Annual Report of the Federal Reserve Board, 2007

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

Letter of Transmittal Board of Governors of the Federal Reserve System Washington, D.C. April 2008 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-fourth annual report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 2007. 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 1,860. 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 OVERVIEW: MONETARY POLICY AND THE ECONOMIC OUTLOOK 7 RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 8 The Household Sector 16 The Business Sector 19 The Government Sector 22 National Saving 22 The External Sector 25 The Labor Market 27 Prices 28 Financial Markets 39 International Developments 43 MONETARY POLICY IN 2007 AND EARLY 2008 49 SUMMARY OF ECONOMIC PROJECTIONS 49 The Outlook 52 Risks to the Outlook 53 Diversity of Participants' Views 57 MONETARY POLICY REPORT OF JULY 2007 57 Monetary Policy and the Economic Outlook 62 Economic and Financial Developments in 2007 Federal Reserve Operations 85 BANKING SUPERVISION AND REGULATION 86 Scope of Responsibilities for Supervision and Regulation 86 Supervision for Safety and Soundness 95 Supervisory Policy 105 Supervisory Information Technology 106 Staff Development 107 Regulation of the U.S. Banking Structure 111 Enforcement of Other Laws and Regulations 111 Federal Reserve Membership 113 CONSUMER AND COMMUNITY AFFAIRS 113 Mortgage Credit 121 Credit Cards 123 Other Regulatory Actions 125 Other Supervisory Activities Related to Compliance with Consumer Protection and Community Reinvestment Laws 138 Consumer Complaints 140 Responding to Community Economic Development Needs in Historically Underserved Markets 143 Advice from the Consumer Advisory Council Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

151 FEDERAL RESERVE BANKS 151 Developments in Federal Reserve Priced Services 155 Developments in Currency and Coin 155 Developments in Fiscal Agency and Government Depository Services 158 Electronic Access to Reserve Bank Services 159 Information Technology 159 Examinations of the Federal Reserve Banks 160 Income and Expenses 161 Holdings of Securities and Loans 162 Volume of Operations 162 Federal Reserve Law Enforcement 162 Federal Reserve Bank Premises 164 Pro Forma Financial Statements for Federal Reserve Priced Services 169 THE BOARD OF GOVERNORS AND THE GOVERNMENT PERFORMANCE AND RESULTS ACT 169 Strategic Plan, Performance Plan, and Performance Report 169 Mission 169 Goals and Objectives Records 175 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS 175 Regulation A (Extensions of Credit by Federal Reserve Banks) 175 Regulation B (Equal Credit Opportunity), Regulation E (Electronic Fund Transfers), Regulation M (Consumer Leasing), Regulation Z (Truth in Lending), Regulation DD (Truth in Savings) 175 Regulation D (Reserve Requirements of Depository Institutions) 176 Regulation E (Electronic Fund Transfers) 176 Regulation H (Membership of State Banking Institutions in the Federal Reserve System), Regulation K (International Banking Operations) 176 Regulation H (Membership of State Banking Institutions in the Federal Reserve System), Regulation Y (Bank Holding Companies and Change in Bank Control) 177 Regulation L (Management Official Interlocks) 177 Regulation O (Loans to Executive Officers, Directors, and Principal Shareholders of Member Banks) 177 Regulation R (Exceptions for Banks from the Definition of Broker in the Securities Exchange Act of 1934) 178 Regulation V (Fair Credit Reporting) 178 Policy Statements and Other Actions 180 Discount Rates in 2007 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

183 MINUTES OF FEDERAL OPEN MARKET COMMITTEE MEETINGS 184 Meeting Held on January 30-31, 2007 197 Meeting Held on March 20-21, 2007 205 Meeting Held on May 9, 2007 213 Meeting Held on June 27-28, 2007 222 Meeting Held on August 7, 2007 230 Meeting Held on September 18, 2007 241 Meeting Held on October 30-31, 2007 259 Meeting Held on December 11, 2007 271 LITIGATION Federal Reserve System Organization 275 BOARD OF GOVERNORS 278 FEDERAL OPEN MARKET COMMITTEE 279 ADVISORY COUNCILS TO THE BOARD OF GOVERNORS 279 Federal Advisory Council 280 Consumer Advisory Council 281 Thrift Institutions Advisory Council 282 FEDERAL RESERVE BANKS AND BRANCHES 282 Officers of the Banks and Branches 283 Conference of Chairmen 283 Conference of Presidents 284 Conference of First Vice Presidents 284 Directors of the Banks and Branches 301 MEMBERS OF THE BOARD OF GOVERNORS, 1913-2007 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 306 1. Federal Reserve Open Market Transactions, 2007 310 2. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2005-2007 311 3. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2007 312 4. Reserve Requirements of Depository Institutions, December 31, 2007 313 5. Banking Offices and Banks Affiliated with Bank Holding Companies in the United States, December 31, 2006 and 2007 314 6. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items A. Year-End 1984-2007 and Month-End 2007 B. Year-End 1918-1983 322 7. Principal Assets and Liabilities of Insured Commercial Banks, by Class of Bank, June 30, 2007 and 2006 323 8. Initial Margin Requirements under Regulations T, U, and X 324 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2007 and 2006 328 10. Income and Expenses of the Federal Reserve Banks, by Bank, 2007 332 11. Income and Expenses of the Federal Reserve Banks, 1914-2007 338 12. Operations in Principal Departments of the Federal Reserve Banks, 2004-2007 339 13. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2007 340 14. Acquisition Costs and Net Book Value of the Premises of the Federal Reserve Banks and Branches, December 31, 2007 Federal Reserve System Audits 343 AUDITS OF THE FEDERAL RESERVE SYSTEM 345 BOARD OF GOVERNORS FINANCIAL STATEMENTS 357 FEDERAL RESERVE BANKS COMBINED FINANCIAL STATEMENTS 375 OFFICE OF INSPECTOR GENERAL ACTIVITIES 376 GOVERNMENT ACCOUNTABILITY OFFICE REVIEWS 378 MAPS OF THE FEDERAL RESERVE SYSTEM 383 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

Parti Overview: Monetary Policy and the Economic Outlook The U.S. economy has weakened con- anchored, energy and other commodity siderably since last July, when the Fed- prices expected to flatten out, and preseral Reserve Board submitted its previ- sures on resources likely to ease, monous Monetary Policy Report to the etary policy makers generally have ex- Congress. Substantial strains have pected inflation to moderate somewhat emerged in financial markets here and in 2008 and 2009. Under these circumabroad, and housing-related activity has stances, the Federal Reserve has eased continued to contract. Also, further in- the stance of monetary policy substancreases in the prices of crude oil and tially since July. some other commodities have eroded The turmoil in financial markets that the real incomes of U.S. households and emerged last summer was triggered by a added to business costs. Overall eco- sharp increase in delinquencies and denomic activity held up reasonably well faults on subprime mortgages. That ininto the autumn despite these adverse crease substantially impaired the funcdevelopments, but it decelerated sharply tioning of the secondary markets for in the fourth quarter. Moreover, the out- subprime and nontraditional residential look for 2008 has become less favorable mortgages, which in turn contributed to since last summer, and considerable a reduction in the availability of such downside risks to economic activity mortgages to households. Partly as a rehave emerged. Headline consumer price sult of these developments as well as inflation picked up in 2007 as a result of continuing concerns about prospects for sizable increases in energy and food house prices, the demand for housing prices, while core inflation (which ex- dropped further. In response to weak decludes the direct effects of movements mand and high inventories of unsold in energy and food prices) was, on bal- homes, homebuilders continued to cut ance, a little lower than in 2006. None- the pace of new construction in the sectheless, with inflation expectations an- ond half of 2007, pushing the level of ticipated to remain reasonably well single-family starts in the fourth quarter more than 50 percent below the high reached in the first quarter of 2006. NOTE: The discussion here and in the next three After midyear, as losses on subprime parts consists of the text, tables, and selected mortgages and related structured investcharts from the Monetary Policy Report submitted ment products continued to mount, into the Congress on February 27, 2008, pursuant to vestors became increasingly skeptical section 2B of the Federal Reserve Act. The complete set of charts is available on the Board's web- about the likely credit performance of site, at www.federalreserve.gov/boarddocs/hh. even highly rated securities backed by Other materials in this annual report related to such mortgages. The loss of confidence the conduct of monetary policy include the minreduced investors' overall willingness to utes of the 2007 meetings of the Federal Open bear risk and caused them to reassess Market Committee (see the "Records" section) and statistical tables 1-4 (at the back of this report). the soundness of the structures of other Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

94th Annual Report, 2007 financial products. That reassessment indicators of business investment have was accompanied by high volatility and become less favorable recently. Howdiminished liquidity in a number of fi- ever, continued expansion of foreign nancial markets here and abroad. The economic activity and a lower dollar pressures in financial markets were rein- kept U.S. exports on a marked uptrend forced by banks' concerns about actual through the second half of last year, proand potential credit losses. In addition, viding some offset to the slowing in dobanks recognized that they might need mestic demand. to take a large volume of assets onto Overall consumer price inflation, as their balance sheets—including lever- measured by the price index for peraged loans, some types of mortgages, sonal consumption expenditures (PCE), and assets relating to asset-backed com- stepped up to 3V2 percent over the four mercial paper programs—given their ex- quarters of 2007 because of the sharp isting commitments to customers and increase in energy prices and the largest the increased resistance of investors to rise in food prices in nearly two depurchasing some securitized products. In cades. Core PCE price inflation picked response to those unexpected strains, up somewhat in the second half of last banks became more conservative in de- year, but the increase came on the heels ploying their liquidity and balance sheet of some unusually low readings in the capacity, leading to tighter credit condi- first half; core PCE price inflation over tions for some businesses and house- 2007 as a whole averaged slightly more holds. The combination of a more than 2 percent, a little less than in 2006. negative economic outlook and a re- The Federal Reserve has taken a numassessment of risk by investors precipi- ber of steps since midsummer to address tated a steep fall in Treasury yields, a strains in short-term funding markets substantial widening of spreads on both and to foster its macroeconomic objecinvestment-grade and speculative-grade tives of maximum employment and corporate bonds, and a sizable net de- price stability. With regard to short-term cline in equity prices. funding markets, the Federal Reserve's Initially, the spillover from the prob- initial actions when market turbulence lems in the housing and financial mar- emerged in August included unusually kets to other sectors of the economy was large open market operations as well as limited. Indeed, in the third quarter, real adjustments to the discount rate and to gross domestic product (GDP) rose at an procedures for discount window borannual rate of nearly 5 percent, in part rowing and securities lending. As presbecause of solid gains in consumer sures intensified near the end of the year, spending, business investment, and ex- the Federal Reserve established a Term ports. In the fourth quarter, however, Auction Facility to supply short-term real GDP increased only slightly, and credit to sound banks against a wide vathe economy seems to have entered riety of collateral; in addition, it entered 2008 with little momentum. In the labor into currency swap arrangements with market, growth in private-sector pay- two other central banks to increase the rolls slowed markedly in late 2007 and availability of term dollar funds in their January 2008. The sluggish pace of hir- jurisdictions. With regard to monetary ing, along with higher energy prices, policy, the Federal Open Market Comlower equity prices, and softening home mittee (FOMC) cut the target for the values, has weighed on consumer senti- federal funds rate 50 basis points at its ment and spending of late. In addition, September meeting to address the poten- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy and the Economic Outlook tial downside risks to the broader minutes of the January FOMC meeting economy from the ongoing disruptions and are reproduced in part 4 of this rein financial markets. The Committee re- port. Economic activity was expected to duced the target 25 basis points at its remain soft in the near term but to pick October meeting and did so again at the up later this year—supported by mon- December meeting. In the weeks follow- etary and fiscal stimulus—and to be exing that meeting, the economic outlook panding at a pace around or a bit above deteriorated further, and downside risks its long-run trend by 2010. Total inflato growth intensified; the FOMC cut an tion was expected to be lower in 2008 additional 125 basis points from the tar- than in 2007 and to edge down further in get in January—75 basis points on Janu- 2009. However, FOMC participants ary 22 and 50 basis points at its regularly (Board members and Reserve Bank scheduled meeting on January 29-30. presidents) indicated that considerable Since the previous Monetary Policy uncertainty surrounded the outlook for Report, the FOMC has announced new economic growth and that they saw the communications procedures, which in- risks around that outlook as skewed to clude publishing enhanced economic the downside. In contrast, most participrojections on a timelier basis. The most pants saw the risks surrounding the forerecent projections were released with the casts for inflation as roughly balanced. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Part 2 Recent Economic and Financial Developments Although the U.S. economy had gener- Change in Real GDP, 2001-07 ally performed well in the first half of 2007, the economic landscape was sub- Percent, annual rate sequently reshaped by the emergence of substantial strains in financial markets — 5 in the United States and abroad, the intensifying downturn in the housing market, and higher prices for crude oil and some other commodities. Rising delinquencies on subprime mortgages led to large losses on related structured credit — 2 products, sparking concerns about the structures of other financial products — 1 and reducing investors' appetite for risk. The resulting dislocations generated unanticipated pressures on bank balance 2001 2003 2005 2007 sheets, and those pressures combined NOTE: Here and in subsequent figures, except as with uncertainty about the size and dis- noted, change for a given period is measured to its final tribution of credit losses to impair short- quarter from the final quarter of the preceding period. SOURCE: Department of Commerce, Bureau of Ecoterm funding markets. Consequently, the nomic Analysis. Federal Reserve and other central banks economy seems to have entered 2008 intervened to support liquidity and funcwith little forward momentum. In part tioning in those markets. Amid a detebecause of tighter credit conditions for riorating economic outlook, and with households and businesses, the housing downside risks increasing, Treasury correction has deepened, and capital yields declined markedly, and the Fedspending has softened. In addition, a eral Open Market Committee cut the number of factors, including steep infederal funds rate substantially. Meancreases in energy prices, lower equity while, risk spreads in a wide variety of prices, and softening home values, have credit markets increased considerably, started to weigh on consumer outlays. In and equity prices tumbled. the labor market, private hiring slowed The financial turmoil did not appear sharply in late 2007 and January 2008. to leave much of a mark on overall eco- The increase in the price index for total nomic activity in the third quarter. Real personal consumption expenditures GDP rose at an annual rate of nearly (PCE) picked up to 3Vi percent in 2007 5 percent, as solid gains in consumer as a result of sizable increases in food spending, business investment, and ex- and energy prices. Core PCE inflation, ports more than offset the continuing though uneven over the course of the drag from residential investment. In the year, averaged a bit more than 2 percent fourth quarter, however, economic activ- during 2007 as a whole, a little less than ity decelerated significantly, and the the increase posted in 2006. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

8 94th Annual Report, 2007 Change in the Chain-Type Price Index Private Housing Starts, 1994-2007 for Personal Consumption Expenditures, 2001 —07 Millions of units, annual rate • Total — 1.6 Single-family H Excluding food and energy — 4 — 1.2 II Multifamily — .4 — 1 ] I I i 1 I I i 1995 1999 2003 2007 NOTE: The data are quarterly and extend through 2001 2003 2005 2007 2007 :Q4. SOURCE: Department of Commerce, Bureau of the SOURCE: Department of Commerce, Bureau of Eco- Census. nomic Analysis. many homebuyers apparently expected The Household Sector that home prices would continue to rise briskly into the indefinite future, thereby Residential Investment and Finance adding a speculative element to the market. In addition, toward the end of the Economic activity in the past two years boom, housing demand was supported has been restrained by the ongoing con- by an upsurge in nonprime mortgage traction in the housing sector, and that lending—in many cases fed by lax lendrestraint intensified in the second half of ing standards.1 By the middle of the de- 2007. Home sales and prices softened cade, house prices had reached very significantly further, and homebuilders high levels in many parts of the United curtailed new construction in response States, and housing was becoming proto weak demand and elevated invento- gressively less affordable. Declining afries. In all, the decline in residential in- fordability and waning optimism about vestment reduced the annual growth rate future house price appreciation apparof real GDP in the second half of 2007 ently started to weigh on the demand for by more than 1 percentage point, and housing, thereby causing sales to fall the further drop in housing starts around and the supply of unsold homes to the turn of the year suggests that the ratchet up relative to the pace of sales. drag on the growth of real GDP remains substantial in early 2008. 1. Nonprime mortgages comprise subprime and The downturn in housing activity folnear-prime loans and accounted for about onelowed a multi-year period of soaring fourth of all home-purchase mortgages in 2006. home sales and construction and rapidly Near-prime mortgages are generally less risky than escalating home prices. The earlier subprime mortgages but riskier than prime mortgages; they may require limited or no borrower strength in housing reflected a number documentation, have nontraditional amortization of factors. One was a low level of global structures or high loan-to-value ratios, or be made real interest rates. Another was that on investment properties. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments Change in Prices of Existing Single-Family for new homes, the constant-quality in- Houses, 1988-2007 dex of new home prices fell 2lA percent over the four quarters of 2007. Moreover, many large homebuilders reportedly have been using not only price dis- S&P/Case-Shilleri counts but also nonprice incentives (for ten-city index example, paying closing costs and including optional upgrades at no cost) in an effort to bolster sales of new homes and reduce inventories. In all, the pace of sales of existing homes fell 30 percent between mid-2005 and the fourth quarter of 2007, and sales of new homes dropped by half. Builders cut production in response to the downshift in demand; by the fourth quarter of 1 i I I i 1 II 1 1 M > 1 1 II I li 2007, starts of single-family homes had 1989 1992 1995 1998 2001 2004 2007 fallen to an annual rate of just 826,000 NOTE: The data are quarterly and extend through units—less than half the quarterly high 2007:Q4; changes are from one year earlier. For the years preceding 1991, the repeat-transactions index reached in early 2006. Nonetheless, the includes appraisals associated with mortgage ongoing declines in sales prevented refinancings; beginning in 1991, it includes purchase transactions only. The S&P/Case-Shiller index reflects builders from making much progress in all arm's-length sales transactions in the metropolitan paring their bloated inventories of areas of Boston. Chicago, Denver, Las Vegas, Los homes. In fact, although the number of Angeles. Miami, New York, San Diego, San Francisco, and Washington, D.C. unsold new homes has decreased, on SOURCE: For repeat transactions, Office of Federal net, since the middle of 2006, invento- Housing Enterprise Oversight: for S&P/Case-Shiller, Chicago Mercantile Exchange. ries have climbed sharply relative to sales. Measured relative to the average Against this backdrop, prices began to pace of sales over the three months enddecelerate, further damping expectations ing in December, the months' supply of of future price increases and exacerbat- unsold new homes at the end of Deceming the downward pressure on demand. ber stood at nine months, more than House prices decelerated dramatically twice the upper end of the narrow range in 2006 and softened further in 2007. In that had prevailed from 1997 to midmany areas of the nation, existing home 2005. prices fell noticeably last year. For the The contraction in housing demand nation as a whole, the OFHEO price and construction was exacerbated in the index declined in the second half of the second half of 2007 by the near eliminayear after rising modestly in the first tion of nonprime mortgage originations half; that measure had risen 4 percent in and a tightening of lending standards on 2006 and about 9Vi percent in each of all types of mortgages. Indeed, large the two years before that.2 In the market fractions of banks that responded to the Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending Prac- 2. The index is the seasonally adjusted tices reported that they had tightened purchase-only version of the repeat-transactions lending standards over this period. price index for existing single-family homes pub- Nonetheless, interest rates on prime conlished by the Office of Federal Housing Enterprise Oversight. forming mortgages have declined on Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

10 94th Annual Report, 2007 net: Rates on conforming thirty-year 2006, a historically large fraction had fixed-rate loans dropped from about high loan-to-value ratios, which were 63/4 percent last summer to just above often boosted by the addition of an asso- 6 percent at year-end. This year they ciated junior lien or "piggyback" mortdipped as low as 5Vi percent but have gage. When house prices decelerated, recently moved back up to about 6 per- borrowers with high loan-to-value ratios cent, within the range that prevailed for on their loans were unable to build eqmuch of the 2003-05 period.3 Rates on uity in their homes, making refinancing conforming adjustable-rate loans have more difficult, and also faced the prosalso fallen significantly over the past pect of significantly higher mortgage several months and now stand at their payments after the initial rates on the lowest level since the end of 2005. Of- loans reset. fered rates on fixed-rate jumbo loans, Subprime ARMs account for about which ran up in the second half of 2007, 7 percent of all first-lien mortgages outhave recently declined somewhat, on standing. Delinquency rates on subprime net.4 Even so, spreads between rates of- ARMs began to increase in 2006, and fered on these loans and conforming by December 2007, more than one-fifth loans remain unusually wide. of these loans were seriously delinquent The softness in home prices has (that is, ninety days or more delinquent played an important role in the ongoing or in foreclosure). Moreover, an increasdeterioration in the credit quality of ing fraction of subprime ARMs in the subprime mortgages. The deterioration past few years have become seriously was rooted in poor underwriting delinquent soon after they were origistandards—and, in some cases, fraudu- nated and often well before the initial lent and abusive lending practices— rate was due to reset.5 For subprime which were based in part on the assump- ARMs originated in 2006, about 10 pertion that house prices would continue to cent had defaulted in the first twelve rise rapidly for some time to come. months, more than double the fraction Many borrowers with weak credit histo- for mortgages originated in earlier years. ries took out adjustable-rate mortgages Furthermore, the path of the default rate (subprime ARMs) with low initial rates; for subprime ARMs originated in 2007 of those loans originated in 2005 and has run even higher. For subprime mortgages with fixed interest rates, delinquency rates have moved up signifi- 3. Conforming mortgages are those eligible for cantly in recent months, to the upper purchase by Fannie Mae and Freddie Mac; they end of their historical range. must be equivalent in risk to a prime mortgage For mortgages made to higher-quality with an 80 percent loan-to-value ratio, and they borrowers (prime and near-prime mortcannot exceed the conforming loan limit. The Economic Stimulus Act of 2008, signed into law on gages), performance weakened some- February 13, retroactively raised the conforming what in 2007, but it generally remains loan limit for a first mortgage on a single-family home in the contiguous United States from $417,000 to 125 percent of the median house price 5. The initial low-rate period for most subprime in an area, with an overall cap of $729,750. The ARMs originated in the period from 2005 to 2007 new conforming limit will be in effect through the was twenty-four months. Roughly l!/2 million end of 2008. subprime ARMs are scheduled to undergo their 4. Jumbo mortgages are those that exceed the first rate reset in 2008. Even with the recent demaximum size of a conforming loan; they are typi- clines in market interest rates, a notable fraction of cally extended to borrowers with relatively strong those subprime ARMs are scheduled to reset to a credit histories. higher interest rate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 11 Mortgage Delinquency Rates, 2001-07 has declined considerably. Such loans are typically made to higher-quality bor- Percent rowers but have nontraditional amortiza- Subprime tion structures or other nonstandard fea- — 24 tures. Some of the loans are categorized — /— 20 as prime or near prime and others as — / — 16 subprime. The rate of serious delin- / — |2 Adjustable rate *J quency on loans with adjustable rates in -c : alt-A pools currently stands at almost Fixed rate 6 percent, far above the rates of less t i ll 1 1 1! I 1 than 1 percent seen as recently as early 2006. The rate of serious delinquency on fixed-rate alt-A loans has also in- Prime and near prime — 8 creased in recent months. The continued erosion in the quality of mortgage credit has led to a rising 4 number of initial foreclosure filings; in- Adjustable rate Fixed rate J— 2 deed, such filings were made at a record 0 pace in the third quarter of 2007. Fore- 1 1 II 1 1 1 I 1 1 closures averaged about 360,000 per quarter over the first three quarters of 2007, compared with a rate of about Alt-A pools 8 235,000 in the corresponding quarters of 2006. As was the case in 2006, more 6 Adjustable rate/ than half of the foreclosure filings in 4 2007 were subprime mortgages despite Fixed rate 2 the relatively smaller share of such loans 0 in total mortgages outstanding. In some 1 1 1 1 I 1 I II cases, falling prices may have tempted 2001 2003 2005 2007 more-speculative buyers with little or no NOTE: The data are monthly. For subprime, prime, equity to walk away from their properand near-prime mortgages, the data extend through ties. Foreclosures have risen most in ar- December 2007; for mortgages in alt-A pools, which are eas where home prices have been falling a mix of prime, near-prime, and subprime mortgages, the data extend through November 2007. For further after a period of rapid increase; foreclodetails on the loans included in alt-A pools, refer to text. sures also have mounted in some re- Delinquency rate is the percent of loans ninety days or more past due or in foreclosure. gions where economic growth has been SOURCE: First American LoanPerformance. below the national average. Avoiding foreclosure—even if it involves granting concessions to the fairly solid. Although the rate of serious borrower—can be an important lossdelinquency on ARMs has moved up, mitigation strategy for financial instituthat on fixed-rate loans has stayed low. tions. To limit the number of delin- Serious delinquencies on jumbo mort- quencies and foreclosures, financial gages—which often carry adjustable institutions can use a variety of aprates—have crept up slightly from very proaches, including renegotiating the low levels. timing and size of rate resets. A compli- The credit quality of loans that were cation in implementing such approaches securitized in pools marketed as t4alt-A" is that the loans have often been pack- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

12 94th Annual Report, 2007 aged and sold in securitized pools that debt to an annual rate of about 7 V2 perare owned by a dispersed group of in- cent over the first three quarters of 2007, vestors, which makes the task of coordi- down from MVA percent in 2006. nating renegotiation among all affected Growth likely slowed further in the parties difficult. In part to address the fourth quarter. challenges in modifying securitized loans, counselors, servicers, investors, Consumer Spending and Household and other mortgage market participants Finance joined in a collaborative effort, called the Hope Now Alliance, to facilitate Consumer spending held up reasonably cross-industry solutions to the problem.6 well in the second half of 2007, though Separately, the Federal Reserve has di- it moderated some in the fourth quarter. rectly responded in a number of ways to Spending continued to be buoyed by the problems with mortgage credit qual- solid gains in aggregate wages and salaity (described in the box entitled "The ries as well as by the lagged effects of Federal Reserve's Responses to the the increases in household wealth in Subprime Mortgage Crisis"). 2005 and 2006. However, other influ- Most commercial banks responding to ences on spending have become less fathe Federal Reserve's January 2008 Se- vorable. Job gains have slowed lately, nior Loan Officer Opinion Survey indi- household wealth has been damped by cated that loan-by-loan modifications the softening in home prices as well as based on individual borrowers' circum- by recent declines in equity values, and stances were an important part of their consumers' purchasing power has been loss-mitigation strategies. Almost two- sapped by sharply higher energy prices. thirds of respondents indicated that they Moreover, consumer sentiment has would consider refinancing the loans of fallen appreciably, and although contheir troubled borrowers into other mort- sumer credit has remained available to gage products at their banks. About onethird of respondents said that streamlined modifications of the sort proposed Change in Real Income and Consumption, by the Hope Now Alliance were impor- 2001-07 tant to their strategies for limiting losses. Percent, annual rate All of the factors discussed above— the drop in home sales, softer house • Disposable personal income prices, and tighter lending standards (es- II Personal consumption — 5 expenditures pecially for subprime and alternative mortgage products)—combined to reduce the growth of household mortgage — 3 6. The Hope Now Alliance (www.hopenow. com) aims to increase outreach efforts to contact — 2 at-risk borrowers and to play an important role in streamlining the process for refinancing and modi- — 1 fying subprime ARMs. The alliance will work to ,[ expand the capacity of an existing national neti 1 1 1 J_J work to counsel borrowers and refer them to par- 2001 2003 2005 2007 ticipating servicers, who have agreed to work toward cross-industry solutions to better serve the SOURCE: Department of Commerce, Bureau of Ecohomeowner. nomic Analysis. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 13 most borrowers, credit standards for although they weakened late in the year. many types of loans have been The aggregate net worth of households tightened. rose modestly through the third quarter, Real personal consumption expendi- as increases in equity values more than tures (PCE) increased at an annual rate offset the effect of softening home of 23/4 percent in the third quarter, a little prices. However, preliminary data sugabove the average pace during the first gest that the value of household wealth half of the year; in the fourth quarter, fell in the fourth quarter, and as a result PCE growth slowed to 2 percent. With the ratio of household wealth to disposthe notable exception of outlays for new able income—a key influence on conlight motor vehicles (cars, sport-utility sumer spending—ended the year well vehicles, and pickup trucks)—which below its level at the end of 2006. Nonewere well maintained through year- theless, because changes in net worth end—the deceleration in spending in the tend to influence consumption with a fourth quarter was widespread. PCE ap- lag, the increases in wealth during 2005 pears to have entered 2008 on a weak and 2006 likely helped sustain spending trajectory, as sales of light vehicles in 2007. In the fourth quarter, the persagged in January and spending on other sonal saving rate was just a shade above goods was soft. zero, about in line with its average value Growth in real disposable personal since 2005. income—that is, after-tax income ad- Overall household debt increased at justed for inflation—was sluggish in the an annual rate of about 1XA percent second half of 2007. Although aggre- through the third quarter of 2007, a nogate wages and salaries rose fairly table deceleration from the 10V4 percent briskly in nominal terms over that pe- pace in 2006; household debt likely riod, the purchasing power of the nomi- slowed further in the fourth quarter. Benal gain was eroded by the energy- cause the growth of household debt driven upturn in consumer price about matched the growth in nominal inflation in the fall. Indeed, for many disposable personal income through the workers, increases in real wages over third quarter, and net changes in interest 2007 as a whole were modest, once rates on mortgage debt to that point again falling short of the rise in aggre- were small, the ratio of financial obligagate labor productivity. For example, av- tions to disposable personal income was erage hourly earnings, a measure of about flat. wages for production or nonsupervisory Consumer (nonmortgage) borrowing workers, increased only Vi percent over picked up a bit in 2007 to 5Vi percent, the four quarters of 2007 after account- perhaps reflecting some substitution of ing for the rise in the overall PCE price consumer credit for mortgage debt. The index. Moreover, for some workers, real pickup in consumer debt was mostly atwages actually declined: Real average tributable to faster growth in revolving hourly earnings in manufacturing edged credit, a pattern consistent with the redown about 3A percent last year, while sults of the Federal Reserve's Senior for retail trade—an industry that typ- Loan Officer Opinion Survey. Banks, on ically pays relatively low wages—this net, reported easing lending standards measure of real wages fell about on credit cards over the first half of 2007 2 percent. and reported little change in those stan- On the whole, household balance dards on net over the second half of the sheets remained in good shape in 2007, year. In contrast, significant fractions of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

14 94th Annual Report 2007 The Federal Reserve's Responses to the Subprime Mortgage Crisis The sharp increases in subprime mortgage homeowners avoid foreclosure. Staff loan delinquencies and foreclosures over members throughout the Federal Reserve the past year have created personal, eco- System are working to identify localities nomic, and social distress for many home- that are likely to experience the highest owners and communities. The Federal Re- rates of foreclosure; the resulting inforserve has taken a number of actions that mation is helping local groups to better directly respond to these problems. Some focus their borrower outreach efforts. In of the efforts are intended to help distressed addition, the Federal Reserve actively subprime borrowers and limit preventable supports NeighborWorks America, a naforeclosures, and others are aimed at reduc- tional nonprofit organization that has ing the likelihood of such problems in the been helping thousands of mortgage borfuture. rowers facing current or potential dis- Home losses through foreclosure can be tress. Federal Reserve staff members have reduced if financial institutions work with worked closely with this organization and borrowers who are having difficulty meet- its local affiliates on an array of forecloing their mortgage payment obligations. sure prevention efforts, and a member of Foreclosure cannot always be avoided, but the Federal Reserve Board serves on its in many cases prudent loss-mitigation tech- board of directors. Other contributions inniques that preserve homeownership are clude efforts by Reserve Banks to conless costly to lenders than foreclosure. In vene workshops for stakeholders to de- 2007, the Federal Reserve and other bank- velop community-based solutions to ing agencies encouraged mortgage lenders mortgage delinquencies in their areas. and mortgage servicers to pursue prudent The Federal Reserve has taken imporloan workouts through such measures as tant steps aimed at avoiding future probmodification of loans, deferral of pay- lems in subprime mortgage markets while ments, extension of loan maturities, capi- still preserving responsible subprime talization of delinquent amounts, and con- lending and sustainable homeownership. version of adjustable-rate mortgages In coordination with other federal super- (ARMs) into fixed-rate mortgages or fully visory agencies and the Conference of indexed, fully amortizing ARMs.1 State Bank Supervisors, the Federal Re- The Federal Reserve has also collabo- serve issued principles-based guidance on rated with community groups to help subprime mortgages last summer.2 The guidance is designed to help ensure that 1. Board of Governors of the Federal Reserve System (2007), "Working with Mortgage Borrowers," Division of Banking Supervision and Regulation, Supervi- 2. Board of Governors of the Federal Reserve Syssion and Regulation Letter SR 07-6 (April 17); and tem (2007). "Statement on Subprime Mortgage Lend- "Statement on Loss Mitigation Strategies for Servicers ing," Division of Banking Supervision and Regulaof Residential Mortgages," Supervision and Regulation tion, Supervision and Regulation Letter SR 07-12 Letter SR 07-16 (September 5). (July 24). respondents in the second half of 2007 cards generally moved down in the secreported that they had tightened stan- ond half of the year, but by less than the dards and terms on other consumer short-term market interest rates on loans, a change that may have contrib- which they are often based. Interest rates uted to a slowing in the growth of nonre- on new auto loans at banks and at auto volving loans over the final months of finance companies have also declined 2007. Average interest rates on credit some in recent months. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 15 borrowers obtain adjustable-rate mortgages extensive consumer testing of loan disthat they can afford to repay and can refi- closure documents. After a similar comnance without prepayment penalty for a prehensive analysis of disclosures related reasonable period before the first interest to credit card and other revolving credit rate reset. The Federal Reserve issued simi- arrangements, the Board issued a prolar guidance on nontraditional mortgages posal in May 2007 to require such discloin 2006.3 sures to be clearer and easier to under- The Federal Reserve is working to help stand. Like the credit card review, the safeguard borrowers in their interactions review of mortgage disclosures will be with mortgage lenders. In support of this lengthy given the critical need for field effort, in December 2007 the Federal Re- testing, but the process should ultimately serve used its authority under the Home help more consumers make appropriate Ownership and Equity Protection Act of choices when financing their homes. 1994 to propose new rules that address un- Finally, strong uniform oversight of all fair or deceptive mortgage lending prac- mortgage lenders is critical to avoiding tices. This proposal addresses abuses re- future problems in mortgage markets. lated to prepayment penalties, failure to Regulatory oversight of the mortgage inescrow for taxes and insurance, problems dustry has become more challenging as related to stated-income and low- the breadth and depth of the market has documentation lending, and failure to give grown over the past decade and as the adequate consideration to a borrower's role of nonbank mortgage lenders, parability to repay. The proposal includes ticularly in the subprime market, has inother protections as well, such as rules de- creased. In response, the Federal Reserve, signed to curtail deceptive mortgage adver- together with other federal and state tising and to ensure that consumers receive agencies, launched a pilot program last mortgage disclosures at a time when the summer focused on selected nondeposiinformation is likely to be the most useful tory lenders with significant subprime to them. mortgage operations.4 The program will The Federal Reserve is also currently review compliance with consumer proundertaking a broad and rigorous review tection regulations and impose corrective of the Truth in Lending Act, including or enforcement actions as warranted. 3. Board of Governors of the Federal Reserve Sys- 4. The other agencies collaborating on the effort tem (2006), "Interagency Guidance on Nontraditional are the Office of Thrift Supervision, the Federal Mortgage Product Risks." Division of Banking Super- Trade Commission, the Conference of State Bank vision and Regulation, Supervision and Regulation Let- Supervisors, and the American Association of Resiter SR 06-15 (October 10). dential Mortgage Regulators. Indicators of the credit quality of con- linquency rates at captive auto finance sumer loans suggest that it has weak- companies increased somewhat but are ened but generally remains sound. Over well below previous highs. Although the second half of the year, delinquency household bankruptcy filings remained rates on consumer loans at commercial low relative to the levels seen before the banks increased, but from relatively changes in bankruptcy law implemented moderate recent levels. Meanwhile, de- in late 2005, the bankruptcy rate rose Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

16 94th Annual Report, 2007 modestly over the first nine months of Change in Real Business Fixed Investment, 2007. 2001-07 The issuance of asset-backed securities (ABS) tied to credit card loans and Percent, annual rate auto loans (consumer loan ABS) has re- • Structures mained robust. Spreads of yields on con- • Equipment and software — 20 sumer loan ABS over comparablematurity swap rates have moved up J iH considerably since July; the rise pushed 0 spreads on two-year BBB-rated con- — 10 sumer loan ABS to almost double their previous peaks in late 2002. Spreads on _L j i U two-year AAA-rated consumer loan ABS jumped to between 60 basis points High-tech equipment and software and 100 basis points after having been — 40 Other equipment excluding near zero for most of the decade, per- transportation haps in part as a result of investors' gen- 20 eral reassessment of the risk in struc- FL ra PI n tured credit products. U J L L_J 2001 2003 2005 2007 The Business Sector NOTE: High-tech equipment consists of computers and peripheral equipment and communications Fixed Investment equipment. SOURCE: Department of Commerce, Bureau of Eco- Real business fixed investment (BFI) nomic Analysis. rose at an annual rate of 8*/2 percent in the second half of 2007, largely because outlays on motor vehicles.7 Real investof a double-digit rise in expenditures on ment in high-technology performed well nonresidential construction. Investment in the second half, with further increases in equipment and software (E&S), in all major components (computers, which had accounted for virtually all of communications equipment, and softthe growth in real BFI from 2003 to ware). Real outlays on equipment other 2005, has been erratic since early 2006 than high-tech and transportation (a but, on balance, has decelerated notice- broad category that accounts for nearly ably. On the whole, the economic and half of investment in E&S when meafinancial conditions that influence capi- sured in nominal terms) posted a solid tal spending were fairly favorable in gain in the third quarter. However, those mid-2007, but they subsequently worsened as the outlook for sales and profits soured and as credit conditions for some 7. The plunge in business outlays on motor veborrowers tightened. A bright spot, how- hicles in the first half was related to new Environmental Protection Agency emissions standards for ever, is that many firms still have ample large trucks, which went into effect at the start of cash on hand to fund potential projects. 2007. Many firms had accelerated their purchases On average, real outlays on E&S rose of such trucks into 2005 and 2006 so that they at an annual rate of 5 percent in the could take delivery before the new standards went into effect and thus avoid the higher costs associsecond half of 2007; in the first half, ated with those standards. Outlays on motor vethese outlays had risen just 2Vi percent, hicles rose modestly, on net, in the second half of in part because of a sharp downswing in the year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 17 outlays edged down in the fourth quar- sued an aggressive strategy of producter, and the relatively slow pace of or- tion adjustments to keep dealer stocks ders, along with the downbeat tone in reasonably well aligned with sales. In recent surveys of business conditions, December 2007, days' supply of light suggests that the softness in spending vehicles stood at a comfortable sixtyhas extended into early 2008. four days—though it ticked up in Janu- Meanwhile, real outlays on nonresi- ary because of the drop in sales noted dential construction remained on a earlier. Apart from motor vehicles, real strong uptrend. Some of the recent nonfarm inventory investment was a strength likely represents a catch-up modest $10 billion (annual rate) in the from the prolonged weakness in this sec- first half of 2007; it stayed around that tor in the first half of the decade. With rate in the third quarter and appears to the notable exception of the non-office have remained modest in the fourth commercial sector—where spending has quarter as manufacturing firms adjusted been about flat since mid-2007—all ma- production promptly in response to jor types of building continued to ex- signs of softening demand. With only a hibit considerable vigor in the second few exceptions—mostly related to the half. In general, the nonfinancial funda- ongoing weakness in construction and mentals affecting nonresidential con- motor vehicle production—book-value struction remain favorable: Vacancy inventory-sales ratios in December rates for office and industrial buildings seemed in line with historical trends. have fallen appreciably over the past Moreover, businesses surveyed in Janufew years despite the addition of a good ary by the Institute for Supply Managedeal of available space; and, although ment reported that their customers were the vacancy rate for retail buildings has generally satisfied with their current moved up somewhat of late, it remains level of stocks. well below its cyclical highs in 1991 and 2003. However, funding has report- Corporate Profits and Business edly become more difficult to obtain in Finance recent months, especially for speculative projects, and the slowing in aggre- Four-quarter growth in economic profits gate output and employment is likely to for all U.S. corporations came in at limit the demand for nonresidential about 2 percent in the third quarter of space in coming quarters. Meanwhile, 2007, with the entire gain attributable to real outlays for drilling and mining a large increase in receipts from foreign structures have continued to rise in re- subsidiaries. The share of profits in the sponse to high prices for petroleum and GDP of the nonfinancial sector peaked natural gas. in the third quarter of 2006, near its previous high reached in 1997, and has since receded. For S&P 500 firms, oper- Inventory Investment ating earnings per share in the third quarter came in about 6 percent below Although inventory imbalances had year-earlier levels.8 Data from about cropped up in a number of industries in late 2006, overhangs were largely eliminated in the first half of 2007, and firms 8. The difference between economic profits and generally continued to keep a tight rein S&P operating earnings in the third quarter is aton stocks in the second half. In the motributable primarily to numerous asset writetor vehicle sector, manufacturers pur- downs and capital losses, which are generally ex- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

18 94th Annual Report, 2007 80 percent of those firms and analysts' Selected Components of Net Financing estimates for the rest indicate that oper- for Nonfinancial Corporate Businesses, ating earnings per share in the fourth 2003-07 quarter fell more than 20 percent from the fourth quarter of 2006. Earnings per Billions of dollars, annual rate share among the group's financial firms • Commercial paper are estimated to have been negative, pri- Bonds — 800 marily because of asset write-downs; in contrast, earnings per share of the nonfinancial firms appear to have increased about 13 percent. Nonfinancial business debt is estimated to have grown about 11 percent 2003 2004 2005 2006 2007 in 2007, buoyed by robust merger and acquisition activity. Net corporate bond NOTE: The data for the components except bonds are seasonally adjusted. The data for 2007:Q4 are estimated. issuance was strong throughout the year, SOURCE: Federal Reserve Board, flow of funds data. although high-yield issuance declined after midyear, as yields on such bonds increased and spreads over yields on bank's cost of funds—the first such Treasury securities of comparable matu- tightening in several years. Large fracrity widened to levels not seen since late tions of banks also indicated that they 2002. The amount of outstanding nonfi- had tightened lending standards. Most nancial commercial paper was about of the banks that tightened terms and flat, on net, over 2007, held down standards indicated that they had done mostly by runoffs of lower-tier paper in so in response to a less favorable or the second half of the year as the market more uncertain economic outlook and a for such paper came under pressure. Af- reduced tolerance for risk. A lesser ter an unprecedented amount of issu- fraction—about one-fourth—cited conance of leveraged syndicated loans over cerns about the liquidity or capital posithe first half of 2007, issuance declined tion of their own banks as reasons for considerably in the second half of the tightening. year, when demand by nonbank inves- Gross equity issuance picked up in tors for those loans fell off. Commercial 2007 on an increase in the pace of seaand industrial (C&I) loans at banks ex- soned offerings. Nonetheless, record panded briskly in 2007 as underlying volumes of share repurchases and cashdemand for bank-intermediated business financed mergers and acquisitions credit seemed to remain solid and banks pushed net equity retirements even took onto their balance sheets loans that higher in 2007 than in 2006. had been intended for syndication. In The credit quality of nonfinancial corthe Senior Loan Officer Opinion Sur- porations remained strong. The sixveys taken in October 2007 and January month trailing bond default rate stayed 2008, considerable net fractions of near zero through January 2008. The debanks reported charging wider spreads linquency rate on C&I loans at commeron C&I loans—the loan rate less the cial banks at the end of 2007 remained near the bottom of its historical range, but it trended higher over the year. eluded in the calculation of economic profits but Charge-offs on C&I loans at banks also are included as an expense in operating earnings per share of financial firms. increased in 2007, particularly in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 19 fourth quarter. Rating downgrades of areas where the banks operate, and a corporate bonds were modest through reduced tolerance for risk. the fourth quarter, and over the year the Moreover, despite the generally solid fraction of debt that was downgraded performance of commercial mortgages roughly equaled the fraction that was in securitized pools, spreads of yields on upgraded. For public firms, balance BBB-rated CMBS over comparablesheet liquidity remained at a high level maturity swap rates soared, and spreads through the third quarter of 2007, and on AAA-rated tranches of those securileverage stayed very low despite robust ties rose to unprecedented levels. The borrowing and surging retirements of widening of spreads reportedly reflected equity. heightened concerns regarding the un- Commercial real estate debt contin- derwriting standards for commercial ued to expand briskly in 2007, reflecting mortgages over the past few years and in part strong investment in nonresiden- likely also investors' general wariness tial structures, but the overall pace ta- of structured finance products. pered off some in the second half of the Issuance of CMBS in 2007 topped the year. As noted above, readings on some pace of 2006. It was fueled by leveraged market fundamentals for existing buyouts of real estate investment trusts structures—for example, vacancy rates in the first half of the year, but issuance and rents—remained solid. Similarly, slowed to a trickle over the final four the latest data for commercial mortgages months of the year on tighter underwritheld by life insurance companies or by ing standards and the higher required issuers of commercial mortgage-backed yields. Nonetheless, the still-steady securities (CMBS)—mortgages that growth of commercial real estate debt mostly finance existing structures— indicates that, thus far, borrowers have show little change in delinquency rates found alternative funding sources for in recent quarters. projects. In contrast, the delinquency rate on commercial mortgages held by banks about doubled over the course of 2007, The Government Sector reaching almost 23/4 percent. The loan performance problems were the most Federal Government striking for construction and land development loans—especially for those that The deficit in the federal unified budget finance residential development—but stood at $162 billion in fiscal year 2007, some increase in delinquency rates was roughly $250 billion below the recent also apparent for loans backed by non- high reached in fiscal 2004 and equal to farm, nonresidential properties and mul- just 1 VA percent of nominal GDP. Howtifamily properties. In the most recent ever, growth in revenues has slowed Senior Loan Officer Opinion Survey, since last summer, and growth in outlarge fractions of banks reported having lays has quickened. Given those develtightened standards and terms on com- opments, the deficit during the first four mercial real estate loans. Among the months of fiscal 2008 (October 2007 to most common reasons cited by those January 2008) was larger than it had that tightened credit conditions were a been during the comparable period of less favorable or more uncertain eco- fiscal 2007. Over the remainder of fiscal nomic outlook, a worsening of commer- 2008, a slow pace of economic activity cial real estate market conditions in the and the revenue loss associated with the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

20 94th Annual Report, 2007 Economic Stimulus Act of 2008 are ex- risen about IV2 percent in each of the pected to boost the deficit. two preceding years. In large part, the Nominal federal receipts have decel- slowing in 2007 reflected a number of erated sharply since posting double-digit transitory factors—most notably, the taadvances in fiscal years 2005 and 2006: pering off of expenditures for flood in- They rose less than 7 percent in fiscal surance and disaster relief related to the 2007 and have slowed substantially fur- 2005 Gulf Coast hurricanes, which had ther thus far in fiscal 2008. The decel- produced a noticeable bulge in spending eration has been most pronounced in in fiscal 2006. So far in fiscal 2008, corporate receipts, which barely in- sharp increases in outlays for defense creased in fiscal 2007 after three years and net interest have helped push spendof exceptional growth and have fallen ing 8 percent above its year-earlier level. well below year-earlier levels so far in As measured in the national income fiscal 2008; the downturn has reflected and product accounts (NIPA), real fedthe recent softness in corporate profits. eral expenditures on consumption and In addition, growth in individual income gross investment—the part of federal tax receipts has moderated from the spending that is a direct component of rapid rates seen around the middle of the GDP—rose at an annual rate of 3 V2 perdecade. Nonetheless, total receipts grew cent, on average, in the second half of faster than nominal GDP for the third calendar 2007 after having been unyear in a row in fiscal 2007 and reached changed in the first half. The step-up 183/4 percent of GDP, slightly above the was concentrated in real defense spendaverage of the past forty years. ing, which tends to be erratic from quar- Nominal federal outlays rose less than ter to quarter and rose at an annual rate 3 percent in fiscal 2007 after having of 4V2 percent in the second half, somewhat above its average pace over the past three years. Federal Receipts and Expenditures, Federal debt rose at an annual rate of 1987-2007 almost 5 percent over the four quarters Percent of nominal GDP Federal Government DebtHeld Expenditures by the Public, 1960-2007 — 22 Receipts Percent of nominal GDP — 20 — 50 \ — 45 \I — 40 — 18 /""— 35 — 30 — 25 — 16 — — 20 Hll Mil!! i I I II I 11 1 1 1 I 1 II I 1 1967 1977 1987 1997 2007 1987 1991 1995 1999 2003 2007 NOTE: The data for debt are as of year-end; the NOTE: The receipts and expenditures data are on a observation for 2007 is an estimate. The corresponding unified-budget basis and are for fiscal years (October values for GDP are for Q4 at an annual rate. Excludes through September); GDP is for the four quarters ending securities held as investments of federal government in Q3. accounts. SOURCE: Office of Management and Budget. SOURCE: Federal Reserve Board, flow of funds data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 21 of calendar year 2007, a bit faster than these circumstances, some states may the roughly 4 percent increase in 2006. have to cut spending or raise taxes to The ratio of federal debt held by the satisfy their balanced-budget requirepublic to nominal GDP remained in the ments. At the local level, property tax narrow range around 361/> percent seen receipts apparently were bolstered in in recent years. The Treasury's decision 2007 by the earlier run-up in real estate in May to discontinue auctions of three- values, but the deceleration in house year nominal notes elicited little reac- prices will likely slow the rise in local tion in financial markets. The Treasury revenues down the road. Moreover, also trimmed some auction sizes for a many state and local governments exfew other coupon securities over the first pect to face significant structural imbalthree quarters of the year as the nar- ances in their budgets in coming years rower deficit reduced borrowing needs. as a result of the ongoing pressures from Data suggest that the proportion of Medic aid and the need to provide pennominal coupon securities purchased at sions and health care to their retired Treasury auctions by foreign official in- employees. stitutions edged down over the second According to the NIPA, real expendihalf of 2007, but the proportion has tures on consumption and gross investchanged little, on net, since mid-2005. ment by state and local governments continued to expand briskly in the second half of 2007. Much of the strength State and Local Government was in construction spending, which The fiscal condition of state and local picked up speed early last year after governments appears to have lost some having been essentially flat between luster in 2007 after improving signifi- 2002 and 2006. Meanwhile, real outlays cantly between the early part of the de- for current operations remained on the cade and 2006. Indeed, for the state and moderate uptrend that has been evident local sector as a whole, net saving as since 2006. measured in the NIPA, which is broadly Boosted by spending on education similar to the surplus in an operating and industrial aid, borrowing for new budget, fell from a recent high of capital expenditures by state and local $25 billion in 2006 to roughly zero, on governments was very strong in 2007. average, during the first three quarters Refundings in advance of retirements of 2007. The downshift occurred as were brisk in the early part of the year as revenue increases tailed off after a issuers locked in low interest rates, but period of hefty gains and as nominal refundings subsided in the second half expenditures—especially on energy and as a result of higher volatility and rehealth care—rose sharply. Recent infor- duced liquidity in the municipal bond mation from individual states points to a market. By contrast, short-term borrowgood deal of unevenness in current bud- ing picked up a bit during the second get conditions. Some states—especially half of the year, possibly because of those in agricultural and energy- some deterioration in state and local producing regions—continue to enjoy budgets. strong fiscal positions. Others, however, Municipal issuers are benefiting from are reporting sizable shortfalls in rev- lower interest rates, as bond yields have enues, in part because sales tax collec- declined some since midyear. However, tions are being hit hard by the weakness investors reportedly have become inin purchases of housing-related items. In creasingly concerned about the weaker Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

22 94th Annual Report, 2007 fiscal outlooks for many state and local rise in the standard of living of U.S. governments and the condition of mu- residents over time and hamper the abilnicipal bond insurers. Partly as a result ity of the nation to meet the retirement of those developments, the ratio of an needs of an aging population. index of municipal bond yields to the yield on comparable-maturity Treasur- The External Sector ies has climbed to the top end of its historical range. International Trade Some indicators of credit quality in the municipal bond sector have begun The external sector provided significant pointing to greater weakness in recent support to economic activity in the secmonths. Rating upgrades have slowed ond half of last year. Net exports added while downgrades have risen. A sub- almost 1 percentage point to U.S. GDP stantial number of revenue bonds for growth during that period, according to projects insured by a subsidiary of a ma- the latest GDP release from the Bureau jor investment bank were downgraded of Economic Analysis, but data received in October. In January another group of since then suggest a somewhat larger bonds was downgraded because of the positive contribution. The contribution downgrade of their insurer. of net exports was supported by a robust expansion—about 11 percent at an annual rate—of real exports of goods and National Saving services that was helped by still-solid Total net national saving—that is, the growth of foreign economies and the efsaving of households, businesses, and fects of the past depreciation of the dolgovernments excluding depreciation lar. The broad-based rise in real exports charges—was equal to about IV2 per- of goods included sizable increases for cent of nominal GDP, on average, dur- automobiles, agricultural goods, and ing the first three quarters of 2007. The capital goods, especially aircraft. Exdrain on national saving from the fed- ports of services rose in 2007 but at a eral budget deficit was smaller than it Change in Real Imports and Exports had been a few years earlier. However, of Goods and Services, 1999-2007 net business saving receded somewhat from the relatively high levels of the Percent preceding few years, and personal saving was very low for the third consecu- • Imports tive year. — • Exports — 15 I Net national saving fell appreciably 1 as a percentage of GDP between the late Mil 1990s and the early part of this decade; — 5 — that ratio has changed little since 2002 + (apart from the third quarter of 2005, which was marked by sizable hurricanerelated property losses). If not boosted — — 5 over the longer run, persistent low levels of national saving will be associated — — 10 with either slower capital formation or M i ll 1 j 1 1 1 U continued heavy borrowing from 1999 2001 2003 2005 2007 abroad, either of which would retard the SOURCE: Department of Commerce. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 23 slower pace than in the previous year. Prices of Oil andof Nonfuel Commodities, The value of exports to China, India, 2003-08 Russia, South America, and the members of OPEC rose quite substantially, January 2003 = 100 Dollars per barrel and gains for exports to Canada and 260 — — 100 western Europe were also sizable. Ex- 240 — V — 90 220 — Oil -. J — 80 ports to Mexico and Japan increased at a 200 — somewhat slower pace. 180 — I\P \* l jL s/r _/ — 60 160 — J\P* *~/^^ — 50 A slowdown in real imports was also 140 — J y — 40 a factor in the positive contribution of 120 — W ^._/ Nonfuel. . — 30 100 ——*S commodities 20 net exports to the growth of real GDP 80 r- —j 10 last year. The growth of real imports of II 1 1 1 I 1 i goods and services decreased to about 2003 2004 2005 2006 2007 2008 \Vi percent in 2007, down from a NOTE: The data are monthly. The last observation for 33/4 percent rise in 2006, in part because the oil price is the average for February 1 through February 21, 2008. The price of nonfuel commodities of a slowdown in U.S. domestic demand extends through January 2008. The oil price is the spot and the depreciation of the dollar. Al- price of West Texas intermediate crude oil. The price of nonfuel commodities is an index of forty-five though real imports of capital goods primary-commodity prices. were strong, the growth of most other SOURCE: For oil, the Commodity Research Bureau; major categories declined. Despite the for nonfuel commodities. International Monetary Fund. moderation in the growth of imports overall, the value of goods (excluding ing countries. In addition, a number of oil) imported from western Europe, actual and potential disruptions to sup- China, and Mexico still rose at solid ply have contributed to the surge in oil rates. prices. OPEC members announced cuts Given those movements in exports to oil production in late 2006. Despite and imports, along with somewhat recent agreements that have reversed higher net investment income, the U.S. some of these cuts, OPEC production current account deficit appears likely to remains restrained. The growth of prohave shrunk in 2007 on an annual basis duction has also been hampered by some for the first time since 2001. The current governments' moves to take control of account deficit narrowed from $811 bil- oil resources or raise their share of revlion in 2006 to an average of $753 bil- enues. Geopolitical tensions in the lion at an annual rate, or around 5Vi per- Middle East and instability in Nigeria cent of nominal GDP, in the first three have contributed to concerns about oil quarters of 2007 (the latest available supply as well. The price of the fardata). However, its largest component, dated NYMEX oil futures contract (curthe trade deficit, widened in the fourth rently for delivery in 2016) now has quarter because of a steep increase in risen to nearly $95 per barrel and likely the price of imported oil. reflects a belief by oil market partici- The price of crude oil soared on world pants that the balance of supply and demarkets in 2007. The spot price of West mand will remain tight for some time to Texas intermediate increased from come. around $60 per barrel at the end of 2006 Broad indexes of non-oil commodito about $100 at present. The strong de- ties prices remain elevated. Although mand for oil was powered by the contin- they fell back slightly over the second ued expansion of the world economy half of last year, prices have again risen through 2007, especially in the develop- since the start of 2008. Prices of a num- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

24 94th Annual Report, 2007 ber of metals, which surged in the spring less-risky positions. On balance, flows on strong global demand, retreated out of non-Treasuries and into U.S. somewhat during the latter half of 2007 Treasuries nearly offset one another, and as production increased and as users total foreign private acquisitions of U.S. substituted into other materials. How- securities recorded an unusually small ever, more recently the prices of copper net inflow for the third quarter. Prelimiand aluminum have moved back up. nary data for the fourth quarter indicate Prices for food commodities continue to renewed foreign acquisitions of U.S. rise steeply. Poor harvests in Australia corporate securities, although at a notaas well as in parts of Europe and Asia bly weaker pace than in the first half of led to higher wheat prices. The price of the year. Foreign private demand for soybeans also has risen sharply because U.S. Treasury securities has remained acreage has been shifted to corn produc- strong. tion, in part to produce biofuel; in addi- As issuers of asset-backed commertion, the soybean harvest in China was cial paper around the globe began to down sharply from last year. encounter difficulties over the summer, Import price inflation increased in nonbank entities that had issued com- 2007, with the depreciation of the dollar mercial paper in the United States and providing an important impetus; higher lent the proceeds to foreign parents oil and food prices also contributed. sharply curtailed those activities. As a Prices of imported goods rose about result, those entities reduced their claims 8V2 percent in 2007, but excluding food, on foreign parents, and net financial inoil, and natural gas, such prices rose flows from nonbank entities thus were 2V* percent; both rates were somewhat sizable in the third quarter. Foreign inhigher than in the previous year. flows through direct investment into the United States surged in the third quarter, The Financial Account as foreign parents injected additional equity capital into their U.S. affiliates. Although the current account deficit ap- Foreign official inflows slowed in pears to have narrowed during 2007, it the third quarter, as Asian central remains sizable and continues to require banks acquired debt securities issued a significant inflow of financing from by government-sponsored enterprises abroad. As in the past, the deficit was largely financed by foreign net acquisi- (GSEs) but on net sold U.S. Treasury tions of U.S. securities. securities. Official inflows appear to The global financial turmoil that be- have strengthened again in the fourth gan in the summer left an imprint on the quarter, with a return to moderate purcomponents of the U.S. financial ac- chases of U.S. Treasury securities, concount. After acquiring record amounts tinued strong purchases of GSE-issued of U.S. securities in the first half of debt securities, and a notable pickup in 2007, foreign private investors sold a acquisitions of both corporate equities sizable net amount of non-Treasury U.S. and corporate debt securities. securities in the third quarter—the first Net purchases of foreign securities by quarterly net sale of such securities in U.S. residents, which represent a finanmore than fifteen years. In contrast, for- cial outflow, were maintained at a brisk eign private demand for U.S. Treasury pace for 2007 as a whole. Outflows assecurities picked up sharply in the third sociated with U.S. direct investment quarter as global investors shifted into abroad remained strong. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 25 The Labor Market more than a quarter-century, have continued to shrink. Meanwhile, some Employment and Unemployment service-producing industries have maintained solid gains. In particular, hiring The demand for labor decelerated early by health and education institutions and last year and has slowed further of late. by food services and drinking establish- The average monthly gain in private ments has remained strong, and job nonfarm payroll employment, which gains at businesses providing professlid from about 160,000 in 2006 to sional and technical services have been 80,000 over the first ten months of 2007, sizable as well. was only 50,000 in November and De- The increase in joblessness since the cember, and private employment was spring of 2007 has been widespread nearly flat in January 2008. The civilian across major demographic groups. In unemployment rate, which had hovered January 2008, unemployment rates for around 4Vi percent in the early part of men and women aged 25 years and older 2007, drifted up about lA percentage were both about VA percentage point point from May to November; it rose above the levels of last spring, and—as another lA percentage point, on net, over typically occurs—rates for teenagers the following two months and stood at and young adults showed larger in- 4.9 percent in January. creases. Among the major racial and Employment in residential construcethnic groups, unemployment rates for tion has been falling for about two years blacks and Hispanics rose somewhat and now stands 375,000 below the high more than did unemployment rates for reached in early 2006. Jobs in related whites, a differential also typical of perifinancial industries have also decreased ods when labor market conditions lately. Payrolls in the manufacturing secsoften. An increase in the number of tor, which have been on a downtrend for unemployed who had lost their last jobs (as opposed to those who had voluntar- Net Change in Private Payroll Employment, 2001-08 ily left their jobs or were new entrants to the labor force) accounted for about half Thousands of jobs, 3-month moving average of the rise in the overall jobless rate between the spring of 2007 and January 2008. The labor force participation rate stood slightly above 66 percent in January; it has changed little, on net, over the past couple of years after falling appreciably over the first half of the decade. Most other recent indicators also point to some softening of labor market conditions. Initial claims for unemployment insurance, which had remained relatively low through the fall, moved up somewhat in the closing months of 1 1 2007; though erratic from week to week, 2002 2004 2006 2008 they appear to have risen further in early NOTE: Nonfarm business sector. The data are monthly 2008. Meanwhile, private surveys sugand extend through January 2008. SOURCE: Department of Labor, Bureau of Labor gest that firms have cut back on plans Statistics. for hiring in the near term. Households Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

26 94th Annual Report, 2007 have also become less upbeat about the Hourly compensation rose at a relaprospects for the labor market in the tively moderate rate in 2007 despite a year ahead. pickup in overall consumer price inflation, a continued advance in labor productivity, and generally tight labor mar- Productivity and Labor kets. The employment cost index (ECI) Compensation for private industry workers, which measures both wages and the cost of Output per hour in the nonfarm business benefits, increased 3 percent in nominal sector rose 2Vi percent in 2007 after avterms over the twelve months of 2007, eraging just 1 Vi percent per year over about in line with its pace in 2005 and the preceding three years. Although esti- 2006. Within the ECI, wages and salamates of the underlying pace of producries increased VA percent in 2007, the tivity growth are quite uncertain, the same as in 2006 but 3A percentage point pickup in measured productivity growth above the increases in 2004 and 2005. in 2007 suggests that the fundamental Meanwhile, increases in the cost of proforces supporting a solid underlying viding benefits have slowed markedly in trend remain in place. Those forces inrecent years, in part because employer clude the rapid pace of technological contributions for health insurance have change as well as the ongoing efforts by decelerated. The increase in benefits firms to use information technology to costs in 2007, which amounted to just improve the efficiency of their opera- 2Vi percent, was also held down by a tions. Increases in the amount of capital drop in employer contributions to per worker also appear to be providing defined-benefit retirement plans in the an impetus to productivity growth. first quarter. The lower contributions appear to have been facilitated by several Change in Output per Hour, 1948-2007 factors, including a high level of employer contributions over the preceding Percent, annual rate few years and the strong performance of the stock market in 2006. According to preliminary data, nomi- — 5 nal compensation per hour in the nonfarm business sector—an alternative measure of hourly compensation derived from the compensation data in the — 3 NIPA—rose 33/4 percent in 2007, somewhat faster than the ECI. In 2006, the nonfarm business measure had risen 5 percent, with an apparent boost from a UlL high level of bonuses and stock option exercises, which do not seem to have been repeated in 2007.y The moderation 1948- 1974- 1996- 2002 2004 2006 73 95 2000 in this measure last year, along with the NOTE: Nonfarm business sector. Change for each multiyear period is measured to the fourth quarter of the final year of the period from the fourth quarter of the 9. Income received from the exercise of stock year immediately preceding the period. options is included in the measure of hourly SOURCE: Department of Labor, Bureau of Labor compensation in the nonfarm business sector but Statistics. not in the ECI. Income received from most types Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 27 step-up in measured productivity early 2007, but they receded over the growth, held the increase in unit labor second half of the year as inventories costs in 2007 to 1 percent. Unit labor reached their highest levels since the costs rose about 2Vi percent per year, on early 1990s. So far in 2008, natural gas average, from 2004 to 2006 after having prices have risen notably as inventories been nearly flat over the preceding three have fallen back into line with seasonal years. norms. Consumer prices for electricity rose sharply last fall, likely because of last year's higher prices of fossil fuel Prices inputs to electricity generation. Headline consumer price inflation Last year's increase in the PCE price slowed dramatically in the third quarter index for food and beverages, at 4V2 perof 2007, when energy prices hit a lull cent, was the largest in nearly two deafter their first-half surge, but it moved cades. Food prices accelerated in reback up in the fourth quarter as energy sponse to strong world demand and high prices climbed again. Over the year as a demand for corn for the production of whole, the overall PCE chain-type price ethanol. Taken together, prices for index rose 3V2 percent, IV2 percentage meats, poultry, fish, and eggs rose points more than in 2006. Core price 5V2 percent, and prices of dairy products inflation excludes the direct effects of were up at double-digit rates. Prices for increases in food and energy prices; purchased meals and beverages, which these increases were sharp last year. typically are influenced more by labor Like headline inflation, core PCE infla- and other business costs than by farm tion was uneven from quarter to quarter prices, also recorded a sizable increase in 2007; over the four quarters of the last year. In commodity markets, grain year, it averaged a bit more than 2 per- prices soared to near-record levels in cent. In 2006, the core index rose late 2007 as strong global demand out- 2l/4 percent. Although data for PCE stripped available supply, and they have prices in January 2008 are not yet avail- moved somewhat higher since the turn able, information from the consumer of the year. Meanwhile, spot prices of price index (CPI) and other sources sug- livestock have declined of late; the degests that both total and core inflation crease should provide some offset to the remained on the high side early this year upward pressure from grain prices and after having firmed in the fourth quarter thus help limit increases in consumer of 2007. food prices in coming months. The PCE price index for energy rose The pattern of core PCE inflation was nearly 20 percent over the four quarters uneven during 2007. In the first half of of 2007 after having fallen modestly in the year, core inflation was damped sig- 2006. The retail price of gasoline was nificantly by unusually soft prices for up about 30 percent over the year as a apparel, prescription drugs, and nonmarwhole, driven higher by the upsurge in ket items (especially financial services the cost of crude oil. In 2008, gasoline provided by banks without explicit prices through mid-February were charge); all of these developments around the high levels seen late last year. proved transitory and were reversed Prices of natural gas rose sharply in later in the year with little net effect on core inflation over the year as a whole. Meanwhile, the rate of increase in the of bonuses is included in both measures of compensation. core CPI dropped from 23A percent in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

28 94th Annual Report, 2007 2006 to 2!/4 percent in 2007; the main Alternative Measures of Price Change, reason for the sharper deceleration in 2005-07 the core CPI than in the core PCE price Percent index is that housing costs, which rose Price measure 2005 2006 2007 less rapidly in 2007 than they had in Chain-type 2006, carry much greater weight in the Gross domestic product (GDP) 3.4 2.7 2.6 core CPI. Excluding food and energy 3.3 2.9 2.3 Personal consumption expenditures More fundamentally, the behavior of (PCE) 3.2 1.9 3.4 core inflation in 2007 was shaped by Excluding food and energy 2.2 2.3 2.1 many of the same forces that were at Market-based PCE excluding food and energy 1.7 2.0 1.9 work in 2006. The December jump in Fixed-weight unemployment notwithstanding, re- Consumer price index 3.8 1.9 4.0 source utilization in labor and product Excluding food and energy 2.1 2.7 2.3 markets remained fairly high last year, NOTE: Changes are based on quarterly averages of and increases in prices for energy and seasonally adjusted data. other industrial commodities continued SOURCE: For chain-type measures, Department of to add to the cost of producing a wide Commerce, Bureau of Economic Analysis; for fixedweight measures, Department of Labor, Bureau of Labor variety of goods and services. Higher Statistics. prices for non-oil imports also likely put some upward pressure on core inflation. 1998. Meanwhile, ten-year inflation Meanwhile, the news on inflation expec- compensation, as measured by the tations has been mixed. Probably re- spreads of yields on nominal Treasury flecting the higher rate of actual head- securities over those on their inflationline inflation, the median expectation for protected counterparts, has changed year-ahead inflation in the Reuters/ little, on balance, since mid-2007. University of Michigan Surveys of Con- Last year's sharp rise in energy prices sumers moved up from 3 percent in also left an imprint on the price index early 2007 to between 3XA percent and for GDP, which rose a little more than 3V2 percent last spring; apart from a 2V2 percent for the second year in a downward blip in the autumn, it re- row.10 Excluding food and energy mained there through January 2008 and prices, the increase in GDP prices spurted to 33A percent in the preliminary slowed from 3 percent in 2006 to 2lA percent in 2007; significantly estimate for February. In contrast, most smaller increases in construction prices indicators suggest that expectations for accounted for much of the deceleration. longer-run inflation have remained reasonably well contained. The preliminary February result for median five- to ten- Financial Markets year inflation expectations in the Reuters/ University of Michigan survey, at Domestic and international financial 3.0 percent, was around the middle of markets experienced substantial strains the narrow range that has prevailed for and volatility in 2007 that were sparked the past few years. And according to the by the ongoing deterioration of the Survey of Professional Forecasters, conducted by the Federal Reserve Bank of 10. The effect of energy prices on GDP prices Philadelphia, expectations of CPI infla- was much smaller than that on PCE prices. The tion over the next ten years have re- reason is that much of the energy-price increase was attributable to the higher price of imported mained around 2V2 percent, a level that oil, which is excluded from GDP because it is not has been essentially unchanged since part of domestic production. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 29 subprime mortgage sector and emerging products and from risky assets more worries about the near-term outlook for generally. Strains began to emerge in the U.S. economic growth. Substantial leveraged syndicated loan market in late losses on structured products related to June and then surfaced in the assetsubprime mortgages caused market par- backed commercial paper and term bank ticipants to reassess the risks associated funding markets in August. After a rewith a wide range of other structured spite in late September and October, revfinancial instruments. The result was a elations of larger-than-expected losses drying up of markets for subprime and at several financial firms and a weaker nontraditional mortgage products as economic outlook contributed to yearwell as a significant impairment of the end pressures in short-term funding markets for asset-backed commercial markets that exacerbated financial paper and leveraged syndicated loans. strains and heightened market volatility. Those dislocations generated unex- Financial markets remained volatile pected balance sheet pressures at some through mid-February, in part owing to major financial institutions, and the a further downgrading of the economic pressures in turn contributed to severe outlook and problems at some financial strains in short-term bank funding mar- guarantors. kets. The Federal Reserve responded to Signs of investor nervousness about the financial turmoil and the risks to the the mortgage situation first appeared in broader economy along two tracks: It December 2006 and then intensified in took a series of actions to support mar- late February 2007, at a time when ket liquidity and functioning (partly in softer-than-expected U.S. economic data coordination with foreign central banks), were adding to market uncertainty. Over and it eased monetary policy in pursuit this period, mortgage companies speof its macroeconomic objectives. As a cializing in subprime products began to result of the downward revision to the experience considerable funding preseconomic outlook and strained financial sures, and many failed, because rising conditions, yields on Treasury securities delinquencies on recently originated fell, risk spreads widened significantly, subprime mortgages required those equity prices dropped, and volatility in firms to repurchase the bad loans from many financial markets increased. securitized pools. Financial markets calmed in April, however, and liquidity in major markets remained ample. In Market Functioning and Financial June, rating agencies downgraded or put Stability under review for possible downgrade the The ongoing erosion in the credit qual- credit ratings of a large number of secuity of subprime residential mortgages, rities backed by subprime mortgages. particularly adjustable-rate mortgages, Shortly thereafter, a few hedge funds exhas exposed weaknesses in other finan- perienced serious difficulties as a result cial markets and posed challenges to fi- of subprime-related investments. nancial institutions. Over the first half of Prices of indexes of credit default 2007, problems were mostly isolated swaps on residential mortgage-backed within the subprime mortgage markets. securities backed by subprime mort- However, around midyear, as credit gages—which had already weakened quality in that sector continued to over the first half of 2007 for the lowerworsen and losses mounted, investors rated tranches—dropped steeply in July began to retreat from structured credit for both lower-rated and higher-rated Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

30 94th Annual Report, 2007 Gross Issuance of Securities Backed by the rating agencies, to evaluate many Alt-A and Subprime Mortgage Pools, other types of structured instruments. 2002-08 The loss of confidence was reflected in significantly higher spreads on the debt Billions of dollars, annual rate of collateralized loan obligations • Alt-A (CLOs), and the issuance of such debt " n 75 Subprime [1 weakened noticeably over the summer. 60 Because CLOs had been the largest pur- — ny 45 chasers of leveraged syndicated loans, — 30 the drop in issuance contributed to the ill decline in leveraged lending. In the sec- 15 ondary market for such loans, trading volumes were reportedly large, but bid- 2002 2004 2006 2008 asked spreads widened sharply and NOTE: Mortgages in alt-A pools are a mix of prime, prices, which had been high in the first near-prime, and subprime mortgages; for further details on alt-A pools, refer to text. half of 2007, declined markedly. Im- SOURCE: Inside MBS & ABS. plied spreads on an index of loan-only credit default swaps (LCDX) spiked in tranches. Subsequently, investor demand July and remained elevated in August. for securities backed by subprime and Unable to distribute many leveraged alt-A mortgage pools dwindled, and the syndicated loans that they had reportsecuritization market for those products edly underwritten—a problem apparvirtually shut down. Those developently affecting about $250 billion of ments amplified credit and funding pressuch loans in the United States alone— sures on mortgage companies specializbanks faced the prospect of bringing ing in subprime mortgages; with no those loans onto their balance sheets as buyers for the mortgages they origithe underlying deals closed. nated, more of those firms were forced At the end of July, European assetto close or drastically reduce their operabacked commercial paper (ABCP) and tions, and subprime originations slowed short-term funding markets were roiled to a crawl. Originations of alt-A by warnings of heavy losses associated mortgages—which had held up over the first half of the year—also dropped with commercial paper programs backed sharply beginning in July. Interest rates by U.S. subprime mortgages. On Augon jumbo loans increased, but institu- ust 9, a major European bank tions that had the capacity to hold such announced that it had frozen redemploans on their balance sheets continued tions for three of its investment funds, to make them available to prime borrow- citing its inability to value some of the ers. In contrast, the market for conform- mortgage-related securities held by the ing mortgages for prime borrowers was funds. After that announcement, liquidaffected relatively little. Indeed, the issu- ity problems and short-term funding ance of securities carrying guarantees pressures intensified in Europe and from Fannie Mae or Freddie Mac rose emerged in U.S. money markets. Partly somewhat in the second half of the year. in response to those developments, the The unprecedented decline in the Federal Reserve and other central banks value of highly rated tranches of took steps to foster smoother functionmortgage-related securities led investors ing of short-term credit markets (refer to doubt their own ability, and that of to the box entitled "The Federal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 31 Reserve's Responses to Financial and commercial paper could lead to sub- Strains"). stantially larger-than-anticipated calls Spreads on U.S. ABCP widened con- on their funding capacity. Moreover, siderably in mid-August, and the vol- creditors found they could not reliably ume of ABCP outstanding began a pre- determine the size of their counterparcipitous decline as investors balked at ties' potential exposures to those marrolling over paper for more than a few kets, and concerns about valuation pracdays. Outstanding European ABCP also tices added to the overall uncertainty. As declined substantially, and the market a result, banks became much less willfor Canadian ABCP not sponsored by ing to provide funding to others, includbanks virtually collapsed.11 Structured ing other banks, especially for terms of investment vehicles (SIVs) and single- more than a few days. Spreads of term seller ABCP conduits that were heavily federal funds rates and term Libor over exposed to securities backed by sub- rates on comparable-maturity overnight prime mortgages experienced the great- index swaps widened appreciably, and est difficulties. Unlike traditional ABCP the liquidity in these markets diminished programs, SIVs had very little explicit (for the definition of overnight index liquidity support from their sponsors. As swaps, refer to the accompanying figa result, investors became particularly ure). European banks also sought to seconcerned about the ability of SIVs— cure term funding in their domestic cureven those with little or no exposure to rencies, and similar spreads were seen in residential mortgages—to make timely term euro and sterling Libor markets. payments, and demand for ABCP issued Liquidity in the foreign exchange swap by SIVs fell sharply. Over the next few market was poor over this period, and weeks, some U.S. issuers invoked their European firms found it more difficult right to extend the maturity of their pa- and costly to use the foreign exchange per. Others temporarily drew on their swap market to swap term funds debank-provided backup credit lines, and a nominated in euros or other currencies few issuers defaulted. The general un- for funds denominated in dollars. Term certainty and lack of liquidity also led to funding markets in the Japanese yen and some decrease in demand for lower-tier Australian dollar also came under presunsecured nonfinancial commercial sure as foreign institutions attempted to paper—especially at longer maturities— borrow in those currencies and swap the and spreads in that segment of the mar- funds into dollars or euros. ket widened markedly in August as well. Against that backdrop, investors fled Issuers of high-grade unsecured com- to the relative safety of Treasury securimercial paper were largely unaffected ties, particularly Treasury bills, during by the turmoil and experienced little mid-August. For example, inflows into disruption. money market mutual funds investing At the same time, term interbank only in Treasury and agency securities funding markets in the United States and jumped in August. Surges of safe-haven Europe came under pressure. Banks rec- demand caused Treasury bill rates to ognized that the difficulties in the mar- plunge at times, and the considerable kets for mortgages, syndicated loans, volatility in that market was likely exacerbated in September by a seasonal reduction in bill supply. Bid-asked spreads 11. In December, a group of investor represenin the Treasury bill market widened subtatives agreed in principle to restructure Canadian nonbank ABCP into longer-term notes. stantially in this period. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

32 94th Annual Report, 2007 The Federal Reserve's Responses to Financial Strains In response to the serious financial strains in keeping the federal funds rate from that emerged last August, the Federal Re- rising above its intended level. (Indeed, serve has undertaken a number of measures despite heightened demand for liquidity, to foster the normal functioning of finan- the effective federal funds rate was somecial markets and thereby promote its dual what below the target for a time in Auobjectives of maximum employment and gust and early September, as efforts to price stability. keep the rate near the target were ham- In mid-August, the Federal Reserve, as pered by technical factors and financial well as several foreign central banks, took market volatility.) After the September actions designed to provide liquidity and meeting of the Federal Open Market help stabilize markets. On August 9, the Committee, conditions in overnight fund- European Central Bank (ECB) conducted ing markets improved further. The volan unscheduled tender operation in re- ume of loans to depository institutions sponse to sharply elevated demands for li- made through the discount window inquidity by European banks, an action it creased at times because of term loans to repeated several more times in subsequent a relatively small number of institutions, weeks. On August 10, similar stresses but it remained generally moderate. Instiemerged in U.S. money markets, and the tutions may have been reluctant to use the Federal Reserve added substantial reserves discount window, perhaps fearing that to meet heightened demand for funds from their borrowing would become known banks. and would be seen by creditors and Short-term markets remained under con- counterparties as a sign of financial siderable pressure over subsequent days weakness—the so-called stigma problem. despite the provision of ample liquidity in Nonetheless, collateral placed by banks overnight funding markets by the Federal at the discount window in anticipation of Reserve, the ECB, and the central banks of possible borrowing rose sharply during other major industrialized countries. On August and September, which suggested August 17, the Federal Reserve Board an- that some banks viewed the discount winnounced a narrowing of the spread between dow as a potentially valuable option. the federal funds rate and the discount rate Pressures in financial markets ebbed from 100 basis points to 50 basis points for a time in the fall but rose again later and changed discount window lending in the year. On November 26, the Federal practices to allow the provision of term Reserve Bank of New York announced financing for as long as thirty days, renew- some additional modest, temporary able by the borrower. To ease pressures in changes to the SOMA securities lending the Treasury market, the Federal Reserve program that were designed to further re- Bank of New York announced on Aug- lax the limitations on borrowing particuust 21 some temporary changes to the lar Treasury securities and to improve the terms and conditions of the System Open functioning of the Treasury market. In Market Account (SOMA) securities lend- addition, the New York Reserve Bank ing program. stated that the Open Market Trading Desk The Federal Reserve's efforts achieved planned to conduct a series of term resome of the desired results. The provision purchase agreements that would extend of increased liquidity generally succeeded over year-end and that it would provide Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 33 sufficient reserves to resist upward pres- ing to the maturity of the credit being sures on the federal funds rate around year- auctioned) was about 50 basis points in end. Then on December 12, the Federal December but was lower in the January Reserve and several foreign central banks and February auctions. The lower spread announced a coordinated effort to facilitate apparently reflected some improvement a return to more-normal pricing and func- in banks* access to term funding after the tioning in term funding markets. As part of turn of the year. Although isolating the that effort, the Federal Reserve announced impact of the TAF on financial markets is the creation of a temporary Term Auction not easy, a decline in spreads in term Facility (TAF) to provide secured term funding markets since early December funding to eligible depository institutions provides some evidence that the TAF may through an auction mechanism beginning have had beneficial effects on financial in mid-December. The Federal Reserve markets. The initial experience with the also established swap lines with the ECB TAF suggests that it may well be a useful and the Swiss National Bank (SNB), which complement to the discount window in provided dollar funds that those central some circumstances, and the Federal Rebanks could lend in their jurisdictions. At serve Board will consider making it a the same time, the Bank of England and the permanent addition to the Federal Re- Bank of Canada announced plans to con- serve's available instruments for providduct similar term funding operations in ing liquidity to the banking system. their own currencies. The swap arrangements with foreign The Federal Reserve has conducted six central banks allowed for up to $20 bil- TAF auctions thus far, two of $20 billion in lion in currency swaps with the ECB and December, two of $30 billion in January, up to $4 billion with the SNB. Drawing and two of $30 billion in February. The upon these lines, the ECB auctioned $10 auctions attracted a large number of bid- billion in dollar funds on December 17 ders. The ratio of the dollar value of bids to and another $10 billion on December 20 the amount offered (the bid-to-cover ratio) in coordination with the Federal Reat the two auctions in December was about serve's TAF auctions. The SNB auc- 3. The auctions in January and February tioned $4 billion in funds on December were somewhat less oversubscribed, with 17. The bid-to-cover ratios at the ECB bid-to-cover ratios of roughly 2 on January and SNB auctions in December ranged 14, February 11, and February 25 and of between WA and 4lA\ the actions were 1 lA on January 28. The lower bid-to-cover considered successful in helping to give ratios in those auctions may have reflected foreign financial institutions access to adimproved liquidity in term funding mar- ditional dollar funding. The December kets, the larger auction size, and, for the loans were renewed by the ECB and SNB January 28 auction, some uncertainty about at auctions in January, with bid-to-cover the monetary policy action that would ratios ranging from 1 lA to 2%. The ECB be taken at the January 29-30 FOMC and SNB have not conducted auctions in meeting. February; ECB officials have indicated The spread of the interest rate for the that consideration would be given to reacauctioned funds over the minimum bid rate tivating dollar auctions if conditions ap- (the overnight-index-swap rate correspond- pear to warrant such actions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

34 94th Annual Report, 2007 Financial conditions appeared to im- period. Strong demand for safe assets prove somewhat in late September and over year-end drove yields on short- October after the larger-than-expected dated Treasury bills maturing in early reduction of 50 basis points in the fed- 2008 to low levels, and liquidity in that eral funds rate at the September FOMC market was impaired at times. meeting and a few encouraging reports In mid-December, the Federal Reon economic activity. Spreads in many serve announced coordinated action short-term funding markets partially re- with a number of other central banks to versed their August run-ups. Bid-asked help facilitate a return to more-normal spreads in the interdealer market for pricing and functioning in term funding Treasury bills were a bit less elevated markets. The efforts of the central banks, than they had been in August. But the combined with the passage of year-end, Treasury bill market remained thin, and appeared to help steady short-term fiyields were volatile at times. In the syn- nancial markets in early 2008. So far dicated loan market, implied LCDX this year, commercial paper spreads— spreads partly reversed their summer both for ABCP and for lower-tier unsesurge, and some multibillion-dollar cured paper—and term bank funding deals were successfully placed in the spreads have dropped, although they remarket. However, underwriting banks main above the levels that prevailed bewere forced to take sizable discounts fore last August. In contrast, liquidity in from par value to induce investors to the Treasury bill market has been inconpurchase the loans, and they retained sistent. The subprime and alt-A mortsignificantly larger-than-intended por- gage markets remain essentially shuttions of deals on their own balance tered. Conditions in the market for sheets. The improvements in market leveraged syndicated loans have worsfunctioning proved to be short lived, in ened, and the forward calendar of compart because of a further worsening in mitted deals remains substantial. Risk the outlook for the housing sector and spreads on corporate bonds widened sigassociated concerns about possible ef- nificantly in January, and equity prices fects on financial institutions and the dropped. Most recently, demand has economy. evaporated for auction-rate securities— The strains in financial markets inten- long-term debt (much of which is musified during November and December. nicipal bonds) with floating interest The syndicated loan market again rates that are reset at frequent, regular ground to a halt, and spreads on the auctions—and thereby imposed higher LCDX indexes moved up. The height- rates on issuers and reduced liquidity for ened uncertainties and ongoing financial current holders. turmoil, along with the desire of finan- In January and February, problems at cial institutions to show safe and liquid several financial guarantors intensified assets on their year-end statements, gen- as rating agencies and investors became erated significant year-end pressures in more concerned that guarantors' exposhort-term funding markets for the first sures to collateralized debt obligations time in several years. Spreads on one- that hold asset-backed securities (espemonth Libor and term federal funds shot cially those backed by subprime residenup in late November when their maturi- tial mortgages) had imperiled the guarties crossed year-end. Similarly, spreads antors' AAA ratings. Indeed, the rating on ABCP and lower-tier unsecured com- agencies downgraded a few financial mercial paper widened further over the guarantors and put some firms on watch Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 35 for possible downgrades; financial guar- stance, the investment-grade corporate antors' equity prices declined, and credit bond market reportedly functioned well default swap spreads increased. A num- over most of the period, and the unseber of guarantors are undertaking efforts cured high-grade commercial paper to bolster their financial strength. market appeared little affected by the Financial guarantors have played an difficulties encountered in other shortimportant role in the markets for munici- term funding markets. The securitizapal bonds and for some structured fi- tion of consumer loans and conforming nance products by providing insurance residential mortgages was robust. Deagainst default. Those markets have al- spite a few notable failures, hedge funds ready felt some effects from the stress at overall seemed to hold up fairly well, the financial guarantors and could be and counterparties of failing hedge more substantially affected by any fu- funds did not sustain material losses. ture downgrades. The direct exposures of U.S. banks to losses from downgrades Policy Expectations and Interest of guarantors' ratings—through banks' Rates holdings of municipal bonds and credit protection on structured products— The current target for the federal funds appear to be moderate relative to the rate, 3 percent, is substantially below banks' capital. But some large banks the level that investors expected at the and broker-dealers could experience sig- end of June 2007. Judging from futures nificant funding pressures from struc- quotes at that time, market participants tured products tied to municipal bonds expected the FOMC to shave at most that might return to their balance sheets 25 basis points from the federal funds if guarantors are downgraded below rate by February 2008 rather than the specified thresholds or if investors 225 basis points that has been realized. choose to unwind their investments in Investors currently expect about 100 baadvance of potential downgrades. sis points of additional easing by the end Although U.S. financial markets and of 2008. Uncertainty about the path of institutions have encountered consider- policy had been very low during the first able difficulties over the past several half of the year, but it increased appremonths, the financial system entered ciably over the summer and generally that period with some distinct strengths. has remained around its long-run histori- In particular, most large financial insti- cal average since then. tutions had strong capital positions, and Although nominal Treasury yields the financial infrastructure was robust. rose somewhat over the first half of last Although some large financial institu- year, rates subsequently fell sharply as tions have experienced sizable losses, the outlook for the economy dimmed the sector generally remains healthy. A and as market participants revised their number of the firms that have reported expectations for monetary policy acsizable write-downs of assets have been cordingly. Treasury bill yields declined able to raise additional capital. Market to particularly low levels at times beinfrastructure for clearing and settlement cause of increased demand for safe and performed well over the year, even when liquid assets. On net, two-year yields volatility spiked and trading volumes fell roughly 180 basis points in the secwere very large. ond half of the year, and ten-year yields Moreover, not all markets experi- shed about 100 basis points. Treasury enced significant impairment. For in- yields fell significantly more in early Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

36 94th Annual Report, 2007 Interest Rates on Selected Treasury Spreads of Corporate Bond Yields over Securities, 2003-08 Comparable Off-the-Run Treasury Yields, by Securities Rating, 1998-2008 Percent Percental- • .11 its — Ten-year HA. — 5 High-yield w KL — ^ V Y 1 — 3 Two-year J\iyJ Three-month 1 — 2 — 4 —Kk jWSs/ J II 1 1 1 1 1 2003 2004 2005 2006 2007 2008 _L 1 1 1 _L 1 1 1998 2000 2002 2004 2006 2008 NOTE: The data are daily and extend through February 21, 2008. NOTE: The data are daily and extend through SOURCE: Department of the Treasury. February 21, 2008. The spreads shown are the yields on ten-year bonds less the ten-year Treasury yield. SOURCE: Derived from smoothed corporate yield curves using Merrill Lynch bond data. 2008, especially for shorter-term securities, as policy expectations shifted down on BBB-rated bonds increased slightly; in response to signs of further weakness spreads on AA-rated and BBB-rated in the economic outlook. As of Febbonds have risen about 90 and 130 basis ruary 21, the two-year yield was about points respectively. Moreover, yields on 2 percent, and the ten-year yield was about 33/4 percent. speculative-grade securities have increased substantially over the same pe- Yields on inflation-indexed Treasury riod, and their spreads have shot up alsecurities also declined considerably in most 300 basis points. the second half of 2007 and into 2008. The difference between the five-year Equity Markets nominal Treasury yield and the fiveyear inflation-indexed Treasury yield— Broad equity indexes logged increases five-year inflation compensation— of around 10 percent over the first half edged down over that period. of 2007 but then lost ground over the Meanwhile, the ten-year inflation com- second half; they ended the year with pensation measure changed little. As Stock Price Indexes, 2005-08 noted earlier, survey-based measures of short-term inflation expectations rose January 3,2005 *100 somewhat in 2007 and early 2008, presumably because of the increase in head- — Wilshire 5OOoM/U 130 line inflation. Survey measures of /TO longer-term inflation expectations L 120 changed only slightly. — r HO Yields on corporate bonds firmed a ^T \ 100 bit over the first half of 2007, and Dow Jones financial index 1 90 spreads of those yields over yields on 1 1 1 comparable-maturity Treasury securities :>005 2006 2007 2008 changed little, on net. Since June, yields on AA-rated corporate bonds have de- NOTE: The data are daily and extend through February21.2OO8. creased somewhat, on net, while those SOURCE: DOW Jones Indexes. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 37 gains of 3 percent to 6 percent. The in- enced large outflows in January as eqcrease reflected continued strong profit- uity prices tumbled worldwide, but ability in many nonfinancial sectors, flows appear to have stabilized in particularly energy, basic materials, and February. technology. By contrast, stock indexes for the financial sector fell about 20 per- Debt and cent in 2007 as investors reacted to the Financial Intermediation fallout from the problems in the The total debt of the domestic nonfinansubprime mortgage sector. So far in cial sectors appears to have expanded 2008, growing concerns about the ecoabout 8 percent in 2007, a slightly nomic outlook, along with announceslower rate of growth than in 2006. The ments of additional substantial losses at slowing reflected a deceleration of some large financial firms, have precipihousehold debt that was only partially tated a widespread drop in equity prices offset by a considerable step-up in borthat has pushed broad indexes down rowing by businesses and governments. about 8 percent. Commercial bank credit rose The continued uncertainty surround- 10% percent last year, a pickup from the ing the ultimate size and distribution of 93/4 percent gain in 2006.12 The accellosses from subprime-related and other eration of bank credit, as well as the investment products, as well as the podifferences in growth rates across bank tential effects of the financial turmoil on asset classes, reflect in part the effects of the broader economy, contributed to the financial market distress. As already higher volatility in equity markets and a noted, commercial and industrial loans wider equity premium. The implied surged in 2007 because of extremely volatility of the S&P 500, as calculated rapid growth in the second half of the from options prices, rose significantly in year that in part resulted from the inabilthe second half of 2007 and remains elity of banks to syndicate leveraged evated. The ratio of twelve-monthloans. At various times over the second forward expected earnings to equity half of the year, banks' balance sheets prices for S&P 500 firms increased over were boosted by extensions of credit to the second half of 2007 and into 2008, nonbank financial institutions, a catwhile the long-term real Treasury yield egory that includes loans to ABCP prodecreased. The difference between these grams that were no longer able to issue two values—a measure of the premium commercial paper. Through the third that investors require for holding equity quarter of 2007, the growth of residenshares—has reached the high end of its tial mortgages (excluding revolving range over the past twenty years. home equity loans) was fairly robust, Flows into equity mutual funds were but the value of such loans on banks' heavy early in 2007 but slowed substanbooks contracted in the fourth quarter. tially after the first quarter. Indeed, eq- The reversal likely stemmed from a uity funds that focused on domestic holdings experienced consistent net outflows beginning in the spring. By contrast, inflows into foreign equity funds 12. The data for commercial bank balance held up through the end of 2007 despite sheets are adjusted for some shifts of assets and liabilities between commercial banks and nonthe weakness in many foreign stock banks, including those resulting from mergers, acmarkets in the fourth quarter. Both doquisitions, changes in charter, and asset purchases mestic and foreign equity funds experi- and sales. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

38 94th Annual Report, 2007 stepped-up pace of securitization of con- Loan delinquency rates rose noticeably forming mortgages and a slowing of for many loan categories, but especially new originations in response to the for residential mortgages, construction weaker demand and the tightening of and land development loans financing lending standards reported in the Senior residential projects, and other construc- Loan Officer Opinion Surveys covering tion and land development loans. the second half of 2007. The growth of Other types of financial institutions revolving home equity loans picked up also faced substantial challenges in in 2007, particularly late in the year; 2007. As a result of exposures to because rates on such loans are gener- subprime loans, some thrift institutions ally tied to short-term market rates, had significant losses. Several of the which declined over the second half of major investment banks and their affili- 2007, that form of financing may have ates booked losses on mortgage-related become relatively more attractive. Bank products and other exposures that were consumer loans grew somewhat faster large enough to lead some of them to in 2007 than in 2006, which is consis- raise additional equity capital. tent with some substitution of nonmort- In the third quarter, Fannie Mae and gage credit for mortgage credit. To fund Freddie Mac each experienced sizable the rapid expansion of their balance losses on their mortgage portfolios and sheets, commercial banks mainly turned on credit guarantees. In response, both to a variety of managed liabilities, in- firms raised additional equity. The firms cluding large time deposits and ad- also tightened underwriting standards vances from Federal Home Loan Banks. slightly and increased the fees that they Branches and agencies of foreign banks charge to purchase some types of loans. also tapped their parent institutions for All else equal, these changes would be funds. The growth of bank credit slowed expected to increase borrower costs for in January 2008, as declines in holdings conforming loans. of securities and residential mortgages partly offset continued growth in most other loan categories. The M2 Monetary Aggregate Bank profits declined significantly in 2007 as fallout from the subprime mort- M2 grew at a solid rate, on balance, in gage crisis and related financial disrup- 2007 and the early part of 2008. Growth tions caused trading income to plunge was supported by declines in the opporand loss provisions to more than double tunity cost of holding money relative to from the previous year. Over the second other financial assets. The considerable half of 2007, the return on assets and the growth of money market mutual funds return on equity both dropped to levels also boosted M2 as investors sought the not seen since the early 1990s. Weak relative safety of these liquid assets profits or outright losses, along with sig- amid the volatility in various financial nificant balance sheet growth, also put markets. The currency component of pressure on capital ratios at some of the M2 decelerated further in 2007 from its largest commercial banks. In response, a already tepid pace in 2006; it actually number of banking organizations raised contracted from November through significant amounts of new capital in the January 2008, probably because of resecond half of 2007 and early 2008. duced demand from foreign sources. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 39 International Developments tern; inflation compensation (the difference between yields on nominal securities and those on inflation- International Financial Markets protected securities) fell modestly in Global financial markets were calm over Canada and rose slightly in the euro the first half of 2007 except for a brief area. Since the beginning of 2008, yields period in late February when equity on nominal securities in most economarkets were roiled in part by worries mies have declined; yields on indexed about U.S. subprime mortgage lenders. securities have fallen in the euro area After midyear, as the global financial but have risen in Canada, the United turmoil began in earnest and the possi- Kingdom, and Japan. bility of slowing growth weighed on in- The Federal Reserve's broadest meavestor sentiment, market volatility rose sure of the nominal trade-weighted forsubstantially, and on net most major for- eign exchange value of the dollar has eign stock markets fell. Despite the declined about 8 percent on net since the rocky end to the year, most major equity beginning of 2007. Over the same peindexes in the advanced foreign econo- riod, the major currencies index of the mies, with the exception of Japan, fin- dollar has moved down a bit more than ished higher on net in local-currency 10 percent. The dollar has depreciated terms compared with the beginning of about 9Vi percent against the yen and 2007. However, indexes of the stock slightly more than 10 percent versus the prices of financial firms in those coun- euro. The dollar has depreciated roughly tries declined 10 percent to 30 percent. The financial turbulence had less effect U.S. Dollar Nominal Exchange Rate, on equity prices in emerging markets, Broad Index, 2004-08 and most major emerging-market stock indexes outperformed their counterparts Week ending January 9,2004 = 100 in the advanced economies. So far in 2008, stock markets in both advanced and emerging-market economies are down further as concerns about global growth have increased. Long-term bond yields in the advanced foreign economies rose over the first half of 2007 but then reversed course as investors reacted to signs in many countries of deteriorating financial conditions, a softening economic outlook, and expectations for a lower — 86 1 I J_ future path of monetary policy rates. All 2(X)4 2005 2006 2007 2008 told, the net changes were not large; NOTE: The data, which are in foreign currency units long-term rates in Canada, the United per dollar, are weekly. The last observation for each Kingdom, and Japan ended the year series is the average for February 18 through February 20 to 30 basis points lower, on net, while 21, 2008. The broad index is a weighted average of the foreign exchange values of the U.S. dollar against the they were about 10 basis points higher currencies of a large group of the most important U.S. in the euro area than at the start of the trading partners. The index weights, which change over time, are derived from U.S. export shares and from U.S. year. Yields on inflation-protected longand foreign import shares. term securities followed a similar pat- SOURCE: Federal Reserve Board. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

40 94th Annual Report, 2007 13V2 percent against the Canadian dollar the changes in the prices of energy and and in November briefly touched its unprocessed food) has moved up as lowest level in decades against that cur- well. Canadian inflation climbed from rency. The dollar has declined %Vi per- less than 1 percent late in 2006 to about cent against the Chinese renminbi since 2Vi percent in the second half of 2007; the beginning of 2007, and the pace of however, core inflation has slowed in depreciation accelerated late last year. recent months, partly because of the continued strength of the Canadian dollar. Although inflation in Japan was Advanced Foreign Economies close to zero for most of 2007, the rate Economic activity in the major ad- picked up to roughly 3A percent at the vanced foreign economies posted rela- end of the year, again mainly a result of tively strong growth over the first three the rise in energy prices. quarters of 2007, and labor markets Faced with a weaker outlook for tightened. However, evidence of a slow- growth but somewhat higher inflation, down has accumulated since the sum- major foreign central banks either have mer. Financial market strains appear to cut official policy rates or have remained be weighing on growth in the major on hold since late 2007—a change from economies. Surveys of banks have re- earlier market expectations of further vealed a tightening of credit standards rate increases. The Bank of Canada and for both households and businesses. the Bank of England lowered their tar- Both consumer and business confidence gets for their respective overnight rates. have slid since August, and readings The European Central Bank and the from surveys of economic activity have Bank of Japan have kept their policy declined. Retail sales have slowed, and rates at 4 percent and 0.5 percent respechousing markets in a number of coun- tively. (Further discussion of actions by tries that until recently had been foreign central banks is in the box enrobust—including Ireland, Spain, and titled "The Federal Reserve's Responses the United Kingdom—have softened. to Financial Strains.") According to initial releases, real GDP growth for the fourth quarter slowed in a number of countries. Although growth Emerging-Market Economies in Japan rebounded in the fourth quarter—pushed up by strong exports The growth of output in the emergingand capital spending—household spend- market economies also slowed in the ing has been relatively weak, and the second half of 2007 but was still strong. construction sector has been depressed In China, government policy measures by changes to regulations that have re- helped moderate the growth rate of real sulted in bottlenecks in reviewing build- GDP in the second half. To damp loan ing plans. growth, the government in 2007 repeat- Headline rates of inflation have con- edly raised the reserve requirement ratio tinued to rise in some economies, and the benchmark rate at which banks mainly because of increasing food and can lend to their customers. In addition, energy prices. The twelve-month change the government directed banks to freeze in consumer prices in the euro area ex- their level of lending over the final two ceeded 3 percent in January, up from months of 2007 at the October level. less than 2 percent just a few months Chinese authorities also allowed the renearlier; core inflation (which excludes minbi's rate of appreciation to step up in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Recent Economic and Financial Developments 41 late 2007, and the People's Bank of Increases in the prices of food and China noted in its monetary policy re- fuel contributed to a rise in consumer port in November that it would be using price inflation in many emerging-market the exchange rate as a tool to fight economies. Prices of edible oils and inflation. grains were boosted by increased de- Elsewhere in emerging Asia, growth mand, higher energy prices, and unfaappears to have stepped down to a more vorable weather in several producing retempered pace in several countries in gions. Meat and dairy prices have also the second half of the year, though gen- increased as consumption of these proderally from very strong levels in the first ucts in developing countries has grown half. One factor suppressing growth in rapidly and as the price of animal feed— these export-dependent economies ap- mostly grain—has risen. Inflation rose pears to be a softening of the rate of during 2007 in many emerging Asian activity in the rest of the world. economies, including China, where the In Mexico, output growth was moder- inflation rate for the twelve months endate in 2007 and followed roughly the ing in January reached just over 7 persame pattern as in the United States. cent. Also, the pace of consumer price The growth of economic activity ex- inflation rose in the second half of the ceeded 5 percent during the third quarter year in Argentina, Chile, Mexico, and but slowed to 3 percent in the fourth Venezuela. The rise in inflation in Venquarter. In Brazil and other Latin Ameri- ezuela was compounded by stimulative can countries, growth was robust. monetary and fiscal policies. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

43 Part 3 Monetary Policy in 2007 and Early 2008 Throughout the first half of 2007, the high resource utilization had the potenavailable information pointed to a gener- tial to sustain upward pressure on inflaally favorable economic outlook despite tion. As a result, during the first half of the ongoing correction in the housing the year, the Committee consistently market. Indicators of consumer and noted in its statement that its predomibusiness spending were somewhat un- nant policy concern was that inflation even, but their generally positive trajec- would fail to moderate as expected. tories suggested that the housing market However, in part owing to indications of developments were, as yet, having little increasing weakness in the housing seceffect on the broader economy. Net ex- tor, the Committee emphasized in the ports, spurred in part by a falling dollar, statements issued at the conclusion of its were providing support to economic March, May, and June meetings that its growth. Outside of the subprime mort- future policy actions would depend on gage sector, financial conditions in gen- the evolution of the outlook for both eral were fairly accommodative. The inflation and economic growth. Federal Open Market Committee ex- When the Committee met on Aupected core inflation to moderate from gust 7, financial markets had been unthe somewhat elevated level that had usually volatile for a few weeks, and prevailed at the start of the year, but credit conditions had become somewhat Selected Interest Rates, 2005-08 Percent Ten-year Treasury rate — 1 2/2 5/3 8/9 11/1 1/31 5/10 8/8 10/25 1/31 5/9 8/7 10/31 1/30 3/22 6/30 9/20 12/13 3/28 6/29 9/20 12/12 3/21 6/28 9/18 12/11 2005 2006 2007 2008 NOTE: The data are daily and extend through February 21, 2008. 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 regularly scheduled FOMC meetings. SOURCE: Department of the Treasury and the Federal Reserve. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

44 94th Annual Report 2007 tighter for some households and busi- FOMC's target rate of 5lA percent. As nesses. Participants in FOMC meetings conditions deteriorated further, the Com- (Board members and Reserve Bank mittee met again on August 16 by conpresidents) noted that adjustments in the ference call to discuss the potential usehousing sector had the potential to prove fulness of various policy responses. The deeper and more prolonged than had following day, the Federal Reserve anseemed likely earlier in the year, and a nounced changes in discount window further underperformance in the housing policies to facilitate the orderly funcarea represented a significant downside tioning of short-term credit markets. risk to the economic outlook. Nonethe- Furthermore, the FOMC released a less, incoming data indicated that eco- statement indicating that the downside nomic growth had strengthened in the risks to growth had increased appreciasecond quarter, as a quicker pace of bly and that the Committee was prebusiness spending offset a slowdown in pared to act as needed to mitigate adconsumer outlays. Participants believed verse effects on the economy. (The box that the economy remained likely to ex- entitled "The Federal Reserve's Repand at a moderate pace in coming quar- sponses to Financial Strains" provides ters, supported in part by continued additional detail on the outcomes of growth in business investment and a ro- these conference calls and other meabust global economy. Although core in- sures taken by the Federal Reserve to flation had moved lower since the start facilitate the orderly functioning of fiof the year, participants were still con- nancial markets over the second half of cerned about several factors—including the year, including coordinated actions a continued high level of resource with other central banks.) utilization—that could augment infla- At the time of the September FOMC tion pressures. They believed that a sus- meeting, financial markets remained tained moderation in those pressures had volatile. Liquidity in short-term funding yet to be convincingly demonstrated. As markets was significantly impaired amid a result, the FOMC decided to leave the heightened investor unease about expotarget for the federal funds rate un- sures to subprime mortgages and to changed at 5VA percent and, despite some- structured credit products more broadly. what greater downside risks to growth, Credit generally remained available for reiterated that the predominant policy most businesses and households, but the concern remained the risk that inflation Committee noted that the tighter credit would fail to moderate as expected. conditions for other borrowers had the In the days following the August 7 potential to restrain economic growth. FOMC meeting, financial conditions de- Incoming economic data were mixed: teriorated rapidly as market participants Consumer spending appeared to have became concerned about counterparty strengthened from its subdued secondcredit risk and their access to liquidity. quarter pace, but a further intensifica- After an FOMC conference call on Au- tion of the housing contraction and gust 10 to review worsening strains in slowing employment growth suggested money and credit markets, the Commit- a weaker economic outlook. Participants tee issued a statement indicating that the noted that incoming data on core infla- Federal Reserve would provide reserves tion continued to be favorable and that as necessary through open market opera- the downwardly revised economic outtions to promote trading in the federal look implied some lessening of presfunds market at rates close to the sures on resources, but they remained Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy in 2007 and Early 2008 45 concerned about possible upside risks to Also at the October meeting, the inflation. To forestall some of the ad- Committee continued its discussions reverse macroeconomic effects that might garding communication with the public. otherwise arise from the disruptions in Participants reached a consensus on infinancial markets and to promote moder- creasing the frequency and expanding ate growth over time, the FOMC low- the content of their periodic economic ered the target for the federal funds rate projections. Under the new procedure, 50 basis points, to 43A percent. The which was announced on November 14, Committee also noted that recent devel- the FOMC compiles and releases the opments had increased the uncertainty projections made by the Federal Reserve surrounding the economic outlook and Governors and Reserve Bank presidents stated that it would act as needed to four times each year, at approximately foster price stability and sustainable eco- quarterly intervals, rather than twice each year, as had been the practice since nomic growth. 1979. In addition, the projection horizon At the time of the October FOMC has been extended from two years to meeting, the data indicated that ecothree years. FOMC meeting participants nomic growth had been solid in the third provide projections for the increase in quarter. A pickup in consumer spending the price index for total personal conand continued expansion of business insumption expenditures (PCE) as well as vestment suggested that spillovers from projections for real GDP growth, the unthe turmoil in the housing and financial employment rate, and core PCE price markets had been limited to that point. inflation. Summaries of the projections Although strains in financial markets and an accompanying narrative are pubhad eased somewhat on balance, tighter lished along with the minutes of the credit conditions were thought likely to FOMC meeting at which they were disslow the pace of economic expansion cussed. Beginning with the present reover coming quarters. Furthermore, the port, the projections made in January are downturn in residential construction had included in the February Monetary deepened, and available indicators Policy Report to the Congress, and the pointed to a further slowing in housing projections made in June are included in activity in the near term. FOMC meetthe July report. ing participants noted that readings on In a conference call on December 6, core inflation had improved somewhat Board members and Reserve Bank over the year and anticipated that some presidents reviewed conditions in doof the moderation likely would be sus- mestic and foreign financial markets and tained. Nonetheless, participants ex- discussed two proposals aimed at impressed concern about the upside risks proving market functioning. The first to the outlook for inflation, stemming in proposal was for the establishment of a part from the effects of recent increases temporary Term Auction Facility (TAF), in commodity prices and the significant which would provide term funding decline in the foreign exchange value of through an auction mechanism to elithe dollar. Against that backdrop, the gible depository institutions against a Committee decided to lower the target broader range of collateral than that used for the federal funds rate 25 basis points, for open market operations. The second to 4J/2 percent, and judged that the up- proposal was to set up a foreign exside risks to inflation roughly balanced change swap arrangement with the Euthe downside risks to growth. ropean Central Bank to address elevated Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

46 94th Annual Report, 2007 pressures in short-term dollar funding FOMC lowered the target for the federal markets. At the conclusion of the discus- funds rate a further 25 basis points, to sion, the Committee voted to direct the 4V4 percent, and, given the heightened Federal Reserve Bank of New York to uncertainty, the Committee decided to establish and maintain a reciprocal cur- refrain from providing an explicit asrency (swap) arrangement for the Sys- sessment of the balance of risks. The tem Open Market Account with the Eu- Committee also indicated that it would ropean Central Bank.1 The Board of continue to assess the effects of finan- Governors approved the TAF via nota- cial and other developments on ecotion vote on December 10. nomic prospects and act as needed to At the Committee's meeting on De- foster price stability and sustainable ecocember 11, participants noted that in- nomic growth. In addition to that policy coming information suggested economic move, the Federal Reserve and several activity had decelerated significantly in other central banks announced on Dethe fourth quarter. The housing contrac- cember 12 the measures they were taktion had steepened further, and partici- ing to address elevated pressures in pants agreed that the sector was weaker short-term funding markets. The Federal than had been expected at the time of Reserve announced the creation of the the Committee's previous meeting. TAF and the establishment of foreign Moreover, spillovers from housing to exchange swap lines with the European other parts of the economy had begun to Central Bank and the Swiss National emerge: Consumption spending ap- Bank. peared to be softening more than had In a conference call on January 9, the been anticipated, and employment gains Committee reviewed recent economic appeared to be slowing. Participants data and financial market developnoted that evidence of further deteriora- ments. The information, which included tion in the credit quality of mortgages weaker-than-expected data on home and other loans to households appeared sales and employment for December, as to be spurring lenders to further tighten well as a sharp decline in equity prices the terms on new extensions of credit since the beginning of the year, sugfor a widening range of credit products. gested that the downside risks to growth Financial market conditions had wors- had increased significantly since the ened significantly. The financial strains time of the December FOMC meeting. were exacerbated by concerns related to Moreover, participants cited concerns year-end pressures in short-term fund- that the slowing of economic growth ing markets, and similar stresses were could lead to a further tightening of fievident in the financial markets of major nancial conditions, which in turn could foreign economies. Although a surge in reinforce the economic slowdown. energy prices pushed up headline con- However, participants noted that core insumer price inflation during September flation had edged up in recent months and October, Committee members and believed that considerable unceragreed that the inflation situation had tainty surrounded the inflation outlook. changed little from the time of the previ- Participants were generally of the view ous meeting. In these circumstances, the that substantial additional policy easing might well be necessary to support economic activity and reduce the downside 1. A swap arrangement with the Swiss National risks to growth, and they discussed the Bank was approved by the Committee on December 11. possible timing of such actions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy in 2007 and Early 2008 47 On January 21, the Committee held tensifying and a range of financial maranother conference call. Participants in kets remaining under pressure, particithe call noted that strains in some finan- pants generally expected economic cial markets had intensified and that growth to remain weak in the first half incoming evidence had reinforced their of 2008 before picking up strength in view that the outlook for economic the second half. However, the continuactivity was weak. Participants ob- ing weakness in home sales and house served that investors apparently were prices, as well as the tightening of credit becoming increasingly concerned about conditions for households and busithe economic outlook and that these nesses, were seen as posing downside developments could lead to an exces- risks to the near-term outlook for ecosive pullback in credit availability. nomic growth. Moreover, many partici- Against that background, members pants cited risks regarding the potential judged that a substantial easing in for adverse feedback between the finanpolicy was appropriate to foster moder- cial markets and the economy. Particiate economic growth and reduce the pants expressed some concern about the downside risks to economic activity. disappointing inflation data received The Committee decided to lower the over the latter part of 2007. Although target for the federal funds rate 75 basis many expected that a leveling out of points, to 3V2 percent, and stated that prices for energy and other commodiappreciable downside risks to growth ties, such as that embedded in futures remained. Although inflation was ex- markets, and a period of below-trend pected to edge lower over the course of growth would contribute to some mod- 2008, participants underscored that this eration in inflation pressures over time, assessment was conditioned upon infla- the Committee believed that it remained tion expectations remaining well an- necessary to monitor inflation developchored and stressed that the inflation ments carefully. Against that backdrop, situation should continue to be moni- the FOMC decided to lower the target tored carefully. for the federal funds rate 50 basis points, to 3 percent. The Committee believed The data reviewed at the regularly that the policy action, combined with scheduled FOMC meeting on January those taken earlier, would help promote 29 and 30 confirmed a sharp deceleramoderate growth over time and mitigate tion in economic growth during the the risks to economic activity. However, fourth quarter of 2007 and continued members judged that downside risks to tightening of financial conditions. With growth remained. • the contraction in the housing sector in- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

49 Part 4 Summary of Economic Projections The following material appeared as ther ahead was projected to pick up to a an addendum to the minutes of the pace around or a bit above its long-run January 29-30, 2008, meeting of the trend by 2010. Inflation was expected to Federal Open Market Committee. decline in 2008 and 2009 from its recent elevated levels as energy prices leveled In conjunction with the January 2008 out and economic slack contained cost FOMC meeting, the members of the and price increases. Most participants Board of Governors and the presidents judged that considerable uncertainty surof the Federal Reserve Banks, all of rounded their projections for output whom participate in the deliberations of growth and viewed the risks to their the FOMC, provided projections for forecasts as weighted to the downside. economic growth, unemployment, and A majority of participants viewed the inflation in 2008, 2009, and 2010. Prorisks to the inflation outlook as broadly jections were based on information balanced, but a number of participants available through the conclusion of the saw the risks to inflation as skewed to January meeting, on each participant's the upside. assumptions regarding a range of factors likely to affect economic outcomes, and The Outlook on his or her assessment of appropriate monetary policy. "Appropriate monetary The central tendency of participants' policy" is defined as the future policy projections for real GDP growth in that, based on current information, is 2008, at 1.3 to 2.0 percent, was considdeemed most likely to foster outcomes erably lower than the central tendency for economic activity and inflation that of the projections provided in conjuncbest satisfy the participant's interpreta- tion with the October FOMC meeting, tion of the Federal Reserve's dual objec- which was 1.8 to 2.5 percent. These tives of maximum employment and downward revisions to the 2008 outlook price stability. stemmed from a number of factors, in- The projections, which are summa- cluding a further intensification of the rized in table 1 and chart 1, suggest that housing market correction, tighter credit FOMC participants expected that output conditions amid increased concerns would grow at a pace appreciably below about credit quality and ongoing turmoil its trend rate in 2008, owing primarily to in financial markets, and higher oil a deepening of the housing contraction prices. However, some participants and a tightening in the availability of noted that a fiscal stimulus package household and business credit, and that would likely provide a temporary boost the unemployment rate would increase to domestic demand in the second half somewhat. Given the substantial reduc- of this year. Beyond 2008, a number of tions in the target federal funds rate factors were projected to buoy economic through the January FOMC meeting as growth, including a gradual turnaround well as the assumption of appropriate in housing markets, lower interest rates policy going forward, output growth fur- associated with the substantial easing of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

50 94th Annual Report, 2007 1. Economic Projections of Federal Reserve Governors and Reserve Bank Presidents (Percent) 2008 2009 2010 Central Tendency1 Growth of real GDP 1.3 to 2.0 2.1 to 2.7 2.5 to 3.0 October projections 1.8 to 2.5 2.3 to 2.7 2.5 to 2.6 Unemployment rate 5.2 to 5.3 5.0 to 5.3 4.9 to 5.1 October projections 4.8 to 4.9 4.8 to 4.9 4.7 to 4.9 PCE inflation 2.1 to 2.4 1.7 to 2.0 1.7 to 2.0 October projections 1.8 to 2.1 1.7 to 2.0 1.6 to 1.9 Core PCE inflation 2.0 to 2.2 1.7 to 2.0 1.7 to 1.9 October projections 1.7 to 1.9 1.7 to 1.9 1.6 to 1.9 Range2 Growth of real GDP 1.0 to 2.2 1.8 to 3.2 2.2 to 3.2 October projections 1.6 to 2.6 2.0 to 2.8 2.2 to 2.7 Unemployment rate 5.0 to 5.5 4.9 to 5.7 4.7 to 5.4 October projections 4.6 to 5.0 4.6 to 5.0 4.6 to 5.0 PCE inflation 2.0 to 2.8 1.7 to 2.3 1.5 to 2.0 October projections 1.7 to 2.3 1.5 to 2.2 1.5 to 2.0 Core PCE inflation 1.9 to 2.3 1.7 to 2.2 1.4 to 2.0 October projections 1.7 to 2.0 1.5 to 2.0 1.5 to 2.0 NOTE: Projections of the growth of real GDP, of PCE ployment rate in the fourth quarter of the year indicated. inflation, and of core PCE inflation are percent changes Each participant's projections are based on his or her from the fourth quarter of the previous year to the fourth assessment of appropriate monetary policy. quarter of the year indicated. PCE inflation and core PCE 1. The central tendency excludes the three highest and inflation are the percentage rates of change in, respec- three lowest projections for each variable in each year. tively, the price index for personal consumption expendi- 2. The range for a variable in a given year includes all tures and the price index for personal consumption expen- participants' projections, from lowest to highest, for that ditures excluding food and energy. Projections for the variable in that year. unemployment rate are for the average civilian unemmonetary policy to date and appropriate to edge lower in 2010 as output growth adjustments to policy going forward, picks up, although in both years the unand an anticipated reduction in financial employment rate was projected to be a market strains. Real GDP was expected little higher than had been anticipated in to accelerate somewhat in 2009 and by October. 2010 to expand at or a little above par- The higher-than-expected rates of ticipants' estimates of the rate of trend overall and core inflation since October, growth. which were driven in part by the steep With output growth running below run-up in oil prices, had caused particitrend over the next year or so, most par- pants to revise up somewhat their proticipants expected that the unemploy- jections for inflation in the near term. ment rate would edge higher. The cen- The central tendency of participants' tral tendency of participants' projections projections for core PCE inflation in for the average rate of unemployment in 2008 was 2.0 to 2.2 percent, up from the the fourth quarter of 2008 was 5.2 to 1.7 to 1.9 percent central tendency in 5.3 percent, above the 4.8 to 4.9 percent October. However, core inflation was unemployment rate forecasted in Octo- expected to moderate over the next two ber and broadly suggestive of some years, reflecting muted pressures on reslack in labor markets. The unemploy- sources and fairly well-anchored inflament rate was generally expected to tion expectations. Overall PCE inflation change relatively little in 2009 and then was projected to decline from its current Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Summary of Economic Projections 51 Chart 1: Central Tendencies and Ranges of Economic Projections Real GDP growth Central tendency of projections — 6 —I— Range of projections — 5 — 4 — 2 * — 1 _| Unemployment rate — 7 — 6 t — 5 — 4 2003 2004 2005 2006 PCE inflation — 4 — 3 — 2 ! — 1 2003 2004 2005 2006 Core PCE inflation — 3 — 2 — 1 _l 2003 2004 2005 2006 Note: See notes to table 1 for variable definitions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

52 94th Annual Report, 2007 elevated rate over the coming year, tential losses at major financial institulargely reflecting the assumption that tions had mounted amid worries about energy and food prices would flatten the condition of financial guarantors, out. Thereafter, overall PCE inflation and credit conditions had tightened in was projected to move largely in step general for both households and firms. with core PCE inflation. The potential for adverse interactions, in Participants' projections for 2010 which weaker economic activity could were importantly influenced by their lead to a worsening of financial condijudgments about the measured rates of tions and a reduced availability of credit, inflation consistent with the Federal Re- which in turn could further damp ecoserve's dual mandate to promote maxi- nomic growth, was viewed as an espemum employment and price stability cially worrisome possibility. and about the time frame over which Regarding risks to the inflation outpolicy should aim to attain those rates look, several participants pointed to the given current economic conditions. possibility that real activity could re- Many participants judged that, given the bound less vigorously than projected, recent adverse shocks to both aggregate leading to more downward pressure on demand and inflation, policy would be costs and prices than anticipated. Howable to foster only a gradual return of ever, participants also saw a number of key macroeconomic variables to their upside risks to inflation. In particular, longer-run sustainable or optimal levels. the pass-through of recent increases in Consequently, the rate of unemployment energy and commodity prices as well as was projected by some participants to of past dollar depreciation to consumer remain slightly above its longer-run sus- prices could be greater than expected. In tainable level even in 2010, and infla- addition, participants recognized a risk tion was judged likely still to be a bit that inflation expectations could become above levels that some participants less firmly anchored if the current eljudged would be consistent with the evated rates of inflation persisted for Federal Reserve's dual mandate. longer than anticipated or if the recent substantial easing in monetary policy was misinterpreted as reflecting less re- Risks to the Outlook solve among Committee members to Most participants viewed the risks to maintain low and stable inflation. On their GDP projections as weighted to the balance, a larger number of participants downside and the associated risks to than in October viewed the risks to their their projections of unemployment as inflation forecasts as broadly balanced, tilted to the upside. The possibility that although several participants continued house prices could decline more steeply to indicate that their inflation projecthan anticipated, further reducing house- tions were skewed to the upside. holds' wealth and access to credit, was The ongoing financial market turbuperceived as a significant risk to the cen- lence and tightening of credit conditions tral outlook for economic growth and had increased participants' uncertainty employment. In addition, despite some about the outlook for economic activity. recovery in money markets after the turn Most participants judged that the uncerof the year, financial market conditions tainty attending their January projeccontinued to be strained—stock prices tions for real GDP growth and for the had declined sharply since the Decem- unemployment rate was above typical ber meeting, concerns about further po- levels seen in the past. (Table 2 provides Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Summary of Economic Projections 53 2. Average Historical Projection Error The dispersion of participants' projec- Ranges (Percentage Points) tions for real GDP growth was markedly wider than in the forecasts submitted in 2008 2009 2010 October, which in turn were consider- Real GDP1 ±1.2 ±1.4 ±1.4 ably more diverse than those submitted Unemployment rate2 . ±0.5 ±0.8 ±1.0 Total consumer prices3 ±1.0 ±1.0 ±0.9 in conjunction with the June FOMC meeting and included in the Board's NOTE: Error ranges shown are measured as plus or Monetary Policy Report to the Congress minus the root mean squared error of projections that were released in the winter from 1986 through 2006 for in July. Mirroring the increase in diverthe current and following two years by various private sity of views on real GDP growth, the and government forecasters. As described in the box dispersion of participants' projections "Forecast Uncertainty," under certain assumptions, there is about a 70 percent probability that actual outcomes for for the rate of unemployment also widreal GDP, unemployment, and consumer prices will be in ened notably, particularly for 2009 and ranges implied by the average size of projection errors made in the past. Further information is in David Reif- 2010. The dispersion of projections for schneider and Peter Tulip (2007), "Gauging the Uncer- output and employment seemed largely tainty of the Economic Outlook from Historical Forecastto reflect differing assessments of the ing Errors," Finance and Economics Discussion Series #2007-60 (November). effect of financial market conditions on 1. Projection is percent change, fourth quarter of the real activity, the speed with which credit previous year to fourth quarter of the year indicated. conditions might improve, and the depth 2. Projection is the fourth quarter average of the civilian unemployment rate (percent). and duration of the housing market con- 3. Measure is the overall consumer price index, the traction. The dispersion of participants' price measure that has been most widely used in governlonger-term projections was also afment and private economic forecasts. Projection is percent change, fourth quarter of the previous year to the fected to some degree by differences in fourth quarter of the year indicated. The slightly narrower their judgments about the economy's estimated width of the confidence interval for inflation in trend growth rate and the unemployment the third year compared with those for the second and first years is likely the result of using a limited sample rate that would be consistent over time period for computing these statistics. with maximum employment. Views also differed about the pace at which output an estimate of average ranges of foreand employment would recover toward cast uncertainty for GDP growth, unemthose levels over the forecast horizon ployment, and inflation over the past twenty years.1) In contrast, the uncer- and beyond, given appropriate monetary tainty attached to participants' inflation policy. The dispersion of the projections projections was generally viewed as be- for PCE inflation in the near term partly ing broadly in line with past experience, reflected different views on the extent to although several participants judged that which recent increases in energy and the degree of uncertainty about inflation other commodity prices would pass was higher than normal. through into higher consumer prices and on the influence that inflation expectations would exert on inflation over the Diversity of Participants' Views short and medium run. Participants' in- Charts 2(a) and 2(b) provide more detail flation projections further out were inon the diversity of participants' views. fluenced by their views of the rate of inflation consistent with the Federal Reserve's dual objectives and the time it 1. The box "Forecast Uncertainty" at the end of this summary discusses the sources and interpreta- would take to achieve these goals given tion of uncertainty in economic forecasts and ex- current economic conditions and approplains the approach used to assess the uncertainty priate policy. and risks attending participants' projections. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

54 94th Annual Report, 2007 Chart 2(a): Distribution of Participants' Projections (Percent) Real GDP Unemployment rate Number of participants Number of participants 2008 2008 January projections January projections — — October projections — 14 — — October projections - 14 - - 12 - 1 "1 - 12 - - 10 - 1 1 - 10 - - 8 - 1 1 - 8 - — 6 - i 1 - 6 4 - 1 1 - 4 !~~l r L, 2 1 - 2 i L-1 I | -' I I I I I II 1 1 1 1 1 1 1 I 1 1 1 1 1 4.6- 4.8- 5.0- 5.2- 5.4 - 5.6 - 4.7 4.9 5.1 5.3 5.5 5.7 Number ofparticipai _ 2009 _ - - - - - -i h r I I I I I II i i i i 1 1 1 1 ts Number of participants _ 2009 16 - 16 14 - - 14 12 - 1 - 12 1 10 1 - 10 • 8 1 1 6 1 1 4 1 r- 2 itlti! liilisl i Ilillll-; 1 1 1 1 1 1 4.6- 4.8 - 5.0 - 5.2 - 3.3 4.7 4.9 5.1 5.3 1 1 1 1 8 6 4 2 1 1 1 5.4 - 5.6 - 5.5 5.7 Ninnber of participants Number of participants 2010 _ 16 _ 2010 - 16 - - 14 - - 14 - - 12 - - 12 - n — 10 _ i - 10 - - 8 - — 8 - i L - 6 - I - 6 - -| 4 T --'i ^ Sit. — 4 1 r i ill 2 1 : 1 — 2 1 I I I I I II i i i|l; 1 | 1 1 1 1 | 1 1 1 1 1 4.6 - 4.8 - 5.0- 5.2- 5.4- 5.6- 4.7 4.9 5.1 5.3 5.5 5.7 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Summary of Economic Projections 55 Chart 2(b): Distribution of Participants' Projections (Percent) PCE inflation Core PCE inflation Number of participants Nunher of participants 2008 2008 ;:: January projections January projections — October projections 14 — October projections - 14 - 12 - - 12 - 10 - - 10 - 8 1 - 8 _ 1 "1 6 — ,.:„: •,:,:, 1 .: m — 6 - - 4 - 111 - 4 1 - 2 - | _ 2 1 0 | 0 1 1 1 1 1 1 1 1 1 1 1.5- 1.7- 1.9- 2.1- 2.3- 2.5 - 2.7 - 1.3- 1.5- 1.7- 1.9- 2.1- 2.3- 1.6 1.8 2.0 2.2 2.4 2.6 2.8 1.4 1.6 1.8 2.0 2.2 2.4 Number of participants _ 2009 - - - - - |l - | iili1 1 1 1 ^ 1 1 1 1 1 1 1.5- 1.7- 1.9- 2.1- 2.3- 1.6 1.8 2.0 2.2 2.4 1 I 1 1 Number of participants _ 2009 16 - 16 14 - - 14 12 - - 12 10 - - 10 8 - 8 6 4 - — 4 r 2 I|9H| - 2 0 1 1 1 i i 2.5 - 2.7 - 1.3- 1.5- 1.7- 1.9- 2.1- 2.3- 2.6 2.8 1.4 1.6 1.8 2.0 2.2 2.4 Number of participants Number of participants 2010 2010 - 16 - 14 - 12 - 10 - 8 - 6 - 4 -I » 1.5- 1.7- 1.9- 2.1 - 2.3- 2.5- 2.7- 1.6 1.8 2.0 2.2 2.4 2.6 2.8 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

56 94th Annual Report, 2007 Forecast Uncertainty The economic projections provided by the numbers reported in table 2 might imply members of the Board of Governors and a probability of about 70 percent that acthe presidents of the Federal Reserve tual GDP would expand between 1.8 per- Banks help shape monetary policy and can cent to 4.2 percent in the current year, aid public understanding of the basis for and 1.6 percent to 4.4 percent in the secpolicy actions. Considerable uncertainty at- ond and third years. The corresponding tends these projections, however. The eco- 70 percent confidence intervals for overnomic and statistical models and relation- all inflation would be 1 percent to 3 perships used to help produce economic cent in the current and second years, and forecasts are necessarily imperfect descrip- 1.1 percent to 2.9 percent in the third tions of the real world. And the future path year. of the economy can be affected by myriad Because current conditions may differ unforeseen developments and events. Thus, from those that prevailed on average over in setting the stance of monetary policy, history, participants provide judgments as participants consider not only what appears to whether the uncertainty attached to to be the most likely economic outcome as their projections of each variable is embodied in their projections, but also the greater than, smaller than, or broadly range of alternative possibilities, the likeli- similar to typical levels of forecast uncerhood of their occurring, and the potential tainty in the past as shown in table 2. costs to the economy should they occur. Participants also provide judgments as to Table 2 summarizes the average histori- whether the risks to their projections are cal accuracy of a range of forecasts, includ- weighted to the upside, downside, or are ing those reported in past Monetary Policy broadly balanced. That is, participants Reports and those prepared by Federal Re- judge whether each variable is more serve Board staff in advance of meetings of likely to be above or below their projecthe Federal Open Market Committee. The tions of the most likely outcome. These projection error ranges shown in the table judgments about the uncertainty and the illustrate the considerable uncertainty asso- risks attending each participant's projecciated with economic forecasts. For ex- tions are distinct from the diversity of ample, suppose a participant projects that participants' views about the most likely real GDP and total consumer prices will outcomes. Forecast uncertainty is conrise steadily at annual rates of, respectively, cerned with the risks associated with a 3 percent and 2 percent. If the uncertainty particular projection, rather than with diattending those projections is similar to that vergences across a number of different experienced in the past and the risks around projections. the projections are broadly balanced, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

57 Monetary Policy Report of July 2007 Monetary Policy and the homes; personal consumption expendi- Economic Outlook tures (PCE) also slowed. Even so, the available data point to solid gains over- The U.S. economy generally performed all in other components of final sales, well in the first half of 2007. Activity and with manufacturing inventory imcontinued to increase moderately, on avbalances significantly reduced, growth erage, over the period; businesses added in real GDP apparently sped up. jobs at a steady pace; and the unemploy- Job growth in the first half of 2007 ment rate remained at 4Vi percent. Overwas driven by sizable increases in all inflation, however, picked up as a service-producing industries. In the result of sizable increases in energy and goods-producing sector, manufacturing food prices. At the same time, core inemployment contracted, especially at flation (which excludes the direct effects firms closely tied to the construction inof movements in energy and food dustry and at producers of motor veprices) held at about the same rate as in hicles and parts. Employment in resi- 2006; this measure smoothes through dential construction, which had turned some of the volatility in the highdown in mid-2006, decreased only modfrequency data and thus is generally a estly further over the first half of 2007 better gauge of underlying inflation despite the substantial decline in hometrends. building. Although real gross domestic product Real hourly compensation increased appears to have expanded at about the over the year ending in the first quarter, same average rate thus far this year as it the most recent period for which comdid in the second half of 2006, the pace plete data are available. In the second of expansion has been uneven. In the quarter, however, gains in real compenfirst quarter, consumer expenditures and sation were probably curtailed by a business fixed investment, taken tosteep, energy-driven rise in consumer gether, posted a solid gain. However, prices. Employment continued to rise homebuilding continued to contract, and apace in the first half of 2007 in the manufacturing firms adjusted producface of moderate growth in output. As a tion to address stock imbalances in that consequence, growth in labor prosector that had emerged over the course ductivity—which had slowed in 2006 of 2006. In the second quarter, housing from the rapid rate observed earlier in activity declined further in response to the decade—appears to have remained the continued softness in home sales and modest. The cooling of productivity still-elevated inventories of unsold new growth in recent quarters likely reflects cyclical or other temporary factors, but the underlying pace of productivity NOTE: The discussion in this chapter consists of gains may also have slowed somewhat. the text and tables from the Monetary Policy Re- Financial market conditions have conport submitted to the Congress on July 18, 2007; tinued to be generally supportive of ecothe charts from that report (as well as earlier renomic expansion thus far in 2007, ports) are available on the Board's web site, at www.federalreserve.gov/boarddocs/hh. though there was a notable repricing in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

58 94th Annual Report, 2007 the subprime-mortgage sector. In recent higher energy prices this year added to weeks, the deterioration in that sector the cost of producing a wide variety of has been particularly marked, and mar- goods and services that are included in kets for lower-quality corporate credits the core index, these effects were offset have also experienced some strains. by other factors—most notably, a slow- Nonetheless, spreads on such corporate down in the rate of increase in shelter credits have remained narrow on the costs from the very high rates seen in whole, and business borrowing has con- 2006. tinued to be fairly brisk. On balance, The U.S. economy seems likely to equity markets posted sizable gains continue to expand at a moderate pace through mid-July, in part because of in the second half of 2007 and in 2008. continued robust corporate profits and The current contraction in residential an upward revision to investors' outlook construction will likely restrain overall for the economy. The improved outlook activity for a while longer, but as stocks led market participants to mark up their of unsold new homes are brought down anticipated path for the federal funds to more comfortable levels, that restraint rate, and intermediate- and long-term in- should begin to abate. In addition, the terest rates rose significantly. The for- inventory correction that damped activeign exchange value of the dollar has ity in the manufacturing sector around declined moderately this year as the the turn of the year appears largely to pace of economic activity abroad has have run its course. Thus, stock adjuststrengthened. ment is unlikely to be a drag on produc- Overall consumer price inflation, as tion in coming quarters. Consumer measured by the PCE price index, spending should also keep moving up. picked up noticeably in the first half of Employment and real wages are on track 2007, largely because of a sharp in- to rise further, and, although the difficulcrease in energy prices. After moving ties in the subprime-mortgage market down over the second half of 2006, the have created severe financial problems prices households pay for energy subse- for some individuals and families, the quently turned up and by May were 14 household sector is in good financial percent (not at an annual rate) above shape overall. Businesses are also contheir level at the end of last year. Food tinuing to enjoy favorable financial conprices also contributed to the step-up in ditions, which, along with a further exoverall inflation this year. The faster rate pansion in business output, should of increase in overall prices has had only support moderate increases in business a modest effect on inflation expecta- investment. The positive outlook for tions: Surveys suggest that near-term in- economic activity abroad bodes well for flation expectations have risen some- U.S. exports. what in recent months, but measures of Core inflation is expected to moderlong-term inflation expectations have re- ate a bit further over the next year and a mained within the range of recent years. half. Longer-run inflation expectations The rate of increase in the core PCE are contained, pressures on resource utiprice index ticked down from 2.1 per- lization should ease slightly in an envicent over the twelve months of 2006 to ronment of economic expansion at or an annual rate of 2.0 percent over the just below the rate of increase in the first five months of 2007, primarily ac- nation's potential to produce, and some counted for by more-favorable readings of the other factors that boosted inflabetween March and May. Although tion in recent years have already receded Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 59 or seem likely to do so. As noted, in- pushed the personal saving rate into creases in shelter costs, which helped negative territory; increases in consumppush up core inflation in 2006, have tion could return to their earlier pace. slowed appreciably this year. In addi- Exports could also boost aggregate detion, the paths for the prices of energy mand more than anticipated, especially and other commodities embedded in fu- if economic conditions abroad continue tures markets suggest that the impetus to to exceed expectations. core inflation from these influences should diminish. And although unit la- The Conduct of Monetary Policy bor costs in the nonfarm business sector over the First Half of 2007 have been rising, the average markup of prices over unit labor costs is still high The Federal Open Market Committee by historical standards, an indication (FOMC) left the stance of monetary that firms could potentially absorb policy unchanged over the first half of higher costs, at least for a time, through 2007. At the time of the January meeta narrowing of profit margins. ing, available economic information Nonetheless, the possibility that the pointed to a relatively favorable outlook expected moderation in inflation will for both economic growth and inflation. fail to materialize remains the predomi- While manufacturing activity had softnant risk to the economic outlook. The ened, the housing sector had shown tenmore-favorable readings on core infla- tative signs of stabilizing, and consumer tion in recent months partly reflect some spending remained strong. Readings on factors that seem likely to prove transi- core inflation had improved some from tory. Moreover, the economy appears to the elevated levels reached in 2006, and be operating at a high level of resource inflation expectations continued to be utilization, which has the potential to stable. Nevertheless, the prevailing level sustain inflation pressures. In addition, of inflation was uncomfortably high, an upward impetus to costs could ema- and elevated resource utilization had the nate from other sources, including potential to sustain inflation pressures. higher prices for energy and other com- Against this backdrop, the Committee modities or a slower rate of increase in decided to leave its target for the federal structural productivity. Another concern funds rate unchanged at 5lA percent and is that high rates of headline inflation, if reiterated in its policy statement that prolonged, could cause longer-run infla- some inflation risks remained. The tion expectations to rise and could thus Committee also explained that the exbecome another factor sustaining infla- tent and timing of any additional firmtion pressures. ing would depend on the evolution of Significant risks also attend the out- the outlook for both inflation and ecolook for real economic activity. On the nomic growth as implied by incoming downside, the fall in housing construc- information. tion could intensify or last longer than When the Committee met in March, expected. In addition, persistent weak- data suggested that the ongoing weakness in the housing sector could spill ness in the housing market had not over to other sectors, especially con- spilled over to consumption spending, sumption. But upside risks also exist. and the strains in the subprime-mortgage For example, consumer spending ap- market did not appear to be affecting the pears to be rising less rapidly of late availability of other types of household after a period of large increases that or business credit. Although investment Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

60 94th Annual Report, 2007 spending had been soft, it was expected of resource utilization had the potential to pick up, primarily because of strong to sustain those pressures. As a result, corporate balance sheets, continued high the FOMC decided to leave its target for profitability, and generally favorable fi- the federal funds rate unchanged at nancial conditions. Nevertheless, slug- 5lA percent and repeated in the stategish business spending and the deterio- ment that its predominant policy conration in the subprime-mortgage market cern remained the risk that inflation suggested that downside risks to growth would fail to moderate as expected. had increased. At the same time, read- At the June meeting, data appeared to ings on core inflation had stayed some- confirm that economic growth had what elevated, and increases in the strengthened in the second quarter of prices of energy and non-energy com- 2007 despite the ongoing adjustment in modities had boosted the risk that the the housing sector. Business spending expected deceleration in inflation would on capital equipment, which had falfail to occur. The FOMC decided to tered around the turn of the year, firmed leave its target for the federal funds rate somewhat in the spring, and nonresidenunchanged at 5lA percent and noted in tial construction advanced briskly. In adthe accompanying statement that its pre- dition, the inventory correction that had dominant policy concern remained the held down economic activity late last risk that inflation would fail to moderate year and early this year seemed to have as expected. In light of the increased mostly run its course. Moreover, defense uncertainty about the outlook for both spending and net exports appeared inflation and growth, the statement indi- poised to rebound after sagging in the cated that future policy adjustments first quarter. These factors more than would depend on the evolution of the offset a slowdown in the growth of conoutlook for both inflation and economic sumer spending. Readings on core inflagrowth as implied by incoming in- tion remained favorable in April and formation—a characterization that has May. Nonetheless, a sustained moderabeen repeated in the two postmeeting tion of inflation pressures had yet to be FOMC statements since then. convincingly demonstrated, and the high In May, the data in hand indicated level of resource utilization had the pothat the adjustment in the housing sector tential to sustain those pressures. Under was continuing and appeared likely to these circumstances, the Committee depersist for longer than previously antici- cided to leave its target for the federal pated. Moreover, growth in consumer funds rate unchanged at 5lA percent. In spending seemed to have slowed in the its policy statement, the Committee reearly spring. Nonetheless, because the peated that its predominant policy conproblems in the subprime-mortgage cern remained the risk that inflation market apparently were contained and would fail to moderate as expected. business spending indicators suggested At their meetings over the first half of improving prospects for investment, the 2007, FOMC meeting participants coneconomy seemed likely to expand at a tinued the discussions they had formally moderate pace over coming quarters. initiated last year regarding their com- Despite more-favorable readings for munications with the public. The discus- March, core inflation remained some- sions included a review of the role of the what elevated from a longer perspective. economic projections that are made Inflation pressures were expected to twice a year by the members of the moderate over time, but the high level Board of Governors and the Reserve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 61 Bank presidents and which are included Economic Projections for 2007 and 2008 in the Board's Monetary Policy Report Percent to the Congress. In addition, participants exchanged views on the possible advan- Federal Reserve Governors and tages and disadvantages of specifying a Reserve Bank presidents Indicator numerical price objective for monetary policy. They also discussed the appro- Range Central tendency priate role of meeting minutes and policy statements. These discussions re- 2007 main ongoing, as participants continue to evaluate the best available means for Change, fourth quarter to fourth quarter1 improving communication with the pub- Nominal GDP 41/2-51/2 4V2-5 lic in furtherance of the Committee's Real GDP 2-2VA 21/4-21/2 PCE price index excluding dual mandate for both maximum em- food and energy 2-21/4 2-2»/4 ployment and stable prices. Average level, fourth quarter Civilian unemployment Economic Projections for 2007 and rate 41/2-43/4 4i/2-43/4 2008 2008 In conjunction with the FOMC meeting Change, fourth quarter at the end of June, the members of the to fourth quarter1 Board of Governors and the Reserve Nominal GDP 41/2-51/2 43/4-5 Bank presidents, all of whom participate R PC ea E l G pr D ic P e index excluding 2V2-3 2V2-23/4 in the deliberations of the FOMC, pro- food and energy VA-2 P/4-2 vided economic projections for 2007 Average level, and 2008 for this report. The central ten- fourth quarter Civilian unemployment dency of the FOMC participants' fore- rate 4Vi-5 About 43A casts for the increase in real GDP is 1. Change from average for fourth quarter of previous 2VA percent to 2Vz percent over the four year to average for fourth quarter of year indicated. quarters of 2007 and 2T/2 percent to 23/4 percent in 2008. The civilian unem- likely to continue to weigh on the rate of ployment rate is expected to lie between economic expansion over the near term. 4Vi percent and 43A percent in the fourth But as that process runs its course, the quarter of 2007 and to be at about the rate of growth of economic activity top of that range in 2008. As for infla- should move up somewhat. The pace of tion, FOMC participants expect that the consumer spending may be restrained in increase in the price index for personal the near term as households continue to consumption expenditures excluding adjust to the latest run-up in energy food and energy (core PCE inflation) prices and to softer house prices; still, will total 2 percent to 2V4 percent over household balance sheets are generally the four quarters of 2007 and will drift in good shape, and increases in employdown to l3/4 percent to 2 percent in ment and real wages over the next year 2008. and a half should be sufficient to sustain Economic activity appears poised to further gains in spending. Regarding expand at a moderate rate in the second business investment, solid gains in real half of 2007, and it should strengthen outlays on equipment and software seem gradually into 2008. The ongoing cor- likely in light of the anticipated expanrection in the housing market seems sion in business output, continuing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

62 94th Annual Report, 2007 strong profits, and generally favorable construction exerted significant restraint financial conditions. Opportunities to re- on economic activity. The rise in real alize significant gains in efficiency by GDP in the first quarter was also investing in high-tech equipment should damped by a downswing in inventory provide ongoing support to equipment investment, a dip in defense spending, spending as well. Investment in nonresi- and an unusually sharp drop in net exdential buildings also seems to be ex- ports. The available information sugpanding briskly. In addition, prospects gests that GDP growth rebounded in the are favorable for continued increases in second quarter as the drag from invendemand for exports of U.S. goods and tory investment waned and as defense services. expenditures and net exports snapped FOMC participants generally expect back after their first-quarter declines. In core inflation to edge down a bit further the labor market, hiring continued at a over the next year and a half. In assess- steady pace throughout the first half, aling the apparent slowing of core infla- though job gains fell short of those retion this spring, participants recognized corded in 2006, and the unemployment that the monthly price data are volatile rate remained at 4Vi percent. Headline and that some of the recent improve- consumer price inflation was boosted by ment may prove to have been transitory. a reversal of the downturn in energy Nonetheless, they believe that the cur- prices in late 2006 and a step-up in retail rent environment will be conducive to food prices, while core inflation was some further moderation in underlying little changed. Real hourly labor comprice pressures. The participants' fore- pensation increased over the year endcasts for real activity imply a slight eas- ing in the first quarter, although gains in ing over the next several quarters of the the second quarter were probably eroded tightness in labor and product markets. by the energy-driven pickup in overall And although core inflation is expected inflation. Conditions in financial marto remain under some upward pressure kets have remained generally supportive in the near term from the pass-through of economic expansion thus far this year of the increases to date in the prices of despite deteriorating conditions in the energy and other commodities, those subprime-mortgage sector. Investors cost pressures should subsequently seemed to become more optimistic wane. Accordingly, with long-run infla- about the outlook for the economy: Intion expectations contained, diminished terest rates rose, credit spreads on corpocost pressures should result in some rate bonds stayed narrow on the whole, moderation in core inflation. and equity markets recorded sizable gains. Economic and Financial Developments in 2007 The Household Sector Real GDP increased at an annual rate of Consumer Spending 2V4 percent in the second half of 2006, and it appears to have risen at roughly After exhibiting considerable vigor in that pace, on average, over the first half late 2006, consumer spending slowed of 2007. Although consumer spending somewhat over the first half of 2007. and business fixed investment posted Spending continued to be bolstered by moderate gains, on balance, during the the strong labor market and the lagged first half, the contraction in residential effects of earlier increases in household Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 63 wealth. However, these positive influ- of 2006 and May 2007, compared with ences were partly offset by the rise in an increase of more than 3 percent over energy prices this year, which drained the four quarters of 2006. consumers' purchasing power, and by Even given the sharp deceleration in reduced home-price appreciation, which residential real estate values, household limited recent gains in wealth for many wealth has remained supportive of households. Surveys of consumer senti- spending growth. One reason is that the ment have remained in a favorable range surge in equity values in recent quarters this year. has allowed overall household wealth to Real PCE rose at an annual rate of keep pace with nominal income despite 4V4 percent in the first quarter. Spending the softness in home prices. In addition, on light motor vehicles (cars, sport- because changes in net worth tend to utility vehicles, and pickup trucks) got influence consumption with a lag of sevoff to a fast start this year, expenditures eral quarters, the increases in wealth on energy services were boosted by un- during 2005 and 2006 are likely still usually cold weather in February, and providing a good deal of impetus to outlays for other goods and services spending. These increases in wealth, posted sizable gains after a steep run-up which have provided many households in the fourth quarter. The available data with the resources and inclination to imply a much slower pace of spending raise their spending at a rate that exgrowth in the second quarter, as sales of ceeds income growth, have been a factor light motor vehicles softened and real pushing down the personal saving rate spending on goods other than motor ve- over the past couple of years even as hicles turned lackluster. interest rates have moved up. After fluc- Real disposable personal income tuating in the vicinity of 2 percent from (DPI)—that is, after-tax income adjusted 1999 to 2004, the saving rate subsefor inflation—also started the year on a quently dropped sharply, and it stood at strong note after a large increase in the negative 1 lA percent, on average, in fourth quarter.1 Wages and salaries and April and May of 2007. some other major categories of personal income continued to rise appreciably in Residential Investment nominal terms throughout the first half. However, these gains were eroded in Residential construction activity rereal terms by the energy-related jump in mained soft in the first half of 2007, as inflation in the spring, and, as a result, builders continued to confront weak dereal DPI rose at an annual rate of just mand and an elevated inventory of un- IV2 percent between the fourth quarter sold new homes. In the single-family sector, new units were started at an average annual rate of 1.18 million between 1. According to the published data, real DPI January and May—more than 30 perrose at an annual rate of 43A percent in the first cent below the quarterly high reached in quarter. However, a substantial part of the increase the first quarter of 2006. Starts in the occurred because the Bureau of Economic Analysis (BEA) added $50 billion (annual rate) to its multifamily sector averaged a little less estimate of first-quarter wages and salaries in re- than 300,000 units during the first five sponse to information that bonus payments and months of 2007, an amount at the lower stock option exercises around the turn of the year end of the range of the past nine years. were unusually large. Because the BEA did not All told, the contraction in housing acassume that these payments carried forward into April, real DPI fell sharply in that month. tivity subtracted nearly 1 percentage Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

64 94th Annual Report, 2007 point from the change in real GDP in the eral Housing Enterprise Oversight, first quarter of 2007—almost as much which tracks sales prices of the same as in the second half of 2006—and the houses over time, rose at an annual rate drag likely remained substantial in the of just 2 percent in the first quarter of second quarter. 2007 (the latest available data) and was The monthly data on home sales have up just 3 percent over the year ending in been erratic this year. But after smooth- the first quarter, compared with an ining through the ups and downs, the data crease of 10 percent over the preceding suggest that demand has softened fur- year. For April and May combined, the ther after falling at a double-digit rate average price of existing single-family between mid-2005 and mid-2006 and homes sold—which does not control for then holding reasonably steady in the changes in the mix of houses sold but is second half of last year. On average, available on a more timely basis—was sales of existing homes over the three about 1 percent below that of a year months ending in May 2007 were AVi earlier. percent below their average level in the second half of last year, while sales of Household Finance new homes were down 10 percent over that period. The further weakening of Household debt expanded at an annual housing demand this year likely reflects, rate of 6 percent in the first quarter of in part, tighter lending standards for 2007, somewhat below the pace of mortgages, and it occurred despite mort- 83/4 percent posted in 2006. The decelgage rates that were relatively low by eration was primarily the result of a siglonger-run standards. The ongoing slip- nificant step-down in the rise of mortpage in sales has made it more difficult gage debt, which reflected the sharp for homebuilders to make much of a slowing of house-price appreciation and dent in their inventories of new homes the slower pace of home sales. Confor sale. When evaluated relative to the sumer (nonmortgage) debt has remained three-month average pace of sales, the on a moderate uptrend this year. months' supply of unsold new homes in Debt rose a little more slowly than May was more than 60 percent above personal income in the first quarter, so the high end of the relatively narrow the financial obligations ratio for the range it occupied from 1997 to 2005. household sector inched down, though it Moreover, these published figures prob- remained only a bit below its historical ably understate the true inventory over- high. Most households were able to hang in this sector to the extent that they meet their debt service obligations, and do not account for the surge in canceled measures of household credit quality sales in the past year; such cancellations were generally little changed. For exreturn homes to unsold inventory but are ample, delinquency rates on consumer not incorporated in the official statistics. loans and prime mortgages—the two The rate of house-price appreciation main components of total household slowed dramatically in 2006 after nearly debt—stayed low through the spring of a decade of rapid increases, and prices 2007, as did those on subprime fixedappear to have moved roughly sideways rate mortgages. In addition, household in the first half of 2007. The purchase- bankruptcy filings continued to be subonly version of the repeat-transactions dued in the first half of the year: They price index for existing single-family ran near the average pace seen since homes published by the Office of Fed- early 2006, after the bulge that accom- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 65 panied the implementation of the new prime-mortgage-backed securities rebankruptcy law in October 2005. portedly have scrutinized the underlying Some households, however, have ex- subprime loans more carefully and lendperienced growing financial strains. De- ers have tightened underwriting stanlinquency rates on subprime mortgages dards. For example, more than half of with variable interest rates, which ac- the respondents to the questions on count for about 9 percent of all first-lien subprime residential mortgages in the mortgages outstanding, continued to Federal Reserve's April 2007 Senior climb in the first five months of 2007 Loan Officer Opinion Survey on Bank and reached a level more than double Lending Practices indicated that they the recent low for this series, which was had tightened credit standards on such recorded in mid-2005. The rise in delin- loans over the previous three months. In quencies has begun to show through to June, the federal financial regulatory new foreclosures. In the first quarter of agencies issued a final Statement on 2007, an estimated 325,000 foreclosure Subprime Mortgage Lending to address proceedings were initiated, up from an issues relating to certain adjustable-rate average quarterly rate of 230,000 over mortgage products. Credit spreads on the preceding two years; about half of the lower-rated tranches of new subthe foreclosures this year were on prime securitizations have increased subprime mortgages. The decline in sharply, on balance, this year, and issucredit quality in the subprime sector has ance of subprime-mortgage-backed selikely stemmed from a combination of curities has moderated from its vigorous several factors, including the modera- pace of the past couple of years. Howtion in overall economic growth and ever, despite the ongoing problems, the some regional economic weakness. In subprime market has continued to funcaddition, a substantial number of sub- tion, and new loans are being made. prime borrowers with variable-rate mortgages have faced an upward adjust- The Business Sector ment of the rates from their initial levels. When house prices were rising rap- Fixed Investment idly and rates on new loans were lower, many of these borrowers qualified to re- After having risen sharply over much of finance into another loan with more- 2006, real business fixed investment favorable terms. With house prices hav- (BFI) lost some steam in the fourth ing decelerated and rates having moved quarter and posted a relatively meager higher, however, the scope for refinanc- gain in the first quarter of 2007. The ing has been reduced. Moreover, inves- slower rise in business output in recent tor owners may have been tempted to quarters has likely been a moderating walk away from properties with little or influence on business investment expenno equity. Subprime mortgages origiditures. But on the whole, economic and nated in late 2005 and 2006 have shown financial conditions still appear to be unusually high rates of early delinfavorable for capital spending: Corpoquency, suggesting that some lenders rate profits remain robust, businesses unduly loosened underwriting standards have ample liquid assets at their disduring that period. posal, and conditions in financial mar- In recent months, credit has become kets remain supportive. less easily available in the subprime- Much of the recent softness in BFI mortgage market, as investors in sub- was in spending on equipment and soft- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

66 94th Annual Report, 2007 ware (E&S), which rose at an annual Nonresidential construction activity rate of less than 2 percent in real terms turned up steeply in 2006 after having in the first quarter after having fallen been stagnant for several years, and it nearly 5 percent in the fourth quarter of continued to exhibit considerable 2006. Within the major components of strength in early 2007. Outlays for of- E&S, real spending on high-tech equip- fice, retail, and industrial buildings are ment expanded at an annual rate of more all running well above year-earlier levthan 20 percent in the first quarter of els, and—given that vacancy rates have 2007 because of both a surge in outlays moved down over the past couple of on computers after the release of a ma- years—prospects for further gains in jor new operating system and a spurt in coming quarters are good. One excepinvestment in communications gear. tion to the recent strength in this sector Aircraft purchases also posted a sizable is the drilling and mining category, in which real outlays fell in the first quarincrease. However, spending on motor ter after three years of sizable gains. The vehicles tumbled, as many firms had acrecent softening in this category of incelerated their purchases of medium and vestment may reflect, in part, reported heavy trucks into 2005 and 2006 so that shortages of specialty equipment and they could take delivery before the Enviskilled labor. ronmental Protection Agency's new emissions standards for engines went Inventory Investment into effect this year. Elsewhere, real investment in equipment other than high- Inventory investment slowed markedly tech and transportation goods dropped in the fourth quarter of 2006 as firms at an annual rate of 10 percent in the acted to stem rising inventory imbalfirst quarter after a fall of nearly 5 perances, and it turned negative in the first cent in the previous quarter. The weakquarter of 2007. The downswing in inness in this category, which accounts for ventory investment shaved about 1 pciroughly 40 percent of investment in centage point from the change in real E&S when measured in nominal terms, GDP in both the fourth and first quarappears to have reflected, in part, appreters, and it appears to have brought ciable declines in spending on equipstocks into better alignment with sales. ment disproportionately used by the Some of the inventory correction was in construction and motor vehicle industhe motor vehicle sector, in which high tries and was most pronounced around gasoline prices have been causing dethe turn of the year. mand to shift to more-fuel-efficient Although the weakness in truck sales models—a trend that, by the middle of apparently extended through midyear, 2006, had left dealers with bloated inreal E&S outlays apart from transporta- ventories of light trucks and sport-utility tion equipment appear to have posted a vehicles. Facing little prospect of sigsolid increase in the second quarter. In- nificantly stronger sales of those vecoming information suggests that high- hicles in the near term, the manufacturtech spending continued to move up in ers instituted sharp cuts in production real terms—albeit not as fast as it did in starting in the second half of last year. the first quarter. Moreover, shipments The production cuts, which in the first and orders for equipment other than quarter of 2007 brought assemblies of high-tech and transportation items re- light vehicles to their lowest level in gained some lost ground. more than a decade, helped clear out Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 67 dealers' lots and thus set the stage for a double-digit gains in 2006; nonetheless, step-up in assemblies in the second before-tax profits measured as a share of quarter. The automakers have scheduled sector GDP were nearly 13 percent, a further rise in assemblies in the third close to the high levels posted last year. quarter, in part to get a good start on Fueled in part by continued heavy producing the new, more-fuel-efficient merger and acquisition activity, nonfimodels that will be introduced to the nancial business debt expanded at an anpublic in coming months. nual rate of 9 percent in the first quarter Excluding motor vehicles, inventories of this year, only a bit slower than in appeared to be well aligned with sales 2006, and data in hand suggest a robust through much of 2006, but they too pace of expansion again in the second started to look excessive as the growth quarter. Net bond issuance has been of aggregate demand slowed in the latter solid so far in 2007, and commercial part of the year. The emerging imbal- and industrial lending by banks has reances, some—though not all—of which mained strong. Although lower-quality appear to have been at firms that supply corporate credit markets experienced the construction and motor vehicle in- some strains, generally narrow credit dustries, prompted production adjust- spreads have encouraged corporate bond ments that reduced non-auto inventory issuance, and the growth of business investment to a very modest rate in the loans has been spurred by banks' acfirst quarter. According to the limited commodative lending posture. Consideravailable information, the pace of real able net fractions of respondents to the stockbuilding appears to have remained April 2007 Senior Loan Officer Opinion low in April and May, and, for the most Survey indicated that they had eased part, inventories seem to have moved some terms—especially spreads of loan back into rough alignment with sales. In rates over their costs of funds, costs of fact, businesses surveyed in June by the credit lines, and loan covenants—on Institute for Supply Management re- commercial and industrial loans over the ported that their customers were mostly previous three months. Banks pointed to comfortable with their current stock lev- more-aggressive competition from other els, whereas earlier in the year an el- banks or nonbank lenders and to inevated number of respondents had char- creased liquidity in the secondary maracterized these inventory positions as ket for these loans as the most important too high. reasons for having eased business lending terms. Commercial paper outstanding was flat in the first quarter but in- Corporate Profits and Business creased somewhat in the second quarter. Finance Gross public issuance of equity by In the first quarter of 2007, growth in nonfinancial corporations has continued corporate profitability slowed from last to be moderate so far this year, but priyear's pace, but the level of profitability vate equity issuance has apparently reremained high. Earnings per share for mained strong, as leveraged buyout ac- S&P 500 firms decelerated but still tivity has continued to climb. However, came in nearly 10 percent above their given the elevated levels of share repuryear-earlier level. In the national income chases and equity retirements from cashaccounts, profits of nonfinancial corpo- financed mergers and acquisitions in the rations in the first quarter were little first quarter, net equity issuance continchanged from year-earlier levels after ued to be deeply negative. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

68 94th Annual Report, 2007 Despite some deceleration in profits, development; nevertheless, this delinthe credit quality of nonfinancial firms quency rate remained low by historical has generally continued to be robust. standards. The six-month trailing bond default rate has stayed near zero this year, and the The Government Sector delinquency rate on commercial and industrial loans at banks remained ex- Federal Government tremely low in the first quarter. For public firms, balance sheet liquidity was The deficit in the federal unified budget still high in the first quarter, whereas narrowed further during the past year: corporate leverage stayed near historical Receipts continued to rise at a fairly lows despite the large net retirement of rapid rate, while growth in outlays was equity. In addition, net interest payments relatively subdued. Over the twelve relative to cash flow continued to be months ending in June, the unified budnear the low end of the range seen over get recorded a deficit of $163 billion, the past two decades. $113 billion less than during the compa- Commercial real estate debt expanded rable period ending in June 2006. When briskly in the first quarter of 2007, measured relative to nominal GDP, the albeit not quite so rapidly as in 2006, a deficit has decreased steadily from a repattern consistent with the net tighten- cent fiscal year high of 3.6 percent in ing of credit standards on commercial 2004 to a little more than 1 percent durreal estate loans reported in the Senior ing the past twelve months. Loan Officer Opinion Survey. Spreads Nominal federal receipts during the on BBB-rated commercial-mortgage- twelve months ending in June were backed securities (CMBS) soared in late 8 percent higher than during the same February and have varied within an el- period a year earlier. This increase was evated range since then. The increase considerably smaller than the doublereportedly came in response to a reduc- digit advances recorded in fiscal 2005 tion in investor interest in collateralized and fiscal 2006. Nonetheless, it was debt obligations, sponsors of which tra- faster than the increase in income and ditionally have purchased many of these pushed up the ratio of receipts to GDP securities, and to plans by the rating to nearly 19 percent. Individual income agencies to increase the level of credit tax receipts continued to outpace the rise support required for such securities. in taxable personal income as measured However, because rents on commercial in the national income and product acproperties have been increasing and va- counts (NIPA), likely a result, at least in cancy rates have remained moderate, part, of larger capital gains realizations credit quality has generally continued to (which are excluded from NIPA inbe good. Delinquency rates on commer- come), the effect of some taxpayers cial mortgages held by life insurance moving into higher tax brackets as their companies and on those backing CMBS real incomes increased, and perhaps a have stayed near the bottom of their re- further shift in the distribution of incent ranges this year. The delinquency come toward high-income households, rate on commercial mortgages held by which typically face higher tax rates. banks edged up further in the first quar- Corporate receipts, after rising at an anter in response to a deterioration in the nual rate of nearly 40 percent, on averperformance of loans for multifamily age, over the three years ending in fiscal properties and for construction and land 2006, rose 15 percent during the year Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 69 ending in June, a rate more in line with deficit has been largely offset by a the increase in corporate profits. downward drift in nonfederal saving. Nominal federal outlays increased Although business saving has increased less than 3 percent during the twelve substantially over this period, personal months ending in June and edged down saving has dropped sharply. Accordto 20 percent of nominal GDP, around ingly, total national saving (that is, fedthe lower end of the narrow range that eral plus nonfederal) has recovered only has prevailed since 2003. In large part, a little from the exceptionally low levels the deceleration in outlays reflected the reached between 2003 and 2005; meatapering off of the temporary bulge in sured net of estimated depreciation, it expenditures for flood insurance and di- has fluctuated between Wi percent and saster relief associated with the 2005 2Vi percent of GDP since the start of hurricanes. Meanwhile, spending on 2006. If not boosted over the longer run, health programs continued to rise persistent low levels of saving will be briskly, only in part because of the net associated with either slower capital forincrement to spending from the Medi- mation or continued heavy borrowing care Part D prescription drug program, from abroad, either of which would rewhich started in January 2006. Defense tard the rise in the standard of living of spending was up 5 percent over the pe- U.S. residents over time and hamper the riod, an increase somewhat below those ability of the nation to meet the retirerecorded in fiscal years 2005 and 2006. ment needs of an aging population. Total federal outlays were also boosted by a sizable rise in net interest payments Federal Borrowing as interest rates moved higher, although the increase in debt service costs was Federal debt rose at an annual rate of significantly smaller than that of a year 63/4 percent in the first quarter of 2007, a earlier. bit slower than in the corresponding As measured in the NIPA, real federal quarter of last year. As of the end of the expenditures on consumption and gross first quarter, the ratio of federal debt investment—the part of federal spend- held by the public to nominal GDP was ing that is a direct component of GDP— about 36 percent, a level little changed fell at an annual rate of nearly 4 percent from that in recent quarters. in the first quarter, as a drop in defense The improvement in the budget posispending more than offset a moderate tion of the federal government has led increase in nondefense purchases. De- the Treasury to scale back issuance of fense expenditures tend to be erratic marketable coupon securities. As part of from quarter to quarter, and the first- its reduction in issuance, the Treasury quarter dip followed a large increase in announced in May that it was disconthe fourth quarter. Defense spending ap- tinuing auctions of three-year nominal pears to have turned back up in the sec- notes. This move had been widely anond quarter, and, given currently enacted ticipated and elicited little reaction in appropriations, it is likely to increase financial markets. further in coming quarters. Overall, foreign purchases of Trea- All else being equal, the significant sury securities appear to have increased narrowing of the unified budget deficit further this year, thereby bringing the over the past few years raises national share of these securities held by foreign saving. However, the positive effect on investors to a new high of almost 45 pernational saving of the smaller federal cent at the end of the first quarter. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

70 94th Annual Report, 2007 proportion of nominal coupon securities According to the NIPA, real expendipurchased at auctions by foreign inves- tures on consumption and gross investtors moved up in late 2006 and has ment by state and local governments stayed elevated thus far this year, albeit rose at an annual rate of nearly 4 percent well off the peak reached in 2004. Bal- in the first quarter, and they apparently ance of payments data point to sizable posted a further increase in the second net purchases by foreign private inves- quarter. Much of the strength in the first tors between January and March, half of 2007 was in construction spendwhereas such investors sold Treasury se- ing, which has been climbing since the curities, on net, in 2006. In contrast, net start of 2006, in part because of very purchases by foreign official investors rapid increases in outlays on highways. have declined somewhat this year. Cus- Hiring by states and localities also extody holdings at the Federal Reserve hibited considerable vigor during the Bank of New York on behalf of foreign first half of 2007, both in the education official and international accounts have sector and elsewhere; on average, state only edged up since the end of 2006. and local government employment rose 30,000 per month over the six months State and Local Government ending in June, compared with an average monthly increase of 22,000 over the On the whole, state and local govern- preceding ten years. ments continue to enjoy strong fiscal positions as a consequence of several years State and Local Government of robust revenue inflows and a period Borrowing of appreciable restraint on spending af- Borrowing by state and local governter these governments' fiscal difficulties ments has been strong thus far in 2007, earlier in the decade. Accordingly, over largely because refundings in advance the past year or so, states and localities of retirements have been elevated as inin the aggregate have been able both to terest rates have remained relatively raise expenditures and to maintain low. In contrast, issuance of short-term healthy balances in their reserve funds. debt has been moderate—a development However, revenue flows in many states consistent with the strong budgets of appear to have slowed a bit of late, a state and local governments. The credit pattern similar to the one that has quality of municipal bonds has remained emerged at the federal level. For local solid on the whole, as the number of governments, property tax receipts are bond-rating upgrades has outpaced the still being bolstered by the earlier run-up number of downgrades thus far this year. in real estate values, but the deceleration The ratio of yields on municipal bonds in house prices over the past year will to those on comparable-maturity Trealikely slow the rise in local revenues sury securities has stayed at the low end down the road. Moreover, many state of its range of the past decade. and local governments expect to face significant structural imbalances in their The External Sector budgets in coming years as a result of the ongoing pressures from Medicaid In 2006, U.S. real net exports made a and the need to provide pensions and positive contribution to the full year's health care to an increasing number of economic growth for the first time since retired state and local government 1995. The contribution of net exports employees. moved into negative territory again, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary? Policy Report of July 2007 71 however, in the first quarter of this year, sumer goods more than offset a further as imports rebounded and exports contraction in exports of capital goods. slowed from their exceptional pace late Prices of exported goods rose at an last year. Data for April and May point annual rate of 4 percent in the first quarto a resurgence of exports and a modera- ter of 2007, up from the pace of about tion of imports in the second quarter. 2Vi percent seen in the second half of The U.S. nominal current account 2006. Prices of non-agricultural indusdeficit widened a bit in the first quarter trial supplies, which had been reduced of 2007 to $770 billion at an annual rate, in the fourth quarter by lower oil prices, or about 53A percent of nominal GDP, were pushed up in the first quarter by from $752 billion in the fourth quarter higher prices for metals and renewed of 2006. The larger deficit was due to an increases in oil prices. In addition, agriincrease in net unilateral transfers cultural prices—especially those of abroad. Although the first-quarter trade corn, soybeans, and wheat—have risen balance deteriorated in real terms, in- briskly over the past several quarters, in creases in export prices outpaced those part because of the direct and indirect in import prices, thereby leaving the effects of the increased demand for ethanominal trade balance unchanged. De- nol. Monthly data on trade prices in the spite the large negative U.S. net interna- second quarter point to further increases tional investment position, the U.S. bal- in export prices on the strength of addiance on investment income remained tional run-ups in the prices of nonpositive and also was about unchanged agricultural industrial supplies, most noin the first quarter. tably metals. After falling at an annual rate of International Trade 2Vi percent in the fourth quarter, real imports of goods and services rose at a Despite continued solid foreign eco- 5Vi percent rate in the first quarter. A nomic expansion and persisting stimu- sharp increase in oil imports, after a lus from earlier declines in the dollar, fourth-quarter decline, was the most imthe growth of real exports of goods and portant contributor to the swing, but imservices slowed to an annual rate of less ports of computers, semiconductors, and than 1 percent in the first quarter from natural gas also accelerated. Imports of its exceptionally strong pace of more other goods continued to be weak, likely than 10 percent in the fourth quarter. a result, in part, of slower U.S. growth; The slowdown was particularly evident imports of autos and industrial supplies, in sales of capital goods—especially air- in particular, contracted sharply. The craft and computers—and industrial growth of real imports of services supplies, which fell in the first quarter dropped from 6VA percent in the fourth after rising robustly in late 2006. Also quarter to 23A percent in the first quarter. contributing to the slowdown, real ex- Data for April and May imply some ports of services rose only 2 percent in slowing of overall real imports in the the first quarter after increasing more second quarter. In particular, imports of than 16 percent in the fourth quarter. oil and computers displayed noteworthy Available data for nominal exports in decelerations. April and May suggest that real export Prices of imported goods excluding growth moved up in the second quarter, oil and natural gas rose at an annual rate as increases in exports of services, auto- of about 1 Vi percent in the first quarter mobiles, industrial supplies, and con- of 2007, as prices of both finished and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

72 94th Annual Report, 2007 material-intensive goods recorded early March, the spot price of Brent higher rates of increase. Monthly trade crude oil, the European benchmark, has price data suggest that import prices ac- risen about $5 per barrel more than has celerated in the second quarter, partly the spot price of WTI; the price of Brent because of higher metals prices, which averaged $76 per barrel in the first half have fluctuated widely in recent months of July. but are up substantially, on balance, so far in 2007. More generally, prices of The Financial Account industrial supplies have been rising briskly, a movement that may reflect, in The U.S. nominal current account deficit part, a response to the depreciation of continued to be financed primarily by the dollar in recent months. No such foreign purchases of U.S. debt securieffect of the dollar's decline is readily ties. Driven by purchases of U.S. govapparent in the prices of finished goods. ernment securities by Asian central Oil prices fell at the beginning of banks, foreign official inflows moved up 2007, as unusually mild temperatures re- noticeably in the first quarter. Although duced oil demand and OPEC members demand for U.S. Treasury securities by appeared less likely to implement fully foreign official investors eased, it was production cuts agreed to at the end of more than offset by increased official 2006. The spot price of West Texas in- purchases of bonds and mortgagetermediate (WTI) crude oil, the U.S. backed securities issued by governmentbenchmark, fell from an average of sponsored enterprises (GSEs). Prelimi- $62 per barrel in December to $54 per nary data indicate that official inflows barrel in January. Oil prices then rose remained strong through April. gradually as it became apparent that Foreign private purchases of U.S. se- OPEC, led by Saudi Arabia, indeed curities maintained the extraordinary would restrain oil production further. Oil pace set in 2006. Demand for U.S. Treaprices also have been supported by solid sury bonds extended its fourth-quarter growth in demand, particularly in devel- strength, while demand for equities oping countries, and by long-running picked up from an already robust level; concerns about supply disruptions. On- purchases of corporate bonds moderated going violence has depressed oil produc- slightly, and, on net, private foreigners tion in Iraq and Nigeria; the Nigerian sold debt issued by GSEs. Foreign direct outage recently worsened to about one- investment flows into the United States fourth of the country's estimated capac- weakened significantly; the rate of inity. Since the start of the year, concerns flows in the first quarter was roughly have also intensified about a possible half that in 2006. future disruption of oil exports from Net purchases of foreign securities by Iran. The spot price of WTI averaged U.S. residents, which represent a finan- $72 per barrel in the first half of July. cial outflow, remained strong in the first Despite its elevated level by historical quarter of this year. Net acquisitions of standards, the spot price of WTI has not bonds continued at the brisk pace reincreased as much in recent months as corded in the second half of 2006, while have the prices of other grades of crude purchases of foreign stocks, although oil because of high inventories of WTI slowing slightly, remained elevated. in the central United States arising from Outflows associated with U.S. direct ininterruptions for maintenance and un- vestment abroad strengthened to a nearplanned outages at refineries. Since record rate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 73 The Labor Market and the job openings rate has held at a high level. According to the Conference Employment and Unemployment Board, households' assessments of job availability cooled a bit in the spring The demand for labor has been increas- after having improved somewhat earlier ing at a moderate rate this year, some- in the year; even so, the June value for what less quickly than in 2006. After this indicator was still relatively having averaged 190,000 per month in positive. 2006, gains in payroll employment aver- After hovering around 43A percent aged 145,000 per month in the first half during the first three quarters of 2006, of 2007. The civilian unemployment the unemployment rate fell to 4V2 perrate has changed little since last fall and cent in the fourth quarter, and it restood at 4.5 percent in June. mained in that neighborhood through As was the case in 2006, job growth June. The labor force participation rate in the first half of 2007 was driven by has continued to be buoyed by the favorsolid gains in service-producing indus- able job market, and it stood at 66.1 pertries. In particular, hiring at health, edu- cent in June, within the narrow range cation, and eating and drinking estab- that has prevailed since 2005. Despite lishments remained on strong uptrends, the recent flatness, the participation rate and job gains at businesses providing has fallen appreciably since the start of professional and technical services were the decade; the downtrend has largely sizable. However, employment in the fi- reflected longer-run demographic forces nancial activities and administrative that include a leveling off in the particisupport sectors softened after two years pation rate of women and an increase in of strong advances. In the goods- the proportion of the workforce in older producing sector, manufacturing em- age groups, which have lower average ployment, which has been on a secular participation rates than do younger age downtrend for more than a quarter- groups. century, declined again over the first half of 2007. The decline this year re- Productivity and Labor Compensation flected cutbacks at firms closely tied to the construction industry and at produc- Gains in labor productivity have slowed ers of motor vehicles and parts, as well lately. According to currently published as the ongoing downtrend in payrolls at data, output per hour in the nonfarm manufacturers of apparel and textiles. business sector rose just 1 percent over Employment in residential construction, the year ending in the first quarter of which had fallen in 2006 after two years 2007, down from the pace of 2 percent of substantial increases, declined just per year recorded over the preceding modestly, on net, over the first half of two years (and down from much larger 2007 despite the substantial contraction increases in the first half of the decade). in housing activity. The slowing in productivity was associ- Other labor market indicators have ated with the deceleration in output and mostly remained positive. Initial claims thus was probably, at least in part, a for unemployment insurance have temporary cyclical phenomenon. Instayed relatively low in recent months. deed, the fundamental forces that in re- In addition, readings from private sur- cent years have supported a solid upveys of hiring plans have remained in a trend in underlying productivity—the favorable range despite recent declines, driver of real wage gains over time— Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

74 94th Annual Report, 2007 remain in place. They include the rapid year ending in March, which amounted pace of technological change and firms' to just 2lA percent, was also held down ongoing efforts to use information tech- by a sharp drop in employer contribunology to improve the efficiency of their tions to retirement plans. The lower conoperations. Increases in the amount of tributions appear to have reflected sevcapital, especially high-tech capital, eral factors, including the strong available to each worker also appear to performance of the stock market in 2006 be providing considerable impetus to and a high level of employer contribuproductivity growth. tions over the past several years; taken Broad measures of hourly compensa- together, these factors significantly tion have been bounced around in recent boosted the funding levels of definedyears by the lumpiness of bonus pay- benefit plans. ments, stock option exercises, and sharp According to preliminary data, comswings in employer benefit costs. Howpensation per hour in the nonfarm busiever, on balance, the evidence points to ness (NFB) sector—an alternative measome pickup recently in the underlying sure of hourly compensation derived pace of compensation gains, a developfrom the data in the NIPA—rose ment consistent with the tight labor mar- 3!/4 percent over the year ending in the ket. The employment cost index (ECI) first quarter of 2007, the same rise as in for private industry workers, which the ECI. Over the year ending in the measures both wages and the cost of first quarter of 2006, NFB hourly combenefits, increased 3V4 percent in nomi- pensation had risen 53/4 percent, in part nal terms between March 2006 and because of an apparent surge in the March 2007, compared with an increase value of stock option exercises (which of 2Vi percent over the preceding twelve are excluded from the ECI) early last months. Adjusted for inflation, as meayear. Largely reflecting the slower sured by the increase in the overall PCE growth in NFB hourly compensation, price index, the ECI rose nearly 1 perunit labor costs rose 2lA percent over cent over the year ending in March after the year ending in the first quarter of having fallen nearly Vi percent over the 2007 after increasing ?>Vi percent over preceding year. Data on hourly compenthe preceding four quarters. sation in the second quarter are not yet available, but a sharp rise in overall consumer prices during that period prob- Prices ably offset much—if not all—of the nominal gains that were realized. Headline inflation picked up again in The step-up in the rate of increase in the first half of 2007, as energy prices the ECI over the past year was concen- surged after having eased late last year trated in its wage and salary component, and increases in food prices quickened. which rose V/i percent over the year The PCE chain-type price index inending in March, 1 lA percentage points creased at an annual rate of 4.4 percent more than the increase over the year- between December 2006 and May 2007 earlier period. Meanwhile, increases in after rising 2.2 percent over the twelve the cost of providing benefits have months of 2006. Core PCE prices— slowed dramatically of late, in part be- which exclude the direct effects of cause premiums for health insurance movements in food and energy prices— have stopped rising at double-digit rates. rose at an annual rate of 2.0 percent over The increase in benefit costs over the the first five months of the year, 0.1 per- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 75 Alternative Measures of Price Change, Food prices have also picked up this 2006-07 year, in part because of the jump in the Percent price of corn, which is now in demand not only as a feedstuff and food but also Price measure 2006 2007 as an input to the production of ethanol. Chain-type (Ql to Ql) Between December 2006 and May Gross domestic product (GDP) .. 3.1 2.8 2007, the PCE price index for food and Excluding food and energy ... 2.9 2.7 Gross domestic purchases 3.5 2.5 beverages increased at an annual rate of Personal consumption expenditures (PCE) 3.0 2.2 nearly 6 percent. The higher cost of corn Excluding food and energy ... 2.0 2.3 was partly responsible for a IOV2 per- Market-based PCE excluding food and energy 1.6 2.1 cent rise over the period in prices for Fixed-weight (Q2 to Q2) meats, poultry, fish, and eggs. The index Consumer price index 4.0 2.6 for fruits and vegetables also posted a Excluding food and energy ... 2.4 2.3 double-digit increase, mainly because a NOTE: Changes are based on quarterly averages of sea- severe freeze in California in January sonally adjusted data. For the consumer price index, the destroyed a substantial portion of the 2007:Q2 value is calculated as the average for April and May compared with the average for the second quarter of citrus crop and set back the harvest of 2006 and is expressed at an annual rate. many other fruits and vegetables. Prices SOURCE: For chain-type measures, Department of for food consumed away from home, Commerce, Bureau of Economic Analysis; for fixedweight measures. Department of Labor, Bureau of Labor which typically are influenced more by Statistics. labor and other business costs than by centage point less than the increase over farm prices, rose at an annual rate of the twelve months of 2006. 4 percent over the first five months of Energy prices, which had fallen sub- the year. stantially in the fourth quarter of 2006, The edging down of core PCE infladecreased further in January in response tion this year largely reflected some to declines in the price of crude oil, un- waning of the sizable increases in shelseasonably mild temperatures in North ter costs that were recorded in 2006. America and Europe, and historically Core PCE inflation in the most recent high inventories of petroleum products few months was also held down signifiand natural gas. However, energy prices cantly by transitory factors—most notashot up from February to May, and the bly, a sharp drop in the price of apparel. rise brought the net increase in the PCE In addition, the retail price of tobacco, price index for energy over the first five which, like apparel, tends to be volatile months of the year to 14 percent (not at from month to month, flattened out after an annual rate). The increase was espe- a steep increase earlier in the year. cially large for gasoline, the price of Meanwhile, the rate of increase in the which was boosted not only by higher core consumer price index (CPI) has prices for crude oil beginning in late dropped from 2.6 percent in 2006 to an winter but also by numerous refinery annual rate of 2.1 percent so far this shutdowns, reflecting both planned year; the main reason for the sharper maintenance and unplanned disruptions. deceleration in the core CPI than in core Retail gasoline prices have fallen some PCE prices is that housing costs receive since May as refiners have made some a much greater weight in this index than progress in bringing output closer to seathey do in the core PCE measure. sonal norms, but they are still about More fundamentally, the behavior of $0.70 per gallon above the levels of late core inflation so far this year has been December. shaped by many of the same forces that Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

76 94th Annual Report, 2007 were at work in 2006. Resource utiliza- prices for some other components of tion in labor and product markets re- final demand, especially construction, mains fairly high. And although last au- decelerated. tumn's drop in energy prices may have offered some temporary relief, the resur- U.S. Financial Markets gence in prices for energy and other U.S. financial markets have functioned commodities is likely putting some upwell thus far in 2007 despite episodes of ward pressure on core inflation. Regardheightened volatility. As the year ing inflation expectations, the Reuters/ opened, financial market quotes put con- University of Michigan Surveys of siderable weight on the expectation of Consumers (Reuters/Michigan) suggest an easing of monetary policy sometime that the median expectation for yearsoon. By the spring, however, investors ahead inflation has moved up in reapparently had become more optimistic sponse to the energy-driven pickup in about the economic outlook and, as a headline inflation: It rose from 3.0 perresult, had concluded that less Federal cent in the first three months of the year Reserve easing would be forthcoming to 3.3 percent in April and remained at than they had anticipated earlier. In line about this level through early July. Howwith the upward shift in policy expectaever, longer-run inflation expectations tions, two-year Treasury yields rose appear to have remained contained. In about 10 basis points, on balance, fact, according to the Reuters/Michigan through mid-July; ten-year yields insurveys, the median five- to ten-year excreased 40 basis points. Supported by pectation, at 3.1 percent in early July, solid corporate profits and the more uphas stayed within the narrow range that beat economic outlook, equity prices adhas prevailed for the past two years. Acvanced roughly 10 percent on net. Decording to the Survey of Professional spite some widening in recent weeks, Forecasters, conducted by the Federal risk spreads on corporate credits gener- Reserve Bank of Philadelphia, expectaally remained narrow, reflecting strong tions of inflation over the next ten years and liquid corporate balance sheets. remained around 2j/2 percent in the first Measures of investors' uncertainty about half of 2007, a level that has been prospects for a number of financial asset essentially unchanged since 1998. Inflaprices widened somewhat, on balance, tion compensation as measured by the from low levels. spreads of yields on nominal Treasury securities over those on their inflation- Market Functioning and Financial protected counterparts has also stayed Stability within its range of recent years. Broader, NIPA-based measures of in- In late February and early March, finanflation, which are available only through cial market volatility increased sharply the first quarter of this year, slowed rela- amid a pullback from riskier assets that tive to the pace of the past couple of was reportedly spurred by a variety of years. The latest data show a rise in the factors, including a sharp dip in the Chiprice index for GDP less food and en- nese equity market, mounting concerns ergy of 23/4 percent over the year ending about conditions in the subprimein the first quarter, down lA percentage mortgage sector, and some softer-thanpoint from the year-earlier figure. Al- expected U.S. economic data. During the though core PCE inflation picked up period, spreads on indexes of subprimeslightly during the past four quarters, mortgage credit default swaps (CDS) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 11 spiked; equity markets in the United been contained, though: In spite of the States and abroad declined; Treasury recent rise, spreads on lower-quality yields dropped across maturities; corporate credits remain near the low spreads of riskier fixed-income instru- end of their historical ranges, and, alments over comparable Treasuries wid- though investors recently have balked at ened somewhat; and measures of market some aggressively structured deals, fiuncertainty, including implied volatili- nancing activity in bond and other credit ties derived from options prices, moved markets continues at a fairly brisk pace. up sharply. Despite some capacity- Market participants do not appear to related technical difficulties in equity have pulled back from risk-taking more markets on February 27, financial mar- generally, in that equity prices have kets generally handled the volatility moved higher in recent weeks, and Treawell. Liquidity in the Treasury market sury bid-ask spreads have stayed within continued to be good, as record-high normal ranges despite elevated trading trading volumes were accompanied by volumes. bid-ask spreads within ranges of the The effects on financial institutions of past few years. Market sentiment subse- this year's difficulties in the subprimequently improved—apparently a result, mortgage sector have depended on the in part, of reduced anxiety about spill- institutions' exposure to the sector. overs to broader markets of the prob- Several mortgage lenders—particularly lems in the subprime-mortgage sector— monoline subprime lenders—experiand financial markets gradually stabil- enced substantial losses, as they had to ized. Many asset prices reversed their repurchase larger-than-expected volearlier declines, and measures of un- umes of previously securitized loans becertainty moved lower. cause of so-called early payment de- Strains in financial markets increased faults. Consequently, a number of these again late in the spring, prompted lenders have gone out of business since largely by renewed concerns about the the beginning of the year. Large investsubprime-mortgage sector. A consider- ment banks active in the securitization able widening in spreads on indexes of of subprime mortgages suffered modest subprime-mortgage CDS contributed to, hits to their earnings, and their CDS and was likely reinforced by, troubles at spreads are considerably higher than at a few small and medium-si zed hedge the beginning of the year. To date, most funds that had taken positions designed large depository institutions appear to to profit from an improvement in have been less affected by the subprime subprime credit quality. These pressures difficulties, in part because of their intensified as a result of actual and an- greater diversification and generally ticipated downgrades of some securities limited subprime lending activity. CDS backed by subprime mortgages. Inves- spreads for these institutions have tors' uncertainty about a range of asset moved up only a little, on the whole, prices increased, and lower-quality cor- thus far in 2007. porate credit spreads widened, reportedly reflecting, in part, heightened un- Interest Rates certainty about the valuation of structured credit products, which are an Since the beginning of the year, invesimportant source of funding in the tors appear to have become more optisubprime-mortgage market and in other mistic, on balance, about the outlook for financing markets. These pressures have economic activity and consequently Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

78 94th Annual Report, 2007 have raised their expected path for the next few years are low while spreads federal funds rate. Judging from futures further out the curve are more in line markets, market participants currently with historical norms. anticipate that the rate will decline about 25 basis points through the end of 2008; Equity Markets at the end of last year, market partici- Broad equity indexes increased between pants had expected about 75 basis points %Vi percent and 12 percent, on net, of easing over the same period. Investhrough mid-July. Stock prices were tors also have apparently become more boosted by solid first-quarter earnings certain about the path for the federal that generally met or exceeded invesfunds rate: Implied volatilities derived tors' expectations and by the more upfrom options on Eurodollar futures over beat economic outlook. Share prices the next year have moved down, on net, rose for a wide range of industries, althis year and remain near historical though basic materials and energy firms lows. Estimated probability distributions outperformed the broader market befor the target federal funds rate between cause of strong global demand for comsix and twelve months ahead were modities. The spread between the somewhat skewed toward lower rates twelve-month forward earnings-price through mid-July. ratio for the S&P 500 and a real long- Reflecting the reduced odds placed on run Treasury yield—a rough gauge of policy easing, yields on two-year nomithe equity risk premium—narrowed a bit nal Treasury securities increased about and now stands close to the middle of its 10 basis points over the year through range of the past few years. After a spike mid-July. Ten-year Treasury yields rose in connection with the period of un- 40 basis points over the same period. A settled conditions in financial markets in portion of the increase in longer-term late February and early March, the imyields appears to be attributable to a plied volatility of the S&P 500 calcuwidening of term premiums, although lated from options prices fell back, but it estimated term premiums remain rela- picked up again recently in response to tively low by historical standards. renewed concerns about the subprime- Yields on inflation-indexed Treasury mortgage market. securities moved nearly in line with those on their nominal counterparts, Debt and Financial Intermediation by thereby leaving inflation compensation Banks only a little higher. In the corporate bond market, yields The total debt of the domestic nonfinanon investment- and speculative-grade cial sectors expanded at an annual rate securities rose about as much, on bal- of 11A percent in the first quarter of ance, as those on comparable-maturity 2007, a somewhat slower pace than in Treasury securities through mid-July, 2006. The deceleration in borrowing and so risk spreads on such instruments was mainly accounted for by a sloware little changed on the year. The nar- down in household debt, particularly row spreads on corporate bonds appear mortgage debt. In contrast, borrowing to reflect investors' positive outlook for by nonfinancial businesses remained robusiness credit quality over the medium bust in the first quarter. Preliminary data term. The term structure of forward risk for the second quarter suggest slightly spreads for corporate bonds supports slower growth in total domestic nonfithis view, as forward spreads for the nancial sector debt. The step-down in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 79 growth is particularly noticeable in the strained by growth in non-interest exfederal government sector, in which penses and a modest increase in provistrong receipts this tax season held down sions for loan losses. Credit quality borrowing. However, the recent data stayed strong overall: Delinquency and suggest somewhat faster growth in non- charge-off rates remained generally low, financial business debt in the second although delinquency rates on residenquarter, a pickup fueled by heavy tial and commercial real estate loans merger and acquisition activity. moved up further from last year's levels. Commercial bank credit increased at an annual rate of about 6V2 percent in The M2 Monetary Aggregate the first half of 2007. However, adjusted M2 expanded at an annual rate of about to remove the effects of a conversion of IV2 percent over the first half of 2007. a bank to a thrift institution, bank credit The increase evidently outstripped expanded at an annual rate of about growth in nominal GDP by a substantial 8l/4 percent over the same period, somemargin and exceeded the rate that would what slower than in 2006. have been expected on the basis of the Excluding this bank-to-thrift conver- aggregate's previous relationship with sion, total loans grew briskly in the first income and interest rates. M2 rose at an half of the year, with most bank loan annual rate of 8 percent in the first quartypes expanding vigorously. Rapid ter before slowing to a pace of 63A pergrowth in commercial and industrial cent in the second quarter. Liquid deposloans was supported by the continued its, by far the largest component of M2, robust merger and acquisition activity. have followed a similar pattern this year. Growth in commercial real estate loans Small time deposits and retail money was also strong even though construc- market funds both grew rapidly last tion and land development loans, a por- year, as the rates paid on them moved up tion of which is used to fund residential with short-term market interest rates. development, decelerated sharply. De- However, these components have decelspite the ongoing adjustment in the erated this year because market rates housing market, residential real estate have changed relatively little. Currency loans on banks' books (adjusted for the growth has remained modest in 2007, bank-to-thrift conversion noted earlier) apparently a result of weak demand for expanded at a strong pace. But home U.S. dollars overseas. equity loans grew only modestly. Because rates on these loans are generally International Developments tied to short-term market interest rates, the flattening of the yield curve last year Foreign economic growth remained made them a relatively more expensive strong in the first quarter of 2007, supsource of credit. Consumer loans held ported by increased domestic demand in by banks picked up in the first quarter, many key countries. Most recent indicabut they slowed in the second quarter. tors point to continued strength in for- Commercial bank profitability de- eign economies in the second quarter as clined somewhat in the first quarter of well. Canada, the euro area, Japan, and 2007 but remained solid. The net inter- the United Kingdom all posted aboveest margin of the industry continued to trend growth rates in the first quarter. narrow, a likely result of ongoing com- Although the expansion of the Japanese petitive pressures and the flat yield economy moderated somewhat in the curve. Bank profitability was also re- first quarter, growth remained brisk rela- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

80 94th Annual Report, 2007 tive to the average pace seen in recent Most major global equity indexes exyears. Output accelerated in emerging perienced another increase in volatility Asia, led by China, and growth in during June and July amid concerns Mexico appears to be picking up again about the U.S. subprime-mortgage marafter a lull in the first quarter. ket, but they were little changed, on net, Rising energy prices boosted con- over this period. On balance, equity insumer prices in many regions of the dexes in the major foreign industrial world last year, and, in some cases, sub- countries have increased between 5 perstantial increases in food prices also cent and 12 percent in local-currency contributed to inflation pressures. Broad terms since the beginning of 2007. The measures of price inflation have contin- Shanghai composite index is up more than 45 percent this year after a remarkued to rise in many foreign economies able increase of about 130 percent last this year, as economic growth has reyear. Leading equity indexes in other mained strong, and core inflation has emerging Asian economies and in Latin moved up noticeably in a number of America have also posted sizable gains these economies. In response, monetary in the range of 10 percent to 35 percent policy has been tightened in many major so far this year. industrial countries as well as in some As in the United States, long-term emerging-market economies. Longerbond yields in Canada, the euro area, term foreign interest rates have also and Japan rose significantly, on balance, risen. in the first half of 2007; increases on Global financial markets were calm at ten-year nominal sovereign debt ranged the beginning of 2007, and volatilities from 25 to 70 basis points. Starting in for many asset prices were at, or close early February, yields declined in global to, record lows. Toward the end of Febmarkets for several weeks amid growing ruary, conditions changed, as internaconcerns about the outlook for the U.S. tional investors scaled back their expoeconomy. Since then, market particisure to risky positions—particularly pants seem to have become more optithose funded in yen—in response to a mistic about prospects for both U.S. and sharp drop in Chinese stock prices and foreign economic growth, and yields concerns about the U.S. economy. As a have more than reversed the declines. result, equity prices in most industrial Yields on inflation-protected long-term and emerging economies fell over the securities also rose during the first half course of several days, while the yen of 2007 in the major industrial counappreciated sharply against most other tries, but, with the exception of those in currencies. the euro area, they did not rise quite as More-placid conditions returned in much as nominal yields did, implying early March, and by early June share some modest increases in inflation comprices around the world had posted solid pensation. gains, reaching multiyear highs or even Our broadest measure of the nominal record highs in many countries. In par- trade-weighted foreign exchange value ticular, Chinese stock prices resumed of the dollar has declined about 3Vi pertheir steep climb, although the rise was cent, on net, since the beginning of interrupted by occasional additional pe- 2007. Over the same period, the major riods of heightened volatility. These epi- currencies index of the dollar has moved sodes had no apparent disruptive effects down more, about 4x/2 percent. On a bion other global financial markets. lateral basis, the dollar has depreciated Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Monetary Policy Report of July 2007 81 10 percent against the Canadian dollar Growth of real GDP in the euro area and roughly 3Vi percent against the euro moved down to 23A percent in the first and sterling; in contrast, it has appreci- quarter after posting growth of 3lA perated about 2l/z percent against the yen. cent over the four quarters of 2006. Al- The bulk of the change against the Ca- though export growth moderated from nadian dollar occurred in the second its strong performance of 2006, recovquarter after better-than-expected news ery of domestic demand appears to have about economic activity and expecta- taken firmer hold, as investment accelertions of monetary policy tightening in ated in the first quarter. Private con- Canada. The U.S. dollar has depreciated sumption in Germany had been muted 3 percent, on net, against the Chinese earlier this year, partly because of a hike renminbi since the beginning of 2007; in the value-added tax at the start of the the pace of change in the renminbi- year, but lately retail sales in Germany dollar rate has accelerated somewhat and the euro area more broadly have over the past two and a half months. picked up, on balance, from their January lows. Survey indicators of consumer Industrial Economies and business sentiment also point to relatively strong growth in the euro area The major foreign industrial economies during the second quarter. Overall conexperienced above-trend growth in the sumer price inflation has remained just first quarter of this year. In Canada, real below the European Central Bank's GDP grew at an annual rate of 33A per- 2 percent ceiling since the fall of last cent after rising nearly 2 percent during year, while core inflation has risen to 2006; inventory accumulation figured about 2 percent from around 1 Vi percent prominently in the faster growth. In the last year. To combat potential inflation United Kingdom, real GDP increased at pressures, the Bank continued to tighten an annual rate of 23/4 percent in the first monetary policy during the first half of quarter. Robust expansions in both this year, implementing two more incountries have been accompanied by in- creases of 25 basis points in its policy creases in inflation rates, which in re- rates. cent months have hovered at or above Japanese economic growth moderated those countries' inflation targets of in the first quarter of this year to a still- 2 percent. Although the pickup in head- brisk annual rate of 3lA percent. Houseline inflation partly reflected higher en- hold consumption rose at a robust rate ergy prices, core inflation has also of about 3 percent, and real exports intrended up in recent months in both creased almost 14 percent. Investment Canada and the United Kingdom. In the growth slowed, although recent surveys midst of elevated inflation and increas- report that businesses are optimistic ing rates of resource utilization, mon- about the outlook. The labor market in etary policy was tightened three times Japan improved further in the first five this year in the United Kingdom (by months of the year: The unemployment 25 basis points each time) after two in- rate fell below 4 percent, and the ratio of creases in the policy rate last year. The job offers to applicants remained el- Bank of Canada also recently raised its evated. Despite the strong growth of policy rate 25 basis points. Market par- output and improved labor markets, conticipants expect that both countries' cen- sumer prices were about unchanged on a tral banks will raise their policy rates twelve-month basis in May; the GDP further. deflator has continued to fall, though, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

82 94th Annual Report, 2007 during the period. Core consumer prices tionary pressures in several emerging have shown small twelve-month de- Asian economies have eased somewhat clines over the past several months, and this year because of the unwinding of wages have declined relative to their previous increases in food prices and, in year-earlier levels. some cases, the effect of currency appreciations. During the past year, political tensions in Thailand and uncertainty Emerging-Market Economies about the government's policy on capi- Economic activity in China accelerated tal controls have periodically disrupted in the first quarter of 2007 and appears markets and economic activity. to have remained robust in the second In a continuation of the deceleration quarter. Growth was supported by a that started about the middle of last year, surge in exports and a pickup in fixed Mexican output rose a scant Vz percent investment, which had slowed some- in the first quarter; manufacturing (parwhat in the second half of 2006. The ticularly in the automobile sector) was strength of exports has resulted in a bal- restrained by the moderation in the U.S. looning of the Chinese trade surplus. economic expansion, and construction Since late 2006, inflation in China has slowed sharply. Recent data on indusincreased—reaching a rate of V/i per- trial production, however, suggest that cent over the twelve months ending in growth may have rebounded in the sec- May—largely because of higher food ond quarter. Mexican headline consumer prices. Continuing rapid growth of ag- price inflation continues to hover at the gregate demand and liquidity pressures upper limit of the Bank of Mexico's tarfrom the accumulation of foreign ex- get range of 2 percent to 4 percent. Monchange reserves have raised concerns etary policy was tightened in Mexico in about broader, more-sustained upward April for the first time since March pressures on inflation. Chinese authori- 2005. ties have tightened monetary policy In Brazil, the growth of real GDP through several increases in banks' re- moderated to about 3 percent in the first serve requirements and two increases in quarter, as the appreciation of the Brazilinterest rates so far this year; they have ian real weighed on the external sector. also continued to use sterilization opera- The strong real has also helped keep tions to partially offset the effect of the inflation in check despite fairly strong reserve accumulation on the money economic growth and a lowering of the supply. policy interest rate. Economic growth in Elsewhere in emerging Asia, real Argentina moved down in the first quar- GDP surged in India and the Philippines ter, in part because of a contraction in in the first quarter and remained strong exports, and reported data suggest that in Malaysia and Singapore. Growth was inflation has continued to decline. generally supported by domestic de- Growth in Venezuela appears to have mand in all four economies. Growth slowed sharply so far in 2007 after three held steady in South Korea, as stronger years of double-digit performances, domestic demand was partially offset by driven by expansionary fiscal policy a drag from net exports. Incoming data funded by high petroleum revenues. Venpoint to strength in the region in the ezuelan twelve-month inflation picked second quarter. Outside of China, infla- up to nearly 20 percent in June. • 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

85 Banking Supervision and Regulation The Federal Reserve has supervisory historically high levels since the midand regulatory authority over a variety 1990s, helping to provide banks with a of financial institutions and activities. It substantial base of capital. Risk-based plays an important role as umbrella su- capital ratios declined modestly over the pervisor of bank holding companies, in- year, but at year-end more than 99 percluding financial holding companies. cent of all commercial banks continued And it is the primary federal supervisor to report capital ratios consistent with a of state banks that are members of the "well capitalized" designation under Federal Reserve System. prompt corrective action standards. Al- Two thousand seven was a challeng- though credit quality indicators also ing year for bank holding companies worsened during the year, overall loan (BHCs) and state member banks. BHC quality measures remained relatively asset quality and earnings deteriorated sound by historical standards. over the second half of the year, mainly In 2007 the banking industry saw because of the effects of developments bank failures for the first time in three in the residential housing market. Non- years as three insured institutions—two performing assets increased notably as state nonmember banks and one thrift the quality of mortgages, home equity institution with assets totaling approxilines of credit, and loans to real estate mately $2.6 billion—were closed. developers weakened. Nevertheless, Banking supervisors focused in 2007 BHCs reported net income exceeding on credit risk issues related to subprime $90 billion for the full year. A sharp lending activities. During the course of increase in subprime mortgage delin- the year the federal financial regulatory quencies adversely affected the securiti- agencies—the Federal Reserve, Federal zation market. Liquidity and capital Deposit Insurance Corporation (FDIC), were strained as some BHCs brought National Credit Union Administration certain off-balance-sheet exposures onto (NCUA), Office of the Comptroller of their books. Several institutions also rec- the Currency (OCC), and Office of ognized significant valuation write- Thrift Supervision (OTS)—issued guiddowns on assets affected by market con- ance encouraging supervised institutions ditions. Despite these pressures, BHCs to work constructively with homeowncontinued to maintain regulatory capital ers unable to continue meeting their ratios in excess of minimum regulatory mortgage payments. The agencies also requirements. released a statement emphasizing the Most state member banks entered need to maintain prudent underwriting 2007 after a sustained period of strong standards and to provide clear and balearnings performance, partly mitigating anced information to consumers so that developments in the market. Although institutions and consumers can assess net income and return on assets fell late the risks arising from certain adjustablein the year, reflecting asset write-downs rate mortgage (ARM) products that ofand higher loan-loss provisions, these fer discounted or low introductory rates. measures of profitability have been at The Federal Reserve also joined with Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

86 94th Annual Report, 2007 the FDIC, NCUA, OCC, OTS, and the ganizations, the Federal Reserve seeks Conference of State Bank Supervisors primarily to promote their safe and to issue a statement encouraging feder- sound operation, including their complially regulated financial institutions and ance with laws and regulations. state-supervised entities that service se- The Federal Reserve also has responcuritized residential mortgages to review sibility for supervising the operations of their authority under pooling and servic- all Edge Act and agreement corporaing agreements so as to identify borrow- tions, the international operations of ers at risk of default and pursue state member banks and U.S. bank holdappropriate loss-mitigation strategies ing companies, and the U.S. operations designed to preserve sustainable home of foreign banking organizations. ownership. The Federal Reserve exercises impor- Federal Reserve staff continued to tant regulatory influence over entry into work with the other federal banking the U.S. banking system, and the strucagencies in 2007 to prepare for U.S. ture of the system, through its adminisimplementation of the Basel II capital tration of the Bank Holding Company accord.1 In November the Board of Gov- Act, the Bank Merger Act (with regard ernors approved final rules implement- to state member banks), the Change in ing new risk-based capital requirements Bank Control Act (with regard to bank for large, internationally active banking holding companies and state member organizations (the Basel II advanced ap- banks), and the International Banking proaches framework) and joined the Act. The Federal Reserve is also respon- OCC, FDIC, and OTS in publishing sible for imposing margin requirements those rules in December. on securities transactions. In carrying out these responsibilities, the Federal Reserve coordinates its supervisory ac- Scope of Responsibilities for tivities with the other federal banking Supervision and Regulation agencies, state agencies, functional regulators, and the bank regulatory The Federal Reserve is the federal suagencies of other nations. pervisor and regulator of all U.S. bank holding companies, including financial holding companies formed under the au- Supervision for thority of the 1999 Gramm-Leach-Bliley Safety and Soundness Act, and state-chartered commercial banks that are members of the Federal To promote the safety and soundness of Reserve System. In overseeing these or- banking organizations, the Federal Reserve conducts on-site examinations and inspections and off-site surveillance 1. The Basel II capital accord, an international and monitoring. It also takes enforceagreement formally titled "International Converment and other supervisory actions as gence of Capital Measurement and Capital Standards: A Revised Framework," was developed by necessary. the Basel Committee on Banking Supervision, which is made up of representatives of the central banks or other supervisory authorities of thirteen Examinations and Inspections countries. The original document was issued in 2004; the original version and an updated version The Federal Reserve conducts examinaissued in November 2005 are available on the website of the Bank for International Settlements tions of state member banks, the U.S. (www.bis.org). branches and agencies of foreign banks, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 87 State Member Banks and Bank Holding Companies, 2003-2007 Entity/Item 2007 2006 2005 2004 2003 State member banks Total number 878 901 907 919 935 Total assets (billions of dollars) 1,519 1,405 1,318 1,275 1,912 Number of examinations 694 761 783 809 822 By Federal Reserve System 479 500 563 581 581 By state banking agency 215 261 220 228 241 Top-tier bank holding companies Large (assets of more than $1 billion) Total number 459 448 394 355 365 Total assets (billions of dollars) ... 13,281 12,179 10,261 8,429 8,295 Number of inspections 492 566 501 500 454 By Federal Reserve System1 ... 476 557 496 491 446 On site 438 500 457 440 399 Off site 38 57 39 51 47 By state banking agency 16 9 5 9 8 Small (assets of $1 billion or less) Total number 4,611 4,654 4,760 4,796 4,787 Total assets (billions of dollars) ... 974 947 890 852 847 Number of inspections 3,186 3,449 3,420 3,703 3,453 By Federal Reserve System 3,007 3,257 3,233 3,526 3,324 On site 120 112 170 186 183 Off site 2,887 3,145 3,063 3,340 3,141 By state banking agency 179 192 187 177 129 Financial holding companies Domestic 597 599 591 600 612 Foreign 43 44 38 36 32 1. For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews. and Edge Act and agreement corpora- by the Federal Reserve during the past tions. In a process distinct from exami- five years. nations, it conducts inspections of bank Inspections of bank holding compaholding companies and their nonbank nies, including financial holding compasubsidiaries. Whether an examination or nies, are built around a rating system an inspection is being conducted, the re- introduced in 2005 that reflects the review of operations entails (1) an assess- cent shift in supervisory practices for ment of the quality of the processes in these organizations away from a historiplace to identify, measure, monitor, and cal analysis of financial condition tocontrol risks; (2) an assessment of the ward a more dynamic, forward looking quality of the organization's assets; (3) assessment of risk-management pracan evaluation of management, including tices and financial factors. Under the an assessment of internal policies, pro- system, known as RFI but more fully cedures, controls, and operations; (4) an termed RFI/C(D), holding companies assessment of the key financial factors are assigned a composite rating (C) that of capital, asset quality, earnings, and is based on assessments of three compoliquidity; and (5) a review for compli- nents: Risk Management (R), Financial ance with applicable laws and regula- Condition (F), and the potential Impact tions. The table provides information on (I) of the parent company and its nondeexaminations and inspections conducted pository subsidiaries on the subsidiary Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

88 94th Annual Report, 2007 depository institution.2 The fourth com- tailored to each banking organization's ponent, Depository Institution (D), is in- size, complexity, and risk profile. As tended to mirror the primary regulator's with the LCBOs, examinations entail rating of the subsidiary depository both off-site and on-site work, including institution. planning, pre-examination visits, de- In managing the supervisory process, tailed documentation, and examination the Federal Reserve takes a risk-focused reports tailored to the scope and findapproach that directs resources to ings of the examination. (1) those business activities posing the greatest risk to banking organizations State Member Banks and (2) the organizations' management processes for identifying, measuring, At the end of 2007, 878 state-chartered monitoring, and controlling risks. The banks (excluding nondepository trust key features of the supervision program companies and private banks) were for large complex banking organizations members of the Federal Reserve Sys- (LCBOs) are (1) identifying those tem. These banks represented approxi- LCBOs that are judged, on the basis of mately 12 percent of all insured U.S. their shared risk characteristics, to commercial banks and held approxipresent the highest level of supervisory mately 14 percent of all insured comrisk to the Federal Reserve; (2) main- mercial bank assets in the United States. taining continual supervision of these The guidelines for Federal Reserve organizations so that the Federal Re- examinations of state member banks are serve's assessment of each organiza- fully consistent with section 10 of the tion's condition is current; (3) assigning Federal Deposit Insurance Act, as to each LCBO a supervisory team com- amended by section 111 of the Federal posed of Reserve Bank staff members Deposit Insurance Corporation Improvewho have skills appropriate for the orga- ment Act of 1991 and by the Riegle nization's risk profile (the team leader is Community Development and Regulathe Federal Reserve System's central tory Improvement Act of 1994. A fullpoint of contact for the organization, has scope, on-site examination of these responsibility for only one LCBO, and banks is required at least once a year, is supported by specialists capable of although certain well-capitalized, wellevaluating the risks of LCBO business managed organizations having total asactivities and functions); and (4) pro- sets of less than $500 million may be moting Systemwide and interagency examined once every eighteen months.3 information-sharing through automated The Federal Reserve conducted 479 exsystems. ams of state member banks in 2007. For other banking organizations, the risk-focused supervision program provides that examination procedures are 3. The total assets threshold for this group of well-capitalized, well-managed organizations was 2. Each of the first two components has four increased during the year. The Financial Services subcomponents: Risk Management—Board and Regulatory Relief Act of 2006, which became ef- Senior Management Oversight; Policies, Proce- fective in October 2006, authorized the federal dures, and Limits; Risk Monitoring and Manage- banking agencies to raise the threshold from $250 ment Information Systems; and Internal Controls. million to $500 million, and final rules incorporat- Financial Condition—Capital; Asset Quality; ing the change into existing regulations were is- Earnings; and Liquidity. sued on September 21, 2007. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 89 Bank Holding Companies statute streamlines the Federal Reserve's supervision of all bank holding compa- At year-end 2007, a total of 5,793 U.S. nies, including financial holding compabank holding companies were in operanies, and sets forth parameters for the tion, of which 5,070 were top-tier bank supervisory relationship between the holding companies. These organizations Federal Reserve and other regulators. controlled 6,038 insured commercial The statute also differentiates between banks and held approximately 96 perthe Federal Reserve's relations with cent of all insured commercial bank asregulators of depository institutions and sets in the United States. its relations with functional regulators Federal Reserve guidelines call for (that is, regulators for insurance, securiannual inspections of large bank holding ties, and commodities firms). companies and complex smaller compa- As of year-end 2007, 597 domestic nies. In judging the financial condition bank holding companies and 43 foreign of the subsidiary banks owned by holdbanking organizations had financial ing companies, Federal Reserve examinholding company status. Of the domesers consult examination reports prepared tic financial holding companies, 33 had by the federal and state banking authoriconsolidated assets of $15 billion or ties that have primary responsibility for more; 136, between $1 billion and the supervision of those banks, thereby $15 billion; 93, between $500 million minimizing duplication of effort and reand $1 billion; and 335, less than ducing the supervisory burden on bank- $500 million. ing organizations. Noncomplex bank holding companies with consolidated as- International Activities sets of $1 billion or less are subject to a special supervisory program that per- The Federal Reserve supervises the formits a more flexible approach.4 In 2007, eign branches and overseas investments the Federal Reserve conducted 476 in- of member banks, Edge Act and agreespections of large bank holding compa- ment corporations, and bank holding nies and 3,007 inspections of small, non- companies and also the investments by complex bank holding companies. bank holding companies in export trading companies. In addition, it supervises Financial Holding Companies the activities that foreign banking Under the Gramm-Leach-Bliley Act, organizations conduct through entities bank holding companies that meet cer- in the United States, including branches, tain capital, managerial, and other re- agencies, representative offices, and quirements may elect to become finan- subsidiaries. cial holding companies and thereby Foreign Operations of engage in a wider range of financial ac- U.S. Banking Organizations tivities, including full-scope securities underwriting, merchant banking, and in- In supervising the international operasurance underwriting and sales. The tions of state member banks, Edge Act and agreement corporations, and bank 4. The special supervisory program was holding companies, the Federal Reserve implemented in 1997 and modified in 2002. See generally conducts its examinations or SR letter 02-01 for a discussion of the factors inspections at the U.S. head offices of considered in determining whether a bank holding these organizations where the ultimate company is complex or noncomplex (www. federalreserve.gov/boarddocs/srletters/). responsibility for the foreign offices lies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

90 94th Annual Report, 2007 Examiners also visit the overseas offices vestments that are broader than those of U.S. banks to obtain financial and permissible for member banks. operating information and, in some in- At year-end 2007, 67 banking organistances, to evaluate the organizations' zations, operating 12 branches, were efforts to implement corrective measures chartered as Edge Act or agreement coror to test their adherence to safe and porations. These corporations are examsound banking practices. Examinations ined annually. abroad are conducted with the cooperation of the supervisory authorities of the U.S. Activities of Foreign Banks countries in which they take place; for national banks, the examinations are co- The Federal Reserve has broad authority ordinated with the OCC. to supervise and regulate the U.S. activi- At the end of 2007, 55 member banks ties of foreign banks that engage in were operating 619 branches in foreign banking and related activities in the countries and overseas areas of the United States through branches, agen- United States; 33 national banks were cies, representative offices, commercial operating 567 of these branches, and 22 lending companies, Edge Act corporastate member banks were operating the tions, commercial banks, bank holding companies, and certain nonbanking remaining 52. In addition, 17 nonmemcompanies. Foreign banks continue to ber banks were operating 23 branches in be significant participants in the U.S. foreign countries and overseas areas of banking system. the United States. As of year-end 2007, 172 foreign banks from 53 countries were operating Edge Act and Agreement Corporations 211 state-licensed branches and agen- Edge Act corporations are international cies, of which 8 were insured by the banking organizations chartered by the FDIC, and 47 OCC-licensed branches Board to provide all segments of the and agencies, of which 4 were insured U.S. economy with a means of financing by the FDIC. These foreign banks also international business, especially ex- owned 9 Edge Act and agreement corports. Agreement corporations are porations and 2 commercial lending similar organizations, state chartered or companies; in addition, they held a confederally chartered, that enter into an trolling interest in 62 U.S. commercial agreement with the Board to refrain banks. Altogether, the U.S. offices of from exercising any power that is these foreign banks at the end of 2007 not permissible for an Edge Act controlled approximately 18 percent of corporation. U.S. commercial banking assets. These Sections 25 and 25A of the Federal 172 foreign banks also operated 91 rep- Reserve Act grant Edge Act and agree- resentative offices; an additional 49 forment corporations permission to engage eign banks operated in the United States in international banking and foreign fi- through a representative office. nancial transactions. These corporations, State-licensed and federally licensed most of which are subsidiaries of mem- branches and agencies of foreign banks ber banks, may (1) conduct a deposit are examined on-site at least once every and loan business in states other than eighteen months, either by the Federal that of the parent, provided that the busi- Reserve or by a state or other federal ness is strictly related to international regulator. In most cases, on-site examitransactions, and (2) make foreign in- nations are conducted at least once ev- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 91 ery twelve months, but the period may supervision for compliance with legal be extended to eighteen months if the requirements. branch or agency meets certain criteria. In cooperation with the other federal Anti-Money-Laundering and state banking agencies, the Federal Examinations Reserve conducts a joint program for supervising the U.S. operations of for- With regard to anti-money-laundering eign banking organizations. The pro- requirements, U.S. Department of the gram has two main parts. One part in- Treasury regulations (31 CFR 103) implementing the Bank Secrecy Act volves examination of those foreign (BSA) generally require banks and other banking organizations that have multiple types of financial institutions to file cer- U.S. operations and is intended to ensure tain reports and maintain certain records coordination among the various U.S. suthat are useful in criminal or regulatory pervisory agencies. The other part is a proceedings. The BSA and separate review of the financial and operational Board regulations require banking orgaprofile of each organization to assess its nizations supervised by the Board to file general ability to support its U.S. operareports on suspicious activity related to tions and to determine what risks, if any, possible violations of federal law, inthe organization poses through its U.S. cluding money laundering, terrorism fioperations. Together, these two pronancing, and other financial crimes. In cesses provide critical information to addition, BSA and Board regulations re- U.S. supervisors in a logical, uniform, quire that banks develop written proand timely manner. The Federal Reserve grams on BSA/anti-money-laundering conducted or participated with state and compliance and that the programs be federal regulatory authorities in 357 exformally approved by bank boards of aminations in 2007. directors. An institution's compliance program must (1) establish a system of internal controls to ensure compliance Compliance with with the BSA, (2) provide for indepen- Regulatory Requirements dent compliance testing, (3) identify in- The Federal Reserve examines super- dividuals responsible for coordinating vised institutions for compliance with a and monitoring day-to-day compliance, broad range of legal requirements, in- and (4) provide training for personnel as cluding anti-money-laundering and con- appropriate. sumer protection laws and regulations, The Federal Reserve is responsible and other laws pertaining to certain for examining its supervised institutions banking and financial activities. Most for compliance with various anticompliance supervision is conducted un- money-laundering laws and regulations. der the oversight of the Division of During examinations of state member Banking Supervision and Regulation, banks and U.S. branches and agencies of but consumer compliance supervision is foreign banks and, when appropriate, inconducted under the oversight of the Di- spections of bank holding companies, vision of Community and Consumer Af- examiners review the institution's comfairs. The two divisions coordinate their pliance with the BSA and determine efforts with each other and also with the whether adequate procedures and con- Board's Legal Division to ensure consis- trols to guard against money laundering tent and comprehensive Federal Reserve and terrorism financing are in place. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

92 94th Annual Report, 2007 Specialized Examinations tential 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 2007, ogy, fiduciary activities, transfer agent Federal Reserve examiners conducted activities, and government and munici- 98 on-site fiduciary examinations. pal securities dealing and brokering. The Federal Reserve also conducts special- Transfer Agents and ized examinations of certain entities, Securities Clearing Agencies other than banks, brokers, or dealers, 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 state member banks and bank holding Information Technology Activities companies that are registered with the In recognition of the importance of in- Board as transfer agents. Among other formation technology to safe and sound things, transfer agents countersign and operations in the financial industry, the monitor the issuance of securities, regis- Federal Reserve reviews the informa- ter the transfer of securities, and extion technology activities of supervised change or convert securities. On-site exbanking organizations as well as certain aminations focus on the effectiveness of independent data centers that provide in- an organization's operations and its formation technology services to these compliance with relevant securities organizations. All safety and soundness regulations. During 2007, the Federal examinations include a risk-focused re- Reserve conducted on-site examinations view of information technology risk at 18 of the 68 state member banks and management activities. During 2007, the bank holding companies that were regis- Federal Reserve was the lead agency in tered as transfer agents and examined 2 cooperative, interagency examinations 1 state member limited-purpose trust of large, multiregional data processing company acting as a national securities servicers. depository. Fiduciary Activities Government and Municipal Securities Dealers and Brokers The Federal Reserve has supervisory responsibility for state member commer- The Federal Reserve is responsible for cial banks and depository trust compa- examining state member banks and fornies that together reported, at the end of eign banks for compliance with the Gov- 2007, $39 trillion of assets in various ernment Securities Act of 1986 and with fiduciary or custodial capacities. Addi- Treasury regulations governing dealing tionally, state member nondepository and brokering in government securities. trust companies supervised by the Fed- Thirty state member banks and 6 state eral Reserve reported $40 trillion of as- branches of foreign banks have notified sets held in a fiduciary or custodial ca- the Board that they are government sepacity. During on-site examinations of curities dealers or brokers not exempt fiduciary activities, an organization's from Treasury's regulations. During compliance with laws, regulations, and 2007, the Federal Reserve conducted general fiduciary principles and its po- 7 examinations of broker-dealer activi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 93 ties in government securities at these or- Federal Reserve exempted 246 lenders ganizations. These examinations are from its on-site inspection program. generally conducted concurrently with Nonexempt lenders are subject to either the Federal Reserve's examination of biennial or triennial inspection. Sixtythe state member bank or branch. eight inspections were conducted during The Federal Reserve is also respon- the year. sible for ensuring that state member banks and bank holding companies that Business Continuity act as municipal securities dealers com- In 2007, the Federal Reserve continued ply with the Securities Act Amendments its efforts to strengthen the resilience of of 1975. Municipal securities dealers are the U.S. financial system in the event of examined pursuant to the Municipal Seunexpected disruptions. The Federal Recurities Rulemaking Board's rule G-16 serve, the OCC, and the Securities and at least once every two calendar years. Exchange Commission (SEC) continued Of the 22 entities that dealt in municipal joint supervisory assessments of the acsecurities during 2007, 7 were examined tivities of core clearing and settlement during the year. firms and significant market participants in implementing and maintaining sound Securities Credit Lenders business resiliency and continuity practices as outlined in "Interagency Paper Under the Securities Exchange Act of on Sound Practices to Strengthen the 1934, the Board is responsible for regu- Resilience of the U.S. Financial Syslating credit in certain transactions intem." The Federal Reserve and the other volving the purchase or carrying of Federal Financial Institutions Examinasecurities. As part of its general examition Council (FFIEC) agencies continnation program, the Federal Reserve exued to coordinate their efforts to ensure amines the banks under its jurisdiction a consistent supervisory approach for for compliance with the Board's Regulabusiness continuity practices.5 tion U (Credit by Banks and Persons other than Brokers or Dealers for the Enforcement Actions Purpose of Purchasing or Carrying Margin Stock). In addition, the Federal Re- The Federal Reserve has enforcement serve maintains a registry of persons authority over the banking organizations other than banks, brokers, and dealers it supervises and their affiliated parties. who extend credit subject to Regulation Enforcement actions may be taken to U. The Federal Reserve may conduct address unsafe and unsound practices or specialized examinations of these lend- violations of any law or regulation. Forers if they are not already subject to mal enforcement actions include ceasesupervision by the Farm Credit Admin- and-desist orders, written agreements, istration (FCA), the NCUA, or the OTS. removal and prohibition orders, and At the end of 2007, 621 lenders other civil money penalties. In 2007, the Fedthan banks, brokers, or dealers were reg- eral Reserve completed 34 formal enistered with the Federal Reserve. Other forcement actions. Civil money penalfederal regulators supervised 200 of ties totaling $20,255,290 were assessed. these lenders, and the remaining 421 were subject to limited Federal Reserve supervision. On the basis of regulatory 5. The FFIEC member agencies are the Federal Reserve Board, the FDIC, the NCUA, the OCC, requirements and annual reports, the and the OTS. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

94 94th Annual Report, 2007 As directed by statute, all civil money including equity prices, debt spreads, penalties are remitted to either the Trea- agency ratings, and measures of exsury or the Federal Emergency Manage- pected default frequency, to gauge marment Agency. Enforcement orders, ket perceptions of the risk in banking which are issued by the Board, and writ- organizations. In addition, the Federal ten agreements, which are executed by Reserve prepares quarterly Bank Holdthe Reserve Banks, are made public ing Company Performance Reports and are posted on the Board's website (BHCPRs) for use in monitoring and in- (www.federalreserve.gov/boarddocs/ specting supervised banking organizaenforcement). tions. The BHCPRs, which are compiled In addition to taking these formal en- from data provided by large bank holdforcement actions, the Reserve Banks ing companies in quarterly regulatory completed 67 informal enforcement ac- reports (FR Y-9C and FR Y-9LP), contions in 2007. Informal enforcement ac- tain, for individual companies, financial tions include memoranda of understand- statistics and comparisons with peer ing and board of directors resolutions. companies. BHCPRs are made available Information about these actions is not to the public on the National Informaavailable to the public. tion Center (NIC) website, which can be accessed at www.ffiec.gov. Surveillance and During 2007, three major upgrades to Off-Site Monitoring the web-based Performance Report Information and Surveillance Monitoring The Federal Reserve uses automated (PRISM) application were completed. screening systems to monitor the finan- PRISM is a querying tool used by Fedcial condition and performance of state eral Reserve analysts to access and dismember banks and bank holding compaplay financial, surveillance, and examinies between on-site examinations. Such nation data. In the analytical module, monitoring and analysis helps direct exusers can customize the presentation of amination resources to institutions that institutional financial information drawn have higher risk profiles. Screening sysfrom Call Reports, Uniform Bank Pertems also assist in the planning of exformance Reports, FR Y-9 statements, aminations by identifying companies BHCPRs, and other regulatory reports. that are engaging in new or complex In the surveillance module, users can activities. generate reports summarizing the results The primary off-site monitoring tool used by the Federal Reserve is the Su- of surveillance screening for banks and pervision and Regulation Statistical As- bank holding companies. The upgrades sessment of Bank Risk model (SR- made more regulatory data available for SABR). Drawing primarily on the querying, gave users the ability to disfinancial data that banks report on their play commercial real estate guidance Reports of Condition and Income (Call data, and provided a way to access struc- Reports), SR-SABR uses econometric ture information for all institutions in techniques to identify banks that report NIC. financial characteristics weaker than The Federal Reserve works through those of other banks assigned similar the FFIEC Task Force on Surveillance supervisory ratings. To supplement the Systems to coordinate surveillance ac- SR-SABR screening, the Federal Re- tivities with the other federal banking serve also monitors various market data, agencies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 95 International Training that conform to international best pracand Technical Assistance tices. The Federal Reserve contributes significantly to ASBA's organizational In 2007, the Federal Reserve continued management and to its training and techto provide technical assistance on bank nical assistance activities. supervisory matters to foreign central banks and supervisory authorities. Technical assistance involves visits by Fed- Supervisory Policy eral Reserve staff members to foreign The Federal Reserve's supervisory authorities as well as consultations with policy function is responsible for develforeign supervisors who visit the Board oping guidance for examiners and bankor the Reserve Banks. Technical assising organizations as well as regulations tance in 2007 was concentrated in Latin for banking organizations under the Fed- America, Asia, and former Soviet bloc eral Reserve's supervision. Staff memcountries. The Federal Reserve, along bers participate in supervisory and reguwith the OCC, the FDIC, and the Trealatory forums, provide support for the sury, was also an active participant in work of the FFIEC, and participate in the Middle East and North Africa Finaninternational forums such as the Basel cial Regulators' Training Initiative, Committee, the Joint Forum, and which is part of the U.S. government's the International Accounting Standards Middle East Partnership Initiative. Board. During the year the Federal Reserve offered training courses exclusively for Capital Adequacy Standards foreign supervisory authorities, both in the United States and in a number of Risk-Based Capital Standards for foreign jurisdictions. System staff also Certain Internationally Active took part in technical assistance and Banking Organizations training missions led by the International Monetary Fund, the World Bank, On December 7, 2007, the Federal Rethe Inter-American Development Bank, serve, OCC, FDIC, and OTS published the Asian Development Bank, the Basel final rules implementing new risk-based Committee on Banking Supervision capital requirements for large, interna- (Basel Committee), and the Financial tionally active banking organizations Stability Institute. (the Basel II advanced approaches The Federal Reserve is also an associ- framework). The advanced approaches ate member of the Association of Super- framework is broadly consistent with invisors of Banks of the Americas ternational approaches to implementa- (ASBA), an umbrella group of bank su- tion of Basel II and includes a number pervisors from countries in the Western of prudential safeguards, such as the re- Hemisphere. The group, headquartered quirement that banking organizations in Mexico, promotes communication satisfactorily complete a four-quarter and cooperation among bank supervi- parallel run period before operating unsors in the region; coordinates training der the Basel II framework, and the use programs throughout the region, with of transitional capital floors. It retains the help of national banking supervisors the long-standing minimum risk-based and international agencies; and aims to capital requirement of 4 percent tier 1 help members develop banking laws, capital and 8 percent total qualifying regulations, and supervisory practices capital and the tier 1 leverage ratio. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

96 94th Annual Report 2007 New Capital Adequacy Framework for UJS, Banking Organizations Aligning regulatory capital requirements with risk and fostering good risk measurement and management practices for our largest and most complex banking organizations will, I believe, contribute to safer and sounder banks and a more resilient financial system. Randall S. Kroszner, Member, Board of Governors November 2007 On December 7, 2007, the US. banking adopted in 2006 by international banking agencies published a new risk-based capi- authorities working through the Basel tal adequacy framework.1 The new Committee on Banking Supervision. framework—known as the advanced ap- The need for a new capital adequacy proaches framework—is designed to align framework arose from continuing rapid more closely the amount of capital U.S. and extensive evolution and innovation in banking organizations are required to hold the financial marketplace, which has subas a cushion against potential losses with stantially reduced the effectiveness of the the risks to which they are exposed. Effec- existing risk-based capital rules (the tive April 2008, large, internationally ac- Basel I-based rules) for large, internationtive U.S. banking organizations will be ally active banking organizations. The required to transition to the advanced Basel II-based rules are more sensitive to approaches framework to calculate the risk and are tailored to the different kinds amount of capital they must hold relative of risk to which banking organizations are to their risk profile; other banking organi- exposed. Basel II regulatory capital rezations may choose to use the new frame- quirements will vary from organization to work.2 The advanced approaches frame- organization in line with the organizawork for U.S. banking organizations is tion's actual risk profile, so that a banking based on the revised international capital organization exposed to greater risk will accord known as Basel II, which was have higher requirements than one exposed to less risk. Both the international and the U.S. 1. The U.S. banking agencies are the Federal frameworks encompass three elements, or Reserve, the Federal Deposit Insurance Corpora- pillars: minimum risk-based capital retion, the Office of the Comptroller of the Cur- quirements (pillar 1); supervisory review rency, and the Office of Thrift Supervision. of capital adequacy (pillar 2); and market 2. Banking organizations with at least discipline through enhanced public disclo- $250 billion of consolidated total assets or at sure (pillar 3). least $10 billion of foreign exposure are required Pillar 1 addresses calculation of regulato use the advanced approaches and to meet the tory capital requirements in relation to cerrule's rigorous qualification requirements; other banking organizations may opt into the advanced tain risk exposures. To calculate their minapproaches framework, provided they also meet imum requirements in relation to the credit its requirements. risk arising from wholesale and retail Banking organizations subject to the action rules for banks that are not adframework are expected to meet certain equately capitalized remain in effect. public disclosure requirements designed (For more information, see the box to foster transparency and market disci- "New Capital Adequacy Framework for pline. In addition, the prompt corrective U.S. Banking Organizations.") Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 97 exposures, U.S. banking organizations will the risk-based regulatory measure of capiuse an internal ratings-based approach, in- tal adequacy and a banking organization's serting their own internal estimates of key actual risk exposures and its day-to-day credit risk parameters into formulas pro- risk management will be stronger and vided by supervisors. They will calculate more consistent. their minimum requirements in relation to Pillars 2 and 3 are also essential eleoperational risk using advanced measure- ments of the advanced approaches framement approaches, which rely on the institu- work. Under pillar 2, banking organizations* internal risk-measurement and capi- tions are required to have an internal tal calculation processes. The advanced process for ensuring that they are holding approaches framework also specifies sepa- enough capital to support their overall risk rate methodologies for calculating capital profile (including those risks not captured requirements in relation to securitization or not fully addressed under pillar 1), parand equity exposures. ticularly during economic downturns and Compared with the Basel I-based rules, periods of financial stress. These internal banking organizations under Basel II-based processes will be subject to rigorous surules will be required to take greater ac- pervisory review. count of their off-balance-sheet activities in Pillar 3 addresses banking organizacalculating their capital requirements. The tions' communication with market particinew framework also provides a more-risk- pants about their risks, the associated levsensitive regulatory capital approach to els of capital, and the manner in which capital markets activities and transactions, they are meeting the requirements of the such as repurchase agreements, securities advanced approaches framework. The borrowing and lending, margin loans, and public disclosures called for under pillar 3 over-the-counter derivatives. The enhanced are expected to increase the transparency risk sensitivity of the advanced approaches of banking organizations' activities and framework should provide incentives for exposures, giving market participants uselending to creditworthy counterparties and ful information about banking organizausing effective credit-risk mitigation tech- tions' risk profiles and their ability to niques, such as requiring collateral. manage risk. The advanced approaches build on the Adoption of the advanced approaches risk-measurement and risk-management framework is an important milestone for approaches already being used by sophisti- the U.S. banking agencies, but effective cated banking organizations and are de- implementation in the coming years will signed to evolve over time as these organi- be just as important. Implementation of zations refine and enhance their internal the Basel II-based rules, and the associpractices. As a result, these approaches are ated improvements in risk management, better able than the Basel 1-based rules to will not be a one-time event, but rather an be adapted to innovations in banking and ongoing process. The agencies will obfinancial markets and to capture the risks serve carefully how the advanced aparising from new products and activities. proaches work in practice, assessing their This increased adaptability and flexibility advantages and limitations, to ensure that suggests that the relationship between they are operating as intended. Revisions to the ments on a September 2006 notice of Market Risk Capital Rule proposed rulemaking that presented re- During 2007, the Federal Reserve, OCC, visions to the market risk capital rule FDIC, and OTS considered public com- used by the Federal Reserve, OCC, and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

98 94th Annual Report, 2007 FDIC since 1997 for banking organiza- posed standardized Basel II capital rule tions having significant exposure to in the first half of 2008. market risk. Under the existing market risk capital rule, certain banking organi- Other Capital Issues zations are required to calculate a capi- Board staff conduct supervisory analytal requirement for the general market ses of innovative capital instruments and risk of their covered positions and the novel transactions to determine whether specific risk of their covered debt and such instruments qualify for inclusion in equity positions. The proposed revisions tier 1 capital.6 Much of this work in would enhance the rule's risk sensitiv- 2007 involved evaluating enhanced ity, require banking organizations that forms of trust preferred securities and model specific risk to reflect any incremandatory convertible securities. mental default risk of traded positions, Staff members also identify and adand require public disclosure of certain dress supervisory concerns related to suqualitative and quantitative market risk pervised banking organizations' capital information. The agencies expect to fiissuances and work with the Reserve nalize this rule in the first half of 2008. Banks to evaluate the overall composi- In July 2007, the Federal Reserve istion of banking organizations' capital. sued a letter reminding supervised bank- In this work, the staff often must review ing organizations that the application of the funding strategies proposed in applithe fair value option to securities may cations for acquisitions and other transsubject the organization to the market actions submitted to the Federal Reserve risk capital rule. The letter directed by banking organizations. those organizations to contact their Reserve Bank to discuss their plans to address the rule's requirements. Accounting Policy The supervisory policy function is also Risk-Based Capital Standards responsible for monitoring major dofor Banking Organizations mestic and international proposals, stan- Not Subject to Basel II dards, and other developments affecting the banking industry in the areas of During 2007, the Federal Reserve, OCC, accounting, auditing, internal controls FDIC, and OTS considered public comover financial reporting, financial ments on a notice of proposed rulemakdisclosure, and supervisory financial ing (NPR) issued in December 2006 reporting. Federal Reserve staff proposing modifications to the current members interact with key constituents Basel I-based capital rules. The proin the accounting and auditing profesposed rules would provide an option to sions, including regulators, standardthose banking organizations that are not setters, accounting firms, accounting required to adopt Basel II and do not and banking industry trade groups, and wish to voluntarily follow the advanced the banking industry, and issue approaches. This option is known as the supervisory guidance as appropriate. Basel I-A proposal. In response to comments calling for an option to adopt the standardized ap- 6. Tier 1 capital comprises common stockholdproach under Basel II, the agencies reers' equity and qualifying forms of preferred vised the Basel I-A proposal and intend stock, less required deductions such as goodwill to issue a new NPR setting forth a pro- and certain intangible assets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 99 Domestic Accounting nancial Reporting, which was established to examine the U.S. financial The Federal Reserve continues to reporting system with the goals of reclosely monitor domestic and internaducing unnecessary complexity and tional accounting standard-setting remaking information more useful and unlated to the use of fair value accounting. derstandable for investors. Federal Re- In previous comment letters to the Fiserve staff also participated in FASB efnancial Accounting Standards Board forts to improve financial reporting, (FASB), the Federal Reserve has raised including roundtable discussions on concerns about the reliability of reported modifications of securitized subprime financial results based on fair value mortgage loans and the joint FASBmeasurements, especially when finan- International Accounting Standards cial instruments are illiquid. In May Board (IASB) project on Financial 2007, Federal Reserve staff issued a Statement Presentation. comment letter to the FASB regarding its "Invitation to Comment on Valua- Bank Secrecy Act and tion Guidance for Financial Reporting" Anti-Money Laundering that strongly supported efforts to consider the need for additional valuation In 2007, the FFIEC again updated the guidance. Bank Secrecy Act/Anti-Money Launder- The FASB's Statement of Financial ing Examination Manual (originally Accounting Standards No. 159, The Fair issued in 2005) to further clarify super- Value Option for Financial Assets and visory expectations, incorporate new Financial Liabilities, issued in February regulatory issuances, and respond to in- 2007, allows most financial assets and dustry requests for additional guidance. financial liabilities to be reported at fair Significant revisions included updates to value. As part of its continued focus on the chapters on customer due diligence, the use of fair value accounting at bank- suspicious activity reporting, foreign ing organizations, and in light of the correspondent accounts, electronic potential increased use of fair value ac- banking, and trade finance. The manual counting for loans, the Federal Reserve provides current and consistent riskstaff conducted a study of fair value based guidance to help banking measurements of commercial loan val- organizations comply with the BSA and ues. The study was intended to provide safeguard operations from money additional insight into valuation method- laundering and terrorism financing. ologies used and related control frame- Also during the year, the FFIEC agenworks for loans at a number of large, cies issued "Interagency Statement on internationally active banking organiza- Enforcement of Bank Secrecy Act/Antitions. The study report, issued in June Money Laundering Requirements" set- 2007, summarizes commercial loan fair ting forth their interpretation of the revalue measurement practices at these quirement in the Federal Deposit organizations. Insurance Act relating to supervisory ac- Federal Reserve staff participated in a tions to address certain BSA compliance number of SEC and FASB efforts to ad- issues. The statement provides greater dress current accounting issues. A se- consistency among the agencies on cernior Federal Reserve representative is tain BSA enforcement decisions and describes considerations that affect those an official observer on the SEC Advidecisions. sory Committee on Improvements to Fi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

100 94th Annual Report, 2007 The Federal Reserve and other fed- of developing a definition of capital. eral banking agencies continued during The Federal Reserve also participated in 2007 to share information with the Fi- a workshop addressing supervisory and nancial Crimes Enforcement Network industry expectations with regard to (FinCEN) under the interagency memo- implementation of pillar 2 of Basel II randum of understanding (MOU) that (supervisory review). was finalized in 2004, and with the Treasury's Office of Foreign Assets Risk Management Control (OFAC) under the interagency The Federal Reserve contributed to su- MOU that was finalized in 2006. pervisory policy papers, reports, and The Federal Reserve continues to par- recommendations issued by the Basel ticipate in efforts to promote transpar- Committee during 2007 that were ency and address risks faced by finan- generally aimed at improving the cial institutions that act as intermediaries supervision of banking organizations' in international funds transfers. The risk-management practices.7 Two of Federal Reserve, other U.S. banking these were agencies, and the Treasury have supported private-sector efforts to address • "Principles for Home-Host Supervithe anti-money-laundering and sanctions sory Cooperation and Allocation concerns of banks that have interna- Mechanisms in the Context of Adtional operations. In addition, the Fed- vanced Measurement Approaches," eral Reserve participates in the Anti- consultative document published in Money Laundering and Countering the February and final document pub- Financing of Terrorism Expert Group, a lished in November subcommittee of the Basel Committee's • "Guidelines for Computing Capital International Liaison Group. for Incremental Default Risk in the Trading Book," consultative docu- International Guidance on ment published in October Supervisory Policies The Federal Reserve contributed to ef- As a member of the Basel Committee, forts begun in January 2007 to look at the Federal Reserve participates in ef- liquidity regulation across jurisdictions forts to advance sound supervisory poli- and to review the 2000 Basel Commitcies for internationally active banking tee paper "Sound Practices for Managorganizations and to improve the stabil- ing Liquidity in Banking Organisations" ity of the international banking system. with a view toward updating the paper. In 2007, the Federal Reserve partici- Joint Forum pated in ongoing cooperative work on implementation of Basel II and on de- In 2007, the Federal Reserve continued velopment of international supervisory to participate in the Joint Forum—a guidance, particularly in the area of group established under the aegis of the funding liquidity risk management. Basel Committee to address issues re- The Federal Reserve also continued lated to the banking, securities, and into participate in Basel Committee work- surance sectors, including the regulation ing groups addressing issues not fully resolved in the Basel II framework. One 7. Papers issued by the Basel Committee can effort is a look at eligible capital instrube accessed via the Bank for International Settlements across jurisdictions with the goal ments website at www.bis.org. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 101 of financial conglomerates. The Joint guidance on fair value measurement, Forum is made up of representatives of particularly as part of the joint FASBthe Basel Committee, the International IASB program on convergence between Organization of Securities Commis- International Financial Reporting Stansions, and the International Association dards and U.S. generally accepted acof Insurance Supervisors. The Federal counting principles (GAAP). Reserve contributed to the development In 2007 the Basel Committee also isof supervisory policy papers, reports, sued a series of comment letters to the and recommendations issued by the IAASB related to the international stan- Joint Forum during 2007, including dards on auditing (ISAs) that are being work on risk concentrations, credit risk revised as part of the IAASB's Clarity transfer, customer suitability, and imple- Project. The Clarity Project is part of an mentation of principles for the supervi- effort by the IAASB to increase consission of financial conglomerates.8 The tency in the application of auditing stan- Federal Reserve also participated in dards around the world and to improve Joint Forum-sponsored information- the clarity of the ISAs. The revised ISAs sharing on pandemic planning and other cover such audit areas as planning the business continuity initiatives. audit, auditing different types of financial statements, audit evidence, related International Accounting parties, going concern, fair value measurements, internal audit, and the audi- The Federal Reserve participates in the tor's report. Basel Committee's Accounting Task Force (ATF), which represents the Basel Committee at international meetings on Credit Risk Management accounting, auditing, and disclosure is- The Federal Reserve works with the sues affecting global banking organizaother federal banking agencies to detions. During 2007, Federal Reserve velop guidance on the management of staff contributed to the development of credit risk. numerous Basel Committee comment letters related to accounting and audit- Working with Mortgage Borrowers ing matters that were submitted to the IASB and the International Auditing and In April 2007 the Federal Reserve, Assurance Standards Board (IAASB). FDIC, NCUA, OCC, and OTS issued The Basel Committee in May 2007 staff guidance to encourage supervised issued a comment letter to the IASB on institutions to work constructively with its discussion paper "Fair Value Mea- homeowners who are financially unable surements." The paper was prepared by to continue meeting their mortgage paythe IASB as part of its efforts to develop ments. The agencies reminded institua standard for fair value measurements tions that prudent workout arrangements similar to the FASB Statement of Finan- that are consistent with safe and sound cial Accounting Standards No. 157, Fair lending practices are generally in the Value Measurements, issued in Septemlong-term best interest of both the finanber 2006. In its letter, the Basel Commitcial institution and the borrower. tee emphasized the importance of sound Subprime Mortgage Lending 8. Papers issued by the Joint Forum can be In June the Federal Reserve, FDIC, accessed via the Bank for International Settlements website at www.bis.org. NCUA, OCC, and OTS issued "State- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

102 94th Annual Report, 2007 ment on Subprime Mortgage Lending" The statement outlines the steps a serto address issues and questions related vicer may take when there is an into certain adjustable-rate mortgage creased risk of default, including identi- (ARM) products marketed to subprime fying borrowers at heightened risk of borrowers. The statement emphasizes delinquency or default, contacting borthe need for prudent underwriting stan- rowers to assess their ability to repay, dards and clear and balanced consumer and determining whether default is reainformation, so that institutions and con- sonably foreseeable. The statement goes sumers can assess the risks arising from on to explain possible loss-mitigation certain ARM products that have dis- techniques that a servicer may pursue counted or low introductory rates. It de- with a borrower, recognizing that the scribes the prudent safety and soundness servicer must consider the documents and consumer protection standards that governing the securitization trust to deinstitutions should follow to ensure that termine its authority to restructure loans borrowers obtain loans they can afford that are delinquent or are at risk of imto repay. These standards include quali- minent default. fying borrowers on a fully indexed, fully amortized basis and guidelines on the Pandemic Planning use of risk-layering features, including an expectation that stated income and In December, the FFIEC agencies pubreduced documentation would be ac- lished guidance on planning for the purcepted only if there are documented fac- pose of minimizing the potential adverse tors that clearly minimize the need for effects of an influenza pandemic. The verification of the borrower's repayment guidance emphasizes the importance of capacity. Consumer protection standards (1) a preventive program to reduce the include clear and balanced product dis- likelihood that the institution's operaclosures for customers and limits on pre- tions will be significantly affected by a payment penalties so that customers pandemic, (2) a documented strategy have a reasonable period to refinance that scales the response to the particular without penalty, typically at least sixty stages of an outbreak, (3) a comprehendays before expiration of the initial fixed sive framework of facilities, systems, or interest rate period. procedures needed to continue critical operations, (4) a testing program, and (5) an oversight program. In September Statement on and October, the Federal Reserve par- Loss-Mitigation Strategies ticipated with the other FFIEC agencies In September the Federal Reserve, in a Treasury-sponsored, industrywide FDIC, NCUA, OCC, OTS, and Confer- business continuity exercise to test the ence of State Bank Supervisors issued a financial sector's ability to respond to a statement encouraging federally regu- pandemic crisis. The Federal Reserve lated financial institutions and state- helped develop the after-exercise report, supervised entities that service securi- which was published in January 2008. tized residential mortgages to review their authority under pooling and servic- Banks' Securities Activities ing agreements to identify borrowers at risk of default and to pursue appropriate In September, the Federal Reserve and loss-mitigation strategies designed to the SEC adopted joint final rules definpreserve sustainable home ownership. ing the scope of securities activities a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 103 bank may conduct without registering needed, to recommend and implement with the SEC as a securities broker. The appropriate and timely revisions to the Gramm-Leach-Bliley Act eliminated the reporting forms and the attendant blanket "broker" exception for banks instructions. that had been contained in section 3(a)(4) of the Securities Exchange Act Bank Holding Company of 1934, but it granted exceptions de- Regulatory Reports signed to allow banks to continue to engage in securities transactions for cus- The Federal Reserve requires that U.S. tomers in connection with their normal bank holding companies periodically trust, fiduciary, custodial, and other submit reports providing financial and banking operations. The rules imple- structure information. The information ment the most important "broker" ex- is essential in supervising the companies ceptions for trust and fiduciary activi- and in formulating regulations and suties, custodial and deposit "sweep" pervisory policies. It is also used in refunctions, and third-party networking sponding to requests from Congress and arrangements. the public for information about bank holding companies and their nonbank subsidiaries. Foreign banking organiza- Economic Growth and Regulatory tions also are required to periodically Paperwork Reduction Act of 1996 submit reports to the Federal Reserve. The Economic Growth and Regulatory Reports in the FR Y-9 series— Paperwork Reduction Act of 1996 FR Y-9C, FR Y-9LP, and FR Y-9SP— (EGRPRA) requires that the federal provide standardized financial statebanking agencies review their regula- ments for bank holding companies on tions every ten years to identify and both a consolidated and a parent-only eliminate any unnecessary requirements basis. The reports are used to detect imposed on insured depository institu- emerging financial problems, to review tions. (In addition, the Board periodi- performance and conduct pre-inspection cally reviews each of its regulations.) analysis, to monitor and evaluate risk During 2007, the Federal Reserve, OCC, profiles and capital adequacy, to evalu- FDIC, and OTS completed the required ate proposals for bank holding company review and issued a joint report to mergers and acquisitions, and to analyze Congress, which is available on the the holding company's overall financial EGRPRA website at www.egrpra.gov. condition. Nonbank subsidiary reports— FR Y-l 1, FR 2314, and FR Y-7N—help Regulatory Reports the Federal Reserve determine the condition of bank holding companies that The supervisory policy function is re- are engaged in nonbank activities and sponsible for developing, coordinating, also aid in monitoring the number, naand implementing regulatory reporting ture, and condition of the companies' requirements for various financial re- nonbank subsidiaries. porting forms filed by domestic and for- In March, several revisions to the eign financial institutions subject to Fed- FR Y-9C report were approved for eral Reserve supervision. Federal implementation during 2007: (1) collec- Reserve staff' members interact with ap- tion of certain data on the sources of fair propriate federal and state supervisors, value measurements from all institutions including foreign bank supervisors as that choose, under GAAP, to apply a fair Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

104 94th Annual Report, 2007 value option to one or more financial and Income (Call Report) as described instruments and one or more classes of in the next section. In addition, the Fedservicing assets and liabilities, and from eral Reserve proposed to collect certain certain institutions that report trading as- data on the FR Y-9LP, FR Y-9SP, sets and liabilities; (2) collection of in- FRY-11, FR 2314, FR Y-7, and formation on the cumulative change in FR 2886b forms from all institutions the fair value of liabilities accounted for that choose to apply a fair value option under the fair value option that is attrib- to financial instruments and servicing utable to changes in the bank holding assets and liabilities, and also proposed company's own creditworthiness, for to collect other information on sources purposes of determining regulatory capi- of income for supervisory purposes. tal; (3) collection of certain data on oneto four-family residential mortgage Commercial Bank loans that have terms allowing for nega- Regulatory Financial Reports tive amortization; and (4) revision of instructions for reporting time deposits As the federal supervisor of state memand brokered deposits. ber banks, the Federal Reserve, along Effective March 2007, four new items with the other banking agencies through were added to the quarterly FR Y-11 the FFIEC, requires banks to submit and FR2314 reporting forms to facili- quarterly Call Reports. Call Reports are tate monitoring of the extension of nega- the primary source of data for the supertively amortizing residential mortgage vision and regulation of banks and the loans. Also, a new section concerning ongoing assessment of the overall notes to the financial statements was soundness of the nation's banking sysadded to the FR 2314. tem. Call Report data, which also serve Effective June 2007, reporting forms as benchmarks for the financial informaused to collect information on changes tion required by many other Federal Rein organizational structure and the status serve regulatory financial reports, are of a foreign branch (FR Y-10, widely used by state and local govern- FRY-10F, FR Y-10S, and FR 2058) ments, state banking supervisors, the were combined into one event-generated banking industry, securities analysts, form called the FR Y-10. Also, a supple- and the academic community. mental form was created (FR Y-10E) to For the 2007 reporting period, the collect additional structure information FFIEC implemented various revisions to that the Federal Reserve deems to be the Call Report to address new safety critical and is needed in an expedited and soundness considerations and to famanner in order to meet new legislative cilitate supervision. Among these revirequirements, answer congressional in- sions were changes related to the reportquiries, or respond to market events. ing of data for deposit insurance Effective December 2007, a require- assessments; changes to provide for the ment that an institution verify its list of reporting of data on nontraditional mortdomestic branches was added to the gage products; and changes to provide FR Y-6. for the reporting of data related to cer- In November, the Federal Reserve tain financial instruments measured at proposed a number of revisions to the fair value. FR Y-9 for the 2008 reporting period In September, the FFIEC proposed a comparable to those proposed for the number of revisions to the Call Report bank Consolidated Reports of Condition for the 2008 reporting period. The pro- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 105 posed revisions include collecting addi- with business needs; (2) identification tional information related to one- to and implementation of improvements to four-family residential mortgage loans; make technology more accessible to modifying the definition of trading ac- staff working in the field; (3) strengthencount in response to the creation of a ing of compliance with data-privacy fair value option in generally accepted regulations; (4) identification of opporaccounting principles; revising certain tunities to converge and streamline IT schedules to enhance the reporting of applications, including key administrainformation available under the fair tive systems, to provide consistent and value option; revising the instructions seamless information; (5) evaluation and for reporting daily average deposit data implementation of collaboration and by newly insured institutions to conform analysis technologies (such as commuwith the FDIC's assessment regulations; nities of practice and business intelliand clarifying the instructions for report- gence tools) to integrate supervisory and ing credit derivatives data in the risk- management information systems that based capital schedule. support both office-based and field staff; In 2007, Federal Reserve staff led a (6) with the other federal regulatory review of the Call Report by the federal agencies, modernization of the Shared banking agencies to determine which National Credit system; and (7) endata requirements are no longer neces- hancement of the information security sary or appropriate. The review, re- framework for the supervisory function, quired by the Financial Regulatory Re- improving both overall security and lief Act of 2006 to be conducted every compliance with best-practices and five years, documented the safety and regulatory requirements (security ensoundness and other public policy uses hancements included the encryption of of each Call Report item and will serve data on all laptop computers and distrias a reference for future changes to the bution of encrypted portable drives). In Call Report. addition, new, advanced security measures were pilot-tested prior to expected implementation in 2008. Supervisory Information Technology National Information Center Information technology supporting Federal Reserve supervisory activities is The National Information Center (NIC) managed within the System supervisory is the Federal Reserve's comprehensive information technology (SSIT) function repository for supervisory, financial, and in the Board's Division of Banking Su- banking structure data and supervisory pervision and Regulation. SSIT works documents. NIC includes data on bankthrough assigned staff at the Board and ing structure throughout the United the Reserve Banks, as well as through States; the National Examination Data- System committees, to ensure that key base (NED), which enables supervisory staff members throughout the System personnel as well as federal and state participate in identifying requirements banking authorities to access NIC data; and setting priorities for information the Banking Organization National technology initiatives. Desktop (BOND), an application that fa- In 2007, the SSIT function worked on cilitates secure, real-time electronic several strategic projects and initiatives: information-sharing and collaboration (1) alignment of technology investments among federal and state banking regula- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

106 94th Annual Report, 2007 tors for the supervision of banking orga- ence of State Bank Supervisors—on a nizations; and the Central Document and variety of technology-related initiatives Text Repository (CDTR), which con- and projects supporting the supervision tains documents supporting the supervi- business function. sory processes. Within the NIC, the supporting sys- Staff Development tems have been modified over time to extend their useful lives and improve The System Staff Development Program business workflow efficiency. During trains staff members at the Board, the 2007 work continued on upgrading the Reserve Banks, and state banking deentire NIC infrastructure in order to pro- partments. Training is offered at the bavide easier access to information, a con- sic, intermediate, and advanced levels in sistent Federal Reserve enterprise infor- several disciplines within bank supervimation layer, a comprehensive metadata sion: safety and soundness, information repository, and uniform security across technology, foreign banking organizathe Federal Reserve. Implementation is tions, and consumer affairs. Classes are expected to be phased in beginning mid- conducted in Washington, D.C., as well year 2008, with a completion target of as at Reserve Banks and other locations. 2010. Also in 2007, the NED system The Federal Reserve also participates in was modified to enhance the collection training offered by the FFIEC and by and reporting of Bank Secrecy Act in- certain other regulatory agencies. The formation. In addition, the BOND and System's involvement includes develop- CDTR systems were enhanced to pro- ing and implementing basic and advide the document storage facility for vanced training in relation to various the new national Federal Reserve Con- emerging issues as well as in specialized sumer Help call center. Key summary areas such as international banking, indocumentation regarding consumer formation technology, anti-money launcomplaints and inquiries is posted into dering, capital markets, payment systhe CDTR and made available to Sys- tems risk, and real estate appraisal (see tem staff and staff at the other federal table). banking agencies via the BOND system. In 2007, the Federal Reserve trained The BOND and CDTR systems were 2,588 students in Federal Reserve Sysalso enhanced to provide an automated, tem schools, 894 in schools sponsored electronic means for passing examina- by the FFIEC, and 26 in other schools, tion and inspection reports to the records for a total of 3,508. The number of trainmanagement system of the Board's Of- ing days in 2007 totaled 16,791. fice of the Secretary. This new elec- The System provides scholarship astronic process has allowed the Reserve sistance to the states for training their Banks to discontinue the long-standing examiners in Federal Reserve and practice of sending hard-copy reports to FFIEC schools. Through this program, the Board for records management pur- 659 state examiners were trained—347 poses. in Federal Reserve courses, 309 in Finally, during 2007 the Federal Re- FFIEC programs, and 3 in other courses. serve continued to work closely with A staff member seeking an examinother federal and state banking er's commission is required to take a agencies—including federal agency first proficiency examination as well as chief information officers, FFIEC task a second proficiency examination in one forces and subgroups, and the Confer- of two specialty areas, safety and sound- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 107 Training Programs for Banking Supervision and Regulation, 2007 Number of sessions conducted Program Total Regional Schools or seminars conducted by the Federal Reserve Core schools Banking and supervision elements 9 8 Financial analysis and risk management 9 8 Bank management 3 1 Report writing 17 17 Team dynamics and negotiation 9 9 Conducting meetings with management 15 15 Other schools Credit risk analysis 7 7 Examination management 6 5 Real estate lending seminar 2 1 Senior forum for current banking and regulatory issues 1 1 Basel II corporate activities 1 1 Basel II operational risk 2 1 Basel II retail activities 2 2 Principles of fiduciary supervision 1 1 Commercial lending essentials for consumer affairs 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 2 2 Foreign banking organizations seminar 1 1 Information systems continuing education 8 8 Asset liability management (ALMl) 2 2 Fundamentals of interest rate risk management . 6 6 Technology risk integration 4 4 Trading risk management 2 2 Leadership and influence 4 4 Fundamentals of fraud 7 7 Information technology seminars1 21 21 Self-study or online learning2 Orientation (core and specialty) 0 0 Self-study programs 1, 2, and 3 0 Self-study modules 0 0 Other agencies conducting courses3 Federal Financial Institutions Examination Council 71 1 The Options Institute 1 1 1. Held at the IT Lab at the Chicago Federal Reserve 2. Self-study programs do not involve group sessions. Bank. 3. Open to Federal Reserve employees. ness or consumer affairs. In 2007, 161 Regulation of the examiners passed the first proficiency U.S. Banking Structure examination and 73 passed the second proficiency examination, 53 examiners The Federal Reserve administers several in safety and soundness and 20 in federal statutes that apply to bank holdconsumer affairs. An information ing companies, financial holding comtechnology specialty is also offered; it panies, member banks, and foreign requires passing a proficiency examina- banking organizations—the Bank Holdtion and an examination administered ing Company Act, the Bank Merger Act, by an information technology industry the Change in Bank Control Act, the association. Federal Reserve Act, and the Interna- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

108 94th Annual Report, 2007 tional Banking Act. In administering plicable law. In the case of a foreign these statutes, the Federal Reserve acts banking organization seeking to acquire on a variety of proposals that directly or control of a U.S. bank, the Federal Reindirectly affect the structure of the U.S. serve also considers whether the foreign banking system at the local, regional, bank is subject to comprehensive superand national levels; the international op- vision or regulation on a consolidated erations of domestic banking organiza- basis by its home-country supervisor. In tions; or the U.S. banking operations of 2007, the Federal Reserve acted on 603 foreign banks. The proposals concern applications and notices filed by bank bank holding company formations and holding companies to acquire a bank or acquisitions, bank mergers, and other a nonbank firm, or to otherwise expand transactions involving bank or nonbank their activities. firms. In 2007, the Federal Reserve acted Bank holding companies generally on 1,365 proposals, which represented may engage in only those nonbanking 2,661 individual applications filed under activities that the Board has previously the five administered statutes. determined to be closely related to banking under section 4(c)(8) of the Bank Holding Company Act. Since 1996, the Bank Holding Company Act act has provided an expedited prior no- Under the Bank Holding Company Act, tice procedure for certain permissible a corporation or similar legal entity must nonbank activities and for acquisitions obtain the Federal Reserve's approval of small banks and nonbank entities. before forming a bank holding company Since that time the act has also permitthrough the acquisition of one or more ted well-run bank holding companies banks in the United States. Once that satisfy certain criteria to commence formed, a bank holding company must certain other nonbank activities on a de receive Federal Reserve approval before novo basis without first obtaining Fedacquiring or establishing additional eral Reserve approval. banks. The act also identifies the non- A bank holding company may repurbanking activities permissible for bank chase its own shares from its shareholdholding companies. Depending on the ers. When the company borrows money circumstances, these activities may or to buy the shares, the transaction inmay not require Federal Reserve ap- creases the company's debt and deproval in advance of their commence- creases its equity. The Federal Reserve ment. may object to stock repurchases by hold- When reviewing a bank holding com- ing companies that fail to meet certain pany application or notice that requires standards, including the Board's capital prior approval, the Federal Reserve may adequacy guidelines. In 2007, the consider the financial and managerial re- Federal Reserve reviewed 11 stock resources of the applicant, the future pros- purchase proposals by bank holding pects of both the applicant and the firm companies. to be acquired, the convenience and The Federal Reserve also reviews needs of the community to be served, elections from bank holding companies the potential public benefits, the com- seeking financial holding company stapetitive effects of the proposal, and the tus under the authority granted by the applicant's ability to make available to Gramm-Leach-Bliley Act. Bank holding the Federal Reserve information deemed companies seeking financial holding necessary to ensure compliance with ap- company status must file a written dec- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 109 laration with the Federal Reserve. In ture prospects of the institution to be 2007, 37 domestic financial holding acquired; the effect of the proposed company declarations and 2 foreign change on competition in any relevant bank declarations were approved. market; the completeness of the information submitted by the acquiring person; and whether the proposed change Bank Merger Act would have an adverse effect on the fed- The Bank Merger Act requires that all eral deposit insurance fund. A proposed proposals involving the merger of in- transaction should not jeopardize the sured depository institutions be acted on stability of the institution or the interests by the appropriate federal banking of depositors. During its review of a proagency. The Federal Reserve has pri- posed transaction, the Federal Reserve mary jurisdiction if the institution sur- may contact other regulatory or law enviving the merger is a state member forcement agencies for information bank. Before acting on a merger pro- about relevant individuals. posal, the Federal Reserve considers the In 2007, the Federal Reserve financial and managerial resources of approved 106 changes in control of state the applicant, the future prospects of the member banks and bank holding existing and combined organizations, companies. the convenience and needs of the community(ies) to be served, and the com- Federal Reserve Act petitive effects of the proposed merger. The Federal Reserve also must consider Under the Federal Reserve Act, a memthe views of the U.S. Department of Jus- ber bank may be required to seek Fedtice regarding the competitive aspects of eral Reserve approval before expanding any proposed bank merger involving un- its operations domestically or internaaffiliated insured depository institutions. tionally. State member banks must ob- In 2007, the Federal Reserve approved tain Federal Reserve approval to estab- 68 merger applications under the act. lish domestic branches, and all member banks (including national banks) must obtain Federal Reserve approval to es- Change in Bank Control Act tablish foreign branches. When review- The Change in Bank Control Act re- ing proposals to establish domestic quires individuals and certain other par- branches, the Federal Reserve considties that seek control of a U.S. bank or ers, among other things, the scope and bank holding company to obtain ap- nature of the banking activities to be proval from the appropriate federal conducted. When reviewing proposals banking agency before completing the for foreign branches, the Federal Retransaction. The Federal Reserve is re- serve considers, among other things, the sponsible for reviewing changes in the condition of the bank and the bank's control of state member banks and bank experience in international banking. In holding companies. In its review, the 2007, the Federal Reserve acted on new Federal Reserve considers the financial and merger-related branch proposals for position, competence, experience, and 1,520 domestic branches and granted integrity of the acquiring person; the ef- prior approval for the establishment of fect of the proposed change on the fi- 20 new foreign branches. nancial condition of the bank or bank State member banks must also obtain holding company being acquired; the fu- Federal Reserve approval to establish fi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

110 94th Annual Report, 2007 nancial subsidiaries. These subsidiaries operations; the managerial resources of may engage in activities that are finan- the foreign bank; whether the homecial in nature or incidental to financial country supervisor shares information activities, including securities and insur- regarding the operations of the foreign ance agency-related activities. In 2007, bank with other supervisory authorities; no financial subsidiary applications whether the foreign bank has provided were filed. adequate assurances that information concerning its operations and activities will be made available to the Federal Overseas Investments by Reserve, if deemed necessary to deter- U.S. Banking Organizations mine and enforce compliance with ap- U.S. banking organizations may engage plicable law; whether the foreign bank in a broad range of activities overseas. has adopted and implemented proce- Many of the activities are conducted in- dures to combat money laundering and directly through Edge Act and agree- whether the home country of the foreign ment corporation subsidiaries. Although bank is developing a legal regime to admost foreign investments are made un- dress money laundering or is participatder general consent procedures that in- ing in multilateral efforts to combat volve only after-the-fact notification to money laundering; and the record of the the Federal Reserve, large and other sig- foreign bank with respect to compliance nificant investments require prior ap- with U.S. law. In 2007, the Federal Reproval. In 2007, the Federal Reserve ap- serve approved 18 applications by forproved 69 proposals for overseas eign banks to establish branches, ageninvestments by U.S. banking organiza- cies, or representative offices in the tions, many of which represented invest- United States. ments through an Edge Act or agreement corporation. Public Notice of Federal Reserve Decisions International Banking Act Certain decisions by the Federal Reserve The International Banking Act, as that involve an acquisition by a bank amended by the Foreign Bank Supervi- holding company, a bank merger, a sion Enhancement Act of 1991, requires change in control, or the establishment foreign banks to obtain Federal Reserve of a new U.S. banking presence by a approval before establishing branches, foreign bank are made known to the agencies, commercial lending company public by an order or an announcement. subsidiaries, or representative offices in Orders state the decision, the essential the United States. facts of the application or notice, and In reviewing proposals, the Federal the basis for the decision; announce- Reserve generally considers whether the ments state only the decision. All orders foreign bank is subject to comprehen- and announcements are made public imsive supervision or regulation on a con- mediately; they are subsequently resolidated basis by its home-country su- ported in the Board's weekly H.2 statispervisor. It also considers whether the tical release. The H.2 release also home-country supervisor has consented contains announcements of applications to the establishment of the U.S. office; and notices received by the Federal Rethe financial condition and resources of serve upon which action has not yet the foreign bank and its existing U.S. been taken. For each pending applica- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Banking Supervision and Regulation 111 tion and notice, the related H.2 contains the credit is used to purchase debt and the deadline for comments. The Board's equity securities. The Board's Regulawebsite (www.federalreserve.gov) pro- tion U limits the amount of credit that vides information on orders and an- may be provided by lenders other than nouncements as well as a guide for U.S. brokers and dealers when the credit is and foreign banking organizations that used to purchase or carry publicly held wish to submit applications or notices to equity securities if the loan is secured by the Federal Reserve. those or other publicly held equity securities. The Board's Regulation X applies these credit limitations, or margin re- Enforcement of quirements, to certain borrowers and to Other Laws and Regulations certain credit extensions, such as credit The Federal Reserve's enforcement re- obtained from foreign lenders by U.S. sponsibilities also extend to the disclo- citizens. sure of financial information by state Several regulatory agencies enforce member banks and the use of credit to the Board's securities credit regulations. purchase and carry securities. The SEC, the Financial Industry Regulatory Authority (formed through the com- Financial Disclosures by bination of the National Association of State Member Banks Securities Dealers and the regulation, enforcement, and arbitration functions State member banks that issue securities of the New York Stock Exchange), and registered under the Securities Exchange the Chicago Board Options Exchange Act of 1934 must disclose certain inforexamine brokers and dealers for complimation of interest to investors, including ance with Regulation T. With respect to annual and quarterly financial reports compliance with Regulation U, the fedand proxy statements. By statute, the eral banking agencies examine banks Board's financial disclosure rules must under their respective jurisdictions; the be substantially similar to those of the FCA, the NCUA, and the OTS examine SEC. At the end of 2007, 12 state memlenders under their respective jurisdicber banks were registered with the tions; and the Federal Reserve examines Board under the Securities Exchange other Regulation U lenders. Act of 1934. Securities Credit Federal Reserve Membership Under the Securities Exchange Act, the At the end of 2007, 2,489 banks were Board is responsible for regulating members of the Federal Reserve System credit in certain transactions involving and were operating 55,603 branches. the purchase or carrying of securities. These banks accounted for 36 percent of The Board's Regulation T limits the all commercial banks in the United amount of credit that may be provided States and for 71 percent of all commerby securities brokers and dealers when cial banking offices. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

113 Consumer and Community Affairs Among the Federal Reserve's responsi- creasing competition and consumer bilities in the areas of consumer and choice. However, the number and types community affairs are of consumer financing products and providers now available means consumers • writing and interpreting regulations to have to become more vigilant and wellimplement federal laws that protect informed as they shop for financial and inform consumers; products and manage their personal finances. The Federal Reserve has strate- • supervising state member banks to engically used its regulatory and supervisure compliance with the regulations; sory authorities to address consumer • investigating complaints from the protection issues in today's complex public about state member banks' consumer financial services marketplace compliance with regulations; and to promote consumer education and community development. • promoting community development in historically underserved markets; and Mortgage Credit • conducting research and promoting consumer education. Homeownership has long been a highly valued goal of both policymakers and These responsibilities are carried out by consumers. In response to the demand the members of the Board of Governors, for home loans, the mortgage industry the Board's Division of Consumer and has introduced innovative and creative Community Affairs, and the consumer loan products into the consumer finanand community affairs staff of the Fed- cial services market. As a result, coneral Reserve Banks. sumers' access to home mortgage credit The Federal Reserve System's vari- has expanded considerably over the last ous consumer protection and commu- decade. Market opportunities and technity development roles were the subject nological advancements have contribof great interest in 2007. Consumer pro- uted to the growth of the mortgage intection concerns moved to the forefront dustry. As the mortgage market grew, of public dialogue as lawmakers, regula- some lenders employed nontraditional tors, the media, and consumers scruti- underwriting and risk-layering strategies nized various practices being used in the in order to capture new market segfinancial services marketplace, particu- ments, particularly consumers who may larly in the markets for subprime mort- not have been able to qualify for gages and credit cards. Intense examina- credit under more-traditional mortgagetion of the policies and practices at issue underwriting criteria. Although innovahas revealed the complexity of the cur- tion in the mortgage market has made rent financial services marketplace. De- access to mortgage credit possible for regulation and technological and finan- increasing numbers of households, loan cial innovation over the last two decades products have become increasingly fueled the growth of this market, in- complex—and underwriting standards Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

114 94th Annual Report, 2007 An Overview of the Subprime Mortgage Market At $ 11 trillion, the depth and breadth of ability of lenders to sell many mortgages the U.S. home mortgage market is unique. to "securitizers" that pooled large numbers Its sheer capacity has enabled many of mortgages and sold the rights to the families to become homeowners, facilitat- resulting cash flows to investors. Previing a long-standing goal of consumers and ously, lenders tended to hold mortgages on policymakers. Over the past two decades, their books until the loans were repaid. the mortgage industry has expanded as a The increasingly popular "originate-toresult of financial innovation, technologi- distribute" lending model gave lenders cal advancements, and deregulation. Lend- (and mortgage borrowers) greater access to ers have been able to provide more capital markets and allowed risk to be consumers with access to mortgage credit. shared more widely. Increased access to In particular, advances in credit scoring mortgage credit was further fueled by the technology and risk-based pricing strate- rise of both mortgage brokers who gies opened up the mortgage market to expanded the sales and distribution chanconsumers considered to be higher-risk nels of mortgage lending and independent because of their limited or negative credit mortgage originators not directly affiliated histories, income limitations, or other with a federally supervised depository financial issues. Lenders charged these institution. borrowers, known as subprime borrowers, The expanding field of nonbank higher rates to reflect the higher level of mortgage lenders was particularly notable risk they presented. The subprime in the subprime mortgage market. Data mortgage market began to expand mark- from 2006 reported under the Home edly in the mid-1990s and peaked in 2006. Mortgage Disclosure Act indicate that The growth of the subprime mortgage 45 percent of high-cost first mortgages market was fueled by expansive develop- were originated by independent mortgage ments across the financial industry that companies, institutions that are not significantly changed every aspect of the regulated by the federal banking agencies mortgage industry, from how mortgages and that typically sell nearly all of the were marketed and underwritten to how mortgages they originate. These nonthey were funded. The use of credit scor- depository institutions fund mortgage lending models to price for risk enabled lend- ing through the capital markets rather than ers to more efficiently evaluate a customer deposits, the traditional source of consumer's creditworthiness, reducing loan funding for banks. transaction costs for lenders. In addition, All of these mortgage market developchanges to and the ongoing growth of the ments increased the supply of mortgage secondary mortgage market increased the credit, which in turn likely contributed to have loosened in recent years, particu- mortgage loans.1 In recent years and larly in the subprime market. (See re- throughout 2007, Federal Reserve staff lated box "An Overview of the have undertaken various initiatives to Subprime Mortgage Market.") (1) scrutinize potentially risky practices Aware of the changing conditions in within the mortgage industry and (2) adthe mortgage market, the Federal Reserve Board has responded to the con- 1. See the testimony of Chairman Ben S. Bersumer protection and supervisory connanke, September 20.2007 (www.federalreserve.gov/ cerns of nontraditional and subprime newsevents/testimony/bernanke20070920a.htm). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 115 the rise in the national homeownership rate As the subprime mortgage crisis exfrom 64 percent in 1994 to about 68 per- panded throughout the last quarter of 2007, cent in 2007. But the broadening of access the Federal Reserve actively used its to mortgage credit also had negative as- policy, supervisory, and regulatory tools to pects. Given their weaker credit histories respond to the needs of markets, lenders, and financial conditions, subprime borrow- consumers, and communities. These activiers tend to default on their loans more fre- ties were discussed in detail by Federal quently than prime borrowers. A higher in- Reserve Board governors and other officidence of weaker underwriting standards cials who testified before Congress and risk-layering practices, such as failing throughout the year, offering lawmakers to document income and lending nearly to and the public an in-depth discussion about the full value of the home, further increased the issues and actions undertaken by the a subprime borrower's vulnerability for Federal Reserve in response to concerns default. about the subprime market.1 In addition, In 2007, the problems in the subprime staff at Federal Reserve Banks across the market, deceleration of the housing market, country worked with regulators, governdecreased house-price appreciation, and the ment officials, lenders, servicers, consumer weakening of the overall economy contrib- advocates, and community leaders to imuted to a significant number of subprime prove their understanding of the complex mortgage defaults. As a result, the sub- issues that contribute to, as well as the efprime mortgage market experienced sig- fects of, widespread mortgage delinquennificant setbacks: several independent cies and foreclosures. (For a detailed dismortgage lenders declared bankruptcy, and cussion of the Federal Reserve's efforts, some large financial organizations experi- see the "Mortgage Credit" section of this enced multimillion dollar losses in their chapter.) The Federal Reserve has a strong portfolios. For consumers, the conse- interest in supporting consumers and comquences of defaulting on a mortgage can be munities. Its activities during 2007 have severe, such as the loss of accumulated laid the foundation for continued efforts to home equity, reduced access to credit, and help stabilize the mortgage industry and foreclosure. And the negative effects can assist consumers to make sound financial spread beyond subprime customers. Clus- decisions. ters of foreclosures in one community can cause the value of nearby properties to decline and lead to an increase in vacant and abandoned properties, thereby inflicting 1. See www.federalreserve.gov/newsevents/ economic harm on entire neighborhoods. testimony/2007testimony.htm) dress issues through regulatory, sup- of the hearing was to gather information ervisory, or community engagement on how the Board might use its rulemakactivities. ing authority to curb abusive lending practices in the home mortgage market, particularly the subprime sector.2 The Regulatory Actions In June, the Board held a public hearing 2. In 1994, HOEPA was enacted in response to under the Home Ownership and Equity reports of predatory home equity lending practices Protection Act (HOEPA). The purpose in underserved markets. HOEPA amended the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

116 94th Annual Report, 2007 meeting, moderated by Governor Ran- tives supported improving the disclodall Kroszner, was the last in a series of sures provided to consumers during the five hearings held under HOEPA; the mortgage process. other four hearings were held through- Conversely, consumer advocates and out the nation during the summer of state and local officials urged the Board 2006.3 Representatives from the finan- to adopt robust regulations under cial services industry, consumer and HOEPA. They acknowledged a useful community groups, and state agencies role for supervisory guidance but conparticipated in the June hearing and tended that recent problems in the mortshared their perspectives on certain gage market indicated a need for stronlending practices, such as prepayment ger requirements that can be enforced penalties, the underwriting of "stated in- through civil actions—actions that come" loans, and the failure to provide would only be possible under regulaescrow accounts for taxes and insur- tions, not supervisory guidance. Conance.4 Representatives from the finan- sumer advocates and others welcomed cial services industry acknowledged that efforts to improve mortgage disclosures some recent lending practices merited but insisted that disclosures alone would concern, but these participants urged the not prevent abusive loans. They argued Board to address most of the concerns that independent mortgage lenders are by issuing supervisory guidance rather not subject to the federal regulators' guidthan regulations under HOEPA. They ance, and enforcement of the existing suggested that recent supervisory guid- laws governing these entities is limited. ance on nontraditional mortgages and In addition to the series of hearings, subprime lending, as well as corrective the Board received information and admeasures initiated within the mortgage vice from its Consumer Advisory Counmarket, had reduced the need for new cil (see "Advice from the Consumer Adregulations. Industry participants said visory Council") and from outreach that if the Board issues regulations, they meetings to gain insight into industry must be clear enough to eliminate uncer- practices. These efforts informed the tainty and avoid unduly restricting Board's release of proposed amendcredit. To help consumers avoid abusive ments to Regulation Z (Truth in Lendlending practices, industry representa- ing) at a public meeting in December.5 The goals of these proposed amendments are to Truth in Lending Act by imposing additional dis- • protect consumers in the mortgage closure requirements and other limits on certain high-cost, home-secured loans. Under HOEPA, the market from unfair, abusive, or decep- Board is authorized to issue rules that prohibit tive lending and servicing practices, certain acts or practices in connection with home while preserving responsible lending mortgage loans. HOEPA also directs the Board to and sustainable homeownership; periodically hold public hearings to examine the home equity lending market and the adequacy of • ensure that advertisements for mortexisting regulatory and legislative provisions for protecting the interests of consumers, particularly gage loans provide accurate and ballow-income consumers. anced information and do not contain 3. For Governor Kroszner's opening com- misleading or deceptive representaments, see www.federalreserve.gov/newsevents/ tions; and speech/kroszner20070614a.htm. 4. For a list of panelists and the agenda, see www.federalreserve.gov/newsevents/press/bcreg/ 5. See www.federalreserve.gov/newsevents/ 20070612a.htm. press/bcreg/20071218a.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 117 • provide additional consumer protec- For closed-end loans, the proposed rules tions on "higher-priced mortgages," would prohibit seven misleading or demortgages whose annual percentage ceptive advertising practices, for exrate (APR) exceeds the yield on com- ample, using the term "fixed" to deparable Treasury securities by at least scribe a rate that is not fixed. The public three percentage points for first-lien comment period ends in early April loans, or five percentage points for 2008. subordinate-lien loans. Supervisory Activities The proposed rules are comprehensive both in their reach and aim: they would Throughout 2007, concerns about the apply to all mortgage lenders, not just mortgage industry continued to grow. depository institutions, and they seek to The Board undertook various superviimprove transparency and enhance con- sory activities in collaboration with sumer protection in mortgage lending. other agencies to provide guidance to lenders and support to consumers. A The proposal directly addresses those comprehensive overview of the Federal practices raising the most significant Reserve Board's ongoing efforts to adconcerns. For higher-priced loans, the dress supervisory concerns in the proposed rule would prohibit lenders subprime mortgage market was outlined from engaging in a pattern or practice of in congressional testimony delivered in making mortgage loans on the basis of March by the director of the Division of collateral alone, without considering a Consumer and Community Affairs.6 In borrower's ability to repay the loan; re- April, the federal financial regulatory quire lenders to verify the income or agencies jointly issued the "Statement assets they rely upon in making the loan; on Working with Mortgage Borrowers" and require lenders to establish escrow that encouraged institutions to work accounts for taxes and insurance. Preconstructively with residential borrowpayment penalties would be permitted ers who are, or who are reasonably exon higher-cost loans only under certain pected to be, unable to make payments conditions. For higher-cost loans and on their home loans.7 The statement emmost other mortgage loans secured by a phasizes that loan-workout arrangeprincipal dwelling, the proposed rules ments are generally in the long-term best would prohibit lenders from paying interest of both financial institutions and yield-spread premiums to brokers, unborrowers, provided the arrangement is less a written agreement between the consistent with safe and sound lending consumer and broker disclosed the bropractices. The statement cites examples ker's total compensation and other imof constructive workout arrangements; portant information; prohibit lenders and for instance, an institution might modify brokers from coercing appraisers to misa borrower's loan terms or move a borstate a home's value; and require that rower from a variable-rate to a fixedservicers credit loan payments on the date of receipt and refrain from charging consumers multiple late fees. 6. See the testimony of Sandra F. Braunstein, With respect to the marketing of March 27, 2007 (www.federalreserve.gov/ home loans, the proposed rules would newsevents/testimony/braunstein20070327a.htm). 7. See www.federalreserve.gov/newsevents/ require lenders to disclose applicable press/bcreg/20070417a.htm (press release) and rates or payments in advertisements as www .federalreserve .gov/boarddocs/srletters/2007/ prominently as advertised teaser rates. sr0706.htm (Consumer Affairs letter). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

118 94th Annual Report, 2007 rate loan. In addition, bank and thrift titled the "Statement on Subprime Mortprograms that transition low- or gage Lending" in June.10 This guidance moderate-income homeowners from describes prudent safety-and-soundness higher-cost loans to lower-cost loans in and consumer protection standards that a safe and sound manner may receive institutions should follow when originatfavorable consideration under the Com- ing certain ARMs that are typically ofmunity Reinvestment Act.8 fered to subprime borrowers. These In May, the federal bank, thrift, and ARMs offer low initial payments that credit union regulatory agencies issued are based on a short-term fixed introducfinal illustrations of the information on tory rate that is significantly discounted nontraditional mortgage products that from the fully indexed rate (the sum of lenders should provide to consumers. the current index and the margin). The The sample illustrations are intended to statement emphasizes the importance of help institutions implement consumer evaluating a borrower's repayment caprotections in the "Interagency Guid- pacity and ability to make payments unance on Nontraditional Mortgage Prod- der the fully indexed rate, assuming a uct Risks" that the agencies adopted in fully amortizing repayment schedule. October 2006.9 The consumer protec- The guidance also stresses the need for tions described in the guidance aim to institutions to consider a borrower's toensure that consumers receive clear and tal monthly housing-related payments balanced information about nontradi- (that is, principal, interest, taxes, and intional mortgages—before they choose a surance) when assessing the borrower's mortgage product or select a payment repayment capacity, using the borrowoption for an existing mortgage. Ac- er's debt-to-income ratio. Finally, the cordingly, the illustrations consist of a guidance instructs lenders to provide narrative explanation of nontraditional consumers with clear and balanced inmortgage products, a chart compar- formation on the benefits and risks of ing interest-only and payment-option this type of ARM. adjustable-rate mortgages (ARMs) with In September, the federal financial a traditional fixed-rate loan, and a table regulatory agencies and the Conference showing the impact of various payment of State Banking Supervisors issued the options on the loan balance of a "Statement on Loss Mitigation Stratepayment-option ARM (such a table gies for Servicers of Residential Mortcould be included in monthly loan state- gages."11 The guidance encourages serments). Institutions are not required to vicers of residential mortgages to pursue use the sample illustrations, but the strategies to mitigate their losses and guidance sets forth information that seek to preserve homeownership among lenders should provide to consumers to their borrowers. The statement outlines allow them to evaluate a nontraditional steps that servicers may pursue to determortgage loan. mine if a borrower is at an increased risk The federal financial regulatory agencies jointly issued additional guidance 10. See www.federalreserve.gov/newsevents/ press/bcreg/20070629a.htm (press release) and ww w .federalreserve .gov/boarddocs/srletters/2007/ 8. For more information, see Q&A § .22(a)-l srO712.htm (Consumer Affairs letter). (Interagency Questions and Answers Regarding 11. See www.federalreserve.gov/newsevents/ Community Reinvestment, July 11, 2001). press/bcreg/20070904a.htm (press release) and 9. See www.federalreserve.gov/newsevents/ www.federalreserve.gov/boarddocs/srletters/2007/ press/bcreg/20070531b.htm. srO716.htm (Consumer Affairs letter). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 119 of mortgage default. Steps include iden- standards, as well as senior managetifying borrowers who have a height- ment's oversight of the risk-manageened risk of delinquency, contacting ment practices the companies used to those borrowers to assess their ability to ensure compliance with state and fedrepay, and determining whether default eral consumer protection regulations and is reasonably foreseeable. The guidance laws, including the Home Mortgage also presents many possible loss- Disclosure Act, the Equal Credit Oppormitigation techniques that a servicer tunity Act, the Truth in Lending Act, the may initiate with a troubled borrower. Real Estate Settlement Procedures Act, In addition to issuing industry guid- the Federal Trade Commission Act, and ance, the Board entered a multiagency the Home Ownership and Equity Protecpartnership to conduct targeted con- tion Act. The agencies will share inforsumer compliance reviews of selected mation about the reviews and investnondepository lenders that have signifi- igations; take supervisory action, as cant subprime mortgage operations.12 appropriate; collaborate on lessons The joint effort, announced in July, is learned; and seek ways to better cooperthe first time multiple agencies have col- ate in ensuring effective and consistent laborated to plan and conduct consumer reviews of these institutions. By jointly compliance reviews of independent developing and applying a coordinated mortgage lenders and nondepository review program, the regulatory agencies subsidiaries of bank and thrift holding will be better positioned to evaluate and companies, as well as mortgage brokers more consistently assess subprime mortdoing business with, or working for, gage practices across a broad range of these entities. mortgage lenders and other participants The agencies involved—the Federal within the industry. On-site reviews are Reserve, the Office of Thrift Supervi- scheduled to begin in February 2008. sion (OTS), the Federal Trade Commission (FTC), state agencies represented Community Outreach Efforts by the Conference of State Bank Supervisors, and the American Association of To augment the Board's regulatory and Residential Mortgage Regulators—have supervisory activities, System commubegun developing plans for the targeted nity affairs staff engaged in numerous consumer compliance reviews. Federal efforts to address the personal, eco- Reserve System examiners, assisted by nomic, and social distress of homeownrepresentatives from the FTC and the ers and communities that have been states, will lead reviews of entities su- negatively affected by the sharp inpervised by the Federal Reserve System. creases in subprime mortgage loan de- At the same time, state regulators will linquencies and foreclosures. Commuconduct a coordinated review of an inde- nity affairs analysts and outreach pendent state-licensed subprime lender specialists used their long-standing netand associated mortgage brokers, and works of industry and community relathe OTS will conduct a review of a se- tionships to convene local community lected mortgage subsidiary of a thrift and business leaders, investors, lenders, holding company. These reviews will servicers, rating agency representatives, evaluate the companies' underwriting government officials, consumer and community groups, and others across the country. To complement these dis- 12. See www.federalreserve.gov/newsevents/ press/bcreg/20070717a.htm. cussions, System research staff collected Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

120 94th Annual Report, 2007 and analyzed data on real estate and the need to modernize the foreclosure subprime mortgage conditions and on system, and the differences in state forethe impact of homeowner counseling closure laws. The Reserve Banks also programs. The Federal Reserve Bank of organized several public workshops and Philadelphia began collecting data for a participated in outreach events to highlongitudinal study of the effectiveness light innovative intervention programs. of homeownership counseling. In a For example, the San Francisco and Dalsimilar but smaller-scale study, the Dal- las Reserve Banks cosponsored a series las Reserve Bank began measuring the of mortgage-streamlining workshops to impact of a local mortgage assistance leverage participants' broader knowlprogram. The New York Reserve Bank edge of community development subcollected zip code-level data on the in- jects and apply this knowledge to homecidence of Alt-A and subprime mort- ownership initiatives for Native gage products in its District. Several Americans. other researchers focused on loan work- During the past year, Board and Sysouts and modifications throughout the tem staff strengthened partnerships with country. Other key initiatives for the re- two prominent national homeownership search functions included providing re- preservation organizations, Neighborgional foreclosure projections and in- Works America and the Hope Now Allidepth analyses of the incidence of ance. Both groups have mobilized their defaults within a particular region. national networks of affiliates and part- The Board and the Reserve Banks ners in order to advance efforts to hosted a number of events, conferences, streamline the mortgage-refinancing and meetings on foreclosure-related process and modify subprime mortmatters in 2007. Many events focused gages. In 2007, Governor Kroszner conon encouraging lenders and servicers to tinued to serve on the NeighborWorks develop systematic loss-mitigation tech- America board of directors. Members of niques and to promote coordinated out- the Board's staff remain involved with reach to distressed borrowers. In the that organization's Center for Hometwelfth District, the San Francisco Re- ownership Education and Counseling, serve Bank and its partners conducted a which establishes education standards series of six forums to explore foreclo- for counseling intermediaries. System sure issues and identify strategies for community affairs staff collaborated preserving homeownership among mi- with NeighborWorks America by parnorities and low-income borrowers.13 ticipating in several foreclosure- The Federal Reserve Bank of Chicago prevention training workshops for homesponsored symposiums in Chicago, In- ownership counselors; staff also helped dianapolis, and Detroit that featured dis- promote the 1-888-995-HOPE hotline cussions on the regional impact of fore- that links borrowers in financial distress closures. The Cleveland Reserve Bank with mortgage counseling. The Atlanta cosponsored a conference on vacant and Reserve Bank produced an educational abandoned properties, and the Federal DVD in partnership with Neighbor- Reserve Bank of Minneapolis hosted Works America that addressed the growseveral events in the Twin Cities area ing foreclosure challenges in its region. focused on mortgage broker licensing, Several Reserve Banks also supported the Hope Now Alliance, a collaboration of counselors, servicers, investors, and 13. See www.sf.frb.org/community/issues/assets/ preservation/index.html. other mortgage market participants. Sys- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 121 tern community affairs staff worked with viously, lenders had relied almost solely local Hope Now partners and commu- on interest from their customers' acnity stakeholders to identify cross- count balances for revenue.) These inindustry technology solutions that would dustry developments have significantly enable servicers and counselors to con- elevated concerns about consumer protact at-risk borrowers and better serve tection; the transparency of credit card homeowners. pricing; and the adequacy of consumer Substantial consumer protection and disclosures in credit card marketing macommunity development concerns con- terials, contracts, and periodic statetinue to be raised about mortgage lend- ments.15 ing practices. The Federal Reserve will Credit card disclosures are intended continue its regulatory, supervisory, and to provide consumers with the informacommunity development efforts to seek tion they need to shop for the product ways to protect and support consumers' that best meets their needs and to enable interests in mortgage credit. The Federal them to make well-informed decisions Reserve will also work collaboratively regarding usage of their cards. However, with a broad spectrum of partners to de- as credit products became more comvelop strategies and programs that will plex, the Board recognized the need to help troubled homeowners address their evaluate its existing regulations governmortgage credit difficulties.14 ing the content and presentation of information on credit card disclosures. This undertaking required an in-depth under- Credit Cards standing of the credit card industry, consumers' information needs, and the way The credit card market is another area of consumers shop for credit cards. Before consumer finance that has grown rapengaging in rule-writing, the Board unidly, spurred by technological advances, dertook extensive consumer testing. new products, and other innovations. In- Working with a consultant, the Board creasingly, electronic payments are acdeveloped a testing methodology that incepted for a wide range of transactions, volved several stages. First, two sets of and consumers now use credit cards to focus-group meetings were held with facilitate everyday purchases, such as credit card customers. The focus groups groceries, gasoline, and even a cup of offered insight on coffee. In 2007, the total level of revolving debt held by consumers increased by • what credit terms consumers usually nearly 8 percent from 2006, to nearly consider when shopping for a credit $944 billion. card, Competition in the credit card market • what information consumers find usehas intensified over the last decade. As a ful when they receive a new card in result, lenders have undertaken aggresthe mail, and sive marketing and product development campaigns and also pursued strategies • what information consumers find useto rely more on fee-based income. (Pre- ful on periodic statements. 14. See the testimony of Governor Randall S. Kroszner, December 6, 2007 (www.federalreserve. gov/newsevents/testimony/kroszner20071206a.htm), 15. See the testimony of Governor Frederic S. and October 24, 2007 (www.federalreserve.gov/ Mishkin, June 7, 2007 (www.federalreserve.gov/ newsevents/testimony/kroszner20071024a.htm). newsevents/testimony/mishkin20070607a.htm). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

122 94th Annual Report, 2007 The second stage of the consumer test- ments. The proposal is intended to iming focused on current credit card dis- prove the effectiveness of the discloclosures. In one-on-one interviews, sures consumers receive in connection credit card customers were presented with credit card accounts and other rewith mock disclosures. Participants were volving credit plans; specifically, the asked to evaluate the information pre- proposal seeks to ensure that such inforsented, and an interviewer asked them mation is provided in a timely manner follow-up questions in order to evaluate and in a form that is readily understandthe usability of the disclosures and con- able. The proposed amendments would sumers' understanding of them. require changes to the format, timing, Feedback from the second stage was and content requirements of the five used to develop revised sample disclo- main types of open-end credit disclosures for the third phase of testing. sures: (1) credit and charge card applica- These sample disclosures were tested tion and solicitation disclosures; (2) acand refined during multiple interviews count-opening disclosures; (3) periodicwith consumers. This process allowed statement disclosures; (4) change-instaff to learn more about what informa- terms notices; and (5) advertising tion consumers read on current credit provisions. The proposed amendments card disclosures; to observe how easily largely reflect the results of the conconsumers can find various pieces of sumer testing described above. information in these disclosures; and to The proposal generated a great deal test consumers' understanding of the ter- of interest, yielding more than 2,500 minology used in the disclosures. comments during the comment period The consumer testing process pro- that ended in October. A large number vided important insights into the way of these comments were submitted by consumers shop for credit cards and the individual consumers. Additional ininformation they need to make informed sights were provided by consumer advodecisions. In particular, staff found that cates and industry representatives servconsumers tend to notice numbers rather ing on the Board's Consumer Advisory than narrative text. Consumers fre- Council. (See "Advice from the Conquently reviewed the summary table of sumer Advisory Council.") rates and terms that they receive with Applications and Solicitations credit card solicitations but paid little attention to densely worded account- The proposal contains changes to make opening disclosures and change-in- the disclosures provided with credit and terms notifications. Likewise, on peri- charge card applications and solicitaodic statements, consumers generally tions more meaningful and easier for focused on numbers, such as fee and consumers to use. Proposed changes ininterest charge information. The Board clude adopting new format requirements took these findings into account as it for the summary table, including rules began drafting proposed amendments to regarding type size and the use of bold- Regulation Z. face type for certain key terms; placement of information; and use of crossreferences. The proposed rules address a Proposed Amendments number of issues regarding the penalties to Regulation Z credit and charge card companies may In May, the Board issued for public charge customers. For example, applicacomment proposed Regulation Z amend- tions and solicitations would have to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 123 state how long penalty rates may be in (for example, an increase in the interest effect, provide a modified disclosure rate) applicable to their accounts, and it about variable rates, describe the effect increases the amount of time these noof creditors' payment-allocation prac- tices must be sent before the change betices, and reference consumer education comes effective. Generally, the proposed materials on the Board's website. rules would increase advance notice before a changed term can be imposed Account-Opening Disclosures from 15 to 45 days, to better allow consumers to obtain alternative financing or The proposal contains revisions to make change their account usage. The prothe cost disclosures provided to consumposed rules would also require a creditor ers at account opening more conspicuto provide 45 days' prior notice before ous and easier to read. The proposed increasing a rate as a result of a consumchanges would require that certain key er's delinquency or default. terms be disclosed in a summary table at account opening; this table would summarize the key information consumers Advertising Provisions need to make informed decisions about The proposal revises the rules governing how they use credit cards. The proposed the advertising of open-end credit, to changes would also adopt a different aphelp consumers better understand the proach to disclosing fees, in order to credit terms being offered. Under the make it easier for consumers to identify proposed revisions, advertisements that the costs associated with using the card. state a minimum monthly payment on a plan offered to finance the purchase of Periodic-Statement Disclosures goods or services would be required to The proposal contains revisions to make disclose, in equal prominence to the the disclosures on periodic statements minimum payment, the time period remore understandable, primarily by quired to pay off the balance and the changing the format requirements for total of payments if only minimum paythese disclosures—for example, by ments were made. Furthermore, advergrouping fees, interest charges, and tisements would be able to refer to a rate transactions together by type. Other for- as "fixed" only if the advertisement mat changes include itemizing the inter- specified the time period for which the est charges for different types of transac- rate was fixed and that the rate would tions, such as purchases and cash not increase for any reason during that advances, and providing aggregate to- time. If a time period is not specified, tals of fees and interest for the month the term "fixed" may be used only if the and year-to-date. In addition, creditors rate will not increase for any reason would have to disclose to consumers the while the plan is open. effect of making only the minimum required payments on their account balances. Other Regulatory Actions Change in Consumer's Interest Rate In addition to proposed rules related to and Other Account Terms mortgages and credit cards, the Board The proposal expands the circumstances issued regulatory amendments in 2007 under which consumers will receive related to the electronic delivery of written notice of changes in the terms consumer disclosures, electronic fund Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

124 94th Annual Report, 2007 transfers, and the privacy of financial banking and commerce and that were information. unnecessary for consumer protection. The November final rules also included guidance on the use of electronic disclo- Electronic Disclosures sures, including provisions to clarify the In November, the Board published circumstances under which consumers amendments to five consumer financial conducting transactions online may observices and fair lending regulations tain electronic disclosures without re- (Regulations B, E, M, Z, and DD). The gard to the consent requirements of the amendments clarify the requirements for E-Sign Act. The mandatory compliance providing consumer disclosures in elec- date for the final rules is October 1, tronic form under the Electronic Signa- 2008.16 tures in Global and National Commerce Act (the E-Sign Act). Enacted in 2000, Regulation E the E-Sign Act provides that electronic documents and electronic signatures The Electronic Fund Transfer Act have the same validity as paper docu- (EFTA) provides a basic framework of ments and handwritten signatures. The rights, liabilities, and responsibilities for E-Sign Act also contains special rules participants in electronic fund transfer for the use of electronic disclosures in systems. The EFTA is implemented by consumer transactions. Under the act, the Board's Regulation E (12 CFR 205). consumer disclosures that are required In July, the Board published a final rule by other laws or regulations to be pro- that exempts transactions of $15 or less vided in writing may be provided in from Regulation E's requirement that reelectronic form if the consumer affirma- ceipts be made available to consumers tively consents after receiving the notice for transactions initiated at an electronic terminal. For this purpose, electronic specified in the statute and if certain terminals include automated teller maother conditions are met. chines and point-of-sale terminals. This In March 2001, the Board published exception is intended to facilitate the interim final rules under Regulations B, ability of consumers to use debit cards E, M, Z, and DD that established uniin retail settings where it may not be form standards for the timing and delivpractical or cost-effective to provide reery of electronic disclosures, consistent ceipts. The rule was effective August 6, with the requirements of the E-Sign Act. 2007.17 The Board later lifted the mandatory compliance date for these rules. As a result, institutions could provide disclo- Fair Credit Reporting Act sures electronically pursuant to the In November, the Board published two E-Sign Act but were not required to final rules under Regulation V to implecomply with the 2001 interim rules. ment provisions of the Fair and Accu- In November, the Board withdrew rate Credit Transactions Act of 2003 certain portions of the 2001 interim rules (the FACT Act), which amended the from the Code of Federal Regulations in order to reduce confusion about their status and simplify the regulations. The 16. See www.federalreserve.gov/newsevents/ Board also withdrew other provisions of press/bcreg/20071101 a.htm. the 2001 interim rules that might have 17. See www.federalreserve.gov/newsevents/ imposed undue burdens on electronic press/bcreg/20070628a.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 125 Fair Credit Reporting Act (FCRA). theft red flags and address discrepancies First, the Board published final rules to were developed on an interagency basis implement the affiliate-marketing-notice with the other federal banking agencies and opt-out requirements of section 214 and the FTC.19 of the FACT Act. The final rules give In December, the Board published consumers the ability to limit the use of proposed rules to implement the provicertain information for marketing pur- sions of section 312 of the FACT Act, poses by affiliates of companies with which apply to those who furnish inforwhich consumers have done business. mation to consumer reporting agencies The final rules also incorporate certain (furnishers). That section requires the statutory exceptions to the notice and Board to issue guidelines to ensure the opt-out requirement, including excep- accuracy and integrity of information tions for when an affiliate has a pre- being furnished to consumer reporting existing business relationship with a agencies. Section 312 also requires the consumer or when the marketing is in Board to issue rules identifying the cirresponse to a consumer-initiated com- cumstances under which furnishers must munication. The mandatory compliance investigate disputes about the accuracy date for the final rule is October 1, 2008. of information contained in consumer The affiliate-marketing rules were de- reports based on a direct request from a veloped on an interagency basis with the consumer. The comment period for the other federal banking agencies, the Fed- proposal will close in February 2008. eral Trade Commission (FTC), and the The furnisher accuracy-and-integrity Securities and Exchange Commission.18 guidelines and the direct-dispute rules Second, the Board published final were developed on an interagency basis rules to implement the identity theft "red with the other federal banking agencies flag" provisions of section 114 of the and the FTC.20 FACT Act and the address-discrepancy provisions of section 315 of the act. The Other Supervisory Activities final rules require financial institutions Related to Compliance with and creditors to develop and implement Consumer Protection and an identity theft protection program that Community Reinvestment Laws is designed to detect, prevent, and mitigate identity theft. The final rules also The Division of Consumer and Commurequire users of consumer reports to (1) nity Affairs supports and oversees the adopt reasonable policies and proce- supervisory efforts of the Reserve Banks dures for verifying the identity of a con- to ensure that consumer protection laws sumer upon receipt of a notice of ad- and regulations are fully and fairly endress discrepancy from a consumer forced. (See "Mortgage Credit" earlier reporting agency and (2) reconcile the in this chapter for a description of the discrepancy when the user opens an ac- division's supervisory activities related count despite the discrepancy and regu- to mortgage lending.) Division staff larly furnishes information to the con- members provide guidance and expersumer reporting agency. The mandatory tise to the Reserve Banks on consumer compliance date for the final rule is November 1, 2008. The rules for identity 19. See www.federalreserve.gov/newsevents/ press/bcreg/20071031 a.htm. 18. See www.federalreserve.gov/newsevents/ 20. See www.federalreserve.gov/newsevents/ press/bcreg/20071025a.htm. press/bcreg/20071129a.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

126 94th Annual Report, 2007 protection regulations, examination and are enforced consistently and rigorously enforcement techniques, examiner train- throughout the Federal Reserve ing, and emerging issues. Routinely, System.23 staff members develop and update ex- The Federal Reserve enforces the amination policies, procedures, and ECOA and the provisions of the Fair guidelines; review Reserve Bank super- Housing Act that apply to lending instivisory reports and work products; and tutions. The ECOA prohibits creditors participate in interagency activities that from discriminating against any applipromote uniformity in examination prin- cant, in any aspect of a credit transacciples and standards. tion, on the basis of race, color, religion, Examinations are the System's pri- national origin, sex, marital status, or mary means of enforcing compliance age. In addition, creditors may not diswith consumer protection laws. During criminate against an applicant because the 2007 reporting period,21 the Reserve the applicant receives income from a Banks conducted 324 consumer compli- public assistance program or has exerance examinations—312 of state mem- cised, in good faith, any right under the ber banks and 12 of foreign banking Consumer Credit Protection Act. The organizations.22 Fair Housing Act prohibits discrimination in residential real estate-related Fair Lending transactions, including the making and purchasing of mortgage loans, on the The Federal Reserve is committed to enbasis of race, color, religion, national suring that the institutions it supervises origin, handicap, familial status, or sex. comply fully with the federal fair lend- Pursuant to the ECOA, if the Board ing laws—the Equal Credit Opportunity has reason to believe that a creditor has Act (ECOA) and the Fair Housing Act. engaged in a pattern or practice of dis- Fair lending reviews are conducted crimination in violation of the ECOA, regularly within the supervisory cycle. the matter will be referred to the Depart- Additionally, examiners may conduct ment of Justice (DOJ) The DOJ reviews fair lending reviews outside of the usual the referral and decides if further invessupervisory cycle, if warranted. When tigation is warranted. A DOJ investigaexaminers find evidence of potential distion may result in a public civil enforcecrimination, they work closely with the ment action or settlement. The DOJ may division's Fair Lending Enforcement decide instead to return the matter to the Section, which brings additional legal Federal Reserve for administrative enand statistical expertise to the examinaforcement. When a matter is returned to tion and ensures that fair lending laws the Federal Reserve, staff ensures that the institution corrects the problems and 21. The 2007 reporting period for examination makes amends to the victims. data was July 1, 2006, through June 30, 2007. During 2007, the Board referred the 22. The foreign banking organizations exam- following eight matters to the DOJ: ined by the Federal Reserve are organizations operating under section 25 or 25A of the Federal Reserve Act (Edge Act and agreement corporations) and state-chartered commercial lending companies owned or controlled by foreign banks. These institutions are not subject to the Commu- 23. See the testimony of Sandra F. Braunstein, nity Reinvestment Act and typically engage in director, Division of Consumer and Community relatively few activities that are covered by con- Affairs, July 25, 2007 (www.federalreserve.gov/ sumer protection laws. newsevents/testimony/braunstein20070725a.htm). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 127 • Two referrals involved ethnic and soon as they become aware of a probracial discrimination in mortgage lem. Thus, the Federal Reserve generpricing by nationwide lenders. These ally uses informal supervisory tools referrals are discussed in more detail (such as memoranda of understanding below. (See "Evaluating Pricing- between the bank's board of directors Discrimination Risk by Ana- and the Reserve Bank) or board resolulyzing HMDA Data and Other tions to ensure that violations are cor- Information.") rected. If necessary to protect consumers, however, the Board can and does • One referral involved racial discrimibring public enforcement actions. nation in the pricing of automobile loans. The institution purchased loans Evaluating Pricing-Discrimination Risk in which auto dealers had charged by Analyzing HMDA Data and higher interest rates, through the use Other Information of markups, that were based on the race of the borrowers. This pricing The two previously mentioned referrals was permitted by the lender, who re- involving mortgage-pricing discriminaceived a share of the markups. tion resulted from a process of targeted pricing reviews that the Federal Reserve • One referral involved an institution initiated when Home Mortgage Disclowith two loan policies that were found sure Act (HMDA) pricing data first beto be discriminatory. One policy procame available in 2005. (See "Reporting hibited lending on Native American on Home Mortgage Disclosure Act lands. The other policy restricted Data.") Board staff developed, and conlending on row houses, which resulted tinue to refine, HMDA screens that in discrimination against African identify institutions that may warrant Americans. further review on the basis of an analy- • Four referrals involved discrimination sis of HMDA pricing data. Because against unmarried people. In one mat- HMDA data lack many factors that ter, an institution combined incomes lenders routinely use to make credit for married applicants, but not for co- decisions and set loan prices, such as information about a borrower's creditapplicants who were unmarried, when worthiness and loan-to-value ratios, underwriting consumer loans. In an- HMDA data alone cannot be used to other matter, an institution only perdetermine whether a lender dismitted spousal co-applicants for concriminates. Thus, the Federal Reserve sumer loans. The institution also staff analyzes HMDA data in conjuncimproperly required non-applicant tion with other supervisory information spouses to sign mortgage notes. The to evaluate a lender's risk for engaging remaining two referrals involved imin discrimination. proper spousal guarantees. For the 2006 HMDA pricing data— If a fair lending violation does not the most recent year for which the data constitute a pattern or practice that is are publicly available—Federal Reserve referred to the DOJ, the Federal Reserve examiners performed a pricingacts on its own to ensure that the bank discrimination risk assessment for each remedies it. Most lenders readily agree institution that was identified through to correct fair lending violations. In fact, the HMDA screening process. These lenders often take corrective steps as risk assessments incorporated not just Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

128 94th Annual Report, 2007 the institution's HMDA data but also uncommon for a lender to offer many the strength of the institution's fair lend- different products, each with its own ing compliance program; past supervi- pricing based on the borrower's credit sory experience with the institution; risk. consumer complaints against the institu- To effectively detect discrimination in tion; and the presence of fair lending the expanding range of products and risk factors, such as discretionary pric- credit-risk categories, the Federal Reing. On the basis of these comprehen- serve increasingly uses statistical techsive assessments, Federal Reserve staff niques. When performing a pricing redetermined which institutions would re- view, staff typically obtain extensive ceive a targeted pricing review. Depend- proprietary loan-level data on all morting on the examination schedule, the tar- gage loans originated by the lender, ingeted pricing review could occur as part cluding prime loans (that is, not just the of the institution's next examination or higher-priced loans reported under outside the usual supervisory cycle. HMDA). To determine how to analyze Even if an institution is not identified these data, the Federal Reserve studies through HMDA screening, examiners the lender's specific business model, may still conclude that the institution is pricing policies, and product offerings. at risk for engaging in pricing discrimi- On the basis of the review of the lendnation and may perform a pricing re- er's policies, staff determine which facview. The Federal Reserve supervises tors from the lender's data should be many institutions that are not required to considered. A statistical model is then report data under HMDA. Also, many developed that takes those factors into of the HMDA-reporting institutions su- account and is then tailored to that spepervised by the Federal Reserve origi- cific lender. Typically, a test for disnate few higher-priced loans and, there- crimination in particular geographic fore, report very little pricing data. For markets, such as metropolitan statistical these institutions, examiners analyze areas (MSAs), is performed. Looking at other available information to assess specific markets is important, as relapricing-discrimination risk and, when tively small unexplained pricing dispariappropriate, perform a pricing review. ties at the national level can mask much During a targeted pricing review, staff larger disparities in individual markets. analyze additional information, includ- On the basis of the results of pricing ing potential pricing factors that are not reviews conducted, Federal Reserve available in the HMDA data, to deter- staff had reason to believe that two namine whether any pricing disparity by tionwide lenders had engaged in a patrace or ethnicity is fully attributable to tern or practice of discrimination and legitimate factors, or whether any por- referred these cases to the DOJ. After tion of the pricing disparity may be at- accounting for legitimate factors retributable to illegal discrimination. To flected in the lenders' specific pricing perform these reviews, staff use analyti- policies, staff found that minorities still cal techniques that account for the in- paid more for their mortgages than noncreasing complexity of the mortgage Hispanic white borrowers in multiple market. Two industry changes in MSAs. The first referral involved two of particular—the proliferation of product the fair lending risk factors that the offerings and the increased use of risk- agencies have identified and used for based pricing—have increased the com- some time: (1) broad discretion in pricplexity of fair lending reviews. It is not ing by loan officers or brokers and (2) fi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 129 nancial incentives for loan officers or implementing regulation) in 2002. The brokers to charge borrowers higher revisions, which became effective in prices. The lending institution gave its 2004, require lenders to collect price inloan officers discretion to charge over- formation for loans they originated in ages and underages, that is, to set loan the higher-priced segment of the homeprices higher or lower than its standard loan market. When applicable, lenders rates. The institution also paid loan of- report the number of percentage points ficers more if they charged overages. by which a loan's annual percentage rate The Federal Reserve found evidence exceeds the threshold that defines that, in multiple MSAs, African Ameri- "higher-priced loans." The threshold is can and Hispanic borrowers paid higher 3 percentage points or more above the overages than comparable non-Hispanic yield on comparable Treasury securities whites. for first-lien loans, and 5 percentage The second referral involved loans points or more above that yield for originated through mortgage brokers at junior-lien loans. The HMDA data colwhich the institution also permitted pric- lected in 2004 and released to the public ing discretion. In multiple MSAs, Afri- in 2005 provided the first publicly availcan Americans and Hispanics paid able loan-level data about loan prices. higher annual percentage rates than The FFIEC released the 2006 HMDA comparable non-Hispanic whites. Pric- data to the public in September 2007. ing discretion and financial incentives to A December 2007 article published charge borrowers more do not always by Federal Reserve staff in the Federal result in fair lending violations; how- Reserve Bulletin uses the 2006 data to ever, these referrals underscore that it is describe the market for higher-priced critical for lenders that permit these loans and patterns of lending across loan practices to have clear policies about products, geographic markets, and bortheir use and to monitor their use rowers and neighborhoods of different effectively. races and incomes.24 The article also analyzed several of the items included in the HMDA data in order to determine Reporting on Home Mortgage their usefulness in predicting mortgage- Disclosure Act Data loan delinquency across metropolitan- The Home Mortgage Disclosure Act area counties. The analysis resulted in (HMDA), enacted by Congress in 1975, several findings, including that the incirequires most mortgage lenders located dence of higher-priced lending and the in metropolitan areas to collect data share of non-owner-occupied loans in a about their housing-related lending ac- county were both related to higher levtivity, report the data annually to the els of default in the future. government, and make the data publicly As in 2004 and 2005, most reporting available. In 1989, Congress expanded institutions reported extending few if the data required by HMDA to include any higher-priced loans in 2006; 61 perinformation about loan applications that cent of the lenders originated less than did not result in a loan origination, as well as information about the race, sex, and income of applicants and borrowers. 24. Robert B. Avery, Kenneth P. Brevoort, and In response to the growth of the Glenn B. Canner, "The 2006 HMDA Data," Federal Reserve Bulletin, December 2007 subprime loan market, the Federal Re- (www.federalreserve.gov/pubs/bulletin/2007/pdf/ serve updated Regulation C (HMDA's hmdaO6final.pdf). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

130 94th Annual Report, 2007 10 higher-priced loans that year. The ern region of the country. Several metrodata also indicate that relatively few politan areas on the West Coast also had lenders accounted for most of the an elevated incidence of higher-priced higher-priced loan originations in 2006. lending in 2006. In many metropolitan Of the nearly 8,900 home lenders report- areas in the South, Southwest, and West, ing HMDA data, 928 of them made 100 30 percent to 40 percent of the homeor more higher-priced loans. The 10 buyers who obtained conventional loans home lenders that had the largest vol- in 2006 received higher-priced loans. ume of higher-priced loans accounted Third, the incidence of higher-priced for about 38 percent of all such loans in lending varies greatly among borrowers 2006. Also as in 2004 and 2005, the of different races and ethnicities. In majority of all loan originations were 2006, as in 2004 and 2005, African not higher priced in 2006; however, the Americans and Hispanics were much incidence of higher-priced lending did more likely than non-Hispanic whites increase from 26.2 percent in 2005 to and Asians to receive higher-priced 28.7 percent in 2006. Some of the in- loans. For example, in 2006, 54 percent crease in the incidence of higher-priced of African American borrowers, and lending is attributed to changes in the 47 percent of Hispanic borrowers, reinterest rate environment from 2005 to ceived higher-priced conventional home 2006, as well as to changes in borrower purchase loans, compared with 18 perprofiles and lender practices. cent of non-Hispanic white and 17 per- Loan pricing is a complex process cent of Asian borrowers. Because that may reflect a wide variety of factors HMDA data lack information about about the level of risk a particular loan credit risk and other legitimate pricing or borrower presents to the lender. As a factors, it is not possible to determine result, the prevalence of higher-priced from HMDA data alone whether the oblending varies widely. First, the inci- served pricing disparities and market dence of higher-priced lending varies by segmentation reflect discrimination. product type. For example, manu- When analyzed in conjunction with other factured-home loans show the greatest fair lending risk factors and supervisory incidence of higher-priced lending information, however, the HMDA data (more than half of these loans are higher can facilitate fair lending supervision priced), because these loans are consid- and enforcement. (See "Fair Lending.") ered higher risk. In addition, first-lien mortgages are generally less risky than comparable junior-lien loans, and the Examinations and Activities pricing for these loans reflects their risk Related to the Community profiles: 25.3 percent of first-lien con- Reinvestment Act ventional home purchase loans were reported as higher-priced in 2006, com- The Community Reinvestment Act pared with 45.7 percent of comparable (CRA) requires that the Federal Reserve junior-lien loans. and other banking agencies encourage Second, higher-priced lending varies financial institutions to help meet the widely by geography. As in 2004 and credit needs of the local communities in 2005, many of the metropolitan areas which they do business, consistent with that reported the greatest incidence of safe and sound operations. To carry out higher-priced lending were in the south- this mandate, the Federal Reserve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 131 • examines state member banks to as- cies had received numerous consumer sess their compliance with the CRA,25 complaints and inquiries about this type of solicitation, and the alert warned that • analyzes applications for mergers and the solicitation appears to be a deceptive acquisitions by state member banks effort to encourage consumers to apply and bank holding companies in relafor a mortgage loan secured by their tion to CRA performance, and26 home. A statement that the agencies do • disseminates information on commu- not sponsor or endorse such programs nity development techniques to bank- and that the CRA does not require such ers and the public through community programs was also included in the alert, affairs offices at the Reserve Banks. along with a warning for consumers to be suspicious about conducting business The Federal Reserve assesses and rates with lenders who make deceptive the performance of state member banks claims. under the CRA in the course of examinations conducted by staff at the twelve Proposed Interagency Questions Reserve Banks. During the 2007 report- and Answers on the CRA ing period, the Reserve Banks con- In July, the federal bank and thrift reguducted 271 CRA examinations of banks: latory agencies released for comment a 33 were rated Outstanding, 237 were series of new and revised interagency rated Satisfactory, none was rated Needs questions and answers on CRA. The to Improve, and one was rated Substantial Noncompliance.27 agencies are proposing new questions and answers, as well as making substan- Consumer Alert on Solicitations tive and technical revisions to the existfor CRA Programs ing material. Some of the proposed revisions are intended to encourage In February, the Board, the Federal De- institutions to work with homeowners posit Insurance Corporation, the Office who are unable to make their mortgage of the Comptroller of the Currency, and payments; the questions and answers the Office of Thrift Supervision jointly emphasize that institutions can receive released a consumer alert about CRA- CRA consideration for foreclosurerelated solicitations from lenders.28 This prevention programs for low- and alert cautioned the public about loan so- moderate-income homeowners, consislicitations or other offers from lenders or tent with the April 2007 interagency mortgage brokers that offer consumers "Statement on Working with Mortgage cash as part of a "Community Reinvest- Borrowers."29 In addition, several techment Act (CRA) Program." The agen- nical changes are being proposed to clarify, update, and improve the read- 25. See the testimony of Sandra F. Braunstein, ability of existing guidance. A few of director, Division of Consumer and Community the more substantive changes include Affairs, October 24, 2007 (www.federalreserve.gov/ newsevents/testimony/braunstein20071024a.htm). • allowing CRA consideration for in- 26. See the testimony of Sandra F. Braunstein, vestments made by banks to minoritydirector, Division of Consumer and Community Affairs, May 21, 2007 (www.federalreserve.gov/ or women-owned financial institune wse vents/testimony/braunstein20070521 a.htm). tions when that investment benefits 27. The 2007 reporting period for examination data was July 1, 2006, through June 30, 2007. 28. See www.federalreserve.gov/newsevents/ 29. See www.federalreserve.gov/newsevents/ press/other/20070216a.htm. press/bcreg/20070417a.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

132 94th Annual Report, 2007 the minority or women-owned finan- • An application by Huntington Banecial institution's local community, shares, Inc., Columbus, Ohio, to aceven if the investment does not ben- quire Sky Financial Group, Inc., efit the bank's own assessment area; Bowling Green, Ohio, was approved in June. • providing flexibility to certain intermediate small banks in the evaluation • An application by Wells Fargo & of their home mortgage, small busi- Company, San Francisco, California, ness, and small farm loans; and to acquire Greater Bay Bancorp, East • clarifying that an institution that Palo Alto, California, was approved makes a loan or investment in a na- in August. tional or regional community devel- The public submitted comments on nine opment fund should be able to demapplications, including those mentioned onstrate that the fund will benefit the above. Many of the commenters referinstitution's assessment area(s) or the enced pricing information on residential broader statewide or regional area that mortgage loans and concerns that miincludes the bank's assessment area(s) nority applicants were more likely than as contemplated by the regulation, nonminority applicants to receive provided the fund meets certain defihigher-priced mortgages. These connition and geographic requirements. cerns were largely based on observa- Analysis of Applications for tions of lenders' 2005 and 2006 HMDA Mergers and Acquisitions pricing data. Other issues raised by comin Relation to the CRA menters involved minority applicants being denied mortgage loans more fre- During 2007, the Board considered apquently than nonminority applicants; poplications for several significant banktentially predatory lending practices by ing mergers. The Board approved two subprime and payday lenders; the potenapplications by Bank of America Corpotial adverse effects of branch closings; ration, Charlotte, North Carolina, the and lenders' failure to address the second largest depository institution in convenience and needs of low- and the United States. The company's acquimoderate-income communities. In addisition of U.S. Trust Corporation, New tion, the Board also received comments York, New York, was approved by the about the adverse effects of increased Board in March and its application to foreclosures, especially in low- and acquire ABN AMRO North America moderate-income communities. Holding Company, Chicago, Illinois, The Board considered forty-two was approved in September. The merger applications with outstanding issues inof two historic bank holding companies, volving compliance with consumer pro- The Bank of New York, New York, New tection statutes and regulations, includ- York, and Mellon Financial Corporation, ing fair lending laws, and the CRA.30 Pittsburgh, Pennsylvania, was approved Thirty-seven of those applications were by the Board in June. Several other sigapproved and five were withdrawn, nificant applications are listed below. including one with an adverse CRA • An application by PNC Financial Ser- rating. vices Group, Inc., Pittsburgh, Pennsylvania, to acquire Mercantile Bankshares Corporation, Baltimore, 30. The forty-two applications do not include Maryland, was approved in February. the nine protested applications. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 133 Initiatives for Minority-Owned Bank Examiner Guidance Financial Institutions and Training The Federal Reserve is committed to en- Examiner Guidance on Unfair and suring the provision of financial services Deceptive Acts and Practices to all consumers and communities. One of the many ways the Board achieves Periodically, the Board issues guidance this goal is by promoting the safety and on consumer protection laws and regulasoundness of all the institutions subject tions to Reserve Bank examiners. Some to System supervision, including those guidance is developed and updated in that are minority owned. Through its concert with the other federal financial regulatory, supervisory, and community institution regulatory agencies, and development functions, the Board con- some is issued solely by the Board. In sistently addresses the unique challenges 2007, the Board issued examination proand needs of minority-owned banks. At cedures designed to help examiners dethe same time, the Board holds these termine whether specific acts or pracinstitutions to the supervisory standards tices conducted by state-chartered banks that are applied to all state member are unfair or deceptive. These procebanks. The Board views this strategy as dures incorporate general guidance prointegral to its efforts to promote a safe, vided in the March 11, 2004, "Statement sound, and competitive banking system on Unfair or Deceptive Acts or Practices that also protects consumer interests. (UDAP) by State-Chartered Banks" issued jointly by the Board and the Fed- To enhance its support of minorityeral Deposit Insurance Corporation. The owned institutions, the Federal Reserve Board's guidance helps examiners anahas been developing an innovative and lyze potential UDAP issues during a comprehensive training and technical consumer compliance examination or a assistance program for minority-owned complaint investigation. depository institutions. Designed to address issues that might inhibit or limit the financial and operating performance Training for Bank Examiners of minority-owned institutions, the pro- Ensuring that financial institutions comgram includes outreach and technical asply with laws that protect consumers and sistance for institution directors. It also encourage community reinvestment is fosters relationship-building between inan important part of the bank examinastitutions and supervisory staff, and tion and supervision process. As the raises supervisory awareness of the number and complexity of consumer fiunique challenges faced by minoritynancial transactions grow, training for owned institutions. The program is staff that review and examine the organischeduled to be fully operational in zations under the Federal Reserve's su- 2008.31 pervisory responsibility becomes even more important. The consumer compliance examiner training curriculum con- 31. See the speech by Governor Randall S. Kroszner, August 1, 2007 (www.federalreserve.gov/ sists of six courses focused on various newsevents/speech/kroszner20070801a.htm). See consumer protection laws, regulations, also the testimony of Sandra F. Braunstein, direc- and examination concepts. In 2007, tor, Division of Consumer and Community Afthese courses were offered in eleven sesfairs, October 30, 2007 (www.federalreserve.gov/ newsevents/testimony/braunstein20071030a.htm). sions to more than 193 consumer com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

134 94th Annual Report, 2007 pliance examiners and System staff determined to have special flood hazmembers. ards. Under the Federal Reserve's Regu- Board and Reserve Bank staff regu- lation H, which implements the act, state larly review the core curriculum for ex- member banks are generally prohibited aminer training, updating subject matter from making, extending, increasing, or and adding new elements as appropriate. renewing any such loan unless the build- During 2007, staff conducted a curricu- ing or mobile home and any personal lum review of the Introduction to Con- property securing the loan are covered sumer Compliance Examinations I by flood insurance for the term of the (CA I) course to incorporate technical loan. Moreover, the act requires the changes in policy and laws, along with Board and other federal financial instituchanges in instructional delivery tech- tion regulatory agencies to impose civil niques. This course, designed for assis- money penalties when it finds a pattern tant examiners, focuses on the (1) con- or practice of violations of the regulasumer laws and regulations that govern tion. The civil money penalties are payoperations and non-real estate lending able to the Federal Emergency Manageand (2) regulations affecting deposit and ment Agency for deposit into the non-real estate lending operations. The National Flood Mitigation Fund. course emphasizes examination tech- During 2007, the Board imposed civil niques and procedures that demonstrate money penalties against eight state the practical application of these laws member banks. The penalties, which and regulations. were assessed via consent orders, to- When appropriate, courses are deliv- taled $246,050. ered via alternative methods, such as the Internet or other distance-learning tech- Agency Reports on Compliance nologies. The CA I course uses a with Consumer Protection Laws combination of instructional methods: The Board reports annually on compli- (1) classroom instruction focused on ance with consumer protection laws by case studies and (2) specially developed entities supervised by federal agencies. computer-based instruction that includes This section summarizes data collected interactive self-check exercises. from the twelve Federal Reserve Banks In addition to providing core training, and the FFIEC member agencies (colthe examiner curriculum emphasizes the lectively, the FFIEC agencies), as well importance of continuing professional as other federal enforcement agencies.32 development. Opportunities for continuing development include special projects Regulation B and assignments, self-study programs, (Equal Credit Opportunity) rotational assignments, the opportunity to instruct at System schools, mentoring The FFIEC agencies reported that programs, and an annual senior exam- 85 percent of the institutions examined iner forum. during the 2007 reporting period were in compliance with Regulation B, com- Flood Insurance The National Flood Insurance Act im- 32. Because the agencies use different methods to compile the data, the information presented here poses certain requirements on loans sesupports only general conclusions. The 2007 recured by buildings or mobile homes loporting period was July 1, 2006, through June 30, cated in, or to be located in, areas 2007. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 135 pared with 87 percent for the 2006 re- the entities they supervise. The FCA's porting period. The most frequently examination activities revealed Regulacited violations involved tion B violations involving the improper collection of government monitoring • the failure to properly collect informa- information. tion for monitoring purposes, including the race, ethnicity, sex, marital Regulation E status, and age of applicants seeking (Electronic Fund Transfers) credit primarily for the purchase or refinancing of a principal residence The FFIEC agencies reported that approximately 94 percent of the institu- • the improper collection of informa- tions examined during the 2007 reporttion on an applicant's race, color, reli- ing period were in compliance with gion, national origin, or sex when not Regulation E, compared with 95 percent permitted by regulation in the 2006 reporting period. The most frequently cited violations involved the • the improper requirement of the sigfailure to take one or more of the follownature of an applicant's spouse or ing actions: other person, other than a joint applicant, when the applicant qualified un- • determine whether an error occurred, der the creditor's standards of creditwithin ten business days of receiving worthiness for the amount and terms a notice of error from a consumer of the credit requested • give the consumer provisional credit • the failure to provide a written notice for the amount of an alleged error of denial or other adverse action to a when an investigation into the alleged credit applicant that contains the speerror cannot be completed within ten cific reason for the adverse action, business days along with other required information • provide initial disclosures that contain During this reporting period, the OTS required information, including limiissued two supervisory agreements and tations on the types of transfers perone cease-and-desist order to a savings mitted and error-resolution proceassociation for alleged violations of the dures, at the time a consumer Equal Credit Opportunity Act (ECOA) contracts for an electronic fund transand Regulation B, as well as other confer service sumer regulations. The other FFIEC agencies did not issue any formal en- • when a determination is made that no forcement actions specific to Regulation error has occurred, provide a written B during the reporting period. explanation and note the consumer's The other agencies that enforce the right to request documentation sup- ECOA—the Farm Credit Administration porting the institution's findings (FCA), the Department of Transportation, the Securities and Exchange Com- The FFIEC agencies did not issue any mission (SEC), the Small Business Ad- formal enforcement actions relating to ministration, and the Grain Inspection, Regulation E during the period. Packers and Stockyards Administration The Federal Trade Commission of the Department of Agriculture— (FTC) settled charges against one corporeported substantial compliance among ration that falsely marketed products and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

136 94th Annual Report, 2007 debited consumer accounts without ob- The FFIEC agencies did not issue any taining consumers' authorization for formal enforcement actions relating to preauthorized electronic fund transfers, Regulation P during the reporting in violation of Regulation E. The FTC period. also continued litigation against a group of defendants for allegedly enrolling Regulation Z (Truth in Lending) consumers in a program and automatically billing them for charges without The FFIEC agencies reported that obtaining authorization for the recurring 82 percent of the institutions examined debits. during the 2007 reporting period were in compliance with Regulation Z, compared with 85 percent for the 2006 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 2007 reporting period actions: were in compliance with Regulation M, • accurately disclose the finance charge which equals the level of compliance for in closed-end credit transactions the 2006 reporting period. The FFIEC agencies did not issue any formal en- • accurately disclose the amount forcement actions relating to Regulation financed, by subtracting any prepaid M during the period. finance charge from the amount financed Regulation P (Privacy of Consumer • accurately disclose the payment Financial Information) schedule, including the number, The FFIEC agencies reported that amounts, and timing of payments scheduled to repay the obligation 97 percent of the institutions examined during the 2007 reporting period were in • ensure that disclosures reflect the compliance with Regulation P, com- terms of the legal obligation between pared with 98 percent for the 2006 re- the parties porting period. The most frequently In addition, 185 banks supervised by the cited violations involved the failure to Federal Reserve, FDIC, OCC, and OTS take one or more of the following were required, under the Interagency actions: Enforcement Policy on Regulation Z, to • provide a clear and conspicuous an- reimburse a total of approximately nual privacy notice to customers $2.75 million to consumers for understating the annual percentage rate or the • disclose the institution's informationfinance charge in their consumer loan sharing practices in initial, annual, disclosures. and revised privacy notices The OTS issued two supervisory • provide customers with a clear and agreements and two cease-and-desist orconspicuous initial privacy notice that ders for violations of a number of conaccurately reflects the institution's sumer regulations, including Regulation privacy policies and practices, not Z, during the reporting period. The other later than when the customer relation- FFIEC agencies did not issue any forship is established mal enforcement actions specific to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 137 Regulation Z during the reporting that are not subject to next-day period. availability The Department of Transportation • follow procedures when invoking the continued to prosecute one air carrier exception for large-dollar deposits for its improper handling of credit card refund requests and other Federal Avia- • provide required information when tion Act violations. placing an exception hold on an The FCA identified creditors that account were using incorrect templates, resulting • make funds from local and certain in violations of Regulation Z. While all other checks available for withdrawal required disclosures were made, the forwithin the times prescribed by mat of the disclosures was not consisregulation tent with regulatory requirements. The FTC continued litigation in fed- The OTS issued one supervisory agreeeral district court against a mortgage ment for violations of a number of conbroker for alleged violations of Regula- sumer regulations, which included tion Z; the alleged violations involved Regulation CC. The other FFIEC agenthe broker's advertisements and finance- cies did not issue any formal enforcecharge disclosures. ment actions specific to Regulation CC during the reporting period. Regulation AA (Unfair or Deceptive Acts or Practices) Regulation DD (Truth in Savings) The FFIEC agencies reported that more The FFIEC agencies reported that than 99 percent of the institutions exam- 88 percent of institutions examined durined during the 2007 reporting period ing the 2007 reporting period were in were in compliance with Regulation compliance with Regulation DD, AA, which equals the level of complicompared with 91 percent for the 2006 ance for the 2006 reporting period. No reporting period. The most frequently formal enforcement actions relating to cited violations involved the failure to Regulation AA were issued during the take one or more of the following reporting period. actions: • provide a statement that fees could Regulation CC (Availability of Funds reduce the earnings on an account, and Collection of Checks) when the term "annual percentage The FFIEC agencies reported that yield" is used in an advertisement 90 percent of institutions examined dur- • use the term "annual percentage ing the 2007 reporting period were in yield" if an advertisement states a rate compliance with Regulation CC, comof return pared with 92 percent for the 2006 re- • provide initial account disclosures porting period. The most frequently containing all required information cited violations involved the failure to take one or more of the following • provide adequate subsequent account actions: disclosures for time accounts that have maturities greater than one year • make available on the next business day the lesser of $100 or the aggre- The OTS issued one supervisory agreegate amount of checks deposited ment and one cease-and-desist order for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

138 94th Annual Report, 2007 violations of a number of consumer Complaints Against State Member regulations, including Regulation DD. Banks The other FFIEC agencies did not issue The majority (61 percent) of complaints any formal enforcement actions specific about regulated practices involved credit to Regulation DD during the reporting cards. The most common credit card period. problem fell into the complaint category called "other rates/terms/fees" (35 per- Consumer Complaints cent), followed by problems with The Federal Reserve investigates com- billing-error resolution (19 percent) and plaints against state member banks and banks' providing inaccurate account inforwards those that involve other credi- formation (8 percent).34 tors and businesses to the appropriate Complaints about checking accounts enforcement agency. Each Reserve were the next largest category (19 per- Bank investigates complaints against cent) of complaints about regulated state member banks in its District. In practices. The most common checking 2007, the Federal Reserve received account concerns were insufficient- 1,540 consumer complaints concerning funds or overdraft charges and proceregulated practices by state member banks. dures (30 percent), funds availability In November, the Federal Reserve (14 percent), and disputed withdrawals System launched Federal Reserve Con- of funds by banks (13 percent). sumer Help (FRCH), an initiative that Real estate-related complaints made consolidates and streamlines the Federal up 5 percent of complaints involving Reserve's process for handling con- regulated practices.35 Of those, only sumer complaints and inquiries. FRCH 4 percent (or three complaints) conimproves consumers' access to the Fed- cerned adjustable-rate mortgages. The eral Reserve by providing a convenient, most common real estate-related loan one-stop website and a toll-free number problems concerned escrow accounts where consumers can get assistance with (15 percent); other rates, terms, or fees their banking problems or questions. (11 percent); and errors or delays in (See related box "The Federal Reserve crediting loan payments (10 percent). Of Consumer Help Center.") all complaints involving regulated prac- Under the direction of the Federal Fi- tices, 13 (0.8 percent) alleged discriminancial Institutions Examination Coun- nation on a basis prohibited by law (race, color, religion, national origin, cil (FFIEC), an interagency working group was formed in late 2007 to explore ways to improve consumers' experiences with contacting a banking the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift agency and with submitting a complaint Supervision, and the National Credit Union Ador inquiry to the appropriate regulator. A ministration. Representatives from the Conference third-party contractor may be used to of State Bank Supervisors are also participating. examine best practices and recommend 34. Includes complaints about interest rates, terms, or fees other than late fees, overlimit fees, improvements to the process consumers prepayment fees, fees related to credit insurance, use to file a complaint or inquiry with or the calculation of the finance charge. one of the FFIEC agencies.33 35. Includes adjustable-rate mortgages; residential construction loans, open-end home equity lines of credit, home improvement loans, home 33. FFIEC agencies represented on the working purchase loans, home refinance or closed-end group are the Federal Reserve Board, the Office of loans; and reverse mortgages. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 139 sex, marital status, handicap, age, the Consumer Complaints against State fact that the applicant's income comes Member Banks That Involve Regulated Practices, by Classification, 2007 from a public assistance program, or the fact that the applicant has exercised a right under the Consumer Credit Protec- Classification Number tion Act). Regulation A A (Unfair or Deceptive Complaint investigations determined Acts or Practices) 85 that banks had handled customers' ac- Regulation B (Equal Credit Opportunity) 62 Regulation C (Home Mortgage Disclosure)... 1 counts in accordance with Federal Re- Regulation E (Electronic Fund Transfers) 98 Regulation H (Bank Sales of Insurance) 2 serve regulations in the majority (96 per- Regulation M (Consumer Leasing) 3 cent) of the complaints reviewed. Regulation P (Privacy of Consumer Financial Information) 35 Investigations for the remaining 4 per- Regulation Q (Payment of Interest) 3 cent determined that the bank had vio- Regulation Z (Truth in Lending) 761 Regulation BB (Community Reinvestment)... 6 lated a consumer protection regulation. Regulation CC (Expedited Funds The most common violations involved Availability) 123 Regulation DD (Truth in Savings) 124 credit cards and checking accounts. (See Regulations T, U, and X 0 Regulation V (Fair and Accurate tables.) Credit Transactions) 13 Fair Credit Reporting Act 138 Fair Debt Collection Practices Act 64 Unregulated Practices Fair Housing Act Flood Insurance 1 Homeownership Counseling 2 As required by section 18(f) of the Fed- HOPA (Homeowners Protection Act) 1 eral Trade Commission Act, the Board Real Estate Settlement Procedures Act 15 Right to Financial Privacy Act 2 continued to monitor complaints about banking practices that are not subject to Total 1,540 existing regulations and to focus on those that concern possible unfair or de- sumers most frequently complained ceptive practices. In 2007, the Board re- about fraud, forgery, or theft (216 comceived more than 2,000 complaints plaints); problems with opening or closagainst state member banks that in- ing an account (196 complaints); issues volved unregulated practices. The prod- involving insufficient-funds or overdraft uct categories that contained the most charges and procedures (190 comcomplaints were credit cards and check- plaints); and certain credit card interest ing accounts. In those categories, con- rates, terms, and fees (129 complaints). Complaints against State Member Banks That Involve Regulated Practices, 2007 All complaints Complaints involving violations Subject of complaint Number Percent Number Percent Total 1,540 100 53 3 Discrimination alleged 13 Real estate loans 1 .1 0 0 Credit cards 8 .5 0 0 Other loans . .. .. 4 .3 0 0 Nondiscrimination complaints, total1 1,527' Credit cards 939 61 39 3 Checking accounts 295 19 13 .8 Real estate loans 80 5 0 0 1. Only the top three product categories of nondiscrimination complaints are listed here. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

140 94th Annual Report, 2007 The Federal Reserve Consumer Help Center: A New Resource for Expert, Immediate Help Credit cards, mortgages, and electronic Consumer complaints are an important funds transfers are just a few of the source of information for the Federal services and products consumers use to Reserve Board. Regardless of their conduct their financial business. The use outcome, complaints often identify areas of these products and services has become of concern that the Board considers when widespread, and it can be easy to lose sight writing regulations or guidance for bank of their complexity—until a consumer has examiners. Complaints can also reveal a question or something goes wrong. emerging consumer-protection issues and Consumers often need help navigating the trends in banking practices. The Federal maze of terminology, regulations, and poli- Reserve established its program for receivcies that governs financial products, ing consumer complaints and inquiries in services, and institutions. For more than 30 1976. Drawing on the resources of the years, the Federal Reserve System has Federal Reserve System*s twelve Reserve provided professional help to consumers Bank Districts, the program answers who have complaints against a financial consumers' questions, investigates cominstitution. In 2007, the Federal Reserve plaints against state member banks launched the Federal Reserve Consumer (those institutions under the Federal Help (FRCH) center, a centralized Reserve's supervisory authority), or refers consumer complaint center that improves consumers to the appropriate agency for a consumers' access to information and response. In addition, the Board responds services. The FRCH website (www. to issues raised by congressional repfederalreserveconsumerhelp.gov) provides resentatives on behalf of their concomprehensive information on consumer stituents. Over the last decade, the financial issues, as well as contact informa- consumer financial services marketplace tion. Consumers can use the site to has dramatically changed. Technological research their issue, or they may contact developments and increased access to the Federal Reserve to ask a question or technology have also changed both the file a complaint via e-mail, a toll-free way institutions operate and how consumnumber, fax, or mail. ers want to communicate with financial Complaint Referrals to HUD Responding to Community Economic Development Needs in In 2007, the Federal Reserve received Historically Underserved one housing-related discrimination com- Markets plaint and forwarded it to HUD in accordance with a memorandum of under- The mission of the community affairs standing between HUD and the federal function within the Federal Reserve Sysbank regulatory agencies regarding tem is to promote community economic complaints alleging a violation of the development and fair access to credit for Fair Housing Act. The Federal Re- low- and moderate-income communities serve's investigation of this complaint and populations. As a decentralized revealed no evidence of illegal credit function, the Community Affairs Offices discrimination. (CAOs) at each of the twelve Reserve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 141 institutions and others. In 2007, the Federal analyze the data so that they can identify Reserve responded to these forces by shared issues, develop best practices for launching FRCH, while continuing to tap customer service and complaint investigastaff expertise and knowledge of regional tion, and develop consumer education banking markets. materials. Such collaboration is critical to The Federal Reserve is committed to addressing consumer protection issues in providing superior service to consumers. the broader financial services marketplace The call center is staffed by highly trained and developing consumer information professionals; 80 percent of incoming calls materials to educate consumers about or e-mail inquiries are answered by a trends in banking products and their rights. representative within 60 seconds or less. In addition, FRCH is establishing a Complaints against banking institutions mechanism for tracking customer satisfacsupervised by the Federal Reserve continue tion, that is, whether consumers feel the to be investigated by the Reserve Bank center helped them with their financial responsible for examining the institution in services issues. question. This approach ensures that Early reviews of available data on complaints are investigated by examiners FRCH call volume and website visits who are knowledgeable about an institu- indicate that consumers are contacting the tion and its regional banking market—and the Federal Reserve in record numbers. who can leverage the bank-supervisor The Federal Reserve is dedicated to relationship to resolve an issue. If a providing superior access to consumers consumer has a complaint against an who need assistance and will continue to institution not supervised by the Federal monitor the performance of FRCH, with Reserve, FRCH can seamlessly connect the goal of identifying further opportunihim or her with the appropriate agency. ties to help consumers exercise their rights FRCH tracks ail incoming questions and and work through their financial services requests for assistance, by issue and challenges. The Federal Reserve plans to volume. Data will be shared with the other launch a Spanish-language version of the federal banking regulatory agencies. The website in the first quarter of 2008. Federal Reserve and other agencies Banks design activities in response to high-priority efforts; in particular, Board the needs of communities in the Dis- community affairs staff focus on issues tricts they serve, with oversight from that have public policy implications.36 Board staff. The CAOs focus on provid- In 2007, disruptions in the housing ing information and promoting aware- market made collaboration among the ness of investment opportunities to financial services community, the financial institutions, government agen- Board, and the Reserve Banks imperacies, and organizations that serve lowand moderate-income communities and populations. Similarly, the Board's CAO 36. See www.federalreserve.gov/communitydev/ promotes and coordinates Systemwide default.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

142 94th Annual Report, 2007 tive. The CAOs worked diligently to System Research Conference, "Financidentify solutions that would help miti- ing Community Development: Learning gate the adverse consequences of the in- from the Past, Looking to the Future," creasing numbers of mortgage defaults cosponsored by the Board and the Fedand foreclosures in many Districts. (See eral Reserve Bank of Philadelphia. The "Mortgage Credit.") System staff also conference brought together a diverse continued work on a number of impor- audience from academia, financial institant topics: improving the sustainability tutions, community organizations, founand financial capacity of community de- dations, and the government. Approxivelopment organizations, creating asset- mately 400 participants learned about building opportunities for low- and and discussed original studies on the opmoderate-income populations, and de- portunities and obstacles to helping lowveloping programs to promote commu- and moderate-income communities and nity development and consumer educa- people build wealth by using home tion. Activities included conducting loans, small business loans, or other firesearch, sponsoring conferences and nancial services. System community afseminars, publishing newsletters and ar- fairs staff were actively involved in the ticles, and supporting the dissemination planning and execution of the conferof information to both general and tar- ence: staff reviewed papers, developed geted audiences. the agenda, presented research, and served as moderators and participants in formal discussion groups. The Board's System Collaborative Efforts Community Affairs officer delivered a The Reserve Banks and the Board con- keynote address during the conference, tinued their work on two substantial col- and Chairman Ben Bernanke provided laborative efforts over the past year. The remarks on the history, evolution, and first effort, an initiative undertaken by new challenges of the Community Rein- System Community Affairs staff and the vestment Act.37 Brookings Institution, analyzes and compares communities that have high Identifying Strategies to Enhance concentrations of poverty. Using sixteen Access to Community case studies from selected communities, Development Financing and the project employs both quantitative Asset-Building and qualitative analyses to explore the In 2007, Community Affairs staff from dynamics of the communities, their resiaround the System continued working dents, their economies, and programs on several initiatives to not only enthat are helping or hindering a commuhance access to affordable credit in curnity's integration into the economic rently underserved markets but also to mainstream. The data generated by this provide information and promote awareongoing initiative help Reserve Banks, ness of investment opportunities to filocal financial institutions, business nancial institutions, government agenleaders, service providers, and philancies, and organizations. The St. Louis thropic organizations better understand Reserve Bank hosted "Exploring Innotheir regional economies and the capital vation: A Conference on Community and credit needs of the communities they serve. The second major collaborative effort 37. See www.federalreserve.gov/newsevents/ in 2007 was the Community Affairs speech/bernanke20070330a.htm. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 143 Development Finance" to explore how Kansas City Reserve Bank cosponsored organizational creativity, learning, and a major conference on entrepreneurship innovation can improve community with the Association for Enterprise Opdevelopment projects, increase their portunity. Together with the San Franaccess to capital, and help projects cisco and Minneapolis Reserve Banks, achieve scale and sustainability. The the Kansas City Reserve Bank also con- San Francisco Reserve Bank's Center tinued work on several Indian country for Community Investments hosted two initiatives focused on improving the ficonferences focused on community nancial literacy and housing options of development investment. One confer- Native Americans. The three Banks conence, which was cosponsored with the tinued to promote the adoption of uni- Board, focused on the availability of ru- form commercial codes to facilitate ral venture capital; the other, cospon- tribes' efforts to borrow from offsored with the New York Reserve Bank, reservation partners or other tribes. The discussed issues related to the creation Federal Reserve Bank of Dallas engaged of a secondary market for community in efforts to promote financial education development loans. Other Reserve in the workplace, including sponsorship Banks hosted symposiums on this topic of a highly successful seminar for huas well, such as the Federal Reserve man resource professionals attended by Bank of Richmond's Community Devel- approximately 80 employers, who in opment Financial Institution (CDFI) turn represented 380,000 employees. workshops that gathered community de- The Richmond Reserve Bank released velopment lenders, local bankers, and two issues of its journal MarketWise, representatives from the CDFI Fund to one which featured an article on the discuss capitalizing and certifying po- earned-income tax credit (EITC). The tential CDFIs. The Federal Reserve New York Reserve Bank cosponsored a Bank of Boston and the Aspen Institute, conference with the New York City Ofa national research and leadership devel- fice of Financial Empowerment that proopment organization, cohosted a confer- moted the EITC. As a result of the conence on socially responsible investment ference, a statewide coalition of EITC and the role of subsidy dollars in public practitioners was created, and several investment. In a related initiative, the statewide asset-building strategies for Boston Reserve Bank collaborated with low- and moderate-income communities the Massachusetts Small Business As- were adopted. sistance Advisory Council on the launch of a loan program for small businesses. Advice from the Asset-building and financial educa- Consumer Advisory Council tion remained major areas of focus for the Community Affairs Offices in 2007. The Board's Consumer Advisory System staff continued to collaborate Council—whose members represent with constituent organizations on efforts consumer and community organizations, to provide advisory services and con- the financial services industry, academic duct outreach to low- and moderate- institutions, and state agencies—advises income communities. The Federal Re- the Board of Governors on matters conserve Bank of Atlanta worked with the cerning laws and regulations that the Federal Deposit Insurance Corporation Board administers and on other issues to create MoneySmart curriculum mod- related to consumer financial services. ules on low-income investment. The Council meetings are held three times a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

144 94th Annual Report, 2007 year, in March, June, and October, and just federally supervised institutions. are open to the public. (For a list of Consumer representatives noted that members of the council, see the section rules would also provide consumers "Federal Reserve System Organiza- with a private right of action. Several tion.") Among other issues, council dis- members stated that rulemaking may be cussions in 2007 focused on two signifi- appropriate for areas in which the Board cant topics: can establish clear, bright lines for regulatory supervision but that guidance is • various issues related to mortgage the best way to ensure that institutions lending, specifically the Board's rulehave appropriate flexibility to meet conmaking authority under the Home sumers' needs. Ownership and Equity Protection Act In considering whether proposed rules (HOEPA) to address concerns about on mortgage lending should apply to the abusive lending practices in the home subprime mortgage market, council mortgage market, and concerns about members generally urged the Board to foreclosures and the subprime lending define "subprime" not by borrower charmarket acteristics but according to the type of • proposed amendments to Regulation loan or its terms, such as a loan's annual Z that would revise the disclosure re- percentage rate. An industry member quirements for credit card accounts endorsed the definition of "subprime" and other open-end (revolving) credit that the Board used in earlier guidance plans that are not secured by a bor- and cautioned against using Home Mortrower's home gage Disclosure Act (HMDA) standards as a pricing criterion for subprime loans, because the HMDA standards may not Mortgage Lending Issues capture all subprime loans. Several members urged the Board to HOEPA ban prepayment penalties, particularly In its June and October meetings, the for subprime loans. They expressed concouncil addressed several issues related cerns that, for subprime borrowers, preto the Board's rulemaking authority un- payment penalties are not balanced by der HOEPA: whether the Board should lower interest rates and often prevent issue rules or guidance, the possibility borrowers from graduating into prime of prohibiting or restricting certain loan loans. Other members acknowledged terms or practices in subprime loans, the problems with using prepayment penaldefinition of "subprime," and the role ties in the subprime market but said the and timing of the disclosures provided penalties can be a useful tool and yield to consumers during the loan-making lower interest rates for consumers. process. These members urged the Board to Several consumer representatives regulate prepayment penalties to ensure strongly supported issuing rules under that borrowers receive a choice about HOEPA rather than guidance. Consumer whether to have a prepayment penalty, representatives expressed the view that which may result in a lower interest rate guidance puts supervised institutions at for them. A consumer representative a competitive disadvantage to other suggested that prepayment penalties for mortgage lenders that do not have to adjustable-rate mortgages should expire comply with guidance. Rules, however, 60 days before the first interest-rate rewould apply to all mortgage lenders, not set on such a loan. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 145 Council members generally agreed the loan to the fully indexed rate. Some that it is a sound underwriting practice members commented that such a stanto require borrowers to make monthly dard would also benefit investors by givpayments to escrow accounts for taxes ing them greater assurance about the and insurance, as loans that include es- quality of the loans they are purchasing. crow payments generally perform better. Members disagreed about the length of There was also consensus on the impor- time for which ability to repay should be tance of clearly disclosing whether an considered. Some industry representaadvertised payment amount includes a tives cautioned that setting too strict a borrower's taxes and insurance. Recog- standard could inappropriately restrict nizing the financial vulnerability of access to credit. subprime borrowers, members generally Members agreed on the importance of agreed that the Board should mandate providing consumers with simplified, that escrow accounts be established for plain-language disclosures for mortgage subprime loans. Some members sug- products. Several members identified gested that escrow accounts should not key terms that should be clearly and be required for borrowers who take out concisely disclosed. Some members exprime loans. Members had a variety of pressed concern, however, that simpliviews about initially mandated escrow fied disclosures may not sufficiently inaccounts that borrowers could later opt form borrowers about the more complex out of. Both consumer and industry rep- or exotic mortgage products being ofresentatives generally agreed that any fered; they suggested such products may opt-out decision should not be made at require a different type of disclosure. loan closing and that clear disclosure of Some members supported a requirement any escrow requirement and opt-out pro- that Truth in Lending Act (TILA) disvision is paramount. closures be provided earlier in the loan- Several council members commented making process for nonpurchase morton the need for stated-income loans, es- gage loans. They also emphasized that pecially in immigrant communities and TILA disclosures should accurately refor borrowers who engage in cash trans- flect the terms of the transaction. actions or are otherwise not connected In a discussion of yield-spread premiwith mainstream financial institutions. ums (YSPs), several members stated The members emphasized the impor- that many consumers do not know about tance of sound, responsible underwrit- YSPs or understand how they work. ing for stated-income loans and urged Members agreed on the importance of that lenders be given flexibility to use providing borrowers with transparent nontraditional, third-party forms of in- YSP disclosures. Several consumer repcome documentation. Some members resentatives expressed concern about highlighted the importance of providing abusive practices related to YSPs; for borrowers with clear disclosures for example, a consumer may receive a stated-income loans to ensure that these higher interest rate because his or her borrowers are aware they may not be mortgage broker has an agreement to receiving the lowest rate for which they receive a YSP from a certain lender, or qualify. some lenders may combine YSPs and Council members generally agreed discount points, resulting in higher fees that the Board should require lenders to for borrowers. An industry member exensure borrowers' ability to repay a loan pressed the view that banning YSPs for a reasonable term by underwriting would hurt small broker businesses by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

146 94th Annual Report, 2007 eliminating a key source of their com- adjustable-rate mortgage loans and (2) pensation and would put small loan these products may pose an elevated risk originators at a competitive disadvan- to financial institutions. Most members tage to large lenders, thereby leaving supported the guidance. Several memconsumers with fewer choices in the bers voiced approval for the provision marketplace. recommending that lenders underwrite a loan at its fully indexed rate. They were also supportive of the recommendation Foreclosures and that a loan's underwriting include an es- Subprime Lending Issues crow component for taxes and insur- At its March meeting, the council dis- ance. Some members supported extendcussed the recent increase in home fore- ing the principles of the guidance to closures in a number of markets across prime mortgage lending, but others the country. Several members described noted possible difficulties to segmenting the impact of defaults and foreclosures the mortgage market in this way. Sevon their communities: large concentra- eral members shared concerns that aptions of abandoned and vacant proper- plying the guidance to prime loans ties and the associated need to enhance might reduce the variety of loan prodpolicing efforts and other city services, a ucts available to consumers. Members rise in homelessness, decreasing prop- representing the financial services inerty values, and declining tax revenues dustry questioned whether the guidance for local governments. Some members might lead to the creation of a loannoted a disproportionate concentration suitability standard, that is, a requireof foreclosures in communities that are ment that lenders gauge the suitability predominately Latino or African Ameri- of a loan product for certain borrowers. can; members also shared concerns Industry members generally thought about foreclosure "rescue" scams and such a standard could limit the array of the "flipping" of previously foreclosed loan products available to consumers. homes, and they stressed the importance Several members emphasized the need of having community-based organiza- for a new Federal Housing Administrations coordinate and manage rescue tion loan product that could meet the funds for homeowners facing forecloneeds of subprime borrowers. sure. Members discussed possible ways to assist households facing default or foreclosure. Several consumer represen- Credit Cards tatives described the difficulty credit counselors face when they try to contact In May, the Board issued proposed servicers on behalf of borrowers. Mem- amendments to Regulation Z, which bers also noted the challenges associ- implements the Truth in Lending Act, ated with restructuring mortgages that that would affect the content, format, have been securitized. and timing of credit card disclosures. Members commented on the proposed The council's discussions in June and statement on subprime mortgage lend- October focused on several dimensions ing issued by the federal financial regu- of the proposal: the summary table, or latory agencies in March. The proposal "Schumer box," for application and soaddressed concerns that (1) subprime licitation disclosures; account-opening borrowers may not fully understand the disclosures; periodic statements; and risks and consequences of products like change-in-terms notices. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community Affairs 147 Several members commended the Members generally approved of the Board for proposed revisions to the new format for periodic statements, par- Schumer box. By highlighting key infor- ticularly the clear grouping of fees and mation on credit card terms, the revi- the year-to-date totals for interest sions would facilitate consumers' ability charges and fees. They noted the importo compare different credit cards, mem- tance of highlighting the late-payment bers said. Several consumer representa- notice by requiring its placement on the tives urged the Board to include a "typi- front of the statement and emphasized cal APR" in the Schumer box. This APR the importance of clearly disclosing day would include the fees that consumers and time deadlines for payments (that is, typically pay during a billing cycle and the cutoff before late-payment charges could alert them to the potential costs of apply). Several consumer representausing the credit card. A typical APR tives stated that the effective APR diswould also allow consumers to compare closure should be retained because it the fees different cards charge. Several more accurately accounts for the total industry members objected to the idea cost of credit. Industry representatives, of a typical APR, however, expressing however, expressed their preference for concerns that such a rate would be mis- eliminating the effective APR disclosure leading and unhelpful, as many fees are on the basis that, even with the change not necessarily incurred by every con- in labeling, the figure is confusing to sumer. Industry representatives sup- consumers. The industry members stated ported the disclosure of fees in dollar that the proposed year-to-date totals for amounts rather than as a percentage of interest and fees represent the most the balance, noting that the Board's con- meaningful disclosure to consumers of sumer testing found that consumers the total cost. Several members commore readily understand dollar amounts mended the Board on its use of conthan percentages. Several consumer rep- sumer testing to develop the credit card resentatives commended the Board for disclosures and urged the Board to conproposing a disclosure to inform con- tinue using both qualitative and quantisumers about the amount of available tative testing as it determines how best credit if the account-opening fees are to communicate complicated financial 25 percent or more of the credit limit, as terms to consumers. is sometimes the case with subprime For change-in-terms notices, several credit cards. consumer representatives expressed For account-opening disclosures, support for requiring 45 days' advance members generally supported the notice for rate increases triggered by a Board's proposal to require a summary consumer's default or delinquency. table similar to the Schumer box. They They emphasized that advance notice noted that a summary would make it will give consumers the opportunity to easy for consumers to compare the ac- pursue other credit options. Industry tual account terms with those they were representatives disagreed with providoriginally offered. Some industry and ing a 45-day advance notice of inconsumer representatives disagreed creased rates when the increase is about the proposal to allow the verbal prompted by consumer default. They disclosure of some fees at the time a noted that default pricing is properly consumer incurs a charge, instead of re- disclosed to consumers at account openlying on account-opening disclosures to ing and that the triggering of a default disclose all fees. rate by a consumer's action does not Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

148 94th Annual Report, 2007 constitute a change in terms. Industry Other Issues representatives expressed support for 45 days' advance notice of charges or At their March meeting, council memchanges in terms that have not been bers discussed additional topics, includpreviously disclosed. Several industry ing model privacy notices, proposed representatives opposed having an opt- amendments to Regulation E, and sevout when a rate increase is prompted by eral aspects of Regulation CC. default or delinquency, but they sup- To comply with their disclosure obliported a consumer's right to opt out in gations on the sharing of consumer inother cases. formation under the Gramm-Leach- The council also discussed credit card Bliley Act, financial institutions may issuers' practice of offering a 0 percent use the model privacy form developed APR for consumers' balance transfers jointly by the federal financial regulafrom other credit cards and a higher tory agencies and the Federal Trade APR for purchases. Typically, issuers Commission. Members generally comthen typically allocate consumers' pay- mended the agencies for the proposed ments to balances that have the lowest form, noting that the prototype was a APR—allowing high-APR balances to marked improvement over current priremain high. Several consumer repre- vacy notices because it is clearer and sentatives urged the Board to prohibit easier to navigate—and thus makes it policies that apply all payments to the easier for consumers to compare differlowest-rate balance first, noting that ent privacy policies. Some industry repmany consumers do not understand how resentatives expressed concerns that the such low-APR products work. Several form did not sufficiently address addiindustry representatives expressed the tional notice and opt-out requirements view that such payment-allocation meth- that may exist under state laws; they ods are appropriate business practices urged the agencies to preempt state priand that consumers benefit from low- vacy law requirements. Institutions may APR cards because they receive an not use the form if they lack confidence interest-free loan for a certain period that doing so would satisfy their obligaof time. Industry representatives did tions under state laws, industry repreacknowledge the need for better sentatives said. disclosures. The council provided feedback on There was consensus among council proposed amendments to Regulation E, members on what they consider to be which implements the Electronic Fund best practices for due dates on credit Transfer Act, that would eliminate the card payments: if creditors do not re- receipt requirement at point-of-sale and ceive mail or post payments on week- other electronic terminals for debit card ends or holidays, then payments that ar- transactions of $15 or less. Members acrive on those days should be posted on knowledged that consumers increasingly the next business day and should be use credit and debit cards for smallcredited as on time if the due date fell dollar transactions but disagreed about on that weekend or holiday. Similarly, a whether receiving a receipt helps conpayment that has a weekend or holiday sumers manage their finances. Industry due date should be credited as on time if members generally expressed the view it is received on the next business day. that consumers receive minimal benefit Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Consumer and Community' Affairs 149 from receipts for small-dollar transac- accounts and the collection and return of tions. They noted that consumers would checks. They focused particularly on continue to receive information about scams involving fraudulent checks and each of their transactions on periodic on the exception-hold practices that fistatements. Several consumer represen- nancial institutions can use to protect tatives opposed the Board's proposal, themselves and their customers from stating that receipts are an important tool these scams. Members expressed conto help consumers accurately track their cern that the brief hold periods permittransactions, obtain reimbursements, ted under Regulation CC for certain and provide documentation in a dispute. checks may impede financial institu- Several industry representatives ex- tions' ability to conduct appropriate due pressed concern that the costs associated diligence. Several industry representawith providing terminal receipts for tives emphasized the importance of codebit card transactions are burdensome operation and information-sharing and impede industry efforts to create among financial institutions when an incashless payment options in certain re- stitution has concerns that a check may tail settings. Consumer representatives be fraudulent. Some members suggested generally regarded the proposed $15 that enhanced enforcement to require a threshold as too high. Industry represen- paying institution to return a check item tatives, however, suggested that the promptly could be helpful in this prothreshold should be increased to $25, cess. Others recommended that the fedconsistent with current credit card rules eral financial regulatory agencies stanthat waive requirements for authoriza- dardize and coordinate fraudulent-check tion by signature or personal identifica- alerts rather than issue separate alerts. tion number for transactions less than Members highlighted the importance of this amount. education to increase awareness of Members discussed several aspects of fraudulent-check issues among both Regulation CC, which governs the avail- financial institution employees and ability of funds deposited in checking consumers. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

151 Federal Reserve Banks In addition to contributing to setting na- ment factor (PSAF).2 Over the past ten tional monetary policy and supervising years, the Reserve Banks have recovand regulating banks and other financial ered 99.1 percent of their priced services entities (discussed in preceding chap- costs, including the PSAF (table).3 ters), the Federal Reserve Banks provide In 2007, the Reserve Banks recovered payment services to depository and cer- 101.9 percent of total costs of tain other institutions, distribute the na- $993.7 million, including the PSAF.4 tion's currency and coin, and serve as Revenue from priced services amounted fiscal agents and depositories for the to $878.4 million, other income was United States. $133.8 million, and costs were $913.3 million, resulting in net income from priced services of $98.9 million. Developments in Federal Reserve Priced Services The Federal Reserve Banks provide a range of payment and related services to depository institutions, including col- 2. In addition to income taxes and the return on equity, the PSAF is made up of three imputed lecting checks, operating an automated costs: interest on debt, sales taxes, and assessclearinghouse service, transferring funds ments for deposit insurance by the Federal Deposit and securities, and providing a multilat- Insurance Corporation (FDIC). Board of Govereral settlement service. The Reserve nors assets and costs that are related to priced services are allocated to priced services; in the pro Banks charge fees for providing these forma financial statements at the end of this chap- "priced services." ter, Board assets are part of long-term assets, and The Monetary Control Act of 1980 Board expenses are included in operating exrequires that the Federal Reserve estab- penses. lish fees for priced services provided to 3. Effective December 31, 2006, the Reserve Banks implemented the Financial Accounting depository institutions so as to recover, Standards Board's Statement of Financial Acover the long run, all direct and indirect counting Standards (SFAS) No. 158, Employers1 costs actually incurred as well as the Accounting for Defined Benefit Pension and Other imputed costs that would have been in- Postretirement Plans, which has resulted in the recognition of a $237.9 million reduction in equity curred, including financing costs, taxes, related to the priced services' benefit plans and certain other expenses, and the rethrough 2007. Including this reduction in equity, turn on equity (profit) that would have which represents a decline in economic value, rebeen earned if a private business firm sults in cost recovery of 96.7 percent for the tenhad provided the services.1 The imputed year period. For details on how implementing SFAS No. 158 affected the pro forma financial costs and imputed profit are collectively statements, refer to notes 2, 3, and 5 at the end of referred to as the private-sector adjustthis chapter. 4. Other income is revenue from investment of clearing balances net of earnings credits, an 1. Financial data reported throughout this amount termed net income on clearing balances. chapter—revenue, other income, cost, income be- Total cost is the sum of operating expenses, imfore taxes, and net income—can be linked to the puted costs (interest on debt, interest on float, sales pro forma financial statements at the end of this taxes, and the FDIC assessment), imputed income chapter. taxes, and the targeted return on equity. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

152 94th Annual Report 2007 Priced Services Cost Recovery, 1998-2007 Millions of dollars except as noted Operating Revenue from Targeted return Total Cost recovery Year servicesl im ex p p u e t n e s d e s c a o n st d s2 on equity costs (percent)3'4 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 2007 1,012.3 913.3 80.4 993.7 101.9 1998-2007 9,343.4 8,528.0 896.6 9,424.8 99.1 NOTE: Here and elsewhere in this chapter, totals and of $7,938.1 million, imputed costs of $227.2 million, and percentages may not reflect components shown because imputed income taxes of $362.8 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 96.7 pervices of $8,816.8 million and other income and expense cent, including the net reduction in equity related to (net) of $526.6 million. FAS 158 reported by the priced services in 2007. 2. For the ten-year period, includes operating expenses Commercial Check-Collection 9.8 percent from 2006 (table). The de- Service cline in Reserve Bank check volume is consistent with nationwide trends away In 2007, the Reserve Banks recovered from the use of checks and toward 100.7 percent of the total costs of their greater use of electronic payment methcommercial check-collection service, in- ods.5 Of all the checks presented by the cluding the PSAF. The Reserve Banks' Reserve Banks to paying banks in 2007, operating expenses and imputed costs 42.2 percent were deposited and 24.6 totaled $743.3 million, of which $26.1 percent were presented using Check 21 million was attributable to the transporproducts, compared with 14.0 percent tation of commercial checks between and 4.3 percent, respectively, in 2006.6 Reserve Bank check-processing centers. By the end of 2007, this growth resulted Revenue amounted to $705.0 million, of in 57.5 percent of the Reserve Bank which $23.1 million was attributable to estimated revenues derived from the transportation of commercial checks be- 5. The Federal Reserve System's retail paytween Reserve Bank check-processing ments research suggests that the number of checks centers, and other income was written in the United States has been declining $106.9 million. The resulting net income since the mid-1990s. For details, see Federal Rewas $68.6 million. Check-service rev- serve System, "The 2007 Federal Reserve Payments Study: Noncash Payment Trends in the enue in 2007 decreased $40.0 million United States, 2003-2006" (December 2007). from 2006, largely because of a drop in (www.frbservices.org/files/communications/pdf/ paper-check fee revenue; this drop was research/2007_pay ments_study.pdf)partially offset by an increase in Check 6. The Reserve Banks also offer non-Check 21 21 fee revenue. electronic-presentment products. In 2007, 19.2 percent of the Reserve Banks' deposit vol- The Reserve Banks handled 10.0 bilume was presented to paying banks using these lion checks in 2007, a decrease of products. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 153 Activity in Federal Reserve Priced Services, 2005-2007 Thousands of items Percent change Service 2007 2006 2005 2006 to 2007 2005 to 2006 Commercial check 10,001,289 11,083,122 12,227,718 -9.8 -9.4 Commercial ACH 9,363.429 8,230,782 7,338,950 13.8 12.2 Funds transfer 137,555 136,399 135,227 0.9 0.9 Multilateral settlement 505 470 440 7.4 6.8 Securities transfer 10,110 9,053 9,235 11.7 -2.0 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 check deposits and 39.0 percent of Re- The Reserve Banks' operating expenses serve Bank check presentments being and imputed costs totaled $85.9 million. made through Check 21 products. Revenue from ACH operations totaled In 2007, the Reserve Banks continued $88.3 million and other income totaled efforts to reduce check-service operat- $13.7 million, resulting in net income of ing costs in response to the ongoing de- $16.0 million. The Banks processed cline in check volume. These efforts in- 9.4 billion commercial ACH transaccluded the consolidation of some check- tions, an increase of 13.8 percent from processing sites. Check processing at 2006. Nashville has now been consolidated to In 2007, nationwide ACH volumes Atlanta; San Francisco operations to Los continued to grow at double-digit rates. Angeles; and Helena (Montana) opera- This growth is largely attributable to tions to Denver. As part of a longervolume increases associated with elecrange strategy, the Reserve Banks have tronic check conversion applications— selected Philadelphia, Cleveland, Atincluding checks converted at lockbox lanta, and Dallas as regional checklocations or at the point of purchase. processing sites, which will provide a ACH rule changes that took effect in full range of check-processing services. early 2007 permitted checks to be con- The transition to this new structure is verted in processing centers or back ofexpected to begin in 2008. The Reserve fices, spurring further growth in the vol- Banks will continue to review their ume of ACH check conversions. check infrastructure regularly to respond to further changes within the nation's payments system and to meet statutory Fedwire Funds and requirements for long-term cost National Settlement Services recovery. In 2007, the Reserve Banks recovered 107.3 percent of the costs of their Fed- Commercial Automated wire Funds and National Settlement Ser- Clearinghouse Services vices, including the PSAF. The Reserve In 2007, the Reserve Banks recovered Banks' operating expenses and imputed 107.6 percent of the total costs of their costs totaled $63.1 million in 2007. Revcommercial automated clearinghouse enue from these operations totaled (ACH) services, including the PSAF. $64.4 million and other income Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

154 94th Annual Report, 2007 amounted to $10.1 million, resulting in government-sponsored enterprises, and net income of $11.4 million. certain international organizations to other participants in the service.7 In Fedwire Funds Service 2007, the number of non-Treasury securities transfers processed by the service The Fedwire Funds Service allows parincreased 11.7 percent from 2006, to apticipants to use their reserve or clearing proximately 10.1 million. balances at the Reserve Banks to trans- In 2007, the Board published an asfer funds to other participants. In 2007, sessment of the compliance of the Fedthe number of Fedwire funds transfers wire Securities Service with the Recomoriginated by depository institutions inmendations for Securities Settlement creased 0.9 percent from 2006, to ap- Systems that are included in the Federal proximately 137.6 million. The average Reserve Policy on Payments System daily value of Fedwire funds transfers in Risk.8 The Fedwire Securities Service 2007 was $2.7 trillion. mostly complied with the recommendations' applicable standards.9 Both the National Settlement Service Fedwire Funds Service and the Fedwire The National Settlement Service is a Securities Service assessments will be multilateral settlement system that al- reviewed periodically to ensure that they lows participants in private-sector clear- remain accurate. ing arrangements to exchange and settle transactions on a net basis using reserve Float or clearing balances. In 2007, the service processed settlement files for ap- The Federal Reserve had daily average proximately fifty-four local and national credit float of $604.9 million in 2007, private arrangements, primarily check clearinghouse associations. The Reserve Banks processed slightly more than 17,000 files that contained almost 7. The expenses, revenues, volumes, and fees 505,000 settlement entries for these ar- reported here are for transfers of securities issued rangements in 2007. by federal government agencies, governmentsponsored enterprises, and certain international organizations. The Reserve Banks provide Treasury Fedwire Securities Service securities services in their role as the US. Treasury's fiscal agent. These services are not consid- In 2007, the Reserve Banks recovered ered priced services. For details, see the section 103.7 percent of the total costs of their "Debt Services" later in this chapter. 8. The Recommendations are a set of nineteen Fedwire Securities Service, including minimum standards, developed by the Committee the PSAF. The Reserve Banks' operaton Payment and Settlement Systems (CPSS) and ing expenses and imputed costs for pro- the Technical Committee of the International Orviding this service totaled $21.0 million ganization of Securities Commissions (IOSCO), to in 2007. Revenue from the service to- address legal, presettlement, settlement, operational, and custody risks, among other issues, in taled $20.6 million, and other income securities settlement systems. See www. totaled $3.2 million, resulting in net in- federalreserve.gov/paymentsystems/fedwiresecsvs/ come of $2.9 million. fedwiresecsvs.pdf. The Fedwire Securities Service al- 9. In 2006, the Board published an assessment of the compliance of the Fedwire Funds Service lows participants to electronically transwith the Core Principles for Systemically Imporfer securities issued by the U.S. TreatantPaymentSystems.Seewww.federalreserve.gov/ sury, federal government agencies, paymentsystems/coreprinciples/coreprinciples.pdf. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 155 compared with credit float of $85.9 mil- the Reserve Banks' Currency Technollion in 2006.10 ogy Office to develop more-secure designs for the $5 Federal Reserve note. The Reserve Banks issued the rede- Developments in signed $5 note in March 2008. Currency and Coin Board staff worked with the Reserve Banks and the United States Mint to The Federal Reserve Banks issue the naimplement the distribution strategy for tion's currency (in the form of Federal the Presidential $1 Coin Program. Con- Reserve notes) and distribute coin sistent with the requirements of the through depository institutions. The Re- Presidential $1 Coin Act, the Federal serve Banks also receive currency and Reserve and the Mint conducted addicoin from circulation through these intional outreach to depository institutions stitutions. The Reserve Banks received and coin users to gauge demand for the 38.0 billion Federal Reserve notes from coins and to anticipate and eliminate obcirculation in 2007, a 0.8 percent destacles to the efficient circulation of $1 crease from 2006, and made payments coins. of 38.5 billion notes into circulation in The Reserve Banks began implement- 2007, a 1.5 percent decrease from 2006. ing a program to extend to 2017 the They received 63.3 billion coins from useful life of the System's BPS 3000 circulation in 2007, a 5.9 percent inhigh-speed currency-processing macrease from 2006, and made payments chines. The program will replace the opof 75.7 billion coins into circulation, a erating systems of the current equip- 2.2 percent increase from 2006. ment but retain the machines' frames, In July, the Reserve Banks implenote-transport mechanisms, and large mented the fee component of the Fedmechanical parts. Software problems eral Reserve currency recirculation and development delays have extended policy. The intent of the policy is to the schedule for completion of the proreduce the overuse of Federal Reserve gram to the fourth quarter of 2009. currency-processing services by deposi- The Reserve Banks selected a vendor tory institutions. Under the policy, the to design software to replace the current Reserve Banks assess fees to institutions standard cash application. The multiyear that, within a one-week period, deposit project will begin in 2008; the target fit $10 or $20 notes and reorder curimplementation date for the new autorency of the same denomination, above mation system is 2010. a de minimis amount, within the same Reserve Bank office's service area. At the end of the first two billing quarters, the Developments in Reserve Banks had collected $5.5 million Fiscal Agency and in recirculation fees from institutions. Government Depository Services Board staff worked with the Treasury As fiscal agents and depositories for the Department, the U.S. Secret Service, and federal government, the Federal Reserve Banks provide services related to the 10. Credit float occurs when the Reserve Banks federal debt, help the Treasury collect present items for collection to the paying bank funds owed to the federal government, prior to providing credit to the depositing bank, process electronic and check payments and debit float occurs when the Reserve Banks for the Treasury, maintain the Treacredit the depositing bank prior to presenting items for collection to the paying bank. sury's bank account, and invest excess Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

156 94th Annual Report 2007 Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2005-2007 Thousands of dollars Agency and service 2007 2006 2005 DEPARTMENT OF THE TREASURY Bureau of the Public Debt Treasury retail securities 74,149.2 73,931.4 86,503.2 Treasury securities safekeeping and transfer 8,687.7 7,535.2 6,055.8 Treasury auction 41,372.0 23,594.9 17,553.5 Computer infrastructure development and support 3,558.7 3,853.1 2,575.5 Other services 724.5 1,578.7 1,806.5 Total 128,492.1 110,493.2 114,494.5 Financial Management Service Payment services Government check processing 17,522.7 20,918.6 20,988.0 Automated clearinghouse 6,050.3 5,823.1 5,709.5 Fedwire funds transfers 116.8 123.1 109.4 Other payment programs 81,636.9 69,696.8 49,366.0 Collection services Tax and other revenue collections 38,254.5 37,095.5 39,736.0 Other collection programs 12,483.6 14,122.6 14,354.2 Cash-management services 46,093.6 48,320.2 40,496.7 Computer infrastructure development and support 70,999.9 67,046.4 67,703.3 Other services 7,507.2 7,414.8 2,332.2 Total 280,665.7 270,561.2 240,795.4 Other Treasury Total 17.997.1 16,786.3 15,726.7 Total, Treasury 427,154.9 397,840.7 371,016.6 OTHER FEDERAL AGENCIES Department of Agriculture Food coupons 2,706.0 2,929.8 2,642.4 United States Postal Service Postal money orders 8,913.2 9,334.4 7,647.8 Other agencies Other services 19,412.0 15,977.1 14,870.2 Total, other agencies 31,031.1 28,241.4 25,160.4 Total reimbursable expenses 458,186.0 426.082.1 396,177.0 Treasury balances. The Reserve Banks reimbursed the Reserve Banks for the also provide limited fiscal agency and costs of providing these services. depository services to other entities. The total cost of providing fiscal Debt Services agency and depository services to the Treasury and other entities in 2007 The Reserve Banks auction, provide amounted to $458.2 million, compared safekeeping for, and transfer Treasury with $426.1 million in 2006 (table). securities. Reserve Bank operating ex- Treasury-related costs were $427.2 mil- penses for these activities totaled $50.1 lion in 2007, compared with $397.8 mil- million in 2007, compared with $31.1 lion in 2006, an increase of 7.4 percent. million in 2006. The Banks processed The cost of providing services to other 104,000 commercial tenders for Treaentities was $31.0 million, compared sury securities in 2007 through the Fedwith $28.2 million in 2006. In 2007, as wire Securities Service, compared with in 2006, the Treasury and other entities 148,000 in 2006. They originated Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 157 13.7 million transfers of Treasury secu- taled $105.3 million in 2007, compared rities in 2007, a 6.4 percent increase with $96.6 million in 2006. The Banks from 2006. The Reserve Banks are de- processed 1,027 million ACH payments veloping a new Treasury auction appli- for the Treasury, an increase of 3.6 percation and infrastructure that will cent from 2007, and more than 618,000 provide increased functionality and se- Fed wire funds transfers. They also procurity. The application will be opera- cessed 214 million government checks, tional in early 2008. a decline of 3.6 percent from 2006. The The Reserve Banks also operate com- proportion of government checks being puter applications and provide customer processed as paper checks has been deservice and back-office support for the clining as an increasing number of Treasury's retail securities programs. checks are being presented by deposi- Reserve Bank operating expenses for tory institutions in image form. Of all these activities were $74.1 million in the government checks processed by the 2007, compared with $73.9 million in Banks in 2007, 54 percent of the checks 2006. The Reserve Banks operate were presented as paper and 46 percent Legacy Treasury Direct, a program that were presented as images, compared allows investors to purchase and hold with 87 percent and 13 percent, respec- Treasury securities directly with the tively, in 2006. In addition, the Banks Treasury through the Reserve Banks inissued more than 131,000 fiscal agency stead of through a broker. The program checks, a decrease of 22.6 percent from held $70.3 billion (par value) of Trea- 2006. sury securities as of December 31. Because the program was designed for investors who plan to hold their securities Collection Services to maturity, it does not provide transfer services. Investors may, however, sell The Reserve Banks support several their securities for a fee through Sell Treasury programs to collect funds Direct, a program operated by one of the owed the federal government. Reserve Reserve Banks. Approximately 13,000 Bank operating expenses related to these securities worth $642.4 million were programs totaled $50.7 million in 2007, sold through Sell Direct in 2007, com- compared with $51.2 million in 2006. pared with 13,000 securities worth The Banks operate the Federal Reserve $678.9 million in 2006. The Banks Electronic Tax Application (FR-ETA) as printed and mailed more than 25.1 mil- an adjunct to the Treasury's Electronic lion savings bonds in 2007, a 13.2 per- Federal Tax Payment System (EFTPS). cent decrease from 2006. They issued EFTPS allows businesses and individual more than 4.2 million Series I (inflation- taxpayers to pay their taxes electroniindexed) bonds and 20.6 million Series cally. It uses the automated clearing- EE bonds. house (ACH) to collect funds, so tax payments must be scheduled at least one day in advance. Some business taxpay- Payments Services ers, however, do not know their tax li- The Reserve Banks process both elec- ability until the tax due date. FR-ETA tronic and check payments for the Trea- allows these taxpayers to use EFTPS by sury. Reserve Bank operating expenses providing a same-day electronic federal for processing government payments tax payment alternative. FR-ETA coland for payments-related programs to- lected $519.8 billion for the Treasury in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

158 94th Annual Report, 2007 2007, compared with $456.3 billion in vides the Repurchase Agreement Pro- 2006. gram on a limited basis, which allows In addition, the Reserve Banks oper- the Treasury to place a portion of its ate Pay.gov, a Treasury program that al- excess operating funds directly with lows members of the public to use the TT&L depositaries through a repurchase Internet to pay for goods and services transaction for a set period at an offered by the federal government. They agreed-on interest rate. In 2007, the Realso operate the Treasury's Paper Check serve Banks placed a total of $499 bil- Conversion and Electronic Check Pro- lion of investments through repurchase cessing programs, whereby checks writ- agreements. ten to government agencies are con- In 2007, the Treasury announced the verted into ACH transactions at the Collections and Cash Management point of sale or at lockbox locations. In Modernization (CCMM) initiative, 2007, the Reserve Banks originated which is a multiyear effort to streamline, more than 10.1 million ACH transac- modernize, and improve the process and tions through these programs, a signifi- systems supporting the Treasury's colcant increase from 2006 due to growth lections and cash-management proin the electronic check processing grams. Several Federal Reserve Banks program. have been selected to work on the CCMM initiative. Treasury Cash-Management Services Services Provided to Other Entities The Reserve Banks provide fiscal The Treasury maintains its bank account agency and depository services to other at the Reserve Banks and invests the domestic and international entities when funds it does not need for current payrequired to do so by the Secretary of the ments with qualified depository institu- Treasury or when required or permitted tions through the Treasury Tax and Loan to do so by federal statute. The majority (TT&L) program, which the Reserve of the work is securities-related. Banks operate. Reserve Bank operating expenses related to this program and other cash-management initiatives to- Electronic Access to taled $46.1 million in 2007, compared Reserve Bank Services with $48.3 million in 2006. The investments either are callable on demand or In 2007, the Federal Reserve Banks conare for a set term. In 2007, the Reserve tinued to migrate their computer inter- Banks placed a total of $308.4 billion in face customers to FedLine Direct and immediately callable investments, which FedLine Command. This migration, includes funds invested through retained typically for high-volume depository intax deposits and direct, special direct, stitutions, comes after the Reserve and dynamic investments, and $687 bil- Banks completed the FedLine Advanlion in term investments. The rate for tage migration, typically for low- to term investments is set by auction; the moderate-volume depository institu- Reserve Banks held 126 such auctions tions, in 2006. FedLine Direct is an in 2007, roughly the same number of internet-protocol-based computer-toauctions as in 2006. In 2007, the Trea- computer electronic access channel used sury's income from the TT&L program to access critical payment services, such was $1.15 billion. The Treasury pro- as Fedwire Funds, Fedwire Securities, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 159 National Settlement, and FedACH Ser- tem has decided not to make any further vices. FedLine Command is a lower- significant investments in the mainframe cost internet-protocol-based computer- platform. System business owners are to-computer electronic access channel looking at alternative platforms for webfor file delivery services, including the based access to applications and data, FedACH Service. The Reserve Banks partly because of concerns about the began the migration to FedLine Direct continued availability of technical reand FedLine Command in 2006 and ex- sources to support mainframe platforms. pect to complete the conversion in 2008. In 2007, the Federal Reserve continued to implement the Information Security Architecture Framework (ISAF), a Information Technology large program scheduled to be com- In 2007, the Federal Reserve Banks en- pleted in 2008. ISAF is intended to rehanced their information technology spond to the continuing and increasingly (IT) governance framework to better sophisticated security threats facing inalign IT management authority and ac- formation technology systems and to countability with the business models improve information security at all used in the System. A System chief in- points in the Federal Reserve by raising formation officer (CIO) position and two the level of enterprise-wide assurance. advisory councils were established. The Major accomplishments in 2007 include Business Technology Council represents improving the separation of sensitive inthe technology needs of the Federal Re- frastructure, limiting access to sensitive serve's business lines, and the Technol- desktop functions, and strengthening ogy Services Council represents the desktop-access protections. Federal Reserve's IT providers. The CIO leads System efforts to develop and Examinations of the implement the Federal Reserve's overall Federal Reserve Banks IT strategy at the Reserve Banks, manages national information-security risk, Section 21 of the Federal Reserve Act and analyzes and coordinates the Sys- requires the Board of Governors to ortem's IT investments. der an examination of each Federal Re- The System continued to develop the serve Bank at least once a year. The National Information Security Assur- Board performs its own reviews and enance function as a central point of gov- gages a public accounting firm. The ernance for enterprise-level information public accounting firm performs an ansecurity. Associated roles and responsi- nual audit of the combined financial bilities within the function were clari- statements of the Reserve Banks (see fied. Efforts to improve the function will the section "Federal Reserve Banks continue as the Federal Reserve's infor- Combined Financial Statements") and mation security environment continues audits the annual financial statements of to evolve. each of the twelve Banks. The Reserve To address the business implications Banks use the framework established by of reduced demand for mainframe ser- the Committee of Sponsoring Organizavices, Federal Reserve Information tions of the Treadway Commission Technology in mid-2007 implemented a (COSO) to assess their internal controls multiyear strategic plan for mainframe over financial reporting, including the technologies. These technologies are no safeguarding of assets. The Reserve longer considered strategic, and the Sys- Banks have further enhanced their as- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

160 94th Annual Report, 2007 sessments under the COSO framework System Open Market Account at the to strengthen the key control assertion Federal Reserve Bank of New York and process and in 2007 met the require- the foreign currency operations conments of the Sarbanes-Oxley Act of ducted by that Bank. In addition, D&T 2002. Within this framework, manage- audits the schedule of participated asset ment of each Reserve Bank provides an and liability accounts and the related assertion letter to its board of directors schedule of participated income acannually confirming adherence to counts at year-end. The FOMC receives COSO standards, and a public account- the external audit reports and the report ing firm confirms management's asser- on the division's examination. tion and issues an attestation report to each Bank's board of directors and to the Board of Governors. Income and Expenses In 2007, the Board engaged Deloitte & Touche LLP (D&T) for the audits of The accompanying table summarizes the the individual and combined financial income, expenses, and distributions of statements of the Reserve Banks. Previ- net earnings of the Federal Reserve ously, PricewaterhouseCoopers LLP per- Banks for 2006 and 2007. Income in formed the audits. Fees for D&T's ser- 2007 was $42,576 million, compared vices totaled $4.7 million. To ensure with $38,410 million in 2006. auditor independence, the Board requires Expenses totaled $4,382 million that D&T be independent in all matters ($3,270 million in operating expenses, relating to the audit. Specifically, D&T $240 million in earnings credits granted may not perform services for the Re- to depository institutions, $296 million serve Banks or others that would place it in assessments for expenditures by the in a position of auditing its own work, Board of Governors, and $576 million making management decisions on behalf for the cost of new currency). Revenue of Reserve Banks, or in any other way from priced services was $878.4 milimpairing its audit independence. In lion. Net additions to and deductions 2007, the Reserve Banks did not engage from current net income showed a net D&T for nonaudit services. profit of $198 million. The profit was The Board's annual examination of due primarily to unrealized gains on asthe Reserve Banks includes a wide range sets denominated in foreign currencies of off-site and on-site oversight activi- revalued to reflect current market exties conducted primarily by the Division change rates offset, in part, by interest of Reserve Bank Operations and Pay- expense on reverse repurchase agreement Systems. Division personnel moni- ments. Statutory dividends paid to memtor the activities of each Reserve Bank ber banks totaled $992 million, on an ongoing basis and conduct on-site $121 million more than in 2006; the inreviews based on the division's risk- crease reflects an increase in the capital assessment methodology. The examina- and surplus of member banks and a contions also include assessing the effi- sequent increase in the paid-in capital ciency and effectiveness of the internal stock of the Reserve Banks. audit function. To assess compliance Payments to the U.S. Treasury in the with the policies established by the Fed- form of interest on Federal Reserve eral Reserve's Federal Open Market notes totaled $34,598 million in 2007, Committee (FOMC), the division also up from $29,052 million in 2006; the reviews the accounts and holdings of the payments equal net income after the de- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 161 Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2007 and 2006 Millions of dollars Item 2007 2006 Current income 42,576 38,410 Current expenses 3,510 3,264 Operating expenses1 3,270 2,987 Earnings credits granted 240 276 Current net income 39,066 35,147 Net additions to (deductions from, - ) current net income 198 -159 Assessments by the Board of Governors 872 793 For expenditures of Board 296 301 For cost of currency 576 492 Change in funded status of benefit plans2 324 Net income before payments to Treasury 38,716 34,195 Dividends paid 992 871 Transferred to (from) surplus and change in accumulated other comprehensive income 3,126 4,272 Payments to Treasury3 ... 34,598 29,052 1. Includes a net periodic pension expense of funded status of benefit plans as an element of other $110 million in 2007 and $53 million in 2006. comprehensive income. 2. Subsequent to the adoption of SFAS 158 in 2006, 3. Interest on Federal Reserve notes. the Reserve Banks began to recognize the change in . . . Not applicable. duction of dividends paid and of the lion, an increase of $28,243 million amount necessary to equate the Reserve from 2006 (table). U.S. government se- Banks' surplus to paid-in capital. curities holdings increased $26,124 mil- In the "Statistical Tables" section of lion, and loans increased $1,297 million. this report, table 10 details the income In December 2007, the Federal Reserve and expenses of each Reserve Bank for established a Term Auction Facility 2007 and table 11 shows a condensed (TAF) under which the Reserve Banks statement for each Bank for the years conduct auctions for a fixed amount of 1914 through 2007; table 9 is a state- funds for a fixed term, with the interest ment of condition for each Bank, and rate determined by the auction process, table 13 gives the number and annual subject to a minimum bid rate. All adsalaries of officers and employees for vances under the TAF must be fully coleach Bank. A detailed account of the lateralized. In 2007, average daily holdassessments and expenditures of the ings of Term Auction Credit (TAC) under Board of Governors appears in the sec- the TAF amounted to $822 million. tion "Board of Governors Financial The average rate of interest earned on Statements." the Reserve Banks' holdings of government securities increased to 4.95 percent, from 4.63 percent in 2006, and the Holdings of Securities and Loans average rate of interest earned on loans The Federal Reserve Banks' average decreased to 2.18 percent, from daily holdings of securities and loans 5.36 percent. The average interest rate during 2007 amounted to $816,115 mil- on TAC was 4.66 percent. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

162 94th Annual Report, 2007 Securities and Loans of the Federal Reserve Banks, 2005-2007 Millions of dollars except as noted U.S. Term Item and year Total government Loans 2 Auction securities1 Credit3 Average daily holdings4 20055 753,748 753,549 199 20065 787,872 787,648 224 2007 816,115 813,772 1,521 822 Earnings b 2005 28,966 28,959 7 2006 36,464 36,452 12 2007 40,369 40,298 33 38 Average interest rate (percent) 20055 3.84 3.84 3.52 20065 4.63 4.63 5.36 2007 .. . 4.95 4.95 2.18 4.66 1. Includes federal agency obligations. 5. Amounts in bold are restatements due to changes in 2. Does not include indebtedness assumed by the Fed- previously reported data. eral Deposit Insurance Corporation. 6. Earnings have not been netted with the interest ex- 3. Reflects temporary Term Auction Facility activity pense on securities sold under agreements to repurchase. beginning in 2007. . . . Not applicable. 4. Based on holdings at opening of business. Volume of Operations law enforcement officers (FRLEOs). The 240-hour program covers a variety Table 12 in the "Statistical Tables" secof topics related to the mission of an tion shows the volume of operations in FRLEO. The Federal Reserve was the principal departments of the Federal granted federal law enforcement author- Reserve Banks for the years 2004 ity by the USA Patriot Act to protect through 2007. and safeguard Board and Federal Reserve Bank premises, grounds, property, Federal Reserve personnel, and operations. Law Enforcement In November, the Federal Reserve Sys- Federal Reserve Bank Premises tem became the eleventh federal law enforcement agency to be awarded ac- In 2007, construction was largely comcreditation from the Federal Law pleted on the Kansas City Bank's new Enforcement Training Accreditation headquarters building and the San Franboard of directors for its Basic Law En- cisco Bank's new Seattle Branch buildforcement Course (BLEC). The primary ing. The multiyear renovation program benefit of accreditation is increased pub- at the New York Bank's headquarters lic confidence in the integrity, profes- building continued. The St. Louis Bank sionalism, and accountability of the law continued a long-term facility redevelenforcement agencies. Accreditation is opment program that includes the ongoconsidered a "best practice" for federal ing construction of an addition to the law enforcement agencies and signifies Bank's headquarters building. compliance with 63 stringent standards. Security enhancement programs con- All law enforcement candidates com- tinued at several facilities. Construction plete the Federal Reserve's BLEC prior of security improvements to the Richto their designation as Federal Reserve mond Bank's headquarters building is Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 163 ongoing. The Philadelphia Bank com- final design of a new parking garage to pleted the purchase of property behind be constructed adjacent to the Richmond its headquarters building for the con- Bank's headquarters building. Efforts to struction of a remote vehicle-screening sell the St. Louis Bank's Little Rock facility and is developing the facility's Branch building continued. design. Design development of a similar Table 14 in the "Statistical Tables" screening facility for the Dallas Bank section of this report details the acquisialso continued. tion costs and net book value of the Fed- During 2007, the Board approved the eral Reserve Banks and Branches. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

164 94th Annual Report, 2007 Pro Forma Financial Statements for Federal Reserve Priced Services Pro Forma Balance Sheet for Priced Services, December 31, 2007 and 2006 Millions of dollars Item 2007 2006 Short-term assets (Note 1) Imputed reserve requirements on clearing balances 755.7 821.7 Imputed investments 6,465.7 7,207.5 Receivables 66.7 73.6 Materials and supplies 1.8 0.9 Prepaid expenses 28.5 24.2 Items in process of collection 1,769.6 3,391.0 Total short-term assets 9,088.0 11,518.9 Long-term assets (Note 2) Premises 453.5 424.9 Furniture and equipment 130.2 127.9 Leases, leasehold improvements, and long-term prepayments 64.2 83.3 Prepaid pension costs 484.6 453.0 Deferred tax asset 109.4 130.0 Total long-term assets 1,242.0 1,219.0 Total assets 10,330.0 12,737.9 Short-term liabilities Clearing balances and balances arising from early credit of uncollected items 7,641.1 8,015.6 Deferred-availability items 1,685.1 3,592.5 Short-term debt 0.0 0.0 Short-term payables 102.4 100.4 Total short-term liabilities 9,428.5 11,708.4 Long-term liabilities Long-term debt 0.0 0.0 Postretirement/postemployment benefits obligation 385.0 392.6 Total long-term liabilities 385.0 392.6 Total liabilities 9,813.5 12,101.0 Equity (including accumulated other comprehensive loss of $237.9 million and $306.1 million at December 31, 2007 and 2006, respectively) 516.5 636.9 Total liabilities and equity (Note 3) ... 10,330.0 12,737.9 NOTE: Components may not sum to totals because of The accompanying notes are an integral part of these rounding. Amounts in bold are restated due to changes in pro forma priced services financial statements. previously reported data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 165 Pro Forma Income Statement for Federal Reserve Priced Services, 2007 and 2006 Millions of dollars Item 2007 2006 Revenue from services provided to depository institutions (Note 4) — 878.4 908.4 Operating expenses (Note 5) 888.2 803.5 Income from operations -9.8 104.8 Imputed costs (Note 6) Interest on float -32.0 -4.9 Interest on debt 0.0 0.0 Sales taxes 11.6 10.8 FDIC insurance 0.0 -20.4 0.0 5.9 Income from operations after imputed costs 10.6 98.9 Other income and expenses (Note 7) Investment income 362.3 383.6 Earnings credits -228.5 133.8 -260.8 122.8 Income before income taxes 144.5 221.8 Imputed income taxes (Note 6) 45.5 66.1 Net income 98.9 155.7 MEMO: Targeted return on equity (Note 6) 80.4 72.0 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, 2007 Millions of dollars Commercial Commercial Fedwire Fedwire Item Total check ACH funds securities collection Revenue from services (Note 4) 878.4 705.0 88.3 64.4 20.6 Operating expenses (Note 5) 888 2 733 6 78 3 56 9 19 3 Income from operations -9.8 -28.6 10.0 7.5 1.3 Imputed costs (Note 6) -20.4 -21.8 0.2 0.9 0.3 Income from operations after imputed costs 106 -6 7 97 66 1 0 Other income and expenses, net (Note 7) 133.8 106.9 13.7 10.1 3.2 Income before income taxes 144.5 100.2 23.4 16.6 4.2 Imputed income taxes (Note 6) 45 5 31 6 74 5 2 1 3 Net income 98 9 68 6 160 11 4 29 MEMO: Targeted return on equity (Note 6) 80.4 63.2 8.8 6.3 2.0 MEMO: Cost recovery (percent) (Note 8) 101.9 100.7 107.6 107.3 103.7 NOTE: Components may not sum to totals because of The accompanying notes are an integral part of these rounding. pro forma priced services financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

166 94th Annual Report, 2007 FEDERAL RESERVE BANKS NOTES TO PRO FORMA FINANCIAL STATEMENTS FOR PRICED SERVICES (1) SHORT-TERM ASSETS with long-term liabilities and clearing balances. As a result, no short- or long-term debt is imputed. Other short- The imputed reserve requirement on clearing balances term liabilities include clearing balances maintained at held at Reserve Banks by depository institutions reflects a Reserve Banks and deposit balances arising from float. treatment comparable to that of compensating balances Other long-term liabilities consist of accrued postheld at correspondent banks by respondent institutions. employment, postretirement, and nonqualified pension The reserve requirement imposed on respondent balances benefits costs and obligations on capital leases. must be held as vault cash or as non-earning balances In order to reflect the funded status of its benefit plans maintained at a Reserve Bank; thus, a portion of priced services clearing balances held with the Federal Reserve as required by SFAS No. 158, the Reserve Banks recogis shown as required reserves on the asset side of the nized the deferred items related to these plans, which balance sheet. Another portion of the clearing balances is include prior service costs and actuarial gains or losses, used to finance short-term and long-term assets. The re- on the balance sheet. In 2007, this resulted in a decrease mainder of clearing balances is assumed to be invested in to the benefits obligation related to the priced services a portfolio of investments, shown as imputed invest- with an offsetting adjustment, net of tax, to AOCI, which ments. is included in equity. Equity is imputed at 5 percent of total assets. Receivables are (1) amounts due the Reserve Banks for priced services and (2) the share of suspense-account and difference-account balances related to priced services. (4) REVENUE Materials and supplies are the inventory value of short- Revenue represents charges to depository institutions for term assets. priced services and is realized from each institution Prepaid expenses include salary advances and travel through one of two methods: direct charges to an instituadvances for priced-service personnel. tion's account or charges against its accumulated earn- Items in process of collection is gross Federal Reserve ings credits (see Note 7). cash items in process of collection (CIPC) stated on a basis comparable to that of a commercial bank. It reflects (5) OPERATING EXPENSES adjustments for intra-System items that would otherwise be double-counted on a consolidated Federal Reserve bal- Operating expenses consist of the direct, indirect, and ance sheet; adjustments for items associated with non- other general administrative expenses of the Reserve priced items, such as those collected for government Banks for priced services plus the expenses for staff memagencies; and adjustments for items associated with pro- bers of the Board of Governors working directly on the viding fixed availability or credit before items are re- development of priced services. The expenses for Board ceived and processed. Among the costs to be recovered staff members were $6.7 million in 2007 and $7.5 million under the Monetary Control Act is the cost of float, or net in 2006. CIPC during the period (the difference between gross Effective January 1, 1987, the Reserve Banks imple- CIPC and deferred-availability items, which is the portion mented SFAS No. 87, Employers' Accounting for Penof gross CIPC that involves a financing cost), valued at sions. Accordingly, the Reserve Banks recognized operatthe federal funds rate. ing expenses for the qualified pension plan of $21.3 million in 2007 and $11.5 million in 2006. Operat- (2) LONG-TERM ASSETS ing expenses also include the nonqualified pension expense of $3.1 million in 2007 and $3.2 million in 2006. Long-term assets consist of long-term assets used solely The implementation of SFAS No. 158 does not change in priced services, the priced-service portion of long-term the systematic approach required by generally accepted assets shared with nonpriced services, and an estimate of accounting principles to recognize the expenses associthe assets of the Board of Governors used in the developated with the Reserve Banks' benefit plans in the income ment of priced services. statement. Effective December 31, 2006, the Reserve Banks implemented the Financial Accounting Standard Board's The income statement by service reflects revenue, op- Statement of Financial Accounting Standards (SFAS) No. erating expenses, imputed costs, and cost recovery. Cer- 158, Employers' Accounting for Defined Benefit Pension tain corporate overhead costs not closely related to any particular priced service are allocated to priced services and Other Postretirement Plans, which requires an embased on an expense-ratio method. Corporate overhead ployer to record the funded status of its benefit plans on was allocated among the priced services during 2007 and its balance sheet. This resulted in a reduction to the pre- 2006 as follows (in millions): paid pension asset related to priced services and the recognition of an associated deferred tax asset with an offsetting adjustment, net of tax, to accumulated other 2007 2006 comprehensive income (AOCI) (see Note 3). Check 34.7 30.6 ACH 4.3 4.1 (3) LIABILITIES AND EQUITY Fedwire funds 3.0 2.8 Under the matched-book capital structure for assets, Fedwire securities 1.7 1.5 short-term assets are financed with short-term payables Total 43.7 39.0 and core clearing balances. Long-term assets are financed Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks 167 (6) IMPUTED COSTS Unrecovered float includes float generated by services to government agencies and by other central bank ser- Imputed costs consist of income taxes, return on equity, vices. Float recovered through income on clearing balinterest on debt, sales taxes, the FDIC assessment, and ances is the result of the increase in investable clearing interest on float. Many imputed costs are derived from the balances; the increase is produced by a deduction for float private-sector adjustment factor (PSAF) model. The cost for CIPC, which reduces imputed reserve requirements. of debt and the effective tax rate are derived from bank The income on clearing balances reduces the float to be holding company data, which serves as the proxy for the recovered through other means. As-of adjustments and financial data of a representative private-sector firm, and direct charges refer to float that is created by interterritory are used to impute debt and income taxes in the PSAF check transportation and the observance of non-standard model. The after-tax rate of return on equity is based on holidays by some depository institutions. Such float may the returns of the equity market as a whole and is used to be recovered from the depository institutions through adimpute the profit that would have been earned had the justments to institution reserve or clearing balances or by services been provided by a private-sector firm. billing institutions directly. Float recovered through direct Interest is imputed on the debt assumed necessary to charges and per-item fees is valued at the federal funds finance priced-service assets; however, no debt was imrate; credit float recovered through per-item fees has been puted in 2007 or 2006. subtracted from the cost base subject to recovery in 2007. Effective in 2007, the Reserve Bank priced services imputed a one-time FDIC assessment credit of $16.6 million. In 2007, the credit fully offset the imputed $4.0 (7) OTHER INCOME AND EXPENSES million assessment, resulting in a remaining credit of Other income and expenses consist of investment income $12.6 million. The remaining credit can be used to offset on clearing balances and the cost of earnings credits. up to 90 percent of the assessment in the future. Investment income on clearing balances for 2007 and Interest on float is derived from the value of float to be 2006 represents the average coupon-equivalent yield on recovered, either explicitly or through per-item fees, dur- three-month Treasury bills plus a constant spread, based ing the period. Float costs include costs for the Check, on the return on a portfolio of investments. The return is Fedwire Funds, National Settlement Service, ACH, and applied to the total clearing balance maintained, adjusted Fedwire Securities services. for the effect of reserve requirements on clearing bal- Float cost or income is based on the actual float in- ances. Expenses for earnings credits granted to depository curred for each priced service. Other imputed costs are institutions on their clearing balances are derived by apallocated among priced services according to the ratio of plying a discounted average coupon-equivalent yield on operating expenses, less shipping expenses, for each ser- three-month Treasury bills to the required portion of the vice to the total expenses, less the total shipping ex- clearing balances, adjusted for the net effect of reserve penses, for all services. requirements on clearing balances. The following shows the daily average recovery of actual float by the Reserve Banks for 2007 in millions of (8) COST RECOVERY dollars: Annual cost recovery is the ratio of revenue to the sum of Total float -603.3 operating expenses, imputed costs, imputed income taxes, Unrecovered float 24.1 and targeted return on equity. Float subject to recovery -627.4 Sources of recovery of float Income on clearing balances -62.7 As-of adjustments -1.6 Direct charges 267.3 Per-item fees -833.6 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

169 The Board of Governors and the Government Performance and Results Act The Government Performance and Re- liminary analysis indicates that the sults Act (GPRA) of 1993 requires that Board generally met its goals for 2006federal agencies, in consultation with 07. Congress and outside stakeholders, pre- All of these documents are available pare a strategic plan covering a multi- on the Board's web site, at www. year period and submit an annual perfor- federalreserve.gov/boarddocs/rptcongress. mance plan and performance report. The Board's mission statement and a Although the Federal Reserve is not summary of the Federal Reserve's goals covered by the GPRA, the Board of and objectives, as set forth in the most Governors voluntarily complies with the recently released strategic and perspirit of the act. formance plans, are listed below. Updated documents will be posted on the website as they are completed. Strategic Plan, Performance Plan, and Performance Report Mission The Board's strategic plan articulates the Board's mission, sets forth major The mission of the Board is to foster the goals, outlines strategies for achieving stability, integrity, and efficiency of the those goals, and discusses the environ- nation's monetary, financial, and payment and other factors that could affect ment systems so as to promote optimal their achievement. It also addresses is- macroeconomic performance. sues that cross agency jurisdictional lines, identifies key quantitative perfor- Goals and Objectives mance measures, and discusses performance evaluation. The most recent stra- The Federal Reserve has six primary tegic plan covers the period 2006-09. goals with interrelated and mutually re- Both the performance plan and the inforcing elements. performance report are prepared every two years. The performance plan in- Goal cludes specific targets for some of the To conduct monetary policy that properformance measures identified in the motes the achievement of maximum strategic plan and describes the operasustainable long-term growth and the tional processes and resources needed to price stability that fosters that goal meet those targets. It also discusses data validation and results verification. The Objectives most recent performance plan covers the period 2006-07. • Stay abreast of recent developments The performance report discusses the and prospects in the U.S. economy and Board's performance in relation to its financial markets, and in those abroad, goals. The report covering the period so that monetary policy decisions will 2006-07 will be completed in 2008. Pre- be well informed. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

170 94th Annual Report, 2007 • Enhance our knowledge of the struc- • Promote compliance by domestic and tural and behavioral relationships in foreign banking organizations superthe macroeconomic and financial mar- vised by the Federal Reserve with kets, and improve the quality of the applicable laws, rules, regulations, data used to gauge economic perfor- policies, and guidelines through a mance, through developmental re- comprehensive and effective supervisearch activities. sion program. • Implement monetary policy effectively in rapidly changing economic Goal circumstances and in an evolving To effectively implement federal laws financial market structure. designed to inform and protect the con- • Contribute to the development of U.S. sumer, to encourage community develinternational policies and procedures, opment, and to promote access to bankin cooperation with the U.S. Departing services in historically underserved ment of the Treasury and other markets agencies. • Promote understanding of Federal Re- Objectives serve policy among other government policy officials and the general public. • Take a leadership role in shaping the national dialogue on consumer protec- Goal tion in financial services, address the rapidly emerging issues that affect To promote a safe, sound, competitive, today's consumers, strengthen conand accessible banking system and sumer compliance supervision prostable financial markets grams when required, and remain sensitive to the burden on supervised Objectives institutions. • Promote overall financial stability, • Promote, develop, and strengthen efmanage and contain systemic risk, and fective communications and collaboidentify emerging financial problems rations within the Board, the Federal early so that crises can be averted. Reserve Banks, and other agencies • Provide a safe, sound, competitive, and organizations. and accessible banking system • Increase public understanding of conthrough comprehensive and effective sumer protection and community desupervision of U.S. banks, bank and velopment and the Board's role in financial holding companies, foreign these areas through increased outreach banking organizations, and related and by developing programs that entities. At the same time, remain address the information needs of sensitive to the burden on supervised consumers and the financial services institutions. industry. • Provide a dynamic work environment • Develop a staff that is highly skilled, that is challenging and rewarding. En- professional, innovative, and diverse; hance efficiency and effectiveness, provide career development opporwhile remaining sensitive to the bur- tunities to improve retention; and den on supervised institutions, by ad- recruit highly qualified and skilled dressing the supervision function's employees. procedures, technology, resource allo- • Promote an efficient and effective cation, and staffing issues. work environment by aligning busi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Government Performance and Results Act 171 ness functions with appropriate work cient and reliable operations, effective processes and implementing solutions performance, and sound project manfor work products and processes that agement and should assist the Board can be handled more efficiently in the effective discharge of its overthrough automation. sight responsibilities. Goal Goal To foster the integrity, efficiency, and To foster the integrity, efficiency, and accessibility of U.S. payment and settle- effectiveness of the Board's programs ment systems Objectives Objectives • Oversee a planning and budget pro- • Develop sound, effective policies and cess that clearly identifies the Board's regulations that foster payment sys- mission, results in concise plans for tem integrity, efficiency, and accessi- the effective accomplishment of opbility. Support and assist the Board in erations, transmits to the staff the inoverseeing U.S. dollar payment and formation needed to attain objectives securities settlement systems by as- efficiently, and allows the public to sessing their risks and risk manage- measure our accomplishments. ment approaches against relevant • Develop appropriate policies, overpolicy objectives and standards. sight mechanisms, and measurement • Conduct research and analysis that criteria to ensure that the recruiting, contributes to policy development and training, and retention of staff meet increases the Board's and others' Board needs. understanding of payment system • Establish, encourage, and enforce a dynamics and risk. climate of fair and equitable treatment for all employees regardless of race, creed, color, national origin, age, or Goal sex. To provide high-quality oversight of • Provide financial management support Reserve Banks needed for sound business decisions. • Provide cost-effective and secure in- Objective formation resource management ser- • Produce high-quality assessments and vices to Board divisions and analyze oversight of Federal Reserve System information technology issues for the strategies, projects, and operations, in- Board, Reserve Banks, other financial cluding adoption of technology to the regulatory institutions, and other nabusiness and operational needs of the tions' central banks. Federal Reserve. The oversight pro- • Efficiently provide safe, modern, and cess should help Federal Reserve secure facilities and necessary support management foster and strengthen for activities conducive to efficient sound internal control systems, effi- and effective Board operations. • 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

175 Record of Policy Actions of the Board of Governors Regulation A Regulation DD Extensions of Credit by Truth in Savings Federal Reserve Banks [Docket Nos. R-1281 through R-1285] [Docket No. R-1304] On October 23, 2007, the Board ap- On December 10, 2007, the Board ap- proved amendments to the requirements proved amendments establishing a tem- in several regulations and official staff porary term auction facility (TAF), with commentaries for electronic disclosures the intention of permitting depository in- to consumers concerning consumer fistitutions to obtain credit from the Fed- nancial services and fair lending. The eral Reserve on a secured basis at rates amendments simplify and clarify the rethat meet the market demand for credit quirements by withdrawing unnecessary of relatively short terms. The TAF al- or unduly burdensome provisions in the lows depository institutions to obtain ad- interim final rules approved in March vances from their local Federal Reserve 2001 and by providing guidance on us- Banks at interest rates determined ing electronic disclosures. The amendthrough auctions. The amendments are ments are effective December 10, 2007, effective December 12, 2007. and compliance is mandatory by October 1, 2008. Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors Votes for this action: Chairman Bernanke, Warsh, Kroszner, and Mishkin. Vice Chairman Kohn, and Governors Warsh, Kroszner, and Mishkin. Regulation B On December 11, 2007, technical Equal Credit Opportunity amendments were approved, under delegated authority, to clarify certain amendments to the official staff com- Regulation E mentaries to Regulations B and Z that Electronic Fund Transfers were approved by the Board on October 23. The technical amendments are effec- Regulation M tive January 14, 2008, and compliance Consumer Leasing is mandatory by October 1, 2008. Regulation Z Regulation D Truth in Lending Reserve Requirements of Depository Institutions NOTE: Full texts of the policy actions are available via the online version of the Annual Report, [Docket No. R-1262] from the "Reading Rooms" on the Board's FOIA On April 2, 2007, the Board approved web page, and on request from the Board's Freedom of Information Office. revisions to its 1980 interpretation of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

176 94th Annual Report, 2007 regulation, which sets forth criteria for amendments are effective August 6, the exemption of bankers' banks from 2007. reserve requirements. The revisions al- Votes for this action: Chairman Bernanke, low the Board to make case-by-case de- Vice Chairman Kohn, and Governors terminations as to whether a bankers' Warsh, Kroszner, and Mishkin. bank may, to a limited extent, have as customers certain entities that are not Regulation H specified in the interpretation without Membership of losing its exemption. The revised inter- State Banking Institutions pretation is effective May 7, 2007. in the Federal Reserve System Votes for this action: Chairman Bernanke, Regulation K Vice Chairman Kohn, and Governors Warsh, Kroszner, and Mishkin. International Banking Operations [Docket No. R-1279] [Docket No. R-1297] On September 14, 2007, the Board, act- On September 24, 2007, the Board ap- ing with the other federal bank and thrift proved amendments to reflect the an- regulatory agencies, approved final rules nual indexing of the reserve requirement to extend, from twelve to eighteen exemption amount and the low reserve months, the on-site examination cycle tranche. For 2008, the reserve require- for certain state member banks and U.S. ment exemption amount is $9.3 million, offices of foreign banks. The extended an increase from $8.5 million in 2007, schedule applies to (1) insured instituand the low reserve tranche is $43.9 mil- tions that have up to $500 million in lion, a decrease from $45.8 million in total assets, are well capitalized and well 2007. The Board also adjusted the non- managed, and receive a composite exempt deposit cutoff level ($216.2 mil- CAMELS rating of 1 or 2 and (2) U.S. lion for 2008) and the reduced reporting branches and agencies of foreign banks limit ($1,211 billion for 2008), which that have up to $500 million in total are used to determine the frequency of assets and meet comparable criteria. The reporting by depository institutions. final rules, which implement the Financial Services Regulatory Relief Act of Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors 2006 and related legislation, are identi- Warsh, Kroszner, and Mishkin. cal to interim final rules approved by the Board on March 16, 2007, and are effective September 25, 2007. Regulation E Votes for this action: Chairman Bernanke, Electronic Fund Transfers Vice Chairman Kohn, and Governors Warsh, Kroszner, and Mishkin. [Docket No. R-1270] Regulation H On June 25, 2007, the Board approved Membership of amendments to the regulation and offi- State Banking Institutions cial staff commentary to exempt elecin the Federal Reserve System tronic fund transfers of $15 or less from the requirement to make paper receipts Regulation Y available to consumers for transactions Bank Holding Companies initiated at electronic terminals. The and Change in Bank Control Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 177 [Docket No. R-1261] lief Act of 2006, is identical to an interim final rule approved in December On November 2, 2007, the Board, acting 2006 and is effective July 16, 2007. with the other federal bank and thrift regulatory agencies, approved a new Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors risk-based capital adequacy framework Warsh, Kroszner, and Mishkin. for banking organizations (which include thrifts), popularly known as Basel II. The new framework requires Regulation O some banking organizations, and per- Loans to Executive Officers, mits other qualifying banking organiza- Directors, and Principal tions, to calculate their regulatory capi- Shareholders of Member Banks tal requirements using an internal ratings-based approach for credit risk [Docket No. R-1271] and advanced measurement approaches On May 23, 2007, the Board approved a for operational risks. Basel II, which final rule to eliminate certain reporting modernizes the Basel Capital Accord of requirements that have not contributed 1988, consists of three components, or significantly to effective monitoring or pillars: minimum regulatory capital reto prevention of insider lending abuse. quirements (pillar 1), supervisory review The final rule, which implements proviof capital adequacy (pillar 2), and marsions of the Financial Services Regulaket discipline through enhanced disclotory Relief Act of 2006, is identical to sure (pillar 3). The final rules set forth an interim final rule approved in Decemthe qualifying criteria and applicable ber 2006 and is effective July 2, 2007. risk-based capital requirements for banking organizations operating under Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors the new framework. They are effective Warsh, Kroszner, and Mishkin. April 1,2008. Votes for this action: Chairman Bernanke, Regulation R Vice Chairman Kohn, and Governors Warsh, Kroszner, and Mishkin. Exceptions for Banks from the Definition of Broker in the Securities Exchange Act of 1934 Regulation L Management Official Interlocks [Docket No. R-1274] On September 24, 2007, the Board, act- [Docket No. R-1272] ing with the Securities and Exchange On July 9, 2007, the Board, acting with Commission (SEC), approved a single the other federal bank and thrift regula- set of joint final rules to implement certory agencies, approved a final rule to tain exceptions for banks from the defipermit management interlocks between nition of broker under section 3(a)(4) of unaffiliated depository institutions that the Securities Exchange Act of 1934 have offices in the same relevant metro- (Exchange Act), as amended by the sopolitan statistical area if one of the insti- called push-out provisions of the tutions has less than $50 million (previ- Gramm-Leach-Bliley Act of 1999. The ously $20 million) in total assets. The final rules help define the scope of secufinal rule, which implements provisions rities activities that banks may conduct of the Financial Services Regulatory Re- in providing banking services to their Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

178 94th Annual Report, 2007 customers without registering with the ten identity theft prevention program SEC as a securities broker or complying that includes reasonable policies and with the SEC's rules. Some portions of procedures for detecting, preventing, the final rules are effective September and mitigating identity theft. The final 28, 2007; the remaining portions are ef- rules provide guidelines for developing fective December 3, 2007. However, and implementing those programs and banks are exempt from complying with examples of "red flags" signaling posthe final rules and the broker exceptions sible identity theft. In addition, the final in section 3(a)(4)(B) of the Exchange rules require (1) debit and credit card Act until the first day of their first fiscal issuers to assess the validity of changeyear that begins after September 30, of-address notifications under certain 2008. circumstances and (2) users of consumer reports to establish and maintain reason- Votes for this action: Chairman Bernanke, able policies and procedures regarding Vice Chairman Kohn, and Governors Warsh, Kroszner, and Mishkin. notifications of address discrepancies they receive from consumer reporting agencies. The final rules and guidelines, Regulation V which implement provisions of the Fair Fair Credit Reporting and Accurate Credit Transactions Act of 2003, are effective January 1, 2008, and [Docket No. R-1203] compliance is mandatory by November 1, 2008. On October 17, 2007, the Board, acting with the other federal financial institu- Votes for this action: Chairman Bernanke, tions regulatory agencies, approved fi- Vice Chairman Kohn, and Governors nal rules requiring that a financial insti- Warsh, Kroszner, and Mishkin. tution provide notice and a reasonable opportunity to opt out before using in- Policy Statements formation from an affiliate to market its and Other Actions own products and services to a consumer. The final rules, which implement Policy on Payments System Risk the affiliate-marketing provisions of the Fair and Accurate Credit Transactions [Docket No. OP-1259] Act of 2003, are effective January 1, 2008, and compliance is mandatory by On January 11, 2007, the Board ap- October 1, 2008. proved revisions to part 1 of its Policy on Payments System Risk to address Votes for this action: Chairman Bernanke, risk management in payments and settle- Vice Chairman Kohn, and Governors ment systems. The revisions establish an Warsh, Kroszner, and Mishkin. expectation that payments and settlement systems under the Board's author- [Docket No. R-1255] ity that are systemically important will On October 23, 2007, the Board, acting publicly disclose self-assessments of with the other federal financial institu- their compliance with the relevant printions regulatory agencies and the Fed- ciples or minimum standards set forth in eral Trade Commission, approved final the policy. Self-assessments should be rules requiring financial institutions and updated after any material change and creditors that open or hold certain ac- should be reviewed at least every two counts to develop and implement a writ- years. In addition, the revisions incorpo- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 179 rate the Recommendations for Central tions regulatory agencies, approved in- Counterparties, which were developed teragency guidance intended to clarify jointly by international committees of how financial institutions may offer cercentral banks and securities commis- tain adjustable-rate mortgages in a mansions, as the Board's minimum stan- ner that is safe and sound and also aldards for central counterparties. The re- lows for clear disclosure of the risks visions also clarify the purpose of and assumed by the borrower. The guidance revise the scope of part 1 relating to is effective July 10, 2007. central counterparties. The revisions are Votes for this action: Chairman Bernanke, effective January 19, 2007, and the ini- Vice Chairman Kohn, and Governors tial self-assessments are expected to be Warsh, Kroszner, and Mishkin. completed and published by December 31,2007. Statement on Loss Mitigation Strategies for Servicers of Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors Residential Mortgages Bies, Warsh, Kroszner, and Mishkin. On August 29, 2007, the Board, acting with the other federal financial institu- Illustrations of tions regulatory agencies and the Con- Consumer Information for ference of State Bank Supervisors, ap- Nontraditional Mortgage Products proved guidance to encourage federally regulated and state-regulated financial [Docket No. OP-1267] institutions and state-supervised servic- On May 25, 2007, the Board, acting with ers of residential mortgages to pursue the other federal financial institutions strategies to mitigate losses while preregulatory agencies, approved final il- serving home ownership to the extent lustrations of consumer information for possible and appropriate. nontraditional mortgage products to as- Votes for this action: Chairman Bernanke sist financial institutions in implementand Governors Warsh, Kroszner, and ing the consumer protection provisions Mishkin. Absent and not voting: Vice of the Interagency Guidance on Nontra- Chairman Kohn. ditional Mortgage Product Risks issued in October 2006. Financial institutions Permissible Complementary may use the illustrations as provided, Activities for change their format, or tailor the infor- Financial Holding Companies mation to specific transactions or prod- On September 6, 2007, the Board deteructs. The illustrations are effective mined under the Gramm-Leach-Bliley June 8, 2007. Act of 1999 that, subject to certain Votes for this action: Chairman Bernanke, limitations, disease management and Vice Chairman Kohn, and Governors mail-order pharmacy services are com- Warsh, Kroszner, and Mishkin. plementary activities permissible for financial holding companies. To qualify, Statement on an activity must complement a financial Subprime Mortgage Lending activity and not pose a substantial risk to the safety or soundness of depository [Docket No. OP-1278] institutions or the financial system gen- On June 27, 2007, the Board, acting erally. The Board concluded that disease with the other federal financial institu- management and mail-order pharmacy Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

180 94th Annual Report, 2007 services complement the financial activ- count window loans to depository instiity of underwriting and selling health tutions at least every fourteen days, insurance and do not pose a substantial subject to review and determination by risk. The determination is effective Sep- the Board of Governors. tember 7, 2007. Primary Credit Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors Primary credit, the Federal Reserve's Warsh, Kroszner, and Mishkin. main lending program, is extended at a On December 3, 2007, the Board simi- rate above the federal funds rate target larly determined that, subject to certain set by the Federal Open Market Comlimitations, energy management activi- mittee (FOMC). It is typically made ties are permissible activities for finan- available with minimal administration cial holding companies because they for very short terms as a backup source complement the financial activities of of liquidity to depository institutions engaging as principal in commodity de- that, in the judgment of the lending Fedrivatives activities and providing advi- eral Reserve Bank, are in generally sory services for derivatives transactions sound financial condition. and do not pose a substantial risk. The During 2007, acting on recommendadetermination is effective December 4, tions of the Reserve Bank boards of di- 2007. rectors, the Board approved four reductions in the primary credit rate, bringing Votes for this action: Chairman Bernanke, the rate from 6!/4 percent to 43A percent. Vice Chairman Kohn, and Governors Warsh, Kroszner, and Mishkin. The first of these reductions came on August 17 in response to the emergence Permissible Financial Activities for of severe financial market strains in pre- Financial Holding Companies vious weeks. The Board approved a temporary narrowing of the spread of On October 10, 2007, the Board deterthe primary credit rate over the FOMC's mined under the Gramm-Leach-Bliley target rate to 50 basis points, from 100 ba- Act of 1999 and after consultation with sis points, and announced a temporary the Secretary of the Treasury that, subchange to the Reserve Banks' discount ject to certain limitations, the acquisiwindow lending practices to allow the tion, management, and operation in the provision of term financing for as long United Kingdom of certain third-party as thirty days, renewable by the bordefined benefit pension plans are finanrower. These changes remained in effect cial activities permissible for financial at the end of 2007. In the remaining holding companies. The determination three instances, the Board reached its is effective October 12, 2007. determinations on the primary credit rate Votes for this action: Chairman Bernanke, in conjunction with the FOMC's deci- Vice Chairman Kohn, and Governors sions to lower the target federal funds Warsh, Kroszner, and Mishkin. rate by a cumulative 1 percentage point, from 5V4 percent to 4J/4 percent. Monetary policy developments are reviewed Discount Rates in 2007 more fully in other parts of this report Under the Federal Reserve Act, the (see the section "Monetary Policy and boards of directors of the Federal Re- Economic Developments" and the minserve Banks must establish rates on dis- utes of FOMC meetings held in 2007). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Record of Policy Actions of the Board of Governors 181 Secondary and Seasonal Credit sonal credit rates. In December, the Board approved proposals by the twelve Secondary credit is available in appro- Reserve Banks to establish the auction priate circumstances to depository instimethod by which the TAF credit rate is tutions that do not qualify for primary set. Details on the four actions by the credit. The secondary credit rate is set at Board to approve changes in the pria spread above the primary credit rate. mary credit rate are provided below. Throughout 2007, the spread was set at 50 basis points. August 16, 2007. The Board approved Seasonal credit is available to smaller actions taken by the directors of the Feddepository institutions to meet liquidity eral Reserve Banks of New York and needs that arise from regular swings in San Francisco to lower the rate on distheir loans and deposits. The rate on sea- counts and advances under the primary sonal credit is calculated every two credit program by Vi percentage point, weeks as an average of selected money- to 53/4 percent, effective August 17, market yields, typically resulting in a 2007. The Board also approved an idenrate close to the federal funds rate target. tical action subsequently taken by the At year-end, the secondary and sea- directors of the Federal Reserve Banks sonal credit rates were 5V4 percent and of Boston, Philadelphia, Cleveland, 4.70 percent, respectively. Richmond, Atlanta, Chicago, Minneapolis, Kansas City, and Dallas, effective August 17, 2007, and the Federal Re- Term Auction Facility Credit serve Bank of St. Louis, effective Au- In December, the Federal Reserve estab- gust 20, 2007. lished a temporary Term Auction Facil- Votes for this action: Chairman Bernanke, ity (TAF). Under the TAF, the Federal Vice Chairman Kohn, and Governors Reserve auctions term funds to deposi- Warsh, Kroszner, and Mishkin. Votes tory institutions that are in generally against this action: None. sound financial condition and are eli- September 18, 2007. Effective this date, gible to borrow under the primary credit the Board approved actions taken by the program. The amount of each auction is directors of the Federal Reserve Banks determined in advance by the Federal of Boston, New York, Cleveland, Min- Reserve, and the interest rate on TAF neapolis, Kansas City, and San Francredit is determined by the bidding procisco to lower the rate on discounts and cess as the rate at which all bids can be advances under the primary credit profulfilled, up to the maximum auction gram by Vi percentage point, to 5]A peramount and subject to a minimum bid cent. The same change was approved for rate. The Federal Reserve conducted the Federal Reserve Bank of St. Louis, two TAF auctions in 2007—on Decemeffective September 19, 2007. The ber 17 and December 20; the resulting Board also approved an identical action rates were 4.65 percent and 4.67 persubsequently taken by the directors of cent, respectively. the Federal Reserve Banks of Richmond, Atlanta, and Dallas, effective Votes on Discount Rate Changes September 19, 2007, and the Federal Re- About every two weeks during 2007, the serve Banks of Philadelphia and Chi- Board approved proposals by the twelve cago, effective September 20, 2007. Reserve Banks to maintain the formulas Votes for this action: Chairman Bernanke, for computing the secondary and sea- Vice Chairman Kohn, and Governors Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

182 94th Annual Report, 2007 Warsh, Kroszner, and Mishkin. Votes December 11, 2007. Effective this date, against this action: None. the Board approved actions taken by the directors of the Federal Reserve Banks October 31, 2007. Effective this date, of New York, Philadelphia, Cleveland, the Board approved actions taken by the Richmond, Atlanta, and Chicago to directors of the Federal Reserve Banks lower the rate on discounts and advances of New York, Richmond, Atlanta, Chiunder the primary credit program by cago, and San Francisco to lower the lA percentage point, to 43A percent. The rate on discounts and advances under same change was approved for the Fedthe primary credit program by V* pereral Reserve Bank of St. Louis, effective centage point, to 5 percent. The same December 12, 2007. The Board also apchange was approved for the Federal proved identical actions subsequently Reserve Bank of St. Louis, effective Notaken by the directors of the Federal Revember 1, 2007. The Board also apserve Banks of San Francisco, effective proved an identical action subsequently December 11, 2007; Boston, Minneapotaken by the directors of the Federal Relis, and Dallas, effective December 12, serve Banks of Boston, Philadelphia, Cleveland, Minneapolis, Kansas City, 2007; and Kansas City, effective Deand Dallas effective November 1, 2007. cember 13, 2007. Votes for this action: Chairman Bernanke, Votes for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors Vice Chairman Kohn, and Governors Warsh, Kroszner, and Mishkin. Votes Warsh, Kroszner, and Mishkin. Votes against this action: None. against this action: None. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

183 Minutes of Federal Open Market Committee Meetings The policy actions of the Federal Open are identified in the minutes and a sum- Market Committee, contained in the mary of the reasons for their dissent is minutes of its meetings, are presented in provided. the Annual Report of the Board of Gov- Policy directives of the Federal Open ernors pursuant to the requirements of Market Committee are issued to the section 10 of the Federal Reserve Act. Federal Reserve Bank of New York as That section provides that the Board the Bank selected by the Committee to shall keep a complete record of the ac- execute transactions for the System tions taken by the Board and by the Fed- Open Market Account. In the area of eral Open Market Committee on all domestic open market operations, the questions of policy relating to open mar- Federal Reserve Bank of New York ket operations, that it shall record operates under instructions from the therein the votes taken in connection Federal Open Market Committee that with the determination of open market take the form of an Authorization for policies and the reasons underlying each Domestic Open Market Operations and policy action, and that it shall include a Domestic Policy Directive. (A new in its annual report to Congress a full Domestic Policy Directive is adopted at account of such actions. each regularly scheduled meeting.) In The minutes of the meetings contain the foreign currency area, the Federal the votes on the policy decisions made Reserve Bank of New York operates at those meetings as well as a summary under an Authorization for Foreign Curof the information and discussions that rency Operations, a Foreign Currency led to the decisions. In addition, four Directive, and Procedural Instructions times a year, starting with the October with Respect to Foreign Currency Op- 2007 Committee meeting, a Summary erations.1 Changes in the instruments of Economic Projections is published as during the year are reported in the minan addendum to the minutes. The de- utes for the individual meetings. scriptions of economic and financial conditions in the minutes and the Summary of Economic Projections are based solely on the information that was avail- 1. As of January 1, 2007, the Federal Reserve able to the Committee at the time of the Bank of New York was operating under the Domestic Policy Directive approved at the Decemmeetings. ber 12, 2006, Committee meeting. The other Members of the Committee voting for policy instruments (the Authorization for Domesa particular action may differ among tic Open Market Operations, the Authorization for themselves as to the reasons for their Foreign Currency Operations, the Foreign Currency Directive, and Procedural Instructions with votes; in such cases, the range of their Respect to Foreign Currency Operations) in effect views is noted in the minutes. When as of January 1, 2007, were approved at the Janumembers dissent from a decision, they ary 31, 2006, meeting. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

184 94th Annual Report, 2007 Meeting Held on Ms. Liang and Mr. Struckmeyer, Asso- January 30-31, 2007 ciate Directors, Division of Research and Statistics, Board of Governors A meeting of the Federal Open Market Committee was held in the offices of the Messrs. Gagnon, Reifschneider, and Board of Governors of the Federal Re- Wascher, Deputy Associate Directors, Divisions of International Fiserve System in Washington, D.C., on nance, Research and Statistics, and Tuesday, January 30, 2007 at 2:00 p.m., Research and Statistics, respecand continued on Wednesday, January tively, Board of Governors 31, 2007 at 9:00 a.m. Messrs. Dale and Orphanides, Senior Present: Advisers, Division of Monetary Mr. Bernanke, Chairman Affairs, Board of Governors Mr. Geithner, Vice Chairman Mr. Small, Project Manager, Division Ms. Bies of Monetary Affairs, Board of Mr. Hoenig Governors Mr. Kohn Mr. Kroszner Ms. Kole2 and Mr. Lebow,2 Section Ms. Minehan Chiefs, Divisions of International Mr. Mishkin Finance, and Research and Statis- Mr. Moskow tics, respectively, Board of Gover- Mr. Poole nors Mr. Warsh Messrs. Doyle,2 Schindler,3 and Wood,2 Mr. Fisher, Ms. Pianalto, and Messrs. Senior Economists, Division of International Finance, Board of Gov- Plosser and Stern, Alternate Memernors bers of the Federal Open Market Committee Messrs. Engen3 and Tetlow,2 Senior Economists, Division of Research Mr. Lacker and Ms. Yellen, Presidents and Statistics, Board of Governors of the Federal Reserve Banks of Richmond and San Francisco, re- Ms. Weinbach, Senior Economist, Divispectively sion of Monetary Affairs, Board of Governors Mr. Barron, First Vice President, Federal Reserve Bank of Atlanta Ms. Roush,3 Economist, Division of Monetary Affairs, Board of Gover- Mr. Reinhart, Secretary and Economist nors Ms. Danker, Deputy Secretary Ms. Smith, Assistant Secretary Mr. Hambley,2 Assistant to the Board, Mr. Skidmore, Assistant Secretary Office of Board Members, Board Mr. Alvarez, General Counsel of Governors Mr. Baxter, Deputy General Counsel Mr. Gross, Special Assistant to the Ms. Johnson, Economist Board, Office of Board Members, Mr. Stockton, Economist Board of Governors Messrs. Connors, Evans, Fuhrer, Kamin, Madigan, Rasche, Sellon, Slifman, Tracy, and Wilcox, Associate Economists Mr. Dudley, Manager, System Open 2. Attended portion of the meeting relating to Market Account the role of economic forecasts in policy communications. Messrs. Clouse and English, Associate 3. Attended portion of the meeting relating to Directors, Division of Monetary the economic outlook and monetary policy discus- Affairs, Board of Governors sion. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 185 Mr. Luecke, Senior Financial Analyst, W. Fisher, President of the Federal Re- Division of Monetary Affairs, serve Bank of Dallas, as alternate. Board of Governors Thomas M. Hoenig, President of the Federal Ms. Low, Open Market Secretariat Spe- Reserve Bank of Kansas City, with cialist, Division of Monetary Af- Gary H. Stern, President of the Federal fairs, Board of Governors Reserve Bank of Minneapolis, as alternate. Messrs. Judd and Rosenblum, Executive Vice Presidents, Federal Re- By unanimous vote, the following ofserve Banks of San Francisco and ficers of the Federal Open Market Com- Dallas mittee were selected to serve until the Mses. Mester and Mosser and Messrs. selection of their successors at the first Sniderman and Weinberg, Senior regularly scheduled meeting of the Vice Presidents, Federal Reserve Committee in 2008, with the under- Banks of Philadelphia, New York, standing that in the event of the discon- Cleveland, and Richmond, respectinuance of their official connection with tively the Board of Governors or with a Fed- Mr. Cunningham, Vice President, Federal Reserve Bank, they would cease to eral Reserve Bank of Atlanta have any official connection with the Mr. Weber, Senior Research Officer, Federal Open Market Committee: Federal Reserve Bank of Minneapolis Ben S. Bernanke Chairman Timothy F. Geithner Vice Chairman In the agenda for this meeting, it was Vincent R. Reinhart Secretary and reported that advices of the election of Economist Deborah J. Danker Deputy Secretary the following members and alternate Michelle A. Smith Assistant Secretary members of the Federal Open Market David W. Skidmore Assistant Secretary Committee for a term beginning January Scott G. Alvarez General Counsel 30, 2007 had been received and that Thomas C. Baxter, Jr. Deputy General these individuals had executed their Counsel oaths of office. Karen H. Johnson Economist David J. Stockton Economist The elected members and alternate members were as follows: Thomas A. Connors, Charles L. Evans, Jeffrey C. Fuhrer, Steven B. Kamin, Brian Timothy F. Geithner, President of the Fed- F. Madigan, Robert H. Rasche, Gordon eral Reserve Bank of New York, with H. Sellon, Lawrence Slifman, Joseph S. Christine M. Cumming, First Vice Tracy, and David W. Wilcox, Associate President of the Federal Reserve Bank Economists of New York, as alternate. By unanimous vote, the Committee Cathy E. Minehan, President of the Federal amended its Rules of Organization by Reserve Bank of Boston, with Charles making a provision for a backup to the I. Plosser, President of the Federal Reserve Bank of Philadelphia, as alter- Manager of the System Open Market nate. Account should he/she be unable to serve, and it made several technical Michael H. Moskow, President of the Federal Reserve Bank of Chicago, with changes to its Program for Security of Sandra Pianalto, President of the Fed- FOMC Information. eral Reserve Bank of Cleveland, as al- By unanimous vote, the Federal Reternate. serve Bank of New York was selected to William Poole, President of the Federal Re- execute transactions for the System serve Bank of St. Louis, with Richard Open Market Account. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

186 94th Annual Report, 2007 By unanimous vote, William C. Dud- (b) To buy U.S. Government securities, ley was selected to serve at the pleasure obligations that are direct obligations of, or fully guaranteed as to principal and interest of the Committee as Manager, System by, any agency of the United States, from Open Market Account, on the underdealers for the account of the System Open standing that his selection was subject to Market Account under agreements for repurbeing satisfactory to the Federal Reserve chase of such securities or obligations in 65 Bank of New York.4 business days or less, at rates that, unless By unanimous vote, the Committee otherwise expressly authorized by the Comapproved the Authorization for domes- mittee, shall be determined by competitive bidding, after applying reasonable limitatic Open Market Operations with an tions on the volume of agreements with indiamendment to paragraph l(b) that brings vidual dealers. the language for repurchase agreements (c) To sell U.S. Government securities into conformity with the authorization's and obligations that are direct obligations of, existing language for outright purchases or fully guaranteed as to principal and interand reverse repurchase agreements. Ac- est by, any agency of the United States to dealers for System Open Market Account cordingly, the Authorization for Domesunder agreements for the resale by dealers of tic Open Market Operations was such securities or obligations in 65 business adopted, effective January 30, 2007, as days or less, at rates that, unless otherwise shown below. expressly authorized by the Committee, shall be determined by competitive bidding, after applying reasonable limitations on the Authorization for Domestic Open volume of agreements with individual Market Operations dealers. (Amended January 30, 2007) 2. In order to ensure the effective conduct 1. The Federal Open Market Committee of open market operations, the Federal Open authorizes and directs the Federal Reserve Market Committee authorizes the Federal Bank of New York, to the extent necessary Reserve Bank of New York to lend on an to carry out the most recent domestic policy overnight basis U.S. Government securities directive adopted at a meeting of the Com- held in the System Open Market Account i:> mittee: dealers at rates that shall be determined by (a) To buy or sell U.S. Government competitive bidding. The Federal R^erve securities, including securities of the Federal Bank of New York shall set a minimum Financing Bank, and securities that are lending fee consistent with the objectives of the program and apply reasonable limitadirect obligations of, or fully guaranteed as tions on the total amount of a specific issue to principal and interest by, any agency of that may be auctioned and on the amount of the United States in the open market, from securities that each dealer may borrow. The or to securities dealers and foreign and inter- Federal Reserve Bank of New York may national accounts maintained at the Federal reject bids which could facilitate a dealer's Reserve Bank of New York, on a cash, reguability to control a single issue as deterlar, or deferred delivery basis, for the Sysmined solely by the Federal Reserve Bank tem Open Market Account at market prices, of New York. and, for such Account, to exchange maturing U.S. Government and Federal agency securi- 3. In order to ensure the effective conduct ties with the Treasury or the individual of open market operations, while assisting in agencies or to allow them to mature without the provision of short-term investments for replacement; foreign and international accounts maintained at the Federal Reserve Bank of New York and accounts maintained at the Federal 4. Secretary's note: Advice subsequently was Reserve Bank of New York as fiscal agent of received that the selection of Mr. Dudley as Man- the United States pursuant to Section 15 of ager was satisfactory to the board of directors of the Federal Reserve Act, the Federal Open the Federal Reserve Bank of New York. Market Committee authorizes and directs Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 187 the Federal Reserve Bank of New York (a) the Committee's foreign currency directive for System Open Market Account, to sell and express authorizations by the Commit- U.S. Government securities to such accounts tee pursuant thereto, and in conformity with on the bases set forth in paragraph l(a) under such procedural instructions as the Commitagreements providing for the resale by such tee may issue from time to time: accounts of those securities in 65 business A. To purchase and sell the following days or less on terms comparable to those foreign currencies in the form of cable transavailable on such transactions in the market; fers through spot or forward transactions on and (b) for New York Bank account, when the open market at home and abroad, includappropriate, to undertake with dealers, sub- ing transactions with the U.S. Treasury, with ject to the conditions imposed on purchases the U.S. Exchange Stabilization Fund estaband sales of securities in paragraph l(b), lished by Section 10 of the Gold Reserve repurchase agreements in U.S. Government Act of 1934, with foreign monetary authoriand agency securities, and to arrange corre- ties, with the Bank for International Settlesponding sale and repurchase agreements ments, and with other international financial between its own account and such foreign, institutions: international, and fiscal agency accounts Canadian dollars Mexican pesos maintained at the Bank. Transactions under- Danish kroner Norwegian kroner taken with such accounts under the provi- Euro Swedish kronor sions of this paragraph may provide for a Pounds sterling Swiss francs service fee when appropriate. Japanese yen B. To hold balances of, and to have 4. In the execution of the Committee's outstanding forward contracts to receive or decision regarding policy during any interto deliver, the foreign currencies listed in meeting period, the Committee authorizes paragraph A above. and directs the Federal Reserve Bank of New York, upon the instruction of the Chair- C. To draw foreign currencies and to man of the Committee, to adjust somewhat permit foreign banks to draw dollars under in exceptional circumstances the degree of the reciprocal currency arrangements listed pressure on reserve positions and hence the in paragraph 2 below, provided that drawintended federal funds rate. Any such adjust- ings by either party to any such arrangement ment shall be made in the context of the shall be fully liquidated within 12 months Committee's discussion and decision at its after any amount outstanding at that time most recent meeting and the Committee's was first drawn, unless the Committee, long-run objectives for price stability and because of exceptional circumstances, spesustainable economic growth, and shall be cifically authorizes a delay. based on economic, financial, and monetary D. To maintain an overall open position developments during the intermeeting in all foreign currencies not exceeding period. Consistent with Committee practice, $25.0 billion. For this purpose, the overall the Chairman, if feasible, will consult with open position in all foreign currencies is the Committee before making any adjust- defined as the sum (disregarding signs) of ment. net positions in individual currencies. The net position in a single foreign currency is By unanimous vote, the Authoriza- defined as holdings of balances in that curtion for Foreign Currency Operations rency, plus outstanding contracts for future receipt, minus outstanding contracts for was reaffirmed in the form shown future delivery of that currency, i.e., as the below. sum of these elements with due regard to sign. Authorization for Foreign Currency 2. The Federal Open Market Committee Operations directs the Federal Reserve Bank of New (Reaffirmed January 30, 2007) York to maintain reciprocal currency arrangements ("swap" arrangements) for the 1. The Federal Open Market Committee System Open Market Account for periods up authorizes and directs the Federal Reserve to a maximum of 12 months with the follow- Bank of New York, for System Open Market ing foreign banks, which are among those Account, to the extent necessary to carry out designated by the Board of Governors of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

188 94th Annual Report, 2007 Federal Reserve System under Section 214.5 foreign government or agency thereof; buyof Regulation N, Relations with Foreign ing such securities under agreements for Banks and Bankers, and with the approval of repurchase of such securities; selling such the Committee to renew such arrangements securities under agreements for the resale of on maturity: such securities; and holding various time and other deposit accounts at foreign institu- Amount of tions. In addition, when appropriate in conarrangement Foreign bank nection with arrangements to provide invest- (millions of dollars equivalent) ment facilities for foreign currency holdings, U.S. Government securities may be pur- Bank of Canada 2,000 chased from foreign central banks under Bank of Mexico 3,000 agreements for repurchase of such securities within 30 calendar days. Any changes in the terms of existing swap arrangements, and the proposed terms of any 6. All operations undertaken pursuant to new arrangements that may be authorized, the preceding paragraphs shall be reported shall be referred for review and approval to promptly to the Foreign Currency Subcomthe Committee. mittee and the Committee. The Foreign Currency Subcommittee consists of the Chair- 3. All transactions in foreign currencies man and Vice Chairman of the Committee, undertaken under paragraph l.A. above the Vice Chairman of the Board of Govershall, unless otherwise expressly authorized nors, and such other member of the Board as by the Committee, be at prevailing market the Chairman may designate (or in the rates. For the purpose of providing an absence of members of the Board serving on investment return on System holdings of the Subcommittee, other Board members foreign currencies or for the purpose of designated by the Chairman as alternates, adjusting interest rates paid or received in and in the absence of the Vice Chairman of connection with swap drawings, transactions the Committee, his alternate). Meetings of with foreign central banks may be underthe Subcommittee shall be called at the taken at non-market exchange rates. request of any member, or at the request of the Manager, System Open Market Account 4. It shall be the normal practice to arrange with foreign central banks for the ("Manager"), for the purposes of reviewing coordination of foreign currency transac- recent or contemplated operations and of tions. In making operating arrangements consulting with the Manager on other matwith foreign central banks on System hold- ters relating to his responsibilities. At the ings of foreign currencies, the Federal request of any member of the Subcommit- Reserve Bank of New York shall not commit tee, questions arising from such reviews and itself to maintain any specific balance, consultations shall be referred for determiunless authorized by the Federal Open Mar- nation to the Federal Open Market Comket Committee. Any agreements or under- mittee. standings concerning the administration of the accounts maintained by the Federal 7. The Chairman is authorized: Reserve Bank of New York with the foreign A. With the approval of the Committee, banks designated by the Board of Governors to enter into any needed agreement or underunder Section 214.5 of Regulation N shall standing with the Secretary of the Treasury be referred for review and approval to the about the division of responsibility for for- Committee. eign currency operations between the System and the Treasury; 5. Foreign currency holdings shall be B. To keep the Secretary of the Treainvested to ensure that adequate liquidity is sury fully advised concerning System formaintained to meet anticipated needs and so eign currency operations, and to consult that each currency portfolio shall generally with the Secretary on policy matters relating have an average duration of no more than to foreign currency operations; 18 months (calculated as Macaulay dura- C. From time to time, to transmit tion). Such investments may include buying appropriate reports and information to the or selling outright obligations of, or fully National Advisory Council on International guaranteed as to principal and interest by, a Monetary and Financial Policies. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 189 8. Staff officers of the Committee are tional Monetary Fund regarding exchange authorized to transmit pertinent information arrangements under IMF Article IV. on System foreign currency operations to appropriate officials of the Treasury Depart- By unanimous vote, the Procedural ment. Instructions with Respect to Foreign Currency Operations were reaffirmed in 9. All Federal Reserve Banks shall parthe form shown below. ticipate in the foreign currency operations for System Account in accordance with paragraph 3G(1) of the Board of Governors' Procedural Instructions Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks with Respect to dated January 1, 1944. Foreign Currency Operations (Reaffirmed January 30, 2007) By unanimous vote, the Foreign Currency Directive was reaffirmed in the In conducting operations pursuant to the form shown below. authorization and direction of the Federal Open Market Committee as set forth in the Authorization for Foreign Currency Opera- Foreign Currency Directive tions and the Foreign Currency Directive, (Reaffirmed January 30, 2007) the Federal Reserve Bank of New York, through the Manager, System Open Market 1. System operations in foreign currencies Account ("Manager"), shall be guided by shall generally be directed at countering dis- the following procedural understandings orderly market conditions, provided that with respect to consultations and clearances market exchange rates for the U.S. dollar with the Committee, the Foreign Currency reflect actions and behavior consistent with Subcommittee, and the Chairman of the IMF Article IV, Section 1. Committee. All operations undertaken pursuant to such clearances shall be reported 2. To achieve this end the System shall: promptly to the Committee. A. Undertake spot and forward purchases and sales of foreign exchange. 1. The Manager shall clear with the Sub- B. Maintain reciprocal currency committee (or with the Chairman, if the ("swap") arrangements with selected foreign Chairman believes that consultation with the central banks. Subcommittee is not feasible in the time C. Cooperate in other respects with available): central banks of other countries and with A. Any operation that would result in a international monetary institutions. change in the System's overall open position in foreign currencies exceeding $300 million 3. Transactions may also be undertaken: on any day or $600 million since the most A. To adjust System balances in light of recent regular meeting of the Committee. probable future needs for currencies. B. Any operation that would result in a B. To provide means for meeting Syschange on any day in the System's net positem and Treasury commitments in particular tion in a single foreign currency exceeding currencies, and to facilitate operations of the $150 million, or $300 million when the Exchange Stabilization Fund. operation is associated with repayment of C. For such other purposes as may be swap drawings. expressly authorized by the Committee. C. Any operation that might generate a 4. System foreign currency operations substantial volume of trading in a particular shall be conducted: currency by the System, even though the A. In close and continuous consultation change in the System's net position in that and cooperation with the United States Trea- currency might be less than the limits specisury; fied in I.B. " B. In cooperation, as appropriate, with D. Any swap drawing proposed by a foreign monetary authorities; and foreign bank not exceeding the larger of (i) C. In a manner consistent with the obli- $200 million or (ii) 15 percent of the size of gations of the United States in the Interna- the swap arrangement. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

190 94th Annual Report, 2007 2. The Manager shall clear with the Com- were expected to prove largely transimittee (or with the Subcommittee, if the tory. The decline in residential construc- Subcommittee believes that consultation tion continued to weigh on overall activwith the full Committee is not feasible in the ity, but some indications of stabilization time available, or with the Chairman, if the Chairman believes that consultation with the in the demand for homes had emerged. Subcommittee is not feasible in the time Outlays for business fixed investment available): softened in the fourth quarter. Although A. Any operation that would result in a a spike in energy prices lifted total conchange in the System's overall open position sumer price inflation in December, readin foreign currencies exceeding $1.5 billion ings on core inflation had edged lower since the most recent regular meeting of the Committee. in recent months. B. Any swap drawing proposed by a The labor market exhibited continued foreign bank exceeding the larger of (i) $200 strength through year-end. Nonfarm million or (ii) 15 percent of the size of the payrolls rose robustly again in Decemswap arrangement. ber, driven by further gains in the 3. The Manager shall also consult with the service-producing sectors. Employment Subcommittee or the Chairman about pro- in the manufacturing and construction posed swap drawings by the System and industries declined further, but by less about any operations that are not of a routine than in the previous several months. Agcharacter. gregate hours of private production or The Manager of the System Open nonsupervisory workers edged up fur- Market Account reported on recent de- ther. The unemployment rate held steady velopments in foreign exchange mar- at 4.5 percent. kets. There were no open market opera- Industrial production firmed in Detions in foreign currencies for the cember after having softened in the pre- System's account in the period since the ceding three months. Output of manuprevious meeting. The Manager also re- facturing industries rose noticeably in ported on developments in domestic fi- December after being flat in November; nancial markets and on System open the increase was associated with sizable market transactions in government secu- gains in the production of semiconducrities and federal agency obligations tors, computers, and commercial airduring the period since the previous craft. Motor vehicle output turned up in meeting. By unanimous vote, the Com- November and December, but remained mittee ratified these transactions. low compared with earlier in the year as The information reviewed at the Janu- vehicle makers continued their efforts to ary meeting, which included the ad- pare inventories. After contracting in vance data on the national income and November, output in the mining sector product accounts for the fourth quarter, increased in December, boosted by a rise showed that economic expansion had in the production of crude oil. In conpicked up in the fourth quarter of 2006, trast, unseasonably warm weather but was uneven across sectors. Consid- caused a sharp cutback in the output of erable vigor in consumer spending late utilities in December. last year boosted economic growth in Real consumer spending rose briskly the fourth quarter, supported by further in November and December, buoyed by increases in employment and income. A sizable increases in outlays for non-auto surge in net exports and a pickup in consumer goods. Spending on services, defense spending also raised output in contrast, appeared to be expanding growth last quarter, but these factors only moderately toward year-end, as Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 191 warmer-than-usual temperatures led to a ment, a volatile spending category, drop in real outlays for energy services dropped considerably. Sales of light vein November and probably damped ex- hicles to business customers declined to penditures in that category again in De- their lowest level in two years, which cember. Real disposable income posted more than offset a surge in sales of mesolid gains in October and November dium and heavy trucks ahead of stricter and likely rose further in December, re- regulations on truck engine emissions flecting increases in wages and salaries that went into effect this year. Spending and further declines in energy prices. on high-tech capital goods moderated. Although house-price appreciation ap- Outside of the transportation and highpeared to have slowed further since the tech sectors, real spending declined last end of the third quarter, robust gains in quarter. That weakness appeared to be equity prices likely resulted in a small concentrated in equipment related to rise in the ratio of household wealth to construction and motor vehicle manudisposable income last quarter. Read- facturing. Nonresidential construction ings on consumer sentiment moved up activity decelerated late last quarter; at the end of last year and held steady in however, indicators of future expendiearly 2007. tures in this sector remained firm, with Residential construction activity re- office and industrial vacancy rates somemained quite weak late last year, but what below their historical averages. home sales showed some tentative signs Overall, prospects for business spending of stabilization. Single-family housing continued to be supported by robust starts declined modestly in December, corporate cash flow and a low cost of reversing about half of November's capital. gain. However, new permit issuance Business inventories remained eledged up in December after having evated in the fourth quarter. In Novemmoved down steadily for nearly a year. ber, the book-value ratio of inventories Construction in the multifamily sector, to sales for the manufacturing and trade which accounts for a much smaller share sectors (excluding motor vehicles) stood of new home construction, rose sharply near its highest level since early 2005. in December to the upper end of the Although relatively high ratios of invenrange that has prevailed over the past tories to sales appeared to be associated decade. Sales of existing single-family in part with developments in the homehomes held steady in November and building and motor vehicle sectors, rose in December, while sales of new some indications of inventory imbalhomes inched up in both months. Inven- ances in other sectors had recently betories of unsold homes remained consid- come evident. erable although they ticked down in De- The U.S. international trade deficit cember for the second straight month. narrowed again in October, primarily re- The most timely indicators of home flecting declines in both the price and prices, which are not adjusted for volume of imported oil. In addition, imchanges in quality or the mix of homes ports of non-oil industrial supplies, capisold, pointed to small declines. tal goods, and automotive products fell, After having risen at a solid average offsetting small increases in imports of pace in the first three quarters of last consumer goods, food, and services. In year, real investment in equipment and November, the trade deficit edged down software fell in the fourth quarter. Busi- further—to its smallest level since midness outlays on transportation equip- 2005—as export growth outpaced a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

192 94th Annual Report, 2007 modest increase in non-oil imports, and ahead of those a year earlier. However, oil imports remained flat. hourly compensation of private industry Economic activity in the advanced workers, as measured by the employforeign economies appeared to have ac- ment cost index, rose at a moderate rate celerated in the fourth quarter, supported in the three months ending in December, by a broad-based firming of domestic a touch below the pace registered in the demand and strong employment gains. previous quarter. Survey measures of In the euro area, consumer sentiment households' year-ahead inflation expecwas lifted by lower unemployment, and tations held steady through January at economic growth continued at a solid levels that were below those reported in pace. After contracting in the third quar- the second and third quarters of last ter, consumption spending in Japan ap- year, and respondents' longer-term inflaparently rebounded last quarter, provid- tion expectations had been unchanged ing significant support to economic since ticking down in the middle of activity. The expansion in the United 2006. Kingdom's economy strengthened, At its December meeting, the Federal likely reflecting a pickup in consump- Open Market Committee (FOMC) detion growth. Output growth in Canada cided to maintain its target for the fedseemed to have firmed but likely re- eral funds rate at 5lA percent. The Commained below trend. Recent economic mittee's accompanying statement noted data for the emerging-market economies that economic growth had slowed over pointed to some moderation in the pace the course of the year, partly reflecting a of growth in the fourth quarter. In China, substantial cooling of the housing marthe most recent evidence suggested that ket. Although recent indicators had been growth had remained strong. mixed, the economy seemed likely to While large fluctuations in energy expand at a moderate pace on balance prices continued to cause swings in over coming quarters. Readings on core overall consumer price inflation in re- inflation had been elevated, and the high cent months, readings on core inflation level of resource utilization had the poimproved. Overall consumer prices were tential to sustain inflation pressures. flat in November, but turned up in De- However, inflation pressures seemed cember because of a surge in retail en- likely to moderate over time, reflecting ergy prices that month. Still, the rise in reduced impetus from energy prices, the price index for personal consump- contained inflation expectations, and the tion expenditures over the twelve cumulative effects of monetary policy months ending in December was esti- actions and other factors restraining agmated to have been noticeably less than gregate demand. Nonetheless, the Comthat of the year-earlier period. Prices for mittee judged that some inflation risks personal consumption expenditures remained. The extent and timing of any other than those for food and energy additional firming that may be needed to were estimated to have increased address these risks would depend on the slightly faster over the twelve months of evolution of the outlook for both infla- 2006 than they did a year earlier. How- tion and economic growth, as implied ever, the three-month change in core by incoming information. prices in December likely was down The FOMC's decision at the Decemconsiderably from its peak in May. Year- ber meeting to leave its target for the over-year increases in average hourly federal funds rate unchanged and to reearnings late last year continued to run tain the language in the statement re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 193 garding the risks to inflation appeared to In its forecast prepared ahead of the match investors' expectations. However, meeting, the staff had revised up its estithe characterization of recent economic mate of growth of aggregate economic growth was reportedly interpreted by activity in the fourth quarter. Nonethemarket participants as suggesting a less, real GDP in the second half of last slight softening in the Committee's out- year was still projected to have inlook for the expansion. As a result, the creased at a pace that was a bit below expected path of the federal funds rate the economy's long-run potential, pribeyond the near term edged down. The marily because of the ongoing adjustsubsequent release of the minutes from ment in the housing sector and the lower the meeting elicited little market reac- level of motor vehicle production. Looktion. Investors' outlook for economic ing ahead, the staff expected the rate of activity firmed over the intermeeting pe- increase in real GDP to be little changed in 2007 relative to the projected pace for riod, as economic data releases came in the second half of 2006. However, with stronger than expected and oil prices dethe contraction in housing activity exclined notably. As a result, investors pected to abate this year, the pace of markedly reduced the extent of policy economic growth was anticipated to easing anticipated over coming quarters, edge back up to a level that was close to and yields on nominal and inflationthe staffs estimate of potential output indexed Treasury coupon securities rose. growth by the end of 2007 and to remain Measures of inflation compensation in that same range throughout 2008. In were little changed on net. Spreads of light of developments in futures marinvestment-grade corporate bond yields kets, the paths of both energy and imover those of comparable-maturity Treaport prices were projected to be lower sury securities moved down a bit, while than was previously thought. Against those of speculative-grade issues dethis background and with the rate of inclined significantly more. Broad equity crease of shelter prices slowing down, indexes edged higher. The foreign exthe staff expected core inflation to edge change value of the dollar against other down in 2007 and 2008. The advance major currencies rose, on balance, pardata on the national income and product ticularly versus the yen. accounts for the fourth quarter that were Debt of the domestic nonfinancial released on the morning of the second sectors was estimated to have expanded day of the FOMC meeting showed in the fourth quarter at a pace that was stronger-than-expected net exports and close to that registered over the first a larger-than-anticipated accumulation three quarters of the year. A pickup in of inventories. The staff interpreted this merger-related borrowing appeared to information as suggesting some upward boost business debt growth last quarter, revision to its estimate of output growth and a sharp rise in the issuance of bonds in the fourth quarter and perhaps a slight and commercial paper more than offset downward revision to its forecast for the a moderation in bank loans. In the current quarter. household sector, the ongoing decelera- In their discussion of the economic tion in house prices further restrained situation and outlook, meeting particithe growth of home mortgage debt. M2 pants noted that the economic informacontinued to expand briskly in Decem- tion received since the last meeting ber and January, primarily reflecting pointed to a somewhat more favorable strength in its liquid deposit component. outlook regarding both inflation and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

194 94th Annual Report, 2007 economic growth than they had earlier These rates of growth were associated anticipated. Incoming data suggesting a with a civilian unemployment rate in the leveling out in housing demand and range of AVi to 43/4 percent in the fourth strength in consumer spending outside quarter of 2007 and AV2 to 5 percent in the housing sector supported the view the fourth quarter of 2008; the central that the expansion remained resilient de- tendency of these projections was AV2 to spite the appreciable decline in housing 43/4 percent for both years. The rate of activity and recent weakness in the inflation, as measured by the core PCE manufacturing sector. Over the next sev- price index, was projected to edge down eral quarters, economic activity would from a range of 2 to 2lA percent in 2007, likely advance at a pace at or modestly with the central tendency being the below the economy's trend rate of same, to a range of 1 Vi to 2lA percent in growth. Thereafter, growth was likely to 2008, centered on l3/4 to 2 percent. return to around its trend rate, which In their discussion of the major secseveral participants viewed as likely to tors of the economy, participants noted be higher than the staff's estimate. Fa- that the housing market showed tentavorable readings on core inflation and tive signs of stabilization in most relower energy prices had also improved gions. Anecdotal reports presented a the odds that inflation pressures would mixed picture, with fairly firm home diminish. However, it was noted that the sales in some areas but continuing deprevailing level of inflation was uncom- cline in others. But aggregate data indifortably high, and resource utilization cated that home sales, which had been was elevated. The upside risks to infla- essentially flat since mid-year, had risen tion remained the Committee's predomi- a bit during the fourth quarter. Mortgage nant concern. applications for home purchases had In preparation for the Federal Re- risen from their low levels of last sumserve's semiannual report to the Con- mer. Sentiment among homebuilders regress on the economy and monetary portedly had improved in the past few policy, the members of the Board of months, and the inventory of new homes Governors and the presidents of the Fed- for sale had fallen. Nonetheless, particieral Reserve Banks submitted individual pants noted that inventories remained elprojections of the growth of nominal and evated and needed to be worked down real GDP, the rate of unemployment, and before growth in this sector resumed. core consumer price inflation for the Unseasonably warm weather so far this years 2007 and 2008, conditioned on winter complicated the interpretation of their views of the appropriate path for recent data, but participants were optimonetary policy. The projections of the mistic that the risk of a much larger growth of nominal GDP were in the contraction in housing had diminished range of 43/4 to 5Vi percent for both and that the drag on growth from the years, with a central tendency of 5 to housing sector would ease later this 5V2 percent for 2007 and 43/4 to 5lA per- year. cent for 2008. Projections of the rate of Participants saw continued gains in expansion in real GDP for 2007 were in employment and incomes and lower enthe 2lA to 3J/4 percent range, with a cen- ergy prices as sustaining solid growth in tral tendency of 2Vi to 3 percent; for consumer spending. Contacts reported 2008 the forecasts were in the slightly healthy holiday sales in many regions, higher range of 2lh to 3V4 percent, with particularly late in the Christmas season. a central tendency of 23A to 3 percent. In addition, the growth of gift cards was Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, January 195 mentioned as a factor that likely boosted The more favorable budget positions retail sales in January. To date, weak- of the state and local governments were ness in the housing market had not ap- seen as permitting additional spending peared to have spilled over to aggregate by such governmental units and hence consumption, although some such effect as an additional source of stimulus to could not be ruled out as the growth in the economy. Strong federal tax receipts households' home equity slowed. The suggested that personal incomes were recent strength of consumption spend- expanding vigorously. ing, together with favorable readings Participants reported some continuing from consumer sentiment surveys, sug- softness in manufacturing, primarily in gested that households were optimistic industries related to housing or automoabout prospects for employment and in- biles. The recent slackness in manufaccome. Indeed, the possibility that the turing activity appeared to be largely an personal saving rate would fail to rise as inventory correction, which participants in the staff forecast was cited by some expected would be completed this year. participants as posing a significant up- Participants noted that the tone of conside risk to the outlook. tacts in the industrial sector was gener- Meeting participants noted that con- ally more positive than at the time of the tinued gains in nonresidential construc- December meeting, and some survey intion spending were offsetting some of formation pointed to expectations of a the weakness on the residential side. rebound in manufacturing activity later Further advances in nonresidential in- this year. However, the recent declines vestment were likely. Office vacancy in energy prices were likely to restrain rates were reported as declining in some energy extraction as well as activity in areas. However, the recent decrease in associated energy-producing sectors. energy prices had already led to a reduc- Many participants observed that labor tion in drilling activity and was likely to markets remained relatively taut, with reduce some investment in alternative significant wage pressures being refuels. Participants noted that business ported in some occupations. In addition fixed investment overall continued to be to the continuing shortages of skilled weaker than anticipated, suggesting workers in technical and professional some caution on the part of businesses fields, recent reports suggested a scarin expanding capacity. Nonetheless, par- city of less skilled and unskilled workticipants expected that, going forward, ers in some areas of the country. One favorable financial conditions, strong participant observed that some of the corporate balance sheets, high profitabil- sluggishness in manufacturing job ity, and growth in sales would support a growth could be due to difficulties in firming of investment spending. hiring rather than indicating weakness Net exports were unexpectedly strong in demand. So far, aggregate measures in the fourth quarter. In part, this devel- of labor compensation were showing opment could be attributed to a temp- only moderate increases, but looking orary reduction in petroleum imports as ahead, the possibility that labor costs a result of the unseasonably warm might rise more rapidly as a result of the weather. Although imports were likely tightness in labor market was seen as an to pick up again, global economic upside risk to inflation. growth, which had been strong of late, All meeting participants expressed was expected to continue to provide on- some concern about the outlook for ingoing support for growth in exports. flation. To be sure, incoming data had Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

196 94th Annual Report, 2007 suggested some improvement in core in- sector and the potential for spillovers to flation, and a further gradual decline other sectors remained notable downwas seen as the most likely outcome, side risks to economic activity, although fostered in part by the continued stabil- those risks had diminished somewhat, ity of inflation expectations. However, and continuing strength in consumption participants did not yet see a downtrend suggested upside risks as well. All memin core inflation as definitively estab- bers agreed that the predominant conlished. Although lower energy prices, cern remained the risk that inflation declining core import prices, and a de- would fail to moderate as desired. celeration in owners' equivalent rent In light of the recent economic data were expected to contribute to slower and anecdotal information, the Commitcore inflation in coming months, the tee agreed that the statement to be reeffects of some of these factors on infla- leased after the meeting should action could well be temporary. The influ- knowledge evidence of somewhat firmer ence of more enduring factors, im- economic growth and tentative signs of portantly including pressures in labor stabilization in the housing market. and product markets and the behavior of They further agreed that the statement inflation expectations, would primarily should reiterate that the economy determine the extent of more persistent seemed likely to expand at a moderate progress. In light of the apparent pace over coming quarters. The stateunderlying strength in aggregate de- ment would also note the modest immand, risks around the desired path of a provement in readings on core inflation further gradual decline in core inflation and the Committee's view that inflation remained mainly to the upside. pressures seemed likely to moderate Participants emphasized that a failure of over time. The members discussed inflation to moderate as expected could whether the balance of risks language in impair the long-term performance of the its recent statements still was the best economy. way to represent the views of the Com- In the Committee's discussion of mittee and decided that a change was monetary policy for the intermeeting pe- not warranted at this time. All members riod, all members favored keeping the agreed that the statement should contarget federal funds rate at 5VA percent at tinue to stress that some inflation risks this meeting. The confluence of better- remained and note that additional policy than-expected news on economic activ- firming was possible. ity and inflation suggested somewhat At the conclusion of the discussion, smaller downside risks to economic the Committee voted to authorize and growth as well as improved prospects direct the Federal Reserve Bank of New for core inflation. Recent developments York, until it was instructed otherwise, were seen as supporting the Commit- to execute transactions in the System tee's view that maintaining the current Account in accordance with the followtarget was likely to foster moderate eco- ing domestic policy directive: nomic growth and to further the gradual reduction of core inflation from its el- The Federal Open Market Committee evated level over the past year. Nonethe- seeks monetary and financial conditions that will foster price stability and promote less, Committee members saw continsustainable growth in output. To further its ued risks to the economic outlook. The long-run objectives, the Committee in the ongoing contraction in the housing immediate future seeks conditions in reserve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 197 markets consistent with maintaining the mously approved the minutes of the federal funds rate at an average of around FOMC meeting held on December 12, 5lA percent. 2006. The vote encompassed approval of By notation vote completed on Januthe text below for inclusion in the state- ary 5, 2007, the Committee unanimously ment to be released at 2:15 p.m.: selected William C. Dudley to serve at the pleasure of the Committee as Man- The Committee judges that some inflation ager, System Open Market Account, on risks remain. The extent and timing of any additional firming that may be needed to the understanding that his selection was address these risks will depend on the evolu- subject to being satisfactory to the Fedtion of the outlook for both inflation and eral Reserve Bank of New York. economic growth, as implied by incoming Secretary's note: Advice subseinformation. quently was received that the selection Votes for this action: Messrs. Bernanke of Mr. Dudley as Manager was satisfacand Geithner, Ms. Bies, Messrs. Hoetory to the board of directors of the Fednig, Kohn, and Kroszner, Ms. Minehan, eral Reserve Bank of New York. Messrs. Mishkin, Moskow, Poole, and Warsh. Votes against this action: None. Vincent R. Reinhart The Committee then moved on to a Secretary discussion of the role of economic projections in policy communications. Meeting Held on Meeting participants reviewed the ob- March 20-21, 2007 jectives, advantages, and disadvantages of potential changes to the production A meeting of the Federal Open Market and communication of policymakers' Committee was held in the offices of the forecasts of key economic variables. Board of Governors of the Federal Re- They expressed support for continuing serve System in Washington, D.C., on to report summaries of their individual Tuesday, March 20, 2007 at 2:30 p.m., forecasts, which they now make twice a and continued on Wednesday, March 21, year and which are included in the Mon- 2007 at 9:00 a.m. etary Policy Report. Participants agreed Present: to explore whether changes to current Mr. Bernanke, Chairman practices might facilitate improved com- Mr. Geithner, Vice Chairman munication internally among themselves Mr. Hoeni^ during the policy debate and externally Mr. Kohn Mr. Kroszner by providing the public with additional Ms. Minehan context for understanding the Commit- Mr. Mishkin tee's policy decisions. No decisions on Mr. Moskow any such changes were made at this Mr. Poole meeting, and a further discussion of Mr. Warsh communications topics was planned for Ms. Cumming, Mr. Fisher, Ms. Pianthe next FOMC meeting, confirmed for alto, and Messrs. Plosser and March 20-21, 2007. Stern, Alternate Members of the Federal Open Market Committee The meeting adjourned at 2:45 p.m. Messrs. Lacker and Lockhart, and Ms. Notation Votes Yellen, Presidents of the Federal Reserve Banks of Richmond, At- By notation vote completed on Decem- lanta, and San Francisco, respecber 29, 2006, the Committee unani- tively Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

198 94th Annual Report, 2007 Mr. Reinhart, Secretary and Economist Ms. Roush, Economist, Division of Ms. Danker, Deputy Secretary Monetary Affairs, Board of Gover- Ms. Smith, Assistant Secretary nors Mr. Skidmore, Assistant Secretary Mr. Alvarez, General Counsel Mr. Gross, Special Assistant to the Ms. Johnson, Economist Board, Office of Board Members, Mr. Stockton, Economist Board of Governors Messrs. Connors, Evans, Fuhrer, Ka- Mr. Luecke, Senior Financial Analyst, min, Madigan, Rasche, Slifman, Division of Monetary Affairs, and Wilcox, Associate Economists Board of Governors Mr. Dudley, Manager, System Open Ms. Low, Open Market Secretariat Spe- Market Account cialist, Division of Monetary Affairs, Board of Governors Messrs. Clouse and English,5 Associate Directors, Division of Monetary Mr. Rosenblum, Executive Vice Presi- Affairs, Board of Governors dent, Federal Reserve Bank of Dallas Mr. Struckmeyer, Associate Director, Division of Research and Statis- Mr. Hakkio, Ms. Mester, Messrs. tics, Board of Governors Rolnick, Rudebusch, and Sniderman, Senior Vice Presidents, Fed- Mr. Reifschneider, Deputy Associate eral Reserve Banks of Kansas City, Director, Division of Research and Philadelphia, Minneapolis, San Statistics, Board of Governors Francisco, and Cleveland, respec- Messrs. Dale6 and Oliner, Senior Advis- tively ers, Divisions of Monetary Affairs Messrs. Cunningham and Hilton, Vice and Research and Statistics, re- Presidents, Federal Reserve Banks spectively. Board of Governors of Atlanta and New York, respec- Mr. Hambley,6 Assistant to the Board, tively Office of Board Members, Board of Governors Ms. Sbordone, Research Officer, Federal Reserve Bank of New York Mr. Meyer, Visiting Reserve Bank Officer, Division of Monetary Af- Mr. Hetzel, Senior Economist, Federal fairs, Board of Governors Reserve Bank of Richmond Mr. Small,5 Project Manager, Division The Manager of the System Open of Monetary Affairs, Board of Market Account reported on recent de- Governors velopments in foreign exchange mar- Mr. Kiley6 and Ms. Kole,6 Section kets. There were no open market opera- Chiefs, Divisions of International tions in foreign currencies for the Finance and Research and Statis- System's account in the period since the tics, respectively, Board of Goverprevious meeting. The Manager also renors ported on developments in domestic fi- Mr. Doyle,6 Ms. Mauskopf,6 and Mr. nancial markets and on System open Wood,6 Senior Economists, Divi- market transactions in government secusions of International Finance, Rerities and federal agency obligations search and Statistics, and International Finance, respectively, Board during the period since the previous of Governors meeting. By unanimous vote, the Committee ratified these transactions. The information reviewed at the 5. Attended Wednesday's session. 6. Attended portion of the meeting relating to March meeting indicated that the the discussion of communications issues. economy appeared to be expanding at a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 199 modest pace in the first quarter. De- motor vehicles. Outside of these areas, clines in residential construction activity however, real consumer spending modcontinued to weigh on overall activity, erated. The determinants of household and business investment had softened spending were mixed. Disposable perconsiderably over the preceding several sonal income was estimated to have months, especially in equipment used in risen sharply in January, but the increase the construction and motor vehicle in- was partly the result of special factors, dustries. However, consumer spending such as pay raises for federal and milihad increased appreciably in the early tary personnel and cost-of-living adjustpart of the year, and labor demand con- ments to Social Security payments. tinued to expand, albeit at a somewhat Meanwhile, readings on consumer sentislower pace than last year. Meanwhile, ment, which had been favorable in rethe twelve-month increase in core con- cent months, edged down in early sumer prices remained elevated relative March. The boost to consumer spending to its pace one year earlier. from earlier gains in wealth was likely Employment gains moderated in early being muted by the lagged effects of the 2007. In February, employment in the upward trend in borrowing costs. In adconstruction industry contracted consid- dition, recent declines in equity prices erably, in part because of severe winter and slowing house price appreciation storms; manufacturing employment also pointed to a modest reduction in housedeclined, but hiring in service-producing holds' wealth-to-income ratio in the first sectors remained solid. A decline in the quarter. average workweek led to a contraction Housing starts declined in January, in aggregate hours. At the same time, extending the downward trend that had the unemployment rate edged down been in place since early 2006, but from 4.6 percent in January to 4.5 perbounced back in February. However, adcent in February. justed permit issuance in the single- Industrial production rose strongly in family sector continued to step down, February and was revised up for both suggesting that builders were still slow- December and January. In February, ing the pace of new construction to work production was boosted by a rebound in off elevated inventories. The inventory motor vehicle assemblies and by a temof new homes for sale remained high, porary surge in output at utilities that reflected a swing from unseasonably although cuts in residential construction warm temperatures in January to colder in the last few months had reduced the weather in February. Production rose at number of unsold homes. As at the time a solid pace in all major high-tech cat- of the January meeting, available data egories. Output of materials and defense suggested that housing demand was staand space equipment expanded as well. bilizing. Sales of both new and existing In contrast, production of consumer single-family homes in recent months goods and business equipment changed were, on balance, in line with the pace little, while output of construction sup- seen since mid-2006. However, a tightplies declined. ening of standards for subprime borrow- Real consumer spending appeared on ers in recent weeks seemed likely to track to rise at a robust pace in the first restrain home sales. House price apprequarter, buoyed in part by a weather- ciation had slowed further, with some related surge in spending on energy ser- measures showing outright declines in vices and by a jump in sales of light home values. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

200 94th Annual Report, 2007 Business fixed investment had been robust increase in deliveries of civilian sluggish in recent months. Real spend- aircraft to foreign buyers, while imports ing on equipment and software fell in were pushed down by a fall in the volthe fourth quarter, and nominal orders ume and price of imported oil. In Janufor and shipments of nondefense capital ary, the trade deficit was little changed. goods excluding aircraft posted wide- Economic activity in the advanced spread declines in January, with trans- foreign economies accelerated in the portation equipment showing a very fourth quarter. In Japan, private conlarge drop. Business purchases of light sumption rebounded strongly, and privehicles remained low, and new orders vate investment and net exports continfor and deliveries of medium and heavy ued to boost growth. The pace of trucks plunged in the last few months economic expansion in the euro area after a surge in 2006. Investment in picked up as investment and exports goods and services other than transpor- rose. Growth in the United Kingdom tation and high-tech equipment softened firmed because of brisk investment more than fundamentals had suggested. spending and a rebound in consumption Declines in spending for capital equip- growth. In contrast, output in Canada ment that is used heavily in the con- decelerated in the fourth quarter as instruction and motor vehicle industries ventory accumulation turned down accounted for an outsized share of the sharply. Recent data for the emergingdrop in orders and shipments at manu- market economies pointed to continued facturers outside high-tech and transpor- strength in activity, although there were tation in January. Investment in catego- signs that growth was moderating in ries such as industrial equipment; some countries. Growth remained solid electromedical, measuring, and control- in China but decelerated in several other ling devices; and other electrical equip- Asian economies and Mexico. ment also softened. In contrast, com- In January, the overall PCE price inputer imports surged in January, dex rose moderately as a decline in ensuggesting rising domestic purchases, ergy prices helped to offset a jump in and computer sales appeared to have food prices. Meanwhile, the PCE price picked up in February. The ample cash index excluding food and energy rose at reserves held by firms and ongoing re- a faster pace than in the previous two ductions in the user cost of high-tech months. Increases in consumer energy capital goods remained supportive of in- prices and higher prices for fruits and vestment going forward. vegetables in February reflected a pe- Businesses accumulated inventories riod of unusually cold weather and conof items other than motor vehicles at a tributed to an acceleration in that slower pace in January than in the previ- month's CPI. Excluding food and enous two quarters. Even so, the ratio of ergy, core CPI inflation slowed slightly inventories to sales for manufacturing in February but remained elevated. In and trade excluding motor vehicles re- recent months, prices had risen across a mained elevated. In addition, purchas- broad range of core goods. On a twelveing managers at manufacturing firms, on month-change basis, core CPI inflation net, continued to view their customers' in February was considerably above its inventory levels as too high. pace a year earlier, largely because of a The U.S. international trade deficit sharp acceleration in shelter rents over narrowed considerably in the fourth the past year. Average hourly earnings quarter. Exports rose, partly reflecting a also rose at a noticeably faster pace dur- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 201 ing the year ending in February than few weeks of the intermeeting period, during the preceding twelve-month pe- and policy expectations moved appreriod. Surveys indicated that households' ciably lower on net by mid-February. expectations of inflation over the next Financial market volatility increased year were little changed in February sharply in the second half of the interwhile households' and professional fore- meeting period amid an apparent pullcasters' longer-term inflation expecta- back from risk-taking that was reporttions edged lower. edly spurred by mixed news on domestic At its January meeting, the Federal economic activity, mounting concerns Open Market Committee maintained its about the subprime mortgage sector, and target for the federal funds rate at significant declines in foreign equity 5x/4 percent. The Committee's accompa- prices. On net over the intermeeting penying statement noted that recent indica- riod, investors tilted their anticipated tors had suggested somewhat firmer path for monetary policy beyond mideconomic growth and that some tenta- 2007 down substantially, and yields on tive signs of stabilization had appeared two- and ten-year nominal Treasury sein the housing market. Overall, the curities fell 30 to 40 basis points. Yields economy seemed likely to expand at a on inflation-indexed Treasury securities moderate pace over coming quarters. generally declined somewhat less than Readings on core inflation had improved their nominal counterparts, leaving inin recent months, and inflation pressures flation compensation slightly lower seemed likely to moderate over time, across the term structure. Broad stock but the high level of resource utilization price indexes dropped several percent had the potential to sustain inflation on net over the period. Yields on pressures. The Committee judged that investment-grade corporate bonds fell some inflation risks remained. The ex- about in line with those on Treasury setent and timing of any additional firm- curities of comparable maturity. In coning that might be needed to address trast, yields on speculative-grade bonds these risks would depend on the evolu- declined only modestly, leaving risk tion of the outlook for both inflation and spreads noticeably wider, albeit still nareconomic growth, as implied by incom- row by historical standards. ing information. Domestic nonfinancial sector debt ap- The FOMC's decision at its January peared to be continuing to rise at a relameeting was in accord with market ex- tively brisk rate in the first quarter. Depectations, but the accompanying state- spite the recent volatility in financial ment reportedly was read as a sign that markets, funding in the bond and syndithe Committee was more sanguine about cated loan markets appeared to remain inflation prospects than in December, readily available. However, borrowing and the expected path for monetary by nonfinancial corporations was estipolicy beyond 2007 edged lower. Policy mated to be moderating somewhat in the expectations declined a bit more in the first quarter, with a step-down in bond wake of the Chairman's semiannual issuance associated with merger and acmonetary policy testimony, which ap- quisition activity. Indicators pointed to a parently reinforced investors' beliefs continuing deceleration in house prices that the FOMC anticipated gradually di- this quarter, and home mortgage borminishing inflation pressures. Economic rowing probably continued to slow. M2 data releases were somewhat weaker increased more moderately in February than expected on balance over the first than at the end of 2006 as the expansion Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

202 94th Annual Report, 2007 of liquid deposits slowed from its out- and recent developments in the sized fourth-quarter rate. subprime mortgage market suggested In its forecast prepared for this meet- that the downside risks relative to the ing, the staff marked down the projected expectation of moderate growth had inincrease in real GDP in the first quarter creased in the weeks since the January in response to weaker-than-expected in- FOMC meeting. At the same time, the coming data on business equipment prevailing level of inflation remained spending and federal defense purchases. uncomfortably high, and the latest infor- The recent increase in oil prices and de- mation cast some doubt on whether core cline in equity prices, along with in- inflation was on the expected downward creased strains in the subprime mort- path. Most participants continued to exgage sector, were expected to exert some pect that core inflation would slow drag on real activity over the remainder gradually, but the recent readings on inof the year. Even so, real GDP growth flation and productivity growth, along was expected to pick up to a rate a little with higher energy prices, had increased below that of the economy's long-run the odds that inflation would fail to potential for the remainder of 2007, as moderate as expected; that risk remained declines in residential construction ac- the Committee's predominant concern. tivity lessened, and to remain at a simi- Participants reported signs of stabililar rate in 2008. The increase in energy zation in housing demand in most reprices over the intermeeting period led gions of the country. At the national the staff to revise up its forecast for level, sales of new and existing homes, headline PCE inflation during the first while fluctuating in recent months, did half of this year, but the staff continued not display declining trends. The invento expect that core PCE inflation would tory of new homes for sale reportedly edge down over the remainder of this had fallen further from its recently elyear and next. evated level. Participants noted, how- In their discussion of the economic ever, that such inventories likely would situation and outlook, meeting partici- need to be worked down appreciably pants agreed that, while recent economic more before growth in housing construcdata had been mixed, the economy was tion would resume. The increase in delikely to expand at a moderate pace in linquencies on subprime adjustable-rate coming quarters. Although the housing mortgage loans and the ensuing increase sector adjustment continued, accumulat- in interest rates and tightening of credit ing data suggested that the demand for standards in the subprime mortgage homes was leveling out. Business fixed market likely would constrain home purinvestment had been soft in recent chases by some borrowers, perhaps remonths, but financing conditions and tarding the recovery in the housing secother fundamentals remained favorable tor. However, there was no sign of for a pickup in capital spending. More- spillovers from the subprime market to over, continuing gains in personal in- the overall mortgage market; indeed, income could be expected to support terest rates on prime mortgage loans had growth in consumer spending. Thus eco- declined somewhat in recent weeks, nomic growth likely would increase in along with yields on U.S. Treasury secucoming quarters to a pace close to or rities. Moreover, home-buying attitudes modestly below the economy's trend had improved and continuing job growth growth rate. However, additional evi- could be expected to support home dence of sluggish business investment sales. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, March 203 Business fixed investment spending rate would fail to rise as projected in the had been surprisingly weak of late, staff forecast remained an upside risk to given strong corporate balance sheets, the outlook. high profitability, anticipated growth in Growth in federal as well as state and sales, and favorable financial conditions. local government spending probably Participants continued to expect these would remain a source of stimulus to the fundamentals to support a firming of in- economy. Moreover, continued expanvestment spending going forward, and sion in domestic demand in our major they saw no indication that recent mar- trading partners could be expected to ket volatility had prompted a reduction sustain solid growth in U.S. exports. in the availability of financing for busi- Many participants again reported softness investment. Also, declining office ness in manufacturing, primarily but not vacancy rates in some areas were spurexclusively in industries related to housring gains in nonresidential construction ing or automobiles. However, a number activity, and further advances in comof firms outside of the housing sector— mercial construction were seen as likely. including auto companies—appeared to Energy prices were high enough to enhave made progress in reducing incourage continued investment in alternaventories to more comfortable levels, tive fuels. However, the relatively slow and contacts in the industrial sector pace of investment in recent months were generally optimistic about future might be signaling that business execugrowth. Such attitudes were consistent tives had become less certain about the with national and regional surveys that outlook, and perhaps that they expected pointed to a rebound in manufacturing quite modest gains in sales. Participants activity later this year. agreed that the possibility of persistently sluggish investment spending was an Anecdotal and statistical evidence important downside risk to the outlook suggested that labor markets remained for economic growth. relatively tight. Business contacts continued to report shortages of skilled Growth in consumer spending would workers in technical and professional likely continue to be supported by gains fields, with significant wage pressures in employment and incomes. Meeting participants noted that weakness in the in some occupations, as well as a scarhousing market had not spilled over to city of less skilled and unskilled workaggregate consumption—though the ers in some areas of the country. So far, flattening out in house prices likely aggregate measures of labor compensawould contribute to an increase in the tion were showing only moderate inpersonal saving rate—and turmoil in the creases, but, looking ahead, the possibilsubprime mortgage market did not ap- ity that labor costs might rise more pear to be generating any diminution in rapidly was seen as an upside risk to the availability of other types of house- inflation. It was noted, however, that inhold credit. The recent increase in oil creases in compensation that exceeded prices and the reduction in household productivity gains might be absorbed to net worth resulting from the small net some extent by a narrowing of firms' declines in equity prices during the in- high profit margins. Participants extermeeting period warranted a modest pected that productivity growth would downward adjustment in projected pick up as firms slowed hiring to a pace growth of consumer spending. Even so, more in line with output growth but acthe possibility that the personal saving knowledged that the improvement might Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

204 94th Annual Report, 2007 be limited, particularly if business in- tainty that the expected gradual decline vestment spending were to remain soft. in core inflation would materialize. Most participants continued to expect In light of the recent economic data a gradual decline in core inflation over and anecdotal information, the Committhe next year or two, fostered by stable tee agreed that the statement to be reinflation expectations, a likely decelera- leased after the meeting should note that tion in shelter costs, and a slight easing economic indicators had been mixed, of pressures on resources. Nonetheless, that the adjustment in the housing marall meeting participants expressed con- ket was ongoing, and that the economy cern about the risks to this outlook. The seemed likely to expand at a moderate latest readings on core inflation were pace over coming quarters. Members higher than expected, and it was diffi- agreed the statement also should indicult to discern whether the apparent cate that inflation pressures seemed downward trend in core inflation during likely to moderate over time, but that the past few quarters was continuing. recent readings on core inflation had Also, the recent increases in prices for been somewhat elevated and the high energy and some non-energy imports level of resource utilization had the polikely would boost overall inflation in tential to sustain inflation pressures. A the near term and might put upward persistence of inflation at recent rates pressure on prices of some core goods could eventually have adverse conseand services. Moreover, rates of re- quences for economic performance. All source utilization that were near the high members agreed the statement should end of historical experience suggested a indicate that the Committee's predomipossibility that inflation pressures could nant policy concern remains the risk that build. Participants agreed that risks inflation will fail to moderate as exaround the expected and desired path of pected. The Committee agreed that fura gradual decline in core inflation re- ther policy firming might prove necesmained mainly to the upside; some sary to foster lower inflation, but in light noted that upside risks to inflation ap- of the increased uncertainty about the outlook for both growth and inflation, peared to have increased slightly in rethe Committee also agreed that the statecent months. ment should no longer cite only the pos- In the Committee's discussion of sibility of further firming. Instead, the monetary policy for the period between statement should indicate that future its March and May meetings, all mempolicy adjustments will depend on the bers favored keeping the target federal evolution of the outlook for both inflafunds rate at 5lA percent. Recent develtion and economic growth, as implied opments were seen as supporting the by incoming information. Committee's view that maintaining the current target was likely to foster moder- At the conclusion of the discussion, ate economic growth and to further the the Committee voted to authorize and gradual reduction of core inflation from direct the Federal Reserve Bank of New its elevated level. Nonetheless, the com- York, until it was instructed otherwise, bination of generally weaker-than- to execute transactions in the System expected economic indicators and un- Account in accordance with the followcomfortably high readings on inflation ing domestic policy directive: suggested increased downside risks to The Federal Open Market Committee economic growth and greater uncer- seeks monetary and financial conditions that Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 205 will foster price stability and promote sus- It was agreed that the next meeting of tainable growth in output. To further its the Committee would be held on long-run objectives, the Committee in the Wednesday, May 9, 2007. immediate future seeks conditions in reserve The meeting adjourned at 1:30 p.m. markets consistent with maintaining the federal funds rate at an average of around 5lA percent. Notation Vote The vote encompassed approval of By notation vote completed on February the text below for inclusion in the state- 20, 2007, the Committee unanimously ment to be released at 2:15 p.m.: approved the minutes of the FOMC meeting held on January 30-31, 2007. In these circumstances, the Committee's predominant policy concern remains the risk Vincent R. Reinhart that inflation will fail to moderate as Secretary expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as Meeting Held on implied by incoming information. May 9, 2007 Votes for this action: Messrs. Bernanke, Geithner, Hoenig, Kohn, and Kroszner, A meeting of the Federal Open Market Ms. Minehan, Messrs. Mishkin, Mos- Committee was held in the offices of the kow, Poole, and Warsh. Votes against Board of Governors of the Federal Rethis action: None. serve System in Washington, D.C., on Wednesday, May 9, 2007 at 8:30 a.m. The Committee then returned to the topic of improving policy communica- Present: tions. Participants expressed a range of Mr. Bernanke, Chairman views on the possible advantages and Mr. Geithner, Vice Chairman Mr. Hoenig disadvantages of specifying a numerical Mr. Kohn price objective for monetary policy and Mr. Kroszner on technical aspects of a quantification. Ms. Minehan Participants emphasized that any such Mr. Mishkin move would need to be consistent with Mr. Moskow Mr. Poole the Committee's statutory objectives for Mr. Warsh promoting maximum employment as well as price stability. The Committee Mr. Fisher, Ms. Pianalto, and Messrs. Plosser and Stern, Alternate Memmade no decisions on this issue. Particibers of the Federal Open Market pants also discussed the communica- Committee tions role of the economic projections Messrs. Lacker and Lockhart, and Ms. that are made periodically by the mem- Yellen, Presidents of the Federal bers of the Board of Governors and the Reserve Banks of Richmond, At- Reserve Bank presidents. A number of lanta, and San Francisco, respecsubstantive and practical issues would tively still need to be evaluated before the Mr. Reinhart, Secretary and Economist Committee could make decisions about Ms. Danker, Deputy Secretary an enhanced role for projections in ex- Ms. Smith, Assistant Secretary plaining policy. The Committee planned Mr. Skidmore, Assistant Secretary to continue its review of communication Mr. Alvarez, General Counsel Mr. Baxter, Deputy General Counsel issues at the FOMC meeting in June Ms. Johnson, Economist 2007. Mr. Stockton, Economist Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

206 94th Annual Report 2007 Messrs. Connors, Evans, Kamin, Madi- Banks of Philadelphia, Atlanta, gan, Rasche, Slifman, Tracy, and and Boston, respectively Wilcox, Associate Economists The Manager of the System Open Mr. Dudley, Manager, System Open Market Account reported on recent de- Market Account velopments in foreign exchange mar- Messrs. Clouse and English, Associate kets. There were no open market opera- Directors, Division of Monetary tions in foreign currencies for the Affairs, Board of Governors System's account in the period since the Ms. Liang and Mr. Struckmeyer, Asso- previous meeting. The Manager also reciate Directors, Division of Re- ported on developments in domestic fisearch and Statistics, Board of nancial markets and on System open Governors market transactions in government secu- Messrs. Leahy and Wascher, Deputy rities and federal agency obligations Associate Directors, Divisions of during the period since the previous International Finance and Re- meeting. By unanimous vote, the Comsearch and Statistics, respectively mittee ratified these transactions. Mr. Dale, Senior Adviser, Division of By unanimous vote, the Committee Monetary Affairs extended for one year beginning in mid- Mr. Blanchard, Assistant to the Board, December 2007 the reciprocal currency Office of Board Members, Board ("swap") arrangements with the Bank of of Governors Canada and the Banco de Mexico. The Mr. Small, Project Manager, Division arrangement with the Bank of Canada is of Monetary Affairs, Board of in the amount of $2 billion equivalent Governors and that with the Banco de Mexico is in the amount of $3 billion equivalent. Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Both arrangements are associated with Board of Governors the Federal Reserve's participation in the North American Framework Agree- Mr. Carlson, Economist, Division of Monetary Affairs, Board of Gover- ment of 1994. The vote to renew the nors System's participation in the swap arrangements maturing in December was Ms. Low, Open Market Secretariat Spetaken at this meeting because of the procialist, Division of Monetary Affairs, Board of Governors vision that each party must provide six months' prior notice of an intention to Ms. Green, First Vice President, Fedterminate its participation. eral Reserve Bank of Richmond The information reviewed at the May Mr. Rosenblum, Executive Vice Presimeeting suggested that economic activdent, Federal Reserve Bank of ity had expanded at a below-trend pace Dallas in recent months. Gains in payroll em- Mr. Hakkio, Ms. Perelmuter, Messrs. ployment had moderated, and the unem- Rolnick, Rudebusch, Sniderman, ployment rate appeared to have stabiand Weinberg, Senior Vice Presidents, Federal Reserve Banks of lized after a period of decline. Housing Kansas City, New York, Minne- construction remained under pressure apolis, San Francisco, Cleveland, from weak demand and large inventoand Richmond, respectively ries of unsold homes, and consumer Messrs. Dotsey, Tallman, and Tootell, spending appeared to have slowed in re- Vice Presidents, Federal Reserve cent months. Business fixed investment Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 207 remained subdued. Manufacturing pro- and light trucks moved up in the first duction, however, showed signs of quarter, but eased a bit in April. Real strengthening after a period of consider- spending on goods other than motor veable softness. Rising energy prices hicles, which had shown exceptional pushed up total PCE price inflation in vigor late last year, was broadly flat be- March, while the twelve-month increase tween December and March. However, in core PCE prices was just slightly outlays on non-energy services were reabove its year-earlier pace. ported to have posted solid gains, espe- The average monthly increase in pay- cially in March. Real disposable perroll employment through the first four sonal income rose smartly in the first months of this year was well below the quarter. Wages and salaries increased relatively strong pace recorded in the solidly, on average, and the Bureau of fourth quarter of 2006. In April, the con- Economic Analysis estimated that instruction industry continued to shed come in January was boosted by unusujobs, manufacturing employment de- ally large bonus payments and stock opclined further, and retailers reduced hir- tion exercises. The household wealth-toing after a large gain in March. The un- income ratio likely ticked down in the employment rate stood at 4.5 percent in first quarter, as the stock market rose April, similar to its average in the first only a little and house prices remained quarter, and the labor force participation soft. However, given the surge in stock rate moved down. prices in April, much of the lost ground Industrial production increased at a had probably since been made up. modest annual rate of 1.4 percent in the Residential construction activity refirst quarter, with the monthly pattern mained soft as builders attempted to reflecting fluctuations in the output of work off elevated inventories of unsold utilities, which was influenced impor- new homes. Single-family housing starts tantly by swings in weather conditions. moved up in March, almost certainly Manufacturing output declined, on net, boosted by unusually warm and dry over the six months ending in February weather; single-family permit issuance as a result of inventory-related adjust- also increased. Although existing home ments in a number of industries. How- sales declined in March, the level of ever, factory production turned up in sales was only slightly below the steady March. The output of high-tech indus- pace that had prevailed in the second tries rose briskly; the production of con- half of 2006. By contrast, new home sumer goods increased; and the output sales fell sharply in the first two months of business equipment, construction sup- of the year and had recovered only a bit plies, and materials picked up. The lim- in March. All told, recent readings on ited information available on industrial home sales suggested that housing deproduction for April suggested that out- mand had weakened further. Houseput had been boosted by the scheduled price appreciation continued to slow, pickup in motor vehicle assemblies. and some measures were again showing Real consumer expenditures in- declines in home values. creased at a brisk pace in the first quar- Real spending on equipment and softter, although monthly gains in spending ware rose modestly in the first quarter slowed over the course of the quarter, in after having fallen in the fourth quarter part because of swings in weather- of 2006. Spending on high-tech equiprelated outlays on energy goods and en- ment, boosted by a surge in outlays on ergy services. Retail sales of both autos computers, posted a substantial increase Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

208 94th Annual Report, 2007 in the first quarter. In addition, pur- drop in imports, which more than offset chases of communications equipment— a sizable decline in exports. Within imwhich tend to be volatile quarter to ports, the value of oil imports plunged, quarter—rebounded strongly after a reflecting decreases in both prices and fourth-quarter dip. By contrast, spend- quantities, and imports of industrial suping on transportation equipment de- plies, capital goods, and automotive clined significantly: Although domestic parts also fell. The lion's share of the spending on aircraft jumped after three February decline in exports was of capiweak quarters, purchases of medium and tal goods. Smaller decreases occurred in heavy trucks dropped sharply, largely as exports of industrial supplies, consumer a consequence of a pull-forward of truck goods, and services. purchases in the latter part of last year in Economic activity in advanced foranticipation of the tighter emissions eign economies appeared to have grown standards that took effect in January. at a steady rate in the first part of the Business investment in equipment other year. Canada's growth seemed to have than high-tech and transportation rebounded from a disappointing fourth dropped in the first quarter, although the quarter. Renewed household demand in weakness in this broad category ap- Japan pointed to further strong growth peared to have been especially pro- in the first quarter, while investment denounced around the turn of the year and mand seemed to be underpinning growth to have lessened somewhat over the in the United Kingdom. Although eurocourse of the quarter. Robust corporate area exports had slowed from the rapid cash reserves and continuing declines in pace set in the fourth quarter and the the user cost of high-tech goods re- hike in the German value-added tax mained supportive of equipment and likely depressed consumption, overall software spending going forward. Real economic conditions remained solid. outlays for nonresidential construction Economic activity in the emerging marregained some momentum in the first ket countries appeared to have continquarter of this year after having hit a lull ued to advance at a robust pace in the in late 2006. first quarter. Surging growth in China Real nonfarm inventory investment was a highlight of the strong perforexcluding motor vehicles increased at a mance of most countries in Asia. In slower pace in the first quarter of 2007 Latin America, indicators pointed to furthan in the previous quarter. The down- ther lackluster growth in Mexico and shift in inventory investment had helped some weakening in Argentina, but in to reduce the apparent overhangs that other countries, especially Brazil, condihad emerged in late 2006. In the motor tions appeared more positive. vehicle sector, the sharp decline in the The total PCE price index rose subpace of assemblies over the past few stantially in both February and March. quarters appeared to have brought in- The advance in February was distribventories back into line with sales. In uted across a broad range of categories, April, surveys indicated that the net while the March increase was driven number of firms who viewed their cus- largely by a jump in the index for entomers' inventory levels as too high had ergy. Core PCE prices were unchanged dropped back from elevated readings in March after an upswing in February. over the previous two quarters. Smoothing through the high-frequency The U.S. international trade deficit movements, the twelve-month change in narrowed in February, reflecting a steep the core PCE price index in March was Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 209 just a touch higher than the increase ing statement as suggesting that the over the year-earlier period. Accelera- Committee's economic outlook had betions in the costs of housing and medical come somewhat more balanced. Howservices were major contributors to both ever, subsequent FOMC communcore CPI and core PCE inflation over ications—including the Chairman's the past year. Household surveys con- testimony before the Joint Economic ducted in April indicated that the me- Committee, speeches by various FOMC dian expectation for year-ahead infla- members, and the minutes from the tion had moved up, consistent with the March meeting—were generally seen as recent pickup in headline CPI inflation. emphasizing the Committee's concern Median expectations of longer-term in- about upside risks to inflation. Over the flation had edged higher but were still in intermeeting period, yields on nominal the narrow range seen over the past few Treasury securities edged up at all matuyears. Average hourly earnings for pro- rities. Measures of inflation compensaduction or nonsupervisory workers, tion based on inflation-indexed Treasury which had accelerated noticeably over securities were little changed despite a the past couple of years, posted moder- significant rise in oil prices. Yields on ate increases in March and April. investment-grade corporate bonds rose At its March meeting, the Federal in line with those on comparable- Open Market Committee (FOMC) main- maturity Treasury securities, leaving tained its target for the federal funds rate their spreads little changed at fairly low at 5V4 percent. The Committee's accom- levels. Spreads on speculative-grade panying statement noted that recent eco- corporate bonds narrowed. Equity prices nomic indicators had been mixed and climbed steeply amid solid earnings rethat the adjustment in the housing sector ports and improved sentiment, more was ongoing. Nevertheless, the econ- than reversing the declines in the previomy seemed likely to expand at a mod- ous intermeeting period. The foreign exerate pace over coming quarters. Recent change value of the dollar against other readings on core inflation had been major currencies moved lower, on somewhat elevated. Although inflation balance. pressures seemed likely to moderate Gross bond issuance by nonfinancial over time, the high level of resource uti- businesses slowed from its torrid firstlization had the potential to sustain those quarter pace in April, but acquisitionpressures. The Committee's predomi- related financing continued to fuel nant policy concern remained the risk the issuance of both investment- and that inflation would fail to moderate as speculative-grade corporate bonds. expected. Future policy adjustments Commercial paper outstanding declined, would depend on the evolution of the but bank lending accelerated. In the outlook for both inflation and economic household sector, the rise in home mortgrowth, as implied by incoming infor- gage debt likely slowed a bit further in mation. the first quarter, as home-price apprecia- Market participants had largely antici- tion appeared to have remained slugpated the FOMC's decision at its March gish. Consumer credit continued to exmeeting to leave the target federal funds pand at a moderate pace early in the rate unchanged. Nevertheless, the ex- year. M2 accelerated during March and pected path for monetary policy moved April, primarily reflecting faster growth lower on the announcement, as investors in liquid deposits, which were likely apparently interpreted the accompany- boosted in April by tax-related flows. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

210 94th Annual Report, 2007 In its forecast prepared for this meet- in line with the economy's trend rate in ing, the staff expected the pace of eco- 2008. Most participants continued to nomic activity to pick up from weak expect core inflation to slow gradually, first-quarter growth to a rate a little be- although considerable uncertainty surlow that of the economy's long-run po- rounded that judgment and the Comtential for the remainder of this year and mittee's predominant concern remained to increase at a pace broadly in line with the risk that inflation would fail to potential output in 2008. The projected moderate as expected. gradual acceleration in economic activ- The incoming data on new home sales ity largely reflected the expected wan- and inventories suggested that the ongoing of the drag from residential invest- ing adjustment in the housing market ment, although recent readings on sales would probably persist for longer than and inventories of new homes had been previously anticipated. In particular, the interpreted by the staff as suggesting that demand for new homes appeared to have the ongoing contraction in residential in- weakened further in recent months, and vestment would continue for longer than the stock of unsold homes relative to previously expected. In response to data sales had increased sharply. That said, received over the past year, the staff had participants also noted that sales of exmarked down slightly its estimate of isting homes appeared to have held up structural productivity growth and somewhat better since the beginning of nudged up its estimate for the increase the year. Moreover, the turmoil in the in labor supply—leaving its estimate of subprime market evidently had not the overall growth of potential GDP spread to the rest of the mortgage marbroadly unchanged. The increases in en- ket; indeed, mortgage rates available to ergy and other commodity prices over prime borrowers remained well below the intermeeting period had led the staff their levels of last summer. Nevertheto revise up its forecast for headline less, most participants agreed that, al- PCE inflation during the first half of the though the level of inventories of unsold year. Nonetheless, the staff continued to homes that homebuilders desired was expect core inflation to edge lower over uncertain, the correction of the housing the course of the next two years. sector was likely to continue to weigh In their discussion of the economic heavily on economic activity through situation and outlook, participants noted most of this year—somewhat longer that their assessments of the medium- than previously expected. term prospects for economic growth and Growth in consumer spending apinflation had not changed materially peared to have slowed over the past few from the previous meeting. The pace of months. Real spending on goods had economic expansion had slowed in the flattened out, and contacts in both the first part of this year, but the recent sub- retail sector and the consumer credit secpar performance probably exaggerated tor reported a softening in the expansion the weakness of underlying demand, and of demand. In contrast to the rapid gains the rate of economic growth was ex- of recent years, meeting participants expected to pick up in coming quarters. pected household expenditure to grow at Meeting participants anticipated that a more moderate pace in coming quarreal GDP would advance at a pace a ters. Consumption was likely to be suplittle below the economy's trend rate of ported by continued advances in emgrowth through the remainder of this ployment and incomes, as well as gains year and then pick up to a rate broadly in stock prices; but the recent increases Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, May 211 in gasoline prices probably would damp at home. Prices of non-energy comhouseholds' spending power in the near modities, especially metals, had moved term, and the effect of the anticipated up markedly since the previous meeting. leveling out in home-price appreciation Moreover, inflationary pressures in a on household wealth was expected to number of overseas economies appeared contribute to a gradual increase in the to have increased of late, perhaps partly personal saving rate over the medium in response to heightened levels of carun. Participants remained concerned pacity utilization in those countries, and that the housing market correction could this development had the potential to have a more pronounced impact on con- add to the prices of U.S. imports. In that sumer spending than currently expected, regard, several participants noted that especially if house prices were to de- the decline in the foreign exchange cline significantly. value of the dollar over the intermeeting The growth of business fixed invest- period could reinforce the upward presment seemed most likely to move higher sure on import prices. in coming quarters, supported by strong Participants discussed how best to corporate balance sheets and profits, fa- reconcile the slowdown in output vorable financial conditions, and a growth over the past year with the relagradual strengthening in business out- tively strong performance of the labor put. The downside risks to business market. This apparent tension could capital spending appeared to have di- partly reflect measurement issues; in minished somewhat since the previous particular, participants noted that the meeting. In particular, participants took more-rapid gains in estimates of gross note of the upturn in orders and ship- domestic income over this period might ments of capital goods, and of more up- better capture the pace of activity than beat surveys of business conditions. the modest advances in measured GDP. However, participants cautioned against Aside from measurement problems, a drawing too much comfort from the possible explanation was that these difmost recent few data observations, and fering trends largely related to the recognized that the current sluggishness lagged adjustment of employment to the of equipment outlays could persist for slowing pace of expansion. In that relonger than currently anticipated, espe- gard, several participants observed that cially if financial market conditions be- the recent moderation in economic came less supportive. Participants were growth had been concentrated in the also encouraged that, outside of the con- construction sector, but that measured struction sector, the correction of inven- employment in construction had not yet tories to more comfortable levels ap- declined by a corresponding amount. peared well advanced, thus reducing the This suggested that increases in overall possibility that going forward this ad- employment in coming quarters may justment process could trigger shortfalls possibly be held down by notable dein business spending and output. clines in construction employment as the Economic activity in the rest of the adjustment of the labor force in that secworld continued to advance briskly. Par- tor played out. A slowing in employticipants noted that strong foreign ex- ment could then occur in conjunction pansion should help to underpin demand with a strengthening in productivity for U.S. exports, but expressed some growth. Alternatively, some of the reconcern that the strength of global de- cent weakness in measured productivity mand could contribute to price pressures growth could reflect a decline in the un- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

212 94th Annual Report, 2007 derlying trend in productivity and so expectations and a likely deceleration in might persist. Although this explanation shelter costs. Some participants also exmight help account for some of the pected the anticipated slight easing of downshift in measured productivity pressures on resources to help nudge ingrowth, participants agreed that there flation lower, although others felt that appeared to be little other evidence small movements in resource utilization pointing to a significant slowing of ad- were unlikely to have discernible effects vances in structural productivity. In the on inflation. All participants agreed that context of this discussion, many partici- the risks around the anticipated moderapants commented that their view of po- tion in inflation were to the upside; and tential output growth was somewhat some noted that a failure of inflation to more optimistic than that of the staff. moderate could entail significant costs Labor markets appeared to remain particularly if it led to an upward drift in relatively tight. Unemployment contin- inflation expectations. ued around the low levels seen since last In the Committee's discussion of fall, and many business contacts re- monetary policy for the intermeeting peported difficulties in recruiting suitably riod, all members favored keeping the qualified workers, especially for certain target federal funds rate at 5lA percent. types of professional and skilled posi- Recent developments were seen as suptions. However, several participants ob- porting the Committee's view that mainserved that aggregate measures of labor taining the current target rate was likely compensation had so far increased only to foster moderate economic growth and modestly, perhaps suggesting that the la- a gradual ebbing in core inflation. Membor market might be less stretched than bers continued to view the risks to ecoit appeared. Moreover, even if wages nomic activity as weighted to the downand salaries did accelerate, the resulting side, although with turmoil in the cost pressures might be absorbed by a subprime market appearing to have renarrowing in firms' profit margins from mained relatively well contained and current elevated levels, rather than being business spending indicators suggesting passed on in the form of higher prices. a more encouraging outlook, these On the other hand, some participants re- downside risks were judged to have diported that their business contacts ap- minished slightly. Members agreed that peared very resistant to any squeeze in considerable uncertainty attended the profit margins. All told, for most partici- prospects for inflation, and the risk that pants, the apparent tightness of the labor inflation would fail to moderate as demarket remained a significant source of sired remained the Committee's preupside risk to inflation. dominant concern. Nearly all participants viewed core in- In light of the recent economic data flation as remaining uncomfortably high and anecdotal information, the Commitand stressed the importance of further tee agreed that the statement to be remoderation. Although readings on core leased after the meeting should acinflation in March had been more favor- knowledge that economic growth had able, this followed several months of el- slowed in the first part of the year. The evated inflation data and price pressures Committee thought that the statement were not yet viewed as convincingly on should reiterate the view that the adjusta downward trend. Most participants ex- ment in the housing market was ongopected core inflation to moderate gradu- ing, but that nevertheless the economy ally, fostered in part by stable inflation seemed likely to expand at a moderate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 213 pace over coming quarters. While read- The meeting adjourned at 1:15 p.m. ings on core inflation were lower in March, members felt that it was appro- Notation Vote priate to emphasize that core inflation By notation vote completed on April 10, remained somewhat elevated. The Com- 2007, the Committee unanimously apmittee agreed that the statement should proved the minutes of the FOMC meetcontinue to note that their predominant ing held on March 20-21, 2007. policy concern was the risk that inflation would fail to moderate as expected, Vincent R. Reinhart and that future policy adjustments would Secretary depend on the evolution of the outlook for both inflation and economic growth. Meeting Held on At the conclusion of the discussion, June 27-28, 2007 the Committee voted to authorize and A meeting of the Federal Open Market direct the Federal Reserve Bank of New Committee was held in the offices of the York, until it was instructed otherwise, Board of Governors of the Federal Reto execute transactions in the System serve System in Washington, D.C., on Account in accordance with the follow- Wednesday, June 27, 2007 at 2:00 p.m. ing domestic policy directive: and continued on Thursday, June 28, The Federal Open Market Committee 2007 at 9:00 a.m. seeks monetary and financial conditions that will foster price stability and promote sus- Present: tainable growth in output. To further its Mr. Bernanke, Chairman long-run objectives, the Committee in the Mr. Geithner, Vice Chairman Mr. Hoenig immediate future seeks conditions in reserve Mr. Kohn markets consistent with maintaining the fed- Mr. Kroszner eral funds rate at an average of around Ms. Minehan 5V4 percent. Mr. Mishkin The vote encompassed approval of Mr. Moskow Mr. Poole the text below for inclusion in the state- Mr. Warsh ment to be released at 2:15 p.m.: Mr. Fisher, Ms. Pianalto, and Messrs. In these circumstances, the Committee's Plosser and Stern, Alternate Mempredominant policy concern remains the risk bers of the Federal Open Market that inflation will fail to moderate as ex- Committee pected. Future policy adjustments will depend on the evolution of the outlook for Messrs. Lacker and Lockhart, and Ms. both inflation and economic growth, as Yellen, Presidents of the Federal implied by incoming information. Reserve Banks of Richmond, Atlanta, and San Francisco, respec- Votes for this action: Messrs. Bernanke, tively Geithner, Hoenig, Kohn, and Kroszner, Ms. Minehan, Messrs. Mishkin, Mos- Mr. Reinhart, Secretary and Economist kow, Poole, and Warsh. Votes against Ms. Smith, Assistant Secretary this action: None. Mr. Skidmore, Assistant Secretary Mr. Alvarez, General Counsel Meeting participants briefly discussed Ms. Johnson, Economist the next steps in their review of commu- Mr. Stockton, Economist nication issues and agreed to consider Messrs. Connors, Evans, Fuhrer, Madithem at the next FOMC meeting, con- gan, Rasche, Sellon, Slifman, and firmed for June 27-28, 2007. Wilcox, Associate Economists Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

214 94th Annual Report, 2007 Mr. Dudley, Manager, System Open Mr. Rosenblum, Executive Vice Presi- Market Account dent, Federal Reserve Bank of Dallas Messrs. Clouse and English, Associate Directors, Division of Monetary Ms. Mester, Messrs. Sniderman, Wein- Affairs, Board of Governors berg, and Williams, Senior Vice Presidents, Federal Reserve Banks Ms. Liang and Mr. Struckmeyer, Assoof Philadelphia, Cleveland, Richciate Directors, Division of Remond, and San Francisco, respecsearch and Statistics, Board of tively Governors Ms. McLaughlin and Mr. Tallman, Vice Messrs. Leahy and Wascher, Deputy Presidents, Federal Reserve Banks Associate Directors, Divisions of of New York and Atlanta, respec- International Finance and Retively search and Statistics, respectively, Board of Governors Ms. McConnell, Assistant Vice President, Federal Reserve Bank of Mr. Dale, Senior Adviser, Division of New York Monetary Affairs, Board of Governors Mr. Weber, Senior Research Officer, Federal Reserve Bank of Minne- Mr. Blanchard, Assistant to the Board, apolis Office of Board Members, Board of Governors The information reviewed at the June Mr. Gross,7 Special Assistant to the meeting suggested that the expansion of Board, Office of Board Members, economic activity rebounded in the sec- Board of Governors ond quarter from its subpar pace in the Mr. Small, Project Manager, Division first quarter. Upswings in net exports of Monetary Affairs, Board of and inventory investment were expected Governors to contribute importantly to the rise in Mr. Ahmed8 and Ms. Kusko,8 Senior real GDP. Consumer spending appeared Economists, Divisions of Interna- to have slowed from its rapid pace eartional Finance and Research and lier in the year, while business fixed in- Statistics, respectively, Board of vestment continued to rise at a modest Governors rate. Residential construction remained Mr. Luecke, Senior Financial Analyst, weak as builders worked further to clear Division of Monetary Affairs, high inventories of unsold homes. Sharp Board of Governors increases in energy prices drove up Ms. Beechey and Mr. Natalucci,8 overall inflation in April and appeared Economists, Division of Monetary to have done so again in May; core Affairs, Board of Governors inflation seemed to have remained Ms. Low, Open Market Secretariat Spe- subdued. cialist, Division of Monetary Af- Employment continued to rise at a fairs, Board of Governors moderate pace; the average monthly in- Mr. Moore, First Vice President, Fed- crease in payroll employment in April eral Reserve Bank of Cleveland and May was a little below that of the first quarter. In May, employment was boosted by strong hiring in the service 7. Attended portion of the meeting relating to sector, but the manufacturing and retail monetary policy communications. sectors continued to shed jobs. Larger 8. Attended portion of the meeting relating to payrolls and a slightly longer average the economic outlook and monetary policy discussion. workweek in May led to an increase in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 215 aggregate hours; the unemployment rate construction activity. In May, singleheld steady at 4.5 percent. family housing starts declined, and ad- Industrial production increased mod- justed permit issuance for the singleestly in April and May after having been family sector stepped down further, little changed in the first quarter when indicating that builders were intending some manufacturers restrained produc- to slow further the pace of new contion to cope with a buildup in invento- struction. The monthly readings on sales ries. Manufacturing output edged up in of new and existing homes through May recent months, reflecting increases in had fluctuated around levels lower than the output of light motor vehicles, other the average over the second half of consumer durable goods, construction 2006. Some, though not all, of this supplies, and durable materials. The pro- weakening in home sales was likely reduction of high-tech industries also rose, lated to the tightening of lending stanalbeit at a relatively sluggish pace com- dards for nonprime borrowers that bepared with the brisk expansion seen gan in February. Even though the around the turn of the year. Capacity inventory of new homes for sale ticked utilization in the manufacturing sector down in May, the months' supply in in May was close to its long-run average May remained noticeably above its level and slightly below its level one year in late 2006. According to OFHEO's earlier. purchase-only price index for existing The pace of real consumer spending homes, house-price appreciation continappeared to have slowed somewhat in ued to slow in the first quarter. the second quarter after substantial in- Outlays for nonresidential construccreases late last year and early this year. tion appeared to have remained robust The deceleration primarily reflected a early in the second quarter. Business flattening out of outlays for goods in spending on equipment and software in recent months; spending on services recent months appeared to be about uncontinued to rise at a solid pace for the changed from the first quarter, although quarter as a whole, although the monthly the softness was largely confined to outpattern was affected by weather-related lays for transportation equipment. Shipswings in outlays on energy services. ments and orders for items other than The determinants of household spend- transportation moved up markedly in ing were broadly supportive. Real dis- March and April after weakness in earposable personal income rose at a mod- lier months, and, even with the small erate pace, on average, in the first four declines in May, the data pointed to a months of the year, boosted not only by healthy rise in outlays in the second ongoing gains in wages and salaries, but quarter. In particular, real spending on also by unusually large bonus payments equipment other than high-tech and and stock option exercises in the first transportation seemed to be rebounding quarter. Although the household wealth- after sizable declines over the previous to-income ratio ticked down in the first two quarters. After a surge in outlays on quarter with the stock market up only a computers in the first quarter, spending little and house prices remaining soft, on high-tech equipment appeared to be the increase in stock prices in the second rising at a more modest pace in April quarter likely made up much of the lost and May. In contrast, spending on transground. portation equipment declined signifi- Elevated inventories of unsold new cantly. Purchases of medium and heavy homes continued to weigh on residential trucks dropped further in May, continu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

216 94th Annual Report, 2007 ing to reflect the payback from sales that Economic activity in advanced forwere pulled forward into 2005 and 2006 eign economies appeared to have grown in anticipation of tighter emissions stan- at a solid rate in the first quarter. Ecodards that took effect in January. New nomic growth in Canada rebounded orders for trucks picked up in May, al- sharply from a disappointing fourth beit from very low levels. Shipments quarter, and growth picked up in the data indicated that spending on aircraft United Kingdom, owing primarily to a dropped back from the elevated level in robust expansion in the service sector. In the first quarter. The downtrend in the the euro area, export growth in the first cost of capital was likely curtailed in quarter slowed from its rapid fourthrecent weeks by the rise in corporate quarter pace, and the hike in the German bond rates. Nonetheless, firms retained value-added tax likely temporarily ample cash in reserve to finance invest- depressed first-quarter consumption ment. growth. Consumer spending showed signs of recovering in recent months, Real nonfarm inventory investment and overall, economic conditions in the excluding motor vehicles slowed appreeuro area remained solid. In Japan, reciably in the first quarter of 2007, as cent data suggested that growth in the firms in most industries appeared to second quarter had moderated from the have made considerable progress in advigorous first-quarter pace, with public dressing the inventory overhangs that spending and net exports likely sources developed in 2006. The adjustment apof weakness. Recent data indicated that parently continued into the second quareconomic activity in emerging-market ter, as the ratio of inventories to sales for economies remained strong. Growth in manufacturing and trade excluding mo- China and India appeared to have modtor vehicles ticked down further in April erated somewhat from the very high after a March decline. Inventories of rates of the first quarter. In Latin light motor vehicles, which were pared America, indicators for Mexico sugdown to more comfortable levels during gested some recovery from the marked the first quarter, continued to edge lower slowdown of the previous few quarters, through May. Indeed, the inventory ad- while growth in Argentina and Brazil justment reached the point that, for the appeared to pick up as well. third month in a row, the May survey of Headline consumer price inflation purchasing managers indicated that, on stepped up in recent months, driven by net, more firms viewed their customers' large increases in the index for energy. inventory levels as too low rather than However, readings on core inflation had too high. declined. Core PCE prices rose 0.1 per- After no change between the fourth cent in April and were estimated to have quarter and first quarter, the U.S. inter- posted a similar, modest increase in national trade deficit narrowed in April May. The recent readings had been held from its March level. The recent narrow- down, in part, by declines in volatile ing reflected a steep decline in many categories such as apparel and tobacco categories of goods imports and a mod- products that were likely to prove transiest increase in exports, especially of ag- tory; the rent components had also dericultural products. Nominal imports of celerated. The twelve-month change in petroleum were flat in April after surg- core PCE prices in May was expected to ing in March despite steady increases in be lower than the increase over the yearthe price of imported oil. earlier period; however, over that longer Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 217 period, the decline in core PCE inflation investors seemed to reappraise their bewas almost entirely the result of a slow- liefs that the economic expansion would ing in its nonmarket component. House- slow and that monetary policy easing hold surveys conducted in early June would be forthcoming. This reappraisal indicated that the median expectation for seemed to be based in part on the release year-ahead inflation increased further, of some economic data in the United consistent with the energy-driven accel- States and abroad that were more favoreration in overall consumer prices in re- able than expected. As a result, the excent months. After edging higher in pected path of the federal funds rate over April and May, median expectations of the coming year was marked up sharply longer-term inflation fell back in June in financial markets. Yields on nominal and remained in the narrow range seen Treasury securities at all maturities also over the past two years. The twelve- rose over the intermeeting period, with month change in average hourly earn- the most pronounced gains in forward ings for production or nonsupervisory rates three to five years ahead. Measures workers edged lower in recent months. of long-horizon inflation compensation At its May meeting, the Federal Open based on inflation-indexed Treasury se- Market Committee (FOMC) maintained curities edged slightly higher. Yields on its target for the federal funds rate at investment-grade corporate bonds rose 5V4 percent. The Committee's accompa- in line with those on comparablenying statement noted that economic maturity Treasury securities, leaving growth slowed in the first part of the their spreads little changed. In contrast, year and that the adjustment in the hous- spreads on speculative-grade corporate ing sector was ongoing. Nevertheless, bonds narrowed. Equity prices were the economy seemed likely to expand at volatile at times during the intermeeting a moderate pace over coming quarters. period, but broad stock price indexes ad- Core inflation remained somewhat el- vanced modestly, on net, as favorable evated. Although inflation pressures news on the economy and announceseemed likely to moderate over time, the ments of mergers and acquisitions outhigh level of resource utilization had the weighed the drag of higher bond yields. potential to sustain those pressures. The The foreign exchange value of the dollar Committee's predominant policy con- against other major currencies was little cern remained the risk that inflation changed, on balance. would fail to moderate as expected. Fu- Gross bond issuance by nonfinancial ture policy adjustments would depend businesses surged in May from the alon the evolution of the outlook for both ready robust pace of earlier in the year. inflation and economic growth, as im- Acquisition-related financing continued plied by incoming information. to support corporate bond issuance, but Market participants had largely antici- a significant share of recent issues was pated the FOMC's decision at its May reportedly designated for capital expenmeeting to leave the target federal funds ditures. Commercial paper outstanding rate unchanged, but some market par- was unchanged in May, but bank lendticipants were reportedly surprised by ing maintained a strong pace. In the the retention of the assessment that in- household sector, mortgage debt exflation was "somewhat elevated." The panded at a slower pace in the first quarpublication of the minutes of the May ter, reflecting the slowdown in homemeeting elicited little market response. price appreciation over the past year and Over the intermeeting period, however, the lower pace of home sales. Interest Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

218 94th Annual Report 2007 rates available to prime borrowers on expanded at a moderate pace on balance both fixed-rate and variable-rate mort- over the first half of the year. In view of gages increased along with other market incoming data and anecdotal informainterest rates. Consumer credit contin- tion, participants continued to anticipate ued to expand at a moderate pace in the moderate economic growth in coming first quarter. After rising at a particularly quarters, with growth rising gradually to rapid rate in the first quarter, M2 in- a pace close to that of potential output. creased at a more moderate pace in Participants interpreted the most recent April and May. information on business spending, busi- In preparation for this meeting, the ness sentiment, and the labor market as staff reduced its estimate of the increase suggesting that the risks to growth were in real GDP in the first quarter and more balanced than at the time of the marked up its forecast of the rebound in May meeting, despite the ongoing adeconomic activity in the second quarter, justment in the housing sector and the in large part because of a more substan- significant recent increases in longertial swing in inventory investment than term interest rates. Participants generpreviously expected. The revisions, ally expected that inflation would probhowever, left the projection of economic ably edge lower over the next two years, growth over the first half of the year reflecting the waning of temporary facunchanged. As was the case in May, tors that had boosted prices last year and economic activity was expected to in- a slight easing of pressures on resources. crease at a rate a little below that of the Recent data on core consumer prices economy's long-run potential for the re- were encouraging in this regard, but parmainder of the year and to rise at a pace ticipants were wary of drawing any firm broadly in line with potential output conclusions about future trends from a growth in 2008. The projected gradual few monthly readings that could reflect acceleration in economic activity in transitory influences and remained concerned about forces that could contribcoming quarters largely reflected the exute to inflation pressures. Against this pected waning of the drag from residenbackdrop, participants agreed that the tial investment and improvements in the risk that inflation would fail to moderate pace of business fixed investment. Inas expected remained their predominant creases in energy and food prices over concern. the intermeeting period led the staff to revise up its forecast for headline PCE In preparation for the Federal Reinflation during the second quarter, but serve's semiannual report to the Conits projection of core PCE inflation was gress on the economy and monetary revised down. Although some of the re- policy, the members of the Board of cent slowing in readings on core PCE Governors and the presidents of the Fedinflation was likely due to transitory fac- eral Reserve Banks submitted individual tors, the staff took some signal from the projections of the growth of nominal and data and trimmed its forecast for core real GDP, the rate of unemployment, and PCE inflation slightly in coming quar- core consumer price inflation for the ters. Over the next several quarters, total years 2007 and 2008, conditioned on PCE inflation was projected to moderate their views of the appropriate path for to a pace close to core PCE inflation. monetary policy. The projections for the In their discussion of the economic growth of nominal GDP were in the situation and outlook, participants noted range of AVi to 5Vi percent, with a centhat economic activity appeared to have tral tendency of AVi to 5 percent for Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 219 2007; for 2008, the projections for the availability of mortgage credit and nominal GDP growth ranged between the demand for housing. 4Vi to 5Vi with a central tendency of Spillovers from the strains in the 43/4 to 5 percent. Projections for the rate housing market to consumption spendof expansion in real GDP in 2007 were ing had apparently been quite limited to in a range from 2 to 23A percent in 2007, date. To be sure, personal consumption with a central tendency of 2!/4 to expenditures appeared to be rising more 2x/2 percent; for 2008, the projections slowly in recent months than earlier in ranged between 2Vi to 3 percent, with a the year, but that development was probcentral tendency of 2Vi to 23A percent. ably, at least in part, a result of the rise These rates of growth were associated in gasoline prices, which was not exwith civilian unemployment rates in the pected to be extended. Participants genrange of 4Vi to 43A percent in the fourth erally anticipated moderate gains in conquarter of 2007 and 4V2 to 5 percent in sumption spending over coming months, the fourth quarter of 2008; the central supported by the strong labor market tendency of these projections was 4Vi to and solid growth in personal income. 43/4 percent in 2007 and about 43/4 per- Still, the advance in spending was excent in 2008. Projections for the rate of pected to fall short of income growth, inflation, as measured by the core PCE and the saving rate was anticipated to price index, in 2007 were in a range of trend higher over coming quarters from 2 to 2lA percent in 2007 and P/4 to the unusually low levels of recent years. 2 percent in 2008. The central tenden- Some participants noted a risk that the cies of these projections in 2007 and saving rate could rise more than cur- 2008 were identical to the ranges for rently foreseen, particularly if household those years. wealth were depressed by a further soft- Participants generally agreed that the ening in house prices or by a less buoyhousing sector was likely to remain a ant equity market that might accompany drag on growth for some time yet and a potential slowing in the growth of correpresented the most significant down- porate earnings. Several participants side risk to the economic outlook. Al- noted that higher interest rates and a pothough starts of single-family homes had tential tightening in credit availability moved up, on balance, over recent might also be factors that could contribmonths, permits for new construction ute to a rise in the personal saving rate. continued to decline. A number of par- At the same time, participants recogticipants noted that inventories of new nized that consumption growth had held homes for sale remained quite elevated. up to date and saw a risk that the saving Housing activity was seen as likely to rate could fail to rise as much as curcontinue to contract for several more rently expected, particularly if equity quarters. Participants also identified a markets continued to register significant number of downside risks associated gains. with their outlook for residential con- A number of participants remarked struction. The recent increase in interest that the recent data on business spendrates for prime mortgages could further ing were more encouraging than those dampen the demand for housing. More- available at the time of the May meetover, a number of participants pointed to ing. In particular, orders and shipments rising mortgage delinquency rates and for nondefense capital goods had related difficulties in the subprime mort- stepped up, on balance, from March gage market as factors that could crimp through May, and survey indicators of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

220 94th Annual Report 2007 business conditions had improved of pants noted that employment data for late. Strength in foreign demand for U.S. 2006 could ultimately be revised down, goods and services was another factor resulting in a corresponding upward rethat seemed likely to contribute to the vision to productivity. Some participants firming of business spending. Partici- also pointed to evidence of lags in empants noted that inventories appeared to ployment adjustments, particularly in be better aligned with sales, boding well the construction industry, as a factor defor a resumption of inventory accumula- pressing productivity in recent quarters. tion and a pickup in manufacturing ac- These observations suggested that the tivity. At the same time, some recog- recent decline in productivity growth nized the possibility that downside risks might prove smaller than now estimated to investment spending persisted. and largely transitory. Still, some de- Longer-term interest rates and the cost cline in the pace of trend productivity of credit generally had moved higher of growth could not be ruled out—a devellate, the growth of business profits opment that could have implications for seemed to be moderating, and measured business costs and price pressures. Some productivity growth had been slower. participants further noted that the level Although credit market conditions of the unemployment rate consistent seemed to remain generally quite ac- with stable inflation could be lower than commodative, in the days just prior to previously thought—a possibility that the meeting, the availability of credit to would help to explain the absence of some highly leveraged and other lower- outsized wage pressures in the current rated borrowers appeared to be tighten- environment. ing a bit and investors seemed to re- The incoming data on core consumer evaluate the risks associated with prices were viewed as favorable, but investments in complex and illiquid fi- were not seen as convincing evidence nancial instruments. that the recent moderation of core infla- Strength in spending abroad and the tion would be sustained. Participants decline in the exchange value of the dol- noted that monthly data on consumer lar were seen as factors boosting U.S. prices are noisy, and recent readings on exports. The rise in global interest rates core inflation seemed to have been dewas cited as evidence of increasing glo- pressed by transitory factors. Moreover, bal demand, and some participants a number of forces could sustain inflapointed to strength of aggregate demand tion pressures, including the generally worldwide and its potential effect on the high level of resource utilization, elprices of imports and globally traded evated energy and commodity prices, commodities as contributing to upside the decline in the exchange value of the risks to U.S. inflation. dollar over recent quarters, and slower Most participants judged labor mar- productivity growth. In addition, while ket conditions to remain rather tight, core consumer price inflation had modparticularly for the most skilled work- erated of late, total consumer price inflaers. The continued tautness of labor tion had moved substantially higher, markets was something of a puzzle in boosted by rising energy and food light of below-trend economic growth prices. While total inflation was exover recent quarters, and this develop- pected to slow toward the pace of core ment seemed to be connected with inflation over time, a number of particislower productivity growth lately. In pants noted that recent elevated readings their discussion of this issue, partici- posed some risk of a deterioration in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, June 221 inflation expectations. On this point, of resource utilization had the potential several participants cited the uptick in to fuel inflation pressures. Against this forward measures of inflation compen- backdrop, members judged that the risk sation over the intermeeting period de- that inflation would fail to moderate as rived from Treasury inflation-indexed expected remained their predominant securities. However, a portion of this in- concern. crease might be attributed to technical At the conclusion of the discussion, factors, and survey measures of long- the Committee voted to authorize and term inflation expectations had held direct the Federal Reserve Bank of New steady over recent weeks. Nonetheless, York, until it was instructed otherwise, several participants emphasized that to execute transactions in the System holding long-run inflation expectations Account in accordance with the followat or below current levels would likely ing domestic policy directive: be necessary for core inflation to moder- The Federal Open Market Committee ate as expected over coming quarters. seeks monetary and financial conditions that In their discussion of monetary policy will foster price stability and promote susfor the intermeeting period, members tainable growth in output. To further its generally regarded the risks to economic long-run objectives, the Committee in the growth as more balanced than at the immediate future seeks conditions in reserve time of the May meeting. Although the markets consistent with maintaining the federal funds rate at an average of around housing market remained a key source 5lA percent. of uncertainty about the outlook, members thought it most likely that the over- The vote encompassed approval of all economy would expand at a moder- the text below for inclusion in the stateate pace over coming quarters. Members ment to be released at 2:15 p.m.: generally anticipated that core inflation In these circumstances, the Committee's would remain relatively subdued but predominant policy concern remains the risk concurred that a sustained moderation in that inflation will fail to moderate as exinflation had not yet been convincingly pected. Future policy adjustments will demonstrated. In these circumstances, depend on the evolution of the outlook for both inflation and economic growth, as members agreed that maintaining the implied by incoming information. target federal funds rate at 5lA percent for this meeting was appropriate and that Votes for this action: Messrs. Bernanke, Geithner, Hoenig, Kohn, and Kroszner, future policy adjustments would depend Ms. Minehan, Messrs. Mishkin, Moson the outlook for economic growth and kow, Poole, and Warsh. Votes against inflation, as implied by incoming inforthis action: None. mation. In light of the recent economic data The Committee then again took up and anecdotal information, the Commit- the topic of monetary policy communitee agreed that the statement to be re- cations. The discussion at this meeting leased after the meeting should indicate focused on several key elements of the that the economy seemed to be expand- Committee's communications vehicles: ing at a moderate pace over the first half the statement released after each FOMC of the year. Members agreed that while meeting; the minutes of FOMC meetmeasures of core inflation had improved ings; and the projections of FOMC parlately, the statement should indicate that ticipants that are summarized in the Feda sustained moderation of inflation re- eral Reserve's semiannual monetary mained in question and that high levels policy reports to the Congress. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

222 94th Annual Report, 2007 Committee made no decisions at this Ms. Smith, Assistant Secretary meeting, and it was understood that the Mr. Skidmore, Assistant Secretary Mr. Alvarez, General Counsel subcommittee on communications is- Mr. Baxter, Deputy General Counsel sues would review the Committee's dis- Ms. Johnson, Economist cussions to date on these matters. It was agreed that the next meeting of Messrs. Connors, Evans, Fuhrer, Kamin, Rasche, Sellon, Slifman, the Committee would be held on Tues- Tracy, and Wilcox, Associate day, August 7, 2007. Economists The meeting adjourned at 2:20 p.m. Mr. Dudley, Manager, System Open Market Account Notation Vote Mr. Struckmeyer, Deputy Staff Direc- By notation vote completed on May 29, tor, Office of Staff Director for 2007, the Committee unanimously ap- Management, Board of Governors proved the minutes of the FOMC meet- Messrs. Clouse and English, Senior Asing held on May 9, 2007. sociate Directors, Division of Vincent R. Reinhart Monetary Affairs, Board of Governors Secretary Ms. Liang and Mr. Reifschneider, Associate Directors, Division of Re- Meeting Held on search and Statistics, Board of August 7, 2007 Governors A meeting of the Federal Open Market Messrs. Dale and Reinhart, Senior Ad- Committee was held in the offices of the visers, Division of Monetary Af- Board of Governors of the Federal Re- fairs, Board of Governors serve System in Washington, D.C., on Mr. Blanchard, Assistant to the Board, Tuesday August 7, 2007 at 8:30 a.m. Office of Board Members, Board of Governors Present: Mr. Bernanke, Chairman Mr. Meyer, Visiting Reserve Bank Of- Mr. Geithner, Vice Chairman ficer, Division of Monetary Af- Mr. Hoenig fairs, Board of Governors Mr. Kohn Ms. Dykes, Project Manager, Division Mr. Kroszner Mr. Mishkin of Monetary Affairs, Board of Mr. Moskow Governors Mr. Poole Mr. Luecke, Senior Financial Analyst, Mr. Rosengren Division of Monetary Affairs, Mr. Warsh Board of Governors Ms. Cumming, Mr. Fisher, Ms. Pian- Mr. Driscoll, Economist, Division of alto, and Messrs. Plosser and Monetary Affairs, Board of Gover- Stern, Alternate Members of the nors Federal Open Market Committee Ms. Low, Open Market Secretariat Spe- Messrs. Lacker and Lockhart, and Ms. cialist, Division of Monetary Af- Yeilen, Presidents of the Federal fairs, Board of Governors Reserve Banks of Richmond, Atlanta, and San Francisco, respec- Mr. Connolly, First Vice President, Fedtively eral Reserve Bank of Boston Mr. Madigan, Secretary and Economist Messrs. Judd and Rosenblum, Execu- Ms. Danker, Deputy Secretary tive Vice Presidents, Federal Re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 223 serve Banks of San Francisco and moderate pace during the first half of Dallas, respectively the year despite the ongoing drag from Ms. Mosser and Mr. Sniderman, Senior the housing sector. While the growth of Vice Presidents, Federal Reserve consumer spending slowed in the sec- Banks of New York and Cleve- ond quarter from its rapid pace in prior land, respectively quarters, wages and salaries increased Mr. Cunningham, Vice President, Fed- solidly and household sentiment aperal Reserve Bank of Atlanta peared supportive of further gains in spending. Business fixed investment Mr. Chatterjee, Senior Economic Adpicked up in the second quarter after viser, Federal Reserve Bank of Philadelphia little net change in the preceding two quarters. Inventories generally appeared Mr. Hetzel, Senior Economist, Federal to be well aligned with sales at midyear. Reserve Bank of Richmond Overall inflation receded in June be- Mr. Weber, Senior Research Officer, cause of a decline in energy prices, Federal Reserve Bank of Minnewhile the core personal consumption exapolis penditure (PCE) price index rose a bit In the agenda for this meeting, it was less than its average pace over the past reported that advices of the election of year. Eric S. Rosengren as a member of the Private nonfarm payroll employment Federal Open Market Committee had continued to increase at a healthy pace; been received and that he had executed the rise in July was about equal to the his oath of office. average increase over the first half of By unanimous vote, the Federal Open the year. Solid hiring in the service sec- Market Committee selected Brian F. tor was partly offset by declines in con- Madigan to serve as Secretary and struction and manufacturing employ- Economist until the selection of a suc- ment. Most of the drop in construction cessor at the first regularly scheduled employment occurred in jobs typically meeting of the Committee in 2008. associated with nonresidential construc- The Manager of the System Open tion. Both the average workweek and Market Account reported on recent de- aggregate hours ticked down in July. velopments in foreign exchange mar- The unemployment rate edged up to kets. There were no open market opera- 4.6 percent; it had remained between tions in foreign currencies for the 4.4 percent and 4.6 percent since Sep- System's account in the period since the tember 2006. previous meeting. The Manager also re- Industrial production picked up in the ported on developments in domestic fi- second quarter after little net change nancial markets and on System open over the preceding two quarters. The inmarket operations in government securi- crease was largely attributable to a ties and federal agency obligations dur- smaller drag from inventory liquidation ing the period since the previous meet- and a modest improvement in net exing. By unanimous vote, the Committee ports. Manufacturing production rose ratified these transactions. solidly in the second quarter because of The information reviewed at the Au- substantial increases in the output of gust meeting suggested that economic light motor vehicles, other durable conactivity picked up in the second quarter sumer goods, business equipment, confrom the slow pace in the first quarter. struction supplies, and materials. Pro- On average, the economy expanded at a duction in high-tech industries rose Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

224 94th Annual Report, 2007 relatively modestly in comparison to its and 2006 in anticipation of tighter emislonger-run growth. sions standards on diesel engines. New The growth of real consumer spend- orders for medium and heavy trucks ing slowed considerably in the second edged up in the second quarter, though quarter after substantial increases earlier they remained at low levels, suggesting in the year. The deceleration primarily that the downturn in business spending reflected sharply slower growth in out- on motor vehicles may be ending. lays for goods as purchases of motor Real nonfarm inventory investment vehicles decreased noticeably. Although was a roughly neutral influence on real a spike in energy prices eroded real in- GDP growth in the second quarter after come growth in the second quarter, there having held down the growth rate by an were solid gains in wages and salaries. average of 1 percentage point in the pre- Despite continued softness in house vious two quarters. Businesses made prices, household wealth moved mark- considerable progress in reducing the edly higher in the second quarter, mostly apparent inventory overhangs that had reflecting rising equity prices. emerged at the end of 2006. In the mo- Demand for housing in the second tor vehicle sector, low rates of assemquarter was restrained by higher interest blies in the first half of this year left rates and by tightening credit conditions inventories of domestic light vehicles at in the subprime mortgage market. Sales the end of the second quarter fairly well of new and existing homes in the second aligned with sales; however, inventories quarter were down substantially from rose again in July as production accelertheir average levels in the second half of ated and sales remained weak. More 2006. In June, single-family housing broadly, the number of purchasing manstarts held steady at their May rate, al- agers who viewed their customers' inthough adjusted permit issuance slipped ventory levels as too high in July only further. The combination of decreased slightly exceeded the number who saw sales and unchanged production left in- them as too low. ventories of new homes for sale still el- The U.S. international trade deficit evated. House-price appreciation contin- widened in May, as a rise in imports ued to slow, with some measures again more than offset an increase in exports. showing declines in home values. Within imports, most categories of Outlays for nonresidential construc- goods recorded an increase, as did sertion rose rapidly in the second quarter. vices. The value of oil imports rose Business spending on equipment and sharply, boosted by a jump in the price software, other than transportation of imported oil. The increase in exports equipment, posted a solid increase after was largely attributable to capital goods, being flat, on net, in the preceding two including aircraft, computers and semiquarters. The rise was led by a rebound conductors, and industrial supplies. in purchases of industrial machinery. Economic activity in advanced for- Expenditures for computers, software, eign economies expanded somewhat and communications equipment grew less rapidly in the second quarter than in moderately in the second quarter after a the prior quarter, but nonetheless apbrisk first-quarter increase. Spending on peared to have grown faster than trend, transportation equipment again declined reflecting upbeat business and consumer sharply. The drop was largely a continu- confidence as well as favorable labor ation of the payback from exceptionally market conditions. Although many of strong purchases of heavy trucks in 2005 those economies recently experienced Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 225 sharp declines in equity prices and wid- of some categories of goods, such as ening credit spreads amid deepening apparel, that tend to be volatile on a concerns about credit quality, these de- monthly basis. Household surveys convelopments occurred too late in the in- ducted in early July indicated that the termeeting period to have any apparent median expectation for inflation over the effect on incoming data. In Japan, sur- next year remained unchanged from vey evidence suggested that its economy June's elevated level despite declines in expanded moderately. Survey evidence gasoline prices in both months. Median indicated high levels of economic senti- expectations of longer-term inflation ment and strong capital spending plans ticked up and were near the top of the among large manufacturers. In the euro narrow range that had prevailed over the area, survey measures of business and past few years. The employment cost consumer confidence remained near index rose somewhat faster in the secrecord highs in July, and labor market ond quarter than over the preceding conditions generally continued to im- three months, and the twelve-month prove in May and June. In the United change was slightly higher than that of a Kingdom, real GDP growth rose in the year ago. second quarter, an increase driven At its June meeting, the Federal Open mainly by robust expansion in the ser- Market Committee (FOMC) maintained vice sector. Canada's growth seemed to its target for the federal funds rate at continue to pick up from its disappoint- 5VA percent. The statement announcing ing rate posted in much of last year. the policy decision noted that economic Recent data indicated that economic growth appeared to have been moderate activity in emerging-market economies during the first half of the year, despite remained generally strong. The Chinese the ongoing adjustment in the housing economy continued to expand at a rapid sector. The economy seemed likely to pace, and activity elsewhere in emerg- continue to expand at a moderate pace ing Asia appeared to have accelerated. over coming quarters. Readings on core In Latin America, Mexican indicators inflation had improved modestly in repointed to a weaker-than-expected re- cent months. However, a sustained modbound in the second quarter, whereas eration in inflation pressures had yet to Brazil and Argentina appeared to have be convincingly demonstrated. Moreexperienced solid growth. While equity over, the high level of resource utilizaprices fell and bond spreads widened in tion had the potential to sustain those several emerging-market economies, pressures. The Committee's predomiparticularly in Latin America, there was nant policy concern remained the risk no evidence that this increased volatility that inflation would fail to moderate as had yet weighed on economic activity. expected. Future policy adjustments U.S. headline consumer price infla- would depend on the evolution of the tion slowed in June as energy prices flat- outlook for both inflation and economic tened out after a rapid increase over the growth, as implied by incoming inforpreceding three months. Core PCE mation. prices rose 0.1 percent in June, as a de- Market participants had largely anticicline in the price index for core goods pated the FOMC's decision at its June nearly offset a rise in the index for core meeting to leave the target for the fedservices. The readings on core PCE eral funds rate unchanged, although the price inflation in recent months had been accompanying statement expressed held down, in part, by declines in prices greater concern about inflation than in- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

226 94th Annual Report, 2007 vestors reportedly had foreseen and credit conditions for investment-grade caused the expected path for the federal businesses and prime households were funds rate to edge higher. Expectations relatively little affected by the market for a policy easing diminished some- turbulence. Issuance of investmentwhat more in the wake of favorable eco- grade bonds continued. Yields on nomic news early in the period. Sub- investment-grade corporate issues rose sequently, the semiannual Monetary relative to yields on Treasury securities, Policy Report to the Congress and the but because yields on Treasuries deaccompanying testimony, which re- clined, yields on investment-grade ported lower projections for real GDP bonds were about unchanged on net. growth than investors apparently ex- Nonfinancial commercial paper outpected, appeared to prompt a downward standing posted a modest gain in July, shift in investors' expected path for the while the pace of bank lending to busifederal funds rate. Later in the inter- nesses picked up from an already solid meeting period, growing apprehension clip. Mortgage loans and consumer that turmoil in markets for subprime credit appeared to remain readily availmortgages and some low-rated corpo- able to households with strong balance rate debt might have adverse effects on sheets, although late in the period some economic growth led investors to mark evidence pointed to diminishing availdown their expectations for the future ability of jumbo mortgages. path of policy considerably further. At Broad stock price indexes declined the same time, measures of long-horizon substantially, on net, over the intermeetinflation compensation based on ing period despite generally solid inflation-indexed Treasury securities second-quarter earnings reports. Share edged down. prices of financial firms fell especially Financial market conditions were sharply, reportedly a reflection, in part, volatile during the intermeeting period, of concerns about exposures to sub particularly over the last few weeks of prime mortgages and about the effect of the interval. Yields on nominal Treasury a potential slowdown in merger activity securities fell on balance, possibly re- on operating profits. The foreign exflecting an increased preference by in- change value of the dollar against other vestors for safe assets as well as revi- major currencies fell, on balance. sions in policy expectations. Conditions Growth of home mortgage debt likely in markets for subprime mortgages and slowed again in the second quarter, related instruments, including segments mainly reflecting the decline in homeof the asset-backed commercial paper price appreciation over the past year and market, deteriorated sharply toward the the drop in home sales. Overall conend of the period. Credit conditions for sumer credit expanded moderately speculative-grade corporate borrowers through the year ending in May. The tightened substantially, as investors debt of nonfinancial businesses expulled back from higher-risk assets. panded at a robust pace in the second Spreads on speculative-grade bonds in- quarter but slowed in July. After rising creased to near their highest levels in the at a rapid pace in the first half of the past four years. A number of high-yield year, M2 grew at a more moderate rate bond and leveraged loan deals intended in July. to finance leveraged buyouts were de- In preparation for this meeting, the layed or restructured, though other high- staff lowered somewhat its forecast of yield bonds were issued. In contrast, real GDP growth in the second half of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 227 2007 and in 2008. The reduction was in tual output probably would remain close part due to the annual revision of na- to growth of potential GDP despite the tional income and product accounts ongoing adjustment in the housing sec- (NIPA), which revealed somewhat less tor. Several mentioned that the revisions rapid growth in output and productivity to the NIPA pointed to a modest downduring the past three years than previ- ward adjustment in projected growth of ously reported and led the staff to trim actual and potential GDP, but thought its estimates of the growth rates of struc- that potential output growth was likely tural productivity and potential GDP; to be a bit higher than forecast by the the reduction also reflected less accom- staff. However, recent spending indicamodative financial conditions and the tors had been mixed, and credit condisofter tone of some near-term indicators. tions had become tighter, suggesting The near-parallel revisions to the fore- greater downside risks to growth. Parcasts for potential and actual GDP left ticipants generally expected that core inthe staff's projections for resource utili- flation would edge lower over the next zation about unchanged. Although part two years, reflecting a slight easing of of the recent favorable monthly readings pressures on resources, well-anchored on core PCE price changes was expected inflation expectations, and the waning to be transitory, the staff revised down of temporary factors that had boosted slightly its forecast for core PCE price prices last year and early this year. Parinflation in the second half of 2007; ticipants anticipated that total inflation however, in light of slower growth in would slow as well, particularly if marstructural productivity and prospects of ket expectations of a modest decline in somewhat greater pressure from import energy prices in coming quarters were prices, the staff left its projection for to prove correct. But they were concore PCE inflation unchanged for 2008. cerned that the high level of resource Overall PCE inflation was expected to utilization and slower productivity slow in the second half of 2007 from the growth could augment inflation preselevated pace of the first half, as the sures. Against this backdrop, the Comeffects of the sizable increases in food mittee agreed that the risk that inflation and energy prices earlier this year would fail to moderate as expected reabated, and then to move down a bit mained its predominant policy concern. further in 2008. Participants agreed that the housing In their discussion of the economic sector was apt to remain a drag on situation and outlook, meeting partici- growth for some time and represented a pants indicated that they still saw mod- significant downside risk to the ecoerate economic expansion in coming nomic outlook. Indeed, developments in quarters as the most likely outcome but mortgage markets during the intermeetthat the downside risks to growth had ing period suggested that the adjustment increased. Participants reported that eco- in the housing sector could well prove to nomic expansion had continued at a be both deeper and more prolonged than moderate pace in many regions of the had seemed likely earlier this year. Parcountry despite further weakness in the ticipants noted that investors had behousing sector. Going forward, most come much more uncertain about the participants anticipated that growth in likely future cash flows from subprime aggregate demand would be supported and certain other nontraditional mortby rising employment, incomes, and ex- gages, and thus about the valuation of ports, with the result that growth in ac- securities backed by such mortgages. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

228 94th Annual Report, 2007 Consequently, the markets for securities though lenders recently appeared to be backed by subprime and other non- less willing to extend credit for financial traditional mortgages had become illiq- restructuring, the supply of credit to fiuid, and originations of new subprime nance real investment did not appear mortgages had dropped sharply. While significantly diminished. Funding had these markets were expected to recover become more costly and difficult to obover time, it was anticipated that credit tain for riskier corporate borrowers, but standards for these types of mortgages there had been little net change in the would be tighter, and interest rates cost of credit for investment-grade busihigher relative to rates on conforming nesses. Also, businesses in the aggremortgages, in the future than in recent gate continued to have sufficient interyears. However, participants also ob- nally generated funds to finance the served that mortgage loans remained expected level of real investment. Nonereadily available to most potential bor- theless, participants recognized that conrowers, and that interest rates on con- ditions in corporate credit markets could forming, conventional mortgage loans change rapidly, and that adverse effects had declined in recent weeks, providing on business spending were possible. some support to the housing sector. Moreover, heightened asset market vola- Participants thought that consumer tility and the associated increase in unexpenditures likely would expand at a certainty, if they were to persist for long, moderate pace in coming quarters, sup- could lead businesses to pare capital ported by solid gains in employment and spending plans. Still, participants judged real income. Though growth in con- that continued growth of investment outsumer spending had slowed in the sec- lays going forward was the most likely ond quarter, the slowing likely reflected outcome. temporary factors in part, including Rapid economic growth abroad and some payback from unusually strong the decline in the foreign exchange growth in prior quarters and the surge in value of the dollar in recent quarters gasoline prices. Several participants were seen as likely to boost U.S. exports noted the risks that house prices could and thus support the economic expandecline significantly and that credit stan- sion. Some participants also anticipated dards for home equity loans could be that growth in government purchases of tightened substantially as factors that goods and services would support concould weigh on consumer spending. tinued growth in output. However, the sizable upward revision— The data on core inflation received from negative to positive—in estimates during the intermeeting period were faof the personal saving rate during the vorable, but meeting participants bepast three years suggested somewhat lieved that the readings for the past few less need for households to rebuild their months likely had been damped by transavings. sitory factors and did not provide reli- Participants expected that business in- able evidence that the recent level would vestment would be supported by solid be sustained. Still, participants thought fundamentals, including high profits, that a slight decrease in pressures on strong business balance sheets, and resources and the stability of inflation moderate growth in output. Recent fi- expectations likely would foster over nancial market developments were time a gradual moderation in core inflathought unlikely to have an appreciable tion. Participants anticipated that total adverse effect on capital spending. Al- inflation would slow as well, particu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, August 229 larly if market expectations for a modest tions, but recognized that the process decline in energy prices in coming quar- likely would take some time, particuters were to prove correct. Participants larly in markets related to subprime remained concerned about factors that mortgages. However, a further deterioracould augment inflation pressures, in- tion in financial conditions could not be cluding the continuing high level of re- ruled out and, to the extent such a develsource utilization and slower trend opment could have an adverse effect on growth in productivity. Some also growth prospects, might require a policy pointed to the strength of aggregate de- response. Policymakers would need to mand worldwide and the depreciation of watch the situation carefully. For the the dollar, and their potential effects on present, however, given expectations the prices of imports and globally traded that the most likely outcome for the commodities, as contributing to upside economy was continued moderate risks to U.S. inflation. Several partici- growth, the upside risks to inflation repants noted significant increases in mained the most significant policy conwages in their Districts, particularly in cern. In these circumstances, members the service sector, but it was also ob- agreed that maintaining the target fedserved that overall gains in labor com- eral funds rate at 5lA percent at this pensation had remained moderate, sug- meeting was appropriate. gesting that sustainable rates of resource In light of the recent economic data, utilization could be slightly higher than anecdotal information, and financial typically estimated. On balance, partici- market developments, the Committee pants continued to agree that risks to the agreed that the statement to be released outlook for sustained moderation in in- after the meeting should indicate that flation pressures remained tilted to the economic growth was moderate during upside. the first half of the year and that the In their discussion of monetary policy economy seemed likely to continue to for the intermeeting period, Committee expand moderately in coming quarters, members again agreed that maintaining supported by solid growth in employthe existing stance of policy at this ment and incomes and by robust ecomeeting was likely to be consistent with nomic growth abroad. Members also the overall economy expanding at a agreed that the statement should incormoderate pace over coming quarters and porate their view that downside risks to inflation pressures moderating over growth had increased somewhat, and time. The expansion would be supported should mention volatile financial marby solid job gains and rising real in- kets, tighter credit conditions for some comes that would bolster consumption, households and businesses, and the onand by increasing foreign demand for going correction in the housing market. goods and services produced in the In addition, the Committee agreed that United States. The ongoing adjustment the statement should again note that in housing markets likely would exert a readings on core inflation had improved restraining influence on overall growth modestly in recent months but did not for several more quarters and remained yet convincingly demonstrate a susa key source of uncertainty about the tained moderation of inflation pressures, outlook. The recent strains in financial and that the high level of resource utilimarkets posed additional downside risks zation had the potential to sustain inflato economic growth. Members expected tion pressures. Against this backdrop, a return to more normal market condi- members judged that the risk that infla- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

230 94th Annual Report, 2007 tion would fail to moderate as expected Meeting Held on continued to outweigh other policy September 18, 2007 concerns. At the conclusion of the discussion, A meeting of the Federal Open Market the Committee voted to authorize and Committee was held in the offices of the Board of Governors of the Federal Redirect the Federal Reserve Bank of New serve System in Washington, D.C., on York, until it was instructed otherwise, Tuesday, September 18, 2007 at 8:30 to execute transactions in the System a.m. Account in accordance with the following domestic policy directive: Present: Mr. Bernanke, Chairman The Federal Open Market Committee Mr. Geithner, Vice Chairman seeks monetary and financial conditions that Mr. Evans will foster price stability and promote sus- Mr. Hoenig tainable growth in output. To further its Mr. Kohn long-run objectives, the Committee in the Mr. Kroszner immediate future seeks conditions in reserve Mr. Mishkin markets consistent with maintaining the fed- Mr. Poole eral funds rate at an average of around 5lA percent. Mr. Rosengren Mr. Warsh The vote encompassed approval of Mr. Fisher, Ms. Pianalto, and Messrs. the text below for inclusion in the state- Plosser and Stern, Alternate Memment to be released at 2:15 p.m.: bers of the Federal Open Market Committee Although the downside risks to growth have increased somewhat, the Committee's Messrs. Lacker and Lockhart, and Ms. predominant policy concern remains the risk Yellen, Presidents of the Federal that inflation will fail to moderate as Reserve Banks of Richmond, Atexpected. Future policy adjustments will lanta, and San Francisco, respecdepend on the outlook for both inflation and tively economic growth, as implied by incoming information. Mr. Madigan, Secretary and Economist Ms. Danker, Deputy Secretary Votes for this action: Messrs. Bernanke, Ms. Smith, Assistant Secretary Geithner, Hoenig, Kohn, Kroszner, Mr. Skidmore, Assistant Secretary Mishkin, Moskow, Poole, Rosengren, Mr. Alvarez, General Counsel and Warsh. Votes against this action: Mr. Baxter, Deputy General Counsel None. Ms. Johnson, Economist Mr. Stockton, Economist It was agreed that the next meeting of the Committee would be held on Tues- Messrs. Clouse, Connors, Fuhrer, Kaday, September 18, 2007. min, Rasche, Slifman, and Wilcox, Associate Economists The meeting adjourned at 1:25 p.m. Mr. Dudley, Manager, System Open Market Account Notation Vote Ms. J. Johnson,9 Secretary, Office of By notation vote completed on July 18, the Secretary, Board of Governors 2007, the Committee unanimously approved the minutes of the FOMC meeting held on June 27-28, 2007. 9. Attended portion of the meeting relating to Brian F. Madigan the discussion of approaches to stabilizing money Secretary markets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 231 Mr. Frierson,9 Deputy Secretary, Office Messrs. Judd, Rosenblum, and Sniderof the Secretary, Board of Gover- man, Executive Vice Presidents, nors Federal Reserve Banks of San Francisco, Dallas, and Cleveland, Ms. Bailey9 and Mr. Roberts,9 Deputy respectively Directors, Division of Banking Supervision and Regulation, Board of Messrs. Dzina and Hakkio, Mses. Governors Krieger9 and Mester, and Messrs. Rolnick and Weinberg, Senior Mr. English, Senior Associate Director, Vice Presidents, Federal Reserve Division of Monetary Affairs, Banks of New York, Kansas City, Board of Governors New York, Philadelphia, Minne- Ms. Liang and Mr. Reifschneider, Asso- apolis, and Richmond, respectively ciate Directors, Division of Re- Messrs. Krane, Peach, and Robertson, search and Statistics, Board of Vice Presidents, Federal Reserve Governors Banks of Chicago, New York, and Mr. Wright, Deputy Associate Director, Atlanta, respectively Division of Monetary Affairs, In the agenda for this meeting, it was Board of Governors reported that advices of the election of Mr. G. Evans,9 Assistant Director, Divi- Charles L. Evans as a member of the sion of Reserve Bank Operations Federal Open Market Committee had and Payment Systems, Board of been received and that he had executed Governors his oath of office. Mr. Blanchard, Assistant to the Board, By unanimous vote, the Federal Open Office of Board Members, Board Market Committee selected James A. of Governors Clouse and Daniel G. Sullivan to serve Mr. Oliner, Senior Adviser, Division of as Associate Economists until the selec- Research and Statistics, Board of tion of their successors at the first regu- Governors larly scheduled meeting of the Commit- Mr. Meyer, Visiting Reserve Bank Of- tee in 2008. ficer, Division of Monetary Af- The Manager of the System Open fairs, Board of Governors Market Account (SOMA) reported on Mr. Small, Project Manager, Division recent developments in foreign exof Monetary Affairs, Board of change markets. There were no open Governors market operations in foreign currencies Mr. Natalucci, Senior Economist, Divi- for the System's account in the period sion of Monetary Affairs, Board of since the previous meeting. The Man- Governors ager also reported on developments in Mr. Luecke, Senior Financial Analyst, domestic financial markets and on Sys- Division of Monetary Affairs, tem open market operations in govern- Board of Governors ment securities and federal agency obli- Ms. Beattie,9 Assistant to the Secretary, gations during the period since the Office of the Secretary, Board of previous meeting. By unanimous vote, Governors the Committee ratified these trans- Ms. Low, Open Market Secretariat Spe- actions. cialist, Division of Monetary Af- The information reviewed at the Sepfairs, Board of Governors tember meeting suggested that economic Ms. Holcomb, First Vice President, activity advanced at a moderate rate Federal Reserve Bank of Dallas early in the third quarter. After expand- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

232 94th Annual Report 2007 ing at a robust pace in July, retail sales though auto sales were weak in July, rose at a somewhat slower rate in Au- real outlays for other goods rose briskly. gust. Orders and shipments of capital At the same time, spending on services goods posted solid gains in July. How- was up moderately despite a drop in outever, residential investment weakened lays for energy associated with relafurther, even before the recent disrup- tively cool weather in the eastern part of tions in mortgage markets. In addition, the United States. In August, consumpprivate payrolls posted only a small gain tion appeared to have posted another in August, and manufacturing produc- solid gain. Although nominal retail sales tion decreased after gains in the previ- outside the motor vehicle sector were ous two months. Meanwhile, core infla- about flat (abstracting from a drop in tion rose a bit from the low rates nominal sales at gasoline stations associobserved in the spring but remained ated with falling gas prices), vehicle moderate through July. sales stepped up and warmer weather Private nonfarm payroll employment likely caused an increase in energy usrose only modestly in August, and the age. Real disposable income rose further levels of employment in June and July in July, as wages and salaries posted a were revised down. The weakness in strong gain and energy prices came employment was spread fairly widely down. However, household wealth across industries. Residential construc- likely was providing a diminishing imtion and manufacturing posted notice- petus to the pace of spending, reflecting able declines in jobs, employment in recent declines in stock market wealth wholesale trade and transportation was and an apparent further deceleration in little changed, and hiring at business ser- house prices. Readings on consumer vices was well below recent trends. Both sentiment turned down in August after the average workweek and aggregate having risen in July, and the Reuters/ hours were unchanged in August. The Michigan index remained near its unemployment rate held steady at relatively low August level in early 4.6 percent, 0.1 percentage point above September. its second-quarter level and equal to its The housing sector remained excep- 2006 average. tionally weak. Home sales had dropped After posting solid gains in June and considerably this year: Sales of new and July, total industrial production edged existing single-family homes in July up only a bit in August. This increase were down substantially from their averwas attributable to a surge in electricity ages over the second half of last year. generation, as temperatures swung from Demand was restrained by deteriorating mild in July to very warm in August. conditions in the subprime mortgage After large gains in the preceding two market and by an increase in rates for months, manufacturing output declined thirty-year fixed-rate conforming mortin August, held down by a decrease in gages. In the nonconforming mortgage the production of motor vehicles and market, the availability of financing to parts. High-tech output rose only mod- borrowers recently appeared to have estly in August, but production gains in been crimped even further. Most June and July were revised up consider- forward-looking indicators of housing ably. demand, including an index of pending Consumer spending appeared to have home sales, pointed to a further deteriostrengthened early in the summer from ration in sales in the near term. Singleits subdued second-quarter pace. Al- family starts slid in July to their lowest Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 233 reading since 1996, and adjusted permit exceeded the number who saw them as issuance continued on a downward tra- too high. jectory. Although single-family housing The U.S. international trade deficit starts had come down substantially from narrowed slightly in July, as exports intheir peak, the drop had lagged the de- creased more than imports. Sharp incline in demand, and as a result, inven- creases in exports of both aircraft and tories of new homes had risen consider- automobiles contributed importantly to ably. In the multifamily sector, starts in the overall gain. Exports of agricultural July were in line with readings thus far products and consumer goods were also this year and at the low end of the fairly strong. In contrast, exports of industrial narrow range seen since 1997. Mean- supplies and semiconductors exhibited while, house prices generally continued declines. The value of imported goods to decelerate. and services was boosted by a large increase in imports of automotive prod- Orders and shipments of capital goods ucts. Higher imports of capital goods posted a strong gain early in the third excluding aircraft, computers, and semiquarter. In particular, orders and shipconductors and of oil also contributed to ments of equipment outside the highthe overall gain in imports. tech and transportation sector registered Economic growth slowed in the seca robust increase in July, and data on ond quarter in most advanced foreign computer production and shipments of economies, except the United Kingdom. high-tech goods pointed to solid in- The step-down was most pronounced in creases in business demand for high- Japan, where GDP contracted, but was tech. In contrast, indicators of spending also substantial in the euro area, where for transportation equipment were total domestic demand rose only mixed. Aircraft shipments in July and slightly. Although growth remained ropublic information on Boeing's deliverbust in Canada, data late in the quarter, ies suggested that domestic spending on including retail sales, indicated a more aircraft was retreating somewhat in the significant weakening in activity. This current quarter. While fleet sales of light softness appeared to have continued into vehicles appeared to have moved up in the third quarter in some economies. In July and August, sales of medium and July, indicators for Europe generally heavy trucks remained below the moderated, on balance, from their second-quarter average. More generally, second-quarter levels; those for Canada surveys of business conditions sugand Japan, however, slowed more notagested that increases in business activity bly. Most of the readings available on were somewhat slower in August than economic developments after August 9, in the second quarter. when financial turmoil intensified, were Book-value data for the manufactur- measures of confidence. They dropped, ing and trade sectors excluding motor on average, but otherwise were consisvehicles and parts suggested that inven- tent with the indicators reported for July. tory accumulation stepped down notice- Data through July suggested that ecoably in July from the second-quarter nomic activity in emerging-market pace. Inventories of light motor vehicles countries remained robust. Output in the rose again in July and August. The num- Asian economies soared in the second ber of manufacturing purchasing manag- quarter, and several countries posted ers who viewed their customers' inven- growth at or near double-digit rates. In tory levels as too low in August slightly Latin America, output in Mexico and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

234 94th Annual Report, 2007 Venezuela rebounded sharply from ear- At its August meeting, the FOMC delier weakness. Indicators for China in cided to maintain its target for the fed- July pointed to only a modest slowing of eral funds rate at 5lA percent. In the output growth from its torrid pace in the statement, the Committee acknowledged first half of the year. The scant data for that financial markets had been volatile August received thus far provided little in recent weeks, credit conditions had indication that the turmoil in financial become tighter for some households and markets had a significant negative im- businesses, and the housing correction pact on real economic activity in was ongoing. The Committee reiterated emerging-market economies. its view that the economy seemed likely After rapid price increases earlier this to continue to expand at a moderate pace year, U.S. headline consumer price infla- over coming quarters, supported by tion was moderate in both June and July. solid growth in employment and in- Although food prices continued their comes and a robust global economy. string of sizable increases, energy prices Readings on core inflation had improved fell in June and July and gasoline prices modestly in recent months. However, a appear to have dropped further in Au- sustained moderation in inflation presgust. Core PCE prices rose 0.2 percent sures had yet to be convincingly demonin June and 0.1 percent in July. On a strated. Moreover, the high level of retwelve-month-change basis, core PCE source utilization had the potential to inflation in July was below the compa- sustain these pressures. Although the rable rate twelve months earlier. Step- downside risks to growth had increased downs in price inflation for prescription somewhat, the Committee repeated that drugs, motor vehicles, and nonmarket its predominant policy concern reservices accounted for nearly all of the mained the risk that inflation would fail deceleration in core PCE prices. Al- to moderate as expected. Future policy though owners' equivalent rent deceler- adjustments would depend on the outated over the past year, this change was look for both inflation and economic largely offset by an acceleration in ten- growth, as implied by incoming inforants' rent and lodging away from home. mation. The FOMC's policy decision Household surveys indicated that the and the accompanying statement were median expectation for year-ahead infla- about in line with market expectations, tion declined in August and edged down and reactions in financial markets were further in early September to a level muted. only slightly above the reading at the In the days after the August FOMC turn of the year; the median expectation meeting, financial market participants of longer-term inflation in early Septem- appeared to become more concerned ber remained in the range seen over the about liquidity and counterparty credit past couple of years. The producer price risk. Unsecured bank funding markets index for core intermediate materials showed signs of stress, including volatilrose only modestly in July. Compensa- ity in overnight lending rates, elevated tion per hour decelerated in the second term rates, and illiquidity in term fundquarter. Nonetheless, the increase over ing markets. On August 10, the Federal the four quarters ending in the second Reserve issued a statement announcing quarter was noticeably above the in- that it was providing liquidity to facilicrease in the preceding four quarters and tate the orderly functioning of financial well above the rise in the employment markets. The Federal Reserve indicated cost index over the same period. that it would provide reserves as neces- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 235 sary through open market operations to Short-term financial markets came promote trading in the federal funds under pressure over the intermeeting pemarket at rates close to the target rate of riod amid heightened investor unease 514 percent. The Federal Reserve also about exposures to subprime mortgages noted that the discount window was and to structured credit products more available as a source of funding. generally. Rates on asset-backed com- On August 17, the FOMC issued a mercial paper and on low-rated unsestatement noting that financial market cured commercial paper soared, and conditions had deteriorated and that some issuers, particularly asset-backed tighter credit conditions and increased commercial paper programs with investuncertainty had the potential to restrain ments in subprime mortgages, found it economic growth going forward. The difficult to roll over maturing paper. FOMC judged that the downside risks to These developments led several progrowth had increased appreciably, indi- grams to draw on backup lines, exercise cated that it was monitoring the situa- options to extend the maturity of outtion, and stated that it was prepared to standing paper, or even default. As a act as needed to mitigate the adverse result, asset-backed commercial paper effects on the economy arising from the outstanding contracted substantially. Indisruptions in financial markets. Simul- vestors sought the safety and liquidity of taneously, the Federal Reserve Board Treasury securities, and yields on Treaannounced that, to promote the restora- sury bills dropped sharply for a period; tion of orderly conditions in financial trading conditions in the bill market markets, it had approved a 50 basis point were impaired at times. Meanwhile, reduction in the primary credit rate to banks took measures to conserve their 53/4 percent. The Board also announced liquidity and were cautious about couna change to the Reserve Banks' usual terparties' exposures to asset-backed practices to allow the provision of term commercial paper. Term interbank fundfinancing for as long as thirty days, re- ing markets were significantly impaired, newable by the borrower. In addition, with rates rising well above expected the Board noted that the Federal Re- future overnight rates and traders reportserve would continue to accept a broad ing a substantial drop in the availability range of collateral for discount window of term funding. Pressures eased a bit in loans, including home mortgages and re- mid-September, but short-term financial lated assets, while maintaining existing markets remained strained. collateral margins. On August 21, the Conditions in corporate credit mar- Federal Reserve Bank of New York an- kets were mixed. Investment- and nounced some temporary changes to the speculative-grade corporate bond terms and conditions of the SOMA se- spreads edged up; they were near their curities lending program, including a re- highest levels in four years, although duction in the minimum fee. The effec- they remained far below the peaks seen tive federal funds rate was somewhat in mid-2002. Investment-grade bond isbelow the target rate for a time over the suance was strong in August as yields intermeeting period, as efforts to keep declined, but issuance of speculativethe funds rate near the target were ham- grade bonds was scant. Speculativepered by technical factors and financial grade bond deals and leveraged loans market volatility. In the days leading up slated to finance leveraged buyouts conto the FOMC meeting, however, the tinued to be delayed or restructured. funds rate traded closer to the target. Bank lending to businesses surged in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

236 94th Annual Report, 2007 August, apparently because some banks at a brisk pace in August. The rise was funded leveraged loans that they had in- led by a surge in liquid deposits and in tended to syndicate to institutional in- retail money funds as investors adjusted vestors and perhaps because some firms their portfolios in response to the tursubstituted bank credit for commercial moil in financial markets. paper. Although markets for noncon- In preparation for this meeting, the forming mortgages were impaired over staff continued to estimate that real GDP the intermeeting period, the supply of increased at a moderate rate in the third conforming mortgages seemed to have quarter. However, the staff marked down been largely unaffected by recent devel- the fourth-quarter forecast, reflecting a opments. Broad stock price indexes judgment that the recent financial turbuwere volatile but about unchanged, on lence would impose restraint on econet, over the intermeeting period. The nomic activity in coming months, parforeign exchange value of the dollar ticularly in the housing sector. The staff against other major currencies fell, on also trimmed its forecast of real GDP balance. growth in 2008 and anticipated a modest Investors appeared to mark down sig- increase in unemployment. Softer denificantly their expected path for the mand for homes amid a reduction in the federal funds rate during the intermeet- availability of mortgage credit would ing period, evidently in response to the likely curtail construction activity strains in money and credit markets and through the middle of next year. Morea few key data releases, including over, lower housing wealth, slower gains weaker-than-expected reports on hous- in employment and income, and reduced ing activity and employment. Yields on confidence seemed likely to restrain nominal Treasury securities fell appre- consumer spending in 2008. Despite the ciably across the term structure. TIPS- recent difficulties in some corporate based inflation compensation at the five- credit markets, financial conditions conyear horizon was about unchanged, fronting most nonfinancial businesses while inflation compensation at longer did not appear to have tightened apprehorizons crept higher. ciably to date. But going forward, the Growth of nonfinancial domestic debt staff anticipated that businesses would was estimated to have slowed a little in scale back their capital spending a touch the third quarter from the average pace in response to financing conditions that in the first half of the year. The decelera- were likely to become a little less action in total nonfinancial debt reflected a commodative and to more modest gains projected slowdown in borrowing across in sales. With credit markets expected to all major sectors of the economy largely recover over coming quarters, excluding the federal government. growth of real GDP was projected to Although it decelerated in the third firm in 2009 to a pace a bit above the quarter, business-sector debt continued rate of growth of its potential. Incoming to advance at a solid pace, boosted by a data on consumer price inflation that surge in business loans. In the house- were slightly to the low side of the prehold sector, mortgage borrowing was vious forecast, in combination with the estimated to have slowed notably, as easing of pressures on resource utilizamortgage interest rates moved up, non- tion in the current forecast, led the staff conforming mortgages became harder to to trim slightly its forecast for core PCE obtain, and as home sales slowed and inflation. Headline PCE inflation, which house prices decelerated. M2 increased was boosted by sizable increases in en- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 237 ergy and food prices earlier in the year, the recent deterioration in various term was expected to slow in 2008 and 2009. funding markets, might well lead banks In their discussion of the economic to tighten the availability of credit to situation and outlook, meeting partici- households and firms. Tighter credit pants focused on the potential for recent conditions were likely to weigh particucredit market developments to restrain larly on residential investment and to a aggregate demand in coming quarters. lesser extent on other components of ag- The disruptions to the market for non- gregate demand in coming quarters. conforming mortgages were likely to re- Meeting participants also noted that fiduce further the demand for housing, nancial market conditions, while seemand recent financial developments could ing to have improved somewhat in the well lead to a more general tightening of most recent days, were still fragile and credit availability. Moreover, some re- that further adverse credit market develcent data and anecdotal information opments could well increase the downpointed to a possible nascent slowdown side risks to the economy. Even after in the pace of expansion. Given the un- market volatility subsided and the recent usual nature of the current financial strains eased, risk spreads probably shock, participants regarded the outlook would be wider and credit terms tighter for economic activity as characterized than they had been a few months ago. by particularly high uncertainty, with the Although these developments would risks to growth skewed to the downside. likely be consistent with longer-term fi- Some participants cited concerns that a nancial stability, they were likely to exweaker economy could lead to a further ert some restraint on aggregate demand. tightening of financial conditions, which In their discussion of individual secin turn could reinforce the economic tors of the economy, participants noted slowdown. But participants also noted that recent data suggested greater weakthat the resilience of the economy in the ness in the housing market than had preface of a number of previous periods of viously been expected. Furthermore, refinancial market disruptions left open cent financial developments had the the possibility that the macroeconomic potential to deepen further and prolong effects of the financial market turbu- the downturn in the housing market, as lence would prove limited. subprime mortgages remained essen- Although financial markets were ex- tially unavailable, little activity was evipected to stabilize over time, partici- dent in the markets for other nonprime pants judged that credit markets were mortgages, and prime jumbo mortgage likely to restrain economic growth in the borrowers faced higher rates and tighter period ahead. Given existing commit- lending standards. The faster pace of ments to customers and the increased foreclosures as subprime mortgage rates resistance of investors to purchasing reset was also seen as posing a downsome securitized products, banks might side risk to the housing market. Noneneed to take a large volume of assets theless, participants observed that cononto their balance sheets over coming forming mortgages remained readily weeks, including leveraged loans, asset- available to creditworthy borrowers and backed commercial paper, and some that rates on these mortgages had detypes of mortgages. Banks' concerns clined in recent weeks. Moreover, condiabout the implications of rapid growth tions in the jumbo mortgage market in their balance sheets for their capital were expected to improve gradually ratios and for their liquidity, as well as over time. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

238 94th Annual Report, 2007 Although employment probably was date on business capital spending plans not as weak as the most recent monthly and expected that business investment data had suggested, trend growth in jobs was likely to remain healthy in coming had fallen off even prior to the recent quarters. The access of investment-grade financial market strains, and participants corporate borrowers to credit so far rejudged that some further slowing of em- mained unimpeded, and rates on ployment growth was likely. Indeed, fi- investment-grade bonds had declined in nancial services firms had already an- recent weeks. Moreover, participants nounced layoffs, largely reflecting noted that many capital expenditures mortgage market developments, the de- were internally financed, making them mand for temporary workers appeared less sensitive to credit market condito have softened, and the most recent tions. Nonetheless, the pace of financing weakening in construction employment for lower-rated firms—including issuwas likely to continue for a while. More- ance of both speculative-grade bonds over, if declines in house prices were to and leveraged loans—had slowed damp consumption, that could feed back sharply over the summer. Participants on employment and income, exerting also noted that standards and terms for additional restraint on the demand for commercial real estate credit reportedly housing. Nonetheless, to date, initial had tightened, and that credit availabilclaims for unemployment insurance did ity for homebuilders could be trimmed not indicate a substantial and wide- going forward. In addition, contacts inspread weakening in labor demand, and dicated that business executives in parts labor markets across the country gener- of the country had apparently become ally remained fairly tight, with several somewhat more cautious and that some participants citing continued reports of were delaying investment outlays in shortages of labor from their contacts in view of heightened economic and finansome sectors. cial uncertainty. Participants thought that the most Some participants noted that foreign likely prospect was for consumer demand remained robust and net exports expenditures to continue to expand at a appeared strong. Port utilization rates remoderate pace on average over coming portedly remained high. Participants disquarters, supported by growth in em- cussed the turbulence in foreign finanployment and income. However, some cial markets and noted that unusually participants saw indications of a pos- high precautionary demand for dollarsible weakening of consumer spending. denominated term funding in Europe Sales of automobiles and building mate- had added to strains in U.S. interbank rials had flagged of late, and survey markets and contributed to a wide measures suggested that consumer con- spread between libor and federal funds fidence had been adversely affected by rates. the recent financial market develop- Participants made only modest reviments. Also, a further tightening of sions to their outlook for inflation in the terms for home equity lines of credit and period since the Committee's last regusecond mortgages seemed possible, lar meeting. Still, they recognized that which could weigh on consumer spend- incoming data on core inflation contining, especially for consumer durables. ued to be favorable, and they generally Participants reported that recent fi- were a little more confident that the denancial market developments generally cline in inflation earlier this year would appeared to have had limited effects to be sustained. Inflation expectations Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, September 239 seemed to be contained, and the less With economic growth likely to run berobust economic outlook implied some- low its potential for a while and with what less pressure on resources going incoming inflation data to the favorable forward. Participants nonetheless re- side, the easing of policy seemed unmained concerned about possible upside likely to affect adversely the outlook for risks to inflation. Higher benefit costs, inflation. rising unit labor costs more generally, The Committee agreed that the statereduced markups, and levels of resource ment to be released after the meeting utilization both in the United States and should indicate that the outlook for ecoabroad that remained relatively high nomic growth had shifted appreciably were all cited as factors that could con- since the Committee's last regular meettribute to inflationary pressures. Infla- ing but that the 50 basis point easing in tion risks could be heightened if the policy should help to promote moderate dollar were to continue to depreciate growth over time. They also agreed that significantly. the inflation situation seemed to have In the Committee's discussion of improved slightly and judged that it was policy for the intermeeting period, all no longer appropriate to indicate that a members favored an easing of the stance sustained moderation in inflation presof monetary policy. Members empha- sures had yet to be shown. Nonetheless, sized that because of the recent sharp all agreed that some inflation risks rechange in credit market conditions, the mained and that the statement should incoming data in many cases were of indicate that the Committee would conlimited value in assessing the likely evo- tinue to monitor inflation developments lution of economic activity and prices, carefully. Given the heightened unceron which the Committee's policy decitainty about the economic outlook, the sion must be based. Members judged Committee decided to refrain from prothat a lowering of the target funds rate viding an explicit assessment of the balwas appropriate to help offset the effects ance of risks, as such a characterization of tighter financial conditions on the could give the mistaken impression that economic outlook. Without such policy the Committee was more certain about action, members saw a risk that tightenthe economic outlook than was in fact ing credit conditions and an intensifying the case. Future actions would depend housing correction would lead to sigon how economic prospects were afnificant broader weakness in output and fected by evolving market developments employment. Similarly, the impaired and by other factors. functioning of financial markets might At the conclusion of the discussion, persist for some time or possibly the Committee voted to authorize and worsen, with negative implications for direct the Federal Reserve Bank of New economic activity. In order to help fore- York, until it was instructed otherwise, stall some of the adverse effects on the to execute transactions in the System economy that might otherwise arise, all Account in accordance with the followmembers agreed that a rate cut of 50 baing domestic policy directive: sis points at this meeting was the most prudent course of action. Such a mea- The Federal Open Market Committee seeks monetary and financial conditions that sure should not interfere with an adjustwill foster price stability and promote susment to more realistic pricing of risk or tainable growth in output. To further its with the gains and losses that implied long-run objectives, the Committee in the for participants in financial markets. immediate future seeks conditions in reserve Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

240 94th Annual Report, 2007 markets consistent with reducing the federal ened in the days since its last meeting. funds rate to an average of around 43A per- Participants discussed the condition of cent. domestic and foreign financial markets, The vote encompassed approval of the Open Market Desk's approach to the text below for inclusion in the state- open market operations, possible adjustment to be released at 2:15 p.m.: ments to the discount rate, and the statement to be issued immediately after the Developments in financial markets since conference call. the Committee's last regular meeting have increased the uncertainty surrounding the On August 16, 2007, the Committee economic outlook. The Committee will con- again met by conference call. With fitinue to assess the effects of these and other nancial market conditions having detedevelopments on economic prospects and riorated further, meeting participants will act as needed to foster price stability and sustainable economic growth. discussed the potential usefulness of various policy responses. The discus- Votes for this action: Messrs. Bernanke, Geithner, Evans, Hoenig, Kohn, sion focused primarily on changes asso- Kroszner, Mishkin, Poole, Rosengren, ciated with the discount window that and Warsh. Votes against this action: would be directed at improving the func- None. tioning of the money markets. Most par- The Committee then resumed its dis- ticipants expressed strong support for cussion of monetary policy communica- taking such steps, although some contion issues. Subsequently, in a joint ses- cern was noted about the likely sion of the Federal Open Market effectiveness of these measures and one Committee and the Board of Governors, participant also questioned their ap- Board members and Reserve Bank propriateness. In light of the risks posed presidents discussed additional policy to the economic outlook by the tighter options to address strains in money mar- credit conditions and the increased kets. No decisions were made in this uncertainty in financial markets, the session, but it was agreed that policy- Committee felt that the downside risks makers should continue to consider such to growth had increased appreciably, but options carefully. that a change in the federal funds rate It was agreed that the next meeting of target was not yet warranted. However, the Committee would be held on the situation bore close watching. Tuesday-Wednesday, October 30-31, At the conclusion of the discussion, 2007. the Committee voted to approve the text The meeting adjourned at 3:55 p.m. below to be released the following morning: Notation Vote Financial market conditions have deteriorated, and tighter credit conditions and By notation vote completed on August increased uncertainty have the potential to 27, 2007, the Committee unanimously restrain economic growth going forward. In approved the minutes of the FOMC these circumstances, although recent data meeting held on August 7, 2007. suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside Conference Calls risks to growth have increased appreciably. The Committee is monitoring the situation On August 10, 2007, the Committee re- and is prepared to act as needed to mitigate viewed developments in money and the adverse effects on the economy arising credit markets, where strains had wors- from the disruptions in financial markets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 241 Votes for: Messrs. Bernanke, Geithner, Mr. Dudley, Manager, System Open Fisher, Hoenig, Kohn, Kroszner, Mish- Market Account kin, Moskow, Rosengren, and Warsh. Mr. Struckmeyer, Deputy Staff Direc- Votes against: None. Mr. Fisher voted tor, Office of Staff Director for as alternate member. Management Brian F. Madigan Mr. English, Senior Associate Director, Secretary Division of Monetary Affairs, Board of Governors Messrs. Reifschneider10 and Wascher, Meeting Held on Associate Directors, Division of October 30-31, 2007 Research and Statistics, Board of Governors A meeting of the Federal Open Market Mr. Wright, Deputy Associate Director, Committee was held in the offices of the Division of Monetary Affairs, Board of Governors of the Federal Re- Board of Governors serve System in Washington, D.C., on Mr. Zakrajsek, Assistant Director, Divi- Tuesday, October 30, 2007 at 2:00 p.m. sion of Monetary Affairs, Board of and continued on Wednesday, October Governors 31, 2007 at 9:00 a.m. Mr. Blanchard, Assistant to the Board, Present: Office of Board Members, Board Mr. Bernanke, Chairman of Governors Mr. Geithner, Vice Chairman Ms. K. Johnson, Senior Adviser, Divi- Mr. Evans sion of International Finance, Mr. Hoenig Board of Governors Mr. Kohn Mr. Kroszner Mr. Oliner, Senior Adviser, Division of Mr. Mishkin Research and Statistics, Board of Mr. Poole Governors Mr. Rosengren Mr. Dale,10 Senior Adviser, Division of Mr. Warsh Monetary Affairs, Board of Gover- Ms. Cumming, Mr. Fisher, Ms. Pian- nors alto, and Messrs. Plosser and Mr. Gross,10 Special Assistant to the Stern, Alternate Members of the Board, Office of Board Members, Federal Open Market Committee Board of Governors Messrs. Lacker and Lockhart, and Ms. Mr. Small, Project Manager, Division Yellen, Presidents of the Federal of Monetary Affairs, Board of Reserve Banks of Richmond, At- Governors lanta, and San Francisco, respectively Messrs. Kumasaka11 and Luecke,12 Senior Financial Analysts, Division Mr. Madigan, Secretary and Economist of Monetary Affairs, Board of Ms. Danker, Deputy Secretary Governors Ms. Smith, Assistant Secretary Mr. Skidmore, Assistant Secretary Ms. Judson, Economist, Division of Mr. Alvarez, General Counsel Monetary Affairs, Board of Gover- Mr. Baxter, Deputy General Counsel nors Mr. Sheets, Economist Mr. Stockton, Economist 10. Attended portion of meeting relating to the Messrs. Clouse, Connors, Fuhrer, Ka- discussion of communication issues. mi n, Rasche, Slifman, Sullivan, 11. Attended Tuesday session. and Wilcox, Associate Economists 12. Attended Wednesday session. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

242 94th Annual Report 2007 Ms. Low, Open Market Secretariat Spe- mates of the third-quarter national incialist, Division of Monetary Af- come and product accounts, indicated fairs, Board of Governors that economic activity expanded at a Mr. Lyon, First Vice President, Federal solid pace in the third quarter. Consumer Reserve Bank of Minneapolis spending rose more strongly after a tepid increase in the second quarter, and the Messrs. Judd and Sniderman, Executive Vice Presidents, Federal Reserve pace of expansion of business outlays Banks of San Francisco and Cleve- for equipment and structures remained land, respectively reasonably solid. Manufacturing posted a sizable gain for the third quarter as a Mr. Altig and Ms. Mester, Senior Vice whole. In contrast, the slump in residen- Presidents, Federal Reserve Banks of Atlanta and Philadelphia, re- tial investment intensified during the spectively third quarter, at least partly because of ongoing disruptions in the markets for Mr. Hakkio, Special Adviser, Federal nonconforming mortgages. The average Reserve Bank of Kansas City monthly gain in private employment Messrs. Hilton, Koenig, and Potter, also slowed significantly. Headline in- Vice Presidents, Federal Reserve flation eased during the third quarter, Banks of New York, Dallas, and reflecting a decline in energy prices; New York, respectively core inflation continued to be moderate. Mr. Weber, Senior Research Officer, Employment increased more slowly Federal Reserve Bank of Minnein the third quarter than in the first half apolis of the year. Private payroll employment Mr. Hetzel, Senior Economist, Federal registered a considerably smaller aver- Reserve Bank of Richmond age monthly gain; employment in resi- By unanimous vote, the Federal Open dential construction, manufacturing, and Market Committee selected D. Nathan industries related to mortgage lending Sheets to serve as Economist until the continued to decline, but most serviceselection of his successor at the first producing industries added jobs at a regularly scheduled meeting of the moderate pace. With gains in employ- Committee in 2008. ment smaller and the workweek flat, the The Manager of the System Open growth of aggregate hours of private Market Account reported on recent de- production or nonsupervisory workers velopments in foreign exchange mar- stepped down from its second-quarter kets. There were no open market opera- pace. The labor force participation rate tions in foreign currencies for the was unchanged, on average, in the third System's account in the period since the quarter, and the unemployment rate previous meeting. The Manager also re- ticked up to 4.7 percent in September. ported on developments in domestic fi- Industrial production changed little in nancial markets and on System open August and September after having market operations in government securi- posted solid advances in June and July. ties and federal agency obligations dur- Manufacturing output expanded in the ing the period since the previous meet- third quarter overall at about the same ing. By unanimous vote, the Committee pace as in the second quarter but deratified these transactions. clined modestly on net in August and The information provided to the Com- September. During those two months, mittee on the first day of the meeting, production was damped by declines in prior to the release of the advance esti- the output of motor vehicles and parts. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 243 In addition, output of construction sup- however, the third-quarter reading replies and products fell, likely reflecting mained within the fairly narrow range the ongoing decline in residential invest- observed over the past decade. ment. Meanwhile, production in the Orders and shipments of nondefense high-tech sector rose at a moderate rate. capital goods excluding aircraft rose on Consumer spending was well main- average over August and September. In tained in August and September. Motor the high-tech category, orders and shipvehicle sales improved, and real spend- ments of computers and peripherals ing on other goods posted solid gains in posted robust gains over the same peboth months. Real outlays on consumer riod. Shipments of communication services were strong in August because equipment also rose in August and Sepof a weather-induced jump in energy tember, but orders were little changed services. Solid increases in nominal on balance over the same period. Outwages and salaries and lower headline side the technology sector, shipments of inflation led to robust gains in real in- nondefense capital goods excluding aircome over the summer. However, other craft increased at a solid rate over Aufactors affecting consumer spending gust and September but orders declined were mixed. Short-term interest rates in August and were flat in September. dropped and stock prices rose, on bal- Sales of medium and heavy trucks levance, after August. By contrast, house eled off in the third quarter after a sharp prices continued to decelerate, standards drop in the first half of the year. Domeson consumer and mortgage credit tight- tic outlays for aircraft likely stepped ened after midsummer, and the turmoil down somewhat in the third quarter. in financial markets that started in the Nonresidential building activity resummer likely exerted some restraint on mained vigorous through August after consumer spending. Moreover, mea- having posted very strong gains in the sures of consumer confidence had de- second quarter; anecdotal evidence clined in recent months. through early October indicated that the The housing downturn deepened as recent turbulence in commercial credit sales of new and existing single-family markets had done little to slow the pace homes continued to fall. Deterioration in of commercial construction. More gennonprime mortgage markets as well as erally, surveys of business conditions higher mortgage interest rates and continued to point to further near-term tighter lending conditions for prime gains in spending, although reports from jumbo loans since earlier in the year ap- business contacts indicated that some peared to be restraining housing de- firms had marked down their capital mand. Forward-looking indicators, in- spending plans. cluding an index of pending home sales Data on the book value of business and adjusted single-family permit issu- inventories through August suggested ance, continued to point to a further that real nonfarm inventory investment slowing in housing activity over the near excluding motor vehicles moved down term. Single-family housing starts de- in the third quarter after having risen at clined significantly over August and a moderate pace in the second quarter. September. Nonetheless, with single- The ratio of book-value inventories to family home sales continuing to sag, in- sales in the manufacturing and trade secventories of unsold homes remained tor excluding motor vehicles, which was quite elevated. In the multifamily sector, available through August, remained well starts declined sharply in September; below the elevated values seen around Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

244 94th Annual Report, 2007 the turn of the year. Purchasing manag- gust, gave no signs that the turmoil in ers, on average, viewed the level of their financial markets was having a significustomers' inventories as about right in cant negative effect on real economic September. activity. In emerging Asia, activity ap- The U.S. international trade deficit peared to have remained robust, alnarrowed in August as exports increased though growth slowed from its elevated and imports decreased. Goods exports second-quarter pace. Economic indicawere boosted by a jump in exports of tors for Mexico pointed to moderate agricultural products and of gold, which growth in the third quarter. In South more than offset a decline in exports of America, activity was strong, boosted other goods. Exports of automotive by high prices for commodities and, in products fell back sharply after a surge Argentina and Venezuela, by expanin July. Exports of capital goods con- sionary macroeconomic policies. Food tracted slightly, led by a drop in aircraft prices continued to be a major source of exports. Exports of semiconductors de- inflationary pressures in emergingclined, while exports of computers were market economies, and Chinese authoriabout flat. On the import side, the de- ties took several steps aimed at quelling cline was concentrated in goods; service rising prices. imports were flat. Higher imports of oil After having risen rapidly in the first and of capital goods, particularly com- half of the year, headline consumer puters and semiconductors, were more prices decelerated considerably over the than offset by lower imports of automo- summer, largely because of a fall in entive products, consumer goods, and in- ergy prices. Over September and Octodustrial supplies excluding oil. ber, gasoline prices appeared to have Indicators of economic activity in the risen only moderately despite a jump in third quarter for advanced foreign crude oil costs. Consumer food prices economies were solid on balance. In the posted further sizable increases in Aueuro area, production and sales picked gust and September and continued to up in the third quarter from their second- run well above the change in core prices. quarter levels. However, recent survey Core consumer price inflation remained data, including the purchasing manag- moderate in August and September and, ers' index for the service sector in the on a twelve-month change basis, was euro area, pointed to a possible slowing down noticeably from a year earlier. in the pace of growth. Likewise, not- Core goods prices fell over the year endwithstanding a strong preliminary esti- ing in September after having risen little mate of third-quarter GDP growth in the over the preceding year; noticeable de- United Kingdom, more recent surveys celerations occurred in the prices of appointed to some softening. Recent Cana- parel, prescription drugs, and motor vedian data were mixed, with relatively hicles. In addition, increases in owners' strong employment growth and some equivalent rent slowed noticeably, while weakness in retail sales. In contrast, Ja- rent inflation remained about the same pan's retail sales and exports rebounded as a year earlier. The producer price inin August, and the October Tankan sur- dex for core intermediate materials vey seemed to suggest that the second edged up in September. The twelvequarter's sharp contraction in invest- month change in that index stepped ment was temporary. down considerably from last year, in In emerging-market economies, re- part because of softer prices for a cent information, mostly through Au- variety of energy-intensive and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 245 construction-related items. Household declined in the wake of the September surveys indicated that median year- policy action, as many investors were ahead inflation expectations inched surprised by the magnitude of the reducdown in September and October to tion in the target rate. Over the interabout the level observed in the first meeting period, many investors came to quarter, and longer-term inflation expec- expect that the Committee would reduce tations slipped to their lowest level in the target federal funds rate at its Octotwo years. Average hourly earnings ber meeting; in addition, the anticipated posted a moderate increase over the policy path further ahead moved down a twelve months ending in September. bit more, on net, over the remainder of At its September meeting, the FOMC the intermeeting period, apparently in lowered its target for the federal funds response to heightened concerns among rate 50 basis points, to 43A percent. The investors about economic growth. Board of Governors also approved a Early in the intermeeting period, the 50 basis point decrease in the discount functioning of short-term funding marrate, to 5lA percent, leaving the gap be- kets improved somewhat, but conditions tween the federal funds rate target and in these markets remained strained. The the discount rate at 50 basis points. The effective federal funds rate was very Committee's statement noted that, while close to the target, on average, but the economic growth had been moderate average absolute daily deviation of the during the first half of the year, the tight- effective rate from the target and the ening of credit conditions had the poten- intraday standard deviation remained eltial to intensify the housing correction evated. Credit spreads declined in the and to restrain economic growth more commercial paper and term interbank generally. The Committee indicated that funding markets but stayed well above its action was intended to help forestall longer-term norms. Liquidity in the some of the adverse effects on the Treasury bill market was poor at times. broader economy that could otherwise Corporate bond spreads narrowed somearise from the disruptions in financial what, leaving private yields a little markets and to promote moderate lower. Nonfinancial bond issuance was growth over time. Readings on core in- robust; speculative-grade offerings inflation had improved modestly during creased markedly. The credit quality of the year, but the Committee judged that most households remained strong, but some inflation risks remained, and the delinquency rates on subprime mort- Committee planned to continue to moni- gages climbed further. Securitization of tor inflation developments carefully. The nonconforming mortgages remained Committee further noted that develop- limited, and spreads on jumbo mortments in financial markets since the last gages relative to conforming mortgages regular FOMC meeting had increased the stayed high. Two-year Treasury yields uncertainty surrounding the economic declined roughly in line with the lower outlook. Accordingly, the Committee expected policy path, while yields on would continue to assess the effects of ten-year Treasuries were little changed, these and other developments on on net. TIPS-based inflation compensaeconomic prospects and remained ready tion was about unchanged on balance to act as needed to foster price stability over the intermeeting period despite a and sustainable economic growth. sharp rise in spot oil prices. Stock prices The expected path for monetary jumped early in the intermeeting period policy as inferred from futures markets in response to the cut in the target fed- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

246 94th Annual Report, 2007 eral funds rate and some favorable eco- staff expected real GDP growth to be nomic news but later dropped back, considerably slower in the fourth quarleaving broad indexes up only a bit on ter, reflecting steepening declines in net. The foreign exchange value of the residential construction, reductions in dollar against other major currencies de- the pace of motor vehicle production, clined notably. and a smaller contribution from net ex- Debt of the domestic nonfinancial ports. Looking forward, the staff exsectors was estimated to have expanded pected residential investment to remain slightly more quickly in the third quarter weak in 2008 with modest declines in than in the previous quarter. Despite evi- house prices. In addition, the staff condence that bank lending standards and tinued to expect the stress in credit marterms had tightened over the previous kets and the appreciably higher oil three months, business debt was still ris- prices indicated by futures markets to ing strongly, reflecting a continued restrain spending by businesses and consurge in commercial and industrial sumers, although the lower foreign ex- (C&I) lending by banks and robust issu- change value of the dollar suggested ance of investment-grade bonds. The ex- some boost to net exports. On balance, pansion of business loans was appar- real GDP growth for 2008 was projected ently due in part to financings for to slow to a pace a bit below that of its leveraged buyouts that underwriters potential, and unemployment was excould not syndicate to institutional in- pected to creep up slightly. For 2009, vestors. Household mortgage borrowing the forecast called for real output growth was estimated to have decelerated again to step up to a pace slightly above potenin the third quarter. M2 increased sig- tial as the drags on economic activity nificantly more slowly in September and exerted by the contraction in residential October than the rapid pace observed in investment and financial strains were August, when the financial market tur- expected to abate. The staff's forecast moil apparently drove investors to the for core PCE inflation was little changed safety of M2 assets. Inflows to retail from that presented at the September money market funds and small time de- meeting because favorable incoming posits were especially strong in Septem- figures on core PCE inflation were offber and October; small time deposits set by expectations for some limited were apparently boosted by the attrac- feed-through into retail prices of recent tive rates that banks were offering in increases in energy prices and for order to help fund their expanding loan slightly less easing in resource utilizaportfolios. tion. The forecast for headline inflation In the forecast prepared for this meet- was in the same range as that for core ing, which was formulated prior to the inflation in 2008 and 2009, reflecting release of the advance estimates of the expectations that energy prices would third-quarter national income and prod- level off and then turn down and that uct accounts, the staff revised up its esti- increases in food prices would slow to a mate of aggregate economic activity in pace more in line with core inflation. the third quarter from its forecast pre- The advance data on the national insented at the September meeting in light come and product accounts for the third of available indicators that suggested quarter, which were released on the that consumer spending, business invest- morning of the second day of the FOMC ment, and exports were stronger than meeting, indicated a stronger increase in previously expected. Nonetheless, the real GDP than the staff had forecast, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 247 mostly because inventory investment weakness in the housing sector abated was estimated to be higher than pro- and stresses in financial markets subjected by the staff. The staff interpreted sided. With aggregate demand showing this information as suggesting some up- somewhat greater than expected strength ward revision to its estimate of output in the third quarter and little evidence of growth in the third quarter, a small significant spillovers from the housing downward revision to its forecast of sector to other components of spending, growth in the current quarter, and no participants viewed the downside risks significant change to its forecast for to growth as somewhat smaller than at coming quarters. the time of the September meeting, but In conjunction with the FOMC meet- those risks were still seen as significant. ing in October, all meeting participants Participants generally expected that in- (Federal Reserve Board members and flation would edge down over the next Reserve Bank presidents) provided an- few years, a projection consistent with nual projections for economic growth, the recent string of encouraging releases unemployment, and inflation for the pe- on core consumer prices, futures prices riod 2007 through 2010. The projections pointing to a flattening of energy costs, are described in the Summary of Eco- and the anticipated easing of pressures nomic Projections, which is attached as on resources. Nonetheless, some upside an addendum to these minutes. risks to inflation remained, reflecting in In their discussion of the economic part the potential feed-through to inflaoutlook and situation, and in the projec- tion expectations of increases in energy tions that they had submitted for this and import prices. meeting, participants noted that eco- Financial market functioning was nomic activity had expanded at a some- judged to have improved somewhat what faster pace in the third quarter than since the previous FOMC meeting, but previously anticipated and that there was the situation in a number of markets rescant evidence of negative spillovers mained strained, and credit market confrom the ongoing housing correction to ditions were thought likely to weigh on other sectors of the economy. Condi- economic growth over coming quarters. tions in financial markets had improved In light of some improvement in the since the September FOMC meeting, commercial paper and leveraged loan but functioning in a number of markets markets over the intermeeting period, remained strained. Even with some fur- participants were somewhat less conther easing of monetary policy, partici- cerned that banks would not have suffipants expected economic growth to slow cient balance-sheet capacity to absorb over the next few quarters, reflecting large volumes of assets. Conditions in continued sharp declines in the housing corporate credit markets also had imsector and tighter lending standards and proved in recent weeks, and most busiterms across a broad range of credit nesses were apparently having little difproducts. The slowing of growth was ficulty raising external funds, as likely to produce a modest increase in evidenced by strong issuance of the unemployment rate from its recent investment-grade corporate bonds, a levels, leading to the emergence of a pickup in speculative-grade issuance, little slack in labor markets. Looking and surging C&I loans. Markets for nonfurther ahead, participants noted that conforming mortgages, by contrast, reeconomic growth should increase gradu- mained disrupted. Meeting participants ally to around its trend rate by 2009 as also mentioned that while financial Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

248 94th Annual Report, 2007 market conditions had improved, the ing the downward pressure on house functioning of some markets remained prices. somewhat impaired. Indeed, several Participants generally agreed that the participants noted some relapse in available data suggested that consumer financial conditions late in the inter- spending had been well maintained over meeting period. Moreover, unusual pres- the past several months and that spillsures in funding markets persisted. overs from the strains in the housing Participants generally viewed financial market had apparently been quite limmarkets as still fragile and were ited to date. Nevertheless, a number of concerned that an adverse shock—such participants cited notable declines in as a sharp deterioration in credit quality survey measures of consumer confior disclosure of unusually large and dence since the onset of financial turbuunanticipated losses—could further dent lence in midsummer, along with sharply higher oil prices, declines in house investor confidence and significantly prices, and tighter underwriting stanincrease the downside risks to the dards for home equity loans and some economy. Participants were also contypes of consumer loans, as factors cerned about a potential scenario in likely to restrain consumer spending gowhich unexpected economic weakness ing forward. Moreover, anecdotal recould cause a further tightening of credit ports by business contacts suggested a conditions that could in turn reinforce softening in retail sales in some regions weakness in aggregate demand. of the country. Participants expressed a In their discussion of individual secconcern that larger-than-expected detors of the economy, participants noted clines in house prices could further sap that the recent declines in housing consumer confidence as well as net activity—while substantial—had largely worth, causing a pullback in consumer been anticipated. Nonetheless, the pospending. All told, however, participants tential for significant further weakening envisioned that the most likely scenario in housing activity and home prices was for consumer spending to continue represented a downside risk to the to advance at a moderate rate in coming economic outlook. Most participants quarters, supported by the generally pointed to the deterioration in non- strong labor market and further gains in prime mortgage markets as well as real personal income. higher interest rates and tighter credit Meeting participants noted that capistandards for prime nonconforming tal expenditures had grown at a solid mortgages as factors that had exacer- pace in recent months and that the finanbated the deterioration in housing mar- cial turmoil generally appeared to have kets, and they noted that these develop- had a limited effect on business capital ments could further limit the availability spending plans to date. Nevertheless, of mortgage credit and depress the de- business sentiment appeared to have mand for housing. Some participants eroded somewhat amid heightened ecoalso pointed to downside risks to the nomic and financial uncertainty, potenhousing market stemming from the large tially restraining investment outlays in volume of substantial upward interest- some industries. However, participants rate resets that were likely on subprime noted that conditions in corporate bond mortgages in coming quarters, which markets had improved since the Septemcould lead to a faster pace of foreclo- ber FOMC meeting, and that credit sures in the near term, thereby intensify- availability generally appeared to be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 249 ample, albeit on somewhat tighter terms. term inflation expectations could move Participants judged that moderate higher, a development that could lead to growth of investment outlays going for- greater inflation pressures over the ward was the most likely outcome. A longer term and be costly to reverse. number of participants saw downside In the Committee's discussion of risk to the outlook for nonresidential policy for the intermeeting period, membuilding activity, reflecting elevated bers discussed the relative merits of lowspreads on commercial-mortgage- ering the target federal funds rate 25 babacked securities and a further tighten- sis points, to 4V2 percent, at this meeting ing of banks' lending standards for or awaiting additional information on commercial real estate loans. prospects for economic activity and in- Data on economic growth outside the flation before assessing whether a fur- United States indicated that the global ther adjustment in the stance of monexpansion, though likely to slow some- etary policy was necessary. Many what in coming quarters, was neverthe- members noted that this policy decision less on a firm footing. The continued was a close call. However, on balance, strength of global growth and the recent nearly all members supported a 25 basis decline in the foreign exchange value of point reduction in the target federal the dollar were seen as likely to support funds rate. The stance of monetary U.S. exports going forward. policy appeared still to be somewhat re- Readings on core inflation received strictive, partly because of the effects of during the intermeeting period contin- tighter credit conditions on aggregate ued to be generally favorable, and meet- demand. Moreover, most members saw ing participants agreed that the recent substantial downside risks to the ecomoderation in core inflation would nomic outlook and judged that a rate likely be sustained. The slower pace of reduction at this meeting would provide economic expansion anticipated for the valuable additional insurance against an next few quarters would help ease infla- unexpectedly severe weakening in ecotionary pressures. Nonetheless, partici- nomic activity. Many members were pants expressed concern about the up- concerned about the still-sensitive state side risks to the outlook for inflation. of financial markets and thought that an The recent increases in the prices of en- easing of policy would help to support ergy and other commodities, along with improvements in market functioning, the significant decline in the foreign ex- thereby mitigating some of the downchange value of the dollar, were cited as side risks to economic growth. With real factors that could exert upward pressure GDP likely to expand below its potenon prices of some core goods and ser- tial over coming quarters, recent price vices in the near term. Increases in unit trends favorable, and inflation expectalabor costs also could add to inflationary tions appearing reasonably well anpressures. Moreover, participants ex- chored, the easing of policy at this meetpressed concern that some measures of ing seemed unlikely to affect adversely inflation compensation calculated from the outlook for inflation. A number of TIPS securities had risen this year, al- members noted that the recent policy though they viewed inflation expecta- moves could readily be reversed if cirtions generally as remaining contained. cumstances evolved in a manner that Participants were concerned that if head- would warrant such action. line inflation remained above core mea- The Committee agreed that the statesures for a sustained period, then longer- ment to be released at this meeting Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

250 94th Annual Report, 2007 should indicate that economic growth eased somewhat on balance. However, the was solid in the third quarter and that pace of economic expansion will likely slow in the near term, partly reflecting the intensistrains in financial markets had eased fication of the housing correction. Today's somewhat on balance. Members also action, combined with the policy action agreed that economic growth seemed taken in September, should help forestall likely to slow over coming quarters, but some of the adverse effects on the broader that the easing action taken at the economy that might otherwise arise from the disruptions in financial markets and promote meeting—combined with the 50 basis moderate growth over time. point cut in the target federal funds rate Readings on core inflation have improved at the September meeting—should help modestly this year, but recent increases in to promote moderate growth over time, energy and commodity prices, among other although some downside risks to growth factors, may put renewed upward pressure would remain. Members felt that it was on inflation. In this context, the Committee judges that some inflation risks remain, and appropriate to underscore the upside it will continue to monitor inflation developrisks to inflation stemming from the rements carefully. cent increases in the prices of energy The Committee judges that, after this and other commodities, even though re- action, the upside risks to inflation roughly cent readings on core inflation had been balance the downside risks to growth. The favorable. While the Committee saw un- Committee will continue to assess the effects of financial and other developments on ecocertainty regarding the economic outnomic prospects and will act as needed to look as still elevated, it judged that, after foster price stability and sustainable ecothis action, the upside risks to inflation nomic growth. roughly balanced the downside risks to Votes for this action: Messrs. Bernanke, growth. Geithner, Evans, Kohn, Kroszner, Mish- At the conclusion of the discussion, kin, Poole, Rosengren, and Warsh. the Committee voted to authorize and Votes against this action: Mr. Hoenig. direct the Federal Reserve Bank of New Mr. Hoenig dissented because he be- York, until it was instructed otherwise, lieved that policy should remain unto execute transactions in the System changed at this meeting. Projections for Account in accordance with the follow- the U.S. and global economies suggested ing domestic policy directive: that growth was likely to proceed at a reasonable pace over the outlook period. The Federal Open Market Committee seeks monetary and financial conditions that To better assure that outcome, the will foster price stability and promote sus- FOMC had moved rates down signifitainable growth in output. To further its cantly at its September meeting. At this long-run objectives, the Committee in the meeting, inflation risks appeared elimmediate future seeks conditions in reserve evated and Mr. Hoenig felt that the tarmarkets consistent with reducing the federal funds rate to an average of around 41/2 per- get federal funds rate was currently cent. close to neutral. In these circumstances, he judged that policy needed to be The vote encompassed approval of slightly firm to better hold inflation in the statement below to be released at check. Going forward, if the data sug- 2:15 p.m.: gested the Committee needed to ease The Federal Open Market Committee further, it could do so. He also recogdecided today to lower its target for the Fednized that liquidity remains a near-term eral funds rate 25 basis points to AVi percent. challenge and that the Federal Reserve Economic growth was solid in the third quarter, and strains in financial markets have would be prepared to act if needed. Mr. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 251 Hoenig saw the risks to both economic covering longer time spans and accomgrowth and inflation to be elevated and panied by explanations of those forepreferred to wait, watch, and be ready to casts was seen as providing the public act depending on how events developed. with more context for understanding the The Committee then resumed its dis- Committee's monetary policy decisions. cussion of an enhanced role for the eco- It was agreed that the next meeting of nomic projections that are made periodi- the Committee would be held on Tuescally by the members of the Board of day, December 11,2007. Governors and the Reserve Bank presi- The meeting adjourned at 12:00 noon. dents. At this meeting, participants reached a consensus on increasing the Notation Vote frequency and expanding the content of By notation vote completed on October the projections that in the past have been 5, 2007, the Committee unanimously apreleased to the public in summary form proved the minutes of the FOMC meettwice a year. They agreed to publish ing held on September 18, 2007 and of with the minutes a summary of particithe conference calls on August 10, 2007 pants' economic projections made for and August 16, 2007. this meeting and to release a press statement describing the plan for the future. Brian F. Madigan The release of more frequent forecasts Secretary The projections, which are summa- Summary of Economic rized in table 1 and chart 1, suggest that Projections FOMC participants expected that, in the In conjunction with the October 2007 near term, output will grow at a pace FOMC meeting, the members of the somewhat below its trend rate and the unemployment rate will edge higher, Board of Governors and the presidents owing primarily to weakness in housing of the Federal Reserve Banks, all of markets and to the tightening in the whom participate in the deliberations of availability of credit resulting from rethe FOMC, provided projections for cent strains in financial markets. Further economic growth, unemployment, and ahead, output was projected to expand at inflation in 2007, 2008, 2009, and 2010. a pace close to its long-run trend. Total Projections were based on information inflation was expected to be lower in available through the conclusion of the 2008 than in 2007, and then to edge October meeting, on each participant's down further in subsequent years. assumptions regarding a range of factors likely to affect economic outcomes, and The Outlook his or her assessment of appropriate monetary policy. "Appropriate monetary Data available at the time of the October policy" is defined as the future policy FOMC meeting indicated that economic most likely to foster outcomes for growth had been solid during the second economic activity and inflation that best and third quarters, and evidence that the satisfy the participant's interpretation of contraction in the housing sector had bethe Federal Reserve's dual objectives gun to spill over substantially to other of maximum employment and price sectors of the economy remained scant. stability. Consequently, despite the recent finan- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

252 94th Annual Report, 2007 1. Economic Projections of Federal Reserve Governors and Reserve Bank Presidents1 2007 2008 2009 2010 Central Tendencies Real GDP Growth .. 2.4 to 2.5 1.8 to 2.5 2.3 to 2.7 2.5 to 2.6 June Projections .. V/4 tO Vh V/2 tO 23/4 Unemployment Rate 4.7 to 4.8 4.8 to 4.9 4.8 to 4.9 4.7 to 4.9 June Projections .. 4Vi to 43A about 43/4 PCE Inflation 2.9 to 3.0 1.8 to 2.1 1.7 to 2.0 1.6 to 1.9 Core PCE Inflation .. 1.8 to 1.9 1.7 to 1.9 1.7 to 1.9 1.6 to 1.9 June Projections .. 2 to 2V4 P/4 tO 2 Ranges Real GDP Growth .. 2.2 to 2.7 1.6 to 2.6 2.0 to 2.8 2.2 to 2.7 June Projections .. 2 to 23/4 V/2 to 3 Unemployment Rate 4.7 to 4.8 4.6 to 5.0 4.6 to 5.0 4.6 to 5.0 June Projections .. 4Vi to 43M 4*/2 to 5 PCE Inflation 2.7 to 3.2 1.7 to 2.3 1.5 to 2.2 1.5 to 2.0 Core PCE Inflation .. 1.8 to 2.1 1.7 to 2.0 1.5 to 2.0 1.5 to 2.0 June Projections .. 2 to 2V4 PA to 2 1. Projections of real GDP growth, PCE inflation, and ment rate are for the average civilian unemployment rate core PCE inflation are fourth-quarter-to-fourth-quarter in the fourth quarter of each year. Each participant's progrowth rates, that is, percentage changes from the fourth jections are based on his or her assessment of appropriate quarter of the prior year to the fourth quarter of the monetary policy. The range for each variable in a given indicated year. PCE inflation and core PCE inflation are year includes all participants' projections, from lowest to the percentage rates of change in the price index for highest, for that variable in the given year; the central personal consumption expenditures and the price index tendencies exclude the three highest and three lowest for personal consumption expenditures excluding food projections for each variable in each year. and energy, respectively. Projections for the unemploycial market turmoil, the central tendency ever, net exports were expected to of participants' projections for real GDP provide some support to growth. The growth in 2007, at 2.4 to 2.5 percent, subpar economic growth projected in the was little changed from the central ten- near term was not anticipated to persist. dency of the projections provided in Growth was expected to pick up as the conjunction with the June FOMC meet- adjustment in housing markets ran its ing and included in the Board's Mon- course, financial markets gradually reetary Policy Report to the Congress in sumed more-normal functioning, and as July. However, the central tendency of the monetary policy easing at the Sepparticipants' projections for real GDP tember and October FOMC meetings growth in 2008 was revised down to 1.8 provided support to aggregate demand. to 2.5 percent, notably below the 2l/i to Economic activity was projected to ex- 23/4 percent central tendency in June. pand at a pace broadly in line with par- These revisions to the 2008 outlook ticipants' estimates of the rate of expansince June stemmed from a number of sion of the economy's productive factors, including the tightened terms potential in 2009 and to continue at and reduced availability of subprime and much the same pace in 2010. Particijumbo mortgages, weaker-than-expected pants read last summer's benchmark rehousing data, and rising oil prices. Partly visions to the national income and prodin response to declining housing wealth, uct accounts as suggesting a somewhat the personal saving rate was expected to slower rate of trend growth than previrise over the next few years, contribut- ously thought. ing to restraint on the growth of per- Most participants expected that, with sonal consumption expenditures. How- output growth running somewhat below Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 253 1. Central Tendencies and Ranges of Economic Projections* Real GDP Growth Hi Central tendency of projections Z1Z Range of projections Unemployment Rate PCE Inflation Core PCE Inflation Percent ^— —• ==£= — 2002 2003 2004 * See notes to table 1 for variable definitions. trend over the next year or so, the unem- labor markets. The central tendency of ployment rate would increase modestly. participants' projections was for the un- The central tendency of participants' employment rate to stabilize in 2009 and projections for the average rate of unem- to fall back a bit in 2010 as output and ployment in the fourth quarter of 2008 employment growth pick up. was 4.8 to 4.9 percent, slightly above Overall inflation was expected to the 43/4 percent unemployment rate fore- edge down over the next few years, foscasted in June; these projections sug- tered by an assumed flattening of energy gested the emergence of a little slack in prices about in line with futures markets Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

254 94th Annual Report, 2007 quotes, a modest easing of pressures on conditions, which could in turn slow the resource utilization, and fairly well an- economy further. The potential for a chored inflation expectations. Partici- more severe contraction in the housing pants' projections for core inflation this sector and a substantial decline in house year and next were marked down from prices was also perceived as a risk to the those provided at the time of the June central outlook for economic growth. FOMC meeting, partly in light of recent But participants also noted that in recent generally favorable core inflation data decades, the U.S. economy had proved that pointed to some reduction in under- quite resilient to episodes of financial lying inflation pressures. The central distress, suggesting that the adverse eftendency of projections for core PCE fects of financial developments on ecoinflation in 2007 was 1.8 to 1.9 percent, nomic activity outside of the housing down from 2 to 2VA percent in June. The sector could prove to be more modest central tendency of core inflation projec- than anticipated. tions for 2008 was 1.7 to 1.9 percent. Participants were more persuaded Participants' projections for PCE infla- than they had been in June that the detion in 2009 and 2010 were importantly cline in core inflation readings this year influenced by their judgments about the represented a sustained albeit modest measured rates of inflation consistent step-down rather than the effect of tranwith the Federal Reserve's dual man- sitory influences. Nonetheless, particidate to promote maximum employment pants saw some upside risks to their inand price stability and about the time flation projections. Recent increases in frame over which policy should aim to energy and commodity prices and the attain those rates given current eco- pass-through of dollar depreciation into nomic conditions. The central tendency import prices would raise inflation over of participants' projections for both core the medium term. That increase could and total inflation in 2010 ranged from lead to an upward drift in inflation ex- 1.6 to 1.9 percent. pectations that would add to price pressures and could be costly to reverse. Risks to the Outlook The possibility that financial market Most participants viewed the risks to turbulence could have larger-thantheir GDP projections as weighted to the anticipated adverse effects on household downside and the associated risks to and business spending heightened partheir projections of unemployment as ticipants' uncertainty about the outlook tilted to the upside. Financial market for economic activity. Most participants conditions had deteriorated sharply in judged that the uncertainty attending August, and although there had been their October projections for real GDP some signs of improvement since then, growth was above typical levels seen in markets remained strained. The possi- the past. (Table 2 provides an estimate bilities that markets could relapse or that of average ranges of forecast uncertainty current tighter credit conditions could for GDP growth, unemployment, and inexert unexpectedly large restraint on flation over the past twenty years.13) In household and business spending were viewed as downside risks to economic activity. Participants were concerned 13. The box "Forecast Uncertainty" at the end about the possibility for adverse feed- of this summary discusses the sources and interpretation of uncertainty in economic forecasts and backs in which economic weakness explains the approach used to assess the uncercould lead to further tightening in credit tainty and risks attending participants' projections. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 255 2. Average HistoricalProjection Error tions for real GDP growth in 2008 was Ranges1 markedly wider than in June. The dispersion of participants' projections for 2007 2008 2009 2010 growth next year seemed largely to re- Real GDP2 ±0.6 ±1.3 ±1.4 ±1.4 flect differing assessments of the likely Unemployment rate3 ±0.2 ±0.6 ±0.9 ±1.1 Total consumer prices2 ... ±0.3 ±1.0 ±1.0 ±1.0 depth and duration of the correction in the housing market, the effect of finan- 1. "Average historical projection error ranges" for the years 2007 through 2010 are measured as plus or minus cial market disruptions on real activity the root mean squared error of projections that were re- outside of the housing sector, and the leased in the autumn from 1986 through 2006 for the speed with which financial markets will current and following three years hy various private and government forecasters. As described in the forecast un- return to more normal functioning. The certainty box, under certain assumptions, there is about a dispersion of participants' projections 70 percent probability that actual outcomes for real activfor the rate of unemployment over the ity, unemployment, and inflation will fall in ranges implied by the average size of projection errors made in the next year or so had changed little. Parpast. For further information, see David Reifschneider ticipants' longer-term projections for and Peter Tulip, "Gauging the Uncertainty of the Economic Outlook from Historical Forecast Errors," Federal real GDP growth and for the rate of Reserve Board Financial and Economics Discussion Se- unemployment were more heavily influries #2007-60 (November 2007). enced by their views about, respectively, 2. Overall consumer price index, as this is the price measure that has been most widely used in government the economy's trend growth rate and the and private economic forecasts. Percent change, fourth unemployment rate that would be conquarter of year relative to fourth quarter of preceding sistent over time with maximum emyear. 3. Percent, fourth-quarter average. ployment. The dispersion of the projections for PCE inflation in the near term contrast, the uncertainty attached to parpartly reflected different weights atticipants' inflation projections was gentached to the various factors expected to erally viewed as being broadly in line foster a moderation of inflation. Some with past experience, although several participants judged that the anticipated participants judged that the degree of modest easing in resource pressures was uncertainty about total inflation was unlikely to have a marked effect on inhigher than usual, reflecting the possiflation. Similarly, views differed about bility that the recent volatility in food the influence that inflation expectations and energy prices might persist. would exert on inflation over the short and medium run. Participants' projec- Diversity of Participants' Views tions further out were also influenced by Charts 2(a) and 2(b) provide more detail their views about the rate of inflation on the diversity of participants' views. consistent with the Federal Reserve's The dispersion of participants' projec- dual mandate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

256 94th Annual Report, 2007 2(a). Distribution of Participants' Projections (percent)* Real GDP Unemployment Rate 2007 2007 Number of Participants Number of Participants October Projeclio 1 October Projections ] 16 June Projections 1 June Projections • 12 i n 1 1 8 1 : 1 4 1 ill 0 2008 2008 Number of Participants Number of Participants T--H I 1 mm•::;-;••:-:••• ~ ——-.—I 1.6-1.7 1.8-1.9 2.0-2.1 2.2-2.3 2.4-2.5 2.6-2.7 2.8-2.9 3.0-3.1 4.44.5 4.64.7 4.8-4.9 5.0-5.1 5.2-5.3 2009 2009 Number of Participants i i 4.44.5 4.6-4.7 4.84.9 5.0-5.1 5.2-5.3 2010 2010 Number of Participants Number of Participants ._ 4.44.5 4.6-4.7 4.8-4.9 5.0-5.1 5.2-5.3 * See notes to table 1 for variable definitions. Those participants' June projections that were provided in quarter points have been rounded to the nearest tenth for the construction of these histograms. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, October 257 2(b). Distribution of Participants' Projections (percent)* PCE Inflation Core PCE Inflation 2007 2007 Number of Participants Number of Participants 16 October Projections 16 October Projections 12 June Projections 12 8 i ! 8 4 1 4 0 •111! liii i 0 1.5- 1.7- 1.9- 2.1- 1.3-1.4 1.5-1.6 1.7-1.8 1.9-2.0 1.6 1.8 2.0 2.2 2008 2008 Number of Participants Number of Participants II 1.3-1.4 1.5-1.6 1.7-1.8 1.9-2.0 2009 2009 Number of Participants Number of Participants I 1.3-1.4 1.5-1.6 1.7-1.8 1.9-2.0 2.1-2.2 2.3-2.4 2010 2010 Number of Participants Number of Participants 16 12 • 4 0 1.5- 1.7- 1.9- 2.1- 2.3- 2.5- 2.7- 2.9- 3.1- 1.3-1.4 1.5-1.6 1.7-1.8 1.9-2.0 2.1-2.2 2.3-2.4 1.6 • See notes to table 1 for variable definitions. Those participants' June projections that were provided in quarter points have been rounded to the nearest tenth for the construction of these histograms. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

258 94th Annual Report, 2007 Forecast Uncertainty The economic projections provided by the numbers reported in table 2 might imply members of the Board of Governors and a probability of about 70 percent that acthe presidents of the Federal Reserve tual GDP would expand 2.4 percent to Banks help shape monetary policy and can 3.6 percent in the current year, 1.7 peraid public understanding of the basis for cent to 4.3 percent next year, and 1.6 policy actions. Considerable uncertainty at- percent to 4.4 percent in the third and tends these projections, however. The eco- fourth years. The corresponding 70 pernomic and statistical models and relation- cent confidence intervals for overall inships used to help produce economic flation would be 1.7 percent to 2.3 perforecasts are necessarily imperfect descrip- cent in the current year and 1.0 percent to tions of the real world. And the future path 3.0 percent in the second, third, and of the economy can be affected by myriad fourth years. unforeseen developments and events. Thus, Because current conditions may differ in setting the stance of monetary policy, from those that prevailed on average over participants consider not only what appears history, participants provide judgments as to be the most likely economic outcome as to whether the uncertainty attached to embodied in their projections, but also the their projections of each variable is range of alternative possibilities, the likeli- greater than, smaller than, or broadly hood of their occurring, and the potential similar to typical levels of forecast uncercosts to the economy should they occur. tainty in the past as shown in table 2. Table 2 summarizes the average histori- Participants also provide judgments as to cal accuracy of a range of forecasts, includ- whether the risks to their projections are ing those reported in past Monetary Policy weighted to the upside, downside, or are Reports and those prepared by Federal Re- broadly balanced. That is, participants serve Board staff in advance of meetings of judge whether each variable is more the Federal Open Market Committee. The likely to be above or below their projecprojection error ranges shown in the table tions of the most likely outcome. These illustrate the considerable uncertainty asso- judgments about the uncertainty and the ciated with economic forecasts. For ex- risks attending each participant's projecample, suppose a participant projects that tions are distinct from the diversity of real GDP and total consumer prices will participants' views about the most likely rise steadily at annual rates of, respectively, outcomes. Forecast uncertainty is con- 3 percent and 2 percent. If the uncertainty cerned with the risks associated with a attending those projections is similar to that particular projection, rather than with diexperienced in the past and the risks around vergences across a number of different the projections are broadly balanced, the projections. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 259 Meeting Held on Ms. Liang and Mr. Wascher, Associate December 11, 2007 Directors, Division of Research and Statistics, Board of Governors A meeting of the Federal Open Market Mr. Blanchard, Assistant to the Board, Committee was held in the offices of the Office of Board Members, Board Board of Governors of the Federal of Governors Reserve System in Washington, D.C., Mr. Meyer, Visiting Reserve Bank Ofon Tuesday, December 11, 2007, at 8:00 ficer, Division of Monetary Afa.m. fairs, Board of Governors Mr. Small, Project Manager, Division Present: of Monetary Affairs, Board of Mr. Bernanke, Chairman Governors Mr. Geithner, Vice Chairman Mr. Evans Mr. Luecke, Senior Financial Analyst, Mr. Hoenig Division of Monetary Affairs, Mr. Kohn Board of Governors Mr. Kroszner Mr. Mishkin Ms. Low, Open Market Secretariat Spe- Mr. Poole cialist, Division of Monetary Af- Mr. Rosengren fairs, Board of Governors Mr. Warsh Mr. Barron, First Vice President, Federal Reserve Bank of Atlanta Ms. Cumming, Mr. Fisher, Ms. Pianalto, and Messrs. Plosser and Mr. Rosenblum, Executive Vice Presi- Stern, Alternate Members of the dent, Federal Reserve Bank of Federal Open Market Committee Dallas Messrs. Lacker and Lockhart, and Ms. Mr. Altig, Ms. Perelmuter, Messrs. Yellen, Presidents of the Federal Rolnick, Weinberg, and Williams, Reserve Banks of Richmond, Senior Vice Presidents, Federal Atlanta, and San Francisco, Reserve Banks of Atlanta, New respectively York, Minneapolis, Richmond, and San Francisco, respectively Mr. Madigan, Secretary and Economist Ms. Danker, Deputy Secretary Messrs. Bryan and Yi, Vice Presidents, Ms. Smith, Assistant Secretary Federal Reserve Banks of Cleve- Mr. Skidmore, Assistant Secretary land and Philadelphia, respectively Mr. Alvarez, General Counsel Mr. Baxter, Deputy General Counsel Mr. McCarthy, Research Officer, Fed- Mr. Sheets, Economist eral Reserve Bank of New York Mr. Stockton, Economist The Manager of the System Open Messrs. Clouse, Connors, Fuhrer, Ka- Market Account reported on recent demin, Rasche, Sellon, Slifman, Sul- velopments in foreign exchange marlivan, and Wilcox, Associate kets. There were no open market opera- Economists tions in foreign currencies for the Mr. Dudley, Manager, System Open System's account in the period since the Market Account previous meeting. The Manager also re- Mr. Struckmeyer, Deputy Staff Direc- ported on developments in domestic fitor, Office of Staff Director for nancial markets and on System open Management market operations in government securi- Mr. English, Senior Associate Director, ties and federal agency obligations dur- Division of Monetary Affairs, ing the period since the previous meet- Board of Governors ing. By unanimous vote, the Committee ratified these transactions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

260 94th Annual Report, 2007 The Committee approved a foreign real estate, and building-material and currency swap arrangement with the garden-supply retailers continued to Swiss National Bank that paralleled the trend down. Elsewhere, factory jobs dearrangement with the European Central clined again, while employment in most Bank approved during the Committee's service-producing industries continued conference call on December 6, 2007. to move up. Aggregate hours of produc- With Mr. Poole dissenting, the Commit- tion or nonsupervisory workers edged tee voted to direct the Federal Reserve up in October and November. Some in- Bank of New York to establish and dicators from the household survey also maintain a reciprocal currency (swap) suggested softening in the labor market, arrangement for the System Open Mar- but the unemployment rate held steady ket Account with the Swiss National at 4.7 percent through November. Bank in an amount not to exceed $4 bil- Industrial production fell in October lion. The Committee authorized associ- after small increases in the previous two ated draws of up to the full amount of months. The index for motor vehicles $4 billion, and the arrangement itself and parts fell for the third consecutive was authorized for a period of up to 180 month, and the index for construction days unless extended by the FOMC. Mr. supplies moved down for the fourth Poole dissented because he viewed the straight month. Materials output also deswap agreement as unnecessary in light clined in October, with production likely of the size of the Swiss National Bank's curbed by weak demand from the condollar-denominated foreign exchange struction and motor vehicle sectors. Proreserves. duction in high-tech industries, however, The information reviewed at the De- increased modestly, and commercial aircember meeting indicated that, after the craft production registered another solid robust gains of the summer, economic gain. In November, output appeared to activity decelerated significantly in the have edged up in manufacturing sectors fourth quarter. Consumption growth (with the exception of the motor veslowed, and survey measures of senti- hicles sector) for which weekly physical ment dropped further. Many readings product data were available. from the business sector were also After posting notable gains in the softer: Industrial production fell in Octo- summer, real consumer spending was ber, as did orders and shipments of capi- nearly flat in September and October. tal goods. Employment gains stepped Spending on goods excluding motor vedown during the four months ending in hicles was little changed on net over that November from their pace earlier in the period. Spending on services edged year. Headline consumer price inflation down, reflecting an extraordinarily large moved higher in September and October drop in securities commissions in Sepas energy prices increased significantly; tember. The most recent readings on core inflation also rose but remained weekly chain store sales as well as inmoderate. dustry reports and surveys suggested The slowing in private employment subdued gains in November and an ungains was due in large part to the ongo- even start to the holiday shopping seaing weakness in the housing market. son. Sales of light motor vehicles in No- Employment in residential construction vember remained close to the pace that posted its fourth month of sizable de- had prevailed since the second quarter. clines in November, and employment in Real disposable income was about unhousing-related sectors such as finance, changed in September and October. The Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 261 Reuters/University of Michigan index of ruptions stemming from the wildfires in consumer sentiment ticked down further Southern California; cutbacks in dein early December as respondents took a mand from large financial institutions more pessimistic view of the outlook for affected by market turmoil may have their personal finances and for business contributed as well. In the transportation conditions in the year ahead. equipment category, purchases of me- In the housing market, new home dium and heavy trucks changed little, sales were below their third-quarter and orders data suggested that sales pace, and sales of existing homes were would remain near their current levels in flat in October following sharp declines the coming months. Orders for equipin August and September. These ment outside high-tech and transportadeclines likely were exacerbated by the tion rose in October, but shipments were deterioration in nonprime mortgage about flat, pointing to a weaker fourth markets and by the higher interest rates quarter for business spending after two and tighter lending conditions for jumbo quarters of brisk increases. Some promiloans. Single-family housing starts nent surveys of business conditions restepped down again in October after mained consistent with modest gains in substantial declines in the June- spending on equipment and software September period. Yet, because of sag- during the fourth quarter, but other surging sales, builders made only limited veys were less sanguine. In addition, alprogress in paring down their substan- though the cost of capital was little tial inventories. Single-family permit is- changed for borrowers in the suance continued along the steep down- investment-grade corporate bond marward trajectory that had begun two years ket, costs for borrowers in the high-yield earlier, which pointed toward further corporate bond market were up signifislowing in homebuilding over the near cantly. In the third quarter, corporate term. Multifamily starts rebounded in cash flows appeared to have dropped October from an unusually low reading off, leaving firms with diminished in September, and the level of multifam- internally generated funds for financing ily starts was near the midpoint of the investment. Data available through range in which this series had fluctuated October suggested that nonresidential over the past ten years. building activity remained vigorous. Real spending on equipment and soft- Real nonfarm inventory investment ware posted a solid increase in the third excluding motor vehicles increased quarter. In October, however, orders and slightly faster in the third quarter than in shipments of nondefense capital goods the second quarter. Outside of motor veexcluding aircraft declined, suggesting hicles, the ratio of book-value inventothat some deceleration in spending was ries to sales had ticked up slightly in under way in the fourth quarter. The Oc- September but remained near the low tober decline in orders and shipments end of its range in recent years. Bookwas led by weakness in the high-tech value estimates of the inventory investsector: Shipments of computers and pe- ment of manufacturers—the only invenripheral equipment declined while the tory data available beyond the third industrial production index for comput- quarter—were up in October at about ers was flat; orders and shipments for the third-quarter pace. communications equipment plunged. The U.S. international trade deficit Some of that weakness may have been narrowed slightly in September as an attributable to temporary production dis- increase in exports more than offset Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

262 94th Annual Report, 2007 higher imports. The September gain in pace in the second quarter, but remained exports primarily reflected higher ex- strong. Economic growth was also solid ports of goods; services exports re- in Latin America, largely reflecting corded moderate growth. Exports of ag- stronger-than-expected activity in ricultural products exhibited particularly Mexico. robust growth, with both higher prices In the United States, headline conand greater volumes. Exports of indus- sumer price inflation increased in Septrial supplies and consumer goods also tember and October from its low rates in moved up smartly in September. Auto- the summer as the surge in crude oil motive products exports, in contrast, prices began to be reflected in retail enwere flat, and capital goods exports fell, ergy prices. In addition, though the rise led by a decline in aircraft. The increase in food prices in October was slower in imports primarily reflected higher im- than in August and September, it reports of capital goods, with imports of mained above that of core consumer computers showing particularly strong prices. Excluding food and energy, inflagrowth. Imports of automotive products, tion was moderate, although it was up consumer goods, and services also in- from its low rates in the spring. The creased. Imports of petroleum, however, pickup in core consumer inflation over were flat, and imports of industrial sup- this period reflected an acceleration in plies fell. some prices that were unusually soft last Output growth in the advanced for- spring, such as those for apparel, preeign economies picked up in the third scription drugs, and medical services, as quarter. In Japan, real output rebounded, well as nonmarket prices. On a twelveled by exports. In the euro area, GDP month-change basis, core consumer growth returned to a solid pace in the price inflation was down noticeably third quarter on the back of a strong from a year earlier. In October, the prorecovery in investment. In Canada and ducer price index for core intermediate the United Kingdom, output growth materials moved up only slightly for a moderated but remained robust, as vig- second month, and the twelve-month inorous domestic demand was partly off- crease in these prices was considerably set by rapid growth of imports. Indica- below that of the year-earlier period. tors of fourth-quarter activity in the This pattern reflected, in part, a deceladvanced foreign economies were less eration in the prices of a wide variety of robust on net. Confidence indicators had construction materials, such as cement deteriorated in most major economies in and gypsum, and in the prices of some the wake of the financial turmoil and metal products. In response to rising enremained relatively weak. In November, ergy prices, household survey measures the euro-area and U.K. purchasing man- of expectations for year-ahead inflation agers indexes for services were well be- picked up in November and then edged low their level over the first half of the higher in December. Households' year; nevertheless they pointed to mod- longer-term inflation expectations also erate expansion. Labor market condi- edged up in both November and Decemtions generally remained relatively ber. Average hourly earnings increased strong in recent months. Incoming data faster in November than in the previous on emerging-market economies were two months. Over the twelve months positive on balance. Overall, growth in that ended in November, however, this emerging Asia moderated somewhat in wage measure rose a bit more slowly the third quarter from its double-digit than over the previous twelve months. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 263 At its October meeting, the FOMC expected path for policy. During the inlowered its target for the federal funds termeeting period, the release of the rate 25 basis points, to 4Vi percent. The FOMC minutes and associated summary Board of Governors also approved a of economic projections, as well as vari- 25 basis point decrease in the discount ous data releases, elicited only modest rate, to 5 percent, leaving the gap be- market reaction. In contrast, markets tween the federal funds rate target and were buffeted by concerns about the pothe discount rate at 50 basis points. The tential adverse effects on credit avail- Committee's statement noted that, while ability and economic growth of sizable economic growth was solid in the third losses at large financial institutions and quarter and strains in financial markets of financial market strains in general. had eased somewhat on balance, the Market participants marked down their pace of economic expansion would expected path for policy substantially, likely slow in the near term, partly re- and by the time of the December meetflecting the intensification of the hous- ing, investors were virtually certain of a ing correction. The Committee indicated rate cut. Two-year Treasury yields fell that its action, combined with the policy on net over the intermeeting period by action taken in September, should help an amount about in line with revisions forestall some of the adverse effects on to policy expectations. Ten-year Treathe broader economy that might other- sury yields also declined, but less than wise arise from the disruptions in finan- shorter-term yields. The steepening of cial markets and should promote moder- the yield curve was due mostly to ate growth over time. Readings on core sharply lower short- and intermediateinflation had improved modestly during term forward rates, consistent with inthe year, but the statement noted that vestors' apparently more pessimistic recent increases in energy and commod- outlook for economic growth. TIPS ity prices, among other factors, may put yields fell less than their nominal counrenewed upward pressure on inflation. terparts, implying modest declines in in- In this context, the Committee judged flation compensation both at the fivethat some inflation risks remained and year and longer horizons. indicated that it would continue to moni- After showing some signs of imtor inflation developments carefully. The provement in late September and Octo- Committee also judged that, after this ber, conditions in financial markets action, the upside risks to inflation worsened over the intermeeting period. roughly balanced the downside risks to Heightened worries about counterparty growth. The Committee said that it credit risk, balance sheet constraints, would continue to assess the effects of and liquidity pressures affected interfinancial and other developments on bank funding markets and commercial economic prospects and would act as paper markets, where spreads over riskneeded to foster price stability and susfree rates rose to levels that were, in tainable economic growth. some cases, higher than those seen in The Committee's action at its Octo- August. Strains in those markets were ber meeting was largely expected by exacerbated by concerns related to yearmarket participants, although the assess- end pressures. In longer-term corporment that the upside risks to inflation ate markets, both investment- and balanced the downside risks to growth speculative-grade credit spreads widwas not fully anticipated and apparently ened considerably; issuance slowed but led investors to revise up slightly the remained strong. In housing finance, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

264 94th Annual Report, 2007 subprime mortgage markets stayed vir- of growth in aggregate economic activtually shut, and spreads on jumbo loans ity in the fourth quarter. Although thirdapparently widened further. Spreads on quarter real GDP was revised up conforming mortgage products also sharply, most available indicators of acwidened after reports of losses and tivity in the fourth quarter were more reduced capital ratios at the housing- downbeat than had previously been exrelated government-sponsored enter- pected. Faster inventory investment conprises. Broad-based equity indexes were tributed importantly to the upward revivolatile and ended the period down no- sion to third-quarter real GDP, but part ticeably. Financial stocks were espe- of that upswing was expected to be uncially hard hit, dropping substantially wound in the fourth quarter. The availmore than the broad indexes. Similar able data for domestic final sales also stresses were evident in the financial suggested a weaker fourth quarter than markets of major foreign economies. had been anticipated. In particular, real The trade-weighted foreign exchange personal consumption expenditures had value of the dollar against major curren- been about unchanged in September and cies moved up, on balance, over the in- October, and the contraction in singletermeeting period. family construction had intensified. Pro- Debt in the domestic nonfinancial viding a bit of an offset to these factors, sector was estimated to be increasing however, was further improvement in somewhat more slowly in the fourth the external sector. The staff also quarter than in the third quarter. Nonfi- marked down its projection for the rise nancial business debt continued to ex- in real GDP over the remainder of the pand strongly, supported by solid bond forecast period. Real GDP was anticiissuance and by a small rebound in the pated to increase at a rate noticeably issuance of commercial paper. Bank below its potential in 2008. Conditions loans outstanding also continued to rise in financial markets had deteriorated rapidly. Household mortgage debt was over the intermeeting period and were expected to expand at a reduced rate in expected to impose more restraint on the fourth quarter, reflecting softer home residential construction as well as conprices and declining home sales, as well sumer and business spending in 2008 as a tightening in credit conditions for than previously expected. In addition, some borrowers. Nonmortgage con- compared with the previous forecast, sumer credit in the fourth quarter ap- higher oil prices and lower real income peared to be expanding at a moderate were expected to weigh on the pace of pace. In November, M2 growth picked real activity throughout 2008 and 2009. up slightly from its October rate. While By 2009, however, the staff projected liquid deposits continued to grow that the drag from those factors would slowly, heightened demand for safety lessen and that an improvement in mortand liquidity appeared to boost holdings gage credit availability would lead to a of retail money market mutual funds. gradual recovery in the housing market. Small time deposits continued to ex- Accordingly, economic activity was expand, likely in part due to high rates pected to increase at its potential rate in offered by some depository institutions 2009. The external sector was projected to attract retail deposits. Currency out- to continue to support domestic ecostanding was about flat in November. nomic activity throughout the forecast In the forecast prepared for this meet- period. Reflecting upward revisions to ing, the staff revised down its estimate previously published data, the forecast Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 265 for core PCE price inflation for 2007 tion temporarily, but with futures prices was a bit higher than in the preceding pointing to a gradual decline in oil prices forecast; core inflation was projected to and with pressures on resource utilizahold steady during 2008 as the indirect tion seen as likely to ease a bit, most effects of higher energy prices on prices participants continued to anticipate of core consumer goods and services some moderation in core and especially were offset by the slight easing of re- headline inflation over the next few source pressures and the expected decel- years. eration in the prices of nonfuel imported Participants discussed in detail the regoods. The forecast for headline PCE surgence of stresses in financial markets inflation anticipated that retail energy in November. The renewed stresses reprices would rise sharply in the first flected evidence that the performance of quarter of 2008 and that food price inflamortgage-related assets was deteriorattion would outpace core price inflation ing further, potentially increasing the in the beginning of the year. As preslosses that were being borne in part by a sures from these sources lessened over number of major financial firms, includthe remainder of 2008 and in 2009, both ing money-center banks, housing-related core and headline price inflation were government-sponsored enterprises, inprojected to edge down, and headline vestment banks, and financial guaraninflation was expected to moderate to a tors. Moreover, participants recognized pace slightly below core inflation. that some lenders might be exposed to In their discussion of the economic additional losses: Delinquency rates on situation and outlook, participants gencredit card loans, auto loans, and other erally noted that incoming information forms of consumer credit, while still pointed to a somewhat weaker outlook moderate, had increased somewhat, parfor spending than at the time of the Octicularly in areas hard hit by house price tober meeting. The decline in housing declines and mortgage defaults. Past and had steepened, and consumer outlays prospective losses appeared to be spurappeared to be softening more than anring lenders to tighten further the terms ticipated, perhaps indicating some spillon new extensions of credit, not just in over from the housing correction to the troubled markets for nonconforming other components of spending. These mortgages but, in some cases, for other developments, together with renewed forms of credit as well. In addition, parstrains in financial markets, suggested ticipants noted that some intermediaries that growth in late 2007 and during 2008 were facing balance sheet pressures and was likely to be somewhat more slugcould become constrained by concerns gish than participants had indicated in about rating-agency or regulatory capitheir October projections. Still, looking tal requirements. Among other factors, further ahead, participants continued to banks were experiencing unanticipated expect that, aided by an easing in the stance of monetary policy, economic growth in loans as a result of continuing growth would gradually recover as illiquidity in the market for leveraged weakness in the housing sector abated loans, persisting problems in the comand financial conditions improved, al- mercial paper market that had sparked lowing the economy to expand at about draws on back-up lines of credit, and its trend rate in 2009. Participants more recently, consolidation of assets of thought that recent increases in energy off-balance-sheet affiliates onto banks' prices likely would boost headline infla- balance sheets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

266 94th Annual Report, 2007 Concerns about credit risk and the tional data. Real personal consumption pressures on banks' balance sheet capac- expenditures had shown essentially no ity appeared to be contributing to dimin- growth in September and October, sugished liquidity in interbank markets and gesting that tighter credit conditions, to a pronounced widening in term higher gasoline prices, and the continuspreads for periods extending through ing housing correction might be restrainyear-end. A number of participants ing growth in real consumer spending. noted some potential for the Federal Re- Retailers reported weaker results in serve's new Term Auction Facility and many regions of the country, but in accompanying actions by other central some, retailers saw solid growth. Job banks to ameliorate pressures in term growth rebounded somewhat in October funding markets. Participants recog- and November, and participants exnized, however, that uncertainties about pected continuing gains in employment values of mortgage-related assets and re- and income to support rising consumer lated losses, and consequently strains in spending, though they anticipated financial markets, could persist for quite slower growth of jobs, income, and some time. spending than in recent years. However, Some participants cited more-positive consumer confidence recently had aspects of recent financial develop- dropped by a sizable amount, leading ments. A number of large financial some participants to voice concerns that intermediaries had been able to raise household spending might increase less substantial amounts of new capital. than currently anticipated. Moreover, credit losses and asset write- Recent data and anecdotal informadowns at regional and community banks tion indicated that the housing sector had generally been modest; these institu- was weaker than participants had extions typically were not facing balance pected at the time of the Committee's sheet pressures and reportedly had not previous meeting. In light of elevated tightened lending standards appreciably, inventories of unsold homes and the except for those on real estate loans. higher cost and reduced availability of And, although spreads on corporate nonconforming mortgage loans, particibonds had widened over the intermeet- pants agreed that the housing correction ing period, especially for speculative- was likely to be both deeper and more grade issues, the cost of credit to most prolonged than they had anticipated in nonfinancial firms remained relatively October. Moreover, rising foreclosures low; nonfinancial firms outside of the and the resulting increase in the supply real estate and construction sectors gen- of homes for sale could put additional erally reported that credit conditions, downward pressure on prices, leading to while somewhat tighter, were not re- a greater decline in household wealth stricting planned investment spending; and potentially to further disruptions in and consumer credit remained readily the financial markets. available for most households. Nonethe- Indicators of capital investment for less, participants agreed that heightened the nation as a whole suggested solid financial stress posed increased down- but appreciably less rapid growth in side risks to growth and made the out- business fixed investment during the look for the economy considerably more fourth quarter than the third. Participants uncertain. reported that firms in some regions and Participants noted the marked decel- industries had indicated they would eration in consumer spending in the na- scale back capital spending, while con- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 267 tacts in other parts of the country or higher input costs and rising prices of industries reported no such change. imports were leading more firms to seek Similarly, business sentiment had dete- price increases for goods and services. riorated in many parts of the country, However, few business contacts had rebut in other areas firms remained cau- ported unusually large wage increases. tiously optimistic. Anecdotal evidence Downward revisions to earlier compengenerally suggested that inventories sation data, along with the latest readwere not out of line with desired levels. ings on compensation and productivity, Even so, participants expected that in- indicated only moderate pressure on unit ventory accumulation would slow from labor costs. With futures prices pointing its elevated third-quarter pace. Several to a gradual decline in oil prices and participants remarked that, unlike resi- with an anticipation of some easing of dential real estate, commercial and in- pressures on resource utilization, particidustrial real estate activity remained pants generally continued to see core solid in their Districts. But participants PCE inflation as likely to trend down a also noted the deterioration in the sec- bit over the next few years, as in their ondary market for commercial real es- October projections, and headline inflatate loans and the possible effects of that tion as likely to slow more substantially development, should it persist, on build- from its currently elevated level. Noneing activity. theless, participants remained concerned The available data showed strong about upside risks to inflation stemming growth abroad and solid gains in U.S. from elevated prices of energy and nonexports. Participants noted that rising energy commodities; some also cited the foreign demand was benefiting U.S. pro- weaker dollar. Participants agreed that ducers of manufactured goods and agri- continued stable inflation expectations cultural products, in particular. Exports would be essential to achieving and suswere unlikely to continue growing at the taining a downward trend to inflation, robust rate reported for the third quarter, that well-anchored expectations couldn't but participants anticipated that the com- be taken for granted, and that policybination of the weaker dollar and still- makers would need to continue to watch strong, though perhaps less-rapid, inflation expectations closely. growth abroad would mean continued In the Committee's discussion of firm growth in U.S. exports. Several par- monetary policy for the intermeeting peticipants observed, however, that strong riod, members judged that the softening growth in foreign economies and U.S. in the outlook for economic growth warexports might not persist if global finan- ranted an easing of the stance of policy cial conditions were to deteriorate at this meeting. In view of the further further. tightening of credit and deterioration of Recent readings on inflation gener- financial market conditions, the stance ally were seen as slightly less favorable of monetary policy now appeared to be than in earlier months, partly due to up- somewhat restrictive. Moreover, the ward revisions to previously published downside risks to the expansion, resultdata. Moreover, earlier increases in en- ing particularly from the weakening of ergy and food prices likely would imply the housing sector and the deterioration higher headline inflation in the next few in credit market conditions, had risen. In months, and past declines in the dollar these circumstances, policy easing would put upward pressure on import would help foster maximum sustainable prices. Some participants said that growth and provide some additional in- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

268 94th Annual Report, 2007 surance against risks. At the same time, sumer spending, and that strains in fimembers noted that policy had already nancial markets had increased. The been eased by 75 basis points and that characterization of the inflation situathe effects of those actions on the real tion could be largely unchanged from economy would be evident only with a that of the previous meeting. Members lag. And some data, including readings agreed that the resurgence of financial on the labor market, suggested that the stresses in November had increased uneconomy retained forward momentum. certainty about the outlook. Given the Members generally saw overall inflation heightened uncertainty, the Committee as likely to be lower next year, and core decided to refrain from providing an exinflation as likely to be stable, even if plicit assessment of the balance of risks. policy were eased somewhat at this The Committee agreed on the need to meeting; but they judged that some in- remain exceptionally alert to economic flation pressures and risks remained, in- and financial developments and their efcluding pressures from elevated com- fects on the outlook, and members modity and energy prices and the would be prepared to adjust the stance possibility of upward drift in the pub- of monetary policy if prospects for ecolic's expectations of inflation. Weighing nomic growth or inflation were to these considerations, nearly all members worsen. judged that a 25 basis point reduction in At the conclusion of the discussion, the Committee's target for the federal the Committee voted to authorize and funds rate would be appropriate at this direct the Federal Reserve Bank of New meeting. Although members agreed that York, until it was instructed otherwise, the stance of policy should be eased, to execute transactions in the System they also recognized that the situation Account in accordance with the followwas quite fluid and the economic out- ing domestic policy directive: look unusually uncertain. Financial The Federal Open Market Committee stresses could increase further, intensifyseeks monetary and financial conditions that ing the contraction in housing markets will foster price stability and promote susand restraining other forms of spending. tainable growth in output. To further its Some members noted the risk of an un- long-run objectives, the Committee in the favorable feedback loop in which credit immediate future seeks conditions in reserve markets consistent with reducing the federal market conditions restrained economic funds rate to an average of around 4lA pergrowth further, leading to additional cent. tightening of credit; such an adverse de- The vote encompassed approval of velopment could require a substantial the statement below to be released at further easing of policy. Members also 2:15 p.m.: recognized that financial market conditions might improve more rapidly than The Federal Open Market Committee members expected, in which case a re- decided today to lower its target for the fedversal of some of the rate cuts might eral funds rate 25 basis points to 4V4 percent. Incoming information suggests that ecobecome appropriate. nomic growth is slowing, reflecting the The Committee agreed that the state- intensification of the housing correction and ment to be released after this meeting some softening in business and consumer spending. Moreover, strains in financial should indicate that economic growth markets have increased in recent weeks. appeared to be slowing, reflecting the Today's action, combined with the policy intensification of the housing correction actions taken earlier, should help promote and some softening in business and con- moderate growth over time. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Minutes of FOMC Meetings, December 269 Readings on core inflation have improved mously approved the minutes of the modestly this year, but elevated energy and FOMC meeting held on October 30-31, commodity prices, among other factors, may 2007. put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to Conference Call monitor inflation developments carefully. Recent developments, including the dete- On December 6, 2007, in a joint session rioration in financial market conditions, of the Federal Open Market Committee have increased the uncertainty surrounding and the Board of Governors, Board the outlook for economic growth and inflamembers and Reserve Bank presidents tion. The Committee will continue to assess reviewed conditions in domestic and the effects of financial and other developments on economic prospects and will act as foreign financial markets and discussed needed to foster price stability and sustain- two proposals aimed at improving marable economic growth. ket functioning. The first proposal was Votes for this action: Messrs. Bernanke, for the establishment of a temporary Geithner, Evans, Hoenig, Kohn, Term Auction Facility (TAF), which Kroszner, Mishkin, Poole, and Warsh. would provide term funding to eligible Votes against this action: Mr. Rosen- depository institutions through an aucgren. tion mechanism beginning in mid- Mr. Rosengren dissented because he December. Meeting participants recogregarded the weakness in the incoming nized that a TAF would not address all economic data and in the outlook for the of the factors giving rise to stresses in economy as warranting a more aggres- money and credit markets, notably the sive policy response. In his view, the ongoing concerns about credit quality combination of a deteriorating housing and balance sheet pressures. Nonethesector, slowing consumer and business less, most participants viewed the TAF, spending, high energy prices, and ill- which would provide liquidity to more functioning financial markets suggested counterparties and against a broader heightened risk of continued economic range of collateral than used for open weakness. In light of that possibility, a market operations, as a potentially usemore decisive policy response was ful tool. Some mentioned that a TAF called for to minimize that risk. In any could help alleviate year-end pressures case, he felt that well-anchored inflation in money markets. A few participants, expectations and the Committee's abil- however, questioned the need for and ity to reverse course on policy would the likely efficacy of the proposal, exlimit the inflation risks of a larger easing pressed concerns about the longer-run move, should the economy instead incentive effects of a TAF, and felt that prove significantly stronger than antici- the possible drawbacks could well outpated. weigh any benefits.14 Participants gener- It was agreed that the next meeting of ally regarded the second proposal, to set the Committee would be held on up a foreign exchange swap arrange- Tuesday-Wednesday, January 29-30, ment with the European Central Bank, 2008. as a positive step in international coop- The meeting adjourned at 1:15 p.m. Notation Vote 14. Secretary's Note: The Board of Governors approved the TAF via notation vote on December By notation vote completed on Novem- 10, 2007 after the staff finalized its proposal for ber 19, 2007, the Committee unani- specifications of the TAF. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

270 94th Annual Report, 2007 eration to address elevated pressures in rized, and the arrangement itself was aushort-term dollar funding markets. thorized for a period of up to 180 days, At the conclusion of the discussion, unless extended by the FOMC. Mr. with Mr. Poole dissenting, the Commit- Poole dissented because he viewed the tee voted to direct the Federal Reserve swap agreement as unnecessary in light Bank of New York to establish and of the size of the European Central maintain a reciprocal currency (swap) Bank's dollar-denominated foreign exarrangement for the System Open Mar- change reserves. ket Account with the European Central Brian F. Madigan Bank in an amount not to exceed Secretary $20 billion. Within that aggregate limit, draws of up to $10 billion were autho- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

271 Litigation During 2007, the Board of Governors motion for summary judgment in a Freewas a party in one lawsuit and one ap- dom of Information Act case. On Seppeal filed that year and in six other cases tember 11, 2006, the court of appeals pending from previous years, for a total affirmed in part and reversed in part the of eight cases; in 2006, the Board had ruling of the district court, and rebeen a party in a total of seven cases. As manded the case. 463 F.3d 239. On of December 31, 2007, six cases were March 20, 2007, the case was dismissed pending. by stipulation of the parties. Interactive Media Entertainment and Barnes v. Greenspan, No. 04-CV- Gaming Association, Inc. v. Federal Re- 1989 (CKK) (D. District of Columbia, serve System, No. 07-2625 (D. New Jer- filed November 15, 2004), is a case unsey, filed June 5, 2007), is an action der the Age Discrimination in Employchallenging the implementation of the ment Act. Unlawful Internet Gambling Enforce- Jones v. Greenspan, No. 04-CV-1696 ment Act of 2006. (RMU) (D. District of Columbia, filed Smith v. Bernanke, No. 07-1710 October 4, 2004), is an employment dis- (Sixth Circuit, filed June 4, 2007), is an crimination action. On December 13, appeal of the dismissal of a district court 2005, the district court granted in part action (No. 07-10453 (E.D. Michigan)) and denied in part the Board's motion to challenging the Federal Reserve's han- dismiss and for summary judgment. 402 dling of appellant's consumer com- F. Supp. 2d 294. On June 11, 2007, the plaint. court granted the Board's motion for Chandler v. Bernanke, No. 06-2082 summary judgment as to Counts I and II (D. District of Columbia, filed Decem- of the plaintiff's First Amended Comber 6, 2006), is an employment discrimi- plaint. 493 F. Supp. 2d 18. nation action. Artis v. Greenspan, No. 01-0400 (D. Price v. Bernanke, No. 06-1569 (D. District of Columbia, filed February 22, District of Columbia, filed September 8, 2001), is an employment discrimination 2006), was an employment discrimina- action. An identical action, No. 99-2073 tion action. The action was dismissed (EGS) (D. District of Columbia, filed voluntarily on November 20, 2007. August 3, 1999), was consolidated with Inner City Press/Community on the this action on August 15, 2001. On Move v. Board of Governors, No. 05- January 31, 2007, the District Court 6162 (Second Circuit, filed November granted the Board's renewed motion to 21, 2005), was an appeal of the district dismiss the action. 474 F. Supp. 2d 16. court's order (No. 04-CV-8337, 380 F. The plaintiffs' motion to alter or amend Supp. 2d 211 (S.D.N.Y. 2005)) granting judgment is pending. • in part and denying in part the Board's 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 275 Board of Governors December 31,2007 Members OFFICE OF THE SECRETARY Term expires JENNIFER J. JOHNSON, Secretary January 31, BEN S. BERNANKE, Chairman1 2020 ROBERT DEV. FRIERSON, Deputy Secretary MARGARET M. SHANKS, Associate DONALD L. KOHN, Vice Chairman1 .. 2016 Secretary KEVIN M. WARSH 2018 RANDALL S. KROSZNER 2008 DIVISION OF FREDERIC S. MISHKIN 2014 INTERNATIONAL FINANCE Officers D. NATHAN SHEETS, Director OFFICE OF BOARD MEMBERS THOMAS A. CONNORS, Senior Associate MICHELLE A. SMITH, Director Director LARICKE D. BLANCHARD, Assistant to the RICHARD T. FREEMAN, Associate Director Board STEVEN B. KAMIN, Associate Director WINTHROP P. HAMBLEY, Assistant to the DALE W. HENDERSON, Senior Adviser Board KAREN H. JOHNSON, Senior Adviser ROSANNA PIANALTO-CAMERON, Assistant to JOSEPH E. GAGNON, Deputy Associate the Board Director DAVID W. SKIDMORE, Assistant to the Board MICHAEL P. LEAHY, Deputy Associate BRIAN J. GROSS, Special Assistant to the Director Board for Congressional Liaison RALPH W. TRYON, Deputy Associate ROBERT M. PRIBBLE, Special Assistant to Director the Board for Congressional Liaison TREVOR A. REEVE, Assistant Director LEGAL DIVISION JOHN ROGERS, Assistant Director SCOTT G. ALVAREZ, General Counsel RICHARD M. ASHTON, Deputy General DIVISION OF Counsel MONETARY AFFAIRS KATHLEEN M. O'DAY, Deputy General BRIAN F. MADIGAN, Director Counsel JAMES A. CLOUSE, Senior Associate STEPHANIE MARTIN, Associate General Director Counsel DEBORAH J. DANKER, Senior Associate ANN MISBACK, Associate General Counsel Director KATHERINE H. WHEATLEY, Associate WILLIAM B. ENGLISH, Senior Associate General Counsel Director KIERAN J. FALLON, Assistant General CHERYL L. EDWARDS, Associate Director Counsel ANDREW T. LEVIN, Deputy Associate STEPHEN H. MEYER, Assistant General Director Counsel WILLIAM NELSON, Deputy Associate PATRICIA A. ROBINSON, Assistant General Director Counsel SETH B. CARPENTER, Assistant Director CARY K. WILLIAMS, Assistant General JOHN B. DURHAM, Assistant Director Counsel ROBERTO PEILI, Assistant Director 1. The designations as Chairman and Vice GRETCHEN C. WEINBACH, Assistant Chairman expire on January 31, 2010, and Director June 22, 2010, respectively, unless the service of these members of the Board terminates sooner. JONATHAN H. WRIGHT, Assistant Director Digitized for FRASER EGON ZAKRAJSEK, Assistant Director http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

276 94th Annual Report, 2007 Board of Governors—Continued DIVISION OF RESEARCH WILLIAM F. TREACY, Adviser AND STATISTICS SARKIS YOGHOURTDJIAN, Adviser DAVID J. STOCKTON, Director NORAH M. BARGER, Associate Director PATRICK M. PARKINSON, Deputy Director BETSY CROSS, Associate Director DAVID W. WILCOX, Deputy Director GERALD A. EDWARDS, JR., Associate MYRON L. KWAST, Senior Associate Director Director JON D. GREENLEE, Associate Director LAWRENCE SLIFMAN, Senior Associate CHARLES H. HOLM, Associate Director Director JACK P. JENNINGS II, Associate Director J. NELLIE LIANG, Associate Director ROBIN L. LUMSDAINE, Associate Director DAVID L. REIFSCHNEIDER, Associate WILLIAM G. SPANIEL, Associate Director Director CORYANN STEFANSSON, Associate Director JANICE SHACK-MARQUEZ, Associate MOLLY S. WASSOM, Associate Director Director DAVID M. WRIGHT, Associate Director WILLIAM L. WASCHER III, Associate KEVIN M. BERTSCH, Deputy Associate Director Director ALICE PATRICIA WHITE, Associate Director BARBARA J. BOUCHARD, Deputy Associate GLENN B. CANNER, Senior Adviser Director DAVID S. JONES, Senior Adviser JAMES A. EMBERSIT, Deputy Associate STEPHEN D. OLINER, Senior Adviser Director MICHAEL S. GIBSON, Deputy Associate ARTHUR W. LINDO, Deputy Associate Director Director S. WAYNE PASSMORE, Deputy Associate WILLIAM C. SCHNEIDER, JR., Deputy Director Associate Director DANIEL E. SICHEL, Deputy Associate ROBERT T. ASHMAN, Assistant Director Director LISA M. DEFERRARI, Assistant Director JOYCE K. ZICKLER, Deputy Associate ROBERT T. MAAS, Assistant Director Director RICHARD A. NAYLOR II, Assistant Director MICHAEL S. CRINGOLI, Assistant Director NINA A. NICHOLS, Assistant Director KAREN E. DYNAN, Assistant Director DANA E. PAYNE, Assistant Director DIANA HANCOCK, Assistant Director NANCY J. PERKINS, Assistant Director MICHAEL T. KILEY, Assistant Director SABETH I. SIDDIQUE, Assistant Director MICHAEL G. PALUMBO, Assistant Director DIVISION OF CONSUMER ROBIN A. PRAGER, Assistant Director AND COMMUNITY AFFAIRS MARY M. WEST, Assistant Director SANDRA F. BRAUNSTEIN, Director DANIEL M. COVITZ, Assistant Director and GLENN E. LONEY, Deputy Director Chief LEONARD CHANIN, Associate Director DAVID E. LEBOW, Assistant Director and MARY T. JOHNSEN, Associate Director Chief TONDA E. PRICE, Associate Director DIVISION OF BANKING SUPERVISION MARYANN F. HUNTER, Adviser AND REGULATION SHEILA F. MAITH, Adviser ROGER T. COLE, Director TIMOTHY R. BURNISTON, Assistant Director DEBORAH P BAILEY, Deputy Director SUZANNE G. KILLIAN, Assistant Director PETER J. PURCELL, Deputy Director JAMES A. MICHAELS, Assistant Director STEVEN M. ROBERTS, Deputy Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 277 Board of Governors—Continued DIVISION OF DIVISION OF RESERVE BANK OPERATIONS INFORMATION TECHNOLOGY AND PAYMENT SYSTEMS MAUREEN T. HANNAN, Director LOUISE L. ROSEMAN, Director GEARY L. CUNNINGHAM, Deputy Director DONALD V. HAMMOND, Deputy Director SHARON L. MOWRY, Deputy Director JEFFREY C. MARQUARDT, Deputy Director WAYNE A. EDMONDSON, Associate Director PAUL W. BETTGE, Senior Adviser LISA M. BELL, Assistant Director KENNETH D. BUCKLEY, Associate Director TILLENA G. CLARK, 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 RAYMOND ROMERO, Assistant Director GREGORY L. EVANS, Assistant Director JILL R. ROSEN, Assistant Director LISA HOSKINS, Assistant Director KOFI A. SAPONG, Assistant Director MICHAEL J. LAMBERT, Assistant Director OFFICE OF INSPECTOR GENERAL OFFICE OF STAFF DIRECTOR ELIZABETH A. COLEMAN, Inspector General FOR MANAGEMENT STEPHEN R. MALPHRUS, Staff Director for ANTHONY J. CASTALDO, Assistant Inspector Management General CHARLES S. STRUCKMEYER, Deputy Staff LAURENCE A. FROEHLICH, Assistant Director Inspector General SHEILA CLARK, Equal Employment WILLIAM L. MITCHELL, Assistant Inspector Opportunity Programs Director General LYNN S. FOX, Senior Adviser HARVEY WITHERSPOON, Assistant Inspector General ADRIENNE D. HURT, Adviser MANAGEMENT DIVISION H. FAY PETERS, Director DARRELL R. PAULEY, Deputy 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 CHARLES F. O'MALLEY, Assistant Director TARA C. TINSLEY-PELITERE, Assistant Director Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

278 94th Annual Report 2007 Federal Open Market Committee December 31,2007 Members Officers BEN S. BERNANKE, Chairman, Board of BRIAN F. MADIGAN, 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 CHARLES L. EVANS, President, Federal SCOTT G. ALVAREZ, General Counsel Reserve Bank of Chicago THOMAS C. BAXTER, JR., Deputy General THOMAS M. HOENIG, President, Federal Counsel Reserve Bank of Kansas City D. NATHAN SHEETS, Economist DONALD L. KOHN, Board of Governors DAVID J. STOCKTON, Economist RANDALL S. KROSZNER, Board of JAMES A. CLOUSE, Associate Economist Governors THOMAS A. CONNORS, Associate Economist FREDERIC S. MISHKIN, Board of Governors JEFFREY C. FUHRER, Associate Economist WILLIAM POOLE, President, Federal STEVEN B. KAMIN, Associate Economist Reserve Bank of St. Louis ROBERT H. RASCHE, Associate Economist ERIC S. ROSENGREN, President, Federal GORDON H. SELLON, JR., Associate Reserve Bank of Boston Economist KEVIN M. WARSH, Board of Governors LAWRENCE SLIFMAN, Associate Economist Alternate Members DANIEL G. SULLIVAN, Associate Economist CHRISTINE M. CUMMING, First Vice JOSEPH S. TRACY, Associate Economist President, Federal Reserve Bank of DAVID W. WILCOX, Associate Economist New York WILLIAM C. DUDLEY, Manager, System RICHARD W. FISHER, President, Federal Open Market Account Reserve Bank of Dallas The Federal Open Market Committee is made up of the seven members of the Board SANDRA PIANALTO, President, Federal of Governors; the president of the Federal Reserve Bank of Cleveland Reserve Bank of New York; and four of the CHARLES I. PLOSSER, President, Federal remaining eleven Reserve Bank presidents, Reserve Bank of Philadelphia who serve one-year terms on a rotating basis. GARY H. STERN, President, Federal During 2007 the Federal Open Market Com- Reserve Bank of Minneapolis mittee held eight regularly scheduled meetings and three conference calls (see "Minutes of Federal Open Market Committee Meetings" in this volume). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 279 Federal Advisory Council December 31, 2007 Members District 10—DAVID C. BOYLES, Chairman and Director, Colombine Capital Corp., 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, G. KENNEDY THOMPSON, President Fifth Third Bancorp, Cincinnati, Ohio. JAMES C. SMITH, 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—a statutory N.C. body established under the Federal Reserve District 6—FRED L. GREEN III, President Act—consults with, and advises, the Board and Chief Operating Officer, Synovus of Governors on all matters within the Financial Corporation, Columbus, Ga. Board's jurisdiction. It is composed of one District 7—WILLIAM DOWNE, Chief Execu- representative from each Federal Reserve tive Officer, Bank of Montreal, Chicago, District, chosen by the Reserve Bank in that 111. District. The Federal Reserve Act requires the council to meet in Washington, D.C., at District 8—ROBERT G. JONES, President and Chief Executive Officer, Old National least four times a year. In 2007, it met on Bancorp, Evansville, Ind. February 8-9, May 10-11, September 6-7, and December 6-7. The council met with the District 9—LYLE R. KNIGHT, President and Board on February 9, May 11, September 7, Chief Executive Officer, First Interstate and December 7, 2007. BancSystem, Inc., Billings, Mont. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

280 94th Annual Report, 2007 Consumer Advisory Council December 31,2007 Members ANNA MCDONALD RENTSCHLER, BSA Officer, Central Bancompany, Jefferson City, STELLA ADAMS, Founder, S J Adams Con- Mo. sulting, Durham, N.C. EDNA SAWADY, Managing Director, Market FAITH L. ANDERSON, Vice President—Legal Innovations, Inc., Orange, Ohio Compliance and General Counsel, Amer- FAITH ARNOLD SCHWARTZ, Executive ican Airlines Federal Credit Union, Fort Director, Hope Now Alliance, The Worth, Tex. Financial Services Roundtable, Wash- DOROTHY BRIDGES, Chief Executive Officer ington, D.C. and President, Franklin National Bank of EDWARD SIVAK, Director of Policy and Eval- Minneapolis, Minneapolis, Minn. uation, Enterprise Corporation of the CAROLYN CARTER, Attorney, National Con- Delta, Jackson, Miss. sumer Law Center, Boston, Mass. H. COOKE SUNOO, Director, Asian Pacific MICHAEL COOK, Vice President of Finance Islander Small Business Program, Los and Assistant Treasurer, Wal-Mart Stores, Angeles, Calif. Inc., Bentonville, Ark. STERGIOS THEOLOGIDES, Executive Vice DONALD S. CURRIE, Executive Director, President, General Counsel, Morgan Community Development Corporation of Stanley Home Loans, Fort Worth, Tex. Brownsville, Brownsville, Tex. LINDA TINNEY, Vice President, Community KURT EGGERT, Professor of Law and Direc- Development, West Metro Region Mantor of Clinical Legal Education, Chapman ager, US Bank, Denver, Colo. University School of Law, Orange, Calif. Luz URRUTIA, President and Chief Operat- JASON ENGEL, Vice President and Chief Reg- ing Officer, Banuestra Financial Corporaulatory Counsel, Experian, Costa Mesa, tion, Roswell, Ga. Calif. ANSELMO VILLARREAL, Executive Director, JOSEPH FALK, Consultant, Akerman Senter- LaCasa de Esperanza, Inc., Waukesha, fitt, Miami, Fla. Wis. LOUISE GISSENDANER, Senior Vice Pres- ALAN WHITE, Assistant Professor, Valparident, Director of Community Develop- aiso University Law School, Valparaiso, ment, Fifth Third Bank, Cleveland, Ohio Ind. PATRICIA A. HASSON, President, Consumer MARVA E. WILLIAMS, Senior Program Credit Counseling Service of Delaware Officer, Chicago LISC, Chicago, 111. Valley, Inc., Philadelphia, Pa. Officers DEBORAH HICKOK, Former Vice President, MoneyGram Payment Systems, Inc., LISA SODEIKA, Chair, Executive Vice Ooltewah, Tenn. President—Corporate Affairs, HSBC THOMAS P. JAMES, Senior Assistant Attorney North America Holdings, Inc., Prospect General—Consumer Counsel, Office of Heights, 111. the Illinois Attorney General, Consumer TONY T. BROWN, Vice Chair, President and Fraud Bureau, Chicago, 111. Chief Executive Officer, Uptown Con- SARAH LUDWIG, Executive Director, sortium, Inc., Cincinnati, Ohio Neighborhood Economic Development The Consumer Advisory Council—a statu- Advocacy Project, New York, N.Y. tory body established pursuant to the 1976 MARK K. METZ, Senior Vice President and amendments to the Equal Credit Opportunity Deputy General Counsel, Wachovia Act—advises the Board of Governors on Corporation, Charlotte, N.C. consumer financial services. Its members, LANCE MORGAN, President, Ho-Chunk, who are appointed by the Board, are academ- Incorporated, Winnebago Tribe of Neb- ics, state and local government officials, and raska, Winnebago, Neb. representatives of the financial services in- JOSHUA PEIREZ, Chief Payment System In- dustry and of consumer and community integrity Officer, MasterCard Worldwide, terests. In 2007, the council met with the Purchase, N.Y. Board on March 8, June 21, and October 25. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 281 Thrift Institutions Advisory Council December 31, 2007 Members DAVID E. POULSEN, President and Chief Executive Officer, American Express FRANK E. BERRISH, President and Chief Centurion Bank, Salt Lake City, Utah Executive Officer, Visions Federal Credit STEVEN J. SWIONTEK, Chairman, President, Union, Endicott, N.Y. and Chief Executive Officer, Gate City ROBERT M. CLEMENTS, Chairman and Bank, Fargo, N.D. Chief Executive Officer, Everbank Financial Corp., Jacksonville, Fla. DAVID RUSSELL TAYLOR, President and Chief Executive Officer, Rahway Savings A. THOMAS HOOD, President and Chief Institution, Rahway, N.J. Executive Officer, First Federal Savings and Loan Association, Charleston, S.C. KERRY KILLINGER, Chairman and Chief Officers Executive Officer, Washington Mutual, Inc., Seattle, Wa. DAVID RUSSELL TAYLOR, President KENNETH KORANDA, President, Mid F. WELLER MEYER, Vice President America Bank, Downers Grove, 111. The Thrift Institutions Advisory Council was ARKADI KUHLMANN, Chairman, President, and Chief Executive Officer, ING established by the Board of Governors to DIRECT USA, Wilmington, Del. consult with, and advise, the Board on issues pertaining to the thrift industry and on other HARRIET MAY, President and Chief Execumatters within the Board's jurisdiction. Its tive Officer, Government Employees members, who are appointed by the Board, Credit Union, El Paso, Tex. represent credit unions, savings and loan as- THOMAS C. MEUSER, Chairman and Chief sociations, and savings banks. In 2007, the Executive Officer, El Dorado Savings council met with the Board on March 16, Bank, Placerville, Calif. June 29, and December 14. F. WELLER MEYER, Chairman, President and Chief Executive Officer, Acacia Federal Savings Bank, Falls Church, Va. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

282 94th Annual Report, 2007 Federal Reserve Banks and Branches December 31,2007 Officers Chairman* President Officer BANK or Branch Deputy Chairman First Vice President in charge of Branch BOSTON2 Lisa M. Lynch Eric S. Rosengren Henri A. Termeer Paul M. Connolly NEW YORK2 Jerry I. Speyer Timothy F. Geithner Denis M. Hughes Christine M. Cumming Buffalo Alphonso O'Neil- Kausar Hamdani White PHILADELPHIA Doris M. Damm Charles I. Plosser William F. Hecht William H. Stone, Jr. CLEVELAND Tanny B. Crane Sandra Pianalto Alfred M. Rankin, Jr. R. Chris Moore Cincinnati James M. Anderson Barbara B. Henshaw Pittsburgh Robert O. Agbede Robert B. Schaub RICHMOND Thomas J. Mackell, Jr. Jeffrey M. Lacker Lemuel E. Lewis Sarah G. Green Baltimore Cynthia Collins Allner David Beck Charlotte Jim Lowry Jeffrey S. Kane ATLANTA V. Larkin Martin Dennis P. Lockhart D. Scott Davis Patrick K. Barron Birmingham Mary am B. Head Lee C. Jones Jacksonville H. Britt Landrum, Jr. Christopher L. Oakley Miami Gay Rebel Thompson Juan del Busto Nashville Debra K. London Melvyn K. Purcell New Orleans Dave Dennis Robert J. Musso CHICAGO2 Miles D. White Charles L. Evans John A. Canning, Jr. Gordon Werkema Detroit Timothy M. Robert Wiley Manganello ST.LOUIS Irl F. Engelhardt William Poole Cynthia J. Brinkley David A. Sapenaro Little Rock C. Sam Walls Robert A. Hopkins Louisville John L. Huber Maria Gerwing Hampton Memphis Meredith B. Allen Martha Perine Beard MINNEAPOLIS Frank L. Sims Gary H. Stern James J. Hynes James M. Lyon Helena Lawrence R. Simkins R. Paul Drake Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 283 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 Kristy A. Schloss Mark Schweitzer Oklahoma City .... Richard K. Ratcliffe Chad Wilkerson Omaha James A. Timmerman Jason Henderson DALLAS James T. Hackett 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 J. Dan Bates Blake Hastings SAN FRANCISCO 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 Clark D. Ivory 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 Windsor Locks, Connecticut; Utica at Oriskany, New Conference of Chairmen Conference of Presidents The chairmen of the Federal Reserve Banks The presidents of the Federal Reserve Banks are organized into the Conference of Chair- are organized into the Conference of Presimen, which meets to consider matters of dents, which meets periodically to consider common interest and to consult with and ad- matters of common interest and to consult vise the Board of Governors. Such meetings, with and advise the Board of Governors. also attended by the deputy chairmen, were Sandra Pianalto, president of the Federal held in Washington, D.C., on May 30 and Reserve Bank of Cleveland, served as chair 31, and on November 28 and 29, 2007. of the conference in 2007, and Jeffrey M. The members of the executive committee Lacker, president of the Federal Reserve of the Conference of Chairmen during 2007 Bank of Richmond, served as vice chair. were, Robert A. Funk, chair; V. Larkin Mar- Gregory L. Stefani, of the Federal Reserve tin, vice chair; and Miles D. White, member. Bank of Cleveland, served as secretary, and On November 29, the conference elected Sandra Tormoen, of the Federal Reserve its executive committee for 2008, naming Bank of Richmond, served as assistant V. Larkin Martin as chair; Lisa M. Lynch as secretary. vice chair; and David K.Y. Tang as the third member. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

284 94th Annual Report, 2007 Conference of of agriculture, commerce, industry, services, First Vice Presidents labor, and consumers; they may not be officers, directors, or employees of any bank or The Conference of First Vice Presidents of bank holding company. In addition, Class C the Federal Reserve Banks was organized in directors may not be stockholders of any 1969 to meet periodically for the consider- bank or bank holding company. ation of operations and other matters. For the election of Class A and Class B Helen E. Holcomb, first vice president of directors, the member banks of each Federal the Federal Reserve Bank of Dallas, served Reserve District are classified into three as chair of the conference in 2007, and James groups. Each group, which comprises banks M. Lyon, first vice president of the Federal with similar capitalization, elects one Class Reserve Bank of Minneapolis, served as vice A director and one Class B director. Annuchair. Harvey R. Mitchell, of the Federal Really, the Board of Governors designates one serve Bank of Dallas, served as secretary, of the Class C directors as chair of the board and Sheryl L. Britsch, of the Federal Reserve and Federal Reserve agent of each District Bank of Minneapolis, served as assistant Bank, and it designates another Class C secretary. director as deputy chair. On October 22, 2007, the conference Federal Reserve Branches have either five elected James M. Lyon as chair for 2008-09 or seven directors, a majority of whom are and R. Chris Moore, first vice president of appointed by the parent Federal Reserve the Federal Reserve Bank of Cleveland, as Bank; the others are appointed by the Board vice chair. of Governors. One of the directors appointed by the Board is designated annually as chair Directors of the board of that Branch in a manner Each Federal Reserve Bank has a nine mem- prescribed by the parent Federal Reserve ber board: three Class A and three Class B Bank. directors, who are elected by the stockhold- The chairs and deputy chairs of the Reing member banks, and three Class C direc- serve Bank boards of directors, and the tors, who are appointed by the Board of chairs of the Branches, are listed in the pre- Governors. ceding table, titled "Officers." The directors Class A directors represent the stockhold- of the Banks and Branches are listed in the ing member banks in each Federal Reserve following table. For each director, the class District. Class B and Class C directors repre- of directorship, the director's principal orgasent the public and are chosen with due, but nizational affiliation, and the date the direcnot exclusive, consideration to the interests tor's term expires are shown. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 285 Directors December 31, 2007 BANK or BRANCH, Category Title Term expires Name Dec. 31 DISTRICT 1—BOSTON RESERVE BANK Class A Ronald E. Logue Chairman and Chief Executive Officer, State Street 2007 Corporation, Boston, Massachusetts Kathleen C. Marcum President and Chief Executive Officer, Millbury 2008 National Bank, Millbury, Massachusetts David A. Lentini Chairman, President and Chief Executive Officer, 2009 The Connecticut Bank and Trust Company, Hartford, Connecticut Class B Robert K. Kraft Chairman and Chief Executive Officer, The Kraft 2007 Group, Foxborough, Massachusetts Michael T. Wedge Former President and Chief Executive Officer, 2008 BJ's Wholesale Club, Inc., Natick, Massachusetts Stuart H. Reese Chairman, President and Chief Executive Officer, 2009 MassMutual Financial Group, Springfield, Massachusetts Class C Samuel O. Thier, M.D Professor of Medicine and Professor of Health Care 2007 Policy-Harvard Medical School, Massachusetts General Hospital, Boston, Massachusetts Henri A. Termeer Chairman, President and Chief Executive Officer, 2008 Genzyme Corporation, Cambridge, Massachusetts Lisa M. Lynch William L. Clayton Professor of International Economic 2009 Affairs, The Fletcher School of Law and Diplomacy, Tufts University, Medford, Massachusetts DISTRICT 2—NEW YORK RESERVE BANK Class A Jill M. Considine Senior Advisor, 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 James Dimon Chairman and Chief Executive Officer, JPMorgan Chase 2009 & Co., New York, New York Class B Richard S. Fuld, Jr. Chairman and Chief Executive Officer, Lehman 2007 Brothers, New York, New York Jeffrey R. Immelt Chairman and Chief Executive Officer, General Electric 2008 Company, Fairfield, Connecticut Indra K. Nooyi Chairman and Chief Executive Officer, PepsiCo, Inc., 2009 Purchase, New York Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

286 94th Annual Report 2007 Directors—Continued BANK or BRANCH, Category Term expires Titlf Name i me Dec. 31 Class C Jerry I. Speyer President and Chief Executive Officer, Tishman Speyer, 2007 New York, New York Denis M. Hughes President, New York State AFL-CIO, New York, 2008 New York Lee C. Bollinger President, Columbia University, New York, New York 2009 BUFFALO BRANCH Appointed by the Federal Reserve Bank Michele D. Trolli Executive Vice President and Chief Information Officer, 2007 M&T Bank, Buffalo, New York Joseph J. Ashton Regional Director-Region 9, United Auto Workers, 2008 Amherst, New York Kim J. Zuber Co-Owner, Zuber Farms, LLC, Churchville, New York 2009 Jonathan J. Judge President and Chief Executive Officer, Paychex, Inc., 2009 Rochester, New York Appointed by the Board of Governors James P. Laurito President and Chief Executive Officer, Rochester Gas 2007 and Electric Corporation and New York State Electric and Gas Corporation, Rochester, New York Vacancy 2008 Alphonso O'Neil-White .... President and Chief Executive Officer, HealthNow 2009 New York Inc., Buffalo, New York DISTRICT 3—PHILADELPHIA RESERVE BANK Class A Wayne R. Weidner Chairman, National Penn Bancshares, Inc., Boyertown, 2007 Pennsylvania John G. Gerlach President and Chief Executive Officer, Pocono 2008 Community Bank, Stroudsburg, Pennsylvania Aaron L. Groff, Jr. Chairman, President and Chief Executive Officer, 2009 Ephrata National Bank, Ephrata, Pennsylvania Class B P. Coleman Townsend, Jr. .. Chairman and Chief Executive Officer, Townsends, Inc. 2007 Wilmington, Delaware Michael F. Camardo Retired Executive Vice President, Lockheed Martin ITS 2008 Cherry Hill, New Jersey Garry L. Maddox President and Chief Executive Officer, A. Pomerantz & 2009 Company, Philadelphia, Pennsylvania Class C 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 Baking 2008 Company, Philadelphia, Pennsylvania William F. Hecht Retired Chairman, President, and Chief Executive 2009 Officer, PPL Corporation, Allentown, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 287 BANK or BRANCH, Category Titlp Term expires Name i nit Dec. 31 DISTRICT 4—CLEVELAND RESERVE BANK Class A Henry L. Meyer III Chairman and Chief Executive Officer, KeyCorp, 2007 Cleveland, Ohio Bick Weissenrieder Chairman and Chief Executive Officer, Hocking Valley 2008 Bank, Athens, Ohio C. Daniel DeLawder Chairman and Chief Executive Officer, Park National 2009 Bank, Newark, Ohio Class B Les C. Vinney Retired President and Chief Executive Officer, STERIS 2007 Corporation, Mentor, Ohio Vacancy 2008 V. Ann Hailey Retired Executive Vice President, Corporate 2009 Development, Limited Brands, Columbus, Ohio Class C Roy W.Haley Chairman and Chief Executive Officer, WESCO 2007 International, Inc., Pittsburgh, Pennsylvania Alfred M. Rankin, Jr. Chairman, President and Chief Executive Officer, 2008 NACCO Industries, Inc., Cleveland, Ohio Tanny B. Crane President and Chief Executive Officer, Crane Group 2009 Company, Columbus, Ohio CINCINNATI BRANCH Appointed by the Federal Reserve Bank James H. Booth President, Czar Coal Corporation, Lovely, Kentucky 2007 Janet B.Reid Principal Partner, Global Lead Management 2008 Consulting, Cincinnati, Ohio Glenn D. Leveridge President, Lexington Market, JPMorgan Chase Bank, 2008 NA, Lexington, Kentucky Charlotte W. Martin President and Chief Executive Officer, Great Lakes 2009 Bankers Bank, Gahanna, Ohio Appointed by the Board of Governors 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 Daniel B. Cunningham President and Chief Executive Officer, Long-Stanton 2009 Manufacturing Companies, Cincinnati, Ohio PITTSBURGH BRANCH Appointed by the Federal Reserve Bank Michael J. Hagan President and Chief Executive Officer, Iron and Glass 2007 Bank, Pittsburgh, Pennsylvania Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

288 94th Annual Report, 2007 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name i me Dec. 31 Howard W. Hanna III Chairman and Chief Executive Officer, Howard Hanna 2008 Real Estate Services, Pittsburgh, Pennsylvania Georgiana N. Riley President and Chief Executive Officer, TIGG 2008 Corporation, Bridgeville, Pennsylvania Margaret Irvine Weir President, NexTier Bank, Butler, Pennsylvania 2009 Appointed by the Board of Governors Robert O. Agbede President and Chief Executive Officer, Chester 2007 Engineers, Inc., Pittsburgh, Pennsylvania Sunil T. Wadhwani Chief Executive Officer and Co-founder, iGATE 2008 Corporation, Pittsburgh, Pennsylvania Robert A. Paul Chairman and Chief Executive Officer, Ampco- 2009 Pittsburgh Corporation, Pittsburgh, Pennsylvania DISTRICT 5—RICHMOND RESERVE BANK Class A Kathleen Walsh Can- President, Cardinal Bank Washington, Washington, D.C 2007 Hunter R. Hollar President and Chief Executive Officer, Sandy Spring 2008 Bancorp and Sandy Spring Bank, Olney, Maryland Dwight V. Neese Director, President, and Chief Executive Officer, 2009 Provident Community Bank and Provident Community Bancshares, Inc., Rock Hill, South Carolina Class B Harry M. Lightsey, III Senior Vice President-Southern Region Legislative and 2007 External Affairs, AT&T, Columbia, South Carolina Dana S. Boole President and Chief Executive Officer, Community 2008 Affordable Housing Equity Corporation, Raleigh, North Carolina Kenneth R. Sparks President and Chief Executive Officer, Ken Sparks 2009 Associates LLC, White Stone, Virginia Class C Margaret E. McDermid Senior Vice President and Chief Information Officer, 2007 Dominion Resources, Inc., Richmond, Virginia Thomas J. Mackell, Jr. President, Association of Benefit Administrators, 2008 Warrenton, Virginia Lemuel E. Lewis Director, Landmark Communications, Inc., Norfolk, 2009 Virginia BALTIMORE BRANCH Appointed by the Federal Reserve Bank Donald P. Hutchinson President and Chief Executive Officer, SunTrust Bank, 2007 Maryland, Baltimore, Maryland Biana J. Arentz President and Chief Executive Officer, Hemingway's 2008 Inc., Stevensville, Maryland James T. Brady Managing Director-Mid-Atlantic, Ballantrae 2009 International, Ltd., Ijamsville, Maryland Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 289 BANK or BRANCH, Category Title Term expires Name Dec. 31 Michael L. Middleton Chairman and President, Community Bank of 2009 Tri-County, Waldorf, Maryland Appointed by the Board of Governors William R. Roberts .. President - Verizon Maryland/DC, Verizon Maryland 2007 Inc., Baltimore, Maryland Cynthia Collins Allner Principal, Miles & Stockbridge P.C., Baltimore, 2008 Maryland Ronald Blackwell Chief Economist, AFL-CIO, Washington, D.C. 2009 CHARLOTTE BRANCH Appointed by the Federal Reserve Bank Barry L. Slider President and Chief Executive Officer, First South 2007 Bancorp, Inc. and 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 Michael C. Miller Chairman and President, FNB United Corp. and 2009 CommunityONE Bank, N.A., Asheboro, North Carolina Donald K. Truslow Chief Risk Officer, Wachovia Corporation, Charlotte, 2009 North Carolina Appointed by the Board of Governors Claude C. Lilly Dean, Clemson University, College of Business and 2007 Behavioral Science, Clemson, South Carolina Linda L. Dolny President, PML Associates, Inc., Greenwood, 2008 South Carolina Jim Lowry Automotive Consultant, High Point, North Carolina 2009 DISTRICT 6—ATLANTA RESERVE BANK Class A James F. Beall Chairman, President, and Chief Executive Officer, 2007 Farmers & Merchants Bank, Centre, Alabama L. Phillip Humann Executive Chairman, SunTrust Banks, Inc., Atlanta, 2008 Georgia Rudy E. Schupp President and Chief Executive Officer, 1st United Bank, 2009 Boca Raton, Florida Class B Lee M. Thomas Chairman, President and Chief Executive Officer, 2007 Rayonier, Jacksonville, Florida Egbert L.J. Perry Chairman and Chief Executive Officer, The Integral 2008 Group, LLC, Atlanta, Georgia Teri G. Fontenot President and Chief Executive Officer, Woman's 2009 Hospital, Baton Rouge, Louisiana Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

290 94th Annual Report, 2007 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name i me Dec. 31 Class C David M. Ratcliffe Chairman, President, and Chief Executive Officer, 2007 Southern Company, Atlanta, Georgia V. Larkin Martin Managing Partner, Martin Farm, Courtland, Alabama 2008 D. Scott Davis Chief Financial Officer and Vice Chairman, United 2009 Parcel Service, Atlanta, Georgia BIRMINGHAM BRANCH Appointed by the Federal Reserve Bank John B. Barnett III Monroeville President, BankTrust, Monroeville, 2007 Alabama John H. Holcomb III Chairman and Chief Executive Officer, Alabama 2008 National Bancorporation, Birmingham, Alabama Samuel F. Dodson Consultant, International Union of Operating Engineers- 2009 Local 312, Birmingham, Alabama Bobby A. Bradley Managing Partner, Lewis Properties, LLC and Anderson 2009 Investments, LLC, Huntsville, Alabama Appointed by the Board of Governors 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 F. Michael Reilly President and Chief Executive Officer, Randall-Reilly 2009 Publishing Co., Tuscaloosa, Alabama JACKSONVILLE BRANCH Appointed by the Federal Reserve Bank Jack B. Healan, Jr President, Amelia Island Plantation Company, Amelia 2007 Island, Florida Alan Rowe President and Chief Executive Officer, The First 2008 Commercial Bank of Florida, Orlando, Florida Wendell A. Sebastian President and Chief Executive Officer, GTE Federal 2009 Credit Union, Tampa, Florida Ellen S. Titen President, E.T. Consultants, Winter Park, Florida 2009 Appointed by the Board of Governors H. Britt Landrum, Jr President and Chief Executive Officer, Landrum Human 2007 Resource Companies, Inc., Pensacola, Florida Fassil Gabremariam President and Founder, US-Africa Free Enterprise 2008 Education Foundation, Tampa, Florida Linda H. Sherrer President and Chief Executive Officer, Prudential 2009 Network Realty, Jacksonville, Florida Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 291 BANK or BRANCH, Category Titlp Term expires Name 1 me Dec. 31 MIAMI BRANCH Appointed by the Federal Reserve Bank Dennis S. Hudson III Chairman and Chief Executive Officer, Seacoast 2007 Banking Corporation of Florida, Stuart, Florida Thomas H. Shea Regional Chief Executive Officer, Right Management, 2008 Fort Lauderdale, Florida Walter Banks President, Lago Mar Resort and Club, Fort Lauderdale, 2008 Florida Leonard L. Abess Chairman, President, and Chief Executive Officer, City 2009 National Bank of Florida, Miami, Florida Appointed by the Board of Governors Gay Rebel Thompson President and Chief Executive Officer, Cement 2007 Industries, Inc., Fort Myers, Florida Edwin A. Jones, Jr President, Angus Investments, Inc., Port St. Lucie, 2008 Florida Marvin O'Quinn President and Chief Executive Officer, Jackson Health 2009 System, Miami, Florida NASHVILLE BRANCH Appointed by the Federal Reser\>e Bank Paul G. Willson Chairman and Chief Executive Officer, Citizens 2007 National Bank, Athens, Tennessee Michael B. Swain Chairman, First National Bank, Oneida, Tennessee 2008 Daniel A. Gaudette Retired Senior Vice President, North American 2009 Manufacturing and Supply Chain Management, Nissan North America, Inc., Smyrna, Tennessee Cordia W. Harrington President and Chief Executive Officer, Tennessee Bun 2009 Company, Nashville, Tennessee Appointed by the Board of Governors Debra K. London President and Chief Executive Officer, St. Mary's 2007 Health System, Knoxville, Tennessee Richard Q. Ford President and Chief Executive Officer, The Sage Group, 2008 Brentwood, Tennessee David Williams 11 Vice Chancellor and General Counsel, Vanderbilt 2009 University, Nashville, Tennessee NEW ORLEANS BRANCH Appointed by the Federal Reserve Bank David E. Johnson Chairman and Chief Executive Officer, The First 2007 Bancshares, Inc., and The First, A National Banking Association, Hattiesburg, Mississippi R. King Milling Vice Chairman, Whitney Holding Corporation & 2008 Whitney National Bank, New Orleans, Louisiana Matthew G. Stuller, Sr. .... Chairman and Chief Executive Officer, Stuller, Inc., 2009 Lafayette, Louisiana Christel C. Slaughter Partner, SSA Consultants, LLC, Baton Rouge, Louisianai 2009 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

292 94th Annual Report, 2007 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name Dec. 31 Appointed by the Board of Governors Dave Dennis President and Chief Executive Officer, Specialty 2007 Contractors & Associates, Inc., Gulfport, Mississippi Earl L. Shipp President-Basic Chemicals Group, The Dow Chemical 2008 Company, Dubai, United Arab Emirates Robert S. Boh President and Chief Executive Officer, Boh Bros. 2009 Construction Co., LLC, New Orleans, Louisiana DISTRICT 7—CHICAGO RESERVE BANK Class A JeffPlagge Chairman, Chief Executive Officer, and President, 2007 Midwest Heritage Bank, Clive, Iowa Dennis J. Kuester Chairman, Marshall & Ilsley Corporation, Milwaukee, 2008 Wisconsin Michael L. Kubacki Chairman, President, and Chief Executive Officer, 2009 Lakeland Financial Corporation, Warsaw, Indiana Class B Ann D. Murtlow President and Chief Executive Officer, Indianapolis 2007 Power & Light Company, Indianapolis, Indiana Vacancy 2008 Mark T. Gaffney President, Michigan AFL-CIO, Lansing, Michigan 2009 Class C Miles D. White Chairman and Chief Executive Officer, Abbott, Abbott 2007 Park, Illinois John A. Canning, Jr. Chairman, Madison Dearborn Partners, LLC, Chicago, 2008 Illinois William C. Foote Chairman and Chief Executive Officer, USG 2009 Corporation, Chicago, Illinois DETROIT BRANCH Appointed by the Federal Reserve Bank Michael M. Magee, Jr President and Chief Executive Officer, Independent 2007 Bank Corporation, Ionia, Michigan Roger A. Cregg Executive Vice President and Chief Financial Officer, 2008 Pulte Homes, Inc., Bloomfield Hills, Michigan Tommi A. White Chief Executive Officer, ER-One, Inc., Livonia, 2008 Michigan Ralph W. Babb, Jr. Chairman, President, and Chief Executive Officer, 2009 Comerica Inc., Dallas, Texas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reseme System Organization 293 BANK or BRANCH, Category Titlp Term expires Name 11UC Dec. 31 Appointed by the Board of Governors Irvin D.Reid President, Wayne State University, Detroit, Michigan 2007 Timothy M. Manganello ... Chairman and Chief Executive Officer, BorgWarner 2008 Inc., Auburn Hills, Michigan Linda S. Likely Director of Housing and Community Development, 2009 Kent County Community Development Department and Housing Commission, Grand Rapids, Michigan DISTRICT 8—ST. LOUIS RESERVE BANK Class A Lewis F. Mallory, Jr Chairman and Chief Executive Officer, Cadence 2007 Financial Corporation, Starkville, Mississippi J. Thomas May Chairman and Chief Executive Officer, Simmons First 2008 National Corporation, Pine Bluff, Arkansas David R. Pirsein President and Chief Executive Officer, First National 2009 Bank in Pinckneyville, Pinckneyville, Illinois Class B Paul T. Combs President, Baker Implement Company, Kennett, 2007 Missouri Vacancy 2008 A. Rogers Yarnell, II President, Yarnell Ice Cream Company, Inc., Searcy, 2009 Arkansas Class C Irl F. Engelhardt Chairman, Patriot Coal Corporation, St. Louis, Missouri 2007 Cynthia J. Brinkley President, AT&T Missouri, St. Louis, Missouri 2008 Steven H. Lipstein President and Chief Executive Officer, BJC Healthcare, 2009 St. Louis, Missouri LITTLE ROCK BRANCH Appointed by the Federal Reserve Bank Sharon Priest Executive Director, Downtown Little Rock Partnership, 2007 Little Rock, Arkansas Robert A. Young III Chairman, Arkansas Best Corporation, Fort Smith, 2008 Arkansas Phillip N. Baldwin President and Chief Executive Officer, Southern 2008 Bancorp, Arkadelphia, Arkansas William C. Scholl President, First Security Bancorp, Searcy, Arkansas 2009 Appointed by the Board of Governors Sonja Yates Hubbard Chief Executive Officer, E-Z Mart Stores, Inc., 2007 Texarkana, Texas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

294 94th Annual Report, 2007 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name 111IC Dec. 31 Cal McCastlain Partner, Pender & McCastlain, P.A., Little Rock, 2008 Arkansas C.Sam Walls Chief Executive Officer, Arkansas Capital Corporation, 2009 Little Rock, Arkansas LOUISVILLE BRANCH Appointed by the Federal Reserve Bank Steven E. Trager Chairman and Chief Executive Officer, Republic Bank 2007 & Trust Company, Louisville, Kentucky L. Clark Taylor, Jr Chief Executive Officer, Ephraim McDowell Health, 2008 Danville, Kentucky John C. Schroeder President, Wabash Plastics, Inc., Evansville, Indiana 2008 Gordon B. Guess Consultant, Marion, Kentucky 2009 Appointed by the Board of Governors Gary A. Ransdell President, Western Kentucky University, Bowling 2007 Green, Kentucky John L. Huber Consultant, Louisville, Kentucky 2008 Barbara Ann Pop Chief Executive Officer, Schuler Bauer Real Estate 2009 Services, New Albany, Indiana MEMPHIS BRANCH Appointed by the Federal Reserve Bank Thomas G. Miller President, Southern Hardware Company, Inc., West 2007 Helena, Arkansas Levon Mathews Director of Sales, Regions Morgan Keegan Private 2008 Banking, Memphis, Tennessee Hunter Simmons President and Chief Executive Officer, First South Bank 2008 Jackson, Tennessee David P. Rumbarger, Jr. .... President and Chief Executive Officer, Community 2009 Development Foundation, Tupelo, Mississippi Appointed by the Board of Governors 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 Nick Clark Partner, Clark & Clark, Memphis, Tennessee 2009 DISTRICT 9—MINNEAPOLIS RESERVE BANK Class A John H. Hoeven, Jr Chairman, First Western Bank & Trust, Minot, North 2007 Dakota Peter J. Haddeland President and Chief Executive Officer, First National 2008 Bank, Mahnomen, Minnesota Thomas W. Scott Chairman of the Board, First Interstate BancSystem, 2009 Inc., Billings, Montana Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 295 BANK or BRANCH, Category Title Term expires Name Dec. 31 Class B Todd L. Johnson Chairman and Chief Executive Officer, Reuben 2007 Johnson & Son, Inc. and Affiliated Companies, Superior, Wisconsin Randy Peterson Facility Director, Lake Superior State University, Sault 2008 Ste. Marie, Michigan William J. Shorma President, Shur-Co., Yankton, South Dakota 2009 Class C 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 James J. Hynes Executive Administrator, Twin City Pipe Trades Service 2009 Association, St. Paul, Minnesota HELENA BRANCH Appointed by the Federal Reserve Bank Joy N. Ott Regional President and Chief Executive Officer, Wells 2007 Fargo Bank Montana, N.A., Billings, Montana John L. Franklin President and Chief Executive Officer, 1 st Bank, Sidney, 2008 Montana Timothy J. Bartz Chief Executive Officer, Anderson ZurMuehlen & 2009 Company, PC, Helena, Montana Appointed by the Board of Governors Dean Folkvord General Manager and Chief Executive Officer, Wheat 2008 Montana Farms and Bakery, Three Forks, Montana Lawrence R. Simkins President, Washington Corporations, Missoula, Montana 2009 DISTRICT 10—KANSAS CITY RESERVE BANK Class A 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 Mark W. Schifferdecker .... President and Chief Executive Officer, Girard National 2009 Bank, Girard, Kansas Class B Vacancy 2007 Dan L. Dillingham Chief Executive Officer, Dillingham Insurance, Enid, 2008 Oklahoma Kevin K. Nunnink Chairman, Integra Realty Resources, Westwood, Kansas 2009 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

296 94th Annual Report, 2007 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name 1 IllC Dec. 31 Class C Terry L. Moore President, Omaha Federation of Labor, Omaha, 2007 Nebraska Lu M. Cordova Chief Executive Officer, Corlund Industries, LLC; 2008 President and General Manager, Almacen Storage Group, Boulder, Colorado Robert A. Funk Chairman and Chief Executive Officer, Express 2009 Personnel Services, Oklahoma City, Oklahoma DENVER BRANCH Appointed by the Federal Reserve Bank Michael R. Stanford President and Chief Executive Officer, First State 2007 Bancorporation, Albuquerque, New Mexico Bruce K. Alexander President and Chief Executive Officer, Vectra Bank 2008 Colorado, Denver, Colorado John D. Pearson President, Pearson Real Estate Co., Inc., Buffalo, 2009 Wyoming Vacancy 2009 Appointed by the Board of Governors Kristy A. Schloss President and Chief Executive Officer, Schloss 2007 Engineered Equipment, Inc., Aurora, Colorado Diane Leavesley President, Mercy Loan Fund, Denver, Colorado 2008 Thomas Williams President and Chief Executive Officer, Williams Group 2009 LLC, Golden, Colorado OKLAHOMA CITY BRANCH Appointed by the Federal Reserve Bank Steve Burrage Chairman of the Board, FirstBank, Antlers, Oklahoma 2007 Terry M. Almon President, Oklahoma Community Capital Corporation, 2007 Broken Arrow, Oklahoma Fred M. Ramos President, RGF, Inc., Oklahoma City, Oklahoma 2008 Barry H. Golsen Board Vice-Chairman, President and Chief Operating 2009 Officer, LSB Industries, Inc., Oklahoma City, Oklahoma Appointed by the Board of Governors Steven C. Agee President, Agee Energy, LLC, Oklahoma City, 2007 Oklahoma Vacancy 2008 Richard K. Ratcliffe Chairman, Ratcliffe's Inc., Weatherford, Oklahoma 2009 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 297 BANK or BRANCH, Categoiy Title Term expires Name Dec. 31 OMAHA BRANCH Appointed by the Federal Reserve Bank Cynthia Hardin Milligan ... Dean-College of Business Administration, University of 2007 Nebraska-Lincoln, Lincoln, Nebraska Mark A. Sutko President and Chief Executive Officer, Platte Valley 2008 State Bank, Kearney, Nebraska Rodrigo Lopez President and Chief Executive Officer, AmeriSphere 2009 Multifamily Finance, L.L.C., Omaha, Nebraska Todd S. Adams Chief Executive Officer and Trust Officer, Adams Bank 2009 & Trust, Ogallala, Nebraska Appointed by the Board of Governors Lyn Wallin Ziegenbein Executive Director, Peter Kiewit Foundation, Omaha, 2007 Nebraska James A. Timmerman Chief Financial Officer, Timmerman and Sons Feeding 2008 Company, Springfield, Nebraska Charles R. Hermes President, Dutton-Lainson Company, Hastings, 2009 Nebraska DISTRICT 11—DALLAS RESERVE BANK Class A David S. Barnard Chairman and Chief Executive Officer, The National 2007 Banks of Central Texas, Gatesville, Texas Richard W. Evans, Jr Chairman and Chief Executive Officer, Cullen/Frost 2008 Bankers, Inc., San Antonio, Texas Pete Cook President and Chief Executive Officer, First National 2009 Bank of Alamogordo, Alamogordo, New Mexico Class B Robert A. Estrada Chairman, Estrada Hinojosa & Company, Inc., Dallas, 2007 Texas James B. Bexley Professor, Finance, Sam Houston State University, 2008 Huntsville, Texas Margaret H. Jordan President and Chief Executive Officer, Dallas Medical 2009 Resource, Dallas, Texas Class C Herb Kelleher Executive Chairman, Southwest Airlines, Dallas, Texas 2007 James T. Hackett Chairman, President, and Chief Executive Officer, 2008 Anadarko Petroleum Corporation, Houston, Texas Anthony R. Chase Chairman and Chief Executive Officer, ChaseSource, 2009 L.P., Houston, Texas EL PASO BRANCH Appointed by the Federal Reserve Bank F. James Volk Regional President, State National Bank, El Paso, Texas 2007 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

298 94th Annual Report 2007 Directors—Continued BANK or BRANCH, Category Titlp Term expires Name 1 lllc Dec. 31 D. Kirk Edwards President, MacLondon Royalty Company, Odessa, 2008 Texas Fred J. Loya Chairman, Fred Loya Insurance, El Paso, Texas 2008 Gerald J. Rubin Chairman, President, and Chief Executive Officer, Helen 2009 of Troy Limited, El Paso, Texas Appointed by the Board of Governors Cecilia Ochoa Levine President, MFI International Mfg., LLC, El Paso, Texas 2007 Ron C. Helm Owner, Helm Land and Cattle Company, Van Horn, 2008 Texas William V. Flores Deputy Secretary, New Mexico Higher Education 2009 Department, Santa Fe, New Mexico HOUSTON BRANCH Appointed by the Federal Reserve Bank Jodie L. Jiles Managing Director, RBC Capital Markets, Houston, 2007 Texas S. Reed Morian Chairman, President, and Chief Executive Officer, DX 2008 Service Company, Inc., Houston, Texas Peter G. Traber, M.D. President and Chief Executive Officer, Baylor College 2008 of Medicine, Houston, Texas Timothy N. Bryan Chairman and Chief Executive Officer, The First 2009 National Bank of Bryan, Bryan, Texas Appointed by the Board of Governors Douglas L. Foshee President and Chief Executive Officer, El Paso 2007 Corporation, Houston, Texas Lupe Fraga Chairman and Chief Executive Officer, Tejas Office 2008 Products, Inc., Houston, Texas Nancy T. Chang President, Apex Enterprises, Inc., Houston, Texas 2009 SAN ANTONIO BRANCH Appointed by the Federal Reserve Bank G.P.Singh Owner, Gur Parsaad Properties, Ltd., San Antonio, 2007 Texas Matt F. Gorges Chairman and Chief Executive Officer, U.S. Packers & 2008 Processors, Harlingen, Texas Guillermo F. Trevino President, Southern Distributing, Laredo, Texas 2008 Steven R. Vandegrift Founder and President, SRV Holdings, Austin, Texas 2009 Appointed by the Board of Governors Ricardo Romo President, The University of Texas at San Antonio, San 2007 Antonio, Texas Elizabeth Chu Richter Chairman and Chief Executive Officer, Richter 2008 Architects, Corpus Christi, Texas J. Dan Bates President, Southwest Research Institute, San Antonio, 2009 Texas Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve System Organization 299 BANK or BRANCH, Category Titlp Term expires Name 1 Hit; Dec. 31 DISTRICT 12—SAN FRANCISCO RESERVE BANK Class A Richard W. Decker, Jr Chairman and Co-Founder, Belvedere Capital Partners 2007 LLC, San Francisco, California Candace H. Wiest President and Chief Executive Officer, West Valley 2008 National Bank, Avondale, Arizona Kenneth P. Wilcox President and Chief Executive Officer, S VB Financial 2009 Group and Silicon Valley Bank, Santa Clara, California Class B Jack McNally Principal, JKM Consulting, Sacramento, California 2007 Karla S. Chambers . Vice President and Co-Owner, Stahlbush Island Farms, 2008 Inc., Corvallis, Oregon Blake W. Nordstrom President, Nordstrom, Inc., Seattle, Washington 2009 Class C David K.Y. Tang Managing Partner, Asia, K&L Gates, Seattle, 2007 Washington Douglas W. Shorenstein Chairman and Chief Executive Officer, Shorenstein 2008 Properties LLC, San Francisco, California T. Gary Rogers Retired Chairman and Chief Executive Officer, Dreyer's 2009 Grand Ice Cream, Inc., Oakland, California Los ANGELES BRANCH Appointed by the Federal Reserve Bank Dominic Ng Chairman, President, and Chief Executive Officer, East 2007 West Bank, Pasadena, California Peter M. Thomas Managing Partner, Thomas & Mack Co., Las Vegas, 2008 Nevada Vacancy 2009 Andrew J. Sale Partner, Media and Entertainment Leader - Pacific 2009 Southwest Area, Ernst & Young LLP, Los Angeles, California Appointed by the Board of Governors James L. Sanford Corporate Vice President, Northrop Grumman 2007 Corporation, Los Angeles, California Ann E. Sewill President, Community Foundation Land Trust, 2008 California Community Foundation, Los Angeles, California Anita Santiago Chief Executive Officer, Anita Santiago Advertising, 2009 Santa Monica, California PORTLAND BRANCH Appointed by the Federal Reserve Bank Alan V. Johnson Regional President, Wells Fargo Bank, Portland, Oregon 2007 George J. Puentes President, Don Pancho Authentic Mexican Foods, Inc., 2008 Salem, Oregon Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

300 94th Annual Report, 2007 Directors—Continued BANK or BRANCH, Category Term expires Titlp Name 1 Hie Dec. 31 Peggy Y. Fowler Chief Executive Officer and President, Portland General 2008 Electric, Portland, Oregon Robert D. Sznewajs President and Chief Executive Officer, West Coast 2009 Bancorp, Lake Oswego, Oregon Appointed by the Board of Governors James H. Rudd Chief Executive Officer and Principal, Ferguson 2007 Wellman Capital Management, Inc., Portland, Oregon William D. Thorndike, Jr. .. Chairman and President, Medford Fabrication, Medford, 2008 Oregon David Y. Chen Managing Director, Equilibrium Capital Group LLC, 2009 Portland, Oregon SALT LAKE CITY BRANCH Appointed by the Federal Reserve Bank Michael M. Mooney President, Idaho Region, Bank of the Cascades, Boise, 2007 Idaho A. Scott Anderson President and Chief Executive Officer, Zions Bank, Salt 2008 Lake City, Utah Deborah S. Bayle President and Chief Executive Officer, United Way of 2008 Salt Lake, Salt Lake City, Utah Scott L. Hymas Chief Executive Officer, RC Willey, Salt Lake City, 2009 Utah Appointed by the Board of Governors Gary L. Crocker Chairman of the Board, Merrimack Pharmaceuticals, 2007 Inc., Salt Lake City, Utah Clark D. Ivory Chief Executive Officer, Ivory Homes, Ltd., Salt Lake 2008 City, Utah Edwin E. Dahlberg President and Chief Executive Officer, St. Luke's Healthi 2009 System, Boise, Idaho SEATTLE BRANCH Appointed by the Federal Reserve Bank Vacancy 2007 Kenneth M. Kirkpatrick .... President, Washington State, U.S. Bank, Seattle, 2008 Washington H. Stewart Parker President and Chief Executive Officer, Targeted 2008 Genetics Corporation, Seattle, Washington Carol K. Nelson President and Chief Executive Officer, Cascade 2009 Financial Corporation, Everett, Washington Appointed by the Board of Governors Mic R. Dinsmore President, Infrastructure Investment Division, Stark 2007 Investments, Seattle, Washington James R. Gill President, Pacific Northwest Title Holding Company, 2008 Seattle, Washington Helvi K. Sandvik President, NANA Development Corporation, 2009 Anchorage, Alaska Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2007 301 Members of the Board of Governors, 1913-2007 Appointed Members Name Fede D ra i l s t R ric es t erve Da o te a th in i o ti f a l o l f y f ic to e ok Other datesl 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

302 94th Annual Report, 2007 Appointed Members—Continued Name Federal Reserve Date initially took Other dates1 District oath of office Chas. N. Shepardson Dallas Mar. 17, 1955 Retired Apr. 30, 1967. G.H. King, Jr. Atlanta Mar. 25, 1959 Reappointed in 1960. Resigned Sept. 18, 1963. George W. Mitchell Chicago Aug. 31, 1961 Reappointed in 1962. Served until Feb. 13, 1976.2 J. Dewey Daane Richmond Nov. 29, 1963 Served until Mar. 8, 1974.2 Sherman J. Maisel San Francisco Apr. 30, 1965 Served through May 31, 1972. Andrew F. Brimmer Philadelphia Mar. 9, 1966 Resigned Aug. 31, 1974. William W. Sherrill Dallas May 1, 1967 Reappointed in 1968. Resigned Nov. 15, 1971. Arthur F. Burns New York Jan. 31, 1970 Term began Feb. 1, 1970. Resigned Mar. 31, 1978. John E. Sheehan St. Louis Jan. 4, 1972 Resigned June 1, 1975. Jeffrey M. Bucher San Francisco June 5, 1972 Resigned Jan. 2, 1976. Robert C. Holland Kansas City June 11, 1973 Resigned May 15, 1976. Henry C. Wallich Boston Mar. 8, 1974 Resigned Dec. 15, 1986. Philip E. Coldwell Dallas Oct. 29, 1974 Served through Feb. 29, 1980. Philip C. Jackson, Jr. Atlanta July 14, 1975 Resigned Nov. 17, 1978. J. Charles Partee Richmond Jan. 5, 1976 Served until Feb. 7, 1986.2 Stephen S. Gardner Philadelphia Feb. 13, 1976 Died Nov. 19, 1978. David M. Lilly Minneapolis June 1, 1976 Resigned Feb. 24, 1978. G. William Miller San Francisco Mar. 8, 1978 Resigned Aug. 6, 1979. Nancy H. Teeters Chicago Sept. 18, 1978 Served through June 27, 1984. Emmett J. Rice New York June 20, 1979 Resigned Dec. 31, 1986. Frederick H. Schultz Atlanta July 27, 1979 Served through Feb. 11, 1982. Paul A. Volcker Philadelphia Aug. 6, 1979 Resigned 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 Resigned Mar. 30, 2007 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. 24, 2006 Randall S. Kroszner Richmond Mar. 1,2006 Frederic S. Mishkin Boston Sept. 5, 2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Members of the Board of Governors, 1913-2007 303 Appointed Members—Continued Name Term Chairmen3 Charles S. Hamlin Aug. 10, 1914-Aug. 9, 1916 W.P.G. Harding Aug. 10, 1916-Aug. 9, 1922 Daniel R. Crissinger May 1, 1923-Sept. 15, 1927 Roy A. Young Oct. 4, 1927-Aug. 31,1930 Eugene Meyer Sept. 16, 1930-May 10, 1933 Eugene R. Black May 19, 1933-Aug. 15, 1934 Marriner S. Eccles Nov. 15, 1934-Jan. 31, 19484 Thomas B. McCabe Apr. 15, 1948-Mar. 31, 1951 Wm. McC. Martin, Jr. Apr. 2, 1951-Jan. 31, 1970 Arthur F. Burns Feb. 1, 1970-Jan. 31, 1978 G. William Miller Mar. 8, 1978-Aug. 6, 1979 Paul A. Volcker Aug. 6, 1979-Aug. 11, 1987 Alan Greenspan Aug. 11, 1987-Jan. 31, 20065 Ben Bernanke Feb. 1,2006- Vice Chairmen3 Frederic A. Delano Aug. 10, 1914-Aug. 9, 1916 Paul M. Warburg Aug. 10, 1916-Aug. 9, 1918 Albert Strauss Oct. 26, 1918-Mar. 15, 1920 Edmund Platt July 23, 1920-Sept. 14, 1930 J.J. Thomas Aug. 21, 1934-Feb. 10, 1936 Ronald Ransom Aug. 6, 1936-Dec. 2, 1947 C. Canby Balderston Mar. 11, 1955-Feb. 28, 1966 J.L. Robertson Mar. 1, 1966-Apr. 30, 1973 George W. Mitchell May 1,1973-Feb. 13, 1976 Stephen S. Gardner Feb. 13, 1976-Nov. 19, 1978 Frederick H. Schultz July 27, 1979-Feb. 11, 1982 Preston Martin Mar. 31, 1982-Apr. 30, 1986 Manuel H. Johnson Aug. 4, 1986-Aug. 3, 1990 David W. Mullins, Jr. July 24, 1991-Feb. 14, 1994 Alan S. Blinder June 27, 1994-Jan. 31, 1996 Alice M. Rivlin June 25, 1996-July 16, 1999 Roger W. Ferguson, Jr. Oct. 5, 1999-Apr. 28, 2006 Donald L. Kohn June 23, 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 Mar. 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

304 94th Annual Report, 2007 Ex Officio Members Name Term Secretaries of the Treasury W.G. McAdoo Dec. 23, 1913-Dec. 15, 1918 Carter Glass Dec. 16, 1918-Feb. 1, 1920 David F. Houston Feb. 2, 1920-Mar. 3, 1921 Andrew W. Mellon Mar. 4, 1921-Feb. 12, 1932 Ogden L. Mills Feb. 12, 1932-Mar.4, 1933 William H. Woodin Mar. 4, 1933-Dec. 31, 1933 Henry Morgenthau, Jr. Jan. 1, 1934-Feb. 1, 1936 Comptrollers of the Currency John Skelton Williams Feb. 2, 1914-Mar. 2, 1921 Daniel R. Crissinger Mar. 17, 1921-Apr. 30, 1923 Henry M. Dawes May 1, 1923-Dec. 17, 1924 Joseph W. Mclntosh Dec. 20, 1924-Nov. 20, 1928 J.W. Pole Nov.21,1928-Sept.20, 1932 J.F.T. O'Connor May 11, 1933-Feb. 1, 1936 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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

306 94th Annual Report, 2007 1. Federal Reserve Open Market Transactions, 2007 Millions of dollars Type of security and transaction Apr. U.S. TREASURY SECURITIES1 Outright transactions 2 Treasury bills Gross purchases 0 Gross sales 0 Exchanges 66,169 For new bills 66,169 Redemptions 0 Others within 1 year Gross purchases .. Gross sales Maturity shifts ... Exchanges Redemptions 1 to 5 years Gross purchases . Gross sales Maturity shifts .. Exchanges 5 to 10 years Gross purchases Gross sales Maturity shifts Exchanges More than 10 years Gross purchases . Gross sales Maturity shifts .. Exchanges All maturities Gross purchases ... Gross sales Redemptions ooooo oooo oooo oooo ooo 0 0 70,706 70,706 0 817 0 0 0 0 1,061 0 0 0 oooo oooo 0 0 88,466 88,466 0 1,878 0 0 ooooo oooo oooo oooo ooo 0 0 76,560 76,560 0 1,394 0 0 0 0 3,742 0 0 0 290 0 0 0 640 0 0 0 6,066 0 0 Net change in U.S. Treasury securities 1,878 6,066 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 307 1.—Continued May June July Aug. Sept. Oct. Nov. Dec. Total 0 0 94,858 94,858 0 ooooo 2,736 0 0 0 oooo oooo 0 0 62,340 62,340 0 2,736 0 0 2,736 ooooo oooo oooo oooo ooo 0 0 72,690 72,690 0 0 ooooo oooo oooo oooo ooo 0 0 75,502 75,502 10,000 0 0 0 0 1,236 0 oooo oooo oooo 0 0 62,083 62,083 0 0 0 11,236 -11,236 ooooo oooo oooo oooo ooo 0 0 62,143 62,143 0 0 ooooo oooo oooo oooo ooo 0 0 83,590 83,590 0 0 ooooo oooo oooo oooo ooo 0 0 24,580 24,580 39,178 0 ooooo oooo oooo oooo 0 0 839,687 839,687 49,178 2,211 0 0 0 1,236 7,539 0 0 0 0 0 39,178 -39,178 oooo oooo 10,680 0 50,414 -39,734 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

308 94th Annual Report, 2007 1. Federal Reserve Open Market Transactions, 2007—Continued Millions of dollars Type of security and transaction Jan. Feb. Mar. Apr. FEDERAL AGENCY OBLIGATIONS Outright transactions 2 Gross purchases 0 0 0 0 Gross sales 0 0 0 0 Redemptions 0 0 0 0 Net change in federal agency obligations TEMPORARY TRANSACTIONS Repurchase agreements3 Gross purchases 176,000 193,750 228,250 179,500 184,750 180,500 240,250 161,250 Gross sales Reverse repurchase agreements 4 Gross purchases 630,544 696,788 843,250 739,145 Gross sales 633,309 704,054 840,887 739,251 Net change in temporary transactions -11,515 5,984 -9,637 18,143 Total net change in System Open Market Account -11,515 7,862 -9,637 24,209 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 309 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 0 174,250 177,750 185,000 209,000 236,500 268,750 318,750 249,250 2,596,750 190,000 188,250 180,000 200,750 230,250 265,000 319,750 250,250 2,591,000 752,100 672,056 673,157 722,358 669,935 786,360 715,682 761,133 8,662,508 749,528 669,588 673,778 725,162 669,850 788,726 713,543 769,202 8,676,878 -13,178 -8,032 4,379 5,446 6,334 1,385 1,139 -9.070 -8,622 -10,442 -8,032 4,379 -5,791 6,334 1,385 1,139 -48,248 -48357 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

310 94th Annual Report, 2007 2. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 2005-2007 Millions of dollars December 31 Change Description 2006 to 2005 to 2007 2006 2005 2007 2006 U.S. TREASURY SECURITIES Held outright1 740,611 778,915 744,215 -38,304 34,700 By remaining maturity Bills 1-90 days 153,829 193,034 187,370 -39,205 5,664 91 days to 1 year 74,012 83,985 83,900 -9,973 85 Notes and bonds 1 year or less 101,447 129,594 128,287 -28,147 1,307 More than 1 year through 5 years 240,562 224,177 210,745 16,385 13,432 More than 5 years through 10 years 81,947 67,645 56,699 14,302 10,946 More than 10 years 88,814 80,479 77,215 8,335 3,264 By type Bills 227,841 277,019 271,270 -49,178 5,749 Notes 401,776 402,367 380,118 -591 22,249 Bonds 110,995 99,528 92,827 11,467 6,701 FEDERAL AGENCY SECURITIES Held outrightl 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 46,500 40,750 46,750 5,750 -6,000 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 43,985 29,615 30,505 14,370 -890 Foreign official and international accounts 43,985 29,615 30,505 14,370 -890 Dealers 0 0 0 0 0 NOTE: Components may not sum to totals because of 2. Cash value of agreements, which are collateralized rounding. by U.S. government and federal agency securities. 1. Excludes the effect of temporary transactions— 3. Cash value of agreements, which are collateralized repurchase agreements, matched sale-purchase agree- by U.S. Treasury securities. ments (MSPs), and reverse repurchase agreements (RRPs). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 31 3. Federal Reserve Bank Interest Rates on Loans to Depository Institutions, December 31, 2007 Reserve Bank Primary credit1 Secondary credit2 Seasonal credit3 All Federal Reserve Banks 4.75 5.25 4.70 NOTE: For details on rate changes over the course of 3. Seasonal credit is available to help relatively small 2007, 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 generally available for very short ments in their deposits and loans. The discount rate on terms as a backup source of liquidity to depository institu- seasonal credit takes into account rates charged by market tions that are in generally sound financial condition in the sources of funds and is reestablished on the first business judgment 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

312 94th Annual Report, 2007 4. Reserve Requirements of Depository Institutions, December 31, 2007 Requirements Type of deposit Percentage of deposits Effective date Net transaction accounts1 $0 million-$9.3 million2 0 12-20-07 More than $9.3 million-$43.9 million3 3 12-20-07 More than $43.9 million 10 12-20-07 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 insti- reportforms/. tution that is a member of the Federal Reserve System 2. The amount of net transaction accounts subject to a must hold that deposit directly with a Reserve Bank; an reserve requirement ratio of 0 percent (the "exemption institution that is not a member of the System can main- amount") is adjusted each year by statute. The exemption tain that deposit directly with a Reserve Bank or with amount is adjusted upward by 80 percent of the previous another institution in a pass-through relationship. Reserve year's (June 30 to June 30) rate of increase in total reservrequirements are imposed on commercial banks, savings able liabilities at all depository institutions. No adjustbanks, savings and loan associations, credit unions, U.S. ment is made in the event of a decrease in such liabilities. branches and agencies of foreign banks, Edge corpora- 3. The amount of net transaction accounts subject to a tions, and agreement corporations. reserve requirement ratio of 3 percent is the "low reserve 1. Total transaction accounts consists of demand de- tranche." By statute, the upper limit of the low reserve posits, automatic transfer service (ATS) accounts, NOW tranche is adjusted each year by 80 percent of the preaccounts, share draft accounts, telephone or preauthorized vious year's (June 30 to June 30) rate of increase or transfer accounts, ineligible banker's acceptances, and decrease in net transaction accounts held by all depository affiliate-issued obligations maturing in seven days or less. institutions. Net transaction accounts are total transaction 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 313 5. Banking Offices and Banks Affiliated with Bank Holding Companies in the United States, December 31, 2006 and 2007 Commercial banks! Statechartered Type of office Total Member savings Total Nonmember banks Total National State All banking offices BANKS Number, Dec. 31, 2006 7,731 7^67 2,592 1,695 897 4,775 364 Changes during 2007 New banks 181 173 40 27 13 133 8 Banks converted into branches -272 -268 -115 -79 -36 -153 -4 Ceased banking operation" -39 -31 -13 -8 -5 -18 -8 Other^ 0 0 -15 -20 5 15 0 Net change -130 -126 -103 -80 -23 -23 -4 Number, Dec. 31, 2007 7,601 7,241 2,489 1,615 874 4,752 360 BRANCHES AND ADDITIONAL OFFICES Number, Dec. 31, 2006 80,872 77,792 55,099 40,760 14^39 22,693 3,080 Changes during 2007 New branches 3,258 3,088 1,966 1,474 492 1,122 170 Branches converted from banks 272 258 133 91 42 125 14 Discontinued2 -3,338 -3,275 -2,662 -2,152 -510 -613 -63 Other3 0 84 1,067 1,157 -90 -983 -84 Net Change 192 155 504 570 -66 -349 37 Number, Dec. 31, 2007 81,064 77,947 55,603 41330 14,273 22344 3,117 Banks affiliated with bank holding companies BANKS Number, Dec. 31, 2006 6,187 6,062 2,274 1,477 797 3,788 125 Changes during 2007 BHC-affiliated new banks 190 180 54 38 16 126 10 Banks converted into branches -224 -220 -96 -65 -31 -124 -4 Ceased banking operation" -35 -29 -13 -8 -5 -16 -6 Other 0 0 -16 -16 0 16 0 Net Change -69 -69 -71 -51 -20 2 0 Number, Dec. 31, 2007 6,118 5,993 2,203 1,426 777 3,790 125 NOTE: Includes banking offices and BHCs in U.S. terri- of making commercial loans or any institution that is tories 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

314 94th Annual Report, 2007 6A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2007 and Month-End 2007 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 i g f o h i u c ts a n t t e s c t u an r o r d u e i t n n - c g y 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 35,468r 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 38,206r 2007 740,611 46,500 48,636 -8 66,308 902,048 11,041 2,200 38,681 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 315 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 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 10,534 18,977 12,007 724.187 25,652 321 5,723 162 717 11,829 19,793 11,229 754,877 30,783 270 5,912 80 1,285 9,963 26,378 14,080 794,014 30,505 202 4,573 83 2,144 8,650' 30,466 10,393 820.1761 29,615 252 4,708 98 958 6,842 36,231 11.857 828.938 43,985 259 16,120 96 1,830 6,615 41.975 14,152 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

316 94th Annual Report, 2007 6A. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1984-2007 and Month-End 2007—Continued Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Period Special Treasury Other Gold drawing currency Securities Repurchase Federal stock rights outou h tr e i l g d ht1 agreements2 Loans Float Reserve Total ce a r c t c if o i u ca n t t e standing 3 assets 2007 Jan 778,863 32,000 1,326 -1,482 40,335 851,042 11,041 2,200 38,254 Feb 780,793 45,250 22 -1,012 37,940 862,993 11,041 2,200 38,305 Mar 780,901 33,250 27 -869 40,048 853,357 11,041 2,200 38,371 Apr 787,188 51,500 70 102 40,986 879.846 11,041 2,200 38,414 May 790,272 35,750 115 -622 38,759 864,274 11,041 2,200 38,462 Jun 790,522 25,250 204 -1,273 40,610 855,313 11,041 2,200 38,521 Jul 790,800 30,250 247 -1,164 41,471 861,604 11,041 2,200 38,541 Aug 779,642 38,500 1,342 -714 38,905 857,674 11.041 2,200 38,595 Sep 779,632 44,750 202 -729 41,355 865,210 11,041 2,200 38,639 Oct 779,586 48,500 92 -745 42,054 869,487 11,041 2,200 38,695 Nov 779,701 47,500 33 -814 40,545 866,965 11,041 2.200 38,765 Dec 740,611 46.500 48,636 -8 66,308 902,048 11,041 2,200 38,681 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 317 6 A.—Continued Factors absorbing reserve funds Reserve Deposits with Federal Reserve Banks, Other balances Currency Reverse Treasury other than reserve balances Required R F e e s d e e r r v a e l Fe w d i e th ral in repurchase cash clearing liabilities Reserve circulation agreements4 holdings5 balances and Banks6 Treasury Foreign Other capital 802,599 32,379 175 6,053 90 285 6,836 36,727 17,392 808,078 39,645 204 5,194 91 274 6,738 38,147 16,168 805,586 37,283 301 4,245 91 224 6,990 38,912 11,338 806,998 37,389 299 29,504 95 316 6,508 39,069 11,322 814,007 34,817 286 5,340 93 256 6,580 39.275 15,322 812,794 32,349 306 4,649 197 210 6,395 39,277 10,898 813.387 32,970 300 5,126 94 305 6,466 39.667 15,071 815,020 35,774 329 4,579 94 330 6,613 40,612 6,158 810,607 35,689 336 5,539 112 245 6,469 41,548 16,545 815,303 38,055 301 4,307 601 287 6,586 41,849 14.134 817,259 35,916 266 4,669 97 285 6,486 42,571 11,421 828,938 43,985 259 16,120 96 1,830 6,615 41,975 14,152 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 collateralized dealers, which are fully collateralized 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 collateralized 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

318 94th Annual Report, 2007 6B. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items, Year-End 1918-1983 Millions of dollars Factors supplying reserve funds Federal Reserve Bank credit outstanding Special Period drawing Treasury S o e u c h t u r e i r l g i d t h ie t1 s m R a c g e e h p r n a e u s t e s e r - 2 - Loans Float3 ot A h l e l r4 R F a O e e ss s d th e e e r e t r v s a r 5 e l Total s G to o c l k d 6 ce a r r c i t c g if o h i u c ts a n t t e s c t u a r n o r d u e i t n n - c g y 7 1918 239 0 1,766 199 294 0 2,498 2,873 1,795 1919 300 0 2,215 201 575 0 3,292 2,707 1,707 1920 287 0 2,687 119 262 0 3,355 2,639 1,709 1921 234 0 1,144 40 146 0 1,563 3,373 1,842 1922 436 0 618 78 273 0 1,405 3,642 1,958 1923 80 54 723 27 355 0 1,238 3,957 2,009 1924 536 4 320 52 390 0 1,302 4,212 2,025 1925 367 8 643 63 378 0 1,459 4,112 1,977 1926 312 3 637 45 384 0 1,381 4,205 1,991 1927 560 57 582 63 393 0 1,655 4,092 2,006 1928 197 31 1,056 24 500 0 1,809 3,854 2,012 1929 488 23 632 34 405 0 1,583 3,997 2,022 1930 686 43 251 21 372 0 1,373 4,306 2,027 1931 775 42 638 20 378 0 1,853 4,173 2.035 1932 1,851 4 235 14 41 0 2,145 4,226 2,204 1933 2,435 2 98 15 137 o 2 688 4,036 2,303 1934 2,430 0 7 5 21 0 2,463 8,238 2,511 1935 2.430 1 5 12 38 0 2,486 10,125 2,476 1936 2,430 0 3 39 28 0 2,500 11,258 2,532 1937 2,564 0 10 19 19 0 2,612 12,760 2,637 1938 2,564 0 4 17 16 0 2,601 14,512 2,798 1939 2,484 0 7 91 11 0 2,593 17,644 2,963 1940 2,184 0 3 80 8 0 2,274 21,995 3,087 1941 2,254 0 3 94 10 0 2,361 22,737 3,247 1942 6,189 0 6 471 14 0 6,679 22,726 3,648 1943 11,543 0 5 681 10 0 12,239 21,938 4,094 1944 18,846 0 80 815 4 0 19,745 20,619 4,131 1945 24,252 0 249 578 2 0 15,091 20,065 4,339 1946 23,350 0 163 580 1 0 24,093 20,529 4,562 1947 22,559 0 85 535 1 0 23,181 22,754 4.562 1948 23,333 0 223 541 1 0 24,097 24,244 4,589 1949 18,885 0 78 534 2 0 19,499 24,427 4,598 1950 20,725 53 67 1,368 3 0 22,216 22,706 4,636 1951 23,605 196 19 1,184 5 0 25,009 22,695 4,709 1952 24.034 663 156 967 4 0 25,825 23,187 4,812 1953 25,318 598 28 935 2 0 26,880 22,030 4,894 1954 24,888 44 143 808 1 0 25,885 21,713 4,985 1955 24,391 394 108 1,585 29 0 26,507 21,690 5,008 1956 24,610 305 50 1.665 70 0 26,699 21,949 5,066 1957 23,719 519 55 1,424 66 0 25,784 22,781 5,146 1958 26,252 95 64 1,296 49 0 27,755 20,534 5,234 1959 26.607 41 458 1,590 75 0 28,771 19,456 5,311 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 319 6B.—Continued Factors absorbing reserve funds Member bank Deposits with reserves9 Federal Reserve Banks, Other Cur- other than reserve balances Other Federal rency Treasury Required Federal Reserve in cash clearing cir ti c o u n la- holdings8 Treasury Foreign Other a R cc e o se u r n v t e s5 balances li c a a b a p i n i li t d t a i l e 5 s R F W e e d se i e t r r h v a e l C c u o r a r n i e n d n 1 c 0 y 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 -AA 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 All 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

320 94th Annual Report, 2007 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 n a e u s t e s e r - 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 t i c i g f o h i u c ts a n t t e s c t u a r n o r d u e i t n n - c g y 7 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 4,293 111 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 Fed- 2. On December 1, 1966, and thereafter, includes eral 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 frac- 3. In 1960 and thereafter, figures reflect a minor tional and dollar coins. For details see "US. 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 321 6B.—Continued Factors absorbing reserve funds Member bank Deposits with reserves9 Federal Reserve Banks, Cur- Other other than reserve balances rency Other Federal Treasury Required in cash Federal clearing Reserve c c u i l r a - - holdings8 a R cc e o se u r n v t e s5 balances liab a i n 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 9gi2 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 1.275 li 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

322 94th Annual Report, 2007 7. Principal Assets and Liabilities of Insured Commercial Banks, by Class of Bank, June 30, 2007 and 2006 Millions of dollars, except as noted Member banks Nonmember Item Total banks Total National State 2007 ASSETS Loans and investments 7,204,435 5,626,102 4,530,594 1,095,508 1,578,333 Loans, gross 5,604,391 4,347,814 3,514,026 833,788 1,256,577 Net 5,601,554 4,345,747 3,512,167 833,580 1,255,807 Investments 1,600,044 1,278,288 1,016,568 261,720 321,756 U.S. Treasury and federal agency securities 258,968 142,174 91,109 51,065 116,794 Other 1,341,075 1,136,113 925,459 210,654 204,962 Cash assets, total 262,729 209,416 173,718 35,698 53,313 LIABILITIES Deposits, total 5,461,849 4,080,633 3,266,165 814,468 1,381,216 Interbank 80,081 65,636 53,471 12,165 14,445 Other transactions 636,731 457,956 365,853 92,104 178,775 Other nontransactions 4,745,036 3,557,041 2,846,842 710,199 1,187,995 Equity capital 1,041,223 831,355 675,149 156,206 209,867 Number of banks 7,322 2,553 1,673 880 4,769 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 transactions 679,778 485,240 38,663 98,577 194,538 Other nontransactions 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 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 323 Initial Margin Requirements under Regulations T, U, and X Percent of market value Margin Convertible Short sales, Effective date stocks bonds T only1 1934, Oct. 1 . 25-45 1936, Feb. 1 . 25-55 Apr. 1 . 55 1937, Nov. 1 . 40 50 1945, Feb. 5 . 50 50 July 5 . 75 75 1946, Jan. 21 . 100 100 1947, Feb. 1 . 75 75 1949, Mar. 3 . 50 50 1951, Jan. 17 . 75 75 1953, Feb. 20 50 50 1955, Jan. 4 .. 60 60 Apr. 23 70 70 1958, Jan. 16 . 50 50 Aug. 5 . 70 70 Oct. 16 90 90 1960, July 28 70 70 1962, July 10 50 50 1963, Nov. 6 70 70 1968, Mar. 11 70 50 70 June 8 . 80 60 80 1970, May 6 . 65 50 65 1971, Dec. 6 55 50 55 1972, Nov. 24 65 50 65 1974, Jan. 3 . 50 50 50 NOTE: These regulations, adopted by the Board of 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 Novemthe purpose of purchasing or carrying "margin securi- ber 1, 1971. The former Regulation G, which was ties" (as defined in the regulations) when the loan is adopted effective March 11, 1968, was merged into collateralized by such securities. The margin requirement, Regulation U, 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

324 94th Annual Report, 2007 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2007 and 2006 Millions of dollars Total Boston Item 2007 2006 2007 2006 ASSETS Gold certificate account 11,037 11,037 449 486 Special drawing rights certificate account 2,200 2,200 115 115 Coin 1,179 801 36 27 Loans Term auction credit1 40,000 0 io Other loans to depository institutions ... 8,636 ' ' 67 178 Securities purchased under agreements to resell (triparty)2 46,500 40,750 2,143 U.S. Treasury securities bought outright3 740,611 778,915 34,132 37,169 Total loans and securities 835,748 819,731 36,453 37,178 Items in process of collection 2,220 4,276 82 97 Bank premises 2,144 1,953 120 117 Other assets Denominated in foreign currencies 4 47,295 20,482 1,222 491 Other5 16,915 18,015 822 782 Interdistrict settlement account 0 0 -1,356 124 Total assets 918,737 878,494 37,942 39,416 LIABILITIES Federal Reserve notes outstanding (issued to Bank) .. 1,010,262 958,680 38,832 39,020 Less: Notes held by Federal Reserve Bank 218,571 175,661 5,886 3,020 791,691 783,019 32,946 36,000 Federal Reserve notes, net 43,985 29,615 2,027 1,413 Securities sold under agreements to repurchase Deposits 20,767 18,699 531 549 Depository institutions 16,120 4,708 0 0 U.S. Treasury, general account 96 98 1 1 Foreign, official accounts 2,020 1,496 31 42 Other6 39,003 25,002 563 592 Total deposits Deferred credit items 2,227 4,602 92 352 Other liabilities and accrued dividends7 4,930 5,608 215 267 Total liabilities 881,837 847,846 35,843 38,624 CAPITAL ACCOUNTS Capital paid in 18,450 15,324 1,049 396 Surplus 18,450 15,324 1,049 396 Total liabilities and capital accounts . 918,737 878,494 37,942 39,416 FEDERAL RESERVE NOTE STATEMENT Federal Reserve notes outstanding 1,010,262 958,680 Less: Held by Banks not subject to collateralization 218.571 175,661 Collateralized Federal Reserve notes 791,691 783,019 Collateral for Federal Reserve notes Gold certificate account 11,037 11,037 Special drawing rights certificate account 2,200 2,200 Other eligible assets 35,328 0 U.S. Treasury and federal agency securities 743,126 769,782 Total collateral 791,691 783,019 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 325 9.—Continued NewYork Philadelphia Cleveland Richmond 2007 2006 2007 2006 2007 2006 2007 2006 4.053 4,139 455 463 428 446 869 853 874 874 83 83 104 104 147 147 55 47 88 53 113 73 134 78 33,957 0 12 775 5,888 0 0 0 841 0 130 0 16,838 40,750 2,057 1,903 4,029 268,173 288,297 32,765 33,817 30,308 33,633 64,168 64,704 324,856 329,047 34,822 33,817 33,064 33,633 69,102 64,704 42 70 317 649 268 451 154 237 216 212 64 58 153 158 186 170 11,503 5,707 5,587 1,152 3,354 1,569 12,633 5,625 6,700 7,099 713 1,055 750 759 1,446 1,502 -12,606 -29,471 794 836 -741 -2,264 -1,177 4,858 335,691 317,724 42,924 38,166 37,494 34,929 83,494 78,174 356,941 341,947 41,729 38,658 39,353 36,516 80,552 75,090 74,297 56,821 7,564 6,957 7,130 6,709 13,767 11,394 282,644 285,126 34,165 31,700 32,223 29,807 66,785 63,695 15,927 10,961 1,946 1,286 1,800 1,279 3,811 2,460 9,158 6.609 2,664 584 447 954 1,780 2,748 16,120 4,708 0 0 0 0 0 0 66 69 5 2 3 3 11 11 698 821 92 1 12 32 503 121 26,042 12,207 2,760 587 461 990 2,294 2,880 51 111 215 718 200 405 112 384 1,790 1,864 211 255 228 275 500 569 326,454 310,270 39,297 34,547 34,912 32,756 73302 69,987 4,619 3,727 1,813 1,810 1,291 1,087 4,996 4,093 4,619 3,727 1,813 1,810 1,291 1,087 4,996 4,093 335,691 317,724 42,924 38,166 37,494 34,929 83,494 78,174 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

326 94th Annual Report, 2007 9. Statement of Condition of the Federal Reserve Banks, by Bank, December 31, 2007 and 2006—Continued Millions of dollars Atlanta Chicago Item 2007 2006 2007 2006 ASSETS Gold certificate account 1,117 1,023 903 947 Special drawing rights certificate account 166 166 212 212 Coin 153 93 137 100 Loans Term auction credit1 25 1,080 Other loans to depository institutions 0 ' ' 3 1,259 24 Securities purchased under agreements to resell (triparty)2 4,313 3,900 US. Treasury securities bought outright3 68,690 65,208 62,120 71,520 Total loans and securities 73,028 65,211 68,359 71,544 Items in process of collection 229 324 155 241 Bank premises 230 232 205 206 Other assets Denominated in foreign currencies4 3,939 1,382 2,648 1,357 Other5 1,473 1,430 1,258 1,481 Interdistrict settlement account 3,909 12,404 6,133 -3,742 Total assets 84,243 82,264 80,010 72346 LIABILITIES Federal Reserve notes outstanding (issued to Banks) 111,626 98,175 86,265 79,818 Less: Notes held by Federal Reserve Banks 36,017 23,938 13,560 14,202 Federal Reserve notes, net 75,609 74,237 72,705 65,616 Securities sold under repurchase agreements 4,080 2,479 3,689 2,719 Deposits Depository institutions 975 1,980 910 1,395 U.S. Treasury, general account 0 0 0 0 Foreign, official accounts 3 3 2 3 Other6 166 63 161 105 Total deposits 1,144 2,046 1,073 1,503 Deferred credit items 143 473 516 276 Other liabilities and accrued dividends7 418 476 396 515 Total liabilities 8133 79,711 78381 70,630 CAPITAL ACCOUNTS Capital paid in 1,425 1,276 814 858 Surplus 1.425 1.276 814 858 Total liabilities and capital accounts 84,243 82,264 80,010 72346 NOTE: Components may not sum to totals because of 3. Includes securities loaned—fully collateralized by rounding. U.S. Treasury securities pledged with Federal Reserve 1. In December 2007, the System established the tempo- Banks—and excludes securities purchased under agreerary Term Auction Facility, which provides credit to eli- ments to resell. gible depository institutions. 4. Valued daily at market exchange rates. Includes de- 2. On February 15, 2007, the System began allocating posits held under foreign currency arrangements with two the activity related to securities purchased under agree- central banks of $24 million at December 31, 2007. ments to resell to all Reserve Banks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 327 9.—Continued St. Louis Minneapolis Kansas City Dallas San Francisco 2007 2006 2007 2006 2007 2006 2007 2006 2007 2006 326 328 203 211 335 324 613 575 1,286 1,242 71 71 30 30 66 66 98 98 234 234 50 39 45 31 72 62 130 81 165 117 1,050 0 0 1,400 1,701 0 0 3 ' "22 7 7 0 ' 0 330 'l 1,486 928 1,505 2,043 5,355 23,671 24,747 14,777 15,835 23,974 22,808 32,540 34,957 85,293 86^218 26,207 24,747 15,708 15,857 25,486 22,815 35,983 34,957 92,680 86,219 13 196 97 219 214 560 126 348 522 884 115 80 113 116 269 159 257 260 218 185 513 223 851 380 544 271 653 236 3,848 2,089 515 552 316 348 513 480 690 751 1,720 1,777 3,742 1,807 2.140 -237 5,239 4,734 -2,425 3,537 -3,651 7,414 31,551 28,045 19,503 16,955 32,740 29,469 36,124 40,844 97,021 100,160 32,982 29,169 19,219 17,442 33,316 30,770 57,270 57,150 112,177 114,925 3,770 3,175 2,790 2,549 3,212 3,717 24,860 19,391 25,719 23,787 29,212 25,994 16,429 14,893 30,103 27,053 32,410 37,759 86,459 91,138 1,406 941 878 602 1,424 867 1,933 1,329 5,066 3,278 289 434 1,104 455 449 546 635 705 1,823 1,741 0 0 0 0 0 0 0 0 0 0 0 0 1 1 0 1 1 0 3 4 55 24 38 18 45 32 59 37 161 200 344 458 1,143 474 495 579 695 742 1,987 1,946 38 103 223 288 157 435 129 306 353 749 192 217 122 147 172 183 230 284 456 556 31,192 27,713 18,794 16,404 32352 29,117 35397 40,420 94,321 97,667 180 166 355 276 194 176 363 212 1,350 1,247 180 166 355 276 194 176 363 212 1,350 1,247 31,551 28,045 19,503 16,955 32,740 29,469 36,124 40,844 97,021 100,160 5. The System total includes depository institution 7. Includes exchange-translation account reflecting the overdrafts of $6 million for 2007 and $2 million for 2006. monthly revaluation of foreign exchange commitments at 6. Includes international organization deposits of $144 market exchange rates. million for 2007 and 2006. These deposits are primarily . . . Not applicable. held by the Federal Reserve Bank of New York. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

328 94th Annual Report, 2007 10. Income and Expenses of the Federal Reserve Banks, by Bank, 2007 Thousands of dollars Item Total Boston New York Philadelphia Cleveland CURRENT INCOME Loans 71,345 275 54,696 142 940 U.S. Treasury securities 40,297,924 1.868,185 14,791,753 1,765,843 1,668,195 Foreign currencies 574,525 14,775 141,114 65,450 40,965 Priced services 878,405 0 65,475 0 0 Compensation received for services provided1 634,819 46,972 29,040 38,486 79,931 Other 119.007 2,967 72,331 2,663 2,893 Total 42,576,025 1,933,174 15,154,409 1,872,583 1,792,924 CURRENT EXPENSES Salaries and other personnel expenses 1,499,112 82,288 302,889 70,493 93,093 Retirement and other benefits . 505,516 22,023 92,280 25,444 34,555 Net periodic pension expense2 109,849 1,271 103,149 173 243 Fees 132,372 4,009 13,120 2,047 5,913 Travel 71,187 3,337 9,947 2,469 4,648 Software expenses 141,444 2,885 20,876 8,460 21,457 Postage and other shipping costs 81,675 1.517 2,475 2,302 6,214 Communications 43,320 788 3,392 521 869 Materials and supplies 70,668 5,065 9,140 5,321 6,733 Building expenses Taxes on real estate 32,610 4,976 4,765 1,567 1.954 Property depreciation 92,998 6,737 16,209 4,066 8.767 Utilities 39,285 4.300 7,833 2.739 2,771 Rent 49.166 3,183 14,929 326 187 Other 39.883 1,663 6,822 2,205 3,625 Equipment Purchases 28,060 3,142 3,972 1,155 1,372 Rentals 3.592 281 1,434 412 162 Depreciation 117,996 6,444 10,459 6,066 7,887 Repairs and maintenance 78,276 4,394 7,491 4,694 6,390 Earnings credit costs 240.354 12,415 65,453 9.140 15,618 Compensation paid for service costs incurred1 634,819 0 28,955 0 0 Other 81,956 21,453 71,392 11,746 15,994 Recoveries -104.730 -15.658 -13,831 -3,569 -3,755 Expenses capitalized3 -20,873 -1,615 -9,547 -339 -516 Total 3,968,537 174,897 773,605 157,437 234,181 Reimbursements -458,331 -25,073 -109,437 -30,812 -62,455 Net expenses 3,510,206 149.824 664,168 126,625 171,726 For notes see end of table. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 329 10.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 3,505 137 2,514 2.596 1,515 954 2,199 1.873 3,435,771 3,617,951 3,457,351 1,280,394 805,010 1,263,466 1,773,992 4,570.014 153,751 47,228 32,571 6,233 10,360 6,678 7,849 47.550 0 753,440 59,491 0 0 0 0 0 55,800 459 81,786 26,252 78,665 81,241 47,010 69,178 11,376 5,448 5,299 1,881 1,215 1,847 2.409 8,678 3,660,202 4,424,663 3,639,012 1,317,356 896,765 1,354,187 1,833,458 4,697,294 212,395 135,008 114.948 77,558 79,344 96,941 83,391 150.765 76,590 46,823 46,292 27,363 25,979 27.660 33,613 46,892 774 740 439 449 565 664 164 1,220 62,831 11,761 10,174 7,719 2,631 7,011 1,565 3,592 10,765 7,420 7,452 3,910 3,147 5,242 3,737 9,113 55,807 2,467 4,866 5,256 3,878 4,535 5.300 5,656 3,421 45,885 3,819 2,203 2,480 1,939 4,252 5,168 26,566 1,786 1.429 1,277 1,883 1,277 1,791 1,743 8,125 7,942 5,726 3,059 3,902 4,516 5,304 5.834 2,408 3,293 2.231 637 3,186 201 3,914 3,479 8,990 9.419 11,380 5.247 4,702 982 8,975 7,523 3,740 4,063 2,294 1,634 1,976 677 4,027 3,232 16,146 566 5,933 1,738 253 4,518 199 1,188 3,728 3,975 5,724 1,481 1,731 399 4,945 3,585 4,709 2,471 1,780 1,071 1,460 2,704 1,579 2.644 249 417 295 143 18 28 88 65 37,635 8,597 9.714 5,318 4,603 6,358 5,326 9,590 16.668 9.556 6.544 2,770 2,798 3,470 5,367 8,134 53,827 15,051 22,197 4,612 4,138 6,913 5,616 25,374 0 596.523 9,341 0 0 0 0 0 -282,072 25,921 56,591 79,734 19,214 16,823 30,145 15,016 -28,656 -8.174 -8,038 -2,313 -993 -4,473 -9,366 -5,905 -2,610 -640 -345 -1,158 -611 -863 -488 -2,141 292,034 930,868 320,790 229,709 166,285 187,521 199,444 301,765 -29,720 -12,264 -5,238 -114,707 -29,292 -11,028 -15,021 -13.283 262,314 918,603 315,551 115,003 136,993 176,493 184,423 288.483 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

330 94th Annual Report, 2007 10. Income and Expenses of the Federal Reserve Banks, by Bank, 2007—Continued Thousands of dollars Item Total Boston New York Philadelphia Cleveland PROFIT AND LOSS Current net income 39,065,820 1,783,349 14,490,241 1,745,959 1,621,198 Additions to (+) and deductions from (—) current net income4 Profits on foreign exchange transactions 1,885,770 49,346 447,281 242,599 131,895 Other additions 580 17 29 91 236 Total additions 1,886,350 49,363 447,310 242,690 132,131 Interest expense on reverse repurchase agreements -1,687,918 -78,664 -615,495 -74,232 -70,285 Other deductions -9 0 0 0 -8 Total deductions -1,687,927 -78,664 -615,495 -74,232 -70,293 Net addition to (+) or deduction from (-) current net income 198,423 -29,301 -168,185 168,458 61,839 Cost of unreimbursed Treasury services 6 0 2 4 0 Assessments by Board Board expenditures5... 296,125 7,534 74,183 34,464 20,766 Cost of currency 576,306 30,970 123,566 32,084 26,174 Net income before payment to U.S. Treasury 38,391,806 1,715,543 14,124,306 1,847,864 1,636,096 Change in funded status of benefit plans6 324,481 3,596 228,568 4,924 5,345 Comprehensive income before payment to U.S. Treasury . 38,716,287 1,719,139 14,352,874 1,852,789 1,641,441 Dividends paid 992,353 34,714 253,678 108,613 65,679 Payments to U.S. Treasury (interest on Federal Reserve notes) 34,598,401 1,031,048 13,207,574 1,740,672 1,371,427 Transferred to/from surplus and change in accumulated other comprehensive income 3,125,533 653,378 891,622 3,504 204,335 Surplus, January 1 15,324,288 396,093 3,727,084 1,809,826 1,086.735 Surplus, December 31 . 18,449,821 1,049,471 4,618,706 1,813,329 1,291,070 NOTE: Components may not sum to totals because of 87). The System Retirement Plan for employees is rerounding. corded on behalf of the System on the books of the 1. The Federal Reserve Bank of Atlanta has overall Federal Reserve Bank of New York, resulting in an inresponsibility for managing the Reserve Banks' provision crease in expenses of $97,419 thousand. The expenses of check and ACH services and recognizes total System related to the Retirement Benefit Equalization Plan and revenue for these services. The Federal Reserve Bank of the Supplemental Employee Retirement Plan are recorded New York has overall responsibility for managing the by each Federal Reserve Bank. Reserve Banks' provision of Fedwire funds transfer and 3. Includes expenses for labor and materials capitalsecurities transfer services and recognizes the total Sys- ized and depreciated or amortized as charges to activities tem revenue for these services. The Federal Reserve Bank in the periods benefited. of Chicago has overall responsibility for managing the 4. Includes reimbursement from the U.S. Treasury for Reserve Banks' provision of electronic access services to uncut sheets of Federal Reserve notes, gains and losses on depository institutions and recognizes the total System the sale of Reserve Bank buildings, counterfeit currency revenue for these services. The Federal Reserve Bank of that is not charged back to the depositing institution, and Atlanta, the Federal Reserve Bank of New York, and the stale Reserve Bank checks that are written off. Federal Reserve Bank of Chicago compensate the other 5. For additional details, see the chapter "Board of Reserve Banks for the costs incurred in providing these Governors Financial Statements." services. 6. Subsquent to the adoption of SFAS 158 at Decem- 2. Reflects the effect of Financial Accounting Stan- ber 31, 2006, the Reserve Banks recognize the change in dards Board Statement of Financial Accounting Stan- funded status of pension and postretirement benefit plans Digitized dfaorrd sF NRoA. 8S7E, ERm ployers' Accounting for Pensions (SFAS as an element of other comprehensive income. http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 331 10.—Continued Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 3,397.889 3,506,059 3.323,461 1,202,353 759,772 1,177,694 1,649,035 4,408.811 501,282 162.120 102,302 20,439 33,756 21,153 26,785 146.812 18 40 51 23 17 5 16 37 501,300 162,160 102,354 20.461 33,773 21,158 26,800 146,849 -144.330 -151,710 -145,835 -53,846 -33,880 -52,984 -74,666 -191,992 0 0 0 0 0 0 0 0 -144,330 -151,710 -145,835 -53,846 -33,880 -52,984 -74,666 -191,992 356,970 10,450 -43,481 -33,385 -107 -31,825 -47,866 -45,143 0 0 0 0 0 0 0 0 77.265 24.941 16,506 3,198 5,485 3,421 4,380 23.982 51,241 78,926 56,393 19,551 14,880 23,518 30,903 88,099 3.626,352 3,412,643 3,207,080 1,146,219 739,300 1,118,929 1,565,886 4,251,587 22.519 5,717 14,711 3,536 10,627 3,547 13,535 7,854 3,648,871 3.418,359 3,221,792 1,149,756 749,927 1,122,477 1,579,422 4,259.441 263,167 78,220 52,775 10,398 19,522 11.109 17,019 77,460 2,483,025 3,191,589 3,212,649 1,125,614 651,634 1,093.644 1,410,713 4,078,811 902,679 148,551 -43,632 13,743 78,771 17,724 151,689 103,171 4.093,301 1,276,288 858.091 166,206 275.762 176,344 211,742 1,246,817 4,995,979 1,424,838 814,459 179,950 354,533 194,068 363,431 1,349,988 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

332 94th Annual Report 2007 11. Income and Expenses of the Federal Reserve Banks, 1914-2007 Thousands of dollars Assessments by Federal Reserve Current Net Net additions Board of Governors fu C n h d a e n d g s e t i at n us Bank and period income expenses deducti o o r ns (-)1 Board Costs of p b l e a n n e s fit 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 ,680 2,178 1937 41,233 25,295 -1,631 ,748 1.757 1938 36,261 25,557 2,232 ,725 1,630 1939 38,501 25,669 ,621 1,356 2,390 1940 43,538 25,951 11,488 ,704 1,511 1941 41,380 28,536 721 ,840 2,588 1942 52,663 32,051 -1,568 ,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 333 11.—Continued Payments to J.S. Treasury Transferred to/from surplus Trn n O fV^ITfH and change in Dividends to/ I f r I o tl m llo l s C u ll r C p U lus accumulated other paid Statutory Interest on (section 13b) comprehensive transfers2 Federal Reserve income notes (section 7) 217 1,743 6,804 1,134 U34 5,541 48,334 5,012 2,704 70,652 5,654 60,725 82,916 6,120 59,974 15,993 6,307 10,851 -660 6,553 3,613 2,546 6,682 114 -3,078 6,916 59 2,474 7,329 818 8,464 7,755 250 5,044 8,458 2,585 21,079 9,584 4,283 22,536 10.269 17 -2,298 10,030 -7,058 9,282 2,011 11,021 8,874 -917 8,782 -60 6,510 8,505 ' 298 28 607 7,830 227 103 353 7,941 177 67 2,616 8,019 120 -419 1,862 8,110 25 -426 4,534 8,215 82 -54 17,617 8,430 141 -4 571 8,669 198 50 3,554 8,911 245 135 40,327 9,500 327 201 48,410 10,183 248 262 81,970 10,962 67 28 81,467 11,523 36 75,284 87 8,366 11,920 166,690 18,523 12,329 193,146 21,462 13,083 196,629 21,849 13,865 254,874 28.321 14,682 291,935 46,334 15,558 342,568 40,337 16.442 276,289 35,888 17,712 251,741 32,710 18,905 401,556 53,983 20,081 542,708 61,604 21,197 524,059 59,215 22,722 910,650 -93,601 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

334 94th Annual Report, 2007 11. Income and Expenses of the Federal Reserve Banks, 1914-2007—Continued Thousands of dollars Assessments by Federal Reserve Current Net Net additions Board of Governors fu C n h d a e n d g e s ta i t n us Bank and period income expenses or of benefit deductions (-) Board Costs plans 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 -412,943 82,116 162,606 1985 18,131,983 1,127,744 1,301,624 77,378 173,739 1986 17,464,528 1,156,868 1,975,893 97,338 180,780 1987 17,633,012 1,146,911 1,796,594 81,870 170,675 1988 19,526,431 1,205,960 -516,910 84,411 164,245 1989 22,249,276 1,332,161 1,254,613 89,580 175,044 1990... 23,476,604 1,349,726 2,099,328 103,752 193,007 1991... 22,553,002 1,429,322 405,729 109,631 261,316 1992... 20,235,028 1,474,531 -987,788 128,955 295,401 1993... 18,914,251 1,657,800 -230,268 140,466 355,947 1994... 20,910,742 1,795,328 2,363,862 146,866 368,187 1995... 25,395,148 1,818,416 857,788 161,348 370,203 1996 .. 25,164,303 1,947,861 -1,676,716 162,642 402,517 1997 .. 26,917,213 1,976,453 -2,611,570 174,407 364,454 1998 .. 28,149,477 1,833,436 1,906,037 178,009 408,544 1999 .. 29,346,836 1,852,162 -533,557 213,790 484,959 2000 .. 33,963,992 1,971,688 -1,500,027 188,067 435,838 2001 .. 31,870,721 2,084,708 -1,117,435 295,056 338,537 2002 .. 26,760,113 2,227,078 2,149,328 205,111 429,568 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 2007 .. 42,576,025 3,510,206 198,417 296,125 576,306 324,481 Total, 1914-2007 753,465,666 58,857,462 4,240,213 5,000,926 9,408318 324,481 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 335 11.—Continued Transferred Payments to U.S. Treasury to/from surplus Tran sferred and change in Dividends to/ X fr X o U m ll o s lv u l r 1 p K l /V u J s accumulated other paid Statutory Interest on (section 13b) comprehensive transfers 2 Federal Reserve income notes (section 7) 23,948 896,816 42,613 25,570 687,393 70,892 27,412 799,366 45,538 28,912 879,685 55,864 30,782 1,582,119 -465,823 32,352 1,296,810 27,054 33,696 1,649,455 18,944 35,027 1,907,498 29,851 36,959 2,463,629 30,027 39,237 3,019,161 39,432 41,137 3,493,571 32,580 43,488 3,356,560 40,403 46,184 3,231,268 50,661 49,140 4,340,680 51,178 52,580 5,549,999 51,483 54,610 5,382,064 33,828 57,351 5,870,463 53,940 60,182 5,937,148 45,728 63,280 7,005,779 47,268 67,194 9,278,576 69,141 70,355 11,706,370 56,821 74,574 14,023,723 76,897 79,352 15,204,591 78,320 85,152 14,228,816 106,663 92,620 16,054,095 161,996 103,029 17,796,464 155,253 109.588 17,803,895 91,954 117,499 17,738,880 173,771 125.616 17,364,319 64,971 129,885 21,646,417 130,802 140,758 23,608,398 180,292 152,553 20,777,552 228,356 171,763 16,774,477 402,114 195,422 15,986,765 347,583 212,090 20.470,011 282,122 230,527 23,389,367 283,075 255,884 5.517,716 14,565,624 635,343 299.652 20,658,972 0 831,705 343,014 17,785,942 8,774,994 731,575 373,579 25,409,736 479,053 409,614 25,343,892 4,114,865 428,183 27,089,222 517,580 483,596 24,495,490 1,068,598 517,705 22,021,528 466,796 582,402 18,078,003 2.782,587 780,863 21,467,545 1,271,672 871,255 29,051,678 4,271,828 992,353 34,598,401 3,125,533 9,731,130 44,113,958 608,526^61 -4 24^92,209 3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

336 94th Annual Report, 2007 11. Income and Expenses of the Federal Reserve Banks, 1914-2007—Continued Thousands of dollars Assessments by Net additions Board of Governors Change in Federal Reserve Current Net funded status or Bank and period income expenses deductions (-)1 Board Costs of p b la e n n s efit expenditures of currency Aggregate for each Bank, 1914-2007 Boston 39,756,660 3,566,677 -77,524 214,794 549,944 3,596 New York 264,885,985 9,049,099* 665,437 1,242,376 2,904,656 228,568 Philadelphia 28,242,547 2,902,768 281,126 232,919 407,154 4,924 Cleveland 44,376,296 3,441,220 358,964 363,689 538,490 5,345 Richmond 58,583,264 4,847,517 1,048,500 746,343 776,985 22,519 Atlanta 44,873,400 7,446,218 300,910 375,667 738,885 5,717 Chicago 88,896,622 6,781,169 570,303 542,013 1,061,746 14,711 St. Louis 25,558,056 2,712,204 9,337 118,324 341,279 3,536 Minneapolis 13,120,386 2,686,112 129,244 145,784 171,112 10.627 Kansas City 26,840,812 3,577,546 71,878 150,184 345,207 3,547 Dallas 34,245,323 3,632,776 291,082 222,824 468,457 13,535 San Francisco 84,086,318 6,214,156 590,956 646,010 1,104,404 7,854 Total 753,465,666 56,857,462 4,240,213 5,000,926 9,408,318 324,481 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 337 11.—Continued Payments to U.S. Treasury Transferred to/from surplus and change Transferred Dividends in accumulated other paid Interest on to/from surplus comprehensive t S ra ta n t s u f t e o r r s y 2 Federa n l o t R es eserve (section 13b) (se i c n t c i o o m n e 7)5 445,359 2,579,504 31,082,719 135 1,243,599 2,429,684 17,307.161 225,798,033 -433 7,049,415 516,216 1,312,118 21,177,901 291 1,979,232 715,167 2,827,043 35,255,476 -10 1,599,529 1,667,095 3,083,928 42,455,863 -72 6,076,623 695,724 2,713,230 31,464,800 5 1,745,497 969,454 4,593,811 74,300,302 12 1,233,130 218,704 1,833,837 20.042,912 -27 303,695 276,350 416,227 9,051,982 65 512,625 259,149 1,249,703 21,017,971 -9 316,487 367,830 1,510,802 27,815,769 55 531,427 1,170,398 4,686,594 69,062,633 -17 1,800,950 9,731,130 44,113,958 608,526,361 -4 24392,2093 3. The $24,392,209 thousand transferred to surplus transfer of $11,131 thousand from reserves for contingenwas reduced by direct charges of $500 thousand for cies (1955); leaving a balance of $18,449,821 thousand charge-off on Bank premises (1927); $139,300 thousand on December 31, 2007. for contributions to capital of the Federal Deposit Insur- 4. This amount is reduced by $2,815,225 thousand ance Corporation (1934); $4 thousand net upon elimina- for expenses of the System Retirement Plan. See note 2, tion of section 13b surplus (1958); $106,000 thousand table 10. (1996), $107,000 thousand (1997), and $3,752,000 thou- 5. Beginning in 2006, accumulated other comprehensand (2000) transferred to the Treasury as statutorily re- sive income is reported as a component of surplus. quired; and $1,848,716 thousand related to the implemen- ... Not applicable. tation of SFAS No. 158 (2006), and was increased by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

338 94th Annual Report, 2007 12. Operations in Principal Departments of the Federal Reserve Banks, 2004-2007 Operation 2007 2006 2005 2004 Millions of pieces Currency processed 35,653 37,694 36,463 36,242 Currency destroyed 6,509 6,766 6,551 6,748 Coin received 63,255 59,705 56,080 55,655 Checks handled U.S. government checks1 214 222 216 234 Postal money orders 164 171 176 187 All other3 10,001 11,083 12,228 13,904 Securities transfers2 24 22 22 20 Funds transfers 135 134 132 125 Automated clearinghouse transactions Commercial 9,363 8,231 7,339 6,486 Government 1,027 992 964 941 Millions of dollars Currency processed 642,168 664,592 639,832 625,127 Currency destroyed 104,082 84,742 83,187 90,943 Coin received 6,124 5,779 5,412 5,403 Checks handled U.S. government checks1 256,994 269,073 252,192 277,649 Postal money orders 31,626 28,066 28,395 29,045 All other3 15,897,747 16,442,820 15,684,615 14,287,740 Securities transfers2 435,577,505 377,258,592 368,896,819 313,425,252 Funds transfers 670,665,569 572,645,790 518,546,733 478,946,947 Automated clearinghouse transactions Commercial 14,547,234 13,124,434 12,801,914 12,543,907 Government 3,716,928 3,474,364 3,156,556 2,913,189 1. Starting in 2005, this category includes government previous years, but the composition of the category rechecks handled electronically (electronic checks); mained the same. Therefore, the data are comparable with amounts in bold are restatements to reflect the inclusion data reported in previous years. of electronic checks. 3. Amounts in bold are restatements. 2. In 2006, the title of this category changed from Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Statistical Tables 339 13. Number and Annual Salaries of Officers and Employees of the Federal Reserve Banks, December 31, 2007 President' Other officers Employees rotal Federal Reserve Bank (including Number Branches) Salary Num- Salaries Salaries Num- (dollars)2 ber (dollars)2 Full- Part- (dollars)2 ber (dollars)2 time time Boston 300,700 66 11,705,861 834 68 60,844,958 969 72,851,519 New York 398,200 289 58,962,284 2,435 51 209,318,220 2,776 268,678,705 Philadelphia 289,000 57 9,156,100 964 32 55,399,380 1,054 64,844,480 Cleveland 294,100 57 9,097,275 1,450 36 74,076,101 1,544 83,467,476 Richmond 323,000 78 12,092,800 1,647 42 97,039,847 1,768 109,455,647 Atlanta 289,000 79 13,820,595 1,822 33 108,183,543 1,935 122,293,138 Chicago 289,000 83 13,151,804 1,292 53 86,678,366 1,429 100,119,170 St. Louis 356,000 79 12,257,140 937 58 55,858,832 1,075 68,471,972 Minneapolis 391.000 43 6,663,760 1,101 87 63,751,595 1,232 70,806,355 Kansas City 356,100 78 13,349,302 1,244 23 71,299,571 1,346 85,004,973 Dallas 289,000 61 9,740,198 1,172 20 66,113,025 1,254 76,142,223 San Francisco ... 360,300 74 14,269,134 1,652 68 119,451,612 1,795 134,081,046 Federal Reserve Information Technology .. 37 5,909,456 770 3 67,164,988 810 73,074,444 Office of Employee Benefits .... 9 1,830,900 34 0 2,896,647 43 4,727,547 Total 3,935,400 1,090 192,006,609 17,354 574 1,138,076,686 19,030 1,334,018,695 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 2007, New ratio. The Board has discretion to approve a higher start- York and San Francisco were in tier 1, which had a ing salary if requested by a Reserve Bank's board of midpoint for presidents' salaries of $379,300. 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 $340,000. 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 $309,600. (through year 9), each president receives a salary increase 2. Annualized salary liability based on salaries in efthat results in a compa-ratio as follows: year 3, 95 (for the fect on December 31, 2007. New York Bank, 105); year 6, 105 (New York, 115); . . . Not applicable. year 9, 115 (New York, 125). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

340 94th Annual Report, 2007 14. Acquisition Costs and Net Book Value of the Premises of the Federal Reserve Banks and Branches, December 31, 2007 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 ... 27,293 135,431 28,808 191,532 119,760 NEW YORK 20,103 267,634 70,071 357,808 215,622 PHILADELPHIA ... 7,312 90,205 13,999 111,516 64,495 CLEVELAND . 4,219 123,320 27,333 154,872 109,497 Cincinnati 2,737 29,516 14,351 46,604 23,489 Pittsburgh 1,739 19,388 15,361 36,488 19,674 RICHMOND 25,539 113,311 44,779 183,628 129,047 Baltimore ... 6,482 32,939 5,924 45,345 26,728 Charlotte 3,130 34,985 6,961 45,076 29,804 ATLANTA .. 22,735 149,949 16,367 189,052 163,202 Birmingham . 5,347 12,749 1,525 19,621 12,962 Jacksonville . 1,779 21,515 3,967 27,261 17,051 Miami 4,254 24,825 4,916 33,996 22,136 Nashville 603 5,690 3,542 9,835 4,529 New Orleans 3,785 8,873 5,529 18,187 9,658 CHICAGO 4,512 168,948 20,681 194,141 116,158 Detroit 9,980 72,437 10,690 93,107 88,645 ST. LOUIS 8,428 110,052 14,348 132,828 100,552 Little Rock 0 0 0 0 0 4,106 Memphis 2,472 14,127 5,162 21,761 14,048 MINNEAPOLIS 15,666 104,953 13,834 134,453 103,464 Helena 2,890 9,716 943 13,549 9,276 KANSAS CITY 37,501 217,038 0 254,539 254,539 Denver 3,511 9,167 4,502 17,179 8,039 Oklahoma City . 0 0 0 0 0 Omaha 3,559 7,374 1,726 12,658 6,207 DALLAS 36,166 110,487 24,205 170,858 119,762 El Paso 262 3,426 1,698 5,386 1,182 Houston 23,699 104,631 8,653 136,983 129,728 7,204 San Antonio . 826 8,227 2,491 11,544 6,038 SAN FRANCISCO 20,129 98,264 22,650 141,043 79,893 Los Angeles 6,306 71,643 14,807 92,755 57,963 Salt Lake City 1,294 4,680 1,467 7,441 2,972 Seattle 8,136 73,234 4,545 85,915 77,486 29 Total . 322^92 2,258,733 415,838 2,996,963 2,143,606 11,339 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

343 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 Re- Board's financial statements, and its serve Banks are subject to annual examicompliance with laws and regulations nation by the Board. As discussed in the affecting those statements, are audited chapter "Federal Reserve Banks," the annually by an outside auditor retained 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 Federal Reserve operations are also Board functions delegated to the Re- subject to review by the Government serve Banks. Accountability Office. • Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

345 Board of Governors Financial Statements The financial statements of the Board for 2007 were audited by Deloitte & Touche LLP, independent auditors. Deloitte INDEPENDENT AUDITORS' REPORT The Board of Governors of the Federal Reserve System: We have audited the accompanying balance sheet of the Board of Governors of the Federal Reserve System (the "Board") as of December 31, 2007, and the related statements of revenues and expenses and changes in cumulative results of operations, and cash flows for the year 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 audit. The financial statements of the Board for the year ended December 31, 2006 were audited by other auditors whose report, dated April 17, 2007, expressed an unqualified opinion on those statements and included an explanatory paragraph related to adoption of the Financial Accounting Standard Board Statement No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes 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 audit provides a reasonable basis for our opinion. In our opinion, such 2007 financial statements present fairly, in all material respects, the financial position of the Board of Governors of the Federal Reserve System as of December 31, 2007, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In accordance with Government Auditing Standards, we have also issued our report dated March 19, 2008 on our consideration of the Board's internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and agreements and other matters. The purpose of that report 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. That report is an integral part of an audit performed in accordance with Government Auditing Standards, and should be considered in assessing the results of our audit. March 19. 2008 Washington, D.C. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

346 94th Annual Report, 2007 BALANCE SHEETS Year ending December 31, 2007 2006 ASSETS CURRENT ASSETS Cash $ 44,613,728 $ 60,030,706 Accounts receivable 2,996,318 2,625,907 Prepaid expenses and other assets 4,653,684 3,916,608 Total current assets 52,263,730 66,573,221 NONCURRENT ASSETS Property and equipment, net (Note 4) 153,350,880 151,205,386 Other assets 166,119 343,899 Total noncurrent assets 153,516,999 151,549,285 Total assets $205,780,729 $218,122,506 LIABILITIES AND CUMULATIVE RESULTS OF OPERATIONS CURRENT LIABILITIES Accounts payable and accrued liabilities $ 20,400,282 $ 10,950,470 Accrued payroll and related taxes 5,647,053 5,421,666 Accrued annual leave 18,429,601 16,334,512 Capital lease payable (current portion) 108,755 327,663 Unearned revenues and other liabilities 702,122 366,304 Total current liabilities 45,287,813 33,400,615 LONG-TERM LIABILITIES Capital lease payable (non-current portion) 0 108,755 Accumulated retirement benefit obligation (Note 5) 2,201,675 1,354,662 Accumulated postretirement benefit obligation (Note 6) 7,972,469 8,111,829 Accumulated postemployment benefit obligation (Note 7) 8,855,613 6,515,301 Total long-term liabilities 19,029,757 16,090,547 Total liabilities 64,317,570 49,491,162 CUMULATIVE RESULTS OF OPERATIONS Working capital 7,084,672 33,500,269 Unfunded long-term liabilities (17,542,943) (14,325,986) Net investment in assets 153,408,244 151,112,867 Accumulated other comprehensive income (loss) (Note 8) (1,486,814) (1,655,806) Total cumulative results of operations 141,463,159 168,631,344 Total liabilities and cumulative results of operations $205,780,729 $218,122,506 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 347 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF REVENUES AND EXPENSES AND CHANGES IN CUMULATIVE RESULTS OF OPERATIONS Year ending December 31, 2007 2006 BOARD OPERATING REVENUES Assessments levied on Federal Reserve Banks for Board operating expenses and capital expenditures $296,124,700 $301,013,500 Other revenues 10,365,414 8,508,949 Total operating revenues 306,490,114 309,522,449 BOARD OPERATING EXPENSES Salaries 197,656,442 182,239,595 Retirement and insurance 39,451,541 35,853,297 Contractual services and professional fees 36,300,185 23,944,564 Depreciation, amortization, and net losses on disposals 13,557,498 13,058,667 Utilities 8,998,496 9,185,840 Travel 8,619,615 8,820,503 Software 6.678,514 6,637,765 Postage and supplies 8,836.143 4,560,368 Repairs and maintenance 3,890.191 2,634,459 Printing and binding 1,976.765 1,505,470 Other expenses 7,861,901 7,435,067 Total operating expenses 333,827,291 295,875,595 RESULTS OF OPERATIONS (27,337,177) 13,646,854 CURRENCY COSTS Assessments levied on Federal Reserve Banks for currency costs 576,306,073 491,962,202 Expenses for printing, transporting, and retiring Federal Reserve Notes 576,306,073 491,962,202 CURRENCY ASSESSMENTS OVER (UNDER) EXPENSES 0 0 TOTAL RESULTS OF OPERATIONS (27,337,177) 13,646,854 CUMULATIVE RESULTS OF OPERATIONS, Beginning of period 168,631,344 156,640,296 OTHER COMPREHENSIVE INCOME Adjustment to initially apply SFAS No. 158 (Note 8) 0 (1,655,806) Amortization of prior service cost (23,831) 0 Amortization of net actuarial loss 113,142 0 Net actuarial loss arising during the year 79.681 0 Total Other Compehensive Income 168,992 (1,655,806) CUMULATIVE RESULTS OF OPERATIONS, End of period $141,463,159 $168,631,344 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

348 94th Annual Report, 2007 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF CASH FLOWS Year ending December 31, 2007 2006 CASH FLOWS FROM OPERATING ACTIVITIES RESULTS OF OPERATIONS $(27,337,177) $13,646,854 Adjustments to reconcile results of operations to net cash provided by (used in) operating activities: Depreciation 13,433,306 13,047,064 Net losses on disposals of property and equipment 124,192 11,603 Increase (decrease) in assets: Accounts receivable, prepaid expenses and other assets (929,708) (812,482) Increase (decrease) in liabilities: Accounts payable and accrued liabilities 9,449,812 (5,955,880) Accrued payroll and related taxes 225,387 561,094 Accrued annual leave 2,095,089 878,028 Unearned revenues and other liabilities 335,818 (417,407) Accumulated retirement benefit obligation 847,013 541,165 Accumulated postretirement benefit obligation (139,360) 1,874,539 Accumulated postemployment benefit obligation 2,340,312 1,403,936 Accumulated other comprehensive income 168,992 (1,655,806) Net cash provided by operating activities 613,676 23,122,708 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposals 65,988 7,212 Capital expenditures (15,768,979) (8,829,712) Net cash used in investing activities (15,702,991) (8,822,500) CASH FLOWS FROM FINANCING ACTIVITIES Capital lease payments (327,663) (239,937) Net cash used in financing activities (327,663) (239,937) NET INCREASE (DECREASE) IN CASH (15,416,978) 14,060,271 CASH BALANCE, Beginning of period 60,030,706 45,970,435 CASH BALANCE, End of period $ 44,613,728 $60,030,706 See accompanying notes to financial statements. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 349 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM NOTES TO FINANCIAL STATEMENTS Currency Costs—Federal Reserve Banks issue new and AS OF AND FOR THE YEARS ENDING fit currency to the public and destroy currency already in DECEMBER 31, 2007 AND 2006 circulation as it becomes unfit or when a new design is issued. Each year, the Board orders new currency from the U.S. Department of Treasury's Bureau of Engraving (1) STRUCTURE and Printing. The Board incurs expenses and assesses the The Federal Reserve System (System) was established Federal Reserve Banks for printing, transporting, and reby Congress in 1913 and consists of the Board of Gover- tiring Federal Reserve Notes. These expenses and assessnors (Board), the Federal Open Market Committee, the ments are reported separately from the Board's operating twelve regional Federal Reserve Banks, the Federal Advi- transactions in the Board's Statement of Revenues and sory Council, and the private commercial banks that are Expenses and Cumulative Results of Operations. members of the System. The Board, unlike the Reserve Allowance for Doubtful Accounts—Accounts receiv- Banks, was established as a federal government agency able considered uncollectible are charged against the aland is supported by Washington, DC based staff number- lowance account in the year they are deemed uncollecting approximately 1,900, as it carries out its responsibili- ible. The allowance for doubtful accounts is adjusted ties in conjunction with other components of the Federal monthly, based upon a review of outstanding receivables. Reserve System. Property, Equipment, and Software—The Board's The Board is required by the Federal Reserve Act to property, buildings, equipment, and software are stated at report its operations to the Speaker of the House of Rep- cost less accumulated depreciation and amortization. Deresentatives. The Act also requires the Board, each year, preciation and amortization are calculated on a straightto order a financial audit of each Federal Reserve Bank line basis over the estimated useful lives of the assets, and to publish each week a statement of the financial which range from three to ten years for furniture and condition of each such Reserve Bank and a consolidated equipment, ten to fifty years for building equipment and statement for all of the Reserve Banks. Accordingly, the structures, and two to ten years for software. Upon the Board believes that the best financial disclosure consis- sale or other disposition of a depreciable asset, the cost and tent with law is achieved by issuing separate financial related accumulated depreciation or amortization are restatements for the Board and for the Reserve Banks. moved from the accounts and any gain or loss is recognized. Therefore, the accompanying financial statements include The Board complies with Statement of Position 98-1, only the results of operations and activities of the Board. Accounting for the Costs of Computer Software Devel- Combined financial statements for the Federal Reserve oped or Obtained for Internal Use, which requires that cer- Banks are included in the Board's annual report to the tain costs incurred in the development of internal use soft- Speaker of the House of Representatives. ware be capitalized and amortized over its useful life. Art Collections—The Board has collections of works (2) OPERATIONS AND SERVICES of art, historical treasures, and similar assets. These col- The Board's responsibilities require thorough analysis lections are maintained and held for public exhibition in of domestic and international financial and economic de- furtherance of public service. Proceeds from any sales of velopments. The Board carries out those responsibilities collections are used to acquire other items for collections. in conjunction with other components of the Federal Re- As permitted by Statement of Financial Accounting Stanserve System. The Board also supervises and regulates dards (SFAS) No. 116, Accounting for Contributions Rethe operations of the Federal Reserve Banks, exercises ceived and Contributions Made, the cost of collections broad responsibility in the nation's payments system, and purchased by the Board is charged to expense in the year administers most of the nation's laws regarding consumer purchased and donated collection items are not recorded. credit protection. Policy regarding open market opera- The value of the Board's collections has not been detertions is established by the Federal Open Market Commit- mined. tee. However, the Board has sole authority over changes Estimates—The preparation of financial statements in in reserve requirements, and it must approve any change conformity with accounting principles generally accepted in the discount rate initiated by a Federal Reserve Bank. in the United States of America requires management to The Board also plays a major role in the supervision make estimates and assumptions that affect the reported and regulation of the U.S. banking system. It has supervi- amounts of assets and liabilities at the date of the finansory responsibilities for state-chartered banks that are cial statements and the reported amounts of revenues and members of the Federal Reserve System, bank holding expenses during the reporting period. Actual results could companies, foreign activities of member banks, and U.S. differ from those estimates. activities of foreign banks. Reclassifications—Certain 2006 amounts have been reclassified to conform with 2007 presentation. (3) SIGNIFICANT ACCOUNTING POLICIES SFAS No. 158, Employers' Accounting for Defined Basis of Accounting—The Board prepares its financial Benefit Pension and Other Postretirement Plans—The statements in accordance with accounting principles gen- Board initially applied the provisions of SFAS No. 158, erally accepted in the United States of America. Employers' Accounting for Defined Benefit Pension and Revenues—The Board assesses the Federal Reserve Other Postretirement Plans, at December 31, 2006. This Banks for operating expenses and additions to property, accounting standard requires recognition of the overwhich are based on expected cash needs. funded or underfunded status of a defined benefit post- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

350 94th Annual Report, 2007 retirement plan in the Balance Sheets, and recognition of (5) ACCUMULATED RETIREMENT BENEFITS changes in the funded status in the years in which the Substantially all of the Board's employees participate changes occur through comprehensive income. The tranin the Retirement Plan for Employees of the Federal sition rules for implementing the standard required apply- Reserve System (System Plan). The System Plan proing the provisions as of the end of the year of initial vides retirement benefits to employees of the Board, the implementation, and the effect as of December 31, 2006 Federal Reserve Banks, and the Office of Employee Benis recorded as "Adjustment to initially apply SFAS No. efits of the Federal Reserve System (OEB). The Federal 158" in the Statements of Revenues and Expenses and Reserve Bank of New York, on behalf of the System, Changes in Cumulative Results of Operations. recognizes the net asset and costs associated with the System Plan in its financial statements. Costs associated (4) PROPERTY AND EQUIPMENT with the System Plan are not redistributed to other partici- The following is a summary of the components of the pating employers. Board's property and equipment, at cost, net of accumu- Employees of the Board who became employed prior lated depreciation and amortization. to 1984 are covered by a contributory defined benefits program under the System Plan. Employees of the Board 2007 2006 who became employed after 1983 are covered by a noncontributory defined benefits program under the System Land $ 18,640,314 $ 18,640,314 Plan. Contributions to the System Plan are actuarially Buildings and determined and funded by participating employers. Based improvements 149,968,504 147,504,169 on actuarial calculations, it was determined that employer Furniture and funding contributions were not required for the years equipment 55,625,014 47,271,434 2007 and 2006, and the Board was not assessed a contri- Software in use 14,745,157 13,681,508 bution for these years. Software in process 2,064,438 941,912 Effective January 1, 1996, Board employees covered Construction in under the System Plan are also covered under a Benefits process 1,550,565 360,967 Equalization Plan (BEP). Benefits paid under the BEP are 242,593,992 228,400,304 limited to those benefits that cannot be paid from the Less accumulated System Plan due to limitations imposed by Sections depreciation and 401(a)(17), 415(b) and 415(e) of the Internal Revenue amortization (89,243,112) (77,194,918) Code of 1986. Activity for the BEP for 2007 and 2006 is Property and equipment, summarized in the following tables: net $153,350,880 $151,205,386 2007 2006 Change in projected Construction in process includes costs incurred in 2007 benefit obligation and 2006 for long-term security projects and building Benefit obligation, enhancements. beginning of year ... $1,354,662 $ 536,339 The Board entered into capital leases for printing Service cost 329,282 185,483 equipment, which terminate in 2008. Furniture and equip- Interest cost 87,837 45,004 ment includes $1,230,000 in 2007 and 2006 for capital- Plan participants' ized leases. Accumulated depreciation includes contributions 0 0 $1,123,000 and $867,000 for capitalized leases as of 2007 Plan amendments 0 0 and 2006, respectively. The Board paid interest related to Actuarial (gain)/loss 453,526 596,114 these capital leases in the amount of $31,000 and $54,000 Benefits paid (23,632) (8,278) for 2007 and 2006, respectively. Benefit obligation, The future minimum lease payments required under end of year $2,201,675 $1,354,662 the capital leases and the present value of the net minimum lease payments as of December 31, 2007, are as Accumulated benefit follows: obligation, end of year $ 685,170 $ 546,854 2008 Weighted-average Total minimum lease assumptions used to payments $ 138,279 determine benefit Less: Amount representing obligation as of maintenance (26,743) December 31 Net minimum lease Discount rate 6.25% 5.75% payments 111,536 Rate of compensation Less: Amount representing increase 5.00% 4.50% interest (2,781) Change in plan assets Present value of net minimum lease payments 108,755 Fair value of plan assets, beginning of year... $ 0 $ 0 Less: Current maturities of Employer contributions .. 23,632 8,278 capital lease payments .. (108,755) Plan participants' Long-term capital lease contributions 0 0 obligations $ 0 Benefits paid (23,632) (8,278) Fair value of plan assets, end of year $ 0 $ 0 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 351 2007 2006 2007 2006 Reconciliation of funded Estimated amounts that status, end of year will be amortized from Funded status $(2,201,675) $(1,354,662) accumulated other Net actuarial (gain) loss .. 1,006,257 580,386 comprehensive income Prior service (credit) cost .. (233,404) (247,417) into net periodic benefit Prepaid (Accrued) cost (credit) in 2008 are pension cost $(1,428,822) $(1,021,693) shown below: Net actuarial (gain)/loss .. $ 79,561 Prior service (credit)/cost .. (14,013) Amounts recognized in Total $ 65,548 the financial statements consist of A relatively small number of Board employees partici- Prepaid benefit cost $ 0 $ 0 pate in the Civil Service Retirement System (CSRS) or Accrued benefit liability .. (1,428,822) (1,021,693) the Federal Employees' Retirement System (FERS). Intangible asset 0 0 These defined benefit plans are administered by the U.S. Accumulated other Office of Personnel Management, which determines the comprehensive required employer contribution levels. The Board's conincome (772,853) (332,969) tributions to these plans totaled $316,000 and $334,000 in Net amount recognized .. $(2,201,675) $(1,354,662) 2007 and 2006, respectively. The Board has no liability for future payments to retirees under these programs and Components of net is not accountable for the assets of the plans. periodic benefit cost Employees of the Board may also participate in the Service cost—benefits Federal Reserve System's Thrift Plan. Board contribuearned during the tions to members' accounts are based upon a fixed period $ 329,282 5; 185,483 percentage of each member's basic contribution and were Interest cost on projected $9,542,000 and $8,964,000 in 2007 and 2006, benefit obligation ... 87,837 45,004 respectively. Expected return on plan assets 0 0 (6) ACCUMULATED POSTRETIREMEN! BENEFITS Amortization of prior The Board provides certain life insurance programs for service (credit) cost .. (14,013) (14,013) its active employees and retirees. Activity for 2007 and Amortization of (gains) 2006 is summarized in the following tables: losses 27,655 0 Amortization of initial 2007 2006 (asset) obligation ... 0 0 Change in benefit Net periodic benefit cost obligation (credit) $ 430,761 3> 216,474 Benefit obligation, beginning of year ... $8,111,829 $8,273,831 Service cost 198,791 230,567 Weighted-average Interest cost 479,903 470,256 assumptions used to Plan participants' determine net periodic contributions 0 0 benefit cost for years Plan amendments 0 0 ended December 31 Actuarial (gain) loss (533.208) (603,500) Discount rate 6.00% 5.75% Benefits paid (284,846) (259,325) Rate of compensation Benefit obligation, increase 4.50% 4.50% end of year $7,972,469 $8,111.829 Expected cashflows Weighted-average Expected employer assumptions used to contributions: determine benefit 2008 $ 82,134 obligation as of December 31 Expected benefit Discount rate 6.25% 6.00% payments: 2008 $ 82,134 Change in plan assets 2009 96,170 Fair value of plan assets, 2010 109,602 beginning of year... $ 0 $ 0 2011 120,750 Employer contribution ... 284,846 259,325 2012 127,690 Plan participants' 2013-2017 724,518 contributions 0 0 Benefits paid (284,846) (259,325) Fair value of plan assets, end of year $ 0 $ 0 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

352 94th Annual Report, 2007 2007 2006 2007 2006 Reconciliation of funded Expected cashflows status at end of year Expected employer Benefit obligations $(7,972,469) $(8,111,829) contributions: Unrecognized net 2008 $ 293,767 actuarial (gain) loss .. 0 0 Unrecognized prior Expected benefit service cost 0 0 payments: Amount recognized, 2008 $ 293,767 end of year $(7,972,469) $(8,111,829) 2009 326,227 2010 352,683 2011 368,728 Amounts recognized in 2012 384,026 the financial statements 2013-2017 2,300,954 consist of Liability: Estimated amounts that Accrued benefit cost $(7,972,469) $(8,111,829) will be amortized from Accumulated other accumulated other comprehensive comprehensive income income 0 0 into net periodic benefit Net amount recognized .. 0 0 cost (credit) in 2008 are $(7,972,469) $(8,111,829) shown below: Net actuarial (gain) loss ... $ 7,425 Amounts recognized in Prior service (credit) cost .. (9,818) accumulated other Total $ (2,393) comprehensive income consist of: The above accumulated postretirement benefit obliga- Net actuarial loss (gain) .. $ 803,702 $ 1,422,398 tion is related to the Board-sponsored life insurance pro- Prior service cost (credit) .. (89,741) (99,560) grams. The Board has no liability for future payments to Transition obligation employees who continue coverage under the federally (asset) 0 0 sponsored life and health programs upon retiring. Contri- Deferred curtailment butions for active employees participating in federally (gain) loss 0 0 sponsored health programs totaled $10,311,000 and $ 713,961 $ 1,322,838 $9,607,000 in 2007 and 2006, respectively. Components of net periodic benefit cost (7) ACCUMULATED POSTEMPLOYMENT BENEFITS Service cost—benefits earned during the The Board provides certain postemployment benefits period $ 198,791 $ 230,567 to eligible former or inactive employees and their depen- Interest cost on projected dents during the period subsequent to employment but benefit obligation ... 479,902 470,256 prior to retirement. Postemployment costs were actuari- Expected return on plan ally determined using a December 31 measurement date assets 0 0 and discount rates of 5.75 percent as of December 31, Amortization of prior 2007 and 2006. The accrued postemployment benefit service (credit) cost .. (9,818) (9,818) costs recognized by the Board for the years ended Decem- Amortization of (gains) ber 31, 2007 and 2006, were $3,055,000 and $1,963,000, losses 85,487 120,022 respectively. Amortization of initial (asset) obligation ... 0 0 (8) ACCUMULATED OTHER COMPREHENSIVE INCOME Net periodic benefit cost (credit) $ 754,362 $ 811,027 Following is a reconciliation of beginning and ending balances of accumulated other comprehensive income. Weighted-average assumptions used to determine net periodic benefit cost for years ended December 31 Discount rate 5.75% 5.50% Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 353 Amount related Amount related to postretirement Total accumulated to defined benefit benefits other other comprehenretirement plans than pensions sive income (loss) Change in funded Balance at status of January 1, benefit 2006 plans— Adjustment to other initially apply comprehensive SFAS income No. 158 332,969 1,322,837 gain (loss) ... 168,992 Balance at Balance at December 31, December 31, 2006 $ 332,969 $ 1,322,837 2007 $(1,486,814) Change in funded status of Additional detail regarding the classification of benefit plans: accumulated other comprehensive income is included in Amortization of notes 5 and 6. prior service costs 14,013 9,818 (9) COMMITMENTS AND CONTINGENCIES Amortization of net actuarial Leases gain (loss) .. (27,655) (85,487) The Board has entered into several operating leases to Net actuarial secure office, training and warehouse space. Minimum (gain) loss annual payments under the operating leases having an arising during the year 453,526 (533,207) initial or remaining noncancelable lease term in excess of Change in funded one year at December 31, 2007, are as follows: status of 2008 $ 1,623,970 benefit 2009 1,961,223 plans— 2010 2.013,281 other comprehensive 2011 1,944,142 income After 2011 .... 9,118,887 gain (loss) .. 439,884 (608,876) $16,661,503 Balance at December 31, Rental expenses under the operating leases were $ 772,853 $ 713,961 2007 $539,000 and $193,000 in 2007 and 2006, respectively. Deferred Leases Total accumulated The Board's operating leases contain rent abatements other comprehenand scheduled rent increases. According to accounting sive income (loss) principles generally accepted in the United States of Balance at America, rent abatements and scheduled rent increases January 1, 2006 $ 0 must be considered in determining the annual rent ex- Adjustment to pense to be recognized. The deferred rent represents the initially apply difference between the actual lease payments and the rent SFAS expense recognized. The current balance of deferred rent No. 158 (1,655,806) is $318,000 and $8,000 in 2007 and 2006, respectively. Balance at Commitments December 31, 2006 $ (1,655,806) The Board has entered into an agreement with the Change in funded Federal Deposit Insurance Corporation and the Office of status of the Comptroller of the Currency, through the Federal Fibenefit plans: nancial Institutions Examination Council (the Council) to Amortization of fund a portion of enhancements and maintenance fees for prior service a central data repository project through 2013. The esticosts (23,831) mated total Board expense to support this effort is Amortization of net actuarial $7.5 million. gain (loss) 113,142 In 2007, the Council began a rewrite of the Home Net actuarial Mortgage Disclosure Act processing system, for which (gain) loss the Board provides data processing services. The estiarising during mated total Board expense to support this effort is the year 79,681 $3.2 million through 2010. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

354 94th Annual Report, 2007 Litigation 2007 2006 The Board is subject to contingent liabilities which Accounts receivable due include litigation cases. These contingent liabilities arise from the Council ... $384,142 $395,551 in the normal course of operations and their ultimate Accounts payable due disposition is unknown. Based on information currently to the Council $ 64,087 54,870 available to management, it is management's opinion that the expected outcome of these matters, individually or in (11) FEDERAL RESERVE BANKS the aggregate, will not have a materially adverse effect on The Board performs certain functions for the Resrvve the financial statements. Management believes the Board Banks in conjunction with its responsibilities for the Syshas substantial defenses and that the likelihood of an tem, and the Reserve Banks provide certain adminisiraadverse judgment is remote. tive functions for the Board. Activity related to the Board and Reserve Banks for 2007 and 2006 is summarized in (io) FEDERAL FINANCIAL INSTITUTIONS EXAMINATION the following table: COUNCIL As of December 31, The Board is one of the five member agencies of the 2007 2006 Council, and currently performs certain management Reserve Bank expenses functions for the Council. The five agencies which are charged to the Board represented on the Council are the Board, Federal Deposit Data processing and Insurance Corporation, National Credit Union Adminis- communication 2,064,110 $ 2,161,298 tration, Office of the Comptroller of the Currency, and Contingency site 1,152,166 1,087,429 Office of Thrift Supervision. The Board's financial state- Total Reserve Bank ments do not include financial data for the Council. Activ- expenses charged ity related to the Board and Council for 2007 and 2006 is to the Board $ 3,216,276 $ 3,248,727 summarized in the following table: Board expenses charged 2007 2006 to the Reserve Banks Council expenses charged Assessments for to the Board currency costs $576,306,073 $491,962,202 Assessments for Assessments for operating expenses . $ 108,163 $ 109.760 operating expenses Central Data of the Board 296,124,700 301,013,500 Repository 1,167,449 740,003 Data processing 704,840 731,999 Uniform Bank Total Board expenses Performance charged to the Report 192,026 204,617 Reserve Banks ... $873,135,613 $793,707,701 Total Council expenses Accounts receivable due charged to from Federal Reserve the Board $1,467,638 $1,054,380 Banks $ 1,270,582 $ 854,142 Accounts payable due to the Reserve Board expenses charged Banks $ 10 $ 12,417 to the Council Data processing (12) THE OFFICE OF EMPLOYEE BENEFITS OF THE related services $4,457,647 $3,429,499 FEDERAL RESERVE SYSTEM Administrative OEB administers certain System benefit programs on services 190,800 183,000 behalf of the Board and the Reserve Banks, and costs Total Board associated with the OEB's activities are assessed to the expenses Board and Reserve Banks. The Board was assessed charged to $2,866,676 and $2,380,474 in 2007 and 2006, the Council $4,648,447 $3,612,499 respectively. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Board of Governors Financial Statements 355 Deloitte INDEPENDENT AUDITORS' REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MAT- TERS BASED UPON THE AUDIT PERFORMED IN ACCORDANCE WITH GOVERNMENT AUDITING STANDARDS To the Board of Governors of the Federal Reserve System: We have audited the financial statements of the Board of Governors of the Federal Reserve System (the "Board") as of and for the year ended December 31, 2007, and have issued our report thereon dated March 19, 2008. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Internal Control over Financial Reporting In planning and performing our audit, we considered the Board's internal control over financial reporting as a basis for designing our audit procedures for the purposes of expressing our opinion on the financial statements, but not for the purpose of expressing 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. Our consideration of internal control over financial reporting was for the limited purpose described in the preceding paragraph and would not necessarily identify all deficiencies in internal control over financial reporting that might be significant deficiencies or material weaknesses. However, as discussed below, we identified certain deficiencies in internal control over financial reporting that we consider to be a significant deficiency. 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 Board's internal controls. 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. During our audit, we noted certain control deficiencies within the general computer control environment within the Board of Governors related to logical access controls, which affect several financial system platforms supporting the Board's financial statements. These deficiencies individually are not considered significant deficiencies, however, when considered collectively, aggregate to a significant deficiency. We have considered these matters in conjunction with our audit of the financial statements and noted no material misstatements or omissions in the Board's financial statements that were caused by these various control deficiencies. Management has taken steps to address these deficiencies by correcting the cause of a deficiency and/or by implementing additional compensating controls and processes. Due to the sensitive nature of these deficiencies, the technical details related to these deficiencies have been provided to Board of Governors' management in a separate, limited distribution communication. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

356 94th Annual Report, 2007 Our consideration of the internal control over financial reporting was for the limited purpose described in the first paragraph of this section and would not necessarily identify all deficiencies in the internal control that might be significant deficiencies and, accordingly, would not necessarily disclose all significant deficiencies that are also considered to be material weaknesses. However, we do not believe that the significant deficiency described above is a material weakness. We have communicated to management, in a separate communication dated March 19, 2008, other control deficiencies involving the Board's internal control over financial reporting and other matters that we identified during our audit. Compliance and Other Matters As part of obtaining reasonable assurance about whether Board's financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. 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 disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. Distribution This report is intended solely for the information and use of the Board, management, and others within the organization, the Office of Inspector General, and the United States Congress, and is not intended to be and should not be used by anyone other than these specified parties. March 19,2008 Washington, D.C. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

357 Federal Reserve Banks Combined Financial Statements The combined financial statements of the Federal Reserve Banks were audited by Deloitte & Touche LLP, independent auditors, for the year ended December 31, 2007, and by PricewaterhouseCoopers LLP, independent auditors, for the year ended December 31, 2006. Deloitte REPORT OF INDEPENDENT AUDITORS To the Board of Governors of the Federal Reserve System and the Boards of Directors of the Federal Reserve Banks: We have audited the accompanying combined statement of condition of the Federal Reserve Banks (the "Reserve Banks") as of December 31, 2007 and the related combined statements of income and comprehensive income, and changes in capital for the year then ended, which have been prepared in conformity with accounting principles 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 audit. The combined financial statements of the Reserve Banks for the year ended December 31, 2006 were audited by other auditors whose report, dated March 30, 2007, expressed an unqualified opinion on those statements. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 audit provides a reasonable basis for our opinion. As described in Note 3 to the combined financial statements, the Reserve Banks have prepared these combined financial statements in conformity with accounting principles established by the Board of Governors of the Federal Reserve System, as set forth in the Financial Accounting Manual for Federal Reserve Banks, which is a comprehensive basis of accounting other than accounting principles generally accepted in the United States of America. The effects on such combined financial statements of the differences between the accounting principles established by the Board of Governors of the Federal Reserve System and accounting principles generally accepted in the United States of America are also described in Note 3. 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, 2007, and the combined results of their operations for the year then ended, on the basis of accounting described in Note 3. ULp March 31, 2008 Washington, D.C. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

358 94th Annual Report, 2007 PRICB/VATERHOUSE(OOPERS § PricewaterhouseCoopers LLP 1800 Tysons Boulevard McLean, VA 22102-4261 Telephone (703) 918 3000 Facsimile (703) 918 3100 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 statement of condition of the Federal Reserve Banks (the "Reserve Banks") as of December 31, 2006 and the related combined statement of income and changes in capital for the year 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 audit. We conducted our audit 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 audit provides 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 the combined results of their operations for the year then ended, on the basis of accounting described in Note 3. March 30, 2007 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 359 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CONDITION (in millions) December 31, 2007 2006 ASSETS Gold certificates $ 11,037 $ 11,037 Special drawing rights certificates 2,200 2,200 Coin 1,179 801 Items in process of collection 1,804 3,486 Loans to depository institutions 48,636 67 Securities purchased under agreements to resell 46.500 40,750 U.S. government securities, net 745,629 783,619 Investments denominated in foreign currencies 47,295 20,482 Accrued interest receivable 6,410 6,761 Bank premises and equipment, net 2,539 2,376 Other assets 1,900 1,785 Total assets $915,129 $873,364 LIABILITIES AND CAPITAL LIABILITIES Federal Reserve notes outstanding, net $791,691 $783,019 Securities sold under agreements to repurchase 43,985 29,615 Deposits: Depository institutions 20,767 18,699 U.S. Treasury, general account 16,120 4,708 Other deposits 363 349 Deferred credit items 1,811 3,813 Interest on Federal Reserve notes due to U.S. Treasury 1,532 908 Accrued benefit costs 1,281 1,314 Other liabilities 679 291 Total liabilities 878,229 842,716 CAPITAL Capital paid-in 18,450 15,324 Surplus (including accumulated other comprehensive loss of $1,524 million and $1,849 million at December 31, 2007 15,324 and 2006, respectively) 18,450 30,648 Total capital 36,900 $873,364 Total liabilities and capital $915,129 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

360 94th Annual Report, 2007 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (in millions) For the year ended December 31, 2007 2006 Interest income Interest on U.S. government securities $40,298 $36,452 Interest on investments denominated in foreign currencies 575 369 Interest on loans to depository institutions 71 12_ Total interest income 40,944 36,833 Interest expense Interest expense on securities sold under agreements to repurchase 1,688 1,342 Net interest income 39,256 35,491 Other operating income Income from services 878 908 Reimbursable services to government agencies 458 426 Foreign "currency gains, net 1,886 1,186 Other income 166 144 Total other operating income 3,388 2,664 Operating expenses Salaries and other benefits 2,093 1,880 Occupancy expense 247 240 Equipment expense 203 212 Assessments by the Board of Governors 872 793 Other expenses 838 835 Total operating expenses 4,253 3,960 Net income prior to distribution 38,391 34,195 Change in funded status of benefit plans 325 __^_LI__ Comprehensive income prior to distribution $38,716 $34,195 Distribution of comprehensive income Dividends paid to member banks $ 992 $ 871 Transferred to surplus and change in accumulated other comprehensive loss 3,126 4,272 Payments to U.S. Treasury as interest on Federal Reserve notes 34,598 29,052 Total distribution $38,716 $34,195 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 361 FEDERAL RESERVE BANKS COMBINED STATEMENTS OF CHANGES IN CAPITAL for the years ended December 31, 2007 and 2006 (in millions) Surplus Accumulated Net Other Capital Income Comprehensive Total Total Paid-in Retained Loss Surplus Capital Balance at January 1, 2006 (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 SFAS 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 Net change in capital stock issued (63 million shares) 3,126 3,126 Transferred to surplus and change in accumulated other 2,801 325 3,126 3,126 comprehensive loss __I_L^_ Balance at December 31, 2007 (369 million shares) $18,450 $19,974 $(1,524) $18,450 $36,900 The accompanying notes are an integral part of these combined financial statements. NOTES TO THE COMBINED FINANCIAL STATEMENTS OF THE FEDERAL RESERVE BANKS (I) STRUCTURE eral agency, is charged by the Federal Reserve Act with a number of specific duties, including general supervision The twelve Federal Reserve Banks ("Reserve Banks") are over the Reserve Banks. The FOMC is composed of part of the Federal Reserve System ("System") created by members of the Board of Governors, the president of the Congress under the Federal Reserve Act of 1913 ("Fed- Federal Reserve Bank of New York ("FRBNY"), and on a eral Reserve Act"), which established the central bank of rotating basis four other Reserve Bank presidents. the United States. The Reserve Banks are chartered by the federal government and possess a unique set of governmental, corporate, and central bank characteristics. (2) OPERATIONS AND SERVICES In accordance with the Federal Reserve Act, supervi- The Reserve Banks perform a variety of services and sion and control of each Reserve Bank is exercised by a operations. Functions include participation in formulating board of directors. The Federal Reserve Act specifies the and conducting monetary policy; participation in the paycomposition of the board of directors for each of the ments system including large-dollar transfers of funds, Reserve Banks. Each board is composed of nine members automated clearinghouse ("ACH") operations, and check serving three-year terms: three directors, including those collection; distribution of coin and currency; performance designated as chairman and deputy chairman, are ap- of fiscal agency functions for the U.S. Treasury, certain pointed by the Board of Governors of the Federal Reserve federal agencies, and other entities; serving as the federal System ("Board of Governors") to represent the public, government's bank; provision of short-term loans to deand six directors are elected by member banks. Banks that pository institutions; service to the consumer and the are members of the System include all national banks and community by providing educational materials and inforany state-chartered banks that apply and are approved for mation regarding consumer laws; and supervision of bank membership in the System. Member banks are divided holding companies, state member banks, and U.S. offices into three classes according to size. Member banks in of foreign banking organizations. Certain services are each class elect one director representing member banks also provided to foreign and international monetary auand one representing the public. In any election of direc- thorities, primarily by the FRBNY. tors, each member bank receives one vote, regardless of The FOMC, in the conduct of monetary policy, estabthe number of shares of Reserve Bank stock it holds. lishes policy regarding domestic open market operations, The System also consists, in part, of the Board of oversees these operations, and annually issues authoriza- Governors and the Federal Open Market Committee tions and directives to the FRBNY for its execution of ("FOMC"). The Board of Governors, an independent fed- transactions. The FRBNY is authorized and directed by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

362 94th Annual Report, 2007 the FOMC to conduct operations in domestic markets, generally accepted accounting principles in the United including the direct purchase and sale of US. government States ("GAAP"), primarily due to the unique nature of securities, the purchase of securities under agreements to the Banks' powers and responsibilities as part of the resell, the sale of securities under agreements to repur- nation's central bank. The primary difference is the prechase, and the lending of U.S. government securities. The sentation of all securities holdings at amortized cost, FRBNY executes these open market transactions at the rather than using the fair value presentation required by direction of the FOMC and holds the resulting securities GAAP. U.S. government securities and investments deand agreements in the portfolio known as the System nominated in foreign currencies comprising the SOMA Open Market Account ("SOMA"). are recorded at cost, on a settlement-date basis, and ad- In addition to authorizing and directing operations in justed for amortization of premiums or accretion of disthe domestic securities market, the FOMC authorizes and counts on a straight-line basis. Amortized cost more apdirects the FRBNY to execute operations in foreign mar- propriately reflects the Reserve Banks' securities holdings kets for major currencies in order to counter disorderly given the System's unique responsibility to conduct monconditions in exchange markets or to meet other needs etary policy. While the application of current market specified by the FOMC in carrying out the System's prices to the securities holdings may result in values central bank responsibilities. The FRBNY is authorized substantially above or below their carrying values, these by the FOMC to hold balances of, and to execute spot and unrealized changes in value would have no direct effect forward foreign exchange ("FX") and securities contracts on the quantity of reserves available to the banking sysfor, nine foreign currencies and to invest such foreign tem or on the prospects for future Reserve Bank earnings currency holdings ensuring adequate liquidity is main- or capital. Both the domestic and foreign components of tained. The FRBNY is authorized and directed by the the SOMA portfolio may involve transactions that result FOMC to maintain reciprocal currency arrangements in gains or losses when holdings are sold prior to matu- ("FX swaps") with four central banks and "warehouse" rity. Decisions regarding securities and foreign currency foreign currencies for the U.S. Treasury and Exchange transactions, including their purchase and sale, are moti- Stabilization Fund ("ESF') through the Reserve Banks. vated by monetary policy objectives rather than profit. In connection with its foreign currency activities, the Accordingly, market values, earnings, and any gains or FRBNY may enter into transactions that contain varying losses resulting from the sale of such securities and curdegrees of off-balance-sheet market risk that result from rencies are incidental to the open market operations and their future settlement and counter-party credit risk. The do not motivate decisions related to policy or open mar- FRBNY controls credit risk by obtaining credit approv- ket activities. als, establishing transaction limits, and performing daily In addition, the Board of Governors and the Reserve monitoring procedures. Banks have elected not to present a Statement of Cash Although the Reserve Banks are separate legal entities, Flows because the liquidity and cash position of the Rein the interests of greater efficiency and effectiveness they serve Banks are not a primary concern given their unique collaborate in the delivery of certain operations and ser- powers and responsibilities. A Statement of Cash Flows, vices. The collaboration takes the form of centralized therefore, would not provide additional meaningful inforoperations and product or function offices that have re- mation. Other information regarding the Reserve Banks' sponsibility for the delivery of certain services on behalf activities is provided in, or may be derived from, the of the Reserve Banks. Various operational and manage- Statements of Condition, Income and Comprehensive Inment models are used and are supported by service agree- come, and Changes in Capital. There are no other signifiments between the Reserve Bank providing the service cant differences between the policies outlined in the and the other eleven Reserve Banks. In some cases, costs Financial Accounting Manual and GAAP. incurred by a Reserve Bank for services provided to other The preparation of the financial statements in confor- Reserve Banks are not shared; in other cases, the Reserve mity with the Financial Accounting Manual requires man- Banks are billed for services provided to them by another agement to make certain estimates and assumptions that Reserve Bank. affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date (3) SIGNIFICANT ACCOUNTING POLICIES of the financial statements, and the reported amounts of Accounting principles for entities with the unique powers income and expenses during the reporting period. Actual and responsibilities of the nation's central bank have not results could differ from those estimates. Certain amounts been formulated by accounting standard-setting bodies. relating to the prior year have been reclassified to con- The Board of Governors has developed specialized ac- form to the current-year presentation. Unique accounts counting principles and practices that it considers to be and significant accounting policies are explained below. appropriate for the nature and function of a central bank, (a) Gold and Special Drawing Rights Certificates which differ significantly from those of the private sector. These accounting principles and practices are documented The Secretary of the US. Treasury is authorized to issue in the Financial Accounting Manual for Federal Reserve gold and special drawing rights ("SDR") certificates to Banks ("Financial Accounting Manual"), which is issued the Reserve Banks. by the Board of Governors. All of the Reserve Banks are Payment for the gold certificates by the Reserve Banks required to adopt and apply accounting policies and prac- is made by crediting equivalent amounts in dollars into tices that are consistent with the Financial Accounting the account established for the U.S. Treasury. The gold Manual and the financial statements have been prepared certificates held by the Reserve Banks are required to be in accordance with the Financial Accounting Manual. backed by the gold of the U.S. Treasury. The US. Trea- Differences exist between the accounting principles sury may reacquire the gold certificates at any time and and practices in the Financial Accounting Manual and the Reserve Banks must deliver them to the U.S. Trea- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 363 sury. At such time, the U.S. Treasury's account is charged, currency market exchange rates in order to report these and the Reserve Banks' gold certificate accounts are re- assets in U.S. dollars. Realized and unrealized gains and duced. The value of gold for purposes of backing the gold losses on investments denominated in foreign currencies certificates is set by law at $42 2/9 a fine troy ounce. The are reported as "Foreign currency gains, net" in the State- Board of Governors allocates the gold certificates among ments of Income and Comprehensive Income. Reserve Banks once a year based on the average Federal Activity related to U.S. government securities, includ- Reserve notes outstanding in each Reserve Bank. ing the premiums, discounts, and realized and unrealized SDR certificates are issued by the International Mon- gains and losses, is allocated to each of the Reserve etary Fund ("Fund") to its members in proportion to each Banks on a percentage basis derived from an annual member's quota in the Fund at the time of issuance. SDR settlement of the interdistrict settlement account that occertificates serve as a supplement to international mon- curs in April of each year. The settlement also equalizes etary reserves and may be transferred from one national Reserve Bank gold certificate holdings to Federal Remonetary authority to another. Under the law providing serve notes outstanding in each District. Activity related for United States participation in the SDR system, the to investments denominated in foreign currencies is allo- Secretary of the U.S. Treasury is authorized to issue SDR cated to each Reserve Bank based on the ratio of each certificates somewhat like gold certificates to the Reserve Reserve Bank's capital and surplus to aggregate capital Banks. When SDR certificates are issued to the Reserve and surplus at the preceding December 31. Banks, equivalent amounts in dollars are credited to the account established for the U.S. Treasury, and the Reserve (d) Securities Purchased Under Agreements to Resell, Banks' SDR certificate accounts are increased. The Re- Securities Sold Under Agreements to Repurchase, serve Banks are required to purchase SDR certificates, at and Securities Lending the direction of the U.S. Treasury, for the purpose of The FRBNY may engage in tri-party purchases of securifinancing SDR acquisitions or for financing exchange ties under agreements to resell ("tri-party agreements"). stabilization operations. At the time SDR transactions Tri-party agreements are conducted with two commercial occur, the Board of Governors allocates SDR certificate custodial banks that manage the clearing and settlement transactions among Reserve Banks based upon each Re- of collateral. Collateral is held in excess of the contract serve Bank's Federal Reserve notes outstanding at the amount. Acceptable collateral under tri-party agreements end of the preceding year. There were no SDR transac- primarily includes US. government securities, passtions in 2007 or 2006. through mortgage securities of the Government National Mortgage Association, Federal Home Loan Mortgage (b) Loans to Depository Institutions Corporation, and Federal National Mortgage Association, Depository institutions that maintain reservable transac- STRIP securities of the US. Government, and "stripped" tion accounts or nonpersonal time deposits, as defined in securities of other government agencies. The tri-party regulations issued by the Board of Governors, have bor- agreements are accounted for as financing transactions, rowing privileges at the discretion of each of the Reserve with the associated interest income accrued over the life Banks. Borrowers execute certain lending agreements and of the agreement. deposit sufficient collateral before credit is extended. The Securities sold under agreements to repurchase are ac- Reserve Banks offer three discount window programs to counted for as financing transactions and the associated depository institutions: primary credit, secondary credit, interest expense is recognized over the life of the transacand seasonal credit, each with its own interest rate. Inter- tion. These transactions are reported in the Statements of est is accrued using the applicable discount rate estab- Condition at their contractual amounts and the related lished at least every fourteen days by the board of direc- accrued interest payable is reported as a component of tors of the Reserve Bank, subject to review and "Other liabilities." determination by the Board of Governors. U.S. government securities held in the SOMA are lent In addition, depository institutions that are eligible to to U.S. government securities dealers in order to facilitate borrow under the Reserve Banks' primary credit program the effective functioning of the domestic securities marare also eligible to participate in the temporary Term ket. Securities-lending transactions are fully collateral- Auction Facility ("TAF") program. Under the TAF pro- ized by other US. government securities and the collatgram, the Reserve Banks conduct auctions for a fixed eral taken is in excess of the market value of the securities amount of funds, with the interest rate determined by the loaned. The FRBNY charges the dealer a fee for borrowauction process, subject to a minimum bid rate. All ad- ing securities and the fees are reported as a component of vances under the TAF must be fully collateralized. "Other income." Outstanding loans are evaluated for collectibility, and Activity related to securities sold under agreements to currently all are considered collectible and fully collater- repurchase and securities lending is allocated to each of alized. If loans were ever deemed to be uncollectible, an the Reserve Banks on a percentage basis derived from an appropriate reserve would be established. annual settlement of the interdistrict settlement account. On February 15, 2007 the FRBNY began allocating to the (c) U.S. Government Securities and Investments other Reserve Banks the activity related to securities pur- Denominated in Foreign Currencies chased under agreements to resell. Interest income on U.S. government securities and invest- (e) FX Swap Arrangements and Warehousing ments denominated in foreign currencies comprising the Agreements SOMA is accrued on a straight-line basis. Gains and losses resulting from sales of securities are determined by FX swap arrangements are contractual agreements bespecific issues based on average cost. Foreign-currency- tween two parties, the FRBNY and an authorized foreign denominated assets are revalued daily at current foreign central bank, to exchange specified currencies, at a speci- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

364 94th Annual Report, 2007 fied price, on a specified date. The parties agree to ex- directors of each Reserve Bank and their designees) to the change their currencies up to a pre-arranged maximum Reserve Banks upon deposit with such agents of specified amount and for an agreed-upon period of time (up to classes of collateral security, typically U.S. government twelve months), at an agreed-upon interest rate. These securities. These notes are identified as issued to a spearrangements give the FOMC temporary access to the cific Reserve Bank. The Federal Reserve Act provides foreign currencies it may need to support its international that the collateral security tendered by the Reserve Bank operations and give the authorized foreign central bank to the Federal Reserve agent must be at least equal to the temporary access to dollars. Drawings under the FX swap sum of the notes applied for by such Reserve Bank. arrangements can be initiated by either party and must be Assets eligible to be pledged as collateral security inagreed to by the other party. The FX swap arrangements clude all of the Reserve Banks' assets. The collateral are structured so that the party initiating the transaction value is equal to the book value of the collateral tendered, bears the exchange rate risk upon maturity. Foreign cur- with the exception of securities, for which the collateral rencies received pursuant to these agreements are re- value is equal to the par value of the securities tendered. ported as a component of "Investments denominated in The par value of securities pledged for securities sold foreign currencies" in the Statements of Condition. under agreements to repurchase is deducted. Warehousing is an arrangement under which the The Board of Governors may, at any time, call upon a FOMC agrees to exchange, at the request of the U.S. Reserve Bank for additional security to adequately collat- Treasury, U.S. dollars for foreign currencies held by the eralize the Federal Reserve notes. To satisfy the obliga- U.S. Treasury or ESF over a limited period of time. The tion to provide sufficient collateral for outstanding Fedpurpose of the warehousing facility is to supplement the eral Reserve notes, the Reserve Banks have entered into U.S. dollar resources of the U.S. Treasury and ESF for an agreement that provides for certain assets of the Refinancing purchases of foreign currencies and related in- serve Banks to be jointly pledged as collateral for the ternational operations. Federal Reserve notes issued to all Reserve Banks. In the FX swap arrangements and warehousing agreements event that this collateral is insufficient, the Federal Reare revalued daily at current market exchange rates. Ac- serve Act provides that Federal Reserve notes become a tivity related to these agreements, with the exception of first and paramount lien on all the assets of the Reserve the unrealized gains and losses resulting from the daily Banks. Finally, Federal Reserve notes are obligations of revaluation, is allocated to each Reserve Bank based on the United States government. the ratio of each Reserve Bank's capital and surplus to "Federal Reserve notes outstanding, net" in the Stateaggregate capital and surplus at the preceding December ments of Condition represents the Federal Reserve notes 31. Unrealized gains and losses resulting from the daily outstanding, reduced by the Reserve Banks' currency revaluation are recorded by FRBNY and not allocated to holdings of $218,571 million and $175,661 million at the other Reserve Banks. December 31, 2007 and 2006, respectively. At December 31, 2007, all Federal Reserve notes were (f) Bank Premises, Equipment, and Software fully collateralized. All gold certificates, all special draw- Bank premises and equipment are stated at cost less accu- ing right certificates, $743,126 million of domestic secumulated depreciation. Depreciation is calculated on a rities and securities purchased under agreements to resell, straight-line basis over the estimated useful lives of the and $35,328 million of loans were pledged as collateral. assets, which range from two to fifty years. Major alter- At December 31, 2007, no investments denominated in ations, renovations, and improvements are capitalized at foreign currencies were pledged as collateral. cost as additions to the asset accounts and are depreciated (h) Items in Process of Collection and Deferred Credit over the remaining useful life of the asset or, if appropri- Items ate, over the unique useful life of the alteration, renovation, or improvement. Maintenance, repairs, and minor Items in process of collection in the Statements of Condireplacements are charged to operating expense in the year tion primarily represents amounts attributable to checks incurred. that have been deposited for collection and that, as of the Costs incurred for software during the application de- balance sheet date, have not yet been presented to the velopment stage, either developed internally or acquired paying bank. Deferred credit items are the counterpart for internal use, are capitalized based on the cost of direct liability to items in process of collection, and the amounts services and materials associated with designing, coding, in this account arise from deferring credit for deposited installing, or testing software. Capitalized software costs items until the amounts are collected. The balances in are amortized on a straight-line basis over the estimated both accounts can vary significantly. useful lives of the software applications, which range from two to five years. Maintenance costs related to soft- (i) Capital Paid-in ware are charged to expense in the year incurred. The Federal Reserve Act requires that each member bank Capitalized assets including software, buildings, lease- subscribe to the capital stock of the Reserve Banks in an hold improvements, furniture, and equipment are im- amount equal to 6 percent of the capital and surplus of the paired when events or changes in circumstances indicate member bank. These shares are nonvoting with a par that the carrying amount of assets or asset groups is not value of $100 and may not be transferred or hypothrecoverable and significantly exceeds their fair value. ecated. As a member bank's capital and surplus changes, its holdings of Reserve Bank stock must be adjusted. (g) Federal Reserve Notes Currently, only one-half of the subscription is paid-in and Federal Reserve notes are the circulating currency of the the remainder is subject to call. A member bank is liable United States. These notes are issued through the various for Reserve Bank liabilities up to twice the par value of Federal Reserve agents (the chairman of the board of stock subscribed by it. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 365 By law, each Reserve Bank is required to pay each (I) Income and Costs Related to U.S. Treasury Services member bank an annual dividend of 6 percent on the The Reserve Banks are required by the Federal Reserve paid-in capital stock. This cumulative dividend is paid Act to serve as fiscal agents and depositories of the semiannually. To reflect the Federal Reserve Act require- United States. By statute, the Department of the Treasury ment that annual dividends are deducted from net earnis permitted, but not required, to pay for these services. ings, dividends are presented as a distribution of compre- During the years ended December 31, 2006 and 2007, the hensive income in the Statements of Income and Reserve Banks were reimbursed for substantially all ser- Comprehensive Income. vices provided to the Department of Treasury. (j) Surplus (m) Assessments by the Board of Governors The Board of Governors requires the Reserve Banks to The Board of Governors assesses the Reserve Banks to maintain a surplus equal to the amount of capital paid-in fund its operations based on each Reserve Bank's capital as of December 31 of each year. This amount is intended and surplus balances as of December 31 of the prior year. to provide additional capital and reduce the possibility The Board of Governors also assesses each Reserve Bank that the Reserve Banks would be required to call on for the expenses incurred for the U.S. Treasury to prepare member banks for additional capital. and retire Federal Reserve notes based on each Reserve Accumulated other comprehensive income is reported Bank's share of the number of notes comprising the Sysas a component of surplus in the Statements of Condition tem's net liability for Federal Reserve notes on December and the Statements of Changes in Capital. The balance of 31 of the prior year. accumulated other comprehensive income is comprised (n) Taxes of expenses, gains, and losses related to defined benefit pension plans and other postretirement benefit plans that, The Reserve Banks are exempt from federal, state, and under accounting standards, are included in other compre- local taxes, except for taxes on real property and sales hensive income, but excluded from net income. Addi- taxes on certain construction projects. Real property taxes tional information regarding the classifications of accu- were $33 million for each of the years ended December mulated other comprehensive income is provided in Notes 31, 2007 and 2006, and are reported as a component of 8, 9, and 10. "Occupancy expense." The Reserve Banks initially applied the provisions of (o) Restructuring Charges SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, at December The Reserve Banks recognize restructuring charges for 31, 2006. This accounting standard requires recognition exit or disposal costs incurred as part of the closure of of the overfunded or underfunded status of a defined business activities in a particular location, the relocation benefit postretirement plan in the Statements of Condi- of business activities from one location to another, or a tion, and recognition of changes in the funded status in fundamental reorganization that affects the nature of opthe years in which the changes occur through comprehen- erations. Restructuring charges may include costs associsive income. The transition rules for implementing the ated with employee separations, contract terminations, standard required applying the provisions as of the end of and asset impairments. Expenses are recognized in the the year of initial implementation, and the effect as of period in which the Bank commits to a formalized restruc- December 31, 2006 is recorded as "Adjustment to ini- turing plan or executes the specific actions contemplated tially apply SFAS No. 158" in the Statements of Changes in the plan and all criteria for financial statement recogniin Capital. tion have been met. Note 11 describes the Reserve Banks' restructuring (k) Interest on Federal Reserve Notes initiatives and provides information about the costs and liabilities associated with employee separations and con- The Board of Governors requires the Reserve Banks to tract terminations. The costs associated with the impairtransfer excess earnings to the US. Treasury as interest ment of certain of the Reserve Banks' assets are dison Federal Reserve notes, after providing for the costs of cussed in Note 6. Costs and liabilities associated with operations, payment of dividends, and reservation of an enhanced pension benefits in connection with the restrucamount necessary to equate surplus with capital paid-in. turing activities for all of the Reserve Banks are recorded This amount is reported as "Payments to U.S. Treasury as on the books of the FRBNY as discussed in Note 8. Costs interest on Federal Reserve notes" in the Statements of and liabilities associated with enhanced postretirement Income and Comprehensive Income and is reported as a benefits are discussed in Note 9. liability, or as an asset if overpaid during the year, in the Statements of Condition. Weekly payments to the U.S. (p) Recently Issued Accounting Standards Treasury may vary significantly. In September, 2006, the FASB issued SFAS No. 157, Fair In the event of losses or an increase in capital paid-in Value Measurements ("SFAS No. 157"). SFAS No. 157 at a Reserve Bank, payments to the U.S. Treasury are establishes a single authoritative definition of fair value, suspended and earnings are retained until the surplus is sets out a framework for measuring fair value, and exequal to the capital paid-in. pands on required disclosures about fair value measure- In the event of a decrease in capital paid-in, the excess ment. SFAS No. 157 is generally effective for the Reserve surplus, after equating capital paid-in and surplus at De- Banks on January 1, 2008, though the effective date of cember 31, is distributed to the U.S. Treasury in the some provisions is January 1, 2009. The provisions of following year. SFAS No. 157 will be applied prospectively and are not Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

366 94th Annual Report, 2007 expected to have a material effect on the Reserve Banks' The maturity distribution of U.S. government securifinancial statements. ties bought outright, securities purchased under agreements to resell, and securities sold under agreements to (4) U.S. GOVERNMENT SECURITIES, SECURITIES repurchase that were held in the SOMA at December 31, PURCHASED UNDER AGREEMENTS TO RESELL, 2007, was as follows (in millions): SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE, AND SECURITIES LENDING Securities Securities purchased sold The FRBNY, on behalf of the Reserve Banks, holds secu- U.S. under under rities bought outright in the SOMA. govern- agree- agree- The securities held in the SOMA at December 31, ment se- ments to ments to were as follows (in millions): curities resell repurchase 2007 2006 (par (contract (contract value) amount) amount) Par value U.S. government: Within 15 days ... $ 27,294 $46,500 $43,985 Bills $227,840 $277,019 16 days to Notes 401,776 402,367 90 days 149,727 Bonds 110.995 99,528 91 days to 1 year .. 152,267 Total par value ... 740,611 778,914 Over 1 year to 5 years 240,562 Unamortized premiums .. 7,988 8,708 Over 5 years to Unaccreted discounts (2,970) (4,003) 10 years 81,947 Total $745,629 $783,619 Over 10 years 88,814 Total $740,611 $46,500 $43,985 At December 31, 2007 and 2006, the fair value of the U.S. government securities held in the SOMA, excluding At December 31, 2007 and 2006, U.S. government accrued interest, was $777,141 million and $795,900 mil- securities with par values of $16,649 million and $6,855 lion, respectively, as determined by reference to quoted million, respectively, were loaned from the SOMA. prices for identical securities. Although the fair value of security holdings can be (5) INVESTMENTS DENOMINATED IN FOREIGN substantially greater or less than the recorded value at any CURRENCIES point in time, these unrealized gains or losses have no effect on the ability of the Reserve Banks, as central bank, The FRBNY, on behalf of the Reserve Banks, holds forto meet their financial obligations and responsibilities, eign currency deposits with foreign central banks and and should not be misunderstood as representing a risk to with the Bank for International Settlements and invests in the Reserve Banks, their shareholders, or the public. The foreign government debt instruments. Foreign governfair value is presented solely for informational purposes. ment debt instruments held include both securities bought Financial information related to securities purchased outright and securities purchased under agreements to under agreements to resell and securities sold under resell. These investments are guaranteed as to principal agreements to repurchase for the year ended December and interest by the issuing foreign governments. 31, 2007 was as follows (in millions): Total investments denominated in foreign currencies, Securities including accrued interest, valued at foreign currency purchased Securities market exchange rates at December 31, were as follows under sold under (in millions): agreements agreements to 2007 2006 to resell repurchase Euro: Contract amount Foreign currency outstanding, end deposits $27,488 $ 6,242 of year $46,500 $43,985 Securities purchased Weighted average under agreements amount outstanding, to resell 2,548 2,214 during the year 35,073 34,846 Government debt Maximum month-end instruments 4,666 4,074 balance outstanding, Japanese Yen: during the year 51,500 43,985 Foreign currency Securities pledged, deposits 2,811 2,601 end of year 44,048 Government debt At December 31, 2006, the total contract amount of instruments 5,708 5,351 securities sold under agreements to repurchase was Swiss Franc: $29,615 million. The total par value of SOMA securities Foreign currency that were pledged for securities sold under agreements to deposits 4,074 _ ^_ repurchase at December 31, 2006 was $29,676 million. Total $47,295 $20,482 The contract amounts for securities purchased under agreements to resell and securities sold under agreements At December 31, 2007, the total amount of foreign to repurchase approximate fair value. currency deposits held under FX contracts was $24,381 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 367 million. At December 31, 2006, there were no open for- Bank premises and equipment at December 31 ineign exchange contracts. cluded the following amounts for capitalized leases (in At December 31, 2007 and 2006, the fair value of total millions): System investments denominated in foreign currencies, 2007 2006 including accrued interest was $47,274 million and Leased premises and $20,434 million, respectively. The fair value of governequipment under ment debt instruments was determined by reference to capital leases $ 21 $12 quoted prices for identical securities. The cost basis of Accumulated depreciation .. (11) (6) foreign currency deposits and securities purchased under agreements to resell, adjusted for accrued interest, Leased premises and approximates fair value. Similar to the U.S. government equipment under securities discussed in Note 4, unrealized gains or losses capital leases, net $ 10 $ 6 have no effect on the ability of a Reserve Bank, as central Depreciation expense related to leased premises and bank, to meet its financial obligations and responsibiliequipment under capital leases was $4 million for the ties. year ended December 31, 2007. The maturity distribution of investments denominated Certain of the Reserve Banks lease space to outside in foreign currencies at December 31, 2007, was as foltenants with remaining lease terms ranging from one to lows (in millions): thirteen years. Rental income from such leases was $27 Japa- million and $25 million for the years ended December 31, nese Swiss 2007 and 2006, respectively, and is reported as a compo- Euro Yen Franc Total nent of "Other income." Future minimum lease payments Within 15 days $ 4,999 $2,991 $... $ 7,990 that the Bank will receive under noncancelable lease 16 days to agreements in existence at December 31, 2007, are as 90 days . 23,103 404 4,074 27,581 follows (in millions): 91 days to 1 year ... 2,756 2,009 4,765 2008 $27 Over 1 year 2009 26 to 5 years 3,844 3,115 6,959 2010 26 Total . $34,702 $8,519 $4,074 $47,295 2011 22 2012 21 At December 31, 2007 and 2006, the authorized ware- Thereafter _68 housing facility was $5,000 million, with no balance out- Total $190 standing. The Reserve Banks have capitalized software assets, net of amortization, of $158 million and $155 million at (6) BANK PREMISES, EQUIPMENT, AND SOFTWARE December 31, 2007 and 2006, respectively. Amortization Bank premises and equipment at December 31 was as expense was $62 million and $66 million for the years follows (in millions): ended December 31, 2007 and 2006, respectively. Capitalized software assets are reported as a component of 2007 2006 "Other assets" and the related amortization is reported as Bank premises and a component of "Other expenses." equipment: Several of the Reserve Banks impaired check equip- Land $ 323 $ 306 ment, leasehold improvements, and furniture assets as a Buildings 1,878 1,817 result of the System's restructuring plans, as discussed in Building machinery Note 11. Asset impairment losses of $32 million and $15 and equipment 416 393 million for the periods ending December 31, 2007 and Construction in progress .... 380 220 2006, respectively, were determined using fair values Furniture and equipment .... 1,118 1,156 based on quoted market values or other valuation tech- Subtotal 4.115 3,892 niques and are reported as a component of "Other Accumulated depreciation (1,576) (1,516) expenses." Bank premises and (7) COMMITMENTS AND CONTINGENCIES equipment, net $ 2,539 $ 2,376 At December 31, 2007, the Reserve Banks were obligated Depreciation expense, under noncancelable leases for premises and equipment for the year ended with remaining terms ranging from one to approximately December 31 $ 185 $ 186 sixteen years. These leases provide for increased rental payments based upon increases in real estate taxes, oper- The Federal Reserve Bank of Kansas City is construct- ating costs, or selected price indices. ing a new building to replace its head office. At Decem- Rental expense under operating leases for certain operber 31, 2007 approximately $38 million of costs associ- ating facilities, warehouses, and data processing and ofated with the acquisition of land and site preparation for fice equipment (including taxes, insurance and maintethe new building are included in the "Land" account, and nance when included in rent), net of sublease rentals, was approximately $217 million of costs associated with the $29 million and $31 million for the years ended Decemconstruction of the new building are included in the "Con- ber 31, 2007 and 2006, respectively. Certain of the Restruction in progress" account. serve Banks' leases have options to renew. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

368 94th Annual Report, 2007 Future minimum rental payments under noncancelable ees at certain compensation levels participate in the Benoperating leases, net of sublease rentals, with remaining efit Equalization Retirement Plan ("BEP") and certain terms of one year or more, at December 31, 2007 are as Reserve Bank officers participate in the Supplemental follows (in millions): Employee Retirement Plan ("SERF'). Operating The System Plan provides retirement benefits to employees of the Federal Reserve Banks, the Board of Gov- 2008 $10 ernors, and the Office of Employee Benefits of the Fed- 2009 9 eral Reserve Employee Benefits System. The FRBNY, on 2010 7 behalf of the System, recognizes the net asset and costs 2011 7 associated with the System Plan in its financial state- 2012 6 ments. Costs associated with the System Plan are not Thereafter _95 redistributed to other participating employers. Future minimum rental payments $134 Following is a reconciliation of the beginning and ending balances of the System Plan benefit obligation (in Future minimum rental payments under noncancelable millions): capital leases, net of sublease rentals, with remaining 2007 2006 terms of one year or more, at December 31, 2007 were Estimated actuarial not material. present value of At December 31, 2007, the Reserve Banks had unreprojected benefit corded unconditional purchase commitments and longobligation at term obligations extending through the year 2017 with a January 1 $5,147 $4,785 remaining fixed commitment of $312 million. Purchases Service cost—benefits of $59 million and $92 million were made against these earned during the commitments during 2007 and 2006, respectively. These period 146 134 commitments represent goods and services for mainte- Interest cost on projected nance of currency processing machines, for licenses and benefit obligation 317 278 maintenance of check software and hardware, and have Actuarial (gain) loss (46) 132 variable and/or fixed components. The variable portion of Contributions by plan the commitments is for additional services above fixed participants 3 3 contractual service limits. The fixed payments for the Special termination next five years under these commitments are as follows benefits loss 22 3 (in millions): Benefits paid (264) (254) Fixed Plan amendments ... 66 Commitment Estimated actuarial 2008 $20 present value of 2009 41 projected benefit 2010 30 obligation at 2011 31 December 31 $5,325 $5,147 2012 31 At December 31, 2007, the Reserve Banks had com- Following is a reconciliation showing the beginning mitments of approximately $66 million for the construc- and ending balances of the System Plan assets, the funded tion of additional building space at the Federal Reserve status, and the prepaid pension benefit costs (in millions): Bank of St. Louis, and security enhancements and an 2007 2006 employee parking deck at the Federal Reserve Bank of Estimated fair value Richmond. Expected payments related to these commitof plan assets at ments are $57 million and $9 million for the years ending January 1 $ 6,330 $ 5,868 December 31, 2008 and 2009, respectively. Actual return on plan The Reserve Banks are involved in certain legal acassets 535 713 tions and claims arising in the ordinary course of busi- Contributions by plan ness. Although it is difficult to predict the ultimate outparticipants 3 3 come of these actions, in management's opinion, based Benefits paid (264) (254) on discussions with counsel, the aforementioned litiga- Estimated fair value tion and claims will be resolved without material adverse of plan assets at effect on the financial position or results of operations of the Reserve Banks. December 31 $6,604 $ 6,330 Funded status and prepaid (8) RETIREMENT AND THRIFT PLANS pension benefit costs .. $ 1,279 $ 1,183 Retirement Plans Amounts included in The Reserve Banks currently offer three defined benefit accumulated other retirement plans to its employees, based on length of comprehensive loss service and level of compensation. Substantially all of the are shown below: Reserve Banks', Board of Governors, and the Office of Prior service cost $ (163) $ (191) Employee Benefits of the Federal Reserve Systems' em- Net actuarial loss (1,135) (1,301) ployees participate in the Retirement Plan for Employees Total accumulated other of the Federal Reserve System ("System Plan"). Employ- comprehensive loss ... $(1,298) $(1,492) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 369 Prepaid pension benefit costs are reported as "Other Estimated amounts that assets" in the Statements of Condition. will be amortized from The accumulated benefit obligation for the System accumulated other Plan, which differs from the estimated actuarial present comprehensive loss value of projected benefit obligation because it is based into net periodic on current rather than future compensation levels, was pension benefit expense $4,621 million and $4,522 million at December 31, 2007 in 2008 are shown and 2006, respectively. below: The weighted-average assumptions used in developing Prior service cost $29 the pension benefit obligation for the System Plan as of Net actuarial loss _50 December 31 are as follows: Total $79 2007 2006 The recognition of special termination benefits losses Discount rate 6.25% 6.00% is the result of enhanced retirement benefits provided to Rate of compensation employees during the restructuring described in Note 11. increase 5.00% 4.50% Following is a summary of expected benefit payments excluding enhanced retirement benefits (in millions): Net periodic benefit expenses are actuarially deter- Expected mined using a January 1 measurement date. The benefit weighted-average assumptions used in developing net pe- payments riodic benefit expenses for the System Plan for the years 2008 $273 at January 1 were as follows: 2009 284 2007 2006 2010 296 2011 309 Discount rate 6.00% 5.75% 2012 324 Expected asset return .. 8.00% 8.00% 2013-2017 1,871 Rate of compensation Total $3,357 increase 4.50% 4.50% The Federal Reserve System's pension plan weighted- Discount rates reflect yields available on high-quality average asset allocations at December 31, by asset catcorporate bonds that would generate the cash flows neces- egory are as follows: sary to pay the plan's benefits when due. The expected 2007 2006 long-term rate of return on assets was based on a combination of methodologies including the System Plan's his- Equities 65.7% 64.3% torical returns; surveys of what other plans' expected Fixed income 33.2% 34.4% rates of return are; building a projected return for equities Cash 1.1% 1.3% and fixed income investments based on real interest rates, Total 100.0% 100.0% inflation expectations and equity risk premiums; and surveys of expected returns in equity and fixed income The System's Committee on Investment Performance markets. ("CIP") selects investment managers who are responsible The components of net periodic pension benefit ex- for implementing the System Plan's investment policies. pense for the System Plan for the years ended December The managers' performance is measured against a trailing 31 are shown below (in millions): 36-month benchmark of 60 percent of a market value weighted index of predominantly large capitalization 2007 2006 stocks trading on the New York Stock Exchange, the American Stock Exchange, and the National Association Service cost—benefits of Securities Dealers Automated Quotation National Marearned during ket System and 40 percent of a broadly diversified the period $ 146 $ 134 investment-grade fixed income index (rebalanced Interest cost on monthly). The managers invest plan funds within CIPaccumulated benefit established guidelines for investment in equities and fixed obligation 317 278 income instruments. Equity investments can range be- Amortization of prior tween 40 percent and 80 percent of the portfolio. Investservice cost 29 23 Amortization of net loss .. 79 75 ments, however, cannot be concentrated in particular in- Expected return on dustries and equity securities holdings of any one plan assets (496) (460) company are limited. Fixed income securities must be investment grade and the effective duration of the fixed Net periodic pension income portfolio must remain within a range of 67 perbenefit expense 75 50 cent and 150 percent of a broadly diversified investment- Special termination grade fixed income index. CIP guidelines prohibit marbenefits loss 22 3 gin, short sale, foreign exchange, and commodities Total periodic pension trading as well as investment in bank, bank holding combenefit expense $ 97 $ 53 pany, savings and loan, and government securities dealers stocks. In addition, investments in non-dollar denomi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

370 94th Annual Report 2007 nated securities are prohibited; however, a small portion 2007 2006 of the portfolio can be invested in American Depositary Plan amendments (\) (5) Receipts/Shares and foreign-issued dollar-denominated Accumulated postfixed income securities. retirement benefit Contributions to the System Plan may be determined obligation at using different assumptions than those required for finan- December 31 $1,121 $1,164 cial reporting. The System does not expect to make a cash contribution during 2008. At December 31, 2007 and 2006, the weighted-average The Reserve Banks' projected benefit obligation, discount rate assumptions used in developing the postrefunded status, and net pension expenses for the BEP and tirement benefit obligation were 6.25 percent and 5.75 the SERP at December 31, 2007 and 2006, and for the percent, respectively. years then ended, were not material. Discount rates reflect yields available on high-quality corporate bonds that would generate the cash flows neces- Thrift Plan sary to pay the plan's benefits when due. Following is a reconciliation of the beginning and end- Employees of the Reserve Banks may also participate in ing balances of the plan assets, the unfunded postretirethe defined contribution Thrift Plan for Employees of the ment benefit obligation, and the accrued postretirement Federal Reserve System ("Thrift Plan"). The Reserve benefit costs (in millions): Banks' Thrift Plan contributions totaled $69 million and 2007 2006 $66 million for the years ended December 31, 2007 and 2006, respectively, and are reported as a component of Fair value of plan assets "Salaries and other benefits" in the Statements of Income at January 1 $ ... $ ... and Comprehensive Income. The Reserve Banks match Contributions by the employer 52 47 employee contributions based on a specified formula. For Contributions by plan the years ended December 31, 2007 and 2006, the Banks participants 13 13 matched 80 percent on the first 6 percent of employee Benefits paid, net of contributions for employees with less than five years of Medicare Part D service and 100 percent on the first 6 percent of employee subsidies (65) (60) contributions for employees with five or more years of service. Fair value of plan assets at December 31 $ .. . $ . .. (9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Unfunded obligation and AND POSTEMPLOYMENT BENEFITS accrued postretirement benefit cost $1,121 $1,164 Postretirement Benefits other than Pensions Amounts included in In addition to the Reserve Banks' retirement plans, em- accumulated other ployees who have met certain age and length-of-service comprehensive loss requirements are eligible for medical benefits and life are shown below: insurance coverage during retirement. Prior service cost $ 60 $ 85 The Reserve Banks fund benefits payable under the Net actuarial loss (292) (443) medical and life insurance plans as due and, accordingly, Deferred curtailment have no plan assets. gain 6 1_ Following is a reconciliation of the beginning and end- Total accumulated other ing balances of the benefit obligation (in millions): comprehensive loss ... $ (226) $ (357) 2007 2006 Accrued postretirement benefit costs are reported as a Accumulated post- component of "Accrued benefit costs" in the Statements retirement benefit of Condition. obligation at For measurement purposes, the assumed health care January 1 $1,164 $947 cost trend rates at December 31 are as follows: Service cost-benefits 2007 2006 earned during the period 41 27 Health care cost trend rate Interest cost on assumed for next year .. 8.00% 9.00% accumulated benefit Rate to which the cost obligation 69 54 trend rate is assumed Net actuarial (gain) loss .. (93) 188 to decline (the ultimate Curtailment gain (10) trend rate) 5.00% 5.00% Special termination Year that the rate reaches benefits loss 3 the ultimate trend rate .. 2013 2012 Contributions by plan Assumed health care cost trend rates have a significant participants ... 13 13 effect on the amounts reported for health care plans. A Benefits paid (69) (64) one percentage point change in assumed health care cost Medicare Part D trend rates would have the following effects for the year subsidies 4 4 ended December 31, 2007 (in millions): Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 371 One One The Medicare Prescription Drug, Improvement and Percentage Percentage Modernization Act of 2003 established a prescription Point Point drug benefit under Medicare ("Medicare Part D") and a Increase Decrease federal subsidy to sponsors of retiree health care benefit Effect on aggregate of plans that provide benefits that are at least actuarially service and interest equivalent to Medicare Part D. The benefits provided cost components of under the Reserve Banks1 plans to certain participants are net periodic post- at least actuarially equivalent to the Medicare Part D retirement benefit prescription drug benefit. The estimated effects of the costs $ 15 $ (13) subsidy, retroactive to January 1, 2004, are reflected in Effect on accumulated actuarial loss in the accumulated postretirement benefit postretirement benefit obligation and net periodic postretirement benefit obligation 123 (107) expense. There were no receipts of federal Medicare Part D The following is a summary of the components of net subsidies in the year ended December 31, 2006. Receipts periodic postretirement benefit expense for the years in the year ending December 31, 2007, related to benefits ended December 31 (in millions): paid in the years ended December 31, 2006 and 2007 were $3 million for each of the years. Expected receipts 2007 2006 in 2008, related to benefits paid in the years ended De- Service cost—benefits cember 31, 2006 and 2007 are $1 million, respectively. earned during Following is a summary of expected postretirement the period $ 41 $27 benefit payments (in millions): Interest cost on Without With accumulated benefit Subsidy Subsidy obligation 69 54 Amortization of prior 2008 $ 66 $ 61 service cost (22) (23) '2009 72 66 Amortization of net 2010 77 72 actuarial loss 48 22 2011 83 76 Total periodic expense ... 136 80 2012 87 80 Special termination 2013-2017 496 446 benefits loss 3 Total $881_ $801 Net periodic postretirement benefit Postemployment Benefits expense $139 $ 80 The Reserve Banks offer benefits to former or inactive Estimated amounts that employees. Postemployment benefit costs are actuarially will be amortized from determined using a December 31 measurement date and accumulated other include the cost of medical and dental insurance, survivor comprehensive loss income, and disability benefits. The accrued postemployinto net periodic ment benefit costs recognized by the Reserve Banks at postretirement benefit December 31, 2007 and 2006 were $124 million and expense in 2008 are $126 million, respectively. This cost is included as a shown below: component of "Accrued benefit costs" in the Statements Prior service cost $(20) of Condition. Net periodic postemployment benefit ex- Net actuarial loss 25 pense included in 2007 and 2006 operating expenses were Total $ 5 $15 million and $20 million, respectively, and is recorded as a component of "Salaries and other benefits" in the Statements of Income and Comprehensive Income. Net postretirement benefit costs are actuarially determined using a January 1 measurement date. At January 1, do) ACCUMULATED OTHER COMPREHENSIVE INCOME 2007 and 2006, the weighted-average discount rate as- AND OTHER COMPREHENSIVE INCOME sumptions used to determine net periodic postretirement benefit costs were 5.75 percent and 5.50 percent, respec- Following is a reconciliation of beginning and ending balances of accumulated other comprehensive loss (in tively. millions): Net periodic postretirement benefit expense is reported as a component of "Salaries and other benefits" in the Amount Statements of Income and Comprehensive Income. Amount related to The recognition of special termination benefits losses related to postretire- Total is primarily the result of enhanced retirement benefits defined ment ben- accumuprovided to employees during the restructuring described benefit efits other lated other in Note 11. Deferred curtailment gains were recorded in retirement than comprehen- 2007 and 2006 as a component of accumulated other plan pensions sive loss comprehensive loss; the gains will be recognized in net Balance at income in future years when the related employees termi- January 1, nate employment. 2006 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

372 94th Annual Report, 2007 Amount announcements in 2007 included restructuring plans asso- Amount related to ciated with the U.S. Treasury's Collections and Cash related to postretire- Total Management Modernization initiative. defined ment ben- accumubenefit efits other lated other 2006 Restructuring Plans retirement than comprehen- In 2006, the Reserve Banks announced restructuring plans plan pensions sive loss related to check and cash operations. Adjustment to initially 2005 and Prior Restructuring Costs apply SFAS The Reserve Banks incurred various restructuring charges No. 158.. $(1,492) $(357) $(1,849) prior to 2006 related to the restructuring of check, cash, Balance at purchasing, and Treasury operations. December 31, Following is a summary of financial information re- 2006 $(1,492) $(357) $(1,849) lated to the restructuring plans (in millions): Change in 2005 funded status and of benefit prior 2006 2007 plans: restruc- restruc- restruc- Prior service turing turing turing costs plans plans plans Total arising Information during related to the year .. (3) (3) restructuring Net actuarial plans as of gain December 31, arising 2007: during Total expected the year .. 86 103 189 costs related to Deferred restructuring curtailment activity $ 32 $ 8 $ 45 $85 gain 5 5 Estimated future Amortization costs related to of prior restructuring service activity $ 6 cost 29 (22) 7 Expected Amortization completion of net date 2008 2008 2011 actuarial loss 79 48 127 Reconciliation Change in of liability funded status balances: of benefit Balance at January 1, plans— 2006 $ 17 $ 17 other com- Employee prehensive separation income 194 131 325 costs and Balance at adjust- December 31, ments 2 9 2007 $(1,298) $(226) $(1,524) Payments ... (12) (12) Balance at Additional detail regarding the classification of accu- December 31, mulated other comprehensive loss is included in Notes 8 2006 $ 14 and 9. Employee separation (i i) BUSINESS RESTRUCTURING CHARGES costs 1 40 41 2007 Restructuring Plans Adjustments . (4) (1) (5) Payments ... (3) (3) (1) (7) In 2007, the Reserve Banks announced a restructuring Balance at initiative to align the check processing infrastructure and December 31, operations with declining check processing volumes. The 2007 39 $43 new infrastructure will involve consolidation of operations into four regional Reserve Bank processing sites in Employee separation costs are primarily severance Philadelphia, Cleveland, Atlanta, and Dallas. Additional costs for identified staff reductions associated with the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Federal Reserve Banks Combined Financial Statements 373 announced restructuring plans. Separation costs that are agency residential mortgage-backed securities, agency provided under terms of ongoing benefit arrangements collateralized mortgage obligations, non-agency AAA/ are recorded based on the accumulated benefit earned by Aaa-rated private-label residential mortgage-backed secuthe employee. Separation costs that are provided under rities, and AAA/Aaa-rated commercial mortgage-backed the terms of one-time benefit arrangements are generally securities. The FRBNY was also authorized to establish a measured based on the expected benefit as of the termina- primary dealer credit facility (PDCF) to provide secured tion date and recorded ratably over the period to termina- overnight funding to primary dealers. The primary dealtion. Restructuring costs related to employee separations ers may pledge U.S. government securities, federal are reported as a component of "Salaries and other ben- agency securities and agency mortgage-backed securities, efits" in the Statements of Income and Comprehensive and investment-grade corporate, municipal, mortgage- Income. backed and asset-backed securities for which a price is Adjustments to the accrued liability are primarily due available, as collateral under the PDCF. In connection to changes in the estimated restructuring costs and are with the announced purchase of The Bear Stearns Compashown as a component of the appropriate expense cat- nies Inc. by JPMorgan Chase & Co. (JPMorgan Chase), egory in the Statements of Income and Comprehensive the Board also authorized the FRBNY to enter into a Income. financing arrangement with JPMorgan Chase for up to Restructuring costs associated with the impairment of $30 billion. The FOMC also authorized increases in its certain of the Reserve Banks' assets, including software, existing temporary reciprocal currency arrangements (see buildings, leasehold improvements, furniture, and equip- Notes 3e and 5) with specific foreign central banks. These ment, are discussed in Note 6. Costs associated with initiatives will affect 2008 activity related to loans, securienhanced pension benefits for all Reserve Banks are re- ties purchased under agreements to resell, US. governcorded on the books of the FRBNY as discussed in Note ment securities, net, and investments denominated in for- 8. Costs associated with enhanced postretirement benefits eign currencies, as well as income and expenses. The are disclosed in Note 9. effects of the initiatives do not require adjustment to the amounts recorded as of December 31, 2007. (12) SUBSEQUENT EVENTS In March 2008, the FRBNY announced it will close In March 2008, the Board of Governors announced sev- the Buffalo Branch, effective October 31, 2008. Restruceral initiatives to address liquidity pressures in funding turing charges associated with this closure are not exmarkets and promote financial stability, including increas- pected to be material. The Federal Reserve Bank of St. ing the Term Auction Facility (see Note 3b) to $100 Louis sold the facility in Little Rock for $4 million on billion and initiating a series of term repurchase transac- March 11, 2008, which included the sale of associated tions (see Notes 3d and 4) that may cumulate to $100 furnishings. In February 2008, the Federal Reserve Bank billion. In addition, the Reserve Banks' securities lending of San Francisco's Seattle Branch office was relocated to program (see Notes 3d and 4) was expanded to lend up to a new facility in the Seattle area. The former facility was $200 billion of Treasury securities to primary dealers for vacated and the property, including related furnishings, a term of 28 days, secured by federal agency debt, federal will be available for sale in 2008. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

375 Office of Inspector General Activities The Board of Governors' Office of In- prevent and detect waste, fraud, and spector General (OIG) functions in ac- abuse in Board and Board-delegated cordance with the Inspector General Act programs and operations. The OIG of 1978, as amended. The OIG plans keeps the Congress and the Chairman of and conducts audits, attestations, inspec- the Board of Governors fully informed tions, evaluations, investigations, and about serious abuses and deficiencies law and regulation reviews relating to and about the status of any corrective the Board's programs and operations actions. and to those functions that the Board has During 2007, the OIG completed delegated to the Federal Reserve Banks. twelve audits, attestations, inspections, In addition, it retains an independent au- evaluations, and other assessments and ditor each year to audit the Board's fi- conducted a number of follow-up renancial statements. The OIG also makes views to evaluate action taken on prior recommendations and conducts activi- recommendations. The OIG also closed ties to promote economy and efficiency, six investigations and performed numerenhance policies and procedures, and ous legislative and regulatory reviews. OIG Audits, Attestations, Inspections, and Evaluations Completed during 2007 Report title Month issued Security Control Review of the Internet Electronic Submission System (Internal Report) February Agreed-Upon Procedures Attestation—Bank Plan Service Credit Data February Agreed-Upon Procedures Attestation—Statement of Financial Accounting Standards No. 87 February Agreed-Upon Procedures Attestation—Statement of Financial Accounting February Standards No. 106 March Audit of Configuration Settings (Internal Report) Audit of the Board's Compliance with Overtime Requirements of the Fair Labor March Standards Act Agreed-Upon Procedures Attestation—Statement of Financial Accounting March Standards No. 112 Audit of the Federal Financial Institutions Examination Council Financial Statements March (Year Ended December 31, 2006) April Audit of the Board's Financial Statements (Year Ended December 31, 2006) September Audit of the Board's Information Security Program September Inspection of the Board's Protective Services Unit (Internal Report) Inspection of Federal Reserve Examination Practices for Assessing Financial September Institutions' Office of Foreign Asset Control Compliance Programs Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

376 Government Accountability Office Reviews Under the Federal Banking Agency various stages of completion at year-end Audit Act (Public Law 95-320), most (table). The Federal Reserve also pro- Federal Reserve System operations are vided information to the GAO during under the purview of the Government the year on numerous other GAO inves- Accountability Office (GAO). In 2007, tigations, including eight other comthe GAO completed eight reports on se- pleted reviews and six other ongoing lected aspects of Federal Reserve opera- reviews. tions (table). In addition, nine projects The reports are available directly concerning the Federal Reserve were in from the GAO. Reports Completed during 2007 Month issued Report title Report number (2007) Risk-Based Capital: Bank Regulators Need to Improve Transparency and Overcome Impediments to Finalizing the Proposed Basel II Framework GAO-07-253 February Deposit Insurance: Assessment of Regulators' Use of Prompt Corrective Action Provisions and FDIC's New Deposit Insurance System GAO-07-242 February Financial Market Regulation: Agencies Engaged in Consolidated Supervision Can Strengthen Performance Measurement and Collaboration GAO-07-154 March Financial Market Preparedness: Significant Progress Has Been Made, but Pandemic Planning and Other Challenges Remain ... . .. GAO-07-399 March Comparability of Compensation among the FRB and Other Federal Financial Regulatory Agencies Internal report April Credit Derivatives: Confirmation Backlogs Increased Dealers' Operational Risks, but Were Successfully Addressed after Joint Regulatory Action GAO-07-716 June Financial Regulators: Agencies Have Implemented Key Performance Management Practices, but Opportunities for Improvement Exist GAO-07-678 June Financial Regulation: Industry Trends Continue to Challenge the Federal Regulatory Structure GAO-08-32 October Projects Active at Year-End 2007 Subject of project Month initiated Hedge funds and federal regulatory oversight October 2006 Bank fees January 2007 Coin production and distribution April 2007 Basel II global and domestic issues July 2007 Federal Reserve's Regulation B September 2007 Check 21 Act mandate September 2007 Suspicious Activity Reports (SAR) process September 2007 Inspector Generals' role in federal entities September 2007 Bank Secrecy Act (BSA) compliance and enforcement October 2007 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

378 94th Annual Report, 2007 The Federal Reserve System 9 1 • 2 BOSTON MINNEAPOLIS 7 12 • o • NEW YORK X.*ml CHICAGO^ CLEVELAND PHTLADELPHIA • SAN FRANCISCO 10 4 S3 KANSAS CITY • RlCHMONE) ST. LOUIS 8 5 6 • 11 • J-i • ATLANTA DALLAS ALASKA HAWAII LEGEND Both pages Facing page • Federal Reserve Bank city • Federal Reserve Branch city E3 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 2007. 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 379 1-A 2-B 3-C 4-D 5-E Pittsburgh Baltimore ME • • CT v( •' "4 wv •Cincinnati •Charlotte Buffalo Bi * NY KY NJ BOSTON NEW YORK PHILADELPHIA CLEVELAND RICHMOND 6-F 7-G 8-H N_^ •Nashville Birmingham Detroit* Louisville •Memphis Little) Rock ATLANTA CHICAGO ST. LOUIS 9-1 • Helena MINNEAPOLIS 10-J 12-L Omaha# Denver Oklahoma City OK KANSAS CITY 11-K Salt Lake City El Paso i ~jr\/£ x A r~<— VHHoouusstto(]n •Los Angeles San Ajitonio^ 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

383 Index ABN AMRO North America Holding Balance sheets Company, acquisition, 132 Board of Governors, 347 Accounting policy, 98-99, 101 Federal Reserve priced services, Accounting Task Force (ATF), 101 164-167 Adjustable-rate mortgages. (See Mortgage Bank examiner training, 106-107, 133-134 products, nontraditional) Bank holding companies Agreement corporations, 86, 89, 90, 110 Assets, 85, 87 Agriculture, U.S. Department of, 135 Banks affiliated with, 313 American Association of Residential Capital standards, 95-98 Mortgage Regulators, 119 Inspections of, 87-88, 89 Anti-money laundering (AML) Number of, 87, 89 Bank Secrecy Act/Anti-Money Rating system, 87-88 Laundering Examination Manual, Regulatory financial reports, 103-104 99 Surveillance and off-site monitoring, 94 Examinations, 91 Bank Holding Companies and Change in Anti-Money Laundering and Countering Bank Control (Regulation Y), the Financing of Terrorism Expert 176-177 Group, 100 Bank Holding Company Act, 86, 107, Applications, notices, and proposals, 108-109 107-111, 132 Bank Holding Company Performance Asian Development Bank, 95 Reports (BHCPRs), 94 Assets and liabilities Bank Merger Act, 86, 107, 109 Board of Governors, 346 Bank of America Corporation, acquisition, Commercial banks, 322 132 Federal Reserve Banks, 324-327 Bank of New York, merger, 132 Association of Supervisors of Banks of the Bank Secrecy Act/Anti-Money Laundering Americas (ASBA), 95 Examination Manual, 99 Auditors' reports, 345, 355-356, 357-358 Bank Secrecy Act (BSA) Audits, reviews, and assessments Examinations, 91 of Board of Governors, 343, 345-356, Overview, 99-100 375 Banking Organization National Desktop of Federal Reserve Banks, 160, 343, (BOND), 105-106 357-373, 375 Banking organizations, U.S. {See also Bank of Federal Reserve System, 343, 375, holding companies and Commercial 376 banks) by Government Accountability Office, Capital standards, 95-98 376 Examinations and inspections of, 86-89 International standards on auditing, 101 Failures of, 85 by Office of Inspector General, 343, 375 Foreign operations, 89, 90, 110 Automated clearinghouse (ACH) services, Minority-owned financial institutions, Federal Reserve Banks, 153, 157-158, 133 338 Number of, 313 Availability of Funds and Collection of Regulation of, 107-111 Checks (Regulation CC), 137, 149 Banks' security activities, 102-103 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

384 94th Annual Report, 2007 Basel Committee on Banking Supervision, Check Clearing for the 21st Century 95, 100, 101 (Check 21), 152 Basel II framework, implementation, 86, Check collection and processing, Federal 95-97, 100 Reserve Banks, 152-153, 338 Board of Governors. {See also Federal Chicago Board Options Exchange, 111 Reserve System) Clarity Project, 101 Appointed members, 301-303 Collection services for federal government, Assessments by, 332-337 Federal Reserve Banks, 157-158 Assets and liabilities, 346 Collections and Cash Management Audits, reviews, and assessments of, Modernization (CCMM) initiative, 158 343, 345-356, 375 Combined financial statements, Federal Cash flows, 348 Reserve Banks, 357-373 Consumer Advisory Council, 116, Commercial banks 143-149, 280 Assets and liabilities of, 322 Decisions, public notice of, 110-111 Number of, 322 Ex officio members, 304 Regulatory financial reports, 104—105 Federal Advisory Council, 279 Committee of Sponsoring Organizations of FFIEC activities, 93, 94, 99, 102, the Treadway Commission (COSO), 104-105, 134-138 159-160 Financial statements, 345-356 Community affairs. {See Consumer and Goals and objectives, 169-171 community affairs) Government Performance and Results Community Affairs Offices (CAOs), Act, 169-171 140-143 Income and expenses, 347 Community development financing and Inspector General, Office of, audits, asset-building strategies, 142-143 reviews and assessments, 343, 375 Community economic development, Litigation, 271 140-143 Members and officers, 275-277 Community Reinvestment Act (CRA) Mission, 169 Applications, analysis in relation to, 132 Policy actions, 175-182 Consumer alert on solicitations for CRA Risk-based capital requirements, 86 programs, 131 Strategic plan, performance plan, and Examinations for compliance with, performance report, 169 130-132 Thrift Institutions Advisory Council, 281 Interagency questions and answers on, BOND (Banking Organization National 131-132 Desktop), 105-106 Compliance examinations, 119, 125-129, Branches. {See Federal Reserve Banks) 130-132 Brookings Institution, 142 Comptroller of the Currency, Office of the Business continuity, 93 (OCC), 85, 86, 93, 95, 101-102, 136 Business investment, profits, and finance, Condition statements, Federal Reserve 16-19, 43, 58, 60, 61-62, 65-68 Banks, 324-327 Conference of State Bank Supervisors, 102, Call Reports, 94, 104-105 118-119 Capital accounts, Federal Reserve Banks, Consumer Advisory Council, 116, 324-327, 359 143-149, 280 Capital standards, 95-98 Consumer and community affairs Cash flows, Board of Governors, 348 Community development financing and Cash-management services, Federal asset-building strategies, 142-143 Reserve Banks, 158 Community economic development, Central Document and Text Repository 140-143 (CDTR), 106 Consumer Advisory Council advice, 116, Change in Bank Control Act, 86, 107, 109 143-149 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 385 Consumer and community Depository institutions. (See also affairs—continued Commercial banks) Consumer complaints, 138-140 Interest rates on loans by Federal Consumer financial education, 120-121, Reserve Banks, 311 143 Reserve requirements, 312 Consumer protection and community Reserves of, 314-321 reinvestment laws, 125-138 Depository services to federal government, Credit cards, 121-123 Federal Reserve Banks, 155-158 Mortgage credit, 113-121 Deposits Outreach activities, 119-121 Commercial banks, 322 Consumer complaints, 138-140 Federal Reserve Banks, 314-321 Consumer Credit Protection Act, 126 Directors, Federal Reserve Banks and Consumer Leasing (Regulation M), 124, Branches, 284-300 136, 175 Disclosures Consumer prices, 4, 27-28, 41, 75 Credit cards, 121-123, 146-147 Consumer protection laws Electronic, 124 Agency reports on compliance with, Mortgage products, 145-146 134-138 State member banks, financial Supervision for compliance with, 119, disclosures, 111 125-138 Yield-spread premiums, 145-146 Consumer spending, 12-16, 43, 44-45, 46, Discount rates, 180-182, 311 57, 58, 59, 61, 62-63 Discrimination Corporate profits, 17-19, 67-68 Complaints related to, 138-139 Credit by Banks or Persons Other Than DOJ reviews of, 126-127, 128-129 Brokers or Dealers for the Purpose of HMDA data analysis, 127-129 Purchasing or Carrying Margin Stock Disposable personal income (DPI), 13, 63 (Regulation U), 93, 111, 323 DOJ. (See Justice, U.S. Department of) Credit cards Dollar exchange rate, 39-40, 43, 45-46, Applications and solicitations, 122-123 71, 80-81 Change-in-terms notices, 123, 147-148 Consumer complaints, 138-139 Earned-income tax credit (EITC), 143 Disclosures, 121-123, 146-147 ECI (employment cost index), 26-27, 74 Due dates on payments, 148 Economic Growth and Regulatory Interest rates, 14 Paperwork Reduction Act, 103 Schumer box, 146-147 Economic Stimulus Act of 2008, 19-20 Credit risk management, 101-102 Economies, foreign, 39-41, 71-72, 79-82 Currency and coin, 155, 338 Economy, U.S. Current account, U.S., 23, 24, 71, 72 Business sector, 16-19, 65-68 Debt, domestic nonfinancial sectors, Debt 37-38, 58 Corporate, 18-19, 58 External sector, 22-24, 70-72 Domestic nonfinancial sectors, 37-38, Financial markets, 4-5, 28-38, 45, 46, 78-79 47, 50, 52-53, 57-58, 62, 76-79 Government, 20-21, 69-70 Government sector, 19-22, 68-70 Household, 13-16, 64-65 Household sector, 8-16, 62-65 Debt services for federal government, Interest rates, 14, 21-22, 34, 35-36, Federal Reserve Banks, 156-157 49-50, 77-78, 311 Defense spending, 60, 62, 69 Labor market, 25-27, 73-74 Delinquencies and foreclosures, 11-12, 19, M2 monetary aggregate, 38, 79 64-65, 68, 85, 146 National saving, 22, 59 Deloitte & Touche LLP (D&T), 160, 345, Outlook and projections, 3-5, 49-56, 355-356, 357 57-62 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

386 94th Annual Report 2007 Economy, U.S.—continued Examinations and inspections—continued Prices, 4, 7, 23-24, 27-28, 39, 41, 46, Securities dealers and brokers, 47, 52, 53, 58, 63, 72, 74-76 government and municipal, 92-93 Edge Act corporations, 86, 89, 90, 110 State member banks, 88 Education, consumer financial, 120-121, Transfer agents, 92 143 Examiners, training, 106-107, 133-134 Electronic access to Federal Reserve Bank Exceptions for Banks from the Definition services, 158-159 of Broker in the Securities Exchange Electronic Fund Transfer Act (EFTA), 124, Act of 1934 (Regulation R), 177-178 148-149 Expenses. (See Income and expenses) Electronic Fund Transfers (Regulation E), Exports, 22-23, 43, 60, 62, 70-71 124, 135-136, 148-149, 175, 176 Extensions of Credit by Federal Reserve Electronic Signatures in Global and Banks (Regulation A), 175 National Commerce Act (E-Sign Act), External sector, developments in, 22-24, 124 70-72 Emerging-market economies, 40-41, 82 Employment, 25-26, 46, 53, 57, 73 Fair and Accurate Credit Transactions Employment cost index (ECI), 26-27, 74 Act (FACT Act), 124-125 Energy prices, 7, 23-24, 27-28, 46, 47, 52, Fair Credit Reporting Act (FCRA), 57, 58, 63, 72, 75, 76, 80 124-125 Enforcement actions Fair Credit Reporting (Regulation V), Federal Reserve System, 93-94, 111 124-125, 178 Other federal agencies, 125-138 Fair Housing Act, 126 Environmental Protection Agency (EPA), Fair lending laws, compliance with, emissions standards for engines, 66 126-129 Equal Credit Opportunity Act (ECOA), Fair Value Measurements, 101 119, 126-129, 135 The Fair Value Option for Financial Assets Equal Credit Opportunity (Regulation B), and Financial Liabilities, 99 124, 134-135, 175 Fannie Mae, 38 Equipment and software, 16-17, 60, 62, Farm Credit Administration (FCA), 93, 65-66 135 Equity markets and prices, 36-37, 39, 46, FedACH Services, 159 58, 67, 77, 78 Federal Advisory Council, members and European Central Bank, swap arrangement officers, 279 with, 45^6, 260, 270 Federal agency securities and obligations Examinations and inspections Commercial bank holdings, 322 Anti-money laundering, 91 Federal Reserve Bank holdings, 310, Bank holding companies, 87-88, 89 314-321 Community Reinvestment Act, Open market transactions, 306-309 compliance with, 130-132 Federal Aviation Act, 137 Consumer protection laws, compliance Federal Banking Agency Audit Act, 376 with, 119, 125-138 Federal Deposit Insurance Act, 88, 99 Edge Act and agreement corporations, Federal Deposit Insurance Corporation 90 (FDIC), 85, 86, 90, 97-98, 101-102, Federal Reserve Banks, 159-160 136 Fiduciary activities, 92 Federal Deposit Insurance Corporation Financial holding companies, 89 Improvement Act of 1991, 88 Foreign banks, 90-91 Federal Emergency Management Agency Information technology activities, 92 (FEMA), 134 International banking activities, 89-91 Federal Financial Institutions Examination Securities clearing agencies, 92 Council (FFIEC), 93, 94, 99, 102, Securities credit lenders, 93 104-105, 134-138 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 387 Federal funds rate, 4-5, 7, 34, 35, 43-47, Federal Reserve Banks—continued 58, 59, 60, 192, 196-197, 204-205, Currency and coin, operations and 212, 213, 217, 221, 225, 230, 234, developments in, 155, 338 239-240, 245-246, 250, 263, 268-269 Debt services for federal government, Federal government 156-157 Federal Reserve Bank services to, Depository services to federal 155-158 government, 155-158 Spending, receipts, and borrowing, Deposits, 315-321 19-21, 68-70 Directors of, 284-300 Federal Housing Enterprise Oversight, Discount rates, 180-182, 311 Office of (OFHEO), 9, 64 Electronic access to services, 158-159 Federal Law Enforcement Training Examinations of, 159-160 Accreditation, 162 Examiner training, 106-107, 133-134 Federal Open Market Committee (FOMC) Federal Law Enforcement Training Authorizations, 186-189 Accreditation, 162 Conference call minutes, 240-241, FedLine Advantage, 158 269-270 FedLine Command, 158, 159 Diversity of participants' views, 53-55, FedLine Direct, 158, 159 255-257 Fedwire Funds Service, 153-154, 158 Domestic policy directives, 43-47, 183, Fedwire Securities Service, 154, 158 196-197, 204-205, 213, 221, 230, Financial statements of, combined, 239-240, 250, 268-269 357-373 Forecast uncertainty, 53, 56, 258 First Vice Presidents, Conference of, 284 Foreign currency directives and Fiscal agency services, 155-158 procedural instructions, 189-190 Float, 154-155 Meetings, minutes of, 183-270 Government depository services, Members, alternate members, and 155-158 officers, 278 Income and expenses, 160-161, Notation votes, 197, 205, 213, 222, 230, 328-337, 360 240, 251, 269 Information technology developments, Summary of economic projections, 159 49-56, 251-258 Interest rates on loans to depository System Open Market Account, 46, 160, institutions, 311 186-190 National Settlement Service, 153-154 Federal Reserve Act, 90, 107, 109-110, Officers, list of, 282-283 159 Officers and employees, number and Federal Reserve Banks salaries of, 339 Assessments by Board of Governors, Operations, volume of, 162, 338 332-337 Payments services, 157 Assets and liabilities of, 324-327 Payments to U.S. Treasury, 155-156, Audits, reviews, and assessments of, 333-337 160, 357-373, 375 Premises of, 162-163, 340 Automated clearinghouse services, 153, Presidents, Conference of, 283 157, 158, 338 Priced services, 151-155, 164-167 Branches of, 282-283, 284-300 Reserve balances, 315-321 Capital accounts, 324-327 Responses to the subprime mortgage Cash-management services, 158 crisis, 14-15 Chairmen, Conference of, 283 Reverse repurchase agreements, 314-317 Check collection and processing, Salaries of officers and employees, 339 152-153, 338 Securities and loans, holdings of, 161, Condition statements, 324-327, 359 310, 314-321 Credit outstanding, 314-321 Statements for priced services, 164-167 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

388 94th Annual Report, 2007 Federal Reserve Banks—continued Fiduciary activities, supervision of, 92 Statements of changes in capital, 361 Finance Statements of condition, 324-327, 359 Business, 17-19, 67-68 Statements of income, 360 Household, 12-16, 64-65 Federal Reserve Consumer Help (FRCH), Financial account, U.S., 24, 72 138, 140-141 Financial Accounting Standards Board Federal Reserve Electronic Tax Application (FASB), 99, 101, 151 (FR-ETA), 157-158 Financial Crimes Enforcement Network Federal Reserve law enforcement officers (FinCEN), 100 (FRLEOs), 162 Financial education, consumer, 120-121, Federal Reserve System. {See also Board 143 of Governors and Federal Reserve Financial holding companies, 87, 89, Banks) 179-180 Audits, reviews, and assessments, 343, Financial Industry Regulatory Authority, 375, 376 111 Banking structure, U.S., regulation of, Financial intermediation, 37-38, 78-79 107-111 Financial markets, 4-5, 28-38, 45, 46, 47, Basel Committee activities, 95, 100, 101 50, 52, 53, 57-58, 62, 76-79 Consumer protection responsibilities, Financial Stability Institute, 95 113-125 Financial statements Decisions, public notice of, 110-111 Board of Governors, 345-356 Enforcement actions, 93-94, 111 Federal Reserve Banks, combined, Information technology developments, 357-373 159 Federal Reserve priced services, International training, 95 164-167 Maps, 378-379 Fiscal agency services, Federal Reserve Membership, 111 Banks, 155-158 Responses to financial strains, 32-33 Float, daily average for Federal Reserve Safety and soundness responsibilities, Banks, 154-155 86-95 Flood insurance, 134 Supervision and regulation FOMC. {See Federal Open Market responsibilities, 86-105 Committee) Supervisory information technology, 105 Foreclosures. {See Delinquencies and Supervisory policy, 95-105 foreclosures) Surveillance and off-site monitoring, 94 Foreign Assets Control, Office of (OFAC), Technical assistance, 95 100 Training and staff development, Foreign Bank Supervision Enhancement 106-107, 133-134 Act, 110 Federal sector, developments in, 19-22, Foreign banks, U.S. activities of, 90-91 68-70 Foreign currency operations Federal tax payments, 157-158 Authorization for conduct of, 187-189 Federal Trade Commission Act, 119, 139 Directives, 189 Federal Trade Commission (FTC), 119, Procedural instructions for, 189-197 125, 135-136 Foreign economies, 39-41, 71-72, 79-82 FedLine Advantage, 158 Foreign operations of U.S. banking FedLine Command, 158, 159 organizations, 89-90, 110 FedLine Direct, 158, 159 Foreign trade, 22-24, 71-72 Fedwire Funds Service, 153-154, 158 Freddie Mac, 38 Fedwire Securities Service, 154, 158 FFIEC (Federal Financial Institutions GDP (gross domestic product), 4, 7, 8, Examination Council), 93, 94, 99, 19, 20, 22, 28, 49, 50, 51, 52-53, 54, 102, 104-105, 134-138 61, 62, 66, 68, 69, 71, 76 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 389 Gold stock, 314-321 Information technology (IT) Government, 20-21, 69-70. (See also Federal Reserve examination of, 92 Federal government and State and in Federal Reserve operations, 159 local governments) supporting Federal Reserve supervision, Government Accountability Office (GAO), 105 376 Inspections. (See Examinations and Government depository services, Federal inspections) Reserve Banks, 155-158 Inspector General, Office of (OIG), 343, Government Performance and Results Act 375 (GPRA), 169-171 Inspector General Act, 375 Government securities, dealers and brokers, Institute for Supply Management, 17 examination of, 92-93 Insured commercial banks. (See Government Securities Act, 92 Commercial banks) Grain Inspection, Packers and Stockyards Inter-American Development Bank, 95 Administration, 135 "Interagency Guidance on Nontraditional Gramm-Leach-Bliley Act, 89, 103, 108, Mortgage Product Risks," 118 148 "Interagency Paper on Sound Practices to Greater Bay Bancorp, acquisition, 132 Strengthen the Resilience of the U.S. "Guidelines for Computing Capital for Financial System," 93 Interest rates, 14, 21-22, 34, 35-36, 49-50, Incremental Default Risk in the 77-78, 80, 311. (See also Discount Trading Book," 100 rates and Federal funds rate) International Accounting Standards Board Home Mortgage Disclosure Act (HMDA), (IASB), 99 119, 127-130, 144 International Association of Insurance Home Mortgage Disclosure (Regulation C), Supervisors, 101 129 International Auditing and Assurance Home Ownership and Equity Protection Standards Board (IAASB), 101 Act (HOEPA), 115-116, 119, International Banking Act, 86, 107-108, 144-146 110 Homeownership counseling programs, International banking activities, supervision 120-121 of, 89-91 HOPE hotline, 120 International Banking Operations Hope Now Alliance, 12, 120-121 (Regulation K), 176 Household sector, 8-16, 62-65 International Monetary Fund, 95 Housing and Urban Development, U.S. International Organization of Securities Department of (HUD), 140 Commissions, 101 Huntington Bancshares, Inc., acquisition, International trade, 22-24, 71-72 132 Inventory investment, 17, 66-67 Investment Identity theft "red Hags," 125 Business sector, 16-19, 58, 60, 61-62, Imports, 23-24, 71-72 65-67 Income and expenses Inventory, 17, 66-67 Board of Governors, 347 Overseas, by U.S. banking organizations, Federal Reserve Banks, 160-161, 110 357-372, 360 Residential, 8-12, 63-64 Federal Reserve priced services, 165 Treasury securities, 31, 34 Industrial economies, 40, 81-82 Inflation, 3, 4, 7, 24, 27, 28, 43-47, 50-52, Joint Forum, 100-101 53, 55, 57, 58-59, 62, 74, 75-76 Justice, U.S. Department of Influenza pandemic, planning for, 102 Discrimination cases, investigation and Information Security Architecture review of, 126-127, 128-129 Framework (ISAF), 159 Views on bank mergers, 109 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

390 94th Annual Report, 2007 Labor market, 25-27, 73-74 Middle East and North Africa Financial Large complex banking organizations Regulators' Training Initiative, 95 (LCBOs), supervision of, 88 Minority-owned financial institutions, 133 Liabilities. {See Assets and liabilities) Monetary aggregate (M2), 38, 79 Litigation involving Board of Governors Monetary Control Act, 151 Artis, 271 Monetary policy, 3-5, 43-47, 57-62. {See Barnes, 271 also Federal Open Market Committee) Chandler, 271 Monetary Policy Reports to the Congress Inner City Press/Community on the February 2008, 3-56 Move, 271 July 2007, 57-82 Interactive Media Entertainment and Money-laundering prevention, 91 Gaming Association, 271 Mortgage interest rates, 30, 145 Jones, 271 Mortgage products, nontraditional, 3, Price, 271 113-121, 144-146, 179. {See also Smith, 271 Subprime mortgage products) Loans, Federal Reserve Bank holdings, Municipal securities, dealers and brokers, 161 examination of, 92-93 Loans to Executive Officers, Directors, and Principal Shareholders of Member National Credit Union Administration Banks (Regulation O), 177 (NCUA), 85, 86, 93, 101-102 Local governments, 21-22, 70 National Examination Database (NED), Loss-mitigation strategies, 12, 102, 105, 106 118-119, 179 National Flood Insurance Act, 134 National Flood Mitigation Fund, 134 Management Official Interlocks National income and product accounts (Regulation L), 177 (NIPA), 20, 21, 67, 68, 69, 70, 74, 76 Maps, Federal Reserve System, 378-379 National Information Center (NIC), 94, Margin requirements, 323 105-106 Market risk capital rule, 97-98 National Information Security Assurance, Medicare Part D prescription drug 159 program, 69 National saving, 22, 59, 69 Mellon Financial Corporation, merger, 132 National Settlement Service, 153-154, 159 Member banks. {See also State member Neighbor Works America, 120 banks) Nonmember banks Assets and liabilities, 322 Assets and liabilities, 322 Examination of foreign operations, Foreign operations, 90 89-90 Number of, 313 Number of, 313 Notes, Federal Reserve, 324-327. {See also Reserves, 314-321 Currency and coin) Members and officers Notice of proposed rulemaking (NPR), Board of Governors, 275-277 97-98 Consumer Advisory Council, 280 NYMEX oil futures contract, 23 Federal Advisory Council, 279 Federal Open Market Committee, 278 Office of Federal Housing Enterprise Federal Reserve Banks and Branches, Oversight (OFHEO), 9, 64 282-283 Office of Foreign Assets Control (OFAC), Thrift Institutions Advisory Council, 281 100 Membership of State Banking Institutions Office of Inspector General (OIG), 343, in the Federal Reserve System 375 (Regulation H), 134, 176 Office of the Comptroller of the Currency Mercantile Bankshares Corporation, (OCC), 85, 86, 93, 95, 97-98, acquisition, 132 101-102, 136 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 391 Office of Thrift Supervision (OTS), 85, 86, PRISM (Performance Report Information 93, 95, 101-102, 119, 135, 136-138 and Surveillance Monitoring), 94 Oil prices. {See Energy prices) Privacy of Consumer Financial Information Open market operations (Regulation P), 136 Authorization for conduct of, 186-187 Private-sector adjustment factor (PSAF), Volume of transactions, 306-309 151-152, 154 Operations, volume of, Federal Reserve Productivity, 26-27, 73-74 Banks, 162, 338 Profits, corporate, 17-19, 67-68 Outreach activities, 119-121 Public notice, Federal Reserve decisions, 110-111 Pandemic, planning for, 102 Paper Check Conversion and Electronic Racial discrimination. {See Check Processing, Treasury Discrimination) Department programs, 158 Real estate, complaints related to, 138-139 Pay.gov, 158 Real Estate Settlement Procedures Act, 119 Payments services, Federal Reserve Banks, Regulations 157 A, Extensions of Credit by Federal Payments to U.S. Treasury, Federal Reserve Reserve Banks, 175 Banks, 155-156, 332-337 B, Equal Credit Opportunity, 124, PCE (personal consumption expenditures), 134-135, 175 4, 7, 13, 27-28, 45, 50-51, 53, 55, 57, C, Home Mortgage Disclosure, 129 58, 61, 63, 74-75, 76 D, Reserve Requirements of Depository Performance Report Information and Institutions, 175-176, 312 Surveillance Monitoring (PRISM), E, Electronic Fund Transfers, 124, 94 135-136, 148-149, 175, 176 PNC Financial Services Group, Inc., H, Membership of State Banking acquisition, 132 Institutions in the Federal Reserve Policy actions System, 134, 176 Board of Governors, 175-182 K, International Banking Operations, 176 Federal Open Market Committee, 43-47, L, Management Official Interlocks, 177 49-56, 59-62, 183-270 M, Consumer Leasing, 124, 136, 175 Premises, Federal Reserve Banks, 162-163, O, Loans to Executive Officers, 340 Directors, and Principal Prepayment penalties, mortgage products, Shareholders of Member Banks, 117, 144 177 Presidential $1 Coin Act, 155 P, Privacy of Consumer Financial Priced services, Federal Reserve Banks, Information, 136 151-155, 164-167 R, Exceptions for Banks from the Prices Definition of Broker in the Consumer, 4, 27-28, 41, 75 Securities Exchange Act of 1934, Energy, 7, 23-24, 27-28, 46, 47, 52, 57, 177-178 58, 63, 72, 75, 76, 80 T, Credit by Brokers and Dealers, 111, Equity, 36-37, 39, 46, 58 323 Exports and imports, 22-24, 43, 60, 62, U, Credit by Banks or Persons Other 70-72 Than Brokers or Dealers for the Pricewaterhouse Coopers LLP, 358 Purpose of Purchasing or Carrying Primary credit rate, 180, 311 Margin Stock, 93, 111, 323 "Principles for Home-Host Supervisory V, Fair Credit Reporting, 124-125, 178 Cooperation and Allocation X, Borrowers of Securities Credit, 111, Mechanisms in the Context of 323 Advanced Measurement Approaches," Y, Bank Holding Companies and Change 100 in Bank Control, 176-177 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

392 94th Annual Report, 2007 Regulations—continued Senior Loan Officer Opinion Survey on Z, Truth in Lending, 116, 122-123, 124, Bank Lending Practices, 9, 13, 18, 19, 136-137, 144, 146-148, 175 38, 65, 67, 68 AA, Unfair and Deceptive Acts and Sky Financial Group, Inc., acquisition, 132 Practices, 137 Small Business Administration, 135 CC, Availability of Funds and Collection Software. (See Equipment and software) of Checks, 137, 149 "Sound Practices for Managing Liquidity in DD, Truth in Savings, 124, 137-138, Banking Organisations," 100 175 Special drawing rights certificate account, Reports of Condition and Income (Call 314-321 Reports), 94, 104-105 SSIT. (See System supervisory information Repurchase Agreement Program, 158 technology) Reserve requirements, depository Staff development, Federal Reserve, institutions, 312 106-107, 133-134 Reserve Requirements of Depository State and local governments, 21-22, 70 Institutions (Regulation D), 175-176 State member banks. (See also Member Residential investment, 8-12, 63-64 banks) Reuters/University of Michigan Surveys of Assets and liabilities, 85, 87 Consumers, 28, 76 Complaints against, 138-140 Revenue. (See Income and expenses) Examinations of, 87, 88 Reverse repurchase agreements, Federal Fair lending violations, 126-127 Reserve Banks, 314-317 Financial disclosures, 111 Riegle Community Development and Financial subsidiaries, 109-110 Regulatory Improvement Act of 1994, Number of, 87, 88, 313 88 Surveillance and off-site monitoring, 94 Risk-focused supervision, Federal Reserve Unregulated practices, 139 System, 88 "Statement on Loss Mitigation Strategies Risk management, 88, 95-98, 100, for Servicers of Residential 101-102, 178-179 Mortgages," 118-119 "Statement on Subprime Mortgage Salaries, Federal Reserve Bank officers Lending," 65, 101-102, 118 and employees, 339 "Statement on Unfair or Deceptive Acts or Sarbanes-Oxley Act, 160 Practices (UDAP) by State-Chartered Secondary and seasonal credit rate, 181, Banks," 133 311 "Statement on Working with Mortgage Securities. (See also Federal agency Borrowers," 117-118, 131-132 securities and Treasury securities) Stocks Banks' activities, 102-103 Margin requirements, 323 Clearing agencies, examinations of, 92 Price indexes, 37, 39, 78 Credit lenders, examination of, 93 Subprime mortgage products, 3-4, 8, Government and municipal, examination 10-11, 14-15, 28-30, 37, 43, 44, of dealers and brokers, 92-93 57-58, 59, 60, 62, 76-77, 80, 85-86, Transfer agents, 92 101-102, 114-121, 144-145, 146, Securities Act Amendments, 93 179. (See also Mortgage products, Securities and Exchange Commission nontraditional) (SEC), 93, 125, 135 Overview, 114-115 Advisory Committee on Improvements Supervision and regulation responsibilities, to Financial Reporting, 99 Federal Reserve System, 86-105 Banks' securities activities, 102-103 Supervision and Regulation Statistical Securities credit, 93, 111 Assessment of Bank Risk (SR-SABR), Securities Exchange Act, 92, 93, 111 94 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Index 393 Surveillance and off-site monitoring, 94 Treasury, U.S. Department of Survey of Professional Forecasters, 28, the—continued 76 Payments to, by Federal Reserve Banks, Swap arrangements, 45-46, 187-189, 206, 160-161, 332-337 260, 270 Treasury securities Swiss National Bank, swap arrangement Commercial bank holdings, 322 with, 45^6, 260 Federal Reserve Bank holdings, 161, System Community Affairs, 142 310, 314-321 System Open Market Account (SOMA). Foreign purchases of, 24, 69-70, 72 {See Federal Open Market Committee Investment in, 31, 34 and Open market operations) Open market transactions, 306-309, 310 System supervisory information technology Repurchase and reverse repurchase (SSIT), 105-106 agreements, 314-321 Yields, 35-36, 77, 78 Technical assistance to foreign banking Treasury Tax and Loan (TT&L) program, authorities, 95 158 Term Auction Facility (TAF), 32-33, Truth in Lending Act (TILA), 115-116, 45-46, 161, 162, 175, 181,266, 119, 145 269-270 Truth in Lending (Regulation Z), 116, 122, Thrift Institutions Advisory Council, 281 124, 136-137, 144, 146-148, 175 Thrift Supervision, Office of (OTS), 85, 86, Truth in Savings (Regulation DD), 124, 93, 95, 101-102, 119, 135, 136-138 137-138, 175 Trade, international, 22-24, 71-72 Training and development, Federal Reserve Unemployment, 25-26, 49, 50, 51, 52-53, staff, 106-107, 133-134, 162 54, 61, 62, 73 Transfer agents, examination of, 92 Unfair and Deceptive Acts and Practices Transportation, U.S. Department of, 135, (Regulation AA), 137 137 Uniform Bank Performance Reports, 94 Treasury, U.S. Department of the Unregulated practices, state member banks, Cash holdings, 314-321 139 Cash-management services, 158 U.S. Trust Corporation, acquisition, 132 Currency outstanding and in circulation, 314-321 Wells Fargo & Company, acquisition, Discontinued auction of three-year 132 nominal notes, 21, 69 West Texas intermediate crude oil prices, Office of Foreign Assets Control, 100 23,72 Paper Check Conversion and Electronic World Bank, 95 Check Processing programs, 158 Payments processed for, 157 Yield-spread premiums (YSPs), 145-146 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis