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~1! , ~_ J r I7 ?~ , J . 7. f\\ ~ 1 ")i 1980 Federal Reserve Bank of San Francisco A,nnual Report 1980 ;' .: / Table of Contents 3 4 From the Boardroom National Scene Western Business Western Fi nance Western Central Bank Directors 9 13 19 24 k cisco FEB 20 1 81 John J. Balles President Caroline Leonetti Ahmanson Deputy Chai rman Cornell C. Maier Cha irman The year just past was one of the most difficult and most challenging that the Federal Reserve System has experi enced since its founding two-thirds of a century ago. The 1980 environment was d ifficult because the nation suf fered severe ups-and-downs in busi nessactivity during the year, along with a continuation of the worst peacetime inflation in its history. Yet 1980 also provided hope for the future, because Congress in March passed new legisla tion designed to create greater competi tion in financial markets and to provide the Federal Reserve with stronger weapons for its continuing struggle against inflation. The national economy produced $2.6 trillion worth of goods and services in 1980-roughly the same amount, in real terms, as during 1979, despite the very sharp decline in business activity in the spring months of the year. The overall stabi Iity of real output was dou bly remarkable, in view of the serious problems affecting some of the nation 's basic industries, such as steel, autos, and home construction. Despite these problems, some areas of the country showed modest growth in activity dur ing 1980-especially the massive nine state area served by the Federal Reserve Bank of San Francisco. This area accounted for one-sixth of the national output, and again grew faster than the rest of the nation, as it has throughout the enti re past decade. The Federal Reserve System encoun tered difficu Ities in its struggle against severe inflation, as prices increased 9 percent according to the broad mea sure of GI'JP price change-and in creased considerably faster according to the more widely reported consumer price index. This situation reflected the Federal Reserve's problem of being "the only game in town" in the absence of parallel tightening actions from gov ernment fiscal policy. Following an operating technique adopted in Octo ber 1979, the Fed tried to limit money growth during 1980 by controlling the quantity of bank reserves rather than by tightly pegging the cost of bank reserves. Money growth fluctuated substantially during the year, in a vola tile atmosphere characterized by con tinued inflation and by severe swings in business activity and interest rates. Nonetheless, the Systemwas successful by year-end in bringing standard mon ey-growth measures close to the targets announced early in the year. A new financial era opened in March, when the President signed into law the Depository Institutions Deregulation and Monetary Control Actof 1980. This pathbreaking piece of legislation, among other things , will promote great er equity and improved monetary con trol by extend ing reserve requ irements to all depository institutions with trans action (chec k-type) accounts and non personal time deposits. In addition, it will promote greater efficiency in financial markets, by providing access to Federal Reserve services, at explicit prices, for all depository institutions subject to reserve requirements. Implementation of the Monetary Con trol Act meant a massive increase in workload for the Federal Reserve Bank of San Francisco. Today, our institution serves not only its original basic constit uency of 147 member banks, but also several thousand other banks and thrift institutions throughout the West. In 1980, many Bank departments became involved in carrying out the provisions of the new legislation, under the super vision of a senior-management group called the MCA Policy Committee. Bank personnel designed systems to handle the new pricing and billing functions, developed computer pro grams to perform these new functions and to process reports from a sharply expanded constituency, developed plans for broader access to credit facil ities, restructured reserve accounts, and created staffing plans to meet all these new operating burdens. Management benefited greatly during 1980 from the broad-based experience and judgment of the Bank's directors at Head Office and four branches. The directors provided guidance on major 3 From the Boardroom management decisions and planning goals, especially in regard to the im plementation of the MCA legislation. In addition , they supplied key information on economic and financial conditions as support to the Federal Reserve's for mulation of monetary policy. Today, 37 public-spirited men and women serve asdirectors, representing a great variety of economic interests and non-profit organizations from every area of the West. And in the future, we hope to obtain useful guidance on implemen tation of the MCA program from an advisory group drawn from our ex panded constituency. We are grateful to all these individuals, and also to those who completed terms as directors during 1980 . We owe a great debt of gratitude to these former directors : Chairman Loran L. Stewart (Director, Bohemia lnc.) and Kenneth Smith (General Manager, Confederated Tribes of Warm Springs) at our Portland office; Robert E. Bryans (Chairman of the Board, Walker Bank and Trust Co .) and Mary S. Knox (Chairman of the Board, Idaho State Bank) at our Salt Lake City office; and Chairman Lloyd E. Cooney (President and General Mana ger, KIRO-Radio and TV) and Rufus C. Smith (Chairman of the Board, The First National Bank of Enumclaw) at our Se attle office. Finally, we wish to express our appreciation to our officers and staff, whose dedication to the efficiency of Bank operations in 1980 enabled us to expand and improve our services to the financial community and to the general public. Cornell C. Maier Chairman of the Board Caroline Leonetti Ahmanson Deputy Chairman John J. Balles President February 1, 1981 National Scene The new decade began badly for the national economy. The economy pro du ced $2.6 trillion worth of goods and servi ces in 1980, as gross national produ ct (adjusted for inf lation) roughly matched the precedin g year's total. But that seemi ng stability masked severe gy ratio ns in business activ ity over the course of the year. The first quarter w as marked by a specu lative upsurge in co mmod ity prices ; the second qu arter wa s marked by a near-record qu arterly decline in real output, and that w as followed by a modest recovery in the second half of the year. Throughout it all, rapid inflation and wildl y flu ctu at ing interest rates undermined the strength of the econom y. Real Growth and Inflation Change (%) 1r.== = = = = = :::::::;, 5 Nominal GNP "C M any anal ysts referred to 1980 as a recession year, but many industries show ed few signs of recession - and the same was true of certain sectio ns of the country, especiall y the Sunbelt states of the South and West. The re verse was true elsewhere , however, especially in the Snowbelt states of the Northeast and Central region s. Indeed, so me observers used the term " depres sio n" to describe the pi ight of autos, steel, hou sing, agriculture, and other key secto rs of the national economy. But tho se w eaknesses were largely off set by an upsurge in activ ity in the ener gy indu stry, not to mention defense manufacturing and offi ce construction. Sluggish Demand Consumer spending, whi ch accounts for two-thirds of total GNP, remained flat overall (in real terms), but buyers redu ced spending sharply in some areas because of wariness about future income prospects. Households record ed less than a one-percent gain in real di sposable income-the weakest per form ance of the past half-de cade. Also, mad e cautious by rising prices and fears of future inflatio n, they boo sted their savi ngs rate a half-percentage-po int higher than in the preceding year, to 5.7 percent of income. Another sign of cau 4 tion was a reduction in credit usage; during the second qu arter in particular, consumers responded to Federal Re serve selective credit restraint s by cut ting back on all type sof con sumer cred it, in the sharpest suc h redu ction on record. Big-ticket items, especially autos, felt the full impact of th is cautious buying attitude. Domestic moto r-vehicle sales plummeted 25 percent in 1980 to about 8.7 million units-the lowest level in almost two decades. That sales decl ine reflected aII the factor s noted above as well as others peculi ar to the industry -su ch asthe high cost of autos and gasolin e, plu s a continued con sumer preference for small foreign model s. Resident ial-hou sing activ ity also declined sharply as builders started work on onl y 1.3 mill ion new homes down 25 percent fo r the year and not much more than half the 1978 level. Business fixed inv estment fell about 3 percent (in real term s) from the record 1979 level. This weak performance could have been expected in view of al l the negative factor s affecting co rpo rate decision makers, such as the sluggish performan ce of sales and co rporate earning s, not to mention the record costs of corporate bo rrowing. Business firms also reduced their invento ries somewhat , espec iall y after midyear, but their earlier cautious inventory purchase attitud es made it unnecessary for them to reduce stoc ks drastically, as they had to do during the 19 75 reces sion. In the government sector , real spending remained relativel y flat (fo r the th ird straight year) at the state-and local level, but continued to increase at the Federal level under the spur of a growing defense bu ild-u p. The foreign trade sector represented by far the strongest element in the GNP statistics, however, as exporters record ed a J Ovpercent jump in business (in real terms). The nation's current ac count moved close to balance during the year , on the basis of this strong export performance and a continued rise in income from U.s. overseas investments. The exchange value of the dollar surged early in the year, and again after midyear, reflecting the strengthen ing of the payments position as well as the attractiveness of high interest rates to foreign investors. Weak Output and Employment Industrial production declined almost 4 percent for the year, but the fortunes of individual industries varied significant ly. Production of consumer durable goods dropped 12% percent, headed by the near-collapse of auto manu facturing, whereas production of con sumer nondurable goods remained stable for the year as a whole. Business equipment output increased slightly, while defense-equipment output rose 4 % percent and headed even higher at year-end . In contrast, farm-equipment production dropped 15 percent, in re sponse to a sharp drop in demand from the nation's hard-pressed farmers. A se vere drought, the Russian grain embar go-and above all , a one-third increase in production expenses over a two-year period -pushed the farm sector deeply into the red. As a result, net farm in come (in real terms) dropped roughly 30 percent for the year . Employment actually increased slightly in 1980, as a second-half gain of almost a million jobs offset a steep early-year decline. These figures reflected a ten dency-evident throughout the last several years-for industries to expand by adding labor rather than capital , because of such factors as a sharp in crease in investment costs relative to wages. But the combination of heavy staffing and sluggish output spelled trouble for productivity, as output per hour actually dropped for the third straight year. (With labor compensation rising sharply, unit labor costs increas ed again at near double-digit levels, thus putti ng heavy pressure on prices. ) Still, these developments helped lim it the rise in the unemployed share of the labor force ; the jobless rate averaged 7.1 percent for the year, but this was less than generally expected. Meanwhile, more than 58 percent of the adult popu lation held jobs during 1980-a figure exceeded only during the 1978-79 peak of the boom . Price Shocks The national and international econo mies were severely affected during 1980 by the effects of the second " o il shock" -the 1979-80 increase of al most 150 percent in the average price of OPEC oil. Like the previous shock of the 1973-74 period, the recent price hikes acted as a giant worldwide sales tax, raising prices and draining off pur chasing power that would otherwise have been available for purchases of other goods and services . Soaring OPEC prices helped boost costs throughout the u.s. economy and discouraged business investment, con tributing to the productivity slowdown noted above. The oil shock's impact tapered off in the second half of the year, but it left con sumers with energy bills almost twoth i rds higher than they were just two years ago. As that shock waned, an other shock arose because of poor growing conditions in this country and abroad, which sent food prices soaring in the second half of the year. The con tinued upsurge in labor costs through out industry, and above all, the pres 5 Change in Produ ction Percent Business Equipment ~ 12 1 ~"' -=:J:::== 1 ::.\:==~ I 8 o1 j::::=t~;IIJ:='.='~ -4 1974 1977 1980 sures on monetary poli cy generated by yet another massive Federal deficit ($60 b illi on in fiscal 1980)-added to the vario us shoc ks to create severe infl a tion ary pressu res throughout the year. Prices increased about 9 percent for the year, acco rd ing to the G N P " deflato r," the broadest measure of price change. The increase in inflation w as several percentage points high er wh en mea sured by the more widely reported con sumer-price index, but that increase w as overstated because of the CPI's treatment of hom e-purchase and mort gage-interest costs (w hic h are not di rectl y inc luded in the GNP deflator). In any event, the 1980 pri ce perfo rmance w as the worst since the inflationary up surge of the mid-1970' s. And for the first tim e since that dism al period , 1980 witnessed a small decline in the aver age ind iv id ual's well-being, as mea sured by the yardstic k of real d isposable per capita income. Consumer Price Change Percent 1974 1977 1980 Policy Problems The Federal Reserve encountered d iffi cu lties in its struggle again st the severe infl ation , reflecting the Fed' s problem of being "the only game in town " in the absence of parallel tightenin g actio ns from government fiscal poli cy. Follow ing a change in operati ng techn iqu es adopt ed in O ctob er 1979, the Fed tried to limit money growth during 1980 by co ntrolling the quantity of bank re serves rather than by tightl y pegging the cost of bank reserves(the Federal-funds rate). Market participants had troubl e adj usting to this new operating environ ment , however, which implied a broad er range of interest-rate fluctu ation s acco rd ing to changes in business and credit co nd itio ns. Indeed, interest rates fo llowed a roll er-coaster course, rising to hi storic highs during the speculative boom of early 1980 , falling sharply in the spring period, and then rising to new peak levels in the late fall months. 6 The Federal Reserve's policy actio ns made headli nes on several occasio ns during the year. In mid-March , amidst fears of run aw ay infl ation and a pos sible liqu idity crisis, the Fed (at the Ad ministratio n's request) imp osed a cred it-restraint progr am to curb money and credi t grow th. This progr am in cluded a 9-percent Iimit on each bank's loan expa nsion, a 3-percentage-point discount rate surcharge on large banks whi ch borr owed frequently at the Fed's d iscount w indow , and a 2-per centage point increase in marginal reserve requ irem ents on large CD ' s and oth er " managed liabil ities" of large banks plu s a 15-percent special depo sit on increases in certain types of co nsumer loans. The Fed terminated the credit restraint pro gram around midyear as busin ess activity weakened. However, the Fed then foll owed more traditional techniqu es of mo netary restraint after a summ er-period upsurge in mon ey growt h. It acted by restricting the avail abi lity of bank reserves throu gh its op en-m arket operatio ns, by raising its discou nt-r ate again to a record 13 per cent , and by reim posing a surcharge on frequent d iscount-window borrowing. The Fed w as onl y moderately success ful in curbing money grow th in the face of sharp changes in infl ation expecta tion s and wide fluctuations in credit demands. The growth rate of the nar row M -1A aggregate (currency plu s bank demand deposits) by year-end was within the Fed' s announced target range of 3'I2-to-6 percent growth. But the growth in the bro ader aggregates, M-l Band M- 2, reached or slightly ex ceeded the upper bound s of their re spective target ranges, reflecting the rapid rise of certain interest-sensiti ve liabilities included in the aggregates. M-l B includes M-1 A plus other check able depo sits (prima ri Iy the so-cal led ATS and NOW acounts), and M-2 includes M-1 B plu s sma ll time and savings accounts , mone y-m arket mu tual-fund shares, and certain other liabilities. Volatile Credit Markets Total fun ds raised in 1980 ' s fina ncia l markets fell below the previous year's tot al, acco rding to prelimi nary esti mates, because of the record cost of cre dit and a recession-induced decline in overa ll cred it de ma nd. Nonethe less, the pub lic sector's snare of the total increa sed substantially during the year. The Federal debt grew at least twice as fast as in 1979 , as inf lation and reces sio n pressures boosted Federal spend ing and forced the Treasury to step up the pace of its fun d- raising efforts. State and local govern me nts w ere also more active in deb t markets, espec iall y through incr eased sales of tax-exempt mo rtgage revenue bond s. Federall y spo nsored agency debt, by cont rast, grew mor e slowly than in 19 79. In the private secto r, co rpora te busi nesses raised rou ghly the same amo u nt offund s as in 1979, primarily in the long-t erm end o f the mark et. In fact, co rporate lo ng-term de bt grew by a rec ord amo unt in 1980-more than half again as much as in 1979 -despite widespread fears abo ut the " d isappear ance" of the bo nd market. New cash offerings of cor po rate equiti es also grew rapid ly d ur ing the year. In co n trast, the mortgage and co nsume r-deb t markets showed co nside rable wea k ness, reflecting the co llapse of consum er hou sing and auto dem and , aswe ll as the imp act of the cred it-restrai nt pro gram and the dry ing up of savings in flows at mortgage-lendin g institu tio ns. Fin anc ial grow th patterns reflected not onl y the wide swin gs in business activ ity, but also the wid e swings in interest rates w hic h led to new record highs at the spri ng and fall peaks. The yield cu rve traced by instruments of gradual ly inc reasing maturity remained invert ed for much of the year-a typical in fl ation phenomenon -as short-term rates rose above lon g-term rates during the spri ng and fall periods. The prim e business-loa n rate rose from 15"\4 per ce nt in J anuary to 20 percen t in Ma rch, fell to 11 percent in August, and then rose again to 2 1V2 in Decembe r. Simi larly, corporate Aaa-rated bond rates rose from 11 Vz percent in Ja nuary to 14 percent in Ma rch, fell to 11 percent in lu ne. and rose again to over 14 percent in December. Corporate-borrowing pattern s shifted stro ngly in response to these sharp fluctu ation s. Businesses re lied heavil y on short-term bo rrowings during the several epi sodes of sharply rising rates, but they issued massive amounts of long-term debt w hen rates fell in the spring month s, in an effort to " lock in " thei r cost offundsand reduce their rel iance on short-term fi nancing. Mortgage bor row ing foll ow ed a similar stop-and-go pattern, as rates rose to a record 18 percent in the spri ng, dro pped to 12 percent in the late sum mer, and then approac hed the earlier peak around year-end . Sluggish Bank Credit Bank c redi t increased only about 9 per cent in 1980-far below the grow th of the 1978-79 peri od -and muc h of that growth was co ncentrated in new securi ties investment rather than new loans. The loan slowdown largely re flected a massive runo ff of consumer loans-down 5 percent for the year as cons ume rs avo ided taking on new 7 Growth of Money Supply Change(%) 6 4 2 19 79 1980 Interest Rates Percent 20 r;:::========i.l debt even after the midyear termination of the credit-restraint program. Busi ness loans, in contrast, grew at a rela tively healthy 11-percent pace over the year, despite a decline in this category during the spring recession period. Bus iness loans expanded rapidly in the fall, as many banks offered financing to firms that couldn't find funds in the corporate-bond market -and addition ally, offered sub-prime loan rates to many firms in an attempt to compete with the commercial-paper market. Banks' real-estate loans increased almost 8 percent during the year-and in fact increased most rapidly in those several crunch periods when many savi ngs-and-Ioan associations ran out of funds to lend on home mortgages. 18 16 14 1979 1980 Funds for financing this bank-credit ex pansion were costly to come by, be cause of the continuing shift of funds from "core" deposits (demand and passbook-savings deposits) to more ex pensive sources acquired at market determined interest rates.The most rap id (15V2 percent) growth occurred in small-denomination time deposits, which included the popular 6-month and 30-month money-market certifi cates. Banks also relied heavily on large-denomination ($100,000 and over) time deposits, especially in those several tight-money periods when they actively sought lendable funds. 8 Stable Bank Earnings Bank earnings in 1980 exceeded the 1979 peak, according to preliminary evidence, despite the impact of record interest rates on both sides of banks' balance sheets. Wholesale (commer cially oriented) banks experienced a large increase in operating income be cause, with their substantial floating rate loan base, prime-rate increases raised the return on a sizable portion of all their assets. But by the same token, they experienced dramatic increases in the cost of funds, because of their heavy reliance on short-term, interest sensitive liabilities. Retail (consumer oriented) banks experienced almost the reverse situation. Because their assets were heavily concentrated in fixed-rate mortgage and consumer loans, they failed to receive higher returns on the bu Ik of thei r po rtfo Iios when rates increased. But because their deposits were heavily concentrated in fixed-rate "core" deposits, they generally experi enced smaller increases in interest costs-except for those cases where funds shifted out of such deposits into certificates bearing market-determined interest rates. On balance, increases in banks' operat ing income generally outpaced in creases in thei r cost offu nds. StiII, re sults varied widely for individual banks because of their different responses to 1980's unsettled credit-market condi tions. The net interest spread -the d if ference between the rate of return on assets and the rate needed to cover the cost of funds--narrowed severely for many banks during the early-year crunch, and again during the similar period in late fall. Nonetheless, the banking industry generally coped very well with 1980's highly volatile credit markets. Th e Western economy experienced a medi ocre year in 1980, suffering first a sharp (but brief) recession and then a falteri ng recove ry tow ard year-end . (This region , the area served by the San Franc isco Federal Reserve Dist rict, in cl udes all nine states w est of the Con tine ntal D ivide-see map, page 23.) Some industries mi ssed all the suffer ing , but others-especial ly hou sing related indu stries-felt the full im pact of all the negative forces operating on the nation al eco no my. And at year-end, inflatio n-b loated in terest rates prom ised furth er problem s for at least the ear ly part of the new year. Still , business activi ty in these Western states remained somewh at stronger than in the " Snow belt" states of the No rtheast. M uch of this relative strength stem med from co nti nued heavy in- m igration from other parts of the country and other parts of the w o rld . Accordin g to 1980 Census data, the West gaine d 23 percent in popul a tion over the past decade -mo re than tw ice the gai n record ed elsew here. The regio n' s 37.7 million peopl e - wh ether they arrive d by car, pl ane, o r stork represent a stro ng underpinn ing of de mand in the 1980's as in the " 1970' s. Those peo p le also mean add itio nal po litica l pow er, because the reappor tion ment req ui red by the 198 0 Census w ill mean tw o new Con gressional seats for Califo rnia, and on e new seat each fo r W ashi ngto n, Oregon, Arizona, N evada and Ut ah. Modest Gains Civi lian em ploy me nt in this nin e-state area rose almost 1 % percent in 1980 - an increase of rou ghl y 200,000 jobs - to reach about 16.2 m illion (annual average basis). That job expansion , how ever, rep resented o nly a fraction of the gai ns reco rded du ring the 1976-79 boo m . But in terms of jo bs as well as populati on , the We st co ntinued to out pace the rest of the nation , as it has do ne since the early 1970's. (In this recessio n-and-recovery year, civ iIian emp loyme nt elsew here in the nation barely matched the 1979 average). Empl oyment gains still were modest th rough out region al industries; even in stro nger indu stries, suc h as aerospace, the jo b exp ansion w as co nsiderably w eaker than in earlier years. Reflecting th is spotty jo b perform ance, regional unemployment rates in creased considera bly during 1980, al though a sharper incr ease elsewhere raised the natio nal rate above the re gio nal figur e for the fir st time in years. Califo rnia's jo bless rate, for examp le, rose fro m 6.2 to 6.8 percent between 1979 and 1980, wh ereas the national rate jumped from 5.8 to 7.1 percent (on average) du ring the year. For more than a decade, California's jo blessrate had hovere d one or tw o percentage points abo ve the national rate, because of heavy in-m igration (w hich bolstered the size of the labor force) and prob lem s wi th key regiona l industries. That situa tio n c hanged by the end of the '70's as the state increasingly outp er forme d the nationa l eco nomy. Indeed, throu ghout 1980, the Cali forni a job less rate lagged far below the 10-percent fig ure reached in the 1975 recession. Person al incom e in the West in creased 11 percent in 1980, to about $385 bi l lion . But hou seholds lost ground in real terms, because of a sharp accelera tio n in co nsumer pri ces. The co nsumer price index increased abo ut 13V2 per cent at the national level, but by several percentage points mo re in Califo rnia because of the greater und erl yi ng hou s ing demand in that area. In both cases, the incre ases were overstated because of the overweighti ng of hou sing costs in the price index -but they rem ain ed in dou ble d igits even after adjustmen t for that facto r. Retail sales, in real terms, co nsequen tly remained flat (or worse) throughout the region, especially in autos and housing related goods. Co nsumer cred it-card buying, wh ich had been held in check by the credit-restraint program during the second quarter, rebounded after midyear but then softened again during the fall month s. And in Decemb er, many retailers resorted to pre-Christmas sales to attract scarce custom ers and to 9 Western Business Change in Emplo yment Percen t 6 r;:::::======:;"1 4 2 It J=~ ":::I::::::Ij,==::.. ,,::\r , -2 L 1971 ~ 1974 1977 1980 avoid paying high interest rates on un wanted inventory. Western governmental agenc ies also had to pull in their belts, because of a recession-caused slowdown in tax rev enues and the impact o f the various tax-and- spendin g lim itation s ado pted by regional voters ove r the past several years. For exampl e, California' s state government had eased the fiscal squeeze on other units by using up budget surpluses of $3.7 bill ion during the 1978-80 period , but it now faces an empty larder as it enters 1981, which w ill make futur e tax inc reases and/o r service cutbacks almost inevi table in that state. Al aska, in contrast, w ith its state own ership of o il lands, parceled out some of its unexpected w ealth by repealing state incom e taxes for the 1979-84 period and decl aring a cash dividend for all Al aska residents except new arrivals . Industrial Performance Some Western indu stries, espec ially aerospace-equipment manu facturing, recorded sales and employ ment gains during 1980, although most of the strength was co ncentrated in the earl y part of the year. O rders for co mmercial aerospace produ cts slowed during the second half because of the impact of the national recession . Orders for commercial jet transport s fell off sharp ly, reflecti ng the decl ine in passenger traffic and the soari ng fuel costs which affected the wo rld ' s airli nes. Civ ilian orders for electro nic equi pment also slowed as business firm s and pri vate hou sehold s spent less on co mputers, communication equi pme nt and elec tronic games. Defense and space business remained strong th roughout the year, however, as Western firm s received a grow ing share of the Federal government's expand ing military and space outlays. O ngoing programs receiving more fundin g in cluded the cruise-missile program, w hich moved from the development to the produ cti on stage du ring the year. Controversy meanw hile erupted over the Pentagon' s selectio n of Utah and Nevada as probable sites for the im mense shelter-and- roadw ay system needed for the deployment of the M X mi ssile. The region al steel industry suffered a year of decl ine. Two major region al produ cers began to clo se down high cost produ ct ion and fabri cating facili ti es, leadin g to a 20-percent decl ine in raw producti on for the year. Foreign produ cers, benefiting from thi s shut down, thu s increased their share of the W estern market from 34 to 43 percent. But the size of the market stiII dec!ined, because of a slow down in indu strial bu ild ing, residential co nstruction, and hou sing-related markets. In contrast, the North west alum inum indu stry suf fered from supp ly probl ems w hic h made it d ifficult to keep pace wi th heavy demand . Aerospace-related de mand for aluminum remained relative ly strong, but production suffered from the Northwest's prolonged dry spell, wh ich forced recu rri ng cutbacks in power supplies from Federal hydro electric faciIiti es. The Western copper industry experi enced the ill effects not onl y of the re cession but also of a summer-long strike . Early in the year, produ cers ben efited from the speculativ e buying fever that sent co pper prices-along with go ld and silver prices-soarin g upw ard on the New York and London commod ity excha nges. Refined-copper pri ces jumped a spectacular 40 percent in early January, to a near-record $1.40 a pound, but by year-end fell below the origi nal level as the hou sing and auto slumps dr ied up demand for the metal. The Western sil ver-mining indu stry also experienced the unsettling effects of a speculative bubble and ensuing co l lapse in pri ces. The average produ cer pri ce qu adrupled in 1979 and then al most doubl ed again in early 1980, to reach a record $48 an ounce-but then fell precip itou sly, and after consider able fluctuatio ns, reached about $15 at year-end. Still, the pri ce upsurge spurred a flur ry of exploratio n and deve lopment w ork at a numb er of.mi n ing locations, especially the century 10 o ld diggings in the Coeur d'Alene dis trict of Idaho. Energy Developments Regional petrol eum co nsumption de c lined during 1980, partly because of the recession, but also because of the pr ice upsurge that foll owed in the wa ke of the Irani an revolution. Western util iti es and indu strial plants reduced their demand for fuel o il, taking advantage of the increased availab ility of c1 ean burning natural gas. But gasoline and diesel-fuel consumpti on fell even more sharply as higher pump prices persuad ed drivers to reduce their consumption per vehicle. Still, Western crude-oil pro ductio n increased sharply for the fourth straig ht year, reflec ting the late 1979 boost in A laskan pipelin e capac ity (and flowthrough) from 1.2 to 1.5 million barrels per day. The import share of the region al market continued dropping to 20 percent - from 48 per cent at the 1976 peak-as Western re fineries substituted mor e and more Alaskan oil for imp ort s. The continuing program to decontrol we llhead pri ces enco uraged the high est level of drill ing activity since the mid-1 950's. In Califo rnia, with its con centration of heavy-gravity petrol eum , the remov al of heavy-oil price contro ls triggered a num ber of " tertiary" recov ery projects to extract oil remaining in old wells after co nventional methods. Higher prices also spurred a flurry of activity in new areas suc h as the Over thrust Belt, a 2,300 -mi le ribb on of tor tured geology extendi ng alo ng the Rocky Mountains from Canada to Mex ico . Thus far, abo ut one billi on barrels of oil and 10 trill ion cu bic feet of gas have been di scovered in that area, and some experts believe that it co ntains even more energy w ealth than Alaska's Prudhoe Bay. Synthetic fuels appeared closer to com mercial development, partly because of soaring pri ces of conventional fuels, and also because of the government's authorization of $88 billion in loan guarantees and subsid ies over the 1980-95 period to spur synfuel com mercialization . The first large-scale production may come from the huge oil-shale deposits of the Green River formation in Colorado, Utah and Wy oming-oil depos its which , wh ile im mensel y difficult to extract, may almost mat ch the enti re world 's proven oil reserves. Me anwhile, several pipel ines in the planning stage moved closer to real ization during 1980. The Canadian government approv ed the construct ion of a pipeline system to bring Al askan North Slope gas across Canada to the Northwest states, while the U.S. government approved a pipeline to transport Al askan oi I between the Puget Sound and Minnesota. Construction Scene An office-build ing boom represented the strongest element in the 1980 con struction picture , as Los Angele s, Seat tle, San Francisco and other regional centers reported a burst of activity in this sector. Historically low vacan cy rates, increased off ice-bu ild ing inve st ment values, and inflation expectations all cont ributed to the boom, whi ch w as nationa l and not ju st regional in scope. In an attempt to keep the boom goin g in the face of record high interest rates, many institutional lenders became de velopers themselves by taking owner ship positions in joint-venture projects. In contrast, the Western housin g mar ket, which had already weakened in 1979, almost coll apsed in 1980. Hous ing starts in the Western census region dropped to about 280,000 units in 1980, as against 460 ,000 units in 1979, because of severe finan cin g problems in the spring and again in the late-fall months . On the other hand, powerful economic and demographic factors continued to stimul ate housing de mand -and these factors suggest the probabi Iity of a strong recovery when ever finan cin g problems can be over com e. Many household s find housing investment attractive because of rising inflation expectations coupled with the favorable tax treatment of housing. Moreover, the West's strong eco nomi c-growth prospects sti mulate in migration and famil y form ation , further amplifying demand. Despite fin ancing problem s, therefore, many areas of the West have continued to exper ience larger price increases than the 8-to- 10 percent increases experi enced nation w ide. Financing con straint s also have been less stringent in the We st, with the devel opment of "creative finan cing" schemes by many mortg age-lending institutions. But in the end, their efforts in 1980 were severely handi capped by soaring mortgage rates and sharpl y re duced saving flows. Housing Starts M illions 2.5 The nationwide housing slump took a severe toll on the Western lumber in dustry, forcing a 17-percent cut in pro duction and heavy layoffs on the heels of more mod erate decl ines in the 1978 79 period . The cutback w asaggravated by decl ine s in other important lumber market s, including nonr esidential con struction . Softwood-lumber prices thus fell 23 percent below their fall-1979 peak by the following spring, and re covered onl y partwa y by year-end. The indu stry also suffered from the Mount St. Hel ens eruption, whi ch downed about one billion board -feet of timber, of which about half may not be salvage able. The pu Ip-and-paper segment of the industry, in contrast, recorded modest gain s in sales and employment until markets began to w eaken late in the year. Farm Developments Western farm ers and ranchers, lik etheir urban cousins, were hard-pressed to keep up with inflation in 1980. Accord ing to prel im inary report s, net farm in come w eakened substantially during the year, as soaring produ ction costs outpa ced an 11-percent increase in farm-m arketing receipts. Pricesfor farm produ cts generally lagged, because of large harvests and recession-weakened 11 r.=======::::;, 2.0 1.5 1.0 0.0 ~~~;;";;;===;;;;";;;;;;;";;=..I 1971 1974 1977 1980 consumer demand, although the West ern indu stry benefited from drought caused shortage s el sewhere in the country. The expo rt trade remained strong, however, because of heavy for eign demand for the We st's wheat , cot ton, and specialty crops. Harvests throughout the region gener ally were on the high side. Grape pro duction approached record levels, de spite a harvest-time strike , and c itrus growers recorded bumper cro ps whi ch sharply depressed oran ge pri ces. Sugar beet growers benefited from stro ng worldwide dem and - w hich sharpl y increased pri ces, thu s offsetti ng the poor profits record ed in the several preceding years. Potato prices doubled over year-befo re level s at the height of the summ er shortage caused by the Eastern drou ght. Northwest cro ps (ex cept for ch errie s) generally benefited from favorable grow ing condi tions, and this helped offset losses from the Mount St. Helens eruption - w hic h in any case were far less than ori ginall y reported . Cattlemen began to move onto the up side of the cattle cycl e. Early in the year, many ranchers continued to reduce their herds, thus puttin g downward pressure on beef prices . But as the year advanced, they began to hold cattle off the market and expand their herds, and beef pri ces rose co rrespo nd ingly. Dairymen meanwhil e report ed a fairl y profitable year, because of grow ing demand for dairy produ cts. While the West benefited from d rought problems elsewhe re, it co ntinued to make long-range plan s to overcome its own long-term w ater sho rtages, espe cially through Cal iforn ia's ado ptio n of a $5-bi IIion water-development pack age. The centerpiece of the package was a planned peripheral canal to co n nect the Sacramento River d irectly with the 444-mile-long California aqueduc t that carries Northern Cal iforn ia water to the farms and cities of semi- arid Southern California. The legislation also authorized major dam and other water-development facilit ies that are designed to meet Southern California's needs through the remai nder of thi s century. Somber Outlook On balance, 1980 turn ed out to be a mediocre year for the Western econ omy, and 1981 cou Id be mor e of the same. Western hou sehold s, lik e their national counterparts, have tightened their belts under the spur of infl ation and a tight policy response, and this could mean weakness in consumer markets for at least the early part of the year. Also, Western metal s indu stries are likely to continue sufferin g from sluggish demand in both nation al and international markets. And increasingly expensive energy could again spell 12 trouble for the West's key touri st in du stry and other industr ies as wel l. Still, the West seems certain to outpace the rest of the U.S. economy in 1981 , as it has in other recent years. This region , because of its resource base, will con tinue to play the dominant role in the nation's search for a solution to its en ergy problems. Similarly, becau se of the presence here of a major aerospace indu stry, it w ill continue to play the domin ant role in the nation's search fo r a stronger defen se posture. O verseas demand for the region 's farm produ cts and high-technology produ cts, espe ci ally in the expand ing Pacifi c Basin countries, sho uld pro vide further un derpinn ing for the regional eco nomy. Western bank sexperienced a moderate expansion in their loans and invest ments during 1980 . Despite substantial buffeting by recession and inflation forces, the relat ive strength of the Wes tern economy provid ed banks with amp le (but expensive) fund s and ready lending opportuniti es. Western bank s generated ample funds to meet loan dem and through much of the year, but had to pay record high market rates to do so. With those funds, they increased out standing bank credit by nearly $14 bi IIio n - an 8-percent gai n -and loan s accounted for $13 bil lion of the increase. Business-loan de mand was relat ivel y stro ng during 1980, although it w as also very erratic. Real-estate loans also expanded through mo st of the year, despite record mortgage rates dur ing the spring months and again at year-end. In con trast, consumer loans w eakened even prior to the impos ition of the credit restraint pro gram , and never recovered from thei r sharp spring run-off. Commerci al bank s nationwide faced extremel y vol atile market condition s during most of 1980 , and Western banks were no except ion. Interest rates reached record levels in the spring, and exceeded those levels in December, so that banks had troubl e maintaining normal spreads between the ir average return on assets and their average co st of funds. Dem and for bank loan svaried with the sharp flu ctu ations in the econ omy , along with the shifti ng develop ments in the bond market and the commercial-paper market. When these markets weaken ed, banks became the primary source of funds for many cor porate borrowers. Lending Fluctuations Business-loan activity flu ctu ated wide ly, but for the year as a whole, Western ban ks added nearly $6 bill ion (a 14 percent increase) in business loans to the ir portfolios. During the winter, and again late in the year, many large firm s sharp ly increased their bank bo rrowing after postponing lon g-term bond issues in the face of record bond rates. In those periods also, many large firms that nor mally rely on the commercial-paper market for short-term funds increased their bank borrowings as the spread narrowed between the prim e rate and co mme rc ial-paper rate, and as banks became more aggressive about making sub-prime loans. In co ntrast, business loan demand slackened abruptly dur ing the second quarter, unde r the im pact of the early-spring upsurge in the pr im e rate, the special credit-restraint pro gram, and the late-spring resur gence of the bond and commerc ial paper m arkets. Mining and petroleum firm s were heavy borrowers during the year, re flecting the regional and nation al em phasis on energy exploration and de velopment. Lending to constru ction firms w eakened, not surpris ingly, be cause of the sharp decline in hou sing and other construction acti vity. But the wholesale and retail trades also were relative ly light borrowers during 1980, because of the second-qu arter sales decline and their year-long effort s to bring inventories under contro l. Banks' mortgage lending conti nued to expand , however, as other institutions dropped out of the market because of lack of fund s. In fact, bank real-estate loans increased by nearly $8 bill ion (15 percent) and once again became the fastest growing loan component. (Sti ll, that increase fell well below the strong gai ns of the 1977- 79 period.) Mortgage lend ing slowed down during the sec ond quarter, in response to record 18 percent mortgage rates, but activity increased again as funds became avail able at lower rates in the summer and early-fall months. 13 Western Finance Western Bank loans Change(%) 30r== = = = = = ::::1 Western consumers , in contrast, actual ly paid down their bank consumer-loan debt by nearly $1 billion during the year. Like their counterparts elsewhere, Westerners tightened thei r belts be cause of recession and inflation fears, record borrowing costs, and (in the spring period) direct credit restraints. Auto and home-improvement financ ing felt the brunt of these cutbacks . Available (But Expensive) Funds Western banks found ample funds to finance their credit expansion . Depos its rose by nearly $16 billion, just under 1979's record increase. However, the deposit mix shifted away from low-cost "core" deposits and towards more expensive instruments paying market determined rates. Non-deposit sources of funds-also relatively expensive provided an additional $2 billion in new funds, which was significantly less than in other recent years. Large-denomination time deposits ($100,000 and over) increased nearly $8 billion. But consumer-type time de posits also became an important source offunds-with a $6-billion inflow from six-month money-market certificates alone-which was necessary because savings deposits provided no net in crease in funds over 1979 levels. In addition, savings deposit flows became extremely volatile, rising and falling in response to the sharp movements in the differential between the 5%-percent ceiling rate on passbook savings and the much higher rates paid on alternate savings instruments (money -market certificates, Treasury bills, and mutual fund shares). Rising Earnings Earnings of Western banks apparently rose modestly in 1980, according to preliminary data, although maintaining earnings growth and profitability was difficult in such a volatile environment. Sharp rate fluctuations, narrowed spreads, and differences in (wholesale or retail) lending orientation affected earnings in diverse ways. Western banks, with their heavy retail orienta tion , apparently lagged behind the earnings increases posted by their money-center counterparts. Still, most regional banks weathered the year's in stability without difficulty, and entered 1981 in relatively good shape. In this, they differed from many thrift institu tions which were more heavily involv ed with the weakened housing industry. Banks' operating income expanded because of the moderate expansion in bank credit-especially floating-rate business loans-and the record level of rates in effect during much of the year. But many retail-oriented banks found themselves holding relatively large po rtfo Iios of fixed-rate loans, either long-term mortgages or intermediate term consumer loans. Their interest spreads narrowed -and their profits dec Iined -as the returns on such assets lagged in the face of soaring costs of funds . Interestexpense surged for both deposit and nondeposit sources as banks paid record market rates to generate new funds. This meant increased reliance on expensive variable-rate consumer de posits and large-denomination time deposits. The increase in interest costs reflected not only the record rates paid on these funds, but also the continuing shift by consumers from low-cost core deposits (demand and savings deposits) to variable-rate certificates. 14 Change and Competition The new year opens a new era in West ern banking and finance , in the wake of the legislative changes described in the next section . The nationwide authori zation of interest-bearing NOW ac counts has made it possible for thrift institutions to become direct competi tors for consumers' transaction (check ing-type) deposits. With broadened lending powers, thrifts also have the opportunity to compete with commer cial banks in the credit-card and con sumer-loan areas as well. All of these competitive factors can dampen bank earning growth in coming years. Western banks enter 1981 with a sig nificant locational advantage, since their domestic operations are concen trated in one of the strongest regions of the country . With any substantial drop in interest rates,they would also benefit from improved margins on their mort gage and consumer-loan portfolios. Still, the cost offunds may remain high-and earnings depressed because of continued fluctuations in interest rates, increased reiiance on var iable-rate deposits, and competition from other financial institutions. Management Committee (Shown from left to right) Kent O. Sims, Senior Vice President, District Departments John B. Williams, First Vice President John J. Balles, President John L Carson , Senior Vice President, Corporate Staff 15 Federal Reserve Bank of San Francisco Organization Chart February 1, 1981 District Departments Vice President Business & Community Relations Vice President Statis tical & Data Services Vacant \Vilhelmine von Turk Director Credit & Consume r Affairs 'IV Gordon Smith Examining Officer Commer cial-San Francisco Wa -ne l. Rickards Domestic Reports Officer ianet L Oliver Research Offi cer International Report s Office r; Resear ch Of ficer Peter Hsieh Sara Garrison Herbert R. Runyon Computer Services Vice Pres ident Computer Systems Vice President Computer Operations S. lee Flynn Operations Hector ,I",\. Martin I Moneta ryC David Systems Officer Applications Systems Operations Suppa Lorraine \'Yal Marina Mann j 1 Salt lake City Vice President Satt Lake City Portlar :\ . Grant Holman Asst. Vice Pres. Analysis & Co ntrol Officer Gerald R. Dalling 16 Asst. Vic, Custod y Control Don W. Sheets Custody ( D,an C. Gu Assistant General Auditors Bruce H. Thompson Brian Mavrogeorge General Auditor Vacant Ombudsman la ne W. La ngho rne Corporate Staff Secretary's Office Senior Vice President Secretary's Office Donald V. Masten Facilities Planning District Security Vice President Facilities Planning O ren L. Chris tensen Asst. Vice Pres. Corporate Personnel Steve n F. Whitmore Asst. Vice Pres . Facilities Planning William K. Ginter Personnel Officer P.A. Tarbutton I I Los Angeles Dire-ctor Monet.a'1' Control Project Team David J.Chrtsterson Admin . Services Officer Charles L. Huffstetler Employee Relations Officer Barbara L. Gahney t h Portland Vice President Portland Angelo S. Ca rella Seattle Asst. Vice Pres. Check Collection Kenneth L. Pete~n Asst. Vice Pres. Analysis & Control Gale P. Ansell 17 Branch Operations (Show n from left to right) H. Peter Franzel, Vice President, Operation s Angelo S. Carella, Vice President, Portland Gerald R. Kelly, Senior Vice President, Seattle Richard C. Dunn, Senior Vice President, Los Angeles A. Grant Holman, Vice President, Salt Lake City 18 During 1980, the op eration s of the Fede ral Reserve Bank of San Francisco began to chan ge dramatically, in re sponse to several historic fin anci al and legislati ve developments. At the same time, the Reserve Bank co ntinued to prov ide central-bank services-in the area of c hec ks, coi n, curren cy, fiscal agency, and electronic fund transfers for a region al eco no my whi ch again grew at a faster pace than the rest of the nation . The Twelfth D istrict, wh ic h is served by five Reserve Bank offices (San Franci sco, Los An geles, Portland , Salt Lake C ity and Seattle) isthe largest Fed era l Reserve Di strict in terms of both geographic size and industrial activ ity. It includes the states of Alask a, Ar izona, Ca li fo rn ia, Hawaii, Idaho, Nevada, Oregon , Utah and W ashingto n, plu s the territories of Guam and Amer ican Sa moa, wi th a total popul atio n of 37.7 m ill ion peopl e. The 1980 combin ation of high inflatio n and high interest rates created an ex panded w o rkload fo r many of the Ban k's operatin g departments, not to ment ion an increased dem and for pol icy analyses by the Bank's research eco no mis ts. The fiscal department, for o ne, came und er heavy pressure at tim es fro m large crow ds of indi vidual inv estor s who w anted to take advan tage of the record-hi gh interest rates avai lable o n gove rnment securities. Thr oughout the spri ng month s, the Bank's staff implem ented the Special Cred it Restraint program that the Fed eral Reserve had un veiled on M arch 14 as part o f the gove rnment-wide dri ve to cur b spec u lative in flatio nary pressures. The Bank 's statistical-services depart ment, for exampl e, thereafter became heavil y involved in the impl ementation of reporting procedures fo r nonbank co nsume r lend ers, w ho w ere subject to a spec ia l deposit requirement und er the credit-restraint program. Creation of MCA A ll of these developments were ove r shado we d by the major operation al changes generated by the Depository Institution s Deregul ation and M onetary Co ntro l Ac t (MCA), w hic h was signed int o law by the President on M arch 31. The path- breakin g M onetary Co ntrol Act was Co ngress' answer to a numb er of pressures w hich had di storted the nation's fin anc ial struc ture in recent decades- such as w idespread fin an cia l inn ovation s, shifti ng competitive patterns, severe inflati on ary pressures, and a related upsurge in interest rates. Throu gh the M CA, Co ngress prom oted greater competitio n in fi nanci al mar kets, pri mari Iy by prov id ing fo r the phase-out of deposit interest-rate ceil ings and a broadenin g of asset and payment powers of banks and thrift in stitutio ns. Congress also prom oted greater equ ity and improved monetary co ntro l by extend ing reserve require ments (fo llow ing a phase-in period ) to all depository instituti on s wi th trans action (check-type) acco unts and non-personal time deposits. This step helped to solve the probl em of decl in ing Federal Reserve mem bership, by reduc ing the cost of reserve require ments fo r memb er banks and imposing similar reserve requirement s on all in sured depository institution s. More ove r, Congress prom oted greater effi cie ncy in financ ial markets, by provid ing access to Federal Reserve services, at explic it prices, for all depository institutions subject to reserve requi rements. Implementation of MCA To implement the MCA, whi ch is per haps the most important piece of fin an cia/ legislatio n since the passageof the Federal Reserve Act in 191 3, the San Francisco Reserve Bank established an M CA Policy Committee. Thi s commit tee is respon sible for rev iewin g plan s and proposals, and for making the de cisio ns requ ired to keep the implemen tatio n moving forw ard smoothly and on schedu Ie. Even prior to passage of the act, the Bank formed a Pric ing and Access Project Team, with the respon sibility for examini ng the potential im pact of pend ing legislative pro posals. The Project Team later too k on the added respon sibility of coo rd inating implementation of the act's provi sion s on a Di strict-wide basis. 19 Western Central Bank Growth of Payment Services Change (%) Automated Clearinghous o t.===~==~ 1980 19 78 1979 Man y Bank depart ments became in vo lved in carrying out the provision s of the new legislation dur ing the course of the year. They designed systems to handle the new pricing and bill ing functions, developed computer pro grams to perform these new fun cti on s and to process reports from a sharpl y expanded constituen cy, developed pl ans for broader access to cred it facil ities, restructu red reserve acco unts, and created staffing plans to meet all these new oper ating bu rdens. In add itio n, a price-administration grou p took over responsibility for analysis and report ing of data related to charges for Federal Reserve services. Growth of Cash Services Change(%) 20 r.=:;=;:::::====:- , ~ Paid into Circulation 15 10 5 o~~~~=:::::!.J 1978 1979 1980 To facilitate understanding of the MCA and its implementing regulation s, the Bank co nducted an extensive two phase orientation effort fo r its new co nstituents. The first phase of the pro gram included 35 general-info rmatio n "outreach" meetings held in 25 major ci ties throughout the Di strict. In add i tion , 54 detailed tech nical semi nars w ere held in 10 Di strict cities, cove ri ng such subjects as reportin g, mai nten ance of reserves, and pass-throu gh requirements. In support of thi s face to- face contact, the Bank established M CA Information Desks at each offi ce to receive and direct inquiries from new co nsti tuents to persons prepared to handl e their specific questi o ns. Implementation Schedule The Federal Reserve revised its implementat ion plans several times during the course of the year in re spo nse to comments solic ited from the fi nanc ial industry and the publ ic. However, considerable progress wa s ev ident by year-end. The San Franci sco Reserve Bank, instead of serving o nly 147 member banks, soon will be deal ing wi th several thousand banks and th rift institutions. Institutions w ith $15 mi lli o n o r more in total deposit s began report ing reserves on a w eekly basis in No vemb er 1980 , and smaller institu tions ($2 milli on to $ 15 million in de posits) began report ing qu arterly in January 1981. A number of very small insti tutio ns with deposits of lessthan $2 20 m illion (pri marily credi t un ion s) will be exempt from reporting and reserves posting requirements unt il M ay 1981. Non-member institutions w ill phase-in their new reserve requirements over an eight-year period , wh ile present mem ber banks will phase-down to low er levels of requi rements over a fou r-year period . Pricing and access to various Fed ser vices are bein g phased- in over a year lon g period, rather than being in troduced all at on ce, to facili tate an order ly transition to the requ irementsof the legislation . Pricin g will begin early in 1981 for wire transfer and net settle ment services. Sometime after midyear, charges wi II be levied for check clea r ing and collection , and for automa ted clearinghouse services, although cer tain limited facilities w ill be avai lable to new co nstituentsat the beginning of the year. Pricin g w ill begin in late 1981 for pur chase and sale of securities, safe keepin g and transfer of securi ties, and non cash co llec tion services, and pric ing will begin early in 198 2 fo r co in and currency-transport ation services. In the credit area, a Federal Reserve task force has developed procedur es fo r administering the di scount w ind ow in an environment characterize d by a much larger number of account rela tionships and d ifferent types of finan cia l institutions. In o rde r to manage thi s situatio n effective ly, the Reserve Bank has made arrangements for off premi ses custody of vi rtually all of the col lateral that its new constituents will post with the Reserve Bank.ln add ition, the Bank has centralized the ad minis tration of loans extended by all five of fices in its San Francisco headqu arters off ice. Supervisory Developments In the supervisory area, bank examina tions and bank holding-company in specti ons during 1980 co nfirmed the generally health y co nd itio n of the insti tuti ons supervised by this Reserve Bank. During the year, the Genera l Accounting Office (GAO) co nd ucted a review of procedures used to mo nito r commercial-ban k compli ance w ith the Treasury Department's record keepi ng and reporting regulation s. Thi s review, part of a broad GAO evalu ation of the effectiveness of Federal bank regulatory agencies, has invol ved field work in San Francisco and thr ee oth er Federal Reserve Distri cts. Superv iso ry personnel imp leme nted several initiatives designed to im prove effic iency and strengthen exami natio n procedur es. These included hosting tw o co nferences o n the subjec t of in ternation al exami natio ns. O ne co nfer ence concerned the exami ner's rol e in evaluati ng " cou ntry risk" -the debt management prob lems of indivi d ual countries- and the second invol ved d iscussions with oth er Federal and state regulatory agencies co nce rni ng the Uniform Report of Exam ination devel oped by the Federal Financi allnstitu tions Examination Coun cil. Bank staff also improved the exami natio n cover age of EdgeAct corpo ration s (firms involved in internati on al trade and fi nance) by establi shing worki ng rel a tion ships w ith the internal-aud it team s sent to review Edge co rpora tio ns by their parent firms located outside th is D istrict. In the trust area, Bank staff co nduc ted a joi nt exami nation wi th perso nnel of the Securities and Ex change Commi ssion (SEC), to co m pare operating proc edu res of deposito ry tru st institutions with standar ds defin ed by the SEC. The consumer-affairs staff co nduc ted examinations at all state-m em ber banks, and also at about o ne-fifth of their branches, in lin e with an expand ed System-wide program designed to achieve broad-ba sed co m plia nce w ith consumer-protectio n laws and regula tion s. The Reserve Bank received num erou s ind iv idual co nsume r co m plaint s against co m merc ial banks, but non e of the co mp lai nts requi red the Bank to reso rt to its enforcemen t pow ers to co mpel remed ial actio n. In addi tion , the staff received several tho usand requests for inform ation from the gen eral public, many of them in respo nse to a series of Bank-produ ced publ ic servi ce announcements on co nsume r regulations, which were show n on a number of television station s in the District. Computer Developments The Bank continued to impl ement a lon g-range automation plan dur ing 1980 . Th is plan calls for District-wide standa rd izatio n of processing for most o peratio ns, and the centralization of some activ ities. Under the pl an, all five offi ces are tied together via a mod ern co m puter network co ntrolled from the San Francisco data center. In 1980, the staff in stalled a standard acco unti ng system in al l branches, in a major step toward standardizin g Di strict systems. To acco mmodate the increasing level of auto matio n over the next several years, computer personnel install ed a new computer in the San Franci sco data center, and made plansto upgrade co m puters in Los An geles and Seattle durin g the first part of 1981 . This up gradi ng was doubl y necessary because of the heavy workload created by impl ement ation of the new M CA program s. D ata-processing and fiscal personnel co ntinued w ork on the automa tion of a Treasury-securities inventory and trans fer system (called SHA RE). Sa n Fran cisco is the lead di strict on thi s project, whi ch on completion in 1981 wi ll pro vide a standardized on-line database serv ic ing 13 offices in the Kansas City, St. Louis and San Francisco distr icts. Payments Services In 1980, as in earlier years, electronic payments systemscontinued to expand rapid ly. While check- processing activ ity increased onl y on e percent, w ire fund s-transfer vo lume ju mped 27 per cen t, as Di strict memb er banks sent several trillion doll ars throu gh the Fed eral Reserve's wi re-transfer system during the year. Moreover, a sharp 27 percent gain in vo lume occ urred at auto mated cl earinghouses (ACHs), whi ch move funds by electronica lly transmitted payment instructio ns that take the place of paper checks. To accom modate rapid volume growt h 21 and improve operational control s, the Bank consolidated its wire-transfer fun ction in San Francisco dur ing the year. ACH personnel meanwh ile in stalied new software to provid e for an automated reconcilement system as a means of redu cin g op erational errors. In check-processing activ ity, Bank staff handl ed 1.5 billion paper checks dur ing the year - a significa nt deceleration from earlie r growt h patterns. How ever, d rastic changes in deposit schedules shortened check-processing ti mesand increased pressure on equipme nt and staff resources. The Bank began to de velop a major automation proj ect in the low-speed processing functi on whi ch handles nonmachin able depos its and checks rejected for poor encod in g, mutilation, improper size, etc. - to replace labor-intensive procedur es. Redu ction of float (checks credi ted prior to receiv ing paym ent) received high priori ty durin g the year, especia lly in view of the requirement to price float under the Monetary Co ntro l Act. Cash, Fiscal Activities Despite the incr ease in check usage and the rapidl y acceleratin g growt h in electro nic payments, the Reserve Bank co ntinued to handle substantia l amounts of coin and curr ency in 1980. Altogether, it paid 4.9 billion co ins and 1.6 bi IIion pieces of currency into ci rcu lation during the year. Effici ency in the cash function improved with the instal lation of more high-speed currency sorting machines, of wh ich six are now in o peratio n at various Di strict loca tio ns. Each mach ine has an o ptimum feed rate of 1,200 notes a mi nute, and is capab le both of detecting co unterfeits and of destroyin g, o n lin e, those notes w hich do not meet fitn essstandards. To improve produ ct ion capabi li ties aswell as the qu al ity of curre ncy in ci rculation, the Sa n Franci sco and Los Angeles of fices both started second-shift process ing o n the new equipment dur ing the year. In its role as fiscal agent for the Government, the Reserve Bank u.s. handl ed substantial amoun ts of pub lic debt instrum ent s in th e form of savings bonds, marketabl e Treasury securi ties and food stamps. A ct ivity in ma rketa ble securities increased 52 percent in vo l u me, reflecti ng stron g investor interest in the record-h igh rates offe red o n suc h issues. Moreover, volume rose because of an increase in th e redem pti on of sav ings bonds, whi ch paid a considerab ly lower rate of interest th an ma rketab le secu ri ties. During thi s same pe riod , the Treasury D ep artment recalled all Series Eand H savi ngs-bo nd stock for repl ace ment w ith Series EE and HH bo nds . Thi s process, w h ic h involved recon cileme nt wi th over 8,800 issui ng agents, was a major effort spanning the entire ye ar. tom ated systems. The summe r decline in interest rates pro vid ed time to reac t to the rapidly changing secu rit ies m ar ket. As rates again surged upward in late fall, the Bank was better po siti oned to cope with significant in cr eases in vo lume. Improved Productivity Throu ghout the year, the Bank 's ma n ageme nt struc k an appropriate balance between cost-effec tive ness of opera tion s and qu al ity of o utpu t. The San Franc isco Reserve Bank rated second in the System in cost effective ness, wi th aggregate unit costs 7 percent be low the Syste m aver age. Produ cti vity (out put pe r w o rker hour) in these ope ra ti on al acti v ities has in creased 74 per ce nt in the past six yea rs, thu s hel ping to offset the sharply rising costs of salaries, m aterial and equipment. M eanwh ile, as a result of a quality-improvem ent p rog ram initiated three year s ago, the Bank ranked among the System leaders The se development s ca used seve re processing backlogs during th e fi rst half of the year. The backl ogs w ere ove r co me by midyear with add itiona l trained staff and enhan cem ent s to au- in q ua lity of performance, as measured by redu ctions in errors and pro cessing times on various operational tasks. Lastly, as a means of assurin g th e ef fec tive ness of future operati on s, the Bank began construction of a 12-sto ry 653,OOO-sq uare-foot headqu arters bui ld ing o n San Franci sco 's M arket Street. Th e present headqu arters bu ild ing was bu ilt in the 1920's and is small and inefficient fro m the standpoin t o f 1980-styl e bank ing o pe rations ; indeed , wi th recent increases in workloa d, the bank's headqu arters opera tions now are spread over five separate bui ldings . G ro und breaking ceremonies for the new bu i ldi ng were held in M arch 1980, and in ea rly 1981 , the steel framewor k began to rise. The new faciliti es are sched u led for occupancy in late 1982, ready to assist the Bank in providing a growing number of central-banking serv ices to its ex pa nded constituen cy of Western fin anci al institutions. Summary of Operations 1977 Volume (thousands) 1978 1979 1980 Custody Services Cash Services 1.187,814 3,943.437 1,281,416 3,991.280 1,407 ,894 4,007,145 1.556 ,278 4.895,306 1.449 515,257 24 257,735 1,547 447,625 59 263,684 1,563 437,053 150 223,232 1,327 446,71 7 231 274,058 1.178,298 110,992 15,043 1,283.807 117,237 17,956 1,358 ,985 109,761 20,225 1,373,421 99 ,096 21,391 2,248 17,137 3,123 23,512 3,847 32,448 4,883 4 1,298 355 43 914 60 1,318 59 1.092 67 164 C urrency paid into ci rcula tio n Coin paid into ci rc ula tion 225 193 297 Fiscal Agency Services Savings Bonds orig inal issues Saving s Bond s redemptions processed Othe r Treasury orig inal issues Foo d coupons p rocesse d Payments Mechanism Services Check Processing Services Commercial c hecks p rocessed Government check s p rocessed Return ite ms processed Electronic Funds Transfer Services Wire tra nsfers processed Au tomated clearinghouse tran sa c tions processed Discounts and Advances T al d iscounts a nd advances* ot Number o f financ ial institutions a c c ommodat ed * Noncash Collections Services *Numb e r (not in thousands) 22 12th Federal Reserve District Directors The Federal Reserve carries out its cent ral-ba nk ing functions throu gh a nationwid e networ k of 12 FederaI Re serve Bank s and the ir 25 branch es, under th e pol icy gu id anc e, co ordi n ation and general supervisi on of the Board of Gov ern o rs in Wa shin gton, D.C. The Head Office of the Federal Reserve Bank of San Franci sco has a nine-member Board of Di rectors. Ea ch o f the Bank 's other off ices at Los A ngeles, Portland , Salt Lake Ci ty and Seattle has a seven-member bo ard . Federal Reserve directors brin g man agement expert ise to the task of over seeing Reserve Bank operatio ns. They aIso pro vid e fi rst-hand in format ion on ke y econom ic developments in vari ous areas of the District, comp le menting th e Bank's internal research efforts. In addi t io n, Board members give advi ce on the general direction of monetary pol icy, especiall y with regard to th e Bank 's dis count rate. The Head Office Board has specific re spon sib ility for i niti at ing changes in the discount rate, subject to revi ew and approval by the Board of Governors. Head Office Chairman of the Board and Federal Reserve Agent Co rnell C. Ma ie r Cha irm an, President and Ch ief Execu tive Officer Kai ser Aluminum & Chem ical Cor p. Oa kl and , Ca lifor n ia O le R. Mettler Presid ent & Chairman of the Board Farm ers & M erch ant s Bank of Ce ntral Ca li fo rn ia Lod i, Ca liforn ia C lai r L. Peck, lnr, Cha i rm an of the Boa rd C. L. Peck Contrac to r Lo s A ngel es, Californ ia Deputy Chairman Ca ro line Leon etti A hma nson Cha irma n of the Board Carol i ne Leo nett i Ltd. Holl yw o od , Califo rnia M alc olm 1. Stamper President T he Boeing Co m pany Seatt le, Washin gton Al an C. Furth Preside nt Southern Pac ifi c Co mpa ny San Fran c isco, Ca lifo rn ia J.R. Vaughan Senio r M ember Rich ard s, W atson , Dr eyfu ss & Gershon Los A nge les, Califo rnia Frederick G . Larkin , Jr. Ch air man o f the Executive Co m m ittee Secur ity Pacific Nation al Bank Lo s An gel es, Californ ia Rob ert A. You ng Cha irm an of the Boa rd and President N orthwest Nati on al Bank Vancouver, W ashington Federal Advisory Council Member Chaun cey E. Schm id t Chai rman of the Board , President and Chief Executi ve O fficer T he Bank of Cal ifo rn ia, N .A. San Franci sco, Cal ifo rn ia 24 Ahmanson Furth Larkin Mettler Peck Stamper Vaughan Young Federal Advisory Council Schmidt 25 Los Angeles Chairman of the Board Harve y A. Procto r Chairman o f the Board Southern Cali forni a Gas Compan y Los Ange les, Cali forn ia Fred W. Andrew President Superio r Farming Company Bakersfield, California James D. McMahon President Santa Cl arita Nat ion al Bank Valencia, Califo rn ia Bram Go ldsmith Chairman of the Board City National Bank Beverly Hills, California Harvey J. Mitchell President First Nat iona l Bank of San Diego Count y Escondido, Cali fornia Lo la M cAlpin-Grant Assistant Dean Loyo la Law School Los Angeles, Californ ia Togo W. Tanaka President Gramercy Enterprises LosAnge les, California 26 Portland Chairman of the Board John C. Ha mpt o n Chairma n of the Board and President W ill ami na Lum ber Company Portl and, O rego n Merle G . Bryan President Forest Grove N atio nal Bank Forest Gr ove, O rego n W illi am S. Nai to Vi ce Presiden t Norcrest C hi na Co mpany Portl and, O rego n Jack W. Gu stavel Presid ent and Chief Execu tive Officer Th e Fir st N ati on al Bank of North Idaho Co eur d 'Al en e, Idah o Phillip W. Sc hneide r Fo rmer Nort hw est Regio nal Executi ve N ation al W ild life Federatio n Port land , Oregon Jean M ater V ice President M ater Engineering, Ltd. Corvall is, O rego n Rob ert F. Wa llace Chairma n of the Board and President First Nati ona l Bank of Oregon Portl and, O rego n 27 Salt Lake City Chairman of the Board Wendell J. Ashton Publ isher Deseret News Salt Lake Ci ty, U tah Spencer F. Eccle s Preside nt and Chi ef Operati ng O fficer First Security Co rpo ratio n Salt Lake Ci ty, Ut ah A lbert C. G ianol i President and Chairman o f the Board First Nation al Bank o f Ely Ely, Nevada Robert A. Erkins Geoth ermal Agri/ Aqu acultu rist W hite Arrow Ranch Bliss, Idaho Fred H. Stringham President Val ley Bank and Trust Company South Salt Lake, Utah David P. Gard ner Presid ent University of Utah Salt Lake Ci ty, Utah J. L. Tertel ing President The Tertelin g Comp any, Inc. Bo ise, Idaho ) E: , ? ,.~ 28 . Seattle Chairman of the Board George H . We yerhaeuser President and Chi ef Executive Offi cer Weyerhaeuser Co mpany Tacoma, Washington Me rle Ad lum President Puget Sound D istrict Council, M aritime Trades Dept . AFL-C1 0 Seattle, W ashingto n Dougl as S. Gamb le President and Chief Execut ive Office r Paci fic Gambl e Ro binson Company Seattle, Washingto n Lonnie G . Bai ley Execut ive Vice President and Chief Operating Officer Farmers and M erchants Bank of Rockford O pport unity, Wa shington Do nald L. Me llis h Chai rman of the Board National Bank of Alaska Anchorage, Al aska C. M . Berry President Seafirst Cor po ration and Seattle-Fi rst N ati onal Bank Seattle, W ashin gto n Virginia L. Parks Vice President for Finance and Treasu rer Seattle Un iversity Seattle, Washi ngto n " ", /, f :', .' I ' ' ~ 29 Comparative Statement of Account (Thousandsof Dolla rs) Dec emb er 31, 1979 1980 Assets 670,016 21 1,000 0 60,642 S 1,253,000 293,000 0 64,883 36,500 0 84,100 55.02 5 0 2,700 1,080,827 1,185,528 5.952,159 7.432,314 1.914,520 5,926,467 7,965,458 2,29 1,565 15,298,993 16,500,420 16,183,490 17,426,743 3.778,141 11.1 05 10,497 827,166 42,508 11 ,127 349,962 459,492 794,379 552.056 22.051,275 21 ,264,862 13,193.695 14,219,242 7.290,498 337,362 42,159 121,199 6,044,474 0 56.604 28,683 7,791.218 6,129,76 1 193.520 508.166 237,572 289,759 21 ,685,599 20,876,334 . . Gold c ertific a te account Sp ec ia l Draw ing Rights certificate a c count Fed eral Reserve noteso f other Fed eral Reserve Banks O ther cash 182.338 182,338 194,264 194,264 . . 22,051.275 0 21.264,862 0 . $ . . . Loans to Member Banks: Sec ured by United States Government & Agency obl igations " Other eligible p a p er , .. , , ., ,.., , .. ", , , ,.. , ,, Other paper . . , " , ,,,,., , ", , , ", ' , , . , , , , , , . , . . Fed e ra l Agency ob lig at ions . , . , , , . . , United States Government securities: Bills Notes Bonds . . . Total United States Government securities . . Total loans and securities , . . . " " "", ... Cash items in process of co llection Bank prem ises , . . , . . . . , Op era ting equ ipment , . , . ". , .. Other a ssets: Denominated in foreig n c urrenc ies A ll o ther . . Total assets Liabilities Fed era l Reserve notes Deposits: T l Member bank-reserve accounts ota United Sta tes Treasu rer-general account Foreign Other deposits . . . . Total deposits ,. , Deferred availability cash item s . . " . ' Other liabi lities ... , , . . , . , .. , . . . , , . , Total liabilities Capital Accounts Capital paid in Surplus Total liabilities and capital accounts . Contingent liability on acceptances p urchased for foreig n correspond ents 30 , , , , Earnings and Expenses (Thousa nds of Do lla rs) December 31 , 1979 1980 Current Earnings Disco unts and adva nc es . , " United States Government sec urities Fore ig n c urrencies All other , ,.., , ,.., , , , , " , ,,,,,,, . . . , ,. ,. ,.. ,. , 12,644 1.323,391 9,684 43 S 1.345,762 Total current earnings S 12,9 77 1,664 ,860 18,630 159 1,696,626 Current Expenses 71.031 6,582 86.389 6,681 64,449 79,708 . 1,281.313 1.616,918 ,..,.. . . 0 0 1,081 0 15.283 2,365 1.081 , . , . Tota l c urrent expenses Less reimbursement for c erta in fiscal agency and other expenses 17,648 , . . 515 20,272 920 0 26,590 3,641 . 21,707 30,231 . . . . ,.., - 20,626 7.330 1,253,357 10,330 1.212,926 - 12,583 9,880 1,594,455 11,192 1,571.337 . . . 30.101 152,237 182.338 11.926 182,338 194.264 ' , .. , Net expenses Profit and Loss Curre nt net earnings Additi ons to c urrent earning s Profit o n sa les of United States Governme nt sec urities (net) " , . . " . , Prof its or. foreign exchange transactions A ll other : Total additions ,.., , .. , . , .. , ,., ,. , , , , , , , , Net addition s ( +) deductions (-) . Assessme nts for exp end itures of Board of Governors Net earn ings before payments to United States Treasury Divid ends paid reasury (interest on Fede ral Reserve notes) Payments to United States T T sferred to surp lus ran Surplus Janua ry 1 . . , Surplus December 31 , , ,.., Deducti on s from current net earnings Loss on fore ig n exch a nge transa ctions (net) , , .. , Loss on sales of United States Government secu rities (net) A ll o ther Total deductions ,."., " , , 31 ,,, '" ,., , , , " , , , ,,.., , , , "" , , " , ,. , - - San Francisco Office P.O. Box 7702, San Francisco, California 94120 Los Angeles Branch P.O. Box 2077, Terminal Annex, Los Angeles, California 90051 Portland Branch P.O. Box 3436, Portland, Oregon 97208 Salt Lake City Branch P.O. Box 30780, Salt Lake City, Utah 84130 Seattle Branch P.O. Box 3567, Terminal Annex, Seattle, Washington 98124 This report was prepared by the staff of the Federal Reserve Bank of San Francisco: produced by William Burke and Karen Rusk; graphics designed by William Rosenthal; copy written by William Burke, Barbara Bennett, Gary Zimmerman, Yvonne Levy, Robert Jacobson, and Randall Pozdena, 32