View PDF

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

98th Annual Report
2011

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

98th Annual Report
2011

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

2011 Annual Report Errata
On p. 83, under ‘‘Performance of bank holding companies’’ the fourth sentence was printed incorrectly and has
been revised. (5/24/12)

To order additional copies of this or other Federal Reserve Board publications, contact:
Publications Fulfillment
Mail Stop N-127
Board of Governors of the Federal Reserve System
Washington, DC 20551
(ph) 202-452-3245
(fax) 202-728-5886
(e-mail) Publications-BOG@frb.gov
This and other Federal Reserve Board reports are also available online at
www.federalreserve.gov/pubs/alpha.htm.

Letter of Transmittal

Board of Governors of the Federal Reserve System
Washington, D.C.
May 2012
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-eighth
annual report of the Board of Governors of the Federal Reserve System.
This report covers operations of the Board during calendar year 2011.
Sincerely,

Ben Bernanke
Chairman

i

Contents

Overview

..................................................................................................................................... 1

About this Report ....................................................................................................................... 1
About the Federal Reserve System .............................................................................................. 1

Monetary Policy and Economic Developments

............................................................ 5

Monetary Policy Report of February 2012 .................................................................................... 5
Monetary Policy Report of July 2011 .......................................................................................... 55

Supervision and Regulation ................................................................................................ 83
2011 Developments .................................................................................................................. 83
Supervision .............................................................................................................................. 84
Regulation .............................................................................................................................. 107

Consumer and Community Affairs ................................................................................ 111
Rulemaking and Regulations ................................................................................................... 111
Oversight and Enforcement ..................................................................................................... 115
Responding to Consumer Complaints and Inquiries .................................................................. 125
Consumer Policy and Emerging Issues Analysis ....................................................................... 127
Supporting Community Economic Development ....................................................................... 127
Consumer Advisory Council ..................................................................................................... 129

Federal Reserve Banks ........................................................................................................ 135
Federal Reserve Priced Services .............................................................................................. 135
Currency and Coin .................................................................................................................. 138
Fiscal Agency and Government Depository Services ................................................................. 139
Use of Federal Reserve Intraday Credit .................................................................................... 141
Electronic Access to Reserve Bank Services ............................................................................ 142
Information Technology ........................................................................................................... 142
Examinations of the Federal Reserve Banks ............................................................................. 143
Income and Expenses ............................................................................................................. 144
SOMA Holdings and Loans ...................................................................................................... 145
Federal Reserve Bank Premises ............................................................................................... 146

Other Federal Reserve Operations .................................................................................. 155
Regulatory Developments: Dodd-Frank Act Implementation ...................................................... 155
The Board of Governors and the Government Performance and Results Act .............................. 163

ii

Record of Policy Actions of the Board of Governors ............................................. 165
Rules and Regulations ............................................................................................................. 165
Policy Statements and Other Actions ....................................................................................... 169
Discount Rates for Depository Institutions in 2011 .................................................................... 170

Minutes of Federal Open Market Committee Meetings ......................................... 173
Meeting Held on January 25–26, 2011 ...................................................................................... 174
Meeting Held on March 15, 2011 ............................................................................................. 200
Meeting Held on April 26–27, 2011 ........................................................................................... 210
Meeting Held on June 21–22, 2011 .......................................................................................... 231
Meeting Held on August 9, 2011 .............................................................................................. 252
Meeting Held on September 20–21, 2011 ................................................................................. 262
Meeting Held on November 1–2, 2011 ...................................................................................... 274
Meeting Held on December 13, 2011 ....................................................................................... 296

Litigation ................................................................................................................................. 309
Statistical Tables .................................................................................................................... 311
Federal Reserve System Audits ........................................................................................ 339
Board of Governors Financial Statements ................................................................................. 340
Federal Reserve Banks Combined Financial Statements ........................................................... 361
Office of Inspector General Activities ........................................................................................ 427
Government Accountability Office Reviews ............................................................................... 428

Federal Reserve System Organization

........................................................................... 431

Board of Governors ................................................................................................................. 431
Federal Open Market Committee ............................................................................................. 436
Board of Governors Advisory Councils ..................................................................................... 437
Federal Reserve Bank Branches .............................................................................................. 440

Index ......................................................................................................................................... 457

1

Overview

The Federal Reserve, the central bank of the United
States, is a federal system composed of a central governmental agency—the Board of Governors—and 12
regional Federal Reserve Banks.
The Board of Governors, located in Washington,
D.C., consists of seven members appointed by the
President of the United States and supported by a
2,400-person staff. Besides conducting research,
analysis, and policymaking related to domestic and
international financial and economic matters, the
Board plays a major role in the supervision and regulation of U.S. financial institutions and activities, has
broad oversight responsibility for the nation’s payments system and the operations and activities of the
Federal Reserve Banks, and plays an important role
in promoting consumer protection, fair lending, and
community development.

About this Report
This report covers Board and System operations and
activities during calendar-year 2011. The report
includes 11 sections:
• Monetary Policy and Economic Developments.
Section 1 provides adapted versions of the Board’s
semiannual monetary policy reports to Congress.

For More Background on Board
Operations
For more information about the Federal Reserve
Board and the Federal Reserve System, visit the
Board’s website at www.federalreserve.gov/
aboutthefed/default.htm. An online version of this
Annual Report is available at www.federalreserve
.gov/pubs/alpha.htm.

by the Board in 2011, including new or amended
rules and regulations and other actions as well as
the deliberations and decisions of the Federal Open
Market Committee (FOMC); Section 8 summarizes litigation involving the Board.1
• Statistical Tables. Section 9 includes 14 statistical
tables that provide updated historical data concerning Board and System operations and activities.
• Federal Reserve System Audits. Section 10 provides
detailed information on the several levels of audit
and review conducted in regards to System operations and activities, including those provided by
outside auditors and the Board’s Office of Inspector General.
• Federal Reserve System Organization. Section 11
provides listings of key officials at the Board and in
the Federal Reserve System, including the Board of
Governors, its officers, FOMC members, several
System councils, and Federal Reserve Bank and
Branch officers and directors.

• Federal Reserve Operations. Section 2 provides a
summary of Board and System activities in the
areas of supervision and regulation; Section 3, in
consumer and community affairs; and Section 4, in
Reserve Bank operations.

About the Federal Reserve System

• Dodd-Frank Act Implementation and Other
Requirements. Section 5 summarizes the Board’s
efforts in 2011 to implement provisions of the
Dodd-Frank Wall Street Reform and Consumer
Protection Act as well as the Board’s compliance
with the Government Performance and Results Act
of 1993.

The Federal Reserve System, which serves as the
nation’s central bank, was created by an act of Congress on December 23, 1913. The System consists of
a seven-member Board of Governors with headquarters in Washington, D.C., and the 12 Reserve Banks
located in major cities throughout the United States.

• Policy Actions and Litigation. Section 6 and
Section 7 provide accounts of policy actions taken

1

For more information on the FOMC, see the Board’s website at
www.federalreserve.gov/monetarypolicy/fomc.htm.

2

98th Annual Report | 2011

The Federal Reserve Banks are the operating arms of
the central banking system, carrying out a variety of
System functions, including operating a nationwide
payment system; distributing the nation’s currency
and coin; under authority delegated by the Board of
Governors, supervising and regulating a variety of
financial institutions and activities; serving as fiscal
agents of the U.S. Treasury; and providing a variety
of financial services for the Treasury, other government agencies, and other fiscal principals.
The maps below and opposite identify Federal
Reserve Districts by their official number, city, and
letter designation.

■ Federal Reserve Bank city
■ Board of Governors of the Federal Reserve System, Washington, D.C.
N

Overview

■ Federal Reserve Bank city
● Federal Reserve Branch city
■ Board of Governors of the Federal Reserve System, Washington, D.C.
N
— Branch boundary

3

5

Monetary Policy and Economic
Developments

As required by section 2B of the Federal Reserve Act,
the Federal Reserve Board submits written reports to
the Congress that contain discussions of “the conduct of monetary policy and economic developments
and prospects for the future.” The Monetary Policy
Report to the Congress, submitted semiannually to the
Senate Committee on Banking, Housing, and Urban
Affairs and to the House Committee on Banking and
Financial Services, is delivered concurrently with testimony from the Federal Reserve Board Chairman.
The following discussion is an annual review of U.S.
monetary policy and economic developments in 2011.
It includes the text, tables, and selected figures from
the February 29, 2012, report; the figures have been
renumbered, and therefore the figure numbers differ
from those in the report. Also included are the text
and table from Parts 1–3 of the July 13, 2011, report;
Part 4 of that report is identical to the addendum to
the minutes of the June 21−22, 2011, meeting of the
Federal Open Market Committee (FOMC) and is
presented with those minutes in the “Minutes” section of this annual report.
The complete Monetary Policy Reports are available
on the Board’s website. Other materials in this annual
report related to the conduct of monetary policy
include the minutes of the 2011 meetings of the
FOMC (see the “Minutes” section on page 173) and
statistical tables 1–4 (see the “Statistical Tables”
section on page 311).

Monetary Policy Report
of February 2012
Part 1
Overview: Monetary Policy
and the Economic Outlook
Economic activity in the United States expanded at a
moderate rate in the second half of 2011 following an
anemic gain in the first half, and the moderate pace

of expansion appears to have continued into the
opening months of 2012. Activity was held down in
the first half of 2011 by temporary factors, particularly supply chain disruptions stemming from the
earthquake in Japan and the damping effect of
higher energy prices on consumer spending. As the
effects of these factors waned over the second half of
the year, economic activity picked up. Conditions in
the labor market have improved since last summer,
with an increase in the pace of job gains and a
noticeable reduction in the unemployment rate.
Meanwhile, consumer price inflation has stepped
down from the temporarily high levels observed over
the first half of 2011, as commodity and import
prices retreated and as longer-term inflation expectations remained stable. Looking ahead, growth is
likely to be modest during the coming year, as several
factors appear likely to continue to restrain activity,
including restricted access to credit for many households and small businesses, the still-depressed housing market, tight fiscal policy at all levels of government, and some slowing in global economic growth.
In light of these conditions, the Federal Open Market
Committee (FOMC) took a number of steps during
the second half of 2011 and early 2012 to provide
additional monetary policy accommodation and
thereby support a stronger economic recovery in the
context of price stability. These steps included modifying the forward rate guidance included in postmeeting statements, increasing the average maturity of the
Federal Reserve’s securities holdings, and shifting the
reinvestment of principal payments on agency securities from Treasury securities to agency-guaranteed
mortgage-backed securities (MBS).
Throughout the second half of 2011 and early 2012,
participants in financial markets focused on the fiscal
and banking crisis in Europe. Concerns regarding the
potential for spillovers to the U.S. economy and
financial markets weighed on investor sentiment,
contributing to significant volatility in a wide range
of asset prices and at times prompting sharp pullbacks from risk-taking. Strains eased somewhat in a

6

98th Annual Report | 2011

number of financial markets in late 2011 and early
this year as investors seemed to become more confident that European policymakers would take the
steps necessary to address the crisis. The more positive market sentiment was bolstered by recent U.S.
data releases, which pointed to greater strength, on
balance, than investors had expected. Nonetheless,
market participants reportedly remain cautious
about risks in the financial system, and credit default
swap spreads for U.S. financial institutions have widened, on net, since early last summer.
After rising at an annual rate of just ¾ percent in the
first half of 2011, real gross domestic product (GDP)
is estimated to have increased at a 2¼ percent rate in
the second half.1 The growth rate of real consumer
spending also firmed a bit in the second half of the
year, although the fundamental determinants of
household spending improved little: Real household
income and wealth stagnated, and access to credit
remained tight for many potential borrowers. Consumer sentiment has rebounded from the summer’s
depressed levels but remains low by historical standards. Meanwhile, real investment in equipment and
software and exports posted solid gains over the second half of the year. In contrast, the housing market
remains depressed, weighed down by the large inventory of vacant houses for sale, the substantial volume
of distressed sales, and homebuyers’ concerns about
the strength of the recovery and the potential for further declines in house prices. In the government sector, real purchases of goods and services continued to
decline over the second half of the year.
Labor market conditions have improved. The unemployment rate moved down from around 9 percent
over the first eight months of 2011 to 8¼ percent in
January 2012. However, even with this improvement,
the jobless rate remains quite elevated. Furthermore,
the share of the unemployed who have been jobless
for more than six months, although down slightly
from its peak, was still above 40 percent in January—
roughly double the fraction that prevailed during the
economic expansion of the previous decade. Meanwhile, private payroll employment gains averaged
165,000 jobs per month in the second half of 2011, a
bit slower than the pace in the first half of the year,
but gains in December and January were more
robust, averaging almost 240,000 per month.
1

The numbers in this report are based on the Bureau of Economic Analysis’s (BEA) advance estimate of fourth-quarter
GDP, which was released on January 27, 2012. The BEA will
release a revised estimate on February 29, 2012.

Consumer price inflation stepped down in the second
half of 2011. After rising at an annual rate of
3½ percent in the first half of the year, prices for personal consumption expenditures (PCE) rose just
1½ percent in the second half. PCE prices excluding
food and energy also decelerated, rising at an annual
rate of roughly 1½ percent in the second half of
2011, compared with about 2 percent in the first half.
The decline in inflation was largely in response to
decreases in global commodity prices following their
surge early in 2011, as well as a restoration of supply
chains for motor vehicle production that had been
disrupted after the earthquake in Japan and some
deceleration in the prices of imported goods other
than raw commodities.
The European fiscal and banking crisis intensified in
the second half of the year. During the summer, the
governments of Italy and Spain came under significant financial pressure and borrowing costs increased
for many euro-area governments and banks. In early
August, the European Central Bank (ECB)
responded by resuming purchases of marketable debt
securities. Although yields on the government debt of
Italy and Spain temporarily moved lower, market
conditions deteriorated in the fall and funding pressures for some governments and banks increased further. Over the second half of the year, European
leaders worked toward bolstering the financial backstop for euro-area governments, reinforcing the fiscal
discipline of those governments, and strengthening
the capital and liquidity positions of banks. Additionally, the ECB made a significant injection of euro
liquidity via its first three-year refinancing operation,
and central banks agreed to reduce the price of U.S.
dollar liquidity based on swap lines with the Federal
Reserve. Since December, following these actions,
yields on the debt of vulnerable European governments declined to some extent and funding pressures
on European banks eased.
A number of sources of investor anxiety—including
the European crisis, concerns about the sustainability
of U.S. fiscal policy, and a slowdown in global
growth—weighed on U.S. financial markets early in
the second half of 2011. More recently, these concerns eased somewhat, reflecting actions taken by
global central banks as well as U.S. data releases that
pointed to greater strength, on balance, than market
participants had anticipated. Broad equity prices fell
notably in August but subsequently retraced, and
they are now little changed, on net, since early July.
Corporate bond spreads remain elevated. Partly as a
result of the forward guidance and ongoing maturity

Monetary Policy and Economic Developments

extension program provided by the Federal Reserve,
market participants expect the target federal funds
rate to remain low for a longer period than they
thought early last July, and Treasury yields have
moved down significantly. Meanwhile, measures of
inflation compensation over the next five years
derived from yields on nominal and inflation-indexed
Treasury securities are little changed, on balance,
though the forward measure 5-to-10 years ahead
remains below its level in the middle of last year.
Among nonfinancial corporations, larger and highercredit-quality firms with access to capital markets
took advantage of generally attractive financing conditions to raise funds in the second half of 2011. On
the other hand, for smaller firms without access to
credit markets and those with less-solid financial situations, borrowing conditions remained more challenging. Reflecting these developments, investmentgrade nonfinancial corporations continued to issue
debt at a robust pace while speculative-grade issuance
declined, as investors’ appetite for riskier assets
diminished. Similar issuance patterns were evident in
the market for syndicated loans, where investmentgrade issuance continued to be strong while that of
higher-yielding leveraged loans fell back. In addition,
commercial and industrial (C&I) loans on banks’
books expanded strongly, particularly for larger
domestic banks that are most likely to lend to big
firms. According to the January Senior Loan Officer
Opinion Survey on Bank Lending Practices
(SLOOS), domestic banks eased terms on C&I loans
and experienced increased loan demand during the
fourth quarter of the year, the latter development in
part reflecting a shift in some borrowing away from
European banks.2 By contrast, although credit supply conditions for smaller firms appear to have eased
somewhat in the last several months, they remained
tighter relative to historical norms than for larger
firms. Commercial mortgage debt continued to
decline through the third quarter of 2011, albeit at a
more moderate pace than in 2010.
Household debt appears to have declined at a slightly
slower pace in the second half of 2011 than in the
first half, with the continued contraction in mortgage
debt partially offset by growth in consumer credit.
Even though mortgage rates continued to be near
historically low levels, the volume of new mortgage
loans remained muted. The smaller quantity of new
mortgage origination reflects potential buyers’ lack
2

The SLOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/boarddocs/SnLoanSurvey.

7

of either the down payment or credit history required
to qualify for these loans, and many appear reluctant
to buy a house now because of concerns about their
income prospects and employment status, as well as
the risk of further declines in house prices. Delinquency rates on most categories of residential mortgages edged lower but stayed near recent highs, and
the number of properties in the foreclosure process
remained elevated. Issuance of consumer assetbacked securities in the second half of 2011 ran at
about the same rate as it had over the previous
18 months. A modest net fraction of SLOOS respondents to both the October and January surveys indicated that they had eased their standards on all categories of consumer loans.
Measures of the profitability of the U.S. banking
industry have edged up, on net, since mid-2011, as
indicators of credit quality continued to show signs
of improvement and banks trimmed noninterest
expenses. Meanwhile, banks’ regulatory capital ratios
remained at historically high levels, as authorities
continued to take steps to enhance their regulation of
financial institutions. Nonetheless, conditions in
unsecured interbank funding markets deteriorated.
Strains were particularly evident for European financial institutions, with funding costs increasing and
maturities shortening, on balance, as investors
focused on counterparty credit risk amid growing
anxiety about the ongoing crisis in Europe. Given
solid deposit growth and modest expansion in bank
credit across the industry, most domestic banks
reportedly had limited need for unsecured funding.
Concerns about the condition of financial institutions gave rise to heightened investor anxiety regarding counterparty exposures during the second half of
2011. Responses to the December Senior Credit Officer Opinion Survey on Dealer Financing Terms, or
SCOOS, indicated that dealers devoted increased
time and attention to the management of concentrated credit exposures to other financial intermediaries over the previous three months, and 80 percent
of dealers reported reducing credit limits for some
specific counterparties.3 Respondents also reported a
broad but moderate tightening of credit terms applicable to important classes of counterparties over the
previous three months, importantly reflecting a worsening in general market liquidity and functioning as
well as a reduced willingness to take on risk.

3

The SCOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/econresdata/releases/scoos.htm.

8

98th Annual Report | 2011

In order to support a stronger economic recovery
and help ensure that inflation, over time, is at levels
consistent with its dual mandate, the FOMC provided additional monetary policy accommodation
during the second half of 2011 and early 2012. In
August, the Committee modified its forward rate
guidance, noting that economic conditions were
likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. The
FOMC decided at its September meeting to extend
the average maturity of its Treasury holdings, and to
reinvest principal payments from its holdings of
agency debt and agency MBS in agency MBS rather
than in Treasury securities.4 Finally, at the Committee’s January 2012 meeting, the FOMC modified its
forward guidance to indicate that it expected economic conditions to warrant exceptionally low levels
for the federal funds rate at least through late 2014.
The Committee noted that it would regularly review
the size and composition of its securities holdings
and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in the
context of price stability.
In addition to these policy actions, the Federal
Reserve took further steps to improve communications regarding its monetary policy decisions and
deliberations. At the Committee’s January 2012
meeting, the FOMC released a statement of its
longer-run goals and policy strategy in an effort to
enhance the transparency, accountability, and effectiveness of monetary policy and to facilitate wellinformed decisionmaking by households and businesses. The statement emphasizes the Federal
Reserve’s firm commitment to pursue its congressional mandate to promote maximum employment,
stable prices, and moderate long-term interest rates.
To clarify how it seeks to achieve these objectives, the
FOMC stated that inflation at the rate of 2 percent,
as measured by the annual change in the PCE price
index, is most consistent over the longer run with the
Federal Reserve’s statutory mandate. While noting
that the Committee’s assessments of the maximum
level of employment are necessarily uncertain and
subject to revision, the statement indicated that the
central tendency of FOMC participants’ current estimates of the longer-run normal rate of unemployment is between 5.2 and 6.0 percent. It stressed that
the Federal Reserve’s statutory objectives are gener4

Between the August 2010 and September 2011 FOMC meetings, principal payments from securities held on the Federal
Reserve balance sheet had been reinvested in longer-term Treasury securities.

ally complementary, but when they are not, the Committee will follow a balanced approach in its efforts
to return both inflation and employment to levels
consistent with its mandate.
In addition, the January Summary of Economic Projections (SEP) provided information for the first time
about FOMC participants’ individual assessments of
the appropriate timing of the first increase in the target federal funds rate given their view of the economic situation and outlook, as well as participants’
assessments of the appropriate level of the target federal funds rate in the fourth quarter of each year
through 2014 and over the longer run. The SEP also
included qualitative information regarding individual
participants’ expectations for the Federal Reserve’s
balance sheet under appropriate monetary policy.
The economic projections in the January SEP (presented in Part 4 of this report) indicated that FOMC
participants (the members of the Board of Governors and the presidents of the 12 Federal Reserve
Banks) generally anticipated aggregate output to
increase at a somewhat faster pace in 2012 than in
2011. Although the participants marked down their
GDP growth projections slightly compared with
those prepared in November, they stated that the economic information received since that time showed
continued gradual improvement in the pace of economic activity during the second half of 2011, as the
influence of the temporary factors that damped
activity in the first half of the year subsided. However, a number of additional factors, including ongoing weakness in the housing sector, modest growth in
real disposable income, and the restraining effects of
fiscal consolidation, suggested that the pace of the
recovery would be modest in coming quarters. Participants also read the information on economic
activity abroad, particularly in Europe, as pointing to
weaker demand for U.S. exports. As these factors
wane, FOMC participants anticipated that the pace
of the economic expansion will gradually strengthen
over the 2013–14 period, pushing the rate of increase
in real GDP above their estimates of the longer-run
rate of output growth. With real GDP expected to
increase at a modest rate in 2012, the unemployment
rate was projected to decline only a little this year.
Participants expected further gradual improvement in
labor market conditions over 2013 and 2014 as the
pace of output growth picks up. They also noted that
inflation expectations had remained stable over the
past year despite fluctuations in headline inflation.
Most participants anticipated that both headline and

Monetary Policy and Economic Developments

9

core inflation would remain subdued over the
2012–14 period at rates at or below the FOMC’s
longer-run objective of 2 percent.

Part 2
Recent Economic
and Financial Developments

With the unemployment rate projected to remain
elevated over the projection period and inflation
expected to be subdued, most participants expected
that the federal funds rate would remain extraordinarily low for some time. Six participants anticipated
that, under appropriate monetary policy, the first
increase in the target federal funds rate would occur
after 2014, and five expected policy firming to commence during 2014. The remaining six participants
judged that raising the federal funds rate sooner
would be required to forestall inflationary pressures
or avoid distortions in the financial system. All of the
individual assessments of the appropriate target federal funds rate over the next few years were below the
participants’ estimates of the longer-run level of the
federal funds rate. Eleven of the 17 participants
placed the target federal funds rate at 1 percent or
lower at the end of 2014, while 5 saw the appropriate
rate as 2 percent or higher.

Real gross domestic product (GDP) increased at an
annual rate of 2¼ percent in the second half of 2011,
according to the advance estimate prepared by the
Bureau of Economic Analysis, following growth of
less than 1 percent in the first half (figure 1). Activity
was held down in the first half of the year by temporary factors, particularly supply chain disruptions
stemming from the earthquake in Japan and the
damping effect of higher energy prices on consumer
spending. As the effects of these factors waned over
the second half of the year, the pace of economic
activity picked up. But growth remained quite modest compared with previous economic expansions,
and a number of factors appear likely to continue to
restrain the pace of activity into 2012; these factors
include restricted access to credit for many households and small businesses, the depressed housing
market, tight fiscal policy, and the spillover effects of
the fiscal and financial difficulties in Europe.

A sizable majority of participants continued to judge
the level of uncertainty associated with their projections for real activity and the unemployment rate as
exceeding the average of the past 20 years. Many also
attached a greater-than-normal level of uncertainty
to their forecasts for inflation. As in November, many
participants saw downside risks attending their forecasts of real GDP growth and upside risks to their
forecasts of the unemployment rate; most participants viewed the risks to their inflation projections as
broadly balanced. Participants also reported their
assessments of the values to which key macroeconomic variables would be expected to converge over
the longer term under appropriate monetary policy
and in the absence of further shocks to the economy.
The central tendencies of these longer-run projections were 2.3 to 2.6 percent for real GDP growth
and 5.2 to 6.0 percent for the unemployment rate. In
light of the 2 percent inflation that is the objective
included in the statement of longer-run goals and
policy strategy adopted at the January meeting, the
range and central tendency of participants’ projections of longer-run inflation were all equal to
2 percent.

Conditions in the labor market have improved since
last summer. The pace of private job gains has
increased, and the unemployment rate has moved
lower. Nonetheless, at 8¼ percent, the jobless rate is
still quite elevated. Meanwhile, consumer price inflaFigure 1. Change in real gross domestic product, 2005–11
Percent, annual rate

H1

4
Q4

H2
Q3
H1

2
+
0
_
2
4

2005

2006

2007

2008

2009

2010

2011

Note: Here and in subsequent figures, except as noted, change for a given period
is measured to its final quarter from the final quarter of the preceding period.
Source: Department of Commerce, Bureau of Economic Analysis.

10

98th Annual Report | 2011

tion stepped down from the higher levels observed
over the first half of last year, as commodity and
import prices retreated while longer-term inflation
expectations remained stable.
The fiscal and banking crisis in Europe was a primary focus of financial markets over the course of
the second half of 2011 and early 2012. Growing
concerns regarding the potential for spillovers to the
U.S. economy and financial markets weighed on
investor sentiment, contributing to significant volatility in a wide range of asset prices. Nonetheless, developments in financial markets have been mixed, on
balance, since July. Unsecured dollar funding markets
became significantly strained, particularly for European institutions, though U.S. institutions generally
did not appear to face substantial funding difficulties.
Risk spreads on corporate debt stayed elevated, on
net, but yields on corporate bonds generally moved
lower. Broad equity prices, which declined significantly in July and August, subsequently returned to
levels near those seen in early July. Credit conditions
for most large nonfinancial firms were accommodative and corporate profit growth remained strong.
In response to a pace of economic growth that was
somewhat slower than expected, the Federal Reserve
provided additional monetary policy accommodation
during the second half of 2011 and early 2012. Partly
as a result, Treasury yields moved down significantly,
and market participants pushed out the date at which
they expect the federal funds rate to move above its
current target range of 0 to ¼ percent and built in
expectations of a more gradual pace of increase in
the federal funds rate after liftoff.
Domestic Developments
The Household Sector

Consumer Spending and Household Finance
Real personal consumption expenditures (PCE) rose
at an annual rate of about 2 percent in the second
half of 2011, following a rise of just 1½ percent in
the first half of the year (figure 2). Part of the spending gain was attributable to a fourth-quarter surge in
purchases of motor vehicles following very weak
spending last spring and summer stemming from the
damping effects of the earthquake in Japan on motor
vehicle supply. Even with the step-up, however, PCE
growth was modest compared with previous business
cycle recoveries. This subpar performance reflects the
continued weakness in the underlying determinants
of consumption, including sluggish income growth,

Figure 2. Change in real personal consumption
expenditures, 2005–11
Percent, annual rate

H1

4

H2

3
H2
H1

2
1
+
0
_
1
2
3
4

2005

2006

2007

2008

2009

2010

2011

Note: The data are quarterly and extend through 2011:Q4.
Source: Department of Commerce, Bureau of Economic Analysis.

sentiment that remains relatively low despite recent
improvements, the lingering effects of the earlier
declines in household wealth, and tight access to
credit for many potential borrowers. With consumer
spending subdued, the saving rate, although down
from its recent high point, remained above levels that
prevailed prior to the recession.
Real income growth is currently estimated to have
been very weak in 2011. After rising 2 percent in
2010, aggregate real disposable personal income
(DPI)—personal income less personal taxes, adjusted
for price changes—was essentially flat in 2011. The
wage and salary component of real DPI, which
reflects both the number of hours worked and average hourly wages adjusted for inflation, rose at an
annual rate of 1 percent in 2011. The increase in real
wage and salary income reflected the continued,
though tepid, recoveries in both employment and
hours worked; in contrast, hourly pay was little
changed in real terms.
The ratio of household net worth to DPI dropped
back a little in the second half of 2011, reflecting further declines in house prices and equity values. The
wealth-to-income ratio has hovered close to 5 in
recent years, roughly the level that prevailed prior to
the late 1990s, but well below the highs recorded during the boom in house prices in the mid-2000s. Consumer sentiment, which dropped sharply last summer, has rebounded since then; nevertheless, these
gains only moved sentiment back to near the top of
the range that has prevailed since late 2009.

Monetary Policy and Economic Developments

Household debt—the sum of both mortgage and
consumer debt—continued to move lower in the second half of 2011. Since peaking in 2008, household
debt has fallen a total of 5 percent. The drop in debt
in the second half of 2011 reflected a continued contraction in mortgage debt that was only partially offset by a modest expansion in consumer credit.
Largely due to the reduction in overall household
debt levels in 2011, the debt service ratio—the aggregate required principal and interest payment on existing mortgages and consumer debt relative to
income—also decreased further and now is at a level
last seen in 1994 and 1995 (figure 3).
The moderate expansion in consumer credit in the
second half of 2011, at an annual rate of about
4½ percent, has been driven primarily by an increase
in nonrevolving credit, which accounts for about
two-thirds of total consumer credit and is composed
mainly of auto and student loans. Revolving consumer credit (primarily credit card lending), while
continuing to lag, appeared to pick up somewhat
toward the end of the year. The increase in consumer
credit is consistent with recent responses to the
Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS). Indeed, modest net fractions
of banks in both the October and January surveys
reported that they had eased standards on all major
categories of consumer loans, and that demand had
strengthened for auto and credit cards loans on balance. However, data on credit card solicitations suggest that lenders in that area are primarily interested
in pursuing higher-quality borrowers.
Figure 3. Household debt service, 1984–2011
Percent of disposable income

11

Indicators of consumer credit quality generally
improved. Delinquency rates on credit card loans
moved down in the second half of 2011 to the low
end of the range observed in recent decades. Delinquencies and charge-offs on nonrevolving consumer
loans also generally improved. Moreover, a majority
of respondents to the January SLOOS reported that
they expect further improvement in the quality of
credit card and other consumer loans this year.
Interest rates on consumer loans held fairly steady,
on net, in the second half of 2011 and into 2012.
Interest rates on new-auto loans continued to be
quite low, while rates on credit card loans remained
stubbornly high. Indeed, spreads of credit card interest rates to the two-year Treasury yield are very
elevated.
Consumer asset-backed securities (ABS) issuance in
the second half of 2011 was in line with that of the
previous 18 months. Securities backed by auto loans
continued to dominate the market, while issuance of
credit card ABS remained weak, as growth of credit
card loans has remained subdued and most major
banks have chosen to fund such loans on their balance sheets. Yields on ABS and their spreads over
comparable-maturity swap rates were little changed,
on net, over the second half of 2011 and early 2012
and remained in the low range that has prevailed
since early 2010.
Housing Activity and Finance
Activity in the housing sector remains depressed by
historical standards (figure 4). Although affordability
has been boosted by declines in house prices and hisFigure 4. Private housing starts, 1998–2012
Millions of units, annual rate

14

13

Single-family

1.8
1.4

12

1.0
11
.6

Multifamily
1987

1991

1995

1999

2003

2007

.2

2011

Note: The data are quarterly and extend through 2011:Q3. Debt service payments
consist of estimated required payments on outstanding mortgage and consumer
debt.
Source: Federal Reserve Board, “Household Debt Service and Financial Obligations Ratios,” statistical release.

1998

2000

2002

2004

2006

2008

2010

Note: The data are monthly and extend through January 2012.
Source: Department of Commerce, Bureau of the Census.

2012

12

98th Annual Report | 2011

torically low interest rates for conventional mortgages, many potential buyers either lack the down
payment and credit history to qualify for loans or are
discouraged by ongoing concerns about future
income, employment, and the potential for further
declines in house prices. Yet other potential buyers—
even those with sufficiently good credit records to
qualify for a mortgage insured by one of the housing
government-sponsored enterprises (GSEs)—continue
to face difficulty in obtaining mortgage financing.
Moreover, much of the demand that does exist has
been channeled to the abundant stock of relatively
inexpensive, vacant single-family houses, thereby limiting the need for new construction activity. Given
the magnitude of the pipeline of delinquent and foreclosed homes, this factor seems likely to continue to
weigh on activity for some time.

Figure 5. Mortgage interest rates, 1995–2012
Percent

9
8
Fixed rate

7
6
5
4
3

Adjustable rate
1997

2000

2003

2006

2009

2012

Note: The data, which are weekly and extend through February 22, 2012, are contract rates on 30-year mortgages.
Source: Federal Home Loan Mortgage Corporation.

Nonetheless, recent indicators of housing construction activity have been slightly more encouraging. In
particular, from July 2011 to January 2012, new
single-family homes were started at an average
annual rate of about 455,000 units, up a bit from the
pace in the first half of 2011. In the multifamily market, demand for apartments appears to be increasing
and vacancy rates have fallen, as families who are
unable or unwilling to purchase homes are renting
properties instead. As a result, starts in the multifamily sector averaged about 200,000 units at an annual
rate in the second half of 2011, still below the
300,000-unit rate that had prevailed for much of the
previous decade but well above the lows recorded in
2009 and early 2010.
House prices, as measured by several national
indexes, fell further over the second half of 2011. One
such measure with wide geographic coverage—the
CoreLogic repeat-sales index—fell at an annual rate
of about 6 percent in the second half of the year.
House prices are being held down by the same factors that are restraining housing construction: the
high number of distressed sales, the large inventory
of unsold homes, tight mortgage credit conditions,
and lackluster demand. The inventory of unsold
homes likely will remain high for some time, given
the large number of homes that are already in the
foreclosure pipeline or could be entering the pipeline
in the coming months. As a result of the cumulative
decline in house prices over the past several years,
roughly one in five mortgage holders owe more on
their mortgages than their homes are worth.

ers confronting depressed home values and high
unemployment. In December, serious delinquency
rates on prime and near-prime loans stood at 5 percent and 13 percent for fixed- and variable-rate loans,
respectively. While delinquencies on variable-rate
mortgages for both prime and subprime borrowers
have moved down over the past two years, delinquencies on fixed-rate mortgages have held steady at levels
near their peaks in early 2010.5 Meanwhile, delinquency and charge-off rates on second-lien mortgages held by banks also are at elevated levels, and
they have declined only slightly from their peaks.
The number of properties at some stage of the foreclosure process remained elevated in 2011. This high
level partly reflected the difficulties that mortgage
servicers continued to have with resolving deficiencies in their foreclosure procedures. Resolution of
these issues could eventually be associated with a sustained increase in the pace of completed foreclosures
as servicers work through the backlog of severely
delinquent loans.
Interest rates on fixed-rate mortgages fell steadily
during the second half of 2011 and in early 2012
(figure 5), though not as much as Treasury yields,
leaving spreads to Treasury securities of comparable
maturities wider. The ability of potential borrowers
to obtain mortgage credit for purchase transactions
or refinancing continued to be limited. In part, the
low level of mortgage borrowing reflected character5

Indicators of credit quality in the residential mortgage sector continued to reflect strains on homeown-

A mortgage is defined as seriously delinquent if the borrower is
90 days or more behind in payments or the property is in
foreclosure.

Monetary Policy and Economic Developments

Figure 6. Credit scores on new prime mortgages, 2003–11
FICO score

800
780

90th percentile

760
740
720

Median

700
680
660

10th percentile

640
2003

2005

2007

2009

2011

Note: The data, which include purchase mortgages only, are monthly and extend
through December 2011.
Source: LPS Applied Analytics.

istics of the would-be borrowers, most prominently
the widespread incidence of negative equity and
unemployment. In addition, credit supply conditions
remained tight. Indeed, it appeared that some lenders
were reluctant to extend mortgages to borrowers with
less-than-pristine credit even when the resulting loans
would be eligible for purchase or guarantee by
GSEs.6 One manifestation of this constriction was
the fact that the distribution of credit scores among
borrowers who succeed in obtaining mortgages had
shifted up significantly (figure 6). As a result of these
influences, the pace of mortgage applications for
home purchase declined, on net, over the second half
of 2011 and remains very sluggish. The same factors
also appear to have limited refinancing activity,
which remains subdued compared with the large
number of households that would potentially benefit
from the low rates available to high-quality
borrowers.

13

The Business Sector

Fixed Investment
Real spending by businesses for equipment and software (E&S) rose at an annual rate of about 11 percent over the second half of 2011, a pace that was a
bit faster than in the first half (figure 7). Much of this
strength was recorded in the third quarter. Spending
growth dropped back in the fourth quarter, to 5 percent, likely reflecting—among other influences—
heightened uncertainty of business owners about
global economic and financial conditions. Although
spending by businesses for high-tech equipment has
held up reasonably well, outlays for a broad range of
other E&S slowed appreciably. More recently, however, indicators of business sentiment and capital
spending plans generally have improved, suggesting
that firms may be in the process of becoming more
willing to undertake new investments.
After tumbling throughout most of 2009 and 2010,
real investment in nonresidential structures other
than drilling and mining turned up last spring, rising
Figure 7. Change in real business fixed investment,
2005–11
Percent, annual rate

Structures
Equipment and software

30
20
H1 H2

10
+
0
_
10
20
30

2005

2006

2007

2008

2009

2010

2011

Percent, annual rate

Structures excluding mining and drilling
Mining and drilling

The outstanding stock of mortgage-backed securities
(MBS) guaranteed by the GSEs was little changed,
on net, over the second half of 2011. The securitization market for mortgage loans not guaranteed by a
housing-related GSE or the Federal Housing Administration continued to be essentially closed.

60
40
H1

20
H2

+
0
_
20
40

6

For example, only about half of lenders reported to LoanSifter
data services that they would offer a conventional fully documented mortgage with a 90 percent loan-to-value ratio for borrowers with FICO scores of 620.

2005

2006

2007

2008

2009

2010

Source: Department of Commerce, Bureau of Economic Analysis.

2011

14

98th Annual Report | 2011

at a surprisingly brisk pace in the second and third
quarters of 2011. However, investment dropped back
in the fourth quarter. Conditions in the sector remain
difficult: Vacancy rates are still high, prices of existing structures are low, and financing conditions for
builders are still tight. Spending on drilling and mining structures also dropped back in the fourth quarter, but outlays in this category should continue to be
supported by elevated oil prices and advances in technology for horizontal drilling and hydraulic
fracturing.
Inventory Investment
Real inventory investment stepped down a bit in the
second half of 2011. Stockbuilding outside of motor
vehicles increased at a modest pace, and surveys suggest that firms are generally comfortable with their
own, and their customers’, current inventory positions. In the motor vehicle sector, inventories were
drawn down in the second half, as the rise in sales
outpaced the rebound in production following the
supply disruptions associated with the earthquake in
Japan last spring.
Corporate Profits and Business Finance
Operating earnings per share for S&P 500 firms continued to rise in the third quarter of 2011, increasing
at a quarterly rate of nearly 10 percent. Fourthquarter earnings reports by firms in the S&P 500
published through late February indicate that this
measure has remained at or near its pre-crisis peaks
throughout the second half of 2011.
In the corporate sector as a whole, economic profits,
which had been rising rapidly since 2008, increased
further in the second half of 2011. This relatively
strong profit growth contributed to the continued
robust credit quality of nonfinancial firms in the second half of 2011. Although the ratio of liquid assets
to total assets on the balance sheets of nonfinancial
corporations edged down in the third quarter, it
remained at a very high level, and the aggregate ratio
of debt to assets—a measure of corporate leverage—
stayed low. With corporate balance sheets in generally healthy shape, credit rating upgrades once again
outpaced downgrades, and the bond default rate for
nonfinancial firms remained low. In addition, the
delinquency rate on commercial and industrial (C&I)
loans at commercial banks continued to decline and
stood at around 1½ percent at year-end, a level near
the low end of its historical range. Most banks
responding to the January SLOOS reported that they
expected further improvements in the credit quality
of C&I loans in 2012.

Borrowing by nonfinancial corporations continued at
a reasonably robust pace through the second half of
2011, particularly for larger, higher-credit-quality
firms. Issuance of investment-grade bonds progressed at a strong pace, similar to that observed in
the first half of the year, buoyed by good corporate
credit quality, attractive financing conditions, and an
improving economic outlook. In contrast to highergrade bonds, issuance of speculative-grade bonds
dropped in the second half of the year as investors’
appetite for riskier assets waned. In the market for
syndicated loans, investment-grade issuance moved
up in the second half of 2011 from its already strong
first-half pace, while issuance of higher-yielding syndicated leveraged loans weakened.
C&I loans on banks’ books grew steadily over the
second half of 2011. Banks reportedly competed
aggressively for higher-rated credits in the syndicated
leveraged loan market, and some nonfinancial firms
reportedly substituted away from bond financing
because of volatility in bond spreads. In addition,
according to the SLOOS, some domestic banks
gained business from customers that shifted away
from European banks. Although domestic banks
reported little change, on net, in lending standards
for C&I loans, they reduced the spreads on these
loans as well as the costs of credit lines. Banks that
reported having eased their credit standards or terms
for C&I loans over the second half of 2011 unanimously cited increased competition from other banks
or nonbank sources of funds as a factor.
Borrowing conditions for smaller businesses continued to be tighter than those for larger firms, and their
demand for credit remained relatively weak. However, some signs of easing began to emerge. Surveys
conducted by the National Federation of Independent Business showed that the net fraction of small
businesses reporting that credit had become more difficult to obtain relative to the previous three months
declined, on balance, during the second half of 2011.
Moreover, the January 2012 SLOOS found that
terms for smaller borrowers had continued to ease,
and about 15 percent of banks, on net, reported that
demand for C&I loans from smaller firms had
increased, the highest reading since 2005. Indeed,
C&I loans held by regional and community banks—
those not in the 25 largest banks and likely to lend
mostly to middle-market and small firms—advanced
at about a 6 percent annual rate in the second half of
2011, up from a 2½ percent pace in the first half.

Monetary Policy and Economic Developments

Commercial mortgage debt has continued to decline,
albeit at a more moderate pace than during 2010.
Commercial real estate (CRE) loans held on banks’
books contracted further in the second half of 2011
and early 2012, though the runoff appeared to ebb
somewhat in 2011. That slowing is more or less consistent with recent SLOOS responses, in which moderate net fractions of domestic banks reported that
demand for such loans had strengthened. In the
January survey, banks also reported that, for the first
time since 2007, they had raised the maximum loan
size and trimmed spreads of rates on CRE loans over
their cost of funds during the past 12 months. By
contrast, life insurance companies reportedly
increased their holdings of CRE loans, especially of
loans issued to higher-quality borrowers. Although
delinquency rates on CRE loans at commercial banks
edged down further in the fourth quarter, they
remained at high levels, especially on loans for construction and land development; delinquencies on
loans held by life insurance companies remained
extraordinarily low, as they have done for more than
a decade. Vacancy rates for most types of commercial
properties are still elevated, exerting downward pressure on property prices and impairing the performance of CRE loans.
Conditions in the market for commercial mortgagebacked securities (CMBS) worsened somewhat in the
second half of the year. Risk spreads on highly rated
tranches of CMBS moved up, on balance, and about
half of the respondents to the December Senior
Credit Officer Opinion Survey on Dealer Financing
Terms (SCOOS) indicated that liquidity conditions in
the markets for such securities had deteriorated
somewhat. Issuance of CMBS slowed further, but did
not halt completely. Delinquency rates on CRE loans
in CMBS pools held steady just below 10 percent.
In the corporate equity market, gross issuance
dropped significantly in the third quarter amid substantial equity market volatility, but it retraced a part
of that decline in the fourth quarter as some previously withdrawn issues were brought back to the
market. Net equity issuance continued to decline in
the third quarter, reflecting the continued strength of
cash-financed mergers and share repurchases.
The Government Sector

Federal Government
The deficit in the federal unified budget remains very
wide. The budget deficit for fiscal year 2011 was
$1.3 trillion, or 8½ percent of nominal GDP—a level

15

comparable with deficits recorded in 2009 and 2010
but sharply higher than the deficits recorded prior to
the onset of the financial crisis and recession. The
budget deficit continued to be boosted by spending
that was committed by the American Recovery and
Reinvestment Act of 2009 (ARRA) and other stimulus policy actions as well as by the weakness of the
economy, which has reduced tax revenues and
increased payments for income support.
Tax receipts rose 6½ percent in fiscal 2011. However,
the level of receipts remained very low; indeed, at
around 15½ percent of GDP, the ratio of receipts to
national income is only slightly above the 60-year
lows recorded in 2009 and 2010. The rise in revenues
in fiscal 2011 was the result of a robust increase of
more than 20 percent in individual income tax payments that reflected strong final payments on 2010
income. Social insurance tax receipts fell about 5 percent in fiscal 2011, held down by the temporary
2 percentage point reduction in payroll taxes enacted
in 2010. Corporate taxes also fell around 5 percent in
2011, with the decline largely the result of legislation
providing more-favorable tax treatment for some
business investment. In the first four months of fiscal
2012, total tax receipts increased 4 percent relative to
the comparable year-earlier period.
Total federal outlays rose 4 percent in fiscal 2011.
Much of the increase relative to last year is attributable to the earlier unwinding of the effects of financial transactions, such as the repayments to the Treasury of obligations for the Troubled Asset Relief Program, which temporarily lowered measured outlays
in fiscal 2010. Excluding these transactions, outlays
were up about 2 percent in 2011. This small increase
reflects reductions in both ARRA spending and
unemployment insurance payments as well as a subdued pace of defense and Medicaid spending. By
contrast, net interest payments rose sharply, reflecting the increase in federal debt. Spending has
remained restrained in the current fiscal year, with
outlays (adjusted to exclude financial transactions)
down about 5 percent in the first four months of fiscal 2012 relative to the comparable year-earlier
period.
As measured in the national income and product
accounts (NIPA), real federal expenditures on consumption and gross investment—the part of federal
spending that is a direct component of GDP—decreased at an annual rate of about 3 percent in the
second half of 2011, a little less rapidly than in the
first half of the year (figure 8). Defense spending fell

16

98th Annual Report | 2011

recent levels. Federal debt held by the public, as
a percentage of GDP, continued to rise in the third
quarter, reaching about 68 percent.

Figure 8. Change in real government expenditures on
consumption and investment, 2005–11
Percent, annual rate

Federal
State and local

9
6
3
H1 H2

+
0
_
3
6

2005

2006

2007

2008

2009

2010

2011

Source: Department of Commerce, Bureau of Economic Analysis.

at an annual rate of about 4 percent in the second
half of the year, a somewhat sharper pace of decline
than in the first half, while nondefense purchases
were unchanged over this period.
Federal debt surged in the second half of 2011, after
the debt ceiling was raised in early August by the
Budget Control Act of 2011.7 Standard and Poor’s
(S&P), which had put the U.S. long-term sovereign
credit rating on credit watch negative in June, downgraded that rating from AAA to AA+ following the
passage of the act, citing the risks of a continued rise
in federal government debt ratios over the medium
term and declining confidence that timely fiscal
measures necessary to place U.S. public finances on a
sustainable path would be forthcoming. Other credit
rating agencies subsequently posted a negative outlook on their rating of U.S. sovereign debt, on similar
grounds, but did not change their credit ratings.
These actions do not appear to have affected participation in Treasury auctions, which continued to be
well subscribed. Demand for Treasury securities was
supported by market participants’ preference for the
relative safety and liquidity of such securities. Bid-tocover ratios were within historical ranges, and indicators of foreign participation remained near their
7

On May 16, the federal debt reached the $14.294 trillion limit,
and the Secretary of the Treasury declared a “debt issuance suspension period” for the Civil Service Retirement and Disability
Fund, permitting the Treasury to redeem a portion of existing
Treasury securities held by that fund as investments and to suspend issuance of new Treasury securities to that fund as investments. The Treasury also began suspending some of its daily
reinvestment of Treasury securities held as investments by the
Government Securities Investment Fund of the Federal
Employees’ Retirement System Thrift Savings Plan.

State and Local Government
State and local governments remain under significant
fiscal strain. Since July, employment in the sector has
declined by an average of 15,000 jobs per month, just
slightly under the pace of job losses recorded for the
first half of 2011. Meanwhile, reductions in real construction expenditures abated after a precipitous
drop in the first half of 2011. As measured in the
NIPA, real state and local expenditures on consumption and gross investment decreased at an annual rate
of about 2 percent in the second half of 2011, a
somewhat slower pace of decline than in the first half
of the year (figure 8).
State and local government revenues appear to have
increased modestly in 2011. Notably, at the state
level, third-quarter tax revenues rose 5½ percent over
the year-earlier period, with the majority of the states
experiencing gains. However, this increase in tax revenues was partly offset by a reduction in federal
stimulus grants. Tax collections have been less robust
at the local level. Property tax receipts have been
roughly flat, on net, since the start of 2010 (based on
data through the third quarter of 2011), reflecting the
downturn in home prices. Furthermore, many localities have experienced a decrease in grants-in-aid from
their state government.
Issuance of long-term securities by state and local
governments moved up in the second half of 2011 to
a pace similar to that seen in 2009 and 2010. Issuance
had been subdued during the first half of the year, in
part because the expiration of the Build America
Bonds program led to some shifting of financing
from 2011 into late 2010.
Yields on state and local government securities
declined in the second half of 2011 and into 2012,
reaching levels near the lower end of their range over
the past decade, but they fell to a lesser degree than
yields on comparable-maturity Treasury securities.
The increase in the ratio of municipal bond yields to
Treasury yields likely reflected, in part, continued
concern regarding the financial health of state and
local governments. Indeed, credit default swap (CDS)
indexes for municipal bonds rose, on balance, over
the second half of 2011 but have narrowed somewhat
in early 2012. Credit rating downgrades outpaced
upgrades in the second half of 2011, particularly in

Monetary Policy and Economic Developments

touch narrower than the $470 billion deficit recorded
in 2010.

Figure 9. Change in real imports and exports of goods and
services, 2007–11
Percent, annual rate

Imports
Exports

15
10
H1

H2
5
+
0
_
5

2007

2008

2009

2010

2011

Source: Department of Commerce, Bureau of Economic Analysis.

December, following the downgrade of a municipal
bond guarantor.8
The External Sector

Real exports of goods and services rose at an annual
rate of 4¾ percent in the second half of 2011,
boosted by continued growth in overall foreign economic activity and the lagged effect of declines in the
foreign exchange value of the dollar earlier in the
year (figure 9). Exports of aircraft and consumer
goods registered some of the largest gains. The
increase in export demand was concentrated in the
emerging market economies (EMEs), while exports
to the euro area declined toward the end of the year.
With growth of economic activity in the United
States moderate during the second half of 2011, real
imports of goods and services rose at only about a
3 percent annual rate, down from about 5 percent in
the first half. Import growth was weak across most
trading partners in the second half of last year, with
the notable exception of imports from Japan, which
grew significantly after dropping sharply in the wake
of the March earthquake.
Altogether, net exports contributed about ¼ percentage point to real GDP growth in the second half of
2011, as export growth outpaced import growth. At
an annual rate, the current account deficit in the third
quarter of 2011 (the latest available data) was
$441 billion, or about 3 percent of nominal GDP, a
8

17

Downgrades to bond guarantors can affect the ratings of all
municipal securities guaranteed by those firms, as the rating of
a security is the higher of either the published underlying security rating or the rating of the entity providing the guarantee.

Oil prices moved down, on net, over the second half
of last year. The spot price of West Texas Intermediate (WTI) crude oil, which jumped to $110 per barrel
last April after a near-complete shutdown of Libyan
oil production, subsequently reversed course and
declined sharply to an average of just under $86 per
barrel in September. The prices of other major
benchmark crude oils also fell over this period,
although by less than the spot price of WTI
(figure 10). The drop in oil prices through September
likely was prompted by the winding down of the conflict in Libya as well as growing concern about the
strength of global growth as the European sovereign
debt crisis intensified, particularly toward the end of
summer. From September to January of this year, the
price of oil from the North Sea (the Brent benchmark) was essentially flat as the potential implications of increased geopolitical tensions—most notably with Iran—have offset ongoing concern over the
strength of global demand and a faster-thanexpected rebound in Libyan oil production. In February, the price of Brent moved higher, both with
increasing optimism regarding the outlook for global
growth as well as a further heightening of tensions
with Iran. The spot price of WTI crude oil also
increased in February, though by less than Brent, fol-

Figure 10. Prices of oil and nonfuel commodities, 2007–12
December 2006 = 100

Dollars per barrel

140

160
140

120

Nonfuel
commodities

100

120
80
Oil

100

60

80

40

2007

2008

2009

2010

2011

2012

Note: The data are monthly. The oil price is the spot price of Brent crude oil, and
the last observation is the average for February 1–24, 2012. The price of nonfuel
commodities is an index of 45 primary-commodity prices and extends through
January 2012.
Source: For oil, the Commodity Research Bureau; for nonfuel commodities, International Monetary Fund.

18

98th Annual Report | 2011

lowing a relatively rapid rise over the final three
months of last year.9

rowing from abroad, limiting the rise in the standard
of living of U.S. residents over time.

After peaking early in 2011, prices of many non-oil
commodities also moved lower during the remainder
of 2011. Despite moving up recently, copper prices
remain well below their early 2011 level. In agricultural markets, corn and wheat prices ended 2011
down about 20 percent from their relatively high levels at the end of August as global production reached
record levels. In early 2012, however, corn prices
edged up on worries about dry growing conditions in
South America.

The Labor Market

After increasing at an annual rate of 6½ percent in
the first half of 2011, prices of non-oil imported
goods were flat in the second half. Fluctuations in
prices of imported finished goods (such as consumer
goods and capital goods) were moderate.
National Saving

Total U.S. net national saving—that is, the saving of
U.S. households, businesses, and governments, net of
depreciation charges—remains extremely low by historical standards. After having reached 4 percent of
nominal GDP in 2006, net national saving dropped
over the subsequent three years, reaching a low of
negative 2½ percent in 2009. Since then, the national
saving rate has increased on balance: In the third
quarter of 2011 (the latest quarter for which data are
available), net national saving was negative ½ percent
of nominal GDP. The recent contour of the saving
rate importantly reflects the pattern of federal budget
deficits, which widened sharply in 2008 and 2009, but
have edged down as a share of GDP since then.
National saving will likely remain relatively low this
year in light of the continuing large federal budget
deficit. If low levels of national saving persist over
the longer run, they will likely be associated with
both low rates of capital formation and heavy bor-

Employment and Unemployment
Conditions in the labor market have improved some
of late. Private payroll employment gains averaged
165,000 jobs per month in the second half of 2011, a
bit slower than the pace in the first half of the year,
but gains in December and January were more
robust, averaging almost 240,000 per month
(figure 11). The unemployment rate, which hovered
around 9 percent for much of last year, is estimated
to have moved down noticeably since September,
reaching 8¼ percent in January, the lowest reading in
almost three years (figure 12).
Although the recent decline in the jobless rate is
encouraging, the level of unemployment remains
very elevated. In addition, long-duration joblessness
continues to account for an especially large share of
the total. Indeed, in January, 5½ million persons
among those counted as unemployed—about 43 percent of the total—had been out of work for more
than six months, figures that were only a little below
record levels (figure 13). Moreover, the number of
individuals who are working part time for economic
reasons—another indicator of the underutilization of
labor—remained roughly twice its pre-recession
value.

Figure 11. Net change in private payroll employment,
2005–12
Thousands of jobs

400
Monthly change
9

The more rapid rise of WTI than other grades of crude oil at
the end of 2011 reflects the narrowing of a discount that had
opened up between WTI and other grades earlier in the year.
Throughout most of 2011, continued increases in the supply of
oil, primarily from Canada and North Dakota, available to flow
into Cushing, Oklahoma (the delivery point for the WTI crude
oil), and the lack of transportation infrastructure to pass the
supplies on to global markets, depressed the price of WTI relative to other grades of crude oil. In mid-November, however,
plans were announced to reverse the flow of a key pipeline that
currently transports crude oil from the Gulf Coast into Cushing. By raising the possibility of alleviating the supply glut of
crude oil in the Midwest, the announcement of this flow reversal has led spot WTI prices to rise to a level that is more in line
with the price of other grades of crude oil.

200
+
0
_
200
400
3-month
moving average

600
800

2005

2006

2007

2008

2009

2010

2011

Note: The data are monthly and extend through January 2012.
Source: Department of Labor, Bureau of Labor Statistics.

2012

Monetary Policy and Economic Developments

Figure 12. Civilian unemployment rate, 1978–2012
Percent

12
10
8
6

19

in nominal terms in 2011. Nominal compensation per
hour in the nonfarm business sector—derived from
the labor compensation data in the NIPA—is estimated to have increased only 1¾ percent in 2011,
well below the average gain of about 4 percent in the
years before the recession. Adjusted for the rise in
consumer prices, hourly compensation was roughly
unchanged in 2011. Unit labor costs rose 1¼ percent
in 2011, as the rise in nominal hourly compensation
outpaced that of labor productivity in the nonfarm
business sector. In 2010, unit labor costs fell almost
1 percent.

4

Prices
1980

1988

1996

2004

2012

Note: The data are monthly and extend through January 2012.
Source: Department of Labor, Bureau of Labor Statistics.

Productivity and Labor Compensation
Labor productivity growth slowed last year. Productivity had risen rapidly in 2009 and 2010 as firms
strove to cut costs in an environment of severe economic stress. In 2011, however, with operations
leaner and workforces stretched thin, firms needed to
add labor inputs to achieve the desired output gains,
and output per hour in the nonfarm business sector
rose only ½ percent.
Increases in hourly compensation remained subdued
in 2011, restrained by the wide margin of labor market slack. The employment cost index, which measures both wages and the cost to employers of providing benefits, for private industry rose just 2¼ percent

Consumer price inflation stepped down in the second
half of 2011. After rising at an annual rate of
3½ percent in the first half of the year, the overall
PCE chain-type price index increased just 1½ percent
in the second half (figure 14). PCE prices excluding
food and energy also decelerated in the second half of
2011, rising at an annual rate of about 1½ percent,
compared with roughly 2 percent in the first half. The
recent contour of consumer price inflation has
reflected movements in global commodity prices,
which rose sharply early in 2011 but have moved
lower during the second half of the year. Information
from the consumer price index and other sources suggests that inflation remained subdued through January 2012, although energy prices have turned up
more recently.
The index of consumer energy prices, which surged
in the first half of 2011, fell back in the second half
of the year. The contour mainly reflected the rise and
subsequent reversal in the price of crude oil; however,

Figure 13. Long-term unemployed, 1978–2012
Percent

Figure 14. Change in the chain-type price index for
personal consumption expenditures, 2005–11
Percent, annual rate

50
Total
Excluding food and energy

40

5
4

H1

30

3

20
H2

2

10
1
1980

1988

1996

2004

2012

Note: The data are monthly and extend through January 2012. The series shown
is the percentage of total unemployed persons who have been unemployed for
27 weeks or more.
Source: Department of Labor, Bureau of Labor Statistics.

+
0
_
2005

2006

2007

2008

2009

2010

Source: Department of Commerce, Bureau of Economic Analysis.

2011

20

98th Annual Report | 2011

gasoline prices started to rise again in February following a recent upturn in crude oil prices. Consumer
natural gas prices also fell at the end of 2011, as
unseasonably mild temperatures and increases in supply from new domestic wells helped boost inventories
above typical levels. All told, the overall index of
consumer energy prices edged lower during the second half of 2011, compared with an increase of
almost 30 percent in the first half of the year.
Consumer prices for food and beverages exhibited a
similar pattern as that of energy prices. Prices for
farm commodities rose briskly early last year, reflecting the combination of poor harvests in several countries that are major producers along with the emerging recovery in the global economy. These commodity price increases fed through to higher consumer
prices for meats and a wide range of other moreprocessed foods. With the downturn in farm commodity prices late in the summer, the index of consumer food prices rose at an annual rate of just
3¾ percent in the second half of 2011 after increasing 6½ percent in the first half.
Prices for consumer goods and services other than
energy and food have also slowed, on net, in recent
months. Core PCE prices had been boosted in the
spring and summer of 2011 by a number of transitory factors, including the pass-through of the firsthalf surge in prices of raw commodities and other
imported goods and a boost to motor vehicle prices
that stemmed from supply shortages following the
earthquake in Japan. As the impulse from these factors faded, core PCE price inflation stepped down so
that, for 2011 as a whole, core PCE price inflation
was just 1¾ percent.
Survey-based measures of near-term inflation expectations are down since the middle of 2011. Median
year-ahead inflation expectations as reported in the
Thomson Reuters/University of Michigan Surveys of
Consumers (Michigan survey), which had risen
sharply earlier in the year reflecting the run-up in
energy and food prices, subsequently fell back as
those prices decelerated. Longer-term expectations
have remained generally stable. In the Michigan survey, the inflation rate expected over the next 5 to
10 years was 2.9 percent in February, within the
range that has prevailed over the past 10 years; in the
Survey of Professional Forecasters, conducted by the
Federal Reserve Bank of Philadelphia, expectations
for the increase in the price index for PCE over the
next 10 years remained at 2¼ percent, in the middle
of its recent range.

Measures of inflation compensation derived from
yields on nominal and inflation-indexed Treasury
securities declined early in the second half of 2011 at
both medium-term and longer-term horizons, likely
reflecting a worsening in the economic outlook and
the intensification of the European fiscal crisis. More
recently, inflation compensation estimates over the
next five years have edged back up, apparently
reflecting investors’ more optimistic economic outlook, and is about unchanged, on net, for the period.
However, the forward measure of five-year inflation
compensation five years ahead remains about
55 basis points below its level in the middle of last
year.
Financial Developments
In light of the disappointing pace of progress toward
meeting its statutory mandate to promote maximum
employment and price stability, the Federal Open
Market Committee (FOMC) took a number of steps
to provide additional monetary policy accommodation during the second half of 2011 and early 2012.
These steps included increasing the average maturity
of the Federal Reserve’s securities holdings, shifting
the reinvestment of principal payments on agency
securities from Treasury securities to agencyguaranteed MBS, and strengthening the forward rate
guidance included in postmeeting statements.
Financial markets were buffeted over the second half
of 2011 and in early 2012 by changes in investors’
assessments of the ongoing European crisis as well as
in their evaluation of the U.S. economic outlook. As
a result, developments in financial market conditions
have been mixed since July. Unsecured dollar funding
markets, particularly for European institutions,
became significantly strained, though domestic
financial firms generally maintained ready access to
short-term unsecured funding. Corporate bond
spreads remained elevated, on net, while broad equity
prices were little changed, although they exhibited
unusually high volatility. Partially reflecting additional monetary policy accommodation, Treasury
yields moved down significantly. Similarly, investors
pushed out the date at which they expect the federal
funds rate to rise above its current target range, and
they are currently anticipating a more gradual pace
of increase in the funds rate following liftoff than
they did last July.
Monetary Policy Expectations and
Treasury Rates

In response to the steps taken by the FOMC to
strengthen its forward guidance and provide addi-

Monetary Policy and Economic Developments

Figure 15. Interest rates on Treasury securities at selected
maturities, 2004–12
Percent

10-year

30-year

5
4
3
2

2-year

1
+
0
_
2004

2006

2008

2010

2012

Note: The data are daily and extend through February 24, 2012.
Source: Department of the Treasury.

tional support to the economic recovery, market participants pushed out further the date when they
expect the federal funds rate to first rise above its current target range of 0 to ¼ percent and scaled back
their expectations of the pace at which monetary
policy accommodation will be removed. On balance,
quotes on overnight index swap (OIS) contracts, as of
late February, imply that investors anticipate the federal funds rate will rise above its current target range
in the fourth quarter of 2013, about four quarters
later than the date implied in July. Investors expect,
on average, that the effective federal funds rate will be
about 70 basis points by late 2014, roughly 165 basis
points lower than anticipated in mid-2011.10
Yields on nominal Treasury securities declined significantly over the second half of 2011 (figure 15).
The bulk of this decline occurred in late July and
August, in part reflecting weaker-than-anticipated
U.S. economic data and increased investor demand
for the relative safety and liquidity of Treasury securities amid an intensification of concerns about the
situation in Europe. Following the FOMC announcement of the maturity extension program (MEP) at its
September meeting, yields on longer-dated Treasury
10

When interest rates are close to zero, determining the point at
which financial market quotes indicate that the federal funds
rate will move above its current range can be complicated. The
path described in the text is the mean of a distribution calculated from OIS rates. Alternatively, one can use similar derivatives to calculate the most likely, or “modal,” path of the federal
funds rate, a measure that tends to be more stable. This alternative measure has also moved down, on net, since the middle of
2011, but it suggests a flatter overall trajectory for the target
federal funds rate, according to which the effective rate does not
rise above its current target range through the end of 2015.

21

securities declined further, while yields on shorterdated securities held steady at very low levels.11 On
net, yields on 2-, 5-, and 10-year Treasury notes have
declined roughly 10, 65, and 110 basis points from
their levels in mid-2011, respectively. The yield on the
30-year bond has dropped about 120 basis points.
Though liquidity and functioning in money markets
deteriorated notably for several days at the height of
the debt ceiling debate last summer, neither the
downgrade of the U.S. long-term sovereign credit rating by S&P in August nor the failure of the Joint
Select Committee on Deficit Reduction to reach an
agreement in November appeared to leave a permanent imprint on the Treasury market. Uncertainty
about longer-term interest rates, as measured by the
implied volatility on 10-year Treasury securities,
moved sideways through most of the second half of
2011 and then declined late in the year and into 2012,
reflecting improved sentiment in financial markets
following a number of policy actions by central
banks and some signs of strengthening in the pace of
economic recovery.
Measures of market functioning suggest that the
Treasury market has continued to operate smoothly
since mid-2011 despite the S&P downgrade in
August. Bid–asked spreads for most Treasury securities were roughly unchanged, though they have widened a bit, on net, for the 30-year bond since August.
Dealer transaction volumes have remained within
historically normal ranges.
Short-Term Funding Markets

Conditions in unsecured short-term dollar funding
markets deteriorated, on net, over the second half of
2011 and in early 2012 amid elevated anxiety about
the crisis in Europe and its implications for European
firms and their counterparties. Funding costs
increased and tenors shortened dramatically for
European institutions throughout the third and into
the fourth quarter. Funding pressures eased somewhat late in the year following the European Central
Bank’s (ECB) first injection of euro liquidity via a
three-year refinancing operation and the reduction of
the price of U.S. dollar liquidity offered by the ECB
and other central banks; they subsequently eased further following the passage of year-end. On balance,
spreads of London interbank offered rates (LIBOR)
over comparable-maturity OIS rates—a measure of
stress in short-term bank funding markets—have
11

As of February 24, the Open Market Desk had sold $223 billion in shorter-term Treasury securities and purchased $211 billion in longer-term Treasury securities.

22

98th Annual Report | 2011

widened considerably since July, particularly for tenors beyond one month, though they have moved
down since late last year. Indeed, throughout much
of the third and fourth quarters, many European
institutions were reportedly unable to obtain unsecured dollar funding at tenors beyond one week.
Additionally, more-forward-looking measures of
interbank funding costs—such as the spread between
a three-month forward rate agreement and the rate
on an OIS contract three to six months ahead—
moved up considerably in the second half of 2011
and have only partially retraced in 2012 (figure 16).
Despite the pressures faced by European financial
institutions, U.S. firms generally maintained ready
access to short-term unsecured funding markets.
Against a backdrop of solid deposit growth and
modest expansion in bank credit across the industry,
most domestic banks reportedly had limited need for
unsecured funding.
Pressures were also evident in the commercial paper
(CP) market. Issuance in the United States of unsecured financial CP and negotiable certificates of
deposit by entities with European parents declined
significantly in the second half of 2011. By contrast,
the pace of issuance by U.S. firms edged down only
slightly, on net, over the period. On balance, spreads
of rates on unsecured A2/P2 commercial paper over
equivalent maturity AA-rated nonfinancial CP rose a
Figure 16. LIBOR minus overnight index swap rate, 2007–12
Basis points

350
300
250
Three-month

200
150

One-month
USD 3x6 FRA–OIS

100
50
+
0
_

Jan. July Jan. July Jan. July Jan. July Jan. July Jan.
2007
2008
2009
2010
2011
2012
Note: The data are daily and extend through February 24, 2012. An overnight
index swap (OIS) is an interest rate swap with the floating rate tied to an index of
daily overnight rates, in this case the effective federal funds rate. At maturity, the
two parties to the swap agreement exchange, on the basis of the agreed notional
amount, the difference between interest accrued at the fixed rate and interest
accrued by averaging the floating, or index, rate. The U.S. dollar (USD) spread is
calculated from a London interbank offered rate (LIBOR) forward rate agreement
(FRA) three to six months in the future and the implied forward OIS rate for the
same period.
Source: Bloomberg.

bit for both overnight and 30-day tenors. AA-rated
asset-backed CP spreads increased more notably over
the second half of 2011 but largely retraced following
year-end.
In contrast to unsecured dollar funding markets,
signs of stress were largely absent in secured shortterm dollar funding markets. For example, in the
market for repurchase agreements (repos), bid–asked
spreads for most collateral types were little changed.
In addition, despite a seasonal dip around year-end,
volumes in the triparty repo market were largely
stable on balance. That said, the composition of collateral pledged in the repo market moved further
away from equities and fixed-income collateral that is
not eligible for open market operations, shifting even
more heavily toward Treasury and agency securities
as counterparty concerns became more evident.
Respondents to the SCOOS in both September and
December noted a continued increase in demand for
funding across collateral types but reported a general
tightening in credit terms under which several securities types are financed. In addition, market participants reportedly became somewhat less willing to
fund riskier collateral types at longer tenors as yearend approached. However, year-end pressures
remained muted overall, with few signs of dislocations in either secured or unsecured short-term markets, and conditions in term funding markets have
improved in early 2012.
Money market funds, a major provider of funds to
short-term funding markets such as those for CP and
for repo, experienced significant outflows across fund
categories in July, as investors’ focus turned to the
deteriorating situation in Europe and to the debt ceiling debate in the United States. Those outflows
largely shifted to bank deposits, resulting in significant pressure on the regulatory leverage ratios of a
few large banks. However, investments in money
market funds rose, on net, over the remainder of
2011, with the composition of those increases reflecting the general tone of increased risk aversion, as
government-only funds faced notable inflows while
prime funds experienced steady outflows.
Financial Institutions

Market sentiment toward the banking industry
declined rapidly early in the second half of 2011 as
investors turned their focus on exposures to European sovereigns and financial institutions and on the
possible spillover effects of the European crisis. Some
large U.S. institutions also remained significantly
exposed to legal risks stemming from their mortgage

Monetary Policy and Economic Developments

Figure 17. Spreads on credit default swaps for selected
U.S. banking organizations, 2007–12
Basis points

400
350
300
Large bank
holding companies

250
200
150
Other banks

100
50

Jan. July
2007

Jan. July Jan. July Jan. July Jan. July Jan.
2008
2009
2010
2011
2012

Note: The data are daily and extend through February 24, 2012. Median spreads
for six bank holding companies and nine other banks.
Source: Markit.

banking operations and foreclosure practices.12 More
recently, however, investor sentiment has improved
somewhat following the actions of central banks and
incoming data suggesting a somewhat better economic outlook in the United States. On balance,
equity prices for banking organizations have completely retraced their declines from last summer, while
CDS spreads (figure 17)—which reflect investors’
assessments of and willingness to bear the risk that
these institutions will default on their debt obligations—have declined from their peaks reached in the
fall, but not all the way back to mid-2011 levels.
Measures of bank profitability edged up, on net, in
recent quarters but remained well below the levels
that prevailed before the financial crisis began.
Although profits at the largest institutions were supported over that period by reductions in noninterest
expenses, net interest margins remained very low,
capital markets revenues were subdued, loan loss provisions are still somewhat elevated relative to precrisis norms, and a few banks booked large reserves
for litigation risks associated with their mortgage
portfolios.
12

On February 9, it was announced that the federal government
and 49 state attorneys general had reached a $25 billion agreement with the nation’s five largest mortgage servicers to address
mortgage loan servicing and foreclosure abuses. The agreement
does not prevent state and federal authorities from pursuing
criminal enforcement actions related to this or other conduct by
the servicers or from punishing wrongful securitization conduct;
it also does not prevent any action by individual borrowers who
wish to bring their own lawsuits.

23

Indicators of credit quality at commercial banks continued to show signs of improvement. Aggregate
delinquency and charge-off rates moved down,
though they remained quite elevated on residential
mortgages and both residential and commercial construction loans. Loss provisioning has leveled out in
recent quarters near the upper end of its pre-crisis
range. Nonetheless, in the January SLOOS, a large
fraction of the respondents indicated that they expect
credit quality to improve over the next 12 months for
most major loan categories if economic activity progresses in line with consensus forecasts.
Credit provided by domestic banks—the sum of
loans and securities—increased moderately in the
second half of 2011, its first such rise since the first
half of 2008. Bank credit grew as holdings of agency
MBS expanded steadily and most major loan categories exhibited improvement in the second half of the
year. The expansion was consistent with recent
SLOOS responses indicating that lending standards
and loan terms eased somewhat and that demand for
loans from businesses and households increased, on
net, in the second half of 2011. In particular, C&I
loans showed persistent and considerable strength
over the second half of 2011 and into early 2012.
Loans to nonbank financial institutions, a category
that tends to be volatile, also grew rapidly over that
period as did holdings of agency MBS. Consumer
loans held by banks edged up in the third and fourth
quarters. Those increases offset ongoing declines in
commercial real estate and home equity loans, both
of which remained very weak.
Regulators continued to take steps to strengthen their
oversight of the financial industry. In particular, a
variety of measures mandated by the Dodd-Frank
Wall Street Reform and Consumer Protection Act of
2010 are being, or are soon to be, implemented,
including enhanced capital and liquidity requirements for large banking organizations, annual stress
testing, additional risk-management requirements,
and the development of early remediation plans (see
box 1). As part of those efforts, the Federal Reserve
began annual reviews of the capital plans for U.S.
bank holding companies with total consolidated
assets of $50 billion or more under its Comprehensive Capital Analysis and Review program. Going
into those reviews, reported regulatory capital ratios
of U.S. banking institutions generally remained at
historically high levels over the second half of 2011.
Concerns about the condition of European financial
institutions, coupled with periods of heightened

24

98th Annual Report | 2011

Box 1. Financial Stability at the Federal Reserve
The Federal Reserve’s responsibility for promoting
financial stability stems from its role in supervising
and regulating banks, operating the nation’s payments system, and serving as the lender of last
resort. In the decades prior to the financial crisis,
financial stability policy tended to be overshadowed
by monetary policy, which had come to be viewed
as the principal function of central banks. However,
in the aftermath of the financial crisis, financial stability policy has taken on greater prominence and is
now generally considered an equally critical responsibility of central banks. As such, the Federal
Reserve has made significant organizational
changes and taken other actions to improve its ability to understand and address systemic risk. In addition, its statutory role in maintaining financial stability
has been expanded by the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010
(Dodd-Frank Act).
One key feature of the Dodd-Frank Act is its macroprudential orientation, as reflected in many of the
provisions to be implemented by the Federal
Reserve and other financial regulators. The macroprudential approach to regulation and supervision
still pays close attention to the safety and soundness of individual financial institutions, but it also
takes into account the linkages among those entities
and the condition of the financial system as a whole.
To implement the macroprudential approach, the
Dodd-Frank Act established the multiagency Financial Stability Oversight Council (FSOC), which is
tasked with promoting a more comprehensive
approach to monitoring and mitigating systemic risk.

attention paid to U.S. securities dealers, raised investor anxiety regarding counterparty exposure to dealers during the second half of 2011. Indeed, responses
to the December SCOOS suggested that dealers
devoted increased time and attention to the management of concentrated credit exposures to dealers and
other financial intermediaries over the previous three
months (figure 18).13 In addition, survey respondents
reported that they had reduced aggregate credit limits
for certain specific institutions. Investors appeared to
be particularly concerned about the stability of funding in the event of financial market stress because
most dealer firms are highly reliant on short-term
secured funding.
13

Following the failure of a primary dealer, the Federal Reserve
Bank of New York implemented a risk-management program
that required primary dealers to post margin on forward-settling
agency MBS transactions.

The Federal Reserve is one of 10 voting members
of the FSOC.
A significant aspect of the macroprudential approach
is the heightened focus on entities whose failure or
financial distress could result in outsized destabilizing effects on the rest of the system. Under the
Dodd-Frank Act, the Federal Reserve is responsible
for the supervision of all systemically important
financial institutions (SIFIs), which include both large
bank holding companies and nonbank financial firms
designated by the FSOC as systemically important.
Even before the Dodd-Frank Act was enacted, the
Federal Reserve was making organizational
changes to facilitate the incorporation of systemic
risk considerations into the supervisory process.
Notably, it created the Large Institution Supervision
Coordinating Committee (LISCC) to bring an interdisciplinary and cross-firm perspective to the supervision of large, complex financial institutions; the
LISCC acts to ensure that the financial positions of
these large institutions are strong enough to withstand adverse shocks. A similar body has been set
up to help in the oversight of systemically important
financial market utilities.
The Federal Reserve has also established the Office
of Financial Stability Policy and Research (OFS) to
help the Federal Reserve more effectively monitor
the financial system and develop policies for mitigating systemic risks. The OFS’s function is to coordinate and analyze information bearing on financial
stability from a wide range of perspectives and to
place the supervision of individual institutions within
a broader macroeconomic and financial context. In
(continued on next page)

Respondents to the December SCOOS reported a
broad but moderate tightening of credit terms applicable to important classes of counterparties over the
previous three months. This tightening was especially
evident for hedge fund clients and trading real estate
investment trusts.14 The institutions that reported
having tightened credit terms pointed to a worsening
in general market liquidity and functioning and a
reduced willingness to take on risk as the most
important reasons for doing so. Indeed, for each type
of collateral covered in the survey, notable net fractions of respondents reported that liquidity and functioning in the underlying asset market had deteriorated over the previous three months. Dealers
reported that the demand for funding most types of
securities continued to increase over the previous
14

Trading real estate investment trusts invest in assets backed by
real estate rather than directly in real estate.

Monetary Policy and Economic Developments

25

Box 1. Financial Stability at the Federal Reserve—continued
addition, the Federal Reserve works with other U.S.
agencies and international bodies on a range of
issues to strengthen the financial system.
Systemic financial risks can take several forms.
Some risks can be described as structural in nature
because they are associated with structural features
of financial markets and thus are largely independent of economic conditions; these include, for
example, the risk posed by a SIFI whose failure can
have outsized effects on the financial system or the
degree to which money market mutual funds are
susceptible to liquidity pressures. Other risks can be
described as cyclical in nature and include, for
example, elevated asset valuations and excessive
credit growth that arise in buoyant economic times
but can unwind in destabilizing ways should conditions change. Attentiveness to both types of risk is
critical in the monitoring of systemic risk and the formulation of appropriate macroprudential policy responses.
The Federal Reserve has taken steps to identify
structural vulnerabilities in the financial system and
to devise policies to mitigate the associated risks.
For example, in December 2011, the Board released
a proposal to strengthen the regulation and supervision of large bank holding companies and systemically important nonbank financial firms. The proposal
comprises a wide range of measures, including riskbased capital and leverage requirements, liquidity
requirements, stress tests, single-counterparty credit
limits, and early remediation requirements. In addition, in October 2011, the Board approved a final
rule to implement the resolution plan (living will)
requirement of the Dodd-Frank Act, which is

three months, particularly the demand for term funding with a maturity greater than 30 days, which
increased for all security types.

intended to reduce the likelihood that the failure of a
SIFI—should it occur—would cause serious damage
to the financial system. In all of its rulemaking
responsibilities, the Federal Reserve is attentive to
the international dimension of financial regulation. It
is also working with its regulatory counterparts to
improve the quality and timeliness of financial data.
The Federal Reserve is likewise moving forward to
address cyclical systemic risks. To identify such
risks, it routinely monitors a number of items—including, for example, measures of leverage and
maturity mismatch at financial intermediaries—and
looks for signs of a credit-induced buildup of systemic risk. In addition, it conducts regular stress
tests of the nation’s largest banking firms; these
tests are based on detailed confidential data about
the balance sheets of the firms and provide a comprehensive, rigorous assessment of how the firms’
financial conditions would likely evolve over a multiyear period under adverse economic and financial
scenarios. Meanwhile, efforts are under way to
evaluate and develop new macroprudential tools
that could help limit future buildups of cyclical systemic risk.
In summary, the Federal Reserve has taken a series
of actions to implement the relevant provisions of
the Dodd-Frank Act and to meet its broader financial
stability responsibilities in a timely way. The Federal
Reserve has made important changes to its organizational structure to support a macroprudential
approach to supervision and regulation, and it has
instituted processes for identifying and responding
to sources of systemic risk.

the entire range of transactions with such clients, had
decreased somewhat.
Corporate Debt and Equity Markets

Net investment flows to hedge funds in the third and
fourth quarters were reportedly significantly smaller
than in the first half of the year as hedge funds
markedly underperformed the broader market in
2011. Information from a variety of sources suggests
that the use of dealer-intermediated leverage has
declined, on balance, since mid-2011. Indeed, while
the use of dealer-intermediated leverage was roughly
unchanged for most types of counterparties according to September and December SCOOS respondents, about half of those surveyed indicated that
hedge funds’ use of financial leverage, considering

On net since July of last year, yields on investmentgrade corporate bonds have declined notably, while
those on speculative-grade corporate debt posted
mixed changes. However, reflecting a decline in investor risk-taking amid concerns about the European
situation and heightened volatility in financial markets, spreads of these yields to those on comparablematurity Treasury securities widened notably in the
third quarter and have only partly retraced since that
time (figure 19). In the secondary market for leveraged loans, the average bid price dropped in line with
the prices of other risk assets in August but has

26

98th Annual Report | 2011

has recovered recently after a sharp deterioration
during the summer.

Figure 18. Net percentage of dealers reporting increased
attention to exposure to other dealers, 2010–11
Percent

80

60

40

20

Q2

Q3
2010

Q4

Q1

Q2

Q3

Q4

2011

Note: The data are drawn from a survey conducted four times per year; the last
observation is from the December 2011 survey, which covers 2011:Q4. Net percentage equals the percentage of institutions that reported increasing attention
(“increased considerably” or “increased somewhat”) minus the percentage of
institutions that reported decreasing attention (“decreased considerably” or
“decreased somewhat”).
Source: Federal Reserve Board, Senior Credit Officer Opinion Survey on Dealer
Financing Terms.

recovered since then, as institutional investors—
which include collateralized loan obligations, pension
funds, insurance companies and other funds investing in fixed-income instruments—have reportedly
continued to exhibit strong appetites for higheryielding leveraged loans against a backdrop of little
new supply of such loans. Liquidity in that market

Percentage points

18
16
14
12
10
8
6
4

BBB

2
+
0
_

AA
1998

2000

2002

2004

2006

2008

2010

2012

Note: The data are daily and extend through February 24, 2012. The spreads
shown are the yields on 10-year bonds less the 10-year Treasury yield.
Source: Derived from smoothed corporate yield curves using Merrill Lynch bond
data.

Amid heightened stock market volatility over the
course of the second half of 2011, equity mutual
funds experienced sizable outflows. Loan funds,
which invest primarily in LIBOR-based syndicated
leveraged loans, also experienced outflows as retail
investors responded to loan price changes following
indications that the Federal Reserve would keep
interest rates lower for longer than previously anticipated. With declining yields on fixed-income securities boosting the performance of bond mutual funds,
these funds, including speculative-grade and municipal bond funds, attracted net inflows.
Monetary Aggregates and
the Federal Reserve’s Balance Sheet

Figure 19. Spreads of corporate bond yields over
comparable off-the-run Treasury yields, by securities
rating, 1997–2012

High-yield

Broad equity prices are about unchanged, on balance, since mid-2011 but exhibited an unusually high
level of volatility. Equity markets fell sharply in late
July and early August in response to concerns about
the European crisis, the U.S. debt ceiling debate, and
a possible slowdown in global growth. Equity prices
roughly retraced these losses during the fourth quarter of 2011 and early 2012, reflecting somewhat
better-than-expected economic data in the United
States as well as actions taken by major central banks
to mitigate the financial strains in Europe. Nonetheless, equity prices have remained highly sensitive to
news regarding developments in Europe. Implied
volatility for the S&P 500 index, calculated from
option prices, ramped up in the third quarter of 2011
but has since reversed much of that rise.

The M2 monetary aggregate expanded at an annual
rate of about 12 percent over the second half of
2011.15 The rapid growth in M2 appears to be the
result of increased demand for safe and liquid assets
due to concerns about the European situation, combined with a very low level of interest rates on alter15

M2 consists of (1) currency outside the U.S. Treasury, Federal
Reserve Banks, and the vaults of depository institutions;
(2) traveler’s checks of nonbank issuers; (3) demand deposits at
commercial banks (excluding those amounts held by depository
institutions, the U.S. government, and foreign banks and official
institutions) less cash items in the process of collection and Federal Reserve float; (4) other checkable deposits (negotiable order
of withdrawal, or NOW, accounts and automatic transfer service accounts at depository institutions; credit union share draft
accounts; and demand deposits at thrift institutions); (5) savings
deposits (including money market deposit accounts); (6) smalldenomination time deposits (time deposits issued in amounts of
less than $100,000) less individual retirement account (IRA)
and Keogh balances at depository institutions; and (7) balances
in retail money market funds less IRA and Keogh balances at
money market funds.

Monetary Policy and Economic Developments

native short-term investments. In addition, a number
of regulatory changes have likely boosted M2 of late.
In particular, unlimited insurance by the Federal
Deposit Insurance Corporation (FDIC) of onshore
noninterest-bearing deposits has made these deposits
increasingly attractive at times of heightened volatility and uncertainty in financial markets. In addition,
the change in the FDIC assessment base in
April 2011 added deposits in domestic banks’ offshore offices, eliminating some of the benefits to
banks of booking deposits abroad and apparently
leading, in some cases, to a decision to rebook some
of these deposits onshore. Indeed, liquid deposits, the
single largest component of M2, grew at an annual
rate of 20 percent in the second half of 2011.16 The
currency component of the money stock grew at an
annual rate of 7 percent over the second half of 2011,
a bit faster than the historical average but a slower
pace than in the first half of the year. The monetary
base—which is equal to the sum of currency in circulation and the reserve balances of depository institutions held at the Federal Reserve—expanded at an
annual rate of 3¾ percent in the second half of the
year, as the rise in currency more than offset a slight
decrease in reserve balances.17
The size of the Federal Reserve’s balance sheet
remained at a historically high level throughout the
second half of 2011 and into early 2012 and stood at
about $2.9 trillion as of February 22. The small rise
of about $61 billion since July largely reflected
increases in temporary U.S. dollar liquidity swap balances with the ECB, which were partially offset by a
decline in securities holdings (table 1). Holdings of
U.S. Treasury securities grew $32 billion over the second half of 2011, as the proceeds from paydowns of
agency debt and agency MBS were reinvested in
longer-term Treasury securities until the FOMC decision in September to switch the reinvestment of those
proceeds to agency MBS; total holdings of MBS
declined into the fall. The subsequent small increase
in MBS holdings reflects the reinvestment of maturing agency debt into MBS. Agency debt declined
about $14 billion over the entire period. The composition of Treasury holdings also changed over this
period as a result of the implementation of the MEP.
16

17

Regulation Q, which had prohibited the payment of interest on
demand deposits, was repealed by the Board on July 14. This
repeal may have also contributed, in a small way, to the growth
in M2.
The MEP that was announced at the September FOMC meeting was designed to increase the average maturity of the Federal
Reserve’s securities holdings while leaving the quantity of
reserve balances roughly unchanged.

27

As of February 24, 2012, the Open Market Desk at
the Federal Reserve Bank of New York (FRBNY)
had purchased $211 billion in Treasury securities
with remaining maturities of 6 to 30 years and sold
$223 billion in Treasury securities with maturities of
3 years or less.
In the second half of 2011 and early 2012, the Federal Reserve reduced some of its exposure to lending
facilities established during the financial crisis to support specific institutions. The portfolio holdings of
Maiden Lane LLC, Maiden Lane II LLC, and
Maiden Lane III LLC—entities that were created
during the crisis to acquire certain assets from the
Bear Stearns Companies, Inc., and American International Group, Inc., or AIG, to avoid the disorderly
failures of those institutions—declined, on net, primarily as a result of asset sales and principal payments. Of note, the FRBNY sold assets with a face
amount of $13 billion from the Maiden Lane II portfolio in early 2012 through two competitive processes
conducted by the FRBNY’s investment manager.18
Use of regular discount window lending facilities,
such as the primary credit facility, continued to be
minimal. Loans outstanding under the Term AssetBacked Securities Loan Facility declined and stood
just below $8 billion in late February.
On November 30, 2011, in order to ease strains in
global financial markets and thereby mitigate the
effects of such strains on the supply of credit to U.S.
households and businesses, the Federal Reserve
announced coordinated actions with other central
banks to enhance their capacity to provide liquidity
support to the global financial system.19 The FOMC
authorized an extension of the existing temporary
U.S. dollar liquidity swap arrangements through February 1, 2013, and the rate on these swap arrangements was reduced from the U.S. dollar OIS rate plus
100 basis points to the OIS rate plus 50 basis points.
18

19

On January 19, 2012, the FRBNY announced the sale of assets
with a face amount of $7.0 billion from the Maiden Lane II
LLC portfolio through a competitive process. On February 8,
2012, the FRBNY announced the sale of additional assets with
a face amount of $6.2 billion from the Maiden Lane II LLC
portfolio, also through a competitive process. Proceeds from
these two transactions will enable the repayment of the entire
remaining outstanding balance of the senior loan from the
FRBNY to Maiden Lane II LLC.
The Bank of Canada, the Bank of England, the Bank of Japan,
the European Central Bank, the Federal Reserve, and the Swiss
National Bank coordinated this action. In addition, as a contingency measure, the FOMC agreed to establish similar temporary swap arrangements with these five central banks to provide
liquidity in any of their currencies if necessary.

28

98th Annual Report | 2011

Table 1. Selected components of the Federal Reserve balance sheet, 2010–12
Millions of dollars
Balance sheet item
Total assets
Selected assets
Credit extended to depository institutions and dealers
Primary credit
Central bank liquidity swaps
Credit extended to other market participants
Term Asset-Backed Securities Loan Facility (TALF)
Net portfolio holdings of TALF LLC
Support of critical institutions
Net portfolio holdings of Maiden Lane LLC, Maiden Lane II LLC, and Maiden Lane III
LLC1
Credit extended to American International Group, Inc.
Preferred interests in AIA Aurora LLC and ALICO Holdings LLC
Securities held outright
U.S. Treasury securities
Agency debt securities
Agency mortgage-backed securities (MBS)2
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits held by depository institutions
Of which: Term deposits
U.S. Treasury, general account
U.S. Treasury, Supplementary Financing Account
Total capital

Dec. 29, 2010

July 6, 2011

Feb. 22, 2012

2,423,457

2,874,049

2,935,149

58
75

5
0

3
107,959

24,704
665

12,488
757

7,629
825

66,312
20,282
26,057

59,637
...
...

30,822
...
...

1,016,102
147,460
992,141
2,366,855

1,624,515
115,070
908,853
2,822,382

1,656,581
100,817
853,045
2,880,556

943,749
59,246
1,025,839
5,113
88,905
199,963
56,602

990,861
67,527
1,663,022
0
67,270
5,000
51,667

1,048,004
89,824
1,622,800
0
36,033
0
54,594

Note: LLC is a limited liability company.
The Federal Reserve has extended credit to several LLCs in conjunction with efforts to support critical institutions. Maiden Lane LLC was formed to acquire certain assets of
the Bear Stearns Companies, Inc. Maiden Lane II LLC was formed to purchase residential mortgage-backed securities from the U.S. securities lending reinvestment portfolio
of subsidiaries of American International Group, Inc. (AIG). Maiden Lane III LLC was formed to purchase multisector collateralized debt obligations on which the Financial
Products group of AIG has written credit default swap contracts.
2
Includes only MBS purchases that have already settled.
. . . Not applicable.
Source: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.”
1

The lower cost spurred increased use of those swap
lines; the outstanding amount of dollars provided
through the swap lines rose from zero in July to
roughly $108 billion in late February.
On the liability side of the Federal Reserve’s balance
sheet, reserve balances held by depository institutions
declined roughly $40 billion in the second half of
2011 and early 2012 while Federal Reserve notes in
circulation increased roughly $57 billion. The Federal
Reserve conducted a series of small-scale reverse
repurchase transactions involving all eligible collateral types and its expanded list of counterparties. The
Federal Reserve also continued to offer small-value
term deposits through the Term Deposit Facility. In
July of last year, the Treasury reduced the balance of
its Supplementary Financing Account at the Federal
Reserve from $5 billion to zero.

International Developments
In the second half of the year, financial market developments abroad were heavily influenced by concerns
about the heightened fiscal stresses in Europe and the
resultant risks to the global economic outlook. Foreign real GDP growth stepped up in the third quarter, as Japan rebounded from the effects of its March
earthquake and tsunami, leading to an easing of supply chain disruptions. In contrast, recent data indicate that foreign economic growth slowed in the
fourth quarter, as activity in the euro area appears to
have contracted and as flooding in Thailand weighed
on growth in several economies in Asia.
International Financial Markets

The foreign exchange value of the dollar has risen
since July about 3½ percent on a trade-weighted
basis against a broad set of currencies (figure 20).

Monetary Policy and Economic Developments

Figure 20. U.S. dollar nominal exchange rate, broad index,
2007–12
December 31, 2007 = 100

120

29

indexes remain below their midsummer levels, they
have risen markedly in the past two months. Emerging markets equity prices followed a path similar to
those in the AFEs. Emerging markets bond and
equity funds experienced large outflows during periods of heightened concerns about the European crisis, but inflows have resumed more recently.

115
110
105
100
95

2007

2008

2009

2010

2011

2012

Note: The data, which are in foreign currency units per dollar, are daily. The last
observation for the series is February 24, 2012. The broad index is a weighted
average of the foreign exchange values of the U.S. dollar against the currencies of
a large group of the most important U.S. trading partners. The index weights,
which change over time, are derived from U.S. export shares and from U.S. and
foreign import shares.
Source: Federal Reserve Board, Statistical Release H.10, “Foreign Exchange
Rates.”

Most of the appreciation occurred in September as
market participants became increasingly pessimistic
about the situation in Europe. Safe-haven flows
buoyed the yen and the Swiss franc, and in response,
the Bank of Japan and the Swiss National Bank
separately intervened to counter further appreciation
of their currencies.
On net in the second half of the year, government
bond yields for Canada, Germany, and the United
Kingdom fell over 100 basis points to record lows,
driven by safe-haven flows as well as a deteriorating
global outlook. By contrast, sovereign bond spreads
for Greece rose steeply, and Spanish and Italian sovereign spreads over German bunds also increased.
Prices of other risky assets were very volatile over the
period as market participants reacted to news about
the crisis. (See box 2.)
As sovereign funding pressures spread to Italy and
Spain in July and August and as concerns also
mounted regarding U.S. fiscal policy and the durability of the global recovery, equity prices in the
advanced foreign economies (AFEs) generally
plunged. Those equity markets remained quite volatile but largely depressed through early December,
when market sentiment seemed to take a more concerted turn for the better. Although most AFE equity

Euro-area bank stock prices underperformed the
broader market, as concerns about the health of
European banks intensified over the second half of
2011. The CDS premiums on the debt of many large
banks in Europe rose substantially, reflecting market
views of increased risk of default. Quarterly earnings
for many banks were reduced by write-downs on
Greek debt. Although only eight banks failed the
European Banking Authority (EBA) European
Union–wide stress test in July, concerns about the
capital adequacy of large European banks persisted.
Partly in response to these concerns, the EBA
announced in October that banks would be required
to put in place a temporary extraordinary capital
buffer by June 2012, boosting their core Tier 1 riskbased capital ratio to 9 percent. As market sentiment
about European banks deteriorated over the period,
their access to unsecured dollar funding diminished,
particularly at tenors beyond one week. (See box 3.)
European banks also faced pressure in euro funding
markets. As banks’ willingness to lend excess liquidity to one another decreased, the cost of obtaining
funding in the market rose, and banks relied more
heavily on the ECB for funding. The first three-year
refinancing operation, held by the ECB on December 21, led to a significant injection of new liquidity,
and funding conditions in Europe seemed to improve
gradually in the weeks that followed. Short-term euro
interbank rates declined, euro-area shorter-duration
sovereign bond yields fell sharply, and both governments and banks were able to raise funds more easily.
The Financial Account

Financial flows in the second half of 2011 reflected
heightened concerns about risk and the pressures in
currency markets resulting from the European crisis.
Based on data for the third quarter and monthly
indicators for the fourth quarter (not shown), foreign
private investors flocked to U.S. Treasury securities
as a safe-haven investment while selling U.S. corporate securities, especially in months when appetite for
risk was particularly weak. U.S. investors also pulled
back from investments in Europe, significantly reduc-

30

98th Annual Report | 2011

Box 2. An Update on the European Fiscal Crisis
The European fiscal crisis intensified in the second
half of 2011, as concerns over fiscal sustainability
spread to additional euro-area economies amid
weakening economic growth prospects and missed
fiscal targets. European financial institutions also
faced sharply reduced access to funds, given their
large exposures to vulnerable sovereigns. In
response, policymakers took steps to improve fiscal
balances, bolster the region’s financial backstop,
and address liquidity shortages for banks. On balance, market conditions have improved somewhat
since December, but concerns about a possible
Greek default and the adequacy of the financial
backstop for other vulnerable economies have kept
yields on sovereign debt elevated and funding for
European financial institutions limited.
The crisis began in smaller euro-area countries with
high fiscal deficits or debt and vulnerable banking
systems. In 2010 and the first half of 2011, governments in Greece, Ireland, and Portugal suffered
reduced access to market funding and required
financial assistance from the European Union (EU)
and the International Monetary Fund (IMF). Last
July, sovereign spreads over German bunds rose
markedly for Italy and Spain, as economic growth
disappointed, doubts increased over political commitment to fiscal consolidation, and calls for the
restructuring of Greek sovereign debt rattled investor
confidence. The deterioration of financial conditions
led to heightened political tensions in vulnerable
economies, contributing to leadership changes in
Greece, Italy, and Spain later in the fall.
Financial stresses spread quickly to European banks
with large exposures to Italy, Spain, and the other
vulnerable economies, and access to funding
became limited for all but the shortest maturities and
strongest institutions. In turn, concerns over the
potential fiscal burdens for governments, should
they need to recapitalize financial institutions,
caused sovereign yields to rise sharply in the fall for

other euro-area countries, including Austria, Belgium, and France.
European leaders responded to these developments
with a number of policy measures. In July, amid the
growing realization that Greece would need further
financial assistance, EU and IMF officials
announced plans for a second rescue package,
including a call for limited reduction in the value of
the debt held by private creditors. In February 2012,
in response to Greece’s faltering fiscal performance
and plunging output, the Greek government and its
creditors agreed on an enhanced rescue package,
including a larger reduction in private creditors’
claims. The Greek government and its creditors are
now working to put in place the private-sector debt
exchange and the new official-sector support program before a large debt amortization payment
comes due in mid-March.
In recent months, European authorities have also
made progress on plans to improve fiscal governance within the region. EU members (excluding the
United Kingdom and Czech Republic) have agreed
on the text of a new fiscal compact treaty designed
to strengthen fiscal rules, surveillance, and enforcement. Among other measures, this treaty will require
countries to legislate national fiscal rules, which
should generally limit structural fiscal deficits to
½ percent of gross domestic product. The treaty is
expected to be signed in March, after which national
parliaments must ratify it and implement the required
legislation.
Leaders also took a number of steps to increase the
size of the financial backstop for the euro area. The
flexibility, scope, and effective lending capacity of
the €440 billion European Financial Stability Facility
(EFSF), designed to support vulnerable governments, were increased. Authorities also moved up
the introduction of the European Stability Mechanism (ESM), a permanent €500 billion lending facil(continued on next page)

ing deposits with European banks and selling securities from euro-area countries. Overall, U.S. purchases
of foreign securities edged down in the third quarter.
The large purchases of Treasury securities dominated
total private financial flows in the third quarter, a
pattern that likely continued in the fourth quarter.
Net flows by banks located in the United States were
small, but these flows masked large offsetting movements by foreign- and U.S.-owned banks. U.S.
branches of European banks brought in substantial
funds from affiliates abroad over the course of 2011,

building reserve balances in the first half of the year
and covering persistent declines in U.S. funding
sources. In contrast, U.S. banks, subject to less-severe
market stress, sent funds abroad to meet strong dollar demand.
Inflows from foreign official institutions slowed notably in the second half of 2011. A number of
advanced countries acquired some U.S. assets, seeking to counteract upward pressure on their currencies
by purchasing U.S. dollars in foreign exchange markets. However, inflows from official institutions in the

Monetary Policy and Economic Developments

31

Box 2. An Update on the European Fiscal Crisis—continued
ity, to July 2012, about a year earlier than originally
planned. This March, euro-area leaders will consider
lifting the €500 billion ceiling on the combined lending of the EFSF and the ESM. In addition, European
officials called for an expansion of the IMF’s lending
capacity and pledged a joint contribution of
€150 billion toward that goal. Finally, to improve the
functioning of sovereign debt markets, the European
Central Bank (ECB) resumed purchases of euroarea marketable debt in August, reportedly including
the debt of Italy and Spain.
Policymakers also took steps to support financial
markets and institutions affected by the sovereign
crisis. To improve transparency and bolster the ability of European banks to withstand losses on sovereign holdings, the European Banking Authority
(EBA) conducted a second stress test of large EU
financial institutions, the results of which were
released in mid-July, along with detailed information
about banks’ exposures to borrowers in EU countries. Market concerns about bank capital persisted,
however, and in October, the EBA announced that
large banks would be required to build up “exceptional and temporary” capital buffers to meet a core
Tier 1 capital ratio of 9 percent and cover the cost of
marking sovereign exposures to market by the end
of June 2012. In December, the EBA disclosed that
the aggregate required capital buffer for large banks
would be €115 billion if risk-weighted assets were to
remain at the levels they had reached at the end of
September 2011. The banks submitted their capital
plans to their national supervisors for approval, and
the EBA has now summarized these plans. Excluding the Greek banks and three other institutions that
will be recapitalized separately by national authorities, the remaining 62 banks intend to create capital
buffers equivalent to €98 billion, about 25 percent
larger than their required buffers, and they plan to
use direct capital measures (such as retaining earnings, issuing new shares, and converting hybrid
instruments to common equity) to achieve €75 bil-

EMEs trended down significantly in 2011, especially
in the third and fourth quarters when the strength of
the dollar led to reductions in their intervention activity.
Advanced Foreign Economies

The intensification of the euro-area sovereign debt
crisis was accompanied by a widespread slowing of
economic activity in the AFEs. In the euro area,
financial tensions increased despite the various measures announced by European leaders to combat the
crisis. Real GDP contracted in the euro area at the
end of last year according to preliminary estimates,
and spillovers from the euro area likely contributed

lion of their buffer. The remainder of the buffer will
be generated by measures that reduce risk-weighted
assets—primarily selling assets and switching from
the standardized to the advanced approach to
measure risk weights. These measures will be subject to supervisory agreement.
To address spillovers to U.S. dollar funding markets
from stresses in Europe, in late November the Federal Reserve, the ECB, and four other major central
banks agreed to reduce the fee on draws on their
dollar liquidity swap lines and extend the duration of
such facilities. In early December, the ECB
announced a reduction in its policy interest rate and
its reserve requirement, an easing of rules on collateral for ECB refinancing operations, and the provision of three-year refinancing to banks to improve
their funding situation. Banks borrowed €489 billion
at the new facility in December, raising the total
amount of outstanding ECB refinancing operations
by roughly €200 billion. A second three-year liquidity operation is scheduled for the end of February.
The improved availability of dollar and euro funds
late in the year, against the background of the other
policies being employed to address the crisis,
appears to have partly allayed market concerns
about banks as well as governments in vulnerable
euro-area countries. Over the past two months,
European banks have seen improvements in their
access to funding, and in vulnerable economies,
credit spreads on the banks and spreads on government bonds have generally declined. Nevertheless,
significant risks remain as Europeans struggle to
implement the new Greek program and debt
exchange, meet targets for budgets and bank capital, and expand the financial backstop. Over the longer term, the region must meet the difficult challenges of achieving sustained fiscal consolidation,
stimulating growth, and improving competitiveness.

to the fourth-quarter GDP decline in the United
Kingdom. In Japan, economic activity rebounded
rapidly from the disruptions of the March earthquake and tsunami but dipped again in the last quarter of 2011 as exports slumped. In Canada, elevated
commodity prices and a resilient labor market have
supported economic activity, but the export sector is
showing signs of weakening.
Survey indicators suggest that conditions improved
somewhat around the turn of the year, with widespread upticks in different countries’ purchasing
managers indexes. However, uncertainty about the

32

98th Annual Report | 2011

Box 3. U.S. Dollar Funding Pressures and Dollar Liquidity
Swap Arrangements
As the euro-area crisis intensified, European banks
faced greater dollar funding pressures. Many European banks were especially vulnerable to changes
in investor sentiment through their reliance on shortterm dollar-denominated funding. As market sentiment deteriorated, European banks’ access to
medium- and long-term dollar funding markets
diminished markedly, with many unable to obtain
unsecured dollar funding at maturities exceeding
one week. The pullback of U.S. money market funds
(MMFs) from liabilities of euro-area banks beginning
in mid-2011 was an important part of the runoff of
short-term dollar funds, although MMFs were not the
only investors to reduce their exposures to European banks. As a result, many European banks
faced higher dollar funding costs. For example, the
cost for euro-area banks to obtain three-month dollar funding through the foreign exchange (FX) swap
market rose as financial pressures increased. The
cost of dollar funding through this market (the black
line in figure A), as banks borrow euros at the euro
London interbank offered rate (LIBOR) and swap
into dollars in the FX swap market, rose from
40 basis points early last summer to about
200 basis points in late November.

Figure A. Costs of three-month dollar funding through
the foreign exchange swap market, the central bank
swap line, and dollar LIBOR, 2011–12
Basis points

200
FX swap market
160
120
Central bank
swap line

80
40

Dollar LIBOR
July

Sept.
2011

Nov.

Jan.
2012

Note: The data are daily. The last observation for each series is February 24, 2012. Three-month dollar funding through the foreign exchange (FX)
swap market assumes that the banks first pay euro LIBOR (London interbank offered rate) to obtain euro funding.
Source: Bloomberg.

49

444

Although the effects of these dollar funding strains
are difficult to gauge, they pose substantial risks for
the U.S. economy. Large European banks borrow
heavily in dollars partly because they are active in
U.S. markets, purchasing government and corporate
securities as well as making loans to U.S. households and businesses. A possible response to dollar
funding strains, along with heightened capital
requirements, might be for European banks to sell
their dollar assets or refrain from further dollar lending, which could in turn result in a reduction of the
credit they supply to U.S. firms and households
while also reducing credit to European and other foreign firms involved in trade with the United States.
Therefore, further stresses on European banks
could spill over to the United States by weighing on
business and consumer activity, restraining our
exports, and adding to pressures on U.S. financial
markets and institutions.
To address strains in dollar funding markets, the
Federal Reserve, the European Central Bank (ECB),
and the central banks of Canada, Japan, Switzerland, and the United Kingdom announced an agreement on November 30 to revise, extend, and
expand the U.S. dollar swap lines. The revised
agreement lowered the price of dollar funding provided through the swaps (the red line in figure A) to
a rate of 50 basis points over the dollar overnight
index swap rate, a reduction of 50 basis points in
the rate at which the foreign central banks had been
providing dollar loans since May 2010.
The reduction in dollar funding costs due to the
revised pricing of the central bank swap lines helped
strengthen the liquidity positions of European and
other foreign banks, thereby benefiting the United
States by supporting the continued supply of credit
to U.S. households and businesses while mitigating
other channels of risk. Draws on the swap lines,
especially from the ECB, have been significant. On
December 7, at the first three-month dollar tender
under the new pricing scheme, the ECB allocated
about $51 billion, a substantial increase over previous operations. As of February 24, the ECB, the
Bank of Japan, and the Swiss National Bank had
about $89 billion, $18 billion, and $0.5 billion outstanding, respectively, from their dollar swap line
allotments, for a total of about $108 billion. In an
indication that the swap lines have been effective at
reducing overall dollar funding pressure, the cost of
obtaining dollars in the FX swap market has
dropped substantially since November 30. Dollar
LIBOR, which measures dollar funding costs in the
interbank market for U.S. and foreign institutions,
has also declined over the past two months.

Monetary Policy and Economic Developments

resolution of the euro-area crisis continues to affect
investors’ sentiment, while trade and financial spillovers weigh on activity for all of the AFEs.

33

cases—such as Brazil, China, Indonesia, and Thailand—to loosen monetary policy.

Twelve-month headline inflation remained elevated in
most of the AFEs through the end of 2011, largely
reflecting the run-up in commodity prices earlier last
year and, in some countries, currency depreciation
and increases in taxes. However, underlying inflation
pressures remained contained and, in recent months,
inflation rates have begun to turn down, reflecting
weaker economic activity and, as in the United
States, declines in commodity prices since last spring.
As with output, inflation performance differs significantly across countries. Twelve-month headline inflation currently ranges from 3.6 percent in the United
Kingdom, partly due to hikes in utility prices, to
slightly negative in Japan, where deflation resumed
toward the end of 2011 as energy price inflation
moderated.

In China, real GDP growth stepped down to an
annual rate of about 8 percent in the fourth quarter.
Retail sales and fixed-asset investment slowed a
touch but continued to grow briskly, reflecting solid
domestic demand. But net exports exerted a small
drag on growth, as weak external demand damped
exports. Twelve-month headline inflation moderated
to about 4½ percent in January, as food prices
retreated from earlier sharp rises. With growth slowing and inflation on the decline, Chinese authorities
reversed the course of monetary policy toward easing
by lowering the reserve requirement for large banks
100 basis points to 20.5 percent. In 2011, the Chinese
renminbi appreciated 4½ percent against the dollar
and about 6 percent on a real trade-weighted basis;
the latter measure gauges the renminbi’s value
against the currencies of China’s major trading partners and adjusts for differences in inflation rates.

Several foreign central banks in the AFEs eased monetary policy in the second half of last year. The ECB
cut its policy rate 50 basis points in the fourth quarter, bringing the main refinancing rate back to 1 percent, where it was at the beginning of the year. At its
December meeting, the ECB also expanded its provision of liquidity to the banking sector by introducing
two three-year longer-term refinancing operations,
reducing its reserve ratio requirement from 2 percent
to 1 percent, and easing its collateral requirements.
The Bank of England has held the Bank Rate at
0.5 percent but announced a £75 billion expansion of
its asset purchase facility in October and a further
£50 billion increase in February that will bring total
asset holdings to £325 billion upon its completion in
May 2012. The Bank of Japan also expanded its asset
purchase program, raising it from ¥15 trillion to ¥20 trillion in October and then to ¥30 trillion in February.

In Mexico, economic activity accelerated in the second and third quarters as domestic demand
expanded robustly. However, incoming indicators,
such as tepid growth of exports to the United States,
point to a slowdown in the fourth quarter. Mexican
consumer price inflation rose sharply in the second
half of the year, driven largely by rising food prices
and the removal of electrical energy subsidies. In Brazil, in contrast to most EMEs, GDP contracted
slightly in the third quarter, but incoming indicators
point to a return to growth in the fourth quarter,
partly as a result of several rounds of monetary
policy easing that began in August. As the direction
of capital flows turned to a net outflow, Brazilian
authorities loosened capital controls that had been
introduced earlier in the face of massive inflows and
associated fears of overheating.

Emerging Market Economies

Many EMEs experienced a slowdown in economic
growth in the third quarter of last year relative to the
pace seen in the first half. Both earlier policy tightening, undertaken amid concerns about overheating,
and weakening external demand weighed on growth.
However, third-quarter growth in China and Mexico
remained strong, supported by robust domestic
demand. Recent data indicate that the slowdown continued and broadened in the fourth quarter, as the
financial crisis in Europe softened external demand
and the floods in Thailand impeded supply chains. In
the second half of last year, concerns about the
global economy prompted EME authorities either to
put monetary policy tightening on hold or, in several

Part 3
Monetary Policy:
Recent Developments and Outlook
Monetary Policy over the Second Half
of 2011 and Early 2012
To promote the Federal Open Market Committee’s
(FOMC) objectives of maximum employment and
price stability, the Committee maintained a target
range for the federal funds rate of 0 to ¼ percent
throughout the second half of 2011 and into 2012.
With the incoming data suggesting a somewhat
slower pace of economic recovery than the Committee had anticipated, and with inflation seen as settling at levels at or below those consistent with its
statutory mandate, the Committee took steps during

34

98th Annual Report | 2011

the second half of 2011 and in early 2012 to provide
additional monetary accommodation in order to support a stronger economic recovery and to help ensure
that inflation, over time, runs at levels consistent with
its mandate. These steps included strengthening its
forward rate guidance regarding the Committee’s
expectations for the period over which economic conditions will warrant exceptionally low levels for the
federal funds rate, increasing the average maturity of
the Federal Reserve’s securities holdings through a
program of purchases and sales, and reinvesting principal payments on agency securities in agencyguaranteed mortgage-backed securities (MBS) rather
than Treasury securities.
On August 1, the Committee met by videoconference
to discuss issues associated with contingencies in the
event that the Treasury was temporarily unable to
meet its obligations because the statutory federal
debt limit was not raised or in the event of a downgrade of the U.S. sovereign credit rating. Participants
generally anticipated that there would be no need to
make changes to existing bank regulations, the operation of the discount window, or the conduct of open
market operations.20 With respect to potential policy
actions, participants agreed that the appropriate
response would depend importantly on the actual
conditions in markets and should generally consist of
standard operations.
The information reviewed at the regularly scheduled
FOMC meeting on August 9 indicated that the pace
of the economic recovery had remained slow in
recent months and that labor market conditions continued to be weak. In addition, revised data for 2008
through 2010 from the Bureau of Economic Analysis
indicated that the recent recession had been deeper
than previously thought and that the level of real
gross domestic product (GDP) had not yet regained
its pre-recession peak by the second quarter of 2011.
Moreover, downward revisions to first-quarter GDP
growth and the slow growth reported for the second
quarter indicated that the recovery had been quite
sluggish in the first half of 2011. Private nonfarm
payroll employment rose at a considerably slower
pace in June and July than earlier in the year, and
participants noted a deterioration in labor market
20

Members of the FOMC consist of the members of the Board of
Governors of the Federal Reserve System plus the president of
the Federal Reserve Bank of New York and 4 of the remaining
11 Reserve Bank presidents, who serve one-year terms on a
rotating basis. Participants at FOMC meetings consist of the
members of the Board of Governors of the Federal Reserve
System and all 12 Reserve Bank presidents.

conditions, slower household spending, a drop in
consumer and business confidence, and continued
weakness in the housing sector. Inflation, which had
picked up earlier in the year as a result of higher
prices for some commodities and imported goods as
well as supply chain disruptions resulting from the
natural disaster in Japan, moderated more recently as
prices of energy and some commodities fell back
from their earlier peaks. Longer-term inflation expectations remained stable. U.S. financial markets were
strongly influenced by developments regarding the
fiscal situations in the United States and in Europe
and by generally weaker-than-expected readings on
economic activity, as foreign economic growth
appeared to have slowed significantly. Yields on
nominal Treasury securities fell notably, on net, while
yields on both investment- and speculative-grade corporate bonds fell a little less than those on
comparable-maturity Treasury securities, leaving risk
spreads wider. Broad U.S. stock price indexes
declined significantly.
Most members agreed that the economic outlook
had deteriorated by enough to warrant a Committee
response at the August meeting. Those viewing a
shift toward more accommodative policy as appropriate generally agreed that a strengthening of the
Committee’s forward guidance regarding the federal
funds rate, by being more explicit about the period
over which the Committee expected the federal funds
rate to remain exceptionally low, would be a measured response to the deterioration in the outlook
over the intermeeting period. The Committee agreed
to keep the target range for the federal funds rate at
0 to ¼ percent and to state that economic conditions—including low rates of resource utilization and
a subdued outlook for inflation over the medium
run—are likely to warrant exceptionally low levels for
the federal funds rate at least through mid-2013. That
anticipated path for the federal funds rate was viewed
as appropriate in light of most members’ outlook for
the economy.
The data in hand at the September 20–21 FOMC
meeting indicated that economic activity continued
to expand at a slow pace and that labor market conditions remained weak. Consumer price inflation
appeared to have moderated since earlier in the year
as prices of energy and some commodities declined
from their peaks, but it had not yet come down as
much as participants had expected at previous meetings. Industrial production expanded in July and
August, real business spending on equipment and
software appeared to expand further, and real con-

Monetary Policy and Economic Developments

sumer spending posted a solid gain in July. However,
private nonfarm employment rose only slightly in
August, and the unemployment rate remained high.
Consumer sentiment deteriorated significantly further in August and stayed downbeat in early September. Activity in the housing sector continued to be
depressed by weak demand, uncertainty about future
home prices, tight credit conditions for mortgages
and construction loans, and a substantial inventory
of foreclosed and distressed properties. Financial
markets were volatile over the intermeeting period as
investors responded to somewhat disappointing news,
on balance, regarding economic activity in the United
States and abroad. Weak economic data contributed
to rising expectations among market participants of
additional monetary accommodation; those expectations and increasing concerns about the financial
situation in Europe led to an appreciable decline in
intermediate- and longer-term nominal Treasury
yields. Fluctuations in investors’ level of concern
about European fiscal and financial prospects also
contributed to market volatility, particularly in equity
markets, and spreads of yields on investment- and
speculative-grade corporate bonds over those on
comparable-maturity Treasury securities rose significantly over the intermeeting period, reaching levels
last registered in late 2009.
In the discussion of monetary policy, most members
agreed that the outlook had deteriorated somewhat,
and that there were significant downside risks to the
economic outlook, including strains in global financial markets. As a result, the Committee decided that
providing additional monetary accommodation
would be appropriate to support a stronger recovery
and to help ensure that inflation, over time, was at a
level consistent with the Committee’s dual mandate.
Those viewing greater policy accommodation as
appropriate at this meeting generally supported a
maturity extension program that would combine
asset purchases and sales to extend the average maturity of securities held in the System Open Market
Account without generating a substantial expansion
of the Federal Reserve’s balance sheet or reserve balances. Specifically, those members supported a program under which the Committee would announce
its intention to purchase, by the end of June 2012,
$400 billion of Treasury securities with remaining
maturities of 6 years to 30 years and to sell an equal
amount of Treasury securities with remaining
maturities of 3 years or less. They expected this program to put downward pressure on longer-term
interest rates and to help make broader financial con-

35

ditions more accommodative. In addition, to help
support conditions in mortgage markets, the Committee decided to reinvest principal received from its
holdings of agency debt and agency MBS in agency
MBS rather than continuing to reinvest those funds
in longer-term Treasury securities as had been the
Committee’s practice since the August 2010 FOMC
meeting. At the same time, the Committee decided to
maintain its existing policy of rolling over maturing
Treasury securities at auction. In its statement, the
Committee noted that it would continue to regularly
review the size and composition of its securities holdings and that it was prepared to adjust those holdings
as appropriate. The Committee also decided to keep
the target range for the federal funds rate at 0 to
¼ percent and to reaffirm its anticipation that economic conditions were likely to warrant exceptionally
low levels for the federal funds rate at least through
mid-2013.
The information reviewed at the November 1–2 meeting indicated that the pace of economic activity
strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that
weighed on economic growth in the first half of the
year. Global supply chain disruptions associated with
the natural disaster in Japan had diminished, and the
prices of energy and some commodities had come
down from their recent peaks, easing strains on
household budgets and likely contributing to a somewhat stronger pace of consumer spending in recent
months. Real equipment and software investment
expanded appreciably, and real personal consumption expenditures (PCE) rose moderately in the third
quarter. However, real disposable income declined in
the third quarter and consumer sentiment continued
to be downbeat in October. In addition, labor market
conditions remained weak as the pace of privatesector job gains in the third quarter as a whole was
less than it was in the first half of the year. Overall
consumer price inflation was more moderate than
earlier in the year, as prices of energy and some commodities declined from their recent peaks, and measures of longer-run inflation expectations remained
stable. Financial markets were quite volatile and
investor sentiment was strongly influenced by prospects for Europe, as market participants remained
highly attuned to developments regarding possible
steps to contain the fiscal and banking problems
there. Longer-term Treasury yields declined appreciably, on net, over the period, and yields on investmentand speculative-grade corporate bonds moved lower,
leaving their spreads to Treasury securities slightly

36

98th Annual Report | 2011

narrower. Although equity markets were volatile,
broad U.S. equity price indexes ended the intermeeting period little changed.
Most FOMC members anticipated that the pace of
economic growth would remain moderate over coming quarters, with unemployment declining only
gradually and inflation settling at or below levels consistent with the dual mandate. Moreover, the recovery
was still seen as subject to significant downside risks,
including strains in global financial markets. Accordingly, in the discussion of monetary policy, all Committee members agreed to continue the program of
extending the average maturity of the Federal
Reserve’s holdings of securities as announced in September. The Committee decided to maintain its existing policy of reinvesting principal payments from its
holdings of agency debt and agency MBS in agency
MBS and of rolling over maturing Treasury securities
at auction. In addition, the Committee agreed to
keep the target range for the federal funds rate at 0 to
¼ percent and to reiterate its expectation that economic conditions were likely to warrant exceptionally
low levels for the federal funds rate at least through
mid-2013.
Over subsequent weeks, financial markets appeared
to become increasingly concerned that a timely resolution of the European sovereign debt situation
might not occur despite the measures that authorities
there announced in October; pressures on European
sovereign debt markets increased, and conditions in
European funding markets deteriorated appreciably.
The greater financial stress appeared likely to damp
economic activity in the euro area and potentially to
pose a risk to the economic recovery in the United
States.
On November 28, the Committee met by videoconference to discuss a proposal to amend and augment
the Federal Reserve’s temporary liquidity swap
arrangements with foreign central banks in light of
the increased strains in global financial markets. The
proposal included a six-month extension of the sunset date and a 50 basis point reduction in the pricing
on the existing dollar liquidity swap arrangements
with the Bank of Canada, the Bank of England, the
Bank of Japan, the European Central Bank (ECB),
and the Swiss National Bank. In addition, the proposal included the establishment, as a contingency
measure, of swap arrangements that would allow the
Federal Reserve to provide liquidity to U.S. institutions in foreign currencies should the need arise. The
proposal was aimed at helping to ease strains in

financial markets and thereby to mitigate the effects
of such strains on the supply of credit to U.S. households and businesses, thus supporting the economic
recovery. Most participants agreed that the proposed
changes to the swap arrangements would represent
an important demonstration of the commitment of
the Federal Reserve and the other central banks to
work together to support the global financial system.
At the conclusion of the discussion, almost all members agreed to support the changes to the existing
swap line arrangements and the establishment of the
new foreign currency swap agreements.
As of the December 13 FOMC meeting, the data
indicated that U.S. economic activity had expanded
moderately despite some apparent slowing in the
growth of foreign economies and strains in global
financial markets. Conditions in the labor market
seemed to have improved somewhat, as the unemployment rate dropped in November and private
nonfarm employment continued to increase moderately. In October, industrial production rose, and
overall real PCE grew modestly following significant
gains in the previous month. However, revised estimates indicated that households’ real disposable
income declined in the second and third quarters, the
net wealth of households decreased, and consumer
sentiment was still at a subdued level in early December. Activity in the housing market remained
depressed by the substantial inventory of foreclosed
and distressed properties and by weak demand that
reflected tight credit conditions for mortgage loans
and uncertainty about future home prices. Overall
consumer price inflation continued to be more modest than earlier in the year, and measures of long-run
inflation expectations had been stable. The risks associated with the fiscal and financial difficulties in
Europe remained the focus of attention in financial
markets over the intermeeting period and contributed to heightened volatility in a wide range of asset
markets. However, stock prices and longer-term
interest rates had changed little, on balance, since the
November meeting.
Members viewed the information on U.S. economic
activity received over the intermeeting period as suggesting that the economy would continue to expand
moderately. Strains in global financial markets continued to pose significant downside risks to economic
activity. Members also anticipated that inflation
would settle, over coming quarters, at levels at or
below those consistent with the Committee’s dual
mandate. In the discussion of monetary policy for
the period immediately ahead, Committee members

Monetary Policy and Economic Developments

generally agreed that their overall assessments of the
economic outlook had not changed greatly since
their previous meeting. As a result, the Committee
decided to continue the program of extending the
average maturity of the Federal Reserve’s holdings of
securities as announced in September, to retain the
existing policies regarding the reinvestment of principal payments from Federal Reserve holdings of securities, and to keep the target range for the federal
funds rate at 0 to ¼ percent. While several members
noted that the reference to mid-2013 in the forward
rate guidance might need to be adjusted before long,
and a number of them looked forward to considering
possible enhancements to the Committee’s communications, the Committee agreed to reiterate its anticipation that economic conditions were likely to warrant exceptionally low levels for the federal funds rate
at least through mid-2013.
The information reviewed at the January 24–25 meeting indicated that U.S. economic activity continued
to expand moderately, while global growth appeared
to be slowing. Labor market indicators pointed to
some further improvement in labor market conditions, but progress was gradual and the unemployment rate remained elevated. Household spending
had continued to advance at a moderate pace despite
diminished growth in real disposable income, but
growth in business fixed investment had slowed. The
housing sector remained depressed. Inflation had
been subdued in recent months, there was little evidence of wage or cost pressures, and longer-term
inflation expectations had remained stable. Meeting
participants observed that financial conditions had
improved and financial market stresses had eased
somewhat during the intermeeting period: Equity
prices were higher, volatility had declined, and bank
lending conditions appeared to be improving. Participants noted that the ECB’s three-year refinancing
operation had apparently resulted in improved conditions in European sovereign debt markets. Nonetheless, participants expected that global financial markets would remain focused on the evolving situation
in Europe and they anticipated that further policy
efforts would be required to fully address the fiscal
and financial problems there.
With the economy facing continuing headwinds and
growth slowing in a number of U.S. export markets,
members generally expected a modest pace of economic growth over coming quarters, with the unemployment rate declining only gradually. At the same
time, members thought that inflation would run at
levels at or below those consistent with the Commit-

37

tee’s dual mandate. Against this backdrop, members
agreed that it would be appropriate to maintain the
existing highly accommodative stance of monetary
policy. They agreed to keep the target range for the
federal funds rate at 0 to ¼ percent, to continue the
program of extending the average maturity of the
Federal Reserve’s holdings of securities as
announced in September, and to retain the existing
policies regarding the reinvestment of principal payments from Federal Reserve holdings of securities. In
light of the economic outlook, most members also
agreed to indicate that the Committee expects to
maintain a highly accommodative stance for monetary policy and anticipates that economic conditions
are likely to warrant exceptionally low levels for the
federal funds rate at least through late 2014, longer
than had been indicated in recent FOMC statements.
The Committee also stated that it is prepared to
adjust the size and composition of its securities holdings as appropriate to promote a stronger economic
recovery in a context of price stability.
FOMC Communications
Transparency is an essential principle of modern central banking because it appropriately contributes to
the accountability of central banks to the government and to the public and because it can enhance
the effectiveness of central banks in achieving their
macroeconomic objectives. To this end, the Federal
Reserve provides to the public a considerable amount
of information concerning the conduct of monetary
policy. Immediately following each meeting of the
FOMC, the Committee releases a statement that lays
out the rationale for its policy decision, and detailed
minutes of each FOMC meeting are made public
three weeks following the meeting. Lightly edited
transcripts of FOMC meetings are released to the
public with a five-year lag.21 Moreover, since last
April, the Chairman has held press conferences after
regularly scheduled two-day FOMC meetings. At the
press conferences, the Chairman presents the current
economic projections of FOMC participants and
provides additional context for its policy decisions.
The Committee continued to consider additional
improvements in its communications approach in the
second half of 2011 and the first part of 2012. In a
discussion on external communications at the September 20–21 FOMC meeting, most participants
indicated that they favored taking steps to increase
21

FOMC statements, minutes, and transcripts, as well as other
related information, are available on the Federal Reserve
Board’s website at www.federalreserve.gov/monetarypolicy/
fomc.htm.

38

98th Annual Report | 2011

further the transparency of monetary policy, including providing more information about the Committee’s longer-run policy objectives and the factors that
influence the Committee’s policy decisions. Participants generally agreed that a clear statement of the
Committee’s longer-run policy objectives could be
helpful; some noted that it would also be useful to
clarify the linkage between these longer-run objectives and the Committee’s approach to setting the
stance of monetary policy in the short and medium
runs. Participants generally saw the Committee’s
postmeeting statements as not well suited to communicate fully the Committee’s thinking about its objectives and its policy framework, and they agreed that
the Committee would need to use other means to
communicate that information or to supplement
information in the statement. A number of participants suggested that the Committee’s periodic Summary of Economic Projections (SEP) could be used
to provide more information about their views on the
longer-run objectives and the likely evolution of
monetary policy.
At the November 1–2 FOMC meeting, participants
discussed alternative monetary policy strategies and
potential approaches for enhancing the clarity of
their public communications, though no decision was
made at that meeting to change the Committee’s
policy strategy or communications. It was noted that
many central banks around the world pursue an
explicit inflation objective, maintain the flexibility to
stabilize economic activity, and seek to communicate
their forecasts and policy plans as clearly as possible.
Many participants pointed to the merits of specifying
an explicit longer-run inflation goal, but it was noted
that such a step could be misperceived as placing
greater weight on price stability than on maximum
employment; consequently, some suggested that a
numerical inflation goal would need to be set forth
within a context that clearly underscored the Committee’s commitment to fostering both parts of its
dual mandate. Most of participants agreed that it
could be beneficial to formulate and publish a statement that would elucidate the Committee’s policy
approach, and participants generally expressed interest in providing additional information to the public
about the likely future path of the target federal
funds rate. The Chairman asked the subcommittee
on communications, headed by Governor Yellen, to
give consideration to a possible statement of the
Committee’s longer-run goals and policy strategy,
and he also encouraged the subcommittee to explore
potential approaches for incorporating information

about participants’ assessments of appropriate monetary policy into the SEP.22
At the December 13 FOMC meeting, participants
further considered ways in which the Committee
might enhance the clarity and transparency of its
public communications. The subcommittee on communications recommended an approach for incorporating information about participants’ projections of
appropriate future monetary policy into the SEP,
which the FOMC releases four times each year. In
the SEP, participants’ projections for economic
growth, unemployment, and inflation are conditioned on their individual assessments of the path of
monetary policy that is most likely to be consistent
with the Federal Reserve’s statutory mandate to promote maximum employment and price stability, but
information about those assessments has not been
included in the SEP. Most participants agreed that
adding their projections of the target federal funds
rate to the economic projections already provided in
the SEP would help the public better understand the
Committee’s monetary policy decisions and the ways
in which those decisions depend on members’ assessments of economic and financial conditions. At the
conclusion of the discussion, participants decided to
incorporate information about their projections of
appropriate monetary policy into the SEP beginning
in January.
Following up on the Committee’s discussion of
policy frameworks at its November meeting, the subcommittee on communications presented a draft
statement of the Committee’s longer-run goals and
policy strategy. Participants generally agreed that
issuing such a statement could be helpful in enhancing the transparency and accountability of monetary
policy and in facilitating well-informed decisionmaking by households and businesses, and thus in
enhancing the Committee’s ability to promote the
goals specified in its statutory mandate in the face of
significant economic disturbances. However, a couple
of participants expressed the concern that a statement that was sufficiently nuanced to capture the
diversity of views on the Committee might not, in
fact, enhance public understanding of the Committee’s actions and intentions. Participants commented
on the draft statement, and the Chairman encouraged the subcommittee to make adjustments to the
22

The subcommittee on communications is chaired by Governor
Yellen and includes Governor Raskin and Presidents Evans and
Plosser.

Monetary Policy and Economic Developments

39

Box 4. FOMC Statement Regarding Longer-Run Goals
and Monetary Policy Strategy
Following careful deliberations at its recent meetings,
the Federal Open Market Committee (FOMC) has
reached broad agreement on the following principles
regarding its longer-run goals and monetary policy
strategy. The Committee intends to reaffirm these
principles and to make adjustments as appropriate at
its annual organizational meeting each January.
The FOMC is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate longterm interest rates. The Committee seeks to explain
its monetary policy decisions to the public as clearly
as possible. Such clarity facilitates well-informed
decisionmaking by households and businesses,
reduces economic and financial uncertainty,
increases the effectiveness of monetary policy, and
enhances transparency and accountability, which are
essential in a democratic society.
Inflation, employment, and long-term interest rates
fluctuate over time in response to economic and
financial disturbances. Moreover, monetary policy
actions tend to influence economic activity and
prices with a lag. Therefore, the Committee’s policy
decisions reflect its longer-run goals, its mediumterm outlook, and its assessments of the balance of
risks, including risks to the financial system that
could impede the attainment of the Committee’s
goals.
The inflation rate over the longer run is primarily
determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for
inflation. The Committee judges that inflation at the
rate of 2 percent, as measured by the annual change
in the price index for personal consumption expenditures, is most consistent over the longer run with the
Federal Reserve’s statutory mandate. Communicating this inflation goal clearly to the public helps keep
longer-term inflation expectations firmly anchored,

draft and to present a revised version for the Committee’s further consideration in January.
At the January 24–25 meeting, the subcommittee on
communications presented a revised draft of a statement of principles regarding the FOMC’s longer-run
goals and monetary policy strategy. Almost all participants supported adopting and releasing the
revised statement (see box 4). It was noted that the
proposed statement did not represent a change in the
Committee’s policy approach. Instead, the statement
was intended to help enhance the transparency,
accountability, and effectiveness of monetary policy.

thereby fostering price stability and moderate longterm interest rates and enhancing the Committee’s
ability to promote maximum employment in the face
of significant economic disturbances.
The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors
may change over time and may not be directly measurable. Consequently, it would not be appropriate to
specify a fixed goal for employment; rather, the Committee’s policy decisions must be informed by
assessments of the maximum level of employment,
recognizing that such assessments are necessarily
uncertain and subject to revision. The Committee
considers a wide range of indicators in making these
assessments. Information about Committee participants’ estimates of the longer-run normal rates of
output growth and unemployment is published four
times per year in the FOMC’s Summary of Economic
Projections. For example, in the most recent projections, FOMC participants’ estimates of the longer-run
normal rate of unemployment had a central tendency
of 5.2 percent to 6.0 percent, roughly unchanged
from last January but substantially higher than the
corresponding interval several years earlier.
In setting monetary policy, the Committee seeks to
mitigate deviations of inflation from its longer-run
goal and deviations of employment from the Committee’s assessments of its maximum level. These
objectives are generally complementary. However,
under circumstances in which the Committee judges
that the objectives are not complementary, it follows
a balanced approach in promoting them, taking into
account the magnitude of the deviations and the
potentially different time horizons over which employment and inflation are projected to return to levels
judged consistent with its mandate.

In addition, in light of the decision made at the
December meeting, the Committee provided in the
January SEP information about each participant’s
assessments of appropriate monetary policy. Specifically, the SEP included information about participants’ estimates of the appropriate level of the target
federal funds rate in the fourth quarter of the current
year and the next few calendar years, and over the
longer run; the SEP also reported participants’ current projections of the likely timing of the appropriate first increase in the target rate given their projections of future economic conditions. The accompanying narrative described the key factors underlying

40

98th Annual Report | 2011

those assessments and provided some qualitative
information regarding participants’ expectations for
the Federal Reserve’s balance sheet. A number of
participants suggested further possible enhancements
to the SEP; the Chairman asked the subcommittee to
explore such enhancements over coming months.

Part 4
Summary of Economic Projections
The following material appeared as an addendum to
the minutes of the January 24–25, 2012, meeting of
the Federal Open Market Committee.
In conjunction with the January 24–25, 2012, Federal
Open Market Committee (FOMC) meeting, the
members of the Board of Governors and the presidents of the Federal Reserve Banks, all of whom participate in the deliberations of the FOMC, submitted
projections for growth of real output, the unemployment rate, and inflation for the years 2012 to 2014
and over the longer run. The economic projections
were based on information available at the time of
the meeting and participants’ individual assumptions
about factors likely to affect economic outcomes,
including their assessments of appropriate monetary
policy. Starting with the January meeting, participants also submitted their assessments of the path for
the target federal funds rate that they viewed as
appropriate and compatible with their individual economic projections. Longer-run projections represent
each participant’s assessment of the rate to which
each variable would be expected to converge over
time under appropriate monetary policy and in the
absence of further shocks. “Appropriate monetary
policy” is defined as the future path of policy that
participants deem most likely to foster outcomes for
economic activity and inflation that best satisfy their
individual interpretation of the Federal Reserve’s
objectives of maximum employment and stable
prices.
As depicted in figure 1, FOMC participants projected
continued economic expansion over the 2012–14
period, with real gross domestic product (GDP) rising at a modest rate this year and then strengthening
further through 2014. Participants generally anticipated only a small decline in the unemployment rate
this year. In 2013 and 2014, the pace of the expansion was projected to exceed participants’ estimates
of the longer-run sustainable rate of increase in real
GDP by enough to result in a gradual further decline
in the unemployment rate. However, at the end of
2014, participants generally expected that the unemployment rate would still be well above their estimates of the longer-run normal unemployment rate

that they currently view as consistent with the
FOMC’s statutory mandate for promoting maximum
employment and price stability. Participants viewed
the upward pressures on inflation in 2011 from factors such as supply chain disruptions and rising commodity prices as having waned, and they anticipated
that inflation would fall back in 2012. Over the projection period, most participants expected inflation,
as measured by the annual change in the price index
for personal consumption expenditures (PCE), to be
at or below the FOMC’s objective of 2 percent that
was expressed in the Committee’s statement of
longer-run goals and policy strategy. Core inflation
was projected to run at about the same rate as overall
inflation.
As indicated in table 1, relative to their previous projections in November 2011, participants made small
downward revisions to their expectations for the rate
of increase in real GDP in 2012 and 2013, but they
did not materially alter their projections for a noticeably stronger pace of expansion by 2014. With the
unemployment rate having declined in recent months
by more than participants had anticipated in the previous Summary of Economic Projections (SEP), they
generally lowered their forecasts for the level of the
unemployment rate over the next two years. Participants’ expectations for both the longer-run rate of
increase in real GDP and the longer-run unemployment rate were little changed from November. They
did not significantly alter their forecasts for the rate
of inflation over the next three years. However, in
light of the 2 percent inflation that is the objective
included in the statement of longer-run goals and
policy strategy adopted at the January meeting, the
range and central tendency of their projections of
longer-run inflation were all equal to 2 percent.
As shown in figure 2, most participants judged that
highly accommodative monetary policy was likely to
be warranted over coming years to promote a
stronger economic expansion in the context of price
stability. In particular, with the unemployment rate
projected to remain elevated over the projection
period and inflation expected to be subdued, six participants anticipated that, under appropriate monetary policy, the first increase in the target federal
funds rate would occur after 2014, and five expected
policy firming to commence during 2014 (the upper
panel). The remaining six participants judged that
raising the federal funds rate sooner would be
required to forestall inflationary pressures or avoid
distortions in the financial system. As indicated in
the lower panel, all of the individual assessments of
the appropriate target federal funds rate over the next
several years were below the longer-run level of the

Monetary Policy and Economic Developments

41

Figure 1. Central tendencies and ranges of economic projections, 2012–14 and over the longer run
Percent

Change in real GDP

4

Central tendency of projections
Range of projections

3
2
1
+
0
_
1

Actual

2
3

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

Unemployment rate
9
8
7
6
5

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

Core PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

2014

Note: Definitions of variables are in the notes to table 1. The data for the actual values of the variables are annual. The data for the change in real GDP, PCE inflation, and core
PCE inflation shown for 2011 incorporate the advance estimate of GDP for the fourth quarter of 2011, which the Bureau of Economic Analysis released on January 27, 2012.
This information was not available to FOMC meeting participants at the time of their meeting.

42

98th Annual Report | 2011

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, January 2012
Percent
Central tendency1

Range2

Variable
2012
Change in real GDP
November projection
Unemployment rate
November projection
PCE inflation
November projection
Core PCE inflation3
November projection

2013

2014

Longer run

2012

2013

2014

Longer run

2.2 to 2.7
2.5 to 2.9
8.2 to 8.5
8.5 to 8.7
1.4 to 1.8
1.4 to 2.0
1.5 to 1.8
1.5 to 2.0

2.8 to 3.2
3.0 to 3.5
7.4 to 8.1
7.8 to 8.2
1.4 to 2.0
1.5 to 2.0
1.5 to 2.0
1.4 to 1.9

3.3 to 4.0
3.0 to 3.9
6.7 to 7.6
6.8 to 7.7
1.6 to 2.0
1.5 to 2.0
1.6 to 2.0
1.5 to 2.0

2.3 to 2.6
2.4 to 2.7
5.2 to 6.0
5.2 to 6.0
2.0
1.7 to 2.0

2.1 to 3.0
2.3 to 3.5
7.8 to 8.6
8.1 to 8.9
1.3 to 2.5
1.4 to 2.8
1.3 to 2.0
1.3 to 2.1

2.4 to 3.8
2.7 to 4.0
7.0 to 8.2
7.5 to 8.4
1.4 to 2.3
1.4 to 2.5
1.4 to 2.0
1.4 to 2.1

2.8 to 4.3
2.7 to 4.5
6.3 to 7.7
6.5 to 8.0
1.5 to 2.1
1.5 to 2.4
1.4 to 2.0
1.4 to 2.2

2.2 to 3.0
2.2 to 3.0
5.0 to 6.0
5.0 to 6.0
2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are from the fourth quarter of the previous year to the fourth
quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures
(PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the
year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s
assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The
November projections were made in conjunction with the meeting of the Federal Open Market Committee on November 1–2, 2011.
1
The central tendency excludes the three highest and three lowest projections for each variable in each year.
2
The range for a variable in a given year includes all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

federal funds rate, and 11 participants placed the target federal funds rate at 1 percent or lower at the end
of 2014. Most participants indicated that they
expected that the normalization of the Federal
Reserve’s balance sheet should occur in a way consistent with the principles agreed on at the June 2011
meeting of the FOMC, with the timing of adjustments dependent on the expected date of the first
policy tightening. A few participants judged that,
given their current assessments of the economic outlook, appropriate policy would include additional
asset purchases in 2012, and one assumed an early
ending of the maturity extension program.
A sizable majority of participants continued to judge
the level of uncertainty associated with their projections for real activity and the unemployment rate as
unusually high relative to historical norms. Many also
attached a greater-than-normal level of uncertainty
to their forecasts for inflation, but, compared with
the November SEP, two additional participants
viewed uncertainty as broadly similar to longer-run
norms. As in November, many participants saw
downside risks attending their forecasts of real GDP
growth and upside risks to their forecasts of the
unemployment rate; most participants viewed the
risks to their inflation projections as broadly
balanced.
The Outlook for Economic Activity
The central tendency of participants’ forecasts for the
change in real GDP in 2012 was 2.2 to 2.7 percent.

This forecast for 2012, while slightly lower than the
projection prepared in November, would represent a
pickup in output growth from 2011 to a rate close to
its longer-run trend. Participants stated that the economic information received since November showed
continued gradual improvement in the pace of economic activity during the second half of 2011, as the
influence of the temporary factors that damped
activity in the first half of the year subsided. Consumer spending increased at a moderate rate, exports
expanded solidly, and business investment rose further. Recently, consumers and businesses appeared to
become somewhat more optimistic about the outlook. Financial conditions for domestic nonfinancial
businesses were generally favorable, and conditions in
consumer credit markets showed signs of
improvement.
However, a number of factors suggested that the
pace of the expansion would continue to be
restrained. Although some indicators of activity in
the housing sector improved slightly at the end of
2011, new homebuilding and sales remained at
depressed levels, house prices were still falling, and
mortgage credit remained tight. Households’ real disposable income rose only modestly through late 2011.
In addition, federal spending contracted toward yearend, and the restraining effects of fiscal consolidation
appeared likely to be greater this year than anticipated at the time of the November projections. Participants also read the information on economic
activity abroad, particularly in Europe, as pointing to

Monetary Policy and Economic Developments

43

Figure 2. Overview of FOMC participants’ assessments of appropriate monetary policy

Appropriate Timing of Policy Firming

Number of Participants
10
9
8
7
6
5

5
4

3

4

3

3
2

2
1

2012

2013

2014

2015

0

2016

Appropriate Pace of Policy Firming

Percent

6

Target Federal Funds Rate at Year-End

5

4

3

2

1

2012

2013

2014

Longer run

0

Note: In the upper panel, the height of each bar denotes the number of FOMC participants who judge that, under appropriate monetary policy and in the absence of further
shocks to the economy, the first increase in the target federal funds rate from its current range of 0 to ¼ percent will occur in the specified calendar year. In the lower panel,
each shaded circle indicates the value (rounded to the nearest ¼ percent) of an individual participant's judgment of the appropriate level of the target federal funds rate at the
end of the specified calendar year or over the longer run.

weaker demand for U.S. exports in coming quarters
than had seemed likely when they prepared their
forecasts in November.
Participants anticipated that the pace of the economic expansion would strengthen over the 2013–14
period, reaching rates of increase in real GDP above

their estimates of the longer-run rates of output
growth. The central tendencies of participants’ forecasts for the change in real GDP were 2.8 to 3.2 percent in 2013 and 3.3 to 4.0 percent in 2014. Among
the considerations supporting their forecasts, participants cited their expectation that the expansion
would be supported by monetary policy accommoda-

44

98th Annual Report | 2011

tion, ongoing improvements in credit conditions, rising household and business confidence, and strengthening household balance sheets. Many participants
judged that U.S. fiscal policy would still be a drag on
economic activity in 2013, but many anticipated that
progress would be made in resolving the fiscal situation in Europe and that the foreign economic outlook would be more positive. Over time and in the
absence of shocks, participants expected that the rate
of increase of real GDP would converge to their estimates of its longer-run rate, with a central tendency
of 2.3 to 2.6 percent, little changed from their estimates in November.
The unemployment rate improved more in late 2011
than most participants had anticipated when they
prepared their November projections, falling from
9.1 to 8.7 percent between the third and fourth quarters. As a result, most participants adjusted down
their projections for the unemployment rate this year.
Nonetheless, with real GDP expected to increase at a
modest rate in 2012, the unemployment rate was projected to decline only a little this year, with the central tendency of participants’ forecasts at 8.2 to
8.5 percent at year-end. Thereafter, participants
expected that the pickup in the pace of the expansion
in 2013 and 2014 would be accompanied by a further
gradual improvement in labor market conditions. The
central tendency of participants’ forecasts for the
unemployment rate at the end of 2013 was 7.4 to
8.1 percent, and it was 6.7 to 7.6 percent at the end of
2014. The central tendency of participants’ estimates
of the longer-run normal rate of unemployment that
would prevail in the absence of further shocks was
5.2 to 6.0 percent. Most participants indicated that
they anticipated that five or six years would be
required to close the gap between the current unemployment rate and their estimates of the longer-run
rate, although some noted that more time would
likely be needed.
Figures 3.A and 3.B provide details on the diversity of
participants’ views regarding the likely outcomes for
real GDP growth and the unemployment rate over
the next three years and over the longer run. The dispersion in these projections reflected differences in
participants’ assessments of many factors, including
appropriate monetary policy and its effects on economic activity, the underlying momentum in economic activity, the effects of the European situation,
the prospective path for U.S. fiscal policy, the likely
evolution of credit and financial market conditions,
and the extent of structural dislocations in the labor
market. Compared with their November projections,
the range of participants’ forecasts for the change in
real GDP in 2012 narrowed somewhat and shifted

slightly lower, as some participants reassessed the
outlook for global economic growth and for U.S. fiscal policy. Many, however, made no material change
to their forecasts for growth of real GDP this year.
The dispersion of participants’ forecasts for output
growth in 2013 and 2014 remained relatively wide.
Having incorporated the data showing a lower rate of
unemployment at the end of 2011 than previously
expected, the distribution of participants’ projections
for the end of 2012 shifted noticeably down relative
to the November forecasts. The ranges for the unemployment rate in 2013 and 2014 showed less pronounced shifts toward lower rates and, as was the
case with the ranges for output growth, remained
wide. Participants made only modest adjustments to
their projections of the rates of output growth and
unemployment over the longer run, and, on net, the
dispersions of their projections for both were little
changed from those reported in November. The dispersion of estimates for the longer-run rate of output
growth is narrow, with only one participant’s estimate outside of a range of 2.2 to 2.7 percent. By
comparison, participants’ views about the level to
which the unemployment rate would converge in the
long run are more diverse, reflecting, among other
things, different views on the outlook for labor supply and on the extent of structural impediments in
the labor market.
The Outlook for Inflation
Participants generally viewed the outlook for inflation as very similar to that in November. Most indicated that, as they expected, the effects of the run-up
in prices of energy and other commodities and the
supply disruptions that occurred in the first half of
2011 had largely waned, and that inflation had been
subdued in recent months. Participants also noted
that inflation expectations had remained stable over
the past year despite the fluctuations in headline
inflation. Assuming no further supply shocks, most
participants anticipated that both headline and core
inflation would remain subdued over the 2012–14
period at rates at or below the FOMC’s longer-run
objective of 2 percent. Specifically, the central tendency of participants’ projections for the increase in
inflation, as measured by the PCE price index, in
2012 was 1.4 to 1.8 percent, and it edged up to a central tendency of 1.6 to 2.0 percent in 2014; the central
tendencies of the forecasts for core PCE inflation
were largely the same as those for the total measure.
Figures 3.C and 3.D provide information about the
diversity of participants’ views about the outlook for
inflation. Compared with their November projections, expectations for inflation in 2012 shifted down
a bit, with some participants noting that the slowing

Monetary Policy and Economic Developments

45

Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2012–14 and over the longer run
Number of participants

2012

18

January projections
November projections

16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

Percent range
Note: Definitions of variables are in the general note to table 1.

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

46

98th Annual Report | 2011

Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2012–14 and over the longer run
Number of participants

2012

18

January projections
November projections

16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

Percent range
Note: Definitions of variables are in the general note to table 1.

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

Monetary Policy and Economic Developments

47

Figure 3.C. Distribution of participants’ projections for PCE inflation, 2012–14 and over the longer run
Number of participants

2012

18

January projections
November projections

16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Note: Definitions of variables are in the general note to table 1.

2.12.2

2.32.4

2.52.6

2.72.8

48

98th Annual Report | 2011

Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2012–14
Number of participants

2012

18

January projections
November projections

16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Note: Definitions of variables are in the general note to table 1.

in inflation at the end of 2011 had been greater than
they anticipated. Nonetheless, the range of participants’ forecasts for inflation in 2012 remained wide,
and the dispersion was only slightly narrower in
2013. By 2014, the range of inflation forecasts narrowed more noticeably, as participants expected that,
under appropriate monetary policy, inflation would
begin to converge to the Committee’s longer-run
objective. In general, the dispersion of views on the
outlook for inflation over the projection period represented differences in judgments regarding the
degree of slack in resource utilization and the extent

to which slack influences inflation and inflation
expectations. In addition, participants differed in
their estimates of how the stance of monetary policy
would influence inflation expectations.
Appropriate Monetary Policy
Most participants judged that the current outlook—
for a moderate pace of economic recovery with the
unemployment rate declining only gradually and
inflation subdued—warranted exceptionally low levels of the federal funds rate at least until late 2014. In
particular, five participants viewed appropriate policy

Monetary Policy and Economic Developments

firming as commencing during 2014, while six others
judged that the first increase in the federal funds rate
would not be warranted until 2015 or 2016. As a
result, those 11 participants anticipated that the
appropriate federal funds rate at the end of 2014
would be 1 percent or lower. Those who saw the first
increase occurring in 2015 reported that they anticipated that the federal funds rate would be ½ percent
at the end of that year. For the two participants who
put the first increase in 2016, the appropriate target
federal funds rate at the end of that year was 1½ and
1¾ percent. In contrast, six participants expected
that an increase in the target federal funds rate would
be appropriate within the next two years, and those
participants anticipated that the target rate would
need to be increased to around 1½ to 2¾ percent at
the end of 2014.
Participants’ assessments of the appropriate path for
the federal funds rate reflected their judgments of the
policy that would best support progress in achieving
the Federal Reserve’s mandate for promoting maximum employment and stable prices. Among the key
factors informing participants’ expectations about
the appropriate setting for monetary policy were their
assessments of the maximum level of employment,
the Committee’s longer-run inflation goal, the extent
to which current conditions deviate from these
mandate-consistent levels, and their projections of
the likely time horizons required to return employment and inflation to such levels. Several participants
commented that their assessments took into account
the risks to the outlook for economic activity and
inflation, and a few pointed specifically to the relevance of financial stability in their policy judgments.
Participants also noted that because the appropriate
stance of monetary policy depends importantly on
the evolution of real activity and inflation over time,
their assessments of the appropriate future path of
the federal funds rate could change if economic conditions were to evolve in an unexpected manner.
All participants reported levels for the appropriate
target federal funds rate at the end of 2014 that were
well below their estimates of the level expected to
prevail in the longer run. The longer-run nominal levels were in a range from 3¾ to 4½ percent, reflecting
participants’ judgments about the longer-run equilibrium level of the real federal funds rate and the Committee’s inflation objective of 2 percent.
Participants also provided qualitative information on
their views regarding the appropriate path of the
Federal Reserve’s balance sheet. A few participants’

49

assessments of appropriate monetary policy incorporated additional purchases of securities in 2012, and
a number of participants indicated that they
remained open to a consideration of additional asset
purchases if the economic outlook deteriorated. All
but one of the participants continued to expect that
the Committee would carry out the normalization of
the balance sheet according to the principles
approved at the June 2011 FOMC meeting. That is,
prior to the first increase in the federal funds rate, the
Committee would likely cease reinvesting some or all
payments on the securities holdings in the System
Open Market Account (SOMA), and it would likely
begin sales of agency securities from the SOMA
sometime after the first rate increase, aiming to eliminate the SOMA’s holdings of agency securities over a
period of three to five years. Indeed, most participants saw sales of agency securities starting no earlier
than 2015. However, those participants anticipating
an earlier increase in the federal funds rate also called
for earlier adjustments to the balance sheet, and one
participant assumed an early end of the maturity
extension program.
Figure 3.E details the distribution of participants’
judgments regarding the appropriate level of the target federal funds rate at the end of each calendar year
from 2012 to 2014 and over the longer run. Most
participants anticipated that economic conditions
would warrant maintaining the current low level of
the federal funds rate over the next two years. However, views on the appropriate level of the federal
funds rate at the end of 2014 were more widely dispersed, with two-thirds of participants seeing the
appropriate level of the federal funds rate as 1 percent or below and five seeing the appropriate rate as
2 percent or higher. Those participants who judged
that a longer period of exceptionally low levels of the
federal funds rate would be appropriate generally also
anticipated that the pace of the economic expansion
would be moderate and that the unemployment rate
would decline only gradually, remaining well above
its longer-run rate at the end of 2014. Almost all of
these participants expected that inflation would be
relatively stable at or below the FOMC’s longer-run
objective of 2 percent until the time of the first
increase in the federal funds rate. A number of them
also mentioned their assessment that a longer period
of low federal funds rates is appropriate when the
federal funds rate is constrained by its effective lower
bound. In contrast, the six participants who judged
that policy firming should begin in 2012 or 2013 indicated that the Committee would need to act decisively to keep inflation at mandate-consistent levels

50

98th Annual Report | 2011

Figure 3.E. Distribution of participants’ projections for the target federal funds rate, 2012–14 and over the longer run
Number of participants

2012

18

January projections

16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

4.634.87

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

4.634.87

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

4.634.87

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

Percent range
Note: The target funds rate is measured as the level of the target rate at the end of the calendar year or in the longer run.

3.633.87

3.884.12

4.134.37

4.384.62

4.634.87

Monetary Policy and Economic Developments

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2012

2013

2014

±1.3
±0.7
±0.9

±1.7
±1.4
±1.0

±1.8
±1.8
±1.0

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1991 through 2010 that were released in the winter by
various private and government forecasters. As described in box 5, under certain
assumptions, there is about a 70 percent probability that actual outcomes for real
GDP, unemployment, and consumer prices will be in ranges implied by the
average size of projection errors made in the past. Further information is in David
Reifschneider and Peter Tulip (2007), “Gauging the Uncertainty of the Economic
Outlook from Historical Forecasting Errors,” Finance and Economics Discussion
Series 2007-60 (Washington: Board of Governors of the Federal Reserve System,
November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

and to limit the risk of undermining Federal Reserve
credibility and causing a rise in inflation expectations. Several were projecting a faster pickup in economic activity, and a few stressed the risk of distortions in the financial system from an extended period
of exceptionally low interest rates.
Uncertainty and Risks
Figure 4 shows that most participants continued to
share the view that their projections for real GDP
growth and the unemployment rate were subject to a
higher level of uncertainty than was the norm during
the previous 20 years.23 Many also judged the level of
uncertainty associated with their inflation forecasts
to be higher than the longer-run norm, but that
assessment was somewhat less prevalent among participants than was the case for uncertainty about real
activity. Participants identified a number of factors
that contributed to the elevated level of uncertainty
about the outlook. In particular, many participants
continued to cite risks related to ongoing developments in Europe. More broadly, they again noted difficulties in forecasting the path of economic recovery
from a deep recession that was the result of a severe
financial crisis and thus differed importantly from
the experience with recoveries over the past 60 years.
In that regard, participants continued to be uncertain
about the pace at which credit conditions would ease
and about prospects for a recovery in the housing
23

Table 2 provides estimates of the forecast uncertainty for the
change in real GDP, the unemployment rate, and total consumer price inflation over the period from 1991 to 2010. At the
end of this summary, box 5 discusses the sources and interpretation of uncertainty in the economic forecasts and explains the
approach used to assess the uncertainty and risks attending the
participants’ projections.

51

sector. In addition, participants generally saw the
outlook for fiscal and regulatory policies as still
highly uncertain. Regarding the unemployment rate,
several expressed uncertainty about how labor
demand and supply would evolve over the forecast
period. Among the sources of uncertainty about the
outlook for inflation were the difficulties in assessing
the current and prospective margins of slack in
resource markets and the effect of such slack on
prices.
A majority of participants continued to report that
they saw the risks to their forecasts of real GDP
growth as weighted to the downside and, accordingly,
the risks to their projections for the unemployment
rate as skewed to the upside. All but one of the
remaining participants viewed the risks to both projections as broadly balanced, while one noted a risk
that the unemployment rate might continue to
decline more rapidly than expected. The most frequently cited downside risks to the projected pace of
the economic expansion were the possibility of
financial market and economic spillovers from the
fiscal and financial issues in the euro area and the
chance that some of the factors that have restrained
the recovery in recent years could persist and weigh
on economic activity to a greater extent than
assumed in participants’ baseline forecasts. In particular, some participants mentioned the downside
risks to consumer spending from still-weak household balance sheets and only modest gains in real
income, along with the possible effects of still-high
levels of uncertainty regarding fiscal and regulatory
policies that might damp businesses’ willingness to
invest and hire. A number of participants noted the
risk of another disruption in global oil markets that
could not only boost inflation but also reduce real
income and spending. The participants who judged
the risks to be broadly balanced also recognized a
number of these downside risks to the outlook but
saw them as counterbalanced by the possibility that
the resilience of economic activity in late 2011 and
the recent drop in the unemployment rate might signal greater underlying momentum in economic
activity.
In contrast to their outlook for economic activity,
most participants judged the risks to their projections
of inflation as broadly balanced. Participants generally viewed the recent decline in inflation as having
been in line with their earlier forecasts, and they
noted that inflation expectations remain stable. While
many of these participants saw the persistence of
substantial slack in resource utilization as likely to
keep inflation subdued over the projection period, a
few others noted the risk that elevated resource slack

52

98th Annual Report | 2011

Figure 4. Uncertainty and risks in economic projections
Number of participants

Uncertainty about GDP growth

Number of participants

18

January projections
November projections

16

Risks to GDP growth

18

January projections
November projections

16

14

10

8

8

6

6

4

4

2

Broadly
similar

12

10

Lower

14

12

2

Higher

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about the unemployment rate

Weighted to
upside
Number of participants

18

Risks to the unemployment rate

18

16

12

10

10

8

8

6

6

4

4

2

Broadly
similar

14

12

Lower

16

14

2

Weighted to
downside

Higher

Broadly
balanced

Number of participants

Uncertainty about PCE inflation

Weighted to
upside
Number of participants

18

Risks to PCE inflation

18

16

12

10

10

8

8

6

6

4

4

2

Broadly
similar

14

12

Lower

16

14

2

Higher

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about core PCE inflation

Weighted to
upside
Number of participants

18

Risks to core PCE inflation

18

16

10

8

8

6

6

4

4

2

Higher

12

10

Broadly
similar

14

12

Lower

16

14

2

Weighted to
downside

Broadly
balanced

Note: For definitions of uncertainty and risks in economic projections, see box 5. Definitions of variables are in the general note to table 1.

Weighted to
upside

Monetary Policy and Economic Developments

53

Box 5. Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public
understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts
are necessarily imperfect descriptions of the real
world, and the future path of the economy can be
affected by myriad unforeseen developments and
events. Thus, in setting the stance of monetary
policy, participants consider not only what appears to
be the most likely economic outcome as embodied in
their projections, but also the range of alternative
possibilities, the likelihood of their occurring, and the
potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy
of a range of forecasts, including those reported in
past Monetary Policy Reports and those prepared by
the Federal Reserve Board’s staff in advance of
meetings of the Federal Open Market Committee.
The projection error ranges shown in the table illustrate the considerable uncertainty associated with
economic forecasts. For example, suppose a participant projects that real gross domestic product (GDP)
and total consumer prices will rise steadily at annual
rates of, respectively, 3 percent and 2 percent. If the
uncertainty attending those projections is similar to
that experienced in the past and the risks around the
projections are broadly balanced, the numbers
reported in table 2 would imply a probability of about
70 percent that actual GDP would expand within a
range of 1.7 to 4.3 percent in the current year, 1.3 to
4.7 percent in the second year, and 1.2 to 4.8 in the

might put more downward pressure on inflation than
expected. In contrast, some participants noted the
upside risks to inflation from developments in global
oil and commodity markets, and several indicated
that the current highly accommodative stance of
monetary policy and the substantial liquidity

third year. The corresponding 70 percent confidence
intervals for overall inflation would be 1.1 to 2.9 percent in the current year and 1.0 to 3.0 percent in the
second and third years.
Because current conditions may differ from those
that prevailed, on average, over history, participants
provide judgments as to whether the uncertainty
attached to their projections of each variable is
greater than, smaller than, or broadly similar to typical levels of forecast uncertainty in the past, as
shown in table 2. Participants also provide judgments
as to whether the risks to their projections are
weighted to the upside, are weighted to the downside, or are broadly balanced. That is, participants
judge whether each variable is more likely to be
above or below their projections of the most likely
outcome. These judgments about the uncertainty
and the risks attending each participant’s projections
are distinct from the diversity of participants’ views
about the most likely outcomes. Forecast uncertainty
is concerned with the risks associated with a particular projection rather than with divergences across a
number of different projections.
As with real activity and inflation, the outlook for the
future path of the federal funds rate is subject to considerable uncertainty. This uncertainty arises primarily
because each participant’s assessment of the appropriate stance of monetary policy depends importantly
on the evolution of real activity and inflation over
time. If economic conditions evolve in an unexpected
manner, then assessments of the appropriate setting
of the federal funds rate would change from that
point forward.

currently in the financial system risked a pickup in
inflation to a level above the Committee’s objective.
A few also pointed to the risk that uncertainty about
the Committee’s ability to effectively remove policy
accommodation when appropriate could lead to a
rise in inflation expectations.

54

98th Annual Report | 2011

Abbreviations
ABS

asset-backed securities

AFE

advanced foreign economy

AIG

American International Group, Inc.

ARRA

American Recovery and Reinvestment Act

CDS

credit default swap

C&I

commercial and industrial

CMBS

commercial mortgage-backed securities

CP

commercial paper

CRE

commercial real estate

DPI

disposable personal income

EBA

European Banking Authority

ECB

European Central Bank

EME

emerging market economy

E&S

equipment and software

FDIC

Federal Deposit Insurance Corporation

FOMC

Federal Open Market Committee; also, the Committee

FRBNY

Federal Reserve Bank of New York

GDP

gross domestic product

GSE

government-sponsored enterprise

LIBOR

London interbank offered rate

MEP

maturity extension program

MBS

mortgage-backed securities

NIPA

national income and product accounts

OIS

overnight index swap

PCE

personal consumption expenditures

repo

repurchase agreement

SCOOS

Senior Credit Officer Opinion Survey on Dealer Financing Terms

SEP

Summary of Economic Projections

SLOOS

Senior Loan Officer Opinion Survey on Bank Lending Practices

S&P

Standard and Poor’s

SOMA

System Open Market Account

WTI

West Texas Intermediate

Monetary Policy and Economic Developments

Monetary Policy Report of July 2011
Part 1
Overview: Monetary Policy
and the Economic Outlook
Economic activity continued to recover over the first
half of 2011, but the pace of the expansion has been
modest. The subdued rate of expansion reflects in
part factors that are likely to be temporary, including
the damping effect of higher food and energy prices
on consumer spending as well as supply chain disruptions associated with the tragic earthquake in Japan.
Nonetheless, even after setting aside temporary influences, the growth of economic activity appears to
have slowed over the first half of this year. Conditions in the labor market remain weak. Although the
average pace of job creation picked up during the
early months of the year, employment growth softened in May and June and the unemployment rate
edged up. Meanwhile, consumer price inflation
increased noticeably in the first part of the year,
reflecting in part higher prices for some commodities
and imported goods as well as shortages of several
popular models of automobiles. The recent rise in
inflation is expected to subside as the effects of past
increases in the prices of energy and other commodities dissipate in an environment of stable longer-term
inflation expectations, and as supply chain disruptions in the automobile industry are remediated.
On net, financial market conditions became somewhat more supportive of economic growth in the first
half of 2011, partly reflecting the continued monetary policy accommodation provided by the Federal
Reserve. Yields on Treasury securities and corporate
debt as well as rates on fixed-rate residential mortgages fell to very low levels, on balance, over the first
half of the year, and equity prices rose. Borrowing
conditions for households and businesses eased
somewhat further, although credit conditions
remained tight for some borrowers.
After rising at an annual rate of 2¾ percent in the
second half of 2010, real gross domestic product
(GDP) increased at about a 2 percent rate in the first
quarter of 2011. Available information suggests that
the pace of economic growth remained soft in the
second quarter. Real consumer spending, which had
brightened near the end of 2010, rose at a noticeably
slower rate over the first five months of 2011, as
household purchasing power was constrained by the
weak pace of nominal income growth and by rising

55

fuel and food prices, and as consumers remained
downbeat. Meanwhile, the housing market continued
to be weighed down by the large inventory of vacant
houses for sale, the substantial volume of distressed
sales, and by homebuyers’ concerns about the
strength of the recovery and fears of future declines
in house prices. In the government sector, state and
local government budgets continued to be very tight,
as a reduction in federal assistance to those governments was only partially offset by an increase in tax
collections; in addition, federal spending appears to
have contracted. In contrast, exports—which have
been a bright spot in the recovery—moved up briskly,
and businesses continued to increase their outlays for
equipment and software.
In the labor market, private payroll employment
gains picked up in the first four months of the year,
averaging about 200,000 jobs per month, an improvement from the average of 125,000 jobs per month
recorded in the second half of 2010. However, private
employment gains slowed sharply in May and June,
averaging only 65,000 per month, with the step-down
widespread across industries. Furthermore, the
unemployment rate, which leveled off at around
9 percent in the early months of the year, has edged
up since then, reaching 9.2 percent in June. The share
of the unemployed who have been jobless for six
months or longer remained close to 45 percent, a
post–World War II high.
Consumer price inflation picked up noticeably in the
first part of 2011. Prices for personal consumption
expenditures rose at an annual rate of about 4 percent over the first five months of the year, compared
with an annual rate of increase of a little less than
2 percent during the second half of 2010. A significant portion of the rise in inflation was associated
with energy and food prices, reflecting the passthrough to retail prices of surges in the costs of crude
oil and a wide range of agricultural commodities.
Recently, however, these commodity prices have
apparently stabilized, a development that should ease
pressure on consumer energy and food prices in coming months. Another important source of upward
pressure on inflation during the first half of the year
was a sharp acceleration in the prices of other
imported items. This factor contributed to a pickup
in consumer inflation for items other than food and
energy; over the first five months of this year, such
inflation ran at an annual rate of more than 2 percent, up from an unusually low ½ percent annual rate
of increase over the second half of 2010. Despite the

56

98th Annual Report | 2011

increase in inflation, longer-term inflation expectations remained stable.
In U.S. financial markets, strong corporate profits
and investors’ perceptions that the economic recovery was firming supported a rise in equity prices and
a narrowing of credit spreads in the early part of the
year. By May, however, indications that the economic
recovery in the United States was proceeding at a
slower pace than previously anticipated—as well as a
perceived moderation in global economic growth and
heightened concerns about the persisting fiscal problems in Europe—weighed on market sentiment,
prompting a pullback from riskier financial assets.
On net over the first half of the year, yields on
longer-term Treasury securities declined. Yields on
corporate debt and other fixed-income products as
well as rates on fixed-rate residential mortgages fell
from already low levels, and credit spreads were little
changed. Broad equity price indexes rose significantly, on balance, over the first half of the year;
however, stock prices of banks declined.
By early July, investors had marked down their
expectations for the path of the federal funds rate
relative to the trajectory anticipated at the start of
the year in response to economic and financial developments and the reiteration by the Federal Open
Market Committee (FOMC) that it expected to
maintain exceptionally low levels of the federal funds
rate for an extended period. These same factors, as
well as safe-haven demands stemming from investor
concerns about global economic growth and about
developments in Europe, contributed to the decline in
nominal Treasury yields. Thus far, uncertainties surrounding the outcome of discussions to raise the U.S.
government’s statutory debt limit do not appear to
have left an appreciable imprint on Treasury prices,
but investors have noted statements by major ratings
agencies regarding the actions the agencies may take
if the fiscal situation is not adequately addressed.
Measures of inflation compensation derived from
yields on nominal and inflation-indexed Treasury
securities fluctuated over the first half of the year in
response to changes in commodity prices and the
outlook for economic growth. On balance, mediumterm inflation compensation edged higher over the
first half of the year, but compensation further out
was little changed.
Large nonfinancial corporations with access to capital markets took advantage of favorable financial

market conditions to issue debt at a robust pace in
the first half of the year, and issuance of corporate
bonds and syndicated leveraged loans surged. The
portfolios of commercial and industrial loans on
banks’ books expanded as standards and terms for
such loans eased further and demand increased. In
contrast, despite some improvement over the first
half of the year, credit conditions for small businesses
appeared to remain tight and demand for credit by
such firms was subdued. Financing conditions for
commercial real estate assets eased somewhat, but the
fundamentals in commercial real estate markets
stayed extremely weak.
Household debt continued to contract in the first half
of 2011, driven primarily by the ongoing decline in
mortgage debt. Even though mortgage rates
remained near historically low levels, demand for new
mortgage loans was weak, reflecting still-depressed
conditions in housing markets and the uncertain outlook for the economic recovery and labor markets.
Delinquency rates on most categories of mortgages
edged lower but stayed near recent highs. The number of homes entering the foreclosure process
declined in the first quarter of 2011, but the number
of properties at some point in the foreclosure process
remained elevated. Mortgage servicers continued to
grapple with deficiencies in their foreclosure procedures; resolution of these issues could eventually be
associated with an increase in the number of foreclosure starts as servicers work through the backlog of
severely delinquent loans more quickly. Revolving
consumer credit—mostly credit card borrowing—
also continued to contract, on net, although at a
slower pace than in 2010. In contrast, nonrevolving
consumer credit, consisting predominantly of auto
and student loans, rose appreciably in 2011, as rates
on most types of these loans remained near the bottom of their historical ranges and as banks eased
standards and terms for such loans. Issuance of consumer asset-backed securities, particularly securities
backed by auto loans, was strong.
Conditions in short-term funding markets changed
little over the first several months of 2011, although
signs of stress for some European financial institutions started to emerge as market participants
became more concerned about potential exposures to
the debts of peripheral European countries. To continue to support liquidity conditions in global money
markets and to help minimize the risk that strains
abroad could spread to the United States, the FOMC

Monetary Policy and Economic Developments

in June approved an extension of the temporary U.S.
dollar liquidity swap arrangements with a number of
foreign central banks until August 1, 2012.
Responses to the Federal Reserve’s Senior Credit
Officer Opinion Survey on Dealer Financing Terms
(SCOOS) indicated that dealers continued to gradually ease price and nonprice terms applicable to
major classes of counterparties over the six months
ending in May, and that demand for funding for a
variety of security types increased over the same
period. Investor appetite for risky assets likely supported issuance of some debt instruments (including
speculative-grade corporate bonds and syndicated
leveraged loans) and contributed to a narrowing of
risk spreads evident in the first several months of the
year. In addition, information from a variety of
sources, including special questions in the SCOOS,
suggested that the use of dealer-intermediated leverage increased modestly among both levered investors
and traditionally unlevered investors, although the
overall use of leverage appeared to be roughly midway between its pre-crisis peak and post-crisis
trough. In recent weeks, however, anecdotal information has suggested that investors have pulled back
somewhat from risk-taking and that their use of
leverage has declined.
With the unemployment rate still elevated and inflation expected to subside to levels at or below those
consistent, over the longer run, with the FOMC’s
dual mandate of maximum employment and price
stability, the Committee maintained a target range
for the federal funds rate of 0 to ¼ percent throughout the first half of 2011. The Committee reiterated
that economic conditions were likely to warrant
exceptionally low levels for the federal funds rate for
an extended period. At the end of June, the Federal
Reserve completed its program of purchasing
$600 billion of longer-term Treasury securities that
was announced in November. In addition, the Committee maintained its existing policy of reinvesting
principal payments from its agency debt and agency
mortgage-backed securities (MBS) holdings in
longer-term Treasury securities. The Federal Reserve
continued to develop and test tools to eventually
drain or immobilize large volumes of banking system
reserves in order to ensure that it will be able to
smoothly and effectively exit from the current accommodative stance of policy at the appropriate time.
The Committee will continue to monitor the economic outlook and financial developments, and it
will act as needed to best foster maximum employment and price stability.

57

The size and composition of the Federal Reserve’s
balance sheet continued to evolve over the first half
of the year. As a result of the FOMC’s policies of
reinvesting principal payments from its securities
holdings and purchasing additional longer-term
Treasury securities, holdings of Treasury securities
rose more than $600 billion and holdings of agency
debt and agency MBS declined about $115 billion.
Emergency credit provided during the crisis continued to decline: The closing of a recapitalization plan
for American International Group, Inc. (AIG), terminated the Federal Reserve’s direct assistance to
AIG; the Federal Reserve Bank of New York sold
some of the securities held in the portfolio of Maiden
Lane II LLC, a special purpose vehicle that was
established to acquire residential mortgage-backed
securities from AIG; and loans outstanding under
the Term Asset-Backed Securities Loan Facility continued to decline as improved conditions in securitization markets allowed borrowers to refinance and
prepay loans made under the facility. On the liability
side of the Federal Reserve’s balance sheet, reserve
balances held by depository institutions rose to
$1.7 trillion, largely as a result of the Federal
Reserve’s longer-term security purchase program.
Federal Reserve notes in circulation also rose. The
Treasury Department’s Supplementary Financing
Account balance at the Federal Reserve declined
from $200 billion early in the year to $5 billion as
part of the Treasury’s efforts to maximize flexibility
in its debt management as the statutory debt limit
approached.
The economic projections prepared in conjunction
with the June FOMC meeting are presented in Part 4
of this report.1 In broad terms, FOMC participants
(the members of the Board of Governors and the
presidents of the 12 Federal Reserve Banks) marked
down their forecasts for economic growth in 2011
relative to their forecasts in January and April,
largely as a result of unexpected weakness in the first
half of the year. Nonetheless, participants anticipated a modest acceleration in economic output in
both 2012 and 2013 based on the effects of continued
monetary policy accommodation, some further easing of credit conditions, a waning in the drag from
elevated commodity prices, and some pickup in
spending from pent-up demand. Participants
expected the unemployment rate to trend down over
the near term, though at a slower pace than they
anticipated in January and April. They continued to
1

These projections were prepared in late June and thus did not
incorporate more recent economic news.

58

98th Annual Report | 2011

anticipate that the unemployment rate at the end of
2013 would remain well above their estimates of the
longer-run rate that they see as consistent with the
Committee’s dual mandate. Participants’ forecasts
indicated a pickup in inflation for 2011 relative to
2010 and their expectations earlier this year. However, most participants expected that the influence on
inflation of higher commodity prices and supply disruptions from Japan would be temporary, and that
inflation pressures would remain subdued against a
backdrop of stable commodity prices, well-anchored
inflation expectations, and large margins of slack in
labor markets. As a result, they anticipated that overall inflation would step down in 2012 and remain at
that lower level in 2013, moving back in line with
core inflation at levels at or slightly below participants’ estimates of the longer-run, mandateconsistent rate of inflation.
Participants generally reported that the levels of
uncertainty attached to their projections for economic growth and inflation had risen since April and
were above historical norms. Most participants
judged that the balance of risks to economic growth
was weighted to the downside, whereas in April, a
majority had seen the risks to growth as balanced.
Most participants saw the risks surrounding their
inflation expectations as broadly balanced, while in
April, a majority had judged those risks as skewed to
the upside. Participants also reported their assessments of the rates to which macroeconomic variables
would be expected to converge over the longer run
under appropriate monetary policy and in the
absence of further shocks to the economy. The central tendencies of these longer-run projections, which
have not changed since April, were 2.5 to 2.8 percent
for real GDP growth, 5.2 to 5.6 percent for the unemployment rate, and 1.7 to 2.0 percent for the inflation
rate. Because inflation in the long run is largely determined by monetary policy, the longer-run projections
for inflation can be viewed as the levels of inflation
that FOMC participants consider to be most consistent with the Committee’s mandate to foster maximum employment and price stability.

suggest that the pace of the recovery remained soft in
the second quarter. Activity in the second quarter
was held down by factors that are likely to be temporary, including the damping effect of higher food and
energy prices on consumer spending as well as the
supply chain disruptions stemming from the earthquake in Japan. But even after setting aside those
effects, the pace of economic expansion in the second
quarter appears to have been subdued.
In the labor market, employment gains picked up
noticeably at the beginning of 2011 but slowed markedly in May and June. The unemployment rate, which
fell in late 2010, held close to 9 percent during the
early months of the year but then edged up, reaching
9.2 percent in June. Furthermore, long-duration joblessness remained at near-record levels. Meanwhile,
consumer price inflation moved up noticeably over
the first half of the year, largely in response to rapid
increases in the prices of some commodities and
imported goods as well as the recent supply chain
disruptions. However, longer-term inflation expectations remained stable.
On balance, financial market conditions became
somewhat more supportive of economic growth over
the first half of 2011, reflecting in part continued
monetary policy accommodation provided by the
Federal Reserve. In the early part of the year, strong
corporate profits and investors’ perceptions that the
economic recovery was firming supported a rise in
equity prices and a narrowing of credit spreads. Since
May, however, indications that the U.S. economic
recovery was proceeding at a slower pace than previously anticipated, a perceived moderation in global
growth, and heightened concerns about the persisting
fiscal pressures in Europe weighed on investor sentiment and prompted a pullback from riskier financial
assets. On net over the first half of the year, yields on
Treasury securities and corporate debt and rates on
fixed-rate residential mortgages declined, and equity
prices rose significantly. Borrowing conditions for
households and businesses eased somewhat further,
although credit conditions continued to be tight for
some borrowers.

Part 2
Recent Economic
and Financial Developments

Domestic Developments

After increasing at a solid pace in the fourth quarter
of 2010, economic activity expanded more slowly
over the first half of 2011. In the first quarter of this
year, real gross domestic product (GDP) increased at
an annual rate of 1.9 percent; preliminary indicators

Housing Activity and Finance
The housing market remained exceptionally weak in
the first half of 2011. Housing demand continued to
be restrained by households’ concerns about the

The Household Sector

Monetary Policy and Economic Developments

strength of the recovery for incomes and jobs as well
as the potential for further declines in house prices;
still-tight credit conditions for potential mortgage
borrowers with less-than-pristine credit also appear
to be damping demand. As a result, sales of singlefamily homes showed no signs of sustained recovery
during the first half of the year. With demand weak,
the overhang of vacant properties for sale substantial, distressed sales elevated, and construction
financing tight, new units were started at an average
annual rate of about 410,000 units between January
and May—a bit below the level recorded in the
fourth quarter of 2010 and just 50,000 units above
the quarterly low reached in the first quarter of 2009.
Activity in the multifamily sector has been a bit more
buoyant, as the ongoing reluctance of potential
homebuyers to purchase a home, compounded by
tight mortgage credit standards, appears to have led
to an increase in demand for rental housing. Indeed,
vacancy rates for multifamily rental units have
dropped noticeably, and rents for apartments in multifamily buildings have moved up. However, construction financing remains difficult to obtain for many
potential borrowers. Starts in the multifamily sector
averaged 160,000 units at an annual rate in the first
five months of 2011, noticeably above the
100,000 units started in the fourth quarter of 2010
but still well below the 300,000-unit rate that had prevailed for much of the previous decade.
House prices fell further over the first half of 2011.
The latest readings from national indexes show price
declines for existing homes over the past 12 months
in the range of 5 to 8 percent. One such measure with
wide geographic coverage—the CoreLogic repeatsales index—fell 8 percent over the 12 months ending
in May to a level that is about 4 percent below the
previous trough in April of 2009. House prices are
being held down by the same factors restraining
housing construction—the large inventory of unsold
homes, the high number of distressed sales, and lackluster household demand. The inventory of unsold
homes will likely put downward pressure on house
prices for some time, given the large number of seriously delinquent mortgages that could still enter the
foreclosure inventory. As a result of the decline in
house prices, the share of mortgages with negative
equity has continued to rise: In March 2011, roughly
one in four mortgage holders owed more on their
mortgages than their homes were worth.
Indicators of credit quality in the residential mortgage sector continued to reflect strains on homeown-

59

ers confronting depressed home values and high
unemployment. Although delinquency rates on most
categories of mortgages edged modestly lower in the
first part of 2011, they stayed at historically high levels. As of May, serious delinquency rates on loans to
prime and near-prime borrowers stood at about
5 percent for fixed-rate loans and 14 percent for
variable-rate loans.2 For subprime loans, as of April
(the latest month for which data are available), serious delinquency rates remained near 20 percent for
fixed-rate loans and 40 percent for variable-rate
loans. The number of homes entering the foreclosure
process declined in the first quarter of 2011, but the
number of properties at some point in the foreclosure
process remained elevated. Mortgage servicers continued to grapple with deficiencies in their foreclosure
procedures; resolution of these issues could eventually be associated with an increase in the number of
properties entering the foreclosure process as servicers work through the backlog of severely delinquent loans more quickly.3
Interest rates on fixed-rate mortgages fell, on net,
during the first half of 2011, a move that largely paralleled the decline in Treasury yields over the period.
Even with mortgage rates near historically low levels,
access to mortgage credit continued to be restrained
by negative equity and tight lending standards. For
example, the April 2011 Senior Loan Officer Opinion
Survey on Bank Lending Practices (SLOOS) indicated that standards on prime and nontraditional
2

3

A mortgage is defined as seriously delinquent if the borrower is
90 days or more behind in payments or the property is in
foreclosure.
The Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit
Insurance Corporation conducted an in-depth interagency
review of practices at the largest mortgage servicing operations
to examine foreclosure practices generally, but with an emphasis
on the breakdowns that led to inaccurate affidavits and other
questionable legal documents being used in the foreclosure process. The review found, among other things, critical weaknesses
in foreclosure-governance practices, foreclosure-documentation
processes, and oversight and monitoring of third-party law
firms and other vendors. Based on the findings from the review,
the agencies issued enforcement actions by consent against
14 mortgage servicers in April 2011 to address the significant
deficiencies in mortgage-servicing and foreclosure practices. See
Board of Governors of the Federal Reserve System (2011),
“Federal Reserve Issues Enforcement Actions Related to Deficient Practices in Residential Mortgage Loan Servicing and
Foreclosure Processing,” press release, April 13, www
.federalreserve.gov/newsevents/press/enforcement/20110413a
.htm; and Board of Governors of the Federal Reserve System
(2011), “Statement for the Record: On Mortgage Servicing,”
testimony submitted to the Subcommittees on Financial Institutions and Consumer Credit and on Oversight and Investigations, Committee on Financial Services, U.S. House of Representatives, Washington, July 7, www.federalreserve.gov/
newsevents/testimony/statement20110707a.htm.

60

98th Annual Report | 2011

residential mortgages and home equity loans were
about unchanged or moderately tighter during the
first quarter, and that demand for these loans continued to decline.4 The pace of mortgage applications
for home purchases remained very sluggish in the
first half of the year, probably reflecting the stringency of lending terms and the overall weakness of
housing demand. Refinancing activity increased
modestly in the second quarter in response to the
downward drift in interest rates, but such activity
remains subdued compared with that seen in 2010. Overall, mortgage debt outstanding continued to contract.
Net issuance of mortgage-backed securities (MBS)
guaranteed by government-sponsored enterprises
(GSEs) expanded slightly in the first half of the year
but remained relatively low, consistent with the slow
pace of mortgage originations to finance home purchases. Net issuance of Ginnie Mae securities
remained considerably more robust than net issuance
of securities by Fannie Mae and Freddie Mac,
reflecting the substantial share of mortgages insured
by the Federal Housing Administration (FHA). The
securitization market for mortgage loans not guaranteed by a housing-related GSE or the FHA remained
essentially closed. Yields on agency MBS fell roughly
in line with those on Treasury securities. The Treasury Department announced on March 21 that it
would begin to sell its $142 billion agency MBS portfolio at a pace of about $10 billion per month; the
announcement appeared to have little lasting effect
on spreads of yields on MBS over those on
comparable-maturity Treasury securities. Through
the end of June, the Treasury had sold MBS with a
current face value of about $34 billion.
Consumer Spending and Household Finance
The rate of increase in consumer spending slowed
appreciably during the first half of the year. After rising at an annual rate of more than 3 percent in the
second half of 2010, real personal consumption
expenditures (PCE) stepped down to about a 2 percent rate of increase in the first quarter, and available
information suggests that the rise in spending in the
second quarter was quite modest as well. Consumer
outlays in the second quarter were held down in part
by the reduced availability of motor vehicles, especially for those models affected by the supply chain
disruptions that followed the earthquake in Japan;
purchases of motor vehicles should rebound in coming months as dealer supplies are replenished. More
4

The SLOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/boarddocs/SnLoanSurvey.

fundamentally, however, continued consumer pessimism and a slower pace of increase in real household
income, only partly due to temporarily high energy
and food prices, also appear to have weighed on consumption. The saving rate, although continuing to
edge down, remains well above levels that prevailed
prior to the recession.
Despite a temporary reduction in payroll tax rates
beginning in January, aggregate real disposable personal income—personal income less personal taxes,
adjusted for price changes—was unchanged, on net,
over the first five months of the year after rising
2 percent in 2010. Before taxes, real wage and salary
income, which reflects both the number of hours
worked and average hourly wages adjusted for inflation, was also flat from December to May after having risen 1¾ percent last year. Wage gains have been
restrained by the weakness in the labor market.
Moreover, the purchasing power of wages and salaries has been drained by this year’s run-up in price
inflation. One measure of real wages—average hourly
earnings of all employees, adjusted for the rise in
PCE prices—fell about 1½ percent at an annual rate
over the first five months of 2011 after having
increased ½ percent over the 12 months of 2010.
Two other important determinants of consumer outlays are also acting as a restraint on spending.
Although the wealth-to-income ratio has trended up
since the beginning of 2009, it remains near the low
end of the range that has prevailed since the mid1990s. In addition, consumer sentiment, which had
moved up early in 2011, retreated again when gas
prices spiked in the spring. More broadly, consumer
sentiment seems to have improved little, if any, from
the readings that were typical of 2009 and 2010.
Total household debt contracted at an annual rate of
about 2 percent in the first quarter of the year,
roughly the same pace seen in 2010, as the decline in
mortgage debt noted earlier was only partially offset
by a moderate increase in consumer credit. Tight
credit conditions precluded some households from
obtaining credit, and charge-offs remained elevated
on many categories of loans. The ongoing reduction
in overall household debt levels, combined with low
interest rates and a slight increase in personal income,
resulted in a further decline in the debt service
ratio—the aggregate required principal and interest
payment on existing mortgages and consumer debt
relative to income. Indeed, as of the first quarter of
2011, the debt service ratio was 11.5 percent, the lowest level seen since 1995.

Monetary Policy and Economic Developments

The modest expansion of consumer credit, which
began in late 2010, reflects a mixed picture. Nonrevolving consumer credit, which consists largely of
auto and student loans and accounts for about twothirds of total consumer credit, rose at an annual rate
of almost 5 percent in the first five months of 2011.
The increase is consistent with responses to the
April 2011 SLOOS, which indicated a sharp rise in
banks’ willingness to make consumer installment
loans and an ongoing easing of terms and standards
on them. However, revolving consumer credit—
mostly credit card borrowing—declined through
April, albeit at a slower pace than in 2010; early estimates point to an increase in May. Although a net
fraction of about 20 percent of banks responding to
the April 2011 SLOOS reported an easing of standards for approval of credit card applications, access
to credit card loans for borrowers with blemished
credit histories remained limited. In addition, the
contraction in home equity loans, historically a
source of funding for consumer durables and other
large household expenditures, appears to have intensified during the first half of 2011, in part owing to
declinesinhomeequityandstill-stringentlendingstandards.
Indicators of consumer credit quality generally
improved. The delinquency rates on credit card loans,
both at commercial banks and in securitized pools,
retreated to less than 4 percent in the first quarter
and May, respectively—at the low ends of their
ranges over recent decades. Delinquencies on nonrevolving consumer loans at commercial banks also
edged lower, while delinquencies on auto loans at
captive finance companies were flat, on net, over the
first four months of the year; both of these measures
remained around their historical averages.
Interest rates on consumer loans held fairly steady,
on net, in the first half of 2011. Interest rates on newauto loans continued to linger at historically low levels. Rates on credit card loans are around their historical averages, but the spread of these rates to the
two-year Treasury yield is quite wide, in part because
of pricing adjustments made in response to the
Credit Card Accountability Responsibility and Disclosure Act, or Credit Card Act, of 2009.5

auto loans made up a large share of the new supply.
Issuance of credit card ABS, however, remained
weak, as the sharp contraction in credit card lending
limited the need for new funding and as last year’s
accounting rule changes reportedly damped the
attractiveness of securitizing these loans, particularly
since banks remained awash in other sources of
cheap funding.6 Yields on ABS and the spreads of
such yields over comparable-maturity interest rate
swap rates were little changed, on net, over the first
half of the year, stabilizing at levels only slightly
higher than those seen prior to the financial crisis.
The Business Sector

Fixed Investment
Real business spending for equipment and software
(E&S) rose at an annual rate of about 10 percent in
the first quarter, roughly the same pace as in the second half of 2010. Business purchases of motor
vehicles rose briskly, and outlays on information
technology (IT) capital and on equipment other than
transportation and IT continued to rise at solid rates.
More-recent data on orders and shipments for a
broad range of equipment categories suggest that
E&S spending will likely post another sizable gain in
the second quarter. Spending is being boosted by the
need to replace older, less-efficient equipment and, in
some cases, to expand capacity. One soft spot in the
second quarter will likely be in business purchases of
motor vehicles, which, like consumer purchases, were
held down by the shortages of Japanese nameplate
cars in the wake of the earthquake in Japan, but this
effect should be reversed during the second half of
the year.
By contrast, investment in nonresidential structures
remains at a low level. After falling 17 percent in
2010, real business outlays on structures outside of
the drilling and mining sector fell at an annual rate of
25 percent in the first quarter. Although the incoming data point to a small increase in outlays in the
second quarter, high vacancy rates, continuing price
declines in all but a few markets, and difficult financing conditions for builders suggest that spending will
6

In the first half of 2011, issuance of consumer assetbacked securities (ABS) remained at about the same
pace as in 2010 but still well below average issuance
rates prior to the financial crisis. Securities backed by
5

The Credit Card Act includes some provisions that place restrictions on issuers’ ability to impose certain fees and to engage in
risk-based pricing.

61

Issued by the Financial Accounting Standards Board (FASB),
Statements of Financial Accounting Standards Nos. 166
(Accounting for Transfers of Financial Assets, an Amendment of
FASB Statement No. 140) and 167 (Amendments to FASB Interpretation No. 46(R)) became effective at the start of a company’s first fiscal year beginning after November 15, 2009, or, for
companies reporting earnings on a calendar-year basis, after
January 1, 2010. The amendments required many credit card
issuers to bring securitizations onto their balance sheets and
therefore to hold more capital against them.

62

98th Annual Report | 2011

be weak for some time to come. However, spending
on drilling and mining structures has continued to
rise at a robust pace in response to elevated oil prices
and advances in technology for horizontal drilling
and hydraulic fracturing.
Inventory Investment
Real inventory investment stepped up in the first
quarter, as stockbuilding outside of motor vehicles
increased somewhat and motor vehicle inventories
were about unchanged following a substantial fourthquarter runoff. Outside of the motor vehicle sector,
the inventory-to-sales ratios for most industries covered by the Census Bureau’s book-value data remain
near the levels observed before the recession, and surveys suggest that inventory positions for most businesses generally are not perceived as being excessive.
In the motor vehicle sector, the effects of the earthquake in Japan and supply constraints on the production of some of the most fuel-efficient domestic
nameplate cars led to a sharp drop in inventories in
the second quarter, but some significant rebuilding of
inventories is likely to occur this quarter.
Corporate Profits and Business Finance
Operating earnings per share for S&P 500 firms continued to rise in the first quarter of 2011, increasing
at a quarterly rate of about 6 percent. With the latest
rise, aggregate earnings per share advanced to their
pre-crisis peak. During much of the first half of the
year, analysts marked up their forecasts of yearahead earnings by a modest amount; however, their
forecasts were flat from May to June.
The credit quality of nonfinancial corporations
improved further in the first half of 2011 as firms
continued to strengthen their balance sheets. Liquid
assets remained at record-high levels in the first quarter, and the aggregate ratio of debt to assets—a
measure of corporate leverage—edged lower. Credit
rating upgrades of corporate debt outpaced downgrades through June, and the six-month trailing bond
default rate for nonfinancial firms remained close to
zero. The delinquency rate on commercial and industrial (C&I) loans at commercial banks decreased in
the first quarter to 2½ percent, about the middle of
its range over the past two decades.
Borrowing by nonfinancial corporations remained
robust in the first half of the year, reflecting both
strong corporate credit quality and favorable financing conditions in capital markets. Gross issuance of
nonfinancial corporate bonds rose to a monthly
record high in May amid heavy issuance of both

investment- and speculative-grade debt. Firms sought
to refinance existing debt, lock in new funding at current low yields, and, to a lesser extent, finance merger
and acquisition activity. The amount of unsecured
nonfinancial commercial paper outstanding also
picked up a bit in the first half of the year. Issuance
in the syndicated leveraged loan market reached precrisis levels, partly owing to heavy refinancing activity and in response to strong demand for floating-rate
assets from institutional investors. Likely reflecting in
part an increased appetite for higher-yielding debt
instruments, the market for collateralized loan obligations (CLOs) showed signs of renewed activity, and
issuance picked up.
After declining sharply in 2009 and 2010, C&I loans
on banks’ books rose at a vigorous pace in the first
half of 2011. The SLOOSs of January 2011 and
April 2011 showed that banks continued to ease standards and terms for C&I loans. In April, more than
half of the survey’s respondents reported having
trimmed spreads over their cost of funds on loans to
firms of all sizes. Respondents also indicated that
nonprice loan terms have eased; these results were
corroborated by the May 2011 Survey of Terms of
Business Lending (STBL), which suggested that the
average size of loan commitments at domestic banks
and the average maturity of loans drawn on those
commitments have trended up in recent quarters.
Banks responding to the SLOOS also noted an ongoing firming of demand for C&I loans, particularly by
large and medium-sized firms.
For small businesses, borrowing conditions remained
tight. The May STBL revealed that the weightedaverage spread on C&I loan commitments of less
than $1 million stayed stubbornly high in recent
quarters, in contrast to a modest decline in the
spread on commitments of more than $1 million.
However, some signs of improvement in credit availability for small businesses have emerged in recent
months. In addition to the easing of terms and standards for C&I loans reported in the April SLOOS,
surveys conducted by the National Federation of
Independent Business showed that the net fraction of
small businesses reporting that credit had become
more difficult to obtain than three months ago has
declined to its lowest level since the financial crisis,
although it remains well above its pre-crisis average.
Moreover, the net percentage of respondents expecting credit conditions to become tighter over the next
three months remained, on average, lower than in
2010. Demand for credit by small businesses is still
weak, with a historically small fraction of such busi-

Monetary Policy and Economic Developments

nesses indicating that they have borrowing needs. In
addition, the fraction of businesses that cited credit
availability as the most important problem that they
faced continued to be small; many firms pointed
instead to weak demand from customers as their
greatest concern.
The fundamentals in commercial real estate (CRE)
markets remained extremely weak in the first half of
2011, although financing conditions for certain CRE
assets did see some modest improvement. Banks’
holdings of CRE loans continued to contract in the
first half of the year, driven by reduced lending for
construction and land development and sizable
charge-offs on existing loans. Although delinquency
rates for CRE loans at commercial banks receded
slightly from recent peaks, they remained at historically high levels, while the delinquency rate for loans
funded by commercial mortgage-backed securities
(CMBS) also continued to be elevated. Responses to
questions on CRE lending in the April 2011 SLOOS
showed that most domestic banks reported no
change in their lending standards for approving CRE
loans, although a few large banks and foreign banks
reported having eased such standards.
On net, financing conditions for investment-quality
properties—roughly, those with stable rent streams in
large cities—improved in the first half of the year,
although conditions worsened a bit in June with the
more general pullback from risky assets. Secondarymarket spreads for AAA-rated CMBS declined to
multiyear lows through May before retracing somewhat in June, and respondents to the Federal
Reserve’s June 2011 Senior Credit Officer Opinion
Survey on Dealer Financing Terms (SCOOS) indicated that funding for less-liquid legacy CMBS had
increased.7 New issuance of CMBS continued to pick
up, with issuance in the first half of 2011 exceeding
that in all of 2010. Renewed investor interest in highquality properties has also been evident in investment
flows into, and the share prices for, equity real estate
investment trusts, or REITs.
In the corporate equity market, combined gross issuance of seasoned and initial offerings continued in
the first quarter of 2011 at the same solid pace seen
throughout 2010. At the same time, however, volumes of equity retirements from share repurchases
and cash-financed mergers and acquisitions
remained high and continued to rise.
7

The SCOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/econresdata/releases/scoos.htm.

63

The Government Sector

Federal Government
The deficit in the federal unified budget remains
elevated. The Congressional Budget Office (CBO)
projects that the deficit for fiscal year 2011 will be
close to $1.4 trillion, or roughly 9 percent of
GDP—a level comparable to deficits recorded in
2009 and 2010 but sharply higher than the deficits
recorded prior to the onset of the recession and
financial crisis. The budget deficit continues to be
boosted by the effects of the stimulus policies
enacted in recent years, including the provisions of
the American Recovery and Reinvestment Act of
2009 (ARRA) and the Tax Relief, Unemployment
Insurance Reauthorization, and Job Creation Act of
2010. In addition, the weakness in the economy continues to damp revenues and boost payments for
income support.
Federal receipts have risen rapidly lately—they are up
about 10 percent in the first eight months of fiscal
2011 compared with the same period in fiscal 2010.
Nonetheless, the level of receipts remains low;
indeed, the ratio of receipts to national income is less
than 16 percent, near the lowest reading for this ratio
in 60 years. The robust rise in revenues thus far this
fiscal year is largely a result of strong growth in individual income tax receipts, likely reflecting some
step-up in the growth of nominal wage and salary
income and an increase in capital gains realizations.
Corporate taxes in the first eight months of the fiscal
year were up only about 5 percent from last year, as
the effect of strong profits growth on receipts was
partially offset by recent legislation providing morefavorable tax treatment for some business investment.
Total federal outlays have risen nearly 6 percent in
the first eight months of fiscal 2011 relative to the
comparable year-earlier period. Much of the increase
in outlays this year relative to last has been related to
financial transactions. In particular, repayments to
the Treasury of obligations for the Troubled Asset
Relief Program lowered measured outlays last year
and hence reduced the base figure for this year’s
comparison. Excluding these transactions, outlays
were up less than 2 percent this year. This relatively
small increase in outlays reflects reductions in both
ARRA spending and unemployment insurance payments as well as a subdued pace of defense spending.
By contrast, net interest payments have increased
sharply, while most other spending has increased at
rates comparable to fiscal 2010.

64

98th Annual Report | 2011

As measured in the national income and product
accounts (NIPA), real federal expenditures on consumption and gross investment—the part of federal
spending that enters directly into the calculation of
real GDP—fell at an annual rate of close to 8 percent
in the first quarter. Defense spending, which tends to
be erratic from quarter to quarter, plunged almost 12 percent and nondefense purchases were unchanged.
Federal Borrowing
Federal debt expanded at a somewhat slower pace in
the first half of this year than in 2010. On May 16,
the federal debt reached the $14.294 trillion limit,
and the Treasury began to implement extraordinary
measures to extend its ability to fund government
operations.8 The Treasury estimates that if the Congress does not raise the debt limit, the capacity of
these extraordinary measures will be exhausted on
August 2. Thus far, financial market participants do
not seem to be pricing in significant odds of a “technical default.” However, the risk of such a default
has been noted by the rating agencies. In June,
Moody’s Investors Service, Fitch Ratings, and Standard & Poor’s each indicated that they may downgrade, to varying degrees, the credit rating of some or
all U.S. debt securities if principal or interest payments are missed. Moody’s noted that even if default
is avoided, its rating outlook would depend on the
achievement of a credible agreement on substantial
deficit reduction. In mid-April, Standard & Poor’s
revised its outlook for the federal government’s AAA
long-term and A-1+ short-term sovereign credit ratings to negative, citing “material risks” that policymakers might fail to reach an agreement within the
next two years on how to address medium- and longterm fiscal imbalances.
Federal debt held by the public reached about 65 percent of nominal GDP in the second quarter of 2011
and, according to CBO projections, will surpass
70 percent of GDP in 2012. Despite continued high
levels of federal government financing needs and the
concerns raised by the debt limit, Treasury auctions
have been generally well received so far this year. For
the most part, bid-to-cover ratios and indicators of
8

On May 16, the Secretary of the Treasury declared a “debt issuance suspension period” for the Civil Service Retirement and
Disability Fund, permitting the Treasury to redeem a portion of
existing Treasury securities held by that fund as investments and
to suspend issuance of new Treasury securities to that fund as
investments. The Treasury also began suspending some of its
daily reinvestment of Treasury securities held as investments by
the Government Securities Investment Fund of the Federal
Employees’ Retirement System Thrift Savings Plan.

foreign participation at auctions fell within historical
ranges. Demand for Treasury securities likely continued to be supported by heightened investor demand
for relatively safe and liquid assets in light of fiscal
troubles in some European countries. However, foreign net purchases of Treasury securities and the
pace of growth of foreign custody holdings of Treasury securities at the Federal Reserve Bank of New
York moderated, on net, during the first half of the
year.
State and Local Government
State and local governments remained under significant fiscal pressure in the first half of 2011. Over the
first six months of the year, these governments cut an
average of 28,000 jobs per month, similar to the pace
of job loss observed in 2010. Real construction
expenditures have also declined. After falling modestly in 2010, real structures investment by state and
local governments plunged in the first quarter of
2011, and available information on nominal construction through May suggests that construction
spending continued to decline in recent months.
Although federal stimulus funds have boosted construction expenditures on highways and other transportation infrastructure, other types of construction
spending—most notably construction of schools—
have been declining. Capital expenditures are not
typically subject to balanced budget requirements.
Nevertheless, the payments of principal and interest
on the bonds used to finance capital projects are generally made out of operating budgets, which are subject to balanced budget constraints. As a result, state
and local governments have had to make difficult
choices even about this form of spending.
State and local revenues appear to have risen moderately over the first half of this year. Many states
reported strong revenue collections during the
income tax filing season, but federal stimulus grants,
while still sizable, have begun to phase out. At the
local level, property tax collections appear to be softening as the sharp declines in house prices increasingly show through to assessments and hence to collections. Thus, despite the recent good news on state
revenues, the state and local sector is likely to continue to face considerable budgetary strain for a
while. Moreover, many state and local governments
will need to set aside money in coming years to
rebuild their employee pension funds after the financial losses sustained over the past couple of years and
to fund health-care benefits for their retired
employees.

Monetary Policy and Economic Developments

State and Local Government Borrowing
While conditions in the municipal bond market
improved somewhat in the first half of the year, those
conditions continue to reflect ongoing concerns over
the financial health of state and local governments.
On balance this year, yields on long-term general
obligation bonds fell somewhat more than those on
comparable-maturity Treasury securities; however,
the ratio of municipal bond yields to Treasury yields
remained high by historical standards. Credit default
swap (CDS) spreads for many states narrowed to
their lowest levels in at least a year but remain well
above their pre-crisis levels, while downgrades of the
credit ratings of state and local governments continued to outpace upgrades by a notable margin during
the first half of the year.
Issuance of long-term securities by state and local
governments dropped to multiyear lows in the first
half of 2011. In part, the decline is a consequence of
the outsized issuance seen in the fourth quarter of
2010, when states and municipalities rushed to issue
long-term bonds before the expiration of the Build
America Bond program at the end of the year.9 However, the recent weakness likely also reflected tepid
investor demand. Mutual funds that invest in longterm municipal bonds experienced heavy net outflows late last year and in January 2011. Net redemptions slowed substantially in subsequent months, and
flows have been roughly flat since May.
The External Sector

Both real exports and imports of goods and services
expanded at a solid pace in the first quarter of 2011.
Real exports increased at an annual rate of 7½ percent, supported by continued robust foreign demand
and the lower value of the dollar. Most major categories of exports rose, with industrial supplies, capital
goods, and automotive products posting the largest
gains. Across trading partners, exports to Canada,
Mexico, and other emerging market economies
(EMEs) were particularly strong, while exports to the
European Union (EU) and China were about flat.
Data for April and May suggest that exports continued to grow at a robust pace in the second quarter.
After moving up only modestly in the second half of
2010, real imports of goods and services accelerated
noticeably in the first quarter of this year, increasing
9

The Build America Bond program, authorized under the
ARRA, allowed state and local governments to issue taxable
bonds for capital projects and receive a subsidy payment from
the Treasury for 35 percent of interest costs.

65

at an annual rate of almost 5¼ percent, reflecting a
return to a more normal pace of expansion. Imports
of all major categories increased, with these gains
fairly broad based across trading partners. Data for
April and May indicate that, despite some drag from
the disruptions to automotive imports from Japan
following the earthquake, imports of goods and services have continued to rise at a moderate pace.
All told, net exports made a small positive contribution of almost ¼ percentage point to real GDP
growth in the first quarter of 2011. The current
account deficit widened slightly from an average
annual rate of $465 billion in the second half of
2010 to $477 billion, or about 3¼ percent of GDP, in
the first quarter of this year; the widening resulted
primarily from the increase in the price of
imported oil.
The spot price of West Texas Intermediate (WTI)
crude oil continued its ascent into the early months
of 2011, rising sharply from around $90 per barrel at
the beginning of the year to peak at almost $115 by
late April. The increase over the first four months of
the year likely reflected continued robust growth in
global oil demand, particularly in the EMEs, coupled
with supply disruptions and the potential for further
disruptions due to the political unrest in the Middle
East and North Africa (MENA) region. In recent
weeks, the spot price of WTI has fallen back to under
$100 per barrel because of increasing concerns that
global activity might be decelerating. On June 23, the
International Energy Agency decided to release
60 million barrels of oil from strategic reserves over
the following 30 days. The price of the far-dated
futures contracts for crude oil (that is, the contracts
expiring in December 2019) mostly fluctuated in the
neighborhood of $100 during the first half of the
year, implying that the markets viewed the run-up in
oil prices seen earlier in the year as partly transitory.
Over the first quarter, prices for a broad variety of
nonfuel commodities also moved up significantly. As
with oil, these increases were supported primarily by
continued strength in global demand, especially from
the EMEs. In addition, tight supply conditions
played a significant role in pushing up prices for
many food commodities. At the onset of the second
quarter, prices stabilized and generally began to
retreat amid growing uncertainty about the outlook
for the global economy, falling back to around the
elevated levels registered at the start of this year (see
box 1).

66

98th Annual Report | 2011

Box 1. Commodity Price Developments
Despite recent declines, nominal prices for many
commodities are near record highs. The increase in
commodity prices since 2002 runs counter to the
trend over the prior two decades of declining real
prices. The earlier trend decline in part reflected the
aftermath of a spike in commodity prices in the
1970s, which eventually boosted supply and curtailed demand for commodities. The relatively low
real commodity prices of the 1980s and 1990s, in
turn, set the stage for the pickup in prices over the
past decade, as underinvestment in new supply
capacity left commodity markets ill-prepared to meet
a surge in demand linked to rapid growth in global
real gross domestic product (GDP). The pickup in
world GDP growth was led by the emerging market
economies (EMEs). As EME growth is relatively commodity intensive, the concentration of world GDP
growth in these economies added to upward pressures on demand for commodities and thus their prices.
EME demand has been important for growth in global
consumption of various commodities over the past
decade. For oil, metals, and soybeans, the entire
increase in consumption over the period is attributable to the EMEs, particularly China. For corn,
increased U.S. ethanol production also has been an
important factor in boosting consumption.
While demand for commodities has been strong,
growth of supply has been relatively limited. For
example, oil production over the past decade
increased by only about half as much as was projected by the U.S. Department of Energy at the start
of the decade. Production in the Organisation for
Economic Co-operation and Development countries
was depressed by lower-than-expected production in

Prices of non-oil imported goods accelerated in the
first quarter of 2011, surging at an annual rate of
7¼ percent, the fastest pace since the first half of
2008. This pickup was driven by a few factors,
including the rise in commodity prices, significant
increases in foreign inflation, and the depreciation of
the dollar. In the second quarter of this year, with
commodity prices apparently stabilizing, import
price inflation likely moderated.
National Saving

Total U.S. net national saving—that is, the saving of
U.S. households, businesses, and governments,
excluding depreciation charges—remains extremely
low by historical standards. After having reached
nearly 4 percent of nominal GDP in early 2006, net
national saving dropped over the subsequent three
years, reaching a low of negative 3 percent in the
third quarter of 2009. Since then, the national saving
rate has edged up, on balance, but remains negative:

Mexico and the North Sea. The substantial miss in
the forecasted production by the Organization of the
Petroleum Exporting Countries (OPEC) in part reflects
a surprising unresponsiveness of OPEC’s supply to
higher prices, suggesting that an upward shift in
OPEC’s perceived price target also held back supply
growth. Likewise, for metals, industry groups were
repeatedly overly optimistic in regard to projected
supply growth, most notably for copper. For agricultural products, although yields and acreage
increased over the past 10 years, unusually unfavorable weather has restrained supplies in recent years.
The current high level of commodity prices is likely to
prompt an expansion of supply and a moderation in
demand that could relieve some of the pressures currently boosting prices. For energy, nonconventional
oil production continues to expand, including the
Canadian oil sands and the recent developments in
North Dakota’s Bakken Shale. Similarly, for natural
gas, new drilling technology has unlocked previously
inaccessible deposits of shale gas, resulting in much
higher U.S. natural gas production and lower prices.
For agriculture, although harvested acres overseas
have expanded briskly since 2000, yields for corn
and some other crops are currently much lower than
in the United States, suggesting the potential for further gains abroad.
Although there are reasons for optimism, the relative
timing and magnitude of these supply and demand
adjustments are uncertain. Commodity prices will
continue to be affected by the general evolution of
the global economy and by even less predictable factors, such as weather and political strife.

Net national saving was negative 1.4 percent of
nominal GDP in the first quarter of 2011 (the latest
data available). The increase in the federal deficit
more than accounts for the decline in the net national
saving rate since 2006, as private saving rose considerably, on balance, over this period. National saving
will likely remain relatively low this year in light of
the continuing large federal budget deficit. If low levels of national saving persist over the longer run, they
will likely be associated with both low rates of capital
formation and heavy borrowing from abroad, limiting the rise in the standard of living of U.S. residents
over time.
The Labor Market

Employment and Unemployment
Conditions in the labor market have improved only
gradually and unevenly. In the first four months of
2011, private payroll employment increased an aver-

Monetary Policy and Economic Developments

age of about 200,000 jobs per month, up from the
average pace of 125,000 jobs per month recorded in
the second half of 2010. However, private employment gains slowed in May and June, averaging only
65,000, with the step-downs widespread across industries. In addition, cutbacks in jobs continued at state
and local governments.
The unemployment rate, which had appeared to be
on a downward trajectory at the turn of the year, leveled off at around 9 percent in the early months of
the year. Since then, it has edged up, and it reached
9.2 percent in June. Long-term joblessness has also
remained elevated. In June, 44 percent of those
unemployed had been out of work for more than six
months (see box 2). Meanwhile, the labor force participation rate, which had declined gradually over
2009 and 2010, has remained roughly flat at a low
level since the beginning of 2011.
Other labor market indicators also corroborate the
view that the labor market remains weak. Initial
claims for unemployment insurance, which had
trended steadily downward over the first part of this
year, backed up some in the second quarter. Measures of job vacancies edged up, on balance, over the
first half of the year, but hiring has remained quite
tepid.
Productivity and Labor Compensation
Labor productivity has risen less rapidly recently.
Following an outsized increase of 6 percent in 2009,
output per hour in the nonfarm business sector
increased 2 percent in 2010 and at an annual rate of
1¾ percent in the first quarter of 2011. Available
information suggests that labor productivity likely
decelerated further in the second quarter.
Increases in hourly compensation continue to be
restrained by the weak condition of the labor market.
The 12-month change in the employment cost index
for private industry workers, which measures both
wages and the cost to employers of providing benefits, has been 2 percent or less since the start of 2009
after several years of increases in the neighborhood
of 3 percent. Nominal compensation per hour in the
nonfarm business sector—a measure derived from
the labor compensation data in the NIPA—has also
decelerated noticeably over the past couple of years;
this measure rose just 2 percent over the year ending
in the first quarter of 2011, well below the average
increase of about 4 percent in the years before the
recession. Similarly, average hourly earnings for all
employees—the timeliest measure of wage develop-

67

Box 2. Long-Term Unemployment
The deep recession and subsequent slow improvement in the labor market have resulted in a sharp
increase in the incidence of long-term unemployment, defined here as being out of work 27 weeks
or longer. In the first quarter of this year, about
6 million persons (4 percent of the labor force) were
long-term unemployed. The long-term unemployment rate is almost twice as high as its previous
peak of about 2½ percent of the labor force following the recession of the early 1980s. Indeed, the
long-term unemployed currently make up 44 percent of all unemployed, up from a previous peak of
25 percent in the early 1980s.
Although all unemployed persons experience a loss
of income, the long-term unemployed often face
particularly serious economic hardships. They are at
greater risk of exhausting unemployment insurance
benefits and drawing down savings and other
assets, and thus they likely suffer a greater deterioration of living standards.
Even in good times, the likelihood of finding a new
job is generally lower for those who have remained
unemployed longer. During the most recent recession, job finding rates fell for workers at all unemployment durations. More recently, job finding rates
have inched up some from their lows at the end of
the recession, but they remain quite low at all
durations.
In part, low job finding rates among the long-term
unemployed reflect the fact that, at any given time,
some attributes—including certain skills, locations,
or other characteristics—are associated with
greater difficulty in finding employment. In addition,
long-term unemployment may compound the difficulty that some individuals have in finding a job by
degrading their skills, employment networks, and
reputations. Moreover, some who have been unsuccessful in their job search for a long period may permanently drop out of the labor force, in some cases
by retiring earlier than planned or applying for disability benefits, thereby reducing aggregate employment for years to come.

ments—rose 1.9 percent in nominal terms over the
12 months ending in June.
Unit labor costs in the nonfarm business sector
edged up ¾ percent over the year ending in the first
quarter of 2011, as the rate of increase of nominal
hourly compensation was just slightly higher than
that of labor productivity. Over the preceding
year, unit labor costs fell nearly 3 percent.
Prices

Inflation stepped up considerably in the first half of
2011. After rising less than 1¼ percent over the
12 months of 2010, the overall PCE chain-type price

68

98th Annual Report | 2011

index increased at an annual rate of more than 4 percent between December 2010 and May 2011 as
energy prices soared and food prices accelerated.
PCE prices excluding food and energy also accelerated over the first five months of the year, rising at
an annual rate of 2¼ percent, compared with the
extremely low rate of about ¾ percent over the
12 months of 2010. The recent increases in both
overall inflation and inflation excluding food and
energy appear to reflect influences that are likely to
wane in coming months.
Consumer energy prices—particularly for motor fuel
and home heating oil—rose sharply in the first few
months of 2011 as the price of crude oil surged.
Between December and April, the PCE price index
for consumer energy items climbed almost 12 percent
(not at an annual rate), and the national-average price
of gasoline approached $4 per gallon. But consumer
energy prices began to turn down in May in response
to declines in the prices of crude oil and wholesale
refined products; while the June reading on the PCE
index is not yet available, survey-based information
on retail gasoline prices suggests that consumer
energy prices likely declined further last month.
After rising modestly last year, consumer prices for
food and beverages accelerated this year, rising at an
annual rate of more than 6 percent from December
to May. Farm commodity prices increased sharply
over the past year as the emerging recovery in the
global economy coincided with poor harvests in several major producing countries, and this sharp
increase has fed through to consumer prices for
meats and a wide range of other more-processed
foods. In addition, a freeze-related upswing in consumer prices for fruits and vegetables boosted PCE
food prices earlier this year; these prices began to
retreat in the spring.
Price inflation for consumer goods and services other
than energy and food appears to have been boosted
during the first five months of 2011 by higher prices
of imported items as well as by cost pressures generated by increases in the prices of oil and other industrial commodities; given the apparent stabilization of
commodity prices, these pressures should fade in
coming months. In addition, prices of motor vehicles
increased sharply when supplies of new models were
curtailed by parts shortages associated with the
earthquake in Japan. These shortages are expected to
diminish in coming months as supply chain problems
are alleviated and motor vehicle production increases.

Longer-term inflation expectations remained stable
during the first half of the year. In the Thomson
Reuters/University of Michigan Surveys of Consumers, median longer-term expectations were 3 percent
in June, well within the range seen over the past several years. Moreover, the second-quarter reading of
10-year-ahead inflation expectations from the Survey
of Professional Forecasters, conducted by the Federal
Reserve Bank of Philadelphia, stood at 2¼ percent in
the second quarter, only slightly higher than the
2 percent reading recorded in the fourth quarter of
last year. Measures of inflation compensation
derived from yields on nominal and inflation-indexed
Treasury securities fluctuated over the first half of
the year in response to changes in commodity prices
and the outlook for economic growth. On balance,
medium-term inflation compensation ended the first
half of the year slightly higher, but compensation at
longer-term horizons was little changed.
Survey-based measures of near-term inflation expectations moved up during the first half of the year,
likely reflecting the run-up in energy and food prices.
Median year-ahead inflation expectations in the
Michigan survey, which had been relatively stable
throughout much of 2010, stepped up markedly
through April but then fell back a bit in May and
June as prices for gasoline and food decreased.
Financial Developments
Financial market conditions became somewhat more
supportive of economic growth, on balance, in the
first half of 2011, reflecting in part continued monetary policy accommodation provided by the Federal
Reserve. In the early part of the year, strong corporate profits and investors’ perceptions that the economic recovery was firming supported a rise in
equity prices and a narrowing of credit spreads. Since
May, however, indications that the U.S. economic
recovery was proceeding at a slower pace than previously anticipated, a perceived moderation in global
growth, and mounting concerns about the persisting
fiscal pressures in Europe weighed on investor sentiment, prompting some pullback from riskier financial assets.
Monetary Policy Expectations and
Treasury Rates

On net over the first half of the year, amid indications of a slowing in the pace of economic recovery,
market participants pushed out the date when they
expect the target federal funds rate to first rise above
its current range of 0 to ¼ percent and scaled back

Monetary Policy and Economic Developments

their expectations of the pace at which monetary
policy accommodation will be removed. Quotes on
money market futures contracts imply that, as of
early July 2011, investors expect the federal funds
rate to rise above its current target range in the fourth
quarter of 2012, about three quarters later than the
date implied at the start of the year.10 Investors also
expect, on average, that the effective federal funds
rate will be about 75 basis points by the middle of
2013, about 90 basis points lower than anticipated at
the beginning of 2011. Over the first half of the year,
investors coalesced around the view that the Federal
Reserve would complete the $600 billion program of
purchases of longer-term Treasury securities
announced at the November 2010 meeting of the
Federal Open Market Committee (FOMC); the program was completed at the end of June.
Yields on nominal Treasury securities declined, on
balance, over the first half of 2011. Treasury yields
initially rose in the first quarter amid signs that the
U.S. economic recovery was on a firmer footing and
that higher prices for energy and other commodities
were boosting inflation and investor uncertainty
about future inflation. However, yields subsequently
more than reversed their earlier increases, as weakerthan-expected economic data pointed to a slower
pace of economic recovery in the United States, commodity prices eased somewhat, and investors sought
the relative safety and liquidity of Treasury securities
in the face of heightened concerns about the ongoing
fiscal strains in Europe. As of early July, yields on 2-,
5-, and 10-year Treasury notes had dropped about
20, 40, and 30 basis points, respectively, since the
start of the year, reaching very low levels. Uncertainty about longer-term interest rates, as measured
by the implied volatility on 10-year Treasury securities, declined, on balance, reflecting in part the resolution of uncertainty about the ultimate size and
duration of the Federal Reserve’s asset purchase program and the lower odds perceived by investors of a
10

When interest rates are close to zero, determining the point at
which financial market quotes indicate that the federal funds
rate will move above its current range can be challenging. The
path described in the text is the mean of a distribution calculated from derivatives contracts on federal funds and Eurodollars. The asymmetry induced in this distribution by the zero
lower bound causes the mean to be influenced strongly by
changes in uncertainty regarding the policy path, complicating
the interpretation of the expected path. Alternatively, one can
use similar derivatives to calculate the most likely, or “modal,”
path of the federal funds rate, which tends to be more stable.
This alternative measure has also moved down, on net, since the
beginning of the year, but it suggests a flatter overall trajectory
for the target federal funds rate, according to which the effective
rate does not rise above its current target range until the second
half of 2013.

69

rapid removal of monetary policy accommodation.
However, volatility increased for a time in mid-June
as concerns escalated about the effects of Europe’s
fiscal problems on European banks. Thus far, the
issues surrounding the statutory debt limit seem not
to have affected either Treasury yields or implied
volatility noticeably, suggesting that investors generally believe that policymakers will reach an agreement
to raise the limit before the Treasury exhausts its
capacity to borrow in early August.
Corporate Debt and Equity Markets

Yields on corporate bonds across the credit spectrum
generally declined, on net, during the first half of the
year by amounts broadly similar to those on
comparable-maturity Treasury securities, leaving risk
spreads little changed. After narrowing in the first
four months of the year, spreads subsequently
retraced, reflecting disappointing news about the
strength of the economic recovery at home as well as
the ongoing fiscal stresses in Europe. Nonetheless,
bond spreads remained at the lower ends of their historical ranges. The term structure of corporate yield
spreads indicated that the recent widening was concentrated in near-term forward spreads rather than
far-term forward spreads. This information suggests
that while investors have become a bit more concerned about near-term risks, there has been little if
any change in their willingness to bear risk at longer
horizons; in fact, far-term forward spreads, particularly for high-yield bonds, are close to their historical
lows. In the secondary market for syndicated leveraged loans, the average bid price edged up further,
reflecting strong demand from institutional investors
for the asset class and a further improvement in
fundamentals.
Broad equity price indexes posted hefty gains in the
first quarter of 2011 because of strong earnings
reports and expectations that the economic recovery
was firming. Equity prices fell back somewhat in
May and June as investors downgraded their expectations for economic growth and reacted to the situation in Europe, but the market subsequently
rebounded as concerns about the near-term risks in
Europe appeared to ease. On net, stock prices ended
the first half of the year significantly higher. Implied
volatility of the S&P 500 stock price index, as calculated from options prices, was slightly lower, on net,
but fluctuated in response to various risk events during the first half of the year.
With some investors seeking to boost nominal
returns in an environment of very low interest rates,

70

98th Annual Report | 2011

monies continued to flow, on net, into mutual funds
that invest in higher-yielding debt instruments
(including speculative-grade corporate bonds and
leveraged loans) in the first half of 2011. These
inflows likely supported strong issuance and contributed to the easing of conditions in corporate bond
markets. However, consistent with the subsequent
downturn in risk sentiment, equity mutual funds
experienced large net outflows in May and June—the
first monthly outflows from such funds since October 2010. Money market mutual funds continued to
have moderate net outflows amid the very low yields
that these funds pay. Within the universe of money
market funds, institutional prime money market
funds experienced a stepped-up pace of outflows in
June, likely reflecting in part some concerns about
such funds’ exposures to European financial
institutions.
Market Functioning and
Dealer-Intermediated Credit

Conditions in short-term funding markets were generally stable in the first half of 2011. Spreads of London interbank offered rates, or Libor, over
comparable-maturity overnight index swap rates—a
measure of stress in short-term bank funding markets—remained relatively narrow. However, forward
agreements for short-term U.S. dollar funding starting three months hence jumped in mid-June as concerns increased regarding the exposures of some
European banks to peripheral European sovereign
debt. In addition, some European financial institutions faced reduced access to U.S. dollar funding, as
evidenced by their declining issuance of commercial
paper in the United States and rates on their paper
that remain noticeably elevated compared with rates
paid by other issuers. In commercial paper markets
more broadly, spreads of yields on lower-quality
A2/P2-rated paper over those on higher-quality
AA-rated nonfinancial paper edged slightly higher,
both at overnight and 30-day tenors; spreads of
yields on AA-rated asset-backed commercial paper
over those on AA-rated nonfinancial paper remained
narrow.
In repurchase agreement (repo) transactions, haircuts
on securities used as collateral were, on balance, little
changed over the first half of the year. The Federal
Deposit Insurance Corporation’s implementation on
April 1 of a change in its deposit insurance assessment system—which, for the first time, effectively
assessed premiums on the nondeposit liabilities of
large banks—reduced banks’ demand for short-term
funding, putting downward pressure on short-term

rates.11 Money market rates softened further in late
June, with rates in secured funding markets near
zero; investors pointed to a shortage of collateral and
higher demand for safe, liquid assets as factors contributing to the decline.
Information from the Federal Reserve’s quarterly
SCOOS suggested a continued gradual easing in
credit terms for most types of counterparties in securities financing and over-the-counter (OTC) derivatives markets in the first half of the year. Dealers
indicated that the easing came primarily in response
to more-aggressive competition from other institutions and an improvement in general market liquidity
and functioning. The easing of terms occurred primarily for securities financing transactions, while
nonprice terms on OTC derivatives transactions were
little changed on balance. Dealers also reported a
continued increase in demand for funding for most
types of securities, excluding equities.
The use of dealer-intermediated leverage appears to
have increased from its very low level reached during
the financial crisis. Responses to special questions
included in the SCOOS in March 2011 and June 2011
also tended to corroborate the view that dealerintermediated leverage had increased somewhat over
the past six months among both hedge funds and traditionally unlevered investors. Nonetheless, respondents to the June survey reported that the overall use
of leverage remained at levels roughly midway
between the pre-crisis peak and the post-crisis
trough. That the usage of dealer-intermediated leverage is still well below the peak appears consistent
with other evidence, including current triparty and
securities lending activity, a lack of any meaningful
issuance of structured finance products other than
CLOs, and no sign of a pickup in financing instruments that embed significant leverage, such as total
return swaps. Responses to another special question
on the June 2011 SCOOS indicated that there was
some unused funding capacity under existing agreements for all types of institutional clients, and that
unused capacity had generally increased since the
11

On April 1, 2011, the Federal Deposit Insurance Corporation
implemented changes to its deposit insurance assessment system
that broadened the definition of the assessment base and altered
assessment rates, especially for large banks. Under the new
system, insurance premiums are based on an insured depository
institution’s total assets less tangible capital—essentially all
liabilities—rather than domestic deposits. The new assessment
rate schedule continued to assign higher assessment rates to
banks that pose greater risks to the insurance system. In the
aggregate, the changes in the assessment system were intended
to be revenue neutral.

Monetary Policy and Economic Developments

beginning of 2011. This finding suggests that leverage is constrained by counterparties’ risk appetites
rather than funding availability. With the pullback
from risk-taking and turn in market sentiment in
June (after responses to the June SCOOS were filed),
leverage use appears to have declined. Hedge funds
saw an erosion of the returns posted during the first
few months of the year, leaving their returns roughly
flat for the year to date.
Measures of liquidity and functioning in most financial markets suggest that conditions were generally
stable during the first half of 2011. In the Treasury
market, various indicators, such as differences in the
prices between alternative securities with similar
remaining maturities and spreads between yields on
on-the-run and off-the-run issues, suggest that the
market continued to operate normally and that the
implementation and subsequent completion of the
Federal Reserve’s program of purchases of longerterm Treasury securities did not have an adverse
effect on market functioning. Bid-asked spreads and
dealer transaction volumes were within historically
normal ranges. Estimates of the bid-asked spreads in
corporate bond markets were steady at low levels,
and the dispersion of dealer quotes in the CDS market reached the lowest level since the financial crisis.
In the secondary market for leveraged loans, bidasked spreads also moved modestly lower, on net,
over the first half of the year.
Banking Institutions

After a relatively positive first quarter, market sentiment toward the banking industry dimmed in the
second quarter against the backdrop of the more
guarded economic outlook and heightened uncertainty over future regulatory requirements for financial institutions. As a result, equity prices of commercial banks fell markedly, significantly underperforming the broader stock market over the first half
of the year. Measures of the profitability of the
banking industry in the first quarter remained at levels noticeably below those that prevailed before the
financial crisis. A decline in pre-provision net revenue
was about offset by a further reduction in loan loss
provisions, which presumably reflected the improvement in most measures of the quality of banks’
assets.12 However, net charge-offs exceeded provisions for the fifth consecutive quarter, and loan loss
reserves remained low relative to delinquent loans
and charge-offs. Net interest margins slid a bit, while
12

Pre-provision net revenue is the sum of net interest income and
noninterest income less noninterest expense.

71

a decline in banks’ income from deposit fees was offset by gains in income from trading activities. About
50 of the roughly 6,500 banks in the United States
failed in the first half of the year, fewer than the
approximately 70 failures in the second half of 2010.
Indicators of credit quality at commercial banks
improved in the first quarter of 2011; the overall
delinquency rate on loans held by such banks fell
somewhat and charge-off rates declined. Median
spreads on CDS written on banking institutions,
which reflect investors’ assessments of and willingness to bear the risk that those institutions will
default on their debt obligations, were about
unchanged, on net, for a group of six of the largest
banks and slightly narrower for a group of nine other
banks. CDS spreads for foreign banking organizations with a presence in U.S. markets widened some,
owing to concerns about developments in Europe
and the organizations’ exposures to sovereign European debt.
Credit provided by domestic banks and the U.S.
branches and agencies of foreign banks decreased
slightly further in the first half of this year, as banks’
holdings of securities were about flat and an increase
in C&I loans to businesses was more than offset by
declines in real estate loans and consumer loans. C&I
loan balances rose vigorously over the first half of
the year; most of this increase was concentrated at
large domestic banks and branches and agencies of
foreign banks, consistent with the easing of credit
conditions for large corporate borrowers seen in
other credit markets. In contrast, available proxies for
lending to small businesses continued to suggest considerable weakness, likely reflecting constraints on
both the demand for, and the supply of, such credit.
CRE loans contracted sharply, especially those funding construction and land development activities. On
the household side, banks’ holdings of closed-end
residential mortgages declined as banks sold large
quantities of such loans to the GSEs. Moreover,
originations trailed off with the end of the refinancing wave that occurred last fall, when interest rates
declined in anticipation of the Federal Reserve’s second round of large-scale asset purchases. Bank lending through home equity lines also remained extraordinarily weak, reflecting in part tight lending standards amid declines in home prices that cut further
into home equity. Both credit card and other consumer loans from banks contracted, on balance, over
the first half of the year, albeit at a much slower pace
in the second quarter than in the first. Banks’ holdings of securities were little changed over the first

72

98th Annual Report | 2011

half of the year, as an increase in holdings of agency
MBS was about offset by declines in holdings of
Treasury and other securities.
Regulatory capital ratios of bank holding companies
rose further as large institutions prepared to meet
future requirements that are expected to be more
stringent than those currently in place. The Basel III
framework agreed to by the governors and heads of
supervision of countries represented on the Basel
Committee on Banking Supervision will raise
required capital ratios, tighten the definition of regulatory capital, and increase the risk weights assigned
to some assets and off-balance-sheet exposures. The
Basel III framework will also strengthen banks’
liquidity requirements. In addition, the Basel Committee is expected to release later this summer a proposal to require that global systemically important
banks hold additional capital to reduce the potential
economic and financial effect of the failure of such
banks. This proposal would be consistent with the
requirement of the Dodd-Frank Wall Street Reform
and Consumer Protection Act that bank holding
companies with more than $50 billion in assets be
subject to additional capital and liquidity
requirements.
Monetary Aggregates and
the Federal Reserve’s Balance Sheet

The M2 monetary aggregate expanded at a moderate
annual rate of 5 percent in the first half of 2011.13
Liquid deposits, the largest component of M2, continued to rise at a solid pace, while investors extended
their reallocation away from other lower-yielding M2
assets. Balances held in small time deposits and retail
money market mutual funds contracted to their lowest levels since 2005 as their yields remained
extremely low. The currency component of the
money stock increased at an annual rate of 10 percent in the first half of the year, likely driven by both
further strong demand from abroad and solid domes13

M2 consists of (1) currency outside the U.S. Treasury, Federal
Reserve Banks, and the vaults of depository institutions;
(2) traveler’s checks of nonbank issuers; (3) demand deposits at
commercial banks (excluding those amounts held by depository
institutions, the U.S. government, and foreign banks and official
institutions) less cash items in the process of collection and Federal Reserve float; (4) other checkable deposits (negotiable order
of withdrawal, or NOW, accounts and automatic transfer service accounts at depository institutions; credit union share draft
accounts; and demand deposits at thrift institutions); (5) savings
deposits (including money market deposit accounts); (6) smalldenomination time deposits (time deposits issued in amounts of
less than $100,000) less individual retirement account (IRA)
and Keogh balances at depository institutions; and (7) balances
in retail money market mutual funds less IRA and Keogh balances at money market mutual funds.

tic demand. The monetary base—which is roughly
equal to the sum of currency in circulation and the
reserve balances of depository institutions held at the
Federal Reserve—increased rapidly in the first half of
the year, reflecting an expansion of reserve balances
that resulted from the Federal Reserve’s longer-term
security purchase program and a reduction in the
Treasury Department’s Supplementary Financing
Account as well as the strong increase in currency.
The size of the Federal Reserve’s balance sheet rose
to $2.9 trillion as of July 6, 2011, about $450 billion
more than at the end of 2010 (table 1). Holdings of
Treasury securities rose more than $600 billion for
the year to date as a result of the FOMC’s decisions
to reinvest the proceeds from paydowns of agency
debt and agency MBS in longer-term Treasury securities, announced at the August 2010 FOMC meeting, and to purchase an additional $600 billion of
longer-term Treasury securities by the end of the second quarter of 2011, announced at the November 2010 FOMC meeting. In contrast, holdings of
agency debt and agency MBS declined about
$115 billion as securities either matured or experienced principal prepayments related to mortgage refinancing activity.
Use of regular discount window lending facilities,
such as the primary credit facility, continued to be
minimal. Loans outstanding under the Term AssetBacked Securities Loan Facility (TALF) declined
from $25 billion at the end of 2010 to $12 billion in
mid-2011 as improved conditions in securitization
markets resulted in prepayments of loans made
under the facility. The facility, which was established
to assist financial markets in accommodating the
credit needs of consumers and businesses by facilitating the issuance of ABS collateralized by a variety of
consumer and business loans, was closed to new
lending in June 2010. All remaining TALF loans are
current on their payments and will mature no later
than March 30, 2015.
In the first half of this year, the Federal Reserve
reduced some of its exposures from lending facilities
established during the financial crisis to support specific institutions. On January 14, 2011, in conjunction
with the closing of a recapitalization plan that terminated the Federal Reserve’s assistance to American
International Group, Inc. (AIG), AIG repaid the
credit extended by the Federal Reserve under the
revolving credit line, and the Federal Reserve was
paid in full for its preferred interests in the special
purpose vehicles AIA Aurora LLC and ALICO

Monetary Policy and Economic Developments

Table 1. Selected components of the Federal Reserve
balance sheet, 2010–11
Millions of dollars
Balance sheet item

Dec. 29, 2010

Total assets
2,423,457
Selected assets
Credit extended to depository institutions and dealers
Primary credit
58
Central bank liquidity swaps
75
Credit extended to other market participants
Term Asset-Backed Securities Loan Facility
(TALF)
24,704
Net portfolio holdings of TALF LLC
665
Support of critical institutions
Net portfolio holdings of Maiden Lane LLC,
66,312
Maiden Lane II LLC, and Maiden Lane III LLC1
Credit extended to American International
Group, Inc.
20,282
Preferred interests in AIA Aurora LLC and ALICO
Holdings LLC
26,057
Securities held outright
U.S. Treasury securities
1,016,102
Agency debt securities
147,460
992,141
Agency mortgage-backed securities (MBS)2
Total liabilities
2,366,855
Selected liabilities
Federal Reserve notes in circulation
943,749
Reverse repurchase agreements
59,246
Deposits held by depository institutions
1,025,839
Of which: Term deposits
5,113
U.S. Treasury, general account
88,905
U.S. Treasury, Supplementary Financing Account
199,963
Total capital
56,602

July 6, 2011
2,874,049

5
0

12,488
757

59,637
…
…
1,624,515
115,070
908,853
2,822,382
990,861
67,527
1,663,022
0
67,270
5,000
51,667

Note: LLC is a limited liability company.
1
The Federal Reserve has extended credit to several LLCs in conjunction with
efforts to support critical institutions. Maiden Lane LLC was formed to acquire
certain assets of the Bear Stearns Companies, Inc. Maiden Lane II LLC was
formed to purchase residential mortgage-backed securities from the U.S.
securities lending reinvestment portfolio of subsidiaries of American
International Group, Inc. (AIG). Maiden Lane III LLC was formed to purchase
multisector collateralized debt obligations on which the Financial Products
group of AIG has written credit default swap contracts.
2
Includes only MBS purchases that have already settled.
…Not applicable.
Source: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting
Reserve Balances of Depository Institutions and Condition Statement of Federal
Reserve Banks.”

Holdings LLC. Neither the revolving credit facility
nor the preferred interests held in connection with
the revolving credit facility generated any loss to the
Federal Reserve or taxpayers. The portfolio holdings
of Maiden Lane LLC, Maiden Lane II LLC, and
Maiden Lane III LLC—entities that were created
during the crisis to acquire certain assets from the
Bear Stearns Companies, Inc., and AIG to avoid the
disorderly failures of those institutions—declined, on
net, primarily as a result of principal payments and
asset sales. Of note, the Federal Reserve Bank of
New York (FRBNY) sold a total of $10 billion in

73

current face value of residential mortgage-backed
securities out of the Maiden Lane II portfolio; competitive sales of these securities were conducted
through the FRBNY’s investment manager.14 The
estimated fair values of the portfolios of the three
Maiden Lane LLCs continue to exceed the corresponding loan balances outstanding to each limited
liability company from the FRBNY.
Only small draws on U.S. dollar liquidity swap
arrangements between the Federal Reserve and foreign central banks have been made since their reestablishment in May 2010, and there have been no
draws on them since early March of this year.
On the liability side of the Federal Reserve’s balance
sheet, reserve balances held by depository institutions
rose about $640 billion over the first half of the year
to $1.7 trillion as of July 6. Federal Reserve notes in
circulation rose from $944 billion to $991 billion. The
Treasury reduced the balance in its Supplementary
Financing Account at the Federal Reserve to $5 billion early in the year as part of its efforts to maximize flexibility in its debt management as the statutory debt limit approached. Balances in the Treasury’s general account at the Federal Reserve also
declined. Reverse repurchase agreements executed
with foreign official and international accounts were
generally steady. As part of its ongoing program to
expand the range of tools available to drain reserves,
the Federal Reserve conducted three 28-day, $5 billion auctions of term deposits to depository institutions as well as a series of small-scale, real-value triparty reverse repurchase operations with eligible primary dealer and money market fund counterparties.
On March 22, the Federal Reserve System released
audited financial statements for 2010 for the combined Federal Reserve Banks, the 12 individual
Reserve Banks, the limited liability companies that
were created to respond to strains in financial markets, and the Board of Governors. The Reserve
Banks reported comprehensive income of close to
$82 billion for the year ending December 31, 2010,
an increase of $28 billion from 2009. The increase
was attributable primarily to interest earnings on the
Federal Reserve’s holdings of agency debt and MBS,
acquired largely in 2009. The Reserve Banks transferred $79 billion of the $82 billion in comprehensive
income to the U.S. Treasury in 2010, a record high
and $32 billion more than was transferred in 2009.
14

Current face value is the remaining principal balance of the
mortgage assets underlying the securities, after prepayments
and amortizations.

74

98th Annual Report | 2011

International Developments
In the first half of the year, developments abroad
have largely been dominated by several shocks,
including the political turmoil in the MENA region,
a major earthquake and tsunami in Japan, heightened fiscal stresses in Europe, and swings in commodity prices. In the face of these shocks, global
financial markets were fairly resilient and foreign economic activity held up. Foreign real GDP accelerated
in the first quarter, most notably in the EMEs, where
performance has continued to outpace that in the
advanced foreign economies (AFEs). Recent data
indicate that foreign economic growth slowed in the
second quarter, but the recovery from the global
recession continued.
International Financial Markets

Spurred in part by monetary policy tightening
abroad and fears that the pace of economic recovery
in the United States was slowing, the foreign
exchange value of the dollar declined over much of
the first half of the year. The lower level of the dollar
is consistent with a weakening of the safe-haven
demands that had boosted it during the global financial crisis; however, the dollar has moved slightly
higher since May on heightened concerns over the
fiscal problems in Europe and uncertainties about
global economic growth. On net, the dollar is about
3¾ percent lower on a trade-weighted basis against a
broad set of currencies over the first half of the year.
Following Japan’s earthquake, as traders anticipated
that Japanese investors would need to repatriate
funds, the yen appreciated sharply, reaching a record
high versus the dollar. In response, the Group of
Seven (G-7) countries conducted coordinated sales of
yen in the foreign exchange markets on March 18.
The yen more than reversed its steep appreciation
immediately following the intervention.
Ten-year sovereign yields in the AFEs generally rose
early in the year on expectations that continued economic recovery and greater inflationary pressures
would prompt monetary policy tightening. However,
since April, yields have begun to retreat. On net,
yields for Germany, Canada, and the United Kingdom are down slightly from the end of last year.
Fiscal and financial stresses worsened in Greece, Portugal, and Ireland over the first half of the year, with
the major credit rating agencies downgrading significantly these countries’ sovereign credit ratings. The
spreads of yields on Greek, Portuguese, and Irish
bonds over those on German bonds soared as market
confidence in the ability of these three countries to

meet their fiscal obligations diminished. Following a
€78 billion rescue package by the EU and the International Monetary Fund (IMF) in early May,
spreads for Portuguese bonds stabilized but soon rose
again amid the high-profile discussions by European
officials on a possible restructuring of Greek debt. In
late June, Greece approved a new austerity and privatization package, opening the door for approval of a
€12 billion EU–IMF disbursement needed to meet
upcoming payments. Although spreads for Greek,
Portuguese, and Irish bonds declined some following
these developments, they have since risen as Moody’s
Investors Service downgraded Portugal’s sovereign
debt rating to junk status and EU officials continued
to seek commitments from private creditors to roll
over maturing Greek debt. Movements in spreads for
the sovereign debts of Italy and Spain have been
more muted, but they have moved up in recent
months.
Equity prices in the AFEs generally continued to rise
through the first few months of this year, falling
sharply after Japan’s earthquake on March 11 but,
outside of Japan, recouping their losses afterward.
By early May, increased uncertainties about global
economic growth and heightened concerns over the
sovereign debt problems in Europe prompted a pullback in equity prices. However, the passage of
Greece’s austerity and privatization legislations in
late June, which assuaged market concerns about an
imminent Greek default, prompted some renewed
demand for risky assets; equity prices in most of the
AFEs were, on net, at about their levels at the start of
the year. In the EMEs, equity prices had also risen
early in the year, but, as in the AFEs, they began to
pull back by early May. On net, over the first half of
the year, equity prices are down in Latin America but
are up in emerging Asia.
Bank stock prices in Europe have declined nearly
9 percent since the start of the year. CDS premiums
for European banks remained significantly higher
than those of nonfinancial firms with similar credit
ratings. European banks experienced large losses during the global financial crisis, and their lending exposure to Greece, Ireland, and other vulnerable European economies remains a concern. In addition,
some banks in the core European countries, such as
France and Germany, still have considerable dollar
funding needs. Most peripheral European banks have
only limited access to market funding and have relied
on ECB funding instead. In Japan, banks have not
experienced crisis-related losses nearly as large as
those incurred by European institutions, but Japa-

Monetary Policy and Economic Developments

nese bank profits have been persistently weaker,
reflecting the fragile state of Japan’s economy.
The newly created European Banking Authority is in
the process of completing an EU-wide stress test of
large European banks. The methodology used in this
year’s test is broadly similar to that of the stress tests
conducted by the Committee of European Banking
Supervisors last year. The results of the stress test are
expected to be released on July 15 of this year. In
anticipation of the test, some European banks took
steps to raise additional capital in recent months.

75

In the euro area, economic activity was strong in
Germany and France but remained generally weak in
the peripheral countries, as concerns about sovereign
debt sustainability continued to weigh on economic
growth. In the United Kingdom, output rebounded
in the first quarter of this year from a contraction in
the fourth quarter of 2010, but the pace was
restrained by declines in households’ real incomes as
inflation increased. Japan’s economic activity was
also bouncing back from its dip in the fourth quarter
of last year until the earthquake and ensuing tsunami
and nuclear disaster caused first-quarter real GDP to
contract sharply.

The Financial Account

Net purchases of U.S. securities by foreign private
investors slowed in the first quarter from the pace of
2010, in part because of reduced safe-haven demand
for U.S. Treasury securities. Foreign investors, on net,
sold both U.S. agency and corporate bonds in the
first quarter, in contrast to purchases of these securities in the second half of last year, but they continued
to make large purchases of U.S. equities. U.S. investors increased the pace of their purchases of foreign
securities, especially foreign equities.
Banks located in the United States registered strong
net inflows from abroad in the first quarter following
small net inflows in the fourth quarter of last year.
These recent net inflows primarily reflect increased
net borrowing from affiliated banking offices abroad
and are in marked contrast to sizable net lending
abroad from U.S. banks in the first half of 2010,
when dollar funding pressures in European interbank
markets had contributed to increased reliance on
funding from U.S. counterparties.
Inflows from foreign official investors eased somewhat in late 2010 and continued at a moderate pace
in the first quarter this year. Such inflows continued
to come primarily from countries seeking to counteract upward pressure on their currencies by purchasing U.S. dollars in foreign currency markets. These
countries then used the proceeds to acquire U.S.
assets, mainly Treasury and U.S. agency securities.
Available data through May indicate that foreign official inflows slowed a bit further in the second
quarter.

The disaster in Japan damaged production facilities,
disrupted supply chains, and reduced electricity generation capacity. In addition, spending on consumer
durables and capital investment fell sharply, reflecting
a substantial slump in consumer and business confidence. The Japanese authorities responded swiftly to
support the economy. The Bank of Japan injected
record amounts of liquidity into money markets,
doubled the size of its asset purchase program to
¥10 trillion, set up a ¥1 trillion loan program for
firms in disaster-hit areas, and expanded by ¥500 billion the funds for an existing program aimed at supporting economic growth. The Japanese Diet
approved a ¥4 trillion supplementary budget to fund
the construction of temporary housing, the restoration of damaged infrastructure, and the provision of
low-interest loans to small businesses. Japan also
requested a coordinated intervention of G-7 countries’ central banks in foreign exchange markets to
stem the appreciation of the yen. Supported by the
various official actions, the financial system continued to operate smoothly and reconstruction activity
has begun, setting the stage for an economic recovery
in the second half of the year.
Supply disruptions due to the Japanese earthquake
weighed on economic growth in other AFEs, and
other incoming data corroborate that economic
activity in the AFEs slowed in the second quarter.
The composite purchasing managers indexes have
moved lower in recent months across the AFEs. In
addition, business confidence has turned down, and
the underlying momentum in consumer spending has
remained weak in the euro area.

Advanced Foreign Economies

The pace of economic recovery in the AFEs picked
up in early 2011 following a soft patch in the second
half of 2010, but performance was uneven across
countries. Real GDP rose at a solid pace in the first
quarter in Canada, boosted by a surge in investment.

A surge in energy and food prices and, in some cases,
higher value-added taxes lifted headline inflation
rates in the major foreign economies earlier in the
year. Twelve-month headline inflation rose to 4½ percent in the United Kingdom and to about 3¾ percent

76

98th Annual Report | 2011

and 2¾ percent in Canada and the euro area, respectively. In Japan, the rise in commodity prices pushed
inflation above zero. Excluding the effects of commodity price movements and tax changes, inflation in
the AFEs has remained relatively subdued amid considerable economic resource slack. With the recent
pullback in commodity prices, overall inflation also
appears to be stabilizing.
Monetary policy remained accommodative in all the
major AFEs, and market participants appear to
expect only gradual tightening. After having kept its
benchmark policy rate at 1 percent since May 2009,
the ECB raised it twice—by 25 basis points in April
and by another 25 basis points in early July—citing
upside risks to the inflation outlook. The Bank of
Canada, which began to tighten last year, has paused
so far this year, maintaining its target for the overnight rate at 1 percent. The Bank of England kept its
policy rate at 0.5 percent and the size of its Asset
Purchase Facility at £200 billion.
Emerging Market Economies

The EMEs continued to expand at a strong pace in
the first quarter of 2011, boosted by both exports
and domestic demand. Exports were lifted by sustained global demand. Domestic demand was supported by macroeconomic policies that remained
generally accommodative despite recent tightening
and by robust household income amid strong labor
market conditions. Recent data indicate that growth
moderated in the second quarter, but to a still-solid
pace, reflecting governments’ policies to cool the
economies that were running unsustainably fast, a
deceleration in activity in the advanced economies,
and spillover effects of the Japanese earthquake.
The Chinese economy expanded at a strong pace in
the first half of 2011, although economic growth
slowed a bit compared with the second half of last
year, largely due to measures by authorities to rein in
the economy. Headline consumer prices were up
6.4 percent in June from a year earlier, led by a rise in
food prices. This year, Chinese authorities have raised
required reserve ratios for all banks 300 basis
points—the requirement for large banks now stands
at 21.5 percent. Authorities have also raised the
benchmark one-year bank lending rate ¾ percentage
point. Over the first half of the year, the Chinese renminbi has appreciated, on net, about 2½ percent
against the dollar. However, on a real multilateral,
trade-weighted basis, which gauges the renminbi’s
value against the currencies of China’s major trading
partners and adjusts for differences in inflation rates,

the renminbi has depreciated. Nonetheless, strong
domestic demand led import growth in the first half
of this year to exceed export growth, and consequently, China’s trade surplus narrowed.
Elsewhere in emerging Asia, the vigorous Chinese
economy provided impetus to exports for several
countries, and domestic demand was also robust.
Accordingly, economic activity was upbeat in the
first quarter, with several countries, including Hong
Kong, Singapore, and Taiwan, all posting doubledigit annualized growth rates. Economic activity was
also upbeat in India. Available indicators for the second quarter suggest that the pace of expansion
slowed but remained solid.
In Mexico, a country with stronger economic linkages to the United States than most EMEs, performance continued to lag that of other EMEs.
Reported first-quarter real GDP rose at an annual
rate of only 2 percent. By contrast, first-quarter real
GDP rose robustly in Brazil and in other South
American countries, supported by generally accommodative macroeconomic policies and the tailwind
from gains in commodity prices.
Higher food prices pushed up consumer price inflation in the EMEs earlier in the year. As food price
pressures subsequently eased, 12-month inflation stabilized and began to retreat in several countries. In
the midst of elevated inflation and strong economic
growth, the stance of macroeconomic policy in the
EMEs has been tightened further to mitigate the
risks of overheating. In the first half of the year,
many EMEs tightened monetary policy by raising
policy rates and reserve requirement ratios several
times, and progress was also made on the removal of
the fiscal support measures enacted at the height of
the global financial crisis.

Part 3
Monetary Policy:
Recent Developments and Outlook
Monetary Policy over the First Half of 2011
To promote the economic recovery and price stability, the Federal Open Market Committee (FOMC)
maintained a target range for the federal funds rate
of 0 to ¼ percent throughout the first half of 2011.
In the statement accompanying each FOMC meeting
over the period, the Committee noted that economic
conditions were likely to warrant exceptionally low
levels for the federal funds rate for an extended
period. At the end of June, the Federal Reserve con-

Monetary Policy and Economic Developments

cluded its purchases of longer-term Treasury securities under the $600 billion purchase program
announced in November 2010; that program was
undertaken to support the economic recovery and to
help ensure that inflation, over time, returns to levels
consistent with the FOMC’s mandate of maximum
employment and price stability. In addition, throughout the first half of 2011, the Committee maintained
its existing policy of reinvesting principal payments
from its agency debt and agency mortgage-backed
securities in longer-term Treasury securities. In its
June statement, the Committee noted that it would
regularly review the size and composition of its securities holdings and was prepared to adjust those
holdings, as appropriate, to foster maximum employment and price stability.
The information reviewed at the January 25–26
FOMC meeting indicated that the economic recovery
was gaining a firmer footing, though the expansion
had not yet been sufficient to bring about a significant improvement in labor market conditions. Consumer spending had risen strongly in late 2010, and
the ongoing expansion in business outlays for equipment and software appeared to have been sustained
in recent months. Industrial production had
increased solidly in November and December. However, construction activity in both the residential and
nonresidential sectors remained weak. Modest gains
in employment had continued, and the unemployment rate remained elevated. Conditions in financial
markets were viewed by FOMC participants as having improved somewhat further over the intermeeting
period, as equity prices had risen and credit spreads
on the debt of nonfinancial corporations had continued to narrow, while yields on longer-term nominal
Treasury securities were little changed.15 Credit conditions were still tight for smaller, bank-dependent
firms, although bank loan growth had picked up in
some sectors. Despite further increases in commodity
prices, measures of underlying inflation remained
subdued and longer-run inflation expectations were
stable.
The information received over the intermeeting
period had increased Committee members’ confidence that the economic recovery would be sus15

Members of the FOMC in 2011 consist of the members of the
Board of Governors of the Federal Reserve System plus the
presidents of the Federal Reserve Banks of Chicago, Dallas,
Minneapolis, New York, and Philadelphia. Participants at
FOMC meetings consist of the members of the Board of Governors of the Federal Reserve System and all Reserve Bank
presidents.

77

tained, and the downside risks to both economic
growth and inflation were viewed as having diminished. Nevertheless, members noted that the pace of
the recovery was insufficient to bring about a significant improvement in labor market conditions and
that measures of underlying inflation were trending
down. Moreover, the economic projections submitted
for this meeting indicated that unemployment was
expected to remain above, and inflation to remain
somewhat below, levels consistent with the Committee’s objectives for some time. Accordingly, the Committee decided to maintain its existing policy of reinvesting principal payments from its securities holdings and reaffirmed its intention to purchase
$600 billion of longer-term Treasury securities by the
end of the second quarter of 2011. Members emphasized that the Committee would continue to regularly
review the pace of its securities purchases and the
overall size of the asset purchase program in light of
incoming information and would adjust the program
as needed to best foster maximum employment and
price stability. In addition, the Committee maintained the target range of 0 to ¼ percent for the federal funds rate and reiterated its expectation that economic conditions were likely to warrant exceptionally
low levels of the federal funds rate for an extended
period.
The data presented at the March 15 FOMC meeting
indicated that the economic recovery continued to
proceed at a moderate pace, with a gradual improvement in labor market conditions. Looking through
weather-related distortions in various indicators,
measures of consumer spending, business investment, and employment continued to show expansion.
Housing, however, remained depressed, and credit
conditions were still uneven. Large firms with access
to financial markets continued to find credit, including bank loans, available on relatively attractive
terms; however, credit conditions reportedly
remained tight for smaller, bank-dependent firms.
Sizable increases in prices of crude oil and other
commodities pushed up headline inflation, but measures of underlying inflation were subdued, and
longer-run inflation expectations remained stable. A
number of participants expected that slack in
resource utilization would continue to restrain
increases in labor costs and prices. Nonetheless, participants observed that rapidly rising commodity
prices posed upside risks to the stability of longerterm inflation expectations, and thus to the outlook
for inflation, even as they posed downside risks to the
outlook for growth in consumer spending and business investment. In addition, participants noted that

78

98th Annual Report | 2011

unfolding events in the Middle East and North
Africa, along with the tragic developments in Japan,
had further increased uncertainty about the economic outlook.
In the FOMC’s discussion of monetary policy for the
period ahead, the members agreed that no changes to
the Committee’s asset purchase program or to its target range for the federal funds rate were warranted.
The economic recovery appeared to be on a firmer
footing, and overall conditions in the labor market
were gradually improving. Although the unemployment rate had declined in recent months, it remained
elevated relative to levels that the Committee judged
to be consistent, over the longer run, with its statutory mandate to foster maximum employment and
price stability. Similarly, measures of underlying
inflation continued to be somewhat low relative to
levels seen as consistent with the dual mandate over
the longer run. With longer-term inflation expectations remaining stable and measures of underlying
inflation subdued, members anticipated that recent
increases in the prices of energy and other commodities would result in only a transitory increase in headline inflation. Given this economic outlook, the
Committee agreed to maintain the existing policy of
reinvesting principal payments from its securities
holdings and reaffirmed its intention to purchase
$600 billion of longer-term Treasury securities by the
end of the second quarter of 2011 to promote a
stronger pace of economic recovery and to help
ensure that inflation, over time, was at levels consistent with the Committee’s mandate. Members
emphasized that the Committee would continue to
regularly review the pace of its securities purchases
and the overall size of the asset purchase program in
light of incoming information and would adjust the
program as needed to best foster maximum employment and price stability. The Committee maintained
the target range for the federal funds rate at 0 to
¼ percent and continued to anticipate that economic
conditions were likely to warrant exceptionally low
levels for the federal funds rate for an extended
period.
The information reviewed at the April 26–27 FOMC
meeting indicated that, on balance, economic activity
was expanding at a moderate pace and that labor
market conditions were continuing to improve gradually. Headline consumer price inflation had been
boosted by large increases in food and energy prices,
but measures of underlying inflation were still subdued and longer-run inflation expectations remained
stable. Participants observed that while construction

activity was still anemic, measures of consumer
spending and business investment continued to
expand, and overall labor market conditions were
improving, albeit gradually. Nevertheless, they agreed
that the pace of economic growth in the first quarter
had slowed unexpectedly. Participants viewed this
weakness as likely to be largely transitory, influenced
by unusually severe weather, increases in energy and
other commodity prices, and lower-than-expected
defense spending; as a result, they saw economic
growth picking up later in the year. In addition, they
noted that higher gasoline and food prices had
weighed on consumer sentiment about near-term
economic conditions but that underlying fundamentals pointed to continued moderate growth in spending. Activity in the industrial sector had expanded
further and manufacturers remained upbeat,
although automakers were reporting some difficulties
in obtaining parts normally produced in Japan,
which could damp motor vehicle production in the
second quarter. Participants noted that financial conditions continued to improve. Equity prices had risen
significantly since the beginning of the year, buoyed
by an improved outlook for earnings. Although loan
demand in general remained weak, banks reported an
easing of their lending standards and terms on commercial and industrial loans. Consumer credit conditions also eased somewhat, although the demand for
consumer credit other than auto loans reportedly
changed little.
Meeting participants judged the information received
over the intermeeting period as indicating that the
economic recovery was proceeding at a moderate
pace, although somewhat more slowly than had been
anticipated earlier in the year. Overall conditions in
the labor market were gradually improving, but the
unemployment rate remained elevated relative to levels that the Committee judged to be consistent, over
the longer run, with its statutory mandate of maximum employment and price stability. Significant
increases in the prices of energy and other commodities had boosted overall inflation, but members
expected this rise to be transitory. Indicators of
medium-term inflation remained subdued and somewhat below the levels seen as consistent with the dual
mandate as indicated by the Committee’s longer-run
inflation projections. Accordingly, the Committee
agreed that no changes to its asset purchase program
or to its target range for the federal funds rate were
warranted at this meeting. Specifically, the Committee agreed to maintain its policy of reinvesting principal payments from its securities holdings and
affirmed that it would complete purchases of

Monetary Policy and Economic Developments

$600 billion of longer-term Treasury securities by the
end of the second quarter. The Committee also
agreed to maintain the target range of the federal
funds rate at 0 to ¼ percent and anticipated that economic conditions would likely warrant exceptionally
low levels for the federal funds rate for an extended
period. Members agreed that the Committee would
regularly review the size and composition of its securities holdings in light of incoming information and
that they were prepared to adjust those holdings as
needed to best foster maximum employment and
price stability.
The information received ahead of the June 21–22
FOMC meeting indicated that the pace of the economic recovery had slowed in recent months and that
conditions in the labor market had softened. Measures of inflation had picked up this year, reflecting in
part higher prices for some commodities and
imported goods. Longer-run inflation expectations,
however, remained stable. In their discussion of the
economic situation and outlook, meeting participants noted a number of transitory factors that were
restraining growth, including the global supply chain
disruptions in the wake of the earthquake in Japan,
the unusually severe weather in some parts of the
United States, a drop in defense spending, and the
effect of increases in oil and other commodity prices
on household purchasing power and spending. Participants expected that the expansion would gain
strength as the effects of these temporary factors
waned. Nonetheless, most participants judged that
the pace of economic recovery was likely to be somewhat slower over coming quarters than they had projected in April, reflecting the persistent weakness in
the housing market, the ongoing efforts by some
households to reduce debt burdens, the recent sluggish growth of income and consumption, the fiscal
contraction at all levels of government, and the effect
of uncertainty regarding the economic outlook and
future tax and regulatory policies on the willingness
of firms to hire and invest. Changes in financial conditions since the April meeting suggested that investors had become more concerned about risk. Equity
markets had seen a broad selloff, and risk spreads for
many corporate borrowers had widened noticeably
since April. Nonetheless, large businesses continued
to enjoy ready access to credit.
In their discussion of monetary policy for the period
ahead, members agreed that the Committee should
complete its $600 billion asset purchase program at
the end of the month and that no changes to the target range of the federal funds rate were warranted.

79

The information received over the intermeeting
period indicated that the economic recovery was continuing at a moderate pace, though somewhat more
slowly than the Committee had expected, and that
the labor market had been weaker than anticipated.
Inflation had increased in recent months as a result
of higher prices for some commodities, as well as
supply chain disruptions related to the tragic events
in Japan. Nonetheless, members saw the pace of the
economic expansion as picking up over the coming
quarters and the unemployment rate resuming its
gradual decline toward levels consistent with the
Committee’s dual mandate. Moreover, with longerterm inflation expectations stable, members expected
that inflation would subside to levels at or below
those consistent with the Committee’s dual mandate
as the effects of past energy and other commodity
price increases dissipate. However, many members
saw the outlook for both employment and inflation
as unusually uncertain. Against this backdrop, members agreed that it was appropriate to maintain the
Committee’s current policy stance and accumulate
further information regarding the outlook for growth
and inflation before deciding on the next policy step.
A few members noted that, depending on how economic conditions evolve, the Committee might have
to consider providing additional monetary policy
stimulus, especially if economic growth remained too
slow to meaningfully reduce the unemployment rate
in the medium run. A few other members, however,
viewed the increase in inflation risks as suggesting
that economic conditions might evolve in a way that
would warrant the Committee taking steps to begin
removing policy accommodation sooner than currently anticipated.
Also at its June meeting, in light of ongoing strains
in some foreign financial markets, the Committee
approved an extension through August 1, 2012, of its
temporary U.S. dollar liquidity swap arrangements
with the Bank of Canada, the Bank of England, the
European Central Bank, the Bank of Japan, and the
Swiss National Bank. The authorization of the swap
arrangements had been set to expire on August 1,
2011.
Tools and Strategies for the Withdrawal
of Monetary Policy Accommodation
Although the FOMC continues to anticipate that
economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an
extended period, the Federal Reserve will eventually
need to remove policy accommodation to maintain a
stance of policy that is consistent with its statutory

80

98th Annual Report | 2011

mandate to foster maximum employment and stable
prices. The FOMC has several tools for smoothly and
effectively exiting at the appropriate time from the
current accommodative policy stance. One tool is the
ability to pay interest on reserve balances; the Federal
Reserve will be able to put significant upward pressure on short-term market interest rates by increasing
the rate paid on excess reserves. Two other tools—executing triparty reverse repurchase agreements
(RRPs) with primary dealers and other counterparties and issuing term deposits to depository institutions through the Term Deposit Facility (TDF)—will
be capable of temporarily reducing the quantity of
reserves held by the banking system and thereby
tightening the relationship between the interest rate
paid on reserves and short-term market interest
rates.16 Finally, the Federal Reserve could pare the
size of its balance sheet over time by ceasing to reinvest principal payments from its securities holdings
or by selling its securities holdings.
During the first half of 2011, the Federal Reserve
continued to refine and test its temporary reserve
draining tools. The Federal Reserve Bank of New
York (FRBNY) took further steps to expand the
range of counterparties for RRPs to include entities
other than primary dealers in order to enhance the
capacity of such operations. The FRBNY completed
its third wave of counterparty expansions aimed at
domestic money market funds in May, bringing the
total number of RRP counterparties, including the
primary dealers, to 110. In May, the FRBNY also set
forth criteria for the acceptance of governmentsponsored enterprises as eligible counterparties for
the next counterparty expansion wave. During the
first half of the year, the FRBNY conducted a series
of small-scale triparty RRP transactions with its primary dealer and money market fund RRP counterparties. The Federal Reserve also conducted three
28-day, $5 billion auctions of term deposits. As a
matter of prudent planning, these operations are
intended to ensure the operational readiness of the
TDF and RRP programs and to increase the familiarity of the participants with the auction procedures.
At its April and June meetings, the Committee discussed strategies for normalizing both the stance and
conduct of monetary policy. Participants noted that
16

In a triparty repurchase agreement, both parties to the agreement must have cash and collateral accounts at the same triparty agent, which is by definition also a clearing bank. The triparty agent will ensure that collateral pledged is sufficient and
meets eligibility requirements, and all parties agree to use collateral prices supplied by the triparty agent.

their discussions of this topic were undertaken as
part of prudent planning and did not imply that a
move toward such normalization would necessarily
begin sometime soon. Almost all participants agreed
with the following principles to guide the exit process:
• The Committee will determine the timing and pace
of policy normalization to promote its statutory
mandate of maximum employment and price
stability.
• To begin the process of policy normalization, the
Committee will likely first cease reinvesting some
or all payments of principal on the securities holdings in the System Open Market Account (SOMA).
• At the same time or sometime thereafter, the Committee will modify its forward guidance on the path
of the federal funds rate and will initiate temporary
reserve-draining operations aimed at supporting
the implementation of increases in the federal
funds rate when appropriate.
• When economic conditions warrant, the Committee’s next step in the process of policy normalization will be to begin raising its target for the federal
funds rate, and from that point on, changing the
level or range of the federal funds rate target will
be the primary means of adjusting the stance of
monetary policy. During the normalization process,
adjustments to the interest rate on excess reserves
and to the level of reserves in the banking system
will be used to bring the funds rate toward its
target.
• Sales of agency securities from the SOMA portfolio will likely commence sometime after the first
increase in the target for the federal funds rate. The
timing and pace of sales will be communicated to
the public in advance; that pace is anticipated to be
relatively gradual and steady, but it could be
adjusted up or down in response to material
changes in the economic outlook or financial
conditions.
• Once sales begin, the pace of sales is expected to be
aimed at eliminating the SOMA’s holdings of
agency securities over a period of three to five
years, thereby minimizing the extent to which the
SOMA portfolio might affect the allocation of
credit across sectors of the economy. Sales at this
pace would be expected to normalize the size of the
SOMA securities portfolio over a period of two to
three years. In particular, the size of the securities
portfolio and the associated quantity of bank
reserves are expected to be reduced to the smallest

Monetary Policy and Economic Developments

levels that would be consistent with the efficient
implementation of monetary policy.
• The Committee is prepared to make adjustments to
its exit strategy if necessary in light of economic
and financial developments.
FOMC Communications
Transparency is an essential principle of modern central banking because it appropriately contributes to
the accountability of central banks to the government and to the public and because it can enhance
the effectiveness of central banks in achieving their
macroeconomic objectives. To this end, the Federal
Reserve provides a considerable amount of information concerning the conduct of monetary policy.
Immediately following each meeting of the FOMC,
the Committee releases a statement that lays out the
rationale for its policy decision, and detailed minutes
of each FOMC meeting are made public three weeks
following the meeting. Lightly edited transcripts of
FOMC meetings are released to the public with a
five-year lag.17
In recent years, the Federal Reserve has taken additional steps to enhance its communications regarding
monetary policy decisions and deliberations. In
November 2010, the FOMC directed a subcommittee, headed by Governor Yellen, to conduct a review
of the Committee’s communications guidelines with
the aim of ensuring that the public is well informed
about monetary policy issues while preserving the
necessary confidentiality of policy discussions until
their scheduled release. In a discussion on external
communications at the January 25–26 FOMC meeting, participants noted the importance of fair and
equal access by the public to information about
future policy decisions. Several participants indicated
that increased clarity of communications was a key
objective, and some referred to the central role of
communications in the monetary policy transmission
process. Discussion focused on how to encourage
dialogue with the public in an appropriate and trans17

FOMC statements, minutes, and transcripts, as well as other
related information, are available on the Federal Reserve
Board’s website at www.federalreserve.gov/monetarypolicy/
fomc.htm.

81

parent manner, and the subcommittee on communications was to consider providing further guidance in
this area.
At the March 15 FOMC meeting, the Committee
endorsed the communications subcommittee’s recommendation that the Chairman conduct regular
press conferences after the four FOMC meetings
each year for which participants provide numerical
projections of several key economic variables. While
those projections are already made public with the
minutes of the relevant FOMC meetings, press conferences were viewed as being helpful in explaining
how the Committee’s monetary policy strategy is
informed by participants’ projections of the rates of
output growth, unemployment, and inflation likely to
prevail during each of the next few years, and by
their assessments of the values of those variables that
would prove most consistent, over the longer run,
with the Committee’s mandate to promote both
maximum employment and stable prices. It was
agreed that the Chairman would begin holding press
conferences effective with the April 26–27, 2011,
FOMC meeting; the second press briefing was held
on June 22 in conjunction with the forecasts that
policymakers submitted at that FOMC meeting.
At its June 21–22 meeting, the Committee followed
up on the discussions from its January meeting about
policies to support effective communication with the
public regarding the outlook for the economy and
monetary policy. The Committee unanimously
approved a set of principles, proposed by the subcommittee on communications, for Committee participants and for the Federal Reserve System staff to
follow in their communications with the public in
order to reinforce the public’s confidence in the
transparency and integrity of the monetary policy
process.18

18

The FOMC policies on external communications of Committee
participants and of the Federal Reserve System staff are available on the Federal Reserve Board’s website at www
.federalreserve.gov/monetarypolicy/files/FOMC_
ExtCommunicationParticipants.pdf and www.federalreserve
.gov/monetarypolicy/files/FOMC_ExtCommunicationStaff.pdf,
respectively.

83

Supervision and Regulation

The Federal Reserve has supervisory and regulatory
authority over a variety of financial institutions and
activities with the goal of promoting a safe, sound,
and stable banking and financial system that supports the growth and stability of the U.S. economy.
As described in this report, the Federal Reserve carries out its supervisory and regulatory responsibilities
and supporting functions primarily by
• promoting the safety and soundness of individual
financial institutions supervised by the Federal
Reserve;
• developing supervisory policy (rulemakings, supervision and regulation letters (SR letters), policy
statements, and guidance);
• identifying requirements and setting priorities for
supervisory information technology initiatives;
• ensuring ongoing staff development to meet evolving supervisory responsibilities;
• regulating the U.S. banking and financial structure
by acting on a variety of proposals; and
• enforcing other laws and regulations.

2011 Developments
During 2011, the U.S. banking system and financial
markets improved further, continuing their recovery
from the financial crisis that started in mid-2007.
Performance of bank holding companies. While a
turnaround in bank holding companies’ (BHCs) performance was evident during 2011, performance
remains weak by historical standards, and the industry recovery could face challenges due to ongoing
and elevated nonperforming asset levels. U.S. BHCs,
in aggregate, reported earnings of $108 billion for
2011, up from $80 billion for the year ending December 31, 2010. Much of this improvement was due to
lower loan loss provisioning and consequent reserve
releases. The proportion of unprofitable BHCs,

although down from 28 percent in 2010, remains high
at 18 percent; unprofitable BHCs encompass roughly
15 percent of banking industry assets. Nonperforming assets present a significant challenge to industry
recovery, with the nonperforming asset ratio remaining high at 4.1 percent of loans and foreclosed assets,
the same percent as in 2010. Weaknesses were broad
based, encompassing residential mortgages (firstlien), commercial real estate—especially non-owner
nonfarm nonresidential and construction other than
single-family—and commercial and industrial (C&I)
loans. In 2011, an additional 172 BHCs that received
funds from the U.S. Department of the Treasury’s
(Treasury) Troubled Asset Relief Program (TARP)
repaid all funds received—120 of these companies
repaid with funds received from the Small Business
Lending Fund (SBLF). At year-end 2011, a total of
332 BHCs and banks that received funds from the
TARP had repaid all funds received, and Treasury
reports that approximately 89 percent of all distributed TARP funds have been repaid. Including
income from dividends, interest and other sources,
Treasury has received $258.44 billion back from bank
support programs, exceeding the $245.10 billion in
funds disbursed.
Although Treasury’s SBLF Program’s authorizing
legislation provided up to $30 billion for investing,
interest in SBLF was lower than anticipated, with
935 financial institutions applying to the program for
a combined funding request of $11.7 billion. About
one-third (320) of the total number of applicants
were seeking to refinance TARP Capital Purchase
Program (CPP) and Community Development Capital Initiative (CDCI) funds. This group of institutions
requested $6.7 billion in funds, which was 57 percent
of the total dollar amount requested. Ultimately, 332
institutions received $4.03 billion in SBLF investments. Treasury approved 137 of the applicants seeking to refinance TARP CPP and CDCI funds, investing a total of $3.3 billion in these institutions. This
represented about 82 percent of all SBLF invest-

84

98th Annual Report | 2011

ments.1 (Also see “Bank Holding Companies” on
page 89.)

cability of the enhanced standards to SLHCs. (See
box 1 for more details.)

Performance of state member banks. Similar to
BHCs, the turnaround at state member banks in 2011
was muted. As a group, state member banks reported
a profit of $11.5 billion for 2011, up from 6.1 billion
for 2010. While earnings were up due largely to lower
provisions ($7.7 billion versus 17.7 billion in 2010),
almost 11 percent of all state member banks continued to report losses. Mirroring trends at BHCs, the
nonperforming assets ratio remained relatively high
at 3.2 percent of loans and foreclosed assets, reflecting both contracting loan balances and ongoing
weaknesses in asset quality. Growth in problem loans
continued to slow during 2011, but weakness encompassed nonfarm nonresidential lending, residential
mortgages, and C&I loans. The number of foreclosed
properties continued to increase, particularly those
associated with construction and land development
and one- to four-family residential lending. The riskbased capital ratios for state member banks improved
during 2011 in the aggregate, and the percent of state
member banks deemed well capitalized under prompt
corrective action standards remained high at 98 percent. In 2011, 12 state member banks with $8.4 billion in assets failed, with losses of $1.7 billion
according to Federal Deposit Insurance Corporation
(FDIC) estimates. (Also see “State Member Banks”
on page 88.)

Capital adequacy standards. In 2011, the Board
issued several rulemakings and guidance documents
related to capital adequacy standards, including joint
proposed rulemakings with the other federal banking
agencies that would implement certain revisions to
the Basel capital framework and that address certain
provisions of the Dodd-Frank Act. These rulemakings included two NPRs to revise the market-risk
capital rules, a final rule that amends the advanced
approaches capital adequacy framework to set minimum capital requirements consistent with section 171
of the Dodd-Frank Act, rules related to the treatment of subordinated debt for certain small banking
organizations, and a final rule requiring U.S. BHCs
with total consolidated assets of $50 billion or more
to submit annual capital plans to the Federal Reserve
for review. (See “Supervisory Policy” on page 96.)

Implementation of enhanced prudential standards of
the Dodd-Frank Act. In December, the Board issued
a notice of proposed rulemaking (NPR) to implement the enhanced prudential standards and early
remediation requirements in sections 165 and 166 of
the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (Dodd-Frank Act). The proposal generally applies to all U.S. BHCs with consolidated assets of $50 billion or more and any nonbank
financial company that may be designated by the
Financial Stability Oversight Council (FSOC) as systemically important. A proposal implementing
enhanced prudential standards for foreign banking
organizations that have $50 billion or more in consolidated assets and a U.S. banking presence will be
issued separately. In general, savings and loan holding companies (SLHCs) would not be subject to the
requirements of this proposal, except certain stress
test requirements, although the Board plans to issue a
separate proposal in the future to address the appli1

The TARP statistics only include those BHCs that did not participate in the Supervisory Capital Assessment Program in 2009.

Supervision of savings and loan holding companies. On
July 21, 2011, responsibility for supervision and regulation of SLHCs transferred from the Office of
Thrift Supervision (OTS) to the Federal Reserve, pursuant to the Dodd-Frank Act.2 (See “Savings and
Loan Holding Companies” on page 90 for details.)
Recovery and resolution planning. The Federal
Reserve is working with other regulatory agencies to
reduce the probability of failure of the largest, most
complex financial firms and to minimize the losses to
the financial system and the economy if such a firm
should fail. (See box 2 for details.)
Actions against mortgage servicers for faulty foreclosure proceedings. In April 2011, the Federal Reserve
announced formal enforcement actions against certain large mortgage servicers to ensure that those servicers addressed deficient practices in residential
mortgage loan servicing and foreclosure processing.
(See box 3 for details.)

Supervision
The Federal Reserve is the federal supervisor and
regulator of all U.S. BHCs, including financial holding companies, and state-chartered commercial banks
that are members of the Federal Reserve System. The
2

Pursuant to the Home Owners’ Loan Act, 12 U.S.C. Section 1461 et. seq., an SLHC is defined as any company that
directly or indirectly controls either a savings association or any
other company that is an SLHC.

Supervision and Regulation

85

Box 1. Enhanced Prudential Standards and Early Remediation Requirements
In December, the Board issued an NPR to implement
the enhanced prudential standards and early remediation requirements in sections 165 and 166 of the
Dodd-Frank Act for large BHCs and systemically
important nonbank financial companies.
The NPR would implement
Risk-based capital and leverage requirements in
two phases. In the first phase, the covered companies would be subject to the Board’s capital plan rule,
which was issued in November 2011. In the second
phase, the Board would issue a proposal to implement a risk-based capital surcharge based on the
framework and methodology developed by the Basel
Committee on Banking Supervision.
Liquidity requirements in multiple phases. First,
covered companies would be subject to qualitative
liquidity risk-management standards generally based
on the interagency liquidity risk-management guidance issued in March 2010. These standards would
require covered companies to conduct internal liquidity stress tests and set internal quantitative limits to
manage liquidity risk. In later phases, the Board
would issue one or more subsequent proposals to
implement quantitative liquidity requirements based
on the Basel III liquidity rules.
Supervisory and company-run stress test requirements. Supervisory stress tests similar to those conducted in recent years would be conducted annually
by the Board. A summary of the results, including
company-specific information, would be made public. In addition, the proposal requires companies to
conduct one or more company-run stress tests each
year and to make a summary of their results public.

Federal Reserve also has responsibility for supervising the operations of all Edge Act and agreement
corporations, the international operations of state
member banks and U.S. BHCs, and the U.S. operations of foreign banking organizations. Furthermore,
through the Dodd-Frank Act, the Federal Reserve
has been assigned responsibilities for nonbank financial firms and financial market utilities (FMUs) designated by the FSOC as systemically important. In
addition, the act transferred authority for consolidated supervision of more than 400 SLHCs and their
non-depository subsidiaries from the OTS to the
Federal Reserve, effective July 21, 2011. In overseeing
the institutions under the Federal Reserve’s authority, the Federal Reserve seeks primarily to promote
safety and soundness, including compliance with laws
and regulations.

Single-counterparty credit limits. The proposal
would limit credit exposure of a covered company to
a single counterparty as a percentage of the covered
company’s regulatory capital. Credit exposure
between the largest covered companies would be
subject to a tighter limit.
Early remediation requirements. The proposal
would implement a framework to address financial
weaknesses promptly. The Board is proposing a
number of triggers for remediation—such as capital
levels, stress test results, and risk-management
weaknesses—calibrated to identify problems at an
early stage. Required actions would vary based on
the severity of the situation, but could include restrictions on growth, capital distributions, and executive compensation, as well as capital raising or asset sales.
Other requirements. The proposal would also implement risk committee requirements and enhanced
risk-management standards for covered companies
and debt-to-equity requirements for companies that
the FSOC determines pose a grave threat to financial
stability and should be subject to a debt-to-equity
limit.
A joint FDIC-Board final rule implementing the resolution plan requirements contained in section 165 of
the Dodd-Frank Act was issued in October (www.gpo
.gov/fdsys/pkg/FR-2011-11-01/pdf/2011-27377.pdf).
The comment period for the NPR ends on April 30,
2012. See press release and notice at www
.federalreserve.gov/newsevents/press/bcreg/
20111220a.htm.

Safety and Soundness
To promote the safety and soundness of financial
institutions, the Federal Reserve conducts on-site
examinations and inspections, conducts off-site surveillance and monitoring, and takes enforcement and
other supervisory actions as necessary. The Federal
Reserve also provides training and technical assistance to foreign supervisors and minority-owned and
de novo depository institutions.
Examinations and Inspections
The Federal Reserve conducts examinations of state
member banks, FMUs, the U.S. branches and agencies of foreign banks, and Edge Act and agreement
corporations. In a process distinct from examinations, it conducts inspections of holding companies

86

98th Annual Report | 2011

Box 2. Recovery and Resolution Planning
Recovery and resolution planning are two separate,
but related, efforts to ensure that the failure of a large
global financial institution does not have serious
adverse effects on the U.S. and the global financial
system. The Federal Reserve, in conjunction with
other U.S. supervisors, has continued to work with
financial institutions to ensure a broad range of
options for de-risking and de-leveraging in crisis.
Large, globally active financial institutions are now
developing the requisite governance and infrastructure to create and maintain recovery and resolution planning processes and to execute relevant strategies.
Recovery Planning
The Federal Reserve has required that the largest
and most globally active U.S. financial institutions
develop recovery plans that describe a menu of
options and actions, excluding any extraordinary official sector assistance, to be taken by management to
maintain the financial institution as a going concern
during situations of extreme stress. These plans were
reviewed in several iterations during 2010 and 2011 by
the Federal Reserve and other U.S. banking supervisors.
Consistent with principles developed by the Financial
Stability Board, these same financial institutions participated in a series of crisis management meetings
with the Federal Reserve, FDIC, Office of the Comptroller of the Currency, and international supervisors
that were intended to consider the specific issues
and impediments to coordinated international action
that may arise in handling severe stress at specific
financial institutions.
Resolution Planning
The Dodd-Frank Act requires large, complex financial
institutions to submit plans for their rapid and orderly
resolution under the Bankruptcy Code in the event of
material financial distress or failure. On November 1,
2011, the Federal Reserve and FDIC jointly issued
rules implementing the resolution plan requirement
for financial institutions that are subject to higher prudential standards (www.gpo.gov/fdsys/pkg/FR-201111-01/html/2011-27377.htm).
In a phased approach based on nonbank asset size,
the first group of financial institutions will submit their

and their nonbank subsidiaries. Whether an examination or an inspection is being conducted, the
review of operations entails
1. an evaluation of the adequacy of governance provided by the board and senior management,
including an assessment of internal policies, procedures, controls, and operations;

plans by July 1, 2012, with two additional groups
submitting plans through December 31, 2013. The
plans will identify/describe
• critical operations (those operations that are
important to financial stability);
• core business lines—that is, business lines that
support the firm’s franchise value;
• material legal entities;
• interconnections and interdependencies;
• the company’s corporate governance structure for
resolution; and
• impediments to resolution and the actions the
financial institution will take to improve its
resolvability.
Plans must also provide explanations as to how and
to what extent affiliated insured depository institutions are protected from risks associated with activities of any of the financial institutions’ nonbank subsidiaries. The plans of foreign banking operations in
the United States must focus on their U.S. operations
along with explanations of how overall resolution
planning for U.S. operations is integrated into their
global contingency planning processes.
The Federal Reserve and the FDIC must review plans
submitted by the financial institutions and may determine that a plan is not credible, or that it would not
facilitate an orderly bankruptcy of the institution.
Financial institutions submitting deficient plans will
be required to resubmit plans with proposed changes
in business operations and corporate structure to
facilitate implementation of the plan. If a financial
institution fails to adopt an acceptable plan, the FDIC
and Federal Reserve may impose additional capital,
leverage, or liquidity requirements on the financial
institution. If suitable plans are not resubmitted within
two years, the Federal Reserve and the FDIC may
place restrictions on growth, activities, or operations
and may require the financial institutions to divest
assets. The Federal Reserve, in close cooperation
with the FDIC, is working with the first group of financial institutions to develop their plans.

2. an assessment of the quality of the riskmanagement and internal control processes in
place to identify, measure, monitor, and control
risks;
3. an assessment of the key financial factors of
capital, asset quality, earnings, and liquidity; and

Supervision and Regulation

Box 3. Actions against Mortgage
Servicers for Faulty Foreclosure
Proceedings
In April 2011, the Federal Reserve issued consent
cease-and-desist orders against certain large mortgage servicers requiring those servicers to implement significant improvements to their mortgage
loan servicing and foreclosure processing practices.
These actions were designed to correct practices
that resulted in servicer errors and to prevent future
abuses in the loan modification and foreclosure
processes. Under the consent orders, each servicer
must, among other things, submit specific plans acceptable to the Federal Reserve that
• ensure there is adequate staff to carry out residential mortgage loan servicing, loss mitigation,
and foreclosure activities;
• strengthen coordination of communications with
borrowers throughout the loss mitigation and
foreclosure processes by providing borrowers a
primary point of contact who has access to current information about loss mitigation and foreclosure activities;
• ensure that foreclosures are not pursued once a
loan modification has been approved, unless repayments under the modified loan are not made;
• establish robust controls and oversight over the
activities of third parties that provide various residential mortgage loan servicing, loss mitigation,
or foreclosure-related support, including local
counsel in foreclosure or bankruptcy proceedings; and
• strengthen programs to ensure compliance with
state and federal laws regarding servicing generally, and foreclosures in particular.
The orders also require the servicers to hire independent consultants to conduct reviews to identify
borrowers who suffered financial injury as a result of
wrongful foreclosure or other identified deficiencies.
The orders require the servicer to provide remediation to such borrowers.
The Federal Reserve also issued consent ceaseand-desist orders against six parent BHCs of
national bank servicers to address deficient practices in the parent companies’ oversight of residential mortgage loan servicing, loan modification, and
foreclosure processes. The orders require the parent companies to implement policies, procedures,
and practices designed to prevent future abuses.
Each institution under an order is required to submit
quarterly reports to the Federal Reserve detailing
the measures it has taken to comply with the
enforcement action and the results of those
measures.
See press release and notice at www.federalreserve
.gov/newsevents/press/enforcement/20110413a
.htm.

87

4. a review for compliance with applicable laws and
regulations.
Table 1 provides information on examinations and
inspections conducted by the Federal Reserve during
the past five years.
The Federal Reserve uses a risk-focused approach to
supervision, with activities directed toward identifying the areas of greatest risk to financial institutions
and assessing the ability of institutions’ management
processes to identify, measure, monitor, and control
those risks. Key aspects of the risk-focused approach
to consolidated supervision of the largest institutions
supervised by the Federal Reserve include
1. developing an understanding of each organization’s legal and operating structure, and its primary strategies, business lines, and riskmanagement and internal control functions;
2. developing and executing a tailored supervisory
plan that outlines the work required to maintain a
comprehensive understanding and assessment of
each institution, incorporating reliance to the fullest extent possible on assessments and information developed by other relevant domestic and
foreign supervisors and functional regulators;
3. maintaining continual supervision of these organizations—including through meetings with the
organization’s management and analysis of internal and external information—so that the Federal
Reserve’s understanding and assessment of each
organization’s condition remains current;
4. assigning to each organization a supervisory team
composed of Reserve Bank staff who have skills
appropriate for the organization’s risk profile; and
5. promoting Systemwide and interagency
information-sharing through automated systems
and other mechanisms.
To strengthen its supervision of the largest, most
complex financial institutions, the Federal Reserve
has created a centralized multidisciplinary body
called the Large Institution Supervision Coordinating Committee (LISCC) to oversee the supervision of
these companies. The committee uses horizontal
evaluations to monitor interconnectedness and common practices among companies that could lead to
greater systemic risk. The committee also uses additional and improved quantitative methods for evaluating the financial condition of companies and the

88

98th Annual Report | 2011

Table 1. State member banks and bank holding companies, 2007–2011
Entity/item
State member banks
Total number
Total assets (billions of dollars)
Number of examinations
By Federal Reserve System
By state banking agency
Top-tier bank holding companies
Large (assets of more than $1 billion)
Total number
Total assets (billions of dollars)
Number of inspections
By Federal Reserve System1
On site
Off site
By state banking agency
Small (assets of $1 billion or less)
Total number
Total assets (billions of dollars)
Number of inspections
By Federal Reserve System
On site
Off site
By state banking agency
Financial holding companies
Domestic
Foreign
1

2011

2010

2009

2008

2007

828
1,891
809
507
302

829
1,697
912
722
190

845
1,690
850
655
195

862
1,854
717
486
231

878
1,519
694
479
215

491
16,443
672
642
461
181
30

482
15,986
677
654
491
163
23

488
15,744
658
640
501
139
18

485
14,138
519
500
445
55
19

459
13,281
492
476
438
38
16

4,251
982
3,306
3,160
163
2,997
146

4,362
991
3,340
3,199
167
3,032
141

4,486
1,018
3,264
3,109
169
2,940
155

4,545
1,008
3,192
3,048
107
2,941
144

4,611
974
3,186
3,007
120
2,887
179

417
40

430
43

479
46

557
45

597
43

For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews.

risks they might pose to each other and to the
broader financial system. The supervisory framework
applicable to the LISCC portfolio, other BHCs with
assets of $50 billion or more, and nonbank financial
firms designated by the FSOC for supervision by the
Board will continue to evolve in coming years to
reflect the recently issued rules for capital planning
and resolution plans (see boxes 2 and 4). In addition,
rules and guidance on enhanced prudential standards
to increase regulatory requirements and expectations
for each of these companies in line with their systemic footprints will be issued.
For other sized financial institutions, the risk-focused
consolidated supervision program provides that
examination and inspection procedures should be tailored to each organization’s size, complexity, risk
profile, and condition. The supervisory program for
an institution, regardless of its asset size, entails both
off-site and on-site work, including development of
supervisory plans, pre-examination visits, detailed
documentation, and preparation of examination

reports tailored to the scope and findings of the
examination.
State Member Banks

At the end of 2011, 2,120 banks (excluding nondepository trust companies and private banks) were
members of the Federal Reserve System, of which
828 were state chartered. Federal Reserve System
member banks operated 58,211 branches, and
accounted for 34 percent of all commercial banks in
the United States and for 71 percent of all commercial banking offices. State-charted commercial banks
that are members of the Federal Reserve, commonly
referred to as state member banks, represented
approximately 13 percent of all insured U.S. commercial banks and held approximately 15 percent of all
insured commercial bank assets in the United States.
Under section 10 of the Federal Deposit Insurance
Act, as amended by section 111 of the Federal
Deposit Insurance Corporation Improvement Act of
1991 and by the Riegle Community Development

Supervision and Regulation

89

Box 4. Capital Planning and Stress Testing
Since the onset of the financial crisis, the Board has
led a series of initiatives to strengthen the capital
positions of large, complex banking organizations,
including working with the firms to bolster their internal processes for assessing capital needs and
enhancing the Board’s supervisory practices for
assessing capital adequacy. These efforts culminated
in a supervisory review of capital plans of 19 banking
organizations in the first quarter of 2011, including
any plans they had for increasing dividends or buying
back stock, a process officially known as the Comprehensive Capital Analysis and Review (CCAR). The
CCAR process is a formal part of the Board’s annual
assessment of all banking organizations with assets
of $50 billion or more, and the requirement to submit
annual capital plans to the Board has been codified
by the issuance of the capital plan rule, as discussed
further below.
A key objective of the annual CCAR exercise is to
ensure that firms’ capital planning processes are sufficiently comprehensive and forward-looking. Part of
this process is the use of internal stress testing to
assess whether firms would have sufficient capital to
withstand a significant decline in revenues and
potentially large losses so that they would be able to
continue functioning as sources of credit and providers of other financial services, even in the event of a
worse-than-anticipated weakening of the economy.
Supervisory evaluations of individual firms’ capital
plans and the analysis supporting them are conducted simultaneously across all participating firms,
allowing the process to be informed by a comparative analysis across the firms and to capture a large
share of domestic U.S. banking system assets and
activities.
This supervisory review of capital planning processes
was formalized in November 2011, as the Board
issued a final rule requiring top-tier U.S. BHCs with
total consolidated assets of $50 billion or more to
submit annual capital plans for review (the capital
plans rule). Under this rule, the Federal Reserve will
annually evaluate institutions’ capital adequacy, internal capital adequacy processes, and plans to make
capital distributions, such as dividend payments or

and Regulatory Improvement Act of 1994, the Federal Reserve must conduct a full-scope, on-site examination of state member banks at least once a year,3
although certain well-capitalized, well-managed organizations having total assets of less than $500 million
may be examined once every 18 months.4 The Fed3

4

The Office of the Comptroller of the Currency examines nationally chartered banks, and the FDIC examines state-chartered
banks that are not members of the Federal Reserve.
The Financial Services Regulatory Relief Act of 2006, which
became effective in October 2006, authorized the federal bank-

stock repurchases. In addition, the Board’s assessment of these practices and of the firms’ capital
adequacy is supported by supervisory stress testing
carried out by the Board in association with the CCAR.
The organizations covered by the capital plan rule are
required to make their projections using scenarios
provided by the Board and at least one stress scenario developed by the firm itself, appropriate to its
business model and portfolios. The rule also requires
a firm to support its analysis of sources and uses of
capital over the planning period. In the annual CCAR
review, the Board assesses a firm’s ability to effectively identify, measure, and assess its risks; its methodologies for estimating firm-wide losses and revenues under stress scenarios; and its analysis for
determining the impact of a stressed operating environment on capital adequacy. And, consistent with
CCAR, the rule requires firms to develop comprehensive capital policies to govern their capital planning,
capital issuance, usage, and distribution.
The capital plan rule relates to certain requirements
for large organizations in the Dodd-Frank Act, particularly the stress testing standards. As the Board
implements these stress testing requirements, it is
expected that firms subject to the capital plan rule
would use their Dodd-Frank Act–required stress test
results to help meet the stress testing requirements
of the capital plans rule. Thus, results of firms’ stress
testing requirements in the Dodd-Frank Act will be an
integral component of firms’ capital plans as they
evaluate possible capital needs and resources under
stress scenarios. Additionally, the Dodd-Frank Act
requires supervisors to conduct independent supervisory stress tests. As part of CCAR, the Board has further developed its ability to make independent supervisory estimates of firms’ potential future losses and
revenues, which is a key tool in the evaluation of
stress testing performed by firms as part of their
capital plans and a key component of our supervisory assessments of capital adequacy. It is expected
that the supervisory tests required under Dodd-Frank
will be an integral part of supervisory stress testing
for CCAR. (Also see “Capital Adequacy Standards”
on page 96.)

eral Reserve conducted 507 exams of state member
banks in 2011.
Bank Holding Companies

At year-end 2011, a total of 5,341 U.S. BHCs were in
operation, of which 4,742 were top-tier BHCs. These
organizations controlled 5,247 insured commercial

ing agencies to raise the threshold from $250 million to
$500 million, and final rules incorporating the change into existing regulations were issued on September 21, 2007.

90

98th Annual Report | 2011

banks and held approximately 99 percent of all
insured commercial bank assets in the United States.
Federal Reserve guidelines call for annual inspections
of large BHCs and complex smaller companies. In
judging the financial condition of the subsidiary
banks owned by holding companies, Federal Reserve
examiners consult examination reports prepared by
the federal and state banking authorities that have
primary responsibility for the supervision of those
banks, thereby minimizing duplication of effort and
reducing the supervisory burden on banking
organizations.
Inspections of BHCs, including financial holding
companies, are built around a rating system introduced in 2005. The system reflects the shift in supervisory practices away from a historical analysis of
financial condition toward a more dynamic, forwardlooking assessment of risk-management practices
and financial factors. Under the system, known as
RFI but more fully termed RFI/C(D), holding companies are assigned a composite rating (C) that is
based on assessments of three components: Risk
Management (R), Financial Condition (F), and the
potential Impact (I) of the parent company and its
nondepository subsidiaries on the subsidiary depository institution. The fourth component, Depository
Institution (D), is intended to mirror the primary
supervisor’s rating of the subsidiary depository institution.5 Noncomplex BHCs with consolidated assets
of $1 billion or less are subject to a special supervisory program that permits a more flexible approach.6
In 2011, the Federal Reserve conducted 642 inspections of large BHCs and 3,160 inspections of small,
noncomplex BHCs.
Financial Holding Companies

Under the Gramm-Leach-Bliley Act, BHCs that
meet certain capital, managerial, and other requirements may elect to become financial holding companies and thereby engage in a wider range of financial
activities, including full-scope securities underwriting, merchant banking, and insurance underwriting
5

6

Each of the first two components has four subcomponents: Risk
Management— (1) Board and Senior Management Oversight;
(2) Policies, Procedures, and Limits; (3) Risk Monitoring and
Management Information Systems; and (4) Internal Controls.
Financial Condition— (1) Capital, (2) Asset Quality, (3) Earnings, and (4) Liquidity.
The special supervisory program was implemented in 1997 and
modified in 2002. See SR letter 02-01 for a discussion of the factors considered in determining whether a BHC is complex or
noncomplex (www.federalreserve.gov/boarddocs/srletters/2002/
sr0201.htm).

and sales. As of year-end 2011, 417 domestic BHCs
and 40 foreign banking organizations had financial
holding company status. Of the domestic financial
holding companies, 36 had consolidated assets of
$15 billion or more; 108, between $1 billion and
$15 billion; 59, between $500 million and $1 billion;
and 214, less than $500 million.
Savings and Loan Holding Companies

On July 21, 2011, responsibility for supervision and
regulation of SLHCs transferred from the OTS to
the Federal Reserve, pursuant to the Dodd-Frank
Act. As of the transfer date, 427 top tier SLHCs with
estimated total consolidated assets of $4.4 trillion
transferred to the Federal Reserve. These SLHCs
included more than 50 companies engaged primarily
in nonbanking activities, such as insurance underwriting (approximately 26 SLHCs), commercial
activities (approximately 20 SLHCs), and securities
brokerage (10 SLHCs). The 25 largest SLHCs
accounted for more than $3.9 trillion of total consolidated assets; however, the savings association subsidiaries of these companies accounted for just
$384 billion of total consolidated assets. Only three
institutions in the top 25 and approximately 86 percent of the total SLHCs (370 firms) were engaged
primarily in depository activities. These firms, however, held only 19 percent ($839 billion) of the total
consolidated assets of all SLHCs. The Office of the
Comptroller of the Currency (OCC) is the primary
regulator for most of the subsidiary savings associations of the firms engaged primarily in depository
activities.
The transfer of SLHC supervision to the Federal
Reserve precipitated legislative, supervisory, and
policy changes. The Dodd-Frank Act requires the
Board to issue specific rulemakings—such as rules to
establish consolidated capital standards, evaluate the
potential for creating intermediate holding companies to facilitate supervision of SLHCs that are primarily engaged in commercial activities, and assess
supervisory fees for the largest companies. Other
rulemakings are prompted by operational and practical considerations, such as rules regarding regulatory
reports and guidance regarding the supervisory
approach for SLHCs. Guidance and rulemakings
issued include the following:
• SR letter 11-11, “Supervision of Savings and Loan
Holding Companies” (July 21, 2011), describes the
supervisory approach to be used for the first cycle
of supervision of SLHCs (www.federalreserve.gov/
bankinforeg/srletters/sr1111.htm).

Supervision and Regulation

• Two interim final rules: (1) “Savings and Loan
Holding Companies,” Regulation LL, sets forth the
regulations governing SLHCs; and (2) “Mutual
Holding Companies,” Regulation MM, sets forth
the regulations governing SLHCs organized in
mutual form. See press release (August 12, 2011) at
www.federalreserve.gov/newsevents/press/bcreg/
20110812a.htm.
• Final notice to require most SLHCs to file Federal
Reserve regulatory reports with the Board, along
with an exemption for some SLHCs from initially
filing existing regulatory reports. See press release
(December 23, 2011) at www.federalreserve.gov/
newsevents/press/bcreg/20111223a.htm.
In addition to the regulatory and supervisory guidance issued on SLHCs,7 Board staff continues to
work on operational, technical, and practical transition issues while engaging the industry, Reserve
Banks, and other financial regulatory agencies. Board
staff has also issued internal policies and procedures,
presented training sessions, conducted bi-weekly conference calls, and developed job aids to enhance the
understanding of the SLHC population and to
ensure consistent supervisory treatment of these
institutions throughout the Federal Reserve System.
A dedicated SLHC section has been staffed and is
working to continue the supervisory and policy oversight of the SLHCs.
Although significant milestones have been achieved,
several complex policy issues still need to be
addressed by the Board, including those related to
consolidated capital requirements, intermediate holding companies, and the determination of the applicability of enhanced prudential standards to the SLHC
population.
Financial Market Utilities

FMUs manage or operate multilateral systems for
the purpose of transferring, clearing, or settling payments, securities, or other financial transactions
among financial institutions or between financial
institutions and the FMU. Under the Federal
Reserve Act, the Board supervises FMUs that are
chartered as member banks or Edge Act corporations and cooperates with other federal banking
7

See also SR-11-13 (7-25-11) “Guidance Regarding Prior Notices
with respect to Dividend Declarations by Savings Association
Subsidiaries of Savings and Loan Holding Companies” (www
.federalreserve.gov/bankinforeg/srletters/sr1113.htm) and SR
11-12 (7-21-11) “Deregistration Procedures for Certain Savings
and Loan Holding Companies” (www.federalreserve.gov/
bankinforeg/srletters/sr1112.htm).

91

supervisors to supervise FMUs organized as bank
service providers under the Bank Service Company
Act. In its supervision of these FMUs, the Board is
also guided by the risk-management standards and
expectations contained in its “Policy on Payments
System Risk.”8
Under title VIII of the Dodd-Frank Act, the Board
has an expanded set of responsibilities related to
FMUs designated by the FSOC as systemically
important, including promoting uniform riskmanagement standards, playing an enhanced role in
the supervision of FMUs, reducing systemic risk,
and supporting the stability of the broader financial
system.
The Board’s risk-based supervision program for
FMUs is administered by the FMU Supervision
Committee (FMU-SC). The FMU-SC is a multidisciplinary committee of senior supervision, payment policy, and legal staff at the Board and Reserve
Banks who are responsible for and knowledgeable
about supervisory issues for FMUs. The FMU-SC’s
primary objective is to provide senior-level oversight,
consistency, and direction to the Federal Reserve’s
supervisory process for FMUs. The FMU-SC coordinates with the LISCC on issues related to large financial institutions’ roles in FMUs; FMUs’ activities
and implications for large financial institutions; and
the payment, clearing, and settlement activities of
large financial institutions more generally.
In an effort to promote greater financial market stability and mitigate systemic risk, the Board also is
working with the U.S. Securities and Exchange Commission (SEC) and the U.S. Commodity Futures
Trading Commission, which also have supervisory
authority for certain FMUs. The Federal Reserve’s
work with these agencies, including the planned sharing of appropriate information, aims to improve consistency in FMU supervision, promote robust FMU
risk management, and improve the regulators’ ability
to monitor and mitigate systemic risk.
International Activities

The Federal Reserve supervises the foreign branches
and overseas investments of member banks, Edge
Act and agreement corporations, and BHCs (including the investments by BHCs in export trading companies). In addition, it supervises the activities that
foreign banking organizations conduct through enti8

www.federalreserve.gov/paymentsystems/psr_about.htm.

92

98th Annual Report | 2011

ties in the United States, including branches, agencies, representative offices, and subsidiaries.
Foreign operations of U.S. banking organizations. In
supervising the international operations of state
member banks, Edge Act and agreement corporations, and BHCs, the Federal Reserve generally conducts its examinations or inspections at the U.S. head
offices of these organizations, where the ultimate
responsibility for the foreign offices lies. Examiners
also visit the overseas offices of U.S. banks to obtain
financial and operating information and, in some
instances, to test their adherence to safe and sound
banking practices and compliance with rules and
regulations or to evaluate an organization’s efforts to
implement corrective measures. Examinations abroad
are conducted with the cooperation of the supervisory authorities of the countries in which they take
place; for national banks, the examinations are coordinated with the OCC. At the end of 2011, 46 member banks were operating 533 branches in foreign
countries and overseas areas of the United States; 25
national banks were operating 475 of these branches;
and 21 state member banks were operating the
remaining 58. In addition, 17 nonmember banks
were operating 25 branches in foreign countries and
overseas areas of the United States.
Edge Act and agreement corporations. Edge Act corporations are international banking organizations
chartered by the Board to provide all segments of the
U.S. economy with a means of financing international business, especially exports. Agreement corporations are similar organizations, state chartered or
federally chartered, that enter into agreements with
the Board to refrain from exercising any power that is
not permissible for an Edge Act corporation. Sections 25 and 25A of the Federal Reserve Act grant
Edge Act and agreement corporations permission to
engage in international banking and foreign financial
transactions. These corporations, most of which are
subsidiaries of member banks, may (1) conduct a
deposit and loan business in states other than that of
the parent, provided that the business is strictly
related to international transactions and (2) make
foreign investments that are broader than those permissible for member banks. At year-end 2011, 48
banking organizations, operating eight branches,
were chartered as Edge Act or agreement corporations. These corporations are examined annually.
U.S. activities of foreign banks. The Federal Reserve
has broad authority to supervise and regulate the
U.S. activities of foreign banks that engage in bank-

ing and related activities in the United States through
branches, agencies, representative offices, commercial
lending companies, Edge Act corporations, commercial banks, BHCs, and certain nonbanking
companies.
Foreign banks continue to be significant participants
in the U.S. banking system. As of year-end 2011, 173
foreign banks from 51 countries operated 205 statelicensed branches and agencies, of which six were
insured by the FDIC, and 47 OCC-licensed branches
and agencies, of which four were insured by the
FDIC. These foreign banks also owned nine Edge
Act and agreement corporations and one commercial
lending company. In addition, they held a controlling
interest in 53 U.S. commercial banks. Altogether, the
U.S. offices of these foreign banks at the end of 2011
controlled approximately 20 percent of U.S. commercial banking assets. These 173 foreign banks also
operated 82 representative offices; an additional 44
foreign banks operated in the United States through
a representative office only.
The Federal Reserve—in coordination with appropriate state regulatory authorities—examines statelicensed, non-FDIC insured branches and agencies of
foreign banks on-site at least once every 18 months.9
In most cases, on-site examinations are conducted at
least once every 12 months, but the period may be
extended to 18 months if the branch or agency meets
certain criteria. As part of the supervisory process, a
review of the financial and operational profile of
each organization is conducted to assess the organization’s ability to support its U.S. operations and to
determine what risks, if any, the organization poses
to the banking system through its U.S. operations.
The Federal Reserve conducted or participated with
state regulatory authorities in 379 examinations in
2011.
Compliance with Regulatory Requirements
The Federal Reserve examines institutions for compliance with a broad range of legal requirements,
including anti-money-laundering (AML) and consumer protection laws and regulations, and other
laws pertaining to certain banking and financial
activities. Most compliance supervision is conducted
under the oversight of the Board’s Division of Banking Supervision and Regulation, but consumer compliance supervision is conducted under the oversight
9

The OCC examines federally licensed branches and agencies,
and the FDIC examines state-licensed FDIC-insured branches
in coordination with the appropriate state regulatory authority.

Supervision and Regulation

93

of the Division of Consumer and Community
Affairs. The two divisions coordinate their efforts
with each other and also with the Board’s Legal Division to ensure consistent and comprehensive Federal
Reserve supervision for compliance with legal
requirements.

technology risk-management activities. During 2011,
the Federal Reserve continued as the lead supervisory
agency for three of the 16 large, multiregional data
processing servicers recognized on an interagency
basis and assumed leadership of two more of the
large servicers.

Anti-Money-Laundering Examinations

Fiduciary Activities

The Treasury regulations implementing the Bank
Secrecy Act (BSA) generally require banks and other
types of financial institutions to file certain reports
and maintain certain records that are useful in criminal, tax, or regulatory proceedings. The BSA and
separate Board regulations require banking organizations supervised by the Board to file reports on suspicious activity related to possible violations of federal
law, including money laundering, terrorism financing, and other financial crimes. In addition, BSA and
Board regulations require that banks develop written
BSA compliance programs and that the programs be
formally approved by bank boards of directors. The
Federal Reserve is responsible for examining institutions for compliance with applicable AML laws and
regulations and conducts such examinations in accordance with the Federal Financial Institutions Examination Council (FFIEC) Bank Secrecy Act/AntiMoney Laundering Examination Manual.10

The Federal Reserve has supervisory responsibility
for state member banks and state member nondepository trust companies that reported $53.9 trillion
and $39.5 trillion of assets, respectively, as of yearend 2011. These assets were held in various fiduciary
and custodial capacities. On-site examinations of
fiduciary and custodial activities are risk-focused and
entail the review of an organization’s compliance
with laws, regulations, and general fiduciary principles, including effective management of conflicts of
interest; management of legal, operational, and reputational risk exposures; and audit and control procedures. In 2011, Federal Reserve examiners conducted
140 on-site fiduciary examinations, excluding transfer
agent examinations, of state member banks.

Specialized Examinations
The Federal Reserve conducts specialized examinations of supervised financial institutions in the areas
of information technology, fiduciary activities, transfer agent activities, and government and municipal
securities dealing and brokering. The Federal Reserve
also conducts specialized examinations of certain
nonbank entities that extend credit subject to the
Board’s margin regulations.
Information Technology Activities

In recognition of the importance of information
technology to safe and sound operations in the financial industry, the Federal Reserve reviews the information technology activities of supervised financial
institutions, as well as certain independent data centers that provide information technology services to
these organizations. All safety-and-soundness examinations include a risk-focused review of information
10

The FFIEC is an interagency body of financial regulatory agencies established to prescribe uniform principles, standards, and
report forms and to promote uniformity in the supervision of
financial institutions. The Council has six voting members: the
Board of Governors of the Federal Reserve System, the FDIC,
the National Credit Union Administration, the OCC, the Consumer Financial Protection Bureau, and the chair of the State
Liaison Committee.

Transfer Agents

As directed by the Securities Exchange Act of 1934,
the Federal Reserve conducts specialized examinations of those state member banks and BHCs that
are registered with the Board as transfer agents.
Among other things, transfer agents countersign and
monitor the issuance of securities, register the transfer of securities, and exchange or convert securities.
On-site examinations focus on the effectiveness of an
organization’s operations and its compliance with
relevant securities regulations. During 2011, the Federal Reserve conducted on-site transfer agent examinations at 11 of the 32 state member banks and
BHCs that were registered as transfer agents.
Government and Municipal Securities
Dealers and Brokers

The Federal Reserve is responsible for examining
state member banks and foreign banks for compliance with the Government Securities Act of 1986
and with the Treasury regulations governing dealing
and brokering in government securities. Thirteen
state member banks and six state branches of foreign
banks have notified the Board that they are government securities dealers or brokers not exempt from
the Treasury’s regulations. During 2011, the Federal
Reserve conducted three examinations of broker–
dealer activities in government securities at these
organizations. These examinations are generally con-

94

98th Annual Report | 2011

ducted concurrently with the Federal Reserve’s
examination of the state member bank or branch.
The Federal Reserve is also responsible for ensuring
that state member banks and BHCs that act as
municipal securities dealers comply with the Securities Act Amendments of 1975. Municipal securities
dealers are examined, pursuant to the Municipal
Securities Rulemaking Board’s rule G-16, at least
once every two calendar years. Three of the 11 entities supervised by the Federal Reserve that dealt in
municipal securities were examined during 2011.
Securities Credit Lenders

Under the Securities Exchange Act of 1934, the
Board is responsible for regulating credit in certain
transactions involving the purchasing or carrying of
securities. As part of its general examination program, the Federal Reserve examines the banks under
its jurisdiction for compliance with Board Regulation U (Credit by Banks and Persons other than Brokers or Dealers for the Purpose of Purchasing or
Carrying Margin Stock). In addition, the Federal
Reserve maintains a registry of persons other than
banks, brokers, and dealers who extend credit subject
to Regulation U. The Federal Reserve may conduct
specialized examinations of these lenders if they are
not already subject to supervision by the Farm Credit
Administration or the National Credit Union
Administration (NCUA).
At the end of 2011, 533 lenders other than banks,
brokers, or dealers were registered with the Federal
Reserve. Other federal regulators supervised 171 of
these lenders, and the remaining 362 were subject to
limited Federal Reserve supervision. The Federal
Reserve exempted 151 lenders from its on-site inspection program on the basis of their regulatory status
and annual reports. Twenty-one inspections were
conducted during the year.
Enforcement Actions
The Federal Reserve has enforcement authority over
the financial institutions it supervises and their affiliated parties. Enforcement actions may be taken to
address unsafe and unsound practices or violations
of any law or regulation. Formal enforcement actions
include cease-and-desist orders, written agreements,
prompt corrective action directives, removal and prohibition orders, and civil money penalties. In 2011,
the Federal Reserve completed 143 formal enforcement actions. Civil money penalties totaling
$85,279,700 were assessed. As directed by statute, all
civil money penalties are remitted to either the Treas-

ury or the Federal Emergency Management Agency.
Enforcement orders and prompt corrective action
directives, which are issued by the Board, and written
agreements, which are executed by the Reserve
Banks, are made public and are posted on the
Board’s website (www.federalreserve.gov/apps/
enforcementactions/).
In addition to taking these formal enforcement
actions, the Reserve Banks completed 353 informal
enforcement actions in 2011. Informal enforcement
actions include memoranda of understanding
(MOU) and board of directors resolutions. Information about these actions is not available to the public.
Surveillance and Off-Site Monitoring
The Federal Reserve uses automated screening systems to monitor the financial condition and performance of state member banks and BHCs in the
period between on-site examinations. Such monitoring and analysis helps direct examination resources to
institutions that have higher-risk profiles. Screening
systems also assist in the planning of examinations
by identifying companies that are engaging in new or
complex activities.
The primary off-site monitoring tool used by the
Federal Reserve is the Supervision and Regulation Statistical Assessment of Bank Risk model (SRSABR). Drawing mainly on the financial data that
banks report on their Reports of Condition and
Income (Call Reports), SR-SABR uses econometric
techniques to identify banks that report financial
characteristics weaker than those of other banks
assigned similar supervisory ratings. To supplement
the SR-SABR screening, the Federal Reserve also
monitors various market data, including equity
prices, debt spreads, agency ratings, and measures of
expected default frequency, to gauge market perceptions of the risk in banking organizations. In addition, the Federal Reserve prepares quarterly Bank
Holding Company Performance Reports (BHCPRs)
for use in monitoring and inspecting supervised
banking organizations. The BHCPRs, which are
compiled from data provided by large BHCs in quarterly regulatory reports (FR Y-9C and FR Y-9LP),
contain, for individual companies, financial statistics
and comparisons with peer companies. BHCPRs are
made available to the public on the National Information Center (NIC) website, which can be accessed
at www.ffiec.gov.
Federal Reserve analysts use Performance Report
Information and Surveillance Monitoring (PRISM),

Supervision and Regulation

a querying tool, to access and display financial, surveillance, and examination data. In the analytical
module, users can customize the presentation of
institutional financial information drawn from Call
Reports, Uniform Bank Performance Reports, FR
Y-9 statements, BHCPRs, and other regulatory
reports. In the surveillance module, users can generate reports summarizing the results of surveillance
screening for banks and BHCs. During 2011, four
major upgrades to the web-based PRISM application
were completed.
The Federal Reserve works through the FFIEC Task
Force on Surveillance Systems to coordinate surveillance activities with the other federal banking
agencies.
Training and Technical Assistance
The Federal Reserve provides training and technical
assistance to foreign supervisors and minority-owned
and de novo depository institutions.
International Training and Technical Assistance

In 2011, the Federal Reserve continued to provide
technical assistance on bank supervisory matters to
foreign central banks and supervisory authorities.
Technical assistance involves visits by Federal
Reserve staff members to foreign authorities as well
as consultations with foreign supervisors who visit
the Board or the Reserve Banks. The Federal
Reserve, along with the OCC, the FDIC, and the
Treasury, was an active participant in the Middle
East and North Africa Financial Regulators’ Training Initiative, which is part of the U.S. government’s
Middle East Partnership Initiative. The Federal
Reserve also contributes to the regional training provision under the Asia Pacific Economic Cooperation
Financial Regulators’ Training Initiative.
In 2011, the Federal Reserve offered a number of
training courses exclusively for foreign supervisory
authorities, both in the United States and in a number of foreign jurisdictions. Federal Reserve staff also
took part in technical assistance and training missions led by the International Monetary Fund, the
World Bank, the Asian Development Bank, the Basel
Committee on Banking Supervision, and the Financial Stability Institute.
The Federal Reserve is also an associate member of
the Association of Supervisors of Banks of the
Americas (ASBA), an umbrella group of bank super-

95

visors from countries in the Western Hemisphere.
The group, headquartered in Mexico,
• promotes communication and cooperation among
bank supervisors in the region;
• coordinates training programs throughout the
region with the help of national banking supervisors and international agencies; and
• aims to help members develop banking laws, regulations, and supervisory practices that conform to
international best practices.
The Federal Reserve contributes significantly to
ASBA’s organizational management and to its training and technical assistance activities.
Initiatives for Minority-Owned and
De Novo Depository Institutions

The Partnership for Progress program is a Federal
Reserve System program created to preserve and promote minority-owned, woman-owned, and de novo
depository institutions (MDIs). Launched in 2008,
the program seeks to help these institutions compete
effectively in today’s marketplace by offering MDIs a
combination of one-on-one assistance and targeted
workshops on topics of particular relevance in terms
of starting and growing a bank in a safe and sound
manner. In addition, training and information on
resources are provided through an extensive public
website (www.fedpartnership.gov).
Designated Partnership for Progress coordinators
serve as local program contacts in each of the 12
Reserve Bank Districts and the Board of Governors
to answer questions and coordinate assistance for
institutions requesting guidance.
During 2011, the banking industry continued to face
significant challenges. MDIs faced increasing marketplace challenges, as many operated in some of the
hardest-hit regions and were adversely impacted by
the recession and sluggish economic recovery. The
economic crisis has significantly impacted a large
number of MDIs primarily due to high unemployment, weak credit demand, capital deficiencies, and
increasing regulatory costs.
In an effort to strengthen the Partnership for Progress program and address the provisions of section 367 of the Dodd-Frank Act, enhancements to
the program were made, including

96

98th Annual Report | 2011

• initiation of an interagency task force to focus on
challenges raised by minority bankers;
• a review of the effectiveness of the methods currently used to promote and preserve minority
banks;
• informational sessions for district coordinators to
discuss the conditions of minority banks, on topics
such as capital investment, asset quality, troubled
asset management, and the impact of bank
failures;
• transition of the program management function to
a senior supervision staff member; and
• development of website enhancements that will
operate as an electronic resource center for MDIs.
This site is expected to be launched in 2012.
Throughout the year, the Federal Reserve Banks
hosted conference calls and meetings with key minority bankers, community leaders, academia leaders,
the National Bankers Association (NBA), the
National Urban League in Philadelphia, the Small
Business Administration in Philadelphia, and other
national partners in order to help coordinate methods and strategies for preserving and promoting
MDIs and the communities they serve.
In 2011, the Federal Reserve Banks hosted/
participated in a variety of workshops and seminars,
including
• a conference on Small Business and Entrepreneurs
and the Impact of the Economic Crisis;
• a presentation on MDI conditions at the NBA
Convention in Dallas;
• an outreach effort with investment firms interested
in providing capital to MDIs;
• a Supplier Diversity Forum and a reception for
small businesses and entrepreneurs— in partnership with the National Urban League—focusing on
Doing Business with Large Businesses; and
• the FDIC MDI Roundtable in Los Angeles, held in
collaboration with the National Association of
Chinese American Bankers, on the topic of “Risk
Management.”
The results of these efforts collectively are expected
to further our initiative to comply with section 367 of
the Dodd-Frank Act in a very challenging environment for the banking industry in general and MDIs
in particular.

Business Continuity
In 2011, the Federal Reserve continued its efforts to
strengthen the resilience of the U.S. financial system
in the event of unexpected disruptions, including
focused supervisory efforts to evaluate the resiliency
of the banking institutions under its jurisdiction. The
Federal Reserve, together with other federal and state
financial regulators, is a member of the Financial
Banking Information Infrastructure Committee
(FBIIC), which was formed to improve coordination
and communication among financial regulators,
enhance the resiliency of the financial sector, and
promote the public/private partnership. The FBIIC
has established emergency communication protocols
to maintain effective communication among members in the event of an emergency. The members of
the FBIIC will convene by conference call no later
than 90 minutes following the first public report of
an event to share situational and operational status
reports. As a member of FBIIC, the Federal Reserve
is then responsible for establishing and maintaining
communication with the institutions for which it has
primary supervisory authority and for ensuring coordination between public affairs and media relations
staff.

Supervisory Policy
The Federal Reserve’s supervisory policy function,
carried out by the Board, is responsible for developing regulations and guidance for financial institutions
under the Federal Reserve’s supervision, as well as
guidance for examiners. The Board, often working
together with the other federal banking agencies,
issues rulemakings, public SR letters, and other
policy statements and guidance in order to carry out
its supervisory policy function. Federal Reserve staff
also take part in supervisory and regulatory forums,
provide support for the work of the FFIEC, and participate in international policymaking forums, including the Basel Committee on Banking Supervision,
the Financial Stability Board, and the Joint Forum.
Capital Adequacy Standards
In 2011, the Board issued several rulemakings and
guidance documents related to capital adequacy standards, including joint proposed rulemakings with the
other federal banking agencies that would implement
certain revisions to the Basel capital framework and
that address certain provisions of the Dodd-Frank
Act.
• In January, the federal banking agencies issued for
comment an NPR to revise their market-risk capi-

Supervision and Regulation

tal rules. These proposed revisions would implement a number of changes to the Basel Accord
intended to (1) better capture positions for which
the market-risk capital rules are appropriate,
(2) reduce procyclicality in market-risk capital
requirements, (3) enhance the rules’ sensitivity to
risks that are not adequately captured by the current regulatory measurement methodologies, and
(4) increase market discipline through enhanced
disclosures. The NPR is available at www.gpo.gov/
fdsys/pkg/FR-2011-01-11/pdf/2010-32189.pdf.
• The federal banking agencies issued a subsequent
NPR in December that amended the January
market-risk NPR by proposing to replace methodologies for calculating specific risk-capital requirements that relied on credit ratings with alternative
methods for evaluating creditworthiness, as
required by section 939A of the Dodd-Frank Act.
The NPR is available at www.gpo.gov/fdsys/pkg/
FR-2011-12-21/pdf/2011-32073.pdf.
• The federal banking agencies published a final rule
in June that amends the advanced approaches capital adequacy framework, consistent with section 171 of the Dodd-Frank Act. The rule requires
a banking organization operating under the
advanced approaches framework to meet, on an
ongoing basis, the higher of the minimum riskbased requirements under the general risk-based
capital rules and the minimum requirements under
the advanced approaches risk-based capital rules.
The rule is available at www.gpo.gov/fdsys/pkg/FR2011-06-28/pdf/2011-15669.pdf.
• In June, the Board sought comment on and
adopted an interim final rule that allows small
BHCs that are S-Corps or that are organized in
mutual form to exclude subordinated debt issued to
Treasury under the SBLF from treatment as “debt”
for purposes of the debt-to-equity standard under
the Board’s “Small Bank Holding Company Policy
Statement.” The interim final rule is available at
www.gpo.gov/fdsys/pkg/FR-2011-06-21/pdf/201114983.pdf.
• The Board also adopted a final rule in June that
allows BHCs that are S-Corps or that are organized in mutual form to include in tier 1 capital all
subordinated debt issued to Treasury under the
TARP, subject to certain limits. The rule also
allows small BHCs that are S-Corps or that are
organized in mutual form to exclude subordinated
debt issued to Treasury under TARP from treatment as “debt” for purposes of the debt-to-equity
standard under the Board’s “Small Bank Holding

97

Company Policy Statement.” This rule makes final
an interim final rule that the Board adopted in
June 2009 and is available at www.gpo.gov/fdsys/
pkg/FR-2011-06-21/pdf/2011-14983.pdf.
• In December, the Board issued a final rule requiring top-tier U.S. BHCs with total consolidated
assets of $50 billion or more to submit annual capital plans for review. The aim of the annual capital
plans is to ensure that institutions have robust,
forward-looking capital planning processes that
account for their unique risks, and to help ensure
that institutions have sufficient capital to continue
operations throughout times of economic and
financial stress. Under the rule, the Federal Reserve
annually will evaluate institutions’ capital
adequacy; internal capital adequacy assessment
processes; and plans to make capital distributions,
such as dividend payments or stock repurchases.
The capital plan rule is available at www.gpo.gov/
fdsys/pkg/FR-2011-12-01/pdf/2011-30665.pdf.
(Also see box 4.)
• In addition, the Board, under a separate rulemaking, proposed to use the capital planning requirements to meet the Board’s obligations to impose
enhanced capital standards on large financial firms
under section 165(b)(1)(A)(i) of the Dodd-Frank
Act. The NPR on enhanced prudential standards
and early remediation requirement for covered
companies is available at www.federalreserve.gov/
newsevents/press/bcreg/20111220a.htm. (Also see
box 1.)
In 2011, Board and Reserve Bank staff conducted
in-depth supervisory analyses of a number of complex capital issuances, private capital investments,
and other transactions to evaluate their qualification
for inclusion in regulatory capital and consistency
with safety and soundness. For certain transactions,
banking organizations were required to make
changes necessary for instruments to satisfy regulatory capital criteria while other transactions were disallowed from inclusion in a banking organization’s
regulatory capital. With respect to certain sales and
structured finance transactions, banking organizations were required to maintain additional capital for
their exposures that were more commensurate with
the risk of the arrangements and the organization’s
support for the transactions.
International Guidance on Supervisory Policies
As a member of the Basel Committee on Banking
Supervision, the Federal Reserve actively participates
in efforts to advance sound supervisory policies for

98

98th Annual Report | 2011

internationally active banking organizations and
enhance the strength and stability of the international banking system.
Basel Capital Framework

During 2011, the Federal Reserve participated in
ongoing international initiatives to enhance the Basel
capital framework through the publication of the
revised version of Basel III: A global regulatory
framework for more resilient banks and banking systems in June 2011 and a series of “Frequently Asked
Questions” on various Basel III-related topics,
including the definition of “regulatory capital” and
“counterparty credit (CCR) risk.”
The Federal Reserve contributed to supervisory
policy recommendations, reports, and papers issued
for consultative purposes or finalized by the Basel
Committee that were designed to improve the supervision of banking organizations’ practices and to
address specific issues that emerged during the financial crisis. The listing below includes key final and
consultative papers from 2011.
Final papers:
• Revisions to the Basel II market risk framework updated as of 31 December 2010 (issued in February and available at www.bis.org/publ/bcbs193
.htm).
• Range of methodologies for risk and performance
alignment of remuneration (issued in May and available at www.bis.org/publ/bcbs194.htm).
• Basel III: A global regulatory framework for more
resilient banks and banking systems - revised version
June 2011 (issued in June and available at www.bis
.org/publ/bcbs189.htm). The revised version
includes capital treatment for bilateral CCR risk
finalized by the Basel Committee in June 2011.
• Principles for the Sound Management of Operational Risk (issued in June and available at www.bis
.org/publ/bcbs195.htm).
• Operational Risk - Supervisory Guidelines for the
Advanced Measurement Approaches (issued in June
and available at www.bis.org/publ/bcbs196.htm).
• Treatment of trade finance under the Basel capital
framework (issued in October and available at www
.bis.org/publ/bcbs205.htm).
• High cost credit protection (issued in December and
available at www.bis.org/publ/bcbs_nl16.htm).

Consultative papers:
• Capitalisation of bank exposures to central counterparties - second consultative document (issued in
November and available at www.bis.org/publ/
bcbs206.htm).
• Core principles for effective banking supervision
(published in December and available at www.bis
.org/publ/bcbs213.htm).
Joint Forum

In 2011, the Federal Reserve continued its participation in the Joint Forum—an international group of
supervisors of the banking, securities, and insurance
industries established to address various cross-sector
issues, including the regulation of financial conglomerates. The Joint Forum operates under the aegis of
the Basel Committee, the International Organization
of Securities Commissions, and the International
Association of Insurance Supervisors.
The Joint Forum, through its founding organizations,
issued a Report on asset securitisation incentives in
July 2011 that provides an update on the conditions
in the global securitization market, as well as an
assessment of regulatory reforms implemented following the financial crisis analyses. The report is
available at www.bis.org/publ/joint26.htm.
In addition, the Joint Forum issued, in December 2011, a consultative document, Principles for the
supervision of financial conglomerates. The document
is available at www.bis.org/publ/joint27.htm.
Accounting Policy
The Federal Reserve strongly endorses sound corporate governance and effective accounting and auditing practices for all regulated financial institutions.
Accordingly, the Federal Reserve’s supervisory policy
function is responsible for monitoring major domestic and international proposals, standards, and other
developments affecting the banking industry in the
areas of accounting, auditing, internal controls over
financial reporting, financial disclosure, and supervisory financial reporting.
During 2011, Federal Reserve staff addressed numerous issues related to financial sector accounting and
reporting, including fair value accounting, financial
instrument accounting and reporting, balance sheet
offsetting, loan accounting, business combinations,
lease accounting, securitizations, securities financing
transactions, consolidation of structured entities,

Supervision and Regulation

external and internal audit processes, and international financial reporting standards.
To address these and other issues, Federal Reserve
staff consulted with key constituents in the accounting and auditing professions, including standardsetters, accounting firms, accounting and financial
sector trade groups, and other financial sector regulators. The Federal Reserve also participated in meetings of the Basel Committee’s Accounting Task
Force, which represents the Basel Committee at international meetings on accounting, auditing, and disclosure issues affecting global banking organizations.
These efforts helped inform our understanding of
domestic and international practices—as well as proposed accounting, auditing, and regulatory standards—and helped in our formulation of policy positions using insight obtained through these forums.
During 2011, the Federal Reserve shared its views
with accounting and auditing standard-setters
through informal discussions and public comment
letters. Comment letters on the following proposals
were issued during the past year:
• Public Company Accounting Oversight Board’s
proposal related to changes in the auditor’s reporting model.
• Financial Accounting Standards Board’s proposals
related to netting of balance sheet amounts, hedge
accounting, impairment of financial assets, and
effective dates and transition methods.
Working with international bank supervisors, Federal
Reserve staff contributed to the development of
numerous other comment letters related to accounting and auditing matters that were submitted to the
International Accounting Standards Board and the
International Auditing and Assurance Standards
Board through the Basel Committee.
Federal Reserve staff also participated in other supervisory activities to assess interactions between
accounting standards and regulatory reform efforts.
These activities included supporting Dodd-Frank
Act initiatives related to stress testing of banks and
credit-risk retention requirements for securitizations,
as well as various Basel III activities.
The Federal Reserve issued supervisory guidance to
financial institutions and supervisory staff on
accounting matters, as appropriate, and participated
in a number of supervisory-related activities. For
example, Federal Reserve staff

99

• issued guidance to address supervisory considerations related to the disposal of nonperforming
assets and foreclosed real estate through exchanges
brokered by marketing agents;
• developed and participated in a number of domestic and international training programs to educate
supervisors about new and emerging accounting
and reporting topics affecting financial institutions; and
• supported the efforts of the Reserve Banks in
financial institution supervisory activities related to
financial accounting, auditing, reporting, and
disclosure.
Credit-Risk Management
The Federal Reserve works with the other federal
banking agencies to develop guidance on the management of credit risk; to coordinate the assessment
of regulated institutions’ credit risk; and to ensure
that institutions properly identify, measure, and manage credit risk.
Supervisory Expectations for Risk Management
of Agricultural Credit Risk

In October, the Federal Reserve issued supervisory
guidance to serve as a reminder to banking organizations and supervisory staff of the key risk factors in
agricultural lending and supervisory expectations for
a banking organization’s risk-management practices.
The guidance was issued largely in response to recent
market developments. The potential for volatile market conditions and risk factors raises the importance
of ensuring that agricultural banks have in place
appropriate risk-management programs and prudent
lending standards. A key component of a sound riskmanagement program is the linkage between an
analysis of market conditions and an agricultural
bank’s risk-management and capital planning practices. The range and extent of market analysis may
vary depending on the composition of the bank’s
portfolio and overall risk exposure.
Shared National Credit Program

In August, the Federal Reserve and the other banking agencies released summary results of the 2011
annual review of the Shared National Credit (SNC)
Program. The agencies established the program in
1977 to promote an efficient and consistent review
and classification of SNCs. A SNC is any loan or formal loan commitment—and any asset, such as other
real estate, stocks, notes, bonds, and debentures taken
as debts previously contracted—extended to borrowers by a supervised institution, its subsidiaries, and

100

98th Annual Report | 2011

affiliates that aggregates to $20 million or more and
either (1) is shared by three or more unaffiliated
supervised institutions under a formal lending agreement or (2) a portion of which is sold to two or more
unaffiliated supervised institutions, with the purchasing institutions assuming their pro rata share of the
credit risk.
The 2011 SNC review was based on analyses of
credit data as of December 31, 2010, provided by
federally supervised institutions. The 2011 SNC portfolio totaled $2.5 trillion, with 8,030 credit facilities
to approximately 5,400 borrowers. From the previous
period, the dollar volume of the portfolio commitment amount rose by $6 billion or 0.2 percent, and
the number of credits declined by 259, or 3.1 percent.
Although credit quality improved significantly over
the past two years, the percentage of criticized and
classified assets remains elevated at 12.7 and 8.5 percent, respectively.11 Criticized assets declined by
$126 billion to $321 billion, a 28.2 percent decrease
from the 2010 results. Criticized assets represented
12.7 percent of the portfolio, compared with
17.8 percent in the 2010 review. Classified credits
declined by $90 billion, a 29.5 percent decrease. Classified credits represented 8.5 percent of the portfolio,
compared with 12.1 percent in the 2010 review. Credits rated special mention declined by $36 billion to
$106 billion, a 25.4 percent decline. Special mention
credits represented 4.2 percent of the portfolio, compared with 5.7 percent in 2010. As in 2010, the reduction in the level of criticized assets is attributed to
improved borrower operating performance, debt
restructurings, bankruptcy resolutions, and greater
borrower access to bond and equity markets.
The number of credits originated in 2010 rose dramatically compared to 2009 and 2008, and equaled
approximately 75 percent of the large volume of
credits originated in 2007. While the overall quality
of underwriting in 2010 was significantly better than
in 2007, some easing of standards was noted, specifically in leveraged finance credits, compared to the
relatively tighter standards present in 2009 and the
latter half of 2008. Underwriting standards were generally satisfactory overall though the observed softening may be due to increasing competition and market
liquidity.
11

Criticized assets are composed of special mention and classified
assets. Special mention assets are loans and securities that
exhibit potential weakness but are not classified. Classified
assets are loans and securities that exhibit well-defined weaknesses or a distinct possibility of loss.

The performance of the SNC portfolio remained
heavily influenced by significant exposure to 2006and 2007-vintage credits with weak underwriting
standards. These loans comprised 40.1 percent of
SNC commitments, but accounted for 58.4 percent of
criticized commitments. Refinancing risk remains
elevated as nearly $2 trillion, or 78 percent, of the
SNC portfolio will mature by the end of 2014. Of
this amount, $204 billion is criticized.
Compliance Risk Management
The Federal Reserve works with international and
domestic supervisors to develop guidance that promotes compliance with BSA/AML and counter terrorism laws.
Bank Secrecy Act and
Anti-Money-Laundering Compliance

In 2011, the Federal Reserve continued to actively
promote the development and maintenance of effective BSA/AML compliance risk-management programs. For example, the Federal Reserve issued guidance in March 2011, SR letter 11-6, “Guidance on
Accepting Accounts from Foreign Embassies, Consulates and Missions (foreign missions).”12 The interagency advisory (attached to SR letter 11-6) supplements prior guidance and provides information to
financial institutions regarding the provision of
account services to foreign missions in a manner that
fulfills the needs of those foreign governments while
complying with the provisions of the BSA. Also,
Federal Reserve supervisory staff participated in
interagency projects designed to clarify regulatory
expectations, including guidance for financial institutions on the reorganization of the Financial Crimes
Enforcement Network’s (FinCEN) BSA regulations.
The Federal Reserve is a member of the Treasury-led
BSA Advisory Group, which includes representatives
of regulatory agencies, law enforcement, and the
financial services industry and covers all aspects of
the BSA. The Federal Reserve also participates in the
FFIEC BSA/AML working group, which is a
monthly forum for the discussion of pending BSA
policy and regulatory matters. In addition to the
FFIEC agencies, the BSA/AML working group
includes FinCEN and, on a quarterly basis, the SEC,
the Commodity Futures Trading Commission, the
Internal Revenue Service, and the Office of Foreign
Assets Control (OFAC) in order to share and discuss
information on policy issues and general trends more
broadly.
12

www.federalreserve.gov/bankinforeg/srletters/sr1106.htm.

Supervision and Regulation

101

The FFIEC BSA/AML working group also is
responsible for updating the FFIEC Bank Secrecy
Act/Anti-Money Laundering Examination Manual
(Manual). The FFIEC developed the Manual as part
of its ongoing commitment to provide current and
consistent interagency guidance on risk-based policies, procedures, and processes for financial institutions to comply with the BSA and safeguard their
operations from money laundering and terrorist
financing.

continue to provide a comprehensive and current
framework for combating money laundering and terrorist financing. Also, the Federal Reserve continues
to participate in a subcommittee of the Basel Committee that focuses on AML/counter-terrorism
financing issues.

In 2011, the Federal Reserve, together with the FDIC
and the OCC, issued a Spanish-language translation
of the Manual. This initiative was largely in response
to requests from industry and trade groups and furthers the collective goal of making regulatory expectations regarding BSA/AML compliance programs
as accessible and useful as possible.

• In January, the Board issued guidance on the
potential impact of high-cost credit protection
transactions on the assessment of a banking organization’s overall capital adequacy. The guidance
states that while credit-risk mitigation techniques
can significantly reduce a banking organization’s
level of risk, in some cases the high premiums or
fees paid for certain credit protection, combined
with other terms and conditions, call into question
the degree of risk transfer of the transaction. The
guidance provides a set of criteria for evaluating
the degree of risk transfer of a transaction and
describes actions that the Board may take in order
to account for high-cost credit protection transactions when assessing a banking organization’s overall capital adequacy. The guidance is available at
www.federalreserve.gov/bankinforeg/srletters/
sr1101.htm.

The Federal Reserve and other federal banking agencies continued during 2011 to regularly share examination findings and enforcement proceedings with
FinCEN under the interagency MOU that was finalized in 2004.
In 2011, the Federal Reserve coordinated extensively
with OFAC on their efforts under the Comprehensive
Iran Sanctions, Accountability, and Divestment Act
of 2010. This law builds upon the U.S. government’s
role in protecting its domestic financial system from
exposure to Iran’s illicit and deceptive financial practices by strengthening existing U.S. sanctions. The
Federal Reserve continued during 2011 to regularly
share examination findings and enforcement proceedings with OFAC under the 2006 interagency MOU.
International Coordination on
Sanctions, Anti-Money-Laundering, and
Counter-Terrorism Financing

The Federal Reserve participates in a number of
international coordination initiatives related to sanctions, money laundering, and terrorism financing.
For example, the Federal Reserve has a long-standing
role in the U.S. delegation to the intergovernmental
Financial Action Task Force (FATF) and its working
groups, contributing a banking supervisory perspective to formulation of international standards on
these matters. In 2011, the Federal Reserve actively
contributed to the development of a FATF typologies report that addressed laundering the proceeds of
corruption. In addition, the Federal Reserve has provided input and review of ongoing work to revise the
FATF Recommendations in order to ensure that they

Other Policymaking Initiatives
In 2011, the Board issued or proposed guidance in a
number of areas including the following:

• The Board and the OCC jointly issued guidance in
April that expands on previous guidance on the use
of models and sets forth the agencies’ expectations
regarding a robust approach to the assessment and
management of model risk. The guidance summarizes the principles of a model risk-management
framework, including robust model development,
implementation, and use; effective validation; and
sound governance, policies, and controls. The guidance is available at www.federalreserve.gov/
bankinforeg/srletters/sr1107.htm.
• In April, the federal banking agencies, Federal
Housing and Finance Agency, Housing and Urban
Development, and the SEC jointly sought comment on an NPR that would implement the
requirements of section 941(b) of the Dodd-Frank
Act. More specifically, the NPR would (1) require a
securitizer to retain not less than 5 percent of the
credit risk of any asset that the securitizer, through
the issuance of an asset-backed security, transfers,
sells, or conveys to a third party; and (2) prohibit a
securitizer from directly or indirectly hedging or
transferring the credit risk the securitizer is
required to retain. The NPR would exempt from

102

98th Annual Report | 2011

risk retention any asset-backed security collateralized solely by qualified residential mortgages as
defined in the proposed rule. The NPR is available
at http://edocket.access.gpo.gov/2011/pdf/20118364.pdf.
• In June, the federal banking agencies jointly
requested comment on proposed stress testing
guidance that outlines high-level principles for
stress testing practices, which are applicable to all
banking organizations with more than $10 billion
in total consolidated assets (see box 4). The proposed guidance highlights the importance of stress
testing as an ongoing risk-management practice
that supports a banking organization’s forwardlooking assessment of its risks. The proposed guidance is available at www.federalreserve.gov/
newsevents/press/bcreg/20110609a.htm.
• The federal banking agencies issued guidance in
July on their expectations for sound CCR riskmanagement practices. This guidance reinforces
sound governance of CCR risk-management practices through prudent board and senior management oversight, management reporting, and riskmanagement functions. In addition, the guidance
also summarizes the sound practices necessary for
an effective CCR management framework and the
characteristics of an appropriate systems infrastructure. The guidance is available at www
.federalreserve.gov/newsevents/press/bcreg/
20110705a.htm.
• The Federal Reserve, along with the other FFIEC
agencies, issued the “Supplement to Authentication
in an Internet Banking Environment” (supplement), which supplements the similarly titled guidance issued in 2005. The supplement is intended to
enhance supervised organizations’ Internet banking control environments. Accordingly, the supplement clarifies and increases supervisory expectations in the areas of risk assessments, customer
authentication, layered security controls, and
awareness and education programs. The guidance
is available at www.federalreserve.gov/bankinforeg/
srletters/sr1109.htm.
• In March, the federal banking agencies requested
comment on a joint proposed rule to ensure that
regulated financial institutions design their incentive compensation arrangements to take account of
risk. The proposed rule, which is being issued pursuant to the Dodd-Frank Act, would apply to certain financial institutions with more than $1 billion
in assets. It also contains heightened standards for
the largest of these institutions. The proposed rule

is available at www.federalreserve.gov/newsevents/
press/bcreg/20110330a.htm. (Also see box 5.)
Regulatory Reports
The Federal Reserve’s supervisory policy function is
also responsible for developing, coordinating, and
implementing regulatory reporting requirements for
various financial reporting forms filed by domestic
and foreign financial institutions subject to Federal
Reserve supervision. Federal Reserve staff members
interact with other federal agencies and relevant state
supervisors, including foreign bank supervisors as
needed, to recommend and implement appropriate
and timely revisions to the reporting forms and the
attendant instructions.
Bank Holding Company Regulatory Reports

The Federal Reserve requires that U.S. BHCs periodically submit reports that provide information
about their financial condition and structure. This
information is essential to formulating and conducting bank regulation and supervision. It is also used in
responding to requests by Congress and the public
for information about BHCs and their nonbank subsidiaries. Foreign banking organizations also are
required to periodically submit reports to the Federal
Reserve.
• FR Y-9 series reports—the FR Y-9C, FR Y-9LP,
and FR Y-9SP—provide standardized financial
statements for BHCs on both a consolidated and a
parent-only basis. The reports are used to detect
emerging financial problems, to review performance and conduct pre-inspection analysis, to
monitor and evaluate risk profiles and capital
adequacy, to evaluate proposals for BHC mergers
and acquisitions, and to analyze a holding company’s overall financial condition.
• Nonbank subsidiary reports—the FR Y-11, FR
2314, FR Y-7N, and FR 2886b—help the Federal
Reserve determine the condition of BHCs that are
engaged in nonbank activities and also aid in monitoring the number, nature, and condition of the
companies’ nonbank subsidiaries.
• The FR Y-8 report provides information on transactions between an insured depository institution
and its affiliates that are subject to section 23A of
the Federal Reserve Act; it is used to monitor bank
exposures to affiliates and to ensure banks’ compliance with section 23A of the Federal Reserve Act.
• The FR Y-10 report provides data on changes in
organization structure at domestic and foreign
banking organizations.

Supervision and Regulation

Box 5. Incentive Compensation
Flawed incentive compensation practices in the
financial industry—providing executives and other
employees with incentives to take imprudent risks
inconsistent with the long-term health of their financial organizations—were among the many factors
contributing to the financial crisis. To help address
these problems, the Federal Reserve issued draft
supervisory guidance on incentive compensation
practices for public comment in October 2009. After
modest revisions, it was adopted by the federal
banking agencies (Federal Reserve, OCC, FDIC,
OTS) in June 2010 (www.federalreserve.gov/
newsevents/press/bcreg/20100621a.htm).
In 2009, the Federal Reserve undertook a supervisory
initiative—a “horizontal review” of incentive compensation practices at the 25 largest banking organizations. The horizontal review was designed to assess
• the potential for incentive compensation arrangements to encourage imprudent risk-taking;
• the actions that the large complex banking organizations have taken to correct deficiencies in incentive compensation design; and
• the adequacy of the organizations’ compensationrelated risk management, controls, and corporate
governance.
These organizations have made significant changes
to their practices and are approaching substantial
conformance with the guidance. A recent Financial
Stability Board report shows that U.S. banks are at or
near the leading edge of practice internationally.
More details about the horizontal review are presented in an October 2011 white paper (www
.federalreserve.gov/publications/other-reports/files/
incentive-compensation-practices-report-201110
.pdf).
The Dodd-Frank Act requires the reporting to regulators of incentive compensation arrangements and
prohibits incentive compensation arrangements that
provide excessive compensation or that could
expose the firm to inappropriate risks. Banking organizations, broker–dealers, investment advisers, and
certain other firms are covered under the act if they
have $1 billion or more in total assets. To implement
the act, seven financial regulatory agencies (Federal
Reserve, OCC, FDIC, OTS, NCUA, SEC, and the
Federal Housing and Finance Agency) issued a joint
proposed rule in April 2011 (www.gpo.gov/fdsys/pkg/
FR-2011-04-14/pdf/2011-7937.pdf). The banking
agencies’ existing reviews have been done using
their safety-and-soundness authority; the proposed
rule would add to that authority and provide regulatory authority to some other agencies, such as the
SEC. The core principles of the proposed rule are
similar to those in the banking agencies’ guidance. A
very large number of comments were received from
the public, and these comments are being carefully
considered in the drafting of the final rule. The final
rule is forthcoming in 2012.

103

• The FR Y-6 and FR Y-7 reports gather additional
information on organization structure and shareholders from domestic banking organizations and
foreign banking organizations, respectively; the
information is used to monitor structure so as to
determine compliance with provisions of the Bank
Holding Company Act (BHC Act) and Regulation Y and to assess the ability of a foreign banking organization to continue as a source of strength
to its U.S. operations.
During 2011, the Federal Reserve implemented a
number of changes to the FR Y-9C reporting
requirements to better understand BHCs’ risk exposures, primarily with respect to lending and securitizations; to better support macroeconomic analysis
and monetary policy purposes; and to collect certain
information prescribed by changes in accounting
standards. These revisions included (1) break out by
loan category of other loans and leases that are
troubled debt restructurings for those that (a) are
past due 30 days or more or in nonaccrual status or
(b) are in compliance with their modified terms and
clarify reporting of restructured troubled debt consumer loans; (2) break out of other consumer loans
into automobile loans and all other consumer loans
in several schedules; (3) break out of commercial
mortgage-backed securities issued or guaranteed by
U.S. government agencies and sponsored agencies;
(4) creation of a new Schedule HC-V, Variable Interest Entities (VIEs), for reporting major categories of
assets and liabilities of consolidated VIEs; (5) break
out of loans and other real estate owned (OREO)
information covered by FDIC loss-sharing agreements by loan and OREO category; (6) break out of
life insurance assets into data items for general
account and separate account life insurance assets;
(7) addition of new data items for the total assets of
captive insurance and reinsurance subsidiaries;
(8) addition of new income statement items for credit
valuation adjustments and debit valuation adjustments included in trading revenues (for BHCs with
total assets of $100 billion or more); (9) revision of
the reporting instructions in the areas of construction lending, one- to four-family residential mortgage
banking activities, and maturity and repricing data;
and (10) collection of expanded information on the
quarterly-averages schedule.
In 2011, the Federal Reserve proposed the following
revisions to the FR Y-9C for implementation in
2012 to better understand BHCs’ risk exposures, to
better support macroeconomic analysis and monetary policy purposes, and to collect certain informa-

104

98th Annual Report | 2011

tion prescribed by changes in accounting standards:
(1) add a section to Schedule HC-C, Loans and
Lease Financing Receivables, to collect information
on the allowance for loan and lease losses by loan
category; (2) add two data items to Schedule HC-P,
1–4 Family Residential Mortgage Banking Activities,
to collect the amount of representation and warranty
reserves for one- to four-family residential mortgage
loans sold; (3) add a data item to Schedule HC-N,
Past Due and Nonaccrual Loans, Leases, and Other
Assets, to collect the outstanding balance of purchased credit impaired loans by past due and nonaccrual status; (4) add a new Schedule HC-U, Loan
Origination Activity in Domestic Offices, to collect
information on loan originations; and (5) modify the
reporting instructions to clarify the reporting and
accounting treatment of specific valuation
allowances.
Savings and Loan Holding Company Regulatory
Reports

On July 21, 2011, the responsibility for supervision
and regulation of SLHCs transferred from the OTS
to the Board, pursuant to section 312 of the DoddFrank Act. In preparation of this event, the Federal
Reserve, on February 8, 2011, published in the Federal Register a notice of intent (76 Fed. Reg. 7091) to
require SLHCs to submit the same reports as BHCs
(FR Y–6, FR Y–7, FR Y–9 reports, FR Y–11/11S,
FR 2314/2314S, FR Y–8, FR Y–12/12A, FR Y–7Q,
or FR Y–7N/NS) beginning with the March 31,
2012, reporting period.13 The notice of intent stated
that the Board would issue a formal proposed notice
on information collection activities for SLHCs after
the transfer date. On August 25, 2011, the Board
issued a proposal to exempt a limited number of
SLHCs from initially submitting Federal Reserve
regulatory reports and allow a two-year phased-in
reporting for most SLHCs beginning with the
March 31, 2012, reporting period (76 Fed. Reg.
53129).14
After consideration of the comments received on the
proposal, the Board issued a press release, on December 23, 2011, announcing that the proposed collections of information from SLHCs had been finalized
with modifications. The final notice was published in
the Federal Register on December 29, 2011, (76 Fed.
Reg. 81933) in which the Board retained the two-year
13

14

See notice of intent at www.gpo.gov/fdsys/pkg/FR-2011-02-08/
html/2011-2782.htm.
See proposal at www.gpo.gov/fdsys/pkg/FR-2011-08-25/html/
2011-21736.htm.

phase-in approach for most SLHCs and modified the
exemption criteria for commercial SLHCs and certain insurance SLHCs.15 The exemption for commercial SLHCs will be reviewed periodically and may be
rescinded if the Board determines that FR Y–9
financial information and other regulatory reports
are needed to effectively and consistently assess compliance with capital and other regulatory requirements. Insurance SLHCs will be exempt only until
consolidated regulatory capital rules are finalized for
SLHCs, at which time they may be required to file
consolidated financial statements—to demonstrate
their compliance with the capital rules—and other
Federal Reserve reports.
Commercial Bank Regulatory Reports

As the federal supervisor of state member banks, the
Federal Reserve, along with the other banking agencies (through the FFIEC), requires banks to submit
quarterly Call Reports. Call Reports are the primary
source of data for the supervision and regulation of
banks and the ongoing assessment of the overall
soundness of the nation’s banking system. Call
Report data provide the most current statistical data
available for evaluating institutions’ corporate applications, for identifying areas of focus for both on-site
and off-site examinations, and for considering monetary and other public policy issues. Call Report
data, which also serve as benchmarks for the financial information required by many other Federal
Reserve regulatory financial reports, are widely used
by state and local governments, state banking supervisors, the banking industry, securities analysts, and
the academic community.
During 2011, the FFIEC implemented revisions to
the Call Report to better understand banks’ risk
exposures, primarily with respect to lending and
securitizations, to better support macroeconomic
analysis and monetary policy purposes, and to collect
certain information prescribed by changes in
accounting standards. The revisions included
(1) break out by loan category of other loans and
leases that are troubled debt restructurings for those
that (a) are past due 30 days or more or in nonaccrual status or (b) are in compliance with their modified terms and clarify reporting of restructured
troubled debt consumer loans; (2) break out other
consumer loans into automobile loans and all other
consumer loans in several schedules; (3) break out of
commercial mortgage-backed securities issued or
15

See press release and notice at www.federalreserve.gov/
newsevents/press/bcreg/20111223a.htm.

Supervision and Regulation

guaranteed by U.S. government agencies and sponsored agencies; (4) addition of a new memorandum
item for the estimated amount of nonbrokered
deposits obtained through the use of deposit-listing
service companies; (5) break out of existing items for
deposits of individuals, partnerships, and corporations into deposits of individuals and deposits of
partnerships and corporations; (6) creation of a new
Schedule RC-V, VIEs, for reporting major categories
of assets and liabilities of consolidated VIEs;
(7) break out of loans and OREO information covered by FDIC loss-sharing agreements by loan and
OREO category; (8) break out of life insurance assets
into data items for general account and separate
account life insurance assets; (9) addition of new
data items for the total assets of captive insurance
and reinsurance subsidiaries; (10) addition of new
income statement items for credit valuation adjustments and debit valuation adjustments included in
trading revenues (for banks with total assets of
$100 billion or more); (11) change of the reporting
frequency from annually to quarterly for the data
reported in Schedule RC-T, Fiduciary and Related
Services, on collective investment funds and common
trust funds; and (12) revision of the reporting
instructions in the areas of construction lending,
one- to four-family residential mortgage banking
activities, and maturity and repricing data.
In addition, during 2011, the FFIEC implemented
several revisions to the Report of Assets and Liabilities of U.S. Branches and Agencies of Foreign Banks
(FFIEC 002) to (1) collect additional detail on trading assets, (2) revise the reporting instructions in
Schedule E for reporting of time deposits of
$100,000 or more, and (3) expand the data collected
on Schedule Q, Financial Assets and Liabilities
Measured at Fair Value.
In 2011, the FFIEC proposed the following revisions
to the Call Report for implementation in 2012 to better understand banks’ risk exposures, to better support macroeconomic analysis and monetary policy
purposes, and to collect certain information prescribed by changes in accounting standards: (1) add a
section to Schedule RC-C, Loans and Lease Financing Receivables, to collect information on the allowance for loan and lease losses by loan category;
(2) add two data items to Schedule RC-P, 1–4 Family
Residential Mortgage Banking Activities, to collect
the amount of representation and warranty reserves
for one- to four-family residential mortgage loans
sold; (3) add a data item to Schedule RC-N, Past Due
and Nonaccrual Loans, Leases, and Other Assets, to

105

collect the outstanding balance of purchased credit
impaired loans by past due and nonaccrual status;
(4) add a new Schedule RC-U, Loan Origination
Activity in Domestic Offices, to collect information
on loan originations; (5) add new items in Schedule RC-M, Memoranda, in which savings associations and certain state savings and cooperative banks
would report on the test they use to determine compliance with the Qualified Thrift Lender requirement
and whether they have remained in compliance with
this requirement; (6) revise two existing items in
Schedule RC-R, Regulatory Capital, used to calculate
the leverage ratio denominator to accommodate certain differences between the regulatory capital standards that apply to the leverage capital ratios of
banks versus savings associations; and (7) modify the
reporting instructions to clarify the reporting and
accounting treatment of specific valuation
allowances.

Supervisory Information Technology
The Federal Reserve’s supervisory information technology function, carried out by the Board’s Division
of Banking Supervision and Regulation and the
Reserve Banks under the guidance of the Subcommittee on Supervisory Administration and Technology, works to identify and set priorities for information technology initiatives within the supervision and
regulation business line.
In 2011, the supervisory information technology
function focused on
• Large Bank Supervision. Improved the supervision
of large and regional financial institutions with
new processes and linked workflows to enable continuous updates of information provided through
examinations and ongoing monitoring activities.
• Community Bank Supervision. Worked with community bank examiners and other regulators to
implement enhanced tools to support community
bank examinations.
• Data Management. (1) Improved the data management infrastructure and inventorying of supervisory information and (2) enhanced data analytics
to support core business needs. These improvements were the result of stress testing, capital
assessments, and additional risk monitoring that
created additional demands for investment in data
collections.
• Collaboration. (1) Enhanced information sharing
among staff at the Board and Reserve Banks

106

98th Annual Report | 2011

through tools to support communities of practice,
(2) developed and piloted an electronic solution to
support exam teams’ ability to share documents,
and (3) created an Interagency Steering Group to
improve methods for sharing work among state
and federal regulators.
• Modernization. Initiated significant projects to
modernize software products and business capabilities in the areas of document management,
resource prioritization, and scheduling.
National Information Center
The NIC is the Federal Reserve’s comprehensive
repository for supervisory, financial, and bankingstructure data. It is also the main repository for many
supervisory documents. NIC includes (1) data on
banking structure throughout the United States as
well as foreign banking concerns; (2) the National
Examination Desktop, which enables supervisory
personnel as well as federal and state banking
authorities to access NIC data; (3) the Banking Organization National Desktop, an application that facilitates secure, real-time electronic information sharing
and collaboration among federal and state banking
regulators for the supervision of banking organizations; and (4) the Central Document and Text
Repository, which contains documents supporting
the supervisory processes.
Within the NIC, the supporting systems have been
modified over time to extend their usefulness and
improve business workflow efficiency. During 2011,
work was completed on upgrading the entire NIC
infrastructure to provide easier access to information,
a consistent Federal Reserve-enterprise information
data repository, a comprehensive metadata repository, and uniform security across the Federal Reserve
System. The transition began in May 2010 and effectively was substantially complete by year-end 2011
with only a limited number of applications requiring
transition in early 2012. Business changes were
implemented to the systems of record for both
examination and inspection mandates, and improvements were made to the collection and reporting of
key examination and inspection findings to track
consistently on a national level across the Federal
Reserve System.
The structure and supervisory databases in the NIC
were modified to support Dodd-Frank changes and
to facilitate the supervision of SLHCs. A significant
amount of progress occurred during 2011 to successfully capture and integrate the former OTS data and

documents into the NIC database constructs. Data
comparisons and validation analyses were performed
to determine which SLHCs and non-depository institution subsidiaries of SLHCs were missing or incomplete on NIC. New data elements were added to the
repositories. Integration of data related to SLHC
organizations will continue in 2012 as regulatory
reports are modified to collect structure, financial,
and supervisory information directly from these
entities.
The NIC also supports the Shared National Credit
Modernization project (SNC Mod), a multiyear,
interagency, information technology development
effort to improve the efficiency and effectiveness of
the systems that support the SNC Program. SNC
Mod focuses on a complete rewrite of the current
legacy systems to take advantage of modern technology to enhance and extend the system’s capabilities.
During 2011, the SNCnet application was implemented in three phases in support of the 2011 SNC
examination process. The creation of this automated
tool is an interagency initiative led by the Federal
Reserve System. Timely delivery of the SNCnet tool
enabled significant process efficiencies for the examination teams and ultimately resulted in the ability to
publish the summary of findings approximately six to
eight weeks ahead of the previous schedule. During
2012, additional enhancements are expected for both
the collection repository and to the exam tool application that will provide further benefits to the examination teams.
During 2011, in support of the Comprehensive Capital Analysis and Review initiative and in planning for
the Dodd-Frank Act stress testing program, NIC
staff were engaged with the teams responsible for
planning the new data collections (FR Y-14). The
Supervision Risk program is also undergoing significant changes with substantial increases in the data
requirements as well as modeling tools to use with
those data. NIC staff are responsible for providing
project management for those initiatives to best serve
the business sponsors.
Finally, the Federal Reserve participated in a number
of technology-related initiatives supporting the
supervision function as part of FFIEC task forces
and interagency committees. These efforts support
standardized data collections and cross-agency information sharing. Work in this area will continue to be
important as the agencies work through the implementation of the Dodd-Frank Act.

Supervision and Regulation

Staff Development

107

urgent training needs associated with implementation
or issuance of new laws, regulations, or guidance.

The Federal Reserve’s staff development program is
responsible for the ongoing development of nearly
3,109 professional supervisory staff to ensure that
they have the skills necessary to meet their evolving
supervisory responsibilities. The Federal Reserve also
provides course offerings to staff at state banking
agencies. Training activities in 2011 are summarized
in table 2.

Regulation
The Federal Reserve exercises important regulatory
influence over entry into the U.S. banking system,
and the structure of the system, through its administration of several federal statutes. The Federal
Reserve is also responsible for imposing margin
requirements on securities transactions. In carrying
out its responsibilities, the Federal Reserve coordinates supervisory activities with the other federal
banking agencies, state agencies, functional regulators (that is, regulators for insurance, securities, and
commodities firms), and foreign bank regulatory
agencies.

Examiner Commissioning Program
The Examiner Commissioning Program (ECP)
involves approximately 22 weeks of instruction. Individuals move through a combination of classroom
offerings, self-paced assignments, and on-the-job
training over a period of two to five years. Achievement is measured by two professionally validated
proficiency examinations: the first proficiency exam
is required of all ECP participants, and the second
proficiency exam is offered in two specialty areas—
(1) safety and soundness and (2) consumer compliance. A third specialty, in information technology,
requires that individuals earn the Certified Information Systems Auditor certification offered by the
Information Systems Audit Control Association. In
2011, 252 examiners passed the first proficiency exam
and 69 passed the second proficiency exam (55 in
safety and soundness and 14 in consumer
compliance).

Regulation of the U.S. Banking Structure
The Federal Reserve administers five federal statutes
that apply to BHCs, financial holding companies,
member banks, and foreign banking organizations—
the BHC Act, the Bank Merger Act, the Change in
Bank Control Act, the Federal Reserve Act, and the
International Banking Act. On July 21, 2011, as a
result of the Dodd-Frank Act, the Federal Reserve
also became responsible for administering section 10
of the Home Owners’ Loan Act that applies to
SLHCs. The Federal Reserve is now also responsible
for administering the Change in Bank Control Act
with respect to SLHCs.

Continuing Professional Development
Other formal and informal learning opportunities are
available to examiners, including other schools and
programs offered within the System and FFIECsponsored schools. System programs are also available to state and federal banking agency personnel.
The Rapid Response® program, introduced in 2008,
offers System and state personnel 60–90 minute teleconference presentations on emerging issues or

In administering these statutes, the Federal Reserve
acts on a variety of proposals that directly or indirectly affect the structure of the U.S. banking system
at the local, regional, and national levels; the international operations of domestic banking organizations;
or the U.S. banking operations of foreign banks. The

Table 2. Training for banking supervision and regulation, 2011
Number of enrollments
Course sponsor or type

Federal Reserve System
FFIEC
The Options Institute2
Rapid ResponseTM
1
2

Federal Reserve
personnel

State and federal
banking agency
personnel

2,273
394
4
11,406

495
217
7
1,045

Instructional time
(approximate training
days)1

Number of course
offerings

910
360
3
10

182
90
1
78

Training days are approximate. System courses were calculated using five days as an average, with FFIEC courses calculated using four days as an average.
The Options Institute, an educational arm of the Chicago Board Options Exchange, provides a three-day seminar on the use of options in risk management.

108

98th Annual Report | 2011

proposals concern BHC and SLHC formations and
acquisitions, bank mergers, and other transactions
involving banks and savings associations or nonbank
firms. In 2011, the Federal Reserve acted on 414 proposals representing 1,035 individual applications filed
under the six statutes. Many of these proposals
involved banking organizations in less than satisfactory financial condition.
Bank Holding Company Act Proposals
Under the BHC Act, a corporation or similar legal
entity must obtain the Federal Reserve’s approval
before forming a BHC through the acquisition of
one or more banks in the United States. Once
formed, a BHC must receive Federal Reserve
approval before acquiring or establishing additional
banks. Also, BHCs generally may engage in only
those nonbanking activities that the Board has previously determined to be closely related to banking
under section 4(c)(8) of the BHC Act. Depending on
the circumstances, these activities may or may not
require Federal Reserve approval in advance of their
commencement.16
When reviewing a BHC application or notice that
requires prior approval, the Federal Reserve may consider the financial and managerial resources of the
applicant, the future prospects of both the applicant
and the firm to be acquired, the convenience and
needs of the community to be served, the potential
public benefits, the competitive effects of the proposal, and the applicant’s ability to make available to
the Federal Reserve information deemed necessary to
ensure compliance with applicable law. In the case of
a foreign banking organization seeking to acquire
control of a U.S. bank, the Federal Reserve also considers whether the foreign bank is subject to comprehensive supervision or regulation on a consolidated
basis by its home-country supervisor. In 2011, the
Federal Reserve acted on 307 applications and
notices filed by BHCs to acquire a bank or a nonbank firm, or to otherwise expand their activities,
including proposals involving private equity firms.
A BHC may repurchase its own shares from its
shareholders. When the company borrows money to
buy the shares, the transaction increases the company’s debt and decreases its equity. The Federal
16

Since 1996, the act has provided an expedited prior notice procedure for certain permissible nonbank activities and for acquisitions of small banks and nonbank entities. Since that time, the
act has also permitted well-run BHCs that satisfy certain criteria
to commence certain other nonbank activities on a de novo
basis without first obtaining Federal Reserve approval.

Reserve may object to stock repurchases by holding
companies that fail to meet certain standards, including the Board’s capital adequacy guidelines. In 2011,
the Federal Reserve acted on seven stock repurchase
proposals by a BHC.
The Federal Reserve also reviews elections submitted
by BHCs seeking financial holding company status
under the authority granted by the Gramm-LeachBliley Act. BHCs seeking financial holding company
status must file a written declaration with the Federal
Reserve. In 2011, 14 domestic financial holding company declarations were approved.
Bank Merger Act Proposals
The Bank Merger Act requires that all proposals
involving the merger of insured depository institutions be acted on by the relevant federal banking
agency. The Federal Reserve has primary jurisdiction
if the institution surviving the merger is a state member bank. Before acting on a merger proposal, the
Federal Reserve considers the financial and managerial resources of the applicant, the future prospects of
the existing and combined organizations, the convenience and needs of the community(ies) to be served,
and the competitive effects of the proposed merger.
The Federal Reserve also must consider the views of
the U.S. Department of Justice regarding the competitive aspects of any proposed bank merger involving unaffiliated insured depository institutions. In
2011, the Federal Reserve approved 67 merger applications under the act.
Change in Bank Control Act Proposals
The Change in Bank Control Act requires individuals
and certain other parties that seek control of a U.S.
bank, BHC, or SLHC to obtain approval from the
relevant federal banking agency before completing
the transaction. The Federal Reserve is responsible
for reviewing changes in the control of state member
banks, BHCs, and SLHCs. In its review, the Federal
Reserve considers the financial position, competence,
experience, and integrity of the acquiring person; the
effect of the proposed change on the financial condition of the bank, BHC, or SLHC being acquired; the
future prospects of the institution to be acquired; the
effect of the proposed change on competition in any
relevant market; the completeness of the information
submitted by the acquiring person; and whether the
proposed change would have an adverse effect on the
Deposit Insurance Fund. A proposed transaction
should not jeopardize the stability of the institution
or the interests of depositors. During its review of a
proposed transaction, the Federal Reserve may con-

Supervision and Regulation

tact other regulatory or law enforcement agencies for
information about relevant individuals. In 2011, the
Federal Reserve approved 115 change in control
notices related to state member banks, BHCs, and
SLHCs, including proposals involving private equity
firms.
Federal Reserve Act Proposals
Under the Federal Reserve Act, a bank must seek
Federal Reserve approval to become a member bank.
A member bank may be required to seek Federal
Reserve approval before expanding its operations
domestically or internationally. State member banks
must obtain Federal Reserve approval to establish
domestic branches, and all member banks (including
national banks) must obtain Federal Reserve
approval to establish foreign branches. When reviewing proposals for membership, the Federal Reserve
considers, among other things, the bank’s financial
condition and its record of compliance with banking
laws and regulations. When reviewing proposals to
establish domestic branches, the Federal Reserve considers, among other things, the scope and nature of
the banking activities to be conducted. When reviewing proposals for foreign branches, the Federal
Reserve considers, among other things, the condition
of the bank and the bank’s experience in international banking. In 2011, the Federal Reserve acted on
membership proposals for 44 banks, and new and
merger-related branch proposals for 427 domestic
branches and eight foreign branches.
State member banks must also obtain Federal
Reserve approval to establish financial subsidiaries.
These subsidiaries may engage in activities that are
financial in nature or incidental to financial activities,
including securities-related and insurance agencyrelated activities. In 2011, no financial subsidiary
applications were submitted.
Overseas Investment Proposals by
U.S. Banking Organizations
U.S. banking organizations may engage in a broad
range of activities overseas. Many of the activities are
conducted indirectly through Edge Act and agreement corporation subsidiaries. Although most foreign investments are made under general consent procedures that involve only after-the-fact notification to
the Federal Reserve, large and other significant
investments require prior approval. In 2011, the Federal Reserve approved 20 applications and notices for
overseas investments by U.S. banking organizations,
many of which represented investments through an
Edge Act or agreement corporation.

109

International Banking Act Proposals
The International Banking Act, as amended by the
Foreign Bank Supervision Enhancement Act of
1991, requires foreign banks to obtain Federal
Reserve approval before establishing branches, agencies, commercial lending company subsidiaries, or
representative offices in the United States.
In reviewing proposals, the Federal Reserve generally
considers whether the foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by its home-country supervisor. It also
considers whether the home-country supervisor has
consented to the establishment of the U.S. office; the
financial condition and resources of the foreign bank
and its existing U.S. operations; the managerial
resources of the foreign bank; whether the homecountry supervisor shares information regarding the
operations of the foreign bank with other supervisory authorities; whether the foreign bank has provided adequate assurances that information concerning its operations and activities will be made available
to the Federal Reserve, if deemed necessary to determine and enforce compliance with applicable law;
whether the foreign bank has adopted and implemented procedures to combat money laundering and
whether the home country of the foreign bank is
developing a legal regime to address money laundering or is participating in multilateral efforts to combat money laundering; and the record of the foreign
bank with respect to compliance with U.S. law. In
2011, the Federal Reserve approved seven applications by foreign banks to establish branches, agencies,
or representative offices in the United States.
Home Owners’ Loan Act Proposals
Under the Home Owners’ Loan Act, a corporation
or similar legal entity must obtain the Federal
Reserve’s approval before forming an SLHC through
the acquisition of one or more savings associations in
the United States. Once formed, an SLHC must
receive Federal Reserve approval before acquiring or
establishing additional savings associations. Also,
SLHCs generally may engage in only those nonbanking activities that are specifically enumerated in the
Home Owners’ Loan Act or which the Board has
previously determined to be closely related to banking under section 4(c)(8) of the BHC Act. Depending
on the circumstances, these activities may or may not
require Federal Reserve approval in advance of their
commencement. In 2011, the Federal Reserve acted
on five applications and notices filed by SLHCs to

110

98th Annual Report | 2011

acquire a bank or a nonbank firm, or to otherwise
expand their activities.
Under the Home Owners’ Loan Act, a savings association reorganizing to a mutual holding company
(MHC) structure must receive Federal Reserve
approval prior to its reorganization. In addition, an
MHC must receive Federal Reserve approval before
converting to stock form, and MHCs must receive
Federal Reserve approval before waiving dividends
declared by the MHC’s subsidiary. In 2011, the Federal Reserve received no applications for MHC reorganizations. In 2011, the Federal Reserve acted on no
applications filed by MHCs to convert to stock form
and 14 applications to waive dividends.
When reviewing an SLHC application or notice that
requires prior approval, the Federal Reserve may consider the financial and managerial resources of the
applicant, the future prospects of both the applicant
and the firm to be acquired, the convenience and
needs of the community to be served, the potential
public benefits, the competitive effects of the proposal, and the applicant’s ability to make available to
the Federal Reserve information deemed necessary to
ensure compliance with applicable law.
The Federal Reserve also reviews elections submitted
by SLHCs seeking treatment as financial holding
companies under the authority granted by the DoddFrank Act. SLHCs seeking financial holding company treatment must file a written declaration with
the Federal Reserve. In 2011, no SLHC financial
holding company declarations were approved.
Public Notice of Federal Reserve Decisions
Certain decisions by the Federal Reserve that involve
an acquisition by a BHC, a bank merger, a change in
control, or the establishment of a new U.S. banking
presence by a foreign bank are made known to the
public by an order or an announcement. Orders state
the decision, the essential facts of the application or
notice, and the basis for the decision; announcements
state only the decision. All orders and announcements are made public immediately; they are subsequently reported in the Board’s weekly H.2 statistical
release. The H.2 release also contains announcements
of applications and notices received by the Federal
Reserve upon which action has not yet been taken.
For each pending application and notice, the related
H.2A release gives the deadline for comments. The
Board’s website (www.federalreserve.gov) provides

information on orders and announcements as well as
a guide for U.S. and foreign banking organizations
that wish to submit applications.

Enforcement of
Other Laws and Regulations
The Federal Reserve’s enforcement responsibilities
also extend to the disclosure of financial information
by state member banks and the use of credit to purchase and carry securities.
Financial Disclosures by State Member Banks
State member banks that issue securities registered
under the Securities Exchange Act of 1934 must disclose certain information of interest to investors,
including annual and quarterly financial reports and
proxy statements. By statute, the Board’s financial
disclosure rules must be substantially similar to those
of the SEC. At the end of 2011, 12 state member
banks were registered with the Board under the Securities Exchange Act.
Securities Credit
Under the Securities Exchange Act of 1934, the
Board is responsible for regulating credit in certain
transactions involving the purchasing or carrying of
securities. The Board’s Regulation T limits the
amount of credit that may be provided by securities
brokers and dealers when the credit is used to purchase debt and equity securities. The Board’s Regulation U limits the amount of credit that may be provided by lenders other than brokers and dealers when
the credit is used to purchase or carry publicly held
equity securities if the loan is secured by those or
other publicly held equity securities. The Board’s
Regulation X applies these credit limitations, or margin requirements, to certain borrowers and to certain
credit extensions, such as credit obtained from foreign lenders by U.S. citizens.
Several regulatory agencies enforce the Board’s securities credit regulations. The SEC, the Financial
Industry Regulatory Authority, and the Chicago
Board Options Exchange examine brokers and dealers for compliance with Regulation T. With respect to
compliance with Regulation U, the federal banking
agencies examine banks under their respective jurisdictions; the Farm Credit Administration and the
NCUA examine lenders under their respective jurisdictions; and the Federal Reserve examines other
Regulation U lenders.

111

Consumer and Community Affairs

The Division of Consumer and Community Affairs
(DCCA) has primary responsibility for carrying out
the Board’s consumer protection, supervision, and
community development programs. DCCA augments
its expertise in consumer protection law, regulation,
and policy with resources from other functions of the
Board and the Federal Reserve System to write and
interpret regulations, educate and inform consumers,
and enforce laws and regulations for consumer financial products and services.
Throughout 2011, the division engaged in significant
activities to further consumer protection and community development, while also supporting the transfer
of certain rules and supervisory responsibilities to the
recently formed Consumer Financial Protection
Bureau (CFPB). Key elements of the division’s program, include
• drafting and proposing regulations to implement
legislation, updating regulations, designing disclosures to provide consumers consistent and vital
information on financial products, and prohibiting
unfair and deceptive acts and practices
• supervising state member banks and bank holding
companies and their nonbank affiliates to enforce
consumer protection laws and regulations
• processing consumer complaints and inquiries to
help consumers resolve grievances with their financial institutions and to answer their questions
• conducting research on consumer decisionmaking
regarding financial services to better understand
consumers’ choices
• researching the implications of policy on consumer
financial markets
• reaching out to national and local government
agencies, consumer and community groups, academia, and industry to gain a broad range of perspectives, and to inform policy decisions and highlight effective practices

• supporting national and local agencies and organizations that work to protect and promote community development and economic empowerment for
historically underserved communities
On July 21, 2011, much of the Board’s rulewriting
and some of its supervisory authority regarding consumer protection transferred to the CFPB, which was
established under the Dodd-Frank Wall Street
Reform and Consumer Financial Protection Act (the
Dodd-Frank Act) to conduct rulemaking, supervise
large insured depository institutions and credit
unions (and their affiliates) for compliance with federal consumer financial laws, and to enforce those
laws.1
The Board retains supervisory authority for state
member banks with assets of $10 billion or less, as
well as responsibility for examinations of all state
member banks, regardless of asset size, for compliance with the Community Reinvestment Act, Fair
Housing Act, Servicemembers’ Civil Relief Act, and
other laws. In addition, DCCA continues to promote
community development and neighborhood revitalization, advise the Board on the implications of economic and supervisory policies on consumer protection, and conduct research on consumer financial
behaviors and policies.

Rulemaking and Regulations
Mortgage Transactions
In 2011, the Federal Reserve issued proposed and
final rules to implement various aspects of the Dodd1

For additional information, see the Consumer Financial Protection Bureau’s website at www.consumerfinance.gov and “Supervisory Statement: Determination of Depository Institution and
Credit Union Asset Size for Purposes of Section 1025 and 1026
of the Dodd-Frank Wall Street Reform and Consumer Protection Act” at www.federalreserve.gov/newsevents/press/bcreg/
bcreg20111117a1.pdf.

112

98th Annual Report | 2011

Frank Act as it relates to certain home mortgages.
Many of the proposed rulemakings transferred to the
CFPB to be finalized.
Escrow Accounts
In late February, the Federal Reserve issued a final
rule under Regulation Z (Truth in Lending) pursuant
to the Dodd-Frank Act that increases the annual percentage rate (APR) threshold used to determine
whether a mortgage lender is required to establish an
escrow account for property taxes and insurance for
first-lien, “jumbo” mortgage loans. Loans subject to
this rule are defined as loans exceeding the conforming loan-size limit for purchase by the Federal Home
Loan Mortgage Corporation (Freddie Mac), as
specified by the legislation. Under this rule, the
escrow requirement applies to first-lien jumbo loans
only if the loan’s APR is higher than the average
prime offer rate by 2.5 percentage points or more.
A second rule was proposed under the Dodd-Frank
Act that would expand the minimum period for mandatory escrow accounts for first-lien, higher-priced
mortgage loans from one year to five years. Under
certain circumstances, such as when the loan is delinquent or in default, the minimum period for mandatory escrow could be even longer. The proposed rule
would provide an exemption from the escrow requirement for certain creditors that operate in “rural or
underserved” counties, as authorized by the legislation. The proposal would also implement the DoddFrank Act requirement that consumers receive disclosures at least three business days before consummation of a mortgage loan to explain, as applicable,
how the escrow account works or the effects of not
having an escrow account if one is not being established. Under the Dodd-Frank Act, consumers must
also receive disclosures three days before an escrow
account is closed.
One concern that emerged from the mortgage crisis
was that some subprime loans did not require an
escrow account for taxes and insurance and, as a
result, borrowers experienced payment shock when
they were required to pay these costs outside of their
monthly mortgage payment.

and insurance associated with a mortgage loan affect
the overall costs of the transaction.2
Ability to Repay
In April, the Federal Reserve Board issued a proposed rule that would require creditors to determine
a consumer’s ability to repay a mortgage before making the loan and would establish minimum mortgage
underwriting standards.3
The proposed rule applied to all consumer mortgages, except home equity lines of credit, timeshare
plans, reverse mortgages, or temporary loans.
The proposal provided four options for a creditor in
complying with the ability-to-repay requirement:
1. Consider and verify specified underwriting factors, such as the consumer’s income or assets.
2. Make a “qualified mortgage,” which provides the
creditor with special protection from liability if
the loan does not have certain features, such as
negative amortization; the fees are within specified limits; and the creditor underwrites the mortgage payment using the maximum interest rate in
the first five years.4
3. For lenders operating predominantly in rural or
underserved areas, make a balloon-payment
qualified mortgage. This option was meant to
preserve access to credit for consumers located in
rural or underserved areas where banks originate
balloon loans to hedge against interest rate risk
for loans held in portfolio.
4. Refinance a “non-standard mortgage” with risky
features into a more stable “standard mortgage”
with a lower monthly payment. This option was
meant to preserve access to streamlined
refinancings.
Provisions of the proposal were designed to also
implement Dodd-Frank Act limits on prepayment
penalties. The proposed revisions to the regulation,
which implement the Truth in Lending Act (TILA),
were made pursuant to the Dodd-Frank Act, which
also transferred general rulemaking authority for
2

The aim of the final and proposed rules is to ensure
more mortgage borrowers are aware of how taxes
3

4

For more information about the Federal Reserve’s final and proposed regulations relating to escrow accounts, go to www
.federalreserve.gov/newsevents/press/bcreg/20110223b.htm.
For more information about the Federal Reserve’s ability-torepay proposal, go to www.federalreserve.gov/newsevents/press/
bcreg/20110419a.htm.
The Board is soliciting comment on two alternative approaches
for defining a “qualified mortgage.”

Consumer and Community Affairs

113

TILA to the CFPB. Thus, the proposed rules were
transferred to the CFPB to be finalized.

areas of uncertainty so that card issuers fully understand their compliance obligations.

Credit Cards and Open-End Credit Plans

In order to protect consumers from incurring unaffordable levels of credit card debt, the Credit Card
Act requires that, before opening a new credit card
account or increasing the credit limit on an existing
account, card issuers consider a consumer’s ability to
make the required payments on the account. As
directed by the Credit Card Act, the Board’s rule
addresses practices that can result in extensions of
credit to consumers who lack the ability to pay. Specifically, the rule states that credit card applications
generally cannot request a consumer’s “household
income” because that term is too vague to allow issu-

In March, the Board amended Regulation Z to
clarify aspects of rules previously issued by the
Board implementing the Credit Card Accountability
Responsibility and Disclosure Act of 2009 (the
Credit Card Act).5 The amendments enhance protections for consumers who use credit cards and resolve
5

For more information about the Federal Reserve’s rule to protect consumers from incurring unaffordable levels of credit card
debt, go to www.federalreserve.gov/newsevents/press/bcreg/
20110318b.htm.

Box 1. The Impact of the Dodd-Frank Act on DCCA
Implementation of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010 (the
Dodd-Frank Act) had unique implications for the
Board’s Division of Consumer and Community Affairs
(DCCA). The statute created the Consumer Financial
Protection Bureau (CFPB), and transferred to the
CFPB much of the Board’s rulewriting authority
regarding consumer financial services and fair lending laws as of July 21, 2011.
However, the Board retains rulewriting authority for
the Community Reinvestment Act (CRA) and for certain entities under specific statutory provisions. For
example, under the Equal Credit Opportunity Act, the
Board must issue rules for data collection by motor
vehicle dealers on their lending to women- and
minority-owned businesses and small businesses.
The Board will also issue interagency rules to implement provisions of the Truth in Lending Act concerning real estate appraisals.
The Board also retains supervisory and examination
oversight authority for more than 800 state member
banks with assets of $10 billion or less for their compliance with consumer protection laws and regulations. As a result, DCCA will continue to develop and
implement examination policy and programs for
these institutions. The Board also continues to oversee all state member banks, regardless of size, for
their compliance with the CRA, the Fair Housing Act,
the Federal Trade Commission Act, the Servicemembers’ Civil Relief Act, and other laws. DCCA staff will
continue to conduct consolidated supervisory activities for bank holding companies, assessing consumer compliance risk at the enterprise-wide level
and incorporating these analyses into the institution’s
overall supervisory standing. With these ongoing
supervisory responsibilities, DCCA oversees the
system’s consumer compliance supervision

programs, implements examiner training and commissioning programs, and reviews and analyzes
banking applications.
The Dodd-Frank Act mandates new coordination and
cooperation among federal banking agencies with
respect to the CFPB. The CFPB is required to coordinate supervisory activities and conduct simultaneous
examinations with prudential regulators, as well as
share draft reports, and to consult the federal banking agencies in exercising its rulemaking functions.
DCCA staff serves as the CFPB’s primary point of
contact for these coordinating activities, and consults
with other Board divisions to provide comments to
the CFPB as necessary. Board and Reserve Bank
staff monitor CFPB regulatory actions and assess
potential implications for consumers, financial institutions, and the relevant markets to help support the
Chairman in his position on the Financial Stability
Oversight Council.
In addition to these supervisory responsibilities,
DCCA has expanded its work in community development, policy analysis, and consumer research.
Because understanding consumer financial services
issues and meeting the financial needs of underserved markets remain top priorities for the Board,
staff analyze issues and monitor new developments.
This process includes outreach to a broad range of
leaders from industry, government, academic, think
tank, and community organizations. Such outreach
and research informs DCCA’s work on issues such as
housing, small business, neighborhood stabilization,
underserved markets, and community economic
development. With these roles, DCCA will continue to
bring forth consumer protection and community
development perspectives within broader federal
efforts to support the American economy.

114

98th Annual Report | 2011

ers to properly evaluate the consumer’s ability to pay.
Instead, issuers must consider the consumer’s individual income or salary.
In addition, the Board’s rule clarifies that promotional programs that waive interest charges for a
specified period of time are subject to the same
Credit Card Act protections as promotional programs that apply a reduced rate for a specified
period. For example, a card issuer that offers to waive
interest charges for six months is prohibited from
revoking the waiver and charging interest during the
six-month period, unless the account becomes more
than 60 days delinquent. Under the Board’s final
rule, application and similar fees that a consumer is
required to pay before a credit card account is
opened would be covered by the same Credit Card
Act limitations as fees charged during the first year
after the account is opened.
A lawsuit challenging the provisions of the final rule
was filed in July 2011 and was still pending at
year-end.
College Credit Card Agreements
In July, the Board released a report containing payment and account information for more than 1,000
agreements between credit card issuers and institutions of higher education or affiliated organizations
in 2010.6 The Board also updated its online database
to include the full text of each agreement that was in
effect during 2010 and the payment and accounts
information submitted by issuers.7 Users may also
search for agreements by card issuer, educational
institution or organization, or the city or state in
which the institution or organization is located.
The report was issued pursuant to the Credit Card
Act, which required issuers to submit to the Board
annually their agreements with educational institutions or affiliated organizations, such as alumni associations. For each agreement, issuers are also required
to submit information regarding payments made to
the institution or organization and the number of
accounts opened under the agreement.

6

7

The report, Federal Reserve Board of Governors Report to the
Congress on College Credit Card Agreements, July 2011, is available at www.federalreserve.gov/boarddocs/rptcongress/
creditcard/2011/downloads/ccap_2011.pdf.
The online database can be accessed at www.federalreserve.gov/
CollegeCreditCardAgreements.

Credit Score Disclosure
In conjunction with the Federal Trade Commission
(FTC), the Board issued final rules in July to implement requirements of the Dodd-Frank Act stipulating that if a credit score is used in setting material
terms of credit or in taking adverse action, creditors
must disclose credit scores and related information to
consumers in notices under the Fair Credit Reporting
Act (FCRA).8
The final rules amended Regulation V (Fair Credit
Reporting) to revise the content requirements for
risk-based pricing notices, and to add related model
forms that reflect the new credit score disclosure
requirements. The final rules also amended certain
model notices in Regulation B (Equal Credit Opportunity), which combine the adverse action notice
requirements for Regulation B and the FCRA, to
reflect the new credit score disclosure requirements.

Consumer Protection for Credit and
Leases
In March, the Board adopted two rules to expand the
coverage of consumer protection regulations to credit
transactions and leases of higher dollar amounts.9
These rules amend Regulation Z (TILA) and Regulation M (Consumer Leasing) to implement a provision of the Dodd-Frank Act, which requires that the
protections of TILA and the Consumer Leasing Act
(CLA) apply to consumer credit transactions and
consumer leases up to $50,000. Previously, the law
required these protections for transactions and leases
up to $25,000. (Private education loans and loans
secured by real property (such as mortgages) are subject to TILA regardless of the amount of the loan.)
The Dodd-Frank Act requires that this amount be
adjusted annually to reflect any increase in the consumer price index; the Board published the first
annual adjustment in June.

Remittances
In May, the Board proposed a rule to create new protections for consumers who send remittance transfers

8

9

For more information on the credit score disclosure requirements, go to www.federalreserve.gov/newsevents/press/bcreg/
20110706a.htm.
For more information about the new rules regarding high-dollar
amount credit transactions and leases, go to www.federalreserve
.gov/newsevents/press/bcreg/20110325a.htm.

Consumer and Community Affairs

to recipients located in a foreign country.10 The proposal was made under Regulation E (Electronic Fund
Transfers) pursuant to the Dodd-Frank Act.
The proposed rule required remittance transfer providers to make certain disclosures to senders of
remittance transfers, including information about
fees and the exchange rate, as applicable, and the
amount of currency to be received by the recipient.
In addition, the proposed rule provided error resolution and cancellation rights for senders of remittance
transfers. The authority for issuing final rules was
transferred to the CFPB in July 2011.

Data Collection by Motor Vehicle Dealers
In September, the Board issued a final rule amending
Regulation B to provide that motor vehicle dealers
are not required to comply with the new data collection requirements in the Dodd-Frank Act until the
Board issues final regulations to implement the statutory requirements.11
The Dodd-Frank Act amended the Equal Credit
Opportunity Act to require creditors to collect information about credit applications made by women- or
minority-owned businesses and small businesses. The
CFPB must implement this provision for all creditors
except certain motor vehicle dealers who are subject
to the Board’s jurisdiction. The CFPB previously
announced that creditors are not obligated to comply
with the data collection requirements until the CFPB
issues detailed rules to implement the law. The Board
amended Regulation B to apply the same approach
to motor vehicle dealers.

Oversight and Enforcement
The Board’s Division of Consumer and Community
Affairs develops and supports supervisory policy and
examination procedures for consumer protection
laws and regulations, as well as the Community Reinvestment Act (CRA), as part of its supervision of
state-chartered, depository institutions, and foreign
banking organizations that are members of the Federal Reserve System. The division also administers
the Federal Reserve System’s risk-focused program
10

11

For more information about the Federal Reserve’s proposal
regarding protections for consumers who send remittance transfers to recipients in foreign countries, go to www.federalreserve
.gov/newsevents/press/bcreg/20110512a.htm.
For more information about the Federal Reserve’s rule regarding data collection by motor vehicle dealers, go to www
.federalreserve.gov/newsevents/press/bcreg/20110920a.htm.

115

for assessing consumer compliance risk at the largest
bank and financial holding companies in the system.
Division staff ensure consumer compliance risk is
effectively integrated into the consolidated supervision of the holding company. The division also oversees the efforts of the 12 Reserve Banks to ensure
that consumer protection laws and regulations are
fully and fairly enforced. Division staff provide guidance and expertise to the Reserve Banks on consumer
protection regulations, bank and bank holding company application analysis and processing, examination and enforcement techniques and policy matters,
examiner training, and emerging issues. Staff also
review Reserve Bank supervisory reports, examination work products, and consumer complaint analyses and responses. Finally, staff members participate
in interagency activities that promote uniformity in
examination principles, standards, and processes.
In addition, throughout 2011, the system continued
its policy for conducting risk-focused consumer compliance supervision of, and the investigation of consumer complaints against, nonbank subsidiaries of
bank holding companies (BHCs) and foreign banking organizations (FBOs) with activities covered by
the consumer protection laws and regulations the
Federal Reserve has the authority to enforce. This
policy is designed to enhance understanding of the
consumer compliance risk profile of nonbank subsidiaries and to guide supervisory activities for these
entities. Initial supervisory activities first targeted
those nonbank subsidiaries considered to be of highest risk to the Federal Reserve System.12
Examinations are the Federal Reserve’s primary
method of enforcing compliance with consumer protection laws and assessing the adequacy of consumer
compliance risk-management systems within regulated entities. During the 2011 reporting period
(July 1, 2010, through June 30, 2011), the Reserve
Banks conducted 279 consumer compliance examinations of the system’s 835 state member banks and
two examinations of foreign banking organizations.13
12

Federal Reserve Board of Governors, 2009 Consumer Affairs
Letters, Consumer Compliance Supervision Policy for Nonbank
Subsidiaries of Bank Holding Companies and Foreign Banking
Organizations, CA-09-8, September 14, 2009, www
.federalreserve.gov/boarddocs/caletters/2009/0908/caltr0908.htm.

13

The foreign banking organizations examined by the Federal
Reserve are organizations that operate 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 Community Reinvestment Act and typically engage in

116

98th Annual Report | 2011

Bank Holding Company Consolidated
Supervision Program
During 2011, staff in the BHC Consolidated Supervision Program had responsibility for reviewing more
than 90 bank and financial holding companies to
ensure consumer compliance risk was appropriately
incorporated into the consolidated risk assessment
for the organization. Through a combination of riskfocused, on-/off-site examination and monitoring
activities, supervisory staff were able to assess the
impact enterprise-wide consumer issues had on the
overall risk profiles of the consolidated entity. In
addition, per changes brought about by the DoddFrank Act, supervisory functions related to savings
and loan holding companies (SLHCs) were transferred to the Board, and SLHCs were added to the
portfolio of entities covered by the Consolidated
Supervision Program.
BHC Consolidated Supervision Program staff also
participated jointly with staff of the Board’s Division
of Banking Supervision and Regulation on numerous
Dodd-Frank Act related implementation projects
regarding supervisory assessment fees, consolidated
supervision, and thrift holding company integration.
Also, as part of the consolidated supervision of
BHCs, staff participated in the reviews of mortgage
servicing and foreclosure processing at four of the 14
federally regulated mortgage servicers that took place
between November 2010 and January 2011, and that
resulted in enforcement actions in April 2011. Program staff monitor compliance with the provisions in
the consent orders for the servicers and BHCs to
ensure that noted deficiencies are corrected, future
abuses in the loan modification and foreclosure process are prevented, and borrowers are compensated
for financial injury they suffered as a result of errors,
misrepresentations, or other deficiencies in the foreclosure process (see box 2).

relatively few activities covered by consumer protection laws.
There are 197 such institutions throughout the Federal Reserve
System.

Throughout 2011, the Federal Reserve System continued to conduct risk-focused consumer compliance
supervision of nonbank subsidiaries of BHCs and
FBOs with regard to activities covered by consumer
protection laws and regulations the Federal Reserve
has the authority to enforce, and to investigate certain consumer complaints against nonbank subsidiaries of BHCs and FBOs. This policy was designed
to enhance the system’s understanding of the consumer compliance risk profile of nonbank subsidiaries and to guide supervisory activities for these entities. Initial supervisory activities first targeted those
nonbank subsidiaries considered to be of highest risk
to the Federal Reserve System.
Supervisory Matters
In July 2011, the Board issued a consent cease and
desist order against Wells Fargo & Company and its
subsidiary, Wells Fargo Financial, Inc., for lack of
sufficient controls in the refinancing of existing home
mortgages.14 The order assessed a $85 million civil
money penalty, the largest penalty in a consumerprotection action, and is the first enforcement action
taken by a federal banking regulator addressing
alleged steering of borrowers to higher-cost loans.
The order alleges that Wells Fargo Financial steered
borrowers who potentially were eligible for prime rate
loans to subprime loans. Additionally, the order
addresses allegations that Wells Fargo Financial
employees falsified borrowers’ income in an effort to
qualify the borrowers for loans they otherwise would
have not qualified for based on their actual income.
The deficiencies noted in the order allege unsafe and
unsound banking practices and unfair or deceptive
acts and practices. The order requires Wells Fargo
Financial to compensate borrowers affected by the
practices between January 2006 and June 2008, and
to develop specific plans to identify and compensate
the affected borrowers. The Board is required to
approve the compensation plans and will monitor
ongoing compliance with the approved plans.
14

See Press Release (July 20, 2011), available at www.federalreserve
.gov/newsevents/press/enforcement/20110720a.htm.

Consumer and Community Affairs

Community Reinvestment Act Compliance
The CRA requires that the Federal Reserve and other
federal banking and thrift agencies encourage financial institutions to help meet the credit needs of the
local communities in which they do business, consistent with safe and sound operations. To carry out this
mandate, the Federal Reserve
• examines state member banks to assess their compliance with the CRA
• analyzes applications for mergers and acquisitions
by state member banks and bank holding companies in part within the context of CRA
performance
• disseminates information about community development techniques to bankers and the public
through Community Development offices at the
Reserve Banks
The Federal Reserve assesses and rates the CRA performance of state member banks in the course of
examinations conducted by staff at the 12 Reserve
Banks. During the 2011 reporting period, the Reserve
Banks conducted 250 CRA examinations of state
member banks. Of those banks examined, 28 were
rated “Outstanding,” 215 were rated “Satisfactory,”
seven were rated “Needs to Improve,” and none were
rated “Substantial Non-Compliance.”
During the summer of 2010, the Federal Reserve and
the other federal banking and thrift regulatory agencies held public hearings in four cities (Arlington,
Virginia; Atlanta, Georgia; Chicago, Illinois; and Los
Angeles, California), and invited public comment on
ways that the regulations implementing the CRA
could be revised to better reflect current banking
practices. In addition to public hearings, the agencies
invited written comments, and the Federal Reserve
received nearly 1,200 comment letters.15 Input from
the hearings and the comment letters continue to be
considered as part of the process for updating CRA
regulations that has been underway throughout 2011.
The agencies are also considering updates to the
regulations and examination policies to reflect
changes in the financial services industry, including
how banking services are delivered to consumers, to
ensure that the CRA continues to be effective in

encouraging institutions to meet community credit
needs.16
Mergers and Acquisitions
in Relation to the CRA
During 2011, the Board considered and approved 10
banking merger applications that were protested on
CRA or fair lending grounds or that raised issues
involving consumer compliance or the CRA.17
• An application by The Goldman Sachs Group,
Inc., New York, New York, to retain 9.8 percent of
the outstanding common stock of Avenue Financial Holdings, Inc., of Nashville, Tennessee, was
approved in March.18
• An application by First Niagara Financial Group,
Inc. and FNFG Merger Sub, Inc., both of Buffalo,
New York, to acquire NewAlliance Bancshares,
Inc., New Haven, Connecticut, was approved in
March.
• An application by M&T Bank Corporation, Buffalo, New York, to acquire Wilmington Trust Corporation, Wilmington, Delaware, was approved in
April.
• An application by Hancock Holding Company,
Gulfport, Mississippi, to acquire Whitney Holding
Corporation, New Orleans, Louisiana, was
approved in May.
• An application by Bank of Montreal, Toronto,
Canada, to acquire Marshall & Ilsley Corporation,
Milwaukee, Wisconsin, was approved in June.
• An application by Comerica, Incorporated, Dallas,
Texas, to acquire Sterling Bancshares, Houston,
Texas, was approved in July.
• An application by Centennial Bank, Conway,
Arkansas, to establish a mobile branch to serve
Bay, Calhoun, Franklin, Gulf, Lake, Leon, Liberty,
Orange, and Seminole Counties in Florida was
approved under delegated authority in July.
16

17

18

15

For additional information on CRA rules, see www
.federalreserve.gov/newsevents/press/bcreg/20101215a.htm.

117

For additional information on the role of the Community Reinvestment Act, see www.federalreserve.gov/newsevents/speech/
yellen20110609a.htm.
Another protested application was withdrawn by the applicant.
For more information on Orders on Banking Applications in
2011, go to www.federalreserve.gov/newsevents/press/orders/
2011orders.htm.
Two other applications by The Goldman Sachs Group, Inc.,
were approved under delegated authority. These were applications to retain 9.0 percent of the outstanding common stock of
Atlantic Capital Bancshares, Inc., Atlanta, Georgia, and to
retain its interest in The First Marblehead Corporation, Boston,
Massachusetts.

118

98th Annual Report | 2011

Box 2. The Foreclosure Crisis: Federal Reserve Enforcement Action
The financial crisis and meltdown of the mortgage
market that began in 2008 marked the beginning of
a sharp rise in foreclosures that has not been seen
since the Great Depression. By the fourth quarter of
2010, 2.4 million mortgage loans were at some point
in the foreclosure process and another two million
loans were 90 or more days past due and at risk of
foreclosure.
In the midst of this wave of foreclosures, concerns
surfaced about improper foreclosure processing
practices by some mortgage servicers; alleged
improper practices ranged from faulty paperwork
processes to wrongful foreclosure. To gain insight
into these matters, the Federal Reserve System,
along with the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corporation, conducted
on-site reviews of 14 federally regulated mortgage
servicers that collectively represent more than twothirds of the servicing industry, or nearly 36.7 million
mortgages.1 This process began in November 2010
and was concluded in January 2011.
The review found critical weaknesses in the firms’
foreclosure governance processes, foreclosure
documentation processes, staffing and training, and
oversight and monitoring of third-party law firms and
other vendors, as well as undue emphasis on quantitative production and timeliness. These weaknesses involved unsafe and unsound practices, violations of federal and state laws, and a pattern of
misconduct and negligence by the mortgage
servicers.
In April 2011, the Board issued formal enforcement
actions against ten banking organizations under its
jurisdiction, requiring them to promptly initiate steps
1

See Interagency Review of Foreclosure Policies and Practices at
www.federalreserve.gov/boarddocs/rptcongress/interagency_
review_foreclosures_20110413.pdf.

• An application by Green Dot Corporation, Monrovia, California, to acquire Bonneville Bancorp,
Provo, Utah, was approved in November.
• An application by Brookline Bancorp, Inc.,
Brookline, Massachusetts, to acquire Bancorp
Rhode Island, Inc., Providence, Rhode Island, was
approved in December.
• An application by Banco de Brasil, S.A., Brasilia
and Caixa de Previdencia dos Funcionarios do
Banco do Brasil, Rio de Janeiro, Brazil, to acquire
EuroBank, Coral Gables, Florida, was approved in
December.

35

444

to establish servicing and foreclosure processes that
treat customers fairly, are fully compliant with all
applicable law, and are safe and sound.2 The banking organizations that have servicing entities regulated by the Board were also assessed monetary
sanctions totaling about $767 million.3 Consent
orders required these mortgage servicers to hire
independent consultants to develop action plans for
remedying borrowers who had been harmed by the
firms’ deficient practices.4 Mortgage servicers were
also required to conduct broad outreach to alert consumers of the opportunity to apply for consideration
for remedy. To assist in this effort, the Board
launched a consumer education campaign on its
website and conducted webinar trainings to educate
housing counselors on the process.5
These enforcement actions are just one element of
the Federal Reserve’s ongoing efforts to assist consumers and communities dealing with the aftermath
of the mortgage and foreclosure crisis. The mortgage servicing remediation process continues
through 2012, and the Board will continue to work to
ensure that a fair and impartial process for redress
is available to borrowers who were harmed by servicer errors, misrepresentations, or other foreclosure
deficiencies.
2

3

4

5

See Press Release (April 13, 2011), available at www
.federalreserve.gov/newsevents/press/enforcement/20110413a
.htm.
See Press Release (February 9, 2012), available at www
.federalreserve.gov/newsevents/press/enforcement/20120209a
.htm.
See Press Release (February 27, 2012), available at www
.federalreserve.gov/newsevents/press/enforcement/20120227a
.htm.
See What You Need to Know: Independent Foreclosure Review
(www.federalreserve.gov/consumerinfo/independent-foreclosurereview.htm) and “Independent Foreclosure Review process
webinar training for housing counselors” (www.federalreserve
.gov/consumerinfo/housing-counselors-webinar.htm).

Members of the public had the opportunity to submit comments on these applications; their comments
raised various issues. Several commenters cited failure to make credit available to certain minority
groups and to low- and moderate-income individuals
and in low- and moderate-income geographies. Commenters also cited predatory and discriminatory lending practices with respect to residential mortgages
and small business loans as well as failure to provide
reverse mortgage candidates with counseling in violation of state law. Other commenters alleged predatory servicing and unethical business practices. Several comments warned of inadequate plans to meet

Consumer and Community Affairs

communities’ credit needs and a reduction in access
to credit for affected communities. Additionally, commenters expressed general concerns about CRA,
including concerns that branches in predominantly
minority census tracts were not proportionate to
the percentage of the population residing in those
tracts.
In approving the application by Green Dot Corporation to become a bank holding company, by converting Bonneville Bank from a retail bank to a “monoline” prepaid debit card bank, the Board considered
the inherent risks of a bank with one primary product, the safeguards established to reduce those risks,
and ways in which the bank would meet its CRA
obligations.
In addition, an application by Capital One Financial
Corporation, McLean, Virginia, to acquire ING,
FSB, Wilmington, Delaware (ING), was filed in July,
and more than 900 comments were submitted by
individuals and community groups, almost two-thirds
of which opposed the merger. The proposal was one
of the first of its kind to be subject to the financial
stability factor mandated by the Dodd-Frank Act.
The Board held three public meetings regarding this
proposal: in Washington, D.C., on September 20,
2011; in Chicago, Illinois, on September 27, 2011;
and in San Francisco, California, on October 5, 2011.
The Board also extended the comment period from
August 22, 2011, to October 12, 2011, to allow members of the public additional time to submit comments on the proposal. Commenters expressed concerns about Capital One’s undue concentration in
credit cards and inadequate affordable mortgage and
small business lending given its nationwide credit
card lending and deposit-taking activities. Commenters urged the Board to delay or deny the proposal
until the CRA regulation has been reformed to
accommodate such nationwide lenders as well as
internet banks, such as ING. Commenters contended
that any public benefits would be inadequate to offset
the increase in risk posed to the financial system
given projected increases in Capital One’s size and
complexity. The proposal ultimately was approved in
February 2012.19
The Board also considered 89 applications with outstanding issues involving compliance with consumer
protection statutes and regulations, including fair
lending laws and the CRA. Some of those issues
19

See Press Release (February 14, 2012), available at www
.federalreserve.gov/newsevents/press/orders/20120214a.htm.

119

involved unfair and deceptive practices as well as
concerns about stored value cards. Eighty-one of
those applications were approved and eight were
withdrawn.

Fair Lending Enforcement
The Federal Reserve is committed to ensuring that
the institutions it supervises comply fully with the
federal fair lending laws—the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act. The
ECOA prohibits creditors from discriminating
against any applicant, in any aspect of a credit transaction, on the basis of race, color, religion, national
origin, sex, marital status, or age. In addition, creditors may not discriminate against an applicant
because the applicant receives income from a public
assistance program or has exercised, in good faith,
any right under the Consumer Credit Protection Act.
The Fair Housing Act prohibits discrimination in
residential real estate-related transactions, including
the making and purchasing of mortgage loans, on
the basis of race, color, religion, sex, handicap, familial status, or national origin.
Supervisory Matters
The Federal Reserve supervises approximately 825
state member banks. Pursuant to provisions of the
Dodd-Frank Act, effective on July 21, 2011, the
CFPB supervises state member banks with assets of
more than $10 billion for compliance with the
ECOA, while the Board retains supervisory authority
for compliance with the Fair Housing Act. For the
approximately 800 state member banks with assets of
$10 billion or less, the Board retains the authority to
enforce both the ECOA and the Fair Housing Act.
Fair lending reviews are conducted regularly within
the supervisory cycle. Additionally, examiners may
conduct fair lending reviews outside of the usual
supervisory cycle, if warranted by fair lending risk.
When examiners find evidence of potential discrimination, they work closely with the division’s Fair
Lending Enforcement Section, which brings additional legal and statistical expertise to the examination and ensures that fair lending laws are enforced
consistently and rigorously throughout the Federal
Reserve System.
Pursuant to the ECOA, if the Board has reason to
believe that a creditor has engaged in a pattern or
practice of discrimination in violation of the ECOA,
the matter will be referred to the U.S. Department of
Justice (DOJ). The DOJ reviews the referral and

120

98th Annual Report | 2011

determines whether further investigation is warranted. A DOJ investigation may result in a public
civil enforcement action or settlement. Alternatively,
the DOJ may decide to return the matter to the
Board for administrative enforcement. When a matter is returned to the Board, staff ensures that the
institution takes all appropriate corrective action.

soon as they become aware of a problem. Thus, the
Federal Reserve generally uses informal supervisory
tools (such as memoranda of understanding between
the bank’s board of directors and the Reserve Bank,
or board resolutions) to ensure that violations are
corrected. If necessary to protect consumers, however, the Board can bring public enforcement actions.

During 2011, the Board referred the following five
matters to the DOJ:

Financial Fraud Enforcement Task Force and
Other Outreach
As an active member of the Financial Fraud
Enforcement Task Force (FFETF), the Board coordinates with other agencies to facilitate consistent
and effective enforcement of the fair lending laws.
The Director of the Board’s Division of Consumer
and Community Affairs co-chairs the FFETF’s NonDiscrimination Working Group with the Assistant
Attorney General for DOJ’s Civil Rights Division,
the Deputy General Counsel of the U.S. Department
of Housing and Urban Development, the Assistant
Director of the CFPB’s Office of Fair Lending and
Equal Opportunity, and the National Association of
Attorneys General, represented by the Attorney General for the State of Illinois. The working group
monitors new practices and trends to proactively
address fair lending issues. The Board has taken a
lead role in the working group’s effort to analyze data
on Treasury’s Home Affordable Modification Program for any evidence of potential discrimination by
participating servicers. The Board and the NonDiscrimination Working Group have also sponsored
outreach events for local housing organizations, community groups, and financial institutions. These
events have included listening sessions as well as a
free interagency webinar that had over 6,000 registrants, most of which were community banks.

• One referral involved discrimination on the basis of
national origin, in violation of the ECOA and the
Fair Housing Act. The lender charged borrowers
fees that were identified as discount points, but that
did not actually result in a proportional decrease in
the interest rate (unearned discount points). The
practice violated Section 5 of the Federal Trade
Commission Act, and had a disparate impact on
Hispanic borrowers.
• One referral involved discrimination on the basis of
sex, in violation of the ECOA and the Fair Housing Act, and on the basis of familial status, in violation of the Fair Housing Act. The lender failed to
consider a woman’s employment status and reasonably expected income while she was on unpaid
maternity leave under the Family and Medical
Leave Act.
• One referral involved discrimination on the basis of
marital status and age, in violation of the ECOA.
The lender treated unmarried joint applicants differently than married joint applicants and applicants 21 years old or younger differently than older
applicants in underwriting for consumer credit.
• One referral involved discrimination on the basis of
sex and marital status in credit reporting, in violation of the ECOA. The lender failed to provide
information to consumer reporting agencies about
the payment history of spouses (almost all of
whom were women) that were contractually obligated on the note.
• One referral involved discrimination on the basis of
marital status, in violation of the ECOA. The bank
improperly required spousal guarantees and signatures on commercial or agricultural loans, in violation of Regulation B.

In addition, the Federal Reserve participates in
numerous meetings, conferences, and trainings sponsored by consumer advocates, industry representatives, and interagency groups. Fair Lending Enforcement staff meets regularly with consumer advocates,
supervised institutions, and industry representatives
to discuss fair lending matters and receive feedback.
Through this outreach, the Board is able to address
emerging fair lending issues and promote sound fair
lending compliance.

Flood Insurance
If a fair lending violation does not constitute a pattern or practice, the Federal Reserve acts on its own
to ensure that the violation is remedied by the bank.
Most lenders readily agree to correct fair lending violations. In fact, lenders often take corrective action as

The National Flood Insurance Act imposes certain
requirements on loans secured by buildings or mobile
homes located in, or to be located in, areas determined to have special flood hazards. Under the Fed-

Consumer and Community Affairs

eral Reserve’s Regulation H, which implements the
act, state member banks are generally prohibited
from making, extending, increasing, or renewing any
such loan unless the building or mobile home, as well
as any personal property securing the loan, are covered by flood insurance for the term of the loan. The
law requires the Board and other federal financial
institution regulatory agencies to impose civil money
penalties when they find a pattern or practice of violations of the regulation. The civil money penalties
are payable to the Federal Emergency Management
Agency (FEMA) for deposit into the National Flood
Mitigation Fund.
During 2011, the Board imposed civil money penalties against 10 state member banks related to violations of Regulation H. The dollar amount of the
penalties, which were assessed via consent orders,
totaled $199,700.

for applications they receive on or after January 30,
2011.
• Revised Interagency Examination Procedures for
Regulation Z: Loan Originator Compensation. Procedures were revised to incorporate final Regulation Z rules with an April 1, 2011, effective date.
Specifically, the rules prohibit loan originators
from receiving compensation that is based on the
interest rate or other loan terms, except the amount
of credit extended. They also prohibit a loan originator who receives compensation directly from the
consumer from also receiving compensation from
the lender or another party. Additionally, loan
originators are prohibited from directing or “steering” a consumer to accept a mortgage loan that is
not in the consumer’s interest in order to increase
the originator’s compensation.
The examination procedures also incorporated
amendments to Regulation Z that implemented the
appraisal independence provision of the DoddFrank Act. These amendments require that fee
appraisers receive customary and reasonable compensation for their services. Finally, the revised procedures also implemented regulatory amendments
that increase the APR threshold used to determine
whether a mortgage lender is required to establish
an escrow account for first lien, “jumbo” mortgage
loans.

Coordination with Other
Federal Banking Agencies
The member agencies of the Federal Financial Institutions Examination Council (FFIEC) develop uniform examination principles, standards, procedures,
and report formats.20 In 2011, the FFIEC member
organizations issued the examination procedures and
guidance regarding a number of regulations.
• Interagency Examination Procedures for Regulation Z: Mortgage Disclosure. Procedures were
revised to incorporate two separate Regulation Z
rulemaking changes that had January 2011 effective
dates. The first rulemaking implemented the Helping Families Save Their Homes Act of 2009, which
amended the Truth in Lending Act and requires
that consumers receive notice when their mortgage
loans are sold, assigned, or otherwise transferred.
The second rulemaking implemented provisions of
the Mortgage Disclosure Improvement Act
(MDIA), which requires lenders to disclose how
borrowers’ regular mortgage payments can change
over time. Specifically, the MDIA, which amended
the Truth in Lending Act, seeks to ensure that
mortgage borrowers are alerted to the risks of payment increases before they take out mortgage loans
with variable rates or payments. Lenders were
required to comply with these MDIA provisions
20

FFIEC member agencies include the Board of Governors of the
Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of
the Comptroller of the Currency, and the CFPB, which replaced
the former Office of Thrift Supervision on the FFIEC.

121

• Revised Interagency Examination Procedures for
Regulation Z: Exempt Transaction Thresholds. Procedures were revised to incorporate Dodd-Frank
Act revisions to Regulation Z that increase the
thresholds for exempt consumer credit transactions
from $25,000 to $50,000, effective July 21, 2011. In
addition, the Dodd-Frank Act provides that, on or
after December 31, 2011, the threshold must be
adjusted annually by any annual percentage
increase in the consumer price index. Accordingly,
the exemption threshold increased from $50,000 to
$51,800 effective January 1, 2012.
• Interagency Examination Procedures for Regulation Z: Credit Card Protections. The Federal
Reserve approved a rule amending Regulation Z to
clarify previous rules implementing the Credit
Card Act. This rule is intended to enhance protections for consumers who use credit cards and to
resolve areas of uncertainty so that card issuers
fully understand their compliance obligations.21
21

Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
bankinforeg/caletters/caltr1108.htm.

122

98th Annual Report | 2011

• Revised Interagency Examination Procedures for
Regulation P: Voluntary Model Privacy Notice. Procedures were revised to incorporate Regulation P
rulemaking through which several federal regulatory agencies adopted a voluntary model privacy
notice form designed to make it easier for consumers to understand how financial institutions collect
and share nonpublic personal information. A
financial institution can use the model form to
obtain a “safe harbor” for compliance with the
requirements to notify consumers of its
information-sharing practices and their right to opt
out of certain sharing practices.22

Training for Bank Examiners
Ensuring that financial institutions comply with laws
that protect consumers and encourage community
reinvestment is an important part of the bank examination and supervision process. As the number and
complexity of consumer financial transactions grow,
training for examiners of the organizations under the
Federal Reserve’s supervisory responsibility becomes
even more important. The staff development function is responsible for the ongoing development of
the professional consumer compliance supervisory
staff, and ensuring that these staff members have the
skills necessary to meet their supervisory responsibilities now and in the future.
Consumer Compliance
Examiner Training Curriculum
The consumer compliance examiner training curriculum consists of six courses focused on various consumer protection laws, regulations, and examining
concepts. In 2011, these courses were offered in 10
sessions, and training was delivered to a total of 197
system consumer compliance examiners and staff
members, and 12 state banking agency examiners.
When appropriate, courses are delivered via alternative methods, such as the Internet or other distancelearning technologies. For instance, several courses
use a combination of instructional methods:
(1) classroom instruction focused on case studies and
(2) specially developed computer-based instruction
that includes interactive self-check exercises.
Board and Reserve Bank staff regularly review the
core curriculum for examiner training, updating sub22

Federal Reserve Board, Banking Information and Regulation,
Supervision, Consumer Affairs Letters, www.federalreserve.gov/
boarddocs/caletters/2011/1104/caltr1104.htm.

ject matter and adding new elements as appropriate.
During 2011, staff initiated one curriculum review.
The “Introduction to Consumer Compliance Examinations” course was reviewed in order to incorporate
technical changes in policy and laws, along with
changes in instructional delivery techniques. This
course is designed to equip assistant-level examiners
with the skills and knowledge of consumer laws and
regulations that govern deposit operations and nonreal estate lending. The course emphasizes the knowledge and practical application of consumer compliance laws, examination techniques, and examination
procedures. In addition, a curriculum review of the
“Fair Lending Examination Techniques” course was
completed and the revised course was successfully
piloted in June. This course is designed to equip
assistant-level examiners with the skills and knowledge to plan and conduct a risk-focused fair lending
examination, and incorporates the FFIEC fair lending examination procedures.
Lifelong Learning
In addition to providing core examiner training, the
examiner staff development function emphasizes the
importance of continuing lifelong learning. Opportunities for continuing learning include special projects
and assignments, self-study programs, rotational
assignments, the opportunity to instruct at system
schools, mentoring programs, and an annual consumer compliance examiner forum, where senior consumer compliance examiners receive information on
emerging compliance issues and are able to share best
practices from across the system.
In 2011, the system continued to offer “Rapid
Response” sessions, which are a powerful training
delivery method for just-in-time training. Debuted in
2008, Rapid Response sessions offer examiners teleconference presentations on emerging issues or
urgent training needs that result from the implementation of new laws, regulations, or supervisory guidance. A total of five consumer compliance Rapid
Response sessions were designed, developed, and presented to system staff during 2011.

Agency Reports on Compliance with
Consumer Protection Laws
The Board reports annually on compliance with consumer protection laws by entities supervised by federal agencies. This section summarizes data collected
from the 12 Federal Reserve Banks, the FFIEC mem-

Consumer and Community Affairs

ber agencies, and other federal enforcement agencies.23
Regulation B (Equal Credit Opportunity)
The FFIEC agencies reported that approximately
89 percent of the institutions examined during the
2011 reporting period were in compliance with Regulation B, compared with 82 percent for the 2010
reporting period. The most frequently cited violations involved failure to
• provide a timely and/or accurate notice of
approval, counteroffer, or adverse action within 30
days after receiving a completed credit application
• include the required information in the credit
action notification letter, including ECOAprohibited bases, the name of the federal agency
responsible for overseeing compliance with the
regulation, and the specific reasons for any adverse
action
• collect information about applicants seeking credit
primarily for the purchase or refinancing of a principal residence, including applicant race, ethnicity,
sex, marital status, and age, for government monitoring purposes
The Office of the Comptroller of the Currency
(OCC) initiated one formal Regulation B-related
public enforcement action during the reporting
period, while the Office of Thrift Supervision (OTS)
initiated six and the Federal Deposit Insurance Corporation (FDIC) initiated 20.24 There were no other
enforcement actions by FFIEC agencies.
The other agencies that enforce the ECOA—the Federal Trade Commission (FTC), the Farm Credit
Administration (FCA), the Department of Transportation (DOT), the Securities and Exchange Commission (SEC), the Small Business Administration, and
the Grain Inspection, Packers and Stockyards
Administration of the Department of Agriculture—
reported substantial compliance among the entities
they supervise.

23

24

Because the agencies use different methods to compile the data,
the information presented here supports only general conclusions. The 2011 reporting period was July 1, 2010, through
June 30, 2011.
Consumer compliance public enforcement actions are categorized by regulation throughout the report. Because some
enforcement actions include violations of more than one regulation, the overall sum of actions derived from each regulation
will be greater than the actual total number of enforcement
actions initiated, which was 107.

123

Regulation E (Electronic Fund Transfers)
The FFIEC agencies reported that approximately
94 percent of the institutions examined during the
2011 reporting period were in compliance with Regulation E, compared with 93 percent for the 2010
reporting period. The most frequently cited violations involved failure to
• investigate account errors within 10 business days
of receiving a notice that an error has occurred,
reporting the results of the investigation to the consumer within three business days, and correcting
any error within one business day
• follow procedures when the financial institution
determines that no account error or a different
error occurred, such as providing a written explanation to the consumer
• provide initial disclosures to consumers that contain required information, including the consumer’s liability for unauthorized transfers, contact
information for reporting unauthorized transfers,
fees for electronic fund transfers, etc.
The FDIC initiated nine formal Regulation E-related
enforcement actions during the reporting period,
while the OCC initiated four, and the OTS initiated
two. There were no other enforcement actions by
FFIEC agencies. However, the FTC initiated actions
against two institutions, continued litigation against
two institutions, and settled one case involving Regulation E violations.
Regulation M (Consumer Leasing)
The FFIEC agencies reported that nearly 100 percent
of the institutions examined during the 2011 reporting period were in compliance with Regulation M,
down slightly from full 100 percent compliance during the 2010 reporting period. The FDIC reported
one violation of Regulation M regarding the failure
to provide required lease disclosures.
The FFIEC agencies did not issue any public
enforcement actions specific to Regulation M during
the period.
Regulation P (Privacy of Consumer
Financial Information)
The FFIEC agencies reported that approximately
98 percent of the institutions examined during the
2011 reporting period were in compliance with Regulation P, which is the same rate of compliance as the
2010 reporting period. The most frequently cited violations involved failure to provide consumers with

124

98th Annual Report | 2011

• clear and conspicuous initial privacy notices
• a clear and conspicuous annual notice reflecting
the institution’s privacy policies and practices
• the required information in initial, annual, and
revised privacy notices
The FDIC initiated seven formal Regulation Prelated enforcement actions during the reporting
period.25 There were no other enforcement actions by
FFIEC agencies.
Regulation Z (Truth in Lending)
The FFIEC agencies reported that approximately
82 percent of the institutions examined during the
2011 reporting period were in compliance with Regulation Z, compared with 85 percent for the 2010
reporting period. The most frequently cited violations involved failure to
• provide a good faith estimate of the required disclosures before consummation, or not later than
three business days after receipt of a written loan
application, for certain residential mortgage transactions
• accurately disclose the finance charges in closedend credit transactions
• accurately disclose the annual percentage rate
(APR)
In addition, 111 banks supervised by the Federal
Reserve, FDIC, OCC, and OTS were required, under
the Interagency Enforcement Policy in Regulation Z,
to reimburse a total of approximately $350,000 to
consumers for understating APRs and/or finance
charges in their consumer loan disclosures.
The FDIC initiated 17 formal Regulation Z-related
enforcement actions during the reporting period, the
OTS initiated five, and the OCC initiated one. The
DOT continued to prosecute one air carrier for its
alleged improper handling of credit card refund
requests and other Federal Aviation Act violations.
The FTC continued its law enforcement activities
against institutions alleged to have violated Regulation Z, which included settling two cases and continuing litigation against another institution.

25

The FDIC’s reported information in this area relates to part
332—Privacy of Consumer Financial Information—of the
agency’s regulations and not Regulation P.

Regulation AA (Unfair or Deceptive
Acts or Practices)
The FFIEC agencies reported that approximately
99 percent of the institutions examined during the
2011 reporting period were in compliance with Regulation AA, which is the same rate of compliance as
for the 2010 reporting period. The most frequently
cited violations involved
• providing inaccurate advertising or misrepresenting
services, contracts, investments, or financial
conditions
• failure to provide clear and conspicuous written
notice of credit obligation to each co-signer prior
to their becoming obligated on a loan
• participating in unfair or deceptive acts or practices
The OCC initiated five formal Regulation AA-related
enforcement actions during the reporting period.
There were no other enforcement actions by FFIEC
agencies.
Regulation CC (Availability of Funds
and Collection of Checks)
The FFIEC agencies reported that approximately
94 percent of institutions examined during the 2011
reporting period were in compliance with Regulation CC, compared with 90 percent for the 2010
reporting period. The most frequently cited violations involved failure to
• make funds deposited from local and certain other
checks available for withdrawal within the times
prescribed by the regulation
• ensure that account deposit slips contain required
disclosures
• provide written notice to a consumer when placing
an exception hold on an account
The FDIC initiated five formal Regulation CCrelated enforcement actions during the reporting
period, while the OTS and OCC each initiated three
actions. There were no other enforcement actions by
FFIEC agencies.
Regulation DD (Truth in Savings)
The FFIEC agencies reported that approximately
89 percent of institutions examined during the 2011
reporting period were in compliance with Regulation DD, compared with 86 percent for the 2010
reporting period. The most frequently cited violations involved

Consumer and Community Affairs

• incorrect use of the phrase “annual percentage
yield” in an advertisement without providing
required additional terms and conditions

Table 1. Complaints against state member banks and
selected nonbank subsidiaries of bank holding companies
about regulated practices, by Regulation/Act, 2011

• providing misleading or inaccurate advertisements

Regulation/Act

• failure to provide accurate and complete account
disclosures

Regulation AA (Unfair or Deceptive Acts or Practices)
Regulation B (Equal Credit Opportunity)
Regulation BB (Community Reinvestment)
Regulation C (Home Mortgage Disclosure)
Regulation CC (Expedited Funds Availability)
Regulation D (Reserve Requirements)
Regulation DD (Truth in Savings)
Regulation E (Electronic Funds Transfers)
Regulation G (Disclosure/Reporting of CRA-Related
Agreements)
Regulation H (National Flood Insurance Act/Insurance Sales)
Regulation M (Consumer Lending)
Regulation P (Privacy of Consumer Financial Information)
Regulation Q (Payment of Interest)
Regulation V (Fair and Accurate Credit Transactions)
Regulation Z (Truth in Lending)
Fair Credit Reporting Act
Fair Debt Collection Practices Act
Fair Housing Act
Home Ownership Counseling
HOPA (Homeowners Protection Act)
Real Estate Settlement Procedures Act
Right to Financial Privacy Act
Protecting Tenants at Foreclosure Act
Servicemembers Civil Relief Act
Total

The FDIC initiated 16 formal Regulation DD-related
enforcement actions during the reporting period,
while the OTS initiated two and the OCC initiated
one. There were no other enforcement actions by
FFIEC agencies.

Responding to Consumer Complaints
and Inquiries
The Federal Reserve investigates complaints against
state member banks and selected nonbank subsidiaries of bank holding companies (Federal Reserveregulated entities), and forwards complaints against
other creditors and businesses to the appropriate
enforcement agency. Each Reserve Bank investigates
complaints against state member banks and selected
nonbank subsidiaries in its district. The Federal
Reserve also responds to consumer inquiries on a
broad range of banking topics, including consumer
protection questions.
In 2011, System complaint analysts processed 41,631
cases through Federal Reserve Consumer Help
(FRCH), which was created in 2007 to centralize the
processing of consumer complaints and inquiries. Of
these cases, more than half (26,097) were inquiries
and the remainder (15,534) were complaints, with
most cases received directly from consumers.
Approximately 4 percent of cases were referred to the
Federal Reserve from other agencies.
While consumers can contact FRCH by telephone,
fax, mail, e-mail, or online (at www
.federalreserveconsumerhelp.gov), most FRCH consumer contacts occurred by telephone (58 percent).
Nevertheless, 38 percent (15,675) of complaint and
inquiry submissions were made electronically (including e-mail, online submissions, and fax) and the
online form page received more than 350,380 visits
during the year.

Consumer Complaints
Complaints against Federal Reserve-regulated entities totaled 4,840 in 2011. Approximately 38 percent

125

Number
12
57
2
0
82
5
206
116
0
26
8
25
1
5
198
67
63
15
0
8
44
3
1
2
946

of these complaints were closed without investigation
pending the receipt of additional information from
consumers. Approximately 2 percent of the total
complaints are still under investigation. Of the
remaining complaints (2,912), 68 percent (1,966)
involved unregulated practices and 32 percent (946)
involved regulated practices.
Complaints about Regulated Practices
The majority of regulated practice complaints concerned checking accounts (34 percent), real estate
loans (23 percent), and credit cards (15 percent).26
The most common checking account complaints
related to insufficient funds or overdraft charges and
procedures (38 percent); disputed withdrawal of
funds (13 percent); disputed rates, terms, or fees
(10 percent); and funds availability not as expected
(9 percent). The most common real estate loan complaints by problem code related to credit denied
(11 percent); disputed rates, terms, and fees (10 percent); payment errors or delays (9 percent); flood
26

Real estate loans include adjustable-rate mortgages, residential
construction loans, open-end home equity lines of credit, home
improvement loans, home purchase loans, home refinance/
closed-end loans, and reverse mortgages.

126

98th Annual Report | 2011

Table 2. Complaints against state member banks and selected nonbank subsidiaries of bank holding companies about
regulated practices, by product type, 2011
Subject of complaint/product type

All complaints
Number

Total
Discrimination alleged
Real estate loans
Credit cards
Other loans
Nondiscrimination complaints
Checking accounts
Real estate loans
Credit cards
Other

insurance (9 percent); and escrow account problems
(9 percent). The most common credit card complaints related to interest rates, terms, and fees
(20 percent); inaccurate credit reporting (15 percent);
bank debt collection tactics (15 percent); billing error
resolutions (10 percent); and payment errors and
delays (8 percent).
FRCH received 17 complaints alleging discrimination
under regulated practices; discrimination was alleged
on the basis of prohibited borrower traits or rights.27
Thirty-four percent of these discrimination complaints were related to the race, color, national origin,
or ethnicity of the applicant or borrower. Fourteen percent of discrimination complaints were
related to either the age or handicap of the applicant
or borrower. One violation, involving a real estate
loan, was identified based on these complaints.
In 85 percent of investigated complaints against Federal Reserve-regulated entities, evidence revealed that
institutions correctly handled the situation. Of the
remaining 15 percent of investigated complaints,
2 percent were deemed violations of law, 2 percent
were identified errors which were corrected by the
bank, 1 percent was referred to other agencies, and
the remainder were matters involving litigation or
factual disputes, withdrawn complaints, internally
referred complaints, or information was provided to
the consumer. The most common violations involved
real estate loans and checking accounts.
27

Prohibited bases include race, color, religion, national origin,
sex, marital status, age, applicant income derived from public
assistance programs, or applicant reliance on provisions of the
Consumer Credit Protection Act.

946

Complaints involving violations
Percent
100

Number

Percent

38

4.0

17
1
11

1.8
0.1
1.1

2
0
1

0.2
0
0.1

317
221
146
233

34.0
23.0
15.0
25.0

14
11
1
9

1.4
1.2
0.1
1.0

Complaints about Unregulated Practices
The Board continued to monitor complaints about
banking practices not subject to existing regulations,
with a focus on instances of potential unfair or
deceptive practices. In 2011, the Board received 1,966
complaints against Federal Reserve-regulated entities
that involved these unregulated practices. Most complaints were related to real estate concerns (41 percent), checking account activity (26 percent), and
credit cards (4 percent). More specifically, consumers
most frequently complained about issues involving
debt collection/foreclosures; insufficient funds or
overdraft charges; interest rates, terms, and fees;
policy and procedure concerns; payment errors/
delays; and opening and closing deposit accounts.
Complaints about Loan Modifications
and Foreclosures
In 2011, the Federal Reserve received 669 complaints
related to loan modifications and foreclosures. Of
these, consumers complained primarily about home
purchase loans (78 percent), home refinance/closed
end loans (9 percent), and adjustable rate mortgage
loans (7 percent). The top consumer protection issues
documented with specific codes were: debt collection/
foreclosure (50 percent) and interest rates, terms, and
fees (22 percent).
Complaint Referrals
In 2011, the Federal Reserve forwarded 10,918 complaints against other banks and creditors to the
appropriate regulatory agencies and government
offices for investigation, including the CFPB after
July 21, 2011. To minimize the time required to

Consumer and Community Affairs

127

re-route complaints to these agencies, referrals were
transmitted electronically.

tors contributing to the crisis and steps for re-starting
the housing market.

The Federal Reserve forwarded 14 complaints to the
Department of Housing and Urban Development
(HUD) that alleged violations of the Fair Housing
Act.28 The Federal Reserve’s investigation of these
complaints revealed one instance of illegal credit
discrimination.

Policy Analysis staff also contributed to the division’s
activities in support of the Board’s mortgage servicing reviews and the publication of Interagency Review
of Foreclosure Policies and Practices.30 This public
report documented the findings of the foreclosure
reviews and was followed by enforcement actions
against mortgage servicers for deficient practices in
residential mortgage loan servicing and foreclosure
processing, and by further public communication to
increase awareness and transparency about the foreclosure review process.

Consumer Inquiries
The Federal Reserve received 26,097 consumer inquiries in 2011, covering a wide range of topics. Consumers were typically directed to other resources,
including other federal agencies or written materials,
to address their inquiries.

Consumer Policy and Emerging
Issues Analysis
The Policy Analysis function of DCCA provides key
insights, information, and analysis on emerging
financial services issues that affect the well-being of
consumers and communities. Throughout 2011, as
financial markets continued to experience dynamic
change in response to the economic downturn, monitoring the financial services landscape for new and
unintended risks to households remained a top priority. To this end, Policy Analysis staff follow trends
and conduct inquiries that help define the issues,
identify emerging risks, and inform policy recommendations. The section also manages a crossfunctional team charged with coordinating the division’s activities and responses on key consumer and
community development matters.
Throughout 2011, Policy Analysis staff facilitated the
division’s activities in response to the foreclosure crisis and recovery of the housing market. These activities included contributing to the efforts of the
Board’s internal working group for analyzing housing issues, and organizing a policy forum entitled,
“The Housing Market Going Forward: Lessons
Learned from the Recent Crisis.”29 The forum
explored consumer and industry perspectives on fac28

29

A memorandum of understanding between HUD and the federal bank regulatory agencies requires that complaints alleging a
violation of the Fair Housing Act be forwarded to HUD.
Materials from the policy forum are available online at www
.federalreserve.gov/newsevents/conferences/housingconf2011
.htm.

Supporting Community
Economic Development
The Federal Reserve System’s Community Development function promotes economic growth and financial stability to underserved populations by informing
and improving the research, policy, and practice of
community development. As a decentralized function, the Community Affairs Officers (CAOs) at each
of the 12 Reserve Banks design activities to respond
to the specific needs of the communities they serve,
with oversight from Board staff. They provide information and promote awareness of investment opportunities to financial institutions, government agencies, and organizations that serve low- and moderateincome communities and populations. Similarly, the
Board’s community development staff promote and
coordinate System-wide priorities; in particular, community development staff focus on five key areas:
• research and community-level data compilation
• economic and small business development and
entrepreneurship
• housing markets and neighborhood revitalization
• community development finance
• workforce and human capital development

Community Development Research
Having learned from the subprime crisis that microeconomic issues can have a magnified impact on the
30

See The Federal Reserve System, the Office of the Comptroller
of the Currency, and the Office of Thrift Supervision (2011),
Interagency Review of Foreclosure Policies and Practices (Washington: Board of Governors of the Federal Reserve System,
April), www.federalreserve.gov/boarddocs/rptcongress/
interagency_review_foreclosures_20110413.pdf.

128

98th Annual Report | 2011

macroeconomy, the Community Development function across the Federal Reserve System is engaged in
a variety of research initiatives that augment the
Board’s systemic risk responsibilities. These efforts to
gather, analyze, and disseminate data on underserved
communities are also useful to policymakers and
community development practitioners.
In 2011, Reserve Banks continued to expand the use
of applied research and analysis to inform community development policy and practice. This expanded
capacity was highlighted at the biennial “Community
Affairs Research Conference: The Changing Landscape of Community Development,” which drew
more than 350 participants and included a number of
recognized experts across a range of disciplines.31
Community Development staff members from across
the system played key roles in this conference as presenters, moderators, and organizers. In addition, the
conference was preceded by an internal system
researchers’ symposium where Federal Reserve staff
discussed research efforts, shared results, and
exchanged ideas on emerging research and policy
issues.

Community Data Initiative
By leveraging information-sharing and partnership
roles with a rigorous analytical capacity, Community
Development provides reliable market intelligence
that has helped to identify and close data gaps for
low- and moderate-income communities. In 2011, the
Board coordinated the Community Data Initiative
(CDI), a CAO collaborative research project. The
goal of the CDI project is to provide Board and
Reserve Bank leadership with systematic and relevant
community conditions and trend information on a
consistent basis. The quarterly or biannual e-polling
of selected district community stakeholders captures
current and emerging community development
issues. In 2011, 11 Reserve Banks were administering
web-based polls and surveys. To provide a national
context for the regional results of Reserve Bank polls,
the Board continued to survey NeighborWorks®
America affiliates and grantees.
While still in an early stage of development, the CDI
has the potential to serve as a valuable complement
to the information that Community Development
31

“Community Affairs Research Conference: The Changing
Landscape of Community Development” was held April 28-29,
2011, in Arlington, Virginia. Materials from the conference are
available at www.frbsf.org/community/conferences/
2011ResearchConference.

staff continue to gather through regional convenings
and applied research efforts.

Supporting Small Business
Development, Entrepreneurship,
and Indian Country
Over the past few years, small businesses have faced
weak sales, diminished asset values, elevated uncertainty, and tight credit market conditions. Like owners of large firms, many small business owners have
had to lay off employees or defer hiring. Even as
credit conditions ease, perceptions of tight credit can
discourage some entrepreneurs from even trying to
obtain financing. These disruptions on the supply
and demand sides of the small business credit market
have resulted in notable credit gaps in lines of credit,
patient capital, small-dollar loans, and commercial
real estate.
In response to these persistent conditions, the Community Development function convened several
regional forums to better understand the characteristics of and challenges facing small businesses. The
discussions informed the framework of a national
convening hosted at the Board in partnership with
the Federal Reserve Bank of Atlanta and the Ewing
Marion Kauffman Foundation entitled, “Small Business and Entrepreneurship during an Economic
Recovery.”32 Research papers presented at the convening noted the importance of new and small firms
to the vitality of the economy, the unique challenges
experienced by female and minority entrepreneurs,
and the need for more timely and relevant small business data.
Given the acute challenges that confront underserved
communities, particularly in rural America, the Federal Reserve partnered with nine federal agencies to
identify barriers to and opportunities for economic
growth in Indian Country.33 More than 750 tribal
stakeholders participated in six regional workshops
32

33

“Small Business and Entrepreneurship during an Economic
Recovery” was held November 9-10, 2011, in Washington, D.C.
Materials from the conference are available at www
.federalreserve.gov/newsevents/conferences/small-businessentrepreneurship-conference.htm.
Indian Country is defined as all land within the limits of an
Indian reservation under the jurisdiction of the United States
government; all dependent Indian communities, such as the New
Mexico Pueblos; and all Indian allotments still in trust, whether
they are located within reservations or not. The term includes
land owned by non-Indians, as well as towns incorporated by
non-Indians if they are within the boundaries of an Indian reservation. It is generally within these areas that tribal sovereignty
applies and state power is limited.

Consumer and Community Affairs

that addressed specific gaps in capital and technical
assistance. A national summit that will serve as a
springboard for integrated research, policy, and economic development strategies is being planned for
2012.

Housing Markets and Neighborhood
Revitalization
Fallout from the economic crisis has included large
inventories of foreclosed properties that stand vacant
and abandoned and can have significant destabilizing
effects on communities, including increased crime
and decreased property values. The longer these
homes remain unoccupied, the worse the effect on
the community and the harder it is to reverse their
condition and put them back on the market. The
challenge of disposing of these real estate owned
(REO) properties often outstrips resources, particularly in low-income communities. Throughout 2011,
the Federal Reserve’s Community Development
function focused on supporting regional efforts to
stabilize and stimulate these neighborhoods, providing housing market data and/or convening local
stakeholders to discuss ways to use existing data to
make strategic investment decisions, such as the disposition of REO properties.
Community Development provided a wealth of
resources to communities in crisis, including a video
series, publication, and national forum. Videos documenting successful neighborhood stabilization strategies in Cleveland, Ohio; Detroit, Michigan; and
Phoenix, Arizona, debuted at the 2011 Community
Affairs Research Conference during Governor Elizabeth A. Duke’s keynote remarks.34 The publication,
Putting Data to Work: Data-Driven Approaches to
Strengthening Neighborhoods, comprises case studies
that demonstrate how communities can use data to
make strategic investment decisions.35 Case-study
authors were drawn from national nonprofits, community development organizations, local units of
government, and academia. The report was distributed at the “Strategic Data-Use to Stabilize Neigh-

34

35

The video reports and other community stabilization resources
are available online at www.federalreserve.gov/communitydev/
stablecommunities.htm.
See Board of Governors of the Federal Reserve System (2011),
Putting Data to Work: Data-Driven Approaches to Strengthening
Neighborhoods (Washington: Board of Governors of the Federal
Reserve System, December), www.federalreserve.gov/
communitydev/files/data-driven-publication-20111212.pdf.

129

borhoods” conference co-hosted by the Board and
the Federal Reserve Bank of Richmond.36
Participants at the conference explored creative uses
of data and technology to promote public and private investment in transitional communities.

Other Community Development Initiatives
As households and communities grapple with limited
resources and persistent challenges, it is imperative
that the Federal Reserve continue to connect with
and respond to Main Street. To that end, the Community Development function works to engage communities in new ways and through new technologies.
Many Reserve Banks produce webinars and podcasts. Several utilize visual analytics and blogs to
share quantitative and qualitative information with
their stakeholders.
In the fall of 2011, the Board partnered with the Federal Reserve Bank of St. Louis to launch “Connecting Communities,” a communications platform
designed to share best practices relating to community development.37 In 2011, the platform offered a
webinar that focused on the challenges of helping
people facing foreclosure and the impact it will have
on their credit score; another webinar shared strategies on how microfinance can serve as a catalyst to
increasing economic opportunity in low- to
moderate-income communities. The webinar series
will continue to be a means for sharing system community development information in 2012.

Consumer Advisory Council
On July 21, 2011, the Board’s Consumer Advisory
Council (CAC) was dissolved pursuant to the DoddFrank Act. Nevertheless, the Council—which was
established in 1976 to bring together representatives
of consumer and community organizations, the
financial services industry, academic institutions, and
state agencies—advised the Board of Governors on
several matters of Board-administered laws and regulations as well as other consumer-related financial
36

37

“Strategic Data-Use to Stabilize Neighborhoods” was held
December 6-7, 2011, in Baltimore, Maryland. Materials from
the conference are available at www.richmondfed.org/
conferences_and_events/community_development/2011/
strategic_data_use_20111206.cfm.
More information about “Connecting Communities” is available at www.stlouisfed.org/bsr/connectingcommunities/index
.cfm.

130

98th Annual Report | 2011

services issues through the first half of 2011.38 Council meetings, open to the public, were held in March
and June.
Among the significant topics of discussion for the
Council in 2011 were
• issues related to foreclosures and neighborhood
stabilization
• proposed rules regarding debit card interchange
fees and routing
• national mortgage servicing standards
• proposed rules regarding ability to pay for mortgage loans
• the proposed rule regarding risk retention and
“qualified residential mortgages”

Foreclosure Assistance
In 2011, the Council discussed loss-mitigation efforts,
including the Administration’s Home Affordable
Modification Program (HAMP), and other issues
related to foreclosures. Consumer representatives
urged that more funding be provided for housing
counseling and legal services programs that assist
borrowers facing foreclosure. Some consumer representatives endorsed a focus on principal reductions
and the implementation of third-party mediation or
settlement programs. One consumer representative
also urged continued funding for programs that assist
temporarily unemployed borrowers in making their
mortgage payments.
Consumer representatives generally expressed the
view that servicing problems remain numerous and
systemic, noting continuing issues with servicers’
capacity and the need for improvements in training.
They pointed to issues such as lost or misplaced
documentation, delays in making a decision about
whether to grant a loan modification, steering of
borrowers from HAMP to in-house modification
programs with less favorable terms, the lack of a
single point of contact, and the lack of response to
borrower communications. They also stated that foreclosures continue to be filed while loan modifications
are being considered. Some consumer representatives
expressed concern that servicers are contributing to
borrowers becoming delinquent, such as by inaccurately representing what constitutes eligibility for
38

For a list of members of the Council, see the “Federal Reserve
System Organization” section in this report. Transcripts of
Council meetings are available at www.federalreserve.gov/
aboutthefed/cac.htm.

HAMP or by making errors regarding payments or
fees.
Some consumer representatives also called attention
to fair housing issues related to loss mitigation,
expressing the view that loan-modification outcomes
are generally worse for borrowers of color. They
urged the Board and other regulators to ensure that
fair housing concerns are included in their review of
servicers, and emphasized the need for HMDA-like
data reporting in the loan-modification context.
In discussing HAMP specifically, several consumer
representatives urged more enforcement to ensure
servicers’ compliance with the program’s guidelines.
They also expressed concern about the lack of information provided to borrowers who are denied a
HAMP modification and emphasized the need for
more transparency and more data collection and
reporting about HAMP activities.
Members commended the Board and other regulators for conducting the interagency review of servicing issues, but several consumer representatives
expressed concern about what constitutes a “wrongful foreclosure” in the context of the review.39 The
consumer representatives stated that the concept of
“wrongful foreclosures” should be defined more
broadly, so that it covers foreclosures that are based
on servicer errors or those that are filed by a party
without an ownership interest in the mortgage.

Neighborhood Stabilization
In 2011, the Council also discussed the effects of
foreclosures that extend beyond households to the
surrounding community and efforts such as the federal Neighborhood Stabilization Program (NSP) to
address the challenges of stabilizing communities.
Several members praised the positive effects of NSP
efforts but stated that significantly more funding
would be required to effectively address the scope of
the problem. They also commended recent regulatory
changes that allow financial institutions to receive
CRA consideration for certain neighborhood stabilization activities.
Consumer representatives described the negative
effects of REO and vacant properties on neighbor39

See The Federal Reserve System, the Office of the Comptroller
of the Currency, and the Office of Thrift Supervision (2011),
Interagency Review of Foreclosure Policies and Practices (Washington: Board of Governors of the Federal Reserve System,
April), www.federalreserve.gov/boarddocs/rptcongress/
interagency_review_foreclosures_20110413.pdf.

Consumer and Community Affairs

hoods, such as increased blight, vandalism, and
crime; the burdens they impose on municipalities;
and the impact on the decisionmaking process of
other homeowners who are struggling to stay current
on their mortgage. They expressed concern about
banks and servicers not maintaining REO properties
and not complying with protections for tenants. They
also expressed concern about lenders and servicers
walking away from and not completing foreclosure
sales, leading to “toxic titles” and additional vacant
properties, and urged federal regulators to increase
the oversight of regulated institutions regarding these
issues. Several consumer representatives stated that
the practices of servicer walkaways and lack of property upkeep are disproportionately concentrated in
neighborhoods of color. One consumer representative described the phenomenon whereby new owners
of REO properties delay recording their ownership in
what may be an attempt to avoid responsibility and
liability for the maintenance of the properties.
Both industry and consumer representatives
expressed concern about increasing investor purchases of REOs and urged consideration of ways to
give potential owner-occupants a better chance to
acquire properties. A consumer representative also
encouraged lenders and servicers to continue renting
to tenants living in REO properties whenever possible, to help prevent additional vacant properties.
An industry representative commented that the
Board and the Federal Reserve Banks could help to
facilitate conversations about the future of neighborhoods in cities that have been hit hard by the foreclosure crisis.
Finally, members discussed the future of housing
finance and recent proposals relating to this issue. An
industry representative expressed concern that some
proposed policies would block many people, particularly lower-income and minority individuals, from the
opportunity of home ownership. Some consumer
representatives emphasized the importance of ensuring that home ownership is achieved in a safe, sustainable way and providing counseling so that borrowers recognize the true costs of home ownership;
they also noted that renting is appropriate for many
people. Several members stated that further attention
should be given to explaining and addressing the per-

131

sistence of lower home ownership rates among
minorities.

Debit Card Interchange Fees and Routing
At the March meeting, the Council discussed the
Board’s proposed rule that would (1) establish debit
card interchange fee standards and (2) prohibit network exclusivity arrangements and routing restrictions. Some industry representatives expressed concerns about the proposal, urging the Board to consider certain additional costs involved in interchange
transactions and to study the potential impact on
consumers, the payment system, and smaller financial
institutions. They pointed to the benefits of debit
cards in terms of connecting consumers with mainstream financial services and expressed the view that
those benefits could be jeopardized if, due to the loss
of interchange revenue, banks were to add fees to
bank accounts to cover their costs. One industry representative commented that the proposed exemption
for small issuers would be difficult to implement
effectively and that the loss of interchange revenue
would have a severe impact on smaller banks and
credit unions.
One industry representative expressed support for the
proposal, stating that it represents a return to fairer
pricing and a more competitive marketplace after distortions due to consolidation and concentration.
Another member commented that some large retailers have engaged in innovative and effective efforts to
reach unbanked individuals.
Regarding the prohibition on network exclusivity
arrangements, an industry representative endorsed
the proposal’s first alternative, stating that the second
alternative would impede innovations in payments.
Several consumer representatives expressed concern
about the proposal’s potential impact on consumers,
particularly if new fees are imposed on bank
accounts. They stated that bank account fees should
be reasonably related to the services provided and
that there should be some accommodation for lowto moderate-income customers through lower fees.
They encouraged regulators to hold financial institutions accountable under CRA for how they respond

132

98th Annual Report | 2011

to these changes and ensure that harmful effects on
low-income consumers are minimized.

National Mortgage Servicing Standards
At the June meeting, the Council discussed the creation of national standards for residential mortgage
loan servicing, providing views about what principles,
policies, and procedures such standards should
include. Several consumer representatives generally
commended the work of the Board and other regulators in reviewing and reporting on servicing and foreclosure practices and the imposition of formal
enforcement actions in connection with the interagency review. Members disagreed about how
national servicing standards should interact with
standards promulgated by states. Consumer representatives stated that national standards should operate
as a floor and states should be able to provide additional protections that address unique circumstances
in their particular jurisdiction. Industry representatives stated that national standards should set a high
bar that operates as both a floor and a ceiling, providing consistent protections across states.
Consumer representatives recommended a variety of
requirements for national servicing standards,
including
• a general obligation of good faith and fair dealing
• robust data collection and reporting, especially
regarding fair housing issues
• recordkeeping about communications with
borrowers

Consumer representatives also stated that national
standards should address issues related to servicer
compensation. One member expressed the view that
the compensation should provide greater incentives
for servicers to do affordable, sustainable loan modifications. Another member noted that the compensation should be structured to ensure that servicers
have sufficient funding to be able to operate effectively during times of increased delinquencies and
foreclosures.
Members also pointed to securitization-related issues
that should be addressed in national servicing standards. A consumer representative supported the creation of standardized pooling and servicing agreements that include greater flexibility for servicers to
offer loan modifications without having to seek
investor approval. An industry representative recommended the adoption, for all securitizations, of the
set of standard representations and warranties created by the American Securitization Forum. A consumer representative suggested that trustees should
be required to collect and keep up-to-date detailed
information about servicers, and that servicing transfers should be registered with trustees. An industry
representative recommended the implementation of
consistent data fields on a loan-level basis for all
securitizations to assist in tracking the performance
of the underlying collateral.

Ability-to-Pay Requirement for Mortgage
Loans

• monitoring of law firms and other external
vendors.

At the June meeting, the Council discussed a proposed rule under Regulation Z that would require
creditors to determine a consumer’s ability to repay a
mortgage before making the loan and would establish
minimum mortgage underwriting standards. There
was strong support for ability-to-pay standards
among Council members and general agreement that
many of the criteria in the proposal represented
sound, common-sense underwriting principles.

Consumer representatives also expressed the view
that the standards should prohibit the dual-track
system of proceeding simultaneously with a foreclosure and a loan modification and should address
post-foreclosure issues, such as property maintenance
obligations and compliance with tenant protections.
Other recommendations included mandating an affirmative duty of loss mitigation that could be enforced
by a private right of action and allowing borrowers
to raise violations of the servicing standards as a
defense to foreclosure.

In considering the definition of “qualified mortgage,” both consumer and industry representatives
expressed support for including the additional underwriting requirements contained in the proposal’s
Alternative 2. They encouraged the Board to adopt a
rule that sets high, robust standards applying to all
mortgage lenders. An industry representative commented that the rule’s approach to the definition of
“qualified mortgage” should operate as a legal safe
harbor rather than as a rebuttable presumption of
compliance. Industry representatives also urged the

• a single point of contact
• greater transparency about calculations of borrower income and net present value
• streamlined systems for document submission

Consumer and Community Affairs

Board to provide additional clarity about the standards that lenders would have to meet to fall within
the safe harbor; a consumer representative recommended that the standards not specify particular
numbers, such as for debt-to-income ratios or credit
scores. Several members expressed concern that 5/1
adjustable-rate mortgages (ARMs) would be considered as qualified mortgages under the proposal; they
stated that such ARMs should be subjected to
greater regulation. A consumer representative praised
the inclusion of a duty for lenders to make a reasonable and good faith determination that the consumer
will have a reasonable ability to repay the loan.
A consumer representative and an industry representative expressed support for the proposal’s approach
to balloon-payment qualified mortgages offered by
small creditors operating predominantly in rural or
underserved areas. Another consumer representative
emphasized the need to ensure that rural borrowers
have adequate protection and urged regulators to use
CRA exams to increase their scrutiny of financial
institutions’ performance in rural communities.

Risk Retention and “Qualified Residential
Mortgages”
At the June meeting, the Council discussed the interagency proposed rule that would require risk retention for asset-backed securities and would exempt
qualified residential mortgages (QRMs) from those
requirements. Both industry and consumer representatives expressed concerns about the proposed definition of a QRM, particularly the requirement of a
20 percent down payment for QRM eligibility. Some
members questioned the effectiveness of the 20 percent requirement: they commented that programs,
such as Ginnie Mae, demonstrate that no- and lowdown payment loans can be sound and sustainable
and that many loans that are currently performing
well would not qualify as a QRM.
Members generally expressed concern about the consequences across the mortgage market if QRM were
to be seen as the “gold standard” and to become the
primary mortgage product, rather than the narrow
exception as intended. Possible consequences that
were mentioned included restricted access to credit
for consumers who do not qualify for QRMs, higher

133

costs and/or less favorable terms for non-QRM loans,
regulatory scrutiny of and limits on non-QRM loans,
reputational risk for offering non-QRM loans, and
lower ratings for non-QRM securities. Several consumer representatives expressed concern that lowerincome individuals and people of color would be
locked out of home ownership opportunities or
forced to obtain credit at a much higher cost.
Members emphasized the need for a healthy, liquid
non-QRM market and for further consideration of
how to achieve safe, productive lending to emerging
markets. They urged the Board and other regulators
to investigate how the markets and investors would
likely to react to the proposed QRM standard and
what the price difference likely would be between
QRM and non-QRM loans.

Other Discussion Topics
At the March meeting, the Council discussed the
Board’s proposed rule to expand and revise Regulation Z’s existing escrow account requirements for certain mortgage loans. Members generally commended
the effort to improve disclosures concerning escrow
accounts and praised the clear, “plain English”
nature of the proposed model forms. Concerns were
expressed about the proposed exemption for loans
made in “rural or underserved areas” if certain conditions are satisfied. A consumer representative commented that the 100-loan annual originations test
could unduly limit lenders’ ability to work with
higher-risk borrowers and communities. Another
consumer representative expressed concern that some
money lenders engaging in risky, higher-cost lending
would fall under the exemption.
At the June meeting, the Council discussed the
Board’s proposed rule that would create new protections for consumers who send remittance transfers to
recipients located in a foreign country. Members generally supported the proposal, particularly the
requirements relating to fee disclosures. Industry representatives noted, however, there can be challenges
in determining fees when dealing with an unaffiliated
international remittance provider. An industry representative expressed the view that the statutorily mandated 90-day timeframe for remittance transfer providers to provide error resolution is too long.

135

Federal Reserve Banks

The Federal Reserve Banks provide payment services
to depository and certain other institutions, distribute
the nation’s currency and coin to depository institutions, and serve as fiscal agents and depositories for
the U.S. government and other entities. The Reserve
Banks also contribute to setting national monetary
policy and supervision of banks and other financial
entities operating in the United States (discussed in
the preceding sections of this report).

Federal Reserve Priced Services

The Monetary Control Act of 1980 requires that the
Federal Reserve establish fees for priced services provided to depository institutions so as to recover, over
the long run, all direct and indirect costs actually
incurred as well as the imputed costs that would have
been incurred—including financing costs, taxes, and
certain other expenses—and the return on equity
(profit) that would have been earned if a private business firm had provided the services.1 The imputed
costs and imputed profit are collectively referred to
as the private-sector adjustment factor (PSAF).2 Over
1

Federal Reserve Banks provide a range of payment
and related services to depository institutions, including collecting checks, operating an automated clearinghouse (ACH) service, transferring funds and securities, and providing a multilateral settlement service.
The Reserve Banks charge fees for providing these
“priced services.”

2

Financial data reported throughout this chapter—including revenue, other income, costs, income before taxes, and net
income—will reference to the “Pro Forma Financial Statements
for Federal Reserve Priced Services” at the end of this chapter.
In addition to income taxes and the return on equity, the PSAF
includes three other imputed costs: interest on debt, sales taxes,
and an assessment for deposit insurance by the Federal Deposit
Insurance Corporation (FDIC). Board of Governors assets and
costs that are related to priced services are also allocated to
priced services; in the pro forma financial statements at the end

Table 1. Priced Services Cost Recovery
Millions of dollars, except as noted
Year
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2002–2011

Revenue from services1

Operating expenses and
imputed costs2

Targeted return on equity3

Total costs

Cost recovery (percent)4, 5

918.3
881.7
914.6
993.8
1,029.7
1,012.3
873.8
675.4
574.7
478.6
8,352.8

891.7
931.3
842.6
834.4
874.8
912.9
820.4
707.5
532.8
444.4
7,792.9

92.5
104.7
112.4
103.0
72.0
80.4
66.5
19.9
13.1
16.8
681.3

984.3
1,036.0
955.0
937.4
946.8
993.3
886.9
727.5
545.9
461.2
8,474.2

93.3
85.1
95.8
106.0
108.8
101.9
98.5
92.8
105.3
103.8
98.6

Note: Here and elsewhere in this chapter, components may not sum to totals or yield percentages shown because of rounding.
1
For the 10-year period, includes revenue from services of $7,837.0 million and other income and expense (net) of $515.7 million.
2
For the 10-year period, includes operating expenses of $7,506.9 million, imputed costs of $42.1 million, and imputed income taxes of $243.8 million.
3
Beginning in 2009, the PSAF has been adjusted to reflect the actual clearing balance levels maintained; previously, the PSAF was calculated based on a projection of clearing
balance levels.
4
Revenue from services divided by total costs.
5
For the 10-year period, cost recovery is 95.3 percent, including the reduction in equity related to ASC 715 reported by the priced services.

136

98th Annual Report | 2011

the past 10 years, Reserve Banks have recovered
98.6 percent of their priced services costs, including
the PSAF (see table 1).3
In 2011, Reserve Banks recovered 103.8 percent of
total priced services costs, including the PSAF.4 The
Banks’ operating costs and imputed expenses totaled
$444.4 million. Revenue from operations totaled
$477.4 million and other income was $1.2 million,
resulting in net income from priced services of
$34.1 million.5
The Reserve Banks are engaged in a number of technology initiatives that will modernize their priced services processing platforms over the next several years.
The Banks are in the process of implementing a new
end-to-end electronic check-processing system to
improve the efficiency and reliability of their current
check-processing operations. They also continued
efforts to migrate the FedACH, Fedwire Funds, and
Fedwire Securities services off a mainframe system
and to a distributed computing environment.

Commercial Check-Collection Service
In 2011, Reserve Banks recovered 105.4 percent of
the total costs of their commercial check-collection
service, including the related PSAF. The Banks’ operating expenses and imputed costs totaled $237.8 million. Revenue from operations totaled $259.2 million
and other income totaled $0.7 million, resulting in
net income of $22.2 million. In 2011, check-service
revenue from operations decreased $94.4 million
from 2010.6 Reserve Banks handled 6.8 billion checks

3

4

5

6

of this chapter, Board assets are part of long-term assets, and
Board expenses are included in operating expenses.
Effective December 31, 2006, the Reserve Banks implemented
the Financial Accounting Standards Board’s Statement of
Financial Accounting Standards (SFAS) No. 158, Employers’
Accounting for Defined Benefit Pension and Other Postretirement
Plans [Accounting Standards Codification (ASC) Topic 715
(ASC 715), Compensation–Retirement Benefits], which has
resulted in the recognition of a $288.9 million reduction in
equity related to the priced services’ benefit plans through 2011.
Including this reduction in equity, which represents a decline in
economic value, results in cost recovery of 95.3 percent for the
10-year period. For details on how implementing ASC 715
affected the pro forma financial statements, refer to notes 3 and
5 to the “Pro Forma Financial Statements for Federal Reserve
Priced Services” at the end of this chapter.
Total cost is the sum of operating expenses, imputed costs
(income taxes, interest on debt, interest on float, sales taxes, and
the FDIC assessment), and the targeted return on equity.
Other income is investment income earned on clearing balances
net of the cost of earnings credits, an amount termed net
income on clearing balances.
In 2008, the Reserve Banks discontinued the transportation of
commercial checks between their check-processing offices. As a

in 2011, a decrease of 12.1 percent from 2010 (see
table 2). The decline in Reserve Bank check volume
continues to be influenced by nationwide trends away
from the use of checks.7
By year-end 2011, 99.9 percent of check deposits
processed by the Reserve Banks and 99.7 percent of
checks presented by the Reserve Banks to paying
banks were processed electronically. By year-end
2011, 98 percent of unpaid checks were returned to a
Reserve Bank electronically and 90 percent were
delivered by the Reserve Bank to the bank of first
deposit electronically. The increased acceptance of
electronic returns in the past couple of years is partly
due to expanded product options offered by the
Reserve Banks, such as a PDF delivery option that
smaller depository institutions use to receive returns.

Commercial Automated
Clearinghouse Services
In 2011, the Reserve Banks recovered 100.8 percent
of the total costs of their commercial ACH services,
including the related PSAF. Reserve Bank operating
expenses and imputed costs totaled $106.9 million.
Revenue from ACH operations totaled $111.7 million
and other income totaled $0.3 million, resulting in
net income of $5.1 million. The Reserve Banks processed 10.4 billion commercial ACH transactions, an
increase of 1.1 percent from 2010.
In 2010, the Reserve Banks introduced an opt-in,
same-day ACH product that clears and settles
selected consumer debit payments on the same day
rather than overnight. The service has had limited
adoption over the past two years, but its availability
has spurred broader industry discussions about
whether to establish a same-day service involving
both U.S. ACH operators and all ACH participants.

Fedwire Funds and National
Settlement Services
In 2011, Reserve Banks recovered 103.0 percent of
the costs of their Fedwire Funds and National Settle-

7

result, in 2011, there were no costs or imputed revenues associated with the transportation of commercial checks between
Reserve Bank check-processing offices.
Federal Reserve System retail payments research suggests that
the number of checks written in the United States has been
declining since the mid-1990s. For details, see “The 2010 Federal
Reserve Payments Study: Noncash Payment Trends in the
United States, 2006–2009” (December 2010), www.frbservices
.org/files/communications/pdf/press/2010_payments_study.pdf.

Federal Reserve Banks

137

Table 2. Activity in Federal Reserve Priced Services, 2009–2011
Thousands of items
Percent change
Service

2011

2010

2009
2010 to 2011

Commercial check
Commercial ACH
Fedwire funds transfer
National settlement
Fedwire securities transfer

6,779,607
10,348,802
129,734
571
7,271

7,711,833
10,232,757
127,762
522
7,913

8,584,929
9,966,260
127,357
464
10,519

2009 to 2010

-12.1
1.1
1.5
9.4
-8.3

-10.2
2.7
0.3
12.5
-24.6

Note: Activity in commercial check is the total number of commercial checks collected, including processed and fine-sort items; in commercial ACH, the total number of
commercial items processed; in Fedwire funds transfer and securities transfer, the number of transactions originated online and offline; and in national settlement, the number
of settlement entries processed.

ment Services, including the related PSAF. Reserve
Bank operating expenses and imputed costs for these
operations totaled $78.8 million in 2011. Revenue
from these services totaled $84.0 million, and other
income amounted to $0.2 million, resulting in a net
income of $5.4 million.
Fedwire Funds Service
The Fedwire Funds Service allows its participants to
use their balances at Reserve Banks to transfer funds
to other participants in the service. In 2011, the number of Fedwire funds transfers originated by depository institutions increased 1.5 percent from 2010, to
approximately 129.7 million. The average daily value
of Fedwire funds transfers in 2011 was $2.6 trillion,
an increase of 9.6 percent from the previous year.
In November 2011, the Federal Reserve Banks introduced a new message format for the Fedwire Funds
Service, the culmination of years of planning and
engagement with depository institutions and their
corporate customers. The new format was implemented to support extended character business
remittance information, an improved cover payments
solution, a new field to support payment notification
and tracking, and better alignment with SWIFT message formats.
National Settlement Service
The National Settlement Service is a multilateral
settlement system that allows participants in privatesector clearing arrangements to settle transactions
using Federal Reserve balances. In 2011, the service
processed settlement files for 16 local and national
private-sector arrangements, a decrease from the 19
arrangements active in 2010. The Reserve Banks processed slightly more than 6,900 files that contained
around 571,000 settlement entries for these arrangements in 2011. Activity in 2011 represents an increase

from the 522,000 settlement entries processed in
2010.

Fedwire Securities Service
In 2011, the Reserve Banks recovered 103.1 percent
of the total costs of the priced-service component of
their Fedwire Securities Service, including the related
PSAF. The Banks’ operating expenses and imputed
costs for providing this service totaled $21.0 million
in 2011. Revenue from the service totaled $22.5 million and there was no other income, resulting in a net
income of $1.5 million.
The Fedwire Securities Service allows its participants
to transfer electronically to other service participants
certain securities issued by the U.S. Treasury, federal
government agencies, government-sponsored enterprises, and certain international organizations.8 In
2011, the number of non-Treasury securities transfers
processed via the service decreased 8.3 percent from
2010, to approximately 7.3 million.

Float
In 2011, the Federal Reserve had daily average credit
float of $1,151.8 million, compared with daily average credit float of $1,795.7 million in 2010.9
8

9

The expenses, revenues, volumes, and fees reported here are for
transfers of securities issued by federal government agencies,
government-sponsored enterprises, and certain international
organizations. Reserve Banks provide Treasury securities services in their role as the U.S. Treasury’s fiscal agent. These services are not considered priced services. For details, see “Treasury Securities Services” on page 139.
Credit float occurs when the Reserve Banks present checks and
other items to the paying bank prior to providing credit to the
depositing bank (debit float occurs when the Reserve Banks
credit the depositing bank before presenting checks and other
items to the paying bank).

138

98th Annual Report | 2011

Provision of Federal Reserve Accounts
and Services to Financial Market Utilities
Financial market utilities (FMUs) manage and operate multilateral systems for the purpose of transferring, clearing, or settling payments, securities, or
other financial transactions among financial institutions, or between financial institutions and an FMU.
The Reserve Banks currently provide accounts and
services only to FMUs with banking charters in a
similar manner to other depository institutions. Title
VIII of the Dodd-Frank Act allows the Board to
authorize a Federal Reserve Bank to provide
accounts and services to FMUs, irrespective of charter type, that are designated as systemically important by the Financial Stability Oversight Council,
subject to any applicable rules, orders, standards, or
guidelines as prescribed by the Board.

Currency and Coin
The Federal Reserve Board is the issuing authority
for the nation’s currency (in the form of Federal
Reserve notes). In 2011, the Board paid the U.S.
Treasury Department’s Bureau of Engraving and
Printing (BEP) approximately $623.3 million to produce 6.2 billion Federal Reserve notes. The Federal
Reserve Banks distribute and receive currency and
coin through depository institutions in response to
public demand. In 2011, the Reserve Banks distributed 36.9 billion Federal Reserve notes into circulation (payments), a 1.6 percent increase from 2010,
and received 35.1 billion Federal Reserve notes from
circulation, a 0.7 percent decrease from 2010. The
value of Federal Reserve notes in circulation
increased approximately 9.6 percent in 2011, to
$1,034.5 billion at year-end, largely because of international demand for $100 notes. In 2011, the Reserve
Banks also distributed 68.1 billion coins into circulation, a 1.5 percent decrease from 2010, and received
59.8 billion coins from circulation, a 4.2 percent
decrease from 2010.
During 2011, the Reserve Banks achieved a nearly
10 percent increase in currency-processing efficiency,
which was associated with a program completed in
2010 to improve the hardware and upgrade the
Reserve Banks’ high-speed currency-processing
machines’ software. Reserve Banks continue to
develop a new cash automation platform that will
replace legacy software applications, automate business concepts and processes, and employ technologies to meet current and future needs for the cash

business cost effectively. The applications will also
facilitate business continuity and contingency planning and enhance the support provided to Reserve
Bank customers.
During 2011, the Federal Reserve eliminated the currency paying, receiving, and processing operations at
the San Antonio and Nashville Branches and
replaced them with outsourced depot operations.
Armored carriers operate the depots, which serve as
collection points for depository institutions' currency
deposits and distribution points for their orders. The
armored carrier transports the deposits to the nearest
Reserve Bank cash operation for processing, and the
Reserve Bank prepares currency orders for the depot
operator to distribute to depository institutions. The
Pittsburgh Branch functioned as a Federal Reserve
operated depot from 1997 to 2011. During 2011, the
Federal Reserve outsourced the Pittsburgh depot
operation to an armored carrier. The Federal Reserve
now has 10 cash depots, all of which are outsourced
to armored carriers.
New functionality of high-speed sorting sensors
allowed the Banks to implement a policy in April
that reduced the premature destruction of notes used
extensively for transactional purposes ($1, $5, $10,
and $20 notes) by allowing Reserve Banks to accept
from and return to depository institutions bank
notes either portrait-side-up or portrait-side-down.
This misfaced notes policy decreased the destruction
rate of $1 notes 5 percentage points, from 21 percent
to 16 percent, and decreased the average destruction
rate of $5 through $20 notes 4 percentage points,
from 22 percent to 18 percent, between April and
December. As a result of this policy, average note life
for these denominations will increase by an estimated
10 months. Also as a result of the policy, the 2012
budget for new currency decreased by $14 million.
The Board continues to work with the BEP and the
U.S. Secret Service to produce a more-secure, newdesign $100 note. During 2011, the Board collaborated with the BEP and its paper supplier to resolve
the creasing problem identified by the BEP in 2010.
The BEP resumed production of the new-design $100
note in late 2011 and the results of production testing
indicate that these mitigation steps have reduced the
incidence of creasing.
The Board and its consulting firm continue to partner with the BEP in developing a new qualityassurance program for currency at the BEP. This new
program will enable the BEP to meet the Board’s

Federal Reserve Banks

increasing print order production quantity requirements and the production of more-complex bank
notes into the future.

Fiscal Agency and Government
Depository Services
As fiscal agents and depositories for the federal government, the Federal Reserve Banks auction Treasury
securities, process electronic and check payments for
Treasury, collect funds owed to the federal government, maintain Treasury’s bank account, and
develop, operate, and maintain a number of automated systems to support Treasury’s mission. The
Reserve Banks also provide certain fiscal agency and
depository services to other entities; these services are
primarily related to book-entry securities. Treasury
and other entities fully reimbursed the Reserve Banks
for the costs of providing fiscal agency and depository services.
In 2011, fiscal agency expenses amounted to
$484.2 million, a 6.1 percent increase over 2010 (see
table 3). These costs increased as a result of requests
from Treasury’s Bureau of the Public Debt and
Financial Management Service. Support for Treasury
programs accounted for 94.2 percent of the cost, and
support for other entities accounted for 5.8 percent.

Treasury Securities Services
The Reserve Banks work closely with Treasury’s
Bureau of the Public Debt in support of the borrowing needs of the federal government. The Banks auction, issue, maintain, and redeem securities; provide
customer service; and operate the automated systems
supporting U.S. savings bonds and marketable Treasury securities (bills, notes, and bonds). Treasury securities services consist of retail securities programs
(which primarily serve individual investors) and
wholesale securities programs (which serve institutional customers).

Retail Securities Programs
Reserve Bank operating expenses for the retail securities programs were $79.3 million in 2011, reflecting
an 8.5 percent increase compared with $73.1 million
in 2010. This cost increase is largely explained by the
transition and implementation costs associated with
the Bureau of the Public Debt’s mandate to consolidate the Reserve Banks’ savings bond operations,
implement image processing for savings bond
redemptions, and continue implementing the Treasury Retail E-Services initiative.
In 2011, Treasury decided to consolidate the savings
bond operations into a single location. The Reserve

Table 3. Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2009–2011
Thousands of dollars
Agency and service
Department of the Treasury
Bureau of the Public Debt
Treasury retail securities
Treasury securities safekeeping and transfer
Treasury auction
Computer infrastructure development and support
Other services
Total
Financial Management Service
Payment services
Collection services
Cash-management services
Computer infrastructure development and support
Other services
Total
Other Treasury
Total
Total, Treasury
Other Federal Agencies
Total, other agencies
Total reimbursable expenses

139

2011

2010

2009

79,346
11,187
29,258
1,969
4,036
125,796

73,104
10,136
30,750
1,980
1,646
117,615

73,679
8,815
30,216
2,333
1,375
116,417

125,196
38,707
53,832
67,014
9,536
294,285

112,224
37,611
48,226
66,461
8,815
273,337

104,355
37,967
49,046
66,958
7,393
265,719

36,233
456,314

37,793
428,744

40,390
422,527

27,893
484,207

27,700
456,445

27,758
450,285

140

98th Annual Report | 2011

Banks completed the consolidation within budget,
ahead of schedule, and with no degradation of customer service. In addition, the Reserve Banks began
a project to take advantage of developments in image
processing to handle savings bond redemptions,
which will allow the Reserve Banks to retire software
that was built solely to support Treasury savingsbond processing. Finally, the Reserve Banks continued working with the Bureau of the Public Debt on
the Treasury Retail E-Services initiative, which will
create a virtual customer service and support environment across the Bureau and Reserve Banks sites.
Each of these initiatives involves up-front costs but is
expected to yield significant savings in the future.

Wholesale Securities Programs
The Reserve Banks support wholesale securities programs through the sale, issuance, safekeeping, and
transfer of marketable Treasury securities for institutional investors. Reserve Bank operating expenses in
2011 in support of Treasury securities auctions were
$29.2 million, compared with $30.7 million in 2010.
In 2011, the Banks conducted 269 Treasury securities
auctions, compared with 301 in 2010. The decrease in
the number of auctions was attributable primarily to
the discontinuation of special cash-management bill
auctions that funded the Supplementary Financing
Program (SFP). The SFP was introduced by Treasury
in 2008 to assist the Federal Reserve System with
operations related to the financial crisis.
Operating expenses associated with Treasury securities safekeeping and transfer activities were $11.2 million in 2011, compared with $10.1 million in 2010.
The cost increase reflected lower agency volume in
2011, which shifted more cost to Treasury.

Go Direct is an ongoing effort focused on converting
check benefit payments to direct deposit or debit
cards. In 2011, expenses for Go Direct increased
69.0 percent, to more than $25 million, largely as a
result of the construction of a new Go Direct call
center. GOVerify is an initiative begun in 2011 and
currently provides a single point of entry, or portal,
where federal agencies will comply with an OMB
mandate to query five data sources before making
federal payments. These data sources are collectively
known as the “Do Not Pay List.” In 2011, expenses
for GOVerify were $2.2 million.
The Reserve Banks also manage the Stored Value
Card (SVC) program and the Internet Payment Platform (IPP). The SVC program provides stored value
cards for use by military personnel on military bases.
In 2011, the SVC program’s expenses increased
6.6 percent, to $18.1 million, primarily because of a
request from the military to purchase additional
EagleCash (SVC) cards and new laptops. These
expenses were slightly offset by the cancellation of a
major SVC deployment.
The Internet Payment Platform (IPP) is part of
Treasury’s all-electronic initiative and is an electronic
invoicing and payment information system that
allows vendors to enter invoice data electronically,
either through a web-based portal or electronic submission. The IPP accepts, processes, and presents
data from agencies and supplier systems related to all
stages of the transactions. During 2011, the Federal
Reserve Banks’ IPP expenses increased 25.8 percent,
to $9.1 million. This increase is primarily driven by
IPP’s increased efforts to expand agency outreach
and support in response to Treasury’s initiative.

Collection Services
Payments Services
The Reserve Banks work closely with Treasury’s
Financial Management Service and other government agencies to process payments to individuals and
companies. For example, the Banks process federal
payroll payments, Social Security and veterans’ benefits, income tax refunds, vendor payments, and
other types of payments.

The Reserve Banks also work closely with Treasury’s
Financial Management Service to collect funds owed
the federal government, including various taxes, fees
for goods and services, and delinquent debts. In 2011,
Reserve Bank operating expenses related to collection
services increased by 2.9 percent largely as a result of
ongoing support for Treasury’s Collections and Cash
Management Modernization initiative.

Reserve Bank operating expenses for paymentsrelated activity totaled $125.2 million in 2011, compared with $112.2 million in 2010. The significant
increase in expenses is largely due to expanded
requirements for several Treasury programs, notably
Go Direct and GOVerify.

The Reserve Banks also continued to operate
Pay.gov, an application supporting Treasury’s program that allows the public to use the Internet to
authorize and initiate payments to federal agencies.
During the year, the Pay.gov program was expanded
to include 103 new agency programs, which almost

Federal Reserve Banks

doubled the number of online payments processed by
Pay.gov. This expansion resulted in expenses increasing 25.0 percent, to $10.5 million.
The Reserve Banks continued to support the government’s centralized delinquent debt-collection program. Specifically, the Banks developed and maintained software that facilitates the collection of delinquent debts owed to federal agencies and states by
matching federal payments against delinquent debts,
including past-due child support payments owed to
custodial parents.

Treasury Cash-Management Services
The Reserve Banks maintain Treasury’s operating
cash account and provide collateral-management and
collateral-monitoring services for those Treasury programs that have collateral requirements. The Reserve
Banks also support Treasury’s efforts to modernize
its financial management processes by developing
software, operating help desks, and managing projects on behalf of the Financial Management Service.
In 2011, Reserve Bank operating expenses related to
Treasury cash-management services totaled
$53.8 million, compared with $48.2 million in 2010.
During 2011, the Reserve Banks continued to support Treasury’s effort to improve centralized government accounting and reporting functions. In particular, the Reserve Banks collaborated with the Financial Management Service on several ongoing software
development efforts, such as the Governmentwide
Accounting and Reporting Modernization initiative,
which is intended to provide Treasury with a modernized system for the collection and dissemination of
financial management and accounting information
transmitted from and to federal program agencies.

Services Provided to Other Entities
When permitted by federal statute or when required
by the Secretary of the Treasury, the Reserve Banks
provide fiscal agency and depository services to other
domestic and international entities. Reserve Bank
operating expenses for services provided to other
entities were $27.9 million in 2011, compared with
$27.7 million in 2010, a change of less than 1 percent.
Book-entry securities issuance and maintenance
activities account for a significant amount of the
work performed for other entities, with the majority
performed for the Federal Home Loan Mortgage
Association, the Federal National Mortgage Associa-

141

tion, and the Government National Mortgage
Association.
Postal money orders also account for a significant
portion of the amount of work performed for other
entities; they are processed primarily in image form,
resulting in operational improvements, lower staffing
levels, and lower costs to the U.S. Postal Service.
Postal money orders accounted for 14.9 percent, or
$4.1 million, of Reserve Bank operating expenses for
services provided to other entities.

Use of Federal Reserve
Intraday Credit
The Board’s Payment System Risk (PSR) policy governs the use of Federal Reserve Bank intraday credit,
also known as daylight overdrafts. A daylight overdraft occurs when an institution’s account activity
creates a negative balance in the institution’s Federal
Reserve account at any time in the operating day.
Daylight overdrafts enable an institution to send payments more freely throughout the day than if it were
limited strictly by its available funds balance. In 2011,
the Board implemented significant revisions to the
PSR policy to recognize explicitly the role of the central bank in providing intraday balances and credit to
healthy depository institutions and to provide collateralized intraday credit at a zero fee. These changes
better aligned the Federal Reserve’s intraday credit
policy with that of other central banks.
Institutions held historically high levels of overnight
balances (on average about $1.5 trillion) at the
Reserve Banks in 2011, while demand for daylight
overdrafts on average remained historically low. In
2011, average daylight overdrafts across the System
decreased to just under $2 billion from more than
$6 billion in 2010, a decrease of about 70 percent (see
figure 1). Similarly, the average level of peak daylight
overdrafts decreased to almost $30 billion in 2011
from $60 billion in 2010, a decrease of about 50 percent. Before the financial crisis, overnight balances
were much lower and daylight overdrafts significantly
higher. In 2007, institutions held on average less than
$20 billion in overnight balances and total average
daylight overdrafts were $60 billion. In 2011, institutions paid less than $1 million in daylight overdraft
fees, down from $6 million in 2010. The decrease in
fees is largely attributable to the 2011 policy revision
that eliminated fees for collateralized daylight
overdrafts.

142

98th Annual Report | 2011

Figure 1. Aggregate Daylight Overdrafts, 2007–2011
$ Billions

200
180
160
140
120
100
80

Peak daylight overdrafts

60
Average daylight overdrafts

40
20
0

2007

2008

2009

Electronic Access to
Reserve Bank Services
The Reserve Banks provide depository institutions
with a variety of alternatives for electronically accessing the Banks’ financial services payment and information services. These electronic-access solutions are
designed to meet the individual connectivity and contingency requirements of depository institution
customers.
For the past few years, as a result of the declining
number of depository institutions, Reserve Bank
electronic-access connections have decreased. At the
same time, the number of employees within depository institutions who have credentials that establish
them as trusted users increased, reflecting in part the
expansion of electronic value-added services provided. Between 2007 and 2011, the total number of
depository institutions in the U.S. declined 12.8 percent. The number of depository institutions with
electronic-access connections declined 1.3 percent,
while the number of trusted users increased 13.0 percent over the same period.
In 2011, the Reserve Banks expanded their service
package options, adding a simplified, bundled payment services package, Fed Complete, and implementing a new product, Fed Transaction Analyzer,
which is a risk-management tool to facilitate the

2010

2011

analysis of payment transactions and to help automate risk and compliance-reporting requirements.

Information Technology
In 2011, the Federal Reserve Banks continued to
improve the efficiency, effectiveness, and security of
information technology (IT) services and operations.
To improve the efficiency and overall quality of
operations, major multiyear initiatives are under way
to consolidate the management and function of the
Federal Reserve’s help desk, server, and network
operations. The consolidation of the help desk function was successfully completed, and progress continues toward the centralization of the remaining enterprise IT functions.
In addition, Federal Reserve Information Technology
(FRIT) continued to lead the Reserve Banks' transition to a more robust information security posture by
appointing a chief information security officer
(CISO), who is responsible for maintaining System
awareness of information security (IS) risk and coordinating IS activities among the Federal Reserve

Federal Reserve Banks

Banks.10 The CISO will be responsible, additionally,
for overseeing the ongoing transition to the Federal
Reserve System’s IS framework, which is based on
guidance from the National Institute of Science and
Technology and adapted to the Federal Reserve's
environment.11

Examinations of the
Federal Reserve Banks
The Reserve Banks and the consolidated limited
liability company (LLC) entities are subject to several
levels of audit and review.12 The combined financial
statements of the Reserve Banks (see “Federal
Reserve Banks Combined Financial Statements” in
the “Federal Reserve System Audits” section of this
report) as well as the financial statements of each of
the 12 Banks and those of the consolidated LLC
entities are audited annually by an independent public accountant retained by the Board of Governors.13
In addition, the Reserve Banks, including the consolidated LLC entities, are subject to oversight by the
Board of Governors, which performs its own reviews.
The Reserve Banks use the framework established by
the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) to assess their internal controls over financial reporting, including the
safeguarding of assets. Within this framework, the
management of each Reserve Bank annually provides
an assertion letter to its board of directors that confirms adherence to COSO standards. Similarly, each
consolidated LLC entity annually provides an assertion letter to the board of directors of the Federal
Reserve Bank of New York (the New York Reserve
Bank).
The Board engaged Deloitte & Touche LLP (D&T)
to audit the 2011 combined and individual financial
10

11

12

13

FRIT supplies national infrastructure and business line technology services to the Federal Reserve Banks and provides thought
leadership regarding the System’s information technology architecture and business use of technology.
The National Institute of Science and Technology is a nonregulatory federal agency within the U.S. Department of Commerce.
The consolidated LLC entities were funded by the Federal
Reserve Bank of New York (the New York Reserve Bank), and
acquired financial assets and financial liabilities pursuant to the
policy objectives. The consolidated LLC entities were determined to be variable interest entities, and the New York Reserve
Bank is considered to be the controlling financial interest holder
of each.
Each consolidated LLC entity reimburses the Board of Governors—from the entity’s available net assets—for the fees related
to the audit of its financial statements.

143

statements of the Reserve Banks and those of the
consolidated LLC entities.14
In 2011, D&T also conducted audits of internal controls over financial reporting for each of the Reserve
Banks and the consolidated LLC entities. Fees for
D&T’s services totaled $8 million, of which $2 million was for the audits of the consolidated LLC entities. To ensure auditor independence, the Board
requires that D&T be independent in all matters
relating to the audits. Specifically, D&T may not perform services for the Reserve Banks or others that
would place it in a position of auditing its own work,
making management decisions on behalf of the
Reserve Banks, or in any other way impairing its
audit independence.
The Board’s reviews of the Reserve Banks include a
wide range of off-site and on-site oversight activities,
conducted primarily by its Division of Reserve Bank
Operations and Payment Systems. Division personnel
monitor on an ongoing basis the activities of each
Reserve Bank and consolidated LLC entity, FRIT,
and the Office of Employee Benefits of the Federal
Reserve System (OEB), and they conduct a comprehensive on-site review of each Reserve Bank, FRIT,
and OEB at least once every three years.
The comprehensive on-site reviews typically include
an assessment of the internal audit function’s effectiveness and its conformance to the Institute of
Internal Auditors’ (IIA) International Standards for
the Professional Practice of Internal Auditing, applicable policies and guidance, and the IIA’s code of
ethics.
The division also reviews the System Open Market
Account (SOMA) and foreign currency holdings to
determine whether the New York Reserve Bank,
while conducting the related transactions, complies
with the policies established by the Federal Open
Market Committee (FOMC) and to assess SOMArelated IT project management and application development, vendor management, and system resiliency
and contingency plans. In addition, D&T audits the
year-end schedule of participated asset and liability
accounts and the related schedule of participated
income accounts. The FOMC is provided with the
14

In addition, D&T audited the Office of Employee Benefits of
the Federal Reserve System (OEB), the Retirement Plan for
Employees of the Federal Reserve System (System Plan), and
the Thrift Plan for Employees of the Federal Reserve System
(Thrift Plan). The System Plan and the Thrift Plan provide
retirement benefits to employees of the Board, the Federal
Reserve Banks, and the OEB.

144

98th Annual Report | 2011

external audit reports and a report on the division’s
review.

Income and Expenses
Table 4 summarizes the income, expenses, and distributions of net earnings of the Reserve Banks for
2011 and 2010. Income in 2011 was $85,241 million,
compared with $79,301 million in 2010.
Expenses totaled $8,719 million: $3,499 million in
operating expenses, $3,773 million in interest paid to
depository institutions on reserve balances and term
deposits, and earnings credits granted to depository
institutions, $44 million in interest expense on securities sold under agreements to repurchase, $472 million in assessments for Board of Governors expenditures, $649 million for new currency costs, $242 million for Consumer Financial Protection Bureau costs,

and $40 million for Office of Financial Research
costs. Net additions to and deductions from current
net income totaled $2,016 million, which includes
$2,268 million in realized gains on Treasury securities
and federal agency and government-sponsored enterprise mortgage-backed securities (GSE MBS),
$356 million in net loss associated with consolidated
LLCs, $48 million in other deductions, and $152 million in unrealized gains on investments denominated
in foreign currencies revalued to reflect current market exchange rates. Dividends paid to member banks,
set at 6 percent of paid-in capital by section 7(1) of
the Federal Reserve Act, totaled $1,577 million.
Distributions to the U.S. Treasury in the form of
interest on Federal Reserve notes totaled $75,424 million in 2011. The distributions equal comprehensive
income after the deduction of dividends paid and the
amount necessary to equate the Reserve Banks’ surplus to paid-in capital.

Table 4. Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2011 and 2010
Millions of dollars
Item
Current income
SOMA interest income
Loan interest income
Other current income1
Current expenses
Operating expenses2
Interest paid to depository institutions and earnings credits granted
Interest expense on securities sold under agreements to repurchase
Current net income
Net additions to (deductions from) current net income
Profit on sales of Treasury securities
Profit on sales of federal agency and government-sponsored enterprise mortgage-backed securities
Profit on foreign exchange transactions
Net income (loss) from consolidated LLCs
Other additions3
Assessments by the Board of Governors
For Board expenditures
For currency costs
For Consumer Financial Protection Bureau costs4
For Office of Financial Research costs4
Change in funded status of benefit plans
Comprehensive income before distributions to Treasury
Dividends paid
Transferred to surplus and change in accumulated other comprehensive income
Distributions to U.S. Treasury5
1
2
3
4

5

2011

2010

85,241
83,874
674
693
7,316
3,499
3,773
44
77,925
2,016
2,258
10
152
-356
-48
1,403
472
649
242
40
-1,162
77,376
1,577
375
75,424

79,301
74,957
3,528
816
6,270
3,489
2,687
94
73,031
9,746
0
782
554
7,560
850
1,088
422
623
33
10
46
81,735
1,583
884
79,268

Includes income from priced services, compensation received for services provided, and securities lending fees.
Includes a net periodic pension expense of $525 million in 2011 and $529 million in 2010.
Includes dividends on preferred interests and unrealized loss on Term Asset-Backed Securities Loan Facility loans.
The Board of Governors assesses the Reserve Banks to fund the operations of the Consumer Financial Protection Bureau and, for a two-year period beginning July 21, 2010,
the Office of Financial Research.
Interest on Federal Reserve notes.

Federal Reserve Banks

145

SOMA Holdings and Loans

The “Statistical Tables” section of this report provides more detailed information on the Reserve
Banks and the LLCs. Table 9 is a statement of condition for each Reserve Bank; table 10 details the
income and expenses of each Reserve Bank for 2011;
table 11 shows a condensed statement for each
Reserve Bank for the years 1914 through 2011; and
table 13 gives the number and annual salaries of officers and employees for each Reserve Bank. A
detailed account of the assessments and expenditures
of the Board of Governors appears in the Board of
Governors Financial Statements (see “Federal
Reserve System Audits”).

The Reserve Banks’ average net daily holdings of
securities and loans during 2011 amounted to
$2,576,882 million, an increase of $453,109 million
from 2010 (see table 5).

SOMA Securities Holdings
The average daily holdings of Treasury securities
increased by $720,800 million, to an average daily
amount of $1,557,878 million. The average daily
holdings of GSE debt securities decreased by

Table 5. System Open Market Account (SOMA) Holdings and Loans of the Federal Reserve Banks, 2011 and 2010
Millions of dollars, except as noted
Average daily assets (+)/liabilities (–)

Current income (+)/expense (–)

Average interest rate (percent)

Item
2011
1

U.S. Treasury securities
Government-sponsored enterprise debt securities1
Federal agency and government-sponsored enterprise
mortgage-backed securities2
Foreign currency denominated assets3
Securities purchased under agreements to resell
Central bank liquidity swaps4
Other SOMA assets5
Total SOMA assets
Securities sold under agreements to repurchase
Other SOMA liabilities6
Total SOMA liabilities
Total SOMA holdings
Primary, secondary. and seasonal credit
Term auction credit
Total loans to depository institutions
Credit extended to American International Group, Inc.
(AIG), net7, 8
Term Asset-Backed Securities Loan Facility (TALF)9
Total loans to others
Total loans
Total SOMA holding and loans
1

2010

2011

2010

2011

2010

42,257
3,053

26,373
3,510

2.71
2.43

3.15
2.10

1,557,878
125,698

837,078
166,810

918,007
26,566
0
5,368
8
2,633,525
-72,159
-56
-72,215
2,561,310
62
0
62

1,079,230
24,936
0
989
288
2,109,331
-58,476
-799
-59,275
2,050,056
4,709
7,105
11,814

38,281
249
0
34
*
83,874
-44
*
-44
83,830
*
0
*

44,839
223
0
12
*
74,957
-94
…
-94
74,863
32
18
50

4.17
0.94
0.00
0.63
…
3.18
0.06
0.00
0.06
3.27
0.43
…
0.43

4.15
0.89
0.00
1.21
…
3.55
0.16
0.00
0.16
3.65
0.68
0.25
0.42

711
14,799
15,510
15,572
2,576,882

22,874
39,029
61,903
73,717
2,123,773

409
265
674
674
84,504

2,728
750
3,478
3,528
78,391

3.94
1.79
4.35
4.33
3.28

11.93
1.92
5.62
1.35
3.69

Face value, net of unamortized premiums and discounts.
Face value of the securities, which is the remaining principal balance of the underlying mortgages, net of unamortized premiums and discounts. Does not include unsettled
transactions.
3
Includes accrued interest. Foreign currency denominated assets are revalued daily at market exchange rates.
4
Dollar value of foreign currency held under these agreements valued at the exchange rate to be used when the foreign currency is returned to the foreign central bank. This
exchange rate equals the market exchange rate used when the foreign currency was acquired from the foreign central bank.
5
Cash and short-term investments related to the federal agency and government-sponsored enterprise mortgage-backed securities portfolio.
6
Represents the obligation to return cash margin posted by counterparties as collateral under commitments to purchase and sell federal agency and GSE MBS, as well as
obligations that arise from the failure of a seller to deliver securities on the settlement date.
7
Average daily balance includes outstanding principal and capitalized interest net of unamortized deferred commitment fees and allowance for loan restructuring, and
excludes undrawn amounts and credit extended to consolidated limited liability companies.
8
As a result of the closing of the AIG recapitalization plan, $381 million of deferred commitment fees and allowances were recognized as interest income. The average interest
rate calculation for 2011 excludes these items.
9
Represents the remaining principal balance. Excludes amount necessary to adjust TALF loans to fair value at December 31, which is reported in “Other assets” in the
Statement of Condition of the Federal Reserve Banks in Table 9A in the “Statistical Tables” section of this report.
* Less than $500 thousand.
…Not applicable.
2

146

98th Annual Report | 2011

$41,112 million, to an average daily amount of
$125,698 million. The average daily holdings of federal agency and GSE MBS decreased by
$161,223 million, to an average daily amount of
$918,007 million.
The increase in average daily holdings of Treasury
securities is due to the purchases through a largescale asset purchase program and reinvestment of
principal payments from other SOMA holdings in
Treasury securities. The average daily holdings of
GSE debt securities and federal agency and GSE
MBS decreased as a result of principal payments
received.
Beginning in August 2010, principal payments
received from Treasury securities, GSE debt securities, and federal agency and GSE MBS were reinvested in Treasury securities. Beginning in September 2011, principal payments from GSE debt securities and federal agency and GSE MBS were
reinvested in federal agency and GSE MBS. There
were no holdings of securities purchased under
agreements to resell in 2011 or 2010. Average daily
holdings of foreign currency denominated assets in
2011 were $26,566 million, compared with
$24,936 million in 2010. The average daily balance of
central bank liquidity swap drawings was $5,368 million in 2011 and $989 million in 2010. The average
daily balance of securities sold under agreements to
repurchase was $72,159 million, an increase of
$13,683 million from 2010.
The average rates of interest earned on the Reserve
Banks’ holdings of Treasury securities decreased to
2.71 percent and the average rates on GSE debt securities increased to 2.43 percent in 2011. The average
rate of interest earned on federal agency and GSE
MBS increased to 4.17 percent in 2011. The average
interest rates for securities sold under agreements to
repurchase decreased to 0.06 percent in 2011. The
average rate of interest earned on foreign currency
denominated assets increased to 0.94 percent while
the average rate of interest earned on central bank
liquidity swaps decreased to 0.63 percent in 2011.

Lending
In 2011, the average daily primary, secondary, and
seasonal credit extended by the Reserve Banks to
depository institutions decreased by $4,647 million to
$62 million. The average rate of interest earned on
primary, secondary, and seasonal credit decreased to
0.43 percent in 2011, from 0.68 percent in 2010.

There were no extensions of credit outstanding under
the Term Auction Facility in 2011; the last auction
under the program was conducted in March 2010,
and the related loans matured in April 2010.
On January 14, 2011, all outstanding draws under the
American International Group, Inc. (AIG) revolving
line of credit and the related accrued interest, capitalized interest, and capitalized commitment fees were
paid in full as a result of the closing of the AIG
recapitalization plan. AIG’s outstanding draws under
the revolving line of credit had an average daily balance of $711 million in 2011, which earned interest at
an average rate of 3.94 percent.
The average daily balance of Term Asset-Backed
Securities Loan Facility (TALF) loans in 2011 was
$14,799 million, which earned interest at an average
rate of 1.79 percent. The Board of Governors’
authorization for the extension of new TALF loans
expired in 2010. The authorization for TALF loans
collateralized by newly issued asset-backed securities
and legacy commercial mortgage-backed securities
(CMBS) expired March 31, 2010, and TALF loans
collateralized by newly issued CMBS expired June 30,
2010.

Investments of the Consolidated LLCs
Additional lending facilities established during 2008
and 2009, under authority of section 13(3) of the
Federal Reserve Act, involved creating and lending to
the consolidated LLC entities (see table 6). Consistent with generally accepted accounting principles,
the assets and liabilities of these LLCs have been
consolidated with the assets and liabilities of the New
York Reserve Bank in the preparation of the statements of condition included in this report. The proceeds at the maturity or the liquidation of the consolidated LLCs’ assets are used to repay the loans
extended by the New York Reserve Bank.

Federal Reserve Bank Premises
Several Reserve Banks took action in 2011 to maintain and renovate their facilities. The multiyear renovation programs at the New York, St. Louis, and San
Francisco Reserve Banks’ headquarters buildings
continued. Security-enhancement programs continued at several facilities, including the construction of
a remote vehicle-screening facility and main entrance
lobby security improvements for the Dallas Reserve
Bank’s headquarters buildings.

Federal Reserve Banks

147

Table 6. Key Financial Data for Consolidated Limited Liability Companies, 2011 and 2010
Millions of dollars

Item

Commercial Paper
Funding Facility LLC
(CPFF)
2011

2010

TALF LLC

2011

2010

Maiden Lane LLC

2011

2010

Maiden Lane II LLC

2011

2010

Maiden Lane III LLC

2011

2010

Total LLCs

2011

2010

Net portfolio assets of the consolidated LLCs and the net position of the New York Reserve Bank (FRBNY) and subordinated interest holders
Net portfolio assets1
…
…
811
665
7,805
27,961
9,257
16,457
17,820
23,583
35,693 68,666
Liabilities of consolidated LLCs
…
…
0
0
-684
-915
-3
-2
-3
-4
-690
-921
…
…
811
665
7,121
27,046
9,254
16,455
17,817
23,579
35,003 67,745
Net portfolio assets available2
Loans extended to the
consolidated LLCs by the
…
…
0
0
4,859
25,845
6,792
13,485
9,826
14,071
21,477 53,401
FRBNY3
Other beneficial interests3, 4
…
…
109
106
1,385
1,315
1,106
1,071
5,542
5,366
8,142
7,858
Total loans and other beneficial
interests
…
…
109
106
6,244
27,160
7,898
14,556
15,368
19,437
29,619 61,259
Cumulative change in net assets since the inception of the program5
Allocated to FRBNY
…
…
32
-65
877
0
1,130
1,582
1,641
2,775
3,680
4,292
Allocated to other beneficial
interests
…
…
669
624
0
-114
226
317
808
1,367
1,703
2,194
Cumulative change in net assets
…
…
701
559
877
-114
1,356
1,899
2,449
4,142
5,383
6,486
Summary of consolidated LLC net income, including a reconciliation of total consolidated LLC net income to the consolidated LLC net income recorded by FRBNY
Portfolio interest income6
…
213
0
1
808
1,133
609
794
2,012
2,299
3,429
4,440
Interest expense on loans
extended by FRBNY7
…
-4
0
0
-138
-205
-117
-186
-146
-204
-401
-599
Interest expense–other
…
0
-4
-4
-70
-66
-36
-34
-175
-173
-285
-277
Portfolio holdings gains (losses)
…
1
0
0
434
2,571
-991
2,467
-3,363
3,141
-3,920
8,180
Professional fees
…
-2
0
-1
-43
-69
-8
-10
-20
-22
-71
-104
Net income (loss) of
consolidated LLCs
…
208
-4
-4
991
3,364
-543
3,031
-1,692
5,041
-1,248 11,640
Less: Net income (loss) allocated
to other beneficial interests
…
…
44
-75
114
1,135
-91
1,353
-558
2,266
-491
4,679
Net income (loss) allocated to
FRBNY
…
208
-48
71
877
2,229
-452
1,678
-1,134
2,775
-757
6,961
Add: Interest expense on loans
extended by FRBNY, eliminated
…
4
0
0
138
205
117
186
146
204
401
599
in consolidation7
Net income (loss) recorded by
FRBNY
…
212
-488
718
1,015
2,434
-335
1,864
-988
2,979
-356
7,560
Balances of loans extended to the consolidated LLCs by the FRBNY
Balance at beginning of the year
…
9,378
0
0
25,845
29,233
13,485
16,004
14,071
18,500
53,401 73,115
Accrued and capitalized interest
…
4
0
0
138
204
117
186
146
204
401
598
Repayments
…
-9,382
0
0
-21,124
-3,592
-6,810
-2,705
-4,391
-4,633
-32,325 -20,312
Balance at end of the year
…
0
0
0
4,859
25,845
6,792
13,485
9,826
14,071
21,477 53,401
Note: CPFF LLC was formed to provide liquidity to the commercial paper market. The last commercial paper purchases by the CPFF matured on April 26, 2010, and the CPFF
was dissolved on August 30, 2010. TALF LLC was formed in 2009 to purchase assets of the Term Asset-Backed Securities Loan Facility, which was formed to improve market
conditions for asset-backed securities. Maiden Lane LLC was formed to acquire certain assets of Bear Stearns; Maiden Lane II LLC and Maiden Lane III LLC were formed to
acquire certain assets of AIG and its subsidiaries.
1
TALF, Maiden Lane, Maiden Lane II, and Maiden Lane III holdings are recorded at fair value. Fair value reflects an estimate of the price that would be received upon selling an
asset if the transaction were to be conducted in an orderly market on the measurement date.
2
Represents the net assets available for repayment of loans extended by FRBNY and “other beneficiaries” of the consolidated LLCs.
3
Book value. Includes accrued interest.
4
The other beneficial interest holders are the U.S. Treasury for TALF LLC, JPMorgan Chase for Maiden Lane LLC, and AIG for Maiden Lane II LLC and Maiden Lane III LLC.
5
Represents the allocation of the change in net assets and liabilities of the consolidated LLCs that are available for repayment of the loans extended by FRBNY and the other
beneficiaries of the consolidated LLCs. The differences between the fair value of the net assets available and the book value of the loans (including accrued interest) are
indicative of gains or losses that would be incurred by the beneficiaries if the assets had been fully liquidated at prices equal to the fair value.
6
Interest income is recorded when earned and includes amortization of premiums, accretion of discounts, and paydown gains and losses.
7
Interest expense recorded by each consolidated LLC on the loans extended by FRBNY is eliminated when the LLCs are consolidated in FRBNY's financial statements and, as a
result, the consolidated LLCs’ net income (loss) recorded by FRBNY is increased by this amount.
8
In addition to the net income attributable to TALF LLC, FRBNY earned $181 million on TALF loans during the year ended December 31, 2011 (interest income of $265 million
and a loss on the valuation of loans of $84 million). FRBNY earned $327 million on TALF loans during the year ended December 31, 2010 (interest income of $750 million,
loss on the valuation of loans of $436 million, and administrative fees of $13 million).
…Not applicable.

148

98th Annual Report | 2011

The New York Reserve Bank evaluated the purchase
of the 33 Maiden Lane property; the purchase was
completed in February 2012. The San Francisco
Reserve Bank continued its efforts to sell the building
formerly used to house its Seattle Branch operations,
and the Atlanta Reserve Bank initiated efforts to sell
its Nashville Branch building. Additionally, the
Cleveland and Dallas Reserve Banks consolidated
certain operations performed at their Pittsburgh and
San Antonio Branches, respectively, into other
Reserve Bank offices. As a result, these Reserve

Banks will maintain smaller Branch staffs. The Cleveland Reserve Bank is preparing to sell the Pittsburgh
Branch building, and the Dallas Reserve Bank is
evaluating options for the San Antonio Branch
building.
For more information on the acquisition costs and
net book value of the Federal Reserve Banks and
Branches, see table 14 in the “Statistical Tables” sectionof this report.

Federal Reserve Banks

Pro Forma Financial Statements for Federal Reserve Priced Services
Table 7: Pro Forma Balance Sheet for Federal Reserve Priced Services, December 31, 2011 and 2010
Millions of dollars
Item
Short-term assets (Note 1)
Imputed reserve requirements on clearing balances
Imputed investments
Receivables
Materials and supplies
Prepaid expenses
Items in process of collection
Total short-term assets
Long-term assets (Note 2)
Premises
Furniture and equipment
Leases, leasehold improvements, and long-term prepayments
Prepaid pension costs
Prepaid FDIC asset
Deferred tax asset
Total long-term assets
Total assets
Short-term liabilities
Clearing balances
Deferred-availability items
Short-term debt
Short-term payables
Total short-term liabilities
Long-term liabilities
Long-term debt
Accrued benefit costs
Total long-term liabilities
Total liabilities
Equity (including accumulated other comprehensive loss of $288.9 million
and $267.6 million at December 31, 2011 and 2010, respectively)
Total liabilities and equity (Note 3)

2011

2010

262.3
2,805.3
38.7
1.4
7.7
275.4

248.8
3,463.4
45.6
1.2
17.2
374.5
3,390.9

180.8
38.2
74.6
321.9
21.7
138.5

4,150.6
245.3
57.3
65.6
354.7
25.0
132.4

775.7
4,166.6
2,622.5
910.3
0.0
44.1

880.2
5,030.8
2,487.6
1,814.7
0.0
43.6

3,576.9
0.0
381.3

4,345.9
0.0
392.3

381.3
3,958.2

392.3
4,738.2

208.3
4,166.6

292.6
5,030.8

Note: Components may not sum to totals because of rounding. The accompanying notes are an integral part of these pro forma priced services financial statements.

149

150

98th Annual Report | 2011

Table 8: Pro Forma Income Statement for Federal Reserve Priced Services, 2011 and 2010
Millions of dollars
Item

2011

Revenue from services provided to depository institutions (Note 4)
Operating expenses (Note 5)
Income from operations
Imputed costs (Note 6)
Interest on float
Interest on debt
Sales taxes
FDIC Insurance
Income from operations after imputed costs
Other income and expenses (Note 7)
Investment income
Earnings credits
Income before income taxes
Imputed income taxes (Note 6)
Net income
Memo: Targeted return on equity (Note 6)

2010
477.4
421.3
56.1

-1.3
0.0
4.8
3.2

566.7
503.9
62.9
-3.2
0.0
5.1
6.3

6.8
49.3

2.5
-1.4

10.7
-2.7

1.2
50.5
16.3
34.1
16.8

8.2
54.6

7.9
62.5
20.7
41.8
13.1

Note: Components may not sum to totals because of rounding. The accompanying notes are an integral part of these pro forma priced services financial statements.

Table 9: Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2011
Millions of dollars
Item
Revenue from services (Note 4)
Operating expenses (Note 5)
Income from operations
Imputed costs (Note 6)
Income from operations after imputed costs
Other income and expenses, net (Note 7)
Income before income taxes
Imputed income taxes (Note 6)
Net income
Memo: Targeted return on equity (Note 6)
Cost recovery (percent) (Note 8)

Total

Commercial check
collection

Commercial ACH

Fedwire funds

Fedwire securities

477.4
421.3
56.1
6.8
49.3
1.2
50.5
16.3
34.1
16.8
103.8

259.2
224.0
35.3
3.2
32.1
0.7
32.8
10.6
22.2
8.8
105.4

111.7
102.7
9.0
1.8
7.2
0.3
7.5
2.4
5.1
4.1
100.8

84.0
74.7
9.3
1.4
7.8
0.2
8.0
2.6
5.4
3.0
103.0

22.5
20.0
2.5
0.4
2.1
0.0
2.2
0.7
1.5
0.8
103.1

Note: Components may not sum to totals because of rounding. The accompanying notes are an integral part of these pro forma priced services financial statements.

Federal Reserve Banks

Notes to Pro Forma Financial Statements for Priced Services
(1) Short-Term Assets
The imputed reserve requirement on clearing balances held at Reserve Banks by
depository institutions reflects a treatment comparable to that of compensating
balances held at correspondent banks by respondent institutions. The reserve
requirement imposed on respondent balances must be held as vault cash or as balances maintained; thus, a portion of priced services clearing balances held with the
Federal Reserve is shown as required reserves on the asset side of the balance
sheet. Another portion of the clearing balances is used to finance short-term and
long-term assets. The remainder of clearing balances and deposit balances arising
from float are assumed to be invested in a portfolio of investments, shown as
imputed investments.
Receivables are composed of fees due the Reserve Banks for providing priced services and the share of suspense-account and difference-account balances related to
priced services.
Materials and supplies are the inventory value of short-term assets.
Prepaid expenses include salary advances and travel advances for priced-service
personnel.
Items in process of collection are gross Federal Reserve cash items in process of
collection (CIPC), stated on a basis comparable to that of a commercial bank.
They reflect adjustments for intra-System items that would otherwise be doublecounted on a combined Federal Reserve balance sheet; adjustments for items associated with nonpriced items (such as those collected for government agencies); and
adjustments for items associated with providing fixed availability or credit before
items are received and processed. Among the costs to be recovered under the Monetary Control Act is the cost of float, or net CIPC during the period (the difference
between gross CIPC and deferred-availability items, which is the portion of gross
CIPC that involves a financing cost), valued at the federal funds rate.
(2) Long-Term Assets
Long-term assets consist of long-term assets used solely in priced services, the
priced-service portion of long-term assets shared with nonpriced services, an estimate of the assets of the Board of Governors used in the development of priced
services, an imputed prepaid Federal Deposit Insurance Corporation (FDIC) asset
(see note 6), and a deferred tax asset related to the priced services pension and
postretirement benefits obligation (see note 3).
(3) Liabilities and Equity
Under the matched-book capital structure for assets, short-term assets are
financed with short-term payables and clearing balances. Long-term assets are
financed with long-term liabilities and core clearing balances. As a result, no shortor long-term debt is imputed. Other short-term liabilities include clearing balances
maintained at Reserve Banks. Other long-term liabilities consist of accrued
postemployment, postretirement, and qualified and nonqualified pension benefits
costs and obligations on capital leases.
Effective December 31, 2006, the Reserve Banks implemented the Financial
Accounting Standard Board’s (FASB) Statement of Financial Accounting Stan-

151

152

98th Annual Report | 2011

dards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans (codified in FASB Accounting Standards Codification
(ASC) Topic 715 (ASC 715), Compensation–Retirement Benefits), which requires
an employer to record the funded status of its benefit plans on its balance sheet. In
order to reflect the funded status of its benefit plans, the Reserve Banks recognized
the deferred items related to these plans, which include prior service costs and
actuarial gains or losses, on the balance sheet. This resulted in an adjustment to
the pension and benefit plans related to priced services and the recognition of an
associated deferred tax asset with an offsetting adjustment, net of tax, to accumulated other comprehensive income (AOCI), which is included in equity. The
Reserve Bank priced services recognized a net pension asset in 2011 and 2010. The
change in the funded status resulted in a corresponding increase in accumulated
other comprehensive loss of $21.3 million in 2011.
To satisfy the FDIC requirements for a well-capitalized institution, equity is
imputed at 5 percent of total assets.
(4) Revenue
Revenue represents fees charged to depository institutions for priced services, and
is realized from each institution through one of two methods: direct charges to an
institution’s account or charges against its accumulated earnings credits (see
note 7).
(5) Operating Expenses
Operating expenses consist of the direct, indirect, and other general administrative
expenses of the Reserve Banks for priced services plus the expenses of the Board
of Governors related to the development of priced services. Board expenses were
$5.2 million in 2011 and $7.2 million in 2010.
Effective January 1, 1987, the Reserve Banks implemented SFAS No. 87, Employers’ Accounting for Pensions (codified in ASC 715). Accordingly, the Reserve
Bank priced services recognized qualified pension-plan operating expenses of
$45.2 million in 2011 and $53.8 million in 2010. Operating expenses also include
the nonqualified pension expense of $3.1 million in 2011 and $4.4 million in 2010.
The implementation of SFAS No. 158 (ASC 715) does not change the systematic
approach required by generally accepted accounting principles to recognize the
expenses associated with the Reserve Banks’ benefit plans in the income statement.
As a result, these expenses do not include amounts related to changes in the
funded status of the Reserve Banks’ benefit plans, which are reflected in AOCI
(see note 3).
The income statement by service reflects revenue, operating expenses, imputed
costs, other income and expenses, and cost recovery.
(6) Imputed Costs
Imputed costs consist of income taxes, return on equity, interest on debt, sales
taxes, an FDIC assessment, and interest on float. Many imputed costs are derived
from the private-sector adjustment factor (PSAF) model. The cost of debt and the
effective tax rate are derived from bank holding company data, which serve as the
proxy for the financial data of a representative private-sector firm, and are used to
impute debt and income taxes in the PSAF model. The after-tax rate of return on
equity is based on the returns of the equity market as a whole and is applied to the
equity on the balance sheet to impute the profit that would have been earned had
the services been provided by a private-sector firm. In October 2008, the Federal

Federal Reserve Banks

Reserve began paying interest on required reserve and excess balances held by
depository institutions at Reserve Banks, as authorized by the Emergency Economic Stabilization Act of 2008. Beginning in 2009, given the uncertain long-term
effect that payment of interest on reserve balances would have on the level of
clearing balances, the equity used to determine the imputed profit has been
adjusted to reflect the actual clearing balance levels maintained; previously, projections of clearing balance levels were used.
Interest is imputed on the debt assumed necessary to finance priced-service assets;
there was no need to impute debt in 2011 or 2010. The imputed FDIC assessment
reflects rate and assessment methodology changes in 2011.
Interest on float is derived from the value of float to be recovered, either explicitly
or through per-item fees, during the period. Float costs include costs for the check,
Fedwire Funds, ACH, and Fedwire Securities services.
Float cost or income is based on the actual float incurred for each priced service.
Other imputed costs are allocated among priced services according to the ratio of
operating expenses, less shipping expenses, for each service to the total expenses,
less the total shipping expenses, for all services.
The following shows the daily average recovery of actual float by the Reserve
Banks for 2011, in millions of dollars:
Total float
Unrecovered float
Float subject to recovery
Sources of recovery of float
Direct charges
Per-item fees

-1,151.8
4.1
-1,156.0
1.6
-1,157.5

Unrecovered float includes float generated by services to government agencies and
by other central bank services. Float that is created by account adjustments due to
transaction errors and the observance of nonstandard holidays by some depository institutions was recovered from the depository institutions through charging
institutions directly. Float recovered through direct charges and per-item fees is
valued at the federal funds rate; credit float recovered through per-item fees has
been subtracted from the cost base subject to recovery in 2011 and 2010.
(7) Other Income and Expenses
Other income and expenses consist of investment and interest income on clearing
balances and the cost of earnings credits. Investment income on clearing balances
for 2011 and 2010 represents the average coupon-equivalent yield on three-month
Treasury bills. The investment return is applied to the required portion of the
clearing balance. Other income also includes imputed interest on the portion of
clearing balances set aside as required reserves. Expenses for earnings credits
granted to depository institutions on their clearing balances are based on a discounted average coupon-equivalent yield on three-month Treasury bills.
(8) Cost Recovery
Annual cost recovery is the ratio of revenue, including other income, to the sum of
operating expenses, imputed costs, imputed income taxes, and targeted return on
equity.

153

155

Other Federal Reserve Operations

Regulatory Developments:
Dodd-Frank Act Implementation
The Federal Reserve continued to work diligently
throughout 2011 to implement the many regulatory
changes required under the Dodd-Frank Wall Street
Reform and Consumer Protection Act (the DoddFrank Act or the act) (Pub. L. No. 111–203).
Enacted on July 21, 2010, the Dodd-Frank Act seeks
to address critical gaps and weaknesses in the U.S.
regulatory framework that were revealed by the financial crisis. The act gives the Federal Reserve important responsibilities to issue rules to enhance financial
stability and preserve the safety and soundness of the
banking system.
In addition to membership on the Financial Stability
Oversight Council (FSOC), the Federal Reserve’s new
responsibilities include the supervision of savings and
loan holding companies (SLHCs) as well as oversight
of nonbank financial firms and certain payment,
clearing, and settlement utilities that the FSOC designates as systemically important. In consultation with
other agencies, the Federal Reserve also is responsible
for developing more stringent prudential standards
for all large banking organizations and for nonbank
firms designated by the FSOC as systemically
important.
As of December 31, 2011, the Board had issued seventeen final rules, four public notices, and nine
reports required by the act. The Board had also proposed an additional 15 rules for public comment.1
(See box 1 for additional information.)

The Rulemaking Process
With each regulation, the Board seeks to identify—
and, to the extent possible consistent with statutory
requirements, minimize—the regulatory burden
1

These figures include Board actions since the enactment of the
act on July 21, 2010.

imposed by the rule. The Board does this in a variety
of ways, and at several different stages in the regulatory process. For example, before developing a regulatory proposal, the Board often collects information
through surveys and meetings directly from the parties that might be affected by the rulemaking. These
efforts help the Board become more informed about
the benefits and costs of the proposed rule and
enable it to craft a proposal that is both effective and
that minimizes regulatory burden.
During the rulemaking process, the Board also specifically seeks comment from the public on the benefits and costs of the proposed approach as well as
on a variety of alternative approaches to the
proposal.

Box 1. Dodd-Frank Implementation
Progresses in 2011
The Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) gives the Federal
Reserve important responsibilities to enhance financial stability and preserve the safety and soundness
of the banking system. In 2011, staff throughout the
Federal Reserve System participated in a wide
range of rulemakings and other projects designed
to implement these new responsibilities. While a
sizable number of projects have already been completed, additional work is needed to ensure the
Board’s obligations under the Dodd-Frank Act are
met quickly, carefully, and responsibly.
As of December 31, 2011, the Board had issued
seventeen final rules, four public notices, and nine
reports required by the act. The Board also has provided assistance to the Financial Stability Oversight
Council, facilitated the transition of certain authority
from the Office of Thrift Supervision to the Board,
helped with the establishment of the Consumer
Financial Protection Bureau and the Office of Financial Research, and participated in several joint rulemakings and consultations with other agencies.
For a full list of initiatives completed in 2011 (and to
preview 2012 initiatives), visit the Board’s Regulatory Reform website at www.federalreserve.gov
/newsevents/reform_milestones.htm.

156

98th Annual Report | 2011

In adopting the final rule, the Board aims for a regulatory approach that faithfully reflects the statutory
provisions and the intent of Congress while minimizing regulatory burden. The Board also provides an
analysis of the costs to small organizations of the
rulemaking, consistent with the Regulatory Flexibility Act, and computes the anticipated costs of paperwork, consistent with the Paperwork Reduction Act.

(collectively, covered companies) to periodically submit to the Board, the FDIC, and the FSOC a plan
for such company’s rapid and orderly resolution,
under the bankruptcy code, in the event of material
financial distress or failure. These resolution plans, or
“living wills,” will assist covered companies and regulators in conducting advance resolution planning for
a covered company.

Changes to Banking Supervision
and Regulation

On October 17, 2011, the Board and the FDIC
issued a final rule requiring covered companies to
annually submit resolution plans. Large, complex
covered companies are required to submit a resolution plan that covers the entire organization. Smaller,
less complex companies can file a streamlined resolution plan.

The Board has issued a variety of final rules to
implement the provisions of the Dodd-Frank Act
that are designed to promote the safety and soundness of the banking system. Following is a summary
of the key regulatory initiatives that were completed
during 2011 under the act.
Regulatory Capital
The Dodd-Frank Act establishes floors for regulatory capital requirements applied to domestic bank
holding companies (BHCs) and designated nonbank
financial companies supervised by the Board. Specifically, section 171 of the act requires the Board to
establish minimum risk-based capital and leverage
requirements for BHCs that are not less than the
“generally applicable” capital requirements for
insured depository institutions.
Consistent with this provision, on June 14, 2011, the
Board adopted a final rule amending its capital
framework to require a banking organization operating under the advanced approaches risk-based capital
rules to meet the higher of the minimum requirements under the generally applicable capital requirements and the minimum requirements under the
advanced approaches risk-based capital rules.
This rule was promulgated jointly with the Federal
Deposit Insurance Corporation (FDIC) and the
Office of the Comptroller of the Currency (OCC). In
the coming months, the federal banking agencies
expect to jointly propose revisions to their regulatory
capital rules consistent with changes to international
capital standards issued by the Basel Committee on
Banking Supervision. The proposed rules would be
consistent with the capital requirements established
under section 171 of the act.
Resolution Planning
The Dodd-Frank Act requires BHCs with total consolidated assets of $50 billion or more and any nonbank financial company supervised by the Board

The Board’s resolution plan rule is codified as Regulation QQ (12 CFR part 243). A company’s resolution plan must describe the company’s strategy for
rapid and orderly resolution in bankruptcy during a
time of financial distress or failure of the company,
and the plan must include information concerning
the company’s operations and funding.
Under Regulation QQ, a company’s resolution plan
must also include information regarding the manner
and extent to which any insured depository institution affiliated with the company is adequately protected from risks arising from the activities of nonbank subsidiaries of the company; detailed descriptions of the ownership structure, assets, liabilities,
and contractual obligations of the company; identification of the cross-guarantees tied to different securities; and a description of the governance and oversight process related to resolution planning.
The act also instructed the Board to conduct two
studies in consultation with the Administrative Office
of the U.S. Courts regarding the resolution of financial companies: one regarding the resolution of
domestic financial companies under the Bankruptcy
Code, and one regarding international coordination
relating to the resolution of systemic financial companies under the Bankruptcy Code and applicable
foreign laws. The Board issued both studies in
July 2011.2
Supervision of SLHCs
The act transferred all supervisory and regulatory
authority over SLHCs from the Office of Thrift
2

The studies are available on the Board’s website at www
.federalreserve.gov/publications/other-reports/default.htm.

Other Federal Reserve Operations

Supervision (OTS) to the Board, effective July 21,
2011 (the transfer date). It also grants the Board the
authority to examine, obtain reports from, and establish consolidated capital standards for SLHCs.
The Board undertook several initiatives to provide
SLHCs with advance notice of how the Board would
supervise and regulate SLHCs after the transfer date.
• The Board, OTS, OCC, and FDIC issued a joint
report on January 25, 2011, regarding the agencies’
plans to implement the transfer of OTS authorities
on January 25, 2011.
• The Board issued a public notice on February 3,
2011, of its intention to require SLHCs to submit
the same regulatory reports as BHCs.3
• The Board issued a public notice on April 15, 2011,
that described how the Board would apply certain
parts of its consolidated supervisory program for
BHCs to SLHCs after the transfer date. On the
transfer date, the Board issued a public notice of all
the OTS regulations that the Board would continue
to enforce.
• The Board issued an interim final rule on
August 12, 2011, establishing regulations for
SLHCs. New Regulation LL, governing SLHCs
generally, and new Regulation MM, governing
SLHCs in mutual form, transfer from the OTS to
the Board the regulations necessary for the Board
to administer the statutes governing SLHCs.
Debit Interchange
Section 1075 of the act restricts the interchange fees
that debit card issuers may receive for electronic debit
card transactions. Specifically, under the act, the
interchange fee an issuer receives for a particular
transaction must be reasonable and proportional to
the cost incurred by the issuer with respect to the
transaction. The act requires the Board to set standards for determining whether an interchange fee is
reasonable and proportional to the issuer’s cost and
permits the Board to adjust the interchange fee to
account for an issuer’s fraud-prevention costs. In
addition, it requires the Board to prescribe rules prohibiting network exclusivity arrangements and routing restrictions in connection with electronic debit
card transactions.

On June 29, 2011, the Board issued a final rule to
establish standards for debit card interchange fees.
Under the final rule, the maximum permissible interchange fee that an issuer may receive for an electronic
debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the
transaction. This provision regarding debit card
interchange fees became effective on October 1, 2011.
Also on June 29, the Board issued an interim final
rule that allows for an upward adjustment of no
more than one cent to an issuer’s debit card interchange fee, provided the issuer satisfies the fraudprevention standards set forth in the interim final
rule. The interim final rule became effective on October 1, 2011.
In accordance with the statute, the final rule exempts
issuers that, together with their affiliates, have assets
of less than $10 billion from the debit card interchange fee standards. To facilitate implementation of
the small issuer exemption, the Board has published
lists of institutions with consolidated assets above
and below the $10 billion exemption threshold and
plans to survey networks and publish annually the
average interchange fees each network provides to its
exempt and nonexempt issuers.
In addition, the rule prohibits all issuers and networks from restricting the number of networks over
which electronic debit transactions may be processed
to less than two unaffiliated networks. The rule also
prohibits issuers and networks from inhibiting a merchant’s ability to direct the routing of the electronic
debit transaction over any network that the issuer has
enabled to process them.
The Board also has issued several reports regarding
interchange fees, as required by the act. On June 29,
2011, the Board issued a report disclosing certain
aggregate and summary information concerning
transaction processing costs and interchange transaction fees charged or received in connection with electronic debit transactions.4 On July 21, 2011, the
Board issued a report on the use of prepaid cards by
government-administered payment programs as well
as the interchange and cardholder fees charged with
respect to such prepaid cards.5

4

3

On December 23, 2011, the Board issued a final notice permitting a two-year phase-in period for most SLHCs to file Federal
Reserve regulatory reports and an exemption for some SLHCs
from initially filing such reports.

157

5

See 2009 Interchange Revenue, Covered Issuer Cost, and Covered
Issuer and Merchant Fraud Loss Related to Debit Card Transactions, www.federalreserve.gov/paymentsystems/files/debitfees_
costs.pdf.
See Report to the Congress on Government-Administered,
General-Use Prepaid Cards, www.federalreserve.gov/

158

98th Annual Report | 2011

Interest on Demand Deposits
Section 627 of the act repealed the provision of the
Federal Reserve Act that prohibited member banks
from paying interest on demand deposits. This prohibition had been implemented through the Board’s
Regulation Q. On July 14, 2011, the Board issued a
final rule repealing Regulation Q and thereby allowing member banks to pay interest on demand
deposits.

Key Regulatory Initiatives Still
in Development
A number of important regulatory developments
remain in the proposal stage. Following is a summary
of additional regulatory initiatives that the Board
proposed in 2011.
Enhanced Prudential Standards for
Financial Firms
The act requires the Board to establish heightened
prudential standards for covered companies.6 The
heightened standards must be more stringent than
the standards that apply to other nonbank financial
companies and BHCs that do not pose similar risks
to the financial system.
On December 20, 2011, the Board proposed
enhanced prudential standards related to capital, limits on credit exposure to single counterparties, liquidity, stress testing, and risk management. The
enhanced prudential standards are intended to
strengthen the financial resilience of covered companies and limit the exposure of such companies to
individual counterparties. The proposed standards
generally apply to covered companies other than covered companies that are foreign banking organizations (U.S. covered companies). The Board expects to
issue a separate proposal that would apply the
enhanced prudential standards to foreign banking
organizations (FBOs).

would not object to proposed dividend increases or
other capital distributions only if companies are able
to demonstrate sufficient financial strength to operate as successful financial intermediaries under
stressed macroeconomic and financial market scenarios, even after making the desired capital
distributions.
The enhanced prudential standards would also apply
a net limit for credit exposure of a U.S. covered company to any single counterparty as a percentage of
the company’s regulatory capital. In addition, the
standards would set a two-tier single-counterparty
credit limit, with a more stringent credit limit applied
to credit exposures between the largest U.S. covered
companies and large counterparties.
Further, the proposed standards would establish a
general limit that prohibits a U.S. covered company
from having aggregate net credit exposures to any
single unaffiliated counterparty in excess of 25 percent of the enhanced standard company’s capital
stock and surplus. The proposal also would set a
more stringent 10 percent aggregate net credit exposure limit between nonbank covered companies and
BHCs with total consolidated assets of $500 billion
or more (collectively, “major covered companies”) on
the one hand, and counterparties that are major covered companies or FBOs with total consolidated
assets of $500 billion or more on the other hand.
Also under the proposed standards, U.S. covered
companies would be required to comply with qualitative liquidity risk-management standards generally
based on interagency liquidity risk-management
guidance. Specifically, the proposal would require
U.S. covered companies to conduct internal liquidity
stress tests and set internal quantitative limits to
manage liquidity risk.

The proposed standards would subject U.S. covered
companies to the Board’s capital plan rule, which the
Board approved on November 22, 2011. Under the
capital plan rule, the Federal Reserve annually would
evaluate institutions’ capital adequacy; their internal
capital adequacy assessment processes; and their
plans to make capital distributions, such as dividend
payments or stock repurchases. The Federal Reserve

In addition, the Board would conduct annual stress
tests of U.S. covered companies using three economic
and financial market scenarios and publish a summary of the results, including company-specific information. The proposed standards also would require
U.S. covered companies and state member banks,
BHCs, and—subject to a delayed effective date—
SLHCs with assets above $10 billion to conduct one
or more company-run stress tests each year and make
a summary of the results public.

publications/other-reports/files/government-prepaid-report201107.pdf.
See “Resolution Planning” on page 156 for more information
on covered companies.

Moreover, the standards would require U.S. covered
companies and publicly traded BHCs with total consolidated assets of $10 billion or more to establish

6

Other Federal Reserve Operations

risk committees of their boards of directors and to
institute enterprise-wide risk-management programs
that would be overseen by the risk committees. The
proposal also would require that each U.S. covered
company retain a chief risk officer, and maintain its
risk committee as a separately chartered committee
of the board of directors.
Finally, the proposed standards would establish early
remediation triggers—such as capital levels, stress test
results, and risk-management weaknesses—so that
financial weaknesses are addressed by U.S. covered
companies at an early stage.
Prohibitions against Proprietary Trading and
Other Activities
Section 619 of the Dodd-Frank Act generally prohibits banking entities from engaging in short-term proprietary trading for a banking entity’s own account,
subject to certain exemptions. That section also prohibits a banking entity from owning, sponsoring, or
having certain relationships with a hedge fund or private equity fund, subject to certain exemptions. These
prohibitions are commonly known as the “Volcker
rule.” The prohibitions and restrictions contained in
the Volcker rule apply to all insured depository institutions; BHCs; SLHCs; companies that control an
industrial loan company; foreign banks with a
branch, agency, or subsidiary bank in the United
States; and affiliates and subsidiaries of these entities.
The Board, OCC, FDIC, Commodity Futures Trading Commission (CFTC), and Securities and
Exchange Commission (SEC) are responsible for
developing and adopting regulations to implement
the prohibitions and restrictions of the Volcker rule.
On October 11, 2011, the Board requested comment
on a proposed rule, developed jointly with the other
agencies, to implement the Volcker rule. The proposal
would implement the Volcker rule’s prohibitions and,
consistent with statutory authority, would provide
certain key statutory exemptions, including market
making, underwriting, and risk-mitigating hedging.
On December 23, 2011, the Board, FDIC, OCC, and
SEC extended the comment period on the proposal
to implement the Volcker rule through February 13,
2012.
The Board alone is responsible for adopting rules to
implement the conformance period provisions of the
Volcker rule. On February 9, 2011, the Board issued
a final rule to give banking entities a period of time
to conform their activities and investments to the

159

prohibitions and restrictions of the Volcker rule. The
final rule includes a general two-year conformance
period, and it allows the Board to extend, by rule or
order, this two-year period by up to three one-year
periods. In addition, the final rule implements a special five-year extended transition period available for
certain qualifying investments in hedge funds and
certain private equity funds. The conformance period
is intended to give markets and firms an opportunity
to adjust to the Volcker rule.
Regulation of Derivative Markets
The act makes a number of significant changes to the
regulation of derivatives, which it refers to as
“swaps” and “security-based swaps,” as well as to the
regulation of participants in the derivatives markets.
In general, the act requires (1) all standardized
derivatives to be centrally cleared and traded on an
exchange or registered execution facility; (2) all
derivatives to be reported to registered data repositories; (3) all derivatives dealers (“swap dealers”) and
major market participants (“major swap participants”) to register with the SEC and/or the CFTC;
and (4) the establishment of new, regulated organizations to support the derivatives market, including
exchanges, clearing organizations, and data repositories. In addition, the act amends sections 23A and
23B of the Federal Reserve Act by, among other
things, expanding the definition of “covered transaction” to include credit exposure of a bank or its subsidiaries to an affiliate resulting from a derivative
transaction.
On April 12, 2011, the Board issued a joint proposed
rule with the Farm Credit Administration, FDIC,
Federal Housing Finance Agency, and OCC to establish margin and capital requirements for swap dealers,
major swap participants, security-based swap dealers,
and security-based swap participants (collectively,
“swap entities”). The proposed rule would require
certain swap entities regulated by the five agencies to
collect minimum amounts of initial margin and
variation margin from counterparties to non-cleared
swaps and non-cleared, security-based swaps.
The amount of margin that would be required under
the proposed rule would vary based on the relative
risk of the counterparty and of the swap or securitybased swap. A swap entity would not be required to
collect margin from a commercial end user as long as
its margin exposure is below an appropriate credit
exposure limit established by the swap entity.

160

98th Annual Report | 2011

On July 28, 2011, the Board issued a proposed rule
that would set standards for banking organizations
regulated by the Federal Reserve that engage in certain types of foreign exchange transactions with
retail customers. The proposal outlines requirements
for disclosure, recordkeeping, business conduct, and
documentation for retail foreign exchange transactions. Institutions engaging in such transactions
would be required to identify themselves to their
regulator and to be well capitalized. They would also
be required to collect margin for retail foreign
exchange transactions.
Removal of References to Credit Ratings from
Capital Guidelines
Section 939A of the act requires all federal agencies
to review their regulations within one year after passage of the act to identify any reference to or requirements regarding credit ratings, and issue a report to
Congress upon conclusion of the review. The Board
completed the required review of its regulations and
issued a report to Congress on July 25, 2011.7
Section 939A also requires the agencies to remove
any reference to, or requirements of reliance on,
credit ratings in regulations that require the use of an
assessment of creditworthiness of a security or
money-market instrument. On August 10, 2010, the
Board, FDIC, and OCC issued an advanced notice
of proposed rulemaking regarding alternatives to the
use of credit ratings in their risk-based capital rules.
The Board, with the FDIC and OCC, also held a
roundtable discussion with industry, academic, and
other participants in November 2010 to hear views
on how to develop alternatives to credit ratings. The
staffs of the agencies considered comments received
on the advanced notice of proposed rulemaking as
well as at the roundtable discussion as they worked to
develop alternatives.
On December 7, 2011, the Board, FDIC, and OCC
issued a second notice of proposed rulemaking that
would modify the agencies’ market risk capital rules
for banking organizations with significant trading
activities. The modified notice of proposed rulemaking included alternative standards of creditworthiness that would be used in place of credit ratings to
determine the capital requirements for certain debt
and securitization positions covered by the market
risk capital rules. The Board anticipates that it will
7

See Report to the Congress on Credit Ratings, www
.federalreserve.gov/publications/other-reports/files/creditratings-report-201107.pdf.

propose additional amendments to remove references
to credit ratings from its regulations in the near
future.
Credit-Risk Retention
Section 941(b) of the act imposes certain credit-risk
retention obligations on securitizers or originators of
assets securitized through the issuance of assetbacked securities (ABS). On March 29, 2011, the
Board issued a joint proposed rule with five other
federal agencies that would require securitizers to
retain risk through one of several options, which
were designed to take into account market practices
and securitization structures across different asset
classes. Under the proposed rule, sponsors of ABS
would be required to retain at least 5 percent of the
credit risk of the assets underlying the securities.
As required by the act, the proposed rule includes a
variety of exemptions from the requirement that
sponsors of ABS retain credit risk of the assets
underlying the securities, including an exemption for
U.S. government-guaranteed ABS and for mortgagebacked securities that are collateralized exclusively by
residential mortgages that qualify as qualified residential mortgages (QRMs). In addition, the proposal
would establish a definition for QRMs—incorporating such criteria as borrower credit history, payment
terms, down payment for purchased mortgages, and
loan-to-value ratio—designed to ensure they are of
very high credit quality.
Ultimately, the proposed rule aims to ensure that the
amount of credit risk retained by sponsors is meaningful, while taking into account market practices
and reducing the potential for the rule to affect negatively the availability and cost of credit to consumers
and businesses.
The agencies received more than 13,000 comments
(including more than 300 non-form substantive comments) on the proposed rule. The staffs of the rulemaking agencies have been meeting regularly to discuss the comments and options for moving forward
on the rulemaking.
Payment, Settlement, and Clearing Activities
and Utilities
The act gives the FSOC the authority to identify and
designate as systemically important a financial market utility (FMU) if the FSOC determines that failure of or a disruption to the FMU could create or
increase the risk of significant liquidity or credit
problems spreading among financial institutions or

Other Federal Reserve Operations

markets and thereby threaten the stability of the U.S.
financial system.
On July 18, 2011, the FSOC issued a final rule
describing the criteria that will inform its processes
and procedures for designating an FMU as systemically important. Under the rule, which incorporates
the act’s criteria, the FSOC will consider the aggregate monetary value of transactions processed by an
FMU; the aggregate exposure of an FMU to its
counterparties; the relationship, interdependencies,
or other interactions of an FMU with other FMUs;
and the effect that the failure of or disruption to an
FMU would have on critical markets, financial institutions, or the broader financial system. The FSOC
also will perform a more in-depth review and analysis
of specific FMUs from both a quantitative and
qualitative perspective before making a designation.
In addition, the act authorizes the Board to prescribe
risk-management standards governing the operations
of designated FMUs (except for designated FMUs
that are registered with the CFTC as derivative clearing organizations or registered with the SEC as clearing agencies). On March 30, 2011, the Board proposed a rule establishing risk-management standards
governing the operations related to payment, clearing, and settlement activities of designated FMUs
that are not registered with the CFTC or SEC. The
proposed risk-management standards are based on
the existing international standards that the Board
has incorporated previously into its Policy on Payment System Risk. The proposed rule would also
establish requirements and procedures for advance
notice of material changes to the rules, procedures, or
operations of a designated FMU for which the Board
is the primary supervisor.
In addition, as required by the act, in July 2011 the
Board, CFTC, and SEC issued a joint report to Congress containing recommendations for promoting
robust risk-management standards and consistency
in the supervisory programs of the CFTC and SEC
for designated clearing entities.8
Executive Compensation
Section 956 of the act requires applicable federal
regulators to develop jointly regulations or guidelines
implementing disclosures and prohibitions concerning incentive-based compensation at depository institutions, depository institution holding companies,
8

See Risk-Management Supervision of Designated Clearing Entities, www.federalreserve.gov/publications/other-reports/files/
risk-management-supervision-report-201107.pdf.

161

registered securities broker-dealers, credit unions,
investment advisors, and certain governmentsponsored enterprises (collectively, “covered financial
institutions”) with at least $1 billion in assets.
On April 14, 2011, the Board and other federal regulators requested comment on a proposal to implement the act’s prohibition on incentive-based compensation arrangements. The proposal is significantly
similar to the interagency guidance published in
June 2010 on which the Federal Reserve led development. In particular, the proposal requires that incentive compensation practices at covered financial institutions be consistent with three key principles:
(1) they should appropriately balance risk and financial rewards, (2) they should be compatible with effective controls and risk management, and (3) they
should be supported by strong corporate governance.
Further, the agencies proposed that covered financial
institutions with at least $1 billion in assets be
required to have policies and procedures to ensure
compliance with the requirements of the rule, and
submit an annual report to their federal regulator
describing the structure of their incentive compensation arrangements. The agencies also proposed that
larger covered financial institutions—generally those
with $50 billion or more in assets—defer at least
50 percent of the incentive compensation of certain
executive officers for at least three years, and that the
amounts ultimately paid reflect losses or other
aspects of performance over time. The Board and
other agencies are in the process of addressing public
comments on the proposal.
Registration of Securities Holding Companies
(SHCs)
The Dodd-Frank Act eliminated the SHC supervision framework pursuant to which the SEC supervised SHCs. In its place, the act permits an SHC to
elect to register with and be supervised by the Board
in order to satisfy the requirements of a foreign regulator or a provision of foreign law that the company
be subject to comprehensive, consolidated supervision. On September 2, 2011, the Board invited public
comment on a proposed rule outlining the registration requirements and procedures for SHCs.
Consumer Financial Protection
The Dodd-Frank Act made many enhancements to
consumer financial protection, and the Board began
implementing several of these enhancements prior to
the transfer of rulemaking authority for most federal
consumer protection statutes to the Consumer

162

98th Annual Report | 2011

Financial Protection Bureau (CFPB) on July 21,
2011. For instance, the act amends the Truth in
Lending Act (TILA) and Consumer Leasing Act
(CLA) to extend the protections of those laws to consumer credit transactions and consumer leases of
higher dollar amounts. Before the Dodd-Frank Act,
TILA and CLA applied to consumer credit transactions and consumer leases, respectively, of $25,000 or
less. The Dodd-Frank Act increased this limit to
$50,000 for each statute. On March 25, 2011, the
Board issued a final rule amending Regulation Z
(Truth in Lending) and Regulation M (Consumer
Leasing) to reflect these higher thresholds.
The Dodd-Frank Act further amends TILA with
respect to home mortgage lending. On February 23,
2011, the Board issued a final rule to increase the
annual percentage rate threshold used to determine
whether a mortgage lender is required to establish an
escrow account for property taxes and insurance for
first-lien jumbo mortgages. Also on February 23, the
Board proposed a rule that would expand the minimum period for mandatory escrow accounts for firstlien, higher-priced mortgage loans from one to five
years, and longer under certain circumstances. The
proposed rule would provide an exemption from the
escrow requirement for certain creditors that operate
in rural or underserved communities. It also contains
new disclosure requirements mandated by the DoddFrank Act. The proposed rule was transferred to the
CFPB on the transfer date.
In addition, the Dodd-Frank Act generally prohibits
lenders from making residential mortgage loans
unless the consumer has a reasonable ability to repay
the loan. On April 19, 2011, the Board proposed a
rule to implement this provision. Under the Board’s
proposal, a lender could comply with the ability-torepay requirement by considering and verifying specified underwriting factors, making certain types of
qualified mortgages, or refinancing a non-standard

mortgage into a more stable standard mortgage. The
proposed rule also would implement the Dodd-Frank
Act’s limits on prepayment penalties. This proposed
rule also was transferred to the CFPB on the transfer
date.
Further, the Dodd-Frank Act amends the Fair Credit
Reporting Act to require a creditor to disclose credit
scores and related information to a consumer when
the creditor uses the consumer’s credit score in setting material terms of credit or in taking adverse
action. On July 6, 2011, the Board and the Federal
Trade Commission issued final rules to implement
this provision. The final rules revise the content
requirements for risk-based pricing notices and add
related model forms that reflect the new credit score
disclosure requirements. The final rules were transferred to the CFPB on the transfer date.
On May 12, 2011, the Board issued a proposed rule
to create protections for consumers who send remittance transfers to recipients located in a foreign
country. Consistent with section 1073 of the DoddFrank Act, the Board proposed to amend Regulation E to require disclosure of information about
fees, exchange rates, and amount of currency to be
received by the recipient of a remittance transfer. The
proposed rule, which was transferred to the CFPB on
the transfer date, would also provide error resolution
and cancellation rights for senders of remittance
transfers. In addition, on July 19, 2011, the Board
issued a report to Congress on the status of automated clearinghouse expansion for remittance transfers to foreign countries.9

9

See Report to the Congress on the Use of the Automated Clearinghouse System for Remittance Transfers to Foreign Countries,
www.federalreserve.gov/boarddocs/rptcongress/ACH_report_
201107.pdf.

Other Federal Reserve Operations

The Board of Governors and the
Government Performance and
Results Act
Overview
The Government Performance and Results Act
(GPRA) of 1993 requires that federal agencies, in
consultation with Congress and outside stakeholders,
prepare a strategic plan covering a multiyear period
and an annual performance plan. The GPRA Modernization Act of 2010 refines those requirements to
include quarterly performance reporting. Although
the Federal Reserve is not covered by the GPRA, the
Board of Governors voluntarily complies with the
spirit of the act.

Strategic Plan, Performance Plan, and
Performance Report
The Board’s strategic plan articulates the Board’s
mission, sets forth major goals, outlines strategies for

163

achieving those goals, and discusses the environment
and other factors that could affect their achievement.
It also addresses issues that cross agency jurisdictional lines, identifies key quantitative measures of
performance, and discusses the evaluation of performance. The Board is currently revising its 2012–15
Strategic Plan, with Board approval anticipated in
2012.
The performance plan includes specific targets for
some of the performance measures identified in the
strategic plan and describes the operational processes
and resources needed to meet those targets. It also
discusses validation of data and verification of
results. The performance report discusses the Board’s
performance in relation to its goals.
The strategic plan, performance plan, and performance report are available on the Board’s website at
www.federalreserve.gov/publications/gpra/default
.htm.

165

Record of Policy Actions
of the Board of Governors

Policy actions of the Board of Governors are presented pursuant to section 10 of the Federal Reserve
Act. That section provides that the Board shall keep
a record of all questions of policy determined by the
Board and shall include in its annual report to Congress a full account of such actions. This chapter provides a summary of policy actions in 2011, as implemented through (1) rules and regulations, (2) policy
statements and other actions, and (3) discount rates
for depository institutions. Policy actions were
approved by all Board members in office, unless indicated otherwise.1 More information on the actions is
available from the “Reading Rooms” on the Board’s
Freedom of Information (FOI) Act web page or on
request from the Board’s FOI Office.
For information on Federal Open Market Committee
policy actions relating to open market operations, see
“Minutes of Federal Open Market Committee
Meetings” on page 173.

Rules and Regulations
Regulation B (Equal Credit Opportunity)
On September 14, 2011, the Board approved a final
rule (Docket No. R-1426) to specify that motor
vehicle dealers temporarily are not required to comply with new requirements for data collection in the
Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act).2 Under the act,
creditors are required to collect information about
credit applications made by women- or minorityowned businesses and by small businesses. The Consumer Financial Protection Bureau (CFPB) will
implement this provision for all creditors except certain motor vehicle dealers subject to the Board’s
jurisdiction. The CFPB had previously announced
that creditors were not obligated to comply with the
data collection requirements until implementing rules
1
2

Governor Warsh resigned from the Board on April 2, 2011.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201109-26/html/2011-24300.htm

were issued. Therefore, the Board amended Regulation B to apply the same approach to motor vehicle
dealers. The final rule is effective September 26, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulation B (Equal Credit Opportunity)
and Regulation V (Fair Credit Reporting)
On July 1, 2011, the Board, acting with the Federal
Trade Commission, approved final rules (Docket
Nos. R-1408 and R-1407) to implement the credit
score disclosure requirements of the Dodd-Frank
Act.3 Under the act, creditors are required to disclose
credit scores and related information to consumers if
their credit scores are used in setting credit terms or
taking an adverse action. Regulation V is amended to
revise the content requirements for risk-based pricing
notices, and Regulations V and B are amended to
add or revise related model forms or notices that
reflect the new disclosure requirements. The final
rules are effective August 15, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulation H (Membership of State
Banking Institutions in the Federal
Reserve System) and Regulation Y
(Bank Holding Companies and
Change in Bank Control)
On June 9, 2011, the Board, acting with the Federal
Deposit Insurance Corporation (FDIC) and Office
of the Comptroller of the Currency (OCC), approved
a final rule (Docket No. R-1402) amending their
(1) advanced approaches risk-based capital rules to
3

See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2011-07-15/html/2011-17585.htm and www.gpo.gov/fdsys/pkg/
FR-2011-07-15/html/2011-17649.htm.

166

98th Annual Report | 2011

establish a floor for the capital requirements applicable to the largest and internationally active banking
organizations and (2) general risk-based capital rules
to provide limited flexibility to establish capital
requirements for certain low-risk assets generally not
held by insured depository institutions.4 The final
rule is consistent with provisions of the Dodd-Frank
Act and is effective July 28, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulation M (Consumer Leasing) and
Regulation Z (Truth in Lending)
On March 22, 2011, the Board approved final rules
(Docket Nos. R-1400 and R-1399) that increase the
coverage of consumer protection regulations to credit
transactions and leases of higher dollar amounts.5
Specifically, the rules increase the thresholds for
exempt consumer credit transactions and consumer
leases (including automobile leases) from $25,000 to
$50,000, in accordance with the Dodd-Frank Act.
This amount will be adjusted annually to reflect
increases in the consumer price index. Private education loans and loans secured by real property (such as
mortgages) remain subject to certain disclosure
requirements and prohibitions regardless of the loan
amount. The final rules are effective July 21, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin. Absent and not voting: Governor Warsh.
On June 11, 2011, the Board approved final rules
(Docket Nos. R-1423 and R-1424) to increase the
dollar threshold for exempt consumer credit and
lease transactions from $50,000 to $51,800.6 The new
threshold reflects the annual percentage increase in
the consumer price index, in accordance with the
Dodd-Frank Act. The final rules are effective January 1, 2012.

4

5

6

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201106-28/html/2011-15669.htm.
See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2011-04-04/html/2011-7377.htm and www.gpo.gov/fdsys/pkg/
FR-2011-04-04/html/2011-7376.htm.
See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2011-06-20/html/2011-15180.htm and www.gpo.gov/fdsys/pkg/
FR-2011-06-20/html/2011-15178.htm.

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulation Q (Prohibition Against the
Payment of Interest on Demand Deposits)
On July 12, 2011, the Board approved a final rule
(Docket No. R-1413) to repeal Regulation Q.7 Regulation Q implemented section 19(i) of the Federal
Reserve Act, which prohibited the payment of interest on demand deposits by institutions that are members of the Federal Reserve System. The Dodd-Frank
Act repealed section 19(i) of the Federal Reserve Act,
effective July 21, 2011. Accordingly, the Board’s final
rule implements the repeal of section 19(i). The final
rule also rescinds the Board’s published interpretations of Regulation Q and removes references to
Regulation Q in other regulations, such as in Regulation D (Reserve Requirements of Depository Institutions) and Regulation DD (Truth in Savings). The
final rule is effective July 21, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulation Y (Bank Holding Companies
and Change in Bank Control)
On February 7, 2011, the Board approved a final rule
(Docket No. R-1397) to implement the provisions of
section 619 of the Dodd-Frank Act that grant banking entities a period of time to conform their activities and investments with the prohibitions and
restrictions on proprietary trading or hedge fund or
private equity fund activities imposed by the section
(the so-called Volcker Rule).8 The act generally provides these institutions with a two-year conformance
period, which the Board may extend under certain
conditions. The rule is effective April 1, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.
On June 11, 2011, the Board approved the following
amendments (Docket No. R-1356) to its capital
adequacy guidelines for bank holding companies:
(1) a final rule to permit bank holding companies
7

8

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201107-18/html/2011-17886.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201102-14/html/2011-3199.htm.

Record of Policy Actions of the Board of Governors

that are organized as S-corporations or in mutual
form to include in tier 1 capital subordinated debt
issued to the Department of the Treasury (Treasury)
under the Troubled Asset Relief Program and to
allow those companies to exclude such debt for purposes of certain provisions of the Board’s Small
Bank Holding Company Policy Statement and (2) an
interim final rule with request for comment to allow
small bank holding companies that are organized as
S-corporations or in mutual form to exclude subordinated debt issued to Treasury under the Small Business Lending Fund from treatment as “debt” for purposes of certain provisions of the policy statement.9
The final rule and interim final rule are effective
June 21, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.
On November 17, 2011, the Board approved a final
rule (Docket No. R-1425) to require large bank holding companies (those with $50 billion or more of
total consolidated assets) to submit capital plans to
the Federal Reserve annually and to require these
companies to obtain approval under certain circumstances before making a capital distribution.10 Under
the final rule, the Federal Reserve evaluates institutions’ capital adequacy, internal capital adequacy
processes, and plans to make capital distributions,
including dividend payments or stock repurchases.
The Federal Reserve approves capital distributions
only when a company’s capital plan is satisfactory
and the company can demonstrate sufficient financial
strength to operate successfully as a financial intermediary under stress scenarios, even after making the
desired distribution. The final rule is effective December 30, 2011, and institutions are required to submit
their initial capital plans by January 9, 2012.

rulemaking authority to the CFPB in July 2011.11
The proposals had been issued in 2009 and 2010 as
part of the Board’s comprehensive review of its
mortgage regulations under the Truth in Lending Act.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.
On February 22, 2011, the Board approved a final
rule (Docket No. R-1392) to increase from 1.5 percent to 2.5 percent the annual percentage rate threshold used to determine whether a mortgage lender is
required to establish an escrow account for property
taxes and insurance for first-lien, “jumbo” mortgage
loans, in accordance with the Dodd-Frank Act.12
Jumbo loans are loans exceeding the conformingloan size limit for purchase by Freddie Mac. The rule
is effective for covered loans for which the creditor
receives an application on or after April 1, 2011.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.
On March 16, 2011, the Board approved a final rule
(Docket No. R-1393) to clarify aspects of Board
rules for open-end (not home-secured) credit plans
that were issued in 2010 to implement the Credit
Card Accountability Responsibility and Disclosure
Act.13 Among other provisions, the rule states that
credit card applications cannot request a consumer’s
“household income” because that term is too vague
to allow credit card issuers to properly evaluate a
consumer’s ability to make payments on the account,
which issuers are required to do under the act.
Instead, issuers must consider a consumer’s individual income or salary. The final rule is effective
October 1, 2011.

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke and Raskin.
Absent and not voting: Governors Warsh and
Tarullo.

Regulation Z (Truth in Lending)
On January 28, 2011, the Board approved an
announcement that it does not expect to finalize
three pending mortgage rulemakings (Docket Nos.
R-1366, R-1367, and R-1390) before the transfer of

11

12
9

10

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201106-21/html/2011-14983.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201112-01/html/2011-30665.htm.

167

13

See press release at www.federalreserve.gov/newsevents/press/
bcreg/20110201a.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201103-02/html/2011-4384.htm.
See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2011-04-25/html/2011-8843.htm and www.gpo.gov/fdsys/pkg/FR2011-05-31/html/2011-12795.htm (correction).

168

98th Annual Report | 2011

Regulation II (Debit Card Interchange Fees
and Routing)
On June 29, 2011, the Board approved a final rule
(Docket No. R-1404) to implement provisions of the
Dodd-Frank Act that require the Board to establish
standards for assessing whether a debit card interchange fee is reasonable and proportional to an issuer’s costs and to prohibit network-exclusivity
arrangements and routing restrictions. Under the
final rule, the maximum permissible interchange fee
that an issuer may receive for an electronic debit
transaction is the sum of 21 cents per transaction
and 5 basis points multiplied by the value of the
transaction. The Board also approved an interim
final rule (Docket No. R-1404) with request for comment that permits an upward adjustment of no more
than 1 cent to an issuer’s debit card interchange fee if
the issuer meets the rule’s fraud-prevention standards.14 The Board will reevaluate this adjustment in
light of comments received.
In accordance with the act, the interchange fee standards in the final rule do not apply to issuers that
have total consolidated assets of less than $10 billion,
debit cards issued pursuant to governmentadministered payment programs, and general-use
reloadable prepaid cards. In addition, the final rule
prohibits issuers and networks from (1) directly or
indirectly restricting the number of payment card
networks over which an electronic debit transaction
may be processed to fewer than two unaffiliated networks and (2) inhibiting a merchant’s ability to route
transactions over any network that an issuer has
enabled to process them. The final rule and interim
final rule are effective October 1, 2011. For most
debit cards, issuers must comply with the networkexclusivity provisions by April 1, 2012. However,
issuers of certain health-related and other benefit
cards and general-use prepaid cards have a delayed
effective date of April 1, 2013, or later in certain
circumstances.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Tarullo and
Raskin. Voting against this action: Governor
Duke.

On September 12, 2011, the Board approved the issuance of a small-entity compliance guide for Regulation II.15
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulation LL (Savings and Loan Holding
Companies) and Regulation MM (Mutual
Holding Companies)
On August 8, 2011, the Board approved an interim
final rule with request for comment (Docket No.
R-1429) establishing regulations for savings and loan
holding companies (SLHCs).16 On July 21, 2011, the
responsibility for supervision and regulation of
SLHCs transferred from the Office of Thrift Supervision (OTS) to the Board, in accordance with the
Dodd-Frank Act. The interim final rule provides for
the corresponding transfer of the OTS regulations
necessary for the Board to administer the statutes
governing SLHCs. The interim final rule, which also
made technical amendments to other Board regulations to reflect the new authority over SLHCs, is
effective September 13, 2011. The Board approved
additional technical amendments to its regulations
delegating certain actions regarding SLHCs by order
dated August 12, 2011.17
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulation QQ (Resolution Plans)
On October 13, 2011, the Board approved a final rule
(Docket No. R-1414) to implement the resolutionplan requirement of the Dodd-Frank Act. The rule,
which was promulgated jointly with the FDIC,
requires bank holding companies with total consolidated assets of $50 billion or more and nonbank
financial firms designated by the Financial Stability
Oversight Council for supervision by the Federal
Reserve to annually submit resolution plans (“living
wills”) to the Board and FDIC.18 The plans must
15

16

14

See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2011-07-20/html/2011-16861.htm (final rule) and www.gpo.gov/
fdsys/pkg/FR-2011-07-20/html/2011-16860.htm (interim final
rule).

17

18

See the compliance guide at www.federalreserve.gov/
bankinforeg/regiicg.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201109-13/html/2011-22854.htm.
See the Board’s order at www.federalreserve.gov/newsevents/
press/bcreg/bcreg20110812a1.pdf.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201111-01/html/2011-27377.htm.

Record of Policy Actions of the Board of Governors

describe a company’s strategy for rapid and orderly
resolution in bankruptcy during times of financial
distress. Among other components, the plans must
include a description of the range of specific actions
a company proposes to take in resolution and a
description of the company’s organizational structure, material entities, interconnections and interdependencies, and management information systems.
The final rule is effective November 30, 2011. Companies must submit their initial resolution plans on a
staggered basis from July 1, 2012, through December 31, 2013, starting with companies that generally
have $250 billion or more in total nonbank assets.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

tional Group, Inc. (AIG) during the financial crisis.20
Maiden Lane II had used the proceeds of a loan
from the Federal Reserve Bank of New York and the
acquisition of a subordinated interest by AIG to purchase residential mortgage-backed securities from
several of AIG’s regulated U.S. insurance subsidiaries. Under the approved disposition process, the
Reserve Bank subsequently disposed of all the securities in the Maiden Lane II portfolio individually and
in segments over time as warranted by market conditions through a competitive sales process. (Note: The
disposition of the assets in 2011 and 2012 resulted in
full repayment of the Reserve Bank’s loan to Maiden
Lane II and generated a net gain for the benefit of
the public of approximately $2.8 billion.)
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin. Absent and not voting: Governor Warsh.

Policy Statements and Other Actions
S.A.F.E. Act Initial Registration Period
On January 28, 2011, the Board, acting with the
FDIC, OCC, OTS, National Credit Union Administration (NCUA), and Farm Credit Administration
(FCA), approved a notice (Docket No. R-1357)
announcing the initial registration period under the
Secure and Fair Enforcement for Mortgage Licensing
Act (S.A.F.E. Act).19 During this initial registration
period (from January 31 through July 29, 2011), residential mortgage loan originators employed by
agency-regulated institutions were required to register with the Nationwide Mortgage Licensing System
and Registry, in accordance with the S.A.F.E. Act.
The Board, along with the other agencies, had issued
final rules implementing the act on July 28, 2010.
Pursuant to those rules, agency-regulated mortgage
loan originators must register with the registry,
obtain a unique identifier from the registry, and
maintain their registrations.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Warsh, Duke,
Tarullo, and Raskin.

American International Group, Inc.
On March 29, 2011, the Board approved a process
for the disposition of assets held by Maiden Lane II,
LLC, a special-purpose vehicle established to alleviate
funding and liquidity pressures on American Interna19

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201102-03/html/2011-2378.htm.

169

Guidance on Authentication in an Internet
Banking Environment
On June 11, 2011, the Board approved interagency
guidance, issued through the Federal Financial Institutions Examination Council (FFIEC), addressing
customer authentication and security in Internet
banking.21 The guidance supplements FFIEC guidance issued in 2005, in light of the heightened and
evolving threats facing online banking and other
activities. The guidance reinforces the original riskmanagement framework for Internet and electronic
banking and updates the agencies’ expectations for
supervised financial organizations regarding customer authentication, layered security, and other
controls.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Interagency Questions and Answers
Regarding Flood Insurance
On September 29, 2011, the Board, acting with the
FDIC, OCC, NCUA, and FCA, approved revisions
(Docket No. OP-1431) to the Interagency Questions
and Answers Regarding Flood Insurance that were

20

See Federal Reserve Bank of New York press release at www
.newyorkfed.org/newsevents/news/markets/2011/an110330.html.

21

See FFIEC press release at www.ffiec.gov/press/pr062811.htm.

170

98th Annual Report | 2011

most recently issued in July 2009.22 The revised guidance, which was published on October 14, 2011,
finalized two questions and answers that related to
insurable value and the force placement of flood
insurance. An additional proposed question on insurable value was withdrawn. (Note: The guidance also
requested comment on three additional proposed
updates to questions and answers relating to flood
insurance.)
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Policies for Directors of Federal Reserve
Banks and Branches
On December 1, 2011, the Board approved revisions
to its Eligibility, Qualifications, and Rotation Policy
for Reserve Bank and Branch directors.23 The revisions extend director stockholding and affiliation
restrictions to institutions that were brought under
the Federal Reserve System’s supervisory authority
by the Dodd-Frank Act. Other revisions address eligibility requirements for Board-appointed Branch
directors and prescribe a standard annual certification for Class B and Class C directors.
The Board also revised its Guide to Conduct for
Reserve Bank and Branch directors to formalize
standards for director conduct regarding access to
Board and Reserve Bank officials and staff and to
prescribe a standard certification form to implement
an existing requirement that directors certify their
lack of financial interest in Reserve Bank procurements. In addition, the Guide to Conduct was revised
to implement recommendations from the October 2011 Government Accountability Office Report
on Federal Reserve Bank Governance, including recommendations to direct each Reserve Bank to clearly
document, in its bylaws, the roles and responsibilities
of directors and to adopt a process for requesting
waivers to the Guide to Conduct.
The Board also adopted a new policy to implement
the Dodd-Frank Act provision that excludes Class A
directors from the appointment process for Reserve
Bank presidents and first vice presidents. The new
policy extends this exclusion to Class B directors
affiliated with firms supervised by the Federal
22

23

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201110-17/html/2011-26749.htm.
See Reserve Bank director policies at www.federalreserve.gov/
generalinfo/listdirectors/policies-directors.htm.

Reserve. The Board also formalized the existing prohibition on directors’ access to confidential supervisory information and limited the involvement of
Class A and some Class B directors in selecting and
compensating Reserve Bank officers whose primary
responsibilities involve supervisory matters.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulatory Reports for Savings and Loan
Holding Companies
On December 22, 2011, the Board approved a twoyear phase-in period for most SLHCs to file Federal
Reserve regulatory reports and an exemption for
some SLHCs from initially filing reports.24 Under the
Dodd-Frank Act, supervisory and regulatory authority for SLHCs and their nondepository subsidiaries
transferred from the OTS to the Board on July 21,
2011. The phase-in approach is intended to allow
SLHCs to develop reporting systems over a period of
time and will begin with the March 31, 2012, reporting period.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Discount Rates for Depository
Institutions in 2011
Under the Federal Reserve Act, the boards of directors of the Federal Reserve Banks must establish
rates on discount window loans to depository institutions at least every 14 days, subject to review and
determination by the Board of Governors.

Primary, Secondary, and Seasonal Credit
Primary credit, the Federal Reserve’s main lending
program for depository institutions, is extended at a
rate above the federal funds rate target set by the
Federal Open Market Committee. It is made available, with minimal administration and for very short
terms, as a backup source of liquidity to depository
institutions that, in the judgment of the lending Federal Reserve Bank, are in generally sound financial

24

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201112-29/html/2011-33432.htm.

Record of Policy Actions of the Board of Governors

condition. Throughout 2011, the primary credit rate
was ¾ percent.
Secondary credit is available in appropriate circumstances to depository institutions that do not qualify
for primary credit. The secondary credit rate is set at
a spread above the primary credit rate. Throughout
2011, the spread was set at 50 basis points; therefore,
the secondary credit rate was 1¼ percent.
Seasonal credit is available to smaller depository
institutions to meet liquidity needs that arise from
regular swings in their loans and deposits. The rate
on seasonal credit is calculated every two weeks as an
average of selected money-market yields, typically

171

resulting in a rate close to the federal funds rate target. At year-end, the seasonal credit rate was
0.30 percent.25

Votes on Changes to Discount Rates for
Depository Institutions
About every two weeks during 2011, the Board
approved proposals by the 12 Reserve Banks to
maintain the formulas for computing the secondary
and seasonal credit rates. In 2011, the Board did not
approve any changes in the primary credit rate.
25

For current and historical discount rates, see www
.frbdiscountwindow.org/.

173

Minutes of Federal Open Market
Committee Meetings

The policy actions of the Federal Open Market Committee, contained in the minutes of its meetings, are
presented in the Annual Report of the Board of Governors pursuant to the requirements of section 10 of
the Federal Reserve Act. That section provides that
the Board shall keep a complete record of the actions
taken by the Board and by the Federal Open Market
Committee on all questions of policy relating to open
market operations, that it shall record therein the
votes taken in connection with the determination of
open market policies and the reasons underlying each
policy action, and that it shall include in its annual
report to Congress a full account of such actions.
The minutes of the meetings contain the votes on the
policy decisions made at those meetings as well as a
summary of the information and discussions that led
to the decisions. In addition, four times a year, starting with the October 2007 Committee meeting, a
Summary of Economic Projections is published as an
addendum to the minutes. The descriptions of economic and financial conditions in the minutes and the
Summary of Economic Projections are based solely
on the information that was available to the Committee at the time of the meetings.
Members of the Committee voting for a particular
action may differ among themselves as to the reasons
for their votes; in such cases, the range of their views
is noted in the minutes. When members dissent from

a decision, they are identified in the minutes and a
summary of the reasons for their dissent is provided.
Policy directives of the Federal Open Market Committee are issued to the Federal Reserve Bank of New
York as the Bank selected by the Committee to
execute transactions for the System Open Market
Account. In the area of domestic open market operations, the Federal Reserve Bank of New York operates under instructions from the Federal Open Market Committee that take the form of an Authorization for Domestic Open Market Operations and a
Domestic Policy Directive. (A new Domestic Policy
Directive is adopted at each regularly scheduled
meeting.) In the foreign currency area, the Federal
Reserve Bank of New York operates under an Authorization for Foreign Currency Operations, a Foreign
Currency Directive, and Procedural Instructions with
Respect to Foreign Currency Operations. Changes in
the instruments during the year are reported in the
minutes for the individual meetings.1
1

As of January 1, 2011, the Federal Reserve Bank of New York
was operating under the Domestic Policy Directive approved at
the December 14, 2010, Committee meeting and the Authorization for Domestic Open Market Operations as amended January 26, 2010. The other policy instruments (the Authorization
for Foreign Currency Operations, the Foreign Currency Directive, and Procedural Instructions with Respect to Foreign Currency Operations) in effect as of January 1, 2011, were approved
at the January 26–27, 2010, meeting.

174

98th Annual Report | 2011

Meeting Held on January 25–26, 2011

Nathan Sheets
Economist

A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors in
Washington, D.C., on Tuesday, January 25, 2011, at
1:00 p.m. and continued on Wednesday, January 26,
2011, at 9:00 a.m.

David J. Stockton
Economist

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Charles L. Evans
Richard W. Fisher
Narayana Kocherlakota
Charles I. Plosser
Sarah Bloom Raskin
Daniel K. Tarullo
Kevin Warsh
Janet L. Yellen
Jeffrey M. Lacker, Dennis P. Lockhart,
John F. Moore, and Sandra Pianalto
Alternate Members of the Federal Open Market
Committee
James Bullard, Thomas M. Hoenig, and
Eric Rosengren
Presidents of the Federal Reserve Banks of St. Louis,
Kansas City, and Boston, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel

James A. Clouse, Thomas A. Connors,
Steven B. Kamin, Loretta J. Mester, Simon Potter,
David Reifschneider, Harvey Rosenblum,
Daniel G. Sullivan, David W. Wilcox, and Kei-Mu Yi
Associate Economists
Brian Sack
Manager, System Open Market Account
Patrick M. Parkinson
Director, Division of Banking Supervision and
Regulation, Board of Governors
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
William Nelson
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Charles S. Struckmeyer1
Deputy Staff Director, Office of the Staff Director,
Board of Governors
Lawrence Slifman and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Andrew T. Levin
Senior Adviser, Office of Board Members,
Board of Governors
Joyce K. Zickler
Visiting Senior Adviser, Division of Monetary
Affairs, Board of Governors
Daniel M. Covitz
Associate Director, Division of Research and
Statistics, Board of Governors
Gretchen C. Weinbach
Deputy Associate Director, Division of Monetary
Affairs, Board of Governors
Beth Anne Wilson2
Assistant Director, Division of International Finance,
Board of Governors
1
2

Attended Wednesday’s session only.
Attended Tuesday’s session only.

Minutes of Federal Open Market Committee Meetings | January

Bruce Fallick2
Group Manager, Division of Research and Statistics,
Board of Governors
David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
David M. Arseneau
Senior Economist, Division of International Finance,
Board of Governors
Stefania D’Amico and Edward M. Nelson
Senior Economists, Division of Monetary Affairs,
Board of Governors
Norman J. Morin
Senior Economist, Division of Research and
Statistics, Board of Governors
Mark A. Carlson
Economist, Division of Monetary Affairs,
Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
Patrick K. Barron
First Vice President, Federal Reserve Bank of Atlanta
Mark S. Sniderman
Executive Vice President, Federal Reserve Bank of
Cleveland
David Altig, Alan D. Barkema, Glenn D. Rudebusch,
Geoffrey Tootell, and Christopher J. Waller
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, Kansas City, San Francisco, Boston, and
St. Louis, respectively

175

been received and that these individuals had executed
their oaths of office.
The elected members and alternate members were as
follows:
William C. Dudley
President of the Federal Reserve Bank of New York,
with
Christine Cumming
First Vice President of the Federal Reserve Bank of
New York, as alternate.
Charles I. Plosser
President of the Federal Reserve Bank of
Philadelphia, with
Jeffrey M. Lacker
President of the Federal Reserve Bank of Richmond,
as alternate.
Charles L. Evans
President of the Federal Reserve Bank of Chicago,
with
Sandra Pianalto
President of the Federal Reserve Bank of Cleveland,
as alternate.
Richard W. Fisher
President of the Federal Reserve Bank of Dallas,
with
Dennis P. Lockhart
President of the Federal Reserve Bank of Atlanta, as
alternate.
Narayana Kocherlakota
President of the Federal Reserve Bank of
Minneapolis, with

Julie Ann Remache
Assistant Vice President, Federal Reserve Bank of
New York

John F. Moore
First Vice President of the Federal Reserve Bank of
San Francisco, as alternate.

Ayşegül Şahin2
Officer, Federal Reserve Bank of New York

By unanimous vote, the following officers of the Federal Open Market Committee were selected to serve
until the selection of their successors at the first regularly scheduled meeting of the Committee in 2012:

R. Jason Faberman2 and Robert L. Hetzel
Senior Economists, Federal Reserve Banks of
Philadelphia and Richmond, respectively

Annual Organizational Matters
In the agenda for this meeting, it was reported that
advices of the election of the following members and
alternate members of the Federal Open Market Committee for a term beginning January 25, 2011, had
2

Attended Tuesday’s session only.

Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary

176

98th Annual Report | 2011

Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas Baxter
Deputy General Counsel
Richard M. Ashton
Assistant General Counsel
Nathan Sheets
Economist
David J. Stockton
Economist
James A. Clouse
Thomas A. Connors
Steven B. Kamin
Loretta J. Mester
Simon Potter
David Reifschneider
Harvey Rosenblum
Daniel G. Sullivan
David W. Wilcox
Kei-Mu Yi
Associate Economists

By unanimous vote, the Authorization for Domestic
Open Market Operations was reaffirmed in the form
shown below. The Guidelines for the Conduct of
System Open Market Operations in Federal-Agency
Issues remained suspended.

Authorization for Domestic Open Market
Operations (Reaffirmed January 25, 2011)
1. The Federal Open Market Committee authorizes
and directs the Federal Reserve Bank of New
York, to the extent necessary to carry out the
most recent domestic policy directive adopted at
a meeting of the Committee:
A. To buy or sell U.S. government securities,
including securities of the Federal Financing
Bank, and securities that are direct obligations of, or fully guaranteed as to principal
and interest by, any agency of the United
States in the open market, from or to securities dealers and foreign and international
accounts maintained at the Federal Reserve
Bank of New York, on a cash, regular, or
deferred delivery basis, for the System Open
Market Account at market prices, and, for
such Account, to exchange maturing U.S.
government and federal agency securities
with the Treasury or the individual agencies
or to allow them to mature without replacement; and

Secretary’s note: Advice subsequently was
received that the selection of Mr. Sack as Manager
was satisfactory to the Board of Directors of the
Federal Reserve Bank of New York.

B. To buy or sell in the open market U.S. government securities, and securities that are
direct obligations of, or fully guaranteed as to
principal and interest by, any agency of the
United States, for the System Open Market
Account under agreements to resell or repurchase such securities or obligations (including
such transactions as are commonly referred
to as repo and reverse repo transactions) in
65 business days or less, at rates that, unless
otherwise expressly authorized by the Committee, shall be determined by competitive
bidding, after applying reasonable limitations
on the volume of agreements with individual
counterparties.

By unanimous vote, the Committee adopted its Program for Security of FOMC Information with
amendments to the section on ongoing responsibility
for maintaining confidentiality and with a number of
technical updates.

2. In order to ensure the effective conduct of open
market operations, the Federal Open Market
Committee authorizes the Federal Reserve Bank
of New York to use agents in agency MBS-related
transactions.

By unanimous vote, the Federal Reserve Bank of
New York was selected to execute transactions for
the System Open Market Account.
By unanimous vote, Brian Sack was selected to serve
at the pleasure of the Committee as Manager, System
Open Market Account, on the understanding that his
selection was subject to being satisfactory to the Federal Reserve Bank of New York.

Minutes of Federal Open Market Committee Meetings | January

3. In order to ensure the effective conduct of open
market operations, the Federal Open Market
Committee authorizes the Federal Reserve Bank
of New York to lend on an overnight basis U.S.
government securities and securities that are
direct obligations of any agency of the United
States, held in the System Open Market Account,
to dealers at rates that shall be determined by
competitive bidding. The Federal Reserve Bank
of New York shall set a minimum lending fee
consistent with the objectives of the program and
apply reasonable limitations on the total amount
of a specific issue that may be auctioned and on
the amount of securities that each dealer may
borrow. The Federal Reserve Bank of New York
may reject bids that could facilitate a dealer’s ability to control a single issue as determined solely
by the Federal Reserve Bank of New York.
4. In order to ensure the effective conduct of open
market operations, while assisting in the provision
of short-term investments for foreign and international accounts maintained at the Federal
Reserve Bank of New York and accounts maintained at the Federal Reserve Bank of New York
as fiscal agent of the United States pursuant to
section 15 of the Federal Reserve Act, the Federal
Open Market Committee authorizes and directs
the Federal Reserve Bank of New York:
A. For the System Open Market Account, to sell
U.S. government securities, and securities
that are direct obligations of, or fully guaranteed as to principal and interest by, any
agency of the United States, to such accounts
on the bases set forth in paragraph 1.A under
agreements providing for the resale by such
accounts of those securities in 65 business
days or less on terms comparable to those
available on such transactions in the market; and
B. For the New York Bank account, when
appropriate, to undertake with dealers, subject to the conditions imposed on purchases
and sales of securities in paragraph l.B,
repurchase agreements in U.S. government
securities, and securities that are direct obligations of, or fully guaranteed as to principal
and interest by, any agency of the United
States, and to arrange corresponding sale and
repurchase agreements between its own

177

account and such foreign, international, and
fiscal agency accounts maintained at the
Bank.
Transactions undertaken with such accounts
under the provisions of this paragraph may
provide for a service fee when appropriate.
5. In the execution of the Committee’s decision
regarding policy during any intermeeting period,
the Committee authorizes and directs the Federal
Reserve Bank of New York, upon the instruction
of the Chairman of the Committee, to adjust
somewhat in exceptional circumstances the degree
of pressure on reserve positions and hence the
intended federal funds rate and to take actions
that result in material changes in the composition
and size of the assets in the System Open Market
Account other than those anticipated by the
Committee at its most recent meeting. Any such
adjustment shall be made in the context of the
Committee’s discussion and decision at its most
recent meeting and the Committee’s long-run
objectives for price stability and sustainable economic growth, and shall be based on economic,
financial, and monetary developments during the
intermeeting period. Consistent with Committee
practice, the Chairman, if feasible, will consult
with the Committee before making any
adjustment.
By unanimous vote, the Authorization for Foreign Currency Operations, the Foreign Currency
Directive, and the Procedural Instructions with
Respect to Foreign Currency Operations were
reaffirmed in the form shown below. The vote to
reaffirm these documents included approval of
the System’s warehousing agreement with the
U.S. Treasury.

Authorization for Foreign Currency
Operations (Reaffirmed January 25, 2011)
1. The Federal Open Market Committee authorizes
and directs the Federal Reserve Bank of New
York, for the System Open Market Account, to
the extent necessary to carry out the Committee’s
foreign currency directive and express authorizations by the Committee pursuant thereto, and in
conformity with such procedural instructions as
the Committee may issue from time to time:

178

98th Annual Report | 2011

A. To purchase and sell the following foreign
currencies in the form of cable transfers
through spot or forward transactions on the
open market at home and abroad, including
transactions with the U.S. Treasury, with the
U.S. Exchange Stabilization Fund established
by section 10 of the Gold Reserve Act of
1934, with foreign monetary authorities, with
the Bank for International Settlements, and
with other international financial institutions:
Australian dollars
Brazilian reais
Canadian dollars
Danish kroner
euro
Japanese yen
Korean won
Mexican pesos
New Zealand dollars
Norwegian kroner
Pounds sterling
Singapore dollars
Swedish kronor
Swiss francs
B. To hold balances of, and to have outstanding
forward contracts to receive or to deliver, the
foreign currencies listed in paragraph A
above.
C. To draw foreign currencies and to permit foreign banks to draw dollars under the reciprocal currency arrangements listed in paragraph
2 below, provided that drawings by either
party to any such arrangement shall be fully
liquidated within 12 months after any
amount outstanding at that time was first
drawn, unless the Committee, because of
exceptional circumstances, specifically authorizes a delay.
D. To maintain an overall open position in all
foreign currencies not exceeding $25.0 billion.
For this purpose, the overall open position in
all foreign currencies is defined as the sum
(disregarding signs) of net positions in individual currencies, excluding changes in dollar
value due to foreign exchange rate movements and interest accruals. The net position
in a single foreign currency is defined as
holdings of balances in that currency, plus
outstanding contracts for future receipt,
minus outstanding contracts for future deliv-

ery of that currency, i.e., as the sum of these
elements with due regard to sign.
2. The Federal Open Market Committee directs the
Federal Reserve Bank of New York to maintain
reciprocal currency arrangements (“swap”
arrangements) for the System Open Market
Account for periods up to a maximum of
12 months with the following foreign banks,
which are among those designated by the Board
of Governors of the Federal Reserve System
under section 214.5 of Regulation N, Relations
with Foreign Banks and Bankers, and with the
approval of the Committee to renew such
arrangements on maturity:

Foreign bank
Bank of Canada
Bank of Mexico

Amount of arrangement
(millions of dollars equivalent)
2,000
3,000

Any changes in the terms of existing swap
arrangements, and the proposed terms of any
new arrangements that may be authorized, shall
be referred for review and approval to the
Committee.
3. All transactions in foreign currencies undertaken
under paragraph 1.A above shall, unless otherwise expressly authorized by the Committee, be at
prevailing market rates. For the purpose of providing an investment return on System holdings
of foreign currencies or for the purpose of adjusting interest rates paid or received in connection
with swap drawings, transactions with foreign
central banks may be undertaken at nonmarket
exchange rates.
4. It shall be the normal practice to arrange with
foreign central banks for the coordination of foreign currency transactions. In making operating
arrangements with foreign central banks on
System holdings of foreign currencies, the Federal
Reserve Bank of New York shall not commit
itself to maintain any specific balance, unless
authorized by the Federal Open Market Committee. Any agreements or understandings concerning the administration of the accounts maintained by the Federal Reserve Bank of New York
with the foreign banks designated by the Board of
Governors under section 214.5 of Regulation N
shall be referred for review and approval to the
Committee.

Minutes of Federal Open Market Committee Meetings | January

5. Foreign currency holdings shall be invested to
ensure that adequate liquidity is maintained to
meet anticipated needs and so that each currency
portfolio shall generally have an average duration
of no more than 18 months (calculated as
Macaulay duration). Such investments may
include buying or selling outright obligations of,
or fully guaranteed as to principal and interest by,
a foreign government or agency thereof; buying
such securities under agreements for repurchase
of such securities; selling such securities under
agreements for the resale of such securities; and
holding various time and other deposit accounts
at foreign institutions. In addition, when appropriate in connection with arrangements to provide investment facilities for foreign currency
holdings, U.S. government securities may be purchased from foreign central banks under agreements for repurchase of such securities within 30
calendar days.
6. All operations undertaken pursuant to the preceding paragraphs shall be reported promptly to
the Foreign Currency Subcommittee and the
Committee. The Foreign Currency Subcommittee
consists of the Chairman and Vice Chairman of
the Committee, the Vice Chairman of the Board
of Governors, and such other member of the
Board as the Chairman may designate (or in the
absence of members of the Board serving on the
Subcommittee, other Board members designated
by the Chairman as alternates, and in the absence
of the Vice Chairman of the Committee, the Vice
Chairman’s alternate). Meetings of the Subcommittee shall be called at the request of any member, or at the request of the Manager, System
Open Market Account (“Manager”), for the purposes of reviewing recent or contemplated operations and of consulting with the Manager on
other matters relating to the Manager’s responsibilities. At the request of any member of the Subcommittee, questions arising from such reviews
and consultations shall be referred for determination to the Federal Open Market Committee.
7. The Chairman is authorized:
A. With the approval of the Committee, to enter
into any needed agreement or understanding
with the Secretary of the Treasury about the
division of responsibility for foreign currency
operations between the System and the
Treasury;

179

B. To keep the Secretary of the Treasury fully
advised concerning System foreign currency
operations, and to consult with the Secretary
on policy matters relating to foreign currency
operations;
C. From time to time, to transmit appropriate
reports and information to the National
Advisory Council on International Monetary
and Financial Policies.
8. Staff officers of the Committee are authorized to
transmit pertinent information on System foreign
currency operations to appropriate officials of the
Treasury Department.
9. All Federal Reserve Banks shall participate in the
foreign currency operations for System Account
in accordance with paragraph 3G(1) of the Board
of Governors’ Statement of Procedure with
Respect to Foreign Relationships of Federal
Reserve Banks dated January 1, 1944.

Foreign Currency Directive (Reaffirmed
January 25, 2011)
1. System operations in foreign currencies shall generally be directed at countering disorderly market
conditions, provided that market exchange rates
for the U.S. dollar reflect actions and behavior
consistent with IMF Article IV, Section 1.
2. To achieve this end the System shall:
A. Undertake spot and forward purchases and
sales of foreign exchange.
B. Maintain reciprocal currency (“swap”)
arrangements with selected foreign central
banks.
C. Cooperate in other respects with central
banks of other countries and with international monetary institutions.
3. Transactions may also be undertaken:
A. To adjust System balances in light of probable future needs for currencies.
B. To provide means for meeting System and
Treasury commitments in particular curren-

180

98th Annual Report | 2011

cies, and to facilitate operations of the
Exchange Stabilization Fund.
C. For such other purposes as may be expressly
authorized by the Committee.
4. System foreign currency operations shall be
conducted:
A. In close and continuous consultation and
cooperation with the United States Treasury;
B. In cooperation, as appropriate, with foreign
monetary authorities; and
C. In a manner consistent with the obligations
of the United States in the International
Monetary Fund regarding exchange arrangements under IMF Article IV.

Procedural Instructions with Respect to
Foreign Currency Operations (Reaffirmed
January 25, 2011)
In conducting operations pursuant to the authorization and direction of the Federal Open Market Committee as set forth in the Authorization for Foreign
Currency Operations and the Foreign Currency
Directive, the Federal Reserve Bank of New York,
through the Manager, System Open Market Account
(“Manager”), shall be guided by the following procedural understandings with respect to consultations
and clearances with the Committee, the Foreign Currency Subcommittee, and the Chairman of the Committee, unless otherwise directed by the Committee.
All operations undertaken pursuant to such clearances shall be reported promptly to the Committee.
1. The Manager shall clear with the Subcommittee
(or with the Chairman, if the Chairman believes
that consultation with the Subcommittee is not
feasible in the time available):
A. Any operation that would result in a change
in the System’s overall open position in foreign currencies exceeding $300 million on any
day or $600 million since the most recent
regular meeting of the Committee.
B. Any operation that would result in a change
on any day in the System’s net position in a
single foreign currency exceeding $150 million, or $300 million when the operation is
associated with repayment of swap drawings.

C. Any operation that might generate a substantial volume of trading in a particular currency by the System, even though the change
in the System’s net position in that currency
might be less than the limits specified in 1.B.
D. Any swap drawing proposed by a foreign
bank not exceeding the larger of (i) $200 million or (ii) 15 percent of the size of the swap
arrangement.
2. The Manager shall clear with the Committee (or
with the Subcommittee, if the Subcommittee
believes that consultation with the full Committee
is not feasible in the time available, or with the
Chairman, if the Chairman believes that consultation with the Subcommittee is not feasible in
the time available):
A. Any operation that would result in a change
in the System’s overall open position in foreign currencies exceeding $1.5 billion since
the most recent regular meeting of the
Committee.
B. Any swap drawing proposed by a foreign
bank exceeding the larger of (i) $200 million
or (ii) 15 percent of the size of the swap
arrangement.
3. The Manager shall also consult with the Subcommittee or the Chairman about proposed swap
drawings by the System and about any operations
that are not of a routine character.
Developments in Financial Markets and the
Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
December 14, 2010. He also reported on System
open market operations, including the continuing
reinvestment into longer-term Treasury securities of
principal payments received on the SOMA’s holdings
of agency debt and agency-guaranteed mortgagebacked securities (MBS) as well as the ongoing purchases of additional Treasury securities authorized at
the November 2–3, 2010, FOMC meeting. Since the
first purchase schedule was released after the November FOMC meeting, the Open Market Desk at the
Federal Reserve Bank of New York purchased a total
of $236 billion of Treasury securities. These purchases included $69 billion associated with the rein-

Minutes of Federal Open Market Committee Meetings | January

vestment of principal payments on agency debt and
MBS and $167 billion associated with the expansion
of the Federal Reserve’s securities holdings. The
maturity distribution of the Desk’s purchases
resulted in an average duration of about 5½ years for
the securities obtained. The Manager reported that
given the purchases completed thus far, achieving a
$600 billion expansion of the SOMA portfolio by the
end of June 2011 would require purchasing the additional securities at a pace of about $80 billion per
month. In addition, the Manager provided projections of the Federal Reserve’s balance sheet and
income under alternative assumptions. There were no
open market operations in foreign currencies for the
System’s account over the intermeeting period. By
unanimous vote, the Committee ratified the Desk’s
transactions over the intermeeting period.
Structural Unemployment
A staff presentation on structural unemployment
summarized a broad range of economic research on
the topic conducted across the Federal Reserve
System. Among the factors cited that could affect the
level of structural unemployment were demographics,
changes in the intensity of job search and worker
screening, differences in the geographic locations of
potential workers and vacant jobs, and mismatches in
characteristics between potential workers and available jobs. Most of the research reviewed suggested
that structural unemployment had likely risen in
recent years, but by less than actual unemployment
had increased.
In discussing the staff presentation, meeting participants mentioned various factors that were seen as
influencing the path of the unemployment rate. Several participants noted that estimates of the contributions of the individual factors depended importantly
on the approach taken by researchers, including the
models used and the assumptions made. Participants
noted that many of the factors that contributed to
the recent apparent rise in structural unemployment
were likely to recede over time. Some participants
stressed that certain determinants of the unemployment rate, such as mismatches in the labor market
and firms’ hiring practices, were both difficult to
measure in real time and not directly affected by
monetary policy. Others emphasized that in the current situation, monetary policy could still play an
important role in reducing unemployment.
Staff Review of the Economic Situation
The information reviewed at the January 25–26 meeting indicated that the economic recovery was firming,

181

though the expansion had not yet been sufficient to
bring about a significant improvement in labor market conditions. Consumer spending rose strongly late
last year, and the ongoing expansion in business outlays for equipment and software appeared to have
been sustained in recent months. However, construction activity in both the residential and nonresidential sectors remained weak. Industrial production
increased solidly in November and December. Modest gains in employment continued, and the unemployment rate remained elevated. Despite further
increases in commodity prices, measures of underlying inflation remained subdued and longer-run inflation expectations were stable.
The labor market situation continued to improve
gradually. Private nonfarm payroll employment
increased in December at a pace roughly the same as
its average for 2010 as a whole, and the average workweek for all employees was unchanged. Services
industries continued to add most of the new jobs in
the private sector. Initial claims for unemployment
insurance trended lower in December and early January, and some indicators of job openings and firms’
hiring plans improved. The unemployment rate
decreased to 9.4 percent in December, but this decline
in part reflected a further drop in the labor force participation rate. Long-duration unemployment
remained elevated, and the employment-topopulation ratio was still at a very low level at the
end of the year.
Total industrial production posted solid increases in
November and December, in part because colder
weather boosted the output of utilities. Although
motor vehicle assemblies dropped back in those
months, production in the manufacturing sector outside of motor vehicles posted solid gains that were
fairly widespread across industries; as a result, capacity utilization in manufacturing increased further,
although it remained below its long-run average.
Most indicators of near-term industrial activity, such
as the new orders diffusion indexes in the national
and regional manufacturing surveys, were at levels
consistent with further increases in industrial production in the near term; in addition, motor vehicle production was scheduled to move up again in early
2011.
Growth in consumer spending appeared to have
picked up in the fourth quarter from the more modest pace seen earlier in the year. Nominal retail sales,
excluding purchases of motor vehicles and parts, rose
again in December, following substantial increases in

182

98th Annual Report | 2011

the previous four months. In addition, sales of new
light motor vehicles climbed further in December
after stepping up to a higher level during the preceding two months. The available data suggested that
consumer spending was supported by gains in personal income in the fourth quarter of 2010. Moreover, household net worth appeared to have risen in
the fourth quarter, as the large increase in equity
prices more than offset further declines in house values. Consumer credit started to increase again in
October and November after having generally
declined since the fall of 2008. However, consumer
sentiment only edged up, on net, in December and
early January, and it was still at a relatively subdued
level.
Activity in the housing market remained weak in an
environment characterized by soft demand, a large
inventory of foreclosed or distressed properties on
the market, and tight credit conditions for construction loans and mortgages. Starts and permits for new
single-family homes in November and December
were still near the very low levels recorded since midyear. Sales of new homes rose in December but
remained historically low. Sales of existing homes
increased in November and December from the more
depressed levels seen during the summer and early
autumn, but these sales stayed relatively weak as well.
Moreover, measures of house prices declined further
in recent months, and survey responses indicated that
households remained concerned that home values
might continue to fall.
Real business investment in equipment and software
appeared to have increased further in the fourth
quarter, although likely at a more moderate rate than
in the first three quarters of 2010. After declining in
October, nominal orders and shipments of nondefense capital goods excluding aircraft rose in November, and the level of new orders remained above the
level of shipments, indicating that the backlog of
unfilled orders was still rising. Available indicators
suggested that business purchases of software stayed
on a solid uptrend, and outlays for computing and
communications equipment appeared to have risen
briskly. However, business spending for transportation equipment, including aircraft and motor
vehicles, likely declined in the fourth quarter of 2010
after expanding rapidly earlier in the year. Surveys of
purchasing managers reported that firms planned to
increase their capital spending this year. Reports on
planned capital expenditures by small businesses
showed some signs of improvement in recent months,
although they remained relatively subdued. Business

outlays for nonresidential structures stayed weak,
reflecting high vacancy rates and low property values
for office and commercial properties, as well as tight
credit conditions for commercial real estate. In contrast, investment in drilling and mining structures
increased, buoyed by rising energy prices.
Real nonfarm inventory investment appeared to have
slowed substantially in the fourth quarter after a sizable increase in the previous quarter. Much of the
fourth-quarter downswing was likely associated with
a drawdown of motor vehicle stocks after an accumulation in the third quarter. Book-value data for
October and November suggested that the pace of
inventory accumulation also was slowing outside of
the motor vehicle sector. Inventory-to-sales ratios
toward the end of 2010 were close to their prerecession norms, and most purchasing managers surveyed in December reported that their customers’
inventories were not too high.
Measures of underlying consumer price inflation
remained low. In December, the core consumer price
index (CPI) edged up, as goods prices were
unchanged and prices of non-energy services rose
slightly. The 12-month change in the core CPI
remained near the very low readings of the previous
two months. Other measures of underlying inflation,
such as the trimmed-mean and median CPIs, also
remained subdued. Despite the steep run-up in agricultural commodity prices over the second half of
last year, increases in retail food prices remained
modest. However, consumer energy prices moved up
sharply in December, and prices of most types of
crude oil increased during December and into January. The prices of nonfuel industrial commodities
also continued to rise over the intermeeting period.
In December and early January, survey measures of
households’ long-term inflation expectations stayed
in the range that has prevailed for some time.
Available measures of labor compensation showed
that labor cost pressures were still restrained, as wage
increases slowed along with inflation and productivity gains appeared to remain substantial. The
12-month change in average hourly earnings for all
employees continued to be low in December.
The U.S. international trade deficit narrowed slightly
in November, as both nominal exports and imports
moved up by almost the same amount. The increase
in exports was driven by agricultural goods, in part
reflecting higher prices, as well as by consumer
goods. In contrast, exports of machinery and auto-

Minutes of Federal Open Market Committee Meetings | January

motive products fell, reversing their October gains.
The rise in imports reflected an increase in the value
of imported petroleum products, mostly explained by
higher prices, and of capital goods, which was supported importantly by a jump in computers. At the
same time, noticeable decreases were registered for
imports of automotive products, services, and consumer goods, which were primarily due to pharmaceuticals. These developments, combined with the
substantial narrowing in the trade deficit in October,
implied that the trade deficit likely shrank considerably in the fourth quarter of 2010.
Recent indicators of foreign economic activity suggested that the global recovery was strengthening.
Much of this strength was centered in the emerging
market economies (EMEs), where widespread
increases in exports and in manufacturing purchasing
managers indexes (PMIs) pointed to a resurgence in
economic growth following a slowdown in the third
quarter of 2010. For China and Singapore, real gross
domestic product (GDP) data for the fourth quarter
confirmed a rebound in economic growth. In contrast, the rise in economic activity in the advanced
foreign economies (AFEs) remained at a subdued
pace. In the euro area, the incoming economic data
were mixed: Industrial production, manufacturing
PMIs, and industrial confidence firmed, but retail
sales and consumer confidence softened. The data
also pointed to an uneven expansion across the euro
area, suggesting that economic growth in Germany
continued to outpace that in the euro-area periphery.
In Japan, exports and household spending were soft,
although industrial production firmed. Foreign inflation picked up noticeably in the fourth quarter of
2010, mostly because of an acceleration of energy
and food prices. Measures of core inflation remained
much more subdued, although they also moved up in
some countries. In the EMEs, concerns about inflation prompted a number of central banks to tighten
policy. Some EMEs reportedly took steps to limit the
appreciation of their currencies by intervening in foreign exchange markets, and some acted to discourage
capital inflows.
Staff Review of the Financial Situation
The decision by the FOMC at its December meeting
to maintain the 0 to ¼ percent target range for the
federal funds rate was widely anticipated. Both the
accompanying statement and the minutes of the
meeting were broadly in line with market expectations and elicited limited price action in financial
markets. Yields on medium- and longer-term nominal Treasury securities increased slightly, on net, over

183

the intermeeting period. Yields rose in response to
data releases that generally pointed to some firming
of the economic recovery, but the upward pressure
on yields apparently was tempered by expectations of
only a gradual pace of improvement in the labor
market, the belief that the Federal Reserve was likely
to maintain an accommodative policy stance, and
ongoing concerns about fiscal and banking pressures
in the euro area. Futures quotes indicated that the
expected path for the federal funds rate did not
change appreciably over the intermeeting period.
Market-based measures of uncertainty about longerterm Treasury yields, which had risen ahead of yearend, declined on balance, likely in part reflecting
solidifying market expectations regarding the ultimate size of the FOMC’s asset purchase program.
The purchases of longer-term Treasury securities by
the Desk during the intermeeting period reportedly
had no significant effects on measures of day-to-day
Treasury market functioning.
Inflation compensation over the next 5 years based
on Treasury inflation-protected securities (TIPS)
moved up, likely pushed higher by rising prices for oil
and other commodities and by the firming of the
economic outlook. Further out, TIPS-based inflation
compensation 5 to 10 years ahead edged down
slightly on net. Yields on investment-grade corporate
bonds were little changed over the intermeeting
period, while those on speculative-grade corporate
bonds declined a little, leaving both investment- and
speculative-grade spreads over yields on comparablematurity Treasury securities somewhat narrower. In
the secondary market for leveraged loans, the average
bid price moved up further over the intermeeting
period. The municipal bond market appeared to continue to price in an atypically high level of default
risk. The ratios of yields on long-term general obligation bonds to those on comparable-maturity Treasury securities moved up to a very high level. Despite
these strains, gross issuance of long-term municipal
bonds remained strong in December.
Conditions in short-term funding markets remained
stable over the intermeeting period. Spreads of dollar
London interbank offered rates, or Libor, over overnight index swap rates held fairly steady across the
term structure, as the year-end passed without incident. Some modest year-end pressures were observed
in repurchase agreement markets, but they dissipated
by early January. On net, spreads on unsecured nonfinancial commercial paper remained low, and
spreads on asset-backed commercial paper appeared
to have stabilized after having been somewhat volatile

184

98th Annual Report | 2011

across year-end. Anecdotal reports suggested that the
modestly rising trend in the use of dealerintermediated leverage evident in 2010 had continued
into 2011, but information from a variety of sources
indicated that leverage remained well below the levels
reached before the crisis.
Broad U.S. stock price indexes rose, on net, over the
intermeeting period, extending their recent strong
performance; bank stock prices modestly outperformed the broader market. The increase in equity
prices reflected the apparent firming of the economic
recovery and favorable early reports on fourthquarter corporate earnings. Option-implied volatility
on the S&P 500 index remained at a relatively low
level. The spread between the staff’s estimate of the
expected real equity return for S&P 500 firms and the
real 10-year Treasury yield—a rough measure of the
equity risk premium—narrowed further over the
period but remained elevated relative to longer-run
norms.
Overall, net debt financing by U.S. nonfinancial corporations was robust in the fourth quarter of 2010.
Net issuance of bonds was particularly strong, supported by heavy issuance in both the speculative- and
investment-grade sectors. Meanwhile, nonfinancial
commercial paper outstanding decreased slightly over
the quarter. Issuance of syndicated leveraged loans,
especially those funded by institutional investors,
stayed strong. Measures of the credit quality of nonfinancial corporations continued to improve. Gross
public equity issuance by nonfinancial firms dropped
back in December to its average pace in 2010.
Financing conditions for most types of commercial
real estate remained tight over the intermeeting
period, and delinquency rates for broad categories of
commercial real estate loans stayed elevated. However, for larger nonresidential properties in strong
markets, credit appeared to have become somewhat
less restricted, and prices moved up, on net, from
their lows at the beginning of 2010; at the same time,
prices of other nonresidential properties continued to
trend down. Issuance of commercial mortgagebacked securities increased in the fourth quarter of
2010 but was still only a fraction of its pre-crisis
level.
Rates on conforming fixed-rate residential mortgages
edged down a bit during the intermeeting period
after having risen appreciably in November and early
December, leaving their spreads over the 10-year
Treasury yield down slightly. Refinancing activity,

which had fallen in response to the increase in mortgage rates in November, remained at a low level during the period. Outstanding residential mortgage
debt declined further in the third quarter of 2010,
reflecting weak housing activity and tight lending
standards. Serious delinquency rates on prime and
subprime mortgages flattened out in October and
November after having moved down earlier in the
year. Signs of improvement were evident in the consumer credit market, where issuance of consumer
asset-backed securities was strong early in the fourth
quarter. In addition, delinquency rates on consumer
loans continued to trend down toward their longerrun norms.
Banks made a sizable reduction in their holdings of
securities in December. Core loans on banks’
books—the sum of commercial and industrial (C&I),
real estate, and consumer loans—edged down again,
but the rate of contraction appeared to be abating.
C&I loans expanded at a robust pace in December.
Despite continued weakness in many residential real
estate indicators, closed-end residential mortgage
loans held by large banks rose noticeably for the fifth
consecutive month in December. By contrast, commercial real estate loans, home equity loans, and consumer loans decreased during that month. The
behavior of the components of core loans in recent
months was broadly consistent with the results of the
Senior Loan Officer Opinion Survey on Bank Lending Practices conducted in January. The survey
responses indicated that, during the fourth quarter of
2010, modest net fractions of banks continued to
ease standards for C&I loans and that larger net fractions eased some terms on such loans. Changes in
banks’ lending policies for other categories of loans
were reportedly mixed and generally small. Meanwhile, moderate net fractions of respondents indicated that demand for C&I loans had strengthened
over the preceding three months, and that inquiries
from business borrowers for new or increased credit
lines had picked up. In contrast, demand reportedly
weakened somewhat, on balance, for residential real
estate loans and was little changed for consumer
loans. Respondents indicated that the recent increase
in their holdings of closed-end residential mortgage
loans reflected the relative attractiveness of such
loans compared with other assets and, for some, a
desire to expand their balance sheets by adding to
this loan category.
In December, M2 expanded at a rate a bit below its
pace in November. Liquid deposits, the largest component of M2, continued to increase rapidly, while

Minutes of Federal Open Market Committee Meetings | January

the contraction in small time deposits and retail
money market mutual funds persisted. The ongoing
compositional shift within M2 toward liquid deposits
likely reflected the relatively high yields on liquid
deposits compared with yields on many other components of M2. Currency growth slowed in December, due in part to weather-related transportation difficulties that delayed flows of U.S. bank notes to
international destinations.
The broad nominal index of the U.S. dollar declined
more than 1 percent over the intermeeting period,
depreciating by roughly similar amounts, on average,
against the currencies of the AFEs and the EMEs.
The dollar’s decline appeared to reflect a variety of
factors: signs of stronger economic activity abroad,
particularly in the EMEs; actual and prospective
monetary policy tightening in foreign economies; and
increases in the prices of oil and other commodities,
which lent support to the currencies of commodityexporting countries. Benchmark 10-year sovereign
yields moved higher in the core euro-area economies
and the United Kingdom but were little changed in
Japan and Canada. Equity prices increased in the
AFEs and in many EMEs as market participants
appeared to revise upward their outlook for the
global economy.
Financial market strains in the euro area continued
during the intermeeting period. Greek, Irish, and
Portuguese sovereign debt spreads over German
bunds rose in December and early January as credit
rating agencies downgraded the sovereign debt of
Ireland and Portugal. Subsequently, though, spreads
narrowed following some relatively successful sovereign debt auctions by countries in the euro-area
periphery, evidence of stepped-up purchases of
peripheral sovereign bonds by the European Central
Bank (ECB), and reports that the European Union
was considering expanding the backstop capacity of
the European Financial Stability Facility. Some modest dollar funding pressures developed as year-end
approached, but they did not persist into January. To
continue to support liquidity conditions in global
money markets, on December 21, the Federal
Reserve announced an extension through August 1,
2011, of its swap line arrangements with the ECB
and the central banks of Japan, Canada, Switzerland, and the United Kingdom. In addition, the
Bank of England established a temporary liquidity
swap facility with the ECB designed to provide Ireland’s central bank with sterling to help meet the
potential needs of the Irish banking system.

185

Staff Economic Outlook
Because the incoming data on production and spending were stronger, on balance, than the staff’s expectations at the time of the December FOMC meeting,
the near-term forecast for the increase in real GDP
was revised up. However, the staff’s outlook for the
pace of economic growth over the medium term was
adjusted only slightly relative to the projection prepared for the December meeting. Compared with the
December forecast, the conditioning assumptions
underlying the forecast were little changed and
roughly offsetting: Although higher equity prices and
a lower foreign exchange value of the dollar were
expected to be slightly more supportive of economic
growth, the staff anticipated that these influences
would be about offset by lower house prices and
higher oil prices. In addition, the staff’s assumptions
about fiscal policy changed little—the fiscal package
enacted in December was close to what the staff had
already incorporated in their previous projection. In
the medium term, the recovery in economic activity
was expected to receive support from accommodative
monetary policy, further improvements in financial
conditions, and greater household and business confidence. Over the projection period, the rise in real
GDP was expected to be sufficient to slowly reduce
the rate of unemployment, but the jobless rate was
anticipated to remain elevated at the end of 2012.
The underlying rate of consumer price inflation in
recent months was in line with what the staff anticipated at the time of the December meeting, and the
staff continued to project that increases in core PCE
prices would remain subdued in 2011 and 2012. As in
previous projections, the persistent wide margin of
economic slack in the forecast was expected to maintain downward pressure on inflation, but this influence was anticipated to be counterbalanced by the
continued stability of inflation expectations and by
increases in the prices of imported goods. The staff
anticipated that brisk increases in energy prices
would raise total consumer price inflation above core
inflation this year, but that upward pressure from
energy prices would wane by next year.
Participants’ Views on Current Conditions and
the Economic Outlook
In conjunction with this FOMC meeting, all meeting
participants—the six members of the Board of Governors and the presidents of the 12 Federal Reserve
Banks—provided projections of output growth, the
unemployment rate, and inflation for each year from
2011 through 2013 and over the longer run. Longer-

186

98th Annual Report | 2011

run projections represent each participant’s assessment of the rate to which each variable would be
expected to converge, over time, under appropriate
monetary policy and in the absence of further
shocks. Participants’ forecasts are described in the
Summary of Economic Projections, which is
attached as an addendum to these minutes.
In the discussion of intermeeting developments and
their implications for the outlook, the participants
generally expressed greater confidence that the economic recovery would be sustained and would gradually strengthen over coming quarters. Their more
positive assessment reflected both the tenor of the
incoming economic data and information received
from business contacts since the previous meeting.
Spending by households picked up noticeably in the
fourth quarter, business outlays continued to grow at
a moderate pace, and conditions in labor and financial markets improved somewhat over the intermeeting period. Although business contacts remained
somewhat cautious about the economic outlook, they
generally indicated greater optimism regarding their
own prospects for sales and hiring than at the time of
the previous meeting. While participants viewed the
downside risks to their forecasts of economic activity
over the projection period as having diminished, their
assessment of the most likely outcomes for economic
activity and inflation over the projection period was
not greatly changed. Most participants raised their
forecast of real GDP growth in 2011 somewhat and
continued to anticipate stronger growth this year
than in 2010, with a further gradual acceleration during 2012 and 2013. The unemployment rate was still
projected to decline gradually over the forecast
period but to remain elevated. Total inflation was still
expected to remain subdued, and core inflation was
projected to trend up slowly over the next few years
as economic activity picks up but inflation expectations remain well anchored.
Participants’ judgment that the economic recovery
was on a firmer footing was supported by the
strength in household spending in the fourth quarter.
The incoming data indicated that households stepped
up sharply their purchases of durable goods, particularly automobiles, last quarter. Spending on luxury
goods also increased, and the pace of holiday sales
was better than in recent years. However, some participants noted that it was not clear whether the
recent pace of consumer spending would be sustained. On the one hand, the additional spending
could reflect pent-up demand following the downturn or greater confidence on the part of households

about the future, in which case it might be expected
to continue. On the other hand, the additional spending could prove short lived given that a good portion
of it appeared to have occurred in relatively volatile
categories such as autos.
Activity in the business sector also indicated that the
economic recovery remained on track. For instance,
indicators of business investment in equipment and
software continued to rise. Industrial production
posted solid gains, supported in part by U.S. exports
that appeared to have been noticeably stronger in the
fourth quarter. A wide range of business contacts
expressed cautious optimism about the durability
and strength of the recovery, and some were planning
for an expansion in production in order to meet an
anticipated rise in sales. In addition, although residential construction spending remained weak, spending on commercial construction projects showed
some tentative signs of bottoming out.
Participants noted that conditions in labor markets
continued to improve gradually. Payroll employment
increased at a modest pace, and, although the data
had been somewhat erratic, a slight downward trend
was apparent in the recent pattern of weekly initial
claims for unemployment insurance. In addition,
some surveys of employers suggested a somewhat
more upbeat outlook for employment. Business contacts provided a range of information regarding hiring intentions, with some indicating that workers at
all skill levels were readily obtainable, while others
reported that they had upgraded skill requirements
and that some of the currently unemployed did not
meet those new requirements. Some businesses
remained reluctant to add permanent positions and
were planning to meet their labor requirements with
temporary workers. Overall, meeting participants
continued to express disappointment in both the pace
and the unevenness of the improvements in labor
markets and noted that they would monitor labor
market developments closely.
Conditions in financial markets improved somewhat
further over the intermeeting period. Broad equity
prices rose, adding to their substantial gains since the
middle of 2010. Yields on longer-term nominal
Treasury securities were little changed, on balance,
over the period, but they had increased quite a bit in
recent months, leaving the Treasury yield curve
noticeably steeper. Some participants noted that a
steep yield curve is a typical feature of an economy in
recovery, and that much of the steepening appeared
to have occurred in response to stronger-than-

Minutes of Federal Open Market Committee Meetings | January

expected economic data. Market-based measures of
inflation compensation over the next few years
increased further over the intermeeting period,
extending the rise that occurred over recent months.
Some participants suggested that the increase likely
reflected, in part, a decline in investors’ perceptions
of the near-term risk of further disinflation. At the
same time, longer-term inflation expectations had
remained stable. Credit spreads on the debt of nonfinancial corporations continued to narrow over the
period, reaching levels noticeably lower than those
posted several months ago, with the largest declines
coming on speculative-grade bonds. However, credit
conditions remained tight for smaller, bankdependent firms, although bank loan growth had
clearly picked up in some sectors. Some participants
noted that, taken together, these financial developments were consistent with a more accommodative
stance of monetary policy since last summer or a
reduction in risk aversion on the part of market
participants.
Meeting participants noted that headline inflation
had been boosted by higher prices for energy and
other commodities, as well as by increases in the
prices of imported goods. Some participants indicated that while unit labor costs generally had
declined and profit margins were wide, the higher
commodity prices were boosting costs of production
for many firms. Some business contacts indicated
that they were going to try to pass a portion of these
higher costs through to their customers but were
uncertain about whether that would be possible given
current market conditions. Many participants
expected that, with significant slack in resource markets and longer-term inflation expectations stable,
measures of core inflation would remain close to current levels in coming quarters. However, the importance of resource slack as a factor influencing inflation was debated, and some participants suggested
that other variables, such as current and expected
rates of economic growth, could be useful indicators
of inflation pressures.
Overall, most participants indicated that the somewhat better-than-expected economic data and anecdotal information from business contacts had importantly increased their confidence in the continuation
of a moderate recovery in activity this year. Accordingly, participants generally agreed that the downside
risks to their forecasts of both economic growth and
inflation—as well as the odds of a period of deflation—had diminished. Participants also generally
agreed that the recent data had not led them to sig-

187

nificantly change their outlooks for the most likely
rates of economic growth and inflation in coming
quarters. Participants noted that some of the
strength in the recent data reflected factors that could
prove temporary, such as the large contribution from
net exports, a volatile category, and the sharp step-up
in auto sales. Most participants continued to anticipate that the recovery in economic activity was likely
to be restrained by a variety of economic factors,
including still-high unemployment, modest income
growth, lower housing wealth, high rates of mortgage
foreclosure, elevated inventories of unsold homes,
and tight credit conditions in a number of sectors. In
addition, although many business contacts expressed
more optimism about the economic recovery, a number had aimed their recent investments primarily at
enhancing productivity rather than expanding
employment, and hiring for some businesses reportedly was focused on temporary workers. Some participants noted that incoming data on production,
spending, and employment would need to be solid
for a while longer to justify a significant upward revision to their outlook for the likely pace of the
recovery.
Participants generally saw the risks to their outlook
for economic growth and employment as having
become broadly balanced, but they continued to see
significant risks to both sides of the outlook. On the
downside, participants remained worried about the
possible effects of spillovers from the banking and
fiscal strains in peripheral Europe, the ongoing fiscal
adjustments by U.S. state and local governments, and
the continued weakness in the housing market. On
the upside, the recent strength in household spending
raised the possibility that domestic final demand
could snap back more rapidly than anticipated. If so,
a considerably stronger recovery could take hold,
more in line with the sorts of recoveries seen following deep economic recessions in the past.
Regarding risks to the inflation outlook, some participants noted that increases in energy and other
commodity prices as well as in the prices of imported
goods from EMEs posed upside risks. Others, however, noted that the pass-through from increases in
commodity prices to broad measures of consumer
price inflation in the United States had generally
been fairly small. Some participants expressed concern that in a situation in which businesses had been
unable to raise prices in response to higher costs for
some time, firms might increase them substantially
once they found themselves with sufficient pricing
power. In any case, the factors affecting the ability of

188

98th Annual Report | 2011

businesses to pass through higher prices to consumers were viewed as complex and hard to monitor in
real time. Most participants saw the large degree of
resource slack in the economy as likely to remain a
force restraining inflation, and while the risk of further disinflation had declined, a number of participants cited concerns that inflation was below its
mandate-consistent level and was expected to remain
so for some time. Finally, some participants noted
that if the very large size of the Federal Reserve’s balance sheet led the public to doubt the Committee’s
ability to withdraw monetary accommodation when
doing so becomes appropriate, the result could be
upward pressure on inflation expectations and so on
actual inflation. To mitigate such risks, it was noted
that the Committee should continue its planning for
the eventual exit from the current exceptionally
accommodative stance of policy.

Committee Policy Action
In their discussion of monetary policy for the period
ahead, members agreed that no changes to the Committee’s asset purchase program or to its target range
for the federal funds rate were warranted at this
meeting. While the information received over the
intermeeting period increased members’ confidence
in the sustainability of the economic recovery, the
pace of the recovery was insufficient to bring about a
significant improvement in labor market conditions,
and measures of underlying inflation had trended
downward. Moreover, the economic projections submitted for this meeting indicated that unemployment
was expected to remain above, and inflation to
remain somewhat below, levels consistent with the
Committee’s objectives for some time. Accordingly,
the Committee agreed to continue to expand its holdings of longer-term Treasury securities as announced
in November in order to promote a stronger pace of
economic recovery and to help ensure that inflation,
over time, is at levels consistent with the Committee’s
mandate. The Committee decided to maintain its
existing policy of reinvesting principal payments
from its securities holdings and reaffirmed its intention to purchase $600 billion of longer-term Treasury
securities by the end of the second quarter of 2011.
A few members remained unsure of the likely effects
of the asset purchase program on the economy, but
felt that making changes to the program at this time
was not appropriate. Members emphasized that the
Committee would continue to regularly review the
pace of its securities purchases and the overall size of
the asset purchase program in light of incoming
information—including information on the outlook

for economic activity, developments in financial markets, and the efficacy of the purchase program and
any unintended consequences that might arise—and
would adjust the program as needed to best foster
maximum employment and price stability. A few
members noted that additional data pointing to a
sufficiently strong recovery could make it appropriate
to consider reducing the pace or overall size of the
purchase program. However, others pointed out that
it was unlikely that the outlook would change by
enough to substantiate any adjustments to the program before its completion. In addition, the Committee reiterated its expectation that economic conditions were likely to warrant exceptionally low levels
for the federal funds rate for an extended period.
With respect to the statement to be released following
the meeting, members agreed that only small changes
were necessary to reflect the improvement in the
near-term economic outlook and to make clear that
the policy decision reflected a continuation of the
asset purchase program announced in November.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to execute purchases of longerterm Treasury securities in order to increase the
total face value of domestic securities held in the
System Open Market Account to approximately
$2.6 trillion by the end of June 2011. The Committee also directs the Desk to reinvest principal
payments from agency debt and agency
mortgage-backed securities in longer-term
Treasury securities. The System Open Market
Account Manager and the Secretary will keep
the Committee informed of ongoing developments regarding the System’s balance sheet that
could affect the attainment over time of the
Committee’s objectives of maximum employment and price stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:

Minutes of Federal Open Market Committee Meetings | January

“Information received since the Federal Open
Market Committee met in December confirms
that the economic recovery is continuing,
though at a rate that has been insufficient to
bring about a significant improvement in labor
market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income
growth, lower housing wealth, and tight credit.
Business spending on equipment and software is
rising, while investment in nonresidential structures is still weak. Employers remain reluctant to
add to payrolls. The housing sector continues to
be depressed. Although commodity prices have
risen, longer-term inflation expectations have
remained stable, and measures of underlying
inflation have been trending downward.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. Currently, the unemployment
rate is elevated, and measures of underlying
inflation are somewhat low, relative to levels that
the Committee judges to be consistent, over the
longer run, with its dual mandate. Although the
Committee anticipates a gradual return to
higher levels of resource utilization in a context
of price stability, progress toward its objectives
has been disappointingly slow.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time,
is at levels consistent with its mandate, the Committee decided today to continue expanding its
holdings of securities as announced in November. In particular, the Committee is maintaining
its existing policy of reinvesting principal payments from its securities holdings and intends to
purchase $600 billion of longer-term Treasury
securities by the end of the second quarter of
2011. The Committee will regularly review the
pace of its securities purchases and the overall
size of the asset-purchase program in light of
incoming information and will adjust the program as needed to best foster maximum employment and price stability.
The Committee will maintain the target range
for the federal funds rate at 0 to ¼ percent and
continues to anticipate that economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation
expectations, are likely to warrant exceptionally

189

low levels for the federal funds rate for an
extended period.
The Committee will continue to monitor the
economic outlook and financial developments
and will employ its policy tools as necessary to
support the economic recovery and to help
ensure that inflation, over time, is at levels consistent with its mandate.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Charles L. Evans, Richard
W. Fisher, Narayana Kocherlakota, Charles I.
Plosser, Sarah Bloom Raskin, Daniel K. Tarullo,
Kevin Warsh, and Janet L. Yellen.
Voting against this action: None.
Next, the Committee turned to a discussion of its
external communications, specifically the importance
of communicating both broadly and effectively.
FOMC participants noted the importance of fair and
equal access by the public to information that could
be informative about future policy decisions, and
they considered approaches to address this issue. Several participants noted that increased clarity of communications was a key objective, and some referred
to the central role of communications in the monetary policy transmission process. A focus of the discussion was on how to encourage dialogue with the
public in an appropriate and transparent manner.
The subcommittee on communications agreed to
consider whether further guidance in this area would
be useful.
It was agreed that the next meeting of the Committee
would be held on Tuesday, March 15, 2011. The
meeting adjourned at 2:40 p.m. on January 26, 2011.

Notation Vote
By notation vote completed on January 3, 2011, the
Committee unanimously approved the minutes of the
FOMC meeting held on December 14, 2010.
William B. English
Secretary

Addendum:
Summary of Economic Projections
In conjunction with the January 25–26, 2011, Federal
Open Market Committee (FOMC) meeting, the
members of the Board of Governors and the presi-

190

98th Annual Report | 2011

dents of the Federal Reserve Banks, all of whom participate in the deliberations of the FOMC, submitted
projections for growth of real output, the unemployment rate, and inflation for the years 2011 to 2013
and over the longer run. The projections were based
on information available through the end of the
meeting and on each participant’s assumptions about
factors likely to affect economic outcomes, including
his or her assessment of appropriate monetary policy.
“Appropriate monetary policy” is defined as the
future path of policy that each participant deems
most likely to foster outcomes for economic activity
and inflation that best satisfy his or her interpretation of the Federal Reserve’s dual objectives of maximum employment and stable prices. Longer-run projections represent each participant’s assessment of
the rate to which each variable would be expected to
converge over time under appropriate monetary
policy and in the absence of further shocks.
As depicted in figure 1, FOMC participants’ projections for the next three years indicated that they
expect a sustained recovery in real economic activity,
marked by a step-up in the rate of increase in real
gross domestic product (GDP) in 2011 followed by
further modest acceleration in 2012 and 2013. They
anticipated that, over this period, the pace of the
recovery would exceed their estimates of the longerrun sustainable rate of increase in real GDP by
enough to gradually lower the unemployment rate.
However, by the end of 2013, participants projected
that the unemployment rate would still exceed their

estimates of the longer-run unemployment rate. Most
participants expected that inflation would likely
move up somewhat over the forecast period but
would remain at rates below those they see as consistent, over the longer run, with the Committee’s dual
mandate of maximum employment and price
stability.
As indicated in table 1, relative to their previous projections in November 2010, participants anticipated
somewhat more rapid growth in real GDP this year,
but they did not significantly alter their expectations
for the pace of the expansion in 2012 and 2013 or for
the longer run. Participants made only minor
changes to their forecasts for the path of the unemployment rate and for the rate of inflation over the
next three years. Although most participants anticipated that the economy would likely converge to sustainable rates of increase in real GDP and prices over
five or six years, a number of participants indicated
that they expected that the convergence of the unemployment rate to its longer-run level would require
additional time.
As they did in November, participants judged the
level of uncertainty associated with their projections
for real economic activity and inflation as unusually
high relative to historical norms. Most continued to
see the risks surrounding their forecasts of GDP
growth, the unemployment rate, and inflation over
the next three years to be generally balanced. However, fewer noted downside risks to the likely pace of

Table 1. Economic projections of Federal Reserve Governors and Reserve Bank presidents, January 2011
Percent
Central tendency1

Range2

Variable
2011
Change in real GDP
November projection
Unemployment rate
November projection
PCE inflation
November projection
Core PCE inflation3
November projection

2012

2013

Longer run

2011

2012

2013

Longer run

3.4 to 3.9
3.0 to 3.6
8.8 to 9.0
8.9 to 9.1
1.3 to 1.7
1.1 to 1.7
1.0 to 1.3
0.9 to 1.6

3.5 to 4.4
3.6 to 4.5
7.6 to 8.1
7.7 to 8.2
1.0 to 1.9
1.1 to 1.8
1.0 to 1.5
1.0 to 1.6

3.7 to 4.6
3.5 to 4.6
6.8 to 7.2
6.9 to 7.4
1.2 to 2.0
1.2 to 2.0
1.2 to 2.0
1.1 to 2.0

2.5 to 2.8
2.5 to 2.8
5.0 to 6.0
5.0 to 6.0
1.6 to 2.0
1.6 to 2.0

3.2 to 4.2
2.5 to 4.0
8.4 to 9.0
8.2 to 9.3
1.0 to 2.0
0.9 to 2.2
0.7 to 1.8
0.7 to 2.0

3.4 to 4.5
2.6 to 4.7
7.2 to 8.4
7.0 to 8.7
0.7 to 2.2
0.6 to 2.2
0.6 to 2.0
0.6 to 2.0

3.0 to 5.0
3.0 to 5.0
6.0 to 7.9
5.9 to 7.9
0.6 to 2.0
0.4 to 2.0
0.6 to 2.0
0.5 to 2.0

2.4 to 3.0
2.4 to 3.0
5.0 to 6.2
5.0 to 6.3
1.5 to 2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and in inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated. PCE
inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures (PCE) and the price index for PCE
excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s
projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each
variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The November projections were made in
conjunction with the meeting of the Federal Open Market Committee on November 2–3, 2010.
1
The central tendency excludes the three highest and three lowest projections for each variable in each year.
2
The range for a variable in a given year consists of all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

Minutes of Federal Open Market Committee Meetings | January

191

Figure 1. Central tendencies and ranges of economic projections, 2011–13 and over the longer run
Percent

Change in real GDP

5

Central tendency of projections
Range of projections

4
3
2
1
+
0
_
1

Actual

2

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

Unemployment rate

10
9
8
7
6
5

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

PCE inflation
3

2

1

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

Core PCE inflation
3

2

1

2006

2007

2008

2009

2010

2011

2012

2013

Note: Definitions of variables are in the notes to table 1. The data for the actual values of the variables are annual. The data for the change in real GDP, PCE inflation, and core
PCE inflation shown for 2010 incorporate the advance estimate of GDP for the fourth quarter of 2010, which the Bureau of Economic Analysis released on January 28, 2011.
This information was not available to FOMC meeting participants at the time of their meeting.

192

98th Annual Report | 2011

the expansion and, accordingly, upside risks to the
unemployment rate than in November; fewer also
saw downside risks to inflation.
The Outlook
The central tendency of participants’ forecasts for the
change in real GDP in 2011 was 3.4 to 3.9 percent,
somewhat higher than in the November projections.
Participants stated that the economic information
received since November indicated that consumer
spending, business investment, and net exports
increased more strongly at the end of 2010 than
expected earlier; industrial production also expanded
more rapidly than they previously anticipated. In
addition, after the November projections were prepared, the Congress approved fiscal stimulus measures that were expected to provide further impetus to
household and business spending in 2011. Moreover,
participants noted that financial conditions had
improved since November, including a rise in equity
prices, a pickup in activity in capital markets, reports
of easing of credit conditions in some markets, and
an upturn in bank lending in some sectors. Many
participants viewed the stronger tenor of the recent
information, along with the additional fiscal stimulus,
as suggesting that the recovery had gained some
strength—a development seen as likely to carry into
2011—and that the expansion was on firmer footing.
Participants expected that the expansion in real economic activity this year would continue to be supported by accommodative monetary policy and by
ongoing improvement in credit and financial market
conditions. The strengthening in private demand was
anticipated to be led by increases in consumer and
business spending; over time, improvements in household and business confidence and in labor market
conditions would likely reinforce the rise in domestic
demand. Nonetheless, participants recognized that
the information available since November also indicated that the expansion remained uneven across sectors of the economy, and they expected that the pace
of economic activity would continue to be moderated
by the weakness in residential and nonresidential construction, the still relatively tight credit conditions in
some sectors, an ongoing desire by households to
repair their balance sheets, business caution about
hiring, and the budget difficulties faced by state and
local governments.
Participants expected that the economic expansion
would strengthen further in 2012 and 2013, with the
central tendencies of their projections for the growth
in real GDP moving up to 3.5 to 4.4 percent in 2012
and then to 3.7 to 4.6 percent in 2013. Participants

cited, as among the likely contributors to a sustained
pickup in the pace of the expansion, a continued
improvement in financial market conditions, further
expansion of credit availability to households and
businesses, increasing household and business confidence, and a favorable outlook for U.S. exports. Several participants noted that, in such an environment,
and with labor market conditions anticipated to
improve gradually, the restraints on household
spending from past declines in wealth and the desire
to rebuild savings should abate. A number of participants saw such conditions fostering a broader and
stronger recovery in business investment, with a few
noting that the market for commercial real estate had
recently shown signs of stabilizing. Nonetheless, participants saw a number of factors that would likely
continue to moderate the pace of the expansion.
Most participants expected that the recovery in the
housing market would remain slow, restrained by the
overhang of vacant properties, prospects for weak
house prices, and the difficulties in resolving foreclosures. In addition, some participants expected that
the fiscal strains on the budgets of state and local
governments would damp their spending for a time
and that the federal government sector would likely
be a drag on economic activity after 2011.
Participants anticipated that a gradual but steady
reduction in the unemployment rate would accompany the pickup in the pace of the economic expansion over the next three years. The central tendency
of their forecasts for the unemployment rate at the
end of 2011 was 8.8 to 9.0 percent—a decline of less
than 1 percentage point from the actual rate in the
fourth quarter of 2010. Although participants generally expected further declines in the unemployment
rate over the subsequent two years—to a central tendency of 6.8 to 7.2 percent at the end of 2013—they
anticipated that, at the end of that period, unemployment would remain noticeably higher than their estimates of the longer-run rate. Many participants
thought that, with appropriate monetary policy and
in the absence of further shocks, the unemployment
rate would continue to converge gradually toward its
longer-run rate within five to six years, but a number
of participants indicated that the convergence process would likely be more extended.
While participants viewed the projected pace of the
expansion in economic activity as the principal factor
underlying their forecasts for the path of the unemployment rate, they also indicated that their projections were influenced by a number of other factors
that were likely to contribute to a relatively gradual

Minutes of Federal Open Market Committee Meetings | January

recovery in the labor market. In that regard, several
participants noted that dislocations associated with
the uneven recovery across sectors of the economy
might retard the matching of workers and jobs. In
addition, a number of participants viewed the modest pace of hiring in 2010 as, in part, the result of
business caution about the durability of the recovery
and of employers’ efforts to achieve additional
increases in productivity; several participants also
cited the particularly slow recovery in demand experienced by small businesses as a factor restraining new
job creation. With demand expected to strengthen
across a range of businesses and with business confidence expected to improve, participants anticipated
that hiring would pick up over the forecast period.
Participants continued to expect that inflation would
be relatively subdued over the next three years and
kept their longer-run projections of inflation
unchanged. Many participants indicated that the persistence of large margins of slack in resource utilization should contribute to relatively low rates of inflation over the forecast horizon. In addition, participants noted that appropriate monetary policy,
combined with stable longer-run inflation expectations, should help keep inflation in check. The central
tendency of their projections for overall personal
consumption expenditures (PCE) inflation in 2011
was 1.3 to 1.7 percent, while the central tendency of
their forecasts for core PCE inflation was lower—1.0
to 1.3 percent. Increases in the prices of energy and
other commodities, which were very rapid in 2010,
were anticipated to continue to push headline PCE
inflation above the core rate this year. The central
tendency of participants’ forecasts for inflation in
2012 and 2013 widened somewhat relative to 2011
and showed that inflation was expected to drift up
modestly. In 2013, the central tendency of forecasts
for both the total and core inflation rates was 1.2 to
2.0 percent. For most participants, inflation in 2013
was not expected to have converged to the longer-run
rate of inflation that they individually considered
most consistent with the Federal Reserve’s dual mandate for maximum employment and stable prices.
However, a number of participants anticipated that
inflation would reach its longer-run rate within the
next three years.
Uncertainty and Risks
Most participants continued to share the view that
their projections for economic activity and inflation
were subject to a higher level of uncertainty than was

193

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2011

2012

2013

±1.3
±0.7
±1.0

±1.7
±1.3
±1.0

±1.8
±1.5
±1.1

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1990 through 2009 that were released in the winter by
various private and government forecasters. As described in the box
“Forecast Uncertainty,” under certain assumptions, there is about a 70 percent
probability that actual outcomes for real GDP, unemployment, and consumer
prices will be in ranges implied by the average size of projection errors made in
the past. Further information is in David Reifschneider and Peter Tulip (2007),
“Gauging the Uncertainty of the Economic Outlook from Historical Forecasting
Errors,” Finance and Economics Discussion Series 2007-60 (Washington: Board of
Governors of the Federal Reserve System, November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

the norm during the previous 20 years.3 They identified a number of uncertainties that compounded the
inherent difficulties in forecasting output growth,
unemployment, and inflation. Among them were
uncertainties about the nature of economic recoveries
from recessions associated with financial crises, the
effects of unconventional monetary policies, the persistence of structural dislocations in the labor market, the future course of federal fiscal policy, and the
global economic outlook.
Almost all participants viewed the risks to their forecasts for the strength of the recovery in real GDP as
broadly balanced. By contrast, in November, the distribution of views had been somewhat skewed to the
downside. In weighing the risks to the projected
growth rate of real economic activity, some participants noted the upside risk that the recent strengthening of aggregate spending might mark the beginning of a more normal cyclical rebound in economic
activity in which consumer spending might be
spurred by pent-up demand for household durables
and in which business investment might be accelerated by the desire to rebuild stocks of fixed capital. A
more-rapid-than-expected easing of credit availabil3

Table 2 provides estimates of forecast uncertainty for the change
in real GDP, the unemployment rate, and total consumer price
inflation over the period from 1990 to 2009. At the end of this
summary, the box “Forecast Uncertainty” discusses the sources
and interpretation of uncertainty in the economic forecasts and
explains the approach used to assess the uncertainty and risks
attending the participants’ projections.

194

98th Annual Report | 2011

ity was also seen as a factor that might boost the
pickup in private demand. As to the downside risks,
many participants pointed to the recent declines in
house prices and the potential for a slower resolution
of existing problems in mortgage and real estate markets as factors that could have more-adverse-thanexpected consequences for household spending and
bank balance sheets. In addition, several participants
expressed concerns that, in an environment of only
gradual improvement in labor market and credit conditions, households might be unusually focused on
reducing debt and boosting saving. A number of participants also saw a downside risk in the possibility
that the fiscal problems of some state and local governments might lead to a greater retrenchment in
their spending than currently anticipated. Finally,
several participants expressed concerns that the
financial and fiscal strains in the euro area might spill
over to U.S. financial markets.
The risks surrounding participants’ forecasts of the
unemployment rate were also broadly balanced and
generally reflected the risks attending participants’
views of the likely strength of the expansion in real
activity. However, a number of participants noted
that the unemployment rate might decline less than
they projected if businesses were to remain hesitant
to expand their workforces because of uncertainty
about the durability of the expansion or about
employment costs or if mismatches of workers and
jobs were more persistent than anticipated.
Most participants judged the risks to their inflation
outlook over the period from 2011 to 2013 to be
broadly balanced as well. Compared with their views
in November, several participants no longer saw the
risks as tilted to the downside, and an additional participant viewed the risks as weighted to the upside. In
assessing the risks, a number of participants indicated that they saw the risks of deflation or further
unwanted disinflation to have diminished. Many participants identified the persistent gap between their
projected unemployment rate and its longer-run rate
as a risk that inflation could be lower than they projected. A few of those who indicated that inflation
risks were skewed to the upside expressed concerns
that the expansion of the Federal Reserve’s balance
sheet, if left in place for too long, might erode the
stability of longer-run inflation expectations. Alter-

natively, several participants noted that upside risks
to inflation could arise from persistently rapid
increases in the costs of energy and other
commodities.
Diversity of Views
Figures 2.A and 2.B detail the diversity of participants’ views regarding the likely outcomes for real
GDP growth and the unemployment rate in 2011,
2012, 2013, and over the longer run. The dispersion
in these projections reflected differences in participants’ assessments of many factors, including the
likely evolution of conditions in credit and financial
markets, the timing and the degree to which various
sectors of the economy and the labor market will
recover from the dislocations associated with the
deep recession, the outlook for economic and financial developments abroad, and appropriate future
monetary policy and its effects on economic activity.
For 2011 and 2012, the dispersions of participants’
forecasts for the strength in the expansion of real
GDP and for the unemployment rate were somewhat
narrower than they were last November, while the
ranges of views for 2013 and for the longer run were
little changed.
Figures 2.C and 2.D provide the corresponding information about the diversity of participants’ views
regarding the outlook for total and core PCE inflation. These distributions were somewhat more tightly
concentrated for 2011, but for 2012 and 2013, they
were much the same as they were in November. In
general, the dispersion in the participants’ inflation
forecasts for the next three years represented differences in judgments regarding the fundamental determinants of inflation, including estimates of the
degree of resource slack and the extent to which such
slack influences inflation outcomes and expectations
as well as estimates of how the stance of monetary
policy may influence inflation expectations. Although
the distributions of participants’ inflation forecasts
for 2011 through 2013 continued to be relatively
wide, the distribution of projections of the longerrun rate of overall inflation remained tightly concentrated. The narrow range illustrates the broad similarity in participants’ assessments of the approximate
level of inflation that is consistent with the Federal
Reserve’s dual objectives of maximum employment
and price stability.

Minutes of Federal Open Market Committee Meetings | January

195

Figure 2.A. Distribution of participants’ projections for the change in real GDP, 2011–13 and over the longer run
Number of participants

2011

14

January projections
November projections

12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

2012

14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

2013

14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

Longer run

14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

Percent range
Note: Definitions of variables are in the general note to table 1.

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

196

98th Annual Report | 2011

Figure 2.B. Distribution of participants’ projections for the unemployment rate, 2011–13 and over the longer run
Number of participants

2011

14

January projections
November projections

12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

9.29.3

Percent range
Number of participants

2012

14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

9.29.3

Percent range
Number of participants

2013

14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

9.29.3

Percent range
Number of participants

Longer run

14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

Percent range
Note: Definitions of variables are in the general note to table 1.

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

9.29.3

Minutes of Federal Open Market Committee Meetings | January

197

Figure 2.C. Distribution of participants’ projections for PCE inflation, 2011–13 and over the longer run
Number of participants

2011

14

January projections
November projections

12
10
8
6
4
2

0.30.4

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2012

14
12
10
8
6
4
2

0.30.4

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2013

14
12
10
8
6
4
2

0.30.4

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

Longer run

14
12
10
8
6
4
2

0.30.4

0.50.6

0.70.8

0.91.0

1.11.2

Percent range
Note: Definitions of variables are in the general note to table 1.

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

198

98th Annual Report | 2011

Figure 2.D. Distribution of participants’ projections for core PCE inflation, 2011–13
Number of participants

2011

14

January projections
November projections

12
10
8
6
4
2

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Number of participants

2012

14
12
10
8
6
4
2
0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Number of participants

2013

14
12
10
8
6
4
2
0.50.6

0.70.8

0.91.0

1.11.2

Percent range
Note: Definitions of variables are in the general note to table 1.

1.31.4

1.51.6

1.71.8

1.92.0

Minutes of Federal Open Market Committee Meetings | January

199

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public
understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts
are necessarily imperfect descriptions of the real
world. And the future path of the economy can be
affected by myriad unforeseen developments and
events. Thus, in setting the stance of monetary
policy, participants consider not only what appears to
be the most likely economic outcome as embodied in
their projections, but also the range of alternative
possibilities, the likelihood of their occurring, and the
potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy of
a range of forecasts, including those reported in past
Monetary Policy Reports and those prepared by Federal Reserve Board staff in advance of meetings of
the Federal Open Market Committee. The projection
error ranges shown in the table illustrate the considerable uncertainty associated with economic forecasts. For example, suppose a participant projects
that real gross domestic product (GDP) and total
consumer prices will rise steadily at annual rates of,
respectively, 3 percent and 2 percent. If the uncertainty attending those projections is similar to that

experienced in the past and the risks around the projections are broadly balanced, the numbers reported
in table 2 would imply a probability of about 70 percent that actual GDP would expand within a range of
1.7 to 4.3 percent in the current year, 1.3 to 4.7 percent in the second year, and 1.2 to 4.8 percent in the
third year. The corresponding 70 percent confidence
intervals for overall inflation would be 1.0 to 3.0 percent in the current and second years, and 0.9 to
3.1 percent in the third year.
Because current conditions may differ from those
that prevailed, on average, over history, participants
provide judgments as to whether the uncertainty
attached to their projections of each variable is
greater than, smaller than, or broadly similar to typical levels of forecast uncertainty in the past as shown
in table 2. Participants also provide judgments as to
whether the risks to their projections are weighted to
the upside, are weighted to the downside, or are
broadly balanced. That is, participants judge whether
each variable is more likely to be above or below
their projections of the most likely outcome. These
judgments about the uncertainty and the risks
attending each participant’s projections are distinct
from the diversity of participants’ views about the
most likely outcomes. Forecast uncertainty is concerned with the risks associated with a particular
projection rather than with divergences across a
number of different projections.

200

98th Annual Report | 2011

Meeting Held on March 15, 2011
A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors in
Washington, D.C., on Tuesday, March 15, 2011, at
8:30 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Charles L. Evans
Richard W. Fisher
Narayana Kocherlakota
Charles I. Plosser
Sarah Bloom Raskin
Daniel K. Tarullo
Janet L. Yellen
Jeffrey M. Lacker, Dennis P. Lockhart,
Sandra Pianalto, and John C. Williams
Alternate Members of the Federal Open Market
Committee
James Bullard, Thomas M. Hoenig, and
Eric Rosengren
Presidents of the Federal Reserve Banks of St. Louis,
Kansas City, and Boston, respectively
William B. English
Secretary and Economist
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Nathan Sheets
Economist
David J. Stockton
Economist
James A. Clouse, Thomas A. Connors,
Steven B. Kamin, Loretta J. Mester,

David Reifschneider, Harvey Rosenblum,
Daniel G. Sullivan, and David W. Wilcox
Associate Economists
Brian Sack
Manager, System Open Market Account
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Maryann F. Hunter
Deputy Director, Division of Banking Supervision
and Regulation, Board of Governors
William Nelson
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director,
Board of Governors
Lawrence Slifman and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Andrew T. Levin
Senior Adviser, Office of Board Members,
Board of Governors
Stephen A. Meyer
Senior Adviser, Division of Monetary Affairs,
Board of Governors
Joyce K. Zickler
Visiting Senior Adviser, Division of Monetary
Affairs, Board of Governors
Michael G. Palumbo
Associate Director, Division of Research and
Statistics, Board of Governors
David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Andrea L. Kusko
Senior Economist, Division of Research and
Statistics, Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
Blake Prichard
First Vice President, Federal Reserve Bank of
Philadelphia

Minutes of Federal Open Market Committee Meetings | March

Jeff Fuhrer and Robert H. Rasche
Executive Vice Presidents, Federal Reserve Banks of
Boston and St. Louis, respectively
David Altig, Richard P. Dzina, Ron Feldman,
Craig S. Hakkio, Richard Peach,
Glenn D. Rudebusch, Mark E. Schweitzer,
and John A. Weinberg
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, New York, Minneapolis, Kansas City,
New York, San Francisco, Cleveland, and
Richmond, respectively
In the agenda for this meeting, it was reported that
advices of the election of John C. Williams as an
alternate member of the Federal Open Market Committee had been received by the Secretariat, and that
he had executed his oath of office.

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
January 25–26, 2011. He also reported on System
open market operations, including the ongoing reinvestment into longer-term Treasury securities of
principal payments received on the SOMA’s holdings
of agency debt and agency-guaranteed mortgagebacked securities (MBS) that the Committee authorized in August 2010, as well as the purchase of additional longer-term Treasury securities to increase the
face value of such securities held in the SOMA that
the FOMC first authorized in November 2010. Since
November, purchases by the Open Market Desk of
the Federal Reserve Bank of New York had increased
the SOMA’s holdings by $310 billion. The Manager
reported that achieving an increase of $600 billion in
SOMA holdings by the end of June 2011 would
require continuing to purchase additional securities
at an unchanged pace of about $80 billion per
month. There were no open market operations in foreign currencies for the System’s account over the
intermeeting period. By unanimous vote, the Committee ratified the Desk’s transactions over the intermeeting period.
The Manager also discussed the possible benefits of
gradually reducing the pace of the Federal Reserve’s
purchases of Treasury securities when the current
asset purchase program nears completion. As its earlier program of agency MBS purchases drew to a

201

close, the Federal Reserve tapered its purchases during the first quarter of 2010 in order to avoid disruptions in the market for those securities. However, the
Manager indicated that the greater depth and liquidity of the Treasury securities market suggested that it
would not be necessary to taper purchases in this
market. The Manager noted that market participants
appeared to have reached the same conclusion, as
they generally did not seem to expect the Federal
Reserve to taper its purchases of Treasury securities.
In light of the Manager’s report, almost all meeting
participants indicated that they saw no need to taper
the pace of the Committee’s purchases of Treasury
securities when its current program of asset purchases approaches its end.

Staff Review of the Economic Situation
The information reviewed at the March 15 meeting
indicated that the economic recovery continued to
proceed at a moderate pace, with a further gradual
improvement in labor market conditions. Sizable
increases in prices of crude oil and other commodities pushed up headline inflation, but measures of
underlying inflation were subdued and longer-run
inflation expectations remained stable.
The labor market continued to show signs of firming.
Private nonfarm payroll employment rose noticeably
in February after a small increase in January, with the
swing in hiring likely magnified by widespread snowstorms, which may have held down the employment
figure for January. Initial claims for unemployment
insurance trended lower through early March, and
surveys of hiring plans had improved this year. The
unemployment rate dropped markedly in January
after a similar decrease in the preceding month, then
ticked down to 8.9 percent in February; the labor
force participation rate was roughly flat in January
and February. The share of workers employed part
time for economic reasons declined further over the
past two months, but long-duration unemployment
was still elevated.
Total industrial production was little changed in
January after a strong rise in December. Manufacturing output posted a relatively subdued gain in January, likely held down somewhat by the extensive
snowfalls during that month; in addition, a scheduled
step-up in assemblies of motor vehicles reportedly
was restrained in part by some temporary bottlenecks in the supply chain. As a result, the rate of
capacity utilization in manufacturing was essentially
unchanged in January, and it remained well below its

202

98th Annual Report | 2011

1972–2010 average. In February, indicators of nearterm industrial production, such as the new orders
diffusion indexes in the national and regional manufacturing surveys, were at levels consistent with solid
increases in factory output in the coming months.
Moreover, motor vehicle assemblies picked up in
February and were scheduled to rise further through
the second quarter of this year.
Consumer spending appeared to have increased at a
modest pace in early 2011 after rising briskly in the
fourth quarter of 2010. In January, total real personal
consumption expenditures (real PCE) were essentially
flat. In February, nominal retail sales, excluding purchases of motor vehicles and parts, rose moderately;
sales of light motor vehicles posted a robust gain.
Consumer spending was supported by a solid
increase in real disposable income in January, reflecting in part the temporary cut in payroll taxes. Household net worth rose in the fourth quarter, as the
increase in equity values during that period more
than offset the further fall in house prices. However,
consumer sentiment dropped back in early March,
retracing its increase over the preceding four months.
Activity in the housing market continued to be
depressed, held down by the large inventory of foreclosed or distressed properties on the market and by
weak demand. In January, starts and permits for new
single-family homes remained near the low levels that
had prevailed since the middle of 2010. New home
sales moved down in January; existing home sales
stepped up somewhat but still were quite low by historical standards. Measures of house prices softened
again in December and January.
Real business investment in equipment and software
(E&S) appeared to rise further in recent months.
Nominal shipments of nondefense capital goods
excluding aircraft increased, on net, in December and
January, and the expanding backlog of unfilled
orders pointed to further gains in shipments in subsequent months. In addition, readings on business conditions and sentiment remained consistent with solid
near-term advances in outlays for E&S. Credit conditions continued to improve for many firms, though
they reportedly were still tight for small businesses. In
contrast to the apparent increase in E&S outlays,
nonresidential construction expenditures dropped
further in December and January, constrained by
high vacancy rates, low prices for commercial real
estate, and persistently tight borrowing conditions for
construction loans for commercial properties.

Real nonfarm inventory investment appeared to have
picked up in early 2011 after slowing markedly in the
fourth quarter. In the motor vehicles sector, inventories rose slightly, on net, in January and February
after having been drawn down in the fourth quarter.
Outside of motor vehicles, the rise in the book value
of business inventories was somewhat larger in January than the average monthly increase in the fourth
quarter, while inventory-to-sales ratios for most
industries covered by these data were similar to their
pre-recession norms. Survey data also suggested that
inventory positions were generally in a comfortable
range.
In the government sector, the available information
suggested that real defense spending in January and
February was below its average level in the fourth
quarter. At the state and local level, ongoing fiscal
pressures were reflected in further job cuts in January
and February. Construction outlays by these governments fell again in January.
The U.S. international trade deficit widened in
December and again in January, with rapid gains in
both exports and imports. The largest increases in
exports were in capital goods, industrial supplies, and
automotive products. Nominal imports of petroleum
products rose sharply, reflecting both higher prices
and greater volumes; imports in other major categories rose solidly on net.
Overall consumer prices in the United States rose
somewhat faster in December and January than in
earlier months, as consumer energy prices posted further sizable increases and consumer food prices
responded to the recent upturn in farm commodity
prices. The price index for PCE excluding food and
energy (the core PCE price index) rose slightly in
January, boosted by an uptick in prices of core goods
after four months of declines; the 12-month change
in this core price index stayed near the very low levels
seen in late 2010. Recent surveys showed further
hefty increases in retail gasoline prices in February
and early March, and prices of nonfuel industrial
commodities also rose sharply on net. According to
the Thomson Reuters/University of Michigan Surveys of Consumers, households’ near-term inflation
expectations increased substantially in early March,
likely because of the run-up in gasoline prices;
longer-term inflation expectations moved up somewhat in the early March survey but were still within
the range that prevailed over the preceding few years.

Minutes of Federal Open Market Committee Meetings | March

Labor cost pressures remained muted in the fourth
quarter, as hourly compensation continued to be
restrained by the wide margin of slack in the labor
market and as productivity rose further. Average
hourly earnings posted a modest increase, on net, in
January and February.
Growth in real activity in the advanced foreign
economies appeared to pick up after a lackluster performance in the fourth quarter. In the euro
area, monthly indicators of activity, such as retail
sales and purchasing managers indexes, were generally positive in January and February. But the divergence in economic performance across euro-area
countries remained large, as economic activity
appeared to have expanded strongly in Germany but
to have contracted in Greece and Portugal. Prior to
the earthquake and tsunami in mid-March, economic
activity in Japan had shown signs of firming. The
upbeat tenor of the incoming data for the emerging
market economies suggested that the economic
expansion in these countries continued to outpace
that in the advanced economies. Foreign consumer
price inflation, which stepped up noticeably in the
fourth quarter, remained elevated in early 2011,
largely because of higher food and energy prices.

203

end of the curve, likely reflecting the jump in oil
prices. In contrast, measures of forward inflation
compensation 5 to 10 years ahead were little
changed, suggesting that longer-term inflation expectations remained stable.
Over the intermeeting period, yields on investmentand speculative-grade corporate bonds edged down
relative to those on comparable-maturity Treasury
securities. The secondary-market prices of syndicated
loans continued to move up. Strains in the municipal
bond market eased as concerns about the budgetary
problems of state and local governments seemed to
diminish somewhat. Conditions in short-term funding markets were little changed.
Broad U.S. stock price indexes were about
unchanged, on net, over the intermeeting period.
Option-implied volatility on the S&P 500 index rose
sharply in mid-February in response to events in the
MENA region and remained somewhat elevated
thereafter. The staff’s estimate of the spread between
the expected real equity return for S&P 500 firms and
the real 10-year Treasury yield—a measure of the
equity risk premium—narrowed a bit more over the
intermeeting period but continued to be quite
elevated relative to longer-term norms.

Staff Review of the Financial Situation
The decisions by the FOMC at its January meeting to
continue its asset purchase program and to maintain
the 0 to ¼ percent target range for the federal funds
rate were largely in line with market expectations, as
was the accompanying statement; they elicited only a
modest market reaction. Over the weeks following
the FOMC meeting, nominal Treasury yields and the
expected path of the federal funds rate in coming
quarters moved higher, as market participants apparently read the incoming economic data as, on balance, somewhat better than expected. After midFebruary, however, Treasury yields and policy expectations retraced their earlier rise amid concerns about
the possible economic fallout from events in the
Middle East and North Africa (MENA) region. In
the days leading up to the March FOMC meeting,
the tragic developments in Japan spurred a further
decline in Treasury yields. On net, expectations for
the federal funds rate, along with yields on nominal
Treasury securities, were little changed over the intermeeting period.
Measures of inflation compensation over the next
5 years rose, on net, over the intermeeting period,
with most of the increase concentrated at the front

In the March 2011 Senior Credit Officer Opinion
Survey on Dealer Financing Terms, dealers reported
a further easing, over the previous three months, in
the price and nonprice terms they offered to different
types of counterparties for all of the categories of
transactions covered in the survey. Dealers noted that
the demand for funding had increased for a broad
range of securities over the same period. In response
to special questions, dealers reported some increase in
the use of leverage over the prior six months by traditionally unlevered investors—in particular, asset
managers, insurance companies, and pension funds.
In addition, dealers reported an increase in leverage
over the past six months by hedge funds that pursue
a variety of investment strategies. More broadly,
while the availability and use of dealer-intermediated
leverage had increased since its post-crisis nadir in
mid-2009, a review of information from a variety of
sources suggested that leverage generally remained
well below the levels reached prior to the recent
financial crisis.
Net debt financing by nonfinancial corporations was
solid in January and February, although it did not
match the sizable amount seen in the fourth quarter.
Net issuance of investment- and speculative-grade

204

98th Annual Report | 2011

bonds was robust in the first two months of this year.
Commercial and industrial (C&I) loans outstanding
also increased, on balance, while the amount of nonfinancial commercial paper outstanding was little
changed. Gross public equity issuance by nonfinancial firms was relatively subdued in January and February. Measures of the credit quality of nonfinancial
firms continued to improve.
Financing conditions for commercial real estate generally remained tight. So far this year, issuance of
commercial mortgage-backed securities (CMBS)
appeared to have maintained its modest fourthquarter pace. Data on delinquency rates for commercial real estate loans were mixed.
Rates on conforming fixed-rate residential mortgages, and their spreads relative to the 10-year Treasury yield, were about unchanged over the intermeeting period. With mortgage rates remaining above the
low levels seen last fall, refinancing activity was tepid.
Outstanding residential mortgage debt was estimated
to have contracted again in the fourth quarter. Rates
of serious delinquency for subprime and prime mortgages were little changed in December and January.
Consumer credit markets showed further signs of
improvement. Total consumer credit expanded moderately in January. As was the case in the fourth quarter, nonrevolving credit expanded while revolving
credit ran off. Delinquency rates on credit card loans
in securitized pools and on auto loans at finance
companies continued to decline through January,
nearly returning to their longer-run averages. The
issuance of consumer asset-backed securities, which
had weakened around the turn of the year, posted a
moderate gain in February.
Bank credit declined, on average, in January and February as a result of a contraction in core loans—the
sum of C&I, real estate, and consumer loans; holdings of securities were about flat on net. The Survey
of Terms of Business Lending conducted in the first
week of February showed that spreads of interest
rates on C&I loans over comparable-maturity Eurodollar and swap rates decreased somewhat but
remained elevated.

their higher yields relative to other M2 components.
Currency continued to advance at a relatively fast
rate in January and February, likely boosted by a
strong expansion in foreign holdings of U.S. bank
notes.
In financial markets abroad, equity prices in the
advanced economies rose early in the intermeeting
period, but they turned down in mid-February as oil
prices increased and then fell sharply in mid-March
in the aftermath of the earthquake and tsunami in
Japan. On net over the intermeeting period, stock
prices were down in most of the advanced economies, with Japan’s index having fallen most significantly. Emerging market equity price indexes, which
had been underperforming in previous months, generally ended the period lower as well, and emerging
market equity funds experienced outflows. Movements in 10-year sovereign bond yields in Europe and
Canada mirrored those in equity prices, climbing
early in the intermeeting period but falling later.
In part because of downgrades by credit rating agencies, yields on the 10-year sovereign bonds of Greece,
Ireland, and Portugal rose sharply, relative to those
on German bonds, through early March. These
spreads subsequently declined somewhat in response
to a general agreement among euro-area leaders to
expand the capacity of the area’s backstop funding
facility, to extend the maturity of the facility’s loans
to Greece, and to lower the interest rates on those
loans.
The European Central Bank (ECB) left its benchmark policy rate unchanged at its March meeting,
but the emphasis on upside risks to inflation at the
postmeeting press conference led market participants
to infer that the ECB might well tighten policy at its
meeting in April. In the United Kingdom, marketbased readings on expected policy rates indicated
that investors anticipated some tightening of policy
before the end of this year. In addition, authorities in
several emerging market economies took steps to
tighten policy. The broad nominal index of the U.S.
dollar declined about 1 percent, on balance, over the
intermeeting period.

Staff Economic Outlook
M2 increased at a moderate rate, on average, over
January and February. Liquid deposits, the largest
component of M2, expanded somewhat less rapidly
than in the fourth quarter of 2010. Nonetheless, as
has been the case for some time, the composition of
M2 shifted toward liquid deposits, likely reflecting

The pace of economic activity appeared to have been
a little slower around the turn of the year than the
staff had anticipated at the time of the January
FOMC meeting, and the near-term forecast for
growth of real gross domestic product (GDP) was

Minutes of Federal Open Market Committee Meetings | March

205

revised down modestly. However, the outlook for
economic activity over the medium term was broadly
similar to the projection prepared for the January
FOMC meeting. Changes to the conditioning
assumptions underlying the staff projection were
mostly small and offsetting: Crude oil prices had
risen sharply and federal fiscal policy seemed likely to
be marginally more restrictive than the staff had
judged in January, but these negative factors were
counterbalanced by higher household net worth and
a slightly lower foreign exchange value of the dollar.
As a result, as in the January forecast, real GDP was
expected to rise at a moderate pace over 2011 and
2012, supported by accommodative monetary policy,
increasing credit availability, and greater household
and business confidence. Reflecting the recent labor
market data, the projection for the unemployment
rate was lower throughout the forecast period than in
the staff’s January forecast, but the jobless rate was
still expected to decline slowly and to remain elevated
at the end of 2012.

pants noted that recent increases in the prices of oil
and other commodities were putting upward pressure
on headline inflation, but that measures of underlying inflation remained subdued. They anticipated
that the effects on inflation of the recent run-up in
commodity prices would prove transitory, in part
because they saw longer-term inflation expectations
remaining stable. Moreover, a number of participants
expected that slack in resource utilization would continue to restrain increases in labor costs and prices.
Nonetheless, participants observed that rapidly rising
commodity prices posed upside risks to the stability
of longer-term inflation expectations, and thus to the
outlook for inflation, even as they posed downside
risks to the outlook for growth in consumer spending
and business investment. In addition, participants
noted that unfolding events in the Middle East and
North Africa, along with the recent earthquake, tsunami, and subsequent developments in Japan, had
further increased uncertainty about the economic
outlook.

The staff revised up its projection for consumer price
inflation in the near term, largely because of the
recent increases in the prices of energy and food.
However, in light of the projected persistence of
slack in labor and product markets and the anticipated stability in long-term inflation expectations, the
increase in inflation was expected to be mostly transitory if oil and other commodity prices did not rise
significantly further. As a result, the forecast for consumer price inflation over the medium run was little
changed relative to that prepared for the January
meeting.

Participants’ judgment that the recovery was gaining
traction reflected both the incoming economic indicators and information received from business contacts. Spending by households, which had picked up
noticeably in the fourth quarter, rose further during
the early part of 2011, with auto sales showing particular strength. Although some participants noted
that growth in consumer spending so far this year
had not been as vigorous as they had anticipated,
they attributed the shortfall in part to unusually bad
weather. While participants expected that household
spending would continue to expand, the pace of
expansion was uncertain. On the one hand, labor
market conditions were improving, though gradually,
and the temporary cut in payroll taxes was contributing to rising after-tax incomes. Some easing of credit
conditions for households, particularly for auto
loans, also appeared to be supporting growth in consumer spending. On the other hand, declining house
prices remained a drag on household wealth and thus
on consumer spending. In addition, sizable recent
increases in oil and gasoline prices had reduced real
incomes and weighed on consumer confidence. Business contacts in a variety of industries had expressed
concern that consumers might pull back if gasoline
prices rose significantly further and persisted at those
elevated levels.

Participants’ Views on Current Conditions
and the Economic Outlook
In discussing intermeeting developments and their
implications for the economic outlook, participants
agreed that the information received since their previous meeting was broadly consistent with their expectations and suggested that the economic recovery was
on a firmer footing. Looking through weather-related
distortions in various indicators, measures of consumer spending, business investment, and employment showed continued expansion. Housing, however, remained depressed. Meeting participants took
note of the significant decline in the unemployment
rate over the past few months but observed that other
indicators pointed to a more gradual improvement in
overall labor market conditions. They continued to
expect that economic growth would strengthen over
coming quarters while remaining moderate. Partici-

A further increase in business activity also indicated
that the economic recovery remained on track.
Industrial production posted solid gains, supported
in part by continuing growth in U.S. exports. Busi-

206

98th Annual Report | 2011

ness contacts in a number of regions reported they
were more confident about the recovery; a growing
number of contacts indicated they were planning for
an expansion in hiring and production to meet an
anticipated rise in sales. Manufacturing firms were
particularly upbeat. Some contacts reported they
were increasing capital budgets to undertake investment that had been postponed during the recession
and early stages of the recovery; in some cases, firms
were planning to expand capacity. Consistent with
the anecdotal evidence, indicators of current and
planned business investment in equipment and software continued to rise and surveys showed a further
improvement in business sentiment. In addition,
although residential construction remained weak,
investment in energy extraction was growing and
spending on commercial construction projects
appeared to be bottoming out.
Meeting participants judged that overall conditions
in labor markets had continued to improve gradually.
The unemployment rate had decreased significantly
in recent months; other labor market indicators,
including measures of job growth and hours worked,
showed more-modest improvements. Several participants noted that the drop in unemployment was
attributable more to people withdrawing from the
labor force and to fewer layoffs than to increased hiring. Even so, participants agreed that gains in
employment seemed to be on a gradually rising trajectory, although the recent data had been somewhat
erratic and distorted by worse-than-usual weather in
many parts of the country. In addition, surveys of
employers showed that an increasing number of
firms were planning to hire. Participants noted
regional differences in the speed of improvement in
labor markets; scattered reports indicated that firms
in some regions were having difficulty hiring some
types of highly skilled workers. Participants generally
judged that there was still substantial slack in the
labor market, though estimates of the degree of slack
were admittedly imprecise and depended in part on
judgments about a number of factors, including the
extent to which labor force participation would
increase as the recovery progresses and employment
expands.
Credit conditions remained uneven. Bankers again
reported improving credit quality and generally weak
loan demand. Large firms that have access to financial markets continued to find credit, including bank
loans, available on relatively attractive terms; how-

ever, credit conditions reportedly remained tight for
smaller, bank-dependent firms. Participants noted
evidence that the availability of student loans and of
consumer loans—particularly auto loans—was
increasing. Indeed, bank and nonbank lenders
reported that terms and conditions for auto loans
had returned to historical norms. In contrast, terms
for commercial and residential real estate loans
remained tight and the volume of outstanding loans
continued to decline, though there was some issuance
of CMBS backed by loans on high-quality properties
in selected large metropolitan areas. A few participants expressed concern that the easing of credit conditions in some sectors was becoming or might
become excessive as investors took on more risk in
order to obtain higher yields.
Participants observed that headline inflation was
being boosted by higher prices for energy and other
commodities, and that prices of other imported
goods also had risen by a substantial, though smaller,
amount. A number of business contacts indicated
that they were passing on at least a portion of these
higher costs to their customers or that they planned
to try to do so later this year; however, contacts were
uncertain about the extent to which they could raise
prices, given current market conditions and the cautious attitudes toward spending still held by households and businesses. Other participants noted that
commodity and energy costs accounted for a relatively small share of production costs for most firms
and that labor costs accounted for the bulk of such
costs; moreover, they observed that unit labor costs
generally had declined in recent years as productivity
growth outpaced wage gains. Several participants
noted that even large commodity price increases have
had only limited effects on underlying inflation in
recent decades.
In contrast to headline inflation, core inflation and
other measures of underlying inflation remained subdued, though they appeared to have bottomed out. A
number of participants noted that, with significant
slack in resource utilization and with longer-term
inflation expectations stable, underlying inflation
likely would remain subdued for some time. However,
the importance of resource slack as a factor influencing inflation was debated. Some participants pointed
to research indicating that measures of slack were
useful in predicting inflation. Others argued that, historically, such measures were only modestly helpful in
explaining large movements in inflation; one noted

Minutes of Federal Open Market Committee Meetings | March

the 2003–04 episode in which core inflation rose rapidly over a few quarters even though there appeared
to be substantial resource slack.
Participants expected that the boost to headline inflation from recent increases in energy and other commodity prices would be transitory and that underlying inflation trends would be little affected as long as
commodity prices did not continue to rise rapidly
and longer-term inflation expectations remained
stable. However, a significant increase in longer-term
inflation expectations could contribute to excessive
wage and price inflation, which would be costly to
eradicate. Accordingly, participants considered it
important to pay close attention to the evolution not
only of headline and core inflation but also of inflation expectations. In this regard, participants
observed that measures of longer-term inflation compensation derived from financial instruments had
remained stable of late, suggesting that longer-term
inflation expectations had not changed appreciably,
although measures of one-year inflation compensation had risen notably. Survey-based measures of
inflation expectations also indicated that longer-term
expected inflation had risen much less than near-term
inflation expectations. A few participants noted that
the adoption by the Committee of an explicit
numerical inflation objective could help keep longerterm inflation expectations well anchored.
Participants generally judged the risks to their forecasts of growth in economic activity to be roughly
balanced. They continued to see some downside risks
from the banking and fiscal strains in the European
periphery, the continuing fiscal adjustments by U.S.
state and local governments, and the ongoing weakness in the housing market. Several also noted the
possibility of larger-than-anticipated near-term cuts
in federal government spending. Moreover, the economic implications of the tragedy in Japan—for
example, with respect to global supply chains—were
not yet clear. On the upside, the improvement in
labor market conditions in recent months raised the
possibility that household spending—and subsequently business investment—might expand more
rapidly than anticipated; if so, the recovery could be
stronger than currently projected. Participants
judged that the potential for more-widespread disruptions in oil production, and thus for a larger jump
in energy prices, posed both downside risks to growth
and upside risks to inflation. Several of them indicated, in light of recent developments, that the risks
to their forecasts of inflation had shifted somewhat
to the upside. Finally, a few participants noted that if

207

the large size of the Federal Reserve’s balance sheet
were to lead the public to doubt the Committee’s
ability to withdraw monetary accommodation when
appropriate, the result could be upward pressure on
inflation expectations and so on actual inflation. To
mitigate such risks, participants agreed that the Committee would continue its planning for the eventual
exit from the current, exceptionally accommodative
stance of monetary policy. In light of uncertainty
about the economic outlook, it was seen as prudent
to consider possible exit strategies for a range of
potential economic outcomes. A few participants
indicated that economic conditions might warrant a
move toward less-accommodative monetary policy
this year; a few others noted that exceptional policy
accommodation could be appropriate beyond 2011.

Committee Policy Action
In their discussion of monetary policy for the period
ahead, Committee members agreed that no changes
to the Committee’s asset purchase program or to its
target range for the federal funds rate were warranted
at this meeting. The information received over the
intermeeting period indicated that the economic
recovery was on a firmer footing and that overall
conditions in the labor market were gradually
improving. Although the unemployment rate had
declined in recent months, it remained elevated relative to levels that the Committee judged to be consistent, over the longer run, with its statutory mandate
to foster maximum employment and price stability.
Similarly, measures of underlying inflation continued
to be somewhat low relative to levels seen as consistent with the dual mandate over the longer run. With
longer-term inflation expectations remaining stable
and measures of underlying inflation subdued, members anticipated that recent increases in the prices of
energy and other commodities would result in only a
transitory increase in headline inflation. Given this
economic outlook, the Committee agreed to continue
to expand its holdings of longer-term Treasury securities as announced in November in order to promote
a stronger pace of economic recovery and to help
ensure that inflation, over time, is at levels consistent
with the Committee’s mandate. Specifically, the
Committee maintained its existing policy of reinvesting principal payments from its securities holdings
and reaffirmed its intention to purchase $600 billion
of longer-term Treasury securities by the end of the
second quarter of 2011. A few members remained
uncertain about the benefits of the asset purchase
program but judged that making changes to the program at this time was not appropriate. The Commit-

208

98th Annual Report | 2011

tee continued to anticipate that economic conditions,
including low rates of resource utilization, subdued
inflation trends, and stable inflation expectations,
were likely to warrant exceptionally low levels for the
federal funds rate for an extended period.
Members emphasized that the Committee would
continue to regularly review the pace of its securities
purchases and the overall size of the asset purchase
program in light of incoming information—including
information on the outlook for economic activity,
developments in financial markets, and the efficacy
of the purchase program and any unintended consequences that might arise—and would adjust the program as needed to best foster maximum employment
and price stability. A few members noted that evidence of a stronger recovery, or of higher inflation or
rising inflation expectations, could make it appropriate to reduce the pace or overall size of the purchase
program. Several others indicated that they did not
anticipate making adjustments to the program before
its intended completion.
With respect to the statement to be released following
the meeting, members decided to note the further
improvement in economic activity and in labor markets. The Committee also decided to summarize its
current thinking about inflation pressures and to
emphasize that it will closely monitor the evolution
of overall inflation and inflation expectations.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Open Market
Account in accordance with the following domestic
policy directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to execute purchases of longerterm Treasury securities in order to increase the
total face value of domestic securities held in the
System Open Market Account to approximately
$2.6 trillion by the end of June 2011. The Committee also directs the Desk to reinvest principal
payments from agency debt and agency
mortgage-backed securities in longer-term
Treasury securities. The System Open Market

Account Manager and the Secretary will keep
the Committee informed of ongoing developments regarding the System’s balance sheet that
could affect the attainment over time of the
Committee’s objectives of maximum employment and price stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:
“Information received since the Federal Open
Market Committee met in January suggests that
the economic recovery is on a firmer footing,
and overall conditions in the labor market
appear to be improving gradually. Household
spending and business investment in equipment
and software continue to expand. However,
investment in nonresidential structures is still
weak, and the housing sector continues to be
depressed. Commodity prices have risen significantly since the summer, and concerns about
global supplies of crude oil have contributed to
a sharp run-up in oil prices in recent weeks.
Nonetheless, longer-term inflation expectations
have remained stable, and measures of underlying inflation have been subdued.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. Currently, the unemployment
rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be
consistent, over the longer run, with its dual
mandate. The recent increases in the prices of
energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it
will pay close attention to the evolution of inflation and inflation expectations. The Committee
continues to anticipate a gradual return to
higher levels of resource utilization in a context
of price stability.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time,
is at levels consistent with its mandate, the Committee decided today to continue expanding its
holdings of securities as announced in November. In particular, the Committee is maintaining
its existing policy of reinvesting principal payments from its securities holdings and intends to
purchase $600 billion of longer-term Treasury
securities by the end of the second quarter of

Minutes of Federal Open Market Committee Meetings | March

2011. The Committee will regularly review the
pace of its securities purchases and the overall
size of the asset-purchase program in light of
incoming information and will adjust the program as needed to best foster maximum employment and price stability.
The Committee will maintain the target range
for the federal funds rate at 0 to ¼ percent and
continues to anticipate that economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation
expectations, are likely to warrant exceptionally
low levels for the federal funds rate for an
extended period.
The Committee will continue to monitor the
economic outlook and financial developments
and will employ its policy tools as necessary to
support the economic recovery and to help
ensure that inflation, over time, is at levels consistent with its mandate.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Charles L. Evans, Richard
W. Fisher, Narayana Kocherlakota, Charles I.
Plosser, Sarah Bloom Raskin, Daniel K. Tarullo, and
Janet L. Yellen.
Voting against this action: None.
The Committee then discussed a recommendation,
from its subcommittee on communications, that the
Chairman conduct regular press conferences. Participants generally saw such press conferences as a
potentially useful way to enhance transparency and

209

strengthen the Committee’s policy communications.
They discussed various implications of, and alternative arrangements for, such press conferences. They
generally endorsed holding press conferences after
the four FOMC meetings each year for which participants provide numerical projections of several key
economic variables, conditional on appropriate monetary policy. While those projections already are
made public in the minutes of the relevant FOMC
meetings, press conferences could be helpful in
explaining how the Committee’s monetary policy
strategy is informed by participants’ projections of
the rates of output growth, unemployment, and
inflation likely to prevail during each of the next few
years, and by their assessments of the values of those
variables that will prove most consistent, over the
longer run, with the Committee’s mandate to promote both maximum employment and stable prices.
The outcome of the discussion was a decision that
the Chairman would begin holding press conferences
effective with the April 26–27, 2011, meeting.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, April 26–27,
2011. The meeting adjourned at 2:35 p.m. on
March 15, 2011.

Notation Vote
By notation vote completed on February 15, 2011,
the Committee unanimously approved the minutes of
the FOMC meeting held on January 25–26, 2011.
William B. English
Secretary

210

98th Annual Report | 2011

Meeting Held on April 26–27, 2011

Scott G. Alvarez
General Counsel

A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday,
April 26, 2011, at 10:30 a.m. and continued on
Wednesday, April 27, 2011, at 8:30 a.m.

Thomas C. Baxter
Deputy General Counsel

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Charles L. Evans
Richard W. Fisher
Narayana Kocherlakota
Charles I. Plosser
Sarah Bloom Raskin
Daniel K. Tarullo
Janet L. Yellen
Christine Cumming, Jeffrey M. Lacker,
Dennis P. Lockhart, Sandra Pianalto,
and John C. Williams
Alternate Members of the Federal Open Market
Committee
James Bullard, Thomas M. Hoenig, and
Eric Rosengren
Presidents of the Federal Reserve Banks of St. Louis,
Kansas City, and Boston, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary

Nathan Sheets
Economist
David J. Stockton
Economist
James A. Clouse, Thomas A. Connors,
Steven B. Kamin, Loretta J. Mester,
David Reifschneider, Harvey Rosenblum,
David W. Wilcox, and Kei-Mu Yi
Associate Economists
Brian Sack
Manager, System Open Market Account
Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors
Patrick M. Parkinson
Director, Division of Banking Supervision and
Regulation, Board of Governors
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Robert deV. Frierson
Deputy Secretary, Office of the Secretary,
Board of Governors
William Nelson
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director,
Board of Governors
Lawrence Slifman and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Andrew T. Levin
Senior Adviser, Office of Board Members,
Board of Governors

Minutes of Federal Open Market Committee Meetings | April

Joyce K. Zickler
Visiting Senior Adviser, Division of Monetary
Affairs, Board of Governors
Michael G. Palumbo
Associate Director, Division of Research and
Statistics, Board of Governors
Trevor A. Reeve1
Associate Director, Division of International Finance,
Board of Governors
Fabio M. Natalucci
Assistant Director, Division of Monetary Affairs,
Board of Governors
David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Jeremy B. Rudd
Senior Economist, Division of Research and
Statistics, Board of Governors
James M. Lyon
First Vice President, Federal Reserve Bank of
Minneapolis
Jamie J. McAndrews and Mark S. Sniderman
Executive Vice Presidents, Federal Reserve Banks of
New York and Cleveland, respectively
David Altig, Alan D. Barkema, Richard P. Dzina,
David Marshall, Christopher J. Waller, and
John A. Weinberg
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, Kansas City, New York, Chicago, St. Louis,
and Richmond, respectively
John Fernald and Giovanni Olivei
Vice Presidents, Federal Reserve Banks of
San Francisco and Boston, respectively

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
March 15, 2011. He also reported on System open
market operations, including the continuing reinvestment into longer-term Treasury securities of principal payments received on the SOMA’s holdings of
agency debt and agency-guaranteed mortgagebacked securities (MBS) as well as the ongoing purchases of additional Treasury securities first author1

Attended Tuesday’s session only.

211

ized in November 2010. Since November, purchases
by the Open Market Desk of the Federal Reserve
Bank of New York had increased the SOMA’s holdings by $422 billion. The Manager reported on the
U.S. authorities’ participation in the coordinated foreign exchange intervention announced by the Group
of Seven (G-7) finance ministers and central bank
governors on March 17, 2011. By unanimous votes,
the Committee ratified the Desk’s domestic and foreign exchange market transactions over the intermeeting period.
By unanimous vote, the Committee agreed to extend
the reciprocal currency (swap) arrangements with the
Bank of Canada and the Banco de México for an
additional year beginning in mid-December 2011;
these arrangements are associated with the Federal
Reserve’s participation in the North American
Framework Agreement of 1994. The arrangement
with the Bank of Canada is in the amount of $2 billion equivalent, and the arrangement with the Banco
de México is in the amount of $3 billion equivalent.
The vote to renew the System’s participation in these
swap arrangements was taken at this meeting because
of a provision in the arrangements that requires each
party to provide six months’ prior notice of an intention to terminate its participation.
The staff next gave a presentation on strategies for
normalizing the stance and conduct of monetary
policy over time as the economy strengthens. Normalizing the stance of policy would entail the withdrawal of the current extraordinary degree of accommodation at the appropriate time, while normalizing
the conduct of policy would involve draining the
large volume of reserve balances in the banking
system and shrinking the overall size of the balance
sheet, as well as returning the SOMA to its historical
composition of essentially only Treasury securities.
The presentation noted a few key issues that the
Committee would need to address in deciding on its
approach to normalization. The first key issue was
the extent to which the Committee would want to
tighten policy, at the appropriate time, by increasing
short-term interest rates, by decreasing its holdings of
longer-term securities, or both. Because the two policies would restrain economic activity by tightening
financial conditions, they could be combined in various ways to achieve similar outcomes. For example,
in principle, the Committee could accomplish essentially the same degree of monetary tightening by selling assets sooner and faster but raising the target for
the federal funds rate later and more slowly, or by
selling assets later and more slowly but increasing the

212

98th Annual Report | 2011

federal funds rate target sooner and faster. The
SOMA portfolio could be reduced by selling securities outright, by ceasing the reinvestment of principal
payments on its securities holdings, or both. A second key issue was the extent to which the Committee
might choose to vary the pace of any asset sales it
undertakes in response to economic and financial
conditions. If it chose to make the pace of sales quite
responsive to conditions, the FOMC would be able to
actively use two policy instruments—asset sales and
the federal funds rate target—to pursue its economic
objectives, which could increase the scope and flexibility for adjusting financial conditions. In contrast,
sales at a pace that varied less with changes in economic and financial conditions and was preannounced and largely predetermined would leave the
federal funds rate target as the Committee’s primary
active policy instrument, which could result in policy
that is more straightforward for the Committee to
calibrate and to communicate. Finally, the staff presentation noted that the Committee would need to
decide if and when to use the tools that it has developed to temporarily reduce reserve balances—reverse
repurchase agreements and term deposits—in order
to tighten the correspondence between any changes
in the interest rate the Federal Reserve pays on excess
reserves and the changes in the federal funds rate.
Meeting participants agreed on several principles that
would guide the Committee’s strategy for normalizing monetary policy. First, with regard to the normalization of the stance of monetary policy, the pace
and sequencing of the policy steps would be driven
by the Committee’s monetary policy objectives for
maximum employment and price stability. Participants noted that the Committee’s decision to discuss
the appropriate strategy for normalizing the stance of
policy at the current meeting did not mean that the
move toward such normalization would necessarily
begin soon. Second, to normalize the conduct of
monetary policy, it was agreed that the size of the
SOMA’s securities portfolio would be reduced over
the intermediate term to a level consistent with the
implementation of monetary policy through the
management of the federal funds rate rather than
through variation in the size or composition of the
Federal Reserve’s balance sheet. Third, over the intermediate term, the exit strategy would involve returning the SOMA to holding essentially only Treasury
securities in order to minimize the extent to which
the Federal Reserve portfolio might affect the allocation of credit across sectors of the economy. Such a
shift was seen as requiring sales of agency securities
at some point. And fourth, asset sales would be

implemented within a framework that had been communicated to the public in advance, and at a pace
that potentially could be adjusted in response to
changes in economic or financial conditions.
In addition, nearly all participants indicated that the
first step toward normalization should be ceasing to
reinvest payments of principal on agency securities
and, simultaneously or soon after, ceasing to reinvest
principal payments on Treasury securities. Most participants viewed halting reinvestments as a way to
begin to gradually reduce the size of the balance
sheet. It was noted, however, that ending reinvestments would constitute a modest step toward policy
tightening, implying that that decision should be
made in the context of the economic outlook and the
Committee’s policy objectives. In addition, changes
in the statement language regarding forward policy
guidance would need to accompany the normalization process.
Participants expressed a range of views on some
aspects of a normalization strategy. Most participants indicated that once asset sales became appropriate, such sales should be put on a largely predetermined and preannounced path; however, many of
those participants noted that the pace of sales could
nonetheless be adjusted in response to material
changes in the economic outlook. Several other participants preferred instead that the pace of sales be a
key policy tool and be varied actively in response to
changes in the outlook. A majority of participants
preferred that sales of agency securities come after
the first increase in the FOMC’s target for short-term
interest rates, and many of those participants also
expressed a preference that the sales proceed relatively gradually, returning the SOMA’s composition
to all Treasury securities over perhaps five years. Participants noted that, for any given degree of policy
tightening, more-gradual sales that commenced later
in the normalization process would allow for an earlier increase of the federal funds rate target from its
effective lower bound than would be the case if asset
sales commenced earlier and at a more rapid pace. As
a result, the Committee would later have the option
of easing policy with an interest rate cut if economic
conditions then warranted. An earlier increase in the
federal funds rate was also mentioned as helpful to
limit the potential for the very low level of that rate
to encourage financial imbalances. A few participants
expressed a preference that sales begin before any
increase in the federal funds rate target, and a few
other participants indicated that sales and increases
in the federal funds rate target should commence at

Minutes of Federal Open Market Committee Meetings | April

the same time. The participants who favored earlier
sales also generally indicated a preference for relatively rapid sales, with some suggesting that agency
securities in the SOMA be reduced to zero over as
little as one or two years. Such an approach was
viewed as allowing for a faster return to a normal
policy environment, potentially reducing any upside
risks to inflation stemming from outsized reserve balances, and more quickly eliminating any effects of
SOMA holdings of agency securities on the allocation of credit.
Most participants saw changes in the target for the
federal funds rate as the preferred active tool for
tightening monetary policy when appropriate. A
number of participants noted that it would be advisable to begin using the temporary reserves-draining
tools in advance of an increase in the Committee’s
federal funds rate target, in part because doing so
would put the Federal Reserve in a better position to
assess the effectiveness of the draining tools and
judge the size of draining operations that might be
required to support changes in the interest on excess
reserves (IOER) rate in implementing a desired
increase in short-term rates. A number of participants also noted that they would be prepared to sell
securities sooner if the temporary reserves-draining
operations and the end of the reinvestment of principal payments were not sufficient to support a fairly
tight link between increases in the IOER rate and
increases in short-term market interest rates.
In the discussion of normalization, some participants
also noted their preferences about the longer-run
framework for monetary policy implementation.
Most of these participants indicated that they preferred that monetary policy eventually operate
through a corridor-type system in which the federal
funds rate trades in the middle of a range, with the
IOER rate as the floor and the discount rate as the
ceiling of the range, as opposed to a floor-type
system in which a relatively high level of reserve balances keeps the federal funds rate near the IOER
rate. A couple of participants noted that any normalization strategy would likely involve an elevated balance sheet with the federal funds rate target near the
IOER rate—as in floor-type systems—for some time,
and therefore the Committee would accumulate experience during the process of normalizing policy that
would allow it to make a more informed choice
regarding the longer-term framework at a later date.
The Committee agreed that more discussion of these
issues was needed, and no decisions regarding the

213

Committee’s strategy for normalizing policy were
made at this meeting.

Staff Review of the Economic Situation
The information reviewed at the April 26–27 meeting
indicated, on balance, that economic activity
expanded at a moderate pace in recent months, and
labor market conditions continued to improve gradually. Headline consumer price inflation was boosted
by large increases in food and energy prices, but
measures of underlying inflation were still subdued
and longer-run inflation expectations remained
stable.
Private nonfarm payroll employment increased again
in March, and the gains in hiring for the first quarter
as a whole were somewhat above the pace seen in the
fourth quarter. A number of indicators of job openings and hiring plans improved in February and
March. Although initial claims for unemployment
insurance were flat, on net, from early March
through the middle of April, they remained lower
than earlier in the year. The unemployment rate
edged down further to 8.8 percent in March, while
the labor force participation rate was unchanged.
However, both long-duration unemployment and the
share of workers employed part time for economic
reasons were still very high.
Industrial production in the manufacturing sector
expanded at a robust pace in February and March.
The manufacturing capacity utilization rate moved
up further, though it continued to be a good bit lower
than its longer-run average. Most forward-looking
indicators of industrial activity, such as the new
orders indexes in the national and regional manufacturing surveys, remained at levels consistent with
solid gains in production in the near term. However,
motor vehicle assemblies were expected to step down
in the second quarter from their level in March,
reflecting emerging shortages of specialized components imported from Japan.
The rise in consumer spending appeared to have
slowed to a moderate rate in the first quarter from
the stronger pace posted in the fourth quarter of last
year. Total real personal consumption expenditures
picked up in February after being about unchanged
in January. Nominal retail sales, excluding purchases
at motor vehicles and parts outlets, posted a sizable
gain in March, but sales of new light motor vehicles
declined somewhat. Real disposable income edged
down in February following an increase in January

214

98th Annual Report | 2011

that reflected the temporary reduction in payroll
taxes. In addition, consumer sentiment declined
noticeably in March and remained relatively downbeat in early April.
Activity in the housing market remained very weak,
as the large overhang of foreclosed and distressed
properties continued to restrain new construction.
Starts and permits of new single-family homes
inched down, on net, in February and March, and
they have been essentially flat since around the
middle of last year. Demand for housing also continued to be depressed. Sales of new and existing homes
moved lower, on net, in February and March, while
measures of home prices slid further in February.
Real business investment in equipment and software
(E&S) appeared to have increased more robustly in
the first quarter than in the fourth quarter of last
year. Nominal shipments of nondefense capital
goods rose in February and March, and businesses’
purchases of new vehicles trended higher. New
orders of nondefense capital goods continued to run
ahead of shipments in February and March, and this
expanding backlog of unfilled orders pointed to further increases in shipments in subsequent months. In
addition, survey measures of business conditions and
sentiment in recent months were consistent with continued robust gains in E&S spending. In contrast,
business outlays for nonresidential construction
remained extremely weak in February, restrained by
high vacancy rates, low prices for office and commercial properties, and tight credit conditions for commercial real estate lending.
Real nonfarm inventory investment appeared to have
moved up to a moderate pace in the first quarter
after slowing sharply in the preceding quarter. Motor
vehicle inventories were drawn down more slowly in
the first quarter than in the fourth quarter, while data
through February suggested that the pace of stockbuilding outside of motor vehicles had picked up a
bit. Book-value inventory-to-sales ratios in February
were in line with their pre-recession norms, and survey data in March provided little evidence that businesses perceived that their inventories were too high.
The available data on government spending indicated
that real federal purchases fell in the first quarter, led
by a reduction in defense outlays. Real expenditures
by state and local governments also appeared to have
declined, as outlays for construction projects
decreased further in February to a level well below

that in the fourth quarter, and state and local
employment continued to contract in March.
The U.S. international trade deficit narrowed slightly
in February after widening sharply in January. Following a solid increase in January, exports fell back
some in February, with declines widespread across
categories. Imports also declined in February after
posting large gains in January. On average, the trade
deficit in January and February was wider than in the
fourth quarter.
Overall U.S. consumer price inflation moved up further in February and March, as increases in the
prices of energy and food commodities continued to
be passed through to the retail level. More recently,
survey data through the middle of April pointed to
additional increases in retail gasoline prices, while
increases in the prices of food commodities appeared
to have moderated somewhat. Excluding food and
energy, core consumer price inflation remained relatively subdued. Although core consumer price inflation over the first three months of the year stepped
up somewhat, the 12-month change in the core consumer price index through March was essentially the
same as it was a year earlier. Near-term inflation
expectations from the Thomson Reuters/University
of Michigan Surveys of Consumers remained
elevated in early April. But longer-term inflation
expectations moved down in early April—reversing
their uptick in March—and stayed within the range
that has prevailed over the past several years.
Available measures of labor compensation suggested
that wage increases continued to be restrained by the
presence of a large margin of slack in the labor market. Average hourly earnings for all employees were
flat in March, and their average rate of increase over
the preceding 12 months remained low.
The pace of recovery abroad appeared to have
strengthened earlier this year, but the disaster in
Japan raised uncertainties about foreign activity in
the near term. In the euro area, production expanded
at a solid pace, though indicators of consumer spending weakened. While measures of economic activity
in Germany posted strong gains, economic conditions in Greece and Portugal deteriorated further.
The damage caused by the earthquake and tsunami
in Japan appeared to be sharply curtailing Japanese
economic activity and posed concerns about disruptions to supply chains and production in other
economies. Emerging market economies (EMEs)

Minutes of Federal Open Market Committee Meetings | April

continued to expand rapidly. Rising prices of oil and
other commodities boosted inflation in foreign
economies. However, core inflation remained subdued in most of the advanced foreign economies, and
inflation in the EMEs seemed to have declined as
food price inflation slowed.

Staff Review of the Financial Situation
The decisions by the FOMC at its March meeting to
continue its asset purchase program and to maintain
the 0 to ¼ percent target range for the federal funds
rate were in line with market expectations; nonetheless, the accompanying statement prompted a modest
rise in nominal yields, as market participants reportedly perceived a somewhat more optimistic tone in
the Committee’s economic outlook, as well as heightened concern about inflation risks. Over the intermeeting period, yields on nominal Treasury securities
changed little, on net, amid swings in investors’
assessments of global risks. Short-term funding rates,
including the effective federal funds rate, shifted
down several basis points in early April following a
change in the Federal Deposit Insurance Corporation’s deposit insurance assessment system. On net,
the expected path of the federal funds rate over the
next two years was little changed over the intermeeting period.
Measures of inflation compensation over the next
5 years based on nominal and inflation-protected
Treasury securities increased slightly, on net, over the
intermeeting period, partly reflecting the ongoing rise
in commodity prices. Staff models suggested that the
modest increase in inflation compensation 5 to
10 years ahead was mostly attributable to increases in
liquidity and inflation-risk premiums rather than
higher expected inflation.
Over the intermeeting period, yields on corporate
bonds were generally little changed, on net, and
spreads of investment- and speculative-grade corporate bonds relative to comparable-maturity Treasury
securities narrowed slightly. Average secondarymarket prices for syndicated leveraged loans moved
up further. However, conditions in the municipal
bond market remained somewhat strained.
Broad U.S. stock price indexes rose, on net, over the
intermeeting period, as initial reports of better-thanexpected first-quarter earnings lifted stock prices in
late April. Option-implied volatility on the S&P 500
index was moderately lower, on net, ending the intermeeting period at the low end of its recent range.

215

Net debt financing by nonfinancial corporations
remained robust in March. Net issuance of
investment- and speculative-grade bonds by nonfinancial corporations continued to be strong, and outstanding amounts of commercial and industrial
(C&I) loans and nonfinancial commercial paper
increased noticeably. Gross public equity issuance by
nonfinancial firms was robust in March, and indicators of the credit quality of nonfinancial firms
improved further.
Commercial mortgage markets showed some signs of
stabilization. Delinquency rates for commercial real
estate loans appeared to have leveled off in recent
months. Issuance of commercial mortgage-backed
securities picked up in the first quarter, although
commercial real estate loans at banks continued to
run off. In commercial real estate markets, property
sales remained tepid, and prices stayed at depressed
levels.
Rates on conforming fixed-rate residential mortgages
rose modestly during the intermeeting period, and
their spreads relative to 10-year Treasury yields narrowed slightly. Mortgage refinancing activity
remained near its lowest level in more than two years.
The Treasury Department’s announcement in late
March that it would begin selling its holdings of
agency MBS at a gradual pace had little lasting effect
on MBS spreads. The Federal Reserve began competitive sales of the non-agency residential MBS held
by Maiden Lane II LLC; initial sales met with strong
demand, but market prices of non-agency residential
MBS were reportedly little changed overall. The rates
of serious delinquencies for subprime and prime
mortgages were nearly unchanged but remained at
elevated levels. However, the rate of new delinquencies on prime mortgages declined further.
Conditions in consumer credit markets continued to
improve gradually. Total consumer credit growth
picked up in February, as a gain in nonrevolving
credit more than offset a further contraction in
revolving credit. Delinquency and charge-off rates
for credit card debt moved down in recent months
and approached pre-crisis levels. Issuance of consumer asset-backed securities remained steady in the
first quarter of the year.
Bank credit was about unchanged in March after
declining, on average, in January and February. Core
loans—the sum of C&I, real estate, and consumer
loans—continued to contract, while holdings of
securities increased moderately. The Senior Loan

216

98th Annual Report | 2011

Officer Opinion Survey on Bank Lending Practices
conducted in April indicated that, on net, bank lending standards and terms had eased somewhat further
during the first quarter of the year and demand for
C&I loans, commercial mortgages, and auto loans
had increased, while demand for residential mortgages continued to decline.
M2 expanded at a moderate pace in March. Liquid
deposits, the largest component of M2, advanced at a
solid pace likely reflecting very low opportunity costs
of holding such deposits. Currency advanced significantly, supported by robust foreign demand for U.S.
bank notes.
Foreign sovereign bond yields generally were little
changed and equity prices rose, on net, over the intermeeting period, although equity prices in Japan
remained below their pre-earthquake levels despite
the record amounts of liquidity injected by the Bank
of Japan and the expansion of its asset purchase program. The European Central Bank raised its main
policy rate 25 basis points to 1¼ percent during the
intermeeting period, and markets appeared to have
priced in additional rate increases over the rest of the
year. The Bank of England and the Bank of Canada
left their policy rates unchanged, but quotes from
futures markets continued to suggest that both central banks would raise rates later this year. China’s
monetary authority further increased banks’ lending
rates and deposit rates and continued to tighten
reserve requirements; monetary policy in a number of
other EMEs was also tightened over the intermeeting
period.
The broad nominal index of the U.S. dollar declined
more than 2 percent over the intermeeting period,
though the dollar appreciated, on net, against the
Japanese yen. The yen strengthened to an all-time
high against the dollar after the earthquake in Japan,
but this move was more than reversed when the G-7
countries intervened to sell yen.
In early April, the Portuguese government requested
financial support from the European Union and the
International Monetary Fund, but market participants reportedly remained concerned about whether
the Portuguese government would reach agreement
on an associated fiscal consolidation plan. Later in
the intermeeting period, yields on Greece’s and other
peripheral European countries’ sovereign debt
jumped, reflecting heightened market focus on a possible restructuring of Greek sovereign debt.

Staff Economic Outlook
With the recent data on spending somewhat weaker,
on balance, than the staff had expected at the time of
the March FOMC meeting, the staff revised down its
projection for the rate of increase in real gross
domestic product (GDP) over the first half of 2011.
The effects from the disaster in Japan were also
anticipated to temporarily hold down real GDP
growth in the near term. Over the medium term, the
staff’s outlook for the pace of economic growth was
broadly similar to its previous forecast: As in the
March projection, the staff expected real GDP to
increase at a moderate rate through 2012, with the
ongoing recovery in activity receiving continued support from accommodative monetary policy, increasing credit availability, and further improvements in
household and business confidence. The average pace
of GDP growth was expected to be sufficient to
gradually reduce the unemployment rate over the
projection period, though the jobless rate was anticipated to remain elevated at the end of 2012.
Recent increases in consumer food and energy prices,
together with the small uptick in core consumer price
inflation, led the staff to raise its near-term projection for consumer price inflation. However, inflation
was expected to recede over the medium term, as
food and energy prices were anticipated to decelerate.
As in previous forecasts, the staff expected core consumer price inflation to remain subdued over the projection period, reflecting stable longer-term inflation
expectations and persistent slack in labor and product markets.

Participants’ Views on Current Conditions
and the Economic Outlook
In conjunction with this FOMC meeting, all meeting
participants—the five members of the Board of
Governors and the presidents of the 12 Federal
Reserve Banks—provided projections of output
growth, the unemployment rate, and inflation for
each year from 2011 through 2013 and over the longer run. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge, over time, under
appropriate monetary policy and in the absence of
further shocks. Participants’ forecasts are described
in the Summary of Economic Projections, which is
attached as an addendum to these minutes.

Minutes of Federal Open Market Committee Meetings | April

In discussing intermeeting developments and their
implications for the economic outlook, participants
agreed that the information received since their previous meeting was broadly consistent with continuation of a moderate economic recovery, despite an
unexpected slowing in the pace of economic growth
in the first quarter. While construction activity
remained anemic, measures of consumer spending
and business investment continued to expand and
labor market conditions continued to improve gradually. Participants viewed the weakness in first-quarter
economic growth as likely to be largely transitory,
influenced by unusually severe weather, increases in
energy and other commodity prices, and lower-thanexpected defense spending. As a result, they saw economic growth picking up later this year.
Participants’ forecasts for economic growth for 2012
and 2013 were largely unchanged from their January
projections and continued to indicate expectations
that the recovery will strengthen somewhat over time.
Nonetheless, the pickup in the pace of the economic
expansion was expected to be limited, reflecting the
effects of high energy prices, modest changes in housing wealth, subdued real income gains, and fiscal contraction at the federal, state, and local levels. Participants continued to project the unemployment rate to
decline gradually over the forecast period but to
remain elevated compared with their assessments of
its longer-run level. Participants revised up their projections for total inflation in 2011, reflecting recent
increases in energy and other commodity prices, but
they generally anticipated that the recent increase in
inflation would be transitory as commodity prices
stabilize and inflation expectations remain anchored.
However, they all agreed on the importance of closely
monitoring developments regarding inflation and
inflation expectations.
Participants’ judgment that the recovery was continuing at a moderate pace reflected both the incoming
economic indicators and information received from
business contacts. Growth in consumer spending
remained moderate despite the effects of higher gasoline and food prices, which appeared to have largely
offset the increase in disposable income from the payroll tax cut. Participants noted that these higher
prices had weighed on consumer sentiment about
near-term economic conditions but that underlying
fundamentals for continued moderate growth in
spending remained in place. These underlying factors
included continued improvement in household balance sheets, easing credit conditions, and strengthening labor markets.

217

Activity in the industrial sector also expanded further. Industrial production posted solid gains, and,
while the most recent readings from some of the
regional manufacturing surveys showed small
declines, in some cases these were from near-record
highs. Manufacturers remained upbeat, although
automakers were reporting some difficulties in
obtaining parts normally produced in Japan, which
might weigh on motor vehicle production in the current quarter. Investment in equipment and software
was fairly robust. In contrast, the housing sector
remained distressed, with house prices flat to down
and a large overhang of vacant properties restraining
new construction, although reports indicated that
sales volumes and traffic were higher in a few areas.
Activity in the commercial real estate sector continued to be weak.
Several participants indicated that, in contrast to the
somewhat weaker recent economic data, their business contacts were more positive about the economy’s prospects, which supported the participants’
view that the recent weakness was likely to prove temporary. They acknowledged, however, that sentiment
can change quickly; indeed, one participant noted
that his contacts had recently turned more pessimistic, and several participants indicated that their business contacts expressed concern about the effects of
higher commodity prices on their own costs and on
the purchasing power of households.
Participants judged that overall conditions in labor
markets had continued to improve, albeit gradually.
The unemployment rate had decreased further and
payroll employment had risen again in March. Some
participants reported that more of their business contacts have plans to increase their payrolls later this
year. A few participants noted that firms may be
poised to accelerate their pace of hiring because they
have exhausted potential productivity gains, but others indicated that some firms may be putting hiring
plans on hold until they are more certain of the
future trend in materials and other input costs. Signs
of rising wage pressures were reportedly limited to a
few skilled job categories for which workers are in
short supply, while, in general, increases in wages
have been subdued. Participants discussed whether
the significant drop in the unemployment rate might
be overstating the degree of improvement in labor
markets because many of the unemployed have
dropped out of the labor force or have accepted jobs
that are less desirable than their former jobs.

218

98th Annual Report | 2011

Financial market conditions continued to improve
over the intermeeting period. Equity prices had risen,
on balance, since the previous meeting, reflecting an
improved outlook for earnings, and were up more
substantially since the start of the year. Bankers
again reported improvements in credit quality, with
the volume of nonperforming assets declining at
larger banks and leveling off at smaller banks. In
general, loan demand remained weak. However, bank
lending to medium-sized and larger companies
increased, and lending to small businesses picked up
slightly. Banks reported an easing of lending terms
on C&I loans, usually prompted by increased competition in the face of still-weak loan demand. Consumer credit conditions also eased somewhat from
the tight conditions seen during the recession. However, demand for consumer credit other than auto
loans reportedly changed little. A few participants
expressed concern that the easing of credit conditions
was creating incentives for increased leverage and
risk-taking in some areas, such as leveraged syndicated loans and loans to finance land acquisition,
and that this trend, if it became widespread and
excessive, could pose a risk to financial stability.
Participants discussed the recent rise in inflation,
which had been driven largely by significant increases
in energy and, to a somewhat lesser extent, other
commodity prices. These commodity price increases,
in turn, reflected robust global demand and geopolitical developments that had reduced supply. One
participant suggested that excess liquidity might be
leading to speculation in commodity markets, possibly putting upward pressure on prices. Many participants reported that an increasing number of business
contacts expressed concerns about rising cost pressures and were intending, or already attempting, to
pass on at least a portion of these higher costs to
their customers in order to protect profit margins.
This development was also reflected in the rising
indexes of prices paid and received in several regional
manufacturing surveys. Some participants noted that
higher commodity prices were negatively affecting
both business and consumer sentiment. Core inflation and other indicators of underlying inflation over
the medium term had increased modestly in recent
months, but their levels remained subdued.
Participants generally anticipated that the higher
level of overall inflation would be transitory. This
outlook was based partly on a projected leveling-off
of commodity prices and the belief that longer-run
inflation expectations would remain stable. Some
participants noted that pressures on labor costs con-

tinued to be muted; if such circumstances continued,
a large, persistent rise in inflation would be unusual.
Measures of near-term inflation expectations had
risen along with the recent rise in overall inflation.
While some indicators of longer-term expectations
had increased, others were little changed or down, on
net, since March. Many participants had become
more concerned about the upside risks to the inflation outlook, including the possibilities that oil prices
might continue to rise, that there might be greater
pass-through of higher commodity costs into
broader price measures, and that elevated overall
inflation caused by higher energy and other commodity prices could lead to a rise in longer-term
inflation expectations. Participants agreed that monitoring inflation trends and inflation expectations
closely was important in determining whether action
would be needed to prevent a more lasting pickup in
the rate of general price inflation, which would be
costly to reverse. Maintaining well-anchored inflation
expectations would depend on the credibility of the
Committee’s commitment to deliver on the price stability part of its mandate. A few participants suggested that clearer communication about the Committee’s inflation outlook, such as explaining the
measures it uses to gauge medium-term trends in
general price inflation and announcing an explicit
numerical inflation objective, would be helpful in this
regard.
While rising energy prices posed an upside risk to the
inflation forecast, they also posed a downside risk to
economic growth. Although most participants continued to see the risks to their outlooks for economic
growth as being broadly balanced, a number now
judged those risks to be tilted to the downside. These
downside risks included a larger-than-expected drag
on household and business spending from higher
energy prices, continued fiscal strains in Europe,
larger-than-anticipated effects from supply disruptions in the aftermath of the disaster in Japan, continuing fiscal adjustments at all levels of government
in the United States, financial disruptions that would
be associated with a failure to increase the federal
debt limit, and the possibility that the economic
weakness in the first quarter was signaling less underlying momentum going forward. However, participants also noted that the rapid decline in the unemployment rate over the past several months suggested
the possibility of stronger-than-anticipated economic
growth over coming quarters.
In their discussion of monetary policy, some participants expressed the view that in the context of

Minutes of Federal Open Market Committee Meetings | April

increased inflation risks and roughly balanced risks
to economic growth, the Committee would need to
be prepared to begin taking steps toward lessaccommodative policy. A few of these participants
thought that economic conditions might warrant
action to raise the federal funds rate target or to sell
assets in the SOMA portfolio later this year, but
noted that even with such steps, monetary policy
would remain accommodative for some time to come.
However, some participants indicated that underlying
inflation remained subdued; that longer-term inflation expectations were likely to remain anchored,
partly because modest changes in labor costs would
constrain inflation trends; and that given the downside risks to economic growth, an early exit could
unnecessarily damp the ongoing economic recovery.

Committee Policy Action
Committee members agreed that no changes to the
Committee’s asset purchase program or to its target
range for the federal funds rate were warranted at
this meeting. The information received over the intermeeting period indicated that the economic recovery
was proceeding at a moderate pace, albeit somewhat
slower than had been anticipated earlier in the year.
Overall conditions in the labor market were gradually
improving, and the unemployment rate continued to
decline, although it remained elevated relative to levels that the Committee judged to be consistent, over
the longer run, with its statutory mandate of maximum employment and price stability. Significant
increases in energy and other commodity prices had
boosted overall inflation, but members expected this
increase to be transitory and to unwind when commodity price increases abated. Notwithstanding
recent modest increases, indicators of medium-term
inflation remained subdued and somewhat below the
levels seen as consistent with the dual mandate as
indicated by the Committee’s longer-run inflation
projections. Near-term inflation expectations had
increased with energy prices and overall inflation.
Recent movements in measures of longer-term inflation expectations were discussed. While some measures of longer-term inflation expectations had risen,
others were little changed or down, on net, since
March, and members agreed that longer-term inflation expectations had remained stable. Given this
economic outlook, the Committee agreed to continue
to expand its holdings of longer-term Treasury securities as announced in November in order to promote
a stronger pace of economic recovery and to help
ensure that inflation, over time, is at levels consistent
with the Committee’s mandate. Specifically, the

219

Committee maintained its existing policy of reinvesting principal payments from its securities holdings
and affirmed that it will complete purchases of
$600 billion of longer-term Treasury securities by the
end of the current quarter. A few members remained
uncertain about the benefits of the asset purchase
program but, with the program nearly completed,
judged that making changes to the program at this
time was not appropriate. The Committee continued
to anticipate that economic conditions, including low
rates of resource utilization, subdued inflation
trends, and stable inflation expectations, were likely
to warrant exceptionally low levels for the federal
funds rate for an extended period. That said, a few
members viewed the increase in inflation risks as suggesting that economic conditions might well evolve in
a way that would warrant the Committee taking steps
toward less-accommodative policy sooner than currently anticipated.
Members agreed that the Committee will regularly
review the size and composition of its securities holdings in light of incoming information and that they
are prepared to adjust those holdings as needed to
best foster maximum employment and price stability.
Some members pointed out that there would need to
be a significant change in the economic outlook, or
the risks to that outlook, before another program of
asset purchases would be warranted; in their view,
absent such changes, the benefits of additional purchases would be unlikely to outweigh the costs.
In the statement to be released following the meeting,
members decided to indicate that the economic
recovery was proceeding at a moderate pace and that
overall conditions in the labor market were gradually
improving. The Committee also decided to summarize its current thinking about inflation pressures and
to emphasize that it will closely monitor the evolution of inflation and inflation expectations. Members
anticipated that the Chairman, who would deliver his
first post-meeting press briefing later that afternoon,
would provide additional context for the Committee’s policy decisions.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will fos-

220

98th Annual Report | 2011

ter price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to execute purchases of longerterm Treasury securities in order to increase the
total face value of domestic securities held in the
System Open Market Account to approximately
$2.6 trillion by the end of June 2011. The Committee also directs the Desk to reinvest principal
payments from agency debt and agency
mortgage-backed securities in longer-term
Treasury securities. The System Open Market
Account Manager and the Secretary will keep
the Committee informed of ongoing developments regarding the System’s balance sheet that
could affect the attainment over time of the
Committee’s objectives of maximum employment and price stability.”
The vote encompassed approval of the statement
below to be released at 12:30 p.m.:
“Information received since the Federal Open
Market Committee met in March indicates that
the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually. Household spending and business investment in equipment and
software continue to expand. However, investment in nonresidential structures is still weak,
and the housing sector continues to be
depressed. Commodity prices have risen significantly since last summer, and concerns about
global supplies of crude oil have contributed to
a further increase in oil prices since the Committee met in March. Inflation has picked up in
recent months, but longer-term inflation expectations have remained stable and measures of
underlying inflation are still subdued.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The unemployment rate
remains elevated, and measures of underlying
inflation continue to be somewhat low, relative
to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.
Increases in the prices of energy and other commodities have pushed up inflation in recent

months. The Committee expects these effects to
be transitory, but it will pay close attention to
the evolution of inflation and inflation expectations. The Committee continues to anticipate a
gradual return to higher levels of resource utilization in a context of price stability.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time,
is at levels consistent with its mandate, the Committee decided today to continue expanding its
holdings of securities as announced in November. In particular, the Committee is maintaining
its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term
Treasury securities by the end of the current
quarter. The Committee will regularly review the
size and composition of its securities holdings in
light of incoming information and is prepared to
adjust those holdings as needed to best foster
maximum employment and price stability.
The Committee will maintain the target range
for the federal funds rate at 0 to ¼ percent and
continues to anticipate that economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation
expectations, are likely to warrant exceptionally
low levels for the federal funds rate for an
extended period.
The Committee will continue to monitor the
economic outlook and financial developments
and will employ its policy tools as necessary to
support the economic recovery and to help
ensure that inflation, over time, is at levels consistent with its mandate.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Charles L. Evans, Richard
W. Fisher, Narayana Kocherlakota, Charles I.
Plosser, Sarah Bloom Raskin, Daniel K. Tarullo, and
Janet L. Yellen.
Voting against this action: None.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, June 21–22,
2011. The meeting adjourned at 10:15 a.m. on
April 27, 2011.

Minutes of Federal Open Market Committee Meetings | April

Notation Vote

221

converge over time under appropriate monetary
policy and in the absence of further shocks.

By notation vote completed on April 4, 2011, the
Committee unanimously approved the minutes of the
FOMC meeting held on March 15, 2011.
William B. English
Secretary

Addendum:
Summary of Economic Projections
In conjunction with the April 26–27, 2011, Federal
Open Market Committee (FOMC) meeting, the
members of the Board of Governors and the presidents of the Federal Reserve Banks, all of whom participate in the deliberations of the FOMC, submitted
projections for growth of real output, the unemployment rate, and inflation for the years 2011 to 2013
and over the longer run. The projections were based
on information available through the end of the
meeting and on each participant’s assumptions about
factors likely to affect economic outcomes, including
his or her assessment of appropriate monetary policy.
“Appropriate monetary policy” is defined as the
future path of policy that each participant deems
most likely to foster outcomes for economic activity
and inflation that best satisfy his or her interpretation of the Federal Reserve’s dual objectives of maximum employment and stable prices. Longer-run projections represent each participant’s assessment of
the rate to which each variable would be expected to

As depicted in figure 1, FOMC participants expected
the economic recovery to continue at a moderate
pace, with growth of real gross domestic product
(GDP) picking up modestly this year (relative to
2010) and strengthening further in 2012 and a bit
more in 2013. With the pace of economic growth
exceeding their estimates of the longer-run sustainable rate of increases in real GDP, the unemployment
rate is projected to gradually trend lower over this
projection period. However, participants anticipated
that, at the end of 2013, the unemployment rate
would still be well above their estimates of the
longer-run unemployment rate. Most participants
expected that overall inflation would move up this
year, but they projected this increase to be temporary,
with overall inflation moving back in line with core
inflation in 2012 and 2013 and remaining at or below
rates they see as consistent, over the longer run, with
the Committee’s dual mandate of maximum employment and price stability. Participants generally saw
core inflation gradually edging higher over the next
two years from its current relatively low level.
On balance, as indicated in table 1, participants
anticipated somewhat lower GDP growth and
slightly higher inflation over the forecast period than
they projected in January. Participants marked down
their forecasts for real GDP growth this year, revised
them down by less for 2012 and 2013, and did not

Table 1. Economic projections of Federal Reserve Governors and Reserve Bank presidents, April 2011
Percent
Central tendency1

Range2

Variable
2011
Change in real GDP
January projection
Unemployment rate
January projection
PCE inflation
January projection
Core PCE inflation3
January projection

2012

2013

Longer run

2011

2012

2013

Longer run

3.1 to 3.3
3.4 to 3.9
8.4 to 8.7
8.8 to 9.0
2.1 to 2.8
1.3 to 1.7
1.3 to 1.6
1.0 to 1.3

3.5 to 4.2
3.5 to 4.4
7.6 to 7.9
7.6 to 8.1
1.2 to 2.0
1.0 to 1.9
1.3 to 1.8
1.0 to 1.5

3.5 to 4.3
3.7 to 4.6
6.8 to 7.2
6.8 to 7.2
1.4 to 2.0
1.2 to 2.0
1.4 to 2.0
1.2 to 2.0

2.5 to 2.8
2.5 to 2.8
5.2 to 5.6
5.0 to 6.0
1.7 to 2.0
1.6 to 2.0

2.9 to 3.7
3.2 to 4.2
8.1 to 8.9
8.4 to 9.0
2.0 to 3.6
1.0 to 2.0
1.1 to 2.0
0.7 to 1.8

2.9 to 4.4
3.4 to 4.5
7.1 to 8.4
7.2 to 8.4
1.0 to 2.8
0.7 to 2.2
1.1 to 2.0
0.6 to 2.0

3.0 to 5.0
3.0 to 5.0
6.0 to 8.4
6.0 to 7.9
1.2 to 2.5
0.6 to 2.0
1.2 to 2.0
0.6 to 2.0

2.4 to 3.0
2.4 to 3.0
5.0 to 6.0
5.0 to 6.2
1.5 to 2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and in inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated. PCE
inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures (PCE) and the price index for PCE
excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s
projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each
variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The January projections were made in
conjunction with the meeting of the Federal Open Market Committee on January 25–26, 2011.
1
The central tendency excludes the three highest and three lowest projections for each variable in each year.
2
The range for a variable in a given year consists of all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

222

98th Annual Report | 2011

Figure 1. Central tendencies and ranges of economic projections, 2011–13 and over the longer run

Percent

Change in real GDP

5

Central tendency of projections
Range of projections

4
3
2
1
+
0
_
1

Actual

2

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

Unemployment rate

10
9
8
7
6
5

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

PCE inflation
3

2

1

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

Core PCE inflation
3

2

1

2006

2007

2008

2009

2010

2011

Note: Definitions of variables are in the notes to table 1. The data for the actual values of the variables are annual.

2012

2013

Minutes of Federal Open Market Committee Meetings | April

alter their expectations for economic growth in the
longer run. Most participants also lowered their forecasts for the average unemployment rate at the end of
this year, but they continued to see the unemployment rate moving down slowly in 2012 and 2013 to
levels that were little changed from the previous projections. Participants raised their forecasts for overall
inflation this year; however, most expected that the
increase would be transitory and made only minor
changes to their forecasts for the rate of inflation in
2012 and 2013 or for the longer run. Most participants anticipated that five or six years would likely be
required for the economy to converge fully to its
longer-run path characterized by rates of output
growth, unemployment, and inflation consistent with
their interpretation of the Federal Reserve’s dual
objectives.
A sizable majority of participants continued to judge
the level of uncertainty associated with their projections for real economic activity and inflation as
unusually high relative to historical norms. About
one-half of the participants viewed the risks to output growth as balanced, but a number now judged
those risks to be tilted to the downside. Meanwhile, a
majority of participants viewed the risks to overall
inflation as weighted to the upside.
The Outlook
Participants marked down their forecasts for real
GDP growth in 2011, with the central tendency of
their projections moving down to 3.1 to 3.3 percent
from 3.4 to 3.9 percent in January. Participants stated
that the change reflected importantly the somewhat
slower-than-expected pace of expansion in the first
quarter. Participants generally thought that much of
the unexpected weakness in the first quarter would
prove temporary, but they viewed a number of recent
developments as potential restraints on the pace of
economic recovery in the near term. Those developments included the effects of the rise in energy prices
on real income and consumer sentiment, indications
that the recovery in the housing market was further
off, and constraints on state and local government
budgets.
Looking further ahead, participants’ revisions to
their forecasts for economic growth were modest, and
they continued to see the economic recovery
strengthening over the forecast period, with the central tendency of their projections for growth in real
GDP stepping up to 3.5 to 4.2 percent in 2012 and
remaining near those rates in 2013. Participants cited
the effects of continued monetary policy accommo-

223

dation, further improvements in banking and financial market conditions, rising consumer confidence as
labor market conditions strengthen gradually,
improved household balance sheets, stabilizing commodity prices, continued expansion in business
investment in equipment and software, and gains in
U.S. exports as being among the likely contributors
to a sustained pickup in the pace of expansion. However, participants also saw a number of factors that
would likely continue to hinder the pace of expansion
over the next two years. Most participants anticipated that the recovery in the housing market would
remain slow, restrained by the overhang of vacant
properties and depressed home values; most also
expected increasing fiscal drag at the federal, state,
and local levels. In addition, some participants noted
the negative impact on household purchasing power
of the elevated levels of energy and food prices. In
the absence of further shocks, participants generally
expected that, over time, real GDP growth would
eventually settle down at an annual rate of 2.5 to
2.8 percent, a pace that appeared to be sustainable in
view of expected long-run trends in labor supply and
labor productivity.
Reflecting the decline in the unemployment rate in
recent months, participants lowered their forecasts
for the average unemployment rate in the fourth
quarter of this year, with the central tendency of
their projections at 8.4 to 8.7 percent, down from
8.8 to 9.0 percent in January. Participants’ projections for the jobless rate at the end of 2012 and 2013
were little changed from their previous forecasts.
Consistent with their expectations of a moderate economic recovery, most participants projected that the
unemployment rate would be 6.8 to 7.2 percent even
in late 2013—still well above the 5.2 to 5.6 percent
central tendency of their estimates of the unemployment rate that would prevail over the longer run in
the absence of further shocks. The central tendency
for the participants’ projections of the unemployment rate in the longer run was somewhat narrower
than the 5 to 6 percent interval reported in January.
Participants noted that the prices of oil and other
commodities had risen significantly since the time of
their January projections, largely reflecting geopolitical developments and robust global demand. Those
increases had led to a sharp rise in consumer energy
prices and, to a lesser extent, food prices, which had
boosted overall inflation. As a result, participants
raised their forecasts for total personal consumption
expenditures (PCE) inflation in 2011, with the central
tendency of their estimates significantly higher. With

224

98th Annual Report | 2011

the outlook for oil and other commodity prices
uncertain, the dispersion of the projections was
noticeably wider than in January. Most participants
expected that overall inflation would run 2.1 to
2.8 percent this year, compared with 1.3 to 1.7 percent in their January projections. However, many participants anticipated that the pass-through of higher
commodity prices into core inflation would be contained by downward pressures on inflation from large
margins of slack in resource utilization and consequent subdued labor costs. Participants indicated
that well-anchored inflation expectations, combined
with the appropriate stance of monetary policy,
should help keep inflation in check. As a result, participants anticipated that the increase in total PCE
inflation would be temporary, with the central tendency of their estimates moving down to 1.2 to
2.0 percent in 2012 and 1.4 to 2.0 percent in 2013—at
or below the 1.7 to 2.0 percent central tendency for
their estimates of the longer-run, mandate-consistent
rate of inflation. Nonetheless, the central tendencies
of participants’ projections for core PCE inflation for
this year and next year shifted up a bit to 1.3 to
1.6 percent in 2011 and 1.3 to 1.8 percent in 2012.
The central tendency of the core PCE inflation projections in 2013 was 1.4 to 2.0 percent, little changed
from the January SEP.
Uncertainty and Risks
A sizable majority of participants continued to judge
that the levels of uncertainty associated with their
projections for economic activity and inflation were
greater than the average levels that had prevailed over
the past 20 years.2 They pointed to a number of factors contributing to their assessments of the uncertainty that they attached to their projections, including structural dislocations in the labor market, the
outlook for fiscal policy, the future path of energy
and other commodity prices, the global economic
outlook, and the effects of unconventional monetary
policy.
About one-half of the participants continued to view
the risks to their outlooks for economic growth as
balanced, but a number of participants now judged
that those risks had become tilted to the downside.
The most frequently mentioned downside risks to
2

Table 2 provides estimates of forecast uncertainty for the change
in real GDP, the unemployment rate, and total consumer price
inflation over the period from 1991 to 2010. At the end of this
summary, the box “Forecast Uncertainty” discusses the sources
and interpretation of uncertainty in the economic forecasts and
explains the approach used to assess the uncertainty and risks
attending the participants’ projections.

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2011

2012

2013

±1.0
±0.5
±0.8

±1.6
±1.2
±1.0

±1.8
±1.8
±1.0

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1991 through 2010 that were released in the spring by
various private and government forecasters. As described in the box
“Forecast Uncertainty,” under certain assumptions, there is about a 70 percent
probability that actual outcomes for real GDP, unemployment, and consumer
prices will be in ranges implied by the average size of projection errors made in
the past. Further information is in David Reifschneider and Peter Tulip (2007),
“Gauging the Uncertainty of the Economic Outlook from Historical Forecasting
Errors,” Finance and Economics Discussion Series 2007-60 (Washington: Board of
Governors of the Federal Reserve System, November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

GDP growth included the possibility of further
increases in energy and other commodity prices, a
tighter-than-anticipated stance of fiscal policy in the
United States, an even weaker-than-expected housing
sector adversely affecting consumer spending and the
health of financial institutions, and possible spillovers from the fiscal strains in Europe. A few participants saw the risks to growth as tilted to the upside;
it was noted that the cyclical rebound in economic
activity might prove stronger than anticipated. The
risks surrounding participants’ forecasts of the
unemployment rate remained broadly balanced and
continued to reflect in large part the risks attending
participants’ views of the likely strength of the
expansion in real activity.
Whereas most participants’ assessments of the risks
associated with their overall inflation projections over
the period from 2011 to 2013 were broadly balanced
in January, a majority of participants now judged the
risks as weighted to the upside. Although participants generally indicated that the amount of passthrough of higher oil and other commodity prices
into core inflation had so far remained limited and
that inflation expectations continued to be stable,
some participants noted the risk that the extent of
pass-through might increase and that the resulting
rise in inflation could unmoor longer-term inflation
expectations. A few participants noted the possibility
that the current highly accommodative stance of
monetary policy could be maintained for too long,
leading to higher inflation expectations and actual
inflation.

Minutes of Federal Open Market Committee Meetings | April

Diversity of Views
Figures 2.A and 2.B provide further details on the
diversity of participants’ views regarding the likely
outcomes for real GDP growth and the unemployment rate in 2011, 2012, 2013, and over the longer
run. The dispersion in these projections generally
continued to reflect differences in participants’
assessments of many factors, including the likely evolution of conditions in credit and financial markets,
the current degree of underlying momentum in economic activity, the timing and the degree to which
the labor market will recover from the dislocations
associated with the deep recession, the outlook for
economic and financial developments abroad, and
appropriate future monetary policy and its effects on
economic activity. Regarding participants’ projections for real GDP growth, the distribution for this
year shifted noticeably lower and was significantly
more tightly concentrated than the distribution in
January, with more than one-half of participants
expecting the change in real GDP in 2011 to be in the
3.2 to 3.3 percent interval. By contrast, the distributions for real GDP growth in 2012 and 2013 were
little changed. Regarding participants’ projections for
the unemployment rate, the distribution for this year
shifted down relative to the distribution in January,
with about one-half of participants anticipating the
unemployment rate in the final quarter of 2011 to be
8.4 to 8.5 percent; this shift likely reflects the recent
improvements in labor market conditions. The distributions of the unemployment rate for 2012 and 2013
were little changed. The distribution of participants’
estimates of the longer-run unemployment rate was
somewhat more tightly concentrated than in January,
while that for their estimates of longer-run GDP
growth was about unchanged.

225

Corresponding information about the diversity of
participants’ views regarding the inflation outlook is
provided in figures 2.C and 2.D. In general, the dispersion in the participants’ inflation forecasts for the
next few years represented differences in judgments
regarding the fundamental determinants of inflation,
including estimates of the degree of resource slack
and the extent to which such slack influences inflation outcomes and expectations, as well as estimates
of how the stance of monetary policy may influence
inflation expectations. Regarding overall PCE inflation, the distribution of participants’ projections for
2011 shifted noticeably higher relative to the distribution in January, reflecting the recent increases in
energy and other commodity prices, but the dispersion in forecasts was little changed. The distributions
for 2012 and 2013 were generally little changed and
remained fairly wide. Regarding core PCE inflation,
the distribution of participants’ projections for 2011
shifted noticeably to the right, but it remained about
as wide as in January. The distributions of core inflation for 2012 and 2013 also shifted somewhat higher
but were otherwise little changed. Although the distributions of participants’ inflation forecasts for 2011
through 2013 continued to be relatively wide, the distribution of projections of the longer-run rate of
overall PCE inflation remained tightly concentrated.
The narrow range illustrates the broad similarity in
participants’ assessments of the approximate level of
inflation that is consistent with the Federal Reserve’s
dual objectives of maximum employment and price
stability.

226

98th Annual Report | 2011

Figure 2.A. Distribution of participants’ projections for the change in real GDP, 2011–13 and over the longer run
Number of participants

2011

16

April projections
January projections

14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

2012

16
14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

2013

16
14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

Longer run

16
14
12
10
8
6
4
2

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

Percent range
Note: Definitions of variables are in the general note to table 1.

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Minutes of Federal Open Market Committee Meetings | April

227

Figure 2.B. Distribution of participants’ projections for the unemployment rate, 2011–13 and over the longer run
Number of participants

2011

16

April projections
January projections

14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

Percent range
Number of participants

2012

16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

Percent range
Number of participants

2013

16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

Percent range
Number of participants

Longer run

16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

Percent range
Note: Definitions of variables are in the general note to table 1.

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

228

98th Annual Report | 2011

Figure 2.C. Distribution of participants’ projections for PCE inflation, 2011–13 and over the longer run
Number of participants

2011

16

April projections
January projections

14
12
10
8
6
4
2

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

2.93.0

3.13.2

3.33.4

3.53.6

Percent range
Number of participants

2012

16
14
12
10
8
6
4
2

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

2.93.0

3.13.2

3.33.4

3.53.6

Percent range
Number of participants

2013

16
14
12
10
8
6
4
2

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

2.93.0

3.13.2

3.33.4

3.53.6

Percent range
Number of participants

Longer run

16
14
12
10
8
6
4
2

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Note: Definitions of variables are in the general note to table 1.

2.12.2

2.32.4

2.52.6

2.72.8

2.93.0

3.13.2

3.33.4

3.53.6

Minutes of Federal Open Market Committee Meetings | April

229

Figure 2.D. Distribution of participants’ projections for core PCE inflation, 2011–13
Number of participants

2011

16

April projections
January projections

14
12
10
8
6
4
2

0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Number of participants

2012

16
14
12
10
8
6
4
2
0.50.6

0.70.8

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Number of participants

2013

16
14
12
10
8
6
4
2
0.50.6

0.70.8

0.91.0

1.11.2

Percent range
Note: Definitions of variables are in the general note to table 1.

1.31.4

1.51.6

1.71.8

1.92.0

230

98th Annual Report | 2011

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public
understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts
are necessarily imperfect descriptions of the real
world. And the future path of the economy can be
affected by myriad unforeseen developments and
events. Thus, in setting the stance of monetary
policy, participants consider not only what appears to
be the most likely economic outcome as embodied in
their projections, but also the range of alternative
possibilities, the likelihood of their occurring, and the
potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy of
a range of forecasts, including those reported in past
Monetary Policy Reports and those prepared by the
Federal Reserve Board’s staff in advance of meetings
of the Federal Open Market Committee. The projection error ranges shown in the table illustrate the considerable uncertainty associated with economic forecasts. For example, suppose a participant projects
that real gross domestic product (GDP) and total
consumer prices will rise steadily at annual rates of,
respectively, 3 percent and 2 percent. If the uncertainty attending those projections is similar to

that experienced in the past and the risks around the
projections are broadly balanced, the numbers
reported in table 2 would imply a probability of about
70 percent that actual GDP would expand within a
range of 2.0 to 4.0 percent in the current year, 1.4 to
4.6 percent in the second year, and 1.2 to 4.8 percent
in the third year. The corresponding 70 percent confidence intervals for overall inflation would be 1.2 to
2.8 percent in the current year, and 1.0 to 3.0 percent
in the second and third years.
Because current conditions may differ from those
that prevailed, on average, over history, participants
provide judgments as to whether the uncertainty
attached to their projections of each variable is
greater than, smaller than, or broadly similar to typical levels of forecast uncertainty in the past as shown
in table 2. Participants also provide judgments as to
whether the risks to their projections are weighted to
the upside, are weighted to the downside, or are
broadly balanced. That is, participants judge whether
each variable is more likely to be above or below
their projections of the most likely outcome. These
judgments about the uncertainty and the risks
attending each participant’s projections are distinct
from the diversity of participants’ views about the
most likely outcomes. Forecast uncertainty is concerned with the risks associated with a particular
projection rather than with divergences across a
number of different projections.

Minutes of Federal Open Market Committee Meetings | June

Meeting Held on June 21–22, 2011
A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday,
June 21, 2011, at 10:30 a.m. and continued on
Wednesday, June 22, 2011, at 9:00 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Charles L. Evans
Richard W. Fisher
Narayana Kocherlakota
Charles I. Plosser
Sarah Bloom Raskin
Daniel K. Tarullo
Janet L. Yellen
Jeffrey M. Lacker, Dennis P. Lockhart,
Sandra Pianalto, and John C. Williams
Alternate Members of the Federal Open Market
Committee
James Bullard, Thomas M. Hoenig, and
Eric Rosengren
Presidents of the Federal Reserve Banks of St. Louis,
Kansas City, and Boston, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
David J. Stockton
Economist

231

James A. Clouse, Thomas A. Connors,
Steven B. Kamin, Loretta J. Mester,
David Reifschneider, Harvey Rosenblum,
Daniel G. Sullivan, David W. Wilcox, and Kei-Mu Yi
Associate Economists
Brian Sack
Manager, System Open Market Account
Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Robert deV. Frierson
Deputy Secretary, Office of the Secretary,
Board of Governors
William Nelson
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Charles S. Struckmeyer
Deputy Staff Director, Office of the Staff Director,
Board of Governors
Seth B. Carpenter
Senior Associate Director, Division of Monetary
Affairs, Board of Governors
Michael Foley
Senior Associate Director, Division of Banking
Supervision and Regulation, Board of Governors
Lawrence Slifman and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Andrew T. Levin
Senior Adviser, Office of Board Members,
Board of Governors
Joyce K. Zickler
Visiting Senior Adviser, Division of Monetary
Affairs, Board of Governors
Daniel M. Covitz and Eric M. Engen
Associate Directors, Division of Research and
Statistics, Board of Governors
Trevor A. Reeve
Associate Director, Division of International Finance,
Board of Governors

232

98th Annual Report | 2011

Egon Zakrajšek
Deputy Associate Director, Division of Monetary
Affairs, Board of Governors
Beth Anne Wilson
Assistant Director, Division of International Finance,
Board of Governors
David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Brahima Coulibaly
Senior Economist, Division of International Finance,
Board of Governors
Louise Sheiner
Senior Economist, Division of Research and
Statistics, Board of Governors
Jean-Philippe Laforte1
Economist, Division of Research and Statistics,
Board of Governors
Penelope A. Beattie
Assistant to the Secretary, Office of the Secretary,
Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
Jeff Fuhrer
Executive Vice President, Federal Reserve Bank of
Boston
David Altig, Glenn D. Rudebusch, and
Mark E. Schweitzer
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, San Francisco, and Cleveland, respectively
Michael Dotsey,1 William Gavin,
Andreas L. Hornstein, and Edward S. Knotek II
Vice Presidents, Federal Reserve Banks of
Philadelphia, St. Louis, Richmond, and Kansas City,
respectively
1

Marco Del Negro, Joshua L. Frost,
Deborah L. Leonard, and Jonathan P. McCarthy
Assistant Vice Presidents, Federal Reserve Bank of
New York
Jeff Campbell1
Senior Economist, Federal Reserve Bank of Chicago

1

Attended the portion of the meeting relating to dynamic stochastic general equilibrium models.

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
April 26–27, 2011. He also reported on System open
market operations, including the continuing reinvestment into longer-term Treasury securities of principal payments received on the SOMA’s holdings of
agency debt and agency-guaranteed mortgagebacked securities, as well as the ongoing purchases of
additional Treasury securities authorized at the
November 2–3, 2010, FOMC meeting. Since November, purchases by the Open Market Desk of the Federal Reserve Bank of New York had increased the
SOMA’s holdings by nearly the full $600 billion
authorized.
In light of ongoing strains in some foreign financial
markets, the Committee considered a proposal to
extend its dollar liquidity swap arrangements with
foreign central banks past August 1, 2011. Following
their discussion, members unanimously approved the
following resolution:
The Federal Open Market Committee directs the
Federal Reserve Bank of New York to extend
the existing temporary reciprocal currency
arrangements (“swap arrangements”) for the
System Open Market Account with the Bank of
Canada, the Bank of England, the European
Central Bank, the Bank of Japan, and the Swiss
National Bank. The swap arrangements shall
now terminate on August 1, 2012, unless further
extended by the Committee.

Dynamic Stochastic General Equilibrium
Models
A staff presentation provided an overview of ongoing Federal Reserve research on dynamic stochastic
general equilibrium (DSGE) models. DSGE models
attempt to capture the dynamics of the overall
economy in a way that is consistent both with the historical data and with optimizing behavior by
forward-looking households and firms. The presentation began by discussing the general features of
DSGE models and considering their advantages and
limitations relative to other approaches of analyzing
macroeconomic dynamics; with regard to the latter,
the presentation noted that while the current generation of DSGE models is still somewhat limited in the

Minutes of Federal Open Market Committee Meetings | June

range of policy issues these models can address, further advances in modeling should increase the usefulness of DSGE models for forecasting and policy
analysis. The presentation then reviewed some specific features of DSGE models that are currently
being studied at the Federal Reserve Board and the
Federal Reserve Banks of New York, Philadelphia,
and Chicago. This review included the four models’
characterizations of the forces affecting the economy
in recent years and the models’ current forecasts for
real economic activity, inflation, and short-term
interest rates. In discussing the staff presentation,
meeting participants expressed the view that DSGE
models are a useful addition to the wide range of
analytical approaches traditionally used at the Federal Reserve, in part because they provide an internally consistent way of exploring how the behavior of
economic agents might change in response to systematic adjustments to policy. Some participants also
expressed interest in seeing on a regular basis projections of key macroeconomic variables and other
products from the DSGE models developed in the
System. Finally, participants encouraged further staff
work to improve these models by, for example,
expanding the range of questions they can be used to
address.

Exit Strategy Principles
The Committee discussed strategies for normalizing
the stance and conduct of monetary policy, following
up on its discussion of this topic at the April meeting. Participants stressed that the Committee’s discussions of this topic were undertaken as part of
prudent planning and did not imply that a move
toward such normalization would necessarily begin
sometime soon. For concreteness, the Committee
considered a set of specific principles that would
guide its strategy of normalizing the stance and conduct of monetary policy. Participants discussed several specific elements of the principles, including how
they should characterize the monetary policy framework that the Committee would adopt after the conduct of policy returned to normal and whether the
principles should encompass the possible timing
between the normalization steps. At the conclusion of
the discussion, all but one of the participants agreed
on the following key elements of the strategy that
they expect to follow when it becomes appropriate to

233

begin normalizing the stance and conduct of monetary policy:
• The Committee will determine the timing and pace
of policy normalization to promote its statutory
mandate of maximum employment and price
stability.
• To begin the process of policy normalization, the
Committee will likely first cease reinvesting some
or all payments of principal on the securities holdings in the SOMA.
• At the same time or sometime thereafter, the Committee will modify its forward guidance on the path
of the federal funds rate and will initiate temporary
reserve-draining operations aimed at supporting
the implementation of increases in the federal
funds rate when appropriate.
• When economic conditions warrant, the Committee’s next step in the process of policy normalization will be to begin raising its target for the federal
funds rate, and from that point on, changing the
level or range of the federal funds rate target will
be the primary means of adjusting the stance of
monetary policy. During the normalization process,
adjustments to the interest rate on excess reserves
and to the level of reserves in the banking system
will be used to bring the funds rate toward its
target.
• Sales of agency securities from the SOMA will
likely commence sometime after the first increase
in the target for the federal funds rate. The timing
and pace of sales will be communicated to the public in advance; that pace is anticipated to be relatively gradual and steady, but it could be adjusted
up or down in response to material changes in the
economic outlook or financial conditions.
• Once sales begin, the pace of sales is expected to be
aimed at eliminating the SOMA’s holdings of
agency securities over a period of three to five
years, thereby minimizing the extent to which the
SOMA portfolio might affect the allocation of
credit across sectors of the economy. Sales at this
pace would be expected to normalize the size of the
SOMA securities portfolio over a period of two to
three years. In particular, the size of the securities
portfolio and the associated quantity of bank
reserves are expected to be reduced to the smallest

234

98th Annual Report | 2011

levels that would be consistent with the efficient
implementation of monetary policy.
• The Committee is prepared to make adjustments to
its exit strategy if necessary in light of economic
and financial developments.

Staff Review of the Economic Situation
The information reviewed at the June 21–22 meeting
indicated that the pace of the economic recovery
slowed in recent months and that conditions in the
labor market had softened. Measures of inflation
picked up this year, reflecting in part higher prices for
some commodities and imported goods. Longer-run
inflation expectations, however, remained stable.
The expansion of private nonfarm payroll employment in May was markedly below the average pace of
job gains in the previous months of this year. Initial
claims for unemployment insurance rose, on net,
between the first half of April and the first half of
June. The unemployment rate moved up in April and
then rose further to 9.1 percent in May, while the
labor force participation rate remained unchanged.
Both long-duration unemployment and the share of
workers employed part time for economic reasons
continued to be elevated.
Total industrial production expanded only a bit during April and May after rising at a solid pace in the
first quarter. Shortages of specialized components
imported from Japan contributed to a decline in the
output of motor vehicles and parts. Manufacturing
production outside of the motor vehicles sector
increased moderately, on balance, during the past two
months. The manufacturing capacity utilization rate
remained close to its first-quarter level, but it was still
well below its longer-run average. Forward-looking
indicators of industrial activity, such as the new
orders diffusion indexes in the national and regional
manufacturing surveys, weakened noticeably during
the intermeeting period to levels consistent with only
tepid gains in factory output in coming months.
However, motor vehicle assemblies were scheduled to
rise notably in the third quarter from their levels in
recent months, as bottlenecks in parts supplies were
anticipated to ease.
Growth in consumer spending declined in recent
months from the already modest pace in the first
quarter. Total real personal consumption expenditures only edged up in April. Nominal retail sales,

excluding purchases at motor vehicles and parts outlets, increased somewhat in May, but sales of new
light motor vehicles declined markedly. Labor income
rose moderately, as aggregate hours worked trended
up, but total real disposable income remained flat in
March and April, as increases in consumer prices offset gains in nominal income. In addition, consumer
sentiment stayed relatively low through early June.
Activity in the housing market remained depressed,
as both weak demand and the sizable inventory of
foreclosed or distressed properties continued to hold
back new construction. Starts and permits of new
single-family homes were essentially unchanged in
April and May, and they stayed near the very low levels seen since the middle of last year. Sales of new
and existing homes remained at subdued levels in
recent months, while measures of home prices fell
further.
The available indicators suggested that real business
investment in equipment and software was rising a
bit more slowly in the second quarter than the solid
pace seen in the first quarter. Nominal orders and
shipments of nondefense capital goods declined in
April. Business purchases of light motor vehicles
edged up in April but dropped in May, while spending for medium and heavy trucks continued to
increase in recent months. Survey measures of business conditions and sentiment weakened during the
intermeeting period. Business expenditures for office
and commercial buildings remained depressed by
elevated vacancy rates, low prices for commercial real
estate, and tight credit conditions for construction
loans. In contrast, outlays for drilling and mining
structures continued to be lifted by high energy
prices.
Real nonfarm inventory investment rose moderately
in the first quarter, but data for April suggested that
the pace of inventory accumulation had slowed.
Book-value inventory-to-sales ratios in April were
similar to their pre-recession norms, and survey data
also suggested that inventory positions generally
remained in a comfortable range.
The available data on government spending indicated
that real federal purchases increased in recent
months, led by a rebound in outlays for defense in
April and May from unusually low levels in the first
quarter. In contrast, real expenditures by state and
local governments appeared to have declined further,

Minutes of Federal Open Market Committee Meetings | June

as outlays for construction projects fell in March and
April, and state and local employment continued to
contract in April and May.
The U.S. international trade deficit widened slightly
in March and then narrowed in April to a level below
its average in the first quarter. Exports rose strongly
in both months, with increases widespread across
major categories in March, while the gains in April
were concentrated in industrial supplies and capital
goods. Imports grew robustly in March, but they fell
slightly in April, as the drop in automotive imports
from Japan together with the decline in imports of
petroleum products more than offset increases in
other imported products.
Headline consumer price inflation, which had risen
in the first quarter, edged down a bit in April and
May, as the prices of consumer food and energy
decelerated from the pace seen in previous months.
More recently, survey data through the middle of
June pointed to declines in retail gasoline prices, and
prices of food commodities appeared to have
decreased somewhat. Excluding food and energy,
core consumer price inflation picked up in April and
May, pushing the 12-month change in the core consumer price index through May above its level of a
year earlier. Upward pressures on core consumer
prices appeared to reflect the elevated prices of commodities and other imports, along with notable
increases in motor vehicle prices likely arising from
the effects of recent supply chain disruptions and the
resulting extremely low level of automobile inventories. However, near-term inflation expectations from
the Thomson Reuters/University of Michigan Surveys of Consumers moved down a little in May and
early June from the high level seen in April, and
longer-term inflation expectations remained within
the range that has generally prevailed over the preceding few years.
Available measures of labor compensation showed
that labor cost pressures were still subdued, as wage
increases continued to be restrained by the large
amount of slack in the labor market. In the first
quarter, unit labor costs only edged up, as the modest
rise in hourly compensation in the nonfarm business
sector was mostly offset by further gains in productivity. More recently, average hourly earnings for all
employees rose in April and May, but the average rate
of increase over the preceding 12 months remained
quite low.

235

Global economic activity appeared to have increased
more slowly in the second quarter than in the first
quarter. The rate of growth in the emerging market
economies stepped down from its rapid pace in the
first quarter, although it remained generally solid.
The Japanese economy contracted sharply following
the earthquake in March, and the associated supply
chain disruptions weighed on the economies of many
of Japan’s trading partners. The pace of economic
growth in the euro area remained uneven, with Germany and France posting moderate gains in economic activity, while the peripheral European economies continued to struggle. Recent declines in the
prices of oil and other commodities contributed to
some easing of inflationary pressures abroad.

Staff Review of the Financial Situation
Investors appeared to adopt a more cautious attitude
toward risk, particularly later in the intermeeting
period. The shift in investors’ sentiment likely
reflected the weak tone of incoming economic data in
the United States along with concerns about the outlook for global economic growth and about potential
spillovers from a possible further deterioration of the
situation in peripheral Europe.
The decisions by the FOMC at its April meeting to
continue its asset purchase program and to maintain
the 0 to ¼ percent target range for the federal funds
rate were generally in line with market expectations.
The accompanying statement and subsequent press
briefing by the Chairman prompted a modest decline
in nominal yields, as market participants reportedly
perceived a somewhat less optimistic tone in the
Committee’s economic outlook. Over the remainder
of the intermeeting period, the expected path for the
federal funds rate, along with yields on nominal
Treasury securities, moved down appreciably further,
as the bulk of the incoming economic data was more
downbeat than market participants had apparently
anticipated. Consistent with the weaker-thanexpected economic data and the recent decline in the
prices of oil and other commodities, measures of
inflation compensation over the next 5 years and 5 to
10 years ahead based on nominal and inflationprotected Treasury securities decreased considerably
over the intermeeting period.
Market quotes did not suggest expectations of significant movements in nominal Treasury yields following the anticipated completion of the asset pur-

236

98th Annual Report | 2011

chase program by the Federal Reserve at the end of
June. Although discussions about the federal debt
ceiling attracted attention in financial markets, judging from Treasury yields and other asset prices, investors seemed to anticipate that the debt ceiling would
be increased in time to avoid any significant market
disruptions.
Yields on corporate bonds stepped down modestly,
on net, over the intermeeting period, but by less than
the decline in yields on comparable-maturity Treasury securities, leaving credit risk spreads a little
wider. In the secondary market for syndicated loans,
conditions were little changed, with average bid
prices for leveraged loans holding steady.
Broad U.S. stock price indexes declined, on net, over
the intermeeting period, apparently in response to
the downbeat economic data. Stock prices of financial firms underperformed the broader market,
reflecting the weaker economic outlook, potential
credit rating downgrades, and heightened concerns
about the anticipated capital surcharge for systemically important financial institutions. Optionadjusted volatility on the S&P 500 index rose somewhat on net.
In the June 2011 Senior Credit Officer Opinion Survey on Dealer Financing Terms, dealers pointed to a
continued gradual easing over the previous three
months in credit terms applicable to major classes of
counterparties across all types of transactions covered in the survey. Dealers also reported that the
demand for funding had increased over the same
period for a broad range of securities, with the exception of equities. More recently, however, against a
backdrop of disappointing economic data, heightened uncertainty about the situation in Europe, and,
possibly, concerns about the U.S. federal debt ceiling,
market participants reported a general pullback from
risk-taking and a decline in liquidity in a range of
financial markets.
Net debt financing by nonfinancial corporations was
strong in April and May. Gross issuance of both
investment- and speculative-grade bonds by nonfinancial corporations hit a record high in May before
slowing somewhat in June, and outstanding amounts
of commercial and industrial (C&I) loans and nonfinancial commercial paper increased. Gross public
equity issuance by nonfinancial firms maintained a
solid pace over the intermeeting period, and most
indicators of business credit quality improved
further.

Commercial mortgage markets continued to show
tentative signs of stabilization. In recent months,
delinquency rates for commercial real estate loans
edged down from their previous peaks. However,
commercial real estate markets remained weak. Property sales were tepid, and prices remained at
depressed levels. Issuance of commercial mortgagebacked securities slowed somewhat in the second
quarter.
Conditions in residential mortgage markets were little
changed overall but remained strained. Rates on conforming fixed-rate residential mortgages declined
about in line with 10-year Treasury yields over the
intermeeting period. Mortgage refinancing activity
picked up, on net, over the intermeeting period but
was still relatively subdued. Outstanding residential
mortgage debt contracted further in the first quarter.
Rates of serious delinquency for subprime and prime
mortgages were little changed at elevated levels. The
rate of new delinquencies on prime mortgages ticked
up in April but remained well below the level of a few
months ago. In March and April, delinquencies on
mortgages backed by the Federal Housing Administration declined noticeably.
The Federal Reserve continued its competitive sales
of non-agency residential mortgage-backed securities
held by Maiden Lane II LLC over the intermeeting
period. Although the initial offerings of these securities were well received, investor demand at the most
recent sales was not as strong, a development consistent with the declines in the prices of non-agency
residential mortgage-backed securities over the intermeeting period.
Conditions in consumer credit markets continued to
improve. Growth in total consumer credit picked up
in April, as the gain in nonrevolving credit more than
offset a further contraction in revolving credit. Delinquency rates for consumer debt edged down further
in recent months, with delinquency rates on some
categories moving back to pre-crisis levels. Issuance
of consumer asset-backed securities remained robust
over the intermeeting period.
Bank credit was flat, on balance, in April and May.
Core loans—the sum of C&I, real estate, and consumer loans—continued to contract modestly, pulled
down by the ongoing decline in commercial and residential real estate loans. In contrast, C&I loans
increased at a brisk pace in April and May. The most
recent Survey of Terms of Business Lending conducted in May indicated that banks had eased some

Minutes of Federal Open Market Committee Meetings | June

lending terms on C&I loans. The survey responses
also suggested that the average size of loan commitments and their average maturity had trended up in
recent quarters.
M2 expanded at a robust pace in April and May. Liquid deposits, the largest component of M2, maintained a solid rate of expansion, likely reflecting the
very low opportunity costs of holding such deposits.
Currency continued to advance, supported by strong
demand for U.S. bank notes from abroad.
The broad nominal index of the U.S. dollar fluctuated over the intermeeting period in response to
changes in investors’ assessment of the outlook for
the U.S. economy and the situation in the peripheral
European economies. Since the April FOMC meeting, the dollar rose modestly, on net, after depreciating over the preceding several months. Headline
equity indexes abroad and foreign benchmark sovereign yields declined over the intermeeting period in
apparent response to signs of a slowdown in the pace
of global economic activity and reduced demand for
risky assets. Concerns about the possibility of a
restructuring of Greek government debt drove
spreads of yields on the sovereign debts of Greece,
Ireland, and Portugal to record highs relative to
yields on German bunds.
In the advanced foreign economies, most central
banks left their policy rates unchanged, and the
anticipated pace of monetary policy tightening indicated by money market futures quotes was pared
back. However, central banks in several emerging
market economies continued to tighten policy, and
the monetary authorities in China increased required
reserve ratios further.

Staff Economic Outlook
With the recent data on spending, income, production, and labor market conditions mostly weaker
than the staff had anticipated at the time of the April
FOMC meeting, the near-term projection for the rate
of increase in real gross domestic product (GDP) was
revised down. The effects of the disaster in Japan and
of higher commodity prices on the rate of increase in
real consumer spending were expected to hold down
U.S. real GDP growth in the near term, but those
effects were anticipated to be transitory. However, the
staff also read the incoming economic data as suggesting that the underlying pace of the recovery was
softer than they had previously anticipated, and they
marked down their outlook for economic growth

237

over the medium term. Nevertheless, the staff still
projected real GDP to increase at a moderate rate in
the second half of 2011 and in 2012, with the ongoing recovery in activity receiving continued support
from accommodative monetary policy, further
increases in credit availability, and anticipated
improvements in household and business confidence.
The average pace of real GDP growth was expected
to be sufficient to bring the unemployment rate down
very slowly over the projection period, and the jobless rate was anticipated to remain elevated at the end
of 2012.
Although increases in consumer food and energy
prices slowed a bit in recent months, the continued
step-up in core consumer price inflation led the staff
to raise slightly its projection for core inflation over
the coming quarters. However, headline inflation was
still expected to recede over the medium term, as
increases in food and energy prices and in non-oil
import prices were anticipated to ease further. As in
previous forecasts, the staff continued to project that
core consumer price inflation would remain relatively
subdued over the projection period, reflecting both
stable long-term inflation expectations and persistent
slack in labor and product markets.

Participants’ Views on Current Conditions
and the Economic Outlook
In conjunction with this FOMC meeting, all meeting
participants—the five members of the Board of
Governors and the presidents of the 12 Federal
Reserve Banks—provided projections of output
growth, the unemployment rate, and inflation for
each year from 2011 through 2013 and over the longer run. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge, over time, under
appropriate monetary policy and in the absence of
further shocks to the economy. Participants’ forecasts
are described in the Summary of Economic Projections, which is attached as an addendum to these
minutes.
In their discussion of the economic situation and
outlook, meeting participants agreed that the economic information received during the intermeeting
period indicated that the economic recovery was continuing at a moderate pace, though somewhat more
slowly than they had anticipated at the time of the
April meeting. Participants noted several transitory
factors that were restraining growth, including the
global supply chain disruptions in the wake of the

238

98th Annual Report | 2011

Japanese earthquake, the unusually severe weather in
some parts of the United States, a drop in defense
spending, and the effects of increases in oil and other
commodity prices this year on household purchasing
power and spending. Participants expected that the
expansion would gain strength as the influence of
these temporary factors waned.
Nonetheless, most participants judged that the pace
of the economic recovery was likely to be somewhat
slower over coming quarters than they had projected
in April. This judgment reflected the persistent weakness in the housing market, the ongoing efforts by
some households to reduce debt burdens, the recent
sluggish growth of income and consumption, the fiscal contraction at all levels of government, and the
effects of uncertainty regarding the economic outlook and future tax and regulatory policies on the
willingness of firms to hire and invest. Moreover, the
recovery remained subject to some downside risks,
such as the possibility of a more extended period of
weak activity and declining prices in the housing sector, the chance of a larger-than-expected near-term
fiscal tightening, and potential financial and economic spillovers if the situation in peripheral Europe
were to deteriorate further. Participants still projected that the unemployment rate would decline
gradually toward levels they saw as consistent with
the Committee’s dual mandate, but at a more gradual
pace than they had forecast in April. While higher
prices for energy and other commodities had boosted
inflation this year, with commodity prices expected to
change little going forward and longer-term inflation
expectations stable, most participants anticipated
that inflation would subside to levels at or below
those consistent with the Committee’s dual mandate.
Activity in the business sector appeared to have
slowed somewhat over the intermeeting period.
Although the effects of the Japanese disaster on U.S.
motor vehicle production accounted for much of the
deceleration in industrial production since March,
the most recent readings from various regional manufacturing surveys suggested a slowing in the pace of
manufacturing activity more broadly. However, business contacts in some sectors—most notably energy
and high tech—reported that activity and business
sentiment had strengthened further in recent months.
Business investment in equipment and software generally remained robust, but growth in new orders for
nondefense capital goods—though volatile from
month to month—appeared to have slowed. While
FOMC participants expected a rebound in investment in motor vehicles to boost capital outlays in

coming months, some also noted that indicators of
current and planned business investment in equipment and software had weakened somewhat, and surveys showed some deterioration in business sentiment. Business contacts in some regions reported
that they were reducing capital budgets in response to
the less certain economic outlook, but in other parts
of the country, contacts noted that business sentiment remained on a firm footing, supported in part
by strong export demand. Compared with the relatively robust outlook for the business sector, meeting
participants noted that the housing sector, including
residential construction and home sales, remained
depressed. Despite efforts aimed at mitigation, foreclosures continued to add to the already very large
inventory of vacant homes, putting downward pressure on home prices and housing construction.
Meeting participants generally noted that the most
recent data on employment had been disappointing,
and new claims for unemployment insurance
remained elevated. The recent deterioration in labor
market conditions was a particular concern for
FOMC participants because the prospects for job
growth were seen as an important source of uncertainty in the economic outlook, particularly in the
outlook for consumer spending. Several participants
reported feedback from business contacts who were
delaying hiring until the economic and regulatory
outlook became more certain and who indicated that
they expected to meet any near-term increase in the
demand for their products without boosting employment; these participants noted the risk that such cautious attitudes toward hiring could slow the pace at
which the unemployment rate normalized. Wage
gains were generally reported to be subdued,
although wages for a few skilled job categories in
which workers were in short supply were said to be
increasing relatively more rapidly.
Changes in financial market conditions since the
April meeting suggested that investors had become
more concerned about risk. Equity markets had seen
a broad selloff, and risk spreads for many corporate
borrowers had widened noticeably. Large businesses
that have access to capital markets continued to enjoy
ready access to credit—including syndicated
loans—on relatively attractive terms; however, credit
conditions remained tight for smaller, bankdependent firms. Bankers again reported gradual
improvements in credit quality and generally weak
loan demand. In identifying possible risks to financial stability, a few participants expressed concern
that credit conditions in some sectors—most notably

Minutes of Federal Open Market Committee Meetings | June

the agriculture sector—might have eased too much
amid signs that investors in these markets were
aggressively taking on more leverage and risk in
order to obtain higher returns. Meeting participants
also noted that an escalation of the fiscal difficulties
in Greece and spreading concerns about other
peripheral European countries could cause significant financial strains in the United States. It was
pointed out that some U.S. money market mutual
funds have significant exposures to financial institutions from core European countries, which, in turn,
have substantial exposures to Greek sovereign debt.
Participants were also concerned about the possible
effect on financial markets of a failure to raise the
statutory federal debt ceiling in a timely manner.
While admitting that it was difficult to know what
the precise effects of such a development would be,
participants emphasized that even a short delay in
the payment of principal or interest on the Treasury
Department’s debt obligations would likely cause
severe market disruptions and could also have a lasting effect on U.S. borrowing costs.
Participants noted several factors that had contributed to the increase in inflation this year. The run-up
in energy prices, as well as an increase in prices of
other commodities and imported goods, had boosted
both headline and core inflation. At same time,
extremely low motor vehicle inventories resulting
from global supply disruptions in the wake of the
Japanese earthquake—by contributing to higher
motor vehicle prices—had significantly raised inflation, although participants anticipated that these
temporary pressures would lessen as motor vehicle
inventories were rebuilt. Participants also observed
that crude oil prices fell over the intermeeting period
and other commodity prices also moderated, developments that were likely to damp headline inflation
at the consumer level going forward. However, a
number of participants pointed out that the recent
faster pace of price increases was widespread across
many categories of spending and was evident in
inflation measures such as trimmed means or medians, which exclude the most extreme price movements in each period. The discussion of core inflation and similar indicators reflected the view
expressed by some participants that such measures
are useful for forecasting the path of inflation over
the medium run. In addition, reports from business
contacts indicated that some already had passed on,
or were intending to try to pass on, at least a portion
of their higher costs to customers in order to maintain profit margins.

239

Most participants expected that much of the rise in
headline inflation this year would prove transitory
and that inflation over the medium term would be
subdued as long as commodity prices did not continue to rise rapidly and longer-term inflation expectations remained stable. Nevertheless, a number of
participants judged the risks to the outlook for inflation as tilted to the upside. Moreover, a few participants saw a continuation of the current stance of
monetary policy as posing some upside risk to inflation expectations and actual inflation over time.
However, other participants observed that measures
of longer-term inflation compensation derived from
financial instruments had remained stable of late,
and that survey-based measures of longer-term inflation expectations also had not changed appreciably,
on net, in recent months. These participants noted
that labor costs were rising only slowly, and that persistent slack in labor and product markets would
likely limit upward pressures on prices in coming
quarters. Participants agreed that it would be important to pay close attention to the evolution of both
inflation and inflation expectations. A few participants noted that the adoption by the Committee of
an explicit numerical inflation objective could help
keep longer-term inflation expectations well
anchored. Another participant, however, expressed
concern that the adoption of such an objective could,
in effect, alter the relative importance of the two
components of the Committee’s dual mandate.
Participants also discussed the medium-term outlook
for monetary policy. Some participants noted that if
economic growth remained too slow to make satisfactory progress toward reducing the unemployment
rate and if inflation returned to relatively low levels
after the effects of recent transitory shocks dissipated, it would be appropriate to provide additional
monetary policy accommodation. Others, however,
saw the recent configuration of slower growth and
higher inflation as suggesting that there might be less
slack in labor and product markets than had been
thought. Several participants observed that the necessity of reallocating labor across sectors as the recovery proceeds, as well as the loss of skills caused by
high levels of long-term unemployment and permanent separations, may have temporarily reduced the
economy’s level of potential output. In that case, the
withdrawal of monetary accommodation may need
to begin sooner than currently anticipated in financial markets. A few participants expressed uncertainty about the efficacy of monetary policy in cur-

240

98th Annual Report | 2011

rent circumstances but disagreed on the implications
for future policy.

Committee Policy Action
In the discussion of monetary policy for the period
ahead, members agreed that the Committee should
complete its $600 billion asset purchase program at
the end of the month and that no changes to the target range for the federal funds rate were warranted at
this meeting. The information received over the intermeeting period indicated that the economic recovery
was continuing at a moderate pace, though somewhat
more slowly than the Committee had expected, and
that the labor market was weaker than anticipated.
Inflation had increased in recent months as a result
of higher prices for some commodities, as well as
supply chain disruptions related to the tragic events
in Japan. Nonetheless, members saw the pace of the
economic expansion as picking up over the coming
quarters and the unemployment rate resuming its
gradual decline toward levels consistent with the
Committee’s dual mandate. Moreover, with longerterm inflation expectations stable, members expected
that inflation would subside to levels at or below
those consistent with the Committee’s dual mandate
as the effects of past energy and other commodity
price increases dissipate. However, many members
saw the outlook for both employment and inflation
as unusually uncertain. Against this backdrop, members agreed that it was appropriate to maintain the
Committee’s current policy stance and accumulate
further information regarding the outlook for growth
and inflation before deciding on the next policy step.
On the one hand, a few members noted that, depending on how economic conditions evolve, the Committee might have to consider providing additional monetary policy stimulus, especially if economic growth
remained too slow to meaningfully reduce the unemployment rate in the medium run. On the other hand,
a few members viewed the increase in inflation risks
as suggesting that economic conditions might well
evolve in a way that would warrant the Committee
taking steps to begin removing policy accommodation sooner than currently anticipated.
In the statement to be released following the meeting,
all members agreed that it was appropriate to
acknowledge that the recovery had been slower than
the Committee had expected at the time of the April
meeting and to note the factors that were currently
weighing on economic growth and boosting inflation.
The Committee agreed that the statement should
briefly describe its current projections for unemploy-

ment and inflation relative to the levels of those variables that members see as consistent with the Committee’s dual mandate. In the discussion of inflation
in the statement, members decided to reference inflation—meaning overall inflation—rather than underlying inflation or inflation trends, in order to be clear
that the Committee’s objective is the level of overall
inflation in the medium term. The Committee also
decided to reiterate that economic conditions were
likely to warrant exceptionally low levels for the federal funds rate for an extended period; in addition,
the Committee noted that it would review regularly
the size and composition of its securities holdings,
and that it is prepared to adjust those holdings as
appropriate.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to complete purchases of
$600 billion of longer-term Treasury securities
by the end of this month. The Committee also
directs the Desk to maintain its existing policy
of reinvesting principal payments on all domestic securities in the System Open Market
Account in Treasury securities in order to maintain the total face value of domestic securities at
approximately $2.6 trillion. The System Open
Market Account Manager and the Secretary will
keep the Committee informed of ongoing developments regarding the System’s balance sheet
that could affect the attainment over time of the
Committee’s objectives of maximum employment and price stability.”
The vote encompassed approval of the statement
below to be released at 12:30 p.m.:
“Information received since the Federal Open
Market Committee met in April indicates that
the economic recovery is continuing at a moderate pace, though somewhat more slowly than the
Committee had expected. Also, recent labor

Minutes of Federal Open Market Committee Meetings | June

market indicators have been weaker than anticipated. The slower pace of the recovery reflects in
part factors that are likely to be temporary,
including the damping effect of higher food and
energy prices on consumer purchasing power
and spending as well as supply chain disruptions
associated with the tragic events in Japan.
Household spending and business investment in
equipment and software continue to expand.
However, investment in nonresidential structures
is still weak, and the housing sector continues to
be depressed. Inflation has picked up in recent
months, mainly reflecting higher prices for some
commodities and imported goods, as well as the
recent supply chain disruptions. However,
longer-term inflation expectations have
remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The unemployment rate
remains elevated; however, the Committee
expects the pace of recovery to pick up over
coming quarters and the unemployment rate to
resume its gradual decline toward levels that the
Committee judges to be consistent with its dual
mandate. Inflation has moved up recently, but
the Committee anticipates that inflation will
subside to levels at or below those consistent
with the Committee’s dual mandate as the
effects of past energy and other commodity
price increases dissipate. However, the Committee will continue to pay close attention to the
evolution of inflation and inflation expectations.
To promote the ongoing economic recovery and
to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee
decided today to keep the target range for the
federal funds rate at 0 to ¼ percent. The Committee continues to anticipate that economic
conditions—including low rates of resource utilization and a subdued outlook for inflation over
the medium run—are likely to warrant exceptionally low levels for the federal funds rate for
an extended period. The Committee will complete its purchases of $600 billion of longerterm Treasury securities by the end of this
month and will maintain its existing policy of
reinvesting principal payments from its securities
holdings. The Committee will regularly review
the size and composition of its securities holdings and is prepared to adjust those holdings as
appropriate.

241

The Committee will monitor the economic outlook and financial developments and will act as
needed to best foster maximum employment and
price stability.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Charles L. Evans, Richard
W. Fisher, Narayana Kocherlakota, Charles I.
Plosser, Sarah Bloom Raskin, Daniel K. Tarullo, and
Janet L. Yellen.
Voting against this action: None.

External Communications
In follow-up to discussions at the January meeting,
the Committee turned to consideration of policies
aimed at supporting effective communication with
the public regarding the outlook for the economy
and monetary policy. The subcommittee on communication, chaired by Governor Yellen and composed
of Governor Duke and Presidents Fisher and Rosengren, proposed policies for Committee participants
and for Federal Reserve System staff to follow in
their communications with the public in order to
reinforce the public’s confidence in the transparency
and integrity of the monetary policy process. By
unanimous vote, the Committee approved the policies.2 Participants all supported the policies, but several of them emphasized that the policy for staff, in
particular, should be applied with judgment and
common sense so as to avoid interfering with legitimate research.
It was agreed that the next meeting of the Committee
would be held on Tuesday, August 9, 2011. The meeting adjourned at 12:10 p.m. on June 22, 2011.

Notation Vote
By notation vote completed on May 17, 2011, the
Committee unanimously approved the minutes of the
FOMC meeting held on April 26–27, 2011.
William B. English
Secretary

2

The policies are available at http://www.federalreserve.gov/
monetarypolicy/files/FOMC_ExtCommunicationParticipants
.pdf and http://www.federalreserve.gov/monetarypolicy/files/
FOMC_ExtCommunicationStaff.pdf.

242

98th Annual Report | 2011

Addendum:
Summary of Economic Projections

of the longer-run sustainable rate of increase in real
GDP, the unemployment rate is projected to trend
gradually lower over this projection period. However,
participants anticipated that, at the end of 2013, the
unemployment rate would still be well above their
estimates of the unemployment rate that they see as
consistent, over the longer run, with the Committee’s
dual mandate of maximum employment and price
stability. Most participants marked up their projections of inflation for 2011 in light of the increase in
inflation in the first half of the year, but they projected this increase to be transitory, with overall inflation moving back in line with core inflation in 2012
and 2013 and remaining at or a bit below rates that
they see as consistent, over the longer run, with the
Committee’s dual mandate. Participants generally
saw the rate of core inflation as likely to stay roughly
the same over the next two years as this year.

In conjunction with the June 21–22, 2011, Federal
Open Market Committee (FOMC) meeting, the
members of the Board of Governors and the presidents of the Federal Reserve Banks, all of whom participate in the deliberations of the FOMC, submitted
projections for growth of real output, the unemployment rate, and inflation for the years 2011 to 2013
and over the longer run. The projections were based
on information available at the time of the meeting
and on each participant’s assumptions about factors
likely to affect economic outcomes, including his or
her assessment of appropriate monetary policy.
“Appropriate monetary policy” is defined as the
future path of policy that each participant deems
most likely to foster outcomes for economic activity
and inflation that best satisfy his or her interpretation of the Federal Reserve’s dual objectives of maximum employment and stable prices. Longer-run projections represent each participant’s assessment of
the rate to which each variable would be expected to
converge over time under appropriate monetary
policy and in the absence of further shocks.

On balance, as indicated in table 1, participants
anticipated somewhat lower real GDP growth over
the near term relative to their projections in April but
left their projections for inflation mostly unchanged
since the April meeting. Participants made noticeable
downward revisions to their projections for GDP
growth this year and next, but they made little
change to their projection for 2013 and no change to
their longer-run projections. Meeting participants
revised up their projections for the unemployment
rate over the forecast period, although they continue
to expect a gradual decline in the unemployment rate
over time. Participants’ projections for overall infla-

As depicted in figure 1, FOMC participants expected
the economic recovery to continue at a moderate
pace, with growth of real gross domestic product
(GDP) about the same this year as in 2010 and then
strengthening over 2012 and 2013. With the pace of
economic growth modestly exceeding their estimates

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, June 2011
Percent
Central tendency1

Range2

Variable
2011
Change in real GDP
April projection
Unemployment rate
April projection
PCE inflation
April projection
Core PCE inflation3
April projection

2012

2013

Longer run

2011

2012

2013

Longer run

2.7 to 2.9
3.1 to 3.3
8.6 to 8.9
8.4 to 8.7
2.3 to 2.5
2.1 to 2.8
1.5 to 1.8
1.3 to 1.6

3.3 to 3.7
3.5 to 4.2
7.8 to 8.2
7.6 to 7.9
1.5 to 2.0
1.2 to 2.0
1.4 to 2.0
1.3 to 1.8

3.5 to 4.2
3.5 to 4.3
7.0 to 7.5
6.8 to 7.2
1.5 to 2.0
1.4 to 2.0
1.4 to 2.0
1.4 to 2.0

2.5 to 2.8
2.5 to 2.8
5.2 to 5.6
5.2 to 5.6
1.7 to 2.0
1.7 to 2.0

2.5 to 3.0
2.9 to 3.7
8.4 to 9.1
8.1 to 8.9
2.1 to 3.5
2.0 to 3.6
1.5 to 2.3
1.1 to 2.0

2.2 to 4.0
2.9 to 4.4
7.5 to 8.7
7.1 to 8.4
1.2 to 2.8
1.0 to 2.8
1.2 to 2.5
1.1 to 2.0

3.0 to 4.5
3.0 to 5.0
6.5 to 8.3
6.0 to 8.4
1.3 to 2.5
1.2 to 2.5
1.3 to 2.5
1.2 to 2.0

2.4 to 3.0
2.4 to 3.0
5.0 to 6.0
5.0 to 6.0
1.5 to 2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are from the fourth quarter of the previous year to the fourth
quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures
(PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the
year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s
assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The April
projections were made in conjunction with the meeting of the Federal Open Market Committee on April 26–27, 2011.
1
The central tendency excludes the three highest and three lowest projections for each variable in each year.
2
The range for a variable in a given year consists of all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

Minutes of Federal Open Market Committee Meetings | June

243

Figure 1. Central tendencies and ranges of economic projections, 2011–13 and over the longer run
Percent

Change in real GDP

5

Central tendency of projections
Range of projections

4
3
2
1
+
0
_
1

Actual

2

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

Unemployment rate

10
9
8
7
6
5

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

PCE inflation
3

2

1

2006

2007

2008

2009

2010

2011

2012

2013

Longer
run
Percent

Core PCE inflation
3

2

1

2006

2007

2008

2009

2010

2011

Note: Definitions of variables are in the notes to table 1. The data for the actual values of the variables are annual.

2012

2013

244

98th Annual Report | 2011

tion this year were somewhat more narrowly distributed than in April, and their projections for 2012 and
2013 were similar to the projections made in April.
A sizable majority of participants continued to judge
the level of uncertainty associated with their projections for economic growth and inflation as unusually
high relative to historical norms. Most participants
viewed the risks to output growth as being weighted
to the downside, and none saw those risks as
weighted to the upside. Meanwhile, a majority of
participants saw the risks to overall inflation as
balanced.
The Outlook
Participants marked down their forecasts for real
GDP growth in 2011 to reflect the unexpected weakness witnessed in the first half of the year, with the
central tendency of their projections moving down to
2.7 to 2.9 percent from 3.1 to 3.3 percent in April.
Participants attributed the downward revision in
their growth outlook to the likely effects of elevated
commodity prices on real income and consumer sentiment, as well as indications of renewed weakness in
the labor market, surprisingly sluggish consumer
spending, a continued lack of recovery in the housing
market, supply disruptions from the events in Japan,
and constraints on government spending at all levels.
Looking further ahead, participants’ forecasts for
economic growth were also marked down in 2012, as
participants saw some of the weakness in economic
activity this year as likely to persist. Nevertheless,
participants still anticipated a modest acceleration in
economic output next year, and they expected a further modest acceleration in 2013 to growth rates that
were largely unchanged from their previous projection. The central tendency of their current projections for real GDP growth in 2012 was 3.3 to 3.7 percent, compared with 3.5 to 4.2 percent in April, and
in 2013 the central tendency of the projections for
real GDP growth was 3.5 to 4.2 percent. Participants
cited the effects of continued monetary policy
accommodation, some further easing in credit market conditions, a waning in the drag from elevated
commodities prices, and an increase in spending from
pent-up demand as factors likely to contribute to a
pickup in the pace of the expansion. Participants did,
however, see a number of factors that would likely
continue to weigh on GDP growth over the next two
years. Most participants pointed to strains in the
household sector, noting impaired balance sheets,
continued declines in house prices, and persistently
high unemployment as restraining the growth of

consumer spending. In addition, some participants
noted that although energy and commodity prices
were expected to stabilize, they would do so at
elevated levels and would likely continue to damp
spending growth for a time. Finally, several participants pointed to a likely drag from tighter fiscal
policy at all levels of government. In the absence of
further shocks, participants generally expected that,
over time, real GDP growth would eventually settle
down at an annual rate of 2.5 to 2.8 percent in the
longer run.
Partly in response to the recent weak indicators of
labor demand and participants’ downwardly revised
views of the economic outlook, participants marked
up their forecasts for the unemployment rate over the
entire forecast period. For the fourth quarter of this
year, the central tendency of their projections rose to
8.6 to 8.9 percent from 8.4 to 8.7 percent in April.
Similar upward revisions were made for 2012 and
2013, with the central tendencies of the projections
for those years at 7.8 to 8.2 percent and 7.0 to
7.5 percent, respectively. Consistent with their expectations of a moderate recovery, with growth only
modestly above trend, the central tendency of the
projections of the unemployment rate at the end of
2013 was well above the 5.2 to 5.6 percent central tendency of their estimates of the unemployment rate
that would prevail over the longer run in the absence
of further shocks. The central tendency for the participants’ projections of the unemployment rate in
the longer run was unchanged from the interval
reported in April.
Participants noted that measures of consumer price
inflation had increased this year, reflecting in part
higher prices of oil and other commodities. However,
participants’ forecasts for total personal consumption
expenditures (PCE) inflation in 2011 were little
changed from April, with the central tendency of
their estimates narrowing to a range of 2.3 to 2.5 percent, compared with 2.1 to 2.8 percent in April. Most
participants anticipated that the influence of higher
commodity prices and supply disruptions from Japan
on inflation would be temporary, and that inflation
pressures in the future would be subdued as commodity prices stabilized, inflation expectations
remained well anchored, and large margins of slack
in labor markets kept labor costs in check. As a
result, participants anticipated that total PCE inflation would step down in 2012 and 2013, with the central tendency of their projections in those years at
1.5 to 2.0 percent. The lower end of these central tendencies was revised up somewhat from April, sug-

Minutes of Federal Open Market Committee Meetings | June

gesting that fewer participants saw a likelihood of
very low inflation in those years. The projections for
these two years were at or slightly below the 1.7 to
2.0 percent central tendency of participants’ estimates of the longer-run, mandate-consistent rate of
inflation. The central tendencies of participants’ projections of core PCE inflation this year shifted up a
bit to 1.5 to 1.8 percent, as participants saw some of
the run-up in commodity prices passing through to
core prices. For 2012 and 2013, participants saw commodity prices as likely to stabilize near current levels,
and the central tendencies for their forecasts of core
inflation were 1.4 to 2.0 percent, essentially
unchanged from their April projections.
Uncertainty and Risks
A substantial majority of participants continued to
judge that the levels of uncertainty associated with
their projections for economic growth and inflation
were greater than the average levels that had prevailed over the past 20 years.3 They pointed to a
number of factors that contributed to their assessments of the uncertainty that they attached to their
projections, including the severity of the recent recession, the uncertain effects of the current stance of
monetary policy, uncertainty about the direction of
fiscal policy, and structural dislocations in the labor
market.
Most participants now judged that the balance of
risks to economic growth was weighted to the downside, and the rest viewed these risks as balanced. The
most frequently cited downside risks included a
potential for a large negative effect on consumer
spending from higher food and energy prices, a
weaker labor market, falling house prices, uncertainty
from the debate over the statutory debt limit and its
potential implications for near-term fiscal policy, and
possible negative financial market spillovers from
European sovereign debt problems. The risks surrounding participants’ forecasts of the unemployment rate shifted higher, with a slight majority of
participants now viewing the risks to the projection
as weighted to the upside, and the rest of the participants seeing the risks as broadly balanced.

3

Table 2 provides estimates of forecast uncertainty for the change
in real GDP, the unemployment rate, and total consumer price
inflation over the period from 1991 to 2010. At the end of this
summary, the box “Forecast Uncertainty” discusses the sources
and interpretation of uncertainty in the economic forecasts and
explains the approach used to assess the uncertainty and risks
attending the participants’ projections.

245

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2011

2012

2013

±0.9
±0.4
±0.8

±1.6
±1.2
±1.0

±1.8
±1.7
±1.0

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1991 through 2010 that were released in the summer by
various private and government forecasters. As described in the box
“Forecast Uncertainty,” under certain assumptions, there is about a 70 percent
probability that actual outcomes for real GDP, unemployment, and consumer
prices will be in ranges implied by the average size of projection errors made in
the past. Further information is in David Reifschneider and Peter Tulip (2007),
“Gauging the Uncertainty of the Economic Outlook from Historical Forecasting
Errors,” Finance and Economics Discussion Series 2007-60 (Washington: Board of
Governors of the Federal Reserve System, November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

Although a majority of participants judged the risks
to their inflation projections over the period from
2011 to 2013 to be weighted to the upside in April,
most participants now viewed these risks as broadly
balanced. On the one hand, participants noted that
the effect on headline inflation of the rise in commodity prices earlier this year was likely to subside as
those prices stabilized, but they could not rule out
the possibility of those effects being more persistent
than anticipated. On the other hand, with the outlook for the economy somewhat weaker than previously expected, some participants saw a risk that
greater resource slack could produce more downward
pressure on inflation than projected. A few participants noted the possibility that the current highly
accommodative stance of monetary policy, if it were
to be maintained longer than is appropriate, could
lead to higher inflation expectations and actual
inflation.
Diversity of Views
Figures 2.A and 2.B provide further details on the
diversity of participants’ views regarding the likely
outcomes for real GDP growth and the unemployment rate in 2011, 2012, 2013, and over the longer
run. The dispersion in these projections continued to
reflect differences in participants’ assessments of
many factors, including the current degree of underlying momentum in economic activity, the outlook
for fiscal policy, the timing and degree of the recovery of labor markets following the very deep recession, and appropriate future monetary policy and its
effects on economic activity. Regarding participants’

246

98th Annual Report | 2011

projections for real GDP growth, the distribution for
this year shifted noticeably lower but remained about
as concentrated as the distribution in April. The distribution for 2012 also shifted down somewhat and
became a bit more concentrated, while the distribution for 2013 did not change appreciably. Regarding
participants’ projections for the unemployment rate,
the distribution for this year and for 2012 shifted up
relative to the corresponding distributions in April,
and more than one-half of participants expected the
unemployment rate in 2012 to be in the 8.0 to
8.1 percent interval. These shifts reflect the recent
softening in labor market conditions along with the
marking down of expected economic growth this
year and next. The distribution of the unemployment
rate in 2013 also shifted upward somewhat but was
narrower than the distribution in April. The distributions of participants’ estimates of the longer-run
growth rate of real GDP and of the unemployment
rate were both little changed from the April
projections.
Corresponding information about the diversity of
participants’ views regarding the inflation outlook is
provided in figures 2.C and 2.D. In general, the dispersion of participants’ inflation forecasts for the next
few years represented differences in judgments

regarding the fundamental determinants of inflation,
including the degree of resource slack and the extent
to which such slack influences inflation outcomes
and expectations, as well as estimates of how the
stance of monetary policy may influence inflation
expectations. Regarding overall PCE inflation, the
distributions for 2011, 2012, and 2013 all narrowed
somewhat, with the top of the distributions remaining unchanged but the lower end of the distributions
moving up somewhat. Although participants continued to expect that the somewhat elevated rate of
inflation this year would subside in subsequent years,
fewer participants anticipated very low levels of
inflation. The distribution of participants’ projections for core inflation for this year shifted noticeably
higher, reflecting incoming data and a view that the
pass-through of commodity prices to core prices may
be greater than previously thought; however, the distributions for 2012 and 2013 were little changed. The
distribution of participants’ projections for overall
inflation over the longer run was essentially
unchanged from its fairly narrow distribution in
April, reflecting the broad similarity in participants’
assessments of the approximate level of inflation that
is consistent with the Federal Reserve’s dual objectives of maximum employment and price stability.

Minutes of Federal Open Market Committee Meetings | June

247

Figure 2.A. Distribution of participants’ projections for the change in real GDP, 2011–13 and over the longer run
Number of participants

2011

16

June projections
April projections

14
12
10
8
6
4
2

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

2012

16
14
12
10
8
6
4
2

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

2013

16
14
12
10
8
6
4
2

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

Percent range
Number of participants

Longer run

16
14
12
10
8
6
4
2

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

Percent range
Note: Definitions of variables are in the general note to table 1.

3.83.9

4.04.1

4.24.3

4.44.5

4.64.7

4.84.9

5.05.1

248

98th Annual Report | 2011

Figure 2.B. Distribution of participants’ projections for the unemployment rate, 2011–13 and over the longer run
Number of participants

2011

16

June projections
April projections

14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

Percent range
Number of participants

2012

16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

Percent range
Number of participants

2013

16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

Percent range
Number of participants

Longer run

16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

Percent range
Note: Definitions of variables are in the general note to table 1.

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

9.09.1

Minutes of Federal Open Market Committee Meetings | June

249

Figure 2.C. Distribution of participants’ projections for PCE inflation, 2011–13 and over the longer run
Number of participants

2011

16

June projections
April projections

14
12
10
8
6
4
2

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

2.93.0

3.13.2

3.33.4

3.53.6

Percent range
Number of participants

2012

16
14
12
10
8
6
4
2

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

2.93.0

3.13.2

3.33.4

3.53.6

Percent range
Number of participants

2013

16
14
12
10
8
6
4
2

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

2.93.0

3.13.2

3.33.4

3.53.6

Percent range
Number of participants

Longer run

16
14
12
10
8
6
4
2

0.91.0

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Note: Definitions of variables are in the general note to table 1.

2.32.4

2.52.6

2.72.8

2.93.0

3.13.2

3.33.4

3.53.6

250

98th Annual Report | 2011

Figure 2.D. Distribution of participants’ projections for core PCE inflation, 2011–13
Number of participants

2011

16

June projections
April projections

14
12
10
8
6
4
2

1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

Percent range
Number of participants

2012

16
14
12
10
8
6
4
2
1.11.2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

Percent range
Number of participants

2013

16
14
12
10
8
6
4
2
1.11.2

1.31.4

1.51.6

1.71.8

Percent range
Note: Definitions of variables are in the general note to table 1.

1.92.0

2.12.2

2.32.4

2.52.6

Minutes of Federal Open Market Committee Meetings | June

251

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public
understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts
are necessarily imperfect descriptions of the real
world, and the future path of the economy can be
affected by myriad unforeseen developments and
events. Thus, in setting the stance of monetary
policy, participants consider not only what appears to
be the most likely economic outcome as embodied in
their projections, but also the range of alternative
possibilities, the likelihood of their occurring, and the
potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy of
a range of forecasts, including those reported in past
Monetary Policy Reports and those prepared by the
Federal Reserve Board’s staff in advance of meetings
of the Federal Open Market Committee. The projection error ranges shown in the table illustrate the considerable uncertainty associated with economic forecasts. For example, suppose a participant projects
that real gross domestic product (GDP) and total
consumer prices will rise steadily at annual rates of,
respectively, 3 percent and 2 percent. If the uncertainty attending those projections is similar to

that experienced in the past and the risks around the
projections are broadly balanced, the numbers
reported in table 2 would imply a probability of about
70 percent that actual GDP would expand within a
range of 2.1 to 3.9 percent in the current year, 1.4 to
4.6 percent in the second year, and 1.2 to 4.8 percent
in the third year. The corresponding 70 percent confidence intervals for overall inflation would be 1.2 to
2.8 percent in the current year, and 1.0 to 3.0 percent
in the second and third years.
Because current conditions may differ from those
that prevailed, on average, over history, participants
provide judgments as to whether the uncertainty
attached to their projections of each variable is
greater than, smaller than, or broadly similar to typical levels of forecast uncertainty in the past, as
shown in table 2. Participants also provide judgments
as to whether the risks to their projections are
weighted to the upside, are weighted to the downside, or are broadly balanced. That is, participants
judge whether each variable is more likely to be
above or below their projections of the most likely
outcome. These judgments about the uncertainty
and the risks attending each participant’s projections
are distinct from the diversity of participants’ views
about the most likely outcomes. Forecast uncertainty
is concerned with the risks associated with a particular projection rather than with divergences across a
number of different projections.

252

98th Annual Report | 2011

Meeting Held on August 9, 2011

Brian Sack
Manager, System Open Market Account

A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal
Reserve System was held in the offices of the Board
of Governors in Washington, D.C., on Tuesday,
August 9, 2011, at 8:00 a.m.

Jennifer J. Johnson
Secretary of the Board, Office of the Secretary,
Board of Governors

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Charles L. Evans
Richard W. Fisher
Narayana Kocherlakota
Charles I. Plosser
Sarah Bloom Raskin
Daniel K. Tarullo
Janet L. Yellen
Christine Cumming, Jeffrey M. Lacker,
Dennis P. Lockhart, Sandra Pianalto, and
John C. Williams
Alternate Members of the Federal Open Market
Committee
James Bullard, Thomas M. Hoenig, and
Eric Rosengren
Presidents of the Federal Reserve Banks of St. Louis,
Kansas City, and Boston, respectively
William B. English
Secretary and Economist
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Thomas C. Baxter
Deputy General Counsel

Patrick M. Parkinson
Director, Division of Banking Supervision and
Regulation, Board of Governors
Robert deV. Frierson
Deputy Secretary, Office of the Secretary,
Board of Governors
Andreas Lehnert
Deputy Director, Office of Financial Stability Policy
and Research, Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Seth B. Carpenter
Senior Associate Director, Division of Monetary
Affairs, Board of Governors
Michael Leahy
Senior Associate Director, Division of International
Finance, Board of Governors
Lawrence Slifman and William Wascher
Senior Associate Directors, Division of Research and
Statistics, Board of Governors
Andrew T. Levin
Senior Adviser, Office of Board Members,
Board of Governors
Stephen A. Meyer
Senior Adviser, Division of Monetary Affairs,
Board of Governors
Joyce K. Zickler
Visiting Senior Adviser, Division of Monetary
Affairs, Board of Governors
David E. Lebow
Associate Director, Division of Research and
Statistics, Board of Governors
Joshua Gallin
Deputy Associate Director, Division of Research and
Statistics, Board of Governors

Richard M. Ashton
Assistant General Counsel

Fabio M. Natalucci
Deputy Associate Director, Division of Monetary
Affairs, Board of Governors

Thomas A. Connors, David Reifschneider,
Daniel G. Sullivan, David W. Wilcox, and Kei-Mu Yi
Associate Economists

Beth Anne Wilson
Assistant Director, Division of International Finance,
Board of Governors

Minutes of Federal Open Market Committee Meetings | August

Penelope A. Beattie
Assistant to the Secretary, Office of the Secretary,
Board of Governors
John C. Driscoll
Senior Economist, Division of Monetary Affairs,
Board of Governors
Carol Low
Open Market Secretariat Specialist, Division of
Monetary Affairs, Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
David Sapenaro
First Vice President, Federal Reserve Bank of
St. Louis
Mark S. Sniderman
Executive Vice President, Federal Reserve Bank of
Cleveland
David Altig, Alan D. Barkema, and Geoffrey Tootell
Senior Vice Presidents, Federal Reserve Banks of
Atlanta, Kansas City, and Boston, respectively
Chris Burke, Fred Furlong, Tom Klitgaard,
Evan F. Koenig, and Daniel L. Thornton
Vice Presidents, Federal Reserve Banks of New York,
San Francisco, New York, Dallas, and St. Louis,
respectively
Keith Sill
Assistant Vice President, Federal Reserve Bank of
Philadelphia
Robert L. Hetzel
Senior Economist, Federal Reserve Bank of
Richmond

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
June 21–22, 2011. He also reported on System open
market operations, including the continuing reinvestment into longer-term Treasury securities of principal payments received on the SOMA’s holdings of
agency debt and agency-guaranteed mortgagebacked securities. By unanimous vote, the Committee
ratified the transactions by the Open Market Desk of
the Federal Reserve Bank of New York over the
intermeeting period.

253

Staff Review of the Economic Situation
The information reviewed at the August 9 meeting
indicated that the pace of the economic recovery
remained slow in recent