Annual Report of the Federal Reserve Board, 2005

'Report >O 2005 Board of Governors of the Federal Reserve System Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

Letter of Transmittal Board of Governors of the Federal Reserve System Washington, D.C. June 2006 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-second annual report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 2005. Sincerely, Ben Bernanke Chairman Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Overview of the Federal Reserve As the nation's central bank, the Federal The Federal Reserve Banks, which Reserve System has numerous, varied combine public and private elements, responsibilities: are the operating arms of the central banking system. They carry out a vari- • conducting the nation's monetary pol- ety of System functions, including opericy by influencing monetary and ating a nationwide payments system; credit conditions in the economy distributing the nation's currency and coin; under authority delegated by the • supervising and regulating banking Board of Governors, supervising and institutions, to ensure the safety and regulating bank holding companies and soundness of the nation's banking and state-chartered banks that are members financial system and to protect the of the System; serving as fiscal agents credit rights of consumers of the U.S. Treasury; and providing a variety of financial services for the Trea- • maintaining the stability of the finan- sury, other government agencies, and cial system and containing systemic other fiscal principals. risk that may arise in financial A major component of the Federal markets Reserve System is the Federal Open Market Committee (FOMC), which is • providing financial services to deposi- made up of the members of the Board of tory institutions, the U.S. government, Governors, the president of the Federal and foreign official institutions Reserve Bank of New York, and presidents of four other Federal Reserve The Federal Reserve is a federal sys- Banks, who serve on a rotating basis. tem composed of a central, governmen- The FOMC establishes monetary policy tal agency—the Board of Governors— and oversees open market operations, and twelve regional Federal Reserve the main tool used by the Federal Banks. The Board of Governors, located Reserve to influence overall monetary in Washington, D.C., is made up of and credit conditions. The FOMC sets seven members appointed by the Presi- the federal funds rate, but the Board has dent of the United States and supported sole authority over changes in reserve by a staff of about 1,800. In addition requirements and must approve any to conducting research, analysis, and change in the discount rate initiated by a policymaking related to domestic and Reserve Bank. international financial and economic Two other groups play roles in the matters, the Board plays a major role functioning of the Federal Reserve Sysin the supervision and regulation of the tem: depository institutions, through U.S. banking system and administers which monetary policy operates, and most of the nation's laws regarding con- advisory councils, which make recomsumer credit protection. It also has broad mendations to the Board of Governors oversight responsibility for the nation's and the Reserve Banks regarding the payments system and the operations and System's responsibilities. • activities of the Federal Reserve Banks. 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 5 Monetary Policy, Financial Markets, and the Economy in 2005 and Early 2006 7 Economic Projections for 2006 and 2007 9 ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2005 AND EARLY 2006 9 The Household Sector 12 The Business Sector 15 The Government Sector 18 The External Sector 20 The Labor Market 22 Prices 24 U.S. Financial Markets 28 International Developments 33 MONETARY POLICY REPORT OF JULY 2005 33 Monetary Policy and the Economic Outlook 36 Economic and Financial Developments in 2005 Federal Reserve Operations 57 BANKING SUPERVISION AND REGULATION 58 Scope of Responsibilities for Supervision and Regulation 59 Supervision for Safety and Soundness 67 Supervisory Policy 77 Supervisory Information Technology 78 Staff Development 80 Regulation of the U.S. Banking Structure 84 Enforcement of Other Laws and Regulations 85 Federal Reserve Membership 87 CONSUMER AND COMMUNITY AFFAIRS 87 Implementation of Statutes Designed to Inform and Protect Consumers 92 Supervision for Compliance with Consumer Protection and Community Reinvestment Laws 103 Consumer Complaints 104 Advice from the Consumer Advisory Council 107 Promotion of Consumer Education and Community Economic Development in Historically Underserved Markets 111 Outreach Activities Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

113 FEDERAL RESERVE BANKS 113 Developments in Federal Reserve Priced Services 118 Developments in Currency and Coin 118 Developments in Fiscal Agency and Government Depository Services 122 Electronic Access to Reserve Bank Services 122 Information Technology 124 Examinations of the Federal Reserve Banks 124 Income and Expenses 125 Holdings of Securities and Loans 126 Volume of Operations 126 Federal Reserve Bank Premises 128 Pro Forma Financial Statements for Federal Reserve Priced Services 133 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE AND RESULTS ACT 133 Strategic Plan, Performance Plan, and Performance Report 133 Mission 133 Goals and Objectives 137 FEDERAL LEGISLATIVE DEVELOPMENTS 137 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 141 Post-Employment Restrictions on Senior Examiners Records 145 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS 145 Regulation D (Reserve Requirements of Depository Institutions) 145 Regulation E (Electronic Fund Transfers) 145 Regulation H (Membership of State Banking Institutions in the Federal Reserve System) and Regulation Y (Bank Holding Companies and Change in Bank Control) 146 Regulation J (Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers through Fedwire) and Regulation CC (Availability of Funds and Collection of Checks 146 Regulation V (Fair Credit Reporting) and Regulation FF (Obtaining and Using Medical Information in Connection with Credit) 147 Regulation BB (Community Reinvestment) 147 Regulation DD (Truth in Savings) 148 Post-Employment Restrictions for Senior Examiners 148 Rules Regarding Equal Opportunity 148 Policy Statements and Other Actions 149 Discount Rates in 2005 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

153 MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS 153 Authorization for Domestic Open Market Operations 155 Domestic Policy Directive 155 Authorization for Foreign Currency Operations 156 Foreign Currency Directive 157 Procedural Instructions with Respect to Foreign Currency Operations 158 Meeting Held on February 1-2, 2005 170 Meeting Held on March 22, 2005 179 Meeting Held on May 3, 2005 187 Meeting Held on June 29-30, 2005 195 Meeting Held on August 9, 2005 201 Meeting Held on September 20, 2005 208 Meeting Held on November 1, 2005 215 Meeting Held on December 13, 2005 223 LITIGATION 223 Litigation under the Financial Institutions Supervisory Act 223 Other Actions Federal Reserve System Organization 227 BOARD OF GOVERNORS 230 FEDERAL OPEN MARKET COMMITTEE 231 ADVISORY COUNCILS TO THE BOARD OF GOVERNORS 231 Federal Advisory Council 232 Consumer Advisory Council 233 Thrift Institutions Advisory Council 234 FEDERAL RESERVE BANKS AND BRANCHES 234 Officers of the Banks and Branches 235 Conference of Chairmen 235 Conference of Presidents 236 Conference of First Vice Presidents 236 Directors of the Banks and Branches 253 MEMBERS OF THE BOARD OF GOVERNORS, 1913-2005 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 258 1. Federal Reserve Open Market Transactions, 2005 262 2. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31,2003-2005 263 3. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31,2005 264 4. Reserve Requirements of Depository Institutions, December 31, 2005 265 5. Banking Offices and Banks Affiliated with Bank Holding Companies in the United States, December 31, 2004 and 2005 266 6. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items A. Year-End 1984-2005 and Month-End 2005 B. Year-End 1918-1983 274 7. Principal Assets and Liabilities of Insured Commercial Banks, by Class of Bank, June 30,2005 and 2004 275 8. Initial Margin Requirements under Regulations T, U, and X 276 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2005 and 2004 280 10. Income and Expenses of the Federal Reserve Banks, by Bank, 2005 284 11. Income and Expenses of the Federal Reserve Banks, 1914-2005 290 12. Operations in Principal Departments of the Federal Reserve Banks, 2002-2005 291 13. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2005 292 14. Acquisition Costs and Net Book Value of the Premises of the Federal Reserve Banks and Branches, December 31, 2005 Federal Reserve System Audits 295 AUDITS OF THE FEDERAL RESERVE SYSTEM 297 BOARD OF GOVERNORS FINANCIAL STATEMENTS 311 FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS 325 OFFICE OF INSPECTOR GENERAL ACnvmES 326 GOVERNMENT ACCOUNTABILITY OFFICE REVIEWS 328 MAPS OF THE FEDERAL RESERVE SYSTEM 333 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 U.S. economy delivered a solid per- In 2005, energy prices were up subformance in 2005 despite a further sharp stantially for a second year in a row. increase in energy prices and devastat- Crude oil costs climbed further, on net, ing hurricanes that claimed many lives, and prices of refined petroleum products destroyed homes and businesses, and and natural gas came under additional displaced more than 1 million persons. upward pressure for a time after sup- Real gross domestic product is estimated plies were curtailed by hurricane damto have risen a little more than 3 per- age to production facilities in the Gulf cent over the four quarters of 2005 even Coast region. As a result, households in though growth slowed significantly in the United States faced steep increases the fourth quarter as a result of storm- in gasoline and home heating expenses, related disruptions and other factors and many firms were likewise burdened that are likely to prove transitory. The with rising energy costs. increase in real GDP in 2005 was suffi- The resilience of the U.S. economy cient to add 2 million new jobs, on net, in the face of these major shocks likely to employers' payrolls and to further reflects, in part, improvements in energy reduce slack in labor and product mar- efficiency over the past several decades. kets. As in 2004, overall consumer price A number of other factors also helped to inflation was boosted by the surge keep economic activity moving forward in energy prices. Core consumer price in 2005. For one, the rapid gain in real inflation (as measured by the price index estate values in the past few years, in for personal consumption expenditures combination with the rise in stock prices excluding the direct effects of move- since 2002, has encouraged households ments in food and energy prices) picked to sustain their spending through a up early in the year, but it subsequently period of relatively weak growth in real eased and totaled less than 2 percent income. For another, credit conditions over the year as a whole. The dollar remained supportive for businesses last appreciated against most major curren- year, facilitating a brisk expansion of cies in 2005, and, with domestic demand capital spending. In addition, labor expanding strongly, the U.S. current productivity has been on a strong account deficit widened further. uptrend in recent years, which has fostered substantial growth in the economy's productive capacity and no doubt NOTE: The discussion here and in the next chapter consists of the text, tables, and selected lifted households' and businesses' charts from the Monetary Policy Report submitted assessments of their long-term income to the Congress on February 15, 2006, pursuant to prospects. section 2B of the Federal Reserve Act; the com- In light of elevated inflation pressures plete set of charts is available on the Board's web site, at www.federakeserve.gov/boarddocs/hh. and shrinking margins of unutilized Other materials in this annual report related to resources, and with short-term interest the conduct of monetary policy include the min- rates relatively low, the Federal Open utes of the 2005 meetings of the Federal Open Market Committee (FOMC) continued Market Committee (see the "Records" section) to remove monetary policy accommodaand statistical tables 1-4 (at the back of this report). tion gradually in 2005, raising the target Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

92nd Annual Report, 2005 federal funds rate 25 basis points at each bodes well for U.S. exports. However, of its eight meetings. This cumulative the effects of the cumulative tightening policy firming of 2 percentage points in monetary policy should keep the was substantially greater than market growth in aggregate output close to that participants had expected at the start of of its longer-run potential. the year. But each action was anticipated Core inflation is likely to remain by the time of the meeting at which it under some upward pressure in the near was taken, as the Committee's commu- term from rising costs as the passnications, policy strategy, and responses through of higher energy prices runs its to incoming economic data appear to course. But those cost pressures should have been well understood. At its wane as the year progresses. Moreover, meeting in January 2006, the FOMC strength in labor productivity should increased the target federal funds rate continue to damp business costs more another 25 basis points, bringing it to generally. With little evidence to date 4Vi percent. The Committee indicated that resource utilization has put apprethat possible increases in resource utili- ciable upward pressure on prices, and zation as well as elevated energy prices with longer-run inflation expectations had the potential to add to inflation pres- continuing to be well anchored, core sures and that, as a result, some further inflation should remain contained in policy tightening may be needed. 2006 and 2007. The U.S. economy should continue to Nonetheless, significant risks attend perform well in 2006 and 2007. To be this economic outlook. Some of the sure, higher energy prices will probably uncertainty is centered on the prospects exert some restraint on activity for a for the housing sector. On the one hand, while longer. But so long as energy some observers believe that home valprice increases slow, as is suggested by ues have moved above levels that can futures prices, this restraint should be supported by fundamentals and that diminish as 2006 progresses. In addi- some realignment is warranted. Such a tion, economic activity should receive realignment—if abrupt—could materisome impetus from post-hurricane ally sap household wealth and confirecovery efforts. Although progress to dence and, in turn, depress consumer date has been uneven in the affected spending. On the other hand, if home regions, the reopening of facilities shut values continue to register outsized down by the hurricanes is already being increases, the accompanying increment reflected in a rebound in industrial pro- to household wealth would stimulate duction. Federal assistance will buttress aggregate demand and raise resource rebuilding activity in coming quarters. utilization further. With the economy More broadly, the major factors already operating in the neighborhood that contributed to the favorable perfor- of its productive potential, this higher mance of the U.S. economy in 2005 resource utilization would risk adding remain in place. Long-term interest rates to inflation pressures. Another major are low, and conditions in corporate source of uncertainty is the price of credit markets are generally positive. energy, which continues to be buffeted The household sector is also in good by concerns about future supply disfinancial shape overall and should stay ruptions. Additional steep increases so even if—as expected—the housing in the price of energy would intensify sector cools. In addition, the improved cost pressures and weigh on economic outlook for economic growth abroad activity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook Monetary Policy, Financial conditions progressed as anticipated, it Markets, and the Economy would need to continue to remove polin 2005 and Early 2006 icy accommodation gradually to keep inflation pressures contained. The year 2005 opened with the target In the spring, policymakers perceived federal funds rate at 2VA percent, a some signs of softness in spending, level that Federal Reserve policymakers which they attributed in part to the earjudged to be quite accommodative. Dur- lier step-up in energy prices. Nonetheing the first few months of the year, less, the federal funds rate was still output appeared to be growing at a relatively low, and robust underlying solid pace despite rising energy prices. growth in productivity was providing Improving labor market conditions and ongoing support to economic activity. favorable financing terms were provid- Accordingly, the Committee anticipated ing considerable support to consumer some strengthening of activity, and it outlays and homebuilding activity, while reduced policy accommodation further reasonably bright sales prospects and in May by lifting the target federal funds strong profitability were buoying busi- rate another quarter percentage point, to ness investment. Pressures on inflation 3 percent. appeared to be mounting, however, In the event, the signs of softness partly owing to increasing energy prices. proved transitory. Incoming data sug- Measures of inflation compensation gested that output, employment, and derived from securities markets were on spending were growing moderately the rise as well. In these circumstances, through midyear. Inflation expectations the Committee firmed policy 25 basis seemed to be well contained, but prespoints at both its February and March sures on inflation remained elevated. meetings and signaled that, if economic With the stance of policy still accommo- Selected Interest Rates, 2003-06 1/29 5/6 8/12 10/28 1/28 5/4 8/10 11/10 2/2 5/3 8/0 \\fl 1/31 3/18 6/25 (V16 12/^ .V16 6/30 9/21 12/14 3/22 6/30 9/20 12/13 2003 2004 2005 2006 NOTE: The data are daily and extend through February 8, 2006. The ten-year Treasury rate is the constant-maturity yield 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. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

92nd Annual Report, 2005 dative, the Committee added another inflation pressures. Accordingly, policy 25 basis points to the target federal was firmed another 25 basis points, funds rate at both its June and August bringing the target federal funds rate meetings. to 4lA percent. In the accompanying Subsequently, the devastation caused statement, monetary policy was no by Hurricane Katrina increased uncer- longer characterized as "accommodatainty about the vitality of the economic tive" because the federal funds rate had expansion in the near term. The destruc- been boosted substantially and was now tion in the Gulf Coast region, the associ- within the broad range of values that, in ated dislocation of economic activity— the judgment of the Committee, might including considerable disruption of turn out to be consistent with output energy production—and the accompa- remaining close to its potential. Indeed, nying further boost to energy prices because policy actions over the previwere expected to impose some restraint ous eighteen months had significantly on spending, production, and employ- reduced the degree of monetary accomment in the near term. Although the modation, Committee members thought region had been dealt a severe blow, the that the outlook for their near-term pol- Committee did not see these develop- icy actions was becoming considerably ments as posing a more persistent threat less certain. In such an environment, to the overall economic expansion. Con- policy decisions would increasingly sequently, it decided to firm policy depend on incoming data and their another 25 basis points at its September implications for future economic growth meeting. and inflation. Nonetheless, the Commit- Over the following weeks, the Gulf tee indicated that some further measured Coast region absorbed further setbacks policy firming was likely to be needed from Hurricanes Rita and Wilma. The to keep the risks to the attainment of its growth of economic activity dipped for goals of sustainable economic growth a time—hiring slowed, consumer spend- and price stability roughly in balance. ing softened, and confidence declined. Over the period leading up to the At the same time, however, soaring January 2006 meeting, incoming data energy prices fed through to top-line on economic activity were uneven. The consumer price inflation and pushed advance estimate of real GDP pointed some survey measures of inflation to a slowing in the growth of output expectations upward. With employment in the fourth quarter, but the underlyand growth expected to be supported by ing strength in consumer and business accommodative financial conditions, the spending suggested that the economic FOMC continued the process of policy expansion remained on solid footing. tightening at its November meeting. With the potential for added pressures By December, incoming data indi- on inflation still evident, the FOMC cated that the overall expansion raised the target federal funds rate remained on track, although recovery another 25 basis points, bringing its from the damage in the hurricane- level to 4Vz percent. In its statement affected areas would apparently require after the meeting, the Committee indiconsiderable time. The Committee cated that some further policy firming judged that possible increases in may be necessary and again noted that it resource utilization as well as elevated would respond to changes in economic energy prices had the potential to add to prospects as needed. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook Economic Projections cent over the four quarters of 2006 and for 2006 and 2007 3 percent to 3Vi percent in 2007. The civilian unemployment rate is expected In conjunction with the FOMC meeting to lie between 43/4 percent and 5 percent in January, the members of the Board of in the fourth quarter of 2006 and to Governors and the Federal Reserve remain in that area in 2007. As for infla- Bank presidents, all of whom participate tion, the FOMC participants expect that in the deliberations of the FOMC, pro- the price index for personal consumpvided economic projections for 2006 tion expenditures excluding food and and 2007. The central tendency of the energy (core PCE) will rise about 2 per- FOMC participants' forecasts for the cent in 2006 and between 13A percent increase in real GDP is about 3Vi per- and 2 percent in 2007. • Economic Projections of Federal Reserve Governors and Reserve Bank Presidents for 2006 and 2007 Percent 2006 2007 Indicator MEMO: 2005 actual Central Central Range Range tendency tendency Change, fourth quarter to fourth quarter1 N Re o a m l i G na D l P GDP 6 3 . . 2 1 5 3V lA A - - 6 A V 2 Ab 5 o V u 2 t - S 6 1 /! 3 5 - - 4 6 • 3 5 - - 3 5 V 3/4 2 PCE price index excluding food and energy 1.9 VA-2V2 About 2 P/4-2 l3/4-2 Average level, fourth quarter Civilian unemployment rate 5.0 4^2-5 43/4-5 4V&-5 43/4-5 1. Change from average for fourth quarter of previous year to average for fourth quarter of year indicated. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 The economic expansion remained Change in PCE Chain-Type Price Index, firmly entrenched in 2005, although the 1999-2005 growth of real GDP late in the year was apparently restrained by the effects of the hurricanes and by sharp drops in D Total some volatile categories of spending. In the labor market, payroll employment rose moderately for a second year in a row, and the unemployment rate declined further. As in 2004, headline inflation was boosted appreciably by soaring energy prices; however, core 1999 2001 2003 2005 inflation remained subdued. In 2005, financial market conditions were once NOTE: The data are for personal consumption expenditures (PCE). again supportive of growth, with long- SOURCE: Department of Commerce, Bureau of Ecoterm market interest rates low and credit nomic Analysis. spreads and risk premiums narrow. remained vigorous in 2005. Higher The Household Sector energy prices last year continued to siphon off household purchasing power, Consumer Spending and short-term interest rates moved up; Consumer spending had gathered con- nevertheless, spending was again bolsiderable steam in 2003 and 2004 and stered by an improving labor market and rising household wealth. Change in Real GDP, 1999-2005 Change in Real Income and Consumption, Percent, annual rate 1999-2005 — 6 Percent, annual rate — 4 expenditures Jll ULnMl Lj 1999 2001 2003 2005 0 NOTE: Here and in subsequent charts, except as noted, L change for a given period is measured to its final quarter 1999 2001 2003 2005 from the final quarter of the preceding period. 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 92nd Annual Report, 2005 Real personal consumption expendi- quarter as a result of uninsured losses on tures (PCE) had posted back-to-back residential and business property. Real increases of 33A percent in 2003 and DPI snapped back in the fourth quarter 2004 and continued to rise at about that as income in these hurricane-affected pace over the first three quarters of categories rebounded from the excep- 2005; in the fourth quarter, PCE growth tionally low levels in the third quarter. slowed to an annual rate of just 1 per- Although the run-up in energy prices cent as consumer outlays for motor vehi- restrained the growth of real DPI in cles slackened after a surge prompted 2005, its effect on overall spending by last summer's "employee discount" appears to have been largely offset programs. For 2005 as a whole, sales by other factors. In particular, sharp of light vehicles (cars, vans, sport-utility increases in household wealth since vehicles, and pickup trucks) totaled 2002 have provided many households nearly 17 million units, about the same with the resources and inclination to susas the annual figure for 2004. Real tain their spending through a period of spending on consumer goods other than relatively weak growth of real income. motor vehicles was robust in 2005, with Household net worth, which typically substantial gains almost across the feeds through to spending over several board; a notable exception was real quarters, posted sizable gains in 2003 spending on gasoline, which was up and 2004, and it rose further in 2005 only modestly for a second year in a as house values continued to climb and row as prices at the pump soared. Real as stock prices moved modestly higher. expenditures on services rose moder- At the end of the third quarter (the ately in 2005, as a sizable further most recent period for which complete increase in outlays for medical care was data on wealth are available), the ratio partly offset by a relatively small gain in of household net worth to disposable outlays for energy services. income stood at 5.65, well above its Excluding the estimated effects of the long-run average level of 4.75. Meanone-time special dividend payment that while, surveys by the Michigan Survey Microsoft made in December 2004, dis- Research Center (SRC) and the Conposable personal income (DPI)—that is, ference Board suggest that, apart from personal income less personal current the first few months after the hurritaxes—rose about IV2 percent in real canes, consumer confidence was about terms in 2005, considerably less than at the favorable levels that had prevailed in 2003 and 2004. Although aggregate in 2004. All in all, personal outlays wages and salaries advanced moderately exceeded disposable income in 2005. As last year and some other major types of a result, the personal saving rate, which nominal income posted notable gains, had dropped below 2 percent in 2004, the increases in real terms were eroded fell further in 2005, ending the year at by the rise in energy prices. In addition, negative V2 percent. personal tax payments rose faster last year than did personal income as mea- Residential Investment sured in the national income and product accounts (NIPA). In the second half Activity in the housing sector remained of the year, the growth of real DPI was torrid through much of 2005. By the end volatile, mainly because of the hurri- of the year, however, a few tentative canes. Rental income and proprietors' signs of cooling had begun to appear. In income were pulled down in the third the single-family sector, starts of new Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 11 units dipped in December after a string nearly five months of supply when meaof exceptionally strong months; still, sured at that month's sales pace. they totaled 1.7 million for the year as a Between 1998 and 2004, the stock of whole—6V2 percent above the already unsold new homes had averaged about rapid pace in 2004. Starts in the multi- four months of supply. family sector totaled 350,000 in 2005, a Measures of house prices that attempt pace similar to that of the preceding to control for shifts in the quality and three years. Real expenditures on resi- composition of homes sold show that dential structures—which include out- prices continued to rise rapidly through lays not only for new construction but the third quarter of 2005, though partial also for additions and alterations as data for the fourth quarter point to some well as commissions paid to real estate slowing. Notably, the purchase-only veragents—rose nearly 8 percent in 2005, sion of the repeat-transactions price the fourth large yearly increase in a row. index for existing homes, which is pub- Sales of both new and existing homes lished by the Office of Federal Housing set records in 2005, although they, like Enterprise Oversight and tracks sales housing starts, seem to have lost some of the same houses over time, rose steam late in the year. Rates on thirty- 11 percent over the year ending in the year fixed-rate mortgages were in the third quarter (the latest available data), neighborhood of 53A percent for much once again outstripping the increases of the year, but they rose in the autumn. in household incomes and rents. The Since October, they have averaged close Census Bureau's constant-quality price to 6lA percent, at the upper end of the index for new homes, which controls narrow range that has prevailed since for changes in the composition of sales 2003 but still fairly low by historical by geography, home size, and other standards. Rates on adjustable-rate mort- readily observable characteristics, had gages have been trending up since early also shown sizable increases through 2004. The softening of home sales in the third quarter, but it decelerated recent months has contributed to an sharply in the fourth quarter and was updrift in the stock of unsold new and up just A3A percent over 2005 as a existing homes. As of December, the whole; in 2004, this measure had risen stock of unsold new homes was equal to 8V2 percent. Mortgage Rates, 2001-06 Household Finance Household debt expanded about IOV2 percent at an annual rate over the first three quarters of last year, roughly the same brisk pace as had been registered in 2004. Home-mortgage debt continued to grow rapidly, as homeowners took advantage of the further sizable increases in house prices last year. The JL J use of alternative mortgage products ?" WOl 2002 2003 2004 2005 2006 spread further in 2005, in part because NOTE: The data, which are weekly and extend rising home values generally made through February 8, 2006, are contract rates on house purchases less affordable. Last thirty-year mortgages. SOURCE: Federal Home Loan Mortgage Corporation. May federal regulators issued guid- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

12 92nd Annual Report, 2005 ance promoting sound risk-manage- final sales, ample financial resources in ment practices to financial institutions the corporate sector, and supportive conwith home equity lending programs. ditions in financial markets. Mortgage-related borrowing likely took Real investment in high-technology the place of some funding with con- equipment rose 17 percent in 2005, as sumer credit, which expanded only further declines in prices provided a submodestly again last year. Overall, the stantial incentive for firms to step up expansion in household debt outpaced their outlays on such items; the increase the growth in disposable personal was 5 percentage points faster than in income, and the financial obligations 2003 and 2004 and about in line with ratio moved up to a level close to the the average annual gain over the past peak that it had reached earlier this twenty-five years. Spending on commudecade. However, the relatively low nications equipment was exceptionally readings on most measures of loan strong last year, as telecom service prodelinquencies last year indicate that viders rolled out major new fiber-optic most households were not struggling to systems and third-generation wireless meet their obligations. gear. Business spending for computing A large number of households filed equipment rose roughly 30 percent in for bankruptcy in the weeks leading real terms, a pace close to its historical up to October 17, the date when a new average, while spending on software bankruptcy law took effect. The law was posted its largest increase in several designed in part to diminish the ability years. of households to discharge their debts through chapter 7 filings. After the new Change in Real Business Fixed Investment, law became effective, filings fell sharply 1999-2005 to a level significantly below the average of recent years, and they have Percent, drnu.il rate since remained low. This suggests that, • Structures to avoid the new rules, some households — • Equipment and software — 20 accelerated filings they would have In 10 JJi undertaken eventually even under the old law. The spike in bankruptcies 0 appears to have induced a jump in charge-offs of consumer loans in the fourth quarter. 1 J L J Q High-tech equipment .,; The Business Sector and software ~~~" ^0 * B Other equipment excluding \ transportation ^ ;• Fixed Investment If Real business fixed investment rose \ it 1 6V2 percent in 2005. Real spending on LI LJT equipment and software (E&S) posted I 1 1 i t 1 i 1 1 i i an increase of more than 8 percent after 1999 2001 2003 2035 rising nearly 14 percent in 2004. The NOTE: High-tech equipment consists of computers broadly based growth in E&S spending and peripheral equipment and communications equipment. last year was supported by favorable SOURCE: Department of Commerce, Bureau of Ecofundamentals: appreciable growth in nomic Analysis. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 13 Although aircraft investment re- inventory investment. Inventories in the mained depressed as domestic airlines motor vehicle sector were drawn down continued to grapple with overcapacity in both the second and third quarters, and soaring fuel prices, the other major though accumulation resumed in the categories of E&S spending outside the fourth quarter after last summer's surge high-tech area did well in 2005. Busi- in sales cleared out dealers' lots. Apart ness outlays on motor vehicles rose from motor vehicles, real stockbuilding markedly, with the demand for heavy slowed sharply over the course of the trucks especially strong. Investment in year and, according to the advance NIPA equipment other than high-tech and estimate, came to a halt in the fourth transportation goods—a broad category quarter. At year-end, inventories seemed that accounts for nearly half of E&S to be in reasonable alignment with sales, spending when measured in nominal even taking into account the downward terms—barely rose in real terms over trend in inventory-sales ratios that has the first half of 2005. Investment in resulted from the ongoing improvement this category sped up after midyear, to in supply-chain management. increase moderately over the year as a whole. Corporate Profits and Apart from the drilling and mining Business Finance sector, where investment has strengthened in response to higher energy prices, With profits posting further solid gains outlays for nonresidential construction in 2005 and ample liquid assets on corhave yet to gain much traction. Spend- porate balance sheets, nonfinancial busiing on office and commercial structures nesses were able to finance much of has been essentially flat since 2003; their capital expenditures out of internal construction of manufacturing facili- funds, pay record sums to shareholders ties leveled out in 2005 after having in the form of share buybacks, and still firmed in late 2004; and investment in maintain strong balance sheets. Nonethe power and communications sector theless, elevated merger and acquisimoved down further last year. How- tion activity and the considerable rise in ever, vacancy rates have continued to share buybacks boosted the pace of busireverse some of the run-up that occurred ness borrowing. Short-term borrowing between 2000 and 2003, and some rose significantly, driven by financing industry reports suggest that an upturn from banks. The issuance of long-term in building activity is in train. debt remained moderate overall, but debt related to commercial mortgages continued to expand rapidly. Indicators Inventory Investment of corporate credit quality generally After having been exceptionally re- remained favorable. strained earlier in the economic expan- Corporate profits continued to grow sion, inventory investment picked up strongly in 2005. The ratio of before-tax sharply in 2004, and the higher pace of profits of domestic nonfinancial corpoaccumulation extended into early 2005. rations to that sector's gross value added The step-up in accumulation, which pro- rose to more than 12 percent, near its vided considerable impetus to industrial 1997 peak. Gains in earnings were fairly production for a time, brought stocks widespread, with profits in the petrointo better alignment with sales and set leum and gas industries especially the stage for a subsequent downswing in strong. In the fourth quarter of 2005, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

14 92nd Annual Report, 2005 operating earnings per share for Selected Components of Net Financing S&P 500 firms appear to have been for Nonfinancial Corporate Businesses, nearly 14 percent above their level four 2003-05 quarters earlier. Billions of dollars, annual rate Gross equity issuance remained modest in 2005, while net equity issuance __ D Commercial paper — 800 sank into deeply negative territory as H Bonds • Bank loans — 600 corporations retired shares at a rapid _ Sum of selected ,— 400 pace. Both a jump in cash-financed components gHHi f — 200 mergers and a record-setting level of •f share repurchases were spurred by the MXfcj._ o strong growth of profits as well as by — 200 the substantial liquidity that firms had | | | | | | ...i 1 i 1-J 2003 2004 2005 built up in recent years. Net corporate bond issuance was NOTE: The data for the components excluding bonds are seasonally adjusted. The data for the sum of selected subdued in 2005, as modest growth components are quarterly; 2005 :Q4 is estimated. in nominal capital expenditures, strong SOURCE: Federal Reserve Board; Securities Data Company; and Federal Financial Institutions Examinacash positions, and robust profits tion Council, Consolidated Reports of Condition and apparently limited the demand for Income (Call Report). such financing. However, commercialmortgage debt grew rapidly last year. ing by both large and small commer- Gross issuance of commercial- cial banks surged. Throughout the year, mortgage-backed securities likely respondents to the Senior Loan Officer reached a record pace in the fourth Opinion Surveys indicated that their quarter. institutions had further eased standards Short-term borrowing by businesses and terms for lending to businesses rose smartly in 2005, as business lend- and that the demand for such loans had continued to strengthen. Most respon- Financing Gap and Net Equity Retirement dents attributed the stronger demand at Nonfinancial Corporations, 1990-2005 to borrowers' increased need to finance inventories, accounts receivable, and Billions of dollars investment in plant and equipment; a substantial fraction of respondents to some surveys also pointed to a pickup in merger and acquisition activity. By contrast, outstanding commercial paper declined last year. Readings on credit quality for nonfi- 100 nancial companies generally remained favorable in 2005 despite some pockets 1993 1997 2001 2005 of distress. The amount of corporate NOTE: The data are annual; the observations for 2005 debt that was downgraded by Moody's are based on partially estimated data. The financing gap is the difference between capital expenditures and Investors Service last year exceeded the internally generated funds. Net equity retirement is the amount that was upgraded, mainly as a difference between equity retired through share repurresult of the high-profile downgrades of chases, domestic cash-financed mergers, or foreign takeovers of U.S. firms and equity issued in public or private the debt of General Motors and Ford. markets, including funds invested by venture capital After trending down over the first three partnerships. quarters of last year, the six-month trail- SOURCE: Federal Reserve Board, flow of funds data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 15 ing bond default rate moved up in the ber 30, was primarily for needs that fall, most notably because of the bank- emerged before Hurricane Katrina.) As ruptcies of Delta Air Lines, Northwest for the major health programs, Medicare Airlines, Delphi, and Calpine. However, outlays continued to climb. Medicaid these bankruptcies were widely antici- spending rose relatively slowly, mainly pated and had little effect on other mea- because it had been boosted during sures of aggregate credit quality. The much of fiscal 2004 by the temporary credit quality of commercial mortgage increase in the federal share of the prodebt also appeared to remain robust gram's costs included in the Jobs and during 2005; delinquency rates on com- Growth Tax Relief Reconciliation Act mercial mortgages held by banks and of 2003 (JGTRRA). Net interest payon those pooled into securities trended ments, which had declined steadily from down on balance over last year, while 1998 to 2003 and had increased only delinquencies on mortgages held by moderately in 2004, were up signifiinsurance companies remained low. cantly in fiscal 2005 as short-term interest rates rose. Thus far in fiscal 2006, outlays have continued to rise rapidly, in The Government Sector part because of heavy spending for flood insurance payouts and other hurricane- Federal Government related disaster relief. According to the The deficit in the federal unified budget NIPA, real federal expenditures on connarrowed appreciably in fiscal year sumption and gross investment, the part 2005. Although outlays continued to rise of government spending that is a comrapidly, receipts rose even faster; as a ponent of real GDP, increased \lA perconsequence, the deficit fell to $318 bil- cent over the four quarters of calendar lion, roughly $100 billion less than the year 2005. deficit in fiscal 2004. The latest pro- Federal receipts rose \AVi percent jections from the Administration and in fiscal 2005; as a ratio to GDP, they the Congressional Budget Office, how- stood at YIV2 percent—more than 1 perever, point to a deterioration in the uni- centage point higher than in 2004. Corfied budget position in fiscal 2006, in part because of the start of the Medi- Federal Receipts and Expenditures, care drug benefit and the need to pay 1985-2005 for post-hurricane reconstruction and relief. Percent ofnominal Nominal federal spending rose nearly 8 percent in fiscal 2005 and stood at 24 about 20 percent of GDP—virtually the Expenditures 22 Receipts same as in 2003 and 2004 but IVi per- Expenditures^. 20 centage points above the recent low in "7C fiscal 2000. Defense spending rose 18 / 8V2 percent after three years of double- — 16 digit increases; outlays for nondefense hill n i I M I 1 1 IM M M 1 1 I il discretionary programs moved up fur- 1985 1990 1995 2000 2005 ther as well, in part because of higher NOTE: The receipts and expenditures data are on a spending for education and for disaster unified-budget basis and are for fiscal years (October relief. (Spending on disaster relief in through September); GDP is for the four quarters ending inQ3. fiscal 2005, which ended on Septem- SOURCE: Office of Management and Budget. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

16 92nd Annual Report, 2005 porate payments rose nearly 50 percent, Federal Borrowing lifted by the robust profits of 2004 Borrowing by the Treasury moderated and 2005 and the termination of the somewhat in calendar year 2005— partial-expensing tax incentive at the federal debt rose 7 percent last year after end of calendar 2004. Individual income increasing 9 percent in 2004. Much of taxes increased nearly 15 percent; nonthe improvement reflected the surge in withheld taxes rose especially rapidly tax receipts noted earlier. As a result, the because of both substantial strength in amount of Treasury bills outstanding nonwage taxable incomes (including contracted on net in 2005, and Treasury capital gains) and certain features of sales of coupon securities declined. As JGTRRA that altered the timing of tax was widely anticipated, the Treasury payments in a way that temporarily announced in August that it would reduced the level of collections in 2004. resume regular semiannual issuance of a Social insurance taxes rose in line with thirty-year nominal bond. The first such wages and salaries. auction, held on February 9, 2006, was Mirroring the narrowing of the uniwell received, with a high level of parfied deficit, federal saving (essentially, ticipation from indirect bidders. The the unified surplus or deficit adjusted Treasury expects issuance of the thirtyto conform to the accounting practices year bond to help stabilize the average followed in the NIPA) improved from maturity of outstanding marketable negative 3Vz percent of GDP in calendar Treasury debt, which declined from a 2004 to negative 2Vi percent in the first high of about seventy months at the end half of 2005. However, the beneficial of 2000 to fifty-three months at the end effect of the smaller deficit in terms of of 2005. national saving was essentially offset by Federal debt held by the public as a a sharp decline in personal saving. Meapercentage of nominal GDP was steady sured net of estimated depreciation, during 2005 and stood at about 36 pernational saving in the first half of 2005 cent at the end of the third quarter. The was equal to just 1 Vi percent of GDP, federal debt ceiling did not need to be about the same as in 2004 and well below the recent highs of more than 6 percent of GDP in the late 1990s. Federal Government Debt Held by the Public, 1960-2005 In the third quarter, net saving was dragged down by sizable hurricanerelated reductions in both federal and nonfederal net saving; excluding these one-time factors, net saving in the third quarter would have been roughly the — 45 same as it was in the first half of the year. If not reversed over the longer haul, persistent low levels of saving will necessitate either slower capital forma- 1 iiinmimiimiiiJiiiMiiii tion or continued heavy borrowing from abroad, either of which would hamper ,^,.r,, 1MS5 , 1975 19S5 1995 the ability of the nation to cope with the NOTE: The final observation is for 2005:Q3. For previous years, the data for debt are as of year-end, and retirement needs of the baby-boom genthe corresponding values for GDP are for Q4 at an eration and would retard the growth of annual rate. Excludes securities held as investments of the standard of living. federal government accounts. SOURCE: Federal Reserve Board, flow of funds data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 17 raised last year, but the Treasury has situations, and some face significant announced that it expects that the debt structural imbalances in their budgets will reach its statutory ceiling in Febru- that likely will be exacerbated in comary 2006. ing years by the need to provide pen- The appetite for Treasury securities sions and health care to a growing numamong foreign investors remained ber of retired employees. In addition, strong in the aggregate in 2005. The the jurisdictions in the Gulf Coast region proportion of outstanding Treasury confront the dual challenge of substansecurities held by foreign investors is tial post-hurricane demands and diminestimated to have climbed to slightly ished flows of tax revenues. more than 45 percent in the third quarter According to the NIPA, real expendiof 2005, a record. Data from the Trea- tures on consumption and gross investsury International Capital reporting ment by state and local governments system suggest that net purchases of rose \lA percent in 2005. Real outlays Treasury securities by foreign private for current consumption were up only investors jumped last year, whereas such about 1 percent for a second year, in part purchases by foreign official institutions because of the relatively slow pace of slowed significantly amid upward pres- hiring. Real investment expenditures sure on the foreign exchange value of also registered a small gain. the dollar. State and Local Government State and Local Governments Borrowing The fiscal positions of state and local Borrowing by state and local governgovernments continued to improve in ments picked up in 2005. Gross issuance 2005. Strong growth in income and of municipal securities was brisk, as retail sales boosted revenues, as did ris- the relatively low level of longer-term ing property values. And although the market interest rates spurred advance sector continued to grapple with higher refundings of outstanding securities. The medical costs and pressures to restore bulk of new capital issues last year funding to programs that had been cut reportedly was earmarked for educationback earlier in the decade, states and related projects. Credit quality in the localities generally kept a tight rein on state and local sector generally remained current outlays. On a NIPA basis, net favorable in 2005. Notable exceptions saving by state and local governments— were the obligations of numerous which is broadly similar to the surplus municipal issuers in Michigan, which in an operating budget—turned positive were downgraded last year largely as a in the first half of 2005 after having consequence of the difficulties of GM been negative between 2002 and 2004, and Ford. In addition, the obligations and it would have remained positive in of a number of issuers in the regions the third quarter in the absence of the that were hit by last year's hurricanes hurricanes. The sizable revenue gains were downgraded in the fourth quarreported by many states in fiscal 2005, ter, and some bonds from these areas which ended on June 30 in all but four remain on watch. Despite these isolated states, appear to have extended into fis- troubles, rating upgrades of municipal cal 2006. Even so, some governments bonds slightly outpaced downgrades in are still struggling with strained fiscal 2005. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

18 92nd Annual Report, 2005 The External Sector International Trade The U.S. current account deficit wid- Real exports of goods and services conened further in 2005. At an annual rate, tinued the solid pace of expansion regisit came in at just under $800 billion, or tered in both 2003 and 2004; they rose about 6VA percent of nominal GDP, in an estimated 53A percent in 2005, supthe first three quarters (the latest avail- ported by robust foreign economic activable data). As in the past, a substantial ity. Export growth was rapid in the first portion of the widening of the current half of the year, spurred by the depreaccount deficit came from a larger defi- ciation of the dollar in previous years; cit on trade of goods and services, but a it then slowed in the second half of decrease in net investment income also the year, in part owing to the dollar's worsened the external account. Net appreciation since the beginning of investment income edged into negative 2005. For the year as a whole, exports territory in the second quarter of 2005 of capital goods posted solid growth. for the first time in the post-World Exports of aircraft performed especially War II period. Unilateral transfer pay- well despite an interruption of their proments to foreigners dropped sharply duction in September because of a strike on net in the third quarter because of a at Boeing. Exports of industrial supplies surge in receipts from foreign insurance were hampered late in the year by the companies for damage caused by the effects of the hurricanes on produchurricanes, leading to a slight narrowing tion and shipping in the Gulf Coast of the deficit from the previous quarter. region. By destination, exports to Can- The trade data through December ada and Mexico grew rapidly in 2005, showed that the U.S. trade deficit wid- those to Western Europe also increased, ened further in the fourth quarter of but exports to Japan were relatively 2005, to about $790 billion at an annual weak. Exports of services rose about rate. This increase suggests that the 3 percent in 2005 in real terms. fourth-quarter current account deficit, Prices of exported goods increased at yet to be reported, will also widen an annual rate of 23A percent in 2005, a substantially. bit below the rate of increase in 2004. Prices decelerated in the second and U.S. Trade and Current Account Balances, third quarters as the dollar strengthened 1998-2005 and as pressures on prices of agricultural exports and other nonfuel commodities ebbed. Prices accelerated again in the fourth quarter, when a sharp rise in the prices of oil and metals drove up prices for many nonagricultural industrial supplies. After expanding at a double-digit pace in 2004, real imports of goods and services decelerated to about 4V2 percent in 2005, even as U.S. GDP growth 1999 2001 2003 2005 remained robust. Although overall NOTE: The data are quarterly. The current account growth of non-oil imports was slower data extend through 2005 :Q3, and the trade data extend last year than in 2004, capital goods through 2005:Q4. imports continued strong. The hurri- SOURCE: Department of Commerce. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 19 canes affected several categories of Prices of Oil and of Nonfuel Commodities, imports. Despite a contraction of domes- 2002-06 tic oil consumption, real imports of oil expanded to offset reduced production Imiwy 2002= 100 Deltas per barrel in the Gulf Coast region. Chemicals 160 — imports also registered strong gains Nonfuel toward year-end amid hurricane-related 140 — losses in domestic production. Real 120 — Of: —— 40 imports of services moved up only — 30" 2V4 percent in 2005, a substantial cooling from their 2004 pace. 80 — — 10 Prices of imported goods excluding I l \ l i 1 I 2002 2003 2004 2005 2006 oil and natural gas increased at an annual rate of 1V2 percent in 2005, down NOTE: The data are monthly and extend through from a rate of 23A percent in 2004. January 2006. The oil price is the spot price of West Texas intermediate crude oil. The price of nonfuel Prices decelerated in midyear as the dol- commodities is an index of forty-five primarylar appreciated and nonfuel commodity commodity prices. SOURCE: For oil, the Commodity Research Bureau; prices steadied. However, import prices for nonfuel commodities, International Monetary Fund. accelerated in the fourth quarter of 2005, led by higher prices for chemicals, for delivery in 2012) from an average of metals, and building materials. In global $38 per barrel for January 2005 to about commodity markets, prices of metals $61 per barrel for January 2006. increased an average of 30 percent in Although the rate of growth in 2005, a surge that reflected both robust world oil consumption slowed in 2005 global demand and limited increases in from its torrid pace of 2004, spare prosupply. duction capacity among OPEC mem- A key event in 2005 was the substan- bers remained limited, at an estimated tial increase in the price of crude oil. level of only about 1 million barrels per The spot price of West Texas inter- day. With the perception that additional mediate (WTI) crude oil climbed from capacity would be slow to come on about $43 per barrel at the start of 2005 line, oil markets were highly sensitive to to a peak of about $70 per barrel in news about fluctuations in supply and late August, at the time of Hurricane demand. Market participants' concerns Katrina. The spot price then edged down about crude oil supply were heightened as production revived in the Gulf of by production difficulties in Iraq and by Mexico and as above-average tempera- the resumption of nuclear activities in tures in the United States reduced oil Iran, both posing risks to the stability of demand. After falling to below $60 per Middle East supply. Elsewhere, producbarrel by late November, oil prices tion problems in Nigeria stemming from moved up to an average of about $65 social unrest and a marked slowdown per barrel for January, in part on con- in the growth of Russian production cerns about possible disruptions of for- also kept upward pressure on oil prices eign supply. However, oil prices have throughout the year. declined so far in February. Growing Domestic crude oil supply was conviction among traders that oil-market severely hampered by last year's hurriconditions would remain tight in future canes, which were the most damaging in years pushed the price of the far-dated the history of the U.S. energy industry. NYMEX oil futures contract (currently At the peak of the disruption, all U.S. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

20 92nd Annual Report, 2005 crude oil production in the Gulf of near the levels recorded in 2003 and Mexico (about 28 percent of total U.S. 2004, with smaller purchases of foreign production) and 88 percent of U.S. natu- bonds offset by larger purchases of forral gas production there (about 17 per- eign equities. By contrast, U.S. direct cent of total U.S. production) were shut investment flows abroad slowed markin. At the end of January 2006, 25 per- edly during the first half of 2005 and cent of Gulf oil production remained turned negative in the third quarter. This shut in, and cumulative lost production unusual pattern reflected responses to in the Gulf stood at about 22 percent of the partial tax holiday provided in the the average annual output from that 2004 Homeland Investment Act, which region. Refinery outages, which peaked allowed firms to repatriate at a preferenafter Hurricane Rita at more than one- tial tax rate previous years' earnings that fourth of total U.S. refining capacity, had been reinvested in their foreign caused sharp increases in the prices of affiliates. refined products. Retail gasoline prices in the United States jumped to more The Labor Market than $3 per gallon in early September, briefly crimping gasoline demand and, Employment and Unemployment in turn, demand for crude oil. Petroleum product prices returned to pre-hurricane Conditions in the labor market continlevels within a few weeks as imports ued to improve, on balance, in 2005, soared and refineries resumed opera- although many individuals lost jobs in tions, but they began to rise again in the aftermath of the hurricanes. Non- December and January. farm payroll employment rose 175,000 per month, on average, through August, the same as the average monthly The Financial Account increase in 2004. Net hiring then slowed In 2005, foreign official financial sharply in September and October, as inflows slowed from their extraordinary job losses in the Gulf Coast region pace of 2004 but remained sizable. Most largely offset moderate increases in payof these official inflows took the form of rolls elsewhere in the nation. In Novempurchases of U.S. long-term government ber and December, monthly job growth and private securities for reserve accumulation, primarily by Asian central Net Change in Payroll Employment, banks. The slowdown in foreign official 2000-06 inflows last year was more than offset, however, by an increase in foreign pri- Thousands of jobs, month y average vate purchases of U.S. securities. Most January of this pickup was concentrated in 1 - 200 bonds, as in 2004, but foreign private ~~~ 100 purchases of U.S. equities also increased somewhat. Foreign direct investment 1 — 0 flows into the United States continued to be strong in 2005, with the average pace during the first three quarters a bit LJ 1 _L 2000 2002 2004 2006 higher than in 2004. U.S. residents' net purchases of for- NOTE: Nonfarm business sector. SOURCE: Department of Labor, Bureau of Labor eign securities remained brisk last year, Statistics. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 21 was uneven, but it averaged 250,000, conditions over the course of 2005. Iniand hiring remained brisk in January. tial claims for unemployment insurance The reemployment of many of those drifted lower, and the job openings rate who lost jobs because of the hurricanes moved up. At year-end, the Conference appears to have provided a modest lift to Board reported that a larger proportion overall hiring in recent months. How- of respondents to its monthly survey ever, others affected by the storms thought that jobs were plentiful than apparently have not found new jobs thought that jobs were hard to get. yet, and the unemployment rate among evacuees seems to have remained quite Productivity and Labor Costs high. Employment gains were widespread Labor productivity in the nonfarm busiby industry in 2005. As in 2004, hiring ness sector continued to advance in was especially strong at firms supplying 2005. Last year's increase in output per professional and business services and hour of 2VA percent was noticeably in health care. The construction industry below the average annual gain over the also continued to exhibit a good deal of preceding four years. But taking the vigor, spurred by the booming housing longer view, growth in labor productivsector. Employment in retail trade and ity over the past five years has averaged in food services rose fairly briskly in the 3% percent per year, nearly 3A percentfirst half of the year, but it was held age point faster than the already impresdown in the second half by job losses in sive gains posted between 1995 and the Gulf Coast region. In the manufac- 2000. Productivity appears to have turing sector, employment was essen- received considerable impetus in recent tially flat for a second year after three years from a number of factors, includyears of steep declines. In the govern- ing the rapid pace of technological ment sector, state and local payrolls con- change and the growing ability of firms tinued to rise modestly, while civilian to use information and other technology employment in the federal government to improve the efficiency of their operawas about unchanged. tions. Increases in the amount of capital After hovering around 5V2 percent per worker, especially high-tech capital, during the second half of 2004, the have also helped to spur productivity unemployment rate fell, on net, over the first three months of 2005. During the Change in Output per Hour, 1948-2005 remainder of the year, it fluctuated in a narrow range around 5 percent. In Janu- Percent, annual rate ary 2006, it decreased to 4.7 percent. The labor force participation rate, which — — 6 had dropped noticeably between 2000 4 and 2004, edged up, on net, in 2005. I — The participation rate in January 2006 • I was 66 percent, well below the high of 61 lA percent reached in early 2000 but 1 • J j 1 not far from its trend, which has been declining in recent years as a conse- 1948- 1973- 1995- 1973 1995 2000 quence of demographic forces. Other indicators also pointed to a gradual improvement in labor market 11 • • • • i 2003 2005 NOTE: Nonfarm business sector. SOURCE: Department of Labor, Bureau of Labor Statistics. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

22 92nd Annual Report, 2005 growth over the past few years, although held the increase in unit labor costs to apparently by less than was the case 1 percent. Unit labor costs had risen during the capital spending boom in the more than 3 percent in 2004 after having late 1990s. been close to flat over the preceding Increases in hourly labor compensa- three years. tion were moderate in 2005 even though overall consumer prices rose relatively Prices rapidly for a second year and the downward pressure on wages from labor mar- Headline inflation continued to be ket slack diminished. As measured by boosted by soaring energy prices in the employment cost index (ECI) for 2005, while core inflation—which private nonfarm businesses, hourly com- excludes the direct effects of movements pensation increased 3 percent last year, in food and energy prices—remained 3/4 percentage point less than in 2004. subdued. The PCE chain-type price The wages and salaries component of index rose 3 percent for the second year the ECI rose just 2Vi percent, the same in a row. The increase in core PCE as in 2004, while the cost of providing prices, which in 2004 had ticked up to benefits rose 4 percent after two years of 2lA percent, remained high in early 2005 increases in the area of 6V2 percent to by recent standards. Core PCE inflation 7 percent. Much of the deceleration in subsequently subsided and came in a benefits costs was in employers' contri- shade below 2 percent for the year as butions to retirement plans, which had a whole. The market-based component increased markedly in 2003 and 2004 as of the core PCE price index—which firms ratcheted up their contributions excludes prices that must be imputed to defined-benefit plans to cover earlier because they cannot be observed in declines in the market value of the market transactions and that often plans' assets. Health insurance costs move erratically—rose 13A percent in rose 6V2 percent in 2005, the smallest 2005, unchanged from its pace in 2004. increase since the late 1990s. According to preliminary data, com- Alternative Measures of Price Change, pensation per hour in the nonfarm busi- 2003-05 ness (NFB) sector—an alternative mea- Percent sure of compensation developments derived from the data in the NIPA—rose Price measure 2003 2004 2005 3Vi percent in 2005, about the same rise as in the ECI. In 2004, NFB compensa- Chain-type Gross domestic product (GDP).. 2.0 2.9 3.0 tion had risen nearly 6 percent; a fourth- Gross domestic purchases 2.0 3.4 3.4 quarter surge in the value of stock Personal consumption expenditures (PCE) 1.7 3.1 3.0 option exercises, which are excluded Excluding food and energy ... 1.3 2.2 1.9 from the ECI, likely contributed to that Market-based PCE excluding food and energy 1.0 1.7 1.7 increase. The preliminary estimate for Fixed-weight NFB compensation in 2005 reflects the Consumer price index 1.9 3.4 3.7 apparent reversal of some of the late- Excluding food and energy ... 1.2 2.1 2.1 2004 upswing in compensation, though NOTE: Changes are based on quarterly averages of it is subject to revision when moreseasonally adjusted data. detailed information becomes available SOURCE: For chain-type measures, Department of later this year. In any event, the decel- Commerce, Bureau of Economic Analysis; for fixedweight measures, Department of Labor, Bureau of Labor eration in hourly compensation last year Statistics. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 23 A similar pattern is evident in the core 10 percent in 2005 after a much smaller consumer price index, which rose about rise in 2004. 2 percent in both 2004 and 2005, and in Consumer food prices rose about broad NIPA price measures such as the 2 percent in 2005 after slightly larger price index for GDP, which was up increases in 2003 and 2004. Food prices about 3 percent in both years. received some upward pressure late in The PCE price index for energy rose the year. Crop damage from Hurricane roughly 20 percent in 2005 for the sec- Wilma temporarily pushed up the prices ond year in a row. The nearly 25 percent of some fruits and vegetables, and beef increase in gasoline prices in 2005 prices were boosted by the resumption largely reflected the effects of the con- of some exports to Pacific Rim countinuing surge in crude oil prices on retail tries after the lifting in early December energy prices. Gasoline prices recorded of an extended ban (which was subsome dramatic spikes—notably in the sequently reinstated in January 2006). spring and after the hurricanes—when But, in general, the higher production disruptions at refineries depleted inven- of several livestock products and a tories and pushed up the margin of the bumper harvest of grains helped to limit retail price over the already-elevated increases in retail food prices to about cost of the associated crude oil. After the rate of core inflation. peaking at more than $3 per gallon in The broad contours of core inflation early September, gasoline prices fell in 2005 were about the same as those in sharply over the balance of 2005 as 2004. Prices of core goods, which had demand moderated, refinery capacity in declined in 2002 and 2003, were about the Gulf Coast region came back on flat for a second year. Prices of core line, and imports surged. In January services decelerated a bit—from about 2006, gasoline prices turned up in 3 percent in 2004 to 23/4 percent in 2005. response to higher crude oil costs, and The deceleration was concentrated in they are now running about 50 cents per some nonmarket categories—in particugallon higher than they were in January lar, prices of financial services provided 2005. by banks without explicit charge, for- Consumer prices for natural gas rose eign travel by U.S. residents, and life more than 35 percent in 2005, with most and motor vehicle insurance—that had of the increase coming in the second posted large increases in 2004. With the half of the year. Prices started to move notable exception of airfares, which up around midyear and then skyrock- picked up in 2005 after having fallen in eted in September and October after 2004, prices in other market-based cate- Hurricanes Katrina and Rita curtailed gories of services rose about as fast as production in the Gulf of Mexico. Most they had in 2004. of the shut-in production was restored The run-up in energy prices in by late 2005, and inventories remained 2005 boosted the cost of producing ample for a normal heating season, but other goods and services—especially spot natural gas prices held at elevated for energy-intensive items, including levels through mid-December. They chemicals, plastics, and nitrogenous ferhave since plummeted in response to tilizers. In addition, prices of other comunseasonably warm weather in much of modities such as lumber and a variety the nation but are still far above their of metals, which had soared in 2004 in levels of a year ago. Reflecting higher response to the strengthening of ecoinput costs, PCE electricity prices rose nomic activity worldwide, moved up Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

24 92nd Annual Report, 2005 further in early 2005. Many of those U.S. Financial Markets prices slackened in the spring and sum- U.S. financial markets withstood some mer as industrial production softened, strains in 2005, most notably a large but they turned up again in the fall. All cumulative upward revision to the told, however, the higher input costs left expected path of monetary policy, sharp only a small mark on the prices of core increases in energy prices, troubles in goods and services. A major reason is the auto and airline sectors, and three that the robust upward trend in labor major hurricanes. Longer-term market productivity helped to hold labor costs interest rates remained low, corporate in check and gave firms scope to absorb risk spreads stayed relatively narrow by cost increases. historical standards, and equity prices Near-term inflation expectations have advanced modestly. Banks continued to come under some upward pressure over ease standards and terms on loans to the past year, but recent readings have businesses, and bank lending to busibeen close to those at the beginning of nesses surged. Overall, debt growth in 2005. Apart from an energy-related the business sector picked up, and the spurt to 4V2 percent in early autumn, the expansion of household debt remained Michigan SRC measure of households' quite brisk, but federal borrowing median expectation for inflation over dropped back. The M2 monetary aggrethe next twelve months has been in the gate grew moderately. neighborhood of 3 percent to 3lA percent since March 2005 after hovering in the area of 23A percent to 3 percent Interest Rates in late 2004 and early 2005. In January 2006, it stood at 3 percent. The The FOMC lifted the target federal Michigan SRC measure of the median funds rate a total of 2 percentage points expectation for inflation over the next in 2005, nearly 1 percentage point more five to ten years was also running a than market participants had anticipated bit above 3 percent in late 2005, but at the start of the year. Over the first it dipped to 2.9 percent in January of half of 2005, short- and intermediatethis year, a reading similar to those in term interest rates rose in line with the 2004 and in the first eight months of gradual firming in the stance of mone- 2005. Other indicators likewise suggest tary policy, but longer-term interest rates that longer-run inflation expectations moved lower on balance. For a time have remained well contained. Accord- early in the year, rising oil prices and ing to the Survey of Professional incoming data showing higher-than- Forecasters, conducted by the Federal expected inflation appeared to lift policy Reserve Bank of Philadelphia, expec- expectations as well as interest rates at tations of inflation over the next ten intermediate- and longer-term horizons. years remained at 2V2 percent in 2005, The minutes of the December 2004 as they have since 1998. In addition, FOMC meeting, released on January 4, inflation compensation, as measured by 2005, and the FOMC's conditioning the spread of yields on nominal Trea- of its risk assessment on "appropriate sury securities over their inflation- monetary policy action" after its March protected counterparts, fell a bit, on bal- 2005 meeting were read as indicating ance, in 2005. more concern among Committee mem- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 25 bers about inflation pressures than landfall of two additional major storms, investors had anticipated. The ten-year investors marked down sharply their Treasury yield moved up after Chair- expectations for the path of moneman Greenspan's semiannual congres- tary policy, predominantly at longer sional testimony in February 2005, as horizons, and nominal Treasury yields investors reportedly focused on his dipped. Those declines in yields proved remark that the low level of long-term temporary, though, as incoming data in interest rates at that time was a "conun- the weeks after the hurricanes indicated drum." However, the subsequent release that output had been expanding briskly of weaker-than-expected data on con- before the storms hit and that the sumer spending, consumer sentiment, resulting disruptions to economic activand output led investors to mark down ity would probably be less severe than again their anticipated path for mone- investors had initially feared. In additary policy and caused intermediate- tion, a drop in some energy prices might term Treasury yields to retreat some- have contributed to an upgrading of the what on balance during the second economic outlook. Over the remaining quarter, while the ten-year Treasury three months of the year, data on spendyield declined sharply. ing and production generally appeared On balance over the second half of robust, and investors raised their expecthe year, investors became more confi- tations for the path of monetary policy a dent that the economic expansion had bit more. substantial momentum, and the expected On net in 2005, the yield on the twopath of policy and nominal Treasury year nominal Treasury note rose about yields moved considerably higher. Eco- 135 basis points, whereas the yield on nomic data that came in over the sum- the ten-year Treasury note increased mer months suggested more strength in only about 15 basis points. As a result, spending and output than investors had longer-horizon forward rates extended been anticipating. However, in response their decline that had begun around the to the devastation caused by Hurricane middle of 2004, the onset of the current Katrina in August and the subsequent tightening cycle. Although the reasons for this large cumulative drop are not Interest Rates on Selected Treasury entirely clear, this general pattern was Securities, 2003-06 also evident last year in other major industrialized economies, where longer- Perceat term interest rates mainly declined. One —- possibility is that higher energy prices Ten-year might have led investors to trim their *—s assessment of the cumulative amount of monetary policy restraint required _^ Two-year over the longer run that would be con- Tltree-month — 2 (/ sistent with sustainable economic i growth. Investors also appeared to ! i 1 ! 1 1 become less uncertain about the outlook 20Q3 2004 . 2005 2006 and so might have become more willing NOTE: The data are daily and extend through Feb- to accept smaller risk premiums on longruary 8,2006. term securities. Another possible expla- SOURCE: Department of the Treasury. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

26 92nd Annual Report, 2005 nation is that long-term inflation expec- To date in 2006, amid uneven incomtations have fallen and have become ing economic data, investors' expectamore firmly anchored. As measured by tions for the path of the target federal the spread between yields on nominal funds rate have edged up, as have Treasury securities and their inflation- intermediate- and longer-term nominal protected counterparts, inflation com- Treasury rates. However, spreads on pensation fell a bit more than 30 basis investment-grade corporate securities points at the ten-year horizon over 2005. have changed little, whereas those on Finally, it is possible that an excess of speculative-grade issues have declined global saving over planned investment somewhat. has lowered real longer-term interest rates. Equity Markets In the corporate bond market, risk spreads widened modestly in 2005, but Share values, as measured by the the generally healthy state of corporate Wilshire 5000 index, rose about 4V2 perbalance sheets and the robust growth of cent in 2005. Higher energy prices and profits kept spreads low by historical expectations for tighter monetary policy standards. Spreads in the auto sector damped equity prices at times during were an exception, however, as the the year, but these downward pressures troubles that emerged in the spring at were offset by continued strong corpo- GM and Ford and the bankruptcy of rate earnings growth and largely upbeat Delphi last fall boosted spreads sharply news on the economy. The response of in this sector. The bankruptcies of two stock prices to the hurricanes was genermajor airlines and the revelation of ally muted—low longer-term interest apparent accounting fraud at Refco, a rates and the prospect of additional fislarge derivatives broker, did not appear cal stimulus apparently offset concerns to have a material effect on broad corpo- that yet-higher energy prices might trim rate risk spreads. economic growth. On net last year, energy-related stocks registered substantial gains in response to the rise in Spreads of Corporate Bond Yields over the price of oil. To date in 2006, major Comparable Off-the-Run Treasury Yields, equity indexes have risen modestly amid 1997-2006 Stock Price Indexes, 2004-06 Percentage points January' 2» 2004 * 100 Russell 2000 A w 1998 2000 2002 2004 2006 NOTE: The data are daily and extend through 2004 2005 2006 February 8, 2006. The high-yield index is compared with the five-year Treasury yield, and the BBB and AA NOTE: The data are daily and extend through Febindexes are compared with the ten-year Treasury yield. ruary 8, 2006. SOURCE: Merrill Lynch AA and BBB indexes and SOURCE: Frank Russell Company; Dow Jones Merrill Lynch Master II high-yield index. Indexes. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 27 largely positive news about fourth- that loan demand had strengthened. Real quarter earnings. estate lending by banks was brisk again Volatilities of equity prices implied last year, though it cooled somewhat by prices on options contracts on both in the fourth quarter in the wake of the S&P 500 and Nasdaq 100 indexes the backup in longer-term interest remained low over most of 2005, rates. Consumer loans on banks' books apparently owing to perceptions of expanded rapidly during the first quarter only modest near-term macroeconomic of 2005 but then less so over the balance risk. However, the spread between the of the year, in part because some housetwelve-month forward earnings-price holds substituted lower-cost mortgage ratio for S&P 500 firms and an estimate credit for consumer loans. of the real long-term Treasury yield— Measures of bank profitability in a measure of the long-term equity risk 2005 fell back a bit from the very premium—widened a bit last year and is high levels posted in 2003 and 2004 but now in the upper part of its range of remained robust by historical standards. the past two decades. Arithmetically, the Profitability was restrained by vigorous widening in this spread can be attributed competition and downward pressure on to a decline in the measure of the real net interest margins from increases in long-term Treasury yield; the measure market interest rates, but it was supof the earnings yield on the S&P 500 ported by excellent asset quality and changed little on balance last year. reductions in noninterest expenses relative to assets. Banks' provisioning for loan losses over the first three quarters Debt and Financial Intermediation of last year was lower, on average, than The total debt of the domestic nonflnan- in 2004, even with the increase in provicial sectors expanded an estimated sioning in the third quarter owing to the 9 percent in 2005, about the same pace prospective surge in personal bankruptas in 2004. However, the composition of cies and to the hurricanes. debt growth differed somewhat from the Mortgage market assets held by previous year: Borrowing by nonfinan- government-sponsored enterprises decial businesses picked up in 2005 while clined in 2005, as Fannie Mae reduced federal borrowing dropped back. The its mortgage portfolio about 20 percent growth of debt of the household sector and the rate of portfolio increase by remained brisk, driven by the rapid Freddie Mac was somewhat below the expansion of mortgages. rate of growth of residential mortgage Commercial bank credit expanded debt in general. The reduction at Fannie lO1^ percent in 2005, a bit faster than Mae occurred partly in response to the brisk pace registered in 2004. regulatory concerns about the adequacy Growth of commercial and industrial of its capitalization. These concerns loans jumped to 13V2 percent, the fastest increased substantially after the compace in more than two decades. As pany revealed in late 2004 that it had noted, senior loan officers reported in improperly accounted for certain derivaquarterly surveys that they had eased tive transactions. Fannie Mae's share terms and standards on such loans last price dropped about 30 percent last year. They attributed the easing to an year, and Freddie Mac's declined about improved economic outlook and more- 10 percent. Yield spreads on both firms' aggressive competition from other banks debt over comparable-maturity Treasury and nonbank lenders. They also reported securities were little changed on net. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

28 92nd Annual Report, 2005 The M2 Monetary Aggregate 2005 was driven importantly by strong demand from the United States and M2 rose 4 percent in 2005, a pace sig- China, but domestic demand picked up nificantly slower than the growth in in a number of other countries as well. nominal income and the lowest annual The run-up in prices of crude oil and rate of expansion in about a decade.1 As other commodities over 2005 appeared is typical in a period of rising rates, the to have had only a modest effect on opportunity cost of holding M2 assets measures of inflation in most countries. increased significantly over the course Cumulative changes in monetary polof the year, as changes in rates on liquid icy in foreign industrial economies durdeposits lagged those in market yields. ing 2005 varied in direction and, in con- Consequently, growth in liquid deposits trast to the United States, were mostly almost came to a halt following doublesmall. The European Central Bank, digit expansion during the previous sevwhich had maintained its main policy eral years. Some offset was provided by interest rate at 2 percent since the middle a rapid increase in small time deposits, of 2003, tightened 25 basis points late rates on which remained better aligned in 2005, citing a need to keep inflation with short-term market rates. After havexpectations in check. The Bank of ing contracted sharply in the past couple England, after tightening 100 basis of years, shares of retail money market points in 2004, lowered its policy rate mutual funds were about flat, on net, as 25 basis points in August 2005, as the the return on such balances improved in U.K. housing market had cooled and as line with short-term interest rates. Hurricane relief efforts likely added a little the growth of household spending and to the growth of M2 last year: Funds business investment had slowed. The provided by the federal government Bank of Canada raised its target for the to displaced households and funds overnight rate a total of 100 basis points advanced by insurance companies prob- in the latter part of 2005 and the beginably buoyed M2 over the last four ning of 2006, stating that the Canadian months of 2005, as did a rise in the use economy was operating again at full of currency in the affected areas. capacity. The Bank of Japan did not depart in 2005 from its policy of quantitative easing, as it continued to provide International Developments large amounts of bank reserves to keep short-term interest rates near zero. How- Foreign economic activity remained ever, in the second half of the year, amid strong in 2005, as the global economy growing evidence that an end to condisplayed resilience in the face of sizsumer price deflation might be near, able increases in energy prices. Manu- Bank of Japan officials began to discuss facturing and trade expanded in most publicly the possibility of ending the industrial and emerging economies. As policy in 2006. in 2004, global economic growth in Ten-year sovereign yields in the euro area and Canada have declined 15 to 1. The Board announced in November that 20 basis points on net since the beginin March 2006 it would cease compilation and ning of 2005, and ten-year U.K. sovpublication of data on the M3 monetary aggregate; ereign yields have dropped 35 basis publication of M3 was judged to be no longer points. Over the same period, Japanese generating sufficient benefit in the analysis of the ten-year sovereign yields have risen economy or of the financial sector to justify the costs of publication. about 15 basis points, somewhat less Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 29 than U.S. Treasury yields of the same 4 percent since early 2005. With respect maturity. Despite higher energy prices, to currencies of other important tradlong-term inflation expectations appear ing partners, the dollar has depreciated to have remained well contained abroad. 6 percent against the Mexican peso, In Europe, Canada, and Japan, the dif- 17 percent versus the Brazilian real, and ferences between ten-year nominal and 7 percent against the Korean won. inflation-indexed bond yields currently Equity prices have risen substantially are little changed from their levels at the in most foreign industrial and emergingstart of 2005. market countries since early 2005; these Our broadest measure of the nominal prices have been supported by the contrade-weighted exchange value of the tinued global economic expansion and dollar has risen 2x/2 percent on net since by interest rates that, in most counthe beginning of 2005. The dollar likely tries, have remained well below historiwas supported by the FOMC's signifi- cal averages. Rising commodity prices cant cumulative policy tightening, only have buoyed share prices of firms in the part of which had been anticipated by energy and mining sectors, and share market participants at the start of 2005. prices in the technology sector have also The dollar's overall appreciation was increased sharply. Since the beginning driven by its sharp gains against the of 2005, headline equity indexes, meacurrencies of several major industrial sured in local currencies, have risen countries; the dollar depreciated on about 20 percent on net in the United average against the currencies of the Kingdom, 30 percent in the euro area, United States' other important trading and 45 percent in Japan. In the United partners. Since the start of 2005, the States, by contrast, equity prices have dollar has appreciated about 15 percent increased only modestly over the same versus the euro and the Japanese yen, period. and 10 percent against the British pound. A notable exception to this Industrial Economies pattern is the Canadian dollar, against which the U.S. dollar has depreciated After expanding at an annual rate of 5lA percent in the first half of 2005, Japanese real GDP growth declined to U.S. Dollar Exchange Rate against Selected Major Currencies, 2003-06 1 percent in the third quarter, largely because of slower inventory accumui Week ending January ~\, 200 \= 100 lation. Throughout the year, the most important source of support to economic V.IC. pound growth was domestic demand, which Japanese yen 100 was lifted by improvements in corporate profitability and labor market conditions. The unemployment rate declined *JL Euro 80 sharply during 2005, ending the year at t Canadian •— 70 just under AVi percent. The rate of defladollar h i i | I 1 tion in core consumer prices subsided \ 2003 2004 2005 2006 considerably in 2005; in fact, from December 2004 to December 2005, core NOTE: The data are weekly and are in foreign currency units per dollar. The last observation for each prices posted a 0.1 percent increase. series is the average of February 6 through February 8, However, the GDP deflator continued to 2006. fall at a slow rate. SOURCE: Bloomberg L.P. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

30 92nd Annual Report, 2005 Economic growth in the euro area inflation settled back toward 2 percent, remained weak in the first half of 2005, the midpoint of the Bank of Canada's at around a IV2 percent annual rate. inflation target range. Growth picked up to 2Vi percent in the third quarter, spurred by stronger Emerging-Market Economies exports, especially by Germany. However, weakness in household spending Growth of real GDP in China remained persisted. The area-wide unemploy- vigorous in 2005, supported again by ment rate fell slightly over the year, robust domestic demand and exports. to 8V4 percent near year-end, although Both personal consumption and investemployment only edged up. For the ment expenditures continued to grow sixth straight year, euro-area inflation rapidly during the year. Export growth remained just above the ECB's medium- also remained strong through most term goal of less than (but close to) of the year, while import growth 2 percent. slowed. As a result, the Chinese trade The rate of growth of real GDP in the surplus more than tripled and exceeded United Kingdom slowed from 3V4 per- $100 billion. Consumer price inflation cent in 2004 to VA percent in 2005. The in 2005 was low in comparison with slowdown was marked by a substantial the previous year, when higher food deceleration of both private and gov- prices had caused inflation to surge; ernment consumption. Labor markets the twelve-month change in consumer remained tight, however; the unemploy- prices finished the year at just over ment rate of 2.9 percent in December IV2 percent. was up only slightly from the twenty- On July 21, China revalued the year low of 2.6 percent recorded in renminbi 2.1 percent versus the dollar January 2005. Consumer price inflation and announced that henceforth it would over the twelve months ending in manage the value of its currency with December 2005 was 2 percent, in line reference to a basket of foreign currenwith the central bank's official target. cies. Since the July revaluation, the In contrast to the substantial run-up in exchange value of the renminbi versus real estate prices of 2004, housing price the dollar has risen about Vi percent. increases in 2005 were small. Chinese authorities also have imple- Canadian economic growth was solid mented some reforms of the financial again in 2005. Recovering from a slow system that are intended to facilitate first quarter that featured a sharp but further exchange rate flexibility, includtemporary pullback in exports, real GDP ing the introduction of an over-thegrowth rebounded to around 3V2 per- counter trading system in the domestic cent in the second and third quarters. foreign exchange market. China's for- For a second straight year, strong eign exchange reserves increased more domestic demand underpinned growth, than $200 billion in 2005; the pace of but net exports also made a positive reserve accumulation did not change contribution to growth late in the year. appreciably after the revaluation of the Employment made gains, although not renminbi in July. as large as in the previous three years, In other emerging-market nations in and the unemployment rate touched a Asia, economic activity also picked up thirty-year low of 6.4 percent at year's substantially in 2005, driven by the end. After spiking in the third quarter on growth of domestic demand and exports. rising gasoline prices, consumer price Despite the global rise of energy costs, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2005 and Early 2006 31 consumer price inflation generally since then. High oil revenues boosted remained contained. Equity indexes the public-sector surplus, and yield registered large increases in a number spreads of Mexican sovereign debt over of Asian countries, led in many cases U.S. Treasuries declined to record lows. by gains in share prices of technology In Brazil, growth in economic activity firms. In particular, Korean equity prices was moderate in the first half of 2005, have risen about 45 percent since early and some indicators point to a slow- 2005. Several countries in the region ing over the second half. Nonetheless, added to their holdings of foreign risk spreads of Brazilian sovereign debt exchange reserves over the period, but declined over the course of the year to in all cases far less than China did. their lowest levels since 1997, the real After a solid performance in 2004, appreciated strongly, and stock prices the Mexican economy slowed in the rose sharply. Concerns over inflation first quarter of 2005 and contracted in kept monetary policy very tight for most the second quarter because of weaker of the year, but the central bank began exports to the United States and a sharp easing in September, and the policy rate drop in agricultural production. How- was reduced a total of 250 basis points, ever, the Mexican economy recovered to 11 VA percent, by January. In late in the second half of the year, as agri- December, Brazil paid in full its debt to cultural and manufacturing production the International Monetary Fund (IMF), bounced back. Aggressive tightening using a portion of its foreign exchange of monetary policy from early 2004 to reserves. March 2005 seemed to be successful in In Argentina, the economic recovery restraining inflationary pressures: Con- continued last year, driven in part by sumer price inflation declined from increases in consumption and investmore than 5 percent at the end of 2004 ment. After more than three years in to a bit less than 4 percent in January default, the government completed a 2006, within the central bank's target debt swap, restructuring $80 billion in range of 2 percent to 4 percent. The bonds and obtaining a participation rate soft economy and an improved outlook of 76 percent. Early this year, Argentina for inflation led the Bank of Mexico to also paid in full its IMF obligations out begin easing policy in August 2005, and of its foreign exchange reserves. • the central bank has continued to ease Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

33 Monetary Policy Report of July 2005 Monetary Policy and the energy components, which are volatile). Economic Outlook As measured by the price index for personal consumption expenditures exclud- The U.S. economy continued to expand ing food and energy, core inflation at a solid pace over the first half of 2005 increased from an annual rate of 1 ¥z perdespite the restraint imposed on aggrecent in 2004 to about 2 percent between gate demand by a further rise in crude the fourth quarter of 2004 and May oil prices. Household spending trended 2005. While survey measures of nearup, propelled by rising wealth and term inflation expectations have edged income and by low interest rates, and up this year, surveys, as well as readings business outlays received ongoing supfrom financial markets, suggest that port from favorable financial conditions, expected inflation at longer horizons has rising sales, and increased profitability. remained contained. Moreover, the earlier declines in the for- With financial conditions advantaeign exchange value of the dollar shifted geous for households and firms, a solid some domestic and foreign demand economic expansion in train, and some toward U.S. producers. Overall, the ecoupward pressure on inflation, the Fednomic expansion was sufficient to create eral Open Market Committee (FOMC) jobs at roughly the same pace as in late continued to remove policy accommo- 2004 and to lower the unemployment dation at a measured pace over the first rate further over the first half of this half of the year, raising the intended year. federal funds rate an additional 1 per- Higher oil prices boosted retail prices centage point, to 3lA percent, by the end of a broad range of consumer energy of June. At the most recent FOMC meetproducts and, as a result, continued to ing, the Committee judged that policy hold up the rate of overall consumer remained accommodative. With approprice inflation in the first half of 2005. priate monetary policy, however, the In addition, the rise in energy prices upside and downside risks to output and this year, coupled with increases in the inflation were viewed as balanced, and prices of some other commodities, the Committee underscored its commitimported goods, and industrial materiment to respond to changes in economic als, put upward pressure on the costs prospects as needed to fulfill its obligaof many businesses. A portion of these tion to maintain price stability. costs was passed on to consumers, The fundamental factors that supwhich contributed to a higher rate of ported the U.S. economy in the first half inflation in core consumer prices (that of 2005 should continue to do so over is, total prices excluding the food and the remainder of 2005 and in 2006. In the household sector, the combination of NOTE: The discussion in this chapter consists further gains in employment, favorable of the text and tables from the Monetary Policy borrowing terms, and generally healthy Report submitted to the Congress on July 20, balance sheets should keep consumer 2005; the charts from that report (as well as earlier reports) are available on the Board's web site, at spending and residential investment on www.federalreserve.gov/boarddocs/hh. an upward path. In the business sector, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

34 92nd Annual Report, 2005 expanding sales, the low cost of capital, tent than currently appears likely, the and the replacement or upgrade of aging outlook for inflation would be adversely equipment and software should help to affected. Economic growth and inflation maintain increases in capital spending. will also be shaped importantly by the And, although economic performance evolution of the imbalance in the U.S. has been uneven across countries, con- current account. tinued growth overall in the economies of U.S. trading partners should sustain The Conduct of Monetary Policy the demand for U.S. exports. In contrast, over the First Half of 2005 ongoing increases in imports will likely continue to subtract from the growth Despite increases in the federal funds of U.S. gross domestic product. In addi- rate totaling 1V4 percentage points in tion, high energy prices remain a drag 2004, monetary policy was still judged on aggregate demand both here and to be accommodative at the start of abroad, though this drag should lessen 2005. At the time of the February over time if prices for crude oil level out FOMC meeting, the available informain line with quotes in futures markets. tion indicated that the economy had Despite the upward pressure on costs expanded at a robust pace through the and prices over the past year or so, core end of 2004 and retained considerable consumer price inflation is likely to momentum. Accordingly, the Commitremain contained in 2005 and 2006. tee voted to raise its target for the Longer-run inflation expectations are federal funds rate from 2VA percent still well anchored, and because busi- to 2V2 percent and to make minimal nesses are adding to their stocks of capi- changes to the text of the accompanytal and are continuing to find ways to ing statement. The statement reiterated use their capital and work forces more that "the Committee believes that policy effectively, structural productivity will accommodation can be removed at a likely rise at a solid pace over the fore- pace that is likely to be measured." seeable future. In addition, barring a fur- Members noted, however, that this ther increase in oil prices, the boost that forward-looking language was clearly higher energy costs have given to core conditioned on economic developments inflation should wane in coming quar- and therefore would not stand in the ters, while the recent appreciation of way of either a pause or a step-up in the dollar, as well as the deceleration policy firming depending on events. in global materials prices, will likely By March, the data were pointing to a reduce the impetus to inflation from ris- further solid gain in activity during the ing import prices. first quarter, fueled especially by contin- Of course, substantial uncertainties ued increases in consumption expensurround this economic outlook. A fur- ditures and residential investment. In ther sharp rise in crude oil prices would addition, private nonfarm payrolls were have undesirable consequences for both posting widespread advances, and slack economic activity and inflation, and the in resource utilization appeared to be possibility that housing prices, at least in diminishing. The Committee voted at its some locales, have moved above levels March meeting to raise the federal funds that can be supported by fundamentals rate another 25 basis points, to 23A perremains a concern. As another example, cent. In view of the rise in prices of if the recent surge in measured unit energy and other commodities and labor costs were to prove more persis- recent elevated readings on inflation in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 35 core consumer prices, the Committee Economic Projections altered the text of the policy statement for 2005 and 2006 to note the pickup in inflationary pres- In conjunction with the FOMC meeting sures. The Committee also decided to at the end of June, the members of the modify the assessment of the balance of Board of Governors and the Federal risks to make it explicitly conditional on Reserve Bank presidents, all of whom an assumption of "appropriate" moneparticipate in the deliberations of the tary policy, so as to underscore that FOMC, were asked to provide economic maintaining balanced risks would likely projections for 2005 and 2006. In genrequire continued removal of policy eral, Federal Reserve policymakers accommodation. expect the economy to continue to The evidence that had accumulated expand at a moderate pace and core by the spring pointed to some moderainflation to remain roughly stable over tion in the pace of activity. Retail spendthis period. The central tendency of the ing flattened out for a time, likely in FOMC participants' forecasts for the response to higher energy prices, and increase in real (that is, inflation the growth of capital spending dropped adjusted) GDP is 3Vi percent over the back from its elevated pace of late last year. Nonetheless, with long-term interest rates still quite low and with employ- Economic Projections for 2005 and 2006 ment and profits continuing to rise, Percent economic activity appeared to retain considerable momentum, suggesting that Federal Reserve Governors and the softness would be short lived. Reserve Bank presidents Indicator Against this backdrop, the FOMC decided to raise the federal funds rate Range Central tendency another 25 basis points at its May meeting and to make few changes to the text 2005 of the accompanying statement. In the weeks after the May meeting, t C o h f a o n u g rt e h , fo q u u r a t r h t er q 1 uarter i th n a c t o m th i e n g u n i d n e d r i l c y a i t n o g rs p s a u c p e p o o f r te a d ct i t v h i e ty v w ie a w s N R PC e o a m E l i p G n r a D i l c P e G i D nd P ex excluding 5 3 - - 6 3 V 3/ 4 4 5y 3 2 V -5 2 3/4 not faltering. The information that the food and energy V/2r-2V4 P/4-2 Committee reviewed at the time of the Average level, June FOMC meeting showed that con- fourth quarter Civilian unemployment sumer spending and business investment rate 5-5V4 5 had turned up, on balance, and that demand for housing continued to be 2006 strong. With economic activity remain- Change, fourth quarter ing firm and crude oil prices ratcheting to fourth quarter1 higher, the FOMC voted to raise the Nominal GDP 5-6 5V*-5Vi Real GDP VA-VA 3lA-VA funds rate an additional 25 basis points, PCE price index excluding to 3lA percent, and to make only mini- food and energy mal changes to the text of the accompa- Average level, \Yz-2Vi P/4-2 nying statement. This action brought the fourth quarter Civilian unemployment cumulative increase in the target federal rate funds rate since June 2004 to 2lA per- 1. Change from average for four5th quarter of p5revious centage points. year to average for fourth quarter of year indicated. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

36 92nd Annual Report, 2005 four quarters of 2005 and 3x/4 percent to Rising energy prices continued to 3V2 percent in 2006. The civilian unem- boost consumer price inflation in the ployment rate is expected to average first half of 2005. With consumer energy 5 percent in both the fourth quarter of prices having climbed more than 13 per- 2005 and the fourth quarter of 2006. cent at an annual rate so far this year, FOMC participants project that the the price index for personal consumpchain-type price index for personal con- tion expenditures (PCE) increased at an sumption expenditures excluding food annual rate of about 2Vi percent between and energy will increase between the fourth quarter of 2004 and May l3/4 percent and 2 percent both this year 2005, the same pace as in 2004. Meanand next. while, the core PCE price index rose at an annual rate of about 2 percent in the first half of 2005, up from 1 Vi percent in 2004. Economic and Financial Developments in 2005 The Household Sector The economic expansion entered 2005 on a solid footing and was led by ongo- Consumer Spending ing increases in consumption, residential investment, and business spending Consumer spending continued to move on equipment and software. Although higher in the first half of this year, the pace of expansion slowed somewhat though not as rapidly as in the second in the early spring, activity has picked half of 2004. After increasing at an averup again more recently. On average, real age annual rate of AVi percent in the GDP appears to have increased a little third and fourth quarters of last year, less rapidly over the first half of 2005 real personal consumption expenditures than in the second half of 2004, a reflec- rose at a 3V2 percent rate in the first tion in part of reduced fiscal stimulus quarter and appear to have advanced at a and the drag on economic activity from roughly similar pace in the second quarhigher energy prices. Industrial produc- ter. Household spending this year has tion has also risen more slowly so far been supported by rising employment this year than in 2004: The increase and household wealth as well as by the totaled 3 percent at an annual rate low level of interest rates. However, between December 2004 and June higher costs for consumer energy prod- 2005, down from 5 percent during the ucts have eroded households' purchasprevious six months. Nevertheless, the ing power. economic expansion has been suffi- Sales of light motor vehicles, which cient to gradually absorb slack in labor had been buoyed in the second half of and product markets. Nonfarm payroll last year by a variety of sales induceemployment has continued to increase, ments, dropped back in the first quarter and the unemployment rate has moved after many of the inducements expired. down further since the beginning of the However, sales firmed again in the secyear, to 5 percent in June. Similarly, the ond quarter to an average annual pace rate of capacity utilization in the man- of more than 17 million units, a level ufacturing sector stood at 78.4 percent similar to that in the fourth quarter of in June, up from 77.9 percent at the end last year. Underlying demand for light of 2004 and just a little below its long- motor vehicles has remained relatively term historical average. strong, though sales likely have also Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 37 been boosted recently by sizable price Because changes in wealth influence discounts. consumer spending with a lag, both the Excluding motor vehicles, consumer earlier and the more-recent increases spending posted strong gains in early in household net worth have supported 2005, flattened out in March, and picked consumption this year. As wealth up again in the spring. On a quarterly increased and interest rates remained average basis, the rate of increase in quite low, the personal saving rate edged non-auto spending appears to have down to just Vi percent of disposable stepped down in the second quarter, income in April and May. Over the prelargely because of a deceleration in out- vious two decades, the personal saving lays for consumer goods. Meanwhile, rate averaged close to 5 percent. real outlays for services rose at an annual rate of about 3 percent in the first Residential Investment quarter, and the available data point to an increase of about the same magnitude Activity in the housing market continin the second quarter. ued at a strong pace in the first half of If the effect of Microsoft's $32 billion 2005. Real expenditures on residential special dividend payment in December structures increased at an annual rate 2004 is excluded from the calculation, of 11V2 percent in the first quarter and real disposable personal income (that is, appear to have posted another gain in after-tax income adjusted for inflation) the second quarter. In the single-family rose at an annual rate of about 2 percent sector, starts of new units averaged between the fourth quarter of 2004 and 1.69 million at an annual rate between May 2005, a slower pace than in 2004. January and June—nearly 4 percent Although increases in employment and above the pace posted over the second earnings pushed up wage and salary half of 2004. Similarly, starts of multiincome over the first half of 2005, the family units averaged 360,000 over the rise in real income was damped to some first six months of 2005, about 3lA perdegree by the energy-driven increase in cent higher than in the previous six consumer prices. Higher energy prices months. also appear to have weighed on con- As in 2004, the demand for housing sumer confidence for much of this during the first half of 2005 was supyear. Surveys by both the Michigan ported by rising employment and Survey Research Center (SRC) and the income and by low mortgage rates. Conference Board indicate that house- Rates on thirty-year fixed-rate morthold sentiment edged down through gages have fluctuated between 5V2 perthe early spring, though readings from cent and 6 percent in recent months and these surveys turned up again more are currently near the low end of that recently. range. In addition, demand reportedly Household wealth appears to have has been boosted by a rise in purchases increased a bit faster than nominal dis- of second homes—either as vacation posable income over the first half of this units or as investments—and by the year; the small increase in the wealth- greater availability of less-conventional to-income ratio comes on the heels of financing instruments. These financing substantial increases in 2003 and 2004. instruments, including interest-only Although stock prices have changed mortgages and adjustable-rate mortlittle, on net, thus far this year, home gages that allow borrowers a degree of prices have continued to rise sharply. flexibility in the size of their monthly Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

38 92nd Annual Report, 2005 payments, have enabled some house- many households would currently find holds to buy homes that would other- refinancing to be attractive. wise have been unaffordable. As a Consumer credit expanded at an result, both new and existing home sales annual rate of about 4V2 percent over the have remained remarkably robust this first quarter of the year and was about year, and both were at or near record unchanged in April and May. The levels in May. growth of consumer credit has contin- The strong demand for housing has ued to be restrained by substitution continued to push up home prices this toward home equity debt as a means to year. Although rates of house price finance household expenditures. appreciation were a little slower in the Measures of household credit quality first quarter of this year than in 2004, have remained favorable. Delinquency the repeat-transactions price index for rates on credit card debt and auto loans existing homes (limited to purchase- have continued to decline from already transactions only), which is published low levels. The pace of bankruptcy filby the Office of Federal Housing Enter- ings has run a little higher than at the prise Oversight and partially adjusts for same time last year; however, that pace changes in the quality of homes sold, has probably been boosted by a rush to was nonetheless up 10 percent relative file before the new rules in the Bankto its year-earlier level. Price apprecia- ruptcy Abuse Prevention and Consumer tion has been especially sharp over the Protection Act of 2005 take effect in past year in some large metropolitan October. Reflecting the rapid pace of areas, including Las Vegas, Miami, household debt growth, the ratio of San Francisco, and New York, but rapid household financial obligations to disincreases in home prices have been posable personal income has edged up observed in other areas as well. In many from a year earlier, though this ratio of these locales, recent price increases remains a bit below the peak level have far exceeded the increases in rents reached in late 2002. and household incomes. Household Finance The Business Sector Supported by rising house prices and Fixed Investment continued economic expansion, household debt increased at an annual rate of After posting a robust gain in the second about 9lA percent in the first quarter of half of 2004, real business fixed invest- 2005. This advance was paced by a rise ment rose at a more moderate pace over in mortgage debt of lOVi percent at an the first half of 2005, as the rate of annual rate. However, even that rapid increase in expenditures on equipment rise in mortgage debt represented a and software (E&S) dropped back and slight deceleration from the torrid pace outlays for nonresidential structures in 2004, a development in line with the remained lackluster. Nonetheless, ecosmall slowdown in the pace of house nomic and financial conditions appear price appreciation. Despite the increase to be supportive of capital spending: in mortgage debt, net housing wealth Sales and corporate profits have continrose. Refinancing activity has remained ued to increase, businesses have ample subdued, as rates on fixed-rate mort- liquid assets at their disposal, and finangages are a little above levels at which cial market participants appear willing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 39 to finance new investment projects at more favorable recently, as shipments favorable terms. and imports for this broad category Real E&S spending rose at an annual increased noticeably, on balance, in rate of 6 percent in the first quarter after April and May. In addition, unfilled having advanced at an 18 percent pace orders for such equipment remain at in the second half of 2004. Led by large high levels. increases in purchases of computers and Real nonresidential construction concommunications equipment, spending tinued at a low level in the first half of on high-tech equipment posted a siz- this year, but fundamentals are starting able gain in the first quarter. In contrast, to show signs of improvement. The conoutlays for transportation equipment struction of office buildings and indusdropped back early in the year because trial facilities has been restrained for of a small decline in business expendi- some time by elevated vacancy rates, tures on motor vehicles and a sharp drop weak demand, and higher costs for conin aircraft purchases after a surge in struction materials. However, vacancy the fourth quarter of 2004. Investment rates in these sectors have recently in equipment other than high-tech and turned down, and construction outlays transportation goods, a category that for these types of buildings appear accounts for about 40 percent of E&S to have edged higher, on net, so far in nominal terms, also edged down in this year. Commercial building—which the first quarter after registering a siz- includes retail outlets and warehouses— able gain in the second half of last year. also appears to have increased this year, The types of equipment in this category in part because of strong growth in the of investment tend to be sensitive to construction of large retail stores. Meantrends in business sales, but the timing while, investment in the drilling and of business spending may have been mining sector has trended up, on balinfluenced by the provisions of the ance, over the past year, as higher prices partial-expensing tax incentive, which for natural gas boosted the demand for encouraged capital spending to be pulled new drilling rigs. forward in advance of the incentive's expiration at the end of 2004. Inventory Investment More-recent indicators of E&S spending point to another moderate rise in As in 2004, businesses accumulated investment in the second quarter. In par- inventories at an appreciable pace early ticular, outlays for transportation equip- this year. Outside the motor vehicle ment appear to have turned up, on net, industry, nonfarm inventories increased as a step-up in purchases of aircraft at an annual rate of $66 billion in real more than offset a further decline in terms in the first quarter of 2005. The business spending on motor vehicles. At rapid rate of inventory accumulation late the same time, the evidence on high- last year and early in 2005 appears pritech spending has been mixed: Real marily to have been the result of efforts spending on computers appears to have by firms to replenish stocks that had registered another large gain in the sec- been depleted by the strong pace of sales ond quarter, while the rate of increase in 2003 and 2004; apart from firms in outlays for communications equip- in a limited number of sectors, such as ment apparently fell back. Indicators of steel and paper, most businesses do not spending on equipment other than trans- appear to be holding excess stocks, portation and high tech have looked even taking into account the downward Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

40 92nd Annual Report, 2005 trend in inventory-sales ratios that has oil prices, but corporate earnings in the resulted from the improvement in automobile sector declined sharply. supply-chain management capabilities. Given continued strong corporate The rebuilding of inventories in most profits and the accompanying strength industries appears to have been largely in cash flow, nonfinancial firms' completed, and the available data for demand for external financing to fund April and May point to a noticeable capital expenditures has remained somestep-down in the pace of stockbuilding. what subdued. Net equity issuance has Indeed, in recent surveys, businesses stayed negative so far this year, and have been reporting that they and their share retirements have been boosted by customers are increasingly comfortable considerable stock buybacks and cashwith current levels of stocks, whereas financed merger and acquisition activin 2004 and early 2005, many were still ity. Gross corporate bond issuance has characterizing inventory positions as too been limited, and the proceeds have lean. been used mainly to pay down existing One important exception to this char- debt. Short-term debt financing, howacterization is the motor vehicle indus- ever, continued to pick up in the first try, for which dealer stocks—especially half of 2005. Both commercial and of light trucks—were high by historical industrial loans and commercial paper standards in recent months. In response, expanded at a brisk pace that was likely several major motor vehicle manufac- in part the result of firms' need to fund turers reduced production in the second the rapid rate of inventory accumulaquarter, and, more recently, some have tion earlier in the year. The Federal introduced price discounts on many Reserve's Senior Loan Officer Opinion 2005 models. These efforts appear to Survey on Bank Lending Practices conhave helped, in that inventories of light ducted in April 2005 indicated that vehicles at the end of June fell to sixty- demand for business loans had strengthfive days of supply, a level more in line ened over the previous three months with historical norms. and that substantial fractions of banks had eased standards and terms on these loans. In response to special questions Corporate Profits regarding longer-term changes in lendand Business Finance ing practices, most banks reported that Corporate profits have continued to rise standards on business loans were someso far this year, though at a slower pace what tighter, but that terms were somethan in 2003 and 2004. Earnings per what easier, than they had been in 1996 share for S&P 500 firms in the first and 1997. quarter of 2005 were up about 13 per- Indicators of credit quality in the cent since the same time last year, a nonfinancial business sector have stayed pace in line with the profit figures generally very strong amid continued reported in the national income and growth of profits and corporate balance product accounts (NIPA). The ratio of sheets that remain flush with liquid before-tax profits of nonfinancial corpo- assets. Both the default rate on outstandrations to that sector's gross value added ing corporate bonds and the delinquency was about flat in the first quarter after rate on business loans stand at the low having moved up in 2003 and 2004. In end of their historical ranges. However, the first half of this year, the petroleum the automobile sector has been an and gas industries benefited from higher exception to the pattern of solid corpo- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 41 rate credit quality. All three major credit period a year earlier and reached 17 perrating agencies downgraded the debt of cent of nominal GDP. Revenues were both Ford and General Motors this year boosted by a large increase in corporate in response to disappointing earnings receipts that was driven by the strength news. General Motors' debt now has of corporate profits. In addition, india below-investment-grade rating from vidual income and payroll taxes rose both Standard & Poor's and Fitch, nearly 12 percent, twice as fast as the though it is still rated as investment- growth of household income. However, grade by Moody's. Ford retains an some of this rise was due to the features investment-grade rating with all the rat- of the Jobs and Growth Tax Relief Recing agencies except Standard & Poor's. onciliation Act of 2003 that altered the Expansion of commercial-mortgage timing of tax payments in a way that debt continued apace in the first half of temporarily reduced the level of tax colthe year and was accompanied by rec- lections last year. ord issuance of commercial-mortgage- Nominal federal outlays during the backed securities. Likely because of twelve months ending in June were that heavy issuance, spreads of yields 7 percent higher than during the same on commercial-mortgage-backed securi- period a year ago and stood at 20 perties over those on comparable-maturity cent of nominal GDP. Spending for Treasuries have turned up recently, but national defense continued to trend up these spreads remain relatively low. The at a rapid clip, and outlays for Medicare credit quality of commercial-mortgage also posted a sizable increase. In addidebt remains quite strong, as delin- tion, federal net interest payments, quency rates on holdings of commercial boosted both by higher interest rates and mortgages at banks and insurance com- by the higher level of federal debt, rose panies and on loans that back mortgage more than 13 percent over this period. securities have been declining from Real federal expenditures for consumpalready low levels. tion and investment—the part of government spending that is a component of real GDP—increased at an annual rate The Government Sector of just Vi percent in the first calendar quarter of 2005 after having risen 4 per- Federal Government cent in 2004. Although defense spend- The deficit in the federal unified bud- ing changed little in real terms in the get narrowed over the past year. Over first quarter, it has risen considerably in the twelve months ending in June, the recent years and is likely to increase unified budget recorded a deficit of further in coming quarters. Nondefense $336 billion, $99 billion less than dur- spending in the first quarter edged up in ing the comparable period last year. line with its recent trend, and enacted Both revenues and outlays rose faster legislation is consistent with its continuthan did nominal GDP over this period, ing to rise at a subdued pace. but the rise in receipts was especially The deficit in the federal budget has strong. Even at its lower level, the defi- depressed national saving in the past cit was still equal to about 23/4 percent few years. The narrowing of the deficit of nominal GDP. of late has lessened this reduction in Nominal federal receipts during the national saving from a little more than twelve months ending in June were 3 percent of nominal GDP in 2003 and 14 percent higher than during the same 2004 to roughly 2 percent in the first Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

42 92nd Annual Report, 2005 quarter of 2005. Even so, as business institutions that place bids through the and personal saving rates changed little, Federal Reserve Bank of New York— on average, over the past year, net have been awarded an average of national saving rose to just 31/* percent 33 percent of coupon securities issued at of nominal GDP in the first quarter, well auctions held so far this year, down from below the long-term historical average 42 percent in 2004. Treasury securities of about 7 percent and below recent held in custody at the Federal Reserve levels of net domestic investment. If not Bank of New York on behalf of foreign reversed, such a low level of net national official institutions have grown only saving will necessitate either slower about $25 billion so far this year after an capital formation or continued heavy increase of more than $200 billion in borrowing from abroad. The pressures 2004. Data from the Treasury Internaon national saving will intensify greatly tional Capital System also suggest an with the retirement of the baby-boom ebbing of demand for Treasury securigeneration and the associated increases ties from foreign official investors durin Social Security and Medicare benefit ing the first five months of the year. payments. These data, however, indicate that foreign private investors have continued to accumulate Treasury securities at a rapid Federal Borrowing pace. Because of the need to finance the sizable federal budget deficit, federal debt State and Local Governments held by the public expanded at a seasonally adjusted annual rate of 13% percent The fiscal positions of states and localiin the first quarter of the year. The ratio ties have improved this year. Ongoing of this debt to nominal GDP increased gains in income and consumer spending, to more than 37 percent for the first time along with sharp increases in property since 2000. The average maturity of out- values, have continued to boost tax standing marketable Treasury debt has receipts. Although many jurisdictions been declining for several years and have increased their spending moderreached fifty-three months at the end of ately, some are also using the additional the first quarter of 2005, down from revenues to rebuild reserve funds. On a about seventy months in 2000. How- NIPA basis, net saving by state and local ever, in the May mid-quarter refunding governments equaled $34 billion at an statement, the Treasury announced that annual rate in the first quarter (roughly it was considering reintroducing regu- lA percent of nominal GDP), double the lar issuance of a thirty-year nominal 2004 average. In addition, virtually all bond in February 2006, a move that states registered surpluses in their genwould presumably slow or arrest this eral fund budgets in fiscal year 2005, downtrend. which ended on June 30 for all but Indicators of demand for Treasury four states. Nevertheless, lingering fissecurities by foreign investors have been cal concerns are still evident in some mixed so far this year; demand by for- jurisdictions; these concerns are related eign official institutions seems to have primarily to rising Medicaid costs, the moderated, but demand by foreign pri- termination of temporary federal grants vate investors appears to have remained that were appropriated in fiscal year robust. Indirect bidders at Treasury 2004, and pressures to restore funding to auctions—which include foreign official programs—such as elementary and sec- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 43 ondary education—that were cut back $780 billion at an annual rate, or about earlier in the decade. 6.4 percent of nominal GDP. The deficit Real consumption and investment in trade in goods continued to widen, spending by state and local governments increasing $17 billion from the previous edged down in the first quarter of 2005 quarter. The deficit on net unilateral after having changed little in 2004. Real transfers also widened in the first quaroutlays for consumption items increased ter, largely because of an increase in at an annual rate of less than Vi percent, government grants. In contrast, the sura reflection of some slowing in the pace plus on trade in services rose $7 bilof hiring. Nominal spending on invest- lion, and the surplus on net investment ment rose at a moderate rate in the first income rose $2 billion. quarter, but because construction costs escalated, investment spending declined International Trade a little in real terms. Real exports of goods and services State and Local Government accelerated in the first quarter of 2005 Borrowing to an annual rate of about 9 percent, roughly twice as fast as the rate in the State and local government debt held second half of last year. The dollar's by the public expanded at a rapid pace decline in recent years has raised the in the first quarter of the year, rising competitiveness of U.S. relative prices at a seasonally adjusted annual rate of and has continued to provide a mount- \6lA percent, up from 5Vi percent in ing boost to exports. Support from forthe fourth quarter of last year. However, eign economic activity, though still much of this borrowing was for the substantial, moderated after the first advance refunding of existing debt, as half of 2004 as growth abroad slowed. state and local governments continued Increases in exports of U.S. goods were to take advantage of low long-term widespread across major U.S. trading interest rates. A significant portion of partners, with the exception of Japan, the proceeds of these advance refundand were concentrated in capital goods ings were invested in U.S. Treasury and consumer goods. Real exports of instruments tailored to meet the cash services rose at an annual rate of about management needs of municipal gov- 13 ^percent. ernments. In addition, financing of Real imports of goods and services transportation- and education-related rose at an annual rate of about 9lA perprojects boosted issuance of long-term cent in the first quarter, a pace similar to municipal bonds for new capital. the average in 2004. The growth of real The credit quality of municipal boroil imports ebbed after surging late last rowers improved last year, and this trend year. Increases in imports of non-oil has generally continued so far in 2005, goods were widespread across cateas upgrades of municipal bonds by Stangories. The expiration of the Multifibre dard & Poor's continued to outpace Arrangement and the resulting eliminadowngrades. tion of quotas shifted the source of some U.S. textile and apparel imports among U.S. trading partners, but these events The External Sector appear to have had a limited effect on The U.S. current account deficit the overall level of imports of these expanded in the first quarter of 2005 to goods. Real imports of services reversed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

44 92nd Annual Report, 2005 their fourth-quarter decline, posting a market participants now expect oil gain of 7 percent at an annual rate, as prices to remain near their current high some travel-related expenditures and levels, a view consistent with the belief also royalties and license fees recovered that demand will remain strong and from a very weak fourth quarter. production will have difficulty keep- Boosted by substantial increases in ing pace. The price of the far-dated the prices of primary commodities and NYMEX oil futures contract (currently industrial supplies, prices of total for delivery in December 2011) rose exports rose at an annual rate of AlA per- from about $38 per barrel as of last cent in the first quarter. Prices of U.S. October to about $56 per barrel in late agricultural exports rebounded in the June. first quarter after good harvests in the OPEC spare production capacity second half of 2004 had caused prices appears to be near historical lows, with to fall sharply. The available data for only Saudi Arabia able to increase prothe second quarter point to continued duction substantially. Many other OPEC increases in export prices. producers are either pumping close to Prices of imported non-oil goods rose capacity or encountering production at an annual rate of 33/4 percent in the problems. Venezuela and Indonesia canfirst quarter, almost IV2 percentage not meet their production quotas, and points faster than in the second half of Iraqi production this year has averaged 2004. Prices of material-intensive items, less than in 2004. In addition, several such as industrial supplies and foods, governments have moved to increase steadily increased in the last quarter of their control of the energy industry as 2004 and in the first quarter of 2005. oil prices have risen. Russian oil produc- In part, this rise reflected higher prices tion, which had provided most of the for nonfiiel primary commodities, as growth in non-OPEC supply over the strength in global demand for many previous five years, has stagnated since commodities outstripped a slow expan- last September amid the partial nationalsion of supply. Prices for finishedg oods, ization of Yukos, formerly Russia's such as consumer goods and many kinds largest oil company. Venezuela has also of capital goods, also turned noticeably increased the taxes and royalty payhigher. Available data for the second ments of foreign oil firms. quarter show that the increases in prices of both material-intensive and finished The Financial Account goods have slowed. The spot price of West Texas interme- Foreign official inflows, which acdiate (WTI) crude oil began 2005 near counted for more than half of all net $43 per barrel, but it climbed above $50 financial inflows to the United States per barrel in late February and breached in 2004, slowed significantly in the first $60 per barrel in late June. The increase quarter but showed signs of renewed in the spot price of WTI largely reflects strength in April and May. In contrast, several global factors: continued strong private inflows moderated in April and demand for oil, limited spare production May after having increased substantially capacity, and concerns about the relia- in the preceding six months. As has bility of supply from some foreign been the case for several years, the U.S. sources. In contrast to the market out- current account has been financed prilook during last October's peak in oil marily by foreign purchases of U.S. debt prices, futures contracts indicate that securities. U.S. residents' purchases of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 45 foreign securities increased after a tem- ment continued to climb at a steady porary lull in the fourth quarter and have pace, a reflection of the buoyant resibeen more heavily weighted toward pur- dential housing market and increased chases of equities. spending on infrastructure by state and Net direct investment outflows in the local governments. In contrast, manufirst quarter were well below their levels facturing employment continued to in the fourth quarter; direct investment trend down, as cutbacks in industries into the United States was roughly that produce wood products, furniture, unchanged, but U.S. direct investment and a variety of nondurable goods more abroad fell back after a surge in new than offset hiring at producers of fabriequity late last year. There is little evi- cated metals and machinery. Employdence to date that U.S. companies have ment in retail trade has advanced at a repatriated earnings from their foreign moderate pace this year. Increases in subsidiaries using the temporarily employment at state and local governreduced tax rate available under the ments slowed somewhat in the first half American Jobs Creation Act of 2004. of this year from the pace in the second However, there are indications that these half of last year, and federal civilian remittances may pick up in the second employment changed little. half of this year. The gradual rise in job opportunities appears to be attracting some potential workers back into the labor market. The The Labor Market labor force participation rate, which had declined noticeably between 2000 and Employment and Unemployment 2004, edged up over the first half of Labor markets have continued to im- 2005. Nevertheless, the participation prove this year, albeit at an uneven pace rate in June, at 66 percent, remained from month to month. On average, non- well below the high of 61 VA percent farm payroll employment expanded reached in early 2000. To some extent, roughly 180,000 per month over the first both the high level of the participahalf of 2005, about the same pace as in tion rate in 2000 and the more recent the fourth quarter of 2004. At the same decline are likely related to cyclical time, the civilian unemployment rate, developments in the economy: The tight which had declined from 53A percent to labor markets of the late 1990s, perjust below 5V2 percent over 2004, con- haps coupled with the introduction of tinued to move down. The jobless rate work requirements for many welfare stood at 5 percent in June, the lowest recipients, undoubtedly drew additional level since September 2001. people into the labor force at that time, The increases in payrolls over the first while the subsequent recession and slow half of 2005 were relatively widespread recovery in the labor market have disacross industries. Particularly sizable couraged many job seekers in recent gains were registered at providers of years. However, the downtrend in the health-care services and leisure and hos- aggregate participation rate also appears pitality services and at establishments to be associated with structural developthat provide business services, such as ments that seem likely to limit future professional and technical assistance increases. For example, the large babyand administrative and support services boom cohorts are now entering ages at (a category that includes temporary which labor force participation rates help). In addition, construction employ- typically drop off sharply. And, in con- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

46 92nd Annual Report, 2005 trast to patterns observed in previous the four quarters ending in the first quardecades, participation rates for women ter of this year, having registered a parbetween 25 and 54 years of age no ticularly large bulge in the final quarter longer appear to be trending up. of 2004. Much of this sharp rise may be the result of the exercise of a large number of stock options late last year, Productivity and Labor Costs a development perhaps induced by an Gains in labor productivity have slowed, increase in equity prices that boosted on balance, in recent quarters. Accord- the number of options that were "in ing to currently published data, output the money" and by a proposed change per hour in the nonfarm business sector in accounting regulations that led some rose 2Vz percent over the year ending in companies to accelerate the vesting the first quarter of 2005, down from the of options that had been previously 5Vi percent pace registered in the com- granted. In addition, the strong perforparable period a year earlier. A deceler- mance of profits in 2004 may have been ation in productivity is not unusual as associated with sizable nonproduction an economic expansion matures and as bonus payments at the end of last year. businesses—which become increasingly A more modest rate of increase in confident about future prospects for hourly compensation is indicated by the sales—step up their pace of hiring. In employment cost index (ECI), which is addition, the recent slowdown in pro- based on a quarterly survey of private ductivity growth was from the unusu- nonfarm establishments conducted by ally rapid average rate that prevailed the Bureau of Labor Statistics and which between 2002 and early 2004. That excludes income received from the exerelevated rate likely reflected both an cise of stock options. In particular, the atypical reluctance to hire—as employ- ECI measure of hourly compensation ers reacted to a succession of economic rose 3V2 percent over the twelve months and geopolitical shocks—and newfound ending in March 2005, about V2 perefficiencies brought about by the better centage point less than the increases use of high-tech capital purchased by over the preceding two years. The wages businesses in earlier years and by orga- and salaries component of the ECI was nizational changes implemented to up just 2Vi percent over the twelve maintain profitability when the econ- months ending in March, a pace similar omy was relatively weak. As the impe- to that in the preceding year, while tus from these influences has waned, employer costs for benefits increased productivity growth has fallen back. 53A percent, a bit below the pace of the Measures of labor compensation for previous year but a sizable gain nonetherecent quarters suggest that the remain- less. Part of the outsized rise in benefit ing slack in labor markets continued to costs stemmed from the need by many restrain increases in base wage rates but companies to rebuild their definedthat large increases in some of the more benefit pension assets to make up for flexible components of worker pay and earlier losses in those plans. In addition, for some types of employer-provided health insurance costs have continued to benefits added to labor costs. In particu- rise more rapidly than wages, although lar, compensation per hour in the non- the IV2 percent increase in these costs farm business sector, which is based on over the year ending in March of this the data from the national income and year was down from the double-digit product accounts, rose 7 percent over rates of growth in 2002 and 2003. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 47 The acceleration in the nonfarm busi- quarter of 2004 and May 2005, having ness measure of hourly compensation, been pushed higher by a further run-up coupled with the deceleration in pro- in crude oil prices. Gasoline prices ductivity, has contributed to a noticeable climbed especially rapidly between pickup in unit labor costs in recent quar- February and April, when higher crude ters. In particular, unit labor costs rose costs were accompanied by a significant 4x/4 percent over the four quarters end- widening in retail margins. Although ing in the first quarter of 2005 after these margins subsequently dropped having declined 1 percent over the pre- back, retail gasoline prices in June were ceding four quarters. However, to the still nearly 10 percent above their level extent that the acceleration in compensa- at the end of last year, and they moved tion was the result of a temporary bulge up further in early July. Electricity in stock option exercises in late 2004, prices also rose sharply over the first unit labor costs should moderate signifi- half of 2005 because of higher input cantly this year. Moreover, the implica- costs for electricity generation. tions of such a spike in unit labor costs Consumer food prices increased at an for price inflation are probably minimal, annual rate of about 2V2 percent over the at least as judged by previous spikes of first half of 2005, a bit less than in 2004. this nature. For example, the sharp rise Prices for fruits and vegetables dropped in unit labor costs in 2000 had little or back early in the year, as supplies recovno subsequent effect on price inflation. ered from the damage associated with last year's succession of hurricanes. Although these prices turned up a little Prices in the spring, they remain below their Higher energy prices continued to show fourth-quarter levels. In contrast, meat through to overall consumer price infla- prices rose at an annual rate of 3 percent tion this year. The chain-type price index over the first half of the year; relatively for personal consumption expenditures strong domestic demand has lifted prices rose at an annual rate of about 2¥z per- despite increases in the number of cattle cent between the fourth quarter of 2004 being fed for slaughter and ample supand May 2005, a rate of increase similar plies of other meats and poultry. Prices to that over the four quarters of 2004. Within that total, core PCE prices accel- Alternative Measures of Price Change erated over that period to an annual rate Percent of about 2 percent, from 1 Vi percent in 2004. However, data for the consumer 2003 2004 Price measure to to price index (CPI), which are available 2004 2005 through June, suggest that core inflation has moderated in recent months; Chain-type (Ql to Ql) Gross domestic product (GDP).. 1.7 2.4 the core CPI rose at an annual rate of Gross domestic purchases 1.7 2.8 VA percent in the three months end- Personal consumption expenditures (PCE) 1.7 2.2 ing in June after having increased at a Excluding food and energy ... 1.4 1.6 3V4 percent pace over the first three Market-based PCE excluding food and energy 1.3 1.7 months of this year. Fixed-weight (Q2 to Q2) The PCE price index for energy, Consumer price index 2.9 2.9 which moved up more than 18 percent Excluding food and energy ... 1.8 2.2 in 2004, increased at an annual rate of NOTE. Changes are based on quarterly averages of nearly 14 percent between the fourth seasonally adjusted data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

48 92nd Annual Report, 2005 for beef were also influenced by a tations have held steady or moved lower. variety of trade restrictions associated Most notably, the Michigan SRC surwith concerns about mad cow disease: vey indicates that households' median Both the full resumption of imports expectations for inflation over the next from Canada (which would tend to push twelve months have ranged between down prices) and the resumption of 3 percent and ?>lA percent in recent exports to other important trading part- months, up from just under 3 percent at ners (which would tend to push up the beginning of the year. In contrast, prices) were delayed. Prices of food households' median expectations for away from home, for which labor costs inflation over the next five to ten years, are more important than raw food costs, at a little under 3 percent, are similar to rose at an annual rate of about 3V2 per- readings in recent years. The latest Surcent over the first half of this year, a vey of Professional Forecasters likewise little higher than the recent trend. shows that inflation is expected to aver- The pickup in core PCE inflation this age 2V2 percent over the next ten years, year is due both to the sharp run-up a figure unchanged since 2001. Readin energy prices and to higher prices ings of longer-term inflation compensafor other intermediate materials; these tion from financial markets show a more developments have raised production pronounced decline: Inflation compenand distribution costs for a wide range sation as measured by the spread of the of domestically produced goods and yield on nominal Treasury securities services. In addition, the decline in the over their indexed counterparts for the exchange value of the dollar into early period five to ten years ahead has fallen 2005 continued to push up prices of core about 50 basis points since the end of nonfuel imports this year, both for items 2004. used in the domestic production of other goods and services and for items sold U.S. Financial Markets directly to consumers. Partially offsetting these influences have been the gains Financial market conditions remained in productivity, which have enabled generally accommodative during the firms to absorb a portion of the higher first half of 2005, as Treasury and pricosts. Moreover, although the price of vate interest rates stayed low. Risk crude oil remains high, prices for some spreads on speculative-grade debt had other industrial materials have deceler- become very tight by the end of the first ated or edged down of late: The Journal quarter, but they subsequently rose, on of Commerce industrial price index— balance, after the downgrades of Ford which excludes energy items—has and General Motors; current levels fallen 6 percent since the beginning of suggest more-typical compensation for April, while the producer price index for default risk. Banks continued easing core intermediate materials rose at an terms and standards on lending to busiannual rate of just \lA percent in the nesses. The pace of business borrowing, second quarter of this year after hav- which had been sluggish, picked up last ing increased at roughly a 7 percent year and remained fairly robust in the pace, on average, in the preceding few first half of 2005. Nevertheless, strong quarters. corporate profits and the large stock- Measures of shorter-term inflation pile of liquid assets already on firms' expectations have edged higher this balance sheets continued to limit their year, while those of longer-term expec- demand for external financing. Debt of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 49 the federal government, of state and yields and distant-horizon forward rates local governments, and of households in the United States since mid-2004. continued to expand briskly. Broad Among these is the possibility that longequity price indexes were little changed term inflation expectations have fallen on net; higher oil prices boosted share and become more firmly anchored. prices in the energy sector but weighed Indeed, longer-term inflation compensaon other stocks. tion, measured by the spread between the yields on ten-year Treasury inflation-protected securities and their Interest Rates nominal counterparts, has fallen about The FOMC boosted the intended federal 30 basis points over this period. A secfunds rate 25 basis points at each of its ond possible explanation is investors' four meetings in the first half of the willingness to accept smaller risk preyear. Judging from federal funds futures miums on long-term securities amid quotes, these policy actions had all been declining macroeconomic and interest widely anticipated by investors for some rate uncertainty. The volatility of shorttime before each meeting. Since the start term interest rates and Treasury yields of the year, rates on interest rate futures implied by option prices has indeed contracts that will expire at the end of declined to historically low levels. A 2005 have moved up about 60 basis third possibility is that several factors points in response to evidence of robust have spurred an excess of global saving economic growth and concerns about over planned investment, such as risthe possible emergence of inflationary ing incomes in countries with high savpressures. Two-year nominal Treasury ing rates, the desire by the aging citiyields have risen about 80 basis points zens of many industrialized countries over that period, reflecting both the firm- to save for retirement, and apparently ing of policy expectations and actual diminished investment prospects in monetary policy tightening. many industrialized and developing economies. Nevertheless, ten-year nominal Treasury yields have edged down so far Spreads of yields on investmentthis year and are now about 60 basis grade corporate debt over those on points below their level just before the comparable-maturity Treasury securities FOMC meeting in June 2004. More- fell during the first quarter of 2005, and over, this fall in long-term yields is a risk spreads on high-yield corporate debt global phenomenon: Long-term yields reached very low levels. However, in have declined in most foreign industrial- March, news about difficulties in the ized economies, in several cases by domestic motor vehicle industry apparmore than in the United States. From the ently became a focal point for a revision term structure of interest rates, the ten- of investors' assessment of risks. Furyear Treasury yield can be decomposed ther revelations of accounting irreguinto a series of ten consecutive one-year larities in the insurance industry also forward rates. The last of these—the seem to have made investors somewhat one-year forward rate ending ten years charier of risk. As a result, risk spreads hence—now stands about 160 basis on corporate bonds and credit default points below its level just before the swaps have widened; speculative-grade June 2004 FOMC meeting. bond spreads are now about 50 basis Several potential explanations have points higher than at the start of the been offered for the decline in long-term year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

50 92nd Annual Report, 2005 Equity Markets quarter of 2005. Financing secured by residential real estate, including home Broad equity price indexes fell modestly mortgages, home equity loans, and in the first quarter, but they rebounded mortgage-backed securities, extended and are now little changed, on net, since its long, robust expansion. In May, the the start of 2005. Thus far this year, Federal Reserve Board and other fedstock prices have been buoyed by coneral agencies that regulate depository tinued strong profits and low long-term institutions issued guidance on sound interest rates, but higher oil prices and underwriting and effective credit-riska few high-profile earnings disappointmanagement practices for home equity ments have weighed on share prices lending. Recently there has been inoutside the energy sector. The forward creased use of potentially riskier types earnings-price ratio held about steady of mortgages, including adjustable-rate despite the fall in real interest rates. and interest-only loans, which could Equity price volatility implied by quotes pose challenges to both lenders and on stock options declined, as the imborrowers. Business loans, which had plied volatility on the S&P 500 index begun to grow in 2004 after several dropped to a record low level of less years of runoffs, accelerated to a 15 perthan 11 percent. cent annual rate of growth in the first Net inflows into equity mutual funds quarter of 2005, supported in part by were moderate in the first half of 2005, strong demand for short-term financdown from the rapid pace during the ing to fund rising accounts receivable, same period last year. These flows likely inventories, and merger and acquisition followed the pattern set by share prices, activity. which surged about 30 percent in 2003, Credit market assets held by rose about 10 percent in 2004, and have government-sponsored enterprises debeen flat so far this year. clined in the first quarter of this year, as Freddie Mac and Fannie Mae reduced their outright holdings of mortgage- Debt and Financial Intermediation backed securities. The aggregate debt of the domestic nonfinancial sectors expanded at an annual The M2 Monetary Aggregate rate of about 10 percent in the first quarter of 2005, up from an SVA percent pace In the first half of 2005, M2 grew at a in the fourth quarter of 2004, mainly 2Vz percent annual rate—probably because of faster growth of federal gov- slower than nominal GDP and down ernment debt and state and local govern- from a 5V4 percent pace last year. ment debt. The mix of household and Slower growth in liquid deposits—likely business debt growth has shifted mod- a consequence of their rising opporestly since the same time last year. tunity cost—accounted for most of this Household debt decelerated, though it deceleration. Yields on retail money continued expanding at a rapid pace, market mutual funds rose noticeably in and the growth of business-sector debt the first half but continued to lag interest picked up even though ample internal rates on market instruments, and assets funding continued to limit firms' need in these funds continued their prolonged for external financing. runoff. Small time deposits, whose Commercial bank credit expanded at yields have better kept pace with rising an annual rate of 13 percent in the first market interest rates, rose briskly during Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 51 the same period. Currency expanded at last year in efforts to restrain inflationa slow rate, apparently a reflection in ary pressures. large measure of weak demand from After having edged up during the first abroad. On net, the velocity of M2 is three months of this year, long-term estimated to have moved up in the first interest rates in the major foreign indushalf at a somewhat slower pace than trial economies have fallen and now would be expected from the historical stand below their levels at the start of relationship between money, income, the year. As in the United States, the and opportunity cost. decline in foreign long-term interest rates continues a trend that began in mid-2004. However, long-term rates in International Developments the major foreign industrial economies Foreign economic activity has expanded have fallen more than rates in the United a bit less rapidly this year than in the States this year. The decline in Eurosecond half of 2004, as measured by pean long-term rates occurred amid an export-weighted average of growth weak economic news and a shift away among U.S. trading partners. The pace from market expectations of a policy of expansion in the industrial economies rate increase. In contrast, long-term rates has generally increased, but, with the in Canada and the United Kingdom important exception of China, this have trended down despite policy rate increase has been offset by moderating increases in the second half of last year growth in many developing economies. by both countries' central banks, though Inflation has remained well contained in market perceptions that the Bank of most countries. England may cut rates have recently The stance of monetary policy has not increased. Although the decline in Japachanged this year in most major foreign nese rates last year was consistent with economies. The European Central Bank both the weak performance of the econhas held its policy rate constant since omy and the persistence of deflation, June 2003, and both the Bank of long-term rates fell further this year England and the Bank of Canada have despite solid growth in the first quarter. kept policy rates unchanged after having As foreign interest rates have fallen raised them in the latter half of 2004. in recent months, the value of the dollar The Bank of Japan has maintained has risen. Most of this rise has been its commitment to a policy of quantita- against the currencies of the major tive easing until deflation ends, but industrial countries; the dollar is largely in late May it made what it described unchanged against the currencies of as a technical change to allow tempo- the United States' other important tradrary deviations below the target range ing partners. The dollar has appreciated for reserve accounts if banks' demand about 12 percent against the euro and for funds is too weak to satisfy the about 9 percent against the yen and target. Reserve account balances tem- sterling since the start of the year. Some porarily fell below ¥30 trillion, the of the appreciation against the euro lower end of the target, in early June. occurred after voters in France and the Monetary policy has also remained Netherlands rejected the proposed conunchanged in most emerging Asian stitution for the European Union by economies; however, several Latin unexpectedly large margins in May. American monetary authorities have European, British, and Canadian continued tightening cycles that began stock indexes have risen more than Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

52 92nd Annual Report, 2005 8 percent since the start of the year. The The pace of activity in the euro area rise in European stock prices is notable appears to have slowed after a stronger because indicators of economic activity start to the year. Real GDP grew at a have been fairly weak. In contrast, Japa- 2 percent annual rate in the first quarter, nese stock prices are now little changed as private consumption rose moderately after having reversed first-quarter gains. and both households and firms switched Equity prices in the majority of emerg- expenditures away from imports and ing markets began the year on a strong toward domestically produced goods. note but reversed course late in the first Both Germany and Spain grew at rates quarter and currently stand close to their above the area average in the first quar- January levels. Despite these swings, ter. In contrast, real GDP in both Italy intraday volatility has remained sub- and the Netherlands declined, while dued in most equity markets. French growth was slower than in most of 2004. Measures of activity point toward slower growth in the euro area Industrial Economies in the second quarter. Retail sales, which Real GDP in Japan increased at an had risen in the first quarter, were annual rate of nearly 5 percent in the roughly flat, on average, in April and first quarter of 2005, bouncing back May. The trade balance fell in April, from last year's recession. Personal con- threatening a main engine of growth, sumption spending reversed its recent though the recent rise in the dollar declines, pushing the household saving against the euro should help stimulate rate down further. Private investment export demand going forward. Twelvealso rose sharply after having grown month consumer price inflation edged tepidly in the second half of 2004. In up in June to just above the European contrast, the external sector made a Central Bank's target ceiling of 2 persmall negative contribution to GDP, as cent for inflation over the medium term. imports rose modestly but exports fell. The European Central Bank's measure While Japanese manufacturers of high- of core inflation, which excludes energy tech goods reduced their levels of inven- and unprocessed foods, has eased since tories from last year's peak, inventory January to an annual rate comfortably stocks of firms outside the high-tech below 2 percent. sector increased, perhaps because of the Consumer spending in the United slowdown in exports. The labor market Kingdom increased only modestly in the has steadily improved: The unemploy- first quarter, slowing real GDP growth ment rate has reached a seven-year low, to lx/2 percent. Nevertheless, the labor and the ratio of job offers to job appli- market remains tight, as unemployment cants is at a twelve-year high. Despite is at its lowest levels since the midthe pickup in economic activity and 1970s and real earnings continue to continuing inflation in wholesale prices, trend up. The twelve-month rate of conconsumer price deflation has wors- sumer price inflation ticked up in June ened slightly. The GDP price deflator to the Bank of England's target of 2 perreturned to a year-over-year rate of cent. In its May Inflation Report, the deflation of more than 1 percent after Bank of England forecast that inflation having temporarily registered a more would temporarily rise but stay near the modest decline in the fourth quarter of target over a two-year period. House 2004. prices have been fairly stable this year, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2005 53 and household net mortgage borrowing Economic developments in other has also been subdued. Asian emerging-market economies have Growth in Canada remains moderate. varied. Hong Kong maintained its strong Continuing a pattern that has largely performance. As in China, growth in held for the past two years, private Hong Kong has been driven by both consumption and investment demand investment and exports. Export growth rose in the first quarter while net exports has also played an important role in fell. Activity in the second quarter supporting growth in most of the other appears to have been solid. Data on countries in this region, but domestic housing starts indicate that construction demand, particularly inventory investspending grew further, and the merchan- ment, has declined in many economies dise trade surplus improved in April, so far this year. Inflation has risen as exports rose and imports decreased slightly, reflecting higher food and slightly. Twelve-month consumer price energy prices, but remains well coninflation fell in May to about IV2 per- tained and under 3 percent in most cent after having averaged slightly above countries. 2 percent in the first quarter. The Bank The Mexican economy has slowed so of Canada's measure of core inflation far this year, as demand for its manufachas stayed below 2 percent throughout turing exports has weakened and monethis year. tary tightening has tempered investment and consumption demand. The Bank of Mexico has left monetary pol- Emerging-Market Economies icy unchanged since March, but its tight- Chinese real GDP continues to rise rap- ening over the preceding twelve months idly following strong growth in 2004. raised short-term interest rates 500 basis Economic expansion has been led by points. Twelve-month consumer price investment, exports, and, more recently, inflation has fallen from its levels of late a surge in domestic production of goods last year but still stands above the Bank that had previously been imported. of Mexico's target range of 2 percent to Investment expenditure has remained 4 percent. After having risen in the secvigorous despite the government's ond half of last year, core inflation has attempts early last year to slow its rate also trended down in recent months. of increase. Import growth slowed in the Economic growth in most South first quarter, but the rise of exports was American economies has also slowed unabated, leading to a significant widen- compared with the pace of activity at ing of the trade surplus. Although recent the end of 2004. Brazil's real GDP rose attention has focused on China's exports at only a \lA percent annual rate in the of textiles, export growth has remained first quarter, as both private consumpstrong across most major categories tion and investment declined in the wake of goods. The slowdown in imports of the Brazilian central bank's decision has also been broadly based. Despite to begin raising its policy rate in the China's strong rate of economic expan- second half of 2004 to counter inflationsion, consumer price inflation fell to less ary pressures. Exports, which rose rapthan 3 percent in the first quarter and idly and outpaced imports, provided the has remained low, as declining food only bright spot. Twelve-month inflaprices have offset modest increases in tion has remained above 7 percent, and nonfood prices. the central bank has continued to raise Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

54 92nd Annual Report, 2005 its policy rate this year. Argentina has earlier in the year, but it still lies above gradually recovered from its 2001 crisis, the central bank's unofficial target range but real GDP sharply decelerated in of 5 percent to 8 percent. The Argentine the first quarter. The unemployment government recently completed the final rate, which had steadily fallen over the settlement of its debt exchange but has past few years, also edged up slightly. not yet resolved the treatment of the Twelve-month consumer price inflation remaining investors (holders of roughly appears to have stabilized after having one-fourth of all defaulted government been pushed up by food price increases bonds) who rejected the agreement. • 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

57 Banking Supervision and Regulation The Federal Reserve has supervisory of the 2005 amendments to the Bankand regulatory authority over a wide ruptcy Code. These filings temporarrange of financial institutions and activ- ily increased loan losses—particularly ities. It works with other federal and within credit card portfolios—but had state supervisory authorities to ensure little effect on the industry's sound loan the safety and soundness of financial quality. The number of consumer bankinstitutions and the stability of the finan- ruptcy filings is expected to diminish in cial markets. 2006. In 2005, U.S. banking organizations Rapid growth in home equity lines of reported record earnings and maintained credit, nontraditional residential mortstrong asset quality. However, banking gages, and commercial real estate loans organizations also faced some chal- raised some supervisory concerns in lenges during the year. Throughout the 2005 and led the federal banking agenyear, a flattening yield curve placed cies to issue or propose guidance on pressure on bank net interest margins, sound risk-management practices for necessitating adjustments to balance- these lines of business. Nevertheless, sheet positions and interest-rate risk delinquencies in these and most other management strategies at many institu- loan segments remained low, and nontions. In September, banking organiza- performing asset ratios reached very low tions in several Gulf Coast states faced levels during the year. extraordinary challenges in the after- While banks and supervisors have tramath of Hurricanes Katrina and Rita. ditionally ranked credit and market risks For the most part, the banking organiza- as top concerns, in recent years these tions supervised by the Federal Reserve risks often have been overshadowed by in the affected areas resumed opera- compliance and other operational risks. tions expeditiously. The Federal Reserve Some of the largest banking organizaand the other federal banking agencies tions have experienced rapid growth and encouraged banking organizations to be significantly expanded their products flexible in responding to the needs- of and services, heightening supervisory borrowers and other customers in com- concern about whether these organimunities and regions affected by the zations' compliance risk management disasters. At year-end, the ramifications practices are keeping pace. One signifiof the hurricanes on banking organi- cant area of concern for supervisors is zations had not been fully quantified. compliance with anti-money-laundering The federal banking agencies continue laws and regulations. In 2005, the Fedto work with the banking organizations eral Reserve, in conjunction with the in the affected regions as they deal with other federal banking agencies and the after-effects of the storms. the Department of the Treasury's Finan- During the latter half of the year, per- cial Crimes Enforcement Network sonal bankruptcy filings rose sharply (FinCEN), issued the Bank Secrecy Act/ as a result of consumers accelerating Anti-Money Laundering (BSA/AML) their filings before the effective date Examination Manual to help strengthen Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

58 92nd Annual Report, 2005 enforcement of these laws and fur- holding companies, including financial ther promote consistent examination holding companies formed under the approaches among supervisors. authority of the 1999 Gramm-Leach- Federal Reserve staff continue to Bliley Act, and state-chartered commerdevote considerable effort to revising cial banks that are members of the domestic and international capital stan- Federal Reserve System. In overseeing dards. In 2006, the U.S. banking agen- these organizations, the Federal Reserve cies expect to issue a notice of proposed seeks primarily to promote their safe rulemaking (NPR) setting forth their and sound operation, including their views and seeking public comment with compliance with laws and regulations.2 respect to the U.S. implementation of The Federal Reserve also has responthe Basel II capital accord, an interna- sibility for the supervision of all Edge tional agreement among banking super- Act and agreement corporations; the visors that was issued in June 2004. * international operations of state member The Federal Reserve is also working banks and U.S. bank holding companies; with the other federal banking agen- and the operations of foreign banking cies to develop supervisory guidance companies in the United States. for both examiners and the banking The Federal Reserve exercises imporindustry. tant regulatory influence over entry into The U.S. banking organizations the U.S. banking system and the strucexpect that only a small number of large, ture of the system through its adminisinternationally active U.S. banking orga- tration of the Bank Holding Company nizations will be subject to the Basel II Act, the Bank Merger Act (with regard framework. The vast majority of bank- to state member banks), the Change in ing organizations are expected to remain Bank Control Act (with regard to bank on the existing risk-based capital frame- holding companies and state member work (Basel I). To update Basel I and banks), and the International Banking mitigate some of the consequences of Act. The Federal Reserve is also responthe differences between Basel I and sible for imposing margin requirements Basel II, the federal banking agencies in on securities transactions. In carrying October jointly published an advance out these responsibilities, the Federal notice of proposed rulemaking that con- Reserve coordinates its supervisory tains proposed revisions to Basel I that activities with the other federal banking would enhance its risk sensitivity. agencies, state agencies, functional regulators, and the bank regulatory agen- Scope of Responsibilities for cies of other nations. Supervision and Regulation The Federal Reserve is the federal 2. The Board's Division of Consumer and supervisor and regulator of all U.S. bank Community Affairs coordinates the Federal Reserve's supervisory activities with regard to 1. The agreement, titled "International Conver- compliance with consumer protection and civil gence of Capital Measurement and Capital Stan- rights laws. Those activities are described in the dards: A Revised Framework," was developed by chapter "Consumer and Community Affairs." the Basel Committee on Banking Supervision, Compliance with other banking laws and regulawhich is made up of representatives of the central tions, which is treated in this chapter, is the banks or other supervisory authorities of thirteen responsibility of the Board's Division of Banking countries. The November 2005 updated version is Supervision and Regulation and the Federal available on the web site of the Bank for Interna- Reserve Banks, whose examiners also check for tional Settlements (www.bis.org). safety and soundness. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 59 Supervision for holding companies and their nonbank Safety and Soundness subsidiaries. Preexamination planning and on-site review of operations are To promote the safety and soundness of integral parts of the overall effort to banking organizations, the Federal ensure the safety and soundness of bank- Reserve conducts on-site examinations ing organizations. Whether an examinaand inspections and off-site surveillance tion or an inspection is being conducted, and monitoring. It also undertakes the review of operations entails (1) an enforcement and other supervisory assessment of the quality of the proactions. cesses in place to identify, measure, monitor, and control risks; (2) an assessment of the quality of the organization's Examinations and Inspections assets; (3) an evaluation of manage- The Federal Reserve conducts exami- ment, including an assessment of internations of state member banks, the U.S. nal policies, procedures, controls, and branches and agencies of foreign banks, operations; (4) an assessment of the key and Edge Act and agreement corpora- financial factors of capital, earnings, tions. In a process distinct from exami- liquidity, and sensitivity to market risk; nations, it conducts inspections of bank and (5) a review for compliance with State Member Banks and Holding Companies, 2001-2005 Entity/Item 2005 2004 2003 2002 2001 State member banks Total number 907 919 935 949 970 Total assets (billions of dollars) 1,318 1,275 1,912 1,863 1,823 Number of examinations 783 809 822 814 816 By Federal Reserve System . 563 581 581 550 561 By state banking agency 220 228 241 264 255 Top-tier bank holding companies Large (assets of more than $1 billion) Total number 394 355 365 329 312 Total assets (billions of dollars) 10,261 8,429 8,295 7,483 6,905 Number of inspections 501 500 454 439 413 By Federal Reserve System1 496 491 446 431 409 On site 457 440 399 385 372 Off site 39 51 47 46 37 By state banking agency 5 9 8 4 Small (assets of $1 billion or less) Total number 4,760 4,796 4,787 4,806 4,816 Total assets (billions of dollars) 890 852 847 821 768 Number of inspections 3,420 3,703 3,453 3,726 3,486 By Federal Reserve System 3,233 3,526 3,324 3,625 3,396 On site2 170 186 183 264 730 Off site 3,063 3,340 3,141 3,361 2,666 By state banking agency 187 177 129 101 90 Financial holding companies Domestic 591 600 612 602 567 Foreign 38 36 32 30 23 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

60 92nd Annual Report, 2005 applicable laws and regulations. The State Member Banks table provides information on the exami- At the end of 2005, 907 state-chartered nations and inspections conducted by banks (excluding nondepository trust the Federal Reserve during the past five companies and private banks) were years. members of the Federal Reserve Sys- To manage the supervisory process, tem. These banks represented approxithe Federal Reserve follows a riskmately 12 percent of all insured U.S. focused approach that seeks to focus commercial banks and held approxisupervisory resources on (1) those busimately 15 percent of all insured comness activities posing the greatest risk to mercial bank assets in the United States. banking organizations and (2) the orga- The guidelines for Federal Reserve nizations' management processes for examinations of state member banks identifying, measuring, monitoring, and are fully consistent with section 10 of controlling risks. The key features of the the Federal Deposit Insurance Act, as supervision program for large complex amended by section 111 of the Federal banking organizations (LCBOs) are Deposit Insurance Corporation Improve- (1) identifying those LCBOs that are ment Act of 1991 and by the Riegle judged, on the basis of their shared risk Community Development and Regulacharacteristics, to present the highest tory Improvement Act of 1994. A fulllevel of supervisory risk to the Federal scope, on-site examination of these Reserve System, (2) maintaining conbanks is required at least once a year, tinual supervision of these organizations although certain well-capitalized, wellso that the Federal Reserve's assessment managed organizations having assets of of each organization's condition is less than $250 million may be examined current, (3) assigning to each LCBO a once every eighteen months. The Fedsupervisory team composed of Reserve eral Reserve conducted 563 exams of Bank staff members who have skills state member banks in 2005. appropriate for the organization's risk profile (the team leader is the central Bank Holding Companies point of contact, has responsibility for only one LCBO, and is supported by At year-end 2005, a total of 5,860 U.S. specialists skilled in evaluating the risks bank holding companies were in operaof LCBO business activities and func- tion, of which 5,154 were top-tier bank tions), and (4) promoting System-wide holding companies. These organizations and interagency information-sharing controlled 6,160 insured commercial through automated systems. banks and held approximately 96 per- For other banking organizations, cent of all insured commercial bank the risk-focused supervision program assets in the United States. provides that examination procedures Federal Reserve guidelines call for should be tailored to each bank's annual inspections of large bank holding size, complexity, and risk profile. companies as well as smaller companies Examinations entail both off-site and that have significant nonbank assets. In on-site work, including planning, pre- judging the financial condition of the examination visits, detailed documen- subsidiary banks owned by holding tation, and examination reports tai- companies, Federal Reserve examiners lored to the scope and findings of the consult examination reports prepared by examination. the federal and state banking authorities Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 61 that have primary responsibility for the holding company status. Of the domessupervision of those banks, thereby tic financial holding companies, 39 minimizing duplication of effort and had consolidated assets of $15 billion reducing the burden on banking organi- or more; 115, between $1 billion and zations. Small, noncomplex bank hold- $15 billion; 82, between $500 million ing companies—those that have consoli- and $1 billion; and 355, less than dated assets of $1 billion or less—are $500 million. subject to a special supervisory program that was implemented in 1997 and Anti-Money-Laundering modified in 2002.3 The program permits Examinations a more flexible approach to the supervision of these companies. In 2005, the The U.S. Department of the Treasury Federal Reserve conducted 496 inspec- regulations (31 CFR 103) implementing tions of large bank holding companies the Bank Secrecy Act (BSA) generand 3,233 inspections of small, noncom- ally require banks and other types of plex bank holding companies. financial institutions to file certain reports and maintain certain records Financial Holding Companies that are useful in criminal or regulatory proceedings. Under the Gramm-Leach-Bliley Act, The BSA and separate Board regulabank holding companies that meet tions require banking organizations certain capital, managerial, and other supervised by the Board to file reports requirements may elect to become finanon suspicious activity related to possible cial holding companies and thereby violations of federal law, including engage in a wider range of financial money laundering, terrorist financing, activities, including full-scope securities and other financial crimes. In addiunderwriting, merchant banking, and tion, BSA and Board regulations require insurance underwriting and sales. The that banks develop written programs statute streamlines the Federal Reserve's on BSA/anti-money-laundering (AML) supervision of all bank holding comcompliance and that the programs be panies, including financial holding comformally approved by bank boards of panies, and sets forth parameters for directors. An institution's compliance the relationship between the Federal program must (1) establish a system of Reserve and other regulators. The statinternal controls to ensure compliance ute also differentiates between the Fedwith the BSA, (2) provide for indepeneral Reserve's relations with regulators dent compliance testing, (3) identify of depository institutions and its relaindividuals responsible for coordinating tions with functional regulators (that is, and monitoring day-to-day compliance, regulators for insurance, securities, and and (4) provide training for personnel as commodities firms). appropriate. As of year-end 2005, 591 domestic The Federal Reserve is responsible bank holding companies and 38 foreign for examining its supervised institubanking organizations had financial tions for compliance with various antimoney-laundering laws and regulations. 3. Refer to SR Letter 02-01 for a discussion of During examinations of state member the factors considered in determining whether a banks and U.S. branches and agencies of bank holding company is complex or noncomplex (www.federalreserve.gov/boarddocs/srletters/). foreign banks and, when appropriate, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

62 92nd Annual Report, 2005 inspections of bank holding companies, Commission (SEC), which specifies examiners review the institution's com- 2005-06 implementation dates. The pliance with the BSA and determine agencies also provided some guidance whether adequate procedures and con- to help firms that are implementing trols to guard against money laundering the sound practices verify their efforts. are in place. In addition, the agencies continue to closely coordinate efforts to ensure a consistent supervisory approach for Quantitative Risk Management business-continuity practices. To better coordinate the System's existing advanced risk-management and Specialized Examinations risk-measurement efforts, the division created a quantitative risk management The Federal Reserve conducts specialgroup in early 2005. This new group ized examinations of banking organizawill focus on Basel II quantification tions in the areas of information technoland validation, and will play a broader ogy, fiduciary activities, transfer agent role by helping the System set prioriactivities, and government and municities on the allocation of quantitative pal securities dealing and brokering. The resources, identifying important issues Federal Reserve also conducts specialat both systemic and institutional levels, ized examinations of certain entities, collaborating on original research and other than banks, brokers, or dealers, data analysis with colleagues in the Fedthat extend credit subject to the Board's eral Reserve's economic research divimargin regulations. sions, and generally providing input on quantitative matters. In 2005, the group participated in the fourth Basel II Quanti- Information Technology Activities tative Impact Study (QIS-4) and other In recognition of the importance of interagency efforts, participated in Basel information technology to safe and Committee on Banking Supervision sound operations in the financial indus- (Basel Committee) working groups and try, the Federal Reserve reviews the projects, and assisted with quantitative information technology activities of training for examiners and other staff. supervised banking organizations as well as certain independent data centers that provide information technology Business Continuity services to these organizations. All In 2005, the Federal Reserve continued safety and soundness examinations are its efforts to strengthen the resilience of expected to include a review of informathe U.S. financial system in the event of tion technology risks and activities. Durunexpected disruptions. Throughout the ing 2005, the Federal Reserve was the year, the Federal Reserve monitored lead agency in 2 examinations of large, financial institutions' progress toward multiregional data processing servicers implementing the sound practices identi- examined in cooperation with the other fied in the April 2003 "Interagency federal banking agencies. Paper on Sound Practices to Strengthen the Resilience of the U.S. Financial Sys- Fiduciary Activities tem," a joint publication with the Office of the Comptroller of the Currency The Federal Reserve has supervisory (OCC) and the Securities and Exchange responsibility for organizations that Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 63 together hold more than $26 trillion of governing dealing and brokering in govassets in various fiduciary or custodial ernment securities. Twenty-eight state capacities. During on-site examinations member banks and 7 state branches of of fiduciary activities, an organization's foreign banks have notified the Board compliance with laws, regulations, and that they are government securities dealgeneral fiduciary principles and poten- ers or brokers not exempt from Treatial conflicts of interest are reviewed; its sury's regulations. During 2005, the management and operations, including Federal Reserve conducted 9 examinaits asset- and account-management, risk- tions of broker-dealer activities in govmanagement, and audit and control ernment securities at these organizaprocedures, are also evaluated. In 2005, tions. These examinations are generally Federal Reserve examiners conducted conducted concurrently with the Federal 119 on-site fiduciary examinations. Reserve's examination of the state member bank or branch. The Federal Reserve is also respon- Transfer Agents and sible for ensuring that both state mem- Securities Clearing Agencies ber banks and bank holding compa- As directed by the Securities Exchange nies that act as municipal securities Act of 1934, the Federal Reserve con- dealers comply with the Securities Act ducts specialized examinations of those Amendments of 1975. Municipal securistate member banks and bank holding ties dealers are examined pursuant to companies that are registered with the the Municipal Securities Rulemaking Board as transfer agents. Among other Board's rule G-16 at least once every things, transfer agents countersign and two calendar years. Of the 22 entities monitor the issuance of securities, reg- that dealt in municipal securities during ister the transfer of securities, and 2005, 7 were examined during the year. exchange or convert securities. On-site examinations focus on the effective- Securities Credit Lenders ness of an organization's operations and its compliance with relevant securities Under the Securities Exchange Act of regulations. During 2005, the Federal 1934, the Board is responsible for reg- Reserve conducted on-site examinations ulating credit in certain transactions at 24 of the 77 state member banks involving the purchase or carrying of and bank holding companies that were securities. As part of its general examiregistered as transfer agents. In 2005, nation program, the Federal Reserve the Federal Reserve also examined examines the banks under its jurisdic- 1 state member limited-purpose trust tion for compliance with the Board's company acting as a national securities Regulation U. In addition, the Federal depository. Reserve maintains a registry of persons other than banks, brokers, and dealers who extend credit subject to Regula- Government and Municipal Securities tion U. The Federal Reserve may con- Dealers and Brokers duct specialized examinations of these The Federal Reserve is responsible for lenders if they are not already subject to examining state member banks and for- supervision by the Farm Credit Admineign banks for compliance with the Gov- istration, the National Credit Union ernment Securities Act of 1986 and with Administration, or the Office of Thrift Department of the Treasury regulations Supervision (OTS). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

64 92nd Annual Report, 2005 At the end of 2005, 628 lenders other and board of directors resolutions. Inforthan banks, brokers, or dealers were reg- mation about these actions is not availistered with the Federal Reserve. Other able to the public. federal regulators supervised 216 of these lenders, and the remaining 412 Surveillance and were subject to limited Federal Reserve Off-Site Monitoring supervision. On the basis of regulatory requirements and annual reports, the The Federal Reserve uses automated Federal Reserve exempted 181 lenders screening systems to monitor the finanfrom its on-site inspection program. The cial condition and performance of state securities credit activities of the remain- member banks and bank holding compaing 231 lenders were subject to either nies between on-site examinations. This biennial or triennial inspection. Eighty analysis helps to direct examination inspections were conducted during the resources to institutions that exhibit year, compared with 55 in 2004. higher risk profiles. Screening systems also assist in the planning of examinations by identifying companies that are Enforcement Actions engaging in new or complex activities. and Special Examinations Since 1994, the Federal Reserve's The Federal Reserve has enforcement screening systems have included a set authority over the banking organizations of two models that together are known it supervises and their affiliated parties. as the System to Estimate Examination Enforcement actions may be taken to Ratings (SEER). These models use address unsafe and unsound practices or econometric techniques to estimate, for violations of any law or regulation. For- each bank, a supervisory rating and mal enforcement actions include cease- probability of failure using the supervand-desist orders, written agreements, isory information and financial data removal and prohibition orders, and banks report on their Reports of Condicivil money penalties. In 2005, the tion and Income (Call Reports). During Federal Reserve completed 64 formal 2005, the Federal Reserve completed an enforcement actions. Civil money pen- initiative to enhance the SEER models; alties totaling $40.2 million were this effort resulted in a new off-site assessed. All civil money penalties, as monitoring tool known as the Supervidirected by statute, are remitted either sion and Regulation Statistical Assessto the Department of the Treasury or to ment of Bank Risk model. The new the Federal Emergency Management model is scheduled for implementation Agency. Enforcement orders, which in early 2006. To supplement these are issued by the Board, and written screens that use financial and superviagreements, which are executed by sory data, the Federal Reserve also the Reserve Banks, are made public monitors various market data, including and posted on the Board's web site equity prices, debt spreads, agency rat- (www.federalreserve.gov/boarddocs/ ings, and measures of expected default enforcement). frequency, to gauge market perceptions In addition to formal enforcement of the risk in banking organizations. actions, the Reserve Banks completed The Federal Reserve also prepares 95 informal enforcement actions in quarterly Bank Holding Company Per- 2005. Informal enforcement actions formance Reports (BHCPRs) for use in include memoranda of understanding monitoring and inspecting supervised Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 65 banking organizations. The reports con- International Activities tain, for individual bank holding companies, financial statistics and com- The Federal Reserve supervises the forparisons with peer companies. BHCPRs eign branches and overseas investments are compiled from data provided by of member banks, Edge Act and agreelarge bank holding companies in quar- ment corporations, and bank holding terly regulatory reports (FR Y-9C and companies and also the investments FR Y-9LP). BHCPRs are made avail- by bank holding companies in export able to the public on the National Infor- trading companies. In addition, it supermation Center web site, which can be vises the activities that foreign banking accessed at www.ffiec.gov. organizations conduct through entities During 2005, the surveillance func- in the United States, including branches, tion implemented two major upgrades agencies, representative offices, and to its web-based Performance Report subsidiaries. Information and Surveillance Monitoring (PRISM) application. PRISM is a Foreign Operations of querying tool used by Federal Reserve U.S. Banking Organizations analysts to access and display financial, surveillance, and examination data. In To examine the international operations the analytical module, users can cus- of state member banks, Edge Act and tomize the presentation of institutional agreement corporations, and bank holdfinancial information drawn from Call ing companies, the Federal Reserve Reports, Uniform Bank Performance generally conducts its examinations or Reports, FR Y-9 statements, BHCPRs, inspections at the U.S. head offices of and other regulatory reports. In the sur- these organizations—where the ultimate veillance module, users can generate responsibility for their foreign offices reports summarizing the results of Sys- lies. Examiners also visit the overseas tem surveillance screens for banks and offices of U.S. banks to obtain financial bank holding companies. The upgrades and operating information and, in some enhanced the range of regulatory data instances, to evaluate the organizations' available for queries, expanded the num- efforts to implement corrective measures ber of surveillance screens, added new or to test their adherence to safe and search options, and improved the user sound banking practices. Examinations interface. abroad are conducted with the coopera- The Federal Reserve works through tion of the supervisory authorities of the the Federal Financial Institutions Exam- countries in which they take place; when ination Council (FFIEC) Task Force on appropriate, the examinations are coor- Surveillance Systems to coordinate sur- dinated with the OCC. veillance activities with the other fed- At the end of 2005, 55 member banks eral banking agencies.4 were operating 748 branches in foreign countries and overseas areas of the United States; 34 national banks were operating 693 of these branches, and 21 state member banks were operating the 4. The member agencies of the FFIEC are the remaining 55. In addition, 16 nonmem- Federal Reserve Board, the Federal Deposit Insur- ber banks were operating 20 branches in ance Corporation, the National Credit Union foreign countries and overseas areas of Administration, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision. the United States. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

66 92nd Annual Report, 2005 Edge Act and Agreement Corporations cies (of which 8 were insured by the Federal Deposit Insurance Corporation) Edge Act corporations are international as well as 50 branches licensed by the banking organizations chartered by the OCC (of which 4 had FDIC insurance). Board to provide all segments of the These foreign banks also directly owned U.S. economy with a means of financ- 12 Edge Act and agreement corporaing international business, especially tions and 2 commercial lending compaexports. Agreement corporations are nies; in addition, they held an equity similar organizations, state chartered or interest of at least 25 percent in 67 U.S. federally chartered, that enter into an commercial banks. agreement with the Board to refrain Altogether, the U.S. offices of these from exercising any power that is not foreign banks at the end of 2005 conpermissible for an Edge Act corporation. trolled approximately 18 percent of U.S. Sections 25 and 25A of the Federal commercial banking assets. These for- Reserve Act grant Edge Act and agreeeign banks also operated 73 representament corporations permission to engage tive offices; an additional 52 foreign in international banking and foreign banks operated in the United States financial transactions. These corporasolely through a representative office. tions, most of which are subsidiaries State-licensed and federally licensed of member banks, may (1) conduct a branches and agencies of foreign banks deposit and loan business in states other are examined on-site at least once every than that of the parent, provided that the eighteen months, either by the Federal business is strictly related to interna- Reserve or by a state or other federal tional transactions, and (2) make foreign regulator. In most cases, on-site examiinvestments that are broader than those nations are conducted at least once every permissible for member banks. twelve months, but the period may be At year-end 2005, 70 banking orgaextended to eighteen months if the nizations, operating 9 branches, were branch or agency meets certain criteria. chartered as Edge Act or agreement cor- In cooperation with the other federal porations. These corporations are examand state banking agencies, the Fedined annually. eral Reserve conducts a joint program for supervising the U.S. operations of foreign banking organizations. The US. Activities of Foreign Banks program has two main parts. One part The Federal Reserve has broad authority addresses the examination process for to supervise and regulate the U.S. activi- those foreign banking organizations that ties of foreign banks that engage in have multiple U.S. operations and is banking and related activities in the intended to ensure coordination among United States through branches, agen- the various U.S. supervisory agencies. cies, representative offices, commercial The other part is a review of the finanlending companies, Edge Act corpora- cial and operational profile of each orgations, commercial banks, and certain nization to assess its general ability to nonbank companies. Foreign banks con- support its U.S. operations and to detertinue to be significant participants in the mine what risks, if any, the organiza- U.S. banking system. tion poses through its U.S. operations. As of year-end 2005, 183 foreign Together, these two processes provide banks from 54 countries were operating critical information to U.S. supervisors 220 state-licensed branches and agen- in a logical, uniform, and timely man- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 67 ner. The Federal Reserve conducted or America, with the help of national bankparticipated with state and federal regu- ing supervisors and international agenlatory authorities in 338 examinations in cies; and aims to help members develop 2005. banking laws, regulations, and supervisory practices that conform to international best practices. For the past Technical Assistance three years, a Federal Reserve official In 2005, the Federal Reserve continued has served as chairman of the board to provide technical assistance on bank of directors of ASBA; the Federal supervisory matters to foreign central Reserve also contributes significantly to banks and supervisory authorities. Tech- ASBA's organizational management and nical assistance involves visits by Fed- to its training and technical assistance eral Reserve staff members to foreign activities. authorities as well as consultations with foreign supervisors who visit the Board or the Reserve Banks. Technical assis- Supervisory Policy tance in 2005 was concentrated in Latin America, Asia, and former Soviet bloc The Federal Reserve's supervisory polcountries. The Federal Reserve, along icy function is responsible for developwith the OCC, FDIC, and Department ing guidance for examiners and banking of the Treasury, was also an active organizations as well as regulations for participant in the newly launched banking organizations under the Federal Middle East and North Africa (MENA) Reserve's supervision. Staff members Financial Regulators' Training Initia- participate in international supervisory tive, which is part of the U.S. gov- forums, such as the Basel Committee ernment's Middle East Partnership and the International Accounting Stan- Initiative. dards Board (IASB), and provide support for the work of the FFEEC. During the year, the Federal Reserve offered training courses exclusively for foreign supervisory authorities in Wash- Capital Adequacy Standards ington, D.C., and in a number of foreign jurisdictions. System staff also took part During 2005, the Federal Reserve, OCC, in technical assistance and training mis- FDIC, and OTS continued to draft prosions led by the International Mone- posed revisions to their risk-based capitary Fund, the World Bank, the Inter- tal adequacy regulations to reflect the American Development Bank, the Asian June 2004 international agreement on Development Bank, the Basel Commit- capital adequacy for banking organizatee, and the Financial Stability Institute. tions, commonly known as Basel n. The The Federal Reserve is also an asso- agencies also issued an advance notice ciate member of the Association of of proposed rulemaking (ANPR) on Supervisors of Banks of the Americas potential changes to the Basel I frame- (ASBA), an umbrella group of bank work; these proposed changes would supervisors from countries in the West- affect banking organizations not subject ern Hemisphere. The group, headquar- to Basel II. Further, the agencies issued tered in Mexico, promotes communi- joint interagency guidance on capital cation and cooperation among bank requirements for asset-backed commersupervisors in the region; coordinates cial paper (ABCP) programs, and they training programs throughout Latin are developing a proposal to revise the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

68 92nd Annual Report, 2005 capital requirements for trading book weighted assets, with the minimum for positions subject to the market risk capi- tier 1 capital set at 4 percent and the tal rule. In addition, the Federal Reserve minimum for total qualifying capital set adopted a final rule on the treatment of at 8 percent. The components of tier 1 trust preferred securities in the tier 1 and total qualifying capital have been capital of bank holding companies. adjusted to an unexpected-loss basis consistent with the denominator. The primary difference between the current Risk-Based Capital Standards rules and the proposed Basel II rule is for Certain Internationally Active the internal-ratings-based methodolo- Banking Organizations gies Basel II uses to calculate risk- During 2005, the agencies continued to weighted assets; the proposed rule also prepare for the U.S. implementation of contains the Basel II advanced measure- Basel II. In early 2006, the U.S. banking ment approach for operational risk. agencies expect to make available a Banking organizations using the methnotice of proposed rulemaking (NPR) ods set forth in the NPR would also setting forth their views on Basel II and be subject to certain public disclosure seeking public comment on the U.S. requirements to foster transparency and plan for implementing the agreement. market discipline. All banking organiza- The agencies expect that only a small tions, including those using the internalnumber of large, internationally active ratings-based approach for credit risk U.S. banking organizations will be and the advanced measurement aprequired to use the Basel II framework. proach for operational risk, would con- In April, the agencies announced pre- tinue to be subject to the tier 1 leverage liminary results from the fourth quan- ratio requirement and the market risk titative impact study (QIS-4), which capital rule, if applicable, as well as the evaluated the potential impact of imple- prompt corrective action rules. menting Basel II at the approximately thirty banking organizations that par- Risk-Based Capital Standards ticipated in the study. The preliminary for Banking Organizations Not Subject results of QIS-4 showed a larger overall to Basel II decline and a greater dispersion in regulatory capital requirements than had On October 20, the agencies issued for been originally expected. QIS-4 results public comment an ANPR that considalso indicated that participating institu- ers modifications to the existing risktions have additional work to do to com- based capital framework, or Basel I, plete the systems and processes they which would continue to apply to bankneed to have in place before Basel II is ing organizations not subject to Basel II. implemented. Partly as a result of con- The changes seek to enhance the risk cerns identified in the analysis of QIS-4 sensitivity of Basel I by increasing the results, the agencies announced on Sep- number of risk-weight categories, pertember 30 additional prudential safe- mitting greater use of external ratings as guards and a one-year delay in the time- an indicator of credit risk for externally line for Basel II implementation in the rated exposures, expanding the types of United States. guarantees and collateral that may be The NPR will maintain the basic recognized, and modifying the risk minimum risk-based capital ratio format weights associated with residential of regulatory capital divided by risk- mortgages. The ANPR also discusses Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 69 approaches that would change the that support the liquidity facility and credit-conversion factor for certain types (2) the notional amount of such credit of commitments, assign a risk-based enhancements exceeds the amount of capital charge to certain securitizations underlying assets that are 90 days or with early-amortization provisions, and more past due, defaulted, or below assign a higher risk weight to loans investment grade that the liquidity prothat are 90 days or more past due or in vider may be obligated to fund under the nonaccrual status and to certain com- facility. mercial real estate exposures. The agencies are also considering modifying the Other Capital Issues risk weights on certain other retail and commercial exposures. The comment In March, the Board adopted a final rule period for the ANPR will end in January that allows for the continued inclusion 2006. of trust preferred securities in the tier 1 capital of bank holding companies, subject to stricter quantitative limits and Asset-Backed clearer qualitative standards. The final Commercial Paper Programs rule revised the quantitative limits On August 4, the agencies issued "Inter- applied to the aggregate amount of ceragency Guidance on the Eligibility of tain core capital elements that may be Asset-Backed Commercial Paper Pro- included in tier 1 capital and revised the gram Liquidity Facilities and the Result- qualitative standards for capital instruing Risk-Based Capital Treatment." The ments included in regulatory capital, guidance reiterates the agencies' posi- consistent with long-standing Board tion that the primary function of an eli- policies. gible ABCP liquidity facility should Board staff members are working be to provide liquidity—not to enhance with the other agencies to develop a credit. The guidance clarifies (1) the proposal to implement a revised, more application of the asset-quality test set risk-sensitive methodology for deterforth in the agencies' risk-based capital mining the capital charge for positions rules for determining the eligibility of subject to the market risk capital rule. an ABCP liquidity facility and (2) the The proposal will address the issues resulting risk-based capital treatment identified in the July 2005 paper "The of such a facility for banking organiza- Application of Basel II to Trading tions. An eligible liquidity facility must Activities and the Treatment of Double have an asset-quality test that precludes Default Effects," which was published funding against assets that are 90 days by the Basel Committee and the Internaor more past due, in default, or below tional Organization of Securities Cominvestment grade. This test implies that missioners (IOSCO). the banking organization providing the The Board's staff also conduct super- ABCP liquidity facility should not be visory analyses of innovative capital exposed to the credit risk associated instruments and novel transactions in with such assets. The guidance clarifies order to determine the appropriate that an ABCP liquidity facility meets supervisory and regulatory capital treatthe asset-quality test if, at all times ment and to identify and address throughout the transaction, (1) the supervisory concerns. These reviews liquidity provider has access to certain frequently require staff to review the types of acceptable credit enhancements various ftinding strategies proposed in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

70 92nd Annual Report, 2005 New Bank Secrecy Act/Anti-Money Laundering Examination Manual This intemgency manual is a significant step toward consistency in the area of anti-money-laundering examination. The new manual promotes a shared understanding of the Bank Secrecy Act and anti-money-laundering regulations and supervisory expectations. Susan Schmidt Bies, Member, Board of Governors Jane 2005 The rclcaM: r- in.. Bank Srcrec} Act/Anil Department of the Treasury's Financial Money Laundering Examination Manual Crimes Enforcement Network {FinCEN), on June 30, 2005, marked an important The state banking agencies and Treasury's milestone for the federal banking agencies Office of Foreign Assets Control (OFAC) in their effort to enhance the consistent also contributed to this initiative. application of the Bank Secrecy Act In the manual, the agencies emphasize (BSA). The five federal financial institu- that banking organizations are responsible tions regulatory agencies1 developed the for establishing and implementing risknew manual, in collaboration with the based policies* procedures, and processes to comply with the BSA and to safeguard their operations from money laun- 1. The agencies are the Board of Governors dering and terrorist financing. The agenof the Federal Reserve System (Federal cies focus on a banking organization's Reserve), Federal Deposit Insurance Corpora- sound risk assessment so that the banktion (FDICX National Credit Union Administraing organization can develop an antition (NCUA), Office of the Comptroller of the money-laundering program calibrated to Currency (OCC), and Office of Thrift Superviits own risk profile. The agencies further < sion (OTS). applications for acquisitions and other Bank Holding Company transactions that institutions submit to Rating System the Federal Reserve. In January, the Federal Reserve adopted a revised bank holding company rating system known as RFI/C(D). The three Bank-Owned Life Insurance main components of the system are Risk In 2005, an interagency working group management, Financial condition, and issued "Interagency Interpretations of potential Impact of the parent company the Interagency Statement on the Pur- and nondepository subsidiaries (collecchase and Risk Management of Life tively, nondepository entities) on the Insurance." The interpretations clarify subsidiary depository institution(s). The financial reporting, credit-exposure lim- fourth component, Depository instituits, concentration limits, and the appro- tion, generally mirrors the primary regpriate methods for calculating the ulator's assessment of the subsidiary amount of insurance a banking organiza- depository institution(s). The revised tion may purchase. rating system reflects the shift that has Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 71 $r tfe'^primary role of the other guidance, or evolving rlslts or conexaminer is to evaluate the adequacy of a trols. The agencies will hold periodic disbanking organization's controls and not to cussions with banking industry represen* second-guess individual, transaction-level tatives so that issues related to the manual decisions. may be raised. These sessions will be held To promote a greater understanding of through the Bank Secrecy Act Advisory the BSA and anti-moiiey-laundering (BSA/ Group (BSAAG), which is a public-private AML) requirements outlined in the manual, partnership sponsored by the Department the Federal Reserve, along with the other of the Treasury devoted to evaluating BSAfederal banking agencies, FinCEN, and related matters. Specifically, the meetings the OFAC participated in a series of out- will be held through a BS AAG subcommit- ? reach events following the manual's tee on examination issues, co-chaired by release. The events, intended for the bank- the Federal Reserve. ing industry and federal and state banking The Federal Reserve recognizes that agency examination staff, consisted of banking organizations have invested signationwide conference calls, regional out- nificant resources to comply with the reach meetings, and a simultaneous broad- BSA and related regulations in order to cast via the Internet. More than 23^000 deter and detect money laundering and bankers and examiners participated In these terrorist financing. Both the banking indussessions, where they also had the opportu- try and the regulatory agencies share the nity to ask questions and receive feedback goal of combating the threats these crimes on specific issues. pose to the US. financial system. The Moving forward, the agencies will Federal Reserve remains committed to ensure that the manual provides the indus- ensuring that supervisory expectations try and examiners with relevant, up-to-date for BSA/AML compliance are clearly information* The manual will be revised in understood by banking organizations and response to changes in law or regulation, examiners. occurred over time in the Federal existing regulatory requirements, super- Reserve's supervisory practices: a shift visory expectations, and sound pracaway from historical analyses of a tices for BSA/AML compliance. To fos- BHC's financial condition toward more- ter consistency, the manual includes the forward-looking assessments of its risk examination procedures that each agenmanagement and financial factors. One cy's examiners are expected to follow. year into the implementation of the new (For more information, see the box ratings system, Federal Reserve super- "New Bank Secrecy Act/Anti-Money visors have found it to be an effective Laundering Examination Manual.") tool for communicating key supervisory In March and April, the Federal points to banking organizations. Reserve, FDIC, OCC, OTS, NCUA, and FinCEN issued guidance to clarify the requirements of the BSA/AML regula- Bank Secrecy Act and tions for banking organizations that Anti-Money Laundering provide banking services to money- In June 2005, the FFIEC issued a new services businesses operating in the examination manual that compiles United States. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

72 92nd Annual Report, 2005 International Guidance on • "Home-Host Information Sharing for Supervisory Policies Effective Basel II Implementation," issued as a consultative document in As a member of the Basel Committee, November by the Basel Committee, in the Federal Reserve in 2005 participated association with the Core Principles in efforts to revise the international Liaison Group capital regime and to develop international supervisory guidance. The Fed- • "Enhancing Corporate Governance eral Reserve's goals in these activities for Banking Organizations," issued in are to advance sound supervisory poli- July (to update guidance published in cies for internationally active bank- 1999) ing organizations and to improve the stability of the international banking • "The Application of Basel II to Tradsystem. ing Activities and the Treatment of Double Default Effects," issued in July by the Basel Committee and Capital Adequacy IOSCO To address issues not fully resolved in the Basel II framework, the Federal • "Compliance and the Compliance Reserve in 2005 continued to partici- Function in Banks," issued in April pate in a number of Basel Committee working groups, including a joint Core Principles for Basel Committee-IOSCO working Effective Banking Supervision group reviewing issues related to counterparty credit risk, double-default The Core Principles, developed by the effects (reflecting the low probabil- Basel Committee in 1997, have become ity that both a borrower and its guar- the de facto international standard for antor will default at the same time), sound prudential regulation and superviand the definition of positions that sion of banks. During 2005, the Federal are subject to a market risk capital Reserve participated in a Basel Commitrequirement. tee effort to update the Core Principles in light of the significant changes that have occurred in international banking Risk Management regulation and the experience that has been gained since the principles were The Federal Reserve contributed to sevlast revised in 1999. eral supervisory policy papers, reports, and recommendations issued by the Joint Forum Basel Committee during 2005 that were generally aimed at improving the super- In 2005, the Federal Reserve also convision of banking organizations' risk- tinued its participation in the Joint management practices.5 Forum—a group made up of representatives of the Basel Committee, IOSCO, and the International Association of Insurance Supervisors. The Joint Forum is a forum for supervisors to discuss their experiences with financial con- 5. Papers issued by the Basel Committee can glomerates. The Federal Reserve conbe accessed via the Bank for International Settlements web site at www.bis.org. tributed to several supervisory policy Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 73 papers, reports, and recommendations During 2005, the Federal Reserve had issued by the Joint Forum during 2005.6 a key role in the development of ATF's consultative document "Supervisory • "High-Level Principles for Business Guidance on the Use of the Fair Value Continuity," issued in December Option by Banks under International Financial Reporting Standards," issued • "Credit Risk Transfer," issued in for public comment in July. The docu- March ment provides guidance for the prudential supervision of banks in their imple- • "Outsourcing in Financial Services," mentation of the FVO rule under the issued in February amended IAS 39. The Federal Reserve also provided input on ATF's proposed consultative International Accounting document "Sound Credit Risk Assessand Disclosure ment and Valuation for Loans," which was issued for comment in November. The Federal Reserve participates in the The guidance consists of ten principles Basel Committee's Accounting Task addressing supervisory expectations Force (ATF) and represents the Basel for and supervisory evaluations of a Committee at international meetings on banking organization's establishment accounting, auditing, and disclosure and support of its loan-loss allowance issues affecting global banking organiaccounts. zations. In particular, officials of the Federal Reserve represent the Basel Committee at meetings that address Response to 2005 Hurricanes financial instruments accounting and disclosure issues associated with inter- In 2005, the Federal Reserve worked national accounting standards. In addi- cooperatively with the other federal tion, an official of the Federal Reserve is banking agencies, state banking agena member of the Standards Advisory cies, and other organizations to deter- Council of the IASB. mine the operating status of financial institutions located in the areas affected The IASB issued an amendment in by Hurricanes Katrina, Rita, and Wilma. June that reflects extensive Basel Com- The agencies encouraged banks to work mittee and European Central Bank comwith consumer and commercial customments. The amended fair value option ers experiencing difficulties due to the (FVO) rule in International Accounting storms. The agencies promptly released Standard (IAS) 39 allows an organizajoint guidance on regulatory and reporttion to irrevocably elect, at inception, ing issues to assist examiners and banka fair value measurement for certain ing organizations affected by the hurrifinancial instruments, with gains and canes. In addition, the Federal Reserve, losses from changes in fair value in consultation with the other federal recorded in current earnings. The FVO banking agencies, issued responses to rule amendment to IAS 39 will become questions frequently asked by financial effective January 1, 2006. institutions about whether certain BSA provisions applied when providing services to victims of Hurricane Katrina. 6. Papers issued by the Joint Forum can be The agencies also exercised their authoraccessed via the Bank for International Settleity under section 2 of the Deposiments web site at www.bis.org. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

74 92nd Annual Report, 2005 tory Institutions Disaster Relief Act of lending requirements when financing 1992 to waive statutory and regulatory residential construction in a tract appraisal requirements for transactions development. that involve real property in major disaster areas, when waiving the appraisal requirements would facilitate disaster Home Equity Lending recovery and would be consistent with In May, the Federal Reserve and the safe and sound banking practice. other federal financial institutions reg- In an effort to provide the industry ulatory agencies issued "Interagency and examiners with further guidance on Credit Risk Management Guidance on a growing number of hurricane-related Home Equity Lending" to promote issues, the FFIEC established a formal sound risk management in banks' home Katrina working group composed of equity lending. The guidance addressed senior supervision officials from each of the agencies' concerns about the easing the FFIEC agencies. The Katrina workof underwriting standards as lenders ing group published frequently asked compete to attract home equity lending questions (FAQs) and developed exambusiness—sometimes by offering prodiner guidance that will be issued in early ucts with high loan-to-value ratios, 2006. Because of the severity and scale requiring only limited documentation of of Katrina and the other natural disasters a borrower's assets and income, using in 2005, the working group's efforts automated valuation models to a greater are expected to continue into 2006. The extent, or relying on loans originated Katrina working group has established by third parties. The guidance advances a user-friendly, web-based "frequently sound underwriting standards, controls asked questions" forum on the FFIEC's over third-party originations, a robust web site (www.ffiec.gov). collateral-valuation process, and account and portfolio management practices. Credit Risk Management Nontraditional Mortgage Products The Federal Reserve works with the other federal banking agencies to In December, the Federal Reserve and develop guidance on credit risk the other federal financial institutions management. regulatory agencies issued for public comment "Proposed Interagency Guidance on Nontraditional Mortgage Products." Nontraditional mortgage prod- Real Estate Appraisals ucts typically include payment-option In September, the Federal Reserve, adjustable-rate mortgages and interest- FDIC, NCUA, OCC, and OTS issued only mortgages. These mortgage prod- FAQs on the requirements of the agen- ucts allow for principal-payment cies' real estate appraisal regulations deferral and negative amortization. Instiand on the October 2003 interagency tutions may also combine these products statement "Independence of Appraisal with other risk-layering practices, such and Evaluation Functions." The agen- as less stringent underwriting standards, cies also issued FAQs in March to help reduced loan documentation, or simultainstitutions comply with the agencies' neous second-lien loans. The proposed appraisal regulations and real estate interagency guidance emphasizes that an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 75 institution needs to develop and main- tions offering these services to the need tain adequate risk-management practices to comply with all applicable federal to monitor and control the risk associ- and state laws; and (3) sets forth ated with these products. The proposed examples of best practices that are curguidance also contains recommended rently observed in, or recommended by, practices for providing consumers with the industry. information about the terms and risks of nontraditional mortgage products. Com- Small Bank Holding Company ments on the proposal are due March 29, Threshold 2006. In September, the Board requested com- Commercial Real Estate ment on a proposal to raise the asset- Concentrations size threshold used to determine whether a bank holding company qualifies for During 2005, the Federal Reserve and (1) the Board's Small Bank Holding the federal financial institutions regu- Company Policy Statement and (2) an latory agencies developed proposed exemption from the Board's risk-based interagency guidance, "Concentrations and leverage capital adequacy guidein Commercial Real Estate Lending, lines for bank holding companies. The Sound Risk Management Practices." proposal would raise that threshold from The proposed guidance, to be issued for $150 million to $500 million in consolipublic comment in January 2006, will dated assets. The proposal would also respond to the agencies' concerns about modify the qualitative criteria used in rising commercial real estate (CRE) determining whether a bank holding concentrations, particularly at small to company that is under the asset-size medium-sized institutions. This guidthreshold nevertheless would not qualance will reinforce the agencies' existify for the policy statement or the ing real estate lending guidelines and exemption from the capital guidelines. provide criteria for identifying insti- In addition, the proposal would clarify tutions that have CRE lending conthe treatment under the policy statecentrations and that should therefore ment of subordinated debt associated employ heightened risk-management with trust preferred securities. Final practices. Comments on the proposal are action on this proposal is expected in due April 13, 2006. early 2006. Overdraft Protection Economic Growth and Regulatory Paperwork Reduction Act of 1996 In February, the Federal Reserve, FDIC, NCUA, and OCC issued interagency The Federal Reserve, OCC, FDIC, and guidance to assist insured depository OTS are in the process of reviewing institutions in the responsible disclo- agency regulations as required by sure and administration of overdraft- the Economic Growth and Regulatory protection services. The guidance Paperwork Reduction Act of 1996 (1) seeks to ensure that institutions adopt (EGRPRA). EGRPRA requires that the adequate policies and procedures to banking agencies review their regulaaddress the credit, operational, and tions every ten years to identify any other risks associated with overdraft- unnecessary regulatory requirements protection services; (2) alerts institu- imposed on insured depository institu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

76 92nd Annual Report, 2005 tions and eliminate these requirements, Bank Holding Company as appropriate. This review is in addi- Regulatory Financial Reports tion to the Board's periodic review of each of its regulations. The Federal Reserve requires that U.S. The agencies met with representa- bank holding companies periodically tives from the banking industry and submit reports providing financial and from consumer groups around the coun- structure information. This information try to listen to their concerns and to is essential to the supervision of the solicit their suggestions for reducing organizations and the formulation of regulatory burden. The agencies have regulations and supervisory policies. received public comments on several of The information is also used in respondtheir regulations and expect to issue a ing to requests from Congress and the final report in 2006. public for information on bank holding companies and their nonbank subsidiaries. In addition, foreign banking organizations must periodically submit Sarbanes-Oxley Act reports to the Federal Reserve. During 2005, the Federal Reserve con- The FR Y-9 series of reports provides tinued to evaluate the effects of the standardized financial statements for Sarbanes-Oxley Act (SOX) on banking bank holding companies on a consoliorganizations. Federal Reserve account- dated and parent-only basis. The reports ing staff reviewed material internal con- are used to detect emerging financial trol weaknesses and deficiencies at cer- problems, to review performance and tain public banking organizations and conduct pre-inspection analysis, to are now drafting supervisory guidance monitor and evaluate risk profiles and for examiners and inspectors. The guid- capital adequacy, to evaluate proposals ance will instruct examiners and inspec- for bank holding company mergers and tors to consider internal control infor- acquisitions, and to analyze the holding mation, including findings generated company's overall financial condition. by the requirements of section 404 of The nonbank subsidiary reports— SOX, in the overall risk-assessment FRY-11, FR 2314, and FR Y-7N—aid process. the Federal Reserve in determining the In addition, an official of the Federal condition of bank holding companies Reserve serves on the Standing Advi- that are engaged in nonbanking activisory Group of the Public Company ties and in monitoring the volume, Accounting Oversight Board (PCAOB); nature, and condition of their nonbankthe group is advising the PCAOB as ing subsidiaries. it develops standards for the external In March, several revisions to the audits of publicly traded companies in FR Y-9C and FR Y-9SP reports were the United States. The Federal Reserve implemented in order to identify private also continued in 2005 to work with the equity merchant banking activity, iden- FDIC and other federal agencies to con- tify firms providing auditing services to sider changes that should be made to the the bank holding company, collect inforregulations implementing the Federal mation on subordinated notes payable to Deposit Insurance Corporation Improve- trusts issuing trust preferred securities ment Act to promote strong internal (changes affected the FR Y-9C balance controls and consistency with the SOX sheet), and collect information on nonrequirements. voting equity capital (changes affected Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 11 the FR Y-9SP). In September, the of the overall soundness of the nation's FR Y-9C was modified to collect infor- banking system. Call Report data, which mation on purchased impaired loans in also serve as benchmarks for the finanresponse to Statement of Position 03-3 cial information required by many other of the American Institute of Certified Federal Reserve regulatory financial Public Accountants, "Accounting for reports, are widely used by state and Certain Loans or Debt Securities local governments, state banking super- Acquired in a Transfer," and to collect visors, the banking industry, securities information related to the Govern- analysts, and the academic community. ment National Mortgage Association The Federal Reserve and the other (GNMA) optional repurchase program banking agencies under the auspices for mortgage loans (rebooked loans of the FFIEC have completed the Call backing GNMA securities). Report modernization project. Through Effective December 31, revisions to the use of new open data exchange stanthe Annual Report of Foreign Banking dards (known as "extensible Business Organizations (FR Y-7) reorganized Reporting Language," or XBRL), the the form and instructions, expanded new Central Data Repository (CDR) information collected on foreign com- system improves the timeliness and panies held under the authority of quality of supervisory data and enhances section 2(h)(2) of the Bank Holding market discipline by ensuring that the Company Act, added language to the public has more timely access to the confidentiality section, and clarified the data. This is the first wide-scale appliinstructions pursuant to Regulation K. cation of XBRL. Enhancements to the In December, a new report was imple- data-collection and -disclosure process mented: the Supplement to the Reports include requiring banks to submit their of Changes in Organizational Structure Call Report data electronically to the (FR Y-10S). In this report, bank holding CDR, moving forward the deadline for companies, financial holding compa- filing reports, and requiring respondents nies, and state member banks not owned to validate their data before filing. The by bank holding companies report their effort to set up the CDR was completed SEC registration status and whether they and became operational on October 1. are subject to the requirements of sec- The FFIEC issued for public comtion 404 of SOX. They also report their ment the proposed changes to the 2006 six-digit CUSIP number to help the Fed- Call Report. The agencies planned to eral Reserve compare regulatory data implement some changes effective with market data. March 31, 2006, and to defer implementation on other issues until September 30, 2006, and March 31, 2007, pend- Commercial Bank ing final interagency approval. Regulatory Financial Reports As the federal supervisor of state mem- Supervisory Information ber banks, the Federal Reserve, acting in Technology concert with the other federal banking agencies through the FFIEC, requires Under the direction of the division's banks to submit quarterly Call Reports. chief technology officer, the supervisory Call Reports are the primary source of information technology (SIT) function data for the supervision and regulation within the division facilitates the manof banks and for the ongoing assessment agement of information technology Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

78 92nd Annual Report, 2005 across the Federal Reserve System's Database (NED), which provides superoverall supervision function. SIT works visory personnel and state banking through assigned staff at the Board and authorities with access to NIC data; the the Reserve Banks, as well as through Banking Organization National Desktop a System-wide committee structure, to (BOND), an application that facilitates ensure that key staff members through- secure, real-time electronic informationout the System participate in identifying sharing and collaboration among federal requirements and setting priorities for and state banking regulators for the IT initiatives. supervision of banking organizations; In 2005, the SIT function worked on and the Central Document and Text the following strategic projects and ini- Repository, which contains documents tiatives: (1) refine and institutionalize supporting the supervisory processes. processes governing IT investments to During 2005, the NED application ensure that all technology investments was modified to incorporate information are aligned with business needs and from consumer affairs and Community that accountability for business suc- Reinvestment Act examinations, thereby cess is clearly defined and accepted; eliminating a separate legacy system. (2) improve the security of information- In early 2006, NED will be enhanced to sharing technologies and provide for begin collecting important BSA inforseamless collaboration in interagency mation in an automated format to supefforts; (3) develop a measurement- port the Federal Reserve's enforcement based management and investment cul- activities. ture; (4) identify opportunities to con- In 2005, the BOND application was verge and streamline IT applications, enhanced to improve usability, reduce including key administrative systems, to administrative burden, and increase the provide consistent and seamless infor- effectiveness of management reporting. mation; (5) develop a foundation for BOND was also updated to accommoevaluating technologies (such as portals, date the new FR Y-10S reporting form search engines, and content manage- (see the section "Bank Holding Comment tools) to improve access to these pany Regulatory Financial Reports"). systems and to integrate supervisory and At year-end 2005, BOND had approximanagement information systems that mately 2,700 registered users across the support both office-based and field staff; Federal Reserve System, the OCC, the (6) enhance the information security FDIC, and eleven state banking departframework for the supervisory function; ments. In 2005, significant resources and (7) participate in the selection of a were also devoted to the FFIEC Call learning management system that will Report modernization initiative (see the enhance the delivery of online examiner section "Commercial Bank Regulatory training. Financial Reports"). National Information Center Staff Development The National Information Center (NIC) The System Staff Development Program is the Federal Reserve's comprehensive trains staff members at the Board, the repository for supervisory, financial, and Reserve Banks, state banking departbanking structure data and supervisory ments, and foreign supervisory authoridocuments. NIC includes the structure ties. Training is offered at the basic, data system; the National Examination intermediate, and advanced levels in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 79 Training Programs for Banking Supervision and Regulation, 2005 Number of sessions conducted Program Total Regional Schools or seminars conducted by the Federal Reserve Core schools Banking and supervision elements 7 5 Operations and analysis 6 5 4 2 Report writing . 12 12 Management skills 9 7 Conducting meetings with management 10 10 Other schools Credit risk analysis 5 4 Examination management 6 4 Real estate lending seminar 3 3 Senior forum for current banking and regulatory issues — 3 3 Assessing capital adequacy 1 1 Basel II corporate activities 2 1 Basel II operational risk 1 1 Basel II retail activities 2 0 Principles of fiduciary supervision 2 2 Commercial lending essentials for consumer affairs 1 1 Consumer compliance examinations I 2 0 Consumer compliance examinations II 2 2 CRA examination techniques 2 1 CRA risk-focused examination techniques 3 3 Fair lending examination techniques 2 2 Foreign banking organizations seminar 1 1 Information systems continuing education 4 4 Asset liability management (ALM1) 2 2 Asset liability management (ALM2) 1 1 Fundamentals of interest rate risk management 5 5 Trading and operations 1 1 Technology risk integration 3 3 Leadership dynamics 7 6 Fundamentals of fraud 5 5 Information technology seminars1 13 13 Seminar for senior supervisors of foreign central banks2 and ten other international courses 35 27 Self-study or online learning3 Orientation (core and specialty) .. Self-study modules (26 modules) . Other agencies conducting courses4 Federal Financial Institutions Examination Council 70 12 The Options Institute 1 1 1. Held at Chicago IT Lab. 3. Self-study programs do not involve group sessions. 2. Conducted jointly with the World Bank. 4. Open to Federal Reserve employees. several disciplines within bank supervi- FFIEC and by certain other regulatory sion: safety and soundness, information agencies. The System's involvement technology, international banking, and includes developing and implementing consumer affairs. Classes are conducted basic and advanced training in relation in Washington, D.C., as well as at to various emerging issues as well as in Reserve Banks and other locations. specialized areas such as international The Federal Reserve System also banking, information technology, participates in training offered by the municipal securities dealing, capital Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

80 92nd Annual Report, 2005 Results of First Proficiency and Second Proficiency Examinations, 2005 Second proficiency Result First proficiency Safety and soundness Consumer affairs Information technology Passed 155 65 18 2 markets, payment systems risk, white- second proficiency examinations was collar crime, and real estate lending. In 78 percent. addition, the System co-hosts the World Bank Seminar for supervisors from developing countries. Regulation of the In 2005, the Federal Reserve trained U.S. Banking Structure 3,296 students in System schools, 946 in The Federal Reserve administers sevschools sponsored by the FFIEC, and eral federal statutes that apply to bank 11 in other schools, for a total of 4,253, holding companies, financial holding including 266 representatives of foreign companies, member banks, and foreign central banks and supervisory agencies banking organizations—the Bank Hold- (see the table on the preceding page). ing Company Act, the Bank Merger Act, The number of training days in 2005 the Change in Bank Control Act, the totaled 18,441. Federal Reserve Act, and the Interna- The System gave scholarship assistional Banking Act. In administering tance to the states for training their these statutes, the Federal Reserve acts examiners in Federal Reserve and on a variety of proposals that directly or FFIEC schools. Through this program, indirectly affect the structure of the U.S. 473 state examiners were trained—267 banking system at the local, regional, in Federal Reserve courses, 203 in and national levels; the international FFIEC programs, and 3 in other courses. operations of domestic banking organi- A staff member seeking an examinzations; or the U.S. banking operations er's commission is required to take a of foreign banks. The proposals include first proficiency examination as well as bank holding company formations and a second proficiency examination in one acquisitions, bank mergers, and other of the following three specialty areas: transactions involving bank or nonbank safety and soundness, consumer affairs, firms. In 2005, the Federal Reserve or information technology. In 2005, 155 acted on 1,283 proposals, which repreexaminers passed the first proficiency sented 3,442 individual applications examination (see Results of Examinafiled under the five administered tions table). In the second proficiency statutes. examination, 65 examiners passed the safety and soundness examination, 18 examiners passed the consumer affairs Bank Holding Company Act examination, and 2 examiners passed the information technology examina- Under the Bank Holding Company Act, tion. The average pass rate for the first a corporation or similar legal entity must proficiency examination was 79 per- obtain the Federal Reserve's approval cent. The average pass rate for the before forming a bank holding com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 81 pany through the acquisition of one ted well-run bank holding companies or more banks in the United States. that satisfy certain criteria to commence Once formed, a bank holding company certain other nonbank activities on a must receive Federal Reserve approval de novo basis without first obtaining before acquiring or establishing addi- Federal Reserve approval. tional banks. The act also identifies A bank holding company may repurthe nonbanking activities permissible chase its own shares from its sharefor bank holding companies; depend- holders. When the company borrows ing on the circumstances, these activi- money to buy the shares, the transties may or may not require Federal action increases the company's debt Reserve approval in advance of their and decreases its equity. The Federal commencement. Reserve may object to stock repurchases When reviewing a bank holding com- by bank holding companies that fail pany application or notice that requires to meet certain standards, including the prior approval, the Federal Reserve may Board's capital adequacy guidelines. In consider the financial and managerial 2005, the Federal Reserve reviewed 6 resources of the applicant, the future stock-repurchase proposals by bank prospects of both the applicant and the holding companies. firm to be acquired, the convenience and The Federal Reserve also reviews needs of the community to be served, elections from bank holding compathe potential public benefits, the com- nies seeking financial holding competitive effects of the proposal, and the pany status under the authority granted applicant's ability to make available to by the Gramm-Leach-Bliley Act. Bank the Federal Reserve information deemed holding companies seeking financial necessary to ensure compliance with holding company status must file a applicable law. In the case of a foreign written declaration with the Federal banking organization seeking to acquire Reserve. In 2005, 35 domestic financontrol of a U.S. bank, the Federal cial holding company declarations and Reserve also considers whether the for- 3 foreign bank declarations were eign bank is subject to comprehensive approved. supervision or regulation on a consolidated basis by its home-country supervi- Bank Merger Act sor. In 2005, the Federal Reserve acted upon 512 applications filed by bank The Bank Merger Act requires that holding companies to acquire a bank or all proposals involving the merger of a nonbank firm, or to otherwise expand insured depository institutions be acted their activities. on by the appropriate federal banking Bank holding companies generally agency. The Federal Reserve has primay engage in only those nonbanking mary jurisdiction if the institution suractivities that the Board has previously viving the merger is a state member determined to be closely related to bank- bank. Before acting on a merger proing under section 4(c)(8) of the Bank posal, the Federal Reserve considers the Holding Company Act. Since 1996, the financial and managerial resources of act has provided an expedited prior- the applicant, the future prospects of the notice procedure for certain permissible existing and combined organizations, nonbank activities and for acquisitions the convenience and needs of the comof small banks and nonbank entities. munities to be served, and the competi- Since that time, the act has also permit- tive effects of the proposed merger. It Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

82 92nd Annual Report, 2005 also considers the views of certain other approved 111 changes in control of agencies regarding the competitive fac- state member banks and bank holding tors involved in the transaction. In 2005, companies. the Federal Reserve approved 58 merger applications under the act. When the FDIC, OCC, or OTS has Federal Reserve Act jurisdiction over a merger, the Federal Under the Federal Reserve Act, a Reserve is asked to comment on the member bank may be required to seek competitive factors related to the proprior Federal Reserve approval before posal. By using standard terminology in expanding its operations domestically assessing competitive factors in merger or internationally. State member banks proposals, the four agencies have sought must obtain Federal Reserve approval to ensure consistency in administering to establish domestic branches, and all the Bank Merger Act. The Federal member banks (including national Reserve submitted 472 reports on combanks) must obtain Federal Reserve petitive factors to the other agencies in approval to establish foreign branches. 2005. When reviewing proposals to establish domestic branches, the Federal Reserve Change in Bank Control Act considers, among other things, the scope and nature of the banking activities to The Change in Bank Control Act be conducted. When reviewing proposrequires individuals and certain other als for foreign branches, the Federal parties that seek control of a U.S. bank Reserve considers, among other things, or bank holding company to obtain the condition of the bank and the bank's approval from the appropriate federal experience in international banking. In banking agency before completing the 2005, the Federal Reserve acted on new transaction. The Federal Reserve is and merger-related branch proposals for responsible for reviewing changes in the 2,435 domestic branches, and granted control of state member banks and bank prior approval for the establishment of holding companies. In its review, the 5 new foreign branches. Federal Reserve considers the financial State member banks must also obtain position, competence, experience, and Federal Reserve approval to establish integrity of the acquiring person; the financial subsidiaries. These subsidiaries effect of the proposed change on the may engage in activities that are finanfinancial condition of the bank or bank cial in nature or incidental to financial holding company being acquired; the activities, including securities and insureffect of the proposed change on compeance agency-related activities. In 2005, tition in any relevant market; the com- 2 applications for financial subsidiaries pleteness of the information submitted were approved. by the acquiring person; and whether the proposed change would have an adverse effect on the federal deposit Overseas Investments by insurance funds. As part of the process, U.S. Banking Organizations the Federal Reserve may contact other regulatory or law enforcement agencies U.S. banking organizations may engage for information about relevant indi- in a broad range of activities overseas. viduals. In 2005, the Federal Reserve Many of the activities are conducted Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 83 indirectly through Edge Act and agree- will be made available to the Federal ment corporation subsidiaries. Although Reserve, if deemed necessary to determost foreign investments are made mine and enforce compliance with under general consent procedures that applicable law; whether the foreign bank involve only after-the-fact notification has adopted and implemented proceto the Federal Reserve, large and other dures to combat money laundering and significant investments require prior whether the home country of the foreign approval. In 2005, the Federal Reserve bank is developing a legal regime to approved 43 proposals for significant address money laundering or is particioverseas investments by U.S. banking pating in multilateral efforts to combat organizations. The Federal Reserve also money laundering; and the record of the approved 11 applications to make addi- foreign bank with respect to compliance tional investments through an Edge Act with U.S. law. In 2005, the Federal or agreement corporation, 3 applications Reserve approved 10 applications by to establish an Edge Act or agreement foreign banks to establish branches, corporation, and 2 applications to extend agencies, or representative offices in the the corporate existence of an Edge Act United States. corporation. Public Notice of International Banking Act Federal Reserve Decisions The International Banking Act, as Certain decisions by the Federal Reserve amended by the Foreign Bank Supervi- that involve an acquisition by a bank sion Enhancement Act of 1991, requires holding company, a bank merger, a foreign banks to obtain Federal Reserve change in control, or the establishment approval before establishing branches, of a new U.S. banking presence by a agencies, commercial lending company foreign bank are made known to the subsidiaries, or representative offices in public by an order or an announcement. the United States. Orders state the decision, the essential In reviewing proposals, the Federal facts of the application or notice, and Reserve generally considers whether the the basis for the decision; announceforeign bank is subject to comprehen- ments state only the decision. All orders sive supervision or regulation on a con- and announcements are made public; solidated basis by its home-country they are subsequently reported in the supervisor. It also considers whether the Board's weekly H.2 statistical release home-country supervisor has consented and in the Federal Reserve Bulletin. The to the establishment of the U.S. office; H.2 release also contains announcethe financial condition and resources of ments of applications and notices the foreign bank and its existing U.S. received by the Federal Reserve upon operations; the managerial resources of which action has not yet been taken. the foreign bank; whether the home- For each pending application and country supervisor shares information notice, the related H.2A contains the regarding the operations of the foreign deadline for comments. The Board's bank with other supervisory authorities; web site (www.federalreserve.gov) prowhether the foreign bank has provided vides information on orders and adequate assurances that information announcements as well as a guide for concerning its operations and activities U.S. and foreign banking organizations Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

84 92nd Annual Report, 2005 submitting applications or notices to the credit in certain transactions involving Federal Reserve. the purchase or carrying of securities. The Board's Regulation T limits the amount of credit that may be provided Enforcement of by securities brokers and dealers when Other Laws and Regulations the credit is used to trade debt and equity securities. The Board's Regula- The Federal Reserve's enforcement tion U limits the amount of credit that responsibilities also extend to financial may be provided by lenders other than disclosures by state member banks, brokers and dealers when the credit is securities credit, and extensions of credit used to purchase or carry publicly held to executive officers. equity securities if the loan is secured by those or other publicly held equity Financial Disclosures by securities. The Board's Regulation X State Member Banks applies these credit limitations, or margin requirements, to certain borrowers State member banks that issue securities and to certain credit extensions, such as registered under the Securities Exchange credit obtained from foreign lenders by Act of 1934 must disclose certain infor- U.S. citizens. mation of interest to investors, including Several regulatory agencies enforce annual and quarterly financial reports the Board's securities credit regulations. and proxy statements. By statute, the The SEC, the National Association of Board's financial disclosure rules must Securities Dealers, and the national be substantially similar to those of the securities exchanges examine brokers SEC. At the end of 2005, 18 state memand dealers for compliance with Regulaber banks were registered with the tion T. With respect to compliance with Board under the Securities Exchange Regulation U, the federal banking agen- Act of 1934. cies examine banks under their respective jurisdictions; the Farm Credit Administration, the NCUA, and the OTS Securities Credit examine lenders under their respective Under the Securities Exchange Act, the jurisdictions; and the Federal Reserve Board is responsible for regulating examines other Regulation U lenders. Extensions of Credit by State Member Banks to their Executive Officers, 2004 and 2005 Range of interest Period Number Amount (dollars) rates charged (percent) 2004 October 1-December 31 479 53,340,000 0.0-20.8 2005 January 1-March 31 414 54,737,000 0.0-21.2 April 1-June 30 530 117,416,000 0.0-20.6 July 1-September 30 504 56,969,000 0.0-21.6 October 1-December 31 485 57,422,000 0.0-18.0 SOURCE. Call Reports. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 85 Extensions of Federal Reserve Membership Credit to Executive Officers At the end of 2005, 2,698 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 52,639 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 72 percent of all commersince the date of the preceding report. cial banking offices. • The accompanying table summarizes this information for 2005. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

87 Consumer and Community Affairs Among the Federal Reserve's responsi- During 2005, the Board, with the bilities in the areas of consumer and Office of the Comptroller of the Curcommunity affairs are rency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the • writing and interpreting regulations to National Credit Union Administraimplement federal laws that protect tion (NCUA), issued joint guidance and inform consumers; on overdraft-protection programs. The guidance is intended to help insured • supervising state member banks to depository institutions responsibly adensure their compliance with the minister and provide appropriate disregulations; closures for these programs. To improve the uniformity and adequacy of informa- • investigating complaints from the tion consumers receive about overdraftpublic about state member bank com- protection services, the Board also pliance with regulations; and issued final rules amending its Truth in Savings Act regulation (Regulation DD) • promoting community development in and the associated commentary. The historically underserved markets. Board, FDIC, and OCC jointly revised certain provisions of their rules imple- These responsibilities are carried out by menting the Community Reinvestment the members of the Board of Governors, Act (CRA). In addition, the Board the Board's Division of Consumer and amended its regulation implementing Community Affairs, and the consumer the Electronic Fund Transfer Act (Reguand community affairs staff of the Fed- lation E) to address the regulation's coveral Reserve Banks. erage of electronic check conversion services; a separate interim final rule under Regulation E dealt with payroll Implementation of Statutes card accounts. The Board issued final Designed to Inform and Protect rules with the FDIC, NCUA, OCC, Consumers and Office of Thrift Supervision (OTS) to implement provisions of the Fair The Board of Governors writes regula- and Accurate Credit Transactions Act tions to implement federal laws involv- of 2003 (the FACT Act) that govern ing consumer financial services and fair the use of medical information in conlending. The Board revises and updates nection with credit-eligibility deterthese regulations to address the intro- minations. Furthermore, the Board duction of new products and technolo- raised the threshold that triggers addigies, to implement legislative changes to tional requirements under the Home existing laws, and to address problems Ownership and Equity Protection Act consumers may encounter in their finan- (HOEPA) and raised the exemption cial transactions. To interpret and clarify threshold for depository institutions the regulations, Board staff issues com- required to collect data under the Home mentaries and other guidance. Mortgage Disclosure Act (HMDA). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88 92nd Annual Report, 2005 Interagency Guidance on Overdraft- of complying with all applicable federal Protection Programs and state laws, and it advises institutions to have legal counsel review their In February, the Board issued guidance overdraft-protection programs—before jointly with the FDIC, NCUA, and OCC implementation—to ensure the overall on overdraft-protection programs at compliance of the programs. The best insured depository institutions. These practices section addresses the marketservices, sometimes referred to as ing and communication of overdraft- "bounced-check protection" or "courprotection programs as well as disclotesy overdraft protection," pay customsures and other operational aspects of er's checks or allow other overdrafts these programs. when a customer has insufficient funds in his or her account. Typically, an overdraft-protection program is an auto- Amendments to Regulation DD mated service provided to transaction (Truth in Savings) account customers as an alternative to a In May, the Board published final traditional overdraft line of credit. amendments to Regulation DD, which In June 2004, the agencies published implements the Truth in Savings Act, for comment proposed interagency guidand to the regulation's official staff comance on overdraft-protection programs, mentary. The amendments address conin response to concerns about the marcerns about the uniformity and adequacy keting, disclosure, and implementation of information provided to consumof these programs. The final guidance ers when they overdraw their deposit responds to comments the agencies accounts, and some of the amendments received from consumer and community specifically address overdraft-protection groups, individual consumers, deposiprograms, which are offered by many tory institutions, trade associations, vendepository institutions. dors offering overdraft-protection prod- To address concerns about the maructs, other industry representatives, and keting of overdraft services, the Board state agencies.1 expanded the regulation's prohibition The final joint guidance has three against misleading advertisements to primary sections: Safety and Soundness cover institutions' communications with Considerations, Legal Risks, and Best current customers about their existing Practices. The safety and soundness disaccounts. The Board also revised the cussion seeks to ensure that financial staff commentary to the regulation to institutions offering overdraft-protection provide examples of misleading adverprograms have adequate policies and tisements for overdraft-protection serprocedures to address the credit, operavices. To help consumers distinguish tional, and other risks associated with overdraft-protection services from the these programs. The legal risks discus- traditional lines of credit offered by an sion alerts institutions to the importance institution, the final rule requires that institutions promoting the payment of overdrafts include, in their advertise- 1. In 2004, the agencies, along with the ments, certain disclosures about the OTS, produced a consumer publication, "Protecting Yourself from Overdraft and Bounced- terms of the service. Check Fees," which is available in English In addition, the final rule includes and Spanish. Both versions are available on provisions to enhance the uniformity the Board's consumer information web site (www.federalreserve.gov/consumers.htm). and adequacy of the cost disclosures Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 89 institutions provide to consumers about the new rules reduce data collection and overdraft and returned-item fees. Insti- reporting burden for "intermediate small tutions that promote the payment of banks" (banks with assets at least overdrafts in an advertisement must $250 million and less than $1 billion) separately disclose, on their periodic and, at the same time, encourage these statements, the total dollar amount banks to engage in meaningful commuimposed on the account for paying over- nity development lending, investment, drafts and the total dollar amount of fees and services. charged for returning items unpaid. Under the new rules, intermediate These disclosures must be provided for small banks will no longer need to colthe statement period and for the cal- lect and report CRA loan data. Neverendar year to date, for any account theless, examiners will continue to to which the advertisement applies. evaluate bank lending activity during To help institutions comply with this their CRA examinations of intermediate requirement, the staff commentary pro- small banks and will disclose those vides specific examples of when an results in the public evaluation. Interinstitution is promoting the payment of mediate small banks will be evaluated overdrafts in an advertisement. The final under two separately rated tests: (1) the rule also requires institutions to state, in small bank lending test and (2) a new, their account-opening disclosures, the flexible community development test categories of transactions for which an that includes an evaluation of commuoverdraft fee may be imposed, for exam- nity development loans, investments, ple, by specifying that fees are imposed and services in light of the community's for overdrafts created by checks, ATM needs and the bank's capacity. Satisfacwithdrawals, or other electronic trans- tory ratings are required on both tests actions, as applicable. to obtain an overall satisfactory CRA The amendments to Regulation DD rating. become effective on July 1, 2006. For banks of any size, the new rules expand the definition of community development to include activities that Community Reinvestment Act revitalize or stabilize designated disaster Rules areas and distressed or underserved rural In July, the Board, FDIC, and OCC areas. By doing so, the agencies seek to approved a joint final rule to revise cer- recognize banks' community developtain provisions of their rules implement- ment efforts in these areas and encouring the Community Reinvestment Act age further efforts in other rural areas. (CRA). (Regulation BB is the Board's The rules also clarify when a bank's (or CRA regulation.) The revised rules are its affiliate's) discrimination or other intended to reduce regulatory burden on illegal credit practices will adversely community banks and make CRA evalu- affect an evaluation of its CRA perforations more effective tools for encour- mance. The joint final rule became aging banks to meet community devel- effective September 1, 2005. opment needs. The final rules raise the small bank FACT Act Rules on asset-size threshold from less than Medical Information $250 million in assets to less than $1 billion in assets without regard to hold- In November, the Board, FDIC, NCUA, ing company affiliation. Accordingly, OCC, and OTS issued final rules under Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

90 92nd Annual Report, 2005 the Fair Credit Reporting Act (FCRA). Amendments to Regulation E (The Board's rules are Regulation V and (Electronic Fund Transfers) Regulation FF.) The rules create exceptions to the statutory prohibition against In December, the Federal Reserve Board creditors' obtaining or using medical announced final amendments to Regulainformation in connection with their tion E, which implements the Electronic credit-eligibility determinations. The Fund Transfer Act. The amendments final rules also address the sharing of clarify the responsibilities of parties medically related information among involved in electronic check conversion affiliates. transactions and require that consumers Section 411 of the Fair and Accurate receive written notification in advance Credit Transactions Act of 2003 (the of these transactions. Additional revi- FACT Act) amended the FCRA to pro- sions to the regulation's official staff vide that a creditor may not obtain or commentary provide guidance on preuse medical information in connec- authorized transfers from consumers' tion with any determination of a con- accounts, error resolution, and disclosumer's eligibility, or continued eligi- sures at ATMs. bility, for credit, except as permitted Among other provisions, the final rule by regulations. The FACT Act requires specifies that merchants and other paythe agencies to prescribe regulations ees that convert consumers' check paythat permit creditors to obtain and ments into electronic fund transfers must use medical information for credit- provide the consumer with a notice and eligibility purposes when necessary and obtain his or her authorization for the appropriate to protect legitimate opera- electronic fund transfer. Merchants and tional, transactional, risk-management, other payees must also notify consumers and other needs. The final rules per- that mit creditors to obtain and use medical information that is typically con- • if a check is converted to an electronic sidered in credit underwriting. Under fund transfer, funds may be debited the final rules, all creditors can rely from their accounts as soon as the upon the exceptions for obtaining and same day that payment is received and using medical information. Section 411 of the FACT Act also • the check will not be returned to them amended the FCRA to limit the ability by their financial institution. of creditors and others to share medically related information among their Revisions to the official staff comaffiliates, except as permitted by the mentary on Regulation E clarify the statute or by regulation or order. The error resolution obligations of finanfinal rules specify the circumstances in cial institutions and clarify the disclowhich certain creditors may share medi- sure obligations of ATM operators with cally related information among affili- respect to the fees they charge a conates without becoming consumer report- sumer for initiating an electronic fund ing agencies, which are subject to transfer or for using an ATM to make a additional requirements. balance inquiry. Final rules will become effective The mandatory compliance date for April 1, 2006. the final rule is January 1, 2007. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 91 Interim Final Rule Governing tion Z to raise from $510 to $528 the Payroll Cards total dollar amount of points and fees that triggers additional requirements In December, the Board adopted a sepafor certain mortgage loans under the rate interim final rule on payroll card Home Ownership and Equity Protecaccounts. Under the interim final rule, tion Act (HOEPA). As prescribed by payroll card accounts that are estabthat statute, the increased amount lished to provide salary, wages, or other (effective January 1, 2006) reflects employee compensation on a recurring changes in the consumer price index. basis are accounts covered by Regulation E. The interim final rule grants flex- • In December, the Board amended the ibility to financial institutions that must official staff commentary to Reguprovide account transaction information lation C to raise to $35 million the to payroll card users. The interim final exemption threshold for depository rule will become effective July 1, 2007. institutions required to collect data in 2006 under HMDA. As prescribed by Other Regulatory Actions that statute, the increased threshold The Board also took the following regu- reflects changes in the consumer price latory actions during 2005: index. • In March, the Board and the other Economic Effects of the federal financial regulatory agencies Electronic Fund Transfer Act adopted in final form, without change, joint interim rules making technical As required by the Electronic Fund changes to the agencies' regulations Transfer Act (EFTA), the Board moniimplementing the Community Rein- tors what effects the act has on comvestment Act (CRA). The joint pliance costs for financial institutions, interim rules had been published for as well as the benefits of the act to comment in July 2004. (Regula- consumers. tion BB is the Board's CRA regula- According to data from the most tion.) The changes conform the CRA recent triennial Survey of Consumer regulations to changes in (1) the Stan- Finances (conducted in 2004), approxidards for Defining Metropolitan and mately 91 percent of U.S. families that Micropolitan Statistical areas, pub- year used or had access to one or more lished by the U.S. Office of Manage- EFT services, for example, automated ment and Budget; (2) the census tracts teller machine (ATM) services, debit designated by the U.S. Bureau of the card services, or direct deposit or pay- Census; and (3) the Board's Regula- ment services—up from approximately tion C, which implements the Home 88 percent in 2001. The 2004 Survey Mortgage Disclosure Act (HMDA). of Consumer Finances also reported that The joint final rule did not make sub- approximately 74 percent of U.S. famistantive changes to the requirements lies had an ATM card. In 2004, the of the CRA regulations. number of ATM transactions per month averaged approximately 919 million, • In August, the Board amended the and the number of installed ATMs rose official staff commentary to Regula- about 3 percent from 2003, to 383,000. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

92 92nd Annual Report, 2005 About 71 percent of U.S. families banking agencies encourage financial had funds deposited directly into their institutions to help meet the credit needs checking or savings account by direct of the local communities in which they deposit in 2004. Use of the service do business, consistent with safe and appears even more common in the sound business practices. To carry out public sector; during fiscal year 2005, this mandate, the Federal Reserve approximately 76 percent of all government payments were made using EFT, • examines state member banks to including 81 percent of Social Security assess their compliance with the CRA; payments, 99 percent of federal salary and retirement payments, and 49 percent • analyzes applications for mergers and of federal income tax refunds. acquisitions by state member banks About 59 percent of U.S. families had and bank holding companies in reladebit cards in 2004; consumers can use tion to CRA performance; and these cards at merchant terminals to pay for purchases. Approximately 17.6 bil- • disseminates information on commulion debit card transactions took place nity development techniques to bankin 2004, an increase of approximately ers and the public through community 9 percent from the previous year's vol- affairs offices at the Reserve Banks. ume. Direct payment appears to be the least widely used EFT payment mecha- Examinations for Compliance nism. About 47 percent of U.S. families with the CRA had payments automatically deducted The Federal Reserve assesses and rates from their accounts in 2004. the CRA performance of state member The incremental costs associated with banks in the course of examinations the EFTA are difficult to quantify conducted by staff at the twelve Reserve because it is difficult to determine how Banks. During the 2005 reporting industry practices would have evolved period, the Reserve Banks conducted in the absence of statutory requirements. 163 CRA examinations. Of the banks The benefits of the EFTA are also examined, 35 were rated "outstanddifficult to measure, as they cannot ing" in meeting community credit be isolated from consumer protections needs, 127 were rated "satisfactory," that would have been provided in the none was rated "needs to improve," absence of regulation. The available and 1 was rated as being in "substantial evidence suggests no serious consumer noncompliance." 2 problems with EFTA. (See "Agency Reports on Compliance with Consumer Analysis of Applications for Protection Laws" later in this chapter.) Mergers and Acquisitions in Relation to the CRA Supervision for Compliance During 2005, the Board of Governors with Consumer Protection and considered applications for several sig- Community Reinvestment Laws nificant banking mergers, including the application by Citigroup, Inc., New Activities Related to the York, New York, to acquire First Ameri- Community Reinvestment Act The Community Reinvestment Act 2. The 2005 reporting period was July 1, 2004, (CRA) requires that the Board and other through June 30, 2005. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 93 can Bank, Bryan, Texas. The Board in December. A total of thirteen comapproved Citigroup's application in ments were submitted in opposition to March, after considering information the application. from ongoing examinations of Citigroup, publicly disclosed investigations, The public submitted comments on and domestic and foreign financial each of these applications. Most of the supervisory authorities, in addition to commenters expressed concerns that an confidential information on Citigroup's institution's lending to lower-income compliance with anti-money-laundering communities and minority populations laws. Citigroup acknowledged some was insufficient or that the institution deficiencies in its compliance and inter- failed to address the convenience and nal controls for the areas being inves- needs of affected communities. Many of tigated and stated that it had devel- the comments referenced the new pricoped plans to address those weaknesses. ing information on residential mortgage The Board noted the improvements Citi- loans that was required to be reported group had made to parts of its compli- for 2004 Home Mortgage Disclosure ance structure; the Board also expected Act (HMDA) data; the new data raised that the company would fully imple- concerns that minority applicants were ment its plan to enhance oversight of its more likely than nonminority applioperations. To that end, the Board fur- cants to receive high-cost mortgages.3 ther expected that Citigroup would not Other commenters raised concerns about undertake significant expansion during potentially predatory lending practices this implementation period. by subprime and payday lenders, as well as the potential adverse effects of branch Several other significant applications closings. are listed below. In total, the Board acted on twenty- • An application by Wells Fargo & Co., three bank and bank holding company San Francisco, California, to acquire applications that involved protests by First Community Capital Corporation, members of the public concerning the Houston, Texas, was approved in CRA performance of insured depository June. institutions. The Board also reviewed twenty-nine applications involving other • An application by Capital One Finan- issues related to CRA, fair lending, or cial Corporation (Capital One), compliance with consumer credit pro- McLean, Virginia, to acquire Hibernia tection laws.4 Bancorporation, New Orleans, Louisiana, was approved in August. The Board considered information on pending lawsuits or investigations undertaken by the attorneys general 3. "High-cost mortgages" refers to mortgage of Minnesota and West Virginia relat- loans whose annual percentage rates (APRs) are 3 percent or more over the yield on comparable ing to Capital One's marketing of its Treasury securities on first liens, and 5 percent or credit cards. more over that yield on subordinate liens. Interest rate spreads that exceed these two thresholds are • An application by Bank of America required to be reported under Regulation C, which implements the Home Mortgage Disclosure Act Corporation, Charlotte, North Caro- (HMDA). lina, to acquire MBNA Corporation, 4. In addition, four applications involving con- Wilmington, Delaware, was approved sumer compliance issues were withdrawn. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

94 92nd Annual Report, 2005 Other Consumer Compliance may involve any pattern or practice of Activities flood insurance violations. The Division of Consumer and Community Affairs supports and oversees Fair Lending the supervisory efforts of the Federal The Board has a responsibility to ensure Reserve Banks to ensure that consumer that the banks under its jurisdiction protection laws and regulations are fully comply with the federal fair lending and fairly enforced. Division staff prolaws—the Equal Credit Opportunity Act vides guidance and expertise to the (ECOA) and the Fair Housing Act. The Reserve Banks on consumer protection ECOA prohibits all creditors from disregulations, examination and enforcecriminating against any applicant, in ment techniques, examiner training, and any aspect of a credit transaction, on emerging issues. They develop and the basis of race, color, religion, national update examination policies, proceorigin, sex, marital status, or age. In dures, and guidelines, as well as review addition, creditors may not discriminate Reserve Bank supervisory reports and against an applicant because the appliwork products. They also participate in cant receives income from a public interagency activities that promote uniassistance program or has exercised, formity in examination principles and in good faith, any right under the Constandards. sumer Credit Protection Act. As pro- Examinations are the Federal Revided by the ECOA, the Board enacted serve's primary means of enforcing Regulation B to fully implement the act compliance with consumer protection and periodically reviews that regulation laws. During the 2005 reporting period, and modifies it as needed. Congress the Reserve Banks conducted 239 conassigned responsibility for administrasumer compliance examinations—220 tive enforcement of the ECOA to the of state member banks and 19 of foreign Board for banks under its jurisdiction, to banking organizations (FBO).5 other regulators for creditors that they The Board periodically issues guidregulate, and to the Federal Trade Comance for Reserve Bank examiners on mission for all other creditors. consumer protection laws and regula- The Fair Housing Act covers credit tions. In addition to updating examinafor the purchase, construction, improvetion procedures for a number of regulament, repair, or maintenance of a dwelltions in concert with the other federal ing. Under the act, it is unlawful for a financial institution regulatory agencies, creditor to deny any form of financial the Board issued guidance that Federal assistance, or discriminate in fixing the Reserve consumer compliance examinamount, interest rate, or any other terms ers are to use when evaluating cases that or conditions of any financial assistance, on the basis of race, color, religion, 5. The foreign banking organizations examined national origin, handicap, familial staby the Federal Reserve are organizations operating tus, or sex. under section 25 or 25A of the Federal Reserve Act (Edge Act and agreement corporations) and The ECOA also obligates the Board state-chartered commercial lending companies and other agencies with enforcement owned or controlled by foreign banks. These insti- responsibilities under the act to refer tutions are not subject to the Community Reinvestany pattern or practice of ECOA vioment Act and typically engage in relatively few lations to the Department of Justice activities that are covered by consumer protection laws. (DOJ). When a violation of the ECOA Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 95 also violates the Fair Housing Act, the Differences among groups of loan matter may be referred to the Depart- applicants are now identified using two ment of Housing and Urban Develop- additional criteria: (1) the incidence ment. To promote consistency in how of higher-priced lending and (2) differfair lending issues are analyzed through- ences in the mean spread paid by borout the System, Division of Consumer rowers who obtained higher-priced and Community Affairs staff coordinate loans. The modified statistical program, the investigation of potential fair lend- like the denial-rate review, can target ing violations with Reserve Bank staff lenders for a more intensive fair lending and develop recommendations for the review that would include the collection division director regarding whether and assessment of additional loan-level referral is necessary or appropriate. information, such as credit scores and During 2005, division staff received debt-to-income and loan-to-value ratios. and analyzed five reports from Reserve Banks regarding possible referral mat- Flood Insurance ters. Three of these reports dealt with potentially discriminatory underwriting The National Flood Insurance Act standards—two involved potential dis- imposes certain requirements on loans crimination on the basis of applicants' secured by buildings or mobile homes marital status and one involved potential located in, or to be located in, areas discrimination on the basis of an appli- determined to have special flood hazcant's sex. In one report, a bank's appar- ards. Under the Federal Reserve's Reguent discriminatory loan-pricing practices lation H, which implements the act, state affected borrowers on the basis of their member banks in general are prohibited marital status. The fifth report involved from making, extending, increasing, or discriminatory redlining on the basis renewing any such loan unless the of race. In one of the cases, the Board building or mobile home and any perdetermined that a referral was not war- sonal property securing the loan are covranted; one case was referred to DOJ; ered by flood insurance for the term of and three cases are pending. the loan. The act requires the Federal Since 1994, the Federal Reserve has Reserve to impose civil money penalties used a two-stage statistical regression when it finds a pattern or practice of program to help assess fair lending com- violations of the regulation. The civil pliance by high-volume mortgage lend- money penalties are payable to the Feders. The program uses reported HMD A eral Emergency Management Agency data for a stage one analysis to identify for deposit into the National Flood Mitibanks having significant disparities in gation Fund. their loan-denial rates for loan applica- During 2005, the Board imposed civil tions submitted by black and Hispanic money penalties on ten state member applicants and those submitted by white banks. The penalties, which were applicants; the program then targets assessed via consent orders, totaled these banks for a stage two analysis that $219,810. considers extensive additional information taken from a sample of a bank's Coordination with loan files. As a result of 2002 amend- Other Federal Banking Agencies ments to Regulation C and the receipt of expanded HMDA data for 2004, the The member agencies of the Federal regression program has been modified. Financial Institutions Examination Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

96 92nd Annual Report, 2005 Council (FFIEC) develop uniform Finally, the Board, OCC, and FDIC examination principles, standards, pro- updated the host-state loan-to-deposit cedures, and report formats.6 In 2005, ratios used to determine compliance the FFIEC revised examination proce- with section 109 of the Riegle-Neal dures for the Fair Credit Reporting Act Interstate Banking and Branching Effi- (FCRA) to reflect amendments to the ciency Act of 1994. FCRA by the Fair and Accurate Credit Transactions Act (the FACT Act). The Training for Bank Examiners FFIEC also issued examination procedures on the Federal Communications Ensuring that financial institutions com- Commission's telemarketing rules and ply with laws that protect consumers its CAN-SPAM Act (Controlling the and encourage community reinvestment Assault of Non-Solicited Pornography is an important part of the bank examiand Marketing Act). The new proce- nation and supervision process. As the dures address the requirements each of number and complexity of consumer these rules lays out for electronic com- financial transactions grow, training for munications with consumers. Finally, examiners of the state member banks the Board, OCC, and FDIC issued under the Federal Reserve's superviexamination procedures for reviewing sory responsibility becomes even more the Community Reinvestment Act important. The consumer affairs curricu- (CRA) performance of intermediate lum is composed of six courses focused small banks. Following the issuance of on various consumer protection laws, new CRA regulations last year, these regulations, and examining concepts. agencies also published for comment In 2005, these courses were offered in proposed questions and answers on their ten sessions to more than 190 consumer new regulations. compliance examiners and System staff The FFIEC issues guidance to the members. agencies' consumer compliance exami- Board and Reserve Bank staff regunation staff and to supervised financial larly review the consumer affairs curinstitutions. The agencies issued final riculum, updating subject matter and guidance on overdraft-protection pro- adding new elements as appropriate. grams (see "Interagency Guidance on During 2005, staff conducted a curricu- Overdraft-Protection Programs" earlier lum review of the Commercial Lending in this chapter). In addition, the Board, Essentials for Consumer Affairs course OCC, and FDIC issued new templates to incorporate different instructional for preparing CRA performance evalua- methods (for example, an expanded case tions for intermediate small banks; these study). This course provides consumer agencies also revised the existing tem- compliance examiners with a basic plates in order to reflect the amended understanding of how a loan officer definition of community development underwrites and prices commercial that now applies to all banks, as the term loans. is defined in the new CRA regulations. In addition to providing core training, the examiner curriculum emphasizes 6. The FFIEC member agencies are the Board the importance of continuing profesof Governors of the Federal Reserve System, the sional development (CPD). Opportuni- Federal Deposit Insurance Corporation, the Office ties for continuing development include of the Comptroller of the Currency, the Office of special projects and assignments, self- Thrift Supervision, and the National Credit Union Administration. study programs, rotational assignments, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 97 the opportunity to instruct at System variations reflect, even in part, unlawful schools, and mentoring programs. discrimination rather than legitimate risk- and cost-related factors. In response to these concerns, the Reporting on Home Mortgage Federal Reserve updated Regulation C, Disclosure Act Data the regulation that implements HMDA. The Home Mortgage Disclosure Act The revisions, which were effective in (HMDA), enacted by Congress in 1975, 2004, required lenders to collect price requires most mortgage lenders located information for loans they originated in in metropolitan areas to collect data the higher-priced segment of the home about their housing-related lending loan market. Lenders report the number activity, report the data annually to the of percentage points (if any) by which government, and make the data publicly a loan's annual percentage rate (known available. In 1989, Congress expanded as the "APR") exceeds a threshold; the the data required by HMDA to include threshold is 3 percentage points above information about loan applications that the yield on comparable Treasury secudid not result in a loan origination, as rities for first-lien loans, and 5 percentwell as information about the race, sex, age points above that yield for juniorand income of applicants and borrow- lien loans. Loans with rates above this ers. Since 1989, mortgage markets have threshold are referred to as "higherchanged dramatically as information priced loans." The HMDA data coltechnology has improved, permitting lected in 2004 and released to the public more-efficient and more-accurate risk in 2005 provide the first publicly availassessment and management. These able loan-level data about loan prices. developments have made it feasible for An article published by Federal institutions to lend to higher-risk bor- Reserve staff in the Summer 2005 issue rowers, albeit at prices commensurate of the Federal Reserve Bulletin uses with the higher risk. In the past, many of the 2004 data to describe the market for the borrowers who now receive higher- higher-priced loans and patterns of lendpriced loans were often denied lower- ing across loan products, geographic priced credit. markets, and borrowers and neighbor- Although a positive development, the hoods of different races and incomes.7 growth of the subprime market has also Relatively few lenders account for most raised public policy concerns. One con- higher-priced originations. In 2004, only cern is whether consumers who obtain 500 of the 8,850 reporting home lenders higher-priced loans are sufficiently made 100 or more higher-priced loans; informed about the loan options avail- the 10 home lenders with the largest able to them, allowing them to shop volume accounted for about 40 percent effectively and protect themselves from of all such loans. Higher-priced lending unfair or deceptive lending practices. is also concentrated by price: in 2004 This concern has contributed to an the vast majority of higher-priced loans ongoing debate about how adequate and had annual percentage rates within 1 or effective proposed or existing mortgage 2 percentage points of the reporting lending disclosures and limitations are thresholds. Furthermore, a relatively in protecting consumers from abuse. In addition, the wider range of loan prices 7. The complete article is available at available in today's marketplace has www.federalreserve.gov/pubs/bulletin/2005/ raised concerns about whether price 05index.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

98 92nd Annual Report, 2005 small share of loan originations are Regulation B higher-priced loans—16 percent in (Equal Credit Opportunity) 2004. The FFIEC agencies reported that The prevalence of higher-priced lend- 85 percent of the institutions examined ing varies widely, however. First, it during the 2005 reporting period were varies by product type. For example, in compliance with Regulation B, com- 15.5 percent of first-lien refinance loans pared with 88 percent for the 2004 were higher-priced in 2004 compared reporting period. The most frequent viowith 27.4 percent of comparable juniorlations involved failure to take one or lien loans. Manufactured-home loans more of the following actions: show the greatest incidence of higher pricing across all loan products, a result • collect information for monitoring consistent with the elevated credit purposes about the race, ethnicity, and risk associated with such lending. Secsex of applicants seeking credit primaond, higher-priced lending varies widely rily for the purchase or refinancing of by geography. Most of the metropolia principal residence tan areas with the greatest incidence of higher-priced lending are in the south- • notify a credit applicant of the action ern region of the country (in many taken on his or her loan request within metropolitan areas in the South and the time frames specified in the Southwest, 30 to 40 percent of homeregulation buyers who obtained conventional loans in 2004 received higher-priced loans), • provide a written notice of denial or whereas metropolitan areas with the other adverse action to a credit applilowest incidence are much more discant that contains the specific reapersed. Third, the incidence of higherson for the adverse action, along with priced borrowing varies greatly among other required information borrowers of different races and ethnicities (see related box "2004 HMDA Data During this reporting period, the OTS and Fair Lending"). All of these patissued two cease-and-desist orders terns are expected to be the subject of against savings associations for their further research. alleged violations of the ECOA and Regulation B, as well as other consumer regulations. For these violations, the Agency Reports on Compliance associations paid civil money penalties with Consumer Protection Laws that totaled $17,500. The other FFIEC The Board reports annually on compli- agencies did not issue any formal ance with consumer protection laws by enforcement actions relating to Regulaentities supervised by federal agencies. tion B during the reporting period. This section summarizes data collected The Federal Trade Commission from the twelve Federal Reserve Banks, (FTC) entered into one settlement with a the FFIEC member agencies, and other mortgage corporation for its alleged viofederal enforcement agencies.8 lations of the ECOA and Regulation B, as well as other statutes. The defendants 8. Because the agencies use different meth- were required to pay consumer restituods to compile the data, the information pre- tion for their alleged violations of the sented here supports only general conclusions. Truth in Lending Act (see the discussion The 2005 reporting period was July 1, 2004, through June 30, 2005. under Regulation Z). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 99 2004 HMDA Data and Fair Lending The 2004 HMDA data included, for the is, a major reason that black and Hispanic first time, information on "higher-priced borrowers were much more likely than loans,** or loans whose pricing (interest non-Hispanic white borrowers to obtain rates and fees) exceeded certain thresholds. higher-priced mortgage loans is the fact An analysis of this new data offers some that black and Hispanic borrowers were insights about where higher-priced lending much more likely to obtain mortgage loans is more prevalent and what types of bor- from institutions that specialize in higherrowers are more likely to receive a higher- priced lending. priced loan. While these statistics alone Some, perhaps much, of the market segcannot explain the reasons why higher- mentation and the related price differences priced lending was concentrated in some for mortgages are the result of differences geographic areas or among some borrow- in legitimate price-determining factors, ers, the 2004 data are still an important tool such as a borrower's credit risk. Credit risk for fair lending enforcement. is typically measured by a borrower's The incidence of higher-priced credit score, his or her debt-to-income borrowing—the proportion of borrowers ratio, the loan-to-value ratio, and other who obtain higher-priced loans—varies information, But the HMDA data do not widely by race and ethnicity. In 2004, include this type of information. Therefore, blacks and Hispanics were much more the data do not yield any conclusions about likely than non-Hispanic whites to receive the reasons behind racial and ethnic differhigher-priced loans, and Asians were less ences in the incidence of higher-priced likely than non-Hispanic whites to receive lending; the data also cannot be used to such loans. For example, 32 percent of prove (or disprove) the legitimacy of any black borrowers, and 20 percent of His- speculated reasons for these di fferenees. panic borrowers, received higher-priced Notwithstanding the limitations of the home purchase loans, but only 9 percent of HMDA loan-pricing data, the data can be non-Hispanic white borrowers did* In other used to improve enforcement of the laws words, black homebuyers received higher- that prohibit racial and ethnic discrimina- * priced loans more than three times as often tion in mortgage lending: the Federal as non-Hispanic white homebuyers, and Reserve md the other agencies that enforce Hispanic homebuyers received higher- these laws can use the data as a screening priced loans more than two times as often* tool to determine which institutions' pric- In general, differences of this magnitude ing practices warrant scrutiny. For exam- ? persist across borrowers with different pie, Board staff used the 2004 data to deterjglacome levels and across neighborhoods mine (1) which lenders exhibited a highly with different median incomes (for exam- statistically significant difference in their ple, low-income versus middle-income), higher-priced lending to black and His- |:.Xhe differences in the incidence of higher- panic borrowers, on the one hand, and to jjlpriced loans shrink minimally when indi- non-Hispanic white borrowers, on the | vidual borrowers are matched by, for exam- other, and (2) when that difference could .) * pie, their income, the amount of their loan, not be explained by a difference in bor- 7 and the location of the property being rower income, loan amount, or property • financed—which are the principal loan- location. Board staff shared statistical A |:|sricing factors reported in the HMDA data. reports about the identified tenders with the { In large part, the differences in what relevant state and federal agencies, who ^ groups of borrowers were more likely to can use the data, as appropriate, in their .£ i: receive a higher-priced loan reflect the seg- fair lending enforcement and supervision ::: f mentation of the home loan market. That efforts. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

100 92nd Annual Report, 2005 The other agencies that enforce the • report the results of an error investiga- ECOA—the Farm Credit Administra- tion to the consumer within three busition (FCA), the Department of Trans- ness days portation, the Securities and Exchange Commission (SEC), the Small Busi- • give the consumer provisional credit ness Administration, and the Grain for the amount of the alleged error Inspection, Packers and Stockyards when the investigation cannot be com- Administration of the Department of pleted within 10 business days Agriculture—reported substantial compliance among the entities they super- The OTS issued one cease-and-desist vise. The FCA's examination activities order for violations of a number of conrevealed that most Regulation B vio- sumer regulations, including Regulalations involved either creditors' provid- tion E. The savings association paid a ing inadequate statements of specific civil money penalty of $10,000 for the reasons for denial or creditors' failure violations. Tlie other FFIEC agencies to request or provide information for and the SEC did not issue any formal government-monitoring purposes. As enforcement actions relating to Regulareported by the SEC, the National Asso- tion E during the period. ciation of Securities Dealers, Inc., (NASD) found that one of its member firms could not produce evidence that Regulation M its customers were notified about the (Consumer Leasing) denial of their applications for margin The FFIEC agencies reported that more accounts. In addition, a different NASD than 99 percent of the institutions examfirm could not demonstrate that it sent ined during the 2005 reporting period required annual margin disclosure statewere in compliance with Regulation M, ments to its customers. However, none which is comparable to the level of comof these other agencies initiated any pliance for the 2004 reporting period. formal enforcement actions relating to The few violations noted involved fail- Regulation B during 2005. ure to adhere to specific disclosure requirements. The FFIEC agencies did not issue any formal enforcement Regulation E actions relating to Regulation M during (Electronic Fund Transfers) the period. The FFIEC agencies reported that approximately 95 percent of the institu- Regulation P tions examined during the 2005 report- (Privacy of Consumer ing period were in compliance with Financial Information) Regulation E, which is comparable to the level of compliance for the 2004 The FFIEC agencies reported that reporting period. The most frequent vio- 97 percent of the institutions examined lations involved failure to comply with during the 2005 reporting period were the following requirements: in compliance with Regulation P, compared with 96 percent for the 2004 • determine whether an error occurred reporting period. The most frequent viowithin ten business days of receiving lations involved failure to comply with a notice of error from a consumer the following requirements: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 101 • provide a clear and conspicuous initial • on certain residential mortgage transprivacy notice to customers that accu- actions, provide a good faith estimate rately reflects the institution's privacy of the required disclosures before policies and practices, not later than consummation, or not later than three when the customer relationship is business days after receipt of the loan established application • provide a clear and conspicuous In addition, 93 banks supervised by annual privacy notice to customers the Federal Reserve and the FDIC were required, under the Interagency Enforce- • disclose the institution's information- ment Policy on Regulation Z, to reimsharing practices in initial, annual, and burse a total of approximately $591,000 revised privacy notices to consumers for understating the annual percentage rate or the finance charge in The OCC issued a civil money pen- their consumer loan disclosures. alty of $180,000 to a mortgage company The OCC entered into a formal agreesubsidiary of a national bank for its fail- ment with a bank and its mortgage comure to properly and securely dispose of pany subsidiary for violations of the confidential customer information. The Truth in Lending Act, the Real Estate OTS issued one cease-and-desist order Settlement Procedures Act, and the Fedto a former institution-affiliated party eral Trade Commission Act. The subsidfor violations of Regulation P and iary was required to reimburse borrowanother consumer regulation. The indi- ers who were harmed and was directed vidual paid a civil money penalty of to set aside at least $14 million to fund $2,000 for the violations. The other these reimbursements. FFIEC agencies did not issue any for- The OCC also issued a prohibition mal enforcement actions relating to and cease-and-desist order, as well as a Regulation P during the reporting civil money penalty of $20,000, against period. a former bank vice president for making tax lien loans that violated the Home Ownership Equity Protection Act, the Regulation Z Truth in Lending Act, the Real Estate (Truth in Lending) Settlement Procedures Act, and the Fed- The FFIEC agencies reported that eral Trade Commission Act. The OCC 80 percent of the institutions examined had previously ordered the bank to reimduring the 2005 reporting period were burse affected customers and had issued in compliance with Regulation Z, com- a cease-and-desist order against the pared with 84 percent for the 2004 company that marketed, originated, and reporting period. The most frequent vio- serviced the loans. lations involved failure to take one or The OTS issued five cease-and-desist more of the following actions: orders for violations of a number of consumer regulations, including Regu- • accurately disclose the finance charge lation Z, during the reporting period. in closed-end credit transactions Three of the banks paid civil money penalties totaling $18,900. The FDIC • accurately disclose the annual percent- issued one cease-and-desist order for age rate (APR) in closed-end credit violations of a number of consumer transactions regulations, including Regulation Z. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

102 92nd Annual Report, 2005 other FFIEC agencies did not issue among other terms. Litigation is ongoany formal enforcement actions relating ing in this case. to Regulation Z during the reporting The FTC settled charges against a period. finance company, seven related com- The FTC settled charges against an panies, and their principals for their individual defendant and a group of alleged violations of the Truth in Lendmortgage brokers for their alleged vio- ing Act and Regulation Z, the Federal lations of the Truth in Lending Act Trade Commission Act, and other statand Regulation Z, the Federal Trade utes. The final order shut down the com- Commission Act, and other statutes. panies and permanently bars them and Under the consent judgment, the their principals from participating in any individual defendant will cease mak- lending or direct-deposit business and ing misrepresentations about home from offering or selling ancillary prodmortgage refinancing offers and cease ucts. The FTC will receive a $10.5 milfuture violations of Regulation Z. The lion claim in the consolidated bankdefendant was also required to pay ruptcy case against the companies, $128,300 in consumer restitution. In 50 percent of the assets in receivership, another case, the FTC settled charges, and two suspended judgments totaling through a stipulated order, against a approximately $674,000. Finally, the mortgage corporation for its alleged FTC continues litigation against two violations of the Truth in Lending Act related companies and their officers for and Regulation Z, the Federal Trade their alleged violations of the Truth in Commission Act, and other statutes. The Lending Act, Regulation Z, and the Fedstipulated order requires the defendant eral Trade Commission Act. The comto pay $750,000 in consumer restitu- panies are alleged to have engaged in tion; the order also set up a $350,000 misrepresentation about merchandise performance fund to be used if the refunds and, when consumers were defendant fails to comply with the owed refunds, to have failed to promptly credit their credit card accounts. order. In addition, the order bars the defendant from making or servicing any The FCA's examination and enforcehome-secured loans and includes other ment activities revealed that most Reguinjunctions. lation Z violations involved inadequate The FTC continued litigation against or incorrect disclosures for closed-end a mortgage broker and its principals for credit. The other agencies that enforce their alleged violations of the Truth Regulation Z—the Department of in Lending Act, Regulation Z, and the Transportation and the Grain Inspection, Federal Trade Commission Act, in Packers, and Stockyards Administraconnection with advertisements for tion of the Department of Agriculture— extremely low mortgage rates. In 2004, reported substantial compliance among the court entered a stipulated prelimi- the entities they supervise. nary injunction against the defendants. In 2005, the court held the defendant's Regulation AA chief executive officer in civil contempt (Unfair or Deceptive Acts of that order; he was subsequently or Practices) arrested under a bench warrant. The court released this individual after he The FFIEC agencies reported that paid $275,000 in sanctions and agreed more than 99 percent of the institutions to pay $400,000 in consumer restitution, examined during the 2005 reporting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 103 period were in compliance with Regu- ing the 2005 reporting period were in lation AA, which is comparable to the compliance with Regulation DD, comlevel of compliance for the 2004 report- pared with 92 percent for the 2004 ing period. No formal enforcement reporting period. Among the institutions actions relating to Regulation AA were not in full compliance, the most freissued during the reporting period. quently cited violations involved the following actions: Regulation CC • using the phrase "annual percentage (Availability of Funds and yield" in an advertisement without Collection of Checks) disclosing required additional terms The FFIEC agencies reported that and conditions for customer accounts 93 percent of institutions examined during the 2005 reporting period were in • providing account disclosures that did compliance with Regulation CC, which not contain all required information is comparable to the level of compliance for the 2004 reporting period. Among • failing to provide timely maturity notithe institutions not in full compliance, fication for time deposits the most frequently cited violations involved the failure to take one or more The OTS issued one cease-and-desist of the following actions: order for violations of a number of consumer regulations, including Regu- • make available on the next business lation DD. The other FFIEC agencies day the lesser of $100 or the aggregate did not issue any formal enforcement amount of checks deposited that are actions related to Regulation DD during not subject to next-day availability the reporting period. • follow special procedures when Consumer Complaints invoking the exception for large-dollar deposits The Federal Reserve investigates complaints against state member banks and • provide required information when forwards to the appropriate enforcement placing an exception hold on an agency complaints that involve other account creditors and businesses. Each Reserve Bank investigates complaints against The OTS issued one cease-and-desist state member banks in its District. In order for violations of a number of 2005, the Federal Reserve received 460 consumer regulations, including Regu- consumer complaints about regulated lation CC. The other FFIEC agencies practices by state member banks— did not issue any formal enforcement complaints were received by mail, by actions related to Regulation CC during telephone, in person, and electronically the reporting period. via the Internet. Regulation DD Complaints against (Truth in Savings) State Member Banks The FFIEC agencies reported that Of the 460 complaints about regulated Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

104 92nd Annual Report, 2005 loans: 5 percent alleged discrimination most common violations involved real on a basis prohibited by law (race, color, estate loans, deposit accounts, and elecreligion, national origin, sex, marital tronic fund transfers. status, age, the fact that the applicant's income comes from a public assist- Unregulated Practices ance program, or the fact that the appli- As required by section 18(f) of the Fedcant has exercised a right under the eral Trade Commission Act, the Board Consumer Credit Protection Act), and continued to monitor complaints about 73 percent concerned other creditbanking practices that are not subject related practices, such as credit card disto existing regulations and to focus on closures, preapproved solicitations, and those that concern possible unfair or billing error resolution. Seventeen perdeceptive practices. In 2005, the Board cent of the complaints involved disputes received more than 1,300 complaints about interest on deposits and other against state member banks that indeposit account practices, including volved unregulated practices. The cateelectronic fund transfers; the remaining gories that received the most complaints 5 percent concerned disputes about trust involved checking accounts and credit services or other practices. (See tables.) cards. Consumers most frequently com- In 95 percent of the complaints plained about insufficient funds charges against state member banks regarding and procedures (95 complaints); other regulated practices that were investiissues concerned interest rates and terms gated in 2005, the banks had correctly on credit cards (95), customer service handled the customer's account. The (83), and fraud (57). The remainder of remaining 5 percent of the complaints the complaints concerned a wide range against state member banks resulted in of unregulated practices involving credit a finding that the bank had violated cards, including banks' refusals to close a consumer protection regulation. The accounts when requested to do so by customers, the amounts banks charge Consumer Complaints against State for late payments, and the unsolicited Member Banks, by Classification, 2005 offers banks send to consumers. Classification Number Complaint Referrals to HUD Regulation B (Equal Credit Opportunity) . 29 In accordance with a memorandum of Regulation C (Home Mortgage understanding between HUD and the Disclosure Act) 0 Regulation E (Electronic Fund Transfers) . 30 federal bank regulatory agencies, in Regulation H (Bank Sales of Insurance) .. 2 Regulation M (Consumer Leasing) 0 2005 the Federal Reserve referred three Regulation P (Privacy of Consumer complaints to HUD that alleged state Financial Information) 4 Regulation Q (Payment of Interest) 0 member bank violations of the Fair Regulation Z (Truth in Lending) 187 Housing Act. Regulation BB (Community Reinvestment) 2 Regulation CC (Expedited Funds Availability) 18 Regulation DD (Truth in Savings) 37 Fair Credit Reporting Act 96 Advice from the Fair Debt Collection Practices Act 40 Fair Housing Act 2 Consumer Advisory Council Flood Insurance 3 Regulations T, U, and X 4 The Board's Consumer Advisory Real Estate Settlement Procedures Act 6 Council—whose members represent Total 460 consumer and community organizations, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 105 Complaints against State Member Banks that Involve Regulated Practices, 2005 All complaints Complaints involving violations Subject of complaint Number Percent Number Percent Total 460 100 22 5 Loans Discrimination alleged Real estate loans 5 10 0 Credit cards 11 2 0 0 Other loans 7 10 0 Other type of complaints Real estate loans 42 9 7 17 Credit cards 257 56 3 1 Other loans 38 8 2 5 Deposits 50 11 4 8 Electronic fund transfers 26 6 4 15 Trust services 1 10 0 Other 23 5 2 9 the financial services industry, academic monetary asset for many unbanked institutions, and state agencies—advises consumers—and consumers should the Board of Governors on matters con- receive periodic statements for these cerning laws and regulations that the accounts, regardless of any statement- Board administers and on other issues delivery or other concerns. related to consumer financial services. In March and June, the council dis- Council meetings are held three times a cussed the advance notice of proposed year and are open to the public. (For rulemaking (ANPR) to revise Regua list of members of the council, see lation Z, which implements the Truth the section "Federal Reserve System in Lending Act (TILA). Members com- Organization.") mented on the current content and In 2005, the council met in March, format of disclosures for credit card June, and October. In March, council accounts and also pointed out that commembers discussed the Board's pro- petition between credit card companies posed amendments to Regulation E, has led to consumers being offered which implements the Electronic Fund complicated and confusing products Transfer Act (EFTA). Members focused that they may not understand. Members on proposed revisions to cover payroll commented on the disclosure table cards as "accounts" under Regula- known as the "Schumer box," which is tion E; the revisions would require provided with credit card applications financial institutions to provide written and solicitations. Although including a periodic statements to consumers who Schumer box on credit card applications use payroll cards. Some members and solicitations has been a successful asserted that providing written periodic way for lenders to disclose the associstatements to these consumers posed ated fees, the design and format of operational problems for lenders, the box could still be improved. Membecause payroll card users are often not bers also discussed whether the TILA bank customers. Other members amendments included in the Bankruptcy believed that payroll cards are a major Abuse and Prevention and Consumer Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

106 92nd Annual Report, 2005 Protection Act of 2005 should be imple- uneven distribution of income levels mented as part of the ongoing regulatory within those census tracts. Members review of Regulation Z. All members generally agreed that, in rural areas, the agreed that developing the Bankruptcy definition of community development Act TILA disclosures in conjunction should be expanded to be more responwith the review of Regulation Z would sive to the community development be beneficial. needs of those areas, regardless of their The Home Mortgage Disclosure Act overall income levels. Members also (HMDA) was a topic of discussion at focused on the community development both the March and October meetings. test for branching services; they did not In March, council members discussed agree with the proposed rule change that revisions to Regulation C (HMDA's would eliminate CRA credit for branchimplementing regulation) that require ing by banks with assets of between federally insured depository and for- $250 million and $1 billion. They proflt nondepository lenders to collect, believed that a branching test should be report, and publicly disclose loan-price required for intermediate small banks data for certain higher-priced home under the revised CRA proposal. mortgage loans. Many lenders and com- In June, council members from finanmunity groups expressed concerns about cial institutions discussed the scope and the release and interpretation of the variety of recent information security new HMDA data. They emphasized that breaches involving customer informathe Federal Reserve System's commu- tion, and they explored the challenges nity affairs staff could promote a better of finding solutions for safeguarding understanding of the data by supporting customer information. Members genereducation efforts and starting a dialogue ally agreed that federal regulation (1) is between lenders and community groups. needed to address information security In October, members noted that the new problems on a national basis and HMDA pricing data show a higher inci- (2) should cover entities beyond finandence of higher-priced lending among cial institutions. Entities that are not minorities; members also believed that subject to regulatory oversight should more research on opportunities for be required to meet federal guidelines reaching underserved individuals, in- for establishing security programs and cluding low-income and minority bor- providing notice to customers and law rowers, is needed. enforcement agencies when breaches The proposed revisions to the finan- occur. cial agencies' regulations implement- In October, pursuant to the Economic ing the Community Reinvestment Act Growth and Regulatory Paperwork (CRA) were discussed at the March and Reduction Act of 1996 (EGRPRA), June meetings. Members' comments members provided comments on conprimarily focused on community devel- sumer protection laws and regulations opment in rural areas. Prior to July 19, that may have become outdated, unnec- 2005, the CRA rules considered com- essary, or unduly burdensome. Memmunity development in rural areas as bers commented on the rules governing eligible for CRA credit if the activities the asset-size exemption for reporting targeted low- or moderate-income cen- HMDA data, TILA's provisions addresssus tracts or populations. However, ing the right to rescind certain mortgage rural areas are frequently categorized as loan transactions, the Gramm-Leachmiddle-income tracts because of the Bliley Act (GLB Act) requirements for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 107 sending annual privacy notices, and the responses that occurred immediately CRA rule requiring federal regulators' after the disaster. Members encouraged prior approval for establishing branches. the Federal Reserve Board to take a Members agreed that the requirements leadership role in bringing federal polifor HMD A reporting and TTLA's right- cymakers together for a dialogue about of-rescission rules were important and long-term goals and solutions. should be retained without change. Members suggested that the rules con- Promotion of Consumer cerning GLB Act privacy notices and Education and Community the CRA notice requirements for estab- Economic Development in lishing branches could be simplified. Historically Underserved Nontraditional mortgage loan prod- Markets ucts were also discussed at the October meeting. During the past two years, the In 2005, the community affairs funcnumber of consumers obtaining non- tion within the Federal Reserve System traditional mortgages, such as payment- supported several initiatives to prooption adjustable-rate mortgages or mote community economic developinterest-only mortgages, has signifi- ment and fair access to credit for lowcantly increased. Council members and moderate-income communities and noted that these products are complex; populations. The function continued to require extensive education on the part focus on financial literacy and educaof consumers, as well as extensive tion, the sustainability of community disclosures by lenders; and are often development organizations, policies to offered without considering sound help low-income individuals build their underwriting criteria for the loan. Mem- assets, and community economic develbers expressed concern that some lend- opment. Activities included conducting ers do not provide consumers with dis- research, publishing newsletters and closures that explain the full range of articles, sponsoring conferences and risks involved in repaying the loan. seminars, and supporting the dissemina- Members highlighted the need for more- tion of information to both general and extensive consumer financial education, targeted audiences. which should be balanced with clear As a decentralized function, the Comdisclosures from lenders, understand- munity Affairs Offices (CAOs) at the able and less complex products, and Board and each of the twelve Reserve underwriting standards that assess bor- Banks design activities in response to rowers' suitability for nontraditional the needs of communities in the regions loan products. Hurricane Katrina was they serve. At the Reserve Banks, CAOs another topic of discussion at the Octo- focus on providing information and ber meeting. Members discussed a wide promoting awareness of investment range of issues connected with the opportunities to financial institutions, impact of the hurricane, commending government agencies, and organizations the performance of the Federal Reserve that serve low- and moderate-income and the other bank regulatory agencies communities and populations; the in addressing immediate issues. How- Board's CAO engages in activities and ever, members noted that the Gulf Coast explores issues that have public policy region now needs long-term rebuilding implications. and revitalization strategies to supple- Promoting well-educated and inment the shorter-term "piecemeal" formed consumers is vital to supporting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

108 92nd Annual Report, 2005 consumer protection and efficient finan- European Credit Research Institute in cial market operations. Accordingly, the Belgium, and at the Third International Board has a long-standing commitment Forum on Financial and Consumer Proto providing consumers with informa- tection and Education in Malaysia. tion that helps them know their rights Recognizing the importance of proand responsibilities in relation to finan- viding access to consumer and financial cial services, including how they can education to its employees, the Board use disclosures to shop and compare offered several informational seminars products and providers. The Federal in conjunction with its Workplace Reserve maintains a consumer informa- Financial Education Task Force, chaired tion web site (www.federalreserve.gov/ by the director of the Division of Conconsumers.htm) that includes educa- sumer and Community Affairs. Four tional materials related to the Board's programs were offered in 2005: identity consumer regulations. In 2005, the con- theft, alternative and interest-only mortsumer publication "How to File a Con- gage loans, credit reports, and an oriensumer Complaint about a Bank" was tation to money and finances for Take substantially revised and updated to Your Sons and Daughters to Work Day. reflect the current marketplace. Staff also assisted in the design and Last year, Board staff continued to launch of a tax resources web site on the be involved with an interagency work- Board's intranet. ing group drafting a national strategy for Board staff continued to be involved financial education. The working group in national financial education initiawas created to fulfill the legislative man- tives throughout the year. The division's date of the Financial Literacy and Edu- director serves as an adviser to the board cation Commission (the commission), of Operation HOPE, a national nonestablished by the Fair and Accurate profit organization dedicated to deliv- Credit Transactions Act (the FACT Act). ering financial education programs to The thirteen-agency working group, led low-income populations with a particuby Treasury Department staff, is charged lar focus on communities suffering from with developing a national strategy to natural disasters. Currently, a member promote basic financial literacy and edu- of the Board of Governors serves on cation. The working group has sought the board of directors of NeighborWorks the participation of government, private, America (the trade name of the Neighnonprofit, and public institutions in this borhood Reinvestment Corporation). effort. In 2005, Board staff submitted Community Affairs staff participate in comments to Treasury Department staff, strategic planning for the Neighborwho are writing the final strategy. Board Works Center for Homeownership Edustaff also worked with the other agen- cation and Counseling, with the objeccies to update the www.MyMoney.gov tive of developing national standards for web site; the update links the web site to financial counseling and training to prothe Federal Reserve's consumer educa- mote homeownership among low- and tion materials. The globalization of the moderate-income populations. To furfinancial services industry has made ther support consumers' informed decifinancial education an international, as sion making about mortgage credit, well as a national, concern. In Novem- Board staff developed an information ber, Board staff shared insights on finan- brochure describing the implications of cial education and consumer protection interest-only loans, a popular product regulation at a conference hosted by the in high-cost housing markets. The bro- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 109 chure describes the rate and payment delving into asset-building and wealthadjustments inherent in the terms of accumulation strategies for lowerthese loans. Board and Reserve Bank income individuals. The San Francisco, staff also continued to support the Con- New York, Boston, and Philadelphia ference of Mayors' financial education Reserve Banks cohosted two conferprogram, Dollar Wi$e. In various cities ences with CFED in San Francisco and throughout the country, the program New York that highlighted privateseeks to increase the awareness of the sector innovations as well as local and importance of personal financial man- national policies that facilitate and agement. Membership in the campaign encourage savings and investment doubled in 2005, with seventy-one cities among lower-income consumers. In now participating. addition, the Board and the Richmond The CAOs at the Reserve Banks Reserve Bank cohosted a forum of remained active in financial education national research and policy experts to initiatives during 2005. The Federal discuss opportunities for improving Reserve Bank of Kansas City actively asset-building among lower-income promoted workplace financial educa- populations. tion by convening employers in Kansas Building on prior years' efforts to City and Denver to discuss the advan- help community development financing tages of providing financial education organizations grow and survive, the to employees. In partnership with the Federal Reserve System and the Aspen Atlanta Reserve Bank, Kansas City Institute collaborated on a series of constaff also published a brochure iden- ferences. Research by the Aspen Institifying the characteristics of an effec- tute, a national research and leadertive financial education program ship development organization, was the (www.kc.frb.org/comaffrs/Workshops/ foundation for conference discussions FEbrochure.pdf). The Oklahoma City about the industry and how to increase Branch of the Kansas City Reserve Bank its impact. One event, sponsored by collaborated with the Oklahoma the Chicago Reserve Bank, explored Jump$tart Coalition to host a conference various business models that have led of local financial-education service to successful community development providers and community members to finance programs. Another event, identify strategies for expanding finan- cohosted by the Boston Reserve Bank, cial education throughout the state. In explored whether socially responsible an effort to expand the scope of the investments can be used to fund comregional financial education collabora- munity development institutions and tives it has helped establish in key cities help them operate more effectively. in the Fourth District, the Cleveland Board staff also participated in an inter- Reserve Bank hosted a conference that national conference, sponsored by the underscored effective strategies for mea- Social Enterprise Initiative at Harvard suring success and conducting research Business School, on effective business on financial education. strategies for serving lower-income Complementing the System's finan- populations. Staff presented a case study cial education efforts, various CAOs of a community development financial partnered with CFED, a national non- institution, highlighting the role banking profit organization formerly known as regulation and policy had in motivating the Corporation for Enterprise Devel- private investment in these institutions, opment, to host a series of events as well as the business strategies these Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

110 92nd Annual Report, 2005 institutions adopted to respond to the at Reserve Banks have expanded their credit and financial services needs of programs to include research and data their lower-income markets. collection. The Boston Reserve Bank The System's CAOs remain commit- launched a series of community ecoted to increasing research and data on nomic development papers that offer community economic development. In in-depth coverage of current community 2005, the System hosted its biennial economic development issues. The Boscommunity development research con- ton Bank also created a new series of ference, "Promises and Pitfalls: As Con- data resources on the socioeconomic sumer Finance Options Multiply, Who characteristics of lower-income commu- Is Being Served and at What Cost?" nities in New England (www.bos.frb.org/ The Research and Community Affairs commdev/index.htm). The New York staffs at the Board and the Cleveland Reserve Bank published research on Reserve Bank collaborated on the event. whether stored-value cards are an effec- Papers presented at the conference tive electronic payment tool for unassessed the impact that consumer banked consumers; the Bank also pubbehavior, alternative financial services lished a paper on using the earned providers, financial education, and other income tax credit to encourage savings factors have on consumers' access to and banking system participation by and experiences with the financial sec- unbanked consumers (www.ny.frb.org/ tor. In one paper, System staff studied regional/commdev.html). To bridge the data from focus groups with Mexican gap between community economic immigrants who remitted money to fam- development theory and practice, the ily members in Mexico. Those results San Francisco Reserve Bank launched a are being used to help immigrants new community development journal connect with the banking system and that features articles and commentary thereby increase market efficiencies for by researchers, policymakers, and pracboth financial institutions and consum- titioners (www .sf.frb.org/publications/ ers. The results are also being used in community/). Research by Board staff interagency efforts to educate consum- on the financial education programs ers about the remittance channels avail- offered to military personnel by the able to them. A call for papers for the Department of Defense (DoD) contin- System's 2007 research conference has ued. Staff collected data from recipients been issued. The 2007 conference will of the DoD's financial education proaddress the effectiveness of the Commu- gram as support for a longitudinal study nity Reinvestment Act (CRA) in pro- to assess the impact of DOD's programs moting access to and encouraging com- on the financial management behavior munity and economic development, in of the recipients. light of the dramatic changes that have Finally, Board staff undertook efforts occurred in the financial services indus- to help the public understand and use try in the thirty years since the CRA was the new Home Mortgage Disclosure enacted.9 Act (HMDA) data. Public interest in In addition to participating in the Sys- HMDA data increased significantly in tem research conference, several CAOs 2005, with the release of previously uncollected data on the pricing of 9. The web site for the 2005 conference home mortgage loans. To address (including conference papers), as well as potential concerns and questions about the 2007 call for papers, can be accessed at www.federakeserve.gov/community.htm. the new HMDA data, Board staff Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 111 worked collaboratively with other ers, to promote community development agencies to develop questions and and consumer education, and to foster answers about the insights and limita- discussion of public policy issues. Board tions the new data provide. (See the staff periodically meet with financial Board's March 31, 2005, press release at institutions, community groups, and www.federalreserve.gov/newsevents.htm.) other members of the public in formal These questions and answers were and informal settings. The Board spondesigned to both help interested parties sors and participates in meetings, conuse the data objectively and to discour- ferences, and seminars for the general age individuals and groups from form- public and targeted audiences. This year, ing conclusions about mortgage lending the Board again participated in the patterns that are not supported by the Congressional Black Caucus Foundadata. tion's 2005 annual legislative conference, which provides a national forum for examining strategies and viable solu- Outreach Activities tions to public policy issues facing Afri- The Board engages in outreach activi- can Americans. Board staff distributed ties throughout the year to provide infor- consumer education materials provided mation to the public about the Board's by the Federal Reserve System and used responsibilities, to facilitate understand- the opportunity to inform conference ing of changes in banking regulations attendees about the Federal Reserve and and their impact on banks and consum- its multifaceted responsibilities. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

113 Federal Reserve Banks In addition to contributing to the setting the past ten years, the Reserve Banks of national monetary policy and super- have recovered 98.4 percent of thenvising and regulating banks and other priced services costs, including the financial entities (discussed in pre- PSAF (table). In 2005, the Board ceding chapters), the Federal Reserve approved changes, to be effective in Banks operate a nationwide payments 2006, to the method for calculating the system, distribute the nation's currency target return on equity measure in the and coin, and serve as fiscal agents and PSAF. depositories for the United States. Overall, the price index for priced services increased 8.4 percent from 2004 to 2005. Revenue from priced ser- Developments in vices amounted to $901.0 million, other Federal Reserve Priced Services income was $93.7 million, and costs In operating a nationwide payments sys- were $834.7 million, resulting in tem, the Federal Reserve Banks provide net income from priced services of numerous services to depository insti- $160.0 million. In 2005, the Reserve tutions, including collecting and pro- Banks recovered 106.1 percent of total cessing checks, operating an automated costs of $937.7 million, including the clearinghouse service, transferring funds PSAF.2 and securities, and providing settlement services. The Reserve Banks charge fees Commercial Check for providing these "priced services." Collection Service The Monetary Control Act of 1980 In 2005, operating expenses and requires that the Federal Reserve estabimputed costs for the Reserve Banks' lish fees for priced services provided to commercial check collection service depository institutions so as to recover, totaled $688.6 million, of which over the long run, all direct and indirect $39.0 million was attributable to the costs actually incurred as well as the transportation of commercial checks imputed costs that would have been incurred, including financing costs, taxes, and certain other expenses, and priced services are also allocated to priced services; in the pro forma statements at the end of the return on equity (profit) that would this chapter, Board expenses are included in operhave been earned if a private business ating expenses and Board assets are part of longfirm had provided the services. The term assets. imputed costs and imputed profit are 2. Financial data reported throughout this collectively referred to as the private- chapter—revenue, other income, cost, net revesector adjustment factor (PSAF).1 Over nue, and income before taxes—can be linked to the pro forma statements at the end of this chapter. Other income is revenue from investment of clear- 1. In addition to income taxes and the return on ing balances net of earnings credits, an amount equity, the PSAF is made up of three imputed termed net income on clearing balances. Total cost costs: interest on debt, sales taxes, and assess- is the sum of operating expenses, imputed costs ments for deposit insurance by the Federal Deposit (interest on debt, interest on float, sales taxes, and Insurance Corporation (FDIC). Board of Gover- the FDIC assessment), imputed income taxes, and nors assets and personnel costs that are related to the targeted return on equity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

114 92nd Annual Report, 2005 Priced Services Cost Recovery, 1996-2005 Millions of dollars except as noted Operating Year Re s v e e r n v u i e c e f s r 1 om im ex p p u e t n e s d e s c a o n st d s2 Tar o g n e t e ed q u r i e ty turn T co o s ta ts l Co (p st e r r c e e c n ov t) e 3 ry 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 2005 994.7 834.7 103.0 937.7 106.1 1996-2005 8,934.6 8,238.4 841.4 9,080.0 98.4 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 $7,585.1 million, imputed costs of $341.4 million, and of rounding. imputed income taxes of $312.0 million. 1. For the ten-year period, includes revenue from ser- 3. Revenue from services divided by total costs. vices of $8,606.3 million and other income and expense (net) of $328.3 million. between Reserve Bank check-processing services increased 10.2 percent from centers. Revenue amounted to $740.3 2004. million, of which $42.9 million was In response to the continuing decline attributable to estimated revenues in check volume, the Reserve Banks in derived from the transportation of com- 2005 continued to reduce check service mercial checks between Reserve Bank operating costs through a combination check-processing centers, and other of measures, including closing some income was $77.1 million. The resulting check-processing sites and increasing net income was $128.7 million. Check capacity at others. Checks that once service revenue in 2005 increased would have been processed in Birming- $20.6 million from 2004, largely ham are now processed in Atlanta. because of price increases and a slower- Detroit check processing has been conthan-anticipated reduction of check- solidated to Cleveland; Salt Lake City to processing volume. Denver; Portland to Seattle; and Hous- The Reserve Banks handled 12.2 bil- ton and Oklahoma City to Dallas. lion checks in 2005, a decrease of Of all the checks presented by the 12.3 percent from the 13.9 billion Reserve Banks to paying banks in 2005, checks handled in 2004 (table). The 25.2 percent (approximately 3.1 bildecline in Reserve Bank check volume lion checks) were presented electroniis consistent with nationwide trends cally, compared with 23.1 percent in away from the use of checks and toward 2004. The Banks captured images of greater use of electronic payment meth- 11.8 percent of the checks they colods.3 Overall, the price index for check Reserve System, "The 2004 Federal Reserve 3. The Federal Reserve System's retail pay- Payments Study: Analysis of Noncash Payments ments research suggests that the number of checks Trends in the United States, 2000-2003" written in the United States has been declining (December 2004). (www.frbservices.org/Retail/ since the mid-1990s. For details, see Federal pdf/2004PaymentResearchReport.pdf) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 115 Activity in Federal Reserve Priced Services, 2003-2005 Thousands of items Percent change Service 2005 2004 2003 2004 to 2005 2003 to 2004 Commercial check 12,195,301 13,904,382 15,805,894 -12.3 -12.0 Funds transfer 135,227 128,270 125,936 5.4 1.9 Securities transfer 9,235 9,208 10,071 .3 -8.6 Commercial ACH 7,338,950 6,486,091 5,588,381 13.1 16.1 Noncash 117 211 280 -44.5 -24.7 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 offlected, an increase from 10.4 percent Fedwire Funds and in 2004. In 2005 the Banks presented National Settlement Services approximately 241.5 million substitute checks, or 2.0 percent of the total num- Reserve Bank operating expenses and ber of checks they collected. (For more imputed costs for the Fedwire Funds information on substitute checks, see the and National Settlement Services totaled box "The First Full Year of Check 21.") $55.3 million in 2005. Revenue from these operations totaled $61.0 million and other income amounted to Commercial Automated $6.3 million, resulting in net income of Clearinghouse Services $12.1 million. Reserve Bank operating expenses and imputed costs for commercial automated Fedwire Funds Service clearinghouse (ACH) services totaled $72.1 million in 2005. Revenue from The Fedwire Funds Service allows par- ACH operations totaled $79.3 million ticipants to draw on their reserve or and other income totaled $8.2 million, clearing balances at the Reserve Banks resulting in net income of $15.2 million. and transfer funds to other institutions The Banks processed 7.3 billion com- that maintain accounts at the Banks. In mercial ACH transactions (worth 2005, the number of Fedwire funds $12.8 trillion), an increase of 13.1 per- transfers originated by depository insticent from 2004. Overall, the price index tutions increased 5.4 percent from 2004, for ACH services decreased 1.1 percent to approximately 135.2 million. The from 2004. average daily value of Fedwire funds In 2005 the Reserve Banks conducted transfers in 2005 was $2.1 trillion. a pilot program of an ACH riskmanagement service that will be available to all depository institutions in National Settlement Service 2006. The service will help originating institutions manage operational, credit, Private clearing arrangements that and third-party risk associated with exchange and settle transactions may originating ACH payments. use the Reserve Banks' National Settle- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

116 92nd Annual Report, 2005 The First Full Year of Check 21 The United States is in the midst of signifi- form of a paper check, it may no longer cant change in Ihe way payments are made. require that the original check be pre* At one time, most nortcash payments were seated* Instead* paying banks must accept a made by paper cheek. Evidence of major ^substitute check/* a special paper copy of change was seen in the results of the an original check that can be processed Federal Reserve's most-recent payments in the same way as the original check. By research, which found that in 2003, for the authorizing this new, legally equivalent first time ever, businesses and consumers negotiable instrument, Check 21 facilitates, made more payments electronically (by through the action of market forces, the debit and credit card, for example) than by adoption of check truncation and the elecpaper check. Hie declining use of checks is tronic collection of checks.1 As banks only a part of the ongoing change within increasingly send and receive checks electhe payments system, however. The way in tronically, they will be able to reduce their which checks are collected is changing as well, as a result of the Check Clearing for the 21st Century Act (commonly referred 1. Check truncation Is the removal of an to as Check 21)* Before implementation of original check from the check-collection system the act in 2004, laws governing check col- and the collection, instead, of a substitute check lection allowed a paying bank to require or, by agreement, information contained on the that the original check be physically original check's magnetic ink character recognipresented for payment. Check 21 was tion (MICR) line, including the paying bank's designed to facilitate the electronic pro- routing number, the check writer's account numcessing of checks, with the goal of making ber, the check serial number, and the amount of the check. Additional consumer information on check collection faster, more efficient, and Check 21 is available at www.federakeserve.gov/ kss costly. consumers.htm. Banking industry educational Under Check 2i> while a paying bank and reference material on Check 21 is available may demand that presentment be in the at www .ffiec. gov/exam/check21 /default.htm. ment Service to settle their transactions. certain international organizations to This service is provided to approxi- other participants in the United States.4 mately fifty-five local and national Reserve Bank operating expenses and private arrangements, primarily check imputed costs for providing this serclearinghouse associations but also other vice totaled $17.4 million in 2005. types of arrangements. In 2005, the Revenue from the service totaled Reserve Banks processed slightly more $19.3 million, and other income totaled than 440,000 settlement entries for these arrangements. 4. The expenses, revenues, and volumes reported here are for transfers of securities issued Fedwire Securities Service by federal government agencies, governmentsponsored enterprises, and certain international The Fedwire Securities Service allows organizations. The Treasury Department assesses participants to electronically transfer fees on depository institutions for some of the transfer, account maintenance, and settlement sersecurities issued by the U.S. Treavices for U.S. Treasury securities provided by the sury, federal government agencies, Reserve Banks. For details, see the section "Debt government-sponsored enterprises, and Services" later in this chapter. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 117 infrastructure for processing paper checks by Check 21, More than 500 depository and the cost of physically transporting institution customers were using Federal original paper checks from the bask where Reserve Check 21 services by year-end they were deposited to the banks that pay 2005, In December 2005, peak daily volthem. ume processed by the Reserve Banks The Federal Reserve Banks have been exceeded 3 million substitute checks valleaders within the payments industry in ued at more than $19 billion. making use of the authority granted by As with many significant operational Check 21. They began offering Check 21 and technological changes, adoption of the services as soon as the law became effec- new check-processing methods made postive in October 2004. The services allow sible by Check 21 has been gradual. To for the deposit of digital check images fully realize the benefits of a faster, more with the Reserve Banks and the truncation efficient, less costly, and more resilient of paper-check deposits by the Reserve check-collection system envisioned when Banks. The check images are transmitted Check 21 was enacted, the banking industo the Reserve Bank closest to the paying try will need to make changes to its current bank, thereby eliminating the need to systems to support the exchange of digital physically transport paper checks between check images. As technology improves the Banks, The receiving Reserve Bank and scale economies are realized, the either prints substitute checks from the cost of collecting checks electronically check images for presentment to the paying will decrease relative to the cost of colbank or, if the paying bank accepts elec- lecting paper checks, and this decrease tronic presentment, provides the check should eventually spur greater adoption of information electronically. Check 21 technologies across the banking Across the industry, banks have begun to industry. take advantage of the opportunities created $2.0 million, resulting in net income of 2005, representing a 44.5 percent $3.8 million. Approximately 9.2 million decline in volume from 2004. Operating transfers of Treasury and other securi- expenses and imputed costs for noncash ties were processed by the service dur- operations totaled $1.1 million in 2005, ing the year, almost unchanged from and revenue and other income totaled 2004. In 2005, the surcharge for offline $1.2 million, resulting in net income of transfers increased from $28 to $33. approximately $0.1 million. Noncash Collection Service Float At year-end 2005, the Reserve Banks The Federal Reserve had daily average withdrew from the noncash collection debit float of $133.4 million in 2005, service, which collected and processed compared with credit float of $76.4 milmunicipal bearer bonds and coupons lion in 2004.5 issued by state and local governments (referred to as "noncash" items), because of a declining volume of cou- 5. Credit float occurs when the Reserve Banks pons and bonds presented for collection. receive settlement for items prior to providing credit to the depositing institution, and debit float The service processed slightly fewer occurs when the Reserve Banks credit the depositthan 117,000 noncash transactions in ing institution prior to receiving settlement. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

118 92nd Annual Report, 2005 Developments in 2005. The Reserve Banks believe that a Currency and Coin permanent custodial inventory program, together with recirculation fees, would The Federal Reserve Banks distribute provide incentives to depository instituthe nation's currency (in the form of tions to recirculate currency. Federal Reserve notes) and coin through Study of the proposed policy's potendepository institutions and receive curtial effects on the quality of currency rency and coin from circulation. As curin circulation continues. In 2005, the rency flows into the Reserve Banks, the Federal Reserve worked with vending Banks inspect the notes and destroy industry representatives to determine the those that are unfit for recirculation. effect of quality variance on machines' The Reserve Banks received 37.2 bilability to accept currency. The Federal lion Federal Reserve notes from circula- Reserve is also developing a technical tion in 2005, a 0.9 percent decrease from definition of currency that is "fit for 2004, and made payments of 38.5 bilcommerce" and a Reserve Bank prolion notes into circulation, a 1.6 pergram to monitor and control the quality cent increase from 2004. They received of currency in circulation. The Board is 56.1 billion coins from circulation in expected to consider approval of a final 2005, a 0.8 percent increase from 2004, recirculation policy in early 2006. and made payments of 72.1 billion coins The Reserve Banks also continue to into circulation, a 6.9 percent increase study cost-effective alternatives to the from 2004.6 existing infrastructure for providing Because many depository institutions cash services. Earlier studies resulted overuse Reserve Bank cash-processing in the elimination of cash operations services, the Board in 2003 requested at the Little Rock, Louisville, Buffalo, comment on a policy of providing incenand Portland (Oregon) offices and the tives to encourage depository institureplacement of these offices with cash tions to recirculate fit currency to their depots. In a cash depot arrangement, customers rather than return it to the armored carrier facilities serve as collec- Federal Reserve for processing. Under tion and distribution points for deposithe policy, the Federal Reserve would tory institutions' currency deposits and establish a custodial inventory program orders. The deposits and orders are that allows depository institutions to transported to and from a nearby transfer a portion of their cash holdings Reserve Bank by armored carrier. to the books of a Reserve Bank. Reserve Banks would charge fees to institutions that, within a one-week period, depos- Developments in ited fit currency and reordered currency Fiscal Agency and of the same denomination within the Government Depository Services same Reserve Bank office's service As fiscal agents and depositories for the area. The Reserve Banks conducted a federal government, the Federal Reserve custodial inventory proof-of-concept Banks provide services related to the program in 2004 to test the effectiveness federal debt, help the Treasury collect of a program that supports the proposed funds owed to the federal government, policy and evaluated the program in process electronic and check payments for the Treasury, maintain the Treasury's bank account, and invest excess 6. Percentages reflect restatements of previously reported data. Treasury balances. The Reserve Banks Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 119 Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2003-2005 Thousands of dollars Agency and service 2005 2004 2003 DEPARTMENT OF THE TREASURY Bureau of the Public Debt Treasury retail securities Savings bonds 59,624.0 72,385.1 66,403.7 TreasuryDirect and Treasury coupons 26,879.2 30,872.7 33,013.5 Treasury securities safekeeping and transfer 6,055.8 6,267.0 4,836.3 Treasury auction 17,553.5 17,159.5 16,802.6 Computer infrastructure development and support 2,575.5 5,935.1 7,836.7 Other services 1,806.5 1,709.8 1,460.7 Total 114,494.5 134,329.1 130,353.4 Financial Management Service Payment services Government check processing 20,988.0 24,245.4 25,624.7 Automated clearinghouse 5,709.5 5,352.9 6,253.9 Fedwire funds transfers 109.4 111.6 187.3 Other payment-related services 49,366.0 33,646.9 23,630.8 Collection services Tax and other revenue collections 39,736.0 34,248.4 29,782.9 Other collection-related services 14,354.2 12,922.8 12,532.6 Cash management services 40,496.7 21,835.8 18,227.8 Computer infrastructure development and support 67,703.3 52,673.3 24,575.3 Other services 2,332.2 6,931.6 6,666.2 Total 240,795.4 191,968.6 147,481.5 Other Treasury Total 15,726.7 15,106.1 13,913.5 Total, Treasury 371,016.6 341,403.7 291,748.5 OTHER FEDERAL AGENCIES Department of Agriculture Food coupons 2,642.4 4,519.0 7,791.4 U.S. Postal Service Postal money orders 7,647.8 7,774.6 10,959.5 Other agencies Other services 14,870.2 16,104.0 16,508.2 Total, other agencies 25,160.4 28,397.5 35,259.2 Total reimbursable expenses 396,177.0 369,801.2 327,007.7 also provide limited fiscal agency and reimbursed the Reserve Banks for the depository services to other entities. costs of providing these services. The total cost of providing fiscal The most-significant development in agency and depository services to the the provision of fiscal agency services Treasury and other entities in 2005 in 2005 was the Reserve Banks' conamounted to $396.2 million, compared solidation of customer service and with $369.8 million in 2004 (table). back-office operations that support the Treasury-related costs were $371 mil- Treasury's retail securities programs, lion in 2005, compared with $341.4 mil- through which retail investors purchase lion in 2004, an increase of 8.7 percent. and hold marketable Treasury securities The cost of providing services to other and savings bonds. As the Treasury entities was $25.2 million, compared replaced paper processes in retail secuwith $28.4 million in 2004. In 2005, as rities with more-efficient electronic in 2004, the Treasury and other entities processes, fewer operations sites were Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

120 92nd Annual Report, 2005 needed. The consolidation to two sites 15,000 securities worth $673.3 million was completed in October 2005. The in 2004. Fees associated with the sale of Banks expect that annual operating costs securities through Sell Direct totaled for retail securities operations will $566,000, an increase of 12.2 percent decline considerably in 2006 because of from the more than $504,000 in fees lower personnel costs. collected in 2004. The Banks printed and mailed more than 32 million savings bonds in 2005, a Debt Services 9.6 percent decrease from 2004. They The Reserve Banks auction, provide issued more than 3 million Series I safekeeping for, and transfer Treasury (inflation indexed) bonds and 12.6 milsecurities. Reserve Bank operating lion Series EE bonds. Reissued or expenses for these activities totaled exchanged bonds accounted for the $23.6 million in 2005, a slight increase remaining bonds printed. The Banks from 2004. The Banks processed processed about 3.5 million redemption, 245,000 tenders for Treasury securities, reissue, and exchange transactions, a compared with 156,000 in 2004. They 9.6 percent decrease from 2004. originated 12.6 million transfers of Treasury securities in 2005, an 18.6 per- Payments Services cent increase from 2004. The Reserve Banks also operate com- The Reserve Banks process both elecputer applications and provide customer tronic and check payments for the Treaservice and back-office support for the sury. Reserve Bank operating expenses Treasury's retail securities programs, for processing government payments including Treasury securities and sav- totaled $76.2 million in 2005, compared ings bonds. Reserve Bank operating with $63.4 million in 2004. The Banks expenses for these activities were processed 981 million ACH payments $86.5 million in 2005, compared with for the Treasury, an increase of 4.4 per- $103.3 million in 2004. cent from 2004, and more than 849,000 In addition, the Reserve Banks oper- Fedwire funds transfers. They also proate Treasury Direct, a program that cessed 214.8 million paper government allows investors to purchase and hold checks, a decline of 8.3 percent from Treasury securities directly with the 2004. In addition, the Banks issued more Treasury instead of through a broker. than 206,000 fiscal agency checks, a The program held $68.1 billion (par decrease of 25.9 percent from 2004. value) of Treasury securities as of In addition to processing payments, December 31, 2005. Because the pro- the Reserve Banks operate several program was designed for investors who grams to help the Treasury increase the plan to hold their securities to maturity, use of electronic payments. One such it does not provide transfer services. program, the Automated Standard Investors may, however, sell their secu- Application for Payment, enables recipirities for a fee through Sell Direct, a ents of federal grants to request payprogram operated by one of the Reserve ments using the Internet. This applica- Banks. Approximately 14,000 securities tion processed $423.8 billion in Fedwire worth $874.8 million were sold through funds transfers and ACH payments in Sell Direct in 2005, compared with 2005, compared with $404.7 billion in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 121 2004. Another such program, the stored- Conversion and Electronic Check Provalue card program, provides salary and cessing programs, whereby checks writbenefit payments to military personnel, ten to government agencies are convia a smart card, for use at military verted into ACH transactions at the bases. In 2005, the Banks worked with point of sale or at lockbox locations. In the Treasury to plan a web-based appli- 2005, the Reserve Banks originated cation to allow federal agencies and ven- more than 2.6 million ACH transactions dors to exchange purchase orders and through these programs, a 36 percent invoices and initiate ACH payments increase from the 1.9 million originated electronically. The operating costs for in 2004. these three programs totaled $19.7 million in 2005, compared with $15.4 million in 2004. Cash Management Services The Treasury maintains its bank account Collection Services at the Reserve Banks and invests the The Reserve Banks support several funds it does not need for current pay- Treasury programs to collect funds ments with qualified depository instituowed the federal government. Reserve tions through the Treasury Tax and Loan Bank operating expenses related to these (TT&L) program, which the Reserve programs totaled $54.1 million in 2005, Banks operate. Reserve Bank operating compared with $47.2 million in 2004. expenses related to this program totaled The Banks operate the Federal Reserve $40.5 million in 2005, compared with Electronic Tax Application (FR-ETA) as $21.8 million in 2004. The investments an adjunct to the Treasury's Electronic either are callable on demand or are for Federal Tax Payment System (EFTPS). a set term. In 2005, the Reserve Banks EFTPS allows businesses and individual placed a total of $8.8 billion in immetaxpayers to pay their taxes electroni- diately callable investments and cally. It uses the automated clearing- $574.1 billion in term investments. The house (ACH) to collect funds, so tax rate for term investments is set at aucpayments must be scheduled at least one tion; the Reserve Banks held 104 such day in advance. Some business taxpay- auctions in 2005, compared with 45 aucers, however, do not know their tax tions in 2004. In 2005, the Treasury's liability until the tax due date. FR-ETA income from the TT&L program was allows these taxpayers to use EFTPS by $597.4 million. providing a same-day electronic federal tax payment alternative. FR-ETA collected $409.2 billion for the Treasury in Services Provided to Other Entities 2005, compared with $344.8 billion in 2004. The Reserve Banks provide fiscal In addition, the Reserve Banks oper- agency and depository services to other ate Pay.gov, a Treasury program that domestic and international entities when allows members of the public to pay for required to do so by the Secretary of the goods and services offered by the fed- Treasury or when required or permitted eral government over the Internet. They to do so by federal statute. The majority also operate the Treasury's Paper Check of the work is securities-related. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

122 92nd Annual Report, 2005 The Federal Reserve System's Response to Hurricane Katrina The damage from Hurricane Katri&a's Bank. The New Orleans Branch building strike along the Gulf Coast on August 29, was not flooded and sustained only minor 2005, and the subsequent flooding of damage from the hurricane, Only a few much of New Orleans when levees were essential employees were able to remain in breached, seriously affected the banking the building, however, so the Branch was system's ability to provide financial ser- unable to provide services as usual. Nonevices at a time when individuals and busi- theless, even before Hurricane Katrina nesses needed access to their funds. Some struck, the Branch implemented its contindepository institutions were flooded and gency operations plans by relocating cer~ unable to open. Others in the Gulf Coast tain essential employees from New Orleans region that were not severely damaged and to the Atlanta Bank's Birmingham, Ala- i might have opened were usable to do so bama, Branch, and it quickly began probecause of interruptions to utility services viding services to depository institutions or a shortage of employees. The transporta- through other Federal Reserve oftiees. Rection of cash for distribution to the public ognizing that depository institutions faced was impeded, and the process of presenting gasoline shortages and could incur high and collecting checks was disrupted. costs to obtain cash from offices outside These conditions presented challenges to New Orleans, the Atlanta and Dallas the Federal Reserve, which is charged with Reserve Banks arranged for armored carridistributing the nation's currency and coin ers to transport cash into the affected areas. and provides check-collection services to To further support recovery efforts, the depository institutions, in the Gulf Coast Atlanta Reserve Bank also opened drop-off region, the Federal Reserve conducts points for check deposits a few days after these operations through the New Orleans the hurricane, These deposits were then Branch of the Atlanta Federal Reserve transported to the Bank's Atlanta office Electronic Access to Information Technology Reserve Bank Services In 2005, the Federal Reserve Banks The Federal Reserve Banks have been completed projects to standardize local using a DOS-based platform, FedLine, area network components and telephone to provide services and information to private branch exchange systems and to about seven thousand depository insti- implement reduced-cost wide area nettution end points, mainly small and work telecommunications services. An medium-sized institutions. A more- initiative is now under way to strengthen efficient replacement delivery channel, information security controls across the FedLine Advantage, which uses Internet System. web technologies to provide financial In partnership with the agencies that institutions with access to such critical make up the Financial and Banking payment systems as Fedwire Funds Ser- Information Infrastructure Committee, vice, Fedwire Securities Service, and the Federal Reserve continued in 2005 FedACH Services, has been developed. to sponsor clearing and settlement utili- Migration to FedLine Advantage began ties, key financial institutions, and key in 2005 and will be completed in 2006. market participants in the national secu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 123 for processing. StafY from other Federal operations and were unable to retrieve their Reserve offices—and, subsequently, relo- ACH (automated clearinghouse) files, cated New Orleans employees—have con- which contained information on payroll, tinued to process checks in Atlanta. The Social Security, and other credit payments Atlanta Bank provided credit for deposited that their customers oeeded in this time of checks drawn on depository institutions in crisis* the New Orleans area even though it was The Board also worked with key governinitially unable to present checks to those ment finance and banking regulatory ageninstitutions for collection, and it did not cies to devise a strategy for restoring vital return the checks that it could not present. telecommunications services to affected During the crisis, the number of checks institutions. The Board served as the cendrawn on New Orleans area institutions tral point of contact for management of the that cleared through the Federal Reserve overall restoration effort under the Telerose significantly as checks that would communications Service Priority (TSP) normally have cleared through other chan- program—a federal program that identifies nels were redirected through the Federal and prioritizes those telecommunications Reserve. services essential to national security and As depository institutions in the affected emergency preparedness.1 Most institutions area began operating at contingency loca- that were assigned high TSP priority had tions, the Atlanta Reserve Bank contacted some measure of telecommunications serthose institutions to gather information on vices available within a matter of days. their situation, particularly on their liquidity and their ability to process payments. 1, The TSP program is administered by the Reestablishing contact with depository National Communications System (NCS), an institutions—an effort on which the Fedinteragency group of federal departments md |eral Reserve worked closely with other agencies that plans for and coordinates national Regulatory agencies—was critical, as some security and emergency preparedness telecom- ^institutions had difficulty restoring their munications, especially during crises. rity and emergency preparedness pro- Task Force of the President's National grams offered by the Department of Security Telecommunications Advisory Homeland Security's National Commu- Committee, the Federal Reserve in 2005 nications System, which coordinates partnered with the Alliance for Telecomactivities to ensure that critical tele- munications Industry Solutions (ATIS) communications services are prepared on a collaborative project. The team to meet natural disasters and national assessed the ability to track changes in emergencies. The Board's role in imple- the way telecommunications circuits menting one of these programs—the are routed to customer locations and Telecommunications Service Priority determined that there is currently no program—to help restore telecommuni- commercially viable product that can cations services to financial institutions be adopted to automate this process. The in Mississippi and Louisiana in the wake greater the number of carriers involved of Hurricane Katrina and the subsequent in providing services, the more difficult flooding in New Orleans is described in it becomes to track such changes. A the accompanying box. diverse network provides more protec- In response to recommendations in tion against disruption of service during the 2004 report of the Financial Services contingencies, however, because diver- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

124 92nd Annual Report, 2005 sity lessens the risk of a single point audit. Specifically, PwC may not perof failure. A report on this initiative, the form services for the Reserve Banks or National Diversity Assurance Initiative, others that would place it in a position was released in February 2006. of auditing its own work, making management decisions on behalf of the Reserve Banks, or in any other way Examinations of the impairing its audit independence. In Federal Reserve Banks 2005, the Reserve Banks did not engage Section 21 of the Federal Reserve Act PwC for non-audit services. requires the Board of Governors to order The Board's annual examination of an examination of each Federal Reserve the Reserve Banks includes a wide range Bank at least once a year. The Board of off-site and on-site oversight activengages a public accounting firm to per- ities conducted by the Division of form an annual audit of the combined Reserve Bank Operations and Payment financial statements of the Reserve Systems. Division personnel monitor the Banks (see the section "Federal Reserve activities of each Reserve Bank on an Banks Combined Financial State- ongoing basis and conduct on-site ments"). The accounting firm also reviews based on the division's riskaudits the annual financial statements of assessment methodology. The 2005 each of the twelve Banks. The Reserve examinations also included assessing the Banks use the framework established by efficiency and effectiveness of the interthe Committee of Sponsoring Organi- nal audit function. To assess compliance zations of the Treadway Commission with the policies established by the Fed- (COSO) in assessing their internal con- eral Reserve's Federal Open Market trols over financial reporting, including Committee (FOMC), the division also the safeguarding of assets. In 2005, the reviews the accounts and holdings of the Reserve Banks further enhanced their System Open Market Account at the assessments under the COSO frame- Federal Reserve Bank of New York work, strengthening the key control and the foreign currency operations assertion process, consistent with the conducted by that Bank. In addition, requirements of the Sarbanes-Oxley Act PwC audits the schedule of participated of 2002. Within this framework, man- asset and liability accounts and the agement of each Reserve Bank provides related schedule of participated income an assertion letter to its board of direc- accounts at year-end. The FOMC tors annually confirming adherence to receives the external audit reports and COSO standards, and a public account- the report on the division's examination. ing firm certifies management's assertion and issues an attestation report to Income and Expenses the Bank's board of directors and to the Board of Governors. The accompanying table summarizes The firm engaged for the audits of the income, expenses, and distributions the individual and combined financial of net earnings of the Federal Reserve statements of the Reserve Banks for Banks for 2004 and 2005. 2005 was PricewaterhouseCoopers LLP Income in 2005 was $30,729 mil- (PwC). Fees for these services totaled lion, compared with $23,540 million $4.6 million. To ensure auditor indepen- in 2004. Expenses totaled $3,633 mildence, the Board requires that PwC be lion ($2,677 million in operating independent in all matters relating to the expenses, $213 million in earnings Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 125 Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2005 and 2004 Millions of dollars Item 2005 2004 Current income 30,729 23,540 Current expenses 2,890 2,239 Operating expenses1 2,677 2,123 Earnings credits granted 213 116 Current net income 27,840 21,301 Net additions to (deductions from, - ) current net income -3,577 918 Assessments by the Board of Governors 743 776 For expenditures of Board 266 272 For cost of currency 477 504 Net income before payments to Treasury 23,520 21,443 Dividends paid 781 582 Transferred to surplus 1,272 2,783 Payments to Treasury2 21,468 18,078 1. Includes net periodic pension credit of $11 million 2. Interest on Federal Reserve notes. in 2005 and $37 million in 2004. credits granted to depository institutions, and expenses of each Reserve Bank for $266 million in assessments for expen- 2005 and table 11 shows a condensed ditures by the Board of Governors, and statement for each Bank for the years $477 million for the cost of new cur- 1914 through 2005; table 9 is a staterency). Revenue from priced services ment of condition for each Bank, and was $901 million. The profit and loss table 13 gives number and annual salaaccount showed a net loss of $3,577 ries of officers and employees for each. million. The loss was due primarily to A detailed account of the assessments unrealized losses on assets denominated and expenditures of the Board of Goverin foreign currencies revalued to reflect nors appears in the section "Board of current market exchange rates. Statutory Governors Financial Statements." dividends paid to member banks totaled $781 million, $199 million more than Holdings of Securities and Loans in 2004; the increase reflects an increase in the capital and surplus of member The Federal Reserve Banks' average banks and a consequent increase in the daily holdings of securities and loans paid-in capital stock of the Reserve during 2005 amounted to $761,509 Banks. million, an increase of $41,862 mil- Payments to the U.S. Treasury in the lion from 2004 (table). Holdings of form of interest on Federal Reserve U.S. government securities increased notes totaled $21,468 million in 2005, $41,801 million, and holdings of loans up from $18,078 million in 2004; the increased $61 million. The average rate payments equal net income after the of interest earned on the Reserve Banks' deduction of dividends paid and of the holdings of government securities amount necessary to equate the Reserve increased to 3.80 percent, from 3.11 per- Banks' surplus to paid-in capital. cent in 2004, and the average rate of In the "Statistical Tables" section of interest earned on loans increased to this report, table 10 details the income 3.49 percent, from 1.74 percent. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

126 92nd Annual Report, 2005 Secunties and Loans of theFederal ]Reserve Banks, 2003-2005 Millions of dollars except as noted U.S. Item and year Total government Loans2 securities1 Average daily holdings3' 2003 683,438 683,294 144 2004 719,647 719,494 153 2005 761,509 761,295 214 Earnings4 2003 .. . .... 22,598 22,597 1 2004 22,347 22,344 3 2005 28,966 28,959 7 Average interest rate (percent) 2003 . 3.31 3.31 1.00 2004 3.11 3.11 1.74 2005 3.80 3.80 3.49 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. Volume of Operations project is an ongoing external perimeter security improvement project at the Table 12 in the "Statistical Tables" sec- Boston Bank. Another is taking place at tion shows the volume of operations in the St. Louis Bank, where, as part of a the principal departments of the Fedlong-term facility redevelopment proeral Reserve Banks for the years 2002 gram, construction of a new pedestrian through 2005. entrance screening vestibule was completed and design work for an addition to the Bank's headquarters building con- Federal Reserve Bank Premises tinued. The St. Louis Bank also com- In 2005, construction was completed on pleted the purchase and renovation of new buildings for the Dallas Federal a building to be used as a business- Reserve Bank's Houston Branch and the continuity relocation facility. In addi- Chicago Bank's Detroit Branch, and tion, the Richmond Bank completed construction began on the Kansas City renovation of a building to be used as a Bank's new headquarters building after relocation site for critical staff and initithe Board approved the project's final ated construction of additional secudesign. Design work continued, and rity improvements to the building. The site preparation work began, for the Dallas Bank completed the purchase San Francisco Bank's new Seattle of property behind its headquarters Branch building. The multiyear renova- building for the construction of a retion program at the New York Bank's mote vehicle screening and shipping/ headquarters building continued, as did receiving facility. facility renovation projects at several Also during 2005, the Board Reserve Bank offices to accommodate approved the Richmond Bank's purthe consolidation of check activities. chase of property adjacent to its head- Security enhancement programs con- quarters building for construction of a tinue at several facilities. One such new parking garage, and the sales of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 127 New York Bank's Buffalo Branch and solidated and relocated to a leased facilthe Kansas City Bank's headquar- ity near the Seattle airport. The Portland ters building were finalized. Efforts to Branch cash operation was relocated to sell the Chicago Bank's Detroit Branch the current Seattle Branch building until building, the St. Louis Bank's Little the new building is completed. Rock Branch building, and the Although utility services were inter- San Francisco Bank's Seattle and Port- rupted, the Atlanta Bank maintained the land Branch buildings continued, as did security and building systems operaefforts by the Dallas Bank to sell excess tions of its New Orleans Branch buildland at its Houston Branch and to lease ing during Hurricane Katrina. Because excess space in the Branch building. the building sits several feet above flood Administrative activities for the level, it was not damaged by flooding. Buffalo, Louisville, and Little Rock Table 14 in the "Statistical Tables" Branches were moved to leased facili- section of this report details the acquisities. Check operations formerly con- tion costs and net book value of the ducted at the San Francisco Bank's Federal Reserve Banks and Branches. • Seattle and Portland Branches were con- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

128 92nd Annual Report, 2005 Pro Forma Financial Statements for Federal Reserve Priced Services Pro Forma Balance Sheet for Priced Services, December 31, 2005 and 2004 Millions of dollars Item 2005 2004 Short-term assets (Note 1) Imputed reserve requirements on clearing balances 993.2 1,115.7 Imputed investments 8,626.4 9,691.9 Receivables 77.0 75.8 Materials and supplies 1.3 1.9 Prepaid expenses 25.6 31.8 Items in process of collection 5,934.4 6,107.1 Total short-term assets 15,657.7 17,024.1 Long-term assets (Note 2) Premises 424.5 471.8 Furniture and equipment 156.1 152.8 Leases, leasehold improvements, and long-term prepayments 88.5 107.9 Prepaid pension costs 796.8 795.4 Total long-term assets 1,465.9 1,528.0 Total assets 17,123.6 18,552.1 Short-term liabilities Clearing balances and balances arising from early credit of uncollected items 10,703.2 11,909.5 Deferred-availability items 5,163.0 5,354.3 Short-term debt .0 .0 Short-term payables 126.2 92.2 Total short-term liabilities 15,992.4 17,355.9 Long-term liabilities Long-term debt .0 .0 Postretirement/postemployment benefits obligation 275.0 268.6 Total long-term liabilities 275.0 268.6 Total liabilities 16,267.4 17,624.5 Equity 856.2 927.6 Total liabilities and equity (Note 3) . 17,123.6 18,552.1 NOTE: Components may not sum to totals because of The accompanying notes are an integral part of these rounding. pro forma priced services financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 129 Pro Forma Income Statement for Federal Reserve Priced Services, 2005 and 2004 Millions of dollars Item 2005 2004 Revenue from services provided to depository institutions (Note 4) 901.0 865.9 Operating expenses (Note 5) 750.0 800.6 Income from operations 150.9 65.3 Imputed costs (Note 6) Interest on float 6.1 -.1 Interest on debt .0 .0 Sales taxes 11.3 11.6 FDIC insurance .0 17.4 .0 11.4 Income from operations after imputed costs 133.5 53.8 Other income and expenses (Note 7) Investment income 292.7 156.8 Earnings credits -199.0 93.7 -108.1 48.7 Income before income taxes 227.2 102.5 Imputed income taxes (Note 6) 67.3 30.6 Net income 160.0 72.0 MEMO: Targeted return on equity (Note 6) ... 103.0 112.4 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, 2005 Millions of dollars Com- Commercial Fedwire Fedwire Noncash Item Total mercial check funds securities services ACH collection Revenue from services (Note 4) 901.0 740.3 61.0 19.3 79.3 1.1 Operating expenses (Note 5) 750.0 619.0 49.3 15.5 65.1 LI Income from operations 150.9 121.3 11.7 3.8 14.1 .0 Imputed costs (Note 6) 17.4 15.5 .9 .3 .6 .0 Income from operations after imputed costs 133.5 105.7 10.9 3.4 13.5 Other income and expenses, net (Note 7) 93.7 77.1 6.3 2.0 8.2 .1 Income before income taxes 227.2 182.9 17.2 5.4 21.6 .1 Imputed income taxes (Note 6) 67.3 54.1 5.1 1.6 6.4 Net income . 160.0 128.7 12.1 3.8 15.2 .1 MEMO: Targeted return on equity (Note 6) 103.0 82.0 7.9 2.9 10.0 .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

130 92nd Annual Report, 2005 FEDERAL RESERVE BANKS NOTES TO PRO FORMA FINANCIAL STATEMENTS FOR PRICED SERVICES (1) SHORT-TERM ASSETS long-term liabilities consist of accrued postemployment, postretiremen^ and nonqualified pension benefits costs The imputed reserve requirement on clearing balances and obligations on capital leases. held at Reserve Banks by depository institutions reflects a Equity is imputed at 5 percent of total assets based on treatment comparable to that of compensating balances the Federal Deposit Insurance Corporation's definition of held at correspondent banks by respondent institutions. a well-capitalized institution for deposit insurance pre- The reserve requirement imposed on respondent balances mium purposes. must be held as vault cash or as non-earning balances maintained at a Reserve Bank; thus, a portion of priced services clearing balances held with the Federal Reserve (4) REVENUE is shown as required reserves on the asset side of the Revenue represents charges to depository institutions for balance sheet. Another portion of the clearing balpriced services and is realized from each institution ances is used to finance short-term and long-term assets. through one of two methods: direct charges to an institu- The remainder of clearing balances is assumed to be tion's account or charges against its accumulated earninvested in a portfolio of investments, shown as imputed ings credits. investments. 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 $6.6 million in 2005 and cash items in process of collection (CIPC) stated on a $7.6 million in 2004. The net credit to expenses under basis comparable to that of a commercial bank. It reflects SFAS 87 (see note 2) that includes the nonqualified adjustments for intra-System items that would otherwise pension expense of $1.0 million in 2005 is reflected in be double-counted on a consolidated Federal Reserve operating expenses. balance sheet; adjustments for items associated with non- The income statement by service reflects revenue, priced items, such as those collected for government operating expenses, and imputed costs. Certain corporate agencies; and adjustments for items associated with overhead costs not closely related to any particular priced providing fixed availability or credit before items are service are allocated to priced services in total based on received and processed. Among the costs to be recovered an expense-ratio method, but are allocated among priced under the Monetary Control Act is the cost of float, or net services based on management decision. Corporate over- CIPC during the period (the difference between gross head was allocated among the priced services during CIPC and deferred-availability items, which is the portion 2005 and 2004 as follows (in millions): of gross CIPC that involves a financing cost), valued at the federal funds rate. 2005 2004 (2) LONG-TERM ASSETS Check 29.4 33.5 ACH 3.7 3.4 Consists of long-term assets used solely in priced ser- Fedwire funds 2.6 2.5 vices, the priced-services portion of long-term assets Fedwire securities 1.3 1.3 shared with nonpriced services, and an estimate of the Noncash services .1^ 1 assets of the Board of Governors used in the development of priced services. Effective Jan. 1, 1987, the Reserve Total 37.1 40.8 Banks implemented the Financial Accounting Standards Board's Statement of Financial Accounting Standards (6) IMPUTED COSTS No. 87, Employers'Accounting for Pensions (SFAS 87). Imputed costs consist of income taxes, return on equity, Accordingly, the Reserve Banks recognized a credit to interest on debt, sales taxes, the FDIC assessment, and expenses for the qualified pension plan of $1.3 million interest on float. Many imputed costs are derived from the in 2005 and a credit to expenses of $7.5 million in 2004 private-sector adjustment factor (PSAF) model, which with a corresponding increase in this asset account. uses bank holding companies as the proxy for a privatesector firm. The cost of debt and the effective tax rate (3) LIABILITIES AND EQUITY from the PSAF model are used to impute debt and income Under the matched-book capital structure for assets, taxes. The after-tax rate of return on equity is used to short-term assets are financed with short-term payables impute the profit that would have been earned had the and clearing balances. Long-term assets are financed with services been provided by a private-sector firm. long-term liabilities and clearing balances. As a result, Interest is imputed on the debt assumed necessary to no short- or long-term debt is imputed. Other short-term finance priced-service assets; however, no debt was liabilities include clearing balances maintained at Reserve imputed in 2005 or 2004. The sales taxes and FDIC Banks and deposit balances arising from float. Other assessment that the Federal Reserve would have paid had Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 131 it been a private-sector firm are also among the compo- balances; the increase is produced by a deduction for float nents of the PS AF. for cash items in process of collection, which reduces Interest on float is derived from the value of float to be imputed reserve requirements. The income on clearing recovered, either explicitly or through per-item fees, dur- balances reduces the float to be recovered through other ing the period. Float costs include costs for checks, book- means. As-of adjustments and direct charges refer to float entry securities, noncash collection, ACH, and funds that is created by interterritory check transportation and transfers. the observance of non-standard holidays by some deposi- Float cost or income is based on the actual float tory institutions. Such float may be recovered from the incurred for each priced service. Other imputed costs are depository institutions through adjustments to institution allocated among priced services according to the ratio of reserve or clearing balances or by billing institutions operating expenses less shipping expenses for each ser- directly. Float recovered through direct charges and pervice to the total expenses for all services less the total item fees is valued at the federal funds rate; credit float shipping expenses for all services. recovered through per-item fees has been subtracted from The following list shows the daily average recovery of the cost base subject to recovery in 2005. actual float by the Reserve Banks for 2005 in millions of dollars: (7) OTHER INCOME AND EXPENSES Consists of investment income on clearing balances and Total float 134.3 the cost of earnings credits. Investment income on clear- Unrecovered float 11.9 ing balances for 2004 and 2005 represents the average Float subject to recovery 122.5 coupon-equivalent yield on three-month Treasury bills plus a constant spread, based on the return on a portfolio Sources of recovery of float of investments. In both years, the return is applied to the Income on clearing balances 12.3 As-of adjustments -1.0 total clearing balance maintained, adjusted for the effect Direct charges 837.7 of reserve requirements on clearing balances. Expenses Per-item fees -728.4 for earnings credits granted to depository institutions on their clearing balances are derived by applying a dis- Unrecovered float includes float generated by services counted average coupon-equivalent yield on three-month to government agencies and by other central bank ser- Treasury bills to the required portion of the clearing vices. Float recovered through income on clearing bal- balances, adjusted for the net effect of reserve requireances is the result of the increase in investable clearing ments on clearing balances. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

133 The Board of Governors and the Government Performance and Results Act The Government Performance and formance plan, covering the period Results Act of 1993 (GPRA) requires 2004-05, was made public in August that federal agencies, in consultation 2004. The equivalent document for with Congress and outside stakeholders, 2006-07, in the form of a performance prepare a strategic plan covering a multi- budget, will be released in 2006. year period and submit an annual per- The most recent performance report, formance plan and performance report. covering the period 2002-03, was made Although the Federal Reserve is not public in August 2004. The report indicovered by the GPRA, the Board of cates that the Board generally met Governors voluntarily complies with the its goals for 2002-03. A performance spirit of the act. report covering 2004-05 will be released in 2006. These documents—the strategic and Strategic Plan, Performance performance plans and the performance Plan, and Performance Report report—are available on the Board's The Board's strategic plan in the GPRA web site, at www.federalreserve.gov/ format, which is prepared biennially and boarddocs/rptcongress. The Board's covers a four-year period, articulates the mission statement and a summary of the Board's mission, sets forth major goals Federal Reserve's goals and objectives, for the period, outlines strategies for as set forth in the most recently released achieving those goals, and discusses strategic and performance plans, are the environment and other factors that given below. could affect their achievement. It also addresses issues that cross agency juris- Mission dictional lines, identifies key quantitative measures of performance, and The mission of the Board is to foster the discusses performance evaluation. The stability, integrity, and efficiency of the most recent strategic plan, covering the nation's monetary, financial, and payperiod 2004-08, was made public in ment systems so as to promote optimal August 2004. (A strategic plan covering macroeconomic performance. the period 2006-09 is scheduled for release in late spring 2006.) Goals and Objectives The Board's performance plan, which is prepared biennially and covers a two- The Federal Reserve has six primary year period, sets forth specific targets goals with interrelated and mutually for some of the performance mea- reinforcing elements: sures identified in the strategic plan and describes the operational processes and Goal resources needed to meet those targets; it also discusses data validation and veri- To conduct monetary policy that profication of results. The most recent per- motes the achievement of maximum Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

134 92nd Annual Report, 2005 sustainable long-term growth and the financial holding companies, foreign price stability that fosters that goal banking organizations, and related entities. At the same time, remain sensitive to the burden on supervised Objectives institutions. • Stay abreast of recent developments • Provide a dynamic work environment and prospects in the U.S. economy that is challenging and rewarding. and financial markets, and in those Enhance efficiency and effectiveness, abroad, so that monetary policy deci- while remaining sensitive to the sions will be well informed. burden on supervised institutions, by • Enhance our knowledge of the struc- addressing the supervision function's tural and behavioral relationships in procedures, technology, resource allothe macroeconomic and financial cation, and staffing issues. markets, and improve the quality of • Promote compliance by domestic and the data used to gauge economic foreign banking organizations superperformance, through developmental vised by the Federal Reserve with research activities. applicable laws, rules, regulations, • Implement monetary policy effec- policies, and guidelines through a tively in rapidly changing economic comprehensive and effective supervicircumstances and in an evolving sion program. financial market structure. • Contribute to the development of U.S. international policies and procedures, Goal in cooperation with the U.S. Depart- To effectively implement federal laws ment of the Treasury and other designed to inform and protect the conagencies. sumer, to encourage community devel- • Promote understanding of Federal opment, and to promote access to bank- Reserve policy among other governing services in historically underserved ment policy officials and the general markets public. Objectives • Take a leadership role in shaping the Goal national dialogue on consumer protec- To promote a safe, sound, competitive, tion in financial services, addressing and accessible banking system and the rapidly emerging issues that affect stable financial markets today's consumers, strengthening consumer compliance supervision programs when required, and remaining Objectives sensitive to the burden on supervised • Promote overall financial stability, institutions. manage and contain systemic risk, and • Promote, develop, and strengthen identify emerging financial problems effective communications and colearly so that crises can be averted. laborations within the Board, the Fed- • Provide a safe, sound, competitive, eral Reserve Banks, and other agenand accessible banking system cies and organizations. through comprehensive and effective • Increase public understanding of consupervision of U.S. banks, bank and sumer protection and community Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Government Performance and Results Act 135 development and the Board's role in Objective these areas through increased outreach • Produce high-quality assessments and and by developing programs that oversight of Federal Reserve System address the information needs of constrategies, projects, and operations, sumers and the financial services including adoption of technology to industry. the business and operational needs of • Develop a staff that is highly skilled, the Federal Reserve. The oversight professional, innovative, and diverse, process and outputs should help Fedproviding career development opporeral Reserve management foster and tunities to ensure the retention of strengthen sound internal control syshighly productive staff and recruittems, efficient and reliable operations, ing highly qualified and skilled effective performance, and sound projemployees. ect management and should assist the • Promote an efficient and effective Board in the effective discharge of its work environment by aligning busioversight responsibilities. ness functions with appropriate work processes and implementing solutions for work products and processes Goal that can be handled more efficiently through automation. To foster the integrity, efficiency, and effectiveness of Board programs Goal Objectives To foster the integrity, efficiency, and accessibility of U.S. payment and settle- • Oversee a planning and budget proment systems cess that clearly identifies the Board's mission, results in concise plans for the effective accomplishment of Objectives operations, transmits to the staff the • Develop sound, effective policies and information needed to attain objecregulations that foster payment sys- tives efficiently, and allows the public tem integrity, efficiency, and accessi- to measure our accomplishments. bility. Support and assist the Board • Develop appropriate policies, overin overseeing U.S. dollar payment sight mechanisms, and measurement and securities settlement systems criteria to ensure that the recruiting, by assessing their risks and risk- training, and retention of staff meet management approaches against rele- Board needs. vant policy objectives and standards. • Establish, encourage, and enforce a • Conduct research and analysis that climate of fair and equitable treatment contributes to policy development and for all employees regardless of race, increases the Board's and others' creed, color, national origin, age, or understanding of payment system sex. dynamics and risk. • Provide financial management support needed for sound business decisions. Goal • Provide cost-effective and secure To provide high-quality professional information resource management seroversight of Reserve Banks vices to Board divisions, support divi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

136 92nd Annual Report, 2005 sional distributed-processing require- • Efficiently provide safe, modern, and ments, and provide analysis on secure facilities and necessary support information technology issues to the for activities conducive to efficient Board, Reserve Banks, other financial and effective Board operations. • regulatory institutions, and central banks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

137 Federal Legislative Developments Bankruptcy Abuse Prevention ting across economically similar transand Consumer Protection Act actions that are the subject of recurring of 2005 dealings in swap agreements. In addition, the Bankruptcy Act of On April 20, 2005, President Bush 2005 clarifies that the FDI Act and signed the Bankruptcy Abuse Preventhe FCUA expressly protect rights under tion and Consumer Protection Act of securities agreements, arrangements, or 2005 (Bankruptcy Act of 2005). Title IX other credit enhancements related to of the act contains provisions designed qualified financial contracts (QFCs). to reduce systemic risk in the banking The act also clarifies that no provision system and the financial markets when of federal or state law relating to the parties to certain types of financial transavoidance of preferential or fraudulent actions become bankrupt or insolvent, transfers may be invoked to avoid a by allowing expeditious termination or transfer made in connection with any netting of certain types of financial QFC of an insured depository institutransactions. In addition, the Bankruptcy tion in conservatorship or receivership, Act of 2005 makes several important absent actual fraudulent intent on the amendments to the Truth in Lending part of the transferee. Act. Cross-Product Netting Financial Contract Provisions The Bankruptcy Act of 2005 also promotes cross-product netting through Treatment of Swaps and QFCs master agreements for QFCs. The act The Bankruptcy Act of 2005 amends the specifies that under the FDI Act and the definitions of several terms that appear FCUA, a master agreement for one or in the Federal Deposit Insurance Act more securities contracts, commodity (FDI Act) and the Federal Credit Union contracts, forward contracts, repurchase Act (FCUA) to make them consistent agreements, or swap agreements is to with the definitions in the Bankruptcy be treated as a single QFC, but only Code and to reflect the enactment of the with respect to the underlying agree- Commodity Futures Modernization Act ments that are themselves QFCs. This of 2000 (CFMA). Of particular impor- provision ensures that cross-product tance, the act updates the definition of netting pursuant to a master agreement, "swap agreement" to include types of or pursuant to an umbrella agreement transactions that have recently entered for separate master agreements between the market. Under the FDI Act, the the same parties, will be enforceable FCUA, and the Bankruptcy Code, swap under the FDI Act and the FCUA. agreements are eligible for termination, Cross-product netting permits the netliquidation, acceleration, offset, and net- ting of a wide variety of financial ting. The amended definition includes transactions between two participants, combinations of the listed agreements or thereby maximizing the present and transactions and permits contractual net- potential future risk-reducing benefits Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

138 92nd Annual Report, 2005 of the netting arrangement between the are also expressly included in the definiparties. tion and may take advantage of these The Bankruptcy Act of 2005 simi- expanded protections. This amendment larly promotes cross-product netting is intended to further the goal of promotthrough amendments to the Bankruptcy ing the clearing of derivatives and other Code. The act adds definitions for "mas- transactions as a way of reducing syster netting agreement" and "master net- temic risk. The act also makes several ting agreement participant" to the Bank- amendments to the Bankruptcy Code to ruptcy Code in order to protect the reflect current market practice and to termination and close-out netting provi- conform certain definitions to the FDI sions of cross-product master agree- Act. ments between parties. These agreements may be used (1) to document FD1CIA Netting Protections a wide variety of securities contracts, commodity contracts, forward contracts, The Bankruptcy Act of 2005 also repurchase agreements, and swap agree- extends the protections afforded to ments or (2) as umbrella agreements for netting arrangements by the Federal separate master agreements between Deposit Insurance Corporation Improvethe same parties, each of which is used ment Act of 1991 (FDICIA). FDICIA to document a discrete type of transac- provides that a netting arrangement will tion. The act also adds a new section 561 be enforced pursuant to its terms, notto the Bankruptcy Code designed to withstanding the failure of a party to the expressly protect the contractual rights agreement. The act extended FDICIA's of a master netting agreement par- protections of netting arrangements to ticipant to enforce any rights of termination, liquidation, acceleration, off- • multilateral clearing organizations, set, or netting under a master netting agreement. • uninsured national and state member banks, "Financial Participants" under the • foreign banks and their branches and Bankruptcy Code agencies, The Bankruptcy Act of 2005 adds a new definition for "financial participant" • netting arrangements governed by the and allows such market participants laws of a foreign country, and to close out and net agreements with insolvent entities under the Bankruptcy • netting arrangements between clear- Code. These changes are designed to ing organizations. limit the potential effect of insolvencies on major market participants. "Finan- Authority of FDIC and NCUAB cial participant" is defined by the act to include entities having contracts of a The Bankruptcy Act of 2005 provides total gross dollar value of not less than that no provision of law may be con- $1 billion in notional or actual princi- strued to limit the power of the FDIC pal amount outstanding or having gross or the National Credit Union Adminismark-to-market positions of not less tration Board (NCUAB) to transfer, or than $100 million (aggregated across to disaffirm or repudiate, any QFC in counterparties). Clearing organizations accordance with its powers under the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Legislative Developments 139 FDI Act or the FCUA, respectively. authority. The act requires that a conser- Moreover, the act denies enforcement of vator or receiver must either disaffirm "walkaway" clauses in QFCs. The act or repudiate all QFCs between the defines a walkaway clause as a provi- depository institution in default and a sion that, after calculation of the value particular counterparty or disaffirm of a party's position or an amount due or repudiate none of such QFCs. This to or from one of the parties upon ter- requirement limits the ability of the mination, liquidation, or acceleration FDIC and the NCUAB to "cherry pick" of the QFC, either (1) does not create the QFCs between a depository institua payment obligation for the party or tion in default and a particular counter- (2) extinguishes a payment obligation party. The amendment is consistent with of the party in whole or in part solely the FDIC's policy not to repudiate or because of the party's status as a non- disaffirm QFCs selectively. The unified defaulting party. treatment is fundamental to the reduc- The Bankruptcy Act of 2005 also tion of systemic risk. amends the FDIA and the FCUA to The Bankruptcy Act of 2005 also limexpand the receivership authority of the its the enforcement of rights of termi- FDIC and the NCUAB, respectively, to nation, liquidation, or netting that arise permit transfers of QFCs to "financial solely because of the insolvency of a institutions." The amendment allows depository institution or that are based the FDIC and the NCUAB, when acting on the "financial condition" of the instias receiver for an insolvent depository tution in receivership or conservatorinstitution, to transfer QFCs to a non- ship. However, any payment, delivery, depository financial institution, provided or other performance-based default, or a the transferee institution is not subject breach of a representation or covenant to bankruptcy or insolvency proceed- putting in question the enforceability of ings. In transferring QFCs, the receiver the agreement, will not be deemed to be may not split the QFCs and related inter- based solely on the financial condition ests between the depository institution of the institution. The amendment does in default and a particular counterparty; not prevent counterparties from taking rather, either the receiver must transfer all actions permitted and recovering all all such QFCs to a single person or it damages authorized upon repudiation of may not transfer any of the QFCs for any QFC by a conservator or receiver. that particular counterparty. The act's The Bankruptcy Act of 2005's amendments also permit transfers to an amendments also permit the FDIC and eligible financial institution that is a the NCUAB to transfer QFCs of a failed non-U.S. person, or the branch or agency depository institution to a bridge bank of a non-U.S. person, or a U.S. financial or a depository institution organized by institution that is not an FDIC-insured the FDIC or NCUAB for which a coninstitution if, following the transfer, the servator is appointed either (1) immedicontractual rights of the parties would ately upon the organization of such instibe enforceable substantially to the same tution or (2) at the time of a purchase extent as under the FDI Act and the and assumption transaction between FCUA. The act similarly limits the dis- the FDIC or NCUAB and the institution. afrirmance and repudiation authorities These institutions are not to be considof the FDIC and NCUAB with respect ered financial institutions that are inelito QFCs so as to make those authorities gible to receive transfers of QFCs under consistent with the agencies' transfer the FDI Act. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

140 92nd Annual Report, 2005 TILA Amendments the Board to develop a "table" that creditors may use in responding to con- The Bankruptcy Act of 2005 also sumers. The Board and the FTC must includes several provisions that amend establish their own toll-free telephone the Truth in Lending Act (TILA). These numbers for use by customers of small provisions deal principally with open- banks and non-depository institution end (revolving) credit accounts and creditors, respectively.1 require new disclosures on periodic statements and on credit card applica- Introductory Rate Offers tions and solicitations. The Board is required to issue regulations implement- Credit card issuers that offer discounted ing most of the new provisions, and introductory interest rates are required, the new provisions generally will not under the Bankruptcy Act of 2005, to become effective until twelve months disclose clearly and conspicuously on after the regulations are finalized. the application or solicitation for the credit card the expiration date of the offer, the rate that will apply after that Minimum-Payment Warnings date, and an explanation of how the The Bankruptcy Act of 2005 requires introductory rate could be lost (for creditors to provide, on each periodic example, by making a late payment). statement for open-end credit, a clear and conspicuous disclosure that mak- Internet Solicitations ing only the minimum payment will increase the interest the consumer pays The act requires that credit card offers and the time it takes to repay the bal- on the Internet must include the same ance. The statute also requires that the disclosure table—commonly known disclosure include as the "Schumer box"—that now is required to be included in applications • a hypothetical example of how long it or solicitations for credit cards that are would take to pay off a specified bal- sent by direct mail. ance with a 17 percent annual percentage rate and Late Fees For open-end credit, the Bankruptcy Act • a toll-free telephone number that conof 2005 requires creditors to disclose, on sumers can call to obtain an estimate each periodic statement, the earliest date of how long it will take to pay off on which a late payment fee may be their own balance if only minimum charged, as well as the amount of the payments are made. fee. The Bankruptcy Act of 2005 contains an exemption from these disclosure requirements for a creditor that maintains a toll-free telephone number for the purpose of providing customers with the actual number of months that it will 1. The Board is required to operate its tolltake to repay the customer's outstanding free telephone number for two years, while the balance. To standardize the information FTC must operate its toll-free telephone number provided to consumers, the act directs indefinitely. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Legislative Developments 141 High Loan-to-Value who acts as the senior examiner of a Mortgage Credit particular bank holding company or savings and loan holding company; in For home-secured credit that may these circumstances, the post-employment exceed the home's fair market value, the restrictions apply to relationships with act requires creditors to disclose in the the bank holding company or savings application and in advertisements that and loan holding company and any the interest on the portion of the loan depository institution subsidiary of the that exceeds the home's fair market holding company. These post-employment value is not tax deductible. restrictions are in addition to any other conflict of interest and ethics rules and Account Termination restrictions that may apply to examiners under applicable federal law or the inter- Creditors are prohibited under the Banknal codes of conduct established by the ruptcy Act of 2005 from terminating an agency or Reserve Bank. open-end credit account before its expi- Under the statute, an officer or ration date solely because the consumer employee of an agency or a Reserve has not incurred finance charges on the Bank is considered to be the "senior account. examiner" of a particular depository institution or depository institution hold- Post-Employment Restrictions ing company only if the examiner has on Senior Examiners "continuing, broad responsibility" for the examination or inspection of that In December 2004, Congress imposed a depository institution or holding comnew federal post-employment restriction pany. In addition, to be subject to these applicable to senior examiners of the new post-employment restrictions, the federal banking agencies, as part of officer or employee must have served the Intelligence Reform Act.2 Under as the senior examiner for the relevant this provision, an officer or employee institution or holding company for two of a federal banking agency or a Federal or more months during the final twelve Reserve Bank who acts as the "senior months of his or her employment with examiner" for a particular depository the agency or Reserve Bank. If a senior institution may not, within one year examiner violates the one-year postafter terminating employment with the employment restrictions, the appropriagency or Reserve Bank, knowingly ate agency must initiate proceedings to accept compensation as an officer, direcimpose an order of removal and prohibitor, employee, or consultant from that tion or a civil money penalty on the depository institution or any company former senior examiner, and may seek (including a bank holding company) both remedies. that controls the depository institution. In November 2005, the Board and the A similar post-employment restriction other federal banking agencies jointly is imposed on an officer or employee adopted rules implementing these new post-employment restrictions. See 70 FR 2. Codified at section 10(k) of the FDI Act. 69,633 (November 17, 2005). 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

145 Record of Policy Actions of the Board of Governors Regulation D error resolutions, and disclosures at Reserve Requirements of ATMs. The amendments are effective Depository Institutions February 9, 2006, and compliance is mandatory by January 1, 2007. [Docket No. R-1236] In addition, the Board approved an On October 4, 2005, the Board approved interim final rule with request for comamendments to reflect the annual index- ment that applies the regulation to paying of the low reserve tranche and of roll card accounts established to distribthe reserve requirement exemption for ute employee salaries, wages, or other use in 2006 reserve requirement calcu- compensation on a recurring basis. lations. The amendments increase the The interim final rule is effective July 1, 3 percent low reserve tranche for net 2007. transaction accounts to $48.3 million (from $47.6 million in 2005) and the Votes for these actions: Chairman Greenspan, Vice Chairman Ferguson, and Govreserve requirement exemption to ernors Bies, Olson, and Kohn. $7.8 million (from $7 million in 2005). Votes for this action: Chairman Green- Regulation H span, Vice Chairman Ferguson, and Gov- Membership of ernors Bies, Olson, and Kohn. State Banking Institutions in the Federal Reserve System Regulation E Electronic Fund Transfers Regulation Y [Docket Nos. R-1210, R-1234, Bank Holding Companies and and R-1247] Change in Bank Control On December 30, 2005, the Board [Docket No. R-1193] approved amendments to clarify the On February 28, 2005, the Board responsibilities of parties in transactions approved amendments to the risk-based involving electronic check conversion capital standards for bank holding comand to require that consumers receive panies to allow the continued inclusion written notification in advance of these of trust preferred securities in tier 1 capitransactions. The Board also revised the tal, under stricter quantitative limits regulation's official staff commentary and qualitative standards. The amendto provide guidance on preauthorized ments also revise (1) quantitative limits transfers from consumers' accounts, for the aggregate amount of trust preferred securities and other restricted core capital elements included in tier 1 capi- NOTE: Full texts of the policy actions are availtal and (2) qualitative standards for capiable via the "Reading Rooms" on the Board's tal instruments included in regulatory FOIA web page and on request from the Board's Freedom of Information Office. capital. The amendments are effective Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

146 92nd Annual Report, 2005 April 11, 2005, with a transition period ated by a seller or creditor with the for the new quantitative limits ending account holder's authorization but with- March 31, 2009. out the account holder's handwritten signature on the check. Such checks are Votes for this action: Chairman Green- typically used to purchase goods or span, Vice Chairman Ferguson, and Govpay bills by telephone. The Board also ernors Gramlich, Bies, Olson, Bernanke, approved amendments shifting liabiland Kohn. ity for unauthorized remotely created checks from the paying bank to the [Docket No. OP-1155] depositary bank (in most cases the bank On March 21, 2005, the Board, acting for the seller or creditor that created and with the other federal banking and thrift deposited the check). The amendments regulatory agencies, approved the Inter- are effective July 1, 2006. agency Guidance on Response Programs Votes for this action: Chairman Greenfor Unauthorized Access to Customer span, Vice Chairman Ferguson, and Gov- Information and for Customer Notice. ernors Bies and Olson. Absent and not The guidance, which builds on the Inter- voting: Governor Kohn. agency Guidelines Establishing Information Security Standards, provides that financial institutions should imple- Regulation V ment a response program for security Fair Credit Reporting breaches involving customer information. As part of their response program, Regulation FF institutions should notify their custom- Obtaining and ers when they determine that misuse of Using Medical Information customer information has occurred or in Connection with Credit is reasonably possible. The guidance is [Docket No. R-1188] effective March 29, 2005. On November 14, 2005, the Board, act- Votes for this action: Chairman Green- ing with the other federal bank, thrift, span, Vice Chairman Ferguson, and Gov- and credit union regulatory agencies, ernors Gramlich, Bies, Olson, Bernanke, approved interagency rules implementand Kohn. ing restrictions in the Fair and Accurate Credit Transactions Act on creditors' Regulation J use and sharing of medical information. Collection of Checks The rules permit creditors (1) to obtain and Other Items by and use consumers' medical informa- Federal Reserve Banks and tion in connection with credit determi- Funds Transfers through Fedwire nations when necessary and appropriate for legitimate purposes, consistent with Regulation CC congressional intent to restrict the use of Availability of Funds and such information for inappropriate pur- Collection of Checks poses, and (2) to share medical information among affiliates under limited [Docket No. R-1226] circumstances without becoming credit On November 21, 2005, the Board reporting agencies. The amendments, approved amendments defining "re- which are substantially similar to motely created checks"—checks cre- interim final rules published by the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 147 agencies on June 10, 2005, are effective expand the definition of "community April 1, 2006. development" to include bank activities in underserved or distressed middle- Votes for this action: Chairman Green- income rural areas as well as in desigspan, Vice Chairman Ferguson, and Govnated disaster areas. Finally, they clarify ernors Bies, Olson, and Kohn. the effect of illegal credit practices on a bank's CRA performance rating. The amendments, which are identical to Regulation BB amendments to their regulations adopted Community Reinvestment by the Office of the Comptroller of the [Docket No. R-1205] Currency and the Federal Deposit Insurance Corporation, are effective Septem- On March 2, 2005, the Board, acting ber 1,2005. with the other federal bank and thrift regulatory agencies, approved inter- Votes for this action: Chairman Greenagency amendments to conform with span, Vice Chairman Ferguson, and Govchanges by the Office of Management ernors Gramlich, Bies, Olson, and Kohn. and Budget in the standards for defining metropolitan and micropolitan statistical areas, by the U.S. Bureau of the Census in designating census tracts, and by the Regulation DD Board in Regulation C (Home Mortgage Truth in Savings Disclosure). The amendments, which [Docket No. R-1197] are identical to the interim final rules published by the agencies on July 8, On May 19, 2005, the Board approved 2004, are effective March 28, 2005. amendments to the regulation and its official staff commentary to improve Votes for this action: Chairman Green- the uniformity and adequacy of informaspan, Vice Chairman Ferguson, and Gov- tion provided to consumers when they ernors Gramlich, Bies, Olson, Bernanke, overdraw their deposit accounts. The and Kohn. amendments, in part, address a specific service, commonly referred to as [Docket No. R-1225] "bounced-check protection" or "courtesy overdraft protection," that pays On July 18, 2005, the Board approved checks and allows other transactions in amendments under the Community accounts that have insufficient funds. Reinvestment Act (CRA) to reduce They also (1) expand the regulation's regulatory burden on intermediate small prohibition against misleading adverbanks (banks with assets between tisements, to address concerns about $250 million and $1 billion) and to more the marketing of this service, and effectively encourage bank investment (2) require additional disclosures about in community development. The amend- fees and other terms for overdraft serments exempt intermediate small banks vices in such materials as advertisefrom certain data collection and report- ments and periodic account statements. ing requirements and provide for the The amendments are effective July 1, evaluation of those banks' CRA perfor- 2006. mance under the small-bank lending test and a new, flexible community devel- Votes for this action: Chairman Greenopment test. The amendments also span, Vice Chairman Ferguson, and Gov- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

148 92nd Annual Report, 2005 ernors Gramlich, Bies, Olson, Bernanke, Policy Statements and and Kohn. Other Actions Overdraft Protection Programs [Docket No. OP-1198] Post-Employment Restrictions for Senior Examiners On February 17, 2005, the Board, act- [Docket No. R-1230] ing with the other federal bank and credit union regulatory agencies, ap- On November 10, 2005, the Board, act- proved joint guidance on overdraft proing with the other federal bank and tection programs to help depository thrift regulatory agencies, approved institutions in the disclosure and adminnew interagency rules implementing istration of their overdraft-protection post-employment restrictions on certain services. senior examiners contained in the Intelligence Reform and Terrorism Preven- Votes for this action: Chairman Greention Act. The rules provide that a senior span and Governors Gramlich, Bies, Olson, Bernanke, and Kohn. Absent and examiner employed by one of the agennot voting: Vice Chairman Ferguson. cies or a Federal Reserve Bank may not knowingly accept compensation, as an employee, officer, director, or con- Reserve Bank Withdrawal from sultant, from a depository institution or Noncash Collection Service holding company that he or she exam- [Docket No. OP-1214] ined, or from certain related entities, for On February 28, 2005, the Board one year after leaving the employment approved the withdrawal of the Federal of the agency or Reserve Bank. The Reserve Banks from the noncash collecrules are effective December 17, 2005. tion service, which involves collecting Votes for this action: Chairman Green- and processing definitive municipal span, Vice Chairman Ferguson, and Gov- securities issued by state and local governors Bies, Olson, and Kohn. ernments. The service was terminated in light of declining volume, expected under-recovery of costs in future years, and the availability of alternative ser- Rules Regarding Equal vice providers and substitutable ser- Opportunity vices. Withdrawal is effective Decem- [Docket No. OP-1239] ber 30, 2005; items will be accepted for deposit until September 30. On November 2, 2005, the Board approved an interim final rule with Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Govrequest for comment to clarify the limiernors Gramlich, Bies, Olson, Bernanke, tations on access to sensitive informaand Kohn. tion by employees who are not U.S. citizens. The interim final rule is effec- Information Security Standards tive November 8, 2005. [Interagency Compliance Guide] Votes for this action: Chairman Greenpan, Vice Chairman Ferguson, and Gover- On November 29, 2005, the Board, actnors Bies, Olson, and Kohn. ing with the other federal bank and thrift Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 149 regulatory agencies, approved publi- 4VA percent and related economic and cation of a Small-Entity Compliance financial developments. The U.S. econ- Guide to help financial institutions com- omy delivered a solid performance in ply with the Interagency Guidelines 2005 despite a further sharp increase Establishing Information Security Stan- in energy prices and devastating hurridards. The guide summarizes in plain canes. The increase in GDP in 2005 was language the obligations of financial sufficient to further reduce slack in labor institutions to protect customer informa- and product markets. Core consumer tion and illustrates how certain provi- price inflation picked up early in the sions of the interagency security guide- year, but it subsequently eased and lines apply in specific situations. totaled less than 2 percent over the year as a whole. In light of these condi- Votes for this action: Chairman Green- tions, the Board and FOMC raised the span, Vice Chairman Ferguson, and Govstructure of policy rates at a measured ernors Bies, Olson, and Kohn. pace. Monetary policy developments are reviewed more fully in other parts of Discount Rates in 2005 this report (see the section "Monetary Policy and Economic Developments" Under the Federal Reserve Act, the and the minutes of FOMC meetings held boards of directors of the Federal in 2005). Reserve Banks must establish rates on loans to depository institutions at least every fourteen days, subject to review Secondary and and determination by the Board of Seasonal Credit Rates Governors. Secondary credit is available in appropriate circumstances to depository institutions that do not qualify for pri- Primary Credit Rate mary credit. The secondary credit rate Primary credit is the Federal Reserve's is set at a spread above the primary main lending program. Primary credit is credit rate. In 2005, the spread was set at made available with minimal adminis- 50 basis points. tration for very short terms as a backup Seasonal credit is available to smaller source of liquidity to depository institu- depository institutions to meet liquidity tions that, in the judgment of the lend- needs that arise from regular swings in ing Federal Reserve Bank, are in gener- their loans and deposits. The rate on ally sound financial condition. Primary seasonal credit is calculated every two credit is extended at a rate above the weeks as an average of selected moneyfederal funds rate target set by the Fed- market yields, typically resulting in a eral Open Market Committee (FOMC). rate close to the federal funds rate target. During 2005, the Board approved At year-end, the secondary and seaeight increases in the primary credit sonal credit rates were 53A percent and rate, bringing the rate from 3x/4 percent 4.35 percent, respectively. to 5lA percent. The Board reached its determinations on the primary credit rate Votes on Discount Rate Changes recommendations of the Reserve Bank boards of directors in conjunction with About every two weeks during 2005, the the FOMC's decisions to raise the target Board approved proposals by the twelve federal funds rate from 2lA percent to Reserve Banks to maintain the formulas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

150 92nd Annual Report, 2005 for computing the secondary and sea- directors of the Federal Reserve Banks sonal credit rates. Details on the eight of Boston, New York, Philadelphia, actions by the Board to approve changes Cleveland, Richmond, Atlanta, Chicago, in the primary credit rate are provided Minneapolis, Kansas City, Dallas, and below. San Francisco to raise the rate on discounts and advances under the primary February 2, 2005. Effective this date, credit program by lA percentage point, the Board approved actions taken by the to 4 percent. The same increase was directors of the Federal Reserve Banks approved for the Federal Reserve Bank of Boston, New York, Philadelphia, of St. Louis, effective May 4, 2005. Cleveland, Richmond, Atlanta, Chicago, Votes for this action: Chairman Green- Minneapolis, Kansas City, Dallas, and span, Vice Chairman Ferguson, and Gov- San Francisco to raise the rate on disernors Gramlich, Bies, Olson, and Kohn. counts and advances under the primary Votes against this action: None. credit program by lA percentage point, to 3V2 percent. The same increase was June 30, 2005. Effective this date, the approved for the Federal Reserve Bank Board approved actions taken by the of St. Louis, effective February 3, 2005. directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Votes for this action: Chairman Green- Cleveland, Richmond, Atlanta, Chicago, span, Vice Chairman Ferguson, and Governors Gramlich, Bies, Olson, Bernanke, Minneapolis, Kansas City, Dallas, and and Kohn. Votes against this action: None. San Francisco to raise the rate on discounts and advances under the primary March 22, 2005. Effective this date, the credit program by lA percentage point, Board approved actions taken by the to AlA percent. The same increase was directors of the Federal Reserve Banks approved for the Federal Reserve Bank of Boston, New York, Philadelphia, of St. Louis, effective July 1, 2005. Cleveland, Richmond, Atlanta, Chicago, Votes for this action: Chairman Green- Minneapolis, and San Francisco to raise span, Vice Chairman Ferguson, and Govthe rate on discounts and advances under ernors Gramlich, Bies, Olson, and Kohn. the primary credit program by lA per- Votes against this action: None. centage point, to 33A percent. The same increase was approved for the Fed- August 9, 2005. Effective this date, the eral Reserve Bank of St. Louis, effec- Board approved actions taken by the tive March 23, 2005. The Board also directors of the Federal Reserve Banks approved identical actions subsequently of Boston, New York, Philadelphia, taken by the directors of the Federal Cleveland, Richmond, Atlanta, Chicago, Reserve Banks of Kansas City, effective Minneapolis, Kansas City, Dallas, and March 23, 2005, and Dallas, effective San Francisco to raise the rate on dis- March 24, 2005. counts and advances under the primary credit program by lA percentage point, Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- to AVi percent. The same increase was ernors Gramlich, Bies, Olson, Bernanke, approved for the Federal Reserve Bank and Kohn. Votes against this action: None. of St. Louis, effective August 10, 2005. May 3, 2005. Effective this date, the Votes for this action: Chairman Green- Board approved actions taken by the 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 Bies, Olson, and Kohn. Votes counts and advances under the primary against this action: None. credit program by lA percentage point, to 5 percent. The same increase was September 20, 2005. Effective this date, approved for the Federal Reserve Bank the Board approved actions taken by the of St. Louis, effective November 2, directors of the Federal Reserve Banks 2005. of Boston, New York, Philadelphia, Richmond, Chicago, Minneapolis, Kan- Votes for this action: Chairman Greensas City, and San Francisco to raise span, Vice Chairman Ferguson, and Govthe rate on discounts and advances under ernors Bies, Olson, and Kohn. Votes the primary credit program by lA per- against this action: None. centage point, to 43/4 percent. The Board December 13, 2005. Effective this date, also approved identical actions subsethe Board approved actions taken by the quently taken by the directors of the directors of the Federal Reserve Banks Federal Reserve Banks of St. Louis, of Boston, New York, Philadelphia, effective September 21, 2005, and Cleveland, Richmond, Atlanta, Chicago, Cleveland, Atlanta, and Dallas, effective Minneapolis, Kansas City, Dallas, and September 22, 2005. San Francisco to raise the rate on discounts and advances under the primary Votes for this action: Chairman Greenspan, Vice Chairman Ferguson, and Gov- credit program by lA percentage point, ernors Bies, Olson, and Kohn. Votes to 5lA percent. The same increase was against this action: None. approved for the Federal Reserve Bank of St. Louis, effective December 14, November 1, 2005. Effective this date, 2005. the Board approved actions taken by the directors of the Federal Reserve Banks Votes for this action: Chairman Greenof Boston, New York, Philadelphia, span, Vice Chairman Ferguson, and Gov- Cleveland, Richmond, Atlanta, Chicago, ernors Bies, Olson, and Kohn. Votes against this action: None. • Minneapolis, Kansas City, Dallas, and San Francisco to raise the rate on dis- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

153 Minutes of Federal Open Market Committee Meetings The policy actions of the Federal Open Open Market Account. In the area of Market Committee, contained in the domestic open market operations, the minutes of its meetings, are presented in Federal Reserve Bank of New York the Annual Report of the Board of Gov- operates under instructions from the ernors pursuant to the requirements of Federal Open Market Committee that section 10 of the Federal Reserve Act. take the form of an Authorization for That section provides that the Board Domestic Open Market Operations and shall keep a complete record of the a Domestic Policy Directive. (A new actions taken by the Board and by the Domestic Policy Directive is adopted at Federal Open Market Committee on all each regularly scheduled meeting.) In questions of policy relating to open mar- the foreign currency area, the Federal ket operations, that it shall record Reserve Bank of New York operates therein the votes taken in connection under an Authorization for Foreign Curwith the determination of open market rency Operations, a Foreign Currency policies and the reasons underlying each Directive, and Procedural Instructions policy action, and that it shall include with Respect to Foreign Currency in its annual report to Congress a full Operations. These policy instruments account of such actions. are shown below in the form in which The minutes of the meetings contain they were in effect at the beginning of the votes on the policy decisions made 2005. Changes in the instruments during at those meetings as well as a summary the year are reported in the minutes for of the information and discussions that the individual meetings. led to the decisions. The descriptions of economic and financial conditions are Authorization for Domestic based solely on the information that was Open Market Operations available to the Committee at the time of the meetings. In Effect January 1, 2005 Members of the Committee voting for a particular action may differ among 1. The Federal Open Market Committee themselves as to the reasons for their authorizes and directs the Federal Reserve votes; in such cases, the range of their Bank of New York, to the extent necesviews is noted in the minutes. When sary to carry out the most recent domestic policy directive adopted at a meeting of the members dissent from a decision, they Committee: are identified in the minutes and a summary of the reasons for their dissent is (a) To buy or sell U.S. Government provided. securities, including securities of the Federal Policy directives of the Federal Open Financing Bank, and securities that are direct obligations of, or fully guaranteed as to Market Committee are issued to the principal and interest by, any agency of the Federal Reserve Bank of New York as United States in the open market, from or to the Bank selected by the Committee to securities dealers and foreign and interexecute transactions for the System national accounts maintained at the Federal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

154 92nd Annual Report, 2005 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 and accounts maintained at the Federal est by, any agency of the United States, from Reserve Bank of New York as fiscal agent dealers for the account of the Federal of the United States pursuant to Section 15 Reserve Bank of New York under agree- of the Federal Reserve Act, the Federal Open ments for repurchase of such securities or Market Committee authorizes and directs the obligations in 65 business days or less, at Federal Reserve Bank of New York (a) for rates that, unless otherwise expressly autho- System Open Market Account, to sell U.S. rized by the Committee, shall be determined Government securities to such accounts on by competitive bidding, after applying rea- the bases set forth in paragraph l(a) under sonable limitations on the volume of agree- agreements providing for the resale by such ments with individual dealers; provided that accounts of those securities within 65 busiin the event Government securities or agency ness days or less on terms comparable to issues covered by any such agreement are those available on such transactions in the not repurchased by the dealer pursuant to the market; and (b) for New York Bank account, agreement or a renewal thereof, they shall be when appropriate, to undertake with dealers, sold in the market or transferred to the Sys- subject to the conditions imposed on purtem Open Market Account; chases and sales of securities in paragraph l(b), repurchase agreements in U.S. (c) To sell U.S. Government securities Government and agency securities, and to and obligations that are direct obligations of, arrange corresponding sale and repurchase or fully guaranteed as to principal and inter- agreements between its own account and est by, any agency of the United States to foreign and international accounts maindealers for System Open Market Account tained at the Bank. Transactions undertaken under agreements for the resale by dealers of with such accounts under the provisions of such securities or obligations in 65 business this paragraph may provide for a service fee days or less, at rates that, unless otherwise when appropriate. expressly authorized by the Committee, shall be determined by competitive bidding, after 4. In the execution of the Committee's deciapplying reasonable limitations on the vol- sion regarding policy during any intermeetume of agreements with individual dealers. ing period, the Committee authorizes and directs the Federal Reserve Bank of 2. In order to ensure the effective conduct New York, upon the instruction of the Chairof open market operations, the Federal Open man of the Committee, to adjust somewhat Market Committee authorizes the Federal in exceptional circumstances the degree of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings 155 pressure on reserve positions and hence the ments, and with other international financial intended federal funds rate. Any such adjust- institutions: ment shall be made in the context of the Canadian dollars Mexican pesos Committee's discussion and decision at its Danish kroner Norwegian kroner most recent meeting and the Committee's Euro Swedish kronor Pounds sterling Swiss francs long-run objectives for price stability and Japanese yen sustainable economic growth, and shall be based on economic, financial, and mone- B. To hold balances of, and to have tary developments during the intermeeting outstanding forward contracts to receive or period. Consistent with Committee prac- to deliver, the foreign currencies listed in tice, the Chairman, if feasible, will consult paragraph A above. with the Committee before making any C. To draw foreign currencies and to adjustment. permit foreign banks to draw dollars under the reciprocal currency arrangements listed in paragraph 2 below, provided that draw- Domestic Policy Directive ings by either party to any such arrangement shall be fully liquidated within 12 months In Effect January 1, 2005l after any amount outstanding at that time was first drawn, unless the Committee, The Federal Open Market Committee seeks because of exceptional circumstances, spemonetary and financial conditions that will cifically authorizes a delay. foster price stability and promote sustainable growth in output. To farther its long-run D. To maintain an overall open posiobjectives, the Committee in the immediate tion in all foreign currencies not exceeding future seeks conditions in reserve markets $25.0 billion. For this purpose, the overall consistent with increasing the federal funds open position in all foreign currencies is rate to an average of around 2lA percent. defined as the sum (disregarding signs) of net positions in individual currencies. The net position in a single foreign currency is Authorization for Foreign defined as holdings of balances in that cur- Currency Operations rency, plus outstanding contracts for future receipt, minus outstanding contracts for In Effect January 1, 2005 future delivery of that currency, i.e., as the sum of these elements with due regard to 1. The Federal Open Market Committee sign. authorizes and directs the Federal Reserve 2. The Federal Open Market Commit- Bank of New York, for System Open Market tee directs the Federal Reserve Bank of Account, to the extent necessary to carry out New York to maintain reciprocal currency the Committee's foreign currency directive arrangements ("swap" arrangements) for the and express authorizations by the Commit- System Open Market Account for periods up tee pursuant thereto, and in conformity with to a maximum of 12 months with the followsuch procedural instructions as the Commiting foreign banks, which are among those tee may issue from time to time: designated by the Board of Governors of the A. To purchase and sell the following Federal Reserve System under Section 214.5 foreign currencies in the form of cable trans- of Regulation N, Relations with Foreign fers through spot or forward transactions on Banks and Bankers, and with the approval of the open market at home and abroad, includ- the Committee to renew such arrangements ing transactions with the U.S. Treasury, with on maturity: the U.S. Exchange Stabilization Fund established by Section 10 of the Gold Reserve Amount Act of 1934, with foreign monetary authori- of arrangement ties, with the Bank for International Settle- Foreign bank (millions of dollars equivalent) Bank of Canada 2,000 1. Adopted by the Committee at its meeting on Bank of Mexico 3,000 December 14, 2004. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

156 92nd Annual Report, 2005 Any changes in the terms of existing swap the absence of members of the Board serving arrangements, and the proposed terms of any on the Subcommittee, other Board members new arrangements that may be authorized, designated by the Chairman as alternates, shall be referred for review and approval to and in the absence of the Vice Chairman of the Committee. the Committee, his alternate). Meetings of the Subcommittee shall be called at the 3. All transactions in foreign currencies request of any member, or at the request of undertaken under paragraph LA. above the Manager, System Open Market Account shall, unless otherwise expressly authorized ("Manager"), for the purposes of reviewing by the Committee, be at prevailing market recent or contemplated operations and of rates. For the purpose of providing an invest- consulting with the Manager on other matment return on System holdings of foreign ters relating to his responsibilities. At the currencies, or for the purpose of adjusting request of any member of the Subcommittee, interest rates paid or received in connection questions arising from such reviews and conwith swap drawings, transactions with for- sultations shall be referred for determination eign central banks may be undertaken at to the Federal Open Market Committee. non-market exchange rates. 7. The Chairman is authorized: 4. It shall be the normal practice to arrange with foreign central banks for the coordina- A. With the approval of the Committion of foreign currency transactions. In mak- tee, to enter into any needed agreement or ing operating arrangements with foreign understanding with the Secretary of the Treacentral banks on System holdings of foreign sury about the division of responsibility for currencies, the Federal Reserve Bank of foreign currency operations between the Sys- New York shall not commit itself to maintain tem and the Treasury; any specific balance unless authorized by the Federal Open Market Committee. Any B. To keep the Secretary of the Treaagreements or understandings concerning the sury fully advised concerning System foradministration of the accounts maintained by eign currency operations, and to consult with the Federal Reserve Bank of New York with the Secretary on policy matters relating to the foreign banks designated by the Board foreign currency operations; of Governors under Section 214.5 of Regu- C. From time to time, to transmit lation N shall be referred for review and appropriate reports and information to the approval to the Committee. National Advisory Council on International 5. Foreign currency holdings shall be Monetary and Financial Policies. invested to ensure that adequate liquidity is 8. Staff officers of the Committee are authomaintained to meet anticipated needs and so rized to transmit pertinent information on that each currency portfolio shall generally System foreign currency operations to approhave an average duration of no more than priate officials of the Treasury Department. 18 months (calculated as Macaulay duration). When appropriate in connection with 9. All Federal Reserve Banks shall particiarrangements to provide investment facilities pate in the foreign currency operations for for foreign currency holdings, U.S. Govern- System Account in accordance with parament securities may be purchased from forgraph 3G(1) of the Board of Governors' eign central banks under agreements for Statement of Procedure with Respect to Forrepurchase of such securities within 30 caleign Relationships of Federal Reserve Banks endar days. dated January 1,1944. 6. All operations undertaken pursuant to the preceding paragraphs shall be reported promptly to the Foreign Currency Sub- Foreign Currency Directive committee and the Committee. The Foreign Currency Subcommittee consists of the Chairman and Vice Chairman of the Com- In Effect January 1, 2005 mittee, the Vice Chairman of the Board of Governors, and such other member of the 1. System operations in foreign currencies Board as the Chairman may designate (or in shall generally be directed at countering dis- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings 157 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 available): C. Cooperate in other respects with central banks of other countries and with A. Any operation that would result in a international monetary institutions. 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 posicurrencies and to facilitate operations of the tion in a single foreign currency exceeding Exchange Stabilization Fund. $150 million, or $300 million when the operation is associated with repayment of C. For such other purposes as may be swap drawings. expressly authorized by the Committee. C. Any operation that might generate a 4. System foreign currency operations shall substantial volume of trading in a particular be conducted: currency by the System, even though the A. In close and continuous consulta- change in the System's net position in that tion and cooperation with the United States currency might be less than the limits speci- Treasury; fied in l.B. B. In cooperation, as appropriate, with D. Any swap drawing proposed by a foreign monetary authorities; and foreign bank not exceeding the larger of C. In a manner consistent with the obli- (i) $200 million or (ii) 15 percent of the size gations of the United States in the Interna- of the swap arrangement. tional Monetary Fund regarding exchange arrangements under the IMF Article IV. 2. The Manager shall clear with the Committee (or with the Subcommittee, if the Subcommittee believes that consultation Procedural Instructions with with the full Committee is not feasible in the Respect to Foreign Currency time available, or with the Chairman, if the Operations Chairman believes that consultation with the Subcommittee is not feasible in the time available): In Effect January 1, 2005 In conducting operations pursuant to the A. Any operation that would result in a authorization and direction of the Federal change in the System's overall open position Open Market Committee as set forth in the in foreign currencies exceeding $1.5 billion Authorization for Foreign Currency Opera- since the most recent regular meeting of the tions and the Foreign Currency Directive, Committee. the Federal Reserve Bank of New York, through the Manager, System Open Market B. Any swap drawing proposed by Account ("Manager"), shall be guided by a foreign bank exceeding the larger of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

158 92nd Annual Report, 2005 (i) $200 million or (ii) 15 percent of the Ms. Johnson, Economist size of the swap arrangement. Mr. Stockton, Economist 3. The Manager shall also consult with the Messrs. Connors, Evans, Howard, Subcommittee or the Chairman about pro- Madigan, Oliner, Rolnick, Tracy, posed swap drawings by the System and and Wilcox, Associate Economists about any operations that are not of a routine character. Mr. Kos, Manager, System Open Market Account Meeting Held on Mr. Ettin, Deputy Director, Division February 1-2, 2005 of Research and Statistics, Board of Governors A meeting of the Federal Open Market Committee was held in the offices of Messrs. Slifman and Struckmeyer, the Board of Governors of the Federal Associate Directors, Division Reserve System in Washington, D.C., of Research and Statistics, on Tuesday, February 1, 2005, at Board of Governors 1:30 p.m. and continued on Wednesday, Messrs. Clouse, Reifschneider,3 and February 2, 2005, at 9:00 a.m. Whitesell, Deputy Associate Directors, Divisions of Monetary Present- Affairs, Research and Statistics, Mr. Greenspan, Chairman and Monetary Affairs, Mr. Geithner, Vice Chairman respectively, Board of Governors Mr. Bernanke Ms. Bies Messrs. Elmendorf,3 English, Faust,3 Mr. Ferguson and Leahy,3 Assistant Directors, Mr. Gramlich Divisions of Research and Mr. Kohn Statistics, Monetary Affairs, Mr. Moskow International Finance, and Mr. Olson International Finance, Mr. Santomero respectively, Board of Governors Mr. Stern Mr. Simpson, Senior Adviser, Division Messrs. Guynn, Lacker, Mses. Pianalto of Research and Statistics, Board and Yellen, Alternate Members of Governors of the Federal Open Market Committee Mr. Skidmore, Special Assistant to the Board, Office of Board Members, Mr. Hoenig, Ms. Minehan, and Board of Governors Mr. Poole, Presidents of the Federal Reserve Banks of Mr. Small, Project Manager, Division Kansas City, Boston, and of Monetary Affairs, Board of St. Louis, respectively Governors Ms. Holcomb, First Vice President, Federal Reserve Bank of Dallas Mr. Reinhart, Secretary and Economist Ms. Danker, Deputy Secretary Ms. Smith, Assistant Secretary Mr. Alvarez, General Counsel Mr. Baxter,2 Deputy General Counsel 3. Attended portion of meeting relating to special topic of a numerical definition of the price- 2. Attended Tuesday's session only. stability objective for monetary policy. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, February 159 Messrs. Bassett, Lebow,4 Ms. Lindner,3 The elected members and alternate Messrs. Rudd,3 Tetlow,3 and members were as follows: Wood,4 Senior Economists, Divisions of Monetary Affairs, Research and Statistics, Timothy F. Geithner, President of the Fed- Reasearch and Statistics, eral Reserve Bank of New York, with Reasearch and Statistics, Christine M. Cumming, First Vice Research and Statistics, and President, Federal Reserve Bank of International Finance, New York as alternate. respectively, Board of Governors Anthony M. Santomero, President of the Mr. Durham,4 Economist, Division of Federal Reserve Bank of Philadelphia, Monetary Affairs, Board of with Jeffrey M. Lacker, President of the Governors Federal Reserve Bank of Richmond, as alternate. Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Michael H. Moskow, President of the Fed- Board of Governors eral Reserve Bank of Chicago, with Sandra Pianalto, President of the Fed- Ms. Low, Open Market Secretariat eral Reserve Bank of Cleveland, as Assistant, Division of Monetary alternate. Affairs, Board of Governors Jack Guynn, President of the Federal Mr. Moore, First Vice President, Reserve Bank of Atlanta as alternate, Federal Reserve Bank of voting pending the election of the Presi- Cleveland dent of the Federal Reserve Bank of Dallas. Mr. Judd, Executive Vice President, Federal Reserve Bank of Gary H. Stern, President of the Federal San Francisco Reserve Bank of Minneapolis, with Janet L. Yellen, President of the Fed- Messrs. Eisenbeis, Fuhrer, Goodfriend, eral Reserve Bank of San Francisco, as Hakkio, and Rasche, Senior Vice alternate. Presidents, Federal Reserve Banks of Atlanta, Boston, Richmond, Kansas City, and St. Louis, By unanimous vote, the following respectively officers of the Federal Open Market Committee were selected to serve until Messrs. Altig, Dotsey, Ms. Hargraves, the selection of their successors at the and Mr. Wynne, Vice Presidents, Federal Reserve Banks of first regularly scheduled meeting after Cleveland, Philadelphia, December 31, 2005, with the under- New York, and Dallas, standing that in the event of the disconrespectively tinuance of their official connection with the Board of Governors or with a Fed- In the agenda for this meeting, it was eral Reserve Bank, they would cease reported that advices of the election to have any official connection with the of the following members and alternate Federal Open Market Committee: members of the Federal Open Market Committee for the period commencing Alan Greenspan Chairman January 1, 2005 had been received and Timothy F. Geithner Vice Chairman that these individuals had executed their Vincent R. Reinhart Secretary and oaths of office. Economist Deborah J. Danker Deputy Secretary 4. Attended portion of meeting related to the Michelle A. Smith Assistant economic outlook. Secretary Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

160 92nd Annual Report, 2005 Scott G. Alvarez General Counsel A. To purchase and sell the following Thomas C. Baxter, Jr. Deputy General foreign currencies in the form of cable trans- Counsel fers through spot or forward transactions on Karen H. Johnson Economist the open market at home and abroad, includ- David J. Stockton Economist ing transactions with the U.S. Treasury, with the U.S. Exchange Stabilization Fund estab- Thomas A. Connors, Charles L. Evans, lished by Section 10 of the Gold Reserve Act David H. Howard, Brian F. Madigan, of 1934, with foreign monetary authori- Loretta J. Mester, Stephen D. Oliner, ties, with the Bank for International Settle- Arthur J. Rolnick, Harvey Rosenblum, ments, and with other international financial Joseph S. Tracy, and David W. Wilcox, institutions: Associate Economists Canadian dollars Mexican pesos Danish kroner Norwegian kroner As customarily occurs at the first Euro Swedish kronor regularly scheduled meeting of the year, Pounds sterling Swiss francs Japanese yen the Committee reviewed a range of organizational items, covered below. B. To hold balances of, and to have By unanimous vote, the Federal outstanding forward contracts to receive or to deliver, the foreign currencies listed in Reserve Bank of New York was selected paragraph A above. to execute transactions for the System C. To draw foreign currencies and to Open Market Account. permit foreign banks to draw dollars under By unanimous vote, Dino Kos was the reciprocal currency arrangements listed selected to serve at the pleasure of the in paragraph 2 below, provided that draw- Committee as Manager, System Open ings by either party to any such arrangement shall be fully liquidated within 12 months Market Account, on the understanding after any amount outstanding at that time that his selection was subject to being was first drawn, unless the Committee, satisfactory to the Federal Reserve Bank because of exceptional circumstances, speof New York.5 cifically authorizes a delay. By unanimous vote, the Authoriza- D. To maintain an overall open position in all foreign currencies not exceeding tion for Foreign Currency Operations $25.0 billion. For this purpose, the overall was reaffirmed in the form shown open position in all foreign currencies is below. defined as the sum (disregarding signs) of net positions in individual currencies. The net position in a single foreign currency is Authorization for Foreign defined as holdings of balances in that cur- Currency Operations rency, plus outstanding contracts for future (Reaffirmed February 1, 2005) receipt, minus outstanding contracts for future delivery of that currency, i.e., as the 1. The Federal Open Market Committee sum of these elements with due regard to authorizes and directs the Federal Reserve sign. Bank of New York, for System Open Market 2. The Federal Open Market Commit- Account, to the extent necessary to carry out tee directs the Federal Reserve Bank of the Committee's foreign currency directive New York to maintain reciprocal currency and express authorizations by the Commit- arrangements ("swap" arrangements) for the tee pursuant thereto, and in conformity with System Open Market Account for periods up such procedural instructions as the Commit- to a maximum of 12 months with the followtee may issue from time to time: ing foreign banks, which are among those designated by the Board of Governors of the Federal Reserve System under Section 214.5 5. Secretary's note: Advice subsequently was of Regulation N, Relations with Foreign received that the selection of Mr. Kos as Manager Banks and Bankers, and with the approval of was satisfactory to the board of directors of the the Committee to renew such arrangements Federal Reserve Bank of New York. on maturity: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, February 161 promptly to the Foreign Currency Subcom- Amount of mittee and the Committee. The Foreign Cur- Foreign bank arrangement rency Subcommittee consists of the Chair- (millions of dollars equivalent) man and Vice Chairman of the Committee, the Vice Chairman of the Board of Gover- Bank of Canada 2,000 nors, and such other member of the Board Bank of Mexico 3,000 as the Chairman may designate (or in the absence of members of the Board serving on the Subcommittee, other Board members Any changes in the terms of existing swap designated by the Chairman as alternates, arrangements, and the proposed terms of any and in the absence of the Vice Chairman new arrangements that may be authorized, of the Committee, his alternate). Meetings shall be referred for review and approval to of the Subcommittee shall be called at the the Committee. request of any member, or at the request of 3. All transactions in foreign currencies the Manager, System Open Market Account undertaken under paragraph LA. above ("Manager"), for the purposes of reviewing shall, unless otherwise expressly authorized recent or contemplated operations and of by the Committee, be at prevailing market consulting with the Manager on other matrates. For the purpose of providing an invest- ters relating to his responsibilities. At the ment return on System holdings of foreign request of any member of the Subcomcurrencies or for the purpose of adjusting mittee, questions arising from such reviews interest rates paid or received in connection and consultations shall be referred for with swap drawings, transactions with for- determination to the Federal Open Market eign central banks may be undertaken at Committee. non-market exchange rates. 7. The Chairman is authorized: 4. It shall be the normal practice to A. With the approval of the Commitarrange with foreign central banks for the tee, to enter into any needed agreement or coordination of foreign currency transac- understanding with the Secretary of the Treations. In making operating arrangements sury about the division of responsibility for with foreign central banks on System hold- foreign currency operations between the Sysings of foreign currencies, the Federal tem and the Treasury; Reserve Bank of New York shall not com- B. To keep the Secretary of the Treamit itself to maintain any specific balance, sury fully advised concerning System forunless authorized by the Federal Open Mar- eign currency operations, and to consult with ket Committee. Any agreements or under- the Secretary on policy matters relating to standings concerning the administration of foreign currency operations; the accounts maintained by the Federal C. From time to time, to transmit Reserve Bank of New York with the foreign appropriate reports and information to the banks designated by the Board of Governors National Advisory Council on International under Section 214.5 of Regulation N shall Monetary and Financial Policies. be referred for review and approval to the 8. Staff officers of the Committee are Committee. authorized to transmit pertinent informa- 5. Foreign currency holdings shall be tion on System foreign currency operations invested to ensure that adequate liquidity is to appropriate officials of the Treasury maintained to meet anticipated needs and so Department. that each currency portfolio shall generally 9. All Federal Reserve Banks shall parhave an average duration of no more than ticipate in the foreign currency operations 18 months (calculated as Macaulay dura- for System Account in accordance with paration). When appropriate in connection with graph 3G(1) of the Board of Governors' arrangements to provide investment facilities Statement of Procedure with Respect to Forfor foreign currency holdings, U.S. Govern- eign Relationships of Federal Reserve Banks ment securities may be purchased from for- dated January 1, 1944. eign central banks under agreements for repurchase of such securities within 30 calendar days. By unanimous vote, the Foreign Cur- 6. All operations undertaken pursuant to rency Directive was reaffirmed in the the preceding paragraphs shall be reported form shown below. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

162 92nd Annual Report, 2005 Foreign Currency Directive tions and the Foreign Currency Directive, (Reaffirmed February 1, 2005) the Federal Reserve Bank of New York, through the Manager, System Open Market Account ("Manager"), shall be guided by 1. System operations in foreign currenthe following procedural understandings cies shall generally be directed at countering with respect to consultations and clearances disorderly market conditions, provided that with the Committee, the Foreign Currency market exchange rates for the U.S. dollar Subcommittee, and the Chairman of the reflect actions and behavior consistent with Committee. All operations undertaken pursu- IMF Article IV, Section 1. ant to such clearances shall be reported 2. To achieve this end the System shall: promptly to the Committee. A. Undertake spot and forward pur- 1. The Manager shall clear with the Subchases and sales of foreign exchange. committee (or with the Chairman, if the B. Maintain reciprocal currency Chairman believes that consultation with the ("swap") arrangements with selected for- Subcommittee is not feasible in the time eign central banks. available): C. Cooperate in other respects with A. Any operation that would result in a central banks of other countries and with change in the System's overall open position international monetary institutions. in foreign currencies exceeding $300 million 3. Transactions may also be undertaken: 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. Any operation that would result in a B. To provide means for meeting Syschange on any day in the System's net positem and Treasury commitments in particular tion in a single foreign currency exceedcurrencies, and to facilitate operations of the ing $150 million, or $300 million when the Exchange Stabilization Fund. operation is associated with repayment of C. For such other purposes as may be swap drawings. expressly authorized by the Committee. C. Any operation that might generate a 4. System foreign currency operations substantial volume of trading in a particular shall be conducted: currency by the System, even though the A. In close and continuous consultachange in the System's net position in that tion and cooperation with the United States currency might be less than the limits speci- Treasury; fied in l.B. B. In cooperation, as appropriate, with D. Any swap drawing proposed by a foreign monetary authorities; and foreign bank not exceeding the larger of C. In a manner consistent with the obli- (i) $200 million or (ii) 15 percent of the size gations of the United States in the Internaof the swap arrangement. tional Monetary Fund regarding exchange 2. The Manager shall clear with the Comarrangements under IMF Article IV. mittee (or with the Subcommittee, if the Subcommittee believes that consultation By unanimous vote, the Procedural with the full Committee is not feasible in the Instructions with Respect to Foreign time available, or with the Chairman, if the Chairman believes that consultation with the Currency Operations were reaffirmed in Subcommittee is not feasible in the time the form shown below. available): A. Any operation that would result in a change in the System's overall open position Procedural Instructions with in foreign currencies exceeding $1.5 billion since the most recent regular meeting of the Respect to Foreign Committee. Currency Operations B. Any swap drawing proposed by a (Reaffirmed February 1, 2005) 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, February 163 about any operations that are not of a routine by competitive bidding, after applying reacharacter. sonable limitations on the volume of agreements with individual dealers; provided that By unanimous vote, the Authoriza- in the event Government securities or agency issues covered by any such agreement are tion for Domestic Open Market Operanot repurchased by the dealer pursuant to the tions was amended and approved in agreement or a renewal thereof, they shall be the form shown below. The amendment sold in the market or transferred to the Sysinvolved removing from paragraph l(a) tem Open Market Account. the reference to the limit on the amount (c) To sell U.S. Government securities and obligations that are direct obligations of, by which the System Open Market or fully guaranteed as to principal and inter- Account holdings of securities can est by, any agency of the United States to change between FOMC meetings. This dealers for System Open Market Account limit had become outdated, as it had under agreements for the resale by dealers been superseded by other, more effec- of such securities or obligations in 65 business days or less, at rates that, unless othertive mechanisms for the Committee to wise expressly authorized by the Committee, oversee Desk operations. shall be determined by competitive bidding, after applying reasonable limitations on the volume of agreements with individual Authorization for Domestic dealers. Open Market Operations 2. In order to ensure the effective conduct (Amended February 1, 2005) of open market operations, the Federal Open Market Committee authorizes the Federal 1. The Federal Open Market Committee Reserve Bank of New York to lend on an authorizes and directs the Federal Reserve overnight basis U.S. Government securities Bank of New York, to the extent neces- held in the System Open Market Account sary to carry out the most recent domestic to dealers at rates that shall be determined policy directive adopted at a meeting of the by competitive bidding. The Federal Reserve Committee: Bank of New York shall set a minimum (a) To buy or sell U.S. Government lending fee consistent with the objectives of securities, including securities of the Federal the program and apply reasonable limitations Financing Bank, and securities that are direct on the total amount of a specific issue that obligations of, or fully guaranteed as to may be auctioned and on the amount of principal and interest by, any agency of the securities that each dealer may borrow. The United States in the open market, from or to Federal Reserve Bank of New York may securities dealers and foreign and interna- reject bids which could facilitate a dealer's tional accounts maintained at the Federal ability to control a single issue as deter- Reserve Bank of New York, on a cash, regu- mined solely by the Federal Reserve Bank of lar, or deferred delivery basis, for the System New York. Open Market Account at market prices, 3. In order to ensure the effective conduct and, for such Account, to exchange maturing of open market operations, while assisting U.S. Government and Federal agency securi- in the provision of short-term investments ties with the Treasury or the individual agen- for foreign and international accounts maincies or to allow them to mature without tained at the Federal Reserve Bank of New replacement; York and accounts maintained at the Federal (b) To buy U.S. Government securities, Reserve Bank of New York as fiscal agent obligations that are direct obligations of, or of the United States pursuant to Section 15 fully guaranteed as to principal and interest of the Federal Reserve Act, the Federal Open by, any agency of the United States, from Market Committee authorizes and directs the dealers for the account of the Federal Federal Reserve Bank of New York (a) for 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

164 92nd Annual Report, 2005 days or less on terms comparable to those developments in foreign exchange maravailable on such transactions in the market; kets. There were no open market operaand (b) for New York Bank account, when tions in foreign currencies for the Sysappropriate, to undertake with dealers, subject to the conditions imposed on purchases tem's account in the period since the and sales of securities in paragraph l(b), previous meeting. The Manager also repurchase agreements in U.S. Government reported on developments in domestic and agency securities, and to arrange corre- financial markets and on System open sponding sale and repurchase agreements market transactions in government secubetween its own account and such foreign, rities and federal agency obligations international, and fiscal agency accounts maintained at the Bank. Transactions under- during the period December 14, 2004 taken with such accounts under the pro- to February 1, 2005. By unanimous visions of this paragraph may provide for a vote, the Committee ratified these service fee when appropriate. transactions. 4. In the execution of the Committee's At this meeting the Committee decision regarding policy during any intermeeting period, the Committee authorizes engaged in a broad-ranging discussion and directs the Federal Reserve Bank of New of the pros and cons of formulating York, upon the instruction of the Chairman a numerical definition of the priceof the Committee, to adjust somewhat in stability objective of monetary policy. A exceptional circumstances the degree of staff presentation on the topic included a pressure on reserve positions and hence the intended federal funds rate. Any such adjust- review of the potential costs and benement shall be made in the context of the fits of introducing such a definition as Committee's discussion and decision at its well as of other countries' experiences. most recent meeting and the Committee's In the subsequent discussion, meeting long-run objectives for price stability and participants uniformly agreed that price sustainable economic growth, and shall be based on economic, financial, and mone- stability provided the best environment tary developments during the intermeeting for maximizing sustainable economic period. Consistent with Committee prac- growth in the long run, but expressed tice, the Chairman, if feasible, will consult a range of views on whether it would with the Committee before making any be helpful for the Committee to articuadjustment. late a specific numerical definition for the Federal Reserve's price-stability By unanimous vote, the Committee objective—either a single figure or a made several amendments to its rules, range. Those who believed such a move statements, and resolutions, including would be on balance beneficial cited, for to align the starting dates of Committee example, its usefulness as an anchor for membership terms of Presidents with long-term inflation expectations, as a those of Committee officers, and to vehicle for enhanced clarity of Commitauthorize the Secretary of the Commit- tee deliberations, and as an additional tee, with the concurrence of the General tool for communications. Several of Counsel, to make technical changes to those who saw greater potential drawthe rules in the future. backs were concerned that such a shift By unanimous vote, the Committee might appear to be inconsistent with the amended its Program for Security of Committee's dual mandate of fostering FOMC Information on February 1, maximum employment as well as price 2005, to reflect an updating and stream- stability or that it might inappropriately lining of the document. bias or constrain policy at times; in any The Manager of the System Open case, with inflation expectations well- Market Account reported on recent contained over recent years, the benefits Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, February 165 of announcing a specific inflation objec- Available weekly physical product data tive were not likely to be large. The suggested that manufacturing produc- Committee decided to defer further tion would increase moderately in Jandiscussion. uary. Capacity utilization continued to The information reviewed at this climb through the end of the year but meeting suggested that the economy remained below its longer-run average. expanded at a solid pace in recent Real consumer spending expanded months. Consumer spending and the briskly in December and in the fourth housing market continued to exhibit quarter as a whole, with retail sales strength, and business fixed investment exhibiting widespread strength across grew robustly in the fourth quarter. The categories. Expenditures on consumer pace of inventory accumulation picked services also continued to post solid up and industrial production acceler- increases. A surge in light vehicle sales ated. The labor market showed further in December pulled the average rate of signs of improvement. Core consumer sales during the fourth quarter slightly prices rose moderately over the past above the third-quarter pace. Real few months, and measures of inflation disposable personal income increased expectations remained well-anchored. at a rapid rate at the end of the year— Moderate increases in payroll boosted in part by the special diviemployment during November and dend payment by Microsoft; exclud- December pushed the average monthly ing this payment, real disposable peradvance in the quarter well above that sonal income rose at a more moderate of the third quarter. Employment gains rate. Measures of consumer confidence were fairly widespread, with hiring in remained favorable and consistent with business services, health care, financial sustained increases in spending. activities, and wholesale trade more Residential housing activity remained than offsetting continued sluggishness buoyant in the fourth quarter. A rebound in manufacturing and a seasonally in single-family housing starts in adjusted decline in retail services during December from a disappointing Novem- December. Surveys of employers' hiring ber brought the fourth quarter pace plans and job openings pointed to con- about in line with that earlier in the year. tinued moderate gains in employment Sales of new and existing homes slipped early this year. The average workweek some late in the year but remained during the fourth quarter was unchanged robust. Mortgage rates had changed from the third quarter, and as a result little since August and continued to supaggregate hours decelerated despite port demand. Construction activity in the pickup in employment growth. The the multifamily sector weakened a bit in unemployment rate held steady at November and December, but indicators 5.4 percent in December. of underlying demand pointed to a Industrial activity accelerated notice- rebound in starts in January. ably during the fourth quarter. The Business fixed investment continued pickup of industrial production in to be bolstered by favorable fundamen- December owed largely to increased tals, including sustained expansion of motor vehicle assemblies and a turn- business output, the flush cash position around in the output of utilities associ- of many firms, readily available credit, ated with cold weather across the north- and a still-favorable cost of capital. east. Production of high-tech goods Equipment and software spending grew slowed slightly in the fourth quarter. at a solid rate in the fourth quarter, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

166 92nd Annual Report, 2005 though not quite as briskly as in the changed over the intermeeting period. third quarter owing to a deceleration in With regard to labor costs, the employspending outside the high-tech sector. ment cost index decelerated in the fourth By contrast, investment in nonresiden- quarter; the slowdown was attributable tial structures had edged down in recent to wages, which gained only slightly, months, with expenditures only for drill- while benefit costs rose a bit faster than ing and mining operations showing in the third quarter. some strength amid flat outlays for At its meeting on December 14,2004, manufacturing facilities and a decline in the Federal Open Market Committee spending on office buildings. decided to increase its target for the Nonfarm inventories increased a bit federal funds rate 25 basis points to more in the fourth quarter than they 2VA percent. In its announcement of this had in the third quarter. The buildup decision, the Committee indicated that of inventories was widespread across the upside and downside risks to the manufacturers, wholesalers, and retail- attainment of both sustainable growth ers as well as across stages of produc- and price stability were roughly equal. tion. Motor vehicle inventories were an The Committee also noted that output exception, as motor vehicle manufac- appeared to be growing at a moderate turers sought to reduce stocks of unsold pace and labor market conditions conlight vehicles. The aggregate inventory- tinued to improve gradually, while inflasales ratio outside of motor vehicles tion and inflation expectations remained likely edged up in the fourth quarter but well-contained. As a result, the Commitremained within the range that had pre- tee again judged that policy accommovailed since the middle of last year. dation could be removed at a pace that The most recent data suggested that was likely to be measured, although the U.S. international trade deficit wid- the path of policy would depend imporened in the fourth quarter as a result tantly on evolving economic prospects. of a broad-based decline in exports of The Committee's decision at its goods and increase in imports of oil December meeting to increase the fedand consumer goods. The expansion in eral funds rate had been fully anticieconomic activity in the major foreign pated in financial markets, and reaction industrialized economies appeared to to the attendant statement was muted. remain sluggish in the fourth quarter, The release of the minutes of the but the growth of real GDP in Latin December meeting on January 4, how- America and emerging Asia likely ever, triggered a significant upward revistepped up. sion in the anticipated path of monetary Core consumer prices decelerated policy: Investors apparently read them over the past few months, while overall as expressing more widespread concern consumer prices were buffeted by move- among Committee members about inflaments in energy prices. The rate of tion pressures than had been the case increase in core prices in the twelve previously. Market participants viewed months ending in December was some- the generally favorable incoming data what higher than the very low rate that on economic activity as consistent with prevailed during the year-earlier period; their expectations of firmer policy. Interthe overall index also accelerated, with est rates on intermediate-term Treasury about half of its advance accounted for securities rose in response to the reviby a sharp rise in energy prices. Mea- sion to policy expectations, but longersures of inflation expectations were little term yields were little changed over Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, February 167 the intermeeting period. As yields on supportive financial conditions, and an inflation-indexed Treasury securities ongoing need to replace or upgrade rose roughly in line with their nominal aging equipment and software. Real net counterparts, longer-term inflation com- exports were projected to be roughly pensation remained about unchanged. stable for several quarters, held up by Risk spreads on corporate bonds were the lagged effect of the lower foreign stable at relatively low levels, consis- exchange value of the dollar and some tent with favorable indicators of corpo- strengthening in foreign demand. Mearate credit quality. Broad stock indexes sures of total consumer price inflation declined a bit over the intermeeting were expected to decline over the foreperiod. In foreign exchange markets, cast horizon as energy prices receded, the dollar ended the period little changed while core inflation was seen as remainon a trade-weighted basis, appreciating ing stable in the staff forecast. Tendenagainst the major European currencies cies for core inflation to increase but falling vis-a-vis other important because of slightly higher trend unit trading partners. labor costs and a narrowing margin of M2 grew moderately in recent resource slack were expected to be offmonths, its expansion restrained by set by the waning contribution of elerising opportunity costs associated with vated prices for energy and imported monetary policy tightening. Because goods. changes in interest rates on liquid depos- In their discussion of the economic its typically lag those in market interest outlook, the meeting participants rates, the growth of that component regarded incoming data since the last slowed in the second half of 2004. By meeting as supporting their expectations contrast, growth of small time deposits, that, with the farther removal of monewhose yields closely track market rates, tary accommodation, GDP would likely picked up. Currency growth was about grow at a moderate pace consistent flat in December. with a gradual reduction of remaining In the staff forecast prepared for this economic slack, and inflation would meeting, the economy was seen as likely probably continue to be low. Domestic to expand at a pace a little above that demand had stayed strong through the of its longer-run potential over this year fourth quarter and should continue to and next, while hiring was expected to be bolstered by favorable financial confirm some more, resulting in a further ditions. Recent data indicated low and decrease in the unemployment rate. stable rates of core consumer inflation Household spending was projected to and apparently well-anchored inflation grow at a fairly solid rate, supported by expectations. Against this backdrop, the higher employment and somewhat lower risks to the outlook for both output and energy prices but damped somewhat by inflation relative to the Committee's lessened stimulus from gains in wealth goals appeared to remain well-balanced. and the need for households to rebuild In preparation for the Federal savings. After a temporary dip in the Reserve's semi-annual report to the level of business investment this quarter Congress on the economy and monetary related to the expiration of the partial- policy, the members of the Board of expensing tax provision, investment out- Governors and the presidents of the Fedlays were seen as likely to resume vigor- eral Reserve Banks submitted individous growth in response to steadily rising ual projections of the growth of GDP, sales, strong corporate balance sheets, the rate of unemployment, and core con- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

168 92nd Annual Report, 2005 sumer price inflation for the years 2005 balance sheets were continuing to supand 2006. As part of its continuing effort port fairly brisk growth of capital expento improve its communications, the ditures. Low longer-term nominal inter- Committee had earlier decided to add est rates were partly attributable to wellone year to the forecast period so as contained inflation expectations, but to make the projections more useful to low real interest rates, along with slight the public. The forecasts of the rate of declines in equity prices so far this year, expansion in real GDP were concen- might reflect lingering caution on the trated in the upper part of a V/i to 4 per- part of businesses about the outlook. cent range for 2005; for 2006 the fore- Nevertheless, narrow credit spreads and casts were in a slightly lower range of risk premiums, along with abundant 3V4 to 3% percent, with a central ten- liquidity in financing markets, suggested dency at 3V2 percent. These rates of that markets now assigned fairly low growth were associated with a civilian odds to significant downside risks. unemployment rate in the range of 5 to Solid income gains, low interest rates, 52/2 percent and a central tendency of and consumer confidence were seen by 5lA percent in the fourth quarter of 2005 participants as helping to sustain strong and 5 to 5lA percent in the fourth quarter growth of household spending. Some of 2006. The rate of inflation, as mea- firms had reported that holiday sales sured by the core PCE price index, was were higher than a year earlier and expected to remain fairly stable, with better than expected, while auto sales forecasts concentrated in the lower por- had responded strongly to incentives in tion of a \lh to 2 percent range for both December. The current low measured this year and next. saving rate seemed mostly explainable In their comments about develop- by the strength of expected income ments in key sectors of the economy, gains, low interest rates, and the increase meeting participants noted that, relative in household wealth resulting from to several months ago, many firms now the rise in equity and housing prices. seemed somewhat more confident about Although the saving rate might well the economic outlook. The anticipa- drift up over the next couple of years, tion of increased sales relative to exist- participants generally thought it likely ing production capacity and also desires that consumer spending would continue to upgrade technology and improve growing at a strong pace. However, a competitiveness were leading firms to marked slowing in home price appreciaincrease spending on equipment and tion and possible increases in longersoftware. Gains in capital spending had term interest rates, which would raise been quite strong last year, and while financing costs and reduce opportunities some of that spending might have been to extract equity from homes through motivated by the year-end expiration of refinancings and home equity loans, the partial-expensing provisions of the were seen as downside risks to the prostax code, participants had seen little pects for consumption spending and for evidence to date that there would be a housing construction. significant slowdown in the growth of Several participants mentioned that spending in the early part of 2005. Low the low level of measured national savlonger-term interest rates on corporate ing, which implied a continued need borrowing—reflecting in part narrow for foreign financing of U.S. investcredit risk spreads—along with strong ment, and imbalances in the external corporate profitability and improved sector imparted additional uncertainty to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, February 169 the longer-term economic outlook. The growth rate of labor costs were perextent to which the federal budget defi- manent, these cost pressures might be cit would decline over coming years was passed through to consumer prices an open question. As regards the cur- fairly quickly to preserve profit margins. rent account balance, some participants While participants generally felt that the noted that the sharp drop in net exports pace of underlying productivity growth in November probably reflected transi- remained robust, careful attention would tory factors in large part, as well as need to be paid to developments regardreported measurement errors. However, ing unit labor costs and profit margins. there has been little hard evidence as Despite some pickup in costs, paryet of a strengthening in the growth of ticipants thought that the rate of core spending in our foreign trading partners inflation likely would remain low and or of substantial effects on net exports stable, assuming further removal of from previous dollar declines. As a policy accommodation. Elevated price result, the external imbalance seemed markups and profits, as well as slack likely to remain elevated, with a high in resource use, had helped absorb cost level of uncertainty surrounding the increases and put downward pressure prospects for and path of adjustment. on inflation and would likely continue A number of participants noted con- to do so. Indeed, core inflation measures tinued modest gains in employment, had eased off, both in the latest readings though some commented that, based and on balance over the second half of on anecdotal information, job growth 2004 relative to the first half. However, seemed to have picked up of late. The several participants suggested the possiincrease in aggregate demand was bility of an upward skew to the distribuexpected to be sufficient over coming tion of inflation outcomes, especially if quarters to allow the rate of unemploy- there were appreciable further declines ment to continue to edge lower even as in the foreign exchange value of the more people return to the labor force. dollar or in structural productivity Participants noted considerable uncer- growth; already some participants were tainty about the sustainable rate of hearing anecdotal reports from firms resource utilization and about structural of an increased ability to pass cost productivity growth. One participant increases through to product prices, suggested that, given the range of uncer- perhaps because of increasing confitainty, output might already be at-or dence in the outlook for the economic close to potential. Others commented expansion. that recent studies did not on balance In the Committee's discussion of polsupport a conclusion that structural labor icy for the intermeeting period, all of the market shifts had caused resource slack members favored raising the target for to be lower than commonly estimated the federal funds rate by 25 basis points and that the flat pattern of growth in to 2lA percent at this meeting. All memwages and compensation suggested an bers judged that a further quarter-point absence of pressures in labor markets. firming in the target federal funds rate However, unit labor costs had acceler- was appropriate in light of current overated over 2004 owing to a tapering off all accommodative financial conditions in productivity growth. If that slowing and the continuing outlook for solid reflected a moderation in structural pro- economic growth and diminished slack ductivity growth and if firms believed in resource utilization. A higher nominal that the associated increases in the federal funds rate was seen as needed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

170 92nd Annual Report, 2005 to contain risks of increased cost and long-run objectives, the Committee in the price pressures, but even with this immediate future seeks conditions in reserve markets consistent with increasing the fedaction, the real federal funds rate was eral funds rate at an average of around generally seen as remaining below lev- 2lh percent. els that might reasonably be associated with maintaining a stable inflation rate The vote encompassed approval of over the medium run. The pace of pol- the paragraph below for inclusion in the icy moves at upcoming meetings, how- statement to be released shortly after the ever, would depend on incoming data. meeting: With regard to the Committee's announcement to be released after the The Committee perceives the upside and meeting, members concurred that over- downside risks to the attainment of both sustainable growth and price stability for the all economic prospects were similar next few quarters to be roughly equal. With to those prevailing at the time of the underlying inflation expected to be relatively December meeting and that conse- low, the Committee believes that policy quently the statement should be altered accommodation can be removed at a pace only to the minor extent required to that is likely to be measured. Nonetheless, the Committee will respond to changes in reflect recent economic developments. economic prospects as needed to fulfill its They concurred that the statement obligation to maintain price stability. should note that output appeared to be growing at a moderate pace despite the Votes for this action: Messrs. Greenspan, rise in energy prices, that labor market Geithner, Bernanke, Ms. Bies, Messrs. conditions continued to improve gradu- Ferguson, Gramlich, Guynn, Kohn, Moskow, Olson, Santomero, and Stern. ally, and that inflation and longer-term Vote against this action: None. Mr. Guynn inflation expectations remained wellvoted as alternate member. contained. They also agreed again to characterize the risks to sustainable It was agreed that the next meeting growth and price stability as balanced. of the Committee would be held on All members agreed that the FOMC Tuesday, March 22, 2005. statement for this meeting should again The meeting adjourned at 12:35 p.m. indicate that policy accommodation on February 2, 2005. could be removed at a pace that was likely to be measured but that the Com- Notation Vote mittee would respond to changes in economic prospects as needed to maintain By notation vote completed on Decemprice stability. ber 31, 2004, the Committee unani- At the conclusion of the discussion, mously approved the minutes of the the Committee voted to authorize and meeting of the Federal Open Market direct the Federal Reserve Bank of New Committee held on December 14, 2004. 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: Meeting Held on The Federal Open Market Committee March 22, 2005 seeks monetary and financial conditions that will foster price stability and promote sus- A meeting of the Federal Open Market tainable growth in output. To further its Committee was held in the offices of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 111 the Board of Governors of the Fed- Mr. Whitesell, Deputy Associate eral Reserve System in Washington, Director, Division of Monetary Affairs, Board of Governors D.C., on Tuesday, March 22, 2005, at 9:00 a.m. Messrs. English and Leahy, Assistant Directors, Divisions of Monetary Present: Affairs and International Finance, Mr. Greenspan, Chairman respectively, Board of Governors Mr. Geithner, Vice Chairman Mr. Bernanke Mr. Simpson, Senior Adviser, Division Ms. Bies of Research and Statistics, Board Mr. Ferguson of Governors Mr. Gramlich Mr. Kohn Mr. Skidmore, Special Assistant to the Mr. Moskow Board, Office of Board Members, Mr. Olson Board of Governors Mr. Santomero Mr. Stern Mr. Small, Project Manager, Division of Monetary Affairs, Board of Ms. Cumming, Messrs. Guynn and Governors Lacker, Mses. Pianalto and Yellen, Alternate Members of the Federal Mr. Nelson, Section Chief, Division Open Market Committee of Monetary Affairs, Board of Governors Mr. Hoenig, Ms. Minehan, and Mr. Poole, Presidents of the Mr. Carpenter, Senior Economist, Federal Reserve Banks of Division of Monetary Affairs, Kansas City, Boston, and Board of Governors St. Louis, respectively Messrs. Kumasaka and Luecke, Senior Ms. Holcomb, First Vice President, Financial Analysts, Division of Federal Reserve Bank of Dallas Monetary Affairs, Board of Governors Mr. Reinhart, Secretary and Economist Ms. Smith, Assistant Secretary Mr. Alvarez, General Counsel Ms. Low, Open Market Secretariat Ms. Johnson, Economist Assistant, Division of Monetary Mr. Stockton, Economist Affairs, Board of Governors Messrs. Connors, Evans, and Madigan, Mr. Judd, Executive Vice President, Ms. Mester, Messrs. Oliner, Federal Reserve Bank of Rolnick, Rosenblum, and Wilcox, San Francisco Associate Economists Messrs. Eisenbeis, Fuhrer, Goodfriend, Mr. Kos, Manager, System Open Hakkio, Rasche, Sniderman, and Steindel, Senior Vice Presidents, Market Account Federal Reserve Banks of Atlanta, Boston, Richmond, Kansas City, Mr. Ettin, Deputy Director, Division St. Louis, Cleveland, and of Research and Statistics, New York, respectively Board of Governors Mr. Elsasser, Vice President, Federal Messrs. Kamin and Slifman, Associate Reserve Bank of New York Directors, Divisions of International Finance and Research and Statistics, The Manager of the System Open respectively, Board of Governors Market Account reported on recent Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

172 92nd Annual Report, 2005 developments in foreign exchange mar- tions equipment far outpacing sluggish kets. There were no open market oper- growth of computer production. Producations in foreign currencies for the Sys- tion of consumer goods, both durable tem's account in the period since the and nondurable, also rose. In contrast, previous meeting. The Manager also the production of non-high-tech busireported on developments in domestic ness equipment edged down, and the financial markets and on System open output of construction and business supmarket transactions in government secu- plies and materials dropped back. Minrities and federal agency obligations ing output edged up, but the output of during the period February 2, 2005, utilities fell for a second consecutive through March 21, 2005. By unani- month amid a generally warm winter. mous vote, the Committee ratified these Supported by strong income gains and transactions. higher wealth, consumer spending had The information reviewed at this increased at a robust rate in the last meeting suggested that the economy quarter of 2004 and appeared to be on was expanding at a solid pace in the track to post another strong advance first quarter of the year. Employment in the first quarter of the year. Apart was improving. Consumer spending still from purchases of motor vehicles, which appeared to be growing briskly, and resi- stepped down early this year after a dential construction expenditures con- year-end surge, the increases in outlays tinued to move higher. Business spend- had been broad based. On average, real ing on equipment and software showed disposable income increased at a vigornotable gains early in the quarter, and ous pace in December and January, well industrial production increased moder- above that seen over most of last year. ately in the first two months of the year. Increases in equity prices and in house Consumer prices moved higher in Janu- values pushed up the wealth-to-income ary after being unchanged in December. ratio in the fourth quarter, and the sav- The labor market continued to ing rate remained low by historical improve in February. Private nonfarm standards. payrolls grew at a solid pace, and these Activity in the housing market congains were widespread across indus- tinued to expand early this year. Starts tries. Of particular note, manufacturing of single-family homes in January and employment, which had been declining, February were well above their fourthedged higher. On balance, surveys of quarter pace, although indicators of employers and of households pointed fiiture production pointed to some slowto firming labor demand. With the aver- ing. Similarly, in the multifamily secage workweek unchanged, aggregate tor, starts increased substantially in hours increased moderately in February. the first two months of the year but Although the unemployment rate in Feb- appeared poised to moderate this month. ruary ticked back up to its December Although both new and existing home level, the set of available information on sales declined somewhat in January, the labor market suggested that resource demand continued to be supported by slack was diminishing. low mortgage rates. Industrial production posted a mod- Business spending on equipment and erate gain in February, led by a surge software increased sharply in the fourth in motor vehicle production. Produc- quarter and, excluding motor vehicles, tion of high-tech equipment rose, with appeared to be growing briskly in the the increase in output of communica- first quarter. The expiration at the end of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 173 2004 of the special tax provisions that Among the emerging-market econopermitted partial expensing of invest- mies, indicators of economic activity ment expenditures seemed not to be were mixed. retarding capital spending. Presumably Consumer prices edged higher in contributing to the vigor of capital January after having been flat in Decemspending were further increases in ber. Core consumer prices rose a bit business output, strong cash positions faster than overall prices, with price of corporations, and an attractive cost increases widespread across commodiof capital amid generally low interest ties and services. Consumer energy rates. Shipments and orders for high- prices fell in January but turned back up tech equipment remained strong in Janu- in February and early March. For the ary. Outside the high-tech sector, ship- twelve-month period ended in January, ments posted a sizable and broad-based overall consumer prices were boosted increase in January, and the rising back- significantly by higher oil prices, but log of orders pointed to further gains in core consumer price inflation over the near future. Spending on nonresiden- the same period was fairly subdued. A tial construction was subdued, as it had survey measure of near-term inflation been for some time. expectations moved up in early March, Increased inventory accumulation but long-term expectations had changed contributed significantly to the rise in little since the end of last year. Producer economic output in the fourth quarter of prices and commodity indexes were last year and appeared likely to make an broadly higher in January, with the additional contribution in the first quar- exception of prices for core crude mateter of this year. In January, manufac- rials. With regard to labor costs, average turers' book-value inventories increased hourly earnings rose slowly over Janat nearly twice the rate seen in the uary and February. Over the precedfourth quarter, while wholesale and ing year, compensation costs increased retail inventories about kept pace with moderately, contributing to a small rise the advance in the previous quarter. in unit labor costs. The rapid buildup in inventories left At its February meeting, the Committhe inventory-to-sales ratio unchanged tee decided to increase the target federal rather than on the downtrend of recent funds rate 25 basis points, to 2x/2 peryears. However, the available evidence cent. In its accompanying statement, the suggested that firms generally were Committee indicated that the upside not uncomfortable with their inventory and downside risks to the attainment of positions. both sustainable growth and price sta- The U.S. international trade deficit bility were roughly equal. In addition, widened in January, primarily reflecting the Committee noted that the economy a surge in imported non-oil goods and appeared to be growing at a moderate services. After a general slowdown in rate despite increases in energy prices, the fourth quarter of last year, indicators that labor market conditions continued for major foreign industrial countries to improve gradually, and that inflarevealed a broad pickup in economic tion and inflation expectations remained growth in the first quarter, with indus- well contained. As a consequence, the trial production rising in Japan and the Committee again judged that policy major euro-area countries. Meanwhile, accommodation could be removed at a consumer price inflation across most pace that was likely to be measured, industrial economies remained subdued. although the path of policy would Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

174 92nd Annual Report, 2005 depend importantly on evolving eco- funds picked up in the first two months nomic prospects. of the year. In the staff forecast prepared The Committee's decision to change for this meeting, the economy was seen the target rate was universally antici- as likely to expand at a rate above the pated by market participants, as was the growth of potential this year and next, tenor of the statement. As a result, the led by strong business demand for reaction in financialm arkets was muted. equipment and software. Consequently, Over the intermeeting period, however, labor markets were expected to conthe Chairman's semiannual testimony tinue to firm and the unemployment on monetary policy, higher oil prices, rate to decline gradually. In light of the and incoming data that showed a pickup robust expansion of capital spending in price inflation led market participants thus far this year, the outlook for busito mark up their expectations for the ness investment spending was revised trajectory of the target federal funds up appreciably, as more of the strength rate. Consistent with the upward revi- over the latter part of 2004 was attribsion to policy expectations, yields on uted to underlying demand and less Treasury securities rose significantly. to the effects of the partial-expensing Some of the increase in nominal rates tax provision. Steadily rising sales, an likely owed to higher inflation expecta- ongoing need to replace and upgrade tions, as inflation compensation, mea- software and equipment, and favorable sured from the spread between Treasury financing costs were all expected to connominal debt and comparable inflation- tinue to buoy business spending this indexed securities, rose. However, staff year and next. Household spending, supanalysis suggested that the increases ported by rising disposable income and, were concentrated over the next few to a lesser degree, by increasing wealth, years and that long-term inflation expec- was projected to expand at a solid rate. tations were little changed. Risk spreads Net exports were seen as exerting less of on most corporate bonds narrowed on an arithmetic drag on economic growth balance, significantly so for speculative- than in 2004. Measures of overall congrade debt, amid generally strong corpo- sumer price inflation were expected to rate balance sheets and good credit per- be lower this year than last and to step formance. Broad stock market indexes down again next year as energy prices edged up over the intermeeting period. retreated. Inflation in core consumer In foreign exchange markets, the trade- prices was seen as being boosted a bit weighted value of the dollar depreciated by the effects of higher import and slightly, with the declines widespread energy costs in the near term but still against the currencies of industrialized largely contained by continued strong countries other than Japan. growth in underlying labor productiv- M2 growth slowed in the first two ity and remaining slack in resource months of the year, as the opportunity markets. cost of holding money rose with mone- In their discussion of current conditary policy tightening. Rates paid on tions and the economic outlook, many liquid deposits were little changed, but participants said that circumstances had those on small time deposits tracked changed from those anticipated at the market rates more closely. As a result, time of the Committee's meeting in growth in liquid deposits was depressed, early February. In particular, incoming while that of small time deposits was data and anecdotal information indivigorous. Rows into equity and bond cated that economic activity had appre- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 175 ciably more forward momentum than tures apparently continued to be spurred previously perceived and that inflation by relatively low interest rates. A few pressures could be intensifying. While participants cited some evidence of underlying inflation appeared to have speculative activity in the housing marmoved up only modestly and nearly all ket in several regions. However, recent participants thought that core and total house price developments were mixed, inflation going forward would be rela- with reports of incipient softness in tively low, they had become less cer- some markets, including high-end proptain of that outlook for the next few erties, and overall house price inflation quarters. was seen as likely to slow in coming Many participants noted that the most quarters. Consumer expenditures were recent data and business commentary expected to continue to advance at a indicated that investment was running solid pace, buoyed by strong gains in considerably stronger in the first quarter personal income, although high energy of the year than had previously been prices could exert some restraint on anticipated. Underlying trends in capital spending. The possibility of an apprespending appeared to be more robust ciable rise in the personal saving rate, than had earlier been recognized, per- which was near its historical low, reprehaps partly in response to unusually sented another possible downside risk supportive financial conditions, and that to consumer spending. The recent sharp strength was thought likely to carry slowing in motor vehicle sales, which forward. Business contacts were more appeared to be related in part to the confident about economic prospects, and paring of purchase incentives and perthat confidence was bolstering firms' haps also to the high level of energy willingness to invest. Anecdotal infor- prices, raised some concerns about the mation suggested that firms were invest- expansion of economic activity in some ing in part to expand capacity and in regions. part to boost productivity and lower Some participants mentioned that costs. Some investment was being expansion abroad was apparently prompted by a need to replace equip- strengthening early this year, particument that was becoming obsolete, in larly in emerging-market economies. part because of the higher level of This development, in turn, was likely energy prices. Increased demand was to help support U.S. exports. Several reported for a wide variety of categories participants noted that past declines in of capital goods, ranging from several the foreign exchange value of the dollar types of heavy equipment, including were contributing to U.S. economic trucks, farm machinery, and construc- activity. Tourism from abroad, for examtion equipment, to software and high- ple, was being spurred by relative curtech equipment. Nonresidential con- rency values. At the same time, though, struction, however, remained soft in it was recognized that growth in U.S. many regions, damped by relatively domestic demand would likely continue high vacancy rates for office buildings to be met in part by imports, tending to and other commercial real estate. trim the increase in domestic output. Spending on housing and consumer U.S. industrial activity was increasing goods and services was also seen as steadily, pushing capacity utilization underpinning economic expansion. With higher. Production was expanding in single-family housing starts at record a broad range of manufacturing catelevels, residential investment expendi- gories, notably including high-tech and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

176 92nd Annual Report, 2005 defense industries. Business contacts advances in productivity through orgaindicated that the high level of energy nizational improvements as well as prices was spurring coal mining activity. through investment in equipment and Drilling for oil and gas was also increas- software. Regarding the latter, some eviing, although extraction was said to be dence suggested that rapid technological crimped in some instances by a scarcity progress was being sustained, which of experienced rig hands as well as spot would continue to drive down the cost shortages of certain key production of many forms of productive capital and inputs, such as drilling pipe. thus boost returns on investment. More- Around the nation, labor markets over, the stronger picture of capital conditions were reported to be stable spending that had emerged of late boded to improving, and meeting participants well for the performance of productivity perceived that slack in labor markets going forward. Still, considerable uncerwas gradually diminishing. In general, tainty persisted about longer-run prosbusiness executives indicated that labor pects for productivity growth, unit labor was readily available, although again costs, and cost pressures on profits and workers with certain skills and in cer- prices. tain occupations, such as trucking, were Meeting participants commented in becoming increasingly difficult to hire. particular detail on the inflation situ- Some commented that the failure of ation. They noted with some concern labor force participation to rise as the recent elevated readings on inflation expected as the expansion gained in prices of core personal consumption momentum likely portended somewhat expenditures, the producer price index, weaker labor force growth than previ- and indicators of prices at earlier stages ously anticipated; such a development, of production, as well as the sizable at the margin, would tend to reduce the further increase in energy prices. Noneexpansion of potential output. Still, pres- theless, many participants stated that sures on prices stemming from labor they expected total inflation to diminish costs seemed well contained and were and any rise in core consumer inflation expected to remain damped in coming to be limited. One source of upward quarters. National data and anecdotal pressure on inflation had been the rise in information suggested that wages gener- energy prices, and it seemed reasonable ally continued to increase moderately. to expect that these prices would level However, health-care expenses were a out or even decline mildly, as built into persistent source of pressure on costs. futures prices. Unit labor costs were still Growth in unit labor costs had contin- being held down by moderate wage ued to be held down by growth of output growth and rising productivity. Indeed, per hour worked, which had continued a few saw a distinct possibility of furto perform surprisingly well. Although ther positive productivity surprises, repproductivity growth had slowed from resenting a downside risk to the inflathe extraordinarily rapid pace that pre- tion outlook. Moreover, the markup of vailed earlier in the expansion, data prices over costs in nonfarm businesses for the fourth quarter of 2004, as well remained quite high, and firms would as preliminary indications for the first likely be pressed by competition to quarter of this year, suggested that gains absorb a portion of any step-up in the from efficiency remained substantial. growth of unit labor costs, at least if that Participants remarked that many busi- acceleration were limited in extent and ness executives were seeking further duration. In addition, prices of many Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 111 non-energy commodities had risen in boosting the target for the federal funds recent weeks, but such inputs consti- rate by 25 basis points to 2% percent at tuted a relatively small fraction of over- this meeting. Monetary conditions eviall business costs, and, partly for that dently were still quite accommodative, reason, in the past commodity prices economic activity appeared to have had demonstrated little predictive con- more momentum than had previously tent for broad inflation rates. While been perceived, and, while core inflashort-term inflation expectations had tion most probably would stay low, risen somewhat, longer-term inflation pressures on inflation seemed to have expectations remained well contained. risen. Prospects for legislative action And lastly, monetary policy would be to apply significant fiscal restraint were aimed at preserving price stability. unclear, even as the expansion became Still, many participants indicated that increasingly well established and pritheir uncertainty about the intensity of vate demand proved strong and resilient. inflation pressures had risen in response Although the required amount of cumuto recent developments and that, in par- lative tightening may have increased, ticular, the distribution of possible infla- members noted that an accelerated pace tion outcomes was now tilted a little of policy tightening did not appear to the upside. Although monthly statisti- necessary at this time, as a degree of cal releases could be quite volatile, the economic slack apparently remained, recent data showing consumer inflation productivity growth would probably a little above previous expectations were continue to damp increases in unit labor of concern. Also, anecdotal indications costs and prices, and inflation would of price increases were becoming more most likely continue to be contained. In common across a number of industries. these circumstances, Committee mem- Some business executives reportedly bers judged that the measured removal believed that, with aggregate demand of policy accommodation was appropriexpanding robustly and the lower for- ate for now. eign exchange value of the dollar put- In discussing the announcement to ting upward pressure on import prices, a be released after the meeting, memdegree of "pricing power" had returned. bers agreed that it was appropriate to Moreover, the recent rebound in spot acknowledge the recent evolution in the crude oil prices, and especially the sub- inflation situation by indicating that stantial advance in prices of crude oil "though longer-term inflation expectafutures contracts for delivery well into tions remain well contained, pressures the future, suggested that a significant on inflation have picked up in recent unwinding of higher energy costs might months and pricing power is more evinot be in prospect. Several participants dent. The rise in energy prices, however, indicated that, in current circumstances, has not notably fed through to core conthey viewed an upside surprise to inflasumer prices." Regarding the risks to tion as potentially more harmful than sustainable growth and price stability, an equivalent downside surprise, partly members discussed a proposal to make because such an outcome could well the Committee's assessment explicitly impart additional upward momentum to conditional on an assumption of approinflation expectations. priate monetary policy so as to under- In the Committee's discussion of score that maintaining balanced risks monetary policy for the intermeeting would require policy action. It was period, all of the members favored noted that the Committee's assessment Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

178 92nd Annual Report, 2005 of balanced risks over the past nine discomfort was expressed with language months—a period in which monetary that related so explicitly to the likely policy had been steadily tightened— trajectory of future policy action. But it necessarily had to be interpreted as was also averred that the Committee based implicitly on an assumption should, to the extent possible, provide that policy accommodation would be information that would help the public removed. A number of members anticipate the probable course of monebelieved that formulaic language by its tary policy; providing such information nature was too rigid to reflect evolving would tend to increase the effectiveness economic circumstances in a satisfac- of monetary policy. More generally, tory manner, especially when develop- members recognized that the Commitments were subtle or complex, and some tee's statement would need to evolve of these members believed that the risk over time. assessment should be discontinued. All At the conclusion of the discussion, the members ultimately approved mak- the Committee voted to authorize and ing the risk assessment in the policy direct the Federal Reserve Bank of New announcement following this meeting York, until it was instructed otherwise, explicitly conditional on appropriate to execute transactions in the System policy. Account in accordance with the follow- Members also focused on the issue of ing domestic policy directive: whether to reiterate the judgment expressed in the Committee's recent The Federal Open Market Committee statements that "... policy accommoda- seeks monetary and financial conditions that tion can be removed at a pace that is will foster price stability and promote sustainable growth in output. To further its longlikely to be measured." Some expressed run objectives, the Committee in the immethe view that such language could diate future seeks conditions in reserve constrain future policy inappropriately; markets consistent with increasing the fedwhile these concerns were not new, they eral funds rate to an average of around were now felt to be more pressing, as 23A percent. the odds that the Committee might need The vote encompassed approval of to step up the pace of policy firming the paragraph below for inclusion in the were thought to have increased. Memstatement to be released shortly after the bers noted, however, that the existing meeting: "measured pace" language was clearly conditional on the economy evolving in a way that promised a gradual return to The Committee perceives that, with appropriate monetary policy action, the upside high levels of resource utilization and and downside risks to the attainment of both on inflation remaining low, and thus sustainable growth and price stability should believed that the wording did not rule be kept roughly equal. With underlying inflaout either picking up the pace of firming tion expected to be contained, the Commitor pausing in the process of removing tee believes that policy accommodation can be removed at a pace that is likely to be policy accommodation should circummeasured. Nonetheless, the Committee will stances warrant. They also noted that the respond to changes in economic prospects as language had not precluded a notable needed to fulfill its obligation to maintain increase in medium- and longer-term price stability. interest rates over the intermeeting period as markets extended the expected Votes for this action: Messrs. Greenspan, gradual increase in policy rates. Some Geithner, Bernanke, Ms. Bies, Messrs. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 179 Ferguson, Gramlich, Guynn, Kohn, Messrs. Guynn and Lacker, Mses. Moskow, Olson, Santomero, and Stern. Pianalto and Yellen, Alternate Vote against this action: None. Mr. Guynn Members of the Federal Open voted as alternate member. Market Committee It was agreed that the next meeting Mr. Hoenig, Ms. Minehan, and of the Committee would be held on Mr. Poole, Presidents of the Tuesday, May 3, 2005. The meeting Federal Reserve Banks of adjourned at 1:25 p.m. Kansas City, Boston, and St. Louis, respectively Notation Vote Mr. Reinhart, Secretary and Economist Ms. Danker, Deputy Secretary By notation vote completed on Febru- Ms. Smith, Assistant Secretary ary 22, 2005, the Committee unani- Mr. Alvarez, General Counsel mously approved the minutes of the Mr. Baxter, Deputy General Counsel Ms. Johnson, Economist meeting of the Federal Open Market Mr. Stockton, Economist Committee held on February 1-2, 2005. Messrs. Connors, Evans, and Madigan, Vincent R. Reinhart Ms. Mester, Messrs. Oliner, Secretary Rosenblum, and Wilcox, Associate Economists Meeting Held on Mr. Kos, Manager, System Open May 3, 2005 Market Account A meeting of the Federal Open Market Mr. Ettin, Deputy Director, Division Committee was held in the offices of of Research and Statistics, Board of Governors the Board of Governors of the Federal Reserve System in Washington, Messrs. Freeman, Slifman, and D.C., on Tuesday, May 3, 2005 at Struckmeyer, Associate Directors, 9:00 a.m. Divisions of International Finance, Research and Statistics, and Present: Research and Statistics, Mr. Greenspan, Chairman respectively, Board of Governors Mr. Geithner, Vice Chairman Ms. Bies Messrs. Clouse and Whitesell, Deputy Mr. Ferguson Associate Directors, Division of Mr. Fisher6 Monetary Affairs, Board of Mr. Gramlich Governors Mr. Kohn Mr. Moskow Messrs. English and Leahy, Assistant Mr. Olson Directors, Divisions of Monetary Mr. Santomero Affairs and International Finance, Mr. Stern respectively, Board of Governors Mr. Simpson, Senior Adviser, Division 6. Secretary's note: Advice had been received of Research and Statistics, Board that Richard W. Fisher had been elected by the of Governors directors of the Federal Reserve Banks of Atlanta, Dallas, and St. Louis, as a member of the Federal Open Market Committee for the period commenc- Mr. Skidmore, Special Assistant to the ing April 4, 2005, and that he had executed his Board, Office of Board Members, oath of office. Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

180 92nd Annual Report, 2005 Mr. Small, Project Manager, Division currency ("swap") arrangements with of Monetary Affairs, Board of the Bank of Canada and the Banco de Governors Mexico. The arrangement with the Bank of Canada is in the amount of $2 bil- Mr. Brady, Section Chief, Division lion equivalent and that with the Banco of Monetary Affairs, Board of de Mexico in the amount of $3 billion Governors equivalent. Both arrangements are associated with the Federal Reserve's par- Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, ticipation in the North American Frame- Board of Governors work Agreement of 1994. The vote to renew the System's participation in the Ms. Low, Open Market Secretariat swap arrangements maturing in Decem- Assistant, Division of Monetary ber was taken at this meeting because of Affairs, Board of Governors the provision that each party must provide six months prior notice of an inten- Mr. Lyon, First Vice President, Federal tion to terminate its participation. Reserve Bank of Minneapolis The information received at this meeting suggested that the growth of eco- Messrs. Eisenbeis, Goodfriend, nomic activity had unexpectedly mod- Hakkio, Rasche, Rudebusch, and Sniderman, Senior Vice erated during the first quarter from Presidents, Federal Reserve the rapid pace seen during the second Banks of Atlanta, Richmond, half of 2004. Gains in private payroll Kansas City, St. Louis, employment over the first quarter were San Francisco, and Cleveland, similar to the average for the second respectively half of 2004 but weakened in March, and manufacturing production rose only Mr. Elsasser, Ms. Little, and Messrs. Peach and Todd, Vice Presidents, a little, on balance, over February and Federal Reserve Banks of March. Consumers appeared to have New York, Boston, New York, turned somewhat cautious in thenand Minneapolis, respectively spending, likely a reflection of higher energy prices. Housing starts fell in The Manager of the System Open March after a sustained stretch of very Market Account reported on recent high readings, but home sales continued developments in foreign exchange mar- at a rapid rate throughout the quarter. kets. There were no open market opera- Growth of capital spending, while tions in foreign currencies for the Sys- strong in the first quarter, was down tem's account in the period since the from the brisk rates of previous quarters. previous meeting. The Manager also Sharp increases in energy prices pushed reported on developments in domestic up headline inflation, and core measures financial markets and on System open were also somewhat elevated. Labor market transactions in government secu- costs, however, advanced at a moderate rities and federal agency obligations rate. Employment continued to expand during the period since the previous in March, although the increase was less meeting. By unanimous vote, the Com- than the strong advance in February. mittee ratified these transactions. Employment declined in manufacturing, By unanimous vote, the Committee retail trade, and temporary help servoted to extend for one year beginning vices, but most other sectors registered in mid-December 2005 the reciprocal gains. The average workweek remained Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 181 at its recent level, and aggregate hours Housing starts slowed in March, after posted a small gain. The unemployment exceptional strength in the prior two rate moved down to 5.2 percent in months. However, a substantial increase March. Also suggesting a gradual ero- in the level of permits in March sugsion of slack in labor markets were sur- gested that starts likely turned back up veys indicating that some employers in April. A similar pattern was observed were finding some jobs requiring spe- in the multifamily sector. The thirtycial skills harder to fill and that house- year mortgage rate in the first quarter holds were experiencing increases in job stayed in a range around its average availability. Nevertheless, survey mea- level for the past two years. Sales of sures of expected conditions in labor existing homes were rapid throughout markets softened somewhat in the early the quarter, and sales of new homes rose months of the year, and the labor mar- to another record level in March. House ket participation rate remained low in prices continued to rise rapidly over the March. first quarter, although recent data sug- Industrial production continued to gested some slowing. expand in the first quarter, but the pace Growth of business spending on was slower than in the final months of equipment and software moderated sub- 2004. Gains were restrained by a decline stantially in the first quarter from in manufacturing output, particularly the very high rates of last year, but for motor vehicles and parts, and by a appeared to retain considerable momenreduction in energy generation at utili- tum; strong gains occurred in all major ties, which was held down by unseason- categories except motor vehicles. This ably warm weather early in the year. performance reflected favorable under- Mining output, however, accelerated, as lying fundamentals, including solid did production in the business equip- growth in business output, strong ment and defense and space equipment retained earnings, high levels of liquid industries. Capacity utilization in manu- assets, and favorable borrowing condifacturing edged up on average in the tions in the form of low interest rates first quarter, but moved down in March and narrow risk spreads in bond and and remained a bit below its thirty-year loan markets. At the same time, conaverage. struction of nonresidential structures Consumer spending advanced solidly remained quite subdued. Over the first in the first quarter despite some slowing quarter, outlays for manufacturing facilin automobile sales. However, much of ities picked up a bit, but those for that strength was registered early in the office buildings stayed low despite some quarter, and spending in March was sub- declines in the office vacancy rate, and dued. Measures of consumer confidence spending on commercial structures fell. declined in the early months of the year Nonfarm inventories accumulated in but remained well above the lows of two the first two months of the year at a years ago. Other factors underlying con- much faster rate than in the preceding sumer spending also remained favor- quarter, prompting a small increase in able: Real wages and salaries continued inventory-sales ratios. Inventory gains to rise, and the ratio of wealth to income were especially strong early in the quarremained high, although it was down a ter and were concentrated in the manubit because of a decline in equity prices. facturing sector. The personal saving rate stayed low over The U.S. international trade deficit the first quarter of the year. widened in February as exports held Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

182 92nd Annual Report, 2005 steady. The value of imported oil up in recent months and pricing power jumped sharply, and nonoil imports also was more evident, longer-term inflation rose. Economic indicators for major for- expectations remained well contained. eign industrial countries suggested some In these circumstances, the Committee slowing of growth late in the quarter believed that policy accommodation after a pickup earlier in the year. In could be removed at a pace that would Japan, industrial production rose briskly likely be measured but noted that it in January before falling back; the would respond to changes in economic euro-area industrial sector evidenced a prospects as needed to fulfill its obligasimilar pattern. By contrast, economic tion to maintain price stability. activity in China and other developing The FOMC's decision in March to countries showed greater buoyancy. raise the intended level of the federal Consumer price inflation abroad re- funds rate 25 basis points was fully mained subdued. anticipated by the market, as were its U.S. consumer price inflation firmed retention in the accompanying statement in recent months as energy prices rose of the "measured pace" language and its sharply. Core consumer prices also rose assessment that the risks to price stabila bit more rapidly recently, but the ity and sustainable economic growth increase over the twelve months end- were balanced. Interest rates, however, ing in March was little different than rose, reportedly in response to the stateover the year-earlier period. According ment's references to increased price to survey information, expectations of pressures and to more evident pricing near-term inflation picked up in March, power as well as to the Committee's consistent with the increase in energy conditioning of its risk assessment on prices. As for labor costs, the employ- "appropriate monetary policy action." ment cost index for private industry Interest rates rose further the next day decelerated over the first quarter from following the release of a larger-thanan already moderate pace. The slowing expected increase in the CPI for Februoccurred in both the wages and salaries ary. Over subsequent weeks, however, component and the benefits component these increases were more than reversed and was fairly widespread across indus- by weaker-than-expected data on contry groups. sumer spending, consumer sentiment, At its March meeting, the Federal and output. Further downward pressure Open Market Committee decided to on interest rates was exerted by the marincrease the target level of the federal ket's response to the release of the minfunds rate 25 basis points, to 23A per- utes of the March meeting, as attention cent. In its accompanying statement, focused on the reference to Committee the Committee expressed its perception members' judgment that an accelerated that, with appropriate monetary policy path of policy tightening was not necaction, the upside and downside risks essary at that time. Despite generally to the attainment of both sustainable good first-quarter earnings reports, growth and price stability should be equity indexes moved down considerkept roughly equal. The Committee also ably in response to the signs of weaker noted that economic output continued to economic growth. In foreign exchange grow at a solid pace despite the rise in markets, the dollar rose on balance, energy prices and that labor market con- apparently due, in part, to disappointditions continued to improve gradually. ing news on employment and output While pressures on inflation had picked abroad. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 183 M2 expanded in March and April at Earlier increases in energy prices about the same sluggish pace as it did seemed to be an important factor conearlier in the year. The growth of M2 tributing to an uptick in core inflation continued to be restrained by increases and a slower pace of economic activity. in its opportunity cost resulting from With energy prices leveling out more rising short-term interest rates. Rates recently, however, and the behavior of paid on its liquid components particu- compensation suggesting a lack of preslarly lagged increases in market rates. sure in labor markets, underlying infla- Partly in response to the receipt of tion appeared to remain contained. The weaker-than-expected data for spend- weakness in spending was widespread ing and output in the first quarter, the and could not be completely dismissed, staff marked down somewhat its fore- but it had appeared only very recently cast of economic growth for 2005 and and could be a product of the inherent 2006. Even so, the economy was seen as noisiness of high-frequency economic retaining considerable momentum, and data. On balance, economic fundamengrowth was expected to pick up some tals including low interest rates, robust after the first quarter, paced by business underlying productivity growth, and spending on equipment and software. strengthened business balance sheets Consumption expenditures were seen as were expected to support economic likely to expand at a moderate rate and growth at a pace sufficient to gradually residential investment to slow. With eliminate remaining slack in resource exports forecast to expand a bit more utilization. Although the economic outrapidly than imports, the arithmetic net look generally seemed favorable, there drag on the economy from trade was was also broad recognition of greater expected to lessen. Fiscal policy was uncertainty attending the outlook for expected to provide a more moderate both inflation and output growth. impetus to growth this year and next, Capital expenditures advanced briskly following the substantial boost esti- over the first quarter, but at a pace sigmated for earlier years. Although eco- nificantly below that registered over the nomic growth was projected to run a bit latter half of last year. To some extent, above the staffs estimate of the econo- businesses probably had pulled capital my's potential, the unemployment rate outlays forward from this year into 2004 was projected to hold around its current to benefit from the partial-expensing level with improvements in job pros- tax provision that expired at year-end, pects expected to lure more workers but the unexpected weakness in capital back into the labor force. Inflation was goods orders for February and March projected to edge lower over the rest seemed hard to attribute to this factor of the year and into 2006, reflecting alone. In addition, the prolonged period the attenuation of the impact of higher of elevated spot energy prices, the sense energy prices and the effects of a slowed supported by futures markets that these rate of growth of import prices and higher prices may persist for some time, remaining slack in resource markets. and the heightened uncertainty about In their discussion of current condi- energy prices going forward, together tions and the economic outlook, meeting may have left businesses less confident participants observed that incoming data about the future and wary of longerover the intermeeting period hinted at term commitments such as expanding possible upside risks for inflation and plant capacity or taking on new workdownside risks for economic growth. ers. A less buoyant and less certain Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

184 92nd Annual Report, 2005 economic outlook seemed apparent in inventory of new autos had moved financial markets as well, where equity appreciably higher. Although difficult prices had fallen and risk spreads had to judge, the inventory buildup was not widened. On balance, though, these regarded as likely to have major implifinancial developments did not appear cations for aggregate manufacturing to signal the onset of a sharp retrench- beyond some modest production cutment in investors' willingness to bear backs in the current quarter. risk, and capital expenditures were seen A relatively high proportion of as likely to remain quite robust, spurred demand had continued to be met by by strong economic fundamentals that imports. Some concern was expressed included elevated profits, opportunities that incoming data suggested weaker to raise efficiency by utilizing new growth in some of our major trading technologies, a low cost of capital, and partners, which posed a downside risk strong corporate balance sheets. Indeed, to forecasts for U.S. exports. Moreover, a substantial weakening in business advances in domestic income were investment in an environment with such expected to contribute to brisk growth favorable fundamentals would be at in imports. Looking ahead, the U.S. odds with the historical record. economy was expected to continue to Incoming data for the household run quite substantial current account sector were viewed as mixed. Higher deficits, although the impact of past gasoline prices seemed to be sapping dollar depreciation should work to boost consumer confidence and consumer exports and slow the rise in imports to spending. The pace of consumption some extent. growth had fallen off appreciably toward Recent energy price developments the end of the first quarter, and some garnered considerable attention. Departicipants worried about the poten- clines in energy prices in recent weeks tial for continued sluggishness in con- were viewed as welcome, but particisumer spending if increasingly cautious pants noted that far-dated futures prices households sought to raise their saving for oil remained quite elevated and that rate rapidly. On balance, though, strong persistently high energy prices could income growth and low interest rates trigger a range of deleterious effects augured well for household spending. on the economy. High energy prices Although housing starts had dropped of appeared to be taking a toll on houselate, home sales and other indicators of hold and business confidence and might activity in the residential real estate mar- be beginning to crimp corporate profits. ket remained at very high levels. House In some cases, firms seemed to be more price appreciation was expected to mod- successfully passing on energy costs to erate over coming quarters, but a num- their customers. Indeed, some portion ber of local real estate markets were still of recent elevated inflation readings regarded as "hot," with signs of pos- probably represented, at least partly, sible speculative excesses in some areas. such pass-through effects from higher The deceleration in final sales over energy costs. However, while passthe first quarter had been accompanied through effects could leave the overall by a sizable accumulation of businesses price level higher, their impact on inflainventories. The available data sug- tion should fade over time, as long as gested that stocks had accumulated in inflation expectations remain well cona variety of industries, but particularly tained. Still, considerable uncertainty in the motor vehicle sector where the surrounded the degree of pass-through Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 185 from energy prices to core consumer on inflation stemming from these three prices, and pass-through effects might sources were expected to lessen over be more pronounced when energy coming quarters. On balance, measures price increases were perceived as more of core inflation were thought likely to likely to be permanent. Persistently high remain in check over the remainder of energy prices were mentioned as a fac- this year and next. tor that could trim the level of potential In the Committee's discussion of output to a small degree over time, pos- monetary policy for the intermeeting sibly contributing to additional upward period, all members favored raising the pressure on consumer prices at the target federal funds rate 25 basis points margin. to 3 percent at this meeting. Although Participants voiced concerns about downside risks to sustainable growth recent price trends; they expected infla- had become more evident, most memtion to remain contained but also per- bers regarded the recent slower growth ceived that the risks to that inflation of economic activity as likely to be tranoutlook now might be skewed some- sitory. In this regard, the ability of the what to the upside. Core measures of U.S. economy to withstand significant price inflation had moved up over recent shocks over recent years buttressed the quarters and particularly so over the last view that policymakers should not overfew months. A discernable upcreep was react to a comparatively small number apparent in survey measures of short- of disappointing indicators, especially and, to a limited extent, long-term infla- when economic fundamentals appeared tion expectations over recent months. to remain quite supportive of continued Moreover, there were risks that the rela- solid expansion. To be sure, the Comtive stability of long-term survey mea- mittee had raised its federal funds rate sures of inflation expectations could target appreciably over the past year, simply reflect lags in households' per- and, in the view of a few members, ceptions of changing economic pros- a larger-than-expected moderation of pects. The success that some businesses aggregate demand in response to this seemed to be encountering in passing cumulative policy action could not through cost increases raised the pos- be ruled out. However, all members sibility that competitive pressures and regarded the stance of policy as accomresource slack were exerting somewhat modative and judged that the current less restraint on inflation than had been level of short-term rates remained too anticipated. low to be consistent with sustainable However, available indicators of growth and stable prices in the long wages and benefits had registered only run. Against the backdrop of the recent modest growth, suggesting to many that uptick in core inflation and in some some slack in labor markets persisted. measures of inflation expectations, mem- Moreover, market measures of infla- bers agreed that they should continue tion compensation had ebbed in recent along the course of removing policy weeks, and survey measures of long- accommodation at a measured pace conterm inflation expectations, albeit a ditional on the outlook for inflation and touch higher of late, remained in the economic growth. broad range of recent years. Along with In discussing the statement to be energy prices, import and materials released after the meeting, members prices apparently had contributed to the agreed that it was appropriate to recent uptick in inflation, and pressures acknowledge that rising energy prices Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

186 92nd Annual Report, 2005 seemed to have spurred an increase in conditioned on economic developments core measures of inflation by dropping and therefore would not stand in the the reference from the March statement way of either a pause or a step-up in indicating that "The rise in energy policy firming depending on events. In prices, however, has not notably fed the end, all members agreed to retain the through to core consumer prices." They forward-looking language. likewise all agreed that mention should At the conclusion of the discussion, be made that, on balance, longer-term the Committee voted to authorize and inflation expectations remained well direct the Federal Reserve Bank of New contained. Regarding the risks to sus- York, until it was instructed otherwise, tainable growth and price stability, some to execute transactions in the System members noted that the risk assess- Account in accordance with the followment conditioned on "appropriate pol- ing domestic policy directive: icy" no longer seemed to convey useful information regarding the Committee's The Federal Open Market Committee seeks monetary and financial conditions economic and policy outlook. Although that will foster price stability and promote some members noted that a case could sustainable growth in output. To further be made that the risks to inflation were its long-run objectives, the Committee in now somewhat skewed to the upside and the immediate future seeks conditions in those to sustainable economic growth reserve markets consistent with increasing the federal funds rate to an average of around perhaps to the downside, the most likely 3 percent. outcome remained one of stable prices and sustainable growth, and the Com- The vote encompassed approval of mittee agreed that it should retain a balthe paragraph below for inclusion in the anced assessment of risks conditional on statement to be released shortly after the appropriate policy. meeting: For many, heightened economic uncertainty in the current environment The Committee perceives that, with approimplied greater uncertainty about the priate monetary policy action, the upside and downside risks to the attainment of both range of possible policy outcomes and sustainable growth and price stability should placed a premium on flexibility in setbe kept roughly equal. With underlying inflating policy at upcoming meetings. Some tion expected to be contained, the Commitmembers commented that this greater tee believes that policy accommodation uncertainty called for eliminating or can be removed at a pace that is likely to be paring back forward-looking language measured. Nonetheless, the Committee will respond to changes in economic prospects as from the statement—if not at this meetneeded to fulfill its obligation to maintain ing, then fairly soon. In the event, most price stability. members viewed the forward-looking language in the statement—including Votes for this action: Messrs. Greenspan the characterization of the stance of and Geithner, Ms. Bies, Messrs. Ferguson, Fisher, Gramlich, Kohn, Moskow, Olson, policy as accommodative as well as Santomero, and Stern. Votes against this the judgment that policy accommodaaction: None. Absent and not voting: tion could be removed at a pace that is Mr. Bernanke "likely to be measured"—as a reasonable characterization of the policy stance It was agreed that the next meeting and its likely evolution over time. More- of the Committee would be held on over, a number remarked that the lan- Wednesday-Thursday, June 29-30,2005. guage in its current form was clearly The meeting adjourned at 1:25 p.m. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 187 Notation Vote Messrs. Evans, Freeman, and Madigan, Ms. Mester, Messrs. Oliner, Rolnick, Rosenblum, Tracy, and By notation vote completed on April 11, Wilcox, Associate Economists 2005, the Committee unanimously approved the minutes of the meeting of Mr. Kos, Manager, System Open the Federal Open Market Committee Market Account held on March 22, 2005. Mr. Ettin, Deputy Director, Division Vincent R. Reinhart of Research and Statistics, Secretary Board of Governors Meeting Held on Messrs. Kamin, Slifman, and June 29-30, 2005 Struckmeyer, Associate Directors, Divisions of International Finance, A meeting of the Federal Open Market Research and Statistics, and Committee was held in the offices of Research and Statistics, the Board of Governors of the Fed- respectively, Board of Governors eral Reserve System in Washington, D.C., on Wednesday, June 29, 2005 at Messrs. Clouse, Wascher, and 2:00 p.m. and continued on Thursday, Whitesell, Deputy Associate June 30, 2005 at 9:00 a.m. Directors, Divisions of Monetary Affairs, Research and Statistics, and Monetary Affairs, Present: respectively, Board of Governors Mr. Greenspan, Chairman Mr. Geithner, Vice Chairman Ms. Bies Messrs. English, Leahy, and Treacy,7 Mr. Ferguson Assistant Directors, Divisions of Mr. Fisher Monetary Affairs, International Mr. Gramlich Finance, and Banking Supervision Mr. Kohn and Regulation, respectively, Mr. Moskow Board of Governors Mr. Olson Mr. Santomero Mr. Stern Mr. Simpson, Senior Adviser, Division of Research and Statistics, Board of Governors Ms. dimming, Messrs. Guynn and Lacker, Mses. Pianalto and Yellen, Alternate Members of the Federal Mr. Skidmore, Special Assistant to the Open Market Committee Board, Office of Board Members, Board of Governors Mr. Hoenig, Ms. Minehan, and Mr. Poole, Presidents of the Federal Reserve Banks of Mr. Small, Project Manager, Division Kansas City, Boston, and of Monetary Affairs, Board of St. Louis, respectively Governors Mr. Reinhart, Secretary and Economist Mr. Wright,8 Section Chief, Division Ms. Danker, Deputy Secretary of Monetary Affairs, Board of Ms. Smith, Assistant Secretary Governors Mr. Alvarez, General Counsel Mr. Baxter, Deputy General Counsel Ms. Johnson, Economist 7. Attended Wednesday's portion of the meeting. Mr. Stockton, Economist 8. Attended Thursday's portion of the meeting. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

188 92nd Annual Report, 2005 Messrs. Bowman,8 Gallin,7 and System's account in the period since Lehnert,7 Senior Economists, the previous meeting. The Manager also Divisions of International Finance, reported on developments in domestic Research and Statistics, and financial markets and on System open Research and Statistics, respectively, Board of Governors market transactions in government securities and federal agency obligations Messrs. Doyle7 and Martin,7 during the period since the previous Economists, Division of meeting. By unanimous vote, the Com- International Finance, Board mittee ratified these transactions. of Governors At this meeting the Committee Messrs. Kumasaka7 and Luecke, Senior reviewed and discussed staff presenta- Financial Analysts, Division of tions on the topic of housing valuations Monetary Affairs, Board of and monetary policy. Prices of houses in Governors the United States had risen sharply in recent years, especially in certain areas Ms. Low, Open Market Secretariat of the country, to very high levels rela- Specialist, Division of Monetary Affairs, Board of Governors tive to incomes or rents. In addition to local market factors, a wide range of Mr. Barron, First Vice President, influences appeared to be supporting Federal Reserve Bank of Atlanta home prices, including solid gains in disposable income, low mortgage rates, Messrs. Eisenbeis and Judd, Executive and financial innovation in the residen- Vice Presidents, Federal Reserve Banks of Atlanta and tial mortgage market. Prices might be San Francisco, respectively somewhat above the levels consistent with these underlying factors, but mea- Messrs. Fuhrer, Goodfriend, and suring the extent of any overvaluation Hakkio, Ms. Perelmuter, either nationally or in regional markets Messrs. Rasche, Rudebusch,7 Sniderman, and Williams,7 Senior posed considerable conceptual and sta- Vice Presidents, Federal Reserve tistical difficulties. Meeting participants Banks of Boston, Richmond, noted that the rise in house prices Kansas City, New York, St. Louis, had been accompanied by a modest shift San Francisco, Cleveland, and toward potentially riskier types of mort- San Francisco, respectively gages, including adjustable-rate and Mr. Peach,7 Vice President, Federal interest-only loans, which could pose Reserve Bank of New York challenges to both lenders and borrowers. Nonetheless, financial institutions By unanimous vote, the Federal Open generally remained in a comfortable Market Committee approved the selec- capital position, such loans had pertion of Richard T. Freeman to serve as formed well thus far, much of the assoassociate economist of the Committee ciated risk had been transferred to other until the selection of a successor at the investors through securitization, and first regularly scheduled meeting after valuations had risen more rapidly than December 31, 2005. mortgage debt on average—so that loanto-value ratios had fallen. The Manager of the System Open Market Account reported on recent The information received at this developments in foreign exchange mar- meeting suggested that the economy kets. There were no open market oper- was expanding at a moderate pace in ations in foreign currencies for the the second quarter. Housing activity Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 189 remained at a high level, business Real personal consumption expendiinvestment appeared to have improved tures appeared to be increasing at a some after a slowdown of growth in the moderate pace this quarter, though a bit first quarter, and manufacturing picked below that of the first quarter. Purchases up notably in May. Supported by a of motor vehicles rebounded smartly rebound in motor vehicle purchases, after declining in the first quarter. consumer spending appeared on track to Excluding motor vehicles, however, post another moderate gain for the quar- the expansion of real consumer outlays ter. Labor demand continued to expand, likely slowed of late, against a backand the unemployment rate edged down drop of modest gains in real income. further in May. Core CPI inflation Recent measures of consumer confislowed in April and May, but crude oil dence improved from their levels earlier prices turned higher again following a in the spring, when higher gasoline decline earlier in the spring. prices and concerns about a slowing in Averaging through a large gain in the pace of the economic expansion may April and a more modest increase in have served as restraining influences. May, growth in payroll employment was Activity in the housing sector on par with that over the preceding six remained robust. Single-family starts months. Payrolls expanded in line with averaged more than 1.65 million units their recent trends in the construction, at an annual rate in April and May, not transportation and utilities, and nonbusi- much below the very strong first-quarter ness services sectors, while hiring in pace. Sales of both new and existing financial services slowed a bit, and the homes remained at a high level in May. manufacturing sector posted further While prices of existing homes continsmall losses of jobs. The average work- ued to increase rapidly, new home prices week of production or nonsupervisory showed signs of decelerating. Available workers edged up over the two-month indicators suggested that, with the ongoperiod, helping to boost aggregate hours ing support of low mortgage rates, the to the highest level since early 2001. housing sector remained strong in June. The unemployment rate dipped to Spending on equipment and soft- 5.1 percent in May. Meanwhile, the ware registered a solid increase in the labor force participation rate moved up first quarter, and the available data a bit, suggesting that the labor market suggested that second-quarter spendhad strengthened enough to attract some ing was continuing at a slightly faster individuals back into the workforce. pace. Shipments of nondefense capital Survey indicators and the continued goods posted sizable increases in recent relatively low level of initial claims for months, although gains in orders were unemployment insurance also supported more uneven. Broadly speaking, the funthe notion of continued improvement in damentals continued to support business the labor market. investment, with the user cost of capital Industrial production declined in still low and corporate balance sheets April, owing to a dip in utilities output, healthy. Outlays for construction of but widespread gains in manufacturing nonresidential structures appeared to output in May offset that loss. On net, have picked up some, but die level of industrial production was little changed such investment remained subdued. And over April and May; capacity utilization although spending on commercial strucgenerally followed the same pattern as tures had moved up in recent months, output. outlays for office buildings were still at Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

190 92nd Annual Report, 2005 depressed levels, and expenditures on estimated to have slowed some after manufacturing and other facilities were advancing notably in the fourth quarter; lackluster. the first quarter increase was broadly The book value of manufacturing and similar to those posted during the middle trade inventories continued to grow in of last year. April, but more slowly than in the At its May meeting, the Federal Open first quarter. With these increases, the Market Committee decided to increase inventory-sales ratio fell back in April the target level of the federal funds after moving up a little in the first rate 25 basis points, to 3 percent. In its quarter. accompanying statement, the Commit- After reaching a record high relative tee expressed its perception that, with to GDP in February, the U.S. interna- appropriate monetary policy action, the tional trade deficit narrowed in March, upside and downside risks to the attainbut widened again in April. While the ment of both sustainable growth and value of exports of goods and services price stability should be kept roughly increased in both months, the value of equal. The Committee also noted that imports of goods and services jumped recent data suggested that the solid pace in April, more than offsetting a decline of spending growth had slowed somein March. GDP growth in most major what, partly in response to the earlier foreign industrial economies picked up increases in energy prices, but that labor slightly in the first quarter, but recent market conditions apparently continued economic indicators for the major for- to improve gradually. While pressures eign economies in the second quarter on inflation had picked up in recent were mixed. months and pricing power was more Consumer prices were about un- evident, longer-term inflation expectachanged in May after posting large tions remained well contained. In these increases in the previous few months. circumstances, the Committee believed Consumer energy prices, in particular, that policy accommodation could be reversed part of their earlier run-up. removed at a pace that would likely Excluding food and energy, inflation be measured but noted that it would appeared to have moderated slightly respond to changes in economic prosfrom its pace in the early part of the pects as needed to fulfill its obligation to year. Despite this moderation, measures maintain price stability. of core consumer price inflation over The decision at the May FOMC meetthe past year were somewhat above ing to raise the federal funds rate tarthose for the comparable period a year get 25 basis points, to 3 percent, to ago. The producer price index rose maintain an assessment that risks to the sharply in April, but dropped back again goals of price stability and sustained in May, driven largely by a swing in the growth were balanced, and to retain the food and energy components. Accord- "measured pace" language was widely ing to recent surveys, both near-term expected in financial markets. The puband longer-term inflation expectations lication of the minutes three weeks later had changed little over the past two also contained few surprises for invesmonths, and market measures of infla- tors and elicited little market reaction. tion compensation had moved lower. Market expectations for the future path With regard to labor costs, growth in of policy ended the period higher in the hourly compensation in the nonfarm near term but lower at longer horizons. business sector in the first quarter was Nominal Treasury yields followed the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 191 shift in policy expectations, with near- imports over the forecast period. The term yields higher and longer-term forecast for consumer price inflation yields modestly lower, on net. Spreads was revised up, with inflation seen as on investment-grade corporate bonds somewhat higher this year than in 2004, were little changed over the intermeet- reflecting in part higher import prices ing period, but spreads on speculative- and the direct and indirect effects of grade bonds contracted notably. Buoyed higher energy prices, and only edging by the drop in longer-term interest rates lower next year as these price pressures and largely upbeat economic news, wane. major equity indexes rose appreciably In their discussion of current condiover the intermeeting period. The posi- tions and the economic outlook, many tive economic data also seemed to lift meeting participants noted that incomthe dollar against major foreign curren- ing data had been reassuring about the cies, though the dollar's moves against strength of the expansion. Following individual currencies varied widely. some softer readings earlier in the year, M2 edged lower over April and May incoming spending and production data as the opportunity cost of holding M2 over the intermeeting period indicated assets rose further. Liquid deposits were that the expansion remained firm, led by especially weak, owing to the slow residential and business investment. In adjustment of yields paid on these addition, labor market conditions contindeposits to increases in market rates. ued to strengthen gradually. The econ- Despite the recent softness in M2, its omy evidently had been resilient in the velocity remained quite low relative to face of rising energy prices, and finanits historical relationships with oppor- cial conditions remained accommodatunity cost. Bank credit decelerated tive, supporting growth going forward. sharply in April and May from rapid Increases in core consumer prices had gains posted in the first quarter, as slowed of late, though underlying inflagrowth in both securities and loans fell. tion was still seen by most meeting par- In the staff forecast prepared for this ticipants as likely to be modestly higher meeting, the economy was seen as likely this year than last, impelled in part to expand this year and next at a rate by the pass-through of a further rise in just above its potential. The effects of energy prices. However, the impetus to reduced monetary and fiscal policy inflation from the prices of oil and other stimulus were expected to be counter- commodities was expected to wane, and balanced by continued low long-term long-term inflation expectations apparinterest rates and an abatement of ently remained well-anchored. With energy-related headwinds. Household some limited remaining slack in labor spending was expected to firm going markets likely damping growth in comforward as real income posts solid pensation, as well as further withdrawal gains attributable in part to the ongoing of policy accommodation, core inflation improvement in the labor market. Busi- was expected to remain contained. ness investment was projected to benefit In preparation for the Federal Refrom the combination of favorable pros- serve's semiannual report to the Conpects for sales, supportive financial mar- gress on monetary policy, the members kets, and the ongoing need to replace or of the Board of Governors and the presiupgrade aging equipment and software. dents of the Federal Reserve Banks A slightly larger portion of domestic submitted individual projections of the demand was expected to be supplied by growth of GDP, the rate of unemploy- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

192 92nd Annual Report, 2005 ment, and core consumer price inflation about the outlook. Conditions in the for 2005 and 2006. The forecasts of the commercial real estate sector, which rate of expansion in real GDP were con- had been weak for some time, were said centrated in the upper part of a 3 to to have improved in some parts of the 33/4 percent range for 2005, and the fore- nation. casts for 2006 were concentrated at the Several meeting participants exlower end of a range of 3XA to 33A per- pressed some concern about domestic cent. These rates of growth were associ- and global imbalances. Large federal ated with a civilian unemployment rate budget deficits were expected to perof 5 to 5V4 percent in the fourth quarter sist despite an increase in tax receipts of this year and a rate of 5 percent in in recent months. These deficits were the fourth quarter of 2006. Forecasts of contributing to a low level of national the rate of inflation, as measured by the saving that would, if not corrected over core PCE price index, were mainly near time, ultimately constrain investment the middle of a V/i to 2VA percent range and overall economic growth. Morethis year and somewhat below the mid- over, U.S. trade deficits were expected dle of a range of lx/2 to 2V2 percent next to remain large going forward, reflectyear. ing both the low level of U.S. saving and In their comments about develop- relatively slow growth in some of our ments in key sectors of the economy, trading partners. Uncertainties regardmeeting participants noted that the fun- ing the nature and timing of the potendamentals underlying household spend- tial correction of these imbalances ing remained firm. With rising home complicated the assessment of the and equity prices buoying household intermediate-term prospects for the U.S. wealth, consumer expenditures contin- economy. ued to advance. Although the recent In their discussion of developments surge in energy prices was anticipated in asset markets, the participants' comto impose some drag for a time, con- ments focused on two related issues: the sumption spending was expected to low level of long-term interest rates and grow about in line with income going the continued run-up in home prices. forward, in an environment of further Despite substantial cumulative policy gradual improvements in labor markets. tightening over the past year, long-term Increased speculative activity in hous- Treasury yields had moved considerably ing markets was evident in some parts lower, implying a significant flattening of the country, but robust demand for of the yield curve (measured as the new homes owed in large part to the spread between long-term and shortongoing economic expansion and low term Treasury yields). Lower compensalong-term interest rates. tion for inflation accounted for a portion Business outlays for capital goods of the decline in longer-term nominal continued to rise, and the outlook for yields, but a larger portion reflected investment spending remained solid, reductions in real yields. Participants supported by increased sales, low inter- cited a variety of factors as possibly est rates, robust profits, and strong busi- contributing to the unusual behavior ness balance sheets. Anecdotal reports of long-term rates over this period. from industry contacts generally pointed For one, investors might have marked to planned increases in investment down the level of real interest rates spending, though in some regions busi- seen as likely to be necessary to connesses apparently remained cautious tain inflation and keep output in line Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 193 with potential—perhaps reflecting weak been higher than most participants had investment demand abroad relative to expected at the start of the year, reflectsaving—or even might have come to ing, at least in part, the pass-through expect a stretch of sub-par U.S. growth. effects of higher energy, commodity, and However, anticipation of slow growth import prices. While such shocks could seemed inconsistent with higher stock be expected to boost inflation tempoprices and thin risk spreads in corporate rarily, some participants expressed condebt markets. The behavior of long-term cern that, with policy still accommodainterest rates could also reflect reduced tive, the underlying pace of inflation uncertainty on the part of investors might be in the process of stepping up, about the economic outlook—as seen perhaps to a level that was at the upper in low readings of implied volatility end of the range that they viewed as in bond and equity markets. Finally, compatible with the Committee's price demands for longer-term U.S. securities stability objective. The degree of slack by both domestic and foreign investors remaining in labor and resource markets might have been boosted by special fac- was very uncertain, and unit labor costs tors. Confidence about the economic in the nonfarm business sector had outlook and low market interest rates— moved notably higher in recent quarters. along with possibly outsized expecta- Trend unit labor costs could also be tions of capital gains in some markets— boosted by slower growth in structural could also help to account for the high productivity; while recent evidence level of home prices the Committee was not conclusive, some participants had discussed on the first day of the thought the underlying pace of promeeting. It was agreed that considerable ductivity growth might well fall back uncertainty attended the outlook for both in coming quarters following the sublong-term interest rates and home prices. stantial gains seen in recent years. And With regard to any role for monetary with higher energy prices already eating policy in responding to possible imbal- into profit margins at firms outside the ances in housing or bond markets, meet- energy sector, increases in unit labor ing participants stressed the importance costs might be more likely to be passed of the pursuit of their core objectives through into prices. of price stability and maximum sustain- While agreeing that inflation developable economic growth. To the extent ments had to be watched carefully, other that an asset price movement threatened meeting participants emphasized that the achievement of those objectives, it recent core inflation data had been relawould of course be taken into consider- tively restrained, and anecdotal reports ation in setting policy. However, given suggested that pricing power at many the unavoidable uncertainties associated firms remained quite limited. Moreover, with judgments regarding the appropri- readings from futures markets suggested ate level of and likely future movements that oil prices would likely flatten out, in asset prices, a strategy of responding so their effect on inflation should gradumore directly to possible mispricing was ally ebb. Similarly, prices of other comseen as very unlikely to contribute, on modities and imports, which had surged balance, to the achievement of the Com- for a time, were now moderating. Surmittee' s objectives over time. vey and market measures of long-term Participants' views on the inflation inflation expectations did not suggest outlook were mixed. Thus far in 2005, that the earlier higher inflation readings core consumer price inflation had were going to persist. Finally, while the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

194 92nd Annual Report, 2005 degree of slack in labor markets was removed at a pace that is likely to be uncertain, total labor compensation had measured" correctly characterized the probably been boosted temporarily outlook for policy for now. The memaround the turn of the year by special bers concurred that at this stage in factors, and the recent behavior of a the expansion, with margins of slack range of other indicators of labor costs resources narrowing and inflation someappeared consistent with some remain- what higher, the Committee needed to ing slack that would likely tend to be particularly alert to signs of a further restrain inflation pressures. Moreover, increase in inflation. Such an increase anecdotal reports of labor market condi- could be particularly problematic tions continued to point to shortages because it might impart upward momenof labor only for certain, mostly skilled, tum to inflation expectations that would occupations. be costly to reverse. In any case, addi- In the Committee's discussion of tional tightening would probably be necmonetary policy for this meeting, all essary, but views differed on the amount members agreed on a 25 basis point of tightening that would likely be increase in the target federal fimds required to keep inflation contained and rate to 3x/4 percent. Economic growth bring output in line with potential. Howremained firm, while rising energy, and ever, members agreed that there was no possibly labor, costs threatened to put need to make such an assessment at this upward pressure on inflation. Even time, and that the appropriate pace and with this action, the federal funds rate degree of cumulative policy adjustment remained below the level members would depend on economic developanticipated would prove necessary in the ments going forward. With the forwardlong run to contain inflation pressures looking language in the statement and keep output near potential. How- clearly conditioned on the outlook, it ever, the pace and extent of future pol- was not seen as limiting the Commiticy moves would depend on incoming tee's flexibility in responding to such data. developments. In considering the statement to be At the conclusion of the discussion, released following this meeting, mem- the Committee voted to authorize and bers concurred that it should note that direct the Federal Reserve Bank of New even with the rise in oil prices, the York, until it was instructed otherwise, expansion remained firm and labor to execute transactions in the System markets continued to improve gradually. Account in accordance with the follow- All also thought that the statement ing domestic policy directive: should note the continued pressures on inflation, while mentioning that long- The Federal Open Market Committee term inflation expectations remained seeks monetary and financial conditions that well contained. With policy still seen as will foster price stability and promote sustainable growth in output. To further its longaccommodative, members agreed that run objectives, the Committee in the immethe statement should retain an assess- diate future seeks conditions in reserve ment that the risks to both sustainable markets consistent with increasing the fedeconomic growth and price stability eral funds rate to an average of around were balanced, conditional on appropri- VA percent. ate policy action. Members also agreed that the statement language indicating The vote encompassed approval of that "policy accommodation can be the paragraph below for inclusion in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 195 statement to be released shortly after the Mr. Ferguson meeting: Mr. Fisher Mr. Kohn Mr. Moskow The Committee perceives that, with appro- Mr. Olson priate monetary policy action, the upside Mr. Santomero and downside risks to the attainment of both Mr. Stern sustainable growth and price stability should be kept roughly equal. With underlying infla- Messrs. Guynn and Lacker, tion expected to be contained, the Commit- Mses. Pianalto and Yellen, tee believes that policy accommodation can Alternate Members of the Federal be removed at a pace that is likely to be Open Market Committee measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain Mr. Hoenig, Ms. Minehan, and price stability. Mr. Poole, Presidents of the Federal Reserve Banks of Kansas City, Boston, and Votes for this action: Messrs. Greenspan St. Louis, respectively and Geithner, Ms. Bies, Messrs. Ferguson, Fisher, Gramlich, Kohn, Moskow, Olson, Santomero, and Stern. Votes against this Ms. Danker, Deputy Secretary action: None. Ms. Smith, Assistant Secretary Mr. Alvarez, General Counsel Ms. Johnson, Economist It was agreed that the next meeting of Mr. Stockton, Economist the Committee would be held on Tuesday, August 9, 2005. Messrs. Connors and Madigan, The meeting adjourned at 1:25 p.m. Ms. Mester, Messrs. Rosenblum, Tracy, and Wilcbx, Associate Economists Notation Vote Mr. Kos, Manager, System Open By notation vote completed on May 23, Market Account 2005, the Committee unanimously approved the minutes of the meeting of Mr. Struckmeyer, Associate Director, Division of Research and the Federal Open Market Committee Statistics, Board of Governors held on May 3, 2005. Messrs. Clouse and Whitesell, Deputy Vincent R. Reinhart Associate Directors, Division of Secretary Monetary Affairs, Board of Governors Meeting Held on Messrs. English and Gagnon, and August 9, 2005 Ms. Liang, Assistant Directors, Divisions of Monetary Affairs, A meeting of the Federal Open Market International Finance, and Research and Statistics, Committee was held in the offices of respectively, Board of Governors the Board of Governors of the Federal Reserve System in Washington, D.C., Mr. Skidmore, Special Assistant to the on Tuesday, August 9, 2005 at 9:00 a.m. Board, Office of Board Members, Board of Governors Present: Mr. Greenspan, Chairman Mr. Small, Project Manager, Division Mr. Geithner, Vice Chairman of Monetary Affairs, Board of Ms. Bies Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

196 92nd Annual Report, 2005 Mr. Wright, Section Chief, Division The information received at this meetof Monetary Affairs, Board of ing suggested that final demand had Governors expanded at a solid pace in the second quarter, led by a surge in net exports and Mr. Luecke, Senior Financial Analyst, another robust gain in residential invest- Division of Monetary Affairs, Board of Governors ment, while business investment and consumer spending rose at moderate Ms. Low, Open Market Secretariat rates. The labor market continued to Specialist, Division of Monetary improve gradually in June and July. Affairs, Board of Governors Core CPI and PCE prices decelerated in recent months, after notable increases Mr. Connolly, First Vice President, earlier in the year. Crude oil prices con- Federal Reserve Bank of Boston tinued to rise, reaching record levels in nominal terms over the intermeeting Mr. Judd, Executive Vice President, period. Federal Reserve Bank of San Francisco Payroll employment grew in June and July at a pace that was roughly on par Messrs. Hakkio, Rasche, and with that over the preceding six months. Sniderman, Senior Vice Hiring in the services and construction Presidents, Federal Reserve sectors remained strong, but the manu- Banks of Kansas City, St. Louis, facturing sector posted further small job and Cleveland, respectively losses. With employment increasing and the average workweek of production or Ms. Mosser and Messrs. Porter, Tallman, and Tootell, Vice nonsupervisory workers unchanged over Presidents, Federal Reserve these two months, aggregate hours con- Banks of New York, Chicago, tinued to firm. The unemployment rate Atlanta, and Boston, respectively dipped to 5.0 percent in June and held steady at that rate in July. Initial claims Mr. Weber, Senior Research Officer, for unemployment insurance remained Federal Reserve Bank of Minneapolis at low levels. Industrial production picked up in Mr. Hetzel, Senior Economist, Federal June. A jump in utilities output, appar- Reserve Bank of Richmond ently owing to unseasonably warm weather, accounted for more than half of The Manager of the System Open the gain. Motor vehicle production also Market Account reported on recent rose a good bit, but the pace of prodevelopments in the foreign exchange duction growth in the high-tech sector markets. There were no open market was sluggish, reflecting a decline in the operations in foreign currencies for the output of communications equipment. System's account in the period since Overall capacity utilization moved up to the previous meeting. The Manager also its highest level since December 2000. reported on developments in domestic Real personal consumption expendifinancial markets and on System open tures increased at a moderate pace in market transactions in government secu- the second quarter, buoyed by a surge rities and federal agency obligations in purchases of motor vehicles that during the period since the previous appeared to be due largely to the extenmeeting. By unanimous vote, the Com- sion by an automaker of its "employee mittee ratified these transactions. discount" program to the general pub- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 197 lie. Excluding spending on motor vehi- Consumer prices were about uncles, the growth of real personal con- changed in June after posting notable sumption expenditures slowed slightly increases earlier in the year. Consumer in the second quarter. Survey measures energy prices reversed a small part of consumer confidence continued to be of their previous run-up, and core quite favorable in July. consumer inflation remained low. The Activity in the housing sector re- producer price index was unchanged mained robust. In June, starts of single- in June. The annual revisions to the family homes maintained the strong national income and product accounts, pace of earlier this year. Both new and which were released in early August, existing home sales jumped. Mortgage included a substantial upward revision rates remained low, and house prices to core PCE inflation for 2004, from apparently continued to rise briskly. 1.6 percent to 2.2 percent, reflecting Business spending on equipment and changes to the nonmarket-based composoftware posted a solid increase in the nents of the index. Survey measures of second quarter, boosted by a surge in near-term inflation expectations edged outlays for transportation equipment. down in July, and longer-term inflation Excluding this volatile component, busi- expectations firmed only a touch. The ness spending on equipment and soft- employment cost index for private ware decelerated markedly in the sec- industry workers again rose at a modest ond quarter. Spending on nonresidential pace in the second quarter, and increases construction remained subdued. None- in compensation per hour in the nontheless, fundamentals appeared to con- farm business sector slowed somewhat tinue to support business investment, from the rapid rate of the first quarter. with the user cost of capital still low and At its June meeting, the Federal Open corporations experiencing strong cash Market Committee decided to increase flows and holding ample liquid assets. the target level of the federal funds Real nonfarm inventories edged down rate 25 basis points, to 3*/4 percent. In in the second quarter, after a substantial its accompanying statement, the Comrise in the first quarter. The strong pace mittee indicated that, with appropriate of motor vehicle sales contributed to the monetary policy action, the upside and runoff of inventories in the second quar- downside risks to the attainment of both ter. Outside the automobile sector, real sustainable growth and price stability nonfarm inventories continued to rise, should be kept roughly equal. In addibut at a much slower pace than earlier tion, the Committee noted that the in the year. The inventory-sales ratio for expansion remained firm, that labor the nonfarm business sector declined market conditions continued to improve further from an already low level, con- gradually, and that, although pressures tinuing its long-term downward trend. on inflation had remained elevated, The U.S. international trade deficit longer-term inflation expectations renarrowed in May as the value of exports mained well contained. In these cirof goods and services rose slightly and cumstances, the Committee believed the value of imports declined, partly that policy accommodation could be reflecting a sharp drop in the value of removed at a pace that would likely oil imports. GDP growth in a number be measured but noted that it would of major foreign industrial economies respond to changes in economic prosappeared to have slowed a bit in the pects as needed to fulfill its obligation to second quarter. maintain price stability. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

198 92nd Annual Report, 2005 The Committee's decision at its June torical relationship with opportunity meeting to raise the intended level of the cost. The growth of bank credit was federal funds rate 25 basis points, to restrained in June by a runoff in securimaintain an assessment that risks to the ties holdings but picked up in July. goals of price stability and sustained In the forecast prepared for this meetgrowth were balanced assuming appro- ing, the staff raised its projection for priate monetary policy action, and to economic growth over the remainder retain the "measured pace" language of 2005 in light of incoming data sugwas widely expected in financial mar- gesting greater near-term momentum kets. Over the intermeeting period, how- in aggregate demand. At the same time, ever, investors appreciably marked up however, it trimmed the growth rate their expectations for the path of policy, forecast for 2006, reflecting the effects primarily in response to incoming eco- of higher energy prices, higher longnomic data suggesting more strength term interest rates, and the somewhat in spending and output than had been slower growth of productive capacity anticipated. Nominal Treasury yields implied by the annual revisions to the increased in line with the revision to national accounts. The output gap was policy expectations. Yields on inflation- predicted to be essentially closed by the indexed Treasury securities rose a touch end of this year. Inventory investment less than their nominal counterparts, was projected to resume contributing leaving inflation compensation only to GDP growth over the second half of slightly higher. Spreads on investment- this year, after the sharp swing toward grade corporate bonds were little inventory runoffs in the second quarter. changed over the intermeeting period, Growth in consumer spending was but those on speculative-grade bonds expected to firm in the third quarter, declined markedly, ending the period buoyed by motor vehicle spending, close to the very low levels reached before falling back in the fourth quarter. earlier this year. Major equity indexes With housing starts essentially flat, advanced, supported by strong corporate residential investment was projected to earnings reports. The trade-weighted decelerate substantially over the remainforeign exchange value of the dollar der of this year. Business investment depreciated slightly over the intermeet- was predicted to continue to rise at a ing period. The People's Bank of China moderate pace, benefiting from stillannounced a change to its exchange-rate accommodative financial conditions and regime, including an immediate 2.1 per- the ongoing need to replace depreciatcent appreciation of the renminbi versus ing equipment and software. The recent the dollar. improvement in the trade balance was M2 continued to grow sluggishly on expected to be transitory. Notwithstandbalance over June and July. Small time ing recent benign readings on inflation, deposits, whose rates of return adjust the forecast for core PCE inflation was relatively quickly to changes in market raised somewhat, owing in part to the rates, expanded briskly. However, liquid recent further rise in energy prices and, deposits and retail money market mutual in light of the revisions to historical funds were little changed on net over data, a higher assumed trajectory for these two months. Despite the recent the nonmarket component of core PCE slow growth of M2, its velocity re- prices. mained low relative to the level that In their discussion of current condiwould be expected based on its his- tions and the economic outlook, meeting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 199 participants noted that aggregate spend- anticipated that the pace of home price ing appeared to have picked up in recent appreciation would slow over time, months by more than anticipated and though the timing and extent of that that current estimates of slack were nar- slowing, as well as its implications rower than those reviewed at the June for consumer spending, were quite meeting. In addition, high and rising uncertain. energy prices were adding to pressures Participants indicated that business on overall inflation, and energy price investment had been evolving roughly increases probably would feed through, in line with their expectations. Strong at least temporarily, to core measures fundamentals, including low interest of inflation. Nonetheless, core infla- rates, wide profit margins, and a high tion recently had been relatively low level of liquid assets, were seen as supand inflation expectations remained porting expenditures on software and well contained. Moreover, participants equipment going forward. Inventory thought that some slowing in final sales investment declined in the second quarwas likely later this year as net exports ter, with much of the falloff concenresumed their decline and purchases of trated in the motor vehicle industry, automobiles fell back with the expira- where sales had been boosted sharply by tion of special discount programs. In the introduction of special discount prothese circumstances, it appeared that, grams. Inventories now seemed to be for now, continued removal of policy coming in line with the trend in final accommodation at a measured pace still demand and were anticipated to expand would likely be sufficient to keep infla- along with sales later this year. tion contained, but participants also rec- Participants viewed the increases in ognized that the pace and cumulative market interest rates over the intermeetextent of policy adjustment going for- ing period as an appropriate response ward would depend importantly on eco- to the stronger economic outlook. A few nomic developments. participants voiced concerns that still- In the household sector, the path for low interest rates and insufficient recogspending was expected to be bolstered nition by investors of the dependency of in the near term by still-low interest the Committee's policy expectations on rates, solid growth in disposable income, economic data were continuing to foster and ongoing increases in wealth. How- an inappropriate degree of risk-taking ever, elevated energy prices were seen in financial markets. Another participant as likely to be a significant drag on mentioned, however, that recent slugconsumption and, on net, household gish growth of the monetary aggregates spending was expected to advance at a suggested that the stance of policy was moderate pace. Housing sales and con- not overly accommodative. Moreover, struction activity generally remained with a higher proportion of mortgages strong across the country, but meeting now tied to short-term rates, it was participants noted anecdotal evidence of noted that increases in short-term rates some cooling in housing markets in could have a somewhat larger-thancertain areas. And at least some banks usual effect on spending. On balance, were reportedly beginning to apply current financial conditions, which somewhat tighter standards in real estate embedded expectations of future policy lending and becoming more cautious in tightening, were generally seen as likely their promotion of nontraditional mort- to be consistent with sustained modgage products. Participants generally erate economic growth and containment Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

200 92nd Annual Report, 2005 of pressures on inflation in coming adverse effects on longer-run economic quarters. performance. Regarding the federal budget, a recent While most participants viewed the narrowing of the deficit was noted, but risks to inflation as having ticked up the improvement appeared to be attribut- over the intermeeting period, many able to cyclical factors and to increases also cited factors that, in concert with in the level of tax collections that were the likely continued removal of polnot likely to be repeated. Few signs were icy accommodation, would tend to evident that greater fiscal discipline in hold inflation pressures in check. For the budget process would emerge any example, few indications had emerged time soon. As a result, federal deficits recently that businesses had enjoyed any were expected to continue to act as a significant increase in pricing power, considerable drain on national saving and the continuing expansion of global over the longer run. trade was seen as an important factor Although net exports had been sig- limiting firms' ability to pass through nificantly higher over the second quarter cost increases. In these circumstances than had been expected, participants did and with markups at relatively high not see this development as signaling levels, a substantial proportion of any the beginning of a sustained improve- increases in business costs might well ment in the trade and current account be reflected in narrower profit margins. balances. The strong advance in exports Moreover, the recent relatively low and weakness in imports in the second monthly readings on core inflation and quarter seemed largely attributable to modest wage pressures, at least by some special factors. Continued brisk import measures, suggested that some slack growth appeared likely to be sustained remained in resource utilization. Despite for the foreseeable future by gains in the rise in oil prices and quickening domestic demand. pace of economic activity, both market- Participants discussed at length the and survey-based measures of inflation factors affecting costs and prices. expectations seemed to remain quite Although uncertainties about the under- well anchored. lying pace of productivity increases, In the Committee's discussion of trends in labor force participation, and monetary policy for the intermeeting the level of potential output complicated period, all of the members favored raisthe inflation outlook, higher energy ing the target federal funds rate by prices and reduced resource slack were 25 basis points to 3Vi percent at this seen as pointing to elevated inflation meeting. Even with this action, the fedpressures. While recent monthly read- eral funds rate would remain below the ings indicated that core inflation had level that members anticipated would been subdued, a number of participants prove necessary to contain inflation noted that underlying core inflation pressures and keep output near potenappeared to be running at a pace around tial, and thus in all likelihood further the upper end of the range they viewed policy action would be required. Howas consistent with price stability—an ever, the pace of future policy moves, assessment that was reinforced by the although likely to be measured, as well recent upward revisions to historical as the extent of those moves, would data on core PCE inflation. Participants depend on incoming data. commented that an increase in inflation In discussing the statement to be from recent rates could have especially released after the meeting, members Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 201 agreed that it was appropriate to high- be removed at a pace that is likely to be light the apparent strengthening in measured. Nonetheless, the Committee will respond to changes in economic prospects as aggregate spending. Policymakers exneeded to fulfill its obligation to maintain changed views on the characterization price stability. of labor market conditions in light of recent employment reports and other Votes for this action: Messrs. Greenspan indicators, but members ultimately con- and Geithner, Ms. Bies, Messrs. Ferguson, curred that the description of labor mar- Fisher, Kohn, Moskow, Olson, Santomero, and Stern. Vote against this action: None. kets as "improving gradually" remained Absent and not voting: Mr. Gramlich. appropriate. Members agreed that it was appropriate to acknowledge the recent It was agreed that the next meeting of relatively low monthly rates of core the Committee would be held on Tuesinflation, but also to emphasize that day, September 20, 2005. inflation pressures remained elevated. The meeting adjourned at 1:00 p.m. As in past meetings, there was some discussion about the desirability of including forward-looking language in Notation Vote the statement, but members agreed to retain the forward-looking language for By notation vote completed on July 20, now. 2005, the Committee unanimously At the conclusion of the discussion, approved the minutes of the meeting of the Committee voted to authorize and the Federal Open Market Committee direct the Federal Reserve Bank of New held on June 29-30, 2005. 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- September 20, 2005 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 Committee was held in the offices of markets consistent with increasing the fedthe Board of Governors of the Federal eral funds rate to an average of around 3x/2 percent. Reserve System in Washington, D.C., on Tuesday, September 20, 2005 at 9:00 a.m. The vote encompassed approval of the paragraph below for inclusion in the Present: statement to be released shortly after the Mr. Greenspan, Chairman meeting: Mr. Geithner, Vice Chairman Ms. Bies The Committee perceives that, with appro- Mr. Ferguson priate monetary policy action, the upside Mr. Fisher and downside risks to the attainment of both Mr. Kohn sustainable growth and price stability should Mr. Moskow be kept roughly equal. With underlying infla- Mr. Olson tion expected to be contained, the Commit- Mr. Santomero tee believes that policy accommodation can Mr. Stern Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

202 92nd Annual Report, 2005 Messrs. Guynn and Lacker, Mr. Luecke, Senior Financial Analyst, Mses. Pianalto and Yellen, Division of Monetary Affairs, Alternate Members of the Federal Board of Governors Open Market Committee Ms. Low, Open Market Secretariat Mr. Hoenig, Ms. Minehan, and Specialist, Division of Monetary Mr. Poole, Presidents of the Affairs, Board of Governors Federal Reserve Banks of Kansas City, Boston, and Mr. Rives, First Vice President, Federal St. Louis, respectively Reserve Bank of St. Louis Mr. Reinhart, Secretary and Economist Mr. Eisenbeis, Executive Vice Ms. Danker, Deputy Secretary President, Federal Reserve Ms. Smith, Assistant Secretary Bank of Atlanta Mr. Alvarez, General Counsel Mr. Baxter, Assistant General Counsel Messrs. Elsasser, Fuhrer, Hakkio, Ms. Johnson, Economist Rasche, Sniderman, Weinberg, Mr. Stockton, Economist and Williams, Senior Vice Presidents, Federal Reserve Messrs. Connors, Evans, Freeman, Banks of New York, Boston, and Madigan, Ms. Mester, Kansas City, St. Louis, Cleveland, Messrs. Oliner, Rosenblum, and Richmond, and San Francisco, Wilcox, Associate Economists respectively Mr. Kos, Manager, System Open Mr. Potter, Assistant Vice President, Market Account Federal Reserve Bank of New York Messrs. Slifman and Struckmeyer, Associate Directors, Division of Research and Statistics, Board Mr. Weber, Senior Research Officer, of Governors Federal Reserve Bank of Minneapolis Messrs. Clouse and Whitesell, Deputy Associate Directors, Division of The Manager of the System Open Monetary Affairs, Board of Market Account reported on recent Governors developments in foreign exchange markets. There were no open market opera- Mr. English, Assistant Director, tions in foreign currencies for the Sys- Division of Monetary Affairs, Board of Governors tem's account in the period since the previous meeting. The Manager also Mr. Simpson, Senior Adviser, Division reported on developments in domestic of Research and Statistics, Board financial markets and on System open of Governors market transactions in government securities and federal agency obligations Mr. Skidmore, Special Assistant to the Board, Office of Board Members, during the period since the previous Board of Governors meeting. By unanimous vote, the Committee ratified these transactions. Mr. Small, Project Manager, Division The information reviewed at this of Monetary Affairs, Board of meeting suggested that, before the land- Governors fall of Hurricane Katrina on the Gulf Coast, expansion of economic activity Mr. Durham, Senior Economist, Division of Monetary Affairs, had been solid, led by robust gains in Board of Governors housing and buoyant consumer spend- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 203 ing. While business investment appeared the pace of production in the high-tech to be losing some momentum, labor sector accelerated somewhat in recent markets continued to improve, and in- months, owing to increased output of creases in core CPI and PCE prices were communications equipment and semimodest after notable increases earlier in conductors. Overall capacity utilization the year. Only limited data bearing on through August remained close to its the likely economic effects of the hur- highest level since December 2000. ricane were available. Oil and gasoline Real personal consumption expendiprices, however, were on the rise, spik- tures, boosted by motor vehicles puring to record levels in the days immedi- chases in response to employee-discount ately following the hurricane. programs, were robust during the sum- Payroll employment grew at a good mer. Spending on goods outside the pace in August, and the average increase automobile sector and on services was over the most recent three months was moderate. Strong overall spending along largely on par with the advances made with lackluster real income growth since the fourth quarter of last year. put downward pressure on the saving Employment gains were widespread rate. Survey measures of consumer conacross industries, with the exception of fidence early in August were generally the manufacturing sector, which con- consistent with solid increases in spendtinued to post small job losses. With ing, but confidence fell appreciably in employment increasing and the average the period immediately after the storm. workweek of production or nonsupervi- Activity in the housing sector sory workers unchanged in August, remained brisk. Starts of new singleaggregate hours continued to firm mod- family homes in July were slightly estly. The unemployment rate dipped above their average level for the first to 4.9 percent in August, its lowest half of the year. New home sales level since August 2001. Given the advanced further in July, and existing increase in the labor-force participa- home sales stayed elevated. Mortgage tion rate reported for the month, the rates remained low and supported employment-population ratio rose to demand. Prices of existing homes again its highest level in three years. Initial rose briskly, while price appreciation for claims for unemployment insurance new homes moderated somewhat. jumped in the latest available week, Although real outlays for equipment however, as workers in the Gulf Coast and software increased solidly in the region began to file claims. second quarter, available data on orders Industrial production increased only and shipments suggested some softness slightly in August; the staff estimated in the third quarter. Amid continued that the curtailment of activity as a result rapid expansion in business output, of Hurricane Katrina shaved 0.3 percent favorable financing conditions, and from the index. Petroleum refining and ample cash balances, the fundamentals crude oil and natural gas extraction were stayed positive. Real spending on nonespecially hard hit by the storm. The residential construction remained lackoutput of utilities declined in August luster despite incremental improvements after surging earlier in the summer in in nonresidential property market condiresponse to unseasonably warm weather. tions this year. Higher production of motor vehicles and Investment in real nonfarm invenparts boosted manufacturing output. tories excluding motor vehicles slowed After slowing in the second quarter, markedly in the second quarter, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

204 92nd Annual Report, 2005 partial data for July suggested that real sustainable growth and price stability stockbuilding continued to be subdued. should be kept roughly equal. In addi- The slower rate of inventory accumula- tion, the Committee noted that, despite tion suggested that firms had largely high energy prices, aggregate spending completed the stockbuilding that had appeared to have strengthened, labor been prompted by earlier low ratios of market conditions continued to improve inventories to sales. gradually, and longer-term inflation The U.S. international trade deficit expectations remained well contained, narrowed somewhat in July, as the value although pressures on inflation had of exports of goods and services stayed elevated. In these circumstances, rose slightly and the value of imports the Committee believed that policy declined. The value of oil imports accommodation could be removed at a increased strongly in July but that rise pace that would likely be measured but was offset by decreases in imports of noted that it would respond to changes services and of non-oil goods. GDP in economic prospects as needed to growth in foreign industrial economies fulfill its obligation to maintain price picked up, on balance, in the second stability. quarter, but performance across econo- The Committee's decision at its mies was mixed. August meeting was widely expected Core consumer price inflation re- in financial markets and evoked little mained benign in July and August. price reaction. Over the intermeeting However, the surge in energy prices period, however, investors marked down considerably boosted overall consumer their expectations for the path of policy, price inflation over those months. Gaso- partly in response to the devastation line prices in particular rose steeply in caused by Hurricane Katrina. Nominal August, and survey data pointed to a Treasury yields decreased about in line larger increase in early September. Pro- with the revision to policy expectations. ducer price inflation was subdued. One Yields on inflation-indexed Treasury survey of households in early Septem- securities fell a bit more than their ber indicated that near-term inflation nominal counterparts, leaving inflation expectations jumped and that longer- compensation slightly higher. Spreads term inflation expectations edged higher. on investment-grade corporate bonds With regard to labor costs, the employ- were little changed over the intermeetment cost index for private industry ing period, but those on speculativeworkers rose at a modest pace in the grade bonds increased from very low second quarter, and the twelve-month levels. Major equity indexes appeared change in this index declined from that to be supported by lower interest rates of a year earlier. Average hourly earn- and posted modest gains despite the ings rose only moderately over the past increases in energy prices. The tradetwelve months. weighted foreign exchange value of the At its August meeting, the Federal dollar depreciated slightly over the inter- Open Market Committee decided to meeting period. increase the target level of the federal M2 grew moderately, on balance, in funds rate 25 basis points, to 3V2 per- August. Liquid deposits edged higher, cent. In its accompanying statement, the but retail money market mutual funds Committee indicated that, with appropri- contracted, on net. Small time deposits, ate monetary policy action, the upside whose rates of return adjust relatively and downside risks to the attainment of quickly to changes in market rates, con- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 205 tinued to expand rapidly. The growth of result of additional increases in energy bank credit surged, as loans expanded prices. briskly. Meeting participants recognized that In the forecast prepared for this meet- Hurricane Katrina would have signifiing, the staff lowered its projection for cant effects on the U.S. economy, but the economic growth over the remainder of size and timing of those effects were 2005 in light of the economic disloca- uncertain. Economic activity in the Gulf tion associated with Hurricane Katrina. Coast region would be disrupted by the At the same time, however, the staff destruction of capital and the displaceincreased the growth rate forecast for ment of a large population, perhaps for 2006 to reflect the boost to economic an extended period. Moreover, damage activity from the rebuilding effort. By to infrastructure for extracting and pro- 2007, the level of output was expected cessing oil and natural gas was expected to move back to the path it would have to be substantial, with significant nearfollowed in the absence of the storm. term implications for energy prices and The staff revised upward its forecast of the national economy, and the projected overall inflation for 2005 and of core track of Hurricane Rita raised additional inflation for 2006, reflecting the effects concerns. In that environment, the prices of higher energy prices, but lowered its of crude oil, natural gas, and gasoline projection for overall inflation slightly likely would remain elevated and subfor 2006. It was recognized that there ject to considerable volatility, particuwere considerable near-term uncertain- larly given the limited spare capacity ties and that many data series in com- available in energy extraction and ing months would be influenced by the refining industries. Participants noted effects of the storm. that very substantial rebuilding would In their discussion of the economic probably be underway soon, supported situation and outlook, meeting partici- importantly by government programs. pants agreed that output and employ- The pace at which reconstruction activment appeared to have been growing at ity would take place, however, was a good pace before Hurricane Katrina's uncertain, as it depended in part on faclandfall. Business fixed investment had tors that were still difficult to assess, been a little softer than expected, but such as how quickly the affected areas household spending had been especially could again be made habitable. On strong. Participants agreed that the wide- balance, participants thought that there spread devastation in the Gulf Coast would likely be a significant shift in region and the dislocation of many the timing of aggregate economic activpeople would hold down indicators of ity over the next several quarters but spending for a time. But they also were probably little effect on the economy's of the view that aggregate demand and intermediate-term growth prospects. output would likely rebound before Several participants voiced concern that long, fueled in part by private spending the effects of the hurricane were likely to rebuild and outlays by the federal to add to already considerable pressures government to assist in the recovery. on prices. With growth of the economy expected For the nation as a whole, participants to recover, meeting participants were noted that household spending had been concerned that price pressures, which fairly robust before the hurricane, suphad been elevated before the storm, ported by strong advances in income could climb further, primarily as a and continuing gains in wealth that Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

206 92nd Annual Report, 2005 reflected in part further large increases ness could reflect only short-term flucin home prices. Most anecdotal informa- tuations in volatile data series, some evition supported the indications from dence suggested that it may also have available data that activity in housing stemmed from concern among business markets generally remained brisk. The executives about the effects of high termination of some inducements to pur- energy prices. The anecdotal informachase motor vehicles was expected to tion on commercial real estate markets retard expenditures on consumer dura- was mixed, with some districts reporting bles in the latter part of this year. The firming markets while activity elsereduction in real disposable incomes where was said to remain subpar. caused by large increases in consumer With regard to fiscal policy, meeting energy prices was also anticipated to participants noted that federal outlays restrain consumer spending, with busi- would increase sharply in order to assist ness contacts indicating that retail out- with recovery and reconstruction efforts lets that typically serve lower- and in the aftermath of the hurricane. The middle-income households could see eventual size of the increment to federal particular weakness. The reduction in outlays was unclear, but it was likely to spending as a result of higher energy be quite large. The substantial step-up in prices and hurricane-related dislocations government spending would add to fedcould be augmented by a weakening eral deficits that were already large and of consumer attitudes. Many of the underscored the worrisome loss of fiscal restraining effects were thought likely to discipline evident in recent years. The dissipate over time, however. Retail expansion of federal spending implied energy prices were likely to retrace at an increase in fiscal stimulus at a time least a portion of the post-hurricane when the margin of unutilized resources increase, and consumer confidence in the overall economy was probably should rebound. Moreover, demands for thin. consumer durables, as well as housing, Participants' concerns about inflation would receive support as hurricane vic- prospects generally had increased over tims repaired or replaced lost property, the intermeeting period. The surge in with help from insurance payments and energy prices, in particular, was boostgovernment transfers. Although uncer- ing overall inflation, and some of that tainties about the outlook for spending increase would probably pass through had increased, it appeared that, over for a time into core prices. This posed time, consumption would probably the risk that there could be a more perexpand at a moderate pace—perhaps a sistent influence on inflation should little below the pace of income growth inflation expectations rise. Indeed, some once the increases in house prices recent survey evidence on such expectaslowed to more historically typical rates. tions had been troubling, and widening Meeting participants noted that, even federal deficits were mentioned as a facprior to the hurricane, business fixed tor that could further stir inflationary investment had been somewhat weaker concerns. Measures of labor costs were than expected. The softness was some- giving conflicting signals, with some what puzzling, as sales were growing, indexes indicating that growth in labor business balance sheets appeared quite compensation remained relatively low strong in the aggregate, profitability was but another showing appreciably more high, and financing was readily avail- rapid increases. Anecdotal information able and relatively inexpensive for most continued to point to shortages of cerfirms. Although the apparent sluggish- tain types of labor, such as truck drivers, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 207 and some business contacts reported materially in coming weeks. Indeed, difficulties in hiring more generally, a underlying economic trends would development that had prompted some be particularly difficult to assess over firms to boost wages. Underlying pro- the next several months as a result of ductivity growth to date apparently had the direct, and presumably temporary, remained robust but, at this stage of effects of the storm and its aftermath on the business cycle, gains in productiv- the incoming data. A pause in policy ity could not necessarily be counted tightening at this meeting had the potenon to stay strong. The prices of a num- tial to mislead the public both about the ber of intermediate goods, including a Committee's perceptions of the fundawide range of petrochemical products mental strength and resilience of the and building materials, were subject to economy and about its commitment to upward pressure, reflecting high crude fostering price stability. oil prices, production disruptions in the In discussing the statement to be energy sector, and elevated demands released after the meeting, members for materials in anticipation of rebuild- agreed that it would be appropriate to ing in the Gulf Coast region. Still, core characterize the macroeconomic effects inflation in recent months had been quite of Hurricane Katrina, while significant, damped, and market-based measures as essentially temporary. Members also of longer-term inflation expectations believed that the statement should again had risen only modestly of late. It was note that both monetary policy accomobserved that, after the early 1980s, the modation and robust underlying propass-through of energy prices into core ductivity growth were continuing to supinflation had been quite limited, sugport economic activity. Although energy gesting that, in current circumstances, prices had the potential to add to inflacore inflation could stay relatively low tion pressures, and inflation expectaand overall inflation would probably tions had recently exhibited some signs drop back if inflation expectations of increasing, members agreed that the remained contained. risks to inflation, as well as those to In the Committee's discussion of growth, remained essentially balanced monetary policy for the intermeeting under an assumption of appropriate polperiod, nearly all members favored rais- icy action. The Committee also agreed ing the target federal funds rate 25 basis to reiterate its previous expectation that points to 33/4 percent at this meeting. " . .. policy accommodation can be Although uncertainty had increased, in removed at a pace that is likely to be the Committee's judgment the funda- measured." However, some sentiment mental factors influencing the longer- was expressed to consider changes to term path of the economy probably had forward-looking aspects of the statenot been affected by the hurricane, but ment at upcoming meetings, in part the upside risks to inflation appeared because of the considerable reduction in to have increased. Even after today's monetary policy accommodation that action, the federal funds rate would had already been accomplished. likely be below the level that would be At the conclusion of the discussion, necessary to contain inflationary pres- the Committee voted to authorize and sures, and further rate increases prob- direct the Federal Reserve Bank of New ably would be required. Moreover, the York, until it was instructed otherwise, uncertainties about near-term economic to execute transactions in the System prospects resulting from Hurricane Account in accordance with the follow- Katrina would probably not be reduced ing domestic policy directive: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

208 92nd Annual Report, 2005 The Federal Open Market Committee meeting of the Federal Open Market seeks monetary and financial conditions that Committee held on August 9, 2005. will foster price stability and promote sustainable growth in output. To further its longrun objectives, the Committee in the imme- Vincent R. Reinhart diate future seeks conditions in reserve Secretary markets consistent with increasing the federal funds rate to an average of around Meeting Held on 33A percent. November 1, 2005 The vote encompassed approval of A meeting of the Federal Open Market the paragraph below for inclusion in the Committee was held in the offices of statement to be released shortly after the the Board of Governors of the Federal meeting: Reserve System in Washington, D.C., on Tuesday, November 1, 2005 at The Committee perceives that, with appro- 9:00 a.m. priate monetary policy action, the upside and downside risks to the attainment of both Present: sustainable growth and price stability should Mr. Greenspan, Chairman be kept roughly equal. With underlying infla- Mr. Geithner, Vice Chairman tion expected to be contained, the Commit- Ms. Bies tee believes that policy accommodation can Mr. Ferguson be removed at a pace that is likely to be Mr. Fisher measured. Nonetheless, the Committee will Mr. Kohn respond to changes in economic prospects as Mr. Moskow needed to fulfill its obligation to maintain Mr. Olson price stability. Mr. Santomero Mr. Stern Votes for this action: Messrs. Greenspan and Geithner, Ms. Bies, Messrs. Fergu- Messrs. Guynn and Lacker, son, Fisher, Kohn, Moskow, Santomero, Mses. Pianalto and Yellen, and Stern. Vote against this action: Alternate Members of the Mr. Olson. Federal Open Market Committee Mr. Olson dissented because he Mr. Hoenig, Ms. Minehan, and preferred that the Committee defer Mr. Poole, Presidents of the policy action at this meeting, pending Federal Reserve Banks of the receipt of additional information Kansas City, Boston, and St. Louis, respectively on the economic effects resulting from the severe shock of Hurricane Mr. Reinhart, Secretary and Economist Katrina. Ms. Danker, Deputy Secretary Ms. Smith, Assistant Secretary It was agreed that the next meeting of Mr. Alvarez, General Counsel the Committee would be held on Tues- Ms. Johnson, Economist Mr. Stockton, Economist day, November 1, 2005. The meeting adjourned at 1:15 p.m. Messrs. Connors, Freeman, and Madigan, Ms. Mester, Messrs. Oliner, Rosenblum, Notation Vote Tracy, Rolnick, and Wilcox, Associate Economists By notation vote completed on August 29, 2005, the Committee unani- Mr. Kos, Manager, System Open mously approved the minutes of the Market Account Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes ofFOMC Meetings, November 209 Messrs. Slifman and Struckmeyer, The Manager of the System Open Associate Directors, Division Market Account reported on recent of Research and Statistics, developments in foreign exchange Board of Governors markets. There were no open market operations in foreign currencies for the Mr. Whitesell, Deputy Associate Director, Division of Monetary System's account in the period since Affairs, Board of Governors the previous meeting. The Manager also reported on developments in domestic Mr. English, Assistant Director, financial markets and on System open Division of Monetary Affairs, market transactions in government secu- Board of Governors rities and federal agency obligations during the period since the previous Mr. Simpson, Senior Adviser, Division of Research and Statistics, Board meeting. By unanimous vote, the Comof Governors mittee ratified these transactions. The information reviewed at this Mr. Small, Project Manager, Division meeting suggested that the economy had of Monetary Affairs, Board of a good deal of forward momentum in Governors the third quarter. Although recent hurricanes caused considerable damage and Mr. Nelson, Section Chief, Division of Monetary Affairs, Board of disruption, particularly in the energy Governors sector, economic activity outside the Gulf region appeared to have been well Mr. Luecke, Senior Financial Analyst, maintained. In September, hiring in Division of Monetary Affairs, other regions remained in line with its Board of Governors pace over the preceding twelve months, and excluding the estimated effects of Ms. Low, Open Market Secretariat the hurricanes and a strike by Boeing Specialist, Division of Monetary Affairs, Board of Governors machinists, industrial production increased briskly. In addition, residential Mr. Werkema, First Vice President, construction remained buoyant. Con- Federal Reserve Bank of Chicago sumer spending, however, showed some signs of weakening. Although consumer Mr. Eisenbeis, Executive Vice spending was strong for the third quarter President, Federal Reserve Bank of Atlanta as a whole, it softened in September, and survey measures of consumer confi- Messrs. Fuhrer, Hakkio, Rasche, dence slumped noticeably. Despite the Rudebusch, and Sniderman, large increase in consumer energy prices Senior Vice Presidents, Federal since midyear, core price inflation was Reserve Banks of Boston, restrained through September. Kansas City, St. Louis, San Francisco, and Cleveland, Hurricane Rita caused further disruprespectively tion to energy production in the Gulf area, which had not yet fully recovered Mr. Krane and Ms. Mucciolo, Vice from Hurricane Katrina. Energy pro- Presidents, Federal Reserve Banks duction in October was still below preof Chicago and New York, hurricane levels, although progress had respectively been made in reopening shut-down Mr. Hetzel, Senior Economist, Federal energy facilities. Rising imports, along Reserve Bank of Richmond with more-subdued consumption of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

210 92nd Annual Report, 2005 gasoline and other petroleum products, ing, food manufacturing, paper, and helped to offset the effect on energy plywood industries. In the transportaprices of some of the output losses in tion equipment category, motor vehicle refined products. In addition, to address production climbed notably, but the the low level of gasoline inventories machinists' strike at Boeing caused the and more-immediate retail demands, company to cease nearly all commercial domestic refiners sharply increased the aircraft production during the month. share of gasoline in their output of total High-tech output—led by strong gains refined product. Wholesale and retail in the production of semiconductors and gasoline prices spiked soon after Rita's communications equipment—surged in landfall but had since declined to pre- September. Manufacturing capacity utihurricane levels. Spot prices for natural lization dropped substantially in Sepgas soared with the hurricanes and tember, but was still noticeably above remained at elevated levels. its year-earlier level. Payroll employment fell in Septem- Real consumer spending increased at ber, held down by substantial job losses a moderate rate in the third quarter as associated with Hurricane Katrina. a whole, although it declined in August Employment in the areas unaffected by and September after having risen subthe hurricane increased at a rate in line stantially earlier in the summer. The with the average pace over the previous softening in spending of late reflected twelve months. The largest employment in part the diminishing boost to light loss occurred in the leisure and hospital- vehicle sales from manufacturers' proity category, an industry particularly grams offering employee discounts to hard hit by the storm. The average nonemployees. Spending on other goods workweek was unchanged in Septem- and services was also sluggish, likely ber, so with employment lower, aggre- because of the direct effects of the dislogate hours declined slightly. The unem- cation of households by the hurricanes, ployment rate rose 0.2 percentage points high energy prices, and falling consumer to 5.1 percent. The labor force partici- confidence. Consumer sentiment in pation rate held steady, but the number October, as measured by both the Michiof individuals reporting that they had a gan Survey and the Conference Board's job but were not at work because of bad indicator, dropped a little further after weather surged. More recently, weekly plunging in September. The personal data on initial claims for unemployment saving rate remained slightly negative in insurance suggested that the job losses September. associated with the hurricane were Residential construction continued at subsiding. a robust pace. In September, new single- Industrial production fell substantially family homes were started at a rate a bit in September, but excluding the effects above their elevated average rate in the of hurricane-related disturbances and first half of the year, and permit issuthe Boeing strike, industrial production ance jumped to a new high. New home was estimated to have risen at a brisk sales remained substantial in August, pace. The hurricanes caused the index but they were below July's elevated for oil and natural gas extraction and level. Although they remained low by refining to plummet in September, and historical standards, both the thirty-year they also significantly affected petro- fixed mortgage rate and the one-year chemical production. Manufacturing adjustable rate had moved up a bit in output fell noticeably in the shipbuild- recent months and were notably above Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, November 211 the levels seen at the beginning of the increase in exports was driven by higher year. The average selling price of exist- merchandise exports, although exports ing homes rose in the twelve months of services also advanced a bit. GDP ending in September at about the same growth in foreign industrial economies rapid clip as a year earlier, but the aver- appeared to have continued at a moderage selling price of new homes rose ate pace in the third quarter. more slowly over the past few months. Soaring energy prices have boosted Real outlays for equipment and soft- overall measures of consumer price ware were sluggish in the summer, but inflation in recent months. However, a broad-based pickup in orders for and measures of core consumer price inflashipments of nondefense capital goods tion were much more restrained. The excluding aircraft in August suggested twelve-month change in core consumer some firming. Investment fundamen- prices through September was about tals remained relatively solid, including unchanged from its year-earlier level. continued expansion in business sales, a One survey of households in October declining cost of capital, and corporate found that expectations for inflation balance sheets that were flush with cash. over the coming year rose to a level well Surveys of executive sentiment squared above the readings that had prevailed well with the fundamentals: Although over the spring and summer, presumably business leaders expressed some misgiv- in response to rising energy prices. ings about the overall macroeconomic However, median expectations for inflaenvironment, their stated capital spend- tion over the next five to ten years were ing intentions pointed to increasing only a little above the average range investment. Vacancy rates for nonresi- reported in recent years. With regard to dential properties continued to edge labor costs, the employment cost index lower, but they remained elevated for for private industry workers rose at a office and industrial properties, and real moderate pace in the third quarter, up spending on new construction had yet to somewhat from its second-quarter pace, improve materially. but the twelve-month change in the Business investment in real nonfarm index declined from that of a year earinventories was subdued over the sum- lier. Hourly compensation in the nonmer. Although inventory-to-sales ratios farm business sector was estimated to moved down some in July and August, have also risen at a moderate rate in the businesses did not appear dissatisfied third quarter. with their level of stocks. For example, At its September meeting, the Federal September results from the Institute for Open Market Committee decided to Supply Management survey indicated increase the target level of the federal that respondents viewed their custom- funds rate 25 basis points, to VA perers' current inventory situation as rea- cent. In its accompanying statement, the sonably well aligned with demand. Committee indicated that, with appropri- The U.S. international trade deficit ate monetary policy action, the upside widened somewhat in August, as a and downside risks to the attainment surge in imports of goods and services of sustainable growth and price stability was partially offset by a sizable gain in should be kept roughly equal. The Comexports. The growth in imports reflected mittee noted that the widespread devasboth a marked increase in oil imports tation in the Gulf region from Hurriand a rise in nonoil goods; imports cane Katrina, the associated dislocation of services were little changed. The of economic activity, and the boost to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

212 92nd Annual Report, 2005 energy prices would set back spending, a bit above the levels seen before Hurproduction, and employment in the near ricane Katrina. As broad indexes of term. However, the Committee judged investment- and speculative-grade corthat these unfortunate developments did porate bond yields moved largely in line not pose a more persistent threat to the with Treasury yields over the period, overall economy. Rather, monetary pol- spreads were little changed. Major stock icy accommodation, coupled with robust price indexes fell moderately and the underlying growth in productivity, was trade-weighted foreign exchange value providing ongoing support to economic of the dollar appreciated slightly over activity. Although higher energy and the intermeeting period. other costs had the potential to add to Domestic nonfinancial debt appeared inflation pressure, core inflation had to have advanced briskly in the third been relatively low in the preceding few quarter. Growth in household debt was months and longer-term inflation expec- estimated to have edged down in the tations remained contained. In these third quarter because of a slowing in circumstances, the Committee believed mortgage debt growth but remained elethat policy accommodation could be vated. Household bankruptcies surged removed at a pace that would likely in the weeks immediately before bankbe measured but noted that it would ruptcy reforms went into effect on respond to changes in economic pros- October 17. The debt of nonfinancial pects as needed to fulfill its obligation to businesses rose in the third quarter at a maintain price stability. rate comparable to the increases seen With investors putting only small in the first half of the year. Bank loans odds on a pause in the tightening cycle to businesses continued to advance following Hurricane Katrina, there was briskly, and the results of the October little market reaction to the Commit- Senior Loan Officer Opinion Survey tee's decision at the September meeting. showed some further easing of lending However, the expected path for mone- terms and standards for such loans. M2 tary policy shifted up in subsequent expanded at a fairly solid rate in Sepweeks, as incoming data indicated that tember. The increase in September was output had been expanding briskly prior in part attributable to a boost to currency to the hurricanes and that the disruptions and liquid deposits resulting from Hurrito economic activity from the hurri- cane Katrina. Growth in nominal output canes were likely to be less severe than in the third quarter exceeded that of M2, initially feared. This upward pressure implying a further rise in velocity. on interest rates may have been ampli- In the forecast prepared for this meetfied by comments from a number of ing, the staff continued to project mod- Federal Reserve officials that were read erate economic growth for the second as stressing inflation concerns. Nominal half of 2005. Output growth was ex- Treasury yields rose in line with the pected to pick up in 2006, as the boost shift in the outlook for monetary policy. from hurricane-related rebuilding activ- Despite a large increase in the overall ity more than offset the effects of someconsumer price index for September, what tighter financial conditions, and measures of inflation compensation then slow in 2007, as the impetus from calculated using yields on nominal and rebuilding waned. The near-term foreinflation-protected Treasury securities cast again entailed a marked downshift were about unchanged over the inter- in headline inflation as energy prices meeting period, although they remained fall back consistent with readings from Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes ofFOMC Meetings, November 213 futures markets. Favorable incoming spending by relocated households. Redata led the staff to reduce its forecast construction along the Gulf Coast would for near-term core inflation a bit. The likely pick up substantially in the next outlook continued to be for core infla- couple of quarters. tion to pick up modestly over coming In the household sector, spending quarters owing to the lagged effects of seemed to have held up fairly well, aside higher energy prices but then to return from a drop in purchases of autos. Some to near current levels in 2007 primarily participants noted, however, that the as the result of the restraining influence erosion of consumer confidence, stillof falling energy prices. elevated gasoline prices, and the pros- In their discussion of the economic pect of higher heating bills might augur situation and outlook, meeting partici- weakness ahead. The housing market pants saw the economy as continuing to had remained robust, although a slowgrow at a solid pace, notwithstanding ing in house price gains in some areas the disruptive effects to economic activ- and recent declines in home equity lendity and employment from the hurricanes. ing at banks could be indicating that However, the near-term outlook contin- the long-expected cooling in the housued to be subject to considerable uncer- ing market was near. Motor vehicle purtainty given the difficulties in assessing chases had slowed substantially in Octothe net effects of the downturn in con- ber, but that seemed to owe primarily sumer confidence and the rise in energy to the end of discount programs that had prices through the summer, on the one generated a surge in auto spending over hand, and the rebuilding from hurricane the summer. Over the longer-term, with damage, on the other. Although oil and house price gains moderating and pergasoline prices had fallen in recent haps greater perceived needs to invest weeks and core inflation had remained for retirement purposes, the household benign, some businesses had reported saving rate was likely to rise gradually. increased ability to pass through cost Growth in business investment spendincreases in the environment of higher ing seemed to remain moderate overall, headline inflation. On balance, meeting but anecdotal reports suggested that a participants remained concerned about number of firms had boosted their plans heightened inflation pressures. for capital spending. Moreover, con- Meeting participants generally saw struction spending and commercial real accumulating evidence as supporting the estate investment seemed to be picking view that the disruptions to aggregate up in some areas. Significant problems economic activity and employment from persisted amongst U.S. nameplates in the hurricanes were likely to be limited the auto sector, however. The rise in and temporary. In areas that had been longer-term real interest rates and some devastated by the hurricanes, recovery widening of private credit spreads in of energy production and the rebuilding recent months were seen as perhaps of homes and businesses might take having a little restraining effect on the longer than had been expected, in part investment outlook. because of a slow return of evacuees. Economic growth in the near term However, in regions just outside those was likely to be boosted by additional that were most severely damaged, re- fiscal stimulus, in part to support recovcovery was already well underway, and ery and rebuilding from the hurricanes. the pace of economic activity had Strong demand from overseas was evistrengthened, in some cases owing to dently boosting exports this year by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

214 92nd Annual Report, 2005 more than the increase in imports, with ruptions associated with the hurricanes, the nation's external accounts thereby and underlying economic slack was providing a small net positive contribu- likely quite limited. In that context, all tion to growth in domestic production. members believed it important to con- Next year, however, the arithmetic con- tinue removing monetary policy accomtribution to growth from net exports modation in order to check upside risks was seen as likely to return to negative to inflation and keep inflation expectaterritory. tions contained, but noted that policy While participants noted some recent setting would need to be increasingly favorable data on core inflation and sensitive to incoming economic data. labor costs, upside risks to the outlook Some members cautioned that risks of for underlying inflation remained a key going too far with the tightening process concern. Wage gains had remained mod- could also eventually emerge. Nonetheest relative to continued strong produc- less, all members agreed to indicate at tivity growth, suggesting that labor costs the conclusion of this meeting that a were not putting much upward pressure continued measured pace of policy firmon prices. Indeed, core inflation contin- ing remained likely. ued to be subdued, and in recent weeks In their ongoing discussion of the gasoline prices had unwound a sig- Committee's communication strategy, nificant portion of their steep increases. participants expressed a variety of per- Nevertheless, there was a risk that the spectives about how the policy statelarge cumulative rise in energy and ment issued at the end of FOMC meetpetroleum product prices through the ings might evolve over time. Several summer would be transmitted to core aspects of the statement language would consumer prices. A number of firms had have to be changed before long, particubeen reporting a greater ability to pass larly those related to the characterizathrough increases in energy and other tion of and outlook for policy. Possible costs to customers, though evidently future changes in the sentence on the more so to other businesses than to balance of risks to the Committee's consumers. A survey measure of the objectives were also discussed. Particinear-term inflation expectations of pants noted that any forward-looking households had risen notably, but elements of the statement should clearly intermediate- and longer-term inflation be conditioned on the outlook for inflaexpectations implied by Treasury secu- tion and economic growth. For this rity yields had remained fairly stable. meeting, members concurred that the It was noted, however, that longer- current statement structure could be term expectations of inflation remained retained, as it accurately conveyed their contained in the context of an increase near-term economic and policy outlook. in the extent of additional monetary pol- In view of the continued rapid pace of icy tightening expected in financial observed productivity gains, members markets. agreed that the statement to be released In the Committee's discussion of after the meeting should again indimonetary policy for the intermeeting cate that robust underlying productivity period, all members favored raising the growth and monetary policy accommotarget federal funds rate 25 basis points dation were supporting the economic to 4 percent at this meeting. The econ- expansion. Those influences were exomy seemed to be growing at a fairly pected to be augmented by planned strong pace, despite the temporary dis- rebuilding and recovery activity in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 215 hurricane-affected areas. While gasoline Fisher, Kohn, Olson, Moskow, Santomero, prices had recently moved lower, the and Stern. Votes against this action: None cumulative rise in energy prices and It was agreed that the next meeting of other costs was seen as having the the Committee would be held on Tuespotential to add to inflation pressures. day, December 13, 2005. However, core inflation had been sub- The meeting adjourned at 1:15 p.m. dued in recent months and longer-run inflation expectations remained contained. Against that backdrop, the risks Notation Vote to the objective of price stability, as well as that for sustainable growth, remained By notation vote completed on Octoin balance, given appropriate monetary ber 7,2005, the Committee unanimously policy actions. approved the minutes of the meeting At the conclusion of the discussion, of the Federal Open Market Committee the Committee voted to authorize and held on September 20, 2005. direct the Federal Reserve Bank of New York, until it was instructed otherwise, Vincent R. Reinhart to execute transactions in the System Secretary Account in accordance with the following domestic policy directive: Meeting Held on December 13, 2005 The Federal Open Market Committee seeks monetary and financial conditions that A meeting of the Federal Open Market will foster price stability and promote sustainable growth in output. To further its long- Committee was held in the offices of run objectives, the Committee in the imme- the Board of Governors of the Federal diate future seeks conditions in reserve Reserve System in Washington, D.C., markets consistent with increasing the on Tuesday, December 13, 2005 at federal funds rate to an average of around 9:00 a.m. 4 percent. Present: The vote encompassed approval of Mr. Greenspan, Chairman the paragraph below for inclusion in the Mr. Geithner, Vice Chairman statement to be released shortly after the Ms. Bies meeting: Mr. Ferguson Mr. Fisher Mr. Kohn The Committee perceives that, with appro- Mr. Moskow priate monetary policy action, the upside and Mr. Olson downside risks to the attainment of both Mr. Santomero sustainable growth and price stability should Mr. Stern be kept roughly equal. With underlying inflation expected to be contained, the Commit- Ms. Cumming, Messrs. Guynn and tee believes that policy accommodation can Lacker, Mses. Pianalto and Yellen, be removed at a pace that is likely to be Alternate Members of the Federal measured. Nonetheless, the Committee will Open Market Committee respond to changes in economic prospects as needed to fulfill its obligation to maintain Mr. Hoenig, Ms. Minehan, and price stability. Mr. Poole, Presidents of the Federal Reserve Banks of Votes for this action: Messrs. Greenspan Kansas City, Boston, and and Geithner, Ms. Bies, Messrs. Ferguson, St. Louis, respectively Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

216 92nd Annual Report, 2005 Mr. Reinhart, Secretary and Economist Messrs. Fuhrer, Hakkio, Rasche, Ms. Danker, Deputy Secretary Sniderman, Weinberg, and Ms. Smith, Assistant Secretary Williams, Senior Vice Presidents, Mr. Alvarez, General Counsel Federal Reserve Banks of Boston, Mr. Baxter, Deputy General Counsel Kansas City, St. Louis, Cleveland, Ms. Johnson, Economist Richmond, and San Francisco, Mr. Stockton, Economist respectively Messrs. Connors, Freeman, and Mr. Cunningham, Ms. Mosser, and Madigan, Ms. Mester, Mr. Sullivan, Vice Presidents, Messrs. Oliner, Rosenblum, Tracy, Federal Reserve Banks of Atlanta, and Wilcox, Associate Economists New York, and Chicago, respectively Mr. Kos, Manager, System Open Market Account Mr. Weber, Senior Research Officer, Messrs. Slifman and Struckmeyer, Federal Reserve Bank of Associate Directors, Division of Minneapolis Research and Statistics, Board of Governors The Manager of the System Open Market Account reported on recent Mr. Whitesell, Deputy Associate developments in foreign exchange mar- Director, Division of Monetary Affairs, Board of Governors kets. There were no open market operations in foreign currencies for the Messrs. English and Sheets, Assistant System's account in the period since Directors, Divisions of Monetary the previous meeting. The Manager also Affairs and International Finance, reported on developments in domestic respectively, Board of Governors financial markets and on System open Mr. Simpson, Senior Adviser, Division market transactions in government of Research and Statistics, Board securities and federal agency obliof Governors gations during the period since the previous meeting. By unanimous Mr. Skidmore, Special Assistant to the vote, the Committee ratified these Board, Office of Board Members, Board of Governors transactions. The information reviewed at this Mr. Small, Project Manager, Division meeting suggested that the economy of Monetary Affairs, Board of continued to expand at a solid rate in Governors the fourth quarter. Industrial production Mr. ZakrajSek, Section Chief, Division rebounded, and employment growth of Monetary Affairs, Board of appeared to have recovered smartly Governors from the depressing effects of recent hurricanes. Although some scattered Mr. Kumasaka, Senior Financial signs of cooling of the housing sector Analyst, Division of Monetary had emerged, the pace of construction Affairs, Board of Governors activity and sales remained brisk. More Ms. Low, Open Market Secretariat broadly, spending by consumers and Specialist, Division of Monetary businesses was well maintained. Core Affairs, Board of Governors consumer price inflation remained subdued, even though some of the increase Mr. Barron, First Vice President, in energy costs had apparently passed Federal Reserve Bank of Atlanta Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 217 through to prices of final goods and slipped further in October. Manufacturservices. ing capacity utilization moved up again Private nonfarm payrolls grew rap- in October and was only a touch below idly in November after a small gain its long-run average. in October. Construction employment Real personal consumption expendiposted another large increase, proba- tures appeared to be increasing solidly bly owing in part to hurricane-related over the course of the fourth quarter, activity. Broad-based gains in durable led by improvements in the fundamengoods industries augmented manufac- tal determinants of consumer spending. turing employment, and employment in Real disposable personal income was the related industries of temporary help bolstered by gains in employment and services and wholesale trade increased falling retail energy prices, while continas well. With employment rising but ued brisk advances in house prices and the average workweek of production or the recent strengthening of equity prices nonsupervisory workers falling slightly, contributed importantly to increases in aggregate hours slipped in November— household wealth. Consumer sentiment albeit to a level above that of their picked up in November and early third-quarter average. The unemploy- December; some survey measures of ment rate held steady at 5 percent, and confidence returned to the range seen the labor force participation rate was during the first half of the year. The also unchanged. Survey measures of personal saving rate—while still slightly individuals' expectations of future labor negative—moved up in October. market conditions improved in Novem- Activity in the housing market ber, largely reversing post-Katrina remained brisk despite a rise in mortdeclines. gage interest rates. Starts of new single- Industrial production rebounded in family homes dropped back some- October after having been held down in what in October from September's September by hurricanes and by a strike very strong pace, but permit issuance at Boeing. The resumption of commer- remained elevated. New home sales cial aircraft production boosted manu- reached a new high in October, and facturing output and more than offset existing home sales eased off only a a fall in the production of motor vehi- little from the high levels recorded durcles and parts. Large output gains in ing the summer. Other available indicahurricane-affected industries—such as tors of housing activity were on the soft segments of the food, rubber and plas- side: An index of mortgage applications tics, and paper industries—also con- for purchases of homes declined in tributed to the increase in manufactur- November, and builders' ratings of new ing output. The growth of high-tech home sales had fallen off in recent output slowed slightly in October, months. In addition, survey measures of mainly as a result of smaller increases homebuying attitudes had declined to in the production of semiconductors. In levels last observed in the early 1990s. contrast, production of communication Real outlays for equipment and softequipment—particularly data network- ware posted a solid gain in the third ing equipment—accelerated. With many quarter. Although business purchases of energy facilities in the Gulf region motor vehicles declined in October and still closed, output at mines, which is November, growth in investment in nondefined to include oil and gas extraction, transportation equipment appeared to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

218 92nd Annual Report, 2005 have been well maintained in the fourth dropped as gasoline inventories requarter. Rising business sales, a declin- bounded. And spot prices for natural ing cost of capital, and ample financial gas fell sharply through mid-November resources in the corporate sector con- amidst unusually temperate weather, tinued to foster a favorable environ- plentiful inventories, and declining ment for capital spending, a sentiment prices of competing fuels; unusually echoed in executive surveys, which gen- cold weather in early December, howerally pointed to widespread increases ever, caused spot prices to move back in planned capital outlays. Real spend- up to their October levels. Presumably ing on nonresidential construction im- in response to falling retail energy proved materially in the third quarter, prices, one survey of households in boosted by substantial gains in drilling November and early December showed and mining expenditures. a marked retreat in expectations for Real nonfarm inventories ran off in inflation over the coming year. Longerthe third quarter as automakers pared term inflation expectations also edged their motor vehicle stocks. But even out- down, but stayed a touch above the side the motor vehicle sector, inventory narrow range observed in recent years. investment was relatively restrained, and Although recent increases in energy partial data for October suggested that costs had pushed up producer prices real stockbuilding continued to be sub- in some sectors, overall producer price dued. The level of stocks appeared inflation remained subdued. With regard reasonably well aligned with sales. to labor costs, the twelve-month change The U.S. international trade deficit in the employment cost index for private reached a new record in September. A industry workers in September was well surge in imports was accompanied by below its year-ago increase. Hourly a fairly sizable drop in exports, part compensation in the nonfarm business of which was due to a steep falloff in sector also appeared to have slowed a aircraft exports as a result of the strike bit recently. at Boeing. The jump in the value of At its November meeting, the Federal imports was driven by strong growth in Open Market Committee decided to most categories of goods and, to a lesser increase the target level of the federal extent, growth in services; increases in funds rate 25 basis points, to 4 perthe dollar value of imports of oil and of cent. In its accompanying statement, the industrial supplies—especially natural Committee indicated that, with approprigas—were particularly strong, a reflec- ate monetary policy action, the upside tion of higher prices. Foreign industrial- and downside risks to the attainment of ized economies expanded robustly in sustainable growth and price stability the third quarter, and available indica- should be kept roughly equal. The Comtors for the fourth quarter appeared mittee also noted that elevated energy promising, on balance. prices and hurricane-related disruptions Core consumer price inflation was in economic activity had temporarily moderate in recent months, although depressed output and employment. some signs of pass-through of higher However, monetary policy accommodaenergy costs were evident, especially tion, coupled with robust underlying in transportation services. Consumer growth in productivity, was providing energy prices had retreated notably from ongoing support to economic activity. their elevated post-hurricane levels. And although the cumulative rise in Wholesale and retail gasoline prices energy and other costs had the poten- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 219 tial to add to inflation pressures, core heights just before the implementation inflation had been relatively low in of more-stringent bankruptcy rules in recent months, and longer-term infla- mid-October. Hurricane relief payments tion expectations remained contained. apparently boosted M2 in October, but In these circumstances, the Committee that aggregate decelerated in November, believed that policy accommodation partly reflecting the continued rise in could be removed at a pace that was the opportunity cost of holding liquid likely to be measured but noted that it deposits. would respond to changes in economic The staff forecast prepared for this prospects as needed to fulfill its obliga- meeting suggested that growth of ecotion to maintain price stability. nomic activity would slow from this Market participants widely antici- year's pace, but remain solid, with outpated the Committee's decision at its put staying near the economy's poten- November meeting, and the policy tial over the next two years. Although announcement evoked little reaction in hurricane-related rebuilding would financial markets. Over the intermeet- boost activity, especially in the near ing period, investors marked up slightly term, this stimulus increasingly would their expectations for the path of be countered by higher interest rates, monetary policy in light of stronger- the anticipated waning of the positive than-expected data on spending and wealth effect associated with large earproduction. Nominal Treasury yields lier gains in equity and house prices, changed little, on net, but measures and reduced impetus from fiscal policy. of inflation compensation at longer Both overall and core consumer price horizons—which are calculated using inflation were projected to move higher yields on nominal and inflation- in the first half of next year, reflecting protected securities—declined some- the effects of higher energy prices, but what. Credit spreads on both then to trend lower as those effects ebb. investment- and speculative-grade cor- In their discussion of the economic porate bonds were about unchanged situation and outlook, meeting particiover the intermeeting period. Major pants noted that incoming data over the equity price indexes posted substantial intermeeting period had been encourgains, spurred by the perception that the aging with regard to both economic economy had retained considerable growth and inflation. The economic momentum with limited inflation pres- expansion had shown considerable sures. In foreign exchange markets, the resilience in the face of higher energy trade-weighted value of the dollar was prices and hurricane-related disruptions, about unchanged over the intermeeting suggesting greater underlying strength period. than had been apparent at the time of The expansion of domestic nonfinan- the November meeting. At the same cial debt appeared to have moderated a time, incoming inflation data had been little from its brisk third-quarter pace. benign, indicating relatively modest Consumer credit dipped in October, and pass-through of higher energy prices to nonfinancial firms' net borrowing in the core inflation to date; subdued gains in form of bank loans, commercial paper, compensation and strong growth in proand bonds was a bit below the third- ductivity were holding down business quarter pace. Household bankruptcies costs; and inflation expectations, which hovered at very low levels in recent had jumped after the hurricanes, had weeks after soaring to unprecedented fallen back. Nonetheless, with growth Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

220 92nd Annual Report, 2005 solid and prices of energy products still economy proved resilient in the face of well above levels earlier in the year, this year's substantial adverse shocks. possible increases in resource utilization Participants noted that the improved had the potential to add to pressures on performance of investment suggested prices, especially in the absence of some that the expansion was becoming more further firming of policy. balanced, with strengthening business In their discussion of major sectors spending potentially offsetting some of the economy, meeting participants moderation in the growth of household noted that, while light vehicle sales had spending from the elevated rates of slowed in the fall, consumer spending recent years. outside the auto sector appeared to have Economic activity also could be remained vigorous. Holiday sales were buoyed by developments in other secsaid to be off to a good start in many tors of the economy. Increased federal parts of the country. The substantial government outlays were expected to recovery in measures of consumer confi- boost output a little next year. Supportdence after their sharp declines in the ive financial conditions and an apparent aftermath of the hurricanes had reduced increase in confidence had contributed meeting participants' concerns about to a pickup in growth abroad. Despite a significant pull-back in spending. possible firming of monetary policy by Going forward, consumer outlays were some foreign central banks and the rise expected to be supported by further in the foreign exchange value of the advances in employment and income. dollar owing to global demands for dol- Meeting participants discussed tenta- lar assets, a good portion of the recent tive signs that activity was beginning to strength in foreign economic growth slow in the housing sector. Reports from was expected to persist and provide supcontacts in many parts of the country port for U.S. exports. suggested somewhat less ebullient mar- In their discussion of prices, particiket conditions, and measures of confi- pants indicated that their concerns about dence of homebuyers and builders had near-term inflation pressures had eased fallen back noticeably. A downshift in somewhat over the intermeeting period. attitudes regarding the outlook for the Recent data suggested that, thus far, housing sector could have significant indirect effects of elevated energy prices market effects, in part by damping the on core inflation had been muted. Moredemand for houses by investors and over, energy prices generally had fallen speculators. A slowing of house price back on balance since earlier in the fall, increases, by restraining the expansion and much of the increases in inflation of consumption, and a moderation in the expectations posted in the aftermath pace of new building were expected to of the hurricanes had reversed. Particireduce the growth of aggregate demand pants noted that robust competition— somewhat in coming quarters. To date, including that from foreign producers— however, the national data on home and further substantial gains in proprices, sales, and construction activity ductivity were helping to contain cost did not suggest a significant weakening and price pressures. Moreover, measures in the sector. of labor compensation showed only Business investment spending had moderate gains while relatively wide accelerated some since midyear. In profit margins could allow firms to part, the pickup may have reflected an absorb somewhat larger increases in increase in business confidence as the labor and other costs without boosting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 221 prices. Nonetheless, surveys and anec- degree of monetary policy accommodadotal reports suggested that some firms tion, members thought that the policy were successfully passing at least a por- outlook was becoming considerably less tion of their increased costs on to cus- certain and that policy decisions going tomers, and many participants remained forward would depend to an increased concerned that elevated energy prices extent on the implications of incoming could put pressure on core inflation. economic data for future growth and Also, in the view of a number of par- inflation. ticipants, the economy was possibly The Committee agreed that several producing in the neighborhood of its changes in the wording of the announcepotential, and the persistent strength in ment to be released after today's meetspending of late suggested that resource ing would be appropriate. The federal markets could tighten further and infla- funds rate had been boosted substantion pressures build. Under these cir- tially, and, in the view of some memcumstances, and with policy having bers, it was now likely within a broad been accommodative for some time, range of values that might turn out to be inflation expectations could rise if consistent with output remaining close monetary policy were not seen as to potential. In these circumstances, the responding to contain such risks. Committee thought that policy should In the Committee's discussion of no longer be characterized as accommonetary policy for the intermeeting modative. Members concurred that the period, all members favored raising the statement should note that the expansion target federal funds rate 25 basis points remained solid despite elevated energy to AlA percent. With spending appar- prices and hurricane-related disruptions. ently retaining considerable momentum, While inflation and long-term inflation and with the indirect effects of increased expectations remained contained, the energy prices still threatening to raise Committee agreed that the announcecore inflation at least for a time, the ment should indicate that possible in- Committee thought that additional pol- creases in resource utilization, as well as icy firming at this meeting was appropri- elevated energy prices, had the potential ate to keep inflation and inflation expec- to add to inflation pressures and that tations in check. Committee members "some further measured policy firming generally anticipated that policy would is likely to be needed to keep the risks to likely need to be firmed further going the attainment of both sustainable ecoforward. In that process, the Committee nomic growth and price stability roughly would need to be mindful of the lags in in balance." Although future action the effect of policy finning on the econ- would depend on the incoming data, this omy. However, it would also have to characterization of the outlook for poltake account of the effects of the sus- icy was seen by most members as inditained period of favorable financial con- cating that, given the information now ditions on asset prices and aggregate in hand, the number of additional firmdemand as well as the resulting possibil- ing steps required probably would not ity of further increases in resource utili- be large. Some members thought that zation and pressures on prices. Views the word "measured" was no longer differed on how much further tightening necessary, but its retention for this might be required. Because the Com- meeting was seen as potentially useful mittee's actions over the past eighteen to preclude a possible misinterpretation months had significantly reduced the that the Committee now saw a sig- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

222 92nd Annual Report, 2005 nificant possibility of adjusting policy statement to be released shortly after the in larger increments in the near ftiture. meeting: Wording of the announcement along these lines was not expected to have The Committee judges that some further measured policy firming is likely to be a substantial effect on market expecneeded to keep the risks to the attainment of tations for policy, though such effects both sustainable economic growth and price were especially difficult to judge given stability roughly in balance. In any event, the the extensive changes being made to the Committee will respond to changes in ecostatement. The members agreed that the nomic prospects as needed to foster these objectives. announcement should end by noting that policy will respond to changes in eco- Votes for this action: Messrs. Greenspan nomic prospects as needed to foster the and Geithner, Ms. Bies, Messrs. Ferguson, Committee's objectives. Fisher, Kohn, Olson, Moskow, Santomero, At the conclusion of the discussion, and Stern. Votes against this action: None the Committee voted to authorize and direct the Federal Reserve Bank of New It was agreed that the next meeting of York, until it was instructed otherwise, the Committee would be held on Tuesto execute transactions in the System day, January 31, 2006. Account in accordance with the follow- The meeting adjourned at 1:00 p.m. ing domestic policy directive: Notation Vote The Federal Open Market Committee seeks monetary and financial conditions that By notation vote completed on Novemwill foster price stability and promote susber 21, 2005, the Committee unanitainable growth in output. To further its longmously approved the minutes of the run objectives, the Committee in the immediate future seeks conditions in reserve meeting of the Federal Open Market markets consistent with increasing the fed- Committee held on November 1, 2005. eral funds rate to an average of around 4lA percent. Vincent R. Reinhart Secretary The vote encompassed approval of the paragraph below for inclusion in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

223 Litigation During 2005, the Board of Governors Ulrich v. Board of Governors, No. 03was a party in three lawsuits or appeals 73854 (9th Circuit, filed October 24, filed that year and was a party in ten 2003), and Diehl McCarthy v. Board of other cases pending from previous Governors, No. 03-73997 (9th Circuit, years, for a total of thirteen cases; in filed October 28, 2003), were petitions 2004, the Board had been a party in a for review of orders of prohibition total of seventeen cases. None of the issued by the Board on October 15, lawsuits or appeals filed in 2005 raised 2003. On April 27, 2005, the court questions under the Bank Holding Com- denied the petitions for review. 129 Fed. pany Act. As of December 31, 2005, App'x. 386 (9th Cir. 2005). five cases were pending. Other Actions Litigation under the Financial Inner City Press/Community on the Institutions Supervisory Act Move v. Board of Governors, No. 05- Bazy v. Board of Governors, No. 05- 6162 (2nd Circuit, filed November 21, 1320 (D.C. Circuit, filed August 12, 2005), is an appeal of the district court's 2005), was a petition for review of an order (No. 04-CV-8337, 380 F. Supp. 2d interlocutory order in an administrative 211 (S.D.N.Y. 2005)) granting in part enforcement proceeding. On August 24, and denying in part the Board's motion 2005, the court dismissed the case on for summary judgment in a Freedom of the motion of the petitioner. Information Act case. On December 5, Board of Governors v. Thomas, et aL, 2005, the Board filed a cross-appeal in No. l:04-CV-0777 (N.D. Georgia, filed the matter. March 19, 2004), was an injunctive Price v. Greenspan, No. 05-5361 action in which, in 2004, the court (D.C. Circuit, filed September 29, ordered eighteen individuals to deposit 2005), is an appeal of an order of funds into the court's registry to satisfy the district court (No. 04-CV-0973, civil money penalties the Board was 374 F. Supp. 2d 17 (D.D.C. 2005)) disseeking against them in a separate missing an employment discrimination administrative enforcement proceeding. action. On July 13, 2005, the court granted the Barnes v. Greenspan, No. 04-CV- Board's motion to dismiss the prelimi- 1989 (CKK) (D. District of Columnary injunction issued on the Board's bia, filed November 15, 2004), is a behalf so that the deposited funds could case under the Age Discrimination in instead be transferred to the United Employment Act. States Bankruptcy Court, Middle Dis- Fakolujo v. Federal Reserve System, trict of Florida, Tampa Division, which et ah, No. 05-304 (E.D. Pennsylvania, had issued judgments against the same filed October 15, 2004, in the Court of eighteen defendants in an adversary pro- Common Pleas, Philadelphia County, ceeding brought by the court-appointed Pa., and removed to federal court on trustee. January 21, 2005), was an action for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

224 92nd Annual Report, 2005 wrongful denial of insurance claim. The June 21, 2004), was a case brought action was dismissed by agreement of under the Freedom of Information Act. the parties on April 15, 2005. On September 30, 2005, the court Jones v. Greenspan, No. 04-CV-1696 granted the Board's motion for sum- (RMU) (D. District of Columbia, filed mary judgment. October 4, 2004), is an employment Artis v. Greenspan, No. 01-0400 discrimination action. On December 13, (D. District of Columbia, filed Febru- 2005, the district court granted in part ary 22, 2001), is an employment disand denied in part the Board's motion to crimination action. An identical action, dismiss and for summary judgment. No. 99-2073 (EGS) (D. District of Texas State Bank v. United States, Columbia, filed August 3, 1999), was No. 04-5126 (Federal Circuit, filed consolidated with this action on July 28, 2004), was an appeal from a August 15, 2001. decision of the United States Court Fraternal Order of Police v. Board of of Federal Claims dismissing an action Governors, No. 98-3116 (D. District of challenging on constitutional grounds Columbia, filed December 22, 1998), the failure to pay interest on reserve was an action seeking a declaratory accounts held at Federal Reserve Banks. judgment regarding the Board's labor On September 21, 2005, the court policy governing Federal Reserve affirmed the lower court's dismissal of Banks. On July 28, 2005, the district the action. 423 F.3d 1370 (Fed. Cir. court granted the Board's motion for 2005). The petitioner's request for summary judgment and dismissed rehearing and rehearing en bane was the action. 391 F. Supp. 2d 1 (D.D.C. denied on December 13, 2005. 2005). . Sciba v. Board of Governors, No. 04- CV-1011 (D. District of Columbia, filed 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 227 Board of Governors December 31, 2005 Members STEPHEN H. MEYER, Assistant General Term expires Counsel January 31, PATRICIA A. ROBINSON, Assistant General ALAN GREENSPAN, Chairman1 2006 Counsel ROGER W. FERGUSON, JR., CARY K. WILLIAMS, Assistant General Vice Chairman1 2014 Counsel SUSAN S. BIES 2012 OFFICE OF THE SECRETARY MARK W. OLSON 2010 JENNIFER J. JOHNSON, Secretary DONALD L. KOHN 2016 ROBERT DEV. FRIERSON, Deputy Secretary MARGARET M. SHANKS, Associate Officers Secretary OFFICE OF BOARD MEMBERS MICHELLE A. SMITH, Director DIVISION OF WINTHROP P. HAMBLEY, Assistant to the INTERNATIONAL FINANCE Board and Director for Congressional KAREN H. JOHNSON, Director Liaison THOMAS A. CONNORS, Senior Associate ROSANNA PIANALTO-CAMERON, Special Director Assistant to the Board for Public WILLIAM L. HELKIE, Senior Adviser Information DALE W. HENDERSON, Senior Adviser DAVID W. SKIDMORE, Special Assistant to RICHARD T. FREEMAN, Associate Director the Board STEVEN B. KAMIN, Associate Director LARICKE D. BLANCHARD, Special Assistant JON W. FAUST, Assistant Director to the Board for Congressional Liaison JOSEPH E. GAGNON, Assistant Director BRIAN J. GROSS, Special Assistant to the MICHAEL P. LEAHY, Assistant Director Board for Congressional Liaison D. NATHAN SHEETS, Assistant Director ROBERT M. PRIBBLE, Special Assistant to the Board for Congressional Liaison RALPH W TRYON, Assistant Director LEGAL DIVISION DIVISION OF MONETARY AFFAIRS SCOTT G. ALVAREZ, General Counsel VINCENT R. REINHART, Director RICHARD M. ASHTON, Deputy General Counsel BRIAN F. MADIGAN, Deputy Director DEBORAH J. DANKER, Special Assistant KATHLEEN M. O'DAY, Deputy General to the Board Counsel ATHANASIOS ORPHANIDES, Adviser STEPHANIE MARTIN, Associate General Counsel JAMES A. CLOUSE, Deputy Associate Director ANN MISBACK, Associate General Counsel WILLIAM C. WHITESELL, Deputy Associate KATHERINE H. WHEATLEY, Associate Director General Counsel CHERYL L. EDWARDS, Assistant Director KIERAN J. FALLON, Assistant General Counsel WILLIAM B. ENGLISH, Assistant Director 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 terminates sooner. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

228 92nd Annual Report, 2005 Board of Governors—Continued DIVISION OF RESEARCH ROGER T. COLE, Senior Associate Director AND STATISTICS MICHAEL G. MARTINSON, Senior Adviser DAVID J. STOCKTON, Director STEVEN M. ROBERTS, Senior Adviser PATRICK M. PARKINSON, Deputy Director DEBORAH P. BAILEY, Associate Director DAVID W. WILCOX, Deputy Director NORAH M. BARGER, Associate Director MYRON L. KWAST, Senior Associate BETSY CROSS, Associate Director Director GERALD A. EDWARDS, JR., Associate STEPHEN D. OLINER, Associate Director Director LAWRENCE SLIFMAN, Associate Director JACK P. JENNINGS, Associate Director CHARLES S. STRUCKMEYER, Associate ROBIN L. LUMSDAINE, Associate Director Director PETER J. PURCELL, Associate Director and ALICE PATRICIA WHITE, Associate Director Chief Technology Officer GLENN B. CANNER, Senior Adviser MOLLY S. WASSOM, Associate Director DAVID S. JONES, Senior Adviser DAVID M. WRIGHT, Associate Director THOMAS D. SIMPSON, Senior Adviser BARBARA J. BOUCHARD, Deputy Associate S. WAYNE PASSMORE, Deputy Associate Director Director ANGELA DESMOND, Deputy Associate DAVID L. REIFSCHNEIDER, Deputy Director JAMES A. EMBERSIT, Deputy Associate Associate Director Director JANICE SHACK-MARQUEZ, Deputy CHARLES H. HOLM, Deputy Associate Associate Director Director WILLIAM L. WASCHER m, Deputy WILLIAM C. SCHNEIDER, JR., Deputy Associate Director Associate Director JOYCE K. ZICKLER, Deputy Associate WILLIAM G. SPANIEL, Deputy Associate Director Director J. NELLIE LIANG, Assistant Director STACY LEE COLEMAN, Assistant Director DANIEL E. SICHEL, Assistant Director JON D. GREENLEE, Assistant Director MARY M. WEST, Assistant Director WALT H. MILES, Assistant Director MICHAEL S. CRINGOLI, Assistant Director WILLIAM F. TREACY, Assistant Director and Chief DOUGLAS W. ELMENDORF, Assistant DIVISION OF CONSUMER Director and Chief AND COMMUNITY AFFAIRS MICHAEL S. GIBSON, Assistant Director SANDRA F. BRAUNSTEIN, Director and Chief GLENN E. LONEY, Deputy Director DIANA HANCOCK, Assistant Director LEONARD CHANIN, Associate Director and Chief ADRIENNE D. HURT, Associate Counsel ROBIN A. PRAGER, Assistant Director and MARY T. JOHNSEN Associate Director Chief TONDA E. PRICE, Associate Director DIVISION OF BANKING SUPERVISION SUZANNE G. KILLIAN, Assistant Director AND REGULATION SHEILA F. MAITH, Assistant Director RICHARD SPILLENKOTHEN, Director JAMES A. MICHAELS, Assistant Director STEPHEN M. HOFFMAN, JR., Deputy Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 229 Board of Governors—Continued DIVISION OF RESERVE BANK DIVISION OF OPERATIONS AND PAYMENT INFORMATION TECHNOLOGY SYSTEMS MARIANNE M. EMERSON, Director LOUISE L. ROSEMAN, Director MAUREEN T. HANNAN, Deputy Director JEFFREY C. MARQUARDT, Deputy Director TILLENA G. CLARK, Assistant Director PAUL W. BETTGE, Senior Associate GEARY L. CUNNINGHAM, Assistant Director Director KENNETH D. BUCKLEY, Associate Director WAYNE A. EDMONDSON, Assistant Director DOROTHY LACHAPELLE, Associate Director Po KYUNG KIM, Assistant Director JACK K. WALTON II, Associate Director SUSAN F. MARYCZ, Assistant Director GREGORY L. EVANS, Assistant Director SHARON L. MOWRY, Assistant Director LISA HOSKINS, Assistant Director RAYMOND ROMERO, Assistant Director MICHAEL J. LAMBERT, Assistant Director JILL R. ROSEN, Assistant Director JEFF J. STEHM, Assistant Director OFFICE OF INSPECTOR GENERAL OFFICE OF STAFF DIRECTOR BARRY R. SNYDER, Inspector General FOR MANAGEMENT DONALD L. ROBINSON, Deputy Inspector STEPHEN R. MALPHRUS, Staff Director for General Management ELIZABETH A. COLEMAN, Assistant SHEILA CLARK, Equal Employment Inspector General Opportunity Programs Director LAURENCE A. FROEHLICH, Assistant LYNN S. FOX, Senior Adviser Inspector General WILLIAM L. MITCHELL, Assistant Inspector MANAGEMENT DIVISION General H. FAY PETERS, Director DARRELL R. PAULEY, Deputy Director STEPHEN J. CLARK, Senior Associate Director CHRISTINE M. FIELDS, Associate Director MARSHA W. REIDHILL, Associate Director BILLY J. SAULS, Associate Director . DONALD A. SPICER, Associate Director CHARLES F. O'MALLEY, Assistant Director JAMES R. RIESZ, Assistant Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

230 92nd Annual Report, 2005 Federal Open Market Committee December 31,2005 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 SUSAN S. BIES, Board of Governors THOMAS C. BAXTER, JR., Deputy General ROGER W. FERGUSON, JR., Board of Counsel Governors KAREN H. JOHNSON, Economist RICHARD W. FISHER, President, Federal DAVID J. STOCKTON, Economist Reserve Bank of Dallas THOMAS A. CONNORS, Associate Economist DONALD L. KOHN, Board of Governors CHARLES L. EVANS, Associate Economist MICHAEL H. MOSKOW, President, Federal RICHARD T. FREEMAN, Associate Economist Reserve Bank of Chicago BRIAN F. MADIGAN, Associate Economist MARK W. OLSON, Board of Governors LORETTA J. MESTER, Associate Economist ANTHONY M. SANTOMERO, President, STEPHEN D. OLINER, Associate Economist Federal Reserve Bank of Philadelphia ARTHUR J. ROLNICK, Associate Economist GARY H. STERN, President, Federal HARVEY ROSENBLUM, Associate Economist Reserve Bank of Minneapolis JOSEPH S. TRACY, Associate Economist Alternate Members DAVID W. WILCOX, Associate Economist CHRISTINE M. CUMMTNG, First Vice DINO Kos, Manager, System Open Market President, Federal Reserve Bank of Account New York During 2005 the Federal Open Market Com- JACK GUYNN, President, Federal Reserve mittee held eight regularly scheduled meet- Bank of Atlanta ings (see "Minutes of Federal Open Market JEFFREY M. LACKER, President, Federal Committee Meetings" in this volume). Reserve Bank of Richmond SANDRA PIANALTO, President, Federal Reserve Bank of Cleveland JANET L. YELLEN, President, Federal Reserve Bank of San Francisco Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 231 Federal Advisory Council December 31, 2005 Members District 10—BYRON G. THOMPSON, Chairman, Country Club Bank, N.A., Kansas District 1—JAMES C. SMITH, Chairman and City, Mo. Chief Executive Officer, Webster Bank, N.A. and Webster Financial Corporation, District 11—GAYLE M. EARLS, President and Chief Executive Officer, TIB—The Waterbury, Conn. Independent BankersBank, Dallas, Tex. District 2—THOMAS A. RENYI, Chairman District 12—RICHARD M. KOVACEVICH, and Chief Executive Officer, The Bank of Chairman, President, and Chief Executive New York, N.Y. Officer, Wells Fargo and Company, San District 3—BRUCE L. HAMMONDS President Francisco, Calif. and Chief Executive Officer, MBNA Corporation, Wilmington, Del. Officers District 4—MARTIN G. MCGUINN, Chairman and Chief Executive Officer, Mellon MARTIN G. MCGUINN, President Financial Corp., Pittsburgh, Pa. JERRY A. GRUNDHOFER, Vice President District 5—G. KENNEDY THOMPSON, Chair- JAMES E. ANNABLE, Secretary man, President, and Chief Executive Officer, Wachovia Corporation, Charlotte, The Federal Advisory Council, which is a N.C. statutory body established under the Federal District 6—FRED L. GREEN HI, Vice Chair- Reserve Act, consults with, and advises, the man, Synovus Financial Corporation, Board of Governors on all matters within the Columbus, Ga. Board's jurisdiction. It is composed of one District 7—DENNIS J. KUESTER, President representative from each Federal Reserve and Chief Executive Officer, Marshall & District, chosen by the Reserve Bank in that Dsley Corporation, Milwaukee, Wis. District. The Federal Reserve Act requires the council to meet in Washington, D.C., at District 8—J. KENNETH GLASS, Chairman, President, and Chief Executive Officer, least four times a year. In 2005, it met on First Horizon National Corporation, February 10-11, May 5-6, September 1-2, Memphis, Tenn. and December 8-9. The council met with the Board on February 11, May 6, September 2, District 9—JERRY A. GRUNDHOFER, Presiand December 9, 2005. dent and Chief Executive Officer, U.S. Bancorp, Minneapolis, Minn. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

232 92nd Annual Report, 2005 Consumer Advisory Council December 31,2005 Members BRUCE B. MORGAN, Chairman, President, and Chief Executive Officer, Valley State STELLA ADAMS, Executive Director, North Bank, Roeland Park, Kans. Carolina Fair Housing Center, Durham, N.C. BENJAMIN ROBINSON III, President and Chief Executive Officer, Innovative Risk DENNIS L. ALGIERE, Senior Vice President, Solutions, LLC, Charlotte, N.C. The Washington Trust Company, MARY JANE SEEBACH, Managing Director, Westerly, R.I. Public Affairs, Countrywide Financial FAITH L. ANDERSON, Vice President/Legal Corporation, Calabasas, Calif. Compliance and General Counsel, LISA SODEIKA, Executive Vice President- American Airlines Federal Credit Union, Corporate Affairs, HSBC North America Fort Worth, Tex. Holdings, Inc., Prospect Heights, 111. SUSAN BREDEHOFT, Senior Vice President/ PAUL J. SPRINGMAN, Chief Marketing Offi- Compliance Risk Management, Comcer, Equifax, Atlanta, Ga. merce Bank, N.A., Cherry Hill, NJ. FORREST F. STANLEY, Senior Vice President SHEILA CANAVAN, Consumer Attorney, Law and Deputy General Counsel, KeyBank Office of Sheila Canavan, Moab, Utah National Association, Cleveland, Ohio CAROLYN CARTER, Attorney, National Con- DIANE THOMPSON, Supervising Attorney, sumer Law Center, Boston, Mass. Land of Lincoln Legal Assistance Foun- MICHAEL COOK, Vice President, Wal-Mart dation, Inc., East St. Louis, 111. Stores, Inc., Bentonville, Ark. ANSELMO VBLLARREAL, Executive Director, DONALD S. CURRIE, Executive Director, LaCasa de Esperanza, Inc., Waukesha, Wis. Community Development Corporation of CLINT WALKER, General Counsel/Chief Brownsville, Brownsville, Tex. Administrative Officer, Juniper Bank, ANNE DIEDRICK, Senior Vice President, Wilmington, Del. JPMorgan Chase Bank, New York, N.Y. KELLY K. WALSH, Former Senior Vice DAN DIXON, Group Senior Vice President, World Savings Bank, FSB, Washington, President, Bank of Hawaii, Honolulu, D.C. Hawaii HATTIE B. DORSEY, President and Chief MARVA E. WILLIAMS, Senior Vice President, Executive Officer, Atlanta Neighborhood Woodstock Institute, Chicago, 111. Development Partnership, Atlanta, Ga. KURT EGGERT, Professor of Law and Direc- Officers tor of Clinical Legal Education, Chapman University School of Law, Orange, Calif. MARK PINSKY, Chair, President and Chief JAMES GARNER, Senior Vice President and Executive Officer, National Community General Counsel, North American Con- Capital Association, Philadelphia, Pa. sumer Finance for Citigroup, Baltimore, LORI SWANSON, Vice Chair, Solicitor Gen- Md. eral, Office of the Minnesota Attorney CHARLES GATSON, Former Vice President, General, St. Paul, Minn. Midtown Community Development Cor- The Consumer Advisory Council—a statuporation, Kansas City, Mo. tory body established pursuant to the 1976 DEBORAH HICKOK, Vice President, amendments to the Equal Credit Opportunity MoneyGram Payment Systems, Inc., Act—advises the Board of Governors on Ooltewah, Tenn. consumer financial services. Its members, W. JAMES KING, President and Chief Execu- who are appointed by the Board, are acative Officer, Community Redevelopment demics, state and local government officials, Group, Cincinnati, Ohio and representatives of the financial services ELSIE MEEKS, Executive Director, First industry and of consumer and community Nations Oweesta Corporation, Rapid City, interests. In 2005, the council met with mem- S.D. bers of the Board on March 17, June 23, and October 27. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 233 Thrift Institutions Advisory Council December 31,2005 Members GEORGE JEFFREY RECORDS, JR., Chairman and Chief Executive Officer, MidFirst ELDON R. ARNOLD, President and Chief Bank, Oklahoma City, Okla. Executive Officer, Citizens Equity First Credit Union (CEFCU), Peoria, HI. DAVID RUSSELL TAYLOR, President and Chief Executive Officer, Rahway Savings H. BRENT BEESLEY, Chairman and Chief Executive Officer, Heritage Bank, Institution, Rahway, N.J. St. George, Utah ROY M. WHITEHEAD, President and Chief CRAIG G. BLUNDEN, Chairman, President, Executive Officer, Washington Federal and Chief Executive Officer, Provident Savings, Seattle, Wash. Savings Bank, FSB, Riverside, Calif. ALEXANDER R.M. BOYLE, Vice Chairman, Officers Chevy Chase Bank, Bethesda, Md. ROBERT M. COUCH, President and Chief CURTIS L. HAGE, President Executive Officer, New South Federal ROY M. WHITEHEAD, Vice President Savings Bank, Birmingham, Ala. The Thrift Institutions Advisory Council was JEFFREY H. FARVER, President and Chief established by the Board of Governors to Executive Officer, San Antonio Federal consult with, and advise, the Board on issues Credit Union, San Antonio, Tex. pertaining to the thrift industry and on other DOUGLAS K. FREEMAN, Chairman and Chief matters within the Board's jurisdiction. Its Executive Officer, NetBank, Alpharetta, members, who are appointed by the Board, Ga. represent credit unions, savings and loan CURTIS L. HAGE, Chairman and Chief associations, and savings banks. In 2005, the Executive Officer, Home Federal Bank, council met with the Board on March 4, Sioux Falls, S.D. July 8, and December 2. DAVID H. HANCOCK, Chief Executive Officer, North American Savings Bank, Grandview, Mo. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

234 92nd Annual Report, 2005 Federal Reserve Banks and Branches December 31,2005 Officers Chairman1 President Officer 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. dimming Buffalo Marguerite D. Kausar Hamdani 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 James M. Anderson Barbara B. Henshaw Pittsburgh Roy W.Haley Robert B. Schaub RICHMOND Thomas J. Mackell, Jr. Jeffrey M. Lacker Theresa M. Stone Walter A. Varvel Baltimore William C.Handorf David Beck Charlotte Michael A. Almond Jeffrey S. Kane ATLANTA David M. Ratcliffe Jack Guynn James M. McKee V. Larkin Martin Patrick K. Barren Birmingham James H. Sanford Lee C. Jones Jacksonville Fassil Gabremariam Christopher L. Oakley Miami Edwin A. Jones, Jr. Juan del Busto Nashville Beth Dortch Franklin Melvyn K. Purcell New Orleans Earl L. Shipp Robert J. Musso CHICAGO2 W. James Farrell Michael H. Moskow Miles D. White Gordon R.G. Werkema Detroit Edsel B. Ford II Glenn Hansen ST. LOUIS Walter L.Metcalfe, Jr. William Poole Gayle P. W. Jackson W. LeGrande Rives Little Rock Stephen M. Erixon Robert A. Hopkins Louisville Norman E. Pfau, Jr. Maria Gerwing Hampton Memphis Russell Gwatney Martha Perine Beard MINNEAPOLIS Linda Hall Whitman Gary H. Stern Frank L. Sims James M. Lyon Helena. . Lawrence R. Simkins Samuel H. Gane Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 235 Officers—Continued Chairman1 President Officer BANK or Branch Deputy Chairman First Vice President in charge of Branch KANSAS CITY Robert A. Funk Thomas M. Hoenig Richard H. Bard Richard K. Rasdall Denver Thomas Williams Pamela L. Weinstein Oklahoma City Tyree O. Minner Dwayne E. Boggs Omaha James A. Timmerman Kevin A. Drusch DALLAS Ray L. Hunt Richard W. Fisher Patricia M. Helen E. Holcomb Patterson El Paso Ron C. Helm Robert W. Gilmer Houston Lupe Fraga Robert Smith III San Antonio Elizabeth Chu Richter D. Karen Diaz SAN FRANCISCO2 George M. Scalise Janet L.Yellen David K.Y. Tang John F. Moore Los Angeles James L. Sanford Mark L. Mullinix Portland James H. Rudd Mary E. Lee Salt Lake City H. Roger Boyer Andrea P. Wolcott Seattle Mic R. Dinsmore Mark Gould 1. The chairman of a Federal Reserve Bank serves, by York; East Rutherford, New Jersey; Columbus, Ohio; statute, as Federal Reserve agent. Des Moines, Iowa; Midway at Bedford Park, Illinois, and 2. Additional offices of these Banks are located at Phoenix, Arizona. Windsor Locks, Connecticut; Utica at Oriskany, New 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, also attended by the deputy chairmen, Governors. were held in Washington, D.C. on June 1 and Cathy E. Minehan, president of the Fed- 2, November 30, and December 1, 2005. eral Reserve Bank of Boston, served as chair The members of the executive com- of the conference in 2005, and Anthony M. mittee of the Conference of Chairmen dur- Santomero, president of the Federal Reserve ing 2005 were George M. Scalise, chair; Bank of Philadelphia, served as vice chair. Walter L. Metcalfe, Jr., vice chair; and John Michael P. Malone, of the Federal Reserve Sexton, member. Bank of Boston, served as secretary, and On December 1, 2005, the conference Herbert E. Taylor, of the Federal Reserve elected its executive committee for 2006, Bank of Philadelphia, served as assistant naming John E. Sexton as chair; Charles E. secretary. Bunch as vice chair; and Robert A. Funk as the third member. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

236 92nd Annual Report, 2005 Conference of First of agriculture, commerce, industry, services, Vice Presidents labor, and consumers; they may not be officers, directors, or employees of any bank or The Conference of First Vice Presidents of bank holding company. In addition, Class C the Federal Reserve Banks was organized in directors may not be stockholders of any 1969 to meet periodically for the consider- bank or bank holding company. ation of operations and other matters. For the election of Class A and Class B Walter A. Varvel, first vice president of directors, the member banks of each Fedthe Federal Reserve Bank of Richmond, eral Reserve District are classified into served as chair of the conference in 2005, three groups. Each group, which comprises and Helen E. Holcomb, first vice president banks with similar capitalization, elects one of the Federal Reserve Bank of Dallas, Class A director and one Class B director. served as vice chair. Janice E. Clatterbuck, Annually, the Board of Governors designates of the Federal Reserve Bank of Richmond, one of the Class C directors as chair of served as secretary, and Harvey R. Mitchell, the board and Federal Reserve agent of of the Federal Reserve Bank of Dallas, each District Bank, and it designates another served as assistant secretary. Class C director as deputy chair. On September 20, 2005, the conference Federal Reserve Branches have either five elected Helen E. Holcomb as chair for or seven directors, a majority of whom are 2006-07 and James M. Lyon, first vice presi- appointed by the parent Federal Reserve dent of the Federal Reserve Bank of Minne- Bank; the others are appointed by the Board apolis, as vice chair. of Governors. One of the directors appointed by the Board is designated annually as chair of the board of that Branch in a manner Directors prescribed by the parent Federal Reserve Each Federal Reserve Bank has a nine- Bank. member board: three Class A and three The chairs and deputy chairs of the Class B directors, who are elected by the Reserve Bank boards of directors, and the stockholding member banks, and three chairs of the Branches, are listed in the pre- Class C directors, who are appointed by the ceding table, titled "Officers." The directors Board of Governors. 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. not exclusive, consideration to the interests Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 237 Directors BANK or BRANCH, Category Term expires Title Name Dec. 31 DISTRICT 1—BOSTON RESERVE BANK Class A James R. Wood President and Chief Executive Officer, The First 2005 National Bank of Suffield, Suffield, Connecticut Peter A. Blyberg President and Chief Executive Officer, 2006 Union Trust Company, Ellsworth, Maine Ronald E. Logue Chairman and Chief Executive Officer, 2007 State Street Corporation, Boston, Massachusetts Class B Orit Gadiesh Chairman, Bain & Company, Inc., 2005 Boston, Massachusetts KirkP.Pond President, Chief Executive Officer, and Chairman, 2006 Fairchild Semiconductor International, South Portland, Maine Robert K. Kraft Chairman and Chief Executive Officer, 2007 The Kraft Group, Foxborough, Massachusetts Class C Blenda J. Wilson President and Chief Executive Officer, 2005 Nellie Mae Education Foundation, Quincy, Massachusetts Lisa M. Lynch William L. Clayton Professor of International Economic 2006 Affairs, The Fletcher School of Law and Diplomacy, Tufts University, Medford, Massachusetts Samuel O. Thier, M.D Professor of Medicine and Professor of Health Care 2007 Policy, Harvard Medical School, Massachusetts General Hospital, Boston, Massachusetts DISTRICT 2—NEW YORK RESERVE BANK Class A 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 Jill M. Considine Chairman and Chief Executive Officer, 2007 The Depository Trust Company, New York, New York Class B 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 Richard S. Fuld, Jr. Chairman and Chief Executive Officer, 2007 Lehman Brothers, New York, New York Class C Loretta E. Lynch Partner, Hogan & Hartson LLP, New York, New York 2005 Jerry I. Speyer President and Chief Executive Officer, Tishman Speyer, 2006 New York, New York Digitized foJr oFhRn AES. ESeRx ton President, New York University, New York, New York 2007 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

238 92nd Annual Report, 2005 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name 1 lllC Dec. 31 BUFFALO BRANCH Appointed by the Federal Reserve Bank 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 Emerson L. Bramback President and Chief Operating Officer, 2007 Manufacturers and Traders Trust Company, Buffalo, New York Appointed by the Board of Governors Brian J. Lipke Chairman and Chief Executive Officer, Gibraltar, 2005 Buffalo, New York Alphonso O'Neil-White .... President and Chief Executive Officer, 2006 HealthNow New York Inc., Buffalo, New York Marguerite D. Hambleton .. President and Chief Executive Officer, 2007 AAA Western and Central New York, Williamsville, New York DISTRICT 3—PHILADELPHIA RESERVE BANK Class A 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 Wayne R.Weidner Chairman, National Penn Bank, 2007 Boyertown, Pennsylvania Class B Robert E. Chappell Chairman and Chief Executive Officer, Penn Mutual 2005 Life Insurance Company, Horsham, Pennsylvania Garry L. Maddox President and Chief Executive Officer, A. Pomerantz & 2006 Company, Philadelphia, Pennsylvania P. Coleman Townsend, Jr. .. Chairman and Chief Executive Officer, Townsends, Inc. 2007 Wilmington, Delaware Class C Ronald J. Naples Chairman and Chief Executive Officer, Quaker 2005 Chemical Corporation, Conshohocken, Pennsylvania William F.Hecht Chairman and Chief Executive Officer, 2006 PPL Corporation, Allentown, Pennsylvania Doris M. Damm President and Chief Executive Officer, ACCU Staffing 2007 Services, Cherry Hill, New Jersey Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 239 BANK or BRANCH, Category Term expires Name line Dec. 31 DISTRICT 4—CLEVELAND RESERVE BANK Class A Bick Weissenrieder Chairman of the Board 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 Henry L. Meyer III Chairman of the Board and Chief Executive Officer, 2007 KeyCorp, Cleveland, Ohio Class B Tanny B. 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 Les C. Vinney President and Chief Executive Officer, 2007 STERIS Corporation, Mentor, Ohio Class C Phillip R. Cox President and Chief Executive Officer, Cox Financial 2005 Corporation, Cincinnati, Ohio Robert W. Mahoney Retired Chairman and Chief Executive Officer, 2006 Diebold, Incorporated, North Canton, Ohio Charles E. Bunch Chairman and Chief Executive Officer, 2007 PPG Industries, Inc., Pittsburgh, Pennsylvania CINCINNATI BRANCH Appointed by the Federal Reserve Bank V. Daniel Radford Executive Secretary-Treasurer, Cincinnati AFL-CIO 2005 Labor Council, Cincinnati, Ohio Glenn D. Leveridge President, Lexington Market, JPMorgan Chase 2005 Bank, NA, Lexington, Kentucky Charlotte W. Martin President and Chief Executive Officer, Great Lakes 2006 Bankers Bank, Gahanna, Ohio James H. Booth President, Czar Coal Corporation, Lovely, Kentucky 2007 Appointed by the Board of Governors James M. Anderson President and Chief Executive Officer, Cincinnati 2005 Children's Hospital Medical Center, Cincinnati, Ohio Charles Whitehead Retired President, Ashland Inc. Foundation, 2006 Covington, Kentucky Herbert R. Brown Senior Vice President, Western and Southern Financial 2007 Group, Cincinnati, Ohio PITTSBURGH BRANCH Appointed by the Federal Reserve Bank Vacancy 2005 Georgiana N. Riley President and Chief Executive Officer, 2005 TIGG Corporation, Bridgeville, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

240 92nd Annual Report, 2005 Directors—Continued BANK or BRANCH, Category Term expires Title Name Dec. 31 Kristine N. Molnar Executive Vice President, WesBanco Bank, Inc., 2006 Wheeling, West Virginia Michael J. Hagan President and Chief Executive Officer, 2007 Iron and Glass Bank, Pittsburgh, Pennsylvania Appointed by the Board of Governors 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 Robert O. Agbede President and Chief Executive Officer, 2007 ATS-Chester Engineers, Inc., Pittsburgh, Pennsylvania DISTRICT 5—RICHMOND RESERVE BANK Class A Barry J. Fitzpatrick Chairman, Branch Banking & Trust Co. of Virginia, 2005 Falls Church, Virginia Ernest J. Sewell Senior Advisor, FNB Southeast, 2006 Greensboro, North Carolina Kathleen Walsh Carr President, Cardinal Bank Washington, Washington, D.C 2007 Class B W. Henry Harmon President and Chief Executive Officer, 2005 Triana Energy, Inc., Charleston, West Virginia Kenneth R. Sparks President and Chief Executive Officer, 2006 Ken Sparks Associates LLC, White Stone, Virginia Harry M. Lightsey, HI State President—South Carolina, BellSouth, 2007 Columbia, South Carolina Class C Thomas J. Mackell, Jr. Director, National Investment Managers, Inc., 2005 Warrenton, Virginia Lemuel E. Lewis Executive Vice President and Chief Financial Officer, 2006 Landmark Communications, Inc., Norfolk, Virginia Theresa M. Stone Chief Financial Officer, Jefferson-Pilot Corporation; 2007 President, Jefferson-Pilot Communications Company, Greensboro, North Carolina BALTIMORE BRANCH Appointed by the Federal Reserve Bank Dyan Brasington Director, Economic and Workforce Development, 2005 Towson University, Towson, Maryland Kenneth C. Lundeen President, C. J. Langenfelder & Son, Inc., 2006 Baltimore, Maryland Michael L. Middleton Chairman and President, Community Bank 2006 of Tri-County, Waldorf, Maryland Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 241 BANK or BRANCH, Category Title Term expires Name Dec. 31 Donald P. Hutchinson President and Chief Executive Officer, 2007 SunTrust Bank, Maryland, Baltimore, Maryland Appointed by the Board of Governors Cynthia Collins Allner Principal, Miles & Stockbridge P.C., 2005 Baltimore, Maryland William C. Handorf Professor of Finance, George Washington University, 2006 Washington, D.C. William R. Roberts President, Verizon Maryland Inc., Baltimore, Maryland 2007 CHARLOTTE BRANCH Appointed by the Federal Reserve Bank Lucy J. Reuben Visiting Fellow, Duke University, 2005 Durham, North Carolina 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 Barry L. Slider President and Chief Executive Officer, 2007 First South Bancorp, Inc., Spartanburg, South Carolina Appointed by the Board of Governors Michael A. Almond Counsel, Parker Poe Adams & Bernstein LLP, 2005 Charlotte, North Carolina Jim Lowry Dealer Operator (Retired), Crown Automotive, 2006 High Point, North Carolina Anthony J. DiGiorgio President, Winthrop University, 2007 Rock Hill, South Carolina DISTRICT 6—ATLANTA RESERVE BANK Class A 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 James F. Beall Chairman, President, and Chief Executive Officer, 2007 Farmers & Merchants Bank, Centre, Alabama Class B Egbert L.J. Perry Chairman and Chief Executive Officer, 2005 The Integral Group, LLC, Atlanta, Georgia Teri G. Fontenot President and Chief Executive Officer, 2006 Woman's Hospital, Baton Rouge, Louisiana Lee M. Thomas President and Chief Operating Officer, 2007 Georgia-Pacific Corporation, Atlanta, Georgia Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

242 92nd Annual Report, 2005 Directors—Continued BANK or BRANCH, Category Term expires Title Name Dec. 31 Class C V. Larkin Martin Managing Partner, Martin Farm, Courtland, Alabama 2005 D. Scott Davis Chief Financial Officer, United Parcel Service, 2006 Atlanta, Georgia David M. Ratcliffe Chairman, President, and Chief Executive Officer, 2007 Southern Company, Atlanta, Georgia BIRMINGHAM BRANCH Appointed by the Federal Reserve Bank 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 Managing Partner, Lewis Properties, LLC and Anderson 2006 Investments, LLC, Athens, Alabama John B. Barnett HI Monroeville Chairman and President, BankTrust, 2007 Monroeville, Alabama Appointed by the Board of Governors James H. Sanford Chairman of the Board, HOME Place Farms, Inc., 2005 . Prattville, Alabama W. Miller Welborn President, Welborn and Associates, Inc., 2006 Lookout Mountain, Tennessee Maryam B. Head President, Ram Tool and Supply Company, Inc., 2007 Birmingham, Alabama JACKSONVILLE BRANCH Appointed by the Federal Reserve Bank Jerry M. Smith Chairman of Alachua County Community Board, 2005 Capital City Bank, Alachua, Florida Robert L. Fisher President and Chief Executive Officer, 2006 MacDill Federal Credit Union, Tampa, Florida Ellen S. Titen President, E.T. Consultants, Winter Park, Florida 2006 Jack B. Healan, Jr. President, Amelia Island Plantation Company, 2007 Amelia Island, Florida Appointed by the Board of Governors Fassil Gabremariam President and Founder, US-Africa Free Enterprise 2005 Education Foundation, Tampa, Florida Linda H. Sherrer President and Chief Executive Officer, 2006 Prudential Network Realty, Jacksonville, Florida H. Britt Landram, Jr. President and Chief Executive Officer, 2007 AmStaff Human Resources, Inc., Pensacola, Florida Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 243 BANK or BRANCH, Category Title Term expires Name Dec. 31 MIAMI BRANCH Appointed by the Federal Reserve Bank Francis V. Gudorf President/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 Dennis S. Hudson III Chairman and Chief Executive Officer, Seacoast 2007 Banking Corporation of Florida, Stuart, Florida Appointed by the Board of Governors Edwin A. Jones, Jr. President, Angus Investments, Inc., 2005 Port St. Lucie, Florida Brian E. Keeley President and Chief Executive Officer, 2006 Baptist Health South Florida, Coral Gables, Florida Gay Rebel Thompson President and Chief Executive Officer, 2007 Cement Industries, Inc., Fort Myers, Florida NASHVILLE BRANCH Appointed by the Federal Reserve Bank Michael B. Swain Chairman, First National Bank, Oneida, Tennessee 2005 James W. Spradley, Jr. President and Chief Executive Officer, 2006 Standard Candy Company, Inc., Nashville, Tennessee Daniel A. Gaudette Senior Vice President, North American Manufacturing 2006 and Quality Assurance, Nissan North America, Inc., Smyrna, Tennessee Ed C. Loughry, Jr. Chairman and Chief Executive Officer, 2007 Cavalry Banking, Murfreesboro, Tennessee Appointed by the Board of Governors Beth Dortch Franklin Chief Executive Officer, Star Transportation, Inc., 2005 Nashville, Tennessee David Williams II Vice Chancellor and General Counsel, 2006 Vanderbilt University, Nashville, Tennessee Debra K. London President and Chief Executive Officer, 2007 St. Mary's Health System, Knoxville, Tennessee NEW ORLEANS BRANCH Appointed by the Federal Reserve Bank C.R. Cloutier President and Chief Executive Officer, 2005 MidSouth Bank, Lafayette, Louisiana Lawrence E. Kurzius President, U.S. Consumer Foods, McCormick & 2006 Company, Incorporated, Baltimore, Maryland Christel C. Slaughter Partner, SSA Consultants, LLC, Baton Rouge, Louisianai 2006 David E. Johnson Chairman and Chief Executive Officer, 2007 The First Bancshares, Inc., and The First, A National Banking Association, Hattiesburg, Mississippi Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

244 92nd Annual Report, 2005 Directors—Continued BANK or BRANCH, Category Term expires Name llllc Dec. 31 Appointed by the Board of Governors EarlL.Shipp Global Business Vice President for Oxides and Glycols, 2005 The Dow Chemical Company, Midland, Michigan BenTomRoberts President, Roberts Brothers Commercial and Property 2006 Management, Inc., Realtors, Mobile, Alabama Dave Dennis President and Chief Executive Officer, 2007 Specialty Contractors & Assoc., Inc., Gulfport, Mississippi DISTRICT 7—CHICAGO RESERVE BANK Class A 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 JeffPlagge President and Chief Executive Officer, The First 2007 National Bank of Waverly, Waverly, Iowa Class B Connie E. Evans President and Chief Executive Officer, WSEP Ventures, 2005 Chicago, Illinois Mark T. Gafrhey President, Michigan AFL-CIO, Lansing, Michigan 2006 Mindy C. Meads Former President and Chief Executive Officer, 2007 Lands' End, Inc., Dodgeville, Wisconsin Class C John A. Canning, Jr. Chairman and Chief Executive Officer, 2005 Madison Dearborn Partners, Inc., Chicago, Illinois W. James Farrell Chairman, Illinois Tool Works, Inc., Glenview, Illinois 2006 MilesD.White Chairman and Chief Executive Officer, 2007 Abbott Laboratories, Abbott Park, Illinois DETROIT BRANCH Appointed by the Federal Reserve Bank Tommi A. White Chief Operating Officer, Compuware Corporation, 2005 Detroit, Michigan Linda S. Likely Director of Housing & Community Development, 2005 Kent County Community Development Department & Housing Commission, Grand Rapids, Michigan Ralph W.Babb, Jr. Chairman, President, and Chief Executive Officer, 2006 Comerica Incorporated, Detroit, Michigan Michael M. Magee, Jr. President and Chief Executive Officer, 2007 Independent Bank Corporation, Ionia, Michigan Appointed by the Board of Governors Edsel B. Ford II Board Director, Ford Motor Company, 2005 Dearborn, Michigan Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 245 BANK or BRANCH, Category Title Term expires Name Dec. 31 Roger A. Cregg Executive Vice President and Chief Financial Officer, 2006 Pulte Homes, Inc., Bloomfield Hills, Michigan IrvinD.Reid President, Wayne State University, Detroit, Michigan 2007 DISTRICT 8—ST. LOUIS RESERVE BANK Class A Lunsford W. Bridges President and Chief Executive Officer, 2005 Metropolitan National Bank, Little Rock, Arkansas David R. Pirsein President and Chief Executive Officer, First National 2006 Bank in Pinckneyville, Pinckneyville, Illinois Lewis F. Mallory, Jr. Chairman and Chief Executive Officer, 2007 NBC Capital Corporation, Starkville, Mississippi Class B Vacancy 2005 A. Rogers Yarnell, II President, Yarnell Ice Cream Company, Inc., 2006 Searcy, Arkansas Paul T. Combs President, Baker Implement Company, 2007 Kennett, Missouri Class C Gayle RW. Jackson Managing Director, FondElec Clean Energy Group, Inc., 2005 St. Louis, Missouri Walter L. Metcalfe, Jr. Partner, Bryan Cave LLP, St. Louis, Missouri 2006 Irl F. Engelhardt Chairman and Chief Executive Officer, Peabody Energy, 2007 St. Louis, Missouri LITTLE ROCK BRANCH Appointed by the Federal Reserve Bank David R.Estes President and Chief Executive Officer, First State Bank, 2005 Lonoke, Arkansas Robert A. Young III Chairman, President, and Chief Executive Officer, 2005 Arkansas Best Corporation, Fort Smith, Arkansas Raymond E. Skelton Retired Regional President, U.S. Bank, 2006 North Little Rock, Arkansas Sharon Priest Executive Director, The Downtown Partnership, 2007 Little Rock, Arkansas Appointed by the Board of Governors 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 Sonja Yates Hubbard Chief Executive Officer, E-Z Mart Stores, Inc., 2007 Texarkana, Texas LOUISVILLE BRANCH Appointed by the Federal Reserve Bank 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

246 92nd Annual Report, 2005 Directors—Continued BANK or BRANCH, Category Term expires Name 1 lllC 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 Steven E. Trager Chairman and Chief Executive Officer, Republic 2007 Bank & Trust Company, Louisville, Kentucky Appointed by the Board of Governors John L. Huber President and Chief Executive Officer, 2005 Louisville Water Company, Louisville, Kentucky Norman E. Pfau, Jr. President and Chief Executive Officer, 2006 Geo. Pfau's Sons Company, Inc., Jeffersonville, Indiana Cornelius A. Martin President and Chief Executive Officer, Martin 2007 Management Group, Bowling Green, Kentucky MEMPHIS BRANCH Appointed by the Federal Reserve Bank James A. England Chairman, President, and Chief Executive Officer, 2005 Decatur County Bank, Decaturville, Tennessee Levon Mathews President, Regions Bank, Memphis, Tennessee 2005 David P. Rumbarger, Jr. President and Chief Executive Officer, Community 2006 Development Foundation, Tupelo, Mississippi Thomas G. Miller President, Southern Hardware Company, Inc., 2007 West Helena, Arkansas Appointed by the Board of Governors Meredith B. Allen Vice President, Marketing, Staple Cotton Cooperative 2005 Association, Greenwood, Mississippi Russell Gwatney President, Gwatney Companies, Memphis, Tennessee 2006 J.W.GibsonH Owner and Chief Executive Officer, Gibson Companies, 2007 Memphis, Tennessee DISTRICT 9—MINNEAPOLIS RESERVE BANK Class A 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 John H. Hoeven, Jr. Chairman, First Western Bank & Trust, 2007 Minot, North Dakota Class B Randy Peterson General Manager, Precision Edge Surgical 2005 Products Co., LLC, Sault Ste. Marie, Michigan D. Greg Heineman Chairman, Williams Insurance Agency, 2006 Sioux Falls, South Dakota Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 247 BANK or BRANCH, Category Term expires Title Name Dec. 31 Todd L. Johnson President and Chief Executive Officer, 2007 Reuben Johnson & Son, Inc. & Affiliated Companies, Superior, Wisconsin Class C Linda Hall Whitman Chief Operating Officer, MinuteClinic, 2005 Minneapolis, Minnesota James J. Hynes Executive Administrator, Twin City Pipe Trades Service 2006 Association, St. Paul, Minnesota Frank L. Sims Corporate Vice President, Transportation, Cargill, Inc., 2007 Wayzata, Minnesota HELENA BRANCH Appointed by the Federal Reserve Bank RonaldD. Scott President and Chief Executive Officer, 2005 The First State Bank of Malta, Malta, Montana Marilyn F. Wessel Former Dean and Director, Museum of the Rockies, 2006 Bozeman, Montana JoyN.Ott Regional President and Chief Executive Officer, 2006 Wells Fargo Bank Montana, N.A., Billings, Montana Appointed by the Board of Governors Lawrence R. Simkins President, Washington Corporations, Missoula, Montana 2005 Dean Folkvord President and Chief Executive Officer, Wheat Montana 2006 Farms and Bakery, Three Forks, Montana DISTRICT 10—KANSAS CITY RESERVE BANK Class A 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 Robert C. Fricke President and Chief Executive Officer, Farmers & 2007 Merchants National Bank, Ashland, Nebraska Class B Dan L. Dillingham Chief Executive Officer, Dillingham Insurance, 2005 Enid, Oklahoma Kevin K. Nunnink Chairman, Integra Realty Resources, Westwood, Kansas 2006 Frank Moore President, Spearhead Ranch Company, 2007 Douglas, Wyoming Class C Lu M. Cordova Chief Executive Officer, Corlund Industries; 2005 Chairman, CTEK Angels, Boulder, Colorado Robert A. Funk Chairman and Chief Executive Officer, 2006 Express Personnel Services International, Oklahoma City, Oklahoma Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

248 92nd Annual Report, 2005 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name 1 ltlC Dec. 31 Richard H. Bard Chairman and Chief Executive Officer, 2007 International Surface Preparation Corporation, Golden, Colorado DENVER BRANCH Appointed by the Federal Reserve Bank Virginia K. Berkeley President, CoBiz Bank, N.A., Denver, Colorado 2005 James A. Helzer President and Chief Executive Officer, 2006 Unicover Corporation, Cheyenne, Wyoming John D. Pearson Real Estate Broker/Owner, Pearson Real Estate 2006 Co., Inc., Buffalo, Wyoming Michael R. Stanford President and Chief Executive Officer, 2007 First State Bancorporation, Albuquerque, New Mexico Appointed by the Board of Governors Kathleen Avila Managing Member, Avila Retail Development & 2005 Management, Albuquerque, New Mexico Thomas Williams ... President and Chief Executive Officer, 2006 Williams Group LLC, Golden, Colorado Kristy A. Schloss President and Chief Executive Officer, 2007 Schloss Engineered Equipment, Inc., Aurora, Colorado OKLAHOMA CITY BRANCH Appointed by the Federal Reserve Bank Fred M. Ramos President, Tulsa Hispanic Chamber of Commerce, 2005 Tulsa, Oklahoma Richard K. Ratcliffe Chairman, Ratcliffe's Inc., Weatherford, Oklahoma 2006 Robert R. Gilbert, m President and Chief Operating Officer, 2007 The F&M Bank & Trust Company, Tulsa, Oklahoma Terry M.Almon President and Chief Executive Officer, Arkansas 2007 Valley State Bank, Broken Arrow, Oklahoma Appointed by the Board of Governors Michael J. Packnett President and Chief Executive Officer, 2005 Mercy Health System of Oklahoma, Inc., Oklahoma City, Oklahoma Tyree O. Minner Plant Manager, General Motors Assembly Plant, 2006 Oklahoma City, Oklahoma J. Larry Nichols Chairman and Chief Executive Officer, Devon Energy 2007 Corporation, Oklahoma City, Oklahoma OMAHA BRANCH Appointed by the Federal Reserve Bank Judith A. Owen Retired President and Chief Executive Officer, 2005 Wells Fargo Bank, Nebraska, Omaha, Nebraska Rodrigo Lopez President and Chief Executive Officer, AmeriSphere 2006 Multifamily Finance, LLC, Omaha, Nebraska Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 249 BANK or BRANCH, Category Term expires Name line Dec. 31 Michael J. Nelson Chairman, FirsTier Bank, Kimball, Nebraska 2006 CynthiaHardinMilligan ... Dean—College of Business Administration, 2007 University of Nebraska-Lincoln, Lincoln, Nebraska Appointed by the Board of Governors James A. Timmerman Chief Financial Officer and Secretary/Treasurer, 2005 Timmerman and Sons Feeding Company, Springfield, Nebraska Charles R. Hermes President, Dutton-Lainson Company, 2006 Hastings, Nebraska Terry L. Moore President, Omaha Federation of Labor, 2007 Omaha, Nebraska DISTRICT 11—DALLAS RESERVE BANK Class A Richard W. Evans, Jr. Chairman and Chief Executive Officer, 2005 Cullen/Frost Bankers, Inc., San Antonio, Texas Matthew T. Doyle Vice Chairman and Chief Executive Officer, 2006 Texas First Bank, Texas City, Texas David S. Barnard Chairman and Chief Executive Officer, 2007 National Banks of Central Texas, Gatesville, Texas Class B Malcolm Gillis University Professor and Zingler Professor 2005 of Economics, Rice University, Houston, Texas Judy Ley Allen Partner, Allen Investments, Houston, Texas 2006 Robert A. Estrada Chairman and Chief Executive Officer, 2007 Estrada Hinojosa & Company, Inc., Dallas, Texas Class C Patricia M. Patterson President, Patterson Investments, Inc., Dallas, Texas 2005 Anthony R. Chase Chairman and Chief Executive Officer, ChaseCom, LP, 2006 Houston, Texas RayL.Hunt Chairman, President, and Chief Executive Officer, 2007 Hunt Consolidated, Inc., Dallas, Texas EL PASO BRANCH Appointed by the Federal Reserve Bank 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 Limited, El Paso, Texas F. James Volk Regional President, State National Bank, El Paso, Texas 2007 Appointed by the Board of Governors 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

250 92nd Annual Report, 2005 Directors—Continued BANK or BRANCH, Category Tttlp Term expires Name 1111C Dec. 31 Cecilia Ochoa Levine President, MFI International Mfg., LLC, 2007 El Paso, Texas HOUSTON BRANCH Appointed by the Federal Reserve Bank Priscilla D. Slade President, Texas Southern University, Houston, Texas 2005 S. Reed Morian Chairman, President, and Chief Executive Officer, 2005 DX Service Company, Inc., Houston, Texas Timothy N. Bryan Chairman and Chief Executive Officer, 2006 The First National Bank of Bryan, Bryan, Texas Jodie L. Jiles Senior Vice President, First Albany Capital, Inc., 2007 Houston, Texas Appointed by the Board of Governors Lupe Fraga Chairman and Chief Executive Officer, Tejas Office 2005 Products, Inc., Houston, Texas Nancy T. Chang President and Chief Executive Officer, Tanox, Inc., 2006 Houston, Texas James T. Hackett President and Chief Executive Officer, 2007 Anadarko Petroleum Corporation, Houston, Texas SAN ANTONIO BRANCH Appointed by the Federal Reserve Bank MattF. 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 James D. Goudge Chairman & Chief Executive Officer, Broadway 2007 National Bank, San Antonio, Texas Appointed by the Board of Governors Elizabeth Chu Richter Chairman and Chief Executive Officer, 2005 Richter Architects, Corpus Christi, Texas J.DanBates President, Southwest Research Institute, 2006 San Antonio, Texas RicardoRomo President, The University of Texas at San Antonio, 2007 San Antonio, Texas DISTRICT 12—SAN FRANCISCO RESERVE BANK Class A Candace Hunter Wiest President, Inland Empire National Bank, 2005 Riverside, California Vacancy 2006 Richard W. Decker, Jr. Chairman and Co-Founder, Belvedere Capital 2007 Partners, LLC, San Francisco, California 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 Class B Karla S. Chambers Vice President, Stahlbush Island Farms, Inc., 2005 Corvallis, Oregon Barbara L. Wilson Consultant; and Regional Vice President (Retired), 2006 Qwest Communications, Boise, Idaho Jack McNally Principal, JKM Consulting, Sacramento, California 2007 Class C George M. Scalise President, Semiconductor Industry Association, 2005 San Jose, California T. Gary Rogers Chairman and Chief Executive Officer, 2006 Dreyer's Grand Ice Cream, Inc., Oakland, California David K.Y. Tang Partner, Preston Gates & Ellis LLP, Seattle, Washington 2007 Los ANGELES BRANCH Appointed by the Federal Reserve Bank Peter M. Thomas Managing Partner, Thomas & Mack Company, 2005 Las Vegas, Nevada D. Linn Wiley President and Chief Executive Officer, 2006 Citizens Business Bank, Ontario, California Karen B. Caplan President and Chief Executive Officer, 2006 Frieda's, Inc., Los Alamitos, California Dominic Ng Chairman, President, and Chief Executive Officer, 2007 East West Bank, San Marino, California Appointed by the Board of Governors Diane Donoghue Executive Director, Esperanza Community Housing 2005 Corporation, Los Angeles, California Anita Santiago President, Anita Santiago Advertising, 2006 Santa Monica, California James L. Sanford Corporate Vice President and Treasurer, Northrop 2007 Grumman Corporation, Los Angeles, California PORTLAND BRANCH Appointed by the Federal Reserve Bank William D. Thorndike, Jr. .. President, Medford Fabrication, Medford, Oregon 2005 George J. Puentes President, Don Pancho Authentic Mexican Foods, Inc., 2005 Salem, Oregon Robert D. Sznewajs President and Chief Executive Officer, 2006 West Coast Bancorp, Lake Oswego, Oregon Alan V. Johnson Regional President for Oregon and Southwest 2007 Washington, Wells Fargo Bank, Portland, Oregon Appointed by the Board of Governors Peter O. Kohler President, Oregon Health & Science University, 2005 Portland, Oregon Vacancy 2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

252 92nd Annual Report, 2005 Directors—Continued BANK or BRANCH, Category Term expires Title Name Dec. 31 JamesH.Rudd Chief Executive Officer and Principal, Ferguson 2007 Wellman Capital Management, Inc., Portland, Oregon SALT LAKE CITY BRANCH Appointed by the Federal Reserve Bank A. Scott Anderson President and Chief Executive Officer, Zions Bank, 2005 Salt Lake City, Utah Deborah Bayle Nielsen President and Chief Executive Officer, 2005 United Way of Salt Lake, Salt Lake City, Utah Annette K. Herman Vice President, Strategic Initiatives Uniprise, 2006 UnitedHealth Group, Salt Lake City, Utah Michael M. Mooney President and Chief Executive Officer, 2007 Farmers & Merchants State Bank, Boise, Idaho Appointed by the Board of Governors H. Roger Boyer Chairman, The Boyer Company, Salt Lake City, Utah 2005 William C. Glynn President, Intermountain Industries, Inc., Boise, Idaho 2006 Gary L. Crocker Chairman of the Board, Merrimack Pharmaceuticals, 2007 Salt Lake City, Utah SEATTLE BRANCH Appointed by the Federal Reserve Bank MaryE.Pugh President, Pugh Capital Management, Inc., 2005 Seattle, Washington Kenneth M. Kirkpatrick .... President, Washington State, U.S. Bank, 2005 Seattle, Washington Helvi K. Sandvik President, NANA Development Corp., 2006 Anchorage, Alaska Blake W. Nordstrom President, Nordstrom, Inc., Seattle, Washington 2007 Appointed by the Board of Governors James R. Gill President, Pacific Northwest Title Holding Co., 2005 Seattle, Washington David W.Wyckoff Chairman and Chief Executive Officer, 2006 Wyckoff Farms, Inc., Grandview, Washington Mic R. Dinsmore Chief Executive Officer, Port of Seattle, 2007 Seattle, Washington Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2005 253 Members of the Board of Governors, 1913-2005 Appointed Members Name Federal Reserve Date initially took Other dates1 District oath of office Charles S. Hamlin Boston Aug. 10, 1914 Reappointed in 1916 and 1926. Served until Feb. 3, 1936.2 Paul M. Warburg New York Aug. 10, 1914 Term expired Aug. 9,1918. Frederic A. Delano Chicago Aug. 10, 1914 Resigned July 21,1918. W.P.G. Harding Atlanta Aug. 10, 1914 Term expired Aug. 9,1922. Adolph C. Miller San Francisco Aug. 10, 1914 Reappointed in 1924. Reappointed in 1934 from the Richmond District. Served until Feb. 3, 1936.2 Albert Strauss New York Oct. 26, 1918 Resigned Mar. 15, 1920. Henry A. Moehlenpah Chicago Nov. 10, 1919 Term expired Aug. 9,1920. Edmund Platt New York June 8, 1920 Reappointed in 1928. Resigned Sept. 14, 1930. David C. Wills Cleveland Sept. 29,1920 Term expired Mar. 4,1921. John R. Mitchell Minneapolis May 12,1921 Resigned May 12,1923. Milo D. Campbell Chicago Mar. 14,1923 Died Mar. 22, 1923. Daniel R. Crissinger Cleveland May 1, 1923 Resigned Sept. 15,1927. George R. James St. Louis May 14, 1923 Reappointed in 1931. Served until Feb. 3, 1936.3 Edward H. Cunningham Chicago May 14, 1923 Died Nov. 28,1930. Roy A. Young Minneapolis Oct. 4, 1927 Resigned Aug. 31, 1930. Eugene Meyer New York Sept. 16,1930 Resigned May 10, 1933. WaylandWMagee Kansas City May 18, 1931 Term expired Jan. 24,1933. Eugene R. Black Atlanta May 19, 1933 Resigned Aug. 15,1934. M.S. Szymczak Chicago June 14, 1933 Reappointed in 1936 and 1948. Resigned May 31,1961. JJ. Thomas Kansas City June 14,1933 Served until Feb. 10,1936.2 Marriner S. Eccles San Francisco Nov. 15, 1934 Reappointed in 1936,1940, and 1944. Resigned July 14,1951. Joseph A. Broderick New York Feb. 3, 1936 Resigned Sept. 30,1937. John K. McKee Cleveland Feb. 3, 1936 Served until Apr. 4, 1946.2 Ronald Ransom Atlanta Feb. 3, 1936 Reappointed in 1942. Died Dec. 2, 1947. Ralph W. Morrison Dallas Feb. 10, 1936 Resigned July 9, 1936. Chester C. Davis Richmond June 25, 1936 Reappointed in 1940. Resigned Apr. 15, 1941. Ernest G. Draper New York Mar. 30,1938 Served until Sept. 1, 1950.2 Rudolph M. Evans Richmond Mar. 14,1942 Served until Aug. 13,1954.2 James K. Vardaman, Jr. St. Louis Apr. 4, 1946 Resigned Nov. 30,1958. Lawrence Clayton Boston Feb. 14, 1947 Died Dec. 4,1949. Thomas B. McCabe Philadelphia Apr. 15, 1948 Resigned Mar. 31, 1951. Edward L. Norton Atlanta Sept. 1, 1950 Resigned Jan. 31,1952. Oliver S. Powell Minneapolis Sept. 1, 1950 Resigned June 30,1952. Wm. McC. Martin, Jr. New York April 2, 1951 Reappointed in 1956. Term expired Jan. 31, 1970. A.L. Mills, Jr. San Francisco Feb.18, 1952 Reappointed in 1958. Resigned Feb. 28, 1965. J.L. Robertson Kansas City Feb. 18, 1952 Reappointed in 1964. Resigned Apr. 30, 1973. C. Canby Balderston Philadelphia Aug. 12,1954 Served through Feb. 28, 1966. Paul E. Miller Minneapolis Aug. 13,1954 Died Oct. 21, 1954. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

254 92nd Annual Report, 2005 Appointed Members—Continued Name Federal Reserve Date initially took Other dates1 District oath of office Chas. N. Shepardson Dallas Mar. 17,1955 Retired Apr. 30,1967. G.H. King, Jr. Atlanta Mar. 25,1959 Reappointed in 1960. Resigned Sept. 18, 1963. George W. Mitchell Chicago Aug. 31,1961 Reappointed in 1962. Served until Feb. 13, 1976.2 J. Dewey Daane Richmond Nov. 29,1963 Served until Mar. 8,1974.2 Sherman J. Maisel San Francisco Apr. 30, 1965 Served through May 31,1972. Andrew F. Brimmer Philadelphia Mar. 9,1966 Resigned Aug. 31,1974. William W.Sherrill Dallas May 1,1967 Reappointed in 1968. Resigned Nov. 15, 1971. Arthur F. Burns New York Jan. 31,1970 Term began Feb. 1,1970. Resigned Mar. 31,1978. John E. Sheehan St. Louis Jan. 4,1972 Resigned June 1,1975. Jeffrey M. Bucher San Francisco June 5,1972 Resigned Jan. 2,1976. Robert C. Holland Kansas City June 11,1973 Resigned May 15, 1976. Henry C. Wallich Boston Mar. 8, 1974 Resigned Dec. 15,1986. Philip E. Coldwell Dallas Oct. 29,1974 Served through Feb. 29,1980. Philip C. Jackson, Jr. Atlanta July 14,1975 Resigned Nov. 17,1978. J. Charles Partee Richmond Jan. 5,1976 Served until Feb. 7, 1986.2 Stephen S. Gardner Philadelphia Feb. 13,1976 Died Nov. 19,1978. David M. Lilly Minneapolis June 1,1976 Resigned Feb. 24,1978. G.William Miller San Francisco Mar. 8,1978 Resigned Aug. 6,1979. Nancy H. Teeters Chicago Sept. 18,1978 Served through June 27,1984. Emmett J. Rice New York June 20,1979 Resigned Dec. 31,1986. Frederick H. Schultz Atlanta July 27, 1979 Served through Feb. 11,1982. Paul A. Volcker Philadelphia Aug. 6,1979 Resigned August 11, 1987. Lyle E. Gramley Kansas City May 28, 1980 Resigned Sept. 1,1985. Preston Martin San Francisco Mar. 31,1982 Resigned April 30,1986. Martha R. Seger Chicago July 2,1984 Resigned March 11,1991. Wayne D. Angell Kansas City Feb. 7,1986 Served through Feb. 9, 1994. Manuel H. Johnson Richmond Feb. 7,1986 Resigned August 3,1990. H. Robert Heller San Francisco Aug. 19,1986 Resigned July 31,1989. Edward W. Kelley, Jr. Dallas May 26,1987 Resigned Dec. 31,2001. Alan Greenspan New York Aug. 11,1987 Reappointed in 1992. John P. LaWare Boston Aug. 15,1988 Resigned April 30,1995. David W. Mullins, Jr. St. Louis May 21,1990 Resigned Feb. 14, 1994. Lawrence B. Lindsey Richmond Nov. 26,1991 Resigned Feb. 5,1997. Susan M. Phillips Chicago Dec. 2,1991 Served through June 30,1998. Alan S. Blinder Philadelphia June 27,1994 Term expired Jan. 31,1996. Janet L.Yellen San Francisco Aug. 12,1994 Resigned Feb. 17,1997. Laurence H. Meyer St. Louis June 24,1996 Term expired Jan. 31, 2002. Alice M. Rivlin Philadelphia June 25,1996 Resigned July 16,1999. Roger W. Ferguson, Jr. Boston Nov. 5,1997 Reappointed in 2001. Edward M. Gramlich Richmond Nov. 5,1997 Resigned August 31,2005. Susan S. Bies Chicago Dec. 7, 2001 Mark W. Olson Minneapolis Dec. 7, 2001 Ben S. Bernanke Atlanta Aug. 5, 2002 Resigned June 21, 2005. 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, 1913-2005 255 Appointed Members—Continued Name Term Chairmen3 Charles S. Hamlin Aug. 10, 1914-Aug. 9, 1916 W.RG. Harding Aug. 10,1916-Aug. 9,1922 Daniel R. Crissinger May 1,1923-Sept. 15,1927 Roy A. Young Oct. 4, 1927-Aug. 31,1930 Eugene Meyer Sept. 16,1930-May 10,1933 Eugene R. Black May 19, 1933-Aug. 15, 1934 Marriner S. Eccles Nov. 15, 1934-Jan. 31,19484 Thomas B.McCabe Apr. 15,1948-Mar. 31,1951 Wm. McC. Martin, Jr. Apr. 2, 1951-Jan. 31, 1970 Arthur F. Burns Feb. 1, 1970-Jan. 31,1978 G.William Miller Mar. 8, 1978-Aug. 6, 1979 Paul A. Volcker Aug. 6, 1979-Aug. 11,1987 Alan Greenspan Aug. 11,1987-5 Vice Chairmen3 Frederic A. Delano Aug. 10,1914-Aug. 9,1916 Paul M. Warburg Aug. 10, 1916-Aug. 9, 1918 Albert Strauss Oct. 26,1918-Mar. 15,1920 Edmund Platt July 23,1920-Sept. 14, 1930 J.J. Thomas Aug. 21, 193^-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

256 92nd Annual Report, 2005 ExOfiBcio 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 OgdenL. 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 Mayll, 1933-Feb. 1,1936 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

258 92nd Annual Report, 2005 1. Federal Reserve Open Market Transactions, 2005 Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. U.S. TREASURY SECURITIES1 Outright transactions2 Treasury bills Gross purchases 0 Gross sales 0 Exchanges 62,448 For new bills 62,448 Redemptions 0 Others within 1 year Gross purchases 0 Gross sales 0 Maturity shifts 6,928 Exchanges -8,000 Redemptions 0 1 to 5 years Gross purchases 0 Gross sales 0 Maturity shifts -6,928 Exchanges 5,000 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 .... oooo 0 0 0 3,000 ooo 35 0 0 0 0 0 66,741 78,822 63,637 66,741 78,822 63,637 0 0 0 0 0 0 0 0 0 2,989 8,334 0 -12,710 -8,000 0 333 211 0 0 0 1,200 0 0 0 3,180 -8,334 0 11,498 8,000 0 0 0 470 0 0 0 -3,112 0 0 1,212 0 0 0 0 230 0 0 0 -3,058 0 0 0 0 0 35 0 1,900 0 0 0 333 111 0 -298 -211 1,900 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 259 1.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 1,760 250 0 2,751 1,992 1,023 489 0 8,300 0 0 0 0 0 0 0 0 0 70,894 91,408 68,438 66,899 87,522 68,397 65,570 80,886 871,661 70,894 91,408 68,438 66,899 87,522 68,397 65,570 80,886 871,661 0 0 0 0 0 0 0 0 0 0 0 0 1,298 0 500 1,096 0 2,894 0 0 0 0 0 0 0 0 0 23,149 7,997 0 26,261 7,999 11,700 14,200 0 109,557 -26,036 -6,667 0 -18,253 -6,585 -6,551 -15,297 0 -108,098 0 1,305 0 757 0 0 189 0 2,795 2,295 0 0 1,390 3,635 1,693 1,096 0 11,309 0 0 0 0 0 0 0 0 0 -19,402 -7,997 0 -20,702 -7,999 -11,700 -11,240 0 -91,121 23,565 6,667 0 16,781 6,585 6,551 13,077 0 97,723 898 340 0 988 130 0 800 0 3,626 0 0 0 0 0 0 0 0 0 -1,277 0 0 -2,919 0 0 266 0 -7,041 2,471 0 0 1,472 0 0 2,221 0 7,375 0 785 0 0 90 902 0 0 2,007 0 0 0 0 0 0 0 0 0 -2,471 0 0 -2,640 0 0 -3,227 0 -11,395 0 0 0 0 0 0 0 0 3,000 4,953 1,375 0 6,427 5,847 4,118 3,481 0 28,136 0 0 0 0 0 0 0 0 0 0 1,305 0 757 0 0 189 0 2,795 4,953 70 0 5,670 5,847 4,118 3,292 0 25,341 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

260 92nd Annual Report, 2005 1. Federal Reserve Open Market Transactions, 2005—Continued Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. FEDERAL AGENCY OBLIGATIONS Outright transactions2 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 148,500 125,250 201,500 163,500 152,750 120,250 204,250 167,000 Gross sales Reverse repurchase agreements4 Gross purchases 563,559 490,482 581,322 505,211 Gross sales 559,501 488,781 580,402 507,649 Net change in temporary transactions -193 6,700 -1,831 -5,938 Total net change in System Open Market Account -193 6,402 -2,041 -4,038 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 261 1.—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 0 186,250 173,250 201,750 200,750 187,300 145,250 140,750 223,000 2,097,050 179,000 173,500 200,750 200,750 197,050 147,000 129,500 211,500 2,083,300 547,538 526,972 531,351 555,779 523,085 509,449 505,101 584,950 6,424,797 546,380 527,769 532,647 554,786 523,518 508,709 508,976 585,400 6,424,519 8,408 -1,047 -297 993 -10,183 -1,010 7,375 11,050 14,028 13,361 -977 -297 6,662 -4336 3,108 10,667 11,050 39369 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

262 92nd Annual Report, 2005 2. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2003-2005 Millions of dollars December 31 Change Description 2004 to 2003 to 2005 2004 2003 2005 2004 U.S. TREASURY SECURITIES Held outright1 744,215 717,816 666,665 26,399 51,151 By remaining maturity Bills 1-90 days 187,370 179,748 168,381 7,622 11,367 91 days to 1 year 83,900 83,222 76,452 678 6,770 Notes and bonds 1 year or less 136,233 116,443 113,301 19,790 3,142 More than 1 year through 5 years .. 193,559 208,269 180,074 -14,710 28,195 More than 5 years through 10 years 52,589 54,372 51,312 -1,783 3,060 More than 10 years 67,213 75,765 77,146 -8,552 -1,381 By type Bills ... 271,270 262,970 244,833 8,300 18,137 Notes .. 380,118 360,830 323,361 19,288 37,469 Bonds .. 92,827 94,016 98,471 -1,189 -4,455 FEDERAL AGENCY SECURITIES Held outright1 By remaining maturity 1 year or less More than 1 year through 5 years .. More than 5 years through 10 years More than 10 years By issuer Federal National Mortgage Association .. TEMPORARY TRANSACTIONS Repurchase agreements2 46,750 35,000 43,750 11,750 -8,750 Matched sale-purchase agreements 0 0 0 0 0 Foreign official and international accounts 0 0 0 0 0 Dealers 0 0 0 0 0 Reverse repurchase agreements3 30305 30,116 25,652 389 4,464 Foreign official and international accounts 30,505 30,116 25,652 389 4,464 Dealers 0 0 0 0 0 NOTE. Components may not sum to totals because of 2. Cash value of agreements, which are coUateralized rounding. by U.S. government and federal agency securities. 1. Excludes the effect of temporary transactions— 3. Cash value of agreements, which are coUateralized 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 263 3. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2005 Reserve Bank Primary credit1 Secondary credit2 Seasonal credit3 All Federal Reserve Banks 5.25 5.75 4.35 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 that 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 that 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

264 92nd Annual Report, 2005 4. Reserve Requirements of Depository Institutions, December 31, 2005 Requirements Type of deposit Percentage of deposits Effective date Net transaction accounts1 $0 million-$7.8 million2 0 12-22-05 More than $7.8 million-$48.3 million3 3 12-22-05 More than $48.3 million 10 12-22-05 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 0 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 banker's accep- vious year's (June 30 to June 30) rate of increase or tances, and affiliate-issued obligations 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

Statistical Tables 265 5. Banking Offices and Banks Affiliated with Bank Holding Companies (BHCs) in the United States,1 December 31, 2004 and 2005 Commercial banks2 Statechartered Type of office Total Member savings Total Nonmember banks Total National State All banking offices BANKS Number, Dec. 31, 2004 .. 7,965 7,591 2,794 1,880 914 4,797 374 Changes during 2005 New banks 173 165 29 20 9 136 8 Banks converted into branches -265 -253 -110 -81 -29 -143 -12 Ceased banking operation3 -29 -20 -5 -3 -2 -15 -9 Other4 0 2 -10 -20 10 12 -2 Net change -121 -106 -96 -84 -12 -10 -15 Number, Dec 31,2005 .. 7,844 7,485 2,698 1,796 902 4,787 359 BRANCHES AND ADDITIONAL OFFICES Number, Dec. 31, 2004 .. 75,272 71,931 52,329 38,985 13,344 19,602 3341 Changes during 2005 New branches 2,256 2,170 1,434 953 481 736 86 Branches converted from banks 265 257 146 101 45 111 8 Discontinued3 -2,062 -1,632 -1,488 -769 -719 -144 -430 Other4 0 250 218 -462 680 32 -250 Net change 459 1,045 310 -177 487 735 -586 Number, Dec. 31, 2005 .. 75,731 72,976 52,639 38,808 13,831 20337 2,755 Banks affiliated with BHCs BANKS Number, Dec. 31, 2004 .. 6340 6,225 2,418 1,612 806 3,807 115 Changes during 2005 BHC-affiliated new banks 170 157 35 26 9 122 13 Banks converted into branches -226 -221 -98 -74 -24 -123 -5 Ceased banking operation3 -23 -21 -9 -5 -4 -12 -2 Other4 0 1 -9 -18 9 10 -1 Net change -79 -84 -81 -71 -10 -3 5 Number, Dec 31,2005 .. 6,261 6,141 2337 1,541 796 3,804 120 1. Includes banking offices and BHCs in U.S. territo- of making commercial loans or any institution that is defined as an insured bank in section 3(h) of the FDIC 2. For purposes of this table, banks are entities that are Act. Covers entities in the United States and its territories defined as banks in the Bank Holding Company Act, as and possessions (affiliated insular areas). amended, which is implemented by Federal Reserve 3. Institutions that no longer meet the Regulation Y Regulation Y. Generally, a bank is any institution that definition of bank. accepts demand deposits and is engaged in the business 4. Interclass changes and sales of branches. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

266 92nd Annual Report, 2005 6A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2005 and Month-End 2005 Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Special Period Treasury drawing S o e u c h t u r e i r l g i d t h ie t1 s a R g e r p e u em rch en as ts e 2 Loans Float R F O e e d s th e e r e r v a r e l Total s G to o c ld k ce a r r c i t c g if o h i u c ts a n t t e s c t u a r o n r u d e t n i - 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 428343 11,050 10,168 24,003 1996 393,132 21,583 85 5,297 32,222 452319 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 39^00 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 36,434r 2005 744,215 46,750 72 891 39,319 831,247 11,043 2,200 36,610 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 267 6 A.—Continued Factors absorbing reserve funds Reserve Other balances 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 Fe e d se e r r v a e l Fe w d i e th ral 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 11,828 19,793 11,230 754,877r 30,783 270 5,912 80 1,285 9,963 26,378 14,080 794,084 30,505 202 4,573 83 2,144 8,652 30,466 10,391 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

268 92nd Annual Report, 2005 6A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2005 and Month-End 2005—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 2005 Jan 717,869 28,750 71 1,277 42,094 790,061 11,042 2,200 36,434 Feb 717,492 33,750 114 3 39,547 790,906 11,042 2,200 36,546 Mar. .... 717326 31,000 52 -1,025 40,327 787,680 11,041 2,200 36,545 Apr. 719,350 27,500 105 -1,160 41,882 787,676 11,041 2,200 36,545 May 724,471 34,750 160 -950 38,704 797,135 11,042 2,200 36,545 June 724,722 34,500 235 -936 39,685 798,206 11,041 2,200 36,615 July .... 724,699 35,500 273 -1,205 40,781 800,048 11,041 2,200 36,429 Aug 730380 35,500 336 741 38,292 805,248 11,041 2,200 36,429 Sept .... 736360 25,750 910 -312 38,974 801,682 11,041 2,200 36,429 Oct .... 740,595 24,000 159 345 39,909 805,008 11,041 2,200 36,429 Nov. .... 744,168 35,250 86 886 37,351 817,741 11,041 2,200 36,540 Dec 744,215 46,750 72 891 39,319 831,247 11,043 2,200 36,610 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 269 6 A.—Continued Factors absorbing reserve funds Reserve Deposits with Federal Reserve Banks, Other balances Currency Reverse Treasury other than reserve balances Required R Fe e d se e r r v a e l Fe w d i e th ral in repurchase cash clearing liabilities Reserve circulation agreements4 holdings5 balances and Banks6 Treasury Foreign Other capital 746,746 26,726 269 4,971 121 313 8,944 26,932 24,715 751,631 25,026 263 4,673 86 282 8,670 27,776 22,286 754,637 24,106 284 5,219 139 235 9,514 27,862 15,470 752,786 26,544 258 3,585 126 318 9,025 28,846 15,975 761,384 25,386 275 5,538 105 274 8,851 29,255 15,854 764,713 26,183 237 4,373 103 250 8,278 29,095 14,830 762,035 27,480 252 5,064 83 297 8,674 30,326 15,508 765,723 26,487 262 5,650 81 265 8,717 30,748 16,985 766,482 26,920 237 4,381 96 295 8,864 31,015 13,063 768,130 26,180 211 5,712 88 315 8,781 31,820 13,440 780,223 30,055 204 4,634 82 255 8,754 31,865 11,450 794,084 30,505 202 4,573 83 2,144 8,652 30,466 10,391 NOTE. Components may not sum tototals 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 coUateralized ties. U.S. Treasury securities contain securities lent to by U.S. Treasury securities. dealers and are fully coUateralized by other U.S. Treasury 5. Coin and paper currency held by the Treasury, as securities. Federal agency securities are included at face well as any gold in excess of the gold certificates issued value. to the Reserve Bank. 2. Cash value of agreements, which are coUateralized 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

270 92nd Annual Report, 2005 6B. 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 Treasury drawing 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 r s - - 2 Loans Float3 ot A h l e l r4 R F a O e e s d s s th e e e e r 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 n o r d u e i t n n - c g y 7 o 1918 239 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 4,205 1,991 1927 560 57 582 63 393 0 1,655 4,092 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 0 1,853 4,173 2,035 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 2,463 838 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 4339 1946 23,350 0 163 580 1 0 24,093 20,529 4362 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 271 6B.—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 cir ti c i o n u n la- hol c d a i s n h gs8 Treasury Foreign Other a R cc e o se u r n v t e s5 b c a le la a n ri c n e g s 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 ^4 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 -A\ 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 18374 -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

272 92nd Annual Report, 2005 6B. 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 r s - - 2 Loans Float3 ot A h l e l r4 R F a O e e s d s 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 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 2,300 51 0 31,362 16,889 5,585 1962 28,722 342 38 2,903 110 0 33,871 15,978 5,567 1963 33,582 11 63 2,600 162 0 36,418 15313 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 76315 10,132 400 7,710 1972 71,119 111 1,981 3,974 106 1,260 78351 10,410 400 8,313 1973 80395 100 1,258 3,099 68 1,152 86,072 11367 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 11399 500 10,218 1976 100,062 4,031 25 2,601 991 3,182 110,892 11398 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 4^43 131,327 11,671 1,300 11,831 1979 124,507 1,660 1,454 6,767 704 5,613 140,705 11,172 1,800 13,083 1980 128,038 2,554 1,809 4,467 776 8,739 146,383 11,160 2,518 13,427 1981 136,863 3,485 1,601 1,762 195 9,230 153,136 11,151 3,318 13,687 1982 144,544 4,293 717 2,735 1,480 9,890 63,659 11,148 4,618 13,786 1983 159,203 1,592 918 1,605 418 8,728 172,464 11,121 4,618 15,732 NOTE. For a description of figures and discussion of 4. Principally acceptances and, until August 21,1959, their significance, see Banking and Monetary Statistics, industrial loans, the authority for which expired on that 1941-1970 (Board of Governors of the Federal Reserve date. System, 1976), pp. 507-23. 5. For the period before April 16, 1969, includes the Components may not sum to totals because of total of Federal Reserve capital paid in, surplus, other capital accounts, and other liabilities and accrued divi- 1. In 1969 and thereafter, includes securities loaned— dends, less the sum of bank premises and other assets, fully guaranteed by U.S. government securities pledged and is reported as "Other Federal Reserve accounts"; with Federal Reserve Banks—and excludes securities thereafter, "Other Federal Reserve assets" and "Other sold and scheduled to be bought back under matched Federal Reserve liabilities and capital" are shown sale-purchase transactions. On September 29, 1971, and separately. thereafter, includes federal agency issues bought outright. 6. Before January 30, 1934, includes gold held in 2. On December 1, 1966, and thereafter, includes Federal Reserve Banks and in circulation. federal agency obligations held under repurchase 7. Includes currency and coin (other than gold) issued agreements. directly by the Treasury. The largest components are 3. In 1960 and thereafter, figures reflect a minor fractional and dollar coins. For details see "Currency and change in concept; see Federal Reserve Bulletin, vol. 47 Coin in Circulation," Treasury Bulletin. (February 1961), p. 164. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 273 6B.—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 9812 72,497 317 2,542 251 1,41913 0 0 2,669 27,060 6,781 35,268 -1,360 79,743 185 2,113 418 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 -1,10314 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 41391 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

274 92nd Annual Report, 2005 7. Principal Assets and Liabilities of Insured Commercial Banks,1 by Class of Bank, June 30, 2005 and 2004 Millions of dollars, except as noted Member banks Nonmember Item Total banks Total National State 2005 ASSETS Loans and investments 6,255,126 4,893,231 3,885,313 1,007,918 1,361,895 Loans, gross 4,714,324 3,691,084 2,955,338 735,746 1,023,240 Net 4,712,455 3,689,964 2,954,473 735,490 1,022,492 Investments 1,540,802 1,202,147 929,975 272,172 338,655 U.S. Treasury and federal agency securities 300,767 182,541 120,644 61,897 118,226 Other 1,240,035 1,019,606 809,331 210,275 220,430 Cash assets, total 262,667 209,058 172,000 37,058 53,608 LIABILITIES Deposits, total 4,844,823 3,692,187 2,941,844 750,342 1,152,636 Interbank 80,342 66,527 55,023 11,504 13,816 Other transaction 703,015 504,561 396,603 107,958 198,454 Other nontransaction 4,061,466 3,121,099 2,490,219 630,880 940,367 Equity capital 871,715 700,401 570,411 12,989 171,314 Number of banks : 7,528 2,764 1,861 903 4,764 2004 ASSETS Loans and investments 5,788,806 4,567,709 3,321,077 1,246,632 1,221,097 Loans, gross 4,267,991 3,381,763 2,481,333 900,430 886,228 Net 4,266,475 3,380,928 2,480,744 900,183 885,547 Investments 1,520,816 1,185,946 839,744 346,202 334,869 U.S. Treasury and federal agency securities 333,738 212,361 122,041 90,320 121,376 Other 1,187,078 973,585 717,703 255,882 213,493 Cash assets, total 271,104 218,068 156,194 61,874 53,037 LIABILITIES Deposits, total 4,460,713 3,419,602 2,442,681 976,921 1,041,111 Interbank 68,721 54,897 37,078 17,819 13,824 Other transaction 682,017 493,695 344,248 149,447 188,322 Other nontransaction 3,709,976 2,871,010 2,061,355 809,655 838,966 Equity capital 721,218 576,854 419,827 157,027 144,364 Number of banks 7,677 2,885 1,955 930 4,792 NOTE. Data are domestic assets and liabilities (except 1. Includes U.S.-insured commercial banks located in for those components reported on a consolidated basis the United States but not U.S.-insured commercial banks only). Components may not sum to totals because of operating in U.S. territories or possessions. rounding. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 275 8. Initial Margin Requirements under Regulations T, U, and X Percent of market value Effective date M st a o r c g k i s n Con b v o e n r d t s ible Sh T o r o t n s l a y l 1 es 1934, Oct. 1 . 25^5 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

276 92nd Annual Report, 2005 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2005 and 2004 Millions of dollars Total Boston Item 2005 2004 2005 2004 ASSETS Gold certificate account 11,039 11,041 510 494 Special drawing rights certificate account 2,200 2,200 115 115 Coin 31 19 Loans 686 728 To depository institutions Securities purchased under agreements 72 43 to resell (triparty) U.S. Treasury securities 46,750 33,000 Bought outright1 744,215 717,819 38,076 33,707 Held under repurchase agreements 0 0 0 0 Total loans and securities 791,036 750,863 38,078 33,708 Items in process of collection 6,834 7,964 368 457 Bank premises 1,827 1,778 112 99 Other assets Denominated in foreign currencies2 ... 18,928 21,368 2,405 1,083 Other3 18,579 19,004 792 1,182 Interdistrict settlement account 0 0 -3,268 2,979 Total assets 851,130 814,946 39,143 40,136 LIABILITIES Federal Reserve notes outstanding (issued to Bank) 906,511 848,370 38,971 38,054 Less: Notes held by Federal Reserve Bank 148,152 128,933 4,424 4,137 Federal Reserve notes, net 758,359 719,437 34,548 33,917 Securities sold under agreements to repurchase 30,505 30,783 1,561 1,445 Deposits Depository institutions 19,043 24,043 622 1,050 U.S. Treasury, general account 4,573 5,912 0 0 Foreign, official accounts 83 80 5 2 Other4 2,168 1,288 1,068 2 Total deposits 25,867 31,323 1,695 1,054 Deferred credit items 5,943 7,038 488 578 Other liabilities and accrued dividends5 4,019 2,821 218 151 Total liabilities 824,693 791,402 38,510 37,145 CAPITAL ACCOUNTS Capital paid in 13,536 11,914 317 1,638 Surplus 12,901 11,630 317 1,353 Total liabilities and capital accounts . 851,130 814,946 39,143 40,136 FEDERAL RESERVE NOTE STATEMENT Federal Reserve notes outstanding 906,511 848,370 Less: Held by Banks not subject to collateralizatio 148,152 128,933 Collateralized Federal Reserve notes 758,359 719,437 Collateral for Federal Reserve notes Gold certificate account 11,039 11,041 Special drawing rights certificate account 2,200 2,200 Other eligible assets 0 0 U.S. Treasury and federal agency securities 745,120 706,196 Total collateral 758,359 719,437 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 277 9.—Continued New York Philadelphia Cleveland Richmond 2005 2004 2005 2004 2005 2004 2005 2004 4,357 4,651 432 382 453 452 836 819 874 874 83 83 104 104 147 147 47 42 34 56 55 52 66 62 0 0 0 5 0 0 1 0 46,750 33,000 0 0 0 0 0 0 295,107 311,256 26,401 21,350 31,439 30,673 56,796 54,557 0 0 0 0 0 0 0 0 341,857 344,256 26,401 21,354 31,439 30,673 56,797 54,558 625 407 586 360 820 814 225 341 207 196 53 53 158 157 153 144 5,514 4,905 473 624 1,712 1,757 3,454 5,009 8,740 9,176 672 530 718 966 1,341 1,337 -45,332 -24,125 6,148 4,007 833 -495 8,521 -420 316,889 340^381 34,883 27,449 36,293 34,479 71,540 61,996 327,194 335,998 37,426 32,698 36,539 34,511 69,647 64,991 43,521 35,347 6,130 7,973 5,081 5,408 11,887 12,275 283,673 300,651 31,296 24,725 31,457 29,103 57,759 52,716 12,096 13,348 1,082 916 1,289 1,315 2,328 2,340 6,389 11,388 485 603 658 1,272 3,182 1,645 4,573 5,912 0 0 0 0 0 0 55 57 1 1 4 2 7 7 523 527 4 28 82 2 146 169 11,539 17,884 490 632 743 1,277 3,336 1,820 797 651 363 490 581 505 509 544 1,414 988 164 99 196 149 359 280 309,519 333,522 33,395 26,861 34,266 32,349 64,291 57,700 3,685 3,430 744 294 1,013 1,065 3,942 2,148 3,685 3,430 744 294 1,013 1,065 3,307 2,148 316,889 340381 34,883 27,449 36,293 34,479 71,540 61,996 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

278 92nd Annual Report, 2005 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2005 and 2004—Continued Millions of dollars Atlanta Chicago Item 2005 2004 2005 2004 ASSETS Gold certificate account 945 894 928 924 Special drawing rights certificate account 166 166 212 212 Coin 89 82 76 111 Loans To depository institutions 27 14 Securities purchased under agreements to resell (triparty) U.S. Treasury securities Bought outright1 57,576 48,408 67,020 64,660 Held under repurchase agreements .. 0 0 0 0 Total loans and securities 57,583 48,415 67,047 64,674 Items in process of collection 1,281 637 414 559 Bank premises 232 276 211 157 Other assets Denominated in foreign currencies2 830 1,181 1,228 2,232 Other3 1,276 1,076 1,386 1,374 Interdistrict settlement account 10,086 9,939 1,908 225 Total assets 72,489 62,666 73,408 70,469 LIABILITIES Federal Reserve notes outstanding (issued to Banks) . 84,653 74,144 76,740 72,517 Less: Notes held by Federal Reserve Banks 19,039 17,376 10,216 9,046 Federal Reserve notes, net 65,614 56,768 66,524 63,470 Securities sold under repurchase agreements 2,360 2,076 2,747 2,773 Deposits Depository institutions 1,626 1,722 1,591 1,762 U.S. Treasury, general account 0 0 0 0 Foreign, official accounts 2 2 3 3 Other4 13 56 72 246 Total deposits 1,641 1,780 1,665 2,011 Deferred credit items 763 796 349 421 Other liabilities and accrued dividends5 326 214 371 267 Total liabilities 70,704 61,634 71,656 68,942 CAPITAL ACCOUNTS Capital paid in 892 516 876 763 Surplus 892 516 876 763 Total liabilities and capital accounts 72,489 62,666 73,408 70,469 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 $2 million for 2005 and $1 million for 2004. 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 279 9.—Continued St. Louis Minneapolis Kansas City Dallas San Francisco 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 327 325 212 218 318 302 549 525 1,172 1,055 71 71 30 30 66 66 98 98 234 234 43 36 22 22 61 48 68 93 94 105 0 2 16 13 11 1 3 0 5 0 0 0 0 0 0 0 0 0 0 0 23,094 21,089 15,543 15,657 21,050 18,863 36,654 32,729 75,459 64,871 0 0 0 0 0 0 0 0 0 0 23,094 21,090 15,560 15,669 21,060 18,864 36,657 32,729 75,464 64,871 217 348 339 512 591 653 535 334 834 2,542 70 68 119 123 84 82 261 257 165 168 379 551 409 835 246 392 217 267 2,062 2,532 524 487 338 351 441 416 786 716 1,563 1,395 2,010 1,401 38 -969 2,422 1,584 -2,693 1,461 19,327 4,414 26,735 24^77 17,067 16,790 25,290 22,408 36,477 36,479 1004)16 77^16 28,096 25,006 17,854 16,370 27,832 24,535 50,474 41,146 111,084 88,401 3,494 2,819 2,789 1,982 5,016 4,497 17,163 7,503 19,391 20,570 24,602 22,187 15,065 14,387 22,816 20,038 33,311 33,643 91,694 67,831 947 904 637 671 863 809 1,502 1,404 3,093 2,782 482 479 388 473 655 721 811 684 2,154 2,244 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 0 0 4 4 108 27 25 115 22 32 31 26 74 57 591 507 414 590 678 753 843 710 2,232 2,305 151 197 353 548 457 409 303 301 830 1,599 156 111 107 85 128 92 212 152 369 234 26,447 23,906 16,576 16,281 24,941 22,101 36,172 36,209 98,218 74,751 144 236 245 254 175 153 153 135 1,349 1,283 144 236 245 254 175 153 153 135 1,349 1,283 26,735 24^77 17,067 16,790 25,290 22,408 36,477 36,479 100,916 77316 4. Includes international organization deposits of 5. Includes exchange-translation account reflecting the $125 million for 2005 and $144 million for 2004. 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

280 92nd Annual Report, 2005 10. Income and Expenses of the Federal Reserve Banks, by Bank, 2005 Thousands of dollars Item Total Boston New York Philadelphia Cleveland CURRENT INCOME Loans 7,453 438 1,217 75 234 U.S. Treasury securities 28,958,637 1,409,356 12,249,381 957,863 1,190,864 Foreign currencies 282,772 34,326 81,081 7,149 25,400 Priced services 900,959 0 66,264 0 0 Compensation received for check services provided1 483,381 45,065 43,001 25,090 60,225 Other 96,154 3,045 57,582 1,975 2,682 Total 30,729,357 1,492,230 12,498^25 992,152 1,279,405 CURRENT EXPENSES Salaries and other personnel expenses 1,345,171 72,098 275,567 63,784 81,748 Retirement and other benefits 398,173 16,139 76,046 18,703 23,990 Net periodic pension costs2 .. -7,183 148 -9,736 162 292 Fees 110,156 2,487 8,916 1,306 7,347 Travel 58,849 2,314 7,512 1,993 3,778 Software expenses 123,740 3,752 13,512 4,206 16,626 Postage and other shipping costs 91,465 1,446 4,637 1,508 4,871 Communications 39,198 2,193 2,799 469 724 Materials and supplies 44,739 2,358 8,459 3,052 3,795 Building expenses Taxes on real estate .. 32,431 4,993 4,885 1,563 2,163 Property depreciation 88,592 4,862 14,495 3,891 6,919 Utilities 37,424 3,640 7,954 2,914 2,376 Rent 37,165 822 11,421 314 386 Other 34,872 1,255 6,495 1,716 2,848 Equipment Purchases 25,873 1,476 3,328 1,051 1,703 Rentals 5,173 231 1,908 3oo 311 Depreciation 91^17 3,894 9,801 5,641 4,576 Repairs and maintenance . 78,727 4,639 8,656 4,289 5,019 Earnings-credit costs 212,773 9,994 71,225 16,036 15,719 Compensation paid for check services costs incurred1 . 483,381 0 0 0 0 Other 68,829 27,839 51,092 9,703 12,429 Recoveries -88,186 -12,108 -10,514 -3,176 -2,696 Expenses capitalized3 -26,794 -430 -9,330 -1,994 0 Total 3086,085 154,040 559,127 137,497 194,924 Reimbursements . -396340 -20,265 -72,912 -25,397 -55,008 Net expenses . 2,889,544 133,775 486,215 112,100 139,916 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 281 10.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 43 220 1,813 881 1,365 628 88 451 2,143,162 2,106,639 2,531,655 860,958 593,462 781,316 1,359,392 2,774,590 52,691 12,633 19,171 5,782 6,477 3,789 3,263 31,011 0 785,660 49,035 0 0 0 0 0 39,736 0 54,319 21,659 30,954 55,727 48,605 59,001 5,674 4,793 5,567 2,259 1,199 1,540 2,588 7,251 2,241,306 2,909,945 2,661,560 891,539 633,457 843,000 1,413,936 2,87233 178,932 127,470 107,750 72,595 69,431 88,102 73,578 134,117 64,877 37,363 28,427 22,602 19,249 21,027 28312 41,238 242 274 148 213 189 160 210 514 54,937 7,355 5,518 13,694 1,865 1,667 2,547 2,516 7,673 7,532 6,180 3,667 2,692 4,379 3,332 7,797 51,773 4,279 4,455 5,156 3,214 3,577 5,157 8,033 3,928 55,031 4,180 2,091 2,850 2,540 2,680 5,703 23,912 1,502 1,320 1,108 1,239 1,011 1,312 1,610 4,755 5,326 3,378 2,162 1,737 2,413 3322 3,782 2,055 2,232 2,631 545 2,721 1,286 4,297 3,061 8,195 11,451 9,239 5,103 4,661 4,022 7,109 8,645 3,600 3,040 1,785 1,910 1,827 1,141 3,630 3,606 15,135 876 2,536 1,602 243 2,759 767 305 3,894 3,618 4,923 1,028 1,568 938 4,169 2,420 5,124 2,432 813 1,364 2,302 2,687 1326 2,067 793 612 378 206 27 50 121 171 34,995 7,817 4,294 3,138 2,509 3,597 4,028 7,226 18,081 9,609 6,734 2,407 2,197 3,046 4,830 9,222 31,683 11,035 19,750 3,585 4,056 6,245 4,042 19,404 0 483,381 0 0 0 0 0 0 -251,340 14,042 41,067 74,996 21,616 17,763 33,827 15,795 -28,720 -2,870 -7,433 ^,522 -1,132 -3,461 -6,699 ^,855 -3,150 0 -267 -6,903 -1,600 -527 -1,008 -1387 231,374 793,405 247,807 207,746 143,462 164,421 181,491 270,790 -27,886 -17,557 -5,085 -111,621 -24,484 -10,518 -11,118 -14,689 203,489 775,848 242,722 96,125 118,978 153,903 170,373 256,101 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

282 92nd Annual Report, 2005 10. Income and Expenses of the Federal Reserve Banks, by Bank, 2005—Continued Thousands of dollars Item Total Boston New York Philadelphia Cleveland PROFIT AND LOSS Current net income 27,839,813 1,358,455 12,012,310 880,052 1,139,488 Additions to and deductions from (-) current net income4 Other additions 933 25 99 3 1 Losses on foreign exchange transactions -2,723,131 -313,128 -766,723 -69,819 -242,721 Interest expense on reverse repurchase agreements -808,808 -40,649 -327,177 -27,694 -34,253 Other deductions -45,875 -1 -545 -5 -2 Total deductions Net addition to or -3,577,814 -353,778 -1,094,445 -97,518 -276,976 deduction from (-) current net income -3,576,881 -353,753 -1,094,347 -97,515 -276,974 Cost of unreimbursed Treasury services 22 0 3 19 0 Assessments by Board Board expenditures5 265,742 24,617 77,166 6,600 23,959 Cost of currency 477,087 28,344 101,397 27,030 26,020 Net income before payment to U.S. Treasury 23,520,080 951,741 10,739,398 748,889 812,534 Dividends paid 780,863 50,819 214,923 30,700 64,845 Payments to U.S. Treasury (interest on Federal Reserve notes) 21,46735 1,937,102 10,268,863 268,048 798,844 Transferred to/from surplus 1,271,672 -1,036,180 255,612 450,140 -51,155 Surplus, January 1 11,629304 1,353,004 3,429,567 293,908 1,064,625 Surplus, December 31 12,901,176 316,824 3,685,179 744,048 1,013,470 NOTE: Components may not sum to totals because of related to the Retirement Benefit Equalization Plan and rounding. the Supplemental Employee Retirement Plan are recorded 1. Beginning in 2005, the Reserve Banks adopted a by each Federal Reserve Bank. new management model for providing check services 3. Includes expenses for labor and materials capitalto depository institutions. The Federal Reserve Bank of ized and depreciated or amortized as charges to activities Atlanta compensates the other eleven Banks for the costs in the periods benefited. incurred to provide check services. 4. Includes reimbursement from the U.S. Treasury for 2. Reflects the effect of Financial Accounting Stan- uncut sheets of Federal Reserve notes, gains and losses on dards Board Statement of Financial Accounting Stan- the sale of Reserve Bank buildings, counterfeit currency dards No. 87, Employers' Accounting for Pensions (SFAS that is not charged back to the depositing institution, and 87). The System Retirement Plan for employees is stale Reserve Bank checks that are written off. recorded on behalf of the System on the books of the 5. For additional details, see the chapter "Board of Federal Reserve Bank of New York, resulting in a Governors Financial Statements." decrease in expenses of $10,652 thousand. The expenses Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 283 10.—Continued Richmond Atlanta Chicago St.Louis Minneapolis Kansas City Dallas San Francisco 2,037,817 2,134,097 2,418,838 795,414 514,479 689,098 1,243,563 2,616,201 0 279 49 427 0 9 6 35 -519,271 -124,274 -193,661 -56,998 -66,356 -37,711 -31,662 -300,808 -61,671 -60,845 -72,841 -24,810 -17,054 -22,527 -39,198 -80,089 -6 -39,568 -979 -2 -1 -4,630 -136 0 -580,949 -224,687 -267,481 -81,810 -83,410 -64,868 -70,996 -380,897 -580,949 -224,408 -267,432 -81,383 -83,410 -64,858 -70,990 -380,862 0 0 0 0 0 0 0 0 57,140 13,260 17,373 4,722 5,639 3,419 3,068 28,779 42,101 58,604 52,210 17,653 12,652 16,897 29,984 64,197 1,357,628 1,837,825 2,081,824 691,656 412,777 603,924 1,139,520 2,142,364 198,386 41,652 50,279 15,403 14,946 9,708 8,788 80,414 0 1,419,942 1,918,743 767,897 406,905 572,526 1,113,058 1,995,617 1,159,242 376,231 112,802 -91,644 -9,073 21,689 17,674 66,333 2,148,210 515,935 763,499 235,644 254,396 153,068 134,953 1,282,696 3,307,452 892,166 876,301 144,000 245,322 174,757 152,628 1,349,029 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

284 92nd Annual Report, 2005 11. Income and Expenses of the Federal Reserve Banks, 1914-2005 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 -AMI 723 1923.. 50,709 29,062 -8,233 703 1924.. 38,340 27,768 -6,191 663 1925.. 41,801 26,819 -4,823 709 1926.. 47,600 24,914 -3,638 722 1,714 1927.. 43,024 24,894 -2,457 779 1,845 1928.. 64,053 25,401 -5,026 698 806 1929.. 70,955 25,810 -4,862 782 3,099 1930.. 36,424 25,358 -93 810 2,176 1931.. 29,701 24,843 311 719 1,479 1932.. 50,019 24,457 -1,413 729 1,106 1933.. 49,487 25,918 -12,307 800 2,505 1934.. 48,903 26,844 -4,430 1,372 1,026 1935.. 42,752 28,695 -1,737 1,406 1,477 1936.. 37,901 26,016 486 1,680 2,178 1937.. 41,233 25,295 -1,631 1,748 1,757 1938.. 36,261 25,557 2,232 1,725 1,630 1939.. 38,501 25,669 2,390 1,621 1,356 1940.. 43,538 25,951 11,488 1,704 1,511 1941.. 41,380 28,536 721 1,840 2,588 1942.. 52,663 32,051 -1,568 1,746 4,826 1943.. 69,306 35,794 23,768 2,416 5,336 1944.. 104,392 39,659 3,222 2,296 7,220 1945.. 142,210 41,666 -830 2,341 4,710 1946.. 150,385 50,493 -626 2,260 4,482 1947.. 158,656 58,191 1,973 2,640 4,562 1948.. 304,161 64,280 -34,318 3,244 5,186 1949.. 316,537 67,931 -12,122 3,243 6,304 1950. 275,839 69,822 36,294 3,434 7,316 1951.. 394,656 83,793 -2,128 4,095 7,581 1952.. 456,060 92,051 1,584 4,122 8,521 1953. 513,037 98,493 -1,059 4,100 10,922 1954. 438,486 99,068 -134 4,175 6,490 1955. 412,488 101,159 -265 4,194 4,707 1956. 595,649 110,240 -23 5,340 5,603 1957. 763,348 117,932 -7,141 7,508 6,374 1958. 742,068 125,831 124 5,917 5,973 1959. 886,226 131,848 98,247 6,471 6,384 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 285 11.—Continued Payments to U.S. Treasury Dividends Interest on to surplus to surplus Statutory Federal Reserve (section 13b) (section 7) transfers2 notes 217 1,743 6,804 1,134 '. ' '. 1,1*34 5,541 48,334 5,012 2,704 ' ' ' 70,652 5,654 60,725 82,916 6,120 59,974 15,993 6,307 10,851 -660 6,553 3,613 2,546 6,682 114 -3,078 6,916 59 2,474 7,329 818 8,464 7,755 250 5,044 8,458 2,585 21,079 9,584 4,283 22,536 10,269 17 -2,298 10,030 -7,058 9,282 2,011 ' . . 11,021 8,874 -917 8,782 ^60 6,510 8,505 298 '.'.'. 28 607 7,830 227 103 353 7,941 177 67 2,616 8,019 120 -419 1,862 8,110 25 -426 4,534 8,215 82 -54 17,617 8,430 141 -4 571 8,669 198 50 3,554 8,911 245 135 40,327 9,500 327 201 48,410 10,183 248 262 81,970 10,962 67 28 81,467 11,523 36 75,284 87 8,366 11,920 166,690 18,523 12,329 193,146 21,462 13,083 196,629 21,849 13,865 254,874 28,321 14,682 291,935 46,334 15,558 342,568 40,337 16,442 276,289 35,888 17,712 251,741 32,710 18,905 401,556 53,983 20,081 542,708 61,604 21,197 524,059 59,215 22,722 910,650 -93,601 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

286 92nd Annual Report, 2005 11. Income and Expenses of the Federal Reserve Banks, 1914-2005—Continued 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 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 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 ^100,366 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 2005 30,729,357 2,889,544 -3,576,903 265,742 477,087 Total, 1914-2005 . 672,479,214 50,083,413 4,200,642 4,403,787 8^40,050 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 287 11.—Continued Payments to U.S. Treasury Transferred Transferred Dividends X KUlOivllvU J. lUliijlvllvU paid Interest on to surplus to surplus Statutory Federal Reserve (section 13b) (section 7) transfers2 notes 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 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 2,782,587 780,863 21,467,545 1,271,672 7,867322 44,113,958 544,876,281 -4 16,994,848 3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

288 92nd Annual Report, 2005 11. Income and Expenses of the Federal Reserve Banks, 1914-2005—Continued Thousands of dollars Assessments by Net additions Board of Governors Federal Reserve Bank Current Net or and period income expenses deductions (-)1 Board Costs expenditures of currency Aggregate for each Bank, 1914-2005 Boston 36,048,784 3,274,732 -15,082 199,880 487,911 New York 234,942,446 7,766,6434 1,007,889 1,086,518 2,674,482 Philadelphia 24,861,783 2,655,034 102,829 176,550 345,554 Cleveland 40,972,417 3,108,697 263,458 320,387 489,061 Richmond 51,911,304 4,345,043 478,516 588,205 685,503 Atlanta 36,743,133 5,665,930 321,649 329,983 594,893 Chicago 81,895,577 6,204,504 658,528 505,921 954,188 St. Louis 23,099,813 2,495,102 72,461 111,872 304,452 Minneapolis 11,417,989 2,418,425 134,715 134,873 143,849 Kansas City 24,386,940 3,235,577 134,127 142,889 304,514 Dallas 30,724,517 3,260,617 386,879 214,756 412,630 San Francisco 75,474,511 5,653,109 654,672 591,953 943,014 Total 672,479,214 50,083,413 4,200,642 4,403,787 8340,050 NOTE. Components may not sum to totals because of 2. Represents transfers made as a franchise tax from rounding. 1917 through 1932; transfers made under section 13b of ... Not applicable. the Federal Reserve Act from 1935 through 1947; and 1. For 1987 and subsequent years, includes the cost of transfers made under section 7 of the Federal Reserve Act services provided to the Treasury by Federal Reserve for 1996 and 1997. Banks for which reimbursement was not received. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 289 11.—Continued Payments to U.S. Treasury Transferred Transferred Dividends paid t S ra ta n t s u f t e o r r s y 2 Fed In e t r e a r l e R st e o se n rve (s t e o c t s io u n rp l 1 u 3 s b) ( t s o e c s t u io rp n l u 7 s ) notes 389,053 2,579,504 28,598,628 135 503,858 1,954,667 17,307,161 200,612,873 -433 4,548,425 327,412 1,312,118 19,261,492 291 886,161 586,203 2,827,043 32,604,787 -10 1,299,708 1,163,247 3,083,928 38,208,638 -72 4,315,327 552,880 2,713,230 26,021,551 5 1,186,310 864,400 4,593,811 68,177,052 12 1,254,217 199,102 1,833,837 17,981,385 -27 246,550 241,764 416,227 7,806,113 65 391,389 237,538 1,249,703 19,059,475 -9 291,380 338,852 1,510,802 25,081,323 55 292,361 1,012,405 4,686,594 61,462,963 -17 1,779,161 7,867,522 44,113,958 544,876,281 -4 16,994,848 3 3. The $16,994,848 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 $12,901,176 thousand on Decemfor contributions to capital of the Federal Deposit Insur- ber 31, 2005. ance Corporation (1934), $4 thousand net upon elimina- 4. This amount is reduced by $2,664,656 thousand tion of section 13b surplus (1958), and $106,000 thou- for expenses of the System Retirement Plan. See note 2, sand (1996), $107,000 thousand (1997), and table 10. $3,752,000 thousand (2000) transferred to the Treasury Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

290 92nd Annual Report, 2005 12. Operations in Principal Departments of the Federal Reserve Banks, 2002-2005 Operation 2005 2004 2003 2002 Millions of pieces (except as noted) Currency processed 36,463 36,242 34,832 34,208 Currency destroyed 6,551 6,748 7,375 8,363 Coin received1 56,080 55,655 48,138 43,445 Checks handled U.S. government checks 215 234 267 289 Postal money orders 176 187 198 216 Other 12,195 13,904 15,806 16,587 Government securities transfers 22 20 20 17 Transfer of funds 132 125 123 115 Automated clearinghouse transactions Commercial 7,339 6,486 5,588 4,986 Government 964 941 914 883 Food stamps redeemed 1 48 287 500 Millions of dollars Currency processed 639,832 625,127 584,915 565,302 Currency destroyed 83,187 90,943 101,338 92,511 Coin received1 5,412 5,403 4,879 4,579 Checks handled U.S. government checks 250,865 277,649 308,055 307,627 Postal money orders 28,395 29,045 29,197 30,161 Other 14,379,874 14,287,740 15,431,625 15,033,298 Government securities transfers 368,896,819 313,425,252 267,644,194 228,907,121 Transfer of funds 518,546,592 469,898,863 436,706,269 405,761,750 Automated clearinghouse transactions Commercial 12,801,914 12,543,907 13,951,600 13,135,350 Government 3,156,556 2,913,189 2,810,283 2,711,384 Food stamps redeemed 2 239 1,510 2,543 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

Statistical Tables 291 13. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2005 President1 Other officers Employees Total Federal Reserve Number Bank (including Branches) Salary Num- Salaries Salaries Num- Salaries (dollars)2 ber (dollars)2 Full- Part- (dollars)2 ber (dollars)2 time time Boston3 355,600 62 10,095,965 927 98 59,160,815 1,088 69,612,380 New York 327,800 271 50,656,321 2,594 54 196,934,336 2,920 247,918,457 Philadelphia 293,700 53 7,735,500 912 36 48,862,872 1,002 56,892,072 Cleveland 249,000 60 8,780,700 1,481 36 70,106,859 1,578 79,136,559 Richmond 262,800 69 9,771,300 1,629 67 91,936,492 1,766 101,970,592 Atlanta 355,600 77 12,185,600 1,917 41 101,452,089 2,036 113,993,289 Chicago 3 355,600 84 12,367,949 1,325 57 81,933,636 1,467 94,657,185 St. Louis 295,700 73 10,227,500 972 54 51,984,088 1,100 62,507,288 Minneapolis 355,600 43 6,221,000 1,164 121 60,410,547 1,329 66,987,147 Kansas City 323,800 73 10,761,200 1,237 47 66,213,955 1,358 77,298,955 Dallas 262,800 54 7,838,405 1,199 25 60,943,991 1,279 69,045,196 San Francisco ... 310,700 73 12,606,008 1,626 30 106,306,340 1,730 119,223,048 Federal Reserve Information Technology . 36 5,432,900 700 3 56,009,962 739 61,442,862 Office of Employee Benefits .... 7 1,412,100 34 0 2,721,309 41 4,133,409 Total 3,748,700 1,035 166,092,448 17,717 669 1,054,977,290 19,433 1,224,818,438 1. The policies governing the salaries of Federal labor in the head-office cities. Currently, the New York Reserve Bank presidents were revised in 2005. Under and San Francisco Banks are in tier 1, which has a midthe revised policies, appointment salaries are normally point of $345,000; the Boston, Philadelphia, Richmond, 85 percent of the midpoint of the salary range (an 85 Atlanta, Chicago, Minneapolis, and Dallas Banks are in compa-ratio), with the exception of the appointment tier 2, which has a midpoint of $309,200; and the Clevesalary of the New York Reserve Bank president, which is land, St. Louis, and Kansas City Banks are in tier 3, normally set at a 95 compa-ratio. The Board has discre- which has a midpoint of $281,600. The Board reviews tion to approve a higher appointment salary if requested Reserve Bank officer salary ranges and the placement of by a Reserve Bank's board of directors. individual Reserve Banks in the salary tiers annually. On January 1 of each year, each president receives a 2. Annualized salary liability based on salaries in effect salary increase equal to the percentage increase in the on December 31, 2005. midpoint of his or her salary range. In addition, on every 3. Data for 2004 have been corrected, as follows: For third-year anniversary of his or her initial appointment the Boston Reserve Bank, employee annual salaries, (through year 9), each president receives a salary increase $57,177,807; total annual salaries, $66,461,907. For the that results in a higher compa-ratio, as follows: year 3, 95 Chicago Reserve Bank, number of full-time employees, (for the New York Bank, 105); year 6, 105 (New York, 1,471; number of part-time employees, 60; total num- 115); year 9, 115 (New York, 125). ber of employees, 1,624; employee annual salaries, There continue to be tiered salary ranges for Reserve $86,707,060; total annual salaries, $100,031,698. Bank presidents, reflecting differences in the costs of . . . Not applicable. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

292 92nd Annual Report, 2005 14. Acquisition Costs and Net Book Value of the Premises of the Federal Reserve Banks and Branches, December 31, 2005 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 ... 27,081 121,666 27,090 175,837 112,296 NEW YORK 20,103 242,759 60,251 323,113 206,967 Buffalo 0 0 0 0 0 PHILADELPHIA ... 2,561 78,924 12,117 93,602 53,461 CLEVELAND . 4,386 123,627 24,766 152,780 114,863 Cincinnati 2,541 29,487 11,575 43,602 23,093 Pittsburgh 1,658 20,117 12,531 34,307 20,093 RICHMOND 22,637 86,413 38,210 147,260 101,465 Baltimore 6,482 29,286 5,815 41,584 24,499 Charlotte 3,130 30,582 6,842 40,554 27,368 ATLANTA .. 22,735 147,904 16,065 186,704 169,033 Birmingham . 5,347 10,939 1,439 17,725 11,623 Jacksonville . 1,730 20,603 3,741 26,074 17,153 48 Miami 4,254 19,381 4,618 28,252 18,738 Nashville .... 603 5,585 3,648 9,836 5,232 New Orleans 3,785 9,437 5,218 18,439 10,418 CHICAGO 4,512 158,996 18,962 182,470 115,395 2,744 Detroit 7,132 76,585 11,845 95,562 95,376 ST. LOUIS 8,3% 59,903 12,217 80,516 54,736 Little Rock 0 0 0 0 0 4,657 Louisville ., 0 0 0 0 0 Memphis ... 2,472 13,935 5,164 21,571 15,704 MINNEAPOLIS 15,666 104,426 13,851 133,943 109,389 Helena 2,890 9,716 943 13,549 9,898 KANSAS CITY 28,771 24,389 0 53,160 53,160 Denver 3,511 12,255 4,502 20,268 12,135 Oklahoma City . 433 8,186 2,629 11,248 3,438 Omaha 7,165 11,770 2,437 21,371 15,429 DALLAS ... 32,135 110,203 23,572 165,911 122,878 1,702 El Paso 262 3,426 1,553 5,241 1,875 Houston 22,938 100,629 8,236 131,802 130,085 7,204 San Antonio . 826 7,351 3,089 11,266 6,285 SAN FRANCISCO 20,122 93,921 22,238 136,280 82,133 Los Angeles 6,306 69,935 13,009 89,249 58,544 Portland 1,287 8,764 2,532 12,584 6,375 Salt Lake City 1,294 4,680 1,680 7,654 3,276 Seattle 380 17,220 4,545 22,145 14,913 8,205 Total 295,531 1,872,998 386^30 2,555,460 1,827,324 24,560 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

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

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

297 Board of Governors Financial Statements The financial statements of the Board for 2005 and 2004 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, 2005 and 2004, 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 Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material nrisstatement. An audit includes 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 also 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 die 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 of Governors of the Federal Reserve System, at December 31, 2005 and 2004, 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 reports dated May 31, 2006, on our consideration of the Board's internal control over financial reporting and our tests of its compliance with certain provisions of laws, regulations, contracts, and other matters. 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 performed in accordance with Government Auditing Standards and should be read in conjunction with this report in assessing the results of our audits. Mr UP May 31,2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

298 92nd Annual Report, 2005 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BALANCE SHEETS As of December 31, 2005 2004 ASSETS CURRENT ASSETS Cash $ 45,970,435 $ 60,107,292 Accounts receivable 3,345,446 1,696,480 Prepaid expenses and other assets 2,728,486 4,015,067 Total current assets 52,044,367 65,818,839 NONCURRENT ASSETS Property and equipment, net (Note 3) 155,441,553 149,028,686 Art collections (Note 2) Total noncurrent assets 155,441,553 149,028,686 Total assets $207,485,920 $214,847,525 LIABILITIES AND CUMULATIVE RESULTS OF OPERATIONS CURRENT LIABILITIES Accounts payable and accrued liabilities $ 16,906,350 $ 13,891,861 Accrued payroll and related taxes 4,860,572 4,552,039 Accrued annual leave 15,456,484 14,195,910 Capital lease payable (current portion) 270,167 250,794 Unearned revenues and other liabilities 783,711 467,664 Total current liabilities 38,277,284 33,358,268 LONG-TERM LIABILITIES Capital lease payable (non-current portion) 406,188 675,271 Accumulated retirement benefit obligation (Note 4) 813,497 594,169 Accumulated postretirement benefit obligation (Note 5) 6,237,290 5,789,566 Accumulated postemployment benefit obligation (Note 6) 5,111,365 5,308,565 Total long-term liabilities 12,568,340 12,367,571 Total liabilities 50,845,624 45,725,839 CUMULATIVE RESULTS OF OPERATIONS Working capital 14,037,250 32,711,365 Unfunded long-term liabilities (12,162,152) (11,692,300) Net investment in property and equipment 154,765,198 148,102,621 Total cumulative results of operations 156,640,296 169,121,686 Total liabilities and cumulative results of operations $207,485,920 $214,847,525 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 299 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF REVENUES AND EXPENSES AND CHANGES IN CUMULATIVE RESULTS OF OPERATIONS For the years ended December 31, 2005 2004 BOARD OPERATING REVENUES Assessments levied on Federal Reserve Banks for Board operating expenses and capital expenditures $265,742,100 $272,331,500 Other revenues (Note 7) 8,520,342 8,336,581 Total operating revenues 274,262,442 280,668,081 BOARD OPERATING EXPENSES Salaries 174,523,825 166,797,724 Retirement and insurance 31,847,951 30,850,441 Contractual services and professional fees 24,695,564 24,835,904 Depreciation and net losses on disposals 12,954,506 12,445,708 Utilities 9,065,329 8,273,801 Travel 7,794,483 7,088,444 Software 6,052,617 6,302,695 Postage and supplies 7,169,829 6,116,355 Repairs and maintenance 3,361,179 3,954,263 Printing and binding 1,973,594 1,944,552 Other expenses (Note 7) 7,304,955 6,515,129 Total operating expenses 286,743,832 275,125,016 RESULTS OF OPERATIONS (12,481,390) 5,543,065 ISSUANCE AND REDEMPTION OF FEDERAL RESERVE NOTES Assessments levied on Federal Reserve Banks for currency costs 477,087,471 503,784,304 Expenses for currency printing, issuance, retirement, and shipping 477,087,471 503,784,304 CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES 0 0 TOTAL RESULTS OF OPERATIONS (12,481,390) 5,543,065 CUMULATIVE RESULTS OF OPERATIONS, Beginning of year 169,121,686 163,578,621 CUMULATIVE RESULTS OF OPERATIONS, End of year $156,640,296 $169,121,686 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

300 92nd Annual Report, 2005 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF CASH FLOWS For the years ended December 31, 2005 2004 CASH FLOWS FROM OPERATING ACTTVITIES RESULTS OF OPERATIONS $(12,481,390) $ 5,543,065 Adjustments to reconcile results of operations to net cash provided by (used in) operating activities: Depreciation and net losses on disposals 12,954,506 12,445,708 Increase in assets: Accounts receivable, prepaid expenses, and other assets (362,385) (1,846,076) Increase (decrease) in liabilities: Accounts payable and accrued liabilities 3,014,489 (1,455,529) Accrued payroll and related taxes 308,533 (504,608) Accrued annual leave 1,260,574 766,917 Unearned revenues and other liabilities 316,047 76,966 Accumulated retirement benefit obligation 219,328 (1,432) Accumulated postretirement benefit obligation 447,724 467,513 Accumulated postemployment benefit obligation (197,200) 358,673 Net cash provided by operating activities 5,480,226 15,851,197 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposals 2,850 4,005 Capital expenditures (19,370,223) (11,715,861) Net cash used in investing activities (19,367,373) (11,711,856) CASH FLOWS FROM FINANCING ACTIVITIES Capital lease payments (249,710) (211,703) Net cash used in financing activities (249,710) (211,703) NET INCREASE (DECREASE) IN CASH (14,136,857) 3,927,638 CASH BALANCE, Beginning of year 60,107,292 56,179,654 CASH BALANCE, End of year $ 45,970,435 $ 60,107,292 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Capital lease obligations incurred $ 0 $ 190,538 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 301 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM NOTES TO FINANCIAL STATEMENTS collections are used to acquire other items for collections. AS OF AND FOR THE YEARS ENDED As permitted by Statement of Financial Accounting Stan- DECEMBER 31, 2005 AND 2004 dards Number 116, Accounting for Contributions Received and Contributions Made, the cost of collections purchased by the Board is charged to expense in the year (1) STRUCTURE purchased and donated collection items are not recorded. The Federal Reserve System was established by Con- The value of the Board's collections has not been gress in 1913 and consists of the Board of Governors determined. (Board), the Federal Open Market Committee, the twelve Estimates—The preparation of financial statements in regional Federal Reserve Banks, the Federal Advisory conformity with accounting principles generally accepted Council, and the private commercial banks that are mem- in the United States of America requires management to bers of the System. The Board, unlike the Reserve Banks, make estimates and assumptions that affect the reported was established as a federal government agency and is amounts of assets and liabilities and the disclosure of supported by Washington DC based staff numbering contingent assets and liabilities at the date of the financial approximately 1,800, as it carries out its responsibilities statements and the reported amounts of revenues and in conjunction with other components of the Federal expenses during the reporting period. Actual results could Reserve System. differ from those estimates. The Board is required by the Federal Reserve Act to Reclassifications—Certain 2004 amounts have been report its operations to the Speaker of the House of reclassified to conform with the 2005 presentation. Representatives. The Act also requires the Board, each year, to order a financial audit of each Federal Reserve (3) PROPERTY AND EQUIPMENT Bank and to publish each week a statement of the finan- The following is a summary of the components of the cial condition of each such Reserve Bank and a consoli- Board's property and equipment, at cost, net of accumudated statement for all of the Reserve Banks. Accord- lated depreciation. ingly, the Board believes that the best financial disclosure consistent with law is achieved by issuing separate finan- As of December 31, cial statements for the Board and for the Reserve Banks. Therefore, the accompanying financial statements include 2005 2004 only the results of operations and activities of the Board. Land $ 18,640,314 $ 18,640,314 Combined financial statements for the Federal Reserve Buildings and Banks are included in the Board's annual report to the improvements ... 135,152,735 132,891,551 Speaker of the House of Representatives. Furniture and equipment 39,926,270 44,450,522 (2) SIGNIFICANT ACCOUNTING POLICIES Software 12,990,050 12,207,125 Construction in Basis of Accounting—The financial statements have process 13,928,149 4,380,259 been prepared on the accrual basis of accounting. 220,637,518 212,569,771 Revenues—Assessments for operating expenses and Less accumulated additions to property are based on expected cash needs. depreciation (65,195,965) (63,541,085) Amounts over or under assessed due to differences Property and between actual and expected cash needs flow in to or out equipment, net ... $155,441,553 $149,028,686 of "Cumulative Results of Operations" during the year. Issuance and Redemption of Federal Reserve Notes— Furniture and equipment includes $1,230,000 each year The Board incurs expenses and assesses the Federal for capitalized leases as of December 31, 2005 and Reserve Banks for currency printing, issuance, retire- 2004. Accumulated depreciation includes $612,000 and ment, and shipping of Federal Reserve Notes. These $356,000 for capitalized leases as of December 31, 2005 assessments and expenses are separately reported in the and 2004, respectively. The Board paid interest related statements of revenues and expenses because they are to these capital leases in the amount of $83,000 and passed through Board accounts and are not Board operat- $104,000 for 2005 and 2004, respectively. ing transactions. Construction in process includes costs incurred in 2005 Property and Equipment—The Board's property, build- and 2004 for long-term security projects and building ings, and equipment are stated at cost less accumulated enhancements. depreciation. Depreciation is calculated on a straight-line The future minimum lease payments required under basis over the estimated useful lives of the assets, which the capital leases and the present value of the net minirange from 3 to 10 years for furniture and equipment and mum lease payments as of December 31, 2005, are as from 10 to 50 years for building equipment and struc- follows: tures. 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. Art 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

302 92nd Annual Report, 2005 Year Effective January 1, 1996, Board employees covered ending under the System Plan are also covered under a Benefits December 31 Amount Equalization Plan (BEP). Benefits paid under the BEP are limited to those benefits that cannot be paid from the 2006 $ 417,358 2007 416,274 System Plan due to limitations imposed by Sec- 2008 138,279 tions 401(a)(17), 415(b), and 415(e) of the Internal Revenue Code of 1986. Activity for the BEP for 2005 and Total minimum lease payments 971,911 2004 is summarized in the following table: Less: Amount representing maintenance included 2005 2004 in total amounts above . (207,125) Change in projected Net minimum lease benefit obligation payments 764,786 Benefit obligation at Less: Amount representing beginning of year .. $ 140,953 $ 74,956 interest (88,431) Service cost 193,209 23,239 Present value of net Interest cost 35,964 6,170 minimum lease Plan participants' payments 676,355 contributions 0 0 Less: Current maturities Plan amendments 0 0 of capital lease Actuarial (gain)/loss .... 168,027 36,588 obligations (270,167) Benefits paid (1,814) 0 Long-term capital lease Benefit obligation at obligations $ 406,188 end of year $ 536,339 $ 140,953 (4) ACCUMULATED RETIREMENT BENEFITS Change in plan assets Fair value of plan assets The following information provides disclosure require- at beginning ments contained in Statement of Financial Accounting of year $ 0 $ 0 Standards No. 132, Employers' Disclosures about Pen- Actual return on plan sions and Other Postretirement Benefits. assets 0 0 Employer contributions . 1,814 0 Substantially all of the Board's employees participate Plan participants' in the Retirement Plan for Employees of the Federal contributions 0 0 Reserve System (System Plan). The System Plan is a Benefits paid (1,814) 0 multi-employer plan which covers employees of the Fair value of plan assets Federal Reserve Banks, the Board, and the Office of at end of year $ 0 $ 0 Employee Benefits. Employees of the Board who became employed prior Reconciliation of funded to 1984 are covered by a contributory defined benefits status at end of year program under the System Plan. Employees of the Board Funded status $ (536,339) $ (140,953) who became employed after 1983 are covered by a non- Unrecognized net contributory defined benefits program under the System actuarial (gain)/ Plan. Contributions to the System Plan are actuarially loss (15,728) (177,773) determined and funded by participating employers. Based Unrecognized prior on actuarial calculations, it was determined that employer service cost (701,125) (817,732) Unrecognized net funding contributions were not required for the years transition 2005 and 2004, and the Board was not assessed a contri- obligation 439,695 542,289 bution for these years. Because the plan is part of a Retirement multi-employer plan, information as to vested and non- benefit liability .... $ (813,4 vested benefits, as well as plan assets, as it relates solely to the Board, is not readily available. Information for pension plans with an A relatively small number of Board employees particiaccumulated benefit pate in the Civil Service Retirement System (CSRS) or obligation in excess of the Federal Employees' Retirement System (FERS). plan asset: These defined benefit plans are administered by the U.S. Projected benefit Office of Personnel Management, which determines the obligation $ 536,339 $ 140,953 required employer contribution levels. The Board's con- Accumulated benefit tributions to these plans totaled $324,000 and $330,000 in obligation 278,252 33 2005 and 2004, respectively. The Board has no liability for future payments to retirees under these programs and is not accountable for the assets of the plans. Employees of the Board may also participate in the Federal Reserve System's Thrift Plan. Board contributions to members' accounts are based upon a fixed percentage of each member's basic contribution and were $8,617,000 and $8,314,000 in 2005 and 2004, respectively. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 303 2005 2004 2005 2004 Weighted-average Change in plan assets assumptions used to Fair value of plan determine benefit assets at beginning obligation as of of year $ 0 $ 0 December 31 Actual return on Discount rate 5.75% 5.75% plan assets 0 0 Rate of compensation Employer contribution .. 284,485 253,717 increase 4.50% 4.25% Plan participants' contributions 0 0 Components of net Benefits paid (284,485) (253,717) periodic benefit cost Fair value of plan Service cost—benefits assets at end earned during the of year $ 0 $ 0 period $ 193,209 $ 23,239 Interest cost on Reconciliation of projected benefit funded status obligation 35,964 6,170 at end of year Expected return Funded status $(8,273,832) $(8,404,551) on plan assets 0 0 Unrecognized net Amortization of actuarial prior service cost .. (116,607) (116,607) (gain)/loss 2,145,920 2,537,211 Amortization of Unrecognized prior (gains)/losses 5,982 (16,828) service cost (109,378) 77,774 Amortization of initial Prepaid/(accrued) (asset)/obligation .. 102,594 102,594 postretirement Net periodic benefit benefit liability .... $(6,237,290) $(5,789,566) cost (credit) $ 221,142 $ (1,432) Components of net Weighted-average periodic cost assumptions used to for year determine net periodic Service cost $ 217,421 $ 203,229 benefit cost for years Interest cost 437,320 443,043 ended December 31 Amortization of prior Discount rate 5.75% 6.25% service cost (9,818) 6,073 Rate of compensation Amortization of increase 4.25% 4.00% (gains)/losses 87,286 68,885 Total net periodic cost $ 732,209 $ 721,230 (5) ACCUMULATED POSTRETIREMENT BENEFITS This following information provides disclosure require- The liability and costs for the postretirement benefit ments contained in Statement of Financial Accounting plan were determined using discount rates of 5.75 percent Standards No. 106, Employers'Accounting for Postretire- as of December 31, 2005 and 2004. Unrecognized losses ment Benefits Other Than Pensions. of $2,145,920 as of December 31, 2005 and $2,537,211 The Board provides certain life insurance programs for as of December 31, 2004 result from changes in the its active employees and retirees. Activity for 2005 and discount rate used to measure the liabilities. Under 2004 is summarized in the following table: Statement of Financial Accounting Standards No. 106, 2005 2004 Employers' Accounting for Postretirement Benefits Other Than Pensions, the Board may have to record some of Change in benefit these unrecognized losses in operations in future years. obligation The assumed salary trend rate for measuring the increase Benefit obligation at in postretirement benefits related to life insurance was an beginning of year .. $ 8,404,552 $ 7,166,146 average of 4.25 percent. Service cost 217,421 203,229 Interest cost 437,320 443,043 The above accumulated postretirement benefit obliga- Plan participants' tion is related to the Board sponsored life insurance contributions 0 0 programs. The Board has no liability for future payments Plan amendments (196,970) 0 to employees who continue coverage under the federally Actuarial (gain)/loss .... (304,006) 845,851 sponsored life and health programs upon retiring. Contri- Benefits paid (284,485) (253,717) butions for active employees participating in federally Benefit obligation sponsored health programs totaled $8,933,000 and atendofyear $ 8,273,832 $ 8,404,552 $8,223,000 in 2005 and 2004, respectively. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

304 92nd Annual Report, 2005 (6) ACCUMULATED POSTEMPLOYMENT BENEFIT PLAN (8) COMMITMENTS AND CONTINGENCIES This following information provides disclosure require- Leases ments contained in Statement of Financial Accounting The Board has entered into several operating leases to Standards No. 112, Employers' Accounting for Postemsecure office, training, and warehouse space for remainployment Benefits. ing periods ranging from one to four years. In addition, The Board provides certain postemployment benefits the Board has entered into an agreement with the Federal to eligible former or inactive employees and their depen- Deposit Insurance Corporation and the Office of the dents during the period subsequent to employment but Comptroller of the Currency, through the Federal Finanprior to retirement. Costs were projected using the same cial Institutions Examination Council (the "Council") to discount rates as were used for projecting postretirement fund a portion of enhancements for a central data reposicosts. The accrued postemployment benefit costs recogtory project through 2013. nized by the Board for the years ended December 31, Mimimum annual payments under the operating leases 2005 and 2004, were $155,800 and $733,000, having an initial or remaining noncancelable lease term in respectively. excess of one year are $71,991 for 2006. Rental expenses under the operating leases were (7) OTHER REVENUES AND OTHER EXPENSES $157,000 in 2005 and $156,000 in 2004. The following are summaries of the components of Other Revenues and Other Expenses. Benefit Obligations For the years ended The Board is subject to potential liabilities for a supple- December 31, mental benefit for certain employees that participate in CSRS and who meet certain other criteria. Based on 2005 2004 information currently available, the exact amount of the Other revenues Data processing additional pension liability as of December 31, 2005 is revenue $3,788,217 $3,984,610 unknown. It is management's opinion that the additional Rent 2,433,833 2,332,089 liability, if any, will not have a materially adverse effect Subscription on the financial statements. revenue 782,743 787,053 Litigation Reimbursable services to The Board is subject to contingent liabilities which other agencies ... 664,755 673,730 include litigation cases. These contingent liabilities arise Board sponsored in the normal course of operations and their ultimate conferences 250,650 0 disposition is unknown. Based on information currently Miscellaneous 600,144 559,099 available to management, it is management's opinion that Total other the expected outcome of these matters, individually or in revenues $8,520,342 $8,336,581 the aggregate, will not have a materially adverse effect on the financial statements. Management believes the Board Other expenses has substantial defenses and that the likelihood of an Tuition, registration, adverse judgement is small. and membership One action pending in the United States District Court fees $2,573,028 $2,048,610 for the District of Columbia under Title VH of the Civil Contingency Rights Act of 1964, as amended, alleges discrimination operations 956,476 782,052 on behalf of a class of African American secretaries at the Public transportation Board. The case is a successor to an earlier lawsuit that subsidy 691,264 800,724 was dismissed for failure to exhaust administrative rem- Subsidies and edies. Following a period of discovery on the issue of contributions .... 656,150 635,336 exhaustion of administrative remedies, the Board has Meals and moved to dismiss the action; that motion is pending. representation ... 518,640 377,963 Should the case proceed beyond the motion to dismiss the Equipment and Board believes it has substantial defenses and intends to facilities rental... 336,342 307,999 defend the case vigorously. Administrative Seven additional matters alleging employment dislaw judges 268,228 492,155 crimination are currently pending administrative resolu- Security tion or have been resolved recently and could be the investigations 184,880 286,711 subject of an administrative appeal or a judicial action. Former employee The chances that any of these cases will result in court related litigation cannot reasonably be estimated at this time. In payments 319,461 205,627 five of these cases, there has not yet been an investigative Miscellaneous 800,486 577,952 report. Therefore, management is unable at this time to Total other determine the potential for a materially adverse effect on expenses $7,304,955 $6,515429 the financial statements. Management believes the likelihood of an unfavorable outcome in the remaining two cases is remote. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 305 (9) FEDERAL FINANCIAL INSTITUTIONS (10) FEDERAL RESERVE BANKS EXAMINATION COUNCIL The Board performs certain functions for the Reserve The Board is one of the five member agencies of Banks in conjunction with its responsibilities for the the Council, and currently performs certain management Federal Reserve System, and the Federal Reserve Banks functions for the Council. The five agencies which are provide certain administrative functions for the Board. represented on the Council are the Board, Federal Deposit Activity related to the Board and Reserve Banks for 2005 Insurance Corporation, National Credit Union Adminis- and 2004 is summarized in the following table: tration, Office of the Comptroller of the Currency, and Office of Thrift Supervision. The Board's financial state- 2005 2004 ments do not include financial data for the Council. Board paid to the Activity related to the Board and Council for 2005 and Reserve Banks: 2004 is summarized in the following table: Assessments for employee benefits .. $ 2,072,595 $ 2,151,078 2005 2004 Data processing and communication 2,106,850 1,920,996 Board paid to the Contingency site 956,476 1,481,452 Council: Total Board paid Assessments for to the Reserve operating expenses Banks $ 5,135,921 $ 5,553,526 of the Council $ 83,811 $ 112,020 Central Data Repository 1,096,062 326,640 Reserve Banks paid Uniform Bank to the Board: Performance Assessments for Report 202,666 199,230 currency costs $477,087,471 $503,784,304 Total Board Assessments for paid to the operating expenses Council $1,382,539 $ 637,890 of the Board 265,742,100 272,331,500 Data processing 516,433 686,312 Total Reserve Banks Council paid to the paid to the Board: Board $743,346,004 $776,802,116 Data processing related services ... 3,572,816 3,360,055 Administrative services 175,000 133,500 Total Council paid to the Board $3,747,816 $3,493,555 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

306 92nd Annual Report, 2005 K/2M.G KPMGLLP 2001 M Street NW Washington. DC 20036 ' 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, 2005 and 2004, 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 May 31, 2006. 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 2005 audit, we considered the Board's internal control over financial reporting by obtaining an understanding of the Board's internal control, determining whether 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 internal control over financial reporting would not necessarily disclose all matters in the internal control over financial reporting that might be reportabk conditions. Under standards issued by the American Institute of Certified Public Accountants, reportable conditions are matters coming to our attention relating to significant deficiencies in the design or operation of the internal control over financial reporting that, in our judgment, could adversely affect the Board's ability to record, process, summarize, and report financial data consistent with the assertions by management in the financial statements. Material weaknesses are reportable 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. In our 2005 audit, we noted certain matters, discussed in Exhibit I, involving the internal control over financial reporting and its operation that we consider to be a reportable condition. However, the reportable condition is not believed to be a material weakness. Management's responses to our findings are also included in Exhibit L Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 307 We also noted certain additional matters that we reported to the management of the Board in a separate letter dated May 31,2006. This report is intended solely for the information and use of the Board and its management, the Office of Inspector General, the Government Accountability Office, and the U.S. Congress and is not intended to be and should not be used by anyone other than these specified parties. May 31,2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

308 92nd Annual Report, 2005 Exhibit I BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Reportable Condition December 31, 2005 Improvement Is Needed in Internal Con- 2005 as the invoices received from GSA trols over Financial Reporting during 2005 and 2006 did not provide sufficient details on the billing period. Management is responsible for developing and maintaining effective internal controls to Control of Census Data provide assurance that the Board has the During our audit, we coordinated with the ability to record, process, summarize, and Office of Inspector General (OIG) to perreport financial data consistent with the form an analysis of the accuracy of the cenassertions of management in its financial sus data used by the Board's actuary in the statements. pension benefit liability and noted that there The following paragraphs discuss weakwere discrepancies between the Board's nesses noted in the Board's internal control Human Resources database and the data used over financial reporting that could adversely by the actuary. We noted that the Board has affect the Board's ability to produce accurate not established controls to verify the accuand timely financial statements. racy of the underlying data used by the actuary in the pension liability calculation. Controls over Accounts Payable and Specifically, we noted the following: Accrued Liabilities During our audit, we noted that the Board • Of the 176 employees included in the recorded material post closing entries Benefits Equalization Plan (BEP) liability: amounting to $1,957,836 to reduce liabili- — One individual was retired and covties, prepayments, and the related expenses ered under the CSRS plan; accordingly as of December 31, 2005. Issues we identi- he/she should not have been included fied that resulted in post closing entries in the BEP population. Also, the genincluded: der of the individual was reported incorrectly. • Recording transactions as liabilities and — One individual was covered under the prepaid expenses, although the Board did FERS plan and therefore does not not receive the related goods/services prior qualify for the BEP. to December 31, 2005. — One individual was included twice in • Recording transactions in both accounts the BEP calculation. payable and accrued liabilities. Therefore, — Two individuals did not have retirethese liabilities were duplicated in the ment service credit dates in Peoplefinancial statements. Soft. • Recording transactions based on incorrect — Sixteen individuals had incorrect sersupporting documents or estimates provice credit dates in the data used by the vided by the operating divisions that difactuary. fered significantly from the actual — For two individuals, the total pay used invoices. in the actuarial calculations was incor- We also noted that the Board received an rect because their variable pay amounts invoice from the General Services Adminis- were not included. tration (GSA) in April 2006 for $275,100 • The 930 employees included by the actuthat might include some expenses for steam ary in the Board Postretirement Welfare provided in 2005. The Board recorded an Benefits Plan (BEGLI) calculation accrual for $50,000 at December 31, 2005. included two retired individuals who However, management is unable to deter- should not have been in the active file. mine if an additional accrual is required for • Of the 1,777 employees included in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 309 Board Postemployment Benefit Plan Management Response (Long-term disability): 1. Concur. Management will — Three individuals who retired prior to strengthen its procedures for January 1, 2005 were incorrectly review and approval of year-end included in the actuarial liability calcutransactions for accounts payables lations. and year-end accruals. In addition — Thirty individuals in the Board Plan to strengthening our procedures, had differences over 30 days that organizational changes have been related to incorrect service credit dates. made to enhance supervision in this We also noted that the actuary incorrectly area and additional resources will included variable pay in the calculations be devoted to this time-sensitive for long-term disability. process. Accounting staff will pro- Recommendations: vide additional training for division staff responsible for reporting year- We recommend that the Board: end accruals and approval of 1. Establish policies and procedures for pro- accruals will require more senior cessing year-end accounts payables and staff approval both in the divisions accruals to include the requirements for and Accounting. management to review and approve all 2. & 3. Concur. We support the recommenentries and supporting documents before dation and work is underway to they are recorded. Management should enhance controls over these data. also perform a review of the year-end Management is working with the accounts payable listings and subsequent Office of Employee Benefits, the disbursements to ensure that the transac- Federal Reserve's actuary, and the tions reported at year end are appropri- Federal Reserve's pension adminisately stated. Further, a reconciliation of trator to ensure data accuracy and the GSA account should be performed the presence of appropriate contimely, to identify any discrepancies on trols over the exchange of census the invoices received. data among the various entities. 2. Confirm the data used by the actuary in The Office of Inspector General the pension liability calculation prior to will review the work of the group recording the entries in the general ledger. and, where appropriate, provide 3. Implement recommendations made by the comments to management on inter- OIG in their report titled "Evaluation of nal control issues. This same group Service Credit Computations." This is working to implement fully the would include performing periodic recon- recommendations provided by the ciliations of the census data between the Office of Inspector General in its Board's system and the data used by the report titled Evaluation of Service actuary; reducing or eliminating the num- Credit Computations, and manageber of data transcriptions; requiring auto- ment has directed the pension mated verifications for all census data administrator to implement approtransmissions; and updating the existing priate changes to its automated sysservice credit form to clearly document tems and supporting processes. all prior government service. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

310 92nd Annual Report, 2005 KPMGLLP 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, 2005 and 2004, 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 May 31 2006. 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 2005 financial statements are free of material misstatement, we performed tests of the Board's compliance with ceitam 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, disclosed no instances of noncompliance or other matters that are requiredt o be reported under Government Auditing Standards. This report is intended solely for die information and use of the Board and its management, the Office of Inspector General, the Government Accountability Office, and the U.S. Congress and is not intended to be and should not be used by anyone other than these specified parties. May 31,2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

311 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, 2005 and 2004. o 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, 2005 and 2004, 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, 2005 and 2004, and the combined results of their operations for the years then ended, on the basis of accounting described in Note 3. March 23, 2006 Washington, D.C. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

312 92nd Annual Report, 2005 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CONDITION December 31, 2005 and 2004 (in millions) ASSETS 2005 2004 Gold certificates $ 11,039 $ 11,041 Special drawing rights certificates 2,200 2,200 Coin 686 728 Items in process of collection 5,930 6,233 Loans to depository institutions 72 43 Securities purchased under agreements to resell 46,750 33,000 U.S. government securities, net 750,202 725,584 Investments denominated in foreign currencies 18,928 21,368 Accrued interest receivable 5,874 5,104 Bank premises and equipment, net 2,252 2,216 Other assets 3,394 3,350 Total assets $847,327 $810,867 LIABILITIES AND CAPITAL LIABILITIES Federal Reserve notes outstanding, net $758,359 $719,437 Securities sold under agreements to repurchase 30,505 30,783 Deposits Depository institutions 19,043 24,043 U.S. Treasury, general account 4,573 5,912 Other deposits 393 332 Deferred credit items 5,039 5,306 Interest on Federal Reserve notes due U.S. Treasury 1,784 329 Accrued benefit costs 913 891 Other liabilities 281 290 Total liabilities 820,890 787,323 CAPITAL Capital paid-in 13,536 11,914 Surplus 12,901 11,630 Total capital 26,437 23,544 Total liabilities and capital $847,327 $810,867 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 313 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF INCOME for the years ended December 31, 2005 and 2004 (in millions) 2005 2004 Interest income Interest on US. government securities $28,959 $22,344 Interest on investments denominated in foreign currencies 283 269 Interest on loans to depository institutions 7 3 Total interest income 29,249 22,616 Interest expense Interest expense on securities sold under agreements to repurchase 809 303 Net interest income 28,440 22,313 Other operating (loss) income Income from services 901 866 Reimbursable services to government agencies 396 370 Foreign currency (losses) gains, net (2,723) 1,230 Other income 131 89 Total other operating (loss) income (1,295) 2,555 Operating expenses Salaries and other benefits 1,709 1,604 Occupancy expense 228 222 Equipment expense 198 245 Assessments by the Board of Governors 743 776 Other expenses 747 578 Total operating expenses 3,625 3,425 Net income prior to distribution $23,520 $21,443 Distribution of net income Dividends paid to member banks $ 781 $ 582 Transferred to surplus 1,271 2,783 Payments to U.S. Treasury as interest on Federal Reserve notes 21,468 18,078 Total distribution $23,520 $21,443 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

314 92nd Annual Report, 2005 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CHANGES IN CAPITAL for the years ended December 31,2005 and 2004 (in millions) Capital Total paid-in Surplus capital Balance at January 1,2004 (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 Transferred to surplus . . . 1,271 1,271 Net change in capital stock issued (32 million shares) 1,622 1,622 Balance at December 31, 2005 (270 million shares) $13,536 $12,901 $26,437 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 Federal Reserve Bank of New York (FRBNY) and on a rotating basis four other Reserve Bank presidents. The twelve Federal Reserve Banks (Reserve Banks) are part of the Federal Reserve System (System) created by (2) OPERATIONS AND SERVICES Congress under the Federal Reserve Act of 1913 (Federal Reserve Act), which established the central bank of the The System performs a variety of services and operations. United States. The Reserve Banks are chartered by the Functions include formulating and conducting monetary federal government and possess a unique set of govern- policy; participating actively in the payments system, mental, corporate, and central bank characteristics. including large-dollar transfers of funds, automated clear- In accordance with the Federal Reserve Act, supervi- inghouse (ACH) operations, and check processing; dission and control of each Reserve Bank is exercised by a tributing coin and currency; performing fiscal agency Board of Directors. The Federal Reserve Act specifies the functions for the U.S. Treasury and certain federal agencomposition of the Board of Directors for each of the cies and other entities; serving as the federal govern- Reserve Banks. Each board is composed of nine members ment's bank; providing short-term loans to depository serving three-year terms: three directors, including those institutions; serving the consumer and the community by designated as Chairman and Deputy Chairman, are providing educational materials and information regardappointed by the Board of Governors, and six directors ing consumer laws; supervising bank holding companies, are elected by member banks. Banks that are members state member banks, and U.S. offices of foreign banking of the System include all national banks and any state- organizations; and administering other regulations of chartered banks that apply and are approved for member- the Board of Governors. The Systm also provides certain ship in the System. Member banks are divided into three services to foreign central banks, governments, and interclasses according to size. Member banks in each class national official institutions. elect one director representing member banks and one In performing fiscal agency functions for the U.S. representing the public. In any election of directors, each Treasury, seven Reserve Banks provide U.S. securities member bank receives one vote, regardless of the number direct purchase and savings bond processing services. In of shares of Reserve Bank stock it holds. March 2004, the U.S. Treasury provided an implementa- The System also consists, in part, of the Board of tion plan for consolidating the provision of these services Governors of the Federal Reserve System (Board of at two Reserve Banks. The costs for the associated restruc- Governors) and the Federal Open Market Committee turing for the affected Banks have been included in foot- (FOMC). The Board of Governors, an independent fed- note 10. eral agency, is charged by the Federal Reserve Act with a The FOMC, in the conduct of monetary policy, estabnumber of specific duties, including general supervision lishes policy regarding domestic open market operations, over the Reserve Banks. The FOMC is composed of oversees these operations, and annually issues authorizamembers of the Board of Governors, the president of the tions and directives to the FRBNY for its execution of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 315 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED transactions. The FRBNY is authorized to conduct opera- ized accounting principles and practices that it believes tions in domestic markets, including direct purchase and are appropriate for the significantly different nature and sale of U.S. government securities, the purchase of securi- function of a central bank as compared with the private ties under agreements to resell, the sale of securities sector. These accounting principles and practices are under agreements to repurchase, and the lending of U.S. documented in the Financial Accounting Manual for Fedgovernment securities. The FRBNY executes these open eral Reserve Banks {Financial Accounting Manual), market transactions and holds the resulting securities, which is issued by the Board of Governors. All Reserve with the exception of securities purchased under agree- Banks are required to adopt and apply accounting policies ments to resell, in the portfolio known as the System and practices that are consistent with the Financial Open Market Account (SOMA). Accounting Manual and the financial statements have In addition to authorizing and directing operations in been prepared in accordance with the Financial Accountthe domestic securities market, the FOMC authorizes and ing Manual. directs the FRBNY to execute operations in foreign mar- Differences exist between the accounting principles kets for major currencies in order to counter disorderly and practices in the Financial Accounting Manual and conditions in exchange markets or to meet other needs those generally accepted in the United States (GAAP) specified by the FOMC in carrying out the System's primarily due to the unique nature of the Reserve Banks' central bank responsibilities. The FRBNY is authorized powers and responsibilities as part of the nation's central by the FOMC to hold balances of, and to execute spot and bank. The primary difference is the presentation of all forward foreign exchange (F/X) and securities contracts security holdings at amortized cost, rather than using the for, nine foreign currencies and to invest such foreign fair value presentation requirements in accordance with currency holdings ensuring adequate liquidity is main- GAAP. Amortized cost more appropriately reflects the tained. The FRBNY is authorized to maintain reciprocal Reserve Banks' security holdings given their unique currency arrangements (F/X swaps) with two central responsibility to conduct monetary policy. While the banks, and "warehouse" foreign currencies for the U.S. application of current market prices to the securities hold- Treasury and Exchange Stabilization Fund (ESF) through ings may result in values substantially above or below the Reserve Banks. In connection with its foreign cur- their carrying values, these unrealized changes in value rency activities, the FRBNY may enter into contracts that would have no direct effect on the quantity of reserves contain varying degrees of off-balance-sheet market risk, available to the banking system or on the prospects for because they represent contractual commitments involv- future Reserve Bank earnings or capital. Both the domesing future settlement and counterparty credit risk. The tic and foreign components of the SOMA portfolio may FRBNY controls credit risk by obtaining credit approv- involve transactions that result in gains or losses when als, establishing transaction limits, and performing daily holdings are sold prior to maturity. Decisions regarding monitoring procedures. security and foreign currency transactions, including their Although Reserve Banks are separate legal entities, in purchase and sale, are motivated by monetary policy the interests of greater efficiency and effectiveness, they objectives rather than profit. Accordingly, market values, collaborate in the delivery of certain operations and ser- earnings, and any gains or losses resulting from the sale vices. The collaboration takes the form of centralized of such securities and currencies are incidental to the competency centers, operations sites, and product or ser- open market operations and do not motivate these activivice offices that have responsibility for the delivery of ties or policy decisions. certain services on behalf of the Reserve Banks. Various In addition, the Board of Governors and the Reserve operational and management models are used and are Banks have elected not to present a Statement of Cash supported by service agreements between the Reserve Flows because the liquidity and cash position of the Bank providing the service and the other eleven Reserve Reserve Banks are not a primary concern given their Banks. In some cases, costs incurred by a Reserve Bank unique powers and responsibilities. A Statement of Cash for services provided to other Reserve Banks are not Flows, therefore, would not provide any additional meanshared; in other cases, Reserve Banks are billed for ser- ingful information. Other information regarding the vices provided to them by another Reserve Bank. Reserve Banks' activities is provided in, or may be Beginning in 2005, the Reserve Banks adopted a new derived from, the Statements of Condition, Income, and management model for providing check services to Changes in Capital. There are no other significant differdepository institutions. Under this new model, the Federal ences between the policies outlined in the Financial Reserve Bank of Atlanta (FRBA) has the overall respon- Accounting Manual and GAAP. sibility for managing the Reserve Banks' provision of The preparation of the financial statements in conforcheck services and recognizes total System check revenue mity with the Financial Accounting Manual requires on its Statements of Income. FRBA compensates the management to make certain estimates and assumptions other eleven Banks for the costs incurred to provide that affect the reported amounts of assets and liabilicheck services. ties, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts (3) SIGNIFICANT ACCOUNTING POLICIES of income and expenses during the reporting period. Actual results could differ from those estimates. Certain Accounting principles for entities with the unique powers amounts relating to the prior year have been reclassified and responsibilities of the nation's central bank have not to conform to the current-year presentation. Unique been formulated by various accounting standard-setting accounts and significant accounting policies are explained bodies. The Board of Governors has developed special- below. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

316 92nd Annual Report, 2005 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED (A) Gold and Special Drawing Rights Certificates tization of premiums or accretion of discounts on a straight-line basis. Interest income is accrued on a The Secretary of the U.S. Treasury is authorized to issue straight-line basis. Gains and losses resulting from sales gold and special drawing rights (SDR) certificates to the of securities are determined by specific issues based on Reserve Banks. average cost. Foreign-currency-denominated assets are Payment for the gold certificates by the Reserve Banks revalued daily at current foreign currency market is made by crediting equivalent amounts in dollars into exchange rates in order to report these assets in U.S. the account established for the U.S. Treasury. These gold dollars. Realized and unrealized gains and losses on certificates held by the Reserve Banks are required to be investments denominated in foreign currencies are backed by the gold of the US. Treasury. The U.S. Trea- reported as "Foreign currency (losses) gains, net." sury may reacquire the gold certificates at any time and Activity related to U.S. government securities, includthe Reserve Banks must deliver them to the U.S. Trea- ing the related premiums, discounts, and realized and sury. At such time, the U.S. Treasury's account is charged, unrealized gains and losses, is allocated to each Reserve and the Reserve Banks' gold certificate accounts are Bank on a percentage basis derived from an annual settlelowered. The value of gold for purposes of backing the ment of interdistrict clearings that occurs in April of each gold certificates is set by law at $42% a fine troy ounce. year. The settlement equalizes Reserve Bank gold certifi- The Board of Governors allocates the gold certificates cate holdings to Federal Reserve notes outstanding in among Reserve Banks once a year based on the average each District. Activity related to investments in foreign- Federal Reserve notes outstanding in each Reserve Bank. currency-denominated assets is allocated to each Reserve Special drawing rights (SDRs) are issued by the Inter- Bank based on the ratio of each Reserve Bank's capital national Monetary Fund (Fund) to its members in propor- and surplus to aggregate capital and surplus at the precedtion to each member's quota in the Fund at the time of ing December 31. issuance. SDRs serve as a supplement to international monetary reserves and may be transferred from one (D) Securities Purchased under Agreements to Resell, national monetary authority to another. Under the law Securities Sold under Agreements to Repurchase, providing for United States participation in the SDR and Securities Lending system, the Secretary of the U.S. Treasury is authorized to issue SDR certificates, somewhat like gold certificates, The FRBNY may engage in tri-party purchases of securito the Reserve Banks. At such time, equivalent amounts ties under agreements to resell (tri-party agreements). in dollars are credited to the account established for the Tri-party agreements are conducted with two commercial U.S. Treasury, and the Reserve Banks' SDR certificate custodial banks that manage the clearing and settlement accounts are increased. The Reserve Banks are required of collateral. Collateral is held in excess of the contract to purchase SDR certificates, at the direction of the U.S. amount. Acceptable collateral under tri-party agreements Treasury, for the purpose of financing SDR acquisitions primarily includes U.S. government securities, passor for financing exchange stabilization operations. At the through mortgage securities of the Government National time SDR transactions occur, the Board of Governors Mortgage Association, Federal Home Loan Mortgage allocates SDR certificate transactions among Reserve Corporation, and Federal National Mortgage Association, Banks based upon Federal Reserve notes outstanding in STRIP securities of the U.S. government, and "stripped" each District at the end of the preceding year. There were securities of other government agencies. The tri-party no SDR transactions in 2005 or 2004. agreements are accounted for as financing transactions, with the associated interest income accrued over the life (B) Loans to Depository Institutions of the agreement. Securities sold under agreements to repurchase are All depository institutions that maintain reservable trans- accounted for as financing transactions and the associated action accounts or nonpersonal time deposits, as defined interest expense is recognized over the life of the transacin regulations issued by the Board of Governors, have tion. These transactions are carried in the Statements of borrowing privileges at the discretion of each of the Condition at their contractual amounts and the related Reserve Banks. Borrowers execute certain lending agree- accrued interest is reported as a component of "Other ments and deposit sufficient collateral before credit is liabilities." extended. Loans are evaluated for collectibility, and cur- U.S. government securities held in the SOMA are lent rently all are considered collectible and fully collateral- to U.S. government securities dealers and to banks particiized. If loans were ever deemed to be uncollectible, an pating in U.S. government securities clearing arrangeappropriate reserve would be established. Interest is ments in order to facilitate the effective functioning of the accrued using the applicable discount rate established at domestic securities market. Securities-lending transacleast every fourteen days by the Board of Directors of tions are fully collateralized by other U.S. government each of the Reserve Banks, subject to review and determi- securities and the collateral taken is in excess of the nation by the Board of Governors. market value of the securities loaned. The FRBNY charges the dealer or bank a fee for borrowing securities (C) US. Government Securities and Investments and the fees are reported as a component of "Other Denominated in Foreign Currencies income" in the Statements of Income. Activity related to U.S. government securities sold U.S. government securities and investments denominated under agreements to repurchase and securities lending in foreign currencies comprising the SOMA are recorded is allocated to each Reserve Bank on a percentage basis at cost, on a settlement-date basis, and adjusted for amor- derived from the annual settlement of interdistrict clear- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 317 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED ings. Securities purchased under agreements to resell are (G) Federal Reserve Notes allocated to the FRBNY and not to the other banks. Federal Reserve notes are the circulating currency of the (E) Foreign Currency Swaps and Warehousing United States. These notes are issued through the various Federal Reserve agents (the Chairman of the Board of F/X swap arrangements are contractual agreements Directors of each Reserve Bank) to the Reserve Banks between two parties to exchange specified currencies, at a upon deposit with such agents of certain classes of collatspecified price, on a specified date. The parties agree to eral security, typically U.S. government securities. These exchange their currencies up to a pre-arranged maximum notes are identified as issued to a specific Reserve Bank. amount and for an agreed-upon period of time (up to The Federal Reserve Act provides that the collateral twelve months), at an agreed-upon interest rate. These security tendered by the Reserve Bank to the Federal arrangements give the FOMC temporary access to the Reserve agent must be equal to the sum of the notes foreign currencies it may need to intervene to support the applied for by such Reserve Bank. dollar and give the counterparty temporary access to Assets eligible to be pledged as collateral security dollars it may need to support its own currency. Drawings include all Reserve Bank assets. The collateral value is under the F/X swap arrangements can be initiated by equal to the book value of the collateral tendered, with the either the FRBNY or the counterparty (the drawer) and exception of securities, whose collateral value is equal to must be agreed to by the drawee. The F/X swaps are the par value of the securities tendered. The par value of structured so that the party initiating the transaction bears securities pledged for securities sold under agreements to the exchange rate risk upon maturity. The FRBNY will repurchase is deducted. generally invest the foreign currency received under an The Board of Governors may, at any time, call upon a F/X swap in interest-bearing instruments. Reserve Bank for additional security to adequately collat- Warehousing is an arrangement under which the eralize the Federal Reserve notes. To satisfy the obliga- FOMC agrees to exchange, at the request of the U.S. tion to provide sufficient collateral for outstanding Fed- Treasury, U.S. dollars for foreign currencies held by the eral Reserve notes, the Reserve Banks have entered into U.S. Treasury or ESF over a limited period of time. The an agreement that provides for certain assets of the purpose of the warehousing facility is to supplement the Reserve Banks to be jointly pledged as collateral for the U.S. dollar resources of the U.S. Treasury and ESF for Federal Reserve notes of all Reserve Banks. In the event financing purchases of foreign currencies and related that this collateral is insufficient, the Federal Reserve Act international operations. provides that Federal Reserve notes become a first and Foreign currency swaps and warehousing agreements paramount lien on all the assets of the Reserve Banks. are revalued daily at current market exchange rates. Finally, as obligations of the United States, Federal Activity related to these agreements, with the exception Reserve notes are backed by the full faith and credit of of the unrealized gains and losses resulting from the daily the United States government. revaluation, is allocated to each Reserve Bank based on The "Federal Reserve notes outstanding, net" account the ratio of each Reserve Bank's capital and surplus to represents Federal Reserve notes outstanding, reduced aggregate capital and surplus at the preceding Decem- by the currency issued to the Reserve Banks but not in ber 31. Unrealized gains and losses resulting from the circulation, of $148,152 million and $128,933 million at daily revaluation are allocated to the FRBNY and not to December 31, 2005 and 2004, respectively. the other Reserve Banks. At December 31, 2005 all Federal Reserve notes outstanding were fully collateralized. All gold certificates, (F) Bank Premises, Equipment, and Software all special drawing rights certificates, and $745,120 million of domestic securities and securities purchased under Bank premises and equipment are stated at cost less agreements to resell were pledged as collateral. At accumulated depreciation. Depreciation is calculated on a December 31, 2005 no loans or investments denominated straight-line basis over estimated useful lives of assets in foreign currencies were pledged as collateral. ranging from two to fifty years. Major alterations, renovations, and improvements are capitalized at cost as addi- (H) Items in Process of Collection and tions to the asset accounts and are amortized over the Deferred Credit Items remaining useful life of the asset. Maintenance, repairs, and minor replacements are charged to operating expense The balance in the "Items in process of collection" in the year incurred. Capitalized assets, including soft- line in the Statements of Condition primarily represents ware, buildings, leasehold improvements, furniture, and amounts that are attributable to checks deposited for equipment are impaired when it is determined that the net collection by a depository institution and that, as of the realizable value is significatly less than book value and is balance sheet date, have not yet been collected from the not recoverable. payor depository institution. Deferred credit items are the Costs incurred for software, either developed internally counterpart liability to items in process of collection, and or acquired for internal use, during the application devel- the amounts in this account arise from deferring credit for opment stage are capitalized based on the cost of direct deposited items until the amounts are collected. The services and materials associated with designing, coding, balances in both accounts can fluctuate and vary signifiinstalling, or testing software. Capitalized software costs cantly from day to day. are amortized on a straight-line basis over the estimated useful lives of the software applications, which range from two to five years. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

318 92nd Annual Report, 2005 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED (I) Capital Paid-in (M) Taxes The Federal Reserve Act requires that each member bank The Reserve Banks are exempt from federal, state, and subscribe to the capital stock of the Reserve Banks in an local taxes, except for taxes on real property. Real propamount equal to 6 percent of the capital and surplus of the ery taxes were $32 million and $33 million for the years member bank. These shares are nonvoting with a par ended December 31,2005 and 2004, respectively, and are value of $100 and may not be transferred or hypoth- reported as a component of "Occupancy expense." ecated. As a member bank's capital and surplus changes, its holdings of Reserve Bank stock must be adjusted. (N) Restructuring Charges Currently, only one-half of the subscription is paid-in and the remainder is subject to call. By law, each Reserve In 2003, the System began the restructuring of several Bank is required to pay each member bank an annual operations, primarily check, cash, and U.S. Treasury serdividend of 6 percent on the paid-in capital stock. This vices. The restructuring included streamlining the mancumulative dividend is paid semiannually. A member agement and support structures, reducing staff, decreasing bank is liable for Reserve Bank liabilities up to twice the the number of processing locations, and increasing propar value of stock subscribed by it. cessing capacity in the remaining locations. These restructuring activities continued in 2004 and 2005. (J) Surplus Footnote 10 describes the restructuring and provides information about the Reserve Banks' costs and liabilities The Board of Governors requires Reserve Banks to main- associated with employee separations and contract termitain a surplus equal to the amount of capital paid-in as of nations. The costs associated with the write-down of December 31. This amount is intended to provide addi- certain Reserve Bank assets are discussed in footnote 6. tional capital and reduce the possibility that the Reserve Costs and liabilities associated with enhanced pension Banks would be required to call on member banks for benefits in connection with the restructuring activities additional capital. Pursuant to Section 16 of the Federal for all Reserve Banks are recorded on the books of the Reserve Act, Reserve Banks are required by the Board of FRBNY and those associated with enhanced post- Governors to transfer to the U.S. Treasury as interest on retirement benefits are discussed in footnote 9. Federal Reserve notes excess earnings, after providing for the costs of operations, payment of dividends, and reser- (4) U.S. GOVERNMENT SECURITIES, SECURITIES vation of an amount necessary to equate surplus with PURCHASED UNDER AGREEMENTS TO RESELL, capital paid-in. SECURITIES SOLD UNDER AGREEMENTS In the event of losses or an increase in capital paid-in at TO REPURCHASE, AND SECURITIES LENDING a Reserve Bank, payments to the U.S. Treasury are suspended and earnings are retained until the surplus is equal The FRBNY, on behalf of the Reserve Banks, holds to the capital paid-in. Weekly payments to the U.S. Trea- securities bought outright in the SOMA. sury may vary significantly. In the event of a decrease in capital paid-in, the excess Total securities held in the SOMA at December 31 surplus, after equating capital paid-in and surplus at were as follows (in millions): December 31, is distributed to U.S. Treasury in the following year. This amount is reported as "Payments to 2005 2004 U.S. Treasury as interest on Federal Reserve notes." Par value US. government (K) Income and Costs Related to US. Treasury Services Bills $271,270 $262,970 Notes 380,118 360,832 The Reserve Banks are required by the Federal Reserve Bonds 92,827 94,017 Act to serve as fiscal agents and depositories of the Total par value 744,215 717,819 United States. By statute, the Department of the Treasury is permitted, but not required, to pay for these services. Unamortized premiums 8,813 9,405 Unaccreted discounts (2,826) (1,640) (L) Assessments by the Board of Governors Total $750,202 $725,584 The Board of Governors assesses the Reserve Banks to fund its operations based on each Reserve Bank's capital The maturity distribution of U.S. government securities and surplus balances. The Board of Governors also bought outright, securities purchased under agreements to assesses each Reserve Bank for the expenses incurred resell, and securities sold under agreements to repurchase, for the U.S. Treasury to issue and retire Federal Reserve that were held in the SOMA at December 31, 2005, was notes based on each Reserve Bank's share of the number as follows (in millions): of notes comprising the System's net liability for Federal Reserve notes on December 31 of the previous year. 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 Securities Securities Maturities of investments purchased sold denominated European Japanese under under in foreign currencies euro yen Total U.S. agree- agree- s *— government ments to ments to within 15 days $ 3379 $2,617 $ 5,996 securities resell repurchase 16 days to 90 days 2,574 679 3,253 Maturities of (Par (Contract (Contract 91 fays t01 year 2,089 1,007 3,096 securities held value) amount) amount) Over 1 year to 5 years 2,855 3,712 6,567 Within 15 days ... $ 41,010 $46,750 $30,505 ^ 5 *""t0 10 ^ ''" * — * 16 days to 90 days. 172,264 ... ... Total $10,913 $8,015 $18,928 91 days to 1 year .. 186,283 ... ... Over 1 year to 5 years 210,745 At December 31, 2005 and 2004, there were no mate- Over 5 years to rial open foreign exchange contracts. 10 years 56,699 ... ... At December 31,2005 and 2004, the warehousing facil- Over 10 years 77,214 _^j__ _ L I^ ity was $5,000 million, with no balance outstanding. Total.... $744,215 $46,750 $30,505 == == ===== (6) BANK PREMISES, EQUIPMENT, AND SOFTWARE At December 31, 2005 and 2004, U.S. government A summary of bank premises and equipment at Decemsecurities with par values of $3,776 million and ber 31 is as follows (in millions): $6,609 million, respectively, were loaned from the SOMA. Remaining At December 31, 2005 and 2004, securities sold under useful agreements to repurchase with a contract amount of $30,505 million and $30,783 million, respectively, were . (g outstanding. At December 31, 2005 and 2004, securities in_yearsj ZUUD sold under agreements to repurchase with a par value of Bank premises and $30,559 million and $30,808 million, respectively, were equipment outstanding Land N/A $ 295 $ 274 Buildings 1-50 1,787 1,631 (5) INVESTMENTS DENOMINATED IN Building machinery and Po—CURRENCIES CooffiKS progress'. \ N/A 3£ 202 Furniture and equipment . 1-19 1,162 1,200 The FRBNY, on behalf of the Reserve Banks, holds — foreign currency deposits with foreign central banks and Subtotal $3,717 $3,680 the Bank for International Settlements and invests in Accumulated foreign government debt instruments. Foreign govern- depreciation (1,465) (1,464) ment debt instruments held include both securities bought outright and securities purchased under agreements to Bank premises and resell. These investments are guaranteed as to principal equipment, net . $2,252 $2*216 and interest by the foreign governments. Depreciation expense, for the Total investments denominated in foreign currencies, years ended $ 175 $ 179 including accrued interest, and valued at current foreign £ c u „ rr ency v mark . e „ t . exc . han ° g e rates at December 31, were as nB an . k premi . ses and , equ . i pmenAt aTt ^ D ecem . ber „ , 3 1 . in , c lu , de follows (in millions): ^ m^ ^o mt e \ J \^ that have been capital- 2005 2004 i*ed (in millions): European Union euro ^95 ?P51 Foreign currency deposits $ 5,424 $ 6,079 fiank ^ ^ ^ $1Q $n Se~S^re^ 1,928 2,142 Accumulated dep c7ti?n J5) J6) re a Government debt instruments .. 3,561 3,947 Capitalized leases, net $_5 $_5 Japanese yen Foreign currency deposits 2,618 1,540 Certain of the Reserve Banks lease space to outside Government debt instruments .. 5,397 7,660 tenants with initial or remaining lease terms from 1 to yotal $ jg ^28 $21 368 2^vears- Rental income from such leases was $23 million ' * and $21 million for the years ended December 31, 2005 and 2004, respectively. Future minimum lease payments The maturity distribution of investments denominated under noncancelable agreements in existence at Decemjn foreign currencies at December 31, 2005, was as ber 31, 2005, were (inmilUons): follows (m millions): Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

320 92nd Annual Report, 2005 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED 2006. $ 21 during 2005 and 2004, respectively. These commitments 2007 . 17 are for goods and services to maintain currency machines, 2008 . 16 for software licenses and maintenance, for services related 2009 . 15 to check processing equipment and transportation, and 2010 . 14 Thereafter 60 have variable and fixed components. The variable portion of the commitments is for additional services above fixed Total $143 contractual service limits. The fixed payments for the next five years under these commitments are (in millions): The Reserve Banks have capitalized software assets, net of amortization, of $162 million and $170 million at Fixed December 31, 2005 and 2004, respectively. Amortization commitment expense was $55 million and $56 million for the years 2006 $50 ended December 31, 2005 and 2004, respectively. Capi- 2007 52 talized software assets are reported as a component of 2008 38 "Other assets" and related amortization is reported as a 2009 32 component of "Other expenses." 2010 27 Several Reserve Banks have impaired assets as a result of the System's restructuring plans, as discussed in foot- The Reserve Banks are involved in certain legal actions note 10. Impaired assets include software, buildings, and claims arising in the ordinary course of business. leasehold improvements, furniture, and equipment. Asset Although it is difficult to predict the ultimate outcome of impairment losses related to the check and cash restruc- these actions, in management's opinion, based on discusturings of $50 million and $21 million for the periods sions with counsel, the aforementioned litigation and ending December 31, 2005 and 2004, respectively, were claims will be resolved without material adverse effect determined using fair values based on quoted market on the financial position or results of operations of the values or other valuation techniques and are reported as a Reserve Banks. component of "Other expenses." (8) RETIREMENT AND THRIFT PLANS (7) COMMITMENTS AND CONTINGENCIES Retirement Plans At December 31,2005, the Reserve Banks were obligated under noncancelable leases for premises and equipment The Reserve Banks currently offer three defined benefit with initital or remaining terms ranging from 1 to retirement plans to their employees, based on length of 18 years. These leases provide for increased rental pay- service and level of compensation. Substantially all of ments based upon increases in real estate taxes, operating the Reserve Banks', Board of Governors', and the Office costs, or selected price indices. of Employee Benefits of the Federal Reserve Employee Rental expense under operating leases for certain oper- Benefits System employees participate in the Retirement ating facilities, warehouses, and data processing and Plan for Employees of the Federal Reserve System (Sysoffice equipment (including taxes, insurance and mainte- tem Plan). Employees at certain compensation levels nance when included in rent), net of sublease rentals, was participate in the Benefit Equalization Retirement Plan $40 million and $70 million for the years ended Decem- (BEP) and certain Bank officers participate in the Suppleber 31, 2005 and 2004, respectively. Certain of the mental Employee Retirement Plan (SERP). Reserve Banks' leases have options to renew. The System Plan is a multi-employer plan with contri- Future minimum rental payments under noncancelable butions fully funded by participating employers. Particioperating leases, net of sublease rentals, with terms of pating employers are the Federal Reserve Banks, the one year or more, at December 31, 2005, were (in Board of Governors of the Federal Reserve System, and millions): the Office of Employee Benefits of the Federal Reserve Employee Benefits System. No separate accounting is maintained of assets contributed by the participating Operating employers. The FRBNY acts as a sponsor of the System 2006 $ 11 Plan and the costs associated with the Plan are not redis- 2007 10 tributed to other participating employers. 2008 8 Following is a reconciliation of the beginning and 2009 8 ending balances of the System Plan benefit obligation (in 2010 7 millions): Thereafter . 109 $153 At December 31, 2005, the Reserve Banks had other commitments and long-term obligations extending through the year 2017 with a remaining amount of $397 million. As of December 31, 2005, commitments of $185 million were recognized. Purchases of $144 million and $124 million were made against these commitments 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 2005 2004 Discount rates reflect yields available on high quality corporate bonds that would generate the cash flows neces- Estimated actuarial present value sary to pay the plan's benefits when due. of projected benefit Expected return on assets was based on a combination obligation at January 1 $4,524 $3,930 of methodologies including the System Plan's historical Service cost—benefits earned during the period 123 returns, surveys of what other plans' expected rates of Interest cost on projected return are, building a projected return for equities and benefit obligation 263 fixed income investments based on real interest rates, Actuarial loss 125 inflation expectations and equity risk premiums, and, Contributions by plan participants .. 3 finally, surveys of expected returns in equity and fixed Special termination benefits loss ... 6 income markets. Benefits paid (259) The components of net periodic pension benefit credit Estimated actuarial present value for the System Plan for the years ended December 31 are of projected benefit shown below (in millions): obligation at December 31 .... $4,785 $4,524 2005 2004 Following is a reconciliation showing the beginning Service cost—benefits earned and ending balance of the System Plan assets, the funded during the period $ 123 $ 116 status, and the prepaid pension benefit costs (in millions): Interest cost on projected benefit obligation 263 245 2005 2004 Amortization of prior service cost 24 24 Estimated fair value of plan Recognized net loss 49 20 assets at January 1 $5,887 $5,703 Expected return on plan assets (476) (462) Actual return on plan assets 237 428 Net periodic pension benefit credit (17) (57) Contributions by the employer • •• • • • Special termination benefits 6 20 Contributions by plan participants .. 3 3 Benefits paid (259) (247) Net periodic pension benefit credit .. $ (11) $ (37) Estimated fair value of plan assets at December 31 $5,868 $5,887 The recognition of special termination benefits is the result of enhanced retirement benefits provided to Funded status $1,083 $1,362 Unrecognized prior service cost 149 173 employees during the restructuring described in foot- Unrecognized net actuarial loss .... 1,496 1,182 note 10. Following is a summary of expected benefit payments Prepaid pension benefit costs $2,728 $2,717 excluding enhanced retirement benefits (in millions): Prepaid pension benefit costs are reported as a component of "Other assets." The accumulated benefit obligation for the System 2006 Plan was $4,162 million and $3,894 million at Decem- 2007 ber 31, 2005 and 2004, respectively. 2008 2009 The weighted-average assumptions used in developing 2010 the pension benefit obligation for the System Plan as of 2011-2015 1,498 December 31 are as follows: Total $2,737 2005 2004 The Federal Reserve System's pension plan weighted- Discount rate 5.75% 5.75% average asset allocations at December 31, by asset cate- Rate of compensation increase 4.50% 4.25% gory, are as follows: Net periodic benefit costs are actually determined using a January 1 measurement date. The weighted-average 2005 2004 assumptions used in developing net periodic benefit cost Equities 65.9% 67.5% for the System Plan for the years at January 1 are as Fixed income 32.0% 30.0% follows: Cash 2.1% 2.5% Total 100.0% 100.0% 2005 2004 Discount rate 5.75% 6.25% Expected asset return 8.25% 8.25% Rate of compensation increase 4.25% 4.00% Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

322 92nd Annual Report, 2005 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED The System's Committee on Investment Performance The Reserve Banks fund benefits payable under the (CIP) contracts with investment managers who are medical and life insurance plans as due and, accordingly, responsible for implementing the System Plan's invest- have no plan assets, ment policies. The managers' performance is measured against a trailing 36-month benchmark of 60 percent of Following is a reconciliation of beginning and ending a market value weighted index of predominantly large balances of the benefit obligation (in millions): capitalization stocks trading on the New York Stock Exchange, the American Stock Exchange, and the 2005 2004 National Association of Securities Dealers Automated Quotation National Market System and 40 percent of a Accumulated postretirement benefit broadly diversified investment-grade fixed income index (Mgatom attauary * A 'A "' (rebalanced monthly). The managers invest Plan funds &m^riod § 32 19 within CIP-established guidelines for investment in Interest cost of accumulated equities and fixed income instruments. Equity invest- benefit obligation 49 52 ments can range between 40 percent and 80 percent of the Actuarial loss 45 10 portfolio. Investments, however, cannot be concentrated Curtailment gain (2) in particular industries and equity security holdings of Special termination loss 1 any one company are limited. Fixed income securities Contributions by plan participants 11 9 must be investment grade and the effective duration of f^t!!!!!!!!!! ]!!!! ]!!! ] ] . . (112) the fixed income portfolio must remain within a range of 67 percent and 150 percent of a broadly diversi- Accumulated postretirement benefit fied investment-grade fixed income index. CIP guidelines obligation at December 31 $9*7 $869 prohibit margin, short sale, foreign exchange, and commodities trading as well as investment in bank, bank At December 31, 2005 and 2004, the weighted-average holding company, savings and loan, and government discount rate assumptions used in developing the postsecurities dealers stocks. In addition, investments in non- retirement benefit obligation were 5.50 percent and dollar denominated securities are prohibited; however, a 5.75 percent, respectively. small portion of the portfolio can be invested in American Discount rates reflect yields available on high quality Depositary Receipts/Shares and foreign-issued dollar corporate bonds that would generate the cash flows necesdenominated fixed income securities. sary to pay the plan's benefits when due. The Federal Reserve System does not expect to make a cash contribution to the System Plan during 2006. Following is a reconciliation of the beginning and ending The Reserve Banks' projected benefit obligation and balance of the plan assets, the unfunded postretirement net pension costs for the BEP and the SERP at Decem- benefit obligation, and the accrued postretirement benefit ber 31, 2005 and 2004, and for the years then ended, are costs (in millions): not material. 2005 2004 Thrift Plan Fair value of plan assets at January 1...$... $ . .. Employees of the Reserve Banks may also participate in Contributions by the employer 48 42 the defined contribution Thrift Plan for Employees of Contributions by plan participants 11 8 the Federal Reserve System (Thrift Plan). The Reserve BmStaV«id J59) J50) Banks' Thrift Plan contributions totaled $63 million for Fair value of plan assets at each of the years ended December 31, 2005 and 2004, December 31 $• • • $• - • and are reported as a component of "Salaries and other TT , , . . .. ^ , r benefits." The Reserve Banks match employee contribu- lM^ST " $947 $869 tions based on a specified formula. For the years ended Unrecognized netcurtailment: gain ........ 5 December 31,2005 and 2004, the Reserve Banks matched Unrecognized prior service cost 105 128 80 percent on the first 6 percent of employee contribu- Unrecognized net actuarial loss (277) (247) tionsf or employees with less than five years of service Accmed postretirement ^fit costs ... $775 $755 and 100 percent on the first 6 percent of employee contn- = = butions for employees with five or more years of service. Accrued postretirement benefit costs are reported as a (9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS component of "Accrued benefit costs." AND POSTEMPLOYMENT BENEFITS For measurement purposes, the assumed health care cost trend rates at December 31 are as follows: Postretirement Benefits Other Than Pensions 2005 2004 In addition to the Reserve Banks' retirement plans, Health care cost trend rate employees who have met certain age and length of ser- assumed for next year 9.00% 9.00% vice requirements are eligible for both medical benefits Rate to which the cost trend rate and life insurance coverage during retirement. is assumed to increase, (the ultimate trend rate) 5.00% 4.75% Year that the rate reaches the ultimate trend rate 2011 2011 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 Assumed health care cost trend rates have a significant the accumulated postretirement benefit obligation and net effect on the amounts reported for health care plans. A periodic postretirement benefit costs. one percentage point change in assumed health care cost trend rates would have the following effects for the year Following is a summary of expected benefit payments (in ended December 31, 2005 (in millions): millions): One percentage One percentage Without With point increase point decrease subsidy subsidy Effect on aggregate 2006 $ 54 $ 49 of service and 2007 57 52 interest cost 2008 59 53 components of 2009 62 56 net periodic 2010 64 58 postretirement 2011-2015 351 308 benefit costs $ 11 $(10) Effect on accumulated Total $647 $576 postretirement benefit obligation ... 103 (86) The following is a summary of the components of net The Reserve Banks offer benefits to former or inactive periodic postretirement benefit costs for the years ended employees. Postemployment benefit costs are actuarially December 31 (in millions): determined using a December 31, 2005, measurement date and include the cost of medical and dental insurance, 2005 2004 survivor income, and disability benefits. The accrued postemployment benefit costs recognized by the Reserve Service cost—benefits earned during Banks at December 31, 2005 and 2004, were $124 milthe period $ 32 $ 19 lion and $128 million, respectively. This cost is included Interest cost of accumulated benefit as a component of "Accrued benefit costs." Net periodic obligation 49 52 postemployment benefit costs included in 2005 and 2004 Amortization of prior service cost (21) (17) operating expenses were $14 million and $17 million, Recognized net actuarial loss 13 8 respectively, and are recorded as a component of "Sala- Total periodic expense 73 62 ries and other benefits." Curtailment gain (5) (86) Special termination loss . . . 1 10. BUSINESS RESTRUCTURING CHARGES Net periodic postretirement In 2003, several Reserve Banks announced plans for benefit costs (credit) $_68 $(23) restructuring to streamline operations and reduce costs, including consolidation of check operations and staff Net postretirement benefit costs are actuarily determined reductions in various functions of the Banks. In 2004 and using a January 1 measurement date. At January 1, 2005 2005, additional consolidation and restructuring initiaand 2004, the weighted-average discount rate assump- tives were announced in the check, cash, savings bonds, tions used to determine net periodic postretirement bene- marketing, purchasing, and Treasury operations. These fit costs were 5.75 percent and 6.25 percent, respectively. actions resulted in the following business restructuring Net periodic postretirement benefit costs are -reported charges (in millions): as a component of "Salaries and other benefits." The 2005 service cost contains an adjustment by one Total Reserve Bank that resulted from a review of plan terms estimated and assumptions. A plan amendment that modified the costs credited service period eligibility requirements created Employee separation . . $60 curtailment gains. The recognition of special termination Contract termination 1 losses is primarily the result of enhanced retirement bene- Total $61 fits provided to employees during the restructuring described in footnote 10. The Medicare Prescription Drug, Improvement and Accrued Accrued Modernization Act of 2003 established a prescription liability Total Total liability drug benefit under Medicare (Medicare Part D) and a 12/31/04 charges paid 12/31/05 federal subsidy to sponsors of retiree health care benefit Employee plans that provide benefits that are at least actuarially separation $28 $6 $(17) $17 equivalent to Medicare Part D. The benefits provided by Contract the Reserve Banks' plan to certain participants are at least termination ... 1 (1) actuarially equivalent to the Medicare Part D prescription Total $29 $6 $(18) $17 drug benefit. The estimated effects of the subsidy, retroactive to January 1, 2004, are reflected in actuarial loss in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

324 92nd Annual Report, 2005 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Adjustments due to unrecognized accrued liabilities were Restructing costs associated with the write-downs of offset against total charges. Without these offsets, total certain Reserve Bank assets, including software, buildcharges would have been $11 million in 2005. ings, leasehold improvements, furniture, and equipment Total employee separation costs are primarily sever- are discussed in footnote 6. Costs associated with ance costs related to staff reductions of approximately enhanced pension benefits for all Reserve Banks are 2,411, including 348 and 945 staff reductions related to recorded on the books of the FRBNY as discussed in restructuring announced in 2005 and 2004, respectively. footnote 8. Costs associated with enhanced postretirement These costs are reported as a component of "Salaries and benefits are disclosed in footnote 9. other benefits." Contract termination costs include the Future costs associated with the announced restructurcharges resulting from terminating existing lease and ing plans are estimed at $3 million. other contracts and are shown as a component of "Other The Reserve Banks anticipate substantially completing expenses." their announced plans in 2007. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

325 Office of Inspector General Activities The Board's Office of Inspector General abuse in Board and Board-delegated (OIG) functions in accordance with programs and operations, and in activithe Inspector General Act of 1978, as ties administered or financed by the amended. In addition to retaining an 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, inspec- ciencies and about the status of any cortions, evaluations, and investigations of rective actions. the Board's programs and operations During 2005, the OIG completed and its delegated functions at the Fed- eleven audits, reviews, and other assesseral Reserve Banks. The OIG also ments and conducted a number of reviews existing and proposed legisla- follow-up reviews to evaluate action tion and regulations for economy and taken on earlier recommendations. Some efficiency. It recommends policies, and of these projects resulted in multiple conducts and supervises activities, that reports. The OIG also closed seven promote economy and efficiency and investigations and performed numerous prevent and detect waste, fraud, and legislative and regulatory reviews. Audits, Reviews, and Assessments Completed during 2005 Report title Month issued Review of Configuration Management (Restricted Report) January Review of the Board's Workers' Compensation Program March Audit of the FFIEC's Financial Statements (Year Ended December 31, 2004) March Audit of the Board's Financial Statements (Year Ended December 31, 2004) April Audit of the Board's Fixed Asset Management Process May Review of Board's Implementation of Software Security Reviews May Review of the Bank of Ephraim Failure August Evaluation of Service Credit Computations (Internal Report) August Agreed Upon Procedures Engagement Regarding Certain Personnel-Related Controls (Internal Report) August Audit of the Supervision and Regulation Function's Efforts to Implement Requirements of the Federal Information Security Management Act September Audit of the Board's Information Security Program October Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

326 Government Accountability Office Reviews Under the Federal Banking Agency projects concerning the Federal Reserve Audit Act (Public Law 95-320), most were in various stages of completion at Federal Reserve System operations are year-end (table). The Federal Reserve under the purview of the Government also provided information to the GAO Accountability Office (GAO). In 2005, during the year on numerous other GAO the GAO completed five reports on investigations. selected aspects of Federal Reserve The reports are available directly operations (table). In addition, five from the GAO. Reports Completed during 2005 Month issued Report title Report number (2005) USA Patriot Act: Additional Guidance Could Improve Implementation of Regulations Related to Customer Identification and Information Sharing Procedures GAO-05-412 May Information Security Practices: Financial Market Organizations Have Taken Steps to Protect against Electronic Attacks, But Could Take Additional Actions GAO-05-679R June Industrial Loan Corporations: Recent Asset Growth and Commercial Interest Highlight Differences in Regulatory Authority GAO-05-621 September Financial Audit: Bureau of the Public Debt's Fiscal Years 2005 and 2004 Schedules of Federal Debt GAO-06-169 November International Remittances: Information on Products, Costs, and Consumer Disclosures GAO-06-204 November Projects Active at Year-End 2005 Subject of project Month initiated Bank Secrecy Act examinations January 2004 Sections 330 and 361of the USA Patriot Act September 2005 Diversity in the financial services sector October 2005 Lending practices associated with alternative mortgage products November 2005 Consolidated supervision of financial institutions November 2005 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

328 92nd Annual Report, 2005 The Federal Reserve System BOSTON 12 n M NEW YORK CLEVELAND PHLADELPHIA 10 ISANRIANCISCO 4 $ ST. LOUIS RICHMOND 8 ATLANTA LEGEND Both pages Facing page • Federal Reserve Bank city • Federal Reserve Branch city 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 2005. 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 329 1-A 2-B 3-C 4-D 5-E Pitts1burg/h Baltimore Buffalo mi •Cincinnati * N' NJ BOSTON NEW YORK PHILADELPHIA CLEVELAND RICHMOND 6-F 7-G 8-H •Nashville Birmingham Detroit* ATLANTA CHICAGO ST. LOUIS 9-1 •Helena m: :• MINNEAPOLIS 10-J 12-L Dem Portland KANSAS CITY 11-K Salt Lake City •Los Angeles 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

333 Index Accounting Task Force (ATF), 73 Bank holding companies—Continued Agreement corporations, examinations of, Small holding company threshold, 75 58, 59, 65-66 Surveillance and off-site monitoring of, Anti-money laundering (AML) 64-65 Bank Secrecy Act/Anti-Money Bank Holding Companies and Change in Laundering (BSA/AML) Bank Control (Regulation Y), 145-46 Examination Manual, 57-58, 70-71 Bank Holding Company Act, 58, 80-81 Examinations, 61-62 Bank Holding Company Performance Applications, notices, and proposals, Reports (BHCPRs), 64-65 80-84, 92-93 Banking Organization National Desktop Asset-backed commercial paper (ABCP) (BOND), 78 programs, 69 Banking organizations, U.S. (See also Bank Assets and liabilities holding companies and Commercial Board of Governors, 298 banks) Commercial banks, 274 Capital standards, 67-70 Federal Reserve Banks, 276-79, 312 Examinations and inspections of, 59-61 Association of Supervisors of Banks of the Foreign operations, 65, 68, 82-83 Americas (ASBA), 67 Number of, 265 ATM (automated teller machine) use, 90, Regulation of, 80-84 91 Risk-focused supervision of, 60 Auditors' reports, 297, 306-7, 310, 311 Bank Merger Act, 58, 81-82 Audits, reviews, and assessments Bank of America Corporation, acquisition, of Board of Governors, 295, 297-310, 93 325 Bank-owned life insurance, 70 of Federal Reserve Banks, 124, 295, Bankruptcy Abuse Prevention and 311-24,325 Consumer Protection Act, 38, 57, of Federal Reserve System, 295, 325, 105-6, 137-41 326 Bank Secrecy Act Advisory Group by Government Accountability Office, (BSAAG), 71 326 Bank Secrecy Act/Anti-Money Laundering by Office of Inspector General, 325 (BSA/AML) Examination Manual, Automated clearinghouse services, Federal 57_58, 70-71 Reserve Banks, 115, 290 Bank Secrecy Act (BSA), examinations, Availability of Funds and Collection of 61-62 Checks (Regulation CC), 103, 146 Basel Committee on Banking Supervision, 62, 67, 72-73 Balance sheets Basel I framework, implementation, 58, Board of Governors, 298 68-69 Federal Reserve priced services, 128 Basel II framework, implementation, 58, Bank examiner training, 78-80, 96-97 62, 68-69, 72 Bank holding companies Board of Governors (See also Federal Banks affiliated with, 265 Reserve System) Capital standards, 69 Assets and liabilities of, 298 Inspections of, 59, 60-61 Audits, reviews, and assessments of, Number of, 59 295, 297-310, 325 Rating system, 70-71 Consumer Advisory Council, 104-7, 232 Regulatory financial reports, 76-77 Decisions, public notice, 83-84 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

334 92nd Annual Report, 2005 Board of Governors—Continued Commercial paper, asset-backed, programs, Ex officio members, 256 69 Federal Advisory Council, 231 Commercial real estate (CRE), 75 FFIEC activities, 65, 74, 77, 80, 95-96 Committee of Sponsoring Organizations of Financial statements of, 297-310 the Treadway Commission (COSO), Government Performance and Results 124 Act, 133-36 Community Affairs Offices (CAOs), 107, Inspector General, Office of, audits, 109-10 Community affairs {See Consumer and reviews, and assessments, 325 community affairs) Litigation, 223-24 Community economic development, Members and officers, 227-29, 253-56 107-11 Outreach activities, 111 Community Reinvestment Act (CRA) Policy actions, 145-51 Applications, analysis in relation to, Thrift Institutions Advisory Council, 233 92-93 BOND (Banking Organization National Effectiveness of, 110 Desktop), 78 Examinations for compliance with, 92 Branches {See Federal Reserve Banks) Review of, 106 Business continuity, 62 Rules revisions, 87, 89, 91, 106 Business investment, profits, and finance, Community Reinvestment (Regulation BB), 12-15, 38-41 89, 91, 106, 147 Compliance examinations, 92, 94 Call Reports, 64, 77 Condition statements, Federal Reserve CAN-SPAM Act, 96 Banks, 276-79, 312 Capital accounts, Federal Reserve Banks, Consumer Advisory Council, 104-7, 232 276-79, 312 Consumer and community affairs Capital One Financial Corporation, Community economic development, acquisition, 93 107-11 Capital standards, 67-70, 72 Consumer Advisory Council advice, Cash flows, Board of Governors, 300 104-7 Cash management services, Federal Consumer complaints, 103-4, 105 Reserve Banks, 121 Consumer financial education, 107-11 Central Document and Text Repository Consumer protection and community (CDTR), 78 reinvestment laws, 87-103 Change in Bank Control Act, 58, 82 Outreach activities, 111 Check Clearing for the 21st Century Act Consumer complaints, 103-4, 105 (Check 21), 116-17 Consumer Credit Protection Act, 94 Check collection and processing, Federal Consumer Leasing (Regulation M), 100 Reserve Banks, 113-15, 290 Consumer price index (CPI), 22-23, 47 Citigroup, Inc., merger, 92-93 Consumer prices, 22-23, 47-48 Collection of Checks and Other Items by Consumer protection laws Federal Reserve Banks and Funds Agency reports on compliance with, Transfers through Fedwire 98-103 (Regulation J), 146 Implementation of, 87-92 Collection services for federal government, Supervision for compliance with, 92-98 Federal Reserve Banks, 121 Consumer spending, 9-10, 36-37 Combined financial statements, Federal Controlling the Assault of Non-Solicited Reserve Banks, 311-24 Pornography and Marketing Commercial banks (CAN-SPAM) Act, 96 Assets and liabilities of, 274 Core Principles for banking supervision, 72 Number of, 265 Corporate profits, 13-15, 40-41 Regulatory financial reports, 77 CPI (consumer price index), 22-23, 47 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 335 Credit, extensions to bank executive Economy, U.S.—Continued officers, 84-85 M2 monetary aggregate, 28, 50-51 Credit risk management, 74-75 Outlook and projections, 3-4, 7, 33-34, Currency and coin, operations and 35-36 developments in, 118, 290 Prices, 19-20, 22-24, 44, 47-48 Current account, U.S., 18, 43 Edge Act corporations, examinations of, 58, 59, 65-66 Debt Education, consumer financial, 107-11 Corporate, 14-15, 40-41 Electronic access to Federal Reserve Bank Domestic nonfinancial sectors, 27, 50 services, 122 Government, 16, 17, 42, 43 Electronic Federal Tax Payment System Household, 11-12, 38 (EFTPS), 121 Debt services for federal government, Electronic Fund Transfer Act (EFTA), 87, Federal Reserve Banks, 120 90-92, 105 Depository Institutions Disaster Relief Act, Electronic Fund Transfers (Regulation E), 73-74 87, 90-91, 100, 105, 145 Depository institutions (See also Emerging-market economies, 30-31, 53-54 Commercial banks) Interest rates on loans by Federal Employment, 20-21, 45-46 Reserve Banks, 263 Employment cost index (ECI), 22, 46 Reserve requirements, 264 Energy prices, 19-20, 23-24, 44, 48 Reserves of, 266-73 Enforcement actions Depository services to federal government, Federal Reserve System, 64 Federal Reserve Banks, 118-21 Other federal agencies, 98, 100-103 Deposits Equal Credit Opportunity Act (ECOA), Commercial banks, 274 94-95 Federal Reserve Banks, 267, 269, 271, Equal Credit Opportunity (Regulation B), 273 94, 98, 100 Directors, Federal Reserve Banks and Equal opportunity rules, 148 Branches, 236-52 Equity markets and prices, 26-27, 50 Disclosures by state member banks, 84 Examinations and inspections Discount rates (See also Interest rates), Anti-money laundering, 61-62 149-51 Bank holding companies, 59, 60-61 Disposable personal income (DPI), 10, 37 Community Reinvestment Act, Dollar exchange rate, 29, 51 compliance with, 92 Dollar Wi$e financial education program, Consumer protection laws, compliance 109 with, 94-96 Edge Act and agreement corporations, ECI (employment cost index), 22, 46 58, 59, 65-66 Economic Growth and Regulatory Federal Reserve Banks, 124 Paperwork Reduction Act (EGRPRA), Fiduciary activities, 62-63 75-76, 106 Economies, foreign, 28-31, 51-54 Financial holding companies, 61 Economy, U.S. Foreign banks, 66-67 Business sector, 12-15, 38-41 Information technology activities, 62 Debt, 27, 50 International banking activities, 65-67 External sector, 18-20, 43-45 Securities clearing agencies, 63 Financial markets, 5-6, 24-28, 48-51 Securities credit lenders, 63-64 Government sector, 15-17, 41-43 Securities dealers and brokers, Household sector, 9-12, 36-38 government and municipal, 63 Interest rates, 5, 24-26, 49 State member banks, 59, 60, 65 Labor market, 20-22, 45-47 Transfer agents, 63 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

336 92nd Annual Report, 2005 Examiners Federal Open Market Committee—Continued Post-employment restrictions on, 141, System Open Market Account, 154-57, 148 160-64, 171-72, 180, 188, 196, Training, 78-80, 96-97 202, 209, 216 Federal Reserve Act, 82 Expenses (See Income and expenses) Federal Reserve Banks Exports, 18, 43-44 Assessments by Board of Governors, External sector, developments in, 18-20, 284, 286, 288 43-45 Assets and liabilities of, 276-79, 312 Audits, reviews, and assessments of, Fair and Accurate Credit Transactions 124, 295, 311-24, 325 Act (FACT Act), 87, 89-90, 96 Automated clearinghouse services, 115, Fair Credit Reporting Act (FCRA), 96 290 Fair Credit Reporting (Regulation V), 90, Branches of, 234-35 146 Capital accounts, 276-79, 312 Fair Housing Act, 94-95 Chairmen, Conference of, 235 Fair lending laws, compliance with, 94-95, Credit outstanding, 266, 268, 270, 272 98,99 Deposits, 267, 269, 271, 273 Fair value option (FVO) rule, 73 Directors of, 236-52 Federal Advisory Council, members and Discount rates, 149-51 officers, 231 Electronic access to services, 122 Federal agency securities and obligations Examinations of, 124 Commercial bank holdings, 274 Examiners, post-employment restrictions Federal Reserve Bank holdings, 266, on, 141, 148 268, 270, 272 Examiner training, 78-80, 96-97 Federal Deposit Insurance Corporation FedLine Advantage, 122 Financial statements of, combined, Improvement Act, 60, 76, 138 311-24 Federal Financial Institutions Examination First Vice Presidents, Conference of, 236 Council (FFIEC), 65, 74, 77, 79, 80, Fiscal agency services, 118-21 95-96 Government depository services, 118-21 Federal funds rate, 3-4, 5-6, 33, 34-35, Income and expenses of, 124-25, 169-70, 177-79, 185-86, 194-95, 280-89 200-201, 207-8, 214-15, 221-22 Information technology developments, Federal government 122-24 Federal Reserve Bank services to, Interest rates on loans to depository 118-21 institutions, 263 Spending, receipts, and borrowing, Noncash collection service, 117, 148 15-17, 41-42 Officers and employees, number and Federal Open Market Committee (FOMC) salaries of, 291 Authorizations, 153-55, 155-56, 160-61, Officers of (list), 234-35 163-64 Operations, volume of, 290 Domestic policy directives, 155, 170, Payments to U.S. Treasury, 125, 282-83 178-79, 186, 194-95, 201, 207-8, Premises of, 126-27, 292 215, 222 Presidents, Conference of, 235 Foreign currency directives and Priced services, 113-17, 128-31 procedural instructions, 156-58, Reserve balances, 267, 269, 271, 273 162-63 Salaries of officers and employees, 291 Meetings, minutes of, 153-222 Securities and loans, holdings of, Members and officers, 230 125-26, 262, 266, 268, 270, 272 Notation votes, 170, 179, 187, 195, 201, Statements for priced services, 128-31 208, 215, 222 Statements of changes in capital, 314 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 337 Federal Reserve Banks—Continued Financial markets, 5-6, 24-28, 48-51 Statements of condition, 276-79, 312 Financial statements Statements of income, 313 Board of Governors, 297-310 Federal Reserve Electronic Tax Application Federal Reserve Banks, combined, (FR-ETA), 121 311-24 Federal Reserve System (See also Board of Federal Reserve priced services, 128-31 Governors and Federal Reserve First American Bank, merger, 92-93 Banks), 67 First Community Capital Corporation, Audits, reviews, and assessments of, acquisition, 93 295, 325, 326 Fiscal agency services, Federal Reserve Banking structure, U.S., regulation of, Banks, 118-21 80-84 Float, 117, 266, 268, 270, 272 Basel Committee activities, 62, 67, Flood insurance, 95 72-73 FOMC (See Federal Open Market Consumer protection responsibilities, Committee) 87-96 Foreign banks, U.S. activities of, 66-67 Decisions, public notice of, 83-84 Foreign currency operations Enforcement actions, 64 Authorization for conduct of, 155-56, Hurricanes, response to, 57, 73-74, 107, 160-61 122-23 Directives, 156-57, 162 Maps of, 328-29 Procedural instructions for, 157-58, Membership, 85 162-63 Safety and soundness responsibilities, Foreign economies, 28-31, 51-54 58-67 Foreign operations of U.S. banking Supervisory information technology, organizations, 65, 68, 82-83 77-78 Foreign trade, 18-20, 43^4 Supervisory policy, 67-77 Surveillance and off-site monitoring, GDP (gross domestic product), 7, 9, 16, 64-65 35-36, 41-42 Technical assistance, 67 Gold stock, 266, 268, 270, 272 Training and staff development, 78-80, Government 96-97 Federal, spending, receipts, and Federal sector, developments in, 15-17, borrowing, 15-17, 41-42 41^2 Federal Reserve Bank services to, Federal tax payments, 121 118-21 FedLine Advantage, 122 State and local, spending, receipts, and Fedwire Funds Service, 115 borrowing, 17, 42^3 Fedwire Securities Service, 116-17 Government Accountability Office (GAO), FFEEC (Federal Financial Institutions 326 Examination Council), 65, 74, 77, 79, Government National Mortgage 80, 95-96 Association (GNMA), 77 Fiduciary activities, supervision of, 62-63 Government Performance and Results Act Finance (GPRA), 133-36 Business, 13-15, 40-41 Government securities dealers and brokers, Household, 11-12, 38 examination of, 63 Financial account, U.S., 20, 44-45 Gramm-Leach-Bliley Act, 58, 61, 81, Financial Crimes Enforcement Network 106-7 (FinCEN), 57, 70-71 Financial education, consumer, 107-11 Hibernia Bancorporation, acquisition, 93 Financial holding companies, 61 Home equity lending (See also Household Financial Institutions Supervisory Act, 223 sector), 74 Financial intermediation, 27, 50 Homeland Investment Act, 20 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

338 92nd Annual Report, 2005 Home Mortgage Disclosure Act (HMDA), Labor market, 20-22, 45-47 87, 91, 93, 95, 97-99, 106-7, 110-11 Large complex banking organizations Home Mortgage Disclosure (Regulation C), (LCBOs), supervision of, 60 91, 95, 106 Legislation, federal, 137-41 Home Ownership and Equity Protection Liabilities (See Assets and liabilities) Act (HOEPA), 87, 91 Life insurance, bank-owned, 70 Household sector, developments in, 9-12, Litigation involving Board of Governors 36-38 Artis, 224 Housing and Urban Development, Barnes, 223 Department of, complaint referrals, Bazy, 223 104 Diehl McCarthy, 223 Hurricane damage and response, 57, 73-74, Fakolujo, 223-24 107, 122-23, Fraternal Order of Police, 224 Inner City Press/Community on the Imports, 18-19, 43-44 Move, 223 Income and expenses Jones, 224 Board of Governors, 299 Federal Reserve Banks, 124-25, 280-89 Price, 223 Federal Reserve priced services, 129 Sciba, 224 Industrial economies, 29-30, 52-53 Texas State Bank, 224 Inflation, 3-4, 7, 9, 22-24, 33-35, 47-48 Thomas, 223 Information security standards, 148-49 Ulrich, 223 Information technology Loans Developments in, 122-24 Federal Reserve Bank holdings, 125-26, Federal Reserve examination of, 62 266, 268, 270, 272 Supervisory, 77-78 Insured commercial bank holdings, 274 Inspections (See Examinations and State member banks to executive inspections) officers, 84-85 Inspector General, Office of (OIG), 325 Local governments, 17, 42-43 Insured commercial banks (See Commercial banks) Maps, Federal Reserve System, 328-29 Interest rates (See also Discount rates and Margin requirements, 275 Federal funds rate), 5, 24-26, 49, 263 MBNA Corporation, acquisition, 93 International Accounting Standards Board Medical information, 89-90, 146-47 (IASB), 67, 73 Member banks (See also State member International Banking Act, 58, 83 banks) International banking activities, supervision Assets and liabilities, 274 of, 65-67, 68, 72-73 Examination of foreign operations, 65 International Organization of Securities Number of, 265 Commissioners (IOSCO), 69, 72 Reserves, 271, 273 International trade, 18-20, 43-44 Members and officers Investment Board of Governors, 227-29, 253-56 Business sector, 12-13, 38-40 Consumer Advisory Council, 232 Overseas, by U.S. banking organizations, 82-83 Federal Advisory Council, 231 Residential, 10-11, 37-38 Federal Open Market Committee, 230 Federal Reserve Banks and Branches, Jobs and Growth Tax Relief 234-35 Reconciliation Act (JGTRRA), Thrift Institutions Advisory Council, 233 15-16, 41 Membership of State Banking Institutions Joint Forum, 72-73 in the Federal Reserve System Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 339 Middle East and North Africa (MENA) Performance Report Information and Financial Regulators' Training Surveillance Monitoring (PRISM), 65 Initiative, 67 Policy actions Monetary aggregate (M2), 28, 50-51 Board of Governors, 145-51 Monetary Policy Reports to the Congress Federal Open Market Committee, February 2006, 3-31 153-222 July 2005, 33-54 Premises, Federal Reserve Banks and Monetary policy {See also Federal Open Branches, 126-27, 292 Market Committee), 3-6, 33-35 Priced services, Federal Reserve Banks, Money-laundering prevention, 61-62, 113-17, 128-31 Prices 70-71 Consumer, 22-23, 47-48 Mortgage interest rates, 11, 37-38 Energy, 19-20, 23-24, 44, 48 Mortgage products, nontraditional, 74-75, Equity, 26-27, 50 107 Primary credit rate, 149 Municipal securities dealers and brokers, PRISM (Performance Report Information examination of, 63 and Surveillance Monitoring), 65 MyMoney.gov, 108 Privacy of Consumer Financial Information (Regulation P), 100-101 National Examination Database (NED), Private-sector adjustment factor (PSAF), 78 113 National Rood Insurance Act, 95 Productivity, 21-22, 46-47 National Information Center (NIC), 78 Profits, corporate, 13-15, 40-41 National Settlement Service, 115-16 Public Company Accounting Oversight Noncash collection service, Federal Board (PCAOB), 76 Reserve Banks, 117, 148 Public notice, Federal Reserve decisions, Nonmember banks, assets and liabilities, 83-84 274 Notes, Federal Reserve {See also Currency Qualified financial contracts (QFCs), and coin), 276-79 137-39 Quantitative Impact Study (QIS-4), 62, 68 Obtaining and Using Medical Quantitative risk management, 62 Information in Connection with Credit (Regulation FF), 90, 146-47 Real estate appraisals, 74 Office of Foreign Assets Control (OFAC), Regulations 70-71 B, Equal Credit Opportunity, 94, 98, 100 Office of Inspector General (OIG), 325 C, Home Mortgage Disclosure, 91, 95, Officers {See Members and officers) 106 Oil prices {See Energy prices) D, Reserve Requirements of Depository Open market operations Institutions, 145 Authorization for conduct of, 153-55, E, Electronic Fund Transfers, 87, 90-91, 100, 105, 145 163-64 H, Membership of State Banking Volume of transactions, 258-61 Institutions in the Federal Reserve Overdraft-protection services, 75, 88-89, System, 145 148 J, Collection of Checks and Other Items by Federal Reserve Banks and Pay.gov, 121 Funds Transfers through Fedwire, Payments services, Federal Reserve Banks, 146 120-21 M, Consumer Leasing, 100 Payroll card accounts, 91, 105 P, Privacy of Consumer Financial PCE (personal consumption expenditures), Information, 100-101 10,36 V, Fair Credit Reporting, 90, 146 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

340 92nd Annual Report, 2005 Regulations—Continued State and local governments, 17, 42-43 Y, Bank Holding Companies and Change State member banks (See also Member in Bank Control, 145-46 banks) Z, Truth in Lending, 91, 101-2, 105-7 Complaints against, 103-4, 105 AA, Unfair or Deceptive Acts or Examinations of, 59, 60, 65 Practices, 102-3 Extensions of credit to executive BB, Community Reinvestment, 89, 91, officers, 84-85 106, 147 Financial disclosures, 84 CC, Availability of Funds and Collection Number of, 59, 265 of Checks, 103, 146 Surveillance and off-site monitoring of, DD, Truth in Savings, 88-89, 103, 64-65 147-48 Stocks FF, Obtaining and Using Medical Margin requirements, 275 Information in Connection with Price indexes, 26, 50 Credit, 90, 146-47 Supervision and regulation responsibilities, Reports of Condition and Income (Call Federal Reserve System, 57-85, 92-96 Reports), 64, 77 Supervisory information technology (SIT), Repurchase agreements, Federal Reserve 77-78 Banks, 266, 268, 270, 272 Surveillance and off-site monitoring, 64-65 Reserve requirements, depository Swaps, 137, 155, 157-58 institutions, 264 System Open Market Account (SOMA) Reserve Requirements of Depository (See Federal Open Market Committee Institutions (Regulation D), 145 and Open market operations) Residential investment, 10-11, 37-38 System to Estimate Examination Ratings Revenue (See Income and expenses) (SEER), 64 Reverse repurchase agreements, Federal Reserve Banks, 267, 269 Tax collection, electronic, 121 Riegle Community Development and Technical assistance to foreign banking Regulatory Improvement Act, 60 authorities, 67 Risk-focused supervision, Federal Reserve Thrift Institutions Advisory Council, 233 System, 60, 68-69 Trade, international, 18-20, 43-44 Risk management, 62, 72, 74-75 Training and development, Federal Reserve staff, 78-80, 96-97 Salaries, Federal Reserve Bank officers Transfer agents, examination of, 63 and employees, 291 Treasury, U.S. Department of the (See also Sarbanes-Oxley Act (SOX), 76 Treasury securities) Savings bonds, 119 Cash holdings, 267, 269, 271, 273 Secondary and seasonal credit rates, 149 Currency outstanding and in circulation, Securities credit, 63-64, 84 266-73 Securities (See also Treasury securities) Payments processed for, 120-21 Clearing agencies, examination of, 63 Payments to, by Federal Reserve Banks, Credit lenders, examination of, 63-64 125, 282-83 Government and municipal, examination Treasury Direct, 120 of dealers and brokers, 63 Treasury securities SEER (System to Estimate Examination Commercial bank holdings, 274 Ratings), 64 Federal Reserve Bank holdings, 125-26, Small bank holding company threshold, 75 262, 266, 268, 270, 272 Special drawing rights certificate account, Interest rates on, 25-26, 49 266, 268, 270, 272 Open market transactions, 258-59 Staff development, Federal Reserve, 78-80, Repurchase and reverse repurchase Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 341 Treasury Tax and Loan (TT&L) program, Unemployment, 7, 20-21, 45-46 121 Unfair or Deceptive Acts or Practices Truth in Lending Act (TILA), 105-7, 140 (Regulation AA), 102-3 Truth in Lending (Regulation Z), 91, 101-2, 105-7 Wells Fargo & Co., acquisition, 93 Truth in Savings (Regulation DD), 88-89, West Texas intermediate (WTI) prices, 19, 103, 147-48 44 0606 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis