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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: paeditor@minneapolisfed.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.




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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

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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.

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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).




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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.

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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?

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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

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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.

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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.

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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.




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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

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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.




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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.

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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

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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

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