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Federal Reserve Bank o f Minneapolis The Region 1998 Annual Report Asking the Right Questions About the IMF Executive Editor: David Levy Editor: David Fettig Associate Editor: Kathy Cobb Art Director: Phil Swenson Designer: Lucinda Gardner The Region Federal Reserve Bank of Minneapolis P.O. Box 291 Minneapolis, MN 55480-0291 E-mail: firstname.lastname@example.org Web: minneapolisfed.org Volume 13 May 1999 ISSN 1045-3369 Special Issue The Region Federal Reserve Bank o f Minneapolis 1998 Annual Report Asking the Right Questions About the IMF By V.V. Chari and Patrick J. Kehoe Chari is professor, department o f econom ics, University o f Minnesota, and Kehoe is Ronald S. Lauder professor o f economics, University o f Pennsylvania; both are monetary advisers at the Federal Reserve Bank o f Minneapolis. The views expressed herein are not necessarily those o f the F ederal R eserve System. The Region President’s Message T his b an k has a history o f addressing issues that relate to the safety and soundness o f the finan cial system and, in particular, questions relating to the financial system’s safety net. Beginning w ith research in the 1970s and continu in g with our A n n u al R ep orts o f 1988 and 1997, we have analyzed the im plications o f broad-based deposit insurance program s and offered solutions that address the attendant problem o f m oral hazard. B ut we have also looked beyond our b o r ders and considered international issues that require a coordinated response, as in ou r A n n u al R ep o rt o f 1989 and its proposal for fixed exchange rates. T his year’s A n n u al R ep o rt essay is an extension o f those efforts. T h e current debate about the proper role o f the International M onetary Fund (IM F ) has focused, in large part, on w hether the IM F should serve as a lender o f last resort, that is, on w hether the IM F should p ro vide an international safety net based on a dom estic m odel. T h e authors o f this year’s essay, V.V. Chari and Pat Kehoe, argue that the dom estic m odel m any have in m ind is n o t appropri ate for the IM F, bu t they also show that this debate misses a m ore fundam ental point: T h e issue is n ot so m uch what the IM F should do, but what needs to be done and who can best do the jo b . In other words— to borrow from the essay title— before we d eterm ine a role for the IM F or any other international institution, we need to ask the right questions. In the end, w hether you agree w ith the authors’ conclusions about the role o f the IM F, we think it im portant that you at least consider their fram ew ork for assessing the need for a coordinated international response. For if we don’t ask the right questions— it alm ost goes w ithout saying— we can hardly be expected to com e to the right policy prescriptions. G ary H. Stern President 0 The Region IM We provide a framework that is based on the presumption that international agencies like the IMF should solve only problems that countries or individuals, acting on their own, cannot solve or solve poorly; such problems are known as international collective action problems. The Region Federal Reserve Bank of Minneapolis 1998 Annual Report Asking the Right Questions About the IMF The International Monetary Fund was established after World War II to manage a system of fixed exchange rates. In the early 1970s that system collapsed, and since then the IMF has been a bureaucracy in search of a mission. In the 1990s the IMF has greatly increased its lending, especially in Mexico in 1995 and in Asia in 1997-1998. This evolution has led to an extensive debate on the appropriateness of its activities and has raised the question: What should be the mission of the IMF? One view in this debate is that the IMF should be abolished. A second view is that the IMF should serve as an international lender of last resort by expanding its lending to debtor countries in financial difficulty to prevent worldwide financial crises. A third view is that the IMF should take on a new role; namely, it should serve as a type of international bankruptcy court that handles international debt problems. Our view is that the IMF should cease its lending activities altogether. We argue that there is no need for the IMF to act as a lender of last resort because any threats to the integri ty of the international financial system as a whole can be effectively handled by the central banks of the major powers. Moreover, current IMF lending policies encourage improvident international lending. We do not believe, however, that the IMF should be abolished. We think, for exam ple, that the IMF can serve an important role as a type of international bankruptcy court that handles international debt problems. We think the last two decades of international lending make it clear that private markets and national governments have not resolved these problems effectively. Our framework for analyzing the debate consists of asking three questions that are the right ones for evaluating the appropriateness of the IMF’s activities. But first the debate. The authors would like to thank Andrew Atkeson, Harold Cole, David Fettig, Narayana Kocherlakota, The debate Lee Ohanian andArtRolnickfor Both critics and defenders of the IMF argue that the recent activities of the IMF resemble helpful comments. The ideas in this those of an international lender of last resort. Krugman (1998) and Fischer (1999) argue that paper were heavily influenced by the recent actions of the IMF are necessary for the smooth functioning of international finan those in Feldstein (1998), cial markets. Indeed, they accept the view that by bailing out financially distressed countries Jackson (1986) and Sachs (1995). E The Region the IMF has become a world lender of last resort and applaud it for doing so. They argue that everyone accepts the need for a domestic lender of last resort so that, by analogy, everyone should also accept the need for a world lender of last resort. Friedman (1998), Schultz (1998) and Schwartz (1998) accept that the IMF is trying to function as a lender of last resort and argue that it should be abolished. The crux of their argument for abolition is that IMF funds too often are used to bail out foreign lenders. The prospect of these bailouts reduces the incentives of lenders to probe into the conditions of individual countries. Individual governments, in turn, have less of an incentive to pursue painful, but responsible policies needed to convince lenders of their creditworthiness. These critics argue that since IMF loans distort the operations of international financial markets it is doing more harm than good. Feldstein (1998) adopts an intermediate and somewhat more nuanced position. He argues that international financial institutions are needed to overcome the problems in the operation of private markets, but severely criticizes the IMF and insists that its lending pro grams should be tailored more finely to overcome problems in private markets. Finally, Sachs (1995) is both a critic and a defender of the IMF. He argues that the world needs a lender of last resort, like the IMF, but that lately the IMF has been doing a poor job. In addition, he argues that the world needs a new institutional framework that functions as an international bankruptcy court. Our framework To help resolve this debate, we provide a framework that is based on the presumption that international agencies like the IMF should solve only problems that countries or individuals, acting on their own, cannot solve or solve poorly; such problems are known as international collective action problems. As we explain below, the IMF was designed to solve this type of problem. Collective action problems exist if actions taken by individuals or governments result in greater welfare when actions are coordinated rather than independently made. Thus, to determine if a suggested role for the IMF is appropriate, we must ask the right questions: ■ Is there a clear collective action problem? ■ Is the proposed solution narrowly tailored to solve the identified collective action problem? ■ Is the IMF the best institution to solve the identified collective action problem? If the answer to any of these questions is no, then the suggested role for the IMF is not appro priate. A classic example of an international collective action problem is in setting tariff pol icy. Each country acting on its own has an incentive to set high tariffs in order to exploit its market power, but if all countries collectively agreed to lower their tariffs, all countries would be made better off. While it is easy to find collective action problems it is often difficult to solve them. The difficulty in solving the tariff problem, for example, is that if all other countries low ered their tariffs there would be an incentive for any one country to charge high tariffs. To solve this problem, then, enforceable agreements need to be reached that provide individual countries with the appropriate incentives to follow the coordinated policy prescription. 0 The Region We use this framework to analyze the historical record of the IMF and to argue that the IMF should cease its lending activities and reconstitute itself as an international bank ruptcy court. An overview of our analysis The IMF’s designers saw the need for an institution to solve a collective action problem in monetary policy similar to that in tariff policy. This problem is that each country acting on its own has the incentive to pursue self-interested monetary policies that help itself and hurt other countries. Coordination in monetary policies could make all countries better off. The particular method proposed to coordinate monetary policy was through a fixed exchange rate system administered by the IMF. By the early 1970s a consensus developed that while there was a collective action problem in monetary policy, this particular solution had smaller benefits than costs, and the system was disbanded. Currently, countries try to solve the collective action problem in monetary policy with informal agreements like those between the United States and Japan, and regional agreements like the European Monetary Union. Since the early 1970s the most coherent rationale for the IMF is that it solves a col lective action problem created when uncoordinated lenders set off a worldwide financial cri sis by fleeing from the debts of many developing countries’ governments or from the banking systems in such countries. The IMF attempts to solve this collective action problem by bailing out financially distressed countries with loans that have various conditions attached. The jus tification for these bailouts is the IMF is acting as a world lender of last resort, a role analo gous to the one a domestic central bank plays in stemming domestic banking panics. Does the world need a lender of last resort, and, if so, are the IMF’s actions appro priate for such a lender? The need for a world lender of last resort is sometimes based on a flawed analogy between individual banks and governments. Just as domestic banking systems could suffer from bank runs, it is argued that governments could suffer from liquidity crises in which they are unable to roll over their short-term debt. In a domestic context the critical feature that allows bank panics to happen in the first place is the mismatch of the duration of assets and liabilities in the banking system taken as a whole. Assets and liabilities of virtually all developed countries’ governments are not mismatched. Hence, a crisis affecting a develop ing country is unlikely to spill over into the developed nations, and this analogy does not jus tify a world lender of last resort. The flawed analogy notwithstanding, the world does need some mechanism to deal with the possibility that worldwide financial crises, similar to domestic banking panics, could occur. The questions here are what is the appropriate way a world lender of last resort should function and what is the extent to which existing central banks can handle crises. We argue that a lender of last resort should not bail out individual financially distressed institutions. In the event of a financial crisis, such a lender should rather provide liquidity to the market as a whole, say by open market operations and by giving all banks more favorable terms at the dis count window of the central bank. In essence the lender will end up supplying liquidity by 0 Collective action problems exist if actions taken by individuals or governments result in greater welfare when actions are coordinated rather than independently made. Thus, to determine if a sug gested role for the IMF is appropriate, we must ask the right questions: ■ Is there a clear collective action problem? ■ Is the proposed solution narrowly tailored to solve the identified collective action problem? ■ Is the IMF the best institution to solve the identified collec tive action problem? The Region replacing less liquid assets with more liquid assets. The market can then allocate this new liq uidity as it sees fit. Under this policy, some financially distressed institutions will fail, but the financial system as a whole will not collapse. Fortunately, we already have mechanisms in place to deal with worldwide financial crises. The major central banks of the world have the capac ity and the will to provide liquidity in a coordinated fashion. One example of this capacity and will was in the fall of 1998 when, in the face of a possible worldwide financial crisis, major cen tral banks reduced short-term interest rates in an apparently coordinated fashion. In this sense, the IMF is redundant to prevent worldwide financial crises. Furthermore, these central banks typically provide liquidity to the market as a whole rather than attempting to bail out specific institutions. In sharp contrast, IMF loans are always made to specific countries and governments in trouble. The IMF’s policies generate rampant moral hazard so that they may actually increase the likelihood that countries get into financial difficulties. In this sense, the IMF’s activities are harmful. While we think the central banks of the major powers can and do deal with world wide financial crises efficiently, we think there is a need for an international bankruptcy court to resolve smaller collective action problems between individual debtor countries and their creditors. We have seen two types of such problems at the country level in the last two decades. First, there can be coordination problems among lenders that lead to creditor panics for oth erwise healthy economies. Cole and Kehoe (1996) argue that the situation in Mexico in 1995 is a classic example of a creditor panic: Mexico was unable to roll over its short-term debts even though most observers agreed that Mexico was fundamentally sound. Second, for unhealthy economies with large external debts, there can be a need for a coordinated debt workout. For example, Bulow and Rogoff (1990) argue that coordination problems among private sector banks blocked efficiency-enhancing debt workouts in the Latin American debt crises of the late 1980s. While we think the central banks of the major powers can and do deal with worldwide financial crises efficiently, we think there is a need for an international bankruptcy court to resolve smaller collective action prob lems between individual debtor countries and their creditors. We argue that both kinds of coordination problems can be efficiently handled by a new international mechanism that is somewhat analogous to a bankruptcy court. This court would work as follows: When a debtor government is unable to meet its debt obligations it would seek the protection of the international bankruptcy court. The court would then assemble the creditors to facilitate negotiations and to provide expertise in evaluating condi tions in the debtor country. If the court and the creditors determined that the government was financially sound, an agreement would be reached to solve the immediate liquidity problem. If they determined that the government was financially unsound, then the court and the cred itors would propose a debt workout plan to the government. If the government in question agreed with the plan, then it would be carried out; if the government in question refused to abide by the plan; then creditors would be free to pursue their claims against the government through the standard channels. This court would thus serve to ameliorate the major coordi nation problems on the creditor side. In addition, there are two other collective action problems that the IMF could solve. Briefly, the IMF could provide a nominal anchor by issuing a type of world money and mak ing its supply independent of any particular country’s economic conditions. Countries could 6 The Region peg their currency to this world money rather than to the currencies of major powers. In so doing they could make their commitment to responsible monetary policy transparent and not be subject to the vagaries of policies in other countries. Such a nominal anchor is a public good that private markets and individual governments have difficulty providing. The IMF could also enforce the disclosure of accurate information regarding countries’ economic con ditions and policies. Such information helps international financial markets function smooth ly. Private markets and individual governments might have problems ensuring that informa tion is accurately disclosed. Origins of the IMF The IMF was originally designed to promote cooperation among countries in the conduct of monetary policy. Before World War I all the major powers were on the gold standard. The commitment to peg to gold both fixed countries’ exchange rates and sharply limited any coun try’s ability to pursue an autonomous monetary policy. During the interwar period countries went on and off the gold standard and exchange rates fluctuated wildly. Figure 1 shows the absolute change in the nominal exchange rates between the currencies of six major economic powers and the U.S. dollar. The figure shows that before 1913 the exchange rates changed hardly at all, while between 1919 and 1938 they fluctuated enormously. Figure 1: Exchange Rates vs. U.S. Dollar 1881 -1938 Level □ In addition, there are two other collective action problems that the IMF could solve. Briefly, the IMF could provide a nominal anchor by issuing a type of world money and making its supply independent of any particular country’s economic conditions. The Region The designers of the IMF saw the extraordinary volatility in exchange rates as deriv ing substantially from the attempts of each country to use its policies for domestic gain. They saw the system as one with a collective action problem in which all nations lost as each nation privately pursued its own gain. Specifically, they believed that during recessions each country has an incentive to devalue its currency to aid exporters and thereby raise domestic employ ment and income. This devaluation reduces imports and thus reduces employment and income abroad. In July 1944, over 300 representatives of 44 allied nations met for three weeks at Bretton Woods, N.H. The participants in the meeting wanted to create an institution that would remedy the collective action problem. The Bretton Woods meeting led to the Articles of Agreement that established the IMF. (See stories on pages 9, 13 and 15.) These articles make clear that the designers wanted to promote cooperation in the conduct of monetary policy. In particular, the articles set up a system in which exchange rates could be altered only by mutu al consent through the approval of the IMF. The idea was that each country would gain more by the commitment of other countries not to devalue than it would lose by giving up its free dom to do so. The evolving role of the IMF The role of the IMF has greatly evolved over its tenure. The Bretton Woods years From 1946-1958 most countries in the world had capital controls that restricted the holdings of foreign assets by their domestic residents and the IMF played a minimal role. Over With the collapse of the IM F’s original mission, the history since 1973, on the face of it, seems to reveal a bureaucracy at the IMF in search of a new mission. The IMF appears to see a variety of collective action problems that it must remedy. Its remedies have been criticized vigorously. this period, the system evolved into one where the United States pegged the dollar to gold and other countries pegged to the dollar. In the 1960s the system ran into more and more prob lems. Germany revalued in 1961 and again in 1969; the United Kingdom suffered a major cur rency crisis and was forced to devalue in 1967; France suffered a currency crisis in 1969 and devalued. Fixed exchange rates constrained monetary policy severely. The persistent devalua tions and revaluations during this period revealed that most countries wanted to use mone tary policy to meet domestic objectives and were unwilling to accept the constraints imposed by the fixed exchange rate system. Thus, when there was a conflict between domestic objec tives and keeping the exchange rate fixed, most countries preferred to change the exchange rate. The United States faced this conflict as well and showed unwillingness to sacrifice domestic objectives for fixed exchange rates. Over the 1960s the United States chose to increase its money supply growth rates substantially to achieve some domestic objectives. The consequent increase in inflation meant that the United States could not maintain the price of the dollar fixed relative to gold without a subsequent deflation. Unwilling to follow deflation ary policies, the United States let the system collapse. After 1973 countries were at liberty to let their exchange rates fluctuate without IMF consent. 8 The Region The Bretton Woods system collapsed and was not revived because o f a growing con sensus that a system o f fixed exchange rates for the world as a whole was not the appropriate solution to the collective action problem in monetary policy. This system placed such severe limits on discretionary monetary policy that the benefits from this type o f coordination were smaller than the costs. A variety o f other formal and informal mechanisms are now pursued to solve this collective action problem. After Bretton Woods: Searching for a mission With the collapse o f the IM F ’s original mission, the history since 1973, on the face o f it, seems to reveal a bureaucracy at the IM F in search o f a new mission. The IMF appears to see a variety o f collective action problems that it must remedy. Its remedies have been criti cized vigorously. During the late 1970s Latin American countries greatly increased their indebtedness to the rest o f the world, particularly to banks in the developed countries. In the 1980s a dete rioration o f their econom ic circumstances made it clear that they would not be able to repay Purposes of the IMF Article I o f the Agreement describes the purposes o f the IMF. The agreement imposed obligations on members. Members were to conduct their policies so as to maintain a stable global financial system. Article I: Purposes (i) To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems. (ii) To facilitate the expansion and balanced growth of international trade, and to con tribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objec tives of economic policy. (iii) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation. (iv) To assist in the establishment of a multilateral system of payments in respect of cur rent transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade. (v) To give confidence to members by making the general resources of the Fund tem porarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance o f payments without resorting to measures destruc tive of national or international prosperity. (vi) In accordance with the above, to shorten the duration and lessen the degree of dise quilibrium in the international balances of payments of members. The Fund shall be guided in all its policies and decisions by the purposes set forth in this Article. The Region these debts. Collectively, creditors could gain by restructuring their debts in a coordinated fashion, thereby preventing default, but each creditor had an incentive to let the burden of restructuring to fall on other creditors. Hence there was the potential for the IMF to play a use ful role in solving this collective action problem by coordinating the restructuring of govern ment debts owed to the banks. A number of economists, including Bulow and Rogoff (1990), argue that instead of helping matters the IMF intervention actually worsened them. They argue that the banks hardened their positions on the hope that by doing so the IMF would end up giving more sub sidized loans to the indebted countries that could then be used to increase the amount that the banks received. Hence, the net effect of the IMF’s interventions was to prolong the bargaining process during which the unresolved claims of the banks discouraged other investors from investing. In this sense, the IMF’s actions may well have harmed its intended beneficiaries. More recently, the IMF has taken on a somewhat more ambitious role. Figure 2 shows The bailout in Mexico reduced the incentives of lenders to probe into the conditions of other coun tries before making new loans. In addition, and perhaps to a lesser extent, the prospect of sim ilar bailouts gave these gov ernments less of an incentive to pursue painful, but responsible policies needed to convince lenders of their creditworthiness. outstanding loans from the IMF to its member countries and shows a very sizable increase in the level of IMF loan activity. In 1994, the Mexican government had difficulty rolling over its short-term debt, raising the possibility that the government would default. The collective action problem here was that if only lenders could jointly agree to roll over the debt there would be no prospect of default and all the lenders would have profited. The fear that other lenders would not lend raised the prospect of default and made each individual lender reluc tant to lend. We refer to this type of collective action problem at the country level as a credi tor panic. Operationally, the IMF and the U.S. government attempted to solve this collective action problem by providing substantial funding. The IMF provided about $18 billion in loans, roughly 5 percent of Mexican GDP, out of a total loan package of $55 billion, about 16 percent of Mexican GDP. The conditions attached to the loans primarily required the Mexican government to follow responsible monetary and fiscal policies. Friedman, Schwartz, Schultz and others argue that this funding package was at better rates than the market would provide and hence was a bailout. They argue that this bailout raised the beliefs of lenders that similar bailouts would occur in other developing countries when a crisis arose. Hence, the bailout in Mexico reduced the incentives of lenders to probe into the conditions of other countries before making new loans. In addition, and perhaps to a lesser extent, the prospect of similar bailouts gave these governments less of an incentive to pursue painful, but responsible policies needed to convince lenders of their creditworthiness. Hence, they argue the bailout policies of the IMF, paradoxically, tend to destablize international financial markets. In our view there is considerable merit to these arguments. The IMF is also extensively involved in providing assistance to the countries of Eastern Europe and the former Soviet Union. The loans to these countries are intended to make their transition to capitalist economies smoother. The conditions attached to these loans go well beyond traditional monetary and fiscal policy prescriptions, specifying a comprehen sive agenda for structural reforms which includes details of privatizing large parts of their economy, facilitating land registration, increasing public awareness of property rights and The Region Figure 2: Outstanding Debt of Member Countries to IMF (Billions of 1997 Dollars) 80,----------------------------------------------------------------------------------------------------------- O '--------------- -------------iH H ------- ■■■------BB 1960 1965 1970 1975 1980 1985 1997 agreements that the government will not renationalize or increase its equity position in enter prises and commercial banks. (See Camdessus 1996.) The nature of the collective action prob lem associated with reforming domestic institutions and legal arrangements is not clear to us. In many of the countries the IMF deals with there is also the problem of misuse of funds. Recently, Treasury Secretary Rubin testified that much of the $4.8 billion in loans to Russia in the summer of 1998 may have simply helped wealthy Russian oligarchs move billions of dollars out of the country, instead of being used to help further the reforms that Russia agreed to. (See New York Times, March 19,1999.) Critics of the IMF like Friedman, Schwartz, Schultz and others use examples like this to argue that besides leading to moral hazard many of the loans are simply wasted. In July 1997, a financial crisis struck a number of countries in Asia. There were sharp reversals in capital flows as lenders refused to roll over short-term loans. Banks in these coun tries had borrowed heavily using short-term debt and had difficulties meeting their payments to foreign creditors. The IMF helped organize substantial loans to these countries. For example, in Indonesia the IMF lent approximately $10 billion, roughly 5 percent of Indonesian GDP out of a total loan package of $33 billion, about 16 percent of Indonesian GDR In Korea, the IMF lent approximately $20 billion, roughly 4 percent of Korean GDP out of a total loan package of $57 billion, about 12 percent of Korean GDP. The conditions attached to these loans went well beyond the traditional strictures governing fiscal and mon etary policy. In Korea, for example, the conditions included raising the ceiling on foreign own ership of a firm’s equity from 7 percent to 50 percent, a variety of measures to open the econ omy to imports, changes in accounting standards for corporations and a variety of detailed reforms of labor markets that made layoffs easier. Again, the collective action problem associ ated with reforming domestic institutions escapes us. li The Region Analyzing the roles of the IMF The IM F’s analysis of its role The IMF’s leadership has sought to develop an intellectual rationale for its actions. The IMF leadership apparently sees three types of problems that it should solve. First, its goal is to ensure that defaults by developing country governments do not have contagious effects on other countries and lead to worldwide financial crises (see Fischer 1999). Second, the IMF’s goal is to prevent financial panics in developing countries even when they do not threaten to destabilize international financial markets. Such panics can reduce the volume of trade and thereby reduce employment and income in the rest of the world. Third, the IMF sees its goal We think that the contagious effects of developing country defaults are partly based on a flawed analogy. We do think worldwide financial crises can be triggered in various ways, including problems in develop ing countries, but they are best handled by the central banks of the major powers. as one of encouraging and enforcing general policy reform, even if it is not directly connect ed to countries’ financial systems (see Masson and Mussa 1997). We think that the contagious effects of developing country defaults are partly based on a flawed analogy. We do think worldwide financial crises can be triggered in various ways, including problems in developing countries, but they are best handled by the central banks of the major powers. We think that financial panics affecting developing country governments are also the result of a collective action problem, but they are best handled by an internation al bankruptcy court. Finally, we question whether poor policy, in general, is the result of an obvious collective action problem. While it is well understood that for some policies, like tar iffs on international trade, there is collective action problem, for a variety of other policies, like facilitating land registration in Russia or reforming labor markets in Korea, there is no obvi ous collective action problem for the world as a whole to solve. An inappropriate role: Lender of last resort The argument for an international lender of last resort begins with the observation that most economists agree on the need for a domestic lender of last resort; therefore, it follows that we need an international lender of last resort. For some, like Krugman (1998), the argument ends with this observation, while others, such as Fischer (1999), conduct a deeper analysis of the strengths and weakness of the analogy. While economists agree that it is desirable to establish institutions that prevent coun trywide financial panics, there is less agreement on how such lenders of last resort should operate. One view, espoused by Fischer (1999), is that in the event of a crisis the lender of last resort should provide favorable terms to those banks that are financially distressed. We term this the bailout prescription. A second view, espoused by Bordo (1993), is that in the event of a crisis this lender of last resort should not focus on financially distressed institutions but instead should provide liquidity to the market as a whole, say by open market operations or by giving all banks more favorable terms at the discount window of the central bank. In essence the central bank will end up supplying liquidity by replacing less liquid assets with more liquid assets. The market can then allocate this new liquidity as it sees fit. We term this the liquidity provider prescription. The Region We argue that bailouts lead to rampant moral hazard problems and that a lender of last resort which acts solely as a liquidity provider can contain financial panics effectively and efficiently. We begin by reviewing the case for a domestic lender o f last resort and then see what parts o f that case apply in the international setting. We will argue that while there is a need for an international lender o f last resort, that role is already adequately filled by the cen tral banks o f the major powers. The case for a domestic lender of last resort Bank liabilities are largely deposits that pay fixed rates and can be redeemed upon demand. Thus deposits can be thought o f as bonds o f instantaneous maturity that are auto matically rolled over by depositors until they are withdrawn. Bank assets are typically relative ly longer-term claims on firms and households. There are a variety o f reasons for this way of structuring assets and liabilities, but this structure almost automatically creates the possibility o f systemwide bank panics. In such panics most depositors attempt to redeem their deposits because they fear General obligations of members Article IV o f the Articles o f Agreement spells out the obligations o f members, authorizes the Fund to maintain a watch to ensure that countries are following responsible policies and empowers the Fund to require members to considt with it on their policies. Article IV: Extract from Section 1. General obligations o f members In particular, each member shall: (i) endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances; (ii) seek to promote stability by fostering orderly underlying economic and financial con ditions and a monetary system that does not tend to produce erratic disruptions; (iii) avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members; and (iv) follow exchange policies compatible with the undertakings under this Section. Article IV: Extract from Section 3. Surveillance over exchange arrangements (a) The Fund shall oversee the international monetary system in order to ensure its effec tive operation, and shall oversee the compliance of each member with its obligations under Section 1 of this Article. (b) In order to fulfill its functions under (a) above, the Fund shall exercise firm surveil lance over the exchange rate policies of members, and shall adopt specific principles for the guidance of all members with respect to those policies. Each member shall provide the Fund with the information necessary for such surveillance, and, when requested by the Fund, shall consult with it on the member’s exchange rate policies. 13 The Region that banks will become insolvent. To meet depositors’ demands the banking system as a whole attempts to sell its assets and call in its loans. Asset prices fall, economic activity declines and the banking system is unable to meet its depositors’ demands. When asset prices fall, many hitherto solvent banks can become insolvent. This panic is self-fulfilling. If depositors did not attempt to redeem their deposits, asset prices would not fall, banks would not become insolvent and each depositor could be assured that his deposits would be reasonably safe. This dependence of the asset side of banks’ balance sheets on the behavior of those who hold their liabilities creates the possibility of an uncertain outcome, or what is known as a multiple equilibrium problem. If depositors fear that other depositors will redeem their deposits, they should rationally attempt to redeem their deposits first, while if they are confident that other depositors will not, then they should not either. In our view the bailout prescrip tion leads to severe moral hazard problems sim ilar to those created by deposit insurance. The pros pect of receiving funds from the lender of last resort, even if the bank is insolvent, reduces the extent to which interest rates on deposits vary with the riskiness of the bank’s portfolio. Thus, the lender of last resort implicitly subsidizes the risk taking by banks. The decline in economic activity associated with a systemwide banking panic impos es significant social costs. Obviously, these costs could be avoided if only depositors could all somehow agree jointly not to withdraw their deposits. Almost from the beginnings of bank ing systems, bankers have understood the extent to which they collectively depend upon the confidence of the public and have attempted a variety of institutional arrangements to solve this problem. The most widely used is the prescription that a central bank should provide all the liquidity that is needed to stem the crisis. This assurance by the central bank enables the banking system to meet the claims of its depositors without selling assets or calling in loans. Individual depositors, therefore, can be confident that their deposits are relatively safe even if other depositors run on banks. This confidence eliminates the panic equilibrium. The central bank can carry out its prescription in two distinct ways. Each way recog nizes that to meet their depositors’ needs banks may have to sell assets both to the central bank and to the public. In the bailout view, the central bank directly lends to troubled banks at sub sidized rates. In the liquidity provider view the central bank purchases a sufficient amount of securities in the marketplace to ensure that the banking system as a whole has access to the liq uidity it needs to fulfill its obligations to depositors. At first the central bank buys securities like treasury bills and commercial paper. If that is insufficient it lends to the banking system as a whole against less liquid assets like mortgages. The net effect of the central bank’s liquid ity injection is to ensure that the panic does not reduce the overall level of asset prices in the economy too much. Troubled banks can then sell their assets, not to the central bank, but to the marketplace to obtain the liquidity they need to pay off their depositors. In our view the bailout prescription leads to severe moral hazard problems similar to those created by deposit insurance. The prospect of receiving funds from the lender of last resort, even if the bank is insolvent, reduces the extent to which interest rates on deposits vary with the riskiness of the bank’s portfolio. Thus, the lender of last resort implicitly subsidizes the risk taking by banks. This subsidy leads banks to take on excessive risk and paradoxically can make financial panics more frequent and more severe when they occur. One way the lender of last resort could avoid moral hazard problems is to lend only to illiquid but solvent banks. In practice, it is often difficult to distinguish insolvent from illiquid banks and to eval- The Region Governance and operating procedures The IMF has roughly 2,600 employees. Their principal day-to-day business is to conduct sur veillance of the policies of the members, consult periodically with them about their policy, make technical assistance available to members, to collect and disseminate a wide variety of statistics on the members’ economies and to make loans to members. The most important function of the IMF is to make loans that are financed by members as follows. On joining the IMF, each member country must make a specified contribution, called a quota. At most, 75 percent of the quota can be in the money o f the member country while the rest must be in readily marketable securities and currency or gold. The size of this quota is determined essentially by a country’s gross domestic product. Figure 3 gives the quo tas o f the largest five members. The quotas contributed by the members serve as the capital that enables the IMF to make loans to member countries. The IMF lends money only to member countries with balance of payment problems. It allows the member to borrow funds temporarily to pay for balance of payments deficits with the expectation that the country will alter its policy so as to reduce its balance of payments deficit. A member borrows from the fund by using its own currency to purchase from the fund other currencies or Special Drawing Rights (which are essentially claims to a weighted average of eight major countries’ currencies). The loan is repaid when the member repurchases its own currency A member country can unilaterally withdraw the 25 percent of its quota that is paid for with readily marketable assets. To borrow more than 25 percent the member country makes a request to the executive directors, who represent the entire membership. Figure 4 gives the amount borrowed by major users. As the figure shows less-developed countries have been the Continued on page 16 Figure 3: Largest IMF M em bers by Quota* in 1997 (with percent of total quotas) United Kingdom i 5.1% France 5.1% Japan T Germany 5.7% 5.7% United States 18.3% 0 10 20 30 40 Billions of 1997 Dollars *Upon joining the IMF, each member must make a contribution, or quota, based on its gross domestic product. These quotas serve as capital to make loans. 15 The Region Continued from page 15 predominant borrowers from the IMF, with the exception of the United Kingdom which bor rowed substantial amounts in the 1960s. Originally, under the Basic Credit Facility, they could borrow up to 125 percent of their quotas. Later a variety’ of special facilities were added to allow members to borrow substantial ly larger amounts. Along with the request for a loan the potential borrower presents to the IMF a plan for reform to reduce the payments problem. This plan of reform stipulates various con ditions for reasonable progress in reform. Typically, these conditions include tightening of monetary policy, raising tax revenues, lowering government spending and other measures to deal with weaknesses in the economy that underlie the payments problem. If the plan for reform meets the executive directors' approval, the loan is disbursed in installments which are tied to the member’s successful progress in meeting the conditions stipulated in the reform plan. Requests for larger loans are typically accompanied by reform plans with more stringent conditions. Currently, borrowers pay a one-time fee of 0.25 percent of the amount borrowed and annual interest charges of about 4.5 percent, while the rate paid to lending countries is roughly 4 percent per annum. The business of the IMF is conducted by the Executive Board. At present eight executive directors represent individual countries: China, France, Germany, Japan, Russia, Saudi Arabia, the United Kingdom and the United States. The other 16 directors each represent groups of individual countries. The voting power of each director is determined by the quotas of the countries represented by that director. Depending on the specific issue, approval requires any where from a simple majority to four-fifths of the vote. Figure 4: Principal Users of IMF Financing 1947-1997 Mexico Korea Argentina Russia United Kingdom i i India mm Indonesia Brazil _______ i mmmmi “ Yugoslavia T Philippines Thailand 0 5 10 15 Billions of 1997 Dollars 20 25 The Region uate the quality of the collateral, so that moral hazard problems cannot be avoided. The moral hazard problems here are essentially identical to those created by deposit insurance. (See Boyd and Rolnick 1988 and the references therein.) The liquidity provider prescription does not suffer from moral hazard problems because the lender of last resort is not implicitly subsidizing individual banks. Under this pre scription illiquid but solvent banks borrow directly from the market, at unsubsidized rates, to pay off their depositors. An important aspect of this prescription is that the lender of last resort should lend directly to troubled banks only on readily marketable securities. If the lender of last resort attempts to substitute its judgment for that of the market about the value of other securities it runs the risk of implicitly subsidizing risk taking. We should emphasize that under this prescription it is quite likely that some banks will fail when financial panics occur. The reason is that financial panics typically occur when economic conditions are poor and in such situations some banks are likely to be insolvent. This kind of failure of individual insolvent banks, like the failure of other firms in the economy, is part of a well-functioning economic system. It is certainly true that domestic lenders of last resort have not always carried out their role by strictly adhering to our liquidity provider prescription. We would argue, however, that in the United States and elsewhere concerns about moral hazard are shifting policy away from bailouts and toward liquidity provision. For example, between 1985 and 1990 over 99.7 per cent of uninsured depositors at failed banks were fully protected by the U.S. government. Concern that the virtual 100 percent guarantee to uninsured depositors was leading to moral hazard led Congress to pass the Federal Deposit Insurance Corp. Improvement Act in 1991. This act erected a number of hurdles that must be passed before any uninsured depositors can be protected. These hurdles include approval by two-thirds of the governors of the Federal Reserve System, two-thirds of the directors of the Federal Deposit Insurance Corp. and approval of the Secretary of the Treasury. Although these new hurdles are an important step in mitigating moral hazard, Feldman and Rolnick (1997) argue that these hurdles are not yet high enough, and they give specific proposals on how they should be raised. In this sense the winds seems to be shifting away from bailouts domestically. We argue that it should shift in the international arena as well. It is sometimes argued (see Fischer 1999) that the bailout prescription follows direct ly from the policies advocated in the classic analyses of a lender of last resort by Bagehot (1873) and Thornton (1802). We argue that this interpretation is mistaken. These writers thought the lender of last resort had the obligation to guarantee the liquidity of the whole economy, but not to particular institutions in the economy. They prescribed last-resort lend ing to the market as a whole during systemwide panics and not for emergency situations affecting isolated banks. For example, Bagehot (1873) in urging the central bank to lend lib erally to the marketplace as a whole wrote: “The holders of the cash reserve must be ready not only to keep it for their own liabil ities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to ‘this man and that man’, whenever the security is good.” (p. 25,1962 edition) 17 It is certainly true that domestic lenders of last resort have not always carried out their role by strictly adhering to our liquidity provider prescription. We would argue, however, that in the United States and elsewhere concerns about moral hazard are shifting policy away from bailouts and toward liquidity provision. The Region Thornton (1802) clearly had moral hazard in mind when he wrote: “It is by no means intended to imply, that it would become the Bank of England to relieve every distress which the rashness of country banks may bring upon them: the bank, by doing this, might encourage their improvidence.”1 To summarize, the case for a domestic lender of last resort stems from the extreme mismatch between maturities and risk characteristics of assets and liabilities common to banking systems. There are compelling reasons for the lender of last resort to lend freely in the general marketplace rather than to individual banks. The case against the IMF as an international lender of last resort In the international arena, there is no necessary mismatch between maturities of assets and liabilities of governments. If assets and liabilities are roughly matched, then inter national financial panics, if they occur at all, are unlikely to bear any resemblance to domestic If assets and liabilities are roughly matched, then interna tional financial panics, if they occur at all, are unlikely to bear any resemblance to domestic banking panics. In this sense, when assets and liabilities are roughly matched there is no case for an international lender of last resort. banking panics. In this sense, when assets and liabilities are roughly matched there is no case for an international lender of last resort. Less-developed countries’ governments, especially those in troubled economic times, rely heavily on short-term debt. Since the assets of governments are mostly claims to future tax revenues, such governments face a mismatch between assets and liabilities. In such a situ ation panics are possible. If the government issues only short-term debt it is forced to rely on the willingness of creditors to roll over the debt as it comes due. If the size of the debt is large relative to the resources of individual creditors, there is a potential coordination problem which arises when each creditor correctly believes that other creditors will be unwilling to roll over their portion of the debt. If few of the lenders are unwilling to role over their debt, then the government is faced with a liquidity crisis and is often forced into default. The prospect of default makes it rational for each creditor to refrain from rolling over the debt and justifies each creditor’s beliefs about other creditors. The basic problem here arises from the presumed inability of creditors to coordinate their behavior. This coordination problem can lead to a flight from the country’s debt, which we refer to as creditor panics. As we describe below, creditor panics can justify an international body to define and enforce rules that help solve the coordination problem. (In the story on page 19, we investi gate whether private markets can solve this coordination problem.) These panics, however, do not provide a justification for lending at subsidized rates to troubled countries. First, such panics can occur only if the government chooses to rely heavily on short-term financing. Most developed countries stagger their debt maturities so that at any given time only a small frac tion of the overall debt has to be rolled over. Therefore, developed countries are relatively 1In stemming the panic, Thorton argues that, in a panic the lender of last resort should greatly increase the amount of liquidity in the system to stop the problem from spreading broadly through the system rather than focus on simply bailing out individual banks. “If any one bank fails, a general run on neighboring ones is apt to take place, which if not checked at the beginning by a pouring into the circulation a large quantity of gold, leads to very extensive mischief.”(p. 180,1962 edition) The Region Can creditor panics be avoided by other means? One might ask whether private markets can solve the coordination problem completely. Private institutions do exist to solve these coordination problems. The most obvious one is the practice of issuing syndicated loans in which groups of lenders jointly commit to make loans. Other institutions, like the London Club, which is an association of private lenders, negotiate debt-restructuring on behalf of all their members. The fact that international financial crises that bear some resemblance to creditor panics have occurred, in spite of the existence of the private institutions, suggests that these institutions cannot completely solve the problem. In any event, the mechanism we describe below to help solve creditor panics will do no harm if private institutions can solve the coordination problems and will do some good if they cannot. One might also ask whether the government could meet its liquidity needs by expanding the money supply, perhaps by borrowing directly from its central bank. This way of meeting liquidity needs typically raises the inflation rate and can wreck the domestic economy. If new creditors think that the government will meet its needs to pay off existing short-term debt by expanding the money supply, they may well become even more reluctant to lend to the gov ernment because future prospects for the domestic economy look so bleak and future default becomes even more likely. These considerations suggest that creditor panics are likely even if the government has access to the printing presses to meet its liquidity needs. One way creditor panics might be avoided is for developing countries to refrain from issu ing short-term debt. Indeed, since short-term debt might lead to creditor panics and develop ing countries suffer costs from these panics, one would expect the countries to willingly refrain from issuing short-term debt. That developing countries seem to prefer short-term debt is prima facie evidence that they view the benefits to short-term debt as outweighing the costs. In Chari and Kehoe (1999) we develop a simple story for why developing countries may prefer short-term to long-term debt, when governments are better informed than markets about future prospects. The principal force is that governments that are more optimistic about their long-term prospects than the markets are better off by issuing short-term debt. Governments that issue long-term debt are regarded by markets as being more pessimistic and are penalized in the form of higher interest rates. This force induces both optimistic and pessimistic govern ments to rely on short-term debt. We argue that substantial uncertainty about future prospects and differences of information between governments and markets are much more likely in developing countries than in developed ones so that developed countries have no problems issuing long-term debt. In practice, another force leads developing countries to rely excessively on short-term debt. The very fact that the IMF stands ready to provide liquidity to countries that are facing credit problems reduces the level of concern over the possibility of creditor panic. Hence, the IM F’s liquidity provision reduces the cost o f issuing short-term debt relative to long-term debt and thereby increases both the number of countries that rely on short-term debt and the vol ume of such borrowing. Paradoxically, the increased reliance on short-term debt increases the possibility of creditor panics and thus the perceived need for the IMF to provide liquidity. Thus, the IM F’s liquidity provision mechanisms cause a subtle moral hazard problem by lead ing countries to shorten the maturity structure of their debt. 19 The Region immune from creditor panics. Second, even if financial panics contagiously spread from one nation to another through some mechanism other than creditor panics, central banks have the ability and the willingness to expand world liquidity to prevent severe damage to the world economy. The liquidity provider role of a lender of last resort can be played, for the world as a whole, through joint intervention by the central banks of the major powers. Recall that these interventions do not require that funds be directed to a particular country. All that is needed is that liquid funds be readily available in the marketplace so that the market can direct them to the best possible use. Indeed, we think there is considerable merit in the argument that interest rate reductions taken in the summer and the fall of 1998 by the Federal Reserve System and most European central banks was a coordinated response by major economic powers to The liquidity provider role of a lender of last resort can be played, for the world as a whole, through joint intervention by the central banks of the major powers. Recall that these inter ventions do not require that funds be directed to a particular country. All that is needed is that liquid funds be readily available in the marketplace so that the market can direct them to the best possible use. stem concerns about potential international financial panics. IMF lending is therefore unnec essary to stem worldwide financial crises. Furthermore, since it is directed at individual bor rowers, it is harmful because of the moral hazard problems such lending creates. The IMF per haps has a role to play in advising central banks about the state of international financial mar kets, but the central banks of the major powers can be, have been and should be the interna tional lenders of last resort. Some appropriate roles for the IMF Since, as we have argued, the IMF is not necessary to solve the collective action problem asso ciated with the lender of last resort, and that such an institution can even exacerbate the prob lem, where does that leave the IMF? Based on our framework, we identify three collective action problems and propose the following roles for the IMF: to serve as an international bankruptcy court, to provide a nominal anchor through issuance of a type of world currency and to enforce disclosure of accurate information regarding countries’ economic conditions and policies. An appropriate role: To establish an international bankruptcy court Even if the central banks of the major powers adequately fill the role of lender of last resort, there still can be smaller collective action problems at the country level that create the need for institutions that can solve the coordination problems of debtors. First, as we argue below, there can be coordination problems among lenders that lead to creditor panics for otherwise healthy economies. Second, for unhealthy economies with large external debts there can be a need for a coordinated debt workout. This is a case where an analogy to a domestic institution is help ful rather than misleading. Coordination problems of this kind occur in lending to firms as well as countries. Countries solve this coordination problem through bankruptcy procedures, which are difficult to set up internationally, but are just as necessary. (This view is held by Eaton (1990), Feldstein (1998) and especially Sachs (1995).) To see how coordination problems can arise at the level of lending to an individual firm consider the following. Suppose the legal system pays off debtors of firms in order of when they lay claims. Consider a firm with an existing stock of debt payments currently due 20 The Region that is larger than the value of its current stock of physical assets. Suppose first that the firm, if allowed to continue in operation, can pay off its debt claims with future revenues. The cred itors of such a firm can face a coordination problem analogous to that faced by debtors to a government. If each creditor believes that none of the other creditors will lay claims, then he has no incentive to do so and the firm will be able to pay off all of its debts. But, if each debtor believes that other creditors will lay claims to the firm and dismember it, then that debtor should attempt to lay a claim as well. This coordination problem can create creditor panics at the level of individual firms. Suppose next that the firm cannot pay off its debt claims with future revenues, even if it is allowed to continue. Coordination problems among creditors can lead to prolonged periods of disagreement during which the value of the assets that will eventually be divided up shrink greatly. Such problems typically do not arise at the level of the individual firm because sensi bly organized societies adopt bankruptcy procedures rather than paying off creditors in the order in which they happen to show up. Three provisions of bankruptcy procedures in the United States seem directly oriented toward resolving coordination problems. The first provi sion is the Automatic Stay Provision which prevents “any act to collect, assess, or recover a claim against the debtor that arose before the commencement” of the bankruptcy proceeding that remains in force until the bankruptcy is resolved. The second provision requires that plans for reorganizing the financial structure of the firm treat creditors within each class equitably with in and across classes of creditors. The third, the Debtor in Possession Provision, allows firms to obtain working capital and continue in operation under court supervision by assigning prior ity to the new loans above the loans obtained before the bankruptcy declaration. The first two provisions ensure that in the event of bankruptcy no debtor gains by attempting to lay claims and seizing assets ahead of other creditors. The third provision allows a bankrupt firm with relatively good prospects to continue in operation and thereby enhance overall payments to the creditors. The three provisions together effectively eliminate creditor panics. This analysis of bankruptcy law draws heavily on Jackson (1986). In the international arena, legal agreements cannot be enforced without the cooper ation of the governments of the involved countries. Debt contracts between lenders and gov ernments are particularly prone to difficulties in enforcement. The absence of international bankruptcy procedures creates the possibility of creditor panics. This is one area where inter national agreements seem particularly necessary and can be highly beneficial. We have argued that there is a need for an institution that can oversee and adminis ter debt contracts between governments and foreign lenders. That is, the world needs an inter national bankruptcy court. Such an institution could be empowered to administer provisions similar to the three described above. The automatic stay and the equitable treatment provi sions have the effect of lengthening the maturity structure of the government debt and, there by, reducing the liquidity squeeze. The debtor in possession provision allows the government to continue collecting revenues from its citizens as well as providing necessary services to them until the financial reorganization is finalized. Notice that suspension of convertibility prac- 21 Even if the central banks of the major powers adequately fill the role of lender of last resort, there can still be smaller collective action problems at the country level that create the need for institutions that can solve the coordination problems of debtors. The Region ticed by the U.S. banking system in the 19th century is a type of automatic stay provision. In the same way that suspension of convertibility helped to stem bank panics, our suggested pro cedures can help to stem creditor panics. An international bankruptcy court can also deal with situations where the borrowing country is simply unable to meet its debt commitments. In such a situation the court could oversee orderly debt workouts and arrange for an equitable reduction in payments owed to foreigners. One concern about the functioning of an international bankruptcy court is that such a court obviously cannot have the powers to dismiss governments or to seize collateral locat ed in the borrowing country. In this respect, such a court seems much weaker than a domes tic bankruptcy court that can replace incumbent management or liquidate assets. This con cern has some validity, but an international court does have effective powers of enforcement. The principal such power is to stop protecting governments from the demands of their cred itors. Effectively, such a move would allow each creditor to pursue his or her claims without hindrance. In this process, ordinary trade, of course, would be disrupted and substantial costs would be imposed upon the borrowing countries. Indeed, the country may be forced into default. A subtle concern is that a well-functioning court, by making it easy to renegotiate contracts, might distort the kinds of contracts the parties sign in the first place.2It is uncertain how important this consideration is relative to the possibility of creditor panics. Fortunately, we can let the market make this judgment by requiring that all new debt contracts specify whether they will be adjudicated by the international bankruptcy court in the event of dis putes. Presumably the parties will agree to the arrangement that delivers the highest ex-ante benefits. Eichengreen and Portes (p. xvi, 1995) take the view that a proposal like ours is “a non starter, given the very great legal obstacles to implementation.” They suggest a variety of more modest proposals, which seem to come down to encouraging countries and lenders to take actions that already seem to be in the interests of the parties concerned. While we take no stand on the political feasibility of our proposal, recent events have made obvious the eco nomic benefits of fundamental institutional change. If the IMF carries out these responsibilities well we would expect to see few, if any, creditor panics at the level of a country, just as the domestic bankruptcy court tends to elimi nate them at the level of a firm. Moreover, for countries that are simply unable to meet their debt commitments we would expect to see efficient debt workouts. An appropriate role: To provide a stable nominal anchor There is another collective action problem that the IMF could solve. The IMF could provide a 2Indeed, in optimal contract theory with private information, a standard result is that ex-ante efficient con tracts are not ex-post efficient and increasing the extent to which contracts are ex-post efficient can reduce their ex-ante efficiency. (See Chari 1983 for example.) 22 The Region public good by providing an easy-to-verify nominal anchor that any country that wishes can peg to for as little or as long as the country sees fit. Private markets and individual govern ments would clearly have difficulty in providing such an anchor. A key monetary policy problem faced by most monetary authorities is to convince their people that they are committed to pursue responsible monetary policies. One transpar ent way of conveying their commitment is to peg their exchange rates to a foreign currency. It is relatively easy to verify whether a monetary authority is adhering to its commitment. Alternative devices, such as money supply or inflation targets, are subject to manipulation and extraneous forces and thus often serve as poor communication devices of commitment to responsible monetary policy. In practice many countries now peg to either a single foreign currency or to a basket of foreign currencies. A major problem with either of these is that changes in the foreign coun tries’ economic conditions and policies typically force domestic policy adjustments. These adjustments are often undesirable, but are the price paid to purchase commitment. A clear example of this problem occurred in the early 1970s when the Bretton Woods system broke down. U.S. monetary policy led to high inflation in the United States, which was then trans mitted to the rest of the world through the fixed exchange rate system. The rest of the world decided the costs of importing this high inflation were less than the benefits from the peg and, since the United States was unwilling to pursue deflationary policies, the system broke down. If the IMF provided a currency whose supply expanded at a steady rate, independent of economic conditions, individual countries could peg to the IMF’s currency, and thus they could purchase commitment without being subject to the whims of other countries’ policies. In one sense, such a system would function somewhat like the gold standard did, without being subject to the problem of fluctuations in the price of gold relative to other commodities occasioned by vagaries in the world supply of gold. This nominal anchor is subject to a natural market test. It would have no value if both no country chose to peg its currency to it and no private individuals or institutions chose to use it in transactions. The need for a stable nominal anchor is self-evident because so many countries choose to peg to foreign countries. An appropriate role: To certify policy and enforce accurate disclosure The IMF appears to act as a certifier of good policy for financially distressed borrowing coun tries. One question is whether there is a collective action problem here, so that a publicly sup ported entity is needed to certify the financial conditions of individual countries. In answer ing this question it is helpful to draw analogies to domestic financial markets. In such markets there are a variety of rating agencies, securities analysts and the like whose job it is to certify the financial conditions of firms. None of these is publicly funded. In this sense, it is not obvi ous there is a collective action problem in certifying good policy. Hence it is unlikely that the IMF is necessary as a certifier of countries in global financial markets. In domestic financial markets it is generally agreed that there is a need for govern ment agencies, like the Securities and Exchange Commission, to enforce accurate disclosure of 23 If the IMF provided a currency whose supply expanded at a steady rate, independent of economic conditions, individual countries could peg to the IM F’s currency, and thus they could purchase commitment without being subject to the whims of other countries’ policies. The Region information. There is every reason to believe that the market and individual governments will not adequately provide these services when it comes to international borrowing as well. Hence, there may well be a collective action problem here that the IMF could solve by provid ing these services. An important and useful service the IMF currently provides is to collect and disseminate data. Given the public good nature of this activity it seems clear that some inter national organization is needed to ensure that this service is provided adequately. Conclusion Worldwide financial crises are the result of a collective action problem, but the IMF should not try to prevent them since the central banks of the major powers can better handle this problem. Country-level finan cial panics are the result of a collective action problem, but the IMF should not bail out countries in order to prevent them since an international bankruptcy court can better solve this problem. To determine the appropriate role for the IMF, we must ask the right questions: ■ Is there a clear collective action problem? ■ Is the proposed solution narrowly tailored to solve the identified collective action problem? ■ Is the IMF the best institution to solve the identified collective action problem? If the answer to any of these questions is no, then the suggested role for the IMF is not appro priate. We have asked these questions and determined the following. Worldwide financial crises are the result of a collective action problem, but the IMF should not try to prevent them since the central banks of the major powers can better handle this problem. Country-level finan cial panics are the result of a collective action problem, but the IMF should not bail out coun tries in order to prevent them since an international bankruptcy court can better solve this prob lem. The role of this international bankruptcy court, then, is an appropriate one for the IMF. Additionally, there are collective action problems in providing a stable nominal anchor and enforcing the accurate disclosure of information, both of which the IMF can best solve. 24 The Region References Bagehot, Walter. 1873. Lombard Street: A description of the money market. Reprinted in 1962. Homewood, 111.: Richard D. Irwin, Inc. Bordo, Michael D. 1993. The Bretton Woods international monetary system: A historical overview. In A retrospective on the Bretton Woods system, ed. Michael D. Bordo and Barry J. Eichengreen. Chicago and London: University of Chicago Press. Boyd, John H. and Rolnick, Arthur J. 1989. A case for reforming federal deposit insurance. 1988 Annual Report. Federal Reserve Bank of Minneapolis. Bulow Jeremy and Rogoff, Kenneth. 1990. Cleaning up third world debt without getting taken to the cleaners. Journal o f Economic Perspectives 4 (Winter): 31-42. Camdessus, Michel. 1996. Russia: Stabilization and reform. Address at the U.S.-Russia Business Council. Washington, D.C. Chari, V.V. 1989. Banking without deposit insurance or bank panics: Lessons from a model of the U.S. national banking system. Federal Reserve Bank o f Minneapolis Quarterly Review 13 (Summer): 3-19. Chari, V.V. 1983. Involuntary Unemployment and Implicit Contracts. Quarterly Journal o f Economics 98(3) Supplement: 107-22. Chari, V.V and Kehoe, Patrick J. 1999. Why do developing countries rely so much on short-term debt? Paper, University of Minnesota. Cole, Harold L. and Kehoe, Timothy J. 1996. A self-fulfilling model of Mexico’s 1994-95 crisis. Journal o f International Economics 41 (November): 309-330. Eaton, Jonathan. 1990. Debt relief and the international enforcement of loan contracts. Journal o f Economic Perspectives 4 (Winter): 43-56. Eichengreen, Barry and Portes, Richard. 1995. Crisis? What crisis? Orderly workouts for sovereign debtors. London: Centre for Economic Policy Research. Feldman, Ron J. and Rolnick, Arthur J. 1998. Fixing FDICIA: A plan to address the too-big-to-fail prob lem. 1997 Annual Report. Federal Reserve Bank of Minneapolis. Feldstein, Martin. 1998. Refocusing the IMF. Foreign Affairs 77 (March/April): 20-33. Fischer, Stanley. 1999. On the need for an international lender of last resort. Paper, International Monetary Fund. Friedman, Milton. 1998. Markets to the rescue. The Wall Street Journal, October 13. Jackson, Thomas H. 1986. The logic and limits o f bankruptcy law. Cambridge, Mass.: Harvard University Press. Keynes, John Maynard. 1942. Proposals for an international currency (or clearing) union. In The 25 The Region International Monetary Fund 1945-1965, Volume III, ed. J. Keith Horsefield. Washington, D.C.: International Monetary Fund. Krugman, Paul. 1998. The indispensable IMF. New York Times, May 15. Masson, Paul R. and Mussa, Michael. 1997. The role of the IMF: Financing and its interactions with adjustment and surveillance. International Monetary Fund Pamphlet Series No. 50. Nurske, Ragnar. 1944. International currency experience. Geneva: League of Nations. Sachs, Jeffrey. 1995. Do we need an international lender of last resort? Lecture delivered at Princeton University, Princeton, N.J., April 20. Schultz, George; Simon, William; and Wriston, Walter. 1998. Who needs the IMF? The Wall Street Journal, February 3. Schwartz, Anna J. 1998. Time to terminate the ESF and the IMF. Paper, New York University. Thornton, Henry. 1802. An enquiry into the nature and effects o f the paper credit o f Great Britain. Reprinted in 1962. New York: Augustus M. Kelley. Wallace, Neil. 1990. A banking model in which partial suspension is best. Federal Reserve Bank o f Minneapolis Quarterly Review 14 (Fall): 11-23. White, Harry Dexter. 1942. Preliminary draft proposal for a United Nations Stabilization Fund and a Bank for Reconstruction and Development of the United and Associated Nations. In The International Monetary Fund 1945-1965, Volume III, ed. J. Keith Horsefield. Washington, D.C.: International Monetary Fund. 26 The Region Federal Reserve Bank of Minneapolis 90 Hennepin Avenue, P.O. Box 291 Minneapolis, M innesota 55480-0291 Phone 612 204-5000 January 6, 1999 To the Board o f Directors The management o f the Federal Reserve Bank o f Minneapolis is responsible for the preparation and fair presentation o f the Statement o f Financial Condition, Statement o f Income, and Statement o f Changes in Capital as o f December 31, 1998 (the “Financial Statements”). The Financial Statements have been prepared in conformity with the accounting principles, policies, and practices established by the Board o f Governors o f the Federal Reserve System and as set forth in the Financial Accounting Manual for the Federal Reserve Banks, and as such, include amounts, some o f which are based on judgments and estimates o f management. The management o f the Federal Reserve Bank o f Minneapolis is responsible for maintaining an effective process o f internal controls over financial reporting including the safeguarding o f assets as they relate to the Financial Statements. Such internal controls are designed to provide reasonable assurance to management and to the Board o f Directors regarding the preparation o f reliable Financial Statements. This process o f internal controls contains self-monitoring mechanisms, including, but not limited to, divisions o f responsibility and a code o f conduct. Once identified, any material deficiencies in the process o f internal controls are reported to management, and appropriate corrective measures are implemented. Even an effective process o f internal controls, no matter how well designed, has inherent limita tions, including the possibility o f human error, and therefore can provide only reasonable assurance with respect to the preparation o f reliable financial statements. The management o f the Federal Reserve Bank of Minneapolis assessed its process o f internal controls over financial reporting including the safeguarding o f assets reflected in the Financial Statements, based upon the criteria established in the “Internal Control— Integrated Framework” issued by the Committee o f Sponsoring Organizations o f the Treadway Commission (CO SO ). Based on this assessment, the management o f the Federal Reserve Bank o f Minneapolis believes that the Federal Reserve Bank of Minneapolis maintained an effective process o f internal controls over financial reporting including the safeguarding o f assets as they relate to the Financial Statements. President Chief Financial Officer First Vice President P ricpM eR housEQopers § PricewaterhouseCoopers LLP 650 Third Avenue South Park Building Suite 1300 Minneapolis M N 55402-4333 Telephone (612) 596 6000 Facsimile (612) 373 7160 R eport of Independent A ccountants To the Board o f Directors o f the Federal Reserve Bank o f Minneapolis: We have examined management’s assertion that the Federal Reserve Bank o f Minneapolis (“FRB Minneapolis”) maintained effective internal control over financial reporting and the safeguarding o f assets as they relate to the Financial Statements as o f December 31, 1998, included in the accompanying Management’s Assertion. Our examination was made in accordance with standards established by the American Institute o f Certified Public Accountants, and accordingly, included obtaining an understanding o f the internal control over financial reporting, testing, and evaluating the design and operating effec tiveness o f the internal control, and such other procedures as we considered necessary in the circumstances. We believe that our examination provides a reasonable basis for our opinion. Because o f inherent limitations in any internal control, misstatements due to error or fraud may occur and not be detected. Also, projections o f any evaluation o f the internal control over financial reporting to future periods are subject to the risk that the internal control may become inadequate because o f changes in conditions, or that the degree o f compliance with the policies or procedures may deteriorate. In our opinion, management’s assertion that the FRB Minneapolis maintained effective internal control over financial reporting and over the safeguarding o f assets as they relate to the Financial Statements as o f December 31, 1998, is fairly stated, in all material respects, based upon criteria described in “Internal Control - Integrated Framework” issued by the Committee o f Sponsoring Organizations o f the Treadway Commission. March 5, 1999 29 Federal Reserve Bank of Minneapolis Financial Statements for the years ended December 31,1998 and 1997 P ricb/V T Rhous^Qdpers ae © PricewaterhouseCoopers LLP 650 Third Avenue South Park Building Suite 1300 Minneapolis M N 55402-4333 Telephone (612) 596 6000 Facsimile (612) 373 7160 R eport of Independent A ccountants To the Board o f Governors o f The Federal Reserve System and the Board o f Directors o f The Federal Reserve Bank o f Minneapolis: We have audited the accompanying statements o f condition o f the Federal Reserve Bank o f Minneapolis (the Bank) as o f December 31, 1998 and 1997, and the related statements o f income and changes in capital for the years then ended. These financial statements are the responsibility o f the Bank’s management. Our responsibility is to express an opinion on the financial statements based on our audit. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free o f 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 discussed in Note 3, the financial statements were prepared in conformity with the accounting principles, policies, and practices established by the Board o f Governors o f The Federal Reserve System. These principles, policies, and practices, which were designed to meet the specialized accounting and reporting needs o f The Federal Reserve System, are set forth in the “Financial Accounting Manual for Federal Reserve Banks” and constitute a comprehensive basis o f accounting other than generally accepted accounting principles. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position o f the Bank as o f December 31, 1998 and 1997, and the results o f its operations for the years then ended, on the basis o f accounting described in Note 3. Minneapolis, Minnesota March 5, 1999 31 Federal Reserve Bank of Minneapolis Statem ents of Condition (in millions) As o f December 31, 1998 1997 Gold certificates 128 147 Special drawing rights certificates 123 123 Assets 15 Total assets $ 160 15 Other assets — 157 Bank premises and equipment, net 57 1,381 Interdistrict settlement account 395 47 Investments denominated in foreign currencies Accrued interest receivable 6,044 710 U.S. government and federal agency securities, net 5 5,017 Loans to depository institutions 701 — Items in process o f collection 20 510 Coin 20 8,103 $ 7,672 Liabilities and Capital Liabilities: 6,136 4,792 1,039 629 6 6 442 Federal Reserve notes outstanding, net 610 Deposits: Depository institutions Other deposits Deferred credit items Surplus transfer due U.S. Treasury 32 2 Interdistrict settlement account — 1,205 Accrued benefit cost 36 34 8 11 7,699 7,289 Capital paid-in 202 194 Surplus 202 189 404 383 Other liabilities Total liabilities Capital: Total capital Total liabilities and capital $ 8,103 The accompanying notes are an integral part of these financial statements. 0 $ 7,672 Federal Reserve Bank of Minneapolis S tatem ents of Incom e (in millions) For the years ended December 31, 1998 1997 Interest income: Interest on U.S. government securities £ h 314 d 1 358 15 9 2 4 331 371 Incom e from services 47 47 Reimbursable services to government agencies 20 16 Foreign currency gains (losses), net 67 (60) 1 1 135 4 Salaries and other benefits 63 63 Occupancy expense 12 10 Equipment expense 7 7 Cost o f unreimbursed Treasury services — 3 Assessments by Board o f Governors 11 9 Other expenses 28 29 121 121 Interest on foreign currencies Interest on loans to depository institutions Total interest income Other operating income: Other income Total other operating income Operating expenses: Total operating expenses Net income prior to distribution $ 345 $ 254 Distribution o f net income: Dividends paid to member banks 12 10 Transferred to surplus 13 87 Payments to U.S. Treasury as interest on Federal Reserve notes 128 Payments to U.S. Treasury as required by statute 192 Total distribution $ 345 The accompanying notes are an integral part o f these financial statements. 33 157 $ 254 Federal Reserve Bank of Minneapolis Statem ents of Changes in Capital for the years ended December 31, 1998, and December 31, 1997 (in millions) Capital Paid-in Surplus Total Capital Balance at January 1, 1997 $ (2.1 shares) 107 $ 104 $ 211 87 87 (2) (2) 87 — 87 194 189 383 — 13 13 8 Net income transferred to surplus — 8 — Statutory surplus transfer to the U.S. Treasury Net change in capital stock issued (1.8 shares) Balance at December 31, 1997 (3.9 shares) Net income transferred to surplus Net change in capital stock issued (0.2 shares) Balance at December 31, 1998 $ (4.1 shares) 202 $ 202 The accompanying notes are an integral part o f these financial statements. 34 $ 404 Federal Reserve Bank of Minneapolis Notes to Financial Statem ents ■ R G A N IZA TIO N .O The Federal Reserve Bank o f Minneapolis (“Bank”) is part o f the Federal Reserve System (“System”) created by Congress under the Federal Reserve Act o f 1913 (“Federal Reserve Act”) which established the central bank o f the United States. The System consists o f the Board o f Governors o f the Federal Reserve System (“Board o f Governors”) and twelve Federal Reserve Banks (“Reserve Banks”). The Reserve Banks are chartered by the federal government and pos sess a unique set o f governmental, corporate, and central bank characteristics. Other major ele ments o f the System are the Federal Open Market Committee (“FO M C ”), and the Federal Advisory Council. The FOM C is composed o f members o f the Board o f Governors, the president o f the Federal Reserve Bank o f New York (“FRBN Y”) and, on a rotating basis, four other Reserve Bank presidents. Structure The Bank and its branch in Flelena, Montana, serve the Ninth Federal Reserve District, which includes Minnesota, Montana, North Dakota, South Dakota, and portions o f Michigan and Wisconsin. In accordance with the Federal Reserve Act, supervision and control o f the Bank is exercised by a Board o f Directors. Banks that are members o f the System include all national banks and any state chartered bank that applies and is approved for membership in the System. Board of Directors The Federal Reserve Act specifies the composition o f the board o f directors for each o f the Reserve Banks. Each board is composed o f nine members serving three-year terms: three direc tors, including those designated as Chairman and Deputy Chairman, are appointed by the Board o f Governors, and six directors are elected by member banks. O f the six elected by member banks, three represent the public and three represent member banks. M ember 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 o f directors, each member bank receives one vote, regardless o f the num ber o f shares o f Reserve Bank stock it holds. 2. O PERA TIO N S AND SERVICES The System performs a variety o f services and operations. Functions include: formulating and conducting monetary policy; participating actively in the payments mechanism, including largedollar transfers o f funds, automated clearinghouse operations, and check processing; distribu tion o f coin and currency; fiscal agency functions for the U.S. Treasury and certain federal agen cies; serving as the federal governments bank; providing short-term loans to depository institu tions; serving the consumer and the community by providing educational materials and infor mation regarding consumer laws; supervising bank holding companies, and state member banks; and administering other regulations o f the Board o f Governors. The Board o f Governors’ oper ating costs are funded through assessments on the Reserve Banks. The FOM C establishes policy regarding open market operations, oversees these operations, and issues authorizations and directives to the FRBNY for its execution o f transactions. Authorized transaction types include direct purchase and sale o f securities, matched sale-purchase transac tions, the purchase o f securities under agreements to resell, and the lending o f U.S. government 35 Federal Reserve Bank of Minneapolis securities. Additionally, the FRBNY is authorized by the FOM C to hold balances o f and to exe Notes to Financial Statements (Continued) maintain reciprocal currency arrangements (“F/X swaps”) with various central banks, and cute spot and forward foreign exchange and securities contracts in fourteen foreign currencies, “warehouse” foreign currencies for the U.S. Treasury and Exchange Stabilization Fund (“ESF”) through the Reserve Banks. 3. SIG N IFIC A N T A C C O U N T IN G P O LIC IES Accounting principles for entities with the unique powers and responsibilities o f the nation’s cen tral bank have not been formulated by the Financial Accounting Standards Board. The Board o f Governors has developed specialized accounting principles and practices that it believes are appropriate for the significantly different nature and function o f a central bank as compared to 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 o f Governors. All Reserve Banks are required to adopt and apply accounting policies and practices that are consistent with the Financial Accounting Manual. The financial statements have been prepared in accordance with the Financial Accounting Manual. Differences exist between the accounting principles and practices o f the System and gen erally accepted accounting principles (“GAAP”). The primary differences are the presentation of all security holdings at amortized cost, rather than at the fair value presentation requirements o f GAAP, and the accounting for matched sale-purchase transactions as separate sales and purchas es, rather than secured borrowings with pledged collateral, as is required by GAAP. In addition, the Bank has elected not to present a Statement o f Cash Flows or a Statement o f Comprehensive Income. The Statement o f Cash Flows has not been included as the liquidity and cash position of the Bank are not o f primary concern to the users o f these financial statements. The Statement of Comprehensive Income, which comprises net income plus or minus certain adjustments, such as the fair value adjustment for securities, has not been included because as stated above the secu rities are recorded at amortized cost and there are no other adjustments in the determination o f Comprehensive Incom e applicable to the Bank. Other information regarding the Bank’s activi ties is provided in, or may be derived from, the Statements o f Condition, Income, and Changes in Capital. Therefore, a Statement o f Cash Flows or a Statement o f Comprehensive Income would not provide any additional useful information. There are no other significant differences between the policies outlined in the Financial Accounting Manual and GAAP. The preparation o f the financial statements in conformity with the Financial Accounting Manual requires management to make certain estimates and assumptions that affect the reported amounts o f assets and liabilities and disclosure o f contingent assets and liabilities at the date o f the financial statements and the reported amounts o f income and expenses during the reporting period. Actual results could differ from those estimates. Unique accounts and significant accounting policies are explained below. a. Gold Certificates The Secretary o f the Treasury is authorized to issue gold certificates to the Reserve Banks to m on etize gold held by the U.S. Treasury. 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 o f the U.S. Treasury. The U.S. Treasury may reacquire the gold certificates at any time and the Federal Reserve Bank of Minneapolis Notes to Financial Statements (Continued) 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 o f gold for pur poses o f backing the gold certificates is set by law at $42 2/9 a fine troy ounce. The Board o f Governors allocates the gold certificates among Reserve Banks once a year based upon Federal Reserve notes outstanding in each District at the end o f the preceding year. b. Special Drawing Rights Certificates Special drawing rights (“SDRs”) are issued by the International Monetary Fund ("Fund") to its members in proportion to each mem ber’s quota in the Fund at the time o f 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 o f 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 cred ited 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 SDRs, at the direction o f the U.S. Treasury, for the purpose o f financing SDR certificate acquisitions or for financing exchange stabilization operations. The Board o f Governors allocates each SD R transaction among Reserve Banks based upon Federal Reserve notes outstanding in each District at the end o f the preceding year. c. Loans to Depository Institutions The Depository Institutions Deregulation and M onetary Control Act o f 1980 provides that all depository institutions that maintain reservable transaction accounts or nonpersonal time deposits, as defined in Regulation D issued by the Board o f Governors, have borrowing privileges at the discretion o f the Reserve Banks. 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 any loans were deemed to be uncollectible, an appropriate reserve would be established. Interest is recorded on the accrual basis and is charged at the applicable discount rate established at least every fourteen days by the Board of Directors o f the Reserve Banks, subject to review by the Board o f Governors. However, Reserve Banks retain the option to impose a surcharge above the basic rate in certain circumstances. d. U.S. Government and Federal Agency Securities and Investments Denominated in Foreign Currencies The FOM C has designated the FRBNY to execute open market transactions on its behalf and to hold the resulting securities in the portfolio known as the System Open Market Account (“SOMA”). In addition to authorizing and directing operations in the domestic securities mar ket, the FOM C authorizes and directs the FRBNY to execute operations in foreign markets for major currencies in order to counter disorderly conditions in exchange markets or other needs specified by the FOM C in carrying out the System’s central bank responsibilities. Purchases o f securities under agreements to resell and matched sale-purchase transactions are accounted for as separate sale and purchase transactions. Purchases under agreements to resell are transactions in which the FRBNY purchases a security and sells it back at the rate specified at the commencement o f the transaction. Matched sale-purchase transactions are transactions in which the FRBNY sells a security and buys it back at the rate specified at the commencement of the transaction. 37 Federal Reserve Bank o f Minneapolis Reserve Banks are authorized by the FOM C to lend U.S. government securities held in the SOMA to U.S. government securities dealers and to banks participating in U.S. government securities Notes to Financial Statem ents clearing arrangements, in order to facilitate the effective functioning o f the domestic securities (C ontinu ed ) securities. FOM C policy requires the lending Reserve Bank to take possession o f collateral in market. These securities-lending transactions are fully collateralized by other U.S. government amounts in excess o f the market values o f the securities loaned. The market values o f the collat eral and the securities loaned are monitored by the lending Reserve Bank on a daily basis, with additional collateral obtained as necessary. The securities loaned continue to be accounted for in the SOMA. Foreign exchange contracts are contractual agreements between two parties to exchange specified currencies, at a specified price, on a specified date. Spot foreign contracts normally settle two days after the trade date, whereas the settlement date on forward contracts is negotiated between the contracting parties, but will extend beyond two days from the trade date. The FRBNY generally enters into spot contracts, with any forward contracts generally limited to the second leg o f a swap/warehousing transaction. The FRBNY, on behalf of the Reserve Banks, maintains renewable, short-term F/X swap arrange ments with authorized foreign central banks. The parties agree to exchange their currencies up to a pre-arranged maximum amount and for an agreed upon period o f time (up to twelve months), at an agreed upon interest rate. These arrangements give the FOM C temporary access to foreign currencies that it may need for intervention operations to support the dollar and give the partner foreign central bank temporary access to dollars it may need to support its own cur rency. Drawings under the F/X swap arrangements can be initiated by either the FRBNY or the partner foreign central bank, and must be agreed to by the drawee. The F/X swaps are structured so that the party initiating the transaction (the drawer) bears the exchange rate risk upon matu rity. The FRBNY will generally invest the foreign currency received under an F/X swap in interest-bearing instruments. Warehousing is an arrangement under which the FOM C agrees to exchange, at the request o f the Treasury, U.S. dollars for foreign currencies held by the Treasury or ESF over a limited period o f time. The purpose of the warehousing facility is to supplement the U.S. dollar resources o f the Treasury and ESF for financing purchases o f foreign currencies and related international operations. In connection with its foreign currency activities, the FRBNY, on behalf o f the Reserve Banks, may enter into contracts which contain varying degrees o f off-balance sheet market risk, because they represent contractual commitments involving future settlement, and counter-party credit risk. The FRBNY controls credit risk by obtaining credit approvals, establishing transaction lim its, and performing daily monitoring procedures. While the application o f current market prices to the securities currently held in the SOMA port folio and investments denominated in foreign currencies may result in values substantially above or below their carrying values, these unrealized changes in value would have no direct effect on the quantity o f reserves available to the banking system or on the prospects for future Reserve Bank earnings or capital. Both the domestic and foreign components o f the SOMA portfolio from time to time involve transactions that can result in gains or losses when holdings are sold prior to maturity. However, decisions regarding the securities and foreign currencies transac Federal Reserve Bank of Minneapolis tions, including their purchase and sale, are motivated by monetary policy objectives rather than Notes to Financial Statements (Continued) securities are incidental to the open market operations and do not motivate its activities or pol profit. Accordingly, earnings and any gains or losses resulting from the sale o f such currencies and icy decisions. U.S. government and federal agency securities and investments denominated in foreign curren cies comprising the SOM A are recorded at cost, on a settlement-date basis, and adjusted for amortization o f premiums or accretion o f discounts on a straight-line basis. Interest income is accrued on a straight-line basis and is reported as “Interest on U.S. government securities” or “Interest on foreign currencies,” as appropriate. Incom e earned on securities lending transactions is reported as a component o f “Other income.” Gains and losses resulting from sales o f securities are determined by specific issues based on average cost. Gains and losses on the sales o f U.S. gov ernment and federal agency securities are reported as “Other income.” Foreign currency denom inated assets are revalued monthly at current 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.” Foreign currencies held through F/X swaps, when initiated by the counter party, and warehousing arrangements are revalued monthly, with the unrealized gain or loss reported by the FRBNY as a com ponent o f “Other assets” or “Other liabilities,” as appropriate. Balances o f U.S. government and federal agencies securities bought outright, investments denominated in foreign currency, interest income, amortization o f premiums and discounts on securities bought outright, gains and losses on sales o f securities, and realized and unrealized gains and losses on investments denominated in foreign currencies, excluding those held under an F/X swap arrangement, are allocated to each Reserve Bank. Securities purchased under agree ments to resell and the related premiums, discounts and income, and unrealized gains and loss es on the revaluation o f foreign currency holdings under F/X swaps and warehousing arrange ments are allocated to the FRBNY and not to other Reserve Banks. Income from securities lend ing transactions is recognized only by the lending Reserve Bank. e. Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over estimated useful lives o f assets ranging from 2 to 50 years. New assets, m ajor alterations, renovations, and improvements are capitalized at cost as additions to the asset accounts. Maintenance, repairs, and minor replacements are charged to operations in the year incurred. f. Interdistrict Settlem ent Account At the close o f business each day, all Reserve Banks and branches assemble the payments due to or from other Reserve Banks and branches as a result o f transactions involving accounts residing in other Districts that occurred during the day’s operations. Such transactions may include funds settlement, check clearing and automated clearinghouse (“ACFi”) operations, and allocations of shared expenses. The cumulative net amount due to or from other Reserve Banks is reported as the “Interdistrict settlement account.” g. Federal Reserve Notes Federal Reserve notes are the circulating currency o f the United States. These notes are issued through the various Federal Reserve agents to the Reserve Banks upon deposit with such Agents 39 Federal Reserve Bank o f Minneapolis o f certain classes o f collateral security, typically U.S. government securities. These notes are iden tified 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 o f Notes to Financial Statements the notes applied for by such Reserve Bank. In accordance with the Federal Reserve Act, gold cer (C ontin ued ) tificates, special drawing rights certificates, U.S. government and agency securities, loans allowed under Section 13, and investments denominated in foreign currencies are pledged as collateral for net Federal Reserve notes outstanding. The collateral value is equal to the book value o f the col lateral tendered, with the exception o f securities, whose collateral value is equal to the par value o f the securities tendered. The Board o f Governors may, at any time, call upon a Reserve Bank for additional security to adequately collateralize the Federal Reserve notes. To satisfy its obligation to provide sufficient collateral for its outstanding Federal Reserve notes, the Reserve Banks have entered into an agreement that provides that certain assets o f the Reserve Banks are jointly pledged as collateral for the Federal Reserve notes o f all Reserve Banks. In the event that this col lateral is insufficient, the Federal Reserve Act provides that Federal Reserve notes become a first and paramount lien on all the assets o f the Reserve Banks. Finally, as obligations o f the United States, Federal Reserve notes are backed by the full faith and credit of the United States government. The “Federal Reserve notes outstanding, net” account represents Federal Reserve notes reduced by cash held in the vaults o f the Bank o f $1, 554 million and $1,689 million at December 3 1 ,1998 and 1997, respectively. h. Capital Paid-in The Federal Reserve Act requires that each member bank subscribe to the capital stock o f the Reserve Bank in an amount equal to 6% o f the capital and surplus o f the member bank. As a member bank’s capital and surplus changes, its holdings o f the Reserve Bank’s stock must be adjusted. Member banks are those state-chartered banks that apply and are approved for m em bership in the System and all national banks. Currently, only one-half o f the subscription is paidin and the remainder is subject to call. These shares are nonvoting with a par value o f $100. They may not be transferred or hypothecated. By law, each member bank is entitled to receive an annu al dividend o f 6% 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 o f stock subscribed by it. i. Surplus The Board o f Governors requires Reserve Banks to maintain a surplus equal to the amount o f capital paid-in as o f 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 additional capital. Reserve Banks are required by the Board o f Governors to transfer to the U.S. Treasury excess earnings, after providing for the costs o f operations, payment o f dividends, and reservation o f an amount necessary to equate surplus with capital paid-in. Payments made after September 30, 1998, represent payment o f interest on Federal Reserve notes outstanding. The Omnibus Budget Reconciliation Act o f 1993 (Public Law 103-66, Section 3002) codified the existing Board surplus policies as statutory surplus transfers, rather than as payments o f interest on Federal Reserve notes, for federal government fiscal years 1998 and 1997 (which began on October 1, 1997 and 1996, respectively). In addition, the legislation directed the Reserve Banks to Federal Reserve Bank o f Minneapolis transfer to the U.S. Treasury additional surplus funds o f $107 million and $106 million during Notes to Financial Statements (Continued) for these amounts during this time. The Reserve Banks made these transfers on October 1, 1997, fiscal years 1998 and 1997, respectively. Reserve Banks were not permitted to replenish surplus and October 1, 1996, respectively. The Bank’s share o f the 1997 transfer is reported as “Statutory surplus transfer to the U.S. Treasury.” In the event o f losses, payments to the U.S. Treasury are suspended until such losses are recov ered through subsequent earnings. Weekly payments to the U.S. Treasury vary significantly. ]. Cost of Unreimbursed Treasury Services The Bank is required by the Federal Reserve Act to serve as fiscal agent and depository o f the United States. By statute, the Department o f the Treasury is permitted, but not required, to pay for these services. The costs o f providing fiscal agency and depository services to the Treasury Department that have been billed but will not be paid are reported as the “Cost o f unreimbursed Treasury services.” k. Taxes The Reserve Banks are exempt from federal, state, and local taxes, except for taxes on real prop erty, which are reported as a component o f “Occupancy expense.” 4. U.S. G OVERN M EN T AND FED ER A L A G E N C Y SEC U R ITIES Securities bought outright and held under agreements to resell are held in the SOM A at the FRBNY. An undivided interest in SOM A activity, with the exception o f securities held under agreements to resell and the related premiums, discounts, and income, is allocated to each Reserve Bank on a percentage basis derived from an annual settlement o f interdistrict clearings. The settlement, performed in April o f each year, equalizes Reserve Bank gold certificate holdings to Federal Reserve notes outstanding. The Bank’s allocated share o f SOM A balances was approx imately 1.099% and 1.393% at December 31, 1998 and 1997, respectively. The Bank’s allocated share o f securities held in the SOM A at December 31, that were bought out right, were as follows (in millions): 1998 1997 Par value: Federal agency < £ 10 U.S. government: Bills 2,140 2,745 Notes 2,064 2,426 Bonds 763 Unamortized premiums 6,008 81 $ 86 (35) Unaccreted discounts Total allocated to Bank 827 4,971 Total par value (50) 5,017 $ 6,044 Total SOM A securities bought outright were $456,667 million and $434,001 million at December 31, 1998 and 1997, respectively. Federal Reserve Bank of Minneapolis The maturities o f U.S. government and federal agency securities bought outright, which were allocated to the Bank at December 31, 1998, were as follows (in millions): Notes to Financial Statements (Continued) Par value Maturities o f Securities Held W ithin 15 days U.S. Government Securities 13 $ Federal Agency Obligations $ — Total $ 13 16 days to 90 days 1,089 — 1,089 91 days to 1 year 1,578 1 1,579 Over 1 year to 5 years 1,183 1 1,184 492 2 494 612 — 612 4,967 4 4,971 Over 5 years to 10 years Over 10 years Total $ $ $ At December 31, 1998 and 1997, matched sale-purchase transactions involving U.S. government securities with par values o f $20,927 million and $17,027 million, respectively, were outstanding, o f which $230 million and $237 million were allocated to the Bank. Matched sale-purchase trans actions are generally overnight arrangements. 5. IN VESTM EN TS DENOM IN ATED IN FO REIGN C U R R EN C IES The FRBNY, on behalf o f the Reserve Banks, holds foreign currency deposits with foreign central banks and the Bank for International Settlements and invests in foreign government debt instru ments. Foreign government debt instruments held include both securities bought outright and securities held under agreements to resell. These investments are guaranteed as to principal and interest by the foreign governments. Each Reserve Bank is allocated a share o f foreign-currency-denominated assets, the related inter est income, and realized and unrealized foreign currency gains and losses, with the exception o f unrealized gains and losses on F/X swaps and warehousing transactions. This allocation is based on the ratio o f each Reserve Bank’s capital and surplus to aggregate capital and surplus at the pre ceding December 31. The Bank’s allocated share o f investments denominated in foreign curren cies was approximately 3.589% and 2.314% at December 31, 1998 and 1997, respectively. 42 Federal Reserve Bank o f Minneapolis Notes to Financial Statem ents (Continued) The Bank’s allocated share of investments denominated in foreign currencies, valued at current exchange rates at December 31 were as follows (in millions): 1998 1997 G erm an M arks: Foreign currency deposits 375 $ Government debt instruments including agreements to resell $ 191 85 74 24 14 222 114 4 2 Japan ese Yen: Foreign currency deposits Government debt instruments including agreements to resell A ccrued interest Total 710 $ $ 395 Total investments denominated in foreign currencies were $19,769 million and $17,046 mil lion at December 31, 1998 and 1997, respectively, which include $15 million and $3 million in unearned interest for 1998 and 1997, respectively, collected on certain foreign currency holdings that is allocated solely to the FRBNY. The maturities o f investments denominated in foreign currencies which were allocated to the Bank at December 31, 1998, were as follows (in millions): Maturities o f Investments Denominated in Foreign Currencies W ithin 1 year $ Over 1 year to 5 years 676 18 Over 5 years to 10 years ___________ 16 Total $ 710 At December 31, 1998 and 1997, there were no open foreign exchange contracts or outstanding F/X swaps. At December 31, 1998, the warehousing facility was $5,000 million, with zero outstanding. 43 Federal Reserve Bank of Minneapolis Notes to Financial Statements (Continued) 6. BAN K PREMISES AND EQ U IPM EN T A summary o f bank premises and equipment at December 31 is as follows (in millions): 1998 1997 Bank premises and equipment: Land 13 $ $ 13 109 107 Building machinery and equipment 14 14 Construction in progress — 1 Furniture and equipment 46 47 182 182 (25) (22) Buildings Accumulated depreciation Bank premises and equipment, net $ 157 $ 160 Depreciation expense was $8 million and $5 million for the years ended December 31, 1998 and 1997, respectively. This Bank has not entered into any capitalized leases for bank premises and equipment. Future minimum payments under agreements in existence at December 31, 1998, were immaterial. 7. COM M ITM ENTS AND C O N T IN G E N C IE S At December 31, 1998 and 1997, the Bank was not obligated under any noncancelable leases for premises and equipment. Rental expense under operating leases for certain operating facilities, warehouses, and data pro cessing and office equipment (including taxes, insurance and maintenance when included in rent), net o f sublease rentals, was $259 thousand and $1 million for the years ended December 31, 1998 and 1997, respectively. Certain o f the Bank’s leases have options to renew. Under the Insurance Agreement o f the Federal Reserve Banks dated as o f June 7, 1994, each o f the Reserve Banks has agreed to bear, on a per incident basis, a pro rata share o f losses in excess o f 1% o f the capital o f the claiming Reserve Bank, up to 50% o f the total capital and surplus o f all Reserve Banks. Losses are borne in the ratio that a Reserve Bank’s capital bears to the total capital o f all Reserve Banks at the beginning o f the calendar year in which the loss is shared. No claims were outstanding under such agreement at December 31, 1998 or 1997. The Bank is involved in certain legal actions and claims arising in the ordinary course o f busi ness. Although it is difficult to predict the ultimate outcome o f 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 o f operations o f the Bank. There were no other commitments and long-term obligations in excess of one year at December 31,1998. 44 Federal Reserve Bank o f Minneapolis Notes to Financial Statements (Continued) 8. RETIREM EN T AND T H R IFT PLANS Retirem ent Plans The Bank currently offers two defined benefit retirement plans to its employees, based on length o f service and level o f compensation. Substantially all o f the Bank’s employees participate in the Retirement Plan for Employees o f the Federal Reserve System (“System Plan”) and the Benefit Equalization Retirement Plan (“BEP”). The System Plan is a multi-employer plan with contri butions fully funded by participating employers. No separate accounting is maintained o f assets contributed by the participating employers. The Bank’s projected benefit obligation and net pen sion costs for the BEP at December 3 1,1998 and 1997, and for the years then ended, are not m ate rial. Thrift plan Employees o f the Bank may also participate in the defined contribution Thrift Plan for Employees o f the Federal Reserve System (“Thrift Plan”). The B anks Thrift Plan contributions totaled $2 million for each o f the years ended December 31, 1998 and 1997, respectively, and are reported as a component o f “Salaries and other benefits.” 9. P O STRETIREM EN T B EN EFIT S O T H ER T H A N PEN SIO N S AND PO STEM PLO YM EN T B EN EFITS Postretirement benefits other than pensions In addition to the Bank’s retirement plans, employees who have met certain age and length o f 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, accord ingly, has no plan assets. Net postretirement benefit cost is actuarially determined using a January 1 measurement date. Following is a reconciliation o f beginning and ending balances of the benefit obligation (in millions): 1997 1998 Accumulated postretirement benefit obligation at January 1 $ 27.0 $ 25.7 Service cost-benefits earned during the period 0.8 0.9 Interest cost of accumulated benefit obligation 1.8 1.8 Actuarial loss (gain) 1.4 (0.7) 0.1 Benefits paid 0.1 (0.9) Contributions by plan participants (0.8) Plan amendments, acquisitions, foreign currency exchange rate changes, business combinations, divestitures, curtailments, settlements, special termination benefits Accumulated postretirement benefit obligation at December 31 45 $ 30.2 $ 27.0 Federal Reserve Bank of Minneapolis Following is a reconciliation o f the beginning and ending balance o f the plan assets, the unfunded postretirement benefit obligation, and the accrued postretirement benefit cost (in millions): Notes to Financial Statements (C ontinued ) 1998 Fair value o f plan assets at January 1 $ — 1997 $ — Actual return on plan assets — — Contributions by the employer 0.8 0.7 Contributions by plan participants 0.1 0.1 Benefits paid (0.9) (0.8) Fair value o f plan assets at December 31 $ 0 $ 0 Unfunded postretirement benefit obligation $ 30.2 $ 27.0 Unrecognized initial net transition asset (obligation) — — Unrecognized prior service cost — — Unrecognized net actuarial gain 1.3 2.9 Accrued postretirement benefit cost $ 31.5 $ 29.9 Accrued postretirement benefit cost is reported as a component o f “Accrued benefit cost.: The weighted-average assumption used in developing the postretirement benefit obligation as o f December 31 is as follows: 1998 6.25% Discount rate 1997 7.00% For measurement purposes, an 8.5% annual rate o f increase in the cost o f covered health care benefits was assumed for 1999. Ultimately, the health care cost trend rate is expected to decrease gradually to 4.75% by 2006, and remain at that level thereafter. 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, 1998 (in millions): 1 Percentage Point Increase 1 Percentage Point Decrease Effect on aggregate o f service and interest cost components of net periodic postretirement benefit cost Effect on accumulated postretirement benefit obligation $ 0.6 6.0 $ (0.5) (5.4) Federal Reserve Bank o f Minneapolis The following is a summary o f the components o f net periodic postretirement benefit cost for the years ended December 31 (in millions): Notes to Financial Statem ents (C ontinu ed ) 1998 Service cost-benefits earned during the period $ 0.8 1997 $ 0.9 Interest cost o f accumulated benefit obligation 1.8 1.8 Amortization o f prior service cost — — (0.1) — Recognized net actuarial loss Net periodic postretirement benefit cost $ 2.5 $ 2.7 Net periodic postretirement benefit cost is reported as a com ponent o f “Salaries and other benefits.” Postemployment benefits The Bank offers benefits to former or inactive employees. Postemployment benefit costs are actuarially determined and include the cost o f medical and dental insurance, survivor income, and disability benefits. Costs were projected using the same discount rate and health care trend rates as were used for projecting postretirement costs. The accrued postemployment benefit costs rec ognized by the Bank for each o f the years ended December 31, 1998 and 1997, were $4 million. This cost is included as a com ponent o f “Accrued benefit cost.” Net periodic postemployment benefit costs included in 1998 and 1997 operating expenses were $1 million for each year. 47 The Region 1998 Minneapolis Board of Directors David A. Koch James J. Howard Chair Deputy Chair C lass A Elected by M em ber Banks C lass B Elected by M em ber Banks C lass C Appointed by the Board of G o verno rs Dale J. Emmel Dennis W. Johnson James J. Howard President First National Bank of Sauk Centre Sauk Centre, Minnesota President TMI Systems Design Corp. Dickinson, North Dakota Chairman, President and CEO Northern States Power Co. Minneapolis, Minnesota Kathryn L. Ogren David A. Koch Lynn M. Hoghaug Owner Chairman President Ramsey National Bitterroot Motors Inc. Missoula, Montana Graco Inc. Plymouth, Minnesota Rob L. Wheeler Ronald N. Zwieg Vice President and Sales Manager Wheeler Manufacturing Co. Inc. Lemmon, South Dakota President United Food and Commercial Workers Local 653 Plymouth, Minnesota Bank & Trust Co. Devils Lake, North Dakota Bruce Parker President Norwest Bank Montana, NA Billings, Montana Seated (from left): lames I. Howard, Kathryn L. Ogren, Rob L. Wheeler, David A. Koch; standing (from left): Dale J. Emmel, Ronald N. Zwieg, Bruce Parker, Dennis W. Johnson, Lynn M. Hoghaug 48 The Region 1998 Helena Branch Board of Directors William P. Underriner Thomas O. Markle Chair Vice Chair Appointed by the Board of G overno rs Appointed by the Minneapolis Board of D irecto rs Thomas O. Markle President Markle’s Inc. Glasgow, Montana Emil W. Erhardt President Citizens State Bank Hamilton, Montana William P. Underriner General Manager Richard E. Hart Selover Buick Inc. President Mountain West Bank Great Falls, Montana Billings, Montana Sandra M. Stash Vice President, Environmental Services ARCO Environmental Remediation L.L.C. Anaconda, Montana Seated: Sandra M. Stash, Emil W. Erhardt; standing (from left): Richard E. Hart, Thomas O. Markle, William P. Underriner Federal A dvisory Council M em ber Richard A. Zona Vice Chairman U.S. Bancorp Minneapolis, Minnesota 49 The Region Advisory Council on Small Business, Agriculture and Labor Eric D. Anderson Howard A. Dahl Kathryn J. Polansky Business Agent United Union of Roofers, Waterproofers and Allied Workers President Amity Technology LLC Fargo, North Dakota President Shorebank BIDCO Marquette, Michigan Eau Claire, Wisconsin Ronald W. Houser Shirley A. Ball President Farmer Nashua, Montana Midwest Security Insurance Cos. Onalaska, Wisconsin Jeanne M. Voigt President MindWare Roseville, Minnesota lames D. Boomsma Dennis W. Johnson, Chair Linda H. Zenk Farmer President TMI Systems Design Corp. Dickinson, North Dakota President Lake Superior Trading Post Grand Marais, Minnesota Wolsey, South Dakota Seated (from left): Kathryn J. Polansky, Eric D. Anderson, Jeanne M. Voigt; standing (from left): Howard A. Dahl, Dennis W. Johnson, James D. Boomsma, Ronald W. Houser, Linda H. Zenk 50 The Region Federal Reserve Bank of Minneapolis O fficers Gary H. Stern Bruce H. Johnson Jacquelyn K. Brunmeier Kenneth C. Theisen President Vice President Assistant Vice President Assistant Vice President Colleen K. Strand John D. Johnson Duane Carter Richard M. Todd First Vice President Vice President Assistant Vice President Assistant Vice President Sheldon L. Azine Thomas E. Kleinschmit James T. Deusterhoff Marie R. Unger Senior Vice President and General Counsel Vice President Assistant Vice President Assistant Vice President Richard L. Kuxhausen Vice President Scott H. Dake M ichael Garrett Assistant Vice President Senior Vice President David Levy Jean C. Garrick Karen L. Grandstrand Vice President and Director of Public Affairs Susan J. Manchester Peter J. Gavin Vice President Assistant Vice President Samuel H. Gane Senior Vice President and E.E.O. Officer Helena Branch Assistant Vice President Vice President and Branch Manager James M. Lyon Senior Vice President Preston J. Miller Linda M. Gilligan Assistant General Auditor Arthur J. Rolnick Vice President and Monetary Advisor Senior Vice President and Director of Research Susan K. Rossbach Assistant Vice President Theodore E. Umhoefer Jr. Vice President and Deputy General Counsel JoAnne F. Lewellen Senior Vice President Kinney G. Misterek Assistant Vice President Thomas M. Supel Vice President Claudia S. Swendseid Kathleen J. Erickson H. Fay Peters Assistant General Counsel and Deputy E.E.O. Officer Vice President Richard W. Puttin Vice President Thomas H. Turner Creighton R. Fricek Vice President Vice President and Corporate Secretary Warren E. Weber Assistant Vice President Paul D. Rimmereid Assistant Vice President Senior Research Officer David E. Runkle Debra A. Ganske General Auditor Niel D. Willardson Research Officer Vice President Edward J. Green James A. Schmitz Senior Research Officer Research Officer Caryl W. Hayward Robert E. Teetshorn Vice President Supervision Officer Ronald 0 . Hostad Vice President December 31, 1998