Annual Report of the Federal Reserve Board, 2006

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

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

Letter of Transmitted Board of Governors of the Federal Reserve System Washington, D.C. June 2007 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-third annual report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 2006. 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 ety of System functions, including oper- Reserve System has numerous, varied ating a nationwide payments system; responsibilities: distributing the nation's currency and coin; under authority delegated by the • conducting the nation's monetary pol- Board of Governors, supervising and icy by influencing monetary and credit regulating bank holding companies and conditions in the economy state-chartered banks that are members • supervising and regulating banking inof the System; serving as fiscal agents stitutions, to ensure the safety and of the U.S. Treasury; and providing a soundness of the nation's banking and variety of financial services for the Treafinancial system and to protect the sury, other government agencies, and credit rights of consumers other fiscal principals. • maintaining the stability of the finan- A major component of the Federal cial system and containing systemic Reserve System is the Federal Open risk that may arise in financial markets Market Committee (FOMC), which is • providing financial services to deposimade 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 presi- The Federal Reserve is a federal sys- dents of four other Federal Reserve tem composed of a central, governmen- Banks, who serve on a rotating basis. tal agency—the Board of Governors— The FOMC establishes monetary policy and twelve regional Federal Reserve and oversees open market operations, Banks. The Board of Governors, located the Federal Reserve's main tool for inin Washington, D.C., is made up of fluencing overall monetary and credit seven members appointed by the Presi- conditions. The FOMC sets the federal dent of the United States and supported funds rate, but the Board has sole auby a staff of about 1,850. In addition thority over changes in reserve requireto conducting research, analysis, and ments and must approve any change in policymaking related to domestic and the discount rate initiated by a Reserve international financial and economic Bank. matters, the Board plays a major role Two other groups play roles in the in the supervision and regulation of the functioning of the Federal Reserve: de- U.S. banking system and administers pository institutions, through which most of the nation's laws regarding con- monetary policy operates, and advisory sumer credit protection. It also has broad councils, which make recommendations oversight responsibility for the nation's to the Board and the Reserve Banks payments system and the operations and regarding System responsibilities. activities of the Federal Reserve Banks. All federally chartered banks are, by The Federal Reserve Banks, which law, members of the Federal Reserve combine public and private elements, System. State-chartered banks may beare the operating arms of the central come members if they meet Board banking system. They carry out a vari- requirements. • 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 2006 and Early 2007 6 Economic Projections for 2007 and 2008 9 ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2006 AND EARLY 2007 10 The Household Sector 13 The Business Sector 17 The Government Sector 20 The External Sector 22 The Labor Market 24 Prices 26 U.S. Financial Markets 30 International Developments 35 MONETARY POLICY REPORT OF JULY 2006 35 Monetary Policy and the Economic Outlook 39 Economic and Financial Developments in 2006 Federal Reserve Operations 63 BANKING SUPERVISION AND REGULATION 63 Scope of Responsibilities for Supervision and Regulation 64 Supervision for Safety and Soundness 73 Supervisory Policy 83 Supervisory Information Technology 84 Staff Development 84 Regulation of the U.S. Banking Structure 88 Enforcement of Other Laws and Regulations 89 Federal Reserve Membership 91 CONSUMER AND COMMUNITY AFFAIRS 91 Implementation of Statutes Designed to Inform and Protect Consumers 96 Supervision for Compliance with Consumer Protection and Community Reinvestment Laws 107 Consumer Complaints 109 Advice from the Consumer Advisory Council 111 Consumer Education and Research 113 Promotion of Community Economic Development and Access to Financial Services in Historically Underserved Markets Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

119 FEDERAL RESERVE BANKS 119 Developments in Federal Reserve Priced Services 123 Developments in Currency and Coin 124 Developments in Fiscal Agency and Government Depository Services 126 Electronic Access to Reserve Bank Services 127 Information Technology 127 Examinations of the Federal Reserve Banks 128 Income and Expenses 129 Holdings of Securities and Loans 129 Volume of Operations 129 Federal Reserve Bank Premises 131 Pro Forma Financial Statements for Federal Reserve Priced Services 135 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE AND RESULTS ACT 135 Strategic Plan, Performance Plan, and Performance Report 135 Mission 135 Goals and Objectives 139 FEDERAL LEGISLATIVE DEVELOPMENTS 139 Financial Services Regulatory Relief Act of 2006 146 Unlawful Internet Gambling Enforcement Act of 2006 147 Military Personnel Financial Services Protection Act 148 Financial Netting Improvements Act of 2006 Records 151 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS 151 Regulation D (Reserve Requirements of Depository Institutions) 151 Regulation E (Electronic Fund Transfers) 152 Regulation H (Membership of State Banking Institutions in the Federal Reserve System) and Regulation Y (Bank Holding Companies and Change in Bank Control) 152 Regulation K (International Banking Operations) 152 Regulation O (Loans to Executive Officers, Directors, and Principal Shareholders of Member Banks) 152 Regulation Y (Bank Holding Companies and Change in Bank Control) 153 Regulation BB (Community Reinvestment) 153 Rules Regarding Equal Opportunity 153 Policy Statements and Other Actions 155 Discount Rates in 2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

157 MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS 157 Authorization for Domestic Open Market Operations 159 Domestic Policy Directive 159 Authorization for Foreign Currency Operations 160 Foreign Currency Directive 161 Procedural Instructions with Respect to Foreign Currency Operations 161 Meeting Held on January 31, 2006 173 Meeting Held on March 27-28, 2006 181 Meeting Held on May 10, 2006 189 Meeting Held on June 28-29, 2006 197 Meeting Held on August 8, 2006 204 Meeting Held on September 20, 2006 211 Meeting Held on October 24-25, 2006 220 Meeting Held on December 12, 2006 229 LITIGATION Federal Reserve System Organization 233 BOARD OF GOVERNORS 236 FEDERAL OPEN MARKET COMMITTEE 237 ADVISORY COUNCILS TO THE BOARD OF GOVERNORS 237 Federal Advisory Council 238 Consumer Advisory Council 239 Thrift Institutions Advisory Council 240 FEDERAL RESERVE BANKS AND BRANCHES 240 Officers of the Banks and Branches 241 Conference of Chairmen 241 Conference of Presidents 242 Conference of First Vice Presidents 242 Directors of the Banks and Branches 259 MEMBERS OF THE BOARD OF GOVERNORS, 1913-2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 264 1. Federal Reserve Open Market Transactions, 2006 268 2. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2004-2006 269 3. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2006 270 4. Reserve Requirements of Depository Institutions, December 31, 2006 271 5. Banking Offices and Banks Affiliated with Bank Holding Companies in the United States, December 31, 2005 and 2006 272 6. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items A. Year-End 1984-2006 and Month-End 2006 B. Year-End 1918-1983 280 7. Principal Assets and Liabilities of Insured Commercial Banks, by Class of Bank, June 30, 2006 and 2005 281 8. Initial Margin Requirements under Regulations T, U, and X 282 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2006 and 2005 286 10. Income and Expenses of the Federal Reserve Banks, by Bank, 2006 290 11. Income and Expenses of the Federal Reserve Banks, 1914-2006 296 12. Operations in Principal Departments of the Federal Reserve Banks, 2003-2006 297 13. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2006 298 14. Acquisition Costs and Net Book Value of the Premises of the Federal Reserve Banks and Branches, December 31, 2006 Federal Reserve System Audits 301 AUDITS OF THE FEDERAL RESERVE SYSTEM 303 BOARD OF GOVERNORS FINANCIAL STATEMENTS 321 FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS 337 OFFICE OF INSPECTOR GENERAL ACTIVITIES 338 GOVERNMENT ACCOUNTABILITY OFFICE REVIEWS 340 MAPS OF THE FEDERAL RESERVE SYSTEM 345 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 turned in another Total consumer price inflation desolid performance in 2006, although the clined in 2006 from its elevated pace in pattern of growth was uneven. After 2005, as energy prices fell, on net, after rebounding in the early part of the year rising rapidly over the preceding couple from hurricane-related disruptions in the of years. Crude oil prices rose during autumn of 2005, the pace of expansion the first half of 2006 but turned down during the remaining three quarters sharply later in the year. As a result, averaged somewhat below that of the consumer price inflation climbed in the preceding two years, responding in part first half of the year before slowing in to the removal of monetary policy ac- the second half. The sharp movements commodation since 2004. The housing in prices of crude oil appear to have market cooled substantially, and, in the affected not only prices of gasoline and latter part of 2006, the production of other petroleum-based types of energy light motor vehicles also stepped down. but also prices of a broader range of Elsewhere in the economy, activity goods and services that use petroleumremained strong. Consumer spending based inputs. Partly as a result, conincreased vigorously in 2006 as house- sumer price inflation excluding food and holds' real income made strong gains. energy—so-called core consumer price Business investment rose at a solid rate inflation—moved up during the first half for the year as a whole, although it of the year but eased subsequently. On decelerated late in the year in part be- balance, core inflation was a bit higher cause of some softening in purchases of over the four quarters of 2006 than in equipment related to construction and 2005. Measures of long-term inflation motor vehicle manufacturing. Demand expectations, however, remained well for U.S. exports rose at a robust pace in anchored. 2006, supported by strong economic ac- The monetary policy decisions of the tivity abroad. Against this backdrop, Federal Open Market Committee businesses continued to add jobs at a (FOMC) in 2006 were intended to foster steady rate, and the unemployment rate sustainable economic expansion and to decreased further. promote a return to low and stable inflation. In that regard, the economic outlook for this year and next appears favorable. Although the contraction in NOTE: The discussion here and in the next chapter consists of the text, tables, and selected homebuilding has been a drag on charts from the Monetary Policy Report submitted growth, that restraint seems likely to to the Congress on February 14, 2007, pursuant to diminish over 2007. Further gains in section 2B of the Federal Reserve Act; the comreal wages as well as ongoing increases plete set of charts is available on the Board's web site, at www.federalreserve.gov/boarddocs/hh. in employment should support a solid Other materials in this annual report related to rise in consumer spending. In addition, the conduct of monetary policy include the min- at the beginning of 2007, households' utes of the 2006 meetings of the Federal Open balance sheets appeared to be in good Market Committee (see the "Records" section) shape. Whereas gains in home prices and statistical tables 1-4 (at the back of this report). slowed last year, household net worth Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

4 93rd Annual Report, 2006 increased moderately as stock market margins rather than by passing on the wealth grew and households lessened costs in the form of higher consumer their accumulation of debt. Delinquency prices, especially if pressures on rerates on consumer loans and on most sources ease modestly as anticipated. types of mortgages remained low, The outlook for real economic activalthough they increased markedly for ity is uncertain. An upside risk is that subprime mortgages with variable inter- consumer spending, which has been est rates. As for businesses, balance especially buoyant in recent months, sheets are quite liquid, credit quality is may continue to expand at a pace that good, and most firms enjoy ready access would ultimately lead to an escalation to funds. These favorable financial con- of pressures on resources and prices. ditions, along with further expansion in Alternatively, prospects for residential business output, user costs of capital construction, which are difficult to equipment that remain attractive, and assess, may pose some downside risks. the potential for further gains in effi- Although residential real estate markets ciency, should continue to spur business have shown some recent signs of investment. In addition, sustained stabilizing, homebuilders' inventories of expansion in foreign economies ought unsold homes remain elevated. Further to maintain demand for U.S. exports. On cutbacks in construction to reduce balance, growth of real gross domestic inventories toward more-comfortable product in the United States appears levels could become steeper and more likely to run slightly below that of the persistent than currently anticipated. economy's potential over the next few Moreover, if home values were to quarters and then to rise to a pace depreciate sharply, the resulting erosion around that of the economy's long-run of household wealth could impose trend. appreciable restraint on consumer Regarding inflation, increases in core spending. consumer prices are expected to moder- Whether inflation will moderate ate, on balance, over the next two years. gradually as expected is also uncertain. Along with inflation expectations that On the one hand, the nation's potential are well anchored, some of the factors to produce could increase more rapidly that boosted inflation in recent years than anticipated, or product and input seem likely to lessen. In particular, the markets could work efficiently at higher paths for prices of energy and other rates of utilization, either of which could commodities embedded in futures mar- lead to a lower trajectory for inflation kets suggest that the impetus to core than currently forecast. On the other inflation from these influences will di- hand, expanding global demand and minish further. In addition, the outsized threats to supply from actual and potenincreases in shelter costs that boosted tial disruptions pose upside risks for core inflation last year are not expected energy prices. In addition, brisk world to persist. Although unit labor costs in demand for non-energy materials and the nonfarm business sector have been commodities could lead to further rising, the average markup of prices upward pressures on business costs. over such costs is high by historical Also, if inflation were to persist around standards. The relatively high markup the elevated average level of the past suggests that further increases in costs three years, longer-run inflation expectacould be absorbed, at least to some tions could deteriorate, particularly if extent, by a narrowing of firms' profit pressures on resources were to intensify. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook At recent meetings, the FOMC indicated business investment, appeared to be that the risk that inflation will fail to growing at a solid rate. By the time of moderate as expected is its predominant the May and June meetings, data policy concern. pointed to a moderation in the growth of consumer spending and a further cooling in the housing market. However, Monetary Policy, Financial core consumer prices had risen more Markets, and the Economy rapidly. Although the Committee judged in 2006 and Early 2007 inflation expectations still to be con- The FOMC firmed the stance of mone- tained, it was mindful that the rising tary policy 25 basis points at each of its prices of energy and other commodities four meetings over the first half of could impart greater inflationary 2006. The Committee raised its target momentum. Against this backdrop, the for the federal funds rate at its January FOMC voted to increase the policy rate and March meetings as available infor- a further 25 basis points at both the May mation pointed to accumulating pres- and June meetings, bringing the federal sures on inflation and solid economic funds rate to 5lA percent. In the stategrowth. Although readings on core ment accompanying its June decision, inflation had remained favorable, the FOMC indicated that it believed that increases in energy prices and the rela- the moderation in economic activity tively high level of resource utilization would help to limit inflationary presthreatened to add to existing inflation sures over time but also noted that some pressures. Meanwhile, underlying ag- upside inflation risks remained. As it gregate demand, supported by robust had in its May statement, the FOMC consumer spending and accelerating made clear in June that the extent and Selected Interest Rates, 2004-07 i i i i j i 1/28 5/4 8/10 11/10 2/2 5/3 8/9 11/1 1/31 5/10 8/8 10/25 1/31 3/16 6/30 9/21 12/14 3/22 6/30 9/20 12/13 3/28 6/29 9/20 12/12 ) 2004 2005 2006 2007 NOTE: The data are daily and extend through February 7, 2007. The ten-year Treasury rate is the constantmaturity 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

93rd Annual Report, 2006 timing of additional finning would meetings, incoming data on inflation and depend on the evolution of the outlook economic activity were generally more for both inflation and economic growth favorable. Core inflation receded further as implied by incoming information. from the elevated levels reached in early In the second half of the year, a fur- 2006, and some indicators suggested ther slowdown in residential construc- that the demand for housing might be tion activity and a contraction in motor stabilizing. Business investment had vehicle production created a significant softened in the fourth quarter, and indusdrag on economic activity. However, trial production decelerated sharply in consumer spending held up, and em- the fall, but consumer spending posted ployment rose at a solid pace. Mean- robust gains in the final months of 2006. while, energy prices reversed much of At its January 2007 meeting, the Comtheir increases of the first half of the mittee again decided to leave its target year, sending headline inflation lower. for the federal funds rate unchanged, Core inflation also eased somewhat, al- reiterated concern about inflation risks, beit to a rate above its year-earlier level. and again cited the role of incoming Against this backdrop, the FOMC left data in determining the extent and timthe stance of policy unchanged at its ing of any additional firming. final four meetings of 2006. Committee In recent years, the FOMC has discussions in those meetings focused in worked to improve the transparency of part on developments in the housing its decisionmaking process, and the market and their implications for the Committee continues to examine broader economy. Although the housing whether further changes would improve market was weakening throughout this its communications with the public. In period, the Committee judged that the spring 2006, the Chairman appointed a downturn had not spilled over signifi- subcommittee to help the FOMC cantly to consumer spending. The econ- organize the discussion of a broad range omy was expected to expand over com- of communication issues. The FOMC ing quarters at a rate close to or a little began its consideration of these issues below its long-run sustainable pace. At at its August meeting and has discussed the same time, FOMC members noted them at several meetings since then. that, even though core inflation had slowed from the very rapid rates of the Economic Projections spring and summer, current rates refor 2007 and 2008 mained undesirably high. Most members expected core inflation to moderate In conjunction with the FOMC meeting gradually, but they were uncertain about in January, the members of the Board of the likely pace and extent of that mod- Governors and the Federal Reserve eration. Thus, in statements accompany- Bank presidents, all of whom participate ing each rate announcement over this in the deliberations of the FOMC, properiod, the FOMC reiterated that infla- vided economic projections for 2007 tion risks remained and that the extent and 2008. The projections indicate that and timing of any additional policy firm- the participants expect sustainable ing would depend on the outlook for expansion of real economic activity durboth inflation and economic growth im- ing the next two years, assuming an plied by incoming information. appropriate course for monetary policy. Over the period between the Decem- The central tendency of the FOMC parber 2006 and January 2007 FOMC ticipants' forecasts for the increase in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook real GDP is 2V2 percent to 3 percent services should rise at a solid pace, in over the four quarters of 2007 and part as a result of ongoing gains in real 23/4 percent to 3 percent over the four wages and employment and of generally quarters of 2008. The central tendency strong household balance sheets. Busiof their forecasts for the civilian unem- ness outlays for new equipment and ployment rate is AVi percent to 43/4 per- software are expected to increase at a cent in the fourth quarter both of this rate consistent with a moderate expanyear and of 2008. For inflation, the cen- sion in business output and to be suptral tendency of the forecasts anticipates ported by continuing declines in the user an increase in the price index for per- cost of high-technology capital equipsonal consumption expenditures exclud- ment and by favorable financial condiing food and energy—the so-called core tions. In addition, the solid expansion of PCE price index—of 2 percent to economic activity abroad should main- 2V4 percent over the four quarters of tain the rising demand for U.S. exports 2007 and l3/4 percent to 2 percent over of goods and services. the four quarters of 2008. Decreased pressures from the costs of The economy is projected to expand energy and other commodities, in an at a moderate rate. Although the cooling environment of moderate economic of the housing market continues to damp expansion and well-anchored longer-run economic activity, the drag on economic inflation expectations, are expected to growth from declining construction ac- contribute to further easing in inflation. tivity is expected to diminish later this In addition, increases in productivity year. Household spending for goods and should help to limit cost pressures. • Economic Projections of Federal Reserve Governors and Reserve Bank Presidents for 2007 and 2008 Percent 2007 2008 Indicator MEMO: 2006 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 5 3 . . 9 4 4 2 3 1 / /4 4 - - 3 5 1 1 / / 4 2 2V 5 2 - - 5 3 V 2 2 4 1 3 / / 2 4 - - 3 5 l 1 A /2 V 23 A /4 - - 5 3 V* PCE price index excluding food and energy 2.3 2-2V4 2-2V4 VA-IVA l3/4-2 Average level, fourth quarter Civilian unemployment rate 4.5 41/2-43/4 4V6-43/4 4V2-5 41/2-43/4 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 2006 and Early 2007 The especially brisk pace of economic considerably over much of the year. activity in early 2006 primarily reflected Financial market conditions were genera rebound after hurricane-related disrup- ally supportive of economic expansion tions in the autumn of 2005. During the in 2006. Equity markets recorded sizrest of the year, however, economic ac- able gains, and long-term interest rates tivity slowed to a pace somewhat below rose only modestly from historically low the average rate of recent years. Real levels. Risk spreads on corporate bonds GDP is reported to have increased at an remained narrow or declined further. average annual rate of 23A percent over Overall economic conditions were such the final three quarters of 2006, down that businesses maintained a steady pace from the average 3V4 percent pace in of hiring, and the unemployment rate 2004 and 2005. The slowdown princi- moved down further. pally was the result of the contraction in Consumer price inflation, as mearesidential construction, which intensi- sured by the rise in the PCE price index, fied later in the year, and the marked moved down in the second half of 2006 decline in production of light motor after having stepped up in the first half. vehicles in the second half of the year as Energy prices, which rose during the manufacturers took steps to trim deal- first half and turned sharply downward ers' inventories. In other sectors of the later in the year, played an important economy, consumer spending remained role in shaping the contour of total strong as employment and income made consumer price inflation. In addition, further solid gains, and business outlays core PCE price inflation eased modestly for new structures and equipment rose over the second half of 2006. Appar- Change in Real GDP, 2000-06 Change in PCE Chain-Type Price Index, 2000-06 Percent, annual rate — 5 • Total — II Excluding food and energy — 4 2000 2002 2004 2006 2000 2002 2004 2006 NOTE: Here and in subsequent figures, except as noted, change for a given period is measured to its final NOTE: The data are for personal consumption quarter from the final quarter of the preceding period. expenditures (PCE). SOURCE: Department of Commerce, Bureau of Eco- SOURCE: Department of Commerce, Bureau of Economic Analysis. nomic Analysis. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

10 93rd Annual Report, 2006 ently influenced by incoming data on Household spending for new motor inflation and economic activity, mea- vehicles slowed in 2006; sales of sures of long-term inflation expecta- 16.5 million new light vehicles (cars, tions rose early in the year but ended sport-utility vehicles, and pickup trucks) the year slightly lower than at the begin- were below the average of nearly ning. Nonetheless, core PCE price infla- 17 million sold in the preceding two tion for the year as a whole—at years. Moreover, households' apparent 2VA percent—was a bit higher than in concerns about elevated gasoline prices, the preceding year, which perhaps re- particularly early in the year, shifted the flected in part the high level of resource composition of light vehicle sales utilization. toward more fuel-efficient autos and away from light trucks and SUVs. The The Household Sector shift helped boost the share of total sales captured by foreign producers Consumer Spending because they tend to offer more fuelefficient vehicles. The rapid increase in consumer spending in 2006 was supported by rising Real PCE for goods other than motor employment, gains in real income, vehicles rose 43A percent over the four increases in household wealth, and quarters of 2006, about in line with the favorable financial conditions. Over the brisk average pace in the preceding two four quarters of 2006, real PCE rose years. Households increased their 33/4 percent—faster than in 2005 and at spending for a broad range of consumer roughly the same rate as in 2004. The goods, though the rise was particularly rise in consumer outlays was particu- strong for electronic equipment and larly robust in the first quarter of 2006 other durables. Real spending on gasobut then moderated in the middle of the line remained about constant in the first year, when households' gains in real half of the year but increased in the secincome slowed and consumer sentiment ond half as prices fell. Consumer spendsoftened. Consumer spending rose ing for services maintained a moderate briskly again in the fourth quarter of the pace of growth; expenditures in this year as gains in real income picked up category rose 23A percent in 2006, about and consumer confidence improved. the same average pace as in 2004 and 2005. In 2006, real household income was Change in Real Income and Consumption, 2000-06 boosted by gains in wage and salary income and the increased purchasing Percent, annual rate power resulting from the deceleration in overall consumer prices. Labor income • Disposable personal income received by households rose both be- || Personal consumption *• expenditures cause of gains in real hourly wages and because of sustained increases in em- — 4 ployment. However, the pickup in real after-tax income was damped because — 2 tax payments made by households LJL M increased at a rate greater than that for 2000 2002 2004 2006 income. The acceleration in tax payments likely reflected, at least in part, SOURCE: Department of Commerce, Bureau of Economic Analysis. several factors: tax payments on larger Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 11 capital gains realizations, which are up further in early 2007 to near the excluded from income in the national upper end of its range since 2003. income and product accounts (NIPA); gains in real income that moved some Residential Investment households into higher tax brackets; and possibly a further shift in the distribu- The deterioration of conditions in the tion of income toward high-income housing market played a significant role households that typically face higher tax in restraining the pace of economic rates. All told, real after-tax income rose expansion in 2006. The demand for new 3 percent over the four quarters of 2006, and existing homes began to weaken in up from the negligible gain posted in the middle of 2005, and the subsequent 2005 but a little below the average rate decline steepened through the first half of 2006. As a result, the inventory of of increase in 2003 and 2004. unsold new homes relative to sales rose The rise in after-tax income in 2006 sharply. Apparently prompted by lower was outpaced by increases in household demand and excessive inventories, spending. As a result, the personal savhomebuilders began to cut back on the ing rate declined further in 2006 and pace of new construction near the beginaveraged negative 1 percent for the year ning of 2006, and the decline in activity as a whole. Households apparently were continued throughout the year. Later in inclined to increase their spending furthe year, however, some indicators were ther above their disposable income, at hinting that the demand for housing was least in part, because their wealth constarting to stabilize. tinued to rise. The ratio of household net By the middle of 2006, sales of both worth to income, which has been trendnew and existing homes had fallen draing higher since 2003, inched up further matically to a pace that was about in 2006. Although increases in the value 15 percent below that of a year earlier. of homes slowed significantly, the value Concurrently, inventories of unsold of corporate equities held by households homes relative to sales rose considerboth indirectly—such as in mutual funds ably above the level that had prevailed and retirement accounts—and directly during the period of robust housing deappreciated considerably. mand from the late 1990s into 2005. By Consumer sentiment deteriorated in the third quarter of 2006, the backlog of the first half of 2006, according to the unsold new homes had reached Reuters/University of Michigan Surveys 63/4 months' supply, and the stock of of Consumers (Reuters/Michigan). In existing homes for sale had risen to the spring, consumer confidence had about 7 months' supply—both well moved to its lowest level for the year, above the average of about 4Vi months' probably in part because energy prices supply of new and existing homes in had surged. The subsequent decline in 2005. By the end of 2006, however, energy prices, along with the rise in the there were tentative signs that the destock market and reductions in the un- mand for homes was stabilizing. The employment rate, boosted consumer decline in sales of new and existing confidence in the second half of the homes appeared to bottom out in the year. On net, the Reuters/Michigan in- summer, and sales were roughly condex of consumer sentiment was a shade stant over the later part of the year. In higher at the end of 2006 than at the the fourth quarter, builders' inventories beginning of the year; sentiment moved of unsold new homes were reported to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

12 93rd Annual Report, 2006 have edged down a bit from their third- first half of 2006, but the drag intensiquarter level, while the stock of existing fied to subtract about \lA percentage homes for sale remained about the same points from the annual rate of increase as in the third quarter. Despite these in real GDP in the second half. For 2006 developments, the extent of any im- as a whole, the contraction in real resiprovement in the inventories of unsold dential investment lowered the annual homes is obscured by the failure of these rate of growth in real GDP 3A percentfigures to account for recorded sales of age point after having added l/i percentnew homes that are subsequently age point, on average, to the rate from canceled. 2003 through 2005. The drag on new residential construc- The rate of house-price appreciation tion in 2006 imposed by the contraction slowed substantially in 2006 after sevin home sales and the buildup of inven- eral years of very rapid gains. The tories was significant. Both the number repeat-transactions index of home prices of permits issued for new single-family published by the Office of Federal Houshomes and the number of home starts ing Enterprise Oversight (OFHEO) dropped sharply. As of the fourth quar- increased at an annual rate of only ter of 2006, new single-family homes 1 Vi percent in the third quarter of 2006, were started at an annual rate of down substantially from average gains 1.23 million units, almost 30 percent of about 10 percent in 2004 and 2005. below the average pace in 2005; permits The OFHEO index attempts to control were down by a similar amount. In con- for the quality of existing single-family trast to the marked slackening in con- homes sold by using prices of homes struction of new single-family homes, involved in repeat transactions. The the rate of starts of new multifamily increase in the OFHEO house-price inhomes in 2006, at 337,000 units, was dex over the four quarters ending in the about the same as in the preceding sev- third quarter of 2006 (a calculation that eral years. smoothes through some of the quarterly Housing activity, as measured by real volatility in the data) was 6 percent, the expenditures on residential structures in smallest four-quarter increase since the the NIPA, trimmed lA percentage point late 1990s. The average price of existing from the rate of real GDP growth in the single-family homes sold, which is published by the National Association of Private Housing Starts, 1993-2006 Realtors (NAR) and does not control for the types of homes sold, declined about Millions of units, annual rate 2 percent over the four quarters of 2006, compared with average gains of roughly 1.6 9 percent in 2004 and 2005. The out- S. gie-family right decline in the NAR index of home — 1.2 prices relative to the deceleration in the constant-quality OFHEO home-price in- .8 dex suggests that the composition of Multifamily A existing homes sold shifted toward 1 Ml ! 1 1 I 1 till Mil lower-priced homes. 1994 1998 2002 2006 The cost of mortgage financing NOTE: The data are quarterly and extend through increased in the first half of 2006, but 2006:Q4. rates decreased in the second half. The SOURCE: Department of Commerce, Bureau of the average rate for a thirty-year fixed-rate Census. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 13 mortgage was 6V4 percent at the end of remained low. Household bankruptcy 2006, about the same as at the beginning filings during 2006 ran at a pace well of the year. The average for a one-year below the average of the preceding sevadjustable-rate mortgage declined also eral years. Bankruptcies likely were in the second half and stood at 5J/2 per- damped in 2006 by the decisions of cent at the end of 2006, about lA per- some households to file before the centage point above the level at the start implementation of more-stringent bankof the year. According to respondents to ruptcy requirements in October 2005. the Reuters/Michigan survey, relatively However, even allowing for such an low mortgage rates and the perception effect, the recent pace is low relative to that purchase prices were more favor- pre-reform norms. able improved their assessment of homebuying conditions in the second The Business Sector half of 2006. Fixed Investment Household Finance Total real business fixed investment rose 63/4 percent over the four quarters of Household sector debt is estimated to 2006, up from a 5Vi percent increase in have slowed from the robust \\3A per- 2005 and about the same pace as in cent increase posted in 2005 to a still- 2004. In general, the fundamentals supvigorous 8V4 percent in 2006. The decelporting business capital spending eration reflected a drop in the pace of mortgage debt growth from about 14 percent in 2005 to less than 9 percent Change in Real Business Fixed Investment, in 2006. Despite the reduction in mort- 2000-06 gage borrowing, home equity lending remained active, and the gross volume Percent, annual rate of cash-out refinancing exceeded 2005 • Structures levels. Meanwhile, consumer debt — Hi Equipment and software — 20 expanded only moderately in 2006. — 10 Although household indebtedness w • J J increased less rapidly in 2006 than in o 2005, it still outpaced the growth of — 10 disposable personal income. In addition, the rise in interest rates contributed to 1 i i \\ t i I i I higher debt service payments, and the • High-tech equipment household financial obligations ratio and software 40 continued its upward trend of the past H Other equipment excluding decade to reach a record high. Evidence transportation — 20 to date suggests that most households fl _ fi n- HtHin have been able to meet their debt service obligations, although there are indications of growing strains among some 1 I I I I 1 I I I 1 borrowers. Delinquency rates on sub- 2000 2002 2004 2006 prime residential mortgages with vari- NOTE: High-tech equipment consists of computers able interest rates have increased mark- and peripheral equipment and communications equipedly; still, delinquency rates on other ment. SOURCE: Department of Commerce, Bureau of Ecomortgages and consumer loans have nomic Analysis. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

14 93rd Annual Report, 2006 remained favorable in 2006: The strong Real business investment in transporrise in profits continued to help firms tation equipment—typically a volatile maintain substantial liquid assets, user category of investment—was about uncosts for equipment declined further, and changed on net in 2006. For motor vehiinterest rates and credit spreads re- cles, business spending increased less mained relatively low. Although the than 1 percent over the year. Purchases pace of real business outlays for equip- of light vehicles weakened, partly bement and software slowed somewhat in cause of cutbacks in sales to rental com- 2006, investment in nonresidential struc- panies. In contrast, business outlays for tures rose H3/4 percent. Capital spend- medium and heavy trucks accelerated in ing was quite robust during most of the 2006, reportedly in anticipation of new year, adding about 1 percentage point to emissions regulations by the Environthe annual rate of increase in real GDP mental Protection Agency that went into effect at the beginning of 2007. New over the first three quarters, but it decelorders for medium and heavy trucks erated sharply in the fourth quarter. The reached new highs early in 2006, and deceleration reflected, in part, a slowing production and sales remained strong in spending for business structures from through the end of the year. Outlays for its brisk pace earlier in the year, a drop new aircraft were brisk in early 2006, in outlays for transportation equipment, but they were depressed over the reand some weakness in purchases of mainder of the year; all told, aircraft equipment related to construction and investment declined more than 15 permotor vehicle manufacturing. cent for the year as a whole. Real investment in high-technology Real investment in equipment other equipment rose 9 percent in 2006, about than high-tech and transportation the same average annual pace as in the goods—a broad category that represents preceding two years. Further decreases about half of total nominal business in the prices of high-technology equipspending for equipment and software— ment continued to reduce the user cost rose at an average annual rate of 5lA perof this type of equipment. Real business cent during the first three quarters of spending for computing equipment 2006. However, spending for these capiincreased 14V2 percent, and software tal goods softened in the final quarter of spending posted an 8 percent gain, both the year. Although the declines in the roughly comparable to their average fourth quarter were generally broad rates of increase in the previous two based, they were led by decreases in years. Business outlays for communica- spending for equipment related to contions equipment rose almost 7 percent in struction and motor vehicle manufactur- 2006. Spending for communications ing. However, the backlog of orders for equipment was particularly robust in the capital goods such as industrial machinearly part of the year and was likely ery and other types of heavy equipment boosted in part by spending to replace remained substantial at the end of 2006, equipment damaged by the hurricanes in and it should sustain production and the autumn of 2005. Investment in com- shipments of these items in early 2007. munications equipment last year contin- Real outlays for nonresidential conued to be supported by demand from struction increased H3/4 percent in 2006 telecommunications service providers after having been little changed since that were expanding their broadband 2003. However, the rise in business connetworks. struction spending slowed near the end Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 15 of 2006 from its rapid pace earlier in the sired level of stocks. The book value of year; outlays increased at an annual rate manufacturing and trade inventories of only about 3 percent in the fourth (excluding motor vehicles) rose relative quarter. For 2006 as a whole, sizable to sales from September through gains were posted for office, retail, and November. The increases were particuindustrial buildings. In addition, outlays larly noticeable for firms that supply the for drilling and mining structures associ- construction and motor vehicle sectors, ated with energy exploration were although increases were apparent in a strong. At the end of 2006, forward- few other sectors as well. Survey data looking indicators for nonresidential also suggested that inventories for some construction activity appeared to be businesses were viewed as too high. favorable: Vacancy rates for buildings However, manufacturers outside of the in both the office and industrial sectors, motor vehicles sector appear to be makwhich peaked a few years ago, contin- ing relatively prompt adjustments to ued to drift down, and the vacancy rate their production, which to date seem to for retail buildings remained at the low be limiting the extent of undesired level that has prevailed since 2000. stockbuilding. Inventory Investment Corporate Profits and Business Finance In the first half of 2006, dealer stocks of motor vehicles rose noticeably as sales Profits of nonfinancial corporations slowed, particularly for light trucks. The extended their upward move, pushing increase in the prices of gasoline earlier the ratio of before-tax profits to income in the year appeared to have reduced in this sector to nearly 14 percent, the consumers' demand for light trucks and highest level reached since 1969. In the SUVs, which tend to be less fuel effi- third quarter, operating earnings per cient. Dealers' inventories of these vehi- share for S&P 500 firms came in 20 percles reached an elevated 90 days' supply cent above levels of a year earlier. About at the end of the second quarter. As a two-thirds of firms in the S&P 500 have result, motor vehicle manufacturers reported earnings for the fourth quarter. scaled back the production of light Current market estimates of earnings per trucks over the second half of 2006, share for S&P 500 firms call for roughly which helped to reduce dealers' inven- 10 percent growth in the fourth quarter tories during that period. Nonetheless, at over year-earlier levels. Earnings growth the end of 2006, inventories of light was widespread across sectors in 2006 but vehicles still appeared to be above de- was particularly strong for financial firms. sired levels. Manufacturers cut produc- Firms' capital expenditures exceeded tion further in January of this year, help- internal funds raised in 2006, an indicaing them make additional progress in tion that businesses funded investments reducing the stock overhang. not only with current cash flow but also Excluding motor vehicles, inventories with external funds and liquid assets. held by businesses in the manufacturing Borrowing by nonfinancial firms picked and trade sectors appeared generally to up in 2006 in association with increased be well aligned with sales in the first real investment as well as with extenhalf of 2006. However, later in the year, sive retirements of equity, which a variety of indicators suggested that resulted from record share repurchases some businesses accumulated an unde- and heavy merger and acquisition activ- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

16 93 rd Annual Report, 2006 Financing Gap and Net Equity Retirement and commercial and industrial lending at Nonfinancial Corporations, 1991-2006 by banks was rapid as well. The Federal Reserve's Senior Loan Officer Opinion Billions of dollars Survey on Bank Lending Practices revealed that a significant net fraction of Net equity retirement — 600 respondents to that survey eased credit — 400 standards and terms on commercial and industrial loans during 2006. Bankers — 200 indicated that they were responding to more-aggressive competition and Financing gap — 200 greater liquidity in the secondary market 1 i i 1 1 1 1 1 1 I 1 for such loans. Loan officers also re- 1991 1994 1997 2000 2003 2006 ported that a contributing factor was an NOTE: The data are annual; the observations for 2006 increased tolerance for risk. are based on partially estimated data. The financing gap The expansion of commercial mortis the difference between capital expenditures and internally generated funds, adjusted for inventory gage debt in 2006 remained rapid by valuation. Net equity retirement is the difference historical standards but fell off from the between equity retired through share repurchases, domestic cash-financed mergers, or foreign takeovers of swift pace of 2005. The deceleration U.S. firms and equity issued by domestic companies in likely reflected the rise in mortgage public or private markets. Equity issuance includes rates and a net tightening of credit stanfunds invested by private equity partnerships and stock option proceeds. dards for these loans—an explanation SOURCE: Federal Reserve Board, flow of funds data. consistent with responses to the loan officer survey. ity. Net bond issuance proceeded at a Gross public issuance of equity by faster clip than in the past several years. nonfinancial corporations in 2006 Similarly, commercial paper issuance roughly maintained the moderate pace was the strongest it had been since 2000, of the past couple of years, and private equity issuance appears to have risen a Selected Components of Net Financing bit to finance buyouts and other restrucfor Nonfinancial Corporate Businesses, turings. Still, net equity issuance turned 2003-06 more negative as equity retirements from cash-financed mergers and acquisi- Billions of dollars, annual rate tions and share repurchases increased considerably. • Commercial paper — 800 H Bonds On balance, despite increased borrow- H Bank loans — 600 ing and net equity retirements, the Su c m om o p f o s n e e le n c t t s ed — 400 strength of corporate earnings growth — 200 has left the credit quality of nonfinancial + firms solid. Balance sheet liquidity 0 remains high, and corporate leverage is near historical lows. In addition, net 2003 2004 2005 2006 interest payments relative to cash flow NOTE: The data for the components excluding bonds remained near the low end of the range are seasonally adjusted. The data for the sum of selected seen over the past two decades. The components are quarterly. The data for 2006:Q4 are six-month trailing bond default rate fell estimated. SOURCE: Federal Reserve Board; Securities Data during the first half of the year as de Company; and Federal Financial Institutions Exami- faults by some large firms in th nation Council, Consolidated Reports of Condition and troubled airline and automobile sectoi Income (Call Report). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 17 in late 2005 dropped out of the series, fied deficit in fiscal 2007 will be smaller and it was near zero throughout the as a percentage of nominal GDP than it second half of 2006. Delinquency rates was in fiscal 2006. Although the unified on business loans remained quite low. deficit has improved recently, the federal budget will face the mounting pressures of providing Social Security and The Government Sector health benefits to a rapidly growing Federal Government number of beneficiaries as the babyboom generation ages in coming years. The deficit in the federal unified budget In fiscal 2006, nominal federal renarrowed further during the past year. ceipts rose H3/4 percent and were The unified budget recorded a deficit of equivalent to almost I8V2 percent of $248 billion in fiscal year 2006— nominal GDP, substantially higher than $70 billion smaller than in the previous their recent fiscal year low of \6lA perfiscal year. The federal deficit in fiscal cent of GDP in 2004. Income tax re- 2006 was a bit less than 2 percent of ceipts from individuals outpaced the rise nominal GDP, significantly lower than in taxable personal income (as measured its recent fiscal year peak of more than in the NIPA), while surging corporate 3Vi percent of GDP in 2004. In fiscal tax payments about matched the robust 2006, outlays rose about in line with growth in profits. As noted above, the nominal GDP, but receipts increased at a increase in individual income tax liabilifaster pace. From October through ties relative to taxable income in the December—the first quarter of fiscal NIPA appears to have reflected, at least 2007—the federal deficit was almost in part, taxes on larger capital gains $40 billion less than in the same period realizations (which are excluded from a year earlier, as the rise in receipts NIPA income), the effect of some taxcontinued to outpace the growth in outpayers moving into higher tax brackets lays. The latest projections from the as their real incomes increased, and pos- Congressional Budget Office and the sibly a further shift in the distribution of Administration anticipate that the uniincome toward high-income households that typically face higher tax rates. In the first quarter of fiscal 2007, revenues Federal Receipts and Expenditures, were more than 8 percent greater than in 1986-2006 the same period a year earlier, as both Percent of nominal GDP individual and corporate tax payments continued to rise briskly. 24 Nominal federal outlays increased Expenditures xRVeceipts — 22 about IV2 percent in fiscal 2006 and Expenditures*^ were about 20VA percent of nominal 20 V ex. net interest GDP, well above their most recent fiscal A 18 year low of less than I8V2 percent of — s ' V-/ _ 16 GDP in 2000. Net interest payments n 111 1 1 1 1 1 I 1 1i i i i i i i i Mill increased 23 percent in fiscal 2006, as 1986 1990 1994 1998 2002 2006 interest rates rose and federal debt continued to grow. Outlays for Medicare NOTE: The receipts and expenditures data are on a unified-budget basis and are for fiscal years (October increased 10V2 percent, reflecting in part through September); GDP is for the four quarters ending new benefits payments associated with inQ3. SOURCE: Office of Management and Budget. the Part D prescription drug program, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

18 93rd Annual Report, 2006 which started in January 2006. At the governments has increased in recent same time, outlays for Medicaid years, the improvement has been offset declined a bit, to some extent because of by declines in the personal saving rate. a shift of some Medicaid payments to Total national saving, net of deprecia- Medicare Part D. Spending for disaster tion, was 2 percent of nominal GDP in relief and national flood insurance was the third quarter of 2006. The recent almost $28 billion greater in fiscal 2006 national saving rate is an improvement than in the previous fiscal year, prima- from the lows of a few years ago, but it rily owing to the federal government's has been insufficient to avoid an increasresponse to the hurricanes in the autumn ing reliance on borrowing from abroad of 2005. Outlays for defense in fiscal to finance the nation's capital spending. 2006 slowed to their lowest rate of increase since fiscal 2001, although the Federal Borrowing rise was still about 6 percent. In the first quarter of fiscal 2007, total federal out- The Treasury responded to the reduction lays were only 1 percent greater than in the federal deficit in 2006 by paying those in the same period a year earlier; down Treasury bills over the course of in this period, defense spending was the year and by trimming the gross issu- 12 percent above its year-earlier level, ance of marketable Treasury coupon sebut outlays related to disaster relief and curities. As of the third quarter of 2006, flood insurance were markedly lower the quantity of federal debt held by the than they were a year earlier. public as a percentage of nominal GDP As measured in the NIPA, real federal had declined about Vi percentage point, expenditures on consumption and gross to about 36 percent. investment—the part of federal spend- Early in the first quarter of 2006, ing that is a direct component of real federal debt subject to the statutory limit GDP—increased 2Vi percent over the reached the then-current ceiling of four quarters of calendar year 2006 and $8.2 trillion. The Treasury employed contributed about lA percentage point to various methods to avoid breaching the the growth rate of real GDP in that year. The increase was the result of a pickup Federal Government Debt Held in real defense purchases, which rose by the Public, 1960-2006 more than 4 percent during calendar 2006 after two years of smaller Percent of nominal GDP increases. At the same time, real nondefense purchases declined more than 55 1 percent after having risen, on average, about 2 percent per year over the preced- — 45 ing two years. — 35 The reduction in the unified deficit in the past two years implies that the fed- — 25 eral government required less national I iiininiHiHinmininiuininimmmiinin I saving to finance its operations. How- 1966 1976 1986 1996 2006 ever, nonfederal saving, which excludes NOTE: The final observation is for 2006:Q3. For borrowing by the federal government previous years, the data for debt are as of year-end, and from total net national saving, remained the corresponding values for GDP are for Q4 at an annual rate. Excludes securities held as investments of relatively low. Although the saving rate federal government accounts. for private business and state and local 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 2006 and Early 2007 19 limit until the Congress increased it to previous two years. The sustained nearly $9 trillion in March. As of the strength in total revenues, along with the end of December, the total amount of efforts of states and localities to restrain federal debt subject to the limit was spending for health care, has enabled $8.6 trillion. these jurisdictions to step up spending In February, the Treasury auctioned on other programs and still rebuild their thirty-year bonds for the first time since reserve funds. As measured in the NIPA, 2001. The offering was apparently well net saving by state and local governreceived, as was the reopening of the ments excluding social insurance issue in August. The Treasury an- funds—a measure that is broadly similar nounced in August that it would issue to the surplus in an operating budget— thirty-year bonds on a quarterly basis was almost $4 billion during the first beginning in 2007. three quarters of 2006. States and locali- The acquisition of Treasury debt by ties generally have seen improvement in foreigners slowed further in 2006 from their fiscal positions recently, but in its peak in 2004. However, outstanding coming years most governments will Treasury debt also grew more slowly, have to face the budget pressures of leaving the share of outstanding debt providing pension and health benefits to held by foreign investors little changed, an expanding number of retired employon balance, from its average level over ees, and the states' costs for Medicaid the preceding two years. According to are expected to rise substantially as the Treasury data on international capital baby-boom generation ages. flows, foreigners (official and other) Real expenditures by state and local purchased considerably fewer U.S. Trea- governments on consumption and gross sury coupon securities in 2006 than in investment, the component of these gov- 2005. The average proportion of nomi- ernments' spending that enters directly nal coupon securities purchased by for- into the calculation of real GDP, rose eign and international investors at auc- 3 percent over the four quarters of 2006. tions in 2006 about matched the average That increase was the largest since 2001 from the previous year at 16 percent, but and contributed about lA percentage it was down noticeably from an average point to the change in real GDP during level of 25 percent in 2004. the year. Real expenditures for investment rose 43/4 percent, largely because of a strong increase in real construction State and Local Government spending in the first half of the year. The fiscal positions of state and local Spending for current consumption in governments improved further in 2006. real terms increased 2Vi percent over Apart from federal grants-in-aid, rev- the four quarters of 2006. Hiring by enues rose at an annual rate of 7 percent state and local governments stepped up over the first three quarters of 2006 after last year. Of the cumulative increase in posting relatively strong gains in the employment of 254,000 in 2006, about preceding two years. Receipts from two-thirds of the jobs were in education. taxes on retail sales and on individual and corporate incomes continued to rise State and Local Government at a brisk pace; however, decreasing Borrowing gains in house prices slowed the rise in property tax revenues in the third quar- Borrowing by state and local governter of 2006 from the rapid pace in the ments dropped below its rapid 2005 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

20 93rd Annual Report, 2006 pace amid improved fiscal positions and fewer advance refunding issues. Nonetheless, bond issuance for new capital expenditures, particularly for education and transportation, boosted long-term borrowing. Credit quality in the state and local sector rose substantially in 2006, as the number of credit-rating upgrades far exceeded the small number of downgrades. The External Sector The U.S. current account deficit averaged $875 billion at an annual rate, or about 6V2 percent of nominal GDP, in the first three quarters of 2006 (the latest available data). The deficit was wider than in 2005, partly because of a larger deficit on trade of goods and services. In addition, net investment income, which turned negative in the fourth quarter of 2005, remained negative in the first three quarters of last year, further expanding the current account deficit. International Trade After widening through most of 2005, the nominal trade deficit leveled out in U.S. Trade and Current Account Balances, 1999-2006 Percent of nominal GDP — Trade Current account 1 1 II 2000 2002 MM the first half of 2006, rose to a record high in August, and then narrowed noticeably through November (the latest available data). On average, the nominal trade deficit was wider in 2006 than in the previous year. Nominal imports of goods grew more slowly than exports did early last year and, after reaching late-summer peaks, dropped because of declines in both the price and volume of imported oil. Meanwhile, imports of services decelerated sharply in the second half of last year. In contrast, nominal exports of goods and services pushed upward steadily throughout the year and grew significantly faster than did nominal imports. Given that the level of exports was smaller than the level of imports, the faster export growth during 2006 was not enough to narrow the nominal trade deficit. Although the nominal trade deficit last year (through November, annualized) was wider in dollar terms, the trade deficit as a share of GDP, at just under 6 percent, was about the same as in 2005. Real exports of goods and services grew a robust 9lA percent last year. In the first quarter, growth was boosted by a catch-up of exports affected by hurricane damage in late 2005. Throughout the year, exports were supported by strong foreign economic activity. Real exports of goods rose IOV4 percent last year, a little faster than in the previous year. Export growth was spread fairly 0 I evenly across all major end-use catego- 2 ries, though exports of computers and 3 semiconductors expanded noticeably A more slowly than in 2005. By destina- 5 tion, exports to China and other emerg- 6 ing Asian economies grew very rapidly, 7 i i i i i as did those to South America. Exports 2004 2006 to Mexico and western Europe rose at a NOTE: The data are quarterly. For the trade account, more modest pace. Real exports of serthe observation for 2006:Q4 is estimated. The data for vices were up a solid 63/4 percent for the the current account extend through 2006:Q3. SOURCE: Department of Commerce. year, double the pace of 2005. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 21 Prices of exported goods rose at a countries, low levels of inventories for 3V2 percent rate last year, a little faster some metals, and perhaps increased than their pace in 2005. Reflecting the speculative demand. Prices for nickel effects of very large jumps in prices of and zinc continued to move up throughindustrial supplies, particularly fuels and out the year. In the second half of the metals, export prices moved up sharply year, aluminum prices trended sideways, in the second and third quarters; they and copper prices moved down from decelerated toward the end of the year their peaks as inventory and supply conas prices of exported fuels retreated ditions improved somewhat. For most of from their high levels and as prices of these metals, those price trends have exported metals moved up more slowly. continued this year. An exception is Real imports of goods and services zinc, the price of which has plummeted. rose 3 percent last year, more slowly The spot price of West Texas intermethan in the previous year. As with the diate crude oil averaged $66 per barrel growth in real exports, real import in 2006, nearly $10 per barrel higher growth got off to a quick start last year than in 2005; moreover, crude oil prices amid robust domestic growth. But im- were especially volatile last year. The port growth slowed, on average, in the spot price climbed from around $61 per middle quarters of the year, along with barrel at the end of 2005 to a peak of U.S. real GDP growth, and real imports $77 per barrel in August as violence in fell in the fourth quarter as a result of a the Middle East, a shutdown of the sharp drop in oil and natural gas im- Prudhoe Bay oil field in Alaska, and ports. Despite some fourth-quarter forecasts of an active hurricane season declines, for the year imports increased led to increased demand. In the event, in every major end-use category except oil supply was affected far less than petroleum and natural gas. Imports of anticipated by these factors, and oil services rose more than 5 percent last prices declined over the next few year, a step-up from the previous year's months as demand dropped and elevated sluggish pace. Prices of imported non-oil goods increased less than 1 percent, on bal- Prices of Oil and of NonfuelCommodities, ance, in 2006 despite some wide gyra- 2003-07 tions. After falling in the first quarter, prices reversed course, surged upward, January 2003 = 100 Dollars per barrel and then cooled in the fourth quarter. 220 — 80 Oil The quarterly pattern was driven by 200 — movements in nonfuel commodity 180 — /v prices, which soared in the second and 160 — r* -50 140 — — 40 third quarters before leveling off in the 120 -W — 30 fourth quarter. 100 *—S Nonfuel — 20 Metals figured prominently among 80 — commodities —• 10 the nonfuel commodities that boosted 1 1 1 1 1 1 1 2003 2004 2005 2006 2007 trade prices last year. Prices for a variety of metals—including copper, aluminum, NOTE: The data are monthly and extend through January 2007. The oil price is the spot price of West nickel, and zinc—skyrocketed in the Texas intermediate crude oil. The price of nonfuel second quarter. Factors contributing to commodities is an index of forty-five primarythe surge in prices included growing commodity prices. SOURCE: For oil, the Commodity Research Bureau; demand, particularly from developing for nonfuel commodities, International Monetary Fund. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

22 93rd Annual Report, 2006 petroleum inventories were drawn inflows slowed in the first quarter but down. Oil demand for heating was de- have changed little since then. pressed by above-average temperatures Foreign private purchases of U.S. sein the Northern Hemisphere in the curities in the second and third quarters fourth quarter and in the early weeks of of 2006 slowed slightly from the 2007, and the spot price fell further, to extraordinary pace set in the second half around $50 per barrel in mid-January, of 2005 and early 2006, but preliminary before moving back up to $58 per barrel fourth-quarter data show recent demand at the end of the month. Far-dated fu- to have been strong. More than half of tures prices began last year at about private flows last year took the form of $60 per barrel, moved in a pattern simi- purchases of corporate bonds, and most lar to spot prices throughout most of the of the remainder went toward investyear, and averaged just over $61 per ment in GSE bonds and corporate equibarrel in January 2007. ties. On net, private foreigners pur- Notwithstanding the decrease of glo- chased few U.S. Treasuries. Foreign bal oil prices since August, several fac- direct investment flows into the United tors continue to support these prices at States remained robust. historically elevated levels. Ongoing Net purchases of foreign securities by violence has diminished oil production U.S. residents, a financial outflow, set a in Iraq and Nigeria. The continuing dis- record pace in the first three quarters of pute with Iran over its nuclear program 2006. Preliminary data show a further threatens a possible curtailment of Ira- surge in net purchases in the fourth quarnian exports. Energy investment by in- ter. Demand for foreign bonds by U.S. ternational oil companies has been ham- residents slightly exceeded that for forpered in some countries, such as Russia eign equities. After the expiration of the and Venezuela, by increased govern- partial tax holiday implemented in the ment control of domestic energy indus- Homeland Investment Act of 2004, U.S. tries. Moreover, in response to the recent direct investment abroad dropped back decline in oil prices, OPEC has reduced to more normal levels. its crude oil production to the lowest level since 2004. Oil demand over the The Labor Market past year has also increased modestly in developing countries despite high prices. Employment and Unemployment Labor markets remained strong in 2006. The Financial Account Nonfarm payroll employment increased Foreign official inflows in the first three 186,000 per month, on average, during quarters of 2006 were above their 2005 the second half of 2006, a rate essenpace but remained below the record lev- tially the same as in the first half of the els of 2004. Most of these official in- year. Employment rose 111,000 in Januflows were attributable to Asian central ary of 2007. The unemployment rate in banks and took the form of purchases of the fourth quarter of last year— U.S. government securities, primarily 4x/2 percent—was at its lowest quarterly bonds and mortgage-backed securities level since 2001, and it was little issued by government-sponsored enter- changed in January 2007. prises (GSEs). Preliminary data indicate In response to the contraction in a slight easing of official purchases in homebuilding, hiring in the construction the fourth quarter of 2006. Net private sector slowed considerably in the sec- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 23 Net Change in Payroll Employment, employment among individuals who had 2001-07 not been participating in the labor force. In line with this cyclical tightening of Thousands of jobs, monthly average the labor market, the labor force participation rate ticked up during 2006, from January 66 percent in the first quarter to 66V4 percent in the fourth quarter, after a VA percentage point rise during 2005. The recent rise in the participation rate follows a period of decline beginning in the late 1990s that in part reflected some I I I I I I 1 I I longer-term secular trends in labor force 2001 2003 2005 2007 behavior. Those trends included a level- NOTE: Nonfarm business sector. ing off in the participation rate of SOURCE: Department of Labor, Bureau of Labor women and an increase in the propor- Statistics. tion of the workforce in older age groups, which have lower average parond and third quarters of 2006, and this ticipation rates. sector shed workers in the fourth quar- Other indicators also suggest that ter. Although hiring for nonresidential labor market conditions remained generbuilding construction remained brisk for ally favorable during the second half of most of the year, the steep decline in 2006. Layoffs remained low as new housing starts curtailed the overall de- claims for unemployment insurance mand for construction workers. Employ- fluctuated around a relatively subdued ment in the manufacturing sector, which level of 315,000 per week. In addition, rose in the first half of 2006, declined in data reported by the Bureau of Labor the second half as factory output slowed. Statistics showed a further increase dur- From July to December, many of the ing the later part of the year in the rate factory layoffs were at makers of motor of job openings as a percentage of vehicles and parts and at producers private-sector employment. closely tied to the construction industry. Outside of the construction and manu- Productivity and facturing sectors, employment generally Labor Compensation increased at a solid pace in the second half of 2006, and hiring was particularly The growth rate of labor productivity in rapid in a number of service industries— the nonfarm business sector, which had especially those providing education and slowed in 2004 and 2005 from an excephealth services, professional and tech- tionally rapid pace earlier in the decade, nical business services, and financial remained relatively subdued in 2006. services. Over the four quarters of 2006, output As a result of the continued expan- per hour of work in the nonfarm busision of labor demand in 2006, the unem- ness sector increased 2 percent, comployment rate fell further. After remain- pared with about a 3 percent average ing around 43A percent in the first three annual rate of increase during the first quarters of 2006, the unemployment rate half of this decade and the second half edged down to 4V2 percent in the fourth of the 1990s. During that earlier period, quarter. The tighter labor market was productivity gains were spurred by the associated with a noticeable increase in rapid pace of technological change, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

24 93rd Annual Report, 2006 Change in Output per Hour, 1948-2006 An alternative measure of employee compensation is the employment cost Percent, annual rate index (ECI) for private nonfarm businesses, which is based on a survey of firms conducted by the Bureau of Labor Statistics. According to this measure, nominal hourly compensation increased 3J/4 percent in 2006, lA percentage point faster than in 2005. In real terms, the ECI for hourly compensation rose VA percent last year after averaging a 1948- 1974- 1996- 2002 2004 2006 Vi percent increase over the preceding 73 95 2000 two years. The nominal wages and sala- NOTE: Nonfarm business sector. Change for each ries component of the ECI rose VA permultiyear period is measured from the fourth quarter of the year immediately preceding the period to the fourth cent in 2006, while the benefits compoquarter of the final year of the period. nent advanced 3 percent. SOURCE: Department of Labor, Bureau of Labor From the perspective of employers, Statistics. the acceleration in hourly compensation in the nonfarm business sector last year boosted the average labor costs associgrowing ability of firms to use informaated with producing a unit of output tion and other technology to improve 23/4 percent, up from increases of about the efficiency of their operations, and P/4 percent in both 2004 and 2005. increases in the amount of capital per Although the rise in unit labor costs worker. Despite the recent slowing in increased, firms' profit margins approductivity growth, these underlying peared to remain elevated in 2006 relafactors do not appear to have waned. tive to longer-run standards. Accordingly, the recent slowdown in labor productivity may be at least in part Prices a temporary cyclical response to the moderation in the pace of economic ac- Headline inflation slowed in 2006. The tivity in 2006 rather than a meaningful PCE chain-type price index rose 2 perdownshift in the longer-run trend. cent over the four quarters of 2006, a As the labor market tightened in step-down from the 3 percent increase 2006, the rise in hourly labor compensa- recorded in 2005. The drop in energy tion, which includes both wages and prices in the latter part of 2006 acemployer payments for employee bene- counted for the deceleration in the headfits, stepped up for workers in the non- line number. Core inflation moved farm business sector. In nominal terms, higher in the first part of 2006 but then compensation per hour increased almost eased toward the end of the year. On 5 percent over the four quarters of 2006, balance, core PCE prices rose about compared with an average 4 percent rise 2lA percent over the four quarters of in the preceding two years. After adjust- 2006, a little faster than the 2 percent ing compensation for increases in the increase in 2005. The market-based PCE price index, real compensation per component of the core PCE price hour rose 3 percent in 2006, up from an index—which excludes imputed prices average gain of about 1 percent in 2004 that are not observed in market transacand 2005. tions and that often change irregularly— Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 25 Alternative Measures of Price Change, the course of the year, and prices of corn 2004-06 and soybeans spiked at the end of the Percent year in the wake of downward revisions to estimates of crop production. Prices Price measure 2004 2005 2006 of corn also were boosted during the year by increased demand for corn to Chain-type Gross domestic product (GDP) . 3.2 3.1 2.5 produce ethanol. But the small share of Gross domestic purchases 3.7 3.6 2.2 wheat, corn, and soybeans in the total Personal consumption expenditures (PCE) 3.0 3.1 1.9 value of food production limited their Excluding food and energy ... 2.2 2.1 2.3 Market-based PCE excluding effect on retail food prices. Prices for food and energy 1.7 1.8 2.0 food consumed away from home, which Fixed-weight are influenced importantly by the costs Consumer price index 3.3 3.7 1.9 of labor, energy, and other business Excluding food and energy ... 2.1 2.1 2.6 inputs, increased 3V4 percent in 2006, a NOTE: Changes are based on quarterly averages of more rapid pace than that for prices of seasonally adjusted data. food consumed at home. SOURCE: For chain-type measures, Department of Commerce, Bureau of Economic Analysis; for fixed- The core PCE price index accelerated weight measures, Department of Labor, Bureau of Labor to an annual rate of about 2Vi percent in Statistics. the first half of 2006 on the strength of pickups in the price indexes for both increased 2 percent in 2006, about goods and services. In the spring, lA percentage point more than in the increases in housing rents were particuprevious year. larly sharp. The rise may have reflected Energy prices recorded dramatic in part a shift in demand toward rental swings during 2006. PCE energy prices housing as rising mortgage rates and increased at an annual rate of about lofty home prices made home purchases 15 percent in the first half of the year less affordable. The pass-through of and declined at an annual rate of almost higher energy costs to a broad range of 17 percent in the second half. The sharp goods and services also probably conmovements in consumer energy prices tributed to the acceleration in core conin 2006 were associated primarily with sumer price inflation in the first half of fluctuations in prices for crude oil. The 2006. changes in energy prices also were amplified by a widening in the margin of In the second half of 2006, core PCE the retail price of gasoline over the asso- price inflation edged down to an annual ciated cost of crude oil in the first half of rate of just below 2lA percent. The dethe year and by some narrowing of that celeration was the result of a decrease in margin in the second half. On balance, core goods prices, which likely reflected the PCE energy price index decreased in some measure the waning influence 4 percent over the four quarters of 2006. of energy prices. In contrast, core ser- Food price inflation remained fairly vices inflation in the second half of the moderate in 2006. The PCE index for year remained at about the same pace as food and beverages increased 2lA per- in the first half. Although housing rents cent, roughly the same pace as in the rose more slowly in the second half of preceding year. Retail prices of meat the year, their effect on the PCE for core and poultry rose modestly for 2006, as services was mostly offset by faster robust demand was met by ample sup- price increases for medical care and a plies of meat. Prices of wheat rose over number of other services. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

26 93rd Annual Report, 2006 The swings in energy costs in 2006 spread of yields on nominal Treasury were apparent in the prices of inputs securities over their inflation-protected used in the production and sale of final counterparts stayed within the relatively goods and services, especially of items narrow range of 2 percent to 23/4 percent for which energy costs represent a rela- during the year. tively large share of total production costs, including industrial chemicals, U.S. Financial Markets plastics, fertilizer, and stone and clay products. In addition, the prices of some Financial conditions in the United States commodities, such as a variety of met- supported economic growth in 2006. als, rose significantly in 2006 in Yields on long-term Treasury securities response to strong worldwide demand. climbed a bit, on balance, but stayed As a result, the core producer price in- low by historical standards, while strong dex for intermediate goods, which corporate profits helped fuel substantial excludes food and energy, rose 5lA per- gains in equity markets. Liquid corpocent in 2006, up from the 43/4 percent rate balance sheets and low corporate increase in 2005. The index increased at leverage helped keep risk spreads on an annual rate of 11A percent in the first corporate bonds narrow. Meanwhile, half of 2006, but it decelerated to an business borrowing picked up to a rapid annual rate of about 3x/4 percent in the pace, spurred in part by a rise in merger second half as energy costs declined. and acquisition activity. In the residen- For the year as a whole, measures of tial real estate sector, mortgage borrowlong-term inflation expectations re- ing slowed markedly, as house prices mained well anchored, although short- decelerated, especially in the second half term expectations were heavily influ- of the year. Consumer credit expanded enced by fluctuations in energy prices. at a moderate pace. Nonetheless, house- The Reuters/Michigan survey measure hold debt growth outpaced the growth of the median expectation of households of disposable personal income, and the for inflation over the next twelve months financial obligations of households was about 3 percent in December, down inched higher. Although households from its peak of 33/4 percent in August. generally appeared able to meet their Longer-term inflation expectations re- obligations, signs of financial strain corded in the Reuters/Michigan survey were apparent in subprime variable-rate showed less variability. The median sur- mortgages. The M2 monetary aggregate vey respondent in December expected expanded at a moderate pace in 2006. the rate of inflation during the next five to ten years to be 3 percent, down from Interest Rates its peak of V-U percent in August. Other indicators likewise suggest that longer- Market interest rates rose modestly, on run inflation expectations have remained balance, in 2006—yields on two- and contained. According to the Survey of ten-year nominal Treasury securities Professional Forecasters, conducted by increased about 40 and 30 basis points the Federal Reserve Bank of Philadel- respectively. Changes in interest rates phia, expectations of inflation over the seemed largely tied to changes in the next ten years remained at 2Vi percent outlook for economic growth and inflain 2006, a level that has been essentially tion. Rates across the maturity spectrum unchanged since 1998. In addition, in- increased notably over the first half of flation compensation implied by the the year, as incoming data on activity Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 27 Interest Rates on Selected Treasury year, forward-looking measures of un- Securities, 2003-07 certainty about monetary policy inferred from interest rate options remained near Percent the low end of historical ranges. Yields on inflation-indexed Treasury securities increased about as much as those on their nominal counterparts in 2006. Medium- and long-term inflation compensation—measured from spreads between yields on nominal and inflation-indexed securities—were about unchanged to a little lower, on net, and 2003 2004 2005 2006 2007 during the year these measures exhib- NOTE: The data are daily and extend through Feb- ited only modest swings in response to ruary 7, 2007. incoming inflation data and oil price SOURCE: Department of the Treasury. movements. In the corporate bond market, yields and inflation came in higher than mar- on investment-grade securities moved kets had expected and as the FOMC about in line with those on comparableraised the target federal funds rate maturity Treasury securities. In contrast, 25 basis points at each of its first four yields on speculative-grade securities meetings. At the time of the June FOMC fell slightly, pulling risk spreads lower meeting, interest rate futures market in that segment of the market. The narquotes indicated that market participants rowness of investment- and speculativeperceived considerable odds of an addi- grade spreads seems to reflect investors' tional rate tightening by year-end. How- sanguine perceptions of corporate credit ever, market interest rates declined, on quality over the medium term, which net, over subsequent months in response likely reflect in large part the strength of to incoming data suggesting that inflation pressures were moderating and that Spreads of Corporate Bond Yields over economic growth was slowing. Market Comparable Off-the-Run Treasury Yields, expectations for the trajectory of the 1998-2007 federal funds rate over the next several years shifted down considerably during Percentage points the second half of the year. More recently, market participants have — 10 High-yield backed away from expectations of a substantial easing of monetary policy as incoming data on economic activity •J** V^ _ 4 B B B have been stronger than expected. Investors now expect the FOMC to ease policy only slightly over the next two years. Although investors modestly revised 1999 2001 2003 2005 2007 their medium-term policy expectations NOTE: The data are daily and extend through over the course of the year, the Commit- February 7, 2007. The ten-year high-yield, ten-year tee's interest rate decisions were largely BBB, and ten-year A A indexes are compared with the anticipated in financial markets by the ten-year Treasury yield. SOURCE: Derived from smoothed corporate yield time of each meeting. Throughout the curves using Merrill Lynch bond data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

28 93rd Annual Report, 2006 business balance sheets and a benign inflows into international equity funds economic outlook. The term structure of were exceptionally strong. forward risk spreads for corporate bonds supports this view, as forward spreads Market Functioning and one and two years ahead are low, while Financial Stability the spreads further out the curve are more in line with historical norms. Overall, financial markets functioned smoothly over the year and proved resilient to several shocks. Equity markets Equity Markets in the United States and currency and Broad equity indexes soared 10 percent fixed-income markets in several to 20 percent in 2006, boosted by strong emerging-market economies experigrowth in corporate earnings. Share enced heightened volatility late in the prices rose across a wide range of sec- second quarter, but the turbulence was tors, but increases in telecommunica- short lived. The liquidation of a few tions and security brokerage stocks were sizable hedge funds attracted considerespecially noteworthy. The difference able attention for a time but had little between the twelve-month forward discernible effect on the broad functionearnings-price ratio for the S&P 500 and ing of markets. Even the liquidation of the long-term real Treasury yield—a Amaranth—a hedge fund that was crude measure of the premium that in- wound down in the fall after reporting a vestors require for holding equity loss in excess of $6 billion, mostly in shares—was little changed on balance. energy trades—left little imprint on The implied volatility of the S&P 500 financial markets, although it raised calculated from options prices spiked some concerns about risk-management temporarily in the late spring in connec- practices. Implied volatilities, risk tion with a period of strain in several spreads, and various other potential markets but remained near historical measures of financial stress generally lows for the remainder of the year. Net stayed at very low levels throughout the inflows into domestic equity mutual year, suggesting that investors were funds were quite modest in 2006, while comfortable taking on risk, likely in part because they were confident about the economic and financial outlook. Stock Price Indexes, 2005-07 Throughout the year, bid-ask spreads on the most actively traded Treasury January 3, 2005 =100 securities remained within narrow ranges. Some instances of questionable 130 trading activities occurred in the second- Russell 2000 ^1 i /- 120 ary market for Treasury securities over 110 the course of the year. The Interagency Working Group for Treasury Market */*< ~ 100 Surveillance monitored these situations v Wilshire 5000 — 90 closely.1 In November, the Federal 1 1 1 1 1 Reserve Bank of New York arranged a 2005 2006 2007 1. The group was established in 1992 and NOTE: The data are daily and extend through February 7, 2007. includes representatives from the Board of Gover- SOURCE: Frank Russell Company; Dow Jones nors of the Federal Reserve System, the Treasury, Indexes. the Securities and Exchange Commission, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 29 meeting with all primary dealers to dis- Following up on a meeting with the cuss developments in Treasury markets Federal Reserve Bank of New York in and to encourage the firms to review the fall of 2005, the largest participants their internal oversight of trading opera- in the fast-growing market for credit tions. Subsequently, a private-sector derivatives agreed to a series of steps to group sponsored by the Federal Reserve strengthen that market's infrastructure. Bank of New York released a draft re- Over the course of 2006, credit derivaport laying out a set of best practices for tives dealers phased out the practice of firms active in the Treasury market on transferring positions to a different topics such as appropriate trading strat- counterparty without first obtaining the egies and internal controls. consent of the original counterparty. In July, the Federal Reserve Board They also reduced by 85 percent the implemented a revision to the treatment number of trade confirmations outstandof GSEs and certain international orga- ing more than thirty days; they doubled nizations under its Policy on Payments the share of trades that are confirmed System Risk. Under the change, interest via an electronic platform, to 80 percent and redemption payments on securities of total trade volume; and they agreed issued by these institutions are now re- upon a new protocol for the settlement of such derivatives after a credit event. leased only when the issuer's Federal Reserve account contains sufficient funds to cover the payments; that is, Debt and Financial Intermediation these institutions no longer may employ by Banks daylight credit to fund such payments. The Board of Governors determined that Total debt of the domestic nonfinancial the change represents an appropriate sectors expanded an estimated VA perrisk-management policy for the central cent in 2006, well below the pace in bank and is consistent with the general 2005 but still faster than that of nominal practices of private issuing and paying income. Debt growth slowed markedly agents. In addition, GSEs and interna- in the household and government sectional organizations are now subject to a tors, but business debt accelerated. penalty fee for daylight overdrafts re- About 30 percent of the growth in sulting from general corporate payment nonfinancial sector debt in 2006 was activity (activity other than interest and intermediated by the banking sector. redemption payments). This change This share is about even with the averaligns the policy for GSEs and interna- age over the past ten years and is about tional organizations with that for other 5 percentage points above the average Federal Reserve account holders that do observed in the 1980s and early 1990s. not have regular access to the Federal Commercial bank credit expanded Reserve's discount window and thus are 9Vi percent in 2006, supported by brisk not eligible for intraday credit. The tran- growth in loans to businesses. Bank sition to the new policy occurred credit also was boosted in the autumn by smoothly with minimal effects on the a consolidation of a substantial volume of thrift assets onto a commercial bank's functioning of the payments system and balance sheet that had resulted from an no notable adverse effects on short-term internal reorganization at a large bank funding markets. holding company. Bank lending to businesses through Commodity Futures Trading Commission, and the Federal Reserve Bank of New York. commercial and industrial loans in- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

30 93rd Annual Report, 2006 creased at a rapid pace last year. The Typically, as short-term interest rates growth was fueled by vigorous merger rise, deposit rates lag somewhat, inand acquisition activity, rising outlays creasing the opportunity cost of holding for investment goods, ongoing inven- money. In 2006, this effect apparently tory accumulation, and an accommoda- slowed money growth less than would tive lending environment. Bank loans have been expected on the basis of hissecured by commercial real estate, torical norms, and the velocity of M2 though strong, decelerated over the rose only about 3A percent. Retail money course of the year. The moderation in market mutual funds and small time decommercial real estate lending was con- posits, components of M2 whose yields sistent with responses by large and move most closely with market rates, medium-sized banks to the Senior Loan grew rapidly. However, liquid deposits, Officer Opinion Survey on Bank Lend- which constitute the largest component ing Practices, which pointed to slowing of M2, and whose yields adjust more demand and a net tightening of credit gradually, were about flat on net. Curstandards for such loans in the second rency expanded a modest 3V2 percent, half of the year. Consumer loans and an increase similar to that in 2005, reresidential mortgages held by banks flecting weak, possibly negative, net degrew at a moderate rate for the year as a mand from overseas. whole. However, excluding the effects Part of the Financial Services Regulaof the thrift consolidation, residential tory Relief Act of 2006 gave the Federal real estate lending slowed considerably Reserve authority, beginning in October in the fourth quarter, no doubt reflecting 2011, to pay interest on reserve balances in part the downturn in the housing and to further reduce or eliminate remarket. serve requirements. At the October Commercial bank profits as a percent- FOMC meeting, the Chairman asked the age of average assets were strong in staff to prepare for the implementation 2006 and rose slightly above 2005 lev- of this legislation. els. Net interest margins declined a bit further, likely in response to continued International Developments competitive pressures and a modest inversion of the yield curve, but bank Foreign economic growth was generally profitability was supported by growth in strong in 2006, as expansion continued non-interest income and by well- in all major regions of the world. The contained costs. Continued strong asset Japanese economy decelerated somequality also helped to support profitabil- what but maintained positive growth, ity in 2006 by allowing banks to reduce and the pace of activity in the euro area their loan-loss provisioning. Robust as- picked up. Labor market conditions in set quality was reflected in loan delin- both areas improved. Emerging-market quency and charge-off rates that re- economies also recorded solid growth mained at low levels through the end of last year and experienced no apparent 2006. lasting ill effects from the brief period of financial market volatility that hit some of them particularly hard in the late The M2 Monetary Aggregate spring. Although there are signs that and Reserves steps taken to slow growth of invest- M2 expanded at a 5 percent rate last ment in China have been effective, the year, somewhat faster than in 2005. Chinese economy continued to grow Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 31 rapidly. Rising energy prices boosted from a further run-up in energy prices consumer price inflation in many areas and indications that global economic of the world early last year, but mone- growth remained robust. tary tightening appears to have pre- From their midyear highs, nominal vented inflation from moving signifi- government benchmark bond yields fell cantly higher, and the effects of higher noticeably until about the beginning of energy prices on core prices were December in most major advanced modest. economies, as investors reacted to Industrial countries tightened mone- moves in U.S. rates and evaluated the tary policy in 2006. Some countries implications for the global economy of paused around the same time as the the economic slowdown that seemed to Federal Reserve, and others continued be under way in the United States. Over to tighten throughout the year. After this period, yields on ten-year nominal ending its policy of quantitative easing bonds declined by amounts that ranged in the spring, the Bank of Japan (BOJ) from about 25 basis points in the United raised its policy rate 25 basis points in Kingdom to about 70 basis points in July. Weak consumer spending and low Canada. Yields on inflation-indexed seinflation have apparently deterred the curities declined less; modest declines BOJ from tightening since then. With in inflation breakeven rates were attribgrowth in the European economies firm- uted in part to lower energy prices in the ing, concerns over inflationary pressures second half of the year. prompted the European Central Bank to Since the beginning of December, raise its policy rate five times last year, however, nominal and indexed governto 3.5 percent. The Bank of Canada ment bond yields have risen once again tightened 75 basis points in several steps in most advanced economies, partly over the first half of the year but has left because new data releases appeared to the overnight rate unchanged since then. alleviate investors' concerns that global After keeping its policy rate constant in economic growth might slow appreciathe first half of the year, the Bank of bly. Yields on both ten-year nominal England tightened policy 25 basis points and indexed securities have risen in August and November 2006 and in 15 basis points in Japan and 25 to January 2007. The statements accompa- 50 basis points in the euro area, the nying each tightening cited the upside United Kingdom, and Canada since risks to inflation posed by low levels of their December lows. As a result, inflaspare capacity. tion breakeven rates have been little During the first half of 2006, ten-year changed. sovereign yields in the euro area, Can- The Federal Reserve's broadest meaada, and Japan rose sharply on balance: sure of the nominal trade-weighted Increases ranged from 45 basis points in exchange value of the dollar declined Japan to 75 basis points in Germany. 33/4 percent from the beginning of last Yields on inflation-protected long-term year through early February of this year. securities in these economies also rose Over that period, the dollar appreciated during the first half of 2006 but not as 2lA percent against the yen and Wi permuch as nominal yields and thus im- cent against the Canadian dollar, but it plied a noteworthy rise in inflation com- depreciated about 9 percent, on net, pensation. These developments occurred against the euro, almost 13 percent largely in reaction to continuing upward against sterling, and 4 percent against pressures on inflation, which stemmed the Chinese renminbi. The renminbi's Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

32 93rd Annual Report, 2006 U.S. Dollar Exchange Rate against taking. Broad-based gains in stock Selected Major Currencies, 2004-07 prices since midsummer appear to be associated with a scaling back of expec- Weekending January 2, 2004 = 100 tations for future tightening of monetary U.K. pound policy in several countries and with declines in energy prices. Since mid- — Japanese yen — 110 June, broad stock market indexes have Euro — 100 gained 10 percent to 20 percent in Europe, Japan, and Canada. — 90 Industrial Economies 2004 2005 2006 2007 After increasing at an annual rate of NOTE: The data are weekly and are in foreign roughly 2 percent in the first half of currency units per dollar. The last observation for each 2006, Japanese real GDP grew only series is the average for February 5 through February 7, 2007. 3/4 percent in the third quarter, largely SOURCE: Bloomberg L.P. because of slower growth of consumption. Capital spending was an important rate of appreciation stepped up in late contributor to growth of output 2006 and early 2007, but daily fluctua- throughout the year, supported by strong tions in the dollar-renminbi exchange corporate profitability. Labor market rate were very small. conditions continued to improve; the un- Most of the dollar's overall decline in employment rate was about 4 percent in 2006 occurred between mid-April and December, its lowest level since 1998, early May. During this period, market and the ratio of job offers to applicants participants reportedly sensed that the remained close to a thirteen-year high. FOMC was approaching the end of its However, wage growth was very series of policy tightenings, and interest subdued, as firms controlled cost rate differentials moved against the dol- increases, and unit labor costs continued lar. Traders also refocused on the large to fall. In 2006, consumer prices started and persistent U.S. current account defi- to rise again, posting small twelvecit, which was further boosted by crude month increases after June, and land oil prices that had moved above $70 per prices in Japan's six largest cities rose barrel. To date in 2007, the dollar's for the first time since 1991. However, broad nominal exchange value has risen the GDP deflator continued to decline 1 percent on balance. slowly. In the wake of strong advances in Real GDP in the euro area accelerated 2005, major global equity indexes somewhat in 2006, posting average posted solid gains, on balance, in 2006 growth of 3lA percent at an annual rate and in early 2007. After rising 5 percent over the first three quarters. Output to 10 percent in the first quarter of 2006, growth was supported in part by strong most global indexes fell sharply begin- consumer spending, which grew subning in early May to reach intra-year stantially faster than in 2005. The lows in mid-June. Market participants stronger performance of the economy attributed the drops in share prices to was reflected in improving labor market increased uncertainty about prospective conditions: The unemployment rate in inflation, caused in part by the run-up in the euro area fell 0.8 percentage point energy prices, and to a retreat from risk- during the year to reach 7.5 percent in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Economic and Financial Developments in 2006 and Early 2007 33 December, continuing a downward Elsewhere in emerging Asia, ecomovement that began in 2004. Wages nomic performance was generally solid and salaries in the manufacturing and in 2006. In Korea, GDP growth slowed services sector grew at an average from the strong pace registered in 2005, annual rate of 2lA percent in the first partly because of monetary tightening, three quarters of the year—a bit lower and consumer price inflation remained than their rate of growth in 2005. Higher modest. The pace of growth in other energy prices boosted euro-area con- countries stayed strong throughout 2006 sumer price inflation, which rose to as a result of robust exports and, in about 2V2 percent in the first half of some cases, strengthening domestic de- 2006; late in the year, it dropped below mand. Four-quarter inflation moderated the European Central Bank's target ceil- across the region. That moderation ing of 2 percent. Core inflation remained resulted from the waning effects of earnear 1V2 percent. lier reductions or removals of domestic Real GDP in the United Kingdom fuel subsidies, but the previous tightengrew 3 percent last year, and real GDP ing of monetary policy in the region and in Canada grew 3 percent, on average, an appreciation of exchange rates also through the first three quarters. Despite made a contribution. Capital inflows declining consumer confidence in the into several Asian emerging-market United Kingdom, the pace of consump- economies—particularly Thailand—in tion growth over the year was slightly late 2006 and early this year put upward higher than in 2005, and consumer pressure on local currencies. Measures spending in Canada, supported by mod- taken by Thai authorities seemed to sucerate employment growth, also remained ceed in limiting upward movement of robust. Declines in energy prices the baht, but share prices in the Thai brought Canadian consumer price infla- stock market fell sharply. Financial martion down after the middle of the year to kets in other countries in the region a twelve-month change of about 1V2 per- were less affected and showed no noticecent in December, below the Bank of able spillovers from events in Thailand. Canada's 2 percent inflation target. In- Output growth in Mexico was excepflation in the United Kingdom edged up tionally strong in the first half of last throughout the year, partly because of year, especially in the manufacturing, increases in electricity and natural gas construction, and services sectors. prices that were implemented in the fall. Growth stepped down in the second half; construction activity remained robust but was offset by a slowdown in Emerging-Market Economies exports of manufactured goods to the United States. Mexican consumer price Real GDP growth in China remained inflation was elevated during the second strong but moderated a bit in the second half by higher food prices and reached half. The mild slowdown suggests that rates above the 4 percent upper limit of the administrative measures put in place the central bank's inflation target range; by the Chinese authorities to cool invest- at year-end, inflation was still at the top ment have had an effect. The trade sur- end of the range. plus recorded a substantial increase in Brazilian output growth was solid in 2006. Four-quarter inflation picked up the first quarter but slowed noticeably near the end of last year to over 2 per- later in the year, partly because of weak cent, reflecting higher food prices. manufacturing performance. Brazilian Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

34 93rd Annual Report, 2006 four-quarter inflation fell markedly, gentine government continued to atfrom almost 6 percent at the end of 2005 tempt to bring down inflation through to just over 3 percent in December. In voluntary price agreements with produc- Argentina, steady growth in investment ers in several sectors; although inflation and consumption kept real GDP on a had edged down to the single-digit range solid uptrend throughout 2006. The Ar- by year-end, it was still high. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

35 Monetary Policy Report of July 2006 Monetary Policy and the Thus far in 2006, inflation pressures Economic Outlook have been elevated. Higher prices for crude oil contributed to a further run-up The U.S. economy continued to expand in domestic energy costs; this year's at a brisk rate, on balance, over the first increases, combined with the steep half of 2006. Spending in the first quarincreases in 2004 and 2005, not only ter, which was especially robust, was boosted the prices of gasoline and heattemporarily buoyed by several factors, ing fuel but also put upward pressure on including federal spending for hurricane the costs of production for a broad range relief and the effects of favorable of goods and services. Partly as a result weather on homebuilding. The pace of of these cost pressures, the rate of core the expansion moderated in the spring, consumer price inflation picked up. to some degree because the influence of Nevertheless, measures of inflation these special factors dissipated. More expectations remained contained, and fundamentally, consumer spending the rate of increase in labor costs was slowed as further increases in energy subdued, having been held down by prices restrained the real incomes of strong gains in productivity and moderhouseholds. In addition, home sales and ate increases in labor compensation. new homebuilding dropped back notice- Taking a longer perspective, the U.S. ably from the elevated levels of last economy appears to be in the midst of a summer, partly in response to higher transition in which the rate of increase mortgage interest rates. Outside of the in real gross domestic product (GDP) is household sector, increases in demand moving from a pace above that of its and production appear to have been well longer-run capacity to a more moderate maintained in the second quarter. Deand sustainable rate. An important elemand for U.S. exports was supported by ment in the transition is the lagged effect strong economic activity abroad, and of the changes in monetary policy since business fixed investment remained on a mid-2004, changes that have been insolid upward trend. Early in the year, as tended to keep inflation low and to proaggregate output increased rapidly, busimote sustainable economic expansion nesses added jobs at a relatively robust by aligning real economic activity more pace, and the unemployment rate moved closely with the economy's productive down further. Since April, monthly potential. Moreover, longer-term intergains in payroll employment have been est rates have risen, contributing to smaller but still sufficient to keep the increased borrowing costs for both jobless rate steady. households and businesses. Over time, pressures on inflation should abate as the pace of real activity moderates and, NOTE: The discussion in this chapter consists of as futures markets suggest, the prices of the text and tables from the Monetary Policy energy and other commodities roughly Report submitted to the Congress on July 19, stabilize. The resulting easing in infla- 2006; the charts from that report (as well as earlier reports) are available on the Board's web site, at tion should help contain long-run inflawww.federakeserve.gov/boarddocs/hh. tion expectations. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

36 93rd Annual Report, 2006 Even as the rate of increase in real cost pressures. Another risk is that the economic activity moderates, the pros- effect on imported-goods prices of earpects for sustained expansion of house- lier declines in the foreign exchange hold and business spending appear value of the dollar, which has been limfavorable. Higher energy prices have put ited to date, could become larger. More strains on household budgets, but once broadly, if the higher rate of core inflathat effect fades, households should ex- tion seen this year persists, it could inperience gains in real income consistent duce a deterioration in longer-run inflawith the ongoing expansion of jobs. tion expectations that, in turn, might Household balance sheets remain gener- give greater momentum to inflation. ally sound; although some pockets of However, the risks to the inflation outdistress have surfaced, average delin- look are not entirely to the upside. In the quency rates on mortgages and other current environment of elevated profit consumer debt are still low. Similarly, in margins, competitive forces, both in the business sector, balance sheets are domestic markets and from abroad, strong, credit quality is high, and most could impose significant restraint on the firms have ready access to funds. Sus- pricing decisions of businesses. tained expansion of the global economy, Regarding risks to the outlook for real along with the effects of the earlier activity, rates of increase in real GDP depreciation of the foreign exchange have been uneven during the past year, value of the dollar, should support de- complicating the assessment of whether mand for U.S. exports. The potential for the pace of the economic expansion is efficiency gains, as well as further moving into line with its underlying podeclines in the relative cost of capital, tential rate. One possible risk to the are likely to continue to spur capital upside is that the softer tone of the spending. Indeed, the ongoing advances recent data on real activity will prove in efficiency should sustain solid growth transitory rather than mark a shift to a of labor productivity, providing support more sustainable underlying rate of for gains in real wages and income. expansion. For example, slower spend- As always, considerable uncertainties ing and hiring in recent months may attend the outlook. Regarding inflation, represent a shorter-lived adjustment to a the margin between production and con- higher level of energy prices or to the sumption of crude oil worldwide is quite unusually robust increases in economic narrow, and oil markets are especially activity earlier in the year. In coming sensitive to news about the balance of months, a sharp rebound in consumer supply and demand and to geopolitical spending accompanied by an acceleraevents with the potential to affect that tion of capital spending could return real balance; adverse developments could activity to a pace that would be unsusresult in yet another surge in energy tainable over the longer run. But downcosts. Indeed, futures markets provide side risks also exist. In particular, the only imperfect readings on the prospects slowing in real estate markets since last for energy markets, as witnessed by the summer has been moderate, and the easfact that the surprises in crude oil prices ing of house-price inflation has been during the past few years have been gradual. If the softening in the demand predominantly to the upside. In addi- for housing and in real estate values tion, a further rise in prices of other, becomes more pronounced, the resulting non-energy materials and commodities, drop in construction activity and the if it materializes, could also intensify erosion of household wealth could Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 37 weaken aggregate demand noticeably. strains. Against this backdrop, the Com- Consumer spending might be depressed mittee raised the target federal funds by the loss of income and wealth, and rate another 25 basis points, to 43A perthat effect could be amplified if the cent. The statement released at the end downturn is abrupt enough to shake of the meeting continued to point to the households' confidence about their abil- possible need for further policy firming. ity to finance spending or manage their Data received by the time of the May current financial obligations. meeting confirmed that the economy had expanded robustly in the first quarter, though both consumer spending and The Conduct of Monetary Policy housing activity appeared to have modover the First Half of 2006 erated in late winter. In addition, infla- The Federal Open Market Committee tionary pressures had intensified as core (FOMC) continued to firm the stance of consumer prices rose more rapidly in monetary policy over the first half of March than in earlier months. Inflation 2006. At the time of the January meet- expectations, as measured by some suring, available information suggested that veys and by comparisons of yields on underlying growth in aggregate demand nominal and inflation-indexed Treasury was solid at the turn of the year. The securities, also rose in April. The Comexpansion of real GDP in the fourth mittee still judged those expectations to quarter of 2005 was estimated to have be contained, but it was mindful that a slowed temporarily, in part because of further increase could impart additional the disruptions associated with last au- momentum to inflation, as could the tumn's hurricanes. Core inflation had surge in energy and other commodity stayed relatively low, and inflation ex- prices and the drop in the foreign pectations had remained contained. With exchange value of the dollar that took rising energy prices and increases in place in April and early May. To gain resource utilization having the potential greater assurance that inflationary forces to add to inflationary pressures, the would not intensify, the FOMC decided FOMC decided to extend the firming of to raise the target federal funds rate policy that it had implemented over the another 25 basis points, bringing it to previous eighteen months by tightening 5 percent. The FOMC also indicated in the policy rate 25 basis points, to the policy statement that some further 4V2 percent. The Committee indicated policy firming could be required. Howthat some further policy firming might ever, the Committee was aware that the be needed to keep the risks to price cumulative effects of past monetary polstability and to sustainable economic icy actions on economic activity could growth roughly in balance. turn out to be larger than expected. Ac- By March, economic activity ap- cordingly, the FOMC stressed that the peared to be expanding rapidly, pro- extent and timing of any further firming pelled by robust consumer spending and would depend importantly on the evoluaccelerating business investment. Al- tion of the economic outlook as implied though readings on core inflation for by incoming data. January and February were generally By the time of the June meeting, favorable, higher prices for energy and available data appeared to confirm that other commodities, together with rela- economic growth had moderated from tively tight labor and product markets, the strong pace evident earlier in the threatened to add to existing inflation year. Consumer spending had softened, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

38 93rd Annual Report, 2006 and activity in housing markets had con- Economic Projections for 2006 and 2007 tinued to cool gradually. Evidence of Percent inflationary pressures was accumulating, however, and core price inflation Federal Reserve Governors and had increased. In addition, the high lev- Reserve Bank presidents Indicator els of resource utilization and of the prices for energy and other commodities Range Central tendency had the potential to spur further inflation. Consequently, the FOMC decided 2006 to increase the target federal funds rate an additional 25 basis points, to Change, fourth quarter 5lA percent. The Committee recognized N to o f m ou in rt a h l G qu D a P rter1 that the moderation in the growth of Real GDP 3-33/4 31/4-31/2 PCE price index excluding aggregate demand that appeared to be food and energy 2V4-3 21/4-21/2 under way would help to limit inflation- Average level, ary pressures over time, but it judged fourth quarter Civilian unemployment that, even after its policy action, some rate 43/4-5 upside inflation risks remained. Yet the FOMC made clear that the extent and 2007 timing of any additional firming needed to address those risks will depend on the Change, fourth quarter to fourth quarter1 evolution of the outlook for both infla- Nominal GDP 43/4-6 5-5V2 tion and economic growth as implied by Real GDP 2V2-31/4 3-3x/4 PCE price index excluding incoming information. food and energy In recent years, the FOMC has Average level, 2-21/4 2-21/4 worked to improve the transparency of fourth quarter Civilian unemployment its decisionmaking process, and it con- rate tinues to seek further improvements. 1. Change from average for f4o1u/4r-t5hV q4uarter 4o 3 f/ 4p-r5evious Between the March and May meetings, year to average for fourth quarter of year indicated. the Chairman appointed a subcommittee to help the FOMC frame and organize participate in the deliberations of the the discussion of a broad range of com- FOMC, provided economic projections munication issues. At the June meeting, for 2006 and 2007. In broad terms, the the Committee discussed the subcom- participants expect a sustained, modermittee's plans for work in coming ate expansion of real economic activity months and decided to begin its consid- during the next year and a half. The eration of communication issues at its central tendency of the FOMC partici- August meeting and to lengthen meet- pants' forecasts for the increase in real ings later this year to allow a fuller GDP is VA percent to 3*/2 percent over discussion of these issues. the four quarters of 2006 and 3 percent to 3V4 percent in 2007. The central tendency of their forecasts for the civilian Economic Projections unemployment rate is 43/4 percent to for 2006 and 2007 5 percent in the fourth quarter of this In conjunction with the FOMC meeting year, and the jobless rate is expected to at the end of June, the members of the still be in that range at the end of 2007. Board of Governors and the Federal For inflation, the central tendency of the Reserve Bank presidents, all of whom forecasts is an increase in the price in- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 39 dex for personal consumption expendi- Moreover, ongoing solid gains in protures excluding food and energy (core ductivity should work to limit increases PCE) of 2J/4 percent to 2l/i percent over in unit labor costs. the four quarters of 2006; in 2007, the Over the next year and a half, FOMC forecast shows a slower rate of 2 percent participants expect the economy to to 2lA percent, which is similar to the achieve a sustainable rate of economic rate of core PCE price inflation in 2004 expansion. That rate will be determined and 2005. in large part by the rate of increase in A slowing in activity now appears to productivity. Productivity has been risbe under way in the housing sector, ing at a solid rate over the past two where home sales and residential con- years, albeit more slowly than the espestruction have receded from the elevated cially rapid pace that prevailed during levels of last summer. The associated the first three years of the expansion. A easing in house-price appreciation will strong trend in productivity is likely to likely temper gains in household wealth, be maintained as businesses take advanwhich, over time, may be a factor in tage of new investment in facilities and damping consumer spending. However, equipment, as diffusion of technology households' financial positions should continues, and as organizational adreceive a boost from an acceleration of vancements and business process imreal income if energy prices stabilize as provements yield further increases in suggested by futures markets. In the efficiency. business sector, participants view the outlook for fixed investment over the Economic and Financial forecast period as positive. Although Developments in 2006 outlays for new equipment and software may increase a little more slowly with Although last year's hurricanes caused the deceleration in real output, invest- the pace of aggregate economic activity ment opportunities appear to remain at- around the turn of the year to be uneven, tractive: The relative user cost of capital real GDP increased at an average annual for equipment, particularly high- rate of 3.6 percent in the final quarter of technology items, is expected to remain 2005 and first quarter of 2006—about favorable, and competitive pressures the same pace that prevailed during the should maintain strong incentives to ex- preceding year and a half. Over this ploit opportunities for efficiency gains period, payroll employment posted addiand cost reduction. At the same time, tional solid gains, and the unemploynonresidential construction seems likely ment rate declined further. In recent to continue to move up. Finally, the months, the incoming information on strong performance of the economies of real activity has suggested that the pace the United States' major trading part- of the expansion is moderating, with the ners should continue to stimulate U.S. deceleration in spending most apparent exports of goods and services. in the household sector. Still, as of mid- The more moderate pace of expan- year, resource utilization in labor and in sion and the stability in resource utiliza- product markets remained high. tion, when coupled with less pressure Inflation picked up over the first five from the prices of energy and other com- months of the year, boosted importantly modities, should contribute to an envi- by the effects of rising energy prices. ronment in which inflation expectations Long-term inflation expectations fluctuare contained and inflation edges lower. ated over the period but remained con- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

40 93rd Annual Report, 2006 tained, and increases in unit labor costs Spending for other household goods, were subdued. Although short-term mar- such as furniture, electronic equipment, ket interest rates rose in line with the food, and clothing, was quite strong in FOMC's firming of monetary policy, the first quarter of 2006; real outlays for financial market conditions were still goods other than motor vehicles generally supportive of economic increased at an annual rate of 83/4 perexpansion in the first half of 2006. cent. Some moderation was to be Long-term interest rates rose but were expected after such a surge in spending. still moderate by historical standards, Estimates of retail sales, which are and credit spreads and risk premiums available through June, suggest that real stayed narrow. expenditures for these goods rose more slowly in the second quarter. In contrast to the uneven pattern of spending for The Household Sector goods, real outlays for consumer services remained on a moderate upward Consumer Spending trend over the first half of 2006; they After increasing at a robust rate around rose at an annual rate of 2V2 percent the turn of the year, consumer spending from the fourth quarter of 2005 through has been rising at a more moderate pace May 2006. in recent months. Over the first half of Boosted by gains in nominal wage 2006, rising employment and the lagged and salary income, after-tax aggregate effect of increases in wealth continued personal income rose at an annual rate to provide support for spending by of 4 percent over the first five months households. However, consumers' pur- of 2006. However, the acceleration in chasing power was restrained by a fur- consumer prices held real income about ther run-up in energy costs in the spring. constant. As a result, the steep decline Sales of new cars and light trucks in the personal saving rate, which began bounced back sharply at the turn of the in 2004, extended into 2006. Since year; those sales had slackened in late 2003, rising household wealth has 2005 after manufacturers ended the spe- provided important support for spendcial "employee discount" programs that ing, even as gains in real income have had boosted sales last summer. New been damped by increases in energy light vehicles sold at an annual rate of prices. In 2005 and the first part of 16.8 million units between January and 2006, much of the increase in wealth April, about the same as the average rate was the result of the rapid appreciation in 2004 and 2005. However, elevated in the value of homes. gasoline prices affected the composition According to the survey by the Uniof demand, and consumers shifted their versity of Michigan Survey Research purchases away from light trucks and Center (SRC), the run-up in energy sport-utility vehicles (SUVs) and to- prices contributed importantly to the deward autos. That shift led to an increase terioration in consumer confidence this in the market share captured by foreign spring. Consumers' pessimism peaked producers. As households' concerns in May and then lessened somewhat, on about the higher price of gasoline average, in June and early July. Noneweighed on their attitudes toward buy- theless, at midyear, households indiing vehicles, sales dipped to an annual cated that they were still concerned rate of 16.2 million units in May and about the effect of the high cost of June. energy on their financial situation. In Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 41 addition, households' assessments of Although recent increases in house current and expected business condi- prices have been smaller than those that tions remained considerably less opti- accompanied the robust real estate marmistic than they were at the beginning kets of 2004 and 2005, the deceleration of the year. thus far appears to have been modest. The repeat-transactions index of house prices, which is published by the Office Residential Investment of Federal Housing Enterprise Over- The demand for homes had begun to sight, increased at an annual rate of soften in the summer of 2005, and, by 11A percent in the first quarter of 2006, the spring of 2006, starts of new single- the smallest quarterly increase since the family homes were well below the very fourth quarter of 2001; that index atrapid pace that had prevailed in the pre- tempts to control for the quality of existceding two years. The reduced level of ing single-family homes sold by using activity in real estate markets also led to prices of homes involved in repeat transsome easing in house-price appreciation actions (excluding refinancings). The early this year. first-quarter reading brought the year- Sales of new and existing single- over-year change in this measure to 10 family homes, which had been climbing percent; in the second and third quarters steadily since 2003, stopped rising dur- of 2005, purchase prices according to ing the third quarter of 2005. By May, this index were up IIV2 percent from sales of new and existing homes to- the level of a year earlier. An alternative gether were 7V4 percent below their measure of house prices is the average peak in June 2005. The cooling in sales price of existing single-family homes caused inventories of unsold homes to sold, which is published by the National rise. In May, the backlog of unsold new Association of Realtors. This measure, homes equaled SVi months' supply at which does not control for the type of that month's selling rate, and the back- homes sold, showed that the year-overlog of existing homes on the market was year change in prices peaked at 6V2 months' supply; in 2005, the stocks IIV2 percent in August 2005 and then of both unsold new and existing homes fell to 4 percent in April and May of this averaged roughly 4V2 months of supply. year. The greater deceleration in the lat- An increase in mortgage rates contrib- ter measure suggests that, in addition to uted to the slackening in the demand for some softening in prices, the mix of housing. Since the middle of 2005, the existing units sold may have shifted toaverage rate for a thirty-year fixed-rate ward lower-priced homes. mortgage has increased about 1 percent- The effect of the slowdown in deage point, to 63/4 percent, and the aver- mand on new construction became apage for a one-year adjustable-rate mort- parent during the second half of 2005, gage has risen a bit more, to 53A percent. when the number of permits issued for According to respondents to the Michi- new single-family homes began to fall. gan SRC survey, the rise in borrowing This year, the decline in permit issuance costs has been an important consider- was relatively steady from January to ation damping their assessment of buy- May. Nonetheless, new single-family ing conditions for homes since mid- homes were started at an exceptionally 2005; the rise in home prices has high annual rate of 1.75 million units apparently also weighed on consumers' during the first quarter, when builders attitudes. were able to begin work on scheduled Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

42 93rd Annual Report, 2006 projects earlier than normal because of placed, in part, some consumer credit favorable weather conditions. With borrowing, which, at an annual rate of a some starts having been advanced into bit less than 3 percent, continued to the first quarter, single-family starts expand modestly in the first five months dropped to an average rate of 1.57 mil- of 2006. lion units in April and May. In contrast The ratio of household financial oblito the recent trend in the single-family gations to disposable income rose sector, construction of new multifamily 0.1 percentage point in the first quarter homes averaged an annual rate of to about 183/4 percent, narrowly exceed- 360,000 units from January to May, ing the top of its historical range. Noneabout where it has been for more than theless, the evidence points to only limfour years. ited pockets of financial distress in the Housing activity, as measured by real household sector. Delinquency rates on expenditures on residential structures, residential mortgages were low by hiscontributed almost Vi percentage point torical standards in the first quarter, per year to the annual rate of increase in though they have edged higher since the real GDP in 2004 and 2005. In the first middle of last year, particularly in the quarter of 2006, that contribution subprime sector. Delinquency rates on dropped to 0.2 percentage point; with consumer debt also continued to be low. the reduced pace of sales and construc- Meanwhile, household bankruptcy filtion since the winter, a decline in resi- ings remained subdued in the first half dential investment is likely to have held of 2006, running at a pace well below down the rise in real GDP in the second the average of recent years. Bankruptquarter. cies have likely been damped this year in part by the decision of some households in the fall of 2005 to accelerate Household Finance their filings to avoid the implementation Household debt expanded at an annual of a stricter bankruptcy law in October. rate of about IIV2 percent in the first More recently, they may also have been quarter of 2006, about the same pace as restrained by the greater costs of bankin 2005. Despite the rise in mortgage ruptcy under the new law. rates and the slowing in housing activity, home mortgage debt expanded rap- The Business Sector idly again early in the year as homeowners apparently continued to extract some Fixed Investment of the substantial gains in equity that they have accumulated on their homes Real business fixed investment inin the past several years. Indeed, accord- creased at a solid rate, on average, during to industry estimates, although the ing the final quarter of 2005 and the first number of homeowners refinancing quarter of 2006. Over that period, real their mortgages has remained well be- business spending for new equipment low that seen during the refinancing and software rose at an annual rate of boom of several years ago, a large frac- 93/4 percent, a pace similar to that over tion of homeowners who have refi- the first three quarters of 2005. In addinanced so far this year have chosen to tion, investment in nonresidential strucwithdraw equity from their homes. As tures, which had remained weak in has been the case in recent years, this 2005, turned up noticeably in early mortgage-related borrowing likely re- 2006. The underlying determinants of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 43 capital spending have stayed quite posi- historical standards so far this year. tive: Businesses have seen steady Industry analysts suggest that firms may increases in sales, robust profits, and be delaying investment in anticipation declining user costs for equipment; they of introductions, later this year and in have ample liquid assets; and, despite early 2007, of several products that will the rise in interest rates, credit quality is allow faster and more energy-efficient strong. processing. Spending on equipment Real outlays for equipment and soft- other than transportation and high-tech ware rose at an annual rate of goods continued to trend up at a solid 143A percent in the first quarter after pace, on average, during the fourth and having risen at a 5 percent rate in the first quarters. Demand was particularly fourth quarter of 2005. As can often be strong for metalworking and general the case, the timing of spending for a industrial machinery as well as for number of types of equipment was un- equipment used in construction, energy even between these two quarters. Busi- extraction, and services industries. ness purchases of cars and trucks slowed Demand for equipment and software in late 2005, after manufacturers re- appears to have risen again in the secduced their special discounts on light ond quarter. The information from U.S. vehicles, and then recovered in the first manufacturers on their orders and shipquarter. The first-quarter rebound was ments of nondefense capital goods and strengthened by a further acceleration of the data on imports of capital goods outlays for medium and heavy trucks. suggest that business spending for According to industry analysts, busi- equipment other than transportation and nesses have been pulling forward these high-tech items remained on a strong purchases because the engines in the upward trajectory in April and May. The 2007 models will be required to meet elevated backlog of unfilled orders at new emission regulations by the Envi- domestic firms likely provided support ronmental Protection Agency that will for factory production of capital equipmake the new vehicles more costly to ment in the second quarter. The indicaoperate. Deliveries of commercial air- tors of demand for high-tech equipment craft to domestic customers also re- suggest that spending for communicabounded in the first quarter from a very tions equipment remained at a high low level in the fourth quarter. level, and real outlays for computing Demand for high-technology equip- equipment were still rising slowly. Sales ment stepped up noticeably in the first of medium and heavy trucks continued quarter because of a sharp jump in out- to be robust in the second quarter, lays for communications equipment. although they eased slightly from the Providers of telecommunications ser- exceptional rate at the beginning of the vices appear to be investing heavily in year. fiber-optic networks, which will allow Real expenditures for nonresidential them to offer a wider range of Internet construction increased at an annual rate services; the recent spurt likely also of 12V2 percent in the first quarter after includes some replacement demand for having edged up slightly during 2005. equipment damaged by last year's hurri- Last year, the small net increase in this canes. In contrast, business demand for sector reflected a sharp upturn in spendcomputing equipment, while still in- ing on structures used in domestic creasing at a double-digit pace in real energy exploration; construction of new terms, has been relatively modest by office and industrial buildings was re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

44 93rd Annual Report, 2006 strained by elevated vacancy rates. corporations measured as a share of sec- However, vacancy rates for office and tor GDP rose to about 14 percent in the industrial properties gradually declined first quarter, above the previous peak over the course of 2005, and, by the reached in 1997. turn of the year, nonresidential construc- The expansion of business debt tion began to firm. As a result, the picked up to an annual rate of nearly increase in nonresidential investment in 10 percent in the first quarter of this the first quarter of 2006 was broadly year, and data in hand suggest a robust based; it included pickups in outlays in pace in the second quarter. A substantial the office, retail, and industrial sectors fraction of borrowing proceeds reportin addition to another steep rise in edly went to finance mergers and acquispending on structures associated with sitions in the first half of the year. Net energy exploration. bond issuance has been strong so far in 2006. Short-term borrowing by nonfinancial corporations stepped up in the Inventory Investment first quarter of 2006 after slowing some- Business inventories appear generally to what in the fourth quarter of last year; it be well aligned with sales. In surveys appears to have remained strong in the taken during the first six months of second quarter as well. Commercial 2006, about two-thirds of purchasing paper outstanding started rising again, managers at manufacturing firms who on balance, after edging lower in 2005. responded characterized the level of Bank business loans outstanding their customers' inventories as about expanded at an annual rate of 15V2 perright. A similar proportion of respon- cent in the first quarter. Businesses bendents at nonmanufacturing firms re- efited from a more accommodative lendported that they were comfortable with ing environment: For example, a their own levels of inventories. How- significant net fraction of respondents to ever, dealer stocks of new light motor the Federal Reserve's Senior Loan Offivehicles, particularly trucks (including cer Opinion Survey on Bank Lending SUVs), have risen noticeably as sales Practices in April 2006 noted that their have slowed; inventories of light trucks institutions had eased both standards and reached an uncomfortable 89 days' sup- terms on commercial and industrial ply in May. In late June, a number of loans in the first three months of the manufacturers introduced a new round year. The most commonly cited reasons of incentives aimed at reducing dealer for the easing of lending policies were stocks in advance of the introduction of more-aggressive competition from other their new models this fall. banks and nonbank lenders, increased liquidity in the secondary market for business loans, and increased tolerance Corporate Profits for risk. and Business Finance Gross equity issuance has remained Corporate profits were again strong in moderate so far this year, while an elthe first quarter of 2006, and earnings evated level of cash-financed mergers per share for S&P 500 firms rose about along with record share repurchases has 15 percent from the same time last year. produced further sizable net equity re- Gains were widespread but were espe- tirements. Taken together, net funds cially large for firms in the energy sec- raised by nonfinancial corporations in tor. Before-tax profits of nonfinancial the credit and equity markets have been Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 45 slightly negative in 2006, an indication Thus, in its recent Mid-Session Review that nonfinancial corporations have fi- of the budget, the Administration estinanced their increased investment mated that the federal government will spending with internal funds. finish fiscal 2006 with a deficit of $296 With profitability strong and balance billion; that figure marks a decline from sheets flush with liquid assets, credit the fiscal 2005 deficit of $318 billion quality in the nonfinancial business sec- and is much lower than most analysts tor generally has remained quite high. had projected at the beginning of this The six-month trailing default rate on year. corporate bonds dropped after some During the twelve months ending in large firms in the troubled airline and June, federal receipts were 13V4 percent automobile sectors defaulted during the higher than over the same period a year past fall and winter. Delinquency rates earlier and equivalent to almost on business loans have stayed near the I8V4 percent of nominal GDP. Income bottom of their historical range. tax receipts from individuals have out- Commercial real estate debt expanded paced the rise in nominal income; final briskly in the first half of 2006, albeit tax payments on income from 2005 were not as quickly as during 2005. Spreads especially strong in April and May. Coron BBB-rated commercial-mortgage- porate tax payments continued to rise at backed securities have fallen this year. a robust rate, even faster than corporate The decline reversed an increase that profits. took place at the end of last year, when Nominal federal outlays rose 9 perissuance surged; these spreads are now cent between June 2005 and June 2006 back in line with those of comparable- and were about 2OV2 percent of nominal quality corporate bonds. With rents GDP. The rise in outlays was bolstered climbing and vacancy rates falling, de- by increases in several components of linquency rates on commercial real es- federal spending. Net interest payments tate loans have been low, and credit increased 20 percent over the year endquality has remained generally good. ing in June as federal debt continued to rise and interest rates increased. Medicare outlays were up 14V2 percent; since The Government Sector the inception of the new Part D prescrip- Federal Government tion drug program in January, outlays for benefits have added more than $20 The deficit in the federal unified budget billion to spending in this category. Legnarrowed further during the past year. islative actions related to the hurricanes Over the twelve months ending in June, in the Gulf Coast region last autumn the unified budget recorded a deficit of have added significantly to spending for $276 billion, about $60 billion less than disaster relief over the past ten months. during the comparable period last year. Although defense spending has slowed The federal deficit over the twelve from the annual double-digit rates of months ending in June was approxi- increase from 2002 to 2004, it still has mately 2 percent of nominal GDP and increased about 8 percent per year in the was significantly lower than its recent past two years. fiscal year peak of 3.6 percent of GDP As measured in the national income in 2004. Although outlays increased and product accounts (NIPA), real fedfaster than nominal GDP over the past eral expenditures on consumption and year, the rise in receipts was even larger. gross investment—the part of federal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

46 93rd Annual Report, 2006 spending that is a direct component of far this year than in the comparable real GDP—increased at an annual rate period of 2005. of VA percent, on average, during the In February, the Treasury conducted final calendar quarter of 2005 and the an auction of thirty-year bonds for the first calendar quarter of 2006 and con- first time since 2001. The issue genertributed roughly 0.3 percentage point to ated strong interest, especially from the annualized change in real GDP over investment funds; foreign investors were the period. Over these two quarters, real awarded only a small fraction of the defense purchases were about constant, total. In general, foreign demand for on average, while spending related to Treasury securities appears to have disaster relief from the hurricanes con- eased somewhat in 2006. The proportributed importantly to a rise in real tion of nominal coupon securities nondefense purchases. bought at auction by foreign investors The narrowing of the federal deficit has continued to fall from its peak of recently has reduced its drain on na- 24 percent in 2004; it averaged about tional saving. However, net national sav- 14 percent in the first six months of ing excluding the federal government 2006. Data from the Treasury Internahas remained low relative to historical tional Capital system generally sugnorms. Although the saving rate for pri- gested subdued demand from both forvate business has moved up during the eign private investors and foreign past two years, the improvement has official institutions over this period. The been offset by the further decline in amount of Treasury securities held in personal saving. Overall, national sav- custody at the Federal Reserve Bank of ing, net of depreciation, stood at New York on behalf of foreign official 2V2 percent of nominal GDP in the first and international accounts has changed quarter of 2006. Although the recent little since the end of 2005. rate is a noticeable improvement from the lows of the preceding few years, it State and Local Governments has been insufficient to avoid an increasing reliance on borrowing from abroad The fiscal positions of states and localito finance the nation's capital spending. ties continued to improve through early 2006. In particular, revenues are on track to post a relatively strong gain for a Federal Borrowing third consecutive year. Tax receipts from Federal debt rose at an annual rate of sales, property, and personal and corpo- 13 percent in the first quarter, a bit less rate income were up %lA percent during than in the corresponding quarter of the year ending in the first quarter of 2005. In February, federal debt subject 2006, a rate similar to the increase in the to the statutory limit reached the ceiling preceding year. The sustained strength of $8,184 trillion, and the Treasury re- in revenues has enabled these jurisdicsorted to accounting devices to avoid tions to increase their nominal spending breaching the limit. The Congress sub- somewhat while rebuilding their reserve sequently increased the debt ceiling to funds. On a NIPA basis, net saving by $8,965 trillion in March. In the second state and local governments—a measure quarter, federal debt likely declined tem- that is broadly similar to the surplus in porarily because of a surge in tax re- an operating budget—rose to an annual ceipts. On net, the Treasury has raised rate of $21 Vi billion in the first quarter substantially less cash in the market so of 2006 after having been close to zero Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 47 in 2005. Although most states have seen downgrades. Consistent with the imimprovement, a number of states are provement in credit quality, yields on still struggling with structural imbal- long-dated municipal bonds have inances in their budgets, and those in the creased substantially less than those on Gulf Coast region are coping with de- comparable-maturity Treasury securimands related to damage from last ties, and the yield ratio has accordingly year's hurricanes. In addition, local gov- fallen sharply. ernments may face pressure to hold the line on property taxes after the sharp The External Sector increases in the past several years, and governments at all levels will have to The U.S. current account deficit narcontend with the need to provide pen- rowed in the first quarter of 2006 to sions and health benefits to a rising $835 billion at an annual rate, or about number of retirees in coming years. 6V2 percent of nominal GDP, from Real expenditures by state and local $892 billion in the fourth quarter of governments on consumption and gross 2005. The narrowing resulted from three investment, as estimated in the NIPA, factors. Unilateral transfer payments to rose at an annual rate of Wi percent in foreigners dropped, largely because of a the first quarter of 2006 after having decrease in government grants. The increased roughly 1 percent per year in trade deficit narrowed, primarily be- 2004 and 2005. Real expenditures for cause the value of imported oil and natuinvestment turned up in the first quarter ral gas declined. In addition, higher after having fallen during the second direct investment receipts and lower half of 2005. Real outlays for current direct investment payments produced consumption posted a moderate increase an increase in the investment income in the first quarter, and that trend balance. appears to have continued into midyear. Hiring by state and local governments International Trade was slow early in the year but appears to have firmed in the spring. Of the cumu- Real exports of goods and services lative increase in employment of increased \A3A percent at an annual rate 100,000 between December and June, in the first quarter of 2006, far faster 40 percent of the jobs were in education. than the 6V2 percent rate recorded in 2005. The surge in export growth in the first quarter resulted in part from a State and Local Government recovery in exports of many types of Borrowing industrial supplies following a period of Borrowing by state and local govern- hurricane-related disruptions late last ments has slowed thus far in 2006. The year. Exports of capital goods also deceleration likely reflects the general increased rapidly in the first quarter, improvement in budget conditions and a with deliveries of aircraft to foreign cardecline in advance refundings, which riers exhibiting particular strength. The have dropped below their 2005 pace first-quarter increase in exports was amid rising interest rates and a dwin- widespread across destinations, a sign of dling pool of eligible securities. Credit robust economic activity in many parts quality in the state and local sector has of the world, and exports to Mexico and continued to improve, and upgrades of Canada showed especially large incredit ratings have far outnumbered creases. Real exports of services rose Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

48 93rd Annual Report, 2006 at an annual rate of about 6*/2 percent in Prices of imported goods excluding the first quarter after increasing just oil and natural gas rose at an annual rate 23/4 percent in 2005. Available data for of about 1 percent in the first quarter of nominal exports in April and May sug- 2006, 3/4 percentage point faster than the gest that the increase in real exports was pace in the second half of 2005. Prices smaller in the second quarter, held down of material-intensive goods, such as in part by a drop in aircraft exports after nonfuel industrial supplies and foods, a strong first quarter. increased steadily in the last quarter of Prices of exported goods increased at 2005 and in the first quarter of 2006. an annual rate of 23A percent in the first Also in the first quarter, prices of finquarter of 2006, a pace somewhat faster ished goods, such as consumer goods than in the second half of 2005. Prices and many kinds of capital goods, turned of non-agricultural industrial supplies up slightly. Available data for the seccontinued to increase steadily in the first ond quarter indicate that prices of finquarter, driven importantly by higher ished goods kept rising at a subdued prices for oil and metals. An accelera- pace. However, prices of materialtion in prices for finished goods, espe- intensive goods continued to increase cially for capital and consumer goods, sharply, a development reflecting higher contributed to the faster pace of export prices for metals. The International price inflation in the first quarter. The Monetary Fund's index of global metals available data for the second quarter prices rose 46 percent between Decempoint to further increases in export ber 2005 and May 2006, largely because prices on the strength of additional run- of robust global demand. In June, metals ups in the prices of non-agricultural prices retreated about 8 percent, industrial supplies, especially metals. although they remained well above the Real imports of goods and services levels of earlier this year. rose at an annual rate of 103/4 percent in The spot price of West Texas intermethe first quarter, slightly slower than in diate crude oil increased from around the fourth quarter but still considerably $60 per barrel at the end of last year to faster than the 5lA percent rate observed more than $75 per barrel in July, higher for 2005 as a whole. Robust growth of than the peak that followed last year's real GDP in the United States supported hurricanes. Oil prices have been highly the first-quarter increase in imports. sensitive to news about both supply and Among categories of goods, large demand, particularly in light of the narincreases in imports of consumer goods, row margin of worldwide spare producautomotive products, and capital goods, tion capacity. Global oil demand has particularly computers, more than offset continued to grow as the foreign ecodeclines in imports of oil and some other nomic expansion has spread, and develindustrial supplies. The rise in imports oping countries have posted the largest in the first quarter was widely distrib- increases in oil consumption. Recent uted across countries, and the increases events in the Middle East—including for China and Mexico were especially concerns over Iran's nuclear program, large. Real imports of services jumped violence in Iraq, and the recent conflict at an annual rate of 8V2 percent in the in Lebanon—have put additional first quarter. Nominal imports in April upward pressure on oil prices. In Nigeand May point to an abrupt slowing of ria, attacks against oil infrastructure real imports in the second quarter from have reduced oil production for most of the first quarter's rapid pace. this year. Government intervention in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 49 energy markets also raised concerns U.S. direct investment abroad, a reversal about supply from some countries: In of some unusual inflows in the second recent months, Bolivia nationalized its half of 2005. These second-half inflows natural gas reserves, and Venezuela and were prompted by the partial tax holiday Russia continued to tighten governmen- offered under the 2004 Homeland tal control of their energy industries. Investment Act (HIA), which induced The rise in the price of the far-dated the foreign affiliates of U.S. firms to NYMEX oil futures contract (currently repatriate a portion of earlier earnings for delivery in 2012) to more than $70 that had been retained abroad. In the per barrel likely reflects a belief by oil first quarter, the foreign affiliates parmarket participants that the balance of tially unwound the HIA-induced flows supply and demand will remain tight by retaining an unusually large portion over the next several years. of their first-quarter earnings. Increased merger activity abroad also boosted direct investment outflows in the first The Financial Account quarter. The U.S. current account deficit continues to be financed primarily by foreign purchases of U.S. debt securities. For- The Labor Market eign official inflows in the first quarter Employment and Unemployment maintained the strength exhibited in 2005 but remained below the record Conditions in the labor market levels of 2004. As in recent years, the continued to improve in the first half of majority of these official inflows were 2006, although the pace of hiring has attributable to Asian central banks and slowed in recent months. Nonfarm have taken the form of purchases of U.S. payroll employment increased 176,000 government securities. per month during the first quarter, a rate Foreign private purchases of U.S. se- roughly in line with the relatively brisk curities continued in the first quarter at pace that prevailed during 2004 and the extraordinary pace set in the second 2005. During the second quarter, hiring half of 2005. Although private flows slowed, and monthly gains in payrolls into U.S. Treasury bonds were signifi- averaged 108,000 jobs per month. Over cantly smaller than in recent quarters, the two quarters, the civilian unemploythis slowing was more than offset by ment rate edged down further, to the larger flows into agency bonds and equi- lowest quarterly level of joblessness in ties. Preliminary data for April and May five years. suggest a slowdown in foreign pur- In the first quarter, with homebuilding chases of U.S. securities relative to the quite strong, hiring continued to be parfirst quarter. Foreign direct investment ticularly robust at construction sites; part flows into the United States continued of this strength was the result of favorin the first quarter near last year's aver- able weather, which allowed more conage levels. struction activity than is typical during Net purchases of foreign securities by the winter months. Although nonresi- U.S. residents, which represent a finan- dential construction activity was firming cial outflow, strengthened slightly in the by the spring, the pullback in housing first quarter and continued at a solid starts slowed the demand for residential pace in April and May. In addition, sig- contractors and workers in the building nificant outflows were associated with trades. As a result, monthly additions to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

50 93rd Annual Report, 2006 construction industry payrolls declined UI claimants who remained on the unfrom more than 25,000 per month in the employment rolls until the exhaustion of first quarter to just 3,000 per month in their benefits continued to recede. the second quarter. Cutbacks at retailers After having edged up during 2005, also were an important factor holding the labor force participation rate was down the overall gain in employment in relatively stable over the first half of the second quarter. After having been 2006 despite the ongoing improvement stable early in 2006, employment at in labor market conditions. Rates for retail outlets fell almost 30,000 per most broad age groups were little month between March and June; most changed from last year's levels. From a of the cutbacks occurred at general longer perspective, developments durmerchandisers. ing the past decade highlight the impor- In other sectors, employment re- tance of structural as well as cyclical mained on a solid upward trend during influences on participation. The rise in the first half of the year. As has been the the attachment of adult women to the case since mid-2004, establishments workforce, which was a significant facproviding education and health services, tor in the secular rise in participation those offering professional and technical over much of the post-World War II business services, and those involved in period, appears to have leveled off. And financial activities, taken together, the aging of the population is increasing added more than 60,000 jobs per month. the proportion of the workforce that is Employment in manufacturing, which 55 years and older; it rose from less than had turned up at the end of 2005, rose 12 percent in 1996 to 163/4 percent in further over the first half of 2006. recent months. Although older workers Expanding industrial production was have tended in recent years to stay in the also associated with further job gains in labor force longer, their participation related industries, such as wholesale rate, at 38 percent in the second quarter, trade and transportation. In addition, the was less than half the rate for workers increase in energy production led to a who are age 25 to 54. Thus, the demosustained rise in employment in the graphic shift to an older population has natural resources and mining industry already begun to reduce the overall rate over the first half of the year. of labor force participation and has off- The increase in job opportunities so set part of the rise in participation that far in 2006 led to a further reduction in has been associated with the cyclical the civilian unemployment rate, from an upturn in job creation. The secular average of 5.0 percent in the second half forces that are slowing the expansion of of 2005 to 4.7 percent in the second the labor force imply that the increase in quarter of 2006. Although hiring moder- employment that is consistent with a ated in the spring, layoffs remained low. stable unemployment rate will, over New claims for unemployment insur- time, be smaller than it was during the ance (UI) dipped below 300,000 per period when labor force participation week in January and February and then was rising steadily. fluctuated around a still-low level of about 315,000 per week for most of the Productivity and Labor Costs period from March through early July. Over the first half of 2006, longer-term After having advanced at an unusually unemployment (fifteen weeks or more) rapid rate from 2001 to mid-2004, labor also moved down, and the proportion of productivity in the nonfarm business Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 51 sector increased at a more moderate 2005. The cost of health insurance, annual rate of 2Vi percent from mid- which typically accounts for about one- 2004 to early 2006. Nonetheless, by his- fourth of overall benefit costs, rose just torical standards, productivity perfor- 43/4 percent during the year ending in mance recently has still been solid, with March 2006; between 2000 and 2005, gains at a rate matching those during the these costs increased, on average, second half of the 1990s. In an environ- 83/4 percent per year. Another likely conment of a sustained expansion of aggre- tributor to the slower rise in benefit gate demand, businesses have gradually costs over the past year was smaller adjusted their use of labor, capital, and employer contributions to their definedservices to achieve ongoing gains in benefit pension plans; those costs efficiency. Productivity has continued dropped back somewhat after employers to benefit importantly from investment made sizable payments to bolster those in new technologies, organizational pension assets in 2004. changes, and improvements in business Indicators of the recent trend in the processes, although the contribution wage component of worker compensafrom capital deepening has been smaller tion have been providing mixed signals. in recent years than it was during the As measured in the ECI, wages rose capital investment boom of the late 2.4 percent between March 2005 and 1990s. March 2006, slightly less than in the Broad measures of hourly labor com- preceding two years. In contrast, the pensation, which include both wages year-over-year change in average hourly and the costs of benefits, posted moder- earnings of production or nonsuperviate gains over the year ending in early sory workers—which refers to a nar- 2006 despite the run-up in headline price rower group of private nonfarm employinflation and the further tightening of ees and has tended to show greater labor markets. Both the employment cyclical variation than the ECI—has cost index (ECI) and the estimate of increased steadily over the past three compensation per hour that uses data years. Average hourly earnings rose from the national income and product 3.9 percent over the twelve months endaccounts increased 23A percent between ing in June 2006, compared with an the first quarter of 2005 and the first increase of 2.7 percent over the twelve quarter of 2006.1 Both series had re- months ending in June 2005. ported higher rates of change in hourly labor compensation a year earlier. Prices The deceleration in labor compensation appears to have been associated Inflation pressures were elevated during largely with smaller increases in em- the first half of 2006. The chain-type ployers' benefit costs. The benefits com- price index for personal consumption ponent of the ECI was up just 3 percent expenditures (PCE) rose at an annual between March 2005 and March 2006, rate of 4x/4 percent between December compared with an increase of 5.5 per- 2005 and May 2006. Over the same cent between March 2004 and March period, core PCE prices increased at an annual rate of 2.6 percent, nearly 1. The Bureau of Labor Statistics (BLS) devel- 0.6 percentage point faster than over the oped a new ECI series and has provided data for twelve months of 2005. the changes in that series beginning in 2001. The Although energy prices eased tempo- BLS considers the new ECI to be continuous with the old series. rarily in February, they turned up Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

52 93rd Annual Report, 2006 Alternative Measures of Price Change Food price inflation remained moder- Percent ate during the first five months of 2006; between December 2005 and May 2006, 2004 2005 the PCE price index for food and bever- Price measure to to 2005 2006 ages increased at an annual rate of 2lA percent. Retail prices of meat and Chain-type (Ql to Ql) poultry have fallen so far this year. Gross domestic product (GDP) . 2.8 3.1 Gross domestic purchases 3.1 3.5 Domestic supplies of meat have been Personal consumption ample. Production has been expanding expenditures (PCE) 2.7 3.0 Excluding food and energy ... 2.2 1.9 at a time when export demand for beef Market-based PCE excluding has been soft largely because of bans on food and energy 1.8 1.5 imports of U.S. beef by Japan and Fixed-weight (Q2 to Q2) Consumer price index 3.0 4.0 Korea. Prices of processed food have Excluding food and energy ... 2.1 2.4 continued to rise at only a moderate rate despite higher prices for grains; export NOTE: Changes are based on quarterly averages of seasonally adjusted data. demand for grains has been strong, and the price of corn has been boosted by demand from producers of ethanol. sharply again from March to May; as a Prices for food consumed away from result, the PCE price index for energy home, which typically are influenced increased 13 percent (not at an annual heavily by labor and other business rate) over the first five months of 2006, costs, have continued to increase a rise that marked a continuation of the relatively rapidly, rising at an annual steep climb in prices that began in 2004. rate of 33A percent over the first five This year, almost the entire rise in months of the year. energy prices has been associated with The pickup in core inflation in the higher prices for petroleum-based prod- first half of 2006 was evident in the ucts. The PCE price index for gasoline indexes for both goods and services. and motor fuel, which increased more Prices of consumer goods excluding than I6V2 percent last year, climbed food and energy, which were unchanged another 24 percent (not at an annual in 2005, edged up at an annual rate of rate) by May. Although recent data from 3/4 percent this year. Prices of consumer the Department of Energy indicate that services also accelerated this spring; as gasoline prices fell back in June, they a result, the PCE price index for nonmoved up again in early July. Retail energy services increased at an annual prices of gasoline this year have risen rate of 3Vi percent between December faster than the cost of crude oil in part 2005 and May 2006, compared with a because of the additional cost of produc- rise of 23/4 percent in 2005. In the three ing and distributing reformulated prod- months ending in May, increases in uct with ethanol. Also, the demand for housing rents were especially steep; the fuel ethanol has been strong relative to rise may reflect, in part, a shift in dethe current capacity to produce it. In mand toward rental units because home contrast, the consumer price of natural purchases have become less affordable. gas has turned down this year as inven- Another contributor to the higher inflatories have remained relatively high; the tion rate for consumer services has been price decline between January and May the acceleration in the index for nonmaralmost completely reversed the steep ket services to an annual rate of 4 perrun-up that occurred last autumn. cent over the first five months of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 53 year from 3 percent last year.2 More through to pricing of final goods and broadly, the pickup in core consumer services even as businesses have seen price inflation over the first five months their labor costs, which represent of 2006 likely is the result of the pass- roughly two-thirds of their costs, remain through of higher energy costs to a wide restrained. range of goods and services. Near-term inflation expectations were The cost pressures from the increase also influenced importantly over the first in energy costs during the past three half of 2006 by movements in energy years have been apparent in rising prices prices, but, as of midyear, they were of inputs used in the production and sale only slightly higher than they were at of final goods and services. The pro- the turn of the year. The Michigan SRC ducer price index for intermediate survey measure of the median expectagoods, excluding food and energy, rose tion of households for inflation over the at an annual rate of 11A percent between next twelve months held steady at December 2005 and May 2006; this in- 3 percent during the first three months dex rose 43A percent in 2005 and of the year but then rose sharply to SV4 percent in 2004. In particular, prices 4 percent in May as gasoline prices of industrial chemicals, fertilizer, and climbed. By early July, this measure of stone and clay products, for which near-term inflation expectations dropped energy represents a relatively high share back to 3.1 percent. Longer-term inflaof the total costs of production, acceler- tion expectations remained within the ated over the past several years. The ranges in which they have fluctuated in costs of a number of important business recent years. On average over the first services, particularly transportation by half of 2006, the median respondent to air, rail, and truck, have also been the Michigan SRC survey continued to boosted by higher energy costs. The expect the rate of inflation during the pass-through of the costs of energy to next five to ten years to be just under consumer prices is clear for a few items, 3 percent. In June, the Survey of Professuch as airfares. For other components sional Forecasters, conducted by the of core consumer price indexes, how- Federal Reserve Bank of Philadelphia, ever, the extent of the pass-through is reported expected inflation at a rate of harder to trace. Quantifying the extent 2x/2 percent over the next ten years, an of the pass-through is difficult, in part expectation that has been roughly unbecause it is diffused through a wide changed for the past eight years. Inflarange of retail goods and services. In tion compensation implied by the spread addition, the cost of energy is a small of yields on nominal Treasury securities share of overall costs—and that share over their inflation-protected counterhas been declining over time as busi- parts rose slightly, on net, over the first nesses adopt more energy-efficient tech- half of the year; in early July it was just nologies and households reduce their above 2Vi percent. consumption of energy. Nonetheless, the cumulative rise in energy costs in recent U.S. Financial Markets years has been large enough to show U.S. financial markets functioned 2. These are services—such as foreign travel or smoothly in the first half of 2006 against the financial services provided by banks—for the backdrop of increased volatility in which no prices based on market transactions are some asset prices. Yields on nominal available; the Bureau of Economic Analysis must impute or estimate these indexes. Treasury coupon securities rose about Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

54 93rd Annual Report, 2006 70 basis points, on net, through early had to be removed, market participants July as investors came to appreciate that more recently have had to focus to a economic conditions and inflation pres- greater degree on economic data resures required more monetary policy leases and their implications for the outtightening than they had expected at the look for economic growth and inflation end of 2005. Equity prices advanced to form expectations about near-term until mid-May but then reversed those policy. Although the information curgains. Apparently, evidence of increased rently available suggests that growth of inflationary pressures and some softer- real output slowed appreciably in the than-expected data on economic activity second quarter, incoming price data have induced market participants to revise pointed to greater-than-expected infladown their longer-term outlook for busi- tionary pressures throughout the first ness profits and to perceive greater risks half of the year. Investors anticipated to that outlook. With corporate balance that the FOMC would act to counter sheets remaining strong and liquid, risk such pressures, and the expected policy spreads on corporate bonds stayed low, path moved upward, on balance, over an indication that the revision to the the first half of 2006. Nevertheless, maroutlook had not sparked broad concerns ket participants currently appear to about credit quality. Firms had ample expect the target federal funds rate to access to funds, and business-sector debt ease after the end of the year. Despite expanded rapidly in the first quarter. investors' apparent awareness that The need to finance brisk merger and monetary policy decisions increasingly acquisition activity was one factor that depend on the implications of incoming reportedly induced nonfinancial busi- information for the economic outlook, nesses to tap the credit markets heavily. the implied volatility on short-term Bond issuance picked up noticeably, and Eurodollar rates calculated from option commercial and industrial loans prices has remained near the low end of increased robustly. Banks continued to its historical range. ease terms and standards on such loans. Yields on nominal Treasury coupon Household debt expanded further in the securities rose about 70 basis points first quarter amid rising house prices across the maturity spectrum through and brisk cash-out refinancing activity. early July, in part because of the expec- As was the case in 2005, the M2 mone- tations for firmer policy. In addition, it tary aggregate has advanced moderately appears that a modest rebound in term so far in 2006. premiums, including investor compensation for inflation risk, may have contributed to the rise in longer-term rates; Interest Rates still, estimated premiums remain low by The FOMC increased the target federal historical standards. Yields on inflationfunds rate 25 basis points at each of its indexed Treasury securities rose less four meetings this year. These actions than those on their nominal counterbrought the rate to 5x/4 percent, about 60 parts, leaving inflation compensation at basis points above the rate expected at medium- and long-term horizons 20 to the end of last year for early July. In 30 basis points higher than at the turn of contrast to the situation earlier in the the year. tightening cycle, when it was evident to In the corporate bond market, yields investors that considerable monetary on investment-grade securities moved policy accommodation was in place and about in line with those on comparable- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 55 maturity Treasury securities through ever, investors withdrew funds as share early July. In contrast, those on prices began to sag. speculative-grade securities rose only about 40 basis points; as a result, risk spreads were 30 basis points lower in Debt and Financial Intermediation that segment of the market. The narrowness of high-yield spreads was likely a In the first quarter of 2006, the total debt reflection of investors' sanguine views of domestic nonfinancial sectors exabout corporate credit quality over the panded at an annual rate of 11 percent. medium term, given the strength of busi- The household, business, and federal ness balance sheets and the outlook for government components all increased continued economic expansion. at double-digit rates, while state and local government debt advanced at about a 6 percent pace. Preliminary Equity Markets data suggest somewhat slower growth Broad equity indexes changed little, on of the debt of nonfinancial sectors in net, through early July. Stock prices the second quarter. The slowdown is were boosted up to the first part of May particularly noticeable in the federal by an upbeat economic outlook and by and state and local government sectors, strong corporate earnings in the first where strong tax receipts held down quarter. However, those gains were sub- borrowing. The available data also sequently reversed as incoming data point to somewhat reduced growth of clouded the prospects for economic nonfinancial business debt in the secgrowth and continued to point to upward ond quarter. pressures on inflation; the drop in share Commercial bank credit increased at prices was led by stocks that had logged an annual rate of about 11 percent in the the largest gains in the previous months, first quarter of 2006, a little faster than including those of firms with small capi- in 2005, and picked up further to an talizations and of firms in cyclically sen- almost 13 percent pace in the second sitive sectors. A measure of the equity quarter. A continued rapid increase in risk premium—computed as the differ- business loans was likely supported by ence between the twelve-month forward brisk merger and acquisition activity, earnings-price ratio for the S&P 500 rising outlays for investment goods, onand an estimate of the real long-term going inventory accumulation, and an Treasury yield—has increased slightly accommodative lending environment. so far this year and remains near the Growth in commercial mortgages was high end of its range of the past two also strong, as fundamentals in that secdecades. The implied volatility of the tor continued to improve. Despite a S&P 500 calculated from option prices slowing of housing activity in recent spiked temporarily in late May and early months, residential mortgage holdings June and remained somewhat elevated expanded robustly. However, higher compared with its levels earlier in the short-term interest rates likely contribyear. uted to a runoff in loans drawn down Net inflows to equity mutual funds under revolving home-equity lines of were very strong through April, as in- credit. Consumer loans adjusted for sevestors were evidently attracted by the curitizations decelerated in the second solid performance of the equity market quarter after rising at a solid pace in the up to that point. In May and June, how- first quarter. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

56 93rd Annual Report, 2006 Bank profitability remained solid, and since. The velocity of M2 rose at an asset quality continued to be excellent in annual rate of 2lA percent in the first the first quarter. Profits were supported quarter and appears to have continued to by gains in non-interest income and re- rise in the second quarter. ductions in loan-loss provisions that more than offset a rise in non-interest expenses. Delinquency and charge-off International Developments rates remained low across all loan types. Delinquency rates on residential mort- Foreign economic growth was strong in gages on banks' books edged lower in the first quarter of 2006 as the t-^panthe first quarter after moving up during sion spread to all major regions of the 2005. Charge-off rates on consumer world. Accelerating domestic demand loans declined to the lowest level seen boosted growth in the foreign industrial in recent years after a fourth-quarter countries, especially Canada and the surge in charge-offs on credit card loans euro area. Emerging-market economies that was associated with the implemen- continued to benefit from rapid export tation of the bankruptcy legislation in growth, and Chinese economic activity October of last year. was also spurred by a surge in invest- As the policy debate about the possi- ment spending. Data for the second bility of curbing the balance sheet quarter suggest continued strong growth growth of both Fannie Mae and Freddie abroad but with moderation in some Mac continued, the combined size of the countries. Rising energy prices have mortgage investment portfolios at the pushed up inflation in many countries two government-sponsored enterprises this year, but upward pressure on core increased about 1 percent over the first inflation has generally continued to be five months of 2006. moderate. Foreign monetary policy tightened in the first half of this year in the context The M2 Monetary Aggregate of solid growth and some heightened In the first quarter of 2006, M2 in- inflation concerns. The European Cencreased at an annual rate of about tral Bank (ECB) raised its policy rate 6V2 percent, but its expansion moder- lA percentage point in March and again ated in the second quarter to a 23/4 per- in June, citing rapid credit growth and cent pace, likely because of some slow- the ECB's expectation of above-target ing in the growth of nominal GDP. inflation. At its July policy meeting, the Rising short-term interest rates contin- Bank of Canada kept its target for the ued to push up the opportunity cost of overnight rate unchanged at 4VA percent, holding M2 assets. Growth in liquid but it had increased its target for the deposits, whose rates tend to adjust slug- overnight rate lA percentage point at gishly to changes in market rates, was each of its previous seven policy meetparticularly slack. By contrast, the ex- ings. On July 14, the Bank of Japan pansion in retail money market funds (BOJ) ended its zero-interest-rate policy and, especially, small time deposits was by raising its target for the call money brisk, as the yields on those instruments rate to lA percent for the first time since kept better pace with rising market inter- 2001. Earlier, on March 9, the BOJ, est rates. Despite apparently modest de- announcing an end to its five-year-old mand from abroad, currency growth was policy of quantitative easing, said that it strong in the first quarter but has slowed would set policy in the future to control Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 57 inflation over the medium to long run, roughly 4 percent, on balance, against defined as one to two years ahead. the Mexican peso this year. During the Long-term bond yields abroad have first half of this year, several smaller risen along with U.S. bond yields on countries experienced episodes of subindications of robust global growth and stantial financial volatility that in some expectations of additional tightening of cases involved sharp depreciations in monetary policy. Ten-year sovereign the exchange value of their currencies. yields have risen roughly 70 basis points Through the first four months of in the euro area since the end of last 2006, a favorable economic outlook and year, while the increases on similar se- low interest rates supported gains in curities in Canada and the United King- equity prices in all major foreign coundom have been about 50 basis points. tries. During May and early June, how- Part of the rise in yields abroad has been ever, equity prices registered widespread increased compensation for possible declines, as market participants grew future inflation as measured by the dif- more concerned about inflation, moneference in yield between ten-year nomi- tary policy, and global economic nal and inflation-indexed bonds. Yield growth. More recently, developments in spreads of emerging-market bonds over the Middle East have weighed further U.S. Treasuries narrowed somewhat on stock prices. On net, equity price early in the year, but that narrowing was indexes are up between 1 percent and more than reversed in the second quarter 4 percent so far in 2006 in Europe and as investors apparently demanded Canada, but they have fallen roughly greater compensation for risk amid un- 8 percent since year-end in Japan. Latin certainties about economic growth and American and Asian emerging-market inflation. equity indexes, which had generally The foreign exchange value of the gained more than industrial-country indollar has declined about 4V2 percent, dexes early in the year, have fallen more on net, this year against a basket of the sharply since early May. Equity indexes currencies of the major industrial coun- in Mexico, Brazil, and Argentina have tries but is down only about 1 percent, dropped between 12 percent and 15 peron net, against the currencies of the cent—leaving them still between other important trading partners of the 5 percent and 7 percent higher so far this United States. Much of the dollar's year—while stock prices in Korea have downward move occurred at times when fallen about 9 percent, on net, for the the market was focused on concerns year. about global current account imbalances. The dollar has recovered some Industrial Economies ground since early May, as investors reportedly have engaged in flight- The Japanese economy has continued to to-safety transactions into dollar- strengthen this year, although economic denominated assets in conjunction with growth has stepped down a bit from the the volatility in global commodity and comparatively strong rate recorded in asset markets. On net, the dollar has 2005. Household consumption maindepreciated since the turn of the year tained a solid rate of growth in the first about 61/2 percent against the euro and quarter, and private investment spending sterling, 3 percent against the Canadian rose 11 percent. However, net exports, dollar, and 1 Vz percent against the Japa- which previously had been an additional nese yen. In contrast, the dollar has risen source of strength, did not contribute to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

58 93rd Annual Report, 2006 growth in the first quarter; the growth of ued to rise in the first half of this year. imports increased while export growth The twelve-month change in consumer remained firm. The labor market in Ja- prices was 2.2 percent in May. Conpan improved further in April and May: sumer prices have been boosted impor- The unemployment rate fell to 4 per- tantly by increases in energy prices over cent, and the ratio of job offers to appli- the past several months. cants reached a thirteen-year high. In Canada, real GDP grew at an Although the GDP deflator has contin- annual rate of nearly 4 percent in the ued to decline, other signs indicate that first quarter, an increase led by a jump deflation is ending. In the first quarter of in spending on consumer durables and 2006, land prices in Japan's six largest housing. Investment in residential struccities rose 3.8 percent over their year- tures grew at its fastest rate in more than ago level, the first increase since 1991. two years, and business investment con- Core consumer prices have shown small tinued to exhibit the strength observed twelve-month increases over the past in the previous two quarters. Indicators several months. for the second quarter point generally to Real GDP in the euro area accelerated a deceleration of GDP. Housing starts in in the first quarter, expanding 2Vi per- the second quarter were significantly becent, a rate of growth somewhat above low their elevated first-quarter levels; its average in recent years. The accelera- the merchandise trade balance declined, tion was spurred by strength in domestic on balance, during the first five months demand, especially private consumption of this year; and in the manufacturing spending, which increased in the first sector, the volume of new orders and of quarter at double its pace in 2005. Retail shipments both fell in April. In contrast, sales were also strong at the start of the in the second quarter, the labor market second quarter. The revival in household maintained its strength of the past year, spending has been supported by a small and the unemployment rate has fallen to rise in the growth rate of employment 6.2 percent, the lowest level in more and by an improvement in employer and than thirty years. Consumer prices rose 2.8 percent in the twelve months ending consumer perceptions of employment in May. prospects. Private investment spending has remained strong in the euro area, and business sentiment has continued to Emerging-Market Economies brighten in recent months. Energy price increases have pushed euro-area con- In China, growth of real output was sumer price inflation to about 2l/i per- especially robust in the first half. Ecocent recently, a level above the ECB's nomic indicators suggest that fixed 2 percent ceiling, but core inflation has investment surged and that export remained near IV2 percent. growth continued to be strong. The rapid In the United Kingdom, real GDP growth of investment prompted the Chiexpanded at an annual rate of 3 percent nese government to impose a series of in the first quarter after rising about new measures to slow capital spending, P/4 percent in 2005. Consumer spend- including controls on credit and land use ing grew about 1V2 percent, the same and stricter criteria for approving investmoderate pace seen last year. House ment projects. In addition, to restrain prices, which remained relatively flat credit, which has soared more than during late 2004 and most of 2005, 15 percent over the past year, China's picked up in late 2005 and have contin- central bank raised the one-year bank Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2006 59 lending rate in April and raised banks' range of 2 percent to 4 percent. After reserve requirements Vi percentage point easing policy nine times between in June. The Chinese trade surplus wid- August and April, the Bank of Mexico ened in the first half of this year as signaled in April that it would leave its exports accelerated. Chinese consumer policy rate unchanged for a time. price inflation is about IV2 percent, Real GDP growth in Brazil also slightly above its pace in the second half increased in the first quarter, rising to of last year but well below the more 53/4 percent, and was supported by very than 5 percent rate seen in 2004. strong performances in manufacturing, Economic growth in India, Malaysia, mining, and construction. The rate of and Hong Kong also was quite strong in inflation has been declining from a high the first quarter, although the pace of of 8 percent reached in April 2005; in activity of some of the other Asian June, the twelve-month change in prices emerging-market economies has moder- edged down to 4 percent. In late May, ated a bit from last year's rapid rate. the central bank reduced its target for Concerns about inflationary pressures the overnight interest rate 50 basis have increased, largely because of ris- points, to \5lA percent, bringing the cuing energy prices. In response, mone- mulative decline to 450 basis points tary policy has been tightened in some since the current easing phase began last countries, including Korea, India, and September. In the minutes of its late- Thailand. May meeting, the policy making com- In Mexico, strong performance in the mittee said that the onset of market volaindustrial sector, an expansion in ser- tility over the past month had increased vices output, and a recovery in agricul- its uncertainty about the prospects for tural production propelled real GDP inflation and had thus prompted it to growth to more than 6 percent at an ease less than it would have otherwise. annual rate in the first quarter. In addi- In Argentina, output growth slowed tion, a surge in manufacturing exports slightly in the first quarter. Amid emergboosted Mexico's trade and current ing capacity constraints, inflation rose to account balances noticeably. Industrial about 11 percent, up from 6 percent in production continued to increase early 2004. The Argentine government has in the second quarter. In June, Mexican tried to hold down inflation, with liminflation was 3.2 percent, just above the ited success, through voluntary price center of the Bank of Mexico's target agreements in several sectors. • 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

63 Banking Supervision and Regulation The Federal Reserve has supervisory issued a joint notice of proposed ruleand regulatory authority over a variety making (NPR) describing proposals for of financial institutions and activities. It implementing the Basel II framework in works with other federal and state super- the United States. In December, they visory authorities to ensure the safety issued an NPR proposing revisions to and soundness of supervised financial capital requirements for trading book institutions and the stability of U.S. positions subject to the market risk capifinancial markets as a whole. tal rule. The agencies are also develop- In 2006, U.S. banking organizations ing Basel II supervisory guidance for examiners and the banking industry. reported record earnings despite tight net interest margins resulting from a Under the NPR implementing Basel persistently flat yield curve and height- II, the new capital framework would be ened competition for deposits and loans. mandatory for large, internationally ac- Credit quality indicators remained his- tive banking organizations and optional torically strong, although nonperform- for all others. Federal banking superviing assets increased, particularly in resi- sors expect that the vast majority of dential real estate portfolios. For a banking organizations will remain subsecond consecutive year, there were no ject to the existing risk-based capital failures of insured banks. Banking su- framework (Basel I). To update Basel I pervisors focused on banking activities and mitigate some of the consequences of the differences between Basel I and that could prove vulnerable in the event Basel II, the agencies in December of an economic downturn. In particular, issued an NPR proposing changes to the the federal banking agencies during the Basel I framework that would be opyear issued guidance for supervised tional for banking organizations not subfinancial institutions on extensions of ject to Basel II. credit for nontraditional residential mortgages and for commercial real estate. Delinquencies among loans of these and Scope of Responsibilities for most other types remained low. Supervision and Regulation Federal Reserve staff continued to work throughout the year with the other The Federal Reserve is the federal sufederal banking agencies to prepare for pervisor and regulator of all U.S. bank U.S. implementation of the Basel II capi- holding companies, including financial tal accord.1 In September, the agencies holding companies formed under the authority of the 1999 Gramm-Leach- 1. The Basel II capital accord, an international Bliley Act, and state-chartered commeragreement formally titled "International Conver- cial banks that are members of the Fedgence of Capital Measurement and Capital Staneral Reserve System. In overseeing these dards: A Revised Framework," was developed by organizations, the Federal Reserve seeks the Basel Committee on Banking Supervision, which is made up of representatives of the central banks or other supervisory authorities of thirteen issued in November 2005 are available on the countries. The original document was issued in web site of the Bank for International Settlements 2004; the original version and an updated version (www.bis.org). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

64 93rd Annual Report, 2006 primarily to promote their safe and and inspections and off-site surveillance sound operation, including their compli- and monitoring. It also takes enforceance with laws and regulations.2 ment and other supervisory actions as The Federal Reserve also has respon- necessary. sibility for supervising the operations of all Edge Act and agreement corpora- Examinations and Inspections tions, the international operations of state member banks and U.S. bank hold- The Federal Reserve conducts examinaing companies, and the U.S. operations tions of state member banks, the U.S. of foreign banking companies. branches and agencies of foreign banks, The Federal Reserve exercises impor- and Edge Act and agreement corporatant regulatory influence over entry into tions. In a process distinct from examithe U.S. banking system, and the struc- nations, it conducts inspections of bank ture of the system, through its adminis- holding companies and their nonbank tration of the Bank Holding Company subsidiaries. Whether an examination or Act, the Bank Merger Act (with regard an inspection is being conducted, the to state member banks), the Change in review of operations entails (1) an as- Bank Control Act (with regard to bank sessment of the quality of the processes holding companies and state member in place to identify, measure, monitor, banks), and the International Banking and control risks; (2) an assessment of Act. The Federal Reserve is also respon- the quality of the organization's assets; sible for imposing margin requirements (3) an evaluation of management, inon securities transactions. In carrying cluding an assessment of internal poliout these responsibilities, the Federal cies, procedures, controls, and opera- Reserve coordinates its supervisory ac- tions; (4) an assessment of the key tivities with the other federal banking financial factors of capital, earnings, liagencies, state agencies, functional quidity, and sensitivity to market risk; regulators, and the bank regulatory and (5) a review for compliance with agencies of other nations. applicable laws and regulations. The table provides information on the examinations and inspections conducted by the Fed- Supervision for eral Reserve during the past five years. Safety and Soundness Inspections of bank holding companies, including financial holding compa- To promote the safety and soundness of nies, are built around a rating system banking organizations, the Federal Re- introduced in 2005 that reflects the reserve conducts on-site examinations cent shift in supervisory practices for these organizations away from the his- 2. The Board's Division of Consumer and torical analysis of financial condition Community Affairs coordinates the Federal Re- toward a more dynamic, forward lookserve's supervisory activities with regard to com- ing assessment of risk-management pliance with consumer protection and civil rights practices and financial factors. Under laws. Those activities are described in the chapter the system, known as RFI but more "Consumer and Community Affairs." Supervision for compliance with other banking laws and regu- fully termed RFI/C(D), holding compalations, which is described in this chapter, is the nies are assigned a composite rating (C) responsibility of the Board's Division of Banking that is based on assessments of three Supervision and Regulation and the Federal Recomponents: risk management (R), fiserve Banks, whose examiners also check for safety and soundness. nancial condition (F), and potential Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 65 State Member Banks and Holding Companies, 2002-2006 Entity/Item 2006 2005 2004 2003 2002 State member banks Total number 901 907 919 935 949 Total assets (billions of dollars) . 1,405 1,318 1,275 1,912 1,863 Number of examinations 761 783 809 822 814 By Federal Reserve System .. 500 563 581 581 550 By state banking agency 261 220 228 241 264 Top-tier bank holding companies Large (assets of more than $1 billion) Total number 448 394 355 365 329 Total assets (billions of dollars) 12,179 10,261 8,429 8,295 7,483 Number of inspections 566 501 500 454 439 By Federal Reserve System1 557 496 491 446 431 On site 500 457 440 399 385 Off site 57 39 51 47 46 By state banking agency 9 5 9 Small (assets of $1 billion or less) Total number 4,654 4,760 4,796 4,787 4,806 Total assets (billions of dollars) 947 890 852 847 821 Number of inspections 3,449 3,420 3,703 3,453 3,726 By Federal Reserve System 3,257 3,233 3,526 3,324 3,625 On site 112 170 186 183 264 Off site 3,145 3,063 3,340 3,141 3,361 By state banking agency 192 187 177 129 101 Financial holding companies Domestic 599 591 600 612 602 Foreign 44 38 36 32 30 1. For large bank holding companies subject to continuous, risk-focused supervision, includes multiple tar- 1 reviews. impact (I) of the parent company and its processes for identifying, measuring, nondepository subsidiaries on the sub- monitoring, and controlling risks. The sidiary depository institution.3 The key features of the supervision program fourth component, depository institution for large complex banking organizations (D), is intended to mirror the primary (LCBOs) are (1) identifying those regulator's rating of the subsidiary de- LCBOs that are judged, on the basis of pository institution. their shared risk characteristics, to In managing the supervisory process, present the highest level of supervisory the Federal Reserve takes a risk-focused risk to the Federal Reserve System; approach that directs resources to (2) maintaining continual supervision of (1) those business activities posing the these organizations so that the Federal greatest risk to banking organizations Reserve's assessment of each organizaand (2) the organizations' management tion's condition is current; (3) assigning to each LCBO a supervisory team composed of Reserve Bank staff members who have skills appropriate for the orga- 3. Each of the first two components has four nization's risk profile (the team leader is subcomponents: Risk Management—Board and Senior Management Oversight; Policies, Proce- the System's central point of contact for dures, and Limits; Risk Monitoring and Manage- the organization, has responsibility for ment Information Systems; and Internal Controls. only one LCBO, and is supported by Financial Condition—Capital; Asset Quality; specialists capable of evaluating the Earnings; and Liquidity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

66 93rd Annual Report, 2006 risks of LCBO business activities and will incorporate this change into existfunctions); and (4) promoting System- ing regulations are being developed. The wide and interagency information- Federal Reserve conducted 500 exams sharing through automated systems. of state member banks in 2006. For other banking organizations, the risk-focused supervision program pro- Bank Holding Companies vides that examination procedures are At year-end 2006, a total of 5,825 U.S. tailored to each banking organization's bank holding companies were in operasize, complexity, and risk profile. As tion, of which 5,102 were top-tier bank with the LCBOs, examinations entail holding companies. These organizations both off-site and on-site work, includcontrolled 6,106 insured commercial ing planning, pre-examination visits, banks and held approximately 96 perdetailed documentation, and examinacent of all insured commercial bank tion reports tailored to the scope and assets in the United States. findings of the examination. Federal Reserve guidelines call for annual inspections of large bank holding State Member Banks companies as well as complex smaller companies. In judging the financial con- At the end of 2006, 901 state-chartered dition of the subsidiary banks owned by banks (excluding nondepository trust holding companies, Federal Reserve excompanies and private banks) were aminers consult examination reports members of the Federal Reserve Sysprepared by the federal and state banktem. These banks represented approxiing authorities that have primary responmately 12 percent of all insured U.S. sibility for the supervision of those commercial banks and held approxibanks, thereby minimizing duplication mately 14 percent of all insured comof effort and reducing the supervisory mercial bank assets in the United States. burden on banking organizations. Non- The guidelines for Federal Reserve complex bank holding companies with examinations of state member banks are consolidated assets of $1 billion or less fully consistent with section 10 of the are subject to a special supervisory pro- Federal Deposit Insurance Act, as gram that permits a more flexible apamended by section 111 of the Federal proach.4 In 2006, the Federal Reserve Deposit Insurance Corporation Improveconducted 557 inspections of large bank ment Act of 1991 and by the Riegle holding companies and 3,257 inspec- Community Development and Regulations of small, noncomplex bank holdtory Improvement Act of 1994. A fulling companies. scope, on-site examination of these banks is required at least once a year, Financial Holding Companies although certain well-capitalized, wellmanaged organizations having total Under the Gramm-Leach-Bliley Act, assets of less than $250 million may be bank holding companies that meet cerexamined once every eighteen months. tain capital, managerial, and other re- The Financial Services Regulatory Relief Act of 2006, signed into law in 4. The program was implemented in 1997 and October, authorized the federal banking modified in 2002. See SR letter 02-01 for a discussion of the factors considered in determining agencies to raise the total asset threshold whether a bank holding company is complex or for certain institutions from $250 milnoncomplex (www.federalreserve.gov/boarddocs/ lion to $500 million. Interim rules that srletters/). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 67 quirements may elect to become finan- and agreement corporations, and bank cial holding companies and thereby holding companies, the Federal Reserve engage in a wider range of financial generally conducts its examinations or activities, including full-scope securities inspections at the U.S. head offices of underwriting, merchant banking, and in- these organizations where the ultimate surance underwriting and sales. The stat- responsibility for the foreign offices lies. ute streamlines the Federal Reserve's Examiners also visit the overseas offices supervision of all bank holding compa- of U.S. banks to obtain financial and nies, including financial holding compa- operating information and, in some nies, and sets forth parameters for the instances, to evaluate the organizations' supervisory relationship between the efforts to implement corrective mea- Federal Reserve and other regulators. sures or to test their adherence to safe The statute also differentiates between and sound banking practices. Examinathe Federal Reserve's relations with tions abroad are conducted with the coregulators of depository institutions and operation of the supervisory authorities its relations with functional regulators of the countries in which they take (that is, regulators for insurance, securi- place; for national banks, the examinaties, and commodities firms). tions are coordinated with the Office of As of year-end 2006, 604 domestic the Comptroller of the Currency (OCC). bank holding companies and 44 foreign At the end of 2006, 53 member banks banking organizations had financial were operating 675 branches in foreign holding company status. Of the domes- countries and overseas areas of the tic financial holding companies, 38 had United States; 34 national banks were consolidated assets of $15 billion or operating 625 of these branches, and 19 more; 121, between $1 billion and state member banks were operating the $15 billion; 86, between $500 million remaining 50. In addition, 17 nonmemand $1 billion; and 359, less than ber banks were operating 21 branches in $500 million. foreign countries and overseas areas of the United States. International Activities Edge Act and Agreement Corporations The Federal Reserve supervises the foreign branches and overseas investments Edge Act corporations are international of member banks, Edge Act and agree- banking organizations chartered by the ment corporations, and bank holding com- Board to provide all segments of the panies and also the investments by bank U.S. economy with a means of financing holding companies in export trading com- international business, especially expanies. In addition, it supervises the ac- ports. Agreement corporations are simitivities that foreign banking organizations lar organizations, state chartered or fedconduct through entities in the United erally chartered, that enter into an States, including branches, agencies, rep- agreement with the Board to refrain resentative offices, and subsidiaries. from exercising any power that is not permissible for an Edge Act corporation. Sections 25 and 25A of the Federal Foreign Operations of Reserve Act grant Edge Act and agree- U.S. Banking Organizations ment corporations permission to engage In supervising the international opera- in international banking and foreign tions of state member banks, Edge Act financial transactions. These corpora- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

68 93rd Annual Report, 2006 tions, most of which are subsidiaries of State-licensed and federally licensed member banks, may (1) conduct a de- branches and agencies of foreign banks posit 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 evpermissible for member banks. ery twelve months, but the period may At year-end 2006, 71 banking organi- be extended to eighteen months if the branch or agency meets certain criteria. zations, operating 9 branches, were chartered as Edge Act or agreement cor- In cooperation with the other federal porations. These corporations are exam- and state banking agencies, the Federal Reserve conducts a joint program for ined annually. supervising the U.S. operations of foreign banking organizations. The pro- U.S. Activities of Foreign Banks gram has two main parts. One part in- The Federal Reserve has broad authority volves examination of those foreign to supervise and regulate the U.S. activi- banking organizations that have multies of foreign banks that engage in tiple U.S. operations and is intended to banking and related activities in the ensure coordination among the various United States through branches, agen- U.S. supervisory agencies. The other cies, representative offices, commercial part is a review of the financial and lending companies, Edge Act corpora- operational profile of each organization tions, commercial banks, bank holding to assess its general ability to support its companies, and certain nonbanking U.S. operations and to determine what companies. Foreign banks continue to risks, if any, the organization poses be significant participants in the U.S. through its U.S. operations. Together, banking system. these two processes provide critical in- As of year-end 2006, 178 foreign formation to U.S. supervisors in a logibanks from 54 countries were operating cal, uniform, and timely manner. The 214 state-licensed branches and agen- Federal Reserve conducted or particicies, of which 8 were insured by the pated with state and federal regulatory Federal Deposit Insurance Corporation authorities in 339 examinations in 2006. (FDIC), and 45 OCC-licensed branches, of which 4 were insured by the FDIC. Anti-Money-Laundering These foreign banks also owned Examinations 12 Edge Act and agreement corporations and 2 commercial lending compa- The U.S. Department of the Treasury nies; in addition, they held a controlling regulations (31 CFR 103) implementing interest in 62 U.S. commercial banks. the Bank Secrecy Act (BSA) generally Altogether, the U.S. offices of these for- require banks and other types of finaneign banks at the end of 2006 controlled cial institutions to file certain reports approximately 19 percent of U.S. com- and maintain certain records that are mercial banking assets. These 178 for- useful in criminal or regulatory proceedeign banks also operated 85 representa- ings. The BSA and separate Board regutive offices; an additional 59 foreign lations require banking organizations subanks operated in the United States pervised by the Board to file reports on solely through a representative office. suspicious activity related to possible Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 69 violations of federal law, including operations in the financial industry, the money laundering, terrorist financing, Federal Reserve reviews the informaand other financial crimes. In addition, tion technology activities of supervised BSA and Board regulations require that banking organizations as well as certain banks develop written programs on independent data centers that provide BSA/anti-money-laundering compliance information technology services to these and that the programs be formally ap- organizations. All safety and soundness proved by bank boards of directors. An examinations include a risk-focused reinstitution's compliance program must view of information technology risk (1) establish a system of internal con- management activities. During 2006, the trols to ensure compliance with the Federal Reserve was the lead agency in BSA, (2) provide for independent com- 1 cooperative, multiagency examination pliance testing, (3) identify individuals of a large, multiregional data processing responsible for coordinating and monitor- servicer. ing day-to-day compliance, and (4) provide training for personnel as appropriate. Fiduciary Activities The Federal Reserve is responsible for examining its supervised institutions The Federal Reserve has supervisory refor compliance with various anti- sponsibility for state member commermoney-laundering laws and regulations. cial banks and depository trust compa- During examinations of state member nies that together reported, at the end of banks and U.S. branches and agencies of 2006, $36 trillion of assets in various foreign banks and, when appropriate, fiduciary or custodial capacities. Addiinspections of bank holding companies, tionally, state member nondepository examiners review the institution's com- trust companies supervised by the Fedpliance with the BSA and determine eral Reserve reported $33 trillion of aswhether adequate procedures and con- sets held in a fiduciary or custodial trols to guard against money laundering capacity. During on-site examinations and terrorism financing are in place. of fiduciary activities, an organization's compliance with laws, regulations, and general fiduciary principles and poten- Specialized Examinations tial conflicts of interest are reviewed; its management and operations, includ- The Federal Reserve conducts specialing its asset- and account-management, ized examinations of banking organizarisk-management, and audit and control tions in the areas of information technolprocedures, are also evaluated. In 2006, ogy, fiduciary activities, transfer agent Federal Reserve examiners conducted activities, and government and munici- 97 on-site fiduciary examinations. pal securities dealing and brokering. The Federal Reserve also conducts specialized examinations of certain entities, Transfer Agents and other than banks, brokers, or dealers, Securities Clearing Agencies that extend credit subject to the Board's As directed by the Securities Exchange margin regulations. Act of 1934, the Federal Reserve conducts specialized examinations of those Information Technology Activities state member banks and bank holding In recognition of the importance of in- companies that are registered with the formation technology to safe and sound Board as transfer agents. Among other Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

70 93rd Annual Report, 2006 things, transfer agents countersign and that dealt in municipal securities during monitor the issuance of securities, regis- 2006, 9 were examined during the year. ter the transfer of securities, and exchange or convert securities. On-site ex- Securities Credit Lenders aminations focus on the effectiveness of Under the Securities Exchange Act of an organization's operations and its 1934, the Board is responsible for regucompliance with relevant securities lating credit in certain transactions regulations. During 2006, the Federal involving the purchase or carrying of Reserve conducted on-site examinations securities. As part of its general examiat 15 of the 78 state member banks and nation program, the Federal Reserve bank holding companies that were regis- examines the banks under its jurisdictered as transfer agents and examined tion for compliance with the Board's 1 state member limited-purpose trust Regulation U (Credit by Banks and company acting as a national securities Persons other than Brokers or Dealers depository. for the Purpose of Purchasing or Carrying Margin Stock). In addition, the Fed- Government and Municipal Securities eral Reserve maintains a registry of per- Dealers and Brokers sons other than banks, brokers, and dealers who extend credit subject to The Federal Reserve is responsible for Regulation U. The Federal Reserve may examining state member banks and forconduct specialized examinations of eign banks for compliance with the Govthese lenders if they are not already ernment Securities Act of 1986 and with subject to supervision by the Farm Department of the Treasury regulations Credit Administration, the National governing dealing and brokering in gov- Credit Union Administration (NCUA), ernment securities. Twenty-five state or the Office of Thrift Supervision member banks and 8 state branches of (OTS). foreign banks have notified the Board At the end of 2006, 602 lenders other that they are government securities dealthan banks, brokers, or dealers were regers or brokers not exempt from Treaistered with the Federal Reserve. Other sury's regulations. During 2006, the federal regulators supervised 210 of Federal Reserve conducted 6 examinathese lenders, and the remaining 392 tions of broker-dealer activities in govwere subject to limited Federal Reserve ernment securities at these organizasupervision. On the basis of regulatory tions. These examinations are generally requirements and annual reports, the conducted concurrently with the Federal Federal Reserve exempted 290 lenders Reserve's examination of the state memfrom its on-site inspection program. The ber bank or branch. securities credit activities of the remain- The Federal Reserve is also responing 102 lenders were subject to either sible for ensuring that both state membiennial or triennial inspection. Sixty ber banks and bank holding companies inspections were conducted during the that act as municipal securities dealers year. comply with the Securities Act Amendments of 1975. Municipal securities dealers are examined pursuant to Business Continuity the Municipal Securities Rulemaking Board's rule G-16 at least once every In 2006, the Federal Reserve continued two calendar years. Of the 20 entities its efforts to strengthen the resilience of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 71 the U.S. financial system in the event of actions in 2006. Informal enforcement unexpected disruptions. Throughout the actions include memoranda of underyear, the staff continued to work with standing and board of directors resolufinancial institutions to assess imple- tions. Information about these actions is mentation of the sound practices identi- not available to the public. fied in the April 2003 "Interagency Paper on Sound Practices to Strengthen the Surveillance and Resilience of the U.S. Financial Sys- Off-Site Monitoring tem," a joint publication with the OCC and the Securities and Exchange Com- The Federal Reserve uses automated mission (SEC). During 2006, the agen- screening systems to monitor the financies provided additional guidance to cial condition and performance of state help institutions implement testing of member banks and bank holding compatheir business continuity plans. The nies between on-site examinations. Such agencies continue to coordinate their monitoring and analysis helps direct exefforts to ensure a consistent supervi- amination resources to institutions that sory approach for business continuity have higher risk profiles. Screening syspractices. tems also assist in the planning of examinations by identifying companies that are engaging in new or complex Enforcement Actions and activities. Special Examinations In January 2006, the Federal Reserve The Federal Reserve has enforcement replaced its primary off-site monitoring authority over the banking organizations tool, SEER (System to Estimate it supervises and their affiliated parties. Examination Ratings), with the Supervi- Enforcement actions may be taken to sion and Regulation Statistical Assessaddress unsafe and unsound practices or ment of Bank Risk model (SR-SABR). violations of any law or regulation. For- Drawing primarily on the financial data mal enforcement actions include cease- that banks report on their Reports of and-desist orders, written agreements, Condition and Income (Call Reports), removal and prohibition orders, and civil SR-SABR uses econometric techniques money penalties. In 2006, the Federal to identify banks that report financial Reserve completed 37 formal enforce- characteristics weaker than those of ment actions. Civil money penalties to- other banks assigned similar supervisory taling $212,050 were assessed. All civil ratings. To supplement the SR-SABR money penalties, as directed by statute, screening, the Federal Reserve also are remitted to either the Department of monitors various market data, including the Treasury or the Federal Emergency equity prices, debt spreads, agency rat- Management Agency. Enforcement or- ings, and measures of expected default ders, which are issued by the Board, and frequency, to gauge market perceptions written agreements, which are executed of the risk in banking organizations. In by the Reserve Banks, are made public addition, the Federal Reserve prepares and are posted on the Board's web quarterly Bank Holding Company site(www.federalreserve.gov/boarddocs/ Performance Reports (BHCPRs) for use enforcement). in monitoring and inspecting supervised In addition to taking these formal en- banking organizations. The reports, forcement actions, the Reserve Banks which are compiled from data provided completed 70 informal enforcement by large bank holding companies in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

72 93rd Annual Report, 2006 quarterly regulatory reports (FR Y-9C banks and supervisory authorities. Techand FR Y-9LP), contain, for individual nical assistance involves visits by Fedcompanies, financial statistics and eral Reserve staff members to foreign comparisons with peer companies. authorities as well as consultations with BHCPRs are made available to the foreign supervisors who visit the Board public on the National Information or the Reserve Banks. Technical assis- Center web site, which can be accessed tance in 2006 was concentrated in Latin at www.ffiec.gov. America, Asia, and former Soviet bloc During the year, four major upgrades countries. The Federal Reserve, along to the web-based Performance Report with the OCC, the FDIC, and the Information and Surveillance Monitor- Department of the Treasury, was also an ing (PRISM) application were com- active participant in the Middle East and pleted. PRISM is a querying tool used North Africa Financial Regulators' by Federal Reserve analysts to access Training Initiative, which is part of the and display financial, surveillance, and U.S. government's Middle East Partnerexamination data. In the analytical ship Initiative. module, users can customize the pre- During the year the Federal Reserve sentation of institutional financial inforoffered training courses exclusively for mation drawn from Call Reports, Uniforeign supervisory authorities in Washform Bank Performance Reports, ington, D.C., and a number of foreign FR Y-9 statements, BHCPRs, and other jurisdictions. System staff also took part regulatory reports. In the surveillance in technical assistance and training mismodule, users can generate reports sions led by the International Monetary summarizing the results of surveillance Fund, the World Bank, the Interscreening for banks and bank holding American Development Bank, the Asian companies. The upgrades made more Development Bank, the Basel Commitregulatory data available for querying, tee on Banking Supervision, and the added the results of surveillance Financial Stability Institute. screens (including SR-SABR), added new search options, and improved the The Federal Reserve is also an assouser interface. ciate member of the Association of Supervisors of Banks of the Americas The Federal Reserve works through (ASBA), an umbrella group of bank suthe Federal Financial Institutions Expervisors from countries in the Western amination Council (FFIEC) Task Force on Surveillance Systems to coordinate Hemisphere. The group, headquartered surveillance activities with the other fed- in Mexico, promotes communication eral banking agencies.5 and cooperation among bank supervisors in the region; coordinates training programs throughout the region, with Technical Assistance the help of national banking supervisors and international agencies; and aims to In 2006, the Federal Reserve continued help members develop banking laws, to provide technical assistance on bank regulations, and supervisory practices supervisory matters to foreign central that conform to international best practices. The Federal Reserve contributes significantly to ASBA's organizational 5. The federal banking agencies that are mem- management and to its training and techbers of the FFIEC are the Federal Reserve Board, nical assistance activities. the FDIC, the NCUA, the OCC, and the OTS. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 73 Supervisory Policy and the advanced measurement approach for operational risk, would con- The Federal Reserve's supervisory tinue to be subject to the tier 1 leverage policy function is responsible for devel- ratio requirement and the market risk oping guidance for examiners and bank- capital rule, if applicable, as well as the ing organizations as well as regulations prompt corrective action rules. for banking organizations under the Federal Reserve's supervision. Staff mem- Revisions to Market Risk Capital Rule bers participate in supervisory and regu- On September 25, 2006, the agencies latory forums, provide support for the issued for public comment a notice of work of the FFIEC, and participate in proposed rulemaking proposing reviinternational forums such as the Basel sions to the market risk capital rule used Committee on Banking Supervision, the by the OCC, Board, and FDIC since Joint Forum, and the International Ac- 1997 for banking organizations having counting Standards Board. significant exposure to market risk. Under the market risk capital rule, certain banking organizations are required to Capital Adequacy Standards calculate a capital requirement for the Risk-Based Capital Standards for general market risk of their covered Certain Internationally Active positions and the specific risk of their Banking Organizations covered debt and equity positions. The proposed revisions would enhance the On September 25, 2006, the Federal rule's risk sensitivity, require the market Reserve, OCC, FDIC, and OTS pubrisk capital charge to reflect any increlished a joint notice of proposed rulemental default risk of traded positions, making (NPR) setting forth their views and require public disclosure of certain on Basel II and seeking public comment qualitative and quantitative market risk on the U.S. plan for implementing the information. The comment period will agreement. Under the proposal, the baend on January 23, 2007. sic minimum risk-based capital ratio format—regulatory capital divided by Risk-Based Capital Standards risk-weighted assets—would be mainfor Banking Organizations tained, with the minimum for tier 1 capi- Not Subject to Basel II tal set at 4 percent and the minimum for total qualifying capital set at 8 percent. On December 26, 2006, the banking The primary differences between the agencies issued for public comment an current and proposed rules are the NPR proposing modifications to Basel I internal-ratings-based methodologies that would be optional for banking orgaused to calculate risk-weighted assets nizations not subject to Basel n. The and the advanced measurement ap- proposals aim to enhance risk sensitivity proach for operational risk under Ba- without unduly increasing regulatory sel II. Banking organizations using the burden. They would expand the number methods set forth in the NPR would also of risk-weight categories, allow the use be subject to certain public disclosure of external credit ratings to risk-weight requirements, to foster transparency and certain exposures, expand the range of market discipline. All banking organiza- recognized collateral and eligible guartions, including those using the internal- antors, use loan-to-value (LTV) ratios ratings-based approach for credit risk to risk-weight residential mortgages, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

74 93rd Annual Report, 2006 increase the credit conversion factor for fecting the banking stry in the areas certain commitments having an original of accounting, auditing, internal conmaturity of one year or less, assess a trols, disclosure, and supervisory financapital charge for early amortizations in cial reporting. Federal Reserve staff securitizations of revolving credit expo- members interact with key entities in the sures, and remove the 50 percent limit accounting and auditing professions, inon the risk weight for certain over-the- cluding standards-setters and accounting counter derivatives transactions. The firms, the other banking agencies, and comment period for the NPR will end the banking industry, and issue suon March 26, 2007. pervisory guidance as appropriate. During 2006, the Federal Reserve, to- Other Capital Issues gether with the other banking agencies, issued a comment letter to the Financial Board staff conduct supervisory analy- Accounting Standards Board (FASB) on ses of innovative capital instruments and its then-proposed Statement of Financial novel transactions to determine whether Accounting Standards titled The Fair such instruments qualify for inclusion in tier 1 capital.6 Much of this work in Value Option for Financial Assets and 2006 involved evaluating enhanced Financial Liabilities.7 The agencies also forms of trust preferred securities that jointly issued guidance on loan and lease bank holding companies developed in losses and on limitations on the liability order to be granted more credit for eq- of external auditors. uity by the rating agencies under the Board's 2005 revisions to the rule on the Policy Statement on the Allowance for qualifying components of tier 1 capital. Loan and Lease Losses Staff members also identify and In December the Federal Reserve, address supervisory concerns related to FDIC, NCUA, OCC, and OTS issued supervised banking organizations' capi- "Interagency Policy Statement on the tal issuances and work with the Reserve Allowance for Loan and Lease Losses," Banks to evaluate the overall composiwhich updates and replaces earlier guidtion of banking organizations' capital. ance on the methodology for calculating In this work, the staff often must the allowance for loan and lease losses review the funding strategies proposed (ALLL). Revisions were made to ensure in applications for acquisitions and that policy is consistent with generally other transactions submitted to the Fedaccepted accounting principles and with eral Reserve by banking organizations. recent supervisory guidance related to the ALLL. Updated in the guidance are the responsibilities of boards of direc- Accounting Policy tors, management, and banking organization examiners; factors to be consid- The supervisory policy function is also ered in estimating the ALLL; and the responsible for monitoring major doobjectives and elements of an effective mestic and international proposals, stanloan review system, including a sound dards, and other developments afcredit-grading system. The guidance 6. Tier 1 capital comprises common stockholders' equity and qualifying forms of preferred stock, 7. The FASB issued the final standard, Stateless required deductions such as goodwill and ment of Financial Accounting Standard No. 159, certain intangible assets. in February 2007. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 75 also reiterates the points of agreement implement a risk-based approach to between the SEC and the banking agen- complying with the BSA. cies since 1999. To assist in application In January, the Federal Reserve, the of the revised guidance, the agencies Department of the Treasury's Financial also issued a supplemental document Crimes Enforcement Network, and the anticipating frequently asked questions. other federal banking agencies issued guidance on sharing Suspicious Activity Advisory on Limitations on the Reports (SARs) with head offices or Liability of External Auditors controlling companies. The guidance confirmed that a U.S. branch or agency The Federal Reserve, FDIC, NCUA, of a foreign bank may disclose a SAR to OCC, and OTS in May issued "Interits head office outside the United States. agency Advisory on the Unsafe and Un- Similarly, a U.S. bank or savings assosound Use of Limitation of Liability ciation may disclose a SAR to its con- Provisions in External Audit Engagetrolling company, whether domestic or ments." The guidance addresses safety foreign. and soundness concerns that may arise In March, the Federal Reserve issued when financial institutions enter into exa final rule amending Regulation K (Internal audit contracts that limit the auditernational Banking Operations) to contor's liability for audit services. Specifiform the Board's regulations to BSA cally, the guidance informs financial requirements and to clarify that Edge institutions that the inclusion of certain and agreement corporations and U.S. auditor liability limitations in external branches, agencies, and representative audit contracts (typically referred to as offices of foreign banks supervised by engagement letters) for audits of finanthe Federal Reserve must establish and cial statements, audits of internal conmaintain procedures reasonably detrol over financial reporting, or attestasigned to ensure and monitor complitions on management's assessment of ance with the BSA and its implementing internal control over financial reporting regulations. is generally unsafe and unsound. In April, the Federal Reserve and the other federal banking agencies entered into a memorandum of understanding Bank Secrecy Act and with the Office of Foreign Assets Con- Anti-Money Laundering trol within the Department of the Trea- In 2006, the FFIEC updated the Bank sury to facilitate information-sharing Secrecy Act/Anti-Money Laundering and to further enhance interagency coor- Examination Manual issued in 2005 by dination in implementing U.S. sanctions adding sections on risk assessment and rules. automated clearinghouse transactions, updating the section on trade finance, International Guidance on and incorporating regulatory changes. Supervisory Policies The manual continues to contain an overview of Bank Secrecy Act (BSA) As a member of the Basel Committee on and anti-money-laundering requirements Banking Supervision (Basel Commitand supervisory expectations, resource tee), the Federal Reserve participates in materials, and examination procedures efforts to advance sound supervisory and to emphasize a banking organiza- policies for internationally active banktion's responsibility to establish and ing organizations and to improve the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

76 93rd Annual Report, 2006 stability of the international banking ance, "Core Principles for Effective Banksystem. In 2006, the Federal Reserve ing Supervision," was issued in October. continued to work cooperatively on Basel II, the 2004 accord to revise the Joint Forum international capital regime, and to de- In 2006, the Federal Reserve also convelop international supervisory guidtinued to participate in the Joint ance. The Federal Reserve also contin- Forum—a group established under the ued to participate in Basel Committee aegis of the Basel Committee to address working groups to address issues not issues related to the banking, securities, fully resolved in the Basel II framework. and insurance sectors, including the regulation of financial conglomerates. It Risk Management is made up of representatives of the The Federal Reserve contributed to su- Basel Committee, the International Orpervisory policy papers, reports, and ganization of Securities Commissions, recommendations issued by the Basel and the International Association of In- Committee during 2006 that were gen- surance Supervisors. The Federal Reerally aimed at improving the super- serve contributed to the following supervision of banking organizations' risk- visory policy papers, reports, and management practices.8 recommendations issued by the Joint Forum during 2006.9 • "Enhancing Corporate Governance for Banking Organizations," final paper • "Regulatory and Market Differences: issued in February, updating guidance Issues and Observations," issued in published in 1999 May • "Basel II: International Convergence • "The Management of Liquidity Risk of Capital Measurement and Capital in Financial Groups," issued in May Standards: A Revised Framework— • "High-Level Principles for Business Comprehensive Version," published Continuity," issued in August in June International Accounting Core Principles for Effective Banking Supervision The Federal Reserve participates in the Basel Committee's Accounting Task The Core Principles, developed by the Force (ATF) and represents the Basel Basel Committee in 1997, have become Committee at international meetings on the de facto international standard for accounting, auditing, and disclosure issound prudential regulation and supervi- sues affecting global banking organizasion of banks. In 2006, the Federal Re- tions. During 2006, Federal Reserve serve participated in a Basel Committee staff were involved in the development effort to update the Core Principles in of two key Basel Committee documents light of the significant changes in inter- issued to national supervisors and also national banking regulation and experi- of various comment letters related to ence gained since the principles were accounting and auditing that were sublast revised in 1999. The revised guid- mitted to the International Accounting 8. Papers issued by the Basel Committee can 9. Papers issued by the Joint Forum can be be accessed via the Bank for International Settle- accessed via the Bank for International Settlements web site at www.bis.org. ments web site at www.bis.org. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 11 Standards Board and the International • conducting a public service campaign Auditing and Assurance Standards encouraging individuals affected by Board. Hurricane Katrina to contact their The Basel Committee document "Su- lenders (and also issuing a statement pervisory Guidance on the Use of the encouraging financial institutions to Fair Value Option for Financial Instru- work with their borrowers to assist ments by Banks," issued in June, pro- them in their financial recovery); and vides guidance on the prudential super- • releasing "Lessons Learned from Hurvision of banks in their implementation ricane Katrina: Preparing Your Instituof the fair value option included in the tion for a Catastrophic Event," a bookamended International Accounting Stanlet describing financial institutions' dard (IAS) 39, which became effective experiences with Hurricane Katrina January 1, 2006. Under IAS 39, the fair and the lessons they learned that other value option allows an organization to institutions might find helpful in conirrevocably elect, at the date of pursidering their readiness for a catachase, a fair value measurement for cerstrophic event. tain financial instruments and to record in current earnings the gains and losses Credit Risk Management resulting from changes in fair value. The Basel Committee document The Federal Reserve works with the "Sound Credit Risk Assessment and other federal banking agencies to Valuation for Loans," issued in June, develop guidance on the management provides guidance on assessing credit of credit risk. risk and accounting for loan impairment. Specifically, the document ad- Real Estate Appraisals dresses supervisory expectations for, and Under the federal banking agencies' supervisory evaluations of, a banking regulations on real estate appraisals, organization's establishment and sup- regulated institutions must ensure that port of its loan-loss-allowance accounts. the appraisals they use in connection with federally related transactions adhere to the Uniform Standards of Profes- Response to Hurricane Katrina sional Appraisal Practice (USPAP). In June 2006, the Federal Reserve, FDIC, Since Hurricane Katrina, the federal NCUA, OCC, and OTS issued an interbanking agencies—the Federal Reserve, agency statement informing regulated FDIC, NCUA, OCC, and OTS—and the institutions that the Appraisal Standards state banking agencies in Alabama, Board of the Appraisal Foundation had Louisiana, and Mississippi have worked made significant revisions to USPAP, together to monitor and support the effective July 1, 2006; providing an recovery efforts of financial institutions overview of the revisions; and discussand their customers in the U.S. Gulf ing the ramifications of the revisions for Coast region. In 2006, the interagency the institutions' compliance with the efforts included regulations. • developing examiner guidance on the Home Equity Lending agencies' expectations related to assessments of the financial condition of In September, the Federal Reserve, institutions affected by the hurricane; FDIC, NCUA, OCC, and OTS issued an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

78 93rd Annual Report, 2006 addendum to guidance issued in 2005— lease losses that reflect the collectibil- "Interagency Credit Risk Management ity of the portfolio; and Guidance for Home Equity Lending"— • ensure that consumers have sufficient that provided additional guidance on information to understand the loan managing the risks associated with terms and the associated risks before open-end home equity lines of credit they choose a product or a payment (HELOCs) that have interest-only or arrangement. negative amortization features. While such HELOCs may give consumers Commercial Real Estate some flexibility, the agencies are con- Concentrations cerned that consumers may not fully understand the product terms and asso- In December, the Federal Reserve, ciated risks. The addendum addressed FDIC, and OCC issued guidance titled the timing and content of communica- "Interagency Guidance on Concentrations with consumers that are obtaining tions in Commercial Real Estate Lend- HELOCs having these features and ing, Sound Risk Management Practices" clarified the agencies' expectations for to remind institutions that strong riskassessing borrower repayment capacity. management practices and appropriate levels of capital are important elements Nontraditional Mortgage Products of a sound lending program, particularly if the institution has a concentration in In September, the Federal Reserve, commercial real estate loans. The guid- FDIC, NCUA, OCC, and OTS issued ance reinforced and enhanced existing guidance, titled "Interagency Guidance regulations and guidelines for safe and on Nontraditional Mortgage Product sound real estate lending. (For more in- Risks," that addresses risk-management formation, see the box "Guidance on and consumer disclosure practices that Concentrations in Commercial Real Esinstitutions should employ to effectively tate Lending.") assess and manage the risks associated with residential mortgage loans that Complex Structured Finance Activities allow borrowers to defer repayment of principal and, sometimes, interest (re- During the year, the Federal Reserve, ferred to as nontraditional mortgage FDIC, OCC, OTS, and SEC prepared a loans). Specifically, the guidance states final statement on sound practices for that regulated institutions should complex structured finance transactions (CSFTs). The statement, to be issued in • ensure that loan terms and underwritearly 2007, describes the types of intering standards are consistent with prunal controls and risk-management prodent lending practices (including, for cedures that financial institutions should example, that they evaluate the boruse to identify, manage, and address the rower's repayment capacity); heightened legal and reputational risks • recognize that many nontraditional that may arise from certain CSFTs. mortgage loans, particularly those that (Excluded are most structured finance have risk-layering features, are un- transactions that are familiar to particitested in a stressed environment and pants in the financial markets and have warrant strong risk-management stan- well-established track records—such as dards, capital levels commensurate standard public mortgage-backed securiwith risk, and allowances for loan and ties and hedging-type transactions in- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 79 volving "plain vanilla" derivatives or Board's Small Bank Holding Company collateralized debt obligations.) Finan- Policy Statement and (2) an exemption cial institutions that engage in CSFTs from the Board's risk-based and levershould, as part of their process for ap- age capital adequacy guidelines for proving transactions and new products, bank holding companies. The final rule establish and maintain policies, proce- also modifies the qualitative criteria dures, and systems that are designed to used in determining whether a bank identify elevated-risk CSFTs and should holding company that is under the ensure that transactions and new prod- asset-size threshold nevertheless would ucts so identified are subject to greater not qualify for the policy statement or review by appropriate levels of manage- the exemption. In addition, the final ment. An institution should decline to rule clarifies the treatment under participate in an elevated-risk CSFT if it the policy statement of subordinated determines that the transaction presents debt associated with trust preferred unacceptable risks or would result in a securities. violation of applicable laws, regulations, or accounting principles. Economic Growth and Regulatory Paperwork Reduction Act of 1996 Banks' Securities Activities The Economic Growth and Regulatory In December, the Board and the SEC Paperwork Reduction Act of 1996 rerequested comments on joint proposed quires that the federal banking agencies rules that would help define the scope of review their regulations every ten years securities activities that a bank may con- to identify and eliminate any unnecesduct without registering with the SEC as sary requirements imposed on insured a securities broker. The Gramm-Leach- depository institutions. (In addition, the Bliley Act eliminated the blanket "bro- Board periodically reviews each of its ker" exception for banks that had been regulations.) During 2006, the Federal contained in section 3(a)(4) of the Secu- Reserve, OCC, FDIC, and OTS conrities Exchange Act of 1934, but it ducted the required review. Among granted exceptions designed to allow other activities, they met with represenbanks to continue to engage in securities tatives of the banking industry and of transactions for customers in connection consumer groups around the country to with their normal trust, fiduciary, custo- hear their concerns and their suggesdial, and other banking operations. The tions for reducing regulatory burden. proposed rules would implement the The agencies expect to issue a final most important "broker" exceptions. report in 2007. Comments on the proposal are due by March 26, 2007. Bank Holding Company Regulatory Financial Reports Small Bank Holding Company The Federal Reserve requires that U.S. Threshold bank holding companies periodically In February, the Board issued a final submit reports providing financial and rule that raises, from $150 million to structure information. This information $500 million, the asset-size threshold is essential to the supervision of the used to determine whether a bank hold- companies and the formulation of reguing company qualifies for (1) the lations and supervisory policies. It is Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

80 93rd Annual Report, 2006 Guidance on Concentrations in Commercial Real Estate Lending As any banker worth his or her salt knows, lending concentrations must be carefully identified, monitored, and managed. It is one of the basics of banking to understand the consequences of placing all your eggs in one basket. Naturally, supervisors from time to time have concerns about growing credit risk concentrations at banks and bankers' ability to manage them. Susan Schmidt Bies, Member, Board of Governors June 2006 In response to rising concentrations of Risk Management Practices," the agencies commercial real estate (CRE) loans at recognize that financial institutions play a many financial institutions, the Federal vital role in funding real estate develop- Reserve, the Office of the Comptroller of ment in their communities and can do so in the Currency, and the Federal Deposit In- a profitable way. However, as an institusurance Corporation on December 12, tion's concentration in CRE lending in- 2006, issued guidance promoting sound creases, management should understand its risk-management practices in this sector.1 possible exposure to a downturn in the In the guidance, titled "Concentrations in CRE market or to other adverse market and Commercial Real Estate Lending, Sound economic events. Supervisors have observed over the past decade that CRE concentrations have been 1. As defined by the guidance, CRE loans rising at many institutions, especially at include land development and construction loans small and medium-size banks. Between (including one- to four-family residential and 1993 and 2005, CRE loans as a proportion commercial construction loans) and other land of total equity plus reserves rose from loans; loans secured by multifamily property; 145 percent to 280 percent for commercial and loans secured by nonfarm nonresidential banks with assets between $100 million property for which 50 percent or more of the and $1 billion and from 120 percent to source of repayment is third-party, nonaffiliated, 230 percent for commercial banks with rental income or the proceeds of the sale, refinancing, or permanent financing of the property. assets of $1 billion to $10 billion. Experi- The guidance also applies to some loans to real ence has shown that credit concentrations estate investment trusts and unsecured loans to add a dimension of risk that compounds developers. the simple risk inherent in individual loans. also used in responding to requests from The reports are used to detect emerging Congress and the public for information financial problems, to review perforon bank holding companies and their mance and conduct pre-inspection nonbank subsidiaries. Foreign banking analysis, to monitor and evaluate risk organizations are also required to peri- profiles and capital adequacy, to evaluodically submit reports to the Federal ate proposals for bank holding company Reserve. mergers and acquisitions, and to analyze The FR Y-9 series of reports provides the holding company's overall financial standardized financial statements for condition. The nonbank subsidiary bank holding companies on both a con- reports—FRY-11, FR 2314, and solidated basis and a parent-only basis. FRY-7N—help the Federal Reserve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 81 Further, supervisors are concerned that The agencies recognize that different risk-management practices at some institu- types of CRE lending present different levtions may not have kept pace with the els of risk. For example, a well-structured growth of CRE concentrations. loan for a multifamily housing project The agencies developed the 2006 CRE would generally have a lower risk profile guidance to remind financial institutions than a loan for an office building to be built that strong risk-management practices and on speculation. The guidance acknowlappropriate capital levels are important edges that institutions are in the best posielements of a sound CRE lending program, tion to make such assessments about the particularly when an institution has a con- level and nature of concentration risk in centration in CRE loans or has experienced their CRE portfolios. rapid portfolio growth. The guidance pro- Building upon the agencies' existing vides the agencies' examiners with two regulations and guidelines for real estate supervisory screening criteria designed to lending and loan portfolio management, identify institutions whose CRE concentra- the guidance describes the key elements tions may require additional scrutiny: that an institution should address in the areas of board and management oversight, • Total loans for construction, land develportfolio management, management inforopment, and other land represent 100 mation systems, market analysis, creditpercent or more of the institution's total underwriting standards, portfolio stresscapital; or testing and sensitivity analysis, and the • Total CRE loans represent 300 percent or credit-risk review function. more of the institution's total capital, and The Federal Reserve recognizes that the outstanding balance of the institu- commercial real estate lending is a critition's commercial real estate loan portfo- cally important activity that has become lio has increased 50 percent or more the "bread and butter" business of many during the previous thirty-six months. small and medium-size banks. Supervisors These screening criteria serve as a start- emphasize that they did not intend the ing point for a dialogue between the agen- guidance to limit commercial real estate cies' supervisory staff and an institution's lending; rather, they expect that the guidmanagement about the level and nature of ance will encourage institutions to develop CRE concentration risk. The guidance fo- and maintain appropriate corporatecuses on CRE loans for which the risk of governance structures to address the risks default is sensitive to CRE market demand, posed by their lending strategies. capitalization rates, vacancy rates, or rents. determine the condition of bank holding was raised from $150 million to companies that are engaged in nonbank $500 million, reducing the number of activities and also aid in monitoring the respondents by approximately 60 pervolume, nature, and condition of the cent. Other FR Y-9C revisions effective companies' nonbank subsidiaries. March 31 included the elimination of a In March, several revisions to the number of data items; the addition of FR Y-9C, FR Y-9LP, and FRY-9SP data items on loans for purchasing and reports were approved for implementa- carrying securities, regulatory capital, tion during 2006. Effective March 31, and credit derivatives; and the removal the asset-size threshold for filing of the FR Y-9C filing requirement for the FRY-9C and FR Y-9LP reports lower-tier bank holding companies hav- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

82 93rd Annual Report, 2006 ing total assets of $1 billion or more. Holding Companies and Change in Revisions effective September 30 in- Bank Control). cluded new officer signature requirements and additional data items on mort- Commercial Bank gage banking activities and secured Regulatory Financial Reports borrowings. Effective June 30, the asset-size cap As the federal supervisor of state memfor the FR Y-9SP was raised from ber banks, the Federal Reserve, along $150 million to $500 million, increasing with the other banking agencies through the number of respondents by approxi- the FFIEC, requires banks to submit mately 50 percent. Other FR Y-9SP re- quarterly Consolidated Reports of Convisions effective June 30 included the dition and Income (Call Reports). Call Reports are the primary source of data addition of two items identifying the for the supervision and regulation of total value of off-balance-sheet activibanks and the ongoing assessment of the ties conducted directly or through a nonoverall soundness of the nation's bankbank subsidiary and the total value of ing system. Call Report data, which also debt and equity securities registered serve as benchmarks for the financial with the SEC. Revised officer signature information required by many other requirements for the FR Y-9SP were Federal Reserve regulatory financial reeffective December 31. ports, are widely used by state and local In March, the Board also revised the governments, state banking supervisors, asset-size threshold for the quarterly the banking industry, securities analysts, FR Y-ll and FR 2314 nonbank subsidand the academic community. iary reports, to make it consistent with For the 2006 reporting period, the the revised threshold for the FR Y-9C FFIEC implemented various revisions and to reduce reporting burden. Revisto the Call Report to streamline the reing the threshold for the FR Y-ll reporting requirements and to add new duced the number of quarterly responitems that focus on areas of increasing dents by approximately 30 percent; the supervisory concern. The principal revirevision had no immediate effect on the sions included the collection of data renumber of FR 2314 filers. Other lated to the implementation of deposit FRY-11 and FR2314 revisions effecinsurance reform provisions, funding tive March 31 included the addition of a sources (Federal Home Loan Bank new equity capital component to the advances and other borrowings), and balance sheet for reporting partnership mortgage banking activities. The signainterest and, for the FR Y-ll only, the ture and attestation requirements were expansion of the scope of several loan revised to add the chief financial officer, items reported on the balance sheet or equivalent, to the list of officials rememoranda. quired to attest to and sign the Call Effective December 31, a new report Report. was implemented: the Annual Report of In October, the FFIEC proposed revi- Merchant Banking Investments Held for sions for the 2007 reporting period to an Extended Period (FR Y-12A). The address new safety and soundness conreport collects data concerning mer- siderations and to facilitate supervision. chant banking investments that are ap- Among the proposed revisions are proaching the end of the holding period changes in data collection related to the permissible under Regulation Y (Bank deposit insurance assessment collection Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 83 process; changes in generally accepted compliance with best-practices and accounting principles (including certain regulatory requirements. financial instruments measured at fair value and principles for accounting for defined benefit pension and other post- National Information Center retirement plans); and nontraditional mortgage products. The National Information Center (NIC) is the Federal Reserve's comprehensive repository for supervisory, financial, and banking structure data and supervisory Supervisory Information documents. NIC includes comprehen- Technology sive data on banking structure through- Information technology supporting Fed- out the United States; the National Exeral Reserve supervisory activities is amination Database (NED), which managed within the System supervisory enables supervisory personnel and state information technology (SSIT) function banking authorities to access NIC data; in the Board's Division of Banking the Banking Organization National Supervision and Regulation. SSIT Desktop (BOND), an application that works through assigned staff at the facilitates secure, real-time electronic Board and the Reserve Banks, as well information-sharing and collaboration as through System committees, to among federal and state banking regulaensure that key staff members through- tors for the supervision of banking orgaout the System participate in identify- nizations; and the Central Document and ing requirements and setting priorities Text Repository (CDTR), which confor IT initiatives. tains documents supporting the supervi- In 2006, the SSIT function worked on sory processes. the following strategic projects and ini- The structure and supervisory data tiatives: (1) align technology invest- systems are continually being updated ments with business needs; (2) improve to extend their useful lives and improve security of information-sharing tech- business workflow efficiency. During nologies and provide for seamless 2006, the NED system was modified to collaboration in interagency efforts; begin collecting Bank Secrecy Act (3) identify and implement improve- information in an automated format, to ments in the accessibility of technology support Federal Reserve enforcement to staff working in the field; (4) identify activities. In 2006, the BOND and opportunities to converge and stream- CDTR systems were modified to proline IT applications, including key vide further integration with the Federal administrative systems, to provide con- Reserve's internal surveillance prosistent and seamless information; gram, to provide additional support for (5) evaluate and implement technolo- the supervision of large financial instigies (such as portals, search engines, tutions, and to allow integration of and content management tools) to examinations of technology service integrate supervisory and management providers. In addition, user authenticainformation systems that support both tion software was upgraded for external office-based and field staff; and agency users, and use of the BOND (6) enhance the information security and CDTR systems was extended to framework for the supervisory function, additional federal and state regulatory improving both overall security and agencies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

84 93rd Annual Report, 2006 Staff Development ness or consumer affairs. In 2006, 190 examiners passed the first proficiency The System Staff Development Program examination, and 61 passed the second trains staff members at the Board, the proficiency examination: 53 the safety Reserve Banks, state banking depart- and soundness exam, and 8 the conments, and foreign supervisory authori- sumer affairs exam. ties. Training is offered at the basic, intermediate, and advanced levels in Regulation of the several disciplines within bank supervi- U.S. Banking Structure sion: safety and soundness, information technology, international banking, and The Federal Reserve administers several consumer affairs. Classes are conducted federal statutes that apply to bank holdin Washington, D.C., as well as at ing companies, financial holding compa- Reserve Banks and other locations. The nies, member banks, and foreign bank- Federal Reserve System also partici- ing organizations—the Bank Holding pates in training offered by the FFIEC Company Act, the Bank Merger Act, the and by certain other regulatory agencies. Change in Bank Control Act, the Fed- The System's involvement includes de- eral Reserve Act, and the International veloping and implementing basic and Banking Act. In administering these advanced training in relation to various statutes, the Federal Reserve acts on a emerging issues as well as in specialized variety of proposals that directly or indiareas such as international banking, in- rectly affect the structure of the U.S. formation technology, anti-money laun- banking system at the local, regional, dering, capital markets, payment sys- and national levels; the international optems risk, and real estate appraisal. In erations of domestic banking organizaaddition, the System co-hosts the World tions; or the U.S. banking operations of Bank Seminar for supervisors from de- foreign banks. The proposals concern veloping countries. bank holding company formations and In 2006, the Federal Reserve trained acquisitions, bank mergers, and other 3,619 students in System schools, 952 in transactions involving bank or nonbank schools sponsored by the FFIEC, and 24 firms. In 2006, the Federal Reserve in other schools, for a total of 4,595, acted on 1,378 proposals, which repreincluding 312 representatives of foreign sented 3,171 individual applications central banks and supervisory agencies filed under the five administered (see table). The number of training days statutes. in 2006 totaled 23,321. The System gave scholarship assis- Bank Holding Company Act tance to the states for training their examiners in Federal Reserve and FFIEC Under the Bank Holding Company Act, schools. Through this program, 605 state a corporation or similar legal entity examiners were trained—308 in Federal must obtain the Federal Reserve's Reserve courses, 293 in FFIEC pro- approval before forming a bank holding grams, and 4 in other courses. company through the acquisition of one A staff member seeking an examin- or more banks in the United States. er's commission is required to take a Once formed, a bank holding company first proficiency examination as well as must receive Federal Reserve approval a second proficiency examination in one before acquiring or establishing addiof two specialty areas: safety and sound- tional banks. The act also identifies the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 85 Training Programs for Banking Supervision and Regulation, 2006 Number of sessions conducted Program Total Regional Schools or seminars conducted by the Federal Reserve Core schools Banking and supervision elements 7 Financial analysis and risk management 8 7 Bank management 3 1 Report writing 15 15 Management skills 8 8 Conducting meetings with management 14 14 Other schools Credit risk analysis 5 4 Examination management 5 5 Real estate lending seminar 3 2 Senior forum for current banking and regulatory issues . 2 2 Basel II corporate activities 3 2 Basel II operational risk 2 0 Basel II retail activities 3 1 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 2 CA risk-focused examination techniques 2 2 Fair lending examination techniques 3 3 Foreign banking organizations seminar 1 1 Information systems continuing education 7 7 Asset liability management (ALM1) 2 2 Asset liability management (ALM2) 2 1 Fundamentals of interest rate risk management 8 8 Trading and operations 1 1 Technology risk integration 3 3 Leadership dynamics 6 4 Fundamentals of fraud 16 15 Information technology seminars1 11 11 Seminar for senior supervisors of foreign central banks2 and 13 other international courses 34 26 Self-study or online learning* Orientation (core and specialty) .. Self-study modules (26 modules). Other agencies conducting courses* Federal Financial Institutions Examination Council. 78 The Options Institute 1 1. Held at the IT Lab at the Chicago Reserve Bank. 3. Self-study programs do not involve group sessions. 2. Conducted jointly with the World Bank. 4. Open to Federal Reserve employees. nonbanking activities permissible for consider the financial and managerial bank holding companies; depending on resources of the applicant, the future the circumstances, these activities may prospects of both the applicant and the or may not require Federal Reserve firm to be acquired, the convenience and approval in advance of their com- needs of the community to be served, mencement. the potential public benefits, the com- When reviewing a bank holding com- petitive effects of the proposal, and the pany application or notice that requires applicant's ability to make available to prior approval, the Federal Reserve may the Federal Reserve information deemed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

86 93rd Annual Report, 2006 necessary to ensure compliance with company status must file a written decapplicable law. In the case of a foreign laration with the Federal Reserve. In banking organization seeking to acquire 2006, 48 domestic financial holding control of a U.S. bank, the Federal company declarations and 7 foreign Reserve also considers whether the for- bank declarations were approved. eign bank is subject to comprehensive supervision or regulation on a consolidated basis by its home-country supervi- Bank Merger Act sor. In 2006, the Federal Reserve acted on 638 applications filed by bank hold- The Bank Merger Act requires that all ing companies to acquire a bank or a proposals involving the merger of 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 Holding Company Act. Since 1996, the the financial and managerial resources act has provided an expedited prior- of the applicant, the future prospects of notice procedure for certain permissible the existing and combined organizanonbank activities and for acquisitions tions, the convenience and needs of the of small banks and nonbank entities. community(ies) to be served, and the Since that time the act has also permit- competitive effects of the proposed ted well-run bank holding companies merger. In 2006, the Federal Reserve that satisfy certain criteria to commence approved 65 merger applications under certain other nonbank activities on a de the act. novo basis without first obtaining Fed- As a result of enactment of the Finaneral Reserve approval. cial Services Regulatory Relief Act of A bank holding company may repur- 2006, the Federal Reserve is no longer chase its own shares from its sharehold- required for each proposed bank merger ers. When the company borrows money to either request competitive factors reto buy the shares, the transaction ports from the other federal banking and increases the company's debt and de- thrift regulatory agencies or provide recreases its equity. The Federal Reserve ports on competitive factors to those may object to stock repurchases by hold- other agencies. The Federal Reserve ing companies that fail to meet certain now must consider only the views of the standards, including the Board's capital U.S. Department of Justice regarding the adequacy guidelines. In 2006, the competitive aspects of a proposed bank Federal Reserve reviewed 7 stock- merger. In addition, the views of the repurchase proposals by bank holding Department of Justice need not be soliccompanies. ited for bank mergers involving affili- The Federal Reserve also reviews ated insured depository institutions. elections from bank holding companies Before these statutory changes occurred seeking financial holding company sta- in the third quarter of 2006, the Federal tus under the authority granted by the Reserve had submitted 451 reports Gramm-Leach-Bliley Act. Bank holding on competitive factors to the other companies seeking financial holding agencies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 87 Change in Bank Control Act tain Federal Reserve approval to establish domestic branches, and all member The Change in Bank Control Act rebanks (including national banks) must quires individuals and certain other parobtain Federal Reserve approval to esties that seek control of a U.S. bank or tablish foreign branches. When reviewbank holding company to obtain aping proposals to establish domestic proval from the appropriate federal branches, the Federal Reserve considbanking agency before completing the ers, among other things, the scope and transaction. The Federal Reserve is renature of the banking activities to be sponsible for reviewing changes in the conducted. When reviewing proposals control of state member banks and bank for foreign branches, the Federal holding companies. In its review, the Reserve considers, among other things, Federal Reserve considers the financial the condition of the bank and the bank's position, competence, experience, and experience in international banking. In integrity of the acquiring person; the 2006, the Federal Reserve acted on new effect of the proposed change on the and merger-related branch proposals for financial condition of the bank or bank 2,033 domestic branches and granted holding company being acquired; the prior approval for the establishment of 7 effect of the proposed change on compenew foreign branches. tition in any relevant market; the com- State member banks must also obtain pleteness of the information submitted Federal Reserve approval to establish by the acquiring person; and whether financial subsidiaries. These subsidiaries the proposed change would have an admay engage in activities that are finanverse effect on the federal deposit insurcial in nature or incidental to financial ance funds. In addition, with enactment activities, including securities and insurof the Financial Services Regulatory Reance agency-related activities. In 2006, lief Act of 2006, the Federal Reserve 1 application for a financial subsidiary must also consider the future prospects was approved. of the institution to be acquired: a proposed transaction should not jeopardize the stability of the institution or the Overseas Investments by interests of depositors. During its review U.S. Banking Organizations of a proposed transaction, the Federal U.S. banking organizations may engage Reserve may contact other regulatory or in a broad range of activities overseas. law enforcement agencies for informa- Many of the activities are conducted tion about relevant individuals. indirectly through Edge Act and agree- In 2006, the Federal Reserve apment corporation subsidiaries. Although proved 98 changes in control of state most foreign investments are made unmember banks and bank holding der general consent procedures that incompanies. volve only after-the-fact notification to the Federal Reserve, large and other significant investments require prior ap- Federal Reserve Act proval. In 2006, the Federal Reserve Under the Federal Reserve Act, a mem- approved 29 proposals for significant ber bank may be required to seek Fed- overseas investments by U.S. banking eral Reserve approval before expanding organizations. The Federal Reserve also its operations domestically or interna- approved 16 applications to make additionally. State member banks must ob- tional investments through an Edge Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88 93rd Annual Report, 2006 Act or agreement corporation, 1 applica- with U.S. law. In 2006, the Federal Retion to establish an Edge Act corpora- serve approved 19 applications by fortion, and 2 applications to extend the eign banks to establish branches, agencorporate existence of an Edge Act cies, or representative offices in the corporation. United States. International Banking Act Public Notice of The International Banking Act, as Federal Reserve Decisions amended by the Foreign Bank Supervi- Certain decisions by the Federal Resion Enhancement Act of 1991, requires serve that involve an acquisition by a foreign banks to obtain Federal Reserve bank holding company, a bank merger, a approval before establishing branches, change in control, or the establishment agencies, commercial lending company of a new U.S. banking presence by a subsidiaries, or representative offices in foreign bank are made known to the the United States. public by an order or an announcement. In reviewing proposals, the Federal Orders state the decision, the essential Reserve generally considers whether the facts of the application or notice, and foreign bank is subject to comprehenthe basis for the decision; announcesive supervision or regulation on a conments state only the decision. All orders solidated basis by its home-country suand announcements are made public impervisor. It also considers whether the mediately; they are subsequently rehome-country supervisor has consented ported in the Board's weekly H.2 statisto the establishment of the U.S. office; tical release. The H.2 release also the financial condition and resources of contains announcements of applications the foreign bank and its existing U.S. and notices received by the Federal Reoperations; the managerial resources of serve upon which action has not yet the foreign bank; whether the homebeen taken. For each pending applicacountry supervisor shares information tion and notice, the related H.2A conregarding the operations of the foreign tains the deadline for comments. The bank with other supervisory authorities; Board's web site (www.federalreserve. whether the foreign bank has provided gov) provides 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 will be made available to the Federal that wish to submit applications or no- Reserve, if deemed necessary to detertices to the Federal Reserve. mine and enforce compliance with applicable law; whether the foreign bank has adopted and implemented proce- Enforcement of dures to combat money laundering and Other Laws and Regulations whether the home country of the foreign bank is developing a legal regime to The Federal Reserve's enforcement readdress money laundering or is partici- sponsibilities also extend to the disclopating in multilateral efforts to combat sure of financial information by state money laundering; and the record of the member banks and the use of credit to foreign bank with resnect to compliance purchase and carry securities. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 89 Financial Disclosures by rities. The Board's Regulation X applies State Member Banks these credit limitations, or margin requirements, to certain borrowers and to State member banks that issue securities certain credit extensions, such as credit registered under the Securities Exchange obtained from foreign lenders by U.S. Act of 1934 must disclose certain inforcitizens. mation of interest to investors, including Several regulatory agencies enforce annual and quarterly financial reports the Board's securities credit regulaand proxy statements. By statute, the tions. The SEC, the National Associa- Board's financial disclosure rules must tion of Securities Dealers, and the be substantially similar to those of the national securities exchanges examine SEC. At the end of 2006, 17 state membrokers and dealers for compliance ber banks were registered with the with Regulation T. With respect to Board under the Securities Exchange compliance with Regulation U, the fed- Act of 1934. eral banking agencies examine banks under their respective jurisdictions; the Securities Credit Farm Credit Administration, the NCUA, and the OTS examine lenders Under the Securities Exchange Act, the under their respective jurisdictions; and Board is responsible for regulating the Federal Reserve examines other credit in certain transactions involving Regulation U lenders. the purchase or carrying of securities. The Board's Regulation T limits the amount of credit that may be provided by securities brokers and dealers when Federal Reserve Membership the credit is used to trade debt and equity securities. The Board's Regula- At the end of 2006, 2,593 banks were tion U limits the amount of credit that members of the Federal Reserve System may be provided by lenders other than and were operating 53,938 branches. brokers and dealers when the credit is These banks accounted for 35 percent of used to purchase or carry publicly held all commercial banks in the United equity securities if the loan is secured by States and for 71 percent of all commerthose or other publicly held equity secu- cial banking offices. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

91 Consumer and Community Affairs Among the Federal Reserve's responsi- which implements the Electronic Fund bilities in the areas of consumer and Transfer Act, and the associated comcommunity affairs are mentary to make the regulation applicable to payroll card accounts established • writing and interpreting regulations to through an employer to provide a conimplement federal laws that protect sumer with electronic fund transfers of and inform consumers; salary, wages, or other employee com- • supervising state member banks to en- pensation on a recurring basis. The sure compliance with the regulations; Board also amended Regulation E to clarify that a person, such as a merchant, • investigating complaints from the must obtain a consumer's authorization public about state member banks' to collect returned-item fees electronicompliance with regulations; and cally from the consumer's account. The • promoting community development in Board engaged in several rulemaking historically underserved markets. and other activities with the other federal banking agencies and the Federal These responsibilities are carried out by Trade Commission (FTC). The Board, the members of the Board of Governors, the Federal Deposit Insurance Corporathe Board's Division of Consumer and tion (FDIC), and the Office of the Community Affairs, and the consumer Comptroller of the Currency (OCC) and community affairs staff of the Fedissued final guidance on the most recent eral Reserve Banks. amendments to the agencies' Community Reinvestment Act (CRA) regulations. The Board also issued joint final Implementation of Statutes guidance with the OCC, the FDIC, the Designed to Inform and Protect Office of Thrift Supervision (OTS), and Consumers the National Credit Union Administration (NCUA) to address the risks associ- The Board of Governors writes regulaated with nontraditional mortgage prodtions to implement federal laws involvucts. In addition, the Board and the FTC ing consumer financial services and fair jointly issued a report to Congress on lending. The Board revises and updates the consumer dispute provisions of the these regulations to address the intro- Fair Credit Reporting Act. duction of new products and technologies, to implement legislative changes to Furthermore, the Board raised the existing laws, and to address problems dollar threshold that triggers additional consumers may encounter in their finan- requirements under the Home Ownercial transactions. To interpret and clarify ship and Equity Protection Act and the regulations, Board staff issue com- raised the exemption threshold for mentaries and other guidance. depository institutions required to col- During 2006, the Board published fi- lect data under the Home Mortgage Disnal amendments to its Regulation E, closure Act. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

92 93rd Annual Report, 2006 Amendments to Regulation E amendments clarify the consumer- (Electronic Fund Transfers) authorization requirements for the electronic collection of returned-item fees. The final rule states that a person seek- Payroll Cards ing to collect a fee for a returned check In August, the Board published final or any other item must obtain a conamendments to Regulation E that ad- sumer's authorization to initiate an EFT dress payroll card accounts established to collect this fee. This requirement through an employer on behalf of a applies to the person initiating the EFT, consumer and to which recurring elec- not to the consumer's account-holding tronic fund transfers of salary, wages, or financial institution. Consumer authoriother employee compensation are made. zation is obtained when (1) a notice Under the final rule, payroll card stating the specific amount of the fee accounts are subject to the same require- (or explaining how the fee is calcuments that apply to traditional transac- lated, if the fee may vary) and a statetion accounts under Regulation E; these ment that the fee will be collected via requirements include a financial institu- an EFT is provided to the consumer tion's duty to provide payroll-card and (2) the consumer goes forward with account holders with initial disclosures, the transaction. For point-of-sale transperiodic statements, and error-resolution actions, the notice must be posted in a and liability provisions. For periodic prominent and conspicuous location, statements, however, the final rule and a copy of the notice must be given allows financial institutions to provide to the consumer to retain. The required the specified account information elec- copy of the notice may be given to the tronically, and in writing upon the con- consumer at the time of the transaction sumer's request, rather than through or mailed to the consumer's address as paper statements. soon as reasonably practicable after the Regulation E applies to financial in- EFT has been initiated. stitutions that (1) hold an account belonging to a consumer or (2) both issue Joint Guidance on the Community an access device (such as a debit card) Reinvestment Act Regulations to a consumer and agree with the consumer to provide electronic fund trans- In March, the Board, along with the fer (EFT) services. The final rule clari- FDIC and the OCC, issued joint final fies that the depository institution guidance to implement changes to the holding the consumer's funds in a pay- agencies' CRA regulations, which were roll card account is a financial institu- effective in September 2005. The guidtion under the regulation. The final rule ance answers frequently asked questions does not generally cover employers or about the new CRA rules, including a third-party service providers. The man- new rule that provides CRA "commudatory compliance date for the final rule nity development" consideration for is July 1, 2007. bank activities that revitalize or stabilize designated disaster areas. The guidance states that banks will receive consider- Returned'Item Fees ation for activities they conduct within In December, the Board published a 36 months of an area's designation as a final rule amending Regulation E and disaster area when such activities help its official staff commentary. These to attract new, or to retain existing, busi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 93 nesses or residents to the area and are for nontraditional mortgage products are related to disaster recovery. consistent with prudent lending prac- The guidance also implements a new tices, which include considering whether rule that provides "community develop- a borrower has the capacity to repay a ment" consideration for bank activities loan. The second section outlines the that revitalize or stabilize underserved need for financial institutions to have or distressed middle-income rural areas. strong risk-management standards, capi- The guidance describes the types of ac- tal levels commensurate with the risk of tivities that will receive consideration as their products and activities, and an alwell as how such activities will be lowance for loan and lease losses that evaluated. In addition, the guidance dis- reflects the collectibility of their loan cusses the new community development portfolio. The third section describes test for intermediate small banks (banks recommended practices to ensure that that have assets of between $250 million financial institutions are providing conand $1 billion). sumers with clear and balanced information that allows them to understand the terms and associated risks of a loan Interagency Guidance before they choose a specific product or on the Risks of payment option. (See related box "Non- Nontraditional Mortgage Products traditional Mortgages—Balancing Innovation, Regulation, and Education.") In September, the Board, along with the OCC, the FDIC, the OTS, and the NCUA, issued final guidance to address Report on Compliance with the risks associated with the growing Consumer Dispute Provisions of use of so-called nontraditional mortgage the Fair Credit Reporting Act products, such as interest-only mortgages and payment-option adjustable- In August, the Board and the FTC issued rate mortgages.1 These products, which a joint report to Congress pursuant to allow borrowers to defer repayment of section 313(b) of the Fair and Accurate the loan's principal and sometimes inter- Credit Transactions Act of 2003 (the est, are being offered to a wide spectrum FACT Act). In addition to other of borrowers. Among other issues, the changes, the FACT Act amended the interagency guidance addresses con- Fair Credit Reporting Act (FCRA) to cerns that some borrowers may not fully enhance the FCRA's consumer dispute understand the risks of these products, provisions. The joint report describes including their potential for negative the extent to which consumer reporting amortization. agencies (CRAs) and furnishers of information to CRAs comply with the con- Specifically, the agencies provided sumer dispute provisions of the FCRA. guidance in three primary areas: loan Before writing the report, the Board and terms and underwriting standards, portthe FTC conducted a study that examfolio and risk-management practices, ined several sources of information: and consumer protection issues. The public comments from consumers, first section of the guidance advises fi- CRAs, and consumer and industry nancial institutions to ensure that their groups; consumer complaints sent to the loan terms and underwriting standards federal financial institution regulatory agencies; bank examination data on 1. See www.federalreserve.gov/boarddocs/press/ FCRA compliance; and other studies, bcreg/2006/20060929/default.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

94 93rd Annual Report, 2006 Nontraditional Mortgages— Balancing Innovation, Regulation, and Education Homeownership has long been viewed as a later in the term of a nontraditional mortfundamental step to furthering personal gage in order to recapture repayment of and financial well-being. A home is often principal. Because nontraditional mortthe largest and most important asset gages typically allow a borrower to make individuals and families acquire, and the lower payments early in the loan, these equity earned on a home can, over time, loans have become increasingly popular in provide homeowners with financial flex- high-cost housing markets. ibility and security. Consumers have But nontraditional mortgages can also benefited from public policies to encour- carry significant risk, including negative age and facilitate homeownership, as well amortization, which occurs when the as from innovations in the financial ser- amount of the loan increases over time, and vices industry that have increased both the "payment shock," which occurs when number of lenders and types of home loans interest rate adjustments result in a much available. While increased competition and higher payment later in the loan term. Furproduct choice provide consumers with ther, reports of aggressive marketing pracnew opportunities, they also present many tices for these loans, as well as reported challenges for both borrowers, who must incidents of consumers receiving inadbe prepared to evaluate their options, and equate or misleading loan disclosures, have for regulators, who seek to ensure raised concerns among consumer groups, consumer protections without hindering financial institution regulatory agencies, market innovation through overly restric- and some lawmakers that nontraditional tive regulation. mortgages are inappropriately marketed to In recent years, so-called nontraditional and used by some borrowers. However, the mortgages, including interest-only and need to ensure that consumer protections payment-option adjustable-rate mortgages, are in place for nontraditional mortgages have become increasingly popular. Origi- must be balanced with the desire to encournally designed as niche products to meet the age innovation and flexibility in the mortneeds of certain borrowers, such as wealthy gage industry. customers or customers who have seasonal In 2006, the Federal Reserve Board took or other fluctuations in their incomes, non- a multifaceted approach to responding to traditional mortgages are now common- consumer-related issues in today's mortplace among more-typical borrowers. In gage market, including the risks presented 2006, nontraditional mortgages accounted by the growing use of nontraditional mortfor one-third of all mortgage originations, gage products. During the summer, the compared with only one-tenth of mortgage Board convened a series of public hearings originations in 2003. Nontraditional mort- to discuss home equity lending markets gages can provide borrowers with greater and practices. After conducting initial outflexibility by allowing them to repay only reach to an array of interested groups, Fedinterest for a period of time or to choose eral Reserve regulatory and research staff among other repayment options, in contrast structured the hearings to include discusto a fully amortizing loan that requires sion panels on the impact of the 2002 fixed payments throughout the loan term. changes to the Home Ownership and The interest rate and payments are adjusted Equity Protection Act (HOEPA) regu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 95 lations, as well as panels on key issues in cludes an in-depth discussion of nontradithe mortgage market. Topics included tional mortgages and illustrations of how trends and issues associated with complex loan payments may result in negative amproducts, such as nontraditional mortgages ortization.1 The Board also published a and reverse mortgages, as well as efforts to consumer information brochure, "Interestprovide consumers with pre- and post- Only Mortgage Payments and Paymentpurchase counseling and intervention, Option ARMs—Are They for You?," lender "best practices" and the role of which includes a glossary of lending terms, mortgage brokers, and the results of re- a mortgage shopping worksheet, and a list search on state predatory lending laws. The of additional information sources to help hearings also explored consumer behavior consumers evaluate whether these types of in shopping for mortgage loans and dis- loans are right for them.2 This publication cussed the challenges of designing more stresses the importance of understanding effective and informative consumer disclo- key mortgage loan terms, warns of the sures. Both lenders and consumer advo- risks consumers may face, and urges borcates participated in the hearings, which rowers to be realistic about whether they enabled diverse viewpoints on both the can handle future payment increases. In benefits and pitfalls of nontraditional mort- addition, interagency guidance on nontradigages to be presented. tional mortgages, issued in September, Lenders testified that nontraditional highlights the increased risk for lenders mortgage loans are appropriately under- and borrowers that nontraditional mortwritten and have historically shown strong gages can present.3 The guidance discusses performance. Consumer advocates and the importance of (1) carefully managing state officials, on the other hand, testified the potential heightened risk levels, for that aggressive marketing and the complex- the benefit of both lenders and borrowers; ity of these products increase the risk that a (2) using prudent loan-structuring and borrower will obtain a mortgage he or she -underwriting standards; (3) considering a does not understand and might not be able borrower's repayment capacity; and (4) ento afford. They also questioned whether suring that consumers have sufficient inforadditional loan disclosures would only mation to understand the terms and risks overwhelm consumers, because the prod- before making a loan or payment choice. ucts are so complex. Board staff are consid- The mortgage industry has proven to be ering the comments from these hearings, as innovative in developing a wide range of well as insights gained from consumer fo- mortgage credit products. Through its sucus groups and other sources of informa- pervisory responsibilities, research, contion, as they evaluate potential revisions to sumer education, and outreach to commuthe mortgage disclosure requirements in nities and lenders, the Federal Reserve Regulation Z. will continue to strive to balance such in- Recognizing the important role of educa- novation in the financial services industry tion in understanding mortgage transac- with responsive oversight and consumer tions, the Board partnered with other fed- protection. eral supervisory agencies to improve the resources available to both consumers and lenders on nontraditional mortgages. For 1. www.federalreserve.gov/pubs/arms/arms_ consumers, the Federal Reserve, in partner- english.htm ship with the Office of Thrift Supervision, 2. www.federalreserve.gov/pubs/mortgage_ interestonly/default.htm updated the "Consumer Handbook on 3. www.federalreserve.gov/boarddocs/press/bcreg/ Adjustable-Rate Mortgages," which in- 2006/20060929/default.htm Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

96 93rd Annual Report, 2006 reports, and data conducted or main- in the consumer price index. As a tained by the federal financial institution result, depository institutions that regulatory agencies. The report found have assets of $36 million or less as of that most CRAs appear to be processing December 31, 2006, are exempt from consumer disputes within the statutory data collection, effective January 1, time frame; however, there was dis- 2007. agreement as to the adequacy of the dispute investigations conducted by CRAs and furnishers of information to Supervision for Compliance CRAs. with Consumer Protection and To ensure that the FACT Act provi- Community Reinvestment Laws sions enhancing the consumer dispute process are given enough time to be effective, the Board and the FTC did not Activities Related to the recommend any additional administra- Community Reinvestment Act tive or legislative actions at this time. The Community Reinvestment Act However, as discussed in the report, the (CRA) requires that the Federal Reserve FTC and the Board will continue to and other banking agencies encourage monitor the performance of the dispute financial institutions to help meet the process, explore possible enhancements, credit needs of the local communities in and recommend actions, if appropriate. which they do business, consistent with safe and sound operations. To carry out this mandate, the Federal Reserve Other Regulatory Actions • examines state member banks to as- The Board also took the following regusess their compliance with the CRA; latory actions during 2006: • analyzes applications for mergers and • In August, the Board amended the acquisitions by state member banks official staff commentary to Regulaand bank holding companies in relation Z to raise from $528 to $547 the tion to CRA performance; and total dollar amount of points and fees that triggers additional requirements • disseminates information on commufor certain mortgage loans under the nity development techniques to bank- Home Ownership and Equity Protec- ers and the public through community tion Act. As prescribed by that statute, affairs offices at the Reserve Banks. the increased threshold (effective January 1, 2007) reflects changes in Examinations for Compliance the consumer price index. with the CRA • In December, the Board amended the The Federal Reserve assesses and rates official staff commentary to Regula- the CRA performance of state member tion C to raise from $35 million to banks in the course of examinations con- $36 million the asset-size exemption ducted by staff at the twelve Reserve threshold for depository institutions Banks. During the 2006 reporting required to collect data under the period, the Reserve Banks conducted Home Mortgage Disclosure Act. As CRA examinations of 276 banks: 27 prescribed by that statute, the were rated Outstanding, 248 were rated increased threshold reflects changes Satisfactory, none was rated Needs to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 97 Improve, and one was rated Substantial cants were being denied mortgage loans Noncompliance.2 more frequently than nonminority applicants; other concerns described included Analysis of Applications for potentially predatory lending practices Mergers and Acquisitions in of subprime and payday lenders; poten- Relation to the CRA tial adverse effects of branch closings; and lenders' failure to address the con- During 2006, the Board considered venience and needs of low- and applications for several significant bankmoderate-income communities. Many of ing mergers. The Board approved the the comments referenced pricing inforapplication by Capital One Financial mation on residential mortgage loans Corporation, McLean, Virginia, to acthat was required to be reported beginquire North Fork Bancorporation, Inc., ning with the 2004 Home Mortgage Dis- Melville, New York, in November; this closure Act (HMDA) data. Commentacquisition was a major expansion of ers' concerns that minority applicants Capital One Corporation's relatively were more likely than nonminority new retail banking operations. In addiapplicants to receive higher-priced morttion, three large bank holding compagages were largely based on observanies, National City Corporation, in tions of the 2004 and 2005 HMDA pric- Cleveland, Ohio; BB&T Corporation, in ing data.3 Winston-Salem, North Carolina; and In total, the Board acted on twenty- Marshall & Ilsley Corporation, in Milfour bank and bank holding company waukee, Wisconsin, each acquired two applications that involved protests by large banking organizations in 2006. members of the public concerning the Several other significant applications CRA performance of insured depository are listed below. institutions. The Board also reviewed • An application by Trustmark Corpora- thirty-six applications involving other tion, Jackson, Mississippi, to acquire issues related to CRA, fair lending, or Republic Bancshares of Texas, Inc., compliance with consumer credit pro- Houston, Texas, was approved in tection laws.4 August. • An application by Wachovia Corpora- Other Consumer Compliance tion, Charlotte, North Carolina, to Activities acquire Golden West Financial Cor- The Division of Consumer and Commuporation, Oakland, California, was apnity Affairs supports and oversees the proved in September. supervisory efforts of the Reserve Banks • An application by Regions Financial to ensure that consumer protection laws Corporation, Birmingham, Alabama, and regulations are fully and fairly ento acquire AmSouth Bancorporation, also of Birmingham, was approved in 3. HMDA requires lenders to collect price infor- October. mation on loans they originated in the higherpriced segment of the home-loan market. "Higher- The public submitted comments on priced mortgages" refers to mortgage loans whose each of these applications. Commenters annual percentage rates are 3 percentage points or expressed concerns that minority appli- more over the yield on comparable Treasury securities on first-lien loans, and 5 percentage points or more over that yield on junior-lien loans. 2. The 2006 reporting period for examination 4. In addition, four applications involving condata was July 1, 2005, through June 30, 2006. sumer compliance issues were withdrawn. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

98 93rd Annual Report, 2006 forced. Division staff provide guidance equately met the needs of their assessand expertise to the Reserve Banks on ment areas. (See "Response to the 2005 consumer protection regulations, exami- Hurricanes" later in this chapter.") nation and enforcement techniques, examiner training, and emerging issues. Fair Lending The staff develop and update examination policies, procedures, and guide- The Federal Reserve is committed to lines, as well as review Reserve Bank ensuring that every institution it supersupervisory reports and work products. vises complies fully with the federal fair They also participate in interagency ac- lending laws—the Equal Credit Opportivities that promote uniformity in ex- tunity Act (ECOA) and the Fair Housing amination principles and standards. Act. Fair lending reviews are conducted regularly within the supervisory cycle. Examinations are the Federal Re- Additionally, examiners may conduct serve's primary means of enforcing fair lending reviews outside of the usual compliance with consumer protection supervisory cycle, if warranted. To prolaws. During the 2006 reporting period, mote rigorous and consistent fair lendthe Reserve Banks conducted 321 coning enforcement, the Division of Consumer compliance examinations—303 sumer and Community Affairs staff of state member banks and 18 of foreign banking organizations.5 coordinate investigations of potential fair lending violations with Reserve The Board periodically issues guid- Bank staff. ance for Reserve Bank examiners on consumer protection laws and regula- The Federal Reserve enforces the tions. In addition to updating examina- ECOA and the provisions of the Fair tion procedures and guidance in concert Housing Act that apply to lending instiwith the other federal financial institu- tutions. The ECOA prohibits creditors tion regulatory agencies, the Board from discriminating against any appliissued guidance on state member banks' cant, in any aspect of a credit transacactivities in disaster areas affected by tion, on the basis of race, color, relithe 2005 hurricanes in the Gulf Coast gion, national origin, sex, marital staregion.6 As put forth in the guidance, tus, or age. In addition, creditors may state member banks located outside of not discriminate against an applicant the hurricane disaster areas will receive because the applicant receives income CRA consideration for their activities from a public assistance program or has that revitalize or stabilize the disaster exercised, in good faith, any right under areas, if the banks have otherwise ad- the Consumer Credit Protection Act. The Fair Housing Act prohibits discrimination in residential real estate- 5. The foreign banking organizations examined by the Federal Reserve are organizations operating related transactions, including the makunder section 25 or 25A of the Federal Reserve ing and purchasing of mortgage loans, Act (Edge Act and agreement corporations) and on the basis of race, color, religion, state-chartered commercial lending companies national origin, handicap, familial staowned or controlled by foreign banks. These institutions are not subject to the Community Reinvest- tus, or sex. ment Act and typically engage in relatively few Pursuant to the ECOA, if the Board activities that are covered by consumer protection has reason to believe that a creditor has laws. engaged in a pattern or practice of dis- 6. The guidance was released in a letter (CA crimination in violation of the ECOA, 06-5) to the Reserve Banks on February 24, 2006 (www.federalreserve.gov/boarddocs/caletters). the matter will be referred to the Depart- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 99 ment of Justice. If a violation of the • Two state member banks were found ECOA also constitutes a violation of to have engaged in discrimination on the Fair Housing Act and a referral is the basis of marital status in their not made to the Department of Justice, pricing of auto loans, in violation of the matter will be referred to the the ECOA. The banks used rate sheets Department of Housing and Urban that expressly provided that non- Development. spousal co-applicants (applicants who During 2006, the Board referred the were not married to each other) should following matters to the Department of be charged higher interest rates. Justice, on the basis of these findings: • The Board determined that a state • The Board determined that a mort- member bank discriminated on the gage company owned by a state basis of age, in violation of the ECOA, member bank had engaged in red- by offering customers over 50 years of lining—that is, discrimination against age a special account with preferential potential borrowers on the basis of credit features. The "over 50" account the racial composition of their provided for an interest rate reduction neighborhoods—in violation of the on consumer loans if payment was ECOA and the Fair Housing Act. The made through automatic debit. This mortgage company had adopted a interest rate reduction was not offered marketing strategy that was based on to borrowers who did not have an negative racial stereotypes and, as a "over 50" account. The ECOA generresult, excluded a cluster of minority ally prohibits creditors from considerneighborhoods from its lending ing age when evaluating creditworthiactivity. ness, except that a creditor may consider the age of an applicant • The Board found that a state member 62 years or older in the applicant's bank had violated the ECOA and the favor. Fair Housing Act by discriminating against several mortgage applicants on Since the addition of pricing informathe basis of race and national origin.7 tion to the data reported under HMDA, The bank rejected several minority the Federal Reserve has used the pricing applicants on the basis of "insufficient data to facilitate its fair lending enforcecollateral" without ordering an ap- ment efforts. (See "Reporting on Home praisal, even though, in contrast, the Mortgage Disclosure Act Data" later in bank did not deny any white appli- this chapter.) The Federal Reserve does cants for insufficient collateral with- not rely on HMDA data alone in its out ordering an appraisal. enforcement efforts, however, because HMDA data do not include many potential determinants of loan pricing, such as the borrower's credit history and the loan-to-value ratio. Instead, the 7. The Board referred this case to the Depart- Federal Reserve analyzes the HMDA ment of Justice in December 2005. It was not included in the 2005 Annual Report because the pricing data in conjunction with other referral occurred outside the reporting period for fair lending risk factors—such as the 2005 report (July 1, 2004, through June 30, discretionary pricing and incentives for 2005). It is included in the 2006 Annual Report, loan officers to charge higher prices—to which otherwise reports referrals occurring during identify lenders that are at risk for pricthe 2006 calendar year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

100 93rd Annual Report, 2006 ing discrimination.8 These lenders will Coordination with receive a targeted pricing review. Dur- Other Federal Banking Agencies ing a targeted pricing review, exam- The member agencies of the Federal iners collect additional information Financial Institutions Examination (including factors that are not available Council (FFIEC) develop uniform exin the HMDA data) to determine amination principles, standards, procewhether a pricing disparity by race or dures, and report formats.9 In 2006, the ethnicity is fully attributable to legiti- FFIEC revised examination procedures mate factors, or whether any portion of for the Fair Credit Reporting Act the pricing disparity is attributable to (FCRA). Section 604(g) of the FCRA discrimination. generally prohibits creditors from obtaining and using medical information Flood Insurance in connection with any determination of a consumer's eligibility, or continued The National Flood Insurance Act imeligibility, for credit unless permitted by poses certain requirements on loans seregulation. The agencies have issued cured by buildings or mobile homes loregulations creating exceptions to the cated in, or to be located in, areas statute's general prohibition; therefore, determined to have special flood hazthe FCRA examination procedures have ards. Under the Federal Reserve's Regubeen revised to reflect these new regulalation H, which implements the act, state tions. In addition, the FFIEC revised the member banks are generally prohibited CRA examination procedures for large from making, extending, increasing, or banks, small banks, wholesale or renewing any such loan unless the buildlimited-purpose banks, and banks opering or mobile home and any personal ating under strategic plans. The reviproperty securing the loan are covered sions incorporate the CRA regulatory by flood insurance for the term of the changes that were approved in 2005. loan. The act requires the Board and In 2006, the four banking agencies other federal financial institution regula- (the FDIC; the Federal Reserve, the tory agencies to impose civil money OCC; and the OTS) convened the first penalties when it finds a pattern or prac- Interagency Consumer Affairs Confertice of violations of the regulation. The ence. The conference's objectives were civil money penalties are payable to to (1) discuss the banking regulatory the Federal Emergency Management issues that affect consumers, (2) deter- Agency for deposit into the National mine more-effective ways for the agen- Flood Mitigation Fund. cies to share information about the com- During 2006, the Board imposed civil plaints they receive, and (3) identify money penalties against four state membest practices for communicating and ber banks. The penalties, which were interacting with the public. These agenassessed via consent orders, totaled cies plan to hold regular consumer $32,050. 9. The FFIEC member agencies are the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), 8. See the Interagency Fair Lending Examina- the Office of the Comptroller of the Currency tion Procedures for a full discussion of fair lending (OCC), the Office of Thrift Supervision (OTS), and risk factors (www.ffiec.gov/PDF/fairlend.pdf). the National Credit Union Administration (NCUA). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 101 affairs conferences; the next conference The FFIEC member agencies, along is scheduled for October 2007. with state financial institution regula- Finally, the Board, the OCC, and the tors, also conducted a public service FDIC updated the host-state loan-to- campaign to encourage banks, thrifts, deposit ratios used to determine compli- and credit unions to continue working ance with section 109 of the Riegle- with borrowers affected by Hurricane Neal Interstate Banking and Branching Katrina or Hurricane Rita. Public ser- Efficiency Act of 1994.10 vice announcements (PSAs) were distributed to radio stations and print publications in geographic areas that had Response to 2005 Hurricanes the highest concentrations of people affected by the hurricanes. The radio In 2006, the Federal Reserve and the PSAs played more than 1,495 times on other banking agencies continued initiathirty-one stations, reaching an estitives to help financial institutions afmated audience of 4.13 million people fected by the 2005 hurricanes in the in the targeted regions. The print PSAs Gulf Coast. The Board, the FDIC, the appeared more than sixteen times in ten OCC, and the OTS sponsored an internewspapers and other local publications, agency forum, "The Future of Banking reaching approximately 565,000 people. in the Gulf Coast: Helping Banks and Thrifts Rebuild Communities," that focused on the short-term and long-term Training for Bank Examiners challenges facing these financial institu- Ensuring that financial institutions comtions, including how they can help meet ply with laws that protect consumers the needs of their local communities. In and encourage community reinvestment addition to officials from the sponsoring is an important part of the bank examiagencies, senior executives from both nation and supervision process. As the large and small financial institutions and number and complexity of consumer representatives from community develfinancial transactions grow, training for opment corporations and a number of examiners of the organizations under other federal agencies participated in the the Federal Reserve's supervisory reforum. sponsibility becomes even more impor- The FFIEC member agencies and the tant. The consumer compliance exam- Conference of State Bank Supervisors iner training curriculum consists of six released a booklet, "Lessons Learned courses focused on various consumer from Hurricane Katrina: Preparing Your protection laws, regulations, and exam- Institution for a Catastrophic Event."11 ining concepts. In 2006, these courses Using financial institutions' experiences were offered in ten sessions to more and lessons learned during Hurricane than 195 consumer compliance examin- Katrina and its aftermath, the booklet is ers and System staff members. intended to help other institutions plan Board and Reserve Bank staff regufor an emergency or a catastrophic larly review the core curriculum for exevent. aminer training, updating subject matter and adding new elements as appropriate. 10. See the June 13, 2006, press release During 2006, staff conducted curricu- (www.federalreserve.gov/boarddocs/press/bcreg/ lum reviews of the following two 2006/). courses in order to incorporate technical 11. The booklet is available on the FFIEC's web site (www.ffiec.gov/Katrina_lessons.htm). changes in policy and laws, along with Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

102 93rd Annual Report, 2006 changes in instructional delivery requires most mortgage lenders located techniques: in metropolitan areas to collect data about their housing-related lending ac- • Community Reinvestment Act Examitivity, report the data annually to the nation Techniques Course. Equips asgovernment, and make the data publicly sistant examiners to participate in all available. In 1989, Congress expanded aspects of a CRA examination, includthe data required by HMDA to include ing the evaluation of a bank's CRA information about loan applications that program and the determination of its did not result in a loan origination, as CRA rating. well as information about the race, sex, • Fair Lending Examination Techniques and income of applicants and borrowers. Course. Provides assistant examiners In response to the growth of the with the skills and knowledge to plan subprime-loan market, the Federal and conduct the risk-focused fair lend- Reserve updated Regulation C in 2002. ing portion of a consumer compliance The revisions, which became effective examination. in 2004, require lenders to collect price information for loans they originated in When appropriate, courses are delivthe higher-priced segment of the homeered via alternative methods, such as the loan market. When applicable, lenders Internet or other distance-learning techreport the number of percentage points nologies. The CRA course discussed by which a loan's annual percentage above uses a combination of instrucrate exceeds the threshold that defines tional methods: (1) classroom instruc- "higher-priced loans." The threshold is tion focused on case studies and 3 percentage points or more above the (2) specially developed computer-based yield on comparable Treasury securities instruction that includes interactive selffor first-lien loans, and 5 percentage check exercises. The computer-based points or more above that yield for instruction is reinforced through daily junior-lien loans. The HMDA data colconference calls and discussions on lected in 2004 and released to the pubelectronic bulletin boards. The Fair lic in 2005 provided the first publicly Lending course discussed above also available loan-level data about loan uses computer-based training. prices. The FFTEC released the 2005 In addition to providing core training, HMDA data to the public in September the examiner curriculum emphasizes the 2006. importance of continuing professional A September 2006 article published development. Opportunities for continuby Federal Reserve staff in the Federal ing development include special projects Reserve Bulletin uses the 2005 data to and assignments, self-study programs, describe the market for higher-priced rotational assignments, the opportunity loans and patterns of lending across loan to instruct at System schools, mentoring products, geographic markets, and borprograms, and an annual senior examrowers and neighborhoods of different iner forum. races and incomes.12 As in 2004, relatively few lenders Reporting on Home Mortgage accounted for most of the higher-priced Disclosure Act Data 12. The complete article is available at The Home Mortgage Disclosure Act www.federalreserve.gov/pubs/bulletin/2006/hmda/ (HMDA), enacted by Congress in 1975, bullO6hmda.pdf. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 103 loan originations in 2005. Of the 8,850 on the West Coast also had an elevated home lenders reporting HMDA data, incidence of higher-priced lending in 1,120 of them made 100 or more higher- 2005. For example, in many metropolipriced loans. The 10 home lenders that tan areas in the South, Southwest, and had the largest volume of higher-priced West, 30 percent to 40 percent of the loans accounted for about 59 percent of homebuyers who obtained conventional all such loans. Higher-priced lending is loans in 2005 received higher-priced also concentrated by price: in 2005, the loans. vast majority of higher-priced loans had Third, the incidence of higher-priced annual percentage rates within 3 per- lending varies greatly among borrowers centage points of the reporting threshof different races and ethnicities. In olds. As in 2004, the majority of all 2005, as in 2004, blacks and Hispanics loan originations were not higher priced were much more likely than nonin 2005, however, the incidence of Hispanic whites and Asians to receive higher-priced lending did increase higher-priced loans. For example, in substantially—26.2 percent in 2005, 2005, 55 percent of black borrowers, compared with 15.5 percent in 2004. and 46 percent of Hispanic borrowers, Some of the increase in the incidence received higher-priced home-purchase of higher-priced lending is attributed to loans, compared with only 17 percent of changes in the interest rate environment non-Hispanic white or Asian borrowers. from 2004 to 2005, as well as to To a large extent, these differences rechanges in borrower profiles and lender flect a segmentation of the home-loan practices. market, that is, black and Hispanic bor- Loan pricing is a complex process rowers were much more likely to obtain that may reflect a wide variety of fac- mortgage loans from institutions that tors about the level of risk a particular specialize in higher-priced lending. loan or borrower presents to the lender. Because HMDA data lack informa- As a result, the prevalence of higher- tion about credit risk and other legitipriced lending varies widely. First, the mate pricing factors, it is not possible to incidence of higher-priced lending vardetermine from HMDA data alone ies by product type. For example, whether the observed pricing disparities manufactured-home loans show the and market segmentation reflect disgreatest incidence of higher-priced crimination. When analyzed in conjunclending, because these loans are considtion with other fair lending risk factors ered higher risk. In addition, first-lien and supervisory information, however, mortgages are generally less risky than the HMDA data can facilitate fair lendcomparable junior-lien loans, and the ing supervision and enforcement. (See pricing for these loans reflects their risk "Fair Lending" earlier in this chapter.) profiles: 25.7 percent of first-lien refinance loans were reported as higherpriced in 2005, compared with 30.2 Agency Reports on Compliance percent of comparable junior-lien loans. with Consumer Protection Laws Second, higher-priced lending varies widely by geography. As in 2004, many The Board reports annually on compliof the metropolitan areas that reported ance with consumer protection laws by the greatest incidence of higher-priced entities supervised by federal agencies. lending were in the southern region of This section summarizes data collected the country. Several metropolitan areas from the twelve Federal Reserve Banks, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

104 93rd Annual Report, 2006 the FFIEC member agencies, and other Act (ECOA) and Regulation B, as well federal enforcement agencies.13 as other consumer regulations. The other FFIEC agencies did not issue any for- Regulation B mal enforcement actions relating to (Equal Credit Opportunity) Regulation B during the reporting period. The FFIEC agencies reported that 87 percent of the institutions examined The other agencies that enforce the during the 2006 reporting period were in ECOA—the Farm Credit Administracompliance with Regulation B, com- tion (FCA), the Department of Transpared with 85 percent for the 2005 re- portation, the Securities and Exchange porting period. The most frequently Commission (SEC), the Small Business cited violations involved the failure to Administration, and the Grain Inspectake one or more of the following ac- tion, Packers and Stockyards Administions: tration of the Department of Agriculture—reported substantial compli- • abstain from inquiring about the race, ance among the entities they supervise. color, religion, national origin, or sex The FCA's examination activities of an applicant in connection with a revealed that most Regulation B violacredit transaction unless permitted by tions involved either creditors' providregulation ing inadequate statements of specific reasons for denial or creditors' failure • collect information for monitoring to request or provide information for purposes about the race, ethnicity, sex, government monitoring purposes. As marital status, and age of applicants reported by the SEC, an examination seeking credit primarily for the purconducted by the National Association chase or refinancing of a principal of Securities Dealers, Inc., found one residence violation of Regulation B at a member • note on the application form monitor- firm. The firm's written supervisory ing information regarding ethnicity, procedures did not contain information race, and sex when an applicant regarding the denial of credit to cuschooses not to provide the informa- tomers. However, none of these other tion agencies initiated any formal enforcement actions relating to Regulation B • provide a written notice of denial or during 2006. other adverse action to a credit applicant that contains the specific reason for the adverse action, along with Regulation E other required information (Electronic Fund Transfers) During this reporting period, the OTS The FFIEC agencies reported that apissued one supervisory agreement to a proximately 95 percent of the institusavings association for its alleged viola- tions examined during the 2006 reporttions of the Equal Credit Opportunity ing period were in compliance with Regulation E, which is comparable to the level of compliance for the 2005 13. Because the agencies use different methods reporting period. The most frequently to compile the data, the information presented cited violations involved the failure to here supports only general conclusions. The 2006 take one or more of the following acreporting period was July 1, 2005, through June 30, 2006. tions: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 105 • determine whether an error occurred, were in compliance with Regulation M, within ten business days of receiving which is comparable to the level of coma notice of error from a consumer pliance for the 2005 reporting period. The FFIEC agencies did not issue any • give the consumer provisional credit formal enforcement actions relating to for the amount of an alleged error Regulation M during the period. when an investigation into the alleged error cannot be completed within ten Regulation P (Privacy of Consumer business days Financial Information) • provide initial disclosures that contain The FFIEC agencies reported that required information, including limita- 98 percent of the institutions examined tions on the types of transfers permitduring the 2006 reporting period were in ted and error-resolution procedures, at compliance with Regulation P, comthe time a consumer contracts for an pared with 97 percent for the 2005 reelectronic fund transfer service porting period. The most frequently • when a determination is made that no cited violations involved the failure to error has occurred, provide a written take one or more of the following explanation and note the consumer's actions: right to request documentation supporting the institution's findings • provide a clear and conspicuous annual privacy notice to customers The Federal Trade Commission (FTC) filed two complaints in federal district • disclose the institution's informationcourt for alleged violations of Regula- sharing practices in initial, annual, and tion E and federal statutes. Among other revised privacy notices allegations, one complaint alleged that • provide customers with a clear and the defendants charged consumers' conspicuous initial privacy notice that credit cards or debited their bank accurately reflects the institution's priaccounts, both on a recurring basis, to vacy policies and practices, not later pay for a discount health plan, without than when the customer relationship is obtaining the consumers' authorization established for preauthorized electronic fund transfers. The other complaint alleged that The FFIEC agencies did not issue any defendants enrolled consumers in a formal enforcement actions relating to mail-order program for dietary supple- Regulation P during the reporting ments and then automatically billed con- period. sumers on a recurring basis, without obtaining their authorizations for the re- Regulation Z (Truth in Lending) curring debits. The FFIEC agencies and the SEC did not issue any formal en- The FFIEC agencies reported that forcement actions relating to Regulation 85 percent of the institutions examined E during the period. during the 2006 reporting period were in compliance with Regulation Z, compared with 80 percent for the 2005 re- Regulation M (Consumer Leasing) porting period. The most frequently The FFIEC agencies reported that more cited violations involved the failure to than 99 percent of the institutions exam- take one or more of the following ined during the 2006 reporting period actions: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

106 93rd Annual Report, 2006 • in closed-end credit transactions, ac- The FTC continued litigation against curately disclose the finance charge a mortgage broker and its principals for and the security interest that the credi- their alleged violations of Regulation Z tor has or will acquire in the property and federal statutes, in connection with identified advertisements for extremely low mortgage rates. In 2004, the court entered a • ensure that disclosures reflect the stipulated preliminary injunction against terms of the legal obligation between the defendants. In 2006, the defendant's the parties and, when any information chief executive filed for bankruptcy, folnecessary for an accurate disclosure is lowing his 2005 agreement to—among unknown, ensure that the creditor other terms—pay the FTC $400,000 unstates that the disclosure is an estimate der a stipulated order releasing him from confinement for civil contempt of the • on certain residential mortgage trans- 2004 stipulated preliminary injunction. actions, provide a good faith estimate The FTC filed a proof of claim for of the required disclosures before conamounts it is owed in the underlying summation, or not later than three federal district court action and the conbusiness days after receipt of the loan tempt action. Litigation is ongoing in application this case. In addition, 106 banks supervised by In 2006, the FTC settled charges in a the Federal Reserve and the FDIC were case alleging that a defendant violated required, under the Interagency En- Regulation Z and federal statutes. The forcement Policy on Regulation Z, to defendant allegedly engaged in misrepreimburse a total of approximately resentation about refunds for tax infor- $1.5 million to consumers for under- mation products. After accepting prodstating the annual percentage rate or the uct returns from consumers, or finance charge in their consumer loan otherwise acknowledging that the condisclosures. sumers were owed refunds, the defen- The OTS issued three supervisory dant failed to credit the consumers' agreements for violations of a number credit card accounts in a timely fashion. of consumer regulations, including Regulation Z, during the reporting Regulation AA (Unfair or Deceptive period. The other FFIEC agencies did Acts or Practices) not issue any formal enforcement The FFIEC agencies reported that more actions relating to Regulation Z during than 99 percent of the institutions examthe reporting period. ined during the 2006 reporting period The Department of Transportation inwere in compliance with Regulation vestigated one air carrier for its im- AA, which is comparable to the level of proper handling of credit card and cash compliance for the 2005 reporting refunds for unused refundable tickets. period. No formal enforcement actions As a result of this investigation, the air relating to Regulation AA were issued carrier made the required refunds and during the reporting period. entered into a consent order under which it was directed to cease and desist from Regulation CC (Availability of Funds further violations of the credit refund and Collection of Checks) requirements of Regulation Z. The air carrier was assessed a civil penalty of The FFIEC agencies reported that $50,000. 92 percent of institutions examined dur- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 107 ing the 2006 reporting period were in • provide account disclosures clearly compliance with Regulation CC, com- and conspicuously, in writing, and in a pared with 93 percent for the 2005 re- form that the consumer may keep porting period. The most frequently The FFIEC agencies did not issue any cited violations involved the failure to formal enforcement actions related to take one or more of the following Regulation DD during the reporting peactions: riod. • make available on the next business day the lesser of $100 or the aggregate Consumer Complaints amount of checks deposited that are not subject to next-day availability The Federal Reserve investigates complaints against state member banks and • follow procedures when invoking the forwards to the appropriate enforcement exception for large-dollar deposits agency any complaints that it receives • provide required information when that involved other creditors and busiplacing an exception hold on an nesses. Each Reserve Bank investigates account complaints against state member banks in its District. In 2006, the Federal Re- • make funds from local and certain serve received 641 consumer complaints other checks available for withdrawal about regulated practices by state memwithin the times prescribed by reguber banks—complaints were received by lation mail, by telephone, in person, and elec- The OTS issued one supervisory agree- tronically via the Internet. ment for violations of a number of consumer regulations, including Regulation CC. The other FFIEC agencies did not Complaints against issue any formal enforcement actions State Member Banks related to Regulation CC during the re- Of the 641 complaints about regulated porting period. practices, 70 percent involved consumer loans: 2 percent alleged discrimination Regulation DD (Truth in Savings) on a basis prohibited by law (race, color, The FFIEC agencies reported that 91 religion, national origin, sex, marital stapercent of institutions examined during tus, handicap, age, the fact that the apthe 2006 reporting period were in com- plicant's income comes from a public pliance with Regulation DD, which is assistance program, or the fact that the comparable to the level of compliance applicant has exercised a right under the for the 2005 reporting period. The most Consumer Credit Protection Act), and frequently cited violations involved the the remainder concerned other creditfailure to take one or more of the follow- related practices, such as fair credit reing actions: porting; billing-error resolution; and credit card rates, terms, and fees. • use the phrase "annual percentage Twenty-eight percent of the complaints yield" in an advertisement disclosing involved disputes about insufficientrequired additional terms and condifunds charges and procedures, amounts tions for customer accounts withdrawn from a consumer's account, • provide account disclosures contain- funds availability, and other deposit acing all required information count practices, including electronic Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

108 93rd Annual Report, 2006 Consumer Complaints against State against state member banks resulted in a Member Banks, by Classification, 2006 finding that the bank had violated a consumer protection regulation. The Classification Number most common violations involved real estate loans, deposit accounts, and elec- Regulation B (Equal Credit Opportunity) 53 tronic fund transfers. Regulation C (Home Mortgage Disclosure)... 0 Regulation E (Electronic Fund Transfers) 73 Regulation H (Bank Sales of Insurance) 1 Regulation H (Flood Insurance) 3 Unregulated Practices Regulation M (Consumer Leasing) 1 Regulation P (Privacy of Consumer As required by section 18(f) of the Fed- Financial Information) 17 Regulation Q (Payment of Interest) 0 eral Trade Commission Act, the Board Regulation Z (Truth in Lending) 243 continued to monitor complaints about Regulation BB (Community Reinvestment)... 1 Regulation CC (Expedited Funds banking practices that are not subject to Availability) 39 existing regulations and to focus on Regulation DD (Truth in Savings) 60 Fair Credit Reporting Act 117 those that concern possible unfair or Fair Debt Collection Practices Act 20 deceptive practices. In 2006, the Fed- Fair Housing Act 3 Regulations T, U, and X 0 eral Reserve received more than 1,300 Real Estate Settlement Procedures Act 10 complaints against state member banks Total 641 that involved unregulated practices. The most common complaints involved fund transfers; the remaining 2 percent checking accounts and credit cards. concerned disputes about trust services Consumers most frequently complained or other practices. (See tables.) about problems with either opening or In 97.5 percent of the 641 complaints closing an account (113 complaints), against state member banks regarding issues involving fraud (104), regulated practices that were investi- insufficient-funds charges and procegated in 2006, the banks had correctly dures (77), and concerns over specific handled the customer's account. The interest rates, terms, and fees on credit remaining 2.5 percent of the complaints cards (70). The remainder of the com- Complaints against State Member Banks That Involve Regulated Practices, 2006 All complaints Complaints involving violations Subject of complaint Number Percent Number Percent Total 641 100 16 2.50 Loans Discrimination alleged Real estate loans 0.47 Credit cards 0.62 Other loans 0.47 Other types of complaints Real estate loans 57 8.89 7.02 Credit cards 342 53.35 0.88 Other loans 41 6.40 2.44 Deposits 108 16.85 2.78 Electronic fund transfers ... 73 11.39 6.85 Trust services 1 0.16 0 Other 9 1.40 0 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 109 plaints concerned a wide range of sure and notification requirements of unregulated practices involving credit financial institutions that provide paycards, including errors or delays in pro- roll card account services to consumers. cessing consumers' payments, the Under the interim final rule, financial amounts banks charged for late pay- institutions are granted relief from the ments, and overlimit fees and proce- requirement to provide consumers with dures. paper periodic statements—if they provide the information in periodic state- Complaint Referrals to HUD ments to consumers through alternative means (such as electronically or by tele- In accordance with a memorandum of phone). Both industry and consumer understanding between HUD and the representatives generally supported the federal bank regulatory agencies that reproposed changes and agreed that their quires that a complaint alleging a violascope and approach effectively adtion of the Fair Housing Act be fordressed consumer protection issues. warded to HUD, in 2006 the Federal Several industry representatives noted Reserve referred three complaints to that substituting alternative methods for HUD that alleged state member bank the delivery of account information apviolations of the Fair Housing Act. In propriately balances consumers' rights two of the three cases, the Federal Reand their need to access their accounts, serve's investigations revealed no evion the one hand, with financial institudence of illegal discrimination. The retions' potential compliance costs, on the maining case was pending at year-end. other. Some consumer representatives, however, suggested that the periodic statements are an important educational Advice from the tool for consumers and, therefore, con- Consumer Advisory Council sumers would benefit from receiving The Board's Consumer Advisory paper periodic statements. Council—whose members represent Council members also discussed proconsumer and community organizations, posed changes to Regulation Z, which the financial services industry, aca- implements the Truth in Lending Act demic institutions, and state agencies— (TILA), at their March meeting. Memadvises the Board of Governors on bers shared their views on whether the matters concerning laws and regula- Board should establish a standard cutoff tions that the Board administers and on time for the crediting of payments on other issues related to consumer finan- open-end credit accounts. The council cial services. Council meetings are held did not reach a consensus on a specific three times a year, in March, June, and cutoff time; however, members noted October, and are open to the public. that such a cutoff would have important (For a list of members of the council, consequences, including high fees and see the section "Federal Reserve Sys- increased interest rates, for consumers tem Organization.") who make late payments. Several mem- During their March meeting, council bers suggested that the need to provide members discussed proposed changes to consumers with more transparency Regulation E, which implements the about the costs and fees imposed as a Electronic Fund Transfer Act (EFTA). result of late payments may be greater The proposed changes addressed payroll than the need to establish cutoff times card accounts, specifically the disclo- for the crediting of payments. Council Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

110 93rd Annual Report, 2006 members also discussed a TBLA amend- programs, methods for educating conment that requires creditors that offer sumers, and how to measure and evaluopen-end credit accounts to provide con- ate the effectiveness of financial educasumers with disclosures, on each peri- tion programs. Members identified odic statement, about the effects of mak- financial education as a fundamental ing only minimum payments on their tool for helping consumers build and accounts. Members expressed a wide preserve assets. Because financial litrange of views on whether such disclo- eracy not only enhances the well-being sures would be meaningful and useful to of individuals or households but also consumers; members also shared con- strengthens neighborhoods and commucerns about ensuring the accuracy of the nities, council members support (1) disclosures. making financial literacy a national pub- During its March and June meetings, lic policy priority and (2) creating nathe council discussed issues related to tional education initiatives and morethe Board's public hearings on the home formalized methods to train and educate equity lending market, as well as the consumers. adequacy of existing consumer disclo- At the October meeting, members sures and protections. Members dis- also discussed proposed regulations and cussed the Board's 2002 revisions to the guidelines to implement provisions of Home Ownership and Equity Protection the Fair and Accurate Credit Transac- Act (HOEPA) rules and their effect on tions Act (FACT Act) that require financonsumer protections and the availabil- cial institutions to identify "red flags" ity of credit in the high-cost and for detecting possible cases of identity subprime-lending markets. The council theft. Most industry representatives exalso discussed several issues related to pressed the need for more-flexible how consumers shop for credit and how guidelines that would allow financial that process may affect the loan terms institutions to use a risk-based approach they ultimately receive. Members dis- to address identity-theft risks, which cussed the increased role that mortgage change rapidly. Consumer representabrokers play in the loan-making tives were concerned that the proposed process—and whether this role high- guidelines give covered institutions and lights a need for additional regulation of creditors too much discretion over their brokers, specifically regulation on the identity-theft prevention and detection broker practice of directing potential policies. Council members also shared borrowers to certain mortgage products. their views on the implementation of the Members addressed the need to proposed regulations, including the staff strengthen consumer disclosures to en- training requirement and requirements sure that borrowers understand key for covered institutions to develop and credit terms and costs, particularly for implement a written identity-theft premortgage products that feature interest- vention program. only periods, prepayment penalties, and At their October meeting, members adjustable or "teaser rates." Several discussed the importance of creating members also expressed a need for addi- greater incentives to encourage investtional research on consumer behavior in ment in affordable housing. Homeownthe home mortgage market. ership is a fundamental part of a con- In June, the council discussed several sumer's asset-building strategy; the issues related to financial literacy, availability of affordable housing in a including goals for financial education neighborhood can create economic op- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 111 portunities that, in turn, support future Members also commented on the proinvestments in entrepreneurship and posed illustrations of consumer informaeducation. Members noted that financial tion, which were part of the guidance. institutions play a critical role by provid- The illustrations are designed to help ing mortgage credit to consumers and borrowers better understand the features by financing the development of afford- of nontraditional mortgages. The counable housing. They highlighted the need cil was generally supportive of the illusfor federal bank regulators to play a trations. Members stated that the illuslarger role by providing institutions with trations highlight important information, greater incentives for (1) meeting afford- such as the costs, terms, features, and able housing needs and (2) expanding risks of a loan, for borrowers. However, their outreach to local community orga- members expressed a need to include nizations, as part of their community additional loan information, such as inreinvestment strategies. formation on the risk of payment shock During each of their meetings this to the consumer, the costs of reducedpast year, council members discussed documentation loans, prepayment penalinteragency guidance on managing the ties, and the potential for negative amorpotential heightened risk of new and tization of the loan. emerging residential mortgage products, often referred to as "nontraditional," "alternative," or "exotic" mortgage loans. Consumer Education Members generally supported the guid- and Research ance, noting its importance in light of The Consumer Education and Research the recent proliferation and use of nonsection produces the Board's consumer traditional mortgage products, especially education materials and supports the by consumers whose household incomes Board's consumer outreach initiatives. are not keeping up with home-price Section staff also conduct research in appreciation. Members generally agreed support of the division's policy developthat these products do not present probment and community development funclems for some borrowers. But the loans tions. For example, research staff anaare risky for consumers whose cash lyze the annual HMDA data, which are flows or income projections may limit then used in the monitoring and enforcetheir ability to repay, who may not have ment of the fair lending laws. the capacity or discipline to manage the The Federal Reserve maintains a conloan, or who are not fully informed sumer information web site (www. about the terms and conditions such federalreserve.gov/consumer.htm) that loans carry. contains publications and educational Several members expressed concern materials related to the Board's conthat the guidance has given certain mortsumer regulations. In 2006, staff progage originators a competitive advanduced or updated the following publicatage, since the key principles of the tions on nontraditional mortgages: guidance apply only to banking and thrift organizations and federal credit • "Interest-Only Mortgage Payments unions. Others reiterated this concern by and Payment-Option ARMs—Are emphasizing that the agencies are only They for You?" (a new publication, providing guidance rather than creating issued jointly with the FFDEC agenrequirements that could be enforced by cies, that includes a glossary of lendconsumers or law enforcement agencies. ing terms, a mortgage-shopping work- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

112 93rd Annual Report, 2006 sheet, and a list of additional Emergency Relief (a private nonprofit information sources) organization), staff are studying whether a two-day financial education program • "Consumer Handbook on Adjustablehad an impact on how the participating Rate Mortgages" (substantially resoldiers manage their finances. At this vised and updated in conjunction with stage, baseline data have been collected, the OTS to incorporate descriptions and staff will be working to gather and illustrations of how changes in follow-up data. interest rates affect a consumer's loan payments, including an example of how an increase in interest rates may actu- Research on Financial Information ally increase the total loan amount) and Disclosures In addition, the Board's brochure "How A financial institution is required to proto File a Consumer Complaint about a vide consumers with disclosures about Bank," was updated. (The brochure is its products and services, including disavailable in both English and Spanish.) closures about its privacy policy or the Print and web-based versions of these terms of a loan. The Federal Reserve is publications are available on the web one of seven agencies working to desite. velop more "consumer-friendly" disclo- Throughout the year, Board staff par- sures, that is, disclosures written in clear, ticipated in a number of financial edu- understandable language that provide incation events, including events for formation a consumer can use to comcommunity members, federal employ- pare financial services providers. In the ees, and congressional staff. The Board spring, the agencies released a report continued to work with the interagency that summarized their research on devel- Financial Literacy and Education Com- oping a comprehensible financial primission (FLEC); last year, staff helped vacy notice for consumers.15 The Finanupdate and expand the FLEC's cial Services Regulatory Relief Act of MyMoney.gov web site to incorporate 2006, which was signed in October, sublinks to Reserve Bank consumer educa- sequently required the federal financial tion resources. In their speeches and regulatory agencies to develop a model other appearances, Board members privacy notice. The design, format, and underscored the importance of financial language of the model notice must be education to an individual's economic easily understood and allow consumers well-being. Former Governor Mark to compare the privacy policies of differ- Olson spoke at the press conference for ent financial institutions. the announcement of FLEC's National As part of its overall effort to improve Strategy for Financial Education in consumer disclosures, the Board studied April. Chairman Ben Bernanke testified how consumers use different types of on the Federal Reserve's role in finaninformation sources—both the quantity cial education before the U.S. Senate and quality of the sources—and whether Committee on Banking, Housing, and this information affected their credit and Urban Affairs in May.14 investment decisions. This study, in In cooperation with the Department addition to the research on privacy noof Defense, the U.S. Army, and Army tices, will be used in the upcoming 14. See www.federalreserve.gov/boarddocs/ 15. See www.federalreserve.gov/boarddocs/ testimony/2006/20060523/default.htm. press/bcreg/2006/20060331/default.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 113 review of the Board's open-end credit organizations that serve low- and regulations. The Board has contracted moderate-income communities and with a market research firm to conduct populations. Similarly, the Board's CAO formative and usability testing on credit promotes and coordinates Systemwide card disclosures, including the disclo- efforts, in addition to engaging in activisures used in solicitation letters, applica- ties and exploring issues that have pubtions, periodic statements, and change- lic policy implications. In 2006, the in-terms notices. Consumer testing will Board and the Reserve Banks collabocontinue in early 2007; the Board will rated on a number of activities that foconsider data collected in these sessions cused on asset-building for individuals as it develops new proposed rules under and strengthening community develop- Regulation Z. ment organizations, while continuing their efforts to expand public understanding of the need to enhance access Promotion of Community to affordable credit in underserved Economic Development and markets. Access to Financial Services in Historically Underserved Markets Collaborative Efforts In 2006, the community affairs function The Reserve Banks and the Board conwithin the Federal Reserve System sup- tinued their work on two substantial colported several initiatives to promote laborative efforts over the past year. The community economic development and System resumed its asset-building and fair access to credit for low- and wealth-creation partnership with the moderate-income communities and CFED, a nonprofit organization dedipopulations. The function continued to cated to expanding access to economic focus on improving the sustainability opportunity by bringing together comand financial capacity of community de- munity development practitioners, pubvelopment organizations, creating asset- lic policy analysts, and private-sector building opportunities for low-income representatives. In 2006, the Federal individuals, and promoting initiatives to Reserve System and the CFED held the help homeowners preserve this impor- last three in a series of five forums tant asset and avoid foreclosure. Activi- convening leaders in economic policy, ties included publishing newsletters and community development, philanthropy, articles, sponsoring conferences and and the financial industry. Starting with seminars, conducting research, and sup- the initial forum in June 2005, the foporting the dissemination of information rums were convened to encourage more to both general and targeted audiences. individuals to engage in asset-building As a decentralized function, the Com- activities, such as homeownership, enmunity Affairs Offices (CAOs) at each trepreneurship, savings, and investment. of the twelve Reserve Banks design ac- One session, held in Kansas City, fotivities in response to the needs of com- cused on the unique challenges to develmunities in the Districts they serve in oping asset-building programs in rural conjunction with staff from the Board. communities; the forum was cospon- The CAOs focus on providing informa- sored by the Reserve Banks of Kansas tion and promoting awareness of City, Dallas, Minneapolis, and St. Louis. investment opportunities to financial A second meeting, hosted by the institutions, government agencies, and Reserve Bank of Atlanta, explored asset- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

114 93rd Annual Report, 2006 building for low- and moderate-income Richmond Reserve Bank chaired the savers, but from the perspective of planning committee for the South Carofinancial institutions. The discussions lina Asset Development Collaborative, focused on developing products to help and staff from the San Francisco this population begin or expand its sav- Reserve Bank facilitated both the Oring efforts. The final forum, hosted by egon Asset Building Convergence and the Board of Governors, gathered a the Washington State Asset Building roundtable of leaders in the asset- Summit. Other Reserve Banks continbuilding field. The leaders reflected on ued to provide advisory services for the results of the regional forums and more than a dozen other state and reidentified next steps to help the industry gional asset-building coalitions throughprogress.16 out the country, such as the Houston A related initiative, led by the San Asset Building Coalition, Minnesota Francisco Reserve Bank, was a call for Saves, and the Nashville Wealth Buildpapers on asset-building issues and strat- ing Alliance. egies. Twenty-eight of the more than Another Systemwide collaboration 100 papers received were presented at a was a partnership with the Aspen Instiresearch forum during CFED's 2006 tute, a national research and leadership Assets Learning Conference, "A Life- development organization. The goal of time of Assets: Building Families, Com- this collaboration was to identify susmunities and Economies." More than tainable and scalable business models 1,000 participants attended; staff from that community development organizaeach Reserve Bank and the Board were tions can use to more effectively actively involved in planning the confer- advance their goals. In 2006, the Federal ence, including developing the agenda, Reserve System and the Aspen Institute presenting research, and serving as mod- cosponsored four conferences around erators and participants in formal discus- the country that explored a variety of sion groups. The Board's Community business models that have led to suc- Affairs officer delivered a keynote ad- cessful community development finance dress during the conference. Board staff programs. A forum at the San Francisco presented research on the asset port- Reserve Bank highlighted funding effolios of low-income households and forts for community development finanhow these assets have changed over the cial institutions (CDFIs), individual depast fifteen years (from 1989 to 2004). velopment account programs, charter Staff also explored homeownership and schools, and child care facilities. A foforeclosure patterns that affect the asset- rum at the Chicago Reserve Bank fobuilding capabilities of low-income cused on collaborative efforts to prohouseholds.17 mote the earned-income tax credit by Beyond the CFED partnership, helping low- to moderate-income fami- Reserve Banks have been active in the lies prepare their taxes. Participants at a promotion and development of regional forum at the New York Reserve Bank asset-building coalitions. Staff from the examined several collaborative efforts undertaken by development organiza- 16. Summaries of the forum sessions are avail- tions, including efforts to share infraable on the CFED web site (www.cfed.org/ structure resources (facilities, equipfocus.m). ment, etc.), collaborate on fundraising, 17. The research papers presented at this conferand pool other resources and strategies ence are available at www.frbsf.org/community/ research/assets.html. to increase their organizational capacity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 115 Finally, a forum at the Dallas Reserve for community development loans, Bank focused on the formation of poten- and included remarks by Governor tial new sources of capital for CDFIs Kroszner, who keynoted the conference. and community development corpora- The Minneapolis Reserve Bank has tions. These forums generated ongoing taken the lead in another initiative to Systemwide research on various aspects expand access to financial services of public and private subsidies for com- through its work with Native American munity development. Staff from several communities. On many reservations, acof the Reserve Banks and the Board are cess to affordable credit is often limited currently involved in a research project by ambiguities and inconsistencies in to measure the magnitude of the need the various tribal laws that govern sefor public and private groups to subsi- cured transactions. In response, Minnedize community development, measure apolis Reserve Bank staff have worked how effectively these subsidies are uti- to help investors and lenders better unlized, and identify emerging strategies derstand the property rights of Native for optimizing the leverage of subsidy Americans. For the past few years, the dollars. Reserve Bank staff have worked to create an improved legal structure that tribes can use to facilitate their efforts to Access to Financial Services borrow from off-reservation partners or other tribes. In 2005, staff were part of a Staff from around the System have conteam that completed a draft Model tinued working on several initiatives to Tribal Secured Transactions Act (MTA) enhance access to affordable credit in for the National Conference of Comcurrently underserved markets. In 2006, missioners on Uniform State Laws the San Francisco Reserve Bank and the (NCCUSL). Throughout 2006, staff sup- Board partnered to study issues related ported education and dissemination efto the creation of a secondary market for forts for the MTA by providing technicommunity development loans. The San cal assistance and making numerous Francisco Reserve Bank devoted an presentations, including one to tribal issue of its Community Development judges, on the benefits of tribal adoption Investment Review to an overview of the of the MTA. During the year, the Crow community development finance industribe adopted the MTA, three additional try, which included advice on best practribes in Montana passed resolutions to tices from industry practitioners. The adopt it, and approximately fifteen tribes Board and the San Francisco Reserve were in various stages of considering Bank followed up by hosting a conferadoption of the MTA. ence in Washington, D.C., for lenders, investors, and financial intermediaries, in addition to policymakers and academ- Resources, Advisory Services, ics. The conference sought to (1) assess and Outreach the status of the industry and (2) discuss ways to innovate and collaborate to In 2006, the Board released an update of increase liquidity for community devel- the Federal Reserve Fiscal Impact Tool opment lending. The next edition of the (FIT). First released in 2003, the FIT Review included the conference pro- software helps users analyze the fiscal ceedings and essays by conference par- impacts of economic development in ticipants laying out a possible road map small- and mid-sized communities. FIT for the creation of a secondary market supports economic development plan- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

116 93rd Annual Report, 2006 ning by producing a cost-benefit analy- to and endorsement of state-level activisis of proposed development projects; ties, for example, the Minneapolis FIT estimates a project's impact on local Reserve Bank's participation in Minnesales and property tax revenues and on sota's Emerging Market Homeownercosts to local government. To supple- ship Initiative and the Cleveland ment this analysis, FIT integrates a wide Reserve Bank's promotion (through the array of data, at the city, county, and Pittsburgh Branch) of the foreclosurestate levels, on incorporated locations in mitigation efforts of the Pennsylvania the United States. The 2006 update con- secretary of banking. tains more and newer data, along with a Over the past year, the Board continmodule that allows for time discounting ued its outreach activities to provide the and the calculation of a net present public with information about the value. The Board distributed more than Board's responsibilities, to facilitate un- 1,000 copies of the updated software in derstanding of changes in banking regu- 2006. Users include state and local eco- lations and their impact on banks and nomic development organizations, aca- consumers, to promote community dedemics, and consultants. A recent sur- velopment and consumer education, and vey of users identified two com- to foster discussion of policy issues. munities—El Paso, Texas, and Lincoln, Board staff periodically met with finan- Nebraska—that have employed FIT to cial institutions, community groups, and assist in setting limits on incentives for other members of the public in formal development projects. and informal settings. For example, the During the past year, the foreclosure Board expanded its prior work with Oprate has risen for certain housing mar- eration HOPE, a national nonprofit orkets. Low- and moderate-income fami- ganization dedicated to developing and lies and communities may be especially implementing programs focused on conat risk for foreclosure. Consequently, necting minority communities with the Board and the Reserve Banks have mainstream, private-sector resources enhanced their efforts to preserve home- and to empowering underserved comownership among these populations. munities. The System has collaborated The Board continued its involvement with Operation HOPE in prior years, with NeighborWorks® America (Neigh- and the director of the Board's Division borWorks), a national network of more of Consumer and Community Affairs than 240 community-based organiza- serves on the Operation HOPE Midtions providing financial support, techni- Atlantic Advisory Board. In 2006, cal assistance, and training for commu- Chairman Bernanke delivered a keynote nity rehabilitation efforts. A member of address at the "Anacostia Economic the Board of Governors serves on the Summit," a conference sponsored by NeighborWorks board of directors, and Operation HOPE and the District of Comembers of the Board's staff serve on lumbia. (Anacostia is an underdeveloped the organization's Center for Homeown- neighborhood in southeast Washington, ership Education and Counseling. Staff D.C.) The summit focused on ways to from the Reserve Banks have led re- encourage revitalization in this area and gional collaborative efforts with Neigh- highlighted the importance of obtaining borWorks through their participation in both targeted public and private investforeclosure-prevention training work- ment to jump-start the development efshops for homeownership counselors. forts in this and other underserved The Banks have also provided support neighborhoods. In preparation for the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 117 conference, Chairman Bernanke toured local property developers to gain firstthe Anacostia community with lenders, hand insight into the community's community development leaders, and redevelopment. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

119 Federal Reserve Banks In addition to contributing to the setting years, the Reserve Banks have recovof national monetary policy and super- ered 99.0 percent of their priced services vising and regulating banks and other costs, including the PSAF (table).2 In financial entities (discussed in preced- 2006, the Board implemented changes ing chapters), the Federal Reserve Banks to the method for calculating the target provide payment services to depository return on equity measure in the PSAF.3 and certain other institutions, distribute Overall, the price index for priced the nation's currency and coin, and services increased 2.4 percent from 2005 serve as fiscal agents and depositories to 2006. Revenue from priced services for the United States. amounted to $908.4 million, other income was $122.8 million, and costs Developments in were $875.5 million, resulting in net Federal Reserve Priced Services income from priced services of $155.7 million. In 2006, the Reserve Banks re- The Federal Reserve Banks provide a covered 108.8 percent of total costs of range of payment and related services to $947.5 million, including the PSAF.4 depository institutions, including collecting checks, operating an automated clearinghouse service, transferring funds nors assets and costs that are related to priced services are also allocated to priced services; in and securities, and providing a multilatthe pro forma financial statements at the end of eral settlement service. The Reserve this chapter, Board assets are part of long-term Banks charge fees for providing these assets, and Board expenses are included in operat- "priced services." ing expenses. 2. Effective December 31, 2006, the Reserve The Monetary Control Act of 1980 Banks implemented the Financial Accounting requires that the Federal Reserve estab- Standards Board's Statement of Financial Aclish fees for priced services provided to counting Standards No. 158, Employers' Accountdepository institutions so as to recover, ing for Defined Benefit Pension and Other Postreover the long run, all direct and indirect tirement Plans (FAS 158), which resulted in the recognition of a $343.9 million reduction in equity costs actually incurred as well as the related to the priced services' benefit plans. Inimputed costs that would have been in- cluding this reduction in equity, which represents curred, including financing costs, taxes, a decline in economic value, results in cost recovand certain other expenses, and the re- ery of 95.5 percent for the ten-year period. For details on how implementing FAS 158 affected the turn on equity (profit) that would have pro forma financial statements, refer to notes 2, 3, been earned if a private business firm and 5 at the end of this chapter. had provided the services. The imputed 3. In 2005, the Board approved changing the costs and imputed profit are collectively method from using the average of the results of referred to as the private-sector adjust- three analytical methods—the comparable acment factor (PSAF).1 Over the past ten counting earnings model, the discounted cashflow model, and the capital asset pricing model (CAPM)—to using only the CAPM. 1. In addition to income taxes and the return on 4. Financial data reported throughout this equity, the PSAF is made up of three imputed chapter—revenue, other income, cost, net revcosts: interest on debt, sales taxes, and assess- enue, and income before taxes—can be linked to ments for deposit insurance by the Federal Deposit the pro forma financial statements at the end of Insurance Corporation (FDIC). Board of Gover- this chapter. Other income is revenue from invest- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

120 93rd Annual Report, 2006 Priced Services Cost Recovery, 1997-2006 Millions of dollars except as noted Operating Revenue from Targeted return Total Cost recovery Year services1 im ex p p u e t n e s d e s c o a s n t d s2 on equity costs (percent)3'4 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 2006 1,031.2 875.5 72.0 947.5 108.8 1997-2006 9,149.9 8,367.5 870.5 9,238.1 99.0 NOTE: Here and elsewhere in this chapter, totals and of $7,722.6 million, imputed costs of $296.4 million, and percentages may not reflect components shown because imputed income taxes of $348.5 million. of rounding. 3. Revenue from services divided by total costs. 1. For the ten-year period, includes revenue from ser- 4. For the ten-year period, cost recovery is 95.5 pervices of $8,727.4 million and other income and expense cent, including the reduction in equity related to FAS 158 (net) of $422.5 million. reported by the priced services in 2006. 2. For the ten-year period, includes operating expenses Commercial Check Collection adoption of check-processing services Service associated with the Check Clearing for the 21st Century Act (Check 21).5 In 2006, operating expenses and im- The Reserve Banks handled 11.0 bilputed costs for the Reserve Banks' comlion checks in 2006, a decrease of 9.9 mercial check collection service totaled percent from 2005 (table). The decline $716.9 million, of which $35.4 million in Reserve Bank check volume is conwas attributable to the transportation of sistent with nationwide trends away commercial checks between Reserve from the use of checks and toward Bank check-processing centers. Revgreater use of electronic payment methenue amounted to $745.0 million, of ods.6 Of all the checks presented by the which $34.2 million was attributable Reserve Banks to paying banks in 2006, to estimated revenues derived from 14.0 percent of the checks were deposthe transportation of commercial ited and 4.3 percent were presented uschecks between Reserve Bank check- ing Check 21 products, compared with processing centers, and other income 1.8 percent and 0.0 percent, respecwas $100.7 million. The resulting net income was $128.7 million. Check ser- 5. The Reserve Banks' Check 21 product suite vice revenue in 2006 increased $4.7 mil- includes electronic alternatives to paper-check collection, return, and presentment. lion from 2005, largely because of price 6. The Federal Reserve System's retail payincreases and faster-than-anticipated ments research suggests that the number of checks written in the United States has been declining ment of clearing balances net of earnings credits, since the mid-1990s. For details, see Federal an amount termed net income on clearing bal- Reserve System, "The 2004 Federal Reserve ances. Total cost is the sum of operating expenses, Payments Study: Analysis of Noncash Payments imputed costs (interest on debt, interest on float, Trends in the United States, 2000-2003" sales taxes, and the FDIC assessment), imputed (December 2004). (www.frbservices.org/Retail/ income taxes, and the targeted return on equity. pdf/2004PaymentResearchReport.pdf) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 121 Activity in Federal Reserve Priced Services, 2004-2006 Thousands of items Percent change Service 2006 2005 2004 2005 to 2006 2004 to 2005 Commercial check . . 10,982,367 12,195,301 13,904,382 -9.9 -12.3 Commercial ACH 8,230,782 7,338,950 6,486,091 12.2 13.1 Funds transfer 136,399 135,227 128,270 0.9 5.4 Multilateral settlement 470 440 435 6.8 1.3 Securities transfer . .. 9,053 9,235 9,208 -2.0 0.3 NOTE: Activity in commercial check is the total num- securities transfer, the number of transactions originated ber of commercial checks collected, including processed online and offline; and in multilateral settlement, the and fine-sort items; in commercial ACH, the total number number of settlement entries processed. of commercial items processed; in funds transfer and tively, in 2005 P Overall, the price index trillion), an increase of 12.2 percent for check services increased 3.6 percent from 2005. Overall, the price index for from 2005. ACH services decreased 9.1 percent In response to the continuing decline from 2005. in check volume, the Reserve Banks in In 2006, the Reserve Banks began 2006 continued to reduce check service offering ACH risk-management services operating costs through a combination to all depository institutions. These serof measures, including consolidating vices help originating institutions mansome check-processing sites. Check pro- age the operational and credit risk assocessing at New Orleans has now been ciated with originating ACH payments. consolidated to Atlanta; New York's By the end of 2006, 76 financial institu- East Rutherford Operations Center to tions subscribed to these services. Philadelphia; Columbus to Cleveland; and Boston to Windsor Locks, Connecticut. Additional consolidations are Fedwire Funds and planned for 2007 and beyond. National Settlement Services Reserve Bank operating expenses and imputed costs for the Fedwire Funds Commercial Automated and National Settlement Services to- Clearinghouse Services taled $59.3 million in 2006. Revenue Reserve Bank operating expenses and from these operations totaled $63.6 milimputed costs for commercial automated lion and other income amounted to $8.6 clearinghouse (ACH) services totaled million, resulting in net income of $13.0 $80.1 million in 2006. Revenue from million. ACH operations totaled $80.5 million and other income totaled $10.9 million, Fedwire Funds Service resulting in net income of $11.3 million. The Fedwire Funds Service allows par- The Banks processed 8.2 billion comticipants to draw on their reserve or mercial ACH transactions (worth $13.1 clearing balances at the Reserve Banks and transfer funds to other institutions 7. The Reserve Banks also offer non-Check 21 that maintain accounts at the Banks. In electronic presentment products. In 2006, 25.2 2006, the number of Fedwire funds percent of the Reserve Banks' deposit volume was presented to paying banks using these products. transfers originated by depository insti- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

122 93rd Annual Report, 2006 tutions increased 0.9 percent from 2005, ticipants in the service.8 Reserve Bank to approximately 136.4 million. The operating expenses and imputed costs average daily value of Fedwire funds for providing this service totaled $19.1 transfers in 2006 was $2.3 trillion. Over- million in 2006. Revenue from the serall, the price index for the Fedwire vice totaled $19.2 million, and other Funds and National Settlement Services income totaled $2.6 million, resulting in increased 3.4 percent from 2005. net income of $2.7 million. Overall, the Last year, the Reserve Banks collabo- price index for the service increased rated with The Clearing House Pay- 2.8 percent from 2005. ments Company to study the use of In 2006, approximately 9.1 million funds transfers for business-to-business non-Treasury securities transfers were payments. The study examined why processed by the service, slightly lower businesses select one payment type over than in 2005. Last year, the Reserve another and what changes are needed to Banks also implemented technical changes to the Fedwire Securities Sermake funds transfers a more attractive vice applications to support changes to payment alternative. Key findings from the Federal Reserve Policy on Payments the study suggested that businesses System Risk (PSR). The PSR policy wanted a more streamlined process for changes require that governmentmaking funds transfers and favored the sponsored enterprises and certain interinclusion of remittance information in national organizations fund principal funds transfer orders. and interest payments before the Reserve Banks distribute those pay- National Settlement Service ments in order to limit the credit expo- The National Settlement Service is a sure of the Reserve Banks. multilateral settlement system that allows participants in private-sector clearing arrangements to exchange and Float settle transactions on a net basis using The Federal Reserve had daily average reserve or clearing balances. In 2006, credit float of $85.9 million in 2006, the service processed settlement files for compared with debit float of $133.4 milapproximately fifty-four local and nalion in 2005.9 tional private arrangements, primarily check clearinghouse associations. The Reserve Banks processed slightly more than 17,300 files that contained more 8. The expenses, revenues, volumes, and fees than 470,000 settlement entries for these reported here are for transfers of securities issued arrangements in 2006. by federal government agencies, governmentsponsored enterprises, and certain international organizations. The Reserve Banks provide Treasury securities services in their role as the U.S. Fedwire Securities Service Treasury's fiscal agent. These services are not considered priced services. For details, see the The Fedwire Securities Service allows section "Debt Services" later in this chapter. participants to transfer electronically se- 9. Credit float occurs when the Reserve Banks curities issued by the U.S. Treasury, fed- present items for collection to the paying bank prior to providing credit to the depositing bank, eral government agencies, governmentand debit float occurs when the Reserve Banks sponsored enterprises, and certain credit the depositing bank prior to presenting items international organizations to other par- for collection to the paying bank. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 123 Developments in curity features and subtle background Currency and Coin colors. The Presidential $1 Coin Act re- The Federal Reserve Banks distribute quires, among other things, that the Fedthe nation's currency (in the form of eral Reserve and the Mint take steps to Federal Reserve notes) and coin through ensure that an adequate supply of $1 depository institutions and also receive coins is available for commerce. To that currency and coin from circulation end, the Federal Reserve worked with through these institutions. As currency the United States Mint to develop an flows into the Reserve Banks, the Banks effective distribution strategy for Presiinspect the notes and destroy those that dential $1 coins, the first of which was are unfit for recirculation. issued by the Mint in February 2007. The Reserve Banks received 38.5 bil- Consistent with the requirements of the lion Federal Reserve notes from circula- Presidential $1 Coin Act, the Federal tion in 2006, a 3.5 percent increase from Reserve and the Mint conducted out- 2005, and made payments of 39.1 bil- reach to depository institutions and coin lion notes into circulation in 2006, a users in an effort to gauge demand for 1.5 percent increase from 2005. They the coins and to anticipate and eliminate received 59.7 billion coins from circula- obstacles to the efficient circulation of tion in 2006, a 6.5 percent increase from $1 coins. 2005, and made payments of 73.9 bil- The Reserve Banks conducted extenlion coins into circulation, a 2.7 percent sive testing of a prototype upgrade to increase from 2005. the high-speed currency-processing ma- In March, the Board approved a pol- chines. The Reserve Banks will begin icy that provides incentives to encour- implementing the upgrades on their maage depository institutions to recirculate chines in 2007; the upgrades are schedfit currency to their customers rather uled to be completed in 2009. than return it to the Federal Reserve for The Federal Reserve developed the processing. Under the policy, the Fed- requirements for an automation system eral Reserve implemented a custodial to replace the current platform used to inventory program that allows deposi- support and facilitate the System's protory institutions to transfer a portion of vision of cash services. The Reserve the currency holdings in their vaults to Banks issued a preview request for prothe books of a Reserve Bank. As of posal for development of the new auto- December 31, the Reserve Banks had mation system and held an orientation established twenty-nine custodial in- with potential vendors in December. ventory sites with depository institu- The Reserve Banks completed a comtions. Beginning in July 2007, the prehensive study of cost-effective alter- Reserve Banks will charge fees to insti- natives to the existing infrastructure for tutions that, within a one-week period, providing cash services. The study deposit fit $10 or $20 notes and reorder resulted in the elimination of cash procurrency of the same denomination, cessing at the Oklahoma City and Birabove a de minimis amount, within the mingham offices in March and May, same Reserve Bank office's service respectively, and the replacement of area. these offices with outsourced cash de- In March, the Reserve Banks began pots. In these cash depot arrangements, issuing the redesigned $10 Federal armored carrier facilities serve as collec- Reserve note that includes enhanced se- tion and distribution points for deposi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

124 93rd Annual Report, 2006 Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2004-2006 Thousands of dollars Agency and service 2006 2005 2004 DEPARTMENT OF THE TREASURY Bureau of the Public Debt Treasury retail securities 73,931.4 86,503.2 103,257.7 Treasury securities safekeeping and transfer 7,535.2 6,055.8 6,267.0 Treasury auction 23,594.9 17,553.5 17,159.5 Computer infrastructure development and support 3,853.1 2,575.5 5,935.1 Other services 1,578.7 1,806.5 1,709.8 Total 110,493.2 114,494.5 134,329.1 Financial Management Service Payment services Government check processing 20,918.6 20,988.0 24,245.4 Automated clearinghouse 5,823.1 5,709.5 5,352.9 Fedwire funds transfers 123.1 109.4 111.6 Other payment programs 69,696.8 49,366.0 33,646.9 Collection services Tax and other revenue collections 37,095.5 39,736.0 34,248.4 Other collection programs 14,122.6 14,354.2 12,922.8 Cash-management services 48,320.2 40,496.7 21,835.8 Computer infrastructure development and support 67,046.4 67,703.3 52,673.3 Other services 7,414.8 2,332.2 6,931.6 Total 270,561.2 240,795.4 191,968.6 Other Treasury Total 16,786.3 15,726.7 15,106.1 Total, Treasury 397,840.7 371,016.6 341,403.7 OTHER FEDERAL AGENCIES Department of Agriculture Food coupons 2,929.8 2,642.4 4,519.0 United States Postal Service Postal money orders 9,334.4 7,647.8 7,774.6 Other agencies Other services 15,977.1 14,870.2 16,104.0 Total, other agencies 28,241.4 25,160.4 28,397.5 Total reimbursable expenses 426,082.1 396,177.0 369,801.2 tory institutions' currency deposits and process electronic and check payments orders. The deposits and orders are for the Treasury, maintain the Treatransported to and from the nearest sury's bank account, and invest excess Reserve Bank by armored carrier for Treasury balances. The Reserve Banks processing. also provide limited fiscal agency and depository services to other entities. Developments in The total cost of providing fiscal Fiscal Agency and agency and depository services to the Government Depository Services Treasury and other entities in 2006 amounted to $426.1 million, compared As fiscal agents and depositories for the with $396.2 million in 2005 (table). federal government, the Federal Reserve Treasury-related costs were $397.8 mil- Banks provide services related to the lion in 2006, compared with $371.0 milfederal debt, help the Treasury collect lion in 2005, an increase of 7.2 percent. funds owed to the federal government, The cost of providing services to other Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 125 entities was $28.2 million, compared Sell Direct in 2006, compared with with $25.2 million in 2005. In 2006, as 14,000 securities worth $874.8 million in 2005, the Treasury and other entities in 2005. The Banks printed and mailed reimbursed the Reserve Banks for the more than 28.9 million savings bonds in costs of providing these services. 2006, a 10 percent decrease from 2005. They issued more than 5.3 million Series I (inflation-indexed) bonds and 23.1 Debt Services million Series EE bonds. The Reserve Banks auction, provide safekeeping for, and transfer Treasury Payments Services securities. Reserve Bank operating expenses for these activities totaled The Reserve Banks process both elec- $31.1 million in 2006, compared with tronic and check payments for the Trea- $23.6 million in 2005. The Banks pro- sury. Reserve Bank operating expenses cessed 148,000 commercial tenders for for processing government payments Treasury securities, compared with and for payments-related programs to- 169,000 in 2005. They originated taled $96.6 million in 2006, compared 12.9 million transfers of Treasury secu- with $76.2 million in 2005. The Banks rities in 2006, a 1.8 percent increase processed 991.6 million ACH payments from 2005. The Reserve Banks are de- for the Treasury, an increase of 2.8 perveloping a new Treasury auction appli- cent from 2005, and more than 855,000 cation and infrastructure that will pro- Fed wire funds transfers. They also provide increased functionality and cessed 192 million paper government security. The application will be opera- checks, a decline of 11 percent from tional in late 2007. 2005. In addition, the Banks issued more The Reserve Banks also operate com- than 170,000 fiscal agency checks, a puter applications and provide customer decrease of 17.4 percent from 2005. service and back-office support for the Treasury's retail securities programs. Collection Services Reserve Bank operating expenses for these activities were $73.9 million in The Reserve Banks support several 2006, compared with $86.5 million in Treasury programs to collect funds 2005. The Reserve Banks operate owed the federal government. Reserve Legacy Treasury Direct, a program that Bank operating expenses related to these allows investors to purchase and hold programs totaled $51.2 million in 2006, Treasury securities directly with the compared with $54.1 million in 2005. Treasury through the Reserve Banks in- The Banks operate the Federal Reserve stead of through a broker. The program Electronic Tax Application (FR-ETA) as held $72 billion (par value) of Treasury an adjunct to the Treasury's Electronic securities as of December 31. Because Federal Tax Payment System (EFTPS). the program was designed for investors EFTPS allows businesses and individual who plan to hold their securities to ma- taxpayers to pay their taxes electroniturity, it does not provide transfer ser- cally. It uses the automated clearingvices. Investors may, however, sell their house (ACH) to collect funds, so tax securities for a fee through Sell Direct, a payments must be scheduled at least one program operated by one of the Reserve day in advance. Some business taxpay- Banks. Approximately 13,000 securities ers, however, do not know their tax worth $678.9 million were sold through liability until the tax due date. FR-ETA Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

126 93rd Annual Report, 2006 allows these taxpayers to use EFTPS by was $1.04 billion. In March, Treasury providing a same-day electronic federal launched the Repurchase Agreement tax payment alternative. FR-ETA col- Program, a pilot program that allows lected $456.3 billion for the Treasury in Treasury to place a portion of its excess 2006, compared with $409.2 billion in operating funds directly with TT&L de- 2005. positaries through a repurchase transac- In addition, the Reserve Banks oper- tion for a set period at an agreed-on ate Pay.gov, a Treasury program that interest rate. In 2006, the Reserve Banks allows members of the public to pay for placed a total of $478.9 billion of investgoods and services offered by the fed- ments through repurchase agreements. eral government over the Internet. They also operate the Treasury's Paper Check Services Provided to Other Entities Conversion and Electronic Check Processing programs, whereby checks writ- The Reserve Banks provide fiscal ten to government agencies are con- agency and depository services to other verted into ACH transactions at the point domestic and international entities when of sale or at lockbox locations. In 2006, required to do so by the Secretary of the the Reserve Banks originated more than Treasury or when required or permitted 2.6 million ACH transactions through to do so by federal statute. The majority these programs, roughly the same num- of the work is securities-related. ber of transactions as in 2005. Electronic Access to Cash-Management Services Reserve Bank Services The Treasury maintains its bank account In 2006, the Federal Reserve Banks at the Reserve Banks and invests the completed the migration of their Fedfunds it does not need for current pay- Line DOS customers to FedLine Advanments with qualified depository institu- tage. About 6,200 customers were contions through the Treasury Tax and Loan verted to FedLine Advantage, a web- (TT&L) program, which the Reserve based access delivery channel typically Banks operate. Reserve Bank operating used by small and medium-sized deposiexpenses related to this program and tory institutions to access critical payother cash-management initiatives to- ment services, such as the Fedwire taled $48.3 million in 2006, compared Funds, Fedwire Securities, National with $40.5 million in 2005. The invest- Settlement, and FedACH Services. In ments either are callable on demand or addition, the Reserve Banks began miare for a set term. In 2006, the Reserve grating their high-volume computer- Banks placed a total of $309.2 billion in interface customers, which are typically immediately callable investments, which large depository institutions, to FedLine includes funds invested through retained Direct, an internet-protocol-based tax deposits and direct, special direct, computer-to-computer access delivery and dynamic investments, and $508 bil- channel for critical payment services. lion in term investments. The rate for Also in 2006, the Reserve Banks anterm investments is set by auction; the nounced a new option, FedLine Reserve Banks held 104 such auctions Command, a lower-cost computer-toin 2006, roughly the same number of computer access delivery channel for auctions as in 2005. In 2006, the Trea- FedACH customers. The Reserve Banks sury's income from the TT&L program will continue to migrate customers to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 127 FedLine Direct and FedLine Command nology projects and to fully transition to in 2007. the TPS by January 1, 2008. Also in 2006, the Federal Reserve Bank of New York migrated its primary Information Technology dealers (banks and securities broker- In early 2006, the Federal Reserve dealers) to the FedTrade application, Banks initiated the first phase of the which provides increased functionality Information Security Architecture and security. The FedTrade application Framework (ISAF), a program that will is used to execute various forms of open cost $30.5 million by the end of 2008, market operations using electronic aucwhen this phase of the program will be tions with the primary dealers as completed. The ISAF program is in- bidders. tended to respond to the continuing and Throughout 2006, the Reserve Banks increasingly sophisticated threats facing continued to focus on initiatives to reinformation technology systems and to duce IT costs over the long term by improve information security at all standardizing processes, increasing propoints in the Federal Reserve System's ductivity, and strengthening the Federal networks. ISAF is a portfolio of initia- Reserve's ability to respond to cyber tives to improve (1) targeted security security threats. services by ensuring that overall risks are reduced and the residual risks of Examinations of the these services are acceptable and (2) the Federal Reserve Banks overall efficiency and coherence of the provisioning of these services. Section 21 of the Federal Reserve Act The System established a National requires the Board of Governors to order Information Security Assurance (NISA) an examination of each Federal Reserve function in 2006 to enhance information Bank at least once a year. The Board security governance. By managing and performs its own reviews and engages a coordinating information security at the public accounting firm. The public enterprise level, NISA will have an inte- accounting firm performs an annual augrated view of information security dit of the combined financial statements compliance across the Reserve Banks. of the Reserve Banks (see the section NISA will implement a business- "Federal Reserve Banks Combined oriented model of information security Financial Statements") and audits the responsibility and accountability and annual financial statements of each of will establish comprehensive informa- the twelve Banks. The Reserve Banks tion security standards and processes for use the framework established by the all the Reserve Banks. Committee of Sponsoring Organizations In mid-2006, the Federal Reserve of the Treadway Commission (COSO) System adopted the Technology Project in assessing their internal controls over Standards (TPS), a set of standards for financial reporting, including the safemanaging information technology guarding of assets. The Reserve Banks projects. The standards are based on the have further enhanced their assessments Project Management Book of Knowl- under the COSO framework to edge (PMBOK), a recognized industry strengthen the key control assertion probest practice. All Reserve Banks are cess and in 2006 met the requirements expected to train their staff members of the Sarbanes-Oxley Act of 2002. who are involved in information tech- Within this framework, management of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

128 93rd Annual Report, 2006 each Reserve Bank provides an asser- schedule of participated income action letter to its board of directors annu- counts at year-end. The FOMC receives ally confirming adherence to COSO the external audit reports and the report standards, and a public accounting firm on the division's examination. confirms management's assertion and issues an attestation report to the Bank's Income and Expenses board of directors and to the Board of Governors. The accompanying table summarizes the The firm engaged for the audits of the income, expenses, and distributions of individual and combined financial state- net earnings of the Federal Reserve ments of the Reserve Banks for 2006 Banks for 2005 and 2006. was PricewaterhouseCoopers LLP Income in 2006 was $38,410 million, (PwC). Fees for these services totaled compared with $30,729 million in 2005. $4.2 million. To ensure auditor indepen- Expenses totaled $4,056 million ($2,987 dence, the Board requires that PwC be million in operating expenses, $276 milindependent in all matters relating to the lion in earnings credits granted to deaudit. Specifically, PwC may not per- pository institutions, $301 million in asform services for the Reserve Banks or sessments for expenditures by the Board others that would place it in a position of Governors, and $492 million for the of auditing its own work, making man- cost of new currency). Revenue from agement decisions on behalf of the priced services was $908 million. Net Reserve Banks, or in any other way additions to and deductions from current impairing its audit independence. In net income showed a net loss of 2006, the Reserve Banks did not engage $159 million. The loss was due prima- PwC for nonaudit services. rily to interest expense on securities sold The Board's annual examination of under agreements to repurchase offset, the Reserve Banks includes a wide range in part, by unrealized gains on assets of off-site and on-site oversight activi- denominated in foreign currencies revalties conducted by the Division of ued to reflect current market exchange Reserve Bank Operations and Payment rates. Statutory dividends paid to mem- Systems. Division personnel monitor the ber banks totaled $871 million, $90 milactivities of each Reserve Bank on an lion more than in 2005; the increase ongoing basis and conduct on-site reflects an increase in the capital and reviews based on the division's risk- surplus of member banks and a conseassessment methodology. The examina- quent increase in the paid-in capital tions also include assessing the effi- stock of the Reserve Banks. ciency and effectiveness of the internal Payments to the U.S. Treasury in the audit function. To assess compliance form of interest on Federal Reserve with the policies established by the Fed- notes totaled $29,052 million in 2006, eral Reserve's Federal Open Market up from $21,468 million in 2005; the Committee (FOMC), the division also payments equal net income after the reviews the accounts and holdings of the deduction of dividends paid and of the System Open Market Account at the amount necessary to equate the Reserve Federal Reserve Bank of New York and Banks' surplus to paid-in capital. The the foreign currency operations con- implementation of FAS 158 required a ducted by that Bank. In addition, PwC reduction to surplus of $1,849 million audits the schedule of participated asset and increased the amount necessary to and liability accounts and the related equate surplus to paid-in capital in 2006. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 129 Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2006 and 2005 Millions of dollars Item 2006 2005 Current income 38,410 30,729 Current expenses 3,264 2,890 Operating expensesx 2,987 2,677 Earnings credits granted 276 213 Current net income 35,147 27,840 Net additions to (deductions from, - ) current net income -159 -3,577 Assessments by the Board of Governors 793 743 For expenditures of Board 301 266 For cost of currency 492 All Net income before payments to Treasury 34,195 23,520 Dividends paid 871 781 Transferred to surplus2 4,272 1,272 Payments to Treasury3 29,052 21,468 1. Includes a net periodic pension expense of $53 mil- surplus by $1,849 million and increased the amount of the lion in 2006 and a net periodic pension credit of $11 mil- transfer required to equate capital and surplus. lion in 2005. 3. Interest on Federal Reserve notes. 2. The implementation of FAS 158 in 2006 reduced In the "Statistical Tables" section of 4.59 percent, from 3.80 percent in 2005, this report, table 10 details the income and the average rate of interest earned and expenses of each Reserve Bank for on loans increased to 5.44 percent, from 2006 and table 11 shows a condensed 3.49 percent. statement for each Bank for the years 1914 through 2006; table 9 is a state- Volume of Operations ment of condition for each Bank, and table 13 gives the number and annual Table 12 in the "Statistical Tables" secsalaries of officers and employees for tion shows the volume of operations in each Bank. A detailed account of the the principal departments of the Federal assessments and expenditures of the Reserve Banks for the years 2003 Board of Governors appears in the sec- through 2006. tion "Board of Governors Financial Statements." Federal Reserve Bank Premises In 2006, construction continued on the Holdings of Securities and Loans Kansas City Bank's new headquarters The Federal Reserve Banks' average building and construction began on the daily holdings of securities and loans San Francisco Bank's new Seattle during 2006 amounted to $794,395 mil- Branch building after the Board aplion, an increase of $32,886 million proved the project's final design. The from 2005 (table). Holdings of U.S. gov- multiyear renovation program at the ernment securities increased $32,879 New York Bank's headquarters building million, and holdings of loans increased continued, as did facility renovation $7 million. The average rate of interest projects at several Reserve Bank offices earned on the Reserve Banks' holdings to accommodate the consolidation of of government securities increased to check activities. A long-term facility re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

130 93rd Annual Report, 2006 Securities and Loans of theFederal Reserve Banks, 2004-2006 Millions of dollars except as noted U.S. Item and year Total government Loans2 securities1 Average daily holdings 3 2004 719,647 719,494 153 2005 761,509 761,295 214 2006 794,395 794,174 221 Earnings4 2004 22,347 22,344 3 2005 28,966 28,959 7 2006 . . 36,464 36,452 12 Average interest rate (percent) 2004 3.11 3.11 1.74 2005 3.80 3.80 3.49 2006 4.59 4.59 5.44 1. Includes federal agency obligations. 4. Earnings have not been netted with the inter- 2. Does not include indebtedness assumed by the Fed- est expense on securities sold under agreements to eral Deposit Insurance Corporation. repurchase. 3. Based on holdings at opening of business. development program at the St. Louis ing garage. The sales of the Chicago Bank continued. Construction of a new Bank's former Detroit Branch building, pedestrian-screening vestibule was com- the Kansas City Bank's Oklahoma City pleted, and construction of an addition Branch building, and the San Francisco to the Board's headquarters building be- Bank's Portland Branch building were gan. finalized. Efforts to sell the St. Louis Security enhancement programs con- Bank's Little Rock Branch building continue at several facilities. One such tinued, as did efforts by the Dallas Bank project is the recently completed exter- to sell excess land at its Houston nal perimeter security improvement Branch. project at the Boston Bank. In addition, Activities for the Portland Branch the Richmond Bank continued construc- were moved to leased facilities. The tion of additional security improvements Kansas City Bank sold its Oklahoma to its headquarters building. The Dallas City Branch building and is leasing Bank completed the purchase of prop- space in the building for the Branch's erty behind its headquarters building for administrative activity. The Birmingthe construction of a remote vehicle- ham Branch check and cash operations screening and shipping/receiving facil- were relocated to the head office in Atity. Planning continues for a similar lanta. The Birmingham building will screening facility at the Philadelphia house the remaining Branch activities, Bank. and available space will be leased. Also during 2006, the Board ap- Table 14 in the "Statistical Tables" proved the Richmond Bank's purchase section of this report details the acquisiof property adjacent to its headquarters tion costs and net book value of the building for construction of a new park- Federal Reserve Banks and Branches. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 131 Pro Forma Financial Statements for Federal Reserve Priced Services Pro Forma Balance Sheet for Priced Services, December 31, 2006 and 2005 Millions of dollars Item 2006 2005 Short-term assets (Note 1) Imputed reserve requirements on clearing balances 821.7 993.2 Imputed investments 7,245.7 8,626.4 Receivables . ... 73.6 77.0 Materials and supplies 0.9 1.3 Prepaid expenses 24.2 25.6 Items in process of collection 3,391.0 5,934.4 Total short-term assets 11,557.1 15,657.7 Long-term assets (Note 2) Premises 424.9 424.5 Furniture and equipment 127.9 156.1 Leases, leasehold improvements, and long-term prepayments 83.3 88.5 Prepaid pension costs 399.0 796.8 Deferred tax asset 146.0 0.0 Total long-term assets 1,181.0 1,465.9 Total assets 12,738.1 17,123.6 Short-term liabilities Clearing balances and balances arising from early credit of uncollected items 8,015.6 10,703.2 Deferred-availability items 3,592.5 5,163.0 Short-term debt 0.0 0.0 Short-term payables 100.4 126.2 Total short-term liabilities 11,708.4 15,992.4 Long-term liabilities Long-term debt 0.0 0.0 Postretirement/postemployment benefits obligation 392.8 275.0 Total long-term liabilities 392.8 275.0 Total liabilities 12,101.2 16,267.4 Equity (including accumulated other comprehensive loss of $343.9 million at December 31, 2006) 636.9 856.2 Total liabilities and equity (Note 3) ... 12,738.1 17,123.6 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

132 93 rd Annual Report,2006 Pro Forma Income Statement for FederalReserve Priced Services,2006and 2005 Millions of dollars Item 2006 2005 Revenue from services provided to depository institutions (Note 4) 908.4 901.0 Operating expenses (Note 5) 803.5 750.0 Income from operations 104.8 150.9 Imputed costs (Note 6) Interest on float -4.9 6.1 Interest on debt 0.0 0.0 Sales taxes 10.8 11.3 FDIC insurance 0.0 5.9 0.0 17.4 Income from operations after imputed costs 98.9 133.5 Other income and expenses (Note 7) Investment income 383.6 292.7 Earnings credits -260.8 122.8 -199.0 93.7 Income before income taxes 221.8 227.2 Imputed income taxes (Note 6) 66.1 67.3 Net income 155.7 160.0 MEMO: Targeted return on equity (Note 6) 72.0 103.0 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, 2006 Millions of dollars Commercial Commercial Fedwire Fedwire Item Total check ACH funds securities collection Revenue from services (Note 4) 908.4 745.0 80.5 63.6 19.2 Operating expenses (Note 5) 803.5 658.2 74.7 52.9 17.7 Income from operations 104.8 86.8 5.8 10.7 1.5 Imputed costs (Note 6) 5.9 4.1 0.6 0.8 0.3 Income from operations after imputed costs 98.9 82.7 5.2 9.9 1.3 Other income and expenses, net (Note 7) 122.8 100.7 10.9 8.6 2.6 Income before income taxes . 221.8 183.3 16.1 18.5 3.9 Imputed income taxes (Note 6) 66.1 54.6 4.8 5.5 1.2 Net income . 155.7 128.7 11.3 13.0 2.7 MEMO: Targeted return on equity (Note 6) 72.0 57.1 7.5 5.6 1.8 NOTE: Components may not sum to totals because of The accompanying notes are an integral part of these rounding. pro forma priced services financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 133 FEDERAL RESERVE BANKS NOTES TO PRO FORMA FINANCIAL STATEMENTS FOR PRICED SERVICES (1) SHORT-TERM ASSETS liabilities include clearing balances maintained at Reserve Banks and deposit balances arising from float. Other The imputed reserve requirement on clearing balances long-term liabilities consist of accrued postemployment, held at Reserve Banks by depository institutions reflects a postretirement, and nonqualified pension benefits costs treatment comparable to that of compensating balances held at correspondent banks by respondent institutions. and obligations on capital leases. The reserve requirement imposed on respondent balances In order to reflect the funded status of its benefit plans must be held as vault cash or as non-earning balances as required by FAS 158, the Reserve Banks recognized maintained at a Reserve Bank; thus, a portion of priced the deferred items related to these plans, which include services clearing balances held with the Federal Reserve prior service costs and actuarial gains or losses, on the is shown as required reserves on the asset side of the balance sheet. This resulted in an increase to the benefits balance sheet. Another portion of the clearing balances is obligation related to the priced services and an offsetting used to finance short-term and long-term assets. The adjustment, net of tax, to AOCI, which is included in remainder of clearing balances is assumed to be invested equity. in a portfolio of investments, shown as imputed Equity is imputed at 5 percent of total assets. investments. Receivables are (1) amounts due the Reserve Banks for (4) REVENUE priced services and (2) the share of suspense-account and difference-account balances related to priced services. Revenue represents charges to depository institutions for Materials and supplies are the inventory value of short- priced services and is realized from each institution term assets. through one of two methods: direct charges to an institu- Prepaid expenses include salary advances and travel tion's account or charges against its accumulated earnadvances for priced-service personnel. ings credits. Items in process of collection is gross Federal Reserve cash items in process of collection (CIPC) stated on a (5) OPERATING EXPENSES basis comparable to that of a commercial bank. It reflects adjustments for intra-System items that would otherwise Operating expenses consist of the direct, indirect, and be double-counted on a consolidated Federal Reserve other general administrative expenses of the Reserve balance sheet; adjustments for items associated with non- Banks for priced services plus the expenses for staff priced items, such as those collected for government members of the Board of Governors working directly on agencies; and adjustments for items associated with pro- the development of priced services. The expenses for viding fixed availability or credit before items are re- Board staff members were $7.5 million in 2006 and $6.6 ceived and processed. Among the costs to be recovered million in 2005. under the Monetary Control Act is the cost of float, or net Effective January 1, 1987, the Reserve Banks imple- CIPC during the period (the difference between gross mented the Financial Accounting Standards Board's CIPC and deferred-availability items, which is the portion Statement of Financial Accounting Standards No. 87, of gross CIPC that involves a financing cost), valued at Employers' Accounting for Pensions (FAS 87). Accordthe federal funds rate. ingly, the Reserve Banks recognized operating expenses for the qualified pension plan of $11.5 million in 2006 (2) LONG-TERM ASSETS and a credit to expenses of $1.3 million in 2005. Operating expenses also include the nonqualified pension ex- Consists of long-term assets used solely in priced serpense of $3.2 million in 2006 and $1.0 million in 2005. vices, the priced-service portion of long-term assets The implementation of FAS 158 does not change the shared with nonpriced services, and an estimate of the systematic approach required by generally accepted assets of the Board of Governors used in the development accounting principles to recognize the expenses associof priced services. ated with the Reserve Banks' benefit plans in the income Effective December 31, 2006, the Reserve Banks statement. implemented FAS 158, which requires an employer to The income statement by service reflects revenue, oprecord the funded status of its benefit plans on its balance erating expenses, and imputed costs. Certain corporate sheet, resulting in a reduction to the prepaid pension asset overhead costs not closely related to any particular priced related to priced services and the recognition of an assoservice are allocated to priced services based on an ciated deferred tax asset with an offsetting adjustment, net expense-ratio method. Corporate overhead was allocated of tax, to accumulated other comprehensive income among the priced services during 2006 and 2005 as (AOCI) (see note 3). follows (in millions): 2006 2005 (3) LIABILITIES AND EQUITY Check 30.6 29.4 Under the matched-book capital structure for assets, ACH 4.1 3.7 short-term assets are financed with short-term payables Fedwire funds 2.8 2.6 and clearing balances. Long-term assets are financed with Fedwire securities 1.5 1.3 long-term liabilities and clearing balances. As a result, no short- or long-term debt is imputed. Other short-term Total 39.0 37.0 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

134 93rd Annual Report, 2006 (6) IMPUTED COSTS Unrecovered float includes float generated by services Imputed costs consist of income taxes, return on equity, to government agencies and by other central bank serinterest on debt, sales taxes, the FDIC assessment, and vices. Float recovered through income on clearing balinterest on float. Many imputed costs are derived from the ances is the result of the increase in investable clearing private-sector adjustment factor (PSAF) model. The cost balances; the increase is produced by a deduction for float of debt and the effective tax rate, which reflect bank for cash items in process of collection, which reduces holding company data as the proxy for a private-sector imputed reserve requirements. The income on clearing firm, are used to impute debt and income taxes in the balances reduces the float to be recovered through other PSAF model. The after-tax rate of return on equity is means. As-of adjustments and direct charges refer to float based on the returns of the equity market as a whole and that is created by interterritory check transportation and is used to impute the profit that would have been earned the observance of non-standard holidays by some deposihad the services been provided by a private-sector firm. tory institutions. Such float may be recovered from the depository institutions through adjustments to institution Interest is imputed on the debt assumed necessary to reserve or clearing balances or by billing institutions finance priced-service assets; however, no debt was imdirectly. Float recovered through direct charges and perputed in 2006 or 2005. The sales taxes and FDIC assessitem fees is valued at the federal funds rate; credit float ment that the Federal Reserve would have paid had it recovered through per-item fees has been subtracted from been a private-sector firm are also among the components the cost base subject to recovery in 2006. of the PSAF. Interest on float is derived from the value of float to be recovered, either explicitly or through per-item fees, dur- (7) OTHER INCOME AND EXPENSES ing the period. Float costs include costs for checks, book-entry securities, ACH, and funds transfers. Consists of investment income on clearing balances and Float cost or income is based on the actual float the cost of earnings credits. Investment income on clearincurred for each priced service. Other imputed costs are ing balances for 2006 and 2005 represents the average allocated among priced services according to the ratio of coupon-equivalent yield on three-month Treasury bills operating expenses less shipping expenses for each ser- plus a constant spread, based on the return on a portfolio vice to the total expenses for all services less the total of investments. In both years, the return is applied to the shipping expenses for all services. total clearing balance maintained, adjusted for the effect The following list shows the daily average recovery of of reserve requirements on clearing balances. Expenses actual float by the Reserve Banks for 2006 in millions of for earnings credits granted to depository institutions on dollars: their clearing balances are derived by applying a discounted average coupon-equivalent yield on three-month Total float -84.7 Treasury bills to the required portion of the clearing Unrecovered float 15.6 balances, adjusted for the net effect of reserve require- Float subject to recovery -100.3 ments on clearing balances. Sources of recovery of float Income on clearing balances -10.0 As-of adjustments -1.2 Direct charges 497.6 Per-item fees -589.1 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

135 The Board of Governors and the Government Performance and Results Act The Government Performance and port indicates that the Board generally Results Act (GPRA) of 1993 requires met its goals for 2004-05. that federal agencies, in consultation All of the aforementioned documents with Congress and outside stakeholders, are available on the Board's web site, prepare a strategic plan covering a mul- at www.federalreserve.gov/boarddocs/ tiyear period and submit an annual per- rptcongress. The Board's mission stateformance plan and performance report. ment and a summary of the Federal Although the Federal Reserve is not Reserve's goals and objectives, as set covered by the GPRA, the Board of forth in the most recently released stra- Governors voluntarily complies with the tegic and performance plans, are listed spirit of the act. below. Mission Strategic Plan, Performance The mission of the Board is to foster the Plan, and Performance Report stability, integrity, and efficiency of the The Board's strategic plan articulates nation's monetary, financial, and paythe Board's mission, sets forth major ment systems so as to promote optimal goals, outlines strategies for achieving macroeconomic performance. those goals, and discusses the environment and other factors that could affect Goals and Objectives their achievement. It also addresses issues that cross agency jurisdictional The Federal Reserve has six primary lines, identifies key quantitative perfor- goals with interrelated and mutually remance measures, and discusses perfor- inforcing elements. mance evaluation. The most recent strategic plan covers the period 2006-09. Goal Both the performance plan and the performance report are prepared bienni- To conduct monetary policy that proally. The performance plan sets forth motes the achievement of maximum specific targets for some of the perfor- sustainable long-term growth and the mance measures identified in the strate- price stability that fosters that goal gic plan and describes the operational Objectives processes and resources needed to meet those targets. It also discusses data vali- • Stay abreast of recent developments dation and results verification. The most and prospects in the U.S. economy recent performance plan covers the and financial markets, and in those period 2006-07. abroad, so that monetary policy deci- The performance report discusses the sions will be well informed. Board's performance in relation to its • Enhance our knowledge of the strucgoals. The most recent performance re- tural and behavioral relationships in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

136 93rd Annual Report, 2006 the macroeconomic and financial mar- Promote compliance by domestic and kets, and improve the quality of the foreign banking organizations superdata used to gauge economic perfor- vised by the Federal Reserve with mance, through developmental re- applicable laws, rules, regulations, search activities. policies, and guidelines through a Implement monetary policy effec- comprehensive and effective supervitively in rapidly changing economic sion program. circumstances and in an evolving financial market structure. Contribute to the development of U.S. Goal international policies and procedures, To effectively implement federal laws in cooperation with the U.S. Departdesigned to inform and protect the conment of the Treasury and other sumer, to encourage community develagencies. opment, and to promote access to bank- Promote understanding of Federal ing services in historically underserved Reserve policy among other governmarkets ment policy officials and the general public. Objectives • Take a leadership role in shaping the Goal national dialogue on consumer protection in financial services, addressing To promote a safe, sound, competitive, the rapidly emerging issues that affect and accessible banking system and today's consumers, strengthening constable financial markets sumer 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 efidentify emerging financial problems fective communications and collaboearly so that crises can be averted. rations within the Board, the Federal • Provide a safe, sound, competitive, Reserve Banks, and other agencies and accessible banking system and organizations. through comprehensive and effective • Increase public understanding of consupervision of U.S. banks, bank and sumer protection and community definancial holding companies, foreign velopment and the Board's role in banking organizations, and related these areas through increased outreach entities. At the same time, remain and by developing programs that adsensitive to the burden on supervised dress the information needs of coninstitutions. sumers and the financial services • Provide a dynamic work environment industry. that is challenging and rewarding. En- • Develop a staff that is highly skilled, hance efficiency and effectiveness, professional, innovative, and diverse, while remaining sensitive to the bur- providing career development opden on supervised institutions, by ad- portunities to ensure the retention dressing the supervision function's of highly productive staff and recruitprocedures, technology, resource allo- ing highly qualified and skilled cation, and staffing issues. employees. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Government Performance and Results Act 137 • Promote an efficient and effective effective performance, and sound work environment by aligning busi- project management and should assist ness functions with appropriate work the Board in the effective discharge of processes and implementing solutions its oversight responsibilities. for work products and processes that can be handled more efficiently through automation. Goal To foster the integrity, efficiency, and Goal effectiveness of Board programs To foster the integrity, efficiency, and Objectives accessibility of U.S. payment and settlement systems • Oversee a planning and budget process that clearly identifies the Board's Objectives mission, results in concise plans for • Develop sound, effective policies and the effective accomplishment of opregulations that foster payment sys- erations, transmits to the staff the intem integrity, efficiency, and accessi- formation needed to attain objectives bility. Support and assist the Board in efficiently, and allows the public to overseeing U.S. dollar payment and measure our accomplishments. securities settlement systems by as- • Develop appropriate policies, oversessing their risks and risk manage- sight mechanisms, and measurement ment approaches against relevant pol- criteria to ensure that the recruiting, icy objectives and standards. training, and retention of staff meet • Conduct research and analysis that Board needs. contributes to policy development and • Establish, encourage, and enforce a increases the Board's and others' un- climate of fair and equitable treatment derstanding of payment system dy- for all employees regardless of race, namics and risk. creed, color, national origin, age, or sex. • Provide financial management sup- Goal port needed for sound business To provide high-quality professional decisions. oversight of Reserve Banks • Provide cost-effective and secure information resource management Objective services to Board divisions, support • Produce high-quality assessments and divisional distributed-processing reoversight of Federal Reserve System quirements, and provide analysis on strategies, projects, and operations, information technology issues to the including adoption of technology to Board, Reserve Banks, other financial the business and operational needs of regulatory institutions, and central the Federal Reserve. The oversight banks. process and outputs should help Fed- • Efficiently provide safe, modern, and eral Reserve management foster and secure facilities and necessary support strengthen sound internal control sys- for activities conducive to efficient tems, efficient and reliable operations, and effective Board operations. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

139 Federal Legislative Developments The following federal laws enacted dur- serve requirements on certain deposits ing 2006 affect the Federal Reserve Sys- held at depository institutions and tem and the institutions it regulates: the mandates that the Board set the ratio Financial Services Regulatory Relief of required reserves on transaction Act of 2006; the Unlawful Internet accounts above a certain percentage Gambling Enforcement Act of 2006; the (8 percent for amounts above the so- Military Personnel Financial Services called low reserve tranche, and 3 per- Protection Act; and the Financial Net- cent for amounts within the low reserve ting Improvements Act of 2006. tranche). Because the Federal Reserve does not pay interest on balances held at Reserve Banks to meet reserve require- Financial Services ments, depositories have an incentive to Regulatory Relief Act of 2006 reduce their reserve balances to a mini- On October 13, 2006, President Bush mum. To do so, they engage in a variety signed into law the Financial Services of reserve-avoidance activities, includ- Regulatory Relief Act of 2006 (Regula- ing using "sweep" arrangements that tory Relief Act), culminating more than move funds from accounts that are subfour years of work by Congress, the ject to reserve requirements to accounts Board, and other interested parties. The and money market investments that are act incorporates a number of significant not. These sweep programs and similar monetary policy, supervisory, and regu- activities absorb resources and therefore latory provisions that were proposed or diminish banking system efficiency. supported by the Board. These provi- Depository institutions also may volunsions should reduce unnecessary burden tarily hold contractual clearing balances on banking organizations and improve and excess reserve balances at a Reserve operation of the financial system. The Bank. These balances also do not explicmost important provisions of the Reguitly earn interest, although contractual latory Relief Act affecting the Federal clearing balances implicitly earn interest Reserve System and banking organizain the form of credits that may be used tions supervised by the Federal Reserve to pay for Federal Reserve services, are discussed below. Except as noted such as check clearing. below, the act became effective on Octo- The Regulatory Relief Act gives the ber 13, 2006. Federal Reserve the authority, effective as of October 1, 2011, to pay explicit Monetary Policy Provisions interest on all types of balances (including required reserves, excess reserves, Authority to Pay Interest and contractual clearing balances) held on Balances Held at Reserve Banks by or for depository institutions at a and Greater Flexibility in Setting Reserve Bank. Paying interest on re- Reserve Requirements quired reserve balances, once autho- For monetary policy purposes, federal rized, will remove a substantial portion law obliges the Board to establish re- of the incentive for depositories to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

140 93rd Annual Report, 2006 engage in reserve-avoidance measures, to the Federal Reserve as required reand the resulting improvements in effi- serve balances. These amendments, ciency should eventually be passed once implemented, will enable national through to bank borrowers and depositors. and state member banks to take advan- Moreover, if the Board were to deter- tage of the same type of pass-through mine to pay explicit interest on contrac- reserve arrangements previously availtual clearing balances, once authorized able only to state nonmember banks. to do so, the action could provide a stable enough supply of voluntary bal- Supervisory and ances to allow the Federal Reserve to Regulatory Provisions effectively implement monetary policy using existing procedures without the Rules Implementing the "Broker" need for required reserves. Exceptions for Banks Adopted as Importantly, the Regulatory Relief Part of the Gramm-Leach-Bliley Act Act gives the Board the discretion, ef- Before the Gramm-Leach-Bliley Act fective as of October 1, 2011, to lower (GLB Act) of 1999, banks had a blanket the ratio of reserves that a depository exception from the definition of "broinstitution must maintain against its ker" in the Securities Exchange Act of transaction accounts below the ranges 1934. This meant that banks could currently established by law, including engage in any type of securities activity potentially establishing a zero reserve permissible under federal and state ratio. Thus, once these authorities banking laws without registering with become effective, the Board could reduce the Securities and Exchange Commisor even eliminate reserve requirements if sion (SEC) as a broker and without comit determined that such action was consisplying with the SEC's rules applicable tent with the effective implementation of to registered brokers. In the GLB Act, monetary policy. Such action, if taken, Congress eliminated this blanket excepwould reduce a significant regulatory tion for banks from the definition of burden for all depository institutions. "broker" and replaced it with eleven Having the authority to pay interest exceptions for broad types of securities on excess reserves also will enhance the activities conducted by banks. These Federal Reserve's monetary policy toolnew activity-focused exceptions were kit. If the Board were to determine to pay designed and intended to allow banks to interest on such balances at some point in continue to provide their customers with the future, the rate paid would act as a securities services as part of their usual minimum for overnight interest rates trust, fiduciary, custodial, and other and, thus, could help mitigate potential banking functions. The SEC requested volatility in overnight interest rates. comment on rules that would implement these "broker" exceptions for banks in Authority for Member Banks 2001 and 2004. to Use Pass-Through Reserves The Regulatory Relief Act requires The Regulatory Relief Act also elimi- that the SEC and the Board, within 180 nated the statutory provisions that pro- days of enactment, jointly request comhibited banks that are members of the ment on a new "single set" of rules to Federal Reserve from counting as implement the "broker" exceptions for reserves their deposits in other banks banks that were adopted as part of the that are "passed through" by those banks GLB Act. The Regulatory Relief Act Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Legislative Developments 141 also requires that the SEC and the Board thereby allowing additional small, welljointly adopt a "single set" of final rules run institutions to potentially qualify for to implement these exceptions after con- an extended examination schedule. On sulting with, and seeking the concur- January 11, 2007, President Bush also rence of, the Office of the Comptroller signed into law a complementary bill, of the Currency (OCC), the Federal De- Pub. L. 109-473, that allows an insured posit Insurance Corporation (FDIC), and depository institution that meets the the Office of Thrift Supervision (OTS). new $500 million total assets threshold In addition, the act provides that the to potentially qualify for an eighteensingle set of final rules adopted jointly month on-site exam cycle if the instituby the Board and the SEC shall super- tion received a composite rating of sede the rules previously issued by the either a 1 or a 2 at its most recent safety SEC to implement these exceptions. and soundness examination. On December 18, 2006—well before Nonwaiver of Privileges the end of the 180-day period established by the Regulatory Relief Act— The Regulatory Relief Act includes an the Board and the SEC issued and re- important provision that should faciliquested comment on joint proposed tate the sharing of information between rules to implement the "broker" excep- banking organizations and federal, state, tions for banks. See 71 FR 77,522 and foreign banking authorities. Specifi- (Dec. 26, 2006). These joint proposed cally, the act provides that any privilege rules—designated Regulation R—are (for example, attorney-client or workdesigned to accommodate the securities product privilege) a person may have activities that banks conduct as part of with respect to information is not their normal banking functions, consis- waived or destroyed if the person protent with the purposes of the GLB Act. vides that information to "any federal banking agency, state bank supervisor, Expanded Eligibility for Eighteen- or foreign banking authority for any pur- Month Examination Schedule pose in the course of the supervisory or for Small Banks regulatory process of such agency, supervisor, or authority." The Regulatory Relief Act expands the number of well-capitalized and well- Voting State Representative Added to managed small insured depository instithe Federal Financial Institutions tutions that may qualify for an eighteen- Examination Council month (rather than a twelve-month) onsite safety and soundness examination Another provision of the Regulatory schedule. Before the act, an insured Relief Act adds a state representative as depository institution could qualify for a voting member of the Federal Finanan extended eighteen-month safety and cial Institutions Examination Council soundness examination schedule only if (FFIEC). Specifically, the act provides the institution had less than $250 mil- for the current State Liaison Committee lion in total assets, was well capitalized of the FFIEC (which is composed of and well managed, and met certain other five representatives of state supervisory supervisory criteria. See 12 USC agencies for depository institutions) to 1820(d)(4). The act raised this $250 mil- elect a chairperson, and adds this lion asset threshold for an eighteen- chairperson as a full voting member of month exam cycle to $500 million, the FFIEC. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

142 93rd Annual Report, 2006 Elimination of Certain Reporting 215) that implement the elimination of Requirements Relating to these reporting requirements. See 71 FR Insider Lending 71,472 (December 11, 2006). The Regulatory Relief Act eliminated Streamlining the Supervisory Process certain reporting requirements previfor Bank Merger Transactions ously imposed on banks and their executive officers and principal shareholders The Regulatory Relief Act streamlines that the federal banking agencies did not the supervisory process for Bank Merger find particularly useful in monitoring Act (12 USC 1828(c)) transactions in insider lending or preventing insider two respects. First, it eliminates the need for the responsible agency in a Bank abuse. Specifically, the act eliminated Merger Act transaction to request a rethe statutory provisions that previously port on the competitive effects of the required transaction from each of the other federal banking agencies, as well as the • an executive officer of a bank to file a Attorney General. Instead, the act rereport with the bank's board of direcquires that the responsible agency retors whenever the executive officer quest a competitive factors report only obtained a loan from another bank in from the Attorney General and provide an amount that exceeded the amount a copy of the request to the FDIC (if it is the executive officer could obtain not the responsible agency). Second, the from his or her own bank (12 USC Regulatory Relief Act allows the 375a(g)(6)), reviewing agency for a Bank Merger • a bank to file a separate report with its Act transaction to avoid requesting a quarterly Call Report concerning any competitive factors report from the other loans the bank made to its executive federal banking agencies and the Attorofficers since its previous Call Report ney General if the transaction involves (12 USC 375a(g)(9)), and affiliated institutions. The act also eliminates the post-approval waiting period • an executive officer or principal sharefor bank mergers involving affiliated inholder of a bank to file an annual stitutions, as these transactions typically report with the bank's board of direcdo not present any competitive issues. tors if the officer or shareholder had a The act does not, however, alter in any loan outstanding from a correspon- way the reviewing agency's obligation dent bank of the bank (12 USC to conduct a competitive analysis of a 1972(2)(G)). proposed Merger Act transaction. Although the act eliminated these re- Amendment Allowing the Board to porting requirements, it did not alter the Grant Exceptions from the Attribution statutory and regulatory limits and re- Rule in Section 2(g)(2) of the Bank strictions on lending to insiders or the Holding Company Act ability of the federal banking agencies to examine for potential insider lending Section 2(g)(2) of the Bank Holding abuses as part of the supervisory pro- Company Act (BHC Act) (12 USC cess. On December 6, 2006, the Board 1841(g)(2)) provides that in all circumadopted, on an interim basis, and re- stances, a company is deemed to control quested public comment on amendments any shares that are held by a trust for the to the Board's Regulation O (12 CFR benefit of the company or its sharehold- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Legislative Developments 143 ers, members, or employees. This attri- serving as a management official of any bution rule was intended to prevent a other nonaffiliated depository organizabank holding company from using a tion if the organizations have offices trust established for the benefit of its located in the same metropolitan statismanagement, shareholders, or employ- tical area. The act provides an exception ees to evade the BHC Act's restrictions from this restriction if each of the on the acquisition of shares of banks and depository organizations involved has nonbanking companies. However, the less than a specified amount of total rule can create inappropriate results in assets. The Regulatory Relief Act raised situations in which the bank holding this specified amount from $20 million company does not have the ability to to $50 million, thus allowing a greater control, directly or indirectly, the shares number of small depository organizaacquired by the trust. Accordingly, the tions to qualify for the exception. Regulatory Relief Act allows the Board to waive application of this attribution Protection of Confidential Information rule if the Board determines that the Received by Federal Banking Agencies exception is appropriate in light of the from Foreign Banking Supervisors facts and circumstances of the case and The Regulatory Relief Act clarifies the the purposes of the BHC Act. Such an authority of the Board and the other exception might be appropriate, for federal banking agencies to maintain the example, if the shares are held by the confidentiality of information obtained trust as part of a participant-directed and from a foreign regulatory or supervisory widely held 401 (k) plan and the plan's authority. Specifically, the act provides investment options are selected by an that a federal banking agency may not independent fiduciary (and not by the be compelled to disclose information bank holding company or its officers, received from a foreign regulatory or directors, or employees). supervisory authority if public disclosure of the information would violate Streamlining Reports of Condition the law of the foreign country and the The Regulatory Relief Act requires the federal banking agency obtained the in- Board and the other federal banking formation in connection with the adminagencies to conduct a review of the istration and enforcement of the federal Call Report forms within one year of banking laws or under a memorandum enactment, and at least once every five of understanding between the foreign years thereafter, and to eliminate any authority and the agency. The act, howinformation or schedule that the agen- ever, would not authorize the agencies cies determine is no longer necessary or to withhold such information from Conappropriate. gress or if the information was sought under a court order in an action initiated Increase in Asset Threshold for the by the United States or the agency. Small Depository Institution Exception under the Depository Institution Modification to Cross-Marketing Management Interlocks Act Restrictions Applicable to Merchant Banking Investments The Depository Institution Management Interlocks Act, among other things, gen- Another provision of the Regulatory Reerally prohibits a management official lief Act allows the depository institution of one depository organization from subsidiaries of a financial holding com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

144 93rd Annual Report, 2006 pany, with prior Board approval, to Amendments to Allow D.C.-Chartered engage in cross-marketing activities Banks to Become State Member Banks through "statement staffers" and Inter- The Regulatory Relief Act makes sevnet web sites with nonfinancial portfolio eral technical changes to the Federal companies held by the financial holding Reserve Act to allow banks chartered in company under the GLB Act's merthe District of Columbia to become state chant banking authority. Previously, the member banks. depository institution subsidiaries of a financial holding company were permitted to engage, with Board approval, in Enforcement-Related Provisions these limited types of cross-marketing activities only with portfolio companies Amendments Expanding the Agencies' held by the financial holding company Suspension Authority under the GLB Act's insurance com- The Federal Deposit Insurance Act (FDI pany investment authority. Act) currently allows the appropriate Change in Bank Control Act federal banking agency to suspend, Amendments remove, or prohibit an institutionaffiliated party (IAP) from participating The Regulatory Relief Act expands the in the affairs of the depository institufactors that the Board and the other fedtion with which he or she is affiliated if eral banking agencies may consider in the IAP is charged with or convicted of determining whether to disapprove, or certain crimes involving dishonesty, extend the time period for processing, a breach of trust, or money laundering. notice filed under the Change in Bank See 12 USC 1818(g)(l). The Regulatory Control Act (CIBC Act). In particular, Relief Act expands this authority by the act allows the appropriate federal allowing the appropriate federal bankbanking agency to disapprove a CIBC ing agency to suspend an IAP that has Act notice if the agency determines that been charged with such a crime from the future prospects of the institution to participating in the affairs of any deposibe acquired might jeopardize the stabiltory institution (not just the institution at ity of the institution or the interests of which the IAP then serves). In addition, depositors. (Currently, the financial and the act clarifies that the appropriate managerial factors in the CIBC Act foagency may suspend, remove, or procus on the resources of the acquiring hibit an LAP even if the IAP is no longer person, not the institution to be acassociated with any depository instituquired.) In addition, the act allows an tion at the time the action is taken. agency to extend the time for processing a CIBC Act notice for up to an addi- Restricting the Ability of Convicted tional two 45-day periods (beyond the Individuals to Participate in the Affairs initial 60-day review period and discreof a Bank Holding Company or tionary 30-day extension) if the agency Edge Act or Agreement Corporation determines that additional time is needed to analyze (1) the future prospects of the Section 19 of the Federal Deposit Insurinstitution to be acquired or (2) the safety ance Act (12 USC 1829) automatically and soundness of any plans by the ac- prohibits a person that has been conquiring person to make major changes in victed of a crime involving dishonesty, a the business, corporate structure, or man- breach of trust, or money laundering agement of the institution. from participating in the affairs of an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Legislative Developments 145 insured depository institution without ten condition imposed on the institution the consent of the FDIC. The Regula- or an IAP, or a written agreement entory Relief Act extends this prohibition tered into by the agency with the instituso that persons convicted of such crimes tion or IAP, without demonstrating that also may not participate in the affairs of the institution or IAP was unjustly ena bank holding company (other than a riched or acted in reckless disregard of foreign bank), an Edge or agreement the law or a prior agency order. Simicorporation, or a savings and loan hold- larly, the act allows the appropriate feding company unless the individual re- eral banking agency for an undercapitalceives the prior consent of the Board or ized institution to enforce a written the OTS, as appropriate. The Regulatory condition imposed on, or a written Relief Act also gives the Board and the agreement entered into with, the institu- OTS additional discretionary authority tion or an IAP without regard to the to remove a person convicted of such a limit in the FDI Act (12 USC crime from, respectively, a nonbank sub- 1831o(e)(2)(E)) that normally caps the sidiary of a bank holding company or a liability of a controlling shareholder unsavings and loan holding company. der a capital restoration plan. Authority to Enforce Clarifying the Ability of the Banking Deposit Insurance Conditions Agencies to Enforce Conditions Imposed in Connection with Section 8 of the Federal Deposit Insur- CIBC Act Notices ance Act currently permits the appropriate federal banking agency for an in- The Regulatory Relief Act amends secsured depository institution to enforce a tion 8(b) of the Federal Deposit Insurwritten condition imposed by that ance Act to provide that the appropriate agency on the institution or an IAP of federal banking agency for an insured the institution. The Regulatory Relief depository institution may enforce writ- Act amended section 8 of the FDI Act to ten conditions imposed in connection allow the appropriate federal banking with "any action on any application, agency for an institution to enforce a notice, or other request" by the deposicondition imposed on an insured deposi- tory institution or an IAP. These changes tory institution by another federal bank- are designed to clarify and confirm the ing agency. This will allow, for exam- agencies' ability to enforce conditions ple, the Board (as the appropriate imposed in connection with a notice filed agency for a state member bank) to en- under the Change in Bank Control Act. force a condition imposed on a state member bank by the FDIC in connec- Board Approval of tion with the bank's application for de- OCC Removal Actions posit insurance The Regulatory Relief Act strikes the provision in the FDI Act (see 12 USC Standards for Enforcing Written 1818(e)(4)) that required the Board to Conditions and Written Agreements issue a final decision in any contested The Regulatory Relief Act also amended administrative action by the OCC to section 8 of the Federal Deposit Insur- remove or prohibit an IAP of a national ance Act to allow the appropriate fed- bank. Thus, the OCC now has the same eral banking agency for an insured authority as the Board, the FDIC, and depository institution to enforce a writ- the OTS to independently remove or Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

146 93rd Annual Report, 2006 prohibit an IAP of an institution under may be used by financial institutions, at the agency's jurisdiction. their option, to fulfill the initial and annual privacy policy disclosure requirements imposed by section 503 of Consumer-Related Provisions the Gramm-Leach-Bliley Act (12 USC Public Welfare Investments by 6803). The model form must be issued National and State Banks in proposed form for public comment within 180 days of enactment. The The Regulatory Relief Act makes sev- Board has been working extensively eral important modifications to the stat- with the other relevant agencies and utes that authorize national and state conducting consumer testing to develop member banks to make "public welfare" potential model privacy forms that may investments. See 12 USC 24 (eleventh) be used by financial institutions. and 338a. First, it raises, from 10 percent of capital and surplus to 15 percent of capital and surplus, the aggregate Studies and Reports amount of "public welfare" investments GAO Study of that a national or state member bank Currency Transaction Reports may make under these authorities.1 In addition, the act refocuses these invest- The Regulatory Relief Act directs the ments on low- and moderate-income Government Accountability Office (LMI) families and communities by pro- (GAO) to conduct a study of the volume viding that to be considered a "public of currency transaction reports (CTRs) welfare" investment, an investment must filed with the Secretary of the Treasury primarily benefit LMI families or com- under the Bank Secrecy Act. The study munities (such as by providing housing, must evaluate, among other things, services, or jobs). The act also clarifies (1) the extent to which depository instithat each "public welfare" investment tutions avail themselves of the current made by a national or state member exemption system for CTRs, (2) ways to bank, either directly or through a subsid- improve the current exemption system iary, must benefit primarily LMI com- for CTRs, and (3) the usefulness of munities or families. CTRs to law enforcement agencies. The Regulatory Relief Act also provides that Development of Model the study should include recommenda- Privacy Disclosure Forms tions for changes to the CTR exemption system that would reduce burden with- The Regulatory Relief Act requires the out adversely affecting the reporting sys- Board, the other federal banking agentem's effectiveness. The GAO must subcies, the National Credit Union Adminmit a report on its findings to Congress istration, the Secretary of the Treasury, by January 13, 2007. the Securities and Exchange Commission, and the Federal Trade Commission to jointly develop a model form that Unlawful Internet Gambling Enforcement Act of 2006 1. As under current law, a national or state member bank would have to obtain the approval The Unlawful Internet Gambling Enof the OCC or the Board, respectively, to make forcement Act of 2006, Pub. L. 109- "public welfare" investments that, in the aggre- 347, (codified at 31 USC 5361 et seq.) gate, exceed 5 percent of the bank's capital and surplus. prohibits a person engaged in the busi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Legislative Developments 147 ness of betting or wagering from know- jointly find that it is not reasonably pracingly accepting credit, electronic fund tical to identify and block, or otherwise transfers, checks, drafts, or similar in- prevent or prohibit, such restricted transstruments drawn on or payable through actions. The regulations must be pubany financial institution in connection lished by July 10, 2007. with the participation of another person in unlawful Internet gambling ("re- Military Personnel Financial stricted transactions"). The act generally Services Protection Act defines "unlawful Internet gambling" as transmitting a bet by any means that The National Defense Authorization Act involves the use, at least in part, of the for Fiscal Year 2007, Pub. L. No. 109- Internet and where such bet or wager is 364, enacted on September 30, 2006, unlawful under any applicable federal or imposes restrictions on and disclosure state law in the state or tribal lands in requirements for consumer credit prowhich the bet or wager is initiated, re- vided to members of the military and ceived, or otherwise made. their families. The act charges the De- The act charges the Secretary of the partment of Defense (DOD) with defin- Treasury and the Board, in consultation ing "consumer credit" in its regulations with the Attorney General, with devel- and permits the DOD to include all conoping regulations to require each pay- sumer credit apart from residential mortment system that the agencies determine gages, loans to fund the purchase of a could be used to process restricted pay- motor vehicle, and other personal propments (as well as financial transaction erty loans when the property purchased providers participating in such payment from the proceeds of the loan serves as systems) to establish "policies and pro- collateral for the loan. Requirements for cedures reasonably designed to identify creditors include a 36 percent annual and block or otherwise prevent or pro- percentage rate (APR) cap, which hibit the acceptance of restricted trans- includes all fees, along with APR calcuactions." In prescribing the regulations, lations and disclosures that differ from the Secretary and the Board must iden- the APR used in disclosures under the tify the types of policies and procedures, Truth in Lending Act (TILA). The act including nonexclusive examples, mandates that all credit disclosures, deemed by the agencies to be reason- including TILA disclosures, be provided ably designed to identify and block re- both orally and in writing prior to the stricted transactions. To the extent prac- extension of credit. tical, any participant in a designated Moreover, the act imposes limitations payment system must be permitted to on lending to members of the military choose among alternative means of and their dependents, such as prohibitcomplying, including by relying on and ing rollovers and refinancings of concomplying with the policies and proce- sumer credit by the same creditor, and dures of the designated payment system, prohibiting loans with prepayment penso long as these policies and procedures alties and mandatory arbitration clauses. comply with the regulation. The act also The act imposes criminal and monetary requires the Secretary and the Board to penalties for knowing violations and grant exemptions from any requirement voids contracts that are prohibited under imposed under the regulations to par- the statute. The legislation was intended, ticular types of transactions or desig- at least in part, to address concerns nated payment systems if the agencies about payday loans, installment loans Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

148 93rd Annual Report, 2006 that are secured by a motor vehicle changes to the netting and financial con- (other than loans for the purchase of a tract provisions that were added or remotor vehicle), and other forms of short- vised by title IX of the 2005 act. The term credit to military members and 2006 act updates the descriptions of their dependents. In prescribing regula- various financial contracts ("securities tions for this legislation, the DOD must contract," "forward contract," and consult with the Board, among other "swap agreement") in the Federal Defederal agencies. The effective date of posit Insurance Act, the Federal Credit the act is October 1, 2007, regardless of Union Act (FCUA), and the Bankruptcy whether the DOD adopts regulations. Code to reflect current market and regu- This statute would become effective ear- latory practice. The 2006 act also relier if interim regulations are issued by vises provisions in the Bankruptcy Code the DOD. to clarify the rights of certain counterparties to exercise self-help foreclosureon-collateral rights, setoff rights, and Financial Netting Improvements netting rights with respect to financial Act of 2006 contracts with a debtor. These provi- In 2005, Congress passed comprehen- sions conform the Bankruptcy Code sive legislation to revise the federal with parallel provisions in the FDI Act bankruptcy laws (Bankruptcy Abuse and the FCUA. In addition, the 2006 act Prevention and Consumer Protection amends the FDI Act and the FCUA to Act of 2005, Pub. L. 109-8). Title IX of clarify the conditions under which a rethat act contained amendments to bank- ceiver of an insolvent depository instituing laws find the Bankruptcy Code to tion can enforce a financial contract that provide increased certainty that netting contains a "walkaway" clause (a clause and close-out of financial market con- that would otherwise allow a contract tracts would be enforceable, even in the participant to suspend, condition, or exevent of a counterparty insolvency. Title tinguish a payment obligation when the IX also clarified certain duties and other party becomes insolvent). The obligations of the FDIC as receiver or 2006 act also makes other technical and conservator of an insured depository conforming revisions to the FDI Act, institution. FCUA, Bankruptcy Code, Federal De- The Financial Netting Improvements posit Insurance Corporation Improve- Act of 2006 (Pub. L. 109-390), enacted ment Act of 1991, and Securities Inveson December 12, 2006, makes technical tor Protection Act of 1970. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

151 Record of Policy Actions of the Board of Governors Regulation D on a recurring basis. The amendments Reserve Requirements also provide financial institutions with of Depository Institutions an alternative to sending periodic statements for payroll card accounts if they [Docket No. R-1268] make account information available to account holders by certain specified On October 18, 2006, the Board apmeans. The amendments are effective proved amendments to reflect the annual July 1, 2007. indexing of the low reserve tranche and of the reserve requirement exemption Votes for this action: Chairman Bernanke, for use in 2007 reserve requirement cal- Vice Chairman Kohn, and Governors culations. The amendments decrease the Bies, Warsh, and Kroszner. 3 percent low reserve tranche for net transaction accounts to $45.8 million (from $48.3 million in 2006) and [Docket No. R-1265] increase the reserve requirement exemption to $8.5 million (from $7.8 million On November 27, 2006, the Board apin 2006). proved amendments to Regulation E and its official staff commentary to clarify Votes for this action: Chairman Bernanke, that the requirement to obtain consumer Vice Chairman Kohn, and Governors authorization applies to any person who Warsh, Kroszner, and Mishkin. Absent and not voting: Governor Bies. intends to collect electronically a fee for a check or other item that is returned unpaid. The amendments also provide Regulation E guidance on the regulation's require- Electronic Fund Transfers ments concerning consumer notice when a returned-item fee is collected elec- [Docket No. R-1247] tronically or a transaction involves an electronic check conversion. The On August 24, 2006, the Board apamendments, which are based substanproved amendments to Regulation E and tially on an interim final rule approved its official staff commentary to apply the on August 24, 2006, are effective Januregulation to payroll card accounts ary 1, 2007; compliance with certain established to distribute employee disclosure requirements for returnedsalaries, wages, or other compensation item fees collected in connection with point-of-sale transactions is delayed until January 1, 2008. NOTE: Full texts of the policy actions are available via the online version of the Annual Report, Votes for this action: Chairman Bernanke, from the "Reading Rooms" on the Board's FOIA Vice Chairman Kohn, and Governors web page, and on request from the Board's Free- Bies, Warsh, and Kroszner. Absent and dom of Information Office. not voting: Governor Mishkin. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

152 93rd Annual Report, 2006 Regulation H Regulation O Membership of Loans to Executive Officers, State Banking Institutions Directors, and Principal in the Federal Reserve System Shareholders of Member Banks [Docket No. R-1271] Regulation Y On December 6, 2006, the Board ap- Bank Holding Companies proved an interim final rule, with reand Change in Bank Control quest for comment, to implement section 601 of the Financial Services Regulatory Relief Act of 2006 by elimi- [Docket No. R-1087] nating certain reporting requirements On February 2, 2006, the Board, acting that have not contributed significantly to with the other federal bank regulatory effective monitoring or prevention of agencies, approved amendments to the insider lending abuse. The interim final agencies' market risk rules to reduce rule is effective December 11, 2006. the capital requirement for certain securities-borrowing transactions collat- Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors eralized with cash. The interagency rule, Bies, Warsh, Kroszner, and Mishkin. which makes permanent and expands an interim final rule approved in 2000, is effective February 22, 2006. Regulation Y Votes for this action: Chairman Bernanke, Bank Holding Companies Vice Chairman Ferguson, and Governors and Change in Bank Control Bies, Olson, and Kohn. [Docket No. R-1235] On February 22, 2006, the Board ap- Regulation K proved amendments to expand the appli- International Banking Operations cability of its Small Bank Holding Company Policy Statement and related [Docket No. R-1147] exemptions from its consolidated capital adequacy guidelines on risk-based and On March 15, 2006, the Board approved leverage measures by increasing the amendments requiring Edge Act and asset-size limitation specified in the polagreement corporations and the U.S. icy statement from $150 million to $500 branches, agencies, and representative million. The amended policy statement offices of foreign banks supervised by does not apply, however, to bank holdthe Board to establish and maintain proing companies with less than $500 milcedures that ensure and monitor complilion in assets that engage in significant ance with the Bank Secrecy Act and nonbanking or off-balance-sheet activirelated regulations. The amendments are ties or have a material amount of debt or effective April 19, 2006. equity securities registered with the Securities and Exchange Commission. The Votes for this action: Chairman Bernanke amendments also clarify that subordiand Governors Bies, Olson, Kohn, Warsh, and Kroszner. Absent and not voting: Vice nated debt related to the issuance of Chairman Ferguson. trust preferred securities generally Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 153 would be treated as debt under the pol- ment, to extend eligibility for access to icy statement, subject to a five-year tran- confidential supervisory information to sition period. The amendments are ef- certain noncitizen employees. The infective March 30, 2006. terim rule is effective August 7, 2006, and also applies to all grants of access Votes for this action: Chairman Bernanke, made as of that date. Vice Chairman Ferguson, and Governors Bies, Olson, and Kohn. Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors Bies, Warsh, and Kroszner. Regulation BB Community Reinvestment Policy Statements [Docket No. OP-1240] and Other Actions On March 1, 2006, the Board, acting with the other federal bank regulatory Interagency Advisory on the agencies, approved guidance intended to Unsafe and Unsound Use of aid implementation of recent changes to Limitation of Liability Provisions the agencies' regulations under the in External Audit Community Reinvestment Act (CRA). Engagement Letters The guidance discusses, among other regulatory topics, (1) the criteria for de- On January 30, 2006, the Board, acting termining if an area is distressed, is with the other federal financial regulaunderserved, or has suffered a disaster; tory agencies, approved an advisory to (2) the period of time that bank activi- address safety and soundness concerns ties in those areas are eligible for consid- associated with agreements by financial eration in a CRA evaluation; and (3) the institutions that limit the liability of their standards used by CRA examiners to external auditors. The advisory applies decide if such activities qualify as "com- to provisions that (1) indemnify an exmunity development." The guidance ternal auditor against claims made by also explains how the new community third parties (including punitive damdevelopment test for intermediate small ages); (2) hold harmless or release an banks (banks with assets between external auditor from liability for claims $250 million and $1 billion) will be or potential claims that might be asapplied. The interagency guidance is ef- serted by the client financial institution; fective March 10, 2006. or (3) limit the remedies available to the client financial institution. Provisions Votes for this action: Chairman Bernanke, that waive the right of financial institu- Vice Chairman Ferguson, and Governors tions to seek punitive damages against Bies, Olson, Kohn, and Warsh. their external auditors are not considered unsafe and unsound under the advisory. The interagency advisory is effec- Rules Regarding tive for engagement letters executed on Equal Opportunity or after February 9, 2006. [Docket No. OP-1264] Votes for this action: Chairman Green- On August 1, 2006, the Board approved span, Vice Chairman Ferguson, and Govan interim rule, with request for com- ernors Bies, Olson, and Kohn. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

154 93rd Annual Report, 2006 Federal Reserve Guidance on Concentrations in Currency Recirculation Policy Commercial Real Estate Lending, Sound Risk-Management Practices [Docket No. OP-1164] [Docket No. OP-1248] On March 17, 2006, the Board revised the Federal Reserve System's cash ser- On December 6, 2006, the Board, acting vices policy, with the intention of with the other federal bank regulatory increasing the recirculation of fit cur- agencies, approved guidance intended to rency by (1) initiating a custodial inven- reinforce sound risk-management practory program to encourage depository tices for institutions that have high and institutions to hold $10 and $20 notes in increasing concentrations of commercial their vaults to meet customer demand real estate loans on their balance sheets. and (2) charging a fee to depository The guidance includes supervisory criteinstitutions that deposit fit $10 or ria to assist in identifying institutions $20 notes at a Reserve Bank and order that have potentially significant concenthe same denominations, above a trations. The interagency guidance is efde minimis amount, during the same fective December 12, 2006. business week. The custodial inventory Votes for this action: Chairman Bernanke, program will begin in July 2006, and Vice Chairman Kohn, and Governors fee assessments are expected to begin in Bies, Warsh, Kroszner, and Mishkin. July 2007. Votes for this action: Chairman Bernanke Interagency Statement on and Governors Olson, Kohn, Warsh, and Sound Practices concerning Kroszner. Absent and not voting: Vice Elevated Risk Complex Structured Chairman Ferguson and Governor Bies. Finance Activities Nontraditional Mortgage [Docket No. OP-1254] Product Risks On December 20, 2006, the Board, acting with the Securities and Exchange [Docket No. OP-1246] Commission and the other federal bank and thrift regulatory agencies, approved On September 27, 2006, the Board, acta statement that describes internal coning with the other federal financial regutrols and risk-management procedures latory agencies, approved interagency to assist financial institutions in identiguidance on underwriting and managing fying, managing, and addressing the nontraditional mortgage products (loans heightened legal and reputational risks that allow borrowers to defer payment associated with certain complex of principal and in some cases interest) structured finance transactions. The in a safe and sound manner and on interagency statement is effective Janclearly disclosing the potential risks of uary 11, 2007. those products. Votes for this action: Chairman Bernanke, Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors Vice Chairman Kohn, and Governors Bies, Kroszner, and Mishkin. Absent and Bies, Warsh, Kroszner, and Mishkin. not voting: Governor Warsh. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 155 Discount Rates in 2006 "Monetary Policy and Economic Developments" and the minutes of FOMC Under the Federal Reserve Act, boards meetings held in 2006). of directors of the Federal Reserve Banks must establish rates on loans to depository institutions at least every Secondary and Seasonal Credit fourteen days, subject to review and de- Secondary credit is available in approtermination by the Board of Governors. priate circumstances to depository institutions that do not qualify for primary Primary Credit credit. The secondary credit rate is set at a spread above the primary credit rate. Primary credit is the Federal Reserve's In 2006, the spread was set at 50 basis main lending program. Primary credit is points. made available with minimal adminis- Seasonal credit is available to smaller tration for very short terms as a backup depository institutions to meet liquidity source of liquidity to depository institu- needs that arise from regular swings in tions that, in the judgment of the lending their loans and deposits. The rate on Federal Reserve Bank, are in generally seasonal credit is calculated every two sound financial condition. Primary weeks as an average of selected moneycredit is extended at a rate above the market yields, typically resulting in a federal funds rate target set by the Fedrate close to the federal funds rate target. eral Open Market Committee (FOMC). At year-end, the secondary and sea- During 2006, the Board approved sonal credit rates were 63A percent and four increases in the primary credit rate, 5.30 percent, respectively. bringing the rate from 5lA percent to 6lA percent. The Board reached its determinations on the primary credit rate Votes on Discount Rate Changes recommendations of the Reserve Bank About every two weeks during 2006, the boards of directors in conjunction with Board approved proposals by the twelve the FOMC's decisions to raise the target Reserve Banks to maintain the formulas federal funds rate from 4V4 percent to for computing the secondary and sea- 5VA percent and related economic and sonal credit rates. Details on the four financial developments. Rising energy actions by the Board to approve changes prices coupled with high levels of in the primary credit rate are provided resource utilization contributed to below. heightened inflation pressures over the first half of the year. Those pressures January 31, 2006. Effective this date, receded over the second half of the year the Board approved actions taken by the as energy prices dropped and weakness directors of the Federal Reserve Banks in the housing sector weighed on eco- of Boston, New York, Philadelphia, nomic activity. In light of these condi- Cleveland, Richmond, Atlanta, Chicago, tions, the Federal Reserve raised the Kansas City, Dallas, and San Francisco structure of policy rates at a measured to raise the rate on discounts and pace in the first half of the year and kept advances under the primary credit prothose rates unchanged for the remainder gram by lA percentage point, to 5Vi perof the year. Monetary policy developcent. The same increase was approved ments are reviewed more fully in other for the Federal Reserve Bank of St. parts of this report (see the section Louis, effective February 1, 2006. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

156 93rd Annual Report, 2006 Board also approved an identical action to raise the rate on discounts and subsequently taken by the directors of advances under the primary credit prothe Federal Reserve Bank of Minneapo- gram by VA percentage point, to 6 perlis, effective February 2, 2006. cent. The same increase was approved for the Federal Reserve Bank of St. Votes for this action: Chairman Green- Louis, effective May 11, 2006. The span, Vice Chairman Ferguson, and Gov- Board also approved an identical action ernors Bies, Olson, and Kohn. Votes against this action: None. subsequently taken by the directors of the Federal Reserve Bank of Kansas March 28, 2006. Effective this date, the City, effective May 11, 2006. Board approved actions taken by the directors of the Federal Reserve Banks Votes for this action: Chairman Bernanke, of Boston, New York, Philadelphia, Vice Chairman Ferguson, and Governors Cleveland, Richmond, Atlanta, Chicago, Bies, Olson, Kohn, Warsh, and Kroszner. Minneapolis, Dallas, and San Francisco Votes against this action: None. to raise the rate on discounts and June 29, 2006. Effective this date, the advances under the primary credit pro- Board approved actions taken by the gram by lA percentage point, to 53/4 perdirectors of the Federal Reserve Banks cent. The same increase was approved of Boston, New York, Philadelphia, for the Federal Reserve Bank of St. Cleveland, Richmond, Atlanta, Chicago, Louis, effective March 29, 2006. The Minneapolis, and Dallas to raise the rate Board also approved an identical action on discounts and advances under the subsequently taken by the directors of primary credit program by lA percentage the Federal Reserve Bank of Kansas point, to 6lA percent. The same increase City, effective March 30, 2006. was approved for the Federal Reserve Bank of St. Louis, effective June 30, Votes for this action: Chairman Bernanke and Governors Bies, Olson, Kohn, Warsh, 2006. The Board also approved identical and Kroszner. Votes against this action: actions subsequently taken by the direc- None. tors of the Federal Reserve Banks of San Francisco, effective June 29, 2006, May 10, 2006. Effective this date, the and Kansas City, effective July 6, 2006. Board approved actions taken by the directors of the Federal Reserve Banks Votes for this action: Chairman Bernanke, of Boston, New York, Philadelphia, Vice Chairman Kohn, and Governors Cleveland, Richmond, Atlanta, Chicago, Bies, Warsh, and Kroszner. Votes against Minneapolis, Dallas, and San Francisco this action: None. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

157 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 therein Reserve Bank of New York operates the votes taken in connection with the under an Authorization for Foreign Curdetermination of open market policies rency Operations, a Foreign Currency and the reasons underlying each policy Directive, and Procedural Instructions action, and that it shall include in its with Respect to Foreign Currency Opannual report to Congress a full account erations. These policy instruments are of such actions. shown below in the form in which they The minutes of the meetings contain were in effect at the beginning of 2006. the votes on the policy decisions made Changes in the instruments during the at those meetings as well as a summary year are reported in the minutes for the of the information and discussions that individual meetings. led to the decisions. The descriptions of economic and financial conditions are based solely on the information that was Authorization for Domestic Open Market Operations available to the Committee at the time of the meetings. In Effect January 1, 2006 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 necessary to carry out the most recent domestic views is noted in the minutes. When policy directive adopted at a meeting of the members dissent from a decision, they Committee: are identified in the minutes and a sum- (a) To buy or sell U.S. Government mary of the reasons for their dissent is securities, including securities of the Federal provided. Financing Bank, and securities that are direct Policy directives of the Federal Open obligations of, or fully guaranteed as to principal and interest by, any agency of the Market Committee are issued to the United States in the open market, from or to Federal Reserve Bank of New York as securities dealers and foreign and interthe Bank selected by the Committee to national accounts maintained at the Federal execute transactions for the System Reserve Bank of New York, on a cash, regu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

158 93rd Annual Report, 2006 lar, or deferred delivery basis, for the System ability to control a single issue as deter- Open Market Account at market prices, and, mined solely by the Federal Reserve Bank of for such Account, to exchange maturing New York. U.S. Government and Federal agency securities with the Treasury or the individual agen- 3. In order to ensure the effective conduct cies or to allow them to mature without of open market operations, while assisting in replacement. 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 in 65 business in the event Government securities or agency days or less on terms comparable to those issues covered by any such agreement are available on such transactions in the market; not repurchased by the dealer pursuant to the and (b) for New York Bank account, when appropriate, to undertake with dealers, subagreement or a renewal thereof, they shall be ject to the conditions imposed on purchases sold in the market or transferred to the Sysand sales of securities in paragraph l(b), tem Open Market Account. repurchase agreements in U.S. Government (c) To sell U.S. Government securities and agency securities, and to arrange correand obligations that are direct obligations of, sponding sale and repurchase agreements or fully guaranteed as to principal and inter- between its own account and such foreign, est by, any agency of the United States to international, and fiscal agency accounts dealers for System Open Market Account maintained at the Bank. Transactions underunder agreements for the resale by dealers taken with such accounts under the proviof such securities or obligations in 65 busi- sions of this paragraph may provide for a ness days or less, at rates that, unless service fee when appropriate. otherwise expressly authorized by the Committee, shall be determined by competitive bidding, after applying reasonable limita- 4. In the execution of the Committee's tions on the volume of agreements with decision regarding policy during any interindividual dealers. meeting 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 Reserve Bank of New York to lend on an pressure on reserve positions and hence the overnight basis U.S. Government securities intended federal funds rate. Any such adjustheld in the System Open Market Account to ment shall be made in the context of the dealers at rates that shall be determined by Committee's discussion and decision at its competitive bidding. The Federal Reserve most recent meeting and the Committee's Bank of New York shall set a minimum long-run objectives for price stability and lending fee consistent with the objectives of sustainable economic growth, and shall be the program and apply reasonable limitations based on economic, financial, and moneon the total amount of a specific issue that tary developments during the intermeeting may be auctioned and on the amount of period. Consistent with Committee pracsecurities that each dealer may borrow. The tice, the Chairman, if feasible, will consult Federal Reserve Bank of New York may with the Committee before making any reject bids which could facilitate a dealer's adjustment. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings 159 Domestic Policy Directive shall be fully liquidated within 12 months after any amount outstanding at that time In Effect January 1, 20061 was first drawn, unless the Committee, because of exceptional circumstances, spe- The Federal Open Market Committee cifically authorizes a delay. seeks monetary and financial conditions that D. To maintain an overall open posiwill foster price stability and promote sus- tion in all foreign currencies not exceeding tainable growth in output. To further its long- $25.0 billion. For this purpose, the overall run objectives, the Committee in the imme- open position in all foreign currencies is diate future seeks conditions in reserve defined as the sum (disregarding signs) of markets consistent with increasing the net positions in individual currencies. The federal funds rate to an average of around net position in a single foreign currency is 4V* percent. defined as holdings of balances in that currency, plus outstanding contracts for future receipt, minus outstanding contracts for Authorization for future delivery of that currency, i.e., as the Foreign Currency Operations sum of these elements with due regard to sign. In Effect January 1, 2006 2. The Federal Open Market Committee directs the Federal Reserve Bank of 1. The Federal Open Market Committee New York to maintain reciprocal currency authorizes and directs the Federal Reserve arrangements ("swap" arrangements) for the Bank of New York, for System Open Market System Open Market Account for periods up Account, to the extent necessary to carry out to a maximum of 12 months with the followthe Committee's foreign currency directive ing foreign banks, which are among those and express authorizations by the Commitdesignated by the Board of Governors of the tee pursuant thereto, and in conformity with Federal Reserve System under Section 214.5 such procedural instructions as the Commitof Regulation N, Relations with Foreign tee may issue from time to time: Banks and Bankers, and with the approval of A. To purchase and sell the following the Committee to renew such arrangements foreign currencies in the form of cable transon maturity: fers through spot or forward transactions on the open market at home and abroad, includ- Amount ing transactions with the U.S. Treasury, with of arrangement the U.S. Exchange Stabilization Fund estab- Foreign bank (millions of lished by Section 10 of the Gold Reserve dollars equivalent) Act of 1934, with foreign monetary authorities, with the Bank for International Settle- Bank of Canada . 2,000 ments, and with other international financial Bank of Mexico . 3,000 institutions: Any changes in the terms of existing swap Canadian dollars Mexican pesos Danish kroner Norwegian kroner arrangements, and the proposed terms of any Euro Swedish kronor new arrangements that may be authorized, Pounds sterling Swiss francs shall be referred for review and approval to Japanese yen the Committee. B. To hold balances of, and to have outstanding forward contracts to receive or 3. All transactions in foreign currencies to deliver, the foreign currencies listed in undertaken under paragraph LA. above paragraph A above. shall, unless otherwise expressly authorized C. To draw foreign currencies and to by the Committee, be at prevailing market permit foreign banks to draw dollars under rates. For the purpose of providing an investthe reciprocal currency arrangements listed ment return on System holdings of foreign in paragraph 2 below, provided that draw- currencies or for the purpose of adjusting ings by either party to any such arrangement interest rates paid or received in connection with swap drawings, transactions with for- 1. Adopted by the Committee at its meeting eign central banks may be undertaken at on December 13, 2005. non-market exchange rates. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

160 93rd Annual Report, 2006 4. It shall be the normal practice to 7. The Chairman is authorized: arrange with foreign central banks for the A. With the approval of the Commitcoordination of foreign currency transac- tee, to enter into any needed agreement or tions. In making operating arrangements understanding with the Secretary of the Treawith foreign central banks on System hold- sury about the division of responsibility for ings of foreign currencies, the Federal foreign currency operations between the Sys- Reserve Bank of New York shall not commit tem and the Treasury; itself to maintain any specific balance, un- B. To keep the Secretary of the Trealess authorized by the Federal Open Market sury fully advised concerning System for- Committee. Any agreements or understand- eign currency operations, and to consult with ings concerning the administration of the the Secretary on policy matters relating to accounts maintained by the Federal Reserve foreign currency operations; Bank of New York with the foreign banks C. From time to time, to transmit designated by the Board of Governors under appropriate reports and information to the Section 214.5 of Regulation N shall be National Advisory Council on International referred for review and approval to the Monetary and Financial Policies. Committee. 8. Staff officers of the Committee are authorized to transmit pertinent information on 5. Foreign currency holdings shall be in- System foreign currency operations to approvested to ensure that adequate liquidity is priate officials of the Treasury Department. maintained to meet anticipated needs and so 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. Foreign Currency Directive 6. All operations undertaken pursuant to the preceding paragraphs shall be reported promptly to the Foreign Currency Sub- In Effect January 1, 2006 committee and the Committee. The Foreign Currency Subcommittee consists of the 1. System operations in foreign curren- Chairman and Vice Chairman of the Com- cies shall generally be directed at countering mittee, the Vice Chairman of the Board of disorderly market conditions, provided that Governors, and such other member of the market exchange rates for the U.S. dollar Board as the Chairman may designate (or in reflect actions and behavior consistent with the absence of members of the Board serving IMF Article IV, Section 1. on the Subcommittee, other Board members 2. To achieve this end the System shall: designated by the Chairman as alternates, A. Undertake spot and forward purand in the absence of the Vice Chairman of chases and sales of foreign exchange. the Committee, his alternate). Meetings of B. Maintain reciprocal currency the Subcommittee shall be called at the ("swap") arrangements with selected foreign request of any member, or at the request of central banks. the Manager, System Open Market Account C. Cooperate in other respects with ("Manager")* for the purposes of reviewing central banks of other countries and with recent or contemplated operations and of international monetary institutions. consulting with the Manager on other matters relating to his responsibilities. At the 3. Transactions may also be undertaken: request of any member of the Subcommittee, A. To adjust System balances in light questions arising from such reviews and con- of probable future needs for currencies. sultations shall be referred for determination B. To provide means for meeting Systo the Federal Open Market Committee. tem and Treasury commitments in particular Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 161 currencies, and to facilitate operations of the currency by the System, even though the Exchange Stabilization Fund. change in the System's net position in that C. For such other purposes as may be currency might be less than the limits speciexpressly authorized by the Committee. fied in l.B. D. Any swap drawing proposed by a 4. System foreign currency operations foreign bank not exceeding the larger of shall be conducted: (i) $200 million or (ii) 15 percent of the size A. In close and continuous consulta- of the swap arrangement. tion and cooperation with the United States Treasury; 2. The Manager shall clear with the Com- B. In cooperation, as appropriate, with mittee (or with the Subcommittee, if the foreign monetary authorities; and Subcommittee believes that consultation C. In a manner consistent with the ob- with the full Committee is not feasible in the ligations of the United States in the Interna- time available, or with the Chairman, if the tional Monetary Fund regarding exchange Chairman believes that consultation with arrangements under IMF Article IV. the Subcommittee is not feasible in the time available): Procedural Instructions A. Any operation that would result in a change in the System's overall open position with Respect to in foreign currencies exceeding $1.5 billion Foreign Currency Operations since the most recent regular meeting of the Committee. In Effect January 1, 2006 B. Any swap drawing proposed by a foreign bank exceeding the larger of In conducting operations pursuant to the (i) $200 million or (ii) 15 percent of the authorization and direction of the Federal size of the swap arrangement. Open Market Committee as set forth in the Authorization for Foreign Currency Opera- 3. The Manager shall also consult with tions and the Foreign Currency Directive, the Subcommittee or the Chairman about the Federal Reserve Bank of New York, proposed swap drawings by the System and through the Manager, System Open Market about any operations that are not of a routine Account ("Manager"), shall be guided by the character. following procedural understandings with respect to consultations and clearances with the Committee, the Foreign Currency Subcommittee, and the Chairman of the Com- Meeting Held on mittee. All operations undertaken pur- January 31, 2006 suant to such clearances shall be reported promptly to the Committee. A meeting of the Federal Open Market 1. The Manager shall clear with the Sub- Committee was held in the offices of the committee (or with the Chairman, if the Board of Governors of the Federal Chairman believes that consultation with the Reserve System in Washington, D.C., Subcommittee is not feasible in the time on Tuesday, January 31, 2006 at 9:00 available): a.m. A. Any operation that would result in a change in the System's overall open position in foreign currencies exceeding $300 million Present: on any day or $600 million since the most Mr. Greenspan, Chairman recent regular meeting of the Committee. Mr. Geithner, Vice Chairman B. Any operation that would result in a Ms. Bies change on any day in the System's net posi- Mr. Ferguson tion in a single foreign currency exceeding Mr. Guynn $150 million, or $300 million when the Mr. Kohn operation is associated with repayment of Mr. Lacker swap drawings. Mr. Olson C. Any operation that might generate a Ms. Pianalto substantial volume of trading in a particular Ms. Yellen Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

162 93rd Annual Report, 2006 Mses. dimming and Minehan, Messrs. Ms. Low, Open Market Secretariat Spe- Moskow, Poole, and Hoenig, Al- cialist, Division of Monetary ternate Members of the Federal Affairs, Board of Governors Open Market Committee Mr. Stone, First Vice President, Federal Messrs. Fisher, Stern, and Santomero, Reserve Bank of Philadelphia Presidents of the Federal Reserve Banks of Dallas, Minneapolis, and Messrs. Fuhrer and Rosenblum, Execu- Philadelphia, respectively tive Vice Presidents, Federal Reserve Banks of Boston and Dal- Mr. Reinhart, Secretary and Economist las, respectively Ms. Danker, Deputy Secretary Ms. Smith, Assistant Secretary Messrs. Evans and Hakkio, Mses. Mr. Skidmore, Assistant Secretary Mester and Perelmuter, and Mr. Alvarez, General Counsel Messrs. Rasche, Rolnick, and Mr. Baxter, Deputy General Counsel Steindel, Senior Vice Presidents, Ms. Johnson, Economist Federal Reserve Banks of Chicago, Mr. Stockton, Economist Kansas City, Philadelphia, New York, St. Louis, Minneapolis, and Messrs. Connors, Eisenbeis, Judd, Ka- New York, respectively min, Madigan, Sniderman, Struckmeyer, and Wilcox, Associate Mr. Hetzel, Senior Economist, Federal Economists Reserve Bank of Richmond Mr. Kos, Manager, System Open Market Account In the agenda for this meeting, it was Messrs. Oliner and Slifman, Associate reported that advices of the election of Directors, Division of Research the following members and alternate and Statistics, Board of Governors members of the Federal Open Market Mr. Whitesell, Deputy Associate Direc- Committee for a term beginning January tor, Division of Monetary Affairs, 31, 2006 had been received and that Board of Governors these individuals had executed their Messrs. English and Sheets, Assistant oaths of office. Directors, Division of Monetary The elected members and alternate Affairs and International Finance, members were as follows: respectively, Board of Governors Timothy F. Geithner, President of the Fed- Mr. Simpson, Senior Adviser, Division eral Reserve Bank of New York, with of Research and Statistics, Board Christine M. Cumming, First Vice of Governors President, Federal Reserve Bank of Mr. Small, Project Manager, Division New York as alternate. of Monetary Affairs, Board of Governors Jeffrey M. Lacker, President of the Federal Reserve Bank of Richmond, with Cathy Mr. Chaboud and Mses. Kusko and E. Minehan, President of the Federal Weinbach, Senior Economists, Di- Reserve Bank of Boston as alternate. visions of International Finance, Research and Statistics, and Mone- Sandra Pianalto, President of the Federal tary Affairs, respectively, Board of Reserve Bank of Cleveland, with Governors Michael H. Moskow, President of the Federal Reserve Bank of Chicago as Ms. Roush, Economist, Division of alternate. Monetary Affairs, Board of Governors Jack Guynn, President of the Federal Mr. Luecke, Senior Financial Analyst, Reserve Bank of Atlanta, with William Division of Monetary Affairs, Poole, President of the Federal Reserve Board of Governors Bank of St. Louis as alternate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings\ January 163 Janet L. Yellen, President of the Federal Freedom of Information Act Officer to Reserve Bank of San Francisco, with comply with an Executive Order issued Thomas M. Hoenig, President of the on December 14, 2005 that requires fed- Federal Reserve Bank of Kansas City as eral agencies to take certain actions realternate. lating to FOIA activities. By unanimous vote, the following By unanimous vote, the Committee officers of the Federal Open Market amended its Program for Security of Committee were selected to serve until FOMC Information, primarily to reflect the selection of their successors at the incorporation of the Board's new rules first regularly scheduled meeting of the on access to confidential information by Committee in 2007, with the under- non-citizens. standing that in the event of the discon- By unanimous vote, the Federal tinuance of their official connection with Reserve Bank of New York was selected the Board of Governors or with a Fedto execute transactions for the System eral Reserve Bank, they would cease to Open Market. have any official connection with the By unanimous vote, Dino Kos was Federal Open Market Committee: selected to serve at the pleasure of the Alan Greenspan Chairman2 Committee as Manager, System Open Timothy F. Geithner Vice Chairman Market Account, on the understanding Vincent R. Reinhart Secretary and that his selection was subject to being Economist satisfactory to the Federal Reserve Bank Deborah J. Danker Deputy Secretary of New York.4 David W. Skidmore Assistant Secretary Michelle A. Smith Assistant Secretary By unanimous vote, the Authoriza- Scott G. Alvarez General Counsel tion for Domestic Open Market Opera- Thomas C. Baxter, Jr. Deputy General tions was reaffirmed in the form shown Counsel below. Karen H. Johnson Economist David J. Stockton Economist Authorization for Domestic Open Thomas A. Connors, Robert A. Eisenbeis, Market Operations John P. Judd, Steven B. Kamin, Brian F. (Reaffirmed January 31, 2006) Madigan, Mark S. Sniderman, Charles S. Struckmeyer, Joseph S. Tracy, John 1. The Federal Open Market Committee A. Weinberg, and David W. Wilcox, authorizes and directs the Federal Reserve Associate Economists Bank of New York, to the extent necessary to carry out the most recent domestic policy In addition, it was agreed that the directive adopted at a meeting of the Committee would conduct a notation Committee: vote upon the swearing in of a new (a) To buy or sell U.S. Government Chairman of the Board of Governors to securities, including securities of the Federal elect Alan Greenspan's successor as Financing Bank, and securities that are direct Chairman of the Committee.3 obligations of, or fully guaranteed as to principal and interest by, any agency of the By unanimous vote, Deborah J. United States in the open market, from or to Danker, or her successor as Deputy Sec- securities dealers and foreign and interretary, was elected to serve as Chief national accounts maintained at the Federal Reserve Bank of New York, on a cash, 2. Alan Greenspan was elected to serve for the regular, or deferred delivery basis, for the remainder of the day. 3. Secretary's note: By notation vote completed 4. Secretary's note: Advice subsequently was on February 1, 2006 the Committee unanimously received that the selection of Mr. Kos as Manager approved the election of Ben S. Bernanke as was satisfactory to the board of directors of the Chairman of the Federal Open Market Committee. Federal Reserve Bank of New York. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

164 93rd Annual Report, 2006 System Open Market Account at market 3. In order to ensure the effective conduct prices, and, for such Account, to exchange of open market operations, while assisting in maturing U.S. Government and Federal the provision of short-term investments for agency securities with the Treasury or the foreign and international accounts mainindividual agencies or to allow them to ma- tained at the Federal Reserve Bank of New ture without replacement; York and accounts maintained at the Federal (b) To buy U.S. Government securities, Reserve Bank of New York as fiscal agent of obligations that are direct obligations of, or the United States pursuant to Section 15 of fully guaranteed as to principal and interest 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 Re- Federal Reserve Bank of New York (a) for serve Bank of New York under agreements System Open Market Account, to sell U.S. for repurchase of such securities or obliga- Government securities to such accounts on tions in 65 business days or less, at rates that, the bases set forth in paragraph l(a) under unless otherwise expressly authorized by the agreements providing for the resale by such Committee, shall be determined by competi- accounts of those securities in 65 business tive bidding, after applying reasonable limi- days or less on terms comparable to those tations on the volume of agreements with available on such transactions in the market; individual dealers; provided that in the event and (b) for New York Bank account, when Government securities or agency issues cov- appropriate, to undertake with dealers, subered by any such agreement are not repur- ject to the conditions imposed on purchases chased by the dealer pursuant to the agree- and sales of securities in paragraph l(b), ment or a renewal thereof, they shall be sold repurchase agreements in U.S. Government in the market or transferred to the System and agency securities, and to arrange corre- Open Market Account. sponding sale and repurchase agreements be- (c) To sell U.S. Government securities tween its own account and such foreign, and obligations that are direct obligations of, international, and fiscal agency accounts or fully guaranteed as to principal and inter- maintained at the Bank. Transactions underest by, any agency of the United States to taken with such accounts under the providealers for System Open Market Account sions of this paragraph may provide for a under agreements for the resale by dealers of service fee when appropriate. such securities or obligations in 65 business days or less, at rates that, unless otherwise 4. In the execution of the Committee's expressly authorized by the Committee, shall decision regarding policy during any interbe determined by competitive bidding, after meeting period, the Committee authorizes applying reasonable limitations on the vol- and directs the Federal Reserve Bank of ume of agreements with individual dealers. New York, upon the instruction of the Chairman of the Committee, to adjust somewhat 2. In order to ensure the effective conduct in exceptional circumstances the degree of of open market operations, the Federal Open pressure on reserve positions and hence the Market Committee authorizes the Federal intended federal funds rate. Any such adjust- Reserve Bank of New York to lend on an ment shall be made in the context of the overnight basis U.S. Government securities held in the System Open Market Account to Committee's discussion and decision at its dealers at rates that shall be determined by most recent meeting and the Committee's competitive bidding. The Federal Reserve long-run objectives for price stability and Bank of New York shall set a minimum sustainable economic growth, and shall be lending fee consistent with the objectives of based on economic, financial, and monetary the program and apply reasonable limitations developments during the intermeeting on the total amount of a specific issue that period. Consistent with Committee practice, may be auctioned and on the amount of the Chairman, if feasible, will consult with securities that each dealer may borrow. The the Committee before making any Federal Reserve Bank of New York may adjustment. reject bids which could facilitate a dealer's ability to control a single issue as determined With Mr. Lacker dissenting, the Comsolely by the Federal Reserve Bank of New mittee approved the Authorization for York. Foreign Currency Operations with an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 165 amendment to paragraph 5 which clari- billion. For this purpose, the overall open fies the language about permissible position in all foreign currencies is defined as the sum (disregarding signs) of net posiinvestment activities for the foreign tions in individual currencies. The net posiportfolio and brings that language into tion in a single foreign currency is defined as alignment with that present in the autho- holdings of balances in that currency, plus rization for the domestic portfolio. Ac- outstanding contracts for future receipt, micordingly, the Authorization for Foreign nus outstanding contracts for future delivery of that currency, i.e., as the sum of these Currency Operations was adopted, effecelements with due regard to sign. tive January 31, 2006, as shown below. 2. The Federal Open Market Committee directs the Federal Reserve Bank of New Authorization for York to maintain reciprocal currency ar- Foreign Currency Operations rangements ("swap" arrangements) for the (Amended January 31, 2006) System Open Market Account for periods up to a maximum of 12 months with the follow- 1. The Federal Open Market Committee ing foreign banks, which are among those authorizes and directs the Federal Reserve designated by the Board of Governors of the Bank of New York, for System Open Market Federal Reserve System under Section 214.5 Account, to the extent necessary to carry out of Regulation N, Relations with Foreign the Committee's foreign currency directive Banks and Bankers, and with the approval of and express authorizations by the Committee the Committee to renew such arrangements pursuant thereto, and in conformity with on maturity: such procedural instructions as the Committee may issue from time to time: Amount of arrangement A. To purchase and sell the following Foreign bank (millions of foreign currencies in the form of cable trans- dollars equivalent) fers through spot or forward transactions on the open market at home and abroad, includ- Bank of Canada 2,000 ing transactions with the U.S. Treasury, with Bank of Mexico 3,000 the U.S. Exchange Stabilization Fund estab- Any changes in the terms of existing swap lished by Section 10 of the Gold Reserve Act arrangements, and the proposed terms of any of 1934, with foreign monetary authorities, with new arrangements that may be authorized, the Bank for International Settlements, and shall be referred for review and approval to with other international financial institutions: the Committee. Canadian dollars Mexican pesos 3. All transactions in foreign currencies Danish kroner Norwegian kroner Euro Swedish kronor undertaken under paragraph I.A. above Pounds sterling Swiss francs shall, unless otherwise expressly authorized Japanese yen by the Committee, be at prevailing market rates. For the purpose of providing an invest- B. To hold balances of, and to have ment return on System holdings of foreign outstanding forward contracts to receive or currencies or for the purpose of adjusting to deliver, the foreign currencies listed in interest rates paid or received in connection paragraph A above. with swap drawings, transactions with for- C. To draw foreign currencies and to eign central banks may be undertaken at permit foreign banks to draw dollars under non-market exchange rates. the reciprocal currency arrangements listed in paragraph 2 below, provided that draw- 4. It shall be the normal practice to arings by either party to any such arrangement range with foreign central banks for the coshall be fully liquidated within 12 months ordination of foreign currency transactions. after any amount outstanding at that time In making operating arrangements with forwas first drawn, unless the Committee, be- eign central banks on System holdings of cause of exceptional circumstances, specifi- foreign currencies, the Federal Reserve Bank cally authorizes a delay. of New York shall not commit itself to main- D. To maintain an overall open position tain any specific balance, unless authorized in all foreign currencies not exceeding $25.0 by the Federal Open Market Committee. Any Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

166 93rd Annual Report, 2006 agreements or understandings concerning the A. With the approval of the Committee, administration of the accounts maintained by to enter into any needed agreement or underthe Federal Reserve Bank of New York with standing with the Secretary of the Treasury the foreign banks designated by the Board of about the division of responsibility for for- Governors under Section 214.5 of Regula- eign currency operations between the Systion N shall be referred for review and ap- tem and the Treasury; proval to the Committee. B. To keep the Secretary of the Treasury fully advised concerning System for- 5. Foreign currency holdings shall be eign currency operations, and to consult with invested to ensure that adequate liquidity is the Secretary on policy matters relating to maintained to meet anticipated needs and so foreign currency operations; that each currency portfolio shall generally C. From time to time, to transmit aphave an average duration of no more than propriate reports and information to the Na- 18 months (calculated as Macaulay durational Advisory Council on International tion). Such investments may include buying Monetary and Financial Policies. or selling outright obligations of, or fully guaranteed as to principal and interest by, a 8. Staff officers of the Committee are auforeign government or agency thereof; buy- thorized to transmit pertinent information on ing such securities under agreements for System foreign currency operations to repurchase of such securities; selling such appropriate officials of the Treasury securities under agreements for the resale of Department. such securities; and holding various time 9. All Federal Reserve Banks shall particiand other deposit accounts at foreign instipate in the foreign currency operations for tutions. In addition, when appropriate in System Account in accordance with paraconnection with arrangements to provide graph 3G(1) of the Board of Governors' investment facilities for foreign currency Statement of Procedure with Respect to Forholdings, U.S. Government securities may eign Relationships of Federal Reserve Banks be purchased from foreign central banks dated January 1, 1944. under agreements for repurchase of such securities within 30 calendar days. With Mr. Lacker dissenting, the For- 6. All operations undertaken pursuant to eign Currency Directive was reaffirmed the preceding paragraphs shall be reported in the form shown below. promptly to the Foreign Currency Subcommittee and the Committee. The Foreign Currency Subcommittee consists of the Chair- Foreign Currency Directive man and Vice Chairman of the Committee, (Reaffirmed January 31, 2006) the Vice Chairman of the Board of Governors, and such other member of the Board as 1. System operations in foreign currencies the Chairman may designate (or in the abshall generally be directed at countering dissence of members of the Board serving on orderly market conditions, provided that the Subcommittee, other Board members market exchange rates for the U.S. dollar designated by the Chairman as alternates, reflect actions and behavior consistent with and in the absence of the Vice Chairman of IMF Article IV, Section 1. the Committee, his alternate). Meetings of the Subcommittee shall be called at the re- 2. To achieve this end the System shall: quest of any member, or at the request of the A. Undertake spot and forward pur- Manager, System Open Market Account chases and sales of foreign exchange. ("Manager"), for the purposes of reviewing B. Maintain reciprocal currency recent or contemplated operations and of ("swap") arrangements with selected foreign consulting with the Manager on other mat- central banks. ters relating to his responsibilities. At the C. Cooperate in other respects with request of any member of the Subcommittee, central banks of other countries and with questions arising from such reviews and con- international monetary institutions. sultations shall be referred for determination to the Federal Open Market Committee. 3. Transactions may also be undertaken: A. To adjust System balances in light 7. The Chairman is authorized: of probable future needs for currencies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 167 B. To provide means for meeting Sys- mittee. All operations undertaken pursuant tem and Treasury commitments in particular to such clearances shall be reported promptly currencies, and to facilitate operations of the to the Committee. Exchange Stabilization Fund. 1. The Manager shall clear with the Sub- C. For such other purposes as may be committee (or with the Chairman, if the expressly authorized by the Committee. Chairman believes that consultation with the Subcommittee is not feasible in the time 4. System foreign currency operations available): shall be conducted: A. Any operation that would result in a A. In close and continuous consultation and cooperation with the United States change in the System's overall open position Treasury; in foreign currencies exceeding $300 million B. In cooperation, as appropriate, with on any day or $600 million since the most foreign monetary authorities; and recent regular meeting of the Committee. C. In a manner consistent with the obli- B. Any operation that would result in a gations of the United States in the Interna- change on any day in the System's net positional Monetary Fund regarding exchange tion in a single foreign currency exceeding arrangements under IMF Article IV. $150 million, or $300 million when the operation is associated with repayment of swap Mr. Lacker dissented in the votes on drawings. the Foreign Currency Directive and C. Any operation that might generate a Authorization for Foreign Currency substantial volume of trading in a particular Operations to indicate his opposition to currency by the System, even though the change in the System's net position in that foreign currency intervention by the currency might be less than the limits speci- Federal Reserve. In his view, such fied in l.B. intervention would be ineffective if it D. Any swap drawing proposed by a did not also signal a shift in domestic foreign bank not exceeding the larger of monetary policy. And if it did signal (i) $200 million or (ii) 15 percent of the size such a shift, it could potentially compro- of the swap arrangement. mise the Federal Reserve's monetary 2. The Manager shall clear with the Compolicy independence. 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 Currency Operations were reaffirmed in Chairman believes that consultation with the the form shown below. Subcommittee is not feasible in the time available): A. Any operation that would result in a Procedural Instructions change in the System's overall open position in foreign currencies exceeding $1.5 billion with Respect to since the most recent regular meeting of the Foreign Currency Operations Committee. (Reaffirmed January 31, 2006) B. Any swap drawing proposed by a foreign bank exceeding the larger of (i) $200 In conducting operations pursuant to the million or (ii) 15 percent of the size of the authorization and direction of the Federal swap arrangement. Open Market Committee as set forth in the Authorization for Foreign Currency Opera- 3. The Manager shall also consult with the tions and the Foreign Currency Directive, Subcommittee or the Chairman about prothe Federal Reserve Bank of New York, posed swap drawings by the System and through the Manager, System Open Market about any operations that are not of a routine Account ("Manager"), shall be guided by the character. following procedural understandings with respect to consultations and clearances with Among the organizational matters the Committee, the Foreign Currency Sub- raised, the Committee indicated that it committee, and the Chairman of the Com- intended to take up at a future meeting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

168 93rd Annual Report, 2006 the relationship between its formal vote ing Hurricanes Katrina and Rita. Several and the policy statement issued after sectors, including manufacturing and each meeting. several service groups, added vigorously The Manager of the System Open to payrolls in December, but the total for Market Account reported on recent de- the month was held down by employvelopments in foreign exchange mar- ment declines in a number of sectors, kets. There were no open market opera- such as retail trade and construction, tions in foreign currencies for the where seasonal adjustment can be diffi- System's account in the period since the cult this time of year. Aggregate hours previous meeting. The Manager also re- fell slightly in December owing to a ported on developments in domestic decrease in the workweek, but they rose financial markets and on System open over the fourth quarter as a whole. The market transactions in government secu- unemployment rate edged down to 4.9 rities and federal agency obligations percent in part due to the labor force during the period since the previous participation rate ticking down. meeting. By unanimous vote, the Com- Industrial production rose notably in mittee ratified these transactions. November and December, boosted by The information reviewed at this partial recovery from the effects of the meeting suggested that underlying hurricanes. Production in the mining growth in aggregate demand remained industry, which includes oil and gas exsolid, even though the expansion of real traction, increased sharply. Utilities out- GDP was estimated to have slowed in put also popped up in December as temthe fourth quarter. Household spending peratures turned unseasonably cold in rose smartly, outside of autos, and or- the first half of the month. Abstracting ders and shipments of nondefense capi- from the effects of these special factors, tal goods in the business sector were underlying activity in the industrial secgenerally quite strong. Housing markets tor advanced moderately. Modest proshowed some signs of cooling, but starts duction increases in most manufacturing and sales remained at high levels. Indus- categories in December, including hightrial production posted moderate gains, tech, consumer goods, and business even after excluding hurricane-related equipment, outweighed production derebounds in some production categories, clines in the motor vehicles and parts and private payrolls expanded at a firm sector. The capacity utilization rate in rate on average. Headline consumer in- manufacturing stood a bit above its level flation had been held down by falling of one year ago and near its long-run consumer energy prices; more recently, average. however, crude oil prices climbed back Real personal consumption expendiup to high levels. Meanwhile, core infla- tures appeared to have increased only tion had moved up a bit from low levels modestly in the fourth quarter, as spendseen last summer. ing on motor vehicles was restrained Labor demand expanded further in following a surge in the summer in the fourth quarter, as private nonfarm response to manufacturers' price incenpayrolls showed large gains in Novem- tives. Outside of motor vehicles, conber followed by more-modest gains in sumption was brisk, supported by job December. The average increase over growth, increases in personal income, those two months represented sturdy job and the decline in energy prices. Congains, even after accounting for the sumption was also likely supported by likely catch-up in employment follow- further gains in home values and equity Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 169 prices that raised the ratio of household structures remained well below recent wealth to disposable income relative to peaks. However, spending on drilling that seen earlier in 2005. Consumer sen- and mining structures continued to timent measured by surveys moved up increase strongly. Business investment in December and, judging by the pre- in real nonfarm inventories increased liminary reading of the Michigan Sur- moderately in the fourth quarter, boosted vey, edged up further in January. by a rapid accumulation of motor vehi- Activity in the housing market cle inventories. Outside of motor vehiappeared to continue at high levels, cles, stocks continued to rise slowly. although there were some indications of The restrained growth in inventories in slowing. Single-family housing starts recent months suggested that firms outdecreased markedly in December; how- side the motor vehicle sector were intenever, this decline may have been due in tionally keeping stockbuilding low; part to unusually cold and wet weather however, it could also have reflected an in some areas of the country. Multifam- unanticipated increase in sales or supply ily housing starts increased in Decem- interruptions following the hurricanes ber. Sales of new and existing homes last fall. That said, the level of stocks remained at elevated levels but slowed appeared reasonably well aligned with somewhat toward the end of the year. demand in most industries. Moreover, the stock of homes for sale After increasing further in October, increased to the upper end of ranges the U.S. international trade deficit narseen in recent years. Recent data on rowed somewhat in November. The remortgage applications and survey mea- duction in the deficit reflected a modest sures of homebuying attitudes also increase in exports and a similar-sized pointed to some cooling in the housing decrease in imports that owed impormarket. tantly to a decline in imports of oil. The Real outlays for equipment and soft- firm pace of third-quarter GDP growth ware appeared to have slowed signif- in foreign economies generally appeared icantly in the fourth quarter, as ex- to continue in the fourth quarter. penditures for transportation and Core consumer price inflation recommunications equipment reversed mained moderate over the second half some of their earlier sharp increases. of last year. Core prices had posted a With few exceptions, however, new or- string of very low increases last sumders appeared to be quite strong, and mer, held down in part by falling motor order backlogs increased for several vehicle prices. In recent months, ingoods in the transportation sector. creases in core prices had rebounded. Underlying fundamentals continued to The overall consumer price index edged support gains in capital spending as down further in December in response business sector output expanded, firms to substantial declines in its volatile remained flush with funds, and relative energy price components. However, surprice declines pushed down the user vey data pointed to large increases in cost of capital equipment. Anecdotal re- gasoline prices in January, which were ports and surveys also indicated that due to the backup in crude oil prices. businesses were optimistic about near- Preliminary survey measures of nearterm capital spending plans. Vacancy term inflation expectations for January rates for nonresidential properties had nonetheless ticked down, continudrifted lower as construction expendi- ing the reversal of a sharp increase after tures on commercial and manufacturing the hurricanes last fall, and longer-term Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

170 93rd Annual Report, 2006 inflation expectations had moved lower weighted foreign exchange value of the as well. Input prices increased some- dollar depreciated slightly over the what less in December, as upward pres- period. sure from previous energy price in- Domestic nonfinancial sector debt creases receded somewhat. Indeed, the appeared to have expanded at a someincrease in core intermediate producer what slower pace in the fourth quarter, prices over the year was estimated to be down from the rapid increase in the considerably lower than over the previ- third quarter. Household debt growth ous year. At its December meeting, the likely moderated amid hints of a down- Federal Open Market Committee de- shift in mortgage borrowing from its cided to increase the target level of the robust third-quarter pace and an outright federal funds rate 25 basis points, to decline in consumer credit, which owed 4VA percent. In its accompanying state- in part to increased charge-offs from ment, the Committee indicated that, October's spike in bankruptcy filings. despite elevated energy prices and Business sector debt slowed somewhat hurricane-related disruptions, the expan- in the fourth quarter, mainly reflecting a sion in economic activity appeared solid. runoff of commercial paper by multina- Core inflation had stayed relatively low tional firms that were reported to have in recent months, and longer-term infla- repatriated foreign earnings to take adtion expectations had remained con- vantage of a recently enacted tax provitained. Nevertheless, the Committee sion. M2 expanded at a somewhat faster noted that possible increases in resource pace in the fourth quarter than had been utilization as well as elevated energy predicted from historical relationships prices had the potential to add to infla- with income and opportunity costs. In tionary pressures. In these circum- part, the monetary aggregate was likely stances, the Committee believed that boosted by payments to hurricane vicsome further measured policy firming tims by the federal government and inwas likely to be needed to keep the risks surance companies. to the attainment of both sustainable The staff forecast prepared for this economic growth and price stability meeting suggested that, after slow roughly in balance. growth in the fourth quarter of 2005, Investors had largely anticipated the real GDP would expand at a fairly ro- Committee's interest rate decision at the bust pace over the first half of this year, December meeting and a change in the boosted in part by spending on recovery portions of the statement characterizing activities associated with the hurricanes. policy as accommodative. Accordingly, Thereafter, real GDP growth was the policy announcement elicited only expected to moderate, importantly remodest reactions in financial markets. flecting a reduced impetus to consump- With mixed readings on economic activ- tion from house price appreciation and ity and inflation over the intermeeting some slowing in residential housing experiod, the market's expectations for the penditures. Core PCE inflation was path of monetary policy and yields on expected to be a touch higher this year Treasury coupon securities ended the than in 2005, largely because of the period little changed, on balance. Yields pass-through of higher energy and nonon investment- and speculative-grade fuel import prices, but, with energy corporate debt moved largely in line prices leveling out, core inflation was with Treasury yields. Major stock price projected to drop back modestly in indexes rose modestly, and the trade- 2007. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 171 In their discussion of the economic 2007. Expectations for the rate of inflasituation and outlook, meeting partici- tion, as measured by the core PCE price pants noted the slowing in GDP growth index, were in a range of I3/* to in the fourth quarter of 2005, but be- 2x/2 percent this year, centered at about lieved that it probably owed in large part 2 percent, and in a range of l3/4 to to transitory factors and that economic 2 percent in 2007. growth would bounce back in the cur- In their discussion of major sectors of rent quarter. In that regard, several high the economy, meeting participants noted frequency indicators of production, that consumer spending in the latter labor markets, and private demand sug- months of 2005 had been buffeted by gested greater underlying strength of the effects of hurricanes, increased late than had been reflected in the most energy prices, and reduced auto sales recent GDP data. Over the next couple incentives. However, anecdotal reports of years, the economy seemed poised to contributed to a view that consumer expand at a moderate rate in the neigh- spending had been solid over the holiborhood of its sustainable pace. Most day season and in recent weeks, while participants expected core inflation to measures of consumer confidence move up slightly in the near term, re- remained high. Nevertheless, signs of flecting some pass-through of increased slowing in the housing sector had energy and other commodity prices. become more evident, and the boost to Although heightened inflation pressures construction from hurricane-related recould also arise from possible increases building now seemed likely to be spread in resource utilization, the outlook for over the next couple of years rather than economic growth and the stability of being more concentrated in the near inflation expectations suggested that term. In some areas, home price apprecore inflation should remain contained ciation reportedly had slowed noticeover time. ably, highlighting the risks to aggregate In preparation for the Federal Re- demand of a pullback in the housing serve's semiannual report to the Con- sector. For instance, the effects of a gress on the economy and monetary pol- leveling out of housing wealth on the icy, the members of the Board of saving rate were difficult to predict, but, Governors and the presidents of the Fed- in the view of some, potentially sizable. eral Reserve Banks submitted individual Rising debt service costs, owing in part projections of the growth of GDP, the to the repricing of variable-rate mortrate of unemployment, and core con- gages, were also mentioned as possibly sumer price inflation for the years 2006 restraining the discretionary spending of and 2007. The forecasts of the rate of consumers. The most likely outlook, expansion in real GDP for 2006 were in however, was for a gradual moderation a range of ?>lA to 4 percent, centered at in house price appreciation and in the 3V2 percent, while those for 2007 were growth of consumption, which would in a range of 3 to 4 percent, with a continue to be supported by increases in central tendency of 3 to 7>Vi percent. jobs and incomes. These rates of growth were associated Participants generally anticipated with projections of the civilian unem- fairly strong growth of capital expendiployment rate in a range of Al/i to tures. Though firms had been cautious 5 percent, with a central tendency of about expanding their plant and equip- 43/4 to 5 percent, in both the fourth ment, business confidence was high, caquarter of 2006 and the fourth quarter of pacity utilization was tightening, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

172 93rd Annual Report, 2006 companies were continuing to look for pace of growth in productivity would investment opportunities that increased importantly condition prospects for emproductivity. As a result, the outlook ployment and business cost pressures. was for reasonably robust spending on Participants noted that, while the capital equipment even if economic pass-through of higher energy and other growth slowed a bit. Anecdotal reports commodity prices to prices of core suggested that nonresidential real estate goods and services had remained submarkets were improving in some areas. dued, there were continuing upside risks The slowdown in government spend- to inflation from these sources. Whating in the fourth quarter was generally ever the size of such pass-through seen as reflecting shifts in the timing of effects, however, it was thought that they outlays, rather than a change in the would probably be temporary in nature underlying trend. However, fiscal stimu- and likely diminish as energy prices flatlus was expected to diminish somewhat tened out, as long as inflation expectaby next year. By contrast, global de- tions did not move higher. In that remand had picked up of late and would gard, participants were encouraged that, provide ongoing support for U.S. ex- despite recent energy price increases, ports; indeed, the sharp increases in survey measures of inflation expectacommodity prices and rallies in world tions had notched down and longer-term equity markets suggested the possibility inflation compensation in financial marof an even stronger path for demand kets was little changed. Although high abroad. profit margins could imply some exist- Financial market conditions in the ing pricing power, they might also pro- United States, as well as those abroad, vide a cushion to absorb some future suggested that investors were optimistic cost increases. Indeed, anecdotal reports about the economic outlook. The recent suggested that the ability of firms to strength in equity markets and the low pass through higher input costs generprevailing term premiums and bond ally remained limited. Nevertheless, the spreads perhaps reflected market assess- increased prices of energy and other ments that economic risks were lower commodities and the possibility of a than usual, as well as strong demands further rise in resource utilization, which for longer-term assets and an ample some members viewed as nearly full supply of liquidity. The possibility that at present, represented continuing term premiums and credit spreads could risks, potentially adding to inflation return to more typical settings rep- pressures. resented a downside risk for interest- In the Committee's discussion of sensitive components of aggregate monetary policy for the intermeeting demand. period, all members favored raising the A variety of indicators, along with target federal funds rate 25 basis points anecdotal reports, suggested that em- to 4V2 percent at this meeting. Although ployment was expanding at a fairly good recent economic data had been uneven, pace and labor compensation was rising the economy seemed to be expanding at moderately. Some participants remarked a solid pace. Members were concerned on the uncertainties regarding the extent that, even after their action today, posof remaining capacity in labor markets sible increases in resource utilization and the outlook for labor costs. In par- and elevated energy prices had the poticular, developments affecting the par- tential to add to inflation pressures. ticipation rate in the labor force and the Although the stance of policy seemed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 173 close to where it needed to be given the statement to be released shortly after the current outlook, some further policy meeting: firming might be needed to keep infla- The Committee judges that some further tion pressures contained and the risks to policy firming may be needed to keep the price stability and sustainable economic risks to the attainment of both sustainable growth roughly in balance. In the view economic growth and price stability roughly of some members, the possibility of in balance. In any event, the Committee will respond to changes in economic prospects as additional policy moves was reinforced needed to foster these objectives. by readings on core inflation and inflation expectations that were somewhat Votes for this action: Messrs. Greenspan and Geithner, Ms. Bies, higher than was desirable over the long Messrs. Ferguson, Guynn, Kohn, run. However, all members agreed that Lacker, and Olson, Mses. Pianalto and the future path for the funds rate would Yellen. Votes against this action: None. depend increasingly on economic devel- The confirmation of the date of the opments and could no longer be prenext meeting of the Committee was judged with the previous degree of postponed, pending the election of a confidence. successor Chairman. As this meeting marked Alan The meeting adjourned at 12:25 p.m. Greenspan's last as a member of the Committee, meeting participants took the opportunity individually and collec- Notation Vote tively to pay tribute to his many years of By notation vote completed on Decemoutstanding service to the Federal ber 30, 2005, the Committee unani- Reserve and to the nation. They exmously approved the minutes of the pressed their appreciation for his colle- Federal Open Market Committee meetgial and successful leadership of the ing held on December 13, 2005. Committee and of the Federal Reserve System and emphasized the privilege Vincent R. Reinhart and honor they felt in having served Secretary with him. At the conclusion of the discussion, Meeting Held on the Committee voted to authorize and March 27-28, 2006 direct the Federal Reserve Bank of New York, until it was instructed otherwise, A meeting of the Federal Open Market to execute transactions in the System Committee was held in the offices of the Account in accordance with the follow- Board of Governors of the Federal ing domestic policy directive: Reserve System in Washington, D.C., on Monday, March 27, 2006 at 3:00 The Federal Open Market Committee seeks monetary and financialc onditions that p.m. and continued on Tuesday, March will foster price stability and promote sus- 28, 2006 at 9:00 a.m. tainable growth in output. To further its longrun objectives, the Committee in the imme- Present: diate future seeks conditions in reserve Mr. Bernanke, Chairman markets consistent with increasing the fed- Mr. Geithner, Vice Chairman eral funds rate to an average of around Ms. Bies AVi percent. Mr. Guynn Mr. Kohn The vote encompassed approval of Mr. Kroszner the paragraph below for inclusion in the Mr. Lacker Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

174 93rd Annual Report, 2006 Mr. Olson Mr. Wright, Section Chief, Division Ms. Pianalto of Monetary Affairs, Board of Mr. Warsh Governors Ms. Yellen Mr. Perli, Senior Economist, Division Mses. Cumming and Minehan, Messrs. of Monetary Affairs, Board of Moskow, Poole, and Hoenig, Al- Governors ternate Members of the Federal Open Market Committee Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Messrs. Fisher and Stern, Presidents of Board of Governors the Federal Reserve Banks of Dallas and Minneapolis, respectively Ms. Low, Open Market Secretariat Specialist, Division of Monetary Mr. Stone, First Vice President, Federal Affairs, Board of Governors Reserve Bank of Philadelphia Mr. Reinhart, Secretary and Economist Mr. Connolly, First Vice President, Fed- Ms. Danker, Deputy Secretary eral Reserve Bank of Boston Ms. Smith, Assistant Secretary Messrs. Fuhrer and Rosenblum, Execu- Mr. Skidmore, Assistant Secretary tive Vice Presidents, Federal Mr. Alvarez, General Counsel Reserve Banks of Boston and Dal- Mr. Baxter, Deputy General Counsel las, respectively Ms. Johnson, Economist Mr. Stockton, Economist Messrs. Evans and Hakkio, Ms. Mester, Messrs. Connors, Eisenbeis, Kamin, and Messrs. Rasche, Rolnick, and Madigan, Sniderman, Struck- Rudebusch, Senior Vice Presimeyer, Tracy, Weinberg, and Wil- dents, Federal Reserve Banks of cox, Associate Economists Chicago, Kansas City, Philadelphia, St. Louis, Minneapolis, and Mr. Kos, Manager, System Open Mar- San Francisco, respectively ket Account Mr. Hambley,5 Assistant to the Board, Ms. Mosser, Vice President, Federal Office of Board Members, Board Reserve Bank of New York of Governors The Manager of the System Open Messrs. Oliner and Slifman, Associate Directors, Division of Research Market Account reported on recent deand Statistics, Board of Governors velopments in foreign exchange markets. There were no open market opera- Mr. Whitesell, Deputy Associate Director, Division of Monetary Affairs, tions in foreign currencies for the Board of Governors System's account in the period since the previous meeting. The Manager also re- Mr. English, Assistant Director, Division of Monetary Affairs, Board of ported on developments in domestic Governors financial markets and on System open Mr. Simpson, Senior Adviser, Division market transactions in government secuof Research and Statistics, Board rities and federal agency obligations of Governors during the period since the previous Mr. Orphanides, Adviser, Division meeting. By unanimous vote, the Comof Monetary Affairs, Board of mittee ratified these transactions. Governors The information reviewed at this Mr. Small, Project Manager, Division meeting suggested that economic activof Monetary Affairs, Board of ity was expanding strongly in the first Governors. quarter. Consumer spending was on 5. Attended Monday's session only. track to rise at a robust pace, and busi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 175 ness purchases of equipment and soft- increase in January. The rate of capacity ware picked up appreciably. Warm utilization in the manufacturing sector weather boosted housing construction in stood a bit above its long-run average. January and February, although sales of Consumer spending appeared to have new homes dropped back and house rebounded strongly in the first quarter. prices decelerated slightly. Private pay- Motor vehicle purchases bounced back rolls advanced solidly in the first two in late 2005 and early 2006 from the months of the year. Headline consumer sluggish pace that followed the end of price inflation jumped in January but the past summer's "employee pricing" moderated in February as energy prices programs. Excluding motor vehicles, moved down. Core inflation remained consumption spending was robust, supcontained. ported by continuing improvement in Labor demand continued to increase the labor market and advances in wage in the first two months of 2006, as pri- and salary income. The annual raise in vate nonfarm payroll employment the pay of federal employees, cost-ofshowed large gains in both January and living adjustments to Social Security February. With favorable weather condi- benefits and other transfer programs, tions, employment growth was espe- and the initiation of the Medicare Precially brisk in the construction sector. scription Drug Plan boosted the level of Financial activities, business services, personal disposable income in January. and nonbusiness services also posted Consumption was likely supported also solid payroll gains. Although the aver- by ongoing increases in home prices and age workweek edged down in February, gains in the stock market. Consumer the level of aggregate hours for produc- confidence as measured by surveys tion and nonsupervisory workers was remained consistent with moderate above its average for the fourth quarter increases in consumer spending. of 2005. The unemployment rate contin- Housing activity had moderated ued to decline and averaged 43A percent somewhat from the robust pace of the over the first two months of the year. past summer. Although the level of Several other labor market indicators single-family housing starts was unusualso signaled a further tightening of ally high in January and February, much labor market conditions. of this strength was likely the result of Industrial production picked up in mild winter weather; new permit issu- February after a modest decline in Janu- ance extended the downward trajectory ary. That pattern was attributable to that began in October. After an unusual swings in utilities output, as tempera- spike in January, multifamily housing tures were historically warm early in the starts dropped back in February to a rate year before reverting to near seasonal well within their historical range. Sales norms in February. Excluding utilities, of new homes fell in the first two industrial production posted a sizable months of the year, while sales of existgain in January before flattening out in ing homes turned up in February for the February, pointing to a solid rise in the first time since last August; both meafirst quarter. Mining output—which sures were well below their peaks of includes oil and natural gas extraction— mid-2005. The stock of homes for sale slipped in February after registering ro- was elevated compared with its range of bust gains in each of the previous three the last several years. Mortgage applicamonths. Manufacturing output was un- tions continued to decline in February, changed in February after a significant and survey measures of homebuying at- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

176 93rd Annual Report, 2006 titudes also maintained their recent Exports of industrial supplies, capital downward trend. Housing demand was goods, and agricultural products picked likely damped by rising mortgage rates, up robustly in January, while the which moved up further in late 2005 and increase in imports was widespread early 2006. House price appreciation across most product categories. Real appeared to have slowed from the rapid GDP growth in foreign industrial econopace of the summer, but price increases mies was mixed in the fourth quarter, as for both new and existing homes economic activity slowed in the euro remained well within the elevated range area and in Canada while the Japanese that has prevailed in recent years. economy expanded briskly and growth Real outlays for equipment and soft- in the United Kingdom firmed. Recent ware decelerated in the fourth quarter of indicators of economic activity in devel- 2005 but appeared to have gained oping economies were generally quite strength in early 2006. This pattern re- positive. flected sizable swings in outlays for Readings on core consumer price intransportation equipment. The fundaflation were favorable in recent months. mentals underlying capital spending Nonetheless, the overall consumer price continued to be supportive, as business index edged up in February after regissector output expanded briskly, firms tering a large increase in January that remained flush with funds, and relative was driven mostly by a spike in energy price declines for high-tech equipment prices. While prices of food and core continued to push down its user cost. items recorded only modest increases in Although vacancy rates for nonresiden- February, energy prices fell back amid tial properties were well below the peaks increases in oil inventories and unseareached in the first quarter of 2004, real sonably mild temperatures since the latspending on new construction had yet to ter part of December. Weekly data for gain traction. In contrast, outlays for March, however, indicated that gasoline drilling and mining structures continued prices rose sharply. Prices of capital to rise rapidly and appeared poised to equipment inched up in February after a increase farther in the near term. more substantial gain in January. Never- The book value of manufacturing and theless, prices of capital equipment detrade inventories excluding motor vehicelerated over the past twelve months. cles rose at a moderate pace in the fourth quarter of 2005, and inventories Higher energy prices still seemed to be appeared to have continued to build in passing through to the prices of a num- January. Much of the increase reflected ber of core intermediate materials, rising prices of goods held, and real although such increases were more modinventory accumulation was subdued. erate than those observed in the immedi- The inventory-sales ratio declined ate aftermath of the hurricanes last auslightly in January, extending its long- tumn. The increase in the employment run downward trend. Inventory stocks cost index in the fourth quarter of 2005 appeared to be well aligned with de- was relatively modest. Compensation mand in most industries. per hour in the nonfarm business sector, The U.S. international trade deficit after having increased substantially in rose in the fourth quarter and widened the third quarter, was estimated to have further in January, as gains in exports of risen somewhat less in the fourth quargoods and services were outweighed by ter. Preliminary survey measures of a substantially larger rise in imports. short-term inflation expectations in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 177 March edged up, but longer-term mea- Growth of domestic nonfinancial secsures remained steady. tor debt appeared to have moderated At its January meeting, the Federal only a bit in the first quarter from its Open Market Committee decided to robust pace in the fourth quarter of raise the target level of the federal funds 2005. Net issuance of corporate bonds rate 25 basis points, to 4Vi percent. In its and expansion of business loans at comaccompanying statement, the Commit- mercial banks had abated in February tee indicated that, although recent eco- and early March after robust growth in nomic data had been uneven, the expan- January; commercial paper outstanding sion in economic activity appeared solid. was about flat in the first quarter. House- Core inflation had stayed relatively low hold mortgage borrowing was thought in recent months, and longer-term infla- to have slowed somewhat in the first tion expectations had remained con- quarter in response to increased morttained. Nevertheless, the Committee gage interest rates. Consumer credit renoted that possible increases in resource bounded some in January after contractutilization as well as elevated energy ing in the fourth quarter because of prices had the potential to add to infla- elevated charge-offs related to the spike tion pressures. In these circumstances, in bankruptcy filings. Based on monthly the Committee judged that some further Treasury statements, federal debt policy firming may be needed to keep seemed likely to have accelerated in the the risks to the attainment of both sus- first quarter. On average, M2 grew tainable economic growth and price sta- briskly in January and February. While bility roughly in balance but reiterated liquid deposits expanded moderately, that it would respond to changes in eco- small time deposits and retail money nomic prospects as needed to foster its funds advanced strongly, supported by objectives. further increases in offering rates. Investors had largely anticipated both The staff forecast prepared for this the Committee's interest rate decision at meeting showed real GDP expanding the January meeting and the text of the briskly in the current quarter. Economic accompanying statement. Consequently, growth was expected to moderate later the policy announcement elicited little this year. The level of output in the market reaction. Policy expectations and current quarter was estimated to be close yields on Treasury coupon securities to the economy's potential and was ansubsequently firmed, on net, over the ticipated to remain so over the projecintermeeting period, as incoming data tion period. Core PCE inflation was indicated robust economic growth in the expected to move slightly higher in 2006 United States and strengthening expan- because of cost pressures induced by sion abroad. Yields on investment-grade high energy and import prices and to corporate debt rose roughly in line with step back down in 2007 as these cost those on comparable-maturity Treasury pressures were anticipated to abate. securities, while yields on speculative- In their discussion of the economic grade corporate debt were little changed. situation and outlook, meeting partici- Broad stock market indexes were mod- pants saw the economy as having reestly higher amid favorable economic bounded strongly from the slowdown in news and lower oil prices, and the trade- the fourth quarter of last year, with weighted foreign exchange value of the aggregate spending and employment dollar appreciated slightly over the expanding briskly in the current quarter. period. Growth was expected to moderate to a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

178 93 rd Annual Report, 2006 more sustainable pace later this year. Meeting participants discussed at The ongoing cooling in the housing mar- some length signs of cooling in the resiket would act to restrain residential con- dential real estate market. Published data struction and growth in consumption, on housing starts showed little evidence but business and household confidence of a significant weakening in construcand supportive financial conditions tion activity. However, anecdotal reports would help to foster growth in employ- from several markets, surveys of homement and incomes, keeping consump- buyer attitudes, and data on inventories, tion and investment on a solid upward home sales, and new home cancellation track. Several meeting participants ob- rates all pointed to a moderation in housserved that, although the economy's sus- ing activity. It was noted that the relatainable potential output could not be tively robust data on construction activobserved directly or estimated with pre- ity could owe in part to unseasonably cision, historical patterns and recent data warm weather. Going forward, particisuggested that current levels of labor pants expected a deceleration in house and product market resource utilization prices to contribute to an increase in the were in a zone consistent with little or household saving rate and to weigh on no remaining economic slack. The consumption growth. Aggregate demand recent behavior of core consumer prices was also expected to be restrained diseemed to indicate that any pass-through rectly by a softening in the pace of home of higher energy and other commodity building. Moreover, rebuilding followprices had been limited. In addition, pro- ing last year's major hurricanes ductivity growth, moderate increases in appeared to be proceeding at a slow compensation, contained inflation ex- pace, and so would provide only limited pectations, and international competi- offset to the implications of more fundation were helping to restrain unit labor mental developments in this market. costs and price pressures. Nonetheless, Generally, however, the economic meeting participants generally remained expansion appeared to be broad-based. concerned about the risk that possible Contacts indicated that certain sectors, increases in resource utilization, in com- such as energy and semiconductor probination with the elevated prices of duction, were particularly strong. energy and other commodities, could Against this backdrop, robust growth in add to inflation pressures. business spending was seen as likely, Regarding the major sectors of the even as household spending growth economy, meeting participants noted moderated somewhat. Business capital that consumer spending appeared to be expenditures, especially on equipment growing at a solid pace, notwithstanding and software, appeared to have considearlier rises in energy prices. Contacts in erable momentum, supported by strong the retail sector reported strong demand, corporate profits, exceptionally liquid and lending to households seemed to be balance sheets, and greater business oprobust. However, some automobile deal- timism. Some participants indicated that ers reported subdued demand for domes- nonresidential construction was in the tic name-plate products. In coming quar- process of picking up and commercial ters, consumer outlays were expected to vacancy rates were declining in some be supported by continued employment regions. gains, household income growth, and Financial market conditions remained relatively low long-term interest rates, supportive of growth, with long-term even if gains in housing wealth abated. rates relatively low, risk spreads in cor- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 179 porate debt markets narrow, and banks could weigh on both household and seeking lending opportunities. Merger business spending. and acquisition activity was strong and Several participants noted that the infusions of private equity continued at labor market had continued to a rapid pace, but the domestic market strengthen, with payrolls increasing at a for initial public offerings was reported solid pace. The labor market was now to be quite weak. Although rates on showing some signs of tightness, consisfixed-rate mortgages remained histori- tent with a relatively low jobless rate. cally low, some ratcheting up of rates on There were anecdotal reports of shortadjustable-rate mortgages was seen as a ages of skilled labor in a few sectors, factor weighing to some degree on the such as health care, technology, and housing market. More generally, the finance. Still, participants expressed uneffects on spending of the substantial certainty about how much slack increase in short- and intermediate-term remained. Pressures on unit labor costs rates since June 2004 had probably not appeared contained, despite rising health-care costs, amid continued robust yet been fully felt. productivity growth and still-moderate There were reports of increased conincreases in several comprehensive meastruction by state and local governsures of compensation growth. ments, which were benefiting from In their discussion of prices, particistrong tax collections. Federal defense pants indicated that data over the interexpenditures had leveled out. Foreign meeting period, including measures of economic growth appeared to have inflation expectations, suggested that strengthened of late, prompting some underlying inflation was not in the profinning of monetary policy by several cess of moving higher. Crude oil prices, foreign central banks. Nonetheless, though volatile, had not risen appreciaincreases in imports were expected to bly in recent months on balance, and a continue to outpace increases in exports flattening in energy prices was beginin coming quarters, trimming the rate of ning to damp headline inflation. In addiexpansion of domestic output. tion, core consumer inflation was flat or Meeting participants saw both upside even a bit lower by some measures. and downside risks to their outlook for Some meeting participants expressed expansion around the rate of growth of surprise at how little of the previous rise the economy's potential. In the housing in energy prices appeared to have passed market, for instance, some downshift through into core inflation measures. from the rapid price increases and strong However, with energy prices remaining activity of recent years seemed to be high, and prices of some other comunderway, but the magnitude of the modities continuing to rise, the risk of at adjustment and its effects on household least a temporary impact on core inflaspending were hard to predict. Some tion remained a concern. participants cited stronger growth Participants noted that there were as abroad and robust nonresidential invest- yet few signs that any tightness in prodment spending as potentially contribut- uct and labor markets was adding to ing more to activity than expected. It inflation pressures. To date, unit labor was also noted that an abrupt rise in costs were not placing pressure on inflalong-term interest rates, reflecting, for tion, and high profit margins left firms a example, a reversion of currently low considerable buffer to absorb cost interm premiums to more typical levels, creases. Moreover, actual and potential Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

180 93rd Annual Report, 2006 competition from abroad could be re- With regard to the Committee's straining cost and price pressures, announcement to be released after the though participants exchanged views on meeting, members expressed some difthe extent to which conditions in foreign ference in views about the appropriate markets might be constraining prices do- level of detail to include in the statemestically. However, participants ob- ment. In the end, they concurred that served that there was a risk that continu- the statement should note that economic ing increases in resource utilization growth had rebounded in the current could add to inflationary pressures. quarter but that it appeared likely to Some participants held that core infla- moderate to a more sustainable pace in tion and inflation expectations were al- coming quarters. Policymakers agreed ready toward the upper end of the range that the announcement should also that they viewed as consistent with price highlight the favorable outlook for inflastability, making them particularly vigi- tion and summarize their reasons for lant about upside risks to inflation, espe- that assessment, but that it should reitercially given how costly it might be to ate that possible increases in resource bring inflation expectations back down utilization, along with elevated levels of if they were to rise. commodity and energy prices, had the In the Committee's discussion of potential to add to inflation pressures. monetary policy for the intermeeting Changes in the sentence on the balance period, all members favored raising the of risks to the Committee's objectives target federal funds rate 25 basis points were discussed. Several members were to 43/4 percent at this meeting. The econ- concerned that market participants omy seemed to be on track to grow near might not fully appreciate the extent to a sustainable pace with core inflation which future policy action will depend remaining close to recent readings on incoming economic data, especially against a backdrop of financial condi- when an end to the tightening process tions embodying an expectation of some seems likely to be near. Some members tightening. Since the available indica- expressed concern that retention of the tors showed that the economy could well phrase "some further policy firming be producing in the neighborhood of its may be needed to keep the risks... sustainable potential and that aggregate roughly in balance" could be misdemand remained strong, keeping rates construed as suggesting that the Comunchanged would run an unacceptable mittee thought that several further risk of rising inflation. Most members tightening steps were likely to be necesthought that the end of the tightening sary. Nonetheless, all concurred that the process was likely to be near, and some current risk assessment could be expressed concerns about the dangers of retained at this meeting. tightening too much, given the lags in The Committee also discussed its exthe effects of policy. However, members perience with the two-day meeting. Paralso recognized that in current circum- ticipants agreed that the additional time stances, checking upside risks to infla- had facilitated their discussion of the tion was important to sustaining good economy, policy, and the wording of the economic performance. The need for announcement. It was agreed that, befurther policy firming would be deter- cause of scheduling conflicts, the next mined by the implications of incoming meeting of the Committee would be held information for future activity and on one day, Wednesday, May 10, 2006. inflation. After experience with that and perhaps Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 181 the subsequent meeting that is already mously approved the minutes of the scheduled for two days, a decision Federal Open Market Committee meetwould be taken about the general format ing held on January 31, 2006. of future meetings. Vincent R. Reinhart At the conclusion of the discussion, Secretary the Committee voted to authorize and direct the Federal Reserve Bank of New Meeting Held on York, until it was instructed otherwise, May 10, 2006 to execute transactions in the System Account in accordance with the follow- A meeting of the Federal Open Market ing domestic policy directive: Committee was held in the offices of the Board of Governors of the Federal The Federal Open Market Committee seeks monetary and financial conditions that Reserve System in Washington, D.C., will foster price stability and promote sus- on Wednesday, May 10, 2006 at 8:30 tainable growth in output. To further its long- a.m. run objectives, the Committee in the immediate future seeks conditions in reserve Present: markets consistent with increasing the fed- Mr. Bernanke, Chairman eral funds rate to an average of around Mr. Geithner, Vice Chairman 43A percent. Ms. Bies Mr. Guynn The vote encompassed approval of Mr. Kohn the paragraph below for inclusion in the Mr. Kroszner statement to be released shortly after the Mr. Lacker Mr. Olson meeting: Ms. Pianalto Mr. Warsh The Committee judges that some further Ms. Yellen policy firming may be needed to keep the risks to the attainment of both sustainable Mr. Hoenig, Ms. Minehan, and Messrs. economic growth and price stability roughly Moskow and Poole, Alternate in balance. In any event, the Committee will Members of the Federal Open respond to changes in economic prospects as Market Committee needed to foster these objectives. Messrs. Fisher and Stern, Presidents of Votes for this action: Messrs. Bernanke the Federal Reserve Banks of Daland Geithner, Ms. Bies, Messrs. Guynn, las and Minneapolis, respectively Kohn, Kroszner, Lacker, and Olson, Mr. Stone, First Vice President, Federal Ms. Pianalto, Mr. Warsh, and Ms. Yel- Reserve Bank of Philadelphia len. Vote against this action: None. Mr. Reinhart, Secretary and Economist The meeting adjourned at 12:15 p.m. Ms. Danker, Deputy Secretary Ms. Smith, Assistant Secretary Mr. Skidmore, Assistant Secretary Notation Vote Mr. Alvarez, General Counsel Ms. Johnson, Economist By notation vote completed on February Mr. Stockton, Economist 1, 2006, the Committee unanimously Messrs. Connors, Eisenbeis, Judd, Kaapproved the election of Ben S. Ber- min, Madigan, Sniderman, Strucknanke as Chairman of the Federal Open meyer, and Wilcox, Associate Market Committee. Economists By notation vote completed on Febru- Mr. Kos, Manager, System Open Marary 17, 2006, the Committee unani- ket Account Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

182 93rd Annual Report, 2006 Messrs. Oliner and Slifman, Associate System's account in the period since the Directors, Division of Research previous meeting. The Manager also reand Statistics, Board of Governors ported on developments in domestic Mr. Simpson, Senior Adviser, Division financial markets and on System open of Research and Statistics, Board market transactions in government secuof Governors rities and federal agency obligations Mr. Orphanides, Adviser, Division during the period since the previous of Monetary Affairs, Board of meeting. By unanimous vote, the Com- Governors mittee ratified these transactions. Mr. Small, Project Manager, Division With Mr. Lacker dissenting, the Comof Monetary Affairs, Board of mittee voted to extend for one year Governors beginning in mid-December 2006 the Mr. Wright, Section Chief, Division reciprocal currency ("swap") arrangeof Monetary Affairs, Board of ments with the Bank of Canada and the Governors Banco de Mexico. The arrangement with the Bank of Canada is in the Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, amount of $2 billion equivalent, and Board of Governors that with the Banco de Mexico is in the amount of $3 billion equivalent. Both Ms. Low, Open Market Secretariat Specialist, Division of Monetary arrangements are associated with the Affairs, Board of Governors Federal Reserve's participation in the North American Framework Agreement Mr. Werkema, First Vice President, of 1994. The vote to renew the System's Federal Reserve Bank of Chicago participation in the swap arrangements Messrs. Fuhrer and Rosenblum, Execumaturing in December was taken at this tive Vice Presidents, Federal meeting because of the provision that Reserve Banks of Boston and Dallas, respectively each party must provide six months prior notice of an intention to terminate Messrs. Evans and Hakkio, Ms. Mester, its participation. Mr. Lacker dissented and Mr. Rasche, Senior Vice Presidents, Federal Reserve Banks of because of his opposition, as indicated Chicago, Kansas City, Philadel- at the January meeting, to foreign phia, and St. Louis, respectively exchange market intervention by the Federal Reserve, which such swap Mr. Hilton, Vice President, Federal Reserve Bank of New York arrangements facilitate, and because of his opposition to direct lending to for- Mr. Potter, Assistant Vice President, eign central banks. Federal Reserve Bank of New York By unanimous vote, the Committee delegated the authority to review and Mr. Weber, Senior Research Officer, determine appeals of a denial of access Federal Reserve Bank of Minneto Committee records under FOIA and apolis other rules to the Board members desig- Mr. Hetzel, Senior Economist, Federal nated as the primary and alternate Ad- Reserve Bank of Richmond ministrative Governors for Freedom of The Manager of the System Open Information and Privacy Act Matters. Market Account reported on recent de- Also by unanimous vote, the Committee velopments in foreign exchange mar- established a FOIA Requester Service kets. There were no open market opera- Center and designated Carol R. Low to tions in foreign currencies for the fulfill the associated responsibilities. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 183 The information reviewed at this rate edged down to 4.7 percent in March meeting suggested that economic activ- and remained at that level in April. ity expanded strongly in the first quarter Industrial production in March exand that gains were widespread across panded at about the same strong pace as most categories of final sales. Consumer it did in February, with gains posted spending posted a sizable increase, across all major components of the indriven by January's bounceback in dex. Manufacturing activity picked up motor vehicle purchases and an accel- in March after a lull in February. While eration in spending on other goods at the manufacturing growth for the first quarturn of the year. In addition, favorable ter as a whole slowed from the rapid weather boosted housing construction pace of the fourth quarter, it exceeded early in the quarter. Later in the quarter, that of the previous year. Manufacturing however, the pace of consumer spending capacity utilization during the quarter was a bit above its long-run average. moderated, and housing starts retraced Mining output—which includes oil and their earlier run-up. Business investment natural gas extraction—strengthened in spending strengthened in the first quarthe first quarter as a whole. Within the ter, in part because of a surge in the quarter, however, the boost from purchases of transportation and highhurricane-related recovery seemed to tech equipment and a step-up in nonresiebb. While utility output surged in Febdential construction. Manufacturing proruary and moved up a bit more in duction also posted solid gains in the March, these increases only partly first quarter and payroll growth moderreversed the weather-related plunge in ated a bit in April after robust gains in January. employment in the first quarter. Overall consumer prices jumped in March be- Growth of consumer spending cause of higher energy prices, while appeared to moderate after posting sizable gains around the turn of the year. core prices rose a bit more rapidly than Excluding motor vehicles, real outlays in earlier months. rose temperately in March, boosted by Nonfarm payrolls increased by the continued rise in spending on ser- 138,000 jobs in April following robust vices. Spending on goods excluding growth in March. The gains in April motor vehicles posted a second-straight were widespread: Manufacturing and remonthly decline after robust gains over lated industries registered significant the previous four months. Sales of light increases, mining activity and employ- vehicles held steady in March and ment were boosted by rising energy picked up a bit in April, bringing the prices, construction hiring posted a mod- average pace for the year well above erate gain, and a range of services- that of the fourth quarter but about even producing industries strengthened, with with the rate of last year. Although conthe important exception of retail trade, tinued improvements in the labor marwhich more than reversed its March ket had been generating considerable gains. Average hours of production or gains in nominal wage and salary nonsupervisory workers on private non- income, rising gasoline prices held farm payrolls edged up in April. The down the increase in real disposable increases in the workweek and employ- personal income in March and were ment in April led to notable growth in expected to damp it in April as well. aggregate hours of production or nonsu- Ongoing increases in home prices and pervisory workers. The unemployment additional gains in the stock market, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

184 93rd Annual Report, 2006 however, further boosted household cles. Spending on high-tech equipment wealth during the first quarter. Measures and software also improved as excepof consumer confidence remained tionally strong growth in expenditures consistent with moderate increases in for communications equipment more consumer spending. than compensated for fairly soft spend- The underlying pace of residential ac- ing on computers and peripherals and on tivity seemed to moderate in the first software. Conditions in the nonresidenquarter. After unseasonably warm tial construction sector improved noticeweather allowed a high level of single- ably. Although spending on nonresidenfamily housing starts in January and tial building construction remained well February, starts fell in March to their short of the robust levels seen in late lowest level in a year. New permit issu- 2000, growth of expenditures in this ance for single-family homes also fell in sector was at its fastest pace in the first March, continuing its downward trend. quarter in nearly six years. Outlays on Multifamily starts recovered a bit in drilling and mining structures continued March from their low rate in February to climb in the first quarter, and availbut remained well within their historical able data pointed to ongoing growth. range. Home sales also declined, on net, Real nonfarm inventories stepped in recent months. Although sales of ex- down in the first quarter, largely reflectisting single-family homes edged up in ing a decline in investment in motor February and March, the level of sales vehicle inventories. Excluding motor for the first quarter as a whole was vehicles, inventories increased at a pace notably below the record high in the well above that in the fourth quarter. second quarter of last year. Sales of new Over the past twelve months, invenhomes also moved up in March, but tories relative to shipments and sales their average in the first quarter was had moved down moderately on baldown substantially from the peak in the ance, extending the long-run downward third quarter of last year. House price trend. appreciation appeared to have slowed The U.S. international trade deficit from the elevated rates seen over the narrowed in February as a sharp past summer. Growth in the average decrease in imports more than offset a sales price of existing homes in March, modest fall in exports. The declines in versus a year earlier, decelerated both categories were generally widesharply, and the average price for new spread across sectors with the exception homes in March fell compared to a year of oil imports, which were flat, and earlier. In addition, other indicators, imported services, which rose. Incomsuch as months' supply of both new and ing data for foreign industrial econoexisting homes for sale and the index of mies were generally favorable and pending home sales, supported the view pointed to continued expansion. Availthat housing markets had cooled in able data showed continued growth in recent months. GDP in the United Kingdom in the first Real outlays for equipment and soft- quarter, continuing strong domestic deware surged in the first quarter after a mand in Canada through February, onrelatively subdued performance in the going recovery in Japan, and a firstfourth quarter of last year. Much of the quarter rebound in euro-area economic growth reflected a sharp jump in busi- performance. ness purchases of transportation equip- Headline inflation turned up in ment, such as airplanes and motor vehi- March. Although the price of natural gas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 185 had fallen because of continued plenti- ongoing productivity gains had helped ful inventories, retail gasoline prices to hold the growth of unit labor costs in surged, leading to a jump in overall check, and inflation expectations had energy prices for the month. Prices of remained contained. Still, the Commitcore goods and services also rose more tee noted that possible increases in quickly in March, largely because of a resource utilization, in combination with spike in the apparel component that un- the elevated prices of energy and other wound a decline in February and a one- commodities, had the potential to add to time step-up in medical prices related to inflation pressures. In these circumchanges in Medicare reimbursement stances, the Committee judged that rules. During the twelve months ending some further policy firming may be in March, overall inflation rose at a needed to keep the risks to the attainslightly faster pace than that in the pre- ment of both sustainable economic ceding twelve-month period, while core growth and price stability roughly in prices for the same period increased a balance, but reiterated that in any event bit more slowly than in the previous the Committee would respond to year. Producer price inflation also changes in economic prospects as moved up in March, driven largely by needed to foster these objectives. higher food and energy prices. Readings Investors anticipated the FOMC's deon the growth in the cost of labor were cision at its March meeting to raise the mixed. Over the three months ending in target federal funds rate 25 basis points, March, the employment cost index for but the Committee's post-meeting statehourly compensation of private industry ment evidently led them to mark up workers rose at its slowest pace in sevsomewhat their expected path for the eral years. Data on compensation per federal funds rate. Subsequently, the hour in the nonfarm business sector, path was pushed up further by data rehowever, pointed toward notably faster leases that were, on balance, stronger growth in the first quarter. Some than market participants had expected. financial-market and survey indicators Speeches by Federal Reserve officials, suggested that inflation expectations, the minutes of the March meeting, and both for the upcoming year and for the Congressional testimony by the Chairlonger term, had moved up since the March meeting. man combined to restrain policy expec- At its March meeting, the Federal tations some. On net, the anticipated Open Market Committee decided to path of the federal funds rate over the raise its target for the federal funds rate next two years nonetheless rotated 25 basis points, to 43A percent. In its upward. Yields on inflation-indexed accompanying statement, the Commit- Treasury securities moved up over the tee indicated that the slowing of the intermeeting period, but yields on nomigrowth of real GDP in the fourth quarter nal Treasury issues rose more. Spreads of 2005 seemed largely to have reflected of yields on investment-grade bonds temporary or special factors. Economic over those on comparable-maturity growth had rebounded strongly in the Treasury securities were about unfirst quarter but seemed likely to moder- changed, while those on speculativeate to a more sustainable pace. As yet, grade bonds declined. Major stock price the run-up in the prices of energy and indexes were up a bit over the intermeetother commodities appeared to have had ing period, as positive first-quarter earnonly a modest effect on core inflation, ings reports more than offset the nega- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

186 93rd Annual Report, 2006 tive effects of higher energy prices and In their discussion of the economic rising interest rates. situation and outlook, meeting partici- The trade-weighted exchange value pants saw the economy as having reof the dollar against major foreign cur- bounded strongly so far this year after rencies fell since the March meeting. the slowing of growth in the fourth quar- Increased focus in public debate on the ter. The advance in output had been risks posed by the large U.S. external vigorous in the first quarter of this year, imbalance appeared to erode investor with real GDP increasing at around a support for the dollar. 5 percent annual rate. Although the Domestic nonfinancial sector debt expansion appeared likely to moderate, was estimated to have grown at a robust it evidently remained solid. Inflation pace in the first quarter, down only pressures appeared to be somewhat slightly from the brisk pace of 2005. greater than the Committee had antici- Business sector debt appeared to have pated at the time of its March meeting. expanded strongly, supported by signifi- Consumer prices recently had risen at a cant net issuance of U.S. corporate pace noticeably above the average rise bonds and double-digit growth of busi- over the previous twelve months. Also, ness loans at commercial banks. In the prices of energy and many other comhousehold sector, consumer credit con- modities had climbed sharply of late, tinued to rise slowly, and the growth of and inflation expectations appeared to household mortgage debt was thought, have risen slightly. If economic growth based on limited data, to have moder- continued to moderate over coming ated somewhat in the first quarter quarters, as anticipated, pressures on against a backdrop of higher mortgage productive resources would most likely interest rates and some signs of a decel- continue to be limited. Most participants eration in house prices. M2 advanced at expected that, after allowing for some a pace somewhat below that of nominal possible near-term volatility related to GDP in the first quarter and was esti- the recent jump in energy and other mated to have expanded moderately in commodity prices, core inflation would April. probably remain around the levels expe- The staff forecast prepared for this rienced on average over the past year. meeting showed real GDP growth mod- However, recent developments sugerating somewhat from the average pace gested that upside risks to inflation had of the previous several quarters. The risen somewhat since the time of the projected deceleration of real GDP re- March meeting. flected the lagged effects of the tighten- In their discussion of major sectors of ing of monetary policy, the waning im- the economy, some participants noted petus from increases in household that growth of household spending was wealth, and reduced stimulus from fiscal likely to slow over the remainder of the policy. While higher energy prices were year. Anecdotal information pointed to expected to boost inflation in the near some cooling of housing markets. That term, structural productivity was strong, cooling was especially noticeable for and the influence of higher energy and high-end homes and for houses in marmaterial costs was thought likely to kets that previously had experienced the moderate. Thus, consumer prices, after steepest appreciation. Data on home increasing at a faster rate in the first half sales, permits, and starts on the whole of the year, were expected to decelerate likewise suggested that activity was later this year and next year. gradually diminishing. Some reports Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 187 indicated that speculative building of the state level. While the precise reasons homes had dropped off considerably, but for the increase in federal receipts were inventories of unsold homes still seemed not entirely clear, robust income growth to be expanding. Although fresh com- was probably an important factor. In any prehensive data were not available, case, the effect was to trim the current home prices on average appeared still to federal budget deficit noticeably. Nonebe rising, but at a slower pace than over theless, the longer-run federal fiscal imthe past few years. Going forward, balance remained a serious concern. growth in consumption spending was Data on economic growth outside the likely to be supported by gains in em- United States indicated that the global ployment and personal income. But expansion was firming, a sense amplislower appreciation of home prices and fied by reports from international conthe effects of the increases in energy tacts. The apparent strengthening of gloprices and interest rates that had already bal growth was likely to support U.S. occurred would likely act to restrain exports and economic activity and consumption spending somewhat. Cer- would also tend to maintain upward tain features of recently popular nontra- pressures on energy and commodity ditional mortgage products had the po- prices. tential to cause financial difficulties for Meeting participants expressed some some households and erode mortgage concern about recent price developloan performance for some lenders. ments and their implications for infla- Nonetheless, the household sector tion prospects. Core consumer inflation seemed likely to remain in sound finan- lately had been a little higher than cial condition overall. On balance, con- expected. Moreover, energy prices had sumption spending was viewed as most risen steeply in the period since the likely to expand at a moderate pace in March meeting, and, although passcoming quarters. through apparently had been limited to Several participants remarked that date, the most recent increases might be business investment spending was ro- reflected to a greater degree in core bust. Nonresidential construction was inflation in coming months. Participants accelerating notably, in the process ab- noted that prices of non-energy comsorbing some of the resources that were modities, such as industrial metals and being diverted from housing. Office va- building supplies, also had been climbcancy rates were declining, spurring ing. The recent decline in the dollar was construction of new office buildings. another factor that could add to inflation Drilling and mining activity was said to pressures, although the effect of prior be particularly strong, propelled by the changes in the foreign exchange value high levels of energy prices. Investment of the dollar on core consumer prices in equipment and software appeared to had apparently been limited. Business be expanding at a solid rate. Capital contacts had reported continued shortformation was likely to continue to be ages of certain types of skilled labor and supported by rising output, strong bal- related wage pressures in some occupaance sheets in the business sector, and tions, which would tend to boost costs. ready availability of financing on attrac- However, participants also cited some tive terms. factors that could be expected to restrain Some participants commented on the inflation. Although alternative measures recent surge in federal tax revenues, a of labor compensation provided diverdevelopment that was being mirrored at gent readings, growth of total compen- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

188 93rd Annual Report, 2006 sation on balance appeared to remain what they viewed as an acceptable moderate. And, even if nominal wages range. Moreover, a number of factors should accelerate somewhat, relatively were augmenting the upside risks to inwide profit margins could buffer the flation: the surge in energy and comeffect on prices of final goods and ser- modity prices, some recent weakness in vices. While firms would seek to main- the foreign exchange value of the dollar, tain those margins, recent experience and the possibility that the apparent suggested that this might be accom- increase in inflation expectations could, plished in part through further produc- if it persisted, impart momentum to intivity gains, which had remained fairly flation. In addition, the economy strong on balance in recent quarters, appeared to be operating at a relatively rather than through more rapid price high level of resource utilization and hikes. had been growing quite strongly, and Participants discussed in some detail whether economic growth would moderinflation expectations—a potentially im- ate to a sustainable pace was not yet portant factor influencing future infla- clear. At the same time, members also tion trends. Some surveys suggested that saw downside risks to economic activinflation expectations had risen in recent ity. For example, the cumulative effect weeks, but others implied that expecta- of past monetary policy actions and the tions were little changed. Measures of recent rise in longer-term interest rates inflation compensation based on the dif- on housing activity and prices could ference between yields on nominal Trea- turn out to be larger than expected. Still, sury securities and inflation-indexed it seemed most likely that, with modest issues had edged higher. It was possible, further policy action, including a though, that investors' uncertainty re- 25 basis point firming today, growth in garding inflation prospects, not just in- activity would moderate gradually over flation expectations themselves, had coming quarters, pressures on resources risen. On balance, participants judged would remain limited, and core inflation that inflation expectations had risen would stay close to levels experienced somewhat—a development that would over the past year. have to be taken into account in policy- Given the risks to growth and inflamaking and warranted close mon- tion, Committee members were unceritoring—but remained contained. tain about how much, if any, further Although the Committee discussed tightening would be needed after topolicy approaches ranging from leaving day's action. In view of the risk that the the stance of policy unchanged at this outlook for inflation could worsen, the meeting to increasing the federal funds Committee decided to repeat the indicarate 50 basis points, all members be- tion in the policy statement released lieved that an additional 25 basis point after the March meeting that some furfirming of policy was appropriate today ther policy firming could be required. to keep inflation from rising and pro- However, the Committee agreed to emmote sustainable economic expansion. phasize that "the extent and timing of Recent price developments argued for any such firming will depend imporanother firming step at today's meeting. tantly on the evolution of the economic Core inflation recently had been a bit outlook as implied by incoming inforhigher than had been expected, and sev- mation." Members debated the approprieral members remarked that core infla- ate characterization of inflation expectation was now around the upper end of tions in the statement. Low and stable Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 189 inflation expectations were key to the Bernanke had appointed a subcommitattainment of the Committee's dual ob- tee on communications issues to be jectives of price stability and maximum chaired by Governor Kohn and includsustainable economic growth. However, ing Presidents Stern and Yellen. At the apparent pickup in longer-term ex- today's meeting, Governor Kohn indipectations, while worrisome, was rela- cated that the objective of the subcomtively small. They remained within the mittee was to help the Committee frame range seen over the past couple of years, and organize discussion of a broad range and the increase could well reverse be- of such issues over coming meetings. fore long. Accordingly, it appeared ap- The meeting adjourned at 1:10 p.m. propriate to characterize inflation expectations again as "contained." Notation Vote At the conclusion of the discussion, By notation vote completed on April 17, the Committee voted to authorize and 2006, the Committee unanimously apdirect the Federal Reserve Bank of New proved the minutes of the Federal Open York, until it was instructed otherwise, Market Committee meeting held on to execute transactions in the System March 27-28, 2006. Account in accordance with the following domestic policy directive: Vincent R. Reinhart Secretary The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sus- Meeting Held on tainable growth in output. To further its long- June 28-29, 2006 run objectives, the Committee in the immediate future seeks conditions in reserve A meeting of the Federal Open Market markets consistent with increasing the fed- Committee was held in the offices of the eral funds rate to an average of around Board of Governors of the Federal 5 percent. Reserve System in Washington, D.C., The vote encompassed approval of on Wednesday, June 28, 2006 at 2:00 the paragraph below for inclusion in the p.m. and continued on Thursday, June statement to be released shortly after the 29, 2006 at 9:00 a.m. meeting: Present: The Committee judges that some further Mr. Bernanke, Chairman policy firming may yet be needed to address Mr. Geithner, Vice Chairman inflation risks but emphasizes that the extent Ms. Bies and timing of any such firming will depend Mr. Guynn importantly on the evolution of the eco- Mr. Kohn nomic outlook as implied by incoming infor- Mr. Kroszner mation. In any event, the Committee will Mr. Lacker respond to changes in economic prospects as Ms. Pianalto needed to support the attainment of its Mr. Warsh objectives. Ms. Yellen Votes for this action: Messrs. Bernanke Ms. Minehan, Messrs. Moskow, Poole, and Geithner, Ms. Bies, Messrs. Guynn, and Hoenig, Alternate Members of Kohn, Kroszner, Lacker, and Olson, the Federal Open Market Commit- Ms. Pianalto, Mr. Warsh, and Ms. Yeltee len. Votes against this action: None. Messrs. Fisher and Stern, Presidents of During the interval between the the Federal Reserve Banks of Dal- March and May meetings, Chairman las and Minneapolis, respectively Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

190 93rd Annual Report, 2006 Mr. Stone, First Vice President, Federal Division of Monetary Affairs, Reserve Bank of Philadelphia Board of Governors Mr. Reinhart, Secretary and Economist Ms. Low, Open Market Secretariat Spe- Ms. Danker, Deputy Secretary cialist, Division of Monetary Ms. Smith, Assistant Secretary Affairs, Board of Governors Mr. Skidmore, Assistant Secretary Mr. Moore, First Vice President, Fed- Mr. Baxter, Deputy General Counsel Ms. Johnson, Economist eral Reserve Bank of Cleveland Mr. Stockton, Economist Messrs. Fuhrer and Rosenblum, Execu- Messrs. Connors, Eisenbeis, Judd, Ka- tive Vice Presidents, Federal min, Madigan, Sniderman, Struck- Reserve Banks of Boston and Dalmeyer, Tracy, Weinberg, and Wil- las, respectively cox, Associate Economists Mr. Evans, Ms. Mester, and Messrs. Mr. Kos, Manager, System Open Mar- Rasche, Rolnick, and Sellon, ket Account Senior Vice Presidents, Federal Reserve Banks of Chicago, Phila- Messrs. Oliner and Slifman, Associate delphia, St. Louis, Minneapolis, Directors, Division of Research and Kansas City, respectively and Statistics, Board of Governors Ms. Mucciolo, Vice President, Federal Ms. Zickler, Deputy Associate Director, Reserve Bank of New York Division of Research and Statistics, Board of Governors By unanimous vote, the Committee approved a "Report and Plan of the Mr. English, Assistant Director, Division of Monetary Affairs, Board of Federal Open Market Committee to Governors Improve FOIA Operations" and ap- Messrs. Dale6 and Simpson, Senior Ad- proved a delegation of authority to the visers, Divisions of Monetary Chairman (or his designee) to take Affairs and Research and actions required under the Freedom of Statistics, respectively, Board of Information Act. Governors The Manager of the System Open Mr. Gross, Special Assistant to the Market Account reported on recent de- Board, Office of Board Members, velopments in foreign exchange mar- Board of Governors kets. There were no open market opera- Mr. Small, Project Manager, Division tions in foreign currencies for the of Monetary Affairs, Board of System's account in the period since the Governors previous meeting. The Manager also re- Mr. Nelson, Section Chief, Division ported on developments in domestic of Monetary Affairs, Board of financial markets and on System open Governors market transactions in government secu- Mr. Perli, Senior Economist, Division rities and federal agency obligations of Monetary Affairs, Board of during the period since the previous Governor meeting. By unanimous vote, the Com- Mr. Doyle and Ms. Judson, Economists, mittee ratified these transactions. Divisions of International Finance The information reviewed at the June and Monetary Affairs, respectively, meeting suggested that the growth of Board of Governors economic activity in the second quarter Mr. Luecke, Senior Financial Analyst, slowed substantially from its rapid firstquarter pace. The expansion of con- 6. Attended Thursday's session only. sumer spending softened, and activity in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 191 the housing market continued to cool. In Real consumer spending appeared to contrast, the underlying rate of business be on track to decelerate noticeably in spending remained strong and was well the current quarter after posting robust supported by fundamentals. The demand growth in the first quarter. The slowing for labor appeared to moderate as hiring reflected both a marked reduction in the stepped down in recent months. Con- growth in real outlays for motor vehisumer price inflation remained elevated cles from an elevated first-quarter pace in April and May, reflecting sharp rises and a moderation in the advance of real in energy prices and more rapid in- expenditures for other goods in recent creases in core prices. months. Underlying this slowing in the expansion of consumer expenditures Gains in nonfarm private payrolls was a moderation in the fundamental averaged 112,000 over the three months determinants of spending. The level of ending in May, a pace considerably benominal wages and salaries beginning in low the average of about 170,000 jobs the fourth quarter of 2005 was revised per month for the prior three-month down considerably, and rising consumer period. The slowing in hiring was most prices held down the gains in real dispronounced in retail trade but was also posable income. Higher interest rates evident in construction and information also likely restrained spending. Noneservices. Establishments in professional theless, despite recent declines in equity and business services, nonbusiness serprices, the wealth-to-income ratio vices, and wholesale trade continued to remained well above its historical averadd jobs at roughly the same pace as age, and consumer sentiment, which earlier in the year. Average hours of dipped in May, rebounded some in early production or nonsupervisory workers June. on private nonfarm payrolls edged up in Residential construction activity mod- April but reversed these gains in May. erated over the past few months but The unemployment rate was 4.6 percent remained at a historically high level. in May, near its average for the year so Single-family starts posted a sizable far. drop in May for the third consecutive Industrial production edged down in month. Although a substantial portion of May after strong growth in April, May's decline seemed to be a partial largely reflecting the patterns of manupayback for the elevated level of starts facturing output. For the year to date, early in the year, when weather condimanufacturing production advanced at a tions had been favorable, the underlying rate significantly below its rapid fourth- pace of single-family housing construcquarter growth rate but only a bit below tion appeared to have slowed. In the its average pace of expansion since mid- multifamily sector, starts in May were 2003. The mining sector, which includes well within the typical range seen since oil and natural gas extraction, expanded 1995. Sales of both new and existing solidly in April before falling back in single-family homes in April and May May. Utilities output also grew strongly were significantly below their peaks of in April but retreated in May as tempera- the summer of 2005, though new home tures returned to normal after having sales continued to regain some ground been unseasonably warm in April. Ca- after having fallen in February. The pacity utilization in manufacturing most reliable measures of house prices remained somewhat above its long-run indicated modest growth following the average in both April and May. rapid increases seen last year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

192 93rd Annual Report, 2006 After a first-quarter surge, real spend- withstanding sharp declines in equity ing on equipment and software appeared indexes in these countries. on track for a much smaller gain in the Headline inflation picked up in April second quarter. Incoming data for the and May, driven partly by sharp current quarter suggested that spending increases in the prices of petroleumon transportation equipment reversed based products. In contrast, natural gas the run-up that occurred in the first quar- prices continued to decline in response ter. Spending on high-tech equipment to excess supply, fully reversing last and software advanced at a slower pace autumn's rises. Higher oil prices showed in the second quarter as a flattening out through to producer prices for a variety of spending on communications equip- of energy-intensive intermediate goods. ment after a huge increase in the first Consumer food prices decelerated markquarter offset some pickup in business- edly since January, reflecting slower sector demand for computers and soft- price increases for food away from ware. The construction of nonresidential home and declines, on balance, in the buildings picked up noticeably so far prices of fruits and vegetables. Core this year, although activity remained price inflation rose less than headline well short of its previous peak in mid- inflation in April and May but above its 2000. Outlays on drilling and mining pace earlier in the year. Core prices structures continued to climb in re- were boosted in part by an acceleration sponse to high projected energy prices. in shelter costs, especially those im- The book value of manufacturing and puted for owner-occupied residences. trade inventories excluding motor vehi- Readings on the growth of labor costs cles stepped up in April. The ratio of were revised down for the fourth quarter book-value inventories to sales held of 2005 and first quarter of 2006, but steady for the year so far after having recent data suggested a pickup in the fallen considerably last year. In general, second quarter. A number of indicators inventories appeared to be well aligned of inflation expectations largely rewith demand, and business surveys sug- versed increases recorded in the spring. gested that firms were comfortable with At its May meeting, the Federal Open the level of inventories. Market Committee (FOMC) decided to The U.S. international trade deficit raise its target for the federal funds rate widened in April, reflecting a large 25 basis points, to 5 percent. The Comincrease in imports coupled with a slight mittee's accompanying statement indidecline in exports. Import growth was cated that economic growth had been led by sharp rises in the value of im- quite strong so far this year. The Comported oil and natural gas and increased mittee saw growth as likely to moderate imports of automotive products and to a more sustainable pace, partly recapital goods. Exports were restrained flecting a gradual cooling of the housing in part by a decline in aircraft exports. market and the lagged effects of Expansion of economic activity in the increases in interest rates and energy foreign industrial countries was solid in prices. At that time, the run-up in the the first quarter, but indications for the prices of energy and other commodities second quarter were more mixed. In- appeared to have had only a modest coming data pointed to a possible slow- effect on core inflation. Ongoing proing in Canada, but signs of further ductivity gains had helped to hold the expansion in the euro area and of contin- growth of unit labor costs in check, and ued growth in Japan were evident, not- inflation expectations remained con- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 193 tained. Still, possible increases in that were interpreted by market particiresource utilization and the elevated pants as suggesting a higher likelihood prices of energy and other commodities of policy tightening at the June FOMC had the potential to add to inflation pres- meeting. Prices of precious and indussures. In these circumstances, the Com- trial metals, which had risen sharply mittee foresaw the possibility of a need since early March, particularly in May, for some further policy firming to ad- reversed those gains later in the interdress inflation risks but emphasized that meeting period. the extent and timing of any such firm- Debt of the domestic nonfinancial ing would depend importantly on the sectors was estimated to have decelerevolution of the economic outlook as ated in the second quarter after a robust implied by incoming information. first-quarter increase. Business sector Investors anticipated the FOMC's de- debt advanced more slowly in the seccision at its May meeting to raise the ond quarter, although the expansion of federal funds rate target 25 basis points, business loans remained brisk and net but near-term policy expectations edged issuance of corporate bonds was solid. up, apparently in response to the accom- In the household sector, mortgage borpanying statement. Subsequent data re- rowing slowed in response to more subleases reporting higher-than-expected dued housing activity and moderating inflation, the release of the FOMC min- house-price appreciation. M2 growth in utes, and speeches by Federal Reserve the second quarter was tepid, as the policymakers all led investors to push growth of nominal income had apparup their expectations for the future path ently softened and rising opportunity of the federal funds rate. Yields on near- cost continued to dampen demand for term nominal Treasury securities rose in money. line with policy expectations over the The staff forecast prepared for this intermeeting period, but those on longer- meeting indicated that, after the signifidated securities moved up by smaller cant deceleration of real GDP in the amounts. Yields on inflation-indexed current quarter from the first quarter of Treasury securities increased by more 2006, growth would proceed through than those on nominal securities, and the the end of 2007 at a pace a bit below the resulting decline in inflation compensa- rate of growth of the economy's potention retraced a substantial share of the tial. The outlook for modest growth of rise that had occurred over the precedreal GDP reflected a slowdown in the ing intermeeting period. Major stock housing market, the effects of past polprice indexes fell sharply over the icy tightening, and a diminished boost to period. Spreads of yields on corporate consumer spending from increases in bonds over those on comparablehousehold wealth. Core consumer price maturity Treasury securities widened inflation was projected to have stepped somewhat, while those on speculativeup in the second quarter from its avergrade issues rose by more. age pace over the preceding several After changing little on balance dur- quarters but to then drop back someing much of May, the dollar's foreign what, albeit to a level higher than previexchange value against other major cur- ously forecasted, as energy and import rencies moved up in June and showed a prices flatten out and some slack modest increase, on net, over the inter- emerges in labor and product markets. meeting period. The dollar appreciated In their discussion of the economic after comments by FOMC policymakers situation and outlook, meeting partici- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

194 93rd Annual Report, 2006 pants saw economic growth as having growth were associated with a civilian moderated in the second quarter from its unemployment rate in a range of 4Vi to robust pace in the first quarter, reflecting 5 percent in the fourth quarter of this a cooling of the housing market and the year and 4lA to 5XA percent in the fourth lagged effects of increases in interest quarter of 2007, with a central tendency rates and energy prices. Most partici- at both horizons of 43A to 5 percent. pants expected output to advance over Forecasts of the rate of inflation, as the next year and a half at a pace close measured by the change in the average to that which the economy can sustain fourth-quarter core PCE price index over time. All participants found the from a year earlier, ranged from 2lA to elevated readings on core inflation of 3 percent for this year, with a central recent months to be of concern and, if tendency of 2x/4 to 2Vi percent, and the sustained, inconsistent with the mainte- range and central tendency were 2 to nance of price stability. However, con- 2lA percent for next year. tained inflation expectations, the abate- In their discussion of the major secment of upward pressure from past tors of the economy, participants obincreases in energy and other commod- served that housing construction activity ity prices, and the slowing in the growth had declined notably in recent months of economic activity that was under way as indicated by lower housing starts and were expected to contribute to a modera- permits; moreover, higher inventories of tion in core inflation in coming quarters. unsold homes, a sharp rise in cancella- Nonetheless, participants noted a risk tions of new home sales, and reports that the drop-back in inflation could be from construction companies suggested slower or more limited than the Com- that the weakness was likely to be mittee would find desirable since extended. Several participants pointed resource utilization was currently tight out that the decline was broadly in line and the pickup in price increases had with expectations in light of the tightenbeen broadly based rather than being ing in monetary policy and the rapid limited to a few specific sectors that run-up in home prices and residential could be linked to energy costs. construction in recent years. Participants In preparation for the Federal Re- also observed that the evidence to date serve's semiannual report to the Con- indicated that the slowdown was orderly gress on monetary policy, the members but were mindful of the possibility of a of the Board of Governors and the presi- sharper downturn in the sector. dents of the Reserve Banks submitted The growth of consumer spending individual projections of the growth of had dropped off significantly in the sec- GDP, the rate of unemployment, and ond quarter from a robust pace earlier in core consumer price inflation for 2006 the year. The slowdown was attributed and 2007, conditioned on the partici- in part to higher energy prices and also pants' views of the appropriate path for to a likely downshift in home price monetary policy. The forecasts of the appreciation and higher interest rates. A rate of fourth-quarter to fourth-quarter reduction in the attractiveness of home expansion in real GDP for 2006 were in equity borrowing was mentioned as posa range of 3 to 33A percent, with a sibly contributing to the slowdown. central tendency of 3V4 to 3V2 percent, Some retailers, especially those catering and those for 2007 were in a range of to lower- and middle-income customers, 2Vi to 3Vi percent, with a central ten- reported weaker growth in sales. Condency of 3 to 3V4 percent. These rates of sumer spending was expected to ad- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 195 vance modestly in coming quarters as had perhaps contributed to a reassessthe effects of more moderate gains in ment of risks by investors globally. Dehome prices and a gradual rebound in spite the tighter policy, however, ecothe household saving rate from recent nomic growth in the United States' historically low levels were offset by major trading partners appeared likely further gains in employment and growth to remain solid, supporting U.S. exports. in labor income. A few participants Participants also discussed the role of noted that the surge in federal tax global capacity utilization in the inflareceipts this year and a similar advance tion process. in revenue at the state level could be a All meeting participants expressed sign of vigorous gains in income, concern about recent elevated readings indicating that household spending may on core inflation. A key issue was the expand more rapidly than many were extent to which this spring's increase in anticipating. inflation reflected transitory or persis- Participants interpreted the incoming tent influences. Many noted that a numdata on orders and shipments of durable ber of factors were temporarily boosting goods, positive readings on business inflation. The pass-through of the subsentiment, and continued high levels of stantial rise in energy prices could corporate profitability as suggesting that account for a considerable part of the business investment would remain a step-up in core inflation in recent quarsource of strength going forward. In a ters. In addition, rising rents had been shift from the pattern observed in the boosting the cost of shelter and so conpast few years, some contacts suggested tributing to the increase in core inflathat businesses were now directing their tion. However, energy prices were capital expenditures toward expanding expected to level out, and rents, while capacity rather than increasing effi- difficult to forecast, were viewed by ciency, a signal of the anticipation of some participants as likely to decelerate continued solid growth in demand. Busi- in coming quarters. The moderation in ness expenditures on nonresidential the economic expansion was expected structures also were seen to be advanc- to prevent pressures on resource utilizaing robustly in a number of markets, tion from intensifying. In sum, with inpossibly providing some offset to re- flation expectations contained and unit duced residential construction activity. labor costs held down by ongoing gains Several participants observed that the in productivity and modest advances in continued ready availability of credit compensation, inflation was seen by would support business expenditures. most participants as likely to edge down. Others, however, noted that the pullback Nevertheless, several factors were from risk-taking that had been observed cited as potentially sustaining upward in some financial markets over the pre- pressure on inflation, and the range of ceding few months could intensify, rais- participants' forecasts for core inflation ing the cost of funds. in 2007 rose by lA percentage point Participants observed that many for- relative to the range of forecasts made in eign central banks had tightened mone- February. Some participants noted that tary policy over the intermeeting period businesses in their Districts were experiin response to strengthening activity and encing difficulty hiring certain types of indications of inflation pressures. skilled workers, suggesting that in- Greater uncertainty about inflation pres- creased wage pressures might emerge. sures and the needed policy response In addition, some business contacts indi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

196 93rd Annual Report, 2006 cated a greater ability to pass higher would likely influence the future path of costs on to customers, although other policy. In light of the possibility that the businesses continued to report that their lessening of inflation pressures could be pricing power remained limited. The more limited than consistent with susrelatively taut resource markets and the tained good performance of the econlagged effects of the increase in energy omy, members agreed to indicate that prices raised the possibility that infla- "[ajlthough the moderation in the tion could continue at somewhat el- growth of aggregate demand should help evated levels for some time. Higher lev- to limit inflation pressures over time .. . els of inflation, should they persist, some inflation risks remain." Neverthecould become embedded in inflation ex- less, with the economy slowing and pectations. In that vein, several partici- some of the effects of past tightening pants noted that inflation expectations still in the pipeline, members recognized had been sensitive to incoming data and the value of accumulating more inforto communications regarding monetary mation for determining what, if any, policy over the intermeeting period. additional policy action would be All Committee members agreed that needed following the tightening adopted raising the target for the federal funds at the current meeting. To indicate that rate 25 basis points, to 5V4 percent, at policy action at future meetings was not this meeting was appropriate given the foreordained and would depend on the recent readings on inflation and the as- forecasts for inflation and activity in the sociated deterioration in the inflation medium term, the Committee agreed to outlook. Such an action would also help state that "[t]he extent and timing of any preserve the decline in inflation expecta- additional firming that may be needed to tions that had occurred over the inter- address these risks will depend on the meeting period and which appeared to evolution of the outlook for both inflabe conditioned on an outlook for a pol- tion and economic growth, as implied icy firming. Characterizing the resulting by incoming information." stance of policy was quite difficult in the After consulting with the participants, view of most members; those who did the communications subcommittee recventure a judgment saw the stance as ommended that the Committee begin its ranging from modestly restrictive to discussions of communications issues at somewhat accommodative. Many mem- the FOMC meeting in August and that bers noted that significant uncertainty the FOMC meetings scheduled for later accompanied the appropriate setting of this year be lengthened to allow a fuller policy going forward, and one indicated initial discussion of some of these that the decision to raise the target fed- issues. The Committee also discussed eral funds rate at this meeting was a briefly the schedule for FOMC meetings close call. next year and tentatively agreed to In their discussion of the wording of increase the number of two-day meetthe statement to be released after the ings to four. meeting, members expressed a wide At the conclusion of the discussion, range of views. Some members favored the Committee voted to authorize and a shorter statement that focused on the direct the Federal Reserve Bank of New Committee's desire to see core inflation York, until it was instructed otherwise, decline from its recent elevated levels, to execute transactions in the System while others were inclined to provide Account in accordance with the followmore information about the forces that ing domestic policy directive: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 197 The Federal Open Market Committee Reserve System in Washington, D.C., seeks monetary and financial conditions that on Tuesday, August 8, 2006 at 8:30 a.m. will foster price stability and promote sustainable growth in output. To further its long- Present: run objectives, the Committee in the imme- Mr. Bernanke, Chairman diate future seeks conditions in reserve Mr. Geithner, Vice Chairman markets consistent with increasing the fed- Ms. Bies eral funds rate to an average of around Mr. Guynn 5VA percent. Mr. Kohn Mr. Kroszner The vote encompassed approval of Mr. Lacker the paragraph below for inclusion in the Ms. Pianalto statement to be released shortly after the Mr. Warsh meeting: Ms. Yellen Although the moderation in the growth of Mr. Hoenig, Ms. Minehan, Messrs. aggregate demand should help to limit infla- Moskow and Poole, Alternate tion pressures over time, the Committee Members of the Federal Open judges that some inflation risks remain. The Market Committee extent and timing of any additional firming Messrs. Fisher, Plosser, and Stern, that may be needed to address these risks Presidents of the Federal Reserve will depend on the evolution of the outlook Banks of Dallas, Philadelphia, and for both inflation and economic growth, as Minneapolis, respectively implied by incoming information. In any event, the Committee will respond to Mr. Reinhart, Secretary and Economist changes in economic prospects as needed to Ms. Smith, Assistant Secretary support the attainment of its objectives. Mr. Skidmore, Assistant Secretary Mr. Alvarez, General Counsel Votes for this action: Messrs. Bernanke Ms. Johnson, Economist and Geithner, Ms. Bies, Messrs. Guynn, Mr. Stockton, Economist Kohn, Kroszner, and Lacker, Ms. Pianalto, Mr. Warsh, and Ms.Yellen. Votes Messrs. Connors, Eisenbeis, Kamin, against this action: None. Madigan, Sniderman, Struckmeyer, and Wilcox, Associate The meeting adjourned at 11:10 a.m. Economists Mr. Kos, Manager, System Open Mar- Notation Vote ket Account Mr. English and Ms. Liang, Associate By notation vote completed on May 30, Directors, Divisions of Monetary 2006, the Committee unanimously ap- Affairs and Research and proved the minutes of the Federal Open Statistics, respectively, Board of Market Committee meeting held on May Governors 10, 2006. Mr. Reifschneider, Deputy Associate Director, Division of Research and Vincent R. Reinhart Statistics, Board of Governors Secretary Messrs. Dale and Orphanides, Senior Advisers, Division of Monetary Affairs, Board of Governors Meeting Held on Mr. Gross, Special Assistant to the August 8, 2006 Board, Office of Board Members, Board of Governors A meeting of the Federal Open Market Mr. Small, Project Manager, Division Committee was held in the offices of the of Monetary Affairs, Board of Board of Governors of the Federal Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

198 93rd Annual Report, 2006 Mr. Luecke, Senior Financial Analyst, slowed from its rapid pace in the first Division of Monetary Affairs, quarter. Residential investment con- Board of Governors tracted as activity in the housing market Ms. Beechey, Economist, Division continued to cool. Consumer spending of Monetary Affairs, Board of and business investment decelerated Governors after posting substantial increases in the Ms. Low, Open Market Secretariat Spe- first quarter. The demand for labor modcialist, Division of Monetary Af- erated, with hiring in recent months befairs, Board of Governors low the pace of earlier this year. Consumer price inflation remained elevated Mr. Barron, First Vice President, Federal Reserve Bank of Atlanta in July, reflecting further increases in energy prices and shelter costs. Messrs. Fuhrer and Rosenblum, Exec- Nonfarm payrolls increased in June utive Vice Presidents, Federal Reserve Banks of Boston and Dallas, and July, but more slowly than in the respectively first quarter. The moderation in hiring was most pronounced in retail trade but Mr. Hakkio, Ms. Mester, Messrs. Rawas also evident in construction and sche and Williams, Senior Vice non-business services. Establishments in Presidents, Federal Reserve Banks of Kansas City, Philadelphia, professional and business services con- St. Louis, and San Francisco, tinued to add jobs at roughly the same respectively pace as that of earlier in the year. Average hours of production or nonsupervi- Messrs. Peach and Krane, and Ms. Weir, Vice Presidents, Federal Re- sory workers on private nonfarm payserve Banks of New York, Chi- rolls edged up. The unemployment rate cago, and New York, respectively rose to 4.8 percent in July, above its Mr. Weber, Senior Research Officer, average over the first half of the year. Federal Reserve Bank of Industrial production picked up in Minneapolis June. For the second quarter as a whole, it grew at a robust rate that was faster Mr. Hetzel, Senior Economist, Federal Reserve Bank of Richmond than its first-quarter pace. Gains in manufacturing production were wide- The Manager of the System Open spread across industries. The mining Market Account reported on recent desector, which includes oil and natural velopments in foreign exchange margas extraction, expanded solidly in June, kets. There were no open market operaalthough average growth in the second tions in foreign currencies for the quarter was below that of the first quar- System's account in the period since the ter, in part because the recovery from previous meeting. The Manager also re- the disruptions caused by last year's ported on developments in domestic fi- hurricanes neared completion. Utilities nancial markets and on System open output grew strongly in the second market transactions in government secu- quarter. The rate of capacity utilization rities and federal agency obligations in the manufacturing sector stepped up during the period since the previous in June and remained above its long-run meeting. By unanimous vote, the Com- average. mittee ratified these transactions. The growth of consumer spending The information reviewed at the slowed considerably in the second quarmeeting suggested that the growth of ter after the surge in purchases around economic activity in the second quarter the turn of the year. Spending on goods Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 199 excluding motor vehicles posted a mod- The book value of manufacturing and est increase in June after remaining flat, trade inventories excluding motor vehion average, over the previous four cles rose in May, and real nonfarm months. Although nominal wages and inventories excluding motor vehicles salaries rose briskly in the first half of appeared to be slightly higher in the the year, gains in real disposable income second quarter than earlier in the year. were held down by rising consumer The ratio of book-value inventories to prices. While past gains in household sales edged down in May in both the wealth, particularly from home prices, trade and manufacturing sectors after supported consumer spending, higher having remained relatively steady over interest rates and energy prices were the previous three months. In the manulikely a restraining influence. Indicators facturing sector, however, inventories of consumer sentiment for July were ticked up again in June. In general, mixed. inventories appeared to be well aligned Residential construction activity con- with demand, and business surveys sugtracted in the second quarter. Single- gested that firms were comfortable with family starts declined in June to a level the level of inventories. well below the average of the previous The U.S. international trade deficit twelve months. Construction in the mul- widened in May, reflecting a sharp tifamily sector remained steady, with increase in imports that more than offset starts in June well within the typical a sizable gain in exports. Import growth range seen since 1995. Sales of both was heavily concentrated in oil, reflectnew and existing single-family homes ing both higher prices and quantities; slowed in June and were significantly other categories of imports fell on balbelow their peaks of the summer of ance. Exports rose across almost all ma- 2005. Available measures of house jor product categories; the largest gains prices indicated that price increases had were in consumer goods and capital moderated over the past four quarters. goods, especially aircraft. Expansion of After surging in the first quarter, real economic activity in the advanced forspending on equipment and software eign economies appeared to continue in edged down in the second quarter. The the second quarter at a pace roughly decline was accounted for primarily by comparable to that of the first quarter, a drop in expenditures on communica- on net. Incoming data for the second tions and transportation equipment. quarter pointed to a pickup in economic Spending on high-tech equipment and growth in the euro area and Japan but software declined as well. The construc- indicated that growth slowed somewhat tion of nonresidential buildings moved in Canada. Recent economic indicators up at a solid pace over the first half of from the developing economies were the year, although activity remained well mixed but, in general, suggested some short of its previous peak in mid-2000. moderation in growth from the rapid Outlays on drilling and mining struc- first-quarter pace. tures continued to climb in response to Headline inflation continued to move high energy prices, and spending on of- up, on balance, in recent months, and fice construction edged up as vacancy consumer prices increased at a faster rates continued to trend down. Overall, pace in the second quarter than over the economic fundamentals and business previous twelve months. Consumer sentiment continued to support in- energy prices, while declining slightly creased investment. in June, surged during the second quar- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

200 93rd Annual Report, 2006 ter, on net. Core consumer prices also that some inflation risks remained. The continued to rise, boosted by an accel- extent and timing of any additional firmeration in shelter costs, particularly ing would depend on the evolution of those for owner-occupied residences, the economic outlook as implied by inand some pass-through of energy cost coming information. increases. Higher oil prices showed Investors anticipated the FOMC's dethrough in producer prices for a variety cision at its June meeting to raise the of energy-intensive intermediate goods. federal funds rate 25 basis points, but Rising import prices, higher domestic near-term policy expectations edged rates of capacity utilization, and strong lower, apparently in response to the acglobal demand for materials were fac- companying statement. Subsequently, tors underlying an acceleration in core data releases on real activity that were prices for intermediate materials. The weaker than expected, the Chairman's price of crude oil increased further over testimony on the semiannual Monetary the intermeeting period, and strong Policy Report, and the release of the weather-related demand caused the price June FOMC minutes all led investors to of natural gas to rise considerably. The revise down their expectations for the employment cost index rose somewhat future path of the federal funds rate. faster in the second quarter than over the Yields on nominal Treasury securities preceding three months, but the twelve- fell in line with policy expectations over month change was less than that of a the intermeeting period. Yields on year ago. Survey measures of house- inflation-indexed Treasury securities holds' inflation expectations in June and declined a bit more than those on com- July reversed their increases in April parable nominal Treasury securities, and May. leaving inflation compensation up At its June meeting, the Federal Open slightly, albeit within recent ranges. Market Committee (FOMC) decided to Spreads of yields on corporate bonds raise its target for the federal funds rate over those on comparable-maturity 25 basis points, to 5lA percent. The Treasury securities were about un- Committee's accompanying statement changed, while those on speculativeindicated that economic growth had grade bonds widened. Major stock price been moderating from its quite strong indexes rose modestly. The foreign pace earlier in the year, partly reflecting exchange value of the dollar against a gradual cooling of the housing market other major currencies fell, on net, over and the lagged effects of increases in the intermeeting period. interest rates and energy prices. Read- Debt of the domestic nonfinancial ings on core inflation had been elevated sectors was estimated to have decelerin recent months, but ongoing produc- ated in the second quarter after a robust tivity gains had held down the rise in first-quarter increase. Business-sector unit labor costs, and inflation expecta- debt increased briskly, as the expansion tions remained contained. However, of business loans remained robust. In high levels of resource utilization and the household sector, mortgage debt dethe high prices for energy and other celerated from the first quarter's rapid commodities had the potential to sustain pace in response to higher mortgage inflation pressures. Although the mod- rates and slower house-price appreciaeration in the growth of aggregate de- tion. M2 growth dropped in the second mand would help limit inflation pres- quarter and remained modest in July, sures over time, the Committee judged consistent with moderating growth of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 201 nominal income and rising opportunity flation expectations contained, core PCE cost. inflation likely would decline gradually The staff forecast prepared for this from its recent elevated level, though meeting indicated that real GDP growth the upside risks to inflation were would slow in the second half of 2006 significant. and 2007, and to a lower rate than had In their discussion of the major secbeen anticipated in the prior forecast. tors of the economy, participants noted The marking down of the outlook was that residential construction activity had largely attributable to the annual revi- continued to recede over the past few sion of the national income and product months and cited the housing sector as a accounts, which involved downward re- downside risk to the outlook for growth. visions to actual GDP growth in prior The rate of new home sale cancellations, years and prompted reductions in the which was identified as an important staffs estimate of potential output. The leading indicator by some contacts in slowdown in the housing market, the the construction industry, had spiked effects of higher energy prices on house- higher. Single-family housing starts and hold purchasing power, the waning im- permits continued to fall, and invenpetus of household wealth effects on tories of unsold housing appeared to consumer spending, and the effects of have risen significantly, pointing to conpast policy tightening were expected to tinued slowing in this sector. Some parhold economic growth below potential ticipants observed that the slowing over the next six quarters. Core con- seemed to be orderly thus far, but it was sumer price inflation was projected to also noted that in some areas of the drop back somewhat later this year and country housing construction had expenext, mainly as the effects of higher rienced a relatively sharp fall. In genenergy and import prices abated. eral, participants expressed considerable In their discussion of the economic uncertainty regarding prospects for the situation and outlook, meeting partici- housing sector. pants noted that the slowing of GDP Meeting participants noted that the growth in the second quarter was gener- continued increases in energy prices and ally in line with expectations, reflecting borrowing costs appeared to have rethe continued cooling of the housing strained consumer spending growth in market, the restraining influence on de- recent months. Contacts in the retail secmand of higher energy prices, and the tor generally reported a continued slowlagged effects of past increases in inter- ing of growth in sales, although the est rates. Going forward, output was situation differed somewhat by region expected to advance at a pace at or and type of good or service. Reliable, slightly below the economy's potential comprehensive data were not yet availrate of growth, but several participants able on recent house price movements, noted that the annual revision to the but the rate of appreciation appeared to national income and product accounts be moderating and was likely to slow suggested this growth rate likely was further in coming months. The slower lower than previously believed. Incom- pace of increase in housing wealth ing information with regard to inflation would restrain consumption growth, had not been encouraging. Still, most though by how much was uncertain. participants thought that, with energy However, the financial condition of prices possibly leveling out, aggregate households, as judged by indicators such demand moderating, and long-term in- as bankruptcy filings and loan delin- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

202 93rd Annual Report, 2006 quencies, appeared to remain solid. could lead to a weakening of import Overall, consumption spending seemed competition in the form of increases in likely to expand at a moderate pace in the prices of tradable goods in the coming quarters. United States. Although business fixed investment As at the June meeting, all particiin the second quarter was a little lower pants expressed concern about continthan had been expected, participants ued elevated readings on core inflation noted that this development appeared and inflation risks going forward. Sevmainly to reflect the timing of pur- eral participants took note of the revichases, particularly of transportation sions to historical data that painted a equipment, and not weakness in the more worrisome picture of cost trends; underlying trend. Some participants measures of unit labor costs had been noted that nonresidential construction marked up, reflecting upward revisions had continued to strengthen, offsetting to labor compensation and downward some of the contraction in residential revisions to labor productivity. Core construction. Looking forward, strong PCE inflation now appeared to have business balance sheets and high profitbeen running at or above a 2 percent ability were seen as supporting continannual rate for more than two years, ued growth in expenditures on software with prices accelerating over the first and equipment. However, it was noted half of 2006. Many participants noted that if the reported slowing of increases that the extent to which the increase in in retail sales continued, businesses core inflation so far this year reflected might trim capital spending plans. transitory or persistent influences re- With regard to the federal sector, mained unclear. The recent pickup in spending related to last year's hurriprice increases appeared to be broadcanes appeared likely to abate, and fedbased, and a number of business coneral expenditures overall would probtacts reported greater ability to pass ably be providing less impetus to through higher costs. However, some aggregate demand going forward. Fedtypes of price pressures were not likely eral receipts had been increasing rapto continue to increase. The recent acidly, a development that reflected celeration in shelter costs, which concontinued strong growth in labor and tributed substantially to the increase in non-labor income. core inflation this year, could prove Some participants noted that global short-lived. Moreover, while energy demand remained strong, potentially prices had risen further in the intermeetadding to worldwide pressures on ing period, energy prices could well resources. Increased geopolitical risks, particularly related to developments in level out in coming quarters. Also, the the Middle East, continued to put pres- anticipated moderation in aggregate desure on energy prices, and the prices of mand implied that pressures on resource many other commodities also had utilization likely would not increase and firmed over the intermeeting period. could abate to a degree going forward. Central banks had been raising interest Finally, inflation expectations appeared rates globally, however, and this was to have remained contained despite adviewed as a factor that should help to verse news about prices. In light of these restrain global inflation pressures. But it factors, most participants expressed the was also noted that the recent decline in view that core inflation was likely to the foreign exchange value of the dollar decline gradually over the next several Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 203 quarters, although appreciable upside agreed that the statement should both risks remained. mention factors contributing to the In the Committee's discussion of likely moderation of inflation pressures monetary policy for the intermeeting over time and reiterate the forces that period, nearly all members favored were seen as having the potential to keeping the target federal funds rate at sustain inflation pressures. 5lA percent at this meeting. In view of At the conclusion of the discussion, the elevated readings on costs and the Committee voted to authorize and prices, many members thought that the direct the Federal Reserve Bank of New decision to keep policy unchanged at York, until it was instructed otherwise, this meeting was a close call and noted to execute transactions in the System that additional firming could well be Account in accordance with the followneeded. But with economic growth hav- ing domestic policy directive: ing moderated some, most members an- The Federal Open Market Committee ticipated that inflation pressures quite seeks monetary and financial conditions that possibly would ease gradually over will foster price stability and promote suscoming quarters and the current stance tainable growth in output. To further its longof policy could well prove to be consis- run objectives, the Committee in the immediate future seeks conditions in reserve tent with satisfactory economic performarkets consistent with maintaining the fedmance. Under these circumstances, eral funds rate at an average of around keeping policy unchanged at this meet- 5lA percent. ing would allow the Committee to accu- The vote encompassed approval of mulate more information before judging the text below for inclusion in the statewhether additional firming would be ment to be released at 2:15 p.m.: necessary to foster the attainment of price stability over time. The full effect The Committee judges that some inflation of previous increases in interest rates on risks remain. The extent and timing of any additional firming that may be needed to activity and prices probably had not yet address these risks will depend on the evolubeen felt, and a pause was viewed as tion of the outlook for both inflation and appropriate to limit the risks of tighten- economic growth, as implied by incoming ing too much. Following seventeen con- information. secutive policy firming actions, mem- Votes for this action: Messrs. Bernanke bers generally saw limited risk in and Geithner, Ms. Bies, Messrs. Guynn, deferring further policy tightening that Kohn, Kroszner, Ms. Pianalto, Mr. Warsh, and Ms. Yellen. Votes against might prove necessary, as long as inflathis action: Mr. Lacker. tion expectations remained contained. All members agreed that the state- Mr. Lacker dissented because he bement to be released after the meeting lieved that further tightening was needed should convey that inflation risks to bring inflation down more rapidly remained dominant and that conse- than would be the case if the policy rate quently keeping policy unchanged at were kept unchanged. The inflation outthis meeting did not necessarily mark look had deteriorated in the intermeetthe end of the tightening cycle. They ing period; the recent surge in core inflaconcurred that an indication that eco- tion had persisted and appeared to be nomic growth had moderated was ap- broad-based, while the revision of the propriate, and a consensus favored cit- national income and product accounts ing the same reasons for that moderation indicated a recent upswing in compensaas in the June statement. Members also tion and unit labor costs. Although real Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

204 93rd Annual Report, 2006 growth was likely to be somewhat lower Meeting Held on in coming quarters, in his view it was September 20, 2006 unlikely to moderate by enough to bring A meeting of the Federal Open Market core inflation down. He noted, more- Committee was held in the offices of the over, that real short-term interest rates Board of Governors of the Federal had fallen in the intermeeting period and Reserve System in Washington, D.C., were still low relative to rates typically on Tuesday, September 20, 2006 at associated with sustained expansions. 8:30 a.m. The Committee then turned to a discussion of the goals and principles that Present: should guide the review of its ap- Mr. Bernanke, Chairman proaches to policy communications that Mr. Geithner, Vice Chairman it had recently undertaken. Participants Ms. Bies agreed that communication was impor- Mr. Guynn Mr. Kohn tant for democratic accountability and Mr. Kroszner could promote the effectiveness of pol- Mr. Lacker icy. Although considerable strides had Mr. Mishkin been made in FOMC communications Ms. Pianalto over the past ten years or so, partici- Mr. Warsh Ms. Yellen pants generally thought that further advances were possible. In that regard, Ms. dimming, Mr. Hoenig, Ms. Mineconsideration of how the Committee ex- han, and Messrs. Moskow and Poole, Alternate Members of the pressed both its economic objectives and Federal Open Market Committee its assessments of expected progress toward those objectives was likely to be Messrs. Fisher, Plosser, and Stern, particularly important. Conveying the Presidents of the Federal Reserve Banks of Dallas, Philadelphia, and degree of uncertainty and conditionality Minneapolis, respectively about Committee expectations of future developments was seen as a major chal- Mr. Reinhart, Secretary and Economist Ms. Danker, Deputy Secretary lenge. It was recognized that communi- Ms. Smith, Assistant Secretary cations should support appropriate deci- Mr. Skidmore, Assistant Secretary sionmaking, including respect for the Mr. Alvarez, General Counsel diversity of views that contributed to Mr. Baxter, Deputy General Counsel good decisions. Participants agreed to Ms. Johnson, Economist Mr. Stockton, Economist continue the Committee's review of communications issues at the FOMC Messrs. Connors, Eisenbeis, Kamin, meeting in October. Madigan, Sniderman, Struckmeyer, Tracy, Weinberg, and Wil- The meeting adjourned at 3:05 p.m. cox, Associate Economists Mr. Kos, Manager, System Open Market Account Notation Vote Messrs. English and Slifman, Associate By notation vote completed on July 19, Directors, Divisions of Monetary 2006, the Committee unanimously ap- Affairs and Research and Staproved the minutes of the FOMC meet- tistics, respectively, Board of Governors ing held on June 28-29, 2006. Mr. Reifschneider, Deputy Associate Vincent R. Reinhart Director, Division of Research and Secretary Statistics, Board of Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 205 Mr. Oliner, Senior Adviser, Division of The information reviewed at the Research and Statistics, Board of meeting suggested that economic activ- Governors ity continued to decelerate in recent Mr. Gross, Special Assistant to the months. Consumer and business spend- Board, Office of Board Members, ing held up well, and payroll employ- Board of Governors ment continued to rise moderately in Mr. Small, Project Manager, Division July and August. However, a contracof Monetary Affairs, Board of tion in homebuilding was damping the Governors economic expansion. Core consumer price inflation eased somewhat but Mr. Durham, Section Chief, Division nonetheless remained higher than it was of Monetary Affairs, Board of Governors in 2005. Total consumer price inflation moderated in August, reflecting a sub- Mr. Luecke, Senior Financial Analyst, stantial slowing of the increase in energy Division of Monetary Affairs, prices. Board of Governors Nonfarm payrolls rose in August at a Ms. Low, Open Market Secretariat Spepace similar to that recorded over the cialist, Division of Monetary previous four months. Employment Affairs, Board of Governors gains were widespread in the service Mr. Lyon, First Vice President, Federal sector, and the construction industry also Reserve Bank of Minneapolis added jobs, particularly in nonresiden- Messrs. Fuhrer and Rosenblum, Execu- tial building. However, employment in tive Vice Presidents, Federal retail trade and manufacturing fell again Reserve Banks of Boston and Dal- in August. Average hours of production las, respectively or nonsupervisory workers edged lower. Mr. Evans, Ms. Mester, Messrs. Rasche, The unemployment rate ticked back Rolnick, Rudebusch, and Sellon, down to 4.7 percent in August, but it Senior Vice Presidents, Federal remained within the narrow band that Reserve Banks of Chicago, Philaprevailed since the beginning of the delphia, St. Louis, Minneapolis, year. San Francisco, and Kansas City, respectively Industrial production rose in July but edged down in August. Manufacturing Ms. Mosser, Vice President, Federal output was unchanged in August, as a Reserve Bank of New York small increase in the production of The Manager of the System Open motor vehicles and parts was offset by a Market Account reported on recent de- slight net decline in other sectors. Outvelopments in foreign exchange mar- put of construction supplies, for examkets. There were no open market opera- ple, dropped a little. In the hightions in foreign currencies for the technology sector, the production of System's account in the period since the computers rose tepidly through the sumprevious meeting. The Manager also re- mer, while output of communications ported on developments in domestic equipment turned down in August after financial markets and on System open increasing markedly during the first half market transactions in government secu- of the year. Semiconductor production rities and federal agency obligations remained sluggish through August. during the period since the previous Consumer spending appeared to be meeting. By unanimous vote, the Com- rising at a moderate pace in recent mittee ratified these transactions. months. Spending on cars and light Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

206 93rd Annual Report, 2006 trucks increased somewhat in July after spending remained sluggish in July. a lackluster pace in the second quarter Business purchases of light vehicles but apparently weakened in August. picked up in August after a weak perfor- Consumer spending on goods excluding mance in July, and sales of medium and motor vehicles increased modestly dur- heavy trucks remained brisk. Available ing the four months ending in July. De- data indicated that aircraft purchases spite the sharp net increase in energy remained flat. Real spending on equipprices, real disposable income rose fur- ment outside the high-tech and transporther, with solid gains in June and July. tation sectors appeared to be increasing Increases in household wealth earlier in moderately in the current quarter. the year continued to boost consumer Book-value data for the manufacturspending. However, consumer borrow- ing and trade sectors suggested that ing costs had risen since the beginning inventory accumulation slowed only of the year with the increase in short- modestly in July from a brisk pace in the term interest rates. Recent readings on second quarter. Outside the motor vehiconsumer sentiment were mixed. The cle sector, inventories appeared to be personal saving rate fell further in July. well aligned with demand, and surveys Residential construction activity con- indicated that firms continued to be gentinued to contract in recent months. erally comfortable with their level of Single-family starts fell further in July inventories. and August to a level well below the Both imports and exports increased in peak in the third quarter of 2005. Con- the second quarter, but imports increased struction in the multifamily sector also and exports decreased in July, widening fell back. Sales of both new and existing the U.S. trade deficit. The growth of single-family homes fell in July and imports was heavily concentrated in oil, were significantly below the peaks of reflecting higher petroleum prices, and last summer. A range of indicators sug- in non-oil industrial supplies and capital gested that housing market activity was goods. Imports of services fell slightly. likely to slow further in the near term. Exports of capital goods and industrial Pending home sales dropped noticeably supplies declined after considerable in July, and mortgage rates had gains in June, but exports of telecommuincreased since the beginning of the nications equipment and automotive year. Available measures suggested that products were strong. Exports of serprices of existing homes increased vices were unchanged in July. through the second quarter at a much Economic activity in the advanced lower rate than the one observed during foreign economies decelerated in the the same period last year. second quarter but remained strong. A After strong increases in the first half fall in net exports held back expansion of 2006, real spending on equipment in Japan and Canada, while strong and software remained robust into the domestic demand boosted growth in the summer against a backdrop of rising United Kingdom and the euro area. Inbusiness output, plentiful corporate cash coming data suggested that overall GDP reserves, positive sentiment among ex- growth in these countries for the current ecutives, and falling relative prices for quarter was dropping a bit from the high-tech equipment. Orders and ship- second-quarter pace. Recent economic ments of communications equipment indicators from the emerging-market leveled off in recent months after climb- economies generally pointed to robust, ing earlier this year. Real computer but moderating, growth. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 207 The overall price index for personal in recent months, and the high levels of consumption expenditures rose rela- resource utilization and of the prices of tively steeply in July and was estimated energy and other commodities had the to have increased further in August, potential to sustain inflation pressures. bringing the advance over the twelve- However, inflation pressures seemed month period above the year-earlier rise. likely to moderate over time, reflecting After July, though, crude oil and gaso- contained inflation expectations and the line prices dropped back significantly, cumulative effects of monetary policy and with inventories of natural gas actions, as well as reduced impetus from remaining near seasonal highs, natural higher energy and materials costs. Nonegas prices fell from their spike earlier theless, the Committee judged that some this summer. Core consumer prices inflation risks remained. The extent and increased at a somewhat more subdued timing of any additional firming that pace over July and August, but despite may be needed to address these risks the recent moderation, the twelve-month would depend on the evolution of the change in core prices remained above outlook for both inflation and economic the increase over the comparable period growth, as implied by incoming twelve months earlier. The producer information. price index for core intermediate materi- Investors had largely anticipated the als rose significantly in July and August. FOMC's decision at its August meeting Substantial upward revisions to wages to maintain the federal funds rate at its and salaries boosted compensation per current level, and short-term rates hour in the first quarter. The increase dropped only a bit in response. Subselikely owed in part to the exercise of quently, data on inflation that were stock options and cash bonuses; other weaker than expected, substantial data that did not include such forms of declines in oil prices, and the release of compensation pointed to more moderate the minutes of the August FOMC meetincreases. Hourly compensation rose ing led investors to revise down their further in the second quarter and re- expectations for the future path of the corded an increase of about 13A percent federal funds rate. Over the intermeeting from four quarters earlier. After more period, yields on short- and interfavorable readings in June and July, sur- mediate-term nominal Treasury securivey measures of households' inflation ties fell, while yields on inflationexpectations turned back up in August, indexed Treasury securities of but preliminary September readings sug- comparable maturity increased somegested a decline. what, pushing inflation compensation At its August meeting, the Federal considerably lower at those horizons. Open Market Committee (FOMC) Nominal forward rates further out the decided to maintain its target for the yield curve fell about the same amount federal funds rate at 5V4 percent. The as real forward rates, implying little Committee's accompanying statement change in far-forward inflation compenindicated that economic growth had sation. Spreads of yields on investmentmoderated from its quite strong pace and speculative-grade corporate bonds earlier in the year, partly reflecting a over those on Treasury securities were gradual cooling of the housing market about unchanged. Major stock price inand the lagged effects of increases in dexes posted solid gains. The foreign interest rates and energy prices. Read- exchange value of the dollar against ings on core inflation had been elevated other major currencies was little Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

208 93rd Annual Report, 2006 changed, on net, over the intermeeting slack in the economy and lower energy period. costs. Debt of the domestic nonfinancial In their discussion of the economic sectors in the third quarter was esti- situation and outlook, meeting particimated to be rising at about the same pants noted that the pace of the expanpace as in second quarter. Business- sion appeared to be continuing to modsector debt was increasing briskly, as the erate in the third quarter. In particular, expansion of business loans remained activity in the housing market seemed to robust. In the household sector, debt be cooling considerably, which would expanded in the second quarter at a rate contribute to relatively subdued growth slightly below that in the first quarter, as over the balance of the year. Growth mortgage debt decelerated somewhat. was likely to strengthen next year as the M2 growth remained modest in August, housing correction abated, with activity consistent with moderating growth of also encouraged by the recent decline in nominal income and lagged increases in energy prices and still-supportive finanopportunity cost. cial conditions. In the view of many The staff forecast prepared for this participants, economic expansion would meeting indicated that real GDP growth probably track close to the rate of would continue to slow into the second growth of the economy's potential next half of 2006 before strengthening graduyear and in 2008. Many participants also ally thereafter. By 2008, output was pronoted that core inflation had been runjected to be expanding at a pace about ning at an undesirably high rate. equal to the staffs forecast of potential Although most participants expected output growth. The staff, however, had core inflation to decline gradually, subagain reduced its projection for potential stantial uncertainty attended this out- GDP growth, and the projected slow look. pace of growth over the next several In their discussion of major sectors of quarters was thus consistent with an the economy, meeting participants foopening of only a small gap in resource cused especially on developments in the utilization. In the near term, the cooling housing market. Although the situation of the housing market and lower motor varied somewhat across the nation, vehicle production were expected to housing activity was continuing to conhold growth back. At the same time, tract in most regions. Home sales had though, significantly lower energy slowed considerably, and anecdotal reprices, sustained increases in labor ports suggested that more buyers were income, and favorable labor market conditions were anticipated to support canceling contracts for purchases. Parexpansion through the end of the year. ticipants noted that inventories of un- Further ahead, the lagged effects of the sold homes had climbed sharply in many previous tightening of monetary policy areas and that builders were taking a and waning stimulus from household number of measures to reduce invenwealth and fiscal policy were antici- tories. Both permits for new construcpated to restrain growth, but the drag tion and housing starts had declined sigfrom the downturn in residential con- nificantly. Available measures of home struction was expected to abate. Core prices suggested that appreciation had consumer price inflation was projected slowed considerably but prices in most to drop back somewhat later this year areas were not falling, although some and next, reflecting the emergence of sellers were reported to be providing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 209 various inducements to potential pur- availability of funding from financial chasers that reduced effective prices. markets and institutions. Thus far, the drop in housing market Participants noted that the financial activity appeared not to have spilled condition of federal and state governover significantly to other sectors of the ments continued to improve. Inflows of economy. Indeed, consumer expendi- tax revenues remained strong, consistent tures appeared to have been expanding with expanding personal incomes, sales, moderately over the previous few and business profits. months, buoyed by increases in employ- Economic activity abroad appeared to ment, personal income, and household be slowing a little from the unusually wealth. Contacts in some Districts re- rapid rate of the first half of the year, but ported that retail sales had picked up a still expanding at a reasonably good little most recently. Meeting participants pace overall. Foreign economic growth noted that consumer spending going for- was expected to continue, albeit perhaps ward would be supported by the higher at a somewhat slower pace than exlevels of personal income indicated by pected by some outside forecasters, conrecent revisions to the national income tributing to increases in U.S. exports. and product accounts, by further gains Participants took note of the jump in in employment, and by the decline in labor compensation in the first half of consumer energy prices over recent the year, but commented that the months. However, considerable uncer- increase likely reflected in part the exertainty was expressed regarding the ulti- cise of stock options. Nonetheless, some mate extent of the downturn in the hous- participants viewed the recent increase ing sector and the degree to which the in overall compensation as pointing to slowing in housing activity and the de- upside risks to inflation. Participants receleration in home prices would affect ported steady gains in employment in consumption and other expenditures go- various regions, roughly in line with ing forward. expansion of the labor force. Many busi- Business investment spending gener- ness contacts continued to experience ally was seen as expanding at a reason- shortages of labor and accelerating ably good pace. Meeting participants wages, particularly for certain types of noted broad strength in manufacturing professionals and skilled workers and, of capital goods. Nonresidential in some areas, unskilled workers. construction activity continued to One participant highlighted that, in strengthen, and in the process was ab- the staff forecast, labor force growth sorbing some of the resources that were would begin to slow over the next few no longer employed in homebuilding. years as more members of the baby- Although some survey evidence sug- boom generation retired. Even if gested that some firms were trimming resource utilization rates were uncapital spending plans, participants re- changed, slower growth of the labor ported that their business contacts gen- force would mean that increases in emerally were quite positive about the eco- ployment would be significantly lower, nomic outlook and the strength of on average, than those registered in demand for their products. In this envi- recent years. In that case, the slower ronment, investment spending would growth of the labor force and employlikely continue to be supported by ment implied that the expansion of poexpansion of overall output, strong bal- tential GDP could be somewhat lower ance sheets and profits, and the ready than it had been earlier this decade. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

210 93rd Annual Report, 2006 Some participants commented, however, were skewed toward higher rather than that they viewed potential output lower inflation rates. growth, as well as expansion of actual In the Committee's discussion of output, as likely to remain solid over the monetary policy for the intermeeting next several years. period, nearly all members favored Many meeting participants empha- keeping the target federal funds rate at sized that they continued to be quite 5lA percent at this meeting. Members concerned about the outlook for infla- generally expected economic activity to tion. Recent rates of core inflation, if expand at a pace below the rate of they persisted, were seen as higher than growth of potential output in the near consistent with price stability, and par- term before strengthening some over ticipants underscored the importance of time. Moreover, given the uncertainties in forecasting, significantly more slugensuring a moderation in inflation. To gish performance than anticipated could be sure, very recent data on inflation not be entirely ruled out. Although the suggested some improvement from the uncertainties were substantial, core insituation in the late spring, partly reflectflation seemed most likely to ebb graduing slower increases in owners' equivaally from its elevated level, in part owlent rent. Also, the considerably lower ing to the waning effects of past level of energy prices of recent weeks, if increases in energy prices. The anticisustained, would help reduce overall inpated expansion of economic activity at flation and damp increases in core a pace slightly below the rate of growth prices. Moreover, businesses would of the economy's potential would likely meet more resistance to attempts to pass also play a role by easing pressures on through cost increases in the less robust resources. Members noted that certain economic circumstances that were likely developments of late—appreciable deto prevail at least for a time. However, clines in energy prices, some softer indienergy prices remained quite sensitive cators of economic activity, and slightly to a wide range of forces, including lower readings on core inflation— geopolitical developments, and might pointed to a modestly better inflation well rebound. To date, the available evioutlook and hence made the policy decidence indicated that inflation expectasion today somewhat less difficult than tions remained contained—indeed, exit was in August, when it was seen as a pectations of price increases for the next particularly close call. few years had fallen some as energy In view of the most recent informaprices declined. Nonetheless, several tion on the economy, members agreed participants worried that inflation expec- that it was appropriate for the posttations could rise and the Federal Re- meeting statement to characterize ecoserve's willingness to carry through on nomic growth as apparently continuing its intention to seek price stability could to moderate. However, in view of stillbe called into question if cost and price high energy and other commodity prices pressures mounted or even if there was and elevated rates of resource utilization no moderation in core inflation. Look- as well as recent indications of a posing forward, most participants thought sible acceleration in labor costs, memthat the most likely outcome was a re- bers continued to see a substantial risk duction in inflation pressures, but the that inflation would not decline as ananticipated decline was only gradual and ticipated by the Committee. Consethe uncertainties around that forecast quently, the Committee agreed that the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 211 statement should again cite such risks to The meeting adjourned at 1:20 p.m. inflation and explicitly reference the possibility of additional policy firming. Notation Vote At the conclusion of the discussion, the Committee voted to authorize and By notation vote completed on August direct the Federal Reserve Bank of New 28, 2006, the Committee unanimously York, until it was instructed otherwise, approved the minutes of the FOMC to execute transactions in the System meeting held on August 8, 2006. Account in accordance with the follow- Vincent R. Reinhart ing domestic policy directive: Secretary The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sus- Meeting Held on tainable growth in output. To further its long- October 24-25, 2006 run objectives, the Committee in the immediate future seeks conditions in reserve A meeting of the Federal Open Market markets consistent with maintaining the fed- Committee was held in the offices of the eral funds rate at an average of around Board of Governors of the Federal 5VA percent. Reserve System in Washington, D.C., The vote encompassed approval of on Tuesday, October 24, 2006 at 2:00 the text below for inclusion in the state- p.m. and continued on Wednesday, ment to be released at 2:15 p.m.: October 25, 2006 at 9:00 a.m. Nonetheless, the Committee judges that Present: some inflation risks remain. The extent and Mr. Bernanke, Chairman timing of any additional firming that may be Mr. Geithner, Vice Chairman needed to address these risks will depend on Ms. Bies the evolution of the outlook for both infla- Mr. Kohn tion and economic growth, as implied by Mr. Kroszner incoming information. Mr. Lacker Votes for this action: Messrs. Bernanke Mr. Mishkin and Geithner, Ms. Bies, Messrs. Guynn, Ms. Pianalto Kohn, Kroszner, and Mishkin, Ms. Pi- Mr. Warsh analto, Mr. Warsh, and Ms. Yellen. Ms. Yellen Votes against this action: Mr. Lacker. Mr. Hoenig, Ms. Minehan, and Messrs. Mr. Lacker dissented because he be- Moskow and Poole, Alternate Members of the Federal Open lieved that further tightening was needed Market Committee to bring inflation down more rapidly than would be the case if the policy rate Messrs. Fisher, Plosser, and Stern, Presidents of the Federal Reserve were kept unchanged. Recent data indi- Banks of Dallas, Philadelphia, and cated that inflation remained above lev- Minneapolis, respectively els consistent with price stability. Moreover, the upswing in compensation and Mr. Barron, First Vice President, Federal Reserve Bank of Atlanta unit labor costs in the first half of the year indicated that inflation risks were Mr. Reinhart, Secretary and Economist tilted to the upside. Although real Ms. Danker, Deputy Secretary Ms. Smith, Assistant Secretary growth was likely to be moderate in Mr. Skidmore, Assistant Secretary coming quarters, in his view it was un- Mr. Alvarez, General Counsel likely to be slow enough to bring core Ms. Johnson, Economist inflation down. Mr. Stockton, Economist Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

212 93rd Annual Report, 2006 Messrs. Connors, Eisenbeis, Judd, Ka- Ms. Mucciolo and Mr. Todd, Vice min, Madigan, Sniderman, Struck- Presidents, Federal Reserve Banks meyer, and Wilcox, Associate of New York and Minneapolis, re- Economists spectively Mr. Kos, Manager, System Open Mar- Ms. McConnell, Assistant Vice Presiket Account dent, Federal Reserve Bank of New York Messrs. English and Slifman, Associate Directors, Divisions of Monetary Mr. Hetzel, Senior Economist, Federal Affairs and Research and Statis- Reserve Bank of Richmond tics, respectively, Board of Gover- The manager of the System Open nors Market Account (SOMA) reported on Messrs. Gagnon and Wascher, Deputy recent developments in foreign ex- Associate Directors, Divisions of change markets. There were no open International Finance and Remarket operations in foreign currencies search and Statistics, respectively, Board of Governors for the System's account in the period since the previous meeting. The Man- Messrs. Dale and Oliner, Senior Advisager also reported on developments in ers, Divisions of Monetary Affairs and Research and Statistics, re- domestic financial markets and on spectively, Board of Governors System open market transactions in government securities and federal Mr. Gross, Special Assistant to the Board, Office of Board Members, agency obligations during the period Board of Governors since the previous meeting. By unanimous vote, the Committee ratified Mr. Small, Project Manager, Division of Monetary Affairs, Board of these transactions. Governors. The Manager also discussed with the Ms. Weinbach, Senior Economist, Divi- Committee the results of a recent review sion of Monetary Affairs, Board of of the management of the domestic se- Governors curity holdings of the SOMA. The Man- Messrs. Kumasaka7 and Luecke,8 ager noted that in 2000, in response to Senior Financial Analysts, Divi- reduced issuance of Treasury securities, sion of Monetary Affairs, Board of limits were adopted on the SOMA's Governors holdings of individual Treasury bonds, Ms. Low, Open Market Secretariat Spe- notes, and bills that ranged between cialist, Division of Monetary 15 percent and 35 percent of amounts Affairs, Board of Governors outstanding. In recent years, those limits Messrs. Fuhrer and Rosenblum, Execu- had created occasional operational tive Vice Presidents, Federal complications for the Trading Desk. Reserve Banks of Boston and Dal- Meanwhile, circumstances in the Trealas, respectively sury securities market had changed con- Mr. Evans, Ms. Mester, and Messrs. siderably, and the Manager noted that he Rasche and Sellon, Senior Vice intended to revert to the previous prac- Presidents, Federal Reserve Banks tice of applying a single 35 percent limit of Chicago, Philadelphia, St. across all issues. Louis, and Kansas City, respectively The Chairman noted that the President had recently signed the Financial Services Regulatory Relief Act of 2006, 7. Attended Tuesday's session only. 8. Attended Wednesday's session only. which among its provisions gave the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 213 Federal Reserve discretion, beginning After having been flat in August, October 2011, both to pay interest on industrial production declined in Sepreserve balances and to reduce further or tember, reflecting a sizable weathereliminate reserve requirements. The Act related decrease in the output of utilities potentially has important implications and a fairly broad-based reduction in for many aspects of the Federal Re- manufacturing output. These declines serve's operations and the Chairman were partially offset by a rise in output asked Vincent Reinhart, Director of the in the mining sector that was led by Division of Monetary Affairs, to form a gains in crude oil extraction and in committee of Federal Reserve System mined construction supplies, such as staff to consider these issues. stone, sand, and gravel. The output of The information reviewed at the motor vehicles and parts fell in September, as automakers continued to trim October meeting suggested that ecoproduction of light trucks in response to nomic activity increased at a slow pace bloated inventories. Output growth in in the third quarter. The contraction in the high-technology sector softened a home construction remained a signifibit in September relative to the summer cant drag on economic activity, and months, reflecting a smaller rise in the steep reductions in motor vehicle assemproduction of semiconductors. Comblies further weighed on growth in the puter production continued to increase third quarter. Nonetheless, consumer at a tepid rate, while output of commuspending and business investment connications equipment turned up noticetinued to hold up well. Payroll employably after a decline in August. For the ment extended its moderate expansion, third quarter as a whole, growth in on average, through September. Sharp industrial production moderated a bit declines in energy prices reduced total relative to the first half of the year; consumer price inflation in September, stronger output in the high-technology but the twelve-month change in core sector and a pickup in the production of prices remained elevated relative to business equipment partially offset a year-earlier readings. steep contraction in the output of motor Nonfarm payrolls rose modestly in vehicles and parts and a slowdown in September after a larger increase in mining output. August, with some of the variation ap- Real consumer spending appeared to parently a result of seasonal factors. In regain some steam in September after a September, job increases in the service- lackluster August. Although nominal reproducing sectors were fairly wide- tail sales fell noticeably in September, spread and were again led by the health- the steep drop in gasoline prices more care industry. The construction sector than accounted for the decline. Excludalso added jobs; the lift came from gains ing sales at gasoline stations, the step-up associated with nonresidential building in consumer spending was the result of that more than offset further losses in faster sales of motor vehicles and broadthe residential sector. Job cutbacks in based strength in outlays for other catethe retail trade and manufacturing sec- gories of goods, particularly apparel. tors continued. Aggregate hours of pri- Real disposable income rose moderately vate production or nonsupervisory in both July and August; the pace was workers again edged lower. The unem- somewhat above its second-quarter ployment rate ticked down to 4.6 per- average. Consumer spending continued cent in August. to draw support from the lagged effects Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

214 93rd Annual Report, 2006 of the increases in household wealth scheduled to take effect in 2007 likely over the past two years. But interest pulled forward some spending on merates on some types of household loans, dium and heavy trucks. Outlays on airboth short- and long-term, had risen this craft appeared to have risen somewhat year, on balance. The latest readings on in the third quarter from their extremely consumer sentiment had been positive, low second-quarter level. Real spending perhaps reflecting the recent declines in on equipment other than high-tech and oil prices. The personal saving rate transportation items seemed to have reedged up in August after a dip in July. tained considerable momentum in the Residential construction activity third quarter. Activity in the nonresidenremained weak. Single-family starts tial construction sector continued to ticked up in September, but new permit strengthen in August. issuance slid further to its lowest level Book-value data on manufacturing in nearly five years. Construction in the and trade inventories, which were availmultifamily sector continued to fluctu- able through August, suggested that the ate within the range that has prevailed rate of stockbuilding remained substanfor several years. Sales of new single- tial in the third quarter. A major excepfamily homes edged up in August, while tion was the motor vehicle sector, where sales of existing homes held steady. the cutbacks in assemblies probably Pending home sales, which rose some- began to reduce the inventory overhang what in August after a noticeable drop in that sector. Outside of the motor vehiin July, and the decline in mortgage cle sector, inventories generally rates since July likely indicated some appeared to be well aligned with desupport for housing demand in the near mand. Although survey data in Septemterm. Still, the overhang of unsold ber showed a noticeable rise in the share homes remained historically high, and of firms that viewed their inventories as price appreciation of existing homes being too high, a large majority recontinued to slow through the second mained comfortable with their level. quarter. The U.S. international trade deficit Real spending on equipment and soft- widened to another record in August, ware increased at a solid pace during the reflecting a surge in imports that more summer as the fundamental influences than offset a sizable jump in exports. on such spending remained favorable The sharp increase in imports was for the most part. In particular, although driven importantly by oil and natural business output had recently been rising gas, but imports of capital goods and at a slower rate, corporate financial non-oil industrial supplies, particularly reserves remained plentiful and the cost metals, also exhibited large gains. Imof high-tech capital goods continued to ports of services fell back slightly. The fall. In the high-tech sector, real outlays increase in exports was led by capital on communications equipment likely goods, with aircraft, computers, semistabilized in August after having surged conductors, and other machinery all earlier this year, and the available data climbing briskly. Exports of industrial suggested that real computer spending supplies and consumer goods also rose picked up in the third quarter. In the strongly, while exports of services transportation sector, business purchases expanded modestly. of motor vehicles were brisk of late; the Economic activity in the foreign Environmental Protection Agency's industrial economies continued to exregulations on truck emissions that are pand at a relatively solid pace in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 215 third quarter. Investment spending ber with the sharp drop in energy prices. boosted the expansion in Japan. In the Respondents' longer-term inflation exeuro area, data on industrial production pectations changed little, remaining well and retail sales were consistent with ro- within the narrow range reported over bust growth in real activity. Mixed indi- the past year. cators in Canada and the United King- At its September meeting, the Federal dom suggested that output growth in Open Market Committee (FOMC) those countries remained around recent decided to maintain its target for the rates. Incoming data across the federal funds rate at 5lA percent. The emerging-market economies continued Committee's accompanying statement to point to moderating, but solid, growth indicated that the moderation in ecoin economic activity in the third quarter. nomic growth had appeared to be con- Core prices for personal consumption tinuing, partly reflecting a cooling of the expenditures were expected to have housing market. Readings on core inflarisen in September at the same pace as tion had been elevated, and the high in July and August, leaving the change levels of resource utilization and of the over the twelve months ending in Sep- prices of energy and other commodities tember a bit higher than the year-earlier had the potential to sustain inflation period. Increases in shelter costs, which pressures. However, inflation pressures accounted for a significant proportion of seemed likely to moderate over time, the pickup in core inflation over the past reflecting reduced impetus from energy year, had slowed considerably in recent prices, contained inflation expectations, months but remained well above the and the cumulative effects of monetary rates that prevailed from 2003 to 2005. policy actions and other factors restrain- The price index for total personal con- ing aggregate demand. Nonetheless, the sumption expenditures was estimated to Committee judged that some inflation have fallen markedly in September be- risks remained. The extent and timing of cause of the steep decline in gasoline any additional firming that may be prices, bringing its twelve-month in- needed to address these risks would decrease to a two-and-one-half-year low. pend on the evolution of the outlook for Retail gasoline prices fell especially rap- both inflation and economic growth, as idly in September as crude oil prices implied by incoming information. declined and as the historically high The FOMC's decision at its Septemlevel of gasoline inventories likely led ber meeting to leave the target federal to a sharp narrowing of margins between funds rate unchanged had been largely retail gasoline prices and crude oil anticipated by investors, and policy exprices. The producer price index for core pectations for mid-2007 and beyond intermediate materials rose only slightly rose only slightly. Investors subsein September; the increase was well be- quently revised down their expectations low its average monthly advance over for the future path of the federal funds the preceding twelve months, reflecting rate in light of some data releases that a drop in prices of some chemicals that indicated weaker-than-expected ecohave a high energy content. Average nomic activity. However, those declines hourly earnings increased moderately in were then rolled back in the wake of both August and September after a speeches by FOMC members, the relarger gain in July. Survey measures of lease of the minutes of the September households' year-ahead inflation expec- FOMC meeting, and stronger-thantations eased substantially in early Octo- expected economic data. Over the inter- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

216 93rd Annual Report, 2006 meeting period, yields on nominal and gains in consumer and business spendinflation-indexed Treasury coupon secu- ing were expected to lead to a pickup in rities rose somewhat, on net. Inflation GDP growth through 2007 and into compensation for 2007 declined mod- 2008. These gains in spending were estly, perhaps reflecting the further drop likely to be supported by past declines in spot energy prices, but was largely in energy prices and continued gains in unchanged at longer maturities. Spreads payroll employment and labor income. of investment-grade corporate bond Real GDP was expected to rise at a yields over those on comparable- somewhat slower rate over the next two maturity Treasury securities held steady, years than in 2006 in part as a result of while those on speculative-grade corpo- less impetus from household wealth, rate bonds narrowed a little. Broad interest rates, and fiscal policy. The equity indexes rose noticeably. The projected increase in real output over trade-weighted index of the foreign the next year or so was a little below the exchange value of the dollar versus ma- staff's estimate of potential output jor currencies rose somewhat on bal- growth, leading to a lessening in presance, and the gains were spread evenly sures on resource utilization. Core inflaagainst most currencies. tion was anticipated to edge down in Debt of the domestic nonfinancial 2007 and 2008 relative to the second sectors in the third quarter was esti- half of this year because of the mated to be expanding at around its diminishing impetus from the prices of second-quarter pace. Business debt rose energy and other commodities and more moderately as bank lending to because of the modest easing in businesses slowed. In particular, bank resource utilization. lending to finance commercial real es- In their discussion of the economic tate activity waned in August and Sep- situation and outlook, meeting particitember, while commercial and industrial pants noted that incoming data over the loans, which had been expanding briskly relatively brief intermeeting period had for many months, slowed sharply in come in broadly as anticipated. The September. In the household sector, the most recent indicators suggested that further slowing of the rate of increase of economic growth had probably slowed house prices appeared to have continued more sharply in the third quarter than to weigh on the expansion of mortgage had been expected at the time of the debt in the third quarter. M2 grew September meeting, but that appeared to slowly in the third quarter, exhibiting largely reflect the impact of temporary the lagged effects of earlier increases in influences. Participants continued to opportunity costs and the slow rise in expect the economy to expand at a rate nominal spending. close to or a little below the economy's The staff forecast prepared for this long-run sustainable pace over coming meeting indicated that growth of real quarters. The ongoing adjustment in the GDP had slowed further in the third housing market was likely to depress quarter, reflecting both a significant drag real activity in the near term, but this from the continuing contraction in resi- effect was expected to wane gradually; dential construction and a steep decline private final domestic purchases had in motor vehicle assemblies. Looking held up well in recent months and ahead, a gradual reduction in the re- looked set to expand at a reasonably straining effects of the contraction in good pace. Although recent monthly inresidential investment and further solid flation readings indicated some slowing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 217 of core inflation from the very rapid previous years. Meeting participants rates of spring and early summer, many judged that consumer expenditures goparticipants noted that current rates of ing forward were likely to expand at a core inflation remained undesirably steady pace a little below the growth in high. Most participants expected core disposable income, supported by favorinflation to moderate gradually, but they able financial conditions, continued were quite uncertain as to the likely increases in employment and income, pace and extent of that moderation. and the recent decline in energy prices. In their discussion of the major sec- Nonetheless, many participants extors of the economy, participants noted pressed concern that ongoing developthat housing activity was likely to ments in the housing market could have remain a substantial drag on economic a more pronounced impact on consumer growth over the next few quarters. Many and other spending, especially if house participants drew some comfort from prices declined significantly. the most recent data, which suggested Investment spending also appeared to that the correction in the housing market be holding up well. Meeting participants was likely to be no more severe than reported that their business contacts they had previously expected and that were generally optimistic and perceived the risk of an even larger contraction in the economic outlook as relatively this sector had ebbed. But further adjust- favorable. Several participants noted ment in the housing market appeared that growth in nonresidential construclikely. Single-family housing permits tion remained robust and was absorbing continued to fall and inventories of un- some of the resources displaced from sold homes remained at historically high the residential sector. The strength of levels. Contacts in the building sector corporate balance sheets and profits was suggested that construction firms were seen as likely to help maintain a solid attempting to reduce their backlogs of profile for investment spending over the unsold homes, both by cutting back next year or so, despite some restraint sharply on new construction and by of- from the slower growth in final sales. fering substantial price incentives. Sev- However, one participant observed that eral meeting participants noted the con- the uncertainty concerning the possible siderable strain on some small- and severity of the current slowing in ecomedium-sized residential construction nomic growth could lead some busifirms. nesses to delay investment plans. To date, weakness in the housing mar- In contrast to the steady expansion of ket and the associated downshift in consumer and business investment house price appreciation did not seem to spending in recent months, several other be spilling over into consumer spending, components of output and demand which appeared to have grown at a appeared to have been somewhat weaker steady pace in recent months. Retail ac- than expected. In particular, apparently tivity in most Districts had been rela- uncomfortably high levels of inventories tively robust and contacts in the retail within the auto sector had prompted a sector were generally upbeat about the sharp reduction in light vehicle producoutlook. Several participants noted, tion in the third quarter. Federal expenhowever, that contacts within the trans- ditures had been held down by surprisportation sector had reported that activ- ingly weak defense outlays. And strong ity in anticipation of the holiday shop- growth in imports in July and August, ping season appeared to be softer than in driven in part by a surge in oil imports, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

218 93 rd Annual Report, 2006 suggested that net exports probably associated modest easing of pressures posed an arithmetic drag on economic on resource utilization should also congrowth in the third quarter. However, tribute slightly to the slowing in core participants judged that the recent weak- inflation. Recent changes in core prices ness in these components largely re- ha*; declined slightly from earlier in the flected temporary influences and was year. Nonetheless, nearly all participants not likely to depress the pace of eco- viewed the current rates of core inflation nomic expansion going forward. That as uncomfortably high and stressed the said, one participant did note the possi- importance of further moderation. The bility that the recent decline in oil prices available measures suggested that may in part stem from weakness in glo- medium- and long-term inflation expecbal demand. tations remained around the levels seen Both data and reports from businesses for the past several years, although in indicated that the labor market remained the view of some participants these extight. Employment had continued to rise pectations were probably higher than at a steady pace, and participants re- would be consistent with their assessported that many of their contacts were ment of long-run price stability. Particiincreasingly concerned about the diffi- pants were concerned that inflation exculty of recruiting suitably qualified pectations could begin to drift upwards workers. Shortages were most pro- if core inflation remained elevated for a nounced for certain types of profes- protracted period. Any such rise in inflasional and skilled workers. These re- tion expectations and associated upward ports of shortages and the associated pressure on inflation itself would likely wage pressures had not unambiguously prove costly to reverse. Although some shown through in the aggregate compen- participants noted that the recent slowsation data, which were giving contra- ing in core inflation had helped to allay dictory signals about whether compen- their fears of a further sustained increase sation increases were picking up. in inflation, all participants emphasized However, the possibility that the tight- that the risks around the desired downness of the labor market could lead to a ward path to inflation remained to the sustained increase in wage pressure was upside. viewed by participants as an upside risk In the Committee's discussion of to costs and their expectations of a monetary policy for the intermeeting gradual decline in inflation. It was period, nearly all members favored noted, though, that continuing high keeping the target federal funds rate at profit margins provided some scope for 5lA percent at this meeting. The Comincreased labor costs to be absorbed mittee's view of the outlook for ecowithout necessarily leading to elevated nomic growth and inflation had changed price pressures. little since the previous meeting. Nearly All meeting participants expressed all members expected that the economy concern about the outlook for inflation. would expand close to or a little below Most participants expected core infla- its potential growth rate and that inflation to edge lower, in part as the effects tion would ebb gradually from its elof the run-up in energy prices in recent evated levels. Although substantial unyears waned. And shelter costs were not certainty continued to attend that expected to add materially to inflation outlook, most members judged that the going forward. Moreover, moderate downside risks to economic activity had growth in aggregate demand and the diminished a little, and likewise, some Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 219 members felt that the upside risks to Nonetheless, the Committee judges that inflation had declined, albeit only some inflation risks remain. The extent and timing of any additional firming that may be slightly. All members agreed that the needed to address these risks will depend on risks to achieving the anticipated reducthe evolution of the outlook for both inflation in inflation remained of greatest tion and economic growth, as implied by concern. Members noted that a signifi- incoming information. cant amount of data would be published Votes for this action: Messrs. Bernanke before the next Committee meeting in and Geithner, Ms. Bies, Messrs. Kohn, December, giving the Committee ample Kroszner, and Mishkin, Ms. Pianalto, scope to refine its assessment of the Messrs. Poole and Warsh, and economic outlook before judging Ms. Yellen. Votes against this action: Mr. Lacker whether any additional firming was needed to address those risks. Mr. Lacker dissented because he be- Members agreed that the statement to lieved that further tightening was needed be released after the meeting should to help ensure that core inflation continue to convey that inflation risks declines to an acceptable rate in coming remained the dominant concern and that quarters. additional policy firming was possible. The Committee then continued its dis- The Committee concurred that the state- cussion of communication issues and ment should mention both that economic considered the advantages and disadvangrowth had slowed over the course of tages of quantifying an inflation objecthe year and that, going forward, the tive. Participants stressed that any such economy seemed likely to expand at a step had to be consistent with the statumoderate pace. With energy prices well tory objectives for monetary policy. In off the highs reached earlier in the year, that regard, it was noted that over time members felt that it was no longer ap- price stability is a prerequisite for maxipropriate to note that the high level of mum employment and moderate longenergy prices had the potential to sus- term interest rates. However, the postain inflation pressures. sible specification of a numerical price At the conclusion of the discussion, objective raised a number of complex the Committee voted to authorize and and interrelated issues that required condirect the Federal Reserve Bank of New siderable further discussion. The Com- York, until it was instructed otherwise, mittee reached no decisions on these to execute transactions in the System issues at this meeting, and participants Account in accordance with the follow- agreed to continue the Committee's ing domestic policy directive: review of communication issues at its meeting in January 2007. The Federal Open Market Committee seeks monetary and financial conditions that The meeting adjourned at 1:30 p.m. will foster price stability and promote sustainable growth in output. To further its long- Notation Vote run objectives, the Committee in the immediate future seeks conditions in reserve By notation vote completed on Octomarkets consistent with maintaining the fed- ber 10, 2006, the Committee unanieral funds rate at an average of around mously approved the minutes of the 5lA percent. FOMC meeting held on September 20, The vote encompassed approval of 2006. the text below for inclusion in the state- Vincent R. Reinhart ment to be released at 2:15 p.m.: Secretary Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

220 93rd Annual Report, 2006 Meeting Held on Messrs. Clouse and English, Associate December 12, 2006 Directors, Division of Monetary Affairs, Board of Governors A meeting of the Federal Open Market Ms. Liang and Mr. Slifman, Associate Committee was held in the offices of the Directors, Division of Research Board of Governors of the Federal and Statistics, Board of Governors Reserve System in Washington, D.C., Messrs. Gagnon and Wascher, Deputy on Tuesday, December 12, 2006 at Associate Directors, Divisions of 8:30 a.m. International Finance and Research and Statistics, respectively, Board of Governors Present: Mr. Bernanke, Chairman Mr. Dale, Senior Adviser, Division Mr. Geithner, Vice Chairman of Monetary Affairs, Board of Ms. Bies Governors Mr. Kohn Mr. Gross, Special Assistant to the Mr. Kroszner Board, Office of Board Members, Mr. Lacker Board of Governors Mr. Mishkin Ms. Pianalto Mr. Luecke, Senior Financial Analyst, Mr. Warsh Division of Monetary Affairs, Ms. Yellen Board of Governors Ms. Cumming, Mr. Hoenig, Ms. Mine- Mr. Driscoll, Economist, Division of han, and Messrs. Moskow and Monetary Affairs, Board of Poole, Alternate Members of the Governors Federal Open Market Committee Ms. Low, Open Market Secretariat Spe- Messrs. Fisher, Plosser, and Stern, cialist, Division of Monetary Presidents of the Federal Reserve Affairs, Board of Governors Banks of Dallas, Philadelphia, and Mr. Rasdall, First Vice President, Fed- Minneapolis, respectively eral Reserve Bank of Kansas City Mr. Barron, First Vice President, Fed- Mr. Rosenblum, Executive Vice Presieral Reserve Bank of Atlanta dent, Federal Reserve Bank of Mr. Reinhart, Secretary and Economist Dallas Ms. Danker, Deputy Secretary Mr. Hakkio, Mses. Mester and Perelmuter, and Messrs. Rasche, Ms. Smith, Assistant Secretary Rolnick, and Williams, Senior Vice Presidents, Federal Reserve Mr. Skidmore, Assistant Secretary Banks of Kansas City, Philadelphia, New York, St. Louis, Minne- Mr. Alvarez, General Counsel apolis, and San Francisco, respec- Mr. Baxter, Deputy General Counsel tively Messrs. Kahn and Sullivan, Vice Presi- Ms. Johnson, Economist dents, Federal Reserve Banks of Mr. Stockton, Economist New York and Chicago, respectively Messrs. Connors, Eisenbeis, Kamin, Mr. Olivei, Senior Economist, Federal Madigan, Sniderman, Struck- Reserve Bank of Boston meyer, Weinberg, and Wilcox, Associate Economists The Manager of the System Open Mr. Kos, Manager, System Open Mar- Market Account (SOMA) reported on ket Account recent developments in foreign ex- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 221 change markets. There were no open Industrial production (IP) declined in market operations in foreign currencies September but rose slightly in October. for the System's account in the period In October, total industrial production since the previous meeting. The Man- was boosted by a weather-related reager also reported on developments in bound in electricity generation, while domestic financial markets and on output in the mining sector posted a System open market transactions in sizable gain as crude oil extraction in government securities and federal Alaska returned to full production folagency obligations during the period lowing pipeline repairs. Manufacturing since the previous meeting. By unani- output fell in both months, partly bemous vote, the Committee ratified these cause of cutbacks in motor vehicle protransactions. duction as vehicle makers pared elevated inventories in light trucks. The information reviewed at the Although less pronounced than in the December meeting suggested that ecomotor vehicle sector, the recent softness nomic activity was increasing at a subin factory output was also apparent in a dued rate during the second half of the number of other sectors. A notable exyear. The contraction in homebuilding ception was production in high-tech was continuing to restrain overall activindustries, which posted another solid ity, and a step-down in motor vehicle increase in October, reflecting a pickup output held down industrial production. in computer output and a rise in semi- In contrast, consumer spending and conductor production attributable to the business investment were increasing at a rollout of a new generation of micromoderate rate, and payroll employment processors. expanded solidly through November. The National Income and Product Additional sharp declines in energy Accounts for the third quarter incorpoprices reduced total consumer price inrated an estimate by the Bureau of Ecoflation in October, but the twelve-month nomic Analysis (BEA) that gross output change in core prices remained above its of new motor vehicles increased at a year-earlier level. rapid pace in the third quarter, a sharp Indicators from the labor market were contrast to a drop in the IP index for generally strong through November. motor vehicles (including parts produc- Nonfarm payrolls increased at a solid tion) for that same period. Much of that pace, while revisions to previous estidifference could be attributed to the mates showed a larger gain, on balance, BEA's method of inferring motor vehiover the preceding two months. Em- cle output from separate data on sales, ployment in manufacturing and con- net international trade, and changes in struction industries fell in November, inventories rather than measuring output but hiring continued to be brisk in the directly using data on production. In professional and nonbusiness service addition, a large drop in the producer industries. Aggregate weekly hours of price index for light trucks in the third private production or nonsupervisory quarter resulted in a jump in the BEA's workers edged up. The unemployment implied unit values of light trucks in rate had fallen to 4.4 percent in October inventory. In the staffs view, these meabut ticked back up to 4.5 percent in surement issues likely caused an over- November, remaining below the average statement of the rate of increase in real of 4.7 percent during the first three quar- GDP in the third quarter, and the gradual ters of the year. unwinding of those effects would prob- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

222 93rd Annual Report, 2006 ably lead to an understatement of real gested a slowdown in spending, in part GDP growth over the next several reflecting the deceleration in business quarters. output. Business purchases of motor Real consumer spending increased vehicles were likely to continue to be strongly in October after a more modest boosted by an increase in spending in gain in September. Although purchases advance of the upcoming change in of motor vehicles weakened in October, regulations on truck engines from the outlays on a broad range of other cate- Environmental Protection Agency. gories of goods, including gasoline, Although spending on high-tech capital food, and apparel, rose briskly. Spurred goods and software expanded at a robust by sharp declines in consumer energy pace in the third quarter, data on new prices, real disposable income also orders and shipments in October pointed increased rapidly in September and to more moderate growth in the fourth October. Despite the further decelera- quarter. Growth of nonresidential contion in house prices, the ratio of house- struction spending appeared to have hold wealth to disposable income slowed from a rapid rate earlier in the remained well above its historical aver- year, responding in part to still-high vaage, buoyed by robust gains in the stock cancy rates in the office and industrial market. Readings on consumer senti- categories. The number of natural gas ment edged down in November and and petroleum drilling rigs in operation early December but stayed above levels had moved down, on balance, since Sepseen in the summer. tember in response to the moderation in Residential construction activity con- energy prices. tinued to be very weak. Single-family Unit stocks of light motor vehicles housing starts dropped substantially in dropped in the third quarter. Outside the October after a slight increase in Sep- motor vehicle sector, real nonfarm tember, while new permit issuance fell inventories edged up, and the ratio of to nearly its lowest level in the past ten book-value inventories to sales for both years. Construction in the much-smaller the manufacturing and trade sectors rose multifamily sector continued to fluctu- in September to levels last seen in midate within a range that had prevailed for 2005. Inventory imbalances appeared the past several years. Inventories of more widespread than a few months unsold homes remained high in October earlier, although business surveys but were a bit lower than those in pre- through November indicated that a large ceding months. Sales of new and exist- majority of firms perceived that their ing homes showed tentative signs of customers' inventories remained at comstabilizing, although at levels well be- fortable levels. low their mid-2005 peaks. Price appre- The U.S. international trade deficit ciation of existing homes continued to declined in September from a record slow in the third quarter, and some price level in August. The narrowing primameasures showed outright declines. rily reflected a sharp falloff in the value Real spending on equipment and soft- of imported oil, although non-oil imware continued to increase at a solid ports, including industrial supplies, capipace in the third quarter, supported by tal goods, and automotive products, also strong corporate cash positions and a declined. Export growth in September low cost of capital. Early indicators for was led by aircraft and industrial supthe fourth quarter, including survey plies, while exports of automotive prodmeasures of business conditions, sug- ucts, consumer goods, and semiconduc- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 223 tors fell. The trade deficit shrank a bit been driven by transitory factors. Hourly further in October. compensation of private industry work- Economic activity in the advanced ers, as measured by the employment foreign economies rose at a moderate cost index, increased at a somewhat rate in the third quarter. The expansion faster rate in the three months ending in in real activity in the euro area, although September than it had in preceding slower than the staff had expected, was quarters. supported by strong domestic demand. At its October meeting, the Federal Canada's real GDP growth was dragged Open Market Committee (FOMC) dedown by weakness in inventories and cided to maintain its target for the fedgovernment spending, while slumping eral funds rate at 5lA percent. The Comprivate consumption weighed on growth mittee's accompanying statement in Japan. The U.K. economy, buoyed by indicated that economic growth had strong investment, continued to expand slowed over the course of the year, solidly. Recent economic indicators for partly reflecting a cooling of the housthe developing economies were some- ing market. Going forward, the econwhat mixed but suggested generally omy seemed likely to expand at a modbrisk growth in the third quarter. erate pace. Readings on core inflation The overall price index for personal had been elevated, and the high level of consumption expenditures fell in Sep- resource utilization had the potential to tember and October, reflecting sharp sustain inflation pressures. However, indeclines in energy prices in both flation pressures seemed likely to modmonths; the declines left the change in erate over time, reflecting reduced impethat index over the twelve months end- tus from energy prices, contained ing in October substantially lower than inflation expectations, and the cumulaover the preceding twelve-month period. tive effects of monetary policy actions In contrast, the change in the core price and other factors restraining aggregate index for personal consumption expen- demand. Nonetheless, the Committee ditures over the twelve months ending judged that some inflation risks in October was still somewhat higher remained. The extent and timing of any than it was a year earlier, largely reflect- additional firming that might be needed ing an acceleration in shelter costs over to address these risks would depend on that period. The producer price index for the evolution of the outlook for both core intermediate materials was flat in inflation and economic growth, as im- October. Increases in average hourly plied by incoming information. earnings had been moderate in recent Investors had largely anticipated the months, and compensation per hour in FOMC's decision at its October meeting the nonfarm business sector appeared to to leave the target federal funds rate have risen at a subdued rate in the third unchanged and to make only modest quarter. The estimated increase in hourly changes in the accompanying policy compensation for the second quarter had statement. As a result, the announcebeen revised down substantially; hourly ment of the decision elicited little marcompensation was now estimated to ket reaction, as did the subsequent pubhave declined in the second quarter fol- lication of the minutes of the meeting. lowing the sharp gain recorded in the However, somewhat weaker-than-anticfirst quarter. This uneven pattern sug- ipated economic data over the intermeetgested that the surge in hourly compen- ing period apparently led to some softsation in the first quarter had largely ening of investors' perception of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

224 93rd Annual Report, 2006 economic outlook. As a result, the likely increases, and the emergence of a small pace and extent of policy easing amount of slack in the economy. expected by investors increased, and In their discussion of the economic yields on nominal and inflation-indexed situation and outlook, meeting partici- Treasury coupon securities fell. Infla- pants noted that their assessments of the tion compensation measures were little medium-term prospects for economic changed. Spreads of investment-grade growth and inflation were little changed corporate bond yields over those of from the previous meeting. Incoming comparable-maturity Treasury securities indicators of near-term activity had been remained about unchanged, while those mixed, with some spending and producon speculative-grade corporate bonds tion data pointing to a more subdued rose a bit. Broad equity indexes showed picture than that suggested by the stillsolid gains. The foreign exchange value solid labor market data. Many participants judged that economic activity in of the dollar against other major currenthe second half of this year was probcies fell, on net, over the intermeeting ably a touch softer than had been period, with pronounced declines expected at the time of the October against the euro and sterling. meeting. But looking over the next year Debt of the domestic nonfinancial or so, participants continued to expect sectors in the third quarter expanded at the economy to expand at a rate close to around its second-quarter pace. Busior a little below the economy's long-run ness debt rose slightly more slowly than sustainable pace. The ongoing adjustin the second quarter, in part reflecting ment of the housing market was likely reduced borrowing in the bond and comto damp economic growth in the near mercial paper markets. In the household term, but this effect was expected to sector, mortgage debt increased at its dissipate, and spending in other categolowest pace since the late 1990s, reflectries looked set to expand at a reasonably ing the continued deceleration in house good pace. Although readings on core prices. M2 rose more strongly in Octoinflation had improved modestly since ber and November than it had in precedthe spring, price pressures were not yet ing months. viewed as convincingly on a downward The staff forecast prepared for this trend. Most participants expected core meeting indicated that growth in eco- inflation to moderate slowly over time, nomic activity had slowed to a pace but stressed that the risks to the inflation below that of the economy's long-run outlook remained to the upside. potential in the second half of 2006, In their discussion of the major secpartly as a result of the ongoing adjust- tors of the economy, participants noted ment of the housing sector. The rate of that developments in the housing market increase in real GDP was expected to continued to weigh heavily on economic pick up gradually as the drag from the activity. Housing starts and permits for contraction in residential construction new construction had dropped sharply diminished, returning towards the end in October, and contacts in the building of 2007 to a rate close to the staff's sector reported that construction firms estimate of potential output growth. were continuing to cancel options on Core inflation was anticipated to edge land purchases. However, there were down in 2007 and 2008 in response to a some indications that home sales might waning of the effects of higher energy be starting to stabilize, aided by a and import prices, a step-down in rent marked slowing in the rate of increase Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 225 of house prices and a decline in mort- very rapid growth earlier in the year, gage rates in recent months. Several par- increases in nonresidential construction ticipants also noted that a range of non- spending could be moderating considerprice incentives and concessions were ably. However, the weaker cast of some being offered by construction firms to of these data contrasted with the sense bolster sales. But even if home pur- of optimism among business contacts. chases had begun to level off, residential Moreover, several participants noted that investment was likely to fall further in contacts within the construction sector coming quarters as homebuilders sought had reported that commercial real estate to reduce their backlogs of unsold activity remained robust, encouraged by homes. lower vacancy rates, some firming in Thus far, the adjustment of activity rents, and accommodative financial conand prices in the housing market did not ditions. Looking further ahead, meeting appear to have spilled over significantly participants expected investment to to consumer spending, which had expand at a solid pace, supported by expanded at a steady pace in recent strong corporate balance sheets and months, buoyed by continued gains in profits and by the ready availability of employment and by a decline in energy funding from financial markets and inprices. Retailers in most Districts stitutions, factors that were expected to expected good sales over the holiday be offset only partially by restraint from season, although some contacts at packslower growth in final sales. age delivery and trucking firms reported Recent data suggested that aggregate that activity was less busy than usual for demand in the rest of the world was this time of year. Participants noted the likely to continue to expand at a somedownward revision to the BEA's estiwhat faster rate than in the United mate of personal income in the second quarter of this year, but nonetheless con- States. Participants noted that the tinued to anticipate consumer expendi- strength of global demand and the recent tures to expand at a steady pace going decline in the foreign exchange value of forward. Growth in consumer spending the dollar should help to support was expected to be supported by favor- increases in U.S. exports. able financial conditions and solid gains The slowing in the pace of economic in income from employment, outweigh- expansion in recent quarters evidenced ing any damping effect of sluggish by the business spending data was also increases in housing wealth. Still, con- apparent in measures of industrial prosiderable uncertainty regarding the ulti- duction. Much of the slowing in producmate extent of the housing market cor- tion had been concentrated in the motor rection meant that spillovers to vehicle sector—as producers had cut asconsumption could become more evi- semblies in order to reduce high invendent, especially if house prices were to tory levels—and in construction-related decline significantly. sectors. But, more recently, inventories Business investment appeared to have had increased in a number of other secdecelerated recently, and surveys and tors, and manufacturing production had orders data pointed to a relatively slow been trimmed in response. Further adrise in equipment and software spending justments remained possible, suggesting over the next few quarters. Incoming an additional source of downside risk to data on construction activity and em- economic growth in the near term. In ployment also suggested that, following contrast, indicators of activity in the ser- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

226 93rd Annual Report, 2006 vices sector implied continued brisk tion. Although readings on core inflagrowth. tion had improved modestly since the Participants noted that recent indica- spring, nearly all participants viewed tors provided mixed signals about the core inflation as uncomfortably high and strength of near-term activity. Solid stressed the importance of further modgains in employment over recent quar- eration. Participants expected core inflaters stood in contrast to the softer pace tion to edge lower over time, in part as of economic expansion suggested by the the pass-through of higher prices for spending and production data. That dif- energy and other commodities ran its ference most likely reflected lags course and as the moderate growth in between movements in activity and em- aggregate demand likely led to a modest ployment, implying that growth in em- easing of pressures on resources. Some ployment would probably slow over the participants also highlighted the impact next quarter or so. Participants sug- that movements in the prices of indigested that other forces might be at work vidual components of the price index, as well. The growth of structural labor such as owners' equivalent rent and productivity could be weaker than cur- medical costs, could have on near-term rently thought, helping to reconcile the readings on core inflation. More genersteady growth in employment with more ally, participants stressed there was consubdued advances in spending and out- siderable uncertainty as to the probable put. Moreover, the recent pace of activ- pace and extent of the moderation in ity may have been stronger than that core inflation and that the risks around indicated by the spending and produc- this desired downward path remained to tion data. With regard to this possibility, the upside. Moreover, participants exit was noted that gross domestic income pressed concern that a failure of inflahad grown substantially more quickly tion to moderate as expected could enthan measured GDP over the past year. tail significant costs if an upward drift in Incoming data and reports from busi- inflation expectations ensued. nesses suggested that the labor market In the Committee's discussion of remained tight. The unemployment rate monetary policy for the intermeeting had moved slightly lower on balance period, nearly all members favored over recent months, and many business keeping the target federal funds rate at contacts reported difficulties in recruit- 5lA percent at this meeting. The outlook ing suitably qualified workers, espe- for economic growth and inflation was cially for certain types of professional thought to have changed relatively little and skilled positions. The downward re- since the previous meeting. Nearly all vision to the estimated increases in labor members felt that maintaining the curcompensation and unit labor costs ear- rent target for now was most likely to lier in the year had eased some partici- foster moderate economic growth and a pants' concerns about the extent of the gradual ebbing of core inflation from its pressures on labor resources. Nonethe- elevated levels. Several members judged less, the possibility that the tightness of that the subdued tone of some incoming the labor market could lead to sustained indicators meant that the downside risks upward pressure on nominal labor costs to economic growth in the near term had was viewed as an upside risk to the increased a little and become a bit more expected moderation in inflation. broadly based than previously thought. All meeting participants remained Nonetheless, all members agreed that concerned about the outlook for infla- the risk that inflation would fail to mod- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 227 erate as desired remained the predomi- The vote encompassed approval of nant concern. the text below for inclusion in the state- In light of the data received over the ment to be released at 2:15 p.m.: intermeeting period, members felt that Nonetheless, the Committee judges that the statement should characterize the some inflation risks remain. The extent and cooling in the housing market as subtiming of any additional finning that may be stantial and should note that recent indi- needed to address these risks will depend on cators had been mixed. The Committee the evolution of the outlook for both inflathought that the statement should reiter- tion and economic growth, as implied by incoming information. ate that the economy seemed likely to expand at a moderate pace, while also Votes for this action: Messrs. Bernanke recognizing the possibility that mea- and Geithner, Ms. Bies, Messrs. Kohn, sured GDP growth could be somewhat Kroszner, and Mishkin, Ms. Pianalto, Messrs. Poole and Warsh, and Ms. uneven in coming quarters. Members Yellen. Votes against this action: agreed that the statement should con- Mr. Lacker tinue to convey that inflation risks remained of greatest concern and that Mr. Lacker dissented because he beadditional policy firming was possible. lieved that further tightening was needed One member did not favor language that to help ensure that core inflation referenced only the possibility of addi- declines to an acceptable rate in coming tional policy firming and believed that, quarters. although the risks to inflation remained Meeting participants briefly reviewed the predominant concern, the statement some issues regarding communications should emphasize that policy could be and the next steps in their continuing adjusted in either direction depending discussion of the topic. At the next on the evolution of the outlook for infla- FOMC meeting, confirmed for Janution and economic growth. ary 30-31, 2007, the Committee intended to consider the role that eco- At the conclusion of the discussion, nomic projections and forecasts can play the Committee voted to authorize and in communicating information. direct the Federal Reserve Bank of New York, until it was instructed otherwise, The meeting adjourned at 1:35 p.m. to execute transactions in the System Account in accordance with the follow- Notation Vote ing domestic policy directive: By notation vote completed on Novem- The Federal Open Market Committee ber 14, 2006, the Committee unaniseeks monetary and financial conditions that will foster price stability and promote sus- mously approved the minutes of the tainable growth in output. To further its long- FOMC meeting held on October 24-25, run objectives, the Committee in the imme- 2006. diate future seeks conditions in reserve markets consistent with maintaining the fed- Vincent R. Reinhart eral funds rate at an average of around Secretary 5V* percent. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

229 Litigation During 2006, the Board of Governors tember 11, 2006, the court of appeals was a party in two lawsuits or appeals affirmed in part and reversed in part the filed that year and was a party in five ruling of the district court, and reother cases pending from previous years, manded the case. 463 F.3d 239. for a total of seven cases; in 2005, the Price v. Bernanke, No. 05-5361 (D.C. Board had been a party in a total of Circuit, filed September 29, 2005), was thirteen cases. As of December 31, an appeal of an order of the district court 2006, five cases were pending. (No. 04-CV-0973, 374 F. Supp. 2d 177) Price v. Bernanke, No. 06-1569 dismissing an employment discrimina- (D.D.C., filed September 8, 2006), is an tion action. On December 15, 2006, the employment discrimination action. court of appeals affirmed the district Texas State Bank v. United States, No. court's dismissal. 470 F.3d 384. 05-1168 (U.S. Supreme Court, filed Barnes v. Greenspan, No. 04-CV- March 10, 2006), was an appeal of a 1989 (CKK) (D.D.C., filed November decision of the Court of Appeals for the 15, 2004), is a case under the Age Dis- Federal Circuit dismissing an action crimination in Employment Act. challenging on constitutional grounds Jones v. Greenspan, No. 04-CV-1696 the failure to pay interest on reserve (RMU) (D.D.C., filed October 4, 2004), accounts held at Federal Reserve Banks. is an employment discrimination action. On June 19, 2006, the Supreme Court On December 13,2005, the district court denied certiorari. 126 S. Ct. 2889. granted in part and denied in part the Inner City Press/Community on the Board's motion to dismiss and for sum- Move v. Board of Governors, No. 05- mary judgment. 402 F. Supp. 2d 294. 6162 (Second Circuit, filed November Artis v. Greenspan, No. 01-0400 21, 2005), is an appeal of the district (D.D.C., filed February 22, 2001), is an court's order (No. 04-CV-8337, 380 F. employment discrimination action. An Supp. 2d 211 (S.D.N.Y. 2005)) granting identical action, No. 99-2073 (EGS) in part and denying in part the Board's (D.D.C., filed August 3,1999), was conmotion for summary judgment in a Free- solidated with this action on August 15, dom of Information Act case. On Sep- 2001. • 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 233 Board of Governors December 31, 2006 Members STEPHEN H. MEYER, Assistant General Term expires Counsel January 31, PATRICIA A. ROBINSON, Assistant General BEN S. BERNANKE, Chairman1 2020 Counsel DONALD L. KOHN, Vice Chairman1 .. 2016 CARY K. WILLIAMS, Assistant General SUSAN S. BIES 2012 Counsel KEVIN M. WARSH 2018 RANDALL S. KROSZNER 2008 OFFICE OF THE SECRETARY FREDERIC S. MISHKIN 2014 JENNIFER J. JOHNSON, Secretary 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, Assistant to Director the Board for Public Information RICHARD T. FREEMAN, Associate Director DAVID W. SKIDMORE, Assistant to the STEVEN B. KAMIN, Associate Director Board DALE W. HENDERSON, Senior Adviser LARICKE D. BLANCHARD, Special Assistant JOSEPH E. GAGNON, Deputy Associate to the Board for Congressional Liaison Director BRIAN J. GROSS, Special Assistant to the MICHAEL P. LEAHY, Deputy Associate Board for Congressional Liaison Director ROBERT M. PRIBBLE, Special Assistant to D. NATHAN SHEETS, Deputy Associate the Board for Congressional Liaison Director RALPH W. TRYON, Deputy Associate LEGAL DIVISION Director SCOTT G. ALVAREZ, General Counsel JON W. FAUST, Assistant Director RICHARD M. ASHTON, Deputy General TREVOR A. REEVE, Assistant Director Counsel JOHN ROGERS, Assistant Director KATHLEEN M. O'DAY, Deputy General Counsel STEPHANIE MARTIN, Associate General DIVISION OF MONETARY AFFAIRS Counsel VINCENT R. REINHART, Director ANN MISBACK, Associate General Counsel BRIAN F. MADIGAN, Deputy Director JAMES A. CLOUSE, Associate Director KATHERINE H. WHEATLEY, Associate General Counsel DEBORAH J. DANKER, Associate Director KIERAN J. FALLON, Assistant General WILLIAM B. ENGLISH, Associate Director Counsel ATHANASIOS ORPHANIDES, Senior Adviser CHERYL L. EDWARDS, Deputy Associate Director 1. The designations as Chairman and Vice Chairman expire on January 31, 2010, and June ANDREW T. LEVIN, Assistant Director 22, 2010, respectively, unless the service of these WILLIAM NELSON, Assistant Director members of the Board terminates sooner. JONATHAN H. WRIGHT, Assistant Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

234 93rd Annual Report, 2006 Board of Governors—Continued DIVISION OF RESEARCH NORAH M. BARGER, Associate Director AND STATISTICS BETSY CROSS, Associate Director DAVID J. STOCKTON, Director GERALD A. EDWARDS, JR., Associate Director PATRICK M. PARKINSON, Deputy Director DAVID W. WILCOX, Deputy Director CHARLES H. HOLM, Associate Director MYRON L. KWAST, Senior Associate JACK P. JENNINGS II, Associate Director Director ROBIN L. LUMSDAINE, Associate Director J. NELLIE LIANG, Associate Director PETER J. PURCELL, Associate Director and Chief Technology Officer LAWRENCE SLIFMAN, Associate Director WILLIAM G. SPANIEL, Associate Director CHARLES S. STRUCKMEYER, Associate Director MOLLY S. WASSOM, Associate Director DAVID M. WRIGHT, Associate Director ALICE PATRICIA WHITE, Associate Director GLENN B. CANNER, Senior Adviser BARBARA J. BOUCHARD, Deputy Associate Director DAVID S. JONES, Senior Adviser STEPHEN D. OLINER, Senior Adviser JAMES A. EMBERSIT, Deputy Associate Director S. WAYNE PASSMORE, Deputy Associate Director JON D. GREENLEE, Deputy Associate Director DAVID L. REIFSCHNEIDER, Deputy Associate Director ARTHUR W. LINDO, Deputy Associate Director JANICE SHACK-MARQUEZ, Deputy Associate Director WILLIAM C. SCHNEIDER, JR., Deputy Associate Director WILLIAM L. WASCHER III, Deputy Associate Director ROBERT T. ASHMAN, Assistant Director JOYCE K. ZICKLER, Deputy Associate KEVIN M. BERTSCH, Assistant Director Director STACY LEE COLEMAN, Assistant Director MICHAEL S. CRINGOLI, Assistant Director ROBERT T. MAAS, Assistant Director and Chief NINA A. NICHOLS, Assistant Director MICHAEL S. GIBSON, Assistant Director DANA E. PAYNE, Assistant Director and Chief NANCY J. PERKINS, Assistant Director DIANA HANCOCK, Assistant Director SABETH I. SIDDIQUE, Assistant Director and Chief DIVISION OF CONSUMER ROBIN A. PRAGER, Assistant Director AND COMMUNITY AFFAIRS and Chief SANDRA F. BRAUNSTEIN, Director DOUGLAS W. ELMENDORF, Assistant GLENN E. LONEY, Deputy Director Director LEONARD CHANIN, Associate Director DANIEL E. SICHEL, Assistant Director ADRIENNE D. HURT, Associate Counsel MARY M. WEST, Assistant Director and Adviser DIVISION OF BANKING SUPERVISION MARY T. JOHNSEN, Associate Director AND REGULATION TONDA E. PRICE, Associate Director ROGER T. COLE, Acting Director MARYANN F. HUNTER, Adviser STEVEN M. ROBERTS, Senior Adviser TIMOTHY R. BURNISTON, Assistant Director WILLIAM F. TREACY, Adviser SUZANNE G. KILLIAN, Assistant Director SARKIS YOGHOURTDJIAN, Adviser SHEILA F. MAITH, Assistant Director DEBORAH P. BAILEY, Associate Director JAMES A. MICHAELS, Assistant Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 235 Board of Governors—Continued DIVISION OF DIVISION OF RESERVE BANK OPERATIONS INFORMATION TECHNOLOGY AND PAYMENT 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 JEFF J. STEHM, Deputy Associate Director SHARON L. MOWRY, Assistant Director GREGORY L. EVANS, Assistant Director RAYMOND ROMERO, Assistant Director LISA HOSKINS, Assistant Director JILL R. ROSEN, Assistant Director MICHAEL J. LAMBERT, Assistant Director OFFICE OF INSPECTOR GENERAL OFFICE OF STAFF DIRECTOR BARRY R. SNYDER, Inspector General FOR MANAGEMENT ANTHONY J. CASTALDO, Assistant 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 TODD A. GLISSMAN, Senior Associate Director MARSHA W. REIDHILL, Senior Associate Director BILLY J. SAULS, Senior Associate Director DONALD A. SPICER, Senior Associate Director CHRISTINE M. FIELDS, Associate Director JAMES R. RIESZ, Deputy Associate Director KEITH F. BATES, Assistant Director ELAINE M. BOUTILIER, Assistant Director TARA C. TINSLEY JONES, Assistant Director CHARLES F. O'MALLEY, Assistant Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

236 93rd Annual Report, 2006 Federal Open Market Committee December 31,2006 Members Officers BEN S. BERNANKE, 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 DAVID W. SKIDMORE, Assistant Secretary SUSAN SCHMIDT BIES, Board of Governors SCOTT G. ALVAREZ, General Counsel DONALD L. KOHN, Board of Governors THOMAS C. BAXTER, JR., Deputy General RANDALL S. KROSZNER, Board of Counsel Governors KAREN H. JOHNSON, Economist JEFFREY M. LACKER, President, Federal DAVID J. STOCKTON, Economist Reserve Bank of Richmond THOMAS A. CONNORS, Associate Economist FREDERIC S. MISHKIN, Board of Governors ROBERT A. EISENBEIS, Associate Economist SANDRA PIANALTO, President, Federal JOHN P. JUDD, Associate Economist Reserve Bank of Cleveland STEPHEN B. KAMIN, Associate Economist KEVIN M. WARSH, Board of Governors BRIAN F. MADIGAN, Associate Economist JANET L. YELLEN, President, Federal MARK S. SNIDERMAN, Associate Economist Reserve Bank of San Francisco CHARLES S. STRUCKMEYER, Associate Alternate Members Economist CHRISTINE M. CUMMING, First Vice JOSEPH S. TRACY, Associate Economist President, Federal Reserve Bank of JOHN A. WEINBERG, Associate Economist New York DAVID W. WILCOX, Associate Economist THOMAS M. HOENIG, President, Federal DINO Kos, Manager, System Open Market Reserve Bank of Kansas City Account CATHY E. MINEHAN, President, Federal During 2006 the Federal Open Market Com- Reserve Bank of Boston mittee held eight regularly scheduled meet- MICHAEL H. MOSKOW, President, Federal ings (see "Minutes of Federal Open Market Reserve Bank of Chicago Committee Meetings" in this volume). WILLIAM POOLE, President, Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 237 Federal Advisory Council December 31, 2006 Members District 10—DAVID C. BOYLES, Chairman, Guaranty Bank and Trust Company, District 1—JAMES C. SMITH, Chairman and Denver, Colo. Chief Executive Officer, Webster Bank, N.A. and Webster Financial Corporation, District 11—JAMES GOUDGE, Chairman and Waterbury, Conn. Chief Executive Officer, Broadway Bank, District 2—THOMAS A. RENYI, Chairman San Antonio, Tex. and Chief Executive Officer, The Bank of District 12—RICHARD M. KOVACEVICH, New York, New York, N.Y. Chairman, President, and Chief Executive District 3—TED T. CECALA Chairman and Officer, Wells Fargo and Company, San Chief Executive Officer, Wilmington Trust Francisco, Calif. Company, Wilmington, Del. Officers District 4—GEORGE A. SCHAEFER, JR., President and Chief Executive Officer, THOMAS A. RENYI, President Fifth Third Bancorp, Cincinnati, Ohio. DENNIS J. KUESTER, 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 III, 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, Chairman representative from each Federal Reserve and Chief Executive Officer, Marshall & District, chosen by the Reserve Bank in that Ilsley 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 2006, it met on First Horizon National Corporation, February 9-10, May 11-12, September 7-8, Memphis, Tenn. and November 30-December 1. The council met with the Board on February 10, May 12, District 9—LYLE R. KNIGHT, President and September 8, and December 1, 2006. Chief Executive Officer, First Interstate BancSystem, Inc., Billings, Mont. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

238 93rd Annual Report, 2006 Consumer Advisory Council December 31,2006 Members JOSHUA PEIREZ, Senior Vice President and Associate General Counsel, MasterCard STELLA ADAMS, Executive Director, North International, Purchase, N.Y. Carolina Fair Housing Center, Durham, N.C. ANNA MCDONALD RENTSCHLER, BSA Officer, Central Bancompany, Jefferson City, DENNIS L. ALGIERE, Senior Vice President, Mo. The Washington Trust Company, FAITH ARNOLD SCHWARTZ, Senior Vice Westerly, R.L President, Enterprise Risk Management FAITH L. ANDERSON, Vice President—Legal and Public Affairs, Option One Mortgage Compliance and General Counsel, Corporation, Washington, D.C. American Airlines Federal Credit Union, Fort Worth, Tex. MARY JANE SEEBACH, Managing Director, Public Affairs, Countrywide Financial DOROTHY BRIDGES, Chief Executive Officer Corporation, Calabasas, Calif. and President, Franklin National Bank of EDWARD SIVAK, Director of Policy and Minneapolis, Minneapolis, Minn. Evaluation, Enterprise Corporation of the TONY T. BROWN, President and Chief Delta, Jackson, Miss. Executive Officer, Uptown Consortium, PAUL J. SPRINGMAN, Chief Marketing Offi- Inc., Cincinnati, Ohio cer, Equifax, Atlanta, Ga. SHEILA CANAVAN, Consumer Attorney, Law FORREST F. STANLEY, Senior Vice President Office of Sheila Canavan, Moab, Utah and Deputy General Counsel, KeyBank CAROLYN CARTER, Attorney, National Con- National Association, Cleveland, Ohio sumer Law Center, Boston, Mass. ANSELMO VILLARREAL, Executive Director, MICHAEL COOK, Vice President, Wal-Mart LaCasa de Esperanza, Inc., Waukesha, Wis. Stores, Inc., Bentonville, Ark. ALAN WHITE, Supervising Attorney, Com- DONALD S. CURRIE, Executive Director, munity Legal Services, Philadelphia, Pa. Community Development Corporation of MARVA E. WILLIAMS, Senior Vice President, Brownsville, Brownsville, Tex. Woodstock Institute, Chicago, 111. ANNE DIEDRICK, Senior Vice President, JPMorgan Chase Bank, New York, N.Y. HATTIE B. DORSEY, President and Chief Officers Executive Officer, Atlanta Neighborhood LORI SWANSON, Chair, Solicitor General, Development Partnership, Atlanta, Ga. Office of the Minnesota Attorney Gen- KURT EGGERT, Professor of Law and Direc- eral, St. Paul, Minn. tor of Clinical Legal Education, Chapman LISA SODEIKA, Vice Chair, Executive Vice University School of Law, Orange, Calif. President—Corporate Affairs, HSBC DEBORAH HICKOK, Vice President, North America Holdings, Inc., Prospect MoneyGram Payment Systems, Inc., Heights, 111. Ooltewah, Tenn. The Consumer Advisory Council—a statu- SARAH LUDWIG, Director, Neighborhood tory body established pursuant to the 1976 Economic Development Advocacy amendments to the Equal Credit Opportunity Project, New York, N.Y. Act—advises the Board of Governors on consumer financial services. Its members, MARK K. METZ, Senior Vice President and who are appointed by the Board, are aca- Deputy General Counsel, Wachovia demics, state and local government officials, Corporation, Charlotte, N.C. and representatives of the financial services BRUCE B. MORGAN, Chairman, President, industry and of consumer and community and Chief Executive Officer, Valley State interests. In 2006, the council met with members of the Board on March 30, June 22, and Bank, Roeland Park, Kans. October 26. LANCE MORGAN, President, Ho-Chunk, Digitized foIrn FcRoArpSoErRat ed, Winnebago Tribe of http://fraserN.setlboruaisskfead, .Worgin/ nebago, Neb. Federal Reserve Bank of St. Louis

Federal Reserve System Organization 239 Thrift Institutions Advisory Council December 31, 2006 Members STEVEN SWIONTEK, Chairman, President, and Chief Executive Officer, Gate City FRANK E. BERRISH, President and Chief Bank, Fargo, N.D. Executive Officer, Visions Federal Credit Union, Endicott, N.Y. DAVID RUSSELL TAYLOR, President and CRAIG G. BLUNDEN, Chairman, President, Chief Executive Officer, Rahway Savings and Chief Executive Officer, Provident Institution, Rahway, N.J. Savings Bank, FSB, Riverside, Calif. ROY M. WHITEHEAD, President and Chief ALEXANDER R.M. BOYLE, Vice Chairman, Executive Officer, Washington Federal Chevy Chase Bank, Bethesda, Md. Savings, Seattle, Wash. JEFFREY H. FARVER, President and Chief Executive Officer, San Antonio Federal Officers Credit Union, San Antonio, Tex. ROY M. WHITEHEAD, President A. THOMAS HOOD, President and Chief Executive Officer, First Federal Savings DAVID RUSSELL TAYLOR, Vice President and Loan Association, Charleston, S.C. The Thrift Institutions Advisory Council was KENNETH KORANDA, President, Mid established by the Board of Governors to America Bank, Downers Grove, 111. consult with, and advise, the Board on issues ARKADI KUHLMANN, Chairman, President, pertaining to the thrift industry and on other and Chief Executive Officer, ING matters within the Board's jurisdiction. Its DIRECT USA, Wilmington, Del. members, who are appointed by the Board, DAVID E. POULSEN, President and Chief represent credit unions, savings and loan Executive Officer, American Express associations, and savings banks. In 2006, the Centurion Bank, Salt Lake City, Utah council met with the Board on March 3, GEORGE JEFFREY RECORDS, JR., Chairman July 7, and December 8. and Chief Executive Officer, MidFirst Bank, Oklahoma City, Okla. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

240 93rd Annual Report, 2006 Federal Reserve Banks and Branches December 31,2006 Officers Chairman1 President Officer BANK or Branch Deputy Chairman First Vice President in charge of Branch BOSTON2 Blenda J. Wilson Cathy E. Minehan Lisa M. Lynch Paul M. Connolly NEWYORK2 John E. Sexton Timothy F. Geithner Jerry I. Speyer Christine M. Cumming Buffalo Alphonso O'Neil- Kausar Hamdani White PHILADELPHIA Doris M. Damm Charles I. Plosser William F. Hecht William H. Stone, Jr. CLEVELAND2 Charles E. Bunch Sandra Pianalto Tanny B. Crane R. Chris 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 Sarah G. Green Baltimore William C. Handorf David Beck Charlotte JimLowry Jeffrey S. Kane ATLANTA David M. Ratcliffe Vacant V. Larkin Martin Patrick K. Barron3 Birmingham W. Miller Welborn Lee C. Jones Jacksonville Linda H. Sherrer Christopher L. Oakley Miami Brian E. Keeley Juan del Busto Nashville David Williams II Melvyn K. Purcell New Orleans Ben Tom Roberts Robert J. Musso CHICAGO2 Miles D. White Michael H. Moskow John A. Canning, Jr. Gordon Werkema Detroit Roger A Crecc Glenn Hansen ST. LOUIS Walter L. Metcalfe, Jr. William Poole Irl F. Engelhardt David A. Sapenaro Little Rock Sonja Yates Hubbard Robert A. Hopkins Louisville John L. Huber Maria Gerwing Hampton Memphis Russell Gwatney Martha Perine Beard MINNEAPOLIS Frank L. Sims Gary H. Stern James J. Hynes James M. Lyon Helena Dean Folkvord Samuel H. Gane Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 241 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 Lu M. Cordova Richard K. Rasdall, Jr. Denver Thomas Williams Michael Orlando Oklahoma City Richard K. Ratcliffe Chad Wilkerson Omaha James A. Timmerman Jason Henderson DALLAS Ray L. Hunt Richard W Fisher Anthony R. Chase Helen E. Holcomb El Paso Ron C. Helm Robert W Gilmer Houston Lupe Fraga Robert Smith III San Antonio , Elizabeth Chu Richter D. Karen Diaz SAN FRANCISCO 2 David K.Y. Tang Janet L. Yellen T. Gary Rogers John F. Moore Los Angeles James L. Sanford Mark L. Mullinix Portland James H. Rudd Mary E. Lee Salt Lake City William C. Glynn Andrea P. Wolcott Seattle Mic R. Dinsmore Mark A. Gould 1. The chairman of a Federal Reserve Bank serves, by York; East Rutherford, New Jersey; Des Moines, Iowa; statute, as Federal Reserve agent. Midway at Bedford Park, Illinois; and Phoenix, Arizona. 2. Additional offices of these Banks are located at 3. Served as acting president as of October 1, 2006, Windsor Locks, Connecticut; Utica at Oriskany, New following the retirement of Jack Guynn. 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 May 31 Cathy E. Minehan, president of the Fedand June 1, and on November 29 and 30, eral Reserve Bank of Boston, served as chair 2006. of the conference in 2006, and Sandra The members of the executive com- Pianalto, president of the Federal Reserve mittee of the Conference of Chairmen dur- Bank of Cleveland, served as vice chair. ing 2006 were John E. Sexton, chair; Charles Jacqueline P. Palladino, of the Federal E. Bunch, vice chair; and Robert A. Funk, Reserve Bank of Boston, served as secretary, member. and Gregory L. Stefani, of the Federal On November 30, the conference elected Reserve Bank of Cleveland, served as assisits executive committee for 2007, naming tant secretary. Robert A. Funk as chair; V. Larkin Martin as On November 1, 2006, the conference vice chair; and Miles D. White as the third elected Sandra Pianalto as chair for 2007-08 member. and Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, as vice chair. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

242 93rd Annual Report, 2006 Conference of cers, directors, or employees of any bank or First Vice Presidents bank holding company. In addition, Class C directors may not be stockholders of any The Conference of First Vice Presidents of bank or bank holding company. the Federal Reserve Banks was organized in For the election of Class A and Class B 1969 to meet periodically for the consider- directors, the member banks of each Fedation of operations and other matters. eral Reserve District are classified into Helen E. Holcomb, first vice president of three groups. Each group, which comprises the Federal Reserve Bank of Dallas, served banks with similar capitalization, elects one as chair of the conference in 2006, and James Class A director and one Class B director. M. Lyon, first vice president of the Federal Annually, the Board of Governors designates Reserve Bank of Minneapolis, served as vice one of the Class C directors as chair of chair. Harvey R. Mitchell, of the Federal the board and Federal Reserve agent of Reserve Bank of Dallas, served as secretary, each District Bank, and it designates another and Sheryl Britsch, of the Federal Reserve Class C director as deputy chair. Bank of Minneapolis, served as assistant Federal Reserve Branches have either five secretary. or seven directors, a majority of whom are appointed by the parent Federal Reserve Bank; the others are appointed by the Board Directors of Governors. One of the directors appointed Each Federal Reserve Bank has a nine- by the Board is designated annually as chair member board: three Class A and three of the board of that Branch in a manner Class B directors, who are elected by the prescribed by the parent Federal Reserve stockholding member banks, and three Bank. Class C directors, who are appointed by the The chairs and deputy chairs of the Board of Governors. Reserve Bank boards of directors, and the Class A directors represent the stockhold- chairs of the Branches, are listed in the preing member banks in each Federal Reserve ceding table, titled "Officers." The directors District. Class B and Class C directors repre- of the Banks and Branches are listed in the sent the public and are chosen with due, but following table. For each director, the class not exclusive, consideration to the interests of directorship, the director's principal orgaof agriculture, commerce, industry, services, nizational affiliation, and the date the direclabor, and consumers; they may not be offi- tor's term expires are shown. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 243 Directors BANK or BRANCH, Category Title Term expires Name Dec. 31 DISTRICT 1—BOSTON RESERVE BANK Class A 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 Kathleen C. Marcum President and Chief Executive Officer, Millbury 2008 National Bank, Millbury, Massachusetts Class B KirkRPond Former President, Chief Executive Officer, 2006 and Chairman, Fairchild Semiconductor International, South Portland, Maine Robert K. Kraft Chairman and Chief Executive Officer, 2007 The Kraft Group, Foxborough, Massachusetts Michael T. Wedge Former President and Chief Executive Officer, 2008 BJ's Wholesale Club, Inc., Natick, Massachusetts Class C Lisa M. Lynch William L. Clayton Professor of International 2006 Economic 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 Blenda J. Wilson Former President and Chief Executive Officer, 2008 Nellie Mae Education Foundation, Quincy, Massachusetts DISTRICT 2—NEW YORK RESERVE BANK Class A Sanford I. Weill Chairman Emeritus, Citigroup Inc., New York, 2006 New York Jill M. Considine Chairman, The Depository Trust Company, 2007 New York, New York Charles V. Wait President, Chief Executive Officer, and Chairman, 2008 The Adirondack Trust Company, Saratoga Springs, New York Class B Indra K. Nooyi President and Chief Executive Officer, 2006 PepsiCo, Inc., Purchase, New York Richard S. Fuld, Jr. Chairman and Chief Executive Officer, 2007 Lehman Brothers, New York, New York Jeffrey R. Immelt Chairman and Chief Executive Officer, 2008 General Electric Company, Fairfield, Connecticut Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

244 93rd Annual Report, 2006 Directors—Continued BANK or BRANCH, Category Term expires Name 1111C Dec. 31 Class C Jerry I. Speyer President and Chief Executive Officer, Tishman Speyer, 2006 New York, New York John E. Sexton President, New York University, New York, New York 2007 Denis M. Hughes President, New York State AFL-CIO, New York, 2008 New York BUFFALO BRANCH Appointed by the Federal Reserve Bank Maureen Torrey Marshall .. Vice President, Torrey Farms, Inc., Elba, New York 2006 Peter G. Humphrey President and Chief Executive Officer, 2006 Financial Institutions, Inc. and Five Star Bank, Warsaw, New York Vacancy 2007 Joseph J. Ashton Regional Director-Region 9, United Auto Workers, 2008 Amherst, New York Appointed by the Board of Governors Alphonso O'Neil-White .... President and Chief Executive Officer, 2006 HealthNow New York Inc., Buffalo, New York James P. Laurito President and Chief Executive Officer, 2007 Rochester Gas and Electric Corporation and New York State Electric and Gas Corporation, Rochester, New York Vacancy 2008 DISTRICT 3—PHILADELPHIA RESERVE BANK Class A Eugene W. Rogers Director and Chief Executive Officer, Newfield 2006 National Bank, Newfield, New Jersey Wayne R. Weidner Chairman, National Penn Bancshares, Inc., 2007 Boyertown, Pennsylvania John G. Gerlach President and Chief Executive Officer, Pocono 2008 Community Bank, Stroudsburg, Pennsylvania Class B Garry L. Maddox President and Chief Executive Officer, A. Pomerantz & 2006 Company, Philadelphia, Pennsylvania P. Coleman Townsend, Jr. .. Chairman and Chief Executive Officer, Townsends, 2007 Inc., Wilmington, Delaware Vacancy 2008 Class C William F. Hecht Retired Chairman, President, and Chief Executive 2006 Officer, PPL Corporation, Allentown, Pennsylvania Doris M. Damm President and Chief Executive Officer, ACCU Staffing 2007 Services, Cherry Hill, New Jersey Charles P. Pizzi President and Chief Executive Officer, Tasty 2008 Baking Company, Philadelphia, Pennsylvania 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 DISTRICT 4—CLEVELAND RESERVE BANK Class A Stephen P. Wilson Chairman, President and Chief Executive Officer, 2006 Lebanon Citizens National Bank, Lebanon, Ohio Henry L. Meyer, III Chairman and Chief Executive Officer, 2007 KeyCorp, Cleveland, Ohio Bick Weissenrieder Chairman and Chief Executive Officer, 2008 Hocking Valley Bank, Athens, Ohio Class B V. Ann Hailey Executive Vice President, Corporate Development, 2006 Limited Brands, Columbus, Ohio Les C. Vinney President and Chief Executive Officer, 2007 STERIS Corporation, Mentor, Ohio Edwin J. Rigaud President and Chief Executive Officer, 2008 Enova Partners, LLC, Cincinnati, Ohio Class C Tanny B. Crane President and Chief Executive Officer, Crane Group 2006 Company, Columbus, Ohio Charles E. Bunch Chairman and Chief Executive Officer, 2007 PPG Industries, Inc., Pittsburgh, Pennsylvania Alfred M. Rankin, Jr. Chairman, President and Chief Executive Officer, 2008 NACCO Industries, Inc., Cleveland, Ohio CINCINNATI BRANCH Appointed by the Federal Reserve Bank 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 Janet B. Reid Managing Partner, Global Lead Management 2008 Consulting, Cincinnati, Ohio Glenn D. Leveridge President, Lexington Market, JPMorgan Chase Bank, 2008 NA, Lexington, Kentucky Appointed by the Board of Governors Charles Whitehead Retired President, Ashland Inc. Foundation, 2006 Covington, Kentucky Herbert R. Brown Senior Vice President, Western and Southern Financial 2007 Group, Cincinnati, Ohio James M. Anderson President and Chief Executive Officer, Cincinnati 2008 Children's Hospital Medical Center, Cincinnati, Ohio PITTSBURGH BRANCH Appointed by the Federal Reserve Bank Kristine N. Molnar Executive Vice President, WesBanco Bank, Inc., 2006 Wheeling, West Virginia Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

246 93rd Annual Report, 2006 Directors—Continued BANK or BRANCH, Category Titip Term expires Name Dec. 31 Michael J. Hagan President and Chief Executive Officer, 2007 Iron and Glass Bank, Pittsburgh, Pennsylvania Sunil T. Wadhwani Chief Executive Officer and Co-founder, 2008 iGATE Corporation, Pittsburgh, Pennsylvania Georgiana N. Riley President and Chief Executive Officer, 2008 TIGG Corporation, Bridgeville, Pennsylvania Appointed by the Board of Governors James I. Mitnick Senior Vice President, Turner Construction Company, 2006 Pittsburgh, Pennsylvania Robert O. Agbede President and Chief Executive Officer, ATS-Chester 2007 Engineers, Inc., Pittsburgh, Pennsylvania RoyW.Haley Chairman and Chief Executive Officer, WESCO 2008 International, Inc., Pittsburgh, Pennsylvania DISTRICT 5—RICHMOND RESERVE BANK Class A Ernest J. Sewell Senior Advisor, FNB Southeast, Greensboro, 2006 North Carolina Kathleen Walsh Carr President, Cardinal Bank Washington, Washington, 2007 D.C. Hunter R. Hollar President and Chief Executive Officer, Sandy Spring 2008 Bancorp, Sandy Spring Bank, Olney, Maryland Class B Kenneth R. Sparks President and Chief Executive Officer, 2006 Ken Sparks Associates LLC, White Stone, Virginia Harry M. Lightsey, III State President-South Carolina, BellSouth, 2007 Columbia, South Carolina Dana S. Boole President and Chief Executive Officer, 2008 Community Affordable Housing Equity Corporation, Raleigh, North Carolina Class C Lemuel E. Lewis Director, Landmark Communications, Inc., 2006 Norfolk, Virginia Theresa M. Stone President (Retired), Lincoln Financial Media, 2007 Greensboro, North Carolina Thomas J. Mackell, Jr. Warrenton, Virginia 2008 BALTIMORE BRANCH Appointed by the Federal Reserve Bank Kenneth C. Lundeen President, Environmental Reclamation Company, 2006 Baltimore, Maryland Michael L. Middleton Chairman and President, Community Bank 2006 of Tri-County, Waldorf, Maryland Donald P. Hutchinson President and Chief Executive Officer, 2007 SunTrust Bank, Maryland, Baltimore, Maryland Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 247 BANK or BRANCH, Category Titl*» Term expires Name 1 lllc Dec. 31 Biana J. Arentz President and Chief Executive Officer, 2008 Hemingway's Inc., Stevensville, Maryland Appointed by the Board of Governors William C. Handorf Professor of Finance, George Washington University, 2006 Washington, D.C. William R. Roberts President, Verizon Maryland Inc., Baltimore, Maryland 2007 Cynthia Collins Allner Principal, Miles & Stockbridge PC, Baltimore, 2008 Maryland CHARLOTTE BRANCH Appointed by the Federal Reserve Bank 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, Charlotte, 2006 North Carolina Barry L. Slider President and Chief Executive Officer, First South 2007 Bancorp, Inc., First South Bank, Spartanburg, South Carolina James H. Speed, Jr. President and Chief Executive Officer, North Carolina 2008 Mutual Life Insurance Company, Durham, North Carolina Appointed by the Board of Governors Jim Lowry Automotive Consultant, High Point, 2006 North Carolina Anthony J. DiGiorgio President, Winthrop University, Rock Hill, 2007 South Carolina Linda L. Dolny President, PML Associates, Inc., Greenwood, 2008 South Carolina DISTRICT 6—ATLANTA RESERVE BANK Class A 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 L. Phillip Humann Chairman and Chief Executive Officer, SunTrust 2008 Banks, Inc., Atlanta, Georgia Class B Teri G. Fontenot President and Chief Executive Officer, 2006 Woman's Hospital, Baton Rouge, Louisiana Lee M. Thomas Past President and Chief Operating Officer, 2007 Georgia-Pacific Corporation, Atlanta, Georgia Egbert L.J. Perry Chairman and Chief Executive Officer, 2008 The Integral Group, LLC, Atlanta, Georgia Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

248 93rd Annual Report, 2006 Directors—Continued BANK or BRANCH, Category Term expires Name 1 lllc Dec. 31 Class C D. Scott Davis Chief Financial Officer and Vice Chairman, United 2006 Parcel Service, Atlanta, Georgia David M. Ratcliffe Chairman, President, and Chief Executive Officer, 2007 Southern Company, Atlanta, Georgia V. Larkin Martin Managing Partner, Martin Farm, Courtland, Alabama 2008 BIRMINGHAM BRANCH Appointed by the Federal Reserve Bank Samuel F. Dodson Business Manager, International Union of Operating 2006 Engineers-Local 312, Birmingham, Alabama Bobby A. Bradley Managing Partner, Lewis Properties, LLC and 2006 Anderson Investments, LLC, Huntsville, Alabama John B. Barnett III Monroeville President, BankTrust, 2007 Monroeville, Alabama John H. Holcomb III Chairman and Chief Executive Officer, Alabama 2008 National Bancorporation, Birmingham, Alabama Appointed by the Board of Governors 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 James H. Sanford Chairman of the Board, HOME Place Farms, Inc., 2008 Prattville, Alabama JACKSONVILLE BRANCH Appointed by the Federal Reserve Bank 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 Alan Rowe President and Chief Executive Officer, 2008 First Commercial Bank of Florida, Orlando, Florida Appointed by the Board of Governors Linda H. Sherrer President and Chief Executive Officer, 2006 Prudential Network Realty, Jacksonville, Florida H. Britt Landrum, Jr President and Chief Executive Officer, 2007 Landrum Human Resource Companies, Inc., Pensacola, Florida Fassil Gabremariam President and Founder, US-Africa Free Enterprise 2008 Education Foundation, Tampa, Florida Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 249 BANK or BRANCH, Category Titlp Term expires Name 11UC Dec. 31 MIAMI BRANCH Appointed by the Federal Reserve Bank 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 Francis V. Gudorf President/Executive Director, Jubilee Community 2008 Development Corporation, Miami, Florida Thomas H. Shea Regional Chief Executive Officer-Florida/Caribbean, 2008 Right Management, Fort Lauderdale, Florida Appointed by the Board of Governors 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 Edwin A. Jones, Jr. President, Angus Investments, Inc., 2008 Port St. Lucie, Florida NASHVILLE BRANCH Appointed by the Federal Reserve Bank 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 Supply Chain Management, Nissan North America, Inc., Smyrna, Tennessee M. Terry Turner President and Chief Executive Officer, Pinnacle 2007 Financial Partners, Nashville, Tennessee Michael B. Swain Chairman, First National Bank, Oneida, Tennessee 2008 Appointed by the Board of Governors 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 Richard Q. Ford President and Chief Executive Officer, The Sage Group, 2008 Brentwood, Tennessee NEW ORLEANS BRANCH Appointed by the Federal Reserve Bank 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, The First 2007 Bancshares, Inc., and The First, A National Banking Association, Hattiesburg, Mississippi J. Herbert Boydstun President and Chief Executive Officer, 2008 Capital One, N.A., New Orleans, Louisiana Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

250 93rd Annual Report, 2006 Directors—Continued BANK or BRANCH, Category Title Term expires Name Dec. 31 Appointed by the Board of Governors Ben Tom Roberts President, Roberts Brothers Commercial and Property 2006 Management, Inc., Realtors, Mobile, Alabama President and Chief Executive Officer, 2007 Dave Dennis Specialty Contractors & Associates, Inc., Gulfport, Mississippi President—Dow India, Middle East and Africa, 2008 EarlL. Shipp Global Vice President for Oxides and Glycols, The Dow Chemical Company, Dubai, United Arab Emirates DISTRICT 7—CHICAGO RESERVE BANK Class A Michael L. Kubacki Chairman, President, and Chief Executive Officer, 2006 Lakeland Financial Corporation, Warsaw, Indiana JeffPlagge Chairman, Chief Executive Officer, and President, 2007 Midwest Heritage Bank, Clive, Iowa William A. Osborn Chairman and Chief Executive Officer, Northern Trust 2008 Corporation and The Northern Trust Company, Chicago, Illinois Class B Mark T. Gaffhey President, Michigan AFL-CIO, Lansing, Michigan 2006 Vacancy 2007 Valerie B. Jarrett Managing Director and Executive Vice President, 2008 The Habitat Company, Chicago, Illinois Class C W. James Farrell Retired Chairman and Chief Executive Officer, 2006 Illinois Tool Works, Inc., Glen view, Illinois Miles D. White Chairman and Chief Executive Officer, Abbott, 2007 Abbott Park, Illinois John A. Canning, Jr. Chairman and Chief Executive Officer, 2008 Madison Dearborn Partners, LLC, Chicago, Illinois DETROIT BRANCH Appointed by the Federal Reserve Bank 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 Tommi A. White Chief Executive Officer, ER-One, Inc., 2008 Livonia, Michigan Linda S. Likely Director of Housing & Community Development, 2008 Kent County Community Development Department & Housing Commission, Grand Rapids, Michigan Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 251 BANK or BRANCH, Category Title Term expires Name Dec. 31 Appointed by the Board of Governors Roger A. Cregg Executive Vice President and Chief Financial Officer, 2006 Pulte Homes, Inc., Bloomfield Hills, Michigan Irvin D. Reid President, Wayne State University, Detroit, Michigan 2007 Timothy M. Manganello ... Chairman and Chief Executive Officer, BorgWarner 2008 Incorporated, Auburn Hills, Michigan DISTRICT 8—ST. LOUIS RESERVE BANK Class A 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 Cadence Financial Corporation, Starkville, Mississippi J. Thomas May Chairman and Chief Executive Officer, 2008 Simmons First National Corporation, Pine Bluff, Arkansas Class B A. Rogers Yarnell, II President, Yarnell Ice Cream Company, Inc., 2006 Searcy, Arkansas Paul T. Combs President, Baker Implement Company, 2007 Kennett, Missouri Jay Fitzsimmons Sr. Vice President of Finance and Treasurer, 2008 Wal-Mart Stores, Inc., Bentonville, Arkansas Class C Walter L. Metcalfe, Jr. Partner, Bryan Cave LLP, St. Louis, Missouri 2006 Irl F. Engelhardt Chairman, Peabody Energy, St. Louis, Missouri 2007 Cynthia J. Brinkley President, AT&T Missouri, St. Louis, Missouri 2008 LITTLE ROCK BRANCH Appointed by the Federal Reserve Bank 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 Robert A. Young III Chairman, Arkansas Best Corporation, 2008 Fort Smith, Arkansas Phillip N. Baldwin President and Chief Executive Officer, Southern 2008 Bancorp, Arkadelphia, Arkansas Appointed by the Board of Governors C.Sam Walls Chief Executive Officer, Arkansas Capital Corporation, 2006 Little Rock, Arkansas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

252 93rd Annual Report, 2006 Directors—Continued BANK or BRANCH, Category Term expires Name 1111C Dec. 31 Sonja Yates Hubbard Chief Executive Officer, E-Z Mart Stores, Inc., 2007 Texarkana, Texas Cal McCastlain Partner, Pender & McCastlain, P.A., Little Rock, 2008 Arkansas LOUISVILLE BRANCH Appointed by the Federal Reserve Bank 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 L. Clark Taylor, Jr. Chief Executive Officer, Ephraim McDowell Health, 2008 Danville, Kentucky JohnC. Schroeder President, Wabash Plastics, Inc., Evansville, Indiana 2008 Appointed by the Board of Governors Norman E. Pfau, Jr. President and Chief Executive Officer, Geo. Pfau's 2006 Sons Company, Inc., Jeffersonville, Indiana Gary A. Ransdell President, Western Kentucky University, 2007 Bowling Green, Kentucky John L. Huber President and Chief Executive Officer, 2008 Louisville Water Company, Louisville, Kentucky MEMPHIS BRANCH Appointed by the Federal Reserve Bank 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 Levon Mathews President, Regions Bank, Memphis, Tennessee 2008 Hunter Simmons President and Chief Executive Officer, 2008 First South Bank, Jackson, Tennessee Appointed by the Board of Governors Russell Gwatney President, Gwatney Companies, Memphis, Tennessee 2006 Charles S. Blatteis Member (Partner), The Bogatin Law Firm, PLC, 2007 Memphis, Tennessee Meredith B. Allen Vice President, Marketing, Staple Cotton Cooperative 2008 Association, Greenwood, Mississippi DISTRICT 9—MINNEAPOLIS RESERVE BANK Class A 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 Peter J. Haddeland President and Chief Executive Officer, 2008 First National Bank, Mahnomen, Minnesota Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 253 BANK or BRANCH, Category Term expires Name 1111C Dec. 31 Class B D. Greg Heineman Chairman, Williams Insurance Agency, 2006 Sioux Falls, South Dakota Todd L. Johnson President and Chief Executive Officer, Reuben 2007 Johnson & Son, Inc. & Affiliated Companies, Superior, Wisconsin Randy Peterson Facility Director, Lake Superior State University, 2008 Sault Ste. Marie, Michigan Class C James J. Hynes Executive Administrator, Twin City Pipe Trades 2006 Service Association, St. Paul, Minnesota Frank L. Sims Corporate Vice President, Transportation, Cargill, Inc., 2007 Wayzata, Minnesota John W. Marvin Chairman and Chief Executive Officer, Marvin 2008 Windows and Doors, Warroad, Minnesota HELENA BRANCH Appointed by the Federal Reserve Bank Marilyn F. Wessel Retired 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 John L. Franklin President and Chief Executive Officer, 1st Bank, 2008 Sidney, Montana Appointed by the Board of Governors Dean Folkvord President and Chief Executive Officer, Wheat Montana 2006 Farms and Bakery, Three Forks, Montana Lawrence R. Simkins President, Washington Corporations, Missoula, 2008 Montana DISTRICT 10—KANSAS CITY RESERVE BANK Class A 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 Rick L. Smalley Chief Executive Officer, Dickinson Financial 2008 Corporation, Kansas City, Missouri Class B Kevin K. Nunnink Chairman, Integra Realty Resources, Westwood, Kansas 2006 Frank Moore President, Spearhead Ranch Company, 2007 Douglas, Wyoming Dan L. Dillingham Chief Executive Officer, Dillingham Insurance, 2008 Enid, Oklahoma Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

254 93rd Annual Report, 2006 Directors—Continued BANK or BRANCH, Category Term expires Name 1 lUC Dec. 31 Class C Robert A. Funk Chairman and Chief Executive Officer, 2006 Express Personnel Services, Oklahoma City, Oklahoma Terry L. Moore President, Omaha Federation of Labor, 2007 Omaha, Nebraska Lu M. Cordova Chief Executive Officer, Corlund Industries; 2008 Chairman, CTEK Angels, Boulder, Colorado DENVER BRANCH Appointed by the Federal Reserve Bank 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 Bruce K. Alexander President and Chief Executive Officer, Vectra Bank 2008 Colorado, Denver, Colorado Appointed by the Board of Governors 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 Diane Leavesley President, Mercy Loan Fund, Denver, Colorado 2008 OKLAHOMA CITY BRANCH Appointed by the Federal Reserve Bank Barry H. Golsen Board Vice-Chairman, President and Chief Operating 2006 Officer, LSB Industries, Inc., Oklahoma City, Oklahoma Robert R. Gilbert, III President, Chief Operating Officer, and Director, 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 Fred M.Ramos Executive Director, State Hispanic Chamber of 2008 Commerce, Oklahoma City, Oklahoma Appointed by the Board of Governors Richard K. Ratcliffe Chairman, Ratcliffe's Inc., Weatherford, Oklahoma 2006 Steven C. Agee President, Agee Energy, LLC, 2007 Oklahoma City, Oklahoma Michael A. Cawley President and Chief Operating Officer, 2008 The Samuel Roberts Noble Foundation, Inc., Ardmore, Oklahoma Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 255 BANK or BRANCH, Category Titlp Term expires Name 1111C Dec. 31 OMAHA BRANCH Appointed by the Federal Reserve Bank Rodrigo Lopez President and Chief Executive Officer, AmeriSphere 2006 Multifamily Finance, LLC, Omaha, Nebraska Michael J. Nelson Chairman, FirsTier Bank, Kimball, Nebraska 2006 Cynthia Hardin Milligan ... Dean-College of Business Administration, 2007 University of Nebraska-Lincoln, Lincoln, Nebraska Mark A. Sutko President and Chief Executive Officer, 2008 Platte Valley State Bank, Kearney, Nebraska Appointed by the Board of Governors Charles R. Hermes President, Dutton-Lainson Company, 2006 Hastings, Nebraska Lyn Wallin Ziegenbein Executive Director, Peter Kiewit Foundation, 2007 Omaha, Nebraska James A. Timmerman Chief Financial Officer, Timmerman 2008 and Sons Feeding Company, Springfield, Nebraska DISTRICT 11—DALLAS RESERVE BANK Class A Matthew T. Doyle Vice Chairman and Chief Executive Officer, 2006 Texas First Bank, Texas City, Texas David S. Barnard Chairman and Chief Executive Officer, The 2007 National Banks of Central Texas, Gatesville, Texas Richard W. Evans, Jr. Chairman and Chief Executive Officer, 2008 Cullen/Frost Bankers, Inc., San Antonio, Texas Class B Judy Ley Allen Partner, Allen Investments, Inc., Houston, Texas 2006 Robert A. Estrada Chairman, Estrada Hinojosa & Company, Inc., 2007 Dallas, Texas James B. Bexley Associate Professor, Finance, Sam Houston 2008 State University, Huntsville, Texas Class C Anthony R. Chase Chairman and Chief Executive Officer, ChaseCom, LP, 2006 Houston, Texas Ray L. Hunt Chairman, President, and Chief Executive Officer, 2007 Hunt Consolidated, Inc., Dallas, Texas James T. Hackett Chairman, President, and Chief Executive Officer, 2008 Anadarko Petroleum Corporation, Houston, Texas EL PASO BRANCH Appointed by the Federal Reserve Bank Gerald J. Rubin Chairman, President, and Chief Executive Officer, 2006 Helen of Troy Limited, El Paso, Texas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

256 93rd Annual Report, 2006 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name 1111C Dec. 31 F.James Volk Regional President, State National Bank, El Paso, Texas 2007 Pete Cook President and Chief Executive Officer, First National 2008 Bank of Alamogordo, Alamogordo, New Mexico Fred J.Loya Chairman, Fred Loya Insurance, El Paso, Texas 2008 Appointed by the Board of Governors William V. Flores Provost, New Mexico State University, 2006 Las Cruces, New Mexico Cecilia Ochoa Levine President, MFI International Mfg., LLC, 2007 El Paso, Texas Ron C. Helm Owner, Helm Land and Cattle Company, 2008 Van Horn, Texas HOUSTON BRANCH Appointed by the Federal Reserve Bank Timothy N. Bryan Chairman and Chief Executive Officer, 2006 The First National Bank of Bryan, Bryan, Texas Jodie L. Jiles Managing Director, RBC Capital Markets, 2007 Houston, Texas S. Reed Morian Chairman, President, and Chief Executive Officer, 2008 DX Service Company, Inc., Houston, Texas Peter G. Traber, M.D. President and Chief Executive Officer, Baylor College 2008 of Medicine, Houston, Texas Appointed by the Board of Governors Nancy T. Chang Chairman, Tanox, Inc., Houston, Texas 2006 Douglas L. Foshee President and Chief Executive Officer, 2007 El Paso Corporation, Houston, Texas Lupe Fraga Chairman and Chief Executive Officer, Tejas Office 2008 Products, Inc., Houston, Texas SAN ANTONIO BRANCH Appointed by the Federal Reserve Bank Steven R. Vandegrift Founder and President, SRV Holdings, Austin, Texas 2006 G.P. Singh Chairman and Chief Executive Officer, 2007 Karta Technologies Inc., San Antonio, Texas Matt F. Gorges Chairman and Chief Executive Officer, Valley 2008 International Cold Storage, Inc., Harlingen, Texas Guillermo F. Trevino Vice President, Southern Distributing, 2008 Lorado, Texas Appointed by the Board of Governors J.Dan Bates President, Southwest Research Institute, 2006 San Antonio, Texas Ricardo Romo President, The University of Texas at San Antonio, 2007 San Antonio, Texas Elizabeth Chu Richter Chairman and Chief Executive Officer, 2008 Richter Architects, Corpus Christi, Texas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 257 BANK or BRANCH, Category Titip Term expires Name llllC Dec. 31 DISTRICT 12—SAN FRANCISCO RESERVE BANK Class A Kenneth P. Wilcox President and Chief Executive Officer, Silicon 2006 Valley Bank, Santa Clara, California Richard W. Decker, Jr. Chairman and Co-Founder, Belvedere Capital 2007 Partners LLC, San Francisco, California Candace Hunter Wiest President and Chief Executive Officer, West Valley 2008 National Bank, Avondale, Arizona Class B Barbara L. Wilson Consultant; and Regional Vice President (Retired), 2006 Qwest Corporation, Boise, Idaho Jack McNally Principal, JKM Consulting, Sacramento, California 2007 Karla S. Chambers Vice President and Co-Owner, Stahlbush Island Farms, 2008 Inc., Corvallis, Oregon Class C 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 Charles H. Smith Former President and Chief Executive Officer, 2008 AT&T West, San Ramon, California Los ANGELES BRANCH Appointed by the Federal Reserve Bank 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, Pasadena, California Peter M. Thomas Managing Partner, Thomas & Mack Co., 2008 Las Vegas, Nevada Appointed by the Board of Governors Anita Santiago Chief Executive Officer, Anita Santiago Advertising, 2006 Santa Monica, California James L. Sanford Corporate Vice President and Treasurer, Northrop 2007 Grumman Corporation, Los Angeles, California AnnE. Sewill President, Community Foundation Land Trust, 2008 California Community Foundation, Los Angeles, California PORTLAND BRANCH Appointed by the Federal Reserve Bank Robert D. Sznewajs President and Chief Executive Officer, 2006 West Coast Bancorp, Lake Oswego, Oregon Alan V. Johnson Regional President, Wells Fargo Bank, Portland, 2007 Oregon Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

258 93rd Annual Report, 2006 Directors—Continued BANK or BRANCH, Category Title Term expires Name Dec. 31 William D. Thorndike, Jr. .. Chairman and President, Medford Fabrication, 2008 Medford, Oregon George J. Puentes President, Don Pancho Authentic Mexican Foods, Inc., 2008 Salem, Oregon Appointed by the Board of Governors David Y. Chen Partner, OVP Venture Partners, Portland, Oregon 2006 James H. Rudd Chief Executive Officer and Principal, Ferguson 2007 Wellman Capital Management, Inc., Portland, Oregon Peter O. Kohler, M.D President, Oregon Health & Science University, 2008 Portland, Oregon SALT LAKE CITY BRANCH Appointed by the Federal Reserve Bank Annette K. Herman Vice President, Strategic Initiatives, Uniprise, 2006 UnitedHealth Group, Salt Lake City, Utah Michael M. Mooney President, Farmers & Merchants Bank, A Bank of the 2007 Cascades Company, Boise, Idaho A. Scott Anderson President and Chief Executive Officer, Zions Bank, 2008 Salt Lake City, Utah Deborah Bayle Nielsen President and Chief Executive Officer, 2008 United Way of Salt Lake, Salt Lake City, Utah Appointed by the Board of Governors William C. Glynn President, Intermountain Industries, Inc., Boise, Idaho 2006 Gary L. Crocker Chairman of the Board, Merrimack Pharmaceuticals, 2007 Inc., Salt Lake City, Utah Clark D. Ivory Chief Executive Officer, Ivory Homes, Ltd., 2008 Salt Lake City, Utah SEATTLE BRANCH Appointed by the Federal Reserve Bank Helvi K. Sandvik President, NANA Development Corporation, 2006 Anchorage, Alaska Blake W. Nordstrom President, Nordstrom, Inc., Seattle, Washington 2007 Kenneth M. Kirkpatrick .... President, Washington State, U.S. Bank, 2008 Seattle, Washington H. Stewart Parker President and Chief Executive Officer, Targeted 2008 Genetics Corporation, Seattle, Washington Appointed by the Board of Governors 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 James R. Gill President, Pacific Northwest Title Holding Company, 2008 Seattle, Washington Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2006 259 Members of the Board of Governors, 1913-2006 Appointed Members Name Federal Reserve Date initially took Other dates1 District oath of office Charles S. Hamlin Boston Aug. 10, 1914 Reappointed in 1916 and 1926. Served until Feb. 3, 1936.2 Paul M. Warburg New York Aug. 10, 1914 Term expired Aug. 9, 1918. Frederic A. Delano Chicago Aug. 10, 1914 Resigned July 21, 1918. W.P.G. Harding Atlanta Aug. 10, 1914 Term expired Aug. 9, 1922. Adolph C. Miller San Francisco Aug. 10, 1914 Reappointed in 1924. Reappointed in 1934 from the Richmond District. Served until Feb. 3, 1936.2 Albert Strauss New York Oct. 26, 1918 Resigned Mar. 15, 1920. Henry A. Moehlenpah Chicago Nov. 10, 1919 Term expired Aug. 9, 1920. Edmund Platt New York June 8, 1920 Reappointed in 1928. Resigned Sept. 14, 1930. David C. Wills Cleveland Sept. 29, 1920 Term expired Mar. 4, 1921. John R. Mitchell Minneapolis May 12, 1921 Resigned May 12, 1923. Milo D. Campbell Chicago Mar. 14, 1923 Died Mar. 22, 1923. Daniel R. Crissinger Cleveland May 1, 1923 Resigned Sept. 15, 1927. George R. James St. Louis May 14, 1923 Reappointed in 1931. Served until Feb. 3, 1936.3 Edward H. Cunningham Chicago May 14, 1923 Died Nov. 28, 1930. Roy A. Young Minneapolis Oct. 4, 1927 Resigned Aug. 31, 1930. Eugene Meyer New York Sept. 16, 1930 Resigned May 10, 1933. Wayland W Magee Kansas City May 18, 1931 Term expired Jan. 24, 1933. Eugene R. Black Atlanta May 19, 1933 Resigned Aug. 15, 1934. M.S. Szymczak Chicago June 14, 1933 Reappointed in 1936 and 1948. Resigned May 31, 1961. J.J. Thomas Kansas City June 14, 1933 Served until Feb. 10, 1936.2 Marriner S. Eccles San Francisco Nov. 15, 1934 Reappointed in 1936, 1940, and 1944. Resigned July 14, 1951. Joseph A. Broderick New York Feb. 3, 1936 Resigned Sept. 30, 1937. John K. McKee Cleveland Feb. 3, 1936 Served until Apr. 4, 1946.2 Ronald Ransom Atlanta Feb. 3, 1936 Reappointed in 1942. Died Dec. 2, 1947. Ralph W. Morrison Dallas Feb. 10, 1936 Resigned July 9, 1936. Chester C. Davis Richmond June 25, 1936 Reappointed in 1940. Resigned Apr. 15, 1941. Ernest G. Draper New York Mar. 30, 1938 Served until Sept. 1, 1950.2 Rudolph M. Evans Richmond Mar. 14, 1942 Served until Aug. 13, 1954.2 James K. Vardaman, Jr. St. Louis Apr. 4, 1946 Resigned Nov. 30, 1958. Lawrence Clayton Boston Feb. 14, 1947 Died Dec. 4, 1949. Thomas B. McCabe Philadelphia Apr. 15, 1948 Resigned Mar. 31, 1951. Edward L. Norton Atlanta Sept. 1, 1950 Resigned Jan. 31, 1952. Oliver S. Powell Minneapolis Sept. 1, 1950 Resigned June 30, 1952. Wm. McC. Martin, Jr. New York Apr. 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

260 93rd Annual Report, 2006 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. Shenill 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 Aug. 11, 1987. Lyle E. Gramley Kansas City May 28, 1980 Resigned Sept. 1, 1985. Preston Martin San Francisco Mar. 31, 1982 Resigned Apr. 30, 1986. Martha R. Seger Chicago July 2, 1984 Resigned Mar. 11, 1991. Wayne D. Angell Kansas City Feb. 7, 1986 Served through Feb. 9, 1994. Manuel H. Johnson Richmond Feb. 7, 1986 Resigned Aug. 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 Resigned Jan. 31,2006. John P. LaWare Boston Aug. 15,1988 Resigned Apr. 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 Resigned Apr. 28, 2006. Edward M. Gramlich Richmond Nov. 5, 1997 Resigned Aug. 31, 2005. Susan S. Bies Chicago Dec. 7, 2001 Mark W.Olson Minneapolis Dec. 7, 2001 Resigned June 20, 2006. Ben S. Bernanke Atlanta Aug. 5, 2002 Resigned June 21, 2005. Donald L. Kohn Kansas City Aug. 5, 2002 Ben. S. Bernanke Atlanta Feb. 1, 2006 Kevin M. Warsh New York Feb. 22, 2006 Randall S. Kroszner Richmond Feb. 27, 2006 Frederic S. Mishkin Boston Seot. 5, 2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2006 261 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-Jan. 31, 20065 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 JJ. Thomas Aug. 21, 1934-Feb. 10, 1936 Ronald Ransom Aug. 6, 1936-Dec. 2, 1947 C. Canby Balderston Mar. 11, 1955-Feb. 28, 1966 J.L. Robertson Mar. 1, 1966-Apr. 30, 1973 George W. Mitchell May 1, 1973-Feb. 13, 1976 Stephen S. Gardner Feb. 13, 1976-Nov. 19, 1978 Frederick H. Schultz July 27, 1979-Feb. 11,1982 Preston Martin Mar. 31, 1982-Apr. 30, 1986 Manuel H. Johnson Aug. 4, 1986-Aug. 3, 1990 David W. Mullins, Jr. July 24, 1991-Feb. 14, 1994 Alan S. Blinder June 27, 1994-Jan. 31, 1996 Alice M. Rivlin June 25, 1996-July 16, 1999 Roger W. Ferguson, Jr. Oct. 5, 1999-Apr. 28, 2006 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 Feb. 3, seven appointed members; that the Secretary of the Trea- 1948, to Apr. 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

262 93rd Annual Report, 2006 ExOfficio Members Name Term Secretaries of the Treasury W.G. McAdoo Dec. 23, 1913-Dec. 15,1918 Carter Glass Dec. 16, 1918-Feb. 1, 1920 David F. Houston Feb. 2, 1920-Mar. 3,1921 Andrew W. Mellon Mar. 4, 1921-Feb. 12, 1932 Ogden L. Mills Feb. 12,1932-Mar. 4,1933 William H.Woodin Mar. 4, 1933-Dec. 31,1933 Henry Morgenthau, Jr. Jan. 1,1934-Feb. 1,1936 Comptrollers of the Currency John Skelton Williams Feb. 2, 1914-Mar. 2, 1921 Daniel R. Crissinger Mar. 17,1921-Apr. 30, 1923 Henry M. Dawes May 1, 1923-Dec. 17, 1924 Joseph W. Mclntosh Dec. 20, 1924-Nov. 20, 1928 J.W Pole Nov. 21, 1928-Sept. 20, 1932 J.F.T. O'Connor 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

264 93rd Annual Report, 2006 1. Federal Reserve Open Market Transactions, 2006 Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. U.S. TREASURY SECURITIES1 Outright transactions2 Treasury bills Gross purchases 1,563 1,308 1,228 0 Gross sales 0 0 0 0 Exchanges 67,302 68,077 79,509 64,886 For new bills 67,302 68,077 79,509 64,886 Redemptions 0 0 0 0 Others within 1 year Gross purchases 0 1,200 0 0 Gross sales 0 0 0 0 Maturity shifts 13,599 11,858 8,000 0 Exchanges -13,594 -10,989 -8,334 -834 Redemptions 1,321 0 0 0 1 to 5 years Gross purchases 2,809 2,498 2,136 1,096 Gross sales 0 0 0 0 Maturity shifts -13,599 -4,775 -4,500 0 Exchanges 11,830 9,306 8,334 834 5 to 10 years Gross purchases 1,505 25 174 0 Gross sales 0 0 0 0 Maturity shifts 0 -5,205 -3,500 0 Exchanges 0 841 0 0 More than 10 years Gross purchases 205 924 90 0 Gross sales 0 0 0 0 Maturity shifts 0 -1,878 0 0 Exchanges 1,765 841 0 0 All maturities Gross purchases 6,082 5,955 3,628 1,096 Gross sales 0 0 0 0 Redemptions 1,321 0 0 0 Net change in U.S. Treasury securities ... 4,761 5,955 3,628 1,096 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 265 1.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 0 0 1,649 0 0 0 0 0 5,748 0 0 0 0 0 0 0 0 0 75,196 95,728 70,972 90,885 72,636 65,400 85,342 69,275 905,208 75,196 95,728 70,972 90,885 72,636 65,400 85,342 69,275 905,208 0 0 0 0 0 0 0 0 0 1,375 0 0 415 0 1,757 220 0 4,967 0 0 0 0 0 0 0 0 0 24,441 6,667 6,614 20,379 6,861 7,427 14,046 0 119,892 -15,746 -7,997 -10,078 -13,535 0 -16,498 -15,441 0 -113,046 1,217 0 3,931 0 0 3,749 335 0 10,553 2,317 2,650 549 1,454 1,320 1,395 3,151 4,979 26,354 0 0 0 0 0 0 0 0 0 -21,298 -3,167 -3,784 -13,673 -6,861 -5,246 -11,009 0 -87,912 13,452 7,997 7,254 10,421 0 15,086 13,147 0 97,661 101 1,080 0 0 548 33 411 445 4,322 0 0 0 0 0 0 0 0 0 949 -3,500 -2,830 -5,149 0 -2,181 2,073 0 -19,343 2,294 0 1,588 1,557 0 1,412 2,294 0 9,986 0 0 0 0 228 0 780 1,072 3,299 0 0 0 0 0 0 0 0 0 ^,092 0 0 -1,557 0 0 -5,110 0 -12,637 0 0 1,235 1,557 0 0 0 0 5,398 3,793 3,730 2,198 1,869 2,096 3,185 4,562 6,496 44,690 0 0 0 0 0 0 0 0 0 1,217 0 3,931 0 0 3,749 335 0 10,553 2,576 3,730 -1,733 1,869 2,096 -564 4,227 6,496 34,137 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

266 93rd Annual Report, 2006 1. Federal Reserve Open Market Transactions, 2006—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 agreements 3 Gross purchases 185,750 157,000 204,250 163,750 206,750 151,250 209,000 166,250 Gross sales Reverse repurchase agreements4 Gross purchases 504,837 445,563 558,568 488,091 Gross sales 498,351 446,346 560,306 485,659 Net change in temporary transactions -14,514 4,967 -6,488 -68 Total net change in System Open Market Account -9,752 10,922 -2,860 1,028 NOTE: Sales, redemptions, and negative figures reduce 2. Excludes the effect of temporary transactions— holdings of the System Open Market Account; all other repurchase agreements, matched sale-purchase agreefigures increase such holdings. Components may not sum ments (MSPs), and reverse repurchase agreements to totals because of rounding. (RRPs). 1. Transactions exclude changes in compensation for 3. Cash value of agreements, which are collateralized the effects of inflation on the principal of inflation- by U.S. government and federal agency securities. indexed securities. Transactions include the rollover of 4. Cash value of agreements, which are collateralized inflation compensation into new securities. by U.S. Treasury securities. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 267 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 0 200,750 182,000 177,000 178,000 128,000 178,000 194,500 176,500 2,125,500 194,250 181,500 178,000 178,000 136,750 169,750 186,500 173,500 2,131,500 531,844 567,926 584,190 642,084 554,480 649,172 665,558 586,711 6,779,024 532,338 572,488 584,959 640,413 557,372 651,821 662,802 585,277 6,778,132 6,006 -4,061 -1,769 1,671 -11,643 5,601 10,756 4,434 -5,108 8,582 -331 -3302 3,540 -9,547 5,037 14,983 10,930 29,030 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

268 93rd Annual Report, 2006 2. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2004-2006 Millions of dollars December 31 Change Description 2005 to 2004 to 2006 2005 2004 2006 2005 U.S. TREASURY SECURITIES Held outright1 778,915 744,215 717,819' 34,700 26,396' By remaining maturity Bills 1-90 days 193,034 187,370 179,748 5,664 7,622 91 days to 1 year 83,985 83,900 83,222 85 678 Notes and bonds 1 year or less 129,594 128,287r 116,443 1,307 ll,844r More than 1 year through 5 years 224,177 210,745r 208,269 13,432 2,476* More than 5 years through 10 years 67,645 56,699r 54,372 10,946 2,327r More than 10 years 80,479 77,215r 75,765 3,264 1,450* By type Bills 277,019 271,270 262,970 5,749 8,300 Notes 402,367 380,118 360,832r 22,249 19,286' Bonds 99,528 92,827 94,017r 6,701 -1,190* FEDERAL AGENCY SECURITIES Held outright1 By remaining maturity 1 year or less 0 0 0 0 0 More than 1 year through 5 years 0 0 0 0 0 More than 5 years through 10 years 0 0 0 0 0 More than 10 years 0 0 0 0 0 By issuer Federal National Mortgage Association TEMPORARY TRANSACTIONS Repurchase agreements2 40,750 46,750 33,000* -6,000 13,75(r~ 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 29,615 30,505 30,783' -890 -278* Foreign official and international accounts 29,615 30,505 3O,783r -890 -278r Dealers 0 0 0 0 0 NOTE: Components may not sum to totals because of 2. Cash value of agreements, which are collateralized rounding. by U.S. government and federal agency securities. 1. Excludes the effect of temporary transactions— 3. Cash value of agreements, which are collateralized repurchase agreements, matched sale-purchase agree- by U.S. Treasury securities. ments (MSPs), and reverse repurchase agreements r. Revised. (RRPs). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 269 3. Federal Reserve Bank Interest Rates on Loans toDepository Institutions, December 31, 2006 Reserve Bank Primary credit1 Secondary credit2 Seasonal credit3 AllFederal Reserve Banks 6.25 6.75 5.30 NOTE: For details on rate changes over the course of 3. Seasonal credit is available to help relatively small 2006, see the section on discount rates in the chapter depository institutions meet regular seasonal needs for "Record of Policy Actions of the Board of Governors." funds that arise from a clear pattern of intra-yearly move- 1. Primary credit is available for very short terms as ments in their deposits and loans. The discount rate on a backup source of liquidity to depository institutions that seasonal credit takes into account rates charged by market are in generally sound financial condition in the judgment sources of funds and is reestablished on the first business of the lending Federal Reserve Bank. day of each two-week reserve maintenance period. 2. Secondary credit is available in appropriate circumstances to depository institutions that do not qualify for primary credit. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

270 93rd Annual Report, 2006 4. Reserve Requirements of Depository Institutions, December 31, 2006 Requirements Type of deposit Percentage of deposits Effective date Net transaction accounts1 $0 million-$8.5 million2 0 12-21-06 More than $8.5 million-$45.8 million3 3 12-21-06 More than $45.8 million 10 12-21-06 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 exemption maintain that deposit directly with a Reserve Bank or amount is adjusted upward by 80 percent of the previous with another institution in a pass-through relationship. year's (June 30 to June 30) rate of increase in total Reserve requirements are imposed on commercial banks, 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 271 5. Banking Offices and Banks Affiliated with Bank Holding Companies (BHCs) in the United States, December 31, 2005 and 2006 Commercial banks * Statechartered Type of office Total Member savings Total Nonmember banks Total National State All banking offices BANKS Number, Dec. 31, 2005 .. 7,853 7,484 2,696 1,794 902 4,788 369 Changes during 2006 New banks 190 187 41 24 17 146 3 Banks converted into branches -290 -284 -132 -92 -40 -152 -6 Ceased banking operation2 -21 -18 -8 -7 -1 -10 -3 Other3 0 -1 -4 -23 19 3 1 Net change -121 -116 -103 -98 -5 -13 -5 Number, Dec. 31,2006 .. 7,732 7368 2,593 1,696 897 4,775 364 BRANCHES AND ADDITIONAL OFFICES Number, Dec. 31, 2005 .. 77,830 74,681 53,122 39,155 13,967 21,559 3,149 Changes during 2006 New branches 2,765 2,694 2,071 1,546 525 623 71 Branches converted from banks 290 287 131 94 37 156 3 Discontinued2 -2,009 -1,832 -1,645 -1,417 -228 -187 -177 Other3 0 53 259 286 -27 -206 -53 Net change 1,046 1,202 816 509 307 386 -156 Number, Dec. 31, 2006 .. 78,876 75,883 53,938 39,664 14,274 21,945 2,993 Banks affiliated with BHCs BANKS Number, Dec. 31, 2005 .. 6,265 6,143 2,336 1,540 796 3,807 122 Changes during 2006 BHC-affiliated new banks 183 174 58 38 20 116 9 Banks converted into branches -244 -239 -112 -76 -36 -127 -5 Ceased banking operation2 -18 -17 -7 -6 -1 -10 -1 Other3 0 0 0 -18 18 0 0 Net change -79 -82 -61 -62 1 -21 3 Number, Dec. 31,2006 .. 6,186 6,061 2,275 1,478 797 3,786 125 NOTE: Includes banking offices and BHCs in U.S. of making commercial loans or any institution that is territories and possessions. defined as an insured bank in section 3(h) of the FDIC 1. 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 2. 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 3. Interclass changes and sales of branches. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

272 93rd Annual Report, 2006 6A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2006 and Month-End 2006 Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Special Period drawing Treasury S o e u c h t u r e i r l g i d t h ie t1 s a R g e r p ee u m rc e h n as ts e 2 Loans Float R F O e e d s th e e 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 i n - n c g y 3 assets 1984 167,612 2,015 3,577 833 12,347 186,384 11,096 4,618 16,418 1985 186,025 5,223 3,060 988 15,302 210,598 11,090 4,718 17,075 1986 205,454 16,005 1,565 1,261 17,475 241,760 11,084 5,018 17,567 1987 226,459 4,961 3,815 811 15,837 251,883 11,078 5,018 18,177 1988 240,628 6,861 2,170 1,286 18,803 269,748 11,060 5,018 18,799 1989 233,300 2,117 481 1,093 39,631 276,622 11,059 8,518 19,628 1990 241,431 18,354 190 2,566 39,880 302,421 11,058 10,018 20,402 1991 272,531 15,898 218 1,026 34,524 324,197 11,059 10,018 21,014 1992 300,423 8,094 675 3,350 30,278 342,820 11,056 8,018 21,447 1993 336,654 13,212 94 963 33,394 384,317 11,053 8,018 22,095 1994 368,156 10,590 223 740 33,441 413,150 11,051 8,018 22,994 1995 380,831 13,862 135 231 33,483 428,543 11,050 10,168 24,003 1996 393,132 21,583 85 5,297 32,222 452,319 11,048 9,718 24,966 1997 431,420 23,840 2,035 561 32,044 489,901 11,047 9,200 25,543 1998 452,478 30,376 17 1,009 37,692 521,573 11,046 9,200 26,270 1999 478,144 140,640 233 407 34,799 654,223 11,048 6,200 28,013 2000 511,833 43,375 110 795 36,896 593,009 11,046 2,200 31,643 2001 551,685 50,250 34 698 36,885 639,552 11,045 2,200 33,017 2002 629,416 39,500 40 832 38,574 708,363 11,043 2,200 34,597 2003 666,665 43,750 62 211 40,214 750,901 11,043 2,200 35,475 2004 717,819 33,000 43 927 42,161 793,950 11,045 2,200 36,434 2005 744,215 46,750 72 891 39,319 831,247 11,043 2,200 36,540* 2006 778,915 40,750 67 -326 39,885 859,290 11,041 2,200 38,233 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 273 6 A.—Continued Factors absorbing reserve funds Reserve Deposits with Federal Reserve Banks, F O ed th e e ra r l ba w la i n th ces Currency Reverse Treasury other than reserve balances Required Reserve Federal in repurchase cash clearing liabilities Reserve circulation agreements4 holdings5 balances and Banks6 Treasury Foreign Other capital 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 10,534r 18,977 12,007r 724,194 25,652 321 5,723 162 717 ll,829r 19,793 11,229' 754,877 30,783 270 5,912 80 1,285 9,963 26,378 14,080 794,014r 30,505 202 4,573 83 2,144 8,650* 30,466 10,393r 820,204 29,615 252 4,708 98 958 6,842 36,231 11,857 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

274 93rd Annual Report, 2006 6A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2006 and Month-End 2006—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 a R g e r p ee u m rc e h n as ts e 2 Loans Float R F O e e s d 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 n at t e s c t u a r o n r u d e t n i - n c g y 3 assets 2006 Jan 748,824 25,750 40 1,796 40,285 816,694 11,044 2,200 36,539 Feb 754,676 31,500 38 1,466 37,675 825,355 11,044 2,200 37,813 Mar 758,542 26,750 566 -836 39,046 824,068 11,043 2,200 37,879 Apr 759,690 24,250 138 -1,084 41,283 824,277 11,041 2,200 37,936 May 762,411 30,750 207 1,028 39,151 833,547 11,041 2,200 37,980 Jun 766,364 31,250 291 -1,032 40,133 837,005 11,041 2,200 37,990 Jul 764,811 30,250 361 48 41,103 836,574 11,041 2,200 38,026 Aug 766,739 30,250 349 -606 38,436 835,168 11,041 2,200 38,025 Sep 768,924 21,500 322 -1,104 40,063 829,705 11,041 2,200 38,084 Oct 768,493 29,750 157 2,604 40,672 841,677 11,041 2,200 38,133 Nov 772,604 37,750 102 -411 37,409 847,455 11,041 2,200 38,177 Dec 778,915 40,750 67 -326 39,885 859,290 11,041 2,200 38,233 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 275 6 A.—Continued Factors absorbing reserve funds Reserve Deposits with Federal Reserve Banks, Other balances Federal with Currency Reverse Treasury other than reserve balances Required Reserve Federal in repurchase cash clearing liabilities Reserve circulation agreements4 holdings5 balances and Banks6 Treasury Foreign Other capital 782,356 24,019 216 5,606 83 281 8,710 31,667 13,540 789,289 24,802 185 5,024 82 279 8,015 32,510 16,226 788,769 26,540 209 5,455 84 217 7,731 32,894 13,291 790,794 24,108 182 4,784 86 278 6,696 33,807 14,718 799,103 24,603 196 2,637 86 242 7,580 34,508 15,815 797,157 29,164 174 5,525 142 226 7,162 34,886 13,801 792,624 29,933 148 4,546 88 320 7,028 35,688 17,466 797,545 28,263 171 4,907 89 259 6,791 35,677 12,734 790,582 31,155 150 5,451 98 236 6,987 36,027 10,343 796,047 33,805 179 5,617 104 344 6,933 36,955 13,067 806,375 31,049 164 4,373 90 278 6,832 36,163 13,549 820,204 29,615 252 4,708 98 958 6,842 36,231 11,857 NOTE: Components may not sum to totals because of fractional and dollar coins. For details see "U.S. Currency rounding. and Coin Outstanding and in Circulation," Treasury Bul- 1. Includes U.S. Treasury and federal agency securi- letin. ties. U.S. Treasury securities include securities lent to 4. Cash value of agreements, which are coUateralized dealers, which are fully coUateralized by other U.S. Trea- by U.S. Treasury securities. sury securities. Federal agency securities are included at 5. Coin and paper currency held by the Treasury, as face value. well as any gold in excess of the gold certificates issued 2. Cash value of agreements, which are coUateralized to the Reserve Bank. by U.S. Treasury and federal agency securities. 6. Excludes required clearing balances and adjust- 3. Includes currency and coin (other than gold) issued ments to compensate for float. directly by the Treasury. The largest components are r. Revised. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

276 93rd Annual Report, 2006 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 Treasury drawing S o e u c h t u r e i r l g i d t h i t e 1 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 he ll r4 R F a O e s e s d s th e e e r e t r v s a r 5 e l Total s G to o c l k d 6 ce a r r c i t c g if o h i u c ts a n t t e s c t u a r o n r u d e t n i - n c g y 7 239 0 1,766 199 294 0 2,498 2,873 1,795 300 0 2,215 201 575 0 3,292 2,707 1,707 287 0 2,687 119 262 0 3,355 2,639 1,709 234 0 1,144 40 146 0 1,563 3,373 1,842 436 0 618 78 273 0 1,405 3,642 1,958 80 54 723 27 355 0 1,238 3,957 2,009 536 4 320 52 390 0 1,302 4,212 2,025 367 643 63 378 0 1,459 4,112 1,977 312 3 637 45 384 0 1,381 4,205 1,991 560 57 582 63 393 0 1,655 4,092 2,006 197 31 1,056 24 500 0 1,809 3,854 2,012 23 632 34 405 0 1,583 3,997 2,022 686 43 251 21 372 0 1,373 4,306 2,027 775 42 638 20 378 0 1,853 4,173 2,035 1,851 4 235 14 41 0 2,145 4,226 2,204 2,435 2 98 15 137 0 2,688 4,036 2,303 2,430 0 7 5 21 0 2,463 8,238 2,511 2,430 1 5 12 38 0 2,486 10,125 2,476 2,430 0 3 39 28 0 2,500 11,258 2,532 2,564 0 10 19 19 0 2,612 12,760 2,637 2,564 0 4 17 16 0 2,601 14,512 2,798 2,484 0 7 91 11 0 2,593 17,644 2,963 2,184 0 3 0 2,274 21,995 3,087 2,254 0 3 94 10 0 2,361 22,737 3,247 6,189 0 6 471 14 0 6,679 22,726 3,648 11,543 0 5 681 10 0 12,239 21,938 4,094 18,846 0 80 815 4 0 19,745 20,619 4,131 24,252 0 249 578 2 0 15,091 20,065 4,339 23,350 0 163 580 1 0 24,093 20,529 4,562 22,559 0 85 535 1 0 23,181 22,754 4,562 23,333 0 223 541 1 0 24,097 24,244 4,589 18,885 0 78 534 2 0 19,499 24,427 4,598 20,725 53 67 1,368 3 0 22,216 22,706 4,636 23,605 196 19 1,184 5 0 25,009 22,695 4,709 24,034 663 156 967 4 0 25,825 23,187 4,812 25,318 598 28 935 2 0 26,880 22,030 4,894 24,888 44 143 1 0 25,885 21,713 4,985 24,391 394 108 1,585 29 0 26,507 21,690 5,008 24,610 305 50 1,665 70 0 26,699 21,949 5,066 23,719 519 55 1,424 66 0 25,784 22,781 5,146 26,252 95 64 1,296 49 0 27,755 20,534 5,234 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 277 6B.—Continued Factors absorbing reserve funds Member bank Deposits with reserves9 Federal Reserve Banks, Cur- other than reserve balances Other Federal rency Treasury Required Federal Reserve in cash clearing cir t c io u n la- holdings8 Treasury Foreign Other a R cc e o se u r n v t e s5 balances li c a a b a p i n i l t i 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 i n e n d n 10 cy qu R ir e e - d11 ces E s x 11 - '12 Banks 4,951 288 51 96 25 118 0 0 1,636 0 1,585 51 5,091 385 51 73 28 208 0 0 1,890 0 1,822 68 5,325 218 57 5 18 298 0 0 1,781 0 0 0 4,403 214 96 12 15 285 0 0 1,753 0 1,654 99 4,530 225 11 3 26 276 0 0 1,934 0 0 0 4,757 213 38 4 19 275 0 0 1,898 0 1,884 14 4,760 211 51 19 20 258 0 0 2,220 0 2,161 59 4,817 203 16 8 21 272 0 0 2,212 0 2,256 -44 4,808 201 17 46 19 293 0 0 2,194 0 2.250 -56 4,716 208 18 5 21 301 0 0 2,487 0 2,424 63 4,686 202 23 6 21 348 0 0 2,389 0 2,430 -41 4,578 216 29 6 24 393 0 0 2,355 0 2,428 -73 4,603 211 19 6 22 375 0 0 2,471 0 2,375 96 5,360 222 54 79 31 354 0 0 1,961 0 1,994 -33 5,388 272 8 19 24 355 0 0 2,509 0 1,933 576 5,519 284 3 4 128 360 0 0 2,729 0 1,870 859 5,536 3,029 121 20 169 241 0 0 4,096 0 2,282 1,814 5,882 2,566 544 29 226 253 0 0 5,587 0 2,743 2,844 6,543 2,376 244 99 160 261 0 0 6,606 0 4,622 1,984 6,550 3,619 142 172 235 263 0 0 7,027 0 5,815 1,212 6,856 2,706 923 199 242 260 0 0 8,724 0 5,519 3,205 7,598 2,409 634 397 256 251 0 0 11,653 0 6,444 5,209 8,732 2,213 368 1,133 599 284 0 0 4,026 0 7,411 6,615 11,160 2,215 867 774 586 291 0 0 12,450 0 9,365 3,085 15,410 2,193 799 793 485 256 0 0 13,117 0 11,129 1,988 20,499 2,303 579 1,360 356 339 0 0 12,886 0 11,650 1,236 25,307 2,375 440 1,204 394 402 0 0 14,373 0 12,748 1,625 28,515 2,287 977 862 446 495 0 0 15,915 0 14,457 1,458 28,952 2,272 393 508 314 607 0 0 16,139 0 15,577 562 28,868 1,336 870 392 569 563 0 0 17,899 0 16,400 1,499 28,224 1,325 1,123 642 547 590 0 0 20,479 0 19,277 1,202 27,600 1,312 821 767 750 106 0 0 16,568 0 15,550 1,018 27,741 1,293 668 895 565 714 0 0 17,681 0 16,509 1,172 29,206 1,270 247 526 363 746 0 0 20,056 0 19,667 389 30,433 1,270 389 550 455 111 0 0 19,950 0 20,520 -570 30,781 761 346 423 493 839 0 0 20,160 0 19,397 763 30,509 796 563 490 441 907 0 0 18,876 0 18,618 258 31,158 767 394 402 554 925 0 0 19,005 0 18,903 102 31,790 775 441 322 426 901 0 0 19,059 0 19,089 -30 31,834 761 481 356 246 998 0 0 19,034 0 19,091 -57 32,193 683 358 111 391 1,122 0 0 18,504 0 18,574 -70 32,591 391 504 345 694 841 0 0 18,174 310 18,619 -135 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

278 93rd Annual Report, 2006 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 i n - n c g y 7 1960 26,984 400 33 1,847 74 0 29,338 17,767 . . . 5,398 1961 30,478 159 130 2,300 51 0 31,362 16,889 . . . 5,585 1962 28,722 342 38 2,903 110 0 33,871 15,978 . . . 5,567 1963 33,582 11 63 2,600 162 0 36,418 15,513 . . . 5,578 1964 36,506 538 186 2,606 94 0 39,930 15,388 . . . 5,405 1965 40,478 290 137 2,248 187 0 43,340 13,733 . . . 5,575 1966 43,655 661 173 2,495 193 0 47,177 13,159 . . . 6,317 1967 48,980 170 141 2,576 164 0 52,031 11,982 . . . 6,784 1968 52,937 0 186 3,443 58 0 56,624 10,367 . . . 6,795 1969 57,154 0 183 3,440 64 2,743 64,584 10,367 . . . 6,852 1970 62,142 0 335 4,261 57 1,123 67,918 10,732 400 7,147 1971 69,481 1,323 39 4,343 261 1,068 76,515 10,132 400 7,710 1972 71,119 111 1,981 3,974 106 1,260 78,551 10,410 400 8,313 1973 80,395 100 1,258 3,099 68 1,152 86,072 11,567 400 8,716 1974 84,760 954 299 2,001 999 3,195 92,208 11,652 400 9,253 1975 92,789 1,335 211 3,688 1,126 3,312 102,461 11,599 500 10,218 1976 100,062 4,031 25 2,601 991 3,182 110,892 11,598 1,200 10,810 1977 108,922 2,352 265 3,810 954 2,442 118,745 11,718 1,250 11,331 1978 117,374 1,217 1,174 6,432 587 4,543 131,327 11,671 1,300 11,831 1979 124,507 1,660 1,454 6,767 704 5,613 140,705 11,172 1,800 13,083 1980 128,038 2,554 1,809 4,467 776 8,739 146,383 11,160 2,518 13,427 1981 136,863 3,485 1,601 1,762 195 9,230 153,136 11,151 3,318 13,687 1982 144,544 4,293 717 2,735 1,480 9,890 63,659 11,148 4,618 13,786 1983 159,203 1,592 918 1,605 418 8,728 172,464 11,121 4,618 15,732 NOTE: For a description of figures and discussion of 4. Principally acceptances and, until August 21, 1959, their significance, see Banking and Monetary Statistics, industrial loans, the authority for which expired on that 1941-1970 (Board of Governors of the Federal Reserve date. System, 1976), pp. 507-23. 5. For the period before April 16, 1969, includes the Components may not sum to totals because of total of Federal Reserve capital paid in, surplus, other rounding. capital accounts, and other liabilities and accrued divi- 1. In 1969 and thereafter, includes securities loaned— dends, less the sum of bank premises and other assets, fully guaranteed by U.S. government securities pledged and is reported as "Other Federal Reserve accounts"; with Federal Reserve Banks—and excludes securities thereafter, "Other Federal Reserve assets" and "Other sold and scheduled to be bought back under matched Federal Reserve liabilities and capital" are shown sale-purchase transactions. On September 29, 1971, and separately. thereafter, includes federal agency issues bought outright. 6. Before January 30, 1934, includes gold held in 2. On December 1, 1966, and thereafter, includes Federal Reserve Banks and in circulation. federal agency obligations held under repurchase 7. Includes currency and coin (other than gold) issued agreements. directly by the Treasury. The largest components are 3. In 1960 and thereafter, figures reflect a minor fractional and dollar coins. For details see "U.S. Currency change in concept; see Federal Reserve Bulletin, vol. 47 and Coin Outstanding and in Circulation," Treasury Bul- (February 1961), p. 164. letin. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 279 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 s u er n v ts e 5 balances liab a i n l d ities F W ed i e t r h al Currency Re- Extion Treasury Foreign Other capital5 Reserve co an in 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 41,391 1,328 171,935 479 3,661 191 851 0 1,013 5,392 20,413 17,821 39,179 -945 8. Coin and paper currency held by the Treasury, as 1973—Ql, $279; Q2, $172; Q3, $112; Q4, $84; well as any gold in excess of the gold certificates issued 1974—Ql, $67; Q2, $58. The transition period ended to the Reserve Bank. with the second quarter of 1974. 9. In November 1979 and thereafter, includes reserves 13. For the period before July 1973, includes certain of member banks, Edge Act corporations, and U.S. agen- deposits of domestic nonmember banks and foreigncies and branches of foreign banks. On November 13, owned banking institutions held with member banks and 1980, and thereafter, includes reserves of all depository redeposited in full with Federal Reserve Banks in coninstitutions. nection with voluntary participation by nonmember insti- 10. Between December 1, 1959, and November 23, tutions in the Federal Reserve System program of credit 1960, part was allowed as reserves; thereafter, all was restraint. allowed. As of December 12, 1974, the amount of voluntary 11. Estimated through 1958. Before 1929, data were nonmember bank and foreign-agency and branch deposits available only on call dates (in 1920 and 1922 the call at Federal Reserve Banks that are associated with date was December 29). Since September 12, 1968, the marginal reserves is no longer reported. However, two amount has been based on close-of-business figures for amounts are reported: (1) deposits voluntarily held as the reserve period two weeks before the report date. reserves by agencies and branches of foreign banks oper- 12. For the week ending November 15, 1972, and ating in the United States and (2) Eurodollar liabilities. thereafter, includes $450 million of reserve deficiencies 14. Adjusted to include waivers of penalties for reserve on which Federal Reserve Banks are allowed to waive deficiencies, in accordance with change in Board policy, penalties for a transition period in connection with bank effective November 19, 1975. adaptation to Regulation J as amended, effective Novem- . . . Not applicable. ber 9,1972. Allowable deficiencies are as follows (beginning with first statement week of quarter, in millions): Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

280 93rd Annual Report, 2006 7. Principal Assets and Liabilities of Insured Commercial Banks, by Class of Bank, June 30, 2006 and 2005 Millions of dollars, except as noted Member banks Nonmember Item Total banks Total National State 2006 ASSETS Loans and investments 6,782,584 5,298,487 4,224,793 1,073,694 1,484,097 Loans, gross 5,177,276 4,018,755 3,218,246 800,509 1,158,520 Net 5,175,292 4,017,598 3,217,313 800,285 1,157,693 Investments 1,605,308 1,279,731 1,006,547 273,184 325,576 U.S. Treasury and federal agency securities 285,687 162,185 102,455 59,730 123,502 Other 1,319,621 1,117,546 904,092 213,454 202,075 Cash assets, total 277,134 219,429 182,292 37,137 57,704 LIABILITIES Deposits, total 5,255,716 3,987,644 3,185,042 802,603 1,268,072 Interbank 88,201 74,038 60,177 13,861 14,163 Other transaction 679,778 485,240 386,663 98,577 194,538 Other nontransaction 4,487,738 3,428,366 2,738,202 690,164 1,059,372 Equity capital 949,489 760,868 624,281 136,587 188,621 Number of banks 7,453 2,672 1,776 896 4,781 2005 ASSETS Loans and investments .. 6,253,909 4,891,946 3,885,394 1,006,552 1,361,963 .oans. 4,713,929 3,690,671 2,955,356 735,315 1,023,258 Net 4,712,060 3,689,551 2,954,491 735,060 1,022,510 Investments 1,539,980 1,201,275 930,038 271,238 338,705 U.S. Treasury and federal agency securities 300,837 182,559 120,732 61,827 118,278 Other 1,239,144 1,018,717 809,306 209,411 220,427 Cash assets, total 262,672 209,055 172,007 37,048 53,618 LIABILITIES Deposits, total 4,844,523 3,691,818 2,941,861 749,958 1,152,704 Interbank 80,546 66,730 55,023 11,707 13,816 Other transaction 702,873 504,424 396,555 107,869 198,449 Other nontransaction 4,061,104 3,120,664 2,490,283 630,381 940,440 Equity capital 872,023 700,699 570,770 129,929 171,324 Number of banks 7,527 2,762 1,862 900 4,765 NOTE: Includes U.S.-insured commercial banks located are domestic assets and liabilities (except for those comin the United States but not U.S.-insured commercial ponents reported on a consolidated basis only). Compobanks operating in U.S. territories or possessions. Data nents may not sum to totals because of rounding. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 281 8. Initial Margin Requirements under Regulations T, U, and X Percent of market value Effective date M sto ar 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 le 1 s, 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 collateral as prescribed by the Board. Regulation T was Governors pursuant to the Securities Exchange Act of adopted effective October 1, 1934; Regulation U, effec- 1934, limit the amount of credit that may be extended for tive May 1, 1936; and Regulation X, effective November the purpose of purchasing or carrying "margin securi- 1, 1971. The former Regulation G, which was adopted ties" (as defined in the regulations) when the loan is effective March 11,1968, was merged into Regulation U, coUateralized by such securities. The margin requirement, effective April 1, 1998. expressed as a percentage, is the difference between the 1. From October 1, 1934, to October 31, 1937, the market value of the securities being purchased or carried requirement was the margin "customarily required" by (100 percent) and the maximum loan value of the brokers and dealers. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

282 93rd Annual Report, 2006 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2006 and 2005 Millions of dollars Total Boston Item 2006 2005 2006 2005 ASSETS Gold certificate account 11,037 11,039 486 510 Special drawing rights certificate account 2,200 2,200 115 115 Coin 801 686 27 31 Loans To depository institutions 67 72 10 Securities purchased under agreements to resell (triparty) 40,750 46,750 0 U.S. Treasury securities Bought outright1 778,915 744,215 37,169 38,076 Held under repurchase agreements 0 0 0 0 Total loans and securities 819,731 791,036 37,178 38,078 Items in process of collection 4,276 6,834 97 368 Bank premises 1,953 1,827 117 112 Other assets Denominated in foreign currencies2 20,482 18,928 491 2,405 Other3 : 18,015 18,579 782 792 Interdistrict settlement account 0 0 124 -3,268 Total assets 878,494 851,130 39,416 39,143 LIABILITIES Federal Reserve notes outstanding (issued to Bank) .. 958,680 906,511 39,020 38,971 Less: Notes held by Federal Reserve Bank 175,661 148,152 3,020 4,424 Federal Reserve notes, net 783,019 758,359 36,000 34,548 Securities sold under agreements to repurchase 29,615 30,505 1,413 1,561 Deposits Depository institutions 18,699 19,043 549 622 U.S. Treasury, general account 4,708 4,573 0 0 Foreign, official accounts 98 83 1 5 Other4 1,496 2,168 42 1,068 Total deposits 25,002 25,867 592 1,695 Deferred credit items 4,602 5,943 352 488 Other liabilities and accrued dividends5 5,608 4,019 267 218 Total liabilities 847,846 824,693 38,624 38^10 CAPITAL ACCOUNTS Capital paid in 15,324 13,536 396 317 Surplus (including accumulated other comprehensive income) 15,324 12,901 396 317 Total liabilities and capital accounts 878,494 851,130 39,416 39,143 FEDERAL RESERVE NOTE STATEMENT Federal Reserve notes outstanding 958,680 906,511 Less: Held by Banks not subject to collateralization 175,661 148,152 Collateralized Federal Reserve notes 783,019 758359 Collateral for Federal Reserve notes Gold certificate account 11,037 11,039 Special drawing rights certificate account 2,200 2,200 Other eligible assets 0 0 U.S. Treasury and federal agency securities 769,782 745,120 Total collateral 783,019 758359 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 283 9.—Continued New York Philadelphia Cleveland Richmond 2006 2005 2006 2005 2006 2005 2006 2005 4,139 4,357 463 432 446 453 853 836 874 874 83 83 104 104 147 147 47 47 53 34 73 55 78 66 40,750 46,750 288,297 295,107 33,817 26,401 33,633 31,439 64,704 56,796 0 0 0 0 0 0 0 0 329,047 341,857 33,817 26,401 33,633 31,439 64,704 56,797 70 625 649 586 451 820 237 225 212 207 58 53 158 158 170 153 5,707 5,514 1,152 473 1,569 1,712 5,625 3,454 7,099 8,740 1,055 672 759 718 1,502 1,341 -29,471 -45,332 836 6,148 -2,264 833 4,858 8,521 317,724 316,889 38,166 34,883 34,929 36,293 78,174 71^40 341,947 327,194 38,658 37,426 36,516 36,539 75,090 69,647 56,821 43,521 6,957 6,130 6,709 5,081 11,394 11,887 285,126 283,673 31,700 31,296 29,807 31,457 63,695 57,759 10,961 12,096 1,286 1,082 1,279 1,289 2,460 2,328 6,609 6,389 584 485 954 658 2,748 3,182 4,708 4,573 0 0 0 0 0 0 69 55 2 1 3 4 11 7 821 523 1 4 32 82 121 146 12,207 11,539 587 490 990 743 2,880 3,336 111 797 718 363 405 581 384 509 1,864 1,414 255 164 275 196 569 359 310,270 309,519 34,547 33395 32,756 34,266 69,987 64,291 3,727 3,685 1,810 744 1,087 1,013 4,093 3,942 3,727 3,685 1,810 744 1,087 1,013 4,093 3,307 317,724 316,889 38,166 34,883 34,929 36,293 78,174 71,540 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

284 93rd Annual Report, 2006 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2006 and 2005—Continued Millions of dollars Atlanta Chicago Item 2006 2005 2006 2005 ASSETS Gold certificate account 1,023 945 947 928 Special drawing rights certificate account 166 166 212 212 Coin 93 89 100 76 Loans To depository institutions 24 27 Securities purchased under agreements to resell (triparty) U.S. Treasury securities Bought outright1 65,208 57,576 71,520 67,020 Held under repurchase agreements 0 0 0 0 Total loans and securities 65,211 57,583 71,544 67,047 Items in process of collection 324 1,281 241 414 Bank premises 232 232 206 211 Other assets Denominated in foreign currencies2 1,382 830 1,357 1,228 Other3 1,430 1,276 1,481 1,386 Interdistrict settlement account 12,404 10,086 -3,742 1,908 Total assets 82,264 72,489 72346 73,408 LIABILITIES Federal Reserve notes outstanding (issued to Banks) 98,175 84,653 79,818 76,740 Less: Notes held by Federal Reserve Banks 23,938 19,039 14,202 10,216 Federal Reserve notes, net 74,237 65,614 65,616 66,524 Securities sold under repurchase agreements 2,479 2,360 2,719 2,747 Deposits Depository institutions 1,980 1,626 1,395 1,591 U.S. Treasury, general account 0 0 0 0 Foreign, official accounts 3 2 3 3 Other4 63 13 105 72 Total deposits 2,046 1,641 1,503 1,665 Deferred credit items 473 763 276 349 Other liabilities and accrued dividends5 476 326 515 371 Total liabilities 79,711 70,704 70,630 71,656 CAPITAL ACCOUNTS Capital paid in 1,276 892 858 876 Surplus (including accumulated other comprehensive income) 1,276 892 858 876 Total liabilities and capital accounts 82,264 72,489 72346 73,408 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 2006 and 2005. 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 285 9.—Continued St. Louis Minneapolis Kansas City Dallas San Francisco 2006 2005 2006 2005 2006 2005 2006 2005 2006 2005 328 327 211 212 324 318 575 549 1,242 1,172 71 71 30 30 66 66 98 98 234 234 39 43 31 22 62 61 81 68 117 94 0 0 22 16 7 11 0 3 1 5 0 0 0 0 0 0 0 0 0 0 24,747 23,094 15,835 15,543 22,808 21,050 34,957 36,654 86,218 75,459 0 0 0 0 0 0 0 0 0 0 24,747 23,094 15,857 15,560 22,815 21,060 34,957 36,657 86,219 75,464 196 217 219 339 560 591 348 535 884 834 80 70 116 119 159 84 260 261 185 165 223 379 380 409 271 246 236 217 2,089 2,062 552 524 348 338 480 441 751 786 1,777 1,563 1,807 2,010 -237 38 4,734 2,422 3,537 -2,693 7,414 19,327 28,045 26,735 16,955 17,067 29,469 25,290 40,844 36,477 100,160 100,916 29,169 28,096 17,442 17,854 30,770 27,832 57,150 50,474 114,925 111,084 3,175 3,494 2,549 2,789 3,717 5,016 19,391 17,163 23,787 19,391 25,994 24,602 14,893 15,065 27,053 22,816 37,759 33,311 91,138 91,694 941 947 602 637 867 863 1,329 1,502 3,278 3,093 434 482 455 388 546 655 705 811 1,741 2,154 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 0 0 4 4 24 108 18 25 32 22 37 31 200 74 458 591 474 414 579 678 742 843 1,946 2,232 103 151 288 353 435 457 306 303 749 830 217 156 147 107 183 128 284 212 556 369 27,713 26,447 16,404 16,576 29,117 24,941 40,420 36,172 97,667 98,218 166 144 276 245 176 175 212 153 1,247 1,349 166 144 276 245 176 175 212 153 1,247 1,349 28,045 26,735 16,955 17,067 29,469 25,290 40,844 36,477 100,160 100,916 4. Includes international organization deposits of 5. Includes exchange-translation account reflecting the $144 million for 2006 and $125 million for 2005. 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

286 93rd Annual Report, 2006 10. Income and Expenses of the FederalReserve Banks, by Bank, 2006 Thousands of dollars Item Total Boston New York Philadelphia Cleveland CURRENT INCOME Loans 12,038 551 1,597 14 478 U.S. Treasury securities 36,452,265 1,712,534 14,520,198 1,454,413 1,511,710 Foreign currencies 368,905 12,756 103,272 19,564 28,793 Priced services 908,363 0 65,846 0 0 Compensation received for services provided1 572,329 46,466 37,091 32,272 67,696 Other 96,527 2,395 61,125 1,918 2,278 Total 38,410,427 1,774,702 14,789,129 1,508,181 1,610,954 CURRENT EXPENSES Salaries and other personnel expenses 1,407,617 76^44 286,428 67,218 86,172 Retirement and other benefits 427,673 19,968 81,799 22,285 25,881 Net periodic pension benefit expense2 65,601 1,071 57,394 374 534 Fees 114,852 2,860 9,949 1,422 4,713 Travel 67,247 2,988 8,717 2,356 4,482 Software expenses 142,574 4,174 18,653 8,775 23,215 costs 94,173 1,596 3,489 1,815 5,904 Communications 39,339 2,036 3,193 513 717 Materials and supplies 55,909 3,532 8,945 3,762 5,255 Building expenses Taxes on real estate 33,260 4,572 4,841 1,551 1,886 Property depreciation 94,732 5,884 17,604 4,056 7,570 Utilities 38,389 3,653 7,444 2,787 2,550 Rent 42,392 1,261 16,021 371 598 Other 34,195 1,277 6,661 1,775 3,177 Equipment Purchases 30,100 2,484 5,507 1,023 1,537 Rentals 4,160 266 1,873 350 233 Depreciation 96,727 4,737 8,600 5,115 5,749 Repairs and maintenance 85,982 5,023 9,559 4,693 6,316 Earnings credit costs 276,389 12,765 80,953 12,508 23,233 Compensation paid for services costs incurred1 572,329 0 29,073 0 0 Other 79,957 23,526 57,522 11,633 13,559 Recoveries -92,292 -13,459 -11,060 -2,409 -3,112 Expenses capitalized3 -21,075 -1,270 -9,580 -315 0 Total 3,690,228 165,488 703,586 151,657 220,173 Reimbursements -426,384 -23,368 -85,297 -30,547 -59,375 Net expenses 3,263,844 142,120 618,289 121,110 160,798 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 287 10.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 412 431 3,031 1,112 2382 1,159 164 506 2,861,861 2,888,396 3,216,671 1,111,823 721,055 1,021,749 1,621,236 3,810,619 97,807 23,987 24,389 4,364 6,959 4,866 4,254 37,893 0 787,847 54,670 0 0 0 0 0 44,012 469 58,784 21,996 74,126 70,644 59,750 59,024 7,665 4,474 4,488 1,593 910 1,266 1,944 6,472 3,011,757 3,705,604 3,362,033 1,140,888 805,632 1,099,685 1,687,348 3,914,513 191,575 129,149 108,688 73,743 74,153 91,041 83,001 139,904 64,130 41,586 32,966 22,130 23,075 22,588 28,771 42,494 760 1,295 402 626 720 762 475 1,187 59,317 8,064 5,974 9,225 1,553 4,189 3,688 3,897 9,829 7,882 6,851 3,591 3,042 4,871 3,911 8,728 53,282 3,460 3,641 7,625 3,230 4,220 4,780 7,518 3,334 57,295 3,954 2,357 2,860 2,053 3,810 5,706 23,241 1,648 1,427 1,279 1,036 1,081 1,514 1,655 5,897 6,709 4,467 2,669 2,440 2,962 4,558 4,714 2,232 3,197 3,507 518 3,153 1,206 3,366 3,230 8,496 9,130 11,083 5,150 4,679 4,166 8,527 8,388 3,621 3,806 2,456 1,734 1,894 794 4,358 3,291 14,272 622 2,423 1,708 251 3,653 159 1,053 3,399 3,925 4,568 1,005 1,472 485 4,016 2,434 6,457 2,455 1,874 1,449 1,730 2,538 1,292 1,754 286 393 300 182 22 42 53 160 35,919 8,747 4,430 3,325 2,759 4,893 5,090 7,364 18,944 10,670 7,009 2,990 2,470 3,212 5,601 9,495 52,610 17,434 26,003 5,100 5,329 8,173 6,080 26,199 0 543,255 0 0 0 0 0 0 -256,628 19,562 42,951 75,530 22,613 17,538 36,101 16,050 -29,564 -3,985 -8,758 -1,867 -1,056 -3,866 -7,025 -6,131 -3,041 0 -456 -2,372 -384 -652 -705 -2,301 268,368 876,298 265,759 217,697 157,042 175,949 201,422 286,791 -28,208 -14,613 -4,646 -115,598 -26,347 -10,472 -13,686 -14,226 240,159 861,685 261,113 102,100 130,694 165,476 187,736 272364 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

288 93rd Annual Report, 2006 10. Income and Expenses of the FederalReserve Banks, by Bank, 2006—Continued Thousands of dollars Item Total Boston New York Philadelphia Cleveland PROFIT AND LOSS Current net income 35,146,583 1,632,582 14,170,841 1,387,071 1,450,157 Additions to and deductions from (-) current net income4 Profits on foreign exchange transactions 1,185,560 31,981 330,788 65,609 91,326 Other additions 7,286 7 23 2 0 Total additions 1,192,847 31,989 330,811 65,610 91,326 Interest expense on reverse repurchase agreements -1,342,144 -65,129 -505,075 -55,771 -57,659 Other deductions -9,550 0 0 0 0 Total deductions -1,351,694 -65,129 -505,075 -55,771 -57,659 Net addition to or deduction from (-) current net income -158,847 -33,141 -174,264 9,840 33,667 Cost of unreimbursed Treasury services -2 0 1 -3 0 Assessments by Board Board expenditures5 301,014 7,379 81,676 21,904 22,535 Cost of currency 491,962 31,062 106,608 29,515 23,255 Net income before payment to U.S. Treasury 34,194,762 1,560,999 13,808,291 1,345,494 1,438,034 Dividends paid 871,255 21,592 221,339 80,190 63,285 Payments to U.S. Treasury (interest on Federal Reserve notes) 29,051,678 1,453,044 11,977^85 175,737 1,279,262 Transferred to/from surplus 4,271,828 86,363 1,609,367 1,089,567 95,487 Adjustments to surplus6 -1,848,716 -7,094 -1,567,462 -23,790 -22,222 Surplus, January 1 12,901,176 316,824 3,685,179 744,048 1,013,470 Surplus, December 31 15,324,288 396,093 3,727,084 1,809,826 1,086,735 NOTE: Components may not sum to totals because of Federal Reserve Bank of New York, resulting in an rounding. increase in expenses of $53,150 thousand. The expenses 1. During 2005, the Federal Reserve Bank of Atlanta related to the Retirement Benefit Equalization Plan and was assigned the overall responsibility for managing the the Supplemental Employee Retirement Plan are recorded Reserve Banks' provision of check services and recog- by each Federal Reserve Bank. nizes total System check revenue on its Statements of 3. Includes expenses for labor and materials capital- Income. In 2006, this policy was extended to ACH ser- ized and depreciated or amortized as charges to activities vices managed by the Federal Reserve Bank of Atlanta, in the periods benefited. as well as to Fedwire funds transfer and securitites trans- 4. Includes reimbursement from the U.S. Treasury for fer services, which are managed by the Federal Reserve uncut sheets of Federal Reserve notes, gains and losses on Bank of New York. The Federal Reserve Bank of Atlanta the sale of Reserve Bank buildings, counterfeit currency and the Federal Reserve Bank of New York compensate that is not charged back to the depositing institution, and the other Reserve Banks for the costs incurred in provid- stale Reserve Bank checks that are written off. ing these services. 5. For additional details, see the chapter "Board of 2. Reflects the effect of Financial Accounting Stan- Governors Financial Statements." dards Board Statement of Financial Accounting Stan- 6. The implementation of FAS 158 in 2006 required an dards No. 87, Employers' Accounting for Pensions (SEAS adjustment in the amount of $1,848,716 thousand to 87). The System Retirement Plan for employees is re- accumulated other comprehensive income, which is recorded on behalf of the System on the books of the ported as a component of surplus. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 289 10.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 2,771,597 2,843,919 3,100,920 1,038,788 674,938 934,209 1,499,612 3,641,949 322,377 79,152 78,502 13,225 22,097 15,658 13,679 121,167 3 20 44 0 0 1,291 0 5,896 322,380 79,172 78,546 13,225 22,097 16,949 13,679 127,063 -109,366 -110,361 -122,680 ^2,409 -27,460 -38,987 -61,610 -145,636 0 0 -610 -555 0 -8,386 0 0 -109,367 -110,361 -123,289 ^2,964 -27,460 -47,372 -61,610 -145,636 213,013 -31,189 -44,743 -29,738 -5,363 -30,424 -47,931 -18,573 0 0 0 0 0 0 0 0 80,873 20,742 19,585 3,254 5,427 3,874 3,688 30,075 40,241 65,067 51,165 17,276 12,383 17,174 24,924 73,291 2,863,497 2,726,921 2,985,426 988,520 651,765 882,737 1,423,068 3,520,010 240,681 64,625 52,280 9,205 15,064 10,502 11,959 80,533 1,764,199 2,251,659 2,910,601 935,913 594,235 864,852 1,323,733 3,520,859 858,617 410,636 22,546 43,402 42,466 7,382 87,377 -81,382 -72,769 -26,515 ^0,756 -21,196 -12,026 -5,795 -28,263 -20,829 3,307,452 892,166 876,301 144,000 245,322 174,757 152,628 1,349,029 4,093,301 1,276,288 858,091 166,206 275,762 176,344 211,742 1,246,817 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

290 93rd Annual Report, 2006 11. Income and Expenses of the Federal Reserve Banks, 1914-2006 Thousands of dollars Assessments by Net additions Board of Governors Federal Reserve Bank Current Net or and period income expenses deductions (-)1 Board Costs expenditures of currency All Banks 1914-15 . 2,173 2,018 6 302 1916 5,218 2,082 -193 192 1917 16,128 4,922 -1,387 238 1918 67,584 10,577 -3,909 383 1919 102,381 18,745 -4,673 595 1920 181,297 27,549 -3,744 710 1921 122,866 33,722 -6,315 741 1922 50,499 28,837 -4,442 723 1923 50,709 29,062 -8,233 703 1924 38,340 27,768 -6,191 663 1925 41,801 26,819 -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 291 11.—Continued Payments to U.S. Treasury Transferred Dividends paid t S ra ta n t s u f t e o r r s y 2 Fed In er te a r l e R st e s o e n rve (s t e o c t s io u n rp l 1 u 3 s b) ( t s o e c s t u io rp n l u 7 s ) notes 217 1,743 6,804 1,134 1,134 5,541 48334 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,bii 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

292 93rd Annual Report, 2006 11. Income and Expenses of the Federal Reserve Banks, 1914-2006—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 1960 1,103,385 139,894 13,875 6,534 7,455 1961 941,648 148,254 3,482 6,265 6,756 1962 1,048,508 161,451 -56 6,655 8,030 1963 1,151,120 169,638 615 7,573 10,063 1964 1,343,747 171,511 726 8,655 17,230 1965 1,559,484 172,111 1,022 8,576 23,603 1966 1,908,500 178,212 996 9,022 20,167 1967 2,190,404 190,561 2,094 10,770 18,790 1968 2,764,446 207,678 8,520 14,198 20,474 1969 3,373,361 237,828 -558 15,020 22,126 1970 3,877,218 276,572 11,442 21,228 23,574 1971 3,723,370 319,608 94,266 32,634 24,943 1972 3,792,335 347,917 -49,616 35,234 31,455 1973 5,016,769 416,879 -80,653 44,412 33,826 1974 6,280,091 476,235 -78,487 41,117 30,190 1975 6,257,937 514,359 -202,370 33,577 37,130 1976 6,623,220 558,129 7,311 41,828 48,819 1977 6,891,317 568,851 -177,033 47,366 55,008 1978 8,455,309 592,558 -633,123 53,322 60,059 1979 10,310,148 625,168 -151,148 50,530 68,391 1980 12,802,319 718,033 -115,386 62,231 73,124 1981 15,508,350 814,190 -372,879 63,163 82,924 1982 16,517,385 926,034 -68,833 61,813 98,441 1983 16,068,362 1,023,678 -400,366 71,551 152,135 1984 18,068,821 1,102,444 ^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 2006 38,410,427 3,263,844 -158,846 301,014 491,962 Total, 1914-2006 710,889,641 53,347,257 4,041,796 4,704,801 8,832,012 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 293 11.—Continued Payments to U.S. Treasury Transferred Tran QffrrpH 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 n a r l o e t R s e t s e s o e n rve (s t e o c t s i u o r n p l 1 u 3 s b) ( t s o e c s t u io rp n l u 7 s ) 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 5,51*7,716 14,565,624 635,343 299,652 20,658,972 0 831,705 343,014 17,785,942 8,774,994 731,575 373,579 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 1,271,672 871,255 29,051,678 4,271,828 8,738,777 44,113,958 573,927,960 -4 2U66,6763 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

294 93rd Annual Report, 2006 11. Income and Expenses of the Federal Reserve Banks, 1914-2006—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, 1914-2006 Boston 37,823,486 3,416,852 -48,223 207,260 518,973 New York 249,731,575 8,384,9314 833,624 1,168,193 2,781,090 Philadelphia 26,369,964 2,776,143 112,671 198,455 375,069 Cleveland 42,583,372 3,269,494 297,125 342,922 512,316 Richmond 54,923,061 4,585,203 691,529 669,078 725,744 Atlanta 40,448,737 6,527,615 290,459 350,725 659,959 Chicago 85,257,610 6,465,618 613,784 525,507 1,005,353 St. Louis 24,240,701 2,597,202 42,722 115,126 321,728 Minneapolis 12,223,622 2,549,119 129,352 140,300 156,232 Kansas City 25,486,625 3,401,053 103,704 146,764 321,689 Dallas 32,411,865 3,448,353 338,948 218,444 437,554 San Francisco 79,389,024 5,925,674 636,099 622,028 1,016,305 Total 710,889,641 53,347,257 4,041,796 4,704,801 8,832,012 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 1. For 1987 and subsequent years, includes the cost of the Federal Reserve Act from 1935 through 1947; and services provided to the Treasury by Federal Reserve transfers made under section 7 of the Federal Reserve Act Banks for which reimbursement was not received. for 1996 and 1997. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 295 11.—Continued Payments to U.S. Treasury Transferred Transferred Dividends Interest on to surplus to surplus t S ra ta n t s u f t e o r r s y 2 Federal Reserve (section 13b) (section 7) notes 410,646 2,579,504 30,051,671 135 590,222 2,176,006 17,307,161 212,590,458 -433 6,157,793 407,602 1,312,118 19,437,229 291 1,975,729 649,488 2,827,043 33,884,049 -10 1,395,195 1,403,928 3,083,928 39,972,837 -72 5,173,944 617,505 2,713,230 28,273,211 5 1,596,946 916,679 4,593,811 71,087,653 12 1,276,762 208,306 1,833,837 18,917,298 -27 289,952 256,828 416,227 8,400,348 65 433,854 248,040 1,249,703 19,924,327 -9 298,763 350,811 1,510,802 26,405,056 55 379,737 1,092,938 4,686,594 64,983,822 -17 1,697,779 8,738,777 44,113,958 573,927,960 -4 21,266,6763 3. The $21,266,676 thousand transferred to surplus The implementation of FAS 158 in 2006 required an was reduced by direct charges of $500 thousand for adjustment to accumulated other comprehensive income charge-off on Bank premises (1927), $139,300 thousand of $1,848,716 thousand, which is reported as a compofor contributions to capital of the Federal Deposit Insur- nent of surplus, leaving a balance of $15,324,288 thouance Corporation (1934), $4 thousand net upon elimina- sand on December 31, 2006. tion of section 13b surplus (1958), and $106,000 thou- 4. This amount is reduced by $2,717,806 thousand sand (1996), $107,000 thousand (1997), and for expenses of the System Retirement Plan. See note 2, $3,752,000 thousand (2000) transferred to the Treasury as table 10. statutorily required; and was increased by transfer of . . . Not applicable. $11,131 thousand from reserves for contingencies (1955). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

296 93rd Annual Report, 2006 12. Operations in Principal Departments of the Federal Reserve Banks, 2003-2006 Operation 2006 2005 2004 2003 Millions of pieces Currency processed 37,694 36,463 36,242 34,832 Currency destroyed 6,766 6,551 6,748 7,375 Coin received 59,705 56,080 55,655 48,138 Checks handled U.S. government checks 192 215 234 267 Postal money orders 171 176 187 198 All other 10,983 12,195 13,904 15,806 Securities transfers1 22 22 20 20 Funds transfers 134 132 125 123 Automated clearinghouse transactions Commercial 8,231 7,339 6,486 5,588 Government 992 964 941 914 Millions of dollars Currency processed 664,592 639,832 625,127 584,915 Currency destroyed 84,742 83,187 90,943 101,338 Coin received 5,779 5,412 5,403 4,879 Checks handled U.S. government checks 231,314 250,865 277,649 308,055 Postal money orders 28,066 28,395 29,045 29,197 Mother 13,628,348 14,379,874 14,287,740 15,431,625 Securities transfers1 377,258,592 368,896,819 313,425,252 267,644,194 Funds transfers2 572,645,790 518,546,733 478,946,947 447,341,692 Automated clearinghouse transactions Commercial 13,124,434 12,801,914 12,543,907 13,951,600 Government 3,474,364 3,156,556 2,913,189 2,810,283 1. The title of this category has changed from previous 2. Amounts in bold are restatements. years, but the composition of the category is the same; therefore, the data here are comparable with data reported in previous years. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 297 13. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2006 President1 Other officers Employees Total Federal Reserve Bank (including Number Branches) Salary Num- Salaries Salaries Num- Salaries (dollars)2 ber (dollars)2 Full- Part- (dollars)2 ber (dollars)2 time time Boston 374,100 62 10,567,765 837 70 57,522,048 970 68,463,913 New York 381,000 279 54,289,191 2,454 54 198,746,036 2,791 254,007,727 Philadelphia 276,500 56 8,595,200 982 34 53,274,392 1,073 62,146,092 Cleveland 281,400 60 9,200,500 1,491 34 72,454,563 1,586 81,936,463 Richmond 276,500 72 10,764,700 1,681 40 95,642,478 1,794 106,683,678 Atlanta Vacant3 78 12,948,880 1,912 40 106,293,498 2,031 119,242,378 Chicago 374,100 86 13,118,406 1,310 59 84,242,032 1,456 97,734,538 St. Louis 311,000 75 10,910,680 954 58 53,627,203 1,088 64,848,883 Minneapolis 374,100 43 6,422,280 1,155 101 62,186,058 1,300 68,982,438 Kansas City 340,600 73 11,504,000 1,218 19 67,284,920 1,311 79,129,520 Dallas 276,500 53 8,337,504 1,219 18 65,143,411 1,291 73,757,415 San Francisco ... 326,900 75 13,691,634 1,656 28 111,625,788 1,760 125,644,322 Federal Reserve Information Technology . 39 5,947,200 719 6 59,314,205 764 65,261,405 Office of Employee Benefits .... 8 1,618,400 33 0 2,669,126 41 4,287,526 Total 3,592,700 1,059 177,916,340 17,621 561 1,090,025,758 19,256 1,272,126,298 1. Under current policies, the appointment salaries of There continue to be tiered salary ranges for Reserve Federal Reserve Bank presidents are normally 85 percent Bank officers, including presidents, reflecting differences of the salary-range midpoint (an 85 compa-ratio), with in the costs of labor in the head-office cities. The Board the exception of the New York Reserve Bank president, reviews Reserve Bank officer salary ranges and Reserve whose appointment salary normally is set at a 95 compa- Bank placement in the salary tiers annually. In 2006, New ratio. The Board has discretion to approve a higher York and San Francisco were in tier 1, which had a starting salary if requested by a Reserve Bank's board of midpoint for presidents' salaries of $362,900. Boston, directors. Philadelphia, Richmond, Atlanta, Chicago, Minneapolis, On January 1 each year, all presidents receive salary and Dallas were in tier 2, which had a midpoint for increases equal to the percentage increase in the midpoint presidents' salaries of $325,300. Cleveland, St. Louis, of their respective salary ranges. In addition, on every and Kansas City were in tier 3, which had a midpoint for third-year anniversary of his or her initial appointment presidents' salaries of $296,200. (through year 9), each president receives a salary increase 2. Annualized salary liability based on salaries in effect that results in a compa-ratio as follows: year 3,95 (for the on December 31, 2006. New York Bank, 105); year 6, 105 (New York, 115); 3. Atlanta president retired in October 2006. year 9, 115 (New York, 125). . . . Not applicable. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

298 93rd Annual Report, 2006 14. Acquisition Costs and Net Book Value of the Premises of the Federal Reserve Banks and Branches, December 31, 2006 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 27,293 127,979 28,019 183,290 117,283 NEW YORK 20,103 254,486 66,929 341,517 211,798 0 0 0 0 0 Buffalo 2,779 84,976 13,545 101,300 57,782 PHILADELPHIA . 4,219 124,865 25,386 154,470 112,851 CLEVELAND 2,593 32,466 11,624 46,683 24,993 Cincinnati 1,739 19,488 14,503 35,730 20,349 Pittsburgh RICHMOND 22,649 107,558 38,279 168,486 118,391 Baltimore 6,482 29,566 5,828 41,876 24,081 Charlotte 3,130 31,498 6,847 41,475 27,295 ATLANTA 22,735 149,625 16,367 188,727 166,998 Birmingham 5,347 11,744 1,525 18,616 12,323 Jacksonville 1,730 20,987 3,810 26,527 16,960 48 Miami 4,254 22,143 4,869 31,266 20,746 Nashville 603 5,690 3,532 9,825 4,843 New Orleans 3,785 8,827 5,231 17,843 9,924 CHICAGO 4,512 165,149 20,268 189,929 115,789 Detroit 9,980 72,293 10,690 92,962 90,657 ST. LOUIS 8,392 73,386 12,578 94,356 65,315 Little Rock 0 0 0 0 0 4,106 Louisville 0 0 0 0 0 Memphis 2,472 14,127 5,164 21,763 14,975 MINNEAPOLIS .. 15,666 104,652 13,834 134,153 106,397 Helena 2,890 9,716 943 13,549 9,587 KANSAS CITY .. 29,460 114,121 0 143,580 143,580 Denver 3,511 9,167 4,502 17,179 8,525 Oklahoma City 0 108 0 108 108 Omaha 3,559 7,374 1,726 12,658 6,390 DALLAS 35,638 111,106 23,715 170,459 123,479 1 El Paso 262 3,584 1,553 5,400 1,616 Houston 23,754 101,555 8,088 133,397 129,024 7,204 San Antonio 826 7,917 2,674 11,418 6,335 SAN FRANCISCO 20,129 96,419 22,370 138,919 80,904 Los Angeles 6,306 71,935 13,009 91,250 57,911 Portland 0 0 0 0 0 Salt Lake City 1,294 4,680 1,385 7,360 3,083 Seattle 8,191 37,798 4,545 50,534 42,639 13 Total 30632 2,0364)85 393340 2,736,606 1,952,930 11372 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

301 Audits of the Federal Reserve System The Board of Governors, the Federal The Reserve Banks' financial state- Reserve Banks, and the Federal Reserve ments are audited annually by an inde- System as a whole are all subject to pendent outside auditor retained by the several levels of audit and review. The Board of Governors. In addition, the Board's financial statements, and its Reserve Banks are subject to annual compliance with laws and regulations examination by the Board. As discussed affecting those statements, are audited in the chapter "Federal Reserve Banks," annually by an outside auditor retained the Board's examination includes a wide by the Board's Office of Inspector Gen- range of ongoing oversight activities eral. The Office of Inspector General conducted on and off site by staff of the also conducts audits, reviews, and inves- Board's Division of Reserve Bank Optigations relating to the Board's pro- erations and Payment Systems. grams and operations as well as to Board Federal Reserve operations are also functions delegated to the Reserve subject to review by the Government Banks. Accountability Office. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

303 Board of Governors Financial Statements The financial statements of the Board for 2006 and 2005 were audited by KPMG LLP, independent auditors. KPMGLLP 2001 M Street, NW Washington, DC 20036 Independent Auditors' Report 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, 2006 and 2005, and the related statements of revenues and expenses and changes in cumulative results of operations, and cash flows (hereinafter referred to as "financial statements") 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 misstatement. 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, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Board of Governors of the Federal Reserve System, as of December 31, 2006 and 2005, and the results of its operations, and its cash flows, for the years then ended, in conformity with U.S. generally accepted accounting principles. As discussed in Note 3 to the financial statements, in 2006, the Board adopted the provisions of the Financial Accounting Standard Board Statement No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans. In accordance with Government Auditing Standards, we have also issued our reports dated April 17, 2007, 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. April 17,2007 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

304 93rd Annual Report, 2006 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BALANCE SHEETS As of December 31, 2006 2005 ASSETS CURRENT ASSETS Cash $ 60,030,706 $ 45,970,435 Accounts receivable 2,625,907 3,081,520 Prepaid expenses and other assets 4,260,507 2,992,412 Total current assets 66,917,120 52,044,367 NONCURRENT ASSETS Property and equipment, net (Note 4) 151,205,386 155,441,553 Total noncurrent assets 151,205,386 155,441,553 Total assets $218,122,506 $207,485,920 LIABILITIES AND CUMULATIVE RESULTS OF OPERATIONS CURRENT LIABILITIES Accounts payable and accrued liabilities $ 10,950,470 $ 16,906,350 Accrued payroll and related taxes 5,421,666 4,860,572 Accrued annual leave 16,334,512 15,456,484 Capital lease payable (current portion) 327,663 270,167 Unearned revenues and other liabilities 366,304 783,711 Total current liabilities 33,400,615 38,277,284 LONG-TERM LIABILITIES Capital lease payable (non-current portion) 108,755 406,188 Accumulated retirement benefit obligation (Note 5) 1,354,662 813,497 Accumulated postretirement benefit obligation (Note 6) 8,111,829 6,237,290 Accumulated postemployment benefit obligation (Note 7) 6,515,301 5,111,365 Total long-term liabilities 16,090,547 12,568,340 Total liabilities 49,491,162 50,845,624 CUMULATIVE RESULTS OF OPERATIONS Working capital 33,844,168 14,037,250 Unfunded long-term liabilities (14,325,986) (12,162,152) Net investment in property and equipment 150,768,968 154,765,198 Accumulated other comprehensive income (loss) (Note 8) (1,655,806) __i^____ Total cumulative results of operations 168,631,344 156,640,296 Total liabilities and cumulative results of operations $218,122,506 $207,485,920 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 305 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF REVENUES AND EXPENSES AND CHANGES IN CUMULATIVE RESULTS OF OPERATIONS For the years ended December 31, 2006 2005 BOARD OPERATING REVENUES Assessments levied on Federal Reserve Banks for Board operating expenses and capital expenditures $301,013,500 $265,742,100 Other revenues (Note 9) 8,508,949 8,520,342 Total operating revenues 309,522,449 274,262,442 BOARD OPERATING EXPENSES Salaries 182,239,595 174,523,825 Retirement and insurance 35,853,297 31,847,951 Contractual services and professional fees 23,944,564 24,695,564 Depreciation, amortization, and net losses on disposals 13,058,667 12,954,506 Utilities 9,185,840 9,065,329 Travel 8,820,503 7,613,280 Software 6,637,765 6,052,617 Postage and supplies 4,560,368 7,169,829 Repairs and maintenance 2,634,459 3,361,179 Printing and binding 1,505,470 1,973,594 Other expenses (Note 9) 7,435,067 7,486,158 Total operating expenses 295,875,595 286,743,832 RESULTS OF OPERATIONS 13,646,854 (12,481,390) ISSUANCE AND REDEMPTION OF FEDERAL RESERVE NOTES Assessments levied on Federal Reserve Banks for currency costs 491,962,202 477,087,471 Expenses for currency printing, issuance, retirement, and shipping 491,962,202 477,087,471 CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES 0 0 TOTAL RESULTS OF OPERATIONS 13,646,854 (12,481,390) CUMULATIVE RESULTS OF OPERATIONS, Beginning of year 156,640,296 169,121,686 OTHER COMPREHENSIVE INCOME Adjustment to initially apply FASB Statement No. 158 (Note 8) (1,655,806) ... Total Other Compehensive Income (1,655,806) CUMULATIVE RESULTS OF OPERATIONS, End of year $168,631,344 $156,640,296 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

306 93rd Annual Report, 2006 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF CASH FLOWS For the years ended December 31, 2006 2005 CASH FLOWS FROM OPERATING ACTIVITIES RESULTS OF OPERATIONS $13,646,854 $(12,481,390) Adjustments to reconcile results of operations to net cash provided by (used in) operating activities: Depreciation and net losses on disposals 13,058,667 12,954,506 Increase in assets: Accounts receivable, and prepaid expenses and other assets (812,482) (362,385) Increase (decrease) in liabilities: Accounts payable and accrued liabilities (5,955,880) 3,014,489 Accrued payroll and related taxes 561,094 308,533 Accrued annual leave 878,028 1,260,574 Unearned revenues and other liabilities (417,407) 316,047 Accumulated retirement benefit obligation 541,165 219,328 Accumulated postretirement benefit obligation 1,874,539 447,724 Accumulated postemployment benefit obligation 1,403,936 (197,200) Accumulated other comprehensive income (1,655,806) _ i ^ __ Net cash provided by operating activities 23,122,708 5,480,226 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposals 7,212 2,850 Capital expenditures (8,829,712) (19,370,223) Net cash used in investing activities (8,822,500) (19,367,373) CASH FLOWS FROM FINANCING ACTIVITIES Capital lease payments (239,937) (249,710) Net cash used in financing activities (239,937) (249,710) NET INCREASE (DECREASE) IN CASH 14,060,271 (14,136,857) CASH BALANCE, Beginning of year 45,970,435 60,107,292 CASH BALANCE, End of year $60,030,706 $ 45,970,435 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 307 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM NOTES TO FINANCIAL STATEMENTS Revenues—Assessments for operating expenses and AS OF AND FOR THE YEARS ENDED additions to property are based on expected cash needs. DECEMBER 31, 2006 AND 2005 Issuance and Redemption of Federal Reserve Notes— The Board incurs expenses and assesses the Federal Reserve Banks for currency printing, issuance, retire- (1) STRUCTURE ment, and shipping of Federal Reserve Notes. These The Federal Reserve System was established by Con- assessments and expenses are separately reported in the gress in 1913 and consists of the Board of Governors statements of revenues and expenses because they are (Board), the Federal Open Market Committee, the twelve passed through the Board account and are not Board regional Federal Reserve Banks, the Federal Advisory operating transactions. Council, and the private commercial banks that are mem- Property, Equipment, and Software—The Board's bers of the System. The Board, unlike the Reserve Banks, property, buildings, equipment, and software are stated at was established as a federal government agency and is cost less accumulated depreciation and amortization. Desupported by Washington DC based staff numbering ap- preciation and amortization is calculated on a straight-line proximately 1,800, as it carries out its responsibilities in basis over the estimated useful lives of the assets, which conjunction with other components of the Federal Re- range from 3 to 10 years for furniture and equipment, serve System. 10 to 50 years for building equipment and structures, and The Board is required by the Federal Reserve Act to 2 to 10 years for software. Upon the sale or other disporeport its operations to the Speaker of the House of sition of a depreciable asset, the cost and related accumu- Representatives. The Act also requires the Board, each lated depreciation or amortization are removed from the year, to order a financial audit of each Federal Reserve accounts and any gain or loss is recognized. Bank and to publish each week a statement of the finan- Art Collections—The Board has collections of works cial condition of each such Reserve Bank and a consoli- of art, historical treasures, and similar assets. These coldated statement for all of the Reserve Banks. Accord- lections are maintained and held for public exhibition in ingly, the Board believes that the best financial disclosure furtherance of public service. Proceeds from any sales of consistent with law is achieved by issuing separate finan- collections are used to acquire other items for collections. cial statements for the Board and for the Reserve Banks. As permitted by Statement of Financial Accounting Stan- Therefore, the accompanying financial statements include dards Number 116, Accounting for Contributions Reonly the results of operations and activities of the Board. ceived and Contributions Made, the cost of collections Combined financial statements for the Federal Reserve purchased by the Board is charged to expense in the year Banks are included in the Board's annual report to the purchased and donated collection items are not recorded. Speaker of the House of Representatives. The value of the Board's collections has not been determined. (2) OPERATIONS AND SERVICES Estimates—The preparation of financial statements in conformity with accounting principles generally accepted The Board's responsibilities require thorough analysis in the United States requires management to make estiof domestic and international financial and economic mates and assumptions that affect the reported amounts of developments. The Board carries out those responsibiliassets and liabilities and the disclosure of contingent ties in conjunction with other components of the Federal assets and liabilities at the date of the financial statements Reserve System. The Board also supervises and regulates and the reported amounts of revenues and expenses durthe operations of the Federal Reserve Banks, exercises ing the reporting period. Actual results could differ from broad responsibility in the nation's payments system, and those estimates. administers most of the nation's laws regarding consumer Reclassifications—Certain 2005 amounts have been credit protection. Policy regarding open market operareclassified to conform with the 2006 presentation. tions is established by the Federal Open Market Commit- Implementation of FASB Statement No. 158, Employtee. However, the Board has sole authority over changes ers' Accounting for Defined Benefit Pension and Other in reserve requirements, and it must approve any change in the discount rate initiated by a Federal Reserve Bank. Postretirement Plans—The Board initially applied the provisions of FASB Statement No. 158, Employers' Ac- The Board also plays a major role in the supervision counting for Defined Benefit Pension and Other Postreand regulation of the U.S. banking system. It has supervitirement Plans, at December 31, 2006. This accounting sory responsibilities for state-chartered banks that are standard requires recognition of the overfunded or undermembers of the Federal Reserve System, bank holding funded status of a defined benefit postretirement plan in companies, foreign activities of member banks, and U.S. activities of foreign banks. the Balance Sheets, and recognition of changes in the funded status in the years in which the changes occur through comprehensive income. The transition rules for (3) SIGNIFICANT ACCOUNTING POLICIES implementing the standard require applying the provi- Basis of Accounting—The financial statements have sions as of the end of the year of initial implementation been prepared on the accrual basis of accounting. with no retrospective application. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

308 93rd Annual Report, 2006 (4) PROPERTY AND EQUIPMENT (5) ACCUMULATED RETIREMENT BENEFITS The following is a summary of the components of the The following information provides disclosure require- Board's property and equipment, at cost, net of accumu- ments contained in Statement of Financial Accounting lated depreciation and amortization. Standards No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. As of December 31, Substantially all of the Board's employees participate 2006 2005 in the Retirement Plan for Employees of the Federal Reserve System (System Plan). The System Plan is a Land $ 18,640,314 $ 18,640,314 multi-employer plan which covers employees of the Buildings and Federal Reserve Banks, the Board, and the Office of improvements ... 147,504,169 135,152,735 Employee Benefits. No separate accounting is maintained Furniture and of assets contributed by the participating employers. The equipment 47,271,434 39,926,270 Software in use 13,681,508 12,415,000 Federal Reserve Bank of New York acts as a sponsor of Software in process ... 941,912 575,050 the System Plan, and the costs associated with the Plan Construction in are not redistributed to other participating employers. process 360,966 13,928,149 Employees of the Board who became employed prior to 1984 are covered by a contributory defined benefits 228,400,304 220,637,518 program under the System Plan. Employees of the Board Less accumulated who became employed after 1983 are covered by a depreciation and amortization (77,194,918) (65,195,965) non-contributory defined benefits program under the Sys- Property and tem Plan. Contributions to the System Plan are actuarially equipment, net.. $151,205,386 $155,441,553 determined and funded by participating employers. Based on actuarial calculations, it was determined that employer Furniture and equipment includes $1,230,000 each year funding contributions were not required for the years for capitalized leases as of December 31, 2006 and 2005. 2006 and 2005, and the Board was not assessed a contri- Accumulated depreciation includes $867,000 and bution for these years. Because the plan is part of a $612,000 for capitalized leases as of December 31, 2006 multi-employer plan, information as to vested and nonand 2005, respectively. The Board paid interest related to vested benefits, as well as plan assets, as it relates solely these capital leases in the amount of $54,000 and $83,000 to the Board, is not readily available. for 2006 and 2005, respectively. Effective January 1, 1996, Board employees covered Construction in process includes costs incurred in 2006 under the System Plan are also covered under a Benefits and 2005 for long-term security projects and building Equalization Plan (BEP). Benefits paid under the BEP are enhancements. limited to those benefits that cannot be paid from the The future minimum lease payments required under System Plan due to limitations imposed by Secthe capital leases and the present value of the net mini- tions 401(a)(17), 415(b), and 415(e) of the Internal Revemum lease payments as of December 31, 2006, are as nue Code of 1986. Activity for the BEP for 2006 and follows: 2005 is summarized in the following table: Year 2006 2005 ending December 31 Amount Change in projected benefit obligation 2007 $ 463,491 Benefit obligation at 2008 138,279 beginning of year .. $ 536,339 $ 140,953 2009 Service cost 185,483 193,209 Total minimum lease Interest cost 45,004 35,964 payments 601,770 Plan participants' Less: Amount representing contributions 0 0 maintenance included Plan amendments 0 0 in total amounts above.. (130,540) Actuarial (gain)/loss .... 596,114 168,027 Net minimum lease Benefitspaid (8,278) (1,814) payments 471,230 Less: Amount representing Benefit obligation at interest (34,812) endofyear $1,354,662 $ 536,339 Present value of net minimum lease Change in plan assets payments 436,418 Fair value of plan assets Less: Current maturities at beginning of capital lease of year $ 0 $ 0 obligations (327,663) Actual return on plan assets 0 0 Long-term capital lease Employer contributions.. 8,278 1,814 obligations $ 108,755 Plan participants' contributions 0 0 Benefits paid (8,278) (1,814) Fair value of plan assets at end of year $ 0 $ 0 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 309 2006 2005 2006 2005 Reconciliation of funded Weighted-average status at end of year assumptions used to Funded status $(1,354,662) $(536,339) determine net periodic Unrecognized net benefit cost for years actuarial (gain)/ ended December 31 loss 580,386 (15,728) Discount rate 5.75% 5.75% Unrecognized prior Rate of compensation service cost (247,417) (261,430) increase 4.50% 4.25% Unrecognized net transition A relatively small number of Board employees particiobligation 0 0 pate in the Civil Service Retirement System (CSRS) or Prepaid/(Accrued) the Federal Employees' Retirement System (FERS). pension cost $(1,021,693) $ (813,497) These defined benefit plans are administered by the U.S. Office of Personnel Management, which determines the Amounts recognized in required employer contribution levels. The Board's conthe financial statements tributions to these plans totaled $334,000 and $324,000 in consist of 2006 and 2005, respectively. The Board has no liability Prepaid benefit cost $ 0 $ 0 for future payments to retirees under these programs and Accrued benefit is not accountable for the assets of the plans. liability (1,021,693) (813,497) Intangible asset 0 0 Employees of the Board may also participate in the Accumulated other Federal Reserve System's Thrift Plan. Board contricomprehensive butions to members' accounts are based upon a fixed income (332,969) 0 percentage of each member's basic contribution Net amount and were $8,964,000 and $8,617,000 in 2006 and 2005, recognized $(1,354,662) $ (813,497) respectively. Information for pension plans with an (6) ACCUMULATED POSTRETIREMENT BENEFITS accumulated benefit The following information provides disclosure requireobligation in excess of plan asset: ments contained in Statement of Financial Accounting Projected benefit Standards No. 106, Employers' Accounting for Postretireobligation $ 1,354,662 $ 536,339 ment Benefits Other Than Pensions. Accumulated benefit The Board provides certain life insurance programs for obligation $ 546,854 $ 278,252 its active employees and retirees. Activity for 2006 and 2005 is summarized in the following table: Weighted-average assumptions used to 2006 2005 determine benefit obligation as of Change in benefit December 31 obligation Discount rate 5.75% 5.75% Benefit obligation at Rate of compensation beginning of year .. $ 8,273,831 $ 8,404,551 increase 4.50% 4.50% Service cost 230,567 217,421 Interest cost 470,256 437,320 Components of net Plan participants' periodic benefit cost contributions 0 0 Service cost—benefits Plan amendments 0 (196,970) earned during the Actuarial (gain)/loss .... (603,500) (304,006) period $ 185,483 $ 193,209 Benefits paid (259,325) (284,485) Interest cost on Benefit obligation projected benefit atendofyear $8,111,829 $ 8,273,831 obligation 45,004 35,964 Expected return Change in plan assets on plan assets 0 0 Fair value of plan Amortization of assets at beginning prior service cost .. (14,013) (14,013) of year $ 0 $ 0 Amortization of Actual return on (gains)/losses 0 5,982 plan assets 0 0 Amortization of initial Employer contribution .. 259,325 284,485 (asset)/obligation .. 0 0 Plan participants' Net periodic benefit contributions 0 0 cost (credit) $ 216,474 $ 221,142 Benefits paid (259,325) (284,485) Fair value of plan Additional information: assets at end Increase in minimum of year $ 0 $ 0 liability included in other comprehensive income $ 0 $ 0 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

310 93rd Annual Report, 2006 butions for active employees participating in federally 2006 2005 sponsored health programs totaled $9,607,000 and Reconciliation of $8,933,000 in 2006 and 2005, respectively. funded status at end of year Benefit obligations $(8,111,829) $(8,273,832) (7) ACCUMULATED POSTEMPLOYMENT BENEFIT PLAN Unrecognized net The following information provides disclosure requireactuarial (gain)/loss 0 2,145,920 ments contained in Statement of Financial Accounting Unrecognized prior Standards No. 112, Employers' Accounting for Postemservice cost 0 (109,378) ployment Benefits. Amount recognized The Board provides certain postemployment benefits at end of year $(8,111,829) $(6,237,290) to eligible former or inactive employees and their dependents during the period subsequent to employment but Amounts recognized in prior to retirement. Costs were projected using the same the financial statements consist of: discount rates as were used for projecting postretirement Liability $(8,111,829) $ 0 costs. The accrued postemployment benefit costs recog- Accrued benefit cost 0 (6,237,290) nized by the Board for the years ended December 31, Accumulated other 2006 and 2005, were $1,963,000 and $155,800, comprehensive respectively. income 0 0 Net amount recognized.. $(8,111,829) $(6,237,290) (8) ACCUMULATED OTHER COMPREHENSIVE INCOME Following is a reconciliation of beginning and ending Amounts recognized in accumulated other balances of accumulated other comprehensive income. comprehensive income Amount related consist of: Amount related to postretirement Net actuarial loss/ to defined benefit benefits other (gain) $1,422,398 $ 0 retirement plans than pensions Prior service cost/ Balance (credit) (99,560) 0 Transition obligation/ January 1, (asset) 0 0 2006 $(1,021,693) $(6,788,992) Deferred curtailment Adjustment to (gain)/loss 0 0 initially apply Statement $1,322,838 $ 0 No. 158 (332,969) (1,322,837) Expected cashflows Balance Expected employer December 31, contributions: 2006 $(1,354,662) $(8,111,829) 2007 $ 274,901 Expected benefit Total accumulated payments: other comprehen- 2007 $ 274,901 sive income (loss) 2008 $ 296,030 Balance 2009 $ 325,793 2010 $ 350,050 January 1, 2011 $ 364,265 2006 $(7,810,685) 2012-2016 $ 2,132,108 Adjustment to initially apply Statement The liability and costs for the postretirement benefit No. 158 (1,655,806) plan were determined using discount rates of 5.75 percent Balance as of December 31, 2006 and 2005. Unrecognized losses December 31, of $2,145,920 as of December 31, 2005 result from 2006 $(9,466,491) changes in the discount rate used to measure the liabilities. The assumed salary trend rate for measuring the Additional detail regarding the classification of accuincrease in postretirement benefits related to life insur- mulated other comprehensive income is included in ance was an average of 4.50 percent. note 6. The above accumulated postretirement benefit obligation is related to the Board-sponsored life insurance pro- (9) OTHER REVENUES AND OTHER EXPENSES grams. The Board has no liability for future payments to The following are summaries of the components of employees who continue coverage under the federally Other Revenues and Other Expenses. sponsored life and health programs upon retiring. Contri- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 311 For the years ended Commitments December 31, The Board has entered into an agreement with the 2006 2005 Federal Deposit Insurance Corporation and the Office of Other revenues the Comptroller of the Currency, through the Federal Data processing Financial Institutions Examination Council (the "Counrevenue $4,180,692 $3,788,217 cil") to fund a portion of enhancements and maintenance Rent 2,450,576 2,433,833 fees for a central data repository project through 2013. Subscription Estimated Board expense to support this effort is $7.5 milrevenue 716,294 782,743 lion. Reimbursable services to Litigation other agencies ... 599,827 664,755 The Board is subject to contingent liabilities which conferences 0 250,650 include litigation cases. These contingent liabilities arise Miscellaneous 561,560 600,144 in the normal course of operations and their ultimate Total other disposition is unknown. Based on information currently revenues $8,508,949 $8,520,342 available to management, it is management's opinion that the expected outcome of these matters, individually or in the aggregate, will not have a materially adverse effect on Other expenses the financial statements. Management believes the Board Tuition, registration, has substantial defenses and that the likelihood of an and membership adverse judgement is remote. fees $2,676,871 $2,573,028 Contingency One action currently pending in U.S. District Court for operations 1,087,429 956,476 the District of Columbia alleges discrimination on behalf Public transportation of a class of African American secretaries at the Board subsidy 988,950 872,467 under Title VII of the Civil Rights Act of 1964, as Subsidies and amended. On January 31, 2007, the action was dismissed contributions 706,497 656,150 for failure to exhaust administrative remedies. The plain- Meals and tiffs have moved to alter or amend judgment on this representation ... 529,557 518,640 ruling; that motion is pending. Should the case be rein- Equipment and stated either as a result of the pending motion or followfacilities rental... 393,122 336,342 ing appeal, the Board believes it has substantial defenses Administrative and intends to defend the case vigorously. law judges 105,587 268,228 Four additional actions are pending in the United States Security District Court for the District of Columbia under Title VII investigations 236,448 184,880 of the Civil Rights Act of 1964, as amended and/or the Former employee Age Discrimination in Employment Act. All four are related believed to be without merit and are being vigorously payments 19,296 319,461 contested. Miscellaneous 691,309 800,486 Five additional matters alleging employment discrimi- Total other nation are currently pending administrative resolution. expenses $7,435,067 $7,486,158 One case is related to, and likely will be joined with, a case currently pending in district court. In that and another case there has not yet been an investigative report. (10) COMMITMENTS AND CONTINGENCIES Therefore, management is unable at this time to deter- Leases mine the potential for a materially adverse effect on the The Board has entered into several operating leases to financial statements. Management believes that the likelisecure office, training, and warehouse space for remain- hood of an unfavorable outcome in the remaining three ing periods ranging from one to four years. Minimum cases is remote. annual payments under the operating leases having an initial or remaining noncancelable lease term in excess of (11) FEDERAL FINANCIAL INSTITUTIONS one year at December 31, 2006, are as follows: EXAMINATION COUNCIL The Board is one of the five member agencies of 2007 $ 176,807 the Council, and currently performs certain management 2008 183,880 functions for the Council. The five agencies which are 2009 191,235 represented on the Council are the Board, Federal Deposit 2010 198,884 Insurance Corporation, National Credit Union Adminis- 2011 84,218 tration, Office of the Comptroller of the Currency, and $ 835,024 Office of Thrift Supervision. The Board's financial statements do not include financial data for the Council. Rental expenses under the operating leases were Activity related to the Board and Council for 2006 and $193,000 in 2006 and $157,000 in 2005. 2005 is summarized in the following table: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

312 93rd Annual Report, 2006 2006 2005 2006 2005 Board paid to the Board paid to the Council: Reserve Banks: Assessments for Assessments for operating expenses employee benefits .. $ 2,380,474 $ 2,072,595 of the Council $ 109,760 $ 83,811 Data processing and Central Data communication 2,161,298 2,106,850 Repository 740,003 1,096,062 Contingency site 1,087,429 956,476 Uniform Bank Total Board paid Performance to the Reserve Report 204,617 202,666 Banks $ 5,629,201 $ 5,135,921 Total Board paid to the Reserve Banks paid Council $1,054,380 $1,382,539 to the Board: Assessments for Council paid to the currency costs $491,962,202 $477,087,471 Board: Assessments for Data processing operating expenses related services .... $3,429,499 $3,572,816 of the Board 301,013,500 265,742,100 Administrative Data processing 731,999 516,433 services 183,000 175,000 Total Reserve Banks Total Council paid to the paid to the Board $793,707,701 $743,346,004 Board $3,612,499 $3,747,816 Accounts receivable Accounts receivable due from Federal due from the Reserve Banks $ 854,142 $ 145,142 Council $ 395,551 $ 277,589 Accounts payable Accounts payable due to Federal due to the Reserve Banks $ 12,417 $ 0 Council $ 54,870 $ 104,864 (13) NONCASH FINANCING ACTIVITIES (12) FEDERAL RESERVE BANKS In 2005, the Board billed a federal government agency The Board performs certain functions for the Reserve $1,096,557 for rent and leasehold improvements. In 2006, Banks in conjunction with its responsibilities for the the federal government agency provided equipment, soft- Federal Reserve System, and the Federal Reserve Banks ware, and services valued at $392,301 to the Board and provide certain administrative functions to the Board. paid the balance of $704,256 in 2006. In 2006, the Board Activity related to the Board and Reserve Banks for 2006 billed the same agency $143,772 for rent, and the agency and 2005 is summarized in the following table: provided telecommunication equipment and services valued at $124,720 to the Board and paid the balance of $19,052 in 2006. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 313 KPMGLLP 2001 M Street NW Washington, DC 20036 Independent Auditors' Report on Internal Control over Financial Reporting To the Board of Governors of the Federal Reserve System: We have audited the balance sheets of the Board of Governors of the Federal Reserve System (the Board) as of December 31, 2006 and 2005, and the related statements of revenues and expenses and changes in cumulative results of operations, and cash flows (hereinafter referred to as "financial statements") for the years then ended, and have issued our report thereon dated April 17,2007. 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 misstatement. The management of the Board is responsible for establishing and maintaining effective internal control. In planning and performing our 2006 audit, we considered the Board's internal control over financial reporting as a basis for designing 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 express an opinion on the effectiveness of the Board's internal control over financial reporting. Accordingly, we do not express an opinion on the effectiveness of the Board's internal control over financial reporting. A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects the Board's ability to initiate, authorize, record, process, or report financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the Board's financial statements that is more than inconsequential will not be prevented or detected by the entity's internal control. A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected by the Board's internal control. Our consideration of internal control over financial reporting was for the limited purpose described in the third paragraph above and would not necessarily identify all deficiencies in internal control that might be significant deficiencies or material weaknesses. In our 2006 audit, we noted a matter described in Exhibit I involving internal control over financial reporting that we consider to be a significant deficiency. We believe that this significant deficiency is not a material weakness. Exhibit II presents the status of the prior year finding. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

314 93rd Annual Report, 2006 The Board's response to the findings identified in our audit is presented in the Exhibit I. We did not audit the Board's response and, accordingly, we express no opinion on it We noted certain additional matters that we have reported to the management of the Board in a separate letter dated April 17,2007. This report is intended solely for the information and use of the Board's management, the Office of Inspector General, the U.S. 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. April 17,2007 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 315 Exhibit I BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Significant Deficiency December 31, 2006 Improvement is needed in Internal Con- Recording Accounts Payable, Accrued Litrols over Financial Reporting abilities, and Prepaid Expenses Management is responsible for developing During 2006, the Management Division and maintaining effective internal controls to identified and processed transactions and provide reasonable assurance that the Board journal entries to reclassify/and or correct has the ability to initiate, authorize, record, several transactions that were initially coded process, and report financial data reliably in to a different general ledger account or reaccordance with generally accepted account- corded in a different accounting period. We ing principles. Internal controls help ensure noted that the original transactions were inithat reliable and timely information is ob- tially reviewed and approved by a supervisor, tained, maintained, reported, and used for and all the required changes were not identidecision making. fied during this initial review as follows. Appropriate internal controls should be • Two disbursements totaling $11,230, of the integrated into each policy and procedure 115 disbursement transactions tested totalestablished by the Board to direct and guide ing $18,473,927, were initially recorded in its operations. Monitoring the effectiveness different general ledger accounts or were of internal controls should occur in the nor- 2007 transactions that were recorded as mal course of business throughout the year. 2006 transactions. One transaction for Periodic reviews, reconciliations, or com- $5,980 was identified and adjusted during parisons of data should be included as part of management's review prior to year end, staffs regularly assigned duties. In addition, and one transaction for $5,250 was corperiodic assessments should be integrated rected as a post closing entry. into management's continuous monitoring of • Two accounts payable transactions totaling internal controls to help provide assurance $45,709, of the 21 accounts payable inthat weaknesses in the design or operation of voices tested totaling $2,969,595, were reinternal control, which could adversely af- ceived in 2006 for services to be provided fect the Board's ability to meet its financial in 2007. These were initially recorded as reporting objectives, are prevented or de- accounts payable in 2006. Both transactected in a timely manner. tions were corrected as a post closing entry. Board management is committed to im- • One prepaid expense totaling $11,927, of proving its internal control environment as the 19 prepaid expenses tested totaling demonstrated by its ability to resolve prior $1,758,579, was a 2007 invoice that was year findings. paid in 2006 and was initially recorded as The following paragraphs discuss weak- 2006 expense. This was subsequently idennesses noted in the Board's internal control tified and adjusted during management's over financial reporting that could adversely review prior to year end. affect the Board's ability to produce accurate We commend the Board for identifying most and timely financial statements. None of of these entries prior to year end. However, these deficiencies individually would be con- the Board should strengthen its procedures sidered a significant deficiency. However, for posting and reviewing all entries to enthe combination of these deficiencies is con- sure initial posting to the proper accounts and sidered to be a significant deficiency. accounting period. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

316 93rd Annual Report, 2006 Posting Accrued Annual Leave • Three adjustments related to 22 assets acquired via trade-in were overstated on the We noted that the annual leave accrual was depreciation schedule in 2005. As a result, overstated by $301,600 at December 31, depreciation for 2005 was overstated by 2006, because the annual leave report did not $27,294 and correspondingly understated reflect the proper year end information for all by the same amount in 2006. employees. The Board subsequently recorded a post closing entry to reflect the appropriate During our physical inspection test work of amounts. property and equipment, we noted that one of the 22 items inspected, valued at $76,744, Billing of Accounts Receivable was included on the asset listing for the We noted that the Board did not record a Board's contingency site, although it was physically located in the Board's Washingyear-end receivable from the Bank for Interton, DC, facility. Our inspection also found national Settlements (BIS) for $157,317 repthat the asset tag number for one item valued resenting services performed in 2006. Alat $7,042 was not identified in the Board's though the invoice for the 2006 services was financial system. not finalized, recorded, and submitted until 2007, this amount should have been recorded Recording Financial Statement Disclosures as a receivable at December 31, 2006. As a result of our audit, the Board recorded a post During our audit, we noted instances where closing entry for this amount. the Board needs to improve its preparation and review process for the financial state- Monitoring Miscellaneous Receivables ments as follows. During our audit, we noted that the Board • Assets traded in for other assets were incordoes not have specific policies and proce- rectly recorded as Proceeds from Disposals dures for monitoring miscellaneous receiv- and Capital Expenditures in the Statement ables related to relocation expenses to deter- of Cash Flows. The entries, totaling mine if amounts are considered collectible $159,519, represent non-cash transactions and appropriately recorded. As a result of our and should not have been included in the audit, the Board recorded post closing entries Proceeds from Disposals or the Capital to write off three accounts receivables Expenditures sections of the Statement of amounting to $105,599 for relocation ex- Cash Flows. penses that were not considered collectible. • In Footnote 4, Property and Equipment, Construction in Process was initially re- Recording Property Transactions ported as zero, and in the corresponding During our audit of property and equipment, roll-forward schedule, the balance was we noted that the Board inappropriately pro- $360,966. cessed property and equipment additions and • In Footnote 7, Accumulated Postemployadjustments as follows. ment Benefit Plan, the Board initially understated the accrued postemployment ben- • Two assets purchased for $113,016 in 2006 efits costs for FY2006. The Board were recorded at an acquisition value of originally reported $1,828,000. However, $109,259. As a result, the asset was overthis amount did not reflect the external stated by $3,757. actuary's revised calculation, which re- • Three assets valued at $329,375 were put sulted in an upward adjustment of into service with the incorrect in-service $134,000. dates. As a result, the 2006 depreciation expense was overstated by $25,700. The Board subsequently made all necessary • One asset was placed in service on March adjustments in the financial statements. 1, 2006 for $811,756, but did not have any Recommendations depreciation recorded in 2006. As a result, the Board's depreciation expense was un- To strengthen internal controls over financial derstated by $20,294. reporting, we recommend that the Board: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 317 Strengthen the control process over the appropriate accounting entries for property initial input and review of disbursement transactions are recorded timely in the gentransactions to ensure that they are prop- eral ledger. The communications should erly coded and recorded in the general include, but not be limited to: when the ledger. We also recommend that manage- asset was placed in service, the cost of the ment conduct periodic training for all rel- asset, the asset's location and tag number, evant personnel, including end users, to and any additional information necessary help ensure the proper use of general led- for the accounting division to make the ger accounts. appropriate entries. The Board should also Enhance the process for determining the enhance its review and approval proceaccrued annual leave to ensure that the dures over property transactions to ensure reports generated include the appropriate that the appropriate entries have been amounts as of the end of the reporting recorded. period. The process should include match- • Strengthen its process over the preparation ing a selection of employees' leave baland review of the financial statements to ances and other information included in the ensure information is accurately reported. report to data in the Board's Human Resources system. Management's Response Implement policies and procedures that require the calculation and reconciliation of KPMG offers six recommendations aimed at amounts due from BIS on a regular basis. strengthening the Board's internal controls Once amounts due are determined, the ap- over financial reporting. In its discussion of plicable adjustments should be promptly these recommendations and the supporting recorded in the general ledger. audit findings, KPMG does not consider any Enhance its policies and procedures to in- individual finding to be a significant deficlude a documented periodic review and ciency. In combination, however, KPMG analysis of all accounts receivables, to de- concludes that the audit findings represent a termine if an allowance is required or if the significant deficiency. While management amounts should be written off. Further, man- does not concur with this conclusion, we do agement should also review the accounting agree that KPMG's recommendations will treatment required for all transactions. strengthen the Board's system of internal Strengthen its policies and procedures to controls, and we will implement the recomimprove communication between the divi- mended actions. sions and the accounting staff to ensure the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

318 93 rd Annual Report, 2006 Exhibit II BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATUS OF PRIOR YEAR REPORTABLE CONDITION December 31, 2006 Reported Issue Prior Year Recommendation 2006 Status Improvement is needed in Internal Control over Financial Reporting Control over accounts 1. Establish policies and procedures for process- Significant Deficiency payable and accrued ing year-end accounts payables and accruals to (see revised comment in liabilities include the requirements for management to Exhibit I). review and approve all entries and supporting documents before they are recorded. Management should also perform a review of the yearend accounts payable listings and subsequent disbursements to ensure that the transactions reported at year end are appropriately stated. Further, a reconciliation of the GS A account should be performed timely, to identify any discrepancies on the invoices received. Control of Census Data 2. Confirm the data used by the actuary in the Completed. pension liability calculation prior to recording the entries in the general ledger. 3. Implement recommendations made by the OIG Substantially resolved. in their report titled "Evaluation of Service See revised comment in Credit Computations." This would include the 2006 management performing periodic reconciliations of the cen- letter. sus data between the Board's system and the data used by the actuary; reducing or eliminating the number of data transcriptions; requiring automated verifications for all census data transmissions; and updating the existing service credit form to clearly document all prior government service. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 319 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, 2006 and 2005, and the related statements of revenues and expenses and changes in cumulative results of operations, and cash flows (hereinafter referred to as "financial statements") for the years then ended, and have issued our report thereon dated April 17,2007. 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 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 financial statements are free of material misstatement, we performed tests of the Board's compliance with certain provisions of laws, regulations, and contracts, noncompliance with which could have a direct and material effect on the determination of the 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 those provisions 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 required to be reported under Government Auditing Standards. This report is intended solely for the information and use of the Board's management, the Office of Inspector General, the U.S. 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. April 17,2007 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

321 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, 2006 and 2005. i 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, 2006 and 2005, 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, 2006 and 2005, and the combined results of their operations for the years then ended, on the basis of accounting described in Note 3. March 30, 2007 Washington, D.C. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

322 93rd Annual Report, 2006 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CONDITION (in millions) December 31, ASSETS 2006 2005 Gold certificates $ 11,037 $ 11,039 Special drawing rights certificates 2,200 2,200 Coin 801 686 Items in process of collection 3,486 5,930 Loans to depository institutions 67 72 Securities purchased under agreements to resell 40,750 46,750 U.S. government securities, net 783,619 750,202 Investments denominated in foreign currencies 20,482 18,928 Accrued interest receivable 6,761 5,874 Bank premises and equipment, net 2,376 2,252 Other assets 1,785 3,394 Totalassets $873,364 $847,327 LIABILITIES AND CAPITAL LIABILITIES Federal Reserve notes outstanding, net $783,019 $758,359 Securities sold under agreements to repurchase 29,615 30,505 Deposits Depository institutions 18,699 19,043 U.S. Treasury, general account 4,708 4,573 Other deposits 349 393 Deferred credit items 3,813 5,039 Interest on Federal Reserve notes due to U.S. Treasury 908 1,784 Accrued benefit costs 1,314 913 Other liabilities 291 281 Total liabilities 842,716 820,890 CAPITAL Capital paid-in 15,324 13,536 Surplus (including accumulated other comprehensive loss of $1,849 million at December 31, 2006) 15,324 12,901 Total capital 30,648 26,437 Total liabilities and capital $873,364 $847,327 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 323 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF INCOME (in millions) For the years ended December 31, 2006 2005 Interest income Interest on U.S. government securities $36,452 $28,959 Interest on investments denominated in foreign currencies 369 283 Interest on loans to depository institutions 12 7 Total interest income 36,833 29,249 Interest expense Interest expense on securities sold under agreements to repurchase 1,342 809 Net interest income 35,491 28,440 Other operating income (loss) Income from services 908 901 Reimbursable services to government agencies 426 396 Foreign currency gains (losses), net 1,186 (2,723) Other income 144 131 Total other operating income (loss) 2,664 (1,295) Operating expenses Salaries and other benefits 1,880 1,709 Occupancy expense 240 228 Equipment expense 212 198 Assessments by the Board of Governors 793 743 Other expenses 835 747 Total operating expenses 3,960 3,625 Net income prior to distribution $34,195 $23,520 Distribution of net income Dividends paid to member banks $ 871 $ 781 Transferred to surplus 4,272 1,271 Payments to U.S. Treasury as interest on Federal Reserve notes 29,052 21,468 Total distribution $34,195 $23,520 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

324 93rd Annual Report, 2006 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CHANGES IN CAPITAL for the years ended December 31, 2006 and 2005 (inmillions) Surplus Accumulated Net other Capital income comprehensive Total Total paid-in retained loss surplus capital Balance at January 1, 2005 (238 million shares) $11,914 $11,630 $ ... $11,630 $23,544 Net change in capital stock issued (32 million shares) 1,622 1,622 Transferred to surplus V,271 1,271 1,271 Balance at December 31, 2005 (270 million shares) $13,536 $12,901 $ ... $12,901 $26,437 Net change in capital stock issued (36 million shares) 1,788 1,788 Transferred to surplus 4,272 4,272 4,272 Adjustment to initially apply FASB Statement No. 158 (1,849) (1,849) (1,849) Balance at December 31, 2006 (306 million shares) $15,324 $17,173 $ (1,849) $15,324 $30,648 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 the 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 Reserve Banks perform a variety of services and the United States. The Reserve Banks are chartered by the operations. Functions include participation in formulating federal government and possess a unique set of govern- and conducting monetary policy; participation in the paymental, corporate, and central bank characteristics. ments system including large-dollar transfers of funds, In accordance with the Federal Reserve Act, supervi- automated clearinghouse ("ACH") operations, and check sion and control of each Reserve Bank are exercised by a collection; distribution of coin and currency; performance board of directors. The Federal Reserve Act specifies the of fiscal agency functions for the U.S. Treasury, certain composition of the board of directors for each of the federal agencies, and other entities; serving as the federal Reserve Banks. Each board is composed of nine members government's bank; provision of short-term loans to serving three-year terms: three directors, including those depository institutions; service to the consumer and the designated as chairman and deputy chairman, are ap- community by providing educational materials and inforpointed by the Board of Governors of the Federal Reserve mation regarding consumer laws; and supervision of bank System ("Board of Governors") to represent the public, holding companies, state member banks, and U.S. offices and six directors are elected by member banks. Banks that of foreign banking organizations. The Reserve Banks also are members of the System include all national banks and provide certain services to foreign central banks, governany state-chartered banks that apply and are approved for ments, and international official institutions. membership in the System. Member banks are divided The FOMC, in the conduct of monetary policy, estabinto three classes according to size. Member banks in lishes policy regarding domestic open market operations, each class elect one director representing member banks oversees these operations, and annually issues authorizaand one representing the public. In any election of direc- tions and directives to the FRBNY for its execution of tors, each member bank receives one vote, regardless of transactions. The FRBNY is authorized and directed by the number of shares of Reserve Bank stock it holds. the FOMC to conduct operations in domestic markets, The System also consists, in part, of the Board of including the direct purchase and sale of U.S. government Governors and the Federal Open Market Committee securities, the purchase of securities under agreements to ("FOMC"). The Board of Governors, an independent resell, the sale of securities under agreements to repurfederal agency, is charged by the Federal Reserve Act chase, and the lending of U.S. government securities. The with a number of specific duties, including general super- FRBNY executes these open market transactions at the vision over the Reserve Banks. The FOMC is composed direction of the FOMC and holds the resulting securities, of members of the Board of Governors, the president of with the exception of securities purchased under agree- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 325 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED ments to resell, in the portfolio known as the System to be appropriate for the nature and function of a central Open Market Account ("SOMA"). bank, which differ significantly from those of the private In addition to authorizing and directing operations in sector. These accounting principles and practices are the domestic securities market, the FOMC authorizes and documented in the Financial Accounting Manual for directs the FRBNY to execute operations in foreign mar- Federal Reserve Banks ("Financial Accounting Manual"), kets for major currencies in order to counter disorderly which is issued by the Board of Governors. All of the conditions in exchange markets or to meet other needs Reserve Banks are required to adopt and apply accountspecified by the FOMC in carrying out the System's ing policies and practices that are consistent with the central bank responsibilities. The FRBNY is authorized Financial Accounting Manual and the financial stateby the FOMC to hold balances of, and to execute spot and ments have been prepared in accordance with the Finanforward foreign exchange ("FX") and securities contracts cial Accounting Manual. for, nine foreign currencies and to invest such foreign Differences exist between the accounting principles currency holdings ensuring adequate liquidity is main- and practices in the Financial Accounting Manual and tained. The FRBNY is authorized and directed by the generally accepted accounting principles in the United FOMC to maintain reciprocal currency arrangements States of America ("GAAP"), primarily due to the unique ("FX swaps") with two central banks, and "warehouse" nature of the Reserve Banks' powers and responsibilities foreign currencies for the U.S. Treasury and Exchange as part of the nation's central bank. The primary differ- Stabilization Fund ("ESF') through the Reserve Banks. ence is the presentation of all securities holdings at In connection with its foreign currency activities, the amortized cost, rather than using the fair value presenta- FRBNY may enter into transactions that contain varying tion required by GAAP. Amortized cost more appropridegrees of off-balance-sheet market risk that results from ately reflects the Reserve Banks' securities holdings given their future settlement and counter-party credit risk. The their unique responsibility to conduct monetary policy. FRBNY controls credit risk by obtaining credit approv- While the application of current market prices to the als, establishing transaction limits, and performing daily securities holdings may result in values substantially monitoring procedures. above or below their carrying values, these unrealized Although the Reserve Banks are separate legal entities, changes in value would have no direct effect on the in the interests of greater efficiency and effectiveness they quantity of reserves available to the banking system or on collaborate in the delivery of certain operations and ser- the prospects for future Reserve Bank earnings or capital. vices. The collaboration takes the form of centralized Both the domestic and foreign components of the SOMA operations and product or service offices that have respon- portfolio may involve transactions that result in gains or sibility for the delivery of certain services on behalf of the losses when holdings are sold prior to maturity. Decisions Reserve Banks. Various operational and management regarding securities and foreign currency transactions, models are used and are supported by service agreements including their purchase and sale, are motivated by monebetween the Reserve Bank providing the service and the tary policy objectives rather than profit. Accordingly, other eleven Reserve Banks. In some cases, costs incurred market values, earnings, and any gains or losses resulting by a Reserve Bank for services provided to other Reserve from the sale of such securities and currencies are inci- Banks are not shared; in other cases, the Reserve Banks dental to the open market operations and do not motivate are billed for services provided to them by another these activities or policy decisions. Reserve Bank. In addition, the Board of Governors and the Reserve During 2005, the Federal Reserve Bank of Atlanta Banks have elected not to present a Statement of Cash ("FRBA") was assigned the overall responsibility for Rows because the liquidity and cash position of the managing the Reserve Banks' provision of check services Reserve Banks are not a primary concern given their to depository institutions and, as a result, recognizes total unique powers and responsibilities. A Statement of Cash System check revenue on its Statements of Income. Be- Rows, therefore, would not provide any additional meancause the other eleven Reserve Banks incur costs to ingful information. Other information regarding the provide check services, a policy was adopted by the Reserve Banks' activities is provided in, or may be Reserve Banks in 2005 that required that the FRBA derived from, the Statements of Condition, Income, and compensate the other Reserve Banks for costs incurred to Changes in Capital. There are no other significant differprovide check services. In 2006 this policy was extended ences between the policies outlined in the Financial to the ACH services, which are managed by the FRBA, as Accounting Manual and GAAP. well as to Fedwire funds transfer and securities transfer The preparation of the financial statements in services, which are managed by the FRBNY. The FRBA conformity with the Financial Accounting Manual and the FRBNY compensate the other Reserve Banks for requires management to make certain estimates and the costs incurred to provide these services. assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the (3) SIGNIFICANT ACCOUNTING POLICIES reported amounts of income and expenses during the Accounting principles for entities with the unique powers reporting period. Actual results could differ from those and responsibilities of the nation's central bank have not estimates. Certain amounts relating to the prior year have been formulated by various accounting standard-setting been reclassified to conform to the current-year presentabodies. The Board of Governors has developed special- tion. Unique accounts and significant accounting policies ized accounting principles and practices that it considers are explained below. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

326 93rd Annual Report, 2006 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED (A) Gold and Special Drawing Rights Certificates at cost, on a settlement-date basis, and adjusted for amortization of premiums or accretion of discounts on a The Secretary of the U.S. Treasury is authorized to issue straight-line basis. Interest income is accrued on a gold and special drawing rights ("SDR") certificates to straight-line basis. Gains and losses resulting from sales the Reserve Banks. of securities are determined by specific issues based on Payment for the gold certificates by the Reserve Banks average cost. Foreign-currency-denominated assets are is made by crediting equivalent amounts in dollars into revalued daily at current foreign currency market the account established for the U.S. Treasury. The gold exchange rates in order to report these assets in U.S. certificates held by the Reserve Banks are required to be dollars. Realized and unrealized gains and losses on backed by the gold of the U.S. Treasury. The U.S. Trea- investments denominated in foreign currencies are resury may reacquire the gold certificates at any time and ported as "Foreign currency gains (losses), net" in the the Reserve Banks must deliver them to the U.S. Trea- Statements of Income. sury. At such time, the U.S. Treasury's account is charged, Activity related to U.S. government securities, includand the Reserve Banks' gold certificate accounts are ing the premiums, discounts, and realized and unrealized reduced. The value of gold for purposes of backing the gains and losses, is allocated to each of the Reserve gold certificates is set by law at $42 2/9 a fine troy ounce. Banks on a percentage basis derived from an annual The Board of Governors allocates the gold certificates settlement of interdistrict clearings that occurs in April of among Reserve Banks once a year based on the average each year. The settlement equalizes Reserve Bank gold Federal Reserve notes outstanding in each Reserve Bank. certificate holdings to Federal Reserve notes outstanding SDR certificates are issued by the International Monein each District. Activity related to investments denomitary Fund ("Fund") to its members in proportion to each nated in foreign currencies is allocated to each Reserve member's quota in the Fund at the time of issuance. SDR Bank based on the ratio of each Reserve Bank's capital certificates serve as a supplement to international monetary reserves and may be transferred from one national and surplus to aggregate capital and surplus at the precedmonetary authority to another. Under the law providing ing December 31. for United States participation in the SDR system, the Secretary of the U.S. Treasury is authorized to issue SDR (D) Securities Purchased under Agreements to Resell, certificates, somewhat like gold certificates, to the Securities Sold under Agreements to Repurchase, Reserve Banks. When SDR certificates are issued to the and Securities Lending Reserve Banks, equivalent amounts in dollars are credited to the account established for the U.S. Treasury, and the The FRBNY may engage in tri-party purchases of securi- Reserve Banks' SDR certificate accounts are increased. ties under agreements to resell ("tri-party agreements"). The Reserve Banks are required to purchase SDR certifi- Tri-party agreements are conducted with two commercial cates, at the direction of the U.S. Treasury, for the purpose custodial banks that manage the clearing and settlement of financing SDR acquisitions or for financing exchange of collateral. Collateral is held in excess of the contract stabilization operations. At the time SDR transactions amount. Acceptable collateral under tri-party agreements occur, the Board of Governors allocates SDR certificate primarily includes U.S. government securities, passtransactions among Reserve Banks based upon each through mortgage securities of the Government National Reserve Bank's Federal Reserve notes outstanding at the Mortgage Association, Federal Home Loan Mortgage end of the preceding year. There were no SDR transac- Corporation, and Federal National Mortgage Association, tions in 2006 or 2005. STRIP securities of the U.S. Government, and "stripped" securities of other government agencies. The tri-party (B) Loans to Depository Institutions agreements are accounted for as financing transactions, with the associated interest income accrued over the life Depository institutions that maintain reservable transac- of the agreement. tion accounts or nonpersonal time deposits, as defined in Securities sold under agreements to repurchase are regulations issued by the Board of Governors, have bor- accounted for as financing transactions and the associated rowing privileges at the discretion of each of the Reserve interest expense is recognized over the life of the transac- Banks. Borrowers execute certain lending agreements and tion. These transactions are reported in the Statements of deposit sufficient collateral before credit is extended. Condition at their contractual amounts and the related Outstanding loans are evaluated for collectibility, and accrued interest payable is reported as a component of currently all are considered collectible and fully collater- "Other liabilities." alized. If loans were ever deemed to be uncollectible, an U.S. government securities held in the SOMA are lent appropriate reserve would be established. Interest is ac- to U.S. government securities dealers in order to facilitate crued using the applicable discount rate established at the effective functioning of the domestic securities marleast every fourteen days by the Board of Directors of the ket. Securities-lending transactions are fully collateral- Reserve Bank, subject to review and determination by the ized by other U.S. government securities and the collat- Board of Governors. eral taken is in excess of the market value of the securities loaned. The FRBNY charges the dealer a fee for borrow- (C) US. Government Securities and Investments ing securities and the fees are reported as a component of Denominated in Foreign Currencies "Other income." Activity related to securities sold under agreements to U.S. government securities and investments denominated repurchase and securities lending is allocated to each of in foreign currencies comprising the SOMA are recorded the Reserve Banks on a percentage basis derived from the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 327 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED annual settlement of interdistrict clearings. Securities pur- from two to five years. Maintenance costs related to chased under agreements to resell are allocated to the software are charged to expense in the year incurred. FRBNY and not to the other Reserve Banks. Capitalized assets including software, buildings, leasehold improvements, furniture, and equipment are im- (E) FX Swap Arrangements and Warehousing Agreements paired when events or changes in circumstances indicate that the carrying amount of assets or asset groups is not FX swap arrangements are contractual agreements recoverable and significantly exceeds their fair value. between two parties, the FRBNY and an authorized foreign central bank, to exchange specified currencies, at a (G) Federal Reserve Notes specified price, on a specified date. The parties agree to exchange their currencies up to a pre-arranged maximum Federal Reserve notes are the circulating currency of the amount and for an agreed-upon period of time (up to United States. These notes are issued through the various twelve months), at an agreed-upon interest rate. These Federal Reserve agents (the chairman of the board of arrangements give the FOMC temporary access to the directors of each Reserve Bank and their designees) to the foreign currencies it may need to intervene to support the Reserve Banks upon deposit with such agents of specified dollar and give the authorized foreign central bank temclasses of collateral, typically U.S. government securities. porary access to dollars it may need to support its own These notes are identified as issued to a specific Reserve currency. Drawings under the FX swap arrangements can Bank. The Federal Reserve Act provides that the collatbe initiated by either party acting as drawer, and must be eral tendered by the Reserve Bank to the Federal Reserve agreed to by the drawee party. The FX swap arrangeagent must be equal to the sum of the notes applied for by ments are structured so that the party initiating the transsuch Reserve Bank. action bears the exchange rate risk upon maturity. The FRBNY will generally invest the foreign currency re- Assets eligible to be pledged as collateral include all of ceived under an FX swap arrangement in interest-bearing the Reserve Banks' assets. The collateral value is equal to instruments. the book value of the collateral tendered, with the excep- Warehousing is an arrangement under which the tion of securities, for which the collateral value is equal to FOMC agrees to exchange, at the request of the U.S. the par value of the securities tendered. The par value of Treasury, U.S. dollars for foreign currencies held by the securities pledged for securities sold under agreements to U.S. Treasury or ESF over a limited period of time. The repurchase is deducted. purpose of the warehousing facility is to supplement the The Board of Governors may, at any time, call upon a U.S. dollar resources of the U.S. Treasury and ESF for Reserve Bank for additional collateral for the Federal financing purchases of foreign currencies and related Reserve notes. To satisfy the obligation to provide suffiinternational operations. cient collateral for outstanding Federal Reserve notes, the FX swap arrangements and warehousing agreements Reserve Banks have entered into an agreement that proare revalued daily at current market exchange rates. Ac- vides for certain assets of the Reserve Banks to be jointly tivity related to these agreements, with the exception of pledged as collateral for the Federal Reserve notes issued the unrealized gains and losses resulting from the daily to all Reserve Banks. In the event that this collateral is revaluation, is allocated to each Reserve Bank based on insufficient, the Federal Reserve Act provides that Fedthe ratio of each Reserve Bank's capital and surplus to eral Reserve notes become a first and paramount lien on aggregate capital and surplus at the preceding December all the assets of the Reserve Banks. Finally, Federal 31. Unrealized gains and losses resulting from the daily Reserve notes are obligations of the United States and are revaluation are allocated to the FRBNY and not allocated backed by the full faith and credit of the United States to the other Reserve Banks. government. "Federal Reserve notes outstanding, net" in the State- (F) Bank Premises, Equipment, and Software ments of Condition represents Federal Reserve notes outstanding, reduced by the currency issued to the Bank premises and equipment are stated at cost less Reserve Banks but not in circulation, of $175,661 million accumulated depreciation. Depreciation is calculated on a and $148,152 million at December 31, 2006 and 2005, straight-line basis over the estimated useful lives of the respectively. assets, which range from two to fifty years. Major alter- At December 31, 2006, all Federal Reserve notes were ations, renovations, and improvements are capitalized at fully collateralized. All gold certificates, all special drawcost as additions to the asset accounts and are depreciated ing right certificates, and $769,782 million of domestic over the remaining useful life of the asset or, if appropri- securities and securities purchased under agreements to ate, over the unique useful life of the alteration, renova- resell were pledged as collateral. At December 31, 2006, tion, or improvement. Maintenance, repairs, and minor no loans or investments denominated in foreign currenreplacements are charged to operating expense in the year cies were pledged as collateral. incurred. Costs incurred for software during the application de- (H) Items in Process of Collection and velopment stage, either developed internally or acquired Deferred Credit Items for internal use, are capitalized based on the cost of direct services and materials associated with designing, coding, "Items in process of collection" in the Statements of installing, or testing software. Capitalized software costs Condition primarily represents amounts attributable to are amortized on a straight-line basis over the estimated checks that have been deposited for collection and that, as useful lives of the software applications, which range of the balance sheet date, have not yet been presented to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

328 93rd Annual Report, 2006 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED the paying bank. "Deferred credit items" are the counter- required due to these events exceeded the Bank's earnpart liability to "items in process of collection," and the ings in 2005. amounts in this account arise from deferring credit for deposited items until the amounts are collected. The (L) Income and Costs Related to U.S. Treasury Services balances in both accounts can vary significantly. The Reserve Banks are required by the Federal Reserve (I) Capital Paid-in Act to serve as fiscal agents and depositories of the United States. By statute, the Department of the Treasury The Federal Reserve Act requires that each member bank is permitted, but not required, to pay for these services. subscribe to the capital stock of the Reserve Banks in an amount equal to 6 percent of the capital and surplus of the (M) Assessments by the Board of Governors member bank. These shares are nonvoting with a par value of $100 and may not be transferred or hypoth- The Board of Governors assesses the Reserve Banks to ecated. As a member bank's capital and surplus changes, fund its operations based on each Reserve Bank's capital its holdings of Reserve Bank stock must be adjusted. and surplus balances as of December 31 of the previous Currently, only one-half of the subscription is paid-in and year. The Board of Governors also assesses each Reserve the remainder is subject to call. By law, each Reserve Bank for the expenses incurred for the U.S. Treasury to Bank is required to pay each member bank an annual issue and retire Federal Reserve notes based on each dividend of 6 percent on the paid-in capital stock. This Reserve Bank's share of the number of notes comprising cumulative dividend is paid semiannually. A member the System's net liability for Federal Reserve notes on bank is liable for Reserve Bank liabilities up to twice the December 31 of the previous year. par value of stock subscribed by it. (N) Taxes (J) Surplus The Reserve Banks are exempt from federal, state, and The Board of Governors requires the Reserve Banks to local taxes, except for taxes on real property and sales maintain a surplus equal to the amount of capital paid-in taxes on certain construction projects. Real property taxes as of December 31 of each year. This amount is intended were $33 million and $32 million for the years ended to provide additional capital and reduce the possibility December 31, 2006 and 2005, respectively, and are rethat the Reserve Banks would be required to call on ported as a component of "Occupancy expense." member banks for additional capital. Accumulated other comprehensive income is treated as (O) Restructuring Charges a component of surplus in the Statements of Condition and the Statements of Changes in Capital. The balance of In 2003, the Reserve Banks began the restructuring of accumulated other comprehensive income is comprised several operations, primarily check, cash, and U.S. Treaof expenses, gains, and losses related to defined benefit sury services. The restructuring included streamlining the pension plans and other postretirement benefit plans that management and support structures, reducing staff, deunder accounting principles are included in comprehen- creasing the number of processing locations, and increassive income but excluded from net income. Additional ing processing capacity in some locations. These restrucinformation regarding the classifications of accumulated turing activities continued in 2004 through 2006. other comprehensive income is provided in Notes 8, 9, Note 11 describes the restructuring and provides inforand 10. mation about the Reserve Banks' costs and liabilities associated with employee separations and contract termi- (K) Interest on Federal Reserve Notes nations. The costs associated with the impairment of certain of the Reserve Banks' assets are discussed in Note The Board of Governors requires the Reserve Banks to 6. Costs and liabilities associated with enhanced pension transfer excess earnings to the U.S. Treasury as interest benefits in connection with the restructuring activities for on Federal Reserve notes, after providing for the costs of all of the Reserve Banks are recorded on the books of the operations, payment of dividends, and reservation of an FRBNY as discussed in Note 8. Costs and liabilities amount necessary to equate surplus with capital paid-in. associated with enhanced post-retirement benefits are This amount is reported as a component of "Payments to discussed in Note 9. US. Treasury as interest on Federal Reserve notes" in the Statements of Income and is reported as a liability in the (P) Implementation ofFASB Statement No. 158, Statements of Condition. Weekly payments to the U.S. Employers' Accounting for Defined Benefit Pension Treasury may vary significantly. and Other Postretirement Plans In the event of losses or an increase in capital paid-in at a Reserve Bank, payments to the U.S. Treasury are sus- The Reserve Banks initially applied the provisions of pended and earnings are retained until the surplus is equal FASB Statement No. 158, Employers' Accounting for to the capital paid-in. Defined Benefit Pension and Other Postretirement Plans, In the event of a decrease in capital paid-in, the excess at December 31, 2006. This accounting standard requires surplus, after equating capital paid-in and surplus at recognition of the overfunded or underfunded status of a December 31, is distributed to the U.S. Treasury in the defined benefit postretirement plan in the Statements of following year. Condition, and recognition of changes in the funded Due to die substantial increase in capital paid-in at one status in the years in which the changes occur through Reserve Bank, surplus was no'-, equated to capital at comprehensive income. The transition rules for imple- December 31, 2005. The amcw K of additional surplus menting the standard require applying the provisions as of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 329 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED the end of the year of initial implementation with no retrospective application. The incremental effects on the Securities Securities purchased sold line items in the Statement of Condition at December 31, under under 2006, were as follows (in millions): U.S. agree- agreegovernment ments to ments to securities resell repurchase Before After (Par (Contract (Contract Applica- Applica- value) amount) amount) tion of tion of Statement Adjust- Statement Within 15 days ... $ 40,588 $40,750 $29,615 158 ments 158 16 days to 90 days. 180,893 91 days to 1 year . 185,132 Other Assets $ 3,277 $ (1,492) $ 1,785 Over 1 year to Total assets $874,856 $ (1,492) $873,364 5 years . 224,177 Over 5 years to Accrued benefit 10years ..... 67,645 costs 957 357 1,314 Over 10 years .... 80,479 Total liabilities . $842,359 $ 357 $842,716 Total ... $778,914 $40,750 $29,615 Surplus 17,173 (1,849) 15,324 At December 31, 2006 and 2005, U.S. government Total capital.... $ 32,497 $(1,849) $ 30,648 securities with par values of $6,855 million and $3,776 million, respectively, were loaned from the SOMA. (4) U.S. GOVERNMENT SECURITIES, SECURITIES At December 31, 2006 and 2005, the total contract PURCHASED UNDER AGREEMENTS TO RESELL, amount of securities sold under agreements to repurchase SECURITIES SOLD UNDER AGREEMENTS was $29,615 million and $30,505 million, respectively. TO REPURCHASE, AND SECURITIES LENDING At December 31, 2006 and 2005, securities sold under agreements to repurchase with a par value of $29,676 The FRBNY, on behalf of the Reserve Banks, holds million and $30,559 million, respectively, were outstandsecurities bought outright in the SOMA. ing. The contract amount for securities sold under agreements to repurchase approximates fair value. Total securities held in the SOMA at December 31, were as follows (in millions): (5) INVESTMENTS DENOMINATED IN 2006 2005 FOREIGN CURRENCIES Par value The FRBNY, on behalf of the Reserve Banks, holds U.S. government foreign currency deposits with foreign central banks and Bills $277,019 $271,270 with the Bank for International Settlements and invests in Notes 402,367 380,118 foreign government debt instruments. Foreign govern- Bonds 99,528 92,827 ment debt instruments held include both securities bought Total par value 778,914 744,215 outright and securities purchased under agreements to resell. These investments are guaranteed as to principal Unamortized premiums 8,708 8,813 and interest by the issuing foreign governments. Unaccreted discounts (4,003) (2,826) Total investments denominated in foreign currencies, Total $783,619 $750,202 including accrued interest, and valued at current foreign currency market exchange rates at December 31, were as follows (in millions): At December 31, 2006 and 2005, the fair value of the U.S. government securities held in the SOMA, excluding 2006 2005 accrued interest, was $795,900 million and $767,472 million, respectively, as determined by reference to European Union euro quoted prices for identical securities. Foreign currency deposits $ 6,242 $ 5,424 Although the fair value of security holdings can be Securities purchased under substantially greater or less than the carrying value at any agreements to resell 2,214 1,928 point in time, these unrealized gains or losses have no Government debt instruments 4,074 3,561 effect on the ability of the Reserve Banks, as a central Japanese yen bank, to meet its financial obligations and responsibili- Foreign currency deposits 2,601 2,618 ties, and should not be misunderstood as representing a Government debt instruments .. 5,351 5,397 risk to the Reserve Banks, their shareholders, or the public. The fair value is presented solely for informa- Total $20,482 $18,928 tional purposes. The maturity distribution of U.S. government securities At December 31, 2006 and 2005, the fair value of the bought outright, securities purchased under agreements to total System investments denominated in foreign currenresell, and securities sold under agreements to repurchase, cies, including accrued interest, was $20,434 million and that were held in the SOMA at December 31, 2006, was $18,965 million, respectively. The fair value of governas follows (in millions): ment debt instruments was determined by reference to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

330 93rd Annual Report, 2006 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED quoted prices for identical securities. The cost basis of 2006 2005 foreign currency deposits and securities purchased under Leased premises and equipment agreements to resell, adjusted for accrued interest, ap- under capital leases $12 $10 proximates fair value. Similar to the U.S. government Accumulated depreciation _(6) (5) securities discussed in Note 4, unrealized gains or losses Leased premises and equipment have no effect on the ability of a Reserve Bank, as a under capital leases, net $_6 $_5 central bank, to meet its financial obligations and responsibilities. Certain of the Reserve Banks lease space to outside The maturity distribution of investments denominated tenants with remaining lease terms ranging from one to in foreign currencies at December 31, 2006, was as fourteen years. Rental income from such leases was $25 follows (in millions): million and $23 million for the years ended December 31, 2006 and 2005, respectively, and is reported as a compo- European Japanese nent of "Other income." Future minimum lease payments euro yen Total that the Bank will receive under noncancelable lease Withinl5days $4,359 $2,601 $6,960 agreements in existence at December 31, 2006, are as 16 days to 90 days 2,378 1,208 3,586 follows (in millions): 91 days to 1 year 2,442 2,213 4,655 Over 1 year to 5 years 3,351 1,930 5,281 2007 $ 23 Over 5 years to 10 years ... ... 2008 23 Over 10 years . . . . . . . . . 2009 22 Total $12,530 $7,952 $20,482 2010 21 2011 18 Thereafter . 70 At December 31, 2006 and 2005, there were no mate- Total $177 rial open foreign exchange contracts. At December 31,2006 and 2005, the warehousing facility was $5,000 million, with no balance outstanding. The Reserve Banks have capitalized software assets, net of amortization, of $155 million and $162 million at (6) BANK PREMISES, EQUIPMENT, AND SOFTWARE December 31, 2006 and 2005, respectively. Amortization expense was $66 million and $55 million for the years A summary of bank premises and equipment at Decemended December 31, 2006 and 2005, respectively. Capiber 31 is as follows (in millions): talized software assets are reported as a component of 2006 2005 "Other assets" and the related amortization is reported as Bank premises and equipment a component of "Other expenses." Land $ 306 $ 295 Several of the Reserve Banks have impaired assets as a Buildings 1,817 1,787 result of the System's restructuring plan, as discussed in Building machinery and Note 11. Impaired assets include software, buildings, equipment 393 387 leasehold improvements, furniture, and equipment. Asset Construction in progress 220 86 impairment losses related to the check and cash restruc- Furniture and equipment 1,156 1,162 turings of $15 million and $50 million for the periods Subtotal 3,892 3,717 ending December 31, 2006 and 2005, respectively, were determined using fair values based on quoted market Accumulated depreciation (1,516) (1,465) values or other valuation techniques and are reported as a Bank premises and equipment, component of "Other expenses." net $2,376 $2,252 Depreciation expense, for the (7) COMMITMENTS AND CONTINGENCIES year ended At December 31,2006, the Reserve Banks were obligated December 31 $ 186 $ 175 under noncancelable leases for premises and equipment with remaining terms ranging from one to approximately The Federal Reserve Bank of Kansas City (FRBKC) is seventeen years. These leases provide for increased rental constructing a new building to replace its head office. payments based upon increases in real estate taxes, oper- Approximately $29 million of costs associated with the ating costs, or selected price indices. acquisition of land and site preparation for the new Rental expense under operating leases for certain operbuilding are included in the "Land" account, and approxi- ating facilities, warehouses, and data processing and ofmately $114 million of costs associated with the construc- fice equipment (including taxes, insurance and maintetion of the new building are included in the "Construction nance when included in rent), net of sublease rentals, was in progress" account. In July 2005, the FRBKC com- $31 million and $26 million for the years ended Decempleted the sale and leaseback of its head office, and will ber 31, 2006 and 2005, respectively. Certain of the lease the space from the purchaser until the new building Reserve Banks' leases have options to renew. is completed in 2008. Future minimum rental payments under noncancelable Bank premises and equipment at December 31 include operating leases, net of sublease rentals, with remaining the following amounts for leases that have been capital- terms of one year or more, at December 31, 2006 are as ized (in millions): follows (in millions): Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 331 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED of the System Plan and the costs associated with the Plan are not redistributed to other participating employers. 2007 $ 12 Following is a reconciliation of the beginning and 2008 9 ending balances of the System Plan benefit obligation (in 2009 2010 millions): 2011 7 2006 2005 Thereafter . 102 Estimated actuarial present value Future minimum rental payments $146 of projected benefit obligation at January 1 $4,785 $4,524 At December 31, 2006, the Reserve Banks had other Service cost—benefits earned commitments and long-term obligations extending during the period 134 123 Interest cost on projected through the year 2017 with a remaining amount of $336 benefit obligation 278 263 million. As of December 31, 2006, commitments of $219 Actuarial loss 132 125 million were recognized. Purchases of $92 million and Contributions by plan participants .. 3 3 $98 million were made against these commitments during Special termination benefits loss ... 3 6 2006 and 2005, respectively. These commitments are for Benefits paid (254) (259) goods and services to maintain currency machines, for Plan amendments 66 . . . software licenses and maintenance, for services related to Estimated actuarial present value check processing equipment and transportation, and have of projected benefit variable and/or fixed components. The variable portion of obligation at December 31 .... $5,147 $4,785 the commitments is for additional services above fixed contractual service limits. The fixed payments for the Following is a reconciliation of the beginning and next five years under these commitments are as follows ending balance of the System Plan assets, the funded (in millions): status, and the prepaid pension benefit costs (in millions): Fixed commitment 2006 2005 2007 $30 Estimated fair value of plan 2008 36 assets at January 1 $5,868 $5,887 2009 32 Actual return on plan assets 713 237 2010 28 Contributions by the employer • • • • • • 2011 29 Contributions by plan participants .. 3 3 Benefits paid (254) (259) The Reserve Banks are involved in certain legal actions Estimated fair value of plan and claims arising in the ordinary course of business. assets at December 31 $6,330 $5,868 Although it is difficult to predict the ultimate outcome of these actions, in management's opinion, based on discus- Funded status $1,183 $1,083 sions with counsel, the aforementioned litigation and Unrecognized prior service cost 149 Unrecognized net actuarial loss 1,496 claims will be resolved without material adverse effect on the financial position or results of operations of the Prepaid pension benefit costs $2,728 Reserve Banks. Amounts included in accumulated other comprehensive (8) RETIREMENT AND THRIFT PLANS loss (in millions) Prior service cost (191) Retirement Plans Net actuarial loss (1,301) The Reserve Banks currently offer three defined benefit Total accumulated other retirement plans to their employees based on length of comprehensive loss $(1,492) service and level of compensation. Substantially all of the Reserve Banks', Board of Governors', and the Office of Prepaid pension benefit costs are reported as "Other Employee Benefits of the Federal Reserve System's em- assets" in die Statements of Condition. ployees participate in the Retirement Plan for Employees The accumulated benefit obligation for the System of the Federal Reserve System ("System Plan"). Employ- Plan, which differs from the estimated actuarial present ees at certain compensation levels participate in the Bene- value of the projected benefit obligation because it is fit Equalization Retirement Plan ("BEP") and certain based on current rather than future compensation levels, Reserve Bank officers participate in the Supplemental was $4,522 million and $4,162 million at December 31, Employee Retirement Plan ("SERP"). 2006 and 2005, respectively. The System Plan is a multi-employer plan with contri- The weighted-average assumptions used in developing butions funded by participating employers. Participating the projected pension benefit obligation for the System employers are the Federal Reserve Banks, the Board of Plan as of December 31 were as follows: Governors, and the Office of Employee Benefits of the Federal Reserve Employee Benefits System. No separate 2006 2005 accounting is maintained of assets contributed by the Discount rate ... 6.00% 5.75% participating employers. The FRBNY acts as the sponsor Rate of compensation increase ...... 4.50% 4.50% Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

332 93rd Annual Report, 2006 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED Net periodic benefit expenses are actuarially deter- Expected mined using a January 1 measurement date. The benefit weighted-average assumptions used in developing net payments periodic benefit expenses for the System Plan for the 2007 . .. $ 260 years at January 1 were as follows: 2008 . .. 270 2009 . .. 281 2006 2005 2010 . 294 2011 306 Discount rate 5.75% 5.75% 2012-2016 1,764 Expected asset return 8.00% 8.25% Rate of compensation increase 4.50% 4.25% Total $3,175 Discount rates reflect yields available on high-quality corporate bonds that would generate the cash flows nec- The Federal Reserve System's pension plan weightedessary to pay the plan's benefits when due. The expected average asset allocations at December 31, by asset catelong-term rate of return on assets was based on a combi- gory, were as follows: nation of methodologies including the System Plan's historical returns, surveys of other plans' expected rates 2006 2005 of return, building a projected return for equities and Equities 64.3% 66.2% fixed income investments based on real interest rates, Fixed income 34.4% 31.7% inflation expectations, equity risk premiums, and, finally, Cash 1.3% 2.1% surveys of expected returns in equity and fixed income Total 100.0% 100.0% markets. The components of net periodic pension benefit ex- The System's Committee on Investment Performance pense (credit) for the System Plan for the years ended (CIP) contracts with investment managers who are re- December 31 are shown below (in millions): sponsible for implementing the System Plan's investment 2006 2005 policies. The managers' performance is measured against a trailing 36-month benchmark of 60 percent of a market Service cost—benefits earned value weighted index of predominantly large capitalizaduring the period $$ 113344 $123 tion stocks trading on the New York Stock Exchange, the Interest cost on projected American Stock Exchange, and the National Association benefit obligation 278 263 of Securities Dealers Automated Quotation National Mar- Amortization of prior service cost 23 24 ket System and 40 percent of a broadly diversified Amortization of actuarial investment-grade fixed income index (rebalanced 75 49 monthly). The managers invest plan funds within CIP- Expected return on plan assets (460) (476) established guidelines for investment in equities and fixed income instruments. Equity investments can range Net periodic pension expense/ (credit) 50 (17) between 40 percent and 80 percent of the portfolio. Special termination benefits losses .. 3 6 Investments, however, cannot be concentrated in particular industries and equity securities holdings of any one Total periodic pension expense/ company are limited. Fixed income securities must be (credit) $53 investment grade and the effective duration of the fixed Estimated amounts that will be income portfolio must remain within a range of 67 peramortized from accumulated cent and 150 percent of a broadly diversified investmentother comprehensive loss grade fixed income index. CIP guidelines prohibit marinto net periodic pension gin, short sale, foreign exchange, and commodities expense in 2007 trading as well as investment in bank, bank holding (in millions): company, savings and loan, and government securities Prior service cost $ 29 dealers' stocks. In addition, investments in non-dollar Actuarial loss 66 denominated securities are prohibited; however, a small Total. $ 95 portion of the portfolio can be invested in American Depositary Receipts/Shares and foreign-issued dollardenominated fixed income securities. The recognition of special termination benefits losses is the result of enhanced retirement benefits provided to Contributions to the System Plan may be determined employees during the restructuring described in Note 11. using different assumptions than those required for finan- Following is a summary of expected benefit payments cial reporting. The System does not expect to make a cash (in millions): contribution to the System Plan during 2007. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 333 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED The Reserve Banks' projected benefit obligation, 2006 2005 funded status, and net pension expenses for the BEP and the SERP at December 31, 2006 and 2005, and for the Fair value of plan assets years then ended, are not material. at January 1 $. . . Contributions by the employer 47 48 Contributions by plan participants . 13 11 Thrift Plan Benefits paid (60) (59) Employees of the Reserve Banks may also participate in Fair v D a e lu ce e m o b f e p r l a 3 n 1 assets at $ • • • $. . . the defined contribution Thrift Plan for Employees of the Federal Reserve System ("Thrift Plan"). The Reserve Unfunded postretirement benefit Banks' Thrift Plan contributions totaled $66 million and obligation $1,164 $947 $63 million for the years ended December 31, 2006 and Unrecognized prior service cost 105 2005, respectively, and are reported as a component of Unrecognized net actuarial loss (277) "Salaries and other benefits" in the Statements of Income. Accrued postretirement benefit costs. $775 The Reserve Banks match employee contributions based on a specified formula. For the years ended December 31, Amounts included in accumulated 2006 and 2005, the Reserve Banks matched 80 percent on other comprehensive the first 6 percent of employee contributions for employ- loss (in millions): ees with less than five years of service and 100 percent on Prior service cost $ 85 the first 6 percent of employee contributions for employ- Net actuarial loss (443) ees with five or more years of service. Deferred curtailment gain 1 Total accumulated other (9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS comprehensive loss $ (357) AND POSTEMPLOYMENT BENEFITS Accrued postretirement benefit costs are reported as a Postretirement Benefits Other Than Pensions component of "Accrued benefit costs" in the Statements of Condition. In addition to the Reserve Banks' retirement plans, em- For measurement purposes, the assumed health care ployees who have met certain age and length-of-service cost trend rates at December 31 are as follows: requirements are eligible for both medical benefits and life insurance coverage during retirement. The Reserve Banks fund benefits payable under the 2006 2005 medical and life insurance plans as due and, accordingly, Health care cost trend rate have no plan assets. assumed for next year 9.00% 9.00% Following is a reconciliation of beginning and ending Rate to which the cost trend rate balances of the benefit obligation (in millions): is assumed to decline (the ultimate trend rate) 5.00% 5.00% Year that the rate reaches the 2006 2005 ultimate trend rate 2012 2011 Accumulated postretirement benefit obligation at January 1 $ 947 $869 Assumed health care cost trend rates have a significant Service cost—benefits earned during effect on the amounts reported for health care plans. A the period 27 32 one percentage point change in assumed health care cost Interest cost of accumulated trend rates would have the following effects for the year benefit obligation 54 49 Actuarial loss 188 45 ended December 31, 2006 (in millions): Contributions by plan participants 13 11 Benefits paid (60) (59) One percentage One percentage Plan amendments (5) point increase point decrease Accumulated postretirement benefit Effect on aggregate obligation at December 31 $1,164 $947 of service and interest cost At December 31,2006 and 2005, the weighted-average components of discount rate assumptions used in developing the postre- net periodic postretirement tirement benefit obligation were 5.75 percent and 5.50 benefit expense .. .. $ 12 $ (10) percent, respectively. Effect on accumulated Discount rates reflect yields available on high-quality postretirement corporate bonds that would generate the cash flows nec- benefit obligation .. 128 (HI) essary to pay the plan's benefits when due. Following is a reconciliation of the beginning and The following is a summary of the components of net ending balance of the plan assets, the unfunded postretire- periodic postretirement benefit expense for the years ment benefit obligation, and the accrued postretirement ended December 31 (in millions): benefit costs (in millions): Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

334 93rd Annual Report, 2006 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED 2006 2005 Without With subsidy subsidy Service cost—benefits earned during theperiod $27 $32 2007 . $ 63 $ 58 Interest cost on accumulated benefit 2008 .. 68 62 obligation 54 49 2009 .. 73 68 2010 .. 79 72 Amortization of prior service cost (23) (21) Amortization of actuarial loss __22 _13 2011 .. 84 77 2012-2016 __476 430 Total periodic expense 80 73 Curtailment gain ^^ (5) Total $843 $767 Net periodic postretirement Postemployment Benefits benefit expense $ 80 $ 68 The Reserve Banks offer benefits to former or inactive Estimated amounts that will be employees. Postemployment benefit costs are actuarially amortized from accumulated determined using a December 31,2006 measurement date other comprehensive loss and include the cost of medical and dental insurance, into net periodic benefit survivor income, and disability benefits. The accrued expense in 2007 postemployment benefit costs recognized by the Reserve (in millions): Banks at December 31,2006 and 2005 were $126 million Prior service cost (22) and $124 million, respectively. This cost is included as a Actuarial loss 45 component of "Accrued benefit costs" in the Statements of Condition. Net periodic postemployment benefit ex- Total $ 23 pense included in 2006 and 2005 operating expenses was $20 million and $14 million, respectively, and is recorded Net postretirement benefit expense is actuarially deter- as a component of "Salaries and other benefits" in the mined using a January 1 measurement date. At January 1, Statements of Income. 2006 and 2005, the weighted-average discount rate assumptions used to determine net periodic postretirement (10) ACCUMULATED OTHER COMPREHENSIVE INCOME benefit expense were 5.50 percent and 5.75 percent, respectively. Following is a reconciliation of beginning and ending Net periodic postretirement benefit expense is reported balances of accumulated other comprehensive loss: as a component of "Salaries and other benefits" in the Statements of Income. Amount The 2005 service cost contains an adjustment by one Amount Related Total Related to Post- Accum- Reserve Bank that resulted from a review of plan terms to retirement ulated and assumptions. A plan amendment that modified the Defined Benefits Other credited service period eligibility requirements created Benefit Other Comprecurtailment gains in 2005. A deferred curtailment gain, Retirement than hensive which was recorded in 2006 as a component of accumu- Plans Pensions Loss lated other comprehensive loss, is expected to be recognized in net income in 2008 when the related employees Balance at terminate employment. December 31, 2005 $ ... $ ... The Medicare Prescription Drug, Improvement and Modernization Act of 2003 established a prescription Adjustment to drug benefit under Medicare ("Medicare Part D") and a initially apply federal subsidy to sponsors of retiree health care benefit FASB Statement plans that provide benefits that are at least actuarially No. 158 (1,492) (357) (1,849) equivalent to Medicare Part D. The benefits provided Balance at under the Reserve Banks' plan to certain participants are December 31, at least actuarially equivalent to the Medicare Part D 2006 $ (1,492) $ (357) $ (1,849) prescription drug benefit. The estimated effects of the subsidy, retroactive to January 1, 2004, are reflected in Additional detail regarding the classification of accuactuarial loss in the accumulated postretirement benefit mulated other comprehensive income is included in notes obligation and net periodic postretirement benefit 8 and 9. expense. The Reserve Banks account for the Medicare subsidies (11) BUSINESS RESTRUCTURING CHARGES as a reduction to benefits payments. The Reserve Banks expect to receive approximately $4 million in subsidies in In 2003, several Reserve Banks announced plans for the year ending December 31, 2007 that relate to benefit restructuring to streamline operations and reduce costs, payments made in the year ended December 31, 2006. including consolidation of check operations and staff Following is a summary of expected postretirement reductions in various functions of the Bank. In 2004 benefit payment (in millions): through 2006, additional consolidation and restructuring Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 335 NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS—CONTINUED initiatives wore announced in the check, cash, purchasing, Employee separation costs are primarily severance and Treasury operations. These actions resulted in the costs related to identified staff reductions of approxifollowing business restructuring charges (in millions): mately 1,949, including 286 and 292 staff reductions related to restructuring announced in 2006 and 2005, Total respectively. Costs related to staff reductions for the years CScosts ended December 31> 2006 and 2005 ^ sported as a component of "Salaries and other benefits" in the State- Employee separation $49 ments of Income. Contract termination costs include the Contract termination 1 charges resulting from terminating existing lease and i other contracts and are shown as a component of "Other Total $51 expenses." Other costs include the continuation of a noncancelable lease agreement and associated facility 12/31/2006 maintenance and are shown as a component of "Occu- Accrued Accrued Pancy expenses." liability Total Total liability Restructuring costs associated with impairment of cer- 12/31/05 charges paid 12/31/06 tain Reserve Bank assets, including software, buildings, leasehold improvements, furniture, and equipment, are p $17 $9 $(12) $14 discussed in Note 6. Costs associated with enhanced Contract pension benefits for all Reserve Banks are recorded on termination ... ... ... the books of the FRBNY as discussed in Note 8. Costs Other .__ ._;_. . . . . . . associated with enhanced postretirement benefits are dis- Total $17 $9 $(12) $14 closed in Note 9. = = = = Future costs associated with the announced restructur- Adjustments to the accrued liability due to changes in ing Plans are estimated at $4 million, the estimated restructuring costs were offset against total The Reserve Banks anticipate substantially completing charges. Without these offsets, total charges would have meir announced plans in 2008. been $10 million in 2006. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

337 Office of Inspector General Activities The Board of Governors' Office of In- fraud, and abuse in Board and Boardspector General (OIG) functions in ac- delegated programs and operations, as cordance with the Inspector General Act well as in activities administered or fiof 1978, as amended. In addition to nanced by the Board. The OIG keeps retaining an independent auditor each the Congress and the Chairman of the year to audit the Board's financial state- Board of Governors fully informed ments, the OIG plans and conducts au- about serious abuses and deficiencies dits, reviews, and investigations relating and about the status of any corrective to the Board's programs and operations actions. and its delegated functions at the Fed- During 2006, the OIG completed eral Reserve Banks. The OIG also re- eight audits, reviews, and other assessviews existing and proposed legislation ments and conducted a number of and regulations for their impact on the follow-up reviews to evaluate action economy and efficiency of the Board's taken on earlier recommendations. The programs and operations. It recommends OIG also closed eight investigations and policies, and it supervises and conducts performed numerous legislative and activities to promote economy and effi- regulatory reviews. ciency and to prevent and detect waste, OIG Audits, Reviews, and Assessments Completed during 2006 Report title Month issued External Quality Control Review of the National Science Foundation Inspector General Audit Organization February Audit of the FFIEC's Financial Statements (Year Ended December 31, 2005) March Inspection of the Board's Security Services Unit March Audit of the Board's Implementation of Electronic Authentication Requirements March Audit of the Board's Financial Statements (Year Ended December 31, 2005) May Audit of the Board's Information Security Program September Security Control Review of the Common Document and Text Repository System (Internal Report) October Audit of the Board's Payroll Process December Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

338 Government Accountability Office Reviews Under the Federal Banking Agency concerning the Federal Reserve were in Audit Act (Public Law 95-320), most various stages of completion at year-end Federal Reserve System operations are (table). The Federal Reserve also prounder the purview of the Government vided information to the GAO during Accountability Office (GAO). In 2006, the year on numerous other GAO the GAO completed six reports on se- investigations. lected aspects of Federal Reserve opera- The reports are available directly tions (table). In addition, seven projects from the GAO. Reports Completed during 2006 Month issued Report title Report number (2006) Credit Cards: Customized Minimum Payment Disclosure Would Provide More Information to Consumers, but GAO-06-434 April Impact Could Vary Bank Secrecy Act: Opportunities Exist for FinCEN and the Banking Regulators to Further Strengthen the GAO-06-386 May Framework for Consistent BSA Oversight Information Security: Federal Reserve Needs to Address GAO-06-659 August Treasury Auction Systems Alternative Mortgage Products: Impact on Defaults Remains Unclear, but Disclosure of Risks to Borrowers Could GAO-06-1021 September Be Improved Minority Banks: Regulators Need to Better Assess GAO-07-6 October Effectiveness of Support Efforts Credit Cards: Increased Complexity in Rates and Fees Heightens GAO-06-929 October Need for More Effective Disclosures to Consumers Projects Active at Year-End 2006 Subject of project Month initiated Consolidated supervision of financial institutions November 2005 Prompt Corrective Action (PCA) program March 2006 Basel H Capital Accord March 2006 Financial markets preparedness March 2006 Financial regulatory agencies' performance pay systems May 2006 Financial regulatory agencies' compensation programs . May 2006 Hedge funds and federal regulatory oversight October 2006 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

340 93rd Annual Report, 2006 The Federal Reserve System f 9 • ^ BOSTON MINNEAPOLIS 7 12 _ n • NEW YORK CHICAGO • CLEVELAND PSLADELPHIA • SAN FRANCISCO 10 4 ° KANSAS CITY • g ST. LOUIS RICHMOND 8 5 6 • 11 • ATLANTA DALLAS ALASKA M|||; HAWAII LEGEND Both pages Facing page • Federal Reserve Bank city • Federal Reserve Branch city D Board of Governors of the Federal — Branch boundary Reserve System, Washington, D.C. NOTE The Federal Reserve officially identifies Bank serves the Commonwealth of Districts by number and by Reserve Puerto Rico and the U.S. Virgin Islands; Bank city (shown on both pages) and by the San Francisco Bank serves Ameriletter (shown on the facing page). can Samoa, Guam, and the Common- In the 12th District, the Seattle wealth of the Northern Mariana Islands. Branch serves Alaska, and the San Fran- The maps show the boundaries within cisco Bank serves Hawaii. the System as of year-end 2006. 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 341 1-A 2-B 3-C 4-D 5-E Pittsburgh Balti PA Buffalo Mi •Cincinnati • Charlotte * NY NJ BOSTON NEW YORK PHILADELPHIA CLEVELAND RICHMOND 6-F 7-G 8-H N^^^ •Nashville Birmingham IL ) IN Detroit* Louisville •—TN Jacksonville •Memphis New Orleans Little Rock Miami ATLANTA CHICAGO ST. LOUIS 9-1 • Helena MINNEAPOLIS 10-J 12-L Omaha* Denver Oklahoma City KANSAS CITY 11-K Salt Lake City El Paso •Los Angeles San Antonio*1 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

345 Index Accounting policy, 74-75 Bank holding companies Accounting Task Force (ATF), 76 Assets, 65 Affordable housing, incentives for, 110-11 Banks affiliated with, 271 Agreement corporations, 64, 67-68, 87-88 Capital instruments, 74 Allowance for loan and lease losses Inspections of, 64-65, 66 (ALLL), 74-75 Number of, 65 AmSouth Bancorporation, acquisition, 97 Regulatory financial reports, 79-82 Anti-money laundering Small holding company threshold, 79 Bank Secrecy Act/Anti-Money Surveillance and off-site monitoring of, Laundering Examination 71-72 Manual, 75 Bank Holding Companies and Change in Examinations, 68-69 Bank Control (Regulation Y), 152-53 Applications, notices, and proposals, Bank Holding Company Act, 64, 84-86, 84-88, 97 142-43 Aspen Institute, 114 Bank Holding Company Performance Assets and liabilities Reports (BHCPRs), 71-72 Board of Governors, 304 Banking Organization National Desktop Commercial banks, 280 (BOND), 83 Federal Reserve Banks, 282-85, 322 Banking organizations, U.S. (See also Bank Association of Supervisors of Banks of the holding companies and Commercial Americas (ASBA), 72 banks) Auditors' reports, 303, 313-14, 319, 321 Capital standards, 73-74 Audits, reviews, and assessments Examinations and inspections of, 64-67 of Board of Governors, 301, 303-19, Foreign operations, 67, 87-88 337 Number of, 271 of Federal Reserve Banks, 127-28, 301, Structure, regulation of, 84-88 321-35, 337 Bank Merger Act, 64, 86 of Federal Reserve System, 301, 337, Bankruptcy Abuse Prevention and 338 Consumer Protection Act, 148 by Government Accountability Office, Bank Secrecy Act/Anti—Money Laundering 301, 338 Examination Manual, 75 Interagency Advisory on the Unsafe and Bank Secrecy Act (BSA) Unsound Use of Limitation of Automated format for information, 83 Liability Provisions in External Examinations, 68-69 Audit Engagement Letters, 75, 153 Overview, 75 by Office of Inspector General, 301, Basel Committee on Banking Supervision, 337 72, 75-77 Automated clearinghouse (ACH) services, Basel I framework, implementation, 63, Federal Reserve Banks, 121, 125-26, 73-74 296 Basel II framework, implementation, 63, Availability of Funds and Collection of 73-74, 76 Checks (Regulation CC), 106-7 BB&T Corporation, acquisition, 97 Board of Governors {See also Federal Balance sheets Reserve System) Board of Governors, 304 Assets and liabilities, 304 Federal Reserve priced services, 131 Audits, reviews, and assessments of, Bank examiner training, 84, 85, 101-2 301, 303-19, 337 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

346 93rd Annual Report, 2006 Board of Governors—Continued Commercial banks—Continued Consumer Advisory Council, 109-11, Number of, 271 238 Regulatory financial reports, 82-83 Decisions, public notice of, 88 Commercial real estate lending, guidance Federal Advisory Council, 237 on, 78, 80-81, 154 FFffiC activities, 72, 73, 82-83, 84, Committee of Sponsoring Organizations of 100-101, 102, 104-7, 141 the Treadway Commission (COSO), Financial statements, 303-19 127-28 Goals and objectives, 135-37 Community affairs (See Consumer and Government Performance and Results community affairs) Act, 135-37 Community Affairs Offices (CAOs), 113 Income and expenses, 305 Community development corporations Inspector General, Office of, audits, (CDCs), 115 reviews, and assessments, 301, 337 Community development financial Litigation, 229 institutions (CDFIs), 114-15 Members and officers, 233-35, 259-62 Community economic development, Mission, 135 113-17 Outreach activities, 111, 115-17 Community Reinvestment Act (CRA) Policy actions, 151-56 Applications, analysis in relation to, 97 Strategic plan, performance plan, and Examinations for compliance with, performance report, 135 96-97 Thrift Institutions Advisory Council, 239 Rules revisions, 91, 92-93, 100 BOND (Banking Organization National Community Reinvestment (Regulation BB), Desktop), 83 153 Branches (See Federal Reserve Banks) Complex structured finance transactions Business continuity, 70-71 (CSFTs), 78-79, 154 Business investment, profits, and finance, Compliance examinations, 96-97, 100 13-17, 39, 42-45 Condition statements, Federal Reserve Banks, 282-85, 322 Call Reports, 71-72, 82, 143 Confidential information protection, 143 Capital accounts, Federal Reserve Banks, Consumer Advisory Council, 109-11, 238 282-85, 322 Consumer and community affairs Capital One Financial Corporation, Community economic development, acquisition, 97 113-17 Capital standards, 73-74 Consumer Advisory Council advice, Cash flows, Board of Governors, 306 109-11 Cash-management services, Federal Consumer complaints, 107-9, 111-12 Reserve Banks, 126 Consumer financial education, 110, Central Document and Text Repository 111-13 (CDTR), 83 Consumer information web site, 111 CFED, Federal Reserve partnership with, Consumer protection and community 113-14 reinvestment laws, 91-96 Change in Bank Control Act, 64, 87, 144 Financial Services Regulatory Relief Act Check Clearing for the 21st Century Act provisions, 146 (Check 21), 120 Outreach activities, 111, 115-17 Check collection and processing, Federal Research on financial information and Reserve Banks, 120-21, 296 disclosures, 112-13 Collection services for federal government, Consumer complaints, 107-09, 111-12 Federal Reserve Banks, 125-26 Consumer Credit Protection Act, 98, 107 Commercial banks (See also Member Consumer information web site, 111 banks and State member banks) Consumer Leasing (Regulation M), 105 Assets and liabilities, 280 Consumer prices, 3, 24-26, 35, 51-53 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 347 Consumer protection laws Earned-income tax credit, 114 Agency reports on compliance with, ECI (employment cost index), 24, 51 103-7 Economic Growth and Regulatory Implementation of, 91-96 Paperwork Reduction Act, 79 Supervision for compliance with, Economies, foreign, 30-34, 56-59 96-103 Economy, U.S. Consumer reporting agencies, 93, 96 Business sector, 13-17, 39, 42-45 Consumer spending, 10-11, 40-41 Debt, domestic nonfinancial sectors, Core Principles for banking supervision, 29-30, 55-56 76 External sector, 20-22, 47-49 Corporate profits, 15-17, 44-45 Financial markets, 5-6, 26-30, 53-56 Credit by Banks and Persons other than Government sector, 17-20, 45^7 Brokers or Dealers for the Purpose of Household sector, 10-13, 40-42 Purchasing or Carrying Margin Stock Interest rates, 9, 26-28, 35, 40, 54-55 (Regulation U), 70, 89, 281 Labor market, 22-24, 49-51 Credit risk management, 77-79 M2 monetary aggregate, 30, 56 Cross-marketing restrictions, 143-44 Outlook and projections, 3-5, 6-7, Currency and coin, 123-24, 272-79, 296 35-37, 38-39 Currency recirculation policy, Federal Prices, 3, 21-22, 24-26, 35-36, 48-49, Reserve, 154 51-53 Currency Transaction Reports, 146 Edge Act corporations, 64, 67-68, 87-88 Current account, U.S., 20, 47, 49 Education, consumer financial, 110, 111-13 Electronic access to Federal Reserve Bank Debt services, 126-29 Corporate, 15-17, 44-45 Electronic Check Processing, Treasury Domestic nonfinancial sectors, 29-30, Department program, 126 55-56 Electronic Federal Tax Payment System Government, 18-19, 19-20, 46, 47 (EFTPS), 125 Household, 13, 42 Electronic Fund Transfer Act (EFTA), 91, Debt services for federal government, 109 Federal Reserve Banks, 125 Electronic Fund Transfers (Regulation E), Depository Institution Management 91, 92, 104-5, 109, 151 Interlocks Act, 143 Emerging-market economies, 30-31, Depository institutions (See also 33-34, 58-59 Commercial banks) Employment, 22-23, 39, 49-50 Interest rates on loans by Federal Employment cost index (ECI), 24, 51 Reserve Banks, 269 Energy prices, 3, 21-22, 24-26, 35-36, Reserve requirements, 270 48-49, 51-53 Reserves of, 272-79 Enforcement actions Depository services to federal government, Federal Reserve System, 71, 98-100 Federal Reserve Banks, 124-26 Other federal agencies, 103-7 Deposits Equal Credit Opportunity Act (ECOA), Commercial banks, 280 98-100, 104 Federal Reserve Banks, 272-79 Equal Credit Opportunity (Regulation B), Directors, Federal Reserve Banks and 104 Branches, 242, 243-58 Equal opportunity, rules regarding, 153 Disclosures, research on, 112-13 Equity markets and prices, 28, 55 Discount rates, 155-56, 269 Examinations and inspections Disposable personal income (DPI), 10-11, Anti-money laundering, 68-69 40,42 Bank holding companies, 64-65, 66 District of Columbia banks, 144 Community Reinvestment Act, Dollar exchange rate, 31-32, 36, 57 compliance with, 96-97 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

348 93rd Annual Report, 2006 Examinations and inspections—Continued Federal Housing Enterprise Oversight, Consumer protection laws, compliance Office of (OFHEO), 12, 41 with, 97-101 Federal Open Market Committee (FOMC) Edge Act and agreement corporations, Authorizations, 157-58, 159-60, 163-66 64, 67-68 Decisionmaking transparency, 38 Federal Reserve Banks, 127-28 Domestic policy directives, 159, 173, Fiduciary activities, 69 181, 189, 196-97, 203, 211, 219, Financial holding companies, 66-67 227 Foreign banks, 68 Foreign currency directives and Information technology activities, 69 procedural instructions, 160-61, International banking activities, 67-68 166-67 Securities clearing agencies, 69-70 Meetings, minutes of, 157-227 Securities credit lenders, 70 Members, alternate members, and Securities dealers and brokers, officers, 236 government and municipal, 70 Notation votes, 173, 181, 189, 197, 204, State member banks, 64, 65, 66 211,219,227 Transfer agents, 69-70 System Open Market Account, 128, Examiners, training, 84, 85, 101-2 157-58, 159-60, 161, 163-64, Expenses (See Income and expenses) 165-66, 166-67, 212 Exports, 20-21, 47-48 Federal Reserve Act, 67, 87, 127 External sector, developments in, 20-22, Federal Reserve Banks 47-49 Assessments by Board of Governors, 290-95 Fair and Accurate Credit Transactions Assets and liabilities of, 282-85, 322 Act (FACT Act), 93, 96, 110 Audits, reviews, and assessments of, Fair Credit Reporting Act (FCRA), 91, 93, 127-28, 301, 321-35, 337 96, 100 Automated clearinghouse services, 121, Fair Housing Act, 98-99, 109 125-26, 296 Fair lending laws, compliance with, 98-100 Branches of, 240-41, 243-58 Fair value option, 74, 77 Capital accounts, 282-85, 322 Federal Advisory Council, 237 Cash-management services, 126 Federal agency securities and obligations Chairmen, Conference of, 241 Commercial bank holdings, 280 Check collection and processing, Federal Reserve Bank holdings, 129, 120-21, 296 130, 268, 272-79 Condition statements, 282-85, 322 Open market transactions, 264-67 Credit outstanding, 272-79 Federal Banking Agency Audit Act, 338 Currency and coin, operations and Federal Deposit Insurance Act (FDI Act), developments in, 123-24, 296 66, 144-45, 148 Debt services for federal government, Federal Deposit Insurance Corporation 125 Improvement Act, 66 Depository services to federal Federal Financial Institutions Examination government, 124-26 Council (FFIEC), 72, 73, 82-83, 84, Deposits, 272-79 100-101, 102, 104-7, 141 Directors of, 242, 243-58 Federal funds rate, 5-6, 37-38, 159, Discount rates, 155-56, 269 172-73, 180-81, 188-89, 196-97, Electronic access to services, 126-29 203, 210-11, 218-19, 226-27 Examinations of, 127-28 Federal government Examiner training, 84, 85, 101-2 Federal Reserve Bank services to, FedLine Advantage, 126 124-26 FedLine Command, 126-27 Spending, receipts, and borrowing, FedLine Direct, 126-27 17-19, 45-46 Fedwire Funds Service, 121-22, 126 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 349 Federal Reserve Banks—Continued Federal Reserve System—Continued Fedwire Securities Service, 122, 126 Maps of, 340-41 Financial statements, combined, 321-35 Membership, 89 First Vice Presidents, Conference of, 242 Safety and soundness responsibilities, Fiscal agency services, 124-26 64-72 Government depository services, 124-26 Supervisory information technology, 83 Income and expenses of, 128-29, Supervisory policy, 73-83 286-89, 290-95, 323 Surveillance and off-site monitoring, Information technology developments, 71-72 127 Technical assistance, 72 Interest rates on loans to depository Training and staff development, 84, 85, institutions, 269 101-2 National Settlement Service, 121-22, Federal sector, developments in, 17-19, 126 45-46 Officers and employees, number and Federal tax payments, 125-26 salaries of, 297 FedLine Advantage, 126 Officers, list of, 240-41 FedLine Command, 126-27 Operations, volume of, 129, 296 FedLine Direct, 126-27 Payments services, 125 Fedwire Funds Service, 121-22, 126 Payments to U.S. Treasury, 129, 288-89 Fedwire Securities Service, 122, 126 Premises of, 129-30, 298 FFIEC (Federal Financial Institutions Presidents, Conference of, 241 Examination Council), 72, 73, 82-83, Priced services, 119-22, 131-34 84, 100-101, 102, 104-7, 141 Reserve balances, 272-79 Fiduciary activities, supervision of, 69 Salaries of officers and employees, 297 Finance Securities and loans, holdings of, 129, Business, 15-17, 44-45 130, 268, 272-79 Household, 13, 42 Statements for priced services, 131-34 Financial account, U.S., 22, 49 Statements of changes in capital, 324 Financial Accounting Standards Board Statements of condition, 282-85, 322 (FASB), 74 Statements of income, 323 Financial education, consumer, 110, Federal Reserve Board (See Board of 111-13 Governors) Financial holding companies, 64, 65, 66-67 Federal Reserve Electronic Tax Application Financial information and disclosures, (FR-ETA), 125-26 research on, 112-13 Federal Reserve Fiscal Impact Tool (FIT), Financial intermediation, 29-30, 55-56 115-16 Financial Literacy and Education Federal Reserve System (See also Board of Commission (FLEC), 112 Governors and Federal Reserve Financial markets, 5-6, 26-30, 53-56 Banks) Financial Netting Improvements Act, 148 Audits, reviews, and assessments, 301, Financial services, access to, 115 337, 338 Financial Services Regulatory Relief Act, Banking structure, U.S., regulation of, 30,66,86,87, 112, 139,212-13 84-88 Consumer-related provisions, 146 Basel Committee activities, 72, 75-77 Enforcement-related provisions, 144-46 Consumer protection responsibilities, Monetary policy provisions, 139-40 91-96 Studies and reports, 146 Decisions, public notice of, 88 Supervisory and regulatory provisions, Enforcement actions, 71 , 98-100 140-44 Hurricanes, response to, 77, 98, 101 Financial Stability Institute, 72 Information technology developments, Financial statements 127 Board of Governors, 303-19 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

350 93rd Annual Report, 2006 Financial statements—Continued Household sector, 10-13, 40-42 Federal Reserve Banks, combined, Housing and Urban Development, 321-35 Department of, complaint referrals, Federal Reserve priced services, 131-34 109 Fiscal agency services, Federal Reserve Hurricane damage and response, 45-47, 77, Banks, 124-26 98, 101 FIT (Federal Reserve Fiscal Impact Tool), 115-16 Imports, 20-22, 48-49 Float, 122, 272-79 Income and expenses Flood insurance, 100 Board of Governors, 305 FOMC (See Federal Open Market Federal Reserve Banks, 128-29, 286-89, Committee) 290-95, 323 Foreign banks, U.S. activities of, 68, 88 Federal Reserve priced services, 132 Foreign Bank Supervision Enhancement Industrial economies, 31, 32-33, 56, Act, 88 57-58 Foreign currency operations Inflation, 4-5, 24-26, 35, 36, 38-40, 52, Authorization for conduct of, 159-60, 53 165-66 Information Security Architecture Directives, 160-61, 166-67 Framework (ISAF), 127 Procedural instructions for, 161, 167 Information technology Foreign economies, 30-34, 56-59 Federal Reserve examination of, 69 Foreign operations of U.S. banking in Federal Reserve operations, 127 organizations, 67, 87-88 supporting Federal Reserve supervision, Foreign trade, 20-22, 47^9 83 Inspections (See Examinations and GDP (gross domestic product), 7, 9, inspections) 17-18, 35, 36, 37, 38, 45 Inspector General, Office of (OIG), 301, Golden West Financial Corporation, 337 acquisition, 97 Insured commercial banks (See Gold stock, 272-79 Commercial banks) Government (See Federal government and Interagency Working Group for Treasury State and local governments) Market Surveillance, 28-29 Government Accountability Office (GAO), Interest rates (See also Discount rates and 146, 301, 338 Federal funds rate), 5, 26-28, 35, 40, Government depository services, Federal 54-55, 269 Reserve Banks, 124-26 International Accounting Standard (IAS), Government Performance and Results Act 39,77 (GPRA), 135-37 International Accounting Standards Board Government Securities Act, 70 (IASB), 76-77 Government securities dealers and brokers, International Banking Act, 64, 88 examination of, 70 International banking activities, supervision Gramm-Leach-Bliley Act, 63, 66, 79, 86, 146 of, 67-68, 73, 75-77 International Banking Operations Home equity lending, 77-78 (See also (Regulation K), 75, 152 Household sector) International Monetary Fund, index of Homeland Investment Act (HIA), 22, 49 global metals prices, 48 Home Mortgage Disclosure Act (HMDA), International trade, 20-22, 47-49 91, 96, 97, 99-100, 102-3 Investment Home Mortgage Disclosure (Regulation C), Business sector, 13-15, 42-44 96, 102 Overseas, by U.S. banking organizations, Home Ownership and Equity Protection 87-88 Act (HOEPA), 91, 96, 110 Residential, 11-13, 41-42 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 351 Joint Forum, 76 Monetary aggregate (M2), 30, 56 Monetary Control Act, 119 Labor market, 22-24, 49-51 Monetary Policy Reports to the Congress Large complex banking organizations February 2007, 3-34 (LCBOs), supervision of, 65-66 July 2006, 35-59 Legislation, federal, 139-48 Monetary policy (See also Federal Open Liabilities (See Assets and liabilities) Market Committee), 3-6, 35-38 Litigation involving Board of Governors Money-laundering prevention, 68-69 Artis, 229 Mortgage interest rates, 12-13, 41 Barnes, 229 Mortgage products, nontraditional, 78, 91, Inner City Press/Community on the 93,94-95, 111-12, 154 Move, 229 Municipal securities dealers and brokers, Jones, 229 examination of, 70 Price, 229 MyMoney.gov, 112 Texas State Bank, 229 Loans, Federal Reserve Bank holdings, National Association of Realtors house 129, 130, 272-79 price index, 12, 41 Loans to Executive Officers, Directors, and National Association of Securities Dealers, Principal Shareholders of Member Inc., 104 Banks (Regulation O), 152 National City Corporation, acquisition, 97 Local governments, 19-20, 46-47 National Defense Authorization Act, 147 National Examination Database (NED), 83 Maps, Federal Reserve System, 340-41 National Flood Insurance Act, 100 Margin requirements, 281 National Flood Mitigation Fund, 100 Market risk capital rule, 73 National income and product accounts Marshall & Ilsley Corporation, acquisition, (NIPA), 11, 17, 19,45-47 97 National Information Center (NIC), 72, 83 Member banks (See also State member National Information Security Assurance banks) (NISA), 127 Assets and liabilities, 280 National Settlement Service, 121-22, 126 Examination of foreign operations, 67 NeighborWorks America, 116 Number of, 271 Nonmember banks Reserves, 277, 279 Assets and liabilities, 280 Members and officers Foreign operations, 67 Board of Governors, 233-35, 259-62 Number of, 271 Consumer Advisory Council, 238 North Fork Bancorporation, Inc., Federal Advisory Council, 237 acquisition, 97 Federal Open Market Committee, 236 Notes, Federal Reserve (See also Currency Federal Reserve Banks and Branches, and coin), 282-85 240-41 Notice of proposed rulemaking (NPR), 63, Thrift Institutions Advisory Council, 73-74 239 Membership of State Banking Institutions Office of Federal Housing Enterprise in the Federal Reserve System Oversight (OFHEO), 12, 41 (Regulation H), 100, 152 Office of Inspector General (OIG), 301, Middle East and North Africa Financial 337 Regulators' Training Initiative, 72 Oil prices (See Energy prices) Mid-Session Review, 45 Open market operations Military Personnel Financial Services Authorization for conduct of, 157-58, Protection Act, 147-48 163-64 Model Tribal Secured Transactions Act Volume of transactions, 264-67 (MTA), 115 Operation HOPE, 116-17 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

352 93rd Annual Report, 2006 Operations, volume of, Federal Reserve Regions Financial Corporation, acquisition, Banks, 129, 296 97 Outreach activities, 111, 115-17 Regulations B, Equal Credit Opportunity, 104 Paper Check Conversion, Treasury C, Home Mortgage Disclosure, 96, 102 Department program, 126 D, Reserve Requirements of Depository Pay.gov, 126 Institutions, 151 Payments services, Federal Reserve Banks, E, Electronic Fund Transfers, 91, 92, 125 104-5, 109, 151 Payments System Risk, Federal Reserve H, Membership of State Banking policy, 29, 122 Institutions in the Federal Reserve Payments to U.S. Treasury, Federal Reserve System, 100, 152 Banks, 129, 288-89 K, International Banking Operations, 75, Payroll card accounts, 92 152 PCE (personal consumption expenditures), M, Consumer Leasing, 105 9, 10, 24-25, 38-39, 51-53 O, Loans to Executive Officers, Performance Report Information and Directors, and Principal Surveillance Monitoring (PRISM), 72 Shareholders of Member Banks, Policy actions 152 Board of Governors, 151-56 P, Privacy of Consumer Financial Federal Open Market Committee, Information, 105 157-227 U, Credit by Banks and Persons other Premises, Federal Reserve Banks, 129-30, than Brokers or Dealers for the 298 Purpose of Purchasing or Carrying Presidential $1 Coin Act, 123 Margin Stock, 70, 89, 281 Priced services, Federal Reserve Banks, Y, Bank Holding Companies and Change 119-22, 131-34 in Bank Control, 152-53 Prices Z, Truth in Lending, 96, 105-6, 109-10 Consumer, 3, 24-26, 35, 51-53 AA, Unfair or Deceptive Acts or Energy, 3, 21-22, 24-26, 35-36, 48^9, Practices, 106 51-53 BB, Community Reinvestment, 153 Equity, 28, 55 CC, Availability of Funds and Collection Exports and imports, 21-22, 48^t9 of Checks, 106-7 PricewaterhouseCoopers LLP, 128, 321 DD, Truth in Savings, 107 Primary credit rate, 155, 269 Reports of Condition and Income (Call PRISM (Performance Report Information Reports), 71-72, 82, 143 and Surveillance Monitoring), 72 Republic Bancshares of Texas, Inc., Privacy of Consumer Financial Information acquisition, 97 (Regulation P), 105 Reserve requirements, depository Private-sector adjustment factor (PSAF), institutions, 270 119, 134 Reserve Requirements of Depository Productivity, 23-24, 50-51 Institutions (Regulation D), 151 Profits, corporate, 15-17, 44-45 Residential investment, 11-13, 41-42 Project Management Book of Knowledge, Returned-item fees, 92 127 Revenue (See Income and expenses) Public notice, Federal Reserve decisions, Riegle Community Development and 88 Regulatory Improvement Act, 66 Risk-focused supervision, Federal Reserve Real estate System, 65-66 Appraisals, 77 Risk management, 65-66, 77-79, 80-81, Lending, 78, 80-81, 154 154 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 353 Salaries, Federal Reserve Bank officers Surveillance and off-site monitoring, and employees, 297 71-72 Sarbanes-Oxley Act (SOX), 127-28 Suspicious Activity Reports (SARs), 75 Secondary and seasonal credit rates, 155, Swaps, 159, 165 269 System Open Market Account (SOMA) Securities (See also Federal agency (See Federal Open Market Committee securities and obligations and and Open market operations) Treasury securities) System supervisory information technology Banks' activities, 79 (SSIT), 83 Clearing agencies, examination of, 69-70 System to Estimate Examination Ratings Credit lenders, examination of, 70 (SEER), 71 Government and municipal, examination of dealers and brokers, 70 Tax collection, electronic, 125-26 Transfer agents, 69-70 Technical assistance to foreign banking Securities credit, 70, 89, 281 authorities, 72 Securities Exchange Act, 69, 70, 79, 89 Technology Project Standards (TPS), 127 SEER (System to Estimate Examination Thrift Institutions Advisory Council, 239 Ratings), 71 Trade, international, 20-22, 47-49 Senior Loan Officer Opinion Survey on Training and development, Federal Reserve Bank Lending Practices, 16 staff, 84, 85, 101-2 Small bank holding company threshold, 79 Transfer agents, examination of, 69-70 Sound Practices concerning Elevated Risk Treasury, U.S. Department of the Complex Structured Finance Cash holdings, 272-79 Activities, interagency statement, 154 Currency outstanding, 272-79 Special drawing rights certificate account, Paper Check Conversion and Electronic 272-79 Check Processing programs, 126 SSIT (See System supervisory information Payments to, by Federal Reserve Banks, technology) 129, 288-89 Staff development, Federal Reserve, 84, 85, Services provided to, by Federal Reserve 101-2 Banks, 124-26 State and local governments, 19-20, 46-47 Treasury securities State member banks (See also Member Commercial bank holdings, 280 banks) Federal Reserve Bank holdings, 129, Assets and liabilities, 65 130, 268, 272-79 Complaints against, 107-9 Open market transactions, 264-67 D.C.-chartered banks, 144 Treasury Tax and Loan (TT&L) program, Examinations of, 64, 65, 66 126 Fair lending violations, 98-99 Trustmark Corporation, acquisition, 97 Financial disclosures, 88-89 Truth in Lending Act (TILA), 109-10, 147 Number of, 65, 271 Truth in Lending (Regulation Z), 96, Surveillance and off-site monitoring of, 105-6, 109-10 71-72 Truth in Savings (Regulation DD), 107 Stocks Margin requirements, 281 Unemployment, 7, 22-23, 38, 49-50 Price indexes, 28 55 Unfair or Deceptive Acts or Practices Supervision and regulation responsibilities, (Regulation AA), 106 Federal Reserve System, 63-89, Uniform Bank Performance Reports, 72 96-107 Unlawful Internet Gambling Enforcement Supervision and Regulation Statistical Act, 146-47 Assessment of Bank Risk (SR-SABR), Unregulated practices, state member banks, 71-72 108-9 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

354 93rd Annual Report, 2006 Unsafe and Unsound Use of Limitation of Wachovia Corporation, acquisition, 97 Liability Provisions in External Audit West Texas intermediate crude oil prices, Engagement Letters, interagency 21, 48 advisory, 75, 153 0607 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis