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F e d e r a l R e s e r v e B a n k o f R i c h m o n d • 2005 ANNUAL REPORT

Fifth F ederal Reserve D istrict O ffices
Richmond
701 East Byrd Street
Richmond, Virginia 23219
804 697 8000
G

G

Baltimore
502 South Sharp Street
Baltimore, Maryland 21201
410 576 3300
G

G

Charlotte
530 East Trade Street
Charlotte, North Carolina 28202
704 358 2100
G

G

Borrowing by
U.S. Households

www.richmondfed.org
34

annual report cover.ps - 4/27/2006 3:26 PM

Mission
As a regional Reserve Bank, we work within the Federal Reserve System
to foster the stability, integrity, and efficiency of the nation’s monetary,
financial, and payments systems. In doing so, we inspire trust and confidence in the U.S. financial system.

Vision
We will excel at everything we do, and make unique and important
contributions to the Federal Reserve System’s mission.

the federal reserve bank of richmond 2005 annual report was produced by the research department,
publications division and the public affairs department, graphics division.

Editor
Alice Felmlee

Designer
Ailsa Long

Editorial
Photographer
Steven Puetzer

Portrait
Photographers
Larry Cain
Geep Schurman

Printer
Federal Reserve Bank
of Richmond

Special Thanks to:
Cecilia Bingenheimer
Andrea Holmes
Ray Owens
Aaron Steelman
Jim Strader

this annual report is also available on the federal reserve bank of richmond’s web site at
www.richmondfed.org.

for

additional

print

copies,

contact

the

public

affairs

department,

f e d e r a l r e s e r v e b a n k o f r i c h m o n d , p . o . b o x 2 7 6 2 2, r i c h m o n d , v a 23 261, o r c a l l 80 4 • 6 97 • 810 9 .

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Contents
Message from the President ........................................................................ 1
Borrowing by U.S. Households ...................................................................... 4
by John A. Weinberg

Boards of Directors and Advisory Groups .................................................... 17
Fifth District Economic Report .................................................................... 27
Message from Management ........................................................................ 30
Officers ...................................................................................................... 32
Financial Statements .................................................................................. 34
Summary of Operations .............................................................................. 52

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“

The expansion of retail credit has brought
distinct benefits to American consumers. At
a fundamental level, the purpose of credit is
to allow people to choose a spending pattern
that is smoother over time than their income
stream.

”
Jeffrey M. Lacker speaking at the North Carolina Bankers Association
109th Annual Convention • June 14, 2005

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Message

• from the President

Jeffrey M. Lacker

The U.S. economy turned in a strong
performance in 2005, with overall output
and incomes expanding at a fairly brisk
pace, while prices remained relatively
stable. A major contributor to economic growth was

fifty years. It stood at 35 percent in 1952, grew to

consumer spending, despite a sluggish fourth quarter

awakening down the road? To answer that question,

in which spending on high-dollar durable goods, in

we need to consider why the debt-to-income ratio

particular, fell sharply from the previous period. The

has grown. First, let’s consider the debt side of the

American consumer, it seems clear, remains at the

equation. It has been driven, in large measure, by the

center of the current economic expansion.

growth in mortgage debt. Since most people do not

roughly 60 percent in the 1960s and 1970s, and then
continued sharply upward from the 1980s to present.

Does this mean that households are in for a rude

buy homes with cash but finance them, growth in
But not everyone is convinced that this is a positive

homeownership tends to increase mortgage debt.

development. Some worry that households are

And, indeed, homeownership has been rising, from

getting in over their heads, spending freely with

55 percent in 1950 to 69 percent in 2005. Also, we

little thought about the future. A quick glance at

would expect mortgage debt to increase if the prices

some of the data seemingly confirms this belief.

of homes increased. That, too, has occurred, espe-

For instance, in 2004 the ratio of all consumer debt

cially since the mid-1990s. Put the two together, and

to disposable personal income was about 108 percent.

it’s not surprising that household debt has been on

That number has grown pretty steadily over the past

the rise.

1

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Federal Reserve Bank of Richmond • 2005 Annual Report

Let’s turn to income. It has a major effect on people’s

in competition can also be attributed to techno-

willingness to borrow. In particular, a household’s

logical improvements. For instance, thirty years ago,

beliefs

about

income

growth will largely determine how much debt
it is willing to incur.
During periods of relatively stagnant real income

“

When you look at the landscape as
a whole, it’s not surprising that
demand for credit has increased

as supply has become more accessible and affordable.

”

if a household wanted a
mortgage loan, it almost
certainly borrowed from
a local institution. Now,
consumers can search
from a nationwide pool

growth—such as the 1970s—the debt-to-income ratio

of potential lenders. Increased competition has

remains pretty stable, as people tend to be cautious

helped drive down average borrowing costs.

about taking on debt. During periods of relatively
robust income growth—such as the mid-1990s to pres-

So when you look at the landscape as a whole, it’s

ent—the debt-to-income ratio often rises, as people

not surprising that demand for credit has increased

grow optimistic about their future ability to repay debt.

as supply has become more accessible and affordable. Consumers, on average, can borrow more

This describes the demand side for credit. At the

efficiently than in the past. We shouldn’t dismiss

same time, there have been major changes in the

concerns about the rising debt-to-income ratio,

supply side. Technological improvements have made

but we must understand the factors that have

it easier for lenders to assess the creditworthiness

contributed to its growth. The actions of consumers

of borrowers and to tailor loan terms accordingly.

appear much more rational than at first blush.

Most borrowers have been made better off by these
changes. They have seen a reduction in the cost of

Credit market developments have been something

borrowing or an increase in access to credit.

that I and others at this Bank have been thinking
about a lot recently. Last summer, I addressed

In addition, the credit market has become more

both the North Carolina and Virginia Bankers

competitive. New lenders have entered, driving

Associations on the topic of “retail financial innova-

down interest-rate spreads. Part of the increase

tion.” In those talks, I cautioned against steps to stifle

2

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the expansion of new financial products. Those prod-

Overall, I’m convinced that retail financial innovation

ucts, like many others, can be abused—both by

has improved most people’s lives. It’s no panacea, to

consumers and lenders. Consumers can take on more

be sure. There are cases where new financial prod-

debt than they ought to, and lenders can prey on

ucts are not particularly useful. For instance, many

people who are not financially savvy. Indeed, given the

people suffering systematic shocks to their income,

complexity of today’s financial instruments, even those

such as those employed in industries that are in

who are financially savvy can have difficulty evaluat-

decline and unlikely to rebound, will be unable to

ing borrowing options. But for the great majority of

borrow to smooth their consumption in the pattern

people—across all income groups—innovation in the

just described. And there are cases where house-

financial industry has brought significant benefits.

holds will make borrowing decisions that will have
negative outcomes. But borrowing, by definition, is a

As the essay in this year’s Annual Report stresses, the

forward-looking activity. As such, we should not

expansion in retail credit has allowed consumers to

judge credit market decisions based upon their

more easily smooth consumption over their lifetimes.

results alone, good or bad. Rather, we should judge

People can borrow when they are young, pay down

them from the perspective of the borrower. Does a

that debt and save during the peak earning years,

particular financial instrument present a household

and draw upon their savings in retirement. Such

with a distribution of outcomes that, on average, is

smoothing helps people to consume in a relatively

better than in its absence? If so, that instrument

consistent, predictable fashion throughout their

serves an important social purpose. I think that an

lives, rather than enjoying a few fat years sand-

examination of the evidence will find that most new

wiched between many lean ones. New financial

financial instruments meet that standard.

instruments have also helped people who suffer onetime shocks to their income stream. For instance,
those who become sick and are temporarily unable
to work can more easily sustain that shock through
borrowing than before, knowing that they will be
able to repay the debt when they return to work.

Jeffrey M. Lacker • President

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BORROWING

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BY U.S. HOUSEHOLDS

by John A. Weinberg • Senior Vice President and Director of Research

W

herever one turns these days, one seems to
run into comments about the financial
condition of the American household. Most
of these comments refer to sources of increasing
stress on the American consumer, from the historically low household savings rate to the historically high
rates of bankruptcy and debt delinquency. On top of
all this, demographic trends are raising the prospect
of having to finance the coming retirement of the
baby boom generation. These conditions have led
some to question the ability of consumer spending to
hold up under such growing financial stress. Credit
markets and consumers’ use of credit products take
a central place in this picture. Stories in the popular
business press have taken the view that consumer
debt will represent a drag on consumption growth in
2006, as the burden of making payments on debt
limits households’ abilities to make other purchases.1

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Debt and credit are value-laden terms that evoke

This essay explores the use of credit by U.S.

distinct images in people’s minds. Indeed, cul-

households. The first section describes some

tural historian Lendol Calder has noted the

facts concerning consumer borrowing and its

seemingly contradictory value judgments that

growth in recent decades. The following

run through American cultural attitudes about

sections present some of the economics of

borrowing.2 “Credit” is seen as a good thing, in

household borrowing, beginning with an expla-

that it allows the household financial flexibility

nation of the role of borrowing in helping a

in meeting its consumption needs. On the other

household to meet its consumption goals over

hand, “debt” is typically viewed as bad, because

time, and then using that perspective to interpret

it represents a lack of self-discipline and holds

the facts. This perspective generally does not

the household hostage to its past choices. And

support the view that consumer debt causes

so we have what appears to be a paradox. The

future weakness in consumption growth at the

ability to borrow is both liberating and con-

macroeconomic level.

straining—a path to both rising wealth and the
poorhouse.

This essay’s initial focus is on averages and
aggregates, examining trends in total borrowing

Another way to view this seeming paradox is

by U.S. households and assessing those trends

to think of “credit” and “debt” from two differ-

from the point of view of the typical or average

ent vantage points. “Credit” typically refers to

household. While this perspective is appropri-

the moment when a borrower has access to

ate for thinking about broad trends in credit

funds made available by a lender. From this

markets, it can mask the fact that market

vantage point, it is a tool to help households

changes can have different impacts on different

achieve their desired levels of consumption.

people. Indeed, these differences are often

“Debt,” on the other hand, is an after-the-fact

important to the way people think about public

concept, referring to the amount owed. We see

policy toward credit markets. A look at more

this dichotomy in contemporary discussions of

disaggregated data, in fact, reveals that much of

credit markets. The expansion of access to

the expansion of credit that has occurred in

credit for households previously thought to be

recent decades has come in the lower brackets

sharply constrained in their ability to borrow

of the income distribution. Accordingly, the

is a stated goal of public policy. On the other

essay will address the question of whether

hand, the financial stress facing some heavily

the economics of borrowing by lower-income

indebted households is seen by many as a

individuals is significantly different from the

problem requiring a public policy solution.

general economics of credit.

(continued)

The views expressed are the author’s and not necessarily those of the Federal Reserve System.
5

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Federal Reserve Bank of Richmond • 2005 Annual Report

How indebted are U.S. consumers? In 2004, the ratio
of all consumer debt to disposable personal income
was about 108 percent. The bulk of this debt, 84 percent of income, was in the form of mortgage debt,
with the remaining 24 percent in revolving and nonrevolving consumer credit. Historically, the debtto-income ratio has shown steady growth over much
of the last half-century as is shown in Figure 1.
Total debt to income stood at about 35 percent in
1952 and rose to around 50 percent by 1960. It then
fluctuated between 55 and 60 percent for much of
the 1960s and 1970s, before beginning a sustained
increase in the mid-1980s. But by far the largest
share of this growth has been in the mortgage portion of household credit, which was 23 percent of
income in 1952. By contrast, nonmortgage consumer
credit roughly doubled in this fifty-year period, going
from 12 to 24 percent.
As is apparent, a very large part of the increase in
household debt since the 1950s has been the rise
of mortgage debt. To some extent, this rise in mortgage debt does not represent the typical homeowner
borrowing more against the house that he or she
owns. Rather, part of this increase is due to a steadily rising rate of homeownership, which went from 55
percent of U.S. households in 1950 to 69 percent in
2005. Another source of this increase is growth in the
value of housing assets owned by consumers.
Especially in the 1990s, the median value of privately
owned homes grew faster than median income.
Still, households have generally increased the share
of their homeownership financed by mortgage debt.
Growth in the use of credit has been widespread
among U.S. households. While borrowing by households in all income ranges has grown, this growth
has been the most pronounced among households
with medium and low levels of income. Also, while
disparities in borrowing behavior continue to exist
between minority and nonminority households,
those disparities have tended to decline. This type
of disaggregated information comes primarily from
the Federal Reserve Board’s Survey of Consumer
Finances (SCF), which is conducted every three
years. An analysis of trends for households in
different ethnic and income groups was conducted
6

by Raphael Bostic.3 Trends for people at different
income levels are discussed later in this essay.
Does rising debt to income mean that the typical
household’s debt burden has risen? The debt burden
of a household is usually measured by the payments
on its debts relative to its income. Given the wide
variety of terms on retail credit—from fixed term,
fixed interest rate mortgages to open-ended lines of
credit with variable rates—specification of the
“payments” used to determine the burden of servicing one’s debts is not straightforward. But the two
main determinants of a household’s repayment obligation are the amount of debt and the interest rates
charged. So, while a precise measurement of the
payment burden would require detailed data on loan
characteristics at a very disaggregated level, it is
possible to construct a rough estimate from aggregate
data. Dean Maki provides one such estimated time
series of the aggregate debt burden of U.S. households.4 For the time period covered in that series,
from 1980 to 2000, the payment burden fluctuates
around an average level of about 13 percent.
The debt-service burden tends to rise during expansions and fall during recessions. This pattern reflects
two other facts. First, interest rates tend to rise in
expansions and fall in recessions. But, perhaps more
importantly, the growth rate of consumer credit is
Figure 1

Household Debt Relative to
Disposable Personal Income

120
Consumer Debt
Mortgage Debt
Total Debt

100

percent of dpi

trends in consumer credit

80

60

40

20

0
1952

1960

1968

1976

1984

year
Source: Federal Reserve Board of Governors

1992

2000

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also procyclical, with credit
growing more rapidly in
expansions, on average.
The burden households face in
servicing their debts, together
with the pattern of growth
in those debts, focuses attention on the “credit is good,
but debt is bad” dichotomy.
Does the data on household
debt suggest more that “credit”
acts as a tool for managing
consumption growth or that
the burden of “debt” constrains consumption growth,
as is suggested in the popular
media. Making this distinction empirically is difficult,
since both these forces may be at work for any given
household and the mix may vary considerably across
households. Maki finds that his debt burden measure
does not have strong predictive power for consumption growth, suggesting that, on average, debt is not a
strong constraining force. In addition, growth in consumer credit tends to be positively correlated with
future consumption growth. This relationship suggests
that credit is an important tool for households in
making their consumption choices. How households
make those choices is the subject of the next section.

how households use financial
instruments
It is important to view use of credit in the broader
context of how a household chooses to consume and
save or borrow over its lifetime. A household’s financial decisions are driven by the fact that its income
varies over time. Broadly speaking, there are two
types of variation in income. First, there is a typical,
largely predictable, pattern by which an individual’s
income first rises, say from young adulthood into
middle age, then falls as the person or household
moves into retirement. But there are also variations in
income that are less predictable. Households face an
array of shocks that affect their ability to participate
and earn income in the labor market. Some of
these shocks have only temporary effects, like an
illness that keeps a worker out of the workforce but
from which the worker fully recovers. Others can be

more long lasting, like a permanent decline in demand
facing an industry in which a
worker has accumulated a great
deal of experience and skill.
Against these variations in
income, a household uses
financial services related to
saving and borrowing to
achieve the best lifetime pattern of consumption possible. What makes one pattern
of consumption better than
another? Well, for one thing,
more is better than less, so a
pattern that gives a household
more consumption of goods and services at every
point in time is clearly better than one that gives less.
But most comparisons of consumption patterns over
one’s lifetime are not so straightforward. In particular, saving and borrowing decisions have to do with
trading off consumption today for consumption in
the future. So the important point to bear in mind
is that household financial decisions are driven not
so much by how people feel about having a bigger
savings account or being more in debt as they are by
how people feel about having more consumption
today versus more consumption in the future.
One principle for thinking about people’s preferences for consumption over time and how those
preferences affect financial decisions is that people
typically have a preference for smooth consumption—consumption that doesn’t vary too much over
time. In other words, a household that gets a
one-time windfall, like from winning a lottery for
example, will probably not want to spend it all
immediately on consumption of goods and services.
Rather, the lucky household will want to save some
of its temporarily higher income, so that it can
spread the consumption benefits over a longer
period of time. An important distinction here is
between spending on durable versus nondurable
goods. A lottery winner may in fact pour a large bulk
of his or her winnings into the purchase of durable
goods. But such expenditures bear a similarity to savings, because durable goods provide benefits to their
7

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Federal Reserve Bank of Richmond • 2005 Annual Report

of income would usually imply borrowing (or drawowner over an extended period of time, and the
ing down savings) when young, paying off debt and
key thing about consumption smoothing is that
accumulating savings in
the individual will want
years,
to use a temporary rise in
The key thing about consumption the peak earningsavings
and using those
income to generate consumption benefits that last
smoothing is that the individual will for consumption in the
later years.
over a long time period.
This logic works on the
want to use a temporary rise in income
Shocks to a household’s
other side as well, when
to generate consumption benefits that income come in two
a household faces a tempoforms. Some shocks are
rary income shortfall but
last over a long time period.
specific to an individual
expects to have higher inhousehold. Prolonged illcome in the future. Such a
ness of a wage earner, for instance, can limit a
household will want to keep its consumption up by
household’s earning ability. This sort of specific
drawing down savings or borrowing against those
uncertainty in income is referred to as idiosyncratic.
future increases in income.
Other shocks affect larger groups of people. Swings
in employment caused by decline of an industry or
The desire for smooth consumption over time can
by the ups and downs of the business cycle affect
be explained by economists’ usual assumption of
the incomes of many households. That is, some
diminishing marginal utility. This simply means that
income fluctuations are associated with aggregate
the less someone has consumed of a good or of
risk. Financial markets are more effective at helping
goods and services in general, the more eager he or
people smooth consumption against idiosyncratic
she is to increase consumption. So, if a household
shocks than against systematic or aggregate shocks.
has a low income today but expects a higher income
In fact, if financial markets worked perfectly, then
in the future, it faces the prospect of having less conpeople would be able to completely protect themsumption today than in the future. According to
selves against idiosyncratic shocks. Similarly,
diminishing marginal utility, the household would be
complete and well-functioning financial markets
eager to give up some of its consumption in the relawould allow people to smooth out their lifetime
tively abundant future for a little more in the present.
variation in income, since this is largely predictable.
In this case, the only fluctuations in consumption
The same characteristic of people’s preferences for
would be those arising from aggregate income risk.
consumption that makes them prefer smooth consumption over time also makes them dislike facing
In perfect financial markets, in addition to cases
risk to their consumption opportunities. That is, diminwhere standard saving and borrowing instruments
ishing marginal utility of consumption implies that
are used, households would have access to a wide
people are risk averse and will be willing to take costarray of contracts that would allow them to insure
ly actions or purchase costly insurance to avoid risk.
against any specific event that might cause a disruption to their incomes. But financial markets are
So the usual assumptions about consumer prefernot perfect, and there are limitations to households’
ences imply that households will typically desire a
abilities to smooth their consumption, even against
smooth consumption path even as their incomes vary
idiosyncratic or life-cycle income fluctuations.
over time. The two main sources of income variation
Households and other market participants face an
are life-cycle effects and the effects of shocks to
array of constraints on the types of financial conan individual’s ability to earn income. To a large
tracts available for managing income risk. Some of
extent, the life-cycle pattern of income is predictable.
these constraints have to do with information.
Labor income rises from young adulthood to middle
Lenders typically cannot perfectly screen borrowers
age, reaches a peak in the 45–54 age range, and then
according to their likelihood or propensity to
falls. Smoothing consumption over this pattern

“

”

8

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default. It is also difficult to monitor the behavior of
borrowers once they have taken a loan. Other
constraints have to do with the costs of enforcing
contracts. Bankruptcy laws, for instance, limit the
options available to a lender if a borrower defaults.
These constraints have two kinds of effects. First,
they limit the extent of specific insurance against
income fluctuations that households can receive,
making saving and borrowing the main means of
consumption smoothing for many households.
Second, the constraints tend to raise the costs of borrowing and place upper limits on the amount of debt
any given household can accumulate. So while the
bankruptcy option actually facilitates consumption
smoothing for households that have fallen on hard
enough times—by releasing them from some debt
payment obligations—the more general effect of
bankruptcy laws and other credit market constraints
is to increase the cost of borrowing and to therefore
limit opportunities to smooth consumption.

thinking about changes in credit
markets—causes

As Figure 1 clearly shows, the largest part of household debt is that used to finance housing. This
specific use of credit is quite similar to the general
use of credit for consumption smoothing purposes,
since the purchase of a home—a very lumpy transaction—allows the household to consume a smooth
stream of housing services. And while constraints
associated with limited information and enforcement costs place limits on a household’s unsecured
borrowing capacity, such limitations are less
stringent when borrowing is
collateralized, as in the case
of mortgage credit. Collateral
reduces the risk of loss for
the lender should a borrower
become unable to repay a
loan. Similarly, a portion of
nonmortgage consumer credit
is used to purchase cars and
other durable goods. Much
of this credit is tied directly
to—that is, secured by—the
items purchased. Still, the
fastest growing part of nonmortgage credit, especially
since the 1990s, has been
unsecured borrowing.

There have, in fact, been several swings in average income growth in the United States in the last fifty years.
Figure 2, for instance, shows real GDP per capita.
(See page 10.) Of particular note is an extended period of slow growth around 1980, with a pickup in
growth beginning around 1984 and continuing to the
present with two brief interruptions for the recessions
of the early 1990s and the early 2000s. This latter
period of faster income growth roughly coincides
with the period of greatest growth in household debtto-income ratios. And debt
growth was basically flat during the extended period of
stagnating income growth.

Figure 1 showed how consumers’ use of credit has
grown over time. This growth could be the result of
a number of factors. One possibility is changes in the
rate of income growth. Remember that in the most
basic description of consumption behavior, a household will seek to perfectly smooth its consumption
over time. This means that a household expecting a
growing income will borrow against future income
to even-out its consumption expenditures. The
amount that a household will want to borrow will
depend on how rapidly it expects its income to grow.
So the total amount of borrowing done by households in an economy might be expected to depend
on the anticipated growth in income. This logic—
faster anticipated income growth makes people willing to take on more debt—carries over to the case
where financial markets (and therefore consumption
smoothing) are not perfect.

People’s beliefs about their
future income prospects are
one determinant of the
demand for credit. Demand
could also be affected by the
variability of income. Given
the limitations to financial
arrangements that result from
information and enforcement
constraints, saving and borrowing constitute the main
tool used by households to
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Federal Reserve Bank of Richmond • 2005 Annual Report

Evidence examined by Dirk Krueger and Fabrizio
Perri suggests that income risk faced by households
has increased since 1980, implying a rising possibility of running up against limits on debt capacity.5
This change could have been a force for lessening
household demand for borrowing, perhaps partially
offsetting the increase in demand that is likely to
have come from faster income growth. On the other
hand, Krueger and Perri argue that rising income risk
could actually increase a household’s borrowing
capacity. Their argument follows from the assumption
that, following default on a loan, a household’s access
to credit would be sharply reduced. Rising income
risk makes losing access to credit more costly
and therefore could make a borrower less likely to
default. Knowing that a borrower is less likely to
default makes a lender more willing to lend. So the
effects of rising income risk on overall household
borrowing are uncertain. But there are other factors
affecting both demand and supply that could be at
work in U.S. credit markets.
The make-up of household consumption among
housing services, durable goods, and nondurable
goods is one additional demand-side factor that
could affect household borrowing. Since homes
and durable goods are quite typically purchased
with credit, an increase in consumers’ relative
demand for these goods could well be associated
with an increase in borrowing. Some evidence in
favor of this factor appeared earlier in this essay.
As previously mentioned, rising homeownership
and rising home values relative to income are
at least suggestive of an increase in the relative
demand for housing.
10

Real GDP Per Capita

Figure 2

(in thousands)

40

chained 2000 dollars

smooth consumption in the face of income risk. A
household will feel well-prepared to deal with shocks
to its income if it has a pool of savings to draw on
or if it is confident that it will have ample access to
credit. So, if a household faces an upper limit on how
much credit it will receive from financial institutions,
it will want to make sure it stays far enough away
from that upper limit so that hitting the limit in the
event of a reduction in income would be unlikely.
If income risk increases—if income becomes more
variable—the household will want to increase this
cushion between its borrowings and its debt limit.

35
30
25
40

20

35

15

30
25

10

20

5

15
1980

1990

2000

0
1950

1960

1970

1980

1990

2000

year
Source: Bureau of Economic Analysis

Also on the demand side, a household’s willingness
to borrow could be affected by its perceptions about
the consequences of default. In the United States,
defaulting borrowers can seek the protection of the
bankruptcy law, which allows them to either reschedule their payments to their creditors (under
Chapter 13 of the bankruptcy code) or dismiss their
debts in exchange for surrendering their assets, above
a personal exemption (under Chapter 7, with exemptions determined at the state level). Some observers
have argued that a greater propensity to file for bankruptcy is evidence of consumers seeing default as less
costly than in the past and is one cause of rising consumer indebtedness. This is often discussed in terms
of a sense of stigma that households may feel when
filing for bankruptcy. The argument is that stigma, a
psychic cost of default, has declined over time,
perhaps for cultural reasons not directly related to
credit market conditions. Such a decline of the
perceived costs of default would make a household
more willing to borrow at a given interest rate.
But the effect that a decline in stigma or in other
costs of default has on borrowing amounts is at least
muted because of the effect this change would have
on lenders and the price of credit. Borrowers who
increase their debt because they do not mind defaulting increase the risk faced by lenders, and lenders,

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in turn, will have to raise their interest rates in order
to compensate for this increase in risk. This rise
in interest rates will tend to reduce borrowing,
especially by those who consider themselves unlikely to default. In fact, Kartik Athreya has shown that
the overall effect of declining stigma would likely be
a decline in total borrowing.6
There could also be factors on the supply side of
credit markets that contributed to a period of rising
debt among U.S. households. In particular, technological improvements have reduced the costs to
lenders of evaluating borrowers and managing
exposures to default risks. This type of change
would amount to a reduction of the overall cost of
lending and would thereby lead to an increase in the
supply of credit. This increase in supply would show
up in a reduction in the financial intermediary’s
“spread” between the interest paid to retail savers
and the rate charged on loans.
Of course, the financial intermediary that makes the
loan is not the ultimate supply of funds to a
borrower. Rather funds originate with the savings
of other households or businesses. And the funds
could come from within the same country or from
abroad. In recent years, funds from other countries
have indeed been a major source of supply for U.S.
credit markets. Even though the bulk of this foreign
investment is the purchase of government securities, these transactions do constitute an increase in
the total amount of funds flowing into U.S. financial
markets, which could translate into an easing
of credit conditions for
borrowing households.

rate at which they lent to all acceptable borrowers.
Lenders then used relatively rough evaluations of
borrower-default risk to determine who got credit.
Advances in credit scoring and other techniques
allow lenders to estimate borrowers’ default risk
in a more precise way than was possible in the
past, making it easier to offer different prices to
borrowers, depending on their risk characteristics.
This change has differing effects on the various
types of borrowers. Very low-risk borrowers probably
benefit, as they pay an interest rate that more
closely reflects their risk level. On the other end of
the spectrum, high-risk borrowers, who previously
were screened out of access to credit, also benefit
by finding their ability to borrow enhanced.
Borrowers in the middle, on the other hand, could
be hurt by a move from uniform to differential
pricing of credit. These in-between borrowers
may have benefited in the past from interest rates
that averaged them in with lower-risk borrowers.
The effects on different types of borrowers of
increased use of differential pricing are detailed
by Wendy Edelberg.7 Still, the technological change
that makes differential pricing more practical is the
same change that lowers the overall costs of lending, making it likely that many, if not most types of
borrowers, have seen either a reduction in the cost
of borrowing or an increase in access to credit.

Another change on the supply side of credit
markets that would have effects similar to declining
costs of lending is an increase in the degree
of competition among
Falling average costs of borrowing, lenders. If competition is
weak, then lenders are
Interpreting evidence on
from a combination of improved able to set interest rate
interest rates or spreads
margins at levels that
technology and increased competi- more than compensate
over time is made difficult
by another trend in the
for risk and the costs of
tion, appears to be a major lending. Many descrippricing of loans. There is
an increasing tendency of
the credit card
contributing factor to the expansion tions of market describe
lenders to differentiate
lending
their lending terms based
it as having relatively
of consumer credit.
on borrower characterisweak competition in the
8 The structure of the credit card market has
tics that are associated with default risk. In the 1980s,
1980s.
consumer lenders, especially for unsecured debt like
changed considerably since then, with many
credit card borrowings, usually set a single interest
observers concluding that increased competition has

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Federal Reserve Bank of Richmond • 2005 Annual Report

put downward pressure on interest rate spreads.
Competition appears to have increased in the mortgage lending market as well, where consumers are
increasingly able to search over a nationwide pool
of potential lenders, rather than being restricted to
a smaller set of local firms. Falling average costs
of borrowing, from a combination of improved
technology and increased competition, appears to
be a major contributing factor to the expansion of
consumer credit.9

thinking about changes in credit
markets—consequences
Changes in credit market conditions shift the
demand or supply of credit, resulting in changes in
the amount of borrowing done by households. The
data show clearly that the net effect of these
changes in recent decades has been to increase
borrowing relative to income. But to evaluate these
changes, we would like to have a sense of how they
affected the overall economic well-being of the
typical household. Some of the changes discussed
in the previous section were supply changes that
have the effect of reducing the cost of borrowing.
These changes enhance households’ ability to
smooth their consumption and are therefore likely
to make the average household better off.

increase is rising expectations of income growth. In
this case, increased debt would be associated with
improving economic well-being.
Given that a main motivation in households’ use of
credit is smoothing of consumption, one way
to assess the impact of credit expansion is to ask
whether this expansion has facilitated consumption
smoothing. The previous section noted evidence
studied by Krueger and Perri that points to rising
income risk for U.S. households since the 1980s.
These authors also examine the variability of
consumption and find that, while consumption risk
has risen over time as well, it has not risen nearly
as much as income risk. They conclude that households’ ability to smooth consumption has improved
over time, consistent with a view that the expansion
of credit has, on average, benefited households.

The fact that the typical household’s welfare
improves with a sustained expansion of credit does
not mean that such a trend creates no problems or
difficulties. Most importantly, the foregoing discussion assumes that household decision-making is
well-informed by the relevant facts and based on
sound analysis of the costs and benefits of credit.
While this may be a reasonable assumption for
enough households to make our conclusion about
the “average” household valid, there may well be
When an increase in borrowing is driven by increases
households whose decisions are imprudent, naive, or
in demand for credit, the effect on a household’s
based on faulty analysis. This may be particularly
well-being depends on the reasons for the increase
true in a period when credit use is growing
in demand. For instance, a temporary increase in
relatively rapidly. First, a
borrowing could result
period of credit expanfrom a disruption to a
Ability to smooth consumption has sion may be a period
household’s income. While
when the number of
the use of credit allows
improved over time, consistent new and inexperienced
the household to respond
efficiently to the disrupwith a view that the expansion of borrowers is particularly
high, and such borrowtion, the rise in borrowing
in such an instance is
credit has, on average, benefited ers may be more likely
to make mistakes in
occurring as the household
their financial decisions.
is becoming worse-off. So,
households.
Second, if the growth of
a short-lived surge in borcredit is associated with the introduction of new
rowing could be an indicator of households experienccredit instruments or new ways of pricing credit,
ing some financial stress. But the evidence reviewed in
even some more experienced borrowers may not
this essay deals more with a sustained rise in borrowfully appreciate the implications of their decisions
ing. As discussed previously, the demand-side factor
under the new arrangements.
most likely to be associated with such a sustained

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If credit market changes leave
some consumers relatively
uninformed about the choices
they face, then these changes
could also create opportunities for some providers of
credit services to exploit consumers’ lack of knowledge. It
should therefore not be surprising to see periods of rapid
credit growth coincide with
increased instances and allegations of abusive practices.
One particular area of change
and growth in credit markets
in the last fifteen years has
been in subprime lending.
Products and practices in the subprime market
have expanded the set of consumers with access to
credit, meaning the average subprime borrower is
even more likely to be an inexperienced borrower
than the average borrower overall. So, in recent
years we have seen rising public concern regarding
potentially predatory lending, or abusive practices
in the subprime lending market.
Of course, even for borrowers who are capable of
evaluating their credit market opportunities and
making well-informed decisions, outcomes are not
always positive. A consumer may face unanticipated
expenses or changes in income that limit the ability to
service debt, leading to default, bankruptcy, or foreclosure on a mortgaged home. And it is often hard to
know, after the fact, whether a distressed borrower
made a sound financial decision at the time a loan was
originally taken out. So distinguishing those who were
victimized from those who were careless and from
those who were just unlucky is not always possible.
The growth in bad outcomes from borrowing, a
trend that follows from the general growth in the
use of credit, can be a driving force for proponents of
a public policy response to credit market phenomena.
As more borrowers find themselves experiencing
difficulties, sentiment emerges for policies that could
keep consumers out of credit-induced financial
trouble. With such policies tending to be aimed at protecting borrowers of low and moderate means, a look

at the relevant facts regarding
credit use by households of
different income levels may
prove useful.

borrowing
trends across the
income distribution
The data presented in Figure 1
provide a picture of the borrowing behavior of the entire
household sector. That is, these
data might be thought of as
reflective of the average household in the United States. These
trends appear to be explained
by the supply and demand
factors discussed in the previous section. But as was
mentioned before, changes in credit market conditions
do not affect all households in the same way. In
particular, the uses and consequences of debt may
differ among households at different income levels.
Figure 3 presents information on household borrowing trends across the income distribution. (See
page 14.) These data are drawn from the Federal
Reserve Board’s Survey of Consumer Finances, which
is conducted every three years, with the most recent
data coming from the 2001 survey.10 The data from this
source do not stretch back as far as the aggregate data,
but they do include the period of rapid credit growth
in the 1990s.
The five graphs in the figure show the growth in
median debt-to-income ratios for the second, third,
and fourth income quintiles and for the top two
income deciles. In broad terms, the trends for different income quintiles look similar to the aggregate,
with debt-to-income ratios rising steadily through
the 1990s. In percentage terms, this growth was the
most pronounced for the group between the 20th
and 39th percentiles, which registered a 290 percent
increase, albeit from a very low base. By contrast,
the median debt-to-income ratio among the wealthiest
households—the top quintile—rose by 48 percent.
The poorest consumers—those in the lowest income
quintile—are missing in Figure 3. This is because
the figure shows median debt to income for each
13

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Federal Reserve Bank of Richmond • 2005 Annual Report

quintile, and throughout this period, fewer than
half of all households in the lowest quintile had any
debt. If we were to plot, instead, the median ratio
in each quintile for only those households with debt,
the lowest quintile would look more similar to the
others. Doing this leaves out growth in debt that
comes from increased participation in credit markets
and measures only the extent to which borrowing
increased by people who were already borrowing.
Among households having at least some debt,
debt-to-income ratios grew fastest—78 percent growth
from 1989 to 2001—for households in the lowest
quintile. At the same time, the fraction of low- and
moderate-income households with debt increased
during this period. This rate of “participation” in
taking on debt increased in all income groups below
the median, with the fastest growth coming in the
second lowest quintile.
The predominance of debt-to-income growth among
households in the lower part of the income distribution raises questions about whether the causes or
consequences of growing credit use among these
households are different than for households at or
above the median income level. As described in
the third section, there are both demand and supply
factors that have contributed to the growing use of
credit among U.S. households. On the demand side,
Figure 3

Total Debt to Income
for Select Income Percentiles
Median of:
Income percentile 20-39
Income percentile 40-59
Income percentile 60-79
Income percentile 80-89
Income percentile >90

debt as percent of income

100

80

20

0
1995

1998

year
Source: Federal Reserve Board of Governors

14

To the extent that growing credit use among lowincome households is being driven by growth in the
number of borrowers, it is likely that this expansion
has brought new, inexperienced borrowers into the
market. This is consistent with the direction of much
of the recent discussion about consumer credit policy.

There are three broad types of policy approaches
to limiting financial difficulties for borrowers. First,
one can imagine policies aimed at the problem of
borrowers being uninformed about financial choices.
Second, policies that seek to identify and punish
instances of abuse by lenders could provide some
protection to borrowers. Finally, regulators could try
to place limits on the terms and prices that lenders
can offer in the marketplace.

40

1992

On the supply side, the main factors increasing debt
have been improvements in technology that allow
improved underwriting practices and a move to
greater sensitivity of prices depending on borrowers’
risk characteristics. Both of these factors are likely to
have improved financial markets’ and institutions’
ability to bear the risks associated with lending
to lower-income households. The greater variability
of pricing, in particular, is likely to have helped
expand credit to households that previously would
have been rationed out of the credit market. This
effect may be reflected in the growth in the fraction
of low-income households that hold credit.

policy responses to changes in
credit markets

60

1989

a major determinant of borrowing is a household’s
expectations of income growth. The growth of the
aggregate use of credit in the 1990s lines up well
with a pickup in income growth during that period.
But income growth was uneven, with income inequality expanding. That is, the acceleration of
income growth occurred more for higher-income
households. So this demand-side factor might not
have been as important for the growth of borrowing
by low-income households.

2001

Efforts to raise consumers’ understanding of financial
choices have gained considerable attention recently.
There are two broad sets of tools that serve this goal.
One can require disclosures by lenders with the aim

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of ensuring that consumers can easily compare alternative credit options. This is the approach taken under
the truth in lending laws. It is not always easy to summarize all of the relevant conditions in a credit contract
with a few simple numbers, however. As the variety of
terms and conditions available in the market continues
to expand, there may be a limit to how much disclosures alone can enhance
consumer knowledge.
What exactly is

more costly on another dimension. Borrowers who
can understand such trade-offs are less likely to make
choices that have a high chance of negative outcomes.

A by-product of raising the level of financial savvy
among borrowers is that the potential gain to deceptive and abusive practices would be reduced. Still,
there will always be
it that consumers instances of such behavior, and effective law
should learn from financial education? enforcement is an imporThe other avenue to cretant supplement to a
ating better informed conThe goal, presumably, is for a house- well-informed population
sumers is through the
provision of financial lithold to be able to make informed, of borrowers. Prosecution
of specific acts, however,
eracy services. Credit counseling is one form of such
forward-looking choices with regard is difficult and costly,
leading some to advocate
services, and the 2005
credit market regulations
bankruptcy legislation into the use of credit instruments.
that prohibit certain praccluded counseling from an
tices that are believed to be particularly susceptible to
approved nonprofit provider as a precondition for
abuse. The prospect of prohibiting specific contractubankruptcy filing. The act also provides for the
al terms presents a difficult trade-off. Such a prohibidevelopment of postfiling educational materials.
tion may effectively prevent some instances of bad
There has also been movement in some states to
outcomes such as defaults, foreclosures, or bankrequire financial literacy curricula in public primary
ruptcies. And some of those instances would
and secondary schools. Some financial institutions
undoubtedly represent cases where it was probably
and trade associations have become directly involved
not in the borrower’s best interest to take out
in the development of financial literacy programs,
a loan with the particular terms. Some would be the
perhaps as an investment in their public image,
result of borrowers simply making mistakes, and
but also perhaps because many banks see better
some would arise from lenders being deceptive or
informed customers as a legitimate business goal.
manipulative. But some cases of bad outcomes would
result even for borrowers making sound, wellWhat exactly is it that consumers should learn from
informed choices. For those, the particular credit confinancial education? The goal, presumably, is for a
tract was the best option at the time they borrowed.
household to be able to make informed, forwardlooking choices with regard to the use of credit
A prohibition of a particular practice limits some
instruments. But being able to fully calculate the
households’ ability to manage their finances and
expected present value of different options may be
consumption. So such a regulatory approach to
beyond the reach of many consumers. Retail credit
credit market behavior necessarily protects some
products are not simple financial contracts. They often
borrowers at the expense of others. Still, one could
involve provisions that amount to options for either
argue that such a policy is warranted if it were the
the borrower or the lender. Such options might be
case that the group that would be helped is much
explicit in the contract, like the option to prepay a
larger than the group that would be hurt, or if
mortgage, or implicit, like the option to file for bankthe amount by which some are helped significantly
ruptcy. Accurately evaluating options is difficult, even
exceeds the amount by which others are hurt.
for the financially sophisticated. Perhaps one realistic
But the type of data necessary to make this kind
goal of financial education is for borrowers to appreof determination is very hard to come by. To
ciate that if one credit alternative has a lower initial
fully understand the overall impact on borrowers
monthly payment than another, then it is probably

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Federal Reserve Bank of Richmond • 2005 Annual Report

Without such detailed data,
the regulatory prohibition of
lending practices should be viewed very cautiously.
The general description provided in this essay of the
economics of and trends in household credit suggest
that, on the whole, the growth of credit we have
observed in recent decades has been beneficial for
consumers, providing them with an expanded set of
options for managing their lifetime consumption. And
this observation points to an important principle for
evaluating changes in credit markets, whether those
changes are in the form of new products or new
regulations. The decision to borrow is inherently a
forward-looking decision. Households borrow to

align their consumption today,
as well as their holdings of
housing and durable goods,
with their beliefs about their
consumption possibilities in
the future. Accordingly, the
appropriate perspective in
evaluating the addition or elimination of a credit product is
from the point in time at
which a household is making
a borrowing choice. Is a
household made better off or
worse off by having access to
this product? Adopting this
perspective does not mean
that one should ignore the bad
outcomes that result from use of the product. It
means, instead, that one should think of those
bad outcomes as part of a distribution of possible
outcomes and ask whether this distribution presents
the household, on average, with better consumption
opportunities than would be available without the
product. Without the data necessary to evaluate
the distribution of outcomes, we are left simply
knowing that the elimination of a particular credit
product may help some but hurt others. Simply
knowing that there is a trade-off is a first step, but a
small step on the way to policy analysis.

Kartik Athreya, Ned Prescott, Aaron Steelman, and Alex Wolman
contributed valuable comments to this article.

Ausubel, Lawrence. 1991. “The Failure of Competition in the Credit
Card Market.” American Economic Review 81 (March): 50-81.

Endnotes

Bostic, Raphael W. 2002. “Trends in Equal Access to Credit Products.”
In Thomas Durkin and Michael Staten (eds.), The Impact of Public
Policy on Consumer Credit. Boston: Kluwer Academic Publishers, 171-203.

of a particular lending practice and to assess the likely
effect of prohibiting it, one
would want to take a look at
a sample of households, some
who used the product in
question and some who did
not. By tracking that sample
for a considerable period,
both before and after taking
on the loan, one would reveal
the average determinants of
using the product together
with its impact.

1. An example is “Night of the Living Debt” in the January 4, 2006,
Wall Street Journal.
2. See Calder (1999).
3. Bostic (2002).
4. Maki (2002).
5. See Krueger and Perri (2005).
6. See Athreya (2004).
7. Edelberg (2003).
8. A noteable example is Ausubel (1991).
9. Athreya (2004) examines alternative sources of rising credit and
finds a strong case for technology and or competition as a primary
factor.
10. At the time this Report was in production, the 2004 SCF results had
not yet been released.

References
Athreya, Kartik. 2004. “Shame as It Ever Was: Stigma and Personal
Bankruptcy.” Federal Reserve Bank of Richmond Economic Quarterly
90 (Spring): 1-19.

16

Calder, Lendol. 1999. Financing the American Dream: A Cultural
History of Consumer Credit. Princeton: Princeton University Press.
Edelberg, Wendy. 2003. “Risk-based Pricing of Interest Rates in
Household Loan Markets.” Board of Governors of the Federal Reserve
System, Divisions of Research & Statistics and Monetary Affairs,
Finance and Economics Discussion Series 2003-62.
Eisinger, Jesse. 2006. “Night of the Living Debt.” Wall Street Journal
( January 4): C1.
Krueger, Dirk, and Fabrizio Perri. 2005. “Does Income Inequality Lead
to Consumption Equality? Evidence and Theory.” Federal Reserve Bank
of Minneapolis, Research Department Staff Report 363 ( June).
Maki, Dean. 2002. “The Growth of Consumer Credit and the Household
Debt Service Burden.” In Thomas Durkin and Michael Staten (eds.),
The Impact of Public Policy on Consumer Credit. Boston: Kluwer
Academic Publishers, 43-63.

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Boards of Directors and Advisory Groups
Federal Reserve Bank of Richmond Board of Directors ................................. 18
Baltimore and Charlotte Office Boards of Directors ...................................... 20
Small Business and Agriculture Advisory Council ......................................... 22
Community Development Advisory Council .................................................... 23
Operations Advisory Committee .................................................................... 24

17

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Federal Reserve Bank of Richmond • Board of Directors
Our Richmond Board oversees the management of the Bank and its Fifth District offices, provides timely business and
economic information, participates in the formulation of national monetary and credit policies, and serves as a link between
the Federal Reserve System and the private sector. The Board also has the responsibility of appointing the Bank’s president
and first vice president, with approval from the Federal Reserve Board of Governors. Six directors are elected by banks in
the Fifth District that are members of the Federal Reserve System, and three are appointed by the Board of Governors.
The Bank’s board of directors annually appoints our District representative to the Federal Advisory Council, which consists
of one member from each of the 12 Federal Reserve Districts. The Council meets four times a year with the Board of
Governors to consult on business conditions and issues related to the banking industry.
from left to right
CHAIRMAN

DEPUTY CHAIRMAN

Thomas J. Mackell, Jr.
Director
National Investment
Managers, Inc.
Warrenton, Virginia

Theresa M. Stone
Chief Financial Officer
Jefferson-Pilot Corporation
President
Jefferson-Pilot
Communications Company
Greensboro, North Carolina

Lemuel E. Lewis
Executive Vice President
and Chief Financial Officer
Landmark
Communications, Inc.
Norfolk, Virginia

18

Harry M. Lightsey, III
State President,
South Carolina
BellSouth
Columbia, South Carolina

Ernest J. Sewell
Senior Advisor
FNB Southeast
Greensboro, North Carolina

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Monetary policy has profound implications for our economic well-being. The regional

“

presence of the District Reserve Banks and their role in implementing and articulating this policy is extremely important.

”

Thomas J. Mackell, Jr., Chairman

right
FEDERAL ADVISORY COUNCIL
REPRESENTATIVE

G. Kennedy Thompson
President and Chief
Executive Officer
Wachovia Corporation
Charlotte, North Carolina

Barry J. Fitzpatrick
Chairman
Branch Banking & Trust
Company of Virginia
Falls Church, Virginia

Kathleen Walsh Carr
President
Cardinal Bank Washington
Washington, D.C.

W. Henry Harmon
President and Chief
Executive Officer
Triana Energy, Inc.
Charleston, West Virginia

Kenneth R. Sparks
President and Chief
Executive Officer
Ken Sparks Associates LLC
White Stone, Virginia

19

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Baltimore and Charlotte Office • Boards of Directors
Our Baltimore and Charlotte Offices have separate boards that oversee operations at their respective offices and, like our
Richmond Board, contribute to policymaking and provide timely business and economic information about the District.
Four directors on each of these boards are appointed by the Richmond directors, and three are appointed by the
Board of Governors.

The Baltimore Office focuses on the northern part of the Fifth District, reaching out

“

to the community to more fully understand the economic concerns of business

”

leaders and households and seeking opportunities to provide educational seminars.

William C. Handorf, Chairman, Baltimore Office

Baltimore Office Board of Directors
from left to right
CHAIRMAN

Kenneth C. Lundeen
President
Environmental Reclamation
Company
Baltimore, Maryland

Cynthia Collins Allner
Principal
Miles & Stockbridge P.C.
Baltimore, Maryland

Michael L. Middleton
Chairman and President
Community Bank of
Tri-County
Waldorf, Maryland

20

William C. Handorf
Professor of Finance
School of Business and
Public Management
George Washington University
Washington, D.C.

Donald P. Hutchinson
President and Chief
Executive Officer
SunTrust Bank, Maryland
Baltimore, Maryland

Dyan Brasington
Director
Economic and Workforce
Development
Towson University
Towson, Maryland

William R. Roberts
President
Verizon Maryland Inc.
Baltimore, Maryland

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As Charlotte has emerged as the nation’s second largest financial center, the

“

Charlotte Office has played a highly visible and important role in the economic growth
of the entire region. Its impact has extended to many sectors in the increasingly
diversified regional economy.

”

Michael A. Almond, Chairman, Charlotte Office

Charlotte Office Board of Directors
from left to right
CHAIRMAN

Donald K. Truslow
Chief Risk Officer
Wachovia Corporation
Charlotte, North Carolina

Anthony J. DiGiorgio
President
Winthrop University
Rock Hill, South Carolina

Michael C. Miller
Chairman and President
FNB Corporation and
First National Bank and
Trust Company
Asheboro, North Carolina

Lucy J. Reuben
Visiting Fellow
Duke University
Durham, North Carolina

Michael A. Almond
Counsel
Parker Poe Adams &
Bernstein LLP
Charlotte, North Carolina

Barry L. Slider
President and Chief
Executive Officer
First South Bancorp, Inc.
First South Bank
Spartanburg, South Carolina

Jim Lowry
Dealer Operator, Retired
Crown Automotive
High Point, North Carolina

21

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Small Business and Agriculture • Advisory Council
Established in 1985, the Small Business and Agriculture Advisory Council advises the Bank president and other senior
officers on the impact that monetary, banking, and fiscal policies have on the District’s small business and agricultural
sectors. The Council’s 12 members are appointed by the Bank president.
from left to right
CHAIRMAN

Jane Tabb
B. Vance Carmean, Jr.
Secretary
President
Lyle C. Tabb & Sons, Inc. Carmean Grain, Inc.
Kearneysville,
Ridgely, Maryland
West Virginia

James G. Patterson
Chairman and Chief
Executive Officer
Webb Patterson
Communications, Inc.
Durham, North Carolina

Thomas B. O’Hanlan
President and Chief
Executive Officer
Sealevel Systems, Inc.
Liberty, South Carolina

Barbara B. Lang
President and Chief
Executive Officer
DC Chamber of
Commerce
Washington, D.C.

James B. Gates, Jr.
Senior Partner
The Ridge Animal
Hospital
Farmville, Virginia

from left to right
R. Gerald Warren
President
Warren Farming
Company, Inc.
Newton Grove,
North Carolina

22

Dawn Gifford
Executive Director
D.C. Greenworks
Washington, D.C.

David Leonard
President
Leonard Companies, Ltd.
Lebanon, Virginia

S. M. Bowling
President
Dougherty Company, Inc.
Charleston, West Virginia

William F. Willard, Sr.
President
Willard Agri-Service of
Frederick, Inc.
Frederick, Maryland

Melvin L. Crum
Owner/Operator
Crum Farms
Rowesville,
South Carolina

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Community Development

• Advisory Council

Created in 1998 to enhance communication between the Bank and the public concerning community development issues,
our Community Development Advisory Council advises the Bank president and other senior officers on community
development concerns and related policy matters. The Council’s eight members are appointed by the Bank president.
from left to right
T. K. Somanath
Executive Director
Better Housing Coalition
Richmond, Virginia

Sharon Walden
Executive Director
Stop Abusive Family
Environments (S.A.F.E.)
Welch, West Viginia

Jane N. Henderson
Independent Consultant
Senior Vice President and Director
of Community Development, Retired
Wachovia Corporation
Charlotte, North Carolina

from left to right

Bernie Mazyck
President and Chief Executive Officer
South Carolina Association of
Community Development
Corporations (SCACDC)
Charleston, South Carolina

not pictured
CHAIR

Eric Stein
President
Center for Community
Self-Help
Durham, North Carolina

Peter J. Ponne
Senior Vice President and
Manager
SunTrust CDC,
Mid-Atlantic Region
SunTrust Bank
Baltimore, Maryland

Greta J. Harris
Senior Program Director
Local Initiatives Support
Corporation (LISC)
Richmond, Virginia

David H. Swinton
President
Benedict College
Columbia, South Carolina

23

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Operations • Advisory Committee
The Operations Advisory Committee was established by the Bank in 1978 to serve as a forum for communication with
financial institutions about the Federal Reserve’s financial services and to help the Bank respond to the changing needs of
our banking constituency. Committee members are appointed by the Bank’s first vice president.
from left to right
CHAIRMAN

Martin W. Patterson
Senior Vice President
Enterprise Check Services
SunTrust Banks, Inc.
Richmond, Virginia

James H. Thompson, III
Vice President and Cashier
The National Capital Bank of
Washington
Washington, D.C.

Cynthia B. Cervenka
President and Chief
Executive Officer
Damascus Community Bank
Damascus, Maryland

Donald G. Chapman
Senior Vice President
Internal Audit
Navy Federal Credit Union
Merrifield, Virginia

R. Allen Young
Executive Director
South Carolina Clearing
House Association, Inc.
Columbia, South Carolina

James T. Riffe
Executive Vice President
and Chief Operating
Officer
Highlands Union Bank
Abingdon, Virginia

from left to right
Daniel O. Cook, Jr.
Executive Vice President
and Chief Operating
Officer
Arthur State Bank
Union, South Carolina

Ralph Reardon
Senior Vice President and
Chief Financial Officer
Coastal Federal
Credit Union
Raleigh, North Carolina

John A. Harper
Vice President
Summit Financial Group
Moorefield, West Virginia

Melissa Quirk
Executive Vice President
The Columbia Bank
Columbia, Maryland

William T. Johnson, Jr.
President and Chief
Executive Officer
Citizens National Bank
Elkins, West Virginia

not pictured
John DuBose
Executive Vice President,
Chief Operating Officer, and
Chief Technology Officer
Carolina First Bank
Lexington, South Carolina

24

Jimmy Graham
Executive Vice President
Coastal Federal Bank
Myrtle Beach, South Carolina

Jay F. Hinkle
Senior Vice President
Wachovia Corporation
Glen Allen, Virginia

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from left to right
Kenneth L. Richey
Executive Vice President
Operations Division
The National Bank of South Carolina
Columbia, South Carolina

Stephen R. Winston
Associate Director
Treasury Cash Operations
Capital One Services, Inc.
Glen Allen, Virginia

Kenneth L. Greear
Executive Vice President
United Bank
Charleston, West Virginia

B. Martin Walker
Senior Vice President
Bank of America
Richmond, Virginia

Tim Dillow
Senior Vice President
Branch Banking & Trust
Company
Wilson, North Carolina

E. Stephen Lilly
Senior Vice President
and Chief Operating
Officer
First Community
Bancshares, Inc.
Bluefield, Virginia

from left to right
Jay G. Fitzhugh
Senior Vice President
Strategic Directions
Provident Bank
Baltimore, Maryland

Terry Childress
Senior Vice President
Virginia Credit Union League
Lynchburg, Virginia

not pictured
W. K. Keener, Jr.
President and Chief
Executive Officer
Allegacy Federal Credit Union
Winston-Salem,
North Carolina

Kent B. Miller
Vice President
Operations and
Service Delivery
RBC Centura Bank
Rocky Mount, North Carolina

Michael A. Tucker
President and Chief
Executive Officer
West Virginia Central
Credit Union
Parkersburg, West Virginia

Paul A. Slaby
Vice President and
Controller
Aberdeen Proving Ground
Federal Credit Union
Edgewood, Maryland

Gerald McQuaid
Senior Vice President
Division Executive,
Bank Operations
Chevy Chase Bank, FSB
Laurel, Maryland

Jack H. Goldstein
President and Chief
Executive Officer
NBRS Financial
Rising Sun, Maryland

25

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Thank You
We express our gratitude to all members of our boards of directors for their
guidance and support in 2005. Their insights are invaluable in the formulation of
monetary policy and the oversight of Bank operations. Our appreciation also goes
to members of our advisory groups for their dedicated service throughout the
year. Thanks to our relationships with all of these individuals we learn a great deal
about the communities and institutions that we serve and how we can work
within the Federal Reserve System to better meet their needs.

We are especially grateful to those members of our boards of directors whose
terms ended in 2005:
Barry J. Fitzpatrick and W. Henry Harmon • from our Richmond Board
Dyan Brasington • from our Baltimore Board
Michael A. Almond and Lucy J. Rueben • from our Charlotte Board

26

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Fifth District • Economic Report
The economy of the Fifth Federal Reserve
District is similar in many ways to the
national economy. For instance, the distribution
of employment and output across industry sectors
in the District is similar to the United States as a
whole. As a result, broad measures of economic
conditions within the District often track national
movements. Recently, the nation has experienced
relatively strong growth in the services sector, while
segments of the manufacturing sector have fared
less well. The same is true in the Fifth District. This
has led to differing levels of economic performance
within the region. Notably, economic growth in the
Fifth District tends to be centered in urban areas
with weaker economic performance in rural areas.
In the region’s largest metropolitan center—
Washington, D.C., along with its suburbs in Northern
Virginia, southern and central Maryland, and the
eastern panhandle of West Virginia—the government
and services sectors play large roles in the economy.
The strong government presence is not surprising
given that the District of Columbia is the seat of the
federal government and the neighboring states catch
a lot of the spillover. In addition, high-wage service
components such as professional services and health
care boost the area’s income levels.

Nonfarm Payroll Employment
december 2005
(thousands of persons)
District of columbia
Maryland
North Carolina
South Carolina
Virginia
West Virginia

Fifth District
United States

% change from
december 2004

687
2,568
3,944
1,876
3,700
752

1.4
1.3
1.6
1.4
2.1
1.6

13,526
134,376

1.6
1.5

source: Bureau of Labor Statistics/Haver Analytics
note: All data are seasonally adjusted.

While North Carolina and South Carolina also have
large services sectors, they have a bigger manufacturing presence than do other District states.
Manufacturing is mainly located in the weakerperforming rural areas of the Carolinas, while the
states’ faster growing urban areas—such as Raleigh,
Charlotte, Columbia, and Charleston—have primarily
services-based economies. The urban/rural distinction
is important in much of West Virginia, Virginia, and
Maryland as well. Beyond the sprawling suburbs of
Washington, D.C, large parts of those states remain
rural, though a number of moderate-to-large urban
areas are scattered throughout. These urban pockets
have typically seen somewhat stronger economic
growth, while the rural regions exhibit economic
characteristics similar to those found in the rural parts
of North and South Carolina.
Reflecting on 2005, the overall Fifth District economy
posted a solid performance during the year. The
District’s unemployment rate remained below the
national figure, job growth was strong, and personal
income expanded briskly. Households shook off
higher gasoline prices and prospects of softening
housing prices, keeping consumer spending on track.
Other measures were bright as well. Though business
and household bankruptcy filings increased, the
increases were below the national averages and likely
boosted by impending changes in the law. Despite the
overall positive tone, however, pockets of concern
remained. In some industries and in some areas of the
District, economic performance was less than robust.

employment
In labor markets, further tightening was the major
trend in 2005. Districtwide, the unemployment rate
edged down slightly, ending the year at 4.7 percent,
0.2 percentage points below the national rate. But
there was significant variation among District jurisdictions. Virginia and Maryland posted the lowest
rates, while West Virginia and North Carolina came
in around the national average. In contrast,
Washington, D.C., and South Carolina saw their
unemployment rates on the high end, hovering well
above both the District and national levels.
The District labor market entered 2005 somewhat
tighter than even the taut national market, and a
27

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Federal Reserve Bank of Richmond • 2005 Annual Report

number of businesses in our region reported some
difficulty finding workers, especially in the latter part
of 2005. This situation hampered the pace of job
growth in some urban areas as a result. Overall, jobs
in the Fifth District expanded at a 1.6 percent clip
for the year, a bit above the national pace.

Total Personal Income
fourth qtr.

2005
(chained 2000 dollars,
in billions)

% change from
fourth qtr. 2004

District of Columbia
Maryland
North Carolina
South Carolina

28
212
240
109

2.8
1.8
1.5
1.8

Virginia
West Virginia

264
45

2.9
1.9

Fifth District
United States

898
9,318

2.1
1.7

source: Bureau of Economic Analysis/Haver Analytics

By sector, job growth was brisker in the goodsproducing side of the economy than in the services
side, a surprise perhaps given recent weakness in
District factory employment. Manufacturing continued
to shed quite a few jobs in 2005—about 2.0 percent of
total employment in that sector—with the losses
coming primarily in the Carolinas, where, despite
these job cuts, the manufacturing presence remains
pronounced. Nevertheless, strong growth in District
construction jobs, combined with solid growth in
natural resource and mining jobs, was more than
enough to offset the factory losses, netting a solid gain
in the Fifth District for the year. As for services, the
pace of job growth was hampered by sluggish growth
in the information, government, and trade/transportation/mining categories. In contrast, job growth was
strong in the professional/business services and
education/health services categories. Solid growth
in these areas was welcome news, since many of
the highest-paying services jobs are concentrated
28

in these sectors. To round out the job numbers,
respectable gains were also registered in the financial
activities and leisure/hospitality categories.

personal income and household
financial conditions
Reasonably strong growth in personal income accompanied strong growth in labor markets. For the year,
total personal income in the District advanced 2.1 percent—several notches above the national pace. More
impressive, perhaps, all District jurisdictions except
North Carolina outpaced the nation. Virginia led the
pack with the District of Columbia close behind.
With firm labor markets and solid growth in personal
income, improvement in households’ financial conditions would be expected. Although that was generally
the case, not all measures strengthened. Personal
bankruptcy filings, for example, increased sharply
across the Fifth District. The increase, however, was
significantly below the national rate and was likely
driven by households’ awareness of more stringent
bankruptcy requirements that took effect October 31.
The expectation of tougher requirements likely led
many households to file in advance of the changes,
leading to a bulge in third-quarter bankruptcies.
The story was more straightforward with past-due
mortgages. At the end of the fourth quarter, only
3.1 percent of mortgages districtwide were past due
30 days or more. This figure represented a small
decline from a year earlier and matched the national
average. The improved performance likely reflected
the firming of household income prospects but also
may have been boosted by relatively low interest
rates and widely available refinancing options.
Overall, there was little evidence that the ability of
Fifth District households to service their mortgage
debt was much changed as 2005 drew to a close.

business conditions
Broad measures of District business conditions also
generally firmed in 2005, though not all gauges
pointed higher. On balance, our monthly surveys of
business conditions painted a fairly positive picture
of services-producing firms in 2005. Over the year,
revenues at these businesses generally expanded
moderately, and managers remained optimistic about

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their customer demand going forward. District
retailers also generally reported good growth in
sales, though strong incentives-driven automobile
sales boosted summer activity, with some slowing
noticed in the late fall. But as the holiday season
got underway, retailers saw sales strengthen in
December.
The firming of retail sales late in the year was
comforting. Solid household financials should have
bolstered spending as the year came to an end, but
households faced several potential obstacles. First, of
course, was the aftermath of the Gulf Coast hurricanes
and the higher energy prices that followed. Second
were the blaring headlines of a pending cooling or
collapse in housing prices and the hit to household
net worth that would ensue. Each of these factors
could have derailed consumer confidence and dampened spending, but they didn’t.
Manufacturers responding to our surveys reported
that they struggled to gain traction on both revenues
and new orders for the first half of the year. Both
measures would register gains only to see the
improvement fade in subsequent months—a pattern
that repeated itself several times. Some momentum
appeared to be building late in the year with several
strong months of revenues and orders, but the
December report showed retrenchment on both
fronts, leaving prospects for early 2006 uncertain.
Compounding the situation, factory job numbers
slipped late in the year.
Another key indicator of District business conditions
suggested a mixed message in 2005. Business bankruptcy filings increased significantly over the previous year, though, like household filings, the increase
was probably driven in large part by pending stricter
laws, which led businesses to take action sooner
than they initially planned. At year’s end, bankruptcy
filings for the District were 37.1 percent ahead of a
year before. While this increase was substantial, the
increase was well below the national gain during
the period. By jurisdiction, changes in the number
of filings varied widely. To cite extreme changes,
filings in Maryland were up nearly 160 percent,
while they were down nearly 50 percent in neighboring Virginia.

housing and commercial real estate
Real estate remained in the headlines throughout
most of the year. The year began with accelerating
activity in housing, leading to multiple offers on
homes in many areas and sharp rises in prices in the
hotter markets. Compared to a year earlier, for example, house prices in the Washington, D.C., metro
area posted a 24.7 percent increase, the fastest rate
ever recorded. National headlines expressed increasing concern about the sustainability of home prices as
the year progressed, leaving many analysts and homeowners uncertain about the future path of home
values. At year’s end, mounting evidence suggested
a cooling in housing activity, as houses remained on
the market longer and fourth-quarter home sales
slipped 2.4 percent from year-earlier levels, but there
were few signs of weakening prices. In commercial
real estate, conditions were less frenzied. Steady
progress was seen in 2005, with vacancy rates in
office buildings gradually falling and some new construction taking hold late in the year. Vacancy rates
also moved lower in industrial space and the construction of retail space progressed at a moderate pace.

looking to the future
The District economy was generally solid in 2005.
Gains in jobs and brisk growth in personal income
left District households on firm footing as they
entered 2006, suggesting bright prospects for the
year ahead. Less clear, though, were prospects for
District businesses. The strong performance of
services firms and retailers in 2005 appeared to
suggest momentum going forward, but conditions
in manufacturing were spotty as the year drew to
a close, creating uncertainty about near-term
prospects. Nevertheless, a few bullets appeared to
have been dodged during the year, in part because
households remained resolute in their spending.
Some of their optimism probably reflected housing
markets that bent but didn’t break. But the optimism
may have had deeper roots. High gas prices and
rising interest rates apparently didn’t substantially
change most households’ opinions about their
financial prospects. Overall, they remain optimistic.
If District household spending holds up, it could
boost the sputtering segments of the business sector
and make for a bright 2006. But, of course, this
outcome is not certain. Only time will tell.
29

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Message • from Management
Over the past year, the Federal Reserve
Bank of Richmond has been working
to sharpen our identity and long-term
goals. As we prepare for the future, we seek to
build on the many things we are and the many
things we do in service to the nation’s economy.
The Richmond Fed is a research economist, bringing
insights to the development of national monetary policy, and also studying our regional economy and the
intricacies of consumer finance to educate the public
by making complex topics understandable.
The Richmond Fed is a bank examiner, reviewing the
financial condition of a commercial bank—from the
smallest community bank to some of the largest banking organizations—to help preserve the safety and
soundness of the nation’s financial institutions. We are
the person sorting checks in the middle of the night or
distributing currency to depository institutions, who
plays an important role in the payments system that
makes the economy run.

The Richmond Fed is a community affairs specialist,
reaching out to people and organizations in the Fifth
District to spread information about economic development, strengthen relationships, and learn about the
region and its issues so that we can better serve our
communities and carry out the mission of the Bank.
We are also the information technology, financial management, and human resources professionals who
support all of our employees and critical activities.
People—as these and countless other examples
demonstrate—are essential to the work and are vital to
the success of the Federal Reserve Bank of Richmond.
As the Bank’s senior management, we recognize the
critical value that all of our people bring to all that we
do to carry out our vision of excellent performance
and making important and unique contributions to the
Federal Reserve System.
Our people influence the nation’s economic policy.
Research economists examine topics that are important to the country, and our publications seek to bring
the voice of the Richmond Fed into national and
regional policy discussions. We also endeavor to build
upon our knowledge of our District and its economy,

from left to right
Robert E. Wetzel, Jr.

Claudia N. MacSwain

Walter A. Varvel

Jeffrey M. Lacker

30

John A. Weinberg

Marsha S. Shuler

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looking for emerging issues to explore and for places
where we can lead, even as we collaborate with
researchers from other Reserve Banks and from
research institutions around the world.
Our people perform valuable and critical functions for
the banking and financial services industries. The
diverse characteristics of commercial banking in our
District have expanded the opportunities for our examiners to do challenging work and reinforced the
responsibility to do complex and important work right.
We have developed expertise that allows us to leverage
our collective knowledge to benefit the Fifth District
and the Federal Reserve System. Collaboration in our
work and a focus on execution has improved performance in a variety of departments within the Bank and
has resulted in recognition and additional responsibilities, such as the selection of our check adjustments
operations for a greater role within the System.
Our people connect us to our District, helping us find
ways to learn about our communities and to share
what we know in a manner that will be meaningful to
our constituencies. This is evident in our community
affairs mission, the outreach we have through our

publications, and our efforts to improve financial
literacy and economic education. But our links to the
District are also much broader, from our varied relationships with the banking industry to our employees’
involvement in the communities where they live and
work. By developing a better understanding and having open communication, we broaden our presence in
the region and help to make the Federal Reserve more
relevant and more effective in meeting the needs of
those we serve.
The Richmond Fed is all of these things and all of the
people whose work is described here. But it is also the
people working in other areas of the Bank who carry
out a variety of tasks critical to our goals. To do what
is necessary to fulfill our mission and achieve our
vision, we have committed to building the strongest
staff we can. We are pursuing a program to further
strengthen the development, retention, and recruitment of talented staff for this important work, with the
goal of matching up the right people for the right jobs.
The right people to advocate ideas that lead to sound
economic policy, the right people to know the industries we serve and perform the functions they rely on,
the right people to understand our District.

from left to right
Malcolm C. Alfriend

• The Management Team
James McAfee

Jeffrey S. Kane

Janice E. Clatterbuck

Victor M. Brugh, II

David E. Beck

31

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Officers • 2005
Jeffrey M. Lacker • President

Eugene W. Johnson, Jr. • Vice President

Walter A. Varvel • First Vice President

Malissa M. Ladd • Vice President

Malcolm C. Alfriend • Senior Vice President

Edgar A. Martindale, III • Vice President
and Controller

Victor M. Brugh, II • Medical Director
Raymond E. Owens, III • Vice President
Janice E. Clatterbuck • Senior Vice President
Howard S. Whitehead • Vice President
Claudia N. MacSwain • Senior Vice President
and Chief Financial Officer
James McAfee • Senior Vice President
and General Counsel

Anthony Bardascino • Assistant Vice President
Hattie R. C. Barley • Assistant Vice President
Granville Burruss • Assistant Vice President

Marsha S. Shuler • Senior Vice President
John B. Carter, Jr. • Assistant Vice President
John A. Weinberg • Senior Vice President
and Director of Research
Robert E. Wetzel, Jr. • Senior Vice President
and General Auditor

Constance B. Frudden • Assistant Vice President
Joan T. Garton • Assistant Vice President
Anne C. Gossweiler • Assistant Vice President

James M. Barnes • Vice President
Cathy I. Howdyshell • Assistant Vice President
Roland Costa • Vice President
Gregory A. Johnson • Assistant Vice President
Alan H. Crooker • Vice President
Jeannette M. Johnson • Assistant Vice President
A. Linwood Gill, III • Vice President
Steve V. Malone • Assistant Vice President
Howard S. Goldfine • Vice President
Mattison W. Harris • Vice President

Page W. Marchetti • Assistant Vice President
and Secretary

Andreas L. Hornstein • Vice President

Jonathan P. Martin • Assistant Vice President

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Andrew S. McAllister • Assistant Vice President

Julie Yoo • Assistant Vice President

William R. McCorvey, Jr. • Assistant General Counsel

David J. Zimmerman • Assistant Vice President

Diane H. McDorman • Assistant Vice President

Baltimore Office

Robert J. Minteer • Assistant Vice President

David E. Beck • Senior Vice President

Susan Q. Moore • Assistant Vice President

Amy L. Eschman • Assistant Vice President

Barbara J. Moss • Assistant Vice President

John I. Turnbull, II • Assistant Vice President

Edward B. Norfleet • Assistant Vice President

Charlotte Office

P. A. L. Nunley • Assistant General Counsel

Jeffrey S. Kane • Senior Vice President

Lisa T. Oliva • Assistant Vice President

R. William Ahern • Vice President

Arlene S. Saunders • Assistant Vice President

Jennifer J. Burns • Vice President

Rebecca J. Snider • Assistant Vice President

Terry J. Wright • Vice President

Daniel D. Tatar • Assistant Vice President

Jennifer R. Zara • Vice President

Jeffrey K. Thomas • Assistant Vice President

T. Stuart Desch • Assistant Vice President

Sandra L. Tormoen • Assistant Vice President

Ronald B. Holton • Assistant Vice President

Mark D. Vaughan • Assistant Vice President

Richard J. Kuhn • Assistant Vice President

Lauren E. Ware • Assistant Vice President

Adam S. Pilsbury • Assistant Vice President

William F. White • Assistant Vice President

Lisa A. White • Assistant Vice President

Michael L. Wilder • Assistant Vice President

Richard F. Westerkamp, Jr. • Examining Officer

Karen J. Williams • Assistant Vice President

Listing as of December 31, 2005

33

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Financial Statements
Management Assertion ............................................................................... 35
Report of Independent Accountants ............................................................ 36
Report of Independent Auditors .................................................................. 37
Comparative Financial Statements .............................................................. 38
Notes to Financial Statements .................................................................... 41

The firm engaged by the Board of Governors for the audits of the individual
and

combined

financial

statements

of

the

Reserve

Banks

for

2005

was

PricewaterhouseCoopers LLP (PwC). Fees for these services totaled $4.6 million. To
ensure auditor independence, the Board of Governors requires that PwC be independent
in all matters relating to the audit. Specifically, PwC 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. In 2005, the Bank did not engage PwC for
any material advisory services.

34

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Management Assertion •

COSO

March 3, 2006

to the board of directors:
The management of the Federal Reserve Bank of Richmond (“FRB Richmond”) is responsible for the preparation and fair presentation of the Statement of Financial Condition, Statement of Income, and Statement
of Changes in Capital as of December 31, 2005 (the “Financial Statements”). The Financial Statements have
been prepared in conformity with the accounting principles, policies, and practices established by the Board
of Governors of the Federal Reserve System and as set forth in the Financial Accounting Manual for the
Federal Reserve Banks (“Manual”), and as such, include amounts, some of which are based on judgments and
estimates of management. To our knowledge, the Financial Statements are, in all material respects, fairly
presented in conformity with the accounting principles, policies and practices documented in the Manual and
include all disclosures necessary for such fair presentation.
The management of the FRB Richmond is responsible for maintaining an effective process of internal
controls over financial reporting including the safeguarding of assets as they relate to the Financial
Statements. Such internal controls are designed to provide reasonable assurance to management and to the
Board of Directors regarding the preparation of reliable Financial Statements. This process of internal
controls contains self-monitoring mechanisms, including, but not limited to, divisions of responsibility and a
code of conduct. Once identified, any material deficiencies in the process of internal controls are reported to
management, and appropriate corrective measures are implemented.
Even an effective process of internal controls, no matter how well designed, has inherent limitations, including the possibility of human error, and therefore can provide only reasonable assurance with respect to the
preparation of reliable financial statements.
The management of the FRB Richmond assessed its process of internal controls over financial reporting
including the safeguarding of assets reflected in the Financial Statements, based upon the criteria established
in the “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on this assessment, we believe that the FRB Richmond maintained an
effective process of internal controls over financial reporting including the safeguarding of assets as they
relate to the Financial Statements.

FEDERAL RESERVE BANK OF RICHMOND

Jeffrey M. Lacker • President

Walter A. Varvel • First Vice President Claudia N. MacSwain • Senior Vice President
and Chief Financial Officer

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Independent Accountants

to the board of directors of the federal reserve bank of richmond:
We have examined management’s assertion, included in the accompanying Management Assertion, that the
Federal Reserve Bank of Richmond (“FRB Richmond”) maintained effective internal control over financial
reporting and the safeguarding of assets as of December 31, 2005, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. FRB Richmond’s management is responsible for maintaining effective internal control over
financial reporting and safeguarding of assets. Our responsibility is to express an opinion on management’s
assertion based on our examination.
Our examination was conducted in accordance with attestation standards established by the American
Institute of Certified Public Accountants and, accordingly, included obtaining an understanding of internal
control over financial reporting, testing and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we considered necessary in the circumstances. We believe
that our examination provides a reasonable basis for our opinion.
Because of inherent limitations in any internal control, misstatements due to error or fraud may occur and
not be detected. Also, projections of any evaluation of internal control over financial reporting to future
periods are subject to the risk that the internal control may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assertion that FRB Richmond maintained effective internal control over financial reporting and over the safeguarding of assets as of December 31, 2005 is fairly stated, in all material
respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission.
This report is intended solely for the information and use of management and the Board of Directors and
Audit Committee of FRB Richmond, and any organization with legally defined oversight responsibilities and
is not intended to be and should not be used by anyone other than these specified parties.

March 8, 2006
McLean, Virginia

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Report of •

Independent Auditors

to the board of governors of the federal reserve system and
the board of directors of the federal reserve bank of richmond:
We have audited the accompanying statements of condition of the Federal Reserve Bank of Richmond (the
“Bank”) as of December 31, 2005 and 2004, and the related statements of income and changes in capital for
the years then ended, which have been prepared in conformity with the accounting principles, policies, and
practices established by the Board of Governors of the Federal Reserve System. These financial statements
are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
As described in Note 3, these financial statements were prepared in conformity with the accounting
principles, policies, and practices established by the Board of Governors of the Federal Reserve System.
These principles, policies, and practices, which were designed to meet the specialized accounting and
reporting needs of the Federal Reserve System, are set forth in the Financial Accounting Manual for
Federal Reserve Banks and constitute a comprehensive basis of accounting other than accounting principles
generally accepted in the United States of America.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial
position of the Bank as of December 31, 2005 and 2004, and results of its operations for the years then ended,
on the basis of accounting described in Note 3.

March 8, 2006
McLean, Virginia

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Statements of Condition • (in millions)
As of December 31,

2005

2004

Assets
Gold certificates
Special drawing rights certificates
Coin
Items in process of collection
Loans to depository institutions
U.S. government securities, net
Investments denominated in foreign currencies
Accrued interest receivable
Interdistrict settlement account
Bank premises and equipment, net
Interest on Federal Reserve notes due from U.S. Treasury
Other assets

$

836
147
66
225
1
57,253
3,454
445
8,521
252
35
90

$

819
147
62
341
–
55,148
5,009
386
–
252
–
124

Total assets

$ 71,325

$ 62,288

$ 57,760
2,328

$ 52,716
2,340

3,182
153
509
–
–
107
36

1,645
71
544
101
420
91
64

Total liabilities

64,075

57,992

Capital:
Capital paid-in
Surplus

3,942
3,308

2,148
2,148

Total capital

7,250

4,296

$ 71,325

$ 62,288

Liabilities and Capital
Liabilities:
Federal Reserve notes outstanding, net
Securities sold under agreements to repurchase
Deposits:
Depository institutions
Other deposits
Deferred credit items
Interest on Federal Reserve notes due U.S. Treasury
Interdistrict settlement account
Accrued benefit costs
Other liabilities

Total liabilities and capital
The accompanying notes are an integral part of these financial statements.

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Statements of Income • (in millions)
For the years ended December 31,

2005

2004

Interest Income
Interest on U.S. government securities
Interest on investments denominated in foreign currencies

$

Total interest income

2,143
53

$

1,677
63

2,196

1,740

62

23

2,134

1,717

Interest Expense
Interest expense on securities sold under agreements
to repurchase
Net interest income

Other Operating Income (Loss)
Income from services
Compensation received for check services provided
Reimbursable services to government agencies
Foreign currency gains (losses), net
Other income

–
40
28
(519)
8

66
–
32
289
5

Total other operating income (loss)

(443)

392

Salaries and other benefits
Occupancy expense
Equipment expense
Assessments by the Board of Governors
Other credits

241
33
59
99
(99)

215
32
88
102
(121)

Total operating expenses

333

316

$ 1,358

$ 1,793

Dividends paid to member banks
Transferred to surplus
Payments to U.S. Treasury as interest on Federal Reserve notes

$

$

Total distribution

$ 1,358

Operating Expenses

Net income prior to distribution

Distribution of Net Income
198
1,160
–

125
74
1,594

$ 1,793

The accompanying notes are an integral part of these financial statements.

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Statements of Changes in Capital • (in millions)
For the years ended December 31, 2005
and December 31, 2004
Balance at January 1, 2004
(41.5 million shares)
Transferred to surplus
Net change in capital stock issued
(1.5 million shares)
Balance at December 31, 2004
(43.0 million shares)
Transferred to surplus
Net change in capital stock issued
(35.8 million shares)
Balance at December 31, 2005
(78.8 million shares)

Capital
Paid-In

$

2,074

Surplus

$

2,074

$

4,148

–

74

74
$

74
–

74

2,148

$

2,148

$

4,296

–

1,160

1,160

1,794

–

1,794

$ 3,942

$ 3,308

$ 7,250

The accompanying notes are an integral part of these financial statements.

40

Total
Capital

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Notes to •
1.

structure

The Federal Reserve Bank of Richmond (“Bank”) is part of
the Federal Reserve System (“System”) and one of the twelve
Reserve Banks (“Reserve Banks”) created by Congress
under the Federal Reserve Act of 1913 (“Federal Reserve
Act”), which established the central bank of the United
States. The Reserve Banks are chartered by the federal government and possess a unique set of governmental, corporate, and central bank characteristics. The Bank and its
branches in Baltimore, Maryland, and Charlotte, North
Carolina serve the Fifth Federal Reserve District, which
includes Maryland, North Carolina, South Carolina, Virginia,
District of Columbia, and portions of West Virginia.
In accordance with the Federal Reserve Act, supervision and
control of the Bank are exercised by a Board of Directors.
The Federal Reserve Act specifies the composition of the
Board of Directors for each of the Reserve Banks. Each
board is composed of nine members serving three-year
terms: three directors, including those designated as
Chairman and Deputy Chairman, are appointed by the
Board of Governors, and six directors are elected by member banks. Banks that are members of the System include all
national banks and any state-chartered banks that apply and
are approved for membership in the System. Member banks
are divided into three classes according to size. Member
banks in each class elect one director representing member
banks and one representing the public. In any election of
directors, each member bank receives one vote, regardless
of the number of shares of Reserve Bank stock it holds.
The System also consists, in part, of the Board of Governors
of the Federal Reserve System (“Board of Governors”) and
the Federal Open Market Committee (“FOMC”). The Board
of Governors, an independent federal agency, is charged by
the Federal Reserve Act with a number of specific duties,
including general supervision over the Reserve Banks. The
FOMC is composed of members of the Board of Governors,
the president of the Federal Reserve Bank of New York
(“FRBNY”), and on a rotating basis four other Reserve Bank
presidents.

2.

operations and services

The System performs a variety of services and operations.
Functions include formulating and conducting monetary
policy; participating actively in the payments system includ-

Financial Statements

ing large-dollar transfers of funds, automated clearinghouse
(“ACH”) operations, and check processing; distributing coin
and currency; performing fiscal agency functions for the
U.S. Treasury and certain federal agencies; serving as the
federal government’s bank; providing short-term loans to
depository institutions; serving the consumer and the community by providing educational materials and information
regarding consumer laws; supervising bank holding companies, state member banks, and U.S. offices of foreign banking organizations; and administering other regulations of the
Board of Governors. The System also provides certain services to foreign central banks, governments, and international official institutions.
The FOMC, in the conduct of monetary policy, establishes
policy regarding domestic open market operations, oversees
these operations, and annually issues authorizations and
directives to the FRBNY for its execution of transactions.
FRBNY is authorized to conduct operations in domestic
markets, including direct purchase and sale of U. S. government securities, the purchase of securities under agreements
to resell, the sale of securities under agreements to repurchase, and the lending of U.S. government securities. FRBNY
executes these open market transactions and holds the
resulting securities, with the exception of securities purchased under agreements to resell, in the portfolio known
as the System Open Market Account (“SOMA”).
In addition to authorizing and directing operations in the
domestic securities market, the FOMC authorizes and directs
FRBNY to execute operations in foreign markets for major
currencies in order to counter disorderly conditions in
exchange markets or to meet other needs specified by the
FOMC in carrying out the System’s central bank responsibilities. The FRBNY is authorized by the FOMC to hold balances of, and to execute spot and forward foreign exchange
(“F/X”) and securities contracts for nine foreign currencies
and to invest such foreign currency holdings ensuring adequate liquidity is maintained. In addition, FRBNY is authorized to maintain reciprocal currency arrangements (“F/X
swaps”) with two central banks, and “warehouse” foreign
currencies for the U.S. Treasury and Exchange Stabilization
Fund (“ESF”) through the Reserve Banks. In connection with
its foreign currency activities, FRBNY may enter into contracts that contain varying degrees of off-balance-sheet market risk, because they represent contractual commitments

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Federal Reserve Bank of Richmond • 2005 Annual Report

involving future settlement and counter-party credit risk.
The FRBNY controls credit risk by obtaining credit
approvals, establishing transaction limits, and performing
daily monitoring procedures.
Although Reserve Banks are separate legal entities, in the
interests of greater efficiency and effectiveness, they collaborate in the delivery of certain operations and services. The
collaboration takes the form of centralized competency centers, operations sites, and product or service offices that have
responsibility for the delivery of certain services on behalf of
the Reserve Banks. Various operational and management
models are used and are supported by service agreements
between the Reserve Bank providing the service and the
other eleven Reserve Banks. In some cases, costs incurred by
a Reserve Bank for services provided to other Reserve Banks
are not shared; in other cases, Reserve Banks are billed for
services provided to them by another Reserve Bank.
Major services provided on behalf of the System by the
Bank, for which the costs were not redistributed to the
other Reserve Banks, include: Standard Cash Automation,
Currency Technology Office, National Procurement Office,
Daylight Overdraft Reporting and Pricing, and the Payroll
Central Business Administration Function. Costs are,
however, redistributed to the other Reserve Banks for
computing and support services the Bank provides for
the System. The Bank’s total reimbursement for these
services was $263 million and $250 million for the years
ended December 31, 2005 and 2004, respectively, and is
included in “Other credits” on the Statements of Income.
Beginning in 2005, the Reserve Banks adopted a new management model for providing check services to depository
institutions. Under this new model, the Federal Reserve Bank
of Atlanta (“FRBA”) has the overall responsibility for managing the Reserve Banks’ provision of check services and recognizes total System check revenue on its Statements of
Income. FRBA compensates the other eleven Banks for the
costs incurred to provide check services. This compensation
is reported as “Compensation received for check services
provided” in the Statements of Income. If the management
model had been in place in 2004, the Bank would have
reported $50 million as compensation received for check
services provided and $67 million in check revenue would
have been reported by FRB Atlanta rather than the Bank.

42

3.

significant accounting policies

Accounting principles for entities with the unique powers
and responsibilities of the nation’s central bank have not
been formulated by the various accounting standard-setting
bodies. The Board of Governors has developed specialized
accounting principles and practices that it believes are
appropriate for the significantly different nature and function of a central bank as compared with the private sector.
These accounting principles and practices are documented
in the Financial Accounting Manual for Federal Reserve
Banks (“Financial Accounting Manual”), which is issued by
the Board of Governors. All Reserve Banks are required to
adopt and apply accounting policies and practices that are
consistent with the Financial Accounting Manual and the
financial statements have been prepared in accordance with
the Financial Accounting Manual.
Differences exist between the accounting principles and
practices in the Financial Accounting Manual and those
generally accepted in the United States (“GAAP”) primarily
due to the unique nature of the Bank’s powers and responsibilities as part of the nation’s central bank. The primary
difference is the presentation of all security holdings at
amortized cost, rather than using the fair value presentation
requirements in accordance with GAAP. Amortized cost
more appropriately reflects the Bank’s security holdings
given its unique responsibility to conduct monetary policy.
While the application of current market prices to the securities holdings may result in values substantially above or
below their carrying values, these unrealized changes in
value would have no direct affect on the quantity of reserves
available to the banking system or on the prospects for
future Bank earnings or capital. Both the domestic and
foreign components of the SOMA portfolio may involve
transactions that result in gains or losses when holdings are
sold prior to maturity. Decisions regarding security and
foreign currency transactions, including their purchase and
sale, are motivated by monetary policy objectives rather
than profit. Accordingly, market values, earnings, and any
gains or losses resulting from the sale of such securities and
currencies are incidental to the open market operations and
do not motivate its activities or policy decisions.
In addition, the Bank has elected not to present a Statement
of Cash Flows because the liquidity and cash position of the
Bank are not a primary concern given the Bank’s unique

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powers and responsibilities. A Statement of Cash Flows,
therefore, would not provide any additional meaningful
information. Other information regarding the Bank’s activities is provided in, or may be derived from, the Statements
of Condition, Income, and Changes in Capital. There are no
other significant differences between the policies outlined in
the Financial Accounting Manual and GAAP.
The preparation of the financial statements in conformity
with the Financial Accounting Manual requires management
to make certain estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of income and expenses
during the reporting period. Actual results could differ from
those estimates. Certain amounts relating to the prior year
have been reclassified to conform to the current-year presentation. Unique accounts and significant accounting policies are explained below.
a. Gold and Special Drawing Rights Certificates
The Secretary of the U.S. Treasury is authorized to issue
gold and special drawing rights (“SDR”) certificates to the
Reserve Banks.
Payment for the gold certificates by the Reserve Banks is
made by crediting equivalent amounts in dollars into the
account established for the U.S. Treasury. These gold certificates held by the Reserve Banks are required to be
backed by the gold of the U.S. Treasury. The U.S. Treasury
may reacquire the gold certificates at any time and the
Reserve Banks must deliver them to the U.S. Treasury. At
such time, the U.S. Treasury’s account is charged, and the
Reserve Banks’ gold certificate accounts are lowered. The
value of gold for purposes of backing the gold certificates
is set by law at $42 2/9 a fine troy ounce. The Board of
Governors allocates the gold certificates among Reserve
Banks once a year based on the average Federal Reserve
notes outstanding in each Reserve Bank.
Special drawing rights (“SDRs”) are issued by the
International Monetary Fund (“Fund”) to its members
in proportion to each member’s quota in the Fund at the
time of issuance. SDRs serve as a supplement to international monetary reserves and may be transferred from
one national monetary authority to another. Under the law

providing for United States participation in the SDR
system, the Secretary of the U.S. Treasury is authorized to
issue SDR certificates, somewhat like gold certificates, to
the Reserve Banks. At such time, equivalent amounts in
dollars are credited to the account established for the U.S.
Treasury, and the Reserve Banks’ SDR certificate accounts
are increased. The Reserve Banks are required to purchase
SDR certificates, at the direction of the U.S. Treasury,
for the purpose of financing SDR acquisitions or for
financing exchange stabilization operations. At the time
SDR transactions occur, the Board of Governors allocates
SDR certificate transactions among Reserve Banks based
upon Federal Reserve notes outstanding in each District
at the end of the preceding year. There were no SDR
transactions in 2005 or 2004.
b. Loans to Depository Institutions
All depository institutions that maintain reservable transaction accounts or nonpersonal time deposits, as defined in
regulations issued by the Board of Governors, have borrowing privileges at the discretion of the Reserve Bank.
Borrowers execute certain lending agreements and deposit
sufficient collateral before credit is extended. Loans are evaluated for collectibility, and currently all are considered collectible and fully collateralized. If loans were ever deemed
to be uncollectible, an appropriate reserve would be established. Interest is accrued using the applicable discount rate
established at least every fourteen days by the Board of
Directors of the Reserve Bank, subject to review by the
Board of Governors.
c. U.S. Government Securities and Investments
Denominated in Foreign Currencies
U.S. government securities and investments denominated
in foreign currencies comprising the SOMA are recorded
at cost, on a settlement-date basis, and adjusted for amortization of premiums or accretion of discounts on a
straight-line basis. Interest income is accrued on a
straight-line basis. Gains and losses resulting from sales of
securities are determined by specific issues based on average cost. Foreign-currency-denominated assets are revalued daily at current foreign currency market exchange
rates in order to report these assets in U.S. dollars.
Realized and unrealized gains and losses on investments
denominated in foreign currencies are reported as
“Foreign currency gains (losses), net.”

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Federal Reserve Bank of Richmond • 2005 Annual Report

Activity related to U.S. government securities, including the
related premiums, discounts, and realized and unrealized
gains and losses, is allocated to each Reserve Bank on a
percentage basis derived from an annual settlement of
interdistrict clearings that occurs in April of each year. The
settlement equalizes Reserve Bank gold certificate holdings
to Federal Reserve notes outstanding in each District.
Activity related to investments in foreign-currency-denominated assets is allocated to each Reserve Bank based on the
ratio of each Reserve Bank’s capital and surplus to aggregate
capital and surplus at the preceding December 31.
d. U.S. Government Securities Sold Under Agreements to
Repurchase and Securities Lending
Securities sold under agreements to repurchase are accounted for as financing transactions and the associated interest
expense is recognized over the life of the transaction. These
transactions are carried in the Statements of Condition at
their contractual amounts and the related accrued interest is
reported as a component of “Other liabilities.”
U.S. government securities held in the SOMA are lent to U.S.
government securities dealers and to banks participating in
U.S. government securities clearing arrangements in order to
facilitate the effective functioning of the domestic securities
market. Securities-lending transactions are fully collateralized by other U.S. government securities and the collateral
taken is in excess of the market value of the securities
loaned. The FRBNY charges the dealer or bank a fee for borrowing securities and the fees are reported as a component
of “Other Income” in the Statements of Income.
Activity related to U.S. government securities sold under
agreements to repurchase and securities lending is allocated
to each Reserve Bank on a percentage basis derived from
the annual settlement of interdistrict clearings. Securities
purchased under agreements to resell are allocated to
FRBNY and not to the other Banks.
e. Foreign Currency Swaps and Warehousing
F/X swap arrangements are contractual agreements between
two parties to exchange specified currencies, at a specified
price, on a specified date. The parties agree to exchange
their currencies up to a pre-arranged maximum amount and
for an agreed-upon period of time (up to twelve months), at
an agreed-upon interest rate. These arrangements give the

44

FOMC temporary access to the foreign currencies it may
need to intervene to support the dollar and give the counterparty temporary access to dollars it may need to support
its own currency. Drawings under the F/X swap arrangements can be initiated by either FRBNY or the counterparty
(the drawer) and must be agreed to by the drawee. The F/X
swaps are structured so that the party initiating the transaction bears the exchange rate risk upon maturity. FRBNY will
generally invest the foreign currency received under an F/X
swap in interest-bearing instruments.
Warehousing is an arrangement under which the FOMC
agrees to exchange, at the request of the U.S. Treasury, U.S.
dollars for foreign currencies held by the U.S. Treasury or
ESF over a limited period of time. The purpose of the warehousing facility is to supplement the U.S. dollar resources of
the U.S. Treasury and ESF for financing purchases of foreign
currencies and related international operations.
Foreign currency swaps and warehousing agreements are
revalued daily at current market exchange rates. Activity
related to these agreements, with the exception of the unrealized gains and losses resulting from the daily revaluation,
is allocated to each Reserve Bank based on the ratio of each
Reserve Bank’s capital and surplus to aggregate capital and
surplus at the preceding December 31. Unrealized gains
and losses resulting from the daily revaluation are allocated
to FRBNY and not to the other Reserve Banks.
f. Bank Premises, Equipment, and Software
Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a
straight-line basis over estimated useful lives of assets ranging from two to fifty years. Major alterations, renovations,
and improvements are capitalized at cost as additions to the
asset accounts and are amortized over the remaining useful
life of the asset. Maintenance, repairs, and minor replacements are charged to operating expense in the year
incurred. Capitalized assets including software, building,
leasehold improvements, furniture, and equipment are
impaired when it is determined that the net realizable value
is significantly less than book value and is not recoverable.
Costs incurred for software, either developed internally or
acquired for internal use, during the application development stage are capitalized based on the cost of direct

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services and materials associated with designing, coding,
installing, or testing software. Capitalized software costs are
amortized on a straight-line basis over the estimated useful
lives of the software applications, which range from two to
five years.

insufficient, the Federal Reserve Act provides that Federal
Reserve notes become a first and paramount lien on all the
assets of the Reserve Banks. Finally, as obligations of the
United States, Federal Reserve notes are backed by the full
faith and credit of the United States government.

g. Interdistrict Settlement Account
At the close of business each day, each Reserve Bank
assembles the payments due to or from other Reserve
Banks as a result of the day’s transactions that involve
depository institution accounts held by other Districts. Such
transactions may include funds settlement, check clearing,
and ACH operations. The cumulative net amount due to or
from the other Reserve Banks is reflected in the
“Interdistrict settlement account” in the Statements of
Condition.

The “Federal Reserve notes outstanding, net” account represents the Bank’s Federal Reserve notes outstanding, reduced
by the currency issued to the Bank but not in circulation, of
$11,887 million, and $12,275 million at December 31, 2005
and 2004, respectively.

h. Federal Reserve Notes
Federal Reserve notes are the circulating currency of the
United States. These notes are issued through the various
Federal Reserve agents (the Chairman of the Board of
Directors of each Reserve Bank) to the Reserve Banks upon
deposit with such agents of certain classes of collateral
security, typically U.S. government securities. These notes
are identified as issued to a specific Reserve Bank. The
Federal Reserve Act provides that the collateral security tendered by the Reserve Bank to the Federal Reserve agent
must be equal to the sum of the notes applied for by such
Reserve Bank.
Assets eligible to be pledged as collateral security include
all Bank assets. The collateral value is equal to the book
value of the collateral tendered, with the exception of securities, whose collateral value is equal to the par value of
the securities tendered. The par value of securities pledged
for securities sold under agreements to repurchase is
deducted.
The Board of Governors may, at any time, call upon a
Reserve Bank for additional security to adequately collateralize the Federal Reserve notes. To satisfy the obligation to
provide sufficient collateral for outstanding Federal Reserve
notes, the Reserve Banks have entered into an agreement
that provides for certain assets of the Reserve Banks to be
jointly pledged as collateral for the Federal Reserve notes
of all Reserve Banks. In the event that this collateral is

i. Items in Process of Collection and Deferred Credit Items
The balance in the “Items in process of collection” line in the
Statements of Condition primarily represents amounts attributable to checks that have been deposited for collection by
the payee depository institution and, as of the balance sheet
date, have not yet been collected from the payor depository
institution. Deferred credit items are the counterpart liability to items in process of collection, and the amounts in this
account arise from deferring credit for deposited items until
the amounts are collected. The balances in both accounts
can fluctuate and vary significantly from day to day.
j. Capital Paid-in
The Federal Reserve Act requires that each member bank
subscribe to the capital stock of the Reserve Bank in an
amount equal to 6 percent of the capital and surplus of
the member bank. These shares are nonvoting with a par
value of $100 and may not be transferred or hypothecated. As a member bank’s capital and surplus changes,
its holdings of Reserve Bank stock must be adjusted.
Currently, only one-half of the subscription is paid-in and
the remainder is subject to call. By law, each Bank is
required to pay each member bank an annual dividend of
6 percent on the paid-in capital stock. This cumulative dividend is paid semiannually. A member bank is liable for
Reserve Bank liabilities up to twice the par value of stock
subscribed by it.
k. Surplus
The Board of Governors requires Reserve Banks to maintain a surplus equal to the amount of capital paid-in as of
December 31. This amount is intended to provide additional capital and reduce the possibility that the Reserve
Banks would be required to call on member banks for

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Federal Reserve Bank of Richmond • 2005 Annual Report

additional capital. Pursuant to Section 16 of the Federal
Reserve Act, Reserve Banks are required by the Board of
Governors to transfer to the U.S. Treasury as interest on
Federal Reserve notes excess earnings, after providing for
the costs of operations, payment of dividends, and reservation of an amount necessary to equate surplus with capital paid-in.
In the event of losses or an increase in capital paid-in at a
Reserve Bank, payments to the U.S. Treasury are suspended and earnings are retained until the surplus is equal to
the capital paid-in. Weekly payments to the U.S. Treasury
may vary significantly.
In the event of a decrease in capital paid-in, the excess surplus, after equating capital paid-in and surplus at December
31, is distributed to the U.S. Treasury in the following year.
This amount is reported as a component of “Payments to
U.S. Treasury as interest on Federal Reserve notes.”
Due to the substantial increase in capital paid-in and the
transfer of surplus, surplus was not equated to capital at
December 31, 2005. The amount of additional surplus
required due to these events exceeded the Bank’s net
income in 2005.
l. Income and Costs related to U.S. Treasury Services
The Bank is required by the Federal Reserve Act to serve as
fiscal agent and depository of the United States. By statute,
the Department of the Treasury is permitted, but not
required, to pay for these services.
m. Assessments by the Board of Governors
The Board of Governors assesses the Reserve Banks to fund
its operations based on each Reserve Bank’s capital and surplus balances. The Board of Governors also assesses each
Reserve Bank for the expenses incurred for the U.S.
Treasury to issue and retire Federal Reserve notes based on
each Reserve Bank’s share of the number of notes comprising the System’s net liability for Federal Reserve notes on
December 31 of the previous year.
n. Taxes
The Reserve Banks are exempt from federal, state, and
local taxes, except for taxes on real property. The Bank’s
real property taxes were $2 million for each of the years

46

ended December 31, 2005 and 2004, and are reported as
a component of “Occupancy expense.”
o. Restructuring Charges
In 2003, the System began the restructuring of several operations, primarily check, cash, and U.S. Treasury services. The
restructuring included streamlining the management and
support structures, reducing staff, decreasing the number of
processing locations, and increasing processing capacity in
the remaining locations. These restructuring activities continued in 2004 and 2005.
Footnote 10 describes the restructuring and provides information about the Bank’s costs and liabilities associated with
employee separations and contract terminations. The costs
associated with the write-down of certain Bank assets are
discussed in footnote 6. Costs and liabilities associated with
enhanced pension benefits in connection with the restructuring activities for all Reserve Banks are recorded on the
books of the FRBNY and those associated with enhanced
post-retirement benefits are discussed in footnote 9.

4.

u.s. government securities,
securities sold under agreements to
repurchase, and securities lending
The FRBNY, on behalf of the Reserve Banks, holds securities bought outright in the SOMA. The Bank’s allocated
share of SOMA balances was approximately 7.632 percent
and 7.600 percent at December 31, 2005 and 2004,
respectively.
The Bank’s allocated share of U.S. Government securities,
net, held in the SOMA at December 31, was as follows (in
millions):
2005
2004
Par value:
U.S. government:
Bills
$ 20,703
$ 19,987
Notes
29,009
27,425
Bonds
7,084
7,146
Total par value
Unamortized premiums
Unaccreted discounts
Total allocated to Bank

56,796
673
(216)

54,558
715
(125)

$ 57,253

$ 55,148

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The total of the U.S. government securities, net held in the
SOMA was $750,202 million and $725,584 million at
December 31, 2005 and 2004, respectively.

The Bank’s allocated share of investments denominated in
foreign currencies was approximately 18.248 percent and
23.442 percent at December 31, 2005 and 2004, respectively.

At December 31, 2005 and 2004, the total contract amount
of securities sold under agreements to repurchase was
$30,505 million and $30,783 million, respectively, of which
$2,328 million and $2,340 million, were allocated to the
Bank. The total par value of the SOMA securities pledged for
securities sold under agreements to repurchase at December
31, 2005 and 2004 was $30,559 million and $30,808 million,
respectively, of which $2,332 million and $2,342 million was
allocated to the Bank.

The Bank’s allocated share of investments denominated in
foreign currencies, including accrued interest, valued at
current foreign currency market exchange rates at
December 31, was as follows (in millions):

The maturity distribution of U.S. government securities
bought outright and securities sold under agreements to
repurchase, that were allocated to the Bank at December 31,
2005, was as follows (in millions):
U.S
Government
Securities
(Par value)

Maturities of
Securities Held

Within 15 days
$
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years

Securities
Sold Under
Agreements
to Repurchase
(Contract amount)

$

$ 56,796

Total

3,130
13,147
14,216
16,083
4,327
5,893

$

2,328
–
–
–
–
–
2,328

At December 31, 2005 and 2004, U.S. government securities with par values of $3,776 million and $6,609 million,
respectively, were loaned from the SOMA, of which $288
million and $502 million, respectively, were allocated to
the Bank.

5.

investments denominated in
foreign currencies
The FRBNY, on behalf of the Reserve Banks, holds foreign
currency deposits with foreign central banks and the
Bank for International Settlements and invests in
foreign government debt instruments. Foreign government debt instruments held include both securities bought
outright and securities purchased under agreements to
resell. These investments are guaranteed as to principal
and interest by the foreign governments.

2005

2004

990

$ 1,425

352
650

502
925

477
985

361
1,796

$ 3,454

$ 5,009

European Union Euro:
Foreign currency deposits
$
Securities purchased
under agreements to resell
Government debt instruments
Japanese Yen:
Foreign currency deposits
Government debt instruments
Total

Total System investments denominated in foreign currencies
were $18,928 million and $21,368 million at December 31,
2005 and 2004, respectively.
The maturity distribution of investments denominated in
foreign currencies which were allocated to the Bank at
December 31, 2005, was as follows (in millions):
Maturities
of Investments
Denominated in
Foreign Currencies

European
Euro

Within 15 days
$
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
Total

Japanese
Yen

Total

616
470
381
521
3
–

$

478
124
184
677
–
–

$ 1,094
594
565
1,198
3
–

$ 1,991

$

1,463

$ 3,454

At December 31, 2005 and 2004, there were no material
open or outstanding foreign exchange contracts.
At December 31, 2005 and 2004, the warehousing facility
was $5,000 million, with no balance outstanding.

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Federal Reserve Bank of Richmond • 2005 Annual Report

6. bank

premises, equipment, and

software
A summary of bank premises and equipment at December
31 is as follows (in millions):
Useful Life
Range
(in Years)

Bank premises
and equipment:
Land
N/A
Buildings
6 - 48
Building machinery
and equipment
2 - 20
Construction
in progress
N/A
Furniture and
equipment
1 - 10
Subtotal
Accumulated depreciation
Bank premises
and equipment, net
Depreciation expense,
for the years ended

2005

$

32
142

2004

$

22
138

51

50

4

312
$ 525
(273)

$ 252

$ 252

$

$

43

44

Bank premises and equipment at December 31 include the
following amounts for leases that have been capitalized (in
millions):
2005
2004
Bank premises and equipment
$
9
$
10
Accumulated depreciation
(5)
(5)
Capitalized leases, net

$

4

$

5

The Bank leases space to outside tenants with lease terms
ranging from one to eleven months. Rental income from
such leases was $1.5 million and $1.4 million for the years
ended December 31, 2005 and 2004, respectively. Future
minimum lease payments under noncancelable agreements
in existence at December 31, 2005, were (in millions):
2006
2007
2008
2009
2010
Thereafter

$

1.3
–
–
–
–
–

$

48

Assets impaired as a result of the Bank’s restructuring
plan, as discussed in footnote 10, include furniture and
equipment. There were no asset impairment losses in
2005 and 2004.

3

288
$ 517
(265)

The Bank has capitalized software assets, net of amortization, of $41 million and $59 million at December 31, 2005
and 2004, respectively. Amortization expense was $19 million and $27 million for the years ended December 31,
2005 and 2004, respectively. Capitalized software assets
are reported as a component of “Other assets” and
related amortization is reported as a component of “Other
expenses.”

1.3

7.

commitments and contingencies

At December 31, 2005, the Bank was obligated undernoncancelable leases for premises and equipment with terms
ranging from one to approximately seven months. These
leases provide for increased rental payments based upon
increases in real estate taxes, operating costs, or selected
price indices.
Rental expense under operating leases for certain operating facilities, warehouses, and data processing and office
equipment (including taxes, insurance and maintenance
when included in rent), net of sublease rentals, was $16
million and $38 million for the years ended December 31,
2005 and 2004, respectively. Certain of the Bank’s leases
have options to renew.
Future minimum rental payments under noncancelable
operating leases and capital leases, net of sublease rentals,
with terms of one year or more, at December 31, 2005,
were not material.
At December 31, 2005, the Bank, acting on behalf of the
Reserve Banks, had contractual commitments extending
through the year 2017 with a remaining amount of
$299 million. As of December 31, 2005, none of these
commitments was recognized. Purchases of $74 million and
$70 million were made against these commitments during
2005 and 2004, respectively. It is estimated that the Bank’s
allocated share of these commitments will be $28 million.
These commitments represent maintenance of currency
processing machines and have variable and fixed
components. The variable portion of the commitment is

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for incremental maintenance above the prepaid basis. The
fixed payments for the next five years under these commitments are (in millions):
Fixed Commitment

2006
2007
2008
2009
2010

$

–
25
26
26
26

Under the Insurance Agreement of the Federal Reserve
Banks, each Reserve Bank has agreed to bear, on a per
incident basis, a pro rata share of losses in excess of one
percent of the capital paid-in of the claiming Reserve Bank,
up to 50 percent of the total capital paid-in of all Reserve
Banks. Losses are borne in the ratio that a Reserve Bank’s
capital paid-in bears to the total capital paid-in of all
Reserve Banks at the beginning of the calendar year in
which the loss is shared. No claims were outstanding
under such agreement at December 31, 2005 or 2004.
The Bank is involved in certain legal actions and claims
arising in the ordinary course of business. Although it is
difficult to predict the ultimate outcome of these actions,
in management’s opinion, based on discussions with
counsel, the aforementioned litigation and claims will be
resolved without material adverse effect on the financial
position or results of operations of the Bank.

8.

retirement and thrift plans

Retirement Plans
The Bank currently offers three defined benefit retirement
plans to its employees, based on length of service and
level of compensation. Substantially all of the Bank’s
employees participate in the Retirement Plan for
Employees of the Federal Reserve System (“System Plan”).
Employees at certain compensation levels participate in
the Benefit Equalization Retirement Plan (“BEP”) and certain Bank officers participate in the Supplemental
Employee Retirement Plan (“SERP”).

Employee Benefits of the Federal Reserve System. No separate accounting is maintained of assets contributed by the
participating employers. The FRBNY acts as a sponsor of the
System Plan and the costs associated with the Plan are not
redistributed to other participating employers. The Bank’s
benefit obligation and net pension costs for the BEP and the
SERP at December 31, 2005 and 2004, and for the years then
ended, are not material.
Thrift Plan
Employees of the Bank may also participate in the defined
contribution Thrift Plan for Employees of the Federal
Reserve System (“Thrift Plan”). The Bank’s Thrift Plan contributions totaled $8 million for each of the years ended
December 31, 2005 and 2004, and are reported as a component of “Salaries and other benefits.” The Bank matches
employee contributions based on a specified formula. For
the years ended December 31, 2005 and 2004, the Bank
matched 80 percent on the first 6 percent of employee contributions for employees with less than five years of service
and 100 percent on the first 6 percent of employee contributions for employees with five or more years of service.

9. postretirement benefits other
than pensions and postemployment
benefits
Postretirement Benefits other than Pensions
In addition to the Bank’s retirement plans, employees who
have met certain age and length of service requirements
are eligible for both medical benefits and life insurance
coverage during retirement.
The Bank funds benefits payable under the medical and life
insurance plans as due and, accordingly, has no plan assets.
Following is a reconciliation of beginning and ending balances of the benefit obligation (in millions):

The System Plan is a multi-employer plan with contributions
fully funded by participating employers. Participating
employers are the Federal Reserve Banks, the Board of
Governors of the Federal Reserve System, and the Office of

49

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Federal Reserve Bank of Richmond • 2005 Annual Report

2005
Accumulated post-retirement
benefit obligation at January 1 $ 93.7
Service cost-benefits earned
during the period
14.0
Interest cost of accumulated
benefit obligation
7.0
Actuarial (gain) loss
27.1
Contributions by plan
participants
1.1
Benefits paid
(7.6)
Plan amendments
–
Accumulated postretirement
benefit obligation at
December 31
$ 135.3

2004
$ 107.8

For measurement purposes, the assumed health care cost
trend rates at December 31 are as follows:

2.0
2005
5.5
(8.0)
0.8
(5.2)
(9.2)

2004

9.00%

9.00%

5.00%

4.75%

2011

Health care cost trend rate
assumed for next year
Rate to which the cost trend
rate is assumed to decline
(the ultimate trend rate)
Year that the rate reaches
the ultimate trend rate

2011

$ 93.7

At December 31, 2005 and 2004, the weighted-average
discount rate assumptions used in developing the postretirement benefit obligation were 5.50 percent and
5.75 percent, respectively.

Assumed health care cost trend rates have a significant effect
on the amounts reported for health care plans. A one percentage point change in assumed health care cost trend
rates would have the following effects for the year ended
December 31, 2005 (in millions):
1% Point
Increase

Discount rates reflect yields available on high quality
corporate bonds that would generate the cash flow
necessary to pay the plan’s benefits when due.
Following is a reconciliation of the beginning and ending
balance of the plan assets, the unfunded postretirement
benefit obligation, and the accrued postretirement benefit
costs (in millions):
2005
Fair value of plan assets
at January 1
$
Actual return on plan assets
Contributions by the employer
Contributions by plan participants
Benefits paid
Fair value of plan assets
at December 31
$
Unfunded postretirement
benefit obligation
Unrecognized prior
service cost
Unrecognized
net actuarial (loss)
Accrued postretirement
benefit costs

–

(1.4)
(14.4)

The following is a summary of the components of net periodic postretirement benefit costs for the years ended
December 31 (in millions):

2004
$

$
$

–
–
4.4
0.8
(5.2)
–
93.7

7.7

10.8

(50.0)

(27.7)

93.0

$ 76.8

Accrued postretirement benefit costs are reported as a component of “Accrued benefit costs.”

50

$

2005
–
–
6.5
1.1
(7.6)

$ 135.3

$

Effect on aggregate of
service and interest cost
components of net periodic
postretirement benefit costs $
1.3
Effect on accumulated postretirement benefit obligation
17.3

1% Point
Decrease

Service cost-benefits
earned during the period
Interest cost of accumulated
benefit obligation
Amortization of prior
service cost
Recognized net actuarial loss
Total periodic expense
Curtailment (gain)
Net periodic postretirement
benefit costs

$

14.0

2004
$

7.0
(1.4)
3.0
$ 22.6
–
$ 22.6

2.0
5.5

$

$

(1.1)
0.9
7.3
(7.2)
0.1

Net postretirement benefit costs are actuarially determined
using a January 1 measurement date. At January 1, 2005 and
2004, the weighted-average discount rate assumptions used
to determine net periodic postretirement benefit costs were
5.75 percent and 6.25 percent, respectively.

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Net periodic postretirement benefit costs are reported as a
component of “Salaries and other benefits.”

and 2004 operating expenses were $1 million and ($2) million, respectively and are recorded as a component of
“Salaries and other benefits.”

The 2005 service cost contains an adjustment that resulted
from a review of plan terms and assumptions.
A plan amendment that modified the credited service period
eligibility requirements created curtailment gains in 2004.
The Medicare Prescription Drug, Improvement and
Modernization Act of 2003 established a prescription drug
benefit under Medicare (“Medicare Part D”) and a federal
subsidy to sponsors of retiree health care benefit plans
that provide benefits that are at least actuarially equivalent
to Medicare Part D. The benefits provided by the Bank’s
plan to certain participants are at least actuarially equivalent
to the Medicare Part D prescription drug benefit. The
estimated effects of the subsidy, retroactive to January 1,
2004, are reflected in the actuarial gain in the accumulated
postretirement benefit obligation and the actuarial loss in
the net periodic postretirement benefit costs.
Following is a summary of expected benefit payments
(in millions):
Expected benefit payments:
Without
Subsidy

2006
2007
2008
2009
2010
2011-2015
Total

$

7.2
7.5
7.9
8.4
8.8
48.0
$ 87.8

With
Subsidy

$

6.7
7.0
7.4
7.7
8.2
43.3
$ 80.3

Postemployment Benefits
The Bank offers benefits to former or inactive employees.
Postemployment benefit costs are actuarially determined
using a December 31, 2005 measurement date and include
the cost of medical and dental insurance, survivor income,
and disability benefits. The accrued postemployment benefit costs recognized by the Bank at December 31, 2005 and
2004, were $13 million and $14 million, respectively. This
cost is included as a component of “Accrued benefit costs.”
Net periodic postemployment benefit costs included in 2005

10.

business restructuring charges

In 2003, the Bank announced plans for restructuring to
streamline operations and reduce costs, including consolidation of check operations and staff reductions in various
functions of the Bank. In 2004 additional consolidation and
restructuring initiatives were announced in the savings
bonds operations. These actions resulted in the following
business restructuring charges (in millions):
Total
Accrued
Estimated Liability
Costs
12/31/04

Employee
separation $ 4.1
Contract
termination 0.3
Total

$ 4.4

$ 3.9
–
$ 3.9

Total
Charges

$ (1.7)
–
$ (1.7)

Accrued
Total Liability
Paid 12/31/05

$ 1.8

$ 0.4

–

–

$ 1.8

$ 0.4

There were no charges in 2005. The negative total charges
amount is due to unrecognized accrued liability adjustments.
Employee separation costs are primarily severance costs
related to identified staff reductions of approximately 177,
including 62 staff reductions related to restructuring
announced in 2004. These costs are reported as a component of “Salaries and other benefits.” Contract termination
costs include the charges resulting from terminating existing
lease and other contracts and are shown as a component of
“Other expenses.”
Restructuring costs associated with the write-downs of certain Bank assets, including software, buildings, leasehold
improvements, furniture, and equipment are discussed in
footnote 6. Costs associated with enhanced pension benefits
for all Reserve Banks are recorded on the books of the
FRBNY as discussed in footnote 8. Costs associated with
enhanced postretirement benefits are disclosed in footnote 9.
The Bank substantially completed its announced plans by
June 2005.

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Summary of Operations • Unaudited
Dollar Amount
Year-to-Date December

2005

Volume
2004

2005

2004

57.0 Billion
5.5 Billion
107.0 Million

53.1 Billion
5.9 Billion
36.8 Million

3.2 Billion
456.2 Million
248 Thousand

3.2 Billion
496.1 Million
107.0 Thousand

1.3 Trillion

1.3 Trillion

1.1 Billion

1.3 Billion

353.3 Billion

361.2 Billion

526.5 Million

587.4 Million

364.2 Million

474.6 Million

425.7 Million

1.0 Billion

Cash
Currency received and counted
Currency destroyed
Coin bags received and counted

Noncash Payments
Commercial checks processed
Commercial checks,
packaged items handled

Loans to Depository Institutions
Discount window loans made

64

47

1.1 Million

4.5 Million

Services to U.S. Treasury and
Government Agencies
Issues, redemptions, and
exchanges of U.S. savings bonds1
1

Fifth District Savings Bonds operations were discontinued June 2005 as a result of System consolidation efforts.

52

annual report cover.ps - 4/27/2006 3:26 PM

Mission
As a regional Reserve Bank, we work within the Federal Reserve System
to foster the stability, integrity, and efficiency of the nation’s monetary,
financial, and payments systems. In doing so, we inspire trust and confidence in the U.S. financial system.

Vision
We will excel at everything we do, and make unique and important
contributions to the Federal Reserve System’s mission.

the federal reserve bank of richmond 2005 annual report was produced by the research department,
publications division and the public affairs department, graphics division.

Editor
Alice Felmlee

Designer
Ailsa Long

Editorial
Photographer
Steven Puetzer

Portrait
Photographers
Larry Cain
Geep Schurman

Printer
Federal Reserve Bank
of Richmond

Special Thanks to:
Cecilia Bingenheimer
Andrea Holmes
Ray Owens
Aaron Steelman
Jim Strader

this annual report is also available on the federal reserve bank of richmond’s web site at
www.richmondfed.org.

for

additional

print

copies,

contact

the

public

affairs

department,

f e d e r a l r e s e r v e b a n k o f r i c h m o n d , p . o . b o x 2 7 6 2 2, r i c h m o n d , v a 23 261, o r c a l l 80 4 • 6 97 • 810 9 .

annual report cover.ps - 4/27/2006 3:26 PM

F e d e r a l R e s e r v e B a n k o f R i c h m o n d • 2005 ANNUAL REPORT

Fifth F ederal Reserve D istrict O ffices
Richmond
701 East Byrd Street
Richmond, Virginia 23219
804 697 8000
G

G

Baltimore
502 South Sharp Street
Baltimore, Maryland 21201
410 576 3300
G

G

Charlotte
530 East Trade Street
Charlotte, North Carolina 28202
704 358 2100
G

G

Borrowing by
U.S. Households

www.richmondfed.org
34


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102