring plan, as discussed in foot- Maturities of Investments Denominated note 10, or as a result of the System's decision to stanin Foreign Currencies dardize check processing. Impaired assets include software, buildings, leasehold improvements, furniture, and Within 1 year $18,243 Over 1 year to 5 years 1,292 equipment. Asset impairment losses related to the restruc- Over 5 years to 10 years 333 turing and check processing standardization of $11 mil- Over 10 years lion and $3 million, respectively, for the period ending December 31, 2003 were determined using fair values Total $19,868 based on quoted market values or other valuation tech- At December 31, 2003 and 2002, there were no out- niques and are reported as a component of "Other standing F/X swaps or material open foreign exchange expenses." contracts. Three Reserve Banks are constructing new buildings, At December 31, 2003 and 2002, the warehousing facil- one to replace the head office and two to replace branch ity was $5,000 million, with no balance outstanding. offices. At December 31, 2003, the contractual obligation for the property for the new head office building site was (6) BANK PREMISES, EQUIPMENT, AND SOFTWARE $18 million, none of which has been recognized. The obligation was satisfied in February 2004. A summary of bank premises and equipment at December 31 is as follows (in millions): (7) COMMITMENTS AND CONTINGENCIES 2003 2002 Bank premises and equipment At December 31, 2003, the Reserve Banks were obligated Land $ 244 $ 209 under noncancelable leases for premises and equipment Buildings 1,559 1,514 with terms ranging from 1 to 20 years. These leases Building machinery and provide for increased rental payments based upon equipment 364 345 increases in real estate taxes, operating costs, or selected Construction in progress 96 51 price indices. Furniture and equipment 1,334 1,362 Rental expense under operating leases for certain oper- Subtotal 3,597 3,481 ating facilities, warehouses, and data processing and office equipment (including taxes, insurance and mainte- Accumulated depreciation (1,480) (1,437) nance when included in rent), net of sublease rentals, was Bank premises and $71 million and $70 million for the years ended December 31, 2003 and 2002, respectively. Certain of the equipment, net $2,117 $2,044 Reserve Banks' leases have options to renew. Digitized for FRDAepSreEciRat ion expense, http://fraser.stlouisffoerd t.hoer yge/a rs ended .... $ 184 $ 187 Federal Reserve Bank of St. Louis

316 90th Annual Report, 2003 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Future minimum rental payments under noncancelable as a sponsor of the Plan for the System and costs assooperating and capital leases, net of sublease rentals, with ciated with the Plan are not redistributed to other particiterms of one year or more, at December 31, 2003, were pating employers. The prepaid pension cost includes (in millions): amounts related to the participating employees of all employers who participate in the plans. Following is a reconciliation of the beginning and ending balances of the System Plan benefit obligation (in 2004 $ 10.5 $ 2.7 millions): 2005 8.2 2.1 2006 7.3 1.9 2007 6.5 .6 2003 2002 2008 6.5 Thereafter .. 124.7 Estimated actuarial present value of projected benefit $163.7 $ 7.3 obligation at January 1 $3,523 $3,091 Service cost—benefits earned Amount representing interest .. (•5) during the period 109 104 $ 6.8 Interest cost on projected benefit obligation 232 226 Actuarial loss 192 126 At December 31, 2003, the Reserve Banks had con- Contributions by plan participants .. 4 3 tractual commitments through the year 2008 totaling Benefits paid (197) (170) $153 million for the maintenance of currency machines, Special termination check-processing-related services, and check transporta- loss/amendments 67 143 tion services, none of which has been recognized. Three Estimated actuarial present value Reserve Banks contract for these services on behalf of the of projected benefit System and two of them allocate the costs to the other obligation at December 31 .... $3,930 $3,523 Reserve Banks. Three Reserve Banks have additional contractural commitments through the year 2008 for software develop- Following is a reconciliation of the beginning and ment and maintenance, architectural and contracting ser- ending balances of the System Plan assets, the funded vices, and building maintenance. At December 31, 2003, status, and the prepaid pension benefit costs (in millions): these contractual commitments totaled $169 million, none of which has been recognized. 2003 2002 The Reserve Banks are involved in certain legal actions Estimated fair value of plan and claims arising in the ordinary course of business. assets at January 1 $4,997 $5,795 Although it is difficult to predict the ultimate outcome of Actual return on plan assets 899 (631) these actions, in management's opinion, based on discus- Contributions by plan participants .. 4 3 sions with counsel, the aforementioned litigation and Employer contributions • • • • • Benefits paid (197) (170) claims will be resolved without material adverse effect on the financial position or results of operations of the Estimated fair value of plan Reserve Banks. assets at December 31 $5,703 $4,997 Funded status $1,774 $1,474 (8) RETIREMENT AND THRIFT PLANS Unrecognized prior service cost 197 223 Unrecognized net actuarial loss 710 1,042 Retirement Plans Prepaid pension benefit costs 2,681 2,739 The Reserve Banks currently offer two defined benefit Prepaid pension benefit costs are reported as a component retirement plans to their employees, based on length of of "Other assets." service and level of compensation. Substantially all of the Reserve Banks', Board of Governors', and the Plan The accumulated benefit obligation for the defined Administrative Office's employees participate in the benefit pension plan was $3,456 million and $2,996 mil- Retirement Plan for Employees of the Federal Reserve lion at December 31, 2003, and 2002, respectively. System (System Plan) and the Benefit Equalization The weighted-average assumptions used in developing Retirement Plans offered by each individual Reserve the pension benefit obligation for the System Plan as of Bank (BEP). In addition, certain Bank officers participate December 31 are as follows: in a Supplemental Employee Retirement Plan (SERP). The System Plan is a multi-employer plan with contributions fully funded by participating employers. Partici- 2003 2002 pating employers are the Federal Reserve Banks, the Discount rate ... 6.25% 6.75% Board of Governors of the Federal Reserve System, and Rate of compensation increase ... 4.00% 4.25% the Office of Employee Benefits of the Federal Reserve Employee Benefits System. Certain Board employees not covered by the Social Security Act also contribute to the plan. No separate accounting is maintained of assets contributed by the participating employers. FRBNY acts Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 317 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED The weighted-average assumptions used in developing broadly diversified investment-grade fixed income index net periodic benefit cost for the System Plan for the years (rebalanced monthly). The managers invest Plan funds ending December 31 are as follows: within CIP-established guidelines for investment in equities and fixed income instruments. Equity invest- 2003 2002 ments can range between 40 percent and 80 percent of the Discount rate 6.75% 7.00% Portfolio. Investments, however, cannot be concentrated Expected asset return 8.50% 9.00% m particular industries and equity security holdings of Rate of compensation increase 4.25% 4.50% any one company are limited. Fixed income securities must be investment grade and the effective duration of The long-term rate of return on assets was based on a the flxed income portfolio must remain within a range combination of methodologies including the System of 67 percent and 150 percent of a broadly diversi- Plan's historical returns, surveys of other plans' expected fied investment-grade fixed income index. System Plan rates of return, building a projected return for equities and investment policies prohibit margin, short sale, foreign fixed income investments based on real interest rates, exchange, and commodities trading as well as investment inflation expectations and equity risk premiums and in bank5 bank holding company, savings and loan, and finally, surveys of expected returns in equity and fixed government securities dealer's stocks. In addition, investincome markets. ments in non-dollar denominated securities are prohib- „, j, . j. , „ ited; however, a small portion of the portfolio can be / Th J- e x c o o mp i on r e . n ts of ™ ne t perio / d -r i x c pens i i on I* b enefit • cost i . nve ' st . e d , i . n AA mer . i can ^ D epos • i « ta . ry r R > e ceip • t/sC/S u hares. (credit) for the System Plan as of December 31 are shown __ „ , . _, / * \ _ . J, '. ii- \ The Federal Reserve System does not expect to make a below (in millions): cash contribution t0 the Retirement Plan during 2004. ?oo? ^e ^eserve Banks' projected benefit obligations and ^^ ^^ net pension costs for the BEP and the SERP at Decem- Service cost benefits earned ber 31, 2003 and 2002, and for the years then ended, are during the period $ 109 $ 104 not material. Interest cost on projected benefit obligation 232 226 Thrift Plan Amortization of prior service cost •••••• ~" ^' Employees of the Reserve Banks may also participate in E^«edereturn on plan assets'!!!! i! (418) (514) *e defined contribution Thrift Plan for Employees of the Federal Reserve System (Thrift Plan). The Reserve Net periodic pension benefit credit .. (9) (157) Banks' Thrift Plan contributions totaled $64 million and Special termination benefits _67 ^_^ $63 million for the years ended December 31, 2003 and Net periodic pension benefit 2002, respectively, and are reported as a component of cost (credit) $ 58 $(157) "Salaries and other benefits." The recognition of special termination benefits is the (9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS result of enhanced retirement benefits provided to 1,184 AND POSTEMPLOYMENT BENEFITS System employees in conjunction with the restructuring disclosed in footnote 10. Net periodic pension benefit Postretirement Benefits Other Than Pensions cost (credit) is reported as a component of "Salaries and other benefits." In addition to the Reserve Banks' retirement plans, employees who have met certain age and length of ser- The Federal Reserve System's pension plan weightedaverage asset allocations at December 31, by asset cate- vice requirements are eligible for both medical benefits gory are as follows: and life insurance coverage during retirement. The Reserve Banks fund benefits payable under the 2003 2002 medical and life insurance plans as due and, accordingly, have no plan assets. Net postretirement benefit costs are Equities 61.9% 64.6% actuarially determined using a January 1 measurement Fixed income 34.8% 32.2% Cash 3.3% 3.2% date. Total 100.0% 100.0% The System's Committee on Investment Performance (CIP) contracts with investment managers who are responsible for implementing the System Plan's investment policies. The managers' performance is measured against a trailing 36-month-benchmark of 60 percent of a market value weighted index of predominantly large capitalization stocks trading on the New York Stock Exchange, the American Stock Exchange, and the National Association of Securities Dealers Automated Quotation National Market System and 40 percent of a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

318 90th Annual Report, 2003 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 Effect on aggregate 2003 2002 of service and Accumulated postretirement benefit interest cost obligation at January 1 $742 $674 components of Service cost—benefits earned during net periodic the period 18 17 postretirement Interest cost of accumulated benefit costs $ 10 $ (8) benefit obligation 50 47 Effect on accumulated Actuarial loss 157 49 postretirement Curtailment loss 7 ... benefit obligation ... 110 (98) Special termination loss 2 ... Contributions by plan participants 6 4 The following is a summary of the components of net Benefits paid (40) (37) periodic postretirement benefit costs for the years ended Plan amendments . . . (12) December 31 (in millions): Accumulated postretirement benefit obligation at December 31 $942 $742 2003 2002 Following is a reconciliation of the beginning and ending Service cost—benefits earned during balances of the plan assets, the unfunded postretirement the period $18 $17 benefit obligation and the accrued postretirement benefit Interest cost of accumulated benefit costs (in millions): obligation 50 47 Amortization of prior service cost (15) (14) Recognized net actuarial loss 4 2 2003 2002 Total periodic expense 57 52 Fair value of plan assets at January 1 ...$... $... Curtailment loss 5 ... Contributions by the employer 34 33 Contributions by plan participants 6 4 Special termination loss 2 •_••_• Benefits paid J40) (37) Net periodic postretirement benefit costs .. $64 $52 Fair value of plan assets at December31 $• • • $• • • Net periodic postretirement benefit costs are reported as a Unfunded postretirement benefit component of "Salaries and other benefits." obligation $942 $742 As a result of the enhanced retirement benefits pro- Unrecognized net curtailment gain 2 • •• vided to employees during the restructuring described in Unrecognized prior service cost 122 141 footnote 10, the postretirement plans of all of the Reserve Unrecognized net actuarial loss (246) (93) Banks incurred special termination losses and the plans of Accrued postretirement benefit costs ... $820 $790 four of the Reserve Banks were curtailed. The combined effect of the three curtailment losses and one gain on the benefit obligation was a loss of $7 million reflected Accrued postretirement benefit costs are reported as a above. One of the curtailment losses was offset by unreccomponent of "Accrued benefit costs." ognized actuarial gains. As a result, there were only two At December 31, 2003 and 2002, the weighted-average Banks with net curtailment losses, both of which were discount rate assumptions used in developing the post- recognized in 2003. The net curtailment gains at the other retirement benefit obligation were 6.25 percent and two Reserve Banks will be recognized when the affected 6.75 percent, respectively. employees terminate employment in 2004. For measurement purposes, a 10.00 percent annual rate Following the guidance of the Financial Accounting of increase in the cost of covered health care benefits was Standards Board, the Reserve Banks elected to defer assumed for 2004. Ultimately, the health care cost trend recognition of the financial effects of the Medicare Prerate is expected to decrease gradually to 5.00 percent by scription Drug Improvement and Modernization Act of 2011 and remain at that level thereafter. 2003 until further guidance is issued. Neither the accumu- Assumed health care cost trend rates have a significant lated postretirement benefit obligation at December 31, effect on the amounts reported for health care plans. A 2003 nor the net periodic postretirement benefit cost for one percentage point change in assumed health care cost the year then ended reflect the effect of the Act on the trend rates would have the following effects for the year plan. ended December 31, 2003 (in millions): Postemployment Benefits The Reserve Banks offer benefits to former or inactive employees. Postemployment benefit costs are actuarially determined and include the cost of medical and dental insurance, survivor income, disability benefits, and those workers' compensation expenses self-insured by individual Reserve Banks. Costs were projected using the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 319 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED same discount rate and health care trend rates as were Employee separation costs are primarily severance costs used for projecting postretirement costs. The accrued related to reductions of approximately 1,662 staff and are postemployment benefit costs recognized by the Reserve reported as a component of "Salaries and other benefits." Banks at December 31, 2003 and 2002, were $130 mil- Contract termination costs include the charges resulting lion and $121 million, respectively. This cost is included from terminating existing lease and other contracts and as a component of "Accrued benefit costs." Net periodic other costs are primarily charges for System contract postemployment benefit costs included in 2003 and 2002 management. Contract termination and other costs are operating expenses were $26 million. shown as a component of "Other expenses." Costs associated with the write-downs of certain Bank 10. RESTRUCTURING CHARGES assets, including software, buildings, leasehold improvements, furniture, and equipment are discussed in foot- In 2003, the Bank announced plans for restructuring to note 6. Costs associated with enhanced pension benefits streamline operations and reduce costs, including consoli- for all Reserve Banks are recorded on the books of the dation of check and currency operations and staff reduc- FRBNY as discussed in footnote 8. Costs associated with tions in various functions of the Bank. These actions enhanced postretirement benefits are disclosed in footresulted in the following business restructuring charges: note 9. Future costs associated with the restructuring that are Major categories of expense (in millions): not estimable and are not recognized as liabilities will be incurred in 2004. Total The Reserve Banks anticipate substantially completing estimated announced plans by December 31, 2004. costs Employee separation $37 Contract termination 1 Other _2 Total $40 Accrued Accrued liability Total Total liability 12/31/02 charges paid 12/31/03 Employee separation $. . . $36 $(7) $29 Contract termination ... 1 1 Other 2 J2) Total $. . . $39 $(9) $30 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

320 Office of Inspector General Activities The Board's Office of Inspector General and abuse in Board and Board-delegated (OIG) functions in accordance with programs and operations, as well as in the 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 fully the Board's financial statements, the informed about serious abuses and defi- OIG plans and conducts audits and ciencies and about the status of any corinvestigations of the Board's programs rective actions. and operations and its delegated func- During 2003, the OIG completed tions at the Federal Reserve Banks. The seven audits, reviews, and other assess- OIG also reviews existing and proposed ments and conducted a number of legislation and regulations for economy 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 ten investigations and that promote economy and efficiency performed numerous legislative and and that prevent and detect waste, fraud, regulatory reviews. Completed OIG Audits, Reviews, and Assessments, 2003 Report title Report number Month issued Review of the Supervision of Hamilton Bancorp, Inc A0201 March Audit of the FFIEC's Financial Statements (Years Ended 2001 and 2002) .. A0210 March Audit of the Board's Financial Statements (Years Ended 2001 and 2002) ... A0210 March Audit of the Retirement Plan Administration A0208 July Survey of Surveillance Activities A0206 August Report on the Evaluation of the Board's E-Government Initiatives R0205 September Audit of the Board's Information Security Program A0302 September Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

321 General Accounting Office Reviews Under the Federal Banking Agency on selected aspects of Federal Reserve Audit Act (Public Law 95-320), most operations. Six projects concerning the of the operations of the Federal Reserve Federal Reserve were in various stages System are under the purview of the of completion at year-end. The reports General Accounting Office (GAO). In are available directly from the GAO. 2003, the GAO completed six reports Completed GAO Reports Relating to the Federal Reserve System, 2003 Report title Report number Date issuec Critical Infrastructure Protection: Efforts of the Financial Services Sector to Address Cyber Threats GAO-03-173 1-30-03 Federal Reserve Banks: Areas for Improvement in Computer Controls ... GAO-03-333R 2-10-03 Potential Terrorist Attacks: Additional Actions Needed to Better Prepare Critical Financial Market Participants GAO-03-414 2-12-03 Information Security: Computer Controls Over Key Treasury Internet Payment System GAO-03-837 7-30-03 Bank Tying: Additional Steps Needed to Ensure Effective Enforcement of Tying GAO-04-3 10-10-03 Information Technology: Leadership Remains Key to Agencies Making Progress on Enterprise Architecture Efforts GAO-04-40 11-17-03 Active GAO Projects Relating to the Federal Reserve System, Year-End 2003 Subject of project Date initiated Federal Reserve's relationship with U.S. Mint and BEP 7-30-02 Predatory home mortgage lending 1-23-03 Updates on impact of 9/11 attacks on U.S. financial markets 5-20-03 Illegal financial assets 5-23-03 Financial services regulation 7-17-03 Regulatory information sharing issues tied to insurance-related products ... 7-25-03 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

324 90th Annual Report, 2003 The Federal Reserve System 9 1 m ^ BOSTON MINNEAPOLIS 7 12 m o • NEW YORK CHICAGO • CLEVELAND PSLADELPHIA • SAN FRANCISCO 10 4 KANSAS CITY • g RICHMOND ST. LOUIS 8 5 6 • 11 • ATLANTA DALLAS \LASK \ j- HAWAII LEGEND Both pages Facing page • Federal Reserve Bank city • Federal Reserve Branch city D Board of Governors of the Federal — Branch boundary Reserve System, Washington, D.C. NOTE The Federal Reserve officially identifies Bank serves the Commonwealth of Districts by number and by Reserve Puerto Rico and the U.S. Virgin Islands; Bank city (shown on both pages) and by the San Francisco Bank serves Ameriletter (shown on the facing page). can Samoa, Guam, and the Common- In the 12th District, the Seattle wealth of the Northern Mariana Islands. Branch serves Alaska, and the San Fran- The maps show the boundaries within cisco Bank serves Hawaii. the System as of year-end 2003. 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 325 1-A 2-B 3-C 4-D 5-E Pittsburgh Baltii Buffalo Mk •Cincinnati • Charlotte / NY BOSTON NEW YORK PHILADELPHIA CLEVELAND RICHMOND 7-G 8-H MI It ) TN Detroit* Louisville Jacksdttville •Memphis Miami ATLANTA CHICAGO ST. LOUIS 9-1 • Helena MINNEAPOLIS 10-J 12-L Omaha • Denver Oklahoma Cit\ KANSAS CITY 11-K Salt Lake City El Paso •Los Aneeles DALLAS SAN FRANCISCO Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

329 Index Agreement corporations, examinations Banking organizations, U.S. of, 92, 109 Examinations and inspections of, 85-94 Albrecht litigation, 225 Foreign operations of, 92 Anti-money laundering, supervision of, Number of, 292 111-13 Overseas investments by, 109-10 Anti-tying restrictions, 98 Regulation of, 106-11 Apffel litigation, 225 Risk-focused supervision of, 89-91 Applications for mergers under the CRA, Basel Accord and Committee, 99 62, 110 Board of Governors {See also Federal Artis litigation, 225-26 Reserve System) Asset-backed commercial paper, treatment Applications to establish banking or of, 94 financial institutions, processing of, Assets and liabilities 110 Board of Governors, 298 Appointed members, 255-57 Commercial banks, 83, 283 Assets and liabilities of, 298 Federal Reserve Banks, 260-63, 308 Audits of, 297-306, 320 ATM card use, 73 Consumer Advisory Council, 76-78, 234 Auditors' reports, 297, 305-7 Ex-officio members, 258 Automated clearinghouse services, Federal Federal Advisory Council, 233 Reserve Banks, 118 FFIEC activities, 64-65, 102-3, 135 Automated Standard Application for Financial statements of, 297-306 Payment (ASAP), 123 Goals and objectives of, 133-35 Availability of Funds and Collection of Government Performance and Results Checks (Regulation CC), 70 Act, 133-35 Litigation, 225-26 Balance sheets Members, 229, 255-58 Board of Governors, 298 Office of the Inspector General, activities Federal Reserve Banks, combined, of, 320 307-19 Officers of, 229-31 Federal Reserve priced services, 129 Policy actions by, 143-49 Bank Control Act, 108-09 Public notice of decisions, 110 Bank examiner training, 65-66, 105-06 Thrift Institutions Advisory Council, 235 Bank holding companies Training and development, staff and Banks affiliated with, 292 bank examiners, 65-66, 105-06 Inspections of, 85-87 Bonds Regulatory financial reports of, 102 Margin requirements for, 282 Stock repurchases by, 110 Savings, 122 Surveillance of, by Federal Reserve Borrowers of Securities Credit (Regulation System, 91 X), 282 Bank Holding Companies and Change in Branches, Federal Reserve Banks, 127, Bank Control (Regulation Y), 144-45 236, 278 Bank Holding Company Act, 106-08 Business sector Bank Holding Company Performance Developments in, 12-16, 40-43 Reports, 91 Employment and unemployment, 20-21, Bank Merger Act, 108 47-48 Banking Organization National Desktop Finance, 14-16 (BOND), 90 Fixed investments, 12-14, 40—41 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

330 90th Annual Report, 2003 Business sector—Continued Complaint Analysis Evaluation System and Labor costs, 21-22, 48^9 Reports (CAESAR), 73-74 Productivity, 21-22, 48-49 Condition statements, Federal Reserve Banks, 260-63, 308 CAESAR {See Complaint Analysis Consumer Advisory Council, 76-78, 234 Evaluation System and Reports) Consumer compliance, training in and Caesar litigation, 225 activities, 62-65 Call Reports, 103 Consumer financial education, 78, 80-81 Capital accounts, Federal Reserve Banks, Consumer Leasing (Regulation M), 64, 69 Consumer price index, 23-24, 50 308, 310 Consumer prices, 22-24, 49-50 Capital adequacy standards, 94-96, 98 Consumer protection laws, compliance Carter litigation, 225 with, 61-71 Cash flows, Board of Governors, 300 Consumer spending, 10-11, 37-38 Cash, special services, Federal Reserve Corporate profits, 14-16, 41-^-3 Banks, 120 CPI {See Consumer price index) CEDRIC {See Community and Economic CRA {See Community Reinvestment Act) Development Research Information Credit Center) Accuracy of reports, 139 Change in Bank Control Act, 108-09 Card lending, 96 Check Clearing for the 21st Century Act Rates, primary, secondary, and seasonal, (Check 21 Act), 137 147-49, 280 Check collection service, commercial, Solicitations, 72 Federal Reserve Banks, 116-18 State member banks to executive Check modernization effort, 115 officers, 113 Civil money penalties, Federal Reserve Credit by Banks, Brokers, and Dealers enforcement of, 89 (Regulation T), 282 Collateral evaluation, guidelines for, 96-97 Credit by Banks for the Purpose of Commercial and industrial loans, 15, 42^-3 Purchasing or Carrying Margin Stocks Commercial banks (Regulation U), 282 Assets and liabilities of, 83, 283 Currency and coin, 120-21, 308 Number of, 292 Current account, U.S., 46-47 Commercial real estate, 43 Commodities derivatives authority, 98 Data, home mortgage lending, 66, 71 Community Debit card use, 73 Affairs issues Debt intermediation, 27-28, 53-54 Community economic development, Debt markets, shorter-term, 52-53 78 Depository institutions Consumer Advisory Council, advice, Interest rates on loans, Federal Reserve 76-78 Banks, 280 Consumer complaints, 73-76 Reserve requirements for, 281 Outreach activities, 82 Reserves of, 284-91 Community and Economic Development Threshold amount to collect data, 72 Research Information Center Depository services to other agencies, by (CEDRIC), 78-79 Federal Reserve Banks, 121-24 Community Bank and Trust litigation, 225 Derivatives, authority, 98 Community banks, risk-focused supervision Direct deposits, use of, 73 by Federal Reserve System, 91 Directors, Federal Reserve Banks and Community Reinvestment Act Branches, 238-54 Compliance examinations, 61 Discount rates, 147-^-9, 280 {See also Mergers and acquisitions, applications Interest rates) for, 61-62 Discount window, guidance on use of, 98 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 331 ECI {See Employment cost index) Examinations and inspections—Continued Economic projections, 7-8, 36-37 Securities credit lenders, 89 Economy, international, 28-32, 54-57 Specialized, 87-89 Economy, U.S., developments State member banks, 85-86 Business sector, 12-16, 20-21, 40-43, Transfer agents, 88 47-48 Expenses {See Income and expenses) Debt, 27-28, 45, 53 Exports and imports, 19, 46 Equity markets, 26-27 External sector, developments, 18-20, External sector, 18-20, 46-47 46-47 Financial account, 20, 47 Financial markets, 4-7, 24-28, 34-36, Fair and Accurate Credit Transactions 50-54 Act of 2003 (FACT Act), 137^0 Government sector, 16-18, A3-A6 Fair Credit Reporting (Regulation V), 145 Household sector, 10-12, 37^0 Fair lending laws, compliance with, 63-64 Interest rates, 5, 25-26, 52-53, 280 Federal Advisory Council, members and Labor market, 20-22, 41-49 officers, 233 Monetary aggregates, 28, 54 Federal agency securities, Federal Reserve Monetary policy, 3-8, 33-37 Bank holdings, 268 Prices, 22-24, 26-27, 49-50 Federal Financial Institutions Examination Trade and current account balances, Council, 64-67, 102-03, 135 18-20, 46^7 Federal funds rate, 5-7, 35, 37, 52, 169, Edge Act corporations, examinations of, 92 176, 184, 193, 200, 208, 216, 224 Education, financial, 80-81, 140 Federal government, economic EFTA {See Electronic Fund Transfer Act) developments, 16-17, 43-45 Electronic access, 124 Federal Open Market Committee Electronic Fund Transfer Act, 73 Authorization for domestic open market Electronic Fund Transfers (Regulation E), operations, 51-53, 158-59 68-69 Authorization for foreign currency Emerging Market Bond Index (EMBI+), operations, 153-55, 159-61 29, 31-32 Authorizations, 151-55, 158-61 Emerging-market economies, 30-32, 56-57 Domestic policy directive, 153, 169, 176, Employment, 20-21, 47-48 184, 193, 200, 208, 215, 224 Employment cost index, 22, 48-49 Foreign currency directive, 155, 161 Enforcement actions, Federal Reserve Guidelines for open market operations, System, 89 Equal Credit Opportunity (Regulation B), 153, 162-63 67-68, 71-72, 143 Meetings, minutes of, 156-224 Equipment and software investment, 40-41 Members and officers of, 232 Equity markets and prices, 26-27 Notation vote, 184 Examinations and inspections Procedural instructions for foreign Bank holding companies, 86-87 currency operations, 155-56, 162 Compliance with System Account, temporary authority Community Reinvestment Act, 61 procedure, 163 Consumer protection laws, 62-64, Federal Reserve Banks 67-71 Acquisition costs, 278 Fair lending laws, 63-64 Assets and liabilities of, 260-63, 308 Federal Reserve Banks, 124-25 Audits of, 24-25, 295, 307-21 Financial holding companies, 87 Automated clearinghouse services, 118 Government and municipal securities Branches of, 127-28, 236, 278 dealers and brokers, 88-89 Capital, changes in, 310 Information technology activities, 87-88 Cash services, special, 120 Securities clearing agencies, 88 Chairmen, Conference of, 237 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

332 90th Annual Report, 2003 Federal Reserve Banks—Continued Federal Reserve System—Continued Check collection service, commercial, Applications to establish banking 116-18 institutions, processing of, 110 Condition statements of, 260-63, 308 Audits of, 295, 297-321 Credit outstanding, 284-91 Balance sheet, 298 Currency and coin, 120-21 Bank holding company regulatory Depository services to other agencies, financial reports to, 102 122 Banks and Branches, list of, 236 Directors of, 238-54 Capital adequacy standards, 94-96, Discount rates of, 147-49, 280 98-99 Electronic access to services, 124 Civil money penalties, assessment of, 89 Examinations of, 124-25 Collateral valuation, appraisal guidelines Examiners, training, 65 for, 96-97 Fedwire Funds Service, 118-19, 124, Commodities derivatives authority, 98 Discount window, guidance on use, 98 146 Edge Act and Agreement corporations, Fedwire Securities Service, 119 examinations, 92 Financial statements of, combined, Enforcement actions, 89 307-19 Examinations and inspections, banking First Vice Presidents, Conference of, 238 institutions, 85-94 Fiscal agency services to other agencies, Fiduciary activities, supervision, 88 121-24 General Accounting Office, reviews by, Float associated with, 120 321 Food coupons (See Food stamp Information technology activities, 87, redemption) 103-04 Food stamp redemption, 121, 123 International guidance on supervisory Government depository services, 121-24 policies, 98-100 Holdings of securities and loans, 126-27 International supervision, 92-93 Holdings of Treasury and federal agency Maps of, 324-25 securities, 268, 284-90 Membership of banking institutions, 113 Income and expenses of, 125-26, Monitoring, off-site, 91-92 270-77, 309 Mortgage banking activities, advisory on, Information technology developments, 97 124 Open market transactions, 264-67 Initiatives, 115-16 Public notice of decisions, 110 Interest rates on loans to depository Regulation of the U.S. banking structure, institutions, 280 106-11 National Settlement Service, 118-19 Risk supervision, 89-91 Noncash collection service, 119-20 Safety and soundness supervision, Officers of, 236-37 responsibilities, 85-94 Operations in principal departments, 279 Sarbanes-Oxley Act, 100-01 Postal money order services, 123 Securities, examination, 88 Premises of, 127-28, 278, 308 Securities credit responsibilities, 89 Presidents, Conference of, 237 Securities underwriting authority, 100 Priced services, 116-20, 129-32, 147 Supervision and regulation Salaries of officers and employees, 269 responsibilities, 61-71, 84-94 Special cash services, 120 Supervisory information technology, Volume of operations, 127 104-05 Federal Reserve System (See also Board of Supervisory policy, 94-103 Governors; Federal Open Market Surveillance, 91-92 Committee) Technical assistance to foreign central Anti-tying restrictions, 98 banks, 93 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 333 Federal Reserve System—Continued General Accounting Office (GAO), Training, staff and examiners, 65-66, reviews, 321 105-06 Goals and objectives, Board of Governors, Transfer agents, examination of, 88 133-35 Transparency efforts, 101 Government, federal Federal sector, developments, 17-18, 43-45 Debt, 17, 45 Federal tax payments, 123 Developments, 16-17, 43-45 Fedwire Funds Service, 118-19, 124, 146 Government, state and local, developments, Fedwire Securities Service, 119 17-18, 45-46 FFIEC {See Federal Financial Institutions Government depository services, 121-24 Examination Council) Government Performance and Results Act, Fiduciary activities, supervision of, 88 133-35 Finance Government sector, developments, 16-18, Business, 14-16, 41-43 43-46 Household, 12, 39-40 Government securities, examination of, 88 Financial accounts, 20, 47 Government-sponsored enterprises, 53 Financial education, 80-81, 140 GPRA {See Government Performance and Financial holding companies, inspections Results Act) and examinations of, 87 Gross domestic product, 7, 9, 36 Financial Institutions Supervisory Act, GSEs {See Government-sponsored litigation under, 225 enterprises) Financial intermediation, 27-28, 53-54 Financial markets, 4-7, 24-28, 34-36, Home Mortgage Disclosure (Regulation 50-54 C), 66-67, 72 Financial reports, bank holding companies, Home Ownership and Equity Protection 102 Act, 72 Financial statements Household sector, developments, 10-12, Board of Governors, 297-306 37-40 Federal Reserve Banks, combined, Housing and Urban Development (HUD), 307-19 Department of, 66-67, 76 Federal Reserve priced services, 129-32 State member banks, disclosure, 111 Fiscal agency services to other agencies, by Identity theft prevention, 138 Federal Reserve Banks, 121-24 Imports and exports, 19, 46 Fiscal Impact Tool, web-based resource, 79 Income and expenses Fixed investments, business sector, 12-14, Board of Governors, 299 40-41 Federal Reserve Banks, 125-26, 270-77, Float, 120 309 Flood Insurance Act, compliance with, 64 Industrial economies, developments, 29-30, FOMC {See Federal Open Market 55-56 Committee) Information technology Food stamp redemption, 121, 123 Developments in, 103-04, 124 Foreign banking operations, 92-93 Federal Reserve examination of, 87-88 Foreign currency directive, 155, 161 Initiatives by the BCBS, IAIS, and IOSCO Foreign currency operations to Combat Money Laundering and the Authorization for, 153-55, 159-61 Financing of Terrorism, joint forum Procedural instructions for, 155-56, 162 paper, 100 Foreign economies, developments, 28-32, Inspections {See Examinations and 54-57 inspections) Foreign trade, 18-20, 46-47 Inspector General, Office of, audits, Fraternal Order of Police, litigation, 226 reviews, and assessments, 320 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

334 90th Annual Report, 2003 Interagency Paper on Sound Practices to Margin requirements, 282 Strengthen the Resilience of the U.S. Medical information, use and sharing of, Financial System, 90 139 Interest rates, 5, 25, 52-53, 280 (See also Member banks (See also State member Discount rates and Federal funds rate) banks) International Applications by, 110 Banking activities, 92-93, 98-100 Number of, 113, 292 Economies, developments, 28-32, 54-57 Members and officers Trade, 18-20, 46-47 Board of Governors, 229-31, 255-58 International Accounting Standards Board, Consumer Advisory Council, 234 100 Federal Advisory Council, 233 International Banking Act, 109 Federal Open Market Committee, 232 International Banking Operations Federal Reserve Banks and Branches, (Regulation K), 144^5 236-37 Intra-governmental Payments and Salaries, Federal Reserve Banks, 269 Collection application, 123 Thrift Institutions Advisory Council, 235 Investments Membership of State Banking Institutions Business sector, 12-14, 40-41 in the Federal Reserve System Fixed, 12-14, 40-41 (Regulation H), 143-44 Merger applications under the CRA, 62 Inventory, 14, 41 Monetary aggregates, 28, 54 Overseas by U.S. organizations, 109 Monetary policy, economic outlook, 3-8, Residential, 11-12, 38-39 33-37 Iraq war, effect on financial markets, 51 Monetary Policy Reports to the Congress February 2004, 3-32 Joint Forum, 100 July 2003, 33-57 Money laundering, regulations prohibiting, Labor market, 20-22, 47-49 111-13 Laigo litigation, 225 Mortgage banking activities, 97 Lessons Learned: Community and Mortgage interest rates, 12 Economic Development Case Studies, Municipal securities, examination of, 88 database, 79 Liabilities (See Assets and liabilities) National Information Center, 104-05 Litigation, involving Board of Governors, National Settlement Service, 118-19 225-26 Noncash collection service, Federal Loans Reserve Banks, 119-20 Federal Reserve Bank holdings, 126-27 Note, new twenty dollar bill, issuance, 120 Interest rates on, to depository institutions, 280 Officers (See Members and officers) State member banks to executive OIG (See Inspector General, Office of) officers, 113 Oil prices, 19-20, 47 Local governments (See State and local Open market operations governments) Authorization for conduct of, 151-53, 158-59 M2 monetary aggregate, 28, 54 Guidelines for the conduct of, 153, Management and Supervision of 162-63 Cross-Border Electronic Banking Transactions, 264-67 Activities, policy paper, 99 Operational Risk Transfer Across Financial Management and Supervision of Sectors, joint forum paper, 100 Operational Risk, policy paper, 99 Maps, Federal Reserve System, 324-25 Paper Check Conversion program, 123 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 335 Papers published, interagency or joint Regulations—Continued forum C, Home Mortgage Disclosure Act, 64, Initiatives by the BCBS, IAIS, and 72 IOSCO to Combat Money D, Reserve Requirements of Depository Laundering and the Financing of Institutions, 143 Terrorism, 100 E, Electronic Fund Transfers, 68-69 Management and Supervision of H, Membership of State Banking Cross-Border Electronic Banking Institutions in the Federal Reserve Activities, 99 System, 143-44 Management and Supervision of K, International Banking Operations, Operational Risk, 99 144-45 Operational Risk Transfer Across M, Consumer Leasing, 64, 69 Financial Sectors, 100 P, Privacy of Consumer Financial Principles and Management and Information, 69 Supervision of Interest Rate Risk, 99 T, Credit by Banks, Brokers, and Sound Practices to Strengthen the Dealers, 282 Resilience of the U.S. Financial U, Credit by Banks for the Purpose of System, 90, 97, 146 Purchasing or Carrying Margin Trends in Risk Integration and Stocks, 282 Aggregation, 100 V, Fair Credit Reporting, 145 Policy statements and actions, 143-49 W, Transactions between Member Banks Postal money order services, Federal and Their Affiliates, 96 Reserve Banks, 123 X, Borrowers of Securities Credit, 282 Premises, Federal Reserve Banks, 127-28, Y, Bank Holding Companies and Change 278 in Bank Control, 144-45 Prescreened credit solicitations, 72 Z, Truth in Lending, 64, 69-70, 72, Priced services 77-78 Federal Reserve Banks, 116-20, 129-32 AA, Unfair or Deceptive Acts or Imputing income from, 147 Practices, 70 Prices CC, Availability of Funds and Collection Consumer, 22-24, 50 of Checks, 70 Energy, 23, 49 DD, Truth in Savings, 70-71 Equity, 26-27 Reports of Condition and Income (Call PriceWaterhouseCoppers LLP, auditors, Reports), 103 Federal Reserve Banks, 125 Repurchase agreements Primary credit rate, 147-49, 280 Federal Reserve Bank credit, 284-91 Principles and Management and Treasury securities, 268 Supervision of Interest Rate Risk, Reserve Requirements of Depository policy paper, 99 Institutions (Regulation D), 143, 281 Privacy of Consumer Financial Information Reserves of depository institutions, 284-91 (Regulation P), 69 Residential investments, 11-12, 38-39 Productivity and labor costs, 21, 48 Revenue and income (See Income and Profits, corporate, 14-16, 41-43 expenses) Risk Management for Electronic Banking, Quantitative Impact Study, 99 99 Risk Supervision, Federal Reserve System, Real estate, commercial, 43 89-91 Real estate appraisal guidelines, 96 Rules of Organization, 145 Regulations Rules of Practice for Hearings, 146 B, Equal Credit Opportunity, 67-68, Rules Regarding Equal Credit Opportunity, 71-73, 143 146 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

336 90th Annual Report, 2003 Salaries, Federal Reserve Bank officers Stocks—Continued and employees, 269 Trust preferred, 96 Sarbanes-Oxley Act, 100-01 Substitute checks, 137 Savings bonds, 122 Supervisory information technology, Seasonal credit rate, 280 104-05 Secondary credit rate, 147, 280 System Open Market Account (See also Securities (See also Treasury securities) Open Market Operations) Government and municipal, supervision Authority to operate, 163 of dealers and brokers, 88-89 Transactions, 264-67 Holdings by Federal Reserve Banks, 126-27 Tax payments, Federal Reserve Banks, Underwriting authority, bank holding 123 companies, 100 Technical assistance to foreign central Securities clearing agencies, examination banks, by Federal Reserve System, 93 of, 88 Term investment option, 123 Securities credit Thrift Institutions Advisory Council, 235 Lenders, examination of, 89 Trade, international, 18-20, 46-47 Regulation of, 111 Training and development, Federal Reserve Sedgwick litigation, 225 staff, 65-66, 105-06 Seeds of Growth—Sustainable Community Transactions between Member Banks and Development: What Works, What Their Affiliates (Regulation W), 96 Doesn't, and Why, conference, 78 Transfer agents, supervision of, 88 Settlement Service, Federal Reserve Banks, Treasury, U.S. Department of the (See also 118-19 Treasury securities) SIT (See Supervisory information Payments processed for, 123 technology) Payments to, by Federal Reserve Banks, Sound Practices to Strengthen the 126, 275, 277 Resilience of the U.S. Financial Treasury securities System, interagency paper, 90, 97, 146 Federal Reserve Bank holdings, 268 Special cash services, Federal Reserve Interest rates, 25, 52 Banks, 120 Marketable, 122 Staff development (See Training for Treasury Tax and Loan program, 123 banking supervision and regulation Trends in Risk Integration and and Training programs, Federal Aggregation, joint forum paper, 100 Reserve staff) Trust preferred stocks, 96 State and local governments, 17-18, 45-46 Truth in Lending (Regulation Z), 64, State-chartered savings banks, number of, 69-70, 72, 77-78 292 Truth in Savings (Regulation DD), 70-71 State member banks (See also Member Twenty dollar note, issuance, 120 banks) Complaints against, 74-76 Ulrich litigation, 225 Credit to executive officers, 113 Unemployment, 20-21, 47-48 Examinations of, 61-71, 85-86 Unfair or Deceptive Acts or Practices Financial disclosure by, 111 (Regulation AA), 70 Number of, 113, 292 USA Patriot Act, 112 Surveillance of, by Federal Reserve System, 91 War in Iraq, 51-52 Stocks West Texas intermediate, oil prices, 19-20, Margin requirements, 282 47 Repurchases, bank holding companies, 110 FRBl/l-5600-0404 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis