Annual Report of the Federal Reserve Board, 2004

'Report xl_-f 2004 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 Transmitted BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Washington, D.C., April 2005 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 ninety-first annual report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 2004. 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 in 2004 and Early 2005 7 Economic Projections for 2005 and 2006 9 ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2004 AND EARLY 2005 10 The Household Sector 12 The Business Sector 15 The Government Sector 18 The External Sector 20 The Labor Market 21 Prices 23 U.S. Financial Markets 27 International Developments 31 MONETARY POLICY REPORT OF JULY 2004 31 Monetary Policy and the Economic Outlook 34 Economic and Financial Developments in 2004 Federal Reserve Operations 55 CONSUMER AND COMMUNITY AFFAIRS 55 Implementation of Statutes Designed to Inform and Protect Consumers 62 Supervision for Compliance with Consumer Protection and Community Reinvestment Laws 73 Consumer Complaints 75 Advice from the Consumer Advisory Council 77 Promotion of Community Economic Development in Historically Underserved Markets 83 Outreach Activities 85 BANKING SUPERVISION AND REGULATION 87 Scope of Responsibilities for Supervision and Regulation 88 Supervision for Safety and Soundness 97 Supervisory Policy 107 Supervisory Information Technology 108 Staff Development 110 Regulation of the U.S. Banking Structure Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

114 Enforcement of Other Laws and Regulations 115 Federal Reserve Membership 117 FEDERAL RESERVE BANKS 117 Major Initiatives 118 Developments in Federal Reserve Priced Services 123 Developments in Currency and Coin 124 Developments in Fiscal Agency and Government Depository Services 127 Electronic Access 127 Information Technology 128 Examinations of the Federal Reserve Banks 129 Income and Expenses 130 Holdings of Securities and Loans 130 Volume of Operations 130 Federal Reserve Bank Premises 132 Pro Forma Financial Statements for Federal Reserve Priced Services 137 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE AND RESULTS ACT 137 Strategic Plan, Performance Plan, and Performance Report 137 Mission 137 Goals and Objectives 139 Interagency Coordination 141 FEDERAL LEGISLATIVE PROPOSALS 141 Interest on Depository Institution Balances Held at Federal Reserve Banks 141 Interest on Demand Deposits 142 Depository Institution Reserve Requirements 142 Interstate Branching Records 147 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS 147 Regulation B (Equal Credit Opportunity), Regulation E (Electronic Fund Transfers), Regulation M (Consumer Leasing), Regulation Z (Truth in Lending), and Regulation DD (Truth in Savings) 147 Regulation C (Home Mortgage Disclosure) 147 Regulation D (Reserve Requirements of Depository Institutions) 148 Regulation H (Membership of State Banking Institutions in the Federal Reserve System) and Regulation Y (Bank Holding Companies and Change in Bank Control) 148 Regulation H, Regulation K (International Banking Operations), Regulation V (Fair Credit Reporting), and Regulation Y 148 Regulation J (Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers through Fedwire) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

148 Regulation V 149 Regulation Z 149 Regulation BB (Community Reinvestment) 150 Regulation CC (Availability of Funds and Collection of Checks) 150 Rules of Practice for Hearings 150 Policy Statements and Other Actions 151 Discount Rates in 2004 155 MINUTES OF FEDERAL OPEN MARKET COMMnTEE MEETINGS 155 Authorization for Domestic Open Market Operations 157 Guidelines for the Conduct of System Open Market Operations in Federal Agency Issues 157 Domestic Policy Directive 157 Authorization for Foreign Currency Operations 159 Foreign Currency Directive 159 Procedural Instructions with Respect to Foreign Currency Operations 160 Meeting Held on January 27-28, 2004 175 Meeting Held on March 16, 2004 183 Meeting Held on May 4, 2004 192 Meeting Held on June 29-30, 2004 200 Meeting Held on August 10, 2004 208 Meeting Held on September 21, 2004 215 Meeting Held on November 10, 2004 222 Meeting Held on December 14, 2004 231 LITIGATION 231 Judicial Review of Board Orders under the Bank Holding Company Act 231 Litigation under the Financial Institutions Supervisory Act 231 Other Actions Federal Reserve System Organization 235 BOARD OF GOVERNORS 238 FEDERAL OPEN MARKET COMMITTEE 239 ADVISORY COUNCILS TO THE BOARD OF GOVERNORS 239 Federal Advisory Council 240 Consumer Advisory Council 241 Thrift Institutions Advisory Council 242 FEDERAL RESERVE BANKS AND BRANCHES 242 Officers of the Banks and Branches Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

243 Conference of Chairmen 243 Conference of Presidents 244 Conference of First Vice Presidents 244 Directors of the Banks and Branches 261 MEMBERS OF THE BOARD OF GOVERNORS, 1913-2004 Statistical Tables 266 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2004 and 2003 270 2. Federal Reserve Open Market Transactions, 2004 274 3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2002-04 275 4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2004 276 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2004 280 6. Income and Expenses of the Federal Reserve Banks, 1914-2004 284 7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks and Branches, December 31, 2004 285 8. Operations in Principal Departments of the Federal Reserve Banks, 2001-2004 286 9. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2004 287 10. Reserve Requirements of Depository Institutions, December 31, 2004 288 11. Initial Margin Requirements under Regulations T, U, and X 289 12. Principal Assets and Liabilities of Insured Commercial Banks in the United States, by Class of Bank, June 30, 2004 and 2003 290 13. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items A. Year-End 1984-2004 and Month-End 2004 B. Year-End 1918-1983 298 14. Banking Offices and Banks Affiliated with Bank Holding Companies in the United States, December 31, 2003 and 2004 Federal Reserve System Audits 301 AUDITS OF THE FEDERAL RESERVE SYSTEM 303 BOARD OF GOVERNORS FINANCIAL STATEMENTS 315 FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS 329 OFFICE OF INSPECTOR GENERAL ACTIVITIES 330 GENERAL ACCOUNTING OFFICE REVIEWS 331 MAPS OF THE FEDERAL RESERVE SYSTEM 337 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 year 2004 was marked by contin- inflation moved up as well. In response ued expansion in economic activity to positive economic news and higher and appreciable gains in employment. inflation during this period, market With fiscal policy stimulative, monetary participants came to anticipate that policy accommodative, and financial monetary policy tightening would begin conditions favorable, household spend- sooner than they had expected, and ing remained buoyant and businesses interest rates increased considerably. increased investment in capital equip- With the economic expansion more ment and inventories, despite the firmly established and slack in labor and restraint imposed by sizable increases product markets somewhat diminished, in oil prices. Labor market conditions the Federal Open Market Committee improved significantly, albeit at an (FOMC) at its June meeting began to uneven pace, and productivity rose nota- reduce the substantial degree of monebly further. Consumer price inflation tary accommodation that was in place. moved higher with the surge in energy The gradual removal of monetary prices, but core consumer price inflation policy stimulus continued in the sec- (that is, excluding food and energy) ond half of the year as the economy remained well contained, and measures expanded at a healthy clip on balance. of expected inflation over longer hori- Around midyear, some measures of zons held steady or edged lower. growth in activity softened, partly Although economic activity had because of the drain on income and the increased substantially in 2003, the rise in business costs created by higher expansion nevertheless appeared some- oil prices. The expansion of consumer what tentative as 2004 opened, in large spending slowed in the spring, and the measure because businesses still seemed pace of hiring and gains in industrial to be reluctant to boost hiring. Over the production dropped back notably durcourse of the spring, however, it became ing the summer. Equity prices and clearer that the expansion was solidify- longer-term interest rates moved lower ing. Businesses added appreciably to over this period as well. In the event, their payrolls, boosted investment in the slowdown in household spending equipment and software, and started growth proved short lived. Both hiring restocking inventories. While household and increases in factory output stepped spending growth softened somewhat, up again in the autumn, and these residential construction expanded rap- gains were extended early this year. idly. Rising energy prices boosted over- With profits healthy and financial condiall consumer price inflation, and core tions still supportive, capital spending increased at a brisk pace throughout the year. Over the final quarter of 2004, NOTE. The discussion here and in the next section ("Economic and Financial Developments short-term interest rates rose further as in 2004 and Early 2005") consists of the text, monetary policy was firmed at each tables, and selected charts from the Monetary Pol- FOMC meeting, but long-term interest icy Report submitted to the Congress on Februrates were largely unchanged. Equity ary 16, 2005, pursuant to section 2B of the Federal prices rose appreciably in the fourth Reserve Act. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

4 91st Annual Report, 2004 quarter, and the dollar depreciated higher oil and import prices diminishagainst most other major currencies. The ing, the prospects for inflation staying FOMC increased the target federal funds low are good. A favorable economic rate 25 basis points again at its meet- outcome is, of course, not assured, but ing this month, bringing the cumulative at the most recent FOMC meeting the tightening over the past year to IV2 per- Committee again assessed the risks to centage points. both output and inflation as balanced. The fundamental factors underlying The Committee also reaffirmed that it is the continued strength of the economy prepared to respond to events as neceslast year should carry forward into sary in its pursuit of price stability. 2005 and 2006, promoting both healthy expansion of activity and low inflation. Monetary Policy, Financial Monetary policy is still accommodative, Markets, and the Economy and financial conditions more generally in 2004 and Early 2005 continue to be advantageous for households and firms. Profits have been ris- In early 2004, against the backdrop of ing briskly, and corporate borrowing stimulative fiscal and monetary policy, costs are low. Household net worth has continued rapid growth in productivincreased with the continued sharp rise ity, and supportive financial market in the value of real estate assets as well conditions, business outlays appeared to as gains in equity prices, and this will be firming significantly and household likely help support consumer demand in spending remained strong. The FOMC the fiiture. Absent a significant increase became more confident that the ecoin oil prices from current levels, the nomic expansion was likely gaining drag from last year's run-up should traction and that the risk of significant wane this year. The lagged effects of further disinflation had been greatly the decline in the exchange value of the reduced. In these circumstances, it recdollar since the autumn and sustained ognized that a highly accommodative foreign economic growth are likely to stance for monetary policy could not boost the demand for U.S. exports. The be maintained indefinitely. Nonetheless, prospects for the expansion of aggregate the Committee was concerned about supply also appear to be quite favorable. the persistently slow pace of hiring and Gains in structural labor productivity viewed underlying inflation pressures as should continue, although not necessar- likely to remain subdued. Accordingly, ily at the pace of recent years. Economic the Committee left its target for the fedgrowth will likely be sufficient to gen- eral funds rate unchanged at 1 percent at erate notable increases in employment, its January and March meetings. Howalthough any reversal of the decline in ever, beginning in January, it modified labor force participation observed since the language of its policy statement to 2001 would tend to hold up the unem- gain greater flexibility to tighten policy ployment rate. Core consumer price should circumstances warrant by indiinflation has remained low since the cating that monetary policy accomlarger increases posted in the early modation would eventually have to be months of 2004, and long-term infla- removed. At the same time, the Comtion expectations have been similarly mittee suggested that it could be patient well contained. With some slack likely in undertaking such actions. remaining in labor and product markets By the time of the May and June at present and with the indirect effects of FOMC meetings, incoming economic Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook Selected Interest Rates Percent Intended federal funds rate 1 \ , 1/30 5/7 8/13 11/6 1/29 5/6 8/12 10/28 1/28 5/4 8/10 U/10 2/2 3/19 6/26 9/24 12/10 3/18 6/25 9/16 12/9 3/16 6/30 9/2! 12/14 2002 2003 2004 2005 NOTE. The data are daily and extend through February 9, 2005. Treasury rates are constant-maturity yields based on the most actively traded securities. The dates on the horizontal axis are those of FOMC meetings. SOURCE. Department of the Treasury and the Federal Reserve. data pointed to a broader and more that policy would probably soon need to firmly established expansion, with con- move toward a more neutral stance, tinued strength in housing markets and though probably not at a rapid pace. The business fixed investment. Also, the Committee retained this language at the employment reports for March, April, June meeting while raising its target for and May had indicated strong and wide- the federal funds rate from 1 percent spread gains in private nonfarm pay- to 1V4 percent and noting that it would rolls, and previous reports for January "respond to changes in economic prosand February were revised upward sig- pects as needed to fulfill its obligation to nificantly. Overall consumer price infla- maintain price stability." tion in the first quarter was faster than The information that the Committee it had been a year earlier, and core infla- had received by the time of its August tion also increased, in part because of meeting indicated that economic growth the indirect effects of higher energy had softened somewhat earlier in the prices. The Committee maintained its summer. Although the housing market target for the federal funds rate at 1 per- had remained strong and business outcent in May, but on the basis of the lays had continued to be healthy, conevolving outlook for economic activity sumer spending growth had slowed sigand prices, it revised its assessment of nificantly, and industrial production had risks to indicate that the upside and begun to level off. Also, the June and downside risks for inflation had moved July labor market reports revealed that into balance. The Committee also stated employment growth had slowed considthat monetary policy accommodation erably. At the same time, core consumer could "be removed at a pace that is price inflation had moderated in May likely to be measured" to communicate and June even though sizable increases its belief, given its economic outlook, in food and energy prices continued. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

6 91st Annual Report, 2004 However, the Committee believed that that higher oil prices had damped the the softness in economic activity was pace of economic activity around midcaused importantly by higher prices of year, it nonetheless saw the expansion imported oil and would prove short as still on solid footing. Consequently, lived. With financial conditions remain- the Committee agreed to increase its ing stimulative, the economy appeared target for the federal funds rate another poised to grow at a pace sufficient to 25 basis points, to P/4 percent; to reitertrim slack in resource utilization. In that ate its view that the risks to price stabilregard, given the unusually low level of ity and to sustainable growth were balthe federal funds rate, especially relative anced; and to repeat its indication that to the level of inflation, policymakers the removal of policy accommodation noted that significant cumulative policy would likely proceed at a "measured" tightening would likely be needed to pace. The reaction in financial markets meet the Federal Reserve's long-run to the policy rate decision and the objectives of price stability and sustain- accompanying statement was muted. able economic growth. The Commit- The information in hand at the time tee's decision at the meeting to raise its of the November FOMC meeting gentarget for the federal funds rate 25 basis erally suggested that the economy had points, to IV2 percent, and to maintain continued to expand at a moderate rate its assessment of balanced risks with despite the restraint that higher oil prices respect to sustainable growth and price imparted to real incomes and consumer stability was largely anticipated by confidence. Consumer and business financial markets. However, market par- spending stayed firm, and the housticipants revised up their expectations ing market remained buoyant. Howfor the path of the federal funds rate, ever, industrial production was about reportedly because the announcement unchanged, and the news on job growth conveyed a somewhat more optimistic was uneven—lackluster increases in outlook for the economy than many had nonfarm payrolls in September were anticipated. followed by robust expansion in Octo- By the time of the September FOMC ber. Inflation rpeasures were moderate, meeting, available information sug- although up somewhat from one year gested that the economy had regained earlier. On balance, the Committee saw momentum. Real consumer spending the economy as growing at a pace that bounced back sharply in July after a would reduce margins of slack in the weak second quarter, and incoming data utilization of resources. The Committee on industrial production indicated a also judged that inflationary pressures modest strengthening. Housing activity would likely be well contained if monehad increased further, and business out- tary policy accommodation were gradulays had picked up significantly in the ally withdrawn. The Committee's decisecond quarter. In addition, the labor sion to raise its target for the federal market showed signs of improvement in funds rate from \3A percent to 2 percent August, as the unemployment rate edged with minimal change in the language in down and nonfarm payrolls grew mod- the accompanying statement was largely erately. Core consumer price inflation anticipated by financial markets and slowed in June and July, and a decline in elicited little reaction. energy prices from record levels pushed At its December meeting, the Comdown readings on headline inflation. mittee viewed available information as Although the Committee acknowledged continuing to indicate that the pace of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook the economic expansion was sufficient and that earlier release might adversely to further reduce the undemtilization affect the Committee's discussions and, of resources, despite elevated oil prices. perhaps, the minutes themselves. After Consumer spending remained solid, weighing these considerations, the Cominvestment spending was strong, and mittee voted unanimously to publish the manufacturing production showed mod- FOMC minutes three weeks after the est growth. Also, employment gains in day of the policy decision. October and November were consistent The information that the Committee with gradual improvement in the labor reviewed at its February 2005 meeting market. Meanwhile, core inflation, while indicated that the economy had conabove the unusually low rates of late tinued to expand at a steady pace. The 2003, remained subdued. Accordingly, labor market showed signs of further the Committee voted to raise its target improvement, and consumer spending for the federal funds rate 25 basis points, and the housing market remained to 2lA percent, and to retain the previous robust. Industrial production accelerstatement that the removal of policy ated, particularly at the end of 2004, and accommodation would likely be "mea- growth of business fixed investment sured." Investors had largely anticipated was solid in the fourth quarter. Core the policy rate decision, but a few mar- inflation stayed moderate, and measures ket participants had reportedly specu- of inflation expectations remained well lated that the Committee would signal anchored. Given the solid economic increased concern about inflationary expansion and limited price pressures, pressures. In the absence of any such the Committee voted to continue its signal, implied rates on near-dated removal of policy accommodation by futures contracts and longer-term Trea- raising its target for the federal funds sury yields declined a few basis points rate from 2lA percent to 2Vi percent after the release of the December and to essentially repeat the language statement. of the December statement. Futures Also at its December meeting, the market quotes indicated that investors Committee considered an accelerated had already priced in a 25 basis point release of the minutes of FOMC meet- increase in the target federal funds rate ings. The Committee's practice had at the meeting, and market participants been to publish the minutes for each reportedly expected no substantive meeting on the Thursday after the next changes to the accompanying statescheduled meeting. Trie Committee ment. Accordingly, the reaction in finanbelieved that, because the minutes con- cial markets to the announcement was tain a more nuanced explanation of pol- minimal. icy decisions than the statement released immediately after each meeting, pub- Economic Projections lishing them on a timelier basis would for 2005 and 2006 help market participants interpret economic developments and thereby better Federal Reserve policymakers expect anticipate the course of interest rates. the economy to expand moderately and Earlier release would also provide a con- inflation to remain low in 2005 and text for the public remarks of individual 2006.l The central tendency of the fore- FOMC members. It was also recognized, however, that financial markets 1. As a further step to enhance monetary policy might misinterpret the minutes at times communications, Federal Reserve policymakers Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

8 91st Annual Report, 2004 Economic Projections for 2005 and 2006 Percent Federal Reserve Governors and Reserve Bank presidents Indicator MEMO: 2005 2006 2004 actual Central Central Range Range tendency tendency Change, fourth quarter to fourth quarter1 Nominal GDP 6.2 5-6 5V2-5V4 5-53/4 5-5V* Real GDP 3.7 VhrA 33/4-4 3V4-3% 3% PCE price index excluding food and energy 1.6 1V2-2 lVfc-1% W2-2 V/2-W4 Average level, fourth quarter Civilian unemployment rate 5.4 5-5V6 5V4 5-5V4 5-5V4 1. Change from average for fourth quarter of previous year to average for fourth quarter of year indicated. casts of real GDP growth made by the project real GDP to increase about members of the Board of Governors and 3V2 percent, and they expect the unemthe Federal Reserve Bank presidents is ployment rate to edge down to between 33/4 percent to 4 percent over the four 5 percent and 5lA percent. With regard quarters of 2005. The civilian unem- to inflation, FOMC participants project ployment rate is expected to average that the chain-type price index for about 5V4 percent in the fourth quarter personal consumption expenditures of 2005. For 2006, the policymakers excluding food and energy (core PCE) will increase between IV2 percent and P/4 percent both this year and next— will now provide economic projections for two about the same as the 1.6 percent years, rather than one, in the February Monetary Policy Report. increase posted over 2004. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 The economy proved to be sufficiently unusually low levels recorded in 2003, it resilient to maintain solid growth and remained well contained. Price increases moderate core inflation in 2004 even were restrained by continuing, though as higher oil prices drained consumers' diminishing, slack in labor and prodpurchasing power and boosted firms' uct markets, which tended to offset the costs. Real GDP rose 33/4 percent last effects of higher energy and commodity year after having increased AVi percent prices, as well as the weaker dollar, in 2003. Activity was supported by con- on firms' overall costs. In addition, solid tinued robust advances in household productivity gains implied that unit spending. In addition, capital spending labor costs rose only modestly, even by businesses increased notably. Labor if up from the declines in the precedmarket conditions improved signifi- ing two years. The decline in crude oil cantly, though at an uneven pace over prices, on balance, since October points the course of the year. Private pay- to some easing of cost pressures on rolls, which turned up in late 2003, rose firms from that source in the period 170,000 per month last year, on average, ahead. and the unemployment rate declined Several forces likely contributed to below 5Vi percent by year-end and to last year's impressive economic perfor- 5V4 percent in January 2005—the lowest mance in the face of the sizable adverse rates since 2001. oil shock. The growth of real output Consumer price inflation was driven continued to be undergirded by gains higher last year by the sharp rise in in structural labor productivity. Moreenergy prices. Although core consumer over, fiscal policy remained stimulative price inflation moved up somewhat from last year through the combination of the lagged effect of earlier cuts in personal Change in Real GDP Change in PCE Chain-Type Price Index Percent, annual rate • Total • Excluding food and energy Mini i — 1 1998 2000 2002 2004 I i ll J_J 1998 2000 2002 2004 NOTE. 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 from the final quarter of the preceding period. expenditures (PCE). SOURCE. Department of Commerce, Bureau of Eco- SOURCE. Department of Commerce, Bureau of Economic Analysis. nomic Analysis. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

10 91st Annual Report, 2004 tax rates, the rise in defense spending, exceeded 5 percent; however, spending and perhaps also the partial-expensing on computing equipment increased less tax incentives for business investment. in 2004 than in preceding years, and Monetary policy was highly accommo- consumers responded to the high cost dative in the early part of the year and of gasoline and heating fuel by cutting remained accommodative, though pro- back on real spending for these items. gressively less so throughout the year, Real outlays for services also increased and credit remained readily available at rapidly last year, and medical services favorable terms. Consumer demand posted especially large gains. was also boosted by the strong increases Real disposable personal income in asset values during the past two (DPI) rose nearly 4 percent last year, but years. this figure is exaggerated by Microsoft's Financial conditions remained stimu- $32 billion special dividend payment lative last year even as market partici- in December (the bulk of which is estipants revised up their expectations for mated to have accrued to U.S. housethe near-term path of monetary policy. holds). If this one-time event is excluded Interest rates on longer-term Treasury from the calculation, real DPI rose only securities remained low, risk spreads on 23/4 percent in 2004, well below the corporate bonds narrowed, and commer- increase posted in 2003. Faster job cial banks eased terms and standards growth helped to support increases in on business loans. In this environment, households' incomes last year in nomi household debt again increased briskly. nal terms, and the Jobs and Growth The borrowing needs of nonfinancial Tax Relief Reconciliation Act of 2003 businesses were damped by their strong (JGTRRA), which brought lower percash flows. Equity values rose, espe- sonal tax rates forward into 2003, led to cially toward the end of the year. At the larger refunds and smaller final paysame time, the exchange value of the ments in the spring of 2004. However, dollar declined, on net, over the year as real income gains were held down, as market participants apparently focused higher oil prices siphoned off household on the financing implications of tnc purchasing power. large and growing U.S. current account With the growth of real consumption deficit. spending outpacing that of real income through most of last year, the personal The Household Sector Change in Real Income and Consumption Consumer Spending Percent, annual rate Consumer spending grew substantially • Disposable personal income last year. Personal consumption expen- • Personal consumption — g ditures (PCE) advanced nearly 4 perexpenditures cent in real terms, about the same as — 6 the increase in 2003. Sales of new motor vehicles remained brisk, on average, llllllllli — 4 at 163/4 million units. Excluding motor — 2 vehicles, consumer spending on most categories of durable and nondurable 1998 2000 2002 2004 goods rose rapidly, as gains in real SOURCE. Department of Commerce, Bureau of Ecoexpenditures for food and clothing both nomic Analysis. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 11 saving rate moved lower, from 1 Vi per- able and relatively low-cost source of cent, on average, in 2003 to only V2 per- funds for financing consumption. cent in the third quarter of last year. Consumer confidence, which had (The fourth-quarter surge in income improved in 2003, remained at generally associated with the Microsoft dividend favorable levels last year, according to payments pushed the saving rate back surveys by both the Michigan Survey up to 1% percent, but this increase will Research Center (SRC) and the Conferlikely be reversed early this year as ence Board. Confidence tended to dip dividend income falls back. Because the at times during the year when energy company's share price declined in step prices were moving up most rapidly, but with the dividend payouts, the dividends it recovered soon after those episodes. had no effect on shareholders' overall financial resources and so probably had Residential Investment little effect on consumption.) Low interest rates were one factor Residential investment remained robust that helped to support consumption last year. Real expenditures increased growth—especially for durable goods— 53/4 percent in 2004—the third straight despite comparatively slow gains in real year of strong gains. Demand for housincome. Higher household wealth was ing was influenced by the same factors also an important force that propelled that affected household spending more consumer spending last year. According generally, but it was especially supto the Federal Reserve's flow of funds ported by nominal mortgage interest accounts, the ratio of household net rates that have remained near their lowworth to disposable income rose sharply est levels since the late 1960s. Rates on in 2003, as corporate equity values thirty-year fixed-rate mortgages flucrebounded and home prices continued to tuated between about 5!/2 percent and rise. Moreover, although equity values 6V4 percent over the past two years; they were little changed, on net, through edged up to the high end of that range much of 2004 before rising notably in during the spring but dropped back to the final quarter, home prices continued under 6 percent by the end of summer to rise throughout the year, and the and now stand below 53A percent. wealth-to-income ratio moved up further; by the third quarter (the most recent period for which the complete Mortgage Rates wealth data are available), the ratio had reversed nearly half its decline since the stock market peak in 2000. Because wealth feeds through into household Fixed rate spending over a period of several quarters, the wealth increases in both 2003 and 2004 were important in supporting consumer spending last year. The rise in house prices, together with continued low interest rates, also led consumers to extract additional equity from their 2001 2002 2003 2004 2005 homes, in particular through home NOTE. The data, which are weekly and extend equity loans. Such actions provided through February 9, 2005, are contract rates on many households with a readily avail- thirty-year mortgages. SOURCE. Federal Home Loan Mortgage Corporation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

12 91st Annual Report, 2004 In the single-family sector, housing in 2003. Refinancing activity fell off starts amounted to 1.6 million units last sharply last year, as the pool of outstandyear, a rate faster than the already rapid ing mortgages with interest rates above pace of 1.5 million units started in 2003. current market rates shrank consider- In the multifamily sector, starts totaled ably. Mortgages with adjustable interest a solid 350,000 units last year, a figure rates, including hybrids that feature both in line with that of the preceding several fixed and adjustable interest rate comyears. Sales of both new and existing ponents, were increasingly popular in single-family homes hit new highs last 2004. Consumer credit continued to year, and home prices moved up sharply. expand at a moderate pace by historical The repeat-transactions price index for standards, restrained in part by the subexisting homes (limited to purchase stitution of other forms of debt, such as transactions only), which is published home equity loans. Higher interest rates by the Office of Federal Housing Enter- on some consumer loans and credit prise Oversight, climbed more than cards in the second half of 2004 may 10 percent over the four quarters end- have also damped the growth of coning in the third quarter of last year (the sumer credit. latest quarter for which data are avail- Relatively low interest rates and furable) and is up a cumulative 65 per- ther gains in disposable personal income cent since 1997, when it started to limited pressures on household balance rise notably more rapidly than overall sheets in 2004. Measures of aggregate inflation. These price increases have household financial obligations and debt also outstripped by a wide margin the service, which capture pre-committed increases in household incomes and expenditures relative to disposable rents. Another nationwide price index, income, were little changed last year, on the Census Bureau's constant-quality balance, though they remained high by price index for new homes, rose only historical standards. Nevertheless, mea- 63/4 percent last year. Because this sures of household credit quality either index does not adjust for the location held steady or improved during the of new homes within metropolitan course of the year. The latest available areas, and because new homes consti- data indicate mat delinquency rates on tute only a small fraction of the overall credit card loans, consumer loans, and housing stock, this index is probably a residential mortgages at commercial less reliable indicator of overall home banks declined, while those on auto values than is the repeat-transactions loans at captive finance companies were index. about unchanged at a low level. Household bankruptcy filings ran below the elevated levels of 2003, although they Household Finance stayed generally above the rates posted Household debt is estimated to have in earlier years. increased about 93/4 percent in 2004, a touch less than in the previous year. The Business Sector Mortgage debt again paced this advance. The brisk expansion of mortgages Fixed Investment reflected continued strong activity in housing markets and rising house prices. Business fixed investment rose robustly However, the growth rate of mortgage for a second consecutive year in 2004. debt did not quite match that registered Real spending on equipment and soft- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 13 ware (E&S) increased \3Vi percent, cent last year after having risen 19 perabout as much as in 2003, as firms' final cent in 2003; these gains followed two sales continued to increase, profits and years of declines. Although the pattern cash flow rose further, and many busi- of spending was uneven over the four nesses reported a need to replace or quarters of 2004, for the year as a whole, upgrade existing equipment and soft- business outlays for computing equipware. Although many firms had little ment rose 25 percent in real terms, while need to seek outside financing given spending on software and communitheir flush cash situation, those that did cations equipment posted increases of generally found financial markets to 13 percent and 10 percent respectively. be receptive—interest rates remained Outside of the high-tech sector, business low, and other terms and conditions spending on aircraft moved lower for stayed relatively favorable. The partial- the third consecutive year, as airlines expensing tax incentives, which covered continued to struggle with a highly comnew equipment and software installed petitive market environment and high by the end of 2004, boosted profits and fuel prices. In contrast, business outlays cash flow and may have also stimulated on motor vehicles rose substantially last some investment spending. year, with the demand for trucks excep- Increases in E&S spending were tionally strong. Investment in equipment fairly widespread across categories other than high-tech and transportation of capital goods. Spending on high- goods—a category that includes industechnology equipment increased \5Vi per- trial machinery and a wide range of other types of equipment—moved up 11 percent last year, the most in more Change in Real Business Fixed Investment than ten years. In contrast to the rebound in equip- Percent, annual rate ment spending, real outlays in the non- • Structures residential construction sector were | Equipment and softwarree — 20 about unchanged for a second year in Jil — 10 2004 and have yet to recover from their + — 0 sharp downturn during 2001 and 2002. In the office sector, where construc- — 10 tion increased rapidly in the late 1990s, — 20 spending has remained especially weak; I 1 J_ J_ _L I 1 vacancy rates for these properties, although down a touch over the past • High-tech equipment year, are still quite elevated. Construcand software — 60 tion of industrial buildings has also • Other equipment excluding transportation — 40 remained low as a result of high vacancy rates. In contrast, demand for [LIU fui — 20 new retail and wholesale properties has r been firmer, reportedly a reflection of the steady increases in consumer spend- 1 I 1998 2000 2002 2004 ing, and outlays for these types of buildings moved higher last year. In addition, NOTE. High-tech equipment consists of computers investment in the drilling and mining and peripheral equipment and communications equipment. sector rose last year in response to high SOURCE. Department of Commerce, Bureau of Eco- prices for natural gas. nomic Analysis. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

14 91st Annual Report, 2004 Inventory Investment Before-Tax Profits of Nonfinancial Corporations as a Percent of Sector GDP Businesses added appreciably to inventories last year for the first time since Percent running down their holdings sharply in 2001. As economic activity strength- — 14 ened during 2002 and 2003, many — 12 businesses chose to operate with inven- — 10 tories that were increasingly lean relative to sales. In 2004, when stocks had become quite spare—even after tak- — 6 ing into account the ongoing improve- 1 i 1 I 1 I I i i 1 I ! 1 1 I! 1 I 1 1 1 I I I I I I I i i 1 ments in inventory management that 1980 1984 1988 1992 19% 2000 2004 have allowed firms to economize NOTE. The data are quarterly and extend through on stockholding—and businesses had 2004 :Q 3. Profits are from domestic operations of nonfinancial corporations, with inventory valuation and apparently grown more confident in the capital consumption adjustments. durability of the recovery, businesses SOURCE. Department of Commerce, Bureau of Ecoaccumulated $45 billion of inventories nomic Analysis. (in real terms), according to preliminary data. The step-up in the pace of stockconsecutive year. In the fourth quarter of building contributed about lA percent- 2004, operating earnings per share for age point to GDP growth last year. S&P 500 firms were nearly 20 percent above their level four quarters earlier. Analysts' earnings forecasts began to Corporate Profits and moderate somewhat in the second half Business Finance of 2004 after several months of strong Strong growth of corporate profits again upward revisions. allowed many firms to finance capital In equity markets, net issuance of spending with internal funds last year. shares by nonfinancial firms turned As a result, nonfinancial business debt more negative in 2004. Although initial rose at only a moderate pace. Net equity public offerings rebounded from the issuance dropped further into negative sluggish pace of the past two years, territory in 2004, and on balance non- ample profits and sizable cash holdings financial corporations are estimated to helped boost share retirements from have raised no net funds in credit and mergers and repurchases. equity markets. However, short-term Net corporate bond issuance was business debt, including commercial sluggish in 2004, as firms evidently paper and commercial and industrial relied heavily on their considerable prof- (C&I) loans, expanded last year after its to fund investment in fixed capital three years of contraction, and commer- and inventories. The timing of gross cial mortgage debt continued to increase bond issuance was influenced by interrapidly. The credit quality of businesses est rate movements during the year, as remained strong. firms took advantage of occasional dips Corporate profits held up well in 2004 in longer-term yields to issue bonds. after surging in the previous year. The Firms reportedly used a large portion ratio of before-tax profits of nonfinan- of the proceeds to pay down existing cial corporations to that sector's gross debt, although some companies used the value added increased for a second funds raised in the bond market to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 15 Selected Components of Net Business already substantial cash positions on Financing firms' balance sheets. The delinquency rate on C&I loans declined further, and Billions ol dollars the twelve-month trailing default rate on Q Commercial paper corporate bonds fell to historically low • Bonds 600 levels before edging up late in the year. • Bank loans 400 Net upgrades of bonds by Moody's Sum of selected components Investors Service for both investment- 200 and speculative-grade nonfinancial 0 firms increased last year. The stock of commercial mortgage debt outstanding grew at a rapid pace in 2002 2003 2004 2004. Some firms reportedly continued NOTE. Seasonally adjusted annual rate for non- to find mortgages an attractive source financial corporate business. The data for the sum of of long-term funding. The expansion of selected components are quarterly. The data for 2004:Q4 are estimated. commercial mortgage credit helped pro- SOURCE. Federal Financial Institutions Examination pel issuance of commercial-mortgage- Council, Consolidated Reports of Condition and Income backed securities (CMBS) to near- (Call Report). record levels. Delinquency rates on repurchase equity shares or to finance commercial mortgages on the books mergers. of banks and insurance companies Short-term business borrowing re- remained low throughout the year, and vived in 2004 after a prolonged contrac- those on loans backing mortgage securition. Commercial paper outstanding ties fell. Considerable gains in comturned up in the first half of the year, mercial real estate prices increased ownalthough it flattened out over the second ers' equity and largely kept pace with half. Business loans at banks rebounded the sizable increase in mortgage debt over the course of last year. According obligations. Yield spreads of CMBS to results from the Federal Reserve's over comparable Treasury securities Senior Loan Officer Opinion Survey remained moderate. on Bank Lending Practices, commercial banks eased terms and standards on The Government Sector business loans during the course of 2004 in response to the improved economic Federal Government outlook and to increased competition from other banks and nonbank lend- The federal budget position deteriorated ers. Survey responses also indicated slightly further in 2004, as spending an increase in demand for C&I loans increases and further tax reductions that reflected firms' need to fund rising offset the effects of stronger economic accounts receivable, inventories, capital growth on revenues. The unified budget expenditures, and merger activity. Con- deficit widened from $378 billion in fiscerns over loan quality seemed to dimin- cal 2003 to $412 billion in fiscal 2004. ish further in 2004, as spreads on lever- As a share of GDP, the federal unified aged deals in the syndicated loan market deficit stood close to V/i percent in both edged down from already low levels. years. Receipts increased 5Vi percent in Corporate credit quality remained fiscal 2004 after two years of declines. solid in 2004 amid strong earnings, low Corporate receipts surged more than interest rates, and a further buildup of 40 percent, or $58 billion, reflecting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

16 91st Annual Report, 2004 Federal Receipts and Expenditures 2004. First, the Working Families Tax Relief Act extended through 2010 a 1*61106111 of nominal GDP variety of personal tax reductions that had previously been set to expire earlier. — 24 Second, the American Jobs Creation Act Expenditures Receipts 22 replaced the exclusion of extraterritorial Expenditures ^ income (which the World Trade Orga- 20 ex. net interest nization had declared an illegal export 18 subsidy) with numerous other tax — v^ _ 16 reductions for domestic manufacturers h i ii i i 1 1 1 11 1 11111111 11 il and U.S. multinationals. The first bill is 1986 1989 1992 1995 1998 2001 2004 expected to have a ten-year budget cost NOTE. The budget data are from the unified budget of around $150 billion, while the second and are for fiscal years (October through September); bill was scored as being revenue neutral. GDP is for the year ending in Q3. As for federal spending in fiscal 2005, SOURCE. Office of Management and Budget. the regular appropriations bills provided the improvement in corporate profits; for sizable increases in spending on individual tax receipts—restrained by defense and homeland security and for JGTRRA, which pulled forward reduc- modest increases in nondefense discretions of personal tax rates that had been tionary expenditures. In addition, emerscheduled for the second half of the gency legislation passed in the autumn decade—rose only about 2 percent. provided disaster aid for victims of Overall federal receipts increased less hurricanes and for ranchers and farmers rapidly than nominal GDP, and the affected by drought conditions. ratio of receipts to GDP edged down to The recent sizable deficits in the uni- 16!/4 percent, the lowest level in more fied budget mean that the federal govthan forty years. ernment, which had been contributing Meanwhile, nominal federal outlays to the pool of national saving from 1997 increased about 6 percent in fiscal 2004. through 2000, has been drawing on that Spending for national defense increased pool since 2001. Net federal saving— especially sharply, but spending also essentially the unified budget balance increased notably for Medicare and adjusted to the accounting practices Medicaid. Debt service costs, which of the national income and product fell sharply from 1997 through 2003 as accounts (NIPA)—dropped from posia result of reduced debt and declining tive 2 percent of GDP in 2000 to a level interest rates, edged higher last year. below negative 3 percent of GDP in Federal government purchases of goods 2003 and 2004. Personal saving moved and services—the part of spending that lower over this period as well, while is counted in GDP—rose about 4 per- business net saving rose with the cent in real terms in 2004 after larger rebound in corporate profits. In all, net increases in the preceding two years. national saving edged up in 2004 but (Government spending on items such remained near its postwar lows. Because as interest payments and transfers is net national saving has fallen increasexcluded from GDP because these items ingly short of net domestic investment do not constitute a direct purchase of over the past several years, the inflow final production.) of foreign funds needed to finance that Regarding legislative initiatives, two investment has risen. The growing new tax bills were enacted in the fall of inflow of foreign capital is mirrored in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 17 Federal Government Debt Held robust, and Treasury securities held in by the Public custody at the Federal Reserve Bank of New York on behalf of such institutions Percent of nominal GDP increased just over $200 billion in 2004. Also, data from the Treasury Interna- — 55 tional Capital System showed a substantial increase in holdings of Treasury — 45 securities by foreign official and private y— 35 investors, particularly those in Japan. The proportion of Treasury securities — 25 held by foreign investors is estimated to 1 if 11i!i11i1S1i111111111 i 111411 i 1111111 i i 1IIMii 1 have risen to a record 43 Vi percent by 1964 1974 1984 1994 2004 the third quarter of 2004. NOTE. Through 2003, the data for debt are year-end Treasury debt reached its statutory figures, and the corresponding value for GDP is for Q4 ceiling late last year. To cope with at an annual rate; the final observation is for 2004:Q3. Excludes securities held as investments of federal gov- the constraint, the Treasury temporarily ernment accounts. resorted to accounting devices, suspended issuance of state and local the widening of the nation's current government series securities, and postaccount deficit. Over time, the low poned a four-week bill auction. In midnational saving rate could eventually November, Congress raised the debt slow the rise in living standards either ceiling from $7.4 trillion to $8.1 trillion, by increasing the burden of servicing and the Treasury subsequently resumed U.S. foreign debt or by impinging on normal financing operations. domestic capital formation. The growth rate of Treasury debt State and Local Governments moderated slightly last year after increasing substantially in 2003. None- Pressures on the budgets of state and theless, federal debt held by the public local governments have eased as ecoas a percentage of GDP continued to nomic activity has strengthened. Tax edge higher over the course of 2004 and receipts have been spurred by the currently stands at about 36Vi percent. increases in household income, con- To help finance substantial budget defi- sumer spending, and property values. cits, the Treasury issued a considerable As a result, many states seem to be on volume of bills as well as two-, three-, track to meet balanced budget requirefive-, and ten-year nominal notes. In ments in the current fiscal year (which addition, the Treasury expanded its ends June 30 for all but a few states) borrowing program in 2004 by adding without using as much borrowing or semiannual auctions of twenty-year other extraordinary measures as in inflation-protected bonds and five-year recent years. Nevertheless, a number of inflation-protected notes. states still must deal with lingering fiscal Various indicators suggested a contin- problems, particularly depleted reserve ued strong appetite for Treasury securi- funds, the expiration of temporary tax ties among foreign investors last year. hikes, and rising Medicaid costs. In Indirect bidding at Treasury auctions, addition, several states still face serious which includes bidding by the Federal structural imbalances in their budgets. Reserve Bank of New York on behalf Real expenditures by state and local of foreign official institutions, remained governments as measured in the NIPAs Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

18 91st Annual Report, 2004 remained about flat for a second year in U.S. Trade and Current Account Balances 2004. Real spending on current operations rose less than 1 percent last year, Percent of nominal GDP while real investment spending declined. + However, even as they were holding the 0 line on spending increases, states and localities were able to resume net hiring in 2004 after having left employment about unchanged in 2003. Net issuance of debt by state and local governments edged down from the rapid pace set in 2003, as improved budget positions permitted some contraction in short-term debt. Advance refunding offerings were again strong during J L 1 i the year, as states and municipalities 1998 2000 2002 2004 took advantage of low long-term inter- NOTE. The data are quarterly. The trade data extend est rates and moderate credit spreads. through 2004 :Q4, and the current account data extend Credit quality of tax-exempt borrowers through 2004:Q3. improved in 2004. Rating upgrades of SOURCE. Department of Commerce. tax-exempt bonds outpaced downgrades, especially later in the year. boost exports in the first half, but that stimulus diminished in the second half of the year when foreign growth slowed. The External Sector For the year as a whole, exports of After narrowing in 2003, the U.S. cur- industrial supplies and capital goods rent account deficit widened again last posted solid growth. Exports to Canada, year and was $660 billion (annual rate), Mexico, and western Europe rose or 5.6 percent of GDP, in both the smartly in 2004, whereas exports to second and third quarters. Much of Japan were relatively weak. Real this widening reflected a considerable exports of services increased about increase in the deficit on goods and ser- 3Vi percent through 2004 as a whole. vices trade, as a marked rise in imports After increasing at an annual rate of more than offset solid increases in almost 6 percent in the first half of 2004, exports. The trade deficit expanded from prices of exported goods moved up at $500 billion during the fourth quarter of just a 2V2 percent rate in the second 2003 to more than $650 billion, on aver- half. This deceleration was due in large age, during the second half of 2004. part to a reversal of the run-up in the prices of agricultural products that had occurred in late 2003 and early 2004. International Trade Better harvests last year returned prices Real exports of goods and services rose of agricultural products to levels near an estimated 5V6 percent in 2004 despite those that had prevailed before the a deceleration in the fourth quarter. In spike. the first half, exports were supported by Solid growth in income in the United the lagged effect of the fall in the dol- States spurred growth of real imports lar's value in 2003. Strong expansion of of 9l/z percent in 2004. The increase priforeign economic activity also helped marily reflected higher imports of goods Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 19 that occurred despite a notable rise in price of WTI relative to other grades their prices. Real oil imports expanded of crude oil. Sabotage of production and almost 10 percent in 2004. Imports of distribution facilities in Iraq hindered oil capital equipment increased throughout exports from that country, which remain the year, but imports of consumer goods below pre-war levels. In Nigeria, ethnic suffered a period of weakness through violence and community protests shut the middle of the year before rebound- down some production. Russian oil ing in the fourth quarter. Imports of output, however, continued despite the services moved up only PA percent in breakup of Yukos, formerly Russia's 2004. largest oil company. Late in the year, Prices of imported non-oil goods oil prices declined from their October increased at an annual rate of just over highs, as production recovered in the 4 percent in the first half of 2004, but Gulf of Mexico and OPEC added new the pace slowed to 2 percent in the capacity. The price of the far-dated second half. This step-down largely NYMEX oil futures contract (currently reflected a deceleration in the prices for delivery in December 2011) rose of industrial supplies, driven by a level- about $10 per barrel during 2004, possiing off of nonfuel commodity prices bly reflecting expectations of greater at the elevated levels reached in March. oil demand in Asian emerging-market Declines in the prices of foods offset economies. The far-dated futures concontinued price increases for metals. tract averaged about $38 per barrel in The spot price of West Texas interme- January 2005, while the spot price of diate (WTI) crude oil moved up during WTI averaged about $48 per barrel. most of 2004 and surged temporarily to a record high of $55 per barrel in Octo- The Financial Account ber. Since then, it has fluctuated somewhat below that peak but still at levels In 2004, the U.S. current account deficit well above $33 per barrel, the price at was financed once again largely by forwhich it started 2004. Oil prices were eign purchases of U.S. bonds. Foreign driven up by intensified concerns that official inflows picked up further last oil supply would not keep pace with year and were especially strong in the surprisingly strong global demand. Oil first quarter, reflecting sizable bond consumption in China grew nearly purchases by Asian central banks. Pri- 15 percent in 2004, pushing that econ- vate foreign purchases of U.S. bonds omy past Japan as the world's second- rebounded in 2004 from a slight decline largest consumer. As oil prices rose, in 2003, with especially large purchases OPEC increased its oil production, coming late in the fourth quarter. In diminishing the cartel's estimated spare contrast, foreign demand for U.S. equicapacity to historically low levels. ties weakened further in 2004, although Increased OPEC production damped this also picked up late in the year. Net particularly the rise in prices of heavier, purchases of foreign securities by U.S. more sulfurous grades of crude oil but investors remained strong in 2004, with had less effect on prices of lighter grades most of the strength coming in the seclike WTI. Supply disruptions also ond half of the year. played a role in the run-up of oil prices. U.S. direct investment abroad contin- In October, Hurricane Ivan extensively ued at a strong pace, as reinvested earndamaged oil and gas production facili- ings remained sizable. Direct investties in the Gulf of Mexico, boosting the ment into the United States rebounded Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

20 91st Annual Report, 2004 in the first three quarters of 2004 from months since then, increases in private its anemic pace in 2003; global mergers payrolls have averaged 165,000 per and acquisitions revived, and reinvested month. earnings picked up. Overall, net direct The improved pace of hiring was investment outflows continued over the widespread, as all major industry groups first three quarters of 2004 but at a lower contributed to faster employment pace than in 2003. growth relative to that of the latter part Net inflows of portfolio capital of 2003. The largest gains were in exceeded net outflows of direct invest- professional and business services and ment and represented the financial coun- health services. The construction secterpart to the U.S. current account defi- tor also posted substantial gains. In the cit. These net financial inflows imply a manufacturing sector—where employfurther decline in the U.S. net interna- ment had declined almost continuously tional investment position, which began since early 2000—payrolls increased in 2004 at a reported level of negative the spring when overall employment $2.4 trillion (22 percent of GDP). was rising sharply but were about unchanged, on net, over the second half of the year. Employment gains in The Labor Market retail trade and in food services were also brisk over the first half of the Employment and Unemployment year but tapered off in the second half. The labor market improved notably in Meanwhile, state and local governments 2004. Private payrolls, which began added substantially to their payrolls last to post sustained increases in late year, especially for education, but civil- 2003, rose an average of 170,000 per ian employment in the federal governmonth last year. Progress was not steady ment edged lower. over the course of the year, however. The unemployment rate fell from Employment growth stepped up sharply near 6 percent in late 2003 to less than in the spring to a pace of almost 300,000 5Vi percent by late last year; joblessness per month in March, April, and May; fell further in January 2005, to 5!/4 pernet hiring then dropped back to subpar cent. The decline in the unemployment rates of about 100,000 per month in rate over the past year reflected both the June through September. In the four pickup in hiring and a labor force participation rate that remained surprisingly low. From 2001 through 2003, the par- Net Change in Payroll Employment ticipation rate declined by more than would have been predicted on the basis Thousands of jobs, monthly average of past relationships with indicators Private nonfarm of labor demand, and in 2004, when the — — 400 Jan. pace of hiring increased, the participa- 1 • .1 1 — 200 tion rate leveled off but failed to rise. • "" These considerations suggest that there III A may be a persistent component to the — 200 recent softness in participation. However, participation had been quite strong 1 i II 1 1 1 1 I 1 1 1 1999 2001 2003 2005 through 2000, when the labor market was extremely tight, and the fact that SOURCE. Department of Labor, Bureau of Labor Statistics. participation turned down at the same Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 21 time that labor demand weakened sug- with the pace of the late 1990s and well gests that at least some of the recent above rates that had prevailed during the low participation is cyclical. To the preceding two decades. extent that some of this low participa- Increases in hourly labor compensation proves to be transitory, the resump- tion remained moderate last year. As tion of more-rapid labor force growth measured by the employment cost index will limit the speed at which employ- (ECI), which is based on a quarterly ment gains further push down the unem- survey from the Bureau of Labor Staployment rate. tistics, hourly compensation in private nonfarm businesses increased 33A percent in 2004, a bit less than in 2003. An Productivity and Labor Costs alternative measure is compensation per Labor productivity rose solidly again hour in the nonfarm business sector as last year. Output per hour in the non- derived from compensation data in the farm business sector increased an esti- NIPAs. This measure of hourly compenmated 2V2 percent over the year. This sation rose 3Vi percent last year, an increase was somewhat below the out- increase similar to that in the ECI but sized 4 percent average pace of increase substantially less than the 5Vz percent from 2001 through 2003. Those earlier rise in 2003. huge productivity gains were not associ- As has been the case for several years, ated with especially large accumulations the cost of employee benefits rose conof new capital equipment, as had been siderably more than did wages and salathe case during the late 1990s; instead, ries last year. The benefits component to a large degree, the gains seem to of the ECI increased nearly 7 percent, have been related to more effective use while the wages and salaries component of capital equipment that had been posted a much more moderate 3 percent acquired earlier and to one-time organi- increase. The rise in hourly wages and zational innovations induced by firms' salaries was about the same as increases earlier reluctance to commit to increased in the preceding two years; although hiring. Still, last year's 2Vi percent probably boosted by last year's higher increase in productivity was impressive rate of price inflation, wages were likely by long-run standards: It was in line held down by the continued, though diminishing, labor market slack and also Change in Output per Hour by employers' attempts to offset continued large increases in benefits costs. l^ercent, annual rale Health insurance costs continued to rise rapidly. As measured by the ECI, employers' costs of health insurance, — — 6 which account for about 6 percent of • •1 overall compensation costs, rose 7 per- 1 cent last year after having increased I 1 more than 10 percent per year in 2002 and 2003. • JL liliIJi i 1948- 1995- 2002 2004 1973 1973- 2000 Prices 1995 NOTE. Nonfarm business sector. Overall consumer prices rose notably SOURCE. Department of Labor, Bureau of Labor Statistics. more in 2004 than they did in 2003, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

22 91st Annual Report, 2004 the sharp increase in energy prices Alternative Measures of Price Change accounted for much of the step-up. The Percent chain-type price index for personal consumption expenditures (PCE) rose Price measure 2002 2003 2004 2Vi percent last year, compared with an Chain-type increase of P/4 percent in 2003. The Gross domestic product 1.6 1.7 2.4 increase in PCE prices excluding food Gross domestic purchases 1.8 1.8 2.9 Personal consumption and energy was considerably smaller— expenditures 1.8 1.7 2.5 only \Vi percent, up a little more than Excluding food and energy ... 1.5 1.2 1.6 Market-based PCE excluding lA percentage point from the increase food and energy 1.4 1.0 1.6 in 2003. Inflation as measured by the Fixed-weight market-based component of core PCE Consumer price index 2.2 1.9 3.4 prices—which excludes a collection of Excluding food and energy ... 2.0 1.2 2.1 erratic prices that are unobservable from NOTE. Changes are based on quarterly averages of market transactions and which the seasonally adjusted data. Bureau of Economic Analysis began to SOURCE. For chain-type measures, Department of Commerce, Bureau of Economic Analysis; for fixedpublish early last year—was in line with weight measures, Department of Labor, Bureau of Labor overall core PCE inflation last year. The Statistics. core consumer price index (CPI) rose about 2 percent last year after having prices for residential and nonresidential increased \lA percent in 2003. (The CPI structures. differs from PCE prices in a number of The jump in consumer energy prices respects, but one factor that boosted CPI in 2004 was driven by the run-up in inflation relative to PCE inflation last crude oil prices. The prices of both gasoyear was a difference in the way the two line and fiiel oil increased approximately indexes measure the prices of medical 30 percent over the year, and higher oil services, especially physicians' services, costs accounted for the bulk of the which rose much more rapidly in the increase. Prices of natural gas, which CPI than in the PCE index.) The rise in can often substitute for fuel oil in the core consumer prices was largest in the industrial sector, rose notably as well early months of 2004: Core PCE prices last year despite the restraining influincreased at an annual rate of nearly ence of ample inventories. Electricity 2 percent over the first half of the year prices, which tend to reflect fuel costs and then decelerated to a \lA percent with a lag, also moved higher through rate of increase in the second half. most of the year but dropped back some The price index for GDP was less near year-end. affected by last year's rise in energy Consumer food prices rose around prices than was the PCE measure; much 3 percent for a second consecutive of the energy price increase was attribut- year in 2004. Exports of beef dropped able to the higher prices of imported oil, sharply last year when most of the largwhich are excluded from GDP because est importing countries placed restricthey are not part of domestic produc- tions on U.S. beef after a case of mad tion. GDP prices increased 2Vi percent cow disease was discovered. Neverthelast year, 3A percentage point faster less, domestic demand was sufficiently than in 2003. In addition to the rise in strong to support consumer meat prices PCE prices (excluding the influence of last year. Fruit and vegetable prices imported oil), GDP prices were affected trended sideways through most of the by a sizable increase in construction year but then rose sharply in the fall Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 23 because of crop damage associated with sharp 2003 declines. Prices of nonthe series of hurricanes that hit the energy PCE services rose about 2 per- Southeast in August and September. cent in 2004—a smaller increase than in In addition, prices for food away from 2003. home, which are driven more by labor Last year's rise in inflation showed costs than by raw food prices, increased through to short-term measures of more rapidly last year than in 2003. expected inflation, but longer-term mea- Core consumer prices were influ- sures remained stable. According to enced by a variety of forces last year. the Michigan SRC, households' median Price increases were likely restrained by expectations for inflation over the next continuing slack in labor markets and year moved up considerably in the in some product markets, but businesses spring as inflation was rising, but then faced considerable pressure from sev- they eased back and ended the year near eral sources of increased costs. First, 3 percent—up from around 2V2 percent the indirect effects of the large jump in in late 2003. In contrast, the median energy prices fed through to businesses expectation for inflation over the next throughout the economy and were espe- five to ten years held about steady cially important for firms in energy- near 23A percent throughout this period. intensive industries, such as those that Inflation compensation as measured produce plastics and fertilizers. Second, by spreads between yields on nominal prices were up sharply for a number Treasury securities and inflationof other industrial commodities, includ- indexed securities—another indicator of ing lumber and a variety of metals. expected inflation, albeit one that is also These price increases reflected strength- influenced by perceptions of inflation ening economic activity abroad as well risk and perhaps also by the developas in the United States. Although these ment of the market for inflation-indexed non-oil commodities represent a small debt—showed a similar pattern. Inflapart of businesses' overall costs, some tion compensation over the next five businesses likely felt the pinch of sus- years moved up about V2 percentage tained price increases in these areas. point during 2004, to 2Vi percent, while Third," the declining exchange value of compensation at the five- to ten-year the dollar boosted import prices, includ- horizon edged lower, on net, over the ing those of many inputs to production. year. Finally, the deceleration in labor productivity boosted unit labor costs after U.S. Financial Markets two years of declines; nevertheless, last year's 1 percent rise in unit labor costs Domestic financial conditions were supwas quite modest. portive of economic growth in 2004. Taken together, these influences left Interest rates on longer-term Treasury their clearest mark on the prices of securities remained low, corporate risk goods rather than services. Core goods spreads fell, and stock prices, on balprices were about unchanged, on aver- ance, registered gains. These developage, last year, but this period of stability ments occurred even as market particifollowed a period of unusually large pants revised up their expectations for declines in 2003. In particular, the prices the path of the federal funds rate. At of new motor vehicles leveled off after the beginning of 2004, futures market falling notably in 2003, and the prices quotes implied that investors expected a of used vehicles reversed some of their PA percent target for the federal funds Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

24 91st Annual Report, 2004 Interest Rates on Selected ary and March, yields fell substantially Treasury Securities in response to employment reports that indicated tepid job growth. Prices of Percent federal funds and Eurodollar futures contracts implied that investors placed Ten-year 6 only small odds on an increase in —wT 5 the target funds rate before late 2004 / 4 and that they envisioned only moderate Zz _yj \ Two-year fh\** 3 monetary policy tightening thereafter. 2 Longer-term interest rates and the iree-month w~^~ * 1 expected path for the federal funds rate 1 1 1 1 were considerably marked up later in 2002 2003 2004 2005 the spring in response to data suggesting NOTE. The data are daily and extend through Feb- a pickup in aggregate demand and hirruary 9, 2005. ing, readings on core inflation that came SOURCE. Department of the Treasury. in above expectations, and rising oil prices. In the statement released after its rate at year-end, 50 basis points below May meeting, the Committee indicated the target actually established at the that policy accommodation was likely to FOMC meeting in December 2004. be removed at a "measured" pace. At Consistent with the revision in policy its June meeting, the Committee raised expectations, yields on two-year Trea- the target for the federal funds rate from sury notes increased about \lA percent- 1 percent to 1 lA percent, but it continued age points in 2004. Yields on longer- to assess the risks to sustainable growth dated Treasury securities, however, and to price stability as balanced and ended the year essentially unchanged. reiterated the "measured pace" lan- Despite the run-up in oil prices, equity guage. Interest rates across the term prices registered solid gains in 2004 structure declined somewhat immediafter rising sharply the year before. Risk ately after the announcement, reportedly spreads on investment-grade corporate because some market participants had debt declined a touch, and those on expected the FOMC to mention upside speculative-grade debt fell more notice- risks to growth or inflation in its ably. Moreover, banks appreciably eased statement. terms and standards for lending to Chairman Greenspan's congressional businesses. testimony in July on monetary policy, which suggested that recent softness in consumer spending would likely prove Interest Rates short lived, sparked a jump in yields Most market interest rates rose, on bal- on Treasury securities. However, interance, over the first half of 2004, particu- est rates subsequently moved lower, on larly at shorter maturities. The FOMC's balance, as incoming data pointed to decision at its January meeting to shift weaker spending and employment than from a statement that monetary policy investors had expected as well as to could remain accommodative for "a more-subdued core inflation. Apart from considerable period" to an indication the August employment report, which that it could be "patient" in removing seemed to hint that the economy was policy accommodation prompted a rise emerging from its "soft patch," incomin market interest rates. In early Febru- ing economic news remained somewhat Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 25 lackluster through the end of the third their willingness to bear risk apparently quarter. However, investors reportedly increased. Risk spreads on investmentviewed FOMC statements and com- grade corporate debt over comparable ments by FOMC officials as more san- Treasuries ended the year slightly below guine on near-term prospects for the their levels at the end of 2003. Spreads economy than they had expected. In par- of speculative-grade yields declined ticular, the release of the minutes from further after narrowing sharply during the August FOMC meeting, which refer- 2003. enced the probable need for "significant In early 2005, market participants cumulative tightening," prompted inves- boosted their expectations for the tors to mark up their expectations for the path of the federal funds rate, partly in near-term path of monetary policy. response to the publication of the min- Short-term Treasury yields rose a bit utes of the December FOMC meeting, further over the fall in association with which investors reportedly interpreted actual and expected policy tightening, as pointing to greater concerns about but long-term Treasury yields were little inflation than had been expected. Shortchanged on net. Investors' expectations and intermediate-term Treasury yields for the path of monetary policy firmed rose along with expectations for the a bit more in the fourth quarter path of monetary policy, but longerin response to higher-than-anticipated term yields edged lower. Yields on inflation and remarks from Federal investment- and speculative-grade cor- Reserve officials that were reportedly porate bonds largely moved with those interpreted as suggesting that an immi- on comparable Treasury securities, and nent pause in the tightening cycle was hence risk spreads remained at low unlikely. levels. As the economic expansion gathered momentum and measures of corporate Equity Markets credit quality improved, investors' perception of risk seemed to diminish, and After surging as much as 30 percent in 2003, broad stock market indexes climbed modestly over the first half of Spreads of Corporate Bond Yields over 2004. The boost to equity prices from Comparable Off-the-Run Treasury Yields robust earnings reports and analysts' upward revisions for future profits Percentage points during this period was offset in part by 10 rising interest rates in the second quarter, worries about geopolitical developments, and sharply higher oil prices. Stock prices dipped early in the second half in response to softer economic data, further concerns about energy prices, and guidance from corporations that I I I I I 1 1 i 1 " pointed to a less optimistic trajectory for 1997 1999 2001 2003 2005 earnings than investors had reportedly NOTE. The data are daily and extend through been expecting. However, as oil prices February 9, 2005. The high-yield index is compared with the five-year Treasury yield, and the BBB and AA pulled back toward the end of 2004 and indexes are compared with the ten-year Treasury yield. news on the economy improved, stock SOURCE. Merrill Lynch AA and BBB indexes and prices rebounded to post solid gains Merrill Lynch Master II high-yield index. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

26 91st Annual Report, 2004 Stock Price Indexes year before. Household and federal debt expanded rapidly. Borrowing by non- January 2, 2003 = 100 financial businesses was moderate, although it picked up in the fourth quarter. Commercial bank credit rose about 9 percent in 2004, a larger advance than in the previous year. Expansion of mortgage and home equity loans on banks' books remained strong, as activity in the housing market stayed robust while 2003 2004 2005 mortgage originations shifted somewhat NOTE. The data are daily and extend through Feb- toward adjustable-rate products. After ruary 9,2005. several years of runoffs, business loans began to grow in the second quarter of for the year. The increases were led by the year. According to survey evidence, stocks with comparatively small market commercial banks eased terms and stancapitalizations; the Russell 2000 index dards on business loans as the economic climbed 17 percent in 2004 to a record outlook improved and competition from high. The S&P 500 and the technology- other banks and nonbank lenders intenladen Nasdaq advanced about 9 percent sified. Also, banks reported a pickup in and 8V2 percent respectively. To date in demand for business loans that was said 2005, equity prices have edged lower, to be driven by customers' needs to fund on balance, as investors have responded rising accounts receivable, inventories, to a rebound in oil prices, lackluster capital expenditures, and mergers. After earnings reports, cautious guidance for adjusting for certain reclassifications future profits, and indications of contin- of securities as loans, the growth of conued monetary policy tightening. sumer loans on banks' books remained Expected volatility implied by options sluggish. Despite reports of increased prices for both the Nasdaq 100 and competition among banks and nonbank the S&P 500 declined further in 2004 intermediaries, bank profits were again from already low levels. The difference strong in 2004. Banks experienced furbetween the earnings-price ratio and the ther improvements in asset quality and, real ten-year Treasury yield—a crude as a result, reduced their provisions for measure of the premium investors loan losses. require for holding equity shares— M2 grew at a pace roughly in line changed little, on balance, remaining with that of nominal GDP during the close to its average value over the past first half of 2004. A resurgence of morttwo decades but above its level during gage refinancing spurred by the firstthe late 1990s. quarter decline in mortgage rates likely boosted liquid deposit growth, as proceeds from refinancing were temporarily Debt, Bank Credit, and M2 held in deposit accounts pending dis- The aggregate debt of domestic non- bursement to the holders of mortgagefinancial sectors is estimated to have backed securities. M2 growth slowed in increased about 73/4 percent in 2004, the second half of the year in response somewhat faster than nominal income to a drop in mortgage refinancing activbut a bit slower than the pace set the ity and the increased opportunity cost of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 27 holding M2 assets, as returns available has been on hold since August amid on market instruments rose more than signs that housing prices and consumer those on M2 components. For example, spending are cooling. After cutting offiyields on retail money market mutual cial interest rates earlier in the year, the funds moved up more slowly than Bank of Canada raised rates in the fall did short-term market interest rates, and in response to diminishing slack in the assets of money funds accordingly con- economy. The Bank of Mexico tighttinued to shrink. Small time deposits, ened policy throughout the year to resist which had contracted over the previous rising inflation, and Chinese authorities three years, resumed expansion in the made monetary policy more restrictive second half of the year, as their yields to rein in soaring investment demand. In began to rise in association with the the euro area and Japan, central banks increase in other market rates. Currency kept policy interest rates unchanged in grew at its slowest rate since 2000, 2004. apparently reflecting sluggish demand Foreign equity price indexes recorded by both domestic and foreign holders. moderate net gains last year after larger On balance, M2 growth from the fourth increases in 2003. Equity markets quarter of 2003 to the fourth quarter of started the year strong, but prices 2004 was about 5x/4 percent. The veloc- declined in the spring as interest rates ity of M2 rose 1 percent, on net, roughly rose. The run-up in oil prices between in line with the historical relationships July and October appeared to weigh among money, income, and opportunity on foreign equity prices, but the subsecost. quent decline in oil prices helped support a rise in equity prices late in the year. Foreign long-term interest rates International Developments declined, on net, during 2004. Rates Foreign economic activity expanded in rose in the second quarter as new data 2004 at a faster pace than in the preced- (including reports from the United ing three years. The pickup in growth States) that showed faster growth and was widespread—global manufactur- higher inflation led market participants ing and trade rebounded across indus- to expect more-aggressive monetary trial and emerging economies, in part tightening. However, foreign long-term because of strong demand from the interest rates slipped after midyear, United States and China. In the second when foreign growth slowed and forhalf of the year, trade and foreign GDP eign currencies appreciated against the growth slowed, partly as a result of dollar. Over the first half of the year, higher oil prices and the appreciation of spreads on internationally issued soversome foreign currencies against the dol- eign debt of emerging-market econolar. The run-up in oil prices and other mies over U.S. Treasuries moved up commodity prices contributed to higher, somewhat from low levels, but spreads though still moderate, inflation across more than reversed those increases in industrial and emerging economies. the second half. Monetary policy in many foreign The path of the exchange rate was economies tightened over the course uneven over the course of 2004. The of 2004. Citing high rates of capacity dollar rose slightly in the first half of the utilization and mounting inflationary year on perceptions that monetary polpressures, the Bank of England raised its icy would tighten more quickly in the target interest rate 100 basis points but United States than abroad. Beginning in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

28 91st Annual Report, 2004 Spread on Internationally Issued Sovereign pound, and the Canadian dollar. The dol- Debt of Emerging-Market Economies lar declined 4 percent, on net, against the Japanese yen and 13 percent against Percentage points the Korean won, but some other Asian central banks, most notably the People's 10 Bank of China, kept their currencies stable against the dollar. So far in 2005, the dollar has rebounded, with market commentary focusing on the positive differential between U.S. economic growth and that in Europe and Japan. 2002 2003 2004 2005 Industrial Economies NOTE. The data are weekly averages. The last observation is the average of trading days through After increasing strongly in the first February 9, 2005. The series shown is the spread of the yield of certain dollar-denominated sovereign debt quarter, Japanese GDP growth stagnated instruments of emerging-market economies over U.S. in the remainder of 2004. Growth in Treasury securities; over the period shown, the index exports and business investment slowed encompassed nineteen countries. SOURCE. J.P. Morgan Emerging Market Bond Index over the year, and government invest- Plus (EMBI+). ment contracted. However, corporate profits and balance sheets improved, and labor market conditions also brightened, September, however, the dollar resumed with the job-offers-to-applicants ratio the depreciation that had started in 2002, rising to a twelve-year high. Consumer as market participants focused on the prices continued to decline in 2004, financing implications of the large and though only slightly. In contrast, higher growing U.S. current account deficit. In commodity prices helped push twelve- 2004, the dollar depreciated about 7 per- month wholesale price inflation up to cent, on net, against the euro, the U.K. 2 percent late in the year, its highest rate since 1990. The yield on the ten-year bellwether government bond rose from its June 2003 record low of about V2 per- U.S. Dollar Exchange Rate against Selected Major Currencies cent to nearly 2 percent in midyear before retreating to about IV2 percent Week ending January 4, 2002= 100 recently. After making substantial sales Canadian of yen for dollars in the first quarter, k dollar 100 Japanese authorities ceased intervention in mid-March and remained on the — v t - R ^ L * J ap y a e n n ese 90 sidelines even as the yen appreciated — Euro 80 significantly against the dollar in the fall. U.K. V 70 Economic conditions in the euro area 1 1 1 1 pound , | firmed during the first half of 2004 but 2002 2003 2004 2005 weakened in the second half. Private NOTE. The data are weekly and are in foreign consumption and investment spending currency units per dollar. The last observation for each continued to rise, but export growth series is the average of trading days through February 9, slowed after midyear. German GDP 2005. SOURCE. Bloomberg L.P. growth slowed to a crawl in the second Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2004 and Early 2005 29 half, as German consumer spending Emerging-Market Economies remained anemic, held down by a weak labor market and low consumer confi- Growth of real GDP in China remained dence. In contrast, French GDP growth very robust in 2004, supported by strong was strong in the fourth quarter. The domestic demand and exports. The euro-area unemployment rate has been Chinese government took steps early in near 9 percent since rising to that level the year to slow investment spending, in early 2003. Inflation for the euro area curbing investment approvals and lendremained just above the European Cen- ing. Investment growth slowed signifitral Bank's medium-term goal of less cantly but remained rapid. At the same than, but close to, 2 percent. time, indicators of personal consump- With the exception of a slowdown in tion spending strengthened, and Chinese the third quarter, economic expansion in exports and imports continued to soar in the United Kingdom stayed strong dur- 2004. Consumer price inflation peaked ing 2004, largely because of the brisk at a twelve-month change of more than growth of consumption and government 5 percent in July but has fallen since spending. Labor markets remained tight then to less than 3 percent, as food in 2004; the unemployment rate ticked prices have moderated. Inflation excluddown to its lowest level in almost three ing food is only about 1 percent. decades, and labor earnings posted solid Supported by exports to China, ecogains. Consumer price inflation over the nomic growth in other Asian emergingtwelve months ending in December was market economies was generally strong IV2 percent, below the central bank's in 2004. Economic expansion in Korea official target rate of 2 percent. Housing remained heavily dependent on external price rises slowed sharply from rapid demand because high levels of conrates and were muted during the second sumer debt continued to weigh on conhalf of 2004. Household net mortgage sumption spending. Inflation across borrowing declined to a level 20 percent emerging Asia, though still moderate, below its 2003 peak. was pushed up by higher energy prices The Canadian economy expanded at and strong aggregate demand. a healthy pace throughout 2004. Sizable The Mexican economy grew rapidly gains in consumption and investment in the first half of the year in response to boosted output throughout the year. strong demand from the United States. Export growth, supported by demand In the third quarter, Mexican GDP from the United States, was strong in growth slowed somewhat, as manufacthe first half of the year but stagnated in turing exports stagnated, but domestic the second half as U.S. manufacturing demand remained buoyant. Increases growth slowed and the Canadian dol- in energy and food prices pushed up lar's appreciation hurt Canadian trade. twelve-month consumer price inflation The unemployment rate declined mod- to more than 5 percent, above the Bank erately over the year, and employment of Mexico's target range of 2 percent posted strong gains. Consumer price to 4 percent. Monetary policy tightened inflation has settled at about 2 percent, throughout the year, and inflation the midpoint of the Bank of Canada's began to fall near year-end. Oil revenues inflation target range, whereas inflation boosted the Mexican public-sector fiscal excluding food, energy, and indirect surplus and allowed Mexican governtaxes declined to around 1 Vi percent by ment spending to provide stimulus while year-end. still meeting fiscal targets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

30 91st Annual Report, 2004 In Brazil, economic activity con- Concerns over inflation pressures have tinued to expand robustly in 2004. prompted the central bank to tighten Domestic demand was supported by the monetary policy since September. monetary loosening that occurred in the In Argentina, the economic recovery second half of 2003 and early 2004. picked up steam last year, as exports Export growth was boosted by demand were supported by strong demand for for commodities and the recovery commodities. The country continues, in Argentina. Brazilian asset prices however, to grapple with difficult declined through May on expectations structural problems. After more than that higher global interest rates would three years in default, the government make it more difficult for the Brazilian launched a debt swap in January with government to finance its debt, but stock the goal of restructuring more than prices have moved up sharply since $80 billion in defaulted bonds. • May, and the currency has appreciated. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

31 Monetary Policy Report of July 2004 Monetary Policy and the and industrial materials. In addition, the Economic Outlook decline in the foreign exchange value of the dollar in 2003 put upward pres- The economic expansion in the United sure on the prices of imported goods and States became increasingly well estabservices. With strong demand in the lished in the first half of 2004, but the United States and increased utilization pace of inflation picked up from its of the productive capacity of the econvery low rate in 2003. At the time of the omy, firms were better able to pass on February Monetary Policy Report to the the higher costs of imports, raise the Congress, considerable evidence was prices of domestically produced items already in hand indicating that the U.S. that compete with imports, and in many economy had made the transition from cases boost their profit margins. Likely a period of subpar growth to one of in response to the faster rate of price more-vigorous expansion. Nevertheless, increases experienced this year, surveys job creation remained limited, and gains suggest that near-term inflation expecin investment, although sizable, still tations have moved up somewhat; still, seemed restrained by a lingering caution expectations for price inflation over the on the part of some businesses. In the longer term have remained in their event, businesses stepped up their hirrecent range. ing in the spring, and capital spending Monetary policy was very accommoseems to have continued apace. dative at the start of 2004 as the Fed- Over the first half of this year, energy eral Open Market Committee (FOMC) prices soared; moreover, inflation in sought to provide continuing support to core consumer prices—as measured by an economic expansion that had yet to the price index for personal consumpproduce a sustained improvement in the tion expenditures excluding the direct labor market and to ensure that the preeffects of movements in food and energy vious year's threat of an unwelcome prices—increased from an exceptionally disinflation would continue to recede. low rate of 1 percent over the four quar- Although real GDP had accelerated ters of 2003 to an annual rate of a little sharply in the second half of 2003, the more than 2 percent. To some extent, the incoming data through the time of the upturn in core inflation reflected the March meeting suggested that employindirect effects of higher energy prices, ment was growing only slowly, as but other forces also played a role. employers were relying on increased Strengthening aggregate demand both at production efficiencies to satisfy considhome and abroad induced a surge in the erable gains in aggregate demand. Surgprices of many primary commodities ing oil prices were boosting overall inflation, while core inflation—though NOTE. The discussion in this section consists no longer declining—was still low. With of the text and tables from the Monetary Policy subsequent labor market reports sug- Report submitted to the Congress on July 20, gesting that hiring was on a stronger 2004; the charts from this report (as well as earlier track, growth in output continuing at a reports) are available on the Board's web site, at solid pace, and core consumer price www.federalreserve.gov/boarddocs/hh. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

32 91st Annual Report, 2004 inflation possibly running higher, the in core inflation in the first half of 2004 FOMC announced in May that it saw are likely to prove transitory. In particuthe risks to the goal of price stability as lar, the upward impetus from the rise in having moved into balance. Even so, the energy and commodity prices is likely Committee stated that it believed that to lessen in coming quarters. For another the monetary policy accommodation reason, the evidence suggests that the then in place could be "removed at a productive capacity of the economy is pace that is likely to be measured." still not being fully used and that the Indeed, at its June meeting, the FOMC attendant slack is probably exerting decided that sufficient evidence was in some downward pressure on inflation. hand to begin moving the federal funds If—as seems likely—the economy rate back toward a more neutral setting approaches full utilization of its producand raised the federal funds rate lA per- tive capacity only gradually, that downcentage point to WA percent, a decision ward pressure should persist for a time. that was widely anticipated by market Moreover, productivity remains on a participants. solid uptrend and should continue to Although some of the recent data restrain costs. To date, the gains in productivity have helped to boost profit have been on the soft side, the availmargins. As firms compete to take able information on the outlook for advantage of profit opportunities, they the U.S. economy is, on balance, posimay eventually be forced to absorb a tive. Households are enjoying a genportion of any increases in labor and erally improving job market, rising other costs that occur. But history sugreal incomes, and greater wealth, all of gests that the absorption of costs has which are providing them with the conlimits. Indeed, unit labor costs have fidence and wherewithal to spend. In the turned up of late, as productivity growth business sector, capital spending apparhas slowed below the rate of increase in ently is continuing to increase briskly, hourly compensation. If increases in bolstered by expectations of strong sales those costs were to develop any upward as well as by booming profits and momentum, the well-behaved nature supportive financial conditions; investof inflation in recent years could be ment should also continue to be buoyed jeopardized. by firms' adoption of productivityenhancing technologies. Moreover, inventories appear to be lean relative to Monetary Policy, Financial sales even after taking account of the Markets, and the Economy substantial improvements firms have over the First Half of 2004 made in managing their stocks, suggesting that stockbuilding may provide At the beginning of 2004, the FOMC some impetus to production in the near was growing more confident that the term. The brightening outlook for eco- economic expansion was likely to be nomic activity abroad suggests that self-sustaining, particularly in light of demand for U.S. exports should grow the significant firming of business outand provide a further lift to domestic lays and the continued strength in houseproduction. hold spending. Moreover, stimulative The prospects also seem favorable for fiscal and monetary policies, in conjuncinflation to remain contained in the tion with receptive financial markets, period ahead. For one reason, some of appeared likely to provide substantial the forces that contributed to the upturn support to economic activity and to ward Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 33 off any further disinflation. However, At the May FOMC meeting, members the Committee remained concerned noted a distinct improvement in the ecoabout the persistent weakness in the nomic outlook. The labor market figures labor market. At its January meeting, reported for March had proved to be the FOMC left the target for the federal strong, and the reports for the two prefunds rate at 1 percent. The Committee vious months had been revised upward generally felt that the apparent slack in significantly. Consumer price inflation labor and product markets and contin- in the first quarter of the year was faster ued strong productivity growth were than it had been in the previous quarter. likely to keep the underlying trend in Although much of this rise was due to inflation subdued, but it nevertheless escalating energy costs, core inflation was cognizant that a highly accommo- also stepped up, and survey-based meadative stance for monetary policy could sures of near-term inflation expectations not be maintained indefinitely. Given had edged higher. In response to the these considerations, the Committee indications of rising aggregate demand modified the language of its policy state- and a strengthening job market, yields ment to gain greater flexibility to firm on Treasury securities had risen apprepolicy should circumstances warrant. ciably. Accordingly, the Committee was The Committee achieved this added of the view that the expansion would be flexibility by removing its assessment vigorous and believed that the odds of that monetary policy would be accom- any further disinflation had been submodative for "a considerable period" stantially reduced. On the basis of the and instead saying that the Committee evolving outlook for economic activity could be "patient" in removing its pol- and prices, the Committee revised its icy accommodation. assessment of risks to indicate that the upside and downside risks for inflation At the time of the March FOMC had moved into balance. To underscore meeting, the Committee believed that its belief that policy would probably conditions were mostly in place for fursoon need to move toward a more neuther solid economic growth. Industrial tral stance while emphasizing that this production had picked up broadly, and process was not expected to be rapid, consumer and business spending continthe Committee stated its judgment that ued to expand briskly. However, the monetary policy accommodation "can employment reports for January and Febbe removed at a pace that is likely to be ruary still painted a picture of subdued measured." hiring. With financial markets quite accommodative, the Committee recog- At the time of the June FOMC meetnized that maintaining the current stance ing, incoming information tended to of policy could fuel inflation pressures confirm that the economy was expandand perhaps encourage excessive risk- ing at a solid pace but also indicated taking by financial market participants. that inflation was higher than had been The Committee concluded that the low anticipated. Quotes on near-term money level of core consumer price inflation market futures and options suggested and continued evidence of weak hiring that market participants were nearly cerargued for the retention of both its 1 per- tain of an increase of 25 basis points in cent target for the federal funds rate the target for the federal funds rate at and the wording in its statement that that meeting and had priced in a cumuthe Committee could be "patient" with lative increase of about 2lA percentage respect to changes in monetary policy. points in the federal funds rate over the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

34 91st Annual Report, 2004 next year. The Committee agreed that Economic Projections for 2004 and 2005 the current substantial degree of policy Percent accommodation was no longer warranted and decided to increase its target Federal Reserve Governors and for the federal funds rate 25 basis points. Reserve Bank presidents Indicator The Committee noted that it considered the risks to both sustainable economic Range Central tendency growth and stable prices to be roughly balanced and maintained its appraisal 2004 that policy accommodation "can be removed at a pace that is likely to be Change, fourth quarter to fourth quarter1 m wi e l a l su "r r e e s d p " o n b d u t to a ls c o h a e n m g p es h a i s n iz e e d c o t n h o a m t i i c t N R o e m al i G na D l P GDP 4 6 - - 4 7 3 /4 6 4 1 1 / / 4 2 - - 6 4 3 3 / / 4 4 PCE price index excluding prospects as needed to fulfill its obliga- food and energy tion to maintain price stability." Average level, 1V&-2 l3/4-2 fourth quarter Civilian unemployment rate Economic Projections for 2004 and 2005 5lA-5V2 2005 SVA-SVI In conjunction with the FOMC meeting Change, fourth quarter at the end of June, the members of the to fourth quarter1 B R o es a e rd rv e o f B a G n o k v e p r r n e o si r d s e n a t n s, d a t l h l e o f F w ed h e o r m al N R PC o ea m E l i G p n r a D i l c P e G i D nd P ex excluding 4 3 3 1 / / 4 2 - - 6 4 1 /2 3 5 V V 2 4 - - 4 6 participate in the deliberations of the food and energy FOMC, were asked to provide economic Average level, W2-2V2 IV2-2 projections for 2004 and 2005. The cen- fourth quarter Civilian unemployment tral tendency of the FOMC participants' rate forecasts for the increase in real GDP is AVi percent to A3A percent over the four 1. Change from average for fou5rt-h5 Vqiu arter of 5p-r5e vViAous year to average for fourth quarter of year indicated. quarters of 2004 and 3V2 percent to 4 percent in 2005. The civilian unemployment rate is expected to lie between pants expect it to lie between l3/4 per- 5lA percent and 5Vi percent in the cent and 2 percent. For 2005, the central fourth quarter of 2004 and to decline to tendency of the projections for core PCE between 5 percent and 5lA percent by inflation is W2 percent to 2 percent. the fourth quarter of 2005. Starting with this report, the Federal Economic and Financial Reserve will provide projections for the Developments in 2004 price index for personal consumption expenditures excluding food and energy After having surged in the second half (core PCE), which the Committee of 2003, economic activity continued to believes is better as an indicator of expand at a solid pace in the first half underlying inflation trends than is the of 2004. In the labor market, payroll overall PCE price measure previously employment started to increase last fall featured. Core PCE inflation appears to after a long string of declines and picked have run a little above an annual rate of up further during the first half of 2 percent in the first half of 2004; for this year. Headline inflation has been 2004 as a whole, most FOMC partici- boosted significantly by the jump in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 35 energy prices this year, but core infla- ings, rose appreciably in nominal terms. tion has also moved up from the excep- In addition, last year's tax legislation, tionally low levels of late 2003. which had already reduced withholding rates in mid-2003, added further to households' cash flow by increasing The Household Sector refunds and lowering final settlements this spring. Consumer Spending Household wealth increased only Consumer spending, which had gath- about in line with nominal DPI in the ered a good bit of steam in the second first quarter of 2004, and the wealth-tohalf of 2003, continued to move higher income ratio was likely little changed in in the first half of 2004. The growth in the second quarter as well. Nonetheless, spending was spurred by substantial the increase in wealth over the past year gains in income. In addition, household has been considerable—and probably wealth has risen sharply over the past large enough to more or less offset year, and consumer surveys indicate that any lingering restraint on spending individuals are generally upbeat in their growth from the earlier declines in stock assessments of the economy's prospects prices. Thus, with wealth approximately and of their own situations. a neutral influence on the growth of Personal consumption expenditures spending of late, the personal saving rose at an annual rate of 33A percent in rate has held fairly steady. In fact, the real terms in the first quarter. Spending average saving rate over the first five on light motor vehicles, which had been months of the year—at 2lA percent of supported in late 2003 by aggressive DPI—was very close to the annual figprice and financing incentives, slipped ures for 2002 and 2003. somewhat in early 2004. But outlays for goods other than motor vehicles, which Residential Investment had risen 6Vz percent in real terms in 2003, posted another huge increase in Activity in the housing sector remained the first quarter; spending on services torrid in the first half of 2004. Although also perked up after having advanced starts in the single-family sector faltered only modestly in 2003. The available a bit early in the year, in part because of data point to a much smaller increase in unusually adverse weather, they subseconsumer spending in the second quar- quently snapped back and reached an ter; the deceleration mainly reflects a annual rate of more than 1.6 million sharp slowing in the growth of outlays units in April and May—8V2 percent on goods other than motor vehicles. greater than the already rapid pace for Real disposable personal income 2003 as a whole. Sales of new and exist- (DPI)—that is, after-tax income adjusted ing homes have also been exceptionally for inflation—rose at an annual rate of strong, and they hit record highs in May. nearly 4 percent between the fourth In general, housing activity has been quarter of 2003 and May 2004, a gain supported by the favorable developabout in line with its rate of growth last ments regarding jobs and income and, year. To be sure, the rise in energy prices especially early in the year, by low mortcut into the growth of real income in the gage rates. Rates on thirty-year fixedfirst half of the year. However, aggre- rate mortgages, which had dipped to gate wages and salaries, boosted by 5V2 percent in March, rose markedly in increases in both employment and earn- the spring; they have edged down in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

36 91st Annual Report, 2004 recent weeks and now stand at 6 per- of the year and at roughly a 4 percent cent, a level still quite low by historical pace in April and May. The growth of standards. consumer credit likely has continued to Home prices have continued to rise be restrained by the substitution toward rapidly. For example, the national mortgage debt as a means to finance repeat-sales price index from the household expenditures. Office of Federal Housing Enterprise Low interest rates, in concert with Oversight—which partially adjusts for strong growth in disposable personal shifts in the quality of homes sold—rose income, have helped to keep financial 73/4 percent over the year ending in the obligations manageable for most housefirst quarter (the latest available data), holds. In the first quarter of the year, the a rate similar to the average annual gain debt service ratio and the financial oblisince late 2000. By this measure—and gations ratio for the household sector in many others—house price increases the aggregate, both of which gauge prehave outstripped gains in incomes as committed expenditures relative to diswell as in rents in recent years. posable income, continued to edge down Starts in the multifamily sector aver- from their peaks in 2001. Other indicaaged an annual rate of 360,000 units tors also suggest that the financial wellover the first five months of the year, a being of households has stabilized and pace slightly faster than that of the past may be improving. Delinquencies on several years. Low interest rates have credit card and auto loans generally apparently helped maintain the profit- declined in the first three months of the ability of apartment construction, given year, and bankruptcy rates, while still that other fundamental determinants of high, stepped down in the first quarter activity in the sector have been weak: In from their recent peak. particular, rents have remained soft, and Rapid increases in home prices have in the first quarter, vacancy rates for continued to buoy household net worth multifamily rental properties reached a this year. In contrast, stock prices are new high. about unchanged. Although news on earnings and economic activity has generally been favorable, rising oil Household Finance prices and interest rates and, perhaps, Household debt rose at an annual rate of heightened geopolitical concerns have about 103/4 percent in the first quarter of weighed on investor sentiment. Never- 2004. The especially rapid growth of theless, inflows into equity mutual funds mortgage debt was driven by the strong have been even stronger thus far in 2004 pace of activity in the housing market than they were last year. and the renewed wave of mortgage refinancing. However, the second-quarter The Business Sector rise in interest rates appears to have slowed the rate of refinancing and, con- Fixed Investment sequently, the amount of equity being extracted from the value of homes For the most part, businesses appear to through such transactions. Consumer be shaking off the extraordinary reluccredit—which constitutes the bulk of tance to undertake new investment household debt aside from mortgage projects that was evident in 2002 and borrowing—expanded at an annual rate 2003. Indeed, although outlays on nonof about 6 percent over the first quarter residential construction have not yet Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 37 turned up decisively, real spending on nontransportation equipment have been equipment and software (E&S) has been a bit soft recently. But the May level of advancing briskly. The broadly based shipments for this broad category was growth in E&S spending has been still above that of the first quarter, and driven by increasingly favorable funda- backlogs of unfilled orders, which have mentals: positive expectations for sales, risen impressively over the past year, high levels of corporate profits and cash continued to build. flow, a desire to replace or upgrade Real nonresidential construction has aging equipment after a period of weak remained about unchanged, on net, since investment spending, and the continued the steep decline in 2001 and 2002. low cost of capital. Construction of office buildings is still Real E&S spending rose at an annual running at roughly half the pace of rate of more than 15 percent in the sec- 2000, although vacancy rates have ond half of last year, and it posted stabilized—albeit at very high levels— another sizable increase in the first quar- and the decline in rents has slowed. Facter of 2004 despite flat business pur- tory construction also remains sluggish. chases of motor vehicles and a dip in Construction of retail and wholesale deliveries of aircraft. Excluding trans- facilities, in contrast, has held up fairly portation equipment, real spending on well, a performance consistent with the E&S rose at an annual rate of \3Vi per- strength in consumer spending. Outlays cent in the first quarter. In the high-tech on buildings for health care and educategory, real purchases of computers cation also have been reasonably well and software remained on the solid sustained. uptrend that has been evident for the past couple of years, and real outlays on Inventory Investment communications equipment increased further, reaching a level about 20 per- Inventory investment has generally cent above the low in the fourth quarter remained subdued even as final sales of 2002. Spending for equipment other have strengthened. Although real nonthan high-tech and transportation, which farm inventory investment picked up to accounts for about 40 percent of E&S an annual rate of $30 billion in the first (measured in nominal terms), also rose quarter, the accumulation occurred markedly in the first quarter. Such almost entirely in the motor vehicle secspending tends to be particularly sen- tor, in which sagging sales and a high sitive to the prospects for aggregate level of production early in the year demand. In addition, it may be receiving created a noticeable bulge in dealer a lift from the partial-expensing tax pro- stocks, especially of light trucks. In the vision, which is especially valuable for second quarter, the automakers reduced equipment with relatively long service assemblies; but with sales running only lives for tax purposes; that provision is a little above their first-quarter pace on slated to expire at the end of 2004. average, inventories of motor vehicles Equipment spending appears to have remained elevated. Outside the motor posted another solid increase in the sec- vehicle industry, nonfarm inventories ond quarter. Outlays on transportation increased at a meager $6 billion annual equipment seem to have rebounded, and rate in real terms in the first quarter, and the incoming data on high-tech equip- the available data point to only a moderment point to robust real expenditures. ate step-up in real stockbuilding, on bal- Some indicators for spending on other ance, in April and May. In general, non- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

38 91st Annual Report, 2004 auto inventories appear lean relative to investment-grade bonds in particular sales, even after factoring in the down- was influenced by movements in interward trend in inventory-sales ratios that est rates; issuance spiked in March in has accompanied the ongoing improve- the wake of the drop in yields but subments in supply-chain and logistics sided in April as rates rebounded. Shortmanagement. term debt financing showed signs of turning around after contracting over the previous three years. Commercial Corporate Profits paper outstanding expanded in the first and Business Finance two quarters of 2004. Business loans at Continuing the gains of last year, profits banks have fallen on balance so far this of the business sector to date have year but at a much slower pace than in remained strong. In the first quarter of 2003. The Federal Reserve's Senior 2004, earnings per share for S&P 500 Loan Officer Opinion Survey conducted firms were about 26 percent higher than in April 2004 indicated that demand for their level four quarters earlier, and business loans had begun to expand and before-tax profits of nonfinancial cor- that commercial banks had again eased porations as a share of GDP from that both standards and terms on these loans sector edged up following a steep over the previous three months. increase in 2003. A jump in profits in Strong profits, low interest rates, and the petroleum and gas industries owing continued deleveraging helped improve to higher oil prices was responsible for the credit quality of nonfinancial firms much of the rise in earnings. However, over the first half of the year. In the firms across many industries, with the second quarter, the delinquency rate on notable exception of telecommunication business loans dropped for the sixth conservices, registered solid gains in earn- secutive quarter; the continued decline ings. In response to this pattern of higher has reversed a large part of the precedprofits, analysts have been steadily ing run-up. Early in the year the twelvemarking up their forecasts for earnings month trailing default rate on outstandin subsequent quarters. ing bonds fell into the relatively low Net equity issuance has remained range observed over much of the 1990s, negative this year. Seasoned offerings and in June it registered another decline. have been scarce, the pace of initial Moreover, in the first part of the year, public offerings has only inched up, and the pace of upgrades of bond ratings by share retirements have continued to be Moody's Investors Service rose while strong. Corporations have continued to the pace of downgrades fell. repurchase shares at a rapid rate to man- Borrowing against commercial real age their cash positions, even as they estate assets continued at a rapid pace have increased dividend payments. during the first half of this year. Anec- Firms relied heavily on their elevated dotal reports suggest that some firms profits and substantial cash holdings to were using mortgages on commercial finance their investment in inventories property to lock in low-cost, long-term and fixed capital in the first half of funding. Despite the persistently high 2004. As a result, the growth of nonfi- vacancy rates for most types of commernancial business debt remained modest. cial property, the loans backed by these Much of the proceeds from bond issu- assets have continued to perform well. ance was used to pay down higher-cost Delinquency rates on commercial mortdebt, and the timing of the issuance of gages held by banks and insurance com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 39 panies remained very low in the first further as well. Spending on the major quarter. A drop in delinquencies on health programs rose at a rapid clip, commercial-mortgage-backed securities in part because the Jobs and Growth (CMBS) in recent months has partially Tax Relief Reconciliation Act of 2003 reversed last year's rise, and the narrow (JGTRRA) temporarily increased grants risk spreads on CMBS suggest that to the states under the Medicaid proinvestors have limited concerns about gram and boosted payments to some loan quality. Medicare providers. In addition, as noted, net interest payments, which had plummeted between 1997 and 2003, The Government Sector flattened out. Real federal expenditures for consumption and gross investment— Federal Government the part of government spending that is The deficit in the federal unified budget a component of real GDP—rose at an has continued to widen. Over the twelve annual rate of 8V2 percent in the first months ending in June, the unified bud- calendar quarter of 2004; that increase get recorded a deficit of $431 billion, reflected a surge in real defense spend- $120 billion more than during the com- ing, which now stands more than 30 perparable period last year and equal to cent above the levels that prevailed, on nearly 4 percent of nominal GDP. In average, from 1997 to 2000. large part, the rise in the deficit is attrib- Federal receipts in the twelve months utable to further rapid increases in ending in June were 1V2 percent higher spending on defense and other programs than during the comparable period of and the loss of revenues resulting from the previous year after having fallen the tax legislation enacted in recent markedly between fiscal 2000 and fiscal years. In addition, interest costs, which 2003. Receipts received a substantial fell sharply between fiscal 1997 and fis- boost over the past year from a strong cal 2003 as a result of budget surpluses gain in corporate taxes, which were and declining interest rates, have leveled lifted by robust profits. Social insurance off and thus are no longer a significant taxes, which tend to move in line with factorhelping to restrain the deficit. The wages and salaries, also increased. But primary deficit, which excludes net individual income taxes were below last interest, totaled $276 billion over the year's level: Although taxable incomes twelve months ending in June, also rose moderately, collections were approximately $120 billion more than reduced by the lower withholding rates over the year ending in June 2003. in place since mid-2003 and by the Over the twelve months ending in effects of JGTRRA on refunds and final June, nominal federal spending was settlements this spring. nearly 7 percent higher than during the The deterioration in the unified budsame period a year earlier and stood at get since 2000 has been mirrored in a about 20 percent of nominal GDP— sharp downswing in federal saving— virtually the same as in fiscal 2003 but essentially, the unified surplus or deficit \Vi percentage points above the recent adjusted to conform to the accountlow in fiscal 2000. Spurred by the war ing practices followed in the national in Iraq, defense spending ramped up income and product accounts (NIPA). another 14 percent; outlays for non- Gross federal saving fell from a high defense discretionary programs, which of nearly 3 percent of nominal GDP in include homeland security, moved up 2000 to negative 3 percent of GDP in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

40 91st Annual Report, 2004 the first quarter of 2004; measured net have continued to put upward presof estimated depreciation, federal saving sure on spending, state and local govfell from 2 percent of GDP to nega- ernments have generally held the line tive 4 percent of GDP over this period. on hiring and have kept other outlays In the past couple of years, the rise in in check. The restraint on spending, business saving from the rebound in in combination with a drawdown of profits and reductions in corporate taxes reserve funds and some increases in has cushioned to some extent the effect taxes, has helped states and localities of growing budget deficits on national satisfy their balanced-budget requiresaving. In fact, because of the dramatic ments. In fact, between the third quarter increase in business saving in recent of 2003 and the first quarter of 2004, quarters, national saving has recovered NIPA net saving (excluding social insursome from the extreme lows of early ance funds) for this sector averaged 2003. Even so, as of the first quarter of $21 billion at an annual rate (}A percent 2004, national saving (measured net of of nominal GDP), compared with negaestimated depreciation) was still equal tive $7 billion in 2002 and negative to just about 2V2 percent of GDP, com- $31 billion in the first half of 2003. (Net pared with a recent high of 6V2 percent saving is roughly similar to the surin 1998. If not reversed over the longer plus or deficit in an operating budget.) haul, such low levels of national saving Although a few states are still struggling could eventually impinge on private with strained fiscal situations, most have capital formation and thus slow the rise entered fiscal 2005 (which started on of living standards. July 1 in all but four states) with expectations of respectable growth in reve- Reflecting the need to finance the siznues and with budgets in place that able federal budget deficit, federal debt allow for some increases in spending on held by the public expanded at an annual rate of H3/4 percent in the first half high-priority services and some rebuilding of reserve funds. of the year. The ratio of this debt to nominal GDP now exceeds 36 percent. Real consumption and investment The Treasury tilted its issuance toward spending by state and local governments longer-term and inflation-indexed secu- was essentially flat in the first quarter rities somewhat, and announced semian- of 2004; available indicators point to a nual issuance of a twenty-year inflation- moderate increase in the second quarter. protected bond beginning in July and a Outlays for consumption items, which five-year inflation-protected note begin- were little changed in 2003, appear to ning in October. have remained subdued throughout the first half of the year. Investment expenditures also were about unchanged in State and Local Governments the first quarter, but they turned up States and localities have started to see sharply in the spring, mainly because of some improvement in their budget posi- a jump in spending on highways. tions after having gone through several Significant demand for infrastructure difficult years. Strong growth in house- spending and favorable interest rates led hold income and consumer spending has to robust issuance of state and local boosted revenues in recent quarters, as government debt to finance capital have the additional federal grants autho- expenditures and to advance refund rized under JGTRRA. And although higher-cost debt. Nevertheless, over the rising medical costs and security needs first half of the year, net issuance edged Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 41 down from its rapid pace in 2003 to the blistering 20 percent pace of the about a 6 percent annual rate. The decel- fourth quarter but still above the average eration reflected a decline in short-term for 2003. Solid gains in exports since borrowing as improvements in the fiscal mid-2003 arose in part from the strong positions of state and local governments economic performance of many of our lessened the need for temporary funding major trading partners. In addition, the of budget shortfalls. net decline in the exchange value of The credit quality of municipal bor- the dollar since 2002 continued to make rowers has stabilized after two years U.S. goods and services more comof deterioration; for the year to date, petitive abroad. Increases in exports of upgrades and downgrades of credit rat- U.S. goods were widespread across our ings have been roughly equal. In a major trading partners, with the excepmarked change from last year's senti- tion of Japan, and were concentrated ment, rating agencies have begun to in real exports of capital goods, indusexpress guarded optimism about the trial supplies, and consumer goods. Real credit quality of states because of im- exports of agricultural products fell provements in state revenue flows and sharply, hurt by foreign bans on U.S. restraint on spending. beef products following reports of mad cow disease in a U.S. herd. Exports of services rose moderately. The External Sector Prices of total exports rose at an annual rate of 53A percent in the first In the first quarter of 2004, the U.S. quarter, boosted by another jump in agricurrent account deficit expanded to an cultural prices along with substantial annual rate of $580 billion, or about increases in the prices of other primary 5 percent of GDP. As in the past, the commodities and industrial supplies. widening was driven primarily by a Prices of U.S. agricultural exports have larger deficit in trade of goods and been pushed up by very strong global services. The surplus on net investment demand, particularly from China. For income declined in the first quarter but specific products, such as cotton and remained well above its average value soybeans, lower production in some in the previous year. The deficit on net countries also contributed to price rununilateral transfers rose because of a ups. More recently, prices of soybeans concentration of disbursements of govand other agricultural products have ernment grants in the first quarter. eased in the face of a slowing in the growth of demand from China and the International Trade anticipation of larger harvests. Even so, The U.S. trade deficit in goods and available data point to continued strong services registered $548 billion at an increases in export prices in the second annual rate in the first quarter, about quarter. $46 billion larger than in the fourth Supported by solid U.S. economic quarter of 2003. On average, data for growth, real imports of goods and ser- April and May suggest that the trade vices rose at an annual rate of 101/2 perdeficit continued to widen in the second cent in the first quarter. This increase quarter. was below the fourth-quarter pace but Real exports of goods and services still roughly double the rate of increase increased at an annual rate of 11A per- for 2003 as a whole. Real imports of cent in the first quarter of 2004, well off goods were boosted by a sharp increase Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

42 91st Annual Report, 2004 in oil imports. Gains in imports of non- flows into U.S. bonds. Foreign official oil goods were also sizable and wide- inflows, already sizable in 2003, rose spread across categories. Imports of ser- sharply in the first quarter of 2004 vices grew slightly in the first quarter. and then moderated somewhat. Simi- The spot price of West Texas interme- larly, private foreign purchases of U.S. diate (WTI) crude oil surged above $40 bonds, which were significant in 2003, per barrel in May and has since fluctu- increased sharply in the first quarter and ated close to that level. The run-up in also appear to have moderated in the the price since the beginning of the year second quarter. In contrast, foreign has been driven by surprisingly strong demand for U.S. equities was weak in global demand for oil. Supply issues 2003 and has remained so in 2004. Purhave been important as well. These were chases of foreign equities by private U.S. mainly continued violence in Iraq, investors appear to be strengthening, but including the sabotage of oil facilities, U.S. investors still show no appetite for attacks on foreigners in Saudi Arabia, foreign bonds. ongoing unrest in Nigeria, political tur- Direct investment into the United moil in Venezuela, and tax payment States in the first quarter continued to be difficulties at a major Russian oil com- restrained by the slowdown of global pany. The recent increase in OPEC pro- mergers and acquisitions since 2002. In duction (mainly by Saudi Arabia) has contrast, U.S. direct investment abroad eased the upward pressure on prices a was strong in 2003 and in the first quarbit, but they have remained elevated. ter of 2004, as the effect of fewer merg- Prices of imported non-oil goods rose ers and acquisitions was offset by sizat an annual rate of 5Vi percent in able reinvested earnings. the first quarter after minimal increases in the second half of 2003. Prices for The Labor Market imported consumer goods rose at an annual rate of 23/4 percent after being Employment and Unemployment flat in 2003. Skyrocketing global commodity prices last year and early this The demand for labor turned up in late year boosted prices of imported indus- 2003 after an extended period of weaktrial supplies (especially metals) and of ness, and it has gathered additional foods, feed, and beverages. The jump steam this year. After averaging about in commodity prices reflected strong 60,000 per month in the fourth quarter demand, the net depreciation of the of 2003, gains in private nonfarm paydollar over the past two years, and the roll employment rose to an average of limited expansion in supply of many about 200,000 per month in the first half commodities since the 2001 trough in of 2004. The job gains were especially commodity prices. Available data sug- large in March, April, and May but gest a modest stepdown in the rate of ebbed somewhat in June. The civilian increase of import prices in the second unemployment rate, which had fallen quarter; the move in part reflects a flat- from a recent peak of 6.3 percent in tening of consumer goods prices. June 2003 to 5.7 percent in December 2003, was little changed over the first half of the year. In June, it stood at The Financial Account 5.6 percent. The U.S. current account deficit has con- The increases in payrolls over the first tinued to be financed largely by foreign half of 2004 were widespread. Espe- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 43 cially notable was the turnaround in the cent per year in the second half of manufacturing sector, in which employ- the 1990s. During that earlier period, an ment bottomed out in January and expansion of the capital stock was an then rose a cumulative 65,000 jobs important source of product! vity growth. through June. The rise in manufacturing However, in the more recent period, jobs was concentrated in the durable when the business environment—at goods industries—in particular, those least until the past few quarters—was making fabricated metals and other characterized by sluggish demand, lean construction-related products, comput- capital budgets, and an extraordinary ers and electronic equipment, and reluctance of firms to add to payrolls, machinery. After a long string of businesses appear to have raised their declines, employment at producers of productivity mainly through changes in nondurable goods was little changed, organizational structures and better use on net, over the first half. Job gains in of the capital already in place. With virtually all other major sectors have hiring having picked up of late, meabeen greater this year than last. In par- sured productivity growth may slow in ticular, hiring in retail trade, which coining quarters; but if recent experihad been lackluster in 2003, turned up ence is any guide, businesses will conappreciably, and construction employ- tinue to focus on achieving structural ment increased further. The professional improvements in the efficiency of their and business services sector also posted operations. The upswing in investment a sizable rise, in part because the spending now under way also bodes rebound in manufacturing activity lifted well for sustained favorable productivhiring at temporary-help firms. A clear ity performance in the period ahead. indication of the breadth of the employ- The rapid productivity growth in ment increases is provided by the six- recent years has helped to bolster month diffusion index compiled by the increases in hourly compensation in the Bureau of Labor Statistics (BLS). The face of the soft labor market and the low index is equal to the percentage of consumer price inflation in 2003. As a industries that increased employment result, increases in the employment cost over the most recent six months plus index (ECI) measure of hourly compenone-half the percentage with unchanged sation, which is based on a survey of employment; in June, the index moved private nonfarm businesses conducted up to its highest level since April 2000. quarterly by the BLS, have held fairly steady of late. In fact, the rise in the ECI over the twelve months ending in Productivity and Labor Costs March—at a shade less than 4 percent— Gains in labor productivity have slowed was virtually the same as the increases somewhat in recent quarters after the over the preceding two years. Benefit spectacular increases of mid-2003. Still, costs, which rose 7 percent over the year according to the currently published ending in March, have continued to data, output per hour in the nonfarm be the fastest rising portion of hourly business sector rose a remarkable compensation; health insurance costs 5V2 percent over the year ending in the have remained on a steep uptrend, and first quarter. Over the past three years, employers have boosted their contribuincreases in productivity have averaged tions to defined-benefit retirement plans more than 4 percent per year, compared to make up for earlier stock market with average increases of about IVi per- losses. The rising benefit costs have Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

44 91st Annual Report, 2004 likely exerted some downward pressure through June and show some moderaon wages, which rose just 2Vi percent tion in the core component of the series. over the twelve months ending in Over the first half of the year, the core March; the twelve-month change in the CPI rose at an annual rate of 2Vi perwage component of the ECI, which was cent, compared with an increase of close to 4 percent in 2000 and 2001, has WA percent over the four quarters of been in the range of 2l/i percent to 3 per- 2003. cent since late 2002. Reflecting the surge in crude oil The change in compensation per prices, PCE energy prices rose at an hour in the nonfarm business (NFB) annual rate of more than 25 percent in sector—an alternative measure of hourly the first quarter; they apparently posted compensation based on data constructed another outsized increase in the second for the NIPA—has swung widely in quarter. Gasoline prices increased raprecent years. Fluctuations in the value idly through May as crude oil costs rose of stock option exercises, which are and as price markups were boosted by excluded from the ECI but included in strong demand and lean inventories; the NFB measure, likely account for although gasoline prices have fallen on some of the differential movements in balance since late May, they are curthe two series. The four-quarter change rently nearly 30 percent above their in the NFB measure bottomed out at a level at the end of last year. As for bit less than 2 percent in 2002, when the natural gas, which can often substitute value of exercised options was drop- for fuel oil in the industrial sector, spot ping; it has moved up steadily since that prices were elevated at the start of the time and, in the first quarter, stood at year, fell somewhat in February and 4V2 percent—a rate not much different March, and trended up over the spring. from the increase in the ECI. With The higher spot prices for natural gas productivity growth slowing to a pace this spring pushed up prices paid by below that of NFB hourly compensa- consumers through June. PCE electriction, unit labor costs rose in both the ity prices appear to have risen at an fourth and first quarters after having annual rate of 3 percent over the first trended down over the preceding two half of the year, a pace similar to that in years. 2003. Although volatile from month to month, consumer food prices rose mod- Prices erately on balance over the first half Inflation moved higher in the first half of 2004 after having moved up in late of 2004. After rising just IV2 percent 2003. Robust global demand is impartover the four quarters of 2003, the price ing upward impetus to food prices, index for personal consumption expen- but U.S. producers are in the process ditures (PCE) increased at an annual of boosting supply, which should help rate of 3V2 percent between the fourth restrain increases in retail food prices in quarter of 2003 and May 2004. In coming quarters. that period, energy prices soared, and The step-up in core PCE inflation this increases in core consumer prices picked year has been especially pronounced up to an annual rate of 2lA percent— in a few categories. In particular, prices more than 1 percentage point faster than of motor vehicles have firmed after a the increase in 2003. Data for the con- noticeable decrease in 2003. In addition, sumer price index (CPI) are available increases in shelter costs, which were Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 45 surprisingly low in 2003, are now run- tant, cyclical swings in commodity ning more in line with earlier trends. prices tend to have only a minor effect Core inflation has also been lifted this on overall inflation, both because they year by substantial increases, on bal- account for a small share of total costs ance, in a number of categories for and because changes in commodity which prices cannot be derived from prices tend to be partly absorbed in market transactions and thus must be firms' profit margins, at least for a time. imputed by the Bureau of Economic The faster rate of inflation this year Analysis—for example, prices of finan- underscores the difficulty of gauging cial services provided by banks without price pressures. Nevertheless, on the explicit charge. These non-market-based whole, the evidence suggests that slack prices, which were about flat in 2003, remains in labor and product marare difficult to estimate, and the imputed kets, which should be exerting some figures tend to be volatile. downward pressure on inflation. The A number of factors have contributed unemployment rate—at 5Vi percent to the run-up in core inflation this year. currently—is not significantly lower Higher oil prices have doubtless raised than it was through much of 2002 and the cost of producing other goods and 2003, when core inflation was trending services. So have the steep increases in down. And despite the run-up this year, prices of non-oil commodities such as capacity utilization in the manufacturing copper and lumber, which came about as sector is still below its longer-run avereconomic activity strengthened world- age. In addition, the strong upward trend wide and as industrial capacity utiliza- in productivity is continuing to help tion both here and abroad tightened. keep the rise in labor costs muted, and Likewise, the decline in the dollar has profit margins are sufficiently wide to boosted non-oil import prices and thus give firms scope to absorb cost increases the costs of inputs for many domestic for a while without putting undue producers. The weaker dollar has also upward pressure on prices. likely lessened the pressure on firms The upturn in actual inflation has facing foreign competition to hold the been echoed in some measures of inflaline on prices—a consideration that is tion expectations. For example, accordprobably contributing to the widespread ing to the Michigan Survey Research perception that firms' pricing power has Center, the median expectation for inflaincreased lately. Moreover, unit labor tion over the coming year has averaged costs have edged up recently after hav- slightly more than 3 percent since early ing declined noticeably in 2002 and spring after hovering in the area of 2003. 2Vi percent to 23A percent in 2003 and From a cyclical perspective, the sharp early 2004. The median expectation for upturn in commodity prices is not sur- inflation over the next five to ten years prising, given the pickup in the growth has been running a bit below 3 percent of industrial production. In fact, such in recent months, a reading similar to the large increases in commodity prices figures for 2002 and 2003. According to are typical as economic activity accel- the Survey of Professional Forecasters erates and capacity utilization rises— conducted by the Federal Reserve Bank especially for products for which the of Philadelphia, expectations of inflasupply is relatively fixed in the short tion over the next ten years held steady run. Some portion of these increases in June at 2Vi percent. Inflation compenusually proves transitory. More impor- sation over the next five years as mea- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

46 91st Annual Report, 2004 Alternative Measures of Price Change dropped from 2V4 percent to l3/4 percent Percent over the same period; the deceleration reflects mainly the effects of energy 2002 2003 prices, which rose even more rapidly Price measure to to 2003 2004 over the year ending in the first quarter of 2003 than they did over the most Chain-type (Ql to Ql) recent year. Gross domestic product 1.7 1.8 Gross domestic purchases 2.3 1.7 Personal consumption expenditures 2.4 1.6 Excluding food and energy ... 1.6 1.3 U.S. Financial Markets Fixed-weight (Q2 to Q2) As 2004 opened, financial market condi- Consumer price index 2.2 2.8 Excluding food and energy ... 1.5 1.8 tions were quite accommodative, with low corporate bond yields, narrow risk NOTE. Changes are based on quarterly averages of spreads, and relatively easy terms and seasonally adjusted data. standards on bank lending. Although equity prices changed little, and interest rates rose on balance in response to sured by the spread between the yield positive economic news and expectaon nominal Treasury securities and their tions of a tightening of monetary policy, indexed counterparts rose noticeably financial conditions in the first half during the first half of 2004. To be sure, of the year remained supportive of inflation compensation is also influ- economic growth. Business borrowing enced by perceptions of inflation risk nevertheless remained tentative, while and the secular increase in demand for increases in the debt of the federal inflation-indexed debt, but the rise in government and of households were near-term inflation compensation likely sizable. reflects, at least in part, higher inflation expectations. Similar to the survey- Interest Rates based measures of longer-run inflation expectations, inflation compensation for From tnt ?nd of 2003 through the end of the period five years to ten years ahead March, yields on nominal Treasury couwas little changed on net over the first pon securities fell, on net, about 30 to half of the year. 45 basis points. Although interest rates Broader NIPA price measures are rose immediately after the FOMC's available only through the first quarter, January meeting in response to the and the four-quarter changes in these Committee's decision to remove its series do not show the rise in inflation statement that monetary policy could indicated by the monthly data discussed remain accommodative for "a considerabove. In particular, the rate of increase able period," the increase proved to be in the price index for GDP over the year short lived. Weak employment reports ending in the first quarter was just released in early February and early P/4 percent, the same as over the pre- March prompted yields to fall amid ceding year. The four-quarter change doubts about the strength of the ecoin the price index for gross domestic nomic expansion. Federal funds futures purchases—which is defined as the contracts at the end of March appeared prices paid for purchases of domestic to indicate that market participants and imported consumption, investment, placed small odds on a tightening of and government goods and services— monetary policy before late 2004, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 47 contracts also seemed to price in only a as the economic expansion was seen as gradual increase in the federal funds rate gathering steam. during 2005. Interest rates backed up in the second Equity Markets quarter as data releases increasingly suggested that the economic expansion Over the first half of 2004, equity prices would remain vigorous. Yields on the were subject to the strong crosscurrents two-year and ten-year nominal Treasury of robust earnings reports, rising interest notes ended the first half of the year rates, fluctuating fears about geopoliti- 90 and 36 basis points higher, respec- cal developments, and sharply higher oil tively, than at the end of 2003, as mar- prices. On balance, broad equity price kets adjusted to the greater likelihood of indexes at the end of June had edged an earlier onset and more rapid pace of about 2Vi percent to 3XA percent above monetary policy tightening. The surpris- year-end levels after having surged ingly strong employment reports pub- 25-30 percent over the course of 2003. lished in April and May, higher-than- Over the first half, analysts raised their expected readings on core inflation, and estimates of profits for coming quarters; surging oil prices all spurred increases the upward revision outstripped the in Treasury yields. After the release of more modest increase in equity prices the employment report in May, federal and boosted the ratio of expected yearfunds futures contracts priced in a hike ahead earnings to stock prices. With real in the target federal funds rate at the interest rates higher, however, the differ- June FOMC meeting and a more rapid ence between the earnings-price ratio tightening of monetary policy than had and the real ten-year Treasury yield— been anticipated. With the evolving out- a crude measure of the equity risk look for monetary policy, the volatility premium—changed little to remain of short-term interest rates implied by close to its average value over the past option prices jumped in the first half of two decades and above its level during the year after staying in a relatively low the late 1990s. range in 2003. Near-term interest rates declined a bit after the Committee's Debt and Financial Intermediation decision at its June meeting to raise the intended federal funds rate 25 basis Aggregate debt of the domestic nonfipoints; the Committee's reaffirmation nancial sectors expanded at an annual that policy accommodation likely could rate of about 8V2 percent in the first be removed at a "measured" pace quarter of 2004, a gain similar to last apparently reassured investors that a year's increase. Debt growth in the busisteep rise in the federal funds rate prob- ness sector has remained subdued so far ably was not in train. this year, as ample internal funding has Yields on investment-grade corporate limited the need for external finance. In debt moved roughly in line with those contrast, household debt has continued on comparable nominal Treasury securi- to expand rapidly, spurred by an eleties over the first half of the year, pro- vated pace of home purchases and cashducing little net change in risk spreads outs from mortgage refinancing. The from their level at the end of last year. large federal budget deficit led to Spreads on speculative-grade debt over another sharp increase in Treasury debt Treasury debt declined a bit further after in the first half of this year. Municipal having narrowed sharply during 2003 borrowing moderated somewhat, on bal- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

48 91st Annual Report, 2004 ance, in the first half of the year, as the weakness in money market mutual funds improving fiscal condition of state and and small time deposits. Given the local governments reduced the need for recent very low yields on these two short-term borrowing to cover budget components of M2, households likely gaps. viewed them as less attractive savings The growth of credit on the books of vehicles than other assets. depository institutions picked up to an annual rate of 14 percent in the first International Developments quarter of 2004. Financing secured by residential real estate—including home Foreign economic activity expanded in mortgages, home equity loans, and the first half of this year at a pace only mortgage-backed securities—drove the slightly below the rapid increase in the expansion. In contrast, business loans second half of 2003. Global trade has continued to run off, falling at an annual been boosted by strong demand, esperate of about 5 percent in the first half cially from the United States and China. of the year after a 10 percent drop in The run-up in oil and commodity prices 2003. The deceleration was consistent has contributed to rising, though still with some signs that demand for busi- moderate, inflation across the industrial ness loans was beginning to recover as and developing countries. well as with an easing of standards and By the end of the first half of this terms on these loans. year, monetary policy in most major foreign economies had either tightened or assumed a less accommodative tone. The M2 Monetary Aggregates Citing high rates of capacity utilization In the first half of 2004, short-term inter- and mounting inflationary pressures, the est rates were stable and M2 grew at an Bank of England has raised its target annual rate of 6V2 percent—a pace that rate 100 basis points since early Novemwas roughly in line with estimates of ber. Mexico and China also have tightnominal GDP—after contracting at a ened policy. Elsewhere, including the record rate in the fourth quarter of 2003. euro area, Canada, and Japan, central Liquid deposits—the largest component banks most recently have kept policy of M2—had been depressed late last unchanged after easing previously. In year by the ebbing of last summer's general, official statements are expressmortgage refinancing boom. Mortgage ing increasing concern over the inflarefinancings tend to boost M2 as the tionary risks associated with stronger proceeds are temporarily placed in non- economic activity and higher world interest-bearing deposit accounts pend- energy and commodity prices. ing disbursement of funds to the hold- In foreign financial markets, equity ers of mortgage-backed securities. When price performance has been more mixed refinancings slowed last year, the so far in 2004 than during the second decline in such escrow accounts held half of 2003; sharply rising interest rates down the growth of liquid deposits. In over the past few months have weighed the first half of this year, M2 probably on equity valuations, damping the received a boost from the new round of effects of an improved earnings outlook. mortgage refinancings that followed the Since year-end, stock prices in Europe first-quarter decline in mortgage interest and Canada have changed little, on balrates. The strength in liquid deposits ance. In contrast, rapidly improving ecowas partly offset, however, by continued nomic conditions in Japan have helped Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 49 boost Japanese equity prices about In financial markets, the stronger econ- 10 percent. Other Asian stock price omy boosted equity markets and helped indexes have fallen, on average, in part drive up the yield on the ten-year bellbecause of concerns about the possibil- wether government bond to more than ity of an acute slowdown in China. PA percent from its June 2003 record Mexican stocks have been bolstered by low of about Vi percent. After making strong earnings growth of leading Mexi- substantial sales of yen for dollars in the can communications firms and, more first quarter, Japanese authorities ceased generally, by the strengthening U.S. intervention in mid-March. Even so, the expansion. Foreign long-term interest yen depreciated early in the second rates rose rapidly in the second quarter quarter before appreciating to around as new data (including from the United ¥109 per dollar. States) showing faster growth and Economic conditions in the euro area higher inflation led market participants firmed over the first half of 2004, but to expect more-aggressive monetary performance varied across countries, tightening. Over the first half of the and the region as a whole continues to year, the spread on internationally issued lag the global upturn. Real GDP in the sovereign debt of emerging-market euro area increased at an annual rate of economies over U.S. Treasuries moved 2VA percent in the first quarter; output up somewhat from its very low level. in France, Spain, and several smaller After depreciating over the previous member countries rose relatively briskly, two years, the value of the dollar rose while growth in Germany and Italy slightly, on balance, in the first half of was less robust. In the first quarter, 2004. The firming of the dollar has been domestic demand firmed noticeably, attributed to perceptions by market par- except in Germany, where growth was ticipants that near-term monetary tight- due entirely to a spike in exports. Gerening in the United States would be man consumer spending remains anefaster than such tightening abroad. mic, held down by a weak labor market and low consumer confidence. Euroarea indicators for the second quarter Industrial Economies initially were upbeat, but more-recent A broadly based recovery appears to data have been mixed. Labor markets have been established in Japan over the have yet to benefit from the recovery, first half of 2004. Real GDP rose at an and the average unemployment rate in annual rate of more than 6 percent in the region edged up to 9 percent in the the first quarter after an even greater spring. Inflation for the euro area over increase in the fourth quarter. Aided by the twelve months ending in June was demand from China, growth of Japanese near 2x/2 percent, a rate above the Euroreal exports remained robust. Personal pean Central Bank's medium-term goal consumption and business investment of less than, but close to, 2 percent. also firmed. More-recent indicators Excluding energy, food, alcohol, and show that domestic strength continued tobacco, prices rose slightly less than in the spring with large gains in house- 2 percent over the same period. hold expenditures and improved labor Economic expansion in the United market conditions. Deflation continued Kingdom continued unabated over the to wane in Japan. Consumer price defla- first half of 2004. Labor markets tighttion over the first half of the year was ened further; the unemployment rate slight, and wholesale prices increased. edged down to its lowest level in almost Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

50 91st Annual Report, 2004 three decades, and labor earnings posted sures included increases in reserve solid gains. Despite the strong econ- requirements and in some interest omy, consumer price inflation over the rates as well as stricter criteria for the twelve months ending in June was approval of investment projects. A sharp IV2 percent, remaining below the central slowdown in estimated real GDP for the bank's official target rate of 2 percent. second quarter suggests that these steps Conditions in the U.K. housing market, are working. Despite the recent slowing however, remained red hot, with double- in growth, Chinese exports and imports digit price increases, high levels of soared in the first half of the year, and household mortgage and consumer trade was close to balanced. borrowing, and sizable withdrawals of Growth in the other Asian emerginghome equity. market economies slowed only moder- The Canadian economy picked up ately in the first quarter from the fast steam in the first half of 2004 after a pace at the end of last year. Exports, year plagued with difficulties including which continued to be the driving force SARS, mad cow disease, and a regional behind that growth, were fueled by power outage. Sizable gains in con- Chinese demand as well as by the sumption and investment boosted output recovery in the global high-tech market in the first quarter, and indicators are and stronger world demand overall. pointing to continued good performance Consumer demand generally rose across in these sectors. Export growth was the region with the notable excepstrong, as the robust economic perfor- tion of Korea, where high levels of conmance of the United States appears to sumer debt are weighing on spendhave outweighed the negative effect of ing. Although still only moderate, Canadian dollar appreciation on trade. inflation across the Asian emerging- The unemployment rate was relatively market economies is beginning to rise stable over the first half, and employ- as stronger aggregate demand takes ment bounced back in the second quar- hold and higher energy and commodter from a first-quarter lull. Consumer ity prices pass through to prices more price inflation decreased early in the generally. year, but energy costs helped drive up The Mexican economy has been prothe rate to 2V2 percent over the twelve pelled this year by strong demand from months ending in June. Prices excluding the United States. Gains have been food, energy, and indirect taxes have broadly based, with sharp increases in remained more subdued, rising slightly industrial production, exports, construcless than IV2 percent over the same tion, and retail sales. Employment in period. the industries most closely linked to U.S. trade also has started to increase. Responding to a rise in twelve-month Emerging-Market Economies inflation to slightly above its 2 percent Estimates suggest that real GDP in to 4 percent target range, the Bank of China surged in the first quarter with Mexico has tightened policy several continued outsized gains in fixed-asset times so far this year. Elevated oil prices investment. Fears of overinvestment, boosted the Mexican public-sector fiscal particularly in the steel, cement, and alu- surplus to a record high during the first minum industries, led Chinese officials five months of the year and facilitated to intensify their tightening measures an increase in federal transfers to state early in the second quarter. These mea- governments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2004 51 In Brazil, GDP grew robustly in the The recovery in Argentina has continfirst quarter, and indications are that ued at a rapid pace in recent quarters, economic activity continued to expand but limited investment in the energy in the second quarter with support from sector, reflecting a lack of structural strong external demand. Job growth has reforms, has forced the government to been robust, although unemployment import electricity, natural gas, and fuel has remained high. Inflation, however, oil from neighboring countries. Credicontinues to concern authorities. Asset tors have shown little enthusiasm for prices weakened earlier this year, in part the country's latest debt restructuring because of rising global interest rates plan, and the federal government faces but also because of market participants' difficult challenges in normalizing its unease about the direction of structural international financial situation and and fiscal reforms; since then, asset reforming its fiscal relations with the prices have partially rebounded. provinces. • 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

55 Consumer and Community Affairs Among the Federal Reserve's responsi- consumer financial products and serbilities in the areas of consumer and vices at the request of Congress. community affairs are During 2004, the Board issued final rules implementing provisions of the • writing and interpreting regulations to Fair and Accurate Credit Transactions implement federal laws that protect Act, an act that significantly amends and inform consumers, the Fair Credit Reporting Act. The Board also issued guidance on the stan- • supervising state member banks to dards it and the Federal Deposit Insurensure their compliance with the ance Corporation (FDIC) will use when regulations, determining whether to take supervisory or enforcement actions in cases involv- • investigating complaints from the ing the unfair and deceptive trade pracpublic about state member bank com- tices provisions of the Federal Trade pliance with regulations, and Commission Act. The Board produced two reports for Congress summarizing • promoting community development in the findings of Board studies on the historically underserved markets. disclosure of fees related to debit card purchases and on the ability of consum- These responsibilities are carried out by ers to avoid receiving unsolicited writthe members of the Board of Governors, ten offers of credit or insurance. In addithe Board's Division of Consumer and tion, the Board revised its Truth in Community Affairs, and the consumer Lending Act regulation and the associand community affairs staff of the Fed- ated commentary, issued interim final eral Reserve Banks. rules incorporating technical changes to the regulation implementing the Community Reinvestment Act, raised Implementation of Statutes certain thresholds that would trigger Designed to Inform and Protect additional requirements under the Home Consumers Ownership and Equity Protection Act, The Board of Governors writes regula- and issued a final rule revising the distions to implement federal laws involv- closure tables that the federal finaning consumer financial services and fair cial regulatory agencies use to publicly lending. The Board revises and updates release Home Mortgage Disclosure Act these regulations to address the intro- data reported by covered institutions. duction of new products, to implement legislative changes to existing laws, and Fair and Accurate Credit to address problems consumers may Transactions Act encounter in their financial transactions. To interpret and clarify the regulations, In December 2003, the President signed Board staff issues commentaries and the Fair and Accurate Credit Transother guidance. In addition, the staff actions Act (the FACT Act) into law. may undertake studies on aspects of The FACT Act amends the Fair Credit Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

56 91st Annual Report, 2004 Reporting Act (FCRA) in numerous established December 31, 2003, as the respects, including making permanent effective date for the preemption proan FCRA provision that preempts states visions of the FACT Act, as well as for from enacting laws in seven areas provisions authorizing the agencies to addressed by the FCRA. The FACT Act adopt rules or take other actions to also includes provisions to address iden- implement the FACT Act. The final joint tity theft, the accuracy of consumer rules the agencies adopted in February reports, the duties of furnishers of infor- 2004 included the same schedule of mation, the ability of consumers to opt effective dates contained in the interim out of receiving marketing solicitations rules. The Board's final rule amended from an organization when the solicita- its Regulation V, which implements the tion is based on information provided FCRA. to that organization by its affiliate, and Also in December 2003, the Board the ability of creditors to obtain or and the FTC had issued for comment use medical information in connection proposed joint rules that would establish with determining credit eligibility. (The a schedule of effective dates for other FACT Act also established the Finan- provisions of the FACT Act that did not cial Literacy and Education Commis- contain effective dates. After reviewing sion. See "Promotion of Community the comments on the proposal, the agen- Economic Development in Historically cies, in the February 2004 joint final Underserved Markets" later in this rules, established March 31, 2004, as chapter.) the effective date for provisions of the The FACT Act requires the Board to FACT Act that did not require signifiissue regulations or guidelines to imple- cant changes to business procedures. For ment various provisions of the statute. those FACT Act provisions that would In 2004, the Board issued three final likely entail significant changes to busirules: one pertaining to effective dates ness procedures, the agencies estabfor certain provisions of the FACT Act, lished December 1, 2004, as the effecone pertaining to the furnishing of nega- tive date, to allow a reasonable time tive information to consumer reporting for the industry to establish systems that agencies, and one pertaining to the comply with the statute. disposal of consumer information. The Board is currently working on several Furnishing of Negative Information additional regulations or guidelines required by the FACT Act. In June, the Board issued a final rule amending Regulation V to add model notices that financial institutions may Effective Dates use to comply with the notice require- In February, the Board and the Federal ment for furnishing negative informa- Trade Commission (FTC) issued joint tion to nationwide consumer reportfinal rules to implement section 3 of the ing agencies. Under section 217 of the FACT Act, which required these agen- FACT Act, a financial institution that cies to establish effective dates for pro- furnishes negative information about visions of the act that did not already credit extended to a customer (such as contain specific effective dates. The information on a customer's delinquen- Board and the FTC had jointly adopted cies or late payments) to a nationwide interim rules in December 2003 that consumer reporting agency is required Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 57 to provide a clear and conspicuous writ- measures for properly disposing of conten notice to the customer about furnish- sumer information derived from coning negative information. The required sumer reports (such as credit reports). notice is a one-time notice, and a finan- The agencies' final rules implement seccial institution may provide the notice tion 216 of the FACT Act by amending before, or no later than thirty days after, the Interagency Guidelines Establishfurnishing the negative information to a ing Standards for Safeguarding Cusnationwide consumer reporting agency. tomer Information (retitled the Inter- Section 217 of the FACT Act became agency Guidelines Establishing Staneffective on December 1, 2004. dards for Information Security), which The FACT Act required the Board were adopted in 2001 (as appendix D-2 to issue a concise model form not to of Regulation H). The National Credit exceed thirty words that institutions Union Administration, the FTC, and may, but are not required to, use to the Securities and Exchange Commiscomply with the notice requirement. The sion adopted similar standards for their Board's final rule added two model institutions. notices to Regulation V. One notice may The interagency guidelines currently be used by financial institutions that require financial institutions to protect give the notice before furnishing nega- customer information by implementing tive information to a nationwide con- information security programs. An instisumer reporting agency. The other may tution's information security program be used by financial institutions that must include measures for the proper give the notice after furnishing negative disposal of "customer information." information to a nationwide consumer Such information is generally defined as reporting agency. The Board also nonpublic personal information about a amended Regulation V to incorporate a "customer," namely, an individual who statutory safe harbor relating to the use obtains a financial product or service to of the model notices. The safe harbor in be used primarily for personal, family, the FACT Act provides that a financial or household purposes, and who has institution will be considered to be in a continuing relationship with the financompliance with the notice requirement cial institution. The final rules amend if the institution uses the model notice the interagency guidelines to require inissued by the Board, or if it uses the model stitutions to also include measures for notice and rearranges the format. The the proper disposal of "consumer infor- Board also provided additional guidance mation," which is generally defined as about using the model notices, including information that is a consumer report guidance on how financial institutions (such as a credit report), or that is may rearrange the format of the notices derived from a consumer report about without losing the safe harbor from liaan individual (regardless of whether that bility that the model notices provide. individual is a customer), and that is maintained or otherwise possessed by, or on behalf of, the institution for a Disposal of Consumer Information business purpose. The final rules will In December, the Board along with the take effect on July 1, 2005; however, other federal financial regulatory agen- financial institutions do not need to cies issued interagency final rules to modify existing contracts with their serrequire financial institutions to adopt vice providers until July 1, 2006. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

58 91st Annual Report, 2004 Interagency Guidance on Unfair unaware of the existence or the source and Deceptive Practices of PIN fees. The primary conclusions of the study address four principal areas: In March, the Board and the FDIC (1) the prevalence of PIN fees; (2) the jointly issued a statement outlining the degree of compliance by depository standards the agencies will use to deterinstitutions with current disclosure mine when state-chartered banks are requirements under the Electronic Fund engaging in unfair or deceptive trade Transfer Act (EFTA), as implemented practices. Such practices are illegal by the Board's Regulation E; (3) the under section 5 of the Federal Trade adequacy of existing disclosures and the Commission Act. The Board and the likely benefits and costs of new require- FDIC will apply these standards when ments for disclosure statements; and weighing the need to take supervisory or (4) the feasibility of real-time disclosure enforcement actions and when seeking (namely, disclosing PIN fees at the to ensure that unfair or deceptive practime of a transaction on a POS terminal tices do not recur. The statement also display). provides best practices and general guidance to state-chartered banks to help them manage risks relating to unfair or Prevalence of PIN Fees deceptive acts or practices, as well as to help them avoid engaging in such acts The Board estimated that in 2004 about or practices. The best practices address 15 percent of all customers with debit some of the business areas that have cards had accounts that were subject to the greatest potential for unfair or PIN fees. Because customers can deceptive acts and practices: advertis- modify their behavior to avoid PIN fees ing and solicitation, servicing and col- (for example, by using a signature lections, and managing and monitor- instead of a PIN to secure a transacing employees and third-party service tion), the fraction of customers with providers. debit cards who actually pay these fees is likely between 10 percent and 15 percent. Board Study of the Disclosure of Point-of-Sale Debit Fees under the Electronic Fund Transfer Act Degree of Compliance by Depository Institutions In November, the Board issued a report summarizing the results of its study of The EFTA and the Board's Regulation E the disclosure of fees related to debit require depository institutions to discard purchases. The study focused spe- close certain fees to consumers on the cifically on the debit fees that a financial initial disclosure of account terms, on institution may impose when a customer change-in-terms notices, and on periengages in a point-of-sale (POS) debit odic statements of account activity. The transaction and provides a personal Board found that more than 95 percent identification number (PIN). These fees of depository institutions satisfy all the are referred to as "PIN fees." Some current regulatory requirements for any members of the U.S. Senate Committee electronic funds transfer, and that an on Banking, Housing, and Urban Affairs even higher percentage satisfy the sperequested the study because they were cific requirements for the disclosure of concerned that consumers may be PIN fees at the point of sale. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 59 Adequacy of Existing Disclosures gress directed the Board to study the ability of consumers to avoid (or opt out Consumer and other data suggest that of) receiving written offers of credit or the PIN fee information in initial discloinsurance in connection with transacsures and in change-in-terms notices tions the consumer did not initiate. The is of limited value to consumers. Some Board also studied the potential effect consumers first learn of debit fees from on consumers of any further restrictions their periodic statements, and many on providing them with such written institutions' periodic statements do not offers of credit or insurance. In particidentify the recipient of a debit fee. ular, Congress directed the Board to These findings suggest that improving address the following five issues: (1) the periodic statements, and potentially availability to consumers of opt-out initial disclosures and change-in-terms mechanisms, that is, methods for connotices, could be a relatively low-cost sumers to opt out of having their names way to provide consumers with better and other information used for preinformation about the PIN fees their screened solicitations; (2) the extent to depository institutions impose. which consumers use existing opt-out mechanisms; (3) the benefits to consum- Feasibility of Real-Time Disclosures ers of receiving written offers; (4) the costs to consumers of receiving written The Board found that disclosing debit offers, or any adverse effects on confees in real time at a POS terminal (for sumers from receiving the offers; and example, showing fee information on a (5) the potential effects on certain fac- POS terminal display before a customer tors, such as the cost and availability commits to a method of payment) would of credit, if further restrictions were involve the most extensive changes to imposed on the ability of creditors and the infrastructure of the payments sysinsurers to make written offers. tem. Although such disclosures would improve consumers' knowledge of debit fees, these improvements would be Availability and Use of achieved at extremely high costs. Opt-Out Provisions The Board found that currently about 6 percent of consumers with credit Board Study of Prescreened records have opted out of receiving pre- Solicitations under the Fair Credit Reporting Act screened written offers of credit or insurance. Further, most consumers who elect In December, the Board issued a report to opt out use the statutory mechanisms to Congress summarizing the Board's provided in section 604 of the FCRA, study of unsolicited written offers of which governs the use of prescreening credit or insurance in which the sender techniques. Beyond that statutory proviof the offer has prescreened the recip- sion, industry groups and individual ients for creditworthiness and suit- companies have voluntarily established ability on the basis of consumer credit ways for consumers to eliminate their records in the files of consumer report- name from the listings companies use ing agencies. The FCRA allows con- to make prescreened written offers of sumer credit records to be used for these credit or insurance. These voluntary so-called prescreened solicitations. In mechanisms are important in the marsection 213(e) of the FACT Act, Con- ketplace; an estimated one-third of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

60 91st Annual Report, 2004 individuals on the opt-out lists of the The Board found that prescreened national consumer reporting agencies written solicitations for credit and insurused a voluntary mechanism to request ance carry some potential costs for conthat their personal information not be sumers, including the inconvenience of used for prescreened offers. receiving unwanted mail, the possibility of identity theft, the possible loss of privacy, and the potential for additional Benefits and Costs of Receiving debt burden. Although these are impor- Written Offers tant considerations, the Board did not The Board found that the benefits to find that restricting written offers of consumers of receiving prescreened credit or insurance would mitigate these written offers of credit or insurance are problems; the alternatives to prescreensignificant. Because prescreened offers ing may even exacerbate some of them. must be "firm offers" of credit or insurance, a consumer generally receives Potential Effects of offers for only those products for which Further Restrictions he or she is likely qualified. Consequently, consumers shopping for credit The Board found that written offers of or insurance are able to quickly iden- credit or insurance sent directly to contify products suitable for them. These sumers have the potential to increase prescreened offers also contain pricing competition in the market for those and product information, often in a form consumer financial services. The prithat allows a consumer to compare the mary benefits of competition are lower terms of products offered with those of prices and an increased availability of accounts he or she already holds—and the product or service in question. As a with products offered by other compa- result, the Board concluded that actions nies. Thus, the widespread availability undertaken to restrict the ability of lendof pricing and product information in ers and insurers to provide written offers prescreened offers helps to make the of credit or insurance to consumers market for these products more com- would, on balance, result in a less competitive, an advantage that benefits all petitive marketplace and thus relatively consumers. higher prices and the reduced availability of credit or insurance. For creditors and insurers, the ability to tailor offers of credit or insurance to consumers' pricing and product Other Regulatory Actions preferences at a relatively low cost enhances competition and marketing The Board also took the following reguefficiency. Moreover, by having access latory actions during 2004: to credit record information for the purposes of prescreening, creditors and • In March, the Board revised Reguinsurers are better able to control certain lation Z (Truth in Lending) and its risks related to offering these products. official staff commentary to add an In a competitive market, cost savings interpretative rule of construction for creditors and insurers translate into clarifying that the word "amount" lower prices and wider credit and insur- referred to a numerical amount. The ance availability for consumers, possi- revisions also provided guidance bly benefiting traditionally underserved on consumers' exercise of rescission consumers. rights for certain home-secured loans. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 61 In July, the Board and the other • In December, the Board raised to federal financial regulatory agencies $34 million the exemption threshold issued joint interim final rules contain- for depository institutions required ing technical changes to their regu- to collect data in 2005 under HMDA lations implementing the Commu- and Regulation C. As prescribed by nity Reinvestment Act (CRA). The the statute, the increased threshold changes conform those regulations reflects changes in the consumer price to changes in (1) the Standards for index. Defining Metropolitan and Micropolitan Statistical Areas, published by the Economic Effects of the U.S. Office of Management and Bud- Electronic Fund Transfer Act get in December 2000; (2) the census tracts designated by the U.S. Bureau As required by the Electronic Fund of the Census; and (3) the Board's Transfer Act (EFTA), the Board moni- Regulation C, which implements tors the effects of the act on the costs of the Home Mortgage Disclosure Act compliance to financial institutions and (HMDA). The joint interim rules did the benefits of the act to consumers. not make substantive changes in the According to data from the most requirements of the CRA regulations. recent triennial Survey of Consumer The Board's regulation implementing Finances (conducted in 2001), approxithe CRA is Regulation BB. mately 88 percent of U.S. families in that year used or had access to one or In August, the Board amended the more EFT services—for example, an official staff commentary to Regula- ATM card, a debit card, direct deposit, tion Z to raise from $499 to $510 the or direct payment—up from approxitotal dollar amount of points and fees mately 85 percent in 1998. ATMs were that triggers additional requirements the most widely used EFT service; for certain mortgage loans under the approximately 70 percent of U.S. fami- Home Ownership and Equity Protec- lies had an ATM card. In 2003, the tion Act. As prescribed by the statute, number of ATM transactions per month the increased amount (effective Janu- averaged approximately 902 million, ary 2005) reflects changes in the con- and the number of installed ATMs sumer price index. rose nearly 5.4 percent from 2002, to 371,000. ( In December, the Board issued a final Direct deposit was almost as widely rule revising disclosure tables the used. About 67 percent of U.S. families Board and the other federal financial had funds deposited directly into their regulatory agencies use to publicly checking or savings account. Use of the release data collected by lenders service is particularly common in the under HMDA and the Board's Regu- public sector; during fiscal year 2004, lation C. In particular, the final rule approximately 75 percent of all governrevised the formats for some of the ment payments were made using EFT, existing disclosure tables, deleted one including 81 percent of Social Security set of existing tables, and added new payments, 98 percent of federal salary tables. These changes reflect the and retirement payments, and 45 percent Board's 2002 revisions to Regula- of federal income tax refunds. tion C that required lenders to collect About 47 percent of U.S. families use new data beginning January 1, 2004. debit cards, which consumers can use at Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

62 91st Annual Report, 2004 merchant terminals to pay for purchases. • disseminates information on commu- Approximately 16.2 billion debit card nity development techniques to banktransactions took place in 2003, an ers and the public through Community increase of approximately 21 percent Affairs Offices at the Reserve Banks. from the previous year's volume. Direct payment is a less widely used EFT pay- Examinations for Compliance ment mechanism; about 40 percent of with the CRA U.S. families have payments automati- The Federal Reserve assesses and rates cally deducted from their accounts. the CRA performance of state mem- The incremental costs associated with ber banks in the course of examinathe EFTA are difficult to quantify tions conducted by staff at the twelve because no one knows how industry Reserve Banks. During the 2004 reportpractices would have evolved in the ing period, the Reserve Banks conabsence of statutory requirements. The ducted 242 CRA examinations. Of the benefits of the EFTA are also difficult to banks examined, 43 were rated "outmeasure, as they cannot be isolated from standing" in meeting community credit consumer protections that would have needs, 198 were rated "satisfactory," been provided in the absence of regulanone was rated "needs to improve," and tion. The available evidence suggests no 1 was rated as being in "substantial serious consumer problems with EFTA. noncompliance."1 (See "Agency Reports on Compliance with Consumer Protection Laws" later Analysis of Applications for in this chapter.) Mergers and Acquisitions in Relation to the CRA Supervision for Compliance Under the Bank Holding Company Act with Consumer Protection and and the Bank Merger Act, the Board Community Reinvestment Laws considers applications for which CRA protests are raised or significant issues Activities Related to the exist regarding CRA or consumer Community Reinvestment Act compliance. Other cases are decided by the Reserve Banks under delegated The Community Reinvestment Act authority. (CRA) requires that the Board and other During 2004, the Board of Governors banking agencies encourage financial considered applications for several siginstitutions to help meet the credit needs nificant banking mergers and acquisiof the local communities in which they tions. The Board sponsored four pubdo business, consistent with safe and lic meetings in connection with two of sound business practices. To carry out these applications. For the application this mandate, the Federal Reserve by Bank of America Corporation (Charlotte, North Carolina) to acquire Fleet • examines state member banks to Financial Group, Inc. (Boston, Massaassess their compliance with the CRA, chusetts), public meetings were held at the Federal Reserve Banks of Boston • analyzes applications for mergers and and San Francisco. Two public meetings acquisitions by state member banks and bank holding companies in rela- 1. The 2004 reporting period was July 1, 2003, tion to CRA performance, and through June 30, 2004. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 63 were held at the Federal Reserve Banks The public submitted comments on of New York and Chicago in connection each of these applications. Most of the with the merger of J.P. Morgan Chase & commenters expressed concerns that Company (New York, New York) with lending to lower-income communities Bank One Corporation (Chicago, Illi- and populations was insufficient and that nois). Members of the public submitted the institutions had failed to address the numerous comments on these two appli- convenience and needs of affected comcations during the thirty-day comment munities. Commenters also raised issues period allocated for such applications. relating to potentially abusive lending The public meetings, however, allowed practices involving subprime and paythe public to enter oral or written testi- day lenders; the potentially adverse mony into the record of information effects of branch closings; the failure of considered by the Board. The Board minority-owned and -operated instituapproved the application by Bank of tions to adequately serve other minority America Corporation in March and the populations; the loss of local ownership; application by J.P. Morgan Chase & institutions' alleged attempts to circum- Company in June. Several other sig- vent state consumer laws; and alleged nificant applications are summarized fraud. below. In addition to considering these applications for significant banking mergers • An application by New Alliance Bane- and acquisitions, the Board acted on shares (New Haven, Connecticut) to thirteen other bank and bank holding acquire New Haven Savings Bank company applications that involved pro- (New Haven, Connecticut) was tests by members of the public conapproved in February. cerning the performance under the CRA of insured depository institutions. The • Three applications by National City System also approved one application Corporation (Cleveland, Ohio) were that involved an institution having a approved in March, June, and August. CRA rating of lower than satisfactory and another thirty-three applications • An application by Regions Financial involving other issues related to CRA, Corporation (Birmingham, Alabama) fair lending, or compliance with conto acquire Union Planters Corporation sumer credit protection laws.2 (Memphis, Tennessee) was approved in June. Other Consumer Compliance Activities • An application by Royal Bank of Scotland and Citizens Financial Group The Division of Consumer and Com- (both in Providence, Rhode Island) to munity Affairs supports and oversees acquire Charter One Financial Group, the supervisory efforts of the Federal Inc. (Cleveland, Ohio), was approved Reserve Banks to ensure that consumer in August. protection laws and regulations are fully and fairly enforced. Division staff pro- • An application by Wachovia Corpo- vide guidance and expertise to the ration (Charlotte, North Carolina) to Reserve Banks on consumer protection acquire SouthTrust Corporation (Birmingham, Alabama) was approved in 2. In addition, five applications involving other October. CRA or compliance issues were withdrawn. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

64 91st Annual Report, 2004 regulations, examination and enforce- ciated with the rapid changes in elecment techniques, examiner training, and tronic banking. emerging issues. They develop and update examination policies, proce- Fair Lending dures, and guidelines, and review Reserve Bank supervisory reports and The Board has a responsibility to ensure work products. They also participate in that the banks under its jurisdiction cominteragency activities that promote uni- ply with the federal fair lending laws— formity in examination principles and the Equal Credit Opportunity Act standards. (ECOA) and the Fair Housing Act. The Examinations are the Federal Re- ECOA prohibits all creditors from disserve's primary means of enforcing criminating against any applicant, in compliance with consumer protection any aspect of a credit transaction, on the laws. During the 2004 reporting period, basis of race, color, religion, national the Reserve Banks conducted 329 con- origin, sex, marital status, or age. In sumer compliance examinations—305 addition, creditors may not discriminate of state member banks and 24 of foreign against an applicant because the applibanking organizations (FBOs).3 cant receives income from a public The Board periodically issues guid- assistance program or has exercised, ance for Reserve Bank examiners on in good faith, any right under the Conconsumer protection laws and regula- sumer Credit Protection Act. As protions. In addition to updating examina- vided by the ECOA, the Board enacted tion procedures for a number of regula- Regulation B to fully implement the act tions in concert with the other federal for the banks under its jurisdiction and financial institution regulatory agen- periodically reviews that regulation cies, the Board revised the procedures and modifies it as needed. Congress that Federal Reserve consumer compli- assigned responsibility for administraance examiners are to use when assess- tive enforcement of the ECOA to the ing whether a compliance or CRA Board for banks under its jurisdiction, to examination of an FBO or special- other regulators for creditors that they purpose bank is necessary. Further, the regulate, and to the Federal Trade Com- Board updated its risk-focused supervi- mission for all other creditors. sion program to reflect new regulations The Fair Housing Act covers credit and the level of risk associated with for the purchase, construction, improveexisting regulations. The Board also ment, repair, or maintenance of a dwellcompleted a pilot program for an inter- ing. Under the act, it is unlawful for disciplinary electronic banking profile a creditor to deny any form of financial to identify and monitor risk factors asso- assistance, or discriminate in fixing the amount, interest rate, or any other terms or conditions of any financial assistance, 3. The foreign banking organizations examined on the basis of race, color, religion, by the Federal Reserve are organizations operating national origin, handicap, familial staunder section 25 or 25A of the Federal Reserve tus, or sex. Act (Edge Act and agreement corporations) and state-chartered commercial lending companies The ECOA also obligates the Board owned or controlled by foreign banks. These insti- and other agencies with enforcement tutions are not subject to the Community Reinvestresponsibilities under the act to refer ment Act and typically engage in relatively few any pattern or practice of ECOA violaactivities that are covered by consumer protection laws. tions to the Department of Justice Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 65 (DOJ). When a violation of the ECOA that have an unintended but unjustified also violates the Fair Housing Act, the discriminatory "disparate impact." In matter may be referred to the Depart- 2004, division staff determined that a ment of Housing and Urban Develop- lender's adoption of a "housing proxy" ment. To promote consistency in how debt payment constituted a disparatefair lending issues are analyzed through- impact violation of the ECOA on the out the System, Division of Consumer basis of the prohibited characteristic of and Community Affairs staff coordinate age. The lender had been adding a multithe investigation of potential fair lend- hundred-dollar payment to the monthly ing violations with Reserve Bank staff debt of persons who applied for credit and develop recommendations for the but reported no housing cost on their division director regarding whether loan application—and for whom no referral is necessary or appropriate. housing cost appeared on their credit During 2004, division staff received bureau report. This proxy practice was and analyzed six reports from Reserve shown to adversely affect a dispropor- Banks regarding possible referral mat- tionate number of younger applicants, ters. Four of these reports had to do with and the lender failed to demonstrate an potentially discriminatory underwriting adequate "business-necessity" justificastandards affecting applicants on the tion for its adoption of the proxy. basis of marital status or sex; the other Since 1994, the Federal Reserve has two matters involved apparent discrimi- used a two-stage statistical regression natory loan-pricing practices on the program to help assess fair lending combasis of marital status. In two of the six pliance by high-volume mortgage lendcases, the Board determined that refer- ers. The program uses reported HMDA rals were not warranted; two cases were data for a stage one analysis to identify referred to the DOJ; and two cases are banks having significant disparities in pending. their loan-denial rates for loan applica- In early 2004, division staff, together tions submitted by members of a prowith staff from the Board's Legal Divi- tected class and those submitted by sion and the Federal Reserve Bank of members of a nonprotected class; the New York, negotiated a consent order program then targets these banks for a to finalize an investigation of a major stage two analysis that considers extenholding company subsidiary. The order sive additional information taken from addressed issues raised during the inves- a sample of a bank's loan files. The tigation, including regulatory compli- program produces statistically reliable ance violations, the making of loans that results, even in cases in which the numwere unsafe and unsound and that bor- ber of denied applicants in a protected rowers could not afford, and misleading class is small. and incorrect statements made by lending personnel to examiners. In addition Flood Insurance to a substantial civil money penalty, the consent order provided for extensive The National Flood Insurance Act corrective measures, including the pay- imposes certain requirements on loans ment of restitution to victims. secured by buildings or mobile homes The ECOA prohibits not only prac- located in, or to be located in, areas tices that constitute intentional discrimi- determined to have special flood haznatory treatment of credit applicants ards. Under the Federal Reserve's Reguon a prohibited basis but also practices lation H, which implements the act, state Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

66 91 st Annual Report, 2004 member banks in general are prohibited developed a Check 21 web site to profrom making, extending, increasing, vide examiners and the financial indusor renewing any such loan unless the try with educational tools, reference building or mobile home and any per- materials, and answers to frequently sonal property securing the loan are cov- asked questions (www.ffiec.gov/exam/ ered by flood insurance for the term of check21). the loan. The act requires the Federal The FFIEC also issues guidance to Reserve to impose civil money penalties the agencies' consumer compliance when it finds a pattern or practice of examination staff and to supervised violations of the regulation. The civil financial institutions. To ensure that money penalties are turned over to CRA performance evaluations are comthe Federal Emergency Management prehensive and include facts and data Agency for deposit into the National to support the evaluation results, the Flood Mitigation Fund. FFIEC in 2004 developed interagency During 2004, the Board imposed civil guidance on examiners' use of data money penalties on three state mem- tables in CRA evaluations. Additionally, ber banks. The penalties, which were the FFIEC member agencies developed assessed via consent orders, ranged from interagency guidance on overdraft pro- $3,250 to $10,000. tection programs, which was released for public comment in 2004. Finally, Coordination with in response to a review of preliminary Other Federal Banking Agencies 2004 HMDA data submissions, the FFIEC issued guidance to HMDA data The member agencies of the Federal reporters regarding proper collection Financial Institutions Examination and reporting of the new data fields Council (FFIEC) develop uniform being collected for the first time in 2004. examination principles, standards, pro- The Board and the FDIC issued joint cedures, and report formats.4 In 2004, guidance outlining standards the two the FFIEC issued revised examination agencies will consider when determinprocedures for determining compliance ing whether specific acts or practices with the fair lending provisions of Reguat state-chartered banks are unfair or lation B (which implements the Equal deceptive. The Board, the OCC, and the Credit Opportunity Act), the Homeown- FDIC also updated the host-state loaners Protection Act, and the new subto-deposit ratios used to determine compart D of Regulation CC. Subpart D pliance with section 109 of the Riegleimplements the Check Clearing for the Neal Interstate Banking and Branching 21st Century Act, or Check 21. (Regu- Efficiency Act of 1994. lation CC continues to implement the Expedited Funds Availability Act.) In addition to issuing revised examination Training for Bank Examiners procedures to implement Check 21, Ensuring that financial institutions comstaff from the FFIEC member agencies ply with laws that protect consumers and encourage community reinvestment 4. The FFIEC member agencies are the Board is an important part of the bank examiof Governors of the Federal Reserve System, the nation and supervisory process. As the Federal Deposit Insurance Corporation, the Office number and complexity of consumer of the Comptroller of the Currency, the Office of financial transactions grow, training for Thrift Supervision, and the National Credit Union Administration. examiners of the state member banks for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 67 which the Federal Reserve has supervi- In 2004, the consumer affairs function sory responsibility becomes even more added a new course to the core curricuimportant. The consumer affairs curricu- lum, Consumer Affairs Risk-Focused lum comprises courses on various con- Examination Techniques. The course is sumer protection laws, regulations, and designed to enhance examiners' analytiexamining concepts. In 2004, these cal, decisionmaking, and leadership courses were offered in eleven sessions skills. to more than 225 Federal Reserve con- In addition to providing core training, sumer compliance examiners. the examiner curriculum emphasizes the Board and Reserve Bank staff reg- importance of continuing professional ularly review the core curriculum for development. Opportunities for continuexaminer training, updating subject mat- ing development include special projects ter and adding new elements as appro- and assignments, self-study programs, priate. During 2004, staff conducted rotational assignments, the opportunity curriculum reviews for two courses to to instruct at System schools, and menincorporate technical changes in policy toring programs. and laws, along with changes in instructional delivery techniques. The two Reporting on Home Mortgage courses reviewed were Disclosure Act Data • Community Reinvestment Act Exami- The Home Mortgage Disclosure Act nation Techniques. Equips assistant (HMDA) requires that mortgage lenders examiners and others to write the per- collect and make public certain data formance evaluation for the CRA por- about their home purchase, home tion of a consumer compliance bank improvement, and refinancing loan examination. transactions. A depository institution generally is covered by the act if (1) it is • Commercial Lending Essentials for located in a metropolitan statistical area, Consumer Affairs. Equips assistant (2) it met the asset threshold at the end examiners with the basic techniques of the preceding calendar year (for 2002 to underwrite and price commercial and 2003, assets of more than $32 milloans. lion; for 2004, assets of more than $33 million), and (3) it originated at Staff members also look for opportu- least one home purchase loan (or refinities to deliver courses via alternative nancing) in the preceding calendar year. channels such as the Internet or other A for-profit mortgage company is covdistance-learning technologies. The two ered if (1) it has offices in a metropolicourses discussed above are now taught tan statistical area, (2) it had assets of using several instructional methods: more than $10 million (when combined classroom instruction focusing on case with the assets of any parent company) studies, specially developed computer- at the end of the preceding calendar based instruction, electronic bulletin year or it originated 100 or more boards, and vendor-delivered online home purchase loans or refinancings in instruction. Additionally, the new exam- the preceding calendar year, and (3) in iner training on the consumer compli- the preceding calendar year, its home ance aspects of the Check 21 Act was purchase loan originations and refinancdelivered on both an interactive web site ings accounted for at least 10 perand an interactive CD-ROM. cent of its total loans by dollar vol- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

68 91st Annual Report, 2004 ume, or if such loans equaled at least tions of lending discrimination and in $25 million. targeting lenders for further inquiry. In 2004, a total of 6,935 depository The HMDA data reported for 2003 institutions and affiliated mortgage com- covered about 42 million loans and loan panies and 1,186 independent mortgage applications, about 33 percent more than companies reported HMDA data for in 2002. The greater volume was due calendar year 2003. Lenders submitted primarily to an increase of about 41 perinformation about the disposition of loan cent in refinancing activity. The numapplications, the geographic location of ber of covered home purchase loans the properties related to loans and loan extended in 2003, compared with 2002, applications, and, in most cases, the race increased 16 percent for Asians, 18 peror national origin, income, and sex of cent for Hispanics, 15 percent for applicants and borrowers. The FFIEC blacks, and 11 percent for whites. processed the data and produced disclo- Native Americans experienced a 5 persure statements on behalf of the FFIEC cent decline in such lending from 2002 member agencies and the Department through 2003. Over the period from of Housing and Urban Development 1993 through 2003, the number of home (HUD). purchase loans extended to Hispanics The FFIEC prepared individual dis- rose 236 percent; to Asians, 163 perclosure statements for each lender that cent; to blacks, 106 percent; to Native reported data—one statement for each Americans, 50 percent; and to whites, metropolitan statistical area in which the 44 percent. For each income category, lender had offices and reported loan the number of home purchase loans activity for 2003. In 2004, the FFIEC reported was higher in 2003 than in prepared 65,808 disclosure statements.5 2002; the increase was 6 percent for In July, each institution made its disclo- lower-income applicants; 8.6 percent for sure statement public, and reports con- middle-income applicants; and 13 pertaining aggregate data for all mortgage cent for upper-income applicants. From and home improvement loans in each of 1993 through 2003, the number of home the 337 metropolitan statistical areas in purchase loans to lower-, middle-, and the United States were also made avail- upper-income applicants increased by able to the public at central deposi- 102 percent, 68 percent, and 88 percent, tories.6 These data are used by the respectively. FFIEC agencies, the reporting institu- In 2003, 19 percent of Hispanic applitions, HUD, the Department of Justice cants and 21 percent of black appli- (DOJ), and members of the public. They cants for home purchase loans reported also assist HUD, the DOJ, and state and under HMDA applied for governmentlocal agencies in responding to allega- backed mortgages; the comparable figures for Asians, whites, and Native Americans were 4 percent, 12 percent, 5. The FFIEC also compiles information on and 15 percent, respectively. Twentyapplications for private mortgage insurance (PMI) one percent of lower-income applicants similar to the information on home mortgage lendfor home purchase loans, compared ing collected under HMDA. Lenders typically require PMI for conventional mortgages that with 5 percent of upper-income appliinvolve small down payments. cants, applied for government-backed 6. Central depository sites include libraries, mortgages. universities, and city planning offices. A list of Overall, the denial rate in 2003 for sites can be found at www.ffiec.gov/hmdacf/ centdep/default2.cfm. conventional home purchase loans Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 69 (that is, loans that are not government- • note on the application form when backed) was 14 percent, a rate un- an applicant chooses not to provide changed from 2002. The denial rate monitoring information regarding race rose from 1993 through 1998 but has or national origin and sex fallen since then. In 2003, denial rates for conventional home purchase loans • notify the credit applicant of the reported under HMDA declined slightly action taken within the time frames for black applicants, to 24 percent; the specified in the regulation rates rose modestly for Native Americans and Asians, to 24 percent and • provide a written notice of credit 11 percent, respectively. Denial rates for denial or other adverse action containwhites and Hispanics remained the same ing a statement of the action taken, the from 2002 to 2003, at 12 percent and name and address of the creditor, a 18 percent, respectively. notice of rights, and the name and address of the federal agency that enforces compliance Agency Reports on Compliance with Consumer Protection Laws • collect information for monitoring The Board reports annually on compli- purposes about the race, color, reliance with consumer protection laws by gion, national origin, or sex of an entities supervised by federal agencies. applicant This section summarizes data collected from the twelve Federal Reserve Banks, During 2004, the Federal Trade Comthe FFIEC member agencies, and other mission (FTC) entered into one settlefederal enforcement agencies.7 ment with a telecommunications corporation for alleged violations of the Regulation B ECOA and Regulation B. The defen- (Equal Credit Opportunity) dants were required to pay civil money penalties of $1,125 million and provide The FFIEC agencies reported that injunctive relief. Additionally, the FTC 88 percent of the institutions examined continued litigation against a mortduring the 2004 reporting period were in gage lender for alleged violations of the compliance with Regulation B, com- ECOA and Regulation B, and continued pared with 84 percent for the 2003 its enforcement efforts against other reporting period. The most frequent vioorganizations. lations involved failure to take one or The other agencies that enforce more of the following actions: the ECOA—the Farm Credit Administration (FCA), the Department of • collect information for monitoring Transportation, the Securities and purposes about the race or national Exchange Commission, the Small Busorigin and sex of applicants seeking iness Administration, and the Grain credit primarily for the purchase or Inspection, Packers and Stockyards refinancing of a principal residence Administration of the Department of Agriculture—reported substantial com- 7. Because the agencies use different methods pliance among the entities they superto compile the data, the information presented vise. The FCAs examination and here supports only general conclusions. The 2004 enforcement activities revealed that reporting period was July 1, 2003, through most Regulation B violations involved June 30, 2004. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

70 91st Annual Report, 2004 creditors' providing inadequate state- In 2004, the FTC settled two cases in ments of specific reasons for denial federal district court involving violaor involved creditors' failure to request tions of the Electronic Fund Transfer or provide information for government- Act (EFTA). In one case, the complaint monitoring purposes. These agencies alleged that the defendants had decepdid not initiate any formal enforcement tively marketed videos and charged actions relating to Regulation B during consumers' credit and debit cards on a 2004, although the FCA indicated that recurring basis, without obtaining writits supervisory process requires correc- ten authorization from the consumers to tive actions for violations noted. initiate preauthorized electronic fund transfers from their accounts, in viola- Regulation E tion of the EFTA. Under the stipulated (Electronic Fund Transfers) court order in this case, defendants were required to pay approximately $1.1 mil- The FFIEC agencies reported that lion in combined consumer redress and approximately 95 percent of the institu- civil penalties and were barred from a tions examined during the 2004 report- range of unlawful activities. In the secing period were in compliance with ond case, the complaint alleged that the Regulation E, compared with 94 per- defendants initiated recurring automatic cent for the 2003 reporting period. charges from consumers' accounts at the The most frequent violations involved conclusion of a "free" trial period assofailure to comply with the following ciated with a variety of offered services, requirements: without disclosing the cancellation policy or obtaining the consumers' • determine whether an error occurred, written authorization. The court order in and transmit the results of the inves- this case included injunctive relief and tigation to the consumer within ten required payment of $2.4 million. business days Regulation M • when a determination is made that no (Consumer Leasing) error has occurred, provide a written The FFIEC agencies reported that more explanation and note the consumer's than 99 percent of the institutions examright to request documentation supined during the 2004 reporting period porting the institution's findings were in compliance with Regulation M, which is comparable to the level of com- • provide initial disclosures that a conpliance for the 2003 reporting period. sumer may retain, at the time he or The few violations noted involved failshe contracts for an electronic fund ure to adhere to specific disclosure transfer service or before the first requirements. The agencies did not issue electronic fund transfer involving the any formal enforcement actions relating consumer's account is made to Regulation M during the period. • provide initial disclosures at the time Regulation P a consumer contracts for an electronic (Privacy of Consumer fund transfer service that contain Financial Information) required information, including limitations on the types of transfers per- The FFIEC agencies reported that mitted and error-resolution procedures 96 percent of the institutions exam- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 71 ined during the 2004 reporting period summation, or not later than three were in compliance with Regulation P, business days after receipt of the loan compared with 97 percent for the 2003 application reporting period. The most frequent violations involved failure to comply with • ensure that disclosures reflect the the following requirements: terms of the legal obligation between the parties, and when any informa- • provide a clear and conspicuous initial tion necessary for an accurate discloprivacy notice to customers that accu- sure is unknown, ensure that the credirately reflects the institution's privacy tor states that the disclosure is an policies and practices, not later than estimate when the customer relationship is established • ensure that disclosures reflect that the creditor has or will acquire a security • provide a clear and conspicuous interest in the property identified annual privacy notice to customers The OCC issued one formal enforce- • disclose the institution's informationment action containing provisions relatsharing practices in initial, annual, and ing to Regulation Z during the 2004 revised privacy notices reporting period. In addition, 114 institutions supervised by the Federal No formal enforcement actions relat- Reserve and the FDIC were required, ing to Regulation P were issued during under the Interagency Enforcement the reporting period. Policy on Regulation Z, to refund a total of approximately $500,000 to Regulation Z consumers. (Truth in Lending) The FTC continued its enforcement activities to halt unlawful subprime- The FFTEC agencies reported that lending practices. The FTC filed two 84 percent of the institutions examined federal district court actions (currently during the 2004 reporting period were in litigation) and continued litigating in compliance with Regulation Z, comthree cases; all five cases concern pared with 78 percent for the 2003 alleged violations of the Truth in Lendreporting period. The most frequent vioing Act, Regulation Z, and the Fedlations involved failure to take one or eral Trade Commission Act. The defenmore of the following actions: dants in these cases include mortgage brokers, a mortgage corporation, a • accurately disclose the finance charge, finance company, and a tax-shelter conusing that term, and provide a brief sulting firm. definition of "finance charge" The FCA's examination and enforcement activities revealed that most Regu- • accurately disclose the payment lation Z violations involved inadequate schedule for closed-end credit or incorrect disclosures for closed-end credit. FCA examiners determined that • on certain residential mortgage trans- all violations had been or were being actions, provide a good faith estimate corrected or adequately addressed by the of the required disclosures before con- respective institutions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

72 91st Annual Report, 2004 Regulation AA amount of checks deposited that are (Unfair or Deceptive Acts not subject to next-day availability or Practices) • follow special procedures when The three banking regulators with invoking the exception for large-dollar responsibility for enforcing Reguladeposits tion AA's Credit Practices Rule—the Federal Reserve, the OCC, and the • when placing an exception hold on an FDIC—along with the NCUA, reported account other than a new account, prothat more than 99 percent of the instituvide the customer with a notice contions examined during the 2004 reporttaining certain information within preing period were in compliance with scribed time periods Regulation AA, which is comparable to the level of compliance for the 2003 reporting period. The few violations • make funds from certain checks, both local and nonlocal, available for withinvolved the following actions: drawal within the times prescribed by • failing to provide a clear and con- the regulation spicuous disclosure regarding a cosigner's liability for a debt • provide training to each employee that performs duties subject to this • entering into a consumer credit obliga- regulation, and establish procedures tion that contains a waiver of exemp- to ensure and monitor employee tion, or enforcing provisions in a pur- compliance chased consumer credit obligation that contains such a waiver, unless the No formal enforcement actions relatwaiver applies solely to property subing to Regulation CC were issued durject to a security interest executed in ing the reporting period. connection with the obligation Regulation DD No formal enforcement actions relat- (Truth in Savings) ing to Regulation AA were issued during the reporting period. The FFIEC agencies reported that 92 percent of institutions examined Regulation CC during the 2004 reporting period were (Availability of Funds and in compliance with Regulation DD, Collection of Checks) compared with 89 percent for the 2003 reporting period. Among the The FFIEC agencies reported that institutions not in full compliance, 93 percent of institutions examined durthe most frequently cited violations ing the 2004 reporting period were in involved compliance with Regulation CC, compared with 90 percent for the 2003 reporting period. Among the institutions • using the phrase "annual percentage not in full compliance, the most fre- yield" in an advertisement without quently cited violations involved the disclosing additional terms and condifailure to take one or more of the follow- tions of customer accounts; ing actions: • failing to provide account disclo- • make available on the next business sures containing certain required Digitized fo d r a F y R A th S e E l R e sser of $100 or the aggregate information; http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 73 • failing to provide timely maturity noti- the scope of complaint investigations fication for time deposits; and improve the quality and timeliness of responses to consumers. • failing to provide account disclosures During 2004, the CAESAR Users clearly and conspicuously, in writing, Advisory Group finalized business and and in a form that the consumer may technical requirements for a web-based keep; and CAESAR application that will streamline the System's consumer complaint • providing an advertisement that did process. These requirements entailed the not disclose that fees could reduce the development of new reports for analyzearnings on the account. ing and monitoring complaint trends. In addition, the advisory group developed No formal enforcement actions relat- a new consumer code structure for the ing to Regulation DD were issued dur- web-based system to allow users to clasing the reporting period. sify consumer complaints in more detail and identify investigation findings more easily. Consumer Complaints The Federal Reserve investigates com- Complaints against plaints against state member banks State Member Banks and forwards to the appropriate enforcement agency complaints that involve In 2004 the Federal Reserve received other creditors and businesses. Each approximately 5,130 complaints from Reserve Bank investigates complaints consumers—by mail, by telephone, in against state member banks in its Dis- person, and electronically via the Intertrict. Complaints and inquiries received net (see tables). About 45 percent of the by the Federal Reserve System are entered into its online database, Com- Consumer Complaints against State plaint Analysis Evaluation System and Member Banks, by Classification, 2004 Reports (CAESAR). The Board provides guidance to the Classification Number Reserve Banks on complaint program policies and procedures through advi- Regulation B (Equal Credit Opportunity) . 36 sory letters and periodic updates to the Regulation C (Home Mortgage Disclosure Act) 1 Consumer Complaint Manual. In 2004, Regulation E (Electronic Fund Transfers) . 75 the Board issued guidance about new Regulation H (Bank Sales of Insurance)... 2 Regulation M (Consumer Leasing) 0 codes for the CAESAR database. The Regulation P (Privacy of Consumer new codes will be used to track con- Financial Information) 17 sumer concerns about emerging issues, Regulation Q (Payment of Interest) 1 such as stored-value cards, reaffirmed Regulation Z (Truth in Lending) 215 Regulation BB (Community Reinvestment) 1 debt, the Check Clearing for the Regulation CC (Expedited Funds 21st Century Act, and the Fair and Availability) 25 Regulation DD (Truth in Savings) 28 Accurate Credit Transactions Act. Addi- Fair Credit Reporting Act 155 tional guidance on the CAESAR data- Fair Debt Collection Practices Act 24 base was issued to strengthen the docu- Fair Housing Act 3 Flood insurance rules 11 mentation of complaint investigations. Regulations T, U, and X 4 In addition to the CAESAR guidance, Real Estate Settlement Procedures Act 12 Unregulated practices 1,708 the Board issued guidance on new pro- Digitized cfoerd FuRreAsS tEhRa t are intended to better focus Total 2318 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

74 91st Annual Report, 2004 Consumer Complaints against State Member ]Banks, by Subject of Complaint, 2004 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 15 1 1 1 Credit cards 13 1 1 1 Other loans 8 0 1 1 Other type of complaint Real estate loans 463 20 4 35 Credit cards 892 38 4 74 Other loans 174 8 1 16 Deposits . 460 20 6 59 Electronic fund transfers 75 3 1 3 Trust services 30 1 8 5 Other 188 8 5 30 Total 2318 100 32 225 complaints (2,318) were against state vices, or other practices. Information member banks. Of the complaints on the outcomes of the investigations against state member banks, 68 percent of these complaints is provided in the involved consumer loans: 2 percent table. alleged discrimination on a basis pro- During 2004, the Federal Reserve hibited by law (race, color, religion, System completed the investigation of national origin, sex, marital status, 125 complaints against state member age, the fact that the applicant's income banks that were pending at year-end comes from a public assistance pro- 2003, finding no violations of regulagram, or the fact that the applicant has tions. In 84 percent of the state member exercised a right under the Consumer bank complaints investigated in 2004, Credit Protection Act), and 66 percent the banks had correctly handled a cusconcerned other credit-related practices, tomer's account. In 44 percent of these such as the imposition of annual mem- cases, the banks nevertheless chose to bership fees on credit card accounts, the reimburse or otherwise accommodate amount of interest banks charge on the customer. credit card accounts, or credit denial The Federal Reserve also handled on a basis not prohibited by law (for more than 1,600 inquiries about conexample, credit history or length of sumer credit and banking policies and residence). Twenty percent of the practices during 2004. In responding complaints involved disputes about to these inquiries, the Board and the interest on deposits and other deposit Reserve Banks gave specific explanaaccount practices; the remaining tions of laws, regulations, and banking 12 percent concerned disputes about practices and provided relevant printed electronic fund transfers, trust ser- materials on consumer issues. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 75 ConsumerComplaints—Continued Investigated Bank legally correct Factual or Pending, contractual bank Goodwill Matter Withdrawn December 31 No reim- Customer Bank dispute— violation— reimburse- in by bursement error error resolvable bank took ment or litigation customer or other only by corrective other accommo- accommo- the courts action dation dation 6 2 0 0 0 1 0 0 4 6 0 0 0 0 0 0 0 5 6 0 0 0 0 0 0 0 0 192 125 0 49 6 13 20 10 9 257 379 1 54 14 5 3 27 74 86 25 0 23 11 1 4 5 2 203 100 0 45 19 4 6 13 5 20 27 0 7 2 10 \ 3 I 8 3 0 2 0 0 0 3 1 72 25 0 9 8 2 14 5 18 856 686 1 189 60 36 48 66 119 Unregulated Practices areas, including credit card fraud, the amount charged for late payments, and As required by section 18(f) of the Feddisputes about the amount withdrawn eral Trade Commission Act, the Board from checking accounts. monitors complaints about banking practices that are not subject to exist- Complaint Referrals to HUD ing regulations, focusing on those that concern possible unfair or deceptive In accordance with a memorandum of practices. In 2004 the Board received understanding between HUD and the approximately 1,700 complaints against federal bank regulatory agencies, in state member banks that involved 2004 the Federal Reserve referred six unregulated practices. The categories complaints to HUD that alleged state that received the most complaints member bank violations of the Fair involved real estate loans, credit card Housing Act. In five of the six cases accounts, and checking accounts. Con- the Federal Reserve's investigations sumers most frequently complained revealed no evidence of illegal discrimiabout escrow account problems (78 nation. The remaining case was pending complaints); other complaints involved at year-end. customer service problems (75), debt collection practices (70), insufficient- Advice from the funds charges and procedures (67), loan Consumer Advisory Council and deposit account fees (64), and interest rates and terms (61). The remainder The Board's Consumer Advisory of the complaints concerned a wide Council—whose members represent range of unregulated practices in other consumer and community organizations, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

76 91st Annual Report, 2004 the financial services industry, academic The Community Reinvestment Act institutions, and state agencies—advises (CRA) was a topic at each of the three the Board of Governors on matters con- meetings. The discussions focused on cerning laws and regulations that the regulatory changes proposed by the Board administers and on other issues Board and three other federal financial related to consumer financial services. institution regulators (the Office of the Council meetings are open to the public. Comptroller of the Currency, the Office (For a list of members of the council, of Thrift Supervision, and the Federal see the section "Federal Reserve Sys- Deposit Insurance Corporation). The tem Organization.") agencies proposed changing the criteria In 2004, the council met in March, for designation as a small bank and add- June, and October. In March, council ing a caveat that abusive asset-based members discussed the Board's proposal lending might reduce a bank's CRA ratto provide more uniform and consistent ing. Some members expressed concern guidance on what constitutes a "clear about the proposal to change the criteria and conspicuous" disclosure for its for small-bank designation because a consumer regulations. The discussion larger number of banks would qualify focused on whether the standards and for a more limited CRA examination, guidance in Regulation P, which imple- and some banks located in rural geograments the financial privacy provisions phies might not have incentives to of the Gramm-Leach-Bliley Act, could participate in community and economic be used as the model for providing clear development initiatives. Further, some and conspicuous standards. While mem- members asserted that additional regulabers applauded the Board's effort to tion of regulated depository institutions make disclosures more understand- is not necessary and should instead be able, they did not support adopting the targeted at unregulated and unsuper- Regulation P standard as a means of vised bank affiliates and other loosely providing more consistent standards supervised organizations. and guidance for consumer protection In June, council members discussed disclosures. an ongoing review to identify outdated The council also discussed the Janu- and unduly burdensome regulatory ary 2004 General Accounting Office requirements pursuant to the Economic (GAO) study on predatory lending. The Growth and Regulatory Paperwork GAO recommended that Congress con- Reduction Act of 1996. Members did sider making certain statutory changes not reach consensus on the necessity to consumer financial services and fair of the Truth in Lending Act provision lending laws. Members commented on giving consumers a three-day right to a proposal that would grant the Board rescind certain mortgage loan transthe authority to routinely monitor and, actions before financial institutions disas necessary, examine nonbank mort- burse the funds, nor did they agree on gage lending subsidiaries of bank and the importance of Home Mortgage Disfinancial holding companies to poten- closure Act data from small banks and tially deter predatory lending. Members rural areas. Members agreed that the who supported this proposal believed CRA provisions of the Gramm-Leachthat the Federal Reserve has the ability Bliley Act, which require financial instiand the expertise to conduct rigorous tutions and other community-based and consistent examinations. Others did organizations that are parties to certain not favor the recommendation. written CRA agreements to make the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 77 agreements available to the public and the Home Ownership and Equity Protectheir primary regulator, serve no useful tion Act (HOEPA), which was estabpurpose. Furthermore, the provisions lished to respond to predatory mortgage have created a data collection and lending practices and to protect consumreporting burden for all parties involved ers from these abusive lending practices. in the agreements. Another topic of dis- Members had differing opinions on cussion at the June meeting was the whether state laws or federal legislation remittance market, or the transfer of is the most effective means of addressfunds by immigrant workers to families ing predatory lending. Some members and friends in their native countries (see believed that state laws provide the necthe related box "Remittances and Immi- essary protections for deterring predagrant Markets: Opportunities and Chal- tory lending practices—protections that lenges" later in this chapter). Members HOEPA does not offer. Other members emphasized the importance of lowering strongly preferred federal legislation the cost of remittances and of providing that preempts state laws because of its immigrants with access to banking uniform application and consistency. services—especially for lower-income The council also discussed proposed immigrant workers who regularly send amendments to Regulation E, which money to their home countries. implements the Electronic Fund Trans- Courtesy overdraft protection, fre- fer Act. Members commented on a reviquently referred to as bounced-check sion that would require that payroll card protection, was a topic at the June accounts, established on behalf of a conand October meetings. The courtesy sumer for the purpose of providing saloverdraft-protection services offered by ary, wages, and other employee compensome financial institutions are covered sation on a recurring basis, be covered under the Truth in Savings Act. Some by Regulation E. Specific comments members had concerns about the ade- addressed whether periodic statements quacy of disclosures, the need for addi- should apply to payroll cards. Some tional regulatory coverage, and decep- members agreed that employers issuing tive marketing practices for these payroll cards either directly or through services. Council members discussed service providers should provide periwhether the Truth in Savings Act or the odic statements to employees. Other Truth in Lending Act is the most effec- members noted that payroll cards are a tive way to inform and protect consum- low-profit service for financial instituers. Some council members asserted that tions; the additional costs associated bounced-check protection programs are with providing payroll statements could short-term extensions of credit that fit discourage institutions from offering the the definition of credit under the Truth cards. in Lending Act; others believed that the programs do not qualify as credit exten- Promotion of Community sions because there is no loan applica- Economic Development in tion, underwriting, note, or annual per- Historically Underserved centage rate calculation in connection Markets with the service. At the October meeting, members During 2004, the community affairs discussed anti-predatory-lending laws. function within the Federal Reserve Sys- Members reviewed various state and tem engaged in a variety of initiatives to federal legislative approaches, including promote community economic develop- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

78 91st Annual Report, 2004 ment that benefit low- and moderate- government to improve the level of income communities and populations. financial literacy among American The function continued to focus on consumers. In October, the web site financial literacy and education, the sus- www.MyMoney.gov and a toll-free tainability of community development number (1-888-my-money [1-888-696organizations, emerging and immigrant 6639]) were launched to provide conmarkets, and community economic sumers with easy access to information development. Activities included con- resources. The national strategy workducting research, publishing newsletters ing group will continue its work, incorand articles, sponsoring conferences porating public remarks submitted in and seminars, and providing advisory response to a request for comment and services, all of which helped to deliver finalizing the national strategy in a pertinent information to both general report to Congress due in June 2005. and targeted audiences. Consistent with the national goal to As a decentralized function, the com- increase financial literacy among conmunity affairs programs at the Board sumers, community affairs staff assisted and each of the twelve Reserve Banks in the planning and delivery of financial design activities that are responsive to and consumer education programs to the communities in the regions they Board employees. Four programs were serve. At the Reserve Banks, Commu- offered in 2004, and a web site for nity Affairs Offices focus on providing online personal finance education was information and promoting awareness established for Board employees. of investment opportunities to finan- Board staff use surveys and focus cial institutions, government agencies, groups to learn about what issues are and organizations that serve low- and important to consumers and to test and moderate-income communities and develop educational materials. Last year populations, while the Board's Commu- Board staff updated the "Consumer's nity Affairs Office engages in activities Guide to Mortgage Settlement Costs" that have implications for public policy. and the "Choosing a Credit Card" In 2004, Board staff actively partici- brochures and issued two new publicapated in interagency working groups tions dealing with checks and the new created to fulfill the legislative man- Check 21 provisions: the "Consumer dates of the U.S. Department of the Guide to Check 21 and Substitute Treasury's Financial Literacy and Edu- Checks" and "What You Should Know cation Commission (the commission), about Your Checks." The Board, in established under the Fair and Accurate cooperation with the other federal bank, Credit Transactions Act (the FACT Act). thrift, and credit union regulators, pro- The commission consists of the chiefs duced materials on "phishing," "Interof twenty federal agencies; Governor net Pirates Are Trying to Steal Your Edward Gramlich represents Chairman Personal Financial Information," and on Alan Greenspan as the Board's member. bounced-check fees, "Protecting Your- Board staff participated on two of the self from Overdraft and Bounced-Check commission's working groups: one to Fees." These publications are availhelp design and launch a web site to link able on the Board's consumer informaconsumers with financial education tion web site (www.federalreserve.gov/ resources available from federal gov- consumers.htm). ernment agencies, and one to frame Board staff are involved in ongoing a national strategy for the federal research projects related to financial Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 79 privacy disclosures, consumers' use of program in Providence, Rhode Island, electronic banking services and stored- offers programs to teach seniors about value cards, remittances and immi- credit card use, predatory lending, and grants' use of financial services (see the financial planning. By serving as advisrelated box "Remittances and Immi- ers to the mayors in the nearly thirtygrant Markets: Opportunities and five cities involved in the campaign, the Challenges"), and the role of financial Federal Reserve Banks are helping to education in community development. increase the public's awareness of and Board staff are also working with the access to resources for financial liter- Department of Defense on a longi- acy and education. In addition, Federal tudinal study on the effects of finan- Reserve System community affairs staff cial education conducted on military continued to work closely with national installations. leaders from the Native American com- Board staff assisted with national munity to develop a financial educafinancial education initiatives through- tion policy and other resources that are out the year. The director of the Divi- responsive to the unique needs of resision of Consumer and Community dents in Indian Country. Board staff Affairs served as an adviser to the board hosted a meeting of the Native Ameriof Operation HOPE, a national non- can Financial Education Task Force in profit organization dedicated to deliver- December. The meeting provided an ing financial education programs to low- opportunity for the five committees income populations through schools and of the task force to focus on the financommunity centers, as well as to com- cial education needs of Native Amerimunities suffering from natural disas- cans and on how to deliver education ters. In addition, staff participated in resources to these communities. two national forums: one sponsored by The Community Affairs Offices at the National Endowment for Financial the Reserve Banks continued their Education to explore strategies for pro- financial education initiatives. The Fedmoting positive financial management eral Reserve Bank of Cleveland worked behaviors, and another convened by the with bank and community partners in Government Accountability Office (for- Cleveland, Pittsburgh, and Cincinnati merly the General Accounting Office) to to form regional collaborations to define the federal government's role in develop and deliver financial education personal financial education. resources. The Federal Reserve Bank of System financial education projects Minneapolis was instrumental in formsupplemented the Board's efforts. The ing the Montana Financial Education community affairs and public informa- Coalition. The Federal Reserve Bank tion officers at the Reserve Banks col- of Boston partnered with a community laborated with the U.S. Conference of group to provide train-the-trainer work- Mayors to explore strategies for estab- shops to social service workers, hosted lishing financial education initiatives in a conference on best practices, and cities throughout the country. The result- worked with Operation HOPE to launch ing "Dollar Wi$e" initiative enables a financial literacy campaign in the cities to create programs that meet the schools in Providence, Rhode Island. needs of their citizens. For example, the In addition, the Federal Reserve Bank campaign in Detroit, Michigan, focuses of Kansas City sponsored a number of on providing financial education train- financial education events that speing to community educators, while the cifically targeted youth, Native Ameri- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

80 91st Annual Report, 2004 Remittances and Immigrant Markets: Opportunities and Challenges The provision of remittance services is a potentially effective method by which mainstream financial institutions can attract unbanked immigrants. Ben S. Bemanke, Member; Board of Governors April 16, 2004 Immigrant workers typically send a large service fees as high as 15 percent of the portion of their earnings back to their home transfer, thus eroding the amount of money countries. The United States is the largest an immigrant's family receives. Many facsource country for these cross-border funds tors influence the fees charged, including transfers, known as remittances: About the service provider's operating costs and $32 billion was remitted in 2003, accord- geographic coverage. ing to a recent report from the Inter- To facilitate cost-effective funds trans- American Dialogue. (As used in this fers to Canada, Mexico, and five transarticle, the term remittances refers specifi- atlantic countries, the Reserve Banks offer cally to the international transfer of funds FedACH International products to banks. between individuals.) Because they are These products allow banks to send intersuch a significant flow of funds, remit- national credit transactions electronically tances have attracted the attention of law- via the same process used to send domestic makers, bankers, consumer and community transactions. Intended primarily for intergroups, and domestic and international national corporate payments, the products banking agencies. provide a potentially less costly way for The Inter-American Development consumers to remit funds. In 2004, the Bank's Multilateral Investment Fund service was expanded to include Mexico. reports that the highest volume of remit- The Reserve Banks worked cooperatively tance traffic—an estimated 100 million with the Central Bank of Mexico to make it transactions each year—occurs between the easier for Mexican retail banking systems United States and Latin America. Billions to support remittances—an effort that may in Motion, a 2002 report published by the also encourage consumers in the United Pew Hispanic Center, described a typical States and Mexico to develop banking remitter in the United States as a thirty- relationships. seven-year-old, lower-skilled immigrant Along with the other Federal Financial from Mexico or another Latin American Institutions Examination Council agencies, country who earns less than $30,000 annu- the Federal Reserve Board examined the ally, has not completed high school, does role of the Community Reinvestment Act not have a credit card, does not own his or in encouraging banks to provide financial her home, and is among the 43 percent of services to immigrants—who are typically Latino immigrants who do not have a bank a low-income, underserved population. As account. a result of policy guidance issued in June The process of remitting funds has 2004, banks that offer remittance services changed significantly since 1990, when may receive CRA credit if these services many immigrants used informal networks, are affordable and meet the needs of the such as friends and family, to transfer lower-income remitters in their markets. funds. Today, money-transfer organizations For banks, immigrants and remittances are the dominant providers of remittance present a market opportunity. The Remitservices. But these firms typically charge tance Marketplace, a 2004 report from the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community- Affairs 81 Pew Hispanic Center, found that only about Conference participants shared insights 3 percent of remittance transactions to on essential policies and practices. Mexico were conducted through banks. • The Federal Reserve Bank of Boston's Despite recent efforts by banks and credit Community Affairs Office conducted unions to increase account ownership in-depth market research on immigrant among Hispanic markets, the report also communities in the First District. The found that 8 million Latinos remain office's other financial education initia- "unbanked." tives targeted Hispanic communities in Banks, however, need to understand the Boston, Massachusetts, and Providence, many issues involved in serving immi- Rhode Island. grants. For example, many immigrants are As the U.S. population becomes more uncomfortable using banks and do not diverse, the Federal Reserve System will understand how banks charge for their sercontinue to work with policymakers, comvices. In 2004, the Federal Reserve System munity groups, and bankers to ensure that undertook several initiatives to share inforimmigrants have fair and equal access to mation on reaching immigrant markets. the U.S. financial system. The following Reserve Bank publications provide more • The Federal Reserve Bank of Chicago information on remittances and immigrant launched the Center for the Study of banking. Financial Access for Immigrants, which hosted a national conference, "Financial • "Financial Access for Immigrants Access for Immigrants: Learning from Conference: Learning from Diverse Diverse Perspectives," in collaboration Perspectives," Profitwise News and with the Brookings Institution. In addi- Views, Federal Reserve Bank of Chicago, tion, the Chicago Reserve Bank's Com- October 2004, www.chicagofed.org/ munity Affairs Office convened several community _development/ forums throughout the Seventh District • "Meeting in the Mainstream," Banking to gain insight into the social, economic, and Community Perspectives, Federal and other issues that inhibit immigrants Reserve Bank of Dallas, issue 1, 2004, from using banks. www.dallasfed.org/ca/index.html • The Federal Reserve Bank of Atlanta • "FedACH International Services Opens hosted "Payments in the Americas," a Payments Channel to Mexico," Partconference that explored the policy and ners in Community and Economic Develregulatory challenges of providing remit- opment, Federal Reserve Bank of tance services. Staff from the Board and Atlanta, volume 14, number 1, 2004, the Atlanta Reserve Bank are also spon- www.atl.frb.org/comm.cfm soring focus groups with Mexican immi- • "Banking Unbanked Immigrants through grants to learn about the factors influ- Remittances," Communities and Bankencing their banking and remitting ing, Federal Reserve Bank of Boston, behaviors. Fall 2003, www.bos.frb.org/commdev/ • Federal Reserve Board staff participated index.htm on a remittances panel at the 2004 • Community Investments Online, Federal conference of the American Council of Reserve Bank of San Francisco, Novem- Consumer Interests. The panel addressed ber 2003, www.sf.frb.org/community/ consumer information, disclosure, and index.html protection issues. • "Banking Latino Immigrants: A Lucra- • The Community Affairs Office of the tive New Market for Progressive Federal Reserve Bank of Dallas hosted Financial Institutions," Bridges, Federal "The Business of Immigrant Markets: Reserve Bank of St. Louis, Autumn Providing Access to Financial Services." 2002, www.stlouisfed.org/community/ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

82 91st Annual Report, 2004 can, and Hispanic populations. The Development Investments; the Bank's Federal Reserve Banks of Atlanta, staff worked closely with an advisory Chicago, and Philadelphia hosted board of industry experts to develop a events on wealth-building and asset- web site of resources, training, and techaccumulation strategies and initiatives nical assistance on community developthroughout their Districts. An article ment investments. The System's Comhighlighting the various financial educa- munity Affairs Offices also continued to tion efforts of the Federal Reserve Sys- work with the Wall Street Without Walls tem was published in the Autumn 2004 initiative to help community developedition of the Federal Reserve Bulletin ment organizations increase their access (www.federakeserve.gov/pubs/bulletin/ to the capital markets for funding. The default.htm). Federal Reserve Banks of Chicago, In recent years, reduced funding and San Francisco, and New York hosted changing priorities among government training events that attracted nearly 370 and philanthropic organizations have community development leaders interdiminished access to resources for many ested in understanding the requirements community development organizations. of the capital markets. In addition, the As it did in 2003, the Board's Com- Community Affairs Office of the Boston munity Affairs Office convened meet- Reserve Bank collaborated with Wall ings of federal government officials Street Without Walls and Southern New and national community development Hampshire University to sponsor the leaders to explore the sustainability and inaugural session of the "Capital Marcapitalization of community economic kets Training Institute" in Manchester, development finance (CEDF) orga- New Hampshire. Participants at this nizations. The Board's Community three-day event learned how they can Affairs Office convened a policy forum use the capital markets to fulfill their in April with the Aspen Institute, organizations' missions more efficiently a national research and leadership and learned how to adapt their operadevelopment organization. The forum tions to allow their organizations to discussed Aspen's research on the access the capital markets. Demonstratattributes of industries, organizations, ing the ongoing commitment of the and products that achieve scale and System's Community Affairs Offices, become self-sustaining. The research the director of the Board's Division compared and contrasted the funding of Consumer and Community Affairs and business strategies of sustainable began serving on the Walls Street Withenterprises with those of CEDF insti- out Walls advisory board in 2004. tutions, identifying areas where the field Reserve Bank efforts also explored needs to focus efforts to increase its ways to increase the effectiveness of future viability. The forum assembled community development finances in leaders from financial institutions, their Districts. The Federal Reserve government agencies, foundations, and Bank of Dallas sponsored "Momentum membership associations. Texas: The Texas Community Devel- Reserve Bank Community Affairs opment Finance Summit" to examine Offices explored new sources of capital the state's strategies for securing and to increase the sustainability of CEDF using community economic developorganizations. The Federal Reserve ment funds. The Cleveland Reserve Bank of San Francisco expanded the Bank organized a policy summit, scope of its Center for Community "Recapitalization of Communities," in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 83 which regional and national community Rodham Clinton was the keynote development leaders discussed chal- speaker. lenges to and opportunities for attracting The Board's Community Affairs new capital to fund CEDF institutions' Office continued to improve and support initiatives for infrastructure develop- its Fiscal Impact Tool (FIT), a webment, wealth-building, and other asset- based modeling tool designed to support accumulation programs. the evaluation of prospective commu- The System's Community Affairs nity and economic development projects Offices remain committed to increasing in midsize communities. This analytic the role of research in their work. Prepa- tool enables community economic rations have begun for the biennial com- developers to conduct a cost-benefit munity affairs research conference in analysis of a proposed development April 2005; Chairman Greenspan will project by estimating its effect on be a keynote speaker at the two-day local sales and property tax reveevent. System community affairs staff nues and on costs to local government. collaborated with their research col- Available at no cost on the Board's leagues at the Board and the Cleveland web site (www.federalreserve.gov/forms/ Reserve Bank to identify and review fiscalimpactrequest.cfm), FIT can aid papers that would best address the con- decisionmakers in determining the ecoference's theme, "Promises and Pitfalls: nomic value of a proposed activity for As Consumer Finance Options Multiply, their community. Who Is Being Served and at What The Board's Community Affairs Cost?" Studies chosen will assess the Office, in partnership with the Chiimpact that consumer behavior, alterna- cago, Kansas City, Philadelphia, tive financial services providers, finan- Richmond, and St. Louis Reserve cial education, and other factors have on Banks, continued to develop bestconsumers' access to and experiences practice case studies for the web-based with the financial sector. database Lessons Learned: Community The New York, Philadelphia, and and Economic Development Case Cleveland Reserve Banks collaborated Studies (www.chicagofed.org/cedric/ to host a community development lesle_index.cfm). The database provides finance research conference in Decem- detailed case studies that identify a ber. The conference commissioned community development issue, present papers from leading researchers on a one community's solution, describe the broad range of topics, including strate- results, and offer "lessons learned" to gies for asset creation among lower- community developers addressing simiincome populations, the role of micro- lar concerns in their communities. The lending in community development, database can be accessed on the Sysmethods for measuring the impact of tem's research repository web site, the community development, and the rela- Community and Economic Developtionship between subprime markets and ment Research Information Center predatory lending. In addition, scholars (CEDRIC). and practitioners explored the roles of alternative depository institutions and Outreach Activities public policy in helping traditionally underserved populations and communi- The Board engages in outreach activities access capital for asset accumula- ties throughout the year to provide infortion and development. Senator Hillary mation to the public about the Board's Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

84 91st Annual Report, 2004 responsibilities, to facilitate understand- the Board again participated in the ing of changes in banking regulations Congressional Black Caucus Foundaand their impact on banks and consum- tion's 2004 annual legislative conferers, to promote community development ence, which provides a national forum and consumer education, and to foster for examining strategies and viable soludiscussion of public policy issues. Board tions to public policy issues facing Afristaff periodically meet with financial can Americans. Board staff distributed institutions, community groups, and consumer education materials provided other members of the public in formal by the Federal Reserve System and used and informal settings. The Board spon- the opportunity to inform conference sors and participates in meetings, con- attendees about the Federal Reserve and ferences, and seminars for the general its multifaceted responsibilities. • public and targeted audiences. This year, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

85 Banking Supervision and Regulation Earnings of insured commercial banks slightly, to 1.35 percent, the third exceeded the $100 billion mark for the consecutive year in which this ratio second consecutive year in 2004 amid exceeded 1.30 percent. significant changes in the interest rate Loans grew a remarkable 11.0 perenvironment, an end to the boom period cent, or $480 billion, in 2004, with most in mortgage refinancings, and several growth occurring in commercial real mergers among large bank holding estate ($131 billion), home equity companies. ($114 billion), residential mortgages At $106.7 billion, profits rose 6.4 per- ($89 billion), and credit card loans cent from 2003, fueled by growth in ($61 billion). The growth of commercial loans (11.0 percent overall) and invest- real estate lending was even more rapid ment securities (6.4 percent) and by a than in the past few years, with condecline in provisions for loan loss struction lending up 25.2 percent and (22.3 percent). The net interest margin loans secured by nonfarm nonresidential on all earning assets fell 7 basis points, properties up 10.7 percent. Home equity to 3.72 percent, low by historical stan- loans grew an extraordinary 40.2 perdards. Non-interest income grew mod- cent, the fifth consecutive year in which estly overall (3.9 percent) despite lower their growth exceeded 20 percent. The revenues from mortgage originations growth of residential mortgages came and soft trading income. Servicing mostly in the first half of the year and income, income from fiduciary activi- slowed considerably once short-term ties, and deposit fees accounted for most market interest rates began to rise in of the growth. Expenses rose sharply June. Some of the increase in credit card (9.4 percent), significantly influenced by lending was technical in nature, related nonrecurring items related to mergers to the reclassification of balances from and the creation of litigation reserves at credit-card-related securities to loans as a few large institutions. accounting treatments were harmonized Return on total shareholders' equity at newly merged large banks. Commerfell a full percentage point, to a still- cial and industrial (C&I) loans rose strong 14.27 percent. The decline in $37 billion, or 4.3 percent, for the year this profitability ratio was due primarily despite having declined modestly in the to significant merger-related increases first quarter amid weak loan demand. in equity that were largely offset by Holdings of investment securities increases in merger-related intangible grew less rapidly than loans, expanding assets.1 Return on assets fell only 6.4 percent overall (or $93 billion) for the full year while experiencing substantial shifts as the year progressed in 1. The number and size of bank-related merger response to changing market conditions. transactions significantly affected the aggregation Essentially all the net growth for the of commercial bank reports of income and con- year could be attributed to mortgage dition (Call Reports) in 2004. The data used in this discussion have been adjusted to address the effects of purchase accounting and, in particular, large holding companies acquired by other bank push-down accounting for bank subsidiaries of holding companies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

86 91st Annual Report, 2004 pass-through securities acquired during significantly ($10.5 billion, or 1.6 perthe first quarter. Reacting to changes in cent); the bulk of the increase came the interest rate environment, banks sold in the final quarter of the year as conoff $36 billion (or 5.9 percent) of their sumers sought to take advantage of mortgage pass-through securities hold- rising interest rates. Time deposits ings in the second and third quarters over $100,000 rose $128.3 billion, or and then purchased roughly the same 21.5 percent, and foreign deposits grew amount during the fourth quarter as $125 billion, or 16.8 percent; these longer-term interest rates stabilized. categories include large-denomination Banks also sold off a modest proportion deposits raised in wholesale and offof their structured mortgage securities shore money markets, which, along with (for example, collateralized mortgage a modest rise in short-term non-deposit obligations) and asset-backed securities borrowings (4.6 percent), accommoin the third quarter and then acquired dated the growth in assets. additional foreign-issued debt securities Influenced by both balance sheet during the fourth quarter. These reposi- changes and movements in market intertioning transactions came in response est rates, net interest margins narrowed to actual and anticipated movements 7 basis points, to 3.72 percent. Yields on in market interest rates (together with domestic real estate loans—including unexpected stability in long-term rates, commercial real estate and home equity leading to a flatter yield curve) and the loans—fell 25 basis points despite associated volatility in the carrying higher short-term interest rates. Overvalue of mortgage-servicing assets. all yields on securities holdings rose Supporting this robust asset growth, modestly—in part because of rising core deposits continued their recent short-term interest rates—while yields strong expansion. Money market deposit on C&I loans held steady at 6.00 peraccount (MMDA) deposits and sav- cent amid reports that bankers were easings deposits grew $270 billion, or ing their lending standards through the 11.7 percent, slightly exceeding the year. Changes in the effective rates for remarkable growth rate for loans. Note- credit cards and other consumer loans worthy increases were evident among were mixed. Funding costs reflected other core deposit categories, including some resistance to higher interest rates, other transaction accounts (up $6.1 bil- as the effective cost of MMDA and lion) and demand deposits (up $24.5 bil- savings deposits remained essentially lion). The increase in demand deposits unchanged from 2003, at 0.73 percent, was influenced by an inflow of balances while the effective cost of other deposits from corporate customers in the latter and borrowings declined 20-30 basis half of the year as short-term market points. interest rates rose, boosting earnings Equity-to-assets ratios rose a full percredits on compensating balances.2 centage point in 2004, primarily as a Time deposits under $100,000 grew less result of the merger-related increases in shareholders' equity noted earlier. 2. Although banks are prohibited from paying Regulatory capital ratios, in contrast, interest on transaction accounts held by commer- remained relatively steady, as the cial customers, these customers in many cases merger-related increase in equity was receive "earnings credits" on their transaction balances that may be used to offset service charges they incur. The amounts of such earnings credits the size of collected balances and prevailing shortare determined by a number of factors, including term market interest rates. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 87 largely offset by goodwill-related intan- Scope of Responsibilities for gible assets, which are deducted from Supervision and Regulation regulatory capital measures. Dividends The Federal Reserve is the federal paid by commercial banks fell sharply, supervisor and regulator of all U.S. bank declining $18 billion, or 23.4 percent. holding companies, including financial Most of the decline (61 percent) came in holding companies formed under the dividends paid to the five largest bank authority of the 1999 Gramm-Leachholding companies (Citigroup, JPMor- Bliley Act, and of state-chartered comgan Chase, Bank of America, Wachovia mercial banks that are members of the and Wells Fargo, all on a merger- Federal Reserve System. In overseeing adjusted basis) by their commercial these organizations, the Federal Reserve bank subsidiaries; dividend payments seeks primarily to promote their safe from the holding companies to their and sound operation, including their shareholders rose. compliance with laws and regulations.3 Already-strong asset quality im- The Federal Reserve also has responproved further in 2004 according to all sibility for the supervision of all Edge conventional measures. Nonperforming Act and agreement corporations; the assets fell to 0.62 percent of loans and international operations of state member related assets, well below both the banks and U.S. bank holding companies; 0.94 percent rate for 2003 and the preand the operations of foreign banking vious credit-cycle low point in 1997-99 companies in the United States. (0.75 percent). Net charge-offs fell to The Federal Reserve exercises impor- 0.63 percent of loans, from 0.88 pertant regulatory influence over entry into cent in 2003, roughly in line with the the U.S. banking system and the struc- 1997-99 period. Reserves fell in absoture of the system through its adminislute terms (4.2 percent), but reserve tration of the Bank Holding Company coverage of nonperforming assets still Act, the Bank Merger Act (with regard improved substantially. to state member banks), the Change in Reflecting ongoing consolidation in Bank Control Act (with regard to bank the industry, the number of insured comholding companies and state member mercial banks declined by 142 (on a net banks), and the International Banking basis), to 7,621. Still, some 122 new Act. The Federal Reserve is also responcharters were granted in 2004 (105 of sible for imposing margin requirements these by state authorities), a sign of the on securities transactions. In carrying continuing attractiveness of commercial out these responsibilities, the Federal bank charters. Assuming a minimum Reserve coordinates its supervisory initial capitalization of $8 million, these newly chartered institutions attracted nearly $1 billion of new capital into the 3. The Board's Division of Consumer and banking industry. Community Affairs coordinates the Federal Consistent with the industry's strong Reserve's supervisory activities with regard to compliance with consumer protection and civil earnings and balance sheets, only three rights laws. Those activities are described in banks failed in 2004 (combined assets the chapter "Consumer and Community Affairs." of roughly $200 million), one more than Compliance with other banking laws and reguin 2003. The number of problem banks lations, which is treated in this chapter, is the responsibility of the Board's Division of Bank- (that is, those receiving a supervisory ing Supervision and Regulation and the Federal rating of 4 or 5 on overall condition) Reserve Banks, whose examiners also check for declined by 28, to 90 institutions. safety and soundness. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88 91st Annual Report, 2004 activities with other federal banking State Member Banks agencies, state agencies, functional At the end of 2004, 919 state-chartered regulators, and the bank regulatory banks (excluding nondepository trust agencies of other nations. companies and private banks) were members of the Federal Reserve System. These banks represented approxi- Supervision for mately 12 percent of all insured U.S. Safety and Soundness commercial banks and held approxi- To ensure the safety and soundness of mately 15 percent of all insured combanking organizations, the Federal mercial bank assets in the United States. Reserve conducts on-site examinations The guidelines for Federal Reserve and inspections and off-site surveillance examinations of state member banks and monitoring. It also undertakes are fully consistent with section 10 of enforcement and other supervisory the Federal Deposit Insurance Act, as actions. amended by section 111 of the Federal Deposit Insurance Corporation Improvement Act of 1991 and by the Riegle Examinations and Inspections Community Development and Regulatory Improvement Act of 1994. A full- The Federal Reserve conducts examinascope, on-site examination of these tions of state member banks, the U.S. banks is required at least once a year; branches and agencies of foreign banks, exceptions are certain well-capitalized, and Edge Act and agreement corporawell-managed organizations having tions. In a process distinct from examiassets of less than $250 million, which nations, it conducts inspections of bank may be examined once every eighteen holding companies and their nonbank months. subsidiaries. Pre-examination planning and on-site review of operations are integral parts of the overall effort to Bank Holding Companies ensure the safety and soundness of banking organizations. Whether it is an At year-end 2004, a total of 5,863 U.S. examination or an inspection, the review bank holding companies were in operaentails (1) an assessment of the quality tion, of which 5,151 were top-tier bank of the processes in place to identify, holding companies. These organizations measure, monitor, and control risks, controlled 6,235 insured commercial (2) an assessment of the quality of the banks and held approximately 96 perorganization's assets, (3) an evaluation cent of all insured commercial bank of management, including an assess- assets in the United States. ment of internal policies, procedures, Federal Reserve guidelines call for controls, and operations, (4) an assess- annual inspections of large bank holding ment of the key financial factors of capi- companies as well as smaller companies tal, earnings, liquidity, and sensitivity to that have significant nonbank assets. In market risk, and (5) a review for compli- judging the financial condition of the ance with applicable laws and regula- subsidiary banks owned by holding tions. The table provides information companies, Federal Reserve examiners on the examinations and inspections consult examination reports prepared conducted by the Federal Reserve dur- by the federal and state banking authoriing the past five years. ties that have primary responsibility for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 89 State Member Banks and Holding Companies, 2000-2004 Entity/Item 2004 2003 2002 2001 2000 State member banks Total number 919 935 949 970 991 Total assets (billions of dollars) 1,275 1,912 1,863 1,823 1,645 Number of examinations 809 822 814 816 899 By Federal Reserve System . 581 581 550 561 610 By state banking agency 228 241 264 255 289 Top-tier bank holding companies Large (assets of more than $1 billion) Total number 355 365 329 312 309 Total assets (billions of dollars) 8,429 8,295 7,483 6,905 6,213 Number of inspections 500 454 439 413 352 By Federal Reserve System1 491 446 431 409 346 On site 440 399 385 372 309 Off site 51 47 46 37 37 By state banking agency 9 4 6 Small (assets of $1 billion or less) Total number 4,796 4,787 4,806 4,816 4,800 Total assets (billions of dollars) 852 847 821 768 716 Number of inspections 3,703 3,453 3,726 3,486 3,347 By Federal Reserve System 3,526 3,324 3,625 3,396 3,264 On site2 186 183 264 730 835 Off site 3,340 3,141 3,361 2,666 2,429 By state banking agency 177 129 101 90 83 Financial holding companies Domestic 600 612 602 567 462 Foreign 36 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 holding companies was revised, resulting in more the supervision of those banks, thereby rial outstanding issues at the holding minimizing duplication of effort and company or consolidated level are otherreducing the burden on banking wise indicated, only a composite rating organizations. and a management rating based on the Small, noncomplex bank holding ratings of the lead subsidiary depository companies—those that have consoli- institution are assigned to the company. dated assets of $1 billion or less—are In 2004 the Federal Reserve conducted subject to a special supervisory program 3,703 reviews of such bank holding that was implemented in 1997 and companies. If a company's subsidiary modified in 2002.4 The program permits depository institutions have ratings a more flexible approach to supervision lower than "satisfactory" or have other of such companies. If all of a company's significant supervisory issues, a more subsidiary depository institutions have thorough off-site review of the organizacomposite and management ratings of tion is conducted using surveillance "satisfactory" or better, and if no mate- results and other information. If the information obtained off-site from these 4. Refer to SR Letter 02-01 for a discussion sources is not sufficient to determine the of the factors considered in determining whether a overall financial condition of the holdbank holding company is complex or noncomplex ing company and to assign the compos- (www.federalreserve.gov/boarddocs/SRLETTERS/ ite and management ratings, the holding 2002/srO201.htm). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

90 91st Annual Report, 2004 company is subject to increased supervi- The BSA and separate Board regusory review that may include an on-site lations require banking organizations review and off-site monitoring. supervised by the Board to file reports on suspicious activity related to possible Financial Holding Companies violations of federal law, including money laundering, terrorist financing, Under the Gramm-Leach-Bliley Act, and other financial crimes. In addition, bank holding companies that meet cer- BSA and Board regulations require that tain capital, managerial, and other rebanks develop written programs on BSA quirements may elect to become financompliance and that the programs be cial holding companies and thereby formally approved by bank boards of engage in full-scope securities underdirectors. An institution's compliance writing, merchant banking, and insurprogram must (1) establish a system of ance underwriting and sales activities. internal controls to ensure compliance The statute streamlines the Federal with the BSA, (2) provide for inde- Reserve's supervision of all bank holdpendent compliance testing, (3) identify ing companies, including financial holdindividuals responsible for coordinating ing companies, and sets forth paramand monitoring day-to-day compliance, eters for the relationship between the and (4) provide training for personnel as Federal Reserve and other regulators. appropriate. The statute also differentiates between The Federal Reserve is responsible the Federal Reserve's relations with for examining supervised institutions for regulators of depository institutions and compliance with various anti-moneyits relations with functional regulators laundering regulations. During examina- (that is, regulators for insurance, securitions of state member banks and U.S. ties, and commodities). branches and agencies of foreign banks As of year-end 2004, 600 domestic and, when appropriate, inspections of bank holding companies and 36 foreign bank holding companies, examiners banking organizations had financial review the institution's compliance with holding company status. Of the domesthe BSA and determine whether adetic financial holding companies, 34 had quate procedures and controls to guard consolidated assets of $15 billion or against money laundering are in place. more; 110, between $1 billion and The Anti-Money-Laundering Policy $15 billion; 82, between $500 million and Compliance Section of the Board's and $1 billion; and 374, less than Division of Banking Supervision and $500 million. Regulation is responsible for BSA/antimoney-laundering matters. The section Anti-Money-Laundering develops BSA polices and examination guidance and oversees the Federal Examinations Reserve Banks' implementation of this The U.S. Department of the Treasury guidance. regulations (31 CFR 103) implementing the Bank Secrecy Act (BSA) gen- Business Continuity erally require banks and other types of financial institutions to file certain In 2004 the Federal Reserve continued reports and maintain certain records that its efforts to strengthen the resilience of are useful in criminal or regulatory the U.S. financial system in the event proceedings. of unexpected disruptions. Throughout Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 91 the year, the Federal Reserve monitored ness examinations are now expected to financial institutions' progress toward include a review of information technolimplementing the sound practices iden- ogy risks and activities. During 2004 the tified in the April 2003 "Interagency Federal Reserve was the lead agency in Paper on Sound Practices to Strengthen two examinations of large, multiregional the Resilience of the U.S. Financial data processing servicers examined in System," a joint publication with the cooperation with the other federal bank- Office of the Comptroller of the Cur- ing agencies. rency (OCC) and the Securities and Exchange Commission (SEC), which Fiduciary Activities specifies 2005-06 implementation dates. The agencies also began analyzing the The Federal Reserve has supervisory risks associated with business continuity responsibility for organizations that testing, in order to develop examiner together hold more than $24 trillion of guidance, and continue to coordinate assets in various fiduciary capacities, efforts to ensure a consistent supervi- including custodial capacities. During sory approach toward implementation of on-site examinations of fiduciary activithe sound practices. ties, the organization's compliance with laws, regulations, and general fiduciary principles and potential conflicts of Specialized Examinations interest are reviewed; its management and operations, including its asset- and The Federal Reserve conducts specialaccount-management, risk-management, ized examinations of banking organizaand audit and control procedures, are tions in the areas of information technolalso evaluated. In 2004 Federal Reserve ogy, fiduciary activities, transfer agent examiners conducted 163 on-site fiduactivities, and government and municiciary examinations. pal securities dealing and brokering. The Federal Reserve also conducts specialized examinations of certain entities, Transfer Agents and other than banks, brokers, or dealers, Securities Clearing Agencies that extend credit subject to the Board's As directed by the Securities Exchange margin regulations. Act of 1934, the Federal Reserve conducts specialized examinations of those Information Technology Activities state member banks and bank holding In recognition of the importance of companies that are registered with the information technology to safe and Board as transfer agents. Among other sound operations in the financial things, transfer agents countersign and industry, the Federal Reserve reviews monitor the issuance of securities, regthe information technology activities ister the transfer of securities, and of supervised banking organizations as exchange or convert securities. On-site well as certain independent data centers examinations focus on the effectivethat provide information technology ness of an organization's operations and services to these organizations. Several its compliance with relevant securities years ago, the information technology regulations. During 2004 the Federal reviews of banking organizations were Reserve conducted on-site examinations integrated into the overall supervisory at 21 of the 86 state member banks and process, and thus all safety and sound- bank holding companies that were reg- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

92 91st Annual Report, 2004 istered as transfer agents. Also during for compliance with the Board's margin the year the Federal Reserve examined regulations as part of its general exami- 1 state member limited-purpose trust nation program, the Federal Reserve company acting as a national securities maintains a registry of persons other depository. than banks, brokers, and dealers who extend credit subject to those regula- Government and Municipal Securities tions. The Federal Reserve may conduct Dealers and Brokers specialized examinations of these lenders if they are not already subject to The Federal Reserve is responsible for supervision by the Farm Credit Adminexamining state member banks and foristration, the National Credit Union eign banks for compliance with the Gov- Administration, or the Office of Thrift ernment Securities Act of 1986 and with Supervision (OTS). Department of the Treasury regulations At the end of 2004, 679 lenders other governing dealing and brokering in than banks, brokers, or dealers were reggovernment securities. Twenty-eight istered with the Federal Reserve. Other state member banks and 7 state branches federal regulators supervised 215 of of foreign banks have notified the Board these lenders, and the remaining 464 that they are government securities dealwere subject to limited Federal Reserve ers or brokers not exempt from Treasupervision. On the basis of regulatory sury's regulations. During 2004 the Fedrequirements and annual reports, the eral Reserve conducted 6 examinations Federal Reserve exempted 245 lenders of broker-dealer activities in governfrom its on-site inspection program. The ment securities at these organizations. securities credit activities of the remain- These examinations are generally coning 219 lenders were subject to either ducted concurrently with the Federal biennial or triennial inspection. Fifty- Reserve's examination of the state memfive inspections were conducted during ber bank or branch. the year, compared with 89 in 2003. The Federal Reserve is also responsible for ensuring compliance with the Securities Act Amendments of 1975 by Enforcement Activities state member banks and bank holding and Special Investigations companies that act as municipal securi- The Federal Reserve has enforcement ties dealers, which are examined pursuauthority over the banking organizations ant to the Municipal Securities Ruleit supervises and their affiliated parties. making Board's rule G-16 at least once Enforcement action may be taken to every two calendar years. Of the 22 entiaddress unsafe and unsound practices or ties that dealt in municipal securities violations of any law or regulation. Forduring 2004, 6 were examined during mal enforcement actions include orders the year. to cease and desist, written agreements, removal and prohibition orders, and Securities Credit Lenders civil money penalties. Informal enforce- Under the Securities Exchange Act of ment actions include memorandums of 1934, the Federal Reserve Board is understanding and board of directors responsible for regulating credit in cer- resolutions. tain transactions involving the purchase In 2004 the Federal Reserve comor carrying of securities. In addition to pleted 64 formal enforcement actions, examining banks under its jurisdiction including the issuance of cease-and- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 93 desist orders, written agreements, and Regional Banking Organizations removal and prohibition orders and the The risk-focused supervision program imposition of civil money penalties. for regional banking organizations Civil money penalties totaling $188 milapplies to organizations having a manlion were assessed. All civil money agement structure organized by funcpenalties, as directed by statute, are tion or business line, a broad array remitted either to the Department of the of products, and operations that span Treasury or to the Federal Emergency multiple supervisory jurisdictions. For Management Agency. Enforcement smaller regional banking organizations, orders, which are issued by the Board, the supervisory program may be impleand written agreements, which are mented with a point-in-time inspection. executed by the Reserve Banks, are pub- For larger organizations, it may take the lic information and are posted on the form of a series of targeted reviews. For Board's web site (www.federalreserve.gov/ the largest, most complex organizations, boarddocs/enforcement). In addition to the process is continuous, as described formal enforcement actions, the Reserve in the next section. To minimize burden Banks completed 102 informal enforceon the organization, work is performed ment actions in 2004. Information about these actions is not available to the off-site to the greatest extent possible. public. Additionally, to minimize the number of requests for information from organiza- The Special Investigations Section of tions, examiners make use of public and the Division of Banking Supervision and regulatory financial reports, market data, Regulation conducts financial investiinformation from automated screening gations, provides expertise to U.S. law systems (see the section "Surveillance enforcement in connection with finanand Off-Site Monitoring"), and internal cial crimes investigations, and offers management reports. training to foreign and domestic government agencies. Board staff also work Large, Complex Banking Organizations with law enforcement, the financial industry, and other regulatory agencies The Federal Reserve applies a riskon various task forces and groups estab- focused supervision program to large, lished to combat bank fraud and other complex banking organizations financial crimes. (LCBOs).5 The key features of the LCBO supervision program are (1) identifying those LCBOs that are judged, on Risk-Focused Supervision the basis of their shared risk character- Programs istics, to present the highest level of In recent years the Federal Reserve has supervisory risk to the Federal Reserve created several programs aimed at System, (2) maintaining continual superenhancing the effectiveness of the super- vision of these organizations to keep visory process. The main objective of current the Federal Reserve's assessthese programs has been to sharpen the ment of each organization's condition, focus on (1) those business activities posing the greatest risk to banking organizations and (2) the organizations' 5. For more information, see Lisa M. DeFerrari management processes for identifying, and David E. Palmer, "Supervision of Large Complex Banking Organizations," Federal Reserve measuring, monitoring, and controlling Bulletin, vol. 87 (February 2001), pp. 47-57 risks. (www.federalreserve.gov/pubs/bulletin/default.htm). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

94 91st Annual Report, 2004 (3) assigning to each LCBO a super- inspections. This analysis aids in directvisory team composed of Reserve Bank ing examination resources to those orgastaff members who have skills appro- nizations that exhibit relatively highpriate for the organization's risk pro- risk profiles. Screening systems also file (the team leader is the central point assist in the planning of examinations of contact, has responsibility for only by identifying companies that are engagone LCBO, and is supported by spe- ing in new or complex activities. The cialists skilled in evaluating the risks Federal Reserve also has systems that of LCBO business activities and func- monitor market data, including equity tions), and (4) promoting Systemwide prices, debt spreads, agency ratings, and and interagency information-sharing measures of expected default frequency, through automated systems. to gauge market perceptions of the risk in banking organizations. Community Banks In addition to using automated screening systems, the Federal Reserve pre- The risk-focused supervision program pares quarterly Bank Holding Company for community banks emphasizes the Performance Reports (BHCPRs) for review of activities posing the greatest use in monitoring and inspecting superrisk to an organization and provides for vised banking organizations. The reports a tiered approach to the examination of are compiled from data provided by those activities. Examination procedures large bank holding companies in quarare tailored to the bank's characteristics, terly regulatory reports (FR Y-9C and keeping in mind its size, complexity, FR Y-9LP) and contain, for individual and risk profile. The examination entails bank holding companies, financial staboth off-site and on-site work, including tistics and comparisons with peer complanning, completing a pre-examination panies. BHCPRs are available to the visit, preparing a detailed scope-ofpublic via the Board's National Informaexamination memorandum, documenttion Center web site (www.ffiec.gov/nic). ing the work done, and preparing an During 2004 the web-based Perforexamination report tailored to the scope mance Report Information and Surveiland findings of the examination. The lance Monitoring (PRISM) application framework for risk-focused supervision received major upgrades. PRISM is a of community banks was developed querying tool used by Federal Reserve jointly with the Federal Deposit Insuranalysts to access and display financial, ance Corporation (FDIC) and has been surveillance, and examination data. In adopted by the Conference of State the analytical module, users can cus- Bank Supervisors. tomize the presentation of institutional financial data drawn from Call Reports, Uniform Bank Performance Reports, Surveillance and FR Y-9 statements, Bank Holding Com- Off-Site Monitoring pany Performance Reports, and other The Federal Reserve uses automated regulatory reports. In the surveillance screening systems that monitor super- module, users can generate reports sumvisory data and regulatory financial marizing the results of surveillance reports in order to analyze the financial screens for banks and bank holding condition and performance of state companies. The upgrades established member banks and bank holding compa- direct links between PRISM and other nies between on-site examinations and automated supervisory tools (the Bank- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 95 ing Organization National Desktop, or efforts to implement corrective measures BOND, and the National Examination or to test their adherence to safe and Database), expanded the number of sur- sound banking practices. Examinations veillance screens available from BOND, abroad are conducted with the cooperaand enhanced the range of regulatory tion of the supervisory authorities of the data available for querying. countries in which they take place; when The Federal Reserve works through appropriate, the examinations are coorthe Federal Financial Institutions dinated with the OCC. Examination Council (FFIEC) Task At the end of 2004, 56 member banks Force on Surveillance Systems to coor- were operating 763 branches in fordinate surveillance activities with the eign countries and overseas areas of the other federal banking agencies.6 United States; 32 national banks were operating 706 of these branches, and 24 International Activities state member banks were operating the remaining 57. In addition, 16 nonmem- The Federal Reserve supervises the for- ber banks were operating 17 branches in eign branches and overseas investments foreign countries and overseas areas of of member banks, Edge Act and agree- the United States. ment corporations, and bank holding companies and also the investments by bank holding companies in export Edge Act and Agreement Corporations trading companies. In addition, it super- Edge Act corporations are international vises the activities that foreign banking banking organizations chartered by the organizations conduct through entities Board to provide all segments of the in the United States, including branches, U.S. economy with a means of financagencies, representative offices, and ing international business, especially subsidiaries. exports. Agreement corporations are similar organizations, state chartered or Foreign Operations of federally chartered, that enter into an U.S. Banking Organizations agreement with the Board to refrain from exercising any power that is not The Federal Reserve examines the permissible for an Edge Act corporation. international operations of state mem- Sections 25 and 25A of the Federal ber banks, Edge Act and agreement cor- Reserve Act grant Edge Act and agreeporations, and bank holding companies ment corporations permission to engage generally at the U.S. head offices of in international banking and foreign these organizations, where the ultimate financial transactions. These corporaresponsibility for their foreign offices tions, most of which are subsidiaries lies. Examiners also visit the overseas of member banks, may (1) conduct a offices of U.S. banks to obtain financial deposit and loan business in states other and operating information and, in some than that of the parent, provided that instances, to evaluate the organizations' the business is strictly related to international transactions, and (2) make foreign 6. The member agencies of the FFIEC are the Board of Governors, the Federal Deposit Insur- investments that are broader than those ance Corporation, the National Credit Union made by member banks, as they may Administration, the Office of the Comptroller of invest in foreign financial organizations, the Currency, and the Office of Thrift Supervision. such as finance companies and leasing State supervisory authorities also participate in companies, as well as in foreign banks. some FFIEC initiatives. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

96 91st Annual Report, 2004 At year-end 2004, 79 banking orga- if the branch or agency meets certain nizations, operating 9 branches, were criteria. chartered as Edge Act or agreement cor- The Federal Reserve conducts a joint porations. These corporations are exam- program for supervising the U.S. operained annually. tions of foreign banking organizations in cooperation with the other federal banking agencies and state banking US. Activities of Foreign Banks agencies. The program has two main The Federal Reserve has broad authority parts. One part addresses the examinato supervise and regulate the U.S. activ- tion process for those foreign banking ities of foreign banks that engage in organizations that have multiple U.S. banking and related activities in the operations and is intended to ensure United States through branches, agen- coordination among the various U.S. cies, representative offices, commercial supervisory agencies. The other part is a lending companies, Edge Act corpora- review of the financial and operational tions, commercial banks, and certain profile of each organization to assess its nonbank companies. Foreign banks con- general ability to support its U.S. operatinue to be significant participants in the tions and to determine what risks, if any, U.S. banking system. the organization poses through its U.S. As of year-end 2004, 188 foreign operations. Together, these two probanks from 54 countries were operating cesses provide critical information to 228 state-licensed branches and agen- U.S. supervisors in a logical, uniform, cies (of which 8 were insured by the and timely manner. The Federal Reserve FDIC) as well as 51 branches licensed conducted or participated with state by the OCC (of which 5 had FDIC and federal regulatory authorities in insurance). These foreign banks also 256 examinations in 2004. directly owned 14 Edge Act and agreement corporations and 3 commercial Technical Assistance lending companies; in addition, they held an equity interest of at least 25 per- In 2004 the Federal Reserve System cent in 88 U.S. commercial banks. continued to provide technical assis- Altogether, the U.S. offices of these tance on bank supervisory matters to foreign banks at the end of 2004 con- foreign central banks and supervitrolled approximately 16 percent of U.S. sory authorities. Technical assistance commercial banking assets. These for- involves visits by System staff members eign banks also operated 68 repre- to foreign authorities as well as consentative offices; an additional 56 for- sultations with foreign supervisors who eign banks operated in the United States visit the Board or the Reserve Banks. solely through a representative office. Technical assistance in 2004 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 training courses exclusively for Reserve or by a state or other federal foreign supervisory authorities in Washregulator; in most cases, on-site exami- ington, D.C., and in a number of fornations are conducted at least once eign jurisdictions. System staff also took every twelve months, but the period part in technical assistance and training may be extended to eighteen months missions led by the International Mone- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 97 tary Fund, the World Bank, the Inter- The rule permits banking organizations American Development Bank, the Asian to continue to exclude from their risk- Development Bank, the Basel Commit- weighted asset base, for purposes of caltee on Banking Supervision, and the culating their risk-based capital ratios, Financial Stability Institute. ABCP program assets that are consolidated onto the balance sheets of sponsoring banking organizations as a result Supervisory Policy of Financial Accounting Standards Board Financial Interpretation No. 46, The Federal Reserve's supervisory pol- "Consolidation of Variable Interest icy function is responsible for develop- Entities" (FIN 46). Sponsoring banking guidance for examiners and banking ing organizations must continue to organizations as well as regulations for hold risk-based capital against all other banking organizations under the Federal risk exposures arising in connection Reserve's supervision. Staff members with ABCP programs, including direct participate in international supervisory credit substitutes, recourse obligations, forums and provide support for the work residual interests, long-term liquidity oftheFFIEC. facilities, and loans, in accordance with existing risk-based capital standards. In addition, any minority interests in Capital Adequacy Standards ABCP programs that are consolidated as a result of FIN 46 are to be excluded During 2004 the Federal Reserve, from the sponsoring banking organitogether with the OCC, the FDIC, and zation's minority interest component the OTS (collectively, the federal bankof tier 1 capital and, hence, from risking agencies), issued a final rule on capibased capital. The amended capital tal requirements for asset-backed comtreatment does not alter the accounting mercial paper programs. The agencies rules for balance sheet consolidation, also continued to consider possible nor does it affect the denominator of the revisions to their risk-based capital tier 1 leverage capital ratio calculation, adequacy regulations to reflect the new which continues to be based primarily Basel II framework and issued proposed on on-balance-sheet assets as reported guidance for internal-ratings-based sysunder generally accepted accounting tems that may be used to determine principles. Thus, as a result of FIN 46, capital for retail credit risk. In addition, banking organizations must include all the Federal Reserve requested public assets of consolidated ABCP programs comment on a proposed rule concerning in on-balance-sheet assets for purposes the treatment of trust preferred securiof calculating their tier 1 leverage capities in the tier 1 capital of bank holding tal ratio. companies. In addition, the rules impose a riskbased capital charge on liquidity facili- Asset-Backed ties having an original maturity of one Commercial Paper Programs year or less that organizations provide to In July the Federal Reserve and the ABCP programs by imposing a 10 perother federal banking agencies adopted cent credit conversion factor on such a final rule that amended the agencies' facilities. This treatment recognizes that risk-based capital rules for asset-backed such facilities expose banking organizacommercial paper (ABCP) programs. tions to credit risk and is consistent with Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

98 91st Annual Report, 2004 the industry's practice of internally allo- Basel II framework, see the box "Implecating economic capital against the risk menting the Basel II Framework in the associated with such facilities. A sepa- United States.") rate capital charge on liquidity facilities provided to an ABCP program is not Capital Treatment of required of banking organizations that Trust Preferred Securities consolidate the program for purposes of risk-based capital. In May the Federal Reserve Board proposed to allow the continued inclusion of outstanding and prospective issuances Risk-Based Capital Standards of trust preferred securities in the tier 1 for Certain Internationally Active capital of bank holding companies while Banking Organizations imposing stricter quantitative limits and In August 2003 the Federal Reserve, clarifying qualitative standards for capitogether with the other federal banking tal instruments included in regulatory agencies, issued for public comment an capital. The stricter quantitative limits advance notice of proposed rulemaking would apply to the aggregate amount and draft supervisory guidance setting of trust preferred securities, cumulative forth the agencies' views on implement- perpetual preferred stock, and minority ing the Basel II framework in the United interests in the equity accounts of cer- States. The proposed plan would allow tain consolidated subsidiaries (collecbanking organizations that meet spe- tively, restricted core capital elements) cific criteria to use their own estimates included in bank holding company tier 1 of certain risk parameters as key inputs capital. The proposed rule would make in determining their regulatory capital explicit a general expectation that interrequirements. nationally active bank holding compa- Over the course of 2004, working nies would limit the amount of restricted both independently and with the mem- core capital elements to 15 percent of ber countries of the Basel Committee on the sum of core capital elements, includ- Banking Supervision, the federal bank- ing restricted core capital elements, net ing agencies continued to modify the of goodwill less any associated deferred methodologies in the Basel II frame- tax liability, consistent with a 1998 work. In October the agencies issued Basel agreement. Other bank holding proposed guidance on internal-ratings- companies would be subject to a 25 perbased systems that may be used to deter- cent limit on the amount of restricted mine regulatory capital for retail credit core capital elements. The proposal prorisk under the Basel II framework. The vides for a three-year transition period proposed guidance describes the agen- for compliance with the stricter quantitacies' views on the components and tive limits. characteristics of a qualifying internal- These revisions were proposed to ratings-based system for measuring address supervisory concerns, competithe credit risk associated with retail tive equity considerations, and changes exposures, including residential mort- in generally accepted accounting pringages, consumer credit cards, automo- ciples. They would have the effect of bile loans, personal loans, and some strengthening the definition of regulasmall business loans. The comment tory capital for bank holding compaperiod was scheduled to end in January nies. A final rule is to be issued in early 2005. (For more information on the 2005. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 99 Bank-Owned Life Insurance assessment of the subsidiary depository institution(s), as had been the case for In December 2004, the Federal Reserve the bank rating under the previous ratand the other federal banking agencies ing system, BOPEC (Bank subsidiaries, issued guidance on the safety-and- Other subsidiaries, Parent, Earnings, soundness and risk-management impli- Capital). cations of purchases and holdings of To provide a consistent framework life insurance by banks and savings for assessing risk management, the riskassociations. The guidance addresses management component of the new ratthe unique characteristics of banking system is supported by four subcomowned life insurance (BOLI) as well as ponents that reflect the effectiveness of the need for a comprehensive pre- and the banking organization's risk manpost-purchase analysis of the risks and agement and controls: board and senior rewards of BOLL management oversight; policies, procedures, and limits; risk monitoring and management information systems; Bank Holding Company and internal controls. The financial- Rating System condition component is similarly sup- To more closely align the supervisory ported by four subcomponents that rating system for bank holding compa- reflect an assessment of the quality nies with its supervisory practices, the of the banking organization's capital, Federal Reserve in December 2004 assets, earnings, and liquidity. A simpliadopted a revised bank holding com- fied version of the rating system that pany rating system, effective January 1, requires only the assignment of the risk- 2005. The increased complexity of the management component rating and U.S. banking industry has necessitated composite rating (C) will be applied to a shift over time in the focus of the noncomplex bank holding companies Federal Reserve's supervisory practices having assets of less than $1 billion. for bank holding companies away from historical analyses of financial condition Bank Secrecy Act and toward more-forward-looking assess- Anti-Money Laundering ments of risk management and financial factors. Under the revised rating system, The Federal Reserve in 2004 issued a each bank holding company is assigned number of supervisory letters to domesa composite rating based on an eval- tic and foreign banking organizations on uation and rating of its managerial and such topics as examination procedures financial condition and an assessment for customer identification programs of future potential risk to its subsidiary and the imposition of "special meadepository institution(s). The three main sures" by the Department of the Treacomponents of the new RFI/C (D) rating sury on certain jurisdictions and forsystem are Risk management, Financial eign financial institutions suspected of condition, and potential Impact of the being of "primary money laundering parent company and nondepository sub- concern." sidiaries (collectively, nondepository The Federal Reserve is actively workentities) on the subsidiary depository ing with the other federal and state institution(s). The rating of a fourth banking agencies to develop intercomponent, Depository institution, will agency Bank Secrecy Act/anti-moneygenerally mirror the primary regulator's laundering examination procedures to be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

100 91st Annual Report, 2004 Implementing the Basel II Framework in the United States We are embarking on an effort to achieve considerably more precision in correlating the riskiness of an institution's activities and its regulatory capital. Roger Ferguson, Vice Chairman, Board of Governors November 2004 Preparation continued during 2004 for Scope of Application in the United States implementation in the United States of a Final rules for application of the Basel II new international agreement on capital adequacy for banking organizations.1 The new framework in the United States are still being developed- It is expected that only agreement, familiarly known as Basel fi, a small number of large, internationally sets forth a framework for ensuring that active U.S. banking organizations will be banks hold adequate capital against risk subject to the new framework. Those and builds on the initial international capiinstitutions would be required to use the tal agreement adopted in 1988. most advanced options of the framework The original Basel Capital Accord, for determining their risk-based capital though widely considered to have achieved requirements (the advanced internalits principal objectives of promoting finanratings-based approach, or A-IRB, for cial stability and providing an equitable credit risk and the advanced measurement basis for competition among internationapproaches, or AMA, for operational risk). ally active banks, has in recent years been Other U.S. banking organizations would viewed as too simple to address the activinot be required to adopt Basel II but could ties of today's large, complex banking opt to do so, provided they could demonorganizations. Basel II creates a stronger strate the ability to develop the risk meaframework for these organizations through sures required as inputs to determine capiminimum capital requirements that are tal requirements. Those banks not adopting more sensitive to each organization's risk Basel II would continue to operate under profile and that reinforce incentives for strong risk management.2 existing capital rules. The Basel II framework contains provisions addressing credit risk (the risk of loss Implementation Plan and Timetable due to failure of a counterparty to meet its obligations) and operational risk (the The U.S. banking and thrift agencies have risk of loss resulting from inadequate or been coordinating their efforts to implefailed internal processes, people, or systems or from external events).3 It relies on the Basel Committee on Banking Supervision, three pillars—minimum capital require- which is made up of representatives of the cenments, supervisory review, and market tral banks or other supervisory authorities of the discipline—and is the basis on which G-10 countries plus Luxembourg and has its revisions to existing US. capital ade- secretariat at the Bank for International Settlements in Basel, Switzerland. See www.bis.org/ quacy regulations and standards are being publ/bcbslO7.htm. developed. 2. See "Capital Standards for Banks: The Evolving Basel Accord," Federal Reserve Bulle- 1. The final agreement, titled "International tin, vol. 89 (September 2003), pp. 395-405 Convergence of Capital Measurement and (www.federalreserve.gov/pubs/bulletin/default.htm). Capital Standards: A Revised Framework" and 3. Basel I was updated in 1996 to account for published in June 2004, was developed by market risk. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 101 rnent Basel II. The new rules are expected capital requirements is seen as among the to take effect on January 1, 2008; before most significant steps institutions can take then, institutions subject to the new rules in advance of the issuance of final rules will be required to conduct a year of paral- and associated guidance. The qualification lel calculations—that is, to simultaneously process will be iterative. The plans will calculate capital requirements according to serve as instruments of communication the Basel II-based rules and the current between institutions and their supervisors rules. Both supervisors and bankers have in their home country and other jurismuch to accomplish before the target 2008 dictions. They are expected to include a date, including the writing of final rules self-assessment by the institution, a gap and guidance by the agencies and the analysis (based on the self-assessment) development and execution of an accept- identifying areas needing additional work, able, detailed written plan for implementa- an action plan for addressing shortcomtion by each adopting institution. ings, objectively measurable milestones, and an assessment of resources needed. Revision of Regulations Issuance of Supervisory Guidance Comments on an advance notice of proposed rulemakmg issued in August 2003 During 2005 the agencies will continue to that set forth possible revisions to the capi- develop supervisory guidance concerning tal adequacy regulations are currently being the various portfolios and risk exposures reviewed. Importantly, all U.S. banking addressed by Basel II; draft supervisory organizations would continue to be sub- guidance on corporate and retail credit risk ject to leverage ratio requirements and to and operational risk has already been pubprompt corrective action regulations, which lished. The guidance will set forth superclosely link enforcement actions to banks' visory expectations for banking organizacapital levels. tions adopting the Basel II-based rules, for The agencies expect that a notice of pro- example, the components and characterisposed rulemaking on possible revisions tics of an acceptable risk-measurement and to the regulations will be published in risk-management infrastructure. mid-2005. Final rules are expected in the second quarter of 2006. The agencies are Completion of Quantitative Studies also considering possible changes to riskbased capital regulations for U.S. institu- In 2004 the agencies began a fourth Quantions not subject to the Basel Il-based reg- titative Impact Study (QIS-4) to evaluate ulations; these changes are expected to the potential effects of U.S. implementabecome effective at the same time as the tion of the Basel II framework and a "loss Basel II -based regulations. data collection exercise" (LDCE) focused on operational risk. About thirty banking organizations are participating in QIS-4; Qualification for Using about twenty are participating in the Advanced Approaches LDCE. These studies are intended to help The agencies have issued guidance setting banking organizations and their supervisors forth their ideas about the qualification pro- better understand the implications of the cess for Basel II in the United States. The Basel II framework for regulatory capital development of a detailed written plan and may provide some insight on implifor implementing the A-IRB and AMA cations of the new approaches for competiapproaches for determining risk-based tion within the banking industry. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

102 91st Annual Report, 2004 released in 2005. The Department of the supervisory policies for internation- Treasury's Financial Crimes Enforce- ally active banking organizations and ment Network (FinCEN) has partici- to improve the stability of the internapated in this initiative. tional banking system. The efforts are To support this work and to pro- described in the following sections. vide a forum for the federal banking agencies to discuss matters related Capital Adequacy to Bank Secrecy Act/anti-money- During 2004 the Federal Reserve conlaundering examination and training, a tinued to participate in a number of tech- Bank Secrecy Act Working Group was nical working groups of the Basel Comformed in 2004 under the FFIEC. The mittee in efforts to develop the revised working group, which also includes Basel framework (familiarly referred FinCEN and state bank regulators, to as Basel II), which was published complements other interagency and in June, and to address issues not fully international efforts, such as the Bank resolved in that framework. In particu- Fraud Working Group, the Financial lar, the Federal Reserve participated in Action Task Force, and various supera joint Basel Committee-International visors committees within the Basel Organization of Securities Commissions Committee on Banking Supervision. (IOSCO) working group on the trading The Federal Reserve participates in book to review issues related to counteranother such group, the BSA Advisory party credit risk, double default effects Group, which was established by statute (reflecting the low probability that both to seek ways to reduce unnecessary bura borrower and its guarantor will default den created by the BSA and to increase at the same time), and the definition of the utility of data gathered under the act the trading book. to aid regulators and law enforcement. In addition, through this group, the Fed- Risk Management eral Reserve assists the Treasury Department in providing feedback to financial The Federal Reserve contributed to institutions on the reporting of suspi- several supervisory policy papers, cious activity. Finally, staff of the Divi- reports, and recommendations issued sion of Banking Supervision and Regu- by the Basel Committee during 2004 lation engage in outreach to the financial that were generally aimed at improvservices industry by, for example, speak- ing the supervision of banking organizaing at banking conferences to promote tions' risk-management practices. best practices to combat money laundering and terrorist financing. • "Consolidated Know-Your-Customer Risk Management," issued in October, provides guidance to help interna- International Guidance on tional banking organizations establish Supervisory Policies centralized processes for sharing As a member of the Basel Committee information and for coordinating and on Banking Supervision, the Federal promulgating customer due diligence Reserve in 2004 participated in efforts policies and procedures on a consolito revise the international capital regime dated basis. The guidance, which and to develop international supervisory builds on Basel Committee publicaguidance. The Federal Reserve's goals tions issued in 2001 and 2003, also in these activities are to advance sound encourages government jurisdictions Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 103 to facilitate consolidated customer due • "Principles for the Home-Host Recdiligence risk management by provid- ognition of AMA Operational Risk ing a legal framework that allows Capital," issued in January, addresses overseas subsidiaries and affiliates of industry concerns about practical banking organizations to share infor- impediments to the cross-border mation with their head offices or par- implementation of the advanced meaent banks. surement approaches for operational risk, an element of the Basel II "Principles for the Management and framework. Supervision of Interest Rate Risk," issued in July, describes the pillar 2 Joint Forum (supervisory review) approach to calculating interest rate risk under In its work with the Basel Committee, Basel II. The paper reflects comments the Federal Reserve also continued its received on a September 2003 consul- participation in the Joint Forum—a tative paper. group made up of representatives of the committee, IOSCO, and the Interna- "Implementation of Basel II: Practi- tional Association of Insurance Supervical Considerations," issued in July, sors. The Joint Forum works to increase discusses the costs and benefits of mutual understanding of issues related Basel II implementation from the to the supervision of firms operating point of view of non-GlO countries, in each of the financial sectors. The focusing in particular on potential Joint Forum issued three publications in changes to the legal and regulatory 2004: framework and on resource and training requirements. • "Credit Risk Transfer," issued in October, reviews the rapid growth in In January the Basel Committee credit risk transfer products, such as issued changes to the internal-ratings- single-name credit default swaps and based approach to securitization expo- collateralized debt obligations, and sures under Basel II, in response to concludes that these markets have industry concerns related to the com- provided banking organizations with plexity of the proposal and the opera- significantly more liquid and efficient tional burdens of implementation. methods of trading and diversifying their credit risks. The report notes that 1 In January the Basel Committee although these products do not raise announced its decision to base the immediate and significant financial Basel II framework on unexpected stability concerns, financial organizalosses rather than a combination of tions should adopt appropriate riskunexpected and expected losses, in management practices when conductresponse to industry requests and ing business in these products. comments. However, under the framework, banks would be required to • "Outsourcing in Financial Services," compare provisions with expected issued in August, discusses the key losses and to deduct any deficiency issues and risks associated with finanfrom capital. Excess provisions would cial firms' outsourcing of significant be eligible for inclusion in tier 2 capi- parts of their regulated and unregutal, subject to a cap. lated activities to third parties and sets Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

104 91st Annual Report, 2004 forth principles to help firms mitigate The Federal Reserve and the Basel these risks. Committee also worked with other international regulatory organizations, such • "Financial Disclosure in the Banking, as IOSCO, the International Association Insurance and Securities Sectors: of Insurance Supervisors, the World Issues and Analysis," issued in May, Bank, and the Financial Stability Forum, outlines the findings of a working as part of an organization called the group established to follow up on Monitoring Group, to promote stronger recommendations contained in a 1999 international audit standards and pracreport that provided advice to super- tices. This effort led to the adoption by visors on enhancing financial institu- the International Federation of Accountions' public disclosures of their finan- tants (IFAC) of comprehensive reforms cial risks. that will result in greater public oversight of IFAC's audit-standard-setting activities. International Accounting and Disclosure The Federal Reserve participates in the Sarbanes-Oxley Act Basel Committee's Accounting Task Force and represents the Basel Commit- During 2004 the Federal Reserve contee at international meetings on account- tinued to evaluate the effects of the ing, auditing, and disclosure issues Sarbanes-Oxley Act on banking organiaffecting global banking organizations. zations. The effort involved the Federal In particular, officials of the Federal Reserve's working closely with banking Reserve represent the Basel Committee organizations and their external audiat meetings that address financial instru- tors to better understand the challenges ments accounting and disclosure issues they are encountering in complying with associated with international accounting the sections of the act that relate to standards. In addition, an official of the internal controls. It also involved dia- Federal Reserve is a member of the logue with the SEC and the Public Standards Advisory Council of the Inter- Company Accounting Oversight Board national Accounting Standards Board (PCAOB) on various interpretative (IASB). issues related to these matters. During 2004 the Federal Reserve had In addition, an official of the Federal a key role in development of the Basel Reserve serves on the Standing Advi- Committee's comments on the IASB's sory Group of the PCAOB, which is proposed amendment to the guidance in advising the PCAOB as it develops stan- International Accounting Standard 39 on dards for the external audits of publicly the optional use of fair value accounting traded companies in the United States. for financial instruments. In addition, The Federal Reserve also continued in the Federal Reserve strongly supported 2004 to work with the FDIC and other the Basel Committee's efforts to develop banking agencies to consider changes guidance on improving disclosure for that should be made to the regulations the purpose of enhancing market dis- implementing the Federal Deposit cipline. This support contributed to Insurance Corporation Improvement Act the finalization of pillar 3 guidance on to promote strong internal controls improved disclosures in support of and consistency with the Sarbanes- Basel E. Oxley Act requirements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 105 Efforts to Enhance Transparency holding companies and their nonbank subsidiaries. As part of ongoing efforts to promote The FR Y-9 series of reports provides sound accounting and disclosure prac- standardized financial statements for tices by banking organizations, the Fed- bank holding companies on a consolieral Reserve, together with the other dated and parent-only basis. The reports banking agencies, in February issued are used to detect emerging financial guidance on the appropriate accounting problems, review performance and contreatment for obligations under certain duct pre-inspection analysis, monitor types of deferred compensation agree- and evaluate risk profiles and capital ments (see SR Letter 04-4). In March adequacy, evaluate proposals for bank the Federal Reserve and the other bankholding company mergers and acquisiing agencies issued guidance identifying tions, and analyze the holding compacurrent sources of generally accepted ny's overall financial condition. The accounting principles (GAAP) and nonbank subsidiary reports—FR Y-ll, supervisory guidance that should be FR 2314, and FR Y-7N—aid the Fedused by banking organizations in detereral Reserve in determining the condimining their allowance for loan and tion of bank holding companies that are lease losses (see SR Letter 04-5). The engaged in nonbanking activities and in Federal Reserve also worked with formonitoring the volume, nature, and coneign supervisors in developing pillar 3 dition of their nonbanking subsidiaries. of the Basel II framework, which aims The FR Y-8 report collects information to enhance banking organizations' pubon transactions between an insured lic disclosure of their risk exposures, depository institution and its affiliate capital, and capital adequacy. that are subject to section 23A of the In October the Federal Reserve sub- Federal Reserve Act; it enhances the mitted a comment letter to the Financial Federal Reserve's ability to monitor Accounting Standards Board (FASB) on bank exposures to affiliates and to its "Fair Value Measurements Exposure ensure compliance with section 23A of Draft." In addition, Federal Reserve the act. staff provided comments to FASB on an In March 2004, several revisions to accounting interpretation that addressed the FR Y-9C report were implemented impairment of securities. for the purpose of collecting preliminary data from selected large bank holding companies on a voluntary basis, improv- Bank Holding Company ing the reporting of trust preferred secu- Regulatory Financial Reports rities, and collecting from some of the largest bank holding companies the The Federal Reserve requires that U.S. addresses of their web pages displaybank holding companies periodically ing risk disclosures. In September and submit reports providing financial and December the electronic filing process structure information. This information for the FR Y-9 series of reports was is essential to the supervision of the enhanced to require respondents to perorganizations and the formulation of form data validation checks prior to regulations and supervisory policies. filing. The information is also used in respond- In May revisions were made to ing to requests from Congress and clarify the language in the reporting the public for information on bank forms and instructions for three Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

106 91st Annual Report, 2004 reports—the Annual Report of Bank ments to the data collection and disclo- Holding Companies (FR Y-6), the sure process include requiring electronic Report of Changes in Organizational submission of Call Reports to a central Structure (FR Y-10), and the Report data repository, moving forward the of Changes in FBO Organizational deadline for filing reports, and requiring Structure for foreign banking organiza- respondents to validate their data before tions (FRY-10F). filing. The effort to set up a central data In June the FR Y-8 was revised to repository is currently in the testing allow for collection of additional infor- phase, and the repository is expected to mation to be used in monitoring compli- be operational in 2005. ance with section 23A of the Federal No significant changes were made to Reserve Act and to assist in monitoring the Call Report in 2004. A proposal was derivatives transactions and establishing issued in April to make two instrucpolicy for regulating such transactions. tional clarifications to the report. The report was also revised to reflect Also in 2004, the Report of Assets interpretations and definitions in Regu- and Liabilities of U.S. Branches and lation W, the rule that comprehensively Agencies of Foreign Banks (FFIEC 002) implements sections 23 A and 23B of the was revised, effective in March, to act. include additional information on derivatives contracts. A proposal was issued in August to revise the Country Commercial Bank Exposure Report (FFIEC 009) and the Regulatory Financial Reports Country Exposure Information Report As the federal supervisor of state mem- (FFIEC 009a) to harmonize U.S. data ber banks, the Federal Reserve, acting in with data on cross-border exposures colconcert with the other federal banking lected by other countries. agencies through the FFIEC, requires banks to submit quarterly Reports of Federal Financial Institutions Condition and Income (Call Reports). Examination Council Call Reports are the primary source of data for the supervision and regulation During 2004 the Federal Financial Instiof banks and for the ongoing assessment tutions Examination Council focused on of the overall soundness of the nation's coordinating the agencies' efforts in the banking system. Call Report data, which area of Bank Secrecy Act examination also serve as benchmarks for the finan- and training by enhancing communicacial information required by many other tion and cooperation with FinCEN, an Federal Reserve regulatory financial agency within the Treasury Department reports, are widely used by state and whose mission is to safeguard the finanlocal governments, state banking super- cial system from terrorist financing, visors, the banking industry, securities money laundering, and other financial analysts, and the academic community. crimes. It also continued its efforts to The Federal Reserve and the other identify and eliminate outdated, unnecbanking agencies have begun a Call essary, or unduly burdensome regula- Report modernization project to tions, pursuant to the Economic Growth improve the timeliness and quality of and Regulatory Paperwork Reduction supervisory data and to enhance market Act of 1996. The FFIEC made signifidiscipline by ensuring more timely cant progress on a project to modernaccess by the public. Proposed enhance- ize and streamline the way in which Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 107 the banking agencies collect, process, Banks, as well as through a Systemwide and distribute quarterly bank financial committee structure, to ensure that key reports. In addition, the FFIEC contin- staff members throughout the System ued its efforts related to examiner train- participate in identifying requirements ing and education, consumer compli- and setting priorities for IT initiatives. ance issues, bank surveillance processes, and information-sharing. SIT Project Management In 2004 the SIT project management Supervisory Information staff, in partnership with other Federal Technology Reserve System staff, developed a stra- Under the direction of the division's tegic plan for 2005-09 that identifies chief technology officer, the supervisory opportunities for enhancing business information technology (SIT) function value through the use of information within the Division of Banking Super- technology. Another major activity was vision and Regulation facilitates the development of a program to ensure management of information technology compliance with the Federal Informawithin the Federal Reserve System's tion Security Management Act. In addisupervision function. Its goals are to tion, staff members supported modernensure that ization of the Shared National Credit program as well as assessments of • IT initiatives support a broad range of opportunities in the areas of electronic supervisory activities without duplica- applications, administrative systems, tion or overlap; and learning management systems to improve information technology ser- • the underlying IT architecture fully vices in conjunction with efforts of supports those initiatives; Board and Reserve Bank internal IT providers. • adequate resources are devoted to interagency working groups on super- National Information Center visory initiatives (for example, Call Report modernization and the federal The National Information Center (NIC) bridge investigation initiatives); is the Federal Reserve's comprehensive repository for supervisory, financial, and • the supervision function's use of tech- banking structure data and documents. nology leverages the resources and NIC includes the structure data sysexpertise available more broadly tem; the National Examination Database within the Federal Reserve System; (NED), which provides supervisory and personnel and state banking authorities with access to NIC data; and the Cen- • practices that maximize the supervi- tral Document and Text Repository sion function's business value, cost (CDTR), which contains documents effectiveness, and quality are iden- supporting the supervisory process. tified, analyzed, and approved for In 2004 the structure data system was implementation. modified to adhere to the industry standards for use of NAICS (North Ameri- SIT works through assigned staff at the can Industry Classification System) Board of Governors and the Reserve business activity codes. Changes were Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

108 91st Annual Report, 2004 made to NED to accommodate the new effort that aims to reduce examination bank holding company supervisory rat- costs and improve the timeliness and ing system and to provide user inter- reliability of data associated with the operability with PRISM and the CDTR. review of large, syndicated credit facili- The CDTR was expanded to contain ties of commercial banks. At year-end examination reports for regional and 2004, BOND had 2,850 registered users community banking organizations pre- across the Federal Reserve System, the pared by Reserve Banks. Significant OCC, the FDIC, and ten state banking resources continue to be devoted to Call departments. Report modernization for the FFIEC Central Data Repository initiative, with implementation expected in 2005. Staff Development The Federal Reserve System's staff Banking Organization development program trains staff mem- National Desktop bers at the Board, the Reserve Banks, Supervision of domestic banking orga- and state banking departments who have nizations and the U.S. operations of supervisory and regulatory responsiforeign banking organizations is sup- bilities as well as students from forported by an automated application— eign supervisory authorities. Training the Banking Organization National is offered at the basic, intermediate, and Desktop (BOND)—that facilitates advanced levels in several disciplines secure, real-time electronic information- within bank supervision: safety and sharing and collaboration among federal soundness, information technology, and state banking regulators. During international banking, and consumer 2004 BOND was enhanced to improve affairs. Classes are conducted in Washits usability, reduce administrative bur- ington, D.C., as well as at Reserve den, increase the effectiveness of man- Banks and other locations. agement reporting, and facilitate the The Federal Reserve System also sharing of information related to Basel II participates in training offered by the and the tracking of parallel-owned banks FFIEC and by certain other regulatory or bank holding companies (that is, agencies. The System's involvement organizations in the United States and includes developing and implementing another country that have the same con- basic and advanced training in relation trolling shareholder). Other enhance- to various emerging issues as well as ments included financial holding com- in specialized areas such as internapany compliance monitoring, improved tional banking, information technology, data quality edits, the addition of appli- municipal securities dealing, capital cations data, and changes to accommo- markets, payment systems risk, white date the new RFI/C (D) rating scheme collar crime, and real estate lending. In for bank holding companies (see the addition, the System co-hosts the World section "Bank Holding Company Rat- Bank Seminar for students from develing System"). BOND has been updated oping countries. to include seamless links to the Federal In 2004 the Federal Reserve trained Reserve's Applications Management 2,365 students in System schools, 721 in and Processing System and to a new schools sponsored by the FFIEC, and 20 system for accessing data on the Shared in other schools, for a total of 3,106, National Credit program, an interagency including 293 representatives of foreign Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 109 Training Programs for Banking Supervision and Regulation, 2004 Number of sessions conducted Program Total Regional Schools or seminars conducted by the Federal Reserve Core schools Banking and supervision elements 7 Operations and analysis 5 43 Bank management 1 2 Report writing 12 12 Management skills 9 8 Conducting meetings with management 13 13 Other schools Credit risk analysis Examination management Real estate lending seminar Senior forum for current banking and regulatory issues Basel II corporate activities Basel II retail activities Principles of fiduciary supervision Commercial lending essentials for consumer affairs Consumer compliance examinations I Consumer compliance examinations II CRA examination techniques CRA risk-focused examinations Fair lending examination techniques Foreign banking organizations Information systems continuing education Capital markets seminars Technology risk integration Leadership dynamics Internal bank ratings and credit risk modeling Seminar for senior supervisors of foreign central banksv and seven other international courses Other agencies conducting courses2 Federal Financial Institutions Examination Council 65 The Options Institute 2 1. Conducted jointly with the World Bank. 2. Open to Federal Reserve employees. central banks (see table). The number of examination in one of three specialty training days in 2004 totaled 17,738. areas: safety and soundness, consumer The System gave scholarship assis- affairs, or information technology. In tance to the states for training their 2004, 135 examiners passed the first examiners in Federal Reserve and proficiency examination. In the second FFIEC schools. Through this program, proficiency examination, 87 examiners 410 state examiners were trained—242 passed the safety and soundness examiin Federal Reserve courses, 158 in nation, 29 passed the consumer affairs FFIEC programs, and 10 in other examination, and 6 passed the informacourses. tion technology examination. The over- A staff member seeking an examin- all pass rate for these examinations was er's commission is required to take a 79 percent. At the end of 2004, the first proficiency examination, which System had 1,223 field examiners, of tests knowledge of a core body of infor- which 950 were commissioned (see mation, and also a second proficiency table). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

110 91st Annual Report, 2004 Year-End Reserve Bank SupervisionLevels, 2000-2004 Type of staff 2004 2003 2002 2001 2000 Field examination staff 1,223 1,239 1,234 1,242 1,172 Commissioned field staff 950 936 892 861 786 Regulation of the considers the financial and managerial U.S. Banking Structure resources of the applicant, the future prospects of both the applicant and the The Federal Reserve administers sevfirm to be acquired, the convenience and eral federal statutes in relation to bank needs of the community to be served, holding companies, financial holding the potential public benefits, the comcompanies, member banks, and foreign petitive effects of the proposal, and the banking organizations—the Bank Holdapplicant's ability to make available to ing Company Act, the Bank Merger Act, the Federal Reserve information deemed the Change in Bank Control Act, and necessary to ensure compliance with the International Banking Act. In adminapplicable law. In the case of a foreign istering these statutes, the Federal banking organization seeking to acquire Reserve acts on a variety of proposals control of a U.S. bank, the Federal that would directly or indirectly affect Reserve also considers whether the forthe structure of U.S. banking at the local, eign bank is subject to comprehensive regional, and national levels; the intersupervision or regulation on a consolinational operations of domestic banking dated basis by its home country superviorganizations; and the U.S. banking sor. Data on decisions regarding domesoperations of foreign banks. tic and international applications in 2004 are shown in the accompanying table. Bank holding companies generally Bank Holding Company Act may engage in only those activities that Under the Bank Holding Company Act, the Board has previously determined a corporation or similar organization to be closely related to banking under must obtain the Federal Reserve's section 4(c)(8) of the Bank Holding approval before forming a bank holding Company Act. Since 1996, the act has company through the acquisition of one provided an expedited prior-notice proor more banks in the United States. cedure for certain permissible nonbank Once formed, a bank holding company activities and for acquisitions of small must receive Federal Reserve approval banks and nonbank entities. Since that before acquiring or establishing addi- time the act has also permitted well-run tional banks. The act also identifies bank holding companies that satisfy ceractivities permissible for bank holding tain criteria to commence certain other companies; depending on the circum- nonbank activities on a de novo basis stances, these activities may or may not without first obtaining Federal Reserve require Federal Reserve approval in approval. advance of their commencement. Since 2000, the Bank Holding Com- When reviewing a bank holding com- pany Act has permitted the creation pany application or notice that requires of a special type of bank holding comprior approval, the Federal Reserve pany called a financial holding com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 111 Decisions by the Federal Reserve on Domestic and International Applications, 2004 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 9 0 0 0 0 0 135 43 187 Merger of bank holding company 14 0 10 0 3 27 25 70 Acquisition or retention of bank 16 0 1 0 0 11 114 26 168 Acquisition of nonbank 0 0 31 0 0 5 0 108 144 Merger of bank 40 0 00 9 67 0 80 Change in control Establishment of a 0 0 1 0 0 0 0 124 125 branch, agency, or representative office by a foreign bank 10 0 80 0 0 09 Other 134 0 0 85 0 98 941 507 1,765 Total 178 0 34 93 0 126 1,284 833 2,548 pany. Financial holding companies are agency. If the institution surviving the allowed to engage in a broader range of merger is a state member bank, the Fednonbank activities than are traditional eral Reserve has primary jurisdiction. bank holding companies. Among other Before acting on a merger proposal, the things, they may affiliate with securi- Federal Reserve considers the financial ties firms and insurance companies and and managerial resources of the appliengage in certain merchant banking cant, the future prospects of the existing activities. Bank holding companies and combined organizations, the conseeking financial holding company sta- venience and needs of the community tus must file a written declaration with to be served, and the competitive effects the Federal Reserve. In 2004, 47 domes- of the proposed merger. It also considtic financial holding company declara- ers the views of certain other agentions and 5 foreign bank declarations cies regarding the competitive factors were approved. involved in the transaction. In 2004 the Federal Reserve approved 80 merger applications. Bank Merger Act When the FDIC, the OCC, or the The Bank Merger Act requires that OTS has jurisdiction over a merger, the all proposals involving the merger of Federal Reserve is asked to comment insured depository institutions be acted on the competitive factors related to the on by the appropriate federal banking proposal. By using standard terminol- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

112 91st Annual Report, 2004 ogy in assessing competitive factors agencies, commercial lending company in merger proposals, the four agencies subsidiaries, or representative offices in have sought to ensure consistency in the United States. administering the Bank Merger Act. The In reviewing proposals, the Federal Federal Reserve submitted 534 reports Reserve generally considers whether on competitive factors to the other agen- the foreign bank is subject to comprecies in 2004. hensive supervision or regulation on a consolidated basis by its home country supervisor. It also considers whether the Change in Bank Control Act home country supervisor has consented to the establishment of the U.S. office; The Change in Bank Control Act the financial condition and resources of requires persons seeking control of a the foreign bank and its existing U.S. U.S. bank or bank holding company to operations; the managerial resources obtain approval from the appropriate of the foreign bank; whether the home federal banking agency before completcountry supervisor shares information ing the transaction. The Federal Reserve regarding the operations of the foreign is responsible for reviewing changes in bank with other supervisory authorities; the control of state member banks and whether the foreign bank has provided bank holding companies. In its review, adequate assurances that information the Federal Reserve considers the financoncerning its operations and activities cial position, competence, experience, will be made available to the Federal and integrity of the acquiring person; Reserve, if deemed necessary to deterthe effect of the proposed change on the mine and enforce compliance with financial condition of the bank or bank applicable law; whether the foreign bank holding company being acquired; the has adopted and implemented proceeffect of the proposed change on compedures to combat money laundering and tition in any relevant market; the comwhether the home country of the foreign pleteness of the information submitted bank is developing a legal regime to by the acquiring person; and whether address money laundering or is particithe proposed change would have an pating in multilateral efforts to combat adverse effect on the federal deposit money laundering; and the record of the insurance funds. As part of the process, foreign bank with respect to compliance the Federal Reserve may contact other with U.S. law. regulatory or law enforcement agen- In 2004 the Federal Reserve approved cies for information about relevant 9 applications by foreign banks to estabindividuals. lish branches, agencies, and representa- In 2004 the Federal Reserve approved tive offices in the United States. 125 changes in control of state member banks and bank holding companies. Overseas Investments by U.S. Banking Organizations International Banking Act U.S. banking organizations may engage The International Banking Act, as in a broad range of activities overseas. amended by the Foreign Bank Supervi- Many of the activities are conducted sion Enhancement Act of 1991, requires indirectly through Edge Act and agreeforeign banks to obtain Federal Reserve ment corporation subsidiaries. Although approval before establishing branches, most foreign investments are made Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 113 under general consent procedures that Stock Repurchases by involve only after-the-fact notification Bank Holding Companies to the Federal Reserve, large and other significant investments require prior A bank holding company may repurapproval. In 2004 the Federal Reserve chase its own shares from its shareapproved 27 proposals for significant holders. When the company borrows overseas investments by U.S. banking money to buy the shares, the transorganizations. The Federal Reserve also action increases the company's debt approved 14 applications to make addi- and decreases its equity. The Federal tional investments through an Edge Act Reserve may object to stock repurchases or agreement corporation, 5 applications by holding companies that fail to meet to extend the corporate existence of certain standards, including the Board's or acquire an Edge Act corporation, and capital adequacy guidelines. In 2004 4 applications to establish or acquire an the Federal Reserve reviewed 16 stock agreement corporation. repurchase proposals by bank holding companies; all were approved by a Reserve Bank under delegated authority. Applications by Member Banks Public Notice of State member banks must obtain Fed- Federal Reserve Decisions eral Reserve approval to establish domestic branches, and all member Certain decisions by the Federal Reserve banks (including national banks) must that involve a bank holding company, a obtain Federal Reserve approval to bank merger, a change in control, or the establish foreign branches. When establishment of a new U.S. banking reviewing proposals to establish domes- presence by a foreign bank are made tic branches, the Federal Reserve con- known to the public by an order or an siders the scope and nature of the announcement. Orders state the decision, banking activities to be conducted. the essential facts of the application or When reviewing proposals for foreign notice, and the basis for the decision; branches, the Federal Reserve consid- announcements state only the decision. ers, among other things, the condition of All orders and announcements are made the bank and the bank's experience in public immediately; they are subseinternational banking. In 2004 the Fed- quently reported in the Board's weekly eral Reserve acted on new and merger- H.2 statistical release and in the Federal related branch proposals for 1,428 Reserve Bulletin. The H.2 release also domestic branches and granted prior contains announcements of applications approval for the establishment of and notices received by the Federal 34 new foreign branches. Reserve upon which action has not yet State member banks must also obtain been taken. For each pending application Federal Reserve approval to establish and notice, the related H.2A contains the financial subsidiaries. These subsidiaries deadline for comments. The Board's web may engage in activities that are finan- site (www.federalreserve.gov) provides cial in nature or incidental to financial information on orders and announceactivities, including securities and insur- ments as well as a guide for U.S. and ance agency-related activities. In 2004, foreign banking organizations submitting 2 applications for financial subsidiaries applications or notices to the Federal were approved. Reserve. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

114 91st Annual Report, 2004 Timely Processing of Applications the credit is used to trade debt and equity securities. The Board's Regula- The Federal Reserve sets internal target tion U limits the amount of credit that time frames for the processing of applimay be provided by lenders other than cations. The setting of internal targets brokers and dealers when the credit is promotes efficiency at the Board and the used to purchase or carry publicly held Reserve Banks and reduces the burden equity securities if the loan is secured by on applicants. Generally, the length of those or other publicly held equity secuthe target period ranges from twelve rities. The Board's Regulation X applies to sixty days, depending on the type of these credit limitations, or margin application or notice filed. In 2004, requirements, to certain borrowers and 92 percent of decisions were made to certain credit extensions, such as within the target time period. credit obtained from foreign lenders by U.S. citizens. Enforcement of Several regulatory agencies enforce the Board's securities credit regulations. Other Laws and Regulations The SEC, the National Association of The Federal Reserve's enforcement Securities Dealers, and the national responsibilities also extend to financial securities exchanges examine brokers disclosures by state member banks, and dealers for compliance with Regulasecurities credit, and extensions of credit tion T. With respect to compliance with to executive officers. 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 OTS State member banks that issue securities examine lenders under their respective registered under the Securities Exchange jurisdictions; and the Federal Reserve Act of 1934 must disclose certain infor- examines other Regulation U lenders. mation of interest to investors, including Since 1998, the Board has published annual and quarterly financial reports a list of foreign stocks that meet the and proxy statements. By statute, the requirements of section 220.11 of Regu- Board's financial disclosure rules must lation T (Credit by Brokers and Dealbe substantially similar to those of ers), thereby making them eligible for the SEC. At the end of 2004, 15 state margin treatment at broker-dealers on member banks were registered with the the same basis as domestic margin secu- Board under the Securities Exchange rities. In March 2004 the Board removed Act. all the stocks from its Foreign Margin Stock List because the stocks had not been recertified under procedures Securities Credit approved by the Board in 1990. For- Under the Securities Exchange Act, the eign stocks may also qualify as margin Board is responsible for regulating securities by being deemed to have credit in certain transactions involving a "ready market" under the SEC's the purchase or carrying of securities. net capital rule (17 CFR 240.15c3-3) The Board's Regulation T limits the (see the March 3, 2004, press release amount of credit that may be provided at www.federalreserve.gov/boarddocs/ by securities brokers and dealers when press/all/2004/). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 115 Extensions of Credit by State Member Banks to their Executive Officers, 2003 and 2004 Range of interest Period Number Amount (dollars) rates charged (percent) 2003 October 1-December 31 590 66,901,000 0.0-18.0 2004 January 1-March 31 545 62,624,000 0.0-18.0 April 1-June 30 576 79,207,000 0.0-18.0 July 1-September 30 479 72,401,000 0.0-19.8 October 1-December 31 476 53,083,000 0.0-20.8 SOURCE. Call Reports. Extensions of Federal Reserve Membership Credit to Executive Officers At the end of 2004, 2,794 banks were Under section 22(g) of the Federal members of the Federal Reserve System Reserve Act, a state member bank must and were operating 51,864 branches. include in its quarterly Call Report These banks accounted for 37 percent of information on all extensions of credit all commercial banks in the United by the bank to its executive officers States and for 73 percent of all commersince the date of the preceding report. cial banking offices. • The accompanying table summarizes this information for 2004. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

117 Federal Reserve Banks The Federal Reserve Banks contribute environment, see the box "Reserve to the setting of national monetary pol- Bank Services in a Changing Payments icy and are involved in the supervision Market.") and regulation of banks and other finan- In addition to acting to control costs cial entities. They also operate a nation- for priced services, the Reserve Banks wide payments system, distribute the have undertaken a number of projects nation's currency and coin, and serve as to reduce support and overhead costs. fiscal agent and depository to the United They have consolidated operations States. locally and nationally, adopted moreefficient practices, and adjusted staffing levels commensurate with a shrinking Major Initiatives base of internal customers requiring sup- In 2004, the Federal Reserve Banks con- port services. Reserve Bank support and tinued to pursue efficiencies in their overhead costs, including national supoperations, including the provision of port services, decreased $68 million, or priced services, and in support and 6 percent, from 2003 to 2004.l Over the overhead. same period, ANP associated with sup- The Reserve Banks are processing a port and overhead areas declined 700, or declining number of checks as consum- 8 percent.2 ers and businesses make more payments Over the past several years, the electronically. Because of the decline, Reserve Banks have consolidated their the Banks have found it challenging to employee health and welfare plans, fully recover their costs as required by human resources information systems, the Monetary Control Act of 1980. In and payroll-processing operations. response, the Banks are fundamentally These plans, systems, and operations restructuring their check operations. previously were unique to each Bank During the year, they completed the first and were managed and administered phase of a check restructuring initiative, from each Reserve Bank head office. reducing the number of Federal Reserve Although some of the consolidations are check-processing and check-adjustment not yet complete, each has already genlocations. The initiative has reduced erated significant cost savings. The sav- Reserve Bank check operating expenses ings resulting from staff reductions in and staffing levels; since 1999, the num- support and overhead functions is ber of employees processing checks has expected to be $3.9 million when fully declined about 25 percent, to approxi- implemented in 2006. The savings mately 4,000 at the end of 2004. As the resulting from lower vendor fees and market for check collection services continues to decline, the Banks will pursue additional restructuring efforts and 1. National support services include functions staffing reductions to achieve full cost and projects managed by a Reserve Bank on behalf of the other Reserve Banks. recovery. (For a broad discussion of 2. ANP is the number of employees during a the Reserve Banks' response to today's year in terms of full-time positions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

118 91st Annual Report, 2004 Reserve Bank Services in a Changing Payments Market More payments in the United States are wide-ranging dialogue on improving the now being made electronically than by payments system by sponsoring several check. The number of checks written annu- conferences and seminars and by conductally peaked in the mid-1990s at around ing other outreach activities. 50 billion. By 2003, the number was down The Federal Reserve also worked with to about 37 billion. In contrast, the number the financial services industry, the legal of payments made electronically via credit community, consumer and business repreand debit cards, the automated clearing- sentatives, and Congress to enact the house (ACH), and electronic benefit trans- Check Clearing for the 21st Century Act fer cards was about 45 billion in 2003, up (Check 21), which facilitates (but does not from approximately 15 billion in the mid- mandate) the greater use of electronics 1990s. in the processing of checks. The Board The shift largely reflects a growing con- amended two of its regulations concerned sumer and business preference for mak- with check processing (Regulations J and ing payments electronically, particularly by CC) to implement the law and has worked debit card. It has also been spurred by the closely with the Reserve Banks and the financial services industry through its use industry to educate the public about the of new technologies, introduction of new implications of Check 21 for consumers. products and services, and adoption of The Board also clarified the application of operating rules and standards that support the consumer protections in Regulation E the greater use of electronic payments. For to electronic payments made via check example, recent industry rule changes have conversion.1 enabled businesses to use the informa- The ongoing shift to electronic payments tion on a consumer's check to transfer has affected the Reserve Banks' checkfunds electronically using the ACH, a pro- processing operations. The number of cess now commonly known as check checks collected annually through the conversion. Banks has fallen nearly 20 percent since The Federal Reserve has supported and helped facilitate this ongoing transition to a 1. Consumer information on Check 21 and more-electronic payments system. Its Payelectronic check conversion is available at ments System Development Committee, www.federalreserve.gov/consumers.htm. Bankchaired by Vice Chairman Roger Ferguson ing industry educational and reference material and Minneapolis Federal Reserve Bank on Check 21 is available at www.ffiec.gov/ President Gary Stern, has promoted a exam/check21/defaulthtm. from lower plan costs due to consoli- innovation and to increase payments dation of health and welfare plans is system efficiency by reducing legal expected to be $25 million in 2005. impediments to check truncation. The other significant initiative affecting Reserve Bank check operations in Developments in 2004 was the introduction of products, Federal Reserve Priced Services services, and associated infrastructure related to the Check Clearing for the The Monetary Control Act of 1980 21st Century Act (Check 21), which requires that the Federal Reserve set took effect in October. Check 21 is fees for providing "priced services" to intended to foster payments system depository institutions that, over the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 119 1999, to fewer than 14 billion in 2004. And with a declining check market, the Banks the decline is accelerating, as the Banks also have begun to fundamentally restrucprocessed 12 percent fewer checks in 2004 ture the location and nature of their than in 2003. As a result, the revenue the national check-processing operations. The Banks earn from providing check collec- number of offices at which checks are protion services to depository institutions has cessed was reduced from forty-five at the begun to decline. Over the past five years, beginning of 2003 to thirty-two by the end the Banks also made a significant invest- of 2004. A further reduction, to twentyment in modernizing and improving three offices, will be completed in early the longer-term efficiency of their check- 2006. As part of these changes, five processing operations. regional sites dedicated solely to process- This combination of market and busi- ing checks have been closed. Additional ness factors has challenged the Reserve restructuring will occur in response to con- Banks' ability to meet the expectations of tinued market changes in the use of checks. the Monetary Control Act of 1980 (MCA). Major improvements in the operational The MCA requires that the Banks set fees efficiency and productivity of Reserve for providing payment services (including Bank check-collection operations have check collection services) to depository resulted from these initiatives. The Cincininstitutions to recover, over the long run, nati check-processing office, for example, all the direct, indirect, and imputed costs of now processes both its own usual volume providing the services, including the taxes and the checks previously processed at the that would have been paid and the return Indianapolis, Louisville, and Charleston on equity that would have been earned had offices. The number of employees providthe services been provided by a private ing check-collection services has been firm. reduced to approximately 4,000, about one- To better meet the MCA requirements, fourth fewer than in 1999 and the lowest the Reserve Banks have undertaken a range level since enactment of MCA. Although of cost-reduction and revenue-generation the one-time charges associated with the initiatives as part of a long-term business restructuring efforts have been substantial, strategy to facilitate the greater use of elec- the costs of ongoing operations have tronics in check processing. These initia- decreased. As a result, the Reserve Banks tives have included streamlining manage- expect to recover fully all the costs of ment structures, reducing staffing levels, providing check-collection services in 2005 increasing productivity, and selectively and to continue to meet their broader staturaising fees. To better align their operations tory obligations over the longer term. long run, recover all the direct and indi- years, the Federal Reserve Banks have rect costs of providing the services as recovered 97.5 percent of their priced well as the imputed costs, such as the services costs, including the PSAF income taxes that would have been paid (table). and the return on equity that would have been earned had the services been provided by a private firm. The imputed ments for deposit insurance by the Federal Deposit costs and imputed profit are collectively Insurance Corporation. Also allocated to priced referred to as the private-sector adjust- services are assets and personnel costs of the ment factor (PSAF).3 Over the past ten Board of Governors that are related to priced services; in the pro forma statements at the end of 3. In addition to income taxes and the return on this chapter, Board expenses are included in operequity, the PSAF is made up of three imputed ating expenses and Board assets are part of longcosts: interest on debt, sales taxes, and assess- term assets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

120 91st Annual Report, 2004 Priced Services Cost Recovery, 1995-2004 Millions of dollars except as noted Operating Revenue from Targeted return Total Cost recovery Year services1 im ex p p u e t n e s d e s c a o n st d s2 on equity costs (percent)3 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 2004 914.6 842.6 112.4 955.0 95.8 1995-2004 8,705.1 8,156.4 769.9 8,926.5 97.5 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 $7,490.2 million, imputed costs of $387.7 million, and of rounding. imputed income taxes of $259.1 million. Also includes 1. For the ten-year period, includes revenue from ser- the effect of a one-time accounting change net of taxes of vices of $8,444.2 million and other income and expense $19.4 million for 1995. (net) of $261.0 million. 3. Revenue from services divided by total costs. Overall, the price index for priced totaled $709.6 million, of which services increased 6.7 percent from $45.3 million was attributable to the 2003. Revenue from priced services transportation of commercial checks amounted to $865.9 million, other between Reserve Bank checkincome related to priced services was processing centers. Revenue amounted $48.7 million, and costs related to priced to $719.7 million, of which $45.8 milservices were $842.6 million, resulting lion was attributable to estimated revein net income of $72.0 million. In 2004, nues derived from the transportation the Reserve Banks recovered 95.8 per- of commercial checks between Reserve cent of total costs of $955 million, Bank check-processing centers, and including the PSAF.4 other income was $40.5 million. The resulting net income was $50.5 million. Check service revenue in 2004 declined Commercial Check $22.3 million from 2003, largely because Collection Service of declining volume and customers' moving to lower-priced products. In 2004, operating expenses and The Reserve Banks handled 13.9 bilimputed costs for the Reserve Banks' lion checks in 2004, a decrease of commercial check collection service 12.0 percent from the 15.8 billion checks handled in 2003 (table). The decline in Reserve Bank check volume 4. Financial data reported throughout this is consistent with nationwide trends chapter—revenue, other income, cost, net revenue, and income before taxes—can be linked to the pro forma statements at the end of this chapter. Other income is revenue from investment of clear- (interest on debt, interest on float, sales taxes, and ing balances net of earnings credits, an amount the Federal Deposit Insurance Corporation assesstermed net income on clearing balances. Total cost ment), imputed income taxes, and the targeted is the sum of operating expenses, imputed costs return on equity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 121 Activity in Federal Reserve Priced Services, 2002-2004 Thousands of items Percent change Service 2004 2003 2002 2003 to 2004 2002 to 2003 Commercial check 13,904,382 15,805,894 16,586,804 -12.0 -4.7 Funds transfer 128,270 125,936 117,133 1.9 7.5 Securities transfer 9,208 10,071 8,480 -8.6 18.8 Commercial ACH 6,486,091 5,588,381 4,986,152 16.1 12.1 Noncash 211 280 333 -24.7 -15.8 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 online and offaway from the use of checks and toward ville. Omaha check processing has been greater use of electronic payment meth- consolidated to Des Moines; Richmond ods.5 Overall, the price index for check to Baltimore; Little Rock to Memphis; services increased 8.7 percent from and Columbia (South Carolina) to Char- 2003. lotte. Both El Paso and San Antonio In response to the continuing decline have been consolidated to Dallas, and in check volume, the Reserve Banks both Milwaukee and Peoria to Chicago. took further steps in 2004 to reduce Volume from Charleston (West Vircheck service operating costs by imple- gina), Louisville, and Indianapolis is menting a business and operational strat- now processed in Cincinnati. egy that will position the service to Of all the checks presented by the achieve its financial and payment sys- Reserve Banks to paying banks, tem objectives over the long term. The 23.1 percent (approximately 3.2 bilstrategy will reduce operating costs lion checks) were presented electronithrough a combination of measures: cally, compared with 22.7 percent in streamlining management structures, 2003. The Banks captured images of reducing staff, decreasing the number of 10.4 percent of the checks they colcheck-processing locations, and increas- lected, an increase from 9.3 percent in ing processing capacity at some 2003. locations. In 2004, check-processing The Reserve Banks also expanded the facilities were closed at some locations services available to depository instituand the work moved to others. Checks tions through the web during the year. that would have been processed in These investments are expected to Miami are now processed in Jackson- increase operating efficiency and the Reserve Banks' ability to offer additional services to depository institutions. 5. The Federal Reserve System's recent retail payments research suggests that the number of checks written in the United States has been declining since the mid-1990s. See Federal Commercial Automated Reserve System, "The 2004 Federal Reserve Clearinghouse Services Payments Study: Analysis of Noncash Payments Trends in the United States, 2000-2003" Reserve Bank operating expenses and (December 2004). (www.frbservices.org/Retail/ pdf/2004PaymentResearchReport.pdf) imputed costs for commercial automated Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

122 91st Annual Report, 2004 clearinghouse (ACH) services totaled eastern time. The impetus for the expan- $64.0 million in 2004. Revenue from sion of operating hours was industry ACH operations totaled $71.1 million requests to achieve greater overlap of and other income totaled $4.0 million, wholesale payments system operating resulting in net income of $11.1 million. hours in U.S. and Asia-Pacific markets. The Banks processed 6.5 billion commercial ACH transactions (worth National Settlement Service $12.5 trillion), an increase of 16.1 per- Private clearing arrangements that cent from 2003. Overall, the price index exchange and settle transactions may for ACH services decreased 10.2 peruse the Reserve Banks' National Settlecent from 2003. ment Service to settle their transactions. In 2004, the Reserve Banks began This service is provided to approxioffering international ACH funds transmately seventy local and national prifer service from the United States to vate arrangements, primarily check Austria, Canada, Germany, Mexico, and clearinghouse associations but also other the Netherlands. The Banks also offer types of arrangements. In 2004, the service to Switzerland and the United Reserve Banks processed slightly fewer Kingdom. than 435,000 settlement entries for these arrangements. Fedwire Funds and National Settlement Services Fedwire Securities Service Reserve Bank operating expenses and The Fedwire Securities Service allows imputed costs for the Fedwire Funds participants to electronically transfer and National Settlement Services totaled securities issued by the U.S. Trea- $50.7 million in 2004. Revenue from sury, federal government agencies, these operations totaled $54.1 milgovernment-sponsored enterprises, and lion, and other income amounted to certain international organizations to $3.0 million, resulting in net income of other participants in the United States.6 $6.5 million. Reserve Bank operating expenses and imputed costs for providing this service Fedwire Funds Service totaled $16.9 million in 2004. Revenue The Fedwire Funds Service allows par- from the service totaled $19.3 milticipants to draw on their reserve or lion, and other income totaled $1.1 milclearing balances at the Reserve Banks lion, resulting in net income of $3.4 miland transfer funds to other institutions lion. Approximately 9.2 million transthat maintain accounts at the Banks. In fers of Treasury and other securities 2004, the number of Fedwire funds transfers originated by depository institutions increased 1.9 percent from 2003, 6. The expenses, revenues, and volumes reported here are for transfers of securities issued to approximately 128.3 million. In May, by federal government agencies, governmentthe Banks expanded the operating hours sponsored enterprises, and international institufor the online service. The service is tions. The Treasury Department assesses fees on now open three and one-half hours depository institutions for some of the transfer, earlier—at 9:00 p.m. eastern time the account maintenance, and settlement services for U.S. Treasury securities provided by the Reserve preceding calendar day rather than the Banks. For details, see the section "Debt Serprevious opening time of 12:30 a.m. vices" later in this chapter. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 123 were processed by the service during The Federal Reserve includes the cost the year, a decrease of 8.6 percent of or income from float associated with from 2003. In 2004, the fee for securi- priced services as part of the fees for ties transfers decreased from $0.40 to those services. $0.32, and the surcharge for offline transfers increased from $25 to $28. Developments in Currency and Coin Noncash Collection Service The Reserve Banks received 37.5 billion The Reserve Banks provide a service to Federal Reserve notes from circulation collect and process municipal bearer in 2004, a 5.1 percent increase from bonds and coupons issued by state and 2003, and made payments of 37.9 billocal governments (referred to as "non- lion notes into circulation, a 3.6 percent cash" items). The service, which is cen- increase from 2003. They received tralized at one Federal Reserve office, 55.7 billion coins from circulation in processed slightly less than 211,000 2004, a 15.6 percent increase from 2003, noncash transactions in 2004, represent- and made payments of 67.5 billion coins ing a 24.7 percent decline in volume into circulation, a 9.8 percent increase from 2003. Operating expenses and from 2003.8 imputed costs for noncash operations In October 2004, the Reserve Banks totaled $1.4 million in 2004, and reve- began issuing the redesigned $50 Fednue and other income totaled $1.9 mil- eral Reserve note, which has enhanced lion, resulting in net income of $0.5 mil- security features and subtle background lion. The fee for return items increased colors. In connection with issuance of from $20 to $35. the new notes, the Federal Reserve and In October, the Board requested com- the Bureau of Engraving and Printing ment on a proposal to withdraw from conducted a public education campaign the noncash collection service at year- to raise awareness of the note's design end 2005. The volume of coupons and and security features. bonds presented for collection is declin- In 2003, the Board requested coming, a result of a continuing decline in ments on a proposed cash-recirculation the number of physical municipal secu- policy intended to change its cashrities outstanding since passage of the services policy to reduce overuse of Tax Equity and Fiscal Responsibility Reserve Bank cash-processing services. Act of 1982, which removed tax advan- Currently, many depository institutions tages for investors and effectively led to order currency late in the week to meet the end of issuance of bearer municipal temporary, cyclical demand and then securities. return the currency to a Federal Reserve facility several days later to minimize their holdings of vault cash, which does Float not earn interest. The process repeats The Federal Reserve had daily average each week, and the Federal Reserve credit float of $76.4 million in 2004, facility receiving the returned currency compared with $43.0 million in 2003.7 must process it each time. To test the effectiveness of a program that supports 7. Credit float occurs when the Reserve Banks receive settlement for items prior to providing 8. Percentages reflect restatements of previcredit to the depositing institution. ously reported data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

124 91st Annual Report, 2004 the proposed cash-recirculation policy, The cost of providing services to other the Banks established eleven custodial entities was $28.4 million, compared inventory sites in 2004. Custodial inven- with $35.3 million in 2003. In 2004, as tories allow depository institutions to in 2003, the Treasury and other entities transfer a portion of their cash holdings reimbursed the Reserve Banks for the to the books of a Reserve Bank and are costs of providing these services. intended to encourage depository insti- The most significant development in tutions to recirculate fit currency rather relation to the fiscal agency service in than return it to the Federal Reserve for 2004 was the Reserve Banks' consoliprocessing. The program will operate dation of operations that support the for six months, after which the Federal Treasury's retail securities programs, Reserve will evaluate the program's through which retail investors purchase effectiveness in promoting currency and hold marketable Treasury securities recirculation. and savings bonds. As the Treasury In 2004, the Federal Reserve also replaced paper processes in retail securiestablished a group to study the poten- ties with more-efficient electronic protial effects of the proposed cash- cesses, fewer operations sites were recirculation policy on the quality of needed. In December 2003, the Treacurrency in circulation. The group is sury directed the Banks to consolidate working with the vending industry and their retail securities operations from manufacturers of currency-handling seven sites to two. The consolidation equipment to evaluate the importance of has proceeded ahead of schedule and currency quality for their industries. should be completed late in 2005. The Banks expect that in 2006, annual operating costs for the retail securities operations will decline significantly because Developments in of lower personnel costs. Fiscal Agency and Government Depository Services Debt Services As fiscal agents and depositories for the federal government, the Federal Reserve The Reserve Banks auction, provide Banks provide services related to the safekeeping for, and transfer marketfederal debt, help the Treasury collect able Treasury securities. Reserve Bank funds owed to the government, process operating expenses for these activielectronic and check payments for the ties totaled $23.4 million in 2004, an Treasury, maintain the Treasury's bank 8.3 percent increase from 2003. The account, and invest excess Treasury bal- Banks processed more than 156,000 tenances. The Reserve Banks also provide ders for Treasury securities, compared limited fiscal agency and depository ser- with 140,000 in 2003, and handled vices to other entities. 2 million reinvestment requests, com- The total cost of providing fiscal pared with 2.2 million in 2003. The agency and depository services to the Banks originated 10.7 million trans- Treasury and other entities in 2004 fers of Treasury securities in 2004, a amounted to $369.8 million, compared 13.6 percent increase from 2003. As of with $327.0 million in 2003 (table). December 31, 2004, the Reserve Banks' Treasury-related costs were $341.4 mil- Fedwire Securities Service maintained lion in 2004, compared with $291.7 mil- custody of $3.9 trillion (par value) of lion in 2003, an increase of 17 percent. Treasury securities. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 125 Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2002-2004 Thousands of dollars Agency and service 2004 2003 2002 DEPARTMENT OF THE TREASURY Bureau of the Public Debt Treasury retail securities Savings bonds 72,385.1 66,403.7 68,888.3 TreasuryDirect and Treasury coupons 30,872.7 33,013.5 33,953.6 Treasury securities safekeeping and transfer 6,267.0 4,836.3 8,830.1 Treasury auction 17,159.5 16,802.6 14,597.6 Computer infrastructure development and support 5,935.1 7,836.7 2,349.6 Other services 1,709.8 1,460.7 2,385.8 Total 134,329.1 130,353.4 131,005.0 Financial Management Service Payment services Government check processing 24,245.4 25,624.7 30,284.4 Automated clearinghouse 5,352.9 6,253.9 6,280.0 Fedwire funds transfers 111.6 187.3 201.4 Other payment-related services 33,646.9 23,630.8 20,172.1 Collection services Tax and other revenue collections 34,248.4 29,782.9 26,361.3 Other collection-related services 12,922.8 12,532.6 10,296.4 Cash management services 21,835.8 18,227.8 17,310.8 Computer infrastructure development and support 52,673.3 24,575.3 7,592.6 Other services 6,931.6 6,666.2 5,415.8 Total 191,968.6 147,481.5 123,914.7 Other Treasury Total 15,106.1 13,913.5 14,471.2 Total, Treasury 341,403.7 291,748.5 269,390.9 OTHER FEDERAL AGENCIES Department of Agriculture Food coupons 4,519.0 7,791.4 10,240.8 U.S. Postal Service Postal money orders 7,774.6 10,959.5 12,381.6 Other agencies Other services 16,104.0 16,508.2 16,494.1 Total, other agencies . 28,397.5 35,259.2 39,116.5 Total reimbursable expenses . 369,801.2 327,007.7 308,507.4 In support of the Treasury's retail As of December 31, 2004, Treasurysecurities programs, the Reserve Banks Direct held $62.2 billion (par value) of operate TreasuryDirect, a program that marketable Treasury securities. allows retail investors to purchase and TreasuryDirect customers may sell hold Treasury securities directly with their securities for a fee through Sell the Treasury instead of through a broker. Direct, a program operated by one of As the program was designed for inves- the Reserve Banks. That Bank sold tors who plan to hold their securities approximately 15,000 securities worth to maturity, TreasuryDirect provides $673.3 million in 2004, compared with custody services only. Reserve Bank more than 14,000 securities worth operating expenses for TreasuryDirect $671.6 million in 2003. It collected totaled $30.9 million in 2004, compared approximately $504,000 in fees on with $33.0 million in 2003. In 2004, behalf of the Treasury, an increase of investors purchased 13.7 billion of Trea- 2.6 percent from the more than $491,000 sury securities through TreasuryDirect. in fees collected in 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

126 91st Annual Report, 2004 Reserve Bank operating expenses for sury's stored value card program, which issuing, servicing, and redeeming sav- provides salary and allowance payments ings bonds totaled $72.4 million in to military personnel, via a smart card, 2004, an increase of 9 percent from for use at military bases. In 2004, the 2003. The Banks printed and mailed Banks worked with the Treasury on more than 35 million savings bonds, an plans for a web-based application to 11.4 percent decrease from 2003. They allow federal agencies and vendors to issued more than 4.2 million Series I electronically exchange purchase orders (inflation indexed) bonds and 25.4 mil- and invoices and initiate ACH paylion Series EE bonds. Reissued or ments. The operating costs for these exchanged bonds accounted for the three programs totaled $15.4 million in remaining bonds printed. The Banks 2004, compared with $14.3 million in processed about 601,000 redemption, 2003. reissue, and exchange transactions, a 5.8 percent increase from 2003. Collection Services The Reserve Banks support several Payments Services Treasury programs to collect funds The Reserve Banks process both elec- owed the government. Reserve Bank tronic and check payments for the Trea- operating expenses related to these prosury. Reserve Bank operating expenses grams totaled $47.2 million in 2004, for processing government payments compared with $42.3 million in 2003. totaled $63.4 million in 2004, compared The Banks operate the Federal Reserve with $55.7 million in 2003. The Banks Electronic Tax Application (FR-ETA) as processed 940 million ACH payments an adjunct to the Treasury's Electronic for the Treasury, an increase of 3.0 per- Federal Tax Payment System (EFTPS). cent from 2003, and 876,000 Fedwire EFTPS allows businesses and individual funds transfers, a decrease of 11.5 per- taxpayers to pay their taxes electronicent from 2003 (the latter percentage cally. Because EFTPS uses the autoreflects a restatement of previously mated clearinghouse to collect funds, reported data). They also processed tax payments must be scheduled at least 234.1 million paper government checks, one day in advance. Some business taxa decline of 12.3 percent from 2003. In payers, however, do not know their tax addition, the Banks issued more than liability until the tax due date. FR-ETA, 278,000 fiscal agency checks, a decrease for wire payments, allows these taxpayof 10.4 percent from 2003. ers to use EFTPS by providing a same- In addition to processing payments, day electronic federal tax payment alterthe Reserve Banks operate programs to native. FR-ETA collected $344.8 billion help the Treasury increase the use of for the Treasury in 2004, compared with electronic payments. They operate a $275.8 billion in 2003. program that enables recipients of fed- The Reserve Banks also operate eral grants to request payments using Pay.gov, a Treasury program that allows the Internet. This application, the Auto- members of the public to make paymated Standard Application for Pay- ments to the federal government over ment, processed $404.7 billion in Fed- the Internet. They also operate the Treawire funds transfers and ACH payments sury's Paper Check Conversion and in 2004, compared with $384.2 billion Electronic Check Processing programs, in 2003. The Banks also operate Trea- whereby checks written to government Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 127 agencies are converted at the point of FedLine Advantage, the next-generation sale or at lockbox locations into auto- platform for providing PC-based elecmated clearinghouse transactions. In tronic access to Federal Reserve finan- 2004, the Reserve Banks originated cial services. The new platform uses more than 1.9 million ACH transactions web technology to provide financial through these programs, a 58.3 percent institutions with more-efficient access increase from the 1.2 million originated to such payments services as the in 2003. Fedwire Funds Service, the Fedwire Securities Service, and FedACH Ser- Cash Management Services vices. To complement the transition to web-based electronic access, the The Treasury maintains its bank account Reserve Banks completed consolidation at the Reserve Banks and invests the of the electronic-access customer supfunds it does not need for making curport function to two offices. The conrent payments with qualified depository solidation will improve the efficiency institutions through the Treasury Tax and consistency of customer support. and Loan (TT&L) program, which the Reserve Banks operate. Reserve Bank operating expenses related to this pro- Information Technology gram totaled $21.8 million in 2004, In 2004, the Federal Reserve Banks compared with $18.2 million in 2003. completed an initiative to standardize The investments either are callable on desktop hardware and software across demand or are for a set term. In 2004, Banks. In addition to reducing costs the Reserve Banks placed a total of over the long term, the standardization $17.1 billion in immediately callable is expected to facilitate interoperability, investments. The rate for term investincrease productivity, and improve the ments is set at Term Investment Option Federal Reserve's ability to respond to (TIO) auctions; the Reserve Banks cyber security threats. Projects are now held 45 TIO auctions in 2004, placing under way to standardize local area net- $309 billion in term investments, comwork components and telephone private pared with 12 auctions placing $66 bilbranch exchange systems and to implelion in 2003. In 2004, the Treasury's ment reduced-cost wide area network investment income, which comes from telecommunications services. the TT&L program, was $87 million. In partnership with the agencies that make up the Financial and Banking Services Provided to Other Entities Information Infrastructure Committee, the Federal Reserve continued in 2004 The Reserve Banks provide fiscal to sponsor clearing and settlement utiliagency and depository services to other ties, key financial institutions, and key domestic and international entities when market participants in the national required to do so by the Secretary of the security/emergency preparedness pro- Treasury or when required or permitted grams offered by the Department of to do so by federal statute. The majority Homeland Security's National Commuof the work is securities-related. nications System, which coordinates the preparedness of critical telecommunica- Electronic Access tions services to meet natural disasters In November 2004, the Reserve Banks and national emergencies. During the announced the general availability of year, the Federal Reserve participated in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

128 91st Annual Report, 2004 the President's National Security Tele- to the Bank's board of directors and to communications Advisory Committee the Board of Governors. Financial Services Task Force, which in The firm engaged for the audits of April 2004 released a report on network the individual and combined financial resilience in support of critical finan- statements of the Reserve Banks for cial services. TTie Reserve Banks are 2004 was PricewaterhouseCoopers LLP currently working with telecommunica- (PwC). Fees for these services totaled tions vendors and other government $2.0 million. To ensure auditor indepenagencies to identify policies that would dence, the Board requires that PwC be improve the resilience of the telecom- independent in all matters relating to the munications infrastructure for critical audit. Specifically, PwC may not perfinancial services functions. form services for the Reserve Banks or others that would place it in a position of auditing its own work, making man- Examinations of the agement decisions on behalf of the Federal Reserve Banks Reserve Banks, or in any other way Section 21 of the Federal Reserve Act impairing its audit independence. In requires the Board of Governors to order 2004 the Reserve Banks did not engage an examination of each Federal Reserve PwC for non-audit services other than a Bank at least once a year. The Board training session at one Reserve Bank engages a public accounting firm to per- that was obtained at a rate available to form an annual audit of the combined the general public. financial statements of the Reserve The Board's annual examination of Banks (see the section "Federal Reserve the Reserve Banks includes a wide Banks Combined Financial State- range of off-site and on-site oversight ments"). The public accounting firm activities conducted by the Division of also audits the annual financial state- Reserve Bank Operations and Payment ments of each of the twelve Banks. The Systems. Division personnel monitor Reserve Banks use the framework estab- the activities of each Reserve Bank on lished by the Committee of Sponsoring an ongoing basis and conduct on-site Organizations of the Treadway Com- reviews based on the division's riskmission (COSO) in assessing their inter- assessment methodology. The 2004 nal controls over financial reporting, examinations also included assessing the including the safeguarding of assets. efficiency and effectiveness of the inter- In 2004, the Reserve Banks enhanced nal audit function. To assess compliance their assessments under the COSO with the policies established by the Fedframework, strengthening the key con- eral Reserve's Federal Open Market trol assertion process, consistent with Committee (FOMC), the division also the requirements of the Sarbanes-Oxley reviews the accounts and holdings of Act of 2002. Within this framework, the System Open Market Account at management of each Reserve Bank pro- the Federal Reserve Bank of New York vides an assertion letter to its board of and the foreign currency operations directors annually confirming adher- conducted by that Bank. In addition, ence to COSO standards, and a public PwC audits the schedule of particiaccounting firm certifies management's pated asset and liability accounts and assertion and issues an attestation report the related schedule of participated Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 129 Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2004 and 2003 Millions of dollars Item 2004 2003 Current income 23,540 23,793 Current expenses 2,239 2,463 Operating expensesi 2,123 2,342 Earnings credits granted 116 121 Current net income 21,301 21,330 Net additions to (deductions from, — ) current net income 918 2,481 Assessments by the Board of Governors 776 805 For expenditures of Board 272 297 For cost of currency 504 508 Net income before payments to Treasury 21,443 23,006 Dividends paid 582 518 Transferred to surplus 2,783 467 Payments to Treasury2 18,078 22,022 1. Includes a net periodic pension credit of $37 million 2. Interest on Federal Reserve notes. in 2004 and net periodic pension costs of $58 million in 2003. income accounts at year-end. The exchange rates. Statutory dividends paid FOMC receives the external audit to member banks totaled $582 million, reports and the report on the division's $64 million more than in 2003; the examination. increase reflects an increase in the capital and surplus of member banks and a consequent increase in the paid-in capi- Income and Expenses tal stock of the Reserve Banks. The accompanying table summarizes the Payments to the U.S. Treasury in the income, expenses, and distributions of form of interest on Federal Reserve net earnings of the Federal Reserve notes totaled $18,078 million in 2004, Banks for 2003 and 2004. down from $22,022 million in 2003; the Income in 2004 was $23,540 million, payments equal net income after the compared with $23,793 million in 2003. deduction of dividends paid and of the Expenses totaled $3,015 million ($2,123 amount necessary to bring the surplus of million in operating expenses, $116 mil- the Reserve Banks to the level of capital lion in earnings credits granted to paid in. depository institutions, $272 million in In the "Statistical Tables" section of assessments for expenditures by the this volume, table 5 details the income Board of Governors, and $504 million and expenses of each Reserve Bank for for the cost of new currency). Revenue 2004 and table 6 shows a condensed from priced services was $866 million. statement for each Bank for the years The profit and loss account showed a 1914 through 2004. A detailed account net profit of $918 million. The profit of the assessments and expenditures of was due primarily to unrealized gains on the Board of Governors appears in the assets denominated in foreign curren- section "Board of Governors Financial cies revalued to reflect current market Statements." Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

130 91st Annual Report, 2004 Securities and Loans of the Federal Reserve Banks, 2002-2004 Millions of dollars except as noted U.S. Item and year Total government Loans2 securities! Average daily holdings3 2002 621,834 621,721 113 2003 683,438 683,294 144 2004 719,647 719,494 153 Earnings4 2002 25,527 25,525 2 2003 22,598 22,597 1 2004 . 22,347 22,344 3 Average interest rate (percent) 2002 4.11 4.11 1.94 2003 3.31 3.31 1.00 2004 3.11 3.11 1.74 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. Holdings of Securities and Loans Reserve Bank's Houston Branch and the Chicago Bank's Detroit Branch. The Federal Reserve Banks' average Security enhancement programs daily holdings of securities and loans prompted by the events of Septemduring 2004 amounted to $719,647 milber 11, 2001, continue at several facililion, an increase of $36,209 million ties. One such project is an ongoing from 2003 (table). Holdings of U.S. govexternal perimeter security improveernment securities increased $36,200 ment project at the Boston Bank that million, and holdings of loans increased involves restoration of the Bank's prop- $9 million. The average rate of interest erty after recently completed construcearned on the Reserve Banks' holdings tion of the Central Artery, an underof government securities declined to ground roadway. 3.11 percent, from 3.31 percent in 2003, The Kansas City Bank purchased and the average rate of interest earned property and retained design and conon loans increased to 1.74 percent, from struction consultants for its new head- 1.00 percent. quarters building project. The Board approved the project's schematic design, Volume of Operations and work continues on the final design. Table 8 in the "Statistical Tables" sec- The Board approved the St. Louis tion shows the volume of operations in Bank's purchase of a building to be the principal departments of the Fed- renovated as a business-continuity reloeral Reserve Banks for the years 2001 cation facility. through 2004. The Richmond Bank purchased and renovated a building as a relocation site for critical staff. Design work on addi- Federal Reserve Bank Premises tional security improvements continued. In 2004, construction continued on the The Dallas Bank continues to pursue new buildings for the Dallas Federal the purchase of property behind its head- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 131 quarters building for the construction of The multiyear renovation program a remote vehicle screening and shipping/ continued at the New York Bank's headreceiving facility. quarters building. As part of its long-term facility rede- Several Banks continue to implevelopment program, the St. Louis Bank ment facility renovation projects to purchased and renovated a parking accommodate the consolidation of check garage for staff parking and a warehouse activities. for remote screening of deliveries. The Agreements were reached in 2004 to Bank retained design consultants for sell the buildings housing the New York expansion of the Bank's headquarters Bank's Buffalo Branch, the St. Louis building, and design work began. Bank's Louisville Branch, and the Chi- The San Francisco Bank retained cago Bank's Milwaukee facility. Addesign and construction consultants for ministration activities for the Buffalo the new Seattle Branch building and and Louisville Branches will be moved finalized an agreement to purchase prop- to leased space. • erty for the new building. Design work has begun. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

132 91st Annual Report, 2004 Pro Forma Financial Statements for Federal Reserve Priced Services Pro Forma Balance Sheet for Priced Services, December 31, 2004 and 2003 Millions of dollars Item 2004 2003 Short-term assets (Note 1) Imputed reserve requirements on clearing balances 1,115.7 1,296.4 Imputed investments 9,691.9 11,332.5 Receivables 75.8 77.1 Materials and supplies 1.9 2.3 Prepaid expenses 31.8 35.6 Items in process of collection 6,107.1 5,271.9 Total short-term assets 17,024.1 18,015.8 Long-term assets (Note 2) Premises 471.8 494.6 Furniture and equipment 152.8 179.4 Leases, leasehold improvements, and long-term prepayments 107.9 103.2 Prepaid pension costs 795.4 787.9 Total long-term assets 1,528.0 1,565.1 Total assets 18,552.1 19,580.9 Short-term liabilities Clearing balances and balances arising from early credit of uncollected items 11,909.5 11,788.1 Deferred-availability items 5,354.3 6,448.3 Short-term debt .0 .0 Short-term payables 92.2 78.1 Total short-term liabilities .. 17,355.9 18,314.4 Long-term liabilities Long-term debt .0 .0 Postretirement/postemployment benefits obligation 268.6 287.5 Total long-term liabilities .. 268.6 287.5 Total liabilities 17,624.5 18,601.9 Equity 927.6 979.0 Total liabilities and equity (Note 3) 18,552.1 19,580.9 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 133 Pro Forma Income Statement for Federal Reserve Priced Services, 2004 and 2003 Millions of dollars Item 2004 2003 Revenue from services provided to depository institutions (Note 4) 865.9 886.9 Operating expenses (Note 5) 800.6 941.6 Income from operations 65.3 -54.7 Imputed costs (Note 6) Interest on float -.1 -.7 Interest on debt .0 .0 Sales taxes 11.6 12.1 FDIC insurance .0 11.4 .0 11.4 Income from operations after imputed costs 53.8 -66.1 Other income and expenses (Note 7) Investment income 156.8 108.0 Earnings credits -108.1 48.7 -113.2 -5.2 Income before income taxes 102.5 -71.3 Imputed income taxes (Note 6) 30.6 -21.7 Net income 72.0 -49.6 MEMO: Targeted return on equity (Note 6) ... 112.4 104.7 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, 2004 Millions of dollars Com- Commercial Fedwire Fedwire Noncash Item Total mercial check funds securities services ACH collection Revenue from services (Note 4) 865.9 719.7 54.1 19.3 71.1 1.8 Operating expenses (Note 5) 800.6 678.5 47.2 15.2 58.6 L2 Income from operations 65.3 41.2 6.9 4.1 12.5 .6 Imputed costs (Note 6) , 11.4 9.7 .7 .3 .7 .0 Income from operations after imputed costs 53.8 31.4 6.2 3.8 11.8 Other income and expenses, net (Note 7) 48.7 40.5 3.0 1.1 4.0 .1 Income before income taxes ... 102.5 71.9 9.2 4.9 15.8 .7 Imputed income taxes (Note 6) 30.6 21.4 2.8 1.4 4.7 .2 Net income . 72.0 50.5 6.5 3.4 11.1 .5 MEMO: Targeted return on equity (Note 6) 112.4 93.6 6.8 2.9 8.9 .2 NOTE. Components may not sum to totals because of The accompanying notes are an integral part of these rounding. pro forma priced services financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

134 91st Annual Report, 2004 FEDERAL RESERVE BANKS NOTES TO PRO FORMA FINANCIAL STATEMENTS FOR PRICED SERVICES (1) SHORT-TERM ASSETS Banks and deposit balances arising from float. Other long-term liabilities consist of accrued postemployment The imputed reserve requirement on clearing balances and postretirement benefits costs and obligations on capiheld at Reserve Banks by depository institutions reflects a tal leases. treatment comparable to that of compensating balances Equity is imputed at 5 percent of total assets based on held at correspondent banks by respondent institutions. the Federal Deposit Insurance Corporation's definition of The reserve requirement imposed on respondent balances a well-capitalized institution for deposit insurance premust be held as vault cash or as non-earning balances mium purposes. maintained at a Reserve Bank; thus, a portion of priced services clearing balances held with the Federal Reserve is shown as required reserves on the asset side of the (4) REVENUE balance sheet. Another portion of the clearing balances Revenue represents charges to depository institutions for is used to finance short-term and long-term assets. The priced services and is realized from each institution remainder of clearing balances is assumed to be invested through one of two methods: direct charges to an instituin a portfolio of investments, shown as imputed investtion's account or charges against its accumulated earnments. For 2003, imputed investments were assumed to ings credits. be three-month Treasury bills. Receivables are (1) amounts due the Reserve Banks for priced services and (2) the share of suspense-account and (5) OPERATING EXPENSES difference-account balances related to priced services. Operating expenses consist of the direct, indirect, and Materials and supplies are the inventory value of short- other general administrative expenses of the Reserve term assets. Banks for priced services plus the expenses for staff Prepaid expenses include salary advances and travel members of the Board of Governors working directly on advances for priced-service personnel. the development of priced services. The expenses for Items in process of collection is gross Federal Reserve Board staff members were $7.6 million in 2004 and cash items in process of collection (CIPC) stated on a $6.4 million in 2003. The credit to expenses under basis comparable to that of a commercial bank. It reflects SFAS 87 (see note 2) is reflected in operating expenses. adjustments for intra-System items that would otherwise The income statement by service reflects revenue, be double-counted on a consolidated Federal Reserve operating expenses, and imputed costs. Certain corporate balance sheet; adjustments for items associated with non- overhead costs not closely related to any particular priced priced items, such as those collected for government service are allocated to priced services in total based on agencies; and adjustments for items associated with an expense-ratio method, but are allocated among priced providing fixed availability or credit before items are services based on management decision. Corporate overreceived and processed. Among the costs to be recovered head was allocated among the priced services during under the Monetary Control Act is the cost of float, or net 2004 and 2003 as follows (in millions): CIPC during the period (the difference between gross CIPC and deferred-availability items, which is the portion 2004 2003 of gross CIPC that involves a financing cost), valued at the federal funds rate. Check 33.5 38.9 ACH 3.4 3.3 Fedwirefunds 2.5 2.1 (2) LONG-TERM ASSETS Fedwire securities 1.3 1.1 Consists of long-term assets used solely in priced ser- Noncash services J_ .1 vices, the priced-services portion of long-term assets shared with nonpriced services, and an estimate of the Total 40.8 45.5* 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 income taxes, return on equity, Board's Statement of Financial Accounting Standards interest on debt, sales taxes, the FDIC assessment, and No. 87, Employers' Accounting for Pensions (SFAS 87). interest on float. Many imputed costs are derived from the Accordingly, the Reserve Banks recognized a credit to private-sector adjustment factor (PSAF) model, which expenses of $7.5 million in 2004 and expenses of uses bank holding companies as the proxy for a private- $21.3 million in 2003 and a corresponding increase and sector firm. The cost of debt and the effective tax rate decrease in this asset account. from the PSAF model are used to impute debt and income taxes. The after-tax rate of return on equity is used to (3) LIABILITIES AND EQUITY impute the profit that would have been earned had the Under the matched-book capital structure for assets, services been provided by a private-sector firm. short-term assets are financed with short-term payables Interest is imputed on the debt assumed necessary to and clearing balances. Long-term assets are financed with finance priced-service assets; however, no debt was long-term liabilities and clearing balances. As a result, no short- or long-term debt is imputed. Other short-term liabilities include clearing balances maintained at Reserve * Restatement of previously reported total. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 135 imputed in 2004 or 2003. The sales taxes and FDIC balances; the increase is produced by a deduction for float assessment that the Federal Reserve would have paid had for cash items in process of collection, which reduces been a private-sector firm are also among the components imputed reserve requirements. The income on clearing of the PS AF. balances reduces the float to be recovered through other Interest on float is derived from the value of float to be means. As-of adjustments and direct charges refer to float recovered, either explicitly or through per-item fees, dur- that is created by interterritory check transportation and ing the period. Float costs include costs for checks, book- the observance of non-standard holidays by some deposientry securities, noncash collection, ACH, and funds tory institutions. Such float may be recovered from the transfers. depository institutions through adjustments to institution Float cost or income is based on the actual float reserve or clearing balances or by billing institutions incurred for each priced service. Other imputed costs are directly. Float recovered through direct charges and perallocated among priced services according to the ratio of item fees is valued at the federal funds rate; credit float operating expenses less shipping expenses for each ser- recovered through per-item fees has been subtracted from vice to the total expenses for all services less the total the cost base subject to recovery in 2004. shipping expenses for all services. The following list shows the daily average recovery of (7) OTHER INCOME AND EXPENSES actual float by the Reserve Banks for 2004 in millions of Consists of investment income on clearing balances and dollars: the cost of earnings credits. Investment income on clearing balances for 2004 represents the average coupon- Total float -13.5 equivalent yield on three-month Treasury bills plus a Unrecovered float 19.4 constant spread, based on the return on a portfolio of Float subject to recovery -33.0 investments. For 2003, the investment income is based on the yield of the three-month Treasury bill. In both years, Sources of recovery of float the return is applied to the total clearing balance main- Income on clearing balances -3.3 As-of adjustments -62.8 tained, adjusted for the effect of reserve requirements on Direct charges 823.4 clearing balances. Expenses for earnings credits granted Per-item fees -915.9 to depository institutions on their clearing balances are derived by applying a discounted average coupon- Unrecovered float includes float generated by services equivalent yield on three-month Treasury bills in 2004 to government agencies and by other central bank ser- and the average federal funds rate in 2003 to the required vices. Float recovered through income on clearing bal- portion of the clearing balances, adjusted for the net effect ances is the result of the increase in investable clearing of reserve requirements on clearing balances. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

137 The Board of Governors and the Government Performance and Results Act Under the Government Performance and cusses data validation and verification Results Act of 1993 (GPRA), federal of results. The performance report indiagencies are required to prepare, in cates that the Board generally met its consultation with Congress and outside explicit goals for 2002-03. stakeholders, a strategic plan covering a The strategic plan, performance multiyear period and to submit annual plan, and performance report are availperformance plans and performance able on the Board's public web site reports. Though not covered by the act, (www.federalreserve.gov/boarddocs/ the Board of Governors is voluntarily rptcongress/). The Board's mission complying with many of the act's statement and a summary of the goals mandates. and objectives set forth in the strategic plan and performance plan are given below. Strategic Plan, Performance Plan, and Performance Report Mission The Board's latest strategic plan in the The mission of the Board is to foster the GPRA format, released in August 2004, stability, integrity, and efficiency of the covers the period 2004-08. The docunation's monetary, financial, and payment articulates the Board's mission, ment systems so as to promote optimal sets forth major goals for the period, outlines strategies for achieving those macroeconomic performance. goals, and discusses the environment and other factors that could affect their Goals and Objectives achievement. It also addresses issues The Federal Reserve has five primary that cross agency jurisdictional lines, goals with interrelated and mutually identifies key quantitative measures of reinforcing elements: performance, and discusses performance evaluation. The 2004-05 performance plan and Goal the 2002-03 performance report were To conduct monetary policy that proposted on the Board's public web site motes the achievement of maximum in August 2004 for access by Consustainable long-term growth and the gress, the public, and the Government price stability that fosters that goal. Accountability Office (formerly the General Accounting Office). The per- Objectives formance plan sets forth specific targets for some of the performance measures • Stay abreast of recent developments identified in the strategic plan. The and prospects in the U.S. economy performance plan also describes the and financial markets, and in those operational processes and resources abroad, so that monetary policy decineeded to meet those targets and dis- sions will be well informed. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

138 91st Annual Report, 2004 • Enhance our knowledge of the struc- • Promote adherence by domestic and tural and behavioral relationships in foreign banking organizations superthe macroeconomic and financial mar- vised by the Federal Reserve with kets, and improve the quality of the applicable laws, rules, regulations, data used to gauge economic per- policies, and guidelines through a formance, through developmental comprehensive and effective superresearch activities. vision program. • 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 vices laws fully and fairly, protect and U.S. international policies and pro- promote the rights of consumers under cedures, in cooperation with the U.S. these laws, and encourage banks to meet Department of the Treasury and other the credit needs of consumers, including agencies. those in low- and moderate-income • Promote an understanding of Federal neighborhoods. Reserve policy among other government policy officials and the general Objectives public. • Maintain a strong consumer compliance supervision and complaint Goal investigation program that protects consumers and reflects the rapidly To promote a safe, sound, competitive, changing financial services industry. and accessible banking system and • Implement statutes designed to inform stable financial markets. and protect consumers that reflect congressional intent, while achieving Objectives the proper balance between consumer protection and industry costs. • Promote overall financial stability, • Promote equal access to banking manage and contain systemic risk, and services. ensure that emerging financial prob- • Promote community development in lems are identified early and successhistorically underserved areas. fully resolved before they become crises. • Provide a safe, sound, competitive, Goal and accessible banking system To provide high-quality professional through comprehensive and effective oversight of Reserve Banks supervision of U.S. banks, bank and financial holding companies, foreign Objective banking organizations, and related entities. • Produce high-quality assessments of • Enhance efficiency and effectiveness, Federal Reserve Bank operations, while remaining sensitive to the projects, and initiatives to help Fedburden on supervised institutions, by eral Reserve management foster and addressing the supervision function's strengthen sound internal control procedures, technology, resource allo- systems and efficient and effective cation, and staffing issues. performance. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

The Board of Governors and the Government Performance and Results Act 139 Goal eral Financial Institutions Examination Council (FFIEC), the most formal coor- To foster the integrity, efficiency, and dination effort has occurred jointly with accessibility of U.S. payment and settlethe other depository institution regulament systems. tory agencies.1 In addition, a coordinating committee of the depository institu- Objectives tion regulatory agencies was created to • Develop sound, effective policies and address and report on issues of mutual regulations that foster payment sys- concern. This interagency working tem integrity, efficiency, and accessi- group has been meeting since June 1997 bility. Support and assist the Board to work on issues related to those in overseeing U.S. dollar payment general goals and objectives that cross and securities settlement systems agency functions, programs, and activagainst relevant policy objectives and ities. Whether interagency coordinastandards. tion was effected through the FFIEC, • Conduct research and analysis that the coordinating group, or interaction contributes to policy development and between agency staff, the results have increases the Board's and others' been positive—resulting in improved understanding of payment system planning for the agencies and substandynamics and risk. tial benefits to the public. • Interagency Coordination 1. The FFIEC consists of the Board of Gover- Interagency coordination helps focus nors of the Federal Reserve System, the Federal efforts to eliminate redundancy and Deposit Insurance Corporation, the National lower costs. As mandated by GPRA and Credit Union Administration, the Office of the Comptroller of the Currency, and the Office of in conformance with past practice, the Thrift Supervision. It was established in 1979 pur- 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 of institutions and to make recommendations to proactivities with the U.S. Department of mote uniformity in the supervision of financial the Treasury and other agencies is evi- institutions. The FFIEC also provides uniform dent throughout both the strategic plan examiner training and has taken a lead in developing standardized software needed for major data and the performance plan. Given the collection programs to support the requirements of degree of similarity in the agencies' the Home Mortgage Disclosure Act and the Commissions and the existence of the Fed- munity Reinvestment Act. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

141 Federal Legislative Proposals In 2004, the Board of Governors pro- remove a substantial portion of the posed and supported a number of legis- incentive for depository institutions to lative initiatives that would reduce regu- engage in avoidance measures, and the latory burden on financial institutions resulting improvements in efficiency and benefit consumers without under- could be expected to eventually be mining the safety and soundness of passed through to bank borrowers and insured depository institutions, con- depositors. When depository institutions sumer protection, or other important keep their balances at Reserve Banks public policy principles, such as the as low as possible to minimize the cost principle of competitive fairness. The of holding these non-interest-bearing Board recommended that Congress assets, their actions could lead to volatiladopt legislation that, among other ity in the federal funds rate. Payment things, would remove restrictions on the of interest on balances at Reserve Banks payment of interest on balances held at could help eliminate the need for these Federal Reserve Banks and on demand actions and help ensure that the Federal deposits. The Board also recommended Reserve can continue to implement that Congress adopt legislation that monetary policy using existing prowould give the Board greater flexibility cedures. The Board therefore recomin setting reserve requirements for mended legislation that explicitly authodepository institutions and would ease rizes the payment of interest on balances restrictions on interstate branching by held by depository institutions at Fedbanks. These proposals are summarized eral Reserve Banks. below. Interest on Demand Deposits Interest on Depository Institution The Board restated in 2004 its long- Balances Held at standing recommendation that Congress Federal Reserve Banks repeal the statutory prohibition against The Board is obliged by law to establish the payment of interest on demand reserve requirements for certain depos- deposits. Since the advent of NOW its held at depository institutions, for the accounts, the prohibition has effecpurpose of implementing monetary pol- tively applied only to checking accounts icy. Banks, thrift institutions, and credit held by businesses and other for-profit unions may satisfy their reserve require- entities. At the time it enacted the ments by holding vault cash, a balance Depression-era legislation, Congress in an account at a Federal Reserve Bank, was concerned that large money center or a combination thereof. Unnecessary banks were bidding deposits away from restrictions on the payment of interest smaller community banks to make loans on balances at Reserve Banks could to stock market speculators, depriving distort market prices and lead to eco- rural areas of financing. This rationale nomically wasteful efforts to circumvent no longer appears applicable, as funds the restrictions. The payment of interest flow freely around the country and on balances at Reserve Banks would among banks of all sizes to find the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

142 91st Annual Report, 2004 most profitable lending opportunities. flexibility to adjust reserve require- The prohibition against the payment of ments: By law, the ratio of required interest on demand deposits distorts the reserves to transaction account deposits pricing of transaction deposits and asso- above a certain level must be set ciated bank services; to compete for between 8 percent and 14 percent. The businesses' liquid assets, banks have set Board in 2004 supported a legislative up complicated procedures for implic- proposal to increase the range within itly paying interest. The prohibition also which it may set transaction account distorts the pricing of other bank prod- reserve requirements, so that it could ucts. Because banks cannot pay explicit lower the requirements to zero percent interest on demand deposits, they often if, at some point in the future, the Board try to attract those deposits by pricing believes it in the best interests of moneother bank services below their actual tary policy to do so. Lower reserve cost. When services are offered below requirement ratios could be possible if cost, they tend to be overused to the explicit statutory authority to pay interextent that the benefits of consuming est on balances held by depository them are less than the costs to society of institutions at Federal Reserve Banks producing them. were to be granted concurrently with The prohibition against the payment greater flexibility in setting reserve of interest on demand deposits has also requirements. led to the introduction of deposit "sweep" services, which permit institu- Interstate Branching tions and their customers to avoid the prohibition's effects to a large extent. Currently, national and state banks are Banks spend resources—and charge permitted to expand into additional fees—for nightly sweeping businesses' states through the acquisition of another excess demand deposits into money bank. However, if they do not acquire market investments. The progress of another bank, they may open a branch in computer technology has reduced the an additional state only if the host state cost of sweep services, but the expenses has adopted legislation that expressly are not trivial, particularly when sys- permits de novo interstate branching tems must be upgraded or the diverse (an "opt-in requirement"). As of 2004, systems of merging banks must be inte- only eighteen states had enacted legisgrated. From the standpoint of the over- lation expressly authorizing interstate all economy, such expenses are a waste branching. of resources and would be unnecessary The restriction on de novo branching if the payment of interest on demand is an obstacle to interstate banking, pardeposits was allowed. ticularly for small banks that seek to operate across state lines, and may limit competition and access to banking ser- Depository Institution vices. Branch entry into new markets Reserve Requirements leads to less concentration in local bank- The Federal Reserve Act requires that ing markets, which in turn results in banks and other depository institutions better banking services for households maintain reserves against certain types and small businesses, lower interest of deposit accounts, also for the purpose rates on loans, and higher interest rates of implementing monetary policy. Cur- on deposits. Allowing banks to operate rently, the Board is constrained in its freely across state lines also benefits Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Legislative Proposals 143 customers as they become more mobile If legislative changes were to permit and live, work, and operate in multiple ELCs to branch de novo on an interstate states. The restriction also places banks basis, companies that are not supervised at a competitive disadvantage in relation or regulated on a consolidated basis to federal savings associations, which would be able to operate a nationwide are allowed to open de novo branches in banking institution. Such a result would any state. be inconsistent with the basis on which In light of the benefits, the Board the exception for ILCs initially was recommended that Congress eliminate granted—that the activities of these the opt-in requirement for interstate institutions were, and would remain, branching by banks and affirmatively limited in scope. In addition, allowing authorize national and state banks to companies to own an ILC that operates establish interstate branches on a de a nationwide banking franchise without novo basis. Under the Board's proposal, being subject to the type of consolidated the establishment and operation of new supervision generally required of the interstate branches by banks would con- owners of other insured banks would tinue to be subject to the other regula- raise significant safety and soundness tory provisions and conditions estab- concerns and place commercial banks lished by Congress for de novo interstate and their owners at a substantial branches, including the financial, mana- competitive disadvantage. Moreover, gerial, and Community Reinvestment because any type of firm, including a Act requirements set forth in the Riegle- commercial or retail firm, may own an Neal Interstate Banking and Branching ILC, permitting these institutions to Efficiency Act of 1994. branch de novo nationwide has the A special exception in existing law potential to undermine seriously the allows companies to own an FDIC- separation of banking and commerce. insured industrial loan company (ILC) For these reasons, the Board's prowithout being subject to the type of con- posal would require the owners of ILCs solidated supervision and activities re- that establish interstate branches to operstrictions generally applicable to the ate within the same supervisory regime owners of insured banks. The number, that generally applies to other compasize, and powers of ILCs generally were nies that own insured banks. Imporlimited when the ILC exception was tantly, the Board's proposal would not adopted in 1987; however, the number alter the rights of companies that own and size of ILCs operating under this ILCs that continue to operate on a limexception recently have increased sig- ited basis. • nificantly, and some states have granted ILCs essentially all the powers of commercial banks. 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

147 Record of Policy Actions of the Board of Governors Regulation B Regulation C Equal Credit Opportunity Home Mortgage Disclosure [Docket No. R-1186] Regulation E Electronic Fund Transfers On December 10, 2004, the Board revised the tables used to publicly dis- Regulation M close mortgage lending data in light of Consumer Leasing revisions to the regulation that require lending institutions to report additional Regulation Z data, including loan pricing and other Truth in Lending data, under the Home Mortgage Disclosure Act. The new data reporting Regulation DD requirements begin January 1, 2004, and Truth in Savings the revised tables are expected to be [Docket Nos. R-1168, R-1169, R-1170, implemented in summer or fall 2005. R-1167, and R-1171] Votes for this action: Chairman Green- On June 22, 2004, the Board withdrew span, Vice Chairman Ferguson, and Governors Gramlich, Olson, Bernanke, and revisions proposed in December 2003 to Kohn. Absent and not voting: Governor define more specifically the standard for Bies. providing "clear and conspicuous" disclosures to consumers and to provide a Regulation D more uniform standard for those disclo- Reserve Requirements of sures among the regulations. In light Depository Institutions of public comment, the Board concluded [Docket No. R-1213] that improving the effectiveness of the disclosures required by each regulation On October 5, 2004, the Board approved rather than adopting general definitions amendments to reflect the annual indexand standards would better ensure that ing of the low reserve tranche and of consumers receive noticeable and under- the reserve requirement exemption for standable information about consumer use in 2005 reserve requirement calfinancial products and services. culations. The amendments increase the 3 percent low reserve tranche for Votes for this action: Chairman Greennet transaction accounts to $47.6 milspan, Vice Chairman Ferguson, and Govlion (from $45.4 million in 2004) and ernors Gramlich, Bies, Olson, Bernanke, and Kohn. the reserve requirement exemption to $7 million (from $6.6 million in 2004). NOTE. Full texts of the policy actions are available via the online version of the Annual Report, Votes for this action: Chairman Greenfrom the "Reading Rooms" on the Board's FOIA span, Vice Chairman Ferguson, and Govweb page, and on request from the Board's Free- ernors Gramlich, Bies, Olson, Bernanke, dom of Information Office. and Kohn. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

148 91st Annual Report, 2004 Regulation H regulatory agencies, approved inter- Membership of agency amendments to implement pro- State Banking Institutions in the visions of the Fair and Accurate Credit Federal Reserve System Transactions Act that require financial institutions to adopt measures for prop- Regulation Y erly disposing of consumer information Bank Holding Companies and derived from consumer reports. The Change in Bank Control amendments are effective July 1, 2005. [Docket No. R-1162] Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- On July 19, 2004, the Board, acting with ernors Gramlich, Bies, Olson, Bernanke, the other federal bank and thrift reguand Kohn. latory agencies, approved interagency amendments to provide for the riskbased capital treatment of asset-backed Regulation J commercial paper program assets that Collection of Checks have been consolidated in accordance and Other Items by with Financial Accounting Standards Federal Reserve Banks and Board Interpretation No. 46, as revised Funds Transfers through Fedwire (FIN 46-R). The amendments are effec- [Docket No. R-1202] tive September 30, 2004, and replace an interim risk-based capital treatment On October 22, 2004, the Board approved in October 2003 and extended approved amendments to provide for in April 2004. the rights and obligations of depository institutions and Federal Reserve Banks Votes for this action: Chairman Green- in connection with items handled in span, Vice Chairman Ferguson, and Govelectronic form by the Reserve Banks. ernors Gramlich, Bies, Olson, Bernanke, The amendments ensure that the reguand Kohn. lation covers the entire range of checkprocessing services that the Reserve Regulation H Banks will offer in light of the Check Membership of Clearing for the 21st Century Act. They State Banking Institutions in the are effective October 28, 2004. Federal Reserve System Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- Regulation K ernors Gramlich, Bies, Olson, Bernanke, International Banking Operations and Kohn. Regulation V Fair Credit Reporting Regulation V Fair Credit Reporting Regulation Y [Docket Nos. R-1172, R-1175, and Bank Holding Companies and R-1187] Change in Bank Control On February 5, 2004, the Board, acting [Docket No. R-1199] with the Federal Trade Commission, On December 16, 2004, the Board, act- approved interagency amendments to ing with the other federal bank and thrift establish effective dates for certain pro- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 149 visions of the Fair and Accurate Credit sure requirements refers to a numerical Transactions Act (FACT Act). The amount and to provide guidance on conamendments establish December 31, sumers' exercise of the right to rescind 2003, as the effective date for the FACT certain home-secured loans. The amend- Act provisions that preempt state laws ments are effective April 1, 2004, and regulating areas governed by the Fair compliance is mandatory by October 1, Credit Reporting Act. The amendments 2004. also establish March 31, 2004, as the effective date for FACT Act provisions Votes for this action: Chairman Greenthat require no changes, or minimal span and Governors Gramlich, Bies, Olson, Bernanke, and Kohn. Absent and changes, to existing business procedures not voting: Vice Chairman Ferguson. and December 1, 2004, as the effective date for provisions that involve changes requiring a significant implementation period or regulatory action. The amend- Regulation BB ments are effective March 12, 2004, Community Reinvestment and replace an interim rule adopted in [Docket No. R-1181] December 2003 that established the December 31 effective date. On July 16, 2004, the Board withdrew proposed amendments that would have Votes for this action: Chairman Green- (1) raised the asset threshold for streamspan, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, lined Community Reinvestment Act and Kohn. (CRA) evaluations of state member banks from $250 million to $500 mil- On June 8, 2004, the Board approved lion and (2) allowed examiners to amendments providing model notices lower a state member bank's CRA rating that financial institutions may use to if the bank engaged in a pattern or comply with the notice requirements of practice of abusive asset-based lending. the FACT Act when furnishing negative In light of public comment, the Board information to consumer reporting agen- concluded that the uncertain savings cies. The amendments are effective to institutions from increasing the July 16, 2004. threshold did not clearly justify the potential adverse effects on community Votes for this action: Chairman Green- development in certain rural commuspan, Vice Chairman Ferguson, and Gov- nities. It also noted that commenters ernors Gramlich, Bies, Olson, Bernanke, were united in their opposition to definand Kohn. ing abusive asset-based lending in the regulation to the exclusion of other abusive practices. The Board and the other federal bank and thrift regulatory agencies had proposed identical amendments Regulation Z to their CRA regulations in February Truth in Lending 2004. [Docket No. R-1167] Votes for this action: Chairman Green- On March 25, 2004, the Board approved span, Vice Chairman Ferguson, and Govamendments to clarify that the term ernors Gramlich, Bies, Olson, Bernanke, "amount" in the description of disclo- and Kohn. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

150 91st Annual Report, 2004 Regulation CC Policy Statements and Availability of Funds and Other Actions Collection of Checks Unfair or Deceptive Acts or [Docket No. R-1176] Practices by State-Chartered Banks [Interagency Guidance] On July 27, 2004, the Board approved amendments that add a subpart D, with On March 9, 2004, the Board, acting commentary, to implement the Check with the Federal Deposit Insurance Cor- Clearing for the 21st Century Act. Sub- poration, issued interagency guidance on part D sets forth the new requirements the standards used by the two agencies for banks, including indorsement and to determine whether acts or practices identification requirements for substi- by state-chartered banks are unfair or tute checks, and contains model notices, deceptive under the Federal Trade including a model consumer-awareness Commission Act. The guidance also disclosure. The amendments also clarify addresses measures and "best practices" provisions of the regulation and its com- that banks may use to avoid such acts or mentary. They are effective October 28, practices. 2004, with the exception of appendix C's model consumer-awareness dis- Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Govclosure, which is effective immediately, ernors Gramlich, Bies, Olson, Bernanke, and appendix D's requirement that bank and Kohn. indorsements and identifications be printed in black ink, which is effective Policy Statement January 1, 2006. on Payments System Risk [Docket Nos. OP-1182 and OP-1191] Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and On September 22, 2004, the Board Governors Bies, Olson, Bernanke, and Kohn. Absent and not voting: Governor revised its policy to modify the daylight Gramlich. overdraft measurement rules for interest and redemption payments on securities issued by government-sponsored enterprises (GSEs) and certain international Rules of Practice for Hearings organizations and to align the treatment of the general corporate account activity [Docket No. OP-1211] of these entities with that of other Fed- On September 20, 2004, the Board eral Reserve account holders that do approved amendments to increase the not have regular access to the discount maximum amount of each statutory civil window. The revised policy also reflects money penalty under its jurisdiction to recent changes to the operating hours account for inflation, as required by the of the online Fedwire Funds Service and Debt Collection Improvement Act. The clarifies or updates certain items. The amendments are effective October 12, revisions related to GSEs and certain 2004. international organizations are effective July 20, 2006, and the other revisions Votes for this action: Chairman Green- are effective September 22, 2004. span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, Votes for this action: Chairman Greenand Kohn. span, Vice Chairman Ferguson, and Gov- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 151 ernors Gramlich, Bies, Olson, Bernanke, Reserve Banks must establish rates on and Kohn. loans to depository institutions at least every fourteen days, subject to review On November 24, 2004, the Board and determination by the Board of revised the part of its policy dealing Governors. with risks and risk management in payments and securities settlement systems. In general, the revisions expand the Primary Credit Rate policy's scope to include those Federal Primary credit is the Federal Reserve's Reserve Bank payments and securities main lending program. Primary credit is settlement systems that meet the polimade available with minimal adminiscy's application criteria, revise general tration for very short terms as a backup risk-management expectations for syssource of liquidity to depository institems subject to the policy, and incortutions that, in the judgment of the porate standards for payments and lending Federal Reserve Bank, are securities settlement systems that are in generally sound financial condition. systemically important. The revisions Primary credit is extended at a rate are effective January 2, 2005. above the Federal Open Market Committee's (FOMC's) federal funds rate Votes for this action: Chairman Greentarget. span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, During 2004, the Board approved five and Kohn. increases in the primary credit rate, bringing the rate from 2 percent to 3lA percent. The Board reached its Bank Holding Company determinations on the primary credit rate Rating System recommendations of the Reserve Bank [Docket No. OP-1207] boards of directors in conjunction with the FOMC's decisions to raise the target On December 1, 2004, the Board revised federal funds rate from 1 percent to its bank holding company rating system 2VA percent and related economic and to emphasize risk management, implefinancial developments. In the first half ment a comprehensive and adaptable of the year, disappointing employment framework for analyzing and rating growth and the continued slack in financial factors, and provide a frameresource utilization led the Board and work for assessing and rating the poten- FOMC to maintain a highly accommotial impact of a bank holding company's dative stance of monetary policy. By nondepository entities on its subsidiary midyear, however, output and employdepository institutions. The revised ratment had begun to show persistent ing system is effective January 1, 2005. improvements and there were indica- Votes for this action: Chairman Green- tions of some increase in inflation, so span, Vice Chairman Ferguson, and Gov- the Board and FOMC began to graduernors Gramlich, Bies, Olson, Bernanke, ally move the structure of policy rates and Kohn. toward a more neutral setting. Monetary policy developments are reviewed more fully elsewhere in this report (see the Discount Rates in 2004 section "Monetary Policy and Eco- Under the Federal Reserve Act, the nomic Developments" and the minutes boards of directors of the Federal of FOMC meetings held in 2004). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

152 91st Annual Report, 2004 Secondary and ernors Gramlich, Bies, Olson, Bernanke, Seasonal Credit Rates and Kohn. Votes against this action: None. Secondary credit is available in appro- August 10, 2004. Effective this date, the priate circumstances to depository insti- Board approved actions taken by the tutions that do not qualify for pri- directors of the Federal Reserve Banks mary credit. The secondary credit rate of Boston, New York, Philadelphia, is set on the basis of a formula at a Cleveland, Richmond, Atlanta, Chicago, spread—50 basis points in 2004—above Minneapolis, Kansas City, Dallas, and the primary credit rate. San Francisco to raise the rate on dis- Seasonal credit is available to smaller counts and advances under the primary depository institutions to meet liquidity credit program by VA percentage point, needs that arise from regular swings in to 2Vi percent. The same increase was their loans and deposits. The rate on approved for the Federal Reserve Bank seasonal credit is calculated every two of St. Louis, effective August 11, 2004. weeks as an average of selected money market yields, typically resulting in a Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Govrate close to the federal funds rate target. ernors Gramlich, Bies, Olson, Bernanke, At year-end, the secondary and seaand Kohn. Votes against this action: None. sonal credit rates were 33/A percent and 2.35 percent, respectively. September 21, 2004. Effective this date, the Board approved actions taken by the directors of the Federal Reserve Banks Votes on Discount Rate Changes of Boston, New York, Philadelphia, About every two weeks during 2004, Cleveland, Richmond, Atlanta, Chicago, the Board approved proposals by the Minneapolis, Kansas City, Dallas, and Reserve Banks to maintain the formulas San Francisco to raise the rate on disfor computing the secondary and sea- counts and advances under the primary sonal credit rates. Details on the five credit program by VA percentage point, actions by the Board to approve changes to 1?/A percent. The same increase was in the primary credit rate are provided approved for the Federal Reserve Bank below. of St. Louis, effective September 22, 2004. June 30, 2004. Effective this date, the Board approved actions taken by the Votes for this action: Chairman Greendirectors of the Federal Reserve Banks span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, of Boston, New York, Philadelphia, and Kohn. Votes against this action: None. Cleveland, Richmond, Atlanta, Chicago, Minneapolis, Kansas City, Dallas, and San Francisco to raise the rate on dis- November 10, 2004. Effective this date, counts and advances under the primary the Board approved actions taken by the credit program by VA percentage point, directors of the Federal Reserve Banks to 2VA percent. The same increase was of Boston, New York, Philadelphia, approved for the Federal Reserve Bank Cleveland, Richmond, Atlanta, Chicago, of St. Louis, effective July 1, 2004. Minneapolis, and Kansas City to raise the rate on discounts and advances Votes for this action: Chairman Green- under the primary credit program by span, Vice Chairman Ferguson, and Gov- VA percentage point, to 3 percent. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 153 same increase was approved for the Fed- directors of the Federal Reserve Banks eral Reserve Bank of St. Louis, effective of Boston, New York, Philadelphia, November 12,2004. Cleveland, Richmond, Atlanta, Chicago, The Board also approved identical Minneapolis, Kansas City, Dallas, and actions subsequently taken by the direc- San Francisco to raise the rate on distors of the Federal Reserve Banks of counts and advances under the primary San Francisco, effective November 10, credit program by lA percentage point, 2004, and Dallas, effective Novem- to 3V4 percent. The same increase was ber 12, 2004. approved for the Federal Reserve Bank of St. Louis, effective December 15, Votes for this action: Chairman Green- 2004. span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, Votes for this action: Chairman Greenand Kohn. Votes against this action: None. span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, December 14, 2004. Effective this date, and Kohn. Votes against this action: the Board approved actions taken by the None. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

155 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 2004. 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, 2004 themselves as to the reasons for their votes; in such cases, the range of then- 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

156 91st Annual Report, 2004 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. The Federal Reserve with the Treasury or the individual agencies Bank of New York shall set a minimum or to allow them to mature without replace- lending fee consistent with the objectives of ment; provided that the aggregate amount of the program and apply reasonable limitations U.S. Government and Federal agency securi- on the total amount of a specific issue that ties held in such Account (including forward may be auctioned and on the amount of commitments) at the close of business on the securities that each dealer may borrow. The day of a meeting of the Committee at which Federal Reserve Bank of New York may action is taken with respect to a domestic reject bids which could facilitate a dealer's policy directive shall not be increased or ability to control a single issue as deterdecreased by more than $12.0 billion during mined solely by the Federal Reserve Bank of the period commencing with the opening of New York. business on the day following such a meeting and ending with the close of business on 3. In order to ensure the effective conduct of the 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 mainobligations 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 (c) To sell U.S. Government securities foreign and international accounts mainand obligations that are direct obligations of, tained at the Bank. Transactions undertaken or fully guaranteed as to principal and inter- with such accounts under the provisions of est by, any agency of the United States to this paragraph may provide for a service fee dealers for System Open Market Account when appropriate. 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 157 in exceptional circumstances the degree of The Committee perceives that the upside pressure on reserve positions and hence the and downside risks to the attainment of susintended federal funds rate. Any such adjust- tainable growth for the next few quarters are ment shall be made in the context of the roughly equal. The probability of an unwel- Committee's discussion and decision at its come fall in inflation has diminished in most recent meeting and the Committee's recent months and now appears almost equal long-run objectives for price stability and to that of a rise in inflation. 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, 2004 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, 2004 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, 20041 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 farther 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 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 sentences below for inclusion in the in paragraph 2 below, provided that drawings by either party to any such arrangement press statement to be released shortly shall be fully liquidated within 12 months after the December 9, 2003, 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 9, 2003. cifically authorizes a delay. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

158 91st Annual Report, 2004 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 159 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 paragraph 3 G(l) of the Board of Governors' Operations Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks In Effect January 1, 2004 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, 2004 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

160 91st Annual Report, 2004 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. Geithner, Vice Chairman swap drawings. Mr. Bernanke Ms. Bies C. Any operation that might generate a Mr. Ferguson substantial volume of trading in a particular Mr. Gramlich currency by the System, even though the Mr. Hoenig change in the System's net position in that Mr. Kohn currency might be less than the limits speci- Ms. Minehan fied in LB. Mr. Olson Ms. Pianalto D. Any swap drawing proposed by a Mr. Poole foreign bank not exceeding the larger of (i) $200 million or (ii) 15 percent of the size Messrs. McTeer, Moskow, Santomero, of the swap arrangement. and Stern, Alternate Members of the Federal Open Market 2. The Manager shall clear with the Com- Committee mittee (or with the Subcommittee, if the Subcommittee believes that consultation Messrs. Broaddus, Guynn, and Parry, with the full Committee is not feasible in the Presidents of the Federal Reserve time available, or with the Chairman, if the Banks of Richmond, Atlanta, Chairman believes that consultation with and San Francisco respectively the Subcommittee is not feasible in the time available): Mr. Reinhart, Secretary and Economist Mr. Bernard, Deputy Secretary A. Any operation that would result in a Ms. Smith, Assistant Secretary change in the System's overall open position Mr. Mattingly, General Counsel in foreign currencies exceeding $1.5 billion Mr. Baxter, Deputy General Counsel since the most recent regular meeting of the Ms. Johnson, Economist Committee. Mr. Stockton, Economist B. Any swap drawing proposed by Mr. Connors, Ms. Cumming, a foreign bank exceeding the larger of Messrs. Fuhrer, Hakkio, Howard, (i) $200 million or (ii) 15 percent of the Madigan, Rasche, Slifman, size of the swap arrangement. Sniderman, and Wilcox, Associate Economists 3. The Manager shall also consult with the Subcommittee or the Chairman about pro- Mr. Kos, Manager, System Open posed swap drawings by the System and Market Account about any operations that are not of a routine character. Mr. Ettin2, Deputy Director, Division of Research and Statistics, Board of Governors Meeting Held on January 27-28, 2004 Messrs. Oliner and Struckmeyer, Associate Directors, Division of A meeting of the Federal Open Market Research and Statistics, Board Committee was held in the offices of of Governors the Board of Governors of the Federal Messrs. Clouse,2 and Whitesell, Deputy Reserve System in Washington, D.C., Associate Directors, Division of starting at 2:00 p.m. on Tuesday, Jan- Monetary Affairs, Board of uary 27, 2004, and continuing at Governors 9:00 a.m. on Wednesday, January 28, 2004. 2. Attended Wednesday's session only. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 161 Mr. Kamin and Ms. Zickler,3 Deputy these individuals had executed their Associate Directors, Divisions oaths of office. of International Finance and The elected members and alternate Research and Statistics members were as follows: respectively, Board of Governors Mr. English, Assistant Director, Timothy F. Geithner, President of the Fed- Division of Monetary Affairs, eral Reserve Bank of New York, with a Board of Governors vacancy in the position of alternate member for the Federal Reserve Bank Mr. Skidmore, Special Assistant to the of New York Board, Office of Board Members, Board of Governors Cathy E. Minehan, President of the Federal Reserve Bank of Boston, with Messrs. Nelson and Wood,3 Senior Anthony M. Santomero, President of Economists, Divisions of the Federal Reserve Bank of Philadel- Monetary Affairs and International phia, as alternate Finance respectively, Board of Governors Sandra Pianalto, President of the Federal Reserve Bank of Cleveland, with Mr. Carpenter,3 Economist, Division Michael H. Moskow, President of the of Monetary Affairs, Board of Federal Reserve Bank of Chicago, as Governors alternate Mr. Luecke, Senior Financial Analyst, William Poole, President of the Federal Division of Monetary Affairs, Reserve Bank of St. Louis, with Rob- Board of Governors ert D. McTeer, Jr., President of the Federal Reserve Bank of Dallas, as Ms. Low, Open Market Secretariat alternate Assistant, Division of Monetary Affairs, Board of Governors Thomas M. Hoenig, President of the Federal Reserve Bank of Kansas City, with Messrs. Eisenbeis, Evans, Goodfriend, Gary H. Stern, President of the Fed- Ms. Mester, Messrs. Rolnick eral Reserve Bank of Minneapolis, as and Rosenblum, Senior Vice alternate Presidents, Federal Reserve Banks of Atlanta, Chicago, Richmond, Following this meeting the board of Philadelphia, Minneapolis, and directors of the Federal Reserve Bank of Dallas respectively New York appointed Christine M. Cum- Messrs. Elsasser and Rudebusch, ming to the position of First Vice Presi- Vice Presidents, Federal Reserve dent of the Bank, effective February 6, Banks of New York and 2004. The directors also elected her to San Francisco respectively serve as an alternate member of the Federal Open Market Committee repre- In the agenda for this meeting, it was senting the Federal Reserve Bank of reported that advices of the election of New York. Subsequently, Ms. Cumming the following members and alternate executed her oath of office as an altermembers of the Federal Open Market nate member of the Committee, effec- Committee for the period commencing tive for the period from February 20 to January 1, 2004, and ending Decem- December 31, 2004. ber 31, 2004, had been received and that By unanimous vote, the following officers of the Federal Open Market 3. Attended portion of meeting relating to the Committee's review of the economic outlook. Committee were elected to serve until Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

162 91st Annual Report, 2004 the election of their successors at the By unanimous vote, the Committee first regularly scheduled meeting of the amended its Program for Security of Committee after December 31, 2004, FOMC Information on January 27, with the understanding that in the event 2004, by making small clarifying addiof the discontinuance of their official tions or changes relating especially to connection with the Board of Governors electronic transmissions of confidential or with a Federal Reserve Bank, they information. would cease to have any official con- By unanimous vote, the Authorizanection with the Federal Open Market tion for Domestic Open Market Opera- Committee: tions was amended in the form shown below. Alan Greenspan Chairman Timothy F. Geithner Vice Chairman Vincent R. Reinhart Secretary and Authorization for Domestic Economist Normand R.V. Bernard Deputy Secretary Open Market Operations Michelle A. Smith Assistant Secretary 1. The Federal Open Market Committee J. Virgil Mattingly, Jr. General Counsel authorizes and directs the Federal Reserve Thomas C. Baxter, Jr. Deputy General Bank of New York, to the extent neces- Counsel sary to carry out the most recent domestic Karen H. Johnson Economist policy directive adopted at a meeting of the David J. Stockton Economist Committee: (a) To buy or sell U.S. Government Thomas A. Connors, Christine M. securities, including securities of the Federal Cumming, Jeffrey C. Fuhrer, Craig S. Financing Bank, and securities that are direct Hakkio, David H. Howard, Brian F. obligations of, or fully guaranteed as to Madigan, Robert H. Rasche, Lawrence principal and interest by, any agency of the Slifman, Mark S. Sniderman, and United States in the open market, from or to David W. Wilcox, Associate securities dealers and foreign and interna- Economists tional accounts maintained at the Federal Reserve Bank of New York, on a cash, regular, or deferred delivery basis, for the System By unanimous vote, the Federal Open Market Account at market prices, and, Reserve Bank of New York was selected for such Account, to exchange maturing U.S. to execute transactions for the System Government and Federal agency securities Open Market Account until the adjourn- with the Treasury or the individual agencies ment of the first regularly scheduled or to allow them to mature without replacemeeting of the Committee after Decem- ment; provided that the aggregate amount of U.S. Government and Federal agency securiber 31, 2004. ties held in such Account (including forward By unanimous vote, Dino Kos was commitments) at the close of business on the selected to serve at the pleasure of the day of a meeting of the Committee at which Committee as Manager, System Open action is taken with respect to a domestic Market Account, on the understanding policy directive shall not be increased or decreased by more than $12.0 billion during that his selection was subject to being the period commencing with the opening of satisfactory to the Federal Reserve Bank business on the day following such a meetof New York.4 ing and ending with the close of business on the day of the next such meeting; (b) To buy U.S. Government securities, 4. Secretary's note: Advice subsequently was obligations that are direct obligations of, or received that the selection of Mr. Kos as Manager fully guaranteed as to principal and interest was satisfactory to the board of directors of the by, any agency of the United States, from Federal Reserve Bank of New York. dealers for the account of the Federal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 163 Reserve Bank of New York under agree- System Open Market Account, to sell U.S. ments for repurchase of such securities or Government securities to such accounts on obligations in 65 business days or less, at the bases set forth in paragraph l(a) under rates that, unless otherwise expressly autho- agreements providing for the resale by such rized by the Committee, shall be determined accounts of those securities in 65 business by competitive bidding, after applying rea- days or less on terms comparable to those sonable limitations on the volume of agree- available on such transactions in the market; ments with individual dealers; provided that and (b) for New York Bank account, when in the event Government securities or agency appropriate, to undertake with dealers, subissues covered by any such agreement are ject to the conditions imposed on purchases not repurchased by the dealer pursuant to the and sales of securities in paragraph l(b), agreement or a renewal thereof, they shall be repurchase agreements in U.S. Government sold in the market or transferred to the Sys- and agency securities, and to arrange corretem Open Market Account. sponding sale and repurchase agreements (c) To sell U.S. Government securities between its own account and such foreign, and obligations that are direct obligations of, international, and fiscal agency accounts or fully guaranteed as to principal and inter- maintained at the Bank. Transactions underest by, any agency of the United States to taken with such accounts under the prodealers for System Open Market Account visions of this paragraph may provide for a under agreements for the resale by dealers service fee when appropriate. of such securities or obligations in 65 busi- 4. In the execution of the Committee's ness days or less, at rates that, unless other- decision regarding policy during any interwise expressly authorized by the Committee, meeting period, the Committee authorizes shall be determined by competitive bidding, and directs the Federal Reserve Bank of New after applying reasonable limitations on York, upon the instruction of the Chairman the volume of agreements with individual of the Committee, to adjust somewhat in dealers. exceptional circumstances the degree of 2. In order to ensure the effective conduct pressure on reserve positions and hence the of open market operations, the Federal Open intended federal funds rate. Any such adjust- Market Committee authorizes the Federal ment shall be made in the context of the Reserve Bank of New York to lend on an Committee's discussion and decision at its overnight basis U.S. Government securities most recent meeting and the Committee's held in the System Open Market Account long-run objectives for price stability and to dealers at rates that shall be determined sustainable economic growth, and shall be by competitive bidding. The Federal Reserve based on economic, financial, and mone- Bank of New York shall set a minimum tary developments during the intermeeting lending fee consistent with the objectives of period. Consistent with Committee practhe program and apply reasonable limitations tice, the Chairman, if feasible, will consult on the total amount of a specific issue that with the Committee before making any may be auctioned and on the amount of adjustment. securities that each dealer may borrow. The Federal Reserve Bank of New York may The amendment to the authorization reject bids which could facilitate a dealer's ability to control a single issue as deter- for domestic open market operations mined solely by the Federal Reserve Bank of involved the addition of a reference in New York. paragraph 3 to accounts held at the Fed- 3. In order to ensure the effective conduct eral Reserve Bank of New York pursuof open market operations, while assisting ant to fiscal agency instructions from in the provision of short-term investments for foreign and international accounts main- the Secretary of the Treasury. Accounts tained at the Federal Reserve Bank of New listed in paragraph 3, which include York and accounts maintained at the Federal those maintained by the Bank on behalf Reserve Bank of New York as fiscal agent of official foreign and international of the United States pursuant to Section 15 accounts, are eligible for participation in of the Federal Reserve Act, the Federal Open Market Committee authorizes and directs the the Bank's short-term investment facil- Federal Reserve Bank of New York (a) for ity, the so-called "repo pool." Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

164 91st Annual Report, 2004 By unanimous vote, the Authoriza- defined as holdings of balances in that curtion for Foreign Currency Operations rency, plus outstanding contracts for future receipt, minus outstanding contracts for was reaffirmed in the form shown future delivery of that currency, i.e., as the below. sum of these elements with due regard to sign. 2. The Federal Open Market Commit- Authorization for Foreign tee directs the Federal Reserve Bank of Currency Operations New York to maintain reciprocal currency arrangements ("swap" arrangements) for the 1. The Federal Open Market Committee System Open Market Account for periods up authorizes and directs the Federal Reserve to a maximum of 12 months with the follow- Bank of New York, for System Open Market ing foreign banks, which are among those Account, to the extent necessary to carry out designated by the Board of Governors of the the Committee's foreign currency directive Federal Reserve System under Section 214.5 and express authorizations by the Committee of Regulation N, Relations with Foreign pursuant thereto, and in conformity with Banks and Bankers, and with the approval of such procedural instructions as the Commit- the Committee to renew such arrangements tee may issue from time to time: on maturity: A. To purchase and sell the following foreign currencies in the form of cable transfers through spot or forward transactions on Amount of the open market at home and abroad, includ- Foreign bank arrangement ing transactions with the U.S. Treasury, with ° (millions of the U.S. Exchange Stabilization Fund estab- dollars equivalent) lished by Section 10 of the Gold Reserve Act Bank of Canada 2,000 of 1934, with foreign monetary authori- Bank of Mexico 3,000 ties, with the Bank for International Settlements, and with other international financial institutions: Any changes in the terms of existing swap arrangements, and the proposed terms of any Canadian dollars Mexican pesos new arrangements that may be authorized, Danish kroner Norwegian kroner shall be referred for review and approval to Euro Swedish kronor the Committee. Pounds sterling Swiss francs Japanese yen 3. All transactions in foreign currencies undertaken under paragraph LA. above B. To hold balances of, and to have shall, unless otherwise expressly authorized outstanding forward contracts to receive or by the Committee, be at prevailing market to deliver, the foreign currencies listed in rates. For the purpose of providing an investparagraph A above. ment return on System holdings of foreign C. To draw foreign currencies and to currencies or for the purpose of adjusting permit foreign banks to draw dollars under interest rates paid or received in connection the reciprocal currency arrangements listed with swap drawings, transactions with forin paragraph 2 below, provided that draw- eign central banks may be undertaken at ings by either party to any such arrangement non-market exchange rates. shall be fully liquidated within 12 months 4. It shall be the normal practice to after any amount outstanding at that time arrange with foreign central banks for the was first drawn, unless the Committee, coordination of foreign currency transacbecause of exceptional circumstances, spe- tions. In making operating arrangements cifically authorizes a delay. with foreign central banks on System hold- D. To maintain an overall open posi- ings of foreign currencies, the Federal tion in all foreign currencies not exceeding Reserve Bank of New York shall not com- $25.0 billion. For this purpose, the overall mit itself to maintain any specific balance, open position in all foreign currencies is unless authorized by the Federal Open Mardefined as the sum (disregarding signs) of ket Committee. Any agreements or undernet positions in individual currencies. The standings concerning the administration of net position in a single foreign currency is the accounts maintained by the Federal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 165 Reserve Bank of New York with the foreign National Advisory Council on International banks designated by the Board of Governors Monetary and Financial Policies. under Section 214.5 of Regulation N shall 8. Staff officers of the Committee are be referred for review and approval to the authorized to transmit pertinent informa- Committee. tion on System foreign currency operations 5. Foreign currency holdings shall be to appropriate officials of the Treasury invested to ensure that adequate liquidity is Department. maintained to meet anticipated needs and so 9. All Federal Reserve Banks shall parthat each currency portfolio shall generally ticipate in the foreign currency operations have an average duration of no more than for System Account in accordance with para- 18 months (calculated as Macaulay dura- graph 3G(1) of the Board of Governors' tion). When appropriate in connection with Statement of Procedure with Respect to Forarrangements to provide investment facilities eign Relationships of Federal Reserve Banks for foreign currency holdings, U.S. Govern- dated January 1,1944. ment securities may be purchased from foreign central banks under agreements for By unanimous vote, the Foreign Currepurchase of such securities within 30 calrency Directive was reaffirmed in the endar days. form shown below. 6. All operations undertaken pursuant to the preceding paragraphs shall be reported promptly to the Foreign Currency Subcom- Foreign Currency Directive mittee and the Committee. The Foreign Currency Subcommittee consists of the Chair- 1. System operations in foreign currenman and Vice Chairman of the Committee, cies shall generally be directed at countering the Vice Chairman of the Board of Gover- disorderly market conditions, provided that nors, and such other member of the Board market exchange rates for the U.S. dollar as the Chairman may designate (or in the reflect actions and behavior consistent with absence of members of the Board serving on IMF Article IV, Section 1. the Subcommittee, other Board members 2. To achieve this end the System shall: designated by the Chairman as alternates, A. Undertake spot and forward purand in the absence of the Vice Chairman chases and sales of foreign exchange. of the Committee, his alternate). Meetings B. Maintain reciprocal currency of the Subcommittee shall be called at the ("swap") arrangements with selected forrequest of any member, or at the request of eign central banks. the Manager, System Open Market Account C. Cooperate in other respects with ("Manager"), for the purposes of reviewing central banks of other countries and with recent or contemplated operations and of international monetary institutions. consulting with the Manager on other mat- 3. Transactions may also be undertaken: ters relating to his responsibilities. At the A. To adjust System balances in light request of any member of the Subcommittee, of probable future needs for currencies. questions arising from such reviews and con- B. To provide means for meeting Syssultations shall be referred for determination tem and Treasury commitments in particular to the Federal Open Market Committee. currencies, and to facilitate operations of the 7. The Chairman is authorized: Exchange Stabilization Fund. A. With the approval of the Commit- C. For such other purposes as may be tee, to enter into any needed agreement or expressly authorized by the Committee. understanding with the Secretary of the Trea- 4. System foreign currency operations sury about the division of responsibility for shall be conducted: foreign currency operations between the Sys- A. In close and continuous consultatem and the Treasury; tion and cooperation with the United States B. To keep the Secretary of the Trea- Treasury; sury fully advised concerning System for- B. In cooperation, as appropriate, with eign currency operations, and to consult with foreign monetary authorities; and the Secretary on policy matters relating to C. In a manner consistent with the obliforeign currency operations; gations of the United States in the Interna- C. From time to time, to transmit tional Monetary Fund regarding exchange appropriate reports and information to the arrangements under IMF Article IV. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

166 91st Annual Report, 2004 By unanimous vote, the Procedural Chairman believes that consultation with the Instructions with Respect to Foreign Subcommittee is not feasible in the time available): Currency Operations were reaffirmed in A. Any operation that would result in a the form shown below. change in the System's overall open position in foreign currencies exceeding $1.5 billion since the most recent regular meeting of the Procedural Instructions with Committee. Respect to Foreign B. Any swap drawing proposed by a Currency Operations 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 On January 9, 2004, the continuing with respect to consultations and clearances rules, regulations, and other instructions with the Committee, the Foreign Currency of the Committee had been distributed Subcommittee, and the Chairman of the Committee. All operations undertaken pur- with the advice that, in accordance with suant to such clearances shall be reported procedures approved by the Committee, promptly to the Committee. they were being called to the Commit- 1. The Manager shall clear with the Sub- tee's attention before the January 27-28 committee (or with the Chairman, if the organization meeting to give members Chairman believes that consultation with the an opportunity to raise any questions Subcommittee is not feasible in the time available): they might have concerning them. Mem- A. Any operation that would result in a bers were asked to indicate if they change in the System's overall open position wished to have any of the instruments in foreign currencies exceeding $300 million in question placed on the agenda on any day or $600 million since the most for consideration at this meeting, and recent regular meeting of the Committee. B. Any operation that would result in a no requests for consideration were change on any day in the System's net posi- received. Accordingly, all of these tion in a single foreign currency exceed- instruments remained in effect in their ing $150 million, or $300 million when the existing form. operation is associated with repayment of The Committee considered a report swap drawings. C. Any operation that might generate a from the Manager of the System Open substantial volume of trading in a particular Market Account that discussed the feasicurrency by the System, even though the bility and costs of purchasing mortgagechange in the System's net position in that backed securities guaranteed by the currency might be less than the limits speci- Government National Mortgage Assofied in I.B. ciation (GNMA), a federal government D. Any swap drawing proposed by a foreign bank not exceeding the larger of agency. A potential advantage of trans- (i) $200 million or (ii) 15 percent of the size actions in such GNMA obligations was of the swap arrangement. their use to supplement purchases of 2. The Manager shall clear with the Comdirect Treasury securities in periods mittee (or with the Subcommittee, if the when large federal surpluses reduced Subcommittee believes that consultation with the full Committee is not feasible in the market supplies of Treasury debt. Howtime available, or with the Chairman, if the ever, the resumption of large federal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 167 deficits had led to sizable increases in reasons for policy decisions and how market supplies of Treasury obligations, those decisions related to the Commitwhich members saw as the preferred tee's longer-term objectives. However, vehicle to supply the need for perma- only limited support emerged for the nent additions to the System Open use of particular standard wording to Market Account. The report concluded express the Committee's appraisals of that outright transactions in mortgage- the economic outlook and views about backed GNMA securities were feasible the balance of risks. Indeed, several but would involve sizable start-up costs members were in favor of discontinuing and would tend to complicate the con- the use of statements regarding the balduct of System open market operations. ance of risks to the outlook and instead Against this background the Committee focusing mostly on the reasons for their decided not to initiate outright transac- policy decisions in the announcement. tions in mortgage-backed GNMA obli- At the same time, all the members indigations. It was understood, however, cated that they could support a flexible that such GNMA obligations would con- approach in which the wording of the tinue to be eligible as collateral for Sys- Committee's announcements, including tem repurchase agreements. the assessment of the balance of risks By unanimous vote, the minutes of going forward, would be adjusted graduthe meeting of the Federal Open Market ally over time in keeping with evolving Committee held on December 9, 2003, economic conditions. were approved. In further discussion the members The Manager of the System Open reviewed the potential value and draw- Market Account reported on recent backs of accelerating the publication of developments in foreign exchange mar- Committee minutes. Possible benefits kets. There were no open market opera- would include the provision of more tions in foreign currencies for the Sys- complete information sooner after meettem's Account in the period since the ings on the considerations that led the previous meeting. Committee to adopt the current stance The Manager also reported on devel- of policy. Some members expressed opments in domestic financial markets concern, however, that accelerated and on System open market transactions release of the minutes might have the in government securities and federal potential to feed back adversely on the agency obligations during the period deliberations of the Committee and on December 9, 2003 to January 27, 2004. the minutes themselves. The members By unanimous vote, the Committee rati- also emphasized the importance of fied these transactions. allowing sufficient time for them to At this meeting the Committee review and comment on the minutes and engaged in a broad-ranging discussion for reconciling differences of opinion of its communication practices. among the members of a large and geo- A portion of this discussion focused graphically dispersed committee. At the on the report of a working group that conclusion of this discussion, staff was had been directed to study how the asked to study the issue further. Committee's announcements might be The members also discussed the improved. In the course of the discus- possible advantages of making some sion, members stressed the importance changes in the content, time horizon, that they attached to conveying clearly and frequency of the individual foreto the public information regarding the casts that are summarized in the semi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

168 91st Annual Report, 2004 annual Monetary Policy Reports to the ment over the average monthly loss dur- Congress. In general, the members saw ing the first half of the year. Manufaclittle to be gained by altering the Com- turing payrolls continued to shrink in mittee's current practices in any signifi- December at about the same pace as in cant way, although some proposed rela- the previous few months, and holidaytively minor changes. It was agreed that related hiring in retail trade was below there was no need to reach a decision on average. In other sectors, job gains were such changes at this time, but staff was recorded in construction, education and instructed to ascertain the degree of health services, and professional and interest on the part of the members in business services. Average weekly hours making possible minor adjustments to of production or nonsupervisory workcurrent procedures. ers declined somewhat in December, The Committee then turned to a dis- reversing the gains of the previous two cussion of the economic outlook and the months. Aggregate hours worked by conduct of monetary policy over the nonfarm employees fell in December intermeeting period. but in the fourth quarter as a whole The economy appeared to have posted their first quarterly increase since expanded at a robust pace in the fourth 2000. Despite the weak payroll data, the quarter, though well below the excep- unemployment rate, which is measured tional pace recorded in the third quar- by the household survey, fell to 5.7 perter. Consumer spending continued to cent in December, in part because of a increase at a solid rate over the final further decline in the labor force particithree months of the year, and activity in pation rate. Initial claims for unemploythe residential sector remained at a very ment insurance continued to drift down high level. On the business side, out- in the weeks following the reference lays for equipment and software likely week for the December employment posted moderate gains in the fourth report, suggesting improved job growth quarter, and firms apparently accumu- in January. lated inventories for the first time in The pace of expansion in the industhree quarters. Despite the strong pace trial sector picked up in the fourth quarof economic activity, the labor market ter. Total industrial production rose at was improving only slowly, with private the fastest rate since the second quarpayrolls showing a small acceleration in ter of 2002, and manufacturing prothe fourth quarter. Core consumer price duction posted solid and widespread inflation continued to slow, and infla- gains. High-tech industries, including tion expectations remained subdued those producing semiconductors, comover the closing months of 2003. puters, and communications equipment, The December employment report accounted for nearly one-third of the suggested that the labor market had not increase in total industrial production in gained as much momentum as previ- the fourth quarter. After having surged ously appeared to be under way. Private in the third quarter, the production of nonfarm payrolls increased only slightly motor vehicles and parts moved up in in that month, and their level in Novem- the fourth quarter at about the same rate ber was revised down appreciably. The as overall manufacturing. Outside the average monthly increase in employ- manufacturing sector, output at mines ment in the fourth quarter was indicative increased modestly in the quarter, while of a fairly weak recovery in the labor output at utilities rose appreciably, led market, although it was a clear improve- by a solid advance in electricity genera- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 169 tion that mirrored the strengthening below the levels that prevailed before in the manufacturing sector. Capacity the downturn following the terrorist utilization was unchanged in December attacks in 2001. Both fleet sales of light and remained well below its long-term vehicles and truck sales also rose signifiaverage. cantly. In the high-tech sector, real out- Sales of light vehicles jumped in lays for computing equipment and for December, and the fourth-quarter aver- software again appeared to have posted age, although below the torrid third- sizable increases in the fourth quarter, quarter pace, was well above that while spending on communications recorded for the first half of the year. equipment was little changed after three These data, along with those on retail quarters of double-digit growth. Outside sales excluding autos, were consistent transportation and high tech, nominal with a solid increase in real personal shipments were about unchanged in the consumption expenditures in the fourth fourth quarter, but the upward trend in quarter. Real disposable personal orders established since the beginning income advanced smartly in Novem- of last year was consistent with further ber. Spending was also supported by gains in spending. After holding roughly the recent stock market gains, and steady, on balance, in the first half of by greater consumer confidence as 2003, real spending on private nonresireflected in the Michigan Survey dential construction appeared to have Research Center's index of consumer slipped further in the third and fourth sentiment and the Conference Board's quarters. In the commercial and healthindex of consumer confidence, both of care sector and in the manufacturwhich stood significantly above then- ing sector, average nominal outlays average readings for 2003. in October and November were about Activity in the housing market unchanged from the previous quarter. remained very robust. In December, However, spending on other types of single-family starts edged down only a construction moved down. bit from the exceptional rate they had The book value of manufacturing and reached in November, and multifamily trade inventories excluding motor vehistarts moved up to the highest level in cles posted the third consecutive signifialmost four years. New home sales cant monthly increase in November. declined in November for the third con- Stocks at manufacturers were down a secutive month, but they were still not little on average in October and Novemfar below the record highs registered ber, but non-auto wholesalers and retailearlier in the year. Existing home sales ers accumulated inventories at a brisk had fallen back from September's high, pace. Strong increases in sales, however, though the level in November was still kept book-value inventory-sales ratios noticeably higher than average monthly at or near their recent lows. Motor vehisales in the first half of 2003. cle and parts inventories ended the year The available data suggested that noticeably above the level at the end of business purchases of transportation the third quarter. equipment strengthened in the fourth The international trade deficit in quarter and that spending on other cap- November shrank to its lowest level in ital goods advanced at a moderate about a year. Exports of goods and serpace. Business expenditures on aircraft vices increased to a level not recorded rebounded noticeably in the fourth quar- since early 2001, while imports fell ter, albeit to a level that was still far moderately. Recent data indicated that Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

170 91st Annual Report, 2004 the pickup in economic activity in the In reaching this decision, the Committee major foreign industrial countries con- members generally perceived the upside tinued in the fourth quarter. Japanese and downside risks to the attainment exports, machinery orders, and indus- of sustainable growth for the next few trial production rose strongly in October quarters to be roughly equal. They also and November. Euro-area manufactur- judged that the probability of an unweling data exhibited increasing strength, come fall in inflation had diminished in particularly in Germany. In the United recent months and now appeared almost Kingdom, indicators of business and equal to that of a rise in inflation. Neverretail sales in December pointed to a theless, with inflation quite low and maintained expansion. And Canadian resource use slack, the Committee employment and sales data were strong believed that policy accommodation in the fourth quarter, with the housing could be maintained for a considerable sector continuing to make a significant period. contribution to growth. The Committee's decision at the Prices of consumer goods and ser- December meeting to keep its target vices other than food and energy contin- for the federal funds rate at 1 percent ued to decelerate through the end of appeared to have been fully anticipated 2003. Overall consumer prices were flat, in financial markets, and interest on balance, over the past three months, rate futures for the first half of 2004 as a small increase in core prices and a were essentially unchanged after the large rise in food prices were offset by a announcement. But futures rates for the sizable drop in energy prices. Over the second half of the year rose a few basis year, the consumer price index posted points, presumably in response to the a moderate increase that was noticeably Committee's assessment that the probbelow that in the previous year. Core ability of an unwelcome decline in inflaconsumer prices decelerated more tion had fallen in recent months to a sharply and rose only slightly over the level almost equal to that of a rise in year. Producer prices for finished goods inflation. Subsequently, however, the were up moderately over the year, and release of the minutes for the October the advance was substantially above that FOMC meeting, which indicated that at over the previous year. The rise last year that time the Committee was concerned was due almost entirely to substantial about the possibility of persistent slack increases in food and energy prices as arising from rapid productivity growth, core producer prices rose only a little and the publication of surprisingly modafter having edged down over 2002. est growth in employment in December With regard to labor costs, the average led most market participants to push hourly earnings of production or non- back the date of the expected onset of supervisory workers on private nonfarm tightening by several months to some payrolls rose modestly in the twelve time in the fall. Reflecting the change in months ending in December, an increase policy expectations, intermediate- and somewhat below that over 2002. longer-term nominal Treasury yields At its meeting on December 9, 2003, declined substantially over the interthe Federal Open Market Committee meeting period. Yields on inflation- (FOMC) adopted a directive that called indexed debt fell by nearly as much, for maintaining conditions in reserve suggesting that the drop in nominal markets consistent with keeping the yields owed more to lower real interest federal funds rate at around 1 percent. rates than to reduced inflation compen- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 171 sation. Yields on investment-grade and able financing conditions. Some slight most speculative-grade securities moved downward pressure on core consumer down by about the same amount as price inflation was anticipated in the Treasury yields. Major equity indexes forecast given the ongoing slack in labor rose strongly in response to the declines and product markets. in yields and positive news about the In the Committee's discussion of curoutlook for profits. rent and prospective economic develop- The exchange value of the dollar, as ments, the members commented that the measured by the major currencies index, information that had become available declined moderately on net over the since the December meeting had tended intermeeting period. Ongoing investor to validate their earlier assessment that concerns about the ability of the United the expansion was firmly established States to finance its current account defi- and that robust economic growth, under cit reportedly were again a primary fac- way since about mid-2003, was likely to tor exerting pressure on the dollar. continue as the year progressed. Many M2 fell in December, the fourth con- emphasized that business expenditures secutive monthly decline. The decline in now appeared to be on a solid upward M2 over the fourth quarter was the larg- trajectory amid widespread reports of est on record since the start of consistent much improved business sentiment. data collection in 1959. The weakness Indeed, business expenditures had was concentrated in liquid deposits and, broadened the sources of significant to a lesser extent, in retail money market strength in the expansion, which earlier mutual funds and appeared to be due in had been sustained mainly by houselarge part to the unwinding of a previous hold and government spending. Factors buildup in deposits associated with underlying a favorable outlook for ecoheavy mortgage refinancing activity and nomic activity continued to include to portfolio shifts by households into stimulative fiscal and monetary policies, equities. accommodative conditions in financial The staff forecast prepared for this markets, and the positive effects of a meeting indicated that the momentum in strong uptrend in productivity on busieconomic activity that had built up in ness investment incentives and, with the second half of 2003 would carry some lag, on household incomes. The over into the first half of the current year members nonetheless expressed disapand that the ongoing gains in spending pointment that the acceleration in ecoand production would soon result in a nomic activity had thus far failed to more visible improvement in labor mar- generate significant strengthening in ket conditions. The considerable stimu- employment, though they pointed to a lus being provided by fiscal and mone- number of positive signs in labor martary policies was expected to keep kets. Given their expectations of persistaggregate demand on a solid uptrend. In ing above-trend economic growth, they addition, improving labor market condi- saw increasing demand for workers as a tions and the effects of strong produc- likely prospect going forward. Regardtivity growth on permanent income were ing the outlook for inflation, members projected to support household spend- observed that wide margins of slack in ing, while business investment spending labor and product markets continued to was seen as strengthening in response hold down wages and prices, especially to the acceleration in business output, given the concurrent strength in producswelling profits, and continued favor- tivity. Core consumer inflation appeared Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

172 91st Annual Report, 2004 to have drifted lower recently, and a the improved financial condition of number of members mentioned the many business firms, the general availpossibility of a modest further decline in ability of financing on favorable terms, such inflation from its current subdued and the temporary tax incentive on level. Over the year ahead, however, the expenditures for new equipment. Anecmembers generally anticipated little net dotal reports from business contacts change in consumer price inflation. about capital spending plans were In keeping with the practice at meet- indicative of appreciable further accelings preceding the Federal Reserve's eration in business expenditures on a semi-annual report to the Congress on widening range of capital goods. While the economy and monetary policy, the many contacts indicated that replacemembers of the Board of Governors and ment demand or the cost-saving opporthe presidents of the Federal Reserve tunities provided by more productive Banks had provided individual projec- new equipment were still the driving tions of the growth of GDP, the rate of factors in guiding investment decisions, unemployment, and consumer price there were more reports of investment inflation for the year 2004. The fore- spending to expand capacity. casts pointed to a continuation of rela- The members also viewed business tively vigorous growth in economic inventory investment as likely to proactivity, some further decline in unem- vide some support to the economic ployment, and a quite low rate of infla- expansion over the year ahead. Business tion. Specifically, the forecasts of the inventories were at exceptionally low expansion in real GDP between the levels in relation to sales, and if farther fourth quarter of 2003 and the fourth brisk growth in demand broadly in line quarter of 2004 had a central tendency with current forecasts materialized this of 4V2 to 5 percent and a full range of year, business firms could be expected 4 to 5Vz percent. The projections of the to make commensurate additions to civilian unemployment rate in the fourth their inventories. Indeed, inventories quarter of 2004 were all in a range of appeared to have turned up in the fourth 5V4 to 5Vi percent. Forecasts of con- quarter after declining on balance earlier sumer price inflation for the year, as in 2003 as businesses evidently became measured by the PCE chain-type price more confident that increases in their index, were centered in a range of 1 to sales would be sustained. 1V4 percent, with a full range of 1 to While business expenditures had IV2 percent. turned up, employers had continued to In their discussion of developments display a high degree of caution in across the nation, members emphasized hiring new workers. Employment had growing indications of rising business trended up since mid-2003 after a proconfidence and, despite persisting soft- tracted period of job losses, but the gains ness in a number of industries, more were significantly weaker than was typiwidespread signs of increasing business cal at similar stages of earlier business spending for equipment and software cycles. A key factor that had tended and for inventories. The members cited to hold down hiring was the continuing a variety of factors that pointed to a ability of business firms to meet increasfurther pickup in business capital expen- ing demand by improving productivity ditures over the coming year, includ- with existing workforces rather than ing the strength in new orders and ship- hiring new workers. Against this backments, increasing profits and cash flow, ground, labor markets continued to be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 173 described as soft in most areas, albeit jected to diminish under existing legwith more signs of at least modest islation. In this regard, one member improvement. In this regard, members questioned whether a robust expansion referred to positive developments such would be sustained once the fiscal as the decline in initial claims and the impulse was removed. Some members rise in aggregate hours worked in the expressed concern about the longer-run fourth quarter. Looking ahead, the mem- prospects for large federal deficits and bers saw considerably faster growth their implications for the future perforin employment as a likely prospect in mance of the economy. the context of further strengthening in In their comments about the interaggregate demand and expectations of national economy, members noted that some slowing in the growth of produc- the strengthening in economic activity tivity from its extraordinary pace in abroad and the decline in the foreign recent quarters. Several emphasized, exchange value of the dollar had boosted however, that the timing and extent of exports. Even so, the ongoing strength the improvement in employment were in imports was still producing a widensubject to considerable uncertainty. ing trade deficit, and net exports were The household sector was continu- expected to be a small arithmetic drag ing to supply major impetus to the on domestic economic activity over the expansion. Household spending was year ahead. Some members indicated benefiting from stimulative fiscal and that they were concerned about the monetary policies, the wealth effects of implications of the nation's rapidly rising real estate and equity prices, and growing external debt for domestic increased consumer confidence about financial markets and the economy over the economic outlook. Members noted time. that retailers in many parts of the coun- In the Committee's discussion of try reported solid sales during the holi- the outlook for inflation, the members day period. With respect to the outlook agreed that increases in core consumer for overall consumer spending, it was prices were likely to remain muted suggested that the elevated growth of this year, with ongoing strength in the productivity could be expected to raise expansion only gradually reducing the incomes over time and thereby help to current output gap and anticipated gains buttress consumption even as the stimu- in productivity exerting downward preslus from earlier tax cuts faded. Residen- sure on costs and prices. Some members tial construction activity remained at a commented, however, that the relahigh level, evidently supported in part tionship between the output gap and by recent declines in mortgage interest inflation was quite loose and that the rates. Contacts in the housing industry outlook for productivity remained indicated that they expected a high level uncertain. Accordingly, while members of construction activity in 2004, though agreed that changes in core consumer perhaps not as robust as in 2003. price inflation were likely to be limited, Fiscal policy was providing consider- there was some divergence of opinion able stimulus to the economy and would about the most probable direction. In the continue to do so in the first part of this view of many, some modest further disyear, reflecting the large tax refunds inflation appeared to be the most likely anticipated as a result of overwithhold- prospect. A few members noted that ings in 2003. Beyond the nearer term, such disinflation, if it was associated however, the fiscal stimulus was pro- with rapid growth in productivity, could Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

174 91st Annual Report, 2004 be viewed as non-threatening. More- accommodative policy stance, but for over, the expected strength in aggre- now they judged that it was desirable to gate demand would curb the extent of take risks on the side of assuring the disinflation over time. A few members rapid elimination of economic slack. expressed the differing view that core With regard to the wording of the consumer prices might well edge up Committee's press statement to be over the course of the year in light of the released shortly after the meeting, memconsiderable stimulus stemming from bers discussed at some length the desircurrent monetary and fiscal policies and ability of retaining a reference from earthe possibility that the expected pickup lier statements to the prospect that an in economic activity and employment, accommodative policy could be mainespecially if it were on the high side of tained "for a considerable period." The current forecasts, would be associated existing language had been explicitly with slower growth in productivity. The qualified at the December meeting by evidence pointing to the possibility of tying it to low inflation and slack in an uptick in inflation was still quite resource use, thereby underscoring the limited, but some members noted that in notion that a move away from the curaddition to sizable advances in the prices rent degree of policy accommodation of many commodities including oil, would depend on economic conditions reports from business contacts indicated rather than simply on the passage of that a few firms had been able to raise time. All the members agreed that a their selling prices and maintain them change in wording was desirable, not at higher levels in an effort to pass on to signal a policy tightening move in increases in costs. Overall, however, the near term, but rather to increase the the pricing power of business firms Committee's flexibility to take such an remained quite limited. action when it was deemed to be desir- In the Committee's discussion of pol- able and to underline that any such icy for the intermeeting period ahead, decision would be made on the basis of all the members favored an unchanged evolving economic conditions. Howpolicy stance that was directed toward ever, some differences of opinion arose maintaining reserve conditions consis- with regard to the specific proposal tent with a target federal funds rate of under consideration, namely to remove 1 percent. While the members were per- the reference to "considerable period" suaded that a relatively vigorous eco- and to substitute one referring to nomic expansion was now firmly estab- "patience." Those who fully endorsed lished and was likely at some point to the proposal believed that the new wordcall for a move toward a more neutral ing conveyed important information policy stance, they concluded that such about the Committee's strategy in an an adjustment was not warranted under environment of price stability and ecocurrent circumstances. In this regard nomic slack and under those circumthey stressed that unused labor and other stances was unlikely to have outsized resources remained substantial, that effects in financial markets. A number inflation was at a very low level, and of members commented that expectathat inflation was not expected to change tions of sustained policy accommoappreciably in either direction over the dation appeared to have contributed to year ahead. Members acknowledged valuations in financial markets that left that there were risks in maintaining what little room for downside risks, and the might eventually prove to be an overly change in wording might prompt those Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 175 markets to adjust more appropriately to Kohn, Ms. Minehan, Mr. Olson, Ms. Pianchanging economic circumstances in the alto, and Mr. Poole. Vote against this action: None. future. A few members, while expressing agreement with respect to the merits It was agreed that the next meeting of of a language change, nonetheless prethe Committee would be held on Tuesferred to drop the reference to a "conday, March 16, 2004. siderable period" entirely without sub- The meeting adjourned at 1:45 p.m. stituting a reference to the Committee's on January 28, 2004. ability to be patient. In this view, even the replacement language would tend to Vincent R. Reinhart shape expectations in ways that could Secretary complicate the conduct of policy, and with the economy in a strong uptrend, the Committee no longer needed to uti- Meeting Held on lize such special language. March 16, 2004 At the conclusion of the meeting, the A meeting of the Federal Open Market Committee voted to authorize and direct Committee was held in the offices of the Federal Reserve Bank of New York, the Board of Governors of the Feduntil it was instructed otherwise, to eral Reserve System in Washington, execute transactions in the System D.C., on Tuesday, March 16, 2004, at Account in accordance with the follow- 9:00 a.m. ing domestic policy directive: The Federal Open Market Committee Present: seeks monetary and financial conditions that Mr. Greenspan, Chairman will foster price stability and promote sus- Mr. Geithner, Vice Chairman tainable growth in output. To further its long- Mr. Bernanke run objectives, the Committee in the imme- Ms. Bies diate future seeks conditions in reserve Mr. Ferguson markets consistent with maintaining the Mr. Gramlich federal funds rate at an average of around Mr. Hoenig 1 percent. Mr. Kohn Ms. Minehan Mr. Olson The vote encompassed approval of Ms. Pianalto the paragraph below for inclusion in the Mr. Poole press statement to be released shortly after the meeting: Messrs. McTeer, Moskow, Santomero, and Stern, Alternate Members of The Committee perceives that the upside the Federal Open Market and downside risks to the attainment of sus- Committee tainable growth for the next few quarters are roughly equal. The probability of an unwel- Messrs. Broaddus, Guynn, and Parry, come fall in inflation has diminished in Presidents of the Federal Reserve recent months and now appears almost equal Banks of Richmond, Atlanta, and to that of a rise in inflation. With inflation San Francisco respectively quite low and resource use slack, the Committee believes that it can be patient in Mr. Reinhart, Secretary and Economist removing its policy accommodation. Mr. Bernard, Deputy Secretary Ms. Smith, Assistant Secretary Votes for this action: Messrs. Green- Mr. Mattingly, General Counsel span, Geithner, Bernanke, Ms. Bies, Ms. Johnson, Economist Messrs. Ferguson, Gramlich, Hoenig, Mr. Stockton, Economist Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

176 91st Annual Report, 2004 Messrs. Connors, Fuhrer, Howard, Mr. Kahn, Vice President, Federal Madigan, Rasche, Sniderman, Reserve Bank of Kansas City Slifman, and Wilcox, Associate Economists The Manager of the System Open Mr. Kos, Manager, System Open Market Account reported on recent Market Account developments in foreign exchange markets. There were no open market opera- Mr. Ettin, Deputy Director, Division tions in foreign currencies for the Sysof Research and Statistics, tem's account in the period since the Board of Governors previous meeting. Messrs. Struckmeyer and Oliner, The Manager also reported on devel- Associate Directors, Division opments in domestic financial markets of Research and Statistics, and on System open market transactions Board of Governors in government securities and securities Messrs. Clouse, Freeman, and issued or fully guaranteed by federal Whitesell, Deputy Associate agencies during the period January 28, Directors, Divisions of Monetary 2004, through March 15, 2004. By Affairs, International Finance, and unanimous vote, the Committee ratified Monetary Affairs respectively, these transactions. Board of Governors The information reviewed at this Mr. English, Assistant Director, meeting suggested that economic activ- Division of Monetary Affairs, ity continued to expand at a solid pace Board of Governors in early 2004. Consumer spending growth appeared to have picked up Mr. Skidmore, Special Assistant to the Board, Office of Board somewhat, and activity in the housing Members, Board of Governors market remained at high levels. In the business sector, spending for equipment Mr. Sack, Section Chief, Division and software was apparently advancing of Monetary Affairs, vigorously, and firms were adding Board of Governors modestly to their inventories. Still, the Mr. Luecke, Senior Financial Analyst, increases in economic activity had not Division of Monetary Affairs, yet generated sizable gains in employ- Board of Governors ment. Core consumer price inflation remained low, and expectations of Ms. Low, Open Market Secretariat future inflation continued to be subdued. Assistant, Division of Monetary Affairs, Board of Governors The January and February employment reports depicted a labor market Mr. Moore, First Vice President, that was slow to pick up momentum. Federal Reserve Bank of The modest gains posted in private non- San Francisco farm payrolls over the period were Messrs. Eisenbeis, Evans, Judd, Lacker, smaller than had been expected by most Mses. Mester and Perelmuter, forecasters. Employment in the manu- Messrs. Rolnick, Rosenblum, and facturing sector, which had fallen con- Steindel, Senior Vice Presidents, tinually for over three years, was essen- Federal Reserve Banks of Atlanta, tially unchanged in February, while Chicago, San Francisco, Richmond, Philadelphia, employment in other sectors showed New York, Minneapolis, Dallas, mixed changes. Average weekly hours and New York respectively of production or nonsupervisory work- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 111 ers edged above the average level of sentiment remained above the levels the fourth quarter of 2003. Despite the seen during most of 2003. weakness in employment, the unem- Activity in the housing market modployment rate in January and Febru- erated in January and February from its ary came in below its fourth-quarter elevated pace in the fourth quarter. level. Single-family housing starts and permits Industrial production moved up stepped down, although both measures briskly in January and February fol- remained above their average levels of lowing strong increases in the fourth the first three quarters of 2003. Housing quarter. These gains in production were starts in the multifamily sector slipped realized across a wide set of industries. only slightly from the fourth quarter High-tech industries, including semi- pace, even though vacancy rates reached conductors, computers, and communi- a record high level in the fourth quarter. cations equipment, posted particularly Sales of new and existing homes slowed strong advances, while the production of in January, but this change retraced only motor vehicles and the output of other a small part of the extraordinary run-up manufacturing sectors were also strong. in home sales that began last spring. Outside the manufacturing sector, power Home prices continued to rise briskly. generation by utilities surged in January Spending on capital goods had but fell back in February in response to advanced at a vigorous pace in the outsized swings in average temperatures fourth quarter and appeared to be conduring those months. Capacity utiliza- tinuing that growth early this year. tion continued to move higher in Janu- Spending by businesses was supported ary and February, although it remained by increases in their sales and the conbelow its longer-run average. tinuation of strong cash flows and a Consumer spending growth in recent low user cost of capital. Nominal shipmonths appeared to pick up somewhat ments of computing and communication from its pace in the fourth quarter of equipment moved up sharply in recent 2003. Retail sales rose briskly, on aver- months, as did shipments outside the age, in January and February, and spend- high-tech sector. By contrast, business ing on services was up in January (the investment in transportation equipment most recent month for which data were was mixed. Data for new orders of nonavailable). In contrast, purchases of defense capital goods excluding aircraft motor vehicles slipped in January and suggested that the strength in capital February from the strong pace in the expenditures would continue going forfourth quarter. Overall, expenditures ward. As has been the case for some were supported by sizable gains in time, real spending on private nonresireal disposable personal income and dential structures languished, and vacanincreases in household wealth owing to cies in industrial buildings and office rising home and equity prices. Dispos- properties were at high levels. able income was boosted by significant Real nonfarm inventory investment growth in private wages and salaries and remained modest in recent months. by a drop in taxes that was due to the Although manufacturers' inventories lower final payments and higher refunds moved higher in January, that increase associated with last year's tax cut. Sur- primarily reflected stockbuilding at proveys indicated that consumer sentiment ducers of petroleum and coal products. moved higher in January but subse- Retail inventories also rose in January, quently fell back. Despite the pullback, as stocks at auto dealers increased; Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

178 91st Annual Report, 2004 wholesalers accumulated inventories at ished and was almost equal to that of a a modest pace. Inventory-sales ratios in rise in inflation. With inflation low and these sectors lingered at or near their resource use slack, the Committee saw historical lows. no need for tightening policy in the near The U.S. international trade deficit future. However, to provide additional rose to a record high level in January. flexibility to adjust monetary policy at a Exports of goods and services fell, later date once such action was deemed owing importantly to a drop in agricul- appropriate given economic developtural exports. Imports edged lower, with ments, the Committee removed from higher oil imports partly offsetting its post-meeting statement the explicit declines in most other categories. reference to a "considerable period" Recent data suggested that economic and substituted a statement that conactivity in major foreign industrial coun- veyed the sense that it could be patient tries strengthened outside the euro area, in removing its policy accommodation. notably including a sizable jump in Although the Committee's decision at Japan's output in the fourth quarter. the January meeting to keep the federal Growth in the euro area remained tepid. funds rate unchanged had been widely Core consumer price inflation stayed anticipated, the changes in the wording very low in early 2004. Over the twelve of the accompanying statement elicited months ending in January, the increase a sharp reaction in financial markets. in core consumer prices was around Investors moved up the date when they 1 percent—about 3/4 percentage point expected policy tightening to combelow the increase over the preceding mence, resulting in a jump in Treasury twelve months. Total consumer price yields. Over the balance of the interinflation, however, was boosted in Janu- meeting period, however, the Chairary by a surge in energy prices. Incom- man's testimony on monetary policy and ing information on trends in labor costs data on nonfarm payroll employment were more mixed. The average hourly with a weakish cast persuaded investors earnings of production or nonsuper- that policy tightening was still some visory workers on private nonfarm ways off. Treasury yields declined conpayrolls rose modestly over the twelve siderably in response and ended the months ending in February, decelerating intermeeting period lower, on balance. from its year-earlier pace. By contrast, Yields on inflation-indexed securities the employment cost index for hourly also fell, leaving measures of inflation compensation in private industry grew a compensation little changed. bit faster over the twelve months ending Yields on investment-grade bonds in December than over the year-earlier generally moved in tandem with those period. on Treasuries over the intermeeting At its meeting on January 27-28, period, but spreads on high-yield bonds 2004, the Federal Open Market Com- widened as investors reassessed credit mittee decided to leave its target for the risks in light of the negative tone of federal funds rate unchanged at 1 per- some incoming economic data. The cent. The Committee also retained its disappointing employment data and assessment that the upside and down- renewed concerns about terrorism conside risks to the attainment of sustain- tributed to a decline in broad equity able growth were roughly equal as well price indexes. Technology-related as its judgment that the probability of an issues, which had registered very large unwelcome fall in inflation had dimin- gains over the preceding year or so, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 179 fell more sharply. The foreign exchange economic activity still seemed to be value of the dollar against other major increasing at a solid pace, though percurrencies declined through the middle haps not quite as quickly as some memof February but subsequently rebounded bers had anticipated at the time of to end the intermeeting period higher. the January meeting. Investment spend- After four consecutive months of ing had continued to advance, and the decline, M2 rose slightly in January and manufacturing sector, which had lagged accelerated markedly in February. The the rest of the economy earlier in the effects of mortgage refinancing, which expansion, had extended recent gains. had depressed M2 growth in the second Residential construction activity was half of last year, appeared to wane, down somewhat from the very high levallowing the expansion in nominal els posted late last year, but increases income to show through to M2 growth. in household wealth and the effects of The staff forecast prepared for this last year's tax cuts continued to buoy meeting indicated that economic activ- consumer spending. Despite the gains ity would continue to expand at a solid in spending and production, however, pace through 2005. Monetary policy is employment growth had been disapexpected to support growth over the pro- pointing. While job losses had moderjection period, and fiscal policy is antici- ated, hiring had yet to strengthen, holdpated to remain accommodative through ing down net increases in employment. 2004. In addition, structural produc- Nonetheless, the breadth of the expantivity growth is projected to remain sion was seen as providing considerable substantial this year and next. Strong assurance of its sustainability, and Comadvances in real disposable income were mittee members generally expected that expected to keep consumer spending accommodative monetary policy, favoron a solid upward trajectory. Business able financial market conditions, and, spending on equipment and software at least in the near term, fiscal stimuwas seen as increasing briskly as a result lus would continue to foster a pace of of sizable profits, an improving outlook output growth that exceeded that of for demand, and continued favorable its potential. Although economic slack financing conditions. Also, inventory likely would be declining, it was investment was anticipated to rise expected to be a little higher than gradually as businesses became more previously had been anticipated. Prices convinced that final demand was for energy, commodities, and non-oil expanding along a sustainable track. The imports were rising, however, and some pace of economic expansion was fore- business contacts had reported seeing a casted to be sufficient to reduce resource return of "pricing power." On balance, slack over this year and next, although inflation was expected to remain near its the employment data received over the current low level. intermeeting period indicated that this In their discussion of economic develprocess would begin from a higher rate opments across the nation, a number of of unused resources than had been previ- Committee members noted some slipously expected. Core inflation was propage in business and consumer confijected to remain low over the forecast dence from the high levels reached late period. last year. While business contacts in In the Committee's discussion of cur- some regions remained optimistic about rent and prospective economic develop- prospects for their sales and planned to ments, the members noted that overall increase investment and, in some cases, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

180 91st Annual Report, 2004 employment, firms in other parts of the investing primarily to replace old equipcountry had become somewhat more ment or to reduce costs, but remained uncertain about the pace of the expan- hesitant to expand capacity. The comsion going forward. Those firms, as mercial real estate sector remained a result, were more wary about com- weak, on balance, although some memmitting to new investment plans or bers suggested that market conditions increased hiring. Financial markets also were stabilizing and, in a few cases, seemed a little less positive about the even beginning to improve. outlook, with stock prices lower and Committee members noted that activsome risk spreads wider than at the time ity in the housing sector, while still of the last meeting. The reasons for the quite elevated, had fallen back from reduced optimism were not entirely its extraordinary pace of late last year. clear but may have included higher However, some of the moderation may energy and commodity prices as well have owed to the effects of severe winas renewed concerns about terrorism. ter weather rather than more lasting Some members also pointed to the per- influences, and the recent decline in sistent weakness in employment, which mortgage interest rates was expected to might be seen as reducing the odds that support the housing sector going forhousehold spending would continue ward. Reports from some contacts sugto expand briskly once the stimulative gested that speculative forces might be effects of tax cuts waned. Lingering boosting housing demand in some parts business caution likely accounted for a of the country, with concomitant effects good deal of the lag in job creation, but on prices, suggesting the possibility that some members also pointed to a number house prices might be moving into the of other factors that might be restraining high end of the range that could be hiring, including ongoing opportunities consistent with fundamentals. to increase efficiency through organiza- Consumer spending outside the auto tional changes and new investments, the sector had remained strong, with data effects on labor costs of increases in the and retail contacts generally suggesting costs of benefits, and, in some selected continued growth in sales this year. industries and regions, a shortage of Committee members noted that sales job candidates with appropriate skills. had been bolstered by rising asset prices The extent and duration of the result- and the effects of last year's tax cuts on ing restraint on hiring were difficult refunds and final payments. By contrast, to assess, however, and the Committee sales of motor vehicles had fallen back continued to expect employment growth noticeably, reflecting in part reductions to pick up as the expansion progressed. in incentives. However, members antici- In their comments about demand in pated that sales would pick up again, key sectors of the economy, members partly in response to an anticipated indicated that investment spending had rebound in incentives. Looking forward, continued to expand at a robust pace. gains in employment and the pass- Members anticipated vigorous growth through of higher productivity to wages in investment outlays going forward, and salaries were also expected to boost supported by rapid productivity growth, consumer spending, even as the stimuhigh profits and cash flow, and accom- lus to growth from tax cuts faded and modative financial markets. Despite this increases in home and equity prices generally upbeat assessment, a number likely slowed from their rapid pace in of members reported that firms were recent quarters. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 181 The Committee anticipated that gov- in slack accompanied by higher unit ernment spending would provide some labor costs and associated pressures on further support for aggregate demand prices. Other members were less certain going forward. The budget pressures that inflation had leveled out. Recent that had constrained state and local gov- price trends were not clear, with some ernment expenditures of late were eas- measures of core inflation still declining in some cases, and federal outlays ing. Increases in commodity prices were expected to rise. Fiscal policy was remained limited to a few selected seen as providing less stimulus to aggre- industries, and with the persistence of gate demand in 2005 than this year, but slack in labor and product markets, core the federal budget deficit was expected inflation might well edge lower once to remain substantial. any transitory influences had ebbed. In their remarks concerning the exter- Moreover, if productivity were to nal sector of the economy, members expand at a rapid pace rather than slowcited the decline in the value of the ing, unit labor costs could fall, putting dollar on foreign exchange markets downward pressure on prices. since the middle of last year and In the Committee's discussion of polstronger economic growth in many of icy for the intermeeting period, all the our trading partners as factors boost- members favored the retention of the ing the demand for exports in a variety current target rate of 1 percent for the of industries. While exports were likely federal funds rate. This preference for to continue to advance, the value of an unaltered stance of policy was based U.S. imports was expected to rise as on the absence of significant changes well, implying continued very large cur- in economic conditions or in the memrent account deficits. Some Committee bers' basic assessment of the outlook members noted that opportunities to cut since the January meeting. To be sure, costs had led some of their business some of the incoming information— contacts to consider moving production notably with regard to labor market abroad. developments—had been somewhat dis- In their review of the outlook for appointing, but the Committee continprices, members generally anticipated ued to see the conditions in place for that core inflation would remain near further solid economic growth. Simicurrent low levels, with output growth larly, despite the rise in energy and comonly gradually eliminating slack in labor modity prices and reports of increased and goods markets and strong growth pricing power in some sectors, many in productivity limiting increases in unit Committee members commented that labor costs. Some members thought that persisting slack in labor and output marcore inflation had stabilized and was kets would keep inflation low. In these unlikely to move lower. Increases in the circumstances, the current accommodaprices of energy, other commodities, and tive stance of monetary policy remained non-oil imports, as well as reports from appropriate. Some members, while supsome business contacts that higher costs porting an unchanged policy at this were increasingly being passed through meeting, nonetheless emphasized that to prices, suggested that the downtrend the maintenance of a very accommodain inflation had ended. Moreover, if, as tive monetary policy over an extended some members thought likely, produc- period in concert with a stimulative tivity growth slowed as employment fiscal policy called for careful attention picked up, the result could be reductions to the possible emergence of inflation- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

182 91st Annual Report, 2004 ary pressures. And, while adjustments the post-meeting statement would be to in financial markets to low rates had update the descriptions of the economic generally been consistent with the usual expansion and labor market conditions operation of the monetary transmission in light of the information received over mechanism, some members were con- the intermeeting period. cerned that keeping monetary policy At the conclusion of the discussion, stimulative for so long might be encour- the Committee voted to authorize and aging increased leverage and excessive direct the Federal Reserve Bank of New risk-taking. Such developments could York, until it was instructed otherwise, heighten the potential for the emergence to execute transactions in the System of financial and economic instability Account in accordance with the followwhen policy tightening proved neces- ing domestic policy directive. sary in the future. At present, however, the persistence of low inflation coupled The Federal Open Market Committee with soft labor markets underscored seeks monetary and financial conditions that the desirability of a monetary policy will foster price stability and promote susstrategy characterized by continued tainable growth in output. To further its longpatience. run objectives, the Committee in the immediate future seeks conditions in reserve In the Committee's discussion of its markets consistent with maintaining the statement to be released shortly after federal funds rate at an average of around this meeting, the members saw merit in 1 percent. not changing the characterization of the risks to the outlook for inflation and The vote encompassed approval of economic activity. Many members held the paragraph below for inclusion in the that a case could be made for moving to Committee's statement to be released a balanced risk assessment with regard shortly after the meeting: to the outlook for inflation, with a number of them expressing a marginal The Committee perceives that the upside preference for such a change. However, and downside risks to the attainment of susother members thought the evidence for tainable growth for the next few quarters arca balanced risk assessment was not yet roughly equal. The probability of an unwelcompelling and pointed out that with come fall in inflation has diminished in inflation quite low and slack in labor recent months and now appears almost equal to that of a rise in inflation. With inflation and output markets likely to persist for a quite low and resource use slack, the Comwhile longer, the costs to the economy mittee believes that it can be patient in associated with a further decline in infla- removing its policy accommodation. tion likely outweighed those associated with a comparable increase. While many Votes for this action: Messrs. Greenviewed it as a close call, all members span, Geithner, Bernanke, Ms. Bies, indicated that they could support a pro- Messrs. Ferguson, Gramlich, Hoenig, posal to retain the existing wording Kohn, Ms. Minehan, Mr. Olson, Ms. Pianinvolving a slight tilt toward the possi- alto, and Mr. Poole. Vote against this action: None. bility of some further disinflation. The members also agreed on the desirability of retaining the assessment that the risks It was agreed that the next meeting of with regard to the outlook for economic the Committee would be held on Tuesgrowth were balanced. Accordingly, it day, May 4, 2004. was agreed that the only changes in The meeting adjourned at 1:00 p.m. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 183 Notation Vote Ms. Johnson, Economist Mr. Stockton, Economist By notation vote completed on March 18, 2004, the Committee unani- Messrs. Connors, Fuhrer, Hakkio, Howard, Madigan, Rasche, mously approved the minutes of the Struckmeyer, Tracy, and Wilcox, meeting of the Federal Open Market Associate Economists Committee held on January 27-28, 2004. Mr. Kos, Manager, System Open Market Account Vincent R. Reinhart Secretary Mr. Ettin, Deputy Director, Division of Research and Statistics, Board of Governors Meeting Held on Messrs. Slifman and Oliner, Associate May 4, 2004 Directors, Division of Research and Statistics, Board of Governors A meeting of the Federal Open Market Committee was held in the offices of Messrs. Clouse and Whitesell, Deputy the Board of Governors of the Fed- Associate Directors, Division of eral Reserve System in Washing- Monetary Affairs, Board of ton, D.C., on Tuesday, May 4, 2004, at Governors 9:00 a.m. Messrs. English and Sheets, Assistant Present: Directors, Divisions of Monetary Mr. Greenspan, Chairman Affairs and International Finance Mr. Geithner, Vice Chairman respectively, Board of Governors Mr. Bernanke Ms. Bies Mr. Simpson, Senior Adviser, Division Mr. Ferguson of Research and Statistics, Mr. Gramlich Board of Governors Mr. Hoenig Mr. Kohn Mr. Skidmore, Special Assistant to the Ms. Minehan Board, Office of Board Members, Mr. Olson Board of Governors Ms. Pianalto Mr. Poole Mr. Bassett, Economist, Division of Monetary Affairs, Board of Messrs. McTeer, Moskow, Santomero, Governors and Stern, Alternate Members of the Federal Open Market Committee Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Board of Governors Messrs. Broaddus and Guynn, Presidents of the Federal Reserve Banks of Richmond and Atlanta Ms. Low, Open Market Secretariat respectively Assistant, Division of Monetary Affairs, Board of Governors Mr. Reinhart, Secretary and Economist Mr. Bernard, Deputy Secretary Messrs. Connolly and Moore, First Ms. Smith, Assistant Secretary Vice Presidents, Federal Mr. Mattingly, General Counsel Reserve Banks of Boston and Mr. Baxter, Deputy General Counsel San Francisco respectively Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

184 91st Annual Report, 2004 Messrs. Eisenbeis, Evans, Goodfriend, was taken at this meeting because of the Judd, Ms. Mester, and provision that each party must provide Mr. Rolnick, Senior Vice six months prior notice of an intention Presidents, Federal Reserve Banks of Atlanta, Chicago, Richmond, to terminate its participation. San Francisco, Philadelphia, and The Manager also reported on devel- Minneapolis respectively opments in domestic financial markets and on System open market transactions Mr. Altig, Ms. Hargraves, and in government securities and securities Mr. Koenig, Vice Presidents, issued or fully guaranteed by federal Federal Reserve Banks of Cleveland, New York, and Dallas agencies during the period March 16, respectively 2004, through May 3, 2004. By unanimous vote, the Committee ratified these By unanimous vote, the minutes of transactions. the meeting of the Federal Open Market The information reviewed at this Committee held on March 16, 2004, meeting suggested that the economy were approved. expanded at a rapid pace in the first By unanimous vote, Joseph S. Tracy quarter. Consumer spending and the was elected to serve as associate econo- housing market continued to exhibit mist until the first regularly scheduled strength. Business fixed investment meeting of the Committee after Decem- grew smartly, reflecting increased outber 31, 2004, with the understanding lays for equipment and software that that in the event of the discontinuance more than offset a significant fall in of his official connection with a Federal investment in nonresidential structures. Reserve Bank or with the Board of Gov- The labor market displayed further signs ernors, he would cease to have any offi- of improvement during the quarter, cial connection with the Committee. capped by a significant increase in pri- The Manager of the System Open vate payrolls in March. Recent increases Market Account reported on recent in the prices of imports and commodidevelopments in foreign exchange mar- ties showed through to a pickup in core kets. There were no open market opera- consumer price inflation during the first tions in foreign currencies for the Sys- quarter, although some of the categories tem's account in the period since the that registered large gains had posted previous meeting. unusually small increases earlier. By unanimous vote, the Committee The labor market showed renewed voted to extend for one year beginning vigor during the first quarter. The in mid-December 2004 the reciprocal growth in payroll employment during currency ("swap") arrangements with March pushed the average monthly gain the Bank of Canada and the Bank of for the first quarter as a whole well Mexico. The arrangement with the Bank above that of the fourth quarter of last of Canada is in the amount of $2 billion year. Hiring during the quarter was equivalent and that with the Bank of widespread across industries, with large Mexico in the amount of $3 billion increases in construction, retail trade, equivalent. Both arrangements are asso- and business and nonbusiness services. ciated with the Federal Reserve's par- Net job losses in manufacturing, which ticipation in the North American Frame- had waned during the winter, reportedly work Agreement. The vote to renew came to an end by March. Some surthe System's participation in the swap veys of business hiring intentions also arrangements maturing in December suggested renewed strength. However, a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 185 small decline in the average workweek pace of single-family housing starts conduring March held down the increase in tinued to display appreciable strength. aggregate hours, which rose at a slightly Sales of new homes jumped to a record slower pace in the first quarter than in level in March, and sales of existing the fourth quarter. Moreover, the unem- homes increased to their highest level ployment rate ticked up to 5.7 percent in since last September. In the multi- March, and the labor force participation family sector, construction activity also rate remained low. remained robust through March, even Despite a weather-related decline in though the vacancy rate for multifamily output at utilities during March, the pace units reached a record high in the first of industrial production quickened dur- quarter. ing the first quarter, and the gains were Business fixed investment continued widespread across industry and market to be supported by favorable underlying groups. The high-tech sector accounted fundamentals, including increased corfor a significant part of the increase, as porate cash flow, a low user cost of output of computers and semiconduc- capital, and, at least as judged by surtors rose rapidly. Production of other vey data, increased business confidence business equipment also increased in the sustainability of the economic markedly, and indexes for business and expansion. Outlays for equipment and construction supplies were up notably. software expanded at a vigorous pace in Motor vehicle assemblies were slightly the first quarter, with the exception of higher for the first quarter as a whole, spending on transportation equipment. although they slowed in March. Manu- Shipments of nondefense capital goods facturing capacity utilization rose for the excluding aircraft were strong, espesecond consecutive quarter, but to a rate cially outside the high-tech industries. well below its long-run average. Avail- Within the high-tech sectors, rapid able weekly physical product data for growth of shipments of communications April were up slightly. equipment offset declines in the com- Real consumer spending grew at a puters and peripherals category. By somewhat faster pace in the first quarter contrast, investment in nonresidential than it had in the fourth quarter. Retail structures fell considerably in the first sales rose briskly, with strength wide- quarter, and vacancy rates for industrial spread across spending categories, while buildings and office properties remained expenditures on services also posted a high. substantial increase. Light vehicle sales Real nonfarm inventories increased a were down slightly for the first quarter bit more in the first quarter than they as a whole, but they firmed in March. had in the fourth quarter. Motor vehicle Solid growth in wages and salaries and inventories at the retail and wholesale an increase in tax refunds generated a levels accounted for the entire increase, large increase in real disposable per- while non-auto inventories ran off sonal income in the first quarter. Mea- slightly. In particular, manufacturers sures of consumer confidence were continued to reduce their stocks, though roughly stable in March and April. at a slower pace than last year. Inven- Residential housing activity remained tory accumulation lagged growth in high in the first quarter despite a marked sales and shipments, and the inventoryrise in mortgage interest rates. Smooth- sales ratio edged down further. ing through weather-related swings in The U.S. international trade deficit the volatile monthly data, the underlying shrank in February from January's Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

186 91st Annual Report, 2004 record high, with exports increasing costs, average hourly earnings of proacross a range of major categories of duction or nonsupervisory workers on goods. Economic growth in the major private nonfarm payrolls rose notably industrialized countries in the first quar- less for the twelve months ending in ter was uneven. The economies of Japan March than they had in the year-earlier and the United Kingdom likely contin- period. The overall increase in the ued to expand, though at paces below employment cost index for private those of late last year. In the euro area, industry for the twelve months ending in economic indicators were mixed. A March was about the same as that for moderation of growth in Canada led the the twelve-month period ending a year Bank of Canada to ease monetary policy earlier, as wages and salaries decelerfor the third time this year, citing a need ated and benefits accelerated. to support aggregate demand. Inflation At its meeting on March 16, 2004, was little changed in Canada and the the Federal Open Market Committee euro area, but it slipped further in the decided to keep its target for the fed- United Kingdom. In Japan, consumer eral funds rate unchanged at 1 percent. prices were about unchanged, while In its announcement of this decision, the wholesale prices edged up in March Committee indicated that the upside and relative to their level of a year earlier downside risks to sustainable growth and posted the first increase on a twelve- were roughly equal and that the probmonth basis since July 2000. ability of an unwelcome fall in infla- In the United States, the core con- tion had declined further so that it was sumer price index advanced at a faster almost equal to that of a rise. The Comrate in the first quarter than it had in mittee also noted in March that although the fourth quarter, reflecting the pass- output had continued to expand at a through of higher energy prices and a solid pace, new hiring had lagged, and leveling off of goods prices after sizable increases in core consumer prices were declines last year. The higher goods muted and expected to remain low. As a price inflation owed, in part, to the result, the Committee determined that it recent run-up in the prices of non-oil could remain patient in removing its polimports, energy, and other commodities. icy accommodation. The price index for core personal con- The Committee's decision at its sumption expenditures also rose at a March meeting to leave the intended faster rate in the first quarter than it had level of the federal funds rate unchanged late last year. Despite the rise in infla- had been fully anticipated in financial tion this year, however, the cumulative markets. However, market participants increase in the overall consumer price reportedly viewed the accompanying index for the year ending in March was statement as suggesting that the Comsomewhat less than the advance for the mittee had a slightly weaker outlook for twelve months ending in March 2003. In the economy than had been expected, the year ending in March, the increase and longer-dated futures rates and in the price index for total personal con- Treasury yields declined a few basis sumption expenditures was similar to points after the announcement. In that of a year earlier. Survey measures response to the generally positive tone of near-term inflation expectations of economic data—especially the edged up somewhat in March and April, release of the much stronger-thanbut measures of longer-term expecta- expected employment report for tions decreased. With regard to labor March—and congressional testimony by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 187 Chairman Greenspan, investors pushed refinancing boosted liquid deposits. The market interest rates substantially higher strength was likely offset somewhat by over the intermeeting period. By the the effects of individual non-withheld time of the FOMC meeting in early tax payments in April, which were lower May, quotes on federal funds futures than last year and therefore probably led contracts suggested that market par- to a smaller buildup in liquid deposits ticipants expected policy tightening to than incorporated in the seasonal adjustbegin sooner than previously anticipated ment factors. Although currency growth and to proceed at a faster pace once continued to be held down in the first it began. The revision to policy expec- quarter by weak demand from abroad, it tations showed through to interest moved closer to its long-term trend in rates on nominal Treasury securities, April. which climbed significantly. Yields on The staff forecast prepared for this inflation-indexed Treasury securities meeting suggested that the economy rose almost as much, implying that would continue to expand briskly for the inflation compensation only edged a rest of 2004 before decelerating somelittle higher. Yields on investment-grade what in 2005 as fiscal policy shifted to a corporate bonds rose a bit less than slightly restrictive stance. The considerthose on comparable-maturity Trea- able monetary and fiscal stimulus this suries, but risk spreads on below- year and still-strong advances in strucinvestment-grade bonds narrowed sig- tural productivity were expected to nificantly as their yields increased by cause businesses to shed still more of a more modest amount. Major equity the caution they had been exhibiting in price indexes were about unchanged, investing and hiring. The labor market as the downward pressure exerted by was projected to show steady improvehigher interest rates was offset by the ment through the end of 2004, but the effects of strong earnings reports, forecasted pace of hiring was expected upward revisions to expected future to slow a little next year as economic earnings, and other positive economic growth moderated. The staff anticipated news. that inventories would increase at a In foreign exchange markets, the dol- modest rate during the forecast horizon lar appreciated against most major cur- as businesses responded to continued rencies over the intermeeting period, strength in demand. Business spendand it also gained against an index of the ing on equipment and software was currencies of other major U.S. trading expected to remain strong, with the partners. The dollar fell sharply against expiration of the partial-expensing tax the yen early in the intermeeting period, provision at the end of 2004 adding but subsequently about reversed the impetus this year. The rise in mortgage decline. Market participants attributed rates was not likely to show through the dollar's overall gains particularly to demand for housing until the second to the stronger-than-expected U.S. half of 2004 and was expected to be economic data and the weaker-than- partially offset in the longer term by expected performance of the Canadian rising employment and personal income. economy and economies in the euro The increases in employment and area. income were also projected to continue M2 grew briskly during March and to boost consumer spending. In light of April as continued low opportunity costs recent increases in some price measures, and the temporary effects of mortgage the staff anticipated a transitory rise in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

188 91st Annual Report, 2004 the pace of core inflation in the near large advances had substantially reduced term. However, it was expected that the the odds of further disinflation and also remaining slack in resource utilization had increased their uncertainty about and strong productivity growth would prospective price trends. Still, most keep core inflation at a low level over members saw low inflation as the most the forecast period. likely outcome. In the Committee's discussion of cur- In their comments about key ecorent and prospective economic develop- nomic sectors, a number of members ments, a number of members noted that pointed to developments that were likely the outlook for production and employ- to support increased investment spendment had improved distinctly in the ing going forward. Many business firms period since the March FOMC meeting. appeared to be experiencing a signifi- Newly available data as well as com- cant pickup in demand. Anecdotal informentary from business contacts almost mation suggested that some manufacturuniformly suggested that the expansion ers had seen a notable rebound in orders, had continued to broaden and had with several members citing, in particbecome more firmly established. Statis- ular, stronger demand for high-tech tical releases confirmed that consumer products as well as for machine tools, spending was rising at a brisk rate, various types of heavy machinery, and housing activity remained at a high aircraft. Also, optimism regarding ecolevel, and business fixed investment was nomic prospects among business execugrowing vigorously. Significantly, the tives seemed to be mounting, no doubt most recent data also provided evidence prompted in part by the increased that the pace of hiring had begun to pick demand they were experiencing and up, a development that was expected to robust growth in profits. Business conprovide further support to the expansion tacts in several districts had indicated going forward. Anecdotal information that, as a result of the improved outlook, gathered from business contacts across they were taking steps to expand thenthe nation—particularly commentary capacity to produce, both by starting to suggesting rising orders, improving con- augment work forces and by boosting fidence, and a growing willingness to fixed investment. Committee members increase payrolls—tended to confirm the generally perceived overall business data that pointed to increasingly solid fixed investment as accelerating conexpansion. Prospects for growth contin- siderably, especially for equipment and ued to be supported by fiscal policy, software. In contrast, investment in nonwhich was expected to remain stimula- residential structures remained sluggish, tive through 2004, and by the effects of as vacancy rates in many markets were monetary policy accommodation. Over- elevated and considerable excess capacall, Committee members were now more ity persisted in many production plants. convinced that robust growth would be Drilling, however, was said to be sustained, and most likely at a pace that strengthening in response to high oil and would be adequate to make appreciable gas prices. headway in narrowing margins of unuti- While Committee members saw an lized resources. Regarding the outlook overall brightening in the outlook for for inflation, members took particular business fixed investment, a number of note of recent data pointing to jumps policymakers commented that some of in consumer and producer prices. Many the considerable caution that had earlier members indicated that the surprisingly marked business attitudes apparently Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 189 lingered. The pace of hiring seemed source of restraint on future household to be picking up only gradually, fixed spending. investment was still moderate in com- Fiscal policy was viewed as likely to parison with the strong cash flow being buoy the expansion of economic activity generated by robust profits, and anec- through 2004. Real federal expenditures dotal information indicated that firms had jumped in the first quarter and were in most industries were continuing to expected to rise further over the balance exercise tight control over inventories. of the year. Next year, fiscal impetus Indeed, several members remarked that was likely to diminish, largely owing to the rate of inventory investment was the expiration of the tax provision persurprisingly modest in the first quarter, mitting partial expensing of certain capialthough motor vehicle inventories were tal outlays. Assessing the prospects for on the high side. On the whole, the fiscal policy, however, was complicated evidence of continued caution and disci- by a lack of legislative progress to date plined spending in the business sector in passing federal appropriations bills. was seen as boding well for the durabil- Regarding the longer-term federal budity of the expansion. getary outlook, an apparent breakdown Members viewed the household sec- in fiscal discipline was seen as an ongotor as continuing to play a key role in ing concern; However, some progress the expansion, with recent data as well was noted in reducing budgetary imbalas anecdotal information indicating that ances at the state and local levels. consumer spending was rising at a The external sector was expected to solid pace. After dropping back in Jan- provide limited support for U.S. ecouary, auto sales had accelerated over nomic growth over the next two years. the remainder of the first quarter and Expansion of foreign economies was appeared to be well maintained in April. likely to fuel increases in U.S. exports, Expenditures for consumer services with strength expected particularly in seemed to be expanding steadily. Sev- computers and semiconductors. Real eral members noted that tourism in imports, however, also appeared likely their regions was picking up. In addi- to continue rising strongly as domestion, housing activity had stayed strong tic demand climbed further, leading to across the nation and was still climbing a widening of already substantial trade in some regions, with reports of growing and current account deficits. Some backlogs in deliveries and substantial members saw a risk that growth in cerprice increases in some markets. The tain rapidly expanding regions abroad overall vigor in household spending was could slow, perhaps sharply, with potenbeing supported by substantial gains in tially significant effects on the demand disposable income, partly reflecting tax for U.S. exports as well as on global cuts, generally sound balance sheets, commodity prices. accommodative financial conditions, After a protracted period of meager and increases in consumer sentiment gains in employment, conditions in over the past year or so. To date, the the U.S. labor market evidently were backup in fixed mortgage interest rates improving in recent weeks. In addition in recent months seemed to have had to noting the substantial jump in paylittle adverse effect on homebuying, rolls in March, several members relayed although it was noted that an appreanecdotal information from business ciable further rise in longer-term marcontacts around the nation that hiring ket rates would represent a potential was continuing to pick up and that firms Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

190 91st Annual Report, 2004 were planning further increases in work- pressures on unit labor costs, currently forces. Some temporary help firms high price markups, and longer-term reported rising demand, a possible pre- inflation expectations that apparently cursor of a pickup in permanent hiring. remained contained. Others, however, A number of members cited reports of were less confident about the degree of difficulties in hiring within certain job restraint on prices, noting that inflation families in which specialized skills were predictions based on estimated output or in short supply together with indications employment gaps were subject to conthat wage increases in those occupations siderable error. tended to be larger than average. Even In the Committee's discussion of polso, considerable slack seemed to remain icy for the intermeeting period, all of the in the labor market overall, and wage members favored maintenance of the gains on the whole were moderate. existing target of 1 percent for the fed- Data on consumer and producer eral funds rate. It was recognized that prices over the intermeeting period had the Committee would need to initiate generally come in on the high side of a process of removing monetary policy expectations, following considerable accommodation at some point, and the increases in commodity prices. A sig- recent experience suggested that the nificant number of Committee members time at which policy firming approprireported information from their contacts ately would commence might be closer that businesses were increasingly able to than previously had seemed most probpass on cost increases to their customers able. However, the appreciable rise in and to boost prices more generally. real long-term interest rates over the Some members cited instances in which intermeeting period implied that finanearlier price discounts had been can- cial market conditions had already tightceled and noted that surcharges for ened on balance. Moreover, the evihigher energy and steel prices were dence of a significant acceleration in being added to base prices for certain hiring was still limited, and some memgoods. Nonetheless, the extent to which bers referred to the possibility that these developments signaled an upturn growth could falter, particularly if marin underlying inflation was unclear. To ket yields were to rise sharply further. some degree, the recent uptick in vari- With inflation low and resource use ous price measures partly reflected slack, the Committee saw a continuation factors, such as jumps in the prices of of its existing policy stance as providing energy and non-oil imports, that were a degree of support to the economic unlikely to be repeated. Also, the recent expansion that was still appropriate. evidence could be interpreted as indicat- With regard to the Committee's ing that the surprisingly sharp decline in announcement to be released after the measured inflation in 2003 exaggerated meeting, it was understood that the the drop in the underlying rate of infla- recent evidence that hiring had picked tion. Indeed, some members saw under- up, as well as the continued solid growth lying inflation as relatively stable and in output, would be highlighted. Policyput low odds on the possibility that makers also concurred that, with the prices now were accelerating. In their expansion apparently well established, view, a range of factors was continuing the statement should again indicate that to restrain inflation, including slack in the upside and downside risks to sustainresource utilization, strong productiv- able growth for the next few quarters ity gains and corresponding downward seemed to be roughly equal. Members Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 191 saw both downside and upside risks policy to a more neutral setting would to prospects for inflation. The probable be more gradual, once under way, than persistence of slack in the economy for in past episodes when inflation was at least several more quarters, together well above levels consistent with price with the likelihood that recent substan- stability. In addition, some policymaktial gains in productivity would be ers observed that the timing and magniextended, should continue to exert slight tude of future policy adjustments would downward pressures on inflation. At the ultimately be determined by the Comsame time, though, the recent stronger- mittee's interpretation of the incomthan-expected increases in a number of ing data on the economy and prices price measures, anecdotal information rather than by its current expectation suggesting a greater ability of businesses of those developments. On balance, all to implement and sustain price hikes, the members agreed that they could and multiplying signs of solid economic accept an indication in the statement growth suggested that the upside risks that "... policy accommodation can be to inflation had increased. The members removed at a pace that is likely to be agreed that, all things considered, the measured." risks to the goal of price stability had At the conclusion of the discussion, moved into balance in the period since the Committee voted to authorize and the last meeting. direct the Federal Reserve Bank of New The Committee also discussed at York, until it was instructed otherwise, length the advantages and disadvantages to execute transactions in the System of modifying or dropping its statement Open Market Account in accordance in the announcement following the with the following domestic policy March meeting that "With inflation directive. quite low and resource use slack, the Committee believes that it can be The Federal Open Market Committee patient in removing its policy accommo- seeks monetary and financial conditions that dation." All of the members agreed that, will foster price stability and promote sustainable growth in output. To further its with policy tightening likely to begin long-run objectives, the Committee in the sooner than previously expected, the refimmediate future seeks conditions in reserve erence to patience was no longer war- markets consistent with maintaining the ranted. The Committee focused instead federal funds rate at an average of around on a formulation that would emphasize 1 percent. that policy tightening, once it began, probably could proceed at a pace that The vote encompassed approval of would be "measured." A number of the paragraph below for inclusion in the policymakers were concerned that such press statement to be released shortly an assertion could unduly constrain after the meeting: future adjustments to the stance of policy should the evidence emerging in The Committee perceives that the upside coming months suggest that an appre- and downside risks to the attainment of susciable firming would be appropriate. tainable growth for the next few quarters are roughly equal. Similarly, the risks to the goal Others, however, saw substantial beneof price stability have moved into balance. fits to inclusion of the proposed lan- At this juncture, with inflation quite low and guage. These members noted that cur- resource use slack, the Committee believes rent economic circumstances made it that policy accommodation can be removed likely that the process of returning at a pace that is likely to be measured. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

192 91st Annual Report, 2004 Votes for this action: Messrs. Green- Mr. Reinhart, Secretary and Economist span, Geithner, Bernanke Ms. Bies, Mr. Bernard, Deputy Secretary Messrs. Ferguson, Gramlich, Hoenig, Ms. Smith, Assistant Secretary Kohn, Ms. Minehan, Mr. Olson, Ms. Pian- Mr. Mattingly, General Counsel alto, and Mr. Poole. Vote against this Ms. Johnson, Economist action: None. Mr. Stockton, Economist It was agreed that the next meeting Messrs. Connors, Fuhrer, Hakkio, Howard, Madigan, Sniderman, of the Committee would be held on Slifman, Tracy, and Wilcox, Tuesday-Wednesday, June 29-30,2004. Associate Economists The meeting adjourned at 1:15 p.m. Mr. Kos, Manager, System Open Vincent R. Reinhart Market Account Secretary Messrs. Oliner and Struckmeyer, Associate Directors, Division Meeting Held on of Research and Statistics, June 29-30, 2004 Board of Governors A meeting of the Federal Open Market Messrs. Clouse and Whitesell, Deputy Committee was held in the offices of Associate Directors, Division of Monetary Affairs, Board of the Board of Governors of the Federal Governors Reserve System in Washington, D.C., on Tuesday, June 29, 2004, at 2:30 p.m. Mr. Kamin,5 Deputy Associate and continued on Wednesday, June 30, Director, Division of International 2004, at 9:00 a.m. Finance, Board of Governors Present: Messrs. Gagnon,5 Leahy,5 and Sheets, Mr. Greenspan, Chairman Assistant Directors, Division Mr. Geithner, Vice Chairman of International Finance, Mr. Bernanke Board of Governors Ms. Bies Mr. Ferguson Mr. English, Assistant Director, Mr. Gramlich Division of Monetary Affairs, Mr. Hoenig Board of Governors Mr. Kohn Ms. Minehan Mr. Simpson, Senior Adviser, Division Mr. Olson of Research and Statistics, Ms. Pianalto Board of Governors Mr. Poole Mr. Thomas,5 Section Chief, Ms. Cumming, Messrs. McTeer, Division of International Finance, Moskow, Santomero, and Stern, Board of Governors Alternate Members of the Federal Open Market Committee Ms. Kusko6 and Mr. Zakrajsek, Senior Economists, Divisions of Research Mr. Guynn and Ms. Yellen, Presidents and Statistics and Monetary of the Federal Reserve Banks of Affairs respectively, Board of Atlanta and San Francisco Governors respectively 5. Attended portion of the meeting relating to Mr. Lacker, President-Elect of the the discussion of prospective external adjustment. Federal Reserve Bank of 6. Attended portion of the meeting relating to Richmond the discussion of economic developments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 193 Mr. Carpenter,6 Economist, Division agencies during the period May 4, of Monetary Affairs, Board of 2004, through June 29, 2004. By unani- Governors mous vote, the Committee ratified these transactions. Mr. Skidmore, Special Assistant to the Board, Office of Board Members, At this meeting, the Committee dis- Board of Governors cussed staff papers and presentations on adjustment of the U.S. external accounts. Mr. Luecke, Senior Financial Analyst, At more than $500 billion, the deficits Division of Monetary Affairs, in trade and current account balances Board of Governors are quite large in comparison with aggregate income. Financing of the defi- Ms. Low, Open Market Secretariat Assistant, Division of Monetary cits had recently included both large for- Affairs, Board of Governors eign private purchases of U.S. securities and increased foreign official inflows. Mr. Lyon, First Vice President, Federal The sizable current account deficit could Reserve Bank of Minneapolis be viewed as reflecting very low levels of national saving, in both its govern- Mr. Judd, Executive Vice President, ment and private components, in rela- Federal Reserve Bank of San Francisco tion to investment opportunities in the United States that were very attractive. Messrs. Eisenbeis, Evans, Goodfriend, The staff noted that outsized external Mses. Mester and Perelmuter,5 deficits could not be sustained indefi- Messrs. Rolnick and Rosenblum, nitely. However, the historical evidence Senior Vice Presidents, Federal indicated that such deficits could be Reserve Banks of Atlanta, Chicago, Richmond, Philadelphia, quite persistent, and the adjustment of New York, Minneapolis, and imbalances was not necessarily immi- Dallas respectively nent. The adjustment, once under way, might well proceed in a relatively Ms. Goldberg5 and Mr. Thornton, benign fashion, particularly if fiscal, Vice Presidents, Federal Reserve monetary, and trade policies were appro- Banks of New York and St. Louis respectively priate, but the possibility that the adjustment could involve more wrenching By unanimous vote, the minutes of changes could not be ruled out. In any the meeting of the Federal Open Market case, a movement toward balance in the Committee held on May 4, 2004, were trade and current accounts would likely approved. have effects that differ appreciably The Manager of the System Open across sectors of the U.S. economy. Market Account reported on recent Members of the Committee noted that developments in foreign exchange mar- monetary policy was not well equipped kets. There were no open market opera- to promote the adjustment of external tions in foreign currencies for the Sys- imbalances but could best contribute by tem's account in the period since the maintaining an environment of price staprevious meeting. bility that would foster maximum sus- The Manager also reported on devel- tainable economic growth. Fiscal policy opments in domestic financial markets had a potentially larger role to play by and on System open market transactions promoting an increase in national savin government securities and securities ing, but the adjustment would involve issued or fully guaranteed by federal shifts in demand and output both domes- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

194 91st Annual Report, 2004 tically and abroad, and changes to U.S. makers trimmed outsized inventory fiscal policy alone probably would not positions. Capacity utilization moved be sufficient to foster the adjustment. higher but stayed below its long-run The information reviewed at this average. meeting suggested that the economy Growth in real consumer spending continued to expand at a solid pace dur- appeared to have slowed somewhat in ing the second quarter. Although growth recent months from its first-quarter in consumer spending appeared to have pace. Although outlays for motor vehislowed somewhat, the demand for cles in May more than retraced their housing increased from its robust first- April decline and purchases of services quarter pace. Business fixed investment, advanced at an appreciable rate, spendboosted by surging outlays on equip- ing on nondurable goods remained slugment and software, also grew rapidly. gish. Despite higher energy prices, real The labor market improved further dur- disposable personal income continued ing the quarter, with large gains in its uptrend in recent months, benefiting employment registered in April and from an improved labor market and last May. Core consumer price inflation year's tax cut. Home prices also continpicked up, reflecting in part the pass- ued to rise at a rapid pace, contributing through of substantial advances in importantly to increases in household energy prices and non-energy import wealth. Survey measures of consumer prices. confidence moved up in June from The labor market rebounded strongly already favorable levels. in recent months. Private nonfarm pay- Activity in the housing market rolls grew rapidly in April and May, increased in April and May despite a with hiring widespread across indus- considerable rise in mortgage interest tries. The manufacturing sector appeared rates. Single-family housing starts edged to be on a more solid footing, as manu- above their rapid first-quarter pace, and facturers added jobs in each of the past sales of both new and existing homes four months after more than three years reached record levels in May. In the of declines. Aggregate hours moved up volatile multifamily sector, housing in both April and May, bringing the starts fell somewhat in May, but, more level of hours substantially above its generally, construction activity in this trough of last summer. Despite the sector had been surprisingly resilient in recent strength in hiring, the unemploy- light of the high vacancy rate for such ment rate changed little in recent units. months, and the labor force participation Business investment spending aprate remained low. peared to have advanced at a brisk pace Industrial production accelerated in in the second quarter, as rising output, April and May after a sizable advance low user cost of capital, and increased in the first quarter. Output at utilities corporate cash flow continued to foster surged in the latter month, reflecting a favorable environment for capital weather-related factors, and factory out- spending. Although new orders and put excluding motor vehicles, buoyed shipments of nondefense capital goods by strong gains in both high-tech manu- excluding aircraft dipped in May, both facturing industries and in most non- series remained on a solid uptrend, high-tech industries, expanded sharply and, with orders exceeding shipments, in both months. In contrast, the produc- backlogs continued to grow. Spending tion of motor vehicles declined as auto- on transportation equipment, which Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 195 dropped in the first quarter, appeared to foreign industrial countries expanded at rebound in recent months, while outside a healthy pace in the first quarter. Indithe transportation and high-tech sectors, cators of economic activity in the secincreases in spending moderated from ond quarter for Canada and the United their rapid first-quarter pace. After Kingdom were also favorable, whereas declining in the first quarter, overall those for the euro area were somewhat investment in nonresidential structures mixed. Japan's economy, supported by appeared to pick up a little in the second robust private domestic demand and risquarter, though the performance of the ing consumer confidence, evidently conmajor types of construction remained tinued to expand strongly in the second mixed. Spending on office buildings and quarter. Mainly as a result of higher manufacturing structures continued to energy prices, consumer price inflation be depressed by high vacancy rates, moved up a bit in the second quarter while outlays for commercial buildings in Canada, the United Kingdom, and the moved up in conjunction with declines euro area, while slight deflation perin vacancy rates for such structures. In sisted in Japan. addition, judging by the number of natu- Consumer price inflation turned up ral gas drilling rigs in operation, spend- this year from the very low rates regising on drilling and mining structures tered in 2003, both for overall measures rose in recent months. and for those that exclude food and The pace of inventory accumulation energy. Overall consumer prices rose remained subdued. Although the book more quickly than core prices, reflecting value of manufacturing and trade inven- the direct contributions of substantial tories increased appreciably in the first increases in prices of food and energy. quarter and continued to rise at about But the step-up in core inflation was the same pace in April, the recent large also due in part to the pass-through of increases in the book-value data were higher energy and import costs into core due importantly to a jump in the price of consumer prices. Some survey measures oil and a run-up in the prices of interme- of short-term inflation expectations diate materials. Inventory-sales ratios in moved higher in recent months, but manufacturing and retail trade edged longer-term expectations remained reahigher in April but remained near their sonably well contained. Commodity historical lows; meanwhile, inventory- prices escalated sharply during the early sales ratios in the wholesale trade sector months of 2004, but indexes of spot trended lower. prices for industrial materials and for The U.S. international trade deficit wholesale gasoline retreated appreciably reached a new record in April, reflecting in recent weeks. Meanwhile, labor costs in large part a sharp decline in exports appeared to have turned up in the first of goods. The fall in goods exports was half of the year. Hourly compensation in widespread, with notable decreases in private industry rose in the first quarter capital goods, industrial supplies, and at the same rate as in 2003, but with the agricultural products. Exports of ser- pace of productivity advance moderatvices, in contrast, increased in April. ing, unit labor costs moved higher. In Imports of goods edged higher, as a April and May, increases in average large decline in the value of imported oil hourly earnings of production or nonwas offset by an increase in imports supervisory workers on private nonfarm of non-oil products, and imports of ser- payrolls exceeded the monthly gains vices increased. Real GDP in the major registered in the first quarter and were Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

196 91st Annual Report, 2004 well above the increases in the fourth on nominal Treasury securities, which quarter of 2003. increased commensurately. Yields on At its meeting on May 4, 2004, the inflation-indexed Treasury securities Federal Open Market Committee rose almost as much as those on their decided to leave its target for the federal nominal counterparts, leaving inflation funds rate unchanged at 1 percent. The compensation only slightly higher, on Committee retained its assessment that net, by the end of the intermeeting the upside and downside risks to the period. Yields on investment- and attainment of sustainable growth were speculative-grade corporate securities roughly equal, but it announced that the rose about the same amount as those risks to the goal of price stability had on comparable Treasuries, leaving risk moved into balance. The Committee spreads about unchanged. Generally also noted that output had continued positive economic news and further to expand at a solid pace, new hiring improvements in the outlook for corpohad appeared to pick up, and although rate earnings evidently offset the influincoming data on inflation showed ence of higher interest rates, and major that it had moved somewhat higher, equity indexes edged higher over the longer-term inflation expectations had intermeeting period. In foreign exchange remained well contained. Reflecting markets, the dollar depreciated somethese developments, the Committee what against major currencies, and it concluded that it could remove policy rose a bit against an index of currencies accommodation at a pace that was likely of other major U.S. trading partners. to be measured. M2 continued to expand rapidly in The Committee's decision at its May May. The upswing in M2 growth since meeting to leave the intended level of late winter stemmed in part from the the federal funds rate unchanged had temporary effects of mortgage refinancbeen fully anticipated by market partici- ing, which boosted liquid deposits over pants. Likewise, the replacement of the this period, though M2 was also buoyed sentence in the announcement reporting by strong gains in nominal income. In that the Committee could be patient recent months, a rebound in currency in removing policy accommodation with growth and reduced portfolio shifts by one indicating that policy accommoda- households from monetary assets to tion can be removed at a pace that is equities and bonds also supported the likely to be measured had little net effect expansion of M2. The growth of M2 on money market futures rates on the slowed appreciably during the first half day of the announcement. Over the bal- of June. Commercial bank credit decelance of the intermeeting period, how- erated in May, reflecting a contraction in ever, market participants marked up sig- bank holdings of securities and a slownificantly the extent of expected policy down in the growth of loans. The slowtightening in response to data that indi- ing in loan growth was concentrated cated robust gains in employment and mainly in real estate credits and was due spending and somewhat elevated infla- partly to heavy securitizations. tion, as well as to comments by Com- The staff forecast prepared for this mittee members providing reassurance meeting suggested that the economy that policy would be tightened as neces- would continue to expand at a solid sary to contain any incipient inflationary pace through 2005. Monetary policy pressures. Revisions to policy expecta- was expected to support economic activtions showed through to interest rates ity over the projection period, and fiscal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 197 policy was anticipated to remain accom- with notable improvement in labor marmodative through 2004. Moreover, per- ket conditions and in manufacturing sisting strong gains in structural produc- activity. Members saw the persistence tivity would likely continue to provide of a relatively vigorous expansion in significant impetus to spending. With overall economic activity as a likely firms shedding their unusual caution prospect in the context of continuing of the past few years, further large stimulus from fiscal and monetary additions to payrolls over the next policies, accommodative financial conseveral quarters were anticipated, fol- ditions, growing business optimism, lowed by a gradual moderation in the favorable consumer sentiment, and rate of increase in employment. Strong robust increases in productivity. Solid profits, sustained increases in aggregate increases in economic activity and demand, and a favorable financing envi- employment should in turn provide ronment were expected to keep business ongoing support to business and conspending on equipment and software sumer spending. Members acknowlon a healthy upward trajectory over the edged that their favorable outlook for forecast period. The impending expira- economic activity was based on the tion of the partial-expensing tax provi- assumption that major terrorist disrupsion was likely to provide an additional tions would be averted. boost to capital spending later this year, In light of the strength of economic although the shifting forward of some activity and recent indications of someinvestment was expected to dampen what increased price pressures, the capital spending in early 2005. In addi- members focused particular attention on tion, inventory investment was forecast the outlook for inflation. They referred to increase gradually in order to bring to statistical and anecdotal evidence that changes in stocks closer in line with on the whole pointed to some recent rising sales. Robust employment growth acceleration of consumer prices and to and the cumulative productivity gains of some increase in near-term inflation recent years were expected to contribute expectations. Factors cited in this regard to strong advances in real disposable included large increases in prices of income, sustaining the expansion of energy and intermediate materials, both consumption spending over the forecast of which appeared to be passing through period. Core inflation was projected to at least in part to core consumer prices. fall back later this year from its pace Members referred to some limited inflain the first five months and to remain tionary impetus as well from the deprelow in 2005, as the transitory effects of ciation of the dollar and larger increases higher energy and non-oil import prices in labor compensation. Considerable waned. uncertainty still surrounded the overall In the Committee's discussion of cur- extent to which competitive pressures rent and prospective economic condi- would allow producers to pass through tions, members commented that the rising costs to prices of finished goods; evidence accumulated over the inter- anecdotal reports suggested that the meeting period continued to portray an ability of many producers to do so was economy that was expanding briskly and increasing but was far from universal was likely to continue to do so for some at this point. With regard to the protime. Business and consumer expendi- spective course of inflation, members tures were on a strong uptrend, and suggested that some of the rise in core related growth in output was associated inflation in recent months appeared to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

198 91st Annual Report, 2004 have resulted from what might well for 2005 the forecasts were in a reduced prove to be transitory factors, notably range of 3Vi to 4 percent. These rates of including increases in energy and other growth were associated with ranges for import prices, which were not seen as the civilian rate of unemployment of likely to persist and indeed might be 5V4 to 5V2 percent in the fourth quarter partially reversed. Just how much slow- of 2004 and 5 to 5Vi percent in the ing of price increases was likely after fourth quarter of 2005. Forecasts of the some relatively elevated readings was rate of inflation, as measured by the difficult to forecast. Those who antici- core PCE price index, pointed to marpated a noticeable deceleration empha- ginally higher rates of inflation encomsized the contribution of the one-time passed by ranges of 1 Vi to 2 percent for price increases that had boosted infla- this year and Wi to 2V2 percent for tion recently, persisting, albeit diminish- 2005. ing, margins of unemployed labor and In their comments about developother productive resources, the anticipa- ments in key sectors of the economy, tion of strong further gains in productiv- many of the members emphasized the ity and declines in markups of goods strength in business capital spending. prices over costs, and steady long-term Explanatory factors included the susinflation expectations. Others tended to tained demand for business output, emphasize the changes in business atti- strong profit margins and cash flow, low tudes and expectations, the strength in capital costs, and the partial-expensing labor compensation, and the tendency tax provision. Weakness persisted, howfor underlying inflation trends to be sub- ever, in the nonresidential construction ject to considerable momentum that was sector, though signs of improvement unlikely to be reversed quickly. What- were emerging in some areas. Many ever their inflation forecasts, several business contacts were expressing a noted that they now had less confidence marked degree of optimism about the in those forecasts than earlier. A number outlook for business activity in the secof members qualified their inflation out- ond half of the year. Currently low look by noting that its realization likely inventory-to-sales ratios, indeed reports would require an adjustment to mone- of emerging bottlenecks in some martary policy over time that brought the kets, were expected to foster efforts to latter to a neutral stance as the economy rebuild inventories and thus add support continued to move toward full utiliza- to the expansion going forward. tion of its resources. Consumer outlays were rising more In preparation for the midyear mone- moderately in the second quarter and tary policy report to Congress, the mem- somewhat below expectations. The bers of the Board of Governors and the slowing was not universal, however. presidents of the Federal Reserve Banks Some members reported a continuation submitted individual projections of the of robust consumer expenditures in varigrowth of GDP, the rate of unemploy- ous parts of the country. Looking ahead, ment, and the rate of inflation for the members, in part echoing the sentiment years 2004 and 2005. The forecasts of of contacts among retailers, anticipated the rate of expansion in real GDP were renewed strength in consumer spending concentrated in the upper part of a 4 to in the context of sizable further growth 43/4 percent range for 2004, implying in employment and disposable incomes expectations by most members of a and a generally high level of consumer pickup over the second half of the year; confidence. In housing markets, activity Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 199 had remained at generally high levels, for the federal funds rate from a level of with only a few signs that rising mort- 1 percent to 1V4 percent. Recent develgage rates were beginning to hold down opments, notably the persistence of solid sales and construction. There was evi- gains in output and employment along dence in some areas that inventories with indications of some increase in of unsold homes had risen. Members inflation, were seen as warranting a first noted that persisting overall strength step in the process of removing policy in housing might to some extent be accommodation. The timing and pace of a response to expectations of further further policy moves would depend, of increases in mortgage rates, implying course, on the members' reading of the that a slowdown might be likely later in incoming economic information and the year. their interpretation of its implications Members commented that fiscal pol- for economic activity and inflation. In icy was continuing to provide appre- this regard, members commented that ciable impetus to the economy, in part they could envision a series of gradual because of the incentives for business or "measured" policy moves as likely investment associated with the partial- to be consistent with the attainment of expensing tax legislation. Following the the Committee's objectives for sustainscheduled expiration of that legislation ing progress toward higher levels of at the end of this year and with more resource utilization and maintaining moderate gains in federal spending fore- price stability. A few indicated, howcast in the absence of new legislation, ever, that their preference would be to the federal budget was expected to remove any characterization of possible become mildly contractionary in 2005, future policy actions from the Commitalthough a marked degree of uncertainty tee's statements. Partly reflecting anticisurrounded this outlook. Many state and pated monetary policy actions, finanlocal governments were increasing their cial market conditions had tightened in spending more rapidly in response to recent months, but short-term interest brightening budget situations. rates were quite low, especially when Expanding foreign economies and the judged against the recent level of infladepreciation of the dollar were expected tion. Depending on the rate at which to foster appreciable growth in U.S. resource utilization increased and the exports, but with imports still consider- level and trend of inflation, a more ably larger than exports, the external aggressive pace toward reaching a neusector was likely to make a measurable tral policy stance might be called for negative contribution to U.S. GDP so as to provide assurance of containing growth this year and next. On the emerging inflationary pressures and inflation side, higher import prices averting the potential need for greater and, importantly, the rise in domestic overall tightening over time. and imported oil prices were adding In the Committee's review of the to domestic inflationary pressures, announcement to be released shortly although improving oil supplies had after this meeting, members agreed that recently contributed to somewhat lower an updating of the reasons for its policy domestic gasoline prices. decision was desirable, specifically by In the Committee's discussion of pol- adding a reference to the possibility that icy for the intermeeting period, all of the some of the recent acceleration in inflamembers indicated that they could sup- tion might reflect transitory factors. The port an upward adjustment in the target members also decided to modify the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

200 91st Annual Report, 2004 reference to labor market conditions by The Committee perceives the upside and referring in general terms to improved downside risks to the attainment of both sustainable growth and price stability for the conditions rather than more narrowly to next few quarters are roughly equal. With a pickup in hiring to acknowledge the underlying inflation still expected to be relabroad range of labor market indicators tively low, the Committee believes that polconsidered by the Committee. They icy accommodation can be removed at a agreed to retain the assessments adopted pace that is likely to be measured. Nonetheat the May meeting indicating that they less, the Committee will respond to changes in economic prospects as needed to fulfill its viewed the upside and downside risks to obligation to maintain price stability. both the attainment of sustainable economic growth and to the goal of price Votes for this action: Messrs. Greenstability as roughly in balance for the span, Geithner, Bernanke, Ms. Bies, next few quarters. However, with regard Messrs. Ferguson, Gramlich, Hoenig, to the outlook for inflation, a number of Kohn, Ms. Minehan, Mr. Olson, Ms. Pianmembers emphasized that they would alto, and Mr. Poole. Vote against this action: None. view the risks as tilted to the upside in the absence of further policy tightening actions that would bring the stance of The next meeting of the Committee policy to a more neutral setting. Many was scheduled to be held on Tuesday, members also underscored their view August 10, 2004. that the statement should make clear The meeting adjourned at 1:35 p.m. that the Committee would be prepared to respond to significant changes in Vincent R. Reinhart economic prospects and take actions that Secretary were deemed necessary to meet the Committee's commitment to maintain price stability. At the conclusion of the discussion, Meeting Held on the Committee voted to authorize and August 10, 2004 direct the Federal Reserve BajpV of New A meeting of the Federal Open Market York, until it was instructed otherwise, Committee was held in the offices of to execute transactions in the System the Board of Governors of the Federal Account in accordance with the follow- Reserve System in Washington, D.C., ing domestic policy directive. on Tuesday, August 10, 2004, at 9:00 a.m. The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sus- Present: tainable growth in output. To further its Mr. Greenspan, Chairman long-run objectives, the Committee in the Mr. Geithner, Vice Chairman immediate future seeks conditions in reserve Mr. Bernanke markets consistent with increasing the fed- Ms. Bies eral funds rate to an average of around Mr. Ferguson 1 VA percent. Mr. Gramlich Mr. Hoenig Mr. Kohn The vote encompassed approval of Ms. Minehan the paragraph below for inclusion in the Mr. Olson press statement to be released shortly Ms. Pianalto after the meeting: Mr. Poole Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 201 Messrs. McTeer, Moskow, Santomero, Ms. Low, Open Market Secretariat and Stern, Alternate Members Assistant, Division of Monetary of the Federal Open Market Affairs, Board of Governors Committee Messrs. Goodfriend and Rudesbusch Messrs. Guynn, Lacker, and and Ms. Mester, Senior Vice Ms. Yellen, Presidents of the Presidents, Federal Reserve Banks Federal Reserve Banks of Atlanta, of Richmond, San Francisco, and Richmond, and San Francisco Philadelphia respectively respectively Messrs. Cunningham, Hilton, Marshall, Mr. Reinhart, Secretary and Economist Tootell, and Wynne, Vice Mr. Bernard, Deputy Secretary Presidents, Federal Reserve Banks Ms. Smith, Assistant Secretary of Atlanta, New York, Chicago, Mr. Alvarez, General Counsel Boston, and Dallas respectively Ms. Johnson, Economist Mr. Stockton, Economist Mr. Weber, Senior Research Officer, Federal Reserve Bank of Messrs. Connors, Hakkio, Howard, Minneapolis Madigan, Rasche, Sniderman, Slifman, Tracy, and Wilcox, Associate Economists By unanimous vote, the minutes of the meeting of the Federal Open Market Mr. Kos, Manager, System Open Committee held on June 29-30, 2004, Market Account were approved. By unanimous vote, the Federal Open Messrs. Oliner and Struckmeyer, Market Committee approved the elec- Associate Directors, Division tion of Scott G. Alvarez as General of Research and Statistics, Counsel of the Committee to serve Board of Governors until the election of a successor at the first regularly scheduled meeting after Mr. Whitesell, Deputy Associate Director, Division of Monetary December 31, 2004. Affairs, Board of Governors The Manager of the System Open Market Account reported on recent Mr. English, Assistant Director, developments in foreign exchange mar- Division of Monetary Affairs, kets. There were no open market opera- Board of Governors tions in foreign currencies for the System's account in the period since the Mr. Simpson, Senior Adviser, Division previous meeting. of Research and Statistics, Board of Governors The Manager also reported on recent developments in domestic financial mar- Mr. Nelson, Section Chief, Division kets and on System open market transof Monetary Affairs, Board actions in government securities and of Governors securities issued or fully guaranteed by federal agencies during the period Mr. Small, Project Manager, Division June 29, 2004, through August 9, 2004. of Monetary Affairs, Board By unanimous vote, the Committee ratiof Governors fied these transactions. The information reviewed at this Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, meeting suggested that economic Board of Governors growth softened somewhat in recent Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

202 91st Annual Report, 2004 months. While strength in the housing the first quarter. However, data on the market persisted and business outlays growth in production-worker hours and remained healthy, growth in consumer other indicators of production suggested spending fell off significantly. Addition- that manufacturing output bounced back ally, gains in employment, which were in July. robust in earlier months, slowed sharply Growth in consumer spending slowed in June and July. Industrial production sharply in the second quarter, posting also decelerated modestly in June, but only a small increase after a robust available indicators suggested a bounce- expansion in the first quarter. Although back in July. Core consumer price infla- gains in outlays for services continued tion moderated in May and June, despite at a solid rate in the second quarter, further increases in energy prices. expenditures for goods declined mark- Growth in employment slowed in edly. Data on consumer expenditures June and July after displaying signifi- showed particular weakness in June, cant improvement in preceding months. with either declines or no growth in The weakness was reported to be wide- purchases across most categories of spread, with the retail trade, informa- goods and services. Purchases of cars tion, financial activities, and govern- and trucks contracted in that month but ment sectors registering declines on rebounded in July. Real disposable average over the two months. The con- income was unchanged in June, held struction and services sectors posted back by increases in prices of food and, gains, but at a pace well below those of especially, energy. previous months. In contrast, after little Activity in the housing market change in June, payrolls in manufactur- remained strong in June despite some ing rose appreciably in July. The aver- variation across segments. Single-family age workweek declined in June but housing starts fell back from very high edged up in July, and aggregate hours levels in April and May. Multifamily of private production workers showed housing starts also declined in June, a similar pattern. Labor force participa- though only a bit. Sales of existing tion moved up slightly in recent months, homes jumped again in June to set a and the unemployment rate, which was new record, and sales of new homes unchanged in June, edged down to came in just below the record pace 5Vi percent in July. posted in May. After rising rapidly in April and May, Business investment spending on industrial production declined modestly equipment and software was solid in the in June, although manufacturing output, second quarter, posting growth a little excluding motor vehicles and parts, above the pace of the first quarter. Perincreased a bit. Production of motor formance across categories, however, vehicles and parts declined noticeably, was uneven. Spending in the transporas automakers scaled back assemblies in tation equipment sector bounced back response to elevated inventories. Output from a first-quarter decline, and outlays at utilities also fell in June as tempera- in the high-tech sector grew twice as tures returned to more normal levels fast as overall equipment and software after an unseasonably warm May. Activ- spending in the quarter. Excluding transity in the mining sector changed little. portation and high-tech equipment, Overall capacity utilization was off however, gains were minimal. Real slightly in June, but utilization on aver- business investment in nonresidential age over the quarter was above that of structures turned up in the second Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 203 quarter, albeit to a still-depressed level. July, households' expectations for con- Increased spending on office buildings, sumer inflation in the year ahead fell commercial structures, and various other somewhat. Overall producer prices for types of buildings more than offset a finished goods were down in June, as sizable decline in the power generation declines in prices for food and energy component. were only partially offset by modest Real nonfarm inventories excluding growth in the core components of the motor vehicles picked up in the sec- index. With regard to labor costs, the ond quarter as the manufacturing, mer- employment cost index for hourly comchant wholesalers, and retail trade seg- pensation of private workers for the ments all boosted stocks. Book-value three months ending in June advanced at inventory-sales ratios edged up, but about the same rate as it had over the remained at fairly low levels. previous year-and-a-half. Unit labor The U.S. international trade deficit costs, however, increased faster in the declined somewhat in May after reach- second quarter than in the first. ing a record high in April. The value of At its meeting on June 29-30, 2004, exports of goods and services climbed the Federal Open Market Committee substantially, with exports of goods adopted a directive that called for condimore than accounting for the entire rise, tions in reserve markets consistent with as exports of services edged down. The increasing the federal funds rate to an value of imports of goods and services average of around \lA percent. The also increased in the month, but by less Committee continued to perceive that than exports. Available data indicated the upside and downside risks to the that major foreign industrial economies attainment of both sustainable growth continued to expand at a solid pace in and price stability for the next few quarrecent months. In Japan, gains in exports ters were roughly equal. In its public and household expenditures fueled the statement, the Committee noted that, advance in output, and surveys of busi- with underlying inflation still expected ness and consumer confidence were also to be relatively low, it believed that polfavorable. Real GDP accelerated in the icy accommodation could be removed at United Kingdom, and economic activity a pace that was likely to be measured, grew at a solid pace in Canada, led by a but that, nonetheless, it would respond surge in investment. Indicators for the to changes in economic prospects as euro area suggested that activity deceler- needed to fulfill its obligation to mainated a bit in the second quarter. Growth tain price stability. of real GDP in China slowed signifi- This decision to raise the intended cantly in the spring. level of the federal funds rate by 25 Core consumer price inflation mod- basis points was anticipated in the finanerated substantially in May and June, cial markets, yet investors revised down though sizable increases in food and their expectations for the path of policy energy prices continued to push up over- upon the release of the accompanying all consumer price inflation. Increases in statement. In particular, investors noted the food and energy components of the that the Committee attributed some of CPI were smaller in June than in May, the recent increase in inflation to transiand further deceleration was expected as tory factors, retained its earlier balance gasoline and natural gas prices eased in of risks assessment, and reiterated its July and supply conditions in a number belief that policy accommodation could of agricultural segments improved. In be removed at a pace that would likely Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

204 91st Annual Report, 2004 be measured. Subsequently, the Chair- would continue to expand at a solid pace man's Congressional testimony on through 2005, supported by a relatively monetary policy, which suggested that accommodative monetary policy over recent softness in consumer spending the projection period and by stimulative should prove short-lived and empha- fiscal policy through 2004. Consumer sized the FOMC's commitment to price spending was expected to strengthen in stability, spurred an upward tilt in the the near term, boosted by strong conmarket's expected path of monetary sumer confidence and rising disposable policy. Over the remainder of the inter- income, which would likely continue meeting period, though, expectations of to be propelled by robust growth in policy tightening were revised down structural productivity. Favorable finansomewhat, on balance, as incoming cial conditions, higher profits, and the data pointed to weaker-than-anticipated partial-expensing tax incentives over the spending and employment and more remainder of this year were projected to subdued core inflation. Yields on lead to a near-term acceleration in busiintermediate- and long-term nominal ness fixed investment. Subsequently, Treasury securities dropped signifi- growth in capital spending was expected cantly over the intermeeting period. to moderate somewhat but still to remain Available data suggested that corpo- on a healthy upward trajectory. Despite rate credit quality remained strong, recent weakness in employment growth, and yields on investment-grade bonds the waning of firms' unusual caution of moved roughly in line with those on recent years was expected to foster a Treasury securities. Speculative-grade pickup in hiring over the next several yields, however, fell by less. In equity quarters. Consumer price inflation was markets, broad indexes declined appre- projected to remain low over the foreciably, reflecting the soft economic cast period as the sharp increases in data, concerns about energy prices, and energy and import prices experienced guidance from corporations pointing to earlier in the year partially unwound. a less-optimistic trajectory for earnings Slack resource utilization through 2005 than investors apparently had been was also expected to help hold down expecting. In foreign exchange markets, inflation. the dollar's trade-weighted value against In the Committee's discussion of curother major currencies ended the period rent and prospective economic devellittle changed, on net. opments, members noted that the pace Following several months of robust of the expansion had moderated. In parexpansion, M2 grew at a slower pace in ticular, consumer spending, which had June and available data implied a slight previously provided considerable supcontraction in July. Most of the weak- port to aggregate demand, had slowed ness owed to a slowdown in liquid sharply in the second quarter. At the deposit growth that was related in part same time, growth in payrolls had fallen to the decline in mortgage refinancing back in June and July after posting sigactivity. In addition, retail money mar- nificant gains in the spring. While the ket funds resumed their earlier decline. recent moderation in growth might por- Currency growth, however, strengthened tend a substantially slower expansion over the two months, partly as a result going forward than had previously been of a pickup in foreign demand. expected, the Committee did not see The staff forecast prepared for this such a sizable shortfall as the most likely meeting suggested that the economy outcome. Activity in the housing sector Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 205 remained strong, and investment out- dent on imported oil appeared to have lays continued to advance at a good been fairly modest thus far. Informed in pace. With economic growth buoyed by part by prices in futures markets, Comaccommodative monetary policy and mittee members anticipated that energy supportive credit conditions more gen- costs would level out and perhaps fall erally as well as by robust underlying back from their recent highs, but they growth in productivity, the Committee noted that there was considerable uncerbelieved that conditions were in place tainty about that outlook. for the pace of expansion to strengthen Policymakers focused their comments enough to continue to trim margins of about key sectors of the economy on the slack in resource utilization. Indeed, the slowdown in consumer spending toward limited available evidence pointed to a the end of the second quarter. Business rebound in household spending, espe- contacts in some parts of the country cially on motor vehicles, in July and suggested that, in addition to higher early August, and some indicators sug- energy prices, unseasonable weather gested continued improvement in labor may have limited spending for a time. market conditions. Regarding the out- The Committee discussed a number of look for inflation, the most recent data other factors that may have contributed were seen as consistent with an assess- to the slowdown, including a waning of ment that a portion of the higher rates of the stimulus from last year's tax cuts, price increases recorded earlier in the which had previously provided considyear had reflected transitory factors. erable impetus to spending, and the pos- Committee members generally agreed sibility that, with stock prices down, that higher energy prices had played an saving rates near historic lows, and the important role in the recent moderation outlook more uncertain, households may of economic growth. While the direct have felt the need to boost saving. effect of higher energy prices on real Although a complete accounting for the disposable income could account for moderation in growth was not possible, only a relatively small part of the reduc- the Committee agreed that a resumption tion in the growth of consumer spend- of faster growth in consumer spending ing, some members suggested that those was very likely. Continued strength in effects may have been exacerbated by home construction did not suggest that substantial increases in expected future households were in the process of energy costs as well as greater uncer- retrenching, and gains in income, low tainty about those costs. Moreover, the interest rates, and robust consumer coneconomy seemed to have responded in fidence were seen as undergirding fursome past episodes to sharp increases in ther gains in household spending going energy costs by much more than could forward. Members noted that reports be explained by most models. Still, of rising motor vehicle sales in July some Committee members doubted that and early August and a firming of chain higher energy prices were sufficient to store sales in recent weeks provided explain all of the recent slowdown in some limited evidence that consumption spending. Effects of increased energy spending was picking up. prices on consumer and business confi- Investment spending had continued to dence, which might have led to a larger advance, though perhaps at a somewhat spending response, had not been evi- slower pace than some members had dent, and the consequences for growth anticipated. Several policymakers noted in other industrialized countries depen- that businesses remained cautious about Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

206 91st Annual Report, 2004 capital spending and hiring and were pointed to data from the survey of attempting to boost production as much households, which showed both a rise in as possible with existing capacity and labor force participation and a decline payrolls. Indeed, some members sug- in the unemployment rate in July, as gested that heightened uncertainty, well as to initial claims for unemployreflecting the effects of higher energy ment compensation, which remained prices and increased concerns about near recent lows. Moreover, survey data geopolitical risks, might have contrib- on labor market attitudes of both conuted to greater business caution of late. sumers and businesses had not signaled Nonetheless, business confidence gen- a significant deterioration in employerally remained high, and the funda- ment prospects. All things considered, mentals for investment—including solid the Committee expected the pace of growth in productivity, robust profits employment gains to improve in coming and cash flow, and accommodative months. financial markets—pointed to continued In their review of the outlook for healthy gains in business outlays. A few prices, members noted that incoming members also noted that the commercial data over the intermeeting period had real estate sector, which had been weak shown a slowing in core inflation from for some time, was showing signs of the high levels posted earlier in the year, improvement. consistent with the Committee's view In their remarks regarding the exter- that a portion of the earlier increase nal sector of the economy, members had reflected transitory factors. Informanoted that on average growth abroad tion from business contacts suggested had remained reasonably robust, which that a number of firms had been able to should support U.S. exports. However, pass on at least some of their higher the U.S. trade deficit was expected to energy and other costs to customers, but remain large as imports increased in few signs of more widespread price response to solid growth in the United increases were apparent. Some members States. expressed concern about developments In their discussion of recent labor in the transportation sector, where truckmarket trends, Committee members ing costs were reportedly on the rise noted the slowing of job growth reported and bottlenecks in the railroad industry in June and July. Committee members were triggering delivery delays. Lookpointed to several factors that that might ing forward, however, most members have contributed to the recent weak- thought that rapid productivity growth ness. Firms' focus on controlling costs and flat or declining energy prices and implementing further productivity would limit increases in the overall improvements were doubtless continu- unit costs of businesses. Despite the ing to play a role. Higher labor costs, higher rates of headline inflation earlier particularly those related to health bene- in the year, longer-term inflation expecfits, were also reportedly weighing on tations remained well contained and some firms' hiring decisions. However, slack in resource markets was seen as policymakers noted that the monthly persisting, leading the Committee to payrolls data might be providing an expect underlying inflation to be relaincomplete picture of expansion in tively low. economic activity because of near-term In the Committee's discussion of polvariation in the rate of growth of pro- icy for the intermeeting period, all the ductivity. In addition, many members members favored an increase in the tar- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 207 get for the federal funds rate from 1V* to stability were balanced over the next 1 Vi percent. Although the pace of eco- few quarters. While a more persistent nomic growth had moderated in the sec- slowing of household spending was ond quarter, the Committee believed that possible, and more subdued inflation the softness would prove short-lived and readings over the intermeeting period that the economy was poised to resume had eased concerns about a potential a stronger rate of expansion going for- increase in underlying inflation, policyward. Given the current quite low level makers continued to judge the risks to of short-term rates, especially when sustainable growth and the inflation outjudged against the recent level of infla- look as roughly balanced. The Committion, members noted that significant tee chose to reiterate its belief that polcumulative policy tightening likely icy accommodation could be removed would be needed to foster conditions at a pace that is likely to be measured consistent with the Committee's objec- as well as its intention to respond tives for price stability and sustainable to changes in economic prospects as economic growth. In this context, a needed to fulfill its obligation to achieve relatively small tightening move at this its goal of price stability. meeting would help to limit the risk of a At the conclusion of the discussion, rise in inflation expectations and reduce the Committee voted to authorize and the likelihood that policy might need to direct the Federal Reserve Bank of New be adjusted more sharply in the future, York, until it was instructed otherwise, thereby lowering the attendant risks to to execute transactions in the System financial markets and the economy. The Account in accordance with the followmembers thought that policy accom- ing domestic policy directive. modation probably could be removed gradually—a view that had been rein- The Federal Open Market Committee forced by the slower pace of growth and seeks monetary and financial conditions that will foster price stability and promote susmore moderate rates of price increase tainable growth in output. To further its that had become evident over the interlong-run objectives, the Committee in the meeting period. However, members also immediate future seeks conditions in reserve recognized that the timing and pace markets consistent with increasing the of additional policy tightening would federal funds rate to an average of around 1 Yi percent. depend importantly on incoming economic data and the Committee's assess- The vote encompassed approval of ment of their implications for economic the paragraph below for inclusion in the activity and inflation. press statement to be released shortly With regard to the Committee's after the meeting: announcement to be released after the meeting, members agreed that the The Committee perceives the upside description of recent economic circumand downside risks to the attainment of both stances should acknowledge the slowsustainable growth and price stability for the ing in output and employment growth, next few quarters are roughly equal. With as well as highlight the role of higher underlying inflation still expected to be energy prices in those developments. relatively low, the Committee believes that policy accommodation can be removed at a They also agreed to retain the assesspace that is likely to be measured. Nonethements adopted at the June meeting that less, the Committee will respond to changes the risks to the Committee's goals of in economic prospects as needed to fulfill its sustainable economic growth and price obligation to maintain price stability. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

208 91st Annual Report, 2004 Votes for this action: Messrs, Green- Ms. Smith, Assistant Secretary span, Geithner, Bernanke, Ms. Bies, Mr. Alvarez, General Counsel Messrs. Ferguson, Gramlich, Hoenig, Mr. Baxter, Deputy General Counsel Kohn, Ms. Minehan, Mr. Olson, Ms. Pian- Ms. Johnson, Economist alto, and Mr. Poole. Vote against this Mr. Stockton, Economist action: None. Messrs. Connors, Fuhrer, Hakkio, It was agreed that the next meeting of Howard, Madigan, Slifman, Tracy, the Committee would be held on Tues- and Wilcox, Associate Economists day, September 21, 2004. Mr. Kos, Manager, System Open The meeting adjourned at 1:00 p.m. Market Account Vincent R. Reinhart Mr. Ettin, Deputy Director, Division Secretary of Research and Statistics, Board of Governors Meeting Held on Messrs. Oliner and Struckmeyer, Associate Directors, Division September 21, 2004 of Research and Statistics, Board of Governors A meeting of the Federal Open Market Committee was held in the offices of Messrs. Clouse and Whitesell, Deputy the Board of Governors of the Federal Associate Directors, Division of Reserve System in Washington, D.C., Monetary Affairs, Board of on Tuesday, September 21, 2004, at Governors 9:00 a.m. Mr. English, Assistant Director, Present: Division of Monetary Affairs, Mr. Greenspan, Chairman Board of Governors Mr. Geithner, Vice Chairman Mr. Bernanke Mr. Simpson, Senior Adviser, Ms. Bies Division of Research and Mr. Ferguson Statistics, Board of Governors Mr. Gramlich Mr. Hoenig Ms. Danker, Special Assistant to the Mr. Kohn Board, Division of Monetary Ms. Minehan Affairs, Board of Governors Mr. Olson Ms. Pianalto Mr. Small, Project Manager, Mr. Poole Division of Monetary Affairs, Board of Governors Messrs. McTeer, Moskow, Santomero, and Stern, Alternate Members Mr. Skidmore, Special Assistant to the of the Federal Open Market Board, Office of Board Members, Committee Board of Governors Messrs. Guynn and Lacker, and Ms. Yellen, Presidents of the Ms. Weinbach, Senior Economist, Federal Reserve Banks of Atlanta, Division of Monetary Affairs, Richmond, and San Francisco Board of Governors respectively Mr. Luecke, Senior Financial Analyst, Mr. Reinhart, Secretary and Economist Division of Monetary Affairs, Mr. Bernard, Deputy Secretary Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 209 Ms. Low, Open Market Secretariat showed a moderate gain in payrolls. Assistant, Division of Monetary After contracting in June, industrial Affairs, Board of Governors production strengthened modestly on average in July and August, and the Mr. Barron, First Vice President, increases were widespread across sec- Federal Reserve Bank of Atlanta tors. Consumer spending rose sharply in July, housing activity increased further Mr. Judd, Executive Vice President, Federal Reserve Bank of in August, and business outlays picked San Francisco up last month. Core consumer price inflation moderated in June and July, Messrs. Eisenbeis, Evans, and and a decline in energy prices further Goodfriend, Mses. Mester and damped overall inflation in July. Perelmuter, and Messrs. Rolnick The labor market improved in and Rosenblum, Senior Vice Presidents, Federal Reserve Banks August, and the unemployment rate of Atlanta, Chicago, Richmond, edged down to 5.4 percent. Private non- Philadelphia, New York, farm payrolls grew moderately, with Minneapolis, and Dallas gains registered in the manufacturing, respectively construction, financial activities, and nonbusiness services categories. In addi- Messrs. Bryan and Gavin, Vice tion, the figures for June and July were Presidents, Federal Reserve Banks revised upward and suggested that the of Cleveland and St. Louis respectively deceleration in hiring over that period was not as abrupt as had been pre- By unanimous vote, the minutes of viously thought. The average workweek the meeting of the Federal Open Market was unchanged in August from the Committee held on August 10, 2004, upward-revised July level and was a bit were approved. higher than its second-quarter average. The Manager of the System Open The labor force participation rate edged Market Account reported on recent down in August. developments in foreign exchange mar- Total industrial production advanced kets. There were no open market oper- modestly on average in July and August, ations in foreign currencies for the down slightly from its second-quarter System's account in the period since the pace. The increases in manufacturing previous meeting. production since the end of the second The Manager also reported on recent quarter were widespread. Output of developments in domestic financial mar- motor vehicles and parts jumped in kets and on System open market trans- August. Excluding motor vehicles and actions in government securities and parts, the expansion in manufacturing securities issued or fully guaranteed output was brisk in July but more subby federal agencies during the period dued in August. In the high-tech sector, August 10, 2004, through September 20, computer production continued to rise 2004. By unanimous vote, the Commit- in August, and the output of communitee ratified these transactions. cations equipment posted its fourth con- The information reviewed at this secutive monthly increase. In contrast, meeting suggested that economic output at utilities declined further in July growth regained some vigor in recent and August, while mining-related promonths after having slowed in late duction was about flat on average over spring. The August labor market report those same months. The rate of capacity Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

210 91st Annual Report, 2004 utilization ticked up in July from its in the second quarter, and the available average over the first half of the year data pointed to a similar advance more and remained steady in August. recently. Spending was being supported Real consumer spending grew sharply by the continued gains in business outin July after having slowed in the sec- put, low financing costs, ongoing price ond quarter, and the available indi- declines for high-tech capital, and the cators suggest that spending held fairly corporate sector's large cushion of liqsteady in August. Expenditures on uid assets. Spending on transportation goods jumped in July and moderated equipment and other capital goods was in August, while spending on services brisk in the second quarter, although moved up somewhat in July. Purchases expenditures in the high-tech sector of motor vehicles surged in July and decelerated. In July, shipments of capifell back in August. For the two months tal goods excluding aircraft fell subtogether, the average pace of these out- stantially from the rate seen in the first lays exceeded that seen in the first half half of the year, but orders were relaof the year, reflecting in part a further tively strong. Real business investment sweetening of incentives. Real dispos- in nonresidential structures remained able income was up slightly in July, as depressed, but the most recent data proincreases in compensation were largely vided a sign of some improvement. In offset by declines in other income cate- the office sector, the vacancy rate came gories. The latest readings on consumer in only a little below its recent peak, confidence showed a drop in August although property values had inched up, amid labor market slack and near-record and the vacancy rate for industrial space gasoline prices, and a further slight also remained near its high. The retail decline in September, but the readings sector, in contrast, continued to fare for the third quarter averaged above better. those for the second quarter. Excluding motor vehicles, the pace of Housing activity increased further in inventory accumulation in July contin- August. Housing starts for new single- ued at its second-quarter rate. A decline family homes bounced up in July and in stocks in the retail trade segment was remained about unchanged in August, more than offset by stockbuilding in and starts of multi-family homes rose the manufacturing and wholesale trade somewhat each month. Taken together, segments. Although the book value of total housing starts in August reached manufacturing and trade inventories the highest level in five months. Home rose appreciably in July, these gains sales remained robust in July for both were again inflated by price increases in existing and new homes, although sales the petroleum sector. Inventory-sales were below the monthly peaks recorded ratios in the manufacturing sector, as earlier in the year. Interest rates on in the retail and wholesale trade sectors thirty-year conventional mortgages (excluding motor vehicles and parts), receded over the past couple of months, remained about flat in July. retracing much of the runup in rates that The U.S. international trade deficit occurred earlier in the year. Weekly data reached a record high in June, bringing on mortgage applications to purchase it to a new high in the second quarter homes continued to move up, on aver- as a percentage of nominal GDP. While age, through mid-September. the deficit fell back in July, it remained Business outlays for equipment and much above May's reading. In June, software increased at a significant pace exports fell sharply, with declines wide- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 211 spread, while imports rose, owing in registered an increase in the second part to a surge in petroleum imports. In quarter. July, exports registered a modest recov- At its meeting on August 10, 2004, ery, driven by capital goods, industrial the Federal Open Market Committee supplies, and automotive products, decided to increase the target federal while the value of imports fell with the funds rate by 25 basis points, to Wi persharp decline in oil imports. Economic cent, and to retain its assessment of balactivity in the major foreign industrial anced risks with respect to sustainable countries continued to expand in the sec- economic growth and price stability. In ond quarter, although growth slowed in its announcement, the Committee noted Japan and in the euro area. Indicators to that output growth had moderated in date for the third quarter were mixed. recent months and that the pace of Core consumer prices edged up improvement in labor market conditions slightly over the months of June and had slowed, but that the softness likely July, as inflation in both goods and ser- owed importantly to the substantial rise vices moderated. The core PCE price in energy prices. It also noted that while index was flat in July but, like the core inflation was somewhat elevated this CPI, was up a bit on balance over June year, a portion of the pickup seemed and July. The twelve-month change in to reflect transitory factors. The Comcore consumer prices based on either mittee went on to comment that the measure was somewhat higher this economy appeared poised to resume July than for the same period last year. a stronger pace of expansion going Retail energy prices fell in July, led forward, that it continued to believe by a drop in gasoline prices after large that policy accommodation could be gains in a number of earlier months. removed at a pace that was likely to be During the summer, gasoline inven- measured, and that it would respond tories climbed above seasonal norms to changes in economic prospects as because of lower demand and increased needed to fulfill its obligation to mainimports, and the resulting downward tain price stability. pressure on margins led gasoline prices Although the Committee's decision to fall even as crude oil prices moved to raise the intended level of the federal higher. Owing to the decline in energy funds rate by 25 basis points was widely prices in July, inflation in overall con- anticipated in financial markets, the sumer prices slowed that month. In accompanying statement was read as August, households' expectations for setting a more optimistic tone about ecoconsumer inflation in the year ahead nomic prospects than had been anticiedged lower for the second consecutive pated and prompted investors to mark month. Meanwhile, after a small rise up their expectations for the near-term in July, the prices of finished goods path of policy. That sentiment was faced by producers moved down a apparently reinforced over the remainbit in August. Turning to labor costs, der of the period by the comments of hourly compensation in the nonfarm several Federal Reserve officials and business sector rose at a faster pace in the release of the August employment the second quarter than it did in the first, report, which seemed to convey the but the advance was in line with the view that the economy was emerging average rate of increase over the preced- from its "soft patch." As a result, policy ing four quarters. Unit labor costs mea- rate expectations for the next two quarsured at nonfinancial corporations also ters ended the intermeeting period Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

212 91st Annual Report, 2004 slightly firmer. Longer-term policy this year to modest restraint next year. expectations, however, moved notice- Consumer spending was expected to ably lower, reflecting the release of rela- pick up in conjunction with the strengthtively benign readings on inflation and ening labor market and associated gains the Chairman's comments on the infla- in wages and salaries that would offset tion outlook in testimony to the House the effects of an anticipated rise in the Budget Committee. In line with these savings rate from its recent low level. revised expectations for the path of pol- The contour of business spending was icy, the term structure of interest rates expected to be affected by the expiration flattened over the intermeeting period, of the partial-expensing tax provisions as the two-year Treasury yield ended at year-end, which gave an incentive for about unchanged and the ten-year Trea- businesses to invest more heavily this sury yield dropped somewhat. While year. Supported by a favorable financcredit spreads on investment-grade cor- ing environment, ample stocks of liquid porate bonds narrowed a bit, spreads assets, and the ongoing need to replace on speculative-grade issues fell signifi- aging or obsolete equipment and softcantly more, particularly in riskier seg- ware, investment outlays were expected ments of the market, probably reflecting to grow robustly once the tax-related greater confidence about prospects in swings were completed. After the curthe business sector. Further evidence of rent period of below-average employsuch confidence was visible in equity ment gains, employers were expected to markets, where broad indexes advanced hire at a relatively robust pace next year. 5Vi to IVi percent. The exchange value At the same time, as labor market conof the dollar against other major curren- ditions improved, individuals who had cies was about unchanged over the inter- withdrawn from the labor force were meeting period. thought likely to return, so that job gains M2 balances were about flat on aver- were expected to have a muted effect on age over the previous two months: After the unemployment rate. Consumer price contracting a bit in July, M2 expanded inflation was projected to remain at or slightly in August. Money growth was below its current level. Slack in resource damped by a rise in the opportunity cost utilization, continued rapid growth in of holding M2 assets (as typically occurs structural productivity, and the passin periods of policy tightening). In addi- through of declining energy prices were tion, the lift to M2 from mortgage refi- expected to contribute to the restraint on nancings in evidence during the spring inflation. was likely still unwinding over the past In the Committee's discussion of couple of months, depressing the growth current and prospective developments, of liquid deposits. Business loans at the members agreed that the economy banks expanded in August for the third had strengthened somewhat after going consecutive month. through a "soft patch" in late spring The staff forecast prepared for this and early summer. Recent data and meeting suggested that the economy anecdotal information suggested solid would continue expanding at a solid growth ahead, but at a pace that could pace through the end of 2006. Labor well be less brisk than previously anticimarket improvements and accommoda- pated. Consumer spending appeared tive monetary policy were seen as coun- to have rebounded in the third quarter. terbalancing the drag from the swing in Business investment also was robust, fiscal policy from considerable stimulus but executives, especially those at larger Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 213 firms, seemed more cautious about the noted that the pace of technological outlook than they had been several advance could be slowing a bit, trimmonths ago. Although higher energy ming the rate of decline in the cost of prices had played an important role in capital for high-tech equipment and damping growth, questions remained software. High vacancy rates for office about the reasons for the shortfall from buildings and industrial structures would expectations held this spring, and sev- likely continue to weigh on nonresieral policymakers remarked that their dential investment, although activity in uncertainty about the likely pace of that sector was showing some signs of the expansion going forward had risen. revival. Members commented that the benign Committee members interpreted incoming data on prices tended to con- recent data and anecdotal information firm their previous judgment that the as indicating that growth in consumer increase in inflation earlier in the year spending was rebounding from its relahad importantly reflected temporary fac- tively slow rate of late spring. They saw tors and that core inflation would prob- household spending as most likely conably remain relatively low. tinuing to expand at a solid pace going In their discussion of developments forward. Gains in nominal income, in key sectors of the economy, policy- partly resulting from gradual increases makers agreed that business investment in employment, were expected to conwould most likely continue to provide tinue to support consumer spending and considerable impetus to the overall eco- low interest rates to buoy residential nomic expansion going forward. The investment. However, members peranticipated further expansion of aggre- ceived several possible sources of downgate demand should boost investment. side risk to household spending. In par- Also, low real interest rates, strong busi- ticular, households might hold back on ness balance sheets, and high levels of spending in an attempt to increase their profits and cash flow were expected to saving, which had fallen to a very low support capital spending. However, the level relative to income. The ebbing of extent to which the federal tax provision stimulus from last year's tax cuts also permitting partial expensing of most could tend to slow growth in consumer investment expenditures had been boost- spending. And a failure of employment ing capital expenditures was difficult to accelerate as expected could underto discern, and it was possible that the mine consumer confidence as well as expiration of that provision at year-end hold down the growth in personal could result in a fairly sharp slowing in income. investment, at least for a time. In addi- With regard to the external sector, tion, recent discussions with business foreign economies were seen as genercontacts, as well as a range of statistical ally expanding steadily, with the high information, suggested a persisting ten- level of crude oil prices apparently havdency for corporate executives to limit ing restrained growth abroad somewhat capital spending commitments. The rea- less than in the United States. Still, sons for this tendency were unclear, but expectations for foreign economic a continuing focus on corporate gover- growth had been marked down somenance issues might still be playing a what, with adverse implications for U.S. role, and business concerns about terror- exports and for overall U.S. growth. ism and other geopolitical risks might Indeed, some policymakers noted that have risen this year. Some members also domestic demand in several major U.S. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

214 91st Annual Report, 2004 trading partners was relatively weak and relatively high, energy prices had that aggregate demand in those econo- declined noticeably from record levels mies was being sustained importantly in recent weeks, and the effects of the by exports to the United States. That energy price shock on inflation were pattern was contributing to a worri- expected to wane. In this regard, a numsome further widening of the U.S. trade ber of policymakers commented that and current account balances, and the data on consumer and producer infla- Committee discussed the significance tion had generally come in at or below of wide external deficits and various expectations over the intermeeting adjustments that might occur in the pro- period, tending to confirm the Commitcess of their return to more sustainable tee's judgment that the upturn in inflalevels. tion earlier in the year had owed impor- Committee members generally tantly to temporary factors. Moreover, viewed labor market conditions as hav- inflation expectations appeared to be ing improved modestly of late. Although well-contained, although those expectapayroll growth had been weak in June tions probably were conditioned in part and July, it registered a somewhat on investors' anticipation that the stance better performance in August, and initial of monetary policy would likely be claims for unemployment insurance tightened over time. continued to hover around relatively low In the Committee's discussion of pollevels. Some members noted a mismatch icy for the intermeeting period, all of between demand and supply for certain the members favored raising the target types of labor. In particular, unskilled for the federal funds rate by 25 basis workers were said to be having con- points to l3/4 percent at this meeting. siderable difficulty finding jobs, while The expansion evidently was resilient firms were facing challenges in hiring and self-sustaining and appeared no workers with some specific skills, longer to require the unusual degree of including truck drivers and heavy- monetary stimulus that had previously equipment operators. Partly as a result, been necessary. A gradual increase in businesses in a few sectors, such as interest rates seemed likely to be contransportation and construction, report- sistent with continued solid economic edly were experiencing constraints on growth that would be sufficient to erode their output. Overall, however, some remaining margins of slack in resource slack appeared to remain in labor mar- utilization over time. In view of these kets. Looking forward, policymakers considerations, the Committee believed expected gradual improvement in labor that another modest reduction in the market conditions as the economy degree of monetary policy accomexpanded. However, anecdotal informa- modation at today's meeting was wartion suggested that many firms remained ranted. With today's action, the real quite cautious about expanding payrolls, federal funds rate—measured as the citing, among other factors, continued difference between the nominal funds uncertainty about economic prospects rate and a moving average of core PCE and the high cost of providing health inflation—would move slightly into care benefits. positive territory. Partly reflecting the likely persistence With regard to the Committee's of some economic slack, members announcement to be released after the expected inflation to stay low. Although meeting, the members agreed that the non-energy commodity prices remained statement should indicate that, after Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 215 moderating earlier in the year, partly in The vote encompassed approval of response to the substantial rise in energy the paragraph below for inclusion in prices, output growth appeared to have the press statement to be released shortly regained some traction and that labor after the meeting: market conditions had improved modestly. In addition, policymakers con- The Committee perceives the upside curred that the statement should indicate and downside risks to the attainment of both sustainable growth and price stability for the that inflation and inflation expectations next few quarters to be roughly equal. With had eased in recent months. They also underlying inflation expected to be relatively agreed again to characterize the risks low, the Committee believes that policy to sustainable growth and price stability accommodation can be removed at a pace as balanced. Members commented that that is likely to be measured. Nonetheless, recent evidence had boosted their confi- the Committee will respond to changes in economic prospects as needed to fulfill its dence that moderate economic growth obligation to maintain price stability. would continue and that inflation would be contained. With aggregate demand Votes for this action: Messrs. Greenprobably expanding at least as rapidly as span, Geithner, Bernanke, Ms. Bies, the economy's potential to produce over Messrs. Ferguson, Gramlich, Hoenig, the next several quarters, policymakers Kohn, Ms. Minehan, Mr. Olson, Ms. Piancontinued to see economic conditions alto, and Mr. Poole. Vote against this action: None. as likely to warrant a further reduction in policy accommodation in coming The Committee noted that Deputy quarters. However, in the view of many Secretary Normand R.V. Bernard had members, policy actions would need to announced his intention to retire in the be increasingly keyed to incoming data. period before the next FOMC meet- Indeed, it was noted that market particiing, following more than four decades pants now appeared to anticipate some at the Federal Reserve. The Committee slowing in the pace of policy firming thanked Mr. Bernard for his dedication, before long and did not interpret the integrity, and steadfast support through removal of policy accommodation at a the more than 345 FOMC meetings he measured rate as necessarily involving attended during his career. the same policy action at each meeting. It was agreed that the next meeting At the conclusion of the discussion, of the Committee would be held on the Committee voted to authorize and Wednesday, November 10, 2004. direct the Federal Reserve Bank of New The meeting adjourned at 1:15 p.m. York, until it was instructed otherwise, to execute transactions in the System Vincent R. Reinhart Account in accordance with the follow- Secretary ing domestic policy directive. The Federal Open Market Committee seeks monetary and financial conditions that Meeting Held on will foster price stability and promote sus- November 10, 2004 tainable growth in output. To further its longrun objectives, the Committee in the imme- A meeting of the Federal Open Market diate future seeks conditions in reserve markets consistent with increasing the fed- Committee was held in the offices of eral funds rate to an average of around the Board of Governors of the Federal l3/4 percent. Reserve System in Washington, D.C., Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

216 91st Annual Report, 2004 on Wednesday, November 10, 2004, at Mr. English, Assistant Director, 9:00 a.m. Division of Monetary Affairs, Board of Governors Present: Mr. Greenspan, Chairman Mr. Simpson, Senior Adviser, Mr. Geithner, Vice Chairman Division of Research and Mr. Bernanke Statistics, Board of Governors Ms. Bies Mr. Ferguson Mr. Brady, Section Chief, Division of Mr. Gramlich Monetary Affairs, Board of Mr. Hoenig Governors Mr. Kohn Ms. Minehan Mr. Small, Project Manager, Division Mr. Olson of Monetary Affairs, Board of Ms. Pianalto Governors Mr. Poole Messrs. Moskow, Santomero, and Mr. Skidmore, Special Assistant to the Stern, Alternate Members of the Board, Office of Board Members, Federal Open Market Committee Board of Governors Messrs. Guynn, Lacker, and Mr. Luecke, Senior Financial Analyst, Ms. Yellen, Presidents of the Division of Monetary Affairs, Federal Reserve Banks of Atlanta, Board of Governors Richmond, and San Francisco respectively Ms. Low, Open Market Secretariat Assistant, Division of Monetary Mr. Reinhart, Secretary and Economist Affairs, Board of Governors Ms. Danker, Deputy Secretary Ms. Smith, Assistant Secretary Ms. Holcomb and Mr. Rasdall, First Mr. Alvarez, General Counsel Vice Presidents, Federal Reserve Mr. Baxter, Deputy General Counsel Banks of Dallas and Kansas City Ms. Johnson, Economist respectively Mr. Stockton, Economist Messrs. Connors, Fuhrer, Hakkio, Messrs. Eisenbeis, Estrella, Evans, Howard, Madigan, Slifman, and Goodfriend, Ms. Mester, Sniderman, Rasche, and Wilcox, Messrs. Rosenblum and Williams, Associate Economists Senior Vice Presidents, Federal Reserve Banks of Atlanta, Mr. Kos, Manager, System Open New York, Chicago, Richmond, Market Account Philadelphia, Dallas, and San Francisco respectively Mr. Ettin, Deputy Director, Division of Research and Statistics, Mr. Hilton, Vice President, Federal Board of Governors Reserve Bank of New York Messrs. Oliner and Struckmeyer, Mr. Weber, Senior Research Officer, Associate Directors, Division Federal Reserve Bank of of Research and Statistics, Minneapolis Board of Governors By unanimous vote, the minutes of Messrs. Clouse and Whitesell, Deputy the meeting of the Federal Open Market Associate Directors, Division of Monetary Affairs, Board of Committee held on September 21, 2004, Governors were approved. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 217 By unanimous vote, the Federal Open current quarter despite the restraint Market Committee approved the selec- imparted on real incomes and consumer tion of Deborah J. Danker as Deputy confidence from higher oil prices. How- Secretary of the Committee to serve ever, industrial production was flat in until the selection of a successor at the recent months, and hiring activity was first regularly scheduled meeting after lackluster through September before December 31, 2004. advancing sharply in October. Inflation The Manager of the System Open measures continued at low levels Market Account reported on recent through September. developments in foreign exchange mar- Employment gains were subdued in kets. There were no open market opera- the third quarter, but showed substantial tions in foreign currencies for the Sys- strength in October. Job growth last tem's account in the period since the month was fairly widespread, although previous meeting. heavy hiring in the construction sector The Manager reported on recent was due partly to efforts to repair damdevelopments in domestic financial mar- age from the four hurricanes that hit kets and on System open market trans- the southeastern states. Employment actions in government securities and increases were particularly large in the securities issued or fully guaranteed by financial and services sectors. Howfederal agencies during the period Sep- ever, a small decline was registered in tember 21, 2004, through November 9, employment in the manufacturing sec- 2004. By unanimous vote, the Commit- tor. The average workweek held steady tee ratified these transactions. in October at its third-quarter level and The Manager also discussed the pres- was a bit above the average for the sures on the federal funds rate prior to, second quarter. Despite the strong and volatility in the rate that has ensued increase in payroll employment, the at times after, recent FOMC meetings as household survey indicated a slight depository institutions sought to satisfy increase in the unemployment rate to a larger portion of their reserve require- 5.5 percent in October. ments before anticipated increases in the Industrial production was about un- FOMC's target funds rate. The Commit- changed in September, likely restrained tee agreed that the Desk would continue by the hurricanes that month. A decline to conduct open market operations as it in manufacturing was about offset by a has in such situations—leaning against jump in utilities output and expansion in anticipatory pressures in the funds mar- high-tech industries. The available data ket while taking account of the reserve suggested that industrial production management implications of such opera- rebounded in October. Capacity utilitions for the remainder of the reserve zation was unchanged in September at maintenance period. about the third-quarter average but was The information received at this up from its level earlier in the year. meeting suggested that the economy Consumer spending advanced expanded at a moderate pace over the strongly in the third quarter from the third quarter. Low interest rates helped sluggish pace of the second quarter. The to maintain a buoyant housing market acceleration reflected a surge in expenand spending by both consumers and ditures on motor vehicles that owed businesses was firm. Available informa- partly to attractive incentives, but spendtion suggested that the recent tempo of ing on other durables and nondurables economic activity continued into the was also up. Spending on services was Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

218 91st Annual Report, 2004 steady for the third quarter on average, imports. The deficit narrowed in Sepbut advanced in September on a boost to tember, however, as imports fell while electricity consumption related to unsea- exports expanded moderately. The lower sonably warm weather. Real disposable level of imports in September mainly income slowed in the third quarter to a reflected declines in the petroleum and moderate pace and was flat in Septem- services categories. Economic expanber, probably in part because of effects sion abroad on average appeared to slow of the hurricanes. Measures of consumer in the third quarter, although it remained confidence moved down in Septem- solid. ber and again in October. Activity in Consumer prices continued to housing markets remained generally advance at a moderate rate in recent strong in September, supported by months, although both overall and core favorable mortgage rates. Although consumer price measures rose a bit starts of single-family homes slowed faster in the twelve months ending in to well below the level of preceding September 2004 than in the year-earlier months, multifamily starts rose and sales period. Expectations of near-term inflaof both existing and new homes were tion picked up in October, consistent elevated. with the increase in energy prices. Labor Business investment spending on costs continued to rise moderately. The equipment and software continued to increase in the employment cost index expand at a rapid pace in the third quar- for private compensation over the third ter, supported by positive fundamentals quarter was a bit below the average pace that included robust business output, of the last two years. low interest rates and readily available At its meeting of September 21, 2004, credit, and healthy business balance the Federal Open Market Committee sheets. Outlays for high-tech equipment adopted a directive that called for conand software stepped down in the third ditions in reserves markets consistent quarter, but spending on other types with increasing the federal funds rate of equipment, including transportation, to an average of around 13A percent. In was at a high level. At the same time, its public statement, the Committee investment in nonresidential structures, expressed a belief that monetary policy which had turned up in the second quar- remained accommodative even after this ter, softened in the third quarter. Con- tightening, and judged the upside and struction spending for retail buildings downside risks to the attainment of both and warehouses advanced, but high sustainable growth and price stability vacancy rates for office buildings held over the next few quarters to be roughly back investment in that sector. equal. The Committee noted its expecta- Accumulation of nonfarm inventories tion that the underlying rate of inflation excluding motor vehicles picked up would continue to be low and that polsmartly over the third quarter. The level icy accommodation could be removed of sales also rose, however, keeping at a pace that is likely to be measured, inventory-sales ratios fairly steady at but also stated that it would nonetheless low levels. respond to changes in economic pros- The U.S. international trade deficit pects as needed to fulfill its obligation to rose in the third quarter on average, maintain price stability. reflecting some weakening in the growth The FOMC's decision in September of service exports and an increase in to raise the intended level of the federal the price and quantity of petroleum funds rate 25 basis points and its atten- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 219 dant public statement were anticipated partial-expensing provisions of the tax by the market, and the reaction was code. Oil prices were anticipated to muted. Over subsequent weeks, how- decline somewhat with the repair of ever, a reference in the minutes of the hurricane-related damage to oil infra- August FOMC meeting to the need for structure in the Gulf of Mexico, leading "significant cumulative tightening" and to some slowing in inflation. With the comments by the Chairman and other economy expected to advance over the FOMC members, which were read as coming year at a rate a bit above its minimizing the likely damping effect on longer-run potential, the pace of hiring the economy of higher energy prices, should firm and the unemployment rate led markets to raise their expectations of should edge lower. In response to rising forthcoming policy tightenings. These real incomes, consumer spending was expectations were boosted further by the forecast to strengthen after the early part release of the strong employment data of next year. The staff expected business for October. The shift in the market's investment spending to slow sharply outlook for monetary policy contributed early next year as partial-expensing proto noticeable upward pressure on short- visions expired, but then to pick up term interest rates, and most long- noticeably in response to favorable term rates also moved up. Yields on financing conditions, ample business investment-grade corporate bonds rose liquidity, and the need to replace or about in line with those on comparable- upgrade aging equipment and software. maturity Treasuries, but yields on In the Committee's discussion of curspeculative-grade bonds edged down rent and prospective developments, the and equity markets posted strong members generally expressed assessadvances. In foreign exchange markets, ments that economic expansion in the the dollar declined appreciably, appar- neighborhood of the rate of growth of ently in part on continuing market con- the economy's potential appeared to cerns about the financing of the U.S. have become even more firmly estabcurrent account deficit. lished over recent months, despite the M2 expanded in October at about the drag from higher energy prices. Recent sluggish pace of the third quarter. The data and anecdotal information suggrowth of M2 was restrained in recent gested that spending by businesses and months by increases in its opportunity households had been reasonably robust cost. Rates paid on its liquid asset com- of late, supported by accommodative ponents have lagged increases in market financial conditions, continuing gains in rates associated with the three monetary productivity, and increasing employtightenings since midyear. ment. Looking forward, economic fun- In the staff forecast prepared for this damentals appeared to be favorable for meeting, the economy was seen as likely continued solid growth, and while fiscal to expand next year at around this year's stimulus would abate next year, a flatsolid pace under an assumption of gen- tening out of energy prices, as markets erally accommodative financial condi- seemed to anticipate, would bolster ecotions. Recent declines in the dollar were nomic expansion. However, significant expected to support domestic economic uncertainties surrounded the prospects activity by boosting net exports. Fiscal for energy prices and fiscal policy, as policy was expected to become much well as the external sector. The Commitless stimulative after the current quarter, tee anticipated that underlying inflatowing to the expiration of the temporary ion pressures would remain contained Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

220 91st Annual Report, 2004 as monetary accommodation was with- recent months, Committee members drawn. Core consumer price inflation reported contacts with retail merchants had been quite damped on average in that suggested mixed readings on the recent months and longer-term inflation ongoing pace of consumer buying. The expectations remained well anchored, effect of higher energy prices on real despite further increases in energy prices incomes was likely still restraining conand prospective increases in near-term sumer spending. Moreover, the stock of headline inflation. automobiles owned by households had In their discussion of key sectors of risen substantially in recent years, and the economy, policymakers noted that the willingness of households to purbusiness investment had been expand- chase autos was seen as continuing to ing robustly and was likely to continue depend importantly on the provision of to be buoyed by the strength of produc- incentives by manufacturers. Home buytivity and profits. Some sectors, such as ing and residential construction genertrucks and heavy equipment, had experi- ally remained robust, although a few enced rapid growth. However, even after members pointed to some moderation in taking account of likely effects of higher activity in selected markets. It was noted oil prices, the pace of overall business that a slowdown in the rate of increase investment spending was still boosting in home prices going forward might lead GDP growth somewhat less than might households to increase their desired savhave been expected given accommoda- ing. However, the risk of any signifitive financial conditions and tax incen- cant drop-off in the growth of consumer tives. Some uncertainties, such as those spending would likely diminish with a associated with the election, had been sustained rebound in the pace of hiring. resolved, but others persisted, including In their comments on fiscal policy, the prospects for oil prices and their Committee members indicated an consequences for the economy. Many expectation that the economic stimulus business firms seemed hesitant about provided in recent years by discretionlarge-scale investment to increase pro- ary fiscal measures was likely to fade ductive capacity and hiring commit- next year. However, considerable uncerments, perhaps partly reflecting an envi- tainty surrounded the likely evolution of ronment of greater scrutiny regarding the federal budget. Members stressed corporate governance and internal con- the importance of fiscal discipline to trol systems. The high-tech sector, and facilitate a better balance between net investment in information technology national saving and investment and more generally, had been growing less thereby promote an adjustment of the rapidly of late and was seen as posing a imbalance in the current account of the possible downside risk to the outlook. If balance of payments. the recent slower rate of price declines Committee members noted that the on high-tech products implied a softer balance of trade had improved a little underlying pace of technological in September and commented that the change, both the outlook for investment decline in the value of the dollar over demand and the prospects for persist- the past few years had been boosting ing high trend growth in productivity demand seen by some exporting firms. could be damped relative to previous However, with foreign economic growth expectations. moderating and the large excess of While acknowledging data indicating imports over exports, members genera rebound in consumption spending in ally viewed the prospects for net exports Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 221 as likely to provide a continuing drag on outlook included possible further depre- U.S. economic expansion. One implica- ciation of the dollar or increases in tion of this outlook was that U.S. exter- energy prices. In addition, a few memnal indebtedness relative to GDP would bers cited the possibility that the elebe increasing further. vated pace of trend productivity growth Committee members remarked on experienced since the mid-1990s would signs of improvement in labor market begin to slow. conditions. While acknowledging the In the Committee's discussion of the need to be cautious about readings from setting of policy, all of the members a single labor market report, members favored raising the target for the federal saw the increase in payroll employment funds rate by 25 basis points to 2 perin October and the upward revisions cent at this meeting. The economy to previous months as encouraging. Fur- appeared to be continuing to expand at thermore, business contacts in several a moderate pace that was likely to be regions were indicating greater diffi- rapid enough to gradually reduce marculty in filling some types of positions, gins of underutilized resources. In that both skilled and unskilled. Nevertheless, regard, the Committee was encouraged many firms evidently remained slow to by more evident signs of improvement expand hiring, in part because of rising in hiring. The Committee felt that the benefit costs. One member commented outlook justified the further removal of on the performance of a few key indus- the policy accommodation that had been tries, citing evidence that the job losses appropriate when the economic expansince the business cycle peak had sion was more tentative. Today's action been driven primarily by weak demand would move the real funds rate, mearather than productivity improvements. sured using core PCE inflation, toward a Although the extent of economic slack more positive setting. was uncertain, some members indicated In discussing the FOMC announcea sense that the economy needed to ment for this meeting and going forgrow faster than trend in order to take ward, several members commented that up remaining unused resources. policy actions would likely become Wage and price pressures were gen- increasingly dependent on incoming erally still modest. While some firms data and their implications for future reportedly were finding it easier to pass activity and prices. This might imply a higher oil and other commodity costs on more gradual path of tightening going to their business customers, most busi- forward than that of the last several ness contacts indicated considerable months, as for example now seemed to difficulty in passing cost increases on be built into the term structure of interto consumers. Longer-term inflation est rates, or it might mean that the Comexpectations had remained reasonably mittee on occasion would need to firm low, helping to restrain the spillover of policy more rapidly. A few members felt elevated energy prices to the prices of that, because of greater uncertainties, it other goods and services. Some mem- might become appropriate eventually bers noted that any remaining resource to move away from the recent practice slack would probably exert downward of providing guidance about the likely pressure on inflation and that the depre- future path of policy, while others ciation of the dollar seemed to be having emphasized the desirability of continua muted effect on import prices to date. ing to be as informative as possible However, upside risks to the inflation about the Committee's perceived out- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

222 91st Annual Report, 2004 look. For now, most members agreed sustainable growth and price stability for the that the current statement language next few quarters to be roughly equal. With underlying inflation expected to be relatively provided considerable flexibility with low, the Committee believes that policy regard to the Committee's future actions accommodation can be removed at a pace and that market participants understood that is likely to be measured. Nonetheless, that flexibility. As regards the announce- the Committee will respond to changes in ment to be released after the meeting, economic prospects as needed to fulfill its obligation to maintain price stability. most members felt that little change in the statement language was required. Votes for this action: Messrs. Green- Policymakers concurred that the statespan, Geithner, Bernanke, Ms. Bies, ment should indicate that output appears Messrs. Ferguson, Gramlich, Hoenig, to be growing at a moderate pace Kohn, Ms. Minehan, Mr. Olson, Ms. Piandespite the rise in energy prices, that alto, and Mr. Poole. Vote against this action: None. labor market conditions have improved, and that inflation and longer-term infla- It was agreed that the next meeting of tion expectations remain well contained. the Committee would be held on Tues- They agreed to characterize the risks day, December 14, 2004. to sustainable growth and price stability The meeting adjourned at 1:15 p.m. as balanced and to reiterate that policy accommodation could be removed at a pace that was likely to be measured Notation Vote but that the Committee will respond to changes in economic prospects as By notation vote completed on Decemneeded to maintain price stability. ber 10, 2004, the Committee authorized At the conclusion of the discussion, Mr. Santomero, an alternate member of the Committee voted to authorize and the Committee, to accept the honor of direct the Federal Reserve Bank of New the title of "Cavaliere" to be awarded York, until it was instructed otherwise, by the government of Italy. to execute transactions in the System Account in accordance with the follow- Votes for this action: Messrs Greenspan, Geithner, Bernanke, Ms. Bies, ing domestic policy directive. Messrs. Ferguson, Gramlich, Hoenig, Kohn, Ms. Minehan, Mr. Olson, Ms. Pian- The Federal Open Market Committee alto, and Mr. Poole. Vote against this seeks monetary and financial conditions that action: None. will foster price stability and promote sustainable growth in output. To further its Vincent R. Reinhart long-run objectives, the Committee in the Secretary immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 2 percent. Meeting Held on December 14, 2004 The vote encompassed approval of the paragraph below for inclusion in the A meeting of the Federal Open Market statement to be released shortly after the Committee was held in the offices of meeting: the Board of Governors of the Federal Reserve System in Washington, D.C., The Committee perceives the upside and on Tuesday, December 14, 2004, at downside risks to the attainment of both 9:00 a.m. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 223 Present: Mr. Reifschneider, Deputy Associate Mr. Greenspan, Chairman Director, Division of Research and Mr. Geithner, Vice Chairman Statistics, Board of Governors Mr. Bernanke Ms. Bies Mr. English, Assistant Director, Mr. Ferguson Division of Monetary Affairs, Mr. Gramlich Board of Governors Mr. Hoenig Mr. Kohn Mr. Simpson, Senior Adviser, Division Ms. Minehan of Research and Statistics, Mr. Olson Board of Governors Ms. Pianalto Mr. Poole Messrs. Brayton and Carpenter, Senior Economists, Divisions of Research Messrs. Moskow, Santomero, and and Statistics and Monetary Stern, Alternate Members of the Affairs, respectively, Board of Federal Open Market Committee Governors Messrs. Guynn, Lacker, and Mr. Skidmore, Special Assistant to the Ms. Yellen, Presidents of the Board, Office of Board Members, Federal Reserve Banks of Atlanta, Board of Governors Richmond, and San Francisco, respectively Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Ms. Holcomb, First Vice President, Board of Governors Federal Reserve Bank of Dallas Ms. Low, Open Market Secretariat Mr. Reinhart, Secretary and Economist Assistant, Division of Monetary Ms. Danker, Deputy Secretary Affairs, Board of Governors Ms. Smith, Assistant Secretary Mr. Alvarez, General Counsel Ms. Cumming, First Vice President, Mr. Baxter, Deputy General Counsel Federal Reserve Bank of Ms. Johnson, Economist New York Mr. Stockton, Economist Messrs. Eisenbeis and Goodfriend, Messrs. Connors, Fuhrer, Hakkio, Ms. Mester, Messrs. Rosenblum Howard, Madigan, Slifman, and Williams, Senior Vice Sniderman, Rasche, and Wilcox, Presidents, Federal Reserve Associate Economists Banks of Atlanta, Richmond, Philadelphia, Dallas and Mr. Kos, Manager, System Open San Francisco, respectively Market Account Messrs. Elsasser, Peach, and Sullivan, Mr. Ettin, Deputy Director, Division Vice Presidents, Federal Reserve of Research and Statistics, Banks of New York, New York, Board of Governors and Chicago, respectively Messrs. Oliner and Struckmeyer, Mr. Weber, Senior Research Officer, Associate Directors, Division Federal Reserve Bank of of Research and Statistics, Minneapolis Board of Governors By unanimous vote, the minutes of Messrs. Clouse and Whitesell, Deputy the meeting of the Federal Open Market Associate Directors, Division of Monetary Affairs, Board of Committee held on November 10, 2004, Governors were approved. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

224 91st Annual Report, 2004 The Manager of the System Open in recent months. Output at mines Market Account reported on recent increased noticeably for a second developments in foreign exchange mar- month, and manufacturing output posted kets. There were no open market opera- a moderate gain. At utilities, output fell tions in foreign currencies for the Sys- back in November after large increases tem's account in the period since the in the preceding two months. Utilization previous meeting. The Manager also rates moved higher in November. reported on recent developments in Consumer spending appeared to be domestic financial markets and on Sys- expanding at a more moderate pace in tem open market transactions in gov- the fourth quarter, after growing at a ernment securities and securities issued robust rate in the third quarter. Although or fully guaranteed by federal agencies sales of motor vehicles declined in during the period November 10, 2004, November, spending on other goods through December 13, 2004. By unani- rose further after the large increase mous vote, the Committee ratified these posted in October. Spending on services transactions. continued to register solid gains. Real The information received at this disposable income, restrained by sharply meeting suggested that the economy higher energy prices, rose slightly. Even expanded at a moderate pace over the so, measures of consumer confidence third quarter and into the current quarter. were little changed and remained con- Consumer spending was solid, and sistent with sustained increases in investment spending remained strong. spending. Manufacturing production increased at Activity in housing markets, buoyed a modest pace, and employment gains by mortgage rates only modestly above in October and November indicated that their recent lows, remained strong in the labor market continued to improve October. Starts of both single-family and gradually. Core inflation measures multifamily homes increased and were remained subdued, albeit running at a above their third-quarter levels. Home slightly higher pace than last year, sales remained at near-record levels. owing, in part, to the indirect effects of Shipments of nondefense capital higher energy prices. goods stepped up in October against the Gains in employment were moderate backdrop of solid expansion in business in November after a surge in October. output, low user cost of capital, and an Job growth was fairly widespread, with ample stock of liquid assets in the corthe exception of slightly weak seasonal porate sector. Shipments of computers hiring in the retail sector. Construction jumped in October, while gains in the employment grew rapidly in November transportation sector were more modest. even after the outsized gains in October Outside the high-tech and transportation due to hurricane-related repair work. In sectors, shipments moved up considercontrast, employment in manufacturing ably in October from their robust thirdedged lower. The average workweek quarter pace. Outlays on nonresidential in November was a touch below its construction edged down in October. level in October, but still a bit above the After a rapid rise in the third quarter, third-quarter average. The unemploy- nonfarm inventories appeared to accument rate ticked down to 5.4 percent in mulate at a moderate pace in Octo- November. ber. The book value of manufacturers' Industrial production expanded a little inventories increased notably; however, more slowly in November than it had shipments also stepped up, an increase Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 225 that left the inventory-shipments ratio in fulfill its obligation to maintain price this sector unchanged. stability. The U.S. international trade deficit The FOMC's decision in November widened in October, primarily because to raise the intended federal funds rate of a surge in merchandise imports. Eco- 25 basis points and its attendant pubnomic activity in most of the major for- lic statement were apparently anticieign industrial countries slowed in the pated by the market, so that the reaction third quarter, and data for the fourth was muted. Subsequently, higher-thanquarter pointed to continued subpar expected inflation data, remarks by the growth. Chairman that were viewed as pointing Consumer prices jumped in October, to future rate increases, and the depreas hurricane damage contributed to ciation of the dollar all led market parhigher prices for food and energy. For ticipants to price in a somewhat steeper the twelve months ending in October, path for future policy. The upward reviconsumer prices rose considerably faster sion in policy expectations prompted than they did in the year-earlier period. modest increases in shorter-term Trea- Core consumer prices increased much sury coupon security yields. The yield more modestly in October than did on the ten-year Treasury note, however, overall consumer prices, although the was unchanged on net. Yields on both twelve-month change for core prices investment-grade and speculative-grade was also somewhat higher than it was a corporate bonds edged lower. The value year before. The employment cost index of the dollar relative to other major curfor private compensation advanced rencies declined. moderately in the year ending the M2 accelerated a bit in November third quarter, and the markup of prices from its sluggish pace in October, but over labor costs remained somewhat growth in money continued to be elevated. restrained by increases in its opportunity At its meeting on November 10, cost. Rates paid on the liquid compo- 2004, the Federal Open Market Com- nents of M2 lagged increases in market mittee (FOMC) adopted a directive that rates associated with the monetary polcalled for conditions in reserves markets icy tightenings this year. Bank credit consistent with increasing the federal rebounded in November, with both secufunds rate to an average of around 2 per- rities and loans registering gains. cent. In its public statement, the Com- In the staff forecast prepared for this mittee expressed a belief that monetary meeting, the economy was seen as likely policy remained accommodative even to expand at a moderate pace, supported after this tightening and judged that the by accommodative monetary policy upside and downside risks to the attain- and financial conditions. Consistent with ment of both sustainable growth and readings from futures markets, oil prices price stability over the next few quarters were anticipated to edge lower. With were roughly equal. The Committee economic activity projected to expand at noted its expectation that the underly- a pace a little above that of its longering rate of inflation would continue to run potential over the coming year, be low and that policy accommodation hiring was projected to continue to could be removed at a pace that is likely firm, causing the unemployment rate to to be measured, but it also stated that edge down next year. The steep run-up it would nonetheless respond to changes in housing prices, recent increases in in economic prospects as needed to equity prices, and anticipated gains in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

226 91st Annual Report, 2004 payrolls were viewed as likely to boost was expected to persist and, along with the growth of consumption spending higher wealth and relatively low internext year to a pace somewhat above that est rates, would support further gains recorded this year. Business investment in spending by households. Rising was anticipated to decline a bit early demand, elevated underlying productivnext year in light of the expiration of ity growth, and accommodative finanthe partial-expensing tax provision at cial conditions should keep business the end of 2004 but was projected to spending on a strong uptrend. With resume vigorous growth in response to a some economic slack persisting and favorable economic outlook, supportive longer-term inflation expectations wellfinancial conditions, ample liquid assets anchored, inflation was anticipated to in the corporate sector, and an ongoing remain subdued. A number of particineed to replace or upgrade aging equip- pants cited the recent depreciation of ment and software. Measures of total the dollar on foreign exchange markets, consumer price inflation were expected elevated energy costs, and the possibilto decline from current levels reflect- ity of a slowing in underlying productiving the direct effect of the downturn in ity growth as factors tending to boost energy prices. By contrast, core infla- the upside risks to their inflation outtion was seen in the staff forecast as look, though, on net, they saw the risks remaining stable. The upward pressure to stable underlying inflation as still on inflation from a slight step-down balanced. in structural productivity growth and a In their discussion of important secnarrowing margin of resource slack was tors of the economy, participants noted expected to be about counterbalanced that increasing equity and home prices by diminishing pressure from the pass- had boosted household net worth, leavthrough of the earlier rise in energy ing consumers well positioned to mainprices and decline in the dollar. tain a brisk pace of spending. Contin- In their discussion of the economic ued gains in employment were thought outlook, the participants at the meeting likely to provide additional support to (the members of the Board of Gover- spending by bolstering consumer connors and the Reserve Bank Presidents fidence and income. Participants comor those acting in their place) generally mented that real disposable incomes regarded incoming data since the prior should receive a further lift from the meeting as consistent with an expecta- recent drop in oil prices. Moreover, tion that the economy would continue to intermediate- and long-term interest expand at a pace that would likely prove rates remained low in both nominal sufficient to reduce margins of underuti- and real terms despite the recent firming lized resources further. Recent data and in the stance of policy, encouraging anecdotal information indicated that the spending on consumer durables and economic expansion was firmly estab- housing. lished and had proven quite resilient Many of the fundamentals underin the face of rising oil prices and the lying the demand for capital goods— reduction in policy accommodation. expanding output, a low cost of capital, Although the November employment strong profits, and ample liquid assets— report had been disappointing, when appeared quite favorable, and particiviewed over several months, labor mar- pants generally were upbeat in their ket conditions were generally seen as assessment of the prospects for investgradually improving. That improvement ment. While some participants noted Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 227 that their business contacts seemed more tors anticipated further increases in the confident about the future and that the federal funds rate over the coming year, sense of caution previously evident in but intermediate- and long-term interest business spending and hiring behavior rates along with financial conditions seemed to be waning, others believed more generally had remained quite supthat many businesses remained quite portive of growth. A few participants wary. Most participants acknowledged commented that the generally low level some significant uncertainties in their of interest rates across a wide range outlook, including the effects of the ex- of maturities and the recent flattening of piration of the partial-expensing provi- the slope of the yield curve (measured sion for investment at the end of 2004 as the spread between ten- and two-year and recent indications of a softening in Treasury yields) might signal that high-tech spending in the United States expectations of longer-term growth had and elsewhere. The possible downshift been marked down. Some participants in the pace of high-tech spending also believed that the prolonged period of raised the possibility of an erosion of policy accommodation had generated a profit margins that could result from a significant degree of liquidity that might slackening in the pace of technology-led be contributing to signs of potentially productivity growth and the associated excessive risk-taking in financial marincrease in cost pressures. kets evidenced by quite narrow credit A number of participants voiced con- spreads, a pickup in initial public offercerns about domestic and global finan- ings, an upturn in mergers and acquisicial imbalances. On the domestic front, tion activity, and anecdotal reports that such concerns focused on the magnitude speculative demands were becoming of current and projected fiscal deficits, apparent in the markets for single-family which seemed likely to keep national homes and condominiums. saving low. Views about the prospects Although the November employment for fiscal restraint in the years ahead report had been disappointing and recent were mixed; some participants believed readings on initial claims for unemthat the odds of significant deficit reduc- ployment insurance had risen, particition over the next few years were pants viewed labor market conditions remote while others were more opti- still as improving gradually. Averaging mistic. Regarding global imbalances over recent months, or even the entire and the current account deficit in the year, employment growth had been fast United States, a number of participants enough to absorb unutilized labor expressed doubts that such imbal- resources over time. Anecdotal informaances would be reduced in the near- tion suggested a significant tightening in term. Better global balance would the market for skilled workers in some require not only greater national saving industries and regions, although demand in the United States but also a notable for less skilled workers still appeared strengthening in domestic demand soft. Recent surveys of hiring plans by among major trading partners. Such a businesses were read as signaling future strengthening seemed unlikely in the gains in employment. Despite the furnear term given the recent softening ther improvement in labor markets, in the economies of several important a number of participants noted that industrial countries. wage and compensation increases had In their discussion of financial market not picked up materially and generally conditions, participants noted that inves- remained moderate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

228 91st Annual Report, 2004 In their discussion of the outlook for tations had been quite stable of late, prices, a number of participants cited despite the previous rise in energy prices developments that could pose upside and the lower dollar. Moreover, several inflation risks. Although oil prices had participants cited factors that likely fallen of late, they were still consider- would continue to provide a counterably higher than they had been in the weight to any upside risks. Although spring, and the recent decline in the participants generally acknowledged dollar would raise import prices and that the degree of economic slack was diminish competitive pressures on many quite uncertain, the moderate pace of industries. The pass-through from both wage and compensation growth in sources should be limited, but they were recent months in the face of higher still a potential source of upward pres- energy prices and several years of rapid sure on prices that could get embedded productivity growth was consistent with in higher inflation under certain circum- an economy still operating somewhat stances. In addition, productivity growth below its potential. In a similar vein, had slowed appreciably in the most the recent quarterly dip in productivity recent quarter and unit labor costs had growth notwithstanding, there were no increased, raising questions about cost clear signs that underlying productivity pressures going forward. A few partici- had slowed appreciably of late, and a pants also noted that uncertainty about close reading of recent history suggested the extent of resource slack in the econ- that upside risks to the outlook for proomy was considerable and that it was ductivity growth could be significant. quite possible that the economy could Even if structural productivity growth soon be operating close to potential, par- were to slow, price markups remained ticularly if labor force participation rates quite elevated and some participants did not turn up much while employment noted that further increases in unit labor continued to register gains. The increase costs could well be absorbed for some over the last few months in five-year time by a return of markups to more measures of inflation compensation normal levels. derived from Treasury nominal and In the Committee's discussion of polinflation-indexed securities might be a icy for the intermeeting period, all of the warning sign that expectations were not members (the members of the Board of as well anchored as they had been over Governors and the five voting Reserve the summer. Bank Presidents) favored raising the tar- Despite these concerns, participants get for the federal funds rate by 25 basis generally expected that inflation would points to 2V4 percent at this meeting. All remain low in the foreseeable future. members judged that a further quarter- While the depreciation of the dollar over point tightening in the target federal recent months had been notable, some funds rate at this meeting was appropriparticipants found persuasive the evi- ate in light of the prospects for solid dence from recent studies pointing to a growth and diminished slack. Even with decline over time and across countries this action, the current level of the in the pass-through of exchange rate real funds rate target remained below movements into domestic prices. For- the level it most likely would need to ward market-based measures of infla- reach to keep inflation stable and outtion compensation beyond the next five put at its potential. With the economic years as well as survey measures of both expansion more firmly entrenched, short- and long-term inflation expec- cost and price pressures were likely Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 229 to become a clearer intermediate-term Account in accordance with the followrisk to sustained good economic per- ing domestic policy directive. formance absent further reduction of accommodation. The Federal Open Market Committee With regard to the Committee's seeks monetary and financial conditions that will foster price stability and promote susannouncement to be released after the tainable growth in output. To further its longmeeting, members generally agreed that run objectives, the Committee in the immeoverall economic prospects were simi- diate future seeks conditions in reserve lar to those prevailing at the time of markets consistent with increasing the fedthe November meeting and that conse- eral funds rate to an average of around quently the statement should be altered 2VA percent. only to the minor extent required to reflect recent economic developments. The vote encompassed approval of They concurred that the statement the paragraph below for inclusion in the should note that output appears to be statement to be released shortly after the growing at a moderate pace despite the meeting: earlier rise in energy prices, that labor market conditions continue to improve The Committee perceives the upside and downside risks to the attainment of both gradually, and that inflation and longersustainable growth and price stability for the term inflation expectations remain wellnext few quarters to be roughly equal. With contained. They also agreed again to underlying inflation expected to be relatively characterize the risks to sustainable low, the Committee believes that policy growth and price stability as balanced. accommodation can be removed at a pace A few members believed that the Com- that is likely to be measured. Nonetheless, the Committee will respond to changes in mittee's flexibility would be enhanced economic prospects as needed to fulfill its by eliminating the forward-looking ele- obligation to maintain price stability. ments of the Committee's statement referring to the pace of removal of Votes for this action: Messrs. Greenpolicy accommodation. More of the span, Geithner, Bernanke, Ms. Bies, members believed that this language Messrs. Ferguson, Gramlich, Hoenig, Kohn, Ms. Minehan, Mr. Olson, Ms. Pianwas useful in conveying the Commitalto, and Mr. Poole. Vote against this tee's sense of the outlook for the econaction: None. omy and the stance of monetary policy and was appropriately conditioned The meeting then turned to considon economic developments. All memeration of releasing FOMC minutes on bers agreed that the FOMC statement an accelerated schedule. Meeting parfor this meeting should again indicate ticipants agreed that an experiment with that policy accommodation could be accelerating the preparation of the minremoved at a pace that was likely to be utes that had been conducted since early measured but that the Committee would in the year had been successful in identirespond to changes in economic prosfying the procedural changes that would pects as needed to maintain price be necessary if an accelerated schedule stability. were to be followed going forward. Par- At the conclusion of the discussion, ticipants noted that the minutes conthe Committee voted to authorize and tained a more complete and nuanced direct the Federal Reserve Bank of New explanation of the reasons for the Com- York, until it was instructed otherwise, mittee's decisions and view of the risks to execute transactions in the System to the outlook than was possible in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

230 91st Annual Report, 2004 post-meeting announcement, and their minutes on an expedited schedule, and earlier release would help markets inter- the Committee voted unanimously to pret economic developments and predict begin publishing the minutes of reguthe course of interest rates. They also larly scheduled meetings three weeks would provide the public a more up- after the day of the policy decision. The to-date context for individual policy- minutes of any other Committee meetmakers' public remarks. Meeting par- ings, such as conference calls, would be ticipants supported the principle of handled somewhat differently. In those openness and transparency, but debated cases, if a policy action were taken, an the possibility that the markets would announcement of that action would be misinterpret the minutes and that the made as soon as practicably possible. prospect of early release would lead to If, however, no action were taken, the either less productive discussions at the fact that the conference call took place meetings or to less comprehensive, and would be reflected in the statement foltherefore less useful, minutes. A few lowing the subsequent regular meeting, participants expressed support for trim- and, in any case, the minutes of the call ming the length and forward-looking would be released along with the minelements of the post-meeting announce- utes of the subsequent regular meeting. ments, should the Committee decide It was agreed that the next meeting to accelerate release of the minutes. of the Committee would be held on Others, however, preferred not to link Tuesday-Wednesday, February 1-2, the two decisions or viewed the more 2005. extensive announcements as useful The meeting adjourned at 1:25 p.m. regardless of the minutes' publication schedule. Vincent R. Reinhart The clear consensus of the partici- Secretary pants at the meeting was to release the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

231 Litigation During 2004, the Board of Governors Litigation under the Financial was a party in eight lawsuits or appeals Institutions Supervisory Act filed that year and was a party in nine Board of Governors v. Thomas, et al., other cases pending from previous No. l:04-CV-0777 (N.D. Georgia, filed years, for a total of seventeen cases; in March 19, 2004), is an injunctive action 2003, the Board had been a party in a brought to compel eighteen individuals total of twelve cases. Two of the lawnamed in a separate Board administrasuits or appeals filed in 2004 raised tive enforcement proceeding to deposit questions under the Bank Holding Comsufficient funds into the registry of the pany Act. As of December 31, 2004, court to satisfy civil money penalties nine cases were pending. sought by the Board in the administrative action. On April 2, 2004, the court issued a temporary restraining order Judicial Review of Board Orders granting the relief sought by the Board, under the Bank Holding and on April 28, 2004, the court issued a Company Act preliminary injunction extending this Haili et ai v. Greenspan et ah, No. 04- relief until completion of the Board's 00089 DAE-LEK (D. Hawaii, filed Feb- enforcement proceeding. ruary 6, 2004), was an action seeking Ulrich v. Board of Governors, No. 03an order requiring the Board to enforce 73854 (9th Circuit, filed October 24, an alleged commitment made under 2003), and Diehl McCarthy v. Board of the Community Reinvestment Act. The Governors, No. 03-73997 (9th Circuit, action also sought a declaratory judg- filed October 28, 2003), are petitions for ment and an injunction preventing the review of orders of prohibition issued approval of an application under the by the Board on October 15, 2003. On Bank Holding Company Act until the December 12, 2003, the court consoliasserted commitment was fulfilled. On dated these cases with related petitions February 23, 2004, the district court for review of orders issued by the Office granted the Board's motion to dismiss of the Comptroller of the Currency the action. imposing civil money penalties and res- CB Bancshares, Inc. v. Board of Gov- titution against the petitioners. ernors, No. 04-70229 (9th Circuit, filed January 14, 2004), was a petition for Other Actions review of the Board order granting Central Pacific Financial Corp. of Honolulu, Inner City Press/Community on the Hawaii, approval to acquire CB Banc- Move v. Board of Governors, No. 04shares, Inc., also of Honolulu. On CV-8337 (S.D. New York, filed Octo- June 3, 2004, the court dismissed the ber 21, 2004), is a case brought under action on the motion of the petitioner. the Freedom of Information Act. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

232 91st Annual Report, 2004 Texas State Bank v. United States, bonds. On June 9, 2004, the court No. 04-5126 (Federal Circuit, filed granted the Board's motion to dismiss July 28, 2004), is an appeal of a decision the action. of the United States Court of Federal Apffel v. Board of Governors, No. 03- Claims dismissing an action {Commu- 343 (S.D. Texas, filed May 20, 2003), nity Bank & Trust v. United States, was a case brought under the Freedom No. 01-571C, 60 Fed. Cl. 815 (2004)) of Information Act. On January 9, 2004, challenging on constitutional grounds the court granted the Board's motion to the failure to pay interest on reserve dismiss the case. accounts held at Federal Reserve Banks. Carter v. Greenspan, No. 03-1026 Sciba v. Board of Governors, No. 04- (D. District of Columbia, filed May 9, CV-1011 (D. District of Columbia, filed 2003), was an employment discrimina- June 21, 2004), is a case brought under tion action. On February 19, 2004, the the Freedom of Information Act. court granted the Board's motion to dis- Price v. Greenspan, No. 04-CV-0973 miss the case. (D. District of Columbia, filed June 14, Albrecht v. Board of Governors, 2004), is an employment discrimination No. 02-5235 (D.C. Circuit, filed Octoaction. ber 18, 2002), was an appeal of a district Thomas v. Board of Governors, court order dismissing a challenge to No. 04-CV-1554 (N.D. Georgia, the pension funding method applicable removed from Superior Court of Gwin- to certain Board employees under the nett County, Georgia, on May 28, 2004), Board's retirement plan. The district was an action against the Board, its court's dismissal was affirmed by the enforcement staff, and others by indi- Court of Appeals on February 10, 2004. viduals involved in a pending enforce- Artis v. Greenspan, No. 01-0400 ment action. On October 4, 2004, the (D. District of Columbia, filed Februcourt granted the Board's motion to dis- ary 22, 2001), is an employment dismiss the action. crimination action. An identical action, Skanska USA Building, Inc. v. Board No. 99-2073 (EGS) (D. District of of Governors, No. 304CV00675 SRU Columbia, filed August 3, 1999), was (D. Connecticut, filed April 22, 2004), consolidated with this action on was a Freedom of Information Act case. August 15,2001. The case was dismissed by stipulation Fraternal Order of Police v. Board of of the parties on November 29, 2004. Governors, No. 98-3116 (D. District Laigo v. Board of Governors, No. 03- of Columbia, filed December 22, 1998), CV-03576-MJP (W.D. Washington, filed is an action seeking a declaratory judg- November 19, 2003), was a claim ment regarding the Board's labor policy regarding redemption of U.S. savings governing Federal Reserve Banks. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

Federal Reserve System Organization 235 Board of Governors December 31,2004 Members OFFICE OF THE SECRETARY Term expires January 31, Jennifer J. Johnson, Secretary Alan Greenspan, Chairman1 2006 Robert deV. Frierson, Deputy Secretary Roger W. Ferguson, Jr., Margaret M. Shanks, Assistant Secretary Vice Chairman1 2014 Edward M. Gramlich 2008 Susan S. Bies 2012 DIVISION OF Mark W. Olson 2010 INTERNATIONAL FINANCE Ben S. Bernanke 2018 Karen H. Johnson, Director Donald L. Kohn 2016 David H. Howard, Deputy Director Thomas A. Connors, Senior Associate Officers Director OFFICE OF BOARD MEMBERS Dale W. Henderson, Senior Adviser Michelle A. Smith, Director Richard T. Freeman, Associate Director Winthrop P. Hambley, Assistant to the Steven B. Kamin, Associate Director Board and Director for Congressional William L. Helkie, Senior Adviser Liaison Jon W. Faust, Assistant Director Rosanna Pianalto-Cameron, Special Joseph E. Gagnon, Assistant Director Assistant to the Board for Public Willene A. Johnson, Adviser Information Michael P. Leahy, Assistant Director David W. Skidmore, Special Assistant D. Nathan Sheets, Assistant Director to the Board Ralph W. Tryon, Assistant Director Laricke D. Blanchard, Special Assistant to the Board for Congressional Liaison DIVISION OF MONETARY AFFAIRS LEGAL DIVISION Vincent R. Reinhart, Director Scott G. Alvarez, General Counsel Brian F. Madigan, Deputy Director Richard M. Ashton, Associate James A. Clouse, Deputy Associate General Counsel Director Stephanie Martin, Associate General William C. Whitesell, Deputy Associate Counsel Director Kathleen M. O'Day, Associate General Cheryl L. Edwards, Assistant Director Counsel William B. English, Assistant Director Ann Misback, Assistant General Counsel Athanasios Orphanides, Adviser Katherine H. Wheatley, Assistant General Deborah J. Danker, Special Assistant Counsel to the Board Cary K. Williams, Assistant General Counsel 1. The designations as Chairman and Vice Chairman expire on June 19, 2008, and October 28, 2007, respectively, unless the service of these members of the Board shall have terminated sooner. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

236 91st Annual Report, 2004 Board of Governors—Continued DIVISION OF RESEARCH Jack P. Jennings, Associate Director AND STATISTICS Molly S. Wassom, Associate Director David J. Stockton, Director David M. Wright, Associate Director Edward C. Ettin, Deputy Director Peter J. Purcell, Associate Director and David W. Wilcox, Deputy Director Chief Technology Officer Myron L. Kwast, Associate Director Howard A. Amer, Deputy Associate Stephen D. Oliner, Associate Director Director Patrick M. Parkinson, Associate Director Barbara J. Bouchard, Deputy Associate Lawrence Slifman, Associate Director Director Charles S. Struckmeyer, Associate Director Angela Desmond, Deputy Associate David L. Reifschneider, Deputy Associate Director Director James A. Embersit, Deputy Associate William L. Wascher HI, Deputy Associate Director Director Charles H. Holm, Deputy Associate Alice Patricia White, Deputy Associate Director Director William G. Spaniel, Deputy Associate Joyce K. Zickler, Deputy Associate Director Director Stacy Lee Coleman, Assistant Director Douglas W. Elmendorf, Assistant Director Jon D. Greenlee, Assistant Director and Chief Walt H. Miles, Assistant Director Michael S. Gibson, Assistant Director William C. Schneider, Jr., Assistant and Chief Director Diana Hancock, Assistant Director William F. Treacy, Assistant Director and Chief DIVISION OF CONSUMER J. Nellie Liang, Assistant Director AND COMMUNITY AFFAIRS S. Wayne Passmore, Assistant Director Sandra F. Braunstein, Director Janice Shack-Marquez, Assistant Director Glenn E. Loney, Deputy Director Daniel E. Sichel, Assistant Director Adrienne D. Hurt, Associate Director Mary M. West, Assistant Director Irene Shawn McNulty, Associate Director Glenn B. Canner, Senior Adviser James A. Michaels, Assistant Director David S. Jones, Senior Adviser Tonda E. Price, Assistant Director Thomas D. Simpson, Senior Adviser DIVISION OF BANKING SUPERVISION DIVISION OF RESERVE BANK AND REGULATION OPERATIONS AND PAYMENT Richard Spillenkothen, Director SYSTEMS Stephen M. Hoffman, Jr., Deputy Director Louise L. Roseman, Director Herbert A. Biern, Senior Associate Paul W. Bettge, Associate Director Director Jeffrey C. Marquardt, Associate Director Roger T. Cole, Senior Associate Director Kenneth D. Buckley, Assistant Director Michael G. Martinson, 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 Betsy Cross, Associate Director Jeff J. Stehm, Assistant Director Gerald A. Edwards, Jr., Associate Director Jack K. Walton II, Assistant Director James V. Houpt, Associate Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 237 Board of Governors—Continued OFFICE OF STAFF DIRECTOR DIVISION OF FOR MANAGEMENT INFORMATION TECHNOLOGY Stephen R. Malphrus, Staff Director for Marianne M. Emerson, Director Management Maureen T. Hannan, Deputy Director Sheila Clark, Equal Employment Tillena G. Clark, Assistant Director Opportunity Programs Director Geary L. Cunningham, Assistant Director Lynn S. Fox, Senior Adviser Wayne A. Edmondson, Assistant Director Po Kyung Kim, Assistant Director MANAGEMENT DIVISION Susan F. Marycz, Assistant Director H. Fay Peters, Director Sharon L. Mowry, Assistant Director Stephen J. Clark, Senior Associate Director Raymond Romero, Assistant Director Darrell R. Pauley, Deputy Director Christine M. Fields, Associate Director OFFICE OF INSPECTOR GENERAL Marsha W. Reidhill, Associate Director Barry R. Snyder, Inspector General Billy J. Sauls, Associate Director Donald L. Robinson, Deputy Inspector Donald A. Spicer, Associate Director General Charles F. O'Malley, Assistant Director Elizabeth A. Coleman, Assistant Inspector James R. Riesz, Assistant Director General Laurence A. Froehlich, Assistant Inspector General William L. Mitchell, Assistant Inspector General Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

238 91st Annual Report, 2004 Federal Open Market Committee December 31,2004 Members Officers ALAN GREENSPAN, Chairman, Board of VINCENT R. REINHART, Secretary and Governors Economist TIMOTHY F. GEITHNER, Vice Chairman, DEBORAH J. DANKER, Deputy Secretary President, Federal Reserve Bank of MICHELLE A. SMITH, Assistant Secretary New York SCOTT G. ALVAREZ, General Counsel THOMAS C. BAXTER, JR., Deputy General BEN S. BERNANKE, Board of Governors Counsel SUSAN SCHMIDT BIES, Board of KAREN H. JOHNSON, Economist Governors DAVID J. STOCKTON, Economist ROGER W. FERGUSON, JR., Board of THOMAS A. CONNORS, Associate Economist Governors JEFFREY C. FUHRER, Associate Economist EDWARD M. GRAMLICH, Board of CRAIG S. HAKKIO, Associate Economist Governors DAVID H. HOWARD, Associate Economist THOMAS M. HOENIG, President, Federal BRIAN F. MADIGAN, Associate Economist Reserve Bank of Kansas City RICHARD H. RASCHE, Associate Economist DONALD L. KOHN, Board of Governors LAWRENCE SLIFMAN, Associate Economist CATHY E. MINEHAN, President, Federal MARK S. SNIDERMAN, Associate Economist JOSEPH S. TRACY, Associate Economist Reserve Bank of Boston DAVID W. WILCOX, Associate Economist MARK W. OLSON, Board of Governors DINO Kos, Manager, System Open Market SANDRA PIANALTO, President, Federal Account Reserve Bank of Cleveland WILLIAM POOLE, President, Federal During 2004 the Federal Open Market Com- Reserve Bank of St. Louis mittee held eight regularly scheduled meet- Alternate Members ings (see "Minutes of Federal Open Market Committee Meetings" in this volume). CHRISTINE M. CUMMING, First Vice President, Federal Reserve Bank of New York MICHAEL H. MOSKOW, President, Federal Reserve Bank of Chicago ANTHONY M. SANTOMERO, President, Federal Reserve Bank of Philadelphia GARY H. STERN, President, Federal Reserve Bank of Minneapolis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 239 Federal Advisory Council December 31,2004 Members District 10—BYRON G. THOMPSON, Chairman, Country Club Bank, N.A., Kansas District 1—WILLIAM J. RYAN, Chairman, City, Missouri President and Chief Executive Officer, Banknorth Group, Inc., Portland, Maine District 11—GAYLE M. EARLS, President and Chief Executive Officer, TIB—The District 2—THOMAS A. RENYI, Chairman Independent BankersBank, Dallas, Texas and Chief Executive Officer, The Bank of New York, New York, New York District 12—VACANT District 3—RUFUS A. FULTON, JR., Chairman and Chief Executive Officer, Ful- Officers ton Financial Corporation, Lancaster, DAVID W. KEMPER, President Pennsylvania VACANT, Vice President District 4—MARTIN G. MCGUINN, Chairman and Chief Executive Officer, Mellon JAMES E. ANNABLE, Secretary Financial Corp., Pittsburgh, Pennsylvania The Federal Advisory Council, which is District 5—FRED L. GREEN III, Chairman, composed of one representative of the bank- President, and Chief Executive Officer, ing industry from each of the twelve Federal The National Bank of South Carolina, Reserve Districts, is required by the Federal Columbia, South Carolina Reserve Act to meet in Washington at least District 6—VACANT four times each year and is authorized by the District 7—DENNIS J. KUESTER, President act to consult with, and advise, the Board and Chief Executive Officer, Marshall & of Governors on all matters within the juris- Ilsley Corporation, Milwaukee, Wisconsin diction of the Board. The council met on February 5-6, May 6-7, September 9-10, District 8—DAVID W. KEMPER, Chairman, President, and Chief Executive Officer, and December 2-3, 2004. The Board met Commerce Bancshares, Inc., St. Louis, with the council on February 6, May 7, Sep- Missouri tember 10, and December 3, 2004. District 9—JERRY A. GRUNDHOFER, President and Chief Executive Officer, U.S. Bancorp, Minneapolis, Minnesota Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

240 91st Annual Report, 2004 Consumer Advisory Council December 31,2004 Members DEBRA S. REYES, President, Neighborhood Lending Partners, Inc., Tampa, Florida DENNIS L. ALGIERE, Senior Vice President, The Washington Trust Company, BENSON ROBERTS, Vice President for Policy, Westerly, Rhode Island Local Initiatives Support Corporation, JANIE BARRERA, President and Chief Execu- Washington, District of Columbia tive Officer, ACCION Texas, San BENJAMIN ROBINSON III, President and Antonio, Texas Chief Executive Officer, Innovative Risks KENNETH P. BORDELON, Chief Executive Solutions, LLC, Charlotte, North Carolina Officer, E Federal Credit Union, Baton MARY JANE SEEBACH, Executive Vice Rouge, Louisiana President, Chief Compliance Officer, SUSAN BREDEHOFT, Senior Vice President/ Countrywide Financial Corporation, Compliance Risk Management, Com- Calabasas, California merce Bank, N.A., Cherry Hill, New Jersey PAUL J. SPRINGMAN, Group Executive, Predictive Sciences, Equifax, Atlanta, SHEILA CANAVAN, Consumer Attorney, Law Office of Sheila Canavan, Moab, Utah Georgia ROBIN COFFEY, Vice President, Harris Bank, FORREST F. STANLEY, Senior Vice President Chicago, Illinois and Deputy General Counsel, KeyBank ANN DIEDRICK, Senior Vice President, National Association, Cleveland, Ohio JPMorgan Chase Bank, New York, New LORI R. SWANSON, Solicitor General, Office York of the Minnesota Attorney General, DAN DIXON, Group Senior Vice President, St. Paul, Minnesota World Savings Bank, FSB, Washington, DIANE THOMPSON, Supervising Attorney, District of Columbia Land of Lincoln Legal Assistance HATTIE B. DORSEY, President and Chief Foundation, Inc., East St. Louis, Illinois Executive Officer, Atlanta Neighborhood Development Partnership, Atlanta, HUBERT VAN TOL, Co-Director, Fairness in Georgia Rural Lending, Sparta, Wisconsin THOMAS FITZGIBBON, Senior Vice President, CLINT WALKER, General Counsel/Chief MB Financial Bank, Chicago, Illinois Administrative Officer, Juniper Bank, JAMES GARNER, Senior Vice President and Wilmington, Delaware General Counsel, North America Consumer Finance for Citigroup, Baltimore, Maryland Officers CHARLES GATSON, Vice President, Midtown AGNES BUNDY SCANLAN, Chair Community Development Corporation, Senior Vice President, Kansas City, Missouri Regulatory Relations Executive LARRY HAWKINS, President and Chief Bank of America Executive Officer, Unity National Bank, Boston, Massachusetts Houston, Texas MARK PINSKY, Vice Chair W. JAMES KING, President and Chief Execu- President and Chief Executive Officer tive Officer, Community Redevelopment National Community Capital Association Group, Cincinnati, Ohio Philadelphia, Pennsylvania RUHI MAKER, Senior Attorney, Law Office The Consumer Advisory Council is comof Rochester, Rochester, New York posed of academics, state and local gov- PATRICIA MCCOY, Professor of Law, ernment officials, representatives of the University of Connecticut School of Law, financial industry, and representatives of Hartford, Connecticut consumer and community interests. It was ELSIE MEEKS, Executive Director, First established pursuant to the 1976 amend- Nations Oweesta Corporation, Rapid City, ments to the Equal Credit Opportunity Act Digitized forS oFuRtAhS DEaRk ota to advise the Board of Governors on conhttp://frasReRrI.TsPtl.oFu iRsfe dM.oOrgR/H AN Chnirmnn President sinner financial services. The council met Federal Reserve Bank of St. Louis

Federal Reserve System Organization 241 Thrift Institutions Advisory Council December 31,2004 Members GEORGE W. NISE, President and Chief Executive Officer, Beneficial Savings ELDON R. ARNOLD, President and Chief Bank, Philadelphia, Pennsylvania Executive Officer, Citizens Equity First WILLIAM J. SMALL, Chairman and Chief Credit Union (CEFCU), Peoria, Illinois Executive Officer, First Federal Bank, H. BRENT BEESLEY, Chairman and Chief Defiance, Ohio Executive Officer, Heritage Bank, ROY M. WHITEHEAD, President and Chief St. George, Utah Executive Officer, Washington Federal MICHAEL J. BROWN, SR., President and Savings, Seattle, Washington Chief Executive Officer, Harbor Federal Savings Bank, Fort Pierce, Florida RICHARD J. DRISCOLL, Chief Executive Offi- Officers cer, First Savings Bank, FSB, Arlington, Texas WILLIAM J. SMALL, President DOUGLAS K. FREEMAN, Chairman and Chief D. TAD LOWREY, Vice President Executive Officer, NetBank, Alpharetta, Georgia The Thrift Institutions Advisory Council, which is composed of representatives from CURTIS L. HAGE, Chairman and Chief credit unions, savings and loan associations, Executive Officer, Home Federal Bank, and savings banks, consults with, and ad- Sioux Falls, South Dakota vises, the Board of Governors on issues per- DAVID H. HANCOCK, Chief Executive Offitaining to the thrift industry and on various cer, North American Savings Bank, other matters within the Board's jurisdiction. Grandview, Missouri The members of the council met with the OLAN 0. JONES, JR., President and Chief Board on March 5, July 9, and December 10, Executive Officer, Eastman Credit Union, 2004. Kingsport, Tennessee D. TAD LOWREY, Chairman, President, and Chief Executive Officer, Jackson Federal Bank, Brea, California Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

242 91st Annual Report, 2004 Federal Reserve Banks and Branches December 31,2004 Officers Chairman1 President Vice President BANK or Branch Deputy Chairman First Vice President in charge of Branch BOSTON2 Samuel 0. Thier Cathy E. Minehan Blenda J. Wilson Paul M. Connolly NEW YORK2 John E. Sexton Timothy F. Geithner Jerry I. Speyer Christine M. Cumming Buffalo Marguerite D. Barbara L.Walter3 Hambleton PHILADELPHIA Ronald J. Naples Anthony M. Santomero Doris M. Damm 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. Jeffrey M. Lacker Thomas J. Walter A. Varvel Mackell, Jr. Baltimore Owen E. Herrnstadt David Beck4 Charlotte Michael A. Almond Jeffreys. Kane3 ATLANTA David M. Ratcliffe Jack Guynn James M.McKee3 V. Larkin Martin Patrick K. Barron Birmingham Catherine Crenshaw Lee C. Jones Jacksonville Julie Hilton Christopher L. Oakley Miami Rosa Sugranes Juan del Busto Nashville Rodney Lawler Melvyn K. Purcell3 New Orleans Dave Dennis Robert J. Musso3 CHICAGO2 W James FarreU Michael H. Moskow Miles D. White Gordon R.G. Werkema Detroit Edsel B. Ford II Glenn Hansen3 ST. LOUIS Walter L. Metcalfe, Jr. William Poole Gayle P. W. Jackson W. LeGrande Rives Little Rock Scott T. Ford Robert A. Hopkins5 Louisville Cornelius A. Martin Thomas A. Boone5 Memphis Meredith B. Allen Martha Perine Beard5 MINNEAPOLIS Linda Hall Whitman Gary H. Stern Frank L. Sims James M. Lyon Helena Dean Folkvord Samuel H. Gane Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 243 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 Thomas Williams Pamela L. Weinstein Oklahoma City Tyree O. Minner Dwayne E. Boggs Omaha A.F. Raimondo Kevin A. Drusch DALLAS Ray L. Hunt Patricia M. Helen E. Holcomb6 Patterson El Paso Ron C. Helm Robert W Gilmer4 Houston Lupe Fraga Robert Smith IIP San Antonio Ron R. Harris D.Karen Diaz8 SAN FRANCISCO George M. Scalise Janet L. Yellen Sheila D. Harris John F. Moore Los Angeles William D. Jones MarkL. Mullinix7 Portland Karla S. Chambers Richardson B. Hornsby Salt Lake City H. Roger Boyer Andrea P. Wolcott Seattle Mic R. Dinsmore Mark Gould3 NOTE. A current list of these officers appears each 3. Senior vice president. quarter in the Federal Reserve Bulletin. 4. Acting vice president. 1. The chairman of a Federal Reserve Bank serves, by 5. Senior branch executive. statute, as Federal Reserve agent. 6. Served as acting president as of November 5, 2004, 2. Additional offices of these Banks are located at following the resignation of President Robert D. Windsor Locks, Connecticut; Utica at Oriskany, New McTeer, Jr. York; East Rutherford, New Jersey, Columbus, Ohio; 7. Executive vice president. Des Moines, Iowa; Midway at Bedford Park, Illinois, and 8. Acting assistant vice president. Phoenix, Arizona. 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. Such meet- to consult with and advise the Board of ings, attended also by the deputy chairmen, Governors. were held in Washington on June 2 and 3, Michael H. Moskow, president of the and on December 1 and 2, 2004. Federal Reserve Bank of Chicago, served The members of the executive com- as chair of the conference in 2004, and mittee of the Conference of Chairmen dur- Cathy E. Minehan, president of the Federal ing 2004 were Wesley S. Williams, Jr., chair; Reserve Bank of Boston, served as its vice George M. Scalise, vice chair; and Walter L. chair. Valerie J. Van Meter, of the Federal Metcalfe, Jr., member. Reserve Bank of Chicago, served as its sec- On December 2, 2004, the conference retary, and Michael P. Malone, of the Federal elected its executive committee for 2005, Reserve Bank of Boston, served as its assisnaming George M. Scalise as chair; tant secretary. Walter L. Metcalfe, Jr., as vice chair; and On October 27, 2004, the conference John E. Sexton as the third member. elected Cathy E. Minehan as its chair for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

244 91st Annual Report, 2004 2005-06 and Anthony M. Santomero, presi- not exclusive, consideration to the interests dent of the Federal Reserve Bank of Phila- of agriculture, commerce, industry, services, delphia, as its vice chair. labor, and consumers; they may not be officers, directors, or employees of any bank or bank holding company. In addition, Class C Conference of First directors may not be stockholders of any Vice Presidents bank or bank holding company. For the election of Class A and Class B The Conference of First Vice Presidents of directors, the member banks of each Fedthe Federal Reserve Banks was organized in eral Reserve District are classified into 1969 to meet periodically for the considerthree groups. Each group, which comprises ation of operations and other matters. banks with similar capitalization, elects one Walter A. Varvel, first vice president of Class A director and one Class B director. the Federal Reserve Bank of Richmond, Annually, the Board of Governors designates served as chair of the conference in 2004, one of the Class C directors as chair of and Helen E. Holcomb, first vice president the board and Federal Reserve agent of of the Federal Reserve Bank of Dallas, each District Bank, and it designates another served as its vice chair. Janice E. Clatter- Class C director as deputy chair. buck, of the Federal Reserve Bank of Rich- Federal Reserve Branches have either five mond, served as its secretary, and Harvey R. or seven directors, a majority of whom are Mitchell, of the Federal Reserve Bank of appointed by the parent Federal Reserve Dallas, served as its assistant secretary. 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. Class B directors, who are elected by the The chairs and deputy chairs of the stockholding member banks, and three Reserve Bank boards of directors, and the Class C directors, who are appointed by the chairs of the Branches, are listed in the pre- Board of Governors of the Federal Reserve ceding table, titled "Officers." The directors System. of the Banks and Branches are listed in the Class A directors represent the stockhold- following table. For each director, the class ing member banks in each Federal Reserve of directorship, the director's principal orga- District. Class B and Class C directors repre- nizational affiliation, and the date the direcsent the public and are chosen with due, but tor's term expires is shown. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 245 Directors BANK or BRANCH, Category Title Term expires Name Dec. 31 DISTRICT 1—BOSTON RESERVE BANK Class A Lawrence K. Fish Chairman, President, and Chief Executive Officer, 2004 Citizens Financial Group, Inc., Providence, Rhode Island James R. Wood President, First National Bank of Suffield, 2005 Suffield, Connecticut Peter A. Blyberg President and Chief Executive Officer, 2006 Union Trust Company, Ellsworth, Maine Class B Robert K. Kraft Chairman and Chief Executive Officer, 2004 The Kraft Group, Foxborough, Massachusetts Orit Gadiesh Chairman, Bain & Company, Inc., Boston, Massachusetts 2005 KirkRPond President, Chief Executive Officer, and Chairman, 2006 Fairchild Semiconductor International, South Portland, Maine Class C Samuel O. Thier Professor of Medicine and Health Care Policy, 2004 Harvard Medical School, Massachusetts General Hospital, Boston, Massachusetts Blenda J. Wilson President and Chief Executive Officer, Nellie Mae 2005 Education Foundation, Quincy, Massachusetts Lisa M. Lynch William L. Clayton Professor of International Affairs, 2006 The Fletcher School of Law and Diplomacy, Medford, Massachusetts DISTRICT 2—NEW YORK RESERVE BANK Class A 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 Sanford I. Weill Chairman, Citigroup Inc., New York, New York 2006 Class B Ronay Menschel Chairman, Phipps Houses, New York, New York 2004 Marta Tienda Maurice P. During Professor of Demographic Studies, 2005 Princeton University, Princeton, New Jersey Denis M. Hughes President, New York State AFL-CIO, 2006 New York, New York Class C John E. Sexton President, New York University, New York, New York 2004 Loretta E. Lynch Partner, Hogan & Hartson LLC, New York, New York 2005 Jerry I. Speyer President and Chief Executive Officer, Tishman Speyer 2006 Properties, New York, New York Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

246 91st Annual Report, 2004 Directors—Continued BANK or BRANCH, Category Term expires Title Name Dec. 31 BUFFALO BRANCH Appointed by the Federal Reserve Bank 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, Amherst, New York 2005 Maureen Torrey Marshall .. Vice President, Torrey Farms, Inc., Elba, New York 2006 Peter G. Humphrey Chairman, President, and Chief Executive Officer, 2006 Financial Institutions, Inc., Warsaw, New York Appointed by the Board of Governors Marguerite D. Hambleton .. President and Chief Executive Officer, AAA Western 2004 and Central New York, Williamsville, New York Brian J. Lipke Chairman and Chief Executive Officer, Gibraltar, 2005 Buffalo, New York Alphonso O'Neil-White .... President and Chief Executive Officer, HealthNow 2006 New York, Inc., Buffalo, New York DISTRICT 3—PHILADELPHIA RESERVE BANK Class A 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 Eugene W. Rogers Chief Executive Officer, Newfield National Bank, 2006 Newfield, New Jersey Class B 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 Garry L. Maddox President and Chief Executive Officer, 2006 A. Pomerantz & Company, Philadelphia, Pennsylvania Class C 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 William F. Hecht Chairman, President, and Chief Executive Officer, 2006 PPL Corporation, Allentown, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 247 BANK or BRANCH, Category Titlf Term expires Name l lllc Dec. 31 DISTRICT 4—CLEVELAND RESERVE BANK Class A John R. Cochran Chairman and Chief Executive Officer, 2004 FirstMerit Corporation, Akron, Ohio Bick Weissenrieder Chairman and Chief Executive Officer, 2005 Hocking Valley Bank, Athens, Ohio Stephen P. Wilson President and Chief Executive Officer, 2006 Lebanon Citizens National Bank, Lebanon, Ohio Class B Wayne R. Embry Former President and Chief Operating Officer, 2004 Cleveland Cavaliers, Cleveland, Ohio Tanny Crane President and Chief Executive Officer, 2005 Crane Group Company, Columbus, Ohio V. Ann Hailey Executive Vice President and Chief Financial Officer, 2006 Limited Brands, Columbus, Ohio Class C 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 Robert W. Mahoney Retired Chairman and Chief Executive Officer, 2006 Diebold, Incorporated, Canton, Ohio CINCINNATI BRANCH Appointed by the Federal Reserve Bank James H. Booth President, Czar Coal Corporation, Lovely, Kentucky 2004 V. Daniel Radford Executive Secretary-Treasurer, Cincinnati AFL-CIO 2005 Labor Council, Cincinnati, Ohio Glenn D. Leveridge President, Bank One, NA, Lexington, Kentucky 2005 Charlotte W. Martin President and Chief Executive Officer, Great Lakes 2006 Bankers Bank, Gahanna, Ohio Appointed by the Board of Governors Herbert R. Brown Senior Vice President, Western and Southern Financial 2004 Group, Cincinnati, Ohio Dennis C. Cuneo Senior Vice President, Toyota Motor North America, 2005 Inc., New York, New York Charles Whitehead Retired President, Ashland Inc. Foundation, 2006 Villa Hills, Kentucky PITTSBURGH BRANCH Appointed by the Federal Reserve Bank Michael J. Hagan President and Chief Executive Officer, 2004 Iron and Glass Bank, Pittsburgh, Pennsylvania Ronnie L. Bryant President and Chief Operating Officer, CEcD, 2005 Pittsburgh Regional Alliance, Pittsburgh, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

248 91st Annual Report, 2004 Directors—Continued BANK or BRANCH, Category Term expires Title Name Dec. 31 Georgiana N. Riley President and Chief Executive Officer, 2005 TIGG Corporation, Bridgeville, Pennsylvania Kristine N. Molnar Executive Vice President, WesBanco Bank, Inc., 2006 Wheeling, West Virginia Appointed by the Board of Governors Robert O. Agbede President and Chief Executive Officer, 2004 ATS-Chester Engineers, Pittsburgh, Pennsylvania Roy W.Haley Chairman and Chief Executive Officer, 2005 WESCO International, Inc., Pittsburgh, Pennsylvania James I. Mitnick Senior Vice President, Turner Construction Company, 2006 Pittsburgh, Pennsylvania DISTRICT 5—RICHMOND RESERVE BANK Class A Eddie Canterbury President and Chief Executive Officer, Logan Bank & 2004 Trust Company, Logan, West Virginia Barry J. Fitzpatrick Chairman, Branch Banking & Trust Co. of Virginia, 2005 Falls Church, Virginia Ernest J. Sewell President and Chief Executive Officer, FNB Southeast, 2006 Greensboro, North Carolina Class B JoeEdens Chairman, Edens & Avant, Columbia, South Carolina 2004 W. Henry Harmon President and Chief Executive Officer, Columbia 2005 Natural Resources, LLC, Charleston, West Virginia Kenneth R. Sparks President and Chief Executive Officer, Ken Sparks 2006 Associates LLC, White Stone, Virginia Class C Theresa M. Stone Chief Financial Officer, Jefferson-Pilot Corporation, 2004 President, Jefferson-Pilot Communications Company, Greensboro, North Carolina Thomas J. Mackell, Jr. President and Chief Operating Officer, 2005 The Kamber Group, Washington, D.C. Wesley S. Williams, Jr. .... Partner, Covington & Burling, Washington, D.C. 2006 BALTIMORE BRANCH Appointed by the Federal Reserve Bank Donald P. Hutchinson President and Chief Executive Officer, SunTrust Bank, 2004 Maryland, Baltimore, Maryland Dyan Brasington President (Retired), Technology Council of Maryland, 2005 Rockville, Maryland Kenneth C. Lundeen President, C.J. Langenfelder & Son, Inc., 2006 Baltimore, Maryland Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 249 BANK or BRANCH, Category Title Term expires Name Dec. 31 Michael L. Middleton Chairman and President, Community Bank of 2006 Tri-County, Waldorf, Maryland Appointed by the Board of Governors 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 William C.Handorf Professor of Finance, George Washington University, 2006 Washington, D.C. CHARLOTTE BRANCH Appointed by the Federal Reserve Bank William H. Nock Chairman and Chief Executive Officer, Wayfarer 2004 Financial Group, Sumter, South Carolina Lucy J. Reuben Durham, North Carolina 2005 Michael C Miller Chairman and President, FNB Corp. and First National 2006 Bank and Trust Company, Asheboro, North Carolina Donald K. Truslow Chief Risk Officer, Wachovia Corporation, 2006 Charlotte, North Carolina Appointed by the Board of Governors James F. Goodmon President and Chief Executive Officer, Capitol 2004 Broadcasting Company, Inc., Raleigh, North Carolina Michael A. Almond President and Chief Executive Officer, Charlotte 2005 Regional Partnership, Charlotte, North Carolina Jim Lowry Dealer Operator, Crown Automotive, 2006 High Point, North Carolina DISTRICT 6—ATLANTA RESERVE BANK Class A James F. Beall Chairman, President, and Chief Executive Officer, 2004 Farmers & Merchants Bank, Centre, Alabama Richard G. Hickson Chairman and Chief Executive Officer, Trustmark 2005 Corporation, Jackson, Mississippi William G. Smith, Jr. Chairman, President, and Chief Executive Officer, 2006 Capital City Bank Group, Inc., Tallahassee, Florida Class B Suzanne E. Boas President, Consumer Credit Counseling Service of 2004 Greater Atlanta, Inc., Atlanta, Georgia Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

250 91st Annual Report, 2004 Directors—Continued BANK or BRANCH, Category Term expires Tiflf Name 1 Hit Dec. 31 Egbert L.J. Perry Chairman and Chief Executive Officer, 2005 The Integral Group, LLC, Atlanta, Georgia Teri G. Fontenot President and Chief Executive Officer, Woman's 2006 Hospital, Baton Rouge, Louisiana Class C David M. Ratcliffe Chairman, President, and Chief Executive Officer, 2004 Southern Company, Atlanta, Georgia V. Larkin Martin Managing Partner, Martin Farm, Courtland, Alabama 2005 D. Scott Davis Chief Financial Officer, United Parcel Service, 2006 Atlanta, Georgia BIRMINGHAM BRANCH Appointed by the Federal Reserve Bank John B. Barnett III Monroeville President and Chairman, BankTrust, 2004 Monroeville, Alabama John H. Holcomb III Chairman and Chief Executive Officer, Alabama 2005 National Bancorporation, Birmingham, Alabama Samuel F. Dodson Business Manager, International Union of Operating 2006 Engineers-Local 312, Birmingham, Alabama Bobby A. Bradley Retired Senior Vice President and Group Manager, 2006 Science Applications International Corporation, Huntsville, Alabama Appointed by the Board of Governors 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 W. Millet Welborn President, Welborn and Associates, Inc., 2006 Lookout Mountain, Tennessee JACKSONVILLE BRANCH Appointed by the Federal Reserve Bank Harvey R. Heller President, Heller Brothers Packing Corporation, 2004 Winter Garden, Florida Jerry M. Smith Chairman and President, First National Bank 2005 of Alachua, Alachua, Florida Robert L. Fisher President and Chief Executive Officer, MacDill 2006 Federal Credit Union, Tampa, Florida Ellen S.Titen President, E.T. Consultants, Winter Park, Florida 2006 Appointed by the Board of Governors Julie K. Hilton Vice President and Co-Owner, Paradise Found Resorts 2004 & Hotels, Panama City Beach, Florida Fassil Gabremariam President and Founder, U.S.-Africa Free Enterprise 2005 Education Foundation, Tampa, Florida Linda H. Sherrer President and Chief Executive Officer, Prudential 2006 Network Realty, Jacksonville, Florida Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 251 BANK or BRANCH, Category Term expires Name 1 lllc Dec. 31 MIAMI BRANCH Appointed by the Federal Reserve Bank Rudy Everett Schupp President and Chief Executive Officer, First United 2004 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 Miriam Lopez Chairman and Chief Executive Officer, 2006 TransAtlantic Bank, Miami, Florida Appointed by the Board of Governors Rosa Sugranes Chairman, Iberia Tiles Corp, Miami, Florida 2004 Edwin A. Jones, Jr. President, Angus Investments, Inc., 2005 Port St. Lucie, Florida Brian E. Keeley President and Chief Executive Officer, Baptist Health 2006 South Florida, Coral Gables, Florida NASHVILLE BRANCH Appointed by the Federal Reserve Bank Sam O. Franklin IE ......... Retired Chairman, SunTrust Bank, Nashville, 2004 Nashville, Tennessee Michael B. Swain President and Chief Executive Officer, First National 2005 Bank, Oneida, Tennessee James W. Spradley, Jr. President and Chief Executive Officer, Standard 2006 Candy Company, Inc., Nashville, Tennessee Daniel A. Gaudette ......... Senior Vice President, North American Manufacturing 2006 and Quality Assurance, Nissan North America, Inc., Smyrna, Tennessee Appointed by the Board of Governors F. Rodney Lawler Co-Founder and Chief Executive Officer, 2004 Lawler-Wood, LLC, Knoxville, Tennessee Beth Dortch Franklin Chief Executive Officer, Star Transportation, Inc., 2005 Nashville, Tennessee David Williams II Vice Chancellor and General Counsel, Vanderbilt 2006 University, Nashville, Tennessee NEW ORLEANS BRANCH Appointed by the Federal Reserve Bank David E. Johnson Chairman and Chief Executive Officer, The First 2004 Bancshares, Inc., and The First, A National Banking Association, Hattiesburg, Mississippi C. R. Cloutier President and Chief Executive Officer, MidSouth Bank, 2005 Lafayette, Louisiana Lawrence E. Kurzius President and Chief Executive Officer, Zatarain's, 2006 Gretna, Louisiana Christel C. Slaughter Partner, General Business, SSA Consultants, LLC, 2006 Baton Rouge, Louisiana Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

252 91st Annual Report, 2004 Directors—Continued BANK or BRANCH, Category Titif* Term expires Name Dec. 31 Appointed by the Board of Governors Dave Dennis Ftesident, Specialty Contractors & Assoc, Inc., 2004 Gulfport, Mississippi Earl L. Shipp Vice President and Site Director, The Dow Chemical 2005 Company, Louisiana Operations, Plaquemine, Louisiana Ben Tom Roberts Senior Executive Vice President/Owner, Roberts 2006 Brothers, Inc., Realtors, Mobile, Alabama DISTRICT 7—CHICAGO RESERVE BANK Class A AlanR.Tubbs President, Maquoketa State Bank and Ohnward 2004 Bancshares Inc., Maquoketa, Iowa William A. Osborn Chairman and Chief Executive Officer, Northern Trust 2005 Corporation and The Northern Trust Company, Chicago, Illinois Michael L. Kubacki Chairman, President, and Chief Executive Officer, 2006 Lakeland Financial Corporation, Warsaw, Indiana Class B James H. Keyes Chairman of the Board-Retired, Johnson Controls, Inc., 2004 Milwaukee, Wisconsin Connie E. Evans President and Chief Executive Officer, WSEP Ventures, 2005 Chicago, Illinois MarkT. Gaffhey President, Michigan AFL-CIO, Lansing, Michigan 2006 Class C Miles D. White Chairman and Chief Executive Officer, Abbott 2004 Laboratories, Abbott Park, Illinois John A. Canning, Jr. Chairman and Chief Executive Officer, Madison 2005 Dearborn Partners, Inc., Chicago, Illinois W. James Farrell Chairman and Chief Executive Officer, Illinois Tool 2006 Works, Inc., Glenview, Illinois DETROIT BRANCH Appointed by the Federal Reserve Bank Robert E. Churchill Chairman and Chief Executive Officer, Citizens 2004 National Bank, Cheboygan, Michigan Tommi A. White Chief Operating Officer, Compuware Corporation, 2005 Detroit, Michigan Linda S. Likely Executive Director, Kalamazoo Neighborhood 2005 Housing Services, Kalamazoo, Michigan Ralph W.Babb, Jr. Chairman, President, and Chief Executive Officer, 2006 Comerica Incorporated, Detroit, Michigan Appointed by the Board of Governors IrvinD.Reid President, Wayne State University, Detroit, Michigan 2004 Edsel B. Ford II Board Director, Ford Motor Company, 2005 Dearborn, Michigan Digitized forR FoRgeAr SAE. RC regg Executive Vice President and Chief Financial Officer, 2006 http://fraser.stlouisfed.org/ Pulte Homes, Inc., Bloomfield Hills, Michigan Federal Reserve Bank of St. Louis

Federal Reserve System Organization 253 BANK or BRANCH, Category Term expires Titlf Name 1 Hie Dec. 31 DISTRICT 8—ST. LOUIS RESERVE BANK Class A Lewis F. Mallory, Jr. Chairman and Chief Executive Officer, National Bank 2004 of Commerce, Starkville, Mississippi Lunsford W. Bridges President and Chief Executive Officer, Metropolitan 2005 National Bank, Little Rock, Arkansas Bradley W. Small Principal, Mathis, Marifian, Richter & Grandy, Ltd., 2006 Belleville, Illinois Class B Bert Greenwalt Partner, Greenwalt Company, Hazen, Arkansas 2004 J. Stephen Barger Taft-Hartley Coordinator, Indiana/Kentucky Regional 2005 Council of Carpenters, Louisville, Kentucky A. Rogers Yarnell II President, Yarnell Ice Cream Co., Inc., Searcy, Arkansas 2006 Class C Charles W. Mueller Retired 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 Walter L. Metcalfe, Jr. Partner, Bryan Cave LLP, St. Louis, Missouri 2006 LITTLE ROCK BRANCH Appointed by the Federal Reserve Bank Lawrence A. Davis, Jr Chancellor, University of Arkansas at Pine Bluff, 2004 Pine Bluff, Arkansas David R. Estes President and Chief Executive Officer, First State Bank, 2005 Lonoke, Arkansas Robert A. Young IE Chairman, President, and Chief Executive Officer, 2005 Arkansas Best Corporation, Fort Smith, Arkansas Raymond E. Skelton Little Rock, Arkansas 2006 Appointed by the Board of Governors Sonja Yates Hubbard Chief Executive Officer, E-Z Mart Stores, Inc., 2004 Texarkana, Texas Stephen M. Erixon Chief Executive Officer, Baxter Regional Medical 2005 Center, Mountain Home, Arkansas Scott T. Ford President and Chief Executive Officer, 2006 ALLTEL Corporation, Little Rock, Arkansas LOUISVILLE BRANCH Appointed by the Federal Reserve Bank David H. Brooks Chairman and Chief Executive Officer, Stock Yards 2004 Bank & Trust Company, Louisville, Kentucky Marjorie Z. Soyugenc Executive Director and Chief Executive Officer, 2005 Welborn Foundation, Evansville, Indiana Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

254 91st Annual Report, 2004 Directors—Continued BANK or BRANCH, Category Term expires Name l me Dec. 31 L. Clark Taylor, Jr. Chief Executive Officer, Ephraim McDowell Health, 2005 Danville, Kentucky Gordon B. Guess Chairman, President, and Chief Executive Officer, 2006 The Peoples Bank, Marion, Kentucky Appointed by the Board of Governors 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 Norman E. Pfau, Jr. President and Chief Executive Officer, Geo. Pfau's Sons 2006 Company, Inc., Jeffersonville, Indiana MEMPHIS BRANCH Appointed by the Federal Reserve Bank 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 TomA.Wright Chairman and Chief Executive Officer, Enterprise 2005 National Bank, Memphis, Tennessee David P. Rumbarger, Jr President and Chief Executive Officer, Community 2006 Development Foundation, Tupelo, Mississippi Appointed by the Board of Governors 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 Russell Gwatney President, Gwatney Companies, Memphis, Tennessee 2006 DISTRICT 9—MINNEAPOLIS RESERVE BANK Class A Kay Clevidence President, Farmers State Bank, Victor, Montana 2004 Robert Dickson Chairman and Chief Executive Officer, The First 2005 National Bank of Fairfax, Fairfax, Minnesota Douglas C. Morrison Chief Financial Officer, Citibank (South Dakota) N.A., 2006 Sioux Falls, South Dakota Class B Jay F. Hoeschler President and Owner, Hoeschler Corporation, 2004 La Crosse, Wisconsin Randy Peterson General Manager, Precision Edge Surgical 2005 Products Co., LLC, Sault Ste. Marie, Michigan Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 255 BANK or BRANCH, Category Term expires Name 11 lie Dec. 31 D. Greg Heineman Chairman, Williams Insurance Agency, 2006 Sioux Falls, South Dakota Class C Frank L. Sims Corporate Vice President, Transportation, Cargill, Inc., 2004 Minnetonka, Minnesota Linda Hall Whitman Chief Executive Officer, MinuteClinic, 2005 Minneapolis, Minnesota James J. Hynes Executive Administrator, Twin City Pipe Trades Service 2006 Association, St. Paul, Minnesota HELENA BRANCH Appointed by the Federal Reserve Bank Marilyn F. Wessel Former Dean and Director, Museum of the Rockies, 2004 Bozeman, Montana Joy N. Ott Regional President and Chief Executive Officer, 2004 Wells Fargo Bank Montana, N.A., Billings, Montana Ronald D. Scott President and Chief Executive Officer, The First State 2005 Bank of Malta, Malta, Montana Appointed by the Board of Governors Dean Folkvord President and Chief Executive Officer, Wheat Montana 2004 Farms and Bakery, Three Forks, Montana Lawrence R. Simkins President, Washington Corporations, Missoula, Montana 2005 DISTRICT 10—KANSAS CITY RESERVE BANK Class A Jeffrey L. Gerhart President and Chief Executive Officer, First National 2004 Bank of Newman Grove, Newman Grove, Nebraska Rick L. Smalley Chief Executive Officer, Dickinson Financial 2005 Corporation, Kansas City, Missouri Mark W. Schifferdecker .... President and Chief Executive Officer, Girard National 2006 Bank, Girard, Kansas Class B Frank Moore President, Spearhead Ranch Company, 2004 Douglas, Wyoming Dan L. Dillingham Chief Executive Officer, Dillingham Insurance, 2005 Enid, Oklahoma Kevin K. Nunnink Chairman, Integra Realty Resources, Westwood, Kansas 2006 Class C Richard H. Bard Chairman and Chief Executive Officer, International 2004 Surface Preparation Corporation, Golden, Colorado Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

256 91st Annual Report, 2004 Directors—Continued BANK or BRANCH, Category Term expires Name 1 lllc Dec. 31 Vacancy 2005 Robert A. Funk Chairman and Chief Executive Officer, 2006 Express Personnel Services International, Oklahoma City, Oklahoma DENVER BRANCH Appointed by the Federal Reserve Bank Michael R. Stanford President and Chief Executive Officer, First State 2004 Bancorporation, Albuquerque, New Mexico Virginia K. Berkeley President, CoBiz Bank, N.A., Denver, Colorado 2005 James A. Helzer President and Chief Executive Officer, Unicover 2006 Corporation, Cheyenne, Wyoming Kristy A. Schloss President and Chief Executive Officer, Schloss 2006 Engineered Equipment, Inc., Aurora, Colorado Appointed by the Board of Governors James A. King Chief Executive Officer, BT, Inc., Riverton, Wyoming 2004 Kathleen Avila Managing Member, Avila Retail Development & 2005 Management, Albuquerque, New Mexico Thomas Williams President and Chief Executive Officer, Williams 2006 Group LLC, Golden, Colorado OKLAHOMA CITY BRANCH Appointed by the Federal Reserve Bank W. Carlisle Mabrey III President and Chief Executive Officer, Citizens 2004 Bank & Trust Co., Okmulgee, Oklahoma Robert R. Gilbert ID President and Chief Operating Officer, 2004 The F&M Bank & Trust Company, Tulsa, Oklahoma Fred M. Ramos President, Greater Tulsa Hispanic Chamber 2005 of Commerce, Tulsa, Oklahoma Richard K. Ratcliffe Chairman, Ratcliffe's Inc., Weatherford, Oklahoma 2006 Appointed by the Board of Governors J. Larry Nichols Chairman and Chief Executive Officer, Devon Energy 2004 Corporation, Oklahoma City, Oklahoma Michael J. Packnett President and Chief Executive Officer, Mercy Health 2005 System of Oklahoma, Inc., Oklahoma City, Oklahoma Tyree O. Minner Plant Manager, Oklahoma City Assembly, 2006 General Motors, Oklahoma City, Oklahoma OMAHA BRANCH Appointed by the Federal Reserve Bank Cynthia Hardin Milligan .. Dean, College of Business Administration, 2004 University of Nebraska-Lincoln, Lincoln, Nebraska Judith A. Owen Retired President and Chief Executive Officer, 2005 Wells Fargo Bank, N.A., Omaha, Nebraska Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 257 BANK or BRANCH, Category Term expires Name l lllc Dec. 31 Rodrigo Lopez President and Chief Executive Officer, AmeriSphere 2006 Multifamily Finance, LLC, Omaha, Nebraska Michael J. Nelson Chairman, FirsTier Bank, Kimball, Nebraska 2006 Appointed by the Board of Governors Terry L. Moore President, Omaha Federation of Labor, 2004 Omaha, Nebraska James A. Timmerman Chief Financial Officer and Secretary/Treasurer, 2005 Timmerman and Sons Feeding Co., Springfield, Nebraska A.F. Raimondo Chairman and Chief Executive Officer, 2006 Behlen Mfg. Co., Columbus, Nebraska DISTRICT 11—DALLAS RESERVE BANK Class A David S. Barnard Chairman and Chief Executive Officer, National Bank, 2004 Gatesville, Texas Richard W. Evans, Jr. Chairman and Chief Executive Officer, Cullen/Frost 2005 Bankers, Inc., San Antonio, Texas Matthew T. Doyle Vice Chairman and Chief Executive Officer, 2006 Texas First Bank, Texas City, Texas Class B Vacancy 2004 Malcolm Gillis University Professor and Past President, 2005 Rice University, Houston, Texas Judy Ley Allen Partner, Allen Investments, Houston, Texas 2006 Class C 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 Anthony R. Chase Chairman and Chief Executive Officer, ChaseCom, LP, 2006 Houston, Texas EL PASO BRANCH Appointed by the Federal Reserve Bank F. James Volk Regional President, State National Bank, El Paso, Texas 2004 Pete Cook President and Chief Executive Officer, First National 2005 Bank of Alamogordo, Alamogordo, New Mexico Fred J. Loya Chairman, Fred Loya Insurance, El Paso, Texas 2005 Gerald J. Rubin Chairman, President, and Chief Executive Officer, 2006 Helen of Troy Corporation Limited, El Paso, Texas Appointed by the Board of Governors Cecilia Ochoa Levine President, MFI International Mfg., LLC, El Paso, Texas 2004 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

258 91st Annual Report, 2004 Directors—Continued BANK or BRANCH, Category Term expires Titlo Name iiiie Dec. 31 Ron C. Helm Owner, Helm Land and Cattle Company, 2005 Van Horn, Texas William V. Flores Provost, New Mexico State University, 2006 Las Cruces, New Mexico HOUSTON BRANCH Appointed by the Federal Reserve Bank Richard W Weekley Chairman, Weekley Development Company, 2004 Houston, Texas Priscilla D. Slade President, Texas Southern University, Houston, Texas 2005 S. Reed Morian Chairman, Chief Executive Officer, and President, 2005 DX Service Company, Inc., Houston, Texas Timothy N. Bryan Chairman and Chief Executive Officer, The First 2006 National Bank of Bryan, Bryan, Texas Appointed by the Board of Governors James T. Hackett President and Chief Executive Officer, Anadarko 2004 Petroleum Corporation, Houston, Texas Lupe Fraga Chairman and Chief Executive Officer, 2005 Tejas Office Products, Inc., Houston, Texas Vacancy 2006 SAN ANTONIO BRANCH Appointed by the Federal Reserve Bank R.TomRoddy Chairman, Lone Star Capital Bank, N.A., 2004 San Antonio, Texas Matt F. Gorges Chairman and Chief Executive Officer, Valley 2005 International Cold Storage, Inc., Harlingen, Texas Daniel B. Hastings, Jr. President and Owner, Daniel B. Hastings, Inc., 2005 Laredo, Texas Steven R. Vandegrift Founder and President, SRV Holdings, Austin, Texas, 2006 Appointed by the Board of Governors 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 Marvin L. Ragsdale President, Iron Workers District Council of the State 2006 of Texas, Georgetown, Texas DISTRICT 12—SAN FRANCISCO RESERVE BANK Class A Richard W. Decker, Jr Chairman and Co-Founder, Belvedere Capital 2004 Partners, LLC, San Francisco, California Candace Hunter Wiest President, Inland Empire National Bank, 2005 Riverside, California Richard C. Hartnack Vice Chairman, Union Bank of California, 2006 Los Angeles, California Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 259 BANK or BRANCH, Category Titip Term expires Name i me Dec. 31 Class B Jack McNally Principal, JKM Consulting, Sacramento, California 2004 David K.Y. Tang Partner, Preston Gates & Ellis LLP, Seattle, Washington 2005 Barbara L. Wilson Consultant and Regional Vice President (Retired), 2006 Qwest Communications, Boise, Idaho Class C Sheila D. Harris Director, Arizona Department of Housing, 2004 Phoenix, Arizona George M. Scalise President, Semiconductor Industry Association, 2005 San Jose, California Vacancy 2006 Los ANGELES BRANCH Appointed by the Federal Reserve Bank Russell Goldsmith Chairman and Chief Executive Officer, City National 2004 Bank, Beverly Hills, California Peter M. Thomas Managing Partner, Thomas & Mack Co., 2005 Las Vegas, Nevada D. Linn Wiley President and Chief Executive Officer, Citizens Business 2006 Bank, Ontario, California Karen Caplan President and Chief Executive Officer, Frieda's, Inc., 2006 Los Alamitos, California Appointed by the Board of Governors 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 Anita Santiago President, Anita Santiago Advertising, 2006 Santa Monica, California PORTLAND BRANCH Appointed by the Federal Reserve Bank George J. Passadore Chairman, Oregon, Wells Fargo Bank, Portland, Oregon 2004 William D. Thorndike, Jr. .. President, Medford Fabrication, Medford, Oregon 2005 James H. Rudd Chief Executive Officer, Ferguson Wellman Capital 2005 Management, Inc., Portland, Oregon Robert D. Sznewajs President and Chief Executive Officer, West Coast 2006 Bancorp, Lake Oswego, Oregon Appointed by the Board of Governors Karla S. Chambers Vice President, Stahlbush Island Farms, Inc., 2004 Corvallis, Oregon Peter O. Kohler President, Oregon Health & Science University, 2005 Portland, Oregon Judi Johansen President and Chief Executive Officer, PacifiCorp, 2006 Portland, Oregon Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

260 91st Annual Report, 2004 Directors—Continued BANK or BRANCH, Category Term expires Title Name Dec. 31 SALT LAKE CITY BRANCH Appointed by the Federal Reserve Bank Curtis H. Harris Chairman, President, and Chief Executive Officer, 2004 Barnes Banking Company, Kaysville, Utah A. Scott Anderson President and Chief Executive Officer, Zions First 2005 National Bank, Salt Lake City, Utah Deborah Bayle Nielsen President and Chief Executive Officer, United Way 2005 of Salt Lake, Salt Lake City, Utah Annette K. Herman President and Chief Executive Officer, 2006 UnitedHealthcare, Salt Lake City, Utah Appointed by the Board of Governors Gary L. Crocker Chairman and Chief Executive Officer, AnZenBio, 2004 Salt Lake City, Utah H. Roger Boyer Chairman, The Boyer Company, Salt Lake City, Utah 2005 William C. Glynn President, Intermountain Industries, Inc., Boise, Idaho 2006 SEATTLE BRANCH Appointed by the Federal Reserve Bank 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, U.S. Bank, Seattle, Washington 2005 Helvi K. Sandvik President, NANA Development Corp., 2006 Anchorage, Alaska Appointed by the Board of Governors Mic R. Dinsmore Chief Executive Officer, Port of Seattle, 2004 Seattle, Washington James R. Gill President, Pacific Northwest Title, Seattle, Washington 2005 David W. Wyckoff Chairman and Chief Executive Officer, Wyckoff 2006 Farms, Inc., Grandview, Washington Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2004 261 Members of the Board of Governors, 1913-2004 Appointed Members Federal Reserve Date initially took Name Other dates' District oath of office Charles S. Hamlin Boston Aug. 10, 1914 Reappointed in 1916 and 1926. Served until Feb. 3, 1936.2 Paul M. Warburg New York Aug. 10, 1914 Term expired Aug. 9, 1918. Frederic A. Delano Chicago Aug. 10, 1914 Resigned July 21, 1918. W.P.G. Harding Atlanta Aug. 10, 1914 Term expired Aug. 9, 1922. Adolph C. Miller San Francisco Aug. 10, 1914 Reappointed in 1924. Reappointed in 1934 from the Richmond District. Served until Feb. 3, 1936.2 Albert Strauss New York Oct. 26, 1918 Resigned Mar. 15,1920. Henry A. Moehlenpah Chicago Nov. 10, 1919 Term expired Aug. 9, 1920. Edmund Platt New York June 8, 1920 Reappointed in 1928. Resigned Sept. 14, 1930. David C. Wills Cleveland Sept. 29, 1920 Term expired Mar. 4, 1921. John R. Mitchell Minneapolis May 12, 1921 Resigned May 12, 1923. Milo D. Campbell Chicago Mar. 14, 1923 Died Mar. 22, 1923. Daniel R. Crissinger Cleveland May 1, 1923 Resigned Sept. 15, 1927. George R. James St. Louis May 14, 1923 Reappointed in 1931. Served until Feb. 3, 1936.3 Edward H. Cunningham Chicago May 14, 1923 Died Nov. 28, 1930. Roy A. Young Minneapolis Oct. 4, 1927 Resigned Aug. 31, 1930. Eugene Meyer New York Sept. 16, 1930 Resigned May 10, 1933. Wayland W. Magee Kansas City May 18, 1931 Term expired Jan. 24, 1933. Eugene R. Black Atlanta May 19, 1933 Resigned Aug. 15, 1934. M.S. Szymczak Chicago June 14, 1933 Reappointed in 1936 and 1948. Resigned May 31, 1961. J.J. Thomas Kansas City June 14, 1933 Served until Feb. 10, 1936.2 Marriner S. Eccles San Francisco Nov. 15, 1934 Reappointed in 1936, 1940, and 1944. Resigned July 14, 1951. Joseph *A. Broderick New York Feb. 3, 1936 Resigned Sept. 30, 1937. John K. McKee Cleveland Feb. 3, 1936 Served until Apr. 4, 1946.2 Ronald Ransom Atlanta Feb. 3,1936 Reappointed in 1942. Died Dec. 2, 1947. Ralph W. Morrison Dallas Feb. 10, 1936 Resigned July 9, 1936. Chester C. Davis Richmond June 25, 1936 Reappointed in 1940. Resigned Apr. 15, 1941. Ernest G. Draper New York Mar. 30, 1938 Served until Sept. 1, 1950 ? 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

262 91st Annual Report, 2004 Appointed Members—Continued Name Federal Reserve Date initially took Other dates1 District oath of office Chas. N. Shepardson Dallas Mar. 17, 1955 Retired Apr. 30,1967. G.H. King, Jr. Atlanta Mar. 25, 1959 Reappointed in 1960. Resigned Sept. 18, 1963. George W. Mitchell Chicago Aug. 31,1961 Reappointed in 1962. Served until Feb. 13, 1976.2 J. Dewey Daane Richmond Nov. 29, 1963 Served until Mar. 8, 1974.2 Sherman J. Maisel San Francisco Apr. 30, 1965 Served through May 31, 1972. Andrew F. Brimmer Philadelphia Mar. 9,1966 Resigned Aug. 31,1974. William W.Sherrill Dallas May 1, 1967 Reappointed in 1968. Resigned Nov. 15, 1971. Arthur F. Burns New York Jan. 31, 1970 Term began Feb. 1, 1970. Resigned Mar. 31, 1978. John E. Sheehan St. Louis Jan. 4, 1972 Resigned June 1, 1975. Jeffrey M. Bucher San Francisco June 5, 1972 Resigned Jan. 2,1976. Robert C. Holland Kansas City June 11, 1973 Resigned May 15, 1976. Henry C. Wallich Boston Mar. 8, 1974 Resigned Dec. 15, 1986. Philip E. ColdweU 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, 1913-2004 263 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 Chairmen3 Frederic A. Delano Aug. 10, 1914-Aug. 9, 1916 Paul M. Warburg Aug. 10, 1916-Aug. 9, 1918 Albert Strauss Oct. 26, 1918-Mar. 15, 1920 Edmund Platt July 23, 1920-Sept. 14, 1930 J.J. Thomas Aug. 21, 1934-Feb. 10, 1936 Ronald Ransom Aug. 6, 1936-Dec.2, 1947 C. Canby Balderston Mar. 11, 1955-Feb.28, 1966 J.L. Robertson Mar. 1, 1966-Apr. 30, 1973 George W. Mitchell May 1, 1973-Feb. 13, 1976 Stephen S. Gardner Feb. 13, 1976-Nov. 19, 1978 Frederick H. Schultz July 27, 1979-Feb. 11, 1982 Preston Martin Mar. 31, 1982-Apr. 30, 1986 Manuel H. Johnson Aug. 4, 1986-Aug. 3, 1990 David W. Mullins, Jr. July 24, 1991-Feb. 14, 1994 Alan S. Blinder June 27, 1994-Jan. 31, 1996 Alice M. Rivlin June 25, 1996-July 16, 1999 Roger W. Ferguson, Jr. Oct. 5, 1999- NOTE. Under the original Federal Reserve Act, the office on Aug. 23, 1935, continue to serve until Feb. 1, Federal Reserve Board was composed of five appointed 1936, or until their successors were appointed and had members, the Secretary of the Treasury (ex officio chair- qualified; and that thereafter the terms of members be man of the Board), and the Comptroller of the Currency. fourteen years and that the designation of Chairman and The original term of office was ten years; the five original Vice Chairman of the Board be for four years. appointed members had terms of two, four, six, eight, and 1. Date following "Resigned" and "Retired" denotes ten years. In 1922 the number of appointed members was final day of service. increased to six, and in 1933 the term of office was raised 2. Successor took office on this date. to twelve years. The Banking Act of 1935 changed the 3. Before Aug. 23, 1935, Chairmen and Vice Chairname to the Board of Governors of the Federal Reserve men were designated Governor and Vice Governor. System and provided that the Board be composed of 4. Served as Chairman Pro Tempore from February 3, seven appointed members; that the Secretary of the Trea- 1948, to April 15, 1948. sury and the Comptroller of the Currency continue to 5. Served as Chairman Pro Tempore from March 3, serve until Feb. 1, 1936; that the appointed members in 1996, to June 20, 1996. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

264 91st Annual Report, 2004 ExOffido Members Name Term Secretaries of the Treasury W.G. McAdoo Dec. 23,1913-Dec. 15, 1918 Carter Glass Dec. 16, 1918-Feb. 1, 1920 David F. Houston Feb. 2,1920-Mar. 3,1921 Andrew W. Mellon Mar. 4,1921-Feb. 12, 1932 Ogden L. Mills Feb. 12,1932-Mar. 4, 1933 William H.Woodin Mar. 4,1933-Dec. 31,1933 Henry Morgenthau, Jr. Jan. 1, 1934-Feb. 1, 1936 Comptrollers of the Currency John Skelton Williams Feb. 2, 1914-Mar. 2,1921 Daniel R. Crissinger Mar. 17,1921-Apr. 30,1923 Henry M. Dawes May 1,1923-Dec. 17, 1924 Joseph W. Mclntosh Dec. 20, 1924-Nov. 20, 1928 J.W. Pole Nov. 21,1928-Sept. 20, 1932 J.F.T. O'Connor May 11,1933-Feb. 1,1936 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

266 91st Annual Report, 2004 Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2004 and 2003 Millions of dollars Total Boston Item 2004 2003 2004 2003 ASSETS Gold certificate account 11,041 11,039 494 495 Special drawing rights certificate account 2,200 2,200 115 115 Coin 728 722 19 23 Loans To depository institutions 43 62 1 0 Other 0 0 0 0 Securities purchased under agreements to resell (triparty) 33,000 43,750 Federal agency obligations Bought outright 0 0 0 0 Held under repurchase agreements 0 0 0 0 US. Treasury securities Bought outright1 717,819 666,665 33,707 32,230 Held under repurchase agreements 0 0 0 0 Total loans and securities 750,863 710,477 33,708 32,230 Items in process of collection 7,964 9,236 457 531 Bank premises 1,778 1,630 99 93 Other assets Denominated in foreign currencies2 21,368 19,868 1,083 1,034 Other3 19,004 18,722 1,182 762 Interdistrict settlement account 0 0 2,979 3,079 Total assets 814,946 773,894 40,136 38363 LIABILITIES Federal Reserve notes outstanding (issued to Bank) .. 848,370 799,933 38,054 38,627 Less: Notes held by Federal Reserve Bank 128,933 110,176 4,137 4,750 Federal Reserve notes, net 719,437 689,757 33,917 33,877 Securities sold under agreements to repurchase 30,783 25,652 1,445 1,240 Deposits Depository institutions 24,043 23,058 1,050 1,633 U.S. Treasury, general account 5,912 5,723 0 0 Foreign, official accounts 80 162 2 2 Other4 1,288 730 2 19 Total deposits 31,323 29,673 1,054 1,653 Deferred credit items 7,038 9,026 578 576 Other liabilities and accrued dividends5 2,821 2,092 151 119 Total liabilities 791,402 756,200 37,145 37,466 CAPITAL ACCOUNTS Capital paid in 11,914 8,847 1,638 448 Surplus 11,630 8,847 1,353 448 Other capital accounts 0 0 0 0 Total liabilities and capital accounts 814,946 773,894 40,136 38363 FEDERAL RESERVE NOTE STATEMENT Federal Reserve notes outstanding 848,370 799,933 Less: Held by Banks not subject to collateralization 128,933 110,176 Collateralized Federal Reserve notes 719,437 689,757 Collateral for Federal Reserve notes Gold certificate account 11,041 11,039 Special drawing rights certificate account 2,200 2,200 Other eligible assets 0 0 U.S. Treasury and federal agency securities 706,196 676,518 Total collateral 719,437 689,757 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 267 1.—Continued NewYork Philadelphia Cleveland Richmond 2004 2003 2004 2003 2004 2003 2004 2003 4,651 4,706 382 380 452 477 819 808 874 874 83 83 104 104 147 147 42 30 56 37 52 33 62 83 0 15 5 0 0 0 0 0 0 0 0 0 0 0 0 0 33,000 43,750 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 311,256 285,221 21,350 20,843 30,673 31,238 54,557 51,269 0 0 0 0 0 0 0 0 344,256 328,986 21,354 20,843 30,673 31,238 54,558 51,269 407 803 360 493 814 595 341 714 196 189 53 53 157 151 144 146 4,905 4,289 624 552 1,757 1,665 5,009 4,915 9,176 9,264 530 588 966 793 1,337 1,384 -24,125 -19,034 4,007 905 -495 -2,103 -420 2,793 340^81 330,106 27,449 23,934 34,479 32,954 61,996 62,258 335,998 325,387 32,698 29,636 34,511 33,115 64,991 59,949 35,347 23,793 7,973 8,288 5,408 4,740 12,275 9,855 300,651 301,594 24,725 21,347 29,103 28,375 52,716 50,094 13,348 10,975 916 802 1,315 1,202 2,340 1,973 11,388 5,607 603 719 1,272 1,259 1,645 5,087 5,912 5,723 0 0 0 0 0 0 57 139 1 1 2 3 7 7 527 324 28 10 2 26 169 108 17,884 11,792 632 730 1,277 1,288 1,820 5,203 651 1,025 490 451 505 521 544 628 988 658 99 87 149 113 280 213 333^22 326,045 26,861 23,417 32^49 31,500 57,700 58,110 3,430 2,031 294 259 1,065 727 2,148 2,074 3,430 2,031 294 259 1,065 727 2,148 2,074 0 0 0 0 0 0 0 0 340^81 330,106 27,449 23,934 34,479 32,954 61,996 62,258 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

268 91st Annual Report, 2004 1. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2004 and 2003—Continued Millions of dollars Atlanta Chicago Item 2004 2003 2004 2003 ASSETS Gold certificate account 894 863 924 982 Special drawing rights certificate account 166 166 212 212 Coin 82 82 111 90 Loans To depository institutions 5 14 17 Other 0 0 0 Securities purchased under agreements to resell (triparty) Federal agency obligations Bought outright 0 0 0 0 Held under repurchase agreements 0 0 0 0 U.S. Treasury securities Bought outright1 48,408 45,037 64,660 67,367 Held under repurchase agreements 0 0 0 0 Total loans and securities 48,415 45,043 64,674 67,384 Items in process of* collection 637 723 559 942 Bank premises 276 278 157 125 Other assets Denominated in foreign currencies2 .. 1,181 1,127 2,232 2,033 Other3 1,076 1,108 1,374 1,571 Interdistrict settlement account. 9,939 4,274 225 -6,831 Total assets 62,666 53,664 70,469 66,509 LIABILITIES Federal Reserve notes outstanding (issued to Banks) . 74,144 66,711 72,517 66,835 Less: Notes held by Federal Reserve Banks 17,376 18,415 9,046 8,141 Federal Reserve notes, net 56,768 48,296 63,470 58,694 Securities sold under repurchase agreements 2,076 1,733 2,773 2,592 Deposits Depository institutions 1,722 1,608 1,762 2,349 U.S. Treasury, general account 0 0 0 0 Foreign, official accounts 2 2 3 3 Other4 56 22 246 29 Total deposits 1,780 1,632 2,011 2,382 Deferred credit items 796 855 421 781 Other liabilities and accrued dividends5 214 170 267 211 Total liabilities 61,634 52,686 68,942 64,660 CAPITAL ACCOUNTS Capital paid in 516 489 763 924 Surplus 516 489 763 924 Other capital accounts 0 0 0 0 Total liabilities and capital accounts 62,666 53,664 70,469 66,509 NOTE. Components may not sum to totals because of 2. Valued daily at market exchange rates. rounding. 3. The System total includes depository institution over- 1. Includes securities loaned—fully guaranteed by U.S. drafts of $1 million for 2004 and $3 million for 2003. Treasury securities pledged with Federal Reserve Banks— and excludes securities purchased under agreements to resell. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 269 1.—Continued St. Louis Minneapolis Kansas City Dallas San Francisco 2004 2003 2004 2003 2004 2003 2004 2003 2004 2003 325 331 218 224 302 303 525 507 1,055 963 71 71 30 30 66 66 98 98 234 234 36 53 22 23 48 42 93 141 105 84 2 0 13 2 1 2 0 0 0 20 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 21,089 20,974 15,657 14,881 18,863 17,916 32,729 26,126 64,871 53,563 0 0 0 0 0 0 0 0 0 0 21,090 20,974 15,669 14,883 18,864 17,919 32,729 26,126 64,871 53,583 348 341 512 426 653 596 334 383 2,542 2,689 68 49 123 125 82 56 257 187 168 179 551 472 835 805 392 476 267 442 2,532 2,058 487 516 351 368 416 439 716 641 1,395 1,287 1,401 -1,330 -969 -166 1,584 25 1,461 6,997 4,414 11,391 24377 21,477 16,790 16,720 22,408 19,921 36,479 35322 77316 72,467 25,006 23,244 16,370 15,491 24,535 21,599 41,146 39,785 88,401 79,553 2,819 3,961 1,982 1,335 4,497 4,083 7,503 7,129 20,570 15,685 22,187 19,283 14,387 14,155 20,038 17,516 33,643 32,657 67,831 63,868 904 807 671 573 809 689 1,404 1,005 2,782 2,061 479 509 473 564 721 813 684 953 2,244 1,957 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 0 1 4 3 22 14 115 12 32 48 26 88 57 30 507 524 590 577 753 861 710 1,041 2,305 1,990 197 308 548 650 409 450 301 487 1,599 2,296 111 98 85 74 92 81 152 110 234 157 23,906 21,020 16,281 16,029 22,101 19396 36,209 35301 74,751 70371 236 228 254 346 153 162 135 111 1,283 1,048 236 228 254 346 153 162 135 111 1,283 1,048 0 0 0 0 0 0 0 0 0 0 24377 21,477 16,790 16,720 22,408 19,921 36,479 35322 77316 72,467 4. Includes international organization deposits of 5. Includes exchange-translation account reflecting the $144 million for 2004 and $139 million for 2003. monthly revaluation at market exchange rates of foreign exchange commitments. . . . Not applicable. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

270 91st Annual Report, 2004 2. Federal Reserve Open Market Transactions, 2004 Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. U.S. TREASURY SECURITIES1 Outright transactions2 Treasury bills Gross purchases 619 Gross sales 0 Exchanges 80,276 For new bills 80,276 Redemptions 0 Others within 1 year Gross purchases .. Gross sales Maturity shifts ... Exchanges Redemptions 1 to 5 years Gross purchases . Gross sales Maturity shifts .. Exchanges 5 to 10 years Gross purchases .. Gross sales Maturity shifts ... Exchanges More than 10 years Gross purchases . Gross sales Maturity shifts .. Exchanges All maturities Gross purchases . Gross sales Redemptions Net change in U.S. Treasury securities . ooooo 747 341 3,516 0 0 0 61,389 56,267 74,959 61,389 56,267 74,959 0 0 0 1,311 0 0 0 0 0 10,791 16,544 7,293 -10,700 -16,333 -8,333 0 0 0 0 1,555 1,293 0 0 0 0 0 0 -9,361 -16,544 -7,293 0 9,627 16,333 8,333 0 510 741 0 0 0 0 0 0 -357 0 0 0 1,072 0 0 0 235 40 0 0 0 0 0 0 -1,072 0 0 0 0 0 0 619 4,358 2,414 3,516 0 0 0 0 0 0 0 0 619 4,358 2,414 3,516 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 271 2.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 409 3,831 952 83 3,473 500 3,155 512 18,138 0 0 0 0 0 0 0 0 0 66,123 63,302 78,894 66,355 80,572 59,837 60,682 73,029 821,685 66,123 63,302 78,894 66,355 80,572 59,837 60,682 73,029 821,685 0 0 0 0 0 0 0 0 0 1,693 0 1,898 0 0 1,593 0 1,499 7,994 0 0 0 0 0 0 0 0 0 9,748 6,998 0 17,703 6,535 0 19,781 7,987 103,380 -8,913 -13,879 0 -21,489 -7,652 0 -23,125 -7,948 -118,373 0 0 0 0 0 0 0 0 0 783 1,760 3,078 428 899 2,765 2,284 2,404 17,249 0 0 0 0 0 0 0 0 0 -4,066 -6,998 0 -10,029 -6,535 0 -16,031 -7,987 -84,844 6,620 13,879 0 19,771 7,652 0 20,655 7,948 110,819 713 275 244 568 695 1,225 453 340 5,763 0 0 0 0 0 0 0 0 0 -2,520 0 0 -5,051 0 0 -84 0 -8,012 2,293 0 0 1,718 0 0 2,471 0 7,554 84 0 29 0 405 400 86 85 1,364 0 0 0 0 0 0 0 0 0 -3,163 0 0 -2,624 0 0 -3,666 0 -10,524 0 0 0 0 0 0 0 0 0 3,681 5,866 6,202 1,078 5,473 6,484 5,977 4,840 50,507 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 3,681 5,866 6,202 1,078 5,473 6,484 5,977 4,840 50,507 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

272 91st Annual Report, 2004 2. Federal Reserve Open Market Transactions, 2004—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 138,250 121,750 167,500 163,650 158,500 116,500 168,750 165,900 Gross sales Reverse repurchase agreements4 Gross purchases 416,239 391,676 444,402 443,463 Gross sales 410,716 393,309 444,341 442,966 Net change in temporary transactions -14,727 3,617 -1,189 -1,752 Total net change in System Open Market Account -14,108 7,975 1,225 1,764 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 273 2.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 138,500 138,750 173,500 179,500 180,000 153,500 166,750 155,250 1,876,900 133,000 136,000 182,250 172,000 183,000 157,500 158,250 156,000 1,887,650 392,021 427,319 416,602 465,642 510,205 510,553 547,160 655,872 5,621,153 391,293 426,071 417,540 468,417 512,957 511,896 548,325 658,454 5,626,285 6,227 3,998 -9,688 4,725 -5,752 -5,343 7,335 -3,332 -15,882 9,908 9,864 -3,487 5,804 -280 1,140 13312 1,508 34,626 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

274 91st Annual Report, 2004 3. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2002-04 Millions of dollars December 31 Change Description 2003 to 2002 to 2004 2003 2002 2004 2003 U.S. TREASURY SECURITIES Held outright1 717,819 666,665 629,406 51,154 37,259 By remaining maturity Bills 1-90 days 179,748 168,381 153,311 11,367 15,070 91 days to 1 year 83,222 76,452 73,372 6,770 3,080 Notes and bonds 1 year or less 116,443 113,301 96,827 3,142 16,474 More than 1 year through 5 years .. 208,269 180,074 172,758 28,195 7,316 More than 5 years through 10 years 54,372 51,312 53,300 3,060 -1,988 More than 10 years 75,765 77,146 79,840 -1,381 -2,694 By type Bills ... 262,970 244,833 226,682 18,137 18,151 Notes .. 360,832 323,361 297,893 37,471 25,468 Bonds .. 94,017 98,471 104,832 -4,454 -6,361 FEDERAL AGENCY SECURITIES Held outright1 10 -10 By remaining maturity 1 year or less 0 10 0 —10 More than 1 year through 5 years .. 0 0 0 0 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 TEMPORARY TRANSACTIONS Repurchase agreements2 33,000 43,750 39,500 -10,750 4,250 Matched sale-purchase agreements 0 0 0 0 Foreign official and international accounts 0 0 0 0 0 Dealers 0 0 0 0 0 Reverse repurchase agreements3 30,783 25,652 21,091 5,131 4361 Foreign official and international accounts 30,783 25,652 21,091 5,131 4,561 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 275 4. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2004 President Other officers Employees Total Federal Reserve Number Bank (including Branches) Salary Num- Salaries Salaries Num- Salaries (dollars)1 ber (dollars)1 Full- Part- (dollars)1 ber (dollars)1 time time Boston 270,900 61 9,284,100 914 112 66,615,928 1,088 76,170,928 New York 310,000 265 47,044,590 2,732 56 190,097,746 3,054 237,452,336 Philadelphia 245,300 57 7,989,500 990 48 48,614,628 1,096 56,849,428 Cleveland 240,500 64 8,719,300 1,400 38 62,609,238 1,503 71,569,038 Richmond 235,000 76 10,407,200 1,715 76 90,915,466 1,868 101,557,666 Atlanta 294,300 74 11,099,000 1,947 39 96,235,343 2,061 107,628,643 Chicago 293,700 92 13,030,938 1,562 62 100,031,698 1,717 113,356,336 St. Louis 248,100 74 10,270,100 985 55 50,158,181 1,115 60,676,381 Minneapolis 275,000 43 6,172,000 1,158 132 57,721,267 1,334 64,168,267 Kansas City 269,800 76 10,645,200 1,350 46 67,793,739 1,473 78,708,739 Dallas Vacant2 54 7,089,154 1,184 35 58,676,998 1,273 65,766,152 San Francisco ... 300,000 73 12,051,966 1,761 38 108,706,295 1,873 121,058,261 Federal Reserve Information Technology . 32 4,761,900 691 4 * 53,371,219 727 58,133,119 Office of Employee Benefits .... 6 1,201,300 29 0 2,369,000 35 3,570,300 Total 2,982,600 1,047 159,766,248 18,418 741 1,053,916,746 20,217 1,216,665,594 1. Annualized salary liability based on salaries in effect 2. Dallas president separated in November 2004. on December 31, 2004. . . . Not applicable. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

276 91st Annual Report, 2004 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2004 Thousands of dollars Item Total Boston New York Philadelphia Cleveland CURRENT INCOME Loans 2,653 185 379 70 47 US. Treasury and federal agency securities 22,344,362 1,040,391 9,855,437 662,490 962,401 Foreign currencies 269,424 13,677 61,630 7,852 22,172 Priced services 865,924 37,678 124,144 38,469 61,225 Other 57,579 975 40,846 622 1,410 Total 23339,542 1,092,906 10,082,437 709,504 1,047,256 CURRENT EXPENSES Salaries and other personnel expenses 1,350,934 76,036 261,274 65,141 76,054 Retirement and other benefits 310,508 14,679 71,851 9,462 26,723 Net periodic pension costs1 .. -33,957 179 -35,938 139 169 Fees 96,778 2,206 8,908 1,196 6,606 Travel 56,528 2,051 7,419 1,918 4,067 Software expenses 116,624 5,047 12,820 4,273 11,549 Postage and other shipping 87,304 1,780 4,415 1,539 2,897 Communications 14,110 1,904 2,472 All 657 Materials and supplies 45,679 2,296 8,551 3,046 3,470 Building expenses Taxes on real estate .. 31,079 4,707 4,452 1,561 1,921 Property depreciation 88,214 4,983 14,581 3,595 6,558 Utilities 32,217 2,900 6,472 2,464 1,998 Rent 40,812 778 16,083 305 351 Other 34,944 933 6,854 2,002 2,605 Equipment Purchases 26,881 1,050 4,752 834 1,713 Rentals 31,836 1,770 1,847 640 342 Depreciation 101,172 5,575 9,049 5,838 5,937 Repairs and maintenance 92,374 6,079 8,662 5,513 6,668 Earnings-credit costs . 116,033 5,900 38,756 7,454 8,230 Other 70,80^ 29,769 48,381 9,532 9,865 Recoveries -79,364 -11,838 -9,695 -3,196 -2,542 Expenses capitalized2 -22,825 -495 -6,880 -2,006 -265 Total 2,608,684 158088 485,085 121,669 175,573 Reimbursements . -369,979 -23,030 -74,709 -21,111 -42,854 Net expenses . 2,238,705 135,259 410,377 100,559 132,718 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 277 5.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 55 109 551 178 549 256 28 247 1,676,581 1,483,890 2,041,238 657,563 482,515 581,234 967,792 1,932,829 63,356 14,915 28,114 6,920 10,545 5,030 3,515 31,696 66,718 160,899 114,006 39,916 45,601 52,761 46,416 78,090 2,520 2,003 2,677 899 439 550 886 3,752 1,809,230 1,661^17 2,186,586 705,476 539,649 639,831 1,018,637 2,046,613 178,316 127,914 121,506 71,919 66,896 91,096 74,450 140,332 38,006 24,164 22,251 13,643 16,270 14,410 19,045 40,004 249 111 167 186 197 137 151 229 50,376 6,546 5,514 6,564 1,603 1,156 2,278 3,826 8,089 5,790 6,500 3,506 2,992 4,223 3,145 6,829 51,250 4,579 3,984 3,384 2,505 3,704 5,183 8,349 4,164 51,388 4,473 2,377 2,734 3,138 2,361 6,038 1,780 1,034 1,239 979 1,011 742 708 1,164 6,029 5,647 3,665 2,450 1,682 2,497 2,983 3,363 2,157 3,417 1,590 477 3,860 1,112 2,834 2,992 7,919 10.080 9,042 4,602 4,548 4,223 5,646 12,438 3,502 2,801 1,885 1,837 1,668 1,683 1,935 3,072 14,586 899 3,186 1,291 233 1,666 1,288 148 4,413 3,467 5,034 1,117 1,577 916 3,739 2,287 7,672 2,002 1,701 1,283 1,339 1,587 1,165 1,783 23,509 726 565 197 541 316 939 445 36,588 8,255 4,831 3,617 2,314 4,746 5,062 9,360 20,302 11,142 8,855 3,755 2,948 3,362 5,346 9,741 16,512 5,318 13,704 1,786 2,309 3,644 2,326 10,094 -235,234 15,106 43,740 65,884 17,747 19,042 31,328 15,646 -26,824 -2,660 -6,227 -1,656 -843 -2,847 -6,196 -4,840 -1,933 -455 -782 -3,819 -1,265 -1,639 -1,133 -2,153 211,428 287^36 256,420 185,379 132^64 158,914 164,583 271,146 -31,751 -16,555 -7,044 -90,742 -21,350 -13,648 -11,578 -15,607 179,677 270,780 249,376 94,636 111,514 145,265 153,005 255,539 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

278 91st Annual Report, 2004 5. Income and Expenses of the Federal Reserve Banks, by Bank, 2004—Continued Thousands of dollars Item Total Boston New York Philadelphia Cleveland PROFIT AND LOSS Current net income 21,301,238 957,648 9,672,060 608,945 914,537 Additions to and deductions from {-) current net income 3 Profits on sales of U.S. Treasury and federal agency securities 0 0 0 0 0 Profits on foreign exchange transactions 1,230,325 62,418 281,819 35,898 101,203 Other additions 396 2 40 21 15 Total additions 1,230,721 62,420 281,859 35,918 101,219 Losses on sales of U.S. Treasury and federal agency securities 0 0 0 0 0 Losses on foreign exchange transactions -13,175 0 0 0 -13,175 Interest expense on reverse repurchase agreements -290,153 -14,315 -131,228 -9,101 0 Other deductions -9,487 -1 -19 -A -1 Total deductions -14,316 Net addition to or deduction from (-) -312,815 -131,247 -9,105 -13,176 current net income 48,104 Cost of unreimbursed Treasury 917,906 150,612 26,813 88,042 services Assessments by Board 35 25 10 0 Board expenditures4 .. 272,331 14,095 62,507 8,023 22,192 Cost of currency 503,784 33,919 117,119 26,153 23,070 Net income before payment to U.S. Treasury 21,442,992 957,738 9,643,022 601,573 957,317 Dividends paid 582,402 53,156 136,390 16,824 45,121 Payments to U.S. Treasury (interest on Federal Reserve notes) 18,078,003 0 8,107,0^2 549,401 574,815 Transferred to/from surplus 2,782,587 904,581 1,399,011 35,348 337,381 Surplus, January 1 8,846,916 448,422 2,030,557 258,560 727,244 Surplus, December 31 11,629,504 1,353,004 3,429,567 293,908 1,064,625 NOTE. Components may not sum to totals because of 2. Includes expenses for labor and materials capitalrounding. ized and depreciated or amortized as charges to activities 1. Reflects the effect of Financial Accounting Stan- in the periods benefited. dards Board Statement of Financial Accounting Stan- 3. Includes reimbursement from the U.S. Treasury for dards No. 87, Employers' Accounting for Pensions (SFAS uncut sheets of Federal Reserve notes, gains and losses on 87). The System Retirement Plan for employees is the sale of Reserve Bank buildings, counterfeit currency recorded on behalf of the System on the books of the that is not charged back to the depositing institution, and Federal Reserve Bank of New York, resulting in a stale Reserve Bank checks that are written off. decrease in expenses of $36,556 thousand. The expenses 4. For additional details, see the chapter "Board of related to the Benefit Equalization Plan and the Supple- Governors Financial Statements." mental Retirement Plan are recorded by each Federal Reserve Bank. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 279 5.-—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 1,629,553 1,391,037 1,937,209 610,840 428,135 494,565 865,633 1,791,074 288,950 68,071 128,442 31,658 48,113 22,814 15,780 145,157 8 5 5 5 3 8 279 4 288,958 68,077 128,448 31,663 48,116 22,822 16,059 145,162 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -23,101 -20,462 -27,892 -9,019 -6,642 -8,002 -13,498 -26,893 -3 -184 -1,404 -3 -2 -1 -4 -7,860 -23,104 -20,646 -29,296 -9,022 -6,644 -8,003 -13,502 -34,753 265,854 47,430 99,152 22,641 41,472 14,819 2,556 110,409 0 0 0 0 0 0 0 0 63,193 15,051 28,933 6,979 9,912 4,851 3,514 33,083 39,010 61,605 47,395 16,115 13,671 17,234 42,533 65,960 1,793,204 1,361,811 1,960,033 610,387 446,024 487,299 822,143 1,802,440 125,013 30,224 56,831 13,930 16,461 9,118 7,513 71,819 1,593,869 1,304,705 2,063,931 589,070 520,699 487,495 790,246 1,496,150 74,322 26,882 -160,728 7,387 -91,136 -9,314 24,383 234,471 2,073,888 489,053 924,227 228,257 345,531 162,382 110,570 1,048,225 2,148,210 515,935 763,499 235,644 254,396 153,068 134,953 1,282,696 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

280 91st Annual Report, 2004 6. Income and Expenses of the Federal Reserve Banks, 1914-2004 Thousands of dollars 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 -4,673 595 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 ^,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 I960.. 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 281 6.—Continued Payments to U.S. Treasury Dividends paid t S ra ta n t s u f t e o r r s y 2 Fed In er te a r l e R st e o se n rve (s t e o c t s io u n rp l 1 u 3 s b) ( t s o e c s t u io rp n l u 7 s ) notes 217 1,743 6,804 1,134 '. '. '. U34 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 2,6il '. '. . 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

282 91st Annual Report, 2004 6. Income and Expenses of the Federal Reserve Banks, 1914-2004—Continued Thousands of dollars Assessments by Net additions Board of Governors Federal Reserve Bank Current Net or and period income expenses deductions (-)] Board Costs expenditures of currency 1970.. 3,877,218 276,572 11,442 21,228 23,574 1971.. 3,723,370 319,608 94,266 32,634 24,943 1972.. 3,792,335 347,917 -49,616 35,234 31,455 1973.. 5,016,769 416,879 -80,653 44,412 33,826 1974.. 6,280,091 476,235 -78,487 41,117 30,190 1975.. 6,257,937 514,359 -202,370 33,577 37,130 1976.. 6,623,220 558,129 7,311 41,828 48,819 1977.. 6,891,317 568,851 -177,033 47,366 55,008 1978.. 8,455,309 592,558 -633,123 53,322 60,059 1979.. 10,310,148 625,168 -151,148 50,530 68,391 1980.. 12,802,319 718,033 -115,386 62,231 73,124 1981.. 15,508,350 814,190 -372,879 63,163 82,924 1982.. 16,517,385 926,034 -68,833 61,813 98,441 1983.. 16,068,362 1,023,678 -^00,366 71,551 152,135 1984.. 18,068,821 1,102,444 ^12,943 82,116 162,606 1985.. 18,131,983 1,127,744 1,301,624 77,378 173,739 1986.. 17,464,528 1,156,868 1,975,893 97,338 180,780 1987.. 17,633,012 1,146,911 1,796,594 81,870 170,675 1988.. 19,526,431 1,205,960 -516,910 84,411 164,245 1989.. 22,249,276 1,332,161 1,254,613 89,580 175,044 1990.. 23,476,604 1,349,726 2,099,328 103,752 193,007 1991.. 22,553,002 1,429,322 405,729 109,631 261,316 1992.. 20,235,028 1,474,531 -987,788 128,955 295,401 1993.. 18,914,251 1,657,800 -230,268 140,466 355,947 1994.. 20,910,742 1,795,328 2,363,862 146,866 368,187 1995.. 25,395,148 1,818,416 857,788 161,348 370,203 1996 . 25,164,303 1,947,861 -1,676,716 162,642 402,517 1997 . 26,917,213 1,976,453 -2,611,570 174,407 364,454 1998 . 28,149,477 1,833,436 1,906,037 178,009 408,544 1999 . 29,346,836 1,852,162 -533,557 213,790 484,959 2000 33,963,992 1,971,688 -1,500,027 188,067 435,838 2001 , 31,870,721 2,084,708 -1,117,435 295,056 338,537 2002 26,760,113 2,227,078 2,149,328 205,111 429,568 2003 23,792,725 2,462,658 2,481,127 297,020 508,144 2004 23,539,942 2,238,705 917,870 272,331 503,784 Total, 1914-2004 641,749,857 47,193,869 7,777345 4,138,045 7,862,963 Aggregate for each Bank, 1914-2004 Boston 34,556,554 3,140,957 338,671 175,263 459,567 New York 222,443,921 7,280,4284 2,102,239 1,009,352 2,573,085 Philadelphia 23,869,631 2,542,934 200,363 169,950 318,524 Cleveland 39,693,014 2,968,781 540,433 296,428 463,041 Richmond 49,669,998 4,141,554 1,059,465 531,065 643,402 Atlanta 33,833,187 4,890,082 546,057 316,723 536,289 Chicago 79,234,017 5,961,783 925,960 488,548 901,978 St. Louis 22,208,274 2,398,978 153,844 107,149 286,799 Minneapolis 10,784,532 2,299,447 218,125 129,234 131,198 Kansas City 23,543,939 3,081,674 198,986 139,470 287,617 Dallas 29,310,581 3,090,244 457,869 211,688 382,645 San Francisco 72,602,208 5,397,008 1,035,534 563,174 878,816 Total 641,749,857 47,193,869 7,777^45 4,138,045 7,8624)63 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 19% and 1997. Digitized Bfoanr kFs RfoAr SwhEiRch reimbursement was not received. http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 283 6.—Continued Payments to U.S. Treasury Transferred Div p i a d i e d nds Interest on to surplus to surplus Statutory Federal Reserve (section 13b) (section 7) transfers - 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 22,021,528 466,796 582,402 18,078,003 2,782,587 7,086,659 44,113,958 523,408,737 -4 15,723,1763 338,234 2,579,504 26,661,526 135 1,540,038 1,739,744 17,307,161 190,344,011 -433 4,292,813 296,712 1,312,118 18,993,444 291 436,021 521,358 2,827,043 31,805,942 -10 1,350,863 964,861 3,083,928 38,208,638 -72 3,156,085 511,227 2,713,230 24,601,609 5 810,079 814,121 4,593,811 66,258,309 12 1,141,414 183,699 1,833,837 17,213,488 -27 338,194 226,818 416,227 7,399,208 65 400,462 227,829 1,249,703 18,486,949 -9 269,691 330,064 1,510,802 23,968,266 55 274,686 931,991 4,686,594 59,467,347 -17 1,712,829 7,086,659 44,113,958 523,408,737 -4 15,723,1763 3. The $15,723,176 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 $11,629,504 thousand on Decemfor contributions to capital of the Federal Deposit Insur- ber 31, 2004. ance Corporation (1934), $4 thousand net upon elimina- 4. This amount is reduced by $2,675,308 thousand Digitized tfioonr FofR sAecStiEonR 13b surplus (1958), and $106,000 thou- for expenses of the System Retirement Plan. See note 1, http://frasseanr.ds tlo(u1i9s9f6e)d, .or$g1/0 7,000 thousand (1997), and table 5. Federal Reserve Bank of St. Louis

284 91st Annual Report, 2004 7. Acquisition Costs and Net Book Value of Premises of the Federal Reserve Banks and Branches, December 31, 2004 Thousands of dollars Acquisition costs Federal Reserve Net Other Bank or Buildings Building ma- book real Branch Land (including chinery and Total2 value estate3 vaults)1 equipment BOSTON ... 22,074 116,556 19,284 157,914 98,853 NEW YORK 20,103 218,243 60,251 298,596 192,722 Buffalo 4,142 3,699 8,729 3,462 PHILADELPHIA 2,561 75,796 11,857 90,214 53,306 CLEVELAND . 3,112 121,824 23,924 148,859 114,370 Cincinnati 2,247 28,740 11,474 42,460 23,160 1,658 18,806 11,967 32,432 19,349 RICHMOND 12,923 84,560 38,545 136,028 94,468 Baltimore ... 6,482 27,956 5,490 39,929 23,530 Charlotte 3,130 28,568 6,104 37,802 25,553 ATLANTA .. 22,735 146,569 15,786 185,090 171,374 Birmingham . 7,194 46,118 4,170 57,483 52,501 Jacksonville . 1,812 20,302 3,839 25,953 17,656 48 Miami 4,266 17,672 4,728 26,667 17,139 Nashville 687 6,147 3,305 10,139 5,845 New Orleans 3,952 9,530 4,943 18,425 11,339 CHICAGO 4,512 147,541 18,392 170,445 108,476 1,386 Detroit .... 4,706 46,497 3,358 54,561 48,865 ST. LOUIS 4,774 52,240 11,160 68,173 45,459 Little Rock 1,148 4,861 2,155 8,165 4,697 Louisville . 800 4,735 2,068 7,603 3,422 Memphis .., 1,136 13,743 4,418 19,297 14,247 MINNEAPOLIS 15,666 104,234 13,742 133,643 112,292 Helena 2,890 9,716 958 13,564 10,216 KANSAS CITY 29,059 28,921 7,999 65,979 48,004 Denver 3,511 8,859 4,573 16,943 9,310 Oklahoma City . 977 12,195 3,488 16,660 8,574 Omaha 7,165 11,824 2,477 21,466 15,992 DALLAS ... 31,597 111,755 20,675 164,027 124,925 2 El Paso 262 3,533 1,487 5,283 2,330 Houston 19,908 102,810 0 122,718 122,718 7,202 San Antonio . 826 7,414 3,103 11,343 6,713 SAN FRANCISCO 20,084 92,910 22,148 135,142 84,251 Los Angeles 6,306 69,700 12,533 88,539 60,223 Portland 1,287 8,764 2,532 12,584 6,801 Salt Lake City 1,294 4,785 1,600 7,679 3,492 Seattle 380 14,406 4,699 19,484 12,765 515 Total 274,111 1,832,974 372,933 2,480,018 1,778^99 9,154 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 285 8. Operations in Principal Departments of the Federal Reserve Banks, 2001-2004 Operation 2004 2003 2002 2001 Millions of pieces (except as noted) Currency processed 36,242 34,832 34,208 33,740 Currency destroyed 6,748 7,375 8,363 7,850 Coin received1 55,655 48,138 43,445 39,735 Checks handled U.S. government checks 234 267 289 346 Postal money orders 187 198 216 229 Other 13,904 15,806 16,587 16,905 Government securities transfers 20 20 17 15 Transfer of funds 125 123 115 112 Automated clearinghouse transactions Commercial 6,486 5,588 4,986 4,448 Government 941 914 883 900 Food stamps redeemed 48 287 500 587 Millions of dollars Currency processed 625,127 584,915 565,302 540,746 Currency destroyed 90,943 101,338 92,511 86,298 Coin received1 5,403 4,879 4,579 4,296 Checks handled U.S. government checks 277,649 308,055 307,627 333,849 Postal money orders 29,045 29,197 30,161 30,461 Other 14,287,740 15,431,625 15,033,298 14,853,072 Government securities transfers 313,425,252 267,644,194 228,907,121 212,343,034 Transfer of funds 469,898,863 436,706,269 405,761,750 423,606,365 Automated clearinghouse transactions Commercial 12,543,907 13,951,600 13,135,350 12,707,247 Government 2,913,189 2,810,283 2,711,384 2,528,562 Food stamps redeemed 239 1,510 2,543 2,989 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

286 91st Annual Report, 2004 9. Federal Reserve Bank Interest Rates on Loans toDepository Institutions, December 31, 2004 Reserve Bank Primary credit1 Secondary credit2 Seasonal credit3 All Federal Reserve Banks 3.25 3.75 2.35 1. Primary credit is available for very short terms as 3. Seasonal credit is available to help relatively small a backup source of liquidity to depository institutions mat depository institutions meet regular seasonal needs for are in generally sound financial condition in the judgment funds that arise from a clear pattern of intra-yearly moveof the lending Federal Reserve Bank. ments in their deposits and loans. The discount rate on 2. Secondary credit is available in appropriate circum- seasonal credit takes into account rates charged by market stances to depository institutions mat do not qualify for sources of funds and is reestablished on the first business primary credit. day of each two-week reserve maintenance period. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 287 10. Reserve Requirements of Depository Institutions, December 31, 2004 Requirements Type of deposit Percentage of deposits Effective date Net transaction accounts1 $0 million-$7.0 million2 0 12-23-04 More than $7.0 million-$47.6 million3 3 12-23-04 More than $47.6 million 10 12-23-04 Nonpersonal time deposits 0 12-27-90 Eurocurrency liabilities 0 12-27-90 NOTE. Required reserves must be held in the form of For a more detailed description of these deposit types, vault cash and, if vault cash is insufficient, also in the see Form FR 2900 at www.federalreserve.gov/boarddocs/ form of a deposit with a Federal Reserve Bank. An reportforms/. institution that is a member of the Federal Reserve Sys- 2. The amount of net transaction accounts subject to a tem must hold that deposit directly with a Reserve Bank; reserve requirement ratio of zero percent (the "exemption an institution that is not a member of the System can amount" ) is adjusted each year by statute. The exempmaintain that deposit directly with a Reserve Bank or tion amount is adjusted upward by 80 percent of the with another institution in a pass-through relationship. previous year's (June 30 to June 30) rate of increase in Reserve requirements are imposed on commercial banks, total reservable liabilities at all depository institutions. savings banks, savings and loan associations, credit No adjustment is made in the event of a decrease in such unions, U.S. branches and agencies of foreign banks, liabilities. Edge corporations, and agreement corporations. 3. The amount of net transaction accounts subject to a 1. Total transaction accounts consists of demand reserve requirement ratio of 3 percent is the "low-reserve deposits, automatic transfer service (ATS) accounts, tranche." By statute, the upper limit of the low-reserve NOW accounts, share draft accounts, telephone or preau- tranche is adjusted each year by 80 percent of the prethorized transfer accounts, ineligible bankers acceptances, vious year's (June 30 to June 30) rate of increase or and obligations issued by affiliates maturing in seven decrease in net transaction accounts held by all depository days or less. Net transaction accounts are total transaction institutions. accounts less amounts due from other depository institutions and less cash items in the process of collection. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

288 91st Annual Report, 2004 11. Initial Margin Requirements under Regulations T, U, and X Percent of market value Short sales, Effective date Tonly1 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 coUateralized 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 289 12. Principal Assets and Liabilities of Insured Commercial Banks in the United States, by Class of Bank, June 30, 2004 and 2003 Millions of dollars, except as noted Member banks Nonmember Item Total banks Total National State 2004 ASSETS Loans and investments 5,788,749 4,567,717 3,321,077 1,246,640 1,221,031 Loans, gross 4,267,979 3,381,763 2,481,333 900,430 886,216 Net 4,266,463 3,380,928 2,480,744 900,183 885,535 Investments 1,520,770 1,185,955 839,744 346,210 334,815 U.S. Treasury and federal agency securities 333,691 212,367 122,046 90,320 121,324 Other 1,187,079 973,588 717,698 255,890 213,491 Cash assets, total 271,089 218,068 156,194 61,874 53,021 LIABILITIES Deposits, total 4,454,462 3,413,426 2,442,362 971,063 1,041,036 Interbank 68,720 54,897 37,078 17,819 13,824 Other transaction 675,846 487,519 343,929 143,589 188,327 Other nontransaction 3,709,896 2,871,010 2,061,355 809,655 838,886 Equity capital 721,273 576,917 419,886 157,031 144,356 Number of banks 7,676 2,885 1,955 930 4,791 2003 ASSETS Loans and investments 5,338,735 4,201,136 2,969,072 1,232,064 1,137,599 Loans, gross 3,922,431 3,105,061 2,225,277 879,784 817,370 Net 3,920,108 3,103,351 2,223,849 879,502 816,757 Investments 1,416,304 1,096,075 743,795 352,280 320,229 U.S. Treasury and federal agency securities 289,327 186,267 101,918 84,349 103,060 Other 1,126,977 909,808 641,877 267,931 217,169 Cash assets, total 301,052 246,847 177,579 69,267 54,205 LIABILITIES Deposits, total 4,206,473 3,240,228 2,292,202 948,026 966,245 Interbank 67,939 56,239 40,330 15,909 11,699 Other transaction 684,284 504,700 361,115 143,585 179,585 Other nontransaction 3,454,250 2,679,289 1,890,756 788,533 774,961 Equity capital 658,407 526,805 371,055 155,750 131,602 Number of banks 7,813 2,995 2,044 951 4,818 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

290 91st Annual Report, 2004 13A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2004 and Month-End 2004 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 ee u m rc e h n as ts e 2 Loans Float R F O e e d s th e e e r 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 n at 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 20,402 1991 272,531 15,898 218 1,026 34,524 324,197 11,059 10,018 21,014 1992 300,423 8,094 675 3,350 30,278 342,820 11,056 8,018 21,447 1993 336,654 13,212 94 963 33,394 384,317 11,053 8,018 22,095 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 24,003 1996 393,132 21,583 85 5,297 32,222 452,319 11,048 9,718 24,966 1997 431,420 23,840 2,035 561 32,044 489,901 11,047 9,200 25,543 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 31,643 2001 551,685 50,250 34 698 36,885 639,552 11,045 2,200 33,017 2002 629,416 39,500 40 832 38,574 708,363 11,043 2,200 34,597 2003 666,665 43,750 62 211 40,214 750,901 11,043 2,200 35,475 2004 717,819 33,000 43 927 42,161 793,950 11,045 2,200 36,505 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 291 13 A.—Continued Factors absorbing reserve funds Reserve Currency Reverse Treasury Depos o i t t h s e w r i t t h h a n F e r d e e se ra rv l e R b es a e la rv n e c e B s anks, Required R F O e e d s th e e r e r v a r e l b F a e w la d i n e th c ra e l s in repurchase cash clearing liabilities Reserve circulation agreements4 holdings5 balances and Banks6 Treasury Foreign Other capital 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 36,713 286,963 0 561 8,960 369 242 1,960 8,147 36,698 307,756 0 636 17,697 968 1,706 3,946 8,113 25,467 334,701 0 508 7,492 206 372 5,897 7,984 26,182 365,271 0 377 14,809 386 397 6,332 9,292 28,619 403,843 0 335 7,161 250 876 4,196 11,959 26,593 424,244 0 270 5,979 386 932 5,167 12,342 24,444 450,648 0 249 7,742 167 892 6,601 13,829 17,923 482,327 0 225 5,444 457 900 6,679 15,500 24,159 517,484 0 85 6,086 167 1,605 6,781 16,354 19,525 628,359 0 109 28,402 71 1,261 7,482 17,256 16,545 593,694 0 450 5,149 216 1,382 6,332 17,962 12,713 643,301 0 425 6,645 61 820 8,525 17,083 8,953 687,518 21,091 367 4,420 136 1,152 10,533 18,977 12,008 724,194 25,652 321 5,723 162 717 11,828r 19,793 11,230r 754,948 30,783 270 5,912 80 1,285 9,963 26,378 14,080 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

292 91st Annual Report, 2004 13A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2004 and Month-End 2004—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 standing3 assets 2004 Jan 667,242 23,500 19 -26 41,456 732,191 11,043 2,200 35,567 Feb 671,583 28,750 23 520 38,754 739,630 11,045 2,200 35,649 Mar. .... 674,084 27,500 64 -586 40,169 74131 11,045 2,200 35,761 677,687 25,250 84 -829 40,345 742,537 11,045 2,200 35,842 May'.'.'.'.'. 681,472 30,750 122 -155 38,354 750,543 11,045 2,200 35,924 June 687,391 33,500 323 116 39,465 760,795 11,045 2,200 36,039 July .... 693,727 24,750 260 -23 40,581 759,294 11,044 2,200 36,087 Aug 694,859 32,250 457 1,002 38,043 766,610 11,043 2,200 36,211 Sept .... 700,341 29,250 236 -25 39,557 769,359 11,043 2,200 36,279 Oct 706,834 25,250 121 -114 41,681 773,772 11,043 2,200 36,364 Nov. .... 712,870 33,750 77 810 39,844 787,351 11,043 2,200 36,435 Dec 717,819 33,000 43 927 42,161 793,950 11,045 2,200 36,505 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 293 13 A.—Continued Factors absorbing reserve funds Reserve Other balances Deposits with Federal Reserve Banks, Federal with Currency Reverse Treasury other than reserve balances Required Reserve Federal in repurchase cash clearing liabilities Reserve circulation agreements4 holdings5 balances and Banks6 Treasury Foreign Other capital 708,952 20,129 356 4,184 84 426 10,614 20,365 15,889 712,613 21,762 318 6,513 82 302 10,078 20,033 16,823 716,136 21,701 366 5,884 83 231 10,410 20,880 14,545 717,528 21,204 321 6,392 96 368 10,561 20,804 14,350 726,367 20,477 320 4,637 86 267 10,145 21,718 15,696 733,183 19,228 303 6,032 280 226 10,861 21,198 18,767 733,020 20,167 283 4,917 81 304 9,802 21,302 18,751 736,506 22,941 330 2,456 158 275 10,206 23,084 20,109 738,372 25,693 291 5,987 128 243 10,718 23,502 13,946 741,440 27,037 299 5,116 92 310 10,571 23,918 14,597 754,226 28,201 283 3,759 89 326 10,024 25,627 14,494 754,948 30,783 270 5,912 80 1,285 9,963 26,378 14,080 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 US. 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

294 91st Annual Report, 2004 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 a n e u s t e e s 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 a r o n r u d e t i n - n c g y 7 1918 239 0 1,766 199 294 0 2,498 2,873 1,795 1919 300 0 2,215 201 575 0 3,292 2,707 1,707 1920 287 0 2,687 119 262 0 3,355 2,639 1,709 1921 234 0 1,144 40 146 0 1,563 3,373 1,842 1922 436 0 618 78 273 0 1,405 3,642 1,958 1923 80 54 723 27 355 0 1,238 3,957 2,009 1924 536 4 320 52 390 0 1,302 4,212 2,025 1925 367 8 643 63 378 0 1,459 4,112 1,977 1926 312 3 637 45 384 0 1,381 435 1,991 1927 560 57 582 63 393 o 1655 4092 2 006 1928 197 31 1,056 24 500 0 1,809 3,854 2,012 1929 488 23 632 34 405 0 1,583 3,997 2,022 1930 686 43 251 21 372 0 1,373 4,306 2,027 1931 775 42 638 20 378 o 1853 4173 2035 1932 1,851 4 235 14 41 0 2,145 4,226 2,204 1933 2,435 2 98 15 137 0 2,688 4,036 2,303 1934 2,430 0 7 5 21 0 2,463 8,238 2,511 1935 2,430 1 5 12 38 0 2,486 10,125 2,476 1936 2,430 0 3 39 28 0 2,500 11,258 2,532 1937 2,564 0 10 19 19 0 2,612 12,760 2,637 1938 2,564 0 4 17 16 0 2,601 14,512 2,798 1939 2,484 0 7 91 11 0 2,593 17,644 2,963 1940 2,184 0 3 80 8 0 2,274 21,995 3,087 1941 2,254 0 3 94 10 0 2,361 22,737 3,247 1942 6,189 0 6 471 14 0 6,679 22,726 3,648 1943 11,543 0 5 681 10 0 12,239 21,938 4,094 1944 18,846 0 80 815 4 0 19,745 20,619 4,131 1945 24,252 0 249 578 2 0 15,091 20,065 4,339 1946 23,350 0 163 580 1 0 24,093 20,529 4,562 1947 22,559 0 85 535 1 0 23,181 22,754 4,562 1948 23,333 0 223 541 1 0 24,097 24,244 4,589 1949 18,885 0 78 534 2 0 19,499 24,427 4,598 1950 20,725 53 67 1,368 3 0 22,216 22,706 4,636 1951 23,605 196 19 1,184 5 0 25,009 22,695 4,709 1952 24,034 663 156 967 4 0 25,825 23,187 4,812 1953 25,318 598 28 935 2 0 26,880 22,030 4,894 1954 24,888 44 143 808 1 0 25,885 21,713 4,985 1955 24,391 394 108 1,585 29 0 26,507 21,690 5,008 1956 24,610 305 50 1,665 70 0 26,699 21,949 5,066 1957 23,719 519 55 1,424 66 0 25,784 22,781 5,146 1958 26,252 95 64 1,296 49 0 27,755 20,534 5,234 1959 26,607 41 458 1,590 75 0 28,771 19,456 5,311 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 295 13B.—Continued Factors absorbing reserve funds Member bank Deposits with reserves9 Federal Reserve Banks, Other 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 se u r n v t e s5 balances li c a a b a p i n i li t d t a i l e 5 s R F W e e d se i e t r r h v a e l C c u o r a r n i e n d n 10 cy qu R ir e e - d11 ces E s x 11 - -12 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

296 91st Annual Report, 2004 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 h e p r a n e u s t e e s r - - 2 Loans Float3 ot A h l e l r4 R F a O e s e s s d 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 c a e r r c i t c g if o h i u c ts n at t e s c t u a r o n r u d e t n i - n c g y 7 1960 26,984 400 33 1,847 74 0 29338 17,767 . . . 5,398 1961 30,478 159 130 2300 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 43,340 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 1335 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 131327 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 US. 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 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 297 13B.—Continued Factors absorbing reserve funds Member bank Deposits with reserves9 Federal Reserve Banks, Cur- Other 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 se u r 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 a i n n d 10 quired11 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 98i2 72,497 317 2,542 251 1,41913 0 0 2,669 27,060 6,781 35,268 -1,360 79,743 185 2,113 418 1,27513 0 0 2,935 25,843 7,370 37,011 -3,798 86,547 483 7,285 353 1,090 0 0 2,968 26,052 8,036 35,197 -1,103 u 93,717 460 10,393 352 1,357 0 0 3,063 25,158 8,628 35,461 -1,535 103,811 392 7,114 379 1,187 0 0 3,292 26,870 9,421 37,615 -1,265 114,645 240 4,196 368 1,256 0 0 4,275 31,152 10,538 42,694 -893 125,600 494 4,075 429 1,412 0 0 4,957 29,792 11,429 44,217 -2,835 136,829 441 3,062 411 617 0 0 4,671 27,456 13,654 40,558 675 144,774 443 4,301 505 781 0 117 5,261 25,111 15,576 42,145 -1,442 154,908 429 5,033 328 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

298 91st Annual Report, 2004 14. Banking Offices and Banks Affiliated with Bank Holding Companies (BHCs) in the United States, December 31, 2003 and 2004 Commercial banks' Statechartered Type of office Total Member savings Total Nonmember banks Total National State All banking offices BANKS Number, Dec 31, 2003 .. 8,116 7,725 2,892 1,963 929 4,833 391 Changes during 2004 New banks 131 126 29 19 10 97 5 Banks converted into branches -248 -236 -121 -79 -42 -115 -12 Ceased banking operation2 -39 -27 -16 -13 -3 -11 -12 Other3 0 -2 10 -10 20 -12 2 Net change -156 -139 -98 -83 -15 -41 -17 Number, Dec 31,2004 .. 7,960 7^86 2,794 1,880 914 4,792 374 BRANCHES AND ADDITIONAL OFFICES Number, Dec 31, 2003 .. 72,936 69,440 50,628 36,553 14,075 18,812 3,496 Changes during 2004 New branches 2,190 2,078 1,535 1,124 411 543 112 Branches converted from banks 248 241 138 99 39 103 7 Discontinued2 -883 -666 -437 -295 -142 -229 -217 Other3 0 81 0 1,202 -1,202 81 -81 Net change 1,555 1,734 1,236 2,130 -894 498 -179 Number, Dec. 31, 2004 .. 74,491 71,174 51,864 38,683 13,181 19310 3317 Banks affiliated with BHCs BANKS Number, Dec 31, 2003 . 6,403 6,287 2,486 1,672 814 3,801 116 Changes during 2004 BHC-affiliated new banks 171 159 47 33 14 112 12 Banks converted into branches -201 -196 -107 -70 -37 -89 -5 Ceased banking operation2 -40 -30 -17 -16 -1 -13 -10 Other3 0 -2 9 -6 15 -11 2 Net change -70 -69 -68 -59 -9 -1 -1 Number, Dec 31,2004 . 6333 6,218 2,418 1,613 805 3,800 115 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

301 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's examinacompliance with laws and regulations tion includes a wide range of ongoing affecting those statements, are audited oversight 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 Government those Board functions delegated to the Accountability 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

303 Board of Governors Financial Statements The financial statements of the Board for 2004 and 2003 were audited by KPMG LLP, independent auditors. KPMGLLP 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, 2004 and 2003, 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 die financial statements are free of material misstatement. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Board's internal control over financial reporting. Accordingly, we express no such opinion. 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, 2004 and 2003, 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 1, 2005, on our consideration of the Board's internal control over financial reporting and its compliance with certain provisions of laws, regulations, and contracts. The purpose of those reports is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. 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 1,2005 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

304 91st Annual Report, 2004 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BALANCE SHEETS As of December 31, 2004 2003 ASSETS CURRENT ASSETS Cash $ 60,107,292 $ 56,179,654 Accounts receivable 1,696,480 1,251,117 Prepaid expenses and other assets 4,015,067 2,614,354 Total current assets 65,818,839 60,045,125 NONCURRENT ASSETS Property and equipment, net (Note 2) 149,028,686 149,595,059 Collections (Note 1) Total noncurrent assets 149,028,686 149,595,059 Total assets $214,847,525 $209,640,184 LIABILITIES AND CUMULATIVE RESULTS OF OPERATIONS CURRENT LIABILITIES Accounts payable and accrued liabilities $ 13,891,861 $ 15,347,390 Accrued payroll and related taxes 4,552,039 5,056,647 Accrued annual leave 14,195,910 13,428,993 Capital lease payable (current portion) 250,794 206,590 Unearned revenues and other liabilities 467,664 390,698 Total current liabilities 33,358,268 34,430,318 LONG-TERM LIABILITIES Capital lease payable (non-current portion) 675,271 763,699 Accumulated retirement benefit obligation (Note 3) 594,169 595,601 Accumulated postretirement benefit obligation (Note 4) 5,789,566 5,322,053 Accumulated postemployment benefit obligation (Note 5) 5,308,565 4,949,892 Total long-term liabilities 12,367,571 11,631,245 Total liabilities 45,725,839 46,061,563 CUMULATIVE RESULTS OF OPERATIONS Working capital 32,711,365 25,821,397 Unfunded long-term liabilities (11,692,300) (10,867,546) Net investment in property and equipment 148,102,621 148,624,770 Total cumulative results of operations 169,121,686 163,578,621 Total liabilities and cumulative results of operations $214,847,525 $209,640,184 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 305 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, 2004 2003 BOARD OPERATING REVENUES Assessments levied on Federal Reserve Banks for Board operating expenses and capital expenditures $272,331,500 $297,020,200 Other revenues (Note 6) 8,336,581 8,835,440 Total operating revenues 280,668,081 305,855,640 BOARD OPERATING EXPENSES Salaries 166,797,724 156,547,392 Retirement and insurance contributions 30,850,441 28,263,776 Contractual services and professional fees 24,835,904 17,501,035 Depreciation and net losses on disposals 12,445,708 12,194,612 Utilities 8,273,801 7,664,716 Travel 7,088,444 5,981,254 Software 6,302,695 5,910,128 Postage and supplies 6,116,355 8,175,120 Repairs and maintenance 3,954,263 4,029,441 Printing and binding 1,944,552 1,864,006 Other expenses (Note 6) 6,515,129 6,642,118 Total operating expenses 275,125,016 254,773,598 RESULTS OF OPERATIONS 5,543,065 51,082,042 ISSUANCE AND REDEMPTION OF FEDERAL RESERVE NOTES Assessments levied on Federal Reserve Banks for currency costs 503,784,304 508,144,248 Expenses for currency printing, issuance, retirement, and shipping 503,784,304 508,144,248 CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES 0 0 TOTAL RESULTS OF OPERATIONS 5,543,065 51,082,042 CUMULATIVE RESULTS OF OPERATIONS, Beginning of year 163,578,621 112,496,579 CUMULATIVE RESULTS OF OPERATIONS, End of year $169,121,686 $163,578,621 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

306 91st Annual Report, 2004 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF CASH FLOWS For the years ended December 31, 2004 2003 CASH FLOWS FROM OPERATING AcnvrnES RESULTS OF OPERATIONS $ 5,543,065 $51,082,042 Adjustments to reconcile results of operations to net cash provided by (used in) operating activities: Depreciation and net losses on disposals 12,445,708 12,194,612 Increase in assets: Accounts receivable, prepaid expenses, and other assets (1,846,076) (2,192,814) Increase (decrease) in liabilities: Accounts payable and accrued liabilities (1,455,529) 3,897,291 Accrued payroll and related taxes (504,608) (3,046,063) Accrued annual leave 766,917 1,555,466 Unearned revenues and other liabilities 76,966 (51,368) Accumulated retirement benefit obligation (1,432) (18,507) Accumulated postretirement benefit obligation 467,513 404,266 Accumulated postemployment benefit obligation 358,673 650,640 Net cash provided by operating activities 15,851,197 64,475,565 CASH FLOWS FROM INVESTING ACTTVITIES Proceeds from disposals 4,005 15,790 Capital expenditures (11,715,861) (16,809,964) Net cash used in investing activities (11,711,856) (16,794,174) CASH FLOWS FROM FINANCING ACTIVITIES Capital lease payments (211,703) (136,901) Net cash used in financing activities (211,703) (136,901) NET INCREASE IN CASH 3,927,638 47,544,490 CASH BALANCE, Beginning of year 56,179,654 8,635,164 CASH BALANCE, End of year $60,107,292 $ 56,179,654 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Capital lease obligations incurred $ 190,538 $ 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 307 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, 2004 AND 2003 determined. Estimates—The preparation of financial statements in conformity with accounting principles generally accepted (1) SIGMFICANT ACCOUNTING POLICIES ta ^ ^ StaKs rf ^^ ^$ management t0 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 2003 amounts have been agency and is supported by Washington staff numbering reclassified to conform with the 2004 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 fonowing js a summary of the components of the The Board is required by the Federal Reserve Act to Board>s property md 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 financial condition of each such Reserve Bank and a consolidated statement for all of the Reserve Banks. Accord- £•*• • OS^403lT $ 18,640,314 ingly, the Board believes_that the best financial disclosure consistent with law is achieved by issuing separate fman- "" ^roTements ... 132,891,551 129,161,957 Furniture and cial statements for the Board and for the Reserve Banks. equipment 44 450 522 43 890 215 Therefore, the accompanying financial statements include Software 12 207 125 11 425 411 only the operations and activities of the Board. Combined Construction in financial statements for the Federal Reserve Banks are process 4 380 259 0 included in the Board's annual report to the Speaker of 212569771 203 117 897 the House of Representatives. Less accumulated Basis of Accounting—The financial statements have depreciation (63,541,085) (53,522,838) been prepared on the accrual basis of accounting. Property and ~~ Revenues—Assessments for operating expenses and equipment, net ... $149,028,686 $149,595,059 additions to property are based on expected cash needs. = = = == = Amounts over or under assessed due to differences Furniture and equipment includes $1,230,000 and between actual and expected cash needs flow in to or out $1,156,000 for capitalized leases as of December 31, of "Cumulative Results of Operations" during the year. 2004 and 2003 respectively. Accumulated depreciation Issuance and Redemption of Federal Reserve Notes— includes $356,000 and $195,000 for capitalized leases as The Board incurs expenses and assesses the Federal of December 31, 2004 and 2003, 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 $104,000 and $76,000 for 2004 and 2003, respectively. assessments and expenses are separately reported in the The future minimum lease payments required under statements of revenues and expenses because they are not the capital leases and the present value of the net mini- Board operating transactions. mum lease payments as of December 31, 2004, are as Property and Equipment—The Board's property, build- follows: ings, and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets, which range from 3 to 10 years for furniture and equipment and from 10 to 50 years for building equipment and structures. Upon the sale or other disposition of a depreciable asset, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is recognized. Collections—The Board has collections of works of art, historical treasures, and similar assets. These collections are maintained and held for public exhibition in furtherance of public service. Proceeds from any sales of collections are used to acquire other items for collections. As permitted by FAS 116, the cost of collections purchased by the Board is charged to expense in the year Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

308 91st Annual Report, 2004 Year for future payments to retirees under these programs, and ending it is not accountable for the assets of the plans. December 31 Amount Employees of the Board may also participate in the 2005 $ 427,659 Federal Reserve System's Thrift Plan. Under the Thrift 2006 416,274 Plan, members may contribute up to a fixed percentage 2007 416,274 of their salary. Board contributions are based upon a 2008 138,279 fixed percentage of each member's basic contribution Total minimum lease and were $8,314,000 and $7,692,000 in 2004 and 2003, payments 1,398,486 respectively. Less: Amount representing Effective January 1, 1996, Board employees covered maintenance included under the System Plan are also covered under a Benefits in total amounts above . (301,512) Equalization Plan (BEP). Benefits paid under the BEP are Net minimum lease limited to those benefits mat cannot be paid from the payments 1,096,974 System Plan due to limitations imposed by Sec- Less: Amount representing tions 401(aX17), 415(b) and 415(e) of the Internal Reveinterest (170,909) nue Code of 1986. Pension costs attributed to the System Present value of net Plan reduce the pension costs of the BEP. Activity for the minimum lease payments 926,065 BEP for 2004 and 2003 is summarized in the following Less: Current maturities table: of capital lease obligations (250,794) 2004 2003 Long-term capital lease Change in projected obligations $ 675,271 benefit obligation Benefit obligation at beginning of year .. $ 74,956 $ 12,866 Construction in process includes costs incurred in 2004 Service cost 23,239 13,689 for two long-term security projects. The first, the Elec- Interest cost 6,170 3,412 tronic Security System, has an estimated cost of $5.1 mil- Plan participants' lion and expected completion in 2005. The second, the contributions 0 0 Plan amendments 0 0 Security Perimeter Barrier Project, has an estimated cost Actuarial (gain)Aoss .... 36,588 44,989 of $11.8 million and expected completion in 2006. Benefits paid 0 0 (3) RETIREMENT BENEFITS Benefit obligation at Substantially all of the Board's employees participate end of year $ 140,953 $ 74,956 in the Retirement Plan for Employees of the Federal Change in plan assets Reserve System (System Plan). The System Plan is a Fair value of plan assets multi-employer plan which covers employees of the Fed- at beginning eral Reserve Banks, the Board, and the Plan Administra- of year $ 0 $ 0 tive Office. Actual return on plan Employees of the Board who became employed prior assets 0 0 to 1984 are covered by a contributory defined benefits Employer contributions . 0 0 program under the System Plan. Employees of the Board Plan participants' contributions 0 0 who became employed after 1983 are covered by a non- Benefits paid 0 0 contributory defined benefits program under the System Fair value of plan assets Plan. Contributions to the System Plan are actuarially at end of year $ 0 $ 0 determined and funded by participating employers at amounts prescribed by the System Plan's administrator. Based on actuarial calculations, it was determined that Reconciliation of funded employer funding contributions were not required for the status at end of year years 2004 and 2003, and the Board was not assessed Funded status $ (140,953) $ (74,956) Unrecognized net a contribution for these years. Excess Plan assets are actuarial (gain)/ expected to continue to fund future years' contributions. loss (177,773) (231,189) Because the plan is part of a multi-employer plan, infor- Unrecognized prior mation as to vested and nonvested benefits, as well as service cost (817,732) (934,339) plan assets, as it relates solely to the Board, is not readily Unrecognized net available. transition obligation 542,289 644,883 A relatively small number of Board employees partici- Retirement pate in the Civil Service Retirement System (CSRS) or benefit liability .... $ (594,169) $ (595,601) the Federal Employees' Retirement System (FERS). The Board matches employee contributions to these plans. These defined benefit plans are administered by the Office of Personnel Management. The Board's contributions to these plans totaled $330,000 and $312,000 in 2004 and 2003, respectively. The Board has no liability Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 309 2004 2003 2004 2003 Information for pension Change in plan assets plans with an Fair value of plan accumulated benefit assets at beginning obligation in excess of of year $ 0 $ 0 plan asset: Actual return on Projected benefit plan assets 0 0 obligation $ 140,953 $ 74,956 Employer contribution .. 253,717 227,202 Accumulated benefit Plan participants' obligation 33 28 contributions 0 0 Benefits paid (253,717) (227,202) Weighted-average Fair value of plan assumptions used to assets at end determine benefit of year $ 0 $ 0 obligation as of December 31 Reconciliation of Discount rate 5.75% 6.25% funded status Rate of compensation at end of year increase 4.25% 4.00% Funded status $(8,404,551) $(7,166,146) Unrecognized net Components of net actuarial periodic benefit cost (gain)/loss 2,537,211 1,760,246 Service cost—benefits Unrecognized prior earned during the service cost 77,774 83,847 period $ 23,239 $ 13,689 PrepaidAaccrued) Interest cost on postretirement projected benefit benefit liability . $(5,789,566) $(5,322,053) obligation 6,170 3,412 Expected return Components of net on plan assets 0 0 periodic cost Amortization of for year prior service cost (116,607) (116,607) Service cost $ 203,229 $ 170,636 Amortization of Interest cost (gains)/losses (16,828) (21,595) Amortization of prior 443,043 414,319 Amortization of initial service cost (asset)/obligation 102,594 102,594 Amortization of 6,073 6,073 Net periodic benefit (gains)/losses ... cost (credit) $ (1,432) $ (18,507) Total net periodic 68,885 40,440 cost $ 721,230 $ 631,468 Weighted-average assumptions used to The liability and costs for the postretirement benefit determine net periodic benefit cost for years plan were determined using discount rates of 5.75 percent ended December 31 and 6.25 percent as of December 31, 2004 and 2003, Discount rate 6.25% 6.75% respectively. Unrecognized losses of $2,537,211 and Rate of compensation $1,760,246 as of December 31, 2004 and 2003, respecincrease 4.00% 4.25% tively, result from changes in the discount rate used to measure the liabilities. Under Statement of Financial Accounting Standards No. 106, Employers' Accounting (4) POSTRETIREMENT BENEFITS for Postretirement Benefits Other Than Pensions, the The Board provides certain life insurance programs for Board may have to record some of these unrecognized its active employees and retirees. Activity for 2004 and losses in operations in future years. The assumed salary 2003 is summarized in the following table: trend rate for measuring the increase in postretirement benefits related to life insurance was an average of 2004 2003 4.25 percent. Change in benefit The above accumulated postretirement benefit obligaobligation tion is related to the Board sponsored life insurance Benefit obligation at programs. The Board has no liability for future payments beginning of year .. $7,166,146 $6,134,395 to employees who continue coverage under the federally Service cost 203,229 170,636 sponsored life and health programs upon retiring. Contri- Interest cost 443,043 414,319 butions for active employees participating in federally Plan participants' contributions 0 0 sponsored health programs totaled $8,223,000 and Plan amendments 0 0 $7,188,000 in 2004 and 2003, respectively. Actuarial (gain)/loss .... 845,851 673,998 Benefits paid (253,717) (227,202) Benefit obligation at end of year $ 8,404,552 $ 7,166,146 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

310 91st Annual Report, 2004 (5) POSTEMPLOYMENT BENEFIT PLAN (7) COMMITMENTS The Board provides certain postemployment benefits The Board has entered into several operating leases to to eligible former or inactive employees and their depen- secure office, training and warehouse space for remaining dents during the period subsequent to employment but periods ranging from one to four years. In addition, the prior to retirement. Costs were projected using the same Board has entered into an agreement with the Federal discount rates as were used for projecting postretirement Deposit Insurance Corporation and the Office of the costs. The accrued postemployment benefit costs recog- Comptroller of the Currency, through the Federal Finannized by the Board for the years ended December 31, cial Institutions Examination Council (the "Council") to 2004 and 2003, were $733,000 and $957,000, fund a portion of enhancements for a central data reposirespectively. tory project through 2013. Mimimum annual payments under the operating leases (6) OTHER REVENUES AND OTHER EXPENSES having an initial or remaining noncancelable lease term in The following are summaries of the components of excess of one year at December 31, 2004, are as follows: Other Revenues and Other Expenses. 2005 $163,363 As of December 31, 2006 71,991 After2006 0 2004 2003 Other revenues $235,354 Data processing revenue $3,984,610 $4,639,084 Rental expenses under the operating leases were Rent 2,332,089 2,029,514 $156,000 in 2004 and 2003. Subscription revenue 787,053 799,356 (8) FEDERAL FINANCIAL INSTITUTIONS Reimbursable EXAMINATION COUNCIL services to other agencies .. 673,730 588,894 The Board is one of the five member agencies of National Information the Council, and currently performs certain management Center 15,422 24,422 functions for the Council. The five agencies which are Board sponsored represented on the Council are the Board, Federal Deposit conferences 0 275,110 Insurance Corporation, National Credit Union Adminis- Miscellaneous 543,677 479,060 tration, Office of the Comptroller of the Currency, and Office of Thrift Supervision. The Board's financial state- Total other revenues $8,336,581 $8,835,440 ments do not include financial data for the Council. Activity related to the Board and Council for 2004 and 2003 is summarized in the following table: Other expenses Tuition, registration, 2004 2003 and membership fees $2,048,610 $1,615,074 Board paid to the Contingency Council: operations 782,052 704,699 Assessments for Public transportation operating expenses subsidy 800,724 732,124 of the Council $ 112,020 $ 105,920 Central Data Subsidies and Repository 326,640 630,000 contributions ... 635,336 627,854 Uniform Bank Administrative Performance law judges 492,155 307,173 Report 199,230 201,666 Meals and Total Board representation .. 377,963 534,618 paid to the Equipment and Council $ 637,890 $ 937,586 facilities rental.. 307,999 439,751 Security Council paid to the investigations ... 286,711 473,659 Board: Former employee Data processing related services 3,360,055 3,485,701 related Administrative payments 205,627 507,082 services 133,500 72,250 Miscellaneous 577,952 700,084 Total Council Total other paid to the expenses $6,515,129 $6,642,118 Board $3,493,555 $3,557,951 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 311 (9) FEDERAL RESERVE BANKS The Board performs certain functions for the Reserve Banks in conjunction with its responsibilities for the Federal Reserve System, and the Federal Reserve Banks provide certain administrative functions for the Board. Activity related to the Board and Reserve Banks for 2004 and 2003 is summarized in the following table: 2004 2003 Board paid to the Reserve Banks: Assessments for employee benefits .. $ 2,151,078 $ 2,137,781 Data processing and communication 1,920,996 1,963,247 Contingency site 1,481,452 704,699 Total Board paid to the Reserve Banks $ 5,553,526 $ 4,805,727 Reserve Banks paid to the Board: Assessments for currency costs $503,784,304 $508,144,248 Assessments for operating expenses of the Board 272,331,500 297,020,200 Data processing 686,312 1,484,015 Total Reserve Banks paid to the Board $776,802,116 $806,648,463 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

312 91st Annual Report, 2004 KPMGLLP 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, 2004 and 2003, and the related statements of revenues and expenses and changes in cumulative results of operations, and cash flows for the years men ended, and have issued our report thereon dated April 1, 2005. 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 2004 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. We limited our internal control testing to those controls necessary to achieve the objectives described in Government Auditing Standards. 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. Because of inherent limitations in any internal control, misstatements due to error or fraud may occur and not be detected. However, we noted no matters involving the internal control and its operation that we consider to be material weaknesses as defined above. We noted other matters involving internal control and its operation that we have reported to the management of the Board in a separate letter dated April 1,2005. This report is intended solely for the information and use of the members of the Board and its management, the Office of the Inspector General, and Congress and is not intended to be and should not be used by anyone other than these specified parties. K UP April 1,2005 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 313 mm KPMG LLP 2001 M Street, NW Washington, DC 20036 Independent Auditors' Report on Compliance and Other Matters 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, 2004 and 2003, 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 1, 2005. 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, regulations, and contracts applicable to the Board. As part of obtaining reasonable assurance about whether the Board's 2004 financial statements are free of material misstatement, we performed tests of the Board's compliance with certain provisions of laws, regulations, and contracts, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. We limited our tests of compliance to the provisions described in the preceding sentence, and we did not test compliance with all laws, regulations, and contracts applicable to the Board. However, providing an opinion on compliance with laws, regulations, and contracts was not an objective of our audit and, accordingly, we do not express such an opinion. The results of our tests of compliance described in the preceding paragraph of this report disclosed no instances of noncompliance or other matters that are required to be reported herein 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 the Inspector General, and Congress and is not intended to be and should not be used by anyone other than these specified parties. H UP April 1, 2005 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

315 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, 2004 and 2003. REPORT OF INDEPENDENT AUDITORS To the Board of Governors of the Federal Reserve System and the Board of Directors 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, 2004 and 2003, 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 combined financial statements are the responsibility of the Reserve Banks' management. Our responsibility is to express an opinion on these combined 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 combined 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 described in Note 3, these 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 accounting principles generally accepted in the United States of America. In our opinion, the combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Reserve Banks as of December 31, 2004 and 2003, and the combined results of their operations for the years then ended, on the basis of accounting described in Note 3. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

316 91st Annual Report, 2004 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CONDITION December 31, 2004 and 2003 (in millions) ASSETS 2004 2003 Gold certificates $ 11,041 $ 11,039 Special drawing rights certificates 2,200 2,200 Coin 728 722 Items in process of collection 6,233 7,793 Loans to depository institutions 43 62 Securities purchased under agreements to resell 33,000 43,750 U.S. government securities, net 725,584 675,569 Investments denominated in foreign currencies 21,368 19,868 Accrued interest receivable 5,104 5,064 Bank premises and equipment, net 2,216 2,117 Other assets 3,350 3,303 Total assets $810,867 $771,487 LIABILITIES AND CAPITAL LIABILITIES Federal Reserve notes outstanding, net $719,437 $689,757 Securities sold under agreements to repurchase 30,783 25,652 Deposits Depository institutions 24,043 23,058 U.S. Treasury, general account 5,912 5,723 Other deposits 332 394 Deferred credit items 5,306 7,582 Interest on Federal Reserve notes due U.S. Treasury 329 428 Accrued benefit costs 891 956 Other liabilities 290 . 243 Total liabilities 787,323 753,793 CAPITAL Capital paid-in 11,914 8,847 Surplus 11,630 8,847 Total capital 23,544 17,694 Total liabilities and capital $810,867 $771,487 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 317 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF INCOME for the years ended December 31, 2004 and 2003 (in millions) 2004 2003 Interest income Interest on U.S. government securities $22,344 $22,597 Interest on investments denominated in foreign currencies 269 260 Interest on loans to depository institutions 3 1 Total interest income 22,616 22,858 Interest expense Interest expense on securities sold under agreements to repurchase 290 215 Net interest income 22,326 22,643 Other operating income Income from services 866 887 Reimbursable services to government agencies 370 328 Foreign currency gains, net 1,217 2,695 Other income 89 79 Total other operating income 2,542 3,989 Operating expenses Salaries and other benefits 1,604 1,819 Occupancy expense 222 213 Equipment expense 245 257 Assessments by Board of Governors 776 805 Other expenses 578 532 Total operating expenses 3,425 3,626 Net income prior to distribution $21,443 $23,006 Distribution of net income Dividends paid to member banks $ 582 $ 518 Transferred to surplus 2,783 467 Payments to U.S. Treasury as interest on Federal Reserve notes 18,078 22,021 Total distribution $21,443 $23,006 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

318 91st Annual Report, 2004 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CHANGES IN CAPITAL for the years ended December 31, 2004 and 2003 (in millions) Capital Total paid-in Surplus capital Balance at January 1, 2003 (167 million shares) $ 8,380 $ 8,380 $16,760 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 Transferred to surplus . . . 2,783 2,783 Net change in capital stock issued (61 million shares) 3,067 3,067 Balance at December 31,2004 (238 million shares) $11,914 $11,630 $23,544 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 repiw~ent 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 319 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED In performing fiscal agency functions for the U.S. requires management to make certain estimates and Treasury, seven Reserve Banks provide U.S. securities assumptions that affect the reported amounts of assets and direct purchase and savings bond processing services. In liabilities, disclosure of contingent assets and liabilities at March 2004, the U.S. Treasury provided an implementa- the date of the combined financial statements, and the tion plan for consolidating the provision of these services reported amounts of income and expenses during the at the Cleveland and Minneapolis Reserve Banks. The reporting period. Actual results could differ from those costs for the associated restructuring for the affected estimates. Certain amounts relating to the prior year have Banks have been included in footnote 10. been reclassified to conform to the current-year presenta- The FOMC establishes policy regarding open market tion. Unique accounts and significant accounting policies operations, oversees these operations, and issues authori- are explained below. zations and directives to the FRBNY for its execution of transactions. Authorized transaction types include direct (A) Gold Certificates purchase and sale of securities, the purchase of securities under agreements to resell, the sale of securities under The Secretary of the Treasury is authorized to issue gold agreements to repurchase, and the lending of U.S. govern- certificates to the Reserve Banks to monetize gold held ment securities. The FRBNY is also authorized by the by the U.S. Treasury. Payment for the gold certificates by FOMC to hold balances of, and to execute spot and the Reserve Banks is made by crediting equivalent forward foreign exchange ("F/X") and securities con- amounts in dollars into the account established for the tracts in, nine foreign currencies and to invest such for- U.S. Treasury. These gold certificates held by the Reserve eign currency holdings ensuring adequate liquidity is Banks are required to be backed by the gold of the US. maintained. In addition, FRBNY is authorized to main- Treasury. The U.S. Treasury may reacquire the gold certain reciprocal currency arrangements ("F/X swaps") tificates at any time and the Reserve Banks must deliver with various central banks, and "warehouse" foreign them to the U.S. Treasury. At such time, the US. Treacurrencies for the U.S. Treasury and Exchange Stabiliza- sury's account is charged and the Reserve Banks' gold tion Fund ("ESF") through the Reserve Banks. certificate account is lowered. The value of gold for purposes of backing the gold certificates is set by law at (3) SIGNIFICANT ACCOUNTING POLICIES $42% a fine troy ounce. Accounting principles for entities with the unique powers and responsibilities of the nation's central bank have not (B) Special Drawing Rights Certificates been formulated by the Financial Accounting Standards Board. The Board of Governors has developed special- Special drawing rights (SDRs) are issued by the Internaized accounting principles and practices that it believes tional Monetary Fund (Fund) to its members in proporare appropriate for the significantly different nature and tion to each member's quota in the Fund at the time of function of a central bank as compared with the private issuance. SDRs serve as a supplement to international sector. These accounting principles and practices are monetary reserves and may be transferred from one documented in the Financial Accounting Manual for Fed- national monetary authority to another. Under the law eral Reserve Banks (Financial Accounting Manual), providing for United States participation in the SDR which is issued by the Board of Governors. All Reserve system, the Secretary of the U.S. Treasury is authorized to Banks are required to adopt and apply accounting policies issue SDR certificates, somewhat like gold certificates, to and practices that are consistent with the Financial the Reserve Banks. At such time, equivalent amounts in Accounting Manual. dollars are credited to the account established for the US. These combined financial statements have been pre- Treasury, and the Reserve Banks' SDR certificate account pared in accordance with the Financial Accounting is increased. The Reserve Banks are required to purchase Manual. Differences exist between the accounting prin- SDR certificates, at the direction of the US. Treasury, for ciples and practices of the System and generally accepted the purpose of financing SDR acquisitions or for financaccounting principles in the United States of America ing exchange stabilization operations. There were no SDR (GAAP). The primary difference is the presentation of all transactions in 2004 or 2003. security holdings at amortized cost, rather than at the fair value presentation requirements of GAAP. In addition, (C) Loans to Depository Institutions the Board of Governors and the Reserve Banks have elected not to present a Statement of Cash Flows. The The Depository Institutions Deregulation and Monetary Statement of Cash Flows has not been included, because Control Act of 1980 provides that all depository instithe liquidity and cash position of the Reserve Banks are tutions that maintain reservable transaction accounts or not of primary concern to users of these combined finan- nonpersonal time deposits, as defined in Regulation D cial statements. Other information regarding the Reserve issued by the Board of Governors, have borrowing privi- Banks' activities is provided in, or may be derived from, leges at the discretion of the Reserve Banks. Borrowers the Statements of Condition, Income, and Changes in execute certain lending agreements and deposit suffi- Capital. A Statement of Cash Flows, therefore, would not cient collateral before credit is extended. Loans are evaluprovide any additional useful information. There are no ated for collectibility, and currently all are considered other significant differences between the policies outlined collectible and fully collateralized. If loans were ever in the Financial Accounting Manual and GAAP. deemed to be uncollectible, an appropriate reserve would The preparation of the combined financial statements be established. Interest is accrued using the applicable in conformity with the Financial Accounting Manual discount rate established at least every fourteen days by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

320 91st Annual Report, 2004 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED the Board of Directors of each Reserve Bank, subject to currencies that it may need for intervention operations to review by the Board of Governors. support the dollar and give the partner foreign central bank temporary access to dollars it may need to support its own currency. Drawings under the F/X swap arrange- (D) US. Government Securities and Investments ments can be initiated by either the FRBNY or the partner Denominated in Foreign Currencies foreign central bank and must be agreed to by the drawee. The F/X swaps are structured so that the party initiating The FOMC has designated the FRBNY to execute open the transaction (the drawer) bears the exchange rate risk market transactions on its behalf and to hold the resulting upon maturity. The Bank will generally invest the foreign securities in the portfolio known as the System Open currency received under an F/X swap in interest-bearing Market Account (SOMA). In addition to authorizing and instruments. directing operations in the domestic securities market, Warehousing is an arrangement under which the the FOMC authorizes and directs the FRBNY to execute FOMC agrees to exchange, at the request of the Treasury, operations in foreign markets for major currencies in U.S. dollars for foreign currencies held by the Treasury order to counter disorderly conditions in exchange mar- or ESF over a limited period of time. The purpose of the kets or to meet other needs specified by the FOMC in warehousing facility is to supplement the U.S. dollar carrying out the System's central bank responsibilities. resources of the Treasury and ESF for financing pur- Such authorizations are reviewed and approved annually chases of foreign currencies and related international by the FOMC. operations. In addition to sales of securities under agreements to In connection with its foreign currency activities, the repurchase, the FRBNY may engage in tri-party pur- FRBNY, on behalf of the Reserve Banks, may enter into chases of securities under agreements to resell (tri-party contracts that contain varying degrees of off-balanceagreements). Tri-party agreements are conducted with sheet market risk, because they represent contractual comtwo custodial banks that manage the clearing and settle- mitments involving future settlement, and counter-party ment of collateral. Acceptable collateral under tri-party credit risk. The FRBNY controls credit risk by obtaining agreements primarily includes U.S. government securi- credit approvals, establishing transaction limits, and perties, pass-through mortgage securities of Government forming daily monitoring procedures. National Mortgage Association, Federal Home Loan While the application of current market prices to the Mortgage Corporation, and Federal National Mortgage securities currently held in the SOMA portfolio and Association, STRIP securities of the U.S. government and investments denominated in foreign currencies may result "stripped" securities of other government agencies. The in values substantially above or below their carrying tri-party agreements are accounted for as financing trans- values, these unrealized changes in value would have no actions with the associated interest income accrued over direct effect on the quantity of reserves available to the 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 may result in gains or losses in U.S. government securities clearing arrangements on when holdings are sold prior to maturity. Decisions behalf of the System, in order to facilitate the effective regarding the securities and foreign currencies transacfunctioning of the domestic securities market. These tions, including their purchase and sale, are motivated securities-lending transactions are fully collateralized by by monetary policy objectives rather than profit. Accordother U.S. government securities. FOMC policy requires ingly, market values, earnings, and any gains or losses FRBNY to take possession of collateral in excess of the resulting from the sale of such currencies and securities market values of the securities loaned. The market values are incidental to the open market operations and do not of the collateral and the securities loaned are monitored motivate its activities or policy decisions. by the FRBNY on a daily basis, with additional collateral U.S. government securities and investments denomiobtained as necessary. The securities lent are accounted nated in foreign currencies comprising the SOMA are for in the SOMA. recorded at cost, on a settlement-date basis, and adjusted F/X contracts are contractual agreements between two for amortization of premiums or accretion of discounts on parties to exchange specified currencies, at a specified a straight-line basis. Securities sold under agreements to price, on a specified date. Spot foreign contracts normally repurchase are accounted for as secured borrowing transsettle two days after the trade date, whereas the settlement actions with the associated interest expense recognized date on forward contracts is negotiated between the con- over the life of the transaction. Such transactions are tracting parties, but will extend beyond two days from the settled by FRBNY. Interest income is accrued on a trade date. The FRBNY generally enters into spot con- straight-line basis. Income earned on securities lending tracts, with any forward contracts generally limited to the transactions is reported as a component of "Other second leg of a swap/warehousing transaction. income." Gains and losses resulting from sales of securi- The FRBNY, on behalf of the Reserve Banks, main- ties are determined by specific issues based on average tains renewable, short-term F/X swap arrangements with cost. Foreign-currency-denominated assets are revalued two authorized foreign central banks. The parties agree to daily at current market exchange rates in order to report exchange their currencies up to a pre-arranged maximum these assets in U.S. dollars. Realized and unrealized gains and losses on investments denominated in foreign currenamount and for an agreed-upon period of time (up to cies are reported as "Foreign currency gains (losses), twelve months), at an agreed-upon interest rate. These net." arrangements give the FOMC temporary access to foreign Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 321 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Activity related to U.S. government securities bought larly deducted. The Board of Governors may, at any time, outright, securities sold under agreements to repurchase, call upon a Reserve Bank for additional security to adesecurities loaned, investments denominated in foreign quately collateralize the Federal Reserve notes. To satisfy currency, excluding those held under an F/X swap the obligation to provide sufficient collateral for outarrangement, and deposit accounts of foreign central standing Federal Reserve notes, the Reserve Banks have banks and governments above core balances are allocated entered into an agreement that provides that certain assets to each Reserve Bank. U.S. government securities pur- of the Reserve Banks are jointly pledged as collateral chased under agreements to resell and unrealized gains for the Federal Reserve notes of all Reserve Banks. In and losses on the revaluation of foreign currency holdings the event that this collateral is insufficient, the Federal under F/X swaps and warehousing arrangements are allo- Reserve Act provides that Federal Reserve notes become cated to the FRBNY and not to other Reserve Banks. a first and paramount lien on all the assets of the Reserve In 2003, additional interest income of $61 million, Banks. Finally, as obligations of the United States, Fedrepresenting one day's interest on the SOMA portfolio, eral Reserve notes are backed by the full faith and credit was accrued to reflect a change in interest accrual calcula- of the United States government. tions. The effect of this change was not material; there- The "Federal Reserve notes outstanding, net" account fore, it was included in 2003 interest income. represents Federal Reserve notes outstanding reduced by the Reserve Banks' currency holdings of $128,933 million and $110,176 million at December 31, 2004 and (E) Bank Premises, Equipment, and Software 2003, respectively. At December 31, 2004, all Federal Reserve notes out- Bank premises and equipment are stated at cost less standing were fully collateralized. All gold certificates, accumulated depreciation. Depreciation is calculated on a all special drawing rights certificates, and $706,196 milstraight-line basis over estimated useful lives of assets lion of domestic securities and securities purchased under ranging from two to fifty years. Major alterations, renovaagreements to resell were pledged as collateral. At tions and improvements are capitalized at cost as addi- December 31, 2004, no loans or investments denominated tions to the asset accounts and are amortized over the in foreign currencies were pledged as collateral. remaining useful life of the asset. Maintenance, repairs and minor replacements are charged to operations in the (G) Capital Paid-in year incurred. Costs incurred for software, either developed internally or acquired for internal use, during the The Federal Reserve Act requires that each member bank application stage are capitalized based on the cost of subscribe to the capital stock of the Reserve Bank in an direct services and materials associated with designing, amount equal to 6 percent of the capital and surplus of the coding, installing, or testing software. Capitalized softmember bank. As a member bank's capital and surplus ware costs are amortized on a straight-line basis over the changes, its holdings of the Reserve Bank's stock must estimated useful lives of the software applications, which be adjusted. Member banks are state-chartered banks that range from two to five years. 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 Federal Reserve agents (the Chairman of the Board of dividend 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 Financial Accounting Standards Board (FASB) The Federal Reserve Act provides that the collateral has deferred the implementation date for SFAS No. 150, security tendered by the Reserve Bank to the Federal "Accounting for Certain Financial Instruments with Char- Reserve agent must be equal to the sum of the notes acteristics of both Liabilities and Equity" for the Banks. applied for by such Reserve Bank. In 2003, the Federal When applicable, the Banks will determine the impact Reserve Act was amended to expand the assets eligible to and provide the appropriate disclosures. be pledged as collateral security to include all Federal Reserve Bank assets. Prior to the amendment, only gold (H) Surplus certificates, special drawing rights certificates, U.S. government securities, securities purchased under agree- The Board of Governors requires Reserve Banks to mainments to resell, loans to depository institutions, and tain a surplus equal to the amount of capital paid-in as of investments denominated in foreign currencies could be December 31. This amount is intended to provide addipledged as collateral. The collateral value is equal to the tional capital and reduce the possibility that the Reserve book value of the collateral tendered, with the exception Banks would be required to call on member banks for of securities, whose collateral value is equal to the par additional capital. value of the securities tendered and securities purchased Pursuant to Section 16 of the Federal Reserve Act, under agreements to resell, which are valued at the Reserve Banks are required by the Board of Governors contract amount. The par value of securities pledged for to transfer to the U.S. Treasury as interest on Federal securities sold under agreements to repurchase is simi- Reserve notes excess earnings, after providing for the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

322 91st Annual Report, 2004 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED costs of operations, payment of dividends, and reserva- 2004 2003 tion of an amount necessary to equate surplus with capital paid-in. In the event of losses or an increase in capital paid-in, ^government payments to the U.S. Treasury are suspended and earn- Notes'\\\\\\\\\\'.'.Y.'.'.'.'.'. 360^832 323361 ings are retained until the surplus is equal to the capital Bonds 94 017 98 471 paid-in. Weekly payments to the U.S. Treasury may vary ^ ^ ^ ; ; " ;; - ^^ significantly. In the event of a decrease in capital paid-in, the excess Unamortized premiums 9,405 9,797 surplus, after equating capital paid-in and surplus at Unaccreted discounts (1,640) (893) December 31, is distributed to US. Treasury in the fol- Total $725 584 $675 569 lowing year. This amount is reported as a component of "Payments to U.S. Treasury as interest on Federal Reserve notes." The maturity distribution of U.S. government securities bought outright, securities purchased under agreements to (I) Income and Costs Related to Treasury Services reserj5 m<^ securities sold under agreements to repurchase, which were held in the SOMA at December 31, 2004, Reserve Banks are required by the Federal Reserve Act was ^ fonows (in millions): to serve as fiscal agents and depositories of the United States. By statute, the Department of the Treasury is Securities Securities permitted, but not required, to pay for these services. purchased sold under under agree- agree- (J) Taxes J^ ^ us tQ tQ The Reserve Banks are exempt from federal, state, and government resell repurchase local taxes, except for taxes on real property. Real prop- Maturities of securities (Contract (Contract ery taxes were $33 million for each of the years ended securities held (Par) amount) amount) December 31, 2004 and 2003, and are reported as a Within 15 days ... $ 30,647 $33,000 $30,783 component of "Occupancy expense." Over 1 year to (K) Restructuring Charges 5 years 208,269 Over 5 years to In 2003, the System started the restructuring of several 10 years 54,372 operations, primarily check, cash, and Treasury services. Over 10 years 75,765 The restructuring included streamlining the management Total.... $717,819 $33,000 $30,783 and support structures, reducing staff, decreasing the ===== ======== ======== number of processing locations, and increasing processing capacity in the remaining locations. These restructur- At December 31, 2004 and 2003, U.S. government ing activities continued in 2004. securities, net with par values of $6,609 million and Footnote 10 describes the restructuring and provides $4,426 million, respectively, were loaned from the information about the Banks' costs and liabilities associ- SOMA. ated with employee separations and contract terminations. At December 31, 2004 and 2003, securities sold under The costs associated with the write-down of certain Bank agreements to repurchase with a contract amount of assets are discussed in footnote 6. Costs and liabilities $30,783 million and $25,652 million, respectively, were associated with enhanced pension benefits for all Reserve outstanding. At December 31, 2004 and 2003, securities Banks are recorded on the books of the FRBNY. sold under agreements to repurchase with a par value of $30,808 million and $25,658 million, respectively, were (4) U.S. GOVERNMENT SECURITIES outstanding. Securities bought outright are held in the SOMA at the (5) INVESTMENTS DENOMINATED IN FRBNY. FOREIGN CURRENCIES Total securities held in the SOMA at December 31 that The FRBNY, on behalf of the Reserve Banks, holds were bought outright, were as follows (in millions): foreign currency deposits with foreign central banks and the Bank for International Settlements, and invests in foreign government debt instruments. Foreign government debt instruments held include both securities bought outright and securities purchased under agreements to resell. These investments are guaranteed as to principal and interest by the foreign governments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 323 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Total investments denominated in foreign currencies, Bank premises and equipment at December 31 include valued at current foreign currency market exchange rates the following amounts for leases that have been capitalat December 31, were as follows (in millions): ized (in millions): 2004 2003 2004 2003 European Union euro Bank premises and equipment $11 $ 9 Foreign currency deposits $ 6,063 $ 6,870 Accumulated depreciation _(6) (6) Securities purchased under Capitalized leases, net $_5 $_3 agreements to resell 2,142 2,057 Government debt instruments .. 3,840 2,033 Certain of the Reserve Banks lease unused space to Japanese yen outside tenants. Those leases have terms ranging from 1 Foreign currency deposits 1,540 1,475 to 12 years. Rental income from such leases totaled Government debt instruments .. 7,660 7,341 $21 million and $20 million for the years ended Decem- Accrued interest 123 92 ber 31, 2004 and 2003, respectively. Future minimum lease payments under noncancelable agreements in exist- Total $21,368 $19,868 ence at December 31, 2004, were (in millions): The maturity distribution of investments denominated 2005 $ 20 in foreign currencies at December 31, 2004, was as 2006 17 follows (in millions): 2007 12 2008 11 Maturities of investments European 2009 10 denominated Union Japanese Thereafter 43 in foreign currencies euro yen Total Total $113 Within 1 year $ 8,978 $9,199 $18,177 Over 1 year to 5 years 3,006 . . . 3,006 Over 5 years to 10 years ... 185 ... 185 The Reserve Banks have capitalized software assets, Over 10 years . . . . . . . . . net of amortization, of $203 million and $164 million at Total $12,169 $9,199 $21,368 December 31, 2004 and 2003, respectively. Amortization expense was $56 million and $54 million for the years ended December 31, 2004 and 2003, respectively. At December 31, 2004 and 2003, there were no out- Several Reserve Banks impaired assets as a result of standing F/X swaps or material open foreign exchange the System's restructuring plans, as discussed in footcontracts. note 10. Impaired assets include software, buildings, At December 31,2004 and 2003, the warehousing facil- leasehold improvements, furniture, and equipment. Asset ity was $5,000 million, with no balance outstanding. impairment losses related to the restructuring and check processing standardization of $21 million and $11 million (6) BANK PREMISES, EQUIPMENT, AND SOFTWARE for the years ended December 31, 2004 and 2003, respectively, were determined using fair values based on quoted A summary of bank premises and equipment at Decemmarket values or other valuation techniques and are ber 31 is as follows (in millions): reported as a component of "Other expenses." Three Reserve Banks are constructing new buildings, Maximum useful one to replace the head office and two to replace branch life offices. At December 31, 2004, the contractual obligation (in years) 2004 2003 for these projects has been recognized or is reported as a commitment in footnote 7 below. Bank premises and equipment (7) COMMITMENTS AND CONTINGENCIES Land N/A $ 274 $ 244 Buildings 50 1,631 1,559 Building machinery and At December 31, 2004, the Reserve Banks were obligated equipment 20 373 364 under noncancelable leases for premises and equipment Construction in progress .. N/A 202 96 with terms ranging from 1 to 20 years. These leases Furniture and equipment . 10 1,200 1,334 provide for increased rental payments based upon Subtotal $3,680 $3,597 increases in real estate taxes, operating costs, or selected price indices. Accumulated Rental expense under operating leases for certain operdepreciation (1,464) (1,480) ating facilities, warehouses, and data processing and Bank premises and office equipment (including taxes, insurance and mainteequipment, net . $2,216 $2,117 nance when included in rent), net of sublease rentals, was $70 million and $71 million for the years ended Decem- Depreciation expense, ber 31, 2004 and 2003, respectively. Certain of the for the Reserve Banks' leases have options to renew. years ended .... $ 179 $ 184 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

324 91st Annual Report, 2004 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Future minimum rental payments under noncancelable (8) RETIREMENT AND THRIFT PLANS operating and capital leases, net of sublease rentals, with terms of one year or more, at December 31, 2004, were Retirement Plans (in millions): The Reserve Banks currently offer two defined benefit Operating Capital retirement plans to their employees, based on length of service and level of compensation. Substantially all of 2005 $ 10.2 $ 1.6 the Reserve Banks', Board of Governors', and the Plan 2006 8.9 1.5 Administrative Office's employees participate in the 2007 8.0 .6 Retirement Plan for Employees of the Federal Reserve 2008 7.1 .2 System (System Plan) and the Benefit Equalization 2009 7.2 .1 Thereafter .. 114.3 Retirement Plans offered by each individual Reserve Bank (BEP). In addition, certain Bank officers participate $155.7 $ 4.0 in a Supplemental Employee Retirement Plan (SERP). Amount representing The System Plan is a multi-employer plan with contri- Interest (.3) butions fully funded by participating employers. Participating employers are the Federal Reserve Banks, the Present value of minimum Board of Governors of the Federal Reserve System, and lease payments $ 3.7 the Office of Employee Benefits of the Federal Reserve Employee Benefits System. Certain Board employees not At December 31, 2004, the Reserve Banks had concovered by the Social Security Act also contribute to the tractual commitments through the year 2011 totaling plan. No separate accounting is maintained of assets $307 million, $58 million of which has been recognized. contributed by the participating employers. FRBNY acts Purchases of $117 million and $76 million were made as a sponsor of the Plan for the System and costs assoagainst these commitments during 2004 and 2003, respecciated with the Plan are not redistributed to other particitively. These commitments are for goods and services for pating employers. The prepaid pension cost includes the maintenance of currency machines, check-processingamounts related to the participating employees of all related services, and check transportation services, and employers who participate in the plans. have variable and fixed components. The variable portion of the commitment is for additional services above fixed Following is a reconciliation of the beginning and contractual service limits. The fixed payments for the ending balances of the System Plan benefit obligation (in next five years under these commitments are (in millions): millions): Fixed 2004 2003 commitment Estimated actuarial present value 2005 . $89.5 of projected benefit 2006. 66.2 obligation at January 1 $3,930 $3,523 2007 . 23.9 Service cost—benefits earned 2008. .7 during the period 116 109 2009. .7 Interest cost on projected benefit obligation 245 232 Actuarial loss 457 192 The Reserve Banks are involved in certain legal actions Special termination loss 20 67 and claims arising in the ordinary course of business. Contributions by plan participants .. 3 4 Although it is difficult to predict the ultimate outcome of Benefits paid (247) (197) these actions, in management's opinion, based on discus- Plan amendments • • • • • • sions with counsel, the aforementioned litigation and Estimated actuarial present value claims will be resolved without material adverse effect of projected benefit on the financial position or results of operations of the obligation at December 31 .... $4,524 $3,930 Reserve Banks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 325 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Following is a reconciliation of the beginning and 2004 2003 ending balances of the System Plan assets, the funded status, and the prepaid pension benefit costs (in millions): Service cost—benefits earned during the period $ 116 $ 109 Interest cost on projected 2004 2003 benefit obligation 245 232 Amortization of prior service Estimated fair value of plan cost 24 26 assets at January 1 $5,703 $4,997 Recognized net loss 20 42 Actual return on plan assets 428 899 Expected return on plan assets (462) (418) Contributions by plan participants .. 3 4 Employer contributions • • • Net periodic pension benefit credit .. (57) (9) Benefits paid (247) (197) Special termination benefits 20 67 Estimated fair value of plan Net periodic pension benefit assets at December 31 $5,887 $5,703 (credit) cost $ (37) $ 58 Funded status $1,362 $1,774 Unrecognized prior service cost 173 197 The recognition of special termination benefits is the Unrecognized net actuarial loss 1,182 710 result of enhanced retirement benefits provided to 384 System employees in conjunction with the restructuring Prepaid pension benefit costs $2,717 $2,681 disclosed in footnote 10. Net periodic pension benefit Prepaid pension benefit costs are reported as a component (credit) cost is reported as a component of "Salaries and of "Other assets." other benefits." The expected benefit payments for the next ten years The accumulated benefit obligation for the defined (in millions) are: benefit pension plan was $3,894 million and $3,456 million at December 31, 2004 and 2003, respectively. The weighted-average assumptions used in developing the pension benefit obligation for the System Plan as of 2005 $ 206 December 31 are as follows: 2006 2007 2004 2003 2008 2009 Discount rate 5.75% 6.25% 2010-2014 1,406 Rate of compensation increase 4.25% 4.00% Total $2,518 The weighted-average assumptions used in developing net periodic benefit cost for the System Plan for the years The Federal Reserve System's pension plan weightedending December 31 are as follows: average asset allocations at December 31, by asset category, are as follows: 2004 2003 Discount rate 6.25% 6.75% 2004 2003 Expected asset return 8.25% 8.50% Equities 67.5% 61.9% Rate of compensation increase 4.00% 4.25% Fixed income 30.0% 34.8% Cash 2.5% 3.3% The long-term rate of return on assets was based on a combination of methodologies including the System Total 100.0% 100.0% Plan's historical returns, surveys of other plans' expected rates of return, building a projected return for equities and The System's Committee on Investment Performance fixed income investments based on real interest rates, (CIP) contracts with investment managers who are inflation expectations and equity risk premiums and responsible for implementing the System Plan's investfinally, surveys of expected returns in equity and fixed ment policies. The managers' performance is measured income markets. against a trailing 36-month-benchmark of 60 percent of The components of net periodic pension benefit (credit) a market value weighted index of predominantly large cost for the System Plan as of December 31 are shown capitalization stocks trading on the New York Stock below (in millions): Exchange, the American Stock Exchange, and the National Association of Securities Dealers Automated Quotation National Market System and 40 percent of a broadly diversified investment-grade fixed income index (rebalanced monthly). The managers invest Plan funds within CIP-established guidelines for investment in equities and fixed income instruments. Equity investments can range between 40 percent and 80 percent of the portfolio. Investments, however, cannot be concentrated in particular industries and equity security holdings of any one company are limited. Fixed income securities Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

326 91st Annual Report, 2004 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED must be investment grade and the effective duration of At December 31, 2004 and 2003, the weighted-average the fixed income portfolio must remain within a range discount rate assumptions used in developing the postof 67 percent and 150 percent of a broadly diversi- retirement benefit obligation were 5.75 percent and fied investment-grade fixed income index. CIP guidelines 6.25 percent, respectively. prohibit margin, short sale, foreign exchange, and commodities trading as well as investment in bank, bank Following is a reconciliation of the beginning and ending holding company, savings and loan, and government balances of the plan assets, the unfunded postretirement securities dealer's stocks. In addition, investments in non- benefit obligation and the accrued postretirement benefit dollar denominated securities are prohibited; however, a costs (in millions): small portion of the portfolio can be invested in American Depositary Receipts/Shares and foreign-issued dollar 2004 2003 denominated fixed income securities. Fair value of plan assets at January 1 ...$... $... The Federal Reserve System does not expect to make a Contributions by the employer 42 34 cash contribution to the Retirement Plan during 2005. Contributions by plan participants 8 6 The Reserve Banks' projected benefit obligations and Benefits paid _(50) (40) net pension costs for the BEP and the SERP at Decem- Fair value of plan assets at ber 31, 2004 and 2003, and for the years then ended, are December31 $. . • $. • • not material. Unfunded postretirement benefit Thrift Plan obligation $869 $942 Unrecognized net curtailment gain 5 2 Employees of the Reserve Banks may also participate in Unrecognized prior service cost 128 122 Unrecognized net actuarial loss (247) (246) the defined contribution Thrift Plan for Employees of the Federal Reserve System (Thrift Plan). The Reserve Accrued postretirement benefit costs ... $755 $820 Banks' Thrift Plan contributions totaled $63 million for the year ended December 31, 2004, and $64 million for Accrued postretirement benefit costs are reported as a the year ended December 31, 2003, and are reported as a component of "Accrued benefit costs." component of "Salaries and other benefits." For measurement purposes, the assumed health care cost trend rates at December 31 are as follows: (9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS AND POSTEMPLOYMENT BENEFITS 2004 2003 Postretirement Benefits Other Than Pensions Health care cost trend rate assumed for next year 9.00% 10.00% In addition to the Reserve Banks' retirement plans, Rate to which the cost trend is assumed to decline employees who have met certain age and length of ser- (the ultimate trend rate) 4.75% 5.00% vice requirements are eligible for both medical benefits Year that the rate reaches the and life insurance coverage during retirement. ultimate trend rate 2011 2011 The Reserve Banks fund benefits payable under the medical and life insurance plans as due and, accordingly, Assumed health care cost trend rates have a significant have no plan assets. Net postretirement benefit costs are effect on the amounts reported for health care plans. A actuarially determined using a January 1 measurement one percentage point change in assumed health care cost date. trend rates would have the following effects for the year ended December 31, 2004 (in millions): Following is a reconciliation of the beginning and ending balances of the benefit obligation (in millions): One percentage One percentage point increase point decrease 2004 2003 Effect on aggregate Accumulated postretirement benefit of service and obligation at January 1 $942 $742 interest cost Service cost—benefits earned during components of theperiod 19 18 net periodic Interest cost of accumulated postretirement benefit obligation 52 50 benefit costs $ 10 $ (8) Actuarial loss 10 157 Effect on accumulated Curtailment (gain)/loss (2) 7 postretirement Special termination loss 1 2 benefit obligation ... 105 (86) Contributions by plan participants 9 6 Benefits paid (50) (40) Plan amendments (112) . . . Accumulated postretirement benefit obligation at December 31 $869 $942 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 327 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED The following is a summary of the components of net Expected benefit payments: periodic postretirement benefit costs for the years ended December 31 (in millions): Without With subsidy subsidy 2004 2003 2005 . . $ 45 $ 45 2006 .. 47 43 Service cost—benefits earned during 2007 .. 49 44 theperiod $ 19 $18 2008 .. 51 46 2009 .. 52 47 Interest cost of accumulated benefit 2010-2014 _288 257 obligation 52 50 Amortization of prior service cost (17) (15) Total $532 $482 Recognized net actuarial loss 8 4 Postemployment Benefits Total periodic expense 62 57 Curtailment (gain)/loss (86) 5 The Reserve Banks offer benefits to former or inactive Special termination loss 1_ 2 employees. Postemployment benefit costs are actuarially determined using a December 31, 2004, measurement Net periodic postretirement date and include the cost of medical and dental insurance, benefit (credit)/costs $(23) $64 survivor income, and disability benefits. For 2004, the Banks changed their practices for estimating postemploy- At December 31, 2004 and 2003, the weighted-average ment costs and used a 5.25 percent discount rate and the discount rate assumptions used to determine net periodic same health care trend rates as were used for projecting postretirement benefit costs were 6.25 percent and 6.75 postretirement costs. Costs for 2003, however, were propercent, respectively. jected using the same discount rate and health care trend Net periodic postretirement benefit costs are reported rates as were used for projecting postretirement costs. as a component of "Salaries and other benefits." The accrued postemployment benefit costs recognized A plan amendment that modified the credited service by the Banks at December 31, 2004 and 2003, were period eligibility requirements created curtailment gains. $128 million and $130 million, respectively. This cost is The recognition of special termination losses is primarily included as a component of "Accrued benefit costs." Net the result of enhanced retirement benefits provided to periodic postemployment benefit costs included in 2004 employees during the restructuring described in footand 2003 operating expenses were $17 million and note 10. $26 million, respectively. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) was enacted in 10. BUSINESS RESTRUCTURING CHARGES December 2003. The Act established a prescription drug benefit under Medicare (Medicare Part D) and a federal In 2003, several Banks announced consolidation and subsidy to sponsors of retiree health care benefit plans restructuring plans to streamline operations and reduce that provide benefits that are at least actuarially equiva- costs, including consolidation of check operations and lent to Medicare Part D. Following the guidance of the staff reductions in various functions. In 2004, addi- Financial Accounting Standards Board, the Bank elected tional consolidation and restructuring initiatives were to defer recognition of the financial effects of the Act announced in the check and fiscal services operations. until further guidance was issued in May 2004. These actions resulted in the following business restruc- Benefits provided to certain participants are at least turing charges: actuarially equivalent to Medicare Part D. The estimated effects of the subsidy, retroactive to January 1, 2004, are reflected in actuarial loss in the accumulated postretirement benefit obligation and net periodic postretirement benefit costs. Following is a summary of the effects of the expected subsidy (in millions): 2004 Decrease in the accumulated postretirement benefit obligation $120 Decrease in the net periodic postretirement benefit costs 16 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

328 91st Annual Report, 2004 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Major categories of expense (in millions): Employee separation costs are primarily severance costs related to identified staff reductions of approximately Total 1,290, including some of the 1,483 staff reductions related estimated to restructuring that was announced in 2003, and have not costs been paid out. These costs are reported as a component of Employee separation $61 "Salaries and other benefits." Contract termination costs Contract termination 1 include the charges resulting from terminating existing Other 1_ lease and other contracts and are shown as a component Total $63 of "Other expenses." = Restructing costs associated with the write-downs of certain Bank assets, including software, buildings, lease- Accrued Accrued hold improvements, furniture, and equipment are disliability Total Total liability cussed in footnote 6. Costs associated with enhanced 12/31/03 charges paid 12/31/04 pension benefits for all Reserve Banks are discussed in Employee footnote 8. Costs associated with enhanced postretirement separation $29 $25 $(26) $28 benefits are disclosed in footnote 9. Contract Future costs associated with the restructuring that are termination ... 1 ... ... 1 not estimable and are not recognized as liabilities will be Other •_!_: — :_L_: :_^j. incurred in 2005 and 2006. Total $30 $25 $(26) $29 The Reserve Banks anticipate substantially completing their announced restructuring plans by March 2006. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

329 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 2004, the OIG completed tions at the Federal Reserve Banks. The ten 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 nine investigations and that promote economy and efficiency performed numerous legislative and and that prevent and detect waste, fraud, regulatory reviews. Audits, Reviews, and Assessments Completed during 2004 Report title Month issued Audit of the FFIEC's Financial Statements (Year Ended December 31, 2003) February Review of Internal Control Assessments Performed during Community Bank Examinations March Evaluation of Key Emergency Preparedness and Security Enhancements March Audit of the Board's Financial Statements (Year Ended December 31, 2003) April Audit of the Board's Outsourcing Operations April Evaluation of the Fine Arts Program April Evaluation of the Administrative Controls Over an Outsourced Contract June Review of the Oversight Function of the Division of Reserve Bank Operations and Payment Systems August Audit of the Board's Information Security Program September Audit of the Board's Automated Travel System November Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

330 Government Accountability Office Reviews Under the Federal Banking Agency concerning the Federal Reserve were in Audit Act (Public Law 95-320), most various stages of completion at year- Federal Reserve System operations are end. The Federal Reserve also provided under the purview of the Government information to the GAO during the year Accountability Office (GAO). In 2004, in relation to numerous other GAO the GAO completed six reports on investigations. selected aspects of Federal Reserve The completed reports are available operations. In addition, five projects directly from the GAO. Reports Completed during 2004 Month issued Report title Report number (2004) Consumer Protection: Federal and State Agencies Face Challenges in Combating Predatory Lending GAO-04-280 January Federal Reserve Banks: Areas for Improvement in Computer Controls GAO-04-336R March Coins and Currency: How the Costs and Earnings Associated with Producing Coins and Currency Are Budgeted and Accounted For GAO-04-283 April Regulatory Information Sharing: Better Information Sharing among Financial Services Regulators Could Improve Protections for Consumers GAO-04-882R June Foreign Regimes' Assets: The United States Faces Challenges in Recovering Assets, but Has Mechanisms that Could Guide Future Efforts ... GAO-04-1006 September Financial Regulation: Industry Changes Prompt Need to Reconsider GAO-05-61 October U.S. Regulatory Structure Projects Active at Year-End 2004 Month initiated Subject of project (2004) USA Patriot Act implementation January Bank Secrecy Act examinations January Industrial loan corporations May Information security at financial organizations . November Consumer impact on remittance transfer system December Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

332 91st Annual Report, 2004 The Federal Reserve System 1 9 • 2 BOSTON MINNEAPOLIS 7 12 o • NEW YORK CHICAGO • CLEVELAND PHILADELPHIA • SAN FRANCISCO 10 4 S KANSAS CITY 9 g Rj > ST. LOUIS CHMONE 8 5 6 • 11 • ATLANTA DALLAS ALASKA HAWAII LEGEND Both pages Facing page • Federal Reserve Bank city • Federal Reserve Branch city El 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 2004. The System serves commonwealths and territories as follows: The New York Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Maps of the Federal Reserve System 333 1-A 2-B 3-C 4-D 5-E ME Pittsburgh Baltimore MD \ PA •TVt$J* • l / vr Buffalo Bi •Cincinnati •Charlotte BOSTON NEW YORK PHILADELPHIA CLEVELAND RICHMOND 6-F 7-G 8-H ™_^ •Nashville r— """— Birmingham ^1 \« Mt — tL ) IK Detroit* ^^ r' Louisville MS 1 ( <5A -V iT j• -- r-2j"-*-™ LA Jacksonville c! •Memphis New Orleans IN tittle) Hock ( MS Miami ATLANTA CHICAGO ST. LOUIS 9-1 • Helena ::>-:vW--. .-«**•••••- • 1 MINNEAPOLIS 10-J 12-L WY 1 CO 1 "^ \ m Dei?ver |I KS • ALASKA ^ Seattle / Oklahoma City • Portland CMC KANSAS CITY "***^-^^ / 1D U-K TX | ^ J Salt Lake City # El Paso A ^r~^VBoustor • V* •Los Angeles San Antonio HAWAII AZ 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

337 Index Agreement corporations, examinations Banking organizations, U.S. of, 95-96 Examinations and inspections of, 88-90 American Jobs Creation Act, 16 Financial reporting, transparency, 105 Anti-money-laundering initiatives, Foreign operations, 95-96, 100-102 examinations for, 90, 99 Number of, 298 Applications, processing of, 62-63, 111, Overseas investments by, 112-13 114 Regulation of, 110-14 Asset-backed commercial paper (ABCP), Risk-focused supervision of, 93-94 97-98 Bank Merger Act, 111-12 Assets and liabilities Bank-owned life insurance (BOLI), 99 Board of Governors, 304 Bank Secrecy Act, examinations, 90, 99, Commercial banks, 289 102 Basel Committee on Banking Supervision, Federal Reserve Banks, 266-69, 315 102-4 ATM (automated teller machine) card use, Basel II framework, implementation, 98, 61 100-101 Auditors' reports, 301, 303, 312-14 BHCPRs (Bank Holding Company Audits, reviews, and assessments, Office of Performance Reports), 94 Inspector General, 329 Board of Governors {See also Federal Automated clearinghouse services, Federal Reserve System) Reserve Banks, 121-22, 285 Applications, processing of, 113 Automated Standard Application for Assets and liabilities of, 304 Payment, 126 Audits of, 303-13, 321, 327 Availability of Funds and Collection of Consumer Advisory Council, 75-77, 240 Checks (Regulation CC), 72, 150 Decisions, public notice, 113 Ex officio members, 264 Balance sheets Federal Advisory Council, 239 Board of Governors, 304 Federal legislative proposals, 141-43 Federal Reserve priced services, 132-35 FFIEC activities, 66, 106-7 Bank credit, 26 Financial statements of, 303-13 Bank examiner training, 66-67 Government Performance and Results Bank holding companies Act, 137-39 Application procedure, 110-11 Inspector General, Office of, audits, Banks affiliated with, 298 reviews, and assessments, 329 Examinations and inspections of, 88-91 Litigation, 231-32 Rating system, 99, 151 Members and officers, lists, 235-37, Regulatory financial reports of, 105-6 261-64 Stock repurchases by, 113 Outreach activities, 83-84 Surveillance by Federal Reserve System, Policy actions by, 147-53 94 Rules of practice for hearings, 150 Bank Holding Companies and Change in Thrift Institutions Advisory Council, 241 Bank Control (Regulation Y), 148 Training and development, staff and Bank Holding Company Act, 110-11 bank examiners, 66-67, 108-9 Bank Holding Company Performance BOLI (Bank-owned life insurance), 99 Reports (BHCPRs), 94 BOND (Banking Organization National Banking Organization National Desktop Desktop), 108 (BOND), 108 Bonds, 126, 288 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

338 91st Annual Report, 2004 Borrowers of Securities Credit Community Reinvestment Act (CRA) (Regulation X), 288 Compliance examinations, 62 Branches, Federal Reserve Banks, 242^3, Mergers and acquisitions, applications 284-85 for, 62-63 BSA (Bank Secrecy Act), 90, 99, 102 Review of, 76 Business continuity, 90-91 Supervision for compliance, 62-63 Business spending, investment, and Technical changes to, 149 finance, 14-21, 36-44 Community Reinvestment (Regulation BB), 149 CAESAR (Complaint Analysis Complaint Analysis Evaluation System and Evaluation System and Reports), 73 Reports (CAESAR), 73 Call Reports, 106 Compliance examinations, 63-67, 69-73 Capital Condition statements, Federal Reserve Accounts, Federal Reserve Banks, Banks, 266-69, 315 266-69, 315 "Consolidated Know-Your-Customer Risk Changes in, Federal Reserve Banks, 317 Management," policy paper, 102-3 Flows, 19, 42 Consumer Advisory Council, 75-77, 240 Standards, 97-98, 102 Consumer and community affairs Cash flows, Board of Governors, 306 Cash management services, 127 Community economic development, Cash-recirculation policy, 123-24 77-83 Change in Bank Control Act, 112 Consumer Advisory Council, advice, Check Clearing for the 21st Century Act 75-77 (Check 21), 66, 117, 118 Consumer complaints, 73-75 Check collection and processing, 120-21, Financial education, 78-79, 82-83 285 Outreach activities, 83-84 Citizens Financial Group, merger, 63 Statutes to inform and protect Civil money penalties, Federal Reserve consumers, 55-62 enforcement of, 92-93 Supervision for compliance with laws, Collection of Checks and Other Items by 62-73 Federal Reserve Banks and Funds Consumer complaints, 73-75 Transfers through Fedwire Consumer financial education, 78-79, (Regulation J), 148 82-83 Collection services, Federal Reserve Banks, Consumer information, reporting and 126-27 solicitation of, 56-57, 59-60 Combined financial statements, Federal Consumer Leasing (Regulation M), 70, 147 Reserve Banks, 314-27 Consumer price index (CPI), 22, 44 Commercial and industrial loans, 14—15, 85 Consumer prices, 21-23, 44 Commercial banks Consumer protection laws, compliance Assets and liabilities of, 289 with, 63-73 Developments, 85 Consumer spending, 10-11, 35 Financial reports, 106 Corporate profits, 14-15, 38-39 Number of, 298 CRA (See Community Reinvestment Act) Commercial-mortgage-backed securities Credit (CMBS), 15, 39 Commercial paper, asset-backed, programs, Rates, primary, secondary, and seasonal, 97-98 151-52, 286 Community affairs (See Consumer and Reports and solicitations, 57, 59-60 community affairs) State member banks to executive Community banks, supervision of, 94 officers, 115 Community economic development, Credit by Banks, Brokers, and Dealers promotion of, 77-83 (Regulation T), 288 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 339 Credit by Banks for the Purpose of Economy, U.S. developments—Continued Purchasing or Carrying Margin Stocks Interest rates, 5, 24-25, 46-47 (Regulation U), 288 Labor market, 20-23, 42-46 "Credit Risk Transfer/' Joint Forum paper, Monetary aggregates, 26-27, 48 103 Monetary policy, 3-7, 31-34 Currency and coin, operations and Prices, 21-23, 44 developments in, 123-24, 285, 291, Projections, 7-8, 34 293, 295, 315 Edge Act corporations, examinations of, 95-96 Data, home mortgage lending, 67, 71 Education, financial, 78-79, 82-83 Debit card use, 61-62 Electronic access and payments services, Debit fees, 58-59 126, 127 Debt, 26, 47-48 Electronic Check Processing program, Debt services, 124-26 126-27 Demand deposits, interest on, 141-42 Electronic Federal Tax Payment System Depository institutions (EFTPS), 126 Compliance with EFTA, 58 Electronic Fund Transfer Act (EFTA), Home mortgage disclosure data, 68 58-59, 61-62, 70 Interest on balances held at Federal Electronic Fund Transfers (Regulation E), Reserve Banks, 141 70, 147 Interest rates on loans, Federal Reserve Electronic fund transfer use and services, Banks, 286 61, 121-22 Reserve requirements, exemption Emerging-market economies, 29-30, 50-51 threshold increased, 61 Employment, 20-21, 42^t3 Reserves held, 142, 287, 290-97 Employment cost index (ECI), 21, 43-44 Services to, Federal Reserve Banks, Energy prices, 22, 44 124-27 Enforcement actions, Federal Reserve Depository services to other agencies by System, 92-93 Federal Reserve Banks, 124-27 Equal Credit Opportunity (Regulation B), Deposits 69-70, 147 Federal Reserve Banks, 266-69, 291, Equipment and software investment, 12-13, 293 37 Insured commercial banks, 289 Equity markets and prices, 25-26, 47 Directors, Federal Reserve Banks and Examinations and inspections Branches, list, 244-60 Anti-money laundering, 90 Disclosures by state member banks, 114 Bank holding companies, 88-90 Disclosure tables for reporting HMDA Community Reinvestment Act, data, 61 compliance with, 62 Discount rate (See also Interest rates), Consumer protection laws, compliance 151-53, 286 with, 63-73 Disposable personal income (DPI), 10, 35 Fair lending laws, compliance with, Dollar exchange rate, 28, 49-50 64-65 Dollar Wi$e initiative, 79 Federal Reserve Banks, 128-29 FFIEC procedures, 66 ECI (See Employment cost index) Financial holding companies, 90 Economy, international, 27-30, 48-51 Financial system continuity, 90-91 Economy, U.S. developments International banking activities, 95-96 Business sector, 12-15, 36-39 Specialized, 91-92 External sector, 18-20, 41-42 State member banks, 88, 89, 95 Financial markets, 4-7, 23-27, 46-48 Supervisory policy, 97-107 Government sector, 15-18, 39-41 Training for bank examiners, 66-67 Household sector, 10-12, 35-36 Transfer agents, 91 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

340 91st Annual Report, 2004 Examinations and inspections—Continued Federal Reserve Banks—Continued U.S. banking organizations, foreign Chairmen, conference of, 243 operations, 95 Check collection service, commercial, Expenses (See Income and expenses) 120-21 Exports, 18, 41 Checks handled, 285 External sector, developments in, 18-20, Collection services, government, 126-27 41-42 Condition statements of, 266-69, 315 Conference of Chairmen, Presidents, and Fair and Accurate Credit Transactions First Vice Presidents, 243-44 Act (FACT Act), 55-57 Credit outstanding, 290-97 Fair Credit Reporting Act (FCRA), 59-60 Currency and coin, operations and Fair Credit Reporting (Regulation V), developments in, 123-24, 285, 291, 293, 295, 314 Fair lending laws, compliance with, 64-65 Depository institution balances, interest Federal Advisory Council, members and on, 141 officers, 239 Depository services, 124-27 Federal agency securities and obligations Deposits, 266-69 Depository institution holdings, 289 Directors of, 244-60 Federal Reserve Bank holdings, 266-69, Discount rate, 151-53, 286 274, 276-79, 290, 292, 294, 296 Electronic access and payments services, Federal Financial Institutions Examination 126, 127 Council (FFIEC), 66, 68, 106-7 Examinations of, 128-29 Federal funds rate, 5-7, 32, 191, 200, 207, Examiners, training, 66-67 215, 222, 229 Federal Reserve decisions, public notice Federal government, economic of, 96 developments, 15-17, 39-40 FedLine Advantage, 127 Federal Open Market Committee (FOMC) Fedwire Funds Service, 122 Authorizations, 155, 157, 162-65 Fedwire Securities Service, 122-23 Directives, 157, 159, 165-66, 191, 200, Financial statements of, combined, 207, 215, 222, 229 314-27 Foreign currency operations, procedural First Vice Presidents, conference of, 244 instructions, 159-60, 166-75 Fiscal agency services, 124—27 Guidelines for open market operations, Float, 123, 290, 292, 294, 296 157 Food coupon services, 285 Meetings, minutes of, 155, 160, 175, Foreign banks, U.S. activities of, 183, 192, 200, 208, 215, 222 supervision, 96 Members and officers, list, 238 Government depository services, 124-27 Notation votes, 183, 222 Holdings of securities and loans, 130, System Open Market Account, 157, 158, 266-69, 274, 290, 292, 294, 296 163, 164 Income and expenses of, 129, 134-35, Federal Reserve Banks 276-83, 316 Acquisition costs, 284 Information technology developments, Assessments by Board of Governors, 127-28 278, 280, 282 Initiatives, 117-18 Assets and liabilities of, 266-69, 315 Interest rates on loans to depository Audit of, 315 institutions, 286 Automated clearinghouse services, National Settlement Service, 122 121-22 Noncash collection service, 123 Bond services, 126 Officers and employees, number of, 275 Branches of, 242-43 Officers of, 242-43 Capital, changes in, 317 Operations in principal departments, 285 Cash, 123, 127 Payments to the U.S. Treasury, 278-79 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 341 Federal Reserve Banks—Continued Federal Reserve System—Continued Premises of, 130-31, 284-85 Specialized examinations, 91-92 Presidents, conference of, 243 Staff development, 66-67, 108-9 Priced services, 118-23, 132-35 Supervision and regulation Profit and loss, 276 responsibilities, 62-73, 87-88 Salaries of officers and employees, 275 Supervision of international banking Securities and loans, holdings of, 124, organizations, 95-96 130, 276-77 Supervisory policy, 97-107 Treasury Tax and Loan program, 127 Surveillance, 94-95 Federal Reserve Electronic Tax Application Technical assistance, 96-97 (FR-ETA), 126 Training, staff and examiners, 66-67, Federal Reserve fifty dollar note, 123 108-9 Federal Reserve System (See also Board of Transparency enhancement efforts, 105 Governors) Federal sector, developments in, 15-17, Anti-money-laundering examinations, 90 39-40 Applications to establish banking Federal tax payments, 126 institutions, processing of, 113-14 FedLine Advantage, 127 Bank holding company regulatory Fedwire Funds Service, 122 financial reports to, 105-6 Fedwire Securities Service, 122-23 Banks and Branches, list of, 242-43 FFTEC (Federal Financial Institutions Basel Committee activities, 102-4 Examination Council), 66, 68, 106-7 Capital adequacy standards, 97-98, 102 Fiduciary activities, supervision of, 91 Decisions, public notice of, 113 Fifty dollar note, issuance, 123 Edge Act and agreement corporations, Finance examinations of, 95-96 Business, 14-15, 38-39 Enforcement actions, 92-93 Household, 12, 36 Enforcement of laws and regulations, Financial Crimes Enforcement Network 114-15 (FinCEN), 106 Examinations and inspections, 88-90 "Financial Disclosure in the Banking, Executive officers, credit to, 115 Insurance and Securities Sectors: Financial system continuity initiatives, Issues and Analysis," Joint Forum 90-91 paper, 104 Government Accountability Office, Financial statements reviews by, 330 Board of Governors, 303-13 International guidance on supervisory Federal Reserve Banks, combined, policies, 102-4 314-27 International supervision, 95-97 Federal Reserve priced services, 132-35 Maps of, 332-33 Financial system Membership, 115 Account, 19-20, 42 Monitoring supervisory data, off-site, Continuity initiatives, 90-91 94-95 Developments, 34-51 Open market transactions, 270-73 Education, 78-79, 82-83 Processing of applications, 114 Holding companies, inspections and Regulation of U.S. banking structure, examinations of, 90 110-14 Intermediation, 26-27, 47-48 Risk management and supervision, Markets, 4-7, 23-27, 32-34, 46-48 93-94, 102-3 Reports, bank holding companies and Safety and soundness supervision commercial banks, 105-6 responsibilities, 88-97 FinCEN (See Financial Crimes Sarbanes-Oxley Act, 104 Enforcement Network) Securities credit responsibilities, 114 Fiscal agency services, by Federal Reserve Special investigations, 92-93 Banks, 124-27 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

342 91st Annual Report, 2004 Fiscal Impact Tool (FIT), web-based "Implementation of Basel II: Practical resource, 83 Considerations," policy paper, 103 Fixed investment, business sector, 12-13, Imports, 18-19, 41^2 36-37 Income and expenses Float, 123, 290, 292, 294, 296 Board of Governors, 305 Flood insurance, compliance with, 65-66 Federal Reserve Banks, 129, 134-35, FOMC (See Federal Open Market 276-83, 316 Committee) Federal Reserve priced services, 118-35, Foreign banking operations of U.S. banks, 276 95-96, 100-102 Industrial economies, developments, 28-29, Foreign banks, U.S. activities of, 96 49-50 Foreign currency operations Inflation, 8, 9, 23, 31, 32, 44-46 Authorizations for, 157-59, 164-65 Information technology Directives, 159, 165-66 Developments in, 107-8, 127-28 Procedural instructions for, 159-60, Federal Reserve examination of, 91 166-75 Supervisory Information Technology Foreign economies, developments in, (SIT), 107-8 27-30, 48-51 Inspections (See Examinations and Foreign trade, 18-19, 41-42 inspections) FR-ETA, 126 Inspector General, Office of (OIG), audits, reviews, and assessments, 329 GDP (gross domestic product), 8, 9, Insured commercial banks, assets and 39-40 liabilities, 289 Gold stock, 290, 292, 294, 296 Interest rates, See also Discount rate and Government Federal funds rate, 5, 24-25, 46-47, Depository services, 124-27 286 Developments in, 15-18, 39^U International Banking Act, 112 Federal, economic developments, 15-17, International Banking Operations (Regulation K), 148 Municipal securities dealers and brokers, International developments examination of, 92 Banking activities, supervision of, Securities, examinations of, 92 95-96, 98, 102-4, 112-13 State and local, economic developments, Economic developments, 27-30, 48-51 17-18, 40-41 Trade, 18-19, 41-42 Government Accountability Office (GAO), Interstate branching, 142-43 330 Investments Government Performance and Results Act Business sector, 12-14, 36-37 (GPRA), 137-39 Inventory, 14, 37-38 Gross domestic product (GDP), 8, 9, 39-40 Overseas, by U.S. organizations, 112-13 Residential, 11-12, 35-36 Hearings, rules of practice, 150 Home Mortgage Disclosure Act (HMDA), Jobs and Growth Tax Relief 61, 67-69 Reconciliation Act (JGTRRA), 10, Home Mortgage Disclosure (Regulation C), 16,39 147 Household sector, developments in, 10-12, Labor market, 20-23, 42-44 35-36 Large, complex banking organizations Housing and Urban Development, (LCBOs), supervision of, 93-94 Department of, complaint referrals, 75 Legislation, Federal, proposals, 141-43 Liabilities (See Assets and liabilities) Immigrant banking services, 80-81 Life insurance, bank-owned, 99 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 343 Litigation involving Board of Governors Monetary Policy Reports to the Congress Albrecht, 232 February 2005, 3-30 Apffel, 232 July 2004, 31-51 Artis, 232 Money laundering prevention, 90, 99 Carter, 232 Money market deposit accounts (MMDAs), CB Bancshares, Inc., 231 86 Fraternal Order of Police, 232 Mortgage interest rates, 11, 12, 36 Haili, 231 Municipal securities dealers and brokers, Inner City Press/Community on the examination of, 92 Move, 231 Laigo, 232 National City Corporation, merger, 63 McCarthy, 231 National Flood Insurance Act of 1968, Price, 232 65-66 Sciba, 232 National Information Center (NIC), 107-8 Skanska USA Building, Inc., 232 National Settlement Service, 122 Texas State Bank, 232 New Alliance Bancshares, merger, 63 Thomas, 231, 232 Noncash collection services, Federal Ulrich, 231 Reserve Banks, 123 Nonfarm business sector, 21, 44 Loans Nonmember banks, assets and liabilities, Federal Reserve Bank holdings, 130, 289,298* 290, 292, 294, 296 Notes, Federal Reserve Insured commercial banks, 289 Fifty dollar bill issuance, 123 Interest rates for depository institutions, Interest, 281, 283 286 Operations, 123-24, 285, 291, 293, 295, State member banks to executive 315 officers, 115 Local governments, 17-18, 40-41 Officers, Board of Governors (See Members and officers) Maps, Federal Reserve System, 332-33 OIG, 329 Margin requirements, 288 Oil prices, 19, 42 Member banks (See also State member Open market operations banks) Authorization for conduct of, 155-57, Applications by, 113 162-64 Assets and liabilities, 289 Guidelines for the conduct of, 157 Number of, 115,298 Volume of transactions, 270-73 Reserves, 295, 297 Opt-out provisions, prescreened Members and officers solicitations, 59-60 Board of Governors, 235-37, 261-64 "Outsourcing in Financial Services," Joint Consumer Advisory Council, 240 Forum paper, 103-4 Federal Advisory Council, 239 Overdraft protection services, 77 Federal Open Market Committee, 238 Overseas investments, U.S. banking Federal Reserve Banks and Branches, organizations, 112 242-43 Salaries, Federal Reserve Banks, 275 Papers, interagency or Joint Forum Thrift Institutions Advisory Council, 241 papers, 102-4 Membership of State Banking Institutions Pay.gov, 126 in the Federal Reserve System Payments services, by Federal Reserve (Regulation H), 148 Banks, 126 Monetary aggregates (M2), 26, 48 Payments system risk, 150-51 Monetary policy, economic outlook, 3-8, Performance Report Information and 31-34 Surveillance Monitoring (PRISM), 94 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

344 91st Annual Report, 2004 Personal consumption expenditures (PCE), Regulati ons—Continued 8-10, 22, 34, 44 U, Credit by Banks for the Purpose of PIN fees, 58-59 Purchasing or Carrying Margin Point-of-sale debit fees, 58-59 Stocks, 288 Policy actions and statements, 97-102, V, Fair Credit Reporting, 148-49 147-51 X, Borrowers of Securities Credit, 288 Premises, Federal Reserve Banks, 130-31, Y, Bank Holding Companies and Change 284, 315 in Bank Control, 148 Prescreened credit solicitations, 59-60 Z, Truth in Lending, 60, 61, 71, 147, Priced services 149 Federal Reserve Banks, 118-23, 132-35 AA, Unfair or Deceptive Acts or Prices Practices, 72 BB, Community Reinvestment, 149 Consumer, 21-23, 44 CC, Availability of Funds and Collection Energy, 22, 44 of Checks, 72, 150 Equity, 25, 47 DD, Truth in Savings, 72-73, 147 Primary credit rate, 151, 286 Remittance services, immigrant markets, "Principles for the Home-Host 80-81 Recognition of AMA Operational Risk Reports of Condition and Income (Call Capital," policy paper, 103 Reports), 106 "Principles for the Management and Repurchase agreements Supervision of Interest Rate Risk," Federal Reserve Bank credit, 290, 292, policy paper, 103 294, 296 PRISM, 94 Treasury securities, 274 Privacy of Consumer Financial Information Reserve requirements, depository (Regulation P), 70-71 institutions, 142, 287, 290-97 Productivity and labor costs, 21, 43-44 Reserve Requirements of Depository Profit and loss, Federal Reserve Banks, 276 Institutions (Regulation D), 147 Profits, corporate, 14-15, 38-39 Residential investment, 11-12, 35-36 Revenue and income (See Income and Regional banking organizations, risk expenses) supervision of, 93 Risk capital, 97-99 Regions Financial Corporation, merger, 63 Risk-focused supervision, Federal Reserve Regulations System, 93-94 B, Equal Credit Opportunity, 69-70, 147 Risk management, Federal Reserve System, C, Home Mortgage Disclosure, 147 102-3, 151 D, Reserve Requirements of Depository Royal Bank of Scotland, merger, 63 Institutions, 147 Rules of Practice for Hearings, 150 E, Electronic Fund Transfers, 70, 147 H, Membership of State Banking Salaries, Federal Reserve Bank officers Institutions in the Federal Reserve and employees, 275 System, 148 Sarbanes-Oxley Act, 104 J, Collection of Checks and Other Items Secondary and seasonal credit rates, 152, by Federal Reserve Banks and 286 Funds Transfers through Fedwire, Securities (See also Treasury securities) 148 Clearing agencies, examination of, 91-92 K, International Banking Operations, 148 Credit lenders, examination of, 92, 114 M, Consumer Leasing, 70, 147 Government and municipal, supervision P, Privacy of Consumer Financial of dealers and brokers, 92 Information, 70-71 Holdings by Federal Reserve Banks, T, Credit by Banks, Brokers and Dealers, 130, 290, 292, 294, 296 288 Trust-preferred, 98 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 345 Settlement Service, National, Federal Technical assistance, 96-97 Reserve Banks, 122 Term Investment Option (TIO), 127 SIT, 107-8 Thrift Institutions Advisory Council, 241 SOMA (See System Open Market Account) Trade, international, 18-19, 41^2 Special drawing rights certificate account, Training and development, Federal Reserve 266-69, 290, 292, 294, 296, 315 staff, 66-67, 108-9 Special investigations, Federal Reserve Transfer agents, supervision of, 91-92 System, 232 Transparency efforts, 105 Staff development, Federal Reserve, 66-67, Treasury, U.S. Department of the, See also 108-9 Treasury securities State and local governments, 17-18, 40-41 Currency outstanding, 290, 292, 294, State-chartered banks, 150, 298 296 State member banks (See also Member Payments processed for, 126 banks) Payments to, by Federal Reserve Banks, Applications by, 113 129, 278, 281, 283 Community Reinvestment Act, TreasuryDirect, 125 compliance with, 62 Treasury securities Complaints against, 73-75 Depository institution holdings, by class Disclosure by, 114 of bank, 289 Examinations of, 62, 66-67, 88, 91, 92 Federal Reserve Bank holdings, 124, Extensions of credit to executive 274, 276-79, 290, 292, 294, 296 officers, 115 Interest rates, 24-25, 46-47 Number of, 115, 298 Open market transactions, 270-73 Securities clearing agents, 91-92 Repurchase agreements, 266-69, 270-73, Surveillance by Federal Reserve System, 274, 290, 292, 294, 296 94-95 Treasury Tax and Loan (TT&L) program, Transfer agents, 91-92 127 Statistical tables, 266-98 Trust-preferred securities, 98 Stocks Truth in Lending (Regulation Z), 60, 61, Margin requirements, 288 71, 147, 149 Price indexes, 25, 26 Truth in Savings (Regulation DD), 72-73, Repurchases, bank holding companies, 147 113 Supervision and regulation responsibilities, Unemployment, 8, 20-21, 42-43 Federal Reserve System, 85-115 Unfair and deceptive practices, 58, 72, 75, Supervisory Information Technology (SIT), 150 107-8 Unfair or Deceptive Acts or Practices Supervisory policy papers, 102-3 (Regulation AA), 72 Surveillance monitoring, 94-95 Unsolicited credit offers, 59-60 System Open Market Account (SOMA), (See also Open market operations), Wachovia Corporation, merger, 63 157, 158, 163, 164 West Texas intermediate (WTI), prices, 19, 42 Tax payment services, electronic, 126 Working Families Tax Relief Act, 16 0405 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis